Business Paper

Organizational Strategy

The definition of organizational strategy often covers decisions about which opportunities an organization will pursue and the development of a long-term action plan for achieving a goal. Osinga (2006) defines the concept as "a mental tapestry of changing intentions for harmonizing and focusing our efforts as a basis for realizing some aim or purpose in an unfolding and often unforeseen world of many bewildering events and many contending interests" (p. 55).

Organizational strategies occur at four levels: global, corporate, business, and functional:

· Global-level strategies are decisions surrounding the methods of pursuing international markets. The most important question here is whether or not the firm can continue to use what it does better than any other competitor (such as a competitive advantage) in that foreign market, and whether or not it can financially meet the specific needs of consumers in that foreign market.

· Corporate-level strategies are long-term actions designed to select the appropriate industry or industries in which to operate. The following questions can serve as guidelines for corporate-level strategies:

· Should we compete in areas similar to our current products?

· Should we purchase one of our suppliers so that we can buy our component parts cheaper?

· Should we buy a business unrelated to what we do now to spread out the economic risks we face?

· Business-level strategies are long-term actions designed to confer competitive advantage over industry rivals. Business-level strategies are concerned with, identifying consumers, meeting consumer needs, and defining the competencies needed to meet those needs.

· Functional-level strategies are the most specific of the levels of strategy, and are concerned with the actions of each function in a company. These must support the business-level strategies and involve the actual implementation of strategy. Generally, the lower levels of management are the executors of functional-level strategy.

Global-Level Strategy

Many organizations make the mistake of taking their existing domestic marketing model and simply dropping it into another location without forethought regarding the many cultural, social, economic, technological, and legal factors that are at play—and without deeply analyzing the conditions that may or may not be conducive to their business.

Sound global-level strategies identify opportunities that allow the firm to build on its competitive advantages, yet are customized to the local market conditions and realities. Of course, the very definition of a competitive advantage is market-specific; when moving into a different market, the competitive advantage may be put at risk. Strategists must be very careful that the competitive advantage can be protected and used, as opposed to being copied or stolen in other markets.

Poor global-level strategies are those that can be realized only by doing something the organization cannot currently do well. For instance, a US chocolate company entering the European chocolate market is not a good strategy if the organization does not have the brand recognition required to overtake many centuries-old brands already present in Europe.

Corporate-Level Strategy

Corporate-level strategy, considered from a single-market perspective (eliminating the global, in other words) requires the firm to think about itself at the highest level. Corporate-level strategy dictates where and how the organization aspires to improve, or to identify other opportunities it wishes to develop. A central aspect of corporate-level strategy is the idea of competitive advantage—an offering or competency the firm does better than anyone else that can it protect from being copied.

A firm that makes shoes may not have a competitive advantage in the shoes themselves (especially if they are considered by the consumer to be relatively generic), but it can develop such an advantage in the manufacturing and supply chain behind the distribution of the shoes. In this case, a good corporate-level strategy allows the company to use this same supply chain and distribution capability in an industry that does not have good supply chain utilization. This practice may seem counterintuitive, but think about the example. Say, for instance, that the electronics industry currently has terrible supply chain management. This firm could use its mastery of supply chain and distribution to improve that industry and meet organizational growth goals. It has nothing to do with shoes—only with opportunity.

Business-Level Strategy

Business-level strategy is concerned primarily with determining whether the organization’s existing set of products (determined in the global- and corporate-level strategies) are taking full advantage of the market opportunities available. For instance, are the products fully meeting the needs of the consumers? Of all segments of consumers? Are there opportunities to more fully meet the needs of the consumer—thereby creating more value, for which consumers are willing to pay more?

This part of organizational strategy is where the firm makes sure it is fully aligned with the needs of the consumer (whatever segment is in focus) in every way possible. It may find it needs to change product attributes, think of different segments to pursue, or engineer better products.

Functional-Level Strategy

Functional-level strategy is all about implementing the strategies determined at the global, corporate, and business levels. Here’s where the individual departments and units get their marching orders to fulfill the higher-level strategies. The product development office, for example, may get instructions to redesign the product for a foreign market; the marketing office may get directions to identify whether a new product offering would meet the needs of a specific segment. The production unit may get instructions to take over the operations of a subsidiary that was purchased; HR may be assigned to bring two workforces together. Only where the strategies are handed to the functional units do any of the higher-level strategies get accomplished.

It should be apparent that all four levels of strategy must be aligned and be complementary. The CEO’s office—the leaders most likely to approve global- and corporate-level strategies—can do nothing to realize a strategy without the functional-level units. All four must be directly aligned with overall organizational strategy, and all strategies must have specific time frames attached to them to ensure each part is accomplished in the appropriate time frame. Planning is a critical component to organizational strategy.

Strategy Frameworks

Low-Cost Producer versus Differentiation

The first dimension of business-level strategy relates to the approach a company takes to satisfy its customers. The concepts of low-cost producer and differentiation are essential for understanding business-level strategy because they define the two fundamental options a firm must consider when formulating its business-level strategy. The concept of low-cost producer refers to a strategy where the business concentrates on keeping its costs of operations at the lowest possible level. This means that significant effort is directed toward keeping costs for raw materials, labor, manufacturing, etc. as low as possible. Frequently, low-cost producers will also have fewer products with fewer options, which further aids in keeping costs low. 

An example of a low-cost producer is Payless ShoeSource. If you visit a Payless shoe store, you will notice that there are few employees. Usually there is a cashier and a stockperson. The store décor is not expensive. The flooring is industrial strength, solid-color carpet, and the shelves are very functional, but made of metal and similar in design to what you would find in a warehouse. The shoes themselves are made from lower-quality materials. All of these characteristics are indicators of a low-cost producer. 

A common area of confusion regarding low-cost producers is that low cost means low price. Usually, low-cost producers compete by selling for a lower price, but this is not always true. For example, Nike sells some athletic shoes for over $150 even though the cost to make that shoe is under $30. The point to remember is that the term "low-cost producer" refers to the cost of manufacturing, not the cost (price) to the customer.

