SM Lecture Nine (Part B) - Creating Effective Organizational Designs

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Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinStrategic Management: Text and Cases, 4e

Creating Effective Organizational Designs

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Learning Objectives

• After reading this chapter, you should have a good understanding of:

- The importance of organizational structure and the concept of the “boundaryless” organization in implementing strategies.

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

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

- The relative advantages and disadvantages of traditional organizational structure

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

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Learning Objectives

• After reading this chapter, you should have a good understanding of:

- Why there is no “one best way” to design strategic reward and evaluation systems, and the important contingent roles of business- and corporate-level strategies.business- and corporate-level strategies.

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

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

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Learning from Mistakes - Airbus

• We lead off this chapter with the opening case of Airbus’s failure to integrate its A380 double-decker jet manufacturing operations at two locations in two countries—Germany and France.

• At the root of the problem were incompatible software designs: engineers in Germany were working on a two-dimensional computer engineers in Germany were working on a two-dimensional computer program and, unfortunately, France’s engineers were working in 3-D.

• As noted by a consultant: “The various Airbus locations had their own legacy software, methods, procedures, and Airbus never succeeded in unifying all of those efforts.”

• The bottom line: The A380 is two years behind schedule, resulting in $6 billion in lost profits (and penalties) and an erosion of its market position vis a visits global rival—Boeing.

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Learning Points:

• The case points out the value of what are called “boundary-less organizations.”

• These are organizational forms in which there are permeable boundaries among the value creating activities in the organization as well as with the value creating activities of organization as well as with the value creating activities of suppliers, customers, and alliance partners.

• Clearly, in the case of the A380, there were insufficient working relationships between the European countries involved in its design and production.

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Traditional Forms of Organizational Structure

• Organizational structure refers to formalized patterns of interactions that link a firm’s

- Tasks- Technologies- Technologies- People

• Structure provides a means of balancing two conflicting forces

- Need for the division of tasks into meaningful groupings- Need to integrate the groupings for efficiency and

effectiveness

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Traditional Forms of Organizational Structure

• This section emphasizes the relationship between strategy and structure and addresses the importance of flexibility and permeability in the context of four traditional forms of in the context of four traditional forms of organizational structure — simple, functional, divisional, and matrix — as well as structures for firms with international operation..

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Patterns of Growth of Large Corporations

• In this section, we discuss how a firm’s strategy and structure change as it increases in size, diversifies into new product-markets, and expands its geographic scope.expands its geographic scope.

• EXHIBIT 10.1 depicts Galbraith and Kazanjian’s model of dominant growth patterns of large corporations.

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Dominant Growth Patterns of Large Corporations

Adapted from Exhibit 10.1 Dominant Growth Patterns of Large CorporationsSource: Adapted from J. R. Galbraith and R. K. Kazanjian, Strategy Implementation: The Role of Structure and Process, 2nd ed. (St. Paul, MN: West Publishing Company, 1986), p. 139.

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Patterns of Growth of Large Corporations

• The dominant pattern of growth is first from a simple structure to a functional structure as sales and volume increase.

• A functional structure enhances efficiency and effectiveness by structuring according to specialized functions.

• When firms grow beyond existing markets or regions, the • When firms grow beyond existing markets or regions, the decision-making burden is too great and a divisional structure is needed to organize around products, projects, or markets.

• As firms grow into international markets and/or enjoy expanding sales revenues, international structures are needed. There are several types of international structures as will be discussed below.

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Simple Structure

• Simple structure is the oldest and most common organizational form

- Staff serve as an extension of the top executive’s - Staff serve as an extension of the top executive’s personality

- Highly informal- Coordination of tasks by direct supervision- Decision making is highly centralized- Little specialization of tasks, few rules and regulations,

informal evaluation and reward system

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Functional Structure

• As firms grow, excessive demands may be placed on the owner-manager in order to process all the information necessary to run the business. Specialists are needed in various functional areas (such as accounting, marketing, and engineering). Thus, a functional structure often develops in engineering). Thus, a functional structure often develops in which functions are managed by specialists. Then, the chief executive’s job shifts to coordinating and managing the departments.

• EXHIBIT 10.2 depicts a diagram of a typical functional organizational structure.

