Managerial economics and strategic analysis
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PART 3 : STRATEGIC IMPLEMENTATION
chapter 9
Strategic Control and Corporate
Governance
After reading this chapter, you should have a good understanding of the following learning objectives:
LO9.1 The value of effective strategic control systems in strategy implementation.
LO9.2 The key difference between “traditional” and “contemporary” control systems.
LO9.3 The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive
and general environments.
LO9.4 The benefits of having the proper balance among the three levers of behavioral control: culture, rewards
and incentives, and boundaries.
LO9.5 The three key participants in corporate governance: shareholders, management (led by the CEO), and
the board of directors.
LO9.6 The role of corporate governance mechanisms in ensuring that the interests of managers are aligned
with those of shareholders from both the United States and international perspectives.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Learning from Mistakes
Hewlett-Packard (HP) is one of the largest firms in the world and also one of the most dysfunctional. Sitting #10
on the Fortune 500 list with $120 billion in sales in 2012, it is a titan in the computer hardware market. 1 However,
it is a struggling titan that lost $12.6 billion in 2012, in contrast to earnings of almost $9 billion only two years
earlier. But HP’s struggles go back much farther than the last two years. Their inability to effectively respond to
the dramatic shifts that have transformed the computing industry in the last several years has been, at least
partly, driven by their toxic corporate governance culture.
The dynamics in the board of directors has resembled a soap opera for over 10 years. Going back to 2002,
HP’s CEO, Carly Fiorina, was pushing hard for HP to acquire one of its main rivals, Compaq. Standing in her
way to get this deal done was Walter Hewitt, the son of one of the firm’s founders. The members of the board
took sides in this debate and started leaking corporate secrets to the press to bolster their side of the argument.
HP eventually did acquire Compaq, but the toxic culture in the boardroom was set.
Fiorina stayed at the helm of HP until early 2005, when she was forced out by the board—but only after board
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members leaked documents damaging to Fiorina in the press. She was replaced by Mark Hurd, but the troubles
with the board continued. The chairwoman of the board was accused in 2006 of hiring private investigators to
obtain the phone records of board members and reporters to try to get at the root of leaks from the board. The
scandal was investigated by both the State of California and the U.S. Congress and resulted in Patricia Dunn,
the chairwoman, being forced from her position. Hurd, the firm’s CEO, was fired in 2010 when it came to light
that he had an inappropriate affair with a subordinate and had charged expenses related to his affair to the firm.
His departure only served to exacerbate the tension on the board. He had been dismissed on a 6-4 vote by the
board, and the tension between the pro- and anti-Hurd factions on the board spilled over to the search for his
replacement. It got so bad that some board members refused to be in the same room with other directors. The
board settled on Leo Apotheker to replace Hurd, but only after the search firm vetting Apotheker didn’t fully
disclose issues related to Apotheker that led to his firing from his position of co-CEO at SAP, an enterprise
software firm. Apotheker lasted all of 11 months as CEO at HP before he was fired, receiving a $13.2 million
dollar severance package from the board. He was replaced by Meg Whitman, the former CEO of eBay, in 2011.
All of the drama in the boardroom has had a devastating effect on HP’s businesses. The strategic direction of
the firm has been inconsistent over time, moving from traditional hardware, to mobile devices, to computing
services, and finally to cloud computing. HP announced it was planning to spin off its PC business only to
quickly move away from that plan once the market reacted to the announcement by pummeling the firm’s stock.
The drama also infested the rest of the company. Both Apotheker and Whitman have had to deal with
employees leaking important and damaging information to the press, much like the board has done for years. As
a result, there has been very little information sharing within the organization, because no one knows who they
can trust and who will leak important information to the press.
278
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Discussion Questions
1. What are the most significant problems with HP’s board?
2. How do we see the problems with the board of directors damaging HP’s ability to compete in its markets?
We first explore two central aspects of strategic control :2 (1) informational control, which is the ability to respond
effectively to environmental change, and (2) behavioral control, which is the appropriate balance and alignment among a
firm’s culture, rewards, and boundaries. In the final section of this chapter, we focus on strategic control from a much
broader perspective—what is referred to as corporate governance. 3 Here, we direct our attention to the need for a firm’s
shareholders (the owners) and their elected representatives (the board of directors) to ensure that the firm’s executives
(the management team) strive to fulfill their fiduciary duty of maximizing long-term shareholder value. As we just saw in
the HP example, poor corporate governance can result in significant loss of managerial attention and of the ability to
manage major strategic issues.
strategic control
the process of monitoring and correcting a firm’s strategy and performance.
LO9.1
The value of effective strategic control systems in strategy implementation.
Ensuring Informational Control: Responding Effectively to
Environmental Change
We discuss two broad types of control systems: “traditional” and “contemporary.” As both general and competitive
environments become more unpredictable and complex, the need for contemporary systems increases.
A Traditional Approach to Strategic Control
The traditional approach to strategic control is sequential: (1) strategies are formulated and top management sets
goals, (2) strategies are implemented, and (3) performance is measured against the predetermined goal set, as illustrated
in Exhibit 9.1 .
traditional approach to strategic control
a sequential method of organizational control in which (1) strategies are formulated and top management sets goals, (2)
strategies are implemented, and (3) performance is measured against the predetermined goal set.
Control is based on a feedback loop from performance measurement to strategy formulation. This process typically
involves lengthy time lags, often tied to a firm’s annual planning cycle. Such traditional control systems, termed “single-
loop” learning by Harvard’s Chris Argyris, simply compare actual performance to a predetermined goal. 4 They are most
appropriate when the environment is stable and relatively simple, goals and objectives can be measured with a high level
of certainty, and there is little need for complex measures of performance. Sales quotas, operating budgets, production
schedules, and similar quantitative control mechanisms are typical. The appropriateness of the business strategy or
standards of performance is seldom questioned. 5
James Brian Quinn of Dartmouth College has argued that grand designs with precise and carefully integrated plans
seldom work. 6 Rather, most strategic change proceeds incrementally—one step at a time. Leaders should introduce some
sense of direction, some logic in incremental steps. 7 Similarly, McGill University’s Henry Mintzberg has written about
leaders “crafting” a strategy. 8 Drawing on the parallel between the potter at her wheel and the strategist, Mintzberg
pointed out that the potter begins work with some general idea of the artifact she wishes to create, but the details of
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. design—even possibilities for a different design—emerge as the work progresses. For businesses facing complex and
turbulent business environments, the craftsperson’s method helps us deal with the uncertainty about how a design will
work out in practice and allows for a creative element.