The low-cost producer strategy has two primary advantages. Due to the lower costs involved, the company can better survive price wars with competitors because it can still make money when other higher cost competitors may actually lose money on a sale. A second advantage is that a low-cost producer makes it more difficult for a new entry into the market because newcomers can’t realize the same cost economies of the more experienced firm. 

There are also two disadvantages of this strategy. The first is that competitors can usually imitate the processes that produce the cost reductions, so the advantage may be relatively short term. Second, the company might focus so much on cost reduction that the its products and services become inferior enough to lose business to the higher-priced competitors’ products.

Differentiation refers to the methods companies use to set their products and services apart from the competition. There are many ways a company may differentiate its products or services, including the features offered, the expected life of the product, the way it advertises, the technology incorporated into the product, the level of customer service, and the convenience of the company’s location (Grant, 2008). When a company is able to differentiate itself effectively in one of these areas, it is called a distinctive competency. The best distinctive competencies are difficult to imitate.

There are several advantages to the differentiation strategy. First, differentiation tends to develop customer loyalty that protects the company from the competition. It is also possible to pass increases in the cost of operations on to the consumer. The difficulty in sustaining the differentiation strategy is that it may be easy to imitate, which erodes the product’s distinctiveness. A second threat to differentiation is the introduction of a substitute product that makes an older product obsolete. For example, the introduction of the miniaturized cell phone has negatively affected not only the sales of traditional landline phones, but also the sales of personal computers.

The final lesson concerning the low-cost producer and differentiation strategy concepts is that is takes an attitude of continuous improvement and adaptability to sustain any advantage gained by either approach.

Broad Market versus Focus Market

A second dimension of business-level strategy is the number of industry market segments a company chooses to compete in. The concept of a market segment refers to a subset of the products and services that constitute an industry. For example, the automobile industry has market segments: sedans, coupes, sports cars, sport utility vehicles, light trucks, vans, etc. If a company competes in virtually all of the market segments, it is said to have a broad market strategy. General Motors and Toyota, for example, compete in virtually all the market segments.

Companies that compete in only one market segment or just a few market segments are pursuing a focus market strategy. A focus company generally has a narrow product line. Ferrari persues a focus strategy, in that it makes only sports cars. (Actually, Ferrari is an extreme example of the focus strategy because it makes only high-priced, high-performance sports cars.) It is common for companies that begin with a focus strategy to expand into other segments of the market. Toyota began as a company focused on producing small, economy cars, but has evolved into a company that follows a broad strategy. Companies expand into new segments to spur growth.

Both the broad and focus strategies can be paired with either the differentiation or low-cost producer strategies, creating four possible business-level strategy choices, according to the marketing strategist, Michael Porter. Years after popularizing his original four-strategy concept, Porter added a fifth strategy option. These five types of business-level strategy are discussed in the next section.

Porter’s Five Business-Level Strategies

Porter’s business level strategies are sometimes referred to as generic because they apply to any type of business such as manufacturing, services, or nonprofit (Hill & Jones, 1994). Choosing a generic strategy is an important strategic planning step because each of the five strategies significantly influences the way company decisions are made. For example, decisions involving the differentiation approach are quite different from decisions involving the low-cost producer approach. To help you better understand these generic strategies, they are illustrated in the figure below, followed by a description of each of the five strategies.

 

 

Five Business-Level Strategies

Broad Differentiation Strategy

Broad differentiation strategy describes actions taken by a company to compete in all or most of an industry’s market segments by differentiating its products from those of competitors. Once again, differentiation may be accomplished in the areas described in the previous section. Another way to think of differentiation is to use the categories of quality, customer service, and innovation. A product or service may be perceived as better than the competition because its quality, customer service, or innovation is better than the competition. Generally, companies that pursue the broad differentiation strategy will charge higher prices for their differentiation. Some well-known companies that pursue this strategy are Sony (consumer electronics), Nordstrom (retail clothing, etc.), and McGraw Hill (publishing).

Focused Differentiation Strategy

Focused differentiation strategy is similar to the broad differentiation strategy, except that a company pursuing this strategy only competes in a single market segment or just a few of the market segments in the industry. Companies using this strategy seek to set themselves apart from the competition through differentiation. Generally speaking, these companies offer products in the higher end of the price range. Ethan Allen Furniture pursues this strategy, and its products are usually significantly higher priced than the competition because the company believes the value added or level of differentiation (primarily due to quality or innovation) justifies the higher price. Some other companies that pursue this strategy are Ferrari (sports cars), Rolex (watches), and Apple (select consumer electronics).

Broad Low-Cost Producer Strategy

This strategy describes actions taken by a company to keep its costs of operations as low as possible. Every aspect of the business is analyzed to identify a cheaper way to perform a given task. A broad low-cost producer strategy also means that the company offers products or services in virtually every market segment of the industry. A good example of a company pursuing this strategy is Payless Shoes, whose cost-cutting measures were described earlier. The advantage of this approach is that a lower price to consumers can be charged and the company can still make a profit. 

Wal-Mart may be the most famous company that pursues the broad low-cost producer strategy. Wal-Mart’s particular strength is its supply chain. Although the stores may not appear to be high-tech, the company’s ordering and delivery systems are highly automated, and the organization has spent years finding the cheapest way to supply its stores with merchandise. Wal-Mart's strategy is considered to be broad, because the company offers thousands of products in its stores.

Focused Low-Cost Producer Strategy

The focused low-cost producer strategy also seeks to keep the costs of operations as low as possible, but the company competes only in one or a few market segments. Companies pursuing this strategy select the market segment or segments where they believe there is the best opportunity to make a profit. McDonald's is a well-known focused low-cost producer. The company seeks to compete by having efficient processes to prepare a limited menu. Its menu items require relatively few ingredients, and most of the items are delivered in single serving–size portions to make food preparation faster and easier. Companies pursuing the focused low-cost producer strategy (as well as those applying the broad low-cost producer strategy) make their profit through the volume of their sales. 

