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PART 3: STRATEGIC IMPLEMENTATION

chapter 10

Creating Effective Organizational Designs

After reading this chapter, you should have a good understanding of the following learning objectives:

LO10.1 The growth patterns of major corporations and the relationship between a firm’s strategy and its structure.

LO10.2 Each of the traditional types of organizational structure: simple, functional, divisional, and matrix.

LO10.3 The implications of a firm’s international operations for organizational structure.

LO10.4 The different types of boundaryless organizations—barrier-free, modular, and virtual—and their relative advantages and disadvantages.

LO10.5 The need for creating ambidextrous organizational designs that enable firms to explore new opportunities and effectively integrate existing operations.

Learning from Mistakes

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The Boeing 787 Dreamliner is a game changer in the aircraft market.1 It is the first commercial airliner that doesn’t have an aluminum skin. Instead, Boeing designed it to have a composite exterior, which provides a weight savings that allows the plane to use 20 percent less fuel than the 767, the plane it is designed to replace. The increased fuel efficiency and other design advancements made the 787 very popular with airlines. Boeing received orders for over 900 Dreamliners before the first 787 ever took flight.

It was also a game changer for Boeing. In 2003, when Boeing announced the development of the new plane, they also decided to design and manufacture it differently than they ever had before. In the past, Boeing had internally designed and engineered the major components of its planes. Boeing would then provide detailed engineering designs and specifications to their key suppliers. The suppliers would then build the components to Boeing’s specifications. To limit the upfront investment they would need to make with the 787, Boeing moved to a modular structure and outsourced much of the engineering of the

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components to suppliers. Boeing provided them with basic specifications and left it to the suppliers to undertake the detailed design, engineering, and manufacturing of components and subsystems. Boeing’s operations in Seattle were then responsible for assembling the pieces into a completed aircraft.

Working with about 50 suppliers on four continents, Boeing found the coordination and integration of the work of suppliers to be very challenging. Some of the contracted suppliers didn’t have the engineering expertise needed to do the work and outsourced the engineering to subcontractors. This made it especially difficult to monitor the engineering work for the plane. Jim Albaugh, Boeing’s commercial aviation chief, identified a core issue with this change in responsibility and stated, “We gave work to people that had never really done this kind of technology before, and we didn’t provide the oversight that was necessary.” With the geographic stretch of the supplier set, Boeing also had difficulty monitoring the progress of the supplying firms. Boeing even ended up buying some of the suppliers once it became apparent they couldn’t deliver the designs and products on schedule. For example, Boeing spent about $1 billion to acquire the Vought Aircraft Industries unit responsible for the plane’s fuselage. When the suppliers finally delivered the parts, Boeing sometimes found they had difficulty assembling or combining the components. With their first 787, they found that the nose section and the fuselage didn’t initially fit together, leaving a sizable gap between the two sections. To address these issues, they were forced to co-locate many of their major suppliers together for six months to smooth out design and integration issues.

In the end, the decision to outsource cost Boeing dearly. The plane was three years behind schedule when the first 787 was delivered to a customer. The entire process took billions of dollars more than originally projected and also more than what it would have cost Boeing to design in house. And as of early 2013, all 49 of the 787s that had been delivered to customers had been grounded because of concerns about onboard fires in the lithium ion batteries used to power the plane—parts

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that were not designed by Boeing. As Boeing CEO Jim NcNerney concluded, “In retrospect, our 787 game plan may have been overly ambitious, incorporating too many firsts all at once–in the application of new technologies, in revolutionary design and build processes, and in increased global sourcing of engineering and manufacturing content.”

Discussion Questions

1. A number of firms benefit from outsourcing design and manufacturing. What is different with Boeing that makes it so much harder to be successful?

2. What lessons does their experience with the 787 offer Boeing for its next plane development effort? One of the central concepts in this chapter is the importance of boundaryless organizations. Successful organizations create permeable boundaries among the internal activities as well as between the organization and its external customers, suppliers, and alliance partners. We introduced this idea in Chapter 3 in our discussion of the value-chain concept, which consisted of several primary (e.g., inbound logistics, marketing and sales) and support activities (e.g., procurement, human resource management). There are a number of possible benefits to outsourcing activities as part of becoming an effective boundaryless organization. However, outsourcing can also create challenges. As in the case of Boeing, the firm lost a large amount of control by using independent suppliers to design and manufacture key subsystems of the 787.

Today’s managers are faced with two ongoing and vital activities in structuring and designing their organizations.2

First, they must decide on the most appropriate type of organizational structure. Second, they need to assess what mechanisms, processes, and techniques are most helpful in enhancing the permeability of both internal and external boundaries.

Traditional Forms of Organizational Structure

Organizational structure refers to the formalized patterns of interactions that link a firm’s tasks, technologies, and people.3 Structures help to ensure that resources are used effectively in accomplishing an organization’s mission. Structure provides a means of balancing two conflicting forces: a need for the division of tasks into meaningful groupings and the need to integrate such groupings in order to ensure efficiency and effectiveness.4 Structure identifies the executive, managerial, and administrative organization of a firm and indicates responsibilities and hierarchical relationships. It also influences the flow of information as well as the context and nature of human interactions.5

organizational structure the formalized patterns of interactions that link a firm’s tasks, technologies, and people.

Most organizations begin very small and either die or remain small. Those that survive and prosper embark on strategies designed to increase the overall scope of operations and enable them to enter new product-market domains. Such growth places additional pressure on executives to control and coordinate the firm’s increasing size and diversity. The most appropriate type of structure depends on the nature and magnitude of growth.

LO10.1

The growth patterns of major corporations and the relationship between a firm’s strategy and its structure.

Patterns of Growth of Large Corporations: Strategy-Structure Relationships A firm’s strategy and structure change as it increases in size, diversifies into new product markets, and expands its geographic scope.6 Exhibit 10.1 illustrates common growth patterns of firms.

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EXHIBIT 10.1 Dominant Growth Patterns of Large Corporations

A new firm with a simple structure typically increases its sales revenue and volume of outputs over time. It may also engage in some vertical integration to secure sources of supply (backward integration) as well as channels of distribution (forward integration). The simple-structure firm then implements a functional structure to concentrate efforts on both increasing efficiency and enhancing its operations and products. This structure enables the firm to group its operations into either functions, departments, or geographic areas. As its initial markets mature, a firm looks beyond its present products and markets for possible expansion.

A strategy of related diversification requires a need to reorganize around product lines or geographic markets. This leads to a divisional structure. As the business expands in terms of sales revenues, and domestic growth opportunities become somewhat limited, a firm may seek opportunities in international markets. A firm has a wide variety of structures to choose from. These include international division, geographic area, worldwide product division, worldwide functional, and worldwide matrix. Deciding upon the most appropriate structure when a firm has international operations depends on three primary factors: the extent of international expansion, type of strategy (global, multidomestic, or transnational), and the degree of product diversity.7

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Some firms may find it advantageous to diversify into several product lines rather than focus their efforts on strengthening distributor and supplier relationships through vertical integration. They would organize themselves according to product lines by implementing a divisional structure. Also, some firms may choose to move into unrelated product areas, typically by acquiring existing businesses. Frequently, their rationale is that acquiring assets and competencies is more economical or expedient than developing them internally. Such an unrelated, or conglomerate, strategy requires relatively little integration across businesses and sharing of resources. Thus, a holding company structure becomes appropriate. There are many other growth patterns, but these are the most common.*

Now we will discuss some of the most common types of organizational structures—simple, functional, divisional (including two variants: strategic business unit and holding company), and matrix and their advantages and disadvantages. We will close the section with a discussion of the structural implications when a firm expands its operations into international markets.8

LO10.2

Each of the traditional types of organizational structure: simple, functional, divisional, and matrix.

Simple Structure The simple organizational structure is the oldest, and most common, organizational form. Most organizations are very small and have a single or very narrow product line in which the owner-manager (or top executive) makes most of the decisions. The owner-manager controls all activities, and the staff serves as an extension of the top executive.

simple organizational structure an organizational form in which the owner-manager makes most of the decisions and controls activities, and the staff serves as an extension of the top executive.

Advantages The simple structure is highly informal and the coordination of tasks is accomplished by direct supervision. Decision making is highly centralized, there is little specialization of tasks, few rules and regulations, and an informal evaluation and reward system. Although the owner-manager is intimately involved in almost all phases of the business, a manager is often employed to oversee day-to-day operations.

Disadvantages A simple structure may foster creativity and individualism since there are generally few rules and regulations. However, such “informality” may lead to problems. Employees may not clearly understand their responsibilities, which can lead to conflict and confusion. Employees may take advantage of the lack of regulations, act in their own self-interest, which can erode motivation and satisfaction and lead to the possible misuse of organizational resources. Small organizations have flat structures that limit opportunities for upward mobility. Without the potential for future advancement, recruiting and retaining talent may become very difficult.

Functional Structure When an organization is small (15 employees or less), it is not necessary to have a variety of formal arrangements and groupings of activities. However, as firms grow, excessive demands may be placed on the owner-manager in order to obtain and process all of the information necessary to run the business. Chances are the owner will not be skilled in all specialties (e.g., accounting, engineering, production, marketing). Thus, he or she will need to hire specialists in the various functional areas. Such growth in the overall scope and complexity of the business necessitates a functional organizational structure wherein the major functions of the firm are grouped internally. The coordination and integration of the functional areas becomes one of the most important responsibilities of the chief executive of the firm (see Exhibit 10.2).

functional organizational structure

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an organizational form in which the major functions of the firm, such as production, marketing, R&D, and accounting, are grouped internally.

*The lowering of transaction costs and globalization have led to some changes in the common historical patterns that we have discussed. Some firms are, in effect, bypassing the vertical integration stage. Instead, they focus on core competencies and outsource other value-creation activities. Also, even relatively young firms are going global early in their history because of lower communication and transportation costs. For an interesting perspective on global start-ups, see McDougall, P. P. & Oviatt, B. M. 1996. New Venture Internationalization, Strategic Change and Performance: A Follow-Up Study. Journal of Business Venturing, 11: 23–40; and McDougall, P. P. & Oviatt, B. M. (Eds.). 2000. The Special Research Forum on International Entrepreneurship. Academy of Management Journal, October: 902–1003.

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EXHIBIT 10.2 Functional Organizational Structure

Functional structures are generally found in organizations in which there is a single or closely related product or service, high production volume, and some vertical integration. Initially, firms tend to expand the overall scope of their operations by penetrating existing markets, introducing similar products in additional markets, or increasing the level of vertical integration. Such expansion activities clearly increase the scope and complexity of the operations. The functional structure provides for a high level of centralization that helps to ensure integration and control over the related product- market activities or multiple primary activities (from inbound logistics to operations to marketing, sales, and service) in the value chain (addressed in Chapters 3 and 4). Strategy Spotlight 10.1 provides an example of an effective functional organization structure—Parkdale Mills.

Advantages By bringing together specialists into functional departments, a firm is able to enhance its coordination and control within each of the functional areas. Decision making in the firm will be centralized at the top of the organization. This enhances the organizational-level (as opposed to functional area) perspective across the various functions in the organization. In addition, the functional structure provides for a more efficient use of managerial and technical talent since functional area expertise is pooled in a single department (e.g., marketing) instead of being spread across a variety of product-market areas. Finally, career paths and professional development in specialized areas are facilitated.

Disadvantages The differences in values and orientations among functional areas may impede communication and coordination. Edgar Schein of MIT has argued that shared assumptions, often based on similar backgrounds and experiences of members, form around functional units in an organization. This leads to what are often called “stove pipes” or “silos,” in which departments view themselves as isolated, self-contained units with little need for interaction and coordination with other departments. This erodes communication because functional groups may have not only different goals but also differing meanings of words and concepts. According to Schein:

The word “marketing” will mean product development to the engineer, studying customers through market research to the product manager, merchandising to the salesperson, and constant change in design to the manufacturing manager. When they try to work together, they will often attribute disagreements to personalities and fail to notice the deeper, shared assumptions that color how each function thinks.9

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Such narrow functional orientations also may lead to short-term thinking based largely upon what is best for the functional area, not the entire organization. In a manufacturing firm, sales may want to offer a wide range of customized products to appeal to the firm’s

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customers; R&D may overdesign products and components to achieve technical elegance; and manufacturing may favor no-frills products that can be produced at low cost by means of long production runs. Functional structures may overburden the top executives in the firm because conflicts have a tendency to be “pushed up” to the top of the organization since there are no managers who are responsible for the specific product lines. Functional structures make it difficult to establish uniform performance standards across the entire organization. It may be relatively easy to evaluate production managers on the basis of production volume and cost control, but establishing performance measures for engineering, R&D, and accounting become more problematic.

STRATEGY SPOTLIGHT 10.1

PARKDALE MILLS: A SUCCESSFUL FUNCTIONAL ORGANIZATIONAL STRUCTURE For more than 80 years, Parkdale Mills, with approximately $1 billion in revenues, has been the industry leader in the production of cotton and cotton blend yarns. Their expertise comes by concentrating on a single product line, perfecting processes, and welcoming innovation. According to CEO Andy Warlick, “I think we’ve probably spent more than any two competitors combined on new equipment and robotics. We do this because we have to compete in a global market where a lot of the competition has a lower wage structure and gets subsidies that we don’t receive, so we really have to focus on consistency and cost control.” Yarn making is generally considered to be a commodity business, and Parkdale is the industry’s low-cost producer.

Tasks are highly standardized and authority is centralized with Duke Kimbrell, founder and chairman, and CEO Andy Warlick. The firm operates a bare-bones staff with a small staff of top executives. Kimbrell and Warlick are considered shrewd about the cotton market, technology, customer loyalty, and incentive pay.

Sources: Stewart, C. 2003. The Perfect Yarn. The Manufacturer.com, July 31; www.parkdalemills.com; Berman, P. 1987. The Fast Track Isn’t Always the Best Track. Forbes, November 2: 60–64; and personal communication with Duke Kimbrell, March 11, 2005.

Divisional Structure The divisional organizational structure (sometimes called the multidivisional structure or M-Form) is organized around products, projects, or markets. Each of the divisions, in turn, includes its own functional specialists who are typically organized into departments.10 A divisional structure encompasses a set of relatively autonomous units governed by a central corporate office. The operating divisions are relatively independent and consist of products and services that are different from those of the other divisions.11 Operational decision making in a large business places excessive demands on the firm’s top management. In order to attend to broader, longer-term organizational issues, top-level managers must delegate decision making to lower-level managers. Divisional executives play a key role: they help to determine the product-market and financial objectives for the division as well as their division’s contribution to overall corporate performance.12 The rewards are based largely on measures of financial performance such as net income and revenue. Exhibit 10.3 illustrates a divisional structure.

divisional organizational structure an organizational form in which products, projects, or product markets are grouped internally.

General Motors was among the earliest firms to adopt the divisional organizational structure.13 In the 1920s the company formed five major product divisions (Cadillac, Buick, Oldsmobile, Pontiac, and Chevrolet) as well as several industrial divisions. Since then, many firms have discovered that as they diversified into new product-market activities,

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functional structures—with their emphasis on single functional departments—were unable to manage the increased complexity of the entire business.

Advantages By creating separate divisions to manage individual product markets, there is a separation of strategic and operating control. Divisional managers can focus

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their efforts on improving operations in the product markets for which they are responsible, and corporate officers can devote their time to overall strategic issues for the entire corporation. The focus on a division’s products and markets—by the divisional executives—provides the corporation with an enhanced ability to respond quickly to important changes. Since there are functional departments within each division of the corporation, the problems associated with sharing resources across functional departments are minimized. Because there are multiple levels of general managers (executives responsible for integrating and coordinating all functional areas), the development of general management talent is enhanced.

EXHIBIT 10.3 Divisional Organizational Structure

Disadvantages It can be very expensive; there can be increased costs due to the duplication of personnel, operations, and investment since each division must staff multiple functional departments. There also can be dysfunctional competition among divisions since each division tends to become concerned solely about its own operations. Divisional managers are often evaluated on common measures such as return on assets and sales growth. If goals are conflicting, there can be a sense of a “zero-sum” game that would discourage sharing ideas and resources among the divisions for the common good of the corporation. Ghoshal and Bartlett, two leading strategy scholars, note:

As their label clearly warns, divisions divide. The divisional model fragmented companies’ resources; it created vertical communication channels that insulated business units and prevented them from sharing their strengths with one another. Consequently, the whole of the corporation was often less than the sum of its parts.14

With many divisions providing different products and services, there is the chance that differences in image and quality may occur across divisions. One division may offer no-frills products of lower quality that may erode the brand reputation of another division that has top quality, highly differentiated offerings. Since each division is evaluated in terms of financial measures such as return on investment and revenue growth, there is often an urge to focus on short-

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term performance. If corporate management uses quarterly profits as the key performance indicator, divisional management may tend to put significant emphasis

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on “making the numbers” and minimizing activities, such as advertising, maintenance, and capital investments, which would detract from short-term performance measures. Strategy Spotlight 10.2 discusses how ArcelorMittal works to overcome some of the disadvantages of the divisional structure by “twinning” its plants.

STRATEGY SPOTLIGHT 10.2

BREAKING DOWN DIVISIONAL BOUNDARIES: LEARNING FROM YOUR TWIN On the edge of Lake Michigan in Burns Harbor, Indiana, sits a 50-year-old steel mill that produces steel for the automotive, appliance, and other industries with midwestern production plants. The steel mill struggled through the 1980s and 1990s and went bankrupt in 2002. It was bought out of bankruptcy and has been owned by ArcelorMittal Steel, the world’s largest steel producer, since 2005. However, the plant faced a another crisis in 2007 when it was threatened with closure unless it became more productive and efficient.

Today, this plant requires 1.32 man hours per ton of steel produced, which is 34 percent more efficient than the average in U.S. steel mills. Further, in 2011, the plant was 19 percent more efficient than it was in 2007 and produced twice the quantity of steel it produced in 2009. Its future as a productive steel plant is now secure.

How did ArcelorMittal achieve these gains and rejuvenate an old steel mill? It did it by breaking down the barriers between organization units to facilitate knowledge transfer and learning. One of the disadvantages of a divisional structure is that the divisions often perceive themselves as being in competition with each other and are therefore unwilling to share information to help other divisions improve. ArcelorMittal has overcome this by “twinning” different steel mills, one efficient and one struggling, and challenging the efficient plant to help out its twin. The Burns Harbor mill was paired with a mill in Ghent, Belgium. Over 100 engineers and managers from Burns Harbor traveled to Belgium to tour the Ghent plant and learn from their colleagues there how to improve operations. They copied routines from that plant, implemented an advanced computer control system used in the Belgian mill, and employed automated machines similar to the ones used in Belgium. ArcelorMittal also provided $150 million in capital investments to upgrade the operations to bring the facilities up to par with the Ghent plant. These changes resulted in dramatic improvements in the efficiency of the Burns Harbor mill. The Belgians take pride in the improvements in Burns Harbor and now find themselves striving to improve their own operations to stay ahead of the Americans. The Ghent plant now produces 950 tons of steel per employee each year, only 50 tons per employee more than Burns Harbor, but the Ghent managers boast they will soon increase productivity to 1100 tons per employee. Thus, Ghent cooperates and is willing to help Burns Harbor, but the managers and employees at Ghent have a competitive streak as well.

The experience of ArcelorMittal demonstrates how firms can act to overcome the typical disadvantages of their divisional structure.

Source: Miller, J. 2012. Indiana steel mill revived with lessons from abroad. WSJ.com, May 21: np; www.nishp.org/bh-history.htm; and Markovich, S. 2012. Morning brief: Foreign investment revives Indiana steel mill. blogs.cfr.org, May 21: np.

We’ll discuss two variations of the divisional form: the strategic business unit (SBU) and holding company structures.

Strategic Business Unit (SBU) Structure Highly diversified corporations such as ConAgra, a $13 billion food producer, may consist of dozens of different divisions.15 If ConAgra were to use a purely divisional structure, it would be nearly impossible for the corporate office to plan and coordinate activities, because the span of control would be too large. To attain synergies, ConAgra has put its diverse businesses into three primary SBUs: food service (restaurants), retail (grocery stores), and agricultural products.

strategic business unit (SBU) structure

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an organizational form in which products, projects, or product market divisions are grouped into homogeneous units.

With an SBU structure, divisions with similar products, markets, and/or technologies are grouped into homogeneous units to achieve some synergies. These include those discussed in Chapter 6 for related diversification, such as leveraging core competencies, sharing infrastructures, and market power. Generally the more related businesses are within a corporation, the fewer SBUs will be required. Each of the SBUs in the corporation operates as a profit center.

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Advantages The SBU structure makes the task of planning and control by the corporate office more manageable. Also, with greater decentralization of authority, individual businesses can react more quickly to important changes in the environment than if all divisions had to report directly to the corporate office.

Disadvantages Since the divisions are grouped into SBUs, it may become difficult to achieve synergies across SBUs. If divisions in different SBUs have potential sources of synergy, it may become difficult for them to be realized. The additional level of management increases the number of personnel and overhead expenses, while the additional hierarchical level removes the corporate office further from the individual divisions. The corporate office may become unaware of key developments that could have a major impact on the corporation.

Holding Company Structure The holding company structure (sometimes referred to as a conglomerate) is also a variation of the divisional structure. Whereas the SBU structure is often used when similarities exist between the individual businesses (or divisions), the holding company structure is appropriate when the businesses in a corporation’s portfolio do not have much in common. Thus, the potential for synergies is limited.

holding company structure an organizational form that is a variation of the divisional organizational structure in which the divisions have a high degree of autonomy both from other divisions and from corporate headquarters.

Holding company structures are most appropriate for firms with a strategy of unrelated diversification. Companies such as Berkshire Hathaway and Loews use a holding company structure to implement their unrelated diversification strategies. Since there are few similarities across the businesses, the corporate offices in these companies provide a great deal of autonomy to operating divisions and rely on financial controls and incentive programs to obtain high levels of performance from the individual businesses. Corporate staffs at these firms tend to be small because of their limited involvement in the overall operation of their various businesses.16

Advantages The holding company structure has the cost savings associated with fewer personnel and the lower overhead resulting from a small corporate office and fewer hierarchical levels. The autonomy of the holding company structure increases the motivational level of divisional executives and enables them to respond quickly to market opportunities and threats.

Disadvantages There is an inherent lack of control and dependence that corporate-level executives have on divisional executives. Major problems could arise if key divisional executives leave the firm, because the corporate office has very little “bench strength”—additional managerial talent ready to quickly fill key positions. If problems arise in a division, it may become very difficult to turn around individual businesses because of limited staff support in the corporate office.

Matrix Structure One approach that tries to overcome the inadequacies inherent in the other structures is the matrix organizational structure. It is a combination of the functional and divisional structures. Most commonly, functional departments are combined with product groups on a project basis. For example, a product group may want to develop a new addition to its line; for this project, it obtains personnel from functional departments such as marketing, production, and engineering. These personnel work under the manager of the product group for the duration of the project, which can vary from a few weeks to an open-ended period of time. The individuals who work in a matrix organization become responsible to two managers: the project manager and the manager of their functional area. Exhibit 10.4 illustrates a matrix structure.

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matrix organizational structure an organizational form in which there are multiple lines of authority and some individuals report to at least two managers.

Some large multinational corporations rely on a matrix structure to combine product groups and geographical units. Product managers have global responsibility for the

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development, manufacturing, and distribution of their own line, while managers of geographical regions have responsibility for the profitability of the businesses in their regions. In the mid-1990s, Caterpillar, Inc., implemented this type of structure.

