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Weber, Eric at IESE B.S.

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REV: DECEMBER 14, 2016

ROBERT SIMONS

Strategy Execution Module 11:

Using Diagnostic and Interactive Control Systems

What You Will Learn in this Module: This module describes the difference between diagnostic and
interactive control systems, and illustrates how each system is used by managers. First, you will
learn how diagnostic control systems are used to implement strategy and conserve scarce
management attention. Next, you will see how interactive control systems are used to identify and
manage strategic uncertainties. Finally, you will learn how interactive control systems are designed,
how these systems are tied to incentives, and how management chooses which interactive control
system best fits their company’s needs.

To achieve financial and nonfinancial goals, managers must rely on the efforts and initiative of
employees. Employees throughout the organization must understand the business’s strategy and their
role in achieving strategically important goals. As businesses grow larger, communication of strategic
goals and measures becomes more important and more difficult. Managers face increasing demands
on their time and must use their scarce resources wisely. Using performance measurement and control
systems effectively becomes critical to success.

Step back in time to the initial start-up of Boston Retail. The founders had an idea that they believed
could be built into a successful business. At first, they rented one retail store and started as most
entrepreneurs do—by doing everything themselves. They tested their value proposition, focusing on
the youthful college fashion market. Feedback from customers was encouraging. The entrepreneurs
worked diligently to build up the scale of the business and attract a loyal customer base. Early profits
were plowed back into the business and additional resources were acquired—new store furnishings,
warehouse facilities, and additional inventory. A few temporary employees were hired to help out in
the evenings and during the busy holiday seasons.

In the day-to-day operation of the store, all important decisions were reserved for the founders.
They were always on hand and could be consulted for any issues that required a judgement call. The
owners signed all checks and monitored carefully the flow of inventory, paperwork, and cash receipts
to ensure that all receipts were safely deposited in the bank, all inventory was properly handled, and

This module was prepared by Professor Robert Simons with the assistance of Research Associate Jennifer Packard. Parts of this module are adapted
from Robert Simons, Performance Measurement and Control Systems for Implementing Strategy, Prentice Hall, 2000 and Levers of Organization Design,
Harvard Business School Press, 2005.

Copyright © 2016, 2017 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-
7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

all sales transactions were accurately recorded. Because of their constant oversight, few errors occurred
and those that did were caught early and rectified.

As Boston Retail prospered, additional stores were opened and new employees were hired to staff
the stores. The founders tried, as much as possible, to give new employees the training and information
needed to effectively perform their jobs. However, as time passed, it became increasingly difficult to
directly monitor work of the employees. The business had grown too large and dispersed. The founders
were experiencing limits as to what they could accomplish single-handedly. There were now too many
employees and too many stores to watch everything themselves; besides, the entrepreneurial founders
wanted to devote more of their time to pursuing expansion opportunities. If the business was to
continue its profitable growth, the founders would have to change their focus. For the first time in the
history of the young company, success would be determined by the founders’ ability to effectively
communicate strategy to employees and control strategy implementation.

To understand how to communicate and control strategy effectively, we differentiate between two
different types of control systems: diagnostic control systems and interactive control systems.
Managers rely on both types of systems, but for different purposes. Diagnostic control systems are used
as levers to communicate critical performance variables and monitor the implementation of intended
strategies. Interactive control systems are used to focus organizational attention on strategic
uncertainties and provide a lever to fine-tune and alter strategy as competitive markets change (Figure
11-1).

We should, however, make a critical point at the outset of our analysis. The difference between
diagnostic and interactive control systems is not in their technical design features. A diagnostic control
system may look identical to an interactive control system. The distinction between the two is solely in
the way that managers use these systems. For example, the same profit planning system or balanced
scorecard can be used either diagnostically or interactively. As we shall see, this choice has profound
implications for maximizing return on management (ROM) and the effective implementation of
strategy.

Figure 11-1 Two Levers of Control: Diagnostic and Interactive Control Systems

Business
Strategy

Critical
Strategic
Performance
Uncertainties
Variables

Interactive Diagnostic
Control Control
Systems Systems

Source: Adapted from Simons, Levers of Control (Boston: Harvard Business School Press, 1995), p. 7.

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

Boston Retail Company

Throughout the fifteen modules that comprise the Strategy Execution series, Boston Retail
Company is used as an example to illustrate key concepts. Boston Retail, introduced in Module 1:
Managing Organizational Tensions, is a clothing chain based in a suburb of Boston. The founders
began with one store and a novel idea: to offer cheap but fashionable clothing to students who
attend Boston’s many colleges and universities. Their customers are young, enjoy wearing the latest
fashions, but have limited income. With early success, Boston Retail began expanding, quickly
increasing the number of stores and employees.

Boston Retail examples can be found in the following modules of the Strategy Execution series.
These modules are available from HBS Publishing at www.hbsp.harvard.edu.

Product #
117-101 Module 1: Managing Organizational Tensions
117-102 Module 2: Building a Successful Strategy
117-103 Module 3: Using Information for Performance Measurement and Control
117-104 Module 4: Organizing for Performance
117-105 Module 5: Building a Profit Plan
117-106 Module 6: Evaluating Strategic Profit Performance
117-107 Module 7: Designing Asset Allocation Systems
117-108 Module 8: Linking Performance to Markets
117-109 Module 9: Building a Balanced Scorecard
117-110 Module 10: Using the Job Design Optimization Tool to Build Effective Organizations
117-111 Module 11: Using Diagnostic and Interactive Control Systems
117-112 Module 12: Aligning Performance Goals and Incentives
117-113 Module 13: Identifying Strategic Risk
117-114 Module 14: Managing Strategic Risk
117-115 Module 15: Using the Levers of Control to Implement Strategy

Diagnostic Control Systems

When driving your car, the speedometer is part of a diagnostic control system. You can use
information from the dial on your dashboard to compare your actual speed with the posted speed limit.
If there is a significant deviation, you can accelerate or slow down to bring the car in line with the
desired speed of travel.

Many of the control systems in businesses operate in much the same way. For example, managers
set annual profit plan or balanced scorecard goals and then receive monthly statements that report

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

actual accomplishments for the period. Variance analysis highlights significant differences. If any
deviations threaten the achievement of key goals, managers can initiate actions to get things back on
track.

We define diagnostic control systems as the formal information systems that managers use to monitor
organizational outcomes and correct deviations from preset standards of performance.1 Any formal information
system can be used diagnostically if it is possible to (1) set a goal in advance, (2) measure outputs, (3)
compute or calculate performance variances, and (4) use that variance information as feedback to alter
inputs and/or processes to bring performance back in line with pre-set goals and standards. Diagnostic
control systems are the prototypical cybernetic feedback systems described in Module 3: Using
Information for Performance Measurement and Control.

Although profit plans are a common diagnostic control system, managers can use many
performance measurement and control systems diagnostically, including:

• balanced scorecards

• expense center budgets

• project monitoring systems

• brand revenue/market share monitoring systems

• human resource systems

• standard cost-accounting systems

Why Use Control Systems Diagnostically?

Managers must be selective about which control systems they should personally monitor. After all,
there are literally thousands of measures in any organization that could be reported to senior managers.
Managers cannot review and monitor every possible measure. To understand how managers choose
among these systems, we must review the two principal reasons for using a system diagnostically: to
implement strategy effectively and conserve scarce management attention.

