This Document Contains Chapters 11 to 13 CHAPTER 11 Corporate Performance, Governance, and Business Ethics Synopsis of Chapter Chapter 11 introduces concepts related to governance and business ethics. The concern is that managers should not only act appropriately, pursuing the interests of the shareholders, but also pay attention to other stakeholders as well. This chapter describes the ways in which various stakeholder groups make contributions to and receive benefits from the organization, and how stakeholder support leads to high organizational performance. Managers don’t always act in the best interests of stakeholders, and this chapter uses agency theory to explain this difficulty and to suggest ways to overcome it. Next, corporate governance is presented, including boards of directors, compensation for principals, independently audited financial statements, the threat of corporate takeover, strategic control systems, and incentive systems. Each of these governance mechanisms is described in detail, and the costs and benefits of each are provided. The final topic of the chapter is ethics and strategy. Business ethics are defined and described. Ethical issues in strategy, the roots of unethical behavior are noted and suggestions for behaving ethically are provided. Learning OBJECTIVES 1. Understand the relationship between stakeholder management and corporate performance. 2. Explain why maximizing returns to stockholders is often viewed as the preeminent goal in many corporations 3. Describe the various governance mechanisms that are used to align the interest of stockholders and managers. 4. Explain why these governance mechanisms do not always work as intended. 5. Identify the main ethical issues that arise in business and the causes of unethical behavior. 6. Identify what managers can do to improve the ethical climate of their organization, and to make sure that business decisions do not violate good ethical principles. Opening Case HP’s Disastrous Acquisition of Autonomy In 2011, Leo Apotheker, HP’s new CEO, proposed acquisition of Autonomy, a British software firm. Even HP’s new chairman of the board, Ray Lane was enthusiastic about the proposal. When the board approved a price for Autonomy it was about a 50% premium over its market value, and its market value was already high at about 15 times its operating profit. In 2012, HP wrote down 8.8 billion of the acquisition, essentially admitting that the company was worth 79% less than it had paid for it. Catherine A. Lesjak, the chief financial officer at HP, had spoken out against the deal before it transpired, arguing that it was not in the best interests of the shareholders and that HP could not afford it. In the third quarter of 2012, HP lost $6.9 billion, largely because of the Autonomy mess. Its stock was trading at $13—almost 60% less than it had been worth when the Autonomy deal was announced. Teaching Note: This case is an excellent example of the themes in this chapter. You could ask your students that following questions: • How HP’s actions were not in the stakeholders’ best interests? • Did HP’s eagerness for a “transformative acquisition” cause them to be sloppy in their valuation of Autonomy? • Was the value of Autonomy lost due to the more mundane cause of integration failure? • Was it the miscommunication regarding the cash flow analysis done for the acquisition impaired HP’s market credibility? • Was HP's behavior towards its shareholders and investors unethical? Lecture Outline I. Overview This chapter takes a close look at the governance mechanisms that shareholders implement to ensure that managers act in the company’s interest and pursue strategies that maximize shareholder value. It also discusses how managers need to pay attention to other stakeholders as well, such as employees, suppliers, and customers. It reviews the ethical implications of strategic decisions, and discusses how managers can make sure that their strategic decisions are founded upon strong ethical principles. II. Stakeholders and Corporate Performance A company’s stakeholders are individuals or groups with an interest, claim, or stake in the company, in what it does, and in how well it performs. They include stockholders, creditors, employees, customers, the communities in which the company does business, and the general public. Stakeholders can be divided into two groups: internal stakeholders and external stakeholders (Figure 11.1). Internal stakeholders are stockholders and employees, including executive officers, other managers, and board members. External stakeholders are all other individuals and groups that have some claim on a company. Typically, this group comprises customers, suppliers, creditors, governments, unions, etc. Figure 11.1: Stakeholders and the Enterprise All stakeholders are in an exchange relationship with their company. Each of the stakeholder groups provides an organization with important resources (or contributions), and in exchange, each expects its interests to be satisfied (by inducements): • Stockholders provide the enterprise with risk capital and in exchange expect management to attempt to maximize the return on their investment. • Creditors, and particularly bondholders, provide the company with capital in the form of debt, and they expect to be repaid on time, with interest. • Employees provide labor and skills and in exchange expect commensurate income, job satisfaction, job security, and good working conditions. • Customers provide a company with its revenues, and in exchange want high-quality, reliable products that represent value for money. • Suppliers provide a company with inputs and in exchange seek revenues and dependable buyers. • Governments provide a company with rules and regulations that govern business practice and maintain fair competition. • Unions help to provide a company with productive employees, and in exchange they want benefits for their members in proportion to their contributions to the company. • Local communities provide companies with local infrastructure, and in exchange want companies that are responsible citizens. • The general public provides companies with national infrastructure, and in exchange seeks some assurance that the quality of life will be improved as a result of the company’s existence. A company must take these claims into account when formulating its strategies, or else stakeholders may withdraw their support. A. Stakeholder Impact Analysis A company cannot always satisfy the claims of all stakeholders. Often the company must make choices. To do so, it must identify the most important stakeholders and give highest priority to pursuing strategies that satisfy their needs. Stakeholder impact analysis can provide such identification. Typically, stakeholder impact analysis follows these steps: • Identify stakeholders. • Identify stakeholders’ interests and concerns. • As a result, identify what claims stakeholders are likely to make on the organization. • Identify the stakeholders who are most important from the organization’s perspective. • Identify the resulting strategic challenges. Most companies that have gone through this process quickly come to the conclusion that three stakeholder groups must be satisfied above all others if a company is to survive and prosper—customers, employees, and stockholders. B. The Unique Role of Stockholders A company’s stockholders are usually put in a different class from other stakeholder groups. Stockholders are the legal owners and the providers of risk capital, a major source of the capital resources that allow a company to operate its business. The capital that stockholders provide to a company is seen as risk capital because there is no guarantee that stockholders will ever recoup their investments and/or earn a decent return. Over the past decade, maximizing returns to stockholders has taken on significant importance as an increasing number of employees have become stockholders in the companies for which they work through employee stock ownership plans (ESOPs). C. Profitability, Profit Growth, and Stakeholder Claim Because of the unique position assigned to stockholders, managers normally seek to pursue strategies that maximize the returns that stockholders receive from holding shares in the company. Stockholders receive a return on their investment in a company’s stock in two ways: • From dividend payments • From capital appreciation in the market value of a share (that is, by increases in stock market prices) The best way for managers to generate the funds for future dividend payments and keep the stock price appreciating is to pursue strategies that maximize the company’s long-term profitability (as measured by the return on invested capital or ROIC) and grow the profits of the company over time. ROIC is an excellent measure of the profitability of a company. It tells managers how efficiently they are using the capital resources of the company (including the risk capital provided by stockholders) to generate profits. To grow profits, companies must be doing one or more of the following: • Participating in a market that is growing • Taking market share from competitors • Consolidating the industry through horizontal integration • Developing new markets through international expansion, vertical integration, or diversification The task of managers is to find the right balance between profitability and profit growth. Too much emphasis on current profitability at the expense of future profitability and profit growth can make an enterprise less attractive to shareholders. Too much emphasis on profit growth can reduce the profitability of the enterprise and have the same effect. In addition to maximizing returns to stockholders, boosting a company’s profitability and profit growth rate is also consistent with satisfying the claims of several other key stakeholder groups. For example, when a company is profitable and its profits are continuing to grow, it can pay higher salaries to productive employees and can also afford benefits such as health insurance coverage, all of which help to satisfy employees. Stakeholder management requires consideration of how the firm’s practices affect the cooperation of stakeholders in the short-term, the benefits of building trust and a knowledge-sharing culture with stakeholders in the long run, and the firm’s profitability and growth that will enable it to serve stakeholder interests in the future. The company that overpays its employees in the current period, for example, may have very happy employees for a short while, but such action will raise the company’s cost structure and limit its ability to attain a competitive advantage in the marketplace, thereby depressing its long-term profitability and hurting its ability to award future pay increases. Not all stakeholder groups want the company to maximize its long-run profitability and profit growth. Suppliers are more comfortable about selling goods and services to profitable companies because they can be assured that the company will have the funds to pay for those products. Similarly, customers may be more willing to purchase from profitable companies because they can be assured that those companies will be around in the long term to provide after-sales services and support. But neither suppliers nor customers want the company to maximize its profitability at their expense. Despite the argument that maximizing long-term profitability and profit growth is the best way to satisfy the claims of several key stakeholder groups, it should be noted that a company must do so within the limits set by the law and in a manner consistent with societal expectations. The unfettered pursuit of profit can lead to behaviors that are outlawed by government regulations, opposed by important public constituencies, or simply unethical. Unfortunately, there is plenty of evidence that managers can be tempted to cross the line between the legal and illegal in their pursuit of greater profitability and profit growth. A body of academic work collectively known as agency theory provides an explanation for why managers might engage in behavior that is either illegal or, at the very least, not in the interest of the company’s shareholders. 11.1 Strategy in Action: Price Fixing at Sotheby’s and Christie’s Sotheby’s and Christie’s, the two largest fine art auction houses in the world, were earning low commissions in the 1990s, as sellers negotiated simultaneously with both firms for the best rates. Sotheby’s CEO, Dede Brooks, secretly met with CEO Christopher Davidge of Christie’s to establish a fixed and nonnegotiable commission structure. This had the effect of illegally fixing prices and reducing competition. The deal was exposed and the auction houses paid settlements to sellers that totaled $512 million in addition to federal fines. The conspirators, and the Chairmen that were their superiors, lost their jobs and received one or more of the following: • Heavy personal fines • Jail time • House arrest • Probation • Community service as restitution • Public humiliation and loss of reputation Teaching Note: In this case, illegal price fixing led to higher commissions paid by sellers. It also might have contributed to buyers paying higher prices as sellers tried to recover some of their additional expenses. Finally, it was not in the best interests of shareholders because the lawsuits and fines led to lower profitability. Use this case to spark classroom discussion by asking students to examine other times when corporations acted to either protect stakeholder interests or hurt their interests by acting unethically or illegally. Examples could include Exxon’s cover-up of the Valdez oil spill, Union Carbide’s Bhopal disaster, or Johnson & Johnson’s exemplary response to Tylenol tampering. After describing the facts of the situation, ask students to indicate how the corporation’s actions either helped or hurt stakeholders. III. Agency Theory Agency theory looks at the problems that can arise in a business relationship when one person delegates decision-making authority to another. It offers a way to understand why managers do not always act in the best interests of stakeholders and why they might sometimes behave unethically, and also illegally. A. Principal-Agent Relationship An agency relationship is held to arise whenever one party delegates decision-making authority or control over resources to another. The principal is the person delegating authority, and the agent is the person to whom the authority is delegated. The relationship between stockholders and senior managers is the classic example of an agency relationship. The agency relationship continues down the hierarchy within the company. B. The Agency Problem Although agency relationships often work well, problems may arise if agents and principals have different goals and if agents take actions that are not in the best interests of their principals. Agents may be able to do this because there is an information asymmetry between the principal and the agent—agents almost always have more information about the resources they are managing than the principal does. In the case of stockholders, the information asymmetry arises because they delegate decision-making authority to the CEO, their agent, who, by virtue of his or her position inside the company, is likely to know far more than stockholders do about the company’s operations. There may be certain information about the company that the CEO is unwilling to share with stockholders because that information would also help competitors. In such a case, withholding some information from stockholders may be in the best interest of all. The information asymmetry between principals and agents is not necessarily a bad thing, but it can make it difficult for principals to measure how well an agent is performing and thus hold the agent accountable for how well he or she is using the entrusted resources. There is a certain amount of performance ambiguity inherent in the relationship between a principal and agent—principals cannot know for sure if the agent is acting in his or her best interests. However, to an extent, principals must trust the agent to do the right thing. Principals put mechanisms in place with the purpose of monitoring agents, evaluating their performance, and, if necessary, taking corrective action. Despite the existence of governance mechanisms and comprehensive measurement and control systems, a degree of information asymmetry will always remain between principals and agents, and there is always an element of trust involved in the relationship. Unfortunately, not all agents are worthy of this trust. Some authors have argued that, like many other people, senior managers are motivated by desires for status, power, job security, and income. By virtue of their position within the company, certain managers, such as the CEO, can use their authority and control over corporate funds to satisfy these desires at the cost of returns to stockholders. CEOs might use their positions to invest corporate funds in various perks that enhance their status—executive jets, lavish offices, etc.—rather than investing those funds in ways that increase stockholder returns. Economists have termed such behavior on-the-job consumption. Aside from engaging in on-the-job consumption, CEOs, along with other senior managers, might satisfy their desires for greater income by using their influence or control over the board of directors to persuade the compensation committee of the board to grant pay increases. Critics of U.S. industry claim that extraordinary pay has now become an endemic problem and that senior managers are enriching themselves at the expense of stockholders and other employees. What rankles critics is the size of some CEO pay packages and their apparent lack of relationship to company performance. Figure 11.2 graphs long-term profitability against the rate of growth in company revenues. A company that does not grow is likely missing out on some profitable opportunities. Figure 11.2: The Tradeoff between Profitability and Revenue Growth Rates The magnitude of agency problems was emphasized in the early 2000s when a series of scandals swept through the corporate world, many of which could be attributed to self-interest-seeking senior executives and a failure of corporate governance mechanisms to hold the largess of those executives in check. It is important to remember that the agency problem is not confined to the relationship between senior managers and stockholders. It can also bedevil the relationship between the CEO and subordinates and between them and their subordinates. Confronted with agency problems, the challenge for principals is to: • Shape the behavior of agents so that they act in accordance with the goals set by principals • Reduce the information asymmetry between agents and principals • Develop mechanisms for removing agents who do not act in accordance with the goals of principals and mislead them Principals try to deal with these challenges through a series of governance mechanisms. 11.2 Strategy in Action: Self-Dealing at Hollinger International Inc. From 1999 to 2003, Conrad Black, CEO, and F. David Radler, chief operating officer (COO), of Hollinger International Inc. illegally diverted cash and assets to themselves, family members, and other corporate insiders. Hollinger International was a global publishing empire that owned newspapers around the world. Black and Radler abused their control of a public company and treated it as their personal piggy bank. They cheated and defrauded the shareholders through a series of deceptive schemes and misstatements. In a practice known as “tunneling,” Black and Radler engaged in a series of self-dealing transactions, such as selling some of Hollinger’s newspapers at below-market prices to companies privately held by Black and Radler themselves— sometimes for a price as low as one dollar. They also directly channeled money out of the firm under the guise of “non-competition payments.” The managers also fraudulently used corporate perks, such as using a company jet to fly for a vacation, and corporate funds to live in swanky New York apartments. Black’s ill-gotten gains are thought to total more than $400 million, and fallout from the scandal resulted in a loss of $2 billion in shareholder value. Although Black was originally sentenced to 6½ years in jail, he ultimately only served 42 months. Teaching Note: This case illustrates the hazards of inappropriate controls over company funds and deluding the shareholders by unethical practices by company chiefs. Even the managers were involved in the fraudulent acts and were corrupt to the extent to use company funds and resources for personal advances rather than bring forth the unscrupulous acts that were being practiced in the company. For classroom discussion purposes, ask students to comment on the following statement: “A white-collar crime, such as banking fraud or ‘cooking the books,’ and embezzlement isn’t a serious crime because it doesn’t really hurt anyone.” IV. Governance Mechanisms Governance mechanisms are mechanisms that principals put in place to align incentives between them and agents and to monitor and control agents. The purpose of governance mechanisms is to reduce the scope and frequency of the agency problem—to help ensure that agents act in a manner that is consistent with the best interests of their principals. The four main types of governance mechanisms for aligning stockholder and management interests are the board of directors, stock-based compensation, financial statements, and, the takeover constraint. A. The Board of Directors The board of directors is the centerpiece of the corporate governance system. Board members are directly elected by stockholders, and under corporate law, they represent the stockholders’ interests in the company. Hence, the Board can be held legally accountable for the company’s actions. Its position at the apex of decision making within the company allows it to monitor corporate strategy decisions and ensure that they are consistent with stockholder interests. In addition, the board has the legal authority to hire, fire, and compensate corporate employees, including, most important, the CEO. The board is also responsible for making sure that audited financial statements of the company present a true picture of its financial situation. The typical board of directors is composed of a mix of inside and outside directors. Inside directors are senior employees of the company, such as the CEO. They are required on the board because