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• Functional Structure

Adapted from Exhibit 10.2 Functional Organizational Structure

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• Functional Structure- Found where there is a single or closely related product or

service, high production volume, and some vertical integrationintegration

• Advantages- Enhanced coordination and control- Centralized decision making- Enhanced organizational-level perspective- More efficient use of managerial and technical talent- Facilitated career paths and development in specialized

areas

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• Disadvantages- A disadvantage of functional organizations is that the beliefs,

assumptions, and goals associated with different functional activities may vary across functions. MIT Professor Edgar Schein suggests that such different orientations may even cause certain suggests that such different orientations may even cause certain words to hold different meanings in different groups. This, in turn, leads to functional biases or “silo” thinking that may impede communication and coordination.

- Other disadvantages of a functional structure include short-term thinking due to excessive concern for the function rather than the whole organization, a heavier burden for top management who must resolve conflicts between functions, and difficulty establishing policies that apply uniformly to all functional areas.

-

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Divisional Structure

• The divisional structure is organized around products, projects, or markets. Each division has its own functional specialists organized into departments. Divisions are independent units managed by a central corporate office. Divisional executives manage divisional performance to achieve corporate financial manage divisional performance to achieve corporate financial objectives.

• EXHIBIT 10.3 presents a diagram of a typical divisional organizational structure.

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Adapted from Exhibit 10.3 Divisional Organizational Structure

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• Organized around products, projects, or markets• Each division includes its own functional specialists

typically organized into departments• Divisions are relatively autonomous and consist of • Divisions are relatively autonomous and consist of

products and services that are different from those of other divisions

• Division executives help determine product-market and financial objectives

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• Advantages- Strategic business unit (SBU) structure- Separation of strategic and operating control- Quick response to important changes in external - Quick response to important changes in external

environment- Minimal problems of sharing resources across functional

departments- Development of general management talent is enhanced

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• Disadvantages- A tendency to duplicate activities such as personnel

management, which makes overall costs higher, dysfunctional competition between divisions, conflicting goals, and uneven performance comparisons that inhibit goals, and uneven performance comparisons that inhibit resource sharing.

- Another potential disadvantage is that with many divisions providing different products and services, there is the chance that differences in image and quality may occur across divisions.

- Finally, since financial success is valued so highly, there may be too much focus on short-term performance.

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Strategic Business Unit Structure

• Highly diversified corporations often combine similar divisions into strategic business units (SBUs).

• Divisions with similar products, markets, and/or technologies are grouped into homogenous SBUs

• This helps coordinate activities and attain synergies.• This helps coordinate activities and attain synergies.• Appropriate when the businesses in a corporation’s portfolio do

not have much in common• Lower expenses and overhead, fewer levels in the

hierarchy• ConAgra is presented as an example of a company with dozens

of divisions grouped into three SBUs — food service, retail, and agricultural products. SBUs are typically run as profit centers.

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Advantages and Disadvantages of SBUs

• The primary advantage of the SBU structure is that it makes planning and control more manageable.

• The disadvantages include it may be difficult to realize synergies even among similar divisions and the additional hierarchical level of an SBU adds personnel and overhead expenses.

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Holding Company Structure

• The holding company structure (also referred to as a conglomerate) is another type of divisional structure.

• Whereas SBUs are used to group similar divisions, the holding company structure is used to manage a portfolio of unrelated businesses.

• Since the businesses are unrelated, most management decisions, controls, and incentives are left to the operating divisions.

• As a result, corporate staffs are small.

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Advantages and Disadvantages of Holding Company Structures

• An advantage of the holding company structure is the cost savings from having a small corporate office. Additionally, autonomy at the division level enhances motivation. division level enhances motivation.

• The disadvantage relates to the dependence that corporate executives have on divisional executives to achieve financial goals.

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Matrix Structures

• A matrix structure is, in essence, a combination of a divisional and functional structure. Most commonly, functional departments are combined with product groups on a project basis.

• As a result, personnel from functional departments work under • As a result, personnel from functional departments work under a product group manager for the duration of a project.

• Multinational corporations combine product groups and geographical units — an alternative to the product/function matrix.

• In both cases, personnel become responsible to two managers.• EXHIBIT 10.4 portrays a diagram of a typical matrix

organizational structure.

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Matrix Structure

Adapted from Exhibit 10.4 Matrix Organizational Structure

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Matrix Structure

• Advantages- An advantage of the matrix structure is that it facilitates the

use of specialized personnel, equipment, and facilities. - This reduces duplication and allows individuals with a high - This reduces duplication and allows individuals with a high

level of expertise to divide their efforts among multiple projects at one time.

