Part of a apple case study

After reading this chapter, you should be able to: • Understand the main steps involved in

the strategic change process. • Appreciate the need to analyze a com-

pany’s set of businesses from a “portfolio of competencies” perspective.

• Review the advantages and risks of im- plementing strategy through (1) internal

new ventures, (2) acquisitions, and (3) strategic alliances.

• Discuss how to limit the risks associated with internal new ventures, acquisitions, and strategic alliances.

• Appreciate the special issues associated with using a joint venture to structure a strategic alliance.

L E A R N I N G O B J E C T I V E S

Strategic Change

Types of Strategic Changes A Model of the Change Process

Analyzing a Company as a Portfolio of Core Competencies

Fill in the Blanks Premier Plus 10 White Spaces Mega- Opportunities

Implementing Strategy Through Internal New Ventures

Pitfalls with Internal New Ventures Guidelines for Successful Internal

New Venturing

Implementing Strategy Through Acquisitions

Pitfalls with Acquisitions Guidelines for Successful

Acquisition

Implementing Strategy Through Strategic Alliances

Advantages of Strategic Alliances Disadvantages of Strategic Alliances Making Strategic Alliances Work

C H A P T E R O U T L I N E

Strategic Change: Implementing Strategies to

Build and Develop a Company8

Strategic Change

The movement of a company away from its present state toward some desired future state to increase its competitive advantage and profi tability.

Reengineering

A process whereby, in their effort to boost company performance, managers focus not on the company’s functional activities but on the business processes underlying its value creation operations.

Business Process

Any business activity, such as order processing, inventory control, or product design, that is vital to delivering goods and services to customers quickly or that promotes high quality or low costs.

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 201

OVERVIEW

In Chapter 7 we examined the different corporate- level strategies that managers can pursue to increase a company’s long- run profi tability. All these choices of strategy have important implications for a company’s future prosperity, and it is vital that managers understand the issues and problems involved in implementing these strat- egies if the strategies are to be successful. We begin this chapter by examining the nature of strategic change and the obstacles that may hinder managers’ attempts to change a company’s strategy and structure to improve its future performance. We then focus on the steps managers can take to overcome these obstacles and make their efforts to change a company successful.

Second, we tackle a crucial question: How do managers determine which busi- nesses or industries a company should continue to participate in or exit from, and how do they determine whether a company should enter one or more new businesses? Obviously managers need to have a vision of where their company should be in the future— that is, a vision of its desired future state— and we discuss an important tech- nique, the portfolio of competencies approach, that helps them accomplish this.

Third, we turn our attention to the different methods that managers can use to enter new businesses or industries in order to build and develop their company and improve its performance over time. The choice here is whether to implement a corporate- level strategy through acquisitions, internal new ventures, or strategic alliances (including joint ventures). Finally, we examine the pros and cons of these different ways of implementing strategy, given the goal of increasing a company’s competitive advantage and long- run profi tability.

STRATEGIC CHANGE Strategic change is the movement of a company away from its present state toward some desired future state to increase its competitive advantage and profi tability.1 In the last decade, most large Fortune 500 companies have gone through some kind of strategic change as their managers have tried to strengthen their existing core com- petencies and build new ones to compete more effectively. Often, because of drastic unexpected changes in the environment, such as the emergence of aggressive new competitors or technological breakthroughs, strategic managers need to develop a new strategy and structure to raise the level of their business’s performance.2

Types of Strategic Change One way of changing a company to enable it to operate more effectively is by reengineering, a process in which managers focus not on a company’s functional activities but on the business processes underlying the value creation process.3 A business process is any activity (such as order processing, inventory control, or product design) that is vital to delivering goods and services to customers quickly or that promotes high quality or low costs.4 Business processes are not the responsibility of any one function but cut across functions.

Hallmark Cards, for example, reengineered its card design process with great success. Before the reengineering effort, artists, writers, and editors worked in differ- ent functions to produce all kinds of cards. After reengineering, these same artists,

202 Part 4 Strategy Implementation

writers, and editors were organized into cross- functional teams, each of which now works on a specifi c type of card (such as birthday, Christmas, or Mother’s Day). The result was that the time it took to bring a new card to market dropped from years to months, and Hallmark’s performance improved dramatically.

Reengineering and total quality management (TQM, discussed in Chapter 4) are highly interrelated and complementary.5 After reengineering has taken place and the question “What is the best way to provide customers with the goods or service they require?” has been answered, TQM takes over and addresses the question “How can we now continue to improve and refi ne the new process and fi nd better ways of managing task and role relationships?” Successful companies examine both ques- tions together, and managers continuously work to identify new and better processes for meeting the goals of increased effi ciency, quality, and responsiveness to customer needs. Thus managers are always working to improve their vision of their company’s desired future state.

Recall from Chapter 7 that restructuring is the process through which managers simplify organizational structure by eliminating divisions, departments, or levels in the hierarchy, and downsize by terminating employees, thereby lowering operating costs. Restructuring may also involve outsourcing, the process whereby one com- pany contracts with other companies to perform a functional activity such as manu- facturing, marketing, or customer service. Restructuring is a second form of strategic change that managers can implement to improve performance. As we noted, there are many reasons why it can become necessary for an organization to streamline, simplify, and downsize its operations. Sometimes a change in the business environ- ment occurs that could not have been foreseen; perhaps a shift in technology renders the company’s products obsolete or a worldwide recession reduces the demand for its products. Sometimes an organization has excess capacity because customers no longer want the goods and services it provides, perhaps because they are outdated or offer poor value for the money. Sometimes organizations downsize because they have grown too tall and bureaucratic and operating costs have become excessive. And sometimes they restructure even when they are in a strong position, simply to build and improve their competitive advantage and stay on top.

All too often, however, companies are forced to downsize and lay off employees because managers have not continuously monitored the way they operate their basic business processes and have not made the incremental changes to their strategies that would allow them to contain costs and adjust to changing conditions. Paradoxically, because they have not paid attention to the need to reengineer themselves, they are forced into a position where restructuring is the only way they can survive and com- pete in an increasingly competitive environment.

A Model of the Change Process In order to understand the issues involved in implementing strategic change, it is use- ful to focus on the series of distinct steps that strategic managers must follow if the change process is to succeed.6 These steps are listed in Figure 8.1.

Determining the Need for Change The fi rst step in the change process is for stra- tegic managers to recognize the need for change. Sometimes this need is obvious, as when divisions are fi ghting or when competitors introduce a product that is clearly superior to anything the company has in production. More often, however, manag- ers have trouble determining that something is going wrong in the organization.

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 203

Problems may develop gradually, and organizational performance may slip for a number of years before the decline becomes obvious. Thus, the fi rst step in the change process occurs when strategic managers, or others in a position to take ac- tion, such as directors or takeover specialists, recognize that there is a gap between desired company performance and actual performance. Using measures such as a decline in profi tability, return on investment (ROI), stock price, or market share as indicators that change is needed, managers can start looking for the source of the problem. To discover it, they conduct a strengths, weaknesses, opportunities, and threats (SWOT) analysis.

Strategic managers examine the company’s strengths and weaknesses. For ex- ample, management conducts a strategic audit of all functions and divisions and assesses their contribution to profi tability over time. Perhaps some divisions have become relatively unprofi table as innovation has slowed without the management realizing it. Perhaps sales and marketing have failed to keep pace with changes in the competitive environment. Perhaps the company’s product is simply outdated. Strategic managers also analyze the company’s level of differentiation and integra- tion to make sure that it is appropriate for its strategy. Perhaps a company does not have the integrating mechanisms in place to achieve gains from synergy, or perhaps the structure has become tall and infl exible so that bureaucratic costs have escalated.

Strategic managers then examine environmental opportunities and threats that might explain the problem, using all the concepts developed in Chapter  3 of this book. For instance, intense competition may have arisen unexpectedly from sub- stitute products, or a shift in technology or consumers’ tastes may have caught the company unawares.

Once the source of the problem has been identifi ed via SWOT analysis, strategic managers must determine the desired future state of the company— that is, how it should change its strategy and structure to achieve the new goals they have set for it. In the next section, we discuss one important tool managers can use to work out the best future mission and strategy for maximizing company profi tability. Of course, the choices they make are specifi c to each individual company, because each company has a unique set of skills and competencies. The challenge for managers is that there is no way they can determine in advance, or even reliably estimate, the accuracy of their assumptions about the future. Strategic change always involves considerable uncertainty and risks that must be borne if above- average returns are to be achieved.

Determining the Obstacles to Change Strategic change is frequently resisted by people and groups inside an organization. Often, for example, the decision to reengineer and restructure a company requires the establishment of a new set of role and authority relationships among managers in different functions and divisions.

Figure 8.1 Stages in the Change Process

Managing change

Determining the obstacles

to change

Determining the need

for change

Evaluating change

204 Part 4 Strategy Implementation

Because this change may threaten the status and rewards of some managers, they resist the changes being implemented. Many efforts at change take a long time, and many fail because of the high level of resistance to change at all levels in the organi- zation. Thus, the second step in implementing strategic change is to determine what obstacles to change exist in a company. Obstacles to change can be found at four levels in the organization: corporate, divisional, functional, and individual.

At the corporate level, changing strategy even in seemingly trivial ways may sig- nifi cantly affect a company’s behavior. For example, suppose that to reduce costs, a company decides to centralize all divisional purchasing and sales activities at the corporate level. Such consolidation could severely damage each division’s ability to develop a unique strategy for its own individual market. Alternatively, suppose that in response to low- cost foreign competition, a company decides to pursue a strategy of increased differentiation. This action would change the balance of power among functions and could lead to problems as functions start fi ghting to retain their status in the organization. A company’s present strategies constitute a powerful obstacle to change. They generate a massive amount of resistance that has to be overcome before change can take place. This is why strategic change is usually a slow process.

Similar factors operate at the divisional level. Change is diffi cult at the divisional level if divisions are highly interrelated, because a shift in one division’s operations affects other divisions. Furthermore, changes in strategy affect different divisions in different ways, because change generally favors the interests of some divisions over those of others. Managers in the different divisions may thus have different attitudes toward change, and some will be less supportive than others. Existing divisions may resist establishing new product divisions, for example, because they will lose re- sources and their status in the organization will diminish.

The same obstacles to change exist at the functional level. Just like divisions, different functions have different strategic orientations and goals and react differ- ently to the changes management proposes. For example, manufacturing generally has a short- term, cost- directed effi ciency orientation; research and development is oriented toward long- term, technical goals; and the sales function is oriented toward satisfying customers’ needs. Thus, production may see the solution to a problem as one of reducing costs, sales as one of increasing demand, and research and develop- ment as product innovation. Differences in functional orientation make it hard to formulate and implement a new strategy and may signifi cantly slow a company’s response to changes in the competitive environment.

At the individual level, too, people are notoriously resistant to change because change implies uncertainty, which breeds insecurity and fear of the unknown. Because managers are people, this individual resistance reinforces the tendency of each function and division to oppose changes that may have uncertain effects on them. Restructuring and reengineering efforts can be particularly stressful for man- agers at all levels of the organization. All these obstacles make it diffi cult to change strategy or structure quickly. That is why U.S. carmakers and companies such as IBM, Kodak, and Motorola were so slow to respond to fi erce global competition, fi rst from Japan and then from China and other Asian countries.

Paradoxically, companies that experience the greatest uncertainty may become best able to respond to it. When companies have been forced to change frequently, managers often develop the ability to handle change easily. Strategic managers must identify potential obstacles to change as they design and implement new strategies. The larger and more complex the organization, the harder it is to implement change because inertia is likely to be more pervasive.

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 205

Managing and Evaluating Change The process of managing and evaluating change raises several questions. For instance, who should actually carry out the change: internal managers or external consultants? Although internal managers may have the most experience or knowledge about a company’s operations, they may lack perspective because they are too close to the situation and “can’t see the forest for the trees.” They also run the risk of appearing to be politically motivated and of having a personal stake in the changes they recommend. This is why companies of- ten turn to external consultants, who can view a situation more objectively. Outside consultants, however, have to spend a lot of time learning about the company and its problems before they can propose a plan of action. It is for both of these reasons that many companies (such as Quaker Oats, Gap, and IBM) bring in new CEOs from outside the company, and even from outside its industry, to spearhead their change efforts. In this way, companies can get the benefi ts of both inside information and external perspective.

Generally, a company can take one of two main approaches to implementing and managing change: top- down change or bottom- up change.7 With top- down change, a strong CEO or top management team analyzes what strategies need to be pursued, recommends a course of action, and then moves quickly to restructure and imple- ment change in the organization. The emphasis is on speed of response and prompt management of problems as they occur. Bottom- up change is much more gradual. Top management consults with managers at all levels in the organization. Then, over time, it develops a detailed plan for change, with a timetable of events and stages that the company will go through. The emphasis in bottom- up change is on partici- pation and on keeping people informed about the situation so that uncertainty is minimized.

The advantage of bottom- up change is that it removes some of the obstacles to change by including them in the strategic plan. Furthermore, the purpose of consult- ing with managers at all levels is to reveal potential problems. The disadvantage of bottom- up change is its slow pace. On the other hand, in the case of the much speedier top- down change, problems may emerge later and may be diffi cult to re- solve. Giants such as GM and Kodak often must apply top- down change because managers are so unaccustomed to and threatened by change that only a radical re- structuring effort provides enough momentum to overcome organizational inertia.

The last step in the change process is to evaluate the effects of the changes in strategy on organizational performance. A company must compare the way it op- erates after implementing change with the way it operated before. Managers use indexes such as changes in stock market price, market share, and higher revenues from increased product differentiation. They also can benchmark their company’s performance against market leaders to see how much they have improved, and how much more they need to improve to catch the market leader.

ANALYZING A COMPANY AS A PORTFOLIO OF CORE COMPETENCIES Earlier we noted that managers must have access to tools that help them determine their companies’ desired future state— the businesses and industries that they should compete in to increase long- run competitive advantage. One conceptual tool that helps them do this was developed by Gary Hamel and C. K. Prahalad. It is to analyze

206 Part 4 Strategy Implementation

a company as a portfolio of core competencies, as opposed to a portfolio of actual businesses.8 Recall from Chapter 1 the importance of adopting a customer- oriented, rather than a product- oriented, business defi nition; now the core competency be- comes the key competitive variable.

According to Hamel and Prahalad, a core competency is a central value creation capability of a company— that is, a core skill. They argue, for example, that Canon, the Japanese concern best known for its cameras and photocopiers, has core com- petencies in precision mechanics, fi ne optics, microelectronics, and electronic imag- ing. Corporate development is oriented toward maintaining existing competencies, building new competencies, and leveraging competencies by applying them to new business opportunities. For example, Hamel and Prahalad argue that the success of a company such as 3M in creating new business has come from its ability to apply its core competency in adhesives to a wide range of businesses opportunities, from Scotch Tape to Post- it- Notes.

Hamel and Prahalad maintain that identifying current core competencies is the fi rst step a company should take in deciding which business opportunities to pur- sue. Once a company has identifi ed its core competencies, they advocate using a matrix similar to that illustrated in Figure  8.2 to establish an agenda for building and leveraging core competencies to create new business opportunities. This matrix distinguishes between existing and new competencies, and between existing and new product markets. Each quadrant in the matrix has a title, and the strategic implica- tions of these quadrants are discussed below.

Fill in the Blanks The lower- left quadrant represents the company’s existing portfolio of competencies and products. Twenty years ago, for example, Canon had competencies in precision mechanics, fi ne optics, and microelectronics and was active in two basic businesses: producing cameras and photocopiers. The competencies in precision mechanics and

Figure 8.2 Establishing a Competency Agenda

New

Existing

Premier plus 10

What new competences will we need to build to protect and extend our franchise in current industries?

New

Mega-opportunities

What new competences will we need to build to participate in the most exciting industries of the future?

Existing

Fill in the blanks

What is the opportunity to improve our position in existing industries and better leverage our existing competences?

White spaces

What new products or services could we create by creatively redeploying or recombining our current competences?

Industry

C o

m p

et en

ce

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 207

fi ne optics were used in the production of basic mechanical cameras. These two competencies, plus an additional competency in microelectronics, were needed to produce plain paper copiers. The title for this quadrant of the matrix, Fill in the blanks, refers to the opportunity to improve the company’s competitive position in existing markets by leveraging existing core competencies. For example, Canon was able to improve the position of its camera business by leveraging microelectronics skills from its copier business to support the development of cameras with electronic features, such as autofocus capabilities.