LO9.2
The key difference between “traditional” and “contemporary” control systems.
EXHIBIT 9.1 Traditional Approach to Strategic Control
279
Mintzberg’s argument, like Quinn’s, questions the value of rigid planning and goal-setting processes. Fixed strategic
goals also become dysfunctional for firms competing in highly unpredictable competitive environments. Strategies need
to change frequently and opportunistically. An inflexible commitment to predetermined goals and milestones can prevent
the very adaptability that is required of a good strategy.
LO9.3
The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive and general
environments.
A Contemporary Approach to Strategic Control
Adapting to and anticipating both internal and external environmental change is an integral part of strategic control. The
relationships between strategy formulation, implementation, and control are highly interactive, as suggested by Exhibit
9.2 . It also illustrates two different types of strategic control: informational control and behavioral control.
Informational control is primarily concerned with whether or not the organization is “doing the right things.”
Behavioral control, on the other hand, asks if the organization is “doing things right” in the implementation of its
strategy. Both the informational and behavioral components of strategic control are necessary, but not sufficient,
conditions for success. What good is a well-conceived strategy that cannot be implemented? Or what use is an energetic
and committed workforce if it is focused on the wrong strategic target?
informational control
a method of organizational control in which a firm gathers and analyzes information from the internal and external
environment in order to obtain the best fit between the organization’s goals and strategies and the strategic environment.
behavioral control
a method of organizational control in which a firm influences the actions of employees through culture, rewards, and
boundaries.
John Weston is the former CEO of ADP Corporation, the largest payroll and tax-filing processor in the world. He
captures the essence of contemporary control systems.
At ADP, 39 plus 1 adds up to more than 40 plus 0. The 40-plus-0 employee is the harried worker who at 40 hours a week just
tries to keep up with what’s in the “in” basket…. Because he works with his head down, he takes zero hours to think about what
he’s doing, why he’s doing it, and how he’s doing it…. On the other hand, the 39-plus-1 employee takes at least 1 of those 40
hours to think about what he’s doing and why he’s doing it. That’s why the other 39 hours are far more productive. 9
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Informational control deals with the internal environment as well as the external strategic context. It addresses the
assumptions and premises that provide the foundation for an organization’s strategy. Do the organization’s goals and
strategies still “fit” within the context of the current strategic environment? Depending on the type of business, such
assumptions may relate to changes in technology, customer tastes, government regulation, and industry competition.
This involves two key issues. First, managers must scan and monitor the external environment, as we discussed in
Chapter 2 . Also, conditions can change in the internal environment of the firm, as we discussed in Chapter 3 , requiring
changes in the strategic direction of the firm. These may include, for example, the resignation of key executives or delays
in the completion of major production facilities.
In the contemporary approach, information control is part of an ongoing process of organizational learning that
continuously updates and challenges the assumptions that underlie the organization’s strategy. In such “double-loop”
learning, the organization’s assumptions, premises, goals, and strategies are continuously monitored, tested, and
reviewed. The benefits of continuous monitoring are evident—time lags are dramatically shortened,
EXHIBIT 9.2 Contemporary Approach to Strategic Control
280
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changes in the competitive environment are detected earlier, and the organization’s ability to respond with speed and
flexibility is enhanced.
STRATEGY SPOTLIGHT 9.1
HOW DO MANAGERS AND EMPLOYEES VIEW THEIR FIRM’S CONTROL SYSTEM?
Top executives of organizations often assert that they are pushing for more contemporary control systems. The
centralized, periodic setting of objectives and rules with top-down implementation processes is ineffective for
organizations facing heterogeneous and dynamic environments. For example, Walmart has, in recent years,
realized its top-down, rule-based leadership system was too rigid for a firm emphasizing globalization and
technological change. Like many other firms, Walmart is moving to a more decentralized, values-based leadership
system where lower-level managers make key decisions, keeping the values of the firm in mind as they do so.
Managers of firms see the need to make this transition, but do lower-level managers and workers see a change
in the control systems at their organizations? To get at this question, the Boston Research Group conducted a study
of 36,000 managers and employees to get their views on their firm’s control systems. Their findings are
enlightening. Only 3 percent of employees saw their firm’s culture as “self-governing,” in which decision making is
driven by a “set of core principles and values.” In contrast, 43 percent of employees saw their firm as operating
using a top-down, command-and-control decision process, what the authors of the study labeled as the “blind
obedience” model. 53 percent of employees saw their firm following an “informed acquiescence” model where the
overall style is top-down but with skilled management that used a mix of rewards and rules to get the desired
behavior. In total, 97 percent of employees saw their firm’s culture and decision style as being top-down.
Interestingly, managers had a different view. 24 percent of managers believed their organizations used the
values-driven, decentralized “self-governing” model. Thus, managers were eight times more likely than employees
to see the firm employing a contemporary, values-driven control system. Similarly, while 41 percent of managers
said that their firm rewarded performance based on values and not just financial outcomes, only 14 percent of
employees saw this.
The cynicism employees expressed regarding the control systems in their firms had important consequences for
the firm. Almost half of the employees who had described their firms as “blind obedience” firms had witnessed
unethical behavior in the firm within the last year. Only one in four employees in firms with the other two control
types said they had witnessed unethical behavior. Additionally, only one-fourth of the employees in “blind
obedience” firms would blow the whistle on unethical behavior, but this rate went up to nine in ten if the firm relied
on “self-governance.” Finally, the impressions of employees influence the ability of the firm to be responsive and
innovative. 90 percent of employees in “self-governing” and 67 percent of employees in “informed acquiescence”
firms agreed with the statement that “good ideas are readily adopted by my company.” Less than 20 percent of
employees in “blind obedience” firms agreed with the same statement.
