This Document Contains Chapters 11 to 13 Chapter 11 Organizational Structure and Controls LEARNING OBJECTIVES 1. Define organizational structure and controls and discuss the difference between strategic and financial controls. 2. Describe the relationship between strategy and structure. 3. Discuss the functional structures used to implement business-level strategies. 4. Explain the use of three versions of the multidivisional (M-form) structure to implement different diversification strategies. 5. Discuss the organizational structures used to implement three international strategies. 6. Define strategic networks and discuss how strategic center firms implement such networks at the business, corporate and international levels. CHAPTER OUTLINE Opening Case Big Box Retailers Struggle to Change Their Strategies and Structures in the Face of Online Competition ORGANIZATIONAL STRUCTURE AND CONTROLS Organizational Structure Organizational Controls RELATIONSHIPS BETWEEN STRATEGY AND STRUCTURE EVOLUTIONARY PATTERNS OF STRATEGY AND ORGANIZATIONAL STRUCTURE Simple Structure Functional Structure Multidivisional Structure Matches between Business-Level Strategies and the Functional Structure Matches between Corporate-Level Strategies and the Multidivisional Structure Strategic Focus A Change in Corporate Strategy Requires a Change in the Corporate Organization Structure Matches between International Strategies and Worldwide Structure Matches between Cooperative Strategies and Network Structures Strategic Focus Unilever Cooperates with Many Firms and Non-Profit Organizations to Implement Its Strategy While Creating a More Sustainable Environment IMPLEMENTING BUSINESS-LEVEL COOPERATIVE STRATEGIES IMPLEMENTING CORPORATE-LEVEL COOPERATIVE STRATEGIES IMPLEMENTING INTERNATIONAL COOPERATIVE STRATEGIES SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE This Document Contains Chapters 11 to 13 LECTURE NOTES Chapter Introduction: As students will recall, the discussion in Chapter 10 described how governance mechanisms are used to align the interests of a firm’s top-level managers with those of the firm’s owners. It also described how those mechanisms influence the firm’s ability to execute strategies that have been implemented successfully as the firm strives to achieve a competitive advantage in the new competitive landscape. The same could be said of organizational structure, the focus of the current chapter. OPENING CASE Big Box Retailers Struggle to Change Their Strategies and Structures in the Face of Online Competition Big box retailing is undergoing significant change. The Opening Case highlights how Borders and Best Buy have been forced to deal with online competitor Amazon.com. Instead of developing its own online capabilities, Borders signed an agreement with competitor Amazon.com to handle its Internet sales. Best Buy is being hurt by “showrooming” in which consumers go to a Best Buy store to view physical products and then go online to purchase the product at a lower cost. Online retailers such as Amazon.com have lower cost structures and are working to provide customer services and support that add value, making it hard for brick-and-mortar stores to compete on price. Big box retailers are responding with different concepts (such as store-within-a- store) and improved layout. All of these changes require adjustments to structure and control systems to effectively monitor performance and make additional strategic moves in a timely manner. Teaching Note: Specialty big box retailers face a significant headwind from online competitors. Ask students to compare and contrast the value propositions of specialty big box retailers (like Borders and Best Buy) and online retailers. Ask them to comment on the ethical dimensions of “showrooming” and whether this activity should be discouraged. The real issue for the big box retailers is how they can compete in a connected world. Ask students if they have any ideas how specialty big box firms could improve their strategic positions and how structure and controls might need to be changed to accommodate their suggestions. 1 Define organizational structure and controls and discuss the difference between strategic and financial controls. The match or degree of fit between strategy and structure influences the firm’s attempts to earn above-average returns. Thus, the ability to select an appropriate strategy and match it with the appropriate structure is an important characteristic of effective strategic leadership. The focus of this chapter is on the structure- and control-related issues of strategy implementation, including: • The pattern of growth and changes in organizational structure experienced by strategically competitive firms • The organizational structures and controls used to implement separate business-level, corporate-level, international, and cooperative strategies • A series of figures to highlight the structures firms match with different strategies ORGANIZATIONAL STRUCTURE AND CONTROLS When the firm’s strategy isn’t matched with the most appropriate structure and controls, performance declines. Teaching Note: Selecting the organizational structure and controls that result in effective implementation of chosen strategies is a fundamental challenge for managers, especially top-level managers. The reasons for this are: • Firms must be flexible, innovative, and creative in the global economy if they are to exploit their core competencies in the pursuit of marketplace opportunities. • Firms must also maintain a certain degree of stability in their structures so that day-to-day tasks can be completed efficiently. Organizational Structure Organizational structure specifies the firm’s formal reporting relationships, procedures, controls, and authority and decision-making processes. Developing an organizational structure that effectively supports the firm’s strategy is difficult, especially because of the uncertainty (or unpredictable variation) in cause-effect relationships in the global economy’s rapidly changing, dynamic competitive environments. Structure facilitates effective implementation of a firm’s strategies when elements of that structure (e.g., reporting relationships, procedures, and so forth) are properly aligned with one another. Thus, organizational structure is a critical component of effective strategy implementation processes. Structure specifies the work to be done and how to do it (given the firm’s strategy or strategies) by specifying the processes to be used to complete organizational tasks. Effective structures provide the stability the firm needs to rely on its current competitive advantages to successfully implement today’s strategies while providing the flexibility required to develop competitive advantages that will be needed to use for future strategies; thus, an effective organizational structure allows the firm to exploit current competitive advantages while developing new ones. Modifications to the firm’s current strategy or selection of a new strategy call for changes to organizational structure. This is not uncommon since organizational inertia often inhibits structural changes, even if performance declines. Because of inertial tendencies, structural change is often induced by the actions of stakeholders who are no longer willing to tolerate the firm’s inadequate performance. Organizational Controls Organizational controls guide the use of strategy, indicate how to compare actual results with expected results, and suggest corrective actions to take when the difference between actual and expected results is unacceptable. Properly designed organizational controls—strategic and financial—provide insights into behaviors that enhance firm performance. Strategic controls are largely subjective criteria intended to verify that the firm is using strategies that are appropriate given the conditions in the external environment and the company’s competitive advantages. Thus, strategic controls are concerned with examining the fit between what the firm might do (external environment) and what it can do (its competitive advantages). Effective strategic controls help the firm understand what it takes to be successful. Strategic controls demand rich communication between managers and those implementing the firm’s strategy. These frequent exchanges are both formal and informal in nature. Strategic controls help evaluate how well a firm is focusing on what it takes to implement its strategies. • For a business-level strategy, the concern is to study primary and support activities (see Tables 3.6 and 3.7) to verify that those that are critical to successful execution of the chosen strategy are being properly emphasized and executed. • With related corporate-level strategies, strategic controls are used to verify that intended levels of sharing of relevant strategic factors—such as knowledge, markets, technologies, and so forth—are taking place. When evaluating related diversification strategies, executives must have a deep understanding of each unit’s business-level strategy. Extensive diversification often requires that financial controls be emphasized. Teaching Note: The use of strategic controls, which are behavioral in nature, requires high levels of cognitive diversity among the firm’s top-level managers. Cognitive diversity is a term that captures differences among top- level executives regarding their beliefs about cause-and-effect relationships and outcome-related preferences. Financial controls are largely objective criteria used to measure the firm’s performance against previously established quantitative standards, including accounting-based (e.g., return on investment, return on assets) and market-based (e.g., Economic Value Added) measures. Both strategic and financial controls are important aspects of each organizational structure; thus, any structure’s effectiveness is determined by using a combination of strategic and financial controls. 2 Describe the relationship between strategy and structure. RELATIONSHIPS BETWEEN STRATEGY AND STRUCTURE Strategy and structure have a reciprocal relationship, highlighting the interconnectedness between strategy formulation (Chapters 4–9) and strategy implementation (Chapters 10–13). In general, structure follows the selection of the firm’s strategy. However, once in place, structure has the potential to influence current strategic actions as well as choices about future strategies. Regardless of the strength of the relationships between strategy and structure, those choosing the firm’s strategy and structure should be committed to matching each strategy with a structure that provides the stability needed to use current competitive advantages as well as the flexibility required to develop future advantages. Teaching Note: Using the four criteria of sustainability, the firm’s strategy/ structure match is an advantage when that match is valuable, rare, imperfectly imitable, and nonsubstitutable. EVOLUTIONARY PATTERNS OF STRATEGY AND ORGANIZATIONAL STRUCTURE Chandler found that firms tended to grow in somewhat predictable patterns: volume geography integration (vertical, horizontal) product/business diversification. Figure Note: Figure 11.1 graphically illustrates the evolution of structure as the organization grows. This evolution is explained in subsequent sections of this chapter. At this point, students should begin to be aware of the necessity of fit. Just as a firm’s strategy must fit with its resources, capabilities, and core competencies, so its strategy must fit with its structure if it hopes to achieve strategic competitiveness. FIGURE 11.1 Strategy and Structure Growth Pattern As indicated by Figure 11.1, firm structure evolves from simple to functional to multidivisional. This evolution is caused by sales growth and/or coordination and control problems that prevent the firm from efficiently implementing its formulated strategy. Thus, as implementation efforts falter due to growth or other problems, the firm may need to change its organizational structure to achieve an appropriate fit between strategy and structure. Simple Structure A simple structure is an organizational form in which the owner-manager makes all major decisions directly and monitors all activities, and the firm’s staff is merely an extension of the manager’s supervision authority. The simple structure is characterized by: • Little specialization of tasks • Few rules • Little formalization • Unsophisticated information systems • Direct involvement of owner-manager in all phases of day-to-day operations • Frequent and informal communications between the owner-manager and employees Teaching Note: In the U.K., some analysts believe that the simple organizational structure may result in competitive advantages for some small firms relative to their larger counterparts. These competitive advantages include a broad openness to innovation, greater structural flexibility, and an ability to respond more rapidly to environmental changes. If they are successful, small firms grow larger; and as a result, the firm outgrows the simple structure. • There is a significant increase in the amount of competitively relevant information that requires analysis. • More extensive and complicated information-processing requirements place significant pressures on owner-managers (often due to a lack of organizational skills or experience). At this evolutionary point, firms tend to move from the simple structure to a functional organizational structure. Functional Structure The functional structure consists of a chief executive officer and limited corporate staff with functional line managers in dominant functions: production, accounting, marketing, R&D, engineering, human resources. This structure allows for functional specialization, facilitating active knowledge sharing within each functional area. Knowledge sharing usually supports career paths and professional development of functional specialists. However, compared to the simple structure, there also are some potential problems. For example, differences in functional specialization and orientation may impede communication and coordination. Teaching Note: Functional specialists often may develop a myopic or narrow perspective, losing sight of the firm’s strategic vision and mission. When this happens, the problem can be overcome by implementing the multidivisional structure. The functional structure supports implementation of business-level strategies and corporate- level strategies with low levels of diversification (e.g., dominant business). Multidivisional Structure Because of limits to an individual CEO’s ability to process complex strategic information, problems related to isolation of functional area managers, and increasing diversification, the structure of the firm must change again. In these instances, the multidivisional or M-form structure is most appropriate. The multidivisional (M-form) structure is composed of operating divisions where each division represents a separate business to which the top corporate officer delegates responsibility for day-to-day operations and business unit strategy to division managers. As initially designed, the M-form was thought to have three major benefits. 1. It allowed corporate officers to accurately monitor business unit performance, simplifying control problems. 2. It facilitated comparisons between divisions, which improved the resource allocation process. 