Premier Plus 10 The upper- left quadrant is referred to as Premier plus 10. This title is meant to sug- gest another important question: What new core competencies must be built today to ensure that the company remains a premier provider of its existing products in 10 years’ time? Canon, for example, decided that in order to maintain a competitive edge in its copier business, it was going to have to build a new competency in digital imaging. This new competency subsequently helped Canon to extend its product range to include laser copiers, color copiers, and digital cameras.

White Spaces The lower- right quadrant is titled White spaces. The question to be addressed here is how best to fi ll the “white space” by creatively redeploying or recombining current core competencies. In Canon’s case, the company has been able to recombine its es- tablished core competencies in precision mechanics, fi ne optics, and microelectronics with its more recently acquired competency in digital imaging to enter the market for computer printers and scanners.

Mega- Opportunities The Mega- opportunities represented by the upper- right quadrant of Figure  8.2 do not overlap with the company’s current market position or with its current endow- ment of competencies. Nevertheless, a company may choose to pursue such oppor- tunities if they are particularly attractive, signifi cant, or relevant to the company’s existing business opportunities. For example, back in 1979 Monsanto was primar- ily a manufacturer of chemicals, including fertilizers. However, the company saw that there were enormous opportunities in the emerging fi eld of biotechnology. Specifi cally, senior research scientists at Monsanto believed it might be possible to produce genetically engineered crop seeds that would produce their own “organic” pesticides. In that year the company embarked upon a massive investment that ulti- mately amounted to over a billion dollars to build a world- class competency in bio- technology. This investment was funded by cash fl ows generated from Monsanto’s core chemical operations. The investment began to bear fruit after Monsanto in- troduced a series of genetically engineered crop seeds, including Bollgard, a cotton seed that is resistant to many common pests, including the bollworm; and Roundup- resistant soybean seeds (Roundup is an herbicide produced by Monsanto) that have earned the company hundreds of billions of dollars in profi t.9

The framework proposed by Hamel and Prahalad helps a company identify busi- ness opportunities, and it has clear implications for resource allocation (as exempli- fi ed by the Monsanto case just discussed). However, the great advantage of Hamel

Internal New Venture

A company’s creation of the value chain functions necessary to start a new business from scratch.

208 Part 4 Strategy Implementation

and Prahalad’s framework is that it focuses explicitly on how a company can create value by building new competencies or by recombining existing competencies to enter new business areas (as Canon did with fax machines and bubble jet printers). Whereas traditional portfolio tools treat businesses as independent, Hamel and Prahalad’s framework recognizes the interdependencies among businesses and fo- cuses on opportunities to create value by building and leveraging competencies. In this sense, their framework is a useful tool to help strategic managers reconceptual- ize their company’s core competencies, activities, and businesses to determine its desired future state— and so reduce the uncertainty surrounding the investment of its scarce resources.

Having reviewed the different businesses in the company’s portfolio, corporate managers might decide to enter a new business area or industry to create more value and profi t— something Monsanto did when it decided to enter the biotechnology in- dustry. In the next three sections, we discuss the three main vehicles that companies can use to enter new businesses or industries: internal new ventures, acquisitions, and strategic alliances (including joint ventures).

IMPLEMENTING STRATEGY THROUGH INTERNAL NEW VENTURES Internal new ventures involve creating the value chain functions necessary to start a new business from scratch. Internal new venturing is typically used to execute corporate- level strategy when a company possesses a set of valuable competencies (resources and capabilities) in its existing businesses that can be leveraged or recom- bined to enter the new business area. As a rule, science- based companies that use their technology to create market opportunities in related areas tend to favor inter- nal new venturing as an entry strategy. 3M, for example, has a near- legendary knack for shaping new markets from internally generated ideas. HP originally started out making test and measurement instruments and later moved into computers and then printers through an internal new- venture strategy. Microsoft started out making software for PCs, but it developed the Xbox video game business by leveraging its software skills and applying them to this new industry.

Even if it lacks the competencies required to compete in a new business, a com- pany may pursue internal new venturing if the industry it is entering is an emerg- ing or embryonic industry. In such an industry there are no established companies that already possess the competencies required to compete in that industry. Thus a company is at no competitive disadvantage if it starts a new venture. Also, the op- tion of acquiring an established enterprise that possesses those competencies is not available, so a company may have no choice but to enter via an internal new venture.

This was the position in which Monsanto found itself back in 1979 when it con- templated entering the biotechnology fi eld to produce herbicide and seeds yielding pest- resistant crops. The biotechnology fi eld was young at that time, and there were no incumbent companies focused on applying biotechnology to agricultural prod- ucts. Accordingly, Monsanto established an internal new venture to enter the busi- ness, even though at the time it lacked the required competencies. Indeed, Monsanto’s whole venturing strategy was built around the notion that it had the ability to build competencies ahead of potential competitors and so gain a strong competitive lead in this newly emerging fi eld.

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 209

Pitfalls with Internal New Ventures Despite the popularity of internal new venturing, there is a high risk of failure. Research suggests that somewhere between 33% and 60% of all new products that reach the marketplace do not generate an adequate economic return,10 and most of these products were the result of internal new ventures. Three reasons are of- ten put forward to explain the relatively high failure rate of internal new ventures: (1) market entry on too small a scale, (2) poor commercialization of the new- venture product, and (3) poor corporate management of the new- venture division.11

Scale of Entry Research suggests that on average, large- scale entry into a new business is often a critical precondition of success with a new venture. In the short run, this means that a substantial capital investment must be made to support large- scale entry; thus, there is a risk of major losses if the new venture fails. But, in the long run, which can be as long as 5–12 years depending on the industry, such a large investment results in far greater returns than if a company chooses to enter on a small scale in order to limit its investment to reduce potential losses.12 Large- scale entrants can more rapidly realize scale economies, build brand loyalty, and gain ac- cess to distribution channels in the new industry, all of which increase the probabil- ity of a new venture’s success. In contrast, small- scale entrants may fi nd themselves handicapped by high costs due to a lack of scale economies and market presence that limits their ability to build brand loyalties and gain access to distribution channels. These scale effects are particularly signifi cant when a company is entering an estab- lished industry where incumbent companies do have the benefi t of scale economies, brand loyalty, and access to distribution channels. In that case, the new entrant has to make a major investment in order to succeed.

Figure  8.3 plots the relationship between scale of entry and profi tability over time for successful small- scale and large- scale ventures. The fi gure shows that suc- cessful small- scale entry is associated with lower initial losses but that in the long

P ro

fi ta

b ili

ty

Large-scale entry

Small-scale entry

(+)

(–)

Time

0

Figure 8.3 Scale of Entry and Profi tability

210 Part 4 Strategy Implementation

run, large- scale entry generates greater returns. However, because of the high costs and risks associated with large- scale entry, many companies make the mistake of choosing a small- scale entry strategy, which often means they fail to build the market share necessary for long- term success.

Commercialization Many internal new ventures are driven by the opportunity to use a new or advanced technology to make better products for customers and out- perform competitors. To be commercially successful, science- based innovations must be developed with market requirements in mind. Many internal new ventures fail when a company ignores the basic needs of the market. A company can be blinded by the technological possibilities of a new product and fail to analyze market oppor- tunities properly. Thus, a new venture may fail because of a lack of commercializa- tion or because it is marketing a technology for which there is no demand. One of the most dramatic new- venture failures in recent history, the Iridium satellite com- munications system developed by Motorola, illustrates this well. The Iridium project was breathtaking in its scope. It called for 66 communications satellites to be placed in an orbital network. In theory, this network of fl ying telecommunications switches would enable anyone with an Iridium satellite phone to place and receive calls, no matter where they were on the planet. Motorola’s CEO, Christopher Galvin, called the project the eighth wonder of the world but after spending 5  billion dollars to launch Iridium Motorola declared that Iridium was bankrupt only 9 months after the service began!

To its critics, the Iridium project was a classic case of a company being so blinded by the promise of a technology that it ignored market realities. Several serious short- comings of the Iridium project limited its market acceptance. First, the phones them- selves were large and heavy by current cell phone standards, weighing more than a pound! They were diffi cult to use, call clarity was poor, the phones themselves cost $3,000 each, and despite the “can be used anywhere” marketing theme, the phones could not be used inside cars or buildings— a major inconvenience for the busy globe- trotting executives at whom the service was aimed! Finally, the rapid ac- ceptance of much cheaper and more convenient cell phones limited the need for the Iridium phone. Why would a customer who had a cheaper, more convenient alterna- tive pay $3,000 for the privilege of owning a phone the size and weight of a brick that would not work in places where other cell phones do?13

Poor Corporate Management Managing the new- venture process and control- ling the new- venture division creates many diffi cult managerial and organizational issues.14 For example, one common mistake some companies make to try to increase their chances of making successful products is to establish too many different inter- nal new- venture divisions at the same time. It places great demands on a company’s cash fl ow and can result in the best ventures being starved of the cash they need for success. In addition, if a company has too many internal new ventures in progress, management attention is likely to be spread too thin over these ventures, inviting disaster.

Another common mistake is failure by corporate management to establish the strategic context within which new- venture projects should be developed. Simply taking a team of research scientists and allowing them to do research in their favorite fi eld may produce novel results, but these results may have little strategic or commer- cial value. It is necessary to be very clear about the strategic objectives of the venture and to understand exactly how it will seek to establish a competitive advantage.

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 211

Failure to anticipate the time and costs involved in the new- venture process is another common mistake. Many companies have unrealistic expectations regarding the time frame involved. Reportedly, some companies operate with a philosophy of killing new businesses if they do not turn a profi t by the end of the third year— a most unrealistic view, given the evidence that it can take 5–12 years before a new venture generates substantial profi ts.

Guidelines for Successful Internal New Venturing To avoid the pitfalls just discussed, a company should adopt a structured approach to managing internal new venturing.15 New venturing typically begins with R&D. To make effective use of its R&D capacity, a company must fi rst spell out its strategic objectives and then communicate them to its scientists and engineers. Research, after all, makes sense only when it is undertaken in areas relevant to strategic goals.16

To increase the probability of commercial success, a company should foster close links between R&D and marketing personnel, for this is the best way to ensure that research projects address the needs of the market. The company should also foster close links between R&D and manufacturing personnel to ensure that the company has the capability to manufacture any proposed new products.

Many companies successfully integrate different functions by setting up project teams. Such teams comprise representatives of the various functional areas; their task is to oversee the development of new products. Another advantage of such teams is that they can signifi cantly reduce the time it takes to develop a new product. Thus, while R&D personnel are working on the design, manufacturing personnel can be setting up facilities, and marketing can be developing its plans. Because of such in- tegration, Apple needed only 12 months to take the iPad tablet computer from an idea on the drawing board to a marketable product that has been wildly successful.

To use resources to the best effect, a company must also devise a selection pro- cess for choosing only the ventures that are most likely to meet with commercial success. Picking future winners is a tricky business; by their very defi nition, new ventures have an uncertain future. One study found the uncertainty surrounding new ventures to be so great that it usually took a company 4–5 years after launching the venture to reasonably estimate the venture’s future profi tability.17 Nevertheless, a selection process is necessary if a company is to avoid spreading its resources over too many projects.

Once a project has been selected, management needs to monitor the progress of the venture closely. Evidence suggests that the most important criterion for evaluat- ing a venture during its fi rst 4–5 years is growth in market share, rather than cash fl ow or profi tability. In the long run, the most successful ventures are those that increase their market share. A company should have clearly defi ned market share objectives for an internal new venture and should decide whether to retain or kill it in its early years on the basis of its ability to achieve market share goals. Only in the medium term should profi tability and cash fl ow begin to take on greater importance.

Finally, the association of large- scale entry with greater long- term profi tability suggests that a company can increase the probability of success for an internal new venture by “thinking big.” Thinking big means the construction of effi cient- scale pro- duction facilities before demand has fully materialized, large marketing expenditures to build a market presence and brand loyalty, and a commitment by corporate man- agement to accept initial losses as long as market share is expanding. Note that it is not just high- tech companies that utilize internal new venturing, any company can take

Acquisition

The purchase of one company by another.

212 Part 4 Strategy Implementation

its existing skills and distinctive competencies to develop new ways to gain access to customers such as Walmart did when it developed its chain of Neighborhood Market stores (see Chapter 7, p. 176).

IMPLEMENTING STRATEGY THROUGH ACQUISITIONS Acquisitions involve one company purchasing another company. A company may use acquisitions in two ways: to strengthen its competitive position in an existing business by purchasing a competitor (horizontal integration) and to enter a new business or industry. Companies may use acquisitions to enter a new business when they lack the distinctive competencies (resources and capabilities) required to com- pete in that area, but they can purchase, at a reasonable price, an incumbent com- pany that does have those competencies.

Companies also have a preference for acquisitions as an entry mode when they feel the need to move fast. As we noted above, building a new business through in- ternal venturing can be a relatively slow process. Acquisition is a much quicker way to establish a signifi cant market presence, create value, and increase profi tability. A company can purchase a leading company with a strong competitive position in months, rather than waiting years to build a market leadership position by engag- ing in internal venturing. Thus when speed is important, acquisition is the favored entry mode.

Acquisitions are also often perceived as somewhat less risky than internal new ventures, primarily because they involve less commercial uncertainty. It is in the very nature of internal new ventures that large uncertainties are associated with project- ing future profi tability, revenues, and cash fl ows. In contrast, when one company ac- quires another, it knows the profi tability, revenues, and market share of the acquired company, so there is considerably less uncertainty. In short, acquisition enables a company to buy an established business with a track record, and for this reason, many companies favor an acquisition strategy.

Finally, acquisitions may be the preferred entry mode when the industry to be en- tered is well established and incumbent companies enjoy signifi cant protection from barriers to entry. As you recall from Chapter 3, barriers to entry arise from factors associated with product differentiation (brand loyalty), absolute cost advantages, and economies of scale. When such barriers are substantial, a company fi nds enter- ing an industry through internal new venturing diffi cult. To enter, a company may have to construct an effi cient- scale manufacturing plant, undertake massive adver- tising to break down established brand loyalties, and quickly build up distribution outlets— all challenging goals likely to involve substantial expenditures.

In contrast, by acquiring an established enterprise, a company can circumvent most entry barriers. It can purchase a market leader that already benefi ts from sub- stantial scale economies and brand loyalty. Thus the greater the barriers to entry, the more likely it is that acquisition will be the favored entry mode. (We should note, however, that the attractiveness of an acquisition is based on the assumption that an incumbent company can be acquired for less than it would cost to enter the same industry through internal new venturing. As we discuss in the next section, the valid- ity of this assumption is often questionable.)

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 213

Pitfalls with Acquisitions For the reasons just noted, acquisitions have long been a popular vehicle for expand- ing the scope of the organization into new business areas. However, despite their popularity, there is ample evidence that many acquisitions fail to add value for the acquiring company and, indeed, often end up dissipating value. For example, a study of 700 large acquisitions found that although 30% of these resulted in higher profi ts, 31% led to losses, and the remainder had little impact.18

In fact, a wealth of evidence from academic research suggests that many acquisitions fail to realize their anticipated benefi ts.19 Not only do profi ts and mar- ket shares often decline following acquisition, but a substantial subset of acquired companies experience traumatic diffi culties that ultimately lead to their being sold off by the acquiring company.20 Thus many acquisitions dilute value rather than create it.21

Why do so many acquisitions fail to create value? There appears to be four major reasons: (1) companies often experience diffi culties when trying to integrate diver- gent corporate cultures; (2) companies overestimate the potential economic benefi ts from an acquisition; (3) acquisitions tend to be very expensive; and (4) companies often do not adequately screen their acquisition targets.

Postacquisition Integration Having made an acquisition, the acquiring com- pany has to integrate the acquired business into its own organizational structure. Integration involves the adoption of common management and fi nancial control systems, the joining together of operations from the acquired and the acquiring company, the establishment of bureaucratic mechanisms to share information and personnel, and the need to create a common culture. When integration is attempted, many unexpected problems can occur. Often they stem from differences in corporate cultures. After an acquisition, many acquired companies experience high manage- ment turnover, possibly because their employees do not like the acquiring company’s way of doing things.22 Research evidence suggests that the loss of management talent and expertise, to say nothing of the damage from constant tension between different business units, can harm the performance of the acquired unit.23

Overestimating Economic Benefi ts Even when companies achieve integration, they often overestimate the potential for creating value by marrying different busi- nesses. They overestimate the strategic advantages that can be derived from the ac- quisition, and thus pay more for the target company than it is probably worth. Why? Top managers typically overestimate their ability to create value from an acquisition, primarily because rising to the top of a corporation gives them an exaggerated sense of their own capabilities.24 The overestimation of economic benefi ts seems to have been a factor in the disastrous 2001 acquisition of Time Warner by AOL, for ex- ample, that resulted in billions of dollars in losses for Time Warner, which spun AOL off into a separate company in December 2009.