- Such sharing and collaboration leads to more efficient use of resources.

- It also provides professionals with greater responsibilities and enhances the use of their skills.

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Matrix Structure

• Disadvantages:- Are related to dual reporting requirements. This

can lead to power struggles and conflict. - Further, matrix structures are often used in - Further, matrix structures are often used in

situations that are complex which may lead to excessive reliance on group processes and teamwork, and erode timely decision making.

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EXHIBIT 10.5 outlines the advantages and disadvantages of the three different organizational structures discussed above — functional, divisional, and matrix.

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• Consistencybetween strategy and structure is required to be successful in global markets. As firms expand into foreign markets, changes in structure follow changes in strategy.

• Three major contingencies influence structure adopted

International Operations: Implications for Organizational Structure

• Three major contingencies influence structure adopted by firms with international operations

- Type of strategy driving the firm’s foreign operations

- Product diversity- Extent to which the firm is dependent on foreign

sales

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• Firms that pursue multidomestic strategies (as discussed in Chapter 7) would most likely use international division or geographic-area divisionstructures. With these, local managers have high autonomy to manage within the demands and


autonomy to manage within the demands and constraints of the local market. If product diversity becomes large, firms may benefit from a worldwide matrix structure.

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• Global strategies, by contrast, typically have more centralized operations in order to manage for overall efficiency. Here, worldwide functional and worldwide product division structures are more likely because the market is more homogeneous and likely because the market is more homogeneous and requires less local attention. Once firms with global strategies become highly diversified, they are likely to shift to a worldwide holding companystructure.

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Global Start-Ups: A New Phenomenon

• Up to this point in this section, we have suggested that international expansion occurs primarily after the potential of domestic growth is exhausted. However, there are two interrelated trends which have given rise to “global start-ups:”to “global start-ups:”

1. many firms now decide to expand internationally relatively early in their history, and,

2. some firms are “born global”— that is from the very beginning many startups are global in their activities.

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• There is no reason for all startups to be global; global startups require a higher level of communication, coordination, and transportation costs. Some of the circumstances under which going global from the beginning is advantageous are:

- the required human resources are globally dispersed, going global may be the best way to access those resources,

- foreign financing may be easier to obtain and more suitable for the project,

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- the target customers in many specialized industries are located in other parts of the world,

- there is a gradual move from domestic markets to foreign markets and if a product (or service) is successful, it may be markets and if a product (or service) is successful, it may be immediately imitated by firms in other countries, and,

- high up-front development costs; a global market is necessary to recover the costs.

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How an Organization’s Structure Can Influence Strategy Formulation

• Typically, in discussing the relationship between strategy and structure, we strongly imply that structure follows strategy.

• However, in this section we stress the caveat • However, in this section we stress the caveat that structure can influence a firm’s strategy.

• Given that a firm’s structure can be rather difficult to change, strategy cannot realistically be formulated without taking structure into account.

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Linking Strategic Reward and Evaluation Systems to Business-Level and Corporate-Level Strategies

• There is not a “one best way” to set up a reward and evaluation system for an organization.

• As with other elements of strategy, are • As with other elements of strategy, are contingent on many factors.

• In this section, we discuss how business-level and corporate-level strategies create needs for different strategic reward and evaluation systems

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A. Business-LevelStrategy: Reward and Evaluation Systems

• Two generic strategies — overall cost leadership and differentiation — require fundamentally different approaches to reward and evaluation systemsreward and evaluation systems

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Rewards and Evaluation System: Overall Cost Leadership

• Cost leadership requires that firms pay close attention to every element of cost.

• They also work best in stable environments where the rate of innovation is low and efficiencies are attained in the production processes.

• Thus, firms competing on the basis of cost rely on tight cost controls, frequent and comprehensive reports in order to monitor the cost of inputs and outputs, and highly structured tasks and responsibilities.

• Incentives are based on financial targets.

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Rewards and Evaluation System: Differentiation

• Differentiation involves the development of unique product and service offerings, often involving innovation and creativity.

• As a result, it may be hard to evaluate success using hard financial indicators.

• Instead qualitative and intangible incentives may be required • Instead qualitative and intangible incentives may be required to reward the kind of specialized design work and/or scientific expertise that is necessary to successfully differentiation products and services.

• The text uses the example of 3M to describe a system in which experimentation is encouraged and managers are not penalized for product failures.