they have valuable information about the company’s activities. Without such information, the board cannot adequately perform its monitoring function. But because insiders are full-time employees of the company, their interests tend to be aligned with those of management. Hence, outside directors are needed to bring objectivity to the monitoring and evaluation processes. Outside directors are not full-time employees of the company. Many of them are full-time professional directors who hold positions on the boards of several companies. The need to maintain a reputation as competent outside directors gives them an incentive to perform their tasks as objectively and effectively as possible. Many boards perform their assigned functions admirably. For example, when the board of Sotheby’s discovered that the company had been engaged in price fixing with Christie’s, board members moved quickly to oust both the CEO and the chairman of the company. Critics of the existing governance system charge that inside directors often dominate the outsiders on the board. Insiders can use their position within the management hierarchy to exercise control over what kind of company-specific information the board receives. Some observers contend that many boards are dominated by the company CEO, particularly when the CEO is also the chairman of the board. To support this view, they point out that both inside and outside directors are often the personal nominees of the CEO. The typical inside director is subordinate to the CEO in the company’s hierarchy and therefore unlikely to criticize the boss. Because outside directors are frequently the CEO’s nominees as well, they can hardly be expected to evaluate the CEO objectively. Thus, the loyalty of the board may be biased toward the CEO, not the stockholders. In the aftermath of a wave of corporate scandals that hit the corporate world in the early 2000s, there are clear signs that many corporate boards are moving away from merely rubber-stamping top-management decisions and are beginning to play a much more active role in corporate governance. In part, they have been prompted by new legislation, such as the 2002 Sarbanes-Oxley Act in the United States, which tightened rules regulating corporate reporting and corporate governance. B. Stock-Based Compensation According to agency theory, one of the best ways to reduce the scope of the agency problem is for principals to establish incentives for agents to behave in the company’s best interest through pay-for-performance systems. In the case of stockholders and top managers, stockholders can encourage top managers to pursue strategies that maximize a company’s long-term profitability and profit growth, and thus the gains from holding its stock, by linking the pay of those managers to the performance of the stock price. Giving managers stock options— the right to purchase the company’s shares at a predetermined (strike) price at some point in the future, usually within 10 years of the grant date—has been the most common pay-for-performance system. Typically, the strike price is the price at which the stock was trading when the option was originally granted. Several academic studies suggest that stock-based compensation schemes for executives, such as stock options and stock grants, can align management and stockholder interests. However, the practice of granting stock options has become increasingly controversial. Many top managers often earn huge bonuses from exercising stock options that were granted several years prior. Other critics of stock options, complain that huge stock-option grants increase the outstanding number of shares in a company and therefore dilute the equity of stockholders; accordingly, they should be shown in company accounts as an expense against profits. C. Financial Statements and Auditors Publicly traded companies in the United States are required to file quarterly and annual reports with the Securities and Exchange Commission (SEC) that are prepared according to the Generally Accepted Accounting Principles (GAAP). The purpose of this requirement is to give consistent, detailed, and accurate information about how efficiently and effectively the agents of stockholders—the managers—are running the company. To make sure that managers do not misrepresent this financial information, the SEC also requires that the accounts be audited by an independent and accredited accounting firm. Unfortunately, this system has not always worked as intended in the United States. Despite that the vast majority of companies do file accurate information in their financial statements, and although most auditors review that information accurately, there is substantial evidence that a minority of companies have abused the system, aided in part by the compliance of auditors. There have been numerous examples in recent years of managers’ gaming of financial statements to present a distorted picture of their company’s finances to investors. In response, the United States passed the Sarbanes-Oxley Act in 2002, representing the biggest overhaul of accounting rules and corporate governance procedures since the 1930s. Among other things, Sarbanes-Oxley set up a new oversight board for accounting firms, required CEOs and CFOs to endorse their company’s financial statements, and barred companies from hiring the same accounting firm for auditing and consulting services. D. The Takeover Constraint Stockholders have some residual power—they can always sell their shares. If stockholders sell in large numbers, the price of the company’s shares will decline. If the share price falls far enough, the company might be worth less on the stock market than the actual value of its assets. At this point, the company may become an attractive acquisition target and runs the risk of being purchased by another enterprise, against the wishes of the target company’s management. The risk of being acquired by another company is known as the takeover constraint—it limits the extent to which managers can pursue strategies and take actions that put their own interests above those of stockholders. If they ignore stockholder interests and the company is acquired, senior managers typically lose their independence, and likely their jobs as well. During the 1980s and early 1990s, the threat of takeover was often enforced by corporate raiders—individuals or corporations that purchase large blocks of shares in companies that appear to be pursuing strategies inconsistent with maximizing stockholder wealth. Corporate raiders argue that if these underperforming companies pursued different strategies, they could create more wealth for stockholders. Raiders purchase stock in a company either to take over the business and run it more efficiently or to precipitate a change in the top management, replacing the existing team with one more likely to maximize stockholder returns. If they succeed in their takeover bid, they can institute strategies that create value for stockholders, including themselves. Even if a takeover bid fails, raiders can still earn millions, for their stockholdings will typically be bought out by the defending company for a hefty premium. Called greenmail, this source of gain has stirred much controversy and debate about its benefits Although the incidence of hostile takeover bids has fallen off significantly since the early 1990s, this should not imply that the takeover constraint has ceased to operate. Unique circumstances existed in the early 2000s that made it more difficult to execute hostile takeovers. Takeovers tend to occur in cycles, and it seems likely that once excesses are worked out of the stock market and off corporate balance sheets, the takeover constraint will begin to reassert itself again. The takeover constraint is the governance mechanism of last resort and is often invoked only when other governance mechanisms have failed. E. Governance Mechanisms inside a Company Agency relationships also exist within a company, and the agency problem can arise between levels of management. The agency problem can be reduced within a company by using two complementary governance mechanisms to align the incentives and behavior of employees with those of upper-level management—strategic control systems and incentive systems. 1. Strategic Control Systems Strategic control systems are the primary governance mechanisms established within a company to reduce the scope of the agency problem between levels of management. These systems are the formal target-setting, measurement, and feedback systems that allow managers to evaluate whether a company is executing the strategies necessary to maximize its long-term profitability and, in particular, whether the company is achieving superior efficiency, quality, innovation, and customer responsiveness. The purpose of strategic control systems is to: • Establish standards and targets against which performance can be measured • Create systems measuring and monitoring performance on a regular basis • Compare actual performance against the established targets • Evaluate results and take corrective action if necessary In governance terms, their purpose is to ensure that lower-level managers, as the agents of top managers, are acting in a way that is consistent with top managers’ goals, which should be to maximize the wealth of stockholders, subject to legal and ethical constraints. One increasingly influential model that guides managers through the process of creating the right kind of strategic control systems to enhance organizational performance is the balanced scorecard model. According to the balanced scorecard model, managers have traditionally emphasized financial measures of performance such as ROIC to gauge and evaluate organizational performance. Financial information is extremely important, but it is not enough alone. If managers are to obtain a true picture of organizational performance, financial information must be supplemented with performance measures that indicate how well an organization has been achieving the four building blocks of competitive advantage—efficiency, quality, innovation, and responsiveness to customers. This is because financial results simply inform strategic managers about the results of decisions they have already taken; the other measures balance this picture of performance by informing managers about how accurately the organization has in place the building blocks that drive future performance One version of the way the balanced scorecard operates is presented in Figure 11.3. Based on an organization’s mission and goals, strategic managers develop a set of criteria for assessing performance according to multiple perspectives, such as: • The financial perspective: for example, the return on capital, cash flow, etc. • The customer perspective: for example, satisfaction, product reliability, etc. • The internal perspective: for example, efficiency, timeliness, etc. • Innovation and learning: for example, the number of new products introduced, the percentage of revenues generated from new products in a defined period, etc. Figure 11.3: A Balanced Scorecard Approach Based on an evaluation of the complete set of measures in the balanced scorecard, strategic managers are in a good position to reevaluate the company’s mission and goals and take corrective action to rectify problems, limit the agency problem, or exploit new opportunities by changing the organization’s strategy and structure—which is the purpose of strategic control. 2. Employee Incentives Control systems alone may not be sufficient to align incentives between stockholders, senior management, and the rest of the organization. To help do this, positive incentive systems are often put into place to motivate employees to work toward goals that are central to maximizing long-term profitability. ESOPs are one form of positive incentive, as are stock-option grants. In addition to stock-based compensation systems, employee compensation can also be tied to goals that are linked to the attainment of superior efficiency, quality, innovation, and customer responsiveness. V. Ethics and Strategy The term ethics refers to accepted principles of right or wrong that govern the conduct of a person, the members of a profession, or the actions of an organization. Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople. Managers may be confronted with ethical dilemmas, which are situations where there is no agreement over what the accepted principles of right and wrong are, or where none of the available alternatives seems ethically acceptable. In our society, many accepted principles of right and wrong are not only universally recognized but also codified into law. The preeminent goal of managers in a business should be to pursue strategies that maximize the long-term profitability and profit growth of the enterprise, thereby boosting returns to stockholders. Strategies, of course, must be consistent with the laws that govern business behavior: managers must act legally while seeking to maximize the long-term profitability of the enterprise. 11.3 Strategy in Action: Nike—the Sweatshop Debate Nike is one of the leading marketers of athletic shoes and apparel in the world. Nike does not do its own manufacturing but contracts out to subcontractors all over the world. Going back at least a decade, Nike had been accused of making its products in “sweatshops” where workers labor in hazardous conditions for minimal wages. Nike initially denied any knowledge of the conditions but eventually was forced (influenced in part by protest actions by college students) to confront the issue. Nike established a code of conduct for its contractors and set up annual monitoring of subcontractor facilities by independent auditors. The code of conduct requires that employees be at least eighteen years old and that exposure to toxic materials does not exceed the U.S. Occupational Safety and Health Administration (OSHA) limits. Teaching Note: The Nike case illustrates the role of ethics in determining firm actions. The firm had not broken any laws with its subcontractor facilities but had come under public scrutiny for the conditions experienced by workers in these facilities. Nike came to realize that the quest for profitability should be constrained not just by law, but also by ethical considerations. A. Ethical Issues in Strategy The ethical issues that strategic managers confront cover many topics, but most are due to a potential conflict between the goals of the enterprise, or the goals of individual managers, and the fundamental rights of important stakeholders. Stakeholders have basic rights that should be respected, and it is unethical to violate those rights. Those who take the stakeholder view of business ethics often argue that it is in the enlightened self-interest of managers to behave in an ethical manner that recognizes and respects the rights of all stakeholders, because doing so will ensure the support of stakeholders and, ultimately, benefit the firm and its managers. Others go beyond this instrumental approach to ethics and argue that, in many cases, acting ethically is simply the right thing to do. Unethical behavior often arises in a corporate setting when managers decide to put the attainment of their own personal goals, or the goals of the enterprise, above the fundamental rights of one or more stakeholder groups. The most common examples of such behavior involve: • Self-dealing—occurs when managers use company funds for their own personal consumption. • Information manipulation—occurs when managers use their control over corporate data to distort or hide information in order to enhance their own financial situation or the competitive position of the firm. • Anti-competitive behavior—covers the range of actions aimed at harming actual or potential competitors, most often by using monopoly power, and thereby enhancing the long-run prospects of the firm. • Opportunistic exploitation—occurs when the managers of a firm seek to unilaterally rewrite the terms of a contract with suppliers, buyers, or complement providers in a way that is more favorable to the firm, often using their power to force a revision to the contract. • Substandard working conditions—arise when managers underinvest in working conditions or pay employees below-market rates, in order to reduce their production costs. • Environmental degradation—occurs when a company’s actions directly or indirectly result in pollution or other forms of environmental harm. • Corruption—can arise in a business context when managers pay bribes to gain access to lucrative business contracts. B. The Roots of Unethical Behavior The following are some of the causes of unethical behavior: • It is important to recognize that business ethics are not divorced from personal ethics, which are the generally accepted principles of right and wrong governing the conduct of individuals. • Many studies of unethical behavior in a business setting have come to the conclusion that businesspeople sometimes do not realize that they are behaving unethically, primarily because they simply fail to ask the relevant question—Is this decision or action ethical? • The third cause of unethical behavior in business is an organizational culture that de-emphasizes business ethics and considers all decisions to be purely economic ones. • The fourth cause of unethical behavior may be pressure from top management to meet performance goals that are unrealistic and can only be attained by cutting corners or acting in an unethical manner. • The fifth root cause of unethical behavior is unethical leadership. C. Behaving Ethically Managers can and should do at least seven things to ensure that basic ethical principles are adhered to and that ethical issues are routinely considered when making business decisions. They can: • Favor hiring and promoting people with a well-grounded sense of personal ethics • Build an organizational culture that places a high value on ethical behavior o Many companies now do this by drafting a code of ethics, a formal statement of the ethical priorities to which a business adheres. • Make sure that leaders within the business not only articulate the rhetoric of ethical behavior but also act in a manner that is consistent with that rhetoric • Put decision-making processes in place that require people to consider the ethical dimension of business decisions • Use ethics officers • Put strong governance processes in place • Act with moral courage Focus On: Wal-Mart Walmart’s Statement of Ethics Walmart’s “Statement of Ethics” covers a wide range of issues spanning from harassment and nondiscrimination to fair competition, insider trading, corruption, and money laundering. The company expects its employees to adhere to personal and professional integrity and hold themselves to the standards of ethical behavior at all times. The code specifically states what employees can or cannot do. Wal-Mart also has a Global Ethics officer, Regional Ethics Committees and global ethics helplines to ensure and provide immediate assistance to employees to understand and practice the guiding principles. Wal-Mart has long supported the Statement of Ethics. Teaching Note: The Wal-Mart’s Statement of Ethics gives students a nice example of the type of statements that companies compile for setting ethical standards. It also points out the importance that Wal-Mart attaches to the statement—the support of Wal-Mart, the Global Ethics officer, Ethics Committees and global ethics helpline, and the specific examples of allowed and disallowed actions. You could point out to students that HP too had a Code of Ethics, and then ask students what might explain the differences in behavior between the two firms. Teaching Note: Ethical Dilemma This dilemma illustrates the economic and moral conflicts encountered by a domestic firm due to globalization. External forces and changes over time created this conflict and management must act. According to agency theory, management is obligated to act as agent for the employees and obligated to maximize profits. However, in practice, if operations move overseas, are the consequences acceptable to them ethically and morally and, more broadly, are they acceptable to the society? If the operation does not move overseas can the firm survive against overseas competitors? Would customers be willing to pay a premium price for clothes made in America? If the mill is closed, what could be done to limit the negative impact of job loss and hardship for employees in the local community? Answers to Discussion Questions 1. How prevalent has the agency problem been in corporate America during the last decade? During the late 1990s, there was a boom in initial public offerings of Internet companies (dot.com companies). The boom was supported by sky-high valuations often assigned to Internet startups that had no revenues or earnings. The boom came to an abrupt end in 2001 when the Nasdaq stock market collapsed, losing almost 80% of its value. Who do you think benefited most from this boom: investors (stockholders) in those companies, managers, or investment bankers? Based on the numerous examples either detailed or referenced in this chapter, the agency problem in corporate America has skyrocketed in the last decade. High-profile and extremely costly debacles have occurred with shattering frequency. The business press has had its hands full trying to keep up with the stories, and politicians have stepped in to the fray. In addition to Sarbanes-Oxley, Congress is seeking ways to control, direct, and motivate corporate entities to act ethically and to abide by corporate governance standards. Corporations, however, have powerful lobbies and it remains to be seen what government interventions will be enacted. During the Internet boom, management and investors compensated with stock options at low strike prices became millionaires overnight when their companies went public. Stockholders who bought at or near the time of the initial public offering (IPO) earned a low rate of return or suffered losses when the dot.com crash occurred. Many lost millions. As investment bankers earn fees, they were somewhat insulated from wide fluctuations in the market. 2. Why is maximizing ROIC consistent with maximizing returns to stockholders? Stockholders profit most when companies focus on maximizing ROIC for three reasons: • High profitability leads to excess funds that can then be used to pay dividends, increasing stockholder wealth. • High profitability leads to excess funds available for long-term investment in growing the corporation or improving its performance, which leads to a long-term appreciation in share value, increasing stockholder wealth. • Other investors see profitability and then buy more of that firm’s stock, driving up the share value and increasing stockholder wealth. 