Best-Cost Strategy

This strategy was added to Porter's framework to recognize the feasibility of simultaneously pursuing both a differentiation strategy and a low-cost strategy. When Porter first published his typology of business-level strategies, he stated that pursuing both the differentiation strategy and the low-cost producer strategy wouldn’t work. His reasoning was that a company would be trying to do too many things at once, resulting in poor performance in both differentiation and low-cost approaches. He referred to this type of effort as stuck-in-the-middle.

Years later, Porter had to recognize that pursuing both the differentiation and low-cost producer strategies was possible due to major changes in technology. More specifically, technology related to manufacturing had evolved so companies could produce custom ordered products at virtually the same cost they incurred for mass-produced items. 

One of the early pioneers of this strategy was Dell Computers. The Dell business model allowed customers to design the computer they wanted. Dell would build it, then charge a lower price than the other computer companies. Dell’s cost savings were in lower costs for component part inventories and a flexible manufacturing process that allowed different computers to be made with very little time spent adjusting the production line. Another way to think of the best cost strategy is that it attempts to offer the best value for the products. This means that you will get a product closer to your specific needs for a price that is probably lower than the competition’s. Many companies have grown into this strategy over a period of years. Toyota and BMW have evolved in their manufacturing processes so that they allow customers to make many custom-feature choices on their automobiles without any significant production cost increases.

Application of Business-Level Strategy

The descriptions of low cost and differentiation should provide you with the ability to determine if a company is pursuing one or both of these approaches. Whether the company is pursuing a broad or a focused strategy is determined by looking at the number of products or services offered compared to the total number of market segments in the industry. Due to technological advances, identifying a specific strategy has become more complicated, but the descriptions provided here should help you to determine the business-level strategy being pursued by any company.

Conclusion

Business-level strategy choices determine how a company chooses to compete in its industry. The strategy types are based on two concept pairs: differentiation vs. low-cost producer, and broad vs. focused market segments. Success by one company using a specific business-level strategy will draw the attention of competitors, who will try to imitate the competency or competencies of that successful company. The more complex the mix of competencies that create a company’s competitive advantage, the longer it will take competitors to copy it. It took the other personal computer manufacturers almost twenty years to imitate Dell’s supply chain and manufacturing competencies. Generally speaking, however, distinctive competencies in pursuing a business-level strategy are becoming more and more short lived. This trend puts a lot of pressure on companies in competitive industries to continuously seek to improve and adapt their business-level strategies.

Step 4 Helpful Information:

Balanced Scorecard and Key Performance Indicators

The article Balanced Scorecard (2009) in the Resources section below, describes a popular framework developed by Kaplan and Norton (1992). When implemented well, the balanced scorecard can help leaders and managers set strategic goals that are informed by multiple important perspectives (e.g., customers, shareholders, and implications for innovation and learning). The scorecard enables the inclusion of nonfinancial information when evaluating an organization’s situation, determining strategic priorities, and identifying needed changes in structure and systems (Kaplan, 2005). However, while the scorecard serves as an organizing framework for strategy formulation, it has proven less useful as a tool for measuring performance in accomplishing specific goals and objectives. Another criticism of the balanced scorecard is that it may be less useful for organizations in especially dynamic industries.

To supplement the balanced scorecard, organizations also need specific measures or indicators that can be used to evaluate their performance in achieving goals and objectives. Key performance indicators, or KPIs, serve this purpose. Read more about key performance indicators in the article located in the Resources section below, and in the journal literature.

Some organizations use neither the balanced scorecard nor KPIs. If this is the case, it is still important to examine the extent to which multiple perspectives are considered in formulating the organization’s strategy or in making changes to structure and systems. It is also important to explore what indicators—even informal indicators—are being used, or might be used, to evaluate an organization’s performance.

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Competitive Advantage

Competitive advantage is what an organization does better than anyone else—something that is difficult or impossible to copy. People often think that a competitive advantage lies in the product an organization produces, but that is not necessarily the case. A competitive advantage could come from any or all of the following factors:

· the product itself

· the organization's brand

· a particular protected technology that results in the consumer seeing the product or service as better

· a method used to produce the product or service that results in a cost advantage over other producers

· exclusive access to a particular market or set of clients

The condition of being difficult or impossible to copy is unequivocally critical; if any competitors can copy your advantage, you will not have an advantage for long.

Not every firm has a true competitive advantage. A true competitive advantage becomes the organization’s primary basis for strategic direction. In other words, if the firm has a true competitive advantage in its brand, for example, it may be able to translate this brand into additional products or ventures. Of course, the firm must carefully protect its competitive advantage so as not to dilute it or expose it to copy.

A competitive advantage may last only a brief time, or it may last a long while. The firm often does not necessarily control the longevity of your competitive advantage. Consider the following issues for each of the sources of competitive advantage listed above:

· the product itself—If you have a competitive advantage from the product itself, you will keep that advantage only as long as the consumer finds your product superior to alternatives. If the consumer decides that a different product better meets their needs (and you cannot control this decision), you will lose your competitive advantage.

· the organization’s brand—There are many brands that have tried to leverage their competitive advantage and actually ended up diluting it and destroying any cachet the brand had with consumers. There are countless examples of companies that had a distinct brand that grew very fast, resulting in a brand that consumers no longer cared as much about: Abercrombie & Fitch, Coach, Gap, Michael Kors, Apple, etc.

· a particular protected technology—It is not the technology itself that gives you a competitive advantage, but the way the consumer feels about the product or service as a result of the technology being a part of it. If a competitor comes out with a different technology that results in their product better meeting the needs of the client, your technology may no longer offer a competitive advantage.