EXHIBIT 10.4 Matrix Organizational Structure

Other organizations, such as Cisco, use a matrix structure to try to maintain flexibility. In these firms, individual workers have a permanent functional home but also are assigned to and work within temporary project teams.17

Advantages The matrix structure facilitates the use of specialized personnel, equipment, and facilities. Instead of duplicating functions, as would be the case in a divisional structure based on products, the resources are shared. Individuals with high expertise can divide their time among multiple projects. Such resource sharing and collaboration enable a firm to use resources more efficiently and to respond more quickly and effectively to changes in the competitive environment. The flexibility inherent in a matrix structure provides professionals with a broader range of responsibility. Such experience enables them to develop their skills and competencies.

Disadvantages The dual-reporting structures can result in uncertainty and lead to intense power struggles and conflict over the allocation of personnel and other resources. Working relationships become more complicated. This may result in excessive reliance on group processes and teamwork, along with a diffusion of responsibility, which in turn may erode timely decision making.

Let’s look at Procter & Gamble (P&G) to see some of the disadvantages associated with a matrix structure:

After 50 years with a divisional structure, P&G went to a matrix structure in 1987. In this structure, they had product categories, such as soaps and detergents, on one dimension and functional managers on the other dimension. Within each product category, country managers reported to regional managers who then reported to product managers. The structure became complex to manage, with 13 layers of management and significant power struggles as the functional managers developed their own strategic agendas that often were

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at odds with the product managers’ agendas. After seeing their growth rate decline from 8.5 percent in the 1980s to 2.6 percent in the late 1990s, P&G scrapped the matrix structure to go to a global product structure with three major product categories to offer unity in direction and more responsive decision making.18

EXHIBIT 10.5 Functional, Divisional, and Matrix Organizational Structures: Advantages and Disadvantages

Functional Structure

Advantages Disadvantages

• Pooling of specialists enhances coordination and control. • Differences in functional area orientation impede communication and coordination.

• Centralized decision making enhances an organizational perspective across functions.

• Tendency for specialists to develop short-term perspective and narrow functional orientation.

• Efficient use of managerial and technical talent. • Functional area conflicts may overburden top-level decision makers.

• Facilitates career paths and professional development in specialized areas.

• Difficult to establish uniform performance standards.

Divisional Structure

Advantages Disadvantages

• Increases strategic and operational control, permitting corporate-level executives to address strategic issues.

• Increased costs incurred through duplication of personnel, operations, and investment.

• Quick response to environmental changes. • Dysfunctional competition among divisions may detract from overall corporate performance.

• Increases focus on products and markets. • Difficult to maintain uniform corporate image.

• Minimizes problems associated with sharing resources across functional areas.

• Overemphasis on short-term performance.

• Facilitates development of general managers.

Matrix Structure

Advantages Disadvantages

• Increases market responsiveness through collaboration and synergies among professional colleagues.

• Dual-reporting relationships can result in uncertainty regarding accountability.

• Allows more efficient utilization of resources. • Intense power struggles may lead to increased levels of conflict.

• Improves flexibility, coordination, and communication. • Working relationships may be more complicated and human resources duplicated

• Increases professional development through a broader range of responsibility.

• Excessive reliance on group processes and teamwork may impede timely decision making.

Exhibit 10.5 briefly summarizes the advantages and disadvantages of the functional, divisional, and matrix organizational structures.

LO10.3

The implications of a firm’s international operations for organizational structure.

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International Operations: Implications for Organizational Structure Today’s managers must maintain an international outlook on their firm’s businesses and competitive strategies. In the global marketplace, managers must ensure consistency between their strategies (at the business, corporate, and international levels) and the structure of their organization. As firms expand into foreign markets, they generally follow

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a pattern of change in structure that parallels the changes in their strategies.19 Three major contingencies that influence the chosen structure are (1) the type of strategy that is driving a firm’s foreign operations, (2) product diversity, and (3) the extent to which a firm is dependent on foreign sales.20

As international operations become an important part of a firm’s overall operations, managers must make changes that are consistent with their firm’s structure. The primary types of structures used to manage a firm’s international operations are:21

• International division

• Geographic-area division

• Worldwide functional

• Worldwide product division

• Worldwide matrix

Multidomestic strategies are driven by political and cultural imperatives requiring managers within each country to respond to local conditions. The structures consistent with such a strategic orientation are the international division and geographic-area division structures. Here local managers are provided with a high level of autonomy to manage their operations within the constraints and demands of their geographic market. As a firm’s foreign sales increase as a percentage of its total sales, it will likely change from an international division to a geographic-area division structure. And, as a firm’s product and/or market diversity becomes large, it is likely to benefit from a worldwide matrix structure.

international division structure an organizational form in which international operations are in a separate, autonomous division. Most domestic operations are kept in other parts of the organization.

geographic-area division structure a type of divisional organizational structure in which operations in geographical regions are grouped internally.

worldwide matrix structure a type of matrix organizational structure that has one line of authority for geographic-area divisions and another line of authority for worldwide product divisions.

Global strategies are driven by economic pressures that require managers to view operations in different geographic areas to be managed for overall efficiency. The structures consistent with the efficiency perspective are the worldwide functional and worldwide product division structures. Here, division managers view the marketplace as homogeneous and devote relatively little attention to local market, political, and economic factors. The choice between these two types of structures is guided largely by the extent of product diversity. Firms with relatively low levels of product diversity may opt for a worldwide product division structure. However, if significant product–market diversity results from highly unrelated international acquisitions, a worldwide holding company structure should be implemented. Such firms have very little commonality among products, markets, or technologies, and have little need for integration.

worldwide functional structure a functional structure in which all departments have worldwide reponsibilities.

worldwide product division structure a product division structure in which all divisions have worldwide responsibilities.

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Global Start-Ups: A Recent Phenomenon International expansion occurs rather late for most corporations, typically after possibilities of domestic growth are exhausted. Increasingly, we are seeing two interrelated phenomena. First, many firms now expand internationally relatively early in their history. Second, some firms are “born global”—that is, from the very beginning, many start-ups are global in their activities. For example, Logitech Inc., a leading producer of personal computer accessories, was global from day one. Founded in 1982 by a Swiss national and two Italians, the company was headquartered both in California and Switzerland. R&D and manufacturing were also conducted in both locations and, subsequently, in Taiwan and Ireland.22

The success of companies such as Logitech challenges the conventional wisdom that a company must first build up assets, internal processes, and experience before venturing into faraway lands. It also raises a number of questions: What exactly is a global start-up? Under what conditions should a company start out as a global start-up? What does it take to succeed as a global start-up?

A global start-up has been defined as a business organization that, from inception, seeks to derive significant competitive advantage from the use of resources and the sale of outputs in multiple countries. Right from the beginning, it uses in-puts from around the world and sells its products and services to customers around the world. Geographical boundaries of nation-states are irrelevant for a global start-up.

global start-up a business organization that, from inception, seeks to derive significant advantage from the use of resources and the sale of outputs in multiple countries.

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STRATEGY

SPOTLIGHT 10.3 ENVIRONMENTAL

SUSTAINABILITY

GLOBAL START-UP AIMING TO BRING A CHARGE TO THE WORLD Buffalo Grid is a firm that has yet to fully roll out its service offerings, but it has already positioned itself as a truly global firm. Buffalo Grid aims to bring inexpensive electrical charging stations to rural markets in Africa and India. In these markets, millions of individuals have mobile phones and other portable electronic devices but live off the grid and have no electrical service in their homes. They charge up their devices in convenience stores, restaurants, and bars, often at very high prices. Buffalo Grid aims to address this issue with an environmentally sustainable and cost- effective solution.

Buffalo Grid has developed zero carbon emission microgenerators for the developing world that can be used for pennies an hour. The generators are mounted on bikes and run on pedal power. Thus, they are environmentally friendly and can easily move through the neighborhoods they serve.

The global orientation of Buffalo Grid is evident in its management core, the geographic spread of its operations, and the location of its partners. Looking at its management core, we see the foundation of its global mindset. The business is the brainchild of six entrepreneurs who have diverse global backgrounds. The founders of the firm include an individual who spent his early childhood years in Kenya and helped run a business that works with suppliers in Africa. Another of the founders grew up in Mexico. Another has lived in Guatemala and Peru. A fourth founder lived in a number of developing countries in his youth. A fifth of the founders grew up in Northern Ireland but also spent time living in India. The geographic scope of the firm is also notable. Its headquarters is set in in Britain, but the firm aims to serve customers thousands of miles away in India and Africa. The firm has also enlisted a global partner and has signed an agreement with Infosys, the Indian IT firm. Infosys will provide a mentor to Buffalo Grid who will support them and provide contacts and business advice to exploit opportunities in India.

Sources: Anonymous. 2013. Infosys to mentor 16 British start-ups locally in the UK. Economictimes.indiatimes.com, February 12: np; and Buffalogrid.com.

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There is no reason for every start-up to be global. Being global necessarily involves higher communication, coordination, and transportation costs. Therefore, it is important to identify the circumstances under which going global from the beginning is advantageous.23 First, if the required human resources are globally dispersed, going global may be the best way to access those resources. For example, Italians are masters in fine leather and Europeans in ergonomics. Second, in many cases foreign financing may be easier to obtain and more suitable. Traditionally, U.S. venture capitalists have shown greater willingness to bear risk, but they have shorter time horizons in their expectations for return. If a U.S. start-up is looking for patient capital, it may be better off looking overseas. Third, the target customers in many specialized industries are located in other parts of the world. Fourth, in many industries a gradual move from domestic markets to foreign markets is no longer possible because, if a product is successful, foreign competitors may immediately imitate it. Therefore, preemptive entry into foreign markets may be the only option. Finally, because of high up-front development costs, a global market is often necessary to recover the costs. This is particularly true for start-ups from smaller nations that do not have access to large domestic markets.

Successful management of a global start-up presents many challenges. Communication and coordination across time zones and cultures are always problematic. Since most global start-ups have far less resources than well-established corporations, one key for success is to internalize few activities and outsource the rest. Managers of such firms must have considerable prior international experience so that they can successfully handle the inevitable communication problems and cultural conflicts. Another key for success is to keep the communication and coordination costs low. The only way to achieve this is by creating less costly administrative mechanisms. The boundaryless organizational designs that we discuss in the next section are particularly suitable for global start-ups because of their flexibility and low cost.

Strategy Spotlight 10.3 discusses a British start-up with a global vision and scope of operations.

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How an Organization’s Structure Can Influence Strategy Formulation Discussions of the relationship between strategy and structure usually strongly imply that structure follows strategy. The strategy that a firm chooses (e.g., related diversification) dictates such structural elements as the division of tasks, the need for integration of activities, and authority relationships within the organization. However, an existing structure can influence strategy formulation. Once a firm’s structure is in place, it is very difficult and expensive to change.24

Executives may not be able to modify their duties and responsibilities greatly, or may not welcome the disruption associated with a transfer to a new location. There are costs associated with hiring, training, and replacing executive, managerial, and operating personnel. Strategy cannot be formulated without considering structural elements.

An organization’s structure can also have an important influence on how it competes in the marketplace. It can also strongly influence a firm’s strategy, day-to-day operations, and performance.25

LO10.4

The different types of boundaryless organizations—barrier-free, modular, and virtual—and their relative advantages and disadvantages.

Boundaryless Organizational Designs

The term boundaryless may bring to mind a chaotic organizational reality in which “anything goes.” This is not the case. As Jack Welch, GE’s former CEO, has suggested, boundaryless does not imply that all internal and external boundaries vanish completely, but that they become more open and permeable.26 Strategy Spotlight 10.4 discusses four types of boundaries.

We are not suggesting that boundaryless organizational designs replace the traditional forms of organizational structure, but they should complement them. Sharp Corp. has implemented a functional structure to attain economies of scale with its applied research and manufacturing skills. However, to bring about this key objective, Sharp has relied on several integrating mechanisms and processes:

boundaryless organizational designs organizations in which the boundaries, including vertical, horizontal, external, and geographic boundaries, are permeable.

To prevent functional groups from becoming vertical chimneys that obstruct product development, Sharp’s product managers have responsibility—but not authority—for coordinating the entire set of value-chain activities. And the company convenes enormous numbers of cross-unit and corporate committees to ensure that shared activities, including the corporate R&D unit and sales forces, are optimally configured and allocated among the different product lines. Sharp invests in such time-intensive coordination to minimize the inevitable conflicts that arise when units share important activities.27

We will discuss three approaches to making boundaries more permeable, that help to facilitate the widespread sharing of knowledge and information across both the internal and external boundaries of the organization. The barrier-free type involves making all organizational boundaries—internal and external—more permeable. Teams are a central building block for implementing the boundaryless organization. The modular and virtual types of organizations focus on the need to create seamless relationships with external organizations such as customers or suppliers. While the modular type emphasizes the outsourcing of noncore activities, the virtual (or network) organization focuses on alliances among independent entities formed to exploit specific market opportunities.

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The Barrier-Free Organization The “boundary” mind-set is ingrained deeply into bureaucracies. It is evidenced by such clichés as “That’s not my job,” “I’m here from corporate to help,” or endless battles over transfer pricing. In the traditional company, boundaries are clearly delineated in the design

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of an organization’s structure. Their basic advantage is that the roles of managers and employees are simple, clear, well- defined, and long-lived. A major shortcoming was pointed out to the authors during an interview with a high-tech executive: “Structure tends to be divisive; it leads to territorial fights.”

STRATEGY SPOTLIGHT 10.4

BOUNDARY TYPES There are primarily four types of boundaries that place limits on organizations. In today’s dynamic business environment, different types of boundaries are needed to foster high degrees of interaction with outside influences and varying levels of permeability.

1. Vertical boundaries between levels in the organization’s hierarchy. SmithKline Beecham asks employees at different hierarchical levels to brainstorm ideas for managing clinical trial data. The ideas are incorporated into action plans that significantly cut the new product approval time of its pharmaceuticals. This would not have been possible if the barriers between levels of individuals in the organization had been too high.

2. Horizontal boundaries between functional areas. Fidelity Investments makes the functional barriers more porous and flexible among divisions, such as marketing, operations, and customer service, in order to offer customers a more integrated experience when conducting business with the company. Customers can take their questions to one person, reducing the chance that customers will “get the run-around” from employees who feel customer service is not their responsibility. At Fidelity, customer service is everyone’s business, regardless of functional area.

3. External boundaries between the firm and its customers, suppliers, and regulators. GE Lighting, by working closely with retailers, functions throughout the value chain as a single operation. This allows GE to track point-of- sale purchases, giving it better control over inventory management.

4. Geographic boundaries between locations, cultures, and markets. The global nature of today’s business environment spurred PricewaterhouseCoopers to use a global groupware system. This allows the company to instantly connect to its 26 worldwide offices.

Source: Ashkenas, R. 1997. The organization’s New Clothes. In Hesselbein, F., Goldsmith, M., and Beckhard, R. (Eds.). The Organization of the Future: 104 –106. San Francisco: Jossey Bass.

Such structures are being replaced by fluid, ambiguous, and deliberately ill-defined tasks and roles. Just because work roles are no longer clearly defined, however, does not mean that differences in skills, authority, and talent disappear. A barrier-free organization enables a firm to bridge real differences in culture, function, and goals to find common ground that facilitates information sharing and other forms of cooperative behavior. Eliminating the multiple boundaries that stifle productivity and innovation can enhance the potential of the entire organization.

barrier-free organization an organizational design in which firms bridge real differences in culture, function, and goals to find common ground that facilitates information sharing and other forms of cooperative behavior.

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Creating Permeable Internal Boundaries For barrier-free organizations to work effectively, the level of trust and shared interests among all parts of the organization must be raised.28 The organization needs to develop among its employees the skill level needed to work in a more democratic organization. Barrier-free organizations also require a shift in the organization’s philosophy from executive to organizational development, and from investments in high- potential individuals to investments in leveraging the talents of all individuals.

Teams can be an important aspect of barrier-free structures.29 Jeffrey Pfeffer, author of several insightful books, including The Human Equation, suggests that teams have three primary advantages.30 First, teams substitute peer-based control for hierarchical control of work activities. Employees control themselves, reducing the time and energy management needs to devote to control. Second, teams frequently develop more creative solutions to problems because they encourage the sharing of the tacit knowledge held by individuals.31

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Brainstorming, or group problem solving, involves the pooling of ideas and expertise to enhance the chances that at least one group member will think of a way to solve the problems at hand. Third, by substituting peer control for hierarchical control, teams permit the removal of layers of hierarchy and absorption of administrative tasks previously performed by specialists. This avoids the costs of having people whose sole job is to watch the people who watch other people do the work.

Effective barrier-free organizations must go beyond achieving close integration and coordination within divisions in a corporation. Research on multidivisional organizations has stressed the importance of interdivisional coordination and resource sharing.32 This requires interdivisional task forces and committees, reward and incentive systems that emphasize interdivisional cooperation, and common training programs.

Frank Carruba (former head of Hewlett-Packard’s labs) found that the difference between mediocre teams and good teams was generally varying levels of motivation and talent.33 But what explained the difference between good teams and truly superior teams? The key difference—and this explained a 40 percent overall difference in performance—was the way members treated each other: the degree to which they believed in one another and created an atmosphere of encouragement rather than competition. Vision, talent, and motivation could carry a team only so far. What clearly stood out in the “super” teams were higher levels of authenticity and caring, which allowed the full synergy of their individual talents, motivation, and vision.

Developing Effective Relationships with External Constituencies In barrier-free organizations, managers must also create flexible, porous organizational boundaries and establish communication flows and mutually beneficial relationships with internal (e.g., employees) and external (e.g., customers) constituencies.34 IBM has worked to develop a long-standing cooperative relationship with the Mayo Clinic. The clinic is a customer but more importantly a research partner. IBM has placed staff at the Mayo Clinic, and the two organizations have worked together on technology for the early identification of aneurysms, the mining of data in electronic health records to develop customized treatment plans for patients, and other medical issues. Having worked collaboratively for over a dozen years, the IBM and Mayo researchers have built strong relationships.35

Barrier-free organizations create successful relationships between both internal and external constituencies, but there is one additional constituency—competitors—with whom some organizations have benefited as they developed cooperative relationships. For example, after struggling on their own to develop the technology, Ford, Renault-Nissan, and Daimler have agreed to cooperate with each other to develop zero emission, hydrogen fuel cell systems to power automobiles.36

By joining and actively participating in the Business Roundtable—an organization consisting of CEOs of leading U.S. corporations—Walmart has been able to learn about cutting-edge sustainable initiatives of other major firms. This free flow of information has enabled Walmart to undertake a number of steps that increased the energy efficiency of its operations. These are described in Strategy Spotlight 10.5.

Risks, Challenges, and Potential Downsides Many firms find that creating and managing a barrier-free organization can be frustrating.37 Puritan-Bennett Corporation, a manufacturer of respiratory equipment, found that its product development time more than doubled after it adopted team management. Roger J. Dolida, director of R&D, attributed this failure to a lack of top management commitment, high turnover among team members, and infrequent meetings. Often, managers trained in rigid hierarchies find it difficult to make the transition to the more democratic, participative style that teamwork requires.

Christopher Barnes, a consultant with PricewaterhouseCoopers, previously worked as an industrial engineer for Challenger Electrical Distribution (a subsidiary of Westinghouse,

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now part of CBS) at a plant which produced circuit-breaker boxes. His assignment was to lead a team of workers from the plant’s troubled final-assembly operation with the mission: “Make things better.” That vague notion set the team up for failure. After a year of futility, the team was disbanded. In retrospect, Barnes identified several reasons for the debacle: (1) limited personal credibility—he was viewed as an “outsider”; (2) a lack of commitment to the team—everyone involved was forced to be on the team; (3) poor communications—nobody was told why the team was important; (4) limited autonomy—line managers refused to give up control over team members; and (5) misaligned incentives—the culture rewarded individual performance over team performance. Barnes’s experience has implications for all types of teams, whether they are composed of managerial, professional, clerical, or production personnel.38 The pros and cons of barrier-free structures are summarized in Exhibit 10.6.

STRATEGY

SPOTLIGHT 10.5 ENVIRONMENTAL

SUSTAINABILITY

THE BUSINESS ROUNDTABLE: A FORUM FOR SHARING BEST ENVIRONMENTAL SUSTAINABILITY PRACTICES The Business Roundtable is a group of chief executive officers of major U.S. corporations that was created to promote probusiness public policy. It was formed in 1972 through the merger of three existing organizations: The March Group, the Construction Users Anti-Inflation Roundtable, and the Labor Law Study Committee. The group has been called President Obama’s “closest ally in the business community.”

The Business Roundtable became the first broad-based business group to agree on the need to address climate change through collective action, and it remains committed to limiting greenhouse gas emissions and setting the United States on a more sustainable path. The organization considers that threats to water quality and quantity, rising greenhouse gas emissions, and the risk of climate change—along with increasing energy prices and growing demand—are of great concern.

Its recent report “Create, Grow, Sustain” provides best practices and metrics from Business Roundtable member companies that represent nearly all sectors of the economy with $6 trillion in annual revenues. CEOs from Walmart, FedEx, PepsiCo, Whirlpool, and Verizon are among the 126 executives from leading U.S. companies that shared some of their best sustainability initiatives in this report. These companies are committed to reducing emissions, increasing energy efficiency, and developing more sustainable business practices.

Let’s look, for example, at some of Walmart’s initiatives. The firm’s CEO, Mike Duke, says it is working with suppliers, partners, and consumers to drive its sustainability program. It has helped establish the Sustainability Consortium to drive metrics for measuring the environmental effects of consumer products across their life cycle. The retailer also helped lead the creation of a Sustainable Product Index to provide product information to consumers about the environmental impact of the products they purchase.

As part of its sustainability efforts, Walmart had either initiated or was in the process of developing over 180 renewable energy projects. Combined, these efforts resulted in more than 1 billion kilowatt hours of renewable energy production each year, enough power to provide the electrical needs of 78,000 homes.

Walmart’s renewable energy efforts have focused on three general initiatives.

• It has invested in developing distributed electrical generation systems on its property. As part of this effort, Walmart has installed rooftop solar panels on 127 locations in seven countries. It also has 26 fuel cell installations, 11 micro-wind projects, and seven solar thermal projects.

• Expanding its contracts with suppliers for renewable energy has also been a focus of Walmart. Thus, Walmart bypasses the local utility to go directly to renewable energy suppliers to sign long-term contracts for renewable energy. With long-term contracts, Walmart has found that providers will give them more favorable terms. Walmart also believes that the long-term contracts give suppliers the incentive to invest in their generation systems, increasing the availability of renewable power for other users.

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• In regions where going directly to renewable energy suppliers is difficult or impossible, Walmart has engaged the local utilities to increase their investment in renewable energy.

Sources: Anonymous. 2010. Leading CEOs Share Best Sustainability Practices. www.environmentalleader.com, April 26: np; Hopkins, M. No date. Sustainable Growth. www.businessroundtable, np; Anonymous. 2012. Create, grow, sustain. www.businessroundtable.org, April 18: 120; and Business Roundtable. www.en.wikipedia.org.

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EXHIBIT 10.6 Pros and Cons of Barrier-Free Structures

Pros Cons

• Leverages the talents of all employees. • Difficult to overcome political and authority boundaries inside and outside the organization.

• Enhances cooperation, coordination, and information sharing among functions, divisions, SBUs, and external constituencies.

• Lacks strong leadership and common vision, which can lead to coordination problems.

• Enables a quicker response to market changes through a single- goal focus.

• Time-consuming and difficult-to-manage democratic processes.

• Can lead to coordinated win–win initiatives with key suppliers, customers, and alliance partners.

• Lacks high levels of trust, which can impede performance.