The Expense of Acquisitions Acquisitions of companies whose stock is publicly traded tend to be very expensive, as Time Warner found out. When a company moves to acquire the stock of another company, the stock price frequently gets bid up in the acquisition process. In such cases the acquiring company must often pay a sig- nifi cant premium over the current market value of the target. Often these premiums are 50%–100% above the stock value of the target company before the acquisition

214 Part 4 Strategy Implementation

was announced. Such a situation is particularly likely to occur in the case of con- tested bids, where two or more companies simultaneously bid for control of a single target company. For example, in 2010 Dell and HP entered into a bidding war for cloud- computing data storage company 3Par. Dell fi rst offered $1 billion to buy the company but then HP offered $1.5 billion. Dell then offered $1.7 billion but gave up the battle after HP bid over $2 billion for 3Par— over a 150% premium.

The debt taken on in order to fi nance expensive acquisitions can later become a noose around the acquiring company’s neck, particularly if interest rates rise. Moreover, if the market value of the target company prior to an acquisition was a true refl ection of that company’s worth under its management at that time, a premium of 50% or 100% over this value means that the acquiring company has to improve the performance of the acquired unit by just as much if it is to reap a positive return on its investment! Such performance gains can be very diffi cult to achieve.

Inadequate Preacquisition Screening One common reason for the failure of ac- quisitions is management’s inadequate attention to preacquisition screening.25 Many companies decide to acquire other fi rms without thoroughly analyzing the potential benefi ts and costs. After the acquisition has been completed, many acquiring com- panies discover that instead of buying a well- run business, they have purchased a troubled organization. IBM avoided this situation in 2009 when it was in negotia- tions to purchase chip maker Sun Microsystems. After spending 1 week examining its books IBM reduced its offer price by 10% after its negotiators had examined Sun’s books and found its customer base was not as solid as they had expected. Sun was eventually sold to Oracle for a much lower price.

Guidelines for Successful Acquisition To avoid pitfalls and make successful acquisitions, companies need to take a struc- tured approach with three main components: (1) target identifi cation and preacqui- sition screening, (2) bidding strategy, and (3) integration.26

Screening Thorough preacquisition screening increases a company’s knowl- edge about potential takeover targets and lessens the risk of purchasing a problem company— one with a weak business model. It also leads to a more realistic assess- ment of the problems involved in executing a particular acquisition so that a com- pany can plan how to integrate the new business and blend organizational structures and cultures. The screening should begin with a detailed assessment of the strategic rationale for making the acquisition and with identifi cation of the kind of enterprise that would make an ideal acquisition candidate.

Next, the company should scan a target population of potential acquisition can- didates, evaluating each in terms of a detailed set of criteria, focusing on (1) fi nancial position, (2) product market position, (3) competitive environment, (4) management capabilities, and (5) corporate culture. Such an evaluation should enable the com- pany to identify the strengths and weaknesses of each candidate, the extent of poten- tial economies of scope between the acquiring and the acquired companies, potential integration problems, and the compatibility of the corporate cultures of the acquir- ing and the acquired companies. For example, Microsoft and SAP, the world’s lead- ing provider of enterprise resource planning software, sat down together to discuss a possible acquisition by Microsoft. Both companies decided that even though there

Strategic Alliance

A cooperative agreement between two or more companies to work together and share resources to achieve a common business objective.

Joint Venture

A formal type of strategic alliance in which two companies jointly create a new, separate company to enter a new product market or industry.

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 215

was a strong strategic rationale for a merger— together they could dominate the software computing market that satisfi es the need of large global companies— the problems of creating an organizational structure that could successfully integrate their hundreds of thousands of employees throughout the world, and blend two very different cultures, were insurmountable.

The company should then reduce the list of candidates to the most promising ones and evaluate them further. At this stage, it should sound out third parties, such as investment bankers, whose opinions may be important and who may be able to offer valuable insights into the effi ciency of target companies. The company that heads the list after this process should be the acquisition target.

Bidding Strategy The objective of bidding strategy is to reduce the price that a company must pay for an acquisition candidate. The essential element of a good bidding strategy is timing. For example, Hanson PLC, one of the most successful companies to pursue unrelated diversifi cation, always looked for essentially sound businesses that were suffering from short- term problems due to cyclical industry factors or from problems localized in one division. Such companies are typically undervalued by the stock market and thus can be picked up without payment of the standard 40% or 50% premium over current stock prices. With good timing, a company can make a bargain purchase.

Integration Despite good screening and bidding, an acquisition will fail unless positive steps are taken to integrate the acquired company into the organizational structure of the acquiring one. Integration should center on the source of the po- tential strategic advantages of the acquisition— for instance, opportunities to share marketing, manufacturing, procurement, R&D, fi nancial, or management resources. Integration should also be accompanied by steps to eliminate any duplication of facilities or functions. In addition, any unwanted divisions of the acquired company should be sold. Finally, if the different business activities are closely related, they will require a high degree of integration. In the case of a company pursuing unrelated diversifi cation, the level of integration may be a minimal problem. But for a strategy of related diversifi cation, the problem of integrating the two companies’ operations is much greater. One company that has succeeded well in its acquisition strategy for these reasons is News Corp., discussed in the following Strategy in Action.

IMPLEMENTING STRATEGY THROUGH STRATEGIC ALLIANCES Strategic alliances are cooperative agreements between two or more companies to work together and share resources to achieve a common business objective. A joint venture is a formal type of strategic alliance in which two companies jointly create a new, separate company to enter a new business area.

A company may prefer internal new venturing to acquisition as an entry strategy into new business areas and yet hesitate to commit itself to an internal new venture because of the risks and costs of building a new operation “from the ground up.” Such a situation is likely when a company sees the advantages of establishing a new business in an embryonic or growth industry, but the risks and costs associated with

216 Part 4 Strategy Implementation

the business are more than it is willing to assume on its own. In this case, a company may decide to form some kind of strategic alliance with another company.

As noted earlier, strategic alliances are cooperative agreements between companies. The parties to an alliance may be actual or potential competitors; or they may be situated at different stages in an industry’s value chain; or they may be in different businesses but have a joint interest in working together to develop distinctive com- petencies in R&D or marketing that are useful to both parties or decide to cooperate on a particular problem, such as developing a new product or technology.

Strategic alliances run the gamut from informal agreements and short- term contracts, where companies agree to share know- how, to formal contractual agree- ments such as long- term outsourcing agreements and joint ventures in which both

News Corp is a company that has engineered scores of acquisitions to become one of the four largest, and most powerful, entertainment media companies in the world. What kind of strategies has its CEO Rupert Murdock used to create his media empire?

Rupert Murdock was born into a newspaper fam- ily; his father owned and ran the Adelaide News, an Australian regional newspaper, and when his father died in 1952 he gained control of it. He quickly set his sights on enlarging his customer base. After all, more profi t is earned when more customers buy your products, and so he used his fi nancial acumen to acquire more and more Australian newspapers. One of these had connections to a major British “pulp” newspaper the Mirror, which is quite similar to National Enquirer, and Murdock acquired and established the Sun as a leading British tabloid.

His growing reputation as an entrepreneur enabled him to borrow more and more money from investors who saw that he could create a much higher return from the assets he controlled than competitors. Murdock carried on buying well- known newspapers such as the British Sunday Telegraph, and then his fi rst U.S. news- paper, the San Antonio Express. Then, he launched the National Star and his growing profi ts allowed him to con- tinue to borrow money and he bought the New York Post and The Times and Sunday Times.

Pursuing this strategy of horizontal integration through acquisitions to create one of the world’s biggest newspaper empires was just one part of Murdock’s cor- porate strategies, however. He realized that industries in the entertainment and media sector can be divided into those that provide media content, or “software,” such as book publishing, movies, and television programming,

and those that provide or supply the media channels or “hardware” necessary to get media software to custom- ers such as movie theatres, TV channels, TV cable, and satellite broadcasting. Murdock realized he could create the most profi t by getting involved in both the media software and media hardware industries, which are es- sentially adjacent stages in the value chain of the enter- tainment and media sector. So, Murdock went all out to pursue a strategy of vertical integration and went on a buying spree to purchase global media companies in both the software and hardware stages of the entertain- ment sector. He paid $1.5 billion for Metromedia, which owned seven stations that reached over 20% of house- holds in the United States. He scored another major coup when he bought Twentieth Century Fox Movie Studios, a premium content provider. Now he had Fox’s huge fi lm library and the creative talents the studio possessed to make new fi lms and TV programming. Murdock decided to create the Fox Broadcasting network and buy or cre- ate its own U.S. network of Fox affi liates that would show programs developed by its own Fox movie stu- dios. After a slow start, the Fox Network gained popular- ity with shows like The Simpson’s, which became Fox’s fi rst blockbuster program. He also engineered another coup when Fox purchased the sole rights to broadcast all NFL games for over $1 billion, shutting out NBC, and making Fox the “fourth network.” The Fox network has never looked back and it was one of the fi rst to get into “reality” programming. News Corp has acquired a host of companies in the entertainment value chain that fi t with its newspaper, TV station, and movie and broadcast- ing companies to strengthen its competitive position in these industries.

8.1 STRATEGY IN ACTION

News Corp’s Successful Acquisition Strategy

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 217

companies establish and assume ownership of a new company. Thus some strategic alliances are meant to be temporary, but others may be a prelude to a permanent re- lationship. For example, sometimes long- term agreements result in the establishment of a joint venture (they may even lead to a merger through acquisition). Strategic alliances of all kinds are often used as a vehicle that enables companies to share the risks and costs of developing a new business. In any event, strategic alliances are a valuable strategic tool that helps companies maximize their business opportunities, especially in today’s competitive global environment.

Advantages of Strategic Alliances Companies enter into strategic alliances with competitors to achieve a number of strategic objectives.27 First, strategic alliances may be a way of facilitating entry into a market. For example, Motorola initially found it very diffi cult to gain access to the Japanese cellular telephone market because of formal and informal Japanese trade barriers. The turning point for Motorola came when it formed its alliance with Toshiba to build microprocessors. As part of the deal, Toshiba provided Motorola with marketing help, including some of its best managers. This helped Motorola win government approval to enter the Japanese market.28

Second, many companies enter into strategic alliances to share the fi xed costs and associated risks that arise from the development of new products or processes. Motorola’s alliance with Toshiba was partly motivated by a desire to share the high fi xed costs associated with setting up the capital- intensive operation that manufac- turing microprocessors entailed (it cost Motorola and Toshiba close to $1 billion to set up their facility). Few companies can afford the costs and risks of going it alone on such a venture. Similarly, an alliance between Boeing and a number of Japanese companies to build Boeing’s latest commercial jet liner, the 787, was motivated by Boeing’s desire to share the burden of the estimated $8 billion investment required to develop the aircraft.

Third, many alliances can be seen as a way of bringing together complementary skills and assets that neither company could easily develop on its own. For example, Microsoft and Toshiba established an alliance aimed at developing embedded micro- processors (essentially, tiny computers) that can perform a variety of entertainment functions in an automobile (for example, they can run a backseat DVD player or a wireless Internet connection). The processors will run a version of Microsoft’s Windows CE operating system. Microsoft brings its software engineering skills to the alliance, and Toshiba brings its skills in developing microprocessors.29

Disadvantages of Strategic Alliances Strategic alliances have many signifi cant advantages, but there are also several dis- advantages that may arise. First, strategic alliances may provide a company’s com- petitors with access to valuable low- cost manufacturing knowledge and a route to gain new technology and market access.30 For example, some commentators have argued that many strategic alliances between U.S. and Japanese fi rms facilitated an implicit Japanese strategy to keep higher- paying, higher- value- added jobs in Japan while gaining the project engineering and production process skills that underlie the competitive success of many U.S. companies.31 These observers maintain that Japanese success in the machine tool and semiconductor industries was the result of knowledge acquired through strategic alliances with U.S. companies. And they

218 Part 4 Strategy Implementation

contend that U.S. managers aided the Japanese by entering into alliances that chan- nel new inventions to Japan and provide a convenient sales and distribution network for the resulting Japanese products sent back for sale in the United States. Although such agreements may generate short- term profi ts, in the long run the result is to “hollow out” U.S. fi rms, leaving them with no competitive advantage in the global marketplace.

Consider, for example, the situation in a joint venture, the formal strategic al- liance in which two companies team up and establish a separate company to pool their complementary skills and assets. Such an arrangement enables a company to share the substantial risks and costs involved in developing a new business oppor- tunity and may increase the probability of success in the new business. But there are three main drawbacks to joint venture arrangements.

First, just as a joint venture allows a company to share the risks and costs of developing a new business, it also requires the sharing of profi ts if the new business succeeds. Second, a company that enters into a joint venture always runs the risk of giving critical know- how away to its joint- venture partner, which might use that know- how to compete directly with the company in the future. Third, the venture partners must share control. If the partners have different business philosophies, time horizons, or investment preferences, substantial problems can arise. Confl icts over how to run the joint venture can tear it apart and result in business failure.

Thus the critics of strategic alliances have a point: Alliances do have risks, and the more formal or extensive the alliance, the greater the possibility that a company may give away more than it gets in return. Nevertheless, there are so many examples of apparently successful alliances between companies, including alliances between U.S. and Japanese companies, that it seems that long- term strategic alliances can and often do result in more advantages than disadvantages. The next section suggests why, and under what conditions, companies can gain these advantages.

Making Strategic Alliances Work The failure rate for strategic alliances is quite high. For example, one study of 49 global strategic alliances found that two- thirds ran into serious managerial and fi nancial troubles within 2 years of their formation. The same study suggests that although many of these problems are ultimately resolved, 33% of strategic alliances are ultimately rated as failures by the parties involved.32 The success of a strategic alliance seems to be a function of three main factors: partner selection, alliance struc- ture, and the manner in which the alliance is managed.

Partner Selection One of the keys to making a strategic alliance work is to select the right kind of partner. A good partner has three principal characteristics. First, a good partner helps the company achieve strategic goals, such as gaining market ac- cess, sharing the costs and risks of new- product development, or gaining access to critical core competencies. In other words, the partner must have capabilities that the company lacks and that it values. Second, a good partner shares the fi rm’s vision for the purpose of the alliance. If two companies approach an alliance with radically different agendas, the chances are great that the relationship will not be harmonious and will end in divorce.

Third, a good partner is unlikely to try to exploit the alliance opportunistically for its own ends— that is, to expropriate or even steal the company’s technological know- how while giving little in return. In this respect, fi rms with reputations for fair play to maintain probably make the best partners. For example, IBM is involved in

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 219

so many strategic alliances that it would not pay the company to cheat on individual alliance partners (in the mid- 2000s, IBM reportedly had more than 150 major stra- tegic alliances).33 Doing so would tarnish IBM’s reputation as a good ally and make it diffi cult for IBM to attract alliance partners in the future. Because IBM attaches great importance to its alliances, it is unlikely to engage in the kind of underhand behavior that critics highlight. Similarly, their reputations make it less likely (though by no means impossible) that such Japanese fi rms as Sony, Toshiba, and Fuji, which have histories of alliances with non- Japanese fi rms, would exploit an alliance partner.

To select a partner with these three characteristics, a company needs to thor- oughly investigate potential alliance candidates. To increase the probability of select- ing a good partner, the company should collect as much relevant publicly available information about potential allies as possible; collect data from informed third parties, including companies that have had alliances with the potential partners, investment bankers who have had dealings with them, and some of their former employees; and get to know potential partners as well as possible before committing to an alliance. This last step should include face- to- face meetings between senior managers to ensure that the “chemistry” is right.