3. How might a company configure its strategy-making processes to reduce the probability that managers will pursue their own self-interest at the expense of stockholders? In order to reduce the agency problem, firms must exercise appropriate and adequate control and monitoring. In order to control the actions of top executives, the board of directors should be involved in strategy-making at high levels, and should be charged with ensuring that the strategies chosen are in the long-term interests of the firm. The board should also be given responsibility for overseeing the actions of top managers to ensure that they are in fact implementing the chosen strategy. The board should be composed of mostly outside members representing any large stockholder groups. Another governance mechanism is the use of strategic controls to ensure that lower-level managers act in agreement with the wishes of top managers. This process requires top managers to establish standards, create a system for periodic measurement, compare actual performance to the standards, and evaluate results. In order to implement this system, there must be some centralization; highly decentralized organizations do not provide adequate opportunities for oversight, and the resulting information asymmetry can lead to the agency problem. 4. In a public corporation, should the CEO of the company also be allowed to be the chairman of the board (as allowed for by the current law)? What problems might this give rise to? There is increasing sentiment that the CEO of the company should not be allowed to serve as the chair of the board as well. When this occurs, the CEO may choose both the inside and the outside directors, who may feel loyalty to the CEO or allow the CEO to control the agenda. This does not provide for good oversight of the CEO’s actions, which are in the interest of the shareholders. 5. Under what conditions is it ethically defensible to outsource production to producers in the developing world who have much lower labor costs when such actions also involve laying off long-term employees in the firm’s home country? It is the responsibility of the managers to maximize profitability for the shareholders. If the choice between moving production to the developing world for lower labor costs versus continuing to employ long-term employees in the firm’s home country means that the firm can continue to be competitive, it is the appropriate action to take. Managers should not endanger the survival of the firm to maintain employment practices. However, this should only be done if it is legal and the foreign employees are paid at a normal rate for their home country and otherwise treated equitably. 6. Is it ethical for a firm faced with a shortage of labor to employ illegal immigrants as labor? It is illegal to employ illegal immigrants as labor. Firms that have shortages of labor should lobby for exceptions or changes to labor statutes that would allow them to hire immigrants. It could also be considered unethical since illegal immigrants are often subject to abuse due to their lack of status. PRACTICING STRATEGIC MANAGEMENT SMALL-GROUP EXERCISE: EVALUATING STAKEHOLDER CLAIMS Students are asked to break into groups of three to five, and appoint one group member as a spokesperson who will communicate their findings to the class when called on by the instructor. They are asked to discuss the following: 1. Identify the key stakeholders of your educational institution. What claims do they place on the institution? 2. Strategically, how is the institution responding to those claims? Do you think the institution is pursuing the correct strategies in view of those claims? What might it do differently, if anything? 3. Prioritize the stakeholders in order of their importance for the survival and health of the institution. Do the claims of different stakeholder groups conflict with each other? If the claims do conflict, whose claim should be tackled first? Teaching Note: Students are likely to see the needs of students as most important, but you should also point out the contributions that are made by groups such as faculty, staff, benefactors, funding agencies, the local community, and corporate sponsors. One way to graphically illustrate for students the importance of a variety of stakeholder groups is to show them how the school’s expenses are paid—what proportion comes from tuition, from alumni, from government agencies, and so on. You can also ask them to consider what would happen if they lost support from one of these groups—for instance, if professors went on strike or the federal government quit offering student loans. Strategy Sign-On Article File 11 Students must find a company that ran into trouble because it failed to take into account the rights of one of its stakeholder groups when making an important strategic decision. Teaching Note: To help students find examples, suggest that they look for some of the following types of events as indicators of troubled stakeholder relationships—strikes, boycotts, dramatic sales losses, lawsuits, regulatory actions, or any intensely negative publicity. Some examples of companies getting into trouble because they failed to take into account the rights of one of their stakeholder groups include the withdrawing of legislative support from Amtrak, negative publicity surrounding Consolidated Edison’s cleanup of the Hudson River, and strikes at Boeing and Delta Dental. In class, ask students to briefly describe some of the examples they found, and then ask the class to consider what could have been done differently in order to satisfy multiple stakeholder groups. Strategic Management Project: Module 11 Students are asked to identify their company’s relationships with its major stakeholder groups. With the information they have at their disposal, they are asked to perform the tasks and answer the following questions: 1. Identify the main stakeholder groups in your company. What claims do they place on the company? How is the company trying to satisfy those claims? 2. Evaluate the performance of the CEO of your company from the perspective of (a) stockholders, (b) employees, (c) customers, and (d) suppliers. What does this evaluation tell you about the ability of the CEO and the priorities that he or she is committed to? 3. Try to establish whether the governance mechanisms that operate in your company do a good job of aligning the interests of top managers with those of stockholders. 4. Pick a major strategic decision made by your company in recent years, and try to think through the ethical implications of that decision. In the light of your review, do you think that the company act correctly? Teaching Note: As students evaluate the CEO’s performance, point out to them that different groups may evaluate the same action in quite different ways, depending on the group’s priorities and needs. In the same way, an ethical evaluation may be done from different viewpoints and may result in quite different conclusions. As a general task and to understand the importance of the relation between company management and its stakeholders, students should look for companies that have experienced an abrupt, unwelcome change in top leadership, such as a sudden resignation. This is one clue that the relationship between managers and principals has deteriorated, although there are many additional troubled relationships that have not yet reached this conclusion. Examples include Skilling’s abrupt departure from Enron, Messier’s departure from Vivendi, and Waksal’s resignation from ImClone. Closing Case Did Goldman Sachs Commit Fraud? In the mid-2000s, hedge fund manager John Paulson approached Goldman Sachs after speculating bubble in housing, fueled by cheap money from banks. During the early 2000s, mortgage originators had started bonds known as collateralized debt obligations, or CDOs. Many of these bonds were given favorable ratings from Moody’s and Standard & Poor’s, suggesting that they were safe investments. Paulson believed that these ratings were wrong and that many CDOs were far more risky than investors thought. He believed that when people started to default on their mortgage payments, the price of these CDOs would collapse. Goldman Sachs decided to offer bonds for sale to institutional investors as synthetic CDOs. Goldman Sachs asked Paulson to identify the CDOs that he thought were very risky and grouped them together into synthetic CDOs. Paulson then took a short position in these synthetic CDOs. Paulson was effectively betting against the synthetic CDOs, a fact that Goldman knew, while he was actively marketing these bonds to institutions. Shortly thereafter, people started to default on their housing payments, the price of houses did fall, and the value of CDOs and the synthetic CDOs that Goldman had created plunged. Paulson made an estimated $3.7 billion in 2007 alone from the event. Goldman Sachs, too, made over $1 billion by betting against the very same bonds that it had been selling. In April 2010, the SEC formally charged Goldman Sachs with civil fraud, arguing that the company had knowingly mislead investors about the risk and value of the synthetic CDOs, and failed to inform them of John Paulson’s involvement in selecting the underlying CDOs. Goldman argued that a market maker like Goldman Sachs owes no fiduciary duty to clients and offers no warranties—it is up to clients to make their own assessment of the value of a security. However, faced with a barrage of negative publicity, Goldman opted to settle the case out of court and pay a $550 million fine. In doing so, Goldman admitted no legal wrongdoing, but did say that the company had made a “mistake” in not disclosing Paulson’s role, and vowed to raise its standards for the future. Teaching Note: The alleged fraud committed by Goldman Sachs is an excellent example of the themes in this chapter. How were their actions not in the best interests of the investors? What governance mechanisms were lacking to allow Goldman Sachs to conspire against their personal clients? Was the fine of $550 million which Goldman Sachs paid anticipating negative publicity fair for their behavior? What motivated their unethical behavior and what measures could have been taken to curtail such behavior at an early stage? Answers to Case Discussion Questions 1. Did Goldman Sachs break the law by not telling investors that Paulson had created the synthetic CDOs and was betting against them? Was it unethical for Goldman Sachs to market the CDOs? Student answers will vary. In April 2010, Goldman Sachs was formally charged by the SEC with civil fraud. However, it argued that a market maker like Goldman Sachs owes no fiduciary duty to clients and offers no warranties—it is up to clients to make their own assessment of the value of a security. Goldman Sachs did pay a fine of $550 million to avoid negative publicity. In doing so, Goldman admitted no legal wrongdoing, but did say that the company had made a “mistake” in not disclosing Paulson’s role, and vowed to raise its standards for the future. They may not have broken the law. However, they did violate the ethical code towards their investors. Ethically, as individuals we are taught that it is wrong to lie and cheat and that it is right to behave with integrity and honor and to stand up for what we believe to be right and true. Goldman Sachs argued that it owes no fiduciary duty to clients and offers no warranties even though it kept information from its clients regarding the involvement of Paulson in creating the synthetic CDOs. This was unethical. It also bet against the very same bonds that it had been selling. This speaks volumes of its unethical behavior. 2. Would your answer to the question above change if Goldman had not made billions from selling the CDOs? Would your answer to the question above change if Paulson had been wrong, and the CDOs had increased in value? Student answers will vary. Some of them will not change their answer to the question above. If Paulson had been wrong, and the CDOs had increased in value, the answer to the above question would still be the same. They would emphasize that the ethical code should be followed in every aspect of life whether one incurs gain or loss. 3. If opinions vary about the quality or riskiness of an investment, does a firm like Goldman Sachs owe a fiduciary duty to its clients to try to represent all of those opinions? Student answers will vary. Some of them may say that a market maker like Goldman Sachs owes no fiduciary duty to clients and offers no warranties—it is up to clients to make their own assessment of the value of a security. However, if the firm knowingly misleads investors about the risk and value of an investment it can be formally charged with civil fraud. 4. Is it unethical for a company like Goldman to permit its managers to trade on the company’s account (i.e., invest on the company’s behalf rather than an external client’s behalf)? If not, how should compensation policies be designed to prevent conflicts of interest from arising between trades on behalf of the firm and trades on behalf of clients? Student answers will vary. Some of them may say that it is not unethical for a company like Goldman to permit its managers to trade on the company’s account. Companies can adopt pay-for-performance systems as compensation policies for managers. Giving managers stock options has been the most common pay-for-performance system. Ideally, stock options will motivate managers to adopt strategies that increase the share price of the company, in doing so managers will also increase the value of their own stock options. Performance based system can also prevent conflicts of interest from arising between trades on behalf of the firm and trades on behalf of clients. CHAPTER 12 Implementing Strategy in Companies That Compete in a Single Industry Synopsis of Chapter Chapter 12 examines how managers can best implement their strategies in single-industry firms in order to achieve a competitive advantage and superior performance. First, the main elements of strategy implementation—structure, control systems, and culture—are analyzed in detail, focusing on the way they work together to create an organizing framework. The chapter then turns to the topic of using structure, control, and culture at the functional level to build distinctive competencies. After that, the chapter addresses the challenges of implementing the generic business strategies of cost leadership or differentiation in a single industry. The final section covers restructuring and reengineering, two strategies that single-business firms can use to improve corporate performance. Learning OBJECTIVES 1. Understand how organizational design requires managers to select the right combination of organizational structure, control, and culture. 2. Discuss how effective organizational design enables a company to increase product differentiation, reduce its cost structure, and build competitive advantage. 3. Explain why it is so important that strategic managers keep the organizational hierarchy as flat as possible and what factors determine the way they decide to centralize or decentralize authority. 4. Explain the many advantages of a functional structure and why and when it becomes necessary to utilize a more complex form of organizational structure. 5. Differentiate between the more complex forms of organizational structure managers adopt to implement specific kinds of business-level strategies. Opening Case Organization at Apple Apple has a legendary ability to produce a steady stream of innovative new products and product improvements that are differentiate by design elegance and ease of use. Product innovation is in many ways the essence of what the company has always done, and what it strives to continue doing. Apple’s ability to continue to innovate, and to improve its existing product offerings, is in large part a result of its organizational structure, controls, and culture. Unlike most companies of its size, Apple has a functional structure. The people reporting directly to current CEO Tim Cook include the senior vice presidents of operations, Internet software and services, industrial design, software engineering, hardware engineering, and worldwide marketing, along with the CFO and company general council. This group meets every Monday morning to review the strategy of the company, its operations, and ongoing product development efforts. Product development at Apple is a cross-functional effort that requires intense coordination. This coordination is achieved through a centralized command and control structure, with the top-management group driving collaboration and the industrial design group setting key parameters. A key feature of the culture of Apple is the secrecy surrounding much of what the company does. Not only is information that reaches the outside world tightly controlled, so is the flow of information within the company. Teaching Note: This case does a good job at describing how organizational structure and culture have a direct effect on a company’s profile. Apple’s functional organization, the tight coordination between functions, the strong power vested in the industrial design function, the tradition of responsibility and accountability at the level of individual tasks, and a culture that keeps new product ideas under wraps until they hit the market all come together to support the company’s goal of producing revolutionary new products that surprise and change the world. Based on this case students should recognize how organizational structure and culture can support a company’s strategy of differentiation through product innovation. Lecture Outline I. Overview This chapter examines how managers can best implement their strategies through their organization’s structure and culture to achieve a competitive advantage and superior performance. A well-thought-out strategy becomes profitable only if it can be implemented successfully. In practice, however, implementing strategy through structure and culture is a difficult, challenging, and never-ending task. The chapter discusses how strategic managers can use structure, control, and culture to pursue functional-level strategies that create and build distinctive competencies. It also discusses the implementation issues facing managers in a single industry at the industry level. II. Implementing Strategy through Organizational Design Strategy implementation involves the use of organizational design, the process of deciding how a company should create, use, and combine organizational structure, control systems, and culture to pursue a business model successfully. Organizational structure assigns employees to specific value creation tasks and roles and specifies how these tasks and roles are to work together in a way that increases efficiency, quality, innovation, and responsiveness to customers—the distinctive competencies that build competitive advantage. The purpose of organizational structure is to coordinate and integrate the efforts of all employees at all levels—corporate, business, and functional—and across a company’s functions and business units so that all levels work together in a way that will allow the company to achieve the specific set of strategies in its business model. Organizational structure does not, by itself, provide the set of incentives through which people can be motivated to make the company work. Hence, there is need for control systems. The purpose of a control system is to provide managers with: • A set of incentives to motivate employees to work toward increasing efficiency, quality, innovation, and responsiveness to customers • Specific feedback on how well an organization and its members are performing and building competitive advantage so that managers can continuously take action to strengthen a company’s business model Organizational culture, the third element of organizational design, is the specific collection of values, norms, beliefs, and attitudes that are shared by people and groups in an organization and that control the way they interact with each other and with stakeholders outside the organization. Organizational culture is a company’s way of doing something—it describes the characteristic ways in which members of an organization get the job done. Organizational structure, control, and culture are the means by which an organization motivates and coordinates its members to work toward achieving the building blocks of competitive advantage (Figure 12.1). Organizational structure, control, and culture shape people’s behaviors, values, and attitudes and determine how they will implement an organization’s business model and strategies. On the basis of such an analysis, top managers can devise a plan to reorganize or change their company’s structure, control systems, and culture to improve coordination and motivation. Figure 12.1: Implementing Strategy through Organizational Design III. Building Blocks of Organizational Structure The value creation activities of organizational members are meaningless unless some type of structure is used to assign people to tasks and connect the activities of different people and functions. Managers must make three basic choices: • How best to group tasks into functions and to group functions into business units or divisions to create distinctive competencies and pursue a particular strategy. • How to allocate authority and responsibility to these functions and divisions. • How to increase the level of coordination or integration between functions and divisions as a structure evolves and becomes more complex. A. Grouping Tasks, Functions, and Divisions Because an organization’s tasks are, to a large degree, a function of its strategy, the dominant view is that companies choose a form of structure to match their organizational strategy. A function is a collection of people who work together and perform the same types of tasks or hold similar positions in an organization. As organizations grow and produce a wider range of products, the amount and complexity of the handoffs—that is, the work exchanges or transfers among people, functions, and subunits—increase. The communications and measurement problems and the managerial inefficiencies surrounding these transfers or handoffs are a major source of bureaucratic costs. Managers first group tasks into functions, and then, group functions into a business unit or division, to reduce bureaucratic costs. A division is a way of grouping functions to allow an organization to better produce and transfer its goods and services to customers. Top managers can choose from the many kinds of structures to group their activities. The choice is made on the basis of the structure’s ability to successfully implement the company’s business models and strategies. B. Allocating Authority and Responsibility As organizations grow and produce a wider range of goods and services, the size and number of their functions and divisions increase. The number of handoffs, or transfers, between employees also increases. To economize on bureaucratic costs and effectively coordinate the activities of people, functions, and divisions, managers must develop a clear and unambiguous hierarchy of authority, or chain of command, that defines each manager’s relative authority beginning with the CEO, continuing through middle managers and first-line managers, and then to the employees who directly make goods or provide services. Every manager at every level of the hierarchy supervises one or more subordinates. The term span of control refers to the number of subordinates who report directly to a manager. 