The Modular Organization As Charles Handy, author of The Age of Unreason, has noted:

While it may be convenient to have everyone around all the time, having all of your workforce’s time at your command is an extravagant way of marshaling the necessary resources. It is cheaper to keep them outside the organization … and to buy their services when you need them.39

The modular organization outsources nonvital functions, tapping into the knowledge and expertise of “best in class” suppliers, but retains strategic control. Outsiders may be used to manufacture parts, handle logistics, or perform accounting activities.40 The value chain can be used to identify the key primary and support activities performed by a firm to create value: Which activities do we keep “in-house” and which activities do we outsource to suppliers?41 The organization becomes a central hub surrounded by networks of outside suppliers and specialists and parts can be added or taken away. Both manufacturing and service units may be modular.42

modular organization an organization in which nonvital functions are outsourced, which uses the knowledge and expertise of outside suppliers while retaining strategic control.

Apparel is an industry in which the modular type has been widely adopted. Nike and Reebok, for example, concentrate on their strengths: designing and marketing high-tech, fashionable footwear. Nike has few production facilities and Reebok owns no plants. These two companies contract virtually all their footwear production to suppliers in China, Vietnam, and other countries with low-cost labor. Avoiding large investments in fixed assets helps them derive large profits on minor sales increases. Nike and Reebok can keep pace with changing tastes in the marketplace because their suppliers have become expert at rapidly retooling to produce new products.43

In a modular company, outsourcing the noncore functions offers three advantages.

1. A firm can decrease overall costs, stimulate new product development by hiring suppliers with superior talent to that of in-house personnel, avoid idle capacity, reduce inventories, and avoid being locked into a particular technology.

2. A company can focus scarce resources on the areas where it holds a competitive advantage. These benefits can translate into more funding for R&D hiring the best engineers, and providing continuous training for sales and service staff.

3. An organization can tap into the knowledge and expertise of its specialized supply-chain partners, adding critical skills and accelerating organizational learning.44

The modular type enables a company to leverage relatively small amounts of capital and a small management team to achieve seemingly unattainable strategic objectives.45 Certain preconditions are necessary before the modular approach

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can be successful. First, the company must work closely with suppliers to ensure that the interests of each party are being fulfilled. Companies need to find loyal, reliable vendors who can be trusted with trade secrets. They also need assurances that suppliers will dedicate their financial,

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physical, and human resources to satisfy strategic objectives such as lowering costs or being first to market. Second, the modular company must be sure that it selects the proper competencies to keep in-house. For Nike and

Reebok, the core competencies are design and marketing, not shoe manufacturing; for Honda, the core competence is engine technology. An organization must avoid outsourcing components that may compromise its long-term competitive advantages.

Strategic Risks of Outsourcing The main strategic concerns are (1) loss of critical skills or developing the wrong skills, (2) loss of cross-functional skills, and (3) loss of control over a supplier.46

Too much outsourcing can result in a firm “giving away” too much skill and control.47 Outsourcing relieves companies of the requirement to maintain skill levels needed to manufacture essential components.48 At one time, semiconductor chips seemed like a simple technology to outsource, but they have now become a critical component of a wide variety of products. Companies that have outsourced the manufacture of these chips run the risk of losing the ability to manufacture them as the technology escalates. They become more dependent upon their suppliers.

Cross-functional skills refer to the skills acquired through the interaction of individuals in various departments within a company.49 Such interaction assists a department in solving problems as employees interface with others across functional units. However, if a firm outsources key functional responsibilities, such as manufacturing, communication across departments can become more difficult. A firm and its employees must now integrate their activities with a new, outside supplier.

The outsourced products may give suppliers too much power over the manufacturer. Suppliers that are key to a manufacturer’s success can, in essence, hold the manufacturer “hostage.” Nike manages this potential problem by sending full-time “product expatriates” to work at the plants of its suppliers. Also, Nike often brings top members of supplier management and technical teams to its headquarters. This way, Nike keeps close tabs on the pulse of new developments, builds rapport and trust with suppliers, and develops long-term relationships with suppliers to prevent hostage situations.

Exhibit 10.7 summarizes the pros and cons of modular structures.50

The Virtual Organization In contrast to the “self-reliant” thinking that guided traditional organizational designs, the strategic challenge today has become doing more with less and looking outside the firm for opportunities and solutions to problems. The virtual organization provides a new means of leveraging resources and exploiting opportunities.51

The virtual organization can be viewed as a continually evolving network of independent companies—suppliers, customers, even competitors—linked together to share skills, costs, and access to one another’s markets.52 The members of a virtual organization, by pooling and sharing the knowledge and expertise of each of the component organizations, simultaneously “know” more and can “do” more than any one member of the group could do alone. By working closely together, each gains in the long run from individual and organizational learning.53 The term virtual, meaning “being in effect but not actually so,” is commonly used in the computer industry. A computer’s ability to appear to have more storage capacity than it really possesses is called virtual memory. Similarly, by assembling resources from a variety of entities, a virtual organization may seem to have more capabilities than it really possesses.54

virtual organization a continually evolving network of independent companies that are linked together to share skills, costs, and access to one another’s markets.

Virtual organizations need not be permanent and participating firms may be involved in multiple alliances. Virtual organizations may involve different firms performing complementary value activities, or different firms involved jointly in the same value activities,

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such as production, R&D, and distribution. The percentage of activities that are jointly performed with partners may vary significantly from alliance to alliance.55

EXHIBIT 10.7 Pros and Cons of Modular Structures

Pros Cons

• Directs a firm’s managerial and technical talent to the most critical activities.

• Inhibits common vision through reliance on outsiders.

• Maintains full strategic control over most critical activities—core competencies.

• Diminishes future competitive advantages if critical technologies or other competencies are outsourced.

• Achieves “best in class” performance at each link in the value chain.

• Increases the difficulty of bringing back into the firm activities that now add value due to market shifts

• Leverages core competencies by outsourcing with smaller capital commitment.

• Leads to an erosion of cross-functional skills.

• Encourages information sharing and accelerates organizational learning.

• Decreases operational control and potential loss of control over a supplier.

How does the virtual type of structure differ from the modular type? Unlike the modular type, in which the focal firm maintains full strategic control, the virtual organization is characterized by participating firms that give up part of their control and accept interdependent destinies. Participating firms pursue a collective strategy that enables them to cope with uncertainty through cooperative efforts. The benefit is that, just as virtual memory increases storage capacity, the virtual organizations enhance the capacity or competitive advantage of participating firms.

Strategy Spotlight 10.6 discusses the collaboration between firms from apparently unrelated industries to develop a technology that could potentially affect all products that use plastic as a component, a container, or a package.

Each company that links up with others to create a virtual organization contributes only what it considers its core competencies. It will mix and match what it does best with the best of other firms by identifying its critical capabilities and the necessary links to other capabilities.56

Challenges and Risks Such alliances often fail to meet expectations: In the 1980s, several competing U.S. computing firms set up a consortium, US Memories, to design and manufacture memory chips for computers. The purpose of the consortium was to allow the firms to better compete with Japanese and Taiwanese competitors. But the consortium collapsed as a result of differences in the interests and objectives of the firms involved.

The virtual organization demands that managers build relationships with other companies, negotiate win–win deals for all parties find the right partners with compatible goals and values, and provide the right balance of freedom and control. Information systems must be designed and integrated to facilitate communication with current and potential partners.

Managers must be clear about the strategic objectives while forming alliances. Some objectives are time bound, and those alliances need to be dissolved once the objective is fulfilled. Some alliances may have relatively long-term objectives and will need to be clearly monitored and nurtured to produce mutual commitment and avoid bitter fights for control. The highly dynamic personal computer industry is characterized by multiple temporary alliances among hardware, operating systems, and software producers.57 But alliances in the more stable automobile industry, such as those involving Nissan and Volkswagen have long-term objectives and tend to be relatively stable.

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STRATEGY

SPOTLIGHT 10.6 ENVIRONMENTAL

SUSTAINABILITY

PLANT PLASTICS 2.0: A COLLABORATIVE INITIATIVE AMONG 5 GLOBAL FIRMS Coca-Cola, Ford Motor Company, H.J. Heinz, Nike, and Procter & Gamble are five firms that are typically neither competitors, suppliers, or customers, but they have come together to address a joint concern. They are working together to develop plant-based plastics. Coca-Cola has been at the forefront of this technology and has developed a plastic bottle that includes 30 percent plant-based plastic. Heinz had already licensed this technology, but these two firms, along with the other three partners, have created the Plant PET Technology Collaborative (PTC) to jointly develop the plant-based plastic technology further, with the goal of creating 100 percent plant-based plastics that can be used in a range of products across a number of industries. As the spokesperson of the PTC stated, “PTC members are committed to supporting and championing research, expanding knowledge and accelerating technology development to enable commercially viable, more sustainably sourced, 100 percent plant-based PET plastic while reducing the use of fossil fuels.”

This cooperative is important for these firms to achieve the sustainability goals that they have laid out. For example, P&G has targeted a 25 percent reduction in the amount of petroleum-based products the firm uses by 2020, with a long-term goal of completely replacing petroleum-based materials with sustainable sources. Ed Sawiki, associate director of global business development, asserted that the collaborative R&D effort is important since it allows P&G to “work with others to advance the pace of technical learning and commercial availability of 100 percent plant-based PET faster than any one party can do alone. This enables us to deliver products and packages that consumers want in a sustainable fashion. It creates a win-win situation for the company, consumers, and the environment.” The members of the PTC hope to have a marketable 100 percent plant-based plastic by 2016 or 2017.

The collaborative also serves a second goal for the firms. That is the development of common methods, standards, and terminology for sustainable plastics. The brands will then promote these standards to facilitate both customer acceptance and preference and use worldwide by other corporations. These standards could also be used in regulatory efforts by governments to incentivize the use of sustainable packaging.

Sources: Caliendo, H. 2012. Five major brands collaborating on plant-based PET. Plasticstoday.com, June 5: np; and Siemers, E. 2012. Nike joins Coke, Ford, Heinz, and P&G to develop plant-based plastics. Sustainablebusinessoregon.com, June 5: np.

The virtual organization is a logical culmination of joint-venture strategies of the past. Shared risks, costs, and rewards are the facts of life in a virtual organization.58 When virtual organizations are formed, they involve tremendous challenges for strategic planning. As with the modular corporation, it is essential to identify core competencies. However, for virtual structures to be successful, a strategic plan is also needed to determine the effectiveness of combining core competencies.

The strategic plan must address the diminished operational control and overwhelming need for trust and common vision among the partners. This new structure may be appropriate for firms whose strategies require merging technologies (e.g., computing and communication) or for firms exploiting shrinking product life cycles that require simultaneous entry into multiple geographical markets. It may be effective for firms that desire to be quick to the market with a new product or service. The recent profusion of alliances among airlines was primarily motivated by the need to provide seamless travel demanded by the full-fare paying business traveler. Exhibit 10.8 summarizes the advantages and disadvantages.

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Boundaryless Organizations: Making Them Work Designing an organization that simultaneously supports the requirements of an organization’s strategy, is consistent with the demands of the environment, and can be effectively implemented by the people around the manager is a tall order for any manager.59 The most effective solution is usually a combination of organizational types. That is, a firm may outsource many parts of its value chain to reduce costs and increase quality, engage simultaneously in multiple alliances to take advantage of technological developments or penetrate new markets, and break down barriers within the organization to enhance flexibility.

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EXHIBIT 10.8 Pros and Cons of Virtual Structures

Pros Cons

• Enables the sharing of costs and skills. • Harder to determine where one company ends and another begins, due to close interdependencies among players.

• Enhances access to global markets. • Leads to potential loss of operational control among partners.

• Increases market responsiveness. • Results in loss of strategic control over emerging technology.

• Creates a “best of everything” organization since each partner brings core competencies to the alliance.

• Requires new and difficult-to-acquire managerial skills.

• Encourages both individual and organizational knowledge sharing and accelerates organizational learning.

Source: Miles, R. E., & Snow, C. C. 1986. Organizations: New Concepts for New Forms. California Management Review, Spring: 62–73; Miles & Snow. 1999. Causes of Failure in Network Organizations. California Management Review, Summer: 53–72; and Bahrami, H. 1991. The Emerging Flexible Organization: Perspectives from Silicon Valley. California Management Review, Summer: 33–52.

When an organization faces external pressures, resource scarcity, and declining performance, it tends to become more internally focused, rather than directing its efforts toward managing and enhancing relationships with existing and potential external stakeholders. This may be the most opportune time for managers to carefully analyze their value-chain activities and evaluate the potential for adopting elements of modular, virtual, and barrier-free organizational types.

In this section, we will address two issues managers need to be aware of as they work to design an effective boundaryless organization. First, managers need to develop mechanisms to ensure effective coordination and integration. Second, managers need to be aware of the benefits and costs of developing strong and long-term relationships with both internal and external stakeholders.

Facilitating Coordination and Integration Achieving the coordination and integration necessary to maximize the potential of an organization’s human capital involves much more than just creating a new structure. Techniques and processes to ensure the coordination and integration of an organization’s key value-chain activities are critical. Teams are key building blocks of the new organizational forms, and teamwork requires new and flexible approaches to coordination and integration.

Managers trained in rigid hierarchies may find it difficult to make the transition to the more democratic, participative style that teamwork requires. As Douglas K. Smith, coauthor of The Wisdom of Teams, pointed out, “A completely diverse group must agree on a goal, put the notion of individual accountability aside and figure out how to work with each other. Most of all, they must learn that if the team fails, it’s everyone’s fault.”60 Within the framework of an appropriate organizational design, managers must select a mix and balance of tools and techniques to facilitate the effective coordination and integration of key activities. Some of the factors that must be considered include:

• Common culture and shared values.

• Horizontal organizational structures.

• Horizontal systems and processes.

• Communications and information technologies.

• Human resource practices.

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Common Culture and Shared Values Shared goals, mutual objectives, and a high degree of trust are essential to the success of boundaryless organizations. In the fluid and flexible environments of the new organizational architectures, common cultures, shared values, and carefully aligned incentives are often less expensive to implement and are often

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a more effective means of strategic control than rules, boundaries, and formal procedures. Tony Hsieh, the founder of Zappos, echoes this need for a shared culture and values when as he describes his role this way. “I think of myself less as a leader and more of being an architect of an environment that enables employees to come up with their own ideas.”61

Horizontal Organizational Structures These structures, which group similar or related business units under common management control, facilitate sharing resources and infrastructures to exploit synergies among operating units and help to create a sense of common purpose. Consistency in training and the development of similar structures across business units facilitates job rotation and cross training and enhances understanding of common problems and opportunities. Cross-functional teams and inter-divisional committees and task groups represent important opportunities to improve understanding and foster cooperation among operating units.

horizontal organizational structures organizational forms that group similar or related business units under common management control and facilitate sharing resources and infrastructures to exploit synergies among operating units and help to create a sense of common purpose.

Horizontal Systems and Processes Organizational systems, policies, and procedures are the traditional mechanisms for achieving integration among functional units. Existing policies and procedures often do little more than institutionalize the barriers that exist from years of managing within the framework of the traditional model. Beginning with an understanding of basic business processes in the context of “a collection of activities that takes one or more kinds of input and creates an output that is of value to the customer,” Michael Hammer and James Champy’s 1993 best-selling Reengineering the Corporation outlined a methodology for redesigning internal systems and procedures that has been embraced by many organizations.62 Successful reengineering lowers costs, reduces inventories and cycle times, improves quality, speeds response times, and enhances organizational flexibility. Others advocate similar benefits through the reduction of cycle times, total quality management, and the like.

Communications and Information Technologies (IT) The effective use of IT can play an important role in bridging gaps and breaking down barriers between organizations. Electronic mail and videoconferencing can improve lateral communications across long distances and multiple time zones and circumvent many of the barriers of the traditional model. IT can be a powerful ally in the redesign and streamlining of internal business processes and in improving coordination and integration between suppliers and customers. Internet technologies have eliminated the paperwork in many buyer–supplier relationships, enabling cooperating organizations to reduce inventories, shorten delivery cycles, and reduce operating costs. IT must be viewed more as a prime component of an organization’s overall strategy than simply in terms of administrative support.

Human Resource Practices Change always involves and affects the human dimension of organizations. The attraction, development, and retention of human capital are vital to value creation. As boundaryless structures are implemented, processes are reengineered, and organizations become increasingly dependent on sophisticated ITs, the skills of workers and managers alike must be upgraded to realize the full benefits.

Strategy Spotlight 10.7 discusses Procter & Gamble’s successful introduction of Crest Whitestrips. This example shows how P&G’s tools and techniques, such as communities of practice, information technology, and human resource practices, help to achieve effective collaboration and integration across the firm’s different business units.

The Benefits and Costs of Developing Lasting Internal and External Relationships Successful boundaryless organizations rely heavily on the relational aspects of organizations. Rather than relying on strict hierarchical and bureaucratic systems, these firms are flexible and coordinate action by leveraging shared social norms and strong social

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relationships between both internal and external stakeholders.63 At the same time, it is important to acknowledge that relying on relationships can have both positive and negative effects. To successfully move to a more boundaryless organization, managers need to acknowledge and attend to both the costs and benefits of relying on relationships and social norms to guide behavior.

STRATEGY SPOTLIGHT 10.7

CREST’S WHITESTRIPS: AN EXAMPLE OF HOW P&G CREATES AND DERIVES BENEFITS FROM A BOUNDARYLESS ORGANIZATION Given its breadth of products—soaps, diapers, toothpaste, potato chips, lotions, detergent—Procter & Gamble (P&G) has an enormous pool of resources it can integrate in various ways to launch exciting new products. For example, the company created a new category, teeth-whitening systems, with Crest Whitestrips. Teeth whitening done at a dentist’s office can brighten one’s smile in as little as one visit, but it can cost hundreds of dollars. On the other hand, over-the-counter home whitening kits like Crest Whitestrips cost far less and are nearly equally effective.

Whitestrip was created through a combined effort of product developers from three different units in P&G. People at the oral-care division provided teeth-whitening expertise; experts from the fabric and home-care division supplied bleach expertise; and scientists at corporate research and development provided a novel film technology. Three separate units, by collaborating and combining their technologies, succeeded in developing an affordable product to brighten smiles and, according to the website, bring “greater success in work and love.” With $300 million in annual retail sales, the launch of the Whitestrips product has been a big success for P&G, one that would not have been possible without the firm’s collaborative ability.

Such collaborations are the outcome of well-established organizational mechanisms. P&G has created more than 20 communities of practice, with 8,000 participants. Each group comprises volunteers from different parts of the company and focuses on an area of expertise (fragrance, packaging, polymer chemistry, skin science, and so on). The groups solve specific problems that are brought to them, and they meet to share best practices. The company also has posted an “ask me” feature on its intranet, where employees can describe a business problem, which is directed to those people with appropriate expertise. At a more fundamental level, P&G promotes from within and rotates people across countries and business units. As a result, its employees build powerful cross-unit networks.

Sources: Hansen, M. T. 2009. Collaboration: How Leaders Avoid the Traps, Create Unity, and Reap Big Results. Boston: Harvard Business Press, 24–25; Anonymous. 2004. At P&G, It’s 360-Degree Innovation. www.businessweek.com, October 11: np; www.whitestrips.com; Anonymous. 2009. The Price of a Whiter, Brighter Smile. www.washingtonpost.com, July 21: np; Hansen, M. T. & Birkinshaw, J. 2007. The Innovation Value Chain. Harvard Business Review, June: 85(6): 121–130.

There are three primary benefits that organizations accrue when relying on relationships.

• Agency costs within the firm can be dramatically cut through the use of relational systems. Managers and employees in relationship-oriented firms are guided by social norms and relationships they have with other managers and employees. As a result, the firm can reduce the degree to which it relies on monitoring, rules and regulations, and financial incentives to ensure that workers put in a strong effort and work in the firm’s interests. A relational view leads managers and employees to act in a supportive manner and makes them more willing to step out of their formal roles when needed to accomplish tasks for others and for the organization. They are also less likely to shirk their responsibilities.

• There is also likely to be a reduction in the transaction costs between a firm and its suppliers and customers. If firms have built strong relationships with partnering firms, they are more likely to work cooperatively with these

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firms and build trust that their partners will work in the best interests of the alliance. This will reduce the need for the firms to write detailed contracts and set up strict bureaucratic rules to outline the responsibilities and define the behavior of each firm. Additionally, partnering firms with strong relationships are more likely to invest in assets that specifically support the partnership. Finally, they will have much less fear that their partner will try to take advantage of them or seize the bulk of the benefits from the partnership.

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• Since they feel a sense of shared ownership and goals, individuals within the firm as well as partnering firms will be more likely to search for win-win rather than win-lose solutions. When taking a relational view, individuals are less likely to look out solely for their personal best interests. They will also be considerate of the benefits and costs to other individuals in the firm and to the overall firm. The same is true at the organizational level. Firms with strong relationships with their partners are going to look for solutions that not only benefit themselves but also provide equitable benefits and limited downside for the partnering firms. Such a situation was evident with a number of German firms during the economic crisis of 2008–2010. The German government, corporations, and unions worked together to find the fairest way to respond to the crisis. The firms agreed not to lay off workers. The unions agreed to reduced workweeks. The government kicked in a subsidy to make up for some of the lost wages. In other words, they negotiated a shared sacrifice to address the challenge. This positioned the German firms to bounce back quickly once the crisis passed.

While there are a number of benefits with using a relational view, there can also be some substantial costs.

• As the relationships between individuals and firms strengthen, they are also more likely to fall prey to suboptimal lock-in effects. The problem here is that as decisions become driven by concerns about relationships, economic factors become less important. As a result, firms become less likely to make decisions that could benefit the firm since those decisions may harm employees or partnering firms. For example, firms may see the economic logic in exiting a market, but the ties they feel with employees that work in that division and partnering firms in that market may reduce their willingness to make the hard decision to exit the market. This can be debilitating to firms in rapidly changing markets where successful firms add, reorganize, and sometimes exit operations and relationships regularly.

• Since there are no formal guidelines, conflicts between individuals and units within firms as well as between partnering firms are typically resolved through ad hoc negotiations and processes. In these circumstances, there are no legal means or bureaucratic rules to guide decision making. Thus, when firms face a difficult decision where there are differences of opinion about the best course of action, the ultimate choices made are often driven by the inherent power of the individuals or firms involved. This power use may be unintentional and subconscious, but it can result in outcomes that are deemed unfair by one or more of the parties.

• The social capital of individuals and firms can drive their opportunities. Thus, rather than identifying the best person to put in a leadership role or the optimal supplier to contract with, these choices are more strongly driven by the level of social connection the person or supplier has. This also increases the entry barriers for potential new suppliers or employees with whom a firm can contract since new firms likely don’t have the social connections needed to be chosen as a worthy partner with whom to contract. This also may limit the likelihood that new innovative ideas will enter into the conversations at the firm.

As mentioned earlier in the chapter, the solution may be to effectively integrate elements of formal structure and reward systems with stronger relationships. This may influence specific relationships so that a manager will want employees to build relationships while still maintaining some managerial oversight and reward systems that motivate the desired behavior. This may also result in different emphases with different relationships. For example, there may be some units, such as accounting, where a stronger role for traditional structures and forms of evaluation may be optimal. However, in new product development units, a greater emphasis on relational systems may be more appropriate.

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LO10.5

The need for creating ambidextrous organizational designs that enable firms to explore new opportunities and effectively integrate existing operations.

