Strategy Planning - Organizational Implementation

6 Organization Structure and Management Systems: The Fundamentals of Strategy Implementation

Ultimately, there may be no long-term sustainable advantage other than the ability to organize and manage.

—JAY GALBRAITH AND ED LAWLER

I’d rather have first-rate execution and second-rate strategy anytime than brilliant ideas and mediocre management.

—JAMIE DIMON, CEO, JPMORGAN CHASE & CO.

Many people regard execution as detail work that’s beneath the dignity of a business leader. That’s wrong. To the contrary, it’s a leader’s most important job.

—LARRY BOSSIDY, FORMER CEO, HONEYWELL

6

◆ Introduction and Objectives

◆ Strategy Formulation and Strategy Implementation

● The Strategic Planning System: Linking Strategy to Action

◆ The Fundamentals of Organizing: Specialization, Cooperation, and Coordination

● Specialization and Division of Labor

● The Cooperation Problem

● The Coordination Problem

◆ Developing Organizational Capability

● Processes

● Motivation

● Structure

◆ Organization Design

● The Role of Hierarchy

● Defining Organizational Units

● Alternative Structural Forms: Functional, Multidivisional, Matrix

● Systems and Style: Mechanistic versus Organic Organizational Forms

● Recent Trends in Organizational Design

◆ Summary

◆ Self-Study Questions

◆ Notes

O U T L I N E

132 PART II THE TOOLS OF STRATEGY ANALYSIS

Introduction and Objectives

We spend a lot of our time strategizing: pondering our next career move, making plans for a vaca- tion; thinking about how to improve our marketability. Most of these strategies remain just wishful thinking: if strategy is to yield results, it must be backed by commitment and translated into action.

The challenges of strategy implementation are even greater for organizations than for individuals. Executing strategy requires the combined efforts of all the members of the organization, many of whom will have played no role in its formulation; others will find that the strategy conflicts with their own personal interests. Even without these impediments, implementation tends to be neglected because it requires commitment, persistence, and hard work. “How many meetings have you attended where people left without firm conclusions about who would do what and when?” asks super-consultant, Ram Charan.1

In this chapter, we consider some of the fundamentals of strategy implementation. We begin by clarifying the relationship between strategy formulation and strategy implementation. If strategy involves translating intention into action, the basic organizational requirements are for coordination and cooperation. We view organizational capability as the mechanism through which coordination and cooperation effectuate action. We disaggregate organizational capability into four components: resources, motivation, processes, and structure and go on to explore the role of each of these in strategy implementation.

This chapter introduces only the fundamentals of strategy implementation. In subsequent chap- ters, we shall consider strategy implementation in particular contexts, such as strategic change (Chapter 8), innovation (Chapter 9), mature industries (Chapter 10), international business (Chapter 12), multi business firms (Chapter  14), and mergers and acquisitions (Chapter  15). At the same time, our consideration of strategy implementation is limited: ultimately strategy implementation embraces the whole of management.

By the time you have completed this chapter, you will be able to:

◆◆ Understand the relationship between strategy formulation and strategy implementation and the role of strategic planning systems in linking strategy to action.

◆◆ Recognize the role of cooperation and coordination as the basic requirements for organi- zational effectiveness.

◆◆ Appreciate the role that resources, processes, motivation, and structure play in developing organizational capabilities.

◆◆ Select the organizational structure best suited to a particular business context.

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 133

Strategy Formulation and Strategy Implementation

The relationship between strategy formulation and strategy implementation has long been a contentious issue. During the early years of corporate planning, strategy was viewed as a two-stage process: first, formulation (mainly by top management), then implementation (mainly by middle management). This conception was challenged by Henry Mintzberg who envisaged strategy as emerging from the interaction between the formulation and implementation (see the discussion of “How is Strategy Made? The Strategy Process” in Chapter 1).2

From what we have learned about the nature of strategy, it is clear that we cannot separate strategic management into self-contained formulation and implementation stages. The intended strategy of any organization is inevitably incomplete: it com- prises goals, directions, and priorities, but it can never be comprehensive. It is during implementation that the gaps are filled in and, because circumstances change, the strategy adapts. Equally, strategy formulation must take account of the conditions of implementation. The observation “Great strategy; lousy implementation” is typically a misdiagnosis of strategic failure: a strategy which has been formulated without taking account of its ability to be implemented is a poorly formulated strategy. Clearly, strategy formulation and implementation are interdependent. Nevertheless, the fact remains that purposeful behavior requires that action must be preceded by intention, and intention needs to be preceded by thought.