· a method to produce the product—There is little that keeps other companies from copying your methods, but there are instances when competing companies could not copy the culture that is integral to a method. In such cases, the competitive advantage can be long lasting. Walmart, for example, may have a competitive advantage based on the company’s supply chain and logistics, such that competitors simply cannot offer the same products at a better price. Note that this advantage is consumer-centric: Walmart’s customers consider price as the most important attribute in their shopping. Target and Kmart have struggled for decades to match Walmart’s supply chain capacity, but they have been unable to duplicate Walmart’s success. There is nothing inherently secret or different about Walmart’s logistics. Competitors simply have not been able to culturally and organizationally position themselves to match Walmart’s logistic success.

· exclusive access—As long as exclusive access is maintained, usually in the form of a contract, it will be difficult for others to enter. However, without careful relationship management (nonexploitation) during the term of the contract, the contract may not be renewed, and that competitive advantage will be lost very quickly.

As you can see, maintaining true competitive advantage requires hard work. The organization must nurture and care for its competitive advantage very carefully in order to keep it, and must also use that same competitive advantage as the basis for its strategic growth.

Strategy that does not center on a competitive advantage (i.e., strategy that can be copied by competitors or that is not fully aligned with customers' needs) is usually short-lived.

Building Blocks of Competitive Advantage: Porter’s Five Forces and VRIN

Porter's Five Forces

The prominent marketing strategist Michael Porter is perhaps best known for the Porter’s five forces model, a strategic framework designed to analyze an organization’s competitive strategies (Porter’s Five Forces Model, 2009). In his book, Competitive Strategy: Techniques for Analyzing Industries and Competitors (1980), Porter described the model as a way to assess profitability and competition in light of five competitive forces: suppliers, competitors, substitute products, customers or buyers, and potential entrants (see the figure below).

Resources

Competitive Advantage

VRIN

To describe the characteristics of competitive advantage, Michael Porter uses the acronym VRIN: valuable, rare, inimitable, and nonsubstitutable. Porter suggests, in essence, that the firm's competitive advantage is truly a competitive advantage only if it is unique to the firm and can't be copied by competitors. Let’s look at each characteristic individually:

· valuable—What the firm thinks has value is unimportant; a competitive advantage can be based only on something that the market or consumers think has value. For example, many suggest that Walmart's competitive advantage is that it has such strong control over its supply chain that it can offer desirable prices for products. In other words, operating (overhead) costs are low enough that the consumer can receive a very attractive price for products. Here's the question: Do low prices have value to the consumer? Clearly, the answer is yes. The competitive advantage Walmart owns, which enables it to offer lower prices, is therefore valuable. Evidence suggests that in the United States, other large-scale retailers have been unable to develop the logistical expertise that Walmart owns. This is a favorable circumstance for Walmart, given consumers’ strong preference for lower prices. On the other hand, a wine company that thinks its competitive advantage rests in the beauty of its label may be in for a rude awakening. While a beautiful label is important in the buying process, the contents of the bottle and quality are far more important. Consumers may choose a bottle with an ugly label if they know the winery makes excellent products. Thus, a label along may not be a good building block for competitive advantage.

· rare—If the competitive advantage offers value to the client, that value must also be rare, meaning that other companies aren't doing the same thing. Many business owners, asked about their company’s competitive advantage, state that it is their customer service. Great customer service is important to clients, but any competitor can offer great customer service relatively easily; it is not rare. A product or service does not constitute an advantage if others do the same thing.

· inimitable—So you have a competitive advantage that is valuable and rare. But can competitors notice that competitive advantage and easily copy it? If so, it is not really a competitive advantage, as others can quickly remove the advantage by copying it, and you are back to square one. A company that has an easily recognized brand, such as Coca-Cola, which has positive consumer sentiment attached to it possesses a great competitive advantage, because it is valuable, rare, and inimitable. Other soft drinks companies have a very difficult time developing the same degree of advantage.

· nonsubstitutable—It is ideal for a company or product to have few or zero substitutes. The more distinctive the product or service is in consumers’ minds, the stronger the degree of competitive advantage will be for the firm. In the case of Coca-Cola, the product isn't quite unique, which lessens Coca-Cola's competitive advantage.

If a firm truly has a competitive advantage that meets these criteria, then it is a sustainable competitive advantage on which to build forward-looking strategy. If, on the other hand, the firm doesn't have a true competitive advantage, it can consider strategies that will help it potentially build a competitive advantage based on these four building blocks. It can grow and build something it does well (but isn't yet a competitive advantage) in a way that will enhance its value, its rarity, its inimitability, and its uniqueness.

Core Competencies

A competency is something an organization is able to do with the resources and capabilities it has created, developed, or acquired. Core competencies build and rely upon the organization’s strengths and typically serve to distinguish it from its competitors. In other words, core competencies are difficult to replicate. One familiar example of core competencies is Apple’s approach to product design.

Especially in dynamic and highly competitive markets, where fast adjustments and innovation are critical for survival, guarding against complacency and over-reliance on past competencies is important.

Organizational Size

Measures of organizational size include the number of employees, the number of locations in which the organization operates, the number of clients or members served, the amount of revenue generated, and the products or services offered by the organization.

Organizational size has implications on a business's ability to accomplish its missions, goals, values, objectives, and strategies. Smaller organizations may have fewer resources available to leverage toward growth and innocation. However, they may be more flexible and agile (Damanpour, 1992). Larger organizations may be slower than optimal to respond to changing circumstances and opportunities (Whetten, 1987), but they may have the resources and capacity needed to tolerate the risks associated with change and innovation (Gopalakrishnan & Damanpour, 2000).

This is a topic of considerable interest for those working in very small organizations, which have limited ability to take advantage of economies of scale. One of the biggest related issues of interest to scholarly experts, consultants, and practitioners has been the influence of size on change and innovation (Ford, 2009). While scholars have long studied the impact of size on organizational effectiveness and innovation, findings and conclusions have been mixed. Thus, we must not assume that large organizations inevitably will be inefficient and ineffective, or that small ones will be agile.