Creating Ambidextrous Organizational Designs

In Chapter 1, we introduced the concept of “ambidexterity,” which incorporates two contradictory challenges faced by today’s managers.64 First, managers must explore new opportunities and adjust to volatile markets in order to avoid complacency. They must ensure that they maintain adaptability and remain proactive in expanding and/or modifying their product–market scope to anticipate and satisfy market conditions. Such competencies are especially challenging when change is rapid and unpredictable.

adaptibility managers’ exploration of new opportunities and adjustment to volatile markets in order to avoid complacency.

Second, managers must also effectively exploit the value of their existing assets and competencies. They need to have alignment, which is a clear sense of how value is being created in the short term and how activities are integrated and properly coordinated. Firms that achieve both adaptability and alignment are considered ambidextrous organizations—aligned and efficient in how they manage today’s business but flexible enough to changes in the environment so that they will prosper tomorrow.

alignment managers’ clear sense of how value is being created in the short term and how activities are integrated and properly coordinated.

Handling such opposing demands is difficult because there will always be some degree of conflict. Firms often suffer when they place too strong a priority on either adaptability or alignment. If it places too much focus on adaptability, the firm will suffer low profitability in the short term. If managers direct their efforts primarily at alignment, they will likely miss out on promising business opportunities.

Ambidextrous Organizations: Key Design Attributes A study by Charles O’Reilly and Michael Tushman65 provides some insights into how some firms were able to create successful ambidextrous organizational designs. They investigated companies that attempted to simultaneously pursue modest, incremental innovations as well as more dramatic, breakthrough innovations. The team investigated 35 attempts to launch breakthrough innovations undertaken by 15 business units in nine different industries. They studied the organizational designs and the processes, systems, and cultures associated with the breakthrough projects as well as their impact on the operations and performance of the traditional businesses.

ambidextrous organizational designs organizational designs that attempt to simultaneously pursue modest, incremental innovations as well as more dramatic, breakthrough innovations.

Companies structured their breakthrough projects in one of four primary ways:

• Seven were carried out within existing functional organizational structures. The projects were completely integrated into the regular organizational and management structure.

• Nine were organized as cross-functional teams. The groups operated within the established organization but outside of the existing management structure.

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• Four were organized as unsupported teams. Here, they became independent units set up outside the established organization and management hierarchy.

• Fifteen were conducted within ambidextrous organizations. Here, the breakthrough efforts were organized within structurally independent units, each having its own processes, structures, and cultures. However, they were integrated into the existing senior management structure.

The performance results of the 35 initiatives were tracked along two dimensions:

• Their success in creating desired innovations was measured by either the actual commercial results of the new product or the application of practical market or technical learning.

• The performance of the existing business was evaluated.

The study found that the organizational structure and management practices employed had a direct and significant impact on the performance of both the breakthrough initiative and the traditional business. The ambidextrous organizational designs were more effective

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than the other three designs on both dimensions: launching breakthrough products or services (i.e., adaptation) and improving the performance of the existing business (i.e., alignment).

Why Was the Ambidextrous Organization the Most Effective Structure? The study found that there were many factors. A clear and compelling vision, consistently communicated by the company’s senior management team was critical in building the ambidextrous designs. The structure enabled cross- fertilization while avoiding cross-contamination. The tight coordination and integration at the managerial levels enabled the newer units to share important resources from the traditional units such as cash, talent, and expertise. Such sharing was encouraged and facilitated by effective reward systems that emphasized overall company goals. The organizational separation ensured that the new units’ distinctive processes, structures, and cultures were not overwhelmed by the forces of “business as usual.” The established units were shielded from the distractions of launching new businesses, and they continued to focus all of their attention and energy on refining their operations, enhancing their products, and serving their customers.

ISSUE FOR DEBATE

Nearly half of the hotel rooms booked in the United States are booked through online travel agents (OTAs), such as Priceline.com and Travelocity.com. These online sites grew from handling $2 billion to $15 billion worth of reservations from 2001 to 2011. Initially, these sites were viewed favorably by the major hotel chains. They gave easy access to customers at a lower cost than traditional travel agents.

Over time, the hotel chains’ perspective regarding the OTAs changed. The fees they charge have grown over time and now account for up to 30 percent of the cost of hotel rooms. This put a real squeeze on the hotel chains. The margins in the hotel industry are fairly low to begin with, and with the OTAs taking a bigger slice, there was little left for the chains. Additionally, they altered the dynamics between hotels and customers. Customers increasingly viewed their preferred OTA as the firm they interacted with and saw less value in the individual brands of hotels. As a result, they became more price- focused and less loyal to a given hotel chain.

Six major chains of hotels, including Hilton, Hyatt, and Choice Hotels, responded to this issue by deciding to cooperate with each other in developing their own joint hotel booking website, Roomkey.com. This site was designed to offer similar pricing as the other OTAs but do so with much lower fees, leaving more of the customers’ payments in the pockets of the hotels. Also, the site would allow the hotels to provide more information and more up-to-date information on the individual

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hotels than the OTAs typically offered. Finally, the hotel chains guaranteed that customers on Roomkey.com would receive full loyalty program benefits for their stays that were booked on the site.

Whether Roomkey.com is the answer to the hotel chains problems with the OTAs is unclear at this point. There are signs that it is off to a nice start. Launched in January 2012, the site was up to 14 million monthly visitors by September 2012. The site also signed up additional chains, including the La Quinta, Millenium, and Vantage Hospitality chains. The system now includes over 50,000 individual hotel locations. On the other hand, it isn’t

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yet clear whether Roomkey.com is eating into the OTA business. While Roomkey.com has generated significant traffic, most of the visitors started at the chains’ own websites and responded to an ad there to get to Roomkey.com. Few of the visitors, only 10 percent according to an analysis by Compete.com, went to Roomkey.com without being prompted by one of the hotel chains’ sites.

Discussion Questions

1. Do you think Roomkey.com will be successful? Why or why not?

2. What actions can Roomkey.com take to try to pull more business away from the OTAs?

3. How can the chains use Roomkey.com to improve their position relative to OTAs even while it is unclear whether or not Roomkey.com will take off?

Sources: Robinson-Jacobs, K. 2012. Hotels unite to take on dot-coms. Dallas Morning News, January 23: 1D, 4D; Solinsky, S. 2012. The curious identity of Roomkey.com. compete.com, September 18: np; DeLollis, B. 2012. Roomkey.com hotel chain adds more chains. usatoday.com, September 24: np; and Bilbao, R. 2012. Five minutes with John Davis, SEO, Roomkey.com. bizjournals.com. May 25: np.

Reflecting on Career Implications …

Boundaryless Organizational Designs: Does your firm have structural mechanisms (e.g., culture, human resources practices) that facilitate sharing information across boundaries? Regardless of the level of boundarylessness of your organization, a key issue for your career is the extent to which you are able to cut across boundaries within your organization. Such boundaryless behavior on your part will enable you to enhance and leverage your human capital. Evaluate how boundaryless you are within your organizational context. What actions can you take to become even more boundaryless?

Horizontal Systems and Processes: One of the approaches suggested in the chapter to improve boundarylessness within organizations is reengineering. Analyze the work you are currently doing and think of ways in which it can be reengineered to improve quality, accelerate response time, and lower cost. Consider presenting the results of your analysis to your immediate superiors. Do you think they will be receptive to your suggestions?

Ambidextrous Organizations: Firms that achieve adaptability and alignment are considered ambidextrous. As an individual, you can also strive to be ambidextrous. Evaluate your own ambidexterity by assessing your adaptability (your ability to change in response to changes around you) and alignment (how good you are at exploiting your existing competencies). What steps can you take to improve your ambidexterity?

summary

Successful organizations must ensure that they have the proper type of organizational structure. Furthermore, they must ensure that their firms incorporate the necessary integration and processes so that the internal and external boundaries of their firms are flexible and permeable. Such a need is increasingly important as the environments of firms become more complex, rapidly changing, and unpredictable.

In the first section of the chapter, we discussed the growth patterns of large corporations. Although most organizations remain small or die, some firms continue to grow in terms of revenues, vertical integration, and diversity of products and services. In addition, their geographical scope may increase to include international operations. We traced the dominant pattern of growth, which evolves from a simple structure to a functional structure as a firm grows in terms of size and

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increases its level of vertical integration. After a firm expands into related products and services, its structure changes from a functional to a divisional form of organization. Finally, when the firm enters international markets, its structure again changes to accommodate the change in strategy.

We also addressed the different types of organizational structure—simple, functional, divisional (including two variations—strategic business unit and holding company), and matrix—as well as their relative advantages and disadvantages. We closed the section with a discussion of the implications for structure when a firm enters international markets. The three primary factors to take into account when determining the appropriate structure are type of international strategy, product diversity, and the extent to which a firm is dependent on foreign sales.

The second section of the chapter introduced the concept of the boundaryless organization. We did not suggest that the concept of the boundaryless organization

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replaces the traditional forms of organizational structure. Rather, it should complement them. This is necessary to cope with the increasing complexity and change in the competitive environment. We addressed three types of boundaryless organizations. The barrier-free type focuses on the need for the internal and external boundaries of a firm to be more flexible and permeable. The modular type emphasizes the strategic outsourcing of noncore activities. The virtual type centers on the strategic benefits of alliances and the forming of network organizations. We discussed both the advantages and disadvantages of each type of boundaryless organization as well as suggested some techniques and processes that are necessary to successfully implement them. These are common culture and values, horizontal organizational structures, horizontal systems and processes, communications and information technologies, and human resource practices.

The final section addresses the need for managers to develop ambidextrous organizations. In today’s rapidly changing global environment, managers must be responsive and proactive in order to take advantage of new opportunities. At the same time, they must effectively integrate and coordinate existing operations. Such requirements call for organizational designs that establish project teams that are structurally independent units, with each having its own processes, structures, and cultures. But, at the same time, each unit needs to be effectively integrated into the existing management hierarchy.

SUMMARY REVIEW QUESTIONS 1. Why is it important for managers to carefully consider the type of organizational structure that they use to

implement their strategies? 2. Briefly trace the dominant growth pattern of major corporations from simple structure to functional structure to

divisional structure. Discuss the relationship between a firm’s strategy and its structure. 3. What are the relative advantages and disadvantages of the types of organizational structure—simple, functional,

divisional, matrix—discussed in the chapter? 4. When a firm expands its operations into foreign markets, what are the three most important factors to take into

account in deciding what type of structure is most appropriate? What are the types of international structures discussed in the text and what are the relationships between strategy and structure?

5. Briefly describe the three different types of boundaryless organizations: barrier-free, modular, and virtual. 6. What are some of the key attributes of effective groups? Ineffective groups? 7. What are the advantages and disadvantages of the three types of boundaryless organizations: barrier-free, modular,

and virtual? 8. When are ambidextrous organizational designs necessary? What are some of their key attributes?

key terms

organizational structure simple organizational structure

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functional organizational structure divisional organizational structure strategic business unit (SBU) structure holding company structure matrix organizational structure international division structure geographic-area division structure worldwide matrix structure worldwide functional structure worldwide product division structure global start-up boundaryless organizational designs barrier-free organization modular organization virtual organization horizontal organizational structures adaptability alignment ambidextrous organizational designs

experiential exercise Many firms have recently moved toward a modular structure. For example, they have increasingly outsourced many of their information technology (IT) activities. Identify three such organizations. Using secondary sources, evaluate (1) the firm’s rationale for IT outsourcing and (2) the implications for performance.

Firm Rationale Implication(s) for Performance

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application questions & exercises 1. Select an organization that competes in an industry in which you are particularly interested. Go on the Internet and

determine what type of organizational structure this organization has. In your view, is it consistent with the strategy that it has chosen to implement? Why? Why not?

2. Choose an article from Bloomberg Businessweek, Fortune, Forbes, Fast Company, or any other well-known publication that deals with a corporation that has undergone a significant change in its strategic direction. What are the implications for the structure of this organization?

3. Go on the Internet and look up some of the public statements or speeches of an executive in a major corporation about a significant initiative such as entering into a joint venture or launching a new product line. What do you feel are the implications for making the internal and external barriers of the firm more flexible and permeable? Does the executive discuss processes, procedures, integrating mechanisms, or cultural issues that should serve this purpose? Or are other issues discussed that enable a firm to become more boundaryless?

4. Look up a recent article in the publications listed in question 2 above that addresses a firm’s involvement in outsourcing (modular organization) or in strategic alliance or network organizations (virtual organization). Was the firm successful or unsuccessful in this endeavor? Why? Why not?

ethics questions 1. If a firm has a divisional structure and places extreme pressures on its divisional executives to meet short-term

profitability goals (e.g., quarterly income), could this raise some ethical considerations? Why? Why not? 2. If a firm enters into a strategic alliance but does not exercise appropriate behavioral control of its employees (in

terms of culture, rewards and incentives, and boundaries—as discussed in Chapter 9) that are involved in the alliance, what ethical issues could arise? What could be the potential long-term and short-term downside for the firm?

references 1. Wilson, K. & Doz, Y. 2012. 10 rules for managing global innovation. Harvard Business Review, 90(10): 84–92; Wallace, J. 2007. Update on

problems joining 787 fuselage sections. Seattlepi.com, June 7: np; Peterson, K. 2011. Special report: A wing and a prayer: Outsourcing at Boeing. Reuters.com, January 20: np; Hiltzik, M. 2011. 787 Dreamliner teaches Boeing costly lesson on outsourcing. Latimes.com, February 15: np; and Gates, D. 2013. Boeing 787’s problems blamed on outsourcing, lack of oversight. Seattletimes.com, February 2: np.

2. For a unique perspective on organization design, see: Rao, R. 2010. What 17th century pirates can teach us about job design. Harvard Business Review, 88(10): 44.

3. This introductory discussion draws upon Hall, R. H. 2002. Organizations: Structures, processes, and outcomes (8th ed.). Upper Saddle River, NJ: Prentice Hall; and Duncan, R. E. 1979. What is the right organization structure? Decision-tree analysis provides the right answer. Organizational Dynamics, 7(3): 59–80. For an insightful discussion of strategy-structure relationships in the organization theory and strategic management literatures, refer to Keats, B. & O’Neill, H. M. 2001. Organization structure: Looking through a strategy lens. In Hitt, M. A., Freeman, R. E., & Harrison, J. S. 2001. The Blackwell handbook of strategic management: 520–542. Malden, MA: Blackwell.

4. Gratton, L. 2011. The end of the middle manager. Harvard Business Review, 89(1/2): 36. 5. An interesting discussion on the role of organizational design in strategy execution is in: Neilson, G. L., Martin, K. L., & Powers, E. 2009.

The secrets to successful strategy execution. Harvard Business Review, 87(2): 60–70. 6. This discussion draws upon Chandler, A. D. 1962. Strategy and structure. Cambridge, MA: MIT Press; Galbraith J. R. & Kazanjian, R. K.

1986. Strategy implementation: The role of structure and process. St. Paul, MN: West Publishing; and Scott, B. R. 1971. Stages of corporate development. Intercollegiate Case Clearing House, 9-371-294, BP 998. Harvard Business School.

7. Our discussion of the different types of organizational structures draws on a variety of sources, including Galbraith & Kazanjian, op. cit.; Hrebiniak, L. G. & Joyce, W. F. 1984. Implementing strategy. New York: Macmillan; Distelzweig, H. 2000. Organizational structure. In Helms, M. M. (Ed.). Encyclopedia of management: 692–699. Farmington Hills, MI: Gale; and Dess, G. G. & Miller, A. 1993. Strategic management. New York: McGraw-Hill.

8. A discussion of an innovative organizational design is in: Garvin, D. A. & Levesque, L. C. 2009. The multiunit enterprise. Harvard Business Review, 87(2): 106–117.

9. Schein, E. H. 1996. Three cultures of management: The key to organizational learning. Sloan Management Review, 38(1): 9–20.

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10. Insights on governance implications for multidivisional forms are in: Verbeke, A. & Kenworthy, T. P. 2008. Multidivisional vs. metanational governance. Journal of International Business, 39(6): 940–956.

11. Martin, J. A. & Eisenhardt, K. 2010. Rewiring: Cross-business-unit collaborations in multibusiness organizations. Academy of Management Journal, 53(2): 265–301.

12. For a discussion of performance implications, refer to Hoskisson, R. E. 1987. Multidivisional structure and performance: The contingency of diversification strategy. Academy of Management Journal, 29: 625–644.

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13. For a thorough and seminal discussion of the evolution toward the divisional form of organizational structure in the United States, refer to Chandler, op. cit. A rigorous empirical study of the strategy and structure relationship is found in Rumelt, R. P. 1974. Strategy, structure, and economic performance. Cambridge, MA: Harvard Business School Press.

14. Ghoshal S. & Bartlett, C. A. 1995. Changing the role of management: Beyond structure to processes. Harvard Business Review, 73(1): 88. 15. Koppel, B. 2000. Synergy in ketchup? Forbes, February 7: 68–69; and Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. 2001. Strategic

management: Competitiveness and globalization (4th ed.). Cincinnati, OH: Southwestern Publishing. 16. Pitts, R. A. 1977. Strategies and structures for diversification. Academy of Management Journal, 20(2): 197–208. 17. Silvestri, L. 2012. The evolution of organizational structure. footnote 1.com, June 6: np. 18. Andersen, M. M., Froholdt, M., Poulfelt, F. 2010. Return on strategy: How to achieve it. New York: Routledge. 19. Haas, M. R. 2010. The double-edged swords of autonomy and external knowledge: Analyzing team effectiveness in a multinational

organization. Academy of Management Journal, 53(5): 989–1008. 20. Daniels, J. D., Pitts, R. A., & Tretter, M. J. 1984. Strategy and structure of U.S. multinationals: An exploratory study. Academy of

Management Journal, 27(2): 292–307. 21. Habib, M. M. & Victor, B. 1991. Strategy, structure, and performance of U.S. manufacturing and service MNCs: A comparative analysis.

Strategic Management Journal, 12(8): 589–606. 22. Our discussion of global startups draws from Oviatt, B. M. & McDougall, P. P. 2005. The internationalization of entrepreneurship. Journal

of International Business Studies, 36(1): 2–8; Oviatt, B. M. & McDougall, P. P. 1994. Toward a theory of international new ventures. Journal of International Business Studies, 25(1): 45–64; and Oviatt, B. M. & McDougall, P. P. 1995. Global start-ups: Entrepreneurs on a worldwide stage. Academy of Management Executive, 9(2): 30–43.

23. Some useful guidelines for global start-ups are provided in Kuemmerle, W. 2005. The entrepreneur’s path for global expansion. MIT Sloan Management Review, 46(2): 42–50.

24. See, for example, Miller, D. & Friesen, P. H. 1980. Momentum and revolution in organizational structure. Administrative Science Quarterly, 13: 65–91.

25. Many authors have argued that a firm’s structure can influence its strategy and performance. These include Amburgey, T. L. & Dacin, T. 1995. As the left foot follows the right? The dynamics of strategic and structural change. Academy of Management Journal, 37: 1427–1452; Dawn, K. & Amburgey, T. L. 1991. Organizational inertia and momentum: A dynamic model of strategic change. Academy of Management Journal, 34: 591–612; Fredrickson, J. W. 1986. The strategic decision process and organization structure. Academy of Management Review, 11: 280–297; Hall, D. J. & Saias, M. A. 1980. Strategy follows structure! Strategic Management Journal, 1: 149–164; and Burgelman, R. A. 1983. A model of the interaction of strategic behavior, corporate context, and the concept of strategy. Academy of Management Review, 8: 61–70.

26. An interesting discussion on how the Internet has affected the boundaries of firms can be found in Afuah, A. 2003. Redefining firm boundaries in the face of the Internet: Are firms really shrinking? Academy of Management Review, 28(1): 34–53.

27. Collis & Montgomery, op. cit. 28. Govindarajan, V. G. & Trimble, C. 2010. Stop the innovation wars. Harvard Business Review, 88(7/8): 76–83. 29. For a discussion of the role of coaching on developing high performance teams, refer to Kets de Vries, M. F. R. 2005. Leadership group

coaching in action: The zen of creating high performance teams. Academy of Management Executive, 19(1): 77–89. 30. Pfeffer, J. 1998. The human equation: Building profits by putting people first. Cambridge, MA: Harvard Business School Press. 31. For a discussion on how functional area diversity affects performance, see Bunderson, J. S. & Sutcliffe, K. M. 2002. Academy of

Management Journal, 45(5): 875–893. 32. See, for example, Hoskisson, R. E., Hill, C. W. L., & Kim, H. 1993. The multidivisional structure: Organizational fossil or source of value?

Journal of Management, 19(2): 269–298. 33. Pottruck, D. A. 1997. Speech delivered by the co-CEO of Charles Schwab Co., Inc., to the Retail Leadership Meeting, San Francisco, CA,

January 30; and Miller, W. 1999. Building the ultimate resource. Management Review, January: 42–45. 34. Public-private partnerships are addressed in: Engardio, P. 2009. State capitalism. BusinessWeek, February 9: 38–43. 35. Aller, R., Weiner, H., & Weilart, M. 2005. IBM and Mayo collaborating to customize patient treatment plans. cap.org, January: np; and

McGee, M. 2010. IBM, Mayo partner on aneurysm diagnostics. informationweek.com, January 25: np. 36. Anonymous. 2013. Automakers in alliance to speed fuel-cell development. latimes.com, January 29: np. 37. Dess, G. G., Rasheed, A. M. A., McLaughlin, K. J., & Priem, R. 1995. The new corporate architecture. Academy of Management Executive,

9(3): 7–20. 38. Barnes, C. 1998. A fatal case. Fast Company, February–March: 173.

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39. Handy, C. 1989. The age of unreason. Boston: Harvard Business School Press; Ramstead, E. 1997. APC maker’s low-tech formula: Start with the box. The Wall Street Journal, December 29: B1; Mussberg, W. 1997. Thin screen PCs are looking good but still fall flat. The Wall Street Journal, January 2: 9; Brown, E. 1997. Monorail: Low cost PCs. Fortune, July 7: 106–108; and Young, M. 1996. Ex-Compaq executives start new company. Computer Reseller News, November 11: 181.

40. An original discussion on how open-sourcing could help the Big 3 automobile companies is in: Jarvis, J. 2009. How the Google model could help Detroit. BusinessWeek, February 9: 32–36.

41. For a discussion of some of the downsides of outsourcing, refer to Rossetti, C. & Choi, T. Y. 2005. On the dark side of strategic sourcing: Experiences from the aerospace industry. Academy of Management Executive, 19(1): 46–60.

42. Tully, S. 1993. The modular corporation. Fortune, February 8: 196. 43. Offshoring in manufacturing firms is addressed in: Coucke, K. & Sleuwaegen, L. 2008. Offshoring as a survival strategy: Evidence from

manufacturing firms in Belgium. Journal of International Business Studies, 39(8): 1261–1277.

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44. Quinn, J. B. 1992. Intelligent enterprise: A knowledge and service based paradigm for industry. New York: Free Press. 45. For an insightful perspective on outsourcing and its role in developing capabilities, read Gottfredson, M., Puryear, R., & Phillips, C. 2005.

Strategic sourcing: From periphery to the core. Harvard Business Review, 83(4): 132–139. 46. This discussion draws upon Quinn, J. B. & Hilmer, F. C. 1994. Strategic outsourcing. Sloan Management Review, 35(4): 43–55. 47. Reitzig, M. & Wagner, S. 2010. The hidden costs of outsourcing: Evidence from patent data. Strategic Management Journal. 31(11): 1183

–1201. 48. Insights on outsourcing and private branding can be found in: Cehn, S-F. S. 2009. A transaction cost rationale for private branding and its

implications for the choice of domestic vs. offshore outsourcing. Journal of International Business Strategy, 40(1): 156–175. 49. For an insightful perspective on the use of outsourcing for decision analysis, read: Davenport, T. H. & Iyer, B. 2009. Should you outsource

your brain? Harvard Business Review, 87(2): 38. 50. See also Stuckey, J. & White, D. 1993. When and when not to vertically integrate. Sloan Management Review, Spring: 71–81; Harrar, G.