Implementing Strategy Managers are interested primarily in monitoring diagnostic control

systems that report variance information about critical performance variables—those factors that must
be achieved or implemented successfully for the intended strategy of the business to succeed.2 In essence,
diagnostic control systems are the top-down monitoring tools for implementing strategy as plan
(Figure 11-2). They link strategy with critical performance goals and targets and monitor their
successful implementation. Without diagnostic control systems, managers could neither communicate
nor implement strategy effectively in large complex organizations.

Because of the importance of these systems, managers must ensure that (1) critical performance
variables have been analyzed and identified, (2) appropriate goals have been set, and (3) feedback
systems are adequate to track performance.

1 Robert Simons, Levers of Control (Boston: Harvard Business School Press, 1995), p. 59.

2 For a full discussion of critical performance variables, see Module 12: Aligning Performance Goals and Incentives.

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

Figure 11-2 Linking Strategy to Diagnostic Control Systems

Business
Strategy

Critical
Performance
Variables

Goals

Inputs Process Outputs

Source: Adapted from Simons, Levers of Control, p. 63.

Conserving Attention When driving for long distances, watching the speedometer and
constantly adjusting the accelerator can be tiring. This activity consumes energy and attention. Thus,
automobile companies offer automatic speed controls that automate this diagnostic process. You can
set the desired speed, and the computer keeps the automobile’s speed within tight bounds. The speed
controller frees up your attention to concentrate on other things (finding your next turn, talking with
your spouse, or worrying about your next appointment).

In organizations, managers can do the same thing with performance measurement and control
systems. They can use them to put the organization on automatic pilot. Instead of constantly
monitoring a variety of internal processes and comparing results with preset targets and goals,
managers receive periodic exception reports from staff accountants. If everything is on track, the
reports can be reviewed quickly and managers can move on to other issues. If, on the other hand,
significant deviations are identified, then—and only then—managers need to invest the time and
attention to investigate the cause of the deviation and initiate appropriate remedial actions. This
process is called management by exception.

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

Using Diagnostic Control Systems Effectively

Using the automatic speed control in your car conserves attention, but you must know how to use
the device effectively. Just as the automobile driver must know how to set the device’s speed and adjust
it from time to time, so, too, must business managers know how to set key targets and make
adjustments as circumstances warrant.

To operate diagnostic control systems effectively, managers must ensure that they devote sufficient
attention to five areas: setting goals, aligning performance measures, designing incentives, reviewing
exception reports, and following-up significant exceptions.

1. Setting and Negotiating Goals Performance goals are the hallmark of diagnostic control
systems. They are critical to the effective implementation of strategy because they define where
subordinates should devote their energy. Because of the importance of goal setting, managers must
personally ensure that goals are appropriate both in terms of desired direction and level of
achievement.

When making a long trip in your car, you must initially set the target speed, but then you do not
need to adjust it for long periods. In a similar way, managers need only set critical performance goals
infrequently—usually once per year. If these goals are properly set, they should not require any
additional adjustment or attention. Managers can monitor progress during the operating period by a
quick scan of exception reports.

2. Aligning Performance Measures Diagnostic control measures define the span of accountability
—that is, the performance variables for which a manager is accountable. Therefore, if managers wish
to rely on diagnostic control systems for assurance that strategy is on track, they must ensure that
performance measures truly reflect strategic goals and priorities. Techniques such as balanced
scorecards (see Module 9: Building a Balanced Scorecard) are important to assure that these measures align
correctly with intended strategy. Again, this need only be done infrequently, but it is extremely
important.

3. Aligning Incentives The speed control in your car is powered by an internal electrical system.
Diagnostic control systems in a business must also be powered up by some energy source. Managers
who wish to maximize their return on management time use formula-based incentives as a way of
powering up, or motivating, goal achievement. Bonuses, promotions, and merit increases can be made
contingent upon performance reported in diagnostic control systems. Then, incentives provide
extrinsic motivation so that managers do not have to monitor the day-to-day activities of subordinates
to be sure that they are working towards desired goals. Diagnostic performance measures, and
formulas that link rewards with results are sufficient to keep everyone focused on strategy
implementation.

4. Reviewing Exception Reports With diagnostic control systems in place, managers can review
monthly and quarterly exception reports as soon as they are released to gain confidence that strategy
implementation is on track. If measurement systems and incentives are well designed and aligned, this
review can be conducted very quickly and efficiently, thereby increasing ROM. Managers need only
scan reports for evidence of large, significant exceptions, or indications that problems may be looming.

5. Following-Up on Significant Exceptions Although managers use diagnostic control systems

to conserve attention, when a significant deviation appears, they must initiate action quickly to get
things back on track. Subordinates are monitoring the same measures as their bosses (remember, these
measures define span of accountability and potential reward incentives), so remedial steps may have

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

already been taken to rectify problems by the time the superior picks up the exception in a diagnostic
report. Managers then need only initiate brief discussions to confirm that problems have already been
identified and resolved.

Risks in Using Diagnostic Control Systems

Putting the business on automatic pilot and powering up the system through performance
measures and incentives is not without risk, just as putting your car on speed control introduces special
risks. All managers who use diagnostic control systems must guard against the following:3

Measuring the Wrong Variables Setting your car’s automatic speed control keeps the vehicle at
the right speed but gives no assurance that the car is pointed in the right direction. It does little good
to get the speed right if you are traveling south when you want to go north. Similarly, misaligned
control systems in businesses can do more harm than good. As the old saying goes, “What gets
measured, gets managed.” Attention is limited, and people must make choices about where they will
spend their time. Sometimes, misaligned diagnostic measures can cause the strategy to go off track.

• NHS Scotland, the Scottish publicly funded health care system, came under fire in 2015 after a
report showed concerns about patient care. Issues included relatively high death rates across
the system and an outbreak of a superbug, clostridium difficile, at a major hospital.
Investigators discovered that pressure on hospital administrators to focus primarily on financial
targets, rather than patient health outcomes, led them to make decisions that adversely affected
patient care. The focus on financial goals resulted in drastic cut-backs in staff levels, highly
inexperienced staff, and a lack of training.4

Building Slack into Targets When performance is a function of achieving preset goals,
employees will naturally want to increase the probability of meeting those goals. One way of doing
this, of course, is to start with a relatively easy goal. Accordingly, employees may try to build slack into
their performance targets. If managers do not compensate for this tendency by ensuring that goals are
set at challenging levels, it can lead to serious problems.

• A large beverage company planned a major holiday promotion. In order to ensure that he met
his revenue goals, the vice-president for one of the company’s largest regions purposely
underestimated demand when sales targets were set. Because the company based its supply
chain planning on this sales forecast, the company did not have enough product on hand to
support the promotion. The firm ran out of its core product at the height of the holiday selling
season resulting in a critical level of missed sales.5

Gaming the System Bonuses tied to diagnostic measures release energy and creativity. People
will generally work hard to achieve what they are measured on. However, this energy may focus on
ways of enhancing the measure, even if increasing the measure does not lead to advancement of the
underlying goal or strategy. This misdirected effort is called gaming.