These findings indicate that managers need to be aware of how the actions they take to improve the control
systems in their firms are being received by employees. If the employees see the pronouncements of management
regarding moving toward a decentralized, culture-centered control system as simply propaganda, the firm is unlikely
to experience the positive changes they desire.
Sources: Anonymous. 2011. The view from the top and bottom. Economist, September 24: 76; and Levit, A. 2012. Your employees aren’t wearing your rose
colored glasses. Openforum.com , November 12: np.
Contemporary control systems must have four characteristics to be effective. 10
1. Focus on constantly changing information that has potential strategic importance.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 2. The information is important enough to demand frequent and regular attention from all levels of the organization.
3. The data and information generated are best interpreted and discussed in face-to-face meetings.
4. The control system is a key catalyst for an ongoing debate about underlying data, assumptions, and action plans.
An executive’s decision to use the control system interactively—in other words, to invest the time and attention to
review and evaluate new information—sends a clear signal to the organization about what is important. The dialogue and
debate that emerge from such an interactive process can often lead to new strategies and innovations. Strategy Spotlight
9.1 discusses how managers and employees each see the control systems at work in their companies and some of the
consequences of those impressions.
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LO9.4
The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and
incentives, and boundaries.
Attaining Behavioral Control: Balancing Culture, Rewards, and
Boundaries
Behavioral control is focused on implementation—doing things right. Effectively implementing strategy requires
manipulating three key control “levers”: culture, rewards, and boundaries (see Exhibit 9.3 ). There are two compelling
reasons for an increased emphasis on culture and rewards in a system of behavioral controls. 11
First, the competitive environment is increasingly complex and unpredictable, demanding both flexibility and quick
response to its challenges. As firms simultaneously downsize and face the need for increased coordination across
organizational boundaries, a control system based primarily on rigid strategies, rules, and regulations is dysfunctional.
The use of rewards and culture to align individual and organizational goals becomes increasingly important.
Second, the implicit long-term contract between the organization and its key employees has been eroded. 12 Today’s
younger managers have been conditioned to see themselves as “free agents” and view a career as a series of opportunistic
challenges. As managers are advised to “specialize, market yourself, and have work, if not a job,” the importance of
culture and rewards in building organizational loyalty claims greater importance.
Each of the three levers—culture, rewards, and boundaries—must work in a balanced and consistent manner. Let’s
consider the role of each.
Building a Strong and Effective Culture
Organizational culture is a system of shared values (what is important) and beliefs (how things work) that shape a
company’s people, organizational structures, and control systems to produce behavioral norms (the way we do things
around here). 13 How important is culture? Very. Over the years, numerous best sellers, such as Theory Z, Corporate
Cultures, In Search of Excellence, and Good to Great, 14, have emphasized the powerful influence of culture on what goes
on within organizations and how they perform.
organizational culture
a system of shared values and beliefs that shape a company’s people, organizational structures, and control systems to
produce behavioral norms.
Collins and Porras argued in Built to Last that the key factor in sustained exceptional performance is a cultlike
culture. 15 You can’t touch it or write it down, but it’s there in every organization; its influence is pervasive; it can work
for you or against you. 16 Effective leaders understand its importance and strive to shape and use it as one of their
important levers of strategic control. 17
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. EXHIBIT 9.3 Essential Elements of Behavioral Control
282
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The Role of Culture Culture wears many different hats, each woven from the fabric of those values that sustain the
organization’s primary source of competitive advantage. Some examples are:
• FedEx and Amazon focus on customer service.
• Lexus (a division of Toyota) and Apple emphasize product quality.
• Google and 3M place a high value on innovation.
• Nucor (steel) and Walmart are concerned, above all, with operational efficiency.
Culture sets implicit boundaries—unwritten standards of acceptable behavior—in dress, ethical matters, and the way
an organization conducts its business. 18 By creating a framework of shared values, culture encourages individual
identification with the organization and its objectives. Culture acts as a means of reducing monitoring costs. 19
Strong culture can lead to greater employee engagement and provide a common purpose and identity. Firms have
typically relied on economic incentives for workers, using a combination of rewards (carrots) and rules and threats
(sticks) to get employees to act in desired ways. But these systems rely on the assumption that individuals are
fundamentally self-interested and selfish. However, research suggests that this assumption is overstated. 20 When given a
chance to act selfishly or cooperatively with others, over half choose to cooperate, while only 30 percent consistently
choose to act selfishly. Thus, cultural systems that build engagement, communication, and a sense of common purpose
and identity would allow firms to leverage these collaborative workers.
Sustaining an Effective Culture Powerful organizational cultures just don’t happen overnight, and they don’t remain in
place without a strong commitment—both in terms of words and deeds—by leaders throughout the organization. 21 A
viable and productive organizational culture can be strengthened and sustained. However, it cannot be “built” or
“assembled”; instead, it must be cultivated, encouraged, and “fertilized.” 22
Storytelling is one way effective cultures are maintained. Many are familiar with the story of how Art Fry’s failure to
develop a strong adhesive led to 3M’s enormously successful Post-it Notes. Perhaps less familiar is the story of Francis
G. Okie. 23 In 1922 Okie came up with the idea of selling sandpaper to men as a replacement for razor blades. The idea
obviously didn’t pan out, but Okie was allowed to remain at 3M. Interestingly, the technology developed by Okie led 3M
to develop its first blockbuster product: a waterproof sandpaper that became a staple of the automobile industry. Such
stories foster the importance of risk taking, experimentation, freedom to fail, and innovation—all vital elements of 3M’s
culture.