3. It stimulated managers of poorly performing divisions to look for ways to improve performance. Teaching Note: An expanded discussion of M-form may be helpful at this point. Some facts related to use of the multidivisional structure at DuPont and GM follow. • The multidivisional or M-form structure was developed in the 1920s, in response to coordination and control problems in large firms such as DuPont and GM. • Functional departments often had difficulty dealing with distinct product lines and markets, especially in coordinating conflicting priorities among the products. • Costs were not allocated to individual products, so it was not possible to assess an individual product’s profit contribution. • Loss of control meant optimal allocation of firm resources between products was difficult. • Top managers got over-involved in short-run matters (e.g., coordination, communications, conflict resolution) and neglected long-term strategic issues. The new, innovative structure adopted at General Motors called for • Creating separate divisions, each representing a distinct business • Each division would house its functional hierarchy • Division managers were given responsibility for managing day-to-day operations • A small corporate office would determine the long-term strategic direction of the firm and exercise overall financial control over the semi-autonomous divisions This would enable the firm to • Accurately monitor performance of each business, simplifying control problems • Facilitate comparisons between divisions, improving the allocation of resources • Stimulate managers of poorly performing divisions to seek ways to improve 3 Discuss the functional structures used to implement business-level strategies. Matches between Business-Level Strategies and the Functional Structure Different forms of the functional organizational structure are used to support implementation of the cost leadership, differentiation, and integrated cost leadership/differentiation strategies. The differences in these forms are accounted for primarily by different uses of three important structural characteristics or dimensions—specialization (the type and number of jobs required to complete work), centralization (the degree to which decision-making authority is retained at higher managerial levels), and formalization (the degree to which formal rules and procedures govern work). Using the Functional Structure to Implement the Cost Leadership Strategy Firms using the cost leadership strategy want to sell large quantities of standardized products to an industry’s or a segment’s typical customer. The cost leadership form of the functional structure usually features: • Simple reporting relationships • Few layers in the decision-making and authority structure • A centralized corporate staff • A strong focus on process improvements through the manufacturing function rather than the development of new products through an emphasis on product R&D Teaching Note: Because of firm restructuring during the late 1980s and early 1990s—and the reduction in the number of management layers—firms now have flatter structures. “Higher” in the organizational structure has thus become a relative term. Cost leadership strategies emphasize: • Centralization of decision-making to maintain cost reduction • Jobs that are specialized to increase efficiency • Formalization of rules and procedures to converge on the most efficient approaches Figure Note: Figure 11.2 summarizes the functional structural characteristics required for successful implementation of the cost leadership strategy. FIGURE 11.2 Functional Structure for Implementing a Cost Leadership Strategy Key points include the following: • Dotted lines from the centralized staff to each function represent tight controls and centralized coordination. • The focus is on the operations (production) function. • Emphasis is placed on process engineering not on new product research and development. • Relatively large central staff coordinates functions. • Job roles are highly structured. • The overall structure is mechanical. • The structure may be either relatively tall or flat (depending on the extent of firm restructuring). Teaching Note: Southwest Airlines has successfully implemented the cost leadership strategy, encouraging the emergence of a low-cost culture by (1) using specialized work tasks and (2) striving continuously to reduce costs below those of competitors. Using the Functional Structure to Implement the Differentiation Strategy Firms offering products that are considered unique by customers usually are following a differentiation strategy. A differentiation strategy requires: • The firm to sell nonstandardized products to customers with unique needs • Relatively complex and flexible reporting relationships • Frequent use of cross-functional product development teams • A strong focus on marketing and product R&D rather than manufacturing and process R&D • Continuous product innovation, requiring people be able to interpret and take action based on ambiguous, incomplete, and uncertain information • A strong focus on the external environment to identify new opportunities • Rapid responses to collected information suggesting a need for decentralization • Creativity and the continuous pursuit of new sources of differentiation and new products requiring a lack of specialization (i.e., workers have a relatively large number of tasks in their job descriptions) • Low formalization, decentralization, and low specialization of work tasks allowing people to interact frequently to further differentiate products while developing ideas for new products Figure Note: Figure 11.3 summarizes the discussion of the relationships between the differentiation strategy and the functional structure. FIGURE 11.3 Functional Structure for Implementing a Differentiation Strategy A first glance, Figure 11.3 appears to be very similar to Figure 11.2 (Functional Structure for Implementing a Cost Leadership Strategy). However, there are several subtle but important differences. • The centralized corporate staff (between the president and the individual functions) has been replaced by the central staffs of R&D and marketing, which work closely together. • Dotted lines between the centralized staff and individual functions have been removed, indicating a decentralization of decision making. Formalization is limited to enable emergence of new product ideas and enhanced ability to change. • Marketing is the main function for keeping track of new product ideas. • Job roles are less structured. • The structure is organic. Using the Functional Structure to Implement the Integrated Cost Leadership/Differentiation Strategy As discussed in Chapter 4, some firms may attempt to implement simultaneously both the cost leadership and differentiation strategies by providing value through • Low cost relative to a differentiated firm’s products • Differentiated features relative to features offered by cost leadership firms’ products The integrated cost leadership/differentiation strategy is used frequently in the global economy, though it is difficult to implement. This difficulty is due largely to the fact that different primary and support activities (see Chapter 3) must be emphasized. • Low-cost strategies emphasize production and manufacturing process engineering and few product changes. • Differentiation strategies require an emphasis on marketing and new product R&D. Teaching Note: Toyota Motor Corporation has become a world leader in the auto industry primarily through its ability to implement cost leadership and differentiation at the same time. The key to Toyota’s success has been the differentiated design and manufacturing process that the company has implemented through its integrated product design process. 4 Explain the use of three versions of the multidivisional (M-form) structure to implement different diversification strategies. Matches between Corporate-Level Strategies and the Multidivisional Structure The firm’s level of diversification is a function of decisions about the number and type of businesses in which it will compete, as well as how it will manage the businesses (see Chapter 6). Geared to managing individual organizational functions, increasing diversification eventually creates information processing, coordination, and control problems that the functional structure can’t handle. This requires a shift from a functional structure to a complex multidivisional structure. The demands created by different levels of diversification require that each strategy be implemented through a unique organizational structure. Teaching Note: From 1950 to the late 1980s, among Fortune 500 firms, diversification and implementation of the multidivisional structure increased dramatically. • The percentage of diversified firms increased from 30% to approximately 75%. • The multidivisional structure increased from less than 20% to approximately 90%. Figure Note: Figure 11.4 should be used to indicate to students that there are three variations (or versions) of the multidivisional structure. FIGURE 11.4 Three Variations of the Multidivisional Structure The three variations of the multidivisional structure that will be discussed from the perspective of how each is best suited to specific diversification strategies are the: • Cooperative form • Strategic Business Unit (SBU) form • Competitive form Teaching Note: It is important to reiterate that the functional structure is not as well suited to managing and controlling multiple businesses as is the multidivisional structure or M-form. Using the Cooperative Form of the Multidivisional Structure to Implement the Related Constrained Strategy The cooperative form structure uses horizontal integration to bring about interdivisional cooperation. The divisions in the firm using the related-constrained diversification strategy commonly are formed around products, markets, or both. Figure Note: Figure 11.5 summarizes the structural characteristics of the Cooperative M-form that create and encourage cooperation. FIGURE 11.5 Cooperative Form of the Multidivisional Structure for Implementing a Related Constrained Strategy The first variant of the M-form structure—the Cooperative M-form—is characterized by an increased emphasis on integration devices and horizontal human resource practices. The large box at the top of Figure 11.5 illustrates what is referred to as the central, corporate, or headquarters office. It includes the firm’s top-level executives and all staff specialty functions. All divisions are controlled by the central office and integrated by one of the integrating mechanisms (such as division managers meeting face-to-face, integrating teams, or task forces). Integrating mechanisms are indicated by the dotted line connecting the divisions, which create: • Tight linkages between divisions • Corporate office emphasizing centralized planning, human resources, and marketing to facilitate cooperation • Centralized R&D to coordinate new product introductions and/or process engineering improvements • A subjective reward system emphasizing corporate and division performance • A cooperative, sharing culture All of the related-constrained firm’s divisions share one or more corporate strengths. Production competencies, marketing competencies, or channel dominance are examples of strengths that the firm’s divisions might share. • Production expertise is one of the strengths of Sony’s divisions, but they have had difficulties coordinating across divisions to create joint products in online music. • Outback Steakhouse, Inc. has sought to diversify across eight different chains using a cooperative M-form structure to centralize a number of critical functions across the businesses for activities sharing, and to share its expertise in running franchise operations across contracting, advertising, training, and more. The sharing of divisional competencies facilitates the corporation’s efforts to develop economies of scope (cost savings resulting from the sharing of competencies developed in one division with another division) that are linked with successful use of the related constrained strategy. Interdivisional sharing of competencies depends on cooperation, suggesting the use of the cooperative form of the multidivisional structure. Increasingly, it is important that the links resulting from effective use of integration mechanisms support the cooperative sharing of both intangible resources (e.g., knowledge) as well as tangible resources (e.g., facilities and equipment). The following are different characteristics of structure that are used as integrating mechanisms by the cooperative structure to facilitate interdivisional cooperation: • Centralization—control at the corporate level allows the linking of activities among divisions. • Frequent, direct contact between division managers—encourages and supports cooperation and the sharing of competencies or resources that can be used to create new advantages. These mechanisms include liaison roles, temporary teams/task forces, formal integration departments, and a matrix organization configuration. • Coordination among divisions sometimes results in an unequal flow of positive outcomes to divisional managers. In other words, when managerial rewards are based at least in part on the performance of individual divisions, the manager of the division that is able to benefit the most by the sharing of corporate competencies might be viewed as receiving relative gains at others’ expense. Strategic controls are important in these instances, as divisional managers’ performance can be evaluated at least partly on the basis of how well they have facilitated interdivisional cooperative efforts. Furthermore, using reward systems that emphasize overall company performance, besides outcomes achieved by individual divisions, helps overcome problems associated with the cooperative form. STRATEGIC FOCUS Change in Corporate Strategy Requires a Change in the Corporate Organizational Structure Constellation Brands become the third largest beer producer in the U.S. in 2013 with its acquisition of Corona. Through this acquisition, it will control nearly 50 percent of U.S. beer imports. Also through acquisitions, Constellation Brands has become the world’s largest wine producer and it has the largest share of premium wine distribution in the U.S., UK, Australia, New Zealand, and Canada. It also has a large number of brands in the spirits category. One of the challenges for the company is that since each of these three categories has different production technologies it must develop appropriate structure and controls to ensure it is deriving expected value. The structure that Constellation Brands has adopted is the SBU structure with wine, beer, and spirits organized into three operating groups with divisional structures for each brand within the group. Although there are obvious differences in the products of the three units, CB has realized some cost benefits in procurement of bottles, cardboard, and freight across all three units. It has also been able to improve its negotiation position with retailers by offering a full menu of alcohol. Another firm using the SBU structure is News Corporation. It has split its business into print (News Corp.) and television/movies (21st Century Fox). Both of these divisions will utilize the cooperative structure due to linkages among business in the unit. Teaching Note: The Strategic Focus highlights the fact that appropriate structures are necessary to manage diverse organizations. Both Constellation Brands and News Corporation have grown through acquisitions and this growth required a change in structure. Students should be familiar enough with both of these companies and the businesses and/or brands that each owns. Ask them to explain why the organizational arrangements described in the Strategic Focus allow for effective management both within, and perhaps even across, the SBU structure. The Strategic Focus allows provides the opportunity to discuss the role of the government in acquisitions. Ask students if they agree with the Justice Department’s decision to block the merger between Anheuser-Busch InBev and Grupo Modelo until Grupo Modelo divested Corona. Had this acquisition been completed without the divestiture of Corona would it have harmed U.S. consumers or is this just another in a long line of controversial decisions by this