The Strategic Planning System: Linking Strategy to Action

Our outline of the development of strategic management in Chapter  1 (see “A Brief History of Business Strategy”) indicated that companies adopted corporate planning, not to formulate strategy but to facilitate coordination and control in increasingly large and complex organizations.

Similarly with entrepreneurial start-ups, when Steve Jobs and Steve Wozniak founded Apple Computer at the beginning of 1977, strategy was developed in their heads and through their conversation. A written articulation of Apple’s strategy did not appear until they needed to write a business plan in order to attract venture capital funding.3 However, Apple did not adopt a systematic strategic planning process until several years later when it needed to establish capital expenditure budgets for its different functions and product teams and link strategy to day-to-day decision-making.

Thus, Mintzberg’s claim that formalized strategic planning is a poor way to make strategy, even if it is right, fails to recognize the real value purpose of strategic planning systems. As we shall see, strategic planning systems provide a framework for the strategy process which can assist in building consensus, communicating the strategy and its rationale throughout the organization, allocating resources to support the strategy, and establishing performance goals to guide and motivate the individuals and groups responsible for carrying out the strategy.

The Strategic Planning Cycle Most large companies have a regular (normally annual) strategic planning process that results in a document that is endorsed by the board of directors and provides a development plan for the company for the next three to five years. The strategic planning process is a systematized approach that assem- bles information, shares perceptions, conducts analysis, reaches decisions, ensures

134 PART II THE TOOLS OF STRATEGY ANALYSIS

consistency among those decisions, and commits managers to courses of action and performance targets.

Strategic planning processes vary between organizations. At some they are highly centralized. Even after an entrepreneurial start-up has grown into a large company, strategy making may remain the preserve of the chief executive. At MCI Communica- tions, former CEO Orville Wright observed: “We do it strictly top-down at MCI.”4 How- ever, at most large companies, the strategic planning process involves a combination of top-down direction and bottom-up initiatives.5

Figure 6.1 shows a typical strategic planning cycle. The principal stages are:

1 Setting the context: guidelines, forecasts, assumptions. The CEO typically initiates the process by indicating strategic priorities—these will be influenced by the outcome of the previous performance reviews. In addition, the strategic planning unit may provide assumptions or forecasts that offer a common basis for strategic planning by different units within the organization. For example, the 2017–20 strategic plan of the Italian oil and gas company Eni was based upon (a) the goal of increasing free cash flow by expanding petroleum production and selling assets and (b) assumptions that the price of crude would rise to $60 per barrel and the dollar/euro exchange rate would appreciate to 1.20 by 2020.6

2 Business plans. On the basis of these priorities and planning assumptions, the different organizational units—product divisions, functional departments, and geographical units—create strategic plans that are then presented for com- ment and discussion to top management. This dialogue represents a critically important feature of the strategy system: it provides a process for sharing knowledge, communicating ideas, and reaching consensus. This process may be more important than the strategic plans that are created. As General (later President) Dwight Eisenhower observed: “Plans are worthless, but planning is everything.”7

Corporate Guidelines

Draft Business

Plans

Discussions with

Corporate

Revised Business

Plans

Approval by

Board

Corporate Plan

Capex Budget

Performance Targets

Operating Plan/ Operating Budget

Performance Review

Forecasts/ Scenarios/ Planning

Assumptions

FIGURE 6.1 The generic annual strategic planning cycle

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 135

3 The corporate plan. Once agreed, the business plans are then integrated to create the corporate strategic plan that is then presented to the board for approval.

4 Capital expenditure budgets. Capital expenditure budgets link strategy to resource allocation. They are established through both top-down and bottom-up initiatives. When organizational units prepare their business plans, they will indicate the major projects they plan to undertake during the stra- tegic planning period and the capital expenditures involved. When top management aggregates business plans to create the corporate plan, it estab- lishes capital expenditure budgets both for the company as a whole and for the individual businesses. The businesses then submit capital expenditure requests for specific projects that are evaluated through standard appraisal methodologies, typically using discounted cash flow analysis. Capital expen- diture approvals take place at different levels of a company according to their size. Projects of up to $5 million might be approved by a business unit head; projects of up to $25 million might be approved by divisional top management; larger projects might need to be approved by the top management committee; the biggest projects may require approval by the board of directors.