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B. Corporate-Level Strategy: Reward and Evaluation Systems

• The type of diversification strategy that a firm follows has implications for the type of controls it should use.

• Related diversification often involves coordination across multiple product lines in order to enjoy the synergies of relatedness. Rewards need to be linked to overall relatedness. Rewards need to be linked to overall behaviors such as teamwork and communication rather than short-term objectives only.

• The text uses the example of Sharp Corporation where promotions are tied to teamwork skills and seniority that encourages employees to pursue what is best for the firm and keeps turnover low.

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B. Corporate-Level Strategy: Reward and Evaluation Systems

• Unrelated diversification, on the other hand, is most successful when each division in a portfolio of businesses is entrepreneurial and competes with others for resources and rewards.

• Corporate policy usually involves top-down budgeting. • Corporate policy usually involves top-down budgeting. Reward and evaluation systems focus division presidents on financial performance and the reward system is linked to attaining outstanding results.

• The text uses the example of Hanson plc to demonstrate how corporate strategies are rewarded.

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An Important Caveat

• In actual practice there is a need for organizations to have combinations of financial and behavioral rewards.

• Both overall cost leadership and differentiation require collaboration and sharing of ideas, for example.

• And, with regard to corporate-level strategies, even firms following unrelated diversification strategies, the sharing of best practices across both value-creating activities and business units.

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EXHIBIT 10.6 summarizes our discussion of the relationship between strategies and reward and evaluation systems

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Boundaryless Organizational Designs

• Organizations that become boundaryless become more open and permeable, not “chaotic.”

• STRATEGY SPOTLIGHT 10.5 discusses four types • STRATEGY SPOTLIGHT 10.5 discusses four types of boundaries — vertical boundaries, horizontal boundaries, external boundaries, and geographic boundaries — and provides examples of how organizations have made them more permeable.

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Boundaryless Organizational Designs

• Boundaryless approaches should be considered a complement to, not a replacement for, traditional forms of organizing.

• Several types of structure can be used to make organizations more boundaryless.

• Barrier-freeapproaches involve removing internal boundaries to encourage teamwork and widespread sharing of information.

• Virtual and modularorganizational forms are used to make external relations more permeable and create seamless

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Making Boundaries More Permeable

• First approach• Permeable internal boundaries

- Teams are an important part of barrier free structures because they

BarrierBarrier--free type free type of organizationof organization

structures because they 1) substitute peer-based for hierarchical control; 2) often develop more creative solutions via

brainstorming and other group problem solving techniques; and

3) absorb administrative tasks previously handled by specialists.

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• Developing Effective Relationships with External Constituencies

- Barrier-free relationships must also extend to other divisions of a corporation and to external stakeholders. stakeholders.

- To promote interdivisional coordination and resource sharing, firms often use interdivisional task forces and common training programs, and create reward and incentive systems that foster cooperation.

- Boundaries between organizations and external constituencies such as customers also need to be more flexible and porous.

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Risks, Challenges, and Potential Downsides

• Not all efforts to create barrier-free structures have been successful.

• Examples are given of companies whose process times increased rather than decreased or broke down because rewards and incentives were not aligned with the objectives of the and incentives were not aligned with the objectives of the boundaryless system.

• An example of team failure by Challenger Electrical Distribution in Jackson, Mississippi identified 5 reasons for failure: 1) limited personal credibility; 2) lack of commitment to the team; 3) poor communications; 4) limited autonomy; and 5) misaligned incentives.

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Pros and Cons of Barrier-Free Structures (Exhibit 10.7)

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• Second approach : Modular Organization and Outsourcing

• The modular type of organization allows a company to leverage relatively small amounts of capital and a

Modular type of Modular type of organizationorganization

leverage relatively small amounts of capital and a small management team. By minimizing the need to make big investments, it can promote rapid growth. Firms taking this approach, however, must 1) identify the best suppliers and establish mutually beneficial working relationships; and 2) avoid outsourcing critical components of its business in ways that compromise it long-term competitive advantage.

•

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Advantages of outsourcing the non-core functions

1. It can decrease overall costs, quicken new product development by hiring suppliers whose talent may be superior to that of in-house personnel, avoid idle capacity, realize inventory savings, and avoid becoming locked into a particular technology.particular technology.

2. It enables a company to focus scarce resources on the areas where they hold a competitive advantage. These benefits can translate into more funding for research and development, hiring the best engineers, and providing continuous training for sales and service staff.