Leaders have used multiple approaches to avoid excessive and limiting bureaucracy as their organizations have grown, and various measures can be implemented to mitigate or eliminate size-related risks (see, for example, Bloodgood, 2006). For small organizations focused on innovation, options have included strategic partnerships and grants. Large organizations have experimented with creating separate R&D divisions, innovation incentive programs and awards, partnerships with start-ups, and so on. A famous example of what was then an innovative idea was Lockheed Martin’s creation in 1943 of a Skunk Works to work secretly, shielded from the organization’s huge bureaucracy, on the XP-80 project. Other examples of how big companies are managing to innovate despite their size include Intuit’s “'lean start-ins' that gather 'intrapreneurs' together" and Whirlpool’s use of “i-mentors” (Kaplan, 2012). If you search the Internet, you will uncover interesting discussions and examples about how big companies are partnering with startups to speed innovation and take advantage of market opportunities.

Core Competencies

A competency is something an organization is able to do with the resources and capabilities it has created, developed, or acquired. Core competencies build and rely upon the organization’s strengths and typically serve to distinguish it from its competitors. In other words, core competencies are difficult to replicate. One familiar example of core competencies is Apple’s approach to product design.

Especially in dynamic and highly competitive markets, where fast adjustments and innovation are critical for survival, guarding against complacency and over-reliance on past competencies is important.

Organizational Structure

Organizational structure refers to how individual work and team work within an organization are coordinated. To achieve organizational goals and objectives, individual work needs to be coordinated and managed. Structure is a valuable tool in achieving coordination, as it specifies reporting relationships (who reports to whom), delineates formal communication channels, and describes how separate actions of individuals are linked together. Organizations can function within a number of different structures, each possessing distinct advantages and disadvantages. Although any structure that is not properly managed will be plagued with issues, some organizational models are better equipped for particular environments and tasks.

Building Blocks of Structure

What exactly do we mean by organizational structure? Which elements of a company’s structure make a difference in how we behave and how work is coordinated? We will review four aspects of structure that have been frequently studied in the literature: centralization, formalization, hierarchical levels, and departmentalization. We view these four elements as the building blocks, or elements, making up a company’s structure. Then we will examine how these building blocks come together to form two different configurations of structures.

Centralization

Centralization is the degree to which decision-making authority is concentrated at higher levels in an organization. In centralized companies, many important decisions are made at higher levels of the hierarchy, whereas in decentralized companies, decisions are made and problems are solved at lower levels by employees who are closer to the problem in question.

As an employee, where would you feel more comfortable and productive? If your answer is "decentralized," you are not alone. Decentralized companies give more authority to lower-level employees, resulting in a sense of empowerment. Decisions can be made more quickly, and employees often believe that decentralized companies provide greater levels of procedural fairness to employees. Job candidates are more likely to be attracted to decentralized organizations. Because centralized organizations assign decision-making responsibility to higher-level managers, they place greater demands on the judgment capabilities of CEOs and other high-level managers.

Many companies find that the centralization of operations leads to inefficiencies in decision making. For example, in the 1980s, the industrial equipment manufacturer Caterpillar suffered the consequences of centralized decision making. At the time, all pricing decisions were made in the corporate headquarters in Peoria, Illinois. This meant that when a sales representative working in Africa wanted to give a discount on a product, they needed to check with headquarters. Headquarters did not always have accurate or timely enough information about the subsidiary markets to make an effective decision. As a result, Caterpillar was at a disadvantage against competitors such as the Japanese firm Komatsu. Seeking to overcome this centralization paralysis, Caterpillar underwent several dramatic rounds of reorganization in the 1990s and 2000s (Nelson & Pasternack, 2005).

CAT Bulldozer

Changing their decision-making approach to a more decentralized style has helped Caterpillar compete at the global level.

Bauma 2007 Bulldozer Caterpillar 2 by Aconcagua is licensed under CC BY-SA 3.0.

However, centralization also has its advantages. Some employees are more comfortable in an organization where their manager confidently gives instructions and makes decisions. Centralization may also lead to more efficient operations, particularly if the company is operating in a stable environment (Ambrose & Cropanzano, 2000; Miller, et al.., 1988; Oldham & Hackman, 1981; Pierce & Delbecq, 1977; Schminke, et al.., 2000; Turban & Keon, 1993; Wally & Baum, 1994).

In fact, organizations can suffer from extreme decentralization. For example, some analysts believe that the FBI experiences some problems because its structure and systems are based on the assumption that crime needs to be investigated after it happens. Over time, this assumption led to a situation where, instead of following an overarching strategy, each FBI unit is completely decentralized, and field agents determine how investigations should be pursued. It has been argued that due to the change in the nature of crimes, the FBI needs to gather accurate intelligence before a crime is committed; this requires more centralized decision making and strategy development (Brazil, 2007).

Hitting the right balance between decentralization and centralization is a challenge for many organizations. At Home Depot, the retail giant with over two thousand stores across the United States, Canada, Mexico, and China, one of the major changes instituted by former CEO Bob Nardelli was to centralize most of its operations. Before Nardelli’s arrival in 2000, Home Depot store managers made a number of decisions autonomously, and each store had an entrepreneurial culture. Nardelli’s changes initially saved the company a lot of money. For example, for a company of that size, centralizing purchasing operations led to big cost savings because the company could negotiate important discounts from suppliers. At the same time, many analysts think that the centralization went too far, leading to the loss of the service-oriented culture at the stores. Nardelli was ousted after seven years (Charan, 2006; Marquez, 2007).

Formalization

Formalization is the extent to which an organization’s policies, procedures, job descriptions, and rules are written and explicitly articulated. Formalized structures are those in which there are many written rules and regulations. These structures control employee behavior using written rules so that employees have little autonomy to decide on a case-by-case basis. An advantage of formalization is that it makes employee behavior more predictable. Whenever a problem at work arises, employees know to turn to a handbook or a procedure guideline. Therefore, employees respond to problems in a similar way across the organization, leading to consistency of behavior.