department? Using the Strategic Business Unit Form of the Multidivisional Structure to Implement the Related Linked Strategy The strategic business unit (SBU) structure is most appropriate for the related linked (mixed related and unrelated) strategy. A strategic business unit (SBU) structure consists of at least three levels, with a corporate headquarters at the top, SBU groups at the second level, and divisions grouped by relatedness within each SBU at the third level. This means that: • Within each SBU, divisions are related to each other • SBU groups are unrelated to each other • Within each SBU, divisions producing similar products and/or using similar technologies can be organized to achieve synergy • Individual SBUs are treated as profit centers and controlled by corporate headquarters • Corporate headquarters can concentrate on strategic planning rather than operational control Figure Note: Figure 11.6 summarizes structural characteristics of the SBU multidivisional structure and leads to a discussion of this structural form’s potential pitfalls or disadvantages. FIGURE 11.6 SBU Form of the Multidivisional Structure for Implementing a Related Linked Strategy Although the SBU M-form appears similar to the Cooperative M-form (Figure 11.5), there are several differences. • The SBU M-form includes an additional layer—the strategic business unit or SBU— between the corporate headquarters and product divisions. • There may be integration and coordination between divisions in a specific SBU. • There is independence among and between SBUs. • Headquarters manages approval of strategic planning of SBUs for the president. • Individual SBUs may have budgets and staffs for within-SBU integrating mechanisms. • Corporate headquarters staff serve as consultants to SBUs and divisions on product strategy (rather than having direct input). Using the Competitive Form of the Multidivisional Structure to Implement the Unrelated Diversification Strategy Recalling the discussion in Chapter 6, firms following an unrelated diversification strategy can create value by: • Efficient internal capital allocations • Restructuring, buying, and selling businesses Unrelated diversified firms should adopt the third variant of the multidivisional structure, the competitive form of the multidivisional structure, where controls emphasize competition between separate (usually unrelated) divisions for corporate capital allocations. Figure Note: Figure 11.7 summarizes structural characteristics of the Competitive M-form. FIGURE 11.7 Competitive Form of the Multidivisional Structure for Implementing an Unrelated Strategy The Competitive M-form differs from both the Cooperative and SBU M-forms (see Figures 11.5 and 11.6) by: • Establishing a smaller headquarters office, generally containing three functions: 1. Legal affairs, which increases in importance when a firm acquires or divests units 2. Auditing, which monitors divisional performance to ensure performance data are accurately reported 3. Finance, which manages the firm’s cash flow and allocates capital • Allowing independent divisions so financial performance can be monitored separately for each • Setting up divisions that retain strategic control, but give up cash flow control • Allowing competition between divisions for capital allocations The efficient internal capital market that is the foundation for use of the unrelated diversification strategy requires organizational arrangements that emphasize divisional competition rather than cooperation, and three benefits are expected from this internal competition: 1. Internal competition creates flexibility, allowing resources to be allocated to the division that is working with the most promising technology to fuel the entire firm’s success. 2. Internal competition challenges the status quo and inertia, because division heads know that future resource allocations are a product of excellent current performance as well as superior positioning of their division in terms of future performance. 3. Internal competition motivates effort. Teaching Note: Textron Inc., is a large “multi-industry” company that seeks to identify, research, select, acquire, and integrate companies, and has developed a set of rigorous criteria to guide decision making. Features of the firm that match this structural selection include the following: • Textron continuously looks to enhance and reshape its portfolio by divesting non-core assets and acquiring branded businesses in attractive industries with substantial long-term growth potential. • Textron operates four independent businesses— Bell Helicopter (31 percent of revenue), Cessna Aircraft (24 percent), Textron Systems (19 percent), Finance (2 percent), and Industrial (24 percent). • The firm uses return on invested capital (ROIC) as a way to evaluate the contribution of its diversified set of businesses as they compete internally for resources. • To emphasize competitiveness among divisions, the headquarters office maintains an arm’s-length relationship with them, intervening in divisional affairs only to audit operations and discipline managers whose divisions perform poorly. • In emphasizing competition between divisions, the headquarters office relies on strategic controls to set rate-of-return targets and financial controls to monitor divisional performance relative to those targets. The headquarters office then allocates cash flow on a competitive basis rather than automatically returning cash to the division that produced it. • The focus of the headquarters’ work is on performance appraisal, resource allocation, and long-range planning to verify that the firm’s portfolio of businesses will lead to financial success. Table Note: Table 11.1 compares the structural attributes of the three variants of the multidivisional structure from the perspectives of centralization, integrating mechanisms, divisional performance appraisal criteria, and bases of incentive compensation. TABLE 11.1 Characteristics of the Structures Necessary to Implement the Related Constrained, Related Linked, and Unrelated Diversification Strategies Table 11.1 provides a handy reference that can be used to compare the structural attributes of the Cooperative, SBU, and Competitive M-form structures based on the • Degree that operations are centralized or decentralized • Extent to which each form uses integrating mechanisms • Emphasis on subjective or objective criteria for appraising divisional performance • Linkages to corporate, SBU, and/or divisional performance as bases for divisional incentive compensation 5 Discuss the organizational structures used to implement three international strategies. Matches between International Strategies and Worldwide Structures Forming proper matches between international strategies and organizational structures intended to support their use facilitates the firm’s efforts to effectively coordinate and control its global operations. Importantly, recent research findings confirm the validity of the strategy/structure matches discussed. Using the Worldwide Geographic Area Structure to Implement the Multidomestic Strategy Although centralization of decision-making authority has been recognized as a means of achieving coordination (and control) in organizations, some strategies require that local business units (or divisions) have the flexibility that will enable them to adapt to local market preferences. This may mean that a decentralized structure is needed to provide this flexibility. The multidomestic strategy is a strategy in which strategic and operating decisions are decentralized to business units in each country to facilitate tailoring of products to each country. The structure used to implement the multidomestic strategy is the worldwide geographic area structure, an organizational form in which national interests dominate and that facilitates managers’ efforts to satisfy local or cultural differences. Figure Note: Characteristics of the worldwide geographic area structure (presented in Figure 11.8) illustrate the decentralized nature of the structure. FIGURE 11.8 Worldwide Geographic Area Structure for Implementing a Multidomestic Strategy The worldwide geographic area structure is characterized by: • An emphasis on differentiation or adaptation to local market preferences or cultural requirements • Individual national market operations as decentralized and independent • Corporate headquarters coordinating movement of financial resources • Organization representing a decentralized federation The multidomestic strategy requires a decentralized structure. • National or country-specific preferences require local adaptation for success. • Little coordination is required because of local market differences. • There is no need for integrating mechanisms among divisions. • The level of formalization is low. • Coordination mechanisms are informal in nature. However, firms adopting multidomestic strategies and the worldwide geographic area structure must give up the ability to achieve global efficiency. Using the Worldwide Product Divisional Structure to Implement the Global Strategy In contrast with the multidomestic strategy, a global strategy is characterized by • A corporate home office that dictates competitive strategy • A firm that offers standardized products across country markets • The development and exploitation of economies of scope and scale on a global level • Decisions to outsource some primary or support activities The appropriate structure for implementation of a global strategy is the worldwide product divisional structure, characterized by centralized decision-making authority at the worldwide division headquarters and the establishment of effective coordination and joint problem- solving among disparate divisional subunits. Figure Note: Characteristics of the worldwide product divisional structure are presented in Figure 11.9. They illustrate the centralized nature of the structure. FIGURE 11.9 Worldwide Product Divisional Structure for Implementing a Global Strategy The worldwide product divisional structure is characterized by: • An emphasis on inter-division coordination devices to facilitate global economies of scale and scope • Information flows that are coordinated by the global headquarters office • Corporate headquarters allocates financial resources in a cooperative way • Organization represents a centralized federation Multiple integrating mechanisms that result in effective coordination through mutual adjustment via personal interaction include: • Encouraging direct, face-to-face contact between managers • Assigning liaison roles between departments • Forming temporary task forces or teams Using the Combination Structure to Implement the Transnational Strategy The last international strategy (the transnational strategy) combines multidomestic and global strategies by • Seeking national or country-specific advantages by emphasizing adaptation to local differences • Attempting simultaneously to achieve global economies of scale and scope The combination structure is an organizational form with characteristics and structural mechanisms that result in an emphasis on both geographic and product structures. The transnational strategy is often implemented through two possible combination structures: a global matrix structure or a hybrid global design. • The global matrix design brings together both local market and product expertise into teams who develop and respond to the global marketplace worldwide. • In the hybrid structure some divisions are oriented toward products whereas others are oriented toward market areas. FIGURE 11.10 Hybrid Form of the Combination Structure for Implementing a Transnational Strategy In this design, some divisions are oriented toward products whereas others are oriented toward market areas. Thus, in some divisions, where the geographic area is more important, the division managers are area-oriented. In other divisions, where worldwide product coordination and efficiencies are more important, the division manager is more product- oriented. As alluded to previously, specific attributes of the transnational structure are difficult to identify because of the conflicting requirements that firms organize to provide the firm simultaneously with the • Flexibility required for adapting to local market preferences • Coordination and control necessary to pursue global economies of scale and scope Firms implementing transnational strategies must encourage employees to understand the effects of cultural diversity on the firm’s operations and adopt a combination structure that is simultaneously • Centralized and decentralized • Integrated and nonintegrated • Formalized and nonformalized Teaching Note: Many features of the transnational strategy are tricky to sort out. Emphasize that point here with the chapter’s discussion of the combination structure. STRATEGIC FOCUS Unilever Cooperates with Many Firms and Non-Profit Organizations to Implement Its Strategy While Creating a More Sustainable Environment Unilever is a European-based global consumer products company with a strong sustainable environment strategy. To improve efficiencies, Unilever has adopted a worldwide product structure. The company emphasizes the geographic areas using a transnational strategy while implementing the combination structure to address local market conditions and improve efficiencies. Unilever has adopted what it calls its Sustainable Living Plan – increasing sales while decreasing its environmental footprint. It also has a campaign to improve the well- being of 1 billion people. Part of this will be done by partnering with key companies and expanding/improving operations at its facilities around the world. It is also implementing a market initiative to produce health/nutrition innovations and strengthen its brand. Unilever works with several NGOs to improve sustainable living, facilitate solutions for suppliers, and reach customers who need information to improve their sustainability approaches to life. Teaching Note: The Strategic Focus provides insight into Unilever’s global cooperative strategy. Most students will appreciate the emphasis that Unilever is placing on sustainability and its objective to help improve the lives of so many people. The Strategic Focus clearly shows how the company is executing its business strategy through an appropriate organizational structure to achieve both business and social objectives. 