5 Operational plans and performance targets. Implementing strategy requires breaking down strategic plans into a series of shorter-term plans that pro- vide a focus for action and a basis for performance monitoring. At the basis of the annual operating plan are a set of performance targets derived from the strategic plan. These performance targets are both financial (sales growth, margins, return on capital) and operational (inventory turns, defect rates, number of new outlets opened). In the section on “Setting Performance Tar- gets” in Chapter 2, I outlined the basic cascading logic for goal setting: overall goals of the organization are disaggregated into more specific performance goals as we move down the organization. As Chapter 2 shows, this can use either a simple financial disaggregation or the balanced scorecard method- ology. There is nothing new about this approach: management by objectives (the process of participative goal setting) was proposed by Peter Drucker in 1954.8 Performance targets can be built into the annual operating budget. The operating budget is a pro forma profit-and-loss statement for the company as a whole and for individual divisions and business units for the upcoming year. It is usually divided into quarters and months to permit continual monitoring and the early identification of variances. The operating budget is part fore- cast and part target. Each business typically prepares an operating budget for the following year that is then discussed with the top management committee and, if acceptable, approved. In some organizations, the budgeting process is part of the strategic planning system: the operating budget is the first year of the strategic plans; in others, budgeting follows strategic planning. Opera- tional planning is more than setting performance targets and agreeing budgets; it also involves planning specific activities. As Bossidy and Charan explain: “An operating plan includes the programs your business is going to complete within one year ... Among these programs are product launches; the marketing plan; a sales plan that takes advantage of market opportunities; a manufac- turing plan that stipulates production outputs; and a productivity plan that improves efficiency.”9

136 PART II THE TOOLS OF STRATEGY ANALYSIS

The Fundamentals of Organizing: Specialization, Cooperation, and Coordination

Translating intention into action requires organizing. To understand what organizing involves, we must understand why firms exist.

Specialization and Division of Labor

Firms exist because of their efficiency advantages in producing goods and services that results from the division of labor: each worker specializing in a specific task. Consider Adam Smith’s description of pin manufacture:

One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the papers.10

Smith’s pin makers produced about 4800 pins per person each day. “But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each have made 20, perhaps not one pin, in a day.”

However, specialization comes at a cost: dividing the production process requires integrating the separate efforts. This involves two problems: first, the cooperation problem, aligning the interests of individuals who have divergent goals; second, the coordination problem, even in the absence of goal conflict, how do individuals harmo- nize their separate efforts?

The Cooperation Problem

The economics literature analyzes cooperation problems arising from goal misalign- ment as the agency problem.11 An agency relationship exists when one party (the principal) contracts with another party (the agent) to act on behalf of the principal. The problem is ensuring that the agent acts in the principal’s interest. Particular attention has been given to agency problems arising between owners (shareholders) and managers. The central issue of corporate governance is ensuring that managers act in the inter- ests of shareholders. However, agency problems exist throughout the entire hierarchy: employees tend to pursue their own interests rather than those of their organization. Even organizational goals fragment as a result of specialization as each department creates its own subgoals. The classic conflicts are between different functions: sales wishes to please customers, production wishes to maximize output, R & D wants to introduce mind-blowing new products, while finance worries about profit and loss.

Several mechanisms are available to management for achieving goal alignment within organizations:

● Control mechanisms typically operate through hierarchical supervision: man- agers supervise the behavior and performance of subordinates using positive and negative incentives. The principal positive incentive is the oppor- tunity for promotion up the hierarchy; negative incentives are dismissal and demotion.

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 137

● Performance incentives link rewards to output: they include piece rates for pro- duction workers and profit bonuses for executives. Performance-related incen- tives have the advantages of being “high powered”—rewards are directly related to performance—and they avoid the need for costly monitoring and supervision of employees. Pay-for-performance is less effective when employees work in teams or where output is difficult to measure.

● Shared values. Some organizations achieve high levels of cooperation and low levels of goal conflict without resorting to either punitive controls or performance incentives. The members of churches, charities, and voluntary organizations often share values that support common purpose. Similarly, for business enterprises, as we saw in Chapter 2 (see pp. 52–53), shared values among members encourage the convergence of interests and perceptions that facilitate consensus and enhances performance.12 In doing so, shared values can act as a control mechanism that is an alternative to bureaucratic control or financial incentives. An organization’s values are one component of its culture. Strategy Capsule 6.1 discusses the role of organizational culture in aligning individual actions with company strategy.

● Persuasion. Implementing strategy requires leadership and at the heart of lead- ership is persuasion. J.-C. Spender argues that, language is central, both to the conceptualization of strategy and to its implementation.13 Leadership requires influencing others, where rhetoric—the use of language for persuasion—is a core skill. Management rhetoric is not simply about communicating strategy; it involves changing the perceptions of organizational members, their relationships with the organization, and, ultimately, guiding their actions to actualize the strategy in the face of uncertainty and ambiguity.