While formalization reduces ambiguity and provides direction to employees, it is not without disadvantages. A high degree of formalization may actually lead to reduced innovation because employees are used to behaving in a certain manner. In fact, strategic decision making in such organizations often occurs only when there is a crisis. A formalized structure is associated with reduced motivation and job satisfaction as well as a slower pace of decision making (Frederickson, 1986; Oldham & Hackman, 1981; Pierce & Delbecq, 1977; Wally & Baum, 1994). The service industry is particularly susceptible to problems associated with high levels of formalization. Sometimes employees who are listening to a customer’s problems may need to take action, but the answer may not be specified in any procedural guidelines or rulebook. For example, while a handful of airlines such as Southwest do a good job of empowering their employees to handle complaints, in many airlines, lower-level employees have limited power to resolve a customer problem and are constrained by stringent rules that outline a limited number of acceptable responses.

Hierarchical Levels

Another important element of a company’s structure is the number of levels it has in its hierarchy. Keeping the size of the organization constant, tall structures have several layers of management between frontline employees and the top level, while flat structures consist of only a few layers. In tall structures, the number of employees reporting to each manager tends to be smaller, resulting in greater opportunities for managers to supervise and monitor employee activities. In contrast, flat structures involve a larger number of employees reporting to each manager. In such a structure, managers will be relatively unable to provide close supervision, leading to greater levels of freedom of action for each employee.

Research indicates that flat organizations provide a greater need satisfaction for employees and greater levels of self-actualization (Ghiselli & Johnson, 1970; Porter & Siegel, 2006). At the same time, there may be some challenges associated with flat structures. Research shows that when managers supervise a large number of employees, which is more likely to happen in flat structures, employees experience greater levels of role ambiguity—the confusion that results from being unsure of what is expected of a worker on the job (Chonko, 1982). This is especially a disadvantage for employees who need closer guidance from their managers. Moreover, in a flat structure, advancement opportunities will be more limited because there are fewer management layers. Finally, while employees report that flat structures are better at satisfying their higher-order needs such as self-actualization, they also report that tall structures are better at satisfying security needs of employees (Porter & Lawler, 1964). Because tall structures are typical of large and well-established companies, it is possible that when working in such organizations employees feel a greater sense of job security.

IKEA Storefront

Companies such as IKEA, the Swedish furniture manufacturer and retailer, are successfully using flat structures within stores to build an employee attitude of job involvement and ownership.

Ikea almhult by Wikimedia Commons is licensed under CC BY-SA 3.0.

Departmentalization

Organizational structures differ in terms of departmentalization, which is broadly categorized as either functional or divisional.

Organizations using functional structures group jobs based on similarity in function. Such structures may have departments such as marketing, manufacturing, finance, accounting, human resources, and information technology. In these structures, each person serves a specialized role and handles large volumes of transactions. For example, in a functional structure, an employee in the marketing department may serve as an event planner, planning promotional events for all the products of the company.

In organizations using divisional structures, departments represent the unique products, services, customers, or geographic locations the company is serving. Thus each unique product or service the company is producing will have its own department. Within each department, functions such as marketing, manufacturing, and other roles are replicated. In these structures, employees act like generalists as opposed to specialists. Instead of performing specialized tasks, employees will be in charge of performing many different tasks in the service of the product. For example, a marketing employee in a company with a divisional structure may be in charge of planning promotions, coordinating relations with advertising agencies, and planning and conducting marketing research, all for the particular product line handled by his or her division.

In reality, many organizations are structured according to a mixture of functional and divisional forms. For example, if the company has multiple product lines, departmentalizing by product may increase innovation and reduce response times. Each of these departments may have dedicated marketing, manufacturing, and customer service employees serving the specific product; yet, the company may also find that centralizing some operations and retaining the functional structure makes sense and is more cost effective for roles such as human resources management and information technology. The same organization may also create geographic departments if it is serving different countries.

Each type of departmentalization has its advantages. Functional structures tend to be effective when an organization does not have a large number of products and services requiring special attention. When a company has a diverse product line, each product will have unique demands, deeming divisional (or product-specific) structures more useful for promptly addressing customer demands and anticipating market changes. Functional structures are more effective in stable environments that are slower to change. In contrast, organizations using product divisions are more agile and can perform better in turbulent environments. The type of employee who will succeed under each structure is also different. Research shows that when employees work in product divisions in turbulent environments, because activities are diverse and complex, their performance depends on their general mental abilities (Hollenbeck, et al.., 2002).

Two Configurations: Mechanistic and Organic Structures

Functional Departmentalization Structure

An example of a pharmaceutical company with a functional departmentalization structure.

Divisional Departmentalization Structure

An example of a pharmaceutical company with a divisional departmentalization structure.

The different elements making up organizational structures in the form of formalization, centralization, number of levels in the hierarchy, and departmentalization often coexist. As a result, we can talk about two configurations of organizational structures, depending on how these elements are arranged.

Mechanistic structures are those that resemble a bureaucracy. These structures are highly formalized and centralized. Communication tends to follow formal channels, and employees are given specific job descriptions delineating their roles and responsibilities. Mechanistic organizations are often rigid and resist change, making them unsuitable for innovation and quick action. These forms have the downside of inhibiting entrepreneurial action and discouraging the use of individual initiative on the part of employees. Not only do mechanistic structures have disadvantages for innovation, but they also limit individual autonomy and self-determination, which will likely lead to lower levels of intrinsic motivation on the job (Burns & Stalker, 1961; Covin & Slevin, 1988; Schollhammer, 1982; Sherman & Smith, 1984; Slevin & Covin, 1990).