1993. Outsource tales. Forbes ASAP, June 7: 37–39, 42; and Davis, E. W. 1992. Global outsourcing: Have U.S. managers thrown the baby out with the bath water? Business Horizons, July–August: 58–64.

51. For a discussion of knowledge creation through alliances, refer to Inkpen, A. C. 1996. Creating knowledge through collaboration. California Management Review, 39(1): 123–140; and Mowery, D. C., Oxley, J. E., & Silverman, B. S. 1996. Strategic alliances and interfirm knowledge transfer. Strategic Management Journal, 17 (Special Issue, Winter): 77–92.

52. Doz, Y. & Hamel, G. 1998. Alliance advantage: The art of creating value through partnering. Boston: Harvard Business School Press. 53. DeSanctis, G., Glass, J. T., & Ensing, I. M. 2002. Organizational designs for R&D. Academy of Management Executive, 16(3): 55–66. 54. Barringer, B. R. & Harrison, J. S. 2000. Walking a tightrope: Creating value through interorganizational alliances. Journal of Management,

26: 367–403. 55. One contemporary example of virtual organizations is R&D consortia. For an insightful discussion, refer to Sakaibara, M. 2002. Formation

of R&D consortia: Industry and company effects. Strategic Management Journal, 23(11): 1033–1050. 56. Bartness, A. & Cerny, K. 1993. Building competitive advantage through a global network of capabilities. California Management Review,

Winter: 78–103. For an insightful historical discussion of the usefulness of alliances in the computer industry, see Moore, J. F. 1993. Predators and prey: A new ecology of competition. Harvard Business Review, 71(3): 75–86.

57. See Lorange, P. & Roos, J. 1991. Why some strategic alliances succeed and others fail. Journal of Business Strategy, January–February: 25 –30; and Slowinski, G. 1992. The human touch in strategic alliances. Mergers and Acquisitions, July–August: 44–47. A compelling argument for strategic alliances is provided by Ohmae, K. 1989. The global logic of strategic alliances. Harvard Business Review, 67(2): 143–154.

58. Some of the downsides of alliances are discussed in Das, T. K. & Teng, B. S. 2000. Instabilities of strategic alliances: An internal tensions perspective. Organization Science, 11: 77–106.

59. This section draws upon Dess, G. G. & Picken, J. C. 1997. Mission critical. Burr Ridge, IL: Irwin Professional Publishing. 60. Katzenbach, J. R. & Smith, D. K. 1994. The wisdom of teams: Creating the high performance organization. New York: HarperBusiness. 61. Bryant, A. 2011. The corner office. New York: St. Martin’s Griffin, 230. 62. Hammer, M. & Champy, J. 1993. Reengineering the corporation: A manifesto for business revolution. New York: HarperCollins. 63. Gupta, A. 2011. The relational perspective and east meets west. Academy of Management Perspectives, 25(3): 19–27. 64. This section draws on Birkinshaw, J. & Gibson, C. 2004. Building ambidexterity into an organization. MIT Sloan Management Review, 45

(4): 47–55; and Gibson, C. B. & Birkinshaw, J. 2004. The antecedents, consequences, and mediating role of organizational ambidexterity. Academy of Management Journal, 47(2): 209–226. Robert Duncan is generally credited with being the first to coin the term “ambidextrous organizations” in his article entitled: Designing dual structures for innovation. In Kilmann, R. H., Pondy, L. R., & Slevin, D. (Eds.). 1976. The management of organizations, vol. 1: 167–188. For a seminal academic discussion of the concept of exploration and exploitation, which parallels adaptation and alignment, refer to: March, J. G. 1991. Exploration and exploitation in organizational learning. Organization Science, 2: 71–86.

65. This section is based on O’Reilly, C. A. & Tushman, M. L. 2004. The ambidextrous organization. Harvard Business Review, 82(4): 74–81.

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PART 3: STRATEGIC IMPLEMENTATION

chapter 11

Strategic Leadership: Creating a Learning Organization and an Ethical Organization

After reading this chapter, you should have a good understanding of the following learning objectives:

LO11.1 The three key interdependent activities in which all successful leaders must be continually engaged.

LO11.2 Two elements of effective leadership: overcoming barriers to change and the effective use of power.

LO11.3 The crucial role of emotional intelligence (EI) in successful leadership as well as its potential drawbacks.

LO11.4 The importance of developing competency companions and creating a learning organization.

LO11.5 The leader’s role in establishing an ethical organization.

LO11.6 The difference between integrity-based and compliance-based approaches to organizational ethics.

LO11.7 Several key elements that organizations must have to become an ethical organization.

Learning from Mistakes

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Most people have never heard of Synthes, a medical device maker headquartered in West Chester, Pennsylvania. Yet in 2012 it made national news when four of its corporate officers were found responsible for illegal actions taken by the company and sentenced to prison.1

When did the problems begin? Between 2002 and 2004, Synthes conducted clinical trials of Norian bone cement, a product used to treat vertebral compression fractures (VCFs), a type of fracture that occurs in nearly 500,000 elderly people each year. Norian, a subsidiary acquired for $50 million in 1999, was already approved for several types of bone-repair treatments. However, the Food and Drug Administration (FDA) had explicitly barred the use of Norian in treating VCFs because of concerns that it could get into the bloodstream and harm patients, possibly leading to death. In spite of the FDA restriction, Synthes decided to forgo the FDA approved clinic trial, launched right into market research, and began promoting Norian for unapproved use in VCF operations. Unfortunately, the patients were unaware of the deadly risks they faced.

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The results? Three patients died on the operating table after spine surgeries in 2003 and 2004! Synthes did not report these deaths to the FDA, because they claimed that the deaths were not due to their product alone. Such disclosures, however, are required by law. The U.S. Department of Justice is still seeking to prove that the cement caused the deaths, a claim supported by the surgeons who used the Norian product. Synthes had to pay $23.2 million in fines and was charged with 44 misdemeanors. Norian was charged with 52 felony counts, including lying to the FDA with the intent to defraud. As U.S. District Court Judge Legroom Davis said, “On the wrongful conduct scale, it’s 11 on a scale of 10. It’s over the top.”

The U.S. Department of Justice prosecuted under the Responsible Corporate Officer Doctrine, which holds executives in certain positions of authority criminally liable for violations of food and drug laws even if they did not have direct knowledge of the underlying conduct. The resulting sentences the four executives received were the stiffest to date under this law.

What might be the underlying problem at Synthes that caused such disregard for the law? In large part, it appears to have been a question of leadership. Hansjorg Wyss was the founder and CEO of

Synthes, which he sold to Johnson and Johnson for $20 billion in June 2012. Prior to the sale, Wyss played an intimidating, hands-on role in managing the company and owned a 50 percent share of it. Wyss was known for paying attention to even the minutia of the company, and nothing went past Wyss without his input or approval. Even the cafeteria plates, which Wyss insisted be square, and the toilet paper brand in the corporate office had Wyss’s input! He was referred to by former employees as “the eight-hundred pound gorilla in the room who liked getting his way.” Even though Wyss was included on emails and reports citing the product’s risks, he held all- hands meetings after the reports were released in order to make a strong push for Norian’s bone cement to be used in VCF. Synthes's strategy was to

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persuade a few doctors to do the procedure on their own and then the company would try to popularize the Norian product.

Early on, it was estimated that it would take three years for an approved clinical study. However, Wyss insisted, without any explanation, that no clinical study would be undertaken. The top levels of executives were all loyal to Wyss, and he had groomed them to come up through the company’s ranks. They knew better than to confront him!

Discussion Questions

1. Why would Synthes engage in such risky behavior for such a relatively small gain?

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2. If you are Johnson and Johnson, what aspects of the Synthes culture would you change?

Clearly, in the end, Synthes paid a high price for their unethical and illegal actions—fines, a loss of reputation, and even prison terms for some top executives. Perhaps the primary responsibility for the fiasco at Synthes lies with the CEO, Hansjorg Wyss. He was imperious and intimidating, tolerated no dissent, and focused on revenues and profits, while minimizing ethical and moral considerations. In contrast, effective leaders play an important and often pivotal role in creating an organizational culture that pursues excellence while adhering to high standards of ethical behavior.

This chapter provides insights into the role of strategic leadership in managing, adapting, and coping in the face of increased environmental complexity and uncertainty. First, we define leadership and its three interdependent activities—setting a direction, designing the organization, and nurturing a culture dedicated to excellence and ethical behavior. Then, we identify two elements of leadership that contribute to success—overcoming barriers to change and the effective use of power. The third section focuses on emotional intelligence, a trait that is increasingly acknowledged to be critical to successful leadership. Next, we emphasize the importance of leaders developing competency companions and creating a learning organization. Here, we focus on empowerment wherein employees and managers throughout an organization develop a sense of self-determination, competence, meaning, and impact that is centrally important to learning. Finally, we address the leader’s role in building an ethical organization and the elements of an ethical culture that contribute to firm effectiveness.

Leadership: Three Interdependent Activities

In today’s chaotic world, few would argue against the need for leadership, but how do we go about encouraging it? Is it enough to merely keep an organization afloat, or is it essential to make steady progress toward some well-defined objective? We believe custodial management is not leadership. Leadership is proactive, goal-oriented, and focused on the creation and implementation of a creative vision. Leadership is the process of transforming organizations from what they are to what the leader would have them become. This definition implies a lot: dissatisfaction with the status quo, a vision of what should be, and a process for bringing about change. An insurance company executive shared the following insight: “I lead by the Noah Principle: It’s all right to know when it’s going to rain, but, by God, you had better build the ark.”

leadership the process of transforming organizations from what they are to what the leader would have them become.

Doing the right thing is becoming increasingly important. Many industries are declining; the global village is becoming increasingly complex, interconnected, and unpredictable; and product and market life cycles are becoming increasingly compressed. When asked to describe the life cycle of his company’s products, the CEO of a supplier of

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computer components replied, “Seven months from cradle to grave—and that includes three months to design the product and get it into production!” Richard D’Aveni, author of Hypercompetition, argued that in a world where all dimensions of competition appear to be compressed in time and heightened in complexity, sustainable competitive advantages are no longer possible.

EXHIBIT 11.1 Three Interdependent Leadership Activities

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Despite the importance of doing the “right thing,” leaders must also be concerned about “doing things right.” Charan and Colvin strongly believe that execution, that is, the implementation of strategy, is also essential to success.

Mastering execution turns out to be the odds-on best way for a CEO to keep his job. So what’s the right way to think about that sexier obsession, strategy? It’s vitally important—obviously. The problem is that our age’s fascination feeds the mistaken belief that developing exactly the right strategy will enable a company to rocket past competitors. In reality, that’s less than half the battle.2

LO11.1

The three key interdependent activities in which all successful leaders must be continually engaged.

Thus, leaders are change agents whose success is measured by how effectively they formulate and implement a strategic vision and mission.3

Many authors contend that successful leaders must recognize three interdependent activities that must be continually reassessed for organizations to succeed. As shown in Exhibit 11.1, these are: (1) setting a direction, (2) designing the organization, and (3) nurturing a culture dedicated to excellence and ethical behavior.4

The interdependent nature of these three activities is self-evident. Consider an organization with a great mission and a superb organizational structure, but a culture that implicitly encourages shirking and unethical behavior. Or one with a sound direction and strong culture, but counterproductive teams and a “zero-sum” reward system that leads to the dysfunctional situation in which one party’s gain is viewed as another party’s loss, and collaboration and sharing are severely hampered. Clearly, such combinations would be ineffective.

Often, failure of today’s organizations can be attributed to a lack of equal consideration of these three activities. The imagery of a three-legged stool is instructive: It will collapse if one leg is missing or broken. Let’s briefly look at each of these activities as well as the value of an ambicultural approach to leadership.

Setting a Direction

setting a direction a strategic leadership activity of strategy analysis and strategy formulation.

A holistic understanding of an organization’s stakeholders requires an ability to scan the environment to develop a knowledge of all of the company’s stakeholders and other salient environmental trends and events. Managers must integrate this knowledge into a vision of

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what the organization could become.5 It necessitates the capacity to solve increasingly complex problems, become proactive in approach, and develop viable strategic options. A strategic vision provides many benefits: a clear future direction; a framework for the organization’s mission and goals; and enhanced employee communication, participation, and commitment.

STRATEGY

SPOTLIGHT 11.1 ENVIRONMENTAL

SUSTAINABILITY

A VISION OF ENVIRONMENTAL SUSTAINABILITY HELPS 3M TO STAY COMPETITIVE Vision and creative change are not solely domains of the CEO. Take former vice president of environmental engineering and pollution control at 3M Joe Ling as an example. In 1975 Mr. Ling oversaw 3M’s efforts to comply with new legal pollution requirements. Years ago, 3M focused on lowering its environmental impact through, for instance, placing scrubbers on smokestacks, treating effluence before releasing wastewater, and segregating solid waste. While this prevention strategy allowed 3M to comply with legal requirements, Mr. Ling’s vision went much further. Instead of seeing environmental concerns as a necessary evil, he asked whether 3M could prevent pollution altogether and profit from doing so. He thought 3M could, and he started 3M’s famous Pollution Prevention Pays (or 3P) program that survives to this day.

While it is challenging to introduce creative change into any organization, Mr. Ling did not shy away from setting challenging goals. Any idea that would reduce pollution must also save money for 3M. Executives at 3M stick to this ideal and reiterate that “anything not a product is considered a cost.” This sustainability strategy is firmly grounded in the 3P philosophy that everything that increases 3M’s footprint is not just pollution or waste, but also a sign of operational inefficiency.

3P not only encourages top executives to rethink products and processes, but also empowers lower-level employees to generate sustainability improvements. Mr. Ling’s vision to embed 3P in 3M’s corporate culture has grown to phenomenal success, culminating in more than 6,300 sustainability projects and 2.6 billion pounds of pollutants saved. Consistent with 3P’s mantra that pollution prevention is instrumental to 3M’s financial success, the company achieved over $1 billion in first-year project savings.

3P has been an integral part of 3M’s corporate strategy in an increasingly global marketplace. One could imagine that sustainability cost savings show up in increased profitability, yet 3M’s profit margins are roughly the same as 30 years ago. Yet 3M operates in increasingly competitive industrial businesses, reducing operating margins and making operational efficiency programs such as 3P crucial to 3M’s long-term success. Therefore, it comes as no surprise that 3M continues to challenge its employees with high sustainability standards. Over the past two decades, 3M has slashed toxic releases by 99 percent and greenhouse gas emissions by 72 percent. This makes 3M the only company that has won the EPA’s Energy Star Award every year since the prize has been awarded, and they have saved costs and stayed competitive while doing so.

Sources: Esty, D.C. & Winston, A.S. 2009. Green to Gold. Hoboken, NJ: Wiley: 106–110; Anonymous. 2012. 2015 Sustainability goals: Sometimes our toughest challenges are the ones we put on ourselves. www.3m.com, June 10: np; and Winston, A.S. 2012. 3M’s sustainability innovation machine. www.businessweek.com, May 15: np.

At times the creative process involves what the CEO of Yokogawa, GE’s Japanese partner in the Medical Systems business, called “bullet train” thinking.6 That is, if you want to increase the speed by 10 miles per hour, you look for incremental advances. However, if you want to double the speed, you’ve got to think “out of the box” (e.g., widen the track, change the overall suspension system). Leaders need more creative solutions than just keeping the same train with a few minor tweaks. Instead, they must come up with more revolutionary visions.

Strategy Spotlight 11.1 discusses Joe Ling’s visionary approach to 3M’s sustainability strategy. This example illustrates that visionary leadership is not just the domain of the CEO.

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Designing the Organization

designing the organization a strategic leadership activity of building structures, teams, systems, and organizational processes that facilitate the implementation of the leader’s vision and strategies.

At times, almost all leaders have difficulty implementing their vision and strategies.7 Such problems may stem from a variety of sources:

• Lack of understanding of responsibility and accountability among managers.

• Reward systems that do not motivate individuals (or collectives such as groups and divisions) toward desired organizational goals.

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• Inadequate or inappropriate budgeting and control systems.

• Insufficient mechanisms to integrate activities across the organization.

Successful leaders are actively involved in building structures, teams, systems, and organizational processes that facilitate the implementation of their vision and strategies. Without appropriately structuring organizational activities, a firm would generally be unable to attain an overall low-cost advantage by closely monitoring its costs through detailed and formalized cost and financial control procedures. With regard to corporate-level strategy, a related diversification strategy would necessitate reward systems that emphasize behavioral measures because interdependence among business units tends to be very important. In contrast, reward systems associated with an unrelated diversification strategy should rely more on financial indicators of performance because business units are relatively autonomous.

These examples illustrate the important role of leadership in creating systems and structures to achieve desired ends. As Jim Collins says about the importance of designing the organization, “Along with figuring out what the company stands for and pushing it to understand what it’s really good at, building mechanisms is the CEO’s role—the leader as architect.”8

Nurturing a Culture Committed to Excellence and Ethical Behavior

excellent and ethical organizational culture an organizational culture focused on core competencies and high ethical standards.

Organizational culture can be an effective means of organizational control.9 Leaders play a key role in changing, developing, and sustaining an organization’s culture. Consider a Chinese firm, Huawei, a highly successful producer of communication network solutions and services.10 In 2012, it achieved revenues of $35.4 billion and net profits of $2.5 billion. Its strong culture can be attributed to its founder, Ren Zhengfei, and his background in the People’s Liberation Army. It is a culture which eliminates individualism and promotes collectivism and the idea of hunting in packs. It is the “wolf culture” of Huawei:

The culture of Huawei is built on a sense of patriotism, with Mr. Zhengfei frequently citing Mao Zedong’s thoughts in his speeches and internal publications such as the employee magazine Huawei People. Sales teams are referred to as “Market Guerrillas,” and battlefield tactics, such as “occupy rural areas first to surround cities,” are used internally. In addition to Mao Zedong, Mr. Zhengfei has urged his employees to look to the Japanese and Germans for inspiration on how to conduct themselves. This is exemplified by the words written in a letter to new hires that states, “I hope you abandon the mentality of achieving quick results, learn from the Japanese down-to-earth attitude and the German’s spirit of being scrupulous to every detail.”

The notion of “wolf culture” stems from the fact that Huawei workers are encouraged to learn from the behavior of wolves, which have a keen sense of smell, are aggressive, and, most important of all, hunt in packs. It is this collective and aggressive spirit that is the center of the Huawei culture. Combining the behavior of wolves with military-style training has been

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instrumental in building the culture of the company, which, in turn, is widely thought to be instrumental in the company’s success.

In sharp contrast, leaders can also have a very detrimental effect on a firm’s culture and ethics. Imagine the negative impact that Todd Berman’s illegal activities have had on a firm that he cofounded—New York’s private equity firm Chartwell Investments.11 He stole more than $3.6 million from the firm and its investors. Berman pleaded guilty to fraud charges brought by the Justice Department. For 18 months he misled Chartwell’s investors concerning the financial condition of one of the firm’s portfolio companies by falsely claiming it needed to borrow funds to meet operating expenses. Instead, Berman transferred the money to his personal bank account, along with fees paid by portfolio companies.

Clearly, a leader’s behavior and values can make a strong impact on an organization—for good or for bad. Strategy Spotlight 11.2 provides a positive example. It discusses how the chairman of Infosys create an ethical culture by “walking the talk.”

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STRATEGY SPOTLIGHT 11.2 ETHICS

INSTILLING ETHICS AND A FIRM’S VALUES: WALKING THE TALK Firms often draft elaborate value statements and codes of conduct, yet many firms do not to live up to their own standards—or in other words, fail to “walk the talk.” Take the positive example of N. R. Narayana Murthy, chairman and one of the founders of Infosys (a giant Indian technology company). In February 1984, shortly after the firm was founded, Infosys decided to import a super minicomputer so that it could start developing software for overseas clients. When the machine landed at Bangalore Airport, the local customs official refused to clear it unless the company “took care of him”—the Indian euphemism for demanding a bribe. A delay at customs could have threatened the project. Yet, instead of caving into the unethical customs official’s demands, Mr. Murthy kept true to his values and took the more expensive formal route of paying a customs duty of 135 percent with dim chances of successfully appealing the duty and receiving a refund.

Reflecting on these events, Mr. Murthy reasons, “We didn’t have enough money to pay the duty and had to borrow it. However, because we had decided to do business ethically, we didn’t have a choice. We would not pay bribes. We effectively paid twice for the machine and had only a slim chance of recovering our money. But a clear conscience is the softest pillow on which you can lay your head down at night…. It took a few years for corrupt officials to stop approaching us for favors.”

Source: Raman, A. P. 2011. “Why don’t we try to be India’s most respected company?” Harvard Business Review, 89(11): 82.

Managers and top executives must accept personal responsibility for developing and strengthening ethical behavior throughout the organization. They must consistently demonstrate that such behavior is central to the vision and mission of the organization. Several elements must be present and reinforced for a firm to become highly ethical, including role models, corporate credos and codes of conduct, reward and evaluation systems, and policies and procedures. Given the importance of these elements, we address them in detail in the last section of this chapter.

LO11.2

Two elements of effective leadership: overcoming barriers to change and the effective use of power.

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Getting Things Done: Overcoming Barriers and Using Power

The demands on leaders in today’s business environment require them to perform a variety of functions. The success of their organizations often depends on how they as individuals meet challenges and deliver on promises. What practices and skills are needed to get the job done effectively? In this section, we focus on two capabilities that are marks of successful leadership—overcoming barriers to change and the effective use of power. Then, in the next section, we will examine an important human trait that helps leaders be more effective—emotional intelligence.

Overcoming Barriers to Change What are the barriers to change that leaders often encounter, and how can they best bring about organizational change? 12 After all, people generally have some level of choice about how strongly they support or resist a leader’s change initiatives. Why is there often so much resistance? Organizations at all levels are prone to inertia and are slow to learn, adapt, and change because:

barriers to change characteristics of individuals and organizations that prevent a leader from transforming an organization.

1. Many people have vested interests in the status quo. People tend to be risk averse and resistant to change. There is a broad stream of research on “escalation,” wherein certain individuals continue to throw “good money at bad decisions” despite negative performance feedback.13

vested interest in the status quo a barrier to change that stems from people’s risk aversion.

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2. There are systemic barriers. The design of the organization’s structure, information processing, reporting relationships, and so forth impede the proper flow and evaluation of information. A bureaucratic structure with multiple layers, onerous requirements for documentation, and rigid rules and procedures will often “inoculate” the organization against change.

systemic barriers barriers to change that stem from an organizational design that impedes the proper flow and evaluation of information.

3. Behavioral barriers cause managers to look at issues from a biased or limited perspective due to their education, training, work experiences, and so forth. Consider an incident shared by David Lieberman, marketing director at GVO, an innovation consulting firm:

behavioral barriers barriers to change associated with the tendency for managers to look at issues from a biased or limited perspective based on their prior education and experience.

A company’s creative type had come up with a great idea for a new product. Nearly everybody loved it. However, it was shot down by a high-ranking manufacturing representative who exploded: “A new color? Do you have any idea of the spare-parts problem that it will create?” This was not a dimwit exasperated at having to build a few storage racks at the warehouse. He’d been hearing for years about cost cutting, lean inventories, and “focus.” Lieberman’s comment: “Good concepts, but not always good for innovation.”