The Coordination Problem

Willingness to cooperate is not enough to ensure that organizational members integrate their efforts—it is not a lack of a common goal that causes Olympic relay teams to drop the baton. Unless individuals can find ways of coordinating their efforts, production does not happen. As we shall see in our discussion of organizational capabilities, the exceptional performance of Disney theme parks, the Ferrari Formula 1 pit crew, and the US Marine Corps band derives less from the skills of the individual members and more from superb coordination among them.

Mechanisms for coordination include the following:

● Rules and directives: A basic feature of all firms is a general employment contract under which individuals agree to perform a range of duties as required by their employer. This allows managers to exercise authority by means of general rules (“Secret agents on overseas missions will have essential expenses reimbursed only on production of original receipts”) and specific directives (“Miss Moneypenny, show Mr Bond his new toothbrush with 4G communica- tion and a concealed death ray”).

● Mutual adjustment: The simplest form of coordination involves the mutual adjustment of individuals engaged in related tasks. In soccer or doubles tennis, players coordinate their actions spontaneously without direction or established routines. Such mutual adjustment occurs in leaderless teams and is especially suited to novel tasks where routinization is not feasible.

138 PART II THE TOOLS OF STRATEGY ANALYSIS

● Routines: Where activities are performed repeatedly, coordination becomes routinized. As we shall see in more detail when we discuss processes, organizational routines are “regular and predictable sequences of coordinated actions by individuals” that provide the foundation of organizational capability. If organizations are to perform complex activities efficiently and reliably, rules, directives, and mutual adjustments are not enough—coordination must become embedded in routines.

STRATEGY CAPSULE 6.1

Organizational Culture as an Integrating Device

Corporate culture comprises the beliefs, values, and

behavioral norms of the company, which influence

how employees think and behave.a It is manifest in

symbols, ceremonies, social practices, rites, vocabulary,

and dress. While shared values are effective in aligning

the goals of organizational members, culture exercises

a wider influence on an organization’s capacity for pur-

poseful action. Organizational culture is a complex

phenomenon. It is shaped by the national and ethnic

cultures within which the firm is embedded and the

social and professional cultures of organizational mem-

bers. Most of all, it is a product of the organization’s his-

tory, especially the founder’s personality and beliefs: the

corporate culture of Walt Disney Company continues to

reflect the values, aspirations, and personal style of Walt

Disney. A corporate culture is seldom homogeneous:

different cultures coexist within different functions and

departments.

Culture can facilitate both cooperation and

coordination through fostering social norms and a sense

of identity. Cultures can also be divisive and dysfunc-

tional. At the British bank NatWest during the 1990s, John

Weeks identified a “culture of complaining” which was a

barrier to top-down strategy initiatives.b A culture may

support some types of corporate action but handicap

others. Lehman Brothers (whose collapse in September

2008 triggered the global financial crisis) was renowned

for its individualistic, entrepreneurial culture whose

downside was ineffective risk management. The culture

of the British Broadcasting Corporation reflects internal

politicization, professional values, and dedication to the

public good, but a lack of customer focus.c

Cultures take a long time to develop and cannot

easily be changed. As the external environment changes,

a highly effective culture may become dysfunctional. The

police forces of some US cities have developed cultures

of professionalism and militarism, which increased their

effectiveness in fighting crime, but led to isolation and

unresponsiveness to community needs.d

Despite its power in determining how an orga-

nization behaves, culture is far from being a flexible

management tool at the disposal of chief executives. It

is a property of the organization as a whole, which is not

amenable to manipulation. CEOs inherit rather than cre-

ate the culture of their organizations. The key issue is to

recognize the culture of the organization and to ensure

that structure and systems work with the culture and not

against it. Where strategy is aligned with organizational

culture, it can act as a control device and a source of flex-

ibility: when individuals internalize the goals and princi-

ples of the organization, they can be allowed to use their

initiative and creativity in their work.

Notes: aE. H. Schein, “Organizational Culture,” American Psychologist 45 (1990): 109–119. bJ. Weeks, Unpopular Culture: The Ritual of Complaint in a British Bank (Chicago: University of Chicago Press, 2004). cT. Burns, The BBC: Public Institution and Private World (London: Macmillan, 1977). d“Policing: Don’t Shoot,” Economist (December 13, 2014): 37.