6 Define strategic networks and discuss how strategic center firms implement such networks at the business, corporate, and international levels. Matches between Cooperative Strategies and Network Structures As discussed in Chapter 9, firms often may develop multiple strategic alliances to implement cooperative strategies. A strategic network is a grouping of organizations that has been formed to create value by participating in an array of cooperative arrangements. It is often a loose federation of partners who participate in the network’s operations on a flexible basis. A strategic center firm is the one around which the network’s cooperative relationships revolve. Figure Note: Figure 11.11 illustrates the structure of the strategic network. FIGURE 11.11 A Strategic Network The strategic center firm sits in the middle of the strategic network so that it can coordinate the activities of network members firms. Note: Four critical aspects of functions performed by the strategic center firm—strategic outsourcing, capability development, technology management, and managing learning processes—are discussed next. As coordinator or manager of activities carried out by partners in the strategic network, the strategic center firm—and other network partners—should note four critical aspects of the strategic center firm’s functions: 1. Strategic Outsourcing 2. Development of Competencies 3. Technology Management 4. Race to Learn (or Managing Learning Processes) Strategic outsourcing is one of the strategic center firm’s key functions. In addition to outsourcing more than other members of the strategic network, the center firm also encourages member firms to go beyond contracting to solve problems and to initiate competitive actions that the network can pursue. The competence-related role of the center firm is to build or develop the core competencies of other network member firms and encourage them to share these with other network partners. Technology aspects of the center firm’s role include managing the development and sharing of technology-based ideas among network partners. Emphasizing the race to learn implies that the strategic center firm must encourage positive rivalry among partner firms that strengthen each partner’s (as well as the network’s) value chain. The effectiveness of the center firm is related to how well it learns to manage learning processes among network partners. IMPLEMENTING BUSINESS-LEVEL COOPERATIVE STRATEGIES Recall from Chapter 9 that complementary assets at the business level can be vertical or horizontal. Vertical complementary strategic alliances are more common than horizontal alliances and generally are focused on buyer-supplier relationships. With Toyota’s strategic network of vertical alliances in Japan, Toyota, as the strategic center firm: • Encourages subcontractors to modernize their facilities • Supplies them with any necessary technical and financial assistance • Reduces transactions costs by entering into long-term contracts that allow supplying partners to increase long-term productivity (as opposed to entering into a series of short- term contracts based on unit pricing) • Provides engineers in upstream companies (suppliers) with better communication with contractees • Allows suppliers and center firms to become more interdependent and less independent • Is able to achieve a competitive advantage because of the imperfect imitability of the structure and the proprietary actions that it uses to manage its strategic network Horizontal complementary strategic alliances are much more difficult to manage than vertical complementary strategic alliances because, in a horizontal alliance, it is difficult to select a strategic center firm when several network members have been aggressive competitors. An example is the instability of alliances between large airlines. IMPLEMENTING CORPORATE-LEVEL COOPERATIVE STRATEGIES It is less difficult to select a strategic center firm in corporate-level cooperative strategic alliances structured as centralized franchise networks than in those that are decentralized sets of diversified strategic alliances. McDonald’s has established a centralized strategic network in which its corporate office acts as the strategic center for its network of franchisees. • The headquarters office uses strategic controls and financial controls to verify that the franchisees’ operations create the greatest value for the entire network. • A strategic control issue is the location of franchisee units—McDonald’s believes that its greatest expansion opportunities are outside the United States. • Financial controls are framed around requirements an interested party must satisfy to become a McDonald’s franchisee, as well as performance standards that are to be met when operating a unit. IMPLEMENTING INTERNATIONAL COOPERATIVE STRATEGIES Competing across national borders increases the complexity of the task of managing strategic networks that have been formed through international cooperative strategies and stifles the selection of a strategic center firm because great differences may exist among the regulatory environments of partners’ home countries. In response to this complexity: • Distributed strategic networks are formed • Multiple regional strategic centers are established Figure Note: Configuration of a distributed strategic network is illustrated in Figure 11.12. FIGURE 11.12 A Distributed Strategic Network Although the distributed strategic network has a primary or main strategic center firm, it also is characterized by multiple strategic center firms that are distributed throughout the world. For example, firms such as Ericsson and Electrolux establish multiple strategic centers, which enable them to better manage multiple cooperative relationships with partnering firms that may cross national or regional boundaries or to manage specific global product markets more effectively. The distributed strategic network form of organization enables the international cooperative network to ensure that region-, country- or product-specific market requirements are managed by the appropriate distributed strategic center firm. Chapter 12 Strategic Leadership LEARNING OBJECTIVES 1. Define strategic leadership and describe top-level managers’ importance. 2. Explain what top management teams are and how they affect firm performance. 3. Describe the managerial succession process using internal and external managerial labor markets. 4. Discuss the value of strategic leadership in determining the firm’s strategic direction. 5. Describe the importance of strategic leaders in managing the firm’s resources. 6. Explain what must be done for a firm to sustain an effective culture. 7. Explain what strategic leaders can do to establish and emphasize ethical practices. 8. Discuss the importance and use of organizational controls. CHAPTER OUTLINE Opening Case A Change at the Top at Proctor & Gamble: An Indication of How Much the CEO Matters? STRATEGIC LEADERSHIP AND STYLE Strategic Focus The Life of a CEO as a Firm’s Primary Strategic Leader: Breadth, Depth, and Complexity THE ROLE OF TOP-LEVEL MANAGERS Top Management Teams Managerial Succession Strategic Focus Keeping Quality People at the Top of the Firm’s Leadership Structure: The Importance of Planning for Managerial Succession KEY STRATEGIC LEADERSHIP ACTIONS Determining Strategic Direction Effectively Managing the Firm’s Resource Portfolio Sustaining an Effective Organizational Culture Emphasizing Ethical Practices Establishing Balanced Organizational Controls SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE NOTES LECTURE NOTES Chapter Introduction: This chapter deals with the importance of strategic leadership, its effects on organizational outcomes, and the great challenges faced by strategic leaders. This indicates that effective strategic leaders must be able to use the strategic management process (illustrated in Figure 1.1) effectively by • Guiding the firm in ways that result in the formation of its vision and mission • Facilitating the development of appropriate strategic actions • Providing guidance that results in strategic competitiveness and above- average returns OPENING CASE A Change at the Top at Proctor & Gamble: An Indication of How Much the CEO Matters? The Opening Case describes how CEO succession at P&G has had a detrimental effect on firm performance. The successor, Bob McDonald, assumed the position in 2009 but lasted a little under four years. During his tenure, P&G failed to keep up with rivals’ sales and share price growth. He was criticized for ineffective responses to competitor actions, failure to control costs, employees’ loss of confidence in his leadership, not understanding the effects of the recession on customers, and cutting R&D to focus on reformulating existing products (as opposed to create new product categories). The board brought back McDonald’s predecessor, A.G. Lafley, to turn things around and return the company to its ‘glory days’ of 2000-2009 (in which share price increased in value 63 percent while the S&P fell 37 percent). Part of Lafley’s strategy for the turnaround includes increased emphasis on product innovation to create new product categories and restructuring P&G’s multiple brands and products into four sectors, each of which will be headed by a president. Each sector will be formed to reflect synergies between the various businesses. Teaching Note: The Opening Case underscores the importance of the CEO in organizational success. In the case of P&G, students should realize that McDonald’s problems stemmed from both poor strategy and ineffective execution. As McDonald was Lafley’s handpicked successor, ask students what this might say about Lafley’s perception. Ask them is they believe P&G should have gone outside for its CEO and to discuss some of the pros and cons for doing so. The case speculates that the next CEO will also come from the inside. Ask students to identify the skill sets that are necessary to lead a multiproduct global company such as P&G. 1 Define strategic leadership and describe top-level managers’ importance. STRATEGIC LEADERSHIP AND STYLE Strategic leadership entails the ability to anticipate, envision, maintain flexibility, and empower others to create strategic change as necessary. Strategic change is change brought about as a result of selecting and implementing a firm’s strategies. In other words, strategic leadership represents a complex form of leadership in organizations. A manager with strategic leadership skills exhibits the ability to guide the firm through the competitive landscape by • Managing an entire enterprise • Influencing the behavior, thoughts, and feelings of coworkers • Managing through others • Successfully processing or making sense of complex, ambiguous information by successfully dealing with change and uncertainty The strategic leader has several responsibilities, including the following: • Establishing a context for efficiency • Attract and then managing human capital (perhaps the most critical of the strategic leader’s skills) • Effectively managing the firm’s operations • Sustaining high performance over time • Being willing to make candid, courageous, yet pragmatic, decisions • Soliciting feedback from peers, superiors, and employees about their difficult decisions and vision • Developing strong partners internally and externally to facilitate execution of their vision Primary responsibility for effective strategic leadership rests at the top of the organization – in particular the CEO. Others commonly recognized as strategic leaders include: • Board of directors • Top management team • Divisional general managers Figure Note: The role of strategic leadership in the strategic management process is illustrated in Figure 12.1. FIGURE 12.1 Strategic Leadership and the Strategic Management Process As illustrated in Figure 12.1, effective strategic leadership • Shapes the formation of the firm’s vision and mission Which influences the • Development of successful strategic actions • Formulation of strategies • Implementation of strategies Which lead to • Strategic competitiveness • Above-average returns Strategic leaders are those at the top of the organization (in particular, the CEO), but other commonly recognized strategic leaders include members of the board of directors, the top management team, and division general managers. The style used to provide leadership often affects the productivity of those being led. The most effective leadership style used by strategic leaders is a transformational leadership style, which encourages followers to exceed expectations and place the organization above self interests. The strategic leadership skills of an organization’s managers represent resources that can affect the firm’s performance. These resources must be developed for the firm’s future benefit. STRATEGIC FOCUS The Life of a CEO as a Firm’s Primary Strategic Leader: Breadth, Depth, and Complexity The Strategic Focus profiles ThyssenKrupp, a global engineering and steel company with over 150,000 employees operating in approximately 80 countries. Recent performance for the firm has been disappointing and it has appointed Hiesinger as the new Chairman of the Executive Board. Hiesinger pledged a “fresh start” for the firm (which included correcting past shortcomings and changing the culture). Hiesingers needs to address poor financial performance, ill-conceived/executed expansion in Brazil and the U.S., waning demand for its products in the soft economy, the resignation of the company’s supervisory chairman, and various scandals including allegations of price fixing and inappropriate business trips with union representatives and journalists. Some of Hiesinger’s actions include the establishment of a whistleblower program, shifting the company’s reliance on the steel business by trying to become an integrated technology provider, increasing its focus on component manufacturing for other industries, and focusing on China and Asia for future growth. Teaching Note: The Strategic Focus gives some insight into the challenges that CEOs face, especially in situations in which performance shortcomings need to be addressed. Seldom are actions one dimensional. As the Strategic Focus makes clear, developing an effective strategic position typically involves actions on several fronts. To develop and execute strategic actions, leaders must possess knowledge that spans multiple disciplines. Ask students to comment on the multiple disciplinary knowledge that is necessary for ThyssenKrupp’s CEO to affect positive change for the company. THE ROLE OF TOP-LEVEL MANAGERS Top-level managers represent an important resource for organizations as they attempt to formulate and implement strategies effectively because of top-level mangers’ roles in designing the organization and the performance outcomes that result from using that design. Thus, it is important for organizations to have a top management team with superior managerial skills. Three factors can be viewed as determining a strategic leader’s decision discretion: • External environmental sources • Organizational characteristics • Managerial characteristics Figure Note: Figure 12.2 shows three factors that affect/determine managerial discretion. FIGURE 12.2 Factors Affecting Managerial Discretion Managerial discretion is a function of three factors: external environment, organizational characteristics, and an individual manager’s characteristics. External Environment (especially the competitive environment) • Industry structure • Rate of market growth • Number and type of competitors • Nature and degree of political/legal constraints • Degree to which products are differentiated Organizational Characteristics • Size • Age • Organizational culture • Availability of resources • Patterns of interaction among employees Managers’ (Individual) Characteristics • Manager’s tolerance for ambiguity • Commitment to the firm and its desired strategic outcomes • Interpersonal skills • Level of aspiration • Degree of self-confidence Other critical roles played by top-level managers include: • Implementing an appropriate organizational structure • Implementing the organization’s reward systems • Shaping the organization’s culture • Influencing organizational activities and performance Teaching Note: Remind students that for top-level managers to make a difference—or enhance a firm’s ability to achieve a competitive advantage— they generally must possess superior knowledge and skills. While all organizations have strategic leaders, the top management team’s portfolio of skills must be rare, valuable, difficult for other top management teams to imitate, and not be readily substitutable if they are to result in a competitive advantage for the firm (as suggested in Chapter 1). Top Management Teams The complexity of the challenges faced by the firm and the need for substantial amounts of information and knowledge require teams of executives to provide the strategic leadership of most firms. Use of a team to make strategic decisions also helps avoid managerial hubris. A firm’s top management team is composed of individuals that are responsible for making certain the firm uses the strategic management process, especially for the purpose of selecting and implementing strategies. In the case of large organizations, members of the top management team usually can be identified as those