• At an international heavy-equipment manufacturer, managers were having trouble hitting their

quarterly revenue target. In order to move more revenue into the current period, they shipped
products early in an unfinished state from their plant in England to a warehouse near the

3 These risks are enumerated in Simons, Levers of Control, pp. 81-84.

4 Stephen Naysmith, “Report Warns Patients Put at Risk by Failings in NHS,” The Herald Scotland, July 10, 2015.

5 Michael C. Jensen, “Corporate Budgeting is Broken—Let’s Fix It,” Harvard Business Review 79 (November 2001), pp. 94-101.

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

customer in the Netherlands where the final assembly took place. The managers made their
bonus goal, but rental costs of the warehouse, additional labor, and the high cost of assembling
goods at a distant location led to lower profit overall for the company.

Common distortions when relying on diagnostic control systems for goal achievement include:

• Smoothing—This occurs when an individual alters the timing and/or recording of transactions
to show better performance. This may happen, for example, when a manager has achieved the
maximum bonus in one accounting period. Rather than book additional sales which are not
eligible for additional bonus, he or she may defer booking the new revenue until the next
accounting period to apply those sales to next period’s bonus goal.

• Biasing—Managers bias information when they attempt to report only good news (goals that
have been achieved) or to hide or downplay bad news (goals that have been missed).

• Illegal acts—Sometimes, performance pressures can cause someone to violate laws or

organizational policies in an attempt to increase diagnostic measures and achieve related
bonuses.6

The negative side effects of diagnostic control systems are pervasive but well known. Whenever
people are rewarded for achieving performance targets and left alone to figure out how to do this, there
is always the risk some may stray out of bounds. In Module 1: Managing Organizational Tensions, we
described the organizational blocks that can cause well-intentioned people to stray from the path of
doing what they know to be right and ethical. Diagnostic control systems and their related incentives
create much of the pressures and temptations that are at the root of this dysfunctional behavior. This
tension creates a dilemma for managers. On the one hand, managers are forced to rely on diagnostic
control tools to motivate goal achievement and allow high ROM. On the other hand, the same tools
inevitably risk dysfunctional behavior from employees who might respond inappropriately to pressure
or temptation to bend the rules.

Whenever diagnostic control systems are used for evaluation and reward, managers must install
good control systems and be alert for the underlying organizational pressures that may cause well-
intentioned people to bend the rules to distort diagnostic measures. We study how to design and use
these control systems in Module 13: Identifying Strategic Risk and Module 14: Managing Strategic Risk.

Interactive Control Systems7

With diagnostic control systems in place, top managers have effectively put their organization on
automatic pilot. If goals, measures, and incentives are properly aligned, the business is like a heat-
seeking missile focused intently on achieving profit goals and strategies. These systems give managers
the freedom to concentrate on growing the business, enhancing profitability, and positioning products
and services in rapidly changing markets.

6 Jacob G, Birnberg, Lawrence Turpolec, and S. Mark Young, “The Organizational Context of Accounting,” Accounting,
Organizations, and Society 8, nos. 2-3 (1983), pp. 111-29.
7 The remainder of this module draws upon ideas, examples, and concepts enumerated in Simons, Levers of Control, Chapter 5.

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

In the previous section, we used an automobile speed control as an analogy for the management by
exception that is the hallmark of diagnostic control systems. However, managers need a different kind
of control system to grow the business and search for new ways of positioning products and services
in dynamic markets. They need a system more like the one used by the National Weather Service to
search for and identify patterns of change. Ground stations all over the world monitor temperature,
relative humidity, barometric pressure, and wind velocity and direction. Satellites and aircraft provide
additional information about emerging storm patterns. All of this information is fed into a central
location where data is gathered and analyzed to predict the likely effects of changing conditions. Based
on predicted changes, action plans are adjusted (should we delay our trip?) and preparations can be
made for impending threats (do we need to evacuate low lying shore areas in advance of a possible
hurricane?).

Clean Up in Aisle 9....and in the Finance Department

Tesco, a £62 billion company, controlled 29% of the British supermarket industry. However, as
new discount grocers entered the market, sales fell and managers struggled to meet their profit
targets. In desperation, they began to manipulate the accounting numbers.

When grocery stores ran a product promotion, it was usually funded by the food supplier
through a payment from the supplier to the grocery store, and payments were often conditional on
hitting sales targets. Managers at Tesco began booking this promotional income from suppliers
based on plans, well in advance of the promotion actually occurring, in order to inflate their revenue
numbers. Additionally, they began delaying accrual of costs, further increasing the reported profit.

In 2014, these issues came to light when a staff member emailed Tesco’s legal department and
the CEO. Investigators found that Tesco’s first-half profits for 2014 were overstated by £300 million.
As a result, nine employees, including the CEO, were fired and may still face criminal charges for
fraud. Tesco’s stock price fell by fifty percent and consumers have shown their disapproval by
shopping elsewhere. While the investigation continues, Tesco could be fined up to £500 million and
faces potential legal action from shareholders.

____________________
Source: Jenny Anderson, “Criminal Investigation Started in Tesco Accounting Case,” The New York Times, October 30,
2014, p. B2; Sarah Butler, “Tesco Shareholders Could Sue for ‘Millions Lost’ after it Overstated Profits,” The Guardian, January
26, 2016, http://www.theguardian.com/business/2016/jan/26/tesco-shareholders-could-sue-overstated-profits, accessed
April 18, 2016.

Strategic Uncertainties
For managers of any business, strategic uncertainties are the emerging threats and opportunities that
could invalidate the assumptions upon which the current business strategy is based. Uncertainty, in general,
results from a difference between the amount of information required to perform a task and the amount
of information possessed by the organization.8 Strategic uncertainties relate to changes in competitive
dynamics and internal competencies that must be understood if the business is to successfully adapt

8 Jay R. Galbraith, Organization Design, (Reading, Mass.: Addison-Wesley, 1977), p. 36.

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

over time. By definition, strategic uncertainties are unknowable in advance and emerge unexpectedly
over time.

New technologies may undermine the business’s ability to create value, changes in population
demographics may decrease the need for specific goods and services, predatory pricing by competitors
may put the existing value proposition at risk, product defects may scare away customers, and changes
in government policy or regulation may unexpectedly remove vital protection or subsidies. Sometimes,
these unexpected changes may bring opportunities. Changing tariff structures may open up new
markets, the unexpected exit of a competitor from the market may offer a chance to serve new
customers, or another business may inquire about the possibility of forming a joint venture. These
events—either good or bad—may necessitate adjustment of the current strategy and value proposition.

Questions must be asked about how to realign the strategy to take advantage of these emerging
opportunities or deflect unexpected threats. Senior managers must energize the entire organization
around these issues. Effective managers know that people can be extremely creative and can turn
almost any threat or opportunity to advantage—if they can just focus the organization on these
uncertainties.

Strategic uncertainties are different than critical performance variables. The critical performance
variables enumerated in balanced scorecards or other diagnostic control systems are determined by
analysis and embedded in plans and goals. Strategic uncertainties, by contrast, trigger a search for new
information and meaning, rather than a cursory check-up to ensure that plans are on track. Strategic
uncertainties focus on questions rather than answers. Table 11-1 summarizes the main differences
between the two concepts.

Table 11-1 Distinction Between Critical Performance Variables and Strategic Uncertainties

CRITICAL PERFORMANCE VARIABLES STRATEGIC UNCERTAINTIES

Recurring questions What must we do well to achieve our What changes in assumptions could
intended strategy? alter the way we achieve our
vision for the future?