Rallies or “pep talks” by top executives also serve to reinforce a firm’s culture. The late Sam Walton was known for
his pep rallies at local Walmart stores. Four times a year, the founders of Home Depot—former CEO Bernard Marcus
and Arthur Blank—used to don orange aprons and stage Breakfast with Bernie and Arthur, a 6:30 a.m. pep rally,
broadcast live over the firm’s closed-circuit TV network to most of its 45,000 employees. 24
Southwest Airlines’ “Culture Committee” is a unique vehicle designed to perpetuate the company’s highly successful
culture. The following excerpt from an internal company publication describes its objectives:
The goal of the Committee is simple—to ensure that our unique Corporate Culture stays alive…. Culture Committee members
represent all regions and departments across our system and they are selected based upon their exemplary display of the
“Positively Outrageous Service” that won us the first-ever Triple Crown; their continual exhibition of the “Southwest Spirit” to
our Customers and to their fellow workers; and their high energy level, boundless enthusiasm, unique creativity, and constant
demonstration of teamwork and love for their fellow workers. 25
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Motivating with Rewards and Incentives
Reward and incentive systems represent a powerful means of influencing an organization’s culture, focusing efforts on
high-priority tasks, and motivating individual and collective task performance. 26 Just as culture deals with influencing
beliefs, behaviors, and attitudes of people within an organization, the reward system —by specifying who gets rewarded
and why—is an effective motivator and control mechanism. 27 The managers at Not Your Average Joe’s, a
Massachusett’s-based restaurant chain, changed their staffing procedures both to let their servers better understand their
performance and to better motivate them. 28 The chain uses sophisticated software to track server performance—both in
per customer sales and customer satisfaction as seen in tips. Highly rated servers are given more tables and preferred
schedules. In shifting more work and better schedules to the best workers, the chain hopes to improve profitability and
motivate all workers.
reward system
policies that specify who gets rewarded and why.
The Potential Downside While they can be powerful motivators, reward and incentive policies can also result in
undesirable outcomes in organizations. At the individual level, incentives can go wrong for multiple reasons. First, if
individual workers don’t see how their actions relate to how they are compensated, they can be demotivating. For
example, if the rewards are related to the firm’s stock price, workers may feel that their efforts have little if any impact
and won’t perceive any benefit from working harder. On the other hand, if the incentives are so closely tied to their
individual work, they may lead to dysfunctional outcomes. For example, if a sales representative is rewarded for sales
volume, she will be incentivized to sell at all costs. This may lead her to accept unprofitable sales or push sales through
distribution channels the firm would rather avoid. Thus, the collective sum of individual behaviors of an organization’s
employees does not always result in what is best for the organization; individual rationality is no guarantee of
organizational rationality.
Reward and incentive systems can also cause problems across organizational units. As corporations grow and evolve,
they often develop different business units with multiple reward systems. They may differ based on industry contexts,
business situations, stage of product life cycles, and so on. Subcultures within organizations may reflect differences
among functional areas, products, services, and divisions. To the extent that reward systems reinforce such behavioral
norms, attitudes, and belief systems, cohesiveness is reduced; important information is hoarded rather than shared,
individuals begin working at cross-purposes, and they lose sight of overall goals.
Such conflicts are commonplace in many organizations. For example, sales and marketing personnel promise
unrealistically quick delivery times to bring in business, much to the dismay of operations and logistics; overengineering
by R&D creates headaches for manufacturing; and so on. Conflicts also arise across divisions when divisional profits
become a key compensation criterion. As ill will and anger escalate, personal relationships and performance may suffer.
Creating Effective Reward and Incentive Programs To be effective, incentive and reward systems need to reinforce
basic core values, enhance cohesion and commitment to goals and objectives, and meet with the organization’s overall
mission and purpose. 29
At General Mills, to ensure a manager’s interest in the overall performance of his or her unit, half of a manager’s
annual bonus is linked to business-unit results and half to individual performance. 30 For example, if a manager simply
matches a rival manufacturer’s performance, his or her salary is roughly 5 percent lower. However, if a manager’s
product ranks in the industry’s top 10 percent in earnings growth and return on capital, the manager’s total pay can rise to
nearly 30 percent beyond the industry norm.
Effective reward and incentive systems share a number of common characteristics. 31 (see Exhibit 9.4 ). The perception
that a plan is “fair and equitable” is critically important.
284
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The firm must have the flexibility to respond to changing requirements as its direction and objectives change. In
recent years many companies have begun to place more emphasis on growth. Emerson Electric has shifted its emphasis
from cost cutting to growth. To ensure that changes take hold, the management compensation formula has been changed
from a largely bottom-line focus to one that emphasizes growth, new products, acquisitions, and international expansion.
Discussions about profits are handled separately, and a culture of risk taking is encouraged. 32 Finally, incentive and
reward systems don’t all have to be about financial rewards. Recognition can be a powerful motivator. For example, at
Mars Central Europe, they hold an event twice a year in which they celebrate innovative ideas generated by employees.
Recognition at the “Make a Difference” event is designed to motivate the winners and also other employees who want to
receive the same recognition. 33
EXHIBIT 9.4 Characteristics of Effective Reward and Evaluation Systems
• Objectives are clear, well understood, and broadly accepted
• Rewards are clearly linked to performance and desired behaviors.
• Performance measures are clear and highly visible.
• Feedback is prompt, clear, and unambiguous.
• The compensation “system” is perceived as fair and equitable.
• The structure is flexible; it can adapt to changing circumstances.
The key is for managers to find a mix of incentives that motivates employees. Gordon Bethune, the former CEO of
Continental Airlines used the following analogy. 34
“I own a twelve-hundred-acre ranch, and it’s got a seventy-acre lake. It’s wonderful. And do you know, in spite of all that, I still
have to use bait when I fish? Can you believe it? The point is there’s got to be something in it for the fish, and it’s up to me to
know what the fish like. It’s not up to them. So maybe if I learn enough about the fish and what they like, they might be easier to
get in the boat and provide me a little recreation.”
Setting Boundaries and Constraints
In an ideal world, a strong culture and effective rewards should be sufficient to ensure that all individuals and subunits
work toward the common goals and objectives of the whole organization. 35 However, this is not usually the case.
Counterproductive behavior can arise because of motivated self-interest, lack of a clear understanding of goals and
objectives, or outright malfeasance. Boundaries and constraints can serve many useful purposes for organizations,
including:
boundaries and constraints
rules that specify behaviors that are acceptable and unacceptable.
• Focusing individual efforts on strategic priorities.
• Providing short-term objectives and action plans to channel efforts.