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 139

The relative roles of these different coordination devices depend on the types of activity being performed and the intensity of collaboration required. Rules are highly efficient for activities where standardized outcomes are required—most quality- control procedures involve the application of simple rules. Routines are essential for activ- ities where close interdependence exists between individuals, be the activity a basic production task (supplying customers at Starbucks) or more complex (performing a heart bypass operation). Mutual adjustment works best for nonstandardized tasks (such as problem-solving), where those involved are well informed of the actions of their coworkers, either because they are in close visual contact (a chef de cuisine and her sous chefs) or because of information exchange (a design team using interactive CAD software).

Developing Organizational Capability

Translating strategy into action requires organizational capability. Hence, the develop- ment and deployment of organizational capabilities lies at the core of strategy imple- mentation. So far, we have said little about the determinants of organizational capability beyond recognizing that capabilities involve combining resources to perform a task. Let us look more closely at the structure of organizational capability in the light of our pre- ceding discussion of the fundamentals of organizing.

Capabilities require resources, and the level of capability depends, to some degree, upon the amount and quality of these resources. However, there is more to capa- bility than resources alone. In sport, all-star teams can be beaten by teams that create strong capabilities from modest resources. In 1992, the US men’s Olympic basketball team—the “Dream Team” that included Charles Barkley, Larry Bird, Patrick Ewing, Magic Johnson, Michael Jordan, Karl Malone, and Scottie Pippen—lost to a team of college players in one of their practice games. In Euro 2016, the English soccer team, with a market value of $810 million, was eliminated by Iceland, a team valued at $30 million. Similarly, in business: upstarts with modest resources can outcompete established giants—Dyson against Electrolux in domestic appliances, ARM against Intel in microprocessors, Spotify against Apple in streamed music. Clearly, there is more to organizational capability than just resources.

The effectiveness with which resources—people especially—are integrated to cre- ate capabilities depends upon three major factors: processes, motivation, and structure. These are depicted in Figure 6.2.

ORGANIZATIONAL CAPABILITIES

RESOURCES

Motivation StructureProcesses

FIGURE 6.2 Integrating resources to build capability

140 PART II THE TOOLS OF STRATEGY ANALYSIS

Processes

The academic literature views organizational capability as based upon organizational routines—“regular and predictable behavioral patterns [comprising] repetitive patterns of activity” that determine what firms do, who they are, and how they develop.14 Like individual skills, organizational routines develop through learning-by-doing—and, if not used, they wither.

However, the academic literature’s emphasis on routines as an emergent phenomenon ignores the role of management. In practice, patterns of coordination among organi- zational members to undertake a productive task are planned by managers who use learning-before-doing as a vital preliminary to learning-by-doing. For this reason, I emphasize organizational processes over organizational routines, where a process is a coordinated sequence of actions through which specific productive tasks are per- formed. Not only is the term process well understood by managers, but there are established tools for their design, mapping, and development.15

Motivation

Processes provide the basis for team members to coordinate their individual actions; however, the effectiveness of the coordination depends upon the extent of their motivation. We discussed motivation in relation to the challenge of aligning the goals of individuals with those of the organization. Team motivation is more complex: it depends not only on each individual’s willingness to strive in performing his/her specific task but also on a willingness to subordinate individuals to team goals. Despite decades of research, the determinant of exceptional team performance remains a mystery—which is why outstandingly successful sports coaches—Alex Ferguson, Joe Gibbs, John Wooden, Scotty Bowman—command huge fees on the corporate lecture circuits.

Structure

The people and processes that contribute to an organizational capability need to be located within the same organizational unit if they are to coordinate effectively. Processes that span internal organizational boundaries rarely achieve high levels of capability. Until the mid-1980s, European and US automakers used a sequential system of new product development which began in marketing then went, in turn, to styling, engineering, manufacturing, and finance. When they adopted the cross- functional product development teams pioneered by Toyota and Honda, the time to develop a new model of car was halved.16 As companies develop new capabilities, so their organizational structures become more complex. Strategy Capsule 6.2 shows the evolution of organizational structure at a management consulting company as it developed specialist capabilities.

The design of organizational structure is a broad topic that cannot be reduced to the simple principle of locating each organizational process within an organizational unit. So let us consider more generally the basic issues that are involved in the design of organizational structures.

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 141

STRATEGY CAPSULE 6.2

Capability Development and Organizational Structure at Booz & Company

During the 1990s, Booz Allen Hamilton (now Strategy&,

a subsidiary of PwC) transitioned from a “generalist” to a

“specialist” model of management consulting. Under the

generalist model, consultants were located in one of its

28 offices throughout the world and were then assigned

to one or more consulting projects. The expectation was

that they would develop, through experience, broad-

based consulting expertise that was not specific either

to a particular management function or particular sector.