Focus on Implementing intended strategy Testing and identifying new

strategies

Driven by Goal achievement Top management unease and focus

Search for Efficiency and effectiveness Disruptive change

Source: Adapted from Simons, Levers of Control, p. 95.

Interactive Control Systems

The challenge for managers in any medium- or large-scale business is finding ways to focus
everyone in the organization on these uncertainties. To do so, they rely on one simple fact: everyone
watches what the boss watches.

To signal where they want people to pay attention, senior managers choose to use one or more
control systems in a highly interactive way. Interactive control systems are the formal information
systems that managers use to personally involve themselves in the decision activities of subordinates. Simply
stated, interactive control systems are the hot buttons for senior managers. They provide the

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

information that the boss pays a lot of attention to and are used to create an ongoing dialogue with
subordinates.

We must now repeat the important point that we made in the introduction to this module.
Interactive control systems are not defined by their technical design features. Instead, they are defined
by how senior managers use these systems. Top managers pore over reports as soon as they are received
and later use the information to challenge the thinking and action plans of subordinates. Senior
managers use the interactive control system to spark information searches throughout the entire
organization. This intensive use and focus stands in stark contrast to the management by exception
that defines diagnostic control systems.

Figure 11-3 illustrates how an interactive control system focuses organizational attention and the
emergence of new strategies over time.

Figure 11-3 Using the Interactive Control Process for Learning

Senior
Management
Vision
Business Strategic
Strategies Uncertainties

Learning Choice

Debate and Interactive

Dialogue Control
System
Signalling

Source: Adapted from Simons, Levers of Control, p. 102.

Business strategy, in the upper left hand corner of Figure 11-3, reflects how the business currently
creates value for customers and differentiates its products and services from competitors.
Management’s vision for the future—how it sees the business evolving in the marketplace—gives rise
to specific strategic uncertainties. These are the issues and questions that keep managers awake at night.
Depending on the current strategy and management’s vision for the future, strategic uncertainties may
relate to changes in customer preferences, competitor actions, new technology, government regulation,
or any number of potential threats and opportunities.

To focus the organization on these strategic uncertainties, managers choose one (or more)
performance measurement and control system and use it in a highly interactive way. Data from the
system is used to challenge subordinates and their action plans and force them to attempt to make
sense of rapidly changing conditions. This choice signals unequivocally what is important. Remember,
everyone watches what the boss watches. In anticipation of the inevitable questioning from their bosses

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

as new data is released, subordinates throughout the business work diligently to gather as much data
as they can to be able to respond to questions and suggest action plans that respond to changing
circumstances. Interactive debate and dialogue takes place at all levels of the organization as new
information is studied and analyzed.

This ongoing discussion highlights the need for changing the ways of doing things, changing the
value proposition, or even changing aspects of the business strategy. The debate and dialog forces
organizational learning, which, in Figure 11-3, loops back to the adjustment of strategy. Thus, emerging
strategy can be an indirect result of bottom-up action plans and experimentation.

Senior managers at Pepsi describe how they use an interactive control system that reports weekly
market share data:

Pepsi’s top managers would carry in their wallets little charts with the latest key
Nielsen figures. They became such an important part of my life that I could quote them
on any product in any market. We would pore over the data, using it to search for Coke’s
vulnerable points where an assault could successfully be launched, or to explore why
Pepsi slipped a fraction of a percentage point in the game…The Nielsens defined the
ground rules of competition for everyone at Pepsi. They were at the epicenter of all we
did. They were the non-public body counts of the Cola Wars… The company wasn’t
always this way. The man at the front of the table made it so.9

A senior manager at Pepsi described how this interactive control system affected the behavior of
managers throughout the business:

No matter where I was at any time of the day, when the Nielsen flash came out, I
wanted to be the first to know about it. I didn’t mind a problem, but I hated surprises. The
last thing I’d want was [Pepsi’s CEO] calling for an explanation behind a weak number
without having had the chance to see it myself. I’d scribble the details down on the back
of an envelope or whatever else was convenient. Within an hour, some sixty or seventy
people at Pepsi also would get the results and begin to work on them.10

The discussions surrounding interactive control systems are always face-to-face, involving
operating managers directly. Meetings are used to brainstorm and use every possible piece of data to
collectively make sense of changing circumstances. The debate focuses on new information,
assumptions, and action plans.

The pressure to use a system interactively is created quite simply by the regular and recurring
attention of the highest levels of management. In face-to-face meetings, senior managers probe
subordinates to explain any unforeseen changes in their business and offer suggested action plans. This
pressure cascades from the top of the organization to the bottom. In response, through a series of
interlocking meetings, the new information and learning flows upward, from the bottom of the
organization to the top (Figure 11-4).

9 John Sculley and John A. Byrne, Odyssey: Pepsi to Apple: A Journey of Adventure, Ideas, and the Future (New York: Harper & Row,
1987), pp. 6-7.
10 Sculley and Byrne, p. 6.

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

Figure 11-4 Top-Down Pressure: Bottom-Up Strategy

Top - Down
Pressure

Strategies
Strategies

Learning
Learning

Tactics
Tactics

Actions
Actions

Source: Adapted from Simons, Levers of Control, p. 99.

In Module 2: Building a Successful Strategy, we discussed how strategies can emerge spontaneously
in organizations as employees experiment and replicate small successes in their attempts to create
value. This is strategy as emerging patterns of action. Interactive control systems provide the principal
means by which managers can guide this otherwise serendipitous process. Many of the best strategies
come from unexpected ideas that originate with employees close to customers and markets. At Pepsi,
a local experiment eventually laid the groundwork for a new strategy:

We fought hard for a meager 7 percent share against Coke’s 37 percent. It was hardly
a contest. Out of sheer desperation, Larry Smith … urged an advertising effort more
powerful than Pepsi’s lifestyle approach. Not wanting to tamper with our hugely
successful Pepsi Generation campaign, Pepsi advertising executives and [our advertising
agency] resisted. Undaunted, Smith hired his own advertising agency in Texas and
dispatched his vice president of marketing to help put together something that would
represent a radical departure from what we or any other company had ever done before.
The result amounted to one of the most devastating advertising and promotional
campaigns ever devised. The Texas agency called it the “Pepsi Challenge.”11

By focusing attention on strategic uncertainties, managers can use the interactive control process to
guide the search for new opportunities, stimulate experimentation and rapid response, and maintain

11 Sculley and Byrne, pp. 43-44.

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

control over what could otherwise be a chaotic process. Over time, the debate and dialogue that is the
hallmark of interactive control systems allow a business to adapt and renew its strategy:

We treated each Challenge as a major event, a battle to be fought in our long-term war
against Coke. Weeks before a Challenge would debut, we would begin quality tests on
the product. If it failed to measure up, we would improve its taste so that a subgoal of the
contest was to upgrade the overall quality of our product.12

Design Features of Interactive Control Systems

An interactive control system is not a unique type of control system; any control system can be used
interactively by senior managers if it meets certain requirements. For example, managers might choose
to use a profit planning system interactively, or a market share monitoring system (like the Nielsen
data used at Pepsi), a project monitoring system, or a balanced scorecard. There are countless other
systems in any organization that could be used interactively as well.