individuals with the title of vice president or above and/or individuals who serve on its board of directors. Teaching Note: Strategic actions taken by a firm’s top management team will have an impact—positive or negative—on firm performance. Research indicates that there seems to be a link between the configuration or mix of expertise and skills of members of a firm’s top management team and firm performance. Top Management Team, Firm Performance, and Strategic Change The job of top-level executives is complex and requires a broad knowledge of the firm’s operations, as well as the three key parts of the firm’s external environment—the general, industry, and competitor environments (see Chapter 2). Thus, firms try to form a top management team that has the appropriate knowledge and expertise to operate the internal organization, yet also can deal with all the firm’s stakeholders as well as its competitors. Research into the relationship or link between top management team composition and firm performance generally indicates that team heterogeneity is important. A heterogeneous top management team is composed of individuals with different functional backgrounds, experiences, and education. The more heterogeneous a top management team is, the more varied its expertise and knowledge, the more capacity it has to provide effective strategic leadership in formulating 2 Define top management teams and explain their effects on firm performance. strategy. Members of a heterogeneous top management team benefit from discussing the different perspectives advanced by team members, and these discussions can increase the quality of the top management team’s decisions. The net benefit of the actions of heterogeneous teams tends to be positive in terms of market share and above-average returns. Research suggests that the path of causality goes something like this: heterogeneity among top management team members increased debate better strategic decisions increased firm performance. It is also important that the top management team members function cohesively. In general, more heterogeneous and larger top management teams find it more difficult to implement strategies effectively. Research indicates a positive relationship between higher levels of a top management team’s heterogeneity, firm innovation, and strategic change. Thus, a team with diverse backgrounds and expertise is more likely to: • Change strategies when it is necessary to do so • Identify internal and external environmental changes that require the firm to change strategic direction • “Think outside of the box” and thus be more creative in making decisions Other factors that are important to top management team effectiveness include: • Members with substantive expertise in the firm’s core businesses • Members with a good understanding of international markets • Characteristics of top management and even CEO personalities The CEO and Top Management Team Power Although the composition of a firm’s top management team is important, a team that is too powerful may negatively affect firm performance. As noted in Chapter 10, the involvement of outsiders as members of a firm’s board of directors also has an impact on firm performance. In fact, involvement of outside directors in shaping the firm’s strategic direction normally results in higher firm performance than when they are not involved. Teaching Note: Inside directors (part of management) can affect CEO power because they • Report to the CEO • Have a greater understanding of firm operations (information they control) • Can control the flow of information to outside directors However, in some cases, a firm’s CEO and members of the top management team may “overpower” the firm’s board of directors. This can happen when: • The CEO appoints members of the board (insiders or sympathetic outsiders) • The CEO also holds the title of Chairman of the Board (sometimes called “CEO duality”) It varies across industries, but duality occurs most commonly in the largest of firms. Increased shareholder activism, however, has brought CEO duality under scrutiny and attack in both US and European firms. Historically, an independent board leadership structure—in which the same person did not hold the positions of CEO and chair—was believed to enhance a board’s ability to monitor top-level managers’ decisions and actions, particularly in terms of the firm’s financial performance. Teaching Note: It should be noted that a recent investigation of the relationship between CEO duality and firm performance found that the stock market was indifferent to changes in duality status. Such changes have a negligible effect of financial performance, and there is weak evidence that duality has an effect on long-term performance. Top management team members with longer team and organization tenure have an increased ability to influence the board of directors. However, long tenure restricts an executive’s knowledge base, which then limits the number of alternatives evaluated when strategic decisions are being made. The net impact is that these individuals may be able to forestall or avoid board involvement in strategic decisions. Because an unhealthy relationship between the board of directors and the top management team can potentially have a negative effect on an organization’s strategic competitiveness: • Boards are challenged to develop an effective relationship with the firm’s top management team • Relative degrees of power between the board and the top management team should be examined with respect to the individual firm’s situation (including firm resources and environmental volatility) Teaching Note: One solution to this dysfunction is to get members of the firm’s management team to have a significant ownership interest in the firm. Though this may provide the team with additional power, a significant level of ownership also should encourage team members to act more in the interests of shareholders, because they also are shareholders. MANAGERIAL SUCCESSION Because of the impact that members of a firm’s top management team—especially the CEO—can have on the organization’s performance, the selection of new top managers requires effective screening systems. Organizations can select their strategic leaders from one of two labor markets. • Internal managerial labor markets represent future promotion or transfer opportunities for managerial positions within the firm. 3 Describe the managerial succession process using internal an external managerial labor markets. • External managerial labor markets represent the collection of managerial career opportunities outside of a manager’s current firm. Because of insiders’ experience within the firm and the industry in which it completes, the benefits of using the internal managerial labor market include: • Familiarity with the organization’s products, markets, technologies, and standard operating procedures • Less turnover among existing personnel with valuable firm-specific knowledge • A desire for continuity and commitment to the firm’s vision, mission, and strategic actions Because of the perceived value of selecting an insider to succeed a CEO (or other top management team member), selection of an outsider is unusual. But there are instances that call for selecting an outsider. • Executives with overly long tenure with the firm may become stale, which reduces the number of innovative approaches developed to help the firm cope with changing conditions that the firm faces. • Insiders may have less of an ability to innovate or create innovation-stimulating conditions, which can be a detriment to the firm’s long-term success in the 21st century competitive landscape. • Outsiders generally have broader, less limited perspectives, which may mean that innovation and strategic change are encouraged. Teaching Note: Outsiders are limited in firm-specific knowledge and/or industry experience. Figure Note: Figure 12.3 is helpful to discuss the relationships among the sources of a successor-CEO, top management team membership, and firm strategy. FIGURE 12.3 Effects of CEO Succession and Top Management Team Composition on Strategy Figure 12.3 illustrates relationships between the source of the successor, top management team heterogeneity/homogeneity (or team makeup), and firm strategy. • Internal CEO Succession: A homogeneous top management team generally results in a stable strategy. A heterogeneous top management team generally results in a stable strategy with continued innovation. • External CEO Succession: A homogeneous top management team often results in changes in both top management team membership and strategy. If the top management team is heterogeneous, strategic change is likely. Teaching Note: Ask students to compare characteristics of successor CEOs in turnaround situations with key managerial resources presented earlier in this chapter. Key differences that should be recognized are that in a turnaround situation, industry-specific knowledge is less important than the ability to radically change the organization, and perhaps its strategy. To have an adequate number of top managers, firms must take advantage of a highly qualified labor pool, including one source of managers that has often been overlooked: women. Firms are beginning to utilize women’s potential managerial talents with substantial success. A few firms have gained value by using the significant talents of women leaders. But many more have not done so, which represents an opportunity cost to them. STRATEGIC FOCUS Keeping Quality People at the Top of the Firm’s Leadership Structure: The Importance of Planning for Managerial Succession The Strategic Focus drives home the point that CEO changes are important organizational events; they are also a fact of corporate life. The board of directors is responsible for the firm having an effective and sustainable succession plan but relatively few (approx.. 16 percent) indicate that they have an effective plan. In North America average CEO tenure is only five years, which makes succession planning essential. A fully-developed plan deals with selecting, developing, evaluating, and compensating the CEO. Benefits include supporting the firm’s corporate governance procedures, increasing stakeholders’ confidence that the board is acting in their best interests, positive returns for stakeholders. Sources of possible successors internal candidates, external candidates, members of the firm’s board of directors, and even former CEOs with a history of success (as in the case of A.G. Lafley in the Opening Case). Teaching Note: Succession planning allows companies to prepare for leadership changes well in advance of when they occur. Ask students to identify the benefits of succession planning. Students should realize that effective succession planning allows potential successors to be groomed for the position, given tasks that can be evaluated and thus help select the best successor, and develop both internal and external networks that will be useful once the successor is CEO. Students should realize that given the importance of strategic leadership, this activity must be planned for and effectively managed. KEY STRATEGIC LEADERSHIP ACTIONS Figure Note: The characteristics of successor CEOs also can be related to the six critical actions required for the effective exercise of strategic leadership (highlighted in Figure 12.4). FIGURE 12.4 Exercise of Effective Strategic Leadership Figure 12.4 highlights the six most critical actions that strategic leaders must perform. • Determining strategic direction • Establishing balanced controls • Effectively managing the firm’s resource portfolio • Sustaining an effective organizational culture • Emphasizing ethical practices Figure 12.4 sets the stage for the balance of Chapter 12. Determining Strategic Direction Determining the strategic direction of the firm refers to developing a long-term vision. This means that a firm’s managers must think beyond the current period to develop a “future” direction for the firm (normally 5 to 10 years forward). The ideal long-term vision has two parts—core ideology and envisioned future. Core ideology motivates employees through the company’s heritage, but the envisioned future encourages employees to go beyond their expectations and requires significant change and progress. The envisioned future serves as a guide to the firm’s strategy implementation, including motivation, leadership, employee empowerment, and organizational design. A charismatic CEO may foster stakeholder commitment to a new vision and strategic direction. It is important that strategic leaders also recognize that, though gaining employee commitment to a new vision and strategic direction is important, factors such as the following must not be overlooked: • The firm’s strengths must be considered when making strategic changes for a new strategic direction. • The firm’s short-term needs must be balanced with long-term growth and survival. • The firm can maintain long-term survivability by effectively managing its portfolio of resources. 4 Discuss the value of strategic leadership in determining the firm’s strategic direction. 5 Describe the importance of strategic leaders in managing the firm’s resources. Effectively Managing the Firm’s Resource Portfolio Probably the most important task for strategic leaders is effectively managing the firm’s portfolio of resources. Firms may have multiple resources that can be categorized into the following categories: • Financial capital • Human capital • Social capital • Organizational capital Strategic leaders manage the firm’s portfolio of resources by • Organizing them into capabilities • Structuring the firm to use the capabilities • Developing and implementing a strategy to leverage those resources to achieve a competitive advantage Exploiting and Maintaining Core Competencies As a reminder, core competencies are those capabilities of the firm around which a competitive advantage may be built (as defined and discussed in Chapters 1 and 3). Core competencies relate to an organization’s functional skills, such as manufacturing, finance, marketing, and research and development. The key is that core competencies must enable the firm to produce and deliver products and services to customers in ways that create value for them. Teaching Note: Before core competencies can serve as building blocks for a firm’s competitive advantage, they must be distinctive. Remind students that the following conditions must be satisfied for core competencies to be classified as distinctive: • Unique to the firm • Valuable • Difficult for competitors to imitate • Nonsubstitutable This means that core competencies must be emphasized as the firm implements strategy. To ensure that core competencies identified as distinctive (and potential sources of competitive advantage) remain distinctive for longer periods of time, firms must recognize the importance of developing their human capital. Developing Human Capital and Social Capital Human capital refers to the knowledge and skills of the firm’s workforce. This means that employees must be viewed as capital resources and as deserving of investment. Teaching Note: An important point to bring out in this section is that people and people-related competencies—the workforce and its capabilities (a firm’s human capital)—historically have contributed more to firm (and economic) success than investment in capital equipment. Teaching Note: One significant problem firms face is inadequate human capital to run an organization effectively. As a remedy, many firms hire temporary employees, whereas others are trying to improve their recruiting and selection techniques. However, solving the problem requires more than “temp hiring” since this limits management’s ability to build effective commitment to organizational goals. Hiring star players is also insufficient. It requires building effective commitment to organizational