1. Tall and Flat Organizations Companies choose the number of hierarchical levels they need on the basis of their strategy and the functional tasks necessary to create distinctive competencies. As an organization grows in size or complexity (measured by the number of its employees, functions, and divisions), its hierarchy of authority typically lengthens, making the organizational structure “taller.” A tall structure has many levels of authority relative to company size; a flat structure has fewer levels relative to company size (Figure 12.2). Figure 12.2: Tall and Flat Structures As the hierarchy becomes taller, problems that make the organization’s structure less flexible and slow managers’ response to changes in the competitive environment may result. • Communication problems may arise. When an organization has many levels in the hierarchy, it can take a long time for the decisions and orders of top managers to reach other managers in the hierarchy, and it can take a long time for top manager to learn how well the actions based upon their decisions work. • A second communication problem that can result is the distortion of commands and orders as they are transmitted up and down the hierarchy, which causes managers at different levels to interpret what is happening in their own unique way. • Tall hierarchies usually indicate that an organization is employing too many expensive managers, creating a third problem. Managerial salaries, benefits, offices, and secretaries are a huge expense for organizations. 2. The Minimum Chain of Command To avoid the problems that result when an organization becomes too tall and employs too many managers, top managers need to ascertain whether they are employing the right number of top, middle, and first-line managers, and see whether they can redesign their hierarchies to reduce the number of managers. Top managers might follow a basic organizing principle—the principle of the minimum chain of command which states that a company should choose the hierarchy with the fewest levels of authority necessary to use organizational resources efficiently and effectively. Effective managers constantly scrutinize their hierarchies to see whether the number of levels can be reduced. This practice has become increasingly common as companies battle with low-cost overseas competitors and search for ways to reduce costs. When companies become too tall, and the chain of command too long, strategic managers tend to lose control over the hierarchy, which means they lose control over their strategies. Disaster often follows because a tall organizational structure decreases, rather than promotes, motivation and coordination between employees and functions, and bureaucratic costs escalate as a result. 12.1 Strategy in Action: Bob Iger Flattens Disney Bob Iger, COO of Disney, chose to eliminate the bureaucratic bottleneck that stifled new ideas and innovation. Claiming that top managers followed financial rules that did not lead to innovation, he dismantled/dissolved Disney’s central strategic planning office and reassigned the managers back to different business units. The result: • Increased ideas generated from business units • Increased innovation • Increased motivation to speak out and champion ideas Teaching Note: This case illustrates the importance of choosing to centralize or decentralize, and for Disney, the decision was to decentralize. You can point out to students that both centralization and decentralization have advantages and disadvantages, and that companies must continually strike the right balance somewhere between the two. For class discussion, you can ask students whether they would prefer to work in a highly centralized or a highly decentralized company. Do specific types of industries call for one type over the other? Why? In what situations would a centralized strategy be the best choice? 3. Centralization or Decentralization? One important way to reduce the problems associated with too-tall hierarchies and reduce bureaucratic costs is to decentralize authority—that is vest authority in managers at lower levels in the hierarchy as well as at the top. Authority is centralized when managers at the upper levels of a company’s hierarchy retain the authority to make the most important decisions. When authority is decentralized, it is delegated to divisions, functions, and employees at lower levels in the company. There are three advantages to decentralization: • When top managers delegate operational decision-making responsibility to middle- and first-level managers, they reduce information overload and are able to spend more time on competitively positioning the company and strengthening its business model. • When managers in the bottom layers of the company become responsible for implementing strategies to suit local conditions, their motivation and accountability increase. o The result is that decentralization promotes flexibility and reduces bureaucratic costs because lower-level managers are authorized to make on-the-spot decisions; handoffs are not needed. • When lower-level employees are given the right to make important decisions, fewer managers are needed to oversee their activities and tell them what to do—a company can flatten its hierarchy. Centralization has its advantages, too. • Centralized decision making allows for easier coordination of the organizational activities needed to pursue a company’s strategy. • Centralization also means that decisions fit an organization’s broad objectives. • In times of crisis, centralization of authority permits strong leadership because authority is focused upon one person or group. o This focus allows for speedy decision making and a concerted response by the whole organization. 12.2 Strategy in Action: Centralization and Decentralization at Union Pacific and Yahoo! In early-2000s, Union Pacific (UP) faced record increases in railroad freight demands coupled with customer service deficiencies. UP’s top managers decided to centralize authority high in the organization and to standardize operations to reduce operating costs. Scheduling and route planning functions handled at the central office with idea of increasing efficiency. However, continued demands for customers responsiveness and efficiency, prompted UP to decentralize operational decisions which has proven successful. On the other hand, Yahoo was recently forced by circumstances to centralize its operation. Its failed merger with Microsoft and increased competition from new entrants such as Google, Facebook and Twitter led to plunging stock prices. Its new CEO, Carol Bartz, centralized functions once performed at the business-unit level, such as product development and marketing. The strategy is meant to gain control, and reduce operating costs. While reigning in business units for better control, Bartz also involved employees in all levels of the organization for input. In 2011, Yahoo! was still in a precarious position with Microsoft, and other dot-coms who had more resources. In the same year, Bartz was fired, Microsoft and Google battled for Yahoo’s acquisition, and Yahoo! is still for sale. Teaching Note: The case presents two companies that changed their organizational structures during times of struggle; one choosing to decentralize authority and the other choosing to recentralize authority. What were the conditions that forced each of these changes? What pitfalls may occur with each strategy? How will the changes affect stakeholders—employees, customers, suppliers, etc? What impact did Bartz’s ‘town hall meetings’ have on organizational culture? Which system do students think produces a better organizational culture? C. Integration and Integrating Mechanisms Much coordination takes place among people, functions, and divisions through the hierarchy of authority. Often, however, as a structure becomes complex, this is not enough, and top managers need to use various integrating mechanisms to increase coordination and communication among functions and divisions. The greater the complexity of an organization’s structure, the greater is the need for coordination among people, functions, and divisions to make the organizational structure work efficiently. 1. Direct Contact Direct contact among managers creates a context within which managers from different functions or divisions can work together to solve mutual problems. Managers from different functions may have different views about what must be done to achieve organizational goals. But if the managers have equal authority, the only manager who can tell them what to do is the CEO. 2. Liaison Roles Managers can increase coordination among functions and divisions by establishing liaison roles. When the volume of contacts between two functions increases, one way to improve coordination is to give one manager in each function or division the responsibility for coordinating with the other. The responsibility for coordination is part of the liaison’s full-time job, and usually an informal relationship forms between the people involved, greatly easing strains between functions. Furthermore, liaison roles provide a way of transmitting information across an organization, which is important in large organizations where employees may know no one outside their immediate function or division. 3. Teams When two or more functions share many common ongoing problems, direct contact and liaison roles may not provide sufficient coordination. In these cases, a more complex integrating mechanism, the team, may be appropriate. One manager from each relevant function or division is assigned to a team that meets to solve a specific mutual problem; team members are responsible for reporting back to their subunits on the issues addressed and the solutions recommended. IV. Strategic Control Systems Managers choose the organizational strategies and structure they hope will allow the organization to use its resources most effectively to pursue its business model and create value and profit. Then they create strategic control systems, tools that allow them to monitor and evaluate whether, in fact, their strategies and structure are working as intended, how they could be improved, and how they should be changed if they are not working. Strategic control is not only about monitoring how well an organization and its members are currently performing, or about how well the firm is using its existing resources. It is also about how to create the incentives to keep employees motivated and focused on the important problems that may confront an organization in the future so that the employees work together and find solutions that can help an organization perform better over time. Strategic control helps managers obtain superior efficiency, quality, innovation, and responsiveness to customers—the four basic building blocks of competitive advantage. An effective control system should have three characteristics: • It should be flexible enough to allow managers to respond as necessary to unexpected events. • It should provide accurate information, thus giving a true picture of organizational performance. • It should supply managers with the information in a timely manner because making decisions on the basis of outdated information is a recipe for failure. Designing an effective strategic control system requires four steps—establishing standards and targets, creating measuring and monitoring systems, comparing performance against targets, and evaluating results (Figure 12.3). Figure 12.3: Steps in Designing an Effective Strategic Control System A. Levels of Strategic Control Strategic control systems are developed to measure performance at for levels in company: • Corporate • Divisional • Functional • Individual levels Care must be taken to ensure that the standards used at each level do not cause problems at the other levels. Furthermore, controls at each level should provide the basis upon which managers at lower levels design their control systems. Figure 12.4 illustrates these relationships Figure 12.4: Levels of Organizational Control B. Types of Strategic Control Systems The balanced scorecard approach is as a way to ensure that manage complement the use of return on invested capital (ROIC) with other kinds of strategic controls to ensure they are pursuing strategies that maximize long-run profitability. Three more types of control systems are personal control, output control, and behavior control. 1. Personal Control Personal control is the desire to shape and influence the behavior of a person in a face-to-face interaction in the pursuit of a company’s goals. The most obvious kind of personal control is direct supervision from a manager farther up in the hierarchy. 2. Output Control Output control is a system in which strategic managers estimate or forecast appropriate performance goals for each division, department, and employee, and then measure actual performance relative to these goals. Often a company’s reward system is linked to performance on these goals, so output control also provides an incentive structure for motivating employees at all levels in the organization. Divisional goals state corporate managers’ expectations for each division concerning performance on dimensions such as efficiency, quality, innovation, and responsiveness to customers. Generally, corporate managers set challenging divisional goals to encourage divisional managers to create more effective strategies and structures in the future. Output control at the functional and individual levels is a continuation of control at the divisional level. Divisional managers set goals for functional managers that will allow the division to achieve its goals. Functional managers establish goals that individual employees are expected to achieve to allow the function to meet its goals. Functions and individuals are then evaluated based on whether or not they are achieving their goals. The inappropriate use of output control can promote conflict among divisions. In general, setting across-the-board output targets, such as ROIC targets for divisions, can lead to destructive results if divisions single-mindedly try to maximize divisional ROIC at the expense of corporate ROIC. 3. Behavior Control Behavior control is control achieved through the establishment of a comprehensive system of rules and procedures to direct the actions or behavior of divisions, functions, and individuals. The intent of behavior controls is not to specify the goals but to standardize the way or means of reaching them. Rules standardize behavior and make outcomes predictable. The primary kinds of behavior controls are operating budgets, standardization, and rules and procedures. Once managers at each level have been given a goal to achieve, they establish operating budgets that regulate how managers and workers are to attain those goals. An operating budget is a blueprint that outlines how managers intend to use organizational resources to most efficiently achieve organizational goals. Once a budget is determined, lower-level managers must decide how they will allocate finances for different organizational activities. Managers are then evaluated on the basis of their ability to stay within the budget and make the best use of it. Most commonly, large companies treat each division as a stand-alone profit center, and corporate managers evaluate each division’s performance by its relative contribution to corporate profitability. Standardization refers to the degree to which a company specifies how decisions are to be made so that employees’ behavior becomes predictable. In practice, there are three things and organization can standardize: • Inputs—when managers standardize, they screen inputs according to preestablished criteria, or standards that determine which inputs to allow into the organization. Just-in-time (JIT) inventory systems also help standardize the flow of inputs. • Conversion activities—the aim of standardizing conversion activities is to program work activities so that they can be done the same way time and time again; the goal is predictability. Behavior controls, such as rules and procedures, are among the chief means by which companies can standardize throughputs. • Outputs—The goal of standardizing outputs is to specify what the performance characteristics of the final product or service should be. Top management must be careful to monitor and evaluate the usefulness of behavior controls over time. Rules constrain people and lead to standardized, predictable behavior. However, rules are always easier to establish than to get rid of, and over time the number of rules an organization uses tends to increase. Consequently, the organization and the people within it become inflexible and are slow to react to changing or unusual circumstances. C. Strategic Reward Systems Organizations strive to control employees’ behavior by linking reward systems to their control systems. Based on a company’s strategy, strategic managers must decide which behaviors to reward. They then create a control system to measure these behaviors and link the reward structure to them. Determining how to relate rewards to performance is a crucial strategic decision because it determines the incentive structure that affects the way managers and employees behave at all levels in the organization. For example, top managers can be encouraged to work on behalf of shareholders’ interests when rewarded with stock options linked to a company’s long-term performance. V. Organizational Culture The third element of successful strategy implementation is managing organizational culture, the specific collection of values and norms shared by people and groups in an organization. Organizational values are beliefs about what kinds of goals the members of an organization should pursue and about the appropriate kinds or standards of behavior organizational members should use to achieve these goals. From organizational values develop organizational norms, guidelines, or expectations that prescribe appropriate kinds of behavior by employees in particular situations and control the behavior of organizational members toward one another. Organizational culture functions as a kind of control because strategic managers can influence the kind of values and norms that develop in an organization—values and norms that specify appropriate and inappropriate behaviors, and that shape and influence the way its members behave. For example, managers might cultivate values that tell employees they should always be conservative and cautious in their dealings with others, consult with their superiors before they make important decisions, and record their actions in writing so they can be held accountable for what happens. Organizational socialization is the term used to describe how people learn organizational culture. Through socialization, people internalize and learn the norms and values of the culture so that they become organizational members. A. Culture and Strategic Leadership Strategic leadership is also provided by an organization’s founder and top managers, who help create its organizational culture. The organization’s founder is particularly important in determining culture because the founder imprints his or her values and management style on the organization. The founder’s established leadership style is transmitted to the company’s managers; as the company grows, it typically attracts new managers and employees who share the same values. Thus, a company’s culture becomes more distinct as its members become more similar. Strategic leadership also affects organizational culture through the way managers design organizational structure—that is, the way they delegate authority and divide task relationships. Thus, the way an organization designs its structure affects the cultural norms and values that develop within the organization. Focus On: Wal-Mart How Sam Walton Shaped Wal-Mart’s Culture Sam Walton, founder of Wal-Mart, created a culture where: • Employees take a hands-on approach to their jobs • Employees are committed to Wal-Mart’s main goal • Employees are provided continuous feedback on individual and company performance • Customers are number one (customer-oriented values) • Both employees and customers feel valued and respected by the company. Of late, Wal-Mart has suffered negative publicity for some of its employment practices. Critics accuse Wal-Mart of having a “hidden” culture of low wages, inadequate health benefits, and anti-union tactics. Wal-Mart has been forced to respond to litigation through huge payouts and increase employee health benefits while at the same time searching for way to reduce the cost of those benefits or pass the cost to the employees. Teaching Note: This case is intended to illustrate leadership’s role in establishing business culture. Sam Walton was able to create an incredibly successful organizational culture which served to both control and motivate employees’ behavior. Ask the students for ideas of what may change the future culture of Wal-Mart. Ask for examples of other companies with organizational cultures that stand out. Do students think culture is ultimately more important in the long run than structure or controls? Which of the three is easiest to change? B. Traits of Strong and Adaptive Corporate Cultures Few environments are stable for a prolonged