By way of example, we can look at the U.S. healthcare industry, where senior managers in different
firms use one of the following five control systems interactively based on their business strategy and
unique strategic uncertainties:13

• Profit planning systems are used interactively where strategic uncertainties relate to the
development and protection of new products and markets (e.g., highly innovative consumer
products).

• Project management systems that report information about the discovery and integration of new
technology projects are used interactively in businesses where changes in product technology
are strategic uncertainties (e.g., high technology medical devices).

• Brand revenue budgets that report revenue, market share, and shipment data by brand or product
category are used interactively in businesses where strategic uncertainties relate to extending
the attractiveness of mature products (e.g., branded consumer goods such as hair coloring).

• Intelligence systems that report information about social, political, and technical business issues
are used interactively when there is significant uncertainty concerning changes in regulation
and government policy (e.g., prescription drug companies).

• Human resource systems that report information on skill inventories, manpower planning, and
succession planning are used interactively when strategic uncertainties relate to acquiring new
skills to meet competitive needs (e.g., in new and/or rapidly growing businesses).

Figure 11-5 illustrates how these system choices are determined by strategy and strategic
uncertainties.

12 Sculley and Byrne, p. 49

13 Robert Simons, “Strategic Orientation and Top Management Attention to Control Systems,” Strategic Management Journal 12
(1991), pp. 49-62

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Figure 11-5 Interactive Control System Choices: A Function of Strategy and Strategic Uncertainties

Top management’s vision of future product/market position

Clear vision Unclear vision

Protected Competitive
Rapid early Crisis Lack of vision
markets markets
growth

Interactive Project Strategic

Low cost, high
Management uncertainties:
volume position
Systems
Levering skills
Focus: into
Strategic uncertainties:
Current and competitive
Fundamental changes
potential technical advantage?
in product technology?
product attributes

Premium price position Interactive Profit

through innovation Planning Systems Interactive Human
Focus: Development
Strategic uncertainties: Changing customer systems
Strategic
Development and needs and
Focus: uncertainties:
protection of new competitive new
products and markets? Organizational How to change
product introductions
capabilities and survive?

Barriers to entry Interactive Brand

through brand Revenue Systems
marketing
Focus:
Strategic uncertainties: Impact of price,
Extending
attractiveness of mature
promotion, and
packaging on customer
Multiple
Interactive
?
products? buying habits Systems

High margin, patent Interactive

protected niche Intelligence
Systems
Focus:
Strategic uncertainties: No
Social, political,
Changes in the rules of Interactive
and technological
competition? Systems
environments

Source: Adapted from Simons, “Strategic Orientation and Top Management Attention to Control Systems,” Strategic
Management Journal 12 (1991), p. 54.

For a system to be eligible for use as an interactive control system, four criteria must be satisfied:

1. The information contained in an interactive control system must be simple to understand. If debate
and dialogue is to be productive, everyone must be working from the same data and have faith
in its accuracy. Managers cannot afford to waste their time arguing about the validity of
complex algorithms or calculations that determine how data is compiled. The market share
indicators used by managers at Pepsi satisfy this condition. They provide simple and
unambiguous data; there is little uncertainty or debate about how the numbers were
constructed or their internal validity.

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2. Interactive control systems must provide information about strategic uncertainties. This condition is
at the heart of why interactive control systems are so important—they focus attention
unerringly throughout the organization. Everyone watches what the boss watches.
Accordingly, it is critical that an interactive control system collect data on the strategic
uncertainties of the business. Determined by a business’s unique strategy, these uncertainties
may relate to customers, technology, government regulation, or any number of other factors
that are critical underpinnings of the current value proposition and strategy.

3. Interactive control systems must be used by managers at multiple levels of the organization. Managers
use control systems interactively to stimulate subordinates to search for, analyze, and discuss
new information. Thus, for any system to be used interactively, the information system must
be available widely and used by a broad array of subordinate managers. This condition is met
by a profit plan; it is not met by a long-range strategic plan which does not leave the executive
suite.

4. Interactive control systems must generate new action plans. An interactive control system focuses
attention on patterns of change. Just as the National Weather Service predictions are used to
change action plans, the critical questions asked over and over again by senior business
managers must be: (1) What has changed? (2) Why? And—most importantly— (3) What are
we going to do about it? Interactive control systems are used above all else to adjust emerging
strategy on a real-time basis.

Choosing Which System to Use Interactively

Given the many systems in an organization that could be used interactively, we can analyze the
factors that influence which systems managers select. At least four factors influence the choice of
systems to which managers devote their attention (Table 11-2):

Table 11-2 Factors Affecting the Design and Choice of Interactive Control Systems

STRATEGIC IF UNCERTAINTY IS HIGH, THEN IF UNCERTAINTY IS LOW, THEN

UNCERTAINTY INTERACTIVE CONTROL SYSTEM INTERACTIVE CONTROL SYSTEM

Technological Dependence Focuses on emerging new technologies Focuses on changing customer needs

Regulation and Market Focuses on sociopolitical threats and Focuses on competitve threats and
Protection opportunities opportunities

Value Chain Complexity Uses accounting-based measures Uses input/output measures

Ease of Tactical Response Uses short planning horizons Uses long planning horizons

Source: Adapted from Simons, Levers of Control, p. 112.

Technological Dependence The more a business is dependent on a specific technological base

(such as an aircraft manufacturer), the more critical it becomes for managers to protect their competitive
advantage by focusing attention on new ways of applying technology. Managers use interactive
project-management systems in these circumstances to focus the organization on emerging
technologies and their potential effects on the current strategy of the business. Failure to do so can

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result in technological obsolescence, as occurred with Border’s Bookstore’s failure to anticipate the
effects of online shopping and downloadable books on the publishing industry.

Mulally's Traffic Lights

Alan Mulally became CEO of Ford in 2006 when the automaker teetered on the edge of
bankruptcy. To drive performance, Mulally implemented a weekly Business Plan Review meeting
(BPR) attended by the global leadership team. In the words of Mulally, “The BPR meeting is a kind
of status check. It is both a strategic plan and a relentless implementation plan. As new information
emerges, we incorporate it right into the plan. If the facts underpinning the plan have changed, our
plan has to change as well.”

Every Thursday at 8 a.m., each member of the leadership team was required to present an
update of their major initiatives using a traffic light system; green meant all is well, yellow meant
some attention is needed, while red signaled a major problem. Before Mulally’s arrival, the
company culture was made up of tough guys and turf battles, and the Ford executives were not
about to show their weaknesses by admitting to a problem in their department. The managers
coded all their operations green at the first couple of BPRs to show how well they were doing.
Mulally remarked, “You guys, you know we lost a few billion dollars last year. Is there anything
that’s not going well?” At the next meeting, Mark Fields, head of the Americas group, showed a
red code, admitting that the Ford Edge would not be ready for production on time. The room went
silent and awaited Mulally’s response. The new CEO clapped and thanked Fields for his openness.
The next week, the charts were rainbows. Mulally knew that the interactive process would only
work if individuals had the courage to share bad news or to disagree with the boss.

Under Mulally’s leadership, Ford became profitable once again. In 2013, the company had one
of its best years ever, earning over $7 billion. In 2014, Mark Fields, the brave manager who was the
first to admit a red code status, became the new president and CEO of Ford.

____________________
Source: Alex Taylor III, “Fixing Up Ford,” Fortune, May 12, 2009, p. 49; Ford Motor Company, 2013 Annual Report,
Detroit: Ford Motor Company, 2013.

