Organization Theory: Strategy Implementation

ProcessSteven E. Phelan

June, 2006

Bureaucracy

Scale & Scope

Economics of Organization

Who am I?Associate Professor of Strategic Management at UNLV, formerly at UT Dallas

I have taught MBA students in 5 countries: Australia, Hong Kong, Singapore, Italy, and US.

Taught EMBA students at UT Dallas and UT Austin

Practitioner background: Telecom Australia Ansett Airlines Bridges Management Group (worked on credit cards,

loyalty schemes, distribution strategy, new product development, and acquisitions)

What is this course about?

Organization Theory Lots of academic textbooks Large membership in AOM (2000+) Dry as dust

Strategy Implementation No textbook since 1980s We know a plan is no good unless it is implemented –

kind of important then

The chosen path… Cover the interesting parts from OT and explore

something useful in strategy implementation (Strategy Execution & Change Management).

Goals

To be able to view organizational life through different lenses

To develop a critical appreciation of organizational discourse

To have an understanding of the major issues in strategy execution and change management

To have acquired skills in changing organizations

To gain an appreciation of some of the issues in strategy implementation

Assessment

Class Participation (30%)

Personal Diary (35%)

Change Agent Interview (35%)

Teaching Philosophy

I am not into one-way transmissions of informationI favor a collaborative learning environment:

We learn from each otherWe learn from the problems and issues we identify and how we solve themI see myself as a coach or mentor guiding the learning experienceThus, the ultimate responsibility for learning is with you

Read the materials Come to class prepared to discuss relevant aspects of your

organizational life (or lives) PLEASE interrupt, discuss, question, argue, debate, clarify

Overview of Today

One Right Way

Metaphor in organizations

Organizations as machines

Perrow on Bureaucracy

Chandler on Scale and Scope

Paths of Glory DVD – Video Case Study

Contingency theory

Morgan Ch. 3

Phelan on Economics of Organization

Metaphor in organizations

We learn how to see…Eskimos are able to identify many different types of snow that are indistinguishable to the average personAsians can identify many different varieties of rice

Can you see the old/young woman?

Morgan on Metaphor

What, then, is truth if different people learn to see the same thing in different ways?Is there value in teaching people to see their organizations in different ways?“If you only have a hammer, does every problem become a nail?”“The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function” -- F. Scott Fitzgerald“It is easy to teach anybody a new fact…but it needs light from heaven to enable a teacher to break the old framework in which the student has been accustomed to seeing” -- Arthur Koestler

Developing multiple interpretations

“At Foxboro, a technical advance was desperately needed for survival in the company’s early days. Late one evening, a scientist rushed into the president’s office with a working prototype. Dumbfounded at the elegance of the solution and bemused about how to reward it, the president bent forward in his chair, rummaged through most of the drawers in his desk, found something, leaned over the desk to the scientist, and said, “Here!” In his hand was a banana, the only reward he could immediately put his hands on. From that point on, the small ‘gold banana’ pin has been the highest accolade for scientific achievement at Foxboro.”

Can you develop 3 different angles or viewpoints on this story?

Viewing your organization as if you were from a foreign land…

On first joining…

What struck you as being novel, strange, or different about the way things happened compared to your expectations or what you had become used to elsewhere?

Organizations as

Machines

Organization as machine

Pre-determined goals and objectivesA rational structure of jobs and activitiesIts blueprint becomes an organizational chartPeople are hired to operate the machine and behave in a predetermined wayWhen an organization is seen as a machine it is expected to operate in a routinized, efficient, reliable, and predictable way

Max Weber

The bureaucratic form routinizes the process of administration exactly as the machine routinizes production.

Bureaucracies provide:

Precision, speed, clarity, regularity, reliability, and efficiency

Through:

A fixed division of tasks, hierarchical supervision, and detailed rules and regulations

Purging Particularism

According to Perrow, one of the major benefits of bureaucracy is purging particularism (incl. nepotism and favoritism)

Loyalty to the king was once everything, incompetence counted for little

Tenure was a early invention that provided freedom from unjust authority, separating the office from the person further controlled it.However, nepotism is still a big problem in a lot of countries – e.g. Italy, Mexico, ChinaWhy is it so bad?

Because there is often little relationship between the social criteria for hiring or promoting people and the characteristics that affect performance in the organizationIt may even hurt performance (lower morale, motivation etc.)

Perrow on corruption

Corruption (or enlightened self-interest) is also a likely to accompany favoritism

Perrow argues corruption is good for the individual and sometimes even good for the organization

“one of the best ways to seize or retain control [of an organization] is to surround oneself with loyal people”

It doesn’t hurt to have a sympathetic friend in government

Bureaucracy limits corruption: “since official goals are proclaimed, unofficial, unpublicized,

and unlegitimated uses can be held up to scrutiny when they are found, and action can be taken.”