goals as well. Effective training and development programs are important because these efforts: • Recognize that knowledge has become more integral to gaining and sustaining a competitive advantage • Help build knowledge and skills • Inculcate core values • Establish a systematic view of the organization • Promote the firm’s vision • Develop organizational cohesion • Contribute to the development of core competencies • Improve strategic managers’ capabilities in the skills that are critical to effective strategic leadership (e.g., determining the firm’s strategic direction, exploiting and maintaining core competencies, and developing an organizational culture that supports ethical practices) When human capital investments are successful, a workforce is capable of learning continuously. Learning continuously and leveraging the firm’s expanding knowledge base is linked with strategic success. It is also important to promoting innovation, which is the foundation of competitive advantage. Layoffs can result in a significant loss of the knowledge possessed by a firm’s human capital. Research has shown that moderate-sized layoffs may improve firm performance, but large layoffs produce stronger performance downturns in firms because of the loss of human capital. Although it is also common for restructuring firms to reduce their spending on training and development programs, restructuring may actually be an important time to increase investments in these programs. Restructuring firms have less slack and cannot absorb as many errors; moreover, the employees who remain after layoffs may find themselves in positions without all of the skill or knowledge they need to perform the required tasks effectively. Viewing employees as a resource to be maximized rather than a cost to be minimized facilitates the successful implementation of a firm’s strategies. The implementation of such strategies also is more effective when strategic leaders approach layoffs in a manner that employees believe is fair and equitable. Social capital involves relationships inside and outside the firm that help the firm accomplish tasks and create value for customers and shareholders. Social capital is a critical asset for a firm. Inside the firm, employees and units must cooperate to get the work done. In multinational organizations, units often must cooperate across country boundaries on activities such as R&D to produce outcomes needed by the firm (e.g., new products). Sustaining an Effective Organizational Culture Organizational culture represents a set of complex ideologies, symbols, and core values that is shared throughout an organization and that influences the way that it conducts business. Because it influences how the firm conducts its business and helps regulate and control employee behavior, organizational culture can be a source of differentiation and, thus, competitive advantage. Entrepreneurial Mind Set An organization’s culture will either encourage or discourage (and, in some cases, even penalize) employee efforts to tap into entrepreneurial opportunities. Teaching Note: IBM produced a handbook designed to infuse an entrepreneurial spirit into its culture. The handbook, Changing the World, is filled with tips designed to break mental barriers and to help employees be more creative in their jobs. Gerald Haman took a different approach. He developed a process, called the Thinkubator, to help firms build a stronger entrepreneurial orientation and boost creativity in their employees. According to Haman, the Thinkubator helps people rediscover their gifts for creativity. One way that the pursuit of entrepreneurial opportunities might be promoted is to invest in opportunities as real options. That is, invest in an opportunity to provide the potential of exercising the option of taking advantage of the opportunity at some point in the future. Firms might enter strategic alliances for this reason. For example, they might do so to have the option of acquiring the partner later or of building a stronger relationship (e.g., developing a joint new venture). Corporate culture characteristics and managerial actions that encourage an entrepreneurial mindset include: 6 Explain what must be done for a firm to sustain an effective culture. • Autonomy – enabling employees to be self-directed in the pursuit of entrepreneurial opportunities • Innovativeness – encouraging the pursuit of new ideas, experimentation, and creative processes that will find new ways to add value • Risk-taking – promoting the willingness of both employees and the organization to accept risk in the pursuit of new market opportunities • Proactiveness – being a market leader rather than a market follower by anticipating the market’s future needs and being the first to satisfy them • Competitive aggressiveness – taking actions that enable the firm to consistently and significantly outperform the competition Changing the Organizational Culture and Restructuring As noted in the text, incremental changes to the organization’s culture typically are used to improve the effectiveness of strategy implementation. A dramatic shift in strategy from the firm’s historical pattern of strategy often means that major changes in the organization’s culture are required, and perhaps even the selection of a new CEO or top management team. Teaching Note: No matter why an organization’s culture must change, the shaping and reinforcing of the new culture requires: • Effective communication and problem solving • Selecting people with the values that managers wish to be infused throughout the organization • Developing an effective performance appraisal process that establishes goals and measures individual performance toward achieving goals that fit with the new core values • implementing reward systems that encourage behaviors that reflect the new core values Teaching Note: It is helpful to show students that effective strategic leadership is reinforced by an appropriate corporate culture. This can be done using video interviews of a CEO that also profile the firm (e.g., any of the many reports on Herb Kelleher and Southwest Airlines, when he was CEO there, will work well for this assignment). As they watch the video, have students write down in separate columns on a piece of paper the clues they find of two things: leadership approaches taken and corporate culture employed. Upon debriefing, they will quickly see that these are mutually reinforcing in successful companies. For cultural changes to be effective, they must be supported fully and actively by the CEO and other members of the top management team. And if large-scale change is needed, support and involvement of mid-level managers is required as they generally are adept at energizing people and aligning their interests and actions. If the required cultural change is major or critical, new top management team members may need to be brought in from outside of the firm to act as a catalyst for the change. Emphasizing Ethical Practices The effectiveness of strategy implementation processes increases when they are based on ethical practices. Ethical companies encourage and enable people at all organizational levels to exercise ethical judgment, but unethical practices become like a contagious disease if they evolve in an organization. To properly influence employee judgment and behavior, ethical practices must shape the firm’s decision-making process and be an integral part of an organization’s culture. Research has found that a value-based culture is the most effective means of ensuring that employees comply with the firm’s ethical standards. In the absence of ethical requirements, managerial opportunism allows managers to make decisions that are in their own best interests, but not in the best interests of the firm or its stakeholders (as discussed in Chapter 10). Teaching Note: Recent research reports that a number of top-level executives and business students appear to be willing to commit either illegal or unethical actions. For example: • 47 percent of upper-level executives, 41 percent of controllers, and 76 percent of graduate-level business students were willing to misrepresent their firms’ financial statements. • 87 percent of managers made one or more fraudulent decisions out of seven total decision situations. • The probability of a fraudulent decision was greater when the individual valued a comfortable life and/or pleasure and placed less value on self- respect. • When cheating was observed, there was a reluctance to report it. Recent ethical lapses at high-profile corporations suggest firms need to employ ethical strategic leaders—ones who include ethical practices as part of their long-term vision for the firm, who desire to do the right thing, and for whom honesty, trust, and integrity are important. Strategic leaders who display these qualities inspire employees to develop/support an organizational culture in which ethical practices are the expected norm. Firms must employ ethical strategic leaders who will infuse ethical values into the organization’s culture by: • Establishing/communicating the firm’s ethical code of conduct to describe the firm’s ethical standards 7 Explain what strategic leaders can do to establish and emphasize ethical practices. • Continuously revising and updating the code of conduct based on stakeholder input • Disseminating the code of conduct to stakeholders, informing them of the firm’s ethical standards/practices. • Developing/implementing methods and procedures that can be used to achieve the firm’s ethical standards • Creating and implementing explicit reward systems that recognize individuals that use the appropriate channels to report wrongdoing • Creating a work environment that treats all people with dignity The effectiveness of these actions increases when they are taken simultaneously, which makes them mutually supportive. When managers/employees do not engage in these actions, perhaps because an ethical culture is lacking, problems are likely to occur. Formal organizational controls may be needed to prevent more problems. Establishing Balanced Organizational Controls Organizational controls—introduced in Chapter 11—are necessary to help ensure that firms meet desired outcomes: strategic competitiveness and above-average returns. Controls are the formal, information-based routines and procedures used by managers to maintain or alter patterns in organizational activities to help strategic leaders. These can be used to do the following: • Build credibility • Demonstrate the value of the firm’s strategies to stakeholders • Promote and support organizational change • Provide the parameters within which strategies are implemented and corrective actions taken when implementation-related adjustments are needed Teaching Note: Strategic controls represent those control systems that focus on the content of actions rather than on outcomes. This is in contrast to financial controls that focus on short-term financial outcomes (or results) rather than on the appropriateness of strategic actions that have been taken. Strategic controls are important because they can encourage managers to make decisions that include moderate and acceptable levels of risk with a focus on the long-term impact of their decisions. The use of financial controls alone often results in managers making risk-averse decisions, taking only the short-term financial impact into account. 8 Discuss the importance and use of organizational controls. The Balanced Scorecard The underlying premise of the balanced scorecard is that firms disadvantage their future performance possibilities when financial controls are emphasized at the expense of strategic controls. Financial controls provide feedback about outcomes achieved from past actions, but do not communicate the drivers of the firm’s future performance, which can promote organizational behavior that has a net effect of sacrificing the firm’s long-term value creating potential for short-term performance gains. An appropriate balance of strategic controls and financial controls, rather than an overemphasis on one or the other, allows firms to effectively monitor their performance. The following four perspectives are integrated to form the balanced scorecard framework: 1. Financial – concerned with growth, profitability, and risk from shareholders’ perspective 2. Customer – concerned with the value customers perceive to be created by the firm’s products 3. Internal business processes – concerned with the priorities for various business processes that create customer and shareholder satisfaction 4. Learning and growth – concerned with creating a climate that supports change, innovation, and growth Generally speaking, strategic controls tend to be emphasized when the firm assesses its performance relative to the learning and growth perspective, whereas financial controls are emphasized when assessing performance in terms of the financial perspective. Study of the customer and internal business processes perspectives often is completed through relatively equal emphasis on strategic and financial controls. Teaching Note: Firms use different criteria to measure their standing relative to the scorecard’s four perspectives. The important point is for the firm to select the number of criteria that will allow it to have both a strategic understanding and a financial understanding of its performance without becoming immersed in too many details. FIGURE 12.5 Strategic Controls and Financial Controls in a Balanced Scorecard Framework Figure 12.5 presents some samples of the criteria included when using the balanced scorecard approach. Teaching Note: In diversified firms, successful strategic leaders also balance strategic controls and financial controls to make appropriate investments for future viability (through strategic controls), while maintaining an appropriate level of financial stability in the present (through financial control). In fact, most corporate restructuring is designed to refocus the firm on its core businesses, thereby allowing top executives to reestablish strategic control of their separate business units. Thus, both types of controls are important. The effective use of strategic controls by top executives is often integrated with appropriate autonomy for the various subunits so they can gain a competitive advantage in their respective markets. Strategic control can be used to promote sharing of both tangible and intangible resources among the firm’s interdependent businesses. The autonomy provided allows the flexibility needed to take advantage of specific marketplace opportunities. As a result, strategic leadership promotes the simultaneous use of strategic controls and autonomy. Chapter 13 Strategic Entrepreneurship LEARNING OBJECTIVES 1. Define strategic entrepreneurship and corporate entrepreneurship. 2. Define entrepreneurship and entrepreneurial opportunities and explain their importance. 3. Define invention, innovation, and imitation and describe the relationship among them. 4. Describe entrepreneurs and the entrepreneurial mind-set. 5. Explain international entrepreneurship and its importance. 6. Describe how firms internally develop innovations. 7. Explain how firms use cooperative strategies to innovate. 8. Describe how firms use acquisitions as a means of innovation. 