Conversely, when technological dependence is low (e.g., household cleaning products), customers
are not locked into any one product or product concept. In these cases, senior managers focus
organizational attention on finding ways of responding to changing customer needs through new
products or marketing programs. In these circumstances, interactive brand-revenue systems or
interactive profit-planning systems that can model business trade-offs are often used.

Regulation Managers operating in regulated or semi-regulated industries, such as public utilities

and research-based pharmaceutical companies, must pay special attention to public sentiment, political
pressures, and emerging regulations that could affect their businesses. For these firms, interactive
intelligence systems are essential for gathering data to understand and influence the complex social,
political, and technical environment of their businesses. Accordingly, managers make these systems
interactive to force the organization to continually scan the environment for signs of impending change
in regulation or political process.

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Complexity of Value Creation Managers of businesses with complex value chains—for example,
businesses that compete through product innovation in multiple markets such as high-technology
consumer electronics—must monitor complex trade-offs across product lines and markets. In these
businesses, R&D, production, distribution, and marketing tend to be linked in complex and dynamic
ways. Accounting-based measures, such as interactive profit-planning systems, are effective tools for
building business models that highlight how changes in one variable is likely to affect the business.

In contrast, managers of businesses with stable, well-understood value chains—for example,

mature consumer brands such as Coca Cola—have fewer complex trade-offs to manage. Their
businesses are relatively simple. They can, therefore, reduce the level of complexity by focusing
attention on simpler input and output measures, such as brand volume and market share. Therefore,
these businesses often use brand-revenue budget systems interactively.

Ease of Tactical Response Finally, if copying a competitor’s tactics is relatively easy (e.g., the cola
wars between Pepsi and Coke), the planning horizon will be extremely short. Tactical responsiveness
becomes the key to competitive success. In these circumstances, interactive brand-revenue systems give
rapid feedback about the effects of pricing, promotion, and packaging tactics. Conversely, if emulating
the strategic initiatives of competitors is difficult due to technological or market constraints (e.g.,
automobile manufacturing), planning horizons will be substantially longer and interactive program
management systems or interactive profit-planning systems will be more effective.

To test these predictions, consider Johnson & Johnson, which competes with premium-price
products and a high level of product innovation. Managers at Johnson & Johnson use their profit
planning system interactively to focus attention on the development and protection of new products
and markets. Periodically during the year, Johnson & Johnson managers reforecast the predicted effects
of competitive tactics and new product roll-outs on their profit plans for the current and following
year. They also adjust five- and ten-year plans.14

Information from Table 11-2 suggests that their choice of an interactive profit-planning system fits
their strategy and strategic uncertainties. The technological dependence of the business is relatively
low, suggesting that the interactive system should focus on changing customer needs, and there is little
government regulation in most parts of its business, so the system can be designed to focus on
competitive threats and opportunities. Also, the emphasis on innovation and product diversity results
in high complexity, suggesting accounting-based measures to monitor trade-offs, and the relative ease
of tactical response by competitors indicates the need for a planning horizon longer than weeks but
shorter than years.

Choosing How Many Control Systems to Use Interactively

Any medium- to large-size business has a multitude of formal performance measurement and
control systems—profit planning systems, budgeting systems, cost accounting systems, balanced
scorecards, project monitoring systems, and so on. Most of these systems are used diagnostically. At
the extreme, if there are (n) control systems in a business, managers will generally use only one of these
systems interactively and (n ̶ 1) of those systems in a diagnostic, management-by-exception way.
Managers choose to use only one system interactively for three reasons: economic, cognitive, and
strategic.

14 Robert Simons, “Codman & Shurtleff: Planning and Control System,” Harvard Business School Case 187-081 (1987).

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Economic Management attention is a scarce and costly resource. By definition, interactive control
systems demand frequent attention throughout the organization and, therefore, exact high opportunity
costs by diverting attention from other tasks.

Cognitive The ability of individuals to process large amounts of disparate information is limited.
Decision makers suffer from information overload as the amount and complexity of information
increases. Attempting to focus intensively on too many things simultaneously risks information
overload, superficial analysis, a lack of perspective, and potential paralysis. Thus, effective managers
avoid asking subordinates to focus on multiple interactive systems (except during periods of
organizational crisis, during which top managers will make all control systems interactive for short
periods to help redefine strategy).15

Strategic The last reason is also the most important. Managers use a control system interactively
to activate learning about strategic uncertainties and generate new action plans. Interactive control
systems are primarily signaling and communication devices. Using multiple systems interactively
diffuses the signal about what is important. Clarity of communication demands focus.

Interactive Control Systems and Formal Incentives

All control systems must be aligned carefully with incentives. As we discussed in previous sections,
the rewards and bonuses tied to the achievement of diagnostic control system goals are generally set
by formulas. These formula-based incentives allow managers to “power up” their diagnostic systems.
Recall also, however, that these same formula-based incentive systems can lead to various type of
“gaming” behaviors—building slack into targets, smoothing, and biasing of information.

If managers want to use a control system interactively to stimulate information sharing and
learning, incentives are necessary but must be designed differently. Linking incentives with pre-
determined formulas will not work. If formula-based incentives are used, people may attempt to game
the system and withhold information, thereby subverting the desired learning.

Incentives for interactive control systems must, therefore, be designed to reward an individual’s
innovative efforts and contribution. This can only be done by subjective assessment. Subjective
rewards—relying on the personal judgement of superiors—allow managers to recognize innovative
behavior that is difficult to specify in advance and to assess the contribution and effort of individuals
in the interactive process. Only subjective rewards provide the flexibility to reward creativity in the
face of unanticipated threats and opportunities.

Subjective rewards yield three outcomes that help stimulate organizational learning:

1. Rewarding contribution and effort provides incentives for employees to make their efforts visible
to their superiors. To demonstrate their contributions, employees are motivated to
communicate information about emerging problems and opportunities to their bosses, as well
as to report how they have responded. In this way, they can demonstrate their competence,
creativity, and effort through information sharing, analysis, and action planning. Of course, this
upward communication feeds the learning process that can lead to better understanding of
competitive markets and potential new action plans.

2. Rewarding contribution and effort, rather than results, reduces information biasing that is a
constant concern in diagnostic control systems. Because rewards are not mechanically tied to

15 See Simons, 1991, for a discussion of the role of interactive control systems during periods of organizational crisis.

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

uncontrollable events that could affect performance expectations, employees are more likely to
share both good news and bad news.

3. Rewarding contribution subjectively requires a good deal of confidence in the ability of the boss
to calibrate the effort of subordinates accurately. To do so, superiors must have a sound
understanding of the business environment, decision context, array of possible decision
alternatives, and potential outcomes of decisions not taken. Without this knowledge, it is
impossible to allocate rewards fairly. However, superiors can only gain this knowledge from a
deep understanding of the business and its changing competitive environment. Superiors must,
therefore, invest a good deal of their own time and attention to really learning about the
business and its changing dynamics.

This last condition also reminds us why most rewards in organizations are based on preset
formulas. Although subjective rewards promote learning and information sharing (which are
undeniably good), they also demand a disproportionate investment of time up and down the hierarchy.
This investment is justified for interactive control systems that focus on strategic uncertainties; but for
diagnostic processes where goals are clear, ROM is maximized by using formulas to automate the
implementation of approved plans.