period of time. If an organization is to survive, managers must take actions that enable it to adapt to environmental changes. Managers can try to create an adaptive culture, one that is innovative and encourages initiative-taking by middle- and lower-level managers for taking initiative. Managers in organizations with adaptive cultures are able to introduce changes in the way the organization operates, including changes in its strategy and structure that allow it to adapt to changes in the external environment. T. J. Peters and R. H. Waterman argue that adaptive organizations show three common value sets: • Successful companies have values promoting a bias for action. The emphasis is on autonomy and entrepreneurship, and employees are encouraged to take risks. • The second set of values stems from the nature of the organization’s mission. The company must continue to do what it does best and develop a business model focused on its mission. • The third set of values determines how to operate the organization. A company should attempt to establish an organizational design that will motivate employees to perform best. VI. Building Distinctive Competencies at the Functional Level The best kind of structure to use to group people and tasks to build competencies for most companies is to group them by function and crate a functional structure. A. Functional Structure: Grouping by Function In the quest to deliver a final product to the customer, two related value chain management problems increase. • The range of value-chain activities that must be performed expands, and it quickly becomes clear that a company lacks the expertise needed to perform these activities effectively. • A single person cannot successfully perform more than one value-chain activity without becoming overloaded. Functional structures group people on the basis of their common expertise and experience or because they use the same resources. Figure 12.5 shows a typical functional structure. Figure 12.5: Functional Structure Functional structures have several advantages: • If people who perform similar tasks are grouped together, they can learn from one another and become more specialized and productive at what they do. • They can monitor each other to make sure that all are performing their tasks effectively and not shirking their responsibilities. • They give managers greater control of organizational activities. B. The Role of Strategic Control An important element of strategic control is to design a system that sets ambitious goals and targets for all managers and employees and then develops performance measures that stretch and encourage managers and employees to excel in their quest to raise performance. The structure also encourages organizational learning because managers working closely with subordinates can mentor them and help develop their technical skills. Grouping by function also makes it easier to apply output control. Measurement criteria can be developed to suit the needs of each function to encourage members to stretch themselves. Each function knows how well it is contributing to overall performance and the part it plays in reducing the cost of goods sold or the gross margin. Managers can look closely to see if they are following the principle of the minimum chain of command and whether or not they need several levels of middle managers. Perhaps, instead of using middle managers, they could practice management by objectives, a system in which employees are encouraged to help set their own goals so that managers manage by exception, intervening only when they sense something is not going right. C. Developing Culture at the Functional Level Often, functional structures offer the easiest way for managers to build a strong, cohesive culture. To understand how structure, control, and culture can help create distinctive competencies, think about how they affect the way these three functions operate—production, R&D, and sales operate. 1. Production In production, functional strategy usually centers upon improving efficiency and quality. A company must create an organizational setting in which managers can learn how to economize on costs and lower the cost structure. 2. R&D The functional strategy for an R&D department is to develop distinctive competencies in innovation, quality, and excellence that result in products that fit customers’ needs. Consequently, the R&D department’s structure, control, and culture should provide the coordination necessary for scientists and engineers to bring high-quality products quickly to market. 3. Sales Salespeople work directly with customers, and when they are dispersed in the field, these employees are especially difficult to monitor. The cost-effective way to monitor their behavior and encourage high responsiveness to customers is usually to develop sophisticated output and behavior controls. D. Functional Structure and Bureaucratic Costs No matter how complex their strategies become, most companies retain a functional orientation because of its many advantages. Whenever different functions work together, however, bureaucratic costs inevitably arise because of information distortions that lead to the communications, measurement, customers, location, and strategy problems. 1. Communication Problems As separate functional hierarchies evolve, functions can grow more remote from one another, and it becomes increasingly difficult to communicate across functions and coordinate their activities. This communication problem stems from differences in goal orientations—the various functions develop distinct outlooks or understandings of the strategic issues facing a company. 2. Measurement Problems Often a company’s product range widens as it develops new competencies and enters new market segments. When this happens, a company may find it difficult to gauge or measure the contribution of a product or a group of products to its overall profitability. 3. Customer Problems As the range and quality of an organization’s goods and services increase, often more and different kinds of customers are attracted to its products. Servicing the needs of more customer groups and tailoring products to suit new kinds of customers will result in increasing the handoff problems among functions. 4. Location Problems Being in a particular location or geographical region may also hamper coordination and control. 5. Strategic Problems The combined effect of all these factors results in long-term strategic considerations that are frequently ignored because managers are preoccupied with solving communication and coordination problems. The result is that a company may lose direction and fail to take advantage of new strategic opportunities—thus bureaucratic costs escalate. Experiencing one or more of these problems is a sign that bureaucratic costs are increasing. If this is the case, managers must change and adapt their organization’s structure, control systems, and culture to economize on bureaucratic costs, build new distinctive competencies, and strengthen the company’s business model. E. The Outsourcing Option Rather than move to a more complex, expensive structure, companies are increasingly turning to the outsourcing option and solving the organizational design problem by contracting with other companies to perform specific functional tasks. It does not make sense to outsource activities in which a company has a distinctive competency, because this would lessen its competitive advantage; but it does make sense to outsource and contract with companies to perform particular value-chain activities in which they specialize and therefore have a competitive advantage. One way of avoiding the kinds of communication and measurement problems that arise when a company’s product line becomes complex is to reduce the number of functional value-chain activities it performs. This allows a company to focus on those competencies that are at the heart of its competitive advantage and to economize on bureaucratic costs. VII. Implementing Strategy in a Single Industry To pursue an organization’s business model successfully, managers must find the right combination of structure, control, and culture that links and combines the competencies in a company’s value chain functions so that it enhances its ability to differentiate products or lower the cost structure. Therefore, it is important to coordinate and integrate across functions and business units or divisions. In organizational design, managers must consider two important issues—one concerns the revenue portion of the profit equation and the other concerns the cost portion (Figure 12.6). Figure 12.6: How Organizational Design Increases Profitability Effective organizational design improves the way in which people and groups choose the business-level strategies that lead to increasing differentiation, more value for customers, and the opportunity to charge a premium price. It reduces the bureaucratic costs associated with solving the measurement and communications problems that derive from factors such as transferring a product in progress between functions or a lack of cooperation between marketing and manufacturing or between business units. Effective organizational design often means moving to a more complex structure that economizes on bureaucratic costs. A. Implementing Cost Leadership The aim of a company pursuing cost leadership is to become the lowest-cost producer in the industry, and this involves reducing costs across all functions in the organization, including R&D and sales and marketing. To implement cost leadership, a company chooses a combination of structure, control, and culture compatible with lowering its cost structure while preserving its ability to attract customers. Cost leadership also requires that managers continuously monitor their structures and control systems to find ways to restructure or streamline them so that they operate more effectively. B. Implementing Differentiation Effective strategy implementation can improve a company’s ability to add value and to differentiate its products. To make its product unique in the eyes of the customer, for example, a differentiated company must design its structure, control, and culture around the particular source of its competitive advantage. Commonly, in pursuing differentiation, a company starts to produce a wider range of products to serve more market segments, which means it must customize its products for different groups of customers. These factors make it more difficult to standardize activities and usually increase the bureaucratic costs associated with managing the handoffs or transfers between functions. Integration becomes much more of a problem; communications, measurement, location, and strategic problems increasingly arise; and the demands upon functional managers increase. For successful differentiation, it is important that the various functions do not pull in different directions; indeed, cooperation among the functions is vital for cross-functional integration. However, when functions work together, output controls become much harder to use. This explains why companies pursuing differentiation often have a markedly different kind of culture from those pursuing cost leadership. Because human resources are often the source of differentiation, these organizations have a culture based on professionalism or collegiality that emphasizes the distinctiveness of the human resources rather than the high pressure of the bottom line. As a company’s business model and strategies evolve, strategic managers usually start to superimpose a more complex divisional grouping of activities on its functional structure to better coordinate value-chain activities. This is especially true of companies seeking to become broad differentiators—companies that have the ability to simultaneously increase differentiation and lower their cost structures. C. Product Structure: Implementing a Wide Product Line The structure that organizations most commonly adopt to solve the control problems that result from producing many different kinds of products for many different market segments is the product structure. The intent is to break up a company’s growing product line into a number of smaller, more manageable subunits to reduce bureaucratic costs due to communication, measurement, and other problems. An organization that chooses a product structure first divides its overall product line into product groups or categories (Figure 12.7). Each product group focuses on satisfying the needs of a particular customer group and is managed by its own team of managers. Second, to keep costs as low as possible, value-chain support functions such as basic R&D, marketing, materials, and finance are centralized at the top of the organization, and the different product groups share their services. Each support function, in turn, is divided into product-oriented teams of functional specialists who focus on the needs of one particular product group. This arrangement allows each team to specialize and become expert in managing the needs of its product group. Figure 12.7: Nokia’s Product Structure Strategic control systems can now be developed to measure the performance of each product group separately from the others. Thus, the performance of each product group is easy to monitor and evaluate, and corporate managers at the center can move more quickly to intervene if necessary. Also, the strategic reward system can be linked more closely to the performance of each product group, although top managers can still decide to make rewards based on corporate performance an important part of the incentive system. D. Market Structure: Increasing Responsiveness to Customer Groups Many companies develop a market structure that is conceptually quite similar to the product structure except that the focus is on customer groups instead of product groups. For a company pursuing a strategy based on increasing responsiveness to customers, it is vital that the nature and needs of each different customer group be identified. Then, employees and functions are grouped by customer or market segment. A typical market structure is shown in Figure 12.8. Figure 12.8: Market Structure A market structure brings customer group managers and employees closer to specific groups of customers. These people can then take their detailed knowledge and feed it back to the support functions, which are kept centralized to reduce costs. E. Geographic Structure: Expanding By Location Suppose a company begins to expand locally, regionally, or nationally through internal expansion or by engaging in horizontal integration and merging with other companies to expand its geographical reach. A company pursuing this competitive approach frequently moves to a geographic structure in which geographic regions become the basis for the grouping of organizational activities (Figure 12.9). Figure 12.9: Geographic Structure A geographic structure provides more coordination and control than a functional structure does because several regional hierarchies are created to take over the work, as in a product structure, where several product group hierarchies are created. At the same time, because the information systems, purchasing, distribution, and marketing functions remain centralized, companies can leverage their skills across all the regions. 12.3 Strategy in Action: The HISD Moves from a Geographic to a Market Structure Houston Independent School District (HISD) was faced with a boom of growth in new students to its schools. As a result, they expanded and eventually adopted a geographic structure to coordinate and control the educational functions. As before the growth boom, HISD came to encounter internal problems with slowdowns and infighting. With a new superintendent, HISD reorganized into a market structure—grouped by the needs of its customers—its students—and three “chief officers.” Cost savings, recentralizing to eliminate redundancies, and new support functions gave hope to HIDS administrators. However, budget deficits have prompted closures and a new integrated divisional structure. Teaching Note: HISD illustrates the necessity of structural change and how the changes impact performance indicators. In a class discussion, ask students to suggest specific ways that HISD could further improve its structure, culture, and control systems. F. Matrix and Product-Team Structures: Competing in High-Tech Environments The communication and measurement problems that lead to bureaucratic costs escalate quickly when technology is rapidly changing and industry boundaries are blurring. Frequently, competitive success depends upon rapid mobilization of a company’s skills and resources, and managers face complex strategy implementation issues. A new grouping of people and resources becomes necessary, often one that is based on fostering a company’s distinctive competencies in R&D. Managers need to make structure, control, and culture choices around the R&D function. At the same time, they need to ensure that implementation will result in new products that cost-effectively meet customer needs and will not result in products so expensive that customers will not wish to buy them. 1. Matrix Structure To address these problems, many companies choose a matrix structure. In a matrix structure, value-chain activities are grouped in two ways (Figure 12.10): • Activities are grouped vertically by function so that there is a familiar differentiation of tasks into functions. • In addition, superimposed upon this vertical pattern is a horizontal pattern based on grouping by product or project, in which people and resources are grouped to meet ongoing product development needs. Figure 12.10: Matrix Structure Matrix structures are flat and decentralized, and employees inside a matrix have two bosses: • A functional boss, who is the head of a function • A product or project boss, who is responsible for managing the individual projects All employees who work on a project team are called two-boss employees and are responsible for managing coordination and communication among the functions and projects. Implementing a matrix structure can promote innovation and speeds product development because this type of structure permits intensive cross-functional integration. Integrating mechanisms such as teams help transfer knowledge among functions and are designed around the R&D function. Matrix structures were first developed by companies in high-technology industries. These companies were developing radically new products in uncertain, competitive environments, and the speed of product development was the crucial consideration. This structure requires a minimum of direct hierarchical control by supervisors. Team members control their own behavior, and participation in project teams allows them to monitor other team members and to learn from each other. Furthermore, as the project goes through its different phases, different specialists from various functions are required. As the demand for the type of specialist changes, team members can be moved to other projects that require their services. Thus, the matrix structure can make maximum use of employees’ skills as existing projects are completed and new ones come into existence. The freedom given by the matrix not only provides the autonomy to motivate employees but also leaves top management free to concentrate upon strategic issues because they do not have to become involved in operating matters. In terms of strategic control and culture, the development of norms and values based on innovation and product excellence is vital if a matrix structure is to work effectively. The constant movement of employees around the matrix means that time and money are spent establishing new team relationships and getting the project running. The two-boss employee’s role, as it balances the interests of the project with the function, means that cooperation among employees is problematic, and conflict between different functions and between functions and projects is possible and must be managed. Furthermore, changing product teams, the ambiguity arising from having two bosses, and the greater difficulty of monitoring and evaluating the work of teams increase the problems of coordinating task activities. 