4. Political barriers refer to conflicts arising from power relationships. This can be the outcome of a myriad of symptoms such as vested interests, refusal to share information, conflicts over resources, conflicts between departments and divisions, and petty interpersonal differences.

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political barriers barriers to change related to conflicts arising from power relationships.

5. Personal time constraints bring to mind the old saying about “not having enough time to drain the swamp when you are up to your neck in alligators.” Gresham’s law of planning states that operational decisions will drive out the time necessary for strategic thinking and reflection. This tendency is accentuated in organizations experiencing severe price competition or retrenchment wherein managers and employees are spread rather thin.

personal time constraints a barrier to change that stems from people’s not having sufficient time for strategic thinking and reflection.

Strategy Spotlight 11.3 discusses how Microsoft and Natura Cosméticos were able to overcome political barriers to change through creating a more collaborative environment.

Leaders must draw on a range of personal skills as well as organizational mechanisms to move their organizations forward in the face of such barriers. Two factors mentioned earlier—building a learning organization and ethical organization—provide the kind of climate within which a leader can advance the organization’s aims and make progress toward its goals.

One of the most important tools a leader has for overcoming barriers to change is their personal and organizational power. On the one hand, good leaders must be on guard not to abuse power. On the other hand, successful leadership requires the measured exercise of power. We turn to that topic next.

The Effective Use of Power Successful leadership requires the effective use of power in overcoming barriers to change.14 As humorously noted by Mark Twain, “I’m all for progress. It’s change I object to.” Power refers to a leader’s ability to get things done in a way he or she wants them to be done. It is the ability to influence other people’s behavior, to persuade them to do things that they otherwise would not do, and to overcome resistance and opposition. Effective exercise of power is essential for successful leadership.15

power a leader’s ability to get things done in a way he or she wants them to be done.

A leader derives his or her power from several sources or bases. The simplest way to understand the bases of power is by classifying them as organizational and personal, as shown in Exhibit 11.2.

Organizational bases of power refer to the power that a person wields because of her formal management position.16

These include legitimate, reward, coercive, and information power. Legitimate power is derived from organizationally conferred decision-making

organizational bases of power a formal management position that is the basis of a leader’s power.

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authority and is exercised by virtue of a manager’s position in the organization. Reward power depends on the ability of the leader or manager to confer rewards for positive behaviors or outcomes. Coercive power is the power a manager exercises over employees using

STRATEGY SPOTLIGHT 11.3

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OVERCOMING POLITICAL BARRIERS TO CHANGE To overcome barriers to organizational change, companies today work more collaboratively than ever before, inside their own organizations and with outsiders. While virtual team meetings and other technology gadgets such as Facebook and Twitter facilitate discussions and employee empowerment, it is not enough for leaders to rely on technology. Instead, top management must lead by example and be good collaborators themselves. One obstacle to effective collaboration is higher-level political battles. Take Microsoft as an example. Before Apple released its tablet smash hit iPad, Microsoft had developed a viable tablet more than a decade earlier. However, entrenched interests and turf fights between competing Microsoft divisions eventually killed the project. Microsoft since then appears to be focusing on closer managerial collaboration, as the recent acquisition of Skype illustrates. The voice and video conferencing provider will become a Microsoft business unit that is required to collaborate closely with other Microsoft divisions in an effort to realize the anticipated synergies of the acquisition.

Brazil’s Natura Cosméticos provides another example of overcoming barriers to change by addressing political barriers. Alessandro Carlucci, CEO of the large manufacturer and marketer of beauty products, has implemented a comprehensive “engagement process” that promotes a collaborative mindset at all levels of the organization. As part of this process, Mr. Carlucci made it a priority to unify his top executives behind common goals and stop internal power struggles that became increasingly evident after Natura became a public company in 2004. He asked top managers to invest in self-development as part of their stewardship of the company. So each executive embarked on a “personal journey” with a dedicated coach, who met with everyone individually and with the team as a whole. Carlucci explains that “it is a different type of coaching. It’s not just talking to your boss or subordinates but talking about a person’s life history, with their families; it is more holistic, broader, integrating all the different roles of a human being.” Different from other developmental processes, this coaching approach emphasizes the human side of top team members, with all their distinct strengths but also their weaknesses. This coaching experience effectively illustrates that no top manager at Natura alone has all the answers and that collaboration is not only possible but also essential for long-term success. Carlucci’s efforts to create a collaborative mindset have started to get recognized by outsiders and have helped the firm win a top spot on Fortune’s list of best companies for leaders.

Source: Ibarra, H. and Hansen, M.T. 2011. Are you a collaborative leader? Harvard Business Review, 89(7/8): 68–75; Anonymous. 2011. Analysis: What does Microsoft’s Skype acquisition mean for businesses? www.computerweekly.com, May 13: np; Hansen, M.T. and Ibarra, H. 2011. Getting collaboration right. blogs.hbr.org, May 16: np.

EXHIBIT 11.2 A Leader’s Bases of Power

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fear of punishment for errors of omission or commission. Information power arises from a manager’s access, control, and distribution of information that is not freely available to everyone in an organization.

STRATEGY SPOTLIGHT 11.4

THE USE OF “SOFT” POWER AT SIEMENS Until 1999, paying bribes in international markets was not only legally allowed in Germany, German corporations could also deduct bribes from taxable income. However, once those laws changed, German industrial powerhouse Siemens found it hard to break its bribing habit in its sprawling global operations. Eventually a major scandal forced many top executives out of the firm, including CEO Klaus Kleinfeld. As the successor to Mr. Kleinfeld, Peter Löscher became the first outside CEO in the more than 160-year history of Siemens in 2007. As an outsider Mr. Löscher found it challenging to establish himself as a strong leader inside the bureaucratic Siemens organization. However, he eventually found a way to successfully transition into his new position.

Naturally, in the early stage of his tenure, he lacked internal connections and the bases of power associated with inside knowledge of people and processes. Yet Siemens faced tremendous challenges, such as a lack of customer orientation, and required a strong leader with the ability to change the status quo. Absent a more formal power base, he turned to more informal means to accomplish his mandate of organizational change and increasing customer orientation.

Once a year, all 700 of Siemens top managers come together for a leadership conference in Berlin. Given the historical lack of customer focus, Löscher used peer pressure as an informal (or soft) form of power in order to challenge and eventually change the lack of customer orientation. As he recalls from his first leadership conference as CEO, “I collected the Outlook calendars for the previous year from all my division CEOs and board members. Then I mapped how much time they had spent with customers and I ranked them. There was a big debate in my inner circle over whether I should use names. Some felt we would embarrass people, but I decided to put the names on the screen anyway.”

The results of this exercise were quite remarkable: Mr. Löscher spent around 50 percent of his time with customers, more than any other top executive. Clearly, the people who were running the business divisions should rank higher on customer interaction than the CEO. This confirmed the lack of customer orientation in the organization. This ranking has been repeated at every Siemens leadership conference since Löscher took office. Over time, customer orientation has improved because nobody wants to fall short on this metric and endure potential ridicule. Löscher’s leadership style and use of soft power during his early time in office seemed to have paid off, as the Siemens board extended his contract as CEO of the German industry icon a year early.

Source: Löscher, P. 2012. The CEO of Siemens on using a scandal to drive change. Harvard Business Review, 90(11): 42; and Anonymous. 2011. Löscher soll Vorstandschef bleiben. www.manager-magazin.de, July 25: np.

A leader might also be able to influence subordinates because of his or her personality characteristics and behavior. These would be considered the personal bases of power, including referent power and expert power. The source of referent power is a subordinate’s identification with the leader. A leader’s personal attributes or charisma might influence subordinates and make them devoted to that leader. The source of expert power is the leader’s expertise and knowledge. The leader is the expert on whom subordinates depend for information that they need to do their jobs successfully.

personal bases of power a leader’s personality characteristics and behavior that are the basis of the leader’s power.

Successful leaders use the different bases of power, and often a combination of them, as appropriate to meet the demands of a situation, such as the nature of the task, the personality characteristics of the subordinates, and the urgency of the issue.17 Persuasion and developing consensus are often essential, but so is pressing for action. At some point

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stragglers must be prodded into line.18 Peter Georgescu, who recently retired as CEO of Young & Rubicam (an advertising and media subsidiary of the UK-based WPP Group), summarized a leader’s dilemma brilliantly (and humorously), “I have knee pads and a .45. I get down and beg a lot, but I shoot people too.”19

Strategy Spotlight 11.4 addresses some of the subtleties of power. Here, the CEO of Siemens successfully brought about organizational change by the effective use of peer pressure.

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LO11.3

The crucial role of emotional intelligence (EI) in successful leadership as well as its potential drawbacks.

Emotional Intelligence: A Key Leadership Trait

In the previous sections, we discussed skills and activities of strategic leadership. The focus was on “what leaders do and how they do it.” Now, the issue becomes “who leaders are,” that is, what leadership traits are the most important. Clearly, these two issues are related, because successful leaders possess the valuable traits that enable them to perform effectively in order to create value for their organization.20

There has been a vast amount of literature on the successful traits of leaders.21 These traits include integrity, maturity, energy, judgment, motivation, intelligence, expertise, and so on. For simplicity, these traits may be grouped into three broad sets of capabilities:

• Purely technical skills (like accounting or operations research).

• Cognitive abilities (like analytical reasoning or quantitative analysis).

• Emotional intelligence (like self-management and managing relationships).

“Emotional intelligence (EI)” has become popular in both the literature and management practice in recent years.22

Harvard Business Review articles published in 1998 and 2000 by psychologist/journalist Daniel Goleman, who is most closely associated with the concept, have become HBR’s most highly requested reprint articles. And two of Goleman’s recent books, Emotional Intelligence and Working with Emotional Intelligence, were both on the New York Times’s best- seller lists. Goleman defines emotional intelligence as the capacity for recognizing one’s own emotions and those of others.23

emotional intelligence (EI) an individual’s capacity for recognizing his or her own emotions and those of others, including the five components of self-awareness, self-regulation, motivation, empathy, and social skills.

Recent studies of successful managers have found that effective leaders consistently have a high level of EI.24

Findings indicate that EI is a better predictor of life success (economic well-being, satisfaction with life, friendship, family life), including occupational attainments, than IQ. Evidence is consistent with the catchy phrase: “IQ gets you hired, but EQ (Emotional Quotient) gets you promoted.” Human resource managers believe this statement to be true, even for highly technical jobs such as those of scientists and engineers.

This is not to say that IQ and technical skills are irrelevant, but they become “threshold capabilities.” They are the necessary requirements for attaining higher-level managerial positions. EI, on the other hand, is essential for leadership success. Without it, Goleman claims, a manager can have excellent training, an incisive analytical mind, and many smart ideas but will still not be a great leader.

Exhibit 11.3 identifies the five components of EI: self-awareness, self-regulation, motivation, empathy, and social skill.

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Self-Awareness Self-awareness is the first component of EI and brings to mind that Delphic oracle who gave the advice “know thyself” thousands of years ago. Self-awareness involves a person having a deep understanding of his or her emotions, strengths, weaknesses, and drives. People with strong self-awareness are neither overly critical nor unrealistically optimistic. Instead, they are honest with themselves and others.

People generally admire and respect candor. Leaders are constantly required to make judgment calls that require a candid assessment of capabilities—their own and those of others. People who assess themselves honestly (i.e., self-aware people) are well suited to do the same for the organizations they run.25

Self-Regulation Biological impulses drive our emotions. Although we cannot do away with them, we can strive to manage them. Self- regulation, which is akin to an ongoing inner conversation, frees us from being prisoners of our feelings.26 People engaged in such conversation feel bad moods and emotional impulses just as everyone else does. However, they find ways to control them and even channel them in useful ways.

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EXHIBIT 11.3 The Five Components of Emotional Intelligence at Work

Definition Hallmarks

Self-management skills:

Self- awareness

• The ability to recognize and understand your moods, emotions, and drives, as well as their effect on others.

• Self-confidence

• Realistic self-assessment

• Self-deprecating sense of humor

Self- regulation

• The ability to control or redirect disruptive impulses and moods. • Trustworthiness and integrity

• Comfort with ambiguity

• The propensity to suspend judgment—to think before acting. • Openness to change

Motivation • A passion to work for reasons that go beyond money or status. • Strong drive to achieve

• Optimism, even in the face of failure

• A propensity to pursue goals with energy and persistence. • Organizational commitment

Managing relationships:

Empathy • The ability to understand the emotional makeup of other people. • Expertise in building and retaining talent

• Cross-cultural sensitivity

• Skill in treating people according to their emotional reactions. • Service to clients and customers

Social skill • Proficiency in managing relationships and building networks. • Effectiveness in leading change

• Persuasiveness

• An ability to find common ground and build rapport. • Expertise in building and leading teams

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Source: Reprinted by permission of Harvard Business Review. Exhibit from “What Makes a Leader,” by D. Goleman, January 2004. Copyright © 2004 by the Harvard Business School Publishing Corporation; all rights reserved.

Self-regulated people are able to create an environment of trust and fairness where political behavior and infighting are sharply reduced and productivity tends to be high. People who have mastered their emotions are better able to bring about and implement change in an organization. When a new initiative is announced, they are less likely to panic; they are able to suspend judgment, seek out information, and listen to executives explain the new program.

Motivation Successful executives are driven to achieve beyond expectations—their own and everyone else’s. Although many people are driven by external factors, such as money and prestige, those with leadership potential are driven by a deeply embedded desire to achieve for the sake of achievement.

Motivated people show a passion for the work itself, such as seeking out creative challenges, a love of learning, and taking pride in a job well done. They also have a high level of energy to do things better as well as a restlessness with the status quo. They are eager to explore new approaches to their work.

Empathy Empathy is probably the most easily recognized component of EI. Empathy means thoughtfully considering an employee’s feelings, along with other factors, in the process of making intelligent decisions. Empathy is particularly important in today’s business

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environment for at least three reasons: the increasing use of teams, the rapid pace of globalization, and the growing need to retain talent.27

STRATEGY SPOTLIGHT 11.5

EMPATHY IN A PEDIATRIC DENTAL PRACTICE A key strength of effective leaders is to see situations from another person’s perspective—or in other words, to show empathy. Empathy is especially important when dealing with customers who may not always be able to articulate their preferences. Take dental practices for children. Children’s dental offices often look, smell, and sound remarkably similar to regular dental practices for the simple reason that the owners design their offices in terms of what they produce (i.e., dental services) instead of what would be best for their customers.

While even many parents have negative feelings toward dental offices, it is naturally quite challenging to create some excitement or at least lower the anxieties children experience. That’s where a healthy portion of empathy enters the picture. Let’s try to view your dental practice from a child’s point of view. How to best accomplish this? Forget conventional wisdom, and experience your dental practice from your knees! Several interesting insights may emerge just by emulating a child’s experience. First, what is the first thing that you see when you enter the practice? Chances are, not much, as the reception area is conveniently set at eye level—adult eye level. Even the most wonderful receptionist remains invisible for children coming into the practice. Second, what do you hear? Again, chances are that you will hear the all-too-familiar sound of dental equipment, something that may sound to children like torturing mice in the next room. Third, what do you smell? Frankly, doctor’s offices have a distinct smell that equals panic for children and even many adults.

So what is the major takeaway from putting yourself into a kid’s shoes? Seeing the world from your customer’s point of view may lead you to lower the reception desk so children can see the sweet receptionist. You may also play some one-beat-per-second music to evoke the sense of a heartbeat. Finally, you could sound-proof the examination rooms so that dental drilling noise is reduced. Overall, this example demonstrates that empathy—or the

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ability to see situations from another person’s perspective—may allow business owners to tailor their service and product offerings to specific customer segments.

Source: Burrus, D. 2011. Flash foresight. New York: Harper Business: xxii–xxiv.

When leading a team, a manager is often charged with arriving at a consensus—often in the face of a high level of emotions. Empathy enables a manager to sense and understand the viewpoints of everyone around the table.

Globalization typically involves cross-cultural dialogue that can easily lead to miscues. Empathetic people are attuned to the subtleties of body language; they can hear the message beneath the words being spoken. They have a deep understanding of the existence and importance of cultural and ethnic differences.

Empathy also plays a key role in retaining talent. Human capital is particularly important to a firm in the knowledge economy when it comes to creating advantages that are sustainable. Leaders need empathy to develop and keep top talent, because when high performers leave, they take their tacit knowledge with them.

Strategy Spotlight 11.5 shows that empathy can pay off in a wide variety of settings. Here it helps a pediatric dental practice to view its business through the eyes of a child.

Social Skill While the first three components of EI are all self-management skills, the last two—empathy and social skill—concern a person’s ability to manage relationships with others. Social skill may be viewed as friendliness with a purpose: moving people in the direction you desire, whether that’s agreement on a new marketing strategy or enthusiasm about a new product.

Socially skilled people tend to have a wide circle of acquaintances as well as a knack for finding common ground and building rapport. They recognize that nothing gets done alone, and they have a network in place when the time for action comes.

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Social skill can be viewed as the culmination of the other dimensions of EI. People will be effective at managing relationships when they can understand and control their own emotions and empathize with others’ feelings. Motivation also contributes to social skill. People who are driven to achieve tend to be optimistic, even when confronted with setbacks. And when people are upbeat, their “glow” is cast upon conversations and other social encounters. They are popular, and for good reason.

A key to developing social skill is to become a good listener—a skill that many executives find to be quite challenging. Teresa Taylor, chief operating officer at Quest Communications, says:28

“Over the years, something I really try to focus on is truly listening. When I say that, I mean sometimes people act like they’re listening but they’re really formulating their own thoughts in their heads. I’m trying to put myself into someone else’s shoes, trying to figure out what’s motivating them, and why they are in the spot they are in.”

Emotional Intelligence: Some Potential Drawbacks and Cautionary Notes Many great leaders have great reserves of empathy, interpersonal astuteness, awareness of their own feelings, and an awareness of their impact on others.29 More importantly, they know how to apply these capabilities judiciously as best benefits the situation. Having some minimum level of EI will help a person be effective as a leader as long as it is channeled appropriately. However, if a person has a high level of these capabilities it may become “too much of a good thing” if he or she is allowed to drive inappropriate behaviors. Some additional potential drawbacks of EI can be gleaned by considering the flip side of its benefits.

Effective Leaders Have Empathy for Others However, they also must be able to make the “tough decisions.” Leaders must be able to appeal to logic and reason and acknowledge others’ feelings so that people feel the decisions are correct. However, it is easy to overidentify with others or confuse empathy with sympathy. This can make it more difficult to make the tough decisions.

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Effective Leaders Are Astute Judges of People A danger is that leaders may become judgmental and overly critical about the shortcomings they perceive in others. They are likely to dismiss other people’s insights, making them feel undervalued.

Effective Leaders Are Passionate about What They Do, and They Show It This doesn’t mean that they are always cheerleaders. Rather, they may express their passion as persistence in pursuing an objective or a relentless focus on a valued principle. However, there is a fine line between being excited about something and letting your passion close your mind to other possibilities or cause you to ignore realities that others may see.

Effective Leaders Create Personal Connections with Their People Most effective leaders take time to engage employees individually and in groups, listening to their ideas, suggestions and concerns, and responding in ways that make people feel that their ideas are respected and appreciated. However, if the leader makes too many unannounced visits, it may create a culture of fear and micromanagement. Clearly, striking a correct balance is essential.

From a moral standpoint, emotional leadership is neither good nor bad. On the one hand, emotional leaders can be altruistic, focused on the general welfare of the company and its employees, and highly principled. On the other hand, they can be manipulative, selfish, and dishonest. For example, if a person is using leadership solely to gain power, that is not leadership at all.30 Rather, they are using their EI to grasp what people want and pander to those desires in order to gain authority and influence. After all, easy answers sell.

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LO11.4

The importance of developing competency companions and creating a learning organization.

Developing Competency Companions and Creating a Learning Organization

Leaders at all levels of the organization need to reflect on the skills that they have and how they can build and extend their skill set.31 Too often leaders get stuck extending the competencies they already have. However, the most promising path for an individual to learn and grow may be to develop new competencies that complement the skills and abilities they already have. For example, a leader who has great competency in developing innovative ideas can extend the value of that competency by developing strong communication skills. Such a leader would benefit from an interaction effect, a situation where the combination of two skills can generate an outcome that is significantly greater than either skill can produce on its own. By enhancing communication skills, this highly innovative leader is more likely to be able to communicate the value of both innovative ideas she has developed and also the necessity to push innovative learning and development throughout the organization.

Strategy Spotlight 11.6 provides useful insights on the benefits of developing competency companions and how to go about it.

Once leaders have reflected on and enhanced their own competencies, they can turn their attention to building a learning organization. Such an organization is capable of adapting to change, fostering creativity, and succeeding in highly competitive markets.

To introduce the concept of a learning organization, we’ll draw on Charles Handy, one of today’s most respected business visionaries. He is author of The Age of Unreason and The Age of Paradox and he shared an amusing story several years ago:

The other day, a courier could not find my family’s remote cottage. He called his base on his radio, and the base called us to ask directions. He was just around the corner, but his base managed to omit a vital part of the directions. So he called them again, and they called us again. Then the courier repeated the cycle a third time to ask whether we had a dangerous dog. When he eventually arrived, we asked whether it would not have been simpler and less aggravating to everyone if he had called us directly from the roadside telephone booth where he had been parked. “I can’t do that,” he said, “because they won’t refund any money I spend.” “But it’s only pennies!” I exclaimed. “I know,” he said, “but that only shows how little they trust us!”32

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At first glance, it would appear that the story epitomizes the lack of empowerment and trust granted to the hapless courier: Don’t ask questions! Do as you’re told!33 However, implicit in this scenario is also the message that learning, information sharing, adaptation, decision making, and so on are not shared throughout the organization. In contrast, leading-edge organizations recognize the importance of having everyone involved in the process of actively learning and adapting. As noted by today’s leading expert on learning organizations, MIT’s Peter Senge, the days when Henry Ford, Alfred Sloan, and Tom Watson “learned for the organization” are gone.

In an increasingly dynamic, interdependent, and unpredictable world, it is simply no longer possible for anyone to “figure it all out at the top.” The old model, “the top thinks and the local acts,” must now give way to integrating thinking and acting at all levels. While the challenge is great, so is the potential payoff. “The person who figures out how to harness the collective genius of the people in his or her organization,” according to former Citibank CEO Walter Wriston, “is going to blow the competition away.”34

Learning and change typically involve the ongoing questioning of an organization’s status quo or method of procedure. This means that all individuals throughout the organization must be reflective.35 Many organizations get so caught up in carrying out their

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day-to-day work that they rarely, if ever, stop to think objectively about themselves and their businesses. They often fail to ask the probing questions that might lead them to call into question their basic assumptions, to refresh their strategies, or to reengineer their work processes. According to Michael Hammer and Steven Stanton, the pioneer consultants who touched off the reengineering movement:

STRATEGY SPOTLIGHT 11.6

COMPETENCY COMPANIONS: LEVERAGING A LEADER’S STRENGTHS Leaders who want to take the next step in their career can follow a straightforward four-step cross-training process. The basic idea behind this cross-training approach is simple yet effective. While the most effective leaders have at least one competency that makes them great and eventually indispensable, it makes little sense to continually work on already great qualities. Instead, leaders can benefit from identifying and developing complementary strengths. Building complementary strengths—or competency companions—may lead to substantially greater leadership effectiveness than finding increasingly rare opportunities to improve an already outstanding competency.

First, leaders must identify their strengths in areas that usually fall into five categories: character, personal capability, getting results, interpersonal skills, and leading change. While this task can be done in multiple ways, it is important to realize that your own view is less important than how others see you, making a 360-degree evaluation the method of choice.