Contingencies
There is one special case relating to profit plans that we should mention before we leave this topic.
Managers who wish to use a profit plan interactively face a special problem. As we have discussed at
length, profit planning systems are a key diagnostic tool for coordination and control. Financial goals
must be communicated in all businesses to meet basic obligations to shareholders. Yet, managers at
some companies—like those at Johnson & Johnson—may wish to use their profit planning system
interactively to stimulate learning about trade-offs among R&D, new product introduction,
advertising, and so on. The question arises, how can a profit plan be used both diagnostically and
interactively at the same time?

Managers who wish to use their profit plans interactively solve this dilemma by adding contingency
buffers to the profit plan to protect key diagnostic targets. These contingencies provide a cushion that
allows managers to reforecast profits during the year as part of an interactive process, while at the same
time ensuring that key targets are not jeopardized. For example, managers may set a $10 million profit
goal in the upcoming year. This target would typically be monitored in a diagnostic fashion, and
incentives would be tied by formula to the achievement of this profit plan goal.

If, however, senior managers wanted to use the profit plan interactively, they can add an additional
contingency line that will hold business managers accountable for an initial target of $11 million, with
a $1 million contingency fund that can be drawn upon if the business is unable to meet their targets.
Monthly meetings will discuss achievement against the profit plan, reasons for unexpected changes,
revised estimates based on new product rollouts and competitor actions, and proposed action plans.
As discussed above, bonuses and incentives related to profit plan achievement will be available
subjectively.

By mutual agreement, profit plan targets could be adjusted during the year and the contingency
could be drawn down if needed to protect the key target of $10 million. Incentives will be determined
subjectively based on innovative efforts to expand and seize new opportunities to meet the $11 million
goal; the contingency fund can be used as a buffer if necessary to ensure that at least $10 million is
achieved.

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Return on Management
In taking charge of a business, one of the most important tasks for managers is to find ways to
leverage their time and attention effectively. In Module 1: Managing Organizational Tensions, we defined
return on management (ROM) as:

Amount of Productive Organizational Energy Released

ROM=
Amount of Management Time and Attention Invested

To maximize the impact of their efforts, managers must find ways to increase the numerator and
decrease the denominator. They must use all the tools and techniques at their disposal to release
productive organizational energy. One of the keys for any manager who wishes to maximize ROM is
to understand what he or she must do personally and what can be delegated to staff assistants. Diagnostic
control systems act as attention-conserving devices for senior managers; they allow the business to
operate without constant monitoring and, thereby, increase ROM. Therefore, much of the work in
diagnostic control systems can be delegated to staff specialists and accountants. In contrast, interactive
control systems are attention enhancers. Senior managers assume primary responsibility for interpreting
the data contained in these systems. The interpretation of data in interactive control systems is not
delegated. Staff groups are used primarily as facilitators in the interactive process.

Table 11-3 provides a recap of the roles and responsibilities for operating managers and staff groups
in designing and using diagnostic and interactive control systems.

Table 11-3 Control System Tasks for Managers and Staff Groups Using Diagnostic and Interactive
Control Systems

MANAGERS STAFF GROUPS

Diagnostic Control Systems Periodically set or negotiate performance Design and maintain systems
targets Interpret data
Receive and review exception reports Prepare exception reports
Follow up significant exceptions Ensure integrity and reliability of data

Interactive Control Systems Choose which system to use interactively Gather and compile data
Schedule frequent face-to-face meetings Facilitate interactive process
with subordinates to discuss data
contained in system
Demand that operating managers
throughout the organization respond
to information contained in the systems

Source: Adapted from Simons, Levers of Control, p. 170.

Diagnostic control systems are critical to the implementation of strategy, so target setting and
follow-up are not delegated. Managers should personally set or negotiate performance goals and
receive periodic exception reports to ensure that strategy is on track. However, these systems typically
require significant expertise to design and substantial resources to maintain. Therefore, profit planning
systems, balanced scorecards, and strategic profitability analysis can all be designed and managed by
staff experts. Managers should supply key assumptions and set targets, but staff groups can interpret

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117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

data, do the necessary calculations and variance analyses, and send exception reports to managers for
review. With this allocation of duties, the ROM of operating managers can be greatly increased.

Interactive control systems require special care in their design and use. Only top managers can
decide which control systems they desire to use interactively, based on their vision of the future for the
business and their personal sense of strategic uncertainties. Effective managers will insist on face-to-
face meetings with subordinates to discuss data, assumptions, and action plans. They will demand that
managers throughout the organization respond to the questions raised by the new data. The role of
staff groups should be carefully constrained to gathering and compiling data and facilitating the
interactive process. Managers should be careful not to allow staff groups to intrude in the interactive
process so that paperwork and forms become more important than face-to-face dialogue and action
planing. The overriding objective should be to keep the interactive system simple and accessible to
operating managers to ensure that it is used by managers throughout the organization.

Building Block Summary

Table 11-4 highlights the essential features of diagnostic and interactive control systems.

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Table 11-4 Building Block Summary for Diagnostic and Interactive Control Systems

DIAGNOSTIC CONTROL SYSTEMS

WHAT feedback systems that monitor organizational outcomes and correct deviations from present
standards of performance
Examples: profit plans and budgets
goals and objectives systems
balanced scorecards
project monitoring systems
brand-revenue monitoring systems
strategic planning systems
WHY to allow effective resource allocation
to define goals
to provide motivation
to establish guidelines for corrective action
to allow ex post evaluation
to free scarce management attention
HOW set standards
measure outputs
link incentives to goal achievement
WHEN performance standards can be preset
outputs can be measured
feedback information can be used to influence or correct deviations from standard
process or output is a critical performance variable
WHO senior managers set or negotiate goals, receive and review exception reports,
follow up significant exceptions
staff groups maintain systems, gather data, and prepare exception reports

INTERACTIVE CONTROL SYSTEMS

WHAT control systems that managers use to involve themselves regularly and personally in the
decision activities of subordinates
Examples: profit planning systems
balanced scorecards
project management systems
brand revenue systems
intelligence systems
WHY to focus organizational attention on strategic uncertainties and provoke the emergence of
discussions with subordinates
HOW ensure that data generated by the system becomes an important and recurring agenda in
discussions with subordinates
ensure that the system is the focus of regular attention by managers throughout the organization
participate in face-to-face meetings with subordinates
continually challenge and debate data, assumptions, and action plans
WHEN strategic uncertainties require search for disruptive changes and opportunities
WHO senior managers actively use the system and assign subjective, effort-based rewards
staff groups act as facilitators

Source: Adapted from Simons, Levers of Control, p. 179-180.

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Module Summary
In Modules 5—10 of this series, we reviewed the design principles and technical features of different
types of profit planning, performance measurement, and control systems. In this module, we introduce
an additional dimension—how managers use those systems. This choice is about allocating attention—
both their own and, by implication, the attention of the managers who report to them.

Diagnostic control systems are the management-by-exception systems that define span of
accountability. If designed properly, these systems give top managers assurance that the goals of each
work unit will be achieved. Diagnostic control systems are powered up by formal incentives and
bonuses that are set in advance by formula.