• Improving efficiency and effectiveness.
• Minimizing improper and unethical conduct.
Focusing Efforts on Strategic Priorities Boundaries and constraints play a valuable role in focusing a company’s
strategic priorities. For example, several years ago, IBM sold off its PC business as part of its desire to focus its business
on computing services. Similarly, Pfizer sold its infant formula business as it refocused its attention on core
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. pharmaceutical products. 36 This concentration of effort and resources provides the firm with greater strategic focus and
the potential for stronger competitive advantages in the remaining areas.
Steve Jobs would use white boards to set priorities and focus attention at Apple. For example, he would take his “top
100” people on a retreat each year. One year, he asked the group what 10 things Apple should do next. The group
identified ideas. Ideas went up on the board, then got erased or revised; new ones were added, revised, and erased. The
group argued about it for a while and finally identified their list of top 10 initiatives. Jobs proceeded to slash the bottom
seven, stating, “We can only do three.” 37
285
Boundaries also have a place in the nonprofit sector. For example, a British relief organization uses a system to
monitor strategic boundaries by maintaining a list of companies whose contributions it will neither solicit nor accept.
Such boundaries are essential for maintaining legitimacy with existing and potential benefactors.
Providing Short-Term Objectives and Action Plans In Chapter 1 we discussed the importance of a firm having a
vision, mission, and strategic objectives that are internally consistent and that provide strategic direction. In addition,
short-term objectives and action plans provide similar benefits. That is, they represent boundaries that help to allocate
resources in an optimal manner and to channel the efforts of employees at all levels throughout the organization. 38 To be
effective, short-term objectives must have several attributes. They should:
• Be specific and measurable.
• Include a specific time horizon for their attainment.
• Be achievable, yet challenging enough to motivate managers who must strive to accomplish them.
Research has found that performance is enhanced when individuals are encouraged to attain specific, difficult, yet
achievable, goals (as opposed to vague “do your best” goals). 39
Short-term objectives must provide proper direction and also provide enough flexibility for the firm to keep pace with
and anticipate changes in the external environment, new government regulations, a competitor introducing a substitute
product, or changes in consumer taste. Unexpected events within a firm may require a firm to make important
adjustments in both strategic and short-term objectives. The emergence of new industries can have a drastic effect on the
demand for products and services in more traditional industries.
Action plans are critical to the implementation of chosen strategies. Unless action plans are specific, there may be
little assurance that managers have thought through all of the resource requirements for implementing their strategies. In
addition, unless plans are specific, managers may not understand what needs to be implemented or have a clear time
frame for completion. This is essential for the scheduling of key activities that must be implemented. Finally, individual
managers must be held accountable for the implementation. This helps to provide the necessary motivation and “sense of
ownership” to implement action plans on a timely basis. Strategy Spotlight 9.2 illustrates how Marks and Spencer puts its
sustainability mission into action by creating clear, measurable goals.
Improving Operational Efficiency and Effectiveness Rule-based controls are most appropriate in organizations with
the following characteristics:
• Environments are stable and predictable.
• Employees are largely unskilled and interchangeable.
• Consistency in product and service is critical.
• The risk of malfeasance is extremely high (e.g., in banking or casino operations). 40
McDonald’s Corp. has extensive rules and regulations that regulate the operation of its franchises. 41 Its policy manual
from a number of years ago stated, “Cooks must turn, never flip, hamburgers. If they haven’t been purchased, Big Macs
must be discarded in 10 minutes after being cooked and French fries in 7 minutes. Cashiers must make eye contact with
and smile at every customer.”
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Guidelines can also be effective in setting spending limits and the range of discretion for employees and managers,
such as the $2,500 limit that hotelier Ritz-Carlton uses to empower employees to placate dissatisfied customers.
Regulations also can be initiated to improve the use of an employee’s time at work. 42 CA Technologies restricts the use
of email during the hours of 10 a.m. to noon and 2 p.m. to 4 p.m. each day. 43
286
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STRATEGY
SPOTLIGHT
9.2 ENVIRONMENTAL
SUSTAINABILITY
BREAKING DOWN SUSTAINABILITY INTO MEASURABLE GOALS
Marks & Spencer (M&S) laid out an ambitious goal in early 2010 to become “the world’s most sustainable retailer”
by 2015. To meet this goal, M&S needed to substantially change how it undertook nearly all of its business
operations. To make this process more tractable and to provide opportunities to identify a range of actions
managers could take, M&S developed an overarching plan for its sustainability efforts, dubbed Plan A. They called it
Plan A because, as M&S managers put it, when it comes to building environmental sustainability, there is no Plan B.
Everyone in the firm needed to be committed to the one vision. In this plan, M&S identified three broad themes.
• Aim for all M&S products to have at least one Plan A quality.
• Help our customers make a difference to the social and environmental causes that matter to them.
• Help our customers live a more sustainable life.
Thus, M&S aimed not only to improve its own operations but also to change the lives of its customers and the
operations of its suppliers and other partners. Marc Bolland, M&S’s CEO, fleshed out the general Plan A goal with
180 environmental commitments. These commitments all had time targets associated with them, some short term
and some longer term. For example, one commitment was to make the company carbon neutral by 2012. To meet
its goal, M&S estimated it needed to achieve a 25 percent reduction in energy use in its stores by 2012 and
extended it to 35 percent by 2015. This provided clear targets for store managers to work toward. Similarly, M&S set
a goal to improve its water use efficiency in stores by 25 percent by the year 2015. Additionally, M&S set out to
design new stores that used 35 percent less water than current stores. These targets provided clear metrics for
store managers as well as architects and designers working on new stores.
In working with its suppliers, M&S similarly rolled out a series of time-based commitments. For example, it
conducted a review with all suppliers on the Plan A initiatives in the first year of the plan. M&S required all suppliers
of fresh meat, dairy, produce, and flowers to engage in a sustainable agriculture program by 2012. All clothing
suppliers were required to install energy efficient lighting and improved insulation by 2015 to attain a 10 percent
reduction in energy usage. These types of efforts spanned across the firm and its supply chain.