Alliance Structure Once a partner has been selected, the alliance should be struc- tured so that the company’s risk of giving too much away to the partner is reduced to an acceptable level. Figure 8.4 depicts the four safeguards against opportunism of cheating by alliance partners discussed below. First, alliances can be designed to make it diffi cult or impossible to transfer technology meant to be kept secret and proprietary. Specifi cally, the design, development, and servicing of a product manufactured by an alliance can be structured so as to “wall off” and protect sensitive technologies from partners. In the alliance between GE and Snecma to build commercial aircraft engines, for example, GE reduced the risk of “excess transfer” by walling off certain sections of the production process. This effectively cut off the transfer of what GE regarded as key competitive technology, while permitting Snecma access to fi nal assembly. Similarly, in the alliance between Boeing and the Japanese to build the 767, Boeing walled off research, design, and marketing functions considered central to its com- petitive position, while allowing the Japanese to share in production technology. Boeing also walled off new technologies not required for 767 production.34

Second, contractual safeguards can be written into an alliance agreement to guard against the risk of being exploited by a partner. For example, TRW Systems,

Establishing contractual safeguards

Agreeing to swap valuable skills and

technologies

Seeking credible commitments

“Walling off” critical

technology

Probability of opportunism by alliance

partner reduced by

Figure 8.4 Structuring Alliances to Reduce Opportunism

220 Part 4 Strategy Implementation

an auto- parts supplier now part of Honeywell, had strategic alliances with large Japanese car component suppliers to produce seat belts, engine valves, and steer- ing gears for sale to Japanese- owned car assembly plants in the United States. TRW ensured that clauses in each of its alliance contracts barred the Japanese fi rms from competing with TRW to supply U.S.- owned auto companies with component parts. So TRW protected itself against the possibility that the Japanese companies entered the alliances only as a way of gaining access to the U.S. market to compete with TRW on its home turf.

Third, both parties to an alliance can promise in advance to swap important proprietary skills and technologies, thereby ensuring the opportunity for equitable gain. Cross- licensing agreements are one way to achieve this goal. For example, in an alliance between Motorola and Toshiba, Motorola licensed some of its micro- processor technology to Toshiba and in return Toshiba licensed some of its memory chip technology to Motorola.

Fourth, the risk of deceitful behavior by an alliance partner can be reduced if the less powerful fi rm extracts a signifi cant credible commitment from its partner in advance. The purpose of a credible commitment is to send a signal that the company making the commitment will do its best to ensure that the alliance works. Such cred- ible commitments often come in the form of capital investments. For example, in 2004 the small British biotechnology fi rm Cambridge Antibody Technology entered into a 5- year alliance with the large pharmaceutical company Astra Zeneca to de- velop new treatments for infl ammatory disorders. As part of the deal, Astra Zeneca agreed to invest $140  million, a 20% equity stake in the smaller company. This investment increases the probability that Astra Zeneca will do its best to ensure the alliance achieves its strategic goals.35

Managing the Alliance Once a partner has been selected and an appropriate alliance structure agreed on, the task facing the company is to maximize the benefi ts from the alliance. One important ingredient of success appears to be sensitivity to cultural differences. Many differences in management style are attributable to cul- tural differences, and managers need to make allowances for these in dealing with their partner. Beyond this, maximizing the benefi ts from an alliance seems to involve building trust between partners and learning from partners.36

Managing an alliance successfully requires building interpersonal relationships between the fi rms’ managers, or what is sometimes referred to as relational capital.37 This is one lesson that can be learned from a successful strategic alliance between Ford and Mazda. Ford and Mazda set up a framework of meetings within which their managers not only discuss matters pertaining to the alliance but also have time to get to know each other better. The belief is that the resulting friendships help build trust and facilitate harmonious relations between the two fi rms. Personal relation- ships also foster an informal management network between the fi rms. This network can then be used to help solve problems arising in more formal contexts (such as in joint committee meetings between personnel from the two fi rms). When entering an alliance, a company must take some measures to ensure that it learns from its alli- ance partner and then puts that knowledge to good use within its own organization.

In sum, although strategic alliances often have a distinct advantage over internal new venturing or acquisitions as a means of establishing a new business operation, they also have certain drawbacks. When deciding whether to go it alone, acquire, or cooperate with another company in a strategic alliance, managers need to assess carefully the pros and cons of the alternatives.

As a top manager of a newly formed strategic alliance, you have been asked to de- velop a contractual control system to ensure ethical and non- exploitive behavior from each of the partner companies. Identifying po- tential ways in which a stra- tegic alliance can go wrong will help you establish the necessary safeguards. From what you’ve learned, can you determine rules or pro- cedures that could  en sure an ethical and successful alliance is maintained?

Ethical Dilemma

Chapter 8 Strategic Change: Implementing Strategies to Build and Develop a Company 221

1. Strategic change is the movement of a company from its present state to some desired future state to increase its competitive advantage. Two main types of strategic changes are reengineering and restructuring.

2. Strategic change is implemented through a series of steps. The fi rst step in the change process is de- termining the need for change. Strategic managers use a SWOT analysis to determine the company’s present state and then characterize its desired fu- ture state. The second stage in the change process is to identify the obstacles to change at all levels in the organization.

3. An important technique used to identify a com- pany’s desired future state is to analyze it as a portfolio of “core competencies”— as opposed to a portfolio of businesses. In this approach, stra- tegic change is oriented toward maintaining ex- isting competencies, building new competencies, and leveraging competencies by applying them to new business opportunities.

4. There are three vehicles that companies use to enter new business areas: internal ventures, ac- quisitions, and strategic alliances (including joint ventures).

5. Internal new venturing is used as an entry strat- egy when a company possesses a set of valuable competencies in its existing businesses that can be leveraged or recombined to enter the new business area.

6. Many internal ventures fail because of entry on too small a scale, poor commercialization, and/or poor corporate management of the internal ven- ture process. Guarding against failure involves a structured approach to project selection and management, integration of R&D and marketing to improve commercialization of a venture idea, and entry on a signifi cant scale.

7. Acquisitions are often favored as an entry strat- egy when the company lacks important compe- tencies (resources and capabilities) required to compete in an area, but when it can purchase, at

a reasonable price, an incumbent company that has those competencies. Acquisitions also tend to be favored when the barriers to entry into the target industry are high and when the company is unwilling to accept the time frame, development costs, and risks of internal new venturing.

8. Many acquisitions fail because of poor post- acquisition integration, overestimation of the value that can be created from an acquisition, the high cost of acquisition, and poor preac- quisition screening. Guarding against acquisi- tion failure requires structured screening, good bidding strategies, and positive attempts to in- tegrate the acquired company into the organiza- tion of the acquiring fi rm.

9. Strategic alliances may be the preferred entry strategy when (1) the risks and costs associated with setting up a new business unit are more than the company is willing to assume on its own and (2) the company can increase the prob- ability of successfully establishing a new busi- ness by teaming up with another company that has skills and assets complementing its own.

10. Strategic alliances are short- term informal or long- term formal cooperative agreements be- tween companies. Alliances can facilitate entry into markets, enable partners to share the fi xed costs and risks associated with new products and processes, facilitate the transfer of comple- mentary skills between companies, and help companies establish technical standards.

11. The drawbacks of formal strategic alliances, particularly joint ventures, include the risk that a company may give away technological know- how and market access to its alliance partner without getting much in return.

12. The disadvantages associated with alliances can be reduced if the company selects partners care- fully, paying close attention to their reputation, and structures the alliance in such a way as to avoid unintended transfers of know- how.

SUMMARY OF CHAPTER

After reading this chapter, you should be able to: • Discuss how organizational strategy is

implemented through organizational structure.

• Explain the building blocks of organizational structure.

• Distinguish between vertical and horizontal differentiation.

• Discuss the importance of integration and the relationship between differentiation and integration.

• Explain the nature and function of strategic control systems.

L E A R N I N G O B J E C T I V E S

The Role of Organizational Structure

Building Blocks of Organizational Structure

Vertical Differentiation

Problems with Tall Structures Centralization or Decentralization?

Horizontal Differentiation

Functional Structure Product Structure Product- Team Structure Geographic Structure Multidivisional Structure

Integration and Organizational Control

Forms of Integrating Mechanisms Differentiation and Integration

The Nature of Organizational Control

Strategic Controls Financial Controls Output Controls Behavior Controls

C H A P T E R O U T L I N E

Implementing Strategy Through

Organizational Design9

Organizational Design

The process through which managers select the combination of organizational structure and control systems that they believe will enable the company to create and sustain a competitive advantage.

Chapter 9 Implementing Strategy Through Organizational Design 227

OVERVIEW

In this chapter, we examine how a company should organize its activities to create the most value. In Chapter 1, we defi ned strategy implementation as the way a com- pany creates the organizational arrangements that enable it to pursue its strategy most effectively. Strategy is implemented through organizational design.

Organizational design means selecting the combination of organizational structure and control systems that allows a company to pursue its strategy most effectively— that lets it create and sustain a competitive advantage. Good organiza- tional design increases profi ts in two ways. First, it economizes on operating costs and lowers the costs of value creation activities. Second, it enhances the ability of a company’s value creation functions to achieve superior effi ciency, quality, inno- vativeness, and customer responsiveness and to obtain a differentiation advantage.

The primary role of organizational structure and control is twofold: (1) to co- ordinate the activities of employees in such a way that they work together most effectively to implement a strategy that increases competitive advantage and (2) to motivate employees and provide them with incentives to achieve superior effi ciency, quality, innovation, or customer responsiveness. Microsoft’s strategy, for example, is to speed decision making and new- product development, and it constantly works to keep its structure as fl exible as possible to allow its teams of programmers to respond quickly to the ever- changing nature of competition in the software industry.

Organizational structure and control shape the way people behave and deter- mine how they will act in the organizational setting. If a new CEO wants to know why it takes a long time for people to make decisions in a company, why there is a lack of cooperation between sales and manufacturing, or why product innovations are few and far between, he or she needs to look at the design of the organizational structure and control system and analyze how it coordinates and motivates employ- ees’ behavior. An analysis of how structure and control work makes it possible to change them to improve both coordination and motivation. Good organizational design allows an organization to improve its ability to create value and obtain a competitive advantage.

In this chapter we fi rst examine the organizational structures available to strate- gic managers to coordinate and motivate employees. Then we consider the strategic control systems that companies use in conjunction with their organizational struc- tures to monitor and motivate managers and employees at all levels and encourage them to be responsive to changes in the competitive environment.

THE ROLE OF ORGANIZATIONAL STRUCTURE After formulating a company’s strategies, management must make designing organizational structure its next priority, for strategy is also implemented through organizational structure. The value creation activities of organizational members are meaningless unless some type of structure is used to assign people to tasks and link the activities of different people and functions.1 As we saw in Chapter 4, each organizational function needs to develop a distinctive competency in a value creation activity in order to increase effi ciency, quality, innovation, or customer responsiveness. Thus, each function needs a structure designed to allow it to de- velop its skills and become more specialized and productive. As functions become

Differentiation

The way in which a company allocates people and resources to organizational tasks and divides them into functions and divisions so as to create value.

Vertical Differentiation

The process by which strategic managers choose how to distribute decision- making authority over value creation activities in an organization.

Horizontal Differentiation

The process by which strategic managers choose how to divide people and tasks into functions and divisions to increase their ability to create value.

Integration

The means a company uses to coordinate people, functions, and divisions to accomplish organizational tasks.

228 Part 4 Strategy Implementation

increasingly specialized, however, they often begin to pursue their own goals ex- clusively and lose sight of the need to communicate and coordinate with other functions. The goals of R&D, for example, center on innovation and product de- sign, whereas the goals of manufacturing often revolve around increasing effi ciency. Left to themselves, the various functions may have little to say to one another, and value creation opportunities will be lost.

The role of organizational structure is to provide the vehicle through which man- agers can coordinate the activities of a company’s various functions, divisions, and business units to take advantage of their skills and competencies. To pursue a cost- leadership strategy, for example, a company must design a structure that facilitates close coordination between the activities of manufacturing and those of R&D to ensure that innovative products can be produced reliably and cost- effectively. To achieve gains from economies of scope and resource sharing between divisions, man- agers must design mechanisms that motivate and encourage divisional managers to communicate and share their skills and knowledge. In pursuing a global or trans- national strategy, managers must create the right kind of organizational structure for managing the fl ow of resources and capabilities between domestic and overseas divisions. Below we examine the basic building blocks of organizational structure to understand how it shapes the behavior of people, functions, and divisions.

Building Blocks of Organizational Structure The basic building blocks of organizational structure are differentiation and integration. Differentiation is the way in which a company allocates people and resources to organizational tasks in order to create value.2 Generally, the greater the number of different functions or divisions in an organization and the more skilled and specialized they are, the higher is the level of differentiation. For example, a company such as General Electric, which has more than 300 different divisions and a multitude of different sales and R&D departments, has a much higher level of dif- ferentiation than a small manufacturing company or a national restaurant chain. In deciding how to differentiate the organization to create value, strategic managers face two choices.

First, strategic managers must choose how to distribute decision- making authority in the organization to control value creation activities best; these are vertical differentiation choices.3 For example, corporate managers must decide how much authority to delegate to managers at the divisional or functional level. Second, corporate managers must choose how to divide people and tasks into functions and divisions to increase their ability to create value; these are horizontal differentiation choices. Should there be separate sales and marketing departments, for example, or should the two be combined? What is the best way to divide the sales force to maximize its ability to serve customers’ needs— by type of customer or by region in which customers are located?

Integration is the means by which a company seeks to coordinate people and functions to accomplish organizational tasks.4 As we have just noted, when separate and distinct value creation functions exist, they tend to pursue their own goals and objectives. An organization has to create an organizational structure that encourages the different functions and divisions to coordinate their activities. An organization uses integrating mechanisms and control systems to promote coordination and co- operation between functions and divisions. In Microsoft and Google, for instance, to speed innovation and product development, these companies have established teams

Span of Control

The number of subordinates a manager directly manages.

Flat Structure

A structure with few hierarchical levels and a relatively wide span of control.

Tall Structure

A structure with many hierarchical levels and a relatively narrow span of control.

Chapter 9 Implementing Strategy Through Organizational Design 229

so that employees could work together to exchange information and ideas and co- operate effectively. Similarly, establishing organizational norms, shared values, and a common culture that supports innovation promotes integration.

In short, differentiation consists of the way a company divides itself into parts (functions and divisions), and integration consists of the way those parts are then combined. Together, the two processes determine how an organizational structure will operate and how successfully strategic managers will be able to create value through their chosen strategies. Consequently, it is necessary to understand the prin- ciples behind organizational design. We start by looking at differentiation.

VERTICAL DIFFERENTIATION The aim of vertical differentiation is to specify the reporting relationships that link people, tasks, and functions at all levels of a company. Fundamentally, this means that management chooses the appropriate number of hierarchical levels and the cor- rect span of control for implementing a company’s strategy most effectively.

The organizational hierarchy establishes the authority structure from the top to the bottom of the organization. The span of control is defi ned as the number of subordinates a manager directly manages.5 The basic choice is whether to aim for a fl at structure, with few hierarchical levels and thus a relatively wide span of control, or a tall structure, with many levels and thus a relatively narrow span of control (see Figure 9.1). Tall structures have many hierarchical levels relative to their size, and fl at structures have relatively few.6 For example, research suggests that the average

Tall Structure (Eight levels)

Flat Structure (Three levels)

8 3

2

1

7

6

5

4

3

2

1

Figure 9.1 Tall and Flat Structures

230 Part 4 Strategy Implementation

number of hierarchical levels for a company employing 3,000 people is seven. Thus, such an organization having nine levels would be called tall, and one having four would be called fl at. With its 22,000 employees and fi ve hierarchical levels, Google, for instance, has a relatively fl at structure.

Companies choose the number of levels they need on the basis of their strategy and the functional tasks necessary to achieve this strategy.7 High- tech companies, for example, often pursue a strategy of differentiation based on service and quality. Consequently, these companies usually have fl at structures, giving employees wide discretion to meet customers’ demands without having to consult constantly with supervisors.8 The crux of the matter is that the allocation of authority and responsi- bility in a company must match the needs of its corporate- , business- , and functional- level strategies.9

Problems with Tall Structures As a company grows and diversifi es, the number of levels in its hierarchy of author- ity increases to allow it to monitor and coordinate employee activities effi ciently. Research shows that the number of hierarchical levels relative to company size is predictable as the size increases (see Figure 9.2).10

Companies with approximately 1,000 employees usually have four levels in the hierarchy: chief executive offi cer (CEO), departmental vice presidents, fi rst- line supervisors, and shop- fl oor employees. Those with 3,000 employees normally increase their level of vertical differentiation by raising the number of levels to seven. However, something interesting happens to companies that employ more than 3,000  employees. Even when companies grow to 10,000 employees or more, the number of hierarchical levels rarely increases beyond nine or ten. As organizations grow, managers work to limit the number of hierarchical levels.