Despite these downsides, however, mechanistic structures have advantages when the environment is more stable. The main advantage of a mechanistic structure is its efficiency. Therefore, in organizations that are trying to maximize efficiency and minimize costs, mechanistic structures provide advantages. For example, McDonald’s has a famously bureaucratic structure where employee jobs are highly formalized, with clear lines of communication and specific job descriptions. This structure is an advantage for them because it allows McDonald’s to produce a uniform product around the world at minimum cost. Mechanistic structures can also be advantageous when a company is new. New businesses often suffer from a lack of structure, role ambiguity, and uncertainty. The presence of a mechanistic structure has been shown to be related to firm performance in new ventures (Sine & Kirsch, 2006).

In contrast to mechanistic structures, organic structures are flexible and decentralized, with low levels of formalization. In organizations with an organic structure, communication lines are more fluid and flexible. Employee job descriptions are broader and employees are asked to perform duties based on the specific needs of the organization at the time as well as their own levels of expertise. Organic structures tend to be related to higher levels of job satisfaction on the part of employees. These structures are conducive to entrepreneurial behavior and innovation (Burns & Stalker, 1961; Covin & Slevin, 1988). An example of a company that has an organic structure is the diversified technology company 3M. The company is strongly committed to decentralization. At 3M, there are close to 100 profit centers, with each division feeling like a small company. Each division manager acts autonomously and is accountable for his or her actions. As operations within each division get too big and a product created by a division becomes profitable, the operation is spun off to create a separate business unit. This is done to protect the agility of the company and the small-company atmosphere.

Conclusion

The degree to which a company is centralized and formalized, the number of levels in the company hierarchy, and the type of departmentalization the company uses are key elements of a company’s structure. These elements of structure affect the degree to which the company is effective and innovative as well as employee attitudes and behaviors at work. These elements come together to create mechanistic and organic structures. Mechanistic structures are rigid and bureaucratic and help companies achieve efficiency, while organic structures are decentralized, flexible, and aid companies in achieving innovativeness.

Discussion Questions

· What are the advantages and disadvantages of decentralization?

· All else being equal, would you prefer to work in a tall or flat organization? Why?

· What are the advantages and disadvantages of departmentalization by product?

Contemporary Forms of Organizational Structures

For centuries, technological advancements that affected business came in slow waves. Over 100 years passed between the invention of the first reliable steam engine and the first practical internal combustion engine. During these early days of advancement, communication would often go hand in hand with transportation. Instead of delivering mail hundreds of miles by horse, messages could be transported more quickly by train and then later by plane. Beginning in the 1900s, the tides of change began to rise much more quickly. From the telegraph to the telephone to the computer to the Internet, each advancement brought about a need for an organization’s structure to adapt and change.

Business has become global, moving into new economies and cultures. Previously nonexistent industries, such as those related to high technology, have demanded flexibility by organizations in ways never before seen. The diverse and complex nature of the current business environment has led to the emergence of several types of organizational structures. Beginning in the 1970s, management experts began to propose organizational designs that they believed were better adapted to the needs of the emerging business environment. Each structure has unique qualities to help businesses handle their particular environment.

Matrix Organizations

Matrix organizations have a design that combines a traditional functional structure with a product structure. Instead of completely switching from a product-based structure, a company may use a matrix structure to balance the benefits of product-based and traditional functional structures. Specifically, employees reporting to department managers are also pooled together to form project or product teams. As a result, each person reports to a department manager as well as a project or product manager. In a matrix structure, product managers have control and say over product-related matters, while department managers have authority over matters related to company policy. Matrix structures are created in response to uncertainty and dynamism of the environment and the need to give particular attention to specific products or projects. Using the matrix structure as opposed to product departments may increase communication and cooperation among departments because project managers will need to coordinate their actions with those of department managers. In fact, research shows that matrix structure increases the frequency of informal and formal communication within the organization (Joyce, 1986). Matrix structures also have the benefit of providing quick responses to technical problems and customer demands. The existence of a project manager keeps the focus on the product or service provided.

 

Matrix Structure

An example of a matrix structure at a software development company. Business analysts, developers, and testers each report to a functional department manager and to a project manager simultaneously.

Despite these potential benefits, matrix structures are not without costs. In a matrix, each employee reports to two or more managers. This situation is ripe for conflict. Because multiple managers are in charge of guiding the behaviors of each employee, there may be power struggles or turf wars among managers. As managers are more interdependent compared to a traditional or product-based structure, they will need to spend more effort coordinating their work. From the employee’s perspective, there is potential for interpersonal conflict with team members as well as with leaders. The presence of multiple leaders may create role ambiguity or, worse, role conflict—being given instructions or objectives that cannot all be met because they are mutually exclusive. The necessity to work with a team consisting of employees with different functional backgrounds increases the potential for task conflict at work (Ford & Randolph, 1992). Solving these problems requires a great level of patience and proactivity on the part of the employee.

The matrix structure is used in many information technology companies engaged in software development. The sportswear manufacturer Nike is another company that uses the matrix organization successfully. New product introduction is a task shared by regional managers and product managers. While product managers are in charge of deciding how to launch a product, regional managers are allowed to make modifications based on the region (Anand & Daft, 2007).

Boundaryless Organizations

Boundaryless organization is a term coined by Jack Welch during his tenure as CEO of GE. It refers to an organization that eliminates traditional barriers between departments as well as barriers between the organization and the external environment (Ashkenas et al., 1995). Many types of boundaryless organizations exist. One form is the modular organization, in which all nonessential functions are outsourced. The idea behind this format is to retain only the value-generating and strategic functions in-house, while the rest of the operations are outsourced to many suppliers. An example of a company that does this is Toyota. By managing relationships with hundreds of suppliers, Toyota achieves efficiency and quality in its operations. Strategic alliances constitute another form of boundaryless design. In this form, similar to a joint venture, two or more companies find an area of collaboration and combine their efforts to create a partnership that is beneficial for both parties. In the process, the traditional boundaries between two competitors may be broken. As an example, Starbucks formed a highly successful partnership with PepsiCo to market its Frappuccino cold drinks. Starbucks has immediate brand-name recognition in this cold coffee drink, but its desire to capture shelf space in supermarkets required marketing savvy and experience that Starbucks did not possess at the time. By partnering with PepsiCo, Starbucks gained an important head start in the marketing and distribution of this product. Finally, boundaryless organizations may involve eliminating the barriers separating employees; these may be intangible barriers, such as traditional management layers, or actual physical barriers, such as walls between different departments. Structures such as self-managing teams create an environment where employees coordinate their efforts and change their own roles to suit the demands of the situation, as opposed to insisting that something is “not my job” (Dess et al., 1995; Rosenbloom, 2003).