With its Plan A, M&S broke down a huge initiative into clear targets that were actionable by managers across the
firm and in its partner firms. Interestingly, while this initiative was hatched as a means to achieve environmental
sustainability gains, it has also turned out to be an economic win for M&S. In the first year of the plan, the firm
experienced an $80 million profit on the actions it undertook. The surplus has resulted from gains in energy
efficiency, lower packaging costs, lower waste bills, and profit from a sustainable energy business it set up that
relies on burning bio-waste to generate electricity.
Sources: Felsted, A. 2011. Marks and Spencer’s green blueprint. Ft.com , March 17: np; Anonymous. 2012. Marks & Spencer’s ambitious sustainability goals.
Sustainablebusiness.com , March 3: np; and plana.marksandspencer.com .
Minimizing Improper and Unethical Conduct Guidelines can be useful in specifying proper relationships with a
company’s customers and suppliers. 44 Many companies have explicit rules regarding commercial practices, including the
prohibition of any form of payment, bribe, or kickback. For example, Singapore Airlines has a 17-page policy outlining
its anticorruption and antibribery policies. 45
Regulations backed up with strong sanctions can also help an organization avoid conducting business in an unethical
manner. After the passing of the Sarbanes-Oxley Act (which provides for stiffer penalties for financial reporting
misdeeds), many chief financial officers (CFOs) have taken steps to ensure ethical behavior in the preparation of
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. financial statements. For example, Home Depot’s CFO, Carol B. Tome, strengthened the firm’s code of ethics and
developed stricter guidelines. Now all 25 of her subordinates must sign personal statements that all of their financial
statements are correct—just as she and her CEO have to do. 46
Behavioral Control in Organizations: Situational Factors
Here, the focus is on ensuring that the behavior of individuals at all levels of an organization is directed toward achieving
organizational goals and objectives. The three fundamental types of control are culture, rewards and incentives, and
boundaries and constraints. An organization may pursue one or a combination of them on the basis of a variety of
internal and external factors.
287
Not all organizations place the same emphasis on each type of control. 47 In high-technology firms engaged in basic
research, members may work under high levels of autonomy. An individual’s performance is generally quite difficult to
measure accurately because of the long lead times involved in R&D activities. Thus, internalized norms and values
become very important.
When the measurement of an individual’s output or performance is quite straightforward, control depends primarily
on granting or withholding rewards. Frequently, a sales manager’s compensation is in the form of a commission and
bonus tied directly to his or her sales volume, which is relatively easy to determine. Here, behavior is influenced more
strongly by the attractiveness of the compensation than by the norms and values implicit in the organization’s culture.
The measurability of output precludes the need for an elaborate system of rules to control behavior. 48
Control in bureaucratic organizations is dependent on members following a highly formalized set of rules and
regulations. Most activities are routine and the desired behavior can be specified in a detailed manner because there is
generally little need for innovative or creative activity. Managing an assembly plant requires strict adherence to many
rules as well as exacting sequences of assembly operations. In the public sector, the Department of Motor Vehicles in
most states must follow clearly prescribed procedures when issuing or renewing driver licenses.
Exhibit 9.5 provides alternate approaches to behavioral control and some of the situational factors associated with
them.
Evolving from Boundaries to Rewards and Culture
In most environments, organizations should strive to provide a system of rewards and incentives, coupled with a culture
strong enough that boundaries become internalized. This reduces the need for external controls such as rules and
regulations.
First, hire the right people—individuals who already identify with the organization’s dominant values and have
attributes consistent with them. Kroger, a supermarket chain, uses a pre-employment test to assess the degree to which
potential employees will be friendly and communicate well with customers. 49 Microsoft’s David Pritchard is well aware
of the consequences of failing to hire properly.
If I hire a bunch of bozos, it will hurt us, because it takes time to get rid of them. They start infiltrating the organization and then
they themselves start hiring people of lower quality. At Microsoft, we are always looking for people who are better than we are.
EXHIBIT 9.5 Organizational Control: Alternative Approaches
Approach Some Situational Factors
Culture: A system of unwritten rules that forms an
internalized influence over behavior.
• Often found in professional organizations.
• Associated with high autonomy.
• Norms are the basis for behavior.
Rules: Written and explicit guidelines that provide external
constraints on behavior.
• Associated with standardized output.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. • Tasks are generally repetitive and routine.
• Little need for innovation or creative activity.
Rewards: The use of performance-based incentive systems
to motivate.
• Measurement of output and performance is rather
straightforward.
• Most appropriate in organizations pursuing unrelated
diversification strategies.
• Rewards may be used to reinforce other means of
control.
288
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Second, training plays a key role. For example, in elite military units such as the Green Berets and Navy SEALs, the
training regimen so thoroughly internalizes the culture that individuals, in effect, lose their identity. The group becomes
the overriding concern and focal point of their energies. At firms such as FedEx, training not only builds skills, but also
plays a significant role in building a strong culture on the foundation of each organization’s dominant values.
Third, managerial role models are vital. Andy Grove, former CEO and co-founder of Intel, didn’t need (or want) a
large number of bureaucratic rules to determine who is responsible for what, who is supposed to talk to whom, and who
gets to fly first class (no one does). He encouraged openness by not having many of the trappings of success—he worked
in a cubicle like all the other professionals. Can you imagine any new manager asking whether or not he can fly first
class? Grove’s personal example eliminated such a need.
Fourth, reward systems must be clearly aligned with the organizational goals and objectives. For example, as part of
its efforts to drive sustainability efforts down through its suppliers, Marks and Spencer pushes the suppliers to develop
employee rewards systems that support a living wage and team collaboration.
LO9.5
The three key participants in corporate governance: shareholders, management (led by the CEO), and the board of
directors.
The Role of Corporate Governance
We now address the issue of strategic control in a broader perspective, typically referred to as “corporate governance.”