2. Product-Team Structure A major structural innovation in recent years is the product-team structure. Its advantages are similar to those of a matrix structure, but it is much easier and far less costly to operate because of the way people are organized into permanent cross-functional teams (Figure 12.11). In the product-team structure, as in the matrix structure, tasks are divided along product or project lines. However, instead of being assigned only temporarily to different projects, as in the matrix structure, functional specialists become part of a permanent cross-functional team that focuses on the development of one particular range of products. As a result, the problems associated with coordinating cross-functional transfers or handoffs are much lower than in a matrix structure, in which tasks and reporting relationships change rapidly. Figure 12.11: Product-Team Structure Cross-functional teams are formed at the beginning of the product development process so that any difficulties that arise can be ironed out early, before they lead to major redesign problems. When all functions have direct input from the beginning, design costs and subsequent manufacturing costs can be kept low. Moreover, the use of cross-functional teams speeds innovation and customer responsiveness because, when authority is decentralized, team decisions can be made more quickly. Product A product-team structure groups tasks by product, and each product group is managed by a cross-functional product team that has all the support services necessary to bring the product to market. This is why it is different from the product structure, in which support functions remain centralized. G. Focusing on a Narrow Product Line A focused company concentrates on developing a narrow range of products aimed at one or two market segments, which may be defined by type of customer or location. As a result, a focuser tends to have a higher cost structure than a cost leader or differentiator, because output levels are lower, making it harder to obtain substantial scale economies. A company using a focus strategy normally adopts a functional structure to meet these needs. This structure is appropriate because it is complex enough to manage the activities necessary to make and sell a narrow range of products for one or a few market segments. At the same time, the handoff problems are likely to be relatively easy to solve because a focuser remains small and specialized. Thus, a functional structure can provide all the integration necessary, provided that the focused firm has a strong, adaptive culture, which is vital to the development of some kind of distinctive competency. Additionally, because such a company’s competitive advantage is often based on personalized service, the flexibility of this kind of structure allows the company to respond quickly to customers’ needs and change its products in response to customers’ requests. VIII. Restructuring and Reengineering To improve corporate performance, a single-business company often employs restructuring and reengineering. Restructuring a company involves two steps: • Streamlining the hierarchy of authority and reducing the number of levels in the hierarchy to a minimum • Reducing the number of employees to lower operating costs A company may operate more effectively using reengineering, which involves the “fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical, contemporary measures of performance, such as cost, quality, service, and speed. Instead of focusing on how a company’s functions operate, strategic managers make business processes the focus of attention. A business process is any activity that is vital to delivering goods and services to customers quickly or that promotes high quality or low costs. It is not the responsibility of any one function but cuts across functions. Because reengineering focuses on business processes, not on functions, a company that reengineers always has to adopt a different approach to organizing its activities. Companies that take up reengineering deliberately ignore the existing arrangement of tasks, roles, and work activities. They start the reengineering process with the customer. Reengineering and TQM, are highly interrelated and complementary. Successful organizations examine both issues simultaneously and continuously attempt to identify new and better processes for meeting the goals of increased efficiency, quality, and customer responsiveness. Teaching Note: Ethical Dilemma The ethical principles of equality, fairness, and justice should be part of every decision that every company makes. Ethical principles should be explicitly stated and adhered to in all aspects of enterprise activities—from the mission statement to the employee handbook—so that stakeholders can be assured that decisions are made ethically, for the right reasons. The claim of an employee that he or she “deserves” employment because of past contributions to the company’s success is an understandable claim, but has little to do with ethics. Managers who use favoritism, nepotism, self-dealing or other unethical behavior in decision-making do so because their company lacks the proper ethical culture and controls to thwart this behavior. Lead students to a discussion of how to create an ethics-based organization and why it is important to do so. Answers to Discussion Questions 1. What is the relationship among organizational structure, control, and culture? Give some examples of when and under what conditions a mismatch among these components might arise. Organizational structure, control, and culture are the main tools used in strategy implementation; therefore, each must be in harmony with the others. For example, if an organization’s culture were informal and collegial, then a highly centralized and bureaucratic organizational structure would be inappropriate. When each is in harmony with the others, organizational effectiveness will be greatly enhanced. As an organization grows and experiences change, mismatch between these three elements can occur. Students’ examples will vary. Some of them may talk about Time Warner’s purchase of Turner Broadcasting. Time Warner experienced post-acquisition integration problems because Turner’s entrepreneurial culture didn’t mesh with Time Warner’s more conservative culture. Mismatch might also result from a change in societal expectations, such as the way in which many firms have changed their culture to embrace diversity. In summary, virtually any type of change may lead to a need to realign the company’s structure, control, and/or culture. 2. What kind of structure best describes the way your (a) business school and (b) university operate? Why is the structure appropriate? Would another structure fit better? Students’ answers may vary. You may need to give students information about organizational structure, as well as the school’s and university’s strategic goals, resources, and external pressure, in order to equip them to answer this question properly. As they answer the questions, encourage them to think about the relationship between strategy and structure. 3. When would a company choose a matrix structure? What are the problems associated with managing this structure, and why might a product-team structure be preferable? Companies use a matrix structure when they need a high level of coordination and communication in order to effectively deal with a fast-changing high-tech environment. The benefits include a simultaneous emphasis on functions and products, a flat organization structure, strong cross-functional integration leading to speed and flexibility, and employee autonomy. Disadvantages of the matrix structure include the time and effort needed to repeatedly formulate teams, the potential for conflict between functional and product managers, and the difficulty of monitoring performance when workers report to two supervisors. Because of the matrix structure’s disadvantages, companies might instead opt for a product-team structure, in which teams are permanent, rather than the temporary teams of the matrix design. The product-team structure has advantages over the matrix structure; especially in reduced time spent formulating and launching teams. 4. For each of the structures discussed in the chapter, outline the most suitable control systems. Students’ answers may vary. Some of them use the following table to outline the most suitable control systems for each structure:
Functional structure Personal supervision and organizational culture
Product structure Output control and bureaucratic culture
Geographic structure Output control and organizational culture
Matrix structure Organizational culture and teams
Product-team structure Organizational culture and bureaucratic control
5. What kind of structure, controls, and culture would you be likely to find in (a) a small manufacturing company, (b) a chain store, (c) a high-tech company, and (d) a Big Four accounting firm? Students’ answers may vary. Some of them may say that a small manufacturing company would be likely to use a functional structure, which is simple and allows for task specialization. Because this company is small, its need for coordination is relatively low, and thus, the functional structure would be best. Control is likely to be personal supervision because the top managers of the firm can have personal contact with every employee. Organizational culture would probably tend to focus on friendly, informal relationships between workers and managers. A chain store would most likely use a geographic structure. This allows the stores to customize product offerings for regional tastes, selling bathing suits in the South and ice skates in the North, for example. Control is likely to be output control, focused on setting challenging goals. Culture would probably emphasize rule compliance and be more formal and bureaucratic in style. A high-tech company would probably use a product-team structure, because that allows flexibility, innovation, and knowledge sharing, while still supporting functional specialization. Controls are likely to be through direct supervision and from group members. The organization’s culture would tend to encourage innovation and entrepreneurial spirit. A Big Four accounting firm would be likely to use a matrix structure, forming temporary audit teams as needed. Each team would contain functional leaders as well as project leaders. Control is likely to be bureaucratic in nature, emphasizing rule compliance. The organization’s culture would tend to encourage professionalism, impersonal relationships, teamwork, and hard work. Practicing Strategic Management Small-Group Exercise: Deciding on an Organizational Structure Students are asked to break into groups of three to five and discuss the following scenario. Your business model is based on increasing your product range to offer a soft drink in every segment of the market to attract customers. Currently you have a functional structure. What you are trying to work out now is how best to implement your business model to launch your new products. • Should you move to a more complex kind of product structure, and if so which one? • Alternatively, should you establish new-venture divisions and spin off each kind of new soft drink into its own company so that it can focus its resources on its market niche? Thinking strategically, the students are asked to debate the pros and cons of the possible organizational structures and decide which structure they will implement. Teaching Note: As students answer the questions, remind them that they must choose an organizational structure that would allow maximum performance under the conditions described in the case. They should be able to easily develop a list of advantages and disadvantages of each alternative structure, based on material found in the chapter. For classroom discussion, ask them to share their ideas with the class and debate the merits of each suggested alternative. You can use this exercise to again point out to students that no strategic choice is perfect—every decision creates advantages but also incurs costs and closes off other avenues. Strategy Sign-On Article File 12 Students should find a company that competes in one industry and has recently changed the way it implements its business model and strategies. They are to describe the changes the company made, why it made the changes, and what effect did the changes have on the behavior of people and functions. Teaching Note: Students will not have a hard time finding examples of firms that have recently changed their structure, controls, or culture. If they need guidance, suggest they look for firms that have recently entered or exited an industry, recently undergone a merger or acquisition, or experienced some other radical shift in their plans. Strategic Management Project: Module 12 This module asks students to identify how their chosen company implements its business model and strategy. For this part of the project, they need to obtain information about the company’s structure, control systems, and culture. Teaching Note: Students may encounter difficulty finding detailed information about their company’s structure, controls, and culture. Encourage them to be creative and make inferences where necessary. For example, interviewing a manager or employee of that firm, looking at job titles to gain an understanding of structure, assessing executive compensation practices for evidence about control, and even visiting a firm’s facilities may give clues. A visit to a local Wal-Mart would give them clues about how they treat their employees and customers, what the firm values, and so on. If the questions seem overwhelming, you can assign a subset. For example, questions 1 and 2 together explore issues about authority, whereas questions 3 and 4 address the organization’s type of structure. CLOSING CASE Alan Mulally Transforms Ford’s Structure and Culture After a loss of more than $13 billion in 2006, William Ford III and other top managers realized they were part of Ford’s management problems. Deciding they needed an outsider to change the way the company operated, Ford recruited Alan Mulally to become the new CEO at Ford. Taking over a culture that never admitted mistakes when they didn’t know something, Mulally discovered that Ford had a tall hierarchy and a lot of turf protecting. He changed Ford’s structure through reorganization. He flattened Ford’s structure and re-centralized control, while at the same time emphasizing teamwork and a cross-functional approach to solving value chain problems. He, also, changed Ford’s culture to that of sharing information, creating new values and norms that encouraged employees to admit mistakes, and finding ways to speed development and reduce costs. Mulally’s efforts helped produce record profits and sales by 2011. Teaching Note: This case does a good job at describing the benefits of changing structure and culture to produce competitive advantages. Ford’s tall hierarchy had increased costs and created too much bureaucracy to get things done. Mulally’s ability to create change successfully brought profitability to Ford after troubled times. Students should realize that organization structure is not static, and that firms should constantly assess internal factors that hinder performance. Answers to Case Discussion Questions 1. How did organizational structure and culture contribute to the poor performance of Ford prior to the arrival of Alan Mulally? Over the years Ford had developed a tall hierarchy composed of managers whose primary goal was to protect their turf and avoid any direct blame for its plunging car sales. When asked why car sales were falling, they did not admit to bad design and poor-quality issues in their divisions; instead they hid in the details. Ford’s top executives had an inward-looking, destructive mind-set. This is how the organizational structure and culture contributed to the poor performance of Ford prior to the arrival of Mulally. 2. One of the first things Mulally did was to flatten the organizational structure at Ford and clearly articulate lines of responsibility. How do you think this contributed to improving Ford’s performance? Students’ answers may vary. Some of them may say that because a flat structure has fewer levels, the organizational structure became more flexible and probably fastened the managers’ response to changes in the competitive environment. 3. Why was changing the organizational structure not enough to improve Ford’s performance? Simply changing Ford’s structure was not enough to change the way it operated because its other major organizational problem was that the values and norms in Ford’s culture that had developed over time hindered cooperation and teamwork. These values and norms promoted secrecy and ambiguity; they emphasized status and rank so managers could protect their information. The managers of its different divisions and functions believe that the best way to maintain jobs and status was to hoard, rather than share, information. 4. How did Mulally go about changing the culture of Ford? How did this cultural change impact the company’s performance? Mullaly issued a direct order that the managers of every division share with every other Ford division a detailed statement of the costs they incurred to build each of its vehicles. He insisted that each of Ford’s divisional presidents should attend a weekly (rather than a monthly) meeting to openly share and discuss the problems all the company’s divisions faced. He also told managers they should bring a different subordinate with them to each meeting so every manager in the hierarchy would learn of the problems that had been kept hidden. Essentially, Mulally’s goal was to demolish the dysfunctional values and norms of Ford’s culture that focused managers’ attention on their own empires at the expense of the entire company. By 2011, it was clear that Mulally’s attempts to change Ford’s structure and culture had succeeded. The company reported a profit in the spring of 2010. CHAPTER 13 Implementing Strategy in Companies That Compete Across Industries and Countries SYNOPSIS OF CHAPTER In this chapter, the focus is on firms that compete in more than one industry and/or more than one country. The first section describes the multidivisional structure, emphasizing its advantages and disadvantages. Next, the chapter describes four global strategies and describes how firms choose the correct strategy. This part of the chapter then details the relationship between global strategy and organizational structure. The chapter goes on to discuss entry modes for firms wishing to enter new industries, including internal new-venturing, joint-venturing, and mergers and acquisitions. This section contains a detailed description of actions that firms can effectively use for each of these entry modes. The final section relates the impact that information technology (IT) has had on strategy implementation, such as the increase in quality and quantity of information from the Internet that can facilitate decision making. This section also mentions the ways in which IT has impacted firms through enabling creation of a virtual organization and outsourcing. Learning Objectives 1. Discuss the reasons why companies pursuing different corporate strategies need to implement these strategies using different combinations of organizational structure, control, and culture. 2. Describe the advantages and disadvantages of a multidivisional structure. 3. Explain why companies that pursue different kinds of global expansion strategies choose different kinds of global structures and control systems to implement these strategies. 4. Discuss the strategy implementation problems associated with the three primary methods used to enter new industries: internal new venturing, joint ventures, and mergers. Opening Case Google Reorganizes In 2011 Google reorganized itself to try to improve its performance. Although Google has had stellar financial performance over the years, many of its new business ideas have failed to become big revenue generators. In an attempt to solve this problem, CEO Larry Page has essentially created a multidivisional structure at Google, with each “division” been given full responsibility to run its own operations, and being held accountable for its own performance. Google is not the first company to wrestle with the problem of how best to manage a company as it grows and starts to generate new-product offerings; there is in fact a long history of companies moving from a functional toward a multidivisional structure as they grow and start to diversify. The organizational structures that are optimal for managing a single business turn out to be inappropriate for managing a more diversified multibusiness enterprise, which Google is in the process of becoming. Indeed, by reorganizing itself, Google may promote more profitable business diversification. Teaching Note: The Google case is a good illustration of the challenges a company can face while implementing and reorganizing its global organizational structure. Ask students to identify the advantages and disadvantages of the strategy and their opinion on whether they think it will be successful or not? Lecture Outline I. Overview This chapter examines how to implement strategy when a company decides to enter and compete in new business areas, new industries, or in new countries when it expands globally. The strategy-implementation issue remains the same; deciding how to use organizational design and combine organizational structure, control, and culture to strengthen a company’s strategy and increase its profitability. II. Corporate Strategy and the Multidivisional Structure Important implementation problems arise when a company enters new industries, often due to the increasing bureaucratic costs associated with managing a collection of business units that operate in different industries. Bureaucratic costs are especially high when a company seeks to gain the differentiation and low-cost advantages of transferring, sharing, or leveraging its distinctive competencies across its business units in different industries. As a company begins to enter new industries and produce different kinds of products, the functional and product structures, are not up to the task. These structures cannot provide the level of coordination between managers, functions, and business units necessary to effectively implement corporate-level strategy. Experiencing these problems is a sign that a company has once again outgrown its structure. Managers need to invest additional resources to develop a different structure—one that allows the company to implement its corporate strategies successfully. The answer for most large, complex companies is to move to a multidivisional structure, design a cross-industry control system, and fashion a global corporate culture to reduce these problems and economize on bureaucratic costs A multidivisional structure has two organizational design advantages over a functional or product structure that allow a company to grow and diversify while also reducing the coordination and control problems that inevitably arise as it enters and competes in new industries: •In each industry in which a company operates, managers group all its different business operations in that industry into one division or subunit. Each industry division contains all the value-chain functions it needs to pursue its industry business model and is thus called a self-contained division. •The office of corporate headquarters staff is created to monitor divisional activities and exercise financial control over each division.. This office contains the corporate-level managers who oversee the activities of divisional managers. In the multidivisional structure, the day-to-day operations of each division are the responsibility of divisional management; that is, divisional managers have operating responsibility. The corporate headquarters staff, which includes top executives as well as their support staff, is responsible for overseeing the company’s long-term growth strategy and providing guidance for increasing the value created by interdivisional projects. Figure 13.1 illustrates a typical multidivisional structure found in a large chemical company. Figure 13.1: Multidivisional Structure A. Advantages of a Multidivisional Structure When managed effectively at both the corporate and the divisional levels, a multidivisional structure offers several strategic advantages. 1. Enhanced Corporate Financial Control The profitability of different business divisions is clearly visible in the multidivisional structure. Because each division is its own profit center, financial controls can be applied to each business on the basis of profitability criteria such as ROIC. 2. Enhanced Strategic Control The multidivisional structure makes divisional managers responsible for developing each division’s business model and strategies; this allows corporate managers to focus on developing corporate strategy, which is their main responsibility. The structure gives corporate managers the time they need to contemplate wider long-term strategic issues and develop a coordinated response to competitive changes, such as quickly changing industry boundaries. 