3. By enabling an organization to tap into the knowledge and expertise of its specialized supply chain partners, it adds critical skills and accelerates organization learning.

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StrategicRisks of Outsourcing

• Potential disadvantages of the modular form include

1) loss of critical skills or developing the wrong skills;

2) loss of cross-functional skills; and

3) loss of control over a supplier.

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Exhibit 10.8: Pros and Cons of Modular Structures

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• Third approach

• The virtual type of organization is an evolving network of independent companies – suppliers, customers, even

Virtual type of Virtual type of organizationorganization

independent companies – suppliers, customers, even competitors — linked together to share skills, costs, and access to one another’s markets. By pooling and sharing resources and working together in a cooperative effort, each gains in the long run.

• Virtual organizations are a type of strategic alliance in which complementary skills are used to pursue common objectives.

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Virtual Organization

• Virtual organizations may not be permanent. And, participating firms may be involved in multiple alliances at once.

• Unlike the modular type, virtual organization firms give up part of their control and participate in a collective strategy that of their control and participate in a collective strategy that enhances their own capacity, makes them better able to cope with uncertainty, and enhances their competitive advantages.

• STRATEGY SPOTLIGHT 10.8 describes how collaborative relationships have benefited the biotechnology industry. Companies work on joint marketing projects, bring R&D scientists together, and contribute technical assistance and financial clout.

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Challenges and Risks of Virtual Organizations

• Despite their many advantages, alliances often fail to meet expectations. One reason is that unique managerial skills are required — managers who can find good partners, build win-win relationships, and achieve the right balance of freedom and control. achieve the right balance of freedom and control.

• Some alliances are short-term only and may be dissolved once the objective is fulfilled. Others may have long-term objectives. The key to managing both is to be clear about the overall strategic objectives at the time the alliance is being formed.

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Challenges and Risks of Virtual Organizations

•The virtual organization is the culmination of joint venture strategies of the past.

• To form effective virtual organizations, strategic planning is needed to determine what synergies exist and how to capitalize on them by combining core competencies.

• As such, the virtual form may work better for some types of organizations than others.

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Exhibit 10.9: Pros and Cons of Virtual Structures

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

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Boundaryless Organizations: Making Them Work

• Often, when firms face external pressures, resource scarcity, and declining performance, they tend to become more internally focused.

• This may actually be the best time to reexamine value chain activities and determine how to better manage relationships activities and determine how to better manage relationships both internally and externally.

• By so doing, organizations may find that they can solve some of their problems by turning to boundaryless forms of organizing.

• In making the transition to more democratic, participative styles of management and greater reliance on teamwork, managers must select a balance of tools and techniques to facilitate the effective coordination and integration of key activities

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Five factors that must be considered in any transition from traditional to boundaryless organization forms.

1. Common Culture and Shared Values

2. Horizontal Organization Structures

3. Horizontal Systems and Processes

4. Communications and Information Technologies

5. Human Resources Practices

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Creating Ambidextrous Organizational Designs

• In this section the text addresses the challenge that organizations face in rapidly changing and complex competitive environments: exploring for new opportunities (adaptability) and effectively exploiting the value of their existing assets and competencies (alignment).

• 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.

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A. Ambidextrous Organizations: Key Design Attributes

• Here, we focus on a study by O’Reilly and Tushman that investigated 35 efforts to launch breakthrough innovations undertaken by 15 business units in nine different industries.different industries.

• They studied the organizational designs as well as the processes, systems, and cultures associated with the innovative projects and their impact on the operations and performance of the traditional businesses.

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A. Ambidextrous Organizations: Key Design Attributes

• The firms organized their breakthrough projects into one of four primary ways:

1. functional organizational structures2. cross-functional teams2. cross-functional teams3. unsupported teams4. ambidextrous organizations (structurally

independent units integrated into the existing senior management structure)

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B. Why Was the Ambidextrous Organization the Most Effective Structure?

• The ambidextrous organizational form was most effective on both dimensions: success in creating desired innovations and the performance of the existing business. The study found that there were many factors which explained the superior performance. Among these were:performance. Among these were:

- a clear and compelling vision,- cross-fertilization among business units,- tight coordination and integration at the managerial levels,- sharing was encouraged and facilitated by effective reward

systems, and,- established units were shielded from the distractions of launching

new businesse