Here we focus on the need for both shareholders (the owners of the corporation) and their elected representatives, the
board of directors, to actively ensure that management fulfills its overriding purpose of increasing long-term shareholder
value. 50
Robert Monks and Nell Minow, two leading scholars in corporate governance, define it as “the relationship among
various participants in determining the direction and performance of corporations. The primary participants are (1) the
shareholders, (2) the management (led by the CEO), and (3) the board of directors.”* Our discussion will center on how
corporations can succeed (or fail) in aligning managerial motives with the interests of the shareholders and their elected
representatives, the board of directors. 51 As you will recall from Chapter 1 , we discussed the important role of boards of
directors and provided some examples of effective and ineffective boards. 52
Good corporate governance plays an important role in the investment decisions of major institutions, and a premium is
often reflected in the price of securities of companies that practice it. The corporate governance premium is larger for
firms in countries with sound corporate governance practices compared to countries with weaker corporate governance
standards. 53
Sound governance practices often lead to superior financial performance. However, this is not always the case. For
example, practices such as independent directors (directors who are not part of the firm’s management) and stock options
are generally assumed to result in better performance. But in many cases, independent directors may not have the
necessary expertise or involvement, and the granting of stock options to the CEO may lead to decisions and actions
calculated to prop up share price only in the short term. Strategy Spotlight 9.3 presents some research evidence on
governance practices and firm performance.
corporate governance
the relationship among various participants in determining the direction and performance of corporations. The primary
participants are (1) the share-holders, (2) the management, and (3) the board of directors.
*Management cannot ignore the demands of other important firm stakeholders such as creditors, suppliers, customers, employees, and government regulators.
At times of financial duress, powerful creditors can exert strong and legitimate pressures on managerial decisions. In general, however, the attention to
stakeholders other than the owners of the corporation must be addressed in a manner that is still consistent with maximizing long-term shareholder returns. For a
seminal discussion on stakeholder management, refer to Freeman, R. E. 1984. Strategic Management: A Stakeholder Approach . Boston: Pitman.
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STRATEGY SPOTLIGHT 9.3 ETHICS
THE RELATIONSHIP BETWEEN RECOMMENDED CORPORATE GOVERNANCE
PRACTICES AND FIRM PERFORMANCE
A significant amount of research has examined the effect of corporate governance on firm performance. Some
research has shown that implementing good corporate governance structures yields superior financial performance.
Other research has not found a positive relationship between governance and performance. Results of a few of
these studies are summarized below.
1. A positive correlation between corporate governance and different measures of corporate performance. Recent
studies show that there is a strong positive correlation between effective corporate governance and different
indicators of corporate performance such as growth, profitability, and customer satisfaction. Over a recent three-
year period, the average return of large capitalized firms with the best governance practices was more than five
times higher than the performance of firms in the bottom corporate governance quartile.
2. Compliance with international best practices leads to superior performance. Studies of European companies
show that greater compliance with international corporate governance best practices concerning board structure
and function has significant and positive relationships with return on assets (ROA). In 10 of 11 Asian and Latin
American markets, companies in the top corporate governance quartile for their respective regions averaged 10
percent greater return on capital employed (ROCE) than their peers. In a study of 12 emerging markets,
companies in the lowest corporate governance quartile had a much lower ROCE than their peers.
3. Many recommended corporate governance practices do not have a positive relationship with firm performance.
In contrast to these studies, there is also a body of research suggesting that corporate governance practices do
not have a positive influence on firm performance. With corporate boards, there is no evidence that including
more external directors on the board of directors of U.S. corporations has led to substantially higher firm
performance. Also, giving more stock options to CEOs to align their interests with stakeholders may lead them to
take high-risk bets in firm investments that have a low probability to improve firm performance. Rather than
making good decisions, CEOs may “swing for the fences” with these high-risk investments. Additionally,
motivating CEOs with large numbers of stock options appears to increase the likelihood of unethical accounting
violations by the firm as the CEO tries to increase the firm’s stock price.
Sources: Dalton, D. R., Daily, C. M., Ellstrand, A. E., & Johnson, J. L., 1998. Meta-analytic reviews of board composition, leadership structure, and financial
performance. Strategic Management Journal, 19(3): 269–290; Sanders, W. G. & Hambrick, D. C. 2007. Swinging for the fences: The effects of CEO stock
options on company risk-taking and performance. Academy of Management Journal, 50(5): 1055–1078; Harris, J. & Bromiley, P. 2007. Incentives to cheat: The
influence of executive compensation and firm performance on financial misrepresentation. Organization Science, 18(3): 350–367; Bauwhede, H. V. 2009. On
the relation between corporate governance compliance and operating performance. Accounting and Business Research. 39(5): 497–513; Gill, A. 2001. Credit
Lyonnais Securities (Asia). Corporate governance in emerging markets: Saints and sinners, April; and Low, C. K. 2002. Corporate governance: An Asia-
Pacific critique. Hong Kong: Sweet & Maxwell Asia.
At the same time, few topics in the business press are generating as much interest (and disdain!) as corporate
governance.
Some recent notable examples of flawed corporate governance include: 54
• In 2012 Japanese camera and medical equipment maker Olympus Corporation and three of its former executives
pleaded guilty to charges that they falsified accounting records over a five-year period to inflate the financial
performance of the firm. The total value of the accounting irregularities came to $1.7 billion. 55
• In October 2010, Angelo Mozilo, the co-founder of Countrywide Financial, agreed to pay $67.5 million to the
Securities and Exchange Commission (SEC) to settle fraud charges. He was charged with deceiving the home loan
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. company’s investors while reaping a personal windfall. He was accused of hiding risks about Countrywide’s loan
portfolio as the real estate market soured. Former Countrywide President David Sambol and former Chief Financial
Officer Eric Sieracki were also charged with fraud, as they failed to disclose the true state of Countrywide’s
deteriorating mortgage portfolio. The SEC accused Mozilo of insider trading, alleging that he sold millions of
dollars worth of Countrywide stock after he knew the company was doomed.
290
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• In 2008, former Brocade CEO Gregory Reyes was sentenced to 21 months in prison and fined $15 million for his
involvement in backdating stock option grants. Mr. Reyes was the first executive to go on trial and be convicted
over the improper dating of stock-option awards, which dozens of companies have acknowledged since the practice
came to light.