9. Explain how strategic entrepreneurship helps firms create value. CHAPTER OUTLINE Opening Case Innovation’s Importance to Competitive Success ENTREPRENEURSHIP AND ENTREPRENEURIAL OPPORTUNITIES INNOVATION ENTREPRENEURS INTERNATIONAL ENTREPRENEURSHIP INTERNAL INNOVATION Incremental and Radical Innovation Autonomous Strategic Behavior Induced Strategic Behavior IMPLEMENTING INTERNAL INNOVATIONS Cross-Functional Product Development Teams Facilitating Integration and Innovation Creating Value from Internal Innovation Strategic Focus An Innovation Failure at J.C. Penney: Its Causes and Consequences INNOVATION THROUGH COOPERATIVE STRATEGIES INNOVATION THROUGH ACQUISITIONS CREATING VALUE THROUGH STRATEGIC ENTREPRENEURSHIP Strategic Focus Pursuing Competitive Success by Using Strategic Entrepreneurship SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE LECTURE NOTES Chapter Introduction: This chapter helps identify ways in which entrepreneurial insights and activities can be harnessed in large firms. The principles identified here may certainly help students see how this can be accomplished. In many ways, students are very motivated by the topic, since it highlights the ways in which an attractive mind-set (entrepreneurship) can be applied to what some students see as the less exciting corporate world. OPENING CASE Innovation’s Importance to Competitive Success The Opening Case makes the point that innovation is important to drive organic growth and generate sustained above-average returns. It also makes the point that a large percentage of CEOs are dissatisfied with the number of innovations produced by their firms. Strategic entrepreneurship is concerned with producing more, successful innovations. To do so, firms need to understand the attributes that are important to customers. Increasingly, a product’s sustainability credentials are something that customers are willing to pay a premium for. The Opening Case further describes how several Chinese companies are seeking to provide value to ‘middle-market’ customers by developing innovations that increase value by delivering product attributes that are ‘good enough’ but doing so at very competitive prices by thoughtful approaches to product design, production processes, and/or choice of materials. An example given in the Opening Case is premeasured pod detergents (of which Proctor & Gamble has roughly a 75 percent market share). Pods allow consumers to use the exact amount of detergent necessary so waste is eliminated. While overall detergent sales are going down because of this innovation, it has allowed P&G to capture a larger share of the market. Teaching Note: The Opening Case makes the argument that strategic entrepreneurship is underlies innovation. Through strategic entrepreneurship companies find ways to create and/or improve products in ways that customers value. Strategic entrepreneurship, and the innovations it leads to, is recognized as an extremely important leadership activity. Ask students to identify examples of innovations from different industries and how they increase customer value. Students should realize that information obtained from environmental analysis is often an important input into the strategic entrepreneurship/innovation process. 1 Define strategic entrepreneurship and corporate entrepreneurship Entrepreneurship is the economic engine driving many nations’ economies in the global competitive landscape. Entrepreneurship and innovation have become important for young and old, large and small organizations in all types of industries. Teaching Note: Research conducted by the Center for Entrepreneurial Leadership at the Kauffman Foundation has shown that in recent years almost 100 percent of the new jobs in the US have been created by entrepreneurial firms of less than two years of age. Strategic entrepreneurship is taking entrepreneurial actions using a strategic perspective. More specifically, it involves engaging in simultaneous opportunity seeking and competitive advantage seeking behaviors to design and implement entrepreneurial strategies to create wealth. The focus in the chapter is on innovation and entrepreneurship within established organizations. This phenomenon is called corporate entrepreneurship, which is the use or application of entrepreneurship within an established firm. Because of today’s uncertain environment (i.e., a complex global marketplace), firms cannot easily predict the future. As a result, they must develop strategic flexibility to have a range of strategic alternatives they can implement as needed. Creating tomorrow’s business requires a constant search for emerging opportunities. 2 Define entrepreneurship and entrepreneurial opportunities and explain their importance. ENTREPRENEURSHIP AND ENTREPRENEURIAL OPPORTUNITIES Entrepreneurship is the process by which individuals or groups identify and pursue entrepreneurial opportunities without being immediately constrained by the resources they currently control. Teaching Note: According to Schumpeter, entrepreneurship is a process of “creative destruction,” through which existing products or methods of production are destroyed and replaced with new ones. Thus, entrepreneurship is concerned with discovering and exploiting profitable opportunities. Entrepreneurial opportunities represent conditions in which new products or services can satisfy a need in the market. The essence of entrepreneurship is to identify and exploit these opportunities. After identifying opportunities, entrepreneurs take actions to exploit them and establish a competitive advantage. To do that, actions must be valuable, rare, costly to imitate, and nonsubstitutable. 3 Define invention, innovation, and imitation and describe the relationship among them. INNOVATION Peter Drucker argues that innovation is a function of entrepreneurship, as well as the means that an entrepreneur uses to create wealth-producing resources or enhance the potential of existing resources for creating wealth. Entrepreneurship and innovation are important for large and small firms (and start-ups) as they compete in the new competitive landscape. These are central to creativity, economic growth, productivity, and job creation. Teaching Note: Innovation has long been recognized as vital to competitive success. For example, Henry Ford, founder of Ford Motor Company, observed that, “The competitor to be feared is one who never bothers about you at all, but goes on making his own business better all the time. Businesses that grow by development and improvement do not die. But when a business ceases to be creative, when it believes it has reached perfection and needs to do nothing but produce—no improvement, no development—it is done.” Innovation has an impact on firm outcomes. • Innovation is a key source of competitive success for firms competing in turbulent, competitive markets. • Innovation is intended to enhance a firm’s strategic competitiveness and financial performance. • Research shows that firms in global industries that invest more in innovation also achieve greater returns. Schumpeter suggested that firms generally engage in three types of innovative activity: • Invention, the act of creating or developing a new product (good or service) or process idea • Innovation, the process of creating a commercializable product from invention • Imitation, the adoption of innovation by similar firms, which often leads to standardization of the product or process and lower prices—all of this while maintaining many of the same features In the United States in particular, innovation is the most critical of the three types of innovative activity. Many companies are able to create ideas that lead to inventions, but commercializing those inventions through innovation has, at times, proved difficult. This difficulty is suggested by the fact that approximately 80 percent of R&D occurs in large firms, but these same firms produce fewer than 50 percent of the patents. 4 Describe entrepreneurs and the entrepreneurial mind-s ENTREPRENEURS Entrepreneurs are individuals, acting independently or as part of an organization, who create a new venture or develop an innovation and take on the risks involved in introducing it to the marketplace. Entrepreneurs tend to demonstrate several characteristics, including those of being optimistic, highly motivated, willing to take responsibility for their projects, and courageous. In addition, entrepreneurs tend to be passionate and emotional about the value and importance of their innovation-based ideas. Evidence suggests that successful entrepreneurs have an entrepreneurial mind-set. The person with an entrepreneurial mind-set values uncertainty in the marketplace and seeks to continuously identify opportunities with the potential to lead to important innovations. Because it has the potential to lead to continuous innovation, individuals’ entrepreneurial mind-sets can be a source of competitive advantage for a firm. Top-level managers should try to establish an entrepreneurial culture that inspires individuals and groups to engage in corporate entrepreneurship. For example, Steve Jobs of Apple Computer believed one of his key responsibilities was to help Apple become more entrepreneurial and more like a start-up. In most cases, knowledge must be transferred to others in the organization (even in smaller ventures) to enhance the entrepreneurial competence of the firm. The transfer is likely to be more difficult in larger firms. Research has shown, however, that units within firms are more innovative if they have access to new knowledge. Managers need to develop the capabilities of their human capital to build on their current knowledge base while incrementally expanding that knowledge. Developing innovations and achieving success in the marketplace require effective human capital. In particular, a firm must have strong human capital throughout its workforce if employees are to develop an entrepreneurial mind-set. 5 Explain international entrepreneurship and its importance. INTERNATIONAL ENTREPRENEURSHIP Entrepreneurship is a top priority in many countries of the world (e.g., Finland, German, Israel, Ireland). A recent study of 42 countries found that the percentage of adults involved in entrepreneurial activity ranged from a high of over 40 percent in Peru to a low of slightly over 3 percent in Belgium. The US had a rate of about 10 percent. Importantly, this study also found a strong positive relationship between the rate of entrepreneurial activity and economic development in the country. Research indicates that there is a direct relationship between entrepreneurship and collectivism: when collectivism is emphasized, entrepreneurship declines. However, extremely high levels of individualism also can have a negative impact on entrepreneurship. Thus, it is important to balance individualism and collectivism (or the spirit of cooperation and group ownership of innovation). With increasing globalization, a growing number of new ventures are “born global” (i.e., started as an international concern). New ventures that enter international markets to increase their technological knowledge thereby enhance their performance. The probability of entering international markets increases when the firm has top executives with international experience. Furthermore, the firm has a higher likelihood of successfully competing in international markets when its top executives have international experience. Because of the learning and economies of scale and scope afforded by operating in international markets, both young and established internationally diversified firms often are stronger competitors in their domestic market as well. Additionally, as research has shown, internationally diversified firms are generally more innovative. 6 Describe how firms internally develop innovations. INTERNAL INNOVATION Most innovation is developed through Research and Development (R&D). In fact, R&D may be the most critical factor in gaining and sustaining a competitive advantage in some industries (e.g., pharmaceuticals). Effective R&D often leads to firms’ filing for patents to protect their innovative work. Increasingly, successful R&D results from integrating the skills available in the global workforce. In the years to come, the ability to have a competitive advantage based on innovation may accrue to firms that are able to meld the talent of human capital from countries across the world. Incremental and Radical Innovation Most innovations are incremental. That is, they build on existing knowledge bases and provide small improvements in the current product lines. Alternatively, radical innovations usually provide significant technological breakthroughs and create new knowledge. Radical innovations are rare because of the difficulty and risk involved in developing them. Internal corporate venturing represents the set of activities used to create inventions and innovations within a single organization. The internal corporate venturing process is illustrated in Figure 13.1. Figure Note: Figure 13.1 should be used as a reference point by students during your discussion of the process. Autonomous Strategic Behavior Autonomous strategic behavior is a bottom-up process in which new product champions pursue new product ideas—often through a political process—where they develop and coordinate the commercialization of a new good or service until it reaches marketplace success. A product champion is a member of an organization who has an entrepreneurial vision (or mental image) of a new good or service and seeks to create support for its commercialization. Product champions play a critical role in advancing innovations within the firm. Autonomous strategic behavior is based on a firm’s knowledge and resources that are the sources of a firm’s innovation, so a firm’s capabilities and competencies are the basis for new products and processes. GE depends on autonomous strategic behavior on a regular basis to produce innovations. Essentially, the search for services with market potential can start in any of GE’s businesses. For example, an operating unit may look for appropriate technology to improve the unit’s function. After it masters that technology, it then shapes it into a service it can sell to others. FIGURE 13.1 Model of Internal Corporate Venturing This model illustrates the two approaches to internal corporate venturing: • Autonomous strategic behavior is a bottom-up process which enables product champions to pursue new product ideas and sponsor them through a political process until they achieve commercial success. • Induced strategic behavior is a top-down process where product and process ideas are developed within the context of a firm’s existing strategy, structure, and strategic vision. Whichever process is followed takes place within and is affected by the structural and strategic context of the organization. Teaching Note: The following is another useful example on the topic. Using state-of-the-art technology and relying in part on autonomous strategic behaviors among some of the firm’s personnel, Callaway Golf Co. is known for reinventing industries. Callaway invented the oversize club segment of the golf club industry when it introduced its “Big Bertha” club, but the firm has also been seeking to reinvent the golf ball segment of the golfing industry. To be effective, an autonomous process for developing new products requires that new knowledge be continuously diffused throughout the firm. In particular, the diffusion of tacit knowledge is important for development of more effective new products. Induced Strategic Behavior The second approach to creating internal corporate venturing is induced strategic behavior, a top-down process where the current strategy and structure foster product innovations that are associated closely with the firm’s current strategy and structure. In other words, strategy is filtered through the firm’s existing structural hierarchy, a process that leads to internal innovations that are highly consistent with the firm’s current strategies. IMPLEMENTING INTERNAL INNOVATIONS Having processes and structures in place through which a firm can successfully implement the outcomes of internal corporate ventures and commercialize innovations is critical. Indeed, the successful introduction of innovations into the marketplace reflects implementation effectiveness. Effective integration of the various functions involved in innovation processes is required to implement the innovations resulting from internal