Figure 9.2 Relationship Between Company Size and Number of Hierarchical Levels

N u

m b

er o

f H

ie ra

rc h

ic al

L ev

el s

1,000 3,0002,000

4

5

6

7

9

8

10

0

Employees

Principle of the Minimum Chain of Command

The principle that managers should choose a hierarchy with the minimum number of levels of authority necessary to achieve its strategy.

Chapter 9 Implementing Strategy Through Organizational Design 231

Managers try to keep the organization as fl at as possible and follow what is known as the principle of the minimum chain of command, which states that an organization should choose a hierarchy with the minimum number of levels of au- thority necessary to achieve its strategy. Managers try to keep the hierarchy as fl at as possible because when companies become too tall, several problems arise that make strategy more diffi cult to implement.11

Coordination Problems Having too many hierarchical levels impedes commu- nication and coordination between employees and functions and also raises costs. Communication between the top and the bottom of the hierarchy takes much longer as the chain of command lengthens. This leads to infl exibility, and valuable time is lost in bringing a new product to market or in keeping up with technological developments.12 For FedEx, rapid communication and coordination is vital, so the company allows a maximum of only fi ve layers of management between employees and the CEO.13 In contrast, Procter & Gamble had a tall hierarchy, and the company needed twice as much time as its competitors to introduce new products. To improve coordination and reduce costs, the company moved to streamline its structure and reduce its number of hierarchical levels.14 Other companies have also taken measures to fl atten their structures to speed communication and decision making.

Information Distortion More subtle, but just as important, are the problems of information distortion that occur as the hierarchy of authority lengthens. Going down the hierarchy, managers at different levels (for example, divisional or corporate managers) may misinterpret information, either through accidental garbling of mes- sages or on purpose to suit their own interests. In either case, information from the top may not reach its destination intact. For instance, a request to share divisional knowledge to achieve gains from synergy may be overlooked or ignored by divisional managers who perceive it as a threat to their autonomy and power. Information transmitted upward in the hierarchy may also be distorted. Subordinates may trans- mit to their superiors only the information that enhances their own standing in the organization. The greater the number of hierarchical levels, the more scope sub- ordinates have to distort facts and, as a consequence, the costs of managing the hierarchy increase.

Motivational Problems As the number of levels in the hierarchy increases, the amount of authority possessed by managers at each hierarchical level diminishes. For example, consider the situation of two organizations of identical size, one of which has three levels in its hierarchy and the other seven. Managers in the fl at structure have much more authority, and greater authority increases their motivation to perform effectively and take responsibility for the organization’s performance. Besides, when there are fewer managers, their performance is more visible, so they can expect greater rewards when the business does well.

By contrast, the ability of managers in a tall structure to exercise authority is limited, and their decisions are constantly scrutinized by their superiors. As a result, managers tend to pass the buck and refuse to take the risks that are often necessary when new strategies are pursued. This increases the costs of coordination because more managerial time must be spent coordinating task activities. Thus, the shape of the organization’s structure strongly affects the motivation of people within it and the way strategy is implemented.15

232 Part 4 Strategy Implementation

Too Many Middle Managers Another drawback of tall structures is that hav- ing many hierarchical levels implies having many middle managers, and employing managers is expensive. As noted earlier, managerial salaries, benefi ts, offi ces, and sec- retaries are a huge expense for an organization. If the average middle manager costs a company a total of $200,000 a year, then employing 100 “surplus” managers costs $20 million a year. Most large U. S. companies have recognized this fact, and in the 2000s, companies such as IBM, HP, and Procter & Gamble have moved to downsize their hierarchies, terminating thousands of managers to reduce billions in operating costs. Also, when companies grow and are successful, they often hire personnel and create new positions without much regard for the effect of these actions on the orga- nizational hierarchy. Later, when managers review that structure, they frequently act to reduce the number of levels because of the disadvantages we have noted.

In sum, when companies become too tall and the chain of command becomes too long, strategic managers tend to lose control over the hierarchy, which means that they lose control over their strategies. Disaster often follows because a tall or- ganizational structure decreases, rather than promotes, motivation and coordination between employees and functions, and operating costs escalate as a result. One way to address such problems and lower costs is to decentralize authority— that is, to vest authority in the hierarchy’s lower levels as well as at the top.

Centralization or Decentralization? Authority is centralized when managers at the upper levels of the organizational hi- erarchy retain the authority to make the most important decisions. When authority is decentralized, it is delegated to divisions, functions, and managers and workers at lower levels in the organization. By delegating authority in this fashion, managers can avoid communication and coordination problems because information does not have to be constantly sent to the top of the organization for decisions to be made. Decentralization has three main advantages:

1. When strategic managers delegate operational decision- making responsibility to middle and fi rst- level managers, they reduce information overload, enabling stra- tegic managers to spend more time on strategic decision making. Consequently, they can make more effective decisions.

2. When managers in the bottom layers of the organization become responsible for adapting the organization to local conditions, their motivation and accountabil- ity increase. The result is that decentralization promotes organizational fl exibil- ity because lower- level managers are authorized to make on- the- spot decisions. This can often provide a company with a signifi cant competitive advantage. Companies such as IBM and Dell empower their employees and allow them to make signifi cant decisions so that they can respond quickly to customers’ needs and so ensure superior service.

3. When lower- level employees are given the right to make important decisions, fewer managers are needed to oversee their activities and tell them what to do. And fewer managers mean lower costs.

If decentralization is so effective, why don’t all companies decentralize decision mak- ing and avoid the problems of tall hierarchies? The answer is that centralization has its advantages, too. First, centralized decision making facilitates coordination of the organizational activities needed to pursue a company’s strategy. If managers at all

Suppose a poorly perform- ing organization has de- cided to terminate hundreds of middle managers. Top managers making the ter- mination decisions might choose to keep subordi- nates that they like rather than the best performers or terminate the most highly paid sub ordinates even if they are top performers. Remembering that organiza- tional structure and culture affects all company stake- holders, which ethical princi- ples about equality, fairness, and justice would you use to redesign the organization hierarchy? Keep in mind that some employees may feel to have as strong a claim on the organization as some of its stockholders, even claiming to “own” their jobs from contributions to past successes. Do you think this is an ethical claim? How would it factor into your design?

Ethical Dilemma

Chapter 9 Implementing Strategy Through Organizational Design 233

levels can make their own decisions, overall planning becomes extremely diffi cult, and the company may lose control of its decision making. Second, centralization also means that decisions fi t broad organizational objectives. When its branch operations were getting out of hand, for example, Merrill Lynch increased centralization by installing more information systems to give corporate managers greater control over branch activities. Similarly, HP centralized R&D responsibility at the corporate level to provide a more directed corporate strategy and to lower operating costs across its growing number of operating divisions.

Union Pacifi c (UP), one of the biggest rail freight carri- ers in the United States, was experiencing a crisis in the 1990 s. An economic boom had led to a record increase in the amount of freight the railroad had to transport— but, at the same time, the railroad was experiencing re- cord delays in moving the freight. UP’s customers were irate and complaining bitterly about the problem, and the delays were costing the company millions of dollars in penalty payments. The problem stemmed from UP’s de- cision to centralize authority high in the organization to cut costs. All scheduling and route planning were han- dled centrally at its headquarters to promote operating effi ciency. The job of regional managers was largely to ensure the smooth fl ow of freight through their regions. Now, recognizing that effi ciency had to be balanced by the need to be responsive to customers, UP’s CEO Dick Davidson announced a sweeping reorganization. In the future, regional, not top managers, would have the au- thority to make operational decisions; they could alter scheduling and routing to accommodate customer re- quests even if it raised costs. The goal of the organization was to “return to excellent performance by simplifying our processes and becoming easier to deal with.” In de- ciding to decentralize authority, UP was following the lead of its competitors who had already decentralized their operations; its managers, would continue to “de- centralize decision making into the fi eld, while fostering improved customer responsiveness, operational excel- lence, and personal accountability.”

Yahoo!, on the other hand, has been forced by cir- cumstances to pursue a different approach to decentral- ization. In 2009, after the failed merger between Yahoo! and Microsoft, the company’s stock price plunged. Jerry

Wang, one of the company’ founders, who had come un- der intense criticism for preventing the merger, resigned as CEO and was replaced by Carol Bartz. Bartz, with a long history of success in managing online companies, had to move quickly to fi nd ways to reduce Yahoo!’s cost structure and simplify its operations to maintain its strong online brand identity. Intense competition from the growing popularity of new online companies such as Facebook, Twitter, and established companies such as Google and Microsoft were threatening its popularity.

Bartz decided the best way to rebuild Yahoo!’s business model was to recentralize authority. To both gain more control over its different business units and reduce operating costs, she decided to centralize func- tions that had been previously performed by Yahoo!’s different business units, such as product development and marketing activities. For example, all the com- pany’s publishing and advertising functions were cen- tralized and put under the control of Hilary Schneider. The control over Yahoo!’s European, Asian, and emerg- ing markets divisions was centralized and another top Yahoo! executive took control. Her goal was to fi nd out how she could make the company work better. While she was centralizing authority, she was also holding many “town hall” meetings. Bartz was asking Yahoo!’s employees, across all departments, “What would you do if you were me?” Even as she centralized authority to help Yahoo! recover its dominant industry position, she was looking for the input of employees at any level in the hierarchy. Once Yahoo! has regained its competi- tive advantage, she will likely decentralize authority to increase Yahoo!’s profi tability, given her general mana- gerial competences.16

9.1 STRATEGY IN ACTION

To Centralize or Decentralize? That Is the Question

Functional Structure

A structure in which people are grouped on the basis of their common expertise and experience or because they use the same resources.

234 Part 4 Strategy Implementation

HORIZONTAL DIFFERENTIATION Managing the strategy- structure relationship when the number of hierarchical levels becomes too great is diffi cult and expensive. Depending on a company’s situation, the problems of tall hierarchies can be reduced by decentralization. As company size increases, however, decentralization may become less effective. How, then, as fi rms grow and diversify, can they operate effectively without becoming too tall or decentralized? How can a fi rm such as Exxon control 300,000 employees without becoming too bureaucratic and infl exible? There must be alternative ways of creat- ing organizational arrangements to achieve corporate objectives.

The fi rst of these ways is to choose the appropriate form of horizontal differentiation— that is, to decide how best to group organizational tasks and activi- ties to meet the objectives of a company’s strategies.17 The kinds of structures that companies can choose among are discussed next.

Functional Structure The issue facing a company is to fi nd the best way to invest its resources to create an infrastructure that allows it to build the distinctive competencies that increase the amount of value a company can create. As a company grows, two things begin to happen. First, the range of tasks that must be performed expands. For example, it suddenly becomes apparent that a professional accountant or a production manager or a marketing expert is needed to perform specialized tasks. Second, no one per- son can successfully perform more than one organizational task without becoming overloaded. The company’s founder, for example, can no longer simultaneously make and sell the product. The question that arises is what grouping of activities— what form of horizontal differentiation— can most effi ciently handle the needs of the grow- ing company at least cost? The answer for most companies is a functional structure.

Functional structures arrange and group people on the basis of their common expertise and experience or because they use the same resources.18 For example, engineers are grouped in a function because they perform the same tasks and use the same skills or equipment. Figure 9.3 shows a typical functional structure. Each of the rectangles represents a different functional specialization (research and develop- ment, sales and marketing, manufacturing, etc.), and each function concentrates on its own specialized task.

Advantages of a Functional Structure Functional structures have several advan- tages. First, if people who perform similar tasks are grouped together, they can learn from one another and become better— more specialized and productive— at what they do. Second, they can monitor each other to make sure that all are performing their tasks effectively and not shirking their responsibilities. As a result, the work process becomes more effi cient, reducing manufacturing costs and increasing opera- tional fl exibility.

A third important advantage of functional structures is that they give managers greater control of organizational activities. As already noted, many diffi culties arise when the number of levels in the hierarchy increases. If people are grouped into dif- ferent functions, however, each with their own managers, then several different hier- archies are created, and the company can avoid becoming too tall. There will be one hierarchy in manufacturing, for example, and another in accounting and fi nance. Managing the business is much easier when different groups specialize in different organizational tasks and are managed separately.

Chapter 9 Implementing Strategy Through Organizational Design 235

Disadvantages of a Functional Structure In adopting a functional structure, a company increases its level of horizontal differentiation to handle more complex tasks. The structure enables it to keep control of its activities as it grows. This struc- ture serves the company well until it starts to grow and diversify. If the company becomes geographically diverse and begins operating in many locations, or if it starts producing a wide range of products, control and coordination problems arise that undermine a company’s ability to coordinate its activities and reduce costs.19

Communications Problems As separate functional hierarchies evolve, functions grow more remote from one another. As a result, it becomes increasingly diffi cult to communicate across functions and to coordinate their activities. This communica- tion problem arises because with greater differentiation, the various functions de- velop different orientations toward the problems and issues facing the organization. Different functions have different time or goal orientations, for example. Some, such as manufacturing, see things in a short time frame and concentrate on achiev- ing short- run goals, such as reducing manufacturing costs. Others, such as R&D, see things from a long- term point of view, and their goals (innovation and product development) may have a time horizon of several years. These factors may cause each function to develop a different view of the strategic issues facing the company. Manufacturing, for example, may see the strategic issue as the need to reduce costs, sales may see it as the need to increase customer responsiveness, and R&D may see it as the need to create new products. In such cases, functions have trouble coordinat- ing with one another, and costs increase.

Measurement Problems As the number of its products grows, a company may fi nd it diffi cult to measure the contribution of one or a few products to its overall profi tability. Consequently, the company may turn out some unprofi table products without realizing it and so make poor resource allocation decisions. This means that the company’s measurement systems are not complex enough to serve its needs. Dell’s explosive growth in the early 1990s, for example, caused it to lose control of its inventory management systems; soon it could not accurately project supply and demand for the components that go into its personal computers. Problems with its organizational structure plagued Dell, reducing effi ciency and quality. As one manager commented, designing its structure to keep pace with its growth was like building a high-performance car while going around the race track. Dell succeeded until the mid- 2000s and it enjoyed a 20% cost advantage over competitors such as HP and Acer because of its innovative organizational design. However, HP and

CEO

ManufacturingSales and marketing

Research and development

Materials management

Engineering

Figure 9.3 Functional Structure

236 Part 4 Strategy Implementation

Acer imitated Dell’s innovations and by 2007 they had caught up with Dell and then overtook it to become the lowest cost PC makers.

Location Problems Location factors may also hamper coordination and control. If a company makes and sells in many different regions, then the centralized system of control provided by the functional structure no longer suits it because managers in the various regions must have the fl exibility to respond to the needs of their customers. Thus, the functional structure is not complex enough to handle regional diversity.

Strategic Problems Sometimes the combined effect of all these factors is that long- term strategic considerations are frequently ignored because management is preoccupied with solving communication and coordination problems. As a result, a company may lose direction and fail to take advantage of new opportunities while costs escalate.

Experiencing these problems is a sign that the company does not have an ap- propriate form of differentiation to achieve its objectives. A company must change its mix of vertical and horizontal differentiation if it is to perform effectively the organizational tasks that will enhance its competitive advantage. Essentially, these problems indicate that the company has outgrown its structure. It needs to invest resources in developing a more complex structure, one that can meet the needs of its competitive strategy. Once again, this is expensive, but as long as the value a com- pany can create is greater than the costs of operating the structure, it makes sense to adopt a more complex structure. To this end, many companies reorganize, adopting a product, geographic, or product- team structure depending on the source of the coordination problem.

Product Structure In the product structure, activities are grouped by product line. The manufacturing function is broken down into different product lines based on the similarities and differences among the products. Figure  9.4 presents a product structure typical of an imaging company. In this company, products are grouped in terms of their being consumer, health, or commercial imaging products. Inside each product group, many kinds of similar products are being manufactured.

Because three different product groupings now exist, the degree of horizontal dif- ferentiation in this structure is higher than that in the functional structure. The spe- cialized support functions, such as accounting and sales, are centralized at the top of the organization, but each support function is divided in such a way that personnel tend to specialize in one of the different product categories to avoid communication problems. Thus there may be three groups of accountants, one for each of the three product categories. In sales, separate sales forces dealing with the different product lines may emerge, but because maintaining a single sales function brings econo- mies of scale to selling and distribution, these groups will coordinate their activities. Dell, for example, moved to a product structure based on serving the product needs of different customer groups; the commercial and the public sectors are two such groups. Dell’s salespeople specialize in one customer group, but all groups coordi- nate their sales activities to ensure good communication and the transfer of knowl- edge among product lines.