“The hidden uses of organizations, always present, can be exposed and addressed”

Hierarchy

Downside to hierarchy:

Lack of motivation - ‘not my problem’

Fear of passing bad news or suggesting changes

Buck passing

Delays and sluggishness

Dictatorial/ignorant decisions by superiors

Stifling of independence and creativity

The Upside

Perrow argues that:

A lack of coordination between departments

The failure to exercise authority or be decisive, and

A lack of accountability are, in fact, much worse problems than the problems identified on the previous slide

Do you agree?

Strengths of the machine metaphor

For Morgan, mechanistic approaches work well when:There is a straightforward task to performThe environment is stable and predictable (to enable efficient division of labor)When one produces the same product time and againWhen efficiency and precision are at a premiumWhen the human parts are compliant and behave as they have been designed

For Perrow:Bureaucracies limit particularism and self-interest, and promote coordination

Limitations of the machine metaphor

Bureaucracies have difficulty adapting to change

They are designed to achieve predetermined goals not innovation

It takes time to get an efficient division of labor through detailed job analysis

Moreover…

Mechanistic approaches result in mindless and unquestioning bureaucracy

Problems can be ignoredCommunication can be ineffectiveParalysis and inaction can lead to backlogsSenior managers can become remoteSpecialization creates myopia and NIH syndromeEmployees know what is expected of them but also what is not expected of themInitiative is discouraged

Chandler on Scale & Scope

Large plants produce products at a much lower cost than small plants (scale)Large plants can make a variety of products from the same raw materials (scope)A constant flow of supply and demand is needed for full capacity utilization

The railroad, telegraph, and steamship made this possibleProfessional managers were needed to coordinate production and distribution (I.e. sales & marketing)

Significant first mover advantages

Modern scale and scope

Does Chandler’s argument apply in the Internet age?

Think: Microsoft/Intel Amazon Google/Yahoo Ebay

What are the lessons for: Startups? Followers? Leaders?

How can scale/scope advantages be lost?

Paths of Glory DVD

What are the strengths and weaknesses of army bureaucracy in the movie (use Perrow)?What evidence of particularism is there?Should/could the organization be redesigned?How would you change the incentive system?

Open Systems and Contingency Theory

Open systems theory emphasizes the importance of the environment (not seen in machine metaphor)Organizations are seen as sets of interrelated subsystems

Molecules, cells, organs, lifeforms, social systems, world, solar system, galaxy, universe

The approach encourages congruencies or alignments between different sub-systems (‘fit’)This led to the development of contingency theory

Contingency theory

There is no best way of organizing. The appropriate form depends on the kind of task or environment – many species of organizations

Management’s job is achieving alignment or fit

Fit applies not only to the org-env but also between sub-systems in an organization

First distinction

Mechanistic vs organic (Burns and Stalker)Changing technology or market conditions pose new problems and challenges that require open and flexible styles of organization and management

Lawrence and Lorsch showed that styles of organization might need to vary between organizational subunits

e.g. R&D departments need to be organized differently from production departments)How is this different from an ideal bureaucracy?

Typologies

This research led to the development of typologies of organizations:

Miles and Snow Prospectors, analyzers, defenders

Mintzberg Machine bureaucracy, divisionalized form, professional

bureaucracy, simple structure, adhocracy

BCG Cash cows, dogs, stars, question marks

Porter Cost leadership, differentiation, focus

Other developments

Organization development

The belief that we can diagnose the environment and thus improve internal and external fit

Expert Systems

Burton and Obel even developed an expert system to choose the right structure for an organization

Strengths of the Organismic Metaphor

Organizations must always pay close attention to their external environments

Achieving congruence with the environment becomes a key managerial task

What are the implications for strategy implementation?

Limitations of the Organismic Metaphor

Organizations are not organismsEnvironments are not concrete

Actual vs perceived vs enactedMetaphor overstates degree of functional unity and cohesion in most organizations and top management’s ability to choose subsystem settingsCan lead to social Darwinism and other ideological traps

i.e. the best performing organizations are the fittest and thus the ‘best’No guarantee the best today will be the best tomorrow

Ecoomics of Organization

Why do firms exist?OR why is all production not undertaken by one giant firm?

Subset of wider questionWhy do we see a diversity of economic arrangements?Spot contracts, joint ventures, firms, strategic alliances, franchises etc.