3. Profitable Long-Term Growth The division of responsibilities between corporate and divisional managers in the multidivisional structure allows a company to overcome organizational problems, such as communication problems and information overload. Divisional managers work to enhance their divisions’ profitability; teams of managers at corporate headquarters devote their time to finding opportunities to expand or diversify existing businesses so that the entire company enjoys profitable growth. 4. Stronger Pursuit of Internal Efficiency Inside one company, considerable degrees of organizational slack—that is, the unproductive use of functional resources—can go undetected. In a multidivisional structure, however, corporate managers can compare the performance of one division’s cost structure, sales, and the profit it generates against another. The corporate office is therefore in a better position to identify the managerial inefficiencies that result in bureaucratic costs; divisional managers have no excuses for poor performance. B. Problems in Implementing a Multidivisional Structure Although research suggests large companies that adopt multidivisional structures outperform those that retain functional structures, multidivisional structures have their disadvantages as well. Good management can eliminate some of these disadvantages, but some problems are inherent in the structure. 1. Establishing the Divisional-Corporate Authority Relationship The multidivisional structure introduces a new level in the management hierarchy—the corporate level. Corporate managers face the problem of deciding how much authority and control to delegate to divisional managers, and how much authority to retain at corporate headquarters to increase long-term profitability. The most important issue in managing a multidivisional structure is how much authority to centralize at the corporate headquarters and how much should be decentralized to the divisions—in different industries or countries. There is no easy answer because every company is different. 13.1 Strategy in Action: Organizational Change at Avon After a decade of profitable growth, Avon suddenly began to experience across the board falling global sales in the mid-2000s. Andrea Jung, Avon’s CEO, recognized that the company had lost the balance between centralization and decentralization of authority. This imbalance had created decisions to benefit divisions rather than the company, operating costs had become out of control, and low-cost and differentiation advantages had become obsolete. Ultimately, the organizational structure had become taller. Jung’s approach to rebalance the company included restructuring the hierarchy with layoffs, transferring authority to regional and corporate managers, and finding the source of rising operating costs. Avon’s new structure includes centralizing new product development with customization input from area managers, having marketing campaigns targeted at the average global customer, and focusing on making operational decisions that lower costs and/or increase differentiation advantage. Teaching Note: The case highlights how rebalancing decentralization and centralization was a success for Avon. Avon’s problem of allowing managers in other countries to decentralize resulted in independent choices rather than beneficial company choices. Ask students to research on how Avon’s performance is today as a result of these changes. Also, have them reflect again on the advantages and disadvantages of a multibusiness strategy. 2. Restrictive Financial Controls lead to Short-Run Focus Suppose corporate managers place too much emphasis on each division’s individual profitability. Divisional managers may be engage in information distortion—that is, they may manipulate the facts they supply to corporate managers to hide declining divisional performance, or start to pursue strategies that increase short-term profitability but reduce future profitability. 3. Competition for Resources The third problem of managing a multidivisional structure is that when the divisions compete among themselves for scarce resources, this rivalry can make it difficult—or sometimes impossible—to obtain the gains from transferring, sharing, or leveraging distinctive competencies across business units. 4. Transfer Pricing Competition among divisions may lead to battles over transfer pricing, that is, conflicts over establishing the fair or “competitive” price of a resource or skill developed in one division that is to be transferred and sold to other divisions that require it. Setting prices for resource transfers between divisions is a major source of these problems, because every supplying division has the incentive to set the highest possible transfer price for its products or resources to maximize its own profitability. 5. Duplication of Functional Resources Because each division has its own set of value chain functions, functional resources are duplicated across divisions; thus, multidivisional structures are expensive to operate. R&D and marketing are especially costly functional activities; to reduce their cost structure, some companies centralize most of the activities of these two functions at the corporate level, in which they service the needs of all divisions. In sum, the advantages of divisional structures must be balanced against the problems of implementing them, but an observant, professional set of corporate (and divisional) managers who are sensitive to the complexities involved can respond to and manage these problems. Indeed, advances in information technology (IT) have made strategy implementation easier. C. Structure, Control, Culture, and Corporate-Level Strategy Once corporate managers select a multidivisional structure, they must then make choices about what kind of integrating mechanisms and control systems are necessary to make the structure work efficiently. Such choices depend on whether a company chooses to pursue a strategy of unrelated diversification, vertical integration, or related diversification. Many possible differentiation and cost advantages derive from vertical integration. For example, a company can coordinate resource transfers between divisions operating in adjacent industries to reduce manufacturing costs and improve quality. The principal benefits from related diversification also derive from transferring, sharing, or leveraging functional competencies across divisions, such as sharing distribution and sales networks to increase differentiation, or lowering the overall cost structure. With both strategies, the benefits to the company result from some exchange of distinctive competencies among divisions. In the case of unrelated diversification, the strategy is based on using general strategic management capabilities, for example, in corporate finance or organizational design. Corporate managers’ ability to create a culture that supports entrepreneurial behavior that leads to rapid product development, or to restructure an underperforming company and establish an effective set of financial controls, can result in substantial increases in profitability. The choice of structure and control mechanisms depends upon the degree to which a company using a multidivisional structure needs to control the handoffs and interactions among divisions. The more interdependent divisions are—that is, the more they depend on each other for skills, resources, and competencies—the greater the bureaucratic costs associated with obtaining the potential benefits from a particular corporate-level strategy. Table 13.1 illustrates what forms of structure and control companies should adopt to economize on the bureaucratic costs associated with the three corporate strategies of unrelated diversification, vertical integration, and related diversification. Table 13.1: Corporate Strategy, Structure, and Control 1. Unrelated Diversification Because there are no exchanges or no linkages among divisions, unrelated diversification is the easiest and cheapest strategy to manage; it is associated with the lowest level of bureaucratic costs. The primary advantage of the structure and control system is that it allows corporate managers to evaluate divisional performance accurately. Divisions usually have considerable autonomy unless they fail to reach their ROIC goals, in which case corporate managers will intervene in the operations of a division to help solve problems. As problems arise, corporate managers step in and take corrective action. If they see no possibility of a turnaround, they may decide to divest the division. The multidivisional structure allows the unrelated company to operate its businesses as a portfolio of investments that can be bought and sold as business conditions change. Typically, managers in the various divisions do not know one another; they may not even know what other companies are represented in the corporate portfolio. The use of financial controls to manage a company means that no integration among divisions is necessary. The biggest problem facing corporate managers is to make capital allocations decisions between divisions to maximize the overall profitability of the portfolio and monitor divisional performance to ensure they are meeting ROIC targets. 2. Vertical Integration Vertical integration is a more expensive strategy to manage than unrelated diversification because sequential resource flows from one division to the next must be coordinated. The multidivisional structure economizes on the bureaucratic costs associated with achieving such coordination because it provides the centralized control necessary for a vertically integrated company to benefit from resource transfers. The way to distribute authority between corporate and divisional managers must be considered carefully in vertically integrated companies. The involvement of corporate managers in operating issues at the divisional level risks that divisional managers feel they have no autonomy, so their performance suffers. Because the interests of their divisions are at stake, divisional managers need to be involved in decisions concerning scheduling and resource transfers. To facilitate communication among divisions, corporate managers create teams composed of both corporate and divisional managers, called integrating roles, whereby an experienced corporate manager assumes the responsibility for managing complex transfers between two or more divisions. Thus, a strategy of vertical integration is managed through a combination of corporate and divisional controls. As a result, the organizational structure and control systems used to economize upon the bureaucratic costs of managing this strategy are more complex and difficult to implement than those used for unrelated diversification. 3. Related Diversification In the case of related diversification, the gains from pursuing this strategy derive from the transfer, sharing, and leveraging of R&D knowledge, industry information, customer bases, and so on, across divisions. However, if a related company is to obtain the potential benefits from using its competencies efficiently and effectively, it has to adopt more complicated forms of integration and control at the divisional level to make the structure work. •Output control is difficult to use because divisions share resources, so it is not easy to measure the performance of an individual division. •Integrating roles and integrating teams of corporate and divisional managers are essential because these teams provide the forum in which managers can meet, exchange information, and develop a common vision of corporate goals. •An organization with a multidivisional structure must have the right mix of incentives and rewards for cooperation if it is to achieve gains from sharing skills and resources among divisions. With unrelated diversification, divisions operate autonomously, and the company can easily reward managers based upon their division’s individual performance. With related diversification, however, rewarding divisions is more difficult because the divisions are engaged in so many shared activities; corporate managers must be alert to the need to achieve equity in the rewards the different divisions receive. III. Implementing Strategy across Countries As companies expand into foreign markets and become multinationals, they face the challenge of how best to organize their activities across different nations and regions. It is important to remember the four different strategies that companies use as they begin to market their products and establish production facilities abroad: •A localization strategy is oriented toward local responsiveness, and a company decentralizes authority to each country in which it operates to produce and customize products to local markets. •In an international strategy, product development is centralized at home and other value creation functions are decentralized to national units. •A global standardization strategy is oriented toward cost reduction, with all the principal value creation functions centralized at the optimal global location. •A transnational strategy is focused so that it can achieve local responsiveness and cost reduction. Some functions are centralized; others are decentralized at the global location best suited to achieving these objectives. A. The International Division When companies initially expand abroad, they often group all of their international activities into an international division. This has tended to be the case for single businesses, and for diversified companies that use the multidivisional organizational form. Regardless of the firm’s domestic structure, its international division tends to be organized geographically. Figure 13.2 illustrates this for a firm with a domestic organization based on product divisions. Figure 13.2: An International Division Structure Many manufacturing enterprises expanded internationally by exporting the product manufactured at home to foreign subsidiaries to sell. In time, however, it might prove viable to manufacture the product in each country, and so production facilities would be added on a country-by-country basis. For firms with a functional structure at home, this might mean replicating the functional structure in every country in which the firm does business. For firms with a divisional structure, this might mean replicating the divisional structure in every country in which the firm does business. One problem with the structure is that the heads of foreign subsidiaries are not given as much voice in the organization as the heads of domestic functions (in the case of functional firms) or divisions (in the case of divisional firms). Rather, the head of the international division is presumed to be able to represent the interests of all countries to headquarters. This effectively relegates each country’s manager to the second tier of the firm’s hierarchy, which is inconsistent with a strategy of trying to expand internationally and build a true multinational organization. Another problem is the implied lack of coordination between domestic operations and foreign operations, which are isolated from each other in separate parts of the structural hierarchy. This can inhibit the worldwide introduction of new products, the transfer of core competencies between domestic and foreign operations, and the consolidation of global production at key locations so as to realize production efficiencies. As a result of such problems, many companies that continue to expand internationally abandon this structure and adopt one of the worldwide structures. The two initial choices are a worldwide product divisional structure, which tends to be adopted by diversified firms that have domestic product divisions, and a worldwide area structure, which tends to be adopted by undiversified firms with domestic structures based on functions. B. Worldwide Area Structure A worldwide area structure tends to be favored by companies with a low degree of diversification and a domestic structure based on functions that are pursuing a localization strategy (Figure 13.3). Under this structure, the world is divided into geographic areas. An area may be a country (if the market is large enough) or a group of countries. Each area tends to be a self-contained, largely autonomous entity with its own set of value creation activities (e.g., its own production, marketing, etc.). Operations authority and strategic decisions relating to each of these activities are typically decentralized to each area, with headquarters retaining authority for the overall strategic direction of the firm and financial control. Figure 13.3: A Worldwide Area Structure This structure facilitates local responsiveness, which is why companies pursuing a localization strategy favor it. Because decision-making responsibilities are decentralized, each area can customize product offerings, marketing strategy, and business strategy to the local conditions. However, this structure encourages fragmentation of the organization into highly autonomous entities. This can make it difficult to transfer distinctive competencies and skills between areas and to realize operating efficiencies. In other words, the structure is consistent with a localization strategy, but may make it difficult to realize gains associated with global standardization. Focus On: Wal-Mart Wal-Mart’s International Division When Wal-Mart started to expand internationally in the early 1990s, it decided to set up an international division to oversee the process. In terms of reporting structure, the division is divided into three regions—Europe, Asia, and the Americas—with the CEO of each region re-porting to the CEO of the international division, who in turn reports to the CEO of Wal-Mart. Initially, the senior management of the international division exerted tight centralized control over merchandising strategy and operations in different countries. They believed, naively perhaps, that centralized control over merchandising strategy and operations was the way to make sure this was the case. The pivotal event that led to a change in policy at Wal-Mart was the company’s 1999 acquisition of Britain’s ASDA supermarket chain. The ASDA acquisition added a mature and successful $14 billion operation to Walmart’s international division. Although Wal-Mart has now decentralized decisions within the international division, it is still struggling to find the right formula for managing global procurement. Ideally, the company would like to centralize procurement in Bentonville so that it could use its enormous purchasing power to bargain down the prices it pays suppliers. Currently, significant responsibility for procurement remains at the country and regional level. As merchandising and operating decisions have been decentralized, the international division has increasingly taken on a new role—that of identifying best practices and transferring them between countries. Teaching Note: The case illustrates that tight centralized control over merchandising strategy and operations in different countries is not the ideal formula for managing global procurement. Ask the students to come up with ideas for the optimum formula for managing global procurement. C. Worldwide Product Divisional Structure A worldwide product divisional structure tends to be adopted by firms that are reasonably diversified and, accordingly, originally had domestic structures based on product divisions. As with the domestic product divisional structure, each division is a self-contained, largely autonomous entity with full responsibility for its own value creation activities. The headquarters retains responsibility for the overall strategic development and financial control of the firm (Figure 13.4) Figure 13.4: A Worldwide Product Divisional Structure Underpinning this organizational form is a belief that the value creation activities of each product division should be coordinated by that division’s management, who should be given the responsibility for deciding the geographic location of different activities. Thus, the worldwide product divisional structure is designed to help overcome the coordination problems that arise with the international division and worldwide area structures. The structure is consistent with the implementation of a global standardization strategy and an international strategy. The main problem with the structure is the limited voice it gives to area or country managers, as they are seen as subservient to product-division managers. The result can be a lack of local responsiveness, which can lead to performance problems. D. Global Matrix Structure Both the worldwide area structure and the worldwide product divisional structure have strengths and weaknesses. The worldwide area structure facilitates local responsiveness, but it can inhibit the realization of location and scale economies and the transfer of core competencies between areas. The worldwide product division structure provides a better framework for pursuing location and scale economies and for transferring skills and competencies within product divisions, but it is weak in local responsiveness. Other things being equal, this suggests that a worldwide area structure is more appropriate if the firm is pursuing a localization strategy, whereas a worldwide product divisional structure is more appropriate for firms pursuing global standardization or international strategies. Some companies have attempted to cope with the conflicting demands of a transnational strategy by using a matrix structure. In the classic global matrix structure, horizontal differentiation proceeds along two dimensions—product division and geographic area (Figure 13.5). The philosophy is that responsibility for operating decisions pertaining to a particular product should be shared by the product division and the various areas of the firm. It is believed that this dual decision-making responsibility should enable the multinational company to simultaneously achieve its particular objectives. In a classic matrix structure, giving product divisions and geographical areas equal status within the organization reinforces the idea of dual responsibility. Figure 13.5: Global-Matrix Structure The reality of the global matrix structure is that it often does not work as well as the theory predicts. In practice, the matrix often is clumsy and bureaucratic. It can require so many meetings that it is difficult to get any work done. The need to get an area and a product division to reach a decision can slow decision making and produce an inflexible organization unable to respond quickly to market shifts or to innovate. The dual-hierarchy structure can lead to conflict and perpetual power struggles between the areas and the product divisions, catching many managers in the middle. In light of these problems, many companies that pursue a transnational strategy have tried to build “flexible” matrix structures based more on enterprise-wide management knowledge networks, and a shared culture and vision, than on a rigid hierarchical arrangement. Within such companies the informal structure plays a greater role than the formal structure. 