Booz’s managing partner referred to the firm as “a colony

of artists” (see Figure 6.3a).

During the 1990s, Booz recognized the need to

develop specialist capabilities in relation to individual

management functions (such as strategy, operations,

information technology, and change management) and

specific sectors (e.g., energy, telecom, financial services,

and automobiles). To develop these specialist capabilities,

Booz adopted a matrix structure comprising functional

practices and sector practices (see Figure  6.3b). Hence,

a new consultant or associate joining Booz would be

located within a particular office and assigned to one or

more client teams, but training and career development

purposes would also be part of a functional practice and

a sector practice.

FIGURE 6.3 Booz Allen Hamilton (Worldwide commercial business)

b 1998: Organizing for capabilitya 1992: “A colony of artists”

FUNCTIONAL PRACTICES

P R A C T I C E S

I N D U S T R Y

NY Tokyo London

Strategy Operations IT Financial services

Energy

Telecom

Consumer

Engineering

Chemicals /Pharma

P r o j e c t Te a m sP r o j e c t Te a m s

NY

Tokyo

London

Project Teams

Project Teams

Project Teams

Project Teams

Project Teams

Project Teams

142 PART II THE TOOLS OF STRATEGY ANALYSIS

Organization Design

Designing structures that can reconcile efficiency through specialization with effective integration is a major management challenge that is informed by a substantial body of organizational theory. Let us restrict ourselves to four issues that are especially rele- vant to implementing strategy. We begin by acknowledging the need for hierarchy—all organizations are hierarchical to a greater or lesser degree. We go on to consider how to define organizational units within these hierarchies. We then examine how these organizational units are configured within the overall structure of the company. Finally, we look at formality within organizations and the relative merits of mechanistic and organic structures.

The Role of Hierarchy

Hierarchy is the fundamental feature of all but the simplest organizations and the primary mechanism for achieving coordination and cooperation. Despite the nega- tive images that hierarchy often conveys, there are no viable alternatives for complex organizations—the critical issue is how hierarchy should be structured and how its var- ious parts should be linked. Hierarchy is a solution both to the problem of cooperation and the problem of coordination.

Hierarchy as Mechanism for Cooperation: Hierarchy is system of control through authority: each member of the organization reports to a superior and has subordinates to supervise and monitor. Hierarchy is a core feature of bureaucracy— a formalized administrative system devised by the Qin emperor of China in about 220BC, and deployed ever since in public administration, the military, and commerce. For the German sociologist, Max Weber, bureaucracy was the most efficient and rational way to organize human activity. It involves “each lower office under the con- trol and supervision of a higher one”; a “systematic division of labor”; formalization in writing of “administrative acts, decisions, and rules”; and work governed by stan- dardized rules and operating procedures. Authority is based on “belief in the legality of enacted rules and the right of those elevated to authority under such rules to issue commands.”17

Hierarchy as Coordination: Hierarchy is a feature not only of human organiza- tions, but of all complex systems:

● The human body comprises subsystems such as the respiratory system, nervous system, and digestive system, each of which consists of organs, each of which is made up of individual cells.

● The physical universe is a hierarchy with galaxies at the top, solar systems below, planets below that, and so on, all the way down to atoms and subatomic particles.

● A novel is organized by chapters, paragraphs, sentences, words, and letters.

The basic principle here is that of modularity: dividing complex systems into hierarchi- cally organized components.18 Modular, hierarchical structures have two major advan- tages in coordinating productive activities:

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 143

● Economizing on coordination: Hierarchy reduces the amount of communica- tion needed to coordinate the activities of organizational members. Suppose that the optimal span of control is five. In a group of six individuals, there are 15 bilateral interactions, if one member is appointed coordinator, there are five vertical interactions. Similarly, a group of 25 involves 250 bilateral interactions; a hierarchical system with a span of control of five requires a three-tier hierarchy and 24 interactions. The larger the number of organiza- tional members, the greater the efficiency benefits from organizing hierar- chically. Complex computer software can require large development teams: Microsoft’s Windows 8 development team comprised about 3200 software development engineers, test engineers, and program managers. These were organized into 35 “feature teams,” each of which was divided into a number of component teams. As a result, each engineer needed to coordinate only with the members of his or her immediate team. The modular structure of the Windows 8 development team mirrored the modular structure of the product.