Learning Organizations

A learning organization is one whose design actively seeks to acquire knowledge and change behavior as a result of the newly acquired knowledge. In learning organizations, experimenting, learning new things, and reflecting on new knowledge are the norms. At the same time, there are many procedures and systems in place that facilitate learning at all organization levels.

In learning organizations, experimentation and testing potentially better operational methods are encouraged. This is true not only in response to environmental threats but also as a way of identifying future opportunities. 3M is one company that institutionalized experimenting with new ideas in the form of allowing each engineer to spend one day a week working on a personal project. At IBM, learning is encouraged by taking highly successful business managers and putting them in charge of emerging business opportunities (EBOs). IBM is a company that has no difficulty coming up with new ideas, as evidenced by the number of patents it holds. Yet commercializing these ideas has been a problem in the past because of an emphasis on short-term results. To change this situation, the company began experimenting with the idea of EBOs. By setting up a structure where failure is tolerated and risk taking is encouraged, the company took a big step toward becoming a learning organization (Deutschman, 2005).

Learning organizations are also good at learning from experience—their own or a competitor’s. To learn from past mistakes, companies conduct a thorough analysis of them. Some companies choose to conduct formal retrospective meetings to analyze the challenges encountered and areas for improvement. To learn from others, these companies vigorously study competitors, market leaders in different industries, clients, and customers. By benchmarking against industry best practices, they constantly look for ways of improving their own operations. Learning organizations are also good at studying customer habits to generate ideas. For example, Xerox uses anthropologists to understand and gain insights to how customers are actually using their office products (Garvin, 1993). By using these techniques, learning organizations facilitate innovation and make it easier to achieve organizational change.

Conclusion

The changing environment of organizations creates the need for newer forms of organizing. Matrix structures are a cross between functional and product-based divisional structures. They facilitate information flow and reduce response time to customers but have challenges because each employee reports to multiple managers. Boundaryless organizations blur the boundaries between departments or the boundaries between the focal organization and others in the environment. These organizations may take the form of a modular organization, strategic alliance, or self-managing teams. Learning organizations institutionalize experimentation and benchmarking.

Discussion Questions

· Have you ever reported to more than one manager? What were the challenges of such a situation? As a manager, what could you do to help your subordinates who have other bosses besides yourself?

· What do you think are the advantages and disadvantages of being employed by a boundaryless organization?

· What can organizations do to institutionalize organizational learning? What practices and policies would aid in knowledge acquisition and retention?

Case in Point: Toyota Struggles With Organizational Structure

Toyota Motor Corporation (TYO: 7203) has often been referred to as the gold standard of the automotive industry. In the first quarter of 2007, Toyota (NYSE: TM) overtook General Motors Corporation in sales for the first time as the top automotive manufacturer in the world. Toyota reached success in part because of its exceptional reputation for quality and customer care. Despite the global recession and the tough economic times that American auto companies such as General Motors and Chrysler faced in 2009, Toyota enjoyed profits of $16.7 billion and sales growth of 6 percent that year. However, late 2009 and early 2010 witnessed Toyota’s recall of eight million vehicles due to unintended acceleration. How could this happen to a company known for quality and structured to solve problems as soon as they arise? To examine this further, you have to understand the Toyota Production System (TPS).

Labadie Toyota Building

Labadie Toyota Building by The Toad is licensed under CC BY-NC 2.0.

TPS is built on the principles of "just-in-time" production. In other words, raw materials and supplies are delivered to the assembly line exactly at the time they are to be used. This system has little room for slack resources, emphasizes the importance of efficiency on the part of employees, and minimizes wasted resources. TPS gives power to the employees on the front lines. Assembly line workers are empowered to pull a cord and stop the manufacturing line when they see a problem.

However, during the 1990s, Toyota began to experience rapid growth and expansion. With this success, the organization became more defensive and protective of information. Expansion strained resources across the organization and slowed response time. Toyota’s CEO, Akio Toyoda, the grandson of its founder, has conceded, "Quite frankly, I fear the pace at which we have grown may have been too quick."

Vehicle recalls are not new to Toyota; after defects were found in the company’s Lexus model in 1989, Toyota created teams to solve the issues quickly, and in some cases the company went to customers’ homes to collect the cars. The question on many people’s minds is, how could a company whose success was built on its reputation for quality have had such failures? All the more puzzling, the brake problems in vehicles became apparent in 2009, but only after being confronted by US transportation secretary Ray LaHood did Toyota begin issuing recalls in the United States. And during the early months of the crisis, Toyota’s top leaders were all but missing from public sight.

The organizational structure of Toyota may give us some insight into the handling of this crisis and ideas for the most effective way for Toyota to move forward. A conflict like this one can paralyze productivity, but if dealt with constructively and effectively, can present opportunities for learning and improvement. Companies such as Toyota that have a rigid corporate culture and a hierarchy of seniority are at risk of reacting to external threats slowly. People often feel reluctant to pass bad news up the chain within a family company such as Toyota. As a result of its power structure, in which power has traditionally been centralized, authority is not generally delegated within the company; all US executives are assigned a Japanese boss to mentor them, and no Toyota executive in the United States is authorized to issue a recall. Most information flow is one-way, back to Japan where decisions are made.

Will Toyota turn its recall into an opportunity for increased participation for its international manufacturers? Will decentralization and increased transparency occur? Only time will tell.