13.2 Strategy in Action: Dow Chemical’s Matrix Structure A handful of major players compete head-to-head around the world in the chemical industry. The barriers to the free flow of chemical products between nations largely disappeared in the 1980s. This, along with the commodity nature of most bulk chemicals, has ushered in a prolonged period of intense price competition. In such an environment, the company that wins the competitive race is the one with the lowest costs. For years, Dow’s managers insisted that part of the credit should be placed at the feet of its “matrix” organization. Dow’s organizational matrix had three inter- acting elements—functions (e.g., R&D, manufacturing, marketing), businesses (e.g., ethylene, plastics, pharmaceuticals), and geography (e.g., Spain, Germany, Brazil). Managers’ job titles incorporated all three elements. Dow’s decision to keep its matrix structure was prompted by its move into the pharmaceuticals industry. The company realized that the pharmaceutical business is very different from the bulk chemicals business. Accordingly, instead of abandoning its matrix, Dow decided to make it more flexible so it could better accommodate the different businesses, each with its own priorities, within a single management system. By the mid-1990s, however, Dow had refocused its business on the chemicals industry, divesting itself of its pharmaceutical activities, where the company’s performance had been unsatisfactory. Dow ultimately found that a matrix structure was unsuited to a company that was competing in very cost- competitive global industries, and it had to abandon its matrix to drive down operating costs. Teaching Note: The case shows that the matrix structure was unsuited to a company that was competing in very cost- competitive global industries. Ask your students to discuss the potential of the matrix structure and ask them to come up with ideas on where the matrix structure could be implemented successfully. IV. Entry Mode and Implementation Many organizations today are altering their business models and strategies and entering or leaving industries to find better ways to use their resources and capabilities to create value. A. Internal New Venturing Corporate managers must treat the internal new-venturing process as a form of entrepreneurship and the managers who are to pioneer new ventures as intrapreneurs, that is, as inside or internal entrepreneurs. This means that organizational structure, control, and culture must be designed to encourage creativity and give new-venture managers real autonomy to develop and champion new products. At the same time, corporate managers want to make sure that their investment in a new market or industry will be profitable because commonalities exist between the new industry and its core industry, so that the potential benefits of transferring or leveraging competencies will be obtained. Another approach to internal new venturing is championed by managers who believe that the best way to encourage new-product development is to separate the new venture unit from the rest of the organization. To provide the new-venture’s managers with the autonomy to experiment and take risks, a company establishes a new-venture division, that is, a separate and independent division to develop a new product. The new-venture unit or division uses controls that reinforce its entrepreneurial spirit. Strict output controls are inappropriate because they may promote short-term thinking and inhibit risk taking. Instead, stock options are often used to create a culture for entrepreneurship. B. Joint Ventures Joint ventures are a second method used by large, established companies to maintain momentum and grow their profits by entering new markets and industries. A joint venture occurs when two companies agree to pool resources and capabilities and establish a new business unit to develop a new product and a business model that will allow it bring the new product to market successfully. Both companies transfer competent managers, who have a proven track record of success, to manage the new subunit that they both own. Sometimes they take an equal “50/50” ownership stake, but sometimes one company insists on having a 51% share or more, giving it the ability to buy out the other party at some point in the future should problems emerge. Allocating authority and responsibility is the first major implementation issue upon which companies must decide. Both companies need to be able to monitor the progress of the joint venture so that they can learn from its activities and benefit from their investment in it. Some companies insist on 51% ownership stakes because only then do they have the authority and control over the new ventures. A company also risks losing control of its core technology or competence when it enters into a strategic alliance. One parent company might believe this is taking place and feel threatened by the other. The implementation issues are strongly dependent upon whether the purpose of the joint venture is to share and develop technology, jointly distribute and market products and brands, or share access to customers. Sometimes companies can simply realize the joint benefits from collaboration without having to form a new company. Once the ownership issue has been settled, one company appoints the CEO, who then becomes responsible for creating a cohesive top-management team out of the managers transferred from the parent companies. The job of the top-management team is to develop a successful business model. These managers then need to choose an organizational structure that will make the best use of the resources and skills they receive from the parent companies. The need to create an effective organizational design that integrates people and functions is of paramount importance to ensure that the best use is made of limited resources. The need to build a new culture that unites managers who used to work in companies with different cultures is equally as important. Managing these implementation issues is difficult, expensive, and time consuming, so it is not surprising that when a lot is at stake and the future is uncertain, many companies decide that it would be better to acquire another company and integrate it into their operations. If the risks are lower, however, and it is easier to forecast the future, then to reduce bureaucratic costs, a strategic alliance (which does not require the creation of a new subunit) may be capable of managing the transfers of complementary resources and skills between companies. C. Mergers and Acquisitions Mergers and acquisitions are the third method companies use to enter new industries or countries. How to implement structure, control systems, and culture to manage a new acquisition is important because many acquisitions are unsuccessful. One of the primary reasons acquisitions perform poorly is that many companies do not anticipate the difficulties associated with merging or integrating new companies into their existing operations. At the level of organizational structure, managers of both the acquiring and acquired companies must confront the problem of how to establish new lines of authority and responsibility that will allow them to make the best use of both companies’ competencies. One problem with a mishandled merger is that skilled managers who feel they have been demoted will leave the company, and if many leave, the loss of their skills may prevent the benefits of the merger from being realized. Once managers have established clear lines of authority, they must decide how to co-ordinate and streamline the operations of both merged companies to reduce costs and leverage and share competencies. If managers make unrelated acquisitions, however, and then attempt to interfere with a company’s strategy in an industry they know little about, or apply inappropriate structure and controls to manage the new business, then major strategy-implementation problems can arise. Even when acquiring a company in a closely related industry, managers must realize that each company has unique norms, values, and culture. Such idiosyncrasies must be understood to effectively integrate the operations of the merged company. In sum, corporate managers’ capabilities in organizational design are vital in ensuring the success of a merger or acquisition. Their ability to integrate and connect divisions to leverage competencies ultimately determines how well the newly merged company will perform. Teaching Note: Ethical Dilemma A strong code of ethics may go a long way in laying out what kind of managerial and employee behavior can and can’t be tolerated. Students should be encouraged to think of the pros and cons of both centralization and decentralization. This was, they will be in a better position to choose between the two and also understand the balance that is required between the two. Answers to Discussion Questions 1. When would a company decide to change from a functional to a multidivisional structure? Typically, companies change from a functional to a multidivisional structure as they grow in size and complexity. Geographic dispersion, wide variety of products, increased need for coordination of efforts, sheer numbers of employees, and diversity in inputs and processes all create a need for a structure that allows closer communication and tighter control. Companies that wish to better that size and complexity, and to gain both cost savings and enhanced differentiation, would consider the use of a multidivisional structure. 2. If a related company begins to buy unrelated businesses, in what ways should it change its structure or control mechanisms to manage the acquisitions? In buying unrelated businesses, the company needs to realize that the controls it applies to related divisions are not appropriate for unrelated divisions. Each set of divisions should be managed separately, and no attempt should be made to realize synergies. Financial controls should be used to evaluate the performance of unrelated divisions and financial resources should be allocated according to where managers can maximize corporate profitability. In terms of structure, a multidivisional structure would be appropriate, but the corporate center must allow divisions to pursue the advantages associated with their respective strategies. 3. What prompts a company to change from a global standardization to a transnational strategy, and what new implementation problems arise as it does so? When a firm pursuing a global strategy grows even larger and more complex, there are increased pressures for responsiveness to local needs. To enhance their ability to respond locally and yet to retain the cost advantages of a global strategy, firms turn to a transnational strategy, which combines the best features of the two. The transnational strategy is the most difficult, because it requires the firm to constantly balance the need for centralization in the home country headquarters with the need for decentralization in each country. Therefore, transnational companies must give some control to regional personnel, but must retain control of key decisions. Also, companies with a transnational strategy often choose a global matrix structure that is complex. Another difficulty is the need for a one global culture to integrate a company’s units, and it can be difficult to implement one global culture in different national cultures. 4. How would you design a structure and control system to encourage entrepreneurship in a large, established corporation? The structures and control systems of large, mature corporations have often become so routine and suited to existing products and markets that they cannot readily sustain a culture geared to innovation. One of the best ways to overcome this problem is to establish a new-ventures division apart from the main organization and give it the opportunity to develop a structure and control system that fosters an entrepreneurial culture. This division should be managed separately from the main organization, and as new products are developed, they should be spun off to the company’s other divisions. Thus the new-ventures division would remain entrepreneurial and not become much involved in commercializing the new ideas. Its job would be to generate more new ideas. 5. What are the problems associated with implementing a strategy of related diversification through acquisitions? One difficulty is that when the acquisition is completed the new units must be integrated, which can be difficult if the new businesses differ substantially from the core business. This is made more difficult by a lack of planning and forethought about integration issues. Also following the acquisition, managers must establish new reporting relationships, new lines of authority and responsibility, and standardized practices across all the businesses. Different cultures also contribute to integration problems. Finally, the needs of the personnel from the acquired businesses must be considered, because the managers of the acquired firm may become dissatisfied and resign, taking important organizational capabilities with them. Practicing Strategic Management Small-Group Exercise: Deciding on an Organizational Structure This small-group exercise is a continuation of the small-group exercise in Chapter 12. Students are asked to break into the same groups that they used in Chapter 12, reread the scenario in that chapter, and recall their group’s debate about the appropriate organizational structure for their soft drink company. Because it is their intention to compete with Coca-Cola for market share worldwide, their strategy should also have a global dimension, and they must consider the best structure globally as well as domestically. They are then asked to debate the pros and cons of the types of global structure and decide which is most appropriate and which will best fit their domestic structure. Teaching Note: Students should be able to readily prepare a list of the advantages and disadvantages of each type of global structure. Again, it is instructive to remind them that every choice has both positive and negative aspects. Therefore, any choice they make will necessarily involve accepting some undesirable consequences. Use this exercise to work out the logic behind the text’s recommended pairings of global strategy and structure. In other words, what makes a particular structure “best” for a company pursuing a particular strategy? Strategy Sign-On Article File 13 Students should find an example of a company pursuing a diversification strategy that has changed its structure and control systems to better management of its strategy. Students should describe the problems with the way the company formerly implemented its strategy, what change it made to its structure and control systems, and what effects did it expect the changes would have on performance. Teaching Note: Examples of firms that have undergone a change in structure or control systems include Vivendi, Kimberly-Clark, and Ford Motors. At each of these firms, a strategic shift prompted the company to reorganize. Students will see that most firms do not see a quick turnaround in performance after a structural change. If the change is effective, positive outcomes might take months or even years to develop. Strategic Management Project: Module 13 Students are asked to take the information they have collected in the strategic management project from Chapter 12 on strategy implementation and link it to the multibusiness model. They should collect information to determine if their company competes across industries or countries. If their company does operate across countries or industries, they are asked to answer the following questions: 1. Does your company use a multidivisional structure? Why or why not? What crucial implementation problems must your company tackle to implement its strategy effectively? For example, what kind of integration mechanisms does it employ? 2. What are your company’s corporate-level strategies? How do they affect the way it uses organizational structure, control, and culture? 3. What kind of international strategy does your company pursue? How does it control its global activities? What kind of structure does it use? Why? 4. Can you suggest ways of altering the company’s structure or control systems to strengthen its business model? Would these changes increase or decrease bureaucratic costs? 5. Does your company have a particular entry mode that it has used to implement its strategy? 6. In what ways does your company use IT to coordinate its value-chain activities? 7. Assess how well your company has implemented its multibusiness (or business) model. Teaching Note: In addition to answering the questions above, you can ask students to investigate the ways in which their single business strategy complements or detracts from their multibusiness strategy. This should emphasize to the students the importance of coordinating strategies at every level of the organization. Students will readily find examples of a firm that is changing the way it implements its strategy. Students should note the relationships between a firm’s strategy, structure, control systems, and use of IT. Closing Case Organizational Change at Unilever Unilever is one of the world’s oldest multinational corporations, with extensive product offerings in the food, detergent, and personal care businesses. Historically, Unilever was organized on a decentralized basis. Subsidiary companies in each major national market were responsible for the production, marketing, sales, and distribution of products in that market. Each was a profit center and each was held accountable for its own performance. This decentralization was viewed as a source of strength. The structure allowed local managers to match product offerings and marketing strategy to local tastes and preferences and to alter sales and distribution strategies to fit the prevailing retail systems. Unilever began to change all this in the late 1990s. It introduced a new structure based on regional business groups. Within each business group were a number of divisions, each focusing on a specific category of products. By the early 2000, however, Unilever found that it was still lagging its competitors, so the company embarked upon another reorganization. This time the goal was to cut the number of brands that Unilever sold from 1,600 to just 400 that could be marketed on a regional or global scale. Similar structure can be found in North America, Latin America, and Asia. Thus, Bestfoods North America, headquartered in New Jersey, has a similar charter to Bestfoods Europe, but in keeping with differences in local history, many of the food brands marketed by Unilever in North America are different from those marketed in Europe. Teaching Note: This case illustrates the need for more flexible organizational structures. You may ask your students to discuss how important they think it is for multinational companies to have a flexible organizational structures. Will all these be enough for Unilever? ANSWERS TO CASE DISCUSSION QUESTIONS 1. Why did Unilever’s decentralized structure make sense in the 1960s and 1970s? Why did this structure start to create problems for the company in the 1980s? Historically, Unilever was organized on a decentralized basis. Subsidiary companies in each major national market were responsible for the production, marketing, sales, and distribution of products in that market. In Western Europe, for example, the company had 17 subsidiaries in the early 1990s, each focused on a different national market. Each was a profit center and each was held accountable for its own performance. This decentralization was viewed as a source of strength. The structure allowed local managers to match product offerings and marketing strategy to local tastes and preferences and to alter sales and distribution strategies to fit the prevailing retail systems. However, by the mid-1990s, this decentralized structure was increasingly out of step with a rapidly changing competitive environment. Its decentralized structure worked against efforts to build global or regional brands. It also meant lots of duplication, particularly in manufacturing; a lack of scale economies; and a high-cost structure. Unilever also found that it was falling behind rivals in the race to bring new products to market. 2. What was Unilever trying to do when it introduced a new structure based on business groups in the mid-1990s? Why do you think that this structure failed to cure Unilever’s ills? Students’ answers may vary. Some of them may say that Unilever meant each business group to focus on a specific category of products. These groups and divisions were to coordinate the activities of national subsidiaries within their regions to drive down operating costs and speed up the process of developing and introducing new products. 3. In the 2000s, Unilever switched to a structure based on global product divisions. What do you think is the underlying logic for this shift? Does the structure make sense given the nature of competition in the detergents and food business? Students’ answers may vary. Unilever’s two global product divisions are a food division and a home and personal care division. Unilever’s underlying logic is that the numerous regional groups within these divisions will focus on developing, manufacturing, and marketing either food or personal care products within their own given region. Solution Manual for Strategic Management: Theory: An Integrated Approach Charles W. L. Hill, Gareth R. Jones, Melissa A. Schilling 9781285184494
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