● Adaptability: Hierarchical, modular systems can evolve more rapidly than uni- tary systems. This adaptability requires decomposability: the ability of each component subsystem to operate with some measure of independence from the other subsystems. Modular systems that allow significant independence for each module are referred to as loosely coupled.19 The modular structure of Win- dows enabled a single feature team to introduce innovative software features without the need to coordinate with all 34 other teams. The key requirement is that the different modules must fit together—this requires a standardized inter- face. Entire companies may be viewed as loosely coupled modular structures. At Procter & Gamble, decisions about developing new shampoos can be made by the Beauty, Hair, and Personal Care sector without involving P&G’s other three sectors (Baby, Feminine, and Family Care; Fabric and Home Care; and Health and Grooming). A modular structure also makes it easier to add new businesses and divest others—in 2015, P&G sold its cosmetics and fragrances business to Coty.20

Organizational capabilities can also be viewed as being organized hierarchically. In the petroleum sector, drilling capability is composed of several specialist capabilities; then drilling capability links with other capabilities to form overall exploration capa- bility (see Figure 6.4). Similarly with Apple’s new product development capability, this

Negotiating Capability

Geological Capability

Directional Drilling

Capability

Well Logging

Capability

Deepwater Drilling

Capability

Well Casing

Capability

Hydraulic Fracturing Capability

Seismic Capability

Drilling Capability

Well Construction Capability

Partnering Capability

Procurement Capability

Exploration Capability

FIGURE 6.4 The hierarchical structure of organization capabilities: The case of oil and gas exploration

144 PART II THE TOOLS OF STRATEGY ANALYSIS

too is a higher-level capability that combines an array of lower-level capabilities such as market insight, microelectronic capability, software engineering, design aesthetics, and partner relations management. Because these upper-level capabilities integrate such a broad span of specialist know-how, they are difficult for others to imitate.

Defining Organizational Units

An organizational hierarchy is composed of organizational units—but how should we define these units? The principle we have established so far is that organizational struc- ture should be aligned with processes: those who perform a process should be located within the same organizational unit. The fundamental issue is intensity of coordination needs: those individuals who need to interact most closely should be located within the same organizational unit. In the case of McDonald’s, the store managers and crew members undertake food preparation, cooking, and cleaning: the individual store is the basic organizational unit. At Infosys Consulting, a client engagement may involve con- sultants and software engineers at different Infosys offices throughout the world as well as those at the client site: the project team is the appropriate organizational unit—even if it is temporary and spans multiple locations. However, individuals’ organizational roles typically involve them in multiple processes—which should take precedence when defining organizational units? James Thompson’s answer was “Where interdepen- dence among organizational members is most intense.”21

Alternative Structural Forms: Functional, Multidivisional, Matrix

The same principle of defining organizational units in the basis of the intensity of interdependence also applies to the integration of lower-level organizational units into higher-level units. On the basis of these alternative approaches to grouping tasks and activities, we can identify three basic organizational forms for companies: the functional structure, the multidivisional structure, and the matrix structure.

The Functional Structure Single-business firms tend to be organized by function. Most airlines have functional structures (see Figure 6.5). Grouping together functionally similar tasks is conducive to exploiting scale economies, promoting learning and capability building, and deploying standardized control systems. Since cross- functional integration occurs at the top of the organization, functional

Finance Legal &

Regulatory Technology Human

ResourcesMarketingOperations

Board of Directors

CEO Michael O’Leary

FIGURE 6.5 Ryanair Holdings plc: Organizational structure

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 145

structures are conducive to a high degree of centralized control by the CEO and top management team.

As functionally organized companies grow and diversify, so there are pressures to decentralize through adopting a divisional structure (see below). However, as com- panies and their industries mature, the advantages of efficiency, centralized control, and well-developed functional capabilities can cause companies to revert to functional structures. General Motors, a pioneer of the multidivisional structure, integrated its product divisions and overseas subsidiaries into a more integrated functional structure as scale economies became its dominant strategic priority.

The Multidivisional Structure In a multidivisional corporation, the divisions are separate businesses, defined by product or geography. The key advantage of the multi- divisional structure is the potential for decentralized decision-making. It is a loosely coupled, modular organization where business-level strategies and operating decisions can be made at the divisional level, while the corporate headquarters concentrate on corporate planning, budgeting, and providing common services.

The effectiveness of the multidivisional form depends on the ability of the corporate center to apply a common management system to the different businesses. At ITT, Harold Geneen’s “managing by the numbers” allowed him to cope with over 50 divisional heads reporting directly to him. At BP, a system of “performance contracts” allowed CEO John Browne to oversee BP’s 24 businesses, each of which reported directly to him. Divi- sional autonomy also fosters the development of leadership capability among divisional heads—an important factor in grooming candidates for CEO succession.