The use of a product structure reduces the problems of control and coordination associated with the functional structure. It pushes aside barriers among functions because the product line, rather than each individual function, becomes the focus

Chapter 9 Implementing Strategy Through Organizational Design 237

of attention. In addition, the profi t contribution of each product line can be clearly identifi ed, and resources can be allocated more effi ciently. Note also that this struc- ture has one more level in the hierarchy than the functional structure— that of the product line manager. This increase in vertical differentiation allows managers at the level of the production line to concentrate on day- to- day operations and gives top managers more time to develop the company’s competitive advantage. Although operating costs are higher, that expense is warranted by the extra coordination and control the structure provides.

Another example of a company that adopted a product structure to manage its product lines is Maytag. Initially, when it manufactured only washers and dryers, Maytag used a functional structure. In trying to increase its market share, however, Maytag bought two other appliance manufacturers: Jenn- Air, known for its electric ranges, and Hardwick, which made gas ranges. Maytag moved to a product struc- ture, and each company operated as a separate product line, but major specialized support functions were centralized to reduce costs (this is similar to the structure of the imaging company shown in Figure 9.4). Maytag continued to diversify, however, and, as we discuss in the next section, it then needed to move to a multidivisional structure to manage its strategy more effectively.

Product- Team Structure A major structural innovation in recent years has been the product- team structure. In today’s competitive environment, many companies have been forced to fi nd bet- ter ways of coordinating their support functions in order to bring their products to market more rapidly and protect their competitive advantage. One way to do this is to use cross functional teams and develop a product- team structure (see Figure 9.5).

Consumer imaging products

CEO

Materials management

Marketing and sales

Finance Engineering Research and development

Health imaging products

Commercial imaging products

Figure 9.4 Product Structure

238 Part 4 Strategy Implementation

In the product- team structure, as in the product structure, task activities are divided along product lines to reduce costs and increase management’s ability to monitor and control the manufacturing process. However, specialists are taken from the various support functions and assigned to work on a product or project, where they are combined into cross- functional teams to serve the needs of the product. These teams are formed right at the beginning of the product development process so that any problems that arise can be ironed out early, before they lead to major rede- sign problems. When all functions have direct input from the beginning, design costs and subsequent manufacturing costs can be kept low. Moreover, the use of cross- functional teams can speed innovation and responsiveness to customers, because when authority is decentralized to the team, decisions can be made more quickly.

Geographic Structure When a company is organized geographically, geographic regions become the basis for the grouping of organizational activities. For example, a company may divide up its manufacturing operations and establish manufacturing plants in different regions of the country. This allows it to be responsive to the needs of regional customers and reduces transportation costs. Similarly, service organizations such as store chains and banks may organize their sales and marketing activities on a regional, rather than national, level to get closer to their customers. Like a product structure, a geo- graphic structure provides more control than a functional structure because there are several regional hierarchies carrying out the work previously performed by a single centralized hierarchy. A company like FedEx clearly needs a geographic structure to fulfi ll its corporate goal: next- day mail. Large merchandising organizations, such as Neiman Marcus, Dillard’s, and Walmart, also moved to a geographic structure soon after they started building stores across the country. With a geographic structure,

Research and development

Sales and marketing

Materials management Engineering

CEO

Product teams

Manufacturing units

Figure 9.5 Product- Team Structure

Chapter 9 Implementing Strategy Through Organizational Design 239

different regional clothing needs— sun wear in the West, down coats in the East— can be handled as required. At the same time, because the purchasing function remains centralized, one central organization can buy for all regions. Thus a company both achieves economies of scale in buying and distribution and reduces coordination and communication problems. For example, Neiman Marcus developed a geographic structure similar to the one shown on Figure  9.6 to manage its nationwide store chain.

In each region, it established a team of regional buyers to respond to the needs of customers in each of the Western, Central, Eastern, and Southern regions. The regional buyers then fed their information to the central buyers at corporate head- quarters, who coordinated their demands in order to obtain purchasing economies and to ensure that Neiman Marcus’s high- quality standards, on which its differentia- tion advantage depends, were maintained nationally. Today, it is the most profi table luxury department store chain.

Once again, however, the usefulness of the product or geographic structure de- pends on the size of the company and its range of products and regions. If a company starts to diversify into unrelated products or to integrate vertically into new indus- tries, the product structure will not be capable of handling the increased diversity. The reason is that it does not allow managers to coordinate the company’s value creation activities effectively; it is not complex enough to deal with the needs of the large, multi business company. At this point in its development, the company would normally adopt the multidivisional structure.

Central operations W estern

reg io

n al o

p eratio

n s

Central regional operations

Individual stores

CEO

Southern regional operations

E as

te rn

re g

io n

al o

p er

at io

n s

Figure 9.6 Geographic Structure

240 Part 4 Strategy Implementation

Multidivisional Structure The multidivisional structure possesses two main advantages over a functional struc- ture, innovations that let a company grow and diversify yet overcome problems that stem from loss of control. First, each distinct product line or business unit is placed in its own self- contained unit or division, with all support functions. For example, GE competes in more than 150 different industries, and in each industry, all of its divisions are self- contained, performing all the value creation functions necessary to give the division a competitive advantage. The result is a higher level of horizontal differentiation.

Second, the offi ce of corporate headquarters staff is created to monitor divisional activities and exercise fi nancial control over each of the divisions.20 This staff con- tains corporate managers who oversee the activities of divisional and functional managers, and it constitutes an additional level in the organizational hierarchy. Hence, there is a higher level of vertical differentiation in a multidivisional structure than in a functional structure.

Figure 9.7 presents a typical multidivisional structure found in a large chemical company such as DuPont. Although this company might easily have 70 operating di- visions, only three— the oil, pharmaceuticals, and plastics divisions— are represented here. As a self- contained business unit, each division possesses a full array of sup- port services. For example, each has self- contained accounting, sales, and personnel departments. Each division functions as a profi t center, which makes it much easier for corporate headquarters staff to monitor and evaluate each division’s activities.21

The costs of operating a multidivisional structure are very high compared with the costs of a functional structure. The size of the corporate staff is a major expense,

Corporate headquarters staff

CEO

Typical Chemical Company

Oil division (functional structure)

Pharmaceuticals division (product-team structure)

Plastics division (matrix structure)

Figure 9.7 Multidivisional Structure

Matrix Structure

A structure in which functional managers work with project managers in temporary teams to develop new products.

Operating Responsibility

In the multidivisional structure, the responsibility of divisional managers for the day- to- day operations of their divisions.

Strategic Responsibility

In the multidivisional structure, responsibility of managers at corporate headquarters for overseeing long- term plans and providing guidance for divisional managers.

Chapter 9 Implementing Strategy Through Organizational Design 241

and while thousands of managers remain on the corporate staff of large companies such as IBM and Ford, all companies today make major efforts to keep their number to a minimum. Similarly, the use of product divisions, each with its own special- ist support functions, such as research and development and marketing, is a major expense. Here again, however, if higher operating costs are offset by a higher level of value creation, it makes sense to move to a more complex structure.

Each division is also able to adopt the structure that best suits its needs. Figure 9.7 shows that the oil division has a functional structure because its activities are stan- dardized; the pharmaceuticals division has a product- team structure; and the plastics division has a matrix structure. In a matrix structure, functional managers work with project managers in temporary teams to develop a new product. But once the product is completed, functional and project managers move to new teams where they can apply their skills to develop a string of new products.

Similarly, Microsoft operates its corporation through a multidivisional structure, but each division is part of a different product group depending on the kind of soft- ware or hardware that it is responsible for developing.

In the multidivisional structure, day- to- day operations of a division are the re- sponsibility of divisional management; that is, divisional management has operating responsibility. Corporate headquarters staff, however, which includes members of the board of directors as well as top executives, is responsible for overseeing long- term plans and providing the guidance for interdivisional projects. This staff has strategic responsibility. Such a combination of self- contained divisions with a cen- tralized corporate management represents a higher level of both vertical and hori- zontal differentiation, as noted earlier.

These two innovations provide the extra control necessary to coordinate growth and diversifi cation. Because this structure, despite its high costs, has now been ad- opted by more than 90% of all large U. S. corporations, we need to consider its ad- vantages and disadvantages in more detail.

Advantages of a Multidivisional Structure When managed effectively at both the corporate level and the divisional level, a multidivisional structure offers sev- eral advantages. Together, they can raise corporate profi tability to a new peak be- cause they enable the organization to operate more complex kinds of corporate- level strategies.

Enhanced Corporate Financial Control The profi tability of different business divisions is clearly visible in the multidivisional structure.22 Because each division is its own profi t center, fi nancial controls can be applied to each business on the basis of profi t criteria. Corporate managers establish performance goals for each divi- sion, monitor their performance on a regular basis, and selectively intervene when problems arise. They can then use this information to identify the divisions in which investment of the company’s fi nancial resources will yield the greatest long- term ROIC. As a result, they can allocate the company’s funds among competing divi- sions in a way that will maximize the profi tability of the whole company. Essentially, managers at corporate headquarters act as “internal investors” who channel funds to high- performing divisions in which they will produce the most profi ts.

Enhanced Strategic Control The multidivisional structure frees corporate man- agers from operating responsibilities. The managers thus gains time for contemplat- ing wider long- term strategic issues and for developing responses to environmental

242 Part 4 Strategy Implementation

changes. The multidivisional structure also enables corporate headquarters to obtain the information it needs to perform strategic planning functions. For example, sepa- rating individual businesses is a necessary prerequisite to portfolio planning.

Growth The multidivisional structure lets the company overcome an organizational limit to its growth. By reducing information overload at the center, corporate manag- ers can handle a greater number of businesses. They can consider opportunities for further growth and diversifi cation. Communication problems are reduced because the same set of standardized accounting and fi nancial control techniques can be used to evaluate all divisions. Corporate managers are also able to implement a policy of man- agement by exception, which means that they intervene only when problems arise.

Stronger Pursuit of Internal Effi ciency Within a functional structure, the inter- dependence of functional departments means that the individual performance of each function inside a company cannot be measured by objective criteria. For example, the profi tability of the fi nance function, marketing function, or manufacturing func- tion cannot be assessed in isolation, because they are only part of the whole. This often means that within the functional structure, considerable degrees of organiza- tional slack— that is, functional resources that are being used unproductively— can go undetected. For example, in order to reduce work pressure within the department and achieve higher personal status, the head of the fi nance function might employ a larger staff than was necessary, resulting in relatively ineffi cient operation.

In a multidivisional structure, however, the individual effi ciency of each autono- mous division can be directly observed and measured in terms of the profi t it generates. Autonomy makes divisional managers accountable; they have no excuses for poor performance. The corporate offi ce is thus in a better position to identify ineffi ciencies.

Disadvantages of a Multidivisional Structure Because multidivisional structure has a number of powerful advantages, it seems to be the preferred choice of most large, diversifi ed enterprises today. Indeed, research suggests that large companies that adopt this structure outperform those that retain the functional structure.23 A multidivisional structure has its disadvantages as well, however. Good manage- ment can eliminate some of them, but others are inherent in the way the structure operates. Corporate managers have to continually pay attention to the way they operate to detect problems. These disadvantages are discussed next.

Establishing the Divisional– Corporate Authority Relationship The authority relationship between corporate headquarters and the divisions must be correctly established. The multidivisional structure introduces a new level in the management hierarchy, the corporate level. The problem for corporate managers is to decide how much authority and control to assign to the operating divisions and how much au- thority to retain at corporate headquarters.

This problem was fi rst noted by Alfred Sloan, who introduced the multidivisional structure at General Motors (which became the fi rst company to adopt it) and cre- ated GM’s original fi ve automobile divisions: Chevrolet, Pontiac, Oldsmobile, Buick, and Cadillac.24 What Sloan found, however, was that when corporate managers re- tained too much power and authority, the managers of operating divisions lacked suffi cient autonomy to develop the business strategy that might best meet the needs of the division. On the other hand, when too much authority is delegated to di- visions, managers may start to pursue strategies that benefi t their own divisional objectives but add little value to the corporation as a whole. As a result, for example, not all of the potential gains from synergy can be achieved.

Transfer Pricing

Establishment of the prices at which the products produced by one business unit are sold to other company- owned business units.

Chapter 9 Implementing Strategy Through Organizational Design 243

Thus, the central issue in managing a multidivisional structure is how much au- thority should be centralized at corporate headquarters and how much should be decentralized to the divisions. This issue must be decided by each company, taking into account the nature of its business- and corporate- level strategies. There are no easy answers, and, as the environment changes or a company alters its strategies over time, the optimal balance between centralization and decentralization of authority will also change.

Distortion of Information If corporate headquarters puts too much emphasis on divisional return on investment— for instance, by setting very high and stringent return- on- investment targets— divisional managers may choose to distort the infor- mation they supply top management and paint a rosy picture of the present situation at the expense of future profi ts. That is, divisions may start to pursue strategies that increase short- run profi tability but reduce future profi tability. The problem stems from too tight fi nancial control. GM suffered from this problem in recent years, as declining performance prompted divisional managers to try to make their divisions look good to corporate headquarters. Managing the corporate- divisional interface requires coping with subtle power issues. Hence, corporate managers must carefully control their interactions with divisional managers to ensure that both the short- and long- term goals of the business are being met.

Competition for Resources A third problem of managing a multidivisional structure is that the divisions themselves may compete for resources, and this ri- valry prevents synergy gains or economies of scope from emerging. For example, the amount of money that corporate personnel have to distribute to the divisions is fi xed. Generally, the divisions that can demonstrate the highest return on invest- ment will get the lion’s share of the money. In turn, because they have more money to invest in their business, this usually will raise their performance the next year so strong divisions grow ever stronger. Consequently, divisions may actively compete for resources and, by doing so, reduce interdivisional coordination.

Transfer Pricing Divisional competition may also lead to battles over transfer pricing. One of the main challenges that vertical integration or related diversifi ca- tion imposes is the need to set the prices at which products are transferred between divisions. Rivalry among divisions increases the problem of setting fair prices. Each supplying division tries to set the highest price for its outputs to maximize its own profi tability. Such competition can completely undermine the corporate culture and make the company a battleground. Many companies have a history of competition among divisions. Some, of course, may encourage competition if managers believe that it leads to maximum performance.

Focus on Short- Term Research and Development If extremely high profi tabil- ity targets are set by corporate headquarters, the danger arises that the divisions will cut back on research and development expenditures to improve the fi nancial per- formance of the division. Although this infl ates divisional performance in the short term, it reduces a division’s ability to develop new products and leads to a fall in the stream of long- term profi ts. Hence, corporate headquarters personnel must carefully control their interactions with the divisions to ensure that both the short- term and long- term goals of the business are being achieved.

High Operating Costs As noted earlier, because each division possesses its own specialized functions, such as fi nance and R&D, multidivisional structures are ex- pensive to run and manage. R&D is especially costly, so some companies centralize

244 Part 4 Strategy Implementation

such functions at the corporate level to serve all divisions. The duplication of spe- cialist services is not a problem if the gains from having separate specialist functions outweigh the costs. Again, strategic managers must decide whether duplication is fi nancially justifi ed. Activities (particularly advisory services and planning functions) are often centralized in times of downturn or recession; divisions, however, are re- tained as profi t centers.

The advantages of divisional structures must be balanced against their disadvan- tages, but the disadvantages can be managed by an observant, professional manage- ment team that is aware of the issues involved. The multidivisional structure is the dominant one today, which clearly suggests its usefulness as a means of managing the multi business corporation.

INTEGRATION AND ORGANIZATIONAL CONTROL As we have seen, an organization must choose the appropriate form of differen- tiation to match its strategy. Greater diversifi cation, for example, requires that a company move from a functional structure to a multidivisional structure. Choosing a type of differentiation, however, is only the fi rst organizational design decision to be made. The second decision concerns the level and type of integration and control necessary to make an organizational structure work effectively.

Forms of Integrating Mechanisms As noted earlier, a company’s level of integration is the extent to which it seeks to coordinate its value creation activities and make them interdependent. The design issue can be summed up simply: The higher a company’s level of differentiation, the higher the level of integration needed to make organizational structure work effectively.25 Thus, if a company adopts a more complex form of differentiation, it requires a more complex form of integration to accomplish its goals. FedEx, for ex- ample, needs a tremendous amount of integration to fulfi ll its promise of next- day package delivery. It is renowned for its innovative use of integrating mechanisms, such as customer liaison personnel, to coordinate its activities quickly and effi ciently.