Second, choose a strength to focus on. Most people find it easy to identity weaknesses and focus their attention on improving them. Unless a competence is extremely underdeveloped (i.e., in the 10th percentile), however, it may pay to focus on an already strong yet not outstanding competency. Developing a competency from strong to outstanding often can raise the perceived leadership effectiveness dramatically. However, choosing between multiple strong competencies is easier said than done, because most people lack clear selection criteria. To engage effectively in this process, leaders should focus on a strong competency that is important to the organization. Moreover, leaders should choose a competency they feel passionate about.

Third, select a companion behavior. While developing a great or outstanding competency is an important step on the journey to becoming an indispensable leader, it may increasingly pay to also focus on a mediocre competency that can be developed in an interacting (or complementary) fashion. As before, this companion competency should be valued by the organization and also be something the leader feels passionate about.

Lastly, develop your companion behavior. Once you have settled on an organizationally valued and personally engaging competency, you should now work on improving the basic skills in this area. Practically speaking, you could look for as many opportunities as possible to develop this competency, both inside and outside of work. For

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instance, you could take courses or practice informally with friends and coworkers. Volunteer to engage in activities that allow you to practice this skill, and ask for continuous feedback.

Extensive research by Zenger Folkman, a leadership development consultancy, provides solid evidence of the benefits of pairing leader attributes. Such findings were based on an analysis of their database of more than a quarter million 360-degree surveys of some 30,000 developing leaders. Take, for example, the competencies “focuses on results” and “builds relationships.” Only 14 percent of leaders who were reasonably strong (that is, scored in the 75th percentile) in focusing on results but less so in building relationships reached the extraordinary leadership level: the 90th percentile in overall leadership effectiveness. Similarly, only 12 percent of those who were reasonably strong in building relationships but less so in focusing on results reached that level. However, when an individual performed well in both categories, something dramatic happened: Fully 72 percent of those in the 75th percentile in both categories reached the 90th percentile on overall leadership effectiveness.

Source: Zenger, J. H., Folkman, J. R., & Edinger, S. K. 2011. Making yourself indispensable. Harvard Business Review, 89(10): 84–92.

Reflection entails awareness of self, of competitors, of customers. It means thinking without preconception. It means questioning cherished assumptions and replacing them with new approaches. It is the only way in which a winning company can maintain its leadership position, by which a company with great assets can ensure that they continue to be well deployed.36

To adapt to change, foster creativity, and remain competitive, leaders must build learning organizations. Exhibit 11.4 lists the five elements of a learning organization.

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EXHIBIT 11.4 Key Elements of a Learning Organization

These are the five key elements of a learning organization. Each of these items should be viewed as necessary, but not sufficient. That is, successful learning organizations need all five elements.

1. Inspiring and motivating people with a mission or purpose.

2. Empowering employees at all levels.

3. Accumulating and sharing internal knowledge.

4. Gathering and integrating external information.

5. Challenging the status quo and enabling creativity.

Inspiring and Motivating People with a Mission or Purpose Successful learning organizations create a proactive, creative approach to the unknown, actively solicit the involvement of employees at all levels, and enable all employees to use their intelligence and apply their imagination. Higher-level skills are required of everyone, not just those at the top.37 A learning environment involves organizationwide commitment to change, an action orientation, and applicable tools and methods.38 It must be viewed by everyone as a guiding philosophy and not simply as another change program.

learning organizations organizations that create a proactive, creative approach to the unknown, characterized by (1) inspiring and motivating people with a mission and purpose, (2) empowering employees at all levels, (3) accumulating and sharing internal knowledge, (4) gathering and integrating external information, and (5) challenging the status quo and enabling creativity.

A critical requirement of all learning organizations is that everyone feels and supports a compelling purpose. In the words of William O’Brien, CEO of Hanover Insurance, “Before there can be meaningful participation, people must share certain values and pictures about where we are trying to go. We discovered that people have a real need to feel that they’re part of an enabling mission.”39 Such a perspective is consistent with an intensive study by Kouzes and Posner, authors of The Leadership Challenge.40 They recently analyzed data from nearly one million respondents who were

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leaders at various levels in many organizations throughout the world. A major finding was that what leaders struggle with most is communicating an image of the future that draws others in, that is, it speaks to what others see and feel. To illustrate:

Buddy Blanton, a principal program manager at Rockwell Collins, learned this lesson firsthand. He asked his team for feedback on his leadership, and the vast majority of it was positive. However, he got some strong advice from his team about how he could be more effective in inspiring a shared vision. “You would benefit by helping us, as a team, to understand how you go to your vision. We want to walk with you while you create the goals and vision, so we all get to the end of the vision together.”41

Inspiring and motivating people with a mission or purpose is a necessary but not sufficient condition for developing an organization that can learn and adapt to a rapidly changing, complex, and interconnected environment.

Empowering Employees at All Levels “The great leader is a great servant,” asserted Ken Melrose, CEO of Toro Company and author of Making the Grass Greener on Your Side.42 A manager’s role becomes one of creating an environment where employees can achieve their potential as they help move the organization toward its goals. Instead of viewing themselves as resource controllers and power brokers, leaders must envision themselves as flexible resources willing to assume numerous roles as coaches, information providers, teachers, decision makers, facilitators, supporters, or listeners, depending on the needs of their employees.43

The central key to empowerment is effective leadership. Empowerment can’t occur in a leadership vacuum. According to Melrose, “You best lead by serving the needs of your people. You don’t do their jobs for them; you enable them to learn and progress on the job.”

Leading-edge organizations recognize the need for trust, cultural control, and expertise at all levels instead of the extensive and cumbersome rules and regulations inherent

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in hierarchical control.44 Some have argued that too often organizations fall prey to the “heroes-and-drones syndrome,” wherein the value of those in powerful positions is exalted and the value of those who fail to achieve top rank is diminished. Such an attitude is implicit in phrases such as “Lead, follow, or get out of the way” or, even less appealing, “Unless you’re the lead horse, the view never changes.” Few will ever reach the top hierarchical positions in organizations, but in the information economy, the strongest organizations are those that effectively use the talents of all the players on the team.

STRATEGY

SPOTLIGHT 11.7

CROWDSOURCING

USING THE WISDOM OF YOUR EMPLOYEES TO MAKE BETTER DECISIONS CEOs are often surrounded by an aura of unfailing business acumen. Yet few CEOs live up to these high expectations over the long run, suggesting that even the most able CEOs have limited abilities. Ironically, shattering the image of the almighty CEO by realizing and identifying cognitive limitations may help us to improve organizational decision making. Consider WBG Construction, a small home builder west of Boston. When important decisions need to be made, Greg Burrill, the president, asks all employees with relevant knowledge or a stake in the outcome for their thoughts. This collaborative approach recently led to a decision that not only sold a house but also inspired a new floor plan that appealed to a whole new segment of buyers.

As another example, EMC, the data storage giant, enables participation by a social media platform called EMC | One. When the recession hit and cost cutting became imperative, EMC used this social media platform to do something most companies would leave to top management: decide where to cut costs. Several thousand

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employees participated and identified cost savings that were largely unknown to top management. The resulting cuts were less painful because employees had a say in the cost reduction. Empowering employees in this manner utilizes the day-to-day insights of lower-level employees and benefits both the firm and the workforce.

In some other cases, bad decisions not only cost money but also can lead to heartbreaking accidents. NASA can look back at some 50 years of pioneering success, but also tragic accidents caused by bad judgment. In February 2009, the flight of space shuttle Discovery was overshadowed by uncertainties about whether an issue with the fuel system should delay the launch. Prior space shuttle launch decisions were made by a small group of individuals supported by a culture of complacency born of many prior successes and communication breakdowns. But NASA finally implemented a much needed change of culture that now values input from all group members. As Mike Ryschkewitsch, NASA’s chief engineer observed, “One of the things that NASA strongly emphasizes now is that any individual who works here, if they see something that doesn’t look right, they have a responsibility to raise it, and they can raise it.” By utilizing the insights of individuals in their organizations, leaders hope to improve organizational decision making and secure the long-term success of their businesses.

Source: Davenport, T. H. 2012. The wisdom of your in-house crowd. Harvard Business Review, 90(10): 40; and Davenport, T. H., & Manville, B. 2012. Judgment calls: Twelve stories of big decisions and the teams that got them right. Boston: Harvard Business Review Press: 25–38.

Empowering individuals by soliciting their input helps an organization to enjoy better employee morale. It also helps create a culture in which middle- and lower-level employees feel that their ideas and initiatives will be valued, and enhance firm performance as explained in Strategy Spotlight 11.7.

Accumulating and Sharing Internal Knowledge Effective organizations must also redistribute information, knowledge (skills to act on the information), and rewards.45 A company might give frontline employees the power to act as “customer advocates,” doing whatever is necessary to satisfy customers. The company needs to disseminate information by sharing customer expectations and feedback as well as financial information. The employees must know about the goals of the business as well as how key value-creating activities in the organization are related to each other. Finally, organizations should allocate rewards on how effectively employees use information, knowledge, and power to improve customer service quality and the company’s overall performance.46

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Let’s take a look at Whole Foods Market, Inc., the largest natural foods grocer in the United States.47 An important benefit of the sharing of internal information at Whole Foods becomes the active process of internal benchmarking. Competition is intense at Whole Foods. Teams compete against their own goals for sales, growth, and productivity; they compete against different teams in their stores; and they compete against similar teams at different stores and regions. There is an elaborate system of peer reviews through which teams benchmark each other. The “Store Tour” is the most intense. On a periodic schedule, each Whole Foods store is toured by a group of as many as 40 visitors from another region. Lateral learning—discovering what your colleagues are doing right and carrying those practices into your organization—has become a driving force at Whole Foods.

In addition to enhancing the sharing of company information both up and down as well as across the organization, leaders also have to develop means to tap into some of the more informal sources of internal information. In a recent survey of presidents, CEOs, board members, and top executives in a variety of nonprofit organizations, respondents were asked what differentiated the successful candidates for promotion. The consensus: The executive was seen as a person who listens. According to Peter Meyer, the author of the study, “The value of listening is clear: You cannot succeed in running a company if you do not hear what your people, customers, and suppliers are telling you…. Listening and understanding well are key to making good decisions.”48

Gathering and Integrating External Information Recognizing opportunities, as well as threats, in the external environment is vital to a firm’s success. As organizations and environments become more complex and evolve rapidly, it is far more critical for employees and managers to

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become more aware of environmental trends and events—both general and industry-specific—and more knowledgeable about their firm’s competitors and customers. Next, we will discuss some ideas on how to do it.

First, the Internet has dramatically accelerated the speed with which anyone can track down useful information or locate people who might have useful information. Prior to the Net, locating someone who used to work at a company—always a good source of information—was quite a challenge. However, today people post their résumés on the web; they participate in discussion groups and talk openly about where they work.

Marc Friedman, manager of market research at $1 billion Andrew Corporation, a fast-growing manufacturer of wireless communications products provides an example of effective Internet use.49 One of Friedman’s preferred sites to visit is Corptech’s website, which provides information on 45,000 high-tech companies and more than 170,000 executives. One of his firm’s product lines consisted of antennae for air-traffic control systems. He got a request to provide a country-by-country breakdown of upgrade plans for various airports. He knew nothing about air-traffic control at the time. However, he found a site on the Internet for the International Civil Aviation Organization. Fortunately, it had a great deal of useful data, including several research companies working in his area of interest.

benchmarking managers seeking out best examples of a particular practice as part of an ongoing effort to improve the corresponding practice in their own organization.

Second, company employees at all levels can use “garden variety” traditional sources to acquire external information. Much can be gleaned by reading trade and professional journals, books, and popular business magazines. Other venues for gathering external information include membership in professional or trade organizations, attendance at meetings and conventions, and networking among colleagues inside and outside of your industry. Intel’s Andy Grove gathered information from people like DreamWorks SKG’s Steven Spielberg and Tele-Communications Inc.’s John Malone.50 He believed that such interaction provides insights into how to make personal computers more entertaining and better at communicating. Internally, Grove spent time with the young engineers who run Intel Architecture labs, an Oregon-based facility that Grove hoped to become the de facto R&D lab for the entire PC industry.

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Third, benchmarking can be a useful means of employing external information. Here managers seek out the best examples of a particular practice as part of an ongoing effort to improve the corresponding practice in their own organization.51 There are two primary types of benchmarking. Competitive benchmarking restricts the search for best practices to competitors, while functional benchmarking endeavors to determine best practices regardless of industry. Industry-specific standards (e.g., response times required to repair power outages in the electric utility industry) are typically best handled through competitive benchmarking, whereas more generic processes (e.g., answering 1-800 calls) lend themselves to functional benchmarking because the function is essentially the same in any industry.

competitive benchmarking benchmarking where the examples are drawn from competitors in the industry.

functional benchmarking benchmarking where the examples are drawn from any organization, even those outside the industry.

Ford Motor Company used benchmarking to study Mazda’s accounts payable operations.52 Its initial goal of a 20 percent cut in its 500-employee accounts payable staff was ratcheted up to 75 percent—and met. Ford found that staff spent most of their time trying to match conflicting data in a mass of paper, including purchase orders, invoices, and receipts. Following Mazda’s example, Ford created an “invoiceless system” in which invoices no longer trigger payments to suppliers. The receipt does the job.

Fourth, focus directly on customers for information. For example, William McKnight, head of 3M’s Chicago sales office, required that salesmen of abrasives products talk directly to the workers in the shop to find out what they needed, instead of calling on only front-office executives.53 This was very innovative at the time—1909! But it illustrates the need to get to the end user of a product or service. (McKnight went on to become 3M’s president from 1929 to 1949 and

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chairman from 1949 to 1969.) More recently, James Taylor, senior vice president for global marketing at Gateway 2000, discussed the value of customer input in reducing response time, a critical success factor in the PC industry.

We talk to 100,000 people a day—people calling to order a computer, shopping around, looking for tech support. Our website gets 1.1 million hits per day. The time it takes for an idea to enter this organization, get processed, and then go to customers for feedback is down to minutes. We’ve designed the company around speed and feedback.54

Challenging the Status Quo and Enabling Creativity Earlier in this chapter we discussed some of the barriers that leaders face when trying to bring about change in an organization: vested interests in the status quo, systemic barriers, behavioral barriers, political barriers, and personal time constraints. For a firm to become a learning organization, it must overcome such barriers in order to foster creativity and enable it to permeate the firm. This becomes quite a challenge if the firm is entrenched in a status quo mentality.

Perhaps the best way to challenge the status quo is for the leader to forcefully create a sense of urgency. For example, when Tom Kasten was vice president of Levi Strauss, he had a direct approach to initiating change.

You create a compelling picture of the risks of not changing. We let our people hear directly from customers. We videotaped interviews with customers and played excerpts. One big customer said, “We trust many of your competitors implicitly. We sample their deliveries. We open all Levi’s deliveries.” Another said, “Your lead times are the worst. If you weren’t Levi’s, you’d be gone.” It was powerful. I wish we had done more of it.55

Such initiative, if sincere and credible, establishes a shared mission and the need for major transformations. It can channel energies to bring about both change and creative endeavors.

Establishing a “culture of dissent” can be another effective means of questioning the status quo and serving as a spur toward creativity. Here norms are established whereby dissenters can openly question a superior’s perspective without fear of retaliation or

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retribution. Consider the perspective of Steven Balmer, Microsoft’s CEO, in discussing the firm’s former chairman, Bill Gates.

Bill [Gates] brings to the company the idea that conflict can be a good thing…. Bill knows it’s important to avoid that gentle civility that keeps you from getting to the heart of an issue quickly. He likes it when anyone, even a junior employee, challenges him, and you know he respects you when he starts shouting back.56

Closely related to the culture of dissent is the fostering of a culture that encourages risk taking. “If you’re not making mistakes, you’re not taking risks, and that means you’re not going anywhere,” claimed John Holt, coauthor of Celebrate Your Mistakes.57 “The key is to make errors faster than the competition, so you have more chances to learn and win.”

Companies that cultivate cultures of experimentation and curiosity make sure that failure is not, in essence, an obscene word. They encourage mistakes as a key part of their competitive advantage. It has been said that innovation has a great paradox: Success—that is, true breakthroughs—usually come through failure. Below are some approaches to encourage risk taking and learning from mistakes in an organization:58

• Formalize Forums for Failure To keep failures and the important lessons that they offer from getting swept under the rug, carve out time for reflection. GE recently began sharing lessons from failure by bringing together managers whose “Imagination Breakthrough” efforts were put on the shelf.

• Move the Goalposts Innovation requires flexibility in meeting goals, since early predictions are often little more than educated guesses. Intuit’s Scott Cook even goes so far as to suggest that teams developing new products ignore forecasts in the early days. “For every one of our failures, we had spreadsheets that looked awesome,” he claims.

• Bring in Outsiders Outsiders can help neutralize the emotions and biases that prop up a flop. Customers can be the most valuable. After its DNA chip failed, Corning brought pharmaceutical companies in early to test its new drug- discovery technology, Epic.

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• Prove Yourself Wrong, Not Right Development teams tend to look for supporting, rather than countervailing, evidence. “You have to reframe what you’re seeking in the early days,” says Innosight’s Scott Anthony. “You’re not really seeking proof that you have the right answer. It’s more about testing to prove yourself wrong.”

Finally, failure can play an important and positive role in one’s professional development. John Donahue, eBay’s CEO, draws on the sport of baseball in recalling the insight (and inspiration!) one of his former bosses shared with him:59

“The best hitters in Major League Baseball, world class, they can strike out six times out of ten and still be the greatest hitters of all time. That’s my philosophy—the key is to get up in that batter’s box and take a swing. And all you have to do is hit one single, a couple of doubles, and an occasional home run out of every ten at-bats, and you’re going to be the best hitter or the best business leader around. You can’t play in the major leagues without having a lot of failures.”

LO11.5

The leader’s role in establishing an ethical organization.

Creating an Ethical Organization

Ethics may be defined as a system of right and wrong.60 Ethics assists individuals in deciding when an act is moral or immoral, socially desirable or not. The sources for an individual’s ethics include religious beliefs, national and ethnic heritage, family practices, community standards, educational experiences, and friends and neighbors. Business ethics is the application of ethical standards to commercial enterprise.

ethics a system of right and wrong that assists individuals in deciding when an act is moral or immoral and/or socially desirable or not.

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Individual Ethics versus Organizational Ethics

organizational ethics the values, attitudes, and behavioral patterns that define an organization’s operating culture and that determine what an organization holds as acceptable behavior.

Many leaders think of ethics as a question of personal scruples, a confidential matter between employees and their consciences. Such leaders are quick to describe any wrongdoing as an isolated incident, the work of a rogue employee. They assume the company should not bear any responsibility for individual misdeeds. In their view, ethics has nothing to do with leadership.

Ethics has everything to do with leadership. Seldom does the character flaw of a lone actor completely explain corporate misconduct. Instead, unethical business practices typically involve the tacit, if not explicit, cooperation of others and reflect the values, attitudes, and behavior patterns that define an organization’s operating culture. Ethics is as much an organizational as a personal issue. Leaders who fail to provide proper leadership to institute proper systems and controls that facilitate ethical conduct share responsibility with those who conceive, execute, and knowingly benefit from corporate misdeeds.61

The ethical orientation of a leader is a key factor in promoting ethical behavior. Ethical leaders must take personal, ethical responsibility for their actions and decision making. Leaders who exhibit high ethical standards become role models for others and raise an organization’s overall level of ethical behavior. Ethical behavior must start with the leader before the employees can be expected to perform accordingly.

ethical orientation

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the practices that firms use to promote an ethical business culture, including ethical role models, corporate credos and codes of conduct, ethically-based reward and evaluation systems, and consistently enforced ethical policies and procedures.

There has been a growing interest in corporate ethical performance. Some reasons for this trend may be the increasing lack of confidence regarding corporate activities, the growing emphasis on quality of life issues, and a spate of recent corporate scandals. Without a strong ethical culture, the chance of ethical crises occurring is enhanced. Ethical crises can be very expensive—both in terms of financial costs and in the erosion of human capital and overall firm reputation. Merely adhering to the minimum regulatory standards may not be enough to remain competitive in a world that is becoming more socially conscious. Strategy Spotlight 11.8 highlights potential ethical problems at utility companies that are trying to capitalize on consumers’ desire to participate in efforts to curb global warming.

The past several years have been characterized by numerous examples of unethical and illegal behavior by many top- level corporate executives. These include executives of firms such as Enron, Tyco, WorldCom, Inc., Adelphia, and Healthsouth Corp., who were all forced to resign and are facing (or have been convicted of) criminal charges. Perhaps the most glaring example is Bernie Madoff, whose Ponzi scheme, which unraveled in 2008, defrauded investors of $50 billion in assets they had set aside for retirement and charitable donations.

The ethical organization is characterized by a conception of ethical values and integrity as a driving force of the enterprise.62 Ethical values shape the search for opportunities, the design of organizational systems, and the decision- making process used by individuals and groups. They provide a common frame of reference that serves as a unifying force across different functions, lines of business, and employee groups. Organizational ethics helps to define what a company is and what it stands for.

There are many potential benefits of an ethical organization, but they are often indirect. Research has found somewhat inconsistent results concerning the overall relationship between ethical performance and measures of financial performance.63 However, positive relationships have generally been found between ethical performance and strong organizational culture, increased employee efforts, lower turnover, higher organizational commitment, and enhanced social responsibility.

The advantages of a strong ethical orientation can have a positive effect on employee commitment and motivation to excel. This is particularly important in today’s knowledge-intensive organizations, where human capital is critical in creating value and competitive advantages. Positive, constructive relationships among individuals (i.e., social capital) are vital in leveraging human capital and other resources in an organization. Drawing on the

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concept of stakeholder management, an ethically sound organization can also strengthen its bonds among its suppliers, customers, and governmental agencies.

STRATEGY

SPOTLIGHT

11.8 ENVIRONMENTAL SUSTAINABILITY

ETHICS

GREEN ENERGY: REAL OR JUST A MARKETING PLOY? Many consumers want to “go green” and are looking for opportunities to do so. Utility companies that provide heat and electricity are one of the most obvious places to turn, because they often use fossil fuels that could be saved through energy conservation or replaced by using alternative energy sources. In fact, some consumers are willing to pay a premium to contribute to environmental sustainability efforts if paying a little more will help curb global warming. Knowing this, many power companies in the United States have developed alternative energy programs and appealed to customers to help pay for them.

Unfortunately, many of the power companies that are offering eco-friendly options are falling short on delivering on them. Some utilities have simply gotten off to a slow start or found it difficult to profitably offer alternative power. Others, however, are suspected of committing a new type of fraud—“greenwashing.” This refers to companies that

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make unsubstantiated claims about how environmentally friendly their products or services really are. In the case of many power companies, their claims of “green power” are empty promises. Instead of actually generating additional renewable energy, most of the premiums are going for marketing costs. “They are preying on people’s goodwill,” says Stephen Smith, executive director of the Southern Alliance for Clean Energy, an advocacy group in Knoxville, Tennessee.

Consider what two power companies offered and how the money was actually spent:

• Duke Power of Indiana created a program called “GoGreen Power.” Customers were told that they could pay a green-energy premium and a specific amount of electricity would be obtained from renewable sources. What actually happened? Less than 18 percent of voluntary customer contributions in a recent year went to renewable energy development.

• Alliant Energy of Iowa established a program dubbed “Second Nature.” Customers were told that they would “support the growth of earth-friendly ‘green power’ created by wind and biomass.” What actually happened? More than 56 percent of expenditures went to marketing and administrative costs, not green-energy development.