corporate ventures. Increasingly, product development teams are being used to integrate activities associated with different organizational functions. Cross-Functional Product Development Teams Cross-functional teams facilitate efforts to integrate activities associated with different organizational functions (e.g., design, manufacturing, and marketing). In addition, new product development processes can be completed more quickly and the products more easily commercialized when cross-functional teams work effectively. Horizontal organization refers to changes in organizational processes where managing across functional units becomes more critical than managing up and down functional hierarchies. Teaching Note: Cross-functional teams group product development stages into parallel or overlapping processes, which allows the firm to tailor its product development efforts to its unique core competencies and to the needs of the market. Some of the core horizontal processes that are critical to innovation efforts are formal; they may be defined and documented as procedures and practices. More commonly, however, these processes are informal—that is, these routines or ways of working evolve over time. Often invisible, informal processes are critical to successful product innovations and are supported properly through horizontal organizational structures moreso than through vertical organizational structures. There are two primary barriers that may prevent the use of cross-functional teams as a means of integrating organizational functions: (1) independent frames of reference of team members and (2) organizational politics. Research suggests that functional departments vary along four dimensions: time orientation, interpersonal orientation, goal orientation, and formality of structure. Thus, individuals from different functional departments have different orientations on these dimensions and will view product development activities in different ways. Political activity may center on allocating resources to different functions. Interunit conflict may result from aggressive competition for resources among those representing different organizational functions. Facilitating Integration and Innovation Shared values and effective leadership are important to achieving cross-functional integration and implementing innovation. Highly effective shared values are framed around the firm’s vision and mission, and they become the glue that promotes integration between functional units. Thus, the firm’s culture promotes unity and internal innovation. Strategic leadership is also highly important for achieving cross-functional integration and promoting innovation. Leaders set goals and allocate resources. The goals include integrated development and commercialization of new goods and services. Effective strategic leaders also ensure a high-quality communication system to facilitate cross-functional integration. Creating Value from Internal Innovation The model in Figure 13.2 shows how value can be created for the firm from internal processes designed to develop and commercialize new goods and services. An entrepreneurial mind-set must be developed so that managers and employees will seek to identify and exploit opportunities for new goods and services and new markets. Cross- functional teams are important to promote integrated new product design ideas and commitment to their implementation thereafter. Effective leadership and shared values promote integration and vision for innovation and commitment to it. The end result for the firm is the creation of value for the customers and shareholders through development and commercialization of new products. Figure Note: Figure 13.2 illustrates relationships discussed in the chapter that enable the firm to appropriate value from innovation: barriers to integration, integration facilitating methods, and the advantages of cross- functional integration. It can either be referred to in summary form or used to summarize the preceding discussion. FIGURE 13.2 Creating Value through Internal Innovation Processes The model in this figure shows how firms can create value from the internal processes they use to develop and commercialize new goods and services. • An entrepreneurial mind-set is necessary so that managers and employees will consistently try to identify entrepreneurial opportunities the firm can pursue by developing new goods and services and new markets. • Cross-functional teams promote integrated new product ideas and commitment to their implementation. • Effective leadership and shared values promote integration and vision for innovation and commitment to it. • The end result for the firm is the creation of value for the customers and shareholders by developing and commercializing new products. As the model in Figure 13.2 suggests, internal corporate ventures must be effectively managed to facilitate cross-functional integration so a firm will be able to gain maximum value from its product design and commercialization efforts. STRATEGIC FOCUS An Innovation Failure at J.C. Penney: Its Causes and Consequences The Opening Case of Chapter 4 provided an introduction to a significant strategic failure at J.C. Penney. The specific causes and consequences of that failure are discussed in more detail in this Strategic Focus. While CEO Ron Johnson clearly was trying to innovate at JCP, the innovations were both ill-conceived and poorly executed. Johnson’s vision for JCP had two main components: the elimination of the firm’s practice of marking up goods and then offering discounts, promotions, and coupons to entice value-conscious customers, and establishing branded boutiques within JCP stores. Development and execution of the strategy was plagued by several problems including customer confusion about the new pricing (never quite believing the company’s everyday low prices were low enough), the fact that Johnson failed to use cross-functional teams to implement the strategy (Johnson both decided that the boutique concept was necessary and how it was going to be done), values required for the new concepts were not shared among JCP’s stakeholders, JCP was trying to do too many things at once without testing customer reaction to them. Thus, even though Johnson did have an entrepreneurial mindset, for numerous reasons the innovations he tried to instill in JCP were unsuccessful. Teaching Note: The Strategic Focus should make obvious that point that there is often considerable risk associated with innovation. Students should realize that innovation needs to be focused on those things that have a compelling customer value proposition. Product/service attributes that are desirable and/or delivered at a lower price to customers should be accepted by them. Those that do not are likely to fail. Ask students to identify and discuss other instances of innovations that failed to provide value and were subsequently viewed as failures. Ask them to speculate about why the innovations were introduced and what the company could (should) have done before the innovations were introduced into the marketplace. 7 Explain how firms use cooperative strategies to innovate. INNOVATION THROUGH COOPERATIVE STRATEGIES Virtually all firms lack the breadth and depth of resources (e.g., human capital and social capital) in their R&D activities to develop internally a sufficient number of innovations. Firms frequently use cooperative strategies to develop innovations and to quicken the pace at which some of their own innovations are distributed. In other instances, they use cooperative strategies to align what they believe are complementary assets with the potential to lead to future innovations. Teaching Note: An alternative to internal innovation is to tap the resources available in other organizations for the following reasons: • Knowledge is increasing rapidly, making it difficult for firms to remain up-to- date. • This vast knowledge base is also becoming increasingly specialized. • Firms may not possess the knowledge needed to commercialize goods and services. • Some countries may have access to resources and capabilities that enable firms located there to create specialized products. Both entrepreneurial ventures and established firms use cooperative strategies (e.g., strategic alliances and joint ventures) to innovate. Entrepreneurial ventures, for example, may seek investment capital as well as established firms’ distribution capabilities to successfully introduce one of its innovative products to the market. Alternatively, more established companies may need new technological knowledge and can gain access to it by forming a cooperative strategy with entrepreneurial ventures. Because of the importance of alliances, particularly in the development of new technology and in commercializing innovations, firms are beginning to build networks of alliances (a form of social capital) to help them obtain the knowledge and other resources necessary to develop innovations. Some firms now even allow external firms to participate in their internal new product development processes. Alliances formed for the purpose of innovation are not without risks. One important risk is that a partner will appropriate a firm’s technology or knowledge and use it to enhance its own competitive abilities. To prevent or at least minimize this risk, firms, particularly new ventures, need to select their partners carefully. 8 Describe how firms use acquisitions as a means of innovation. INNOVATION THROUGH ACQUISITIONS Firms sometimes acquire companies to gain access to their innovations and to their innovative capabilities. One reason companies do this is that the capital markets value growth; acquisitions provide a means to rapidly extend one or more product lines and increase the firm’s revenues. A key risk of acquisitions is that a firm may substitute an ability to buy innovations for an ability to produce innovations internally. In support of this contention, research shows that firms engaging in acquisitions introduce fewer new products into the market. 9 Explain how strategic entrepreneurship helps firms create value. CREATING VALUE THROUGH STRATEGIC ENTREPRENEURSHIP Newer entrepreneurial firms often are more effective than larger firms in identifying opportunities. These firms tend to be more innovative as well because of their flexibility and willingness to take risks. Alternatively, larger and well-established firms often have more resources and capabilities to exploit opportunities that are identified. In general, entrepreneurial ventures need to improve their advantage-seeking behaviors whereas larger firms need to improve their opportunity-seeking skills. Teaching Note: It is interesting and certainly worthwhile to note that individual entrepreneurs and small firms are responsible for a significant amount of innovation as measured by the ratio of R&D input to R&D output. To wit: • 80 percent of R&D activity is concentrated in large firms (10,000+ employees). • Large firms account for less than 50 percent of technological activity (measured by patenting). To be entrepreneurial, firms must develop an entrepreneurial mind-set among their managers and employees. Managers must emphasize the management of their resources, particularly human capital and social capital. The importance of knowledge to identify and exploit opportunities as well as to gain and sustain a competitive advantage suggests that firms must have strong human capital. Social capital is critical for access to complementary resources from partners in order to compete effectively in domestic and international markets. By entering global markets that are new to them, firms can learn new technologies and management practices and diffuse this knowledge throughout the entire enterprise. Furthermore, the knowledge firms gain can contribute to their innovations. Research has shown that firms operating in international markets tend to be more innovative. By developing resources (human and social capital), taking advantage of opportunities in domestic and international markets, and using the resources and knowledge gained in these markets to be innovative, firms achieve competitive advantages. In so doing, they create value for their customers and shareholders. Research shows that because of its economic importance and individual motives, entrepreneurial activity is increasing across the globe. Furthermore, more women are becoming entrepreneurs because of the economic opportunity entrepreneurship provides and the individual independence it affords. In the United States, for example, women are the nation’s fastest growing group of entrepreneurs. Teaching Note: Large firms can take several measures to act small and increase their innovative capacity. These include the following: • Greater levels of individual autonomy can be created through the restructuring of a firm into smaller and more manageable units (see Chapter 7). • The additional amounts of creativity and innovation that tend to be witnessed among those granted more autonomy stimulates autonomous strategic behavior when a firm pursues innovation through internal corporate ventures. • A firm can reengineer its operations to develop more efficient work-related processes and to form channels through which customers’ interests can be expressed with greater clarity and intensity. • Cross-functional teams provide opportunities for workers to think and act creatively. • When handled effectively, downsizing can create arrangements through which a firm is able to focus efforts more on key tasks—e.g., those required for innovation. • Allocating significant levels of resources to R&D can stimulate innovation. • Cooperative arrangements can help spawn innovations in the firm. STRATEGIC FOCUS Pursuing Competitive Success by Using Strategic Entrepreneurship The Strategic Focus discusses the role of strategic entrepreneurship at Boeing and Airbus. As these firms share high degrees of market commonality and resource similarity, competition between them is intense. To satisfy customer needs, both companies are engaged in efforts to produce innovative aircraft that their customers need to satisfy the markets that they serve (787 Dreamliner for Boeing and A350 for Airbus). Several of the innovations that both companies are pursuing involve the development of technologies that make aircraft more fuel efficient and comfortable for passengers. A major challenge is to produce innovative aircraft in a way that still keeps costs reasonable. Both companies have different versions of the aircraft that are targeted to different customer groups. All of the innovations that are going into these firms’ aircraft are not without risk. Boeing has had problems with the lithium-ion batteries used in the 787 spontaneously combusting. The Strategic Focus notes that when introducing the sorts of radical innovations that these firms are developing, the existence of some issues is expected. Going forward, both companies’ ability to extend some of these innovations across their product line may be important for their future success. Teaching Note: One of the takeaways of the Strategic Focus is that radical innovation is not without risks. Some of the other issues associated with the 787 has to do with the radical redesign of Boeing’s supply chain and the myriad of problems that resulted. Students should realize, however, that for both companies, innovation is crucial and if one company were to rest on existing technologies it would likely suffer the consequences. Students should also realize that in many other industries innovation is not a choice but a way of life. Instructor Manual for Strategic Management: Concepts and Cases: Competitiveness and Globalization Michael A. Hitt, R. Duane Ireland, Robert E. Hoskisson 9781285425184, 9781285425177, 9780538753098, 9781133495239, 9780357033838, 9781305502208, 9781305502147
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