The large, divisionalized corporation is typically organized into three levels: the corporate center, the divisions, and the individual business units, each representing a distinct business for which financial accounts can be drawn up and strategies formu- lated. Figure 6.6 shows General Electric’s organizational structure at the corporate and divisional levels. Chapter 14 will look in greater detail at the management of the multi- divisional corporation.

Matrix Structure Whatever the primary basis for grouping, all companies that embrace multiple products, multiple functions, and multiple locations must coordinate across all three dimensions. Organizational structures that formalize coordination and control across multiple dimensions are called matrix structures.

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FIGURE 6.6 General Electric: Organizational structure, January 2018

146 PART II THE TOOLS OF STRATEGY ANALYSIS

Figure  6.7 shows the Shell management matrix (prior to reorganization in 1996). Within this structure, the general manager of Shell’s Berre refinery in France reported to his country manager, the managing director of Shell France, but also to his business sector head, the coordinator of Shell’s refining sector, as well as having a functional relationship with Shell’s head of manufacturing.

Many diversified, multinational companies, including Philips, Nestlé, and Unilever, adopted matrix structures during the 1960s and 1970s, although in all cases one dimension of the matrix tended to be dominant in terms of authority. Thus, in the old Shell matrix, the geographical dimension, as represented by country heads and regional coordinators, had primary responsibility for budgetary control, personnel appraisal, and strategy formulation.

Since the 1980s, the matrix structure has fallen out of favor and several large corpo- rations have claimed to have dismantled their matrix organizations: “They led to conflict and confusion; the proliferation of channels created informational logjams as a pro- liferation of committees and reports bogged down the organization; and overlapping responsibilities produced turf battles and a loss of accountability.”22 Yet, any company that operates over multiple products, multiple functions, and multiple geographical

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FIGURE 6.7 Royal Dutch Shell Group: Pre-1996 matrix structure

CHAPTER 6 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 147

markets has to coordinate with each of these dimensions. So, all multifunctional, multi- product, multinational companies are de facto matrix organizations. The problem is over-formalization, resulting in a top-heavy corporate HQ and over-complex systems that slow decision-making and dull entrepreneurial initiative. The trend has been for companies to focus on formal systems of coordination and control on one dimension, then allowing the other dimensions of coordination to be mainly informal. Thus, while Shell claims to have dismantled its matrix and organized itself around four business sec- tors, the reality is that it still has country heads, responsible for coordinating all Shell’s activities in relation to legal, taxation, and government relations within each country, and functional heads, responsible for technical matters and best-practice transfer within their particular function.

Systems and Style: Mechanistic versus Organic Organizational Forms

So far, we have looked just at structure—the architecture of organizations. Equally important are the systems through which the structure operates and the management styles through which these systems are manifest. During the first half of the 20th century, management thought was dominated by Weber’s theory of bureaucracy and Frederick Taylor’s rational approach to job design and employee incentives. During the 1950s, the human relations school of management recognized the importance of social relation- ships within organizations and adverse impact of inertia and alienation on employee effort. “Theory X” had been challenged by “Theory Y.”23 The important issue here is that different types of management suit different circumstances. Among Scottish engi- neering companies, Burns and Stalker found that firms in stable environments had mechanistic forms, characterized by formality and high degrees of job specialization; those in less stable markets had organic forms that were less formal and more flex- ible.24 Table 6.1 contrasts key characteristics of the two forms.

This principle that an organization’s structure, systems, and management style should reflect the environment, in which it operates forms the basis of contingency theory— there is no one best way to organize; it depends upon circumstances.25 Although Alphabet (Google) and McDonald’s are both large international companies, their struc- tures and systems are very different. McDonald’s is highly bureaucratized: high levels

TABLE 6.1 Mechanistic versus organic organizational forms

Feature Mechanistic forms Organic forms

Task definition Rigid and highly specialized Flexible and broadly defined

Coordination and control Rules and directives vertically imposed

Mutual adjustment, common culture

Communication Vertical Vertical and horizontal

Knowledge Centralized Dispersed

Commitment and loyalty To immediate superior To the organization and its goals

Environmental context Stable with low technological uncertainty

Dynamic with significant technological uncertainty and ambiguity

Source: Adapted from Richard Butler, Designing Organizations: A Decision-Making Perspective (London: Routledge, 1991): 76, by permission of Cengage Learning.