There is a series of integrating mechanisms a company can use to increase its level of integration as its level of differentiation increases.26 Some of these mechanisms— on a continuum from simple to complex— are diagrammed in Figure 9.8. Like increasing the level of differentiation, increasing the level of integration is also expensive. There are high costs associated with using managers to coordinate value creation activities. Hence, a company uses more complex integrating mechanisms to coordinate its activities only to the extent necessary to implement its strategy effectively.

Direct Contact The aim behind establishing direct contact among managers is to set up a context within which managers from different divisions or functions can work together to solve mutual problems. Managers from different functions have different goals and interests but equal authority, so they may tend to compete rather than cooperate when confl icts arise. In a typical functional structure, for example, the heads of each of the functions have equal authority; the nearest common point of authority is the CEO. Consequently, when disputes arise, no mechanism exists to resolve the confl icts except the authority of the boss.

Chapter 9 Implementing Strategy Through Organizational Design 245

In fact, one sign of confl ict in organizations is the number of problems sent up the hierarchy for upper- level managers to solve. This wastes management time and ef- fort, retards strategic decision making, and makes it diffi cult to create a cooperative culture in the company. For this reason, companies generally choose more complex integrating mechanisms to coordinate interfunctional and divisional activities.

Interdepartmental Liaison Roles A company can improve its interfunctional coordination through the interdepartmental liaison role. When the volume of con- tacts between two departments or functions increases, one of the ways of improving coordination is to give one manager in each division or function the responsibility for coordinating with the other function. These managers may meet daily, weekly, monthly, or as needed. Figure 9.8a depicts the nature of the liaison role; the small dot represents the manager inside the functional department who has responsibil- ity for coordinating with the other function. The responsibility for coordination is part of a manager’s full- time job, but through these roles a permanent relationship forms between the managers involved, greatly easing strains between departments. Furthermore, liaison roles offer a way of transferring information across the organi- zation, which is important in large, anonymous organizations whose employees may not know anyone outside their immediate department.

Temporary Task Forces When more than two functions or divisions share com- mon problems, direct contact and liaison roles are of limited value because they do not provide enough coordination. The solution is to adopt a more complex integrat- ing mechanism called a task force. The nature of the task force is represented dia- grammatically in Figure 9.8 b. One member of each function or division is assigned to a task force created to solve a specifi c problem. Essentially, task forces are ad hoc committees, and members are responsible for reporting to their departments on the issues addressed and the solutions recommended. Task forces are temporary because once the problem has been solved, members return to their normal roles in their own departments or are assigned to other task forces. Task force members also perform many of their normal duties while serving on the task force.

Permanent Teams In many cases, the issues addressed by a task force recur. To deal with these issues effectively, an organization must establish a permanent inte- grating mechanism, such as a permanent team. An example of a permanent team is a new- product development committee, which is responsible for the choice, design, and marketing of new products. Such an activity obviously requires a great deal of integration among functions if new products are to be successfully introduced, and establishing a permanent integrating mechanism accomplishes this. Intel, for instance, emphasizes teamwork. It devised a council system based on approximately 90 cross- functional groups, which meet regularly to set functional strategy in areas such as engineering and marketing and to develop business- level strategy.

The importance of teams in the management of the organizational structure can- not be overemphasized. Essentially, permanent teams are the organization’s standing committees, and much of the strategic direction of the organization is formulated in their meetings. Henry Mintzberg, in a study of how the managers of corpora- tions spend their time, discovered that they spend more than 60% of their time in these committees.27 The reason is not bureaucracy but rather that integration is pos- sible only in intensive, face- to- face sessions, in which managers can understand oth- ers’ viewpoints and develop a cohesive organizational strategy. The more complex

246 Part 4 Strategy Implementation

the company, the more important these teams become. Microsoft, for example, has established a whole new task force and team system to promote integration among divisions and improve corporate performance. As we noted earlier, the product- team structure is based on the use of cross- functional teams to speed products to market. These teams assume the responsibility for all aspects of product development; their goal is to increase coordination and integration among functions.

Figure 9.8 Types of Integrating Mechanisms

Integrating role

Plastics division

Indicates manager with responsibility for integration

Sales

Production

Production

Engineering Research and development

Sales

Oil division

(a) Liaison Role

(b) Task Force or Team

(c) Integrating Role

Organizational Control

The process by which managers monitor the ongoing activities of an organization and its members to evaluate whether activities are being performed effi ciently and effectively and to take corrective action to improve performance if they are not.

Chapter 9 Implementing Strategy Through Organizational Design 247

Integrating Roles The only function of the integrating role is to prompt integra- tion among divisions or departments; it is a full- time job. As Figure 9.8c indicates, this role is independent of the subunits or divisions being integrated. It is staffed by an independent expert, who is normally a senior manager with a great deal of experience in the joint needs of the two departments. The job is to coordinate the decision process among departments or divisions in order to reap synergetic gains from cooperation. One study found that DuPont had created 160 integrating roles to provide coordination among the different divisions of the company and improve corporate performance.28 Once again, the more differentiated the company, the more common are these roles. Often people in these roles take the responsibility for chair- ing task forces and teams, and this provides additional integration. Sometimes the number of integrating roles becomes so high that a permanent integrating depart- ment is established at corporate headquarters. Normally, this occurs only in large, diversifi ed corporations that see the need for integration among divisions.

Differentiation and Integration Clearly, fi rms have a large number of options available to them when they increase their level of differentiation as a result of increased growth or diversifi cation. The implementation issue is for managers to match differentiation with the level of inte- gration to meet organizational objectives. Note that just as too much differentiation and not enough integration lead to a failure of implementation, the converse is also true. The combination of low differentiation and high integration leads to an over- controlled, bureaucratized organization in which fl exibility and speed of response are reduced rather than enhanced by the level of integration. Besides, too much integration is expensive for the company because it raises costs. For these reasons, the goal is to decide on the optimum amount of integration necessary for meeting organizational goals and objectives. A company needs to operate the simplest struc- ture consistent with implementing its strategy effectively.

In practice, integrating mechanisms are only the fi rst means through which a com- pany seeks to increase its ability to coordinate its activities. Control systems are a second.

THE NATURE OF ORGANIZATIONAL CONTROL Organizational control is the process by which managers monitor the ongoing ac- tivities of an organization and its members to evaluate whether activities are being performed effi ciently and effectively and to take corrective action to improve perfor- mance if they are not. First, strategic managers choose the organizational strategy and structure they hope will allow the organization to use its resources most ef- fectively to create value for its customers. Second, strategic managers create control systems to monitor and evaluate whether, in fact, their organization’s strategy and structure are working as managers intended, how they could be improved, and how they should be changed if they are not working.

Organizational control does not just mean reacting to events after they have occurred; it also means keeping an organization on track, anticipating events that might occur, and responding swiftly to new opportunities that present themselves. For this reason, control is a strategic process. Companies develop strategic control systems that establish ambitious goals and targets for all managers and employees,

Strategic Control Systems

The formal target- setting, measurement, and feedback systems that enable strategic managers to evaluate whether a company is implementing its strategy successfully.

248 Part 4 Strategy Implementation

and then they develop performance measures that stretch and encourage mangers and employees to excel in their quest to raise performance. Thus, control is not just about monitoring how well an organization and its members are achieving current goals or how well the fi rm is utilizing its existing resources. It is also about keeping employees motivated, focused on the important problems confronting an organiza- tion now and for the future, and working together to fi nd ways to change a company so that it will perform better over time.29

Strategic Controls Strategic control systems are developed to measure performance at four levels in an organization: the corporate, divisional, functional, and individual levels. Managers at all levels must develop the most appropriate set of measures to evaluate corporate- , business- , and functional- level performance. These measures should be tied as closely as possibly to the goals of achieving superior effi ciency, quality, innovativeness, and responsiveness to customers. Care must be taken, however, to ensure that the standards used at each level do not cause problems at the other levels. Rather, the controls at each level should provide a platform on which managers at the levels below can base their control systems.

Strategic control systems are the formal target- setting, measurement, and feed- back systems that allow strategic managers to evaluate whether a company is achieving superior effi ciency, quality, innovation, and customer responsiveness and is implementing its strategy successfully. An effective control system should have three characteristics. It should be fl exible enough to allow managers to respond as necessary to unexpected events; it should provide accurate information, giving a true picture of organizational performance; and it should supply managers with the information in a timely manner because making decisions on the basis of outdated information is a recipe for failure.30 As Figure 9.9 shows, designing an effective stra- tegic control system requires four steps.

Evaluate results and take corrective action, if necessary.

Compare actual performance to established targets.

Create measuring and monitoring systems.

Established standards and targets.

Figure 9.9 Steps in Designing an Effective Control System

Chapter 9 Implementing Strategy Through Organizational Design 249

1. Establish the standards and targets against which performance is to be evaluated. The standards and targets that managers select are the ways in which a company chooses to evaluate its performance. General performance standards often derive from the goal of achieving superior effi ciency, quality, innovation, or responsive- ness to customers. Specifi c performance targets are derived from the strategy pur- sued by the company. For example, if a company is pursuing a low- cost strategy, then reducing costs by 7% a year might be a target. If the company is a service organization such as Walmart or McDonald’s, then its standards might include time targets for serving customers or guidelines for food quality.

2. Create the measuring and monitoring systems that indicate whether the stan- dards and targets are being reached. The company establishes procedures for assessing whether work goals at all levels in the organization are being achieved. In some cases, measuring performance is fairly straightforward. For example, managers can measure quite easily how many customers their employees serve by counting the number of receipts from the cash register. In many cases, how- ever, measuring performance is diffi cult because the organization is engaged in many complex activities. How can managers judge how well their research and development department is doing when it may take 5 years for products to be developed? How can they measure the company’s performance when the company is entering new markets and serving new customers? How can they evaluate how well divisions are integrating their activities? The answer is that managers need to use various types of control systems, which we discuss later in this chapter.

3. Compare actual performance against the established targets. Managers evaluate whether and to what extent performance deviates from the standards and targets developed in step one. If performance is higher, management may decide that it has set the standards too low and may raise them for the next time period. The Japanese are renowned for the way they use targets on the production line to control costs. They are constantly trying to raise performance, and they raise the standards to provide a goal for managers to work toward. On the other hand, if performance is too low, managers must decide whether to take remedial action. This decision is easy when the rea- sons for poor performance can be identifi ed— for instance, high labor costs. More often, however, the reasons for poor performance are hard to uncover. They may stem from external factors, such as a recession. Alternatively, the cause may be internal. For instance, the research and development laboratory may have underestimated the problems it would encounter or the extra costs of doing unforeseen research.

4. Initiate corrective action when it is determined that the standards and targets are not being achieved. The fi nal stage in the control process is to take the cor- rective action that will allow the organization to meet its goals. Such corrective action may mean changing any aspect of strategy or structure discussed in this book. For example, managers may invest more resources in improving R&D, or diversify, or even decide to change their organizational structure. The goal is continuously to enhance the organization’s competitive advantage.

Table 9.1 shows the various types of strategic control systems that managers can use to monitor and coordinate organizational activities. Each of these types of control, along with its use at the corporate, divisional, functional, and individual levels, is discussed next.

250 Part 4 Strategy Implementation

Financial Controls The measures most commonly used by managers and other stakeholders to moni- tor and evaluate a company’s performance are fi nancial controls. Typically, strategic managers select fi nancial goals they wish their company to achieve (such as goals related to growth, profi tability, and/or return to shareholders), and then they mea- sure whether or not these goals have been achieved. One reason for the popularity of fi nancial performance measures is that they are objective. The performance of one company can be compared with that of another in terms of its stock market price, return on investment, market share, or even cash fl ow so that strategic managers and other stakeholders, particularly shareholders, have some way of judging their company’s performance relative to that of other companies.

Stock price, for example, is a useful measure of a company’s performance, pri- marily because the price of the stock is determined competitively by the number of buyers and sellers in the market. The stock’s value is an indication of the market’s ex- pectations for the fi rm’s future performance. Thus, movements in the price of a stock provide shareholders with feedback on a company’s and its manager’s performance. Stock market price acts as an important measure of performance because top man- agers watch it closely and are sensitive to its rise and fall— particularly its fall! When Ford’s stock price plunged in the 2000s, for example, its then CEO Bill Ford, and present CEO Alan Mulally, heeded its shareholders’ complaints that Ford’s operat- ing costs were too high. In response, they both took radical steps, such as laying off thousands of employees and closing many plants to reduce costs in order to boost the company’s profi tability and stock price. Finally, because stock price refl ects the long- term future return from the stock, it can be regarded as an indicator of the company’s long- run potential.

Return on investment (ROI), a measure of profi tability determined by dividing net income by invested capital, is another popular kind of fi nancial control. At the cor- porate level, the performance of the whole company can be evaluated against that of other companies to assess its relative performance. Top managers, for example, can as- sess how well their strategies have worked by comparing their company’s performance against that of similar companies. In the PC industry, companies such as Dell, HP, and Apple use ROI to gauge their performance relative to that of their competitors. A de- clining ROI signals a potential problem with a company’s strategy or structure. When HP’s ROI fell in relation to Dell’s in the early 2000s because HP could not match the effi ciency of Dell’s inventory management systems, this signaled to its managers the need to fi nd new and improved materials management strategies. By 2007 they had succeeded and HP overtook Dell to become the largest global PC maker.

Table 9.1 Types of Control Systems

Financial Controls

Output Controls

Behavior Controls

Organizational Controls

Stock price Divisional goals Budgets Values

ROI Functional goals Standardization Norms

Individual goals Rules and procedures Socialization

Output Control

A system of control in which strategic managers estimate or forecast appropriate performance goals for each division, department, and employee and then measure actual performance relative to these goals.

Chapter 9 Implementing Strategy Through Organizational Design 251

ROI can also be used inside the company at the divisional level to judge the per- formance of an operating division by comparing it to that of a similar freestanding business or other internal division. Indeed, one reason for selecting a multidivisional structure is that each division can be evaluated as a self- contained profi t center. Consequently, management can directly measure the performance of one division against that of another. HP moved to a divisional structure partly because it gave corporate managers information about the relative costs of its various divisions, allowing them to base capital allocations on the divisions’ relative performance.

Similarly, manufacturing companies often establish production facilities at differ- ent locations, domestically and globally, so that they can measure the performance of one against the other. For example, Xerox was able to identify the relative inef- fi ciency of its U. S. division by comparing its profi tability with that of its Japanese counterpart. ROI is a powerful form of control at the divisional level, especially if divisional managers are rewarded on the basis of their performance vis- à- vis other divisions. The most successful divisional managers are promoted to become the next generation of corporate executives.

Failure to meet stock price or ROI targets also indicates that corrective action is necessary. It signals the need for corporate reorganization in order to meet corporate objectives, and such reorganization can involve a change in structure or the liqui- dation and divestiture of businesses. It can also indicate the need for new strategic leadership. In recent years, the CEOs of Merck, Ford, and Motorola have all been ousted by disgruntled boards of directors, dismayed at the declining performance of their companies relative to that of competitors.

Output Controls Financial goals and controls are important, but it is also necessary to develop goals and controls that tell managers how well their strategies are creating a competitive advantage and building distinctive competences and capabilities that will lead to future success. When strategic managers establish goals and measures to evaluate ef- fi ciency, quality, innovation, and responsiveness to customers, they are using output control. In output control, strategic managers estimate or forecast appropriate per- formance goals for each division, department, and employee and then measure ac- tual performance relative to these goals. Often a company’s reward system is linked to performance on these goals, so that output control also provides an incentive structure for motivating employees at all levels in the organization.

Divisional Goals Divisional goals state corporate managers’ expectations for each division’s performance on such dimensions as effi ciency, quality, innovation, and res- ponsiveness to customers. Generally, corporate managers set challenging divisional goals to encourage divisional managers to create more effective strategies and structures in the future. At GE, for example, CEO Jeffrey Immelt sets clear performance goals for GE’s more than 150 divisions. He expects each division to be number  one or number two in its industry in terms of market share. Divisional managers are given considerable autonomy to formulate a strategy to meet this goal (to fi nd ways to increase effi ciency, innovation, etc.), and the divisions that fail are divested.

Functional and Individual Goals Output control at the functional and individual levels is a continuation of control at the divisional level. Divisional managers set goals for functional managers that will allow the division to achieve its goals. As at

Behavior Control

A system of control based on the establishment of a comprehensive system of rules and procedures to direct the actions or behavior of divisions, functions, and individuals.

Operating Budget

A blueprint that states how managers intend to use organizational resources to achieve organizational goals most effi ciently.