Interactive control systems supply signals for people to infer what is important in allowing the
business to reposition itself over time. Interactive control systems absorb a great deal of management
attention, but it is attention well spent, because it is leveraged throughout the whole organization and
allows high ROM. Using a control system interactively forces the entire organization to focus on
strategic uncertainties—those assumptions about competition and distinctive competencies that keep
the boss awake at night.

In tandem, diagnostic control systems and interactive control systems work together to allow the
implementation of today’s strategy, while at the same time allowing the organization to position itself
for tomorrow’s changing marketplace.

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Terms Defined in Previous Modules

Accountability the outputs that a work unit is expected to produce and the performance standards
that managers and employees of that unit are expected to meet. (Module 4: Organizing for
Performance)

Accounting systems procedures and mechanisms to collect information about the transactions of a
business. Account balances are ultimately summarized in financial statements such as balance
sheets, income statements, and cash flow statements. (Module 1: Managing Organizational Tensions)

Assumptions the starting point for any profit plan is a set of assumptions about the future. These
assumptions describe the consensus among managers about how various markets—customer,
supplier, and financial—will look in the future. (Module 5: Building a Profit Plan)

Balanced scorecard the multiple, linked objectives that companies must achieve to compete based
on capabilities and innovation, not just tangible physical assets. It translates mission and strategy
into objectives and measures. (Module 9: Building a Balanced Scorecard)

Budget resource plans of any organizational unit that either generates or consumes resources.
(Module 5: Building a Profit Plan)

Business strategy how a company creates value for customers and differentiates itself from
competitors in a defined product market. (Module 1: Managing Organizational Tensions)

Control the process of using information to ensure that inputs, processes, and outputs are aligned to
achieve organizational goals. (Module 3: Using Information for Performance Measurement and Control)

Coordination the ongoing ability to integrate disparate parts of a business to achieve objectives.
(Module 3: Using Information for Performance Measurement and Control)

Cybernetics the study of information and its use in feedback processes. (Module 3: Using Information
for Performance Measurement and Control)

Extrinsic motivation desire to engage in behaviors or actions in anticipation of tangible rewards,

such as money or promotions. (Module 3: Using Information for Performance Measurement and Control)

Feedback return of variance information from the output of a process to the input or process stages
so that adjustments can be made to maintain desired levels of performance or control the stability
of a system. (Module 3: Using Information for Performance Measurement and Control)

Function the most basic organization component, comprising a group of managers and employees
who specialize in specific work processes. (Module 4: Organizing for Performance)

Goal a formal aspiration that defines purpose or expected levels of achievement in implementing the
business strategy. (Module 2: Building a Successful Strategy)

Information the communication or reception of intelligence or knowledge. It is the critical vehicle

for profit planning, performance measurement, and management control. (Module 3: Using
Information for Performance Measurement and Control)

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This document is an authorized copy for the course EMBA-BCN-2026 - EMBA-BCN-2026 - Aligning Organizations for Performance - WK taught by prof. Weber, Eric at IESE B.S.

117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

Intended strategy planned strategy that managers attempt to implement in a specific product
market based on analysis of competitive dynamics and current capabilities. (Module 2: Building a
Successful Strategy)

Organizational blocks obstacles that organizations create that inhibit employees from working to
their true potential. (Module 1: Managing Organizational Tensions)

Organizational learning the ability of an organization to monitor changes in its environment and
internal processes and adjust its processes, products, and services to capitalize on those changes.
(Module 2: Building a Successful Strategy)

Performance measurement and control systems the formal information-based routines and
procedures managers use to maintain or alter patterns in organizational activities. (Module 1:
Managing Organizational Tensions)

Planning the process of preparing an economic and strategic road map for a business. Planning
provides a framework for setting aspirations through performance goals and ensuring an
adequate level and mix of resources to achieve these goals. (Module 3: Using Information for
Performance Measurement and Control)

Planning systems recurring procedures to routinely disseminate planning assumptions, gather

market information, provide details about relevant analyses, and prompt managers to estimate
resource needs and performance goals and milestones. (Module 1: Managing Organizational
Tensions)

Product market a defined competitive market for a specific product or category of products.
(Module 2: Building a Successful Strategy)

Profit the residual economic value after interest expense and income taxes (both of which are
nondiscretionary payments). Based on accounting assumptions, profit is the economic value that
is available for distribution to the residual claimants—equity holders—or for reinvestment in the
business. (Module 3: Using Information for Performance Measurement and Control)

Profit plan a summary of future financial inflows and outflows for a specified future accounting
period. It is usually prepared in the familiar form of an income statement. (Module 1: Managing
Organizational Tensions)

Profitability the ratio of net income to sales. Profitability indicates how much profit was generated
for each dollar of sales. (Module 5: Building a Profit Plan)

Resource a strength of the business embodied in the tangible or intangible assets that are tied semi-
permanently to the firm. (Module 2: Building a Successful Strategy)

Return on management (ROM) the amount of productive organizational energy released divided
by the amount of management time and attention invested. (Module 1: Managing Organizational
Tensions)

Signaling when managers send cues throughout the organization about their values, preferences,
and the types of opportunities that they want employees to seek and exploit. (Module 3: Using
Information for Performance Measurement and Control)

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Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems 117-111

Span of accountability the range of performance measures used to evaluate a manager's

achievements. At a most basic level, span of accountability defines the financial statement items
for which a manager is accountable. (Module 4: Organizing for Performance)

Standard a formal representation of performance expectations. (Module 3: Using Information for

Performance Measurement and Control)

Strategic profitability analysis variance analysis techniques to evaluate the success of a business in
generating profit from the implementation of its strategy. (Module 6: Evaluating Strategic Profit
Performance)

Value proposition the mix of product and service attributes that a firm offers to customers in terms
of price, product features, quality, availability, image, buying experience and after-sales warranty
and service. (Module 8: Linking Performance to Markets)

Variance analysis the difference between an item estimated on a profit plan or budget prepared
prior to the start of an accounting period and the actual income or expense as reflected on
accounting statements prepared after the accounting period has ended. (Module 6: Evaluating
Strategic Profit Performance)

Variance information the difference between actual outputs and preset standards of performance.
Used as feedback for corrective action by managers. (Module 3: Using Information for Performance
Measurement and Control)

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This document is an authorized copy for the course EMBA-BCN-2026 - EMBA-BCN-2026 - Aligning Organizations for Performance - WK taught by prof. Weber, Eric at IESE B.S.

117-111 Strategy Execution Module 11: Using Diagnostic and Interactive Control Systems

Suggested Study Cases

To enhance your understanding of the ideas covered in this module, we recommend that you
study one or more of the following Harvard Business School Cases. These cases are available from
Harvard Business School Publishing at www.hbsp.harvard.edu.

• Nordstrom: Dissension in the Ranks?

- Case A (HBS No. 191-002)

- Case B (HBS No. 192-027)

- Case Flash Forward (HBS No. 8561)

• Raleigh & Rosse: Measures to Motivate Exceptional Service (HBS Brief Case, HBS No. 4353)

• Evergreen Natural Markets 2012 (HBS Brief Case, HBS No. 4450)

• China Resources Corp. (A): 6S Management (HBS No. 107-013)

• Continental Media Group: Business Highlights (HBS No. 110-087)

• Codman & Shurtleff, Inc.: Planning and Control System (HBS No. 187-081)

• Turner Construction Company: Project Management Control Systems (HBS No. 190-128)

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