Sources: Elgin, B. & Holden, D. 2008. Green Power: Buyers Beware. BusinessWeek, September 29: 68–70; www.cleanenergy.org; duke-energy.com; and alliantenergy.com.

LO11.6

The difference between integrity-based and compliance-based approaches to organizational ethics.

Integrity-Based versus Compliance-Based Approaches to Organizational Ethics Before discussing the key elements of an ethical organization, one must understand the links between organizational integrity and the personal integrity of an organization’s members.64 There cannot be high-integrity organizations without high-integrity individuals. However, individual integrity is rarely self-sustaining. Even good people can lose their bearings when faced with pressures, temptations, and heightened performance expectations in the absence of organizational support systems and ethical boundaries. Organizational integrity rests on a concept of purpose, responsibility, and ideals for an organization as a whole. An important responsibility of leadership is to create this ethical framework and develop the organizational capabilities to make it operational.65

Lynn Paine, an ethics scholar at Harvard, identifies two approaches: the compliance-based approach and the integrity- based approach. (See Exhibit 11.5 for a comparison of compliance-based and integrity-based strategies.) Faced with the prospect of litigation, several organizations reactively implement compliance-based ethics programs. Such programs are typically designed by a corporate counsel with the goal of preventing, detecting, and punishing legal violations. But being ethical is much more than being legal, and an integrity-based approach addresses the issue of ethics in a more comprehensive manner.

compliance-based ethics programs programs for building ethical organizations that have the goal of preventing, detecting, and punishing legal violations.

Integrity-based ethics programs combine a concern for law with an emphasis on managerial responsibility for ethical behavior. It is broader, deeper, and more demanding

integrity-based ethics programs programs for building ethical organizations that combine a concern for law with an emphasis on managerial responsibility for ethical behavior, including (1) enabling ethical conduct; (2) examining the organization’s and members’ core guiding values, thoughts, and actions; and (3) defining the responsibilities and aspirations that constitute an organization’s ethical compass.

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than a legal compliance initiative. It is broader in that it seeks to enable responsible conduct. It is deeper in that it cuts to the ethos and operating systems of an organization and its members, their core guiding values, thoughts, and actions. It is

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more demanding because it requires an active effort to define the responsibilities that constitute an organization’s ethical compass. Most importantly, organizational ethics is seen as the responsibility of management.

EXHIBIT 11.5 Approaches to Ethics Management

Characteristics Compliance-Based Approach Integrity-Based Approach

Ethos Conformity with externally imposed standards

Self-governance according to chosen standards

Objective Prevent criminal misconduct Enable responsible conduct

Leadership Lawyer-driven Management-driven with aid of lawyers, HR, and others

Methods Education, reduced discretion, auditing and controls, penalties

Education, leadership, accountability, organizational systems and decision processes, auditing and controls, penalties

Behavioral Assumptions

Autonomous beings guided by material self-interest

Social beings guided by material self-interest, values, ideals, peers

Source: Reprinted by permission of Harvard Business Review. Exhibit from “Managing Organizational Integrity,” by L. S. Paine. Copyright © 1994 by the Harvard Business School Publishing Corporation; all rights reserved.

A corporate counsel may play a role in designing and implementing integrity strategies, but it is managers at all levels and across all functions that are involved in the process. Once integrated into the day-to-day operations, such strategies can prevent damaging ethical lapses, while tapping into powerful human impulses for moral thought and action. Ethics becomes the governing ethos of an organization and not burdensome constraints. Here is an example of an organization that goes beyond mere compliance to laws in building an ethical organization:

In teaching ethics to its employees, Texas Instruments, the $13 billion chip and electronics manufacturer, asks them to run an issue through the following steps: Is it legal? Is it consistent with the company’s stated values? Will the employee feel bad doing it? What will the public think if the action is reported in the press? Does the employee think it is wrong? If the employees are not sure of the ethicality of the issue, they are encouraged to ask someone until they are clear about it. In the process, employees can approach high-level personnel and even the company’s lawyers. At TI, the question of ethics goes much beyond merely being legal. It is no surprise, that this company is a benchmark for corporate ethics and has been a recipient of three ethics awards: the David C. Lincoln Award for Ethics and Excellence in Business, American Business Ethics Award, and Bentley College Center for Business Ethics Award.66

LO11.7

Several key elements that organizations must have to become an ethical organization.

Compliance-based approaches are externally motivated—that is, based on the fear of punishment for doing something unlawful. On the other hand, integrity-based approaches are driven by a personal and organizational commitment to ethical behavior.

A firm must have several key elements to become a highly ethical organization:

• Role models.

• Corporate credos and codes of conduct.

• Reward and evaluation systems.

• Policies and procedures.

These elements are highly interrelated. Reward structures and policies will be useless if leaders are not sound role models. That is, leaders who implicitly say, “Do as I say, not as

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I do,” will quickly have their credibility eroded and such actions will sabotage other elements that are essential to building an ethical organization.

Role Models For good or for bad, leaders are role models in their organizations. Perhaps few executives can share an experience that better illustrates this than Linda Hudson, president of General Dynamics.67 Right after she was promoted to become her firm’s first female president, she went to Nordstrom and bought some new suits to wear to work. A lady at the store showed her how to tie a scarf in a very unique way. The day after she wore it to work, guess what: no fewer than a dozen women in the organization were wearing scarves tied exactly the same way! She reflects:

“And that’s when I realized that life was never going to be the way it had been before, that people were watching everything I did. And it wasn’t just going to be about how I dressed. It was about my behavior, the example I set, the tone I set, the way I carried myself, and how confident I was—all those kinds of things…. As the leader, people are looking at you in a way you could not have imagined in other roles.”

Clearly, leaders must “walk the talk”; they must be consistent in their words and deeds. The values as well as the character of leaders become transparent to an organization’s employees through their behaviors. When leaders do not believe in the ethical standards that they are trying to inspire, they will not be effective as good role models. Being an effective leader often includes taking responsibility for ethical lapses within the organization—even though the executives themselves are not directly involved. Consider the perspective of Dennis Bakke, CEO of AES, the $18 billion global electricity company based in Arlington, Virginia.

There was a major breach (in 1992) of the AES values. Nine members of the water treatment team in Oklahoma lied to the EPA about water quality at the plant. There was no environmental damage, but they lied about the test results. A new, young chemist at the plant discovered it, told a team leader, and we then were notified. Now, you could argue that the people who lied were responsible and were accountable, but the senior management team also took responsibility by taking pay cuts. My reduction was about 30 percent.68

Such action enhances the loyalty and commitment of employees throughout the organization. Many would believe that it would have been much easier (and personally less expensive!) for Bakke and his management team to merely take strong punitive action against the nine individuals who were acting contrary to the behavior expected in AES’s ethical culture. However, by sharing responsibility for the misdeeds, the top executives—through their highly visible action—made it clear that responsibility and penalties for ethical lapses go well beyond the “guilty” parties. Such courageous behavior by leaders helps to strengthen an organization’s ethical environment.

Corporate Credos and Codes of Conduct

corporate credo a statement of the beliefs typically held by managers in a corporation.

Corporate credos and codes of conduct are mechanisms that provide statements of norms and beliefs as well as guidelines for decision making. They provide employees with a clear understanding of the organization’s policies and ethical position. Such guidelines also provide the basis for employees to refuse to commit unethical acts and help to make them aware of issues before they are faced with the situation. For such codes to be truly effective, organization members must be aware of them and what behavioral guidelines they contain.69 Strategy Spotlight 11.9 identifies four key reasons why codes of conduct support organizational efforts to maintain a safe and ethical workplace.

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STRATEGY SPOTLIGHT 11.9 ETHICS

ELEMENTS OF A CORPORATE CODE Corporate codes are not simply useful for conveying organizational norms and policies, but they also serve to legitimize an organization in the eyes of others. In the United States, federal guidelines advise judges, when determining how to sentence a company convicted of a crime, to consider whether it had a written code and was out of compliance with its own ethical guidelines. The United Nations and countries around the world have endorsed codes as a way to promote corporate social responsibility. As such, a code provides an increasingly important corporate social contract that signals a company’s willingness to act ethically.

For employees, codes of conduct serve four key purposes:

1. Help employees from diverse backgrounds work more effectively across cultural backgrounds.

2. Provide a reference point for decision making.

3. Help attract individuals who want to work for a business that embraces high standards.

4. Help a company to manage risk by reducing the likelihood of damaging misconduct.

With recent scandals on Wall Street, many corporations are trying to put more teeth into their codes of conduct. Nasdaq now requires that listed companies distribute a code to all employees. German software giant SAP’s code informs employees that violations of the code “can result in consequences that affect employment, and could possibly lead to external investigation, civil law proceedings, or criminal charges.” Clearly, codes of conduct are an important part of maintaining an ethical organization.

Sources: Paine, L., Deshpande, R., Margolis, J. D., & Bettcher, K. E. 2005. Up to Code: Does Your Company’s Conduct Meet World Class Standards? Harvard Business Review, 82(12): 122–126; and Stone, A. 2004. Putting Teeth in Corporate Ethics Codes. www.businessweek.com, February 19.

Large corporations are not the only ones to develop and use codes of conduct. Consider the example of Wetherill Associates (WAI), a small, privately held supplier of electrical parts to the automotive market.

Rather than a conventional code of conduct, WAI has a Quality Assurance Manual—a combination of philosophy text, conduct guide, technical manual, and company profile—that describes the company’s commitment to honesty, ethical action, and integrity. WAI doesn’t have a corporate ethics officer, because the company’s corporate ethics officer is Marie Bothe, WAI’s CEO. She sees her main function as keeping the 350-employee company on the path of ethical behavior and looking for opportunities to help the community. She delegates the “technical” aspects of the business—marketing, finance, personnel, and operations—to other members of the organization.70

Reward and Evaluation Systems It is entirely possible for a highly ethical leader to preside over an organization that commits several unethical acts. How? A flaw in the organization’s reward structure may inadvertently cause individuals to act in an inappropriate manner if rewards are seen as being distributed on the basis of outcomes rather than the means by which goals and objectives are achieved.71

Generally speaking, unethical (or illegal) behaviors are also more likely to take place when competition is intense. Some have called this the “dark side of competition.” Consider a couple of examples:72

• Competition among educational institutions for the best student is becoming stiffer. A senior admissions officer at Claremont McKenna College resigned after admitting to inflating SAT scores of the incoming classes for six years. The motive, of course, was to boost the school’s rankings in the U.S. News and World Report’s annual listing of top colleges and universities in the United States. Carmen Nobel, who reported the incident in Working

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Knowledge (a Harvard Business School publication), suggested that the scandal “questions the value of competitive rankings.”

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• A study of 11,000 New York vehicle emission test facilities found that companies with a greater number of local competitors passed cars with considerably high emission rates, and lost customers when they failed to pass the tests. The authors of the study concluded, “In contexts when pricing is restricted, firms use illicit quality as a business strategy.”

Many companies have developed reward and evaluation systems that evaluate whether a manager is acting in an ethical manner. For example, Raytheon, a $24 billion defense contractor, incorporates the following items in its “Leadership Assessment Instrument”:73

• Maintains unequivocal commitment to honesty, truth, and ethics in every facet of behavior.

• Conforms with the letter and intent of company policies while working to affect any necessary policy changes.

• Actions are consistent with words; follows through on commitments; readily admits mistakes.

• Is trusted and inspires others to be trusted.

As noted by Dan Burnham, Raytheon’s former CEO: “What do we look for in a leadership candidate with respect to integrity? What we’re really looking for are people who have developed an inner gyroscope of ethical principles. We look for people for whom ethical thinking is part of what they do—no different from ‘strategic thinking’ or ‘tactical thinking.’ ”

Policies and Procedures Many situations that a firm faces have regular, identifiable patterns. Leaders tend to handle such routine by establishing a policy or procedure to be followed that can be applied uniformly to each occurrence. Such guidelines can be useful in specifying the proper relationships with a firm’s customers and suppliers. For example, Levi Strauss has developed stringent global sourcing guidelines and Chemical Bank (part of J. P. Morgan Chase Bank) has a policy of forbidding any review that would determine if suppliers are Chemical customers when the bank awards contracts.

Carefully developed policies and procedures guide behavior so that all employees will be encouraged to behave in an ethical manner. However, they must be reinforced with effective communication, enforcement, and monitoring, as well as sound corporate governance practices. In addition, the Sarbanes-Oxley Act of 2002 provides considerable legal protection to employees of publicly traded companies who report unethical or illegal practices. Provisions in the Act coauthored by Senator Grassley include:74

• Make it unlawful to “discharge, demote, suspend, threaten, harass, or in any manner discriminate against ‘a whistleblower.’ ”

• Establish criminal penalties of up to 10 years in jail for executives who retaliate against whistleblowers.

• Require board audit committees to establish procedures for hearing whistleblower complaints.

• Allow the Secretary of Labor to order a company to rehire a terminated whistleblower with no court hearings whatsoever.

• Give a whistleblower the right to a jury trial, bypassing months or years of cumbersome administrative hearings.

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ISSUE FOR DEBATE

Pacific Investment Management Company, LLC (commonly called PIMCO), is an investment firm headquartered in Newport Beach, California. PIMCO oversees investments on behalf of a wide range of clients, including millions of retirement savers, public and private pension plans, educational institutions, central banks, foundations and endowments, among others. With $290 billion in assets, PIMCO Total Return Fund is managed by co-founder and Co-Chief Investment Officer Bill Gross.

Several years ago, Gross noted a problem brewing that could really affect his investment strategy:

“In 2006, there were signs that this had become a highly leveraged Ponzi economy and that housing was at the pinnacle of this leverage. The temperature of the U.S. housing market was always the best read here in Orange County (California). But one day that August, as I was going across the street for my daily yoga exercise, it occurred to me that we needed to get a feel for the rest of the country.”

Gross’s radical idea was to take 10 of PIMCO’s 40 credit analysts and turn them into “fake” home buyers to see what was actually happening in the housing market! While they didn’t have a bankroll and had no intention of buying a house, they each were given a territory that they would visit multiple times a month. These analysts would pretend to be a serious buyer in order to get information on mortgage lending practices. Over a two-year period, they found that many houses could be bought with no money down, or without any documentation to prove income. This was occurring all across the country!

Gross admitted that he was “not necessarily proud of the obvious deception.” However, “this little bit of trickery alerted [PIMCO] to what was really going on—liar loans and extravagant lending practices.” The information these analysts found was shocking and led PIMCO to stay out of the subprime mortgage market. Although not readily apparent at the time to all, the housing bubble and subprime mortgage market would later play a key role in the economy’s meltdown.

Discussion Questions

1. What do you think about the ethics of pretending to buy homes?

2. Do the means justify the ends?

3. Was this effective leadership?

Sources: Brady, D. 2011. Etc. Hard choices—Interview with Bill Gross. Bloomberg Businessweek, June 13:88; and Vaishampayan, S. & Collins, M. 2012. Bill Miller looks to housing for redemption. Bloomberg Businessweek, October 22: 53–54.

Reflecting on Career Implications …

Strategic Leadership: The chapter identifies three interdependent activities that are central to strategic leadership; namely, setting direction, designing the organization, and nurturing a culture dedicated to excellence and ethical behavior. Both during your life as a student and in organizations you work, you have often assumed leadership positions. To what extent have you consciously and successfully engaged in each of these activities? Observe the leaders in your organizations and assess to what extent you can learn from them the qualities of strategic leadership that you can use to advance your own careers.

Power: Identify the sources of power used by your superior at work. How do his or her primary source of power and the way he/she uses it affect your own creativity, morale, and willingness to stay with the organization? In addition, identify approaches you will use to enhance your power as

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you move up your career ladder. Explain why you chose these approaches.

Emotional Intelligence: The chapter identifies the five components of Emotional Intelligence (self- awareness, self-regulation, motivation, empathy, and social skills). How do you rate yourself on each of these components? What steps can you take to improve your Emotional Intelligence and achieve greater career success?

Creating an Ethical Organization: Identify an ethical dilemma that you personally faced in the course of your work. How did you respond to it? Was your response compliance-based, integrity-based, or even unethical? If your behavior was compliance-based, speculate on how it would have been different if it were integrity-based. What have you learned from your experience that would make you a more ethical leader in the future?

summary

Strategic leadership is vital in ensuring that strategies are formulated and implemented in an effective manner. Leaders must play a central role in performing three critical and interdependent activities: setting the direction, designing the organization, and nurturing a culture committed to excellence and ethical behavior. If leaders ignore or are ineffective at performing any one of the three, the organization will not be very successful. We also identified two elements of leadership that contribute to success—overcoming barriers to change and the effective use of power.

For leaders to effectively fulfill their activities, emotional intelligence (EI) is very important. Five elements that contribute to EI are self-awareness, self-regulation, motivation, empathy, and social skill. The first three elements pertain to self-management skills, whereas the last two are associated with a person’s ability to manage relationships with others. We also addressed some of the potential drawbacks from the ineffective use of EI. These include the dysfunctional use of power as well as a tendency to become overly empathetic, which may result in unreasonably lowered performance expectations.

Leaders need to develop competency companions and play a central role in creating a learning organization. Gone are the days when the top-level managers “think” and everyone else in the organization “does.” With rapidly changing, unpredictable, and complex competitive environments, leaders must engage everyone in the ideas and energies of people throughout the organization. Great ideas can come from anywhere in the organization—from the executive suite to the factory floor. The five elements that we discussed as central to a learning organization are inspiring and motivating people with a mission or purpose, empowering people at all levels throughout the organization, accumulating and sharing internal knowledge, gathering external information, and challenging the status quo to stimulate creativity.

In the final section of the chapter, we addressed a leader’s central role in instilling ethical behavior in the organization. We discussed the enormous costs that firms face when ethical crises arise—costs in terms of financial and reputational loss as well as the erosion of human capital and relationships with suppliers, customers, society at large, and governmental agencies. And, as we would expect, the benefits of having a strong ethical organization are also numerous. We contrasted compliance-based and integrity-based approaches to organizational ethics. Compliance-based approaches are largely externally motivated; that is, they are motivated by the fear of punishment for doing something that is unlawful. Integrity-based approaches, on the other hand, are driven by a personal and organizational commitment to ethical behavior. We also addressed the four key elements of an ethical organization: role models, corporate credos and codes of conduct, reward and evaluation systems, and policies and procedures.

SUMMARY REVIEW QUESTIONS 1. Three key activities—setting a direction, designing the organization, and nurturing a culture and ethics—are all part

of what effective leaders do on a regular basis. Explain how these three activities are interrelated. 2. Define emotional intelligence (EI). What are the key elements of EI? Why is EI so important to successful strategic

leadership? Address potential “downsides.”

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3. The knowledge a firm possesses can be a source of competitive advantage. Describe ways that a firm can continuously learn to maintain its competitive position.

4. How can the five central elements of “learning organizations” be incorporated into global companies? 5. What are the benefits to firms and their shareholders of conducting business in an ethical manner? 6. Firms that fail to behave in an ethical manner can incur high costs. What are these costs and what is their source? 7. What are the most important differences between an “integrity organization” and a “compliance organization” in a

firm’s approach to organizational ethics? 8. What are some of the important mechanisms for promoting ethics in a firm?

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key terms

leadership setting a direction designing the organization excellent and ethical organizational culture barriers to change vested interest in the status quo systemic barriers behavioral barriers political barriers personal time constraints power organizational bases of power personal bases of power emotional intelligence (EI) learning organizations benchmarking competitive benchmarking functional benchmarking ethics organizational ethics ethical orientation compliance-based ethics programs integrity-based ethics programs corporate credo

experiential exercise Select two well-known business leaders—one you admire and one you do not. Evaluate each of them on the five characteristics of emotional intelligence.

Emotional Intelligence Characteristics Admired Leader Leader Not Admired

Self-awareness

Self-regulation

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Motivation

Empathy

Social skills

application questions & exercises 1. Identify two CEOs whose leadership you admire. What is it about their skills, attributes, and effective use of power

that causes you to admire them? 2. Founders have an important role in developing their organization’s culture and values. At times, their influence

persists for many years. Identify and describe two organizations in which the cultures and values established by the founder(s) continue to flourish. You may find research on the Internet helpful in answering these questions.

3. Some leaders place a great emphasis on developing superior human capital. In what ways does this help a firm to develop and sustain competitive advantages?

4. In this chapter we discussed the five elements of a “learning organization.” Select a firm with which you are familiar and discuss whether or not it epitomizes some (or all) of these elements.

ethics questions 1. Sometimes organizations must go outside the firm to hire talent, thus bypassing employees already working for the

firm. Are there conditions under which this might raise ethical considerations? 2. Ethical crises can occur in virtually any organization. Describe some of the systems, procedures, and processes that

can help to prevent such crises.

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unapproved bone cement study. www.orthostreams.com, December 13: np; Lotus, P. 2011. Corporate News: Former Synthes officers receive prison sentences. Wall Street Journal, November 22: B4; and Synthes Annual Report, 2011.

2. Charan, R. & Colvin, G. 1999. Why CEOs fail. Fortune, June 21: 68–78. 3. Yukl, G. 2008. How leaders influence organizational effectiveness. Leadership Quarterly, 19(6): 708–722. 4. These three activities and our discussion draw from Kotter, J. P. 1990. What leaders really do. Harvard Business Review, 68(3): 103–111;

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5. García-Morales, V. J., Lloréns-Montes, F. J., & Verdú-Jover, A. J. 2008. The effects of transformational leadership on organizational

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61. Pinto, J., Leana, C. R., & Pil, F. K. 2008. Corrupt organizations or organizations of corrupt individuals? Two types of organization-level corruption. Academy of Management Review, 33(3): 685–709.

62. Soule, E. 2002. Managerial moral strategies—in search of a few good principles. Academy of Management Review, 27(1): 114–124. 63. Carlson & Perrewe, op. cit. 64. This discussion is based upon Paine. Managing for organizational integrity; Paine, L. S. 1997. Cases in leadership, ethics, and

organizational integrity: A Strategic approach. Burr Ridge, IL: Irwin; and Fontrodona, J. 2002. Business ethics across the Atlantic. Business Ethics Direct, www.ethicsa.org/BED_art_fontrodone.html.

65. For more on operationalizing capabilities to sustain an ethical framework, see Largay III, J. A. & Zhang, R. 2008. Do CEOs worry about being fired when making investment decisions. Academy of Management Perspectives, 22(1): 60–61.

66. See www.ti.com/corp/docs/company/citizen/ethics/benchmark.shtml; and www.ti.com/corp/docs/company/citizen/ethics/quicktest.shtml. 67. Bryant, A. 2011. The corner office. New York: St. Martin’s Griffin, 91. 68. Wetlaufer, S. 1999. Organizing for empowerment: An interview with AES’s Roger Sant and Dennis Bakke. Harvard Business Review, 77

(1): 110–126. 69. For an insightful, academic perspective on the impact of ethics codes on executive decision making, refer to Stevens, J. M., Steensma, H. K.,

Harrison, D. A., & Cochran, P. S. 2005. Symbolic or substantive document? The influence of ethics code on financial executives’ decisions. Strategic Management Journal, 26(2): 181–195.

70. Paine. Managing for organizational integrity. 71. For a recent study on the effects of goal setting on unethical behavior, read Schweitzer, M. E., Ordonez, L., & Douma, B. 2004. Goal setting

as a motivator of unethical behavior. Academy of Management Journal, 47(3): 422–432. 72. Williams, R. 2012. How competition can encourage unethical business practices. business.financialpost.com, July 31: np. 73. Fulmer, R. M. 2004. The challenge of ethical leadership. Organizational Dynamics, 33 (3): 307–317. 74. www.sarbanes-oxley.com.