252 Part 4 Strategy Implementation

the divisional level, functional goals are established to encourage development of competencies that give the company a competitive advantage. The same four build- ing blocks of competitive advantage (effi ciency, quality, innovation, and customer re- sponsiveness) act as the standards against which functional performance is evaluated. In the sales function, for example, goals related to effi ciency (such as cost of sales), quality (such as number of returns), and customer responsiveness (such as the time needed to respond to customer needs) can be established for the whole function.

Finally, functional managers establish goals that individual employees are ex- pected to achieve to allow the function to achieve its goals. Sales personnel, for example, can be given specifi c goals (related to functional goals) that they in turn are required to achieve. Functions and individuals are then evaluated on the basis of whether they achieve their goals— and in sales, compensation is commonly pegged to achievement. The achievement of these goals is a sign that the company’s strategy is working and it is meeting organizational objectives.

Behavior Control The fi rst step in strategy implementation is for managers to design the right kind of organizational structure. To make the structure work, however, employees must learn the kinds of behaviors they are expected to perform. Using managers to tell employees what to do lengthens the organizational hierarchy, is expensive, and raises costs; consequently, strategic managers rely on behavior controls. Behavior control is control through the establishment of a comprehensive system of rules and procedures to direct the actions or behavior of divisions, functions, and individuals.31

The objective of using behavior controls is not to specify the goals but to stan- dardize the way of reaching them. Rules standardize behavior and make outcomes predictable. If employees follow the rules, then actions are performed and decisions handled the same way, time and time again. The result is predictability and accuracy, the aim of all control systems. The main kinds of behavior controls are operating budgets, standardization, rules and procedures, and organizational culture.

Operating Budgets Once managers at each level have been given a goal to achieve, operating budgets that regulate how managers and workers are to attain those goals are established. An operating budget is a blueprint that states how managers intend to use organizational resources to achieve organizational goals most effi ciently. Most often, managers at one level allocate to managers at a lower level a specifi c amount of resources to use to produce goods and services.

Once they have been given a budget, managers must decide how they will allo- cate certain amounts of money for different organizational activities. These lower- level managers are then evaluated on the basis of their ability to stay inside the budget and make the best use of it. Thus, for example, managers at GE’s washing machine division might have a budget of $50  million to develop and sell a new line of washing machines, and they have to decide how much money to allocate to R&D, engineering, sales, and the other functions so that the division will generate the most revenue and hence make the biggest profi t possible. Most commonly, large organizations treat each division as a stand- alone profi t center, and corporate man- agers evaluate each division’s performance by its relative contribution to corporate profi tability.

Standardization

The degree to which a company specifi es how decisions are to be made so that employees’ behavior becomes predictable.

Chapter 9 Implementing Strategy Through Organizational Design 253

Standardization Standardization is the degree to which a company specifi es how decisions are to be made so that employees’ behavior becomes predictable.32 In practice, there are three things an organization can standardize: inputs, conver- sion activities, and outputs. First, an organization can control the behavior of both people and resources by standardizing inputs into the organization. This means that managers screen inputs according to preestablished criteria or standards and then decide which inputs to allow into the organization. If employees are the input in question, one way of standardizing them is to specify which qualities and skills they must possess and then to select only those applicants who possess them. If the inputs in question are raw materials or component parts, the same considerations apply. The Japanese are renowned for the high quality and precise tolerances they demand from component parts to minimize problems with the product at the manu- facturing stage. Just- in- time (JIT) inventory systems also help standardize the fl ow of inputs.

Second, the aim of standardizing conversion activities is to program work activities such that they are done the same way time and time again. The goal is predictability. Behavior controls, such as rules and procedures, are among the chief means by which companies can standardize throughputs. Fast food restaurants such as McDonald’s and Burger King, for example, standardize all aspects of their restau- rant operations; the result is standardized fast food.

Third, the goal of standardizing outputs is to specify what the performance characteristics of the fi nal product or service should be— what the dimensions or tolerances the product should conform to, for example. To ensure that their prod- ucts are standardized, companies apply quality control and use various criteria to measure this standardization. One criterion might be the number of goods returned from customers or the number of customers’ complaints. On production lines, pe- riodic sampling of products can indicate whether they are meeting performance standards.

Rules and Procedures As with other kinds of controls, the use of behavior con- trol is accompanied by potential pitfalls that must be managed if the organization is to avoid strategic problems. Top management must be careful to monitor and evaluate the usefulness of behavior controls over time. Rules constrain people and lead to standardized, predictable behavior. However, rules are always easier to establish than to get rid of, and over time the number of rules an organization uses tends to increase. As new developments lead to additional rules, often the old rules are not discarded, and the company becomes overly bureaucratized. Consequently, the organization and the people in it become infl exible and are slow to react to changing or unusual circumstances. Such infl exibility can reduce a company’s com- petitive advantage by lowering the pace of innovation and reducing responsiveness to customers.

Similarly, inside the organization, integration and coordination may fall apart as rules impede communication between functions. Managers must therefore be con- stantly on the alert for opportunities to reduce the number of rules and procedures necessary to manage the business, and they should always prefer to discard a rule rather than add a new one. Hence, reducing the number of rules and procedures to the essential minimum is important. Strategic managers frequently neglect this task, however, and often only a change in strategic leadership brings the company back on course.

Organizational Culture

The specifi c collection of values and norms that are shared by people and groups in an organization and that control the way they interact with each other and with stakeholders outside the organization.

Organizational Values

Beliefs and ideas about what kinds of goals members of an organization should pursue and what behaviors they should use to achieve these goals.

Organizational Norms

Unwritten guidelines or expectations that prescribe the kinds of behavior employees should adopt in particular situations and regulate the way they behave.

254 Part 4 Strategy Implementation

Organizational Culture One important kind of behavioral control that serves this dual function of keeping organizational members goal- directed yet open to new op- portunities to use their skills to create value is organizational culture. Organizational culture is the specifi c collection of values and norms that are shared by people and groups in an organization and that control the way they interact with each other and with stakeholders outside the organization.33 Organizational values are beliefs and ideas about what kinds of goals members of an organization should pursue and what kinds or standards of behavior employees should use to achieve these goals. Bill Gates of Microsoft is famous for the set of organizational values that he created for his company, which include entrepreneurship, ownership, honesty, frankness, and open communication. Gates stressed entrepreneurship and ownership because he wanted Microsoft to operate less like a big bureaucracy and more like a collection of smaller and very adaptive companies. Gates also emphasized giving lower- level managers considerable decision- making autonomy and encouraged them to take risks— that is, to behave more like entrepreneurs and less like corporate bureaucrats. The stress Gates, and its current top managers, place on values such as honesty, frankness, and open communication refl ects their belief that an open internal dia- logue is necessary for competitive success at Microsoft.

From organizational values develop organizational norms, the guidelines or ex- pectations that prescribe appropriate kinds of behavior by employees in particular situations and control the behavior of organizational members toward one another. The norms of behavior for software programmers at Microsoft include working long hours and weekends, wearing whatever clothing is comfortable (but never a suit and tie), consuming junk food, and communicating with other employees via electronic mail and the company’s state- of- the- art intranet.

Organizational culture functions as a form of control in that strategic managers can infl uence the values and norms that develop in an organization— values and norms that specify appropriate and inappropriate behaviors and that shape the way its members behave.34 Strategic managers such as Gates and Michael Dell, for exam- ple, deliberately cultivate values that encourage subordinates to perform their roles in innovative and creative ways. They establish and support norms dictating that to be innovative and entrepreneurial, employees should feel free to experiment and go out on a limb even if there is a signifi cant chance of failure.

Managers of other companies, however, might cultivate values that encourage employees always to be conservative and cautious in their dealings with others, to consult their superiors before they make important decisions, and to record their actions in writing so they can be held accountable for what happens. Managers of organizations such as chemical and oil companies, fi nancial institutions, and insur- ance companies— indeed, any organization in which caution is needed— may en- courage such an approach to making decisions.35 In a bank or mutual fund, the risk of losing all your investors’ money makes a cautious approach to investing highly appropriate. Thus, we might expect that managers of different kinds of organiza- tions will deliberately try to cultivate and develop the organizational values and norms that are best suited to their strategy and structure.

Culture and Strategic Leadership Because both an organization’s structure (the design of its task and reporting relationships) and its culture shape employees’ behavior, it is crucial to match organizational structure and culture to implement strategy successfully. How do managers design and create their cultures? In gen- eral, organizational culture is the product of strategic leadership provided by an

Chapter 9 Implementing Strategy Through Organizational Design 255

organization’s founder and top managers. The organization’s founder is particularly important in determining culture, because the founder imprints his or her values and management style on the organization. Walt Disney’s conservative infl uence on the company he established continued until well after his death, for example. Managers were afraid to experiment with new forms of entertainment because they were afraid Walt Disney wouldn’t have liked it.

The leadership style established by the founder is transmitted to the company’s managers, and as the company grows, it typically attracts new managers and em- ployees who share the same values. Moreover, members of the organization typically recruit and select only those who share their values. Thus, a company’s culture be- comes more and more distinct as its members become more similar.

The virtue of these shared values and common culture is that it increases integra- tion and improves coordination among organizational members. For example, the common language that typically emerges in an organization because people share the same beliefs and values facilitates cooperation among managers. Similarly, rules and procedures and direct supervision are less important when shared norms and values regulate behavior and motivate employees. When organizational members subscribe to the organization’s cultural norms and values, this bonds them to the or- ganization and increases their commitment to fi nd new ways to help it succeed. That is, such employees are more likely to commit themselves to organizational goals and work actively to develop new skills and competencies to help achieve those goals. Strategic managers need to establish the values and norms that will help them bring their organizations into the future.

Finally, organizational structure contributes to the implementation process by providing the framework of tasks and roles that reduces transaction diffi culties and allows employees to think and behave in ways that allow a company to achieve superior performance. The way in which the frugal Sam Walton (he used to drive a 30- year- old pickup truck, for example, and lived in a very modest home) used all the kinds of control systems discussed above to implement Walmart’s cost- leadership strategy is very instructive, as discussed in the Running Case.

Walmart, headquartered in Bentonville, Arkansas, is the largest retailer in the world. In 2009, it sold more than $700  billion worth of products. A large part of Walmart’s success is due to the nature of the culture that its founder, the late Sam Walton, established for the company. Walton wanted all his managers and workers to take a hands- on approach to their jobs and be totally committed to Walmart’s main goal, which he defi ned as total customer satisfaction. To

motivate his employees, Walton created a culture that gave all employees, called “associates,” continuous feedback about their performance and the company’s performance.

To involve his associates in the business and en- courage them to develop work behaviors focused on providing quality customer service, Walton established strong cultural values and norms for his company. One of the norms associates are expected to follow is the

How Sam Walton Created Walmart’s Culture

R U N N I N G C A S E

(continued)

256 Part 4 Strategy Implementation

“10- foot attitude.” This norm encourages associates, in Walton’s words, to “promise that whenever you come within 10 feet of a customer, you will look him in the eye, greet him, and ask him if you can help him.” The “sundown rule” states that employees should strive to answer customer requests by sundown of the day they are made. The Walmart cheer (“Give me a W, give me an A,” etc.) is used in all its stores.

The strong customer- oriented values that Walton created are exemplifi ed in the stories Walmart mem- bers tell one another about associates’ concern for customers. They include stories like the one about Sheila, who risked her own safety when she jumped in front of a car to prevent a little boy from being struck; about Phyllis, who administered CPR to a customer who had suffered a heart attack in her store; and about Annette, who gave up the Power Ranger she had on lay- away for her own son to fulfi ll the birthday wish of a cus- tomer’s son. The strong Walmart culture helps to control and motivate employees to achieve the stringent output and fi nancial targets the company sets for itself.

A notable way Walmart builds its culture is through its annual stockholders’ meeting, its extravagant cer- emony celebrating the company’s success. Every year, Walmart fl ies thousands of its highest performers to

its annual meeting at its corporate headquarters in Arkansas for a show featuring famous singers, rock bands, and comedians. Walmart feels that expensive entertainment is a reward its employees deserve and that the event reinforces the company’s high- performance values and culture. The proceedings are even broadcast live to all of Walmart’s stores so that employees can celebrate the company’s achievements together.

Since Sam Walton’s death, public attention to Walmart, which has more than 1 million employees, has revealed the “hidden side” of its culture. Critics claim that few Walmart employees receive reasonably priced health care or other benefi ts, and the company pays employees at little above the minimum wage. They also contend that employees do not question these policies because managers have convinced them into believing that this has to be the case— that the only way Walmart can keep its prices low is by keeping their pay and benefi ts low. In 2009, Walmart was threatened by proposed changes to health care laws that would force it to pay a much higher percent- age of employee benefi ts. Will its loyal employees de- cide to follow Sam Walton’s 10- foot- attitude rule in the future?36

1. Implementing a strategy successfully depends on selecting an organizational structure and control system appropriate to the company’s strategy.

2. The basic tool of strategy implementation is or- ganizational design. Good organizational design increases profi ts in two ways. First, it economizes on operating costs and lowers the costs of value creation activities. Second, it enhances the abil- ity of a company’s value creation functions to achieve a differentiation advantage through su- perior effi ciency, quality, innovativeness, and re- sponsiveness to customers.

3. Differentiation and integration are the two de- sign concepts that govern how a structure will work. Differentiation has two aspects: Vertical differentiation refl ects how a company chooses to allocate its decision- making authority, and horizontal differentiation refl ects the way a com- pany groups organizational activities into func- tions, departments, or divisions.

4. Tall hierarchies have a number of disadvan- tages, such as problems with communication and information transfer, motivation, and cost. Decentralization, or delegation of authority, can solve some of these problems, however.

5. Most companies fi rst choose a functional struc- ture. Then, as a company grows and diversifi es, it adopts a multidivisional structure. Although a multidivisional structure has higher costs than a functional structure, it overcomes the control problems associated with a functional structure and gives a company the capability to handle its value creation activities effectively.

6. Other kinds of structures include the product, product- team, and geographic structures. Each has a specialized use and, to be effective, must match the needs of the organization.

7. The more complex the company and the higher its level of differentiation, the higher the level of inte- gration needed to manage its structure. The kinds

SUMMARY OF CHAPTER

Chapter 9 Implementing Strategy Through Organizational Design 257

of integrating mechanisms available to a company range from direct contact to integrating roles. The more complex the mechanism, the greater the costs of using it. A company should take care to match these mechanisms to its strategic needs.

8. Strategic control is the process of setting tar- gets and monitoring, evaluating, and rewarding organizational performance. Managers should develop strategic control systems that measure all important aspects of their organization’s performance.

9. Control takes place at all levels in the organi- zation: corporate, divisional, functional, and individual. Effective control systems are fl exible,

accurate, and able to provide quick feedback to strategic planners.

10. Control systems range from those directed at measuring outputs to those that measure be- haviors or actions. Output controls establish goals for divisions, functions, and individuals. They can be used only when outputs can be objectively measured and are often linked to a “management by objectives” system. Behavior controls are achieved through budgets, stan- dardization, rules and procedures, and orga- nizational culture, the collection of norms and values that govern the way people act and be- have inside the organization.

1. What is the difference between vertical differen- tiation and horizontal differentiation? Rank the various structures discussed in this chapter along these two dimensions.

2. What kind of structure best describes the way your business school or university operates? Why is that structure appropriate? Would another structure fi t better?

3. When would a company decide to change from a functional to a multidivisional structure?

4. What are the relationships among differentia- tion, integration, and strategic control systems? Why are these relationships important?

5. For each of the structures we discussed in this chapter, outline the most suitable control system.

6. What kinds of control and reward systems would we be likely to fi nd in (a) a small manufacturing company, (b) a chain store, (c) a high- tech com- pany, and (d) a Big Five accounting fi rm?

DISCUSSION QUESTIONS

PRACTICING STRATEGIC MANAGEMENT Small- Group Exercise: Speeding Up Product Development

Break up into groups of three to fi ve people, and discuss the following scenario. Appoint one group member as spokesperson for the group, who will communicate your fi ndings to the class when called on to do so by the instructor.

You are the top functional manager of a small greeting card company whose new lines of humorous cards for every occasion are selling out as fast as they are reaching the stores. Currently, your employees

are organized into different functions such as card designers, artists, and joke writers, as well as functions such as marketing and manufacturing. Each function works on a wide range of different kinds of cards (birthday, Christmas, Hanukkah, Thanksgiving, etc.). Sometimes the design depart- ment comes up with the initial idea for a new card and sends the idea to the artists, who draw and color the picture. Then the card is sent to the joke writers, who write the joke to suit the card. At other times the process starts with writing the

(continued)