Payoff for managersShould help in determining the vertical boundaries of the firm = corporate strategyShould help in deciding when to start a new business – when you can beat the market

The BasicsAdam SmithThe wealth of society grows when we allow people to specialize in activities in which they have a comparative advantage and then exchange their surplus with other specialists

Harold DemsetzA firm is any individual or group that produces for exchange rather than personal consumptionThe alternative to the firm is therefore NOT the market but the householdFirms exist only because of gains from specializationBut, ‘the division of labor is limited by the extent of the market’Firm vs. market decisions are really MY firm vs. YOUR firm decisions

CoordinationMost products in today’s economy require the input of a multitude of specialists

First, an entrepreneur must perceive a need for a product or serviceThen, identify the inputs required to produce the product or serviceThen, assemble the inputs – make or buy (rent or own)

This problem of coordination is to make the right combination of make and buy decisions to maximize producer surplus or profit

Think of the inputs required to get just one product to market – start small…a pencil

CooperationNaturally, the specialists providing the inputs will try to maximize their own gains from exchange

The problem of cooperation is ensuring that the specialists (or agents) do what they are paid to do (i.e. that they don’t shirk or act opportunistically)

This is usually achieved through a combination of incentives and supervision (monitoring).

The problems of coordination and cooperation arise because of information costs

In a world with perfect knowledge/information these problems would not exist. Why?

EfficiencyAn organization is efficient when it has no better way of organizing itself

i.e. all opportunities for gain or profit are exhausted

Decisions are efficient with respect to information and transaction costs as well as coordination and cooperation costs

Is it efficient to sell wine for $5 per bottle in Las Vegas and the same wine for $10 per bottle in Henderson?

Efficiency Tautology If I could have made a better decision then I would have

But I didn’t so the actual observed outcome must be the most efficient case.

Decisions can be efficient ex ante but appear inefficient ex post.

Regret is irrelevant if it is too costly to change a decision.

So, if we commonly observe firms, joint ventures, strategic alliances, and market exchanges then they must all be efficient in some circumstances.

The task is to figure out when and why.

Ronald Coase (1937)Firms exist because there are costs to using the market Transaction costs are the costs of:

Searching for sellers of inputs and buyers of outputs, and negotiating and enforcing contracts between them when foundLong term contracts lower these transaction costs but require more flexibility for unforeseen developments, hence employment contracts usually allow employers to direct employees (specialists) to any reasonable task

All transactions do not occur in one firm:The number, dispersion, and dissimilarity of transactions increases coordination (administrative) costs What about cooperation costs?

Applications

What is the effect on firms of:

Railroads/telegraph/telephone

Internet

Government corruption

Single European market

Alchian and Demsetz (1972)

Firms are a fictionThere is no difference between an employment contract and a market contractFirms are just a particularly dense ‘network of contracts’

Team production provides opportunities for shirking (agency costs)

Someone must monitor the shirkers but who monitors the monitor?Solution: Give monitor rights to residual income --> provides strong incentive to monitor well

Holdup (another transaction cost)

Relying on a single supplier creates an incentive for opportunism in the form of hold-up

E.g. If I make you the exclusive supplier of a critical part then I expose myself to your demands

Firms integrate to avoid the threat of hold-up or the costs of avoiding it (e.g. litigation, distrust)Integration is efficient if the transaction costs of hold-up exceed governance costsIn theory, hold-up should be very rare because potential victims will integrate before being held up.

Property Rights

Why is the firm defined by ownership of physical assets?

Grossman, Hart, and Moore (1986, 1990) say it is because asset ownership grants residual rights of income and control

Owners can freely allocate assets to new uses AND control access to assets (=power)

They also keep any income from new usesThus, assets with real options should be ownedNote, human capital cannot be owned so doctors and lawyers tend to form partnerships. Why?

Summary: Reasons to Make

To avoid ex ante transaction costs

Searching, negotiating, re-negotiating, and enforcing contracts

To avoid ex post transaction costs

Holdup and costs of avoiding holdup

To gain upside from ownership advantage

Ability to re-deploy or sell resources

To gain management by fiat (authority)

Reasons to BuySpecialization (Smith)

Market specialists have greater economies of scale and scope

Information (Hayek)Market prices signal profit opportunities Market prices tell us how consumers value various offerings Market prices also convey information on supply and demand conditionsAll difficult to duplicate in companies

IncentivesMarkets provide high powered incentivesPay for performanceFirms must be efficient and innovative to survive(But measures must be affordable and relevant)

Firms often use low powered incentives (wages)

Creates shirking and agency costs (costs of monitoring) and influence costsLack of internal competition generates inertia

Other reasonsBusiness models may be dissimilar

Concept of dominant logicExternal suppliers may have unique capabilities

For instance, if Intel is the only company capable of producing a certain microprocessor

Using outsiders reduces risk and increases flexibility

Suppliers can be changedRisk and lack of flexibility are also costs of doing business

Final Thoughts

Alternative forms of organization existStrategic alliances, joint ventures, keiretsu, clan-based organization, franchises

According to efficiency principle, the fact that these forms persist points to their relative efficiencyAll make/buy decisions are a balance of

Technical efficiency and agency efficiencyTransaction costs and governance (administrative) costs

There is no such thing as a costless organization