Because of the many lapses in corporate governance, we can see the benefits associated with effective practices. 56
However, corporate managers may behave in their own self-interest, often to the detriment of shareholders. Next we
address the implications of the separation of ownership and management in the modern corporation, and some
mechanisms that can be used to ensure consistency (or alignment) between the interests of shareholders and those of the
managers to minimize potential conflicts.
The Modern Corporation: The Separation of Owners (Shareholders) and
Management
Some of the proposed definitions for a corporation include:
• “The business corporation is an instrument through which capital is assembled for the activities of producing and
distributing goods and services and making investments. Accordingly, a basic premise of corporation law is that a
business corporation should have as its objective the conduct of such activities with a view to enhancing the
corporation’s profit and the gains of the corporation’s owners, that is, the shareholders.” (Melvin Aron Eisenberg,
The Structure of Corporation Law )
• “A body of persons granted a charter legally recognizing them as a separate entity having its own rights, privileges,
and liabilities distinct from those of its members.” (American Heritage Dictionary)
• “An ingenious device for obtaining individual profit without individual responsibility.” (Ambrose Bierce, The
Devil’s Dictionary )57
All of these definitions have some validity and each one reflects a key feature of the corporate form of business
organization—its ability to draw resources from a variety of groups and establish and maintain its own persona that is
separate from all of them. As Henry Ford once said, “A great business is really too big to be human.”
Simply put, a corporation is a mechanism created to allow different parties to contribute capital, expertise, and labor
for the maximum benefit of each party. 58 The shareholders (investors) are able to participate in the profits of the
enterprise without taking direct responsibility for the operations. The management can run the company without the
responsibility of personally providing the funds. The shareholders have limited liability as well as rather limited
involvement in the company’s affairs. However, they reserve the right to elect directors who have the fiduciary
obligation to protect their interests.
corporation
a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each
party.
Over 75 years ago, Columbia University professors Adolf Berle and Gardiner C. Means addressed the divergence of
the interests of the owners of the corporation from the professional managers who are hired to run it. They warned that
widely dispersed ownership “released management from the overriding requirement that it serve stockholders.” The
separation of ownership from management has given rise to a set of ideas called “agency theory.” Central to agency
theory is the relationship between two primary players—the principals who are the owners of the firm (stockholders) and
the agents, who are the people paid by principals to perform a job on their behalf (management). The stockholders elect
and are represented by a board of directors that has a fiduciary responsibility to ensure that management acts in the best
interests of stockholders to ensure long-term financial returns for the firm.
Agency theory is concerned with resolving two problems that can occur in agency relationships. 59 The first is the
agency problem that arises (1) when the goals of the principals
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a theory of the relationship between principals and their agents, with emphasis on two problems: (1) the conflicting goals
of principals and agents, along with the difficulty of principals to monitor the agents, and (2) the different attitudes and
preferences toward risk of principals and agents.
291
and agents conflict, and (2) when it is difficult or expensive for the principal to verify what the agent is actually doing. 60
The board of directors would be unable to confirm that the managers were actually acting in the shareholders’ interests
because managers are “insiders” with regard to the businesses they operate and thus are better informed than the
principals. Thus, managers may act “opportunistically” in pursuing their own interests—to the detriment of the
corporation. 61 Managers may spend corporate funds on expensive perquisites (e.g., company jets and expensive art),
devote time and resources to pet projects (initiatives in which they have a personal interest but that have limited market
potential), engage in power struggles (where they may fight over resources for their own betterment and to the detriment
of the firm), and negate (or sabotage) attractive merger offers because they may result in increased employment risk. 62
The second issue is the problem of risk sharing. This arises when the principal and the agent have different attitudes
and preferences toward risk. The executives in a firm may favor additional diversification initiatives because, by their
very nature, they increase the size of the firm and thus the level of executive compensation. 63 At the same time, such
diversification initiatives may erode shareholder value because they fail to achieve some synergies that we discussed in
Chapter 6 (e.g., building on core competencies, sharing activities, or enhancing market power). Agents (executives) may
have a stronger preference toward diversification than shareholders because it reduces their personal level of risk from
potential loss of employment. Executives who have large holdings of stock in their firms were more likely to have
diversification strategies that were more consistent with shareholder interests—increasing long-term returns. 64
At times, top-level managers engage in actions that reflect their self-interest rather than the interests of shareholders.
We provide two examples below:
• Steve Wynn, the CEO of Wynn Resorts, had a great year in 2011, even though his stockholders barely broke even.
He received a starting salary of $3.9 million. On top of that, he received two bonuses, one worth $2 million and
another for $9 million. In addition to cash compensation, he received over $900,000 worth of personal flying time
on the corporate jet and over $500,000 worth of use of the company’s villa. 65
• John Sperling retired as chairman emeritus of Apollo Group in early 2013. He founded Apollo, the for-profit
education company best known for its University of Phoenix unit, in 1973. Even though he already owns stock in
Apollo worth in excess of $200 million, the board of directors, which includes his son as a member, granted him a
“special retirement bonus” of $5 million, gave him two cars, and awarded him a lifetime annuity of $71,000 a
month. He received all of these benefits even though Apollo’s stock at the time of his retirement was worth one-
fourth of its value in early 2009. 66
Governance Mechanisms: Aligning the Interests of Owners and Managers
As noted above, a key characteristic of the modern corporation is the separation of ownership from control. To minimize
the potential for managers to act in their own self-interest, or “opportunistically,” the owners can implement some
governance mechanisms. 67 First, there are two primary means of monitoring the behavior of managers. These include (1)
a committed and involved board of directors that acts in the best interests of the shareholders to create long-term value
and (2) shareholder activism, wherein the owners view themselves as share owners instead of share holders and become
actively engaged in the governance of the corporation. Finally, there are managerial incentives, sometimes called
“contract-based outcomes,” which consist of reward and compensation agreements. Here the goal is to carefully craft
managerial incentive packages to align the interests of management with those of the stockholders. 68
LO9.6
The role of corporate governance mechanisms in ensuring that the interests of managers are aligned with those of
shareholders from both the United States and international perspectives.
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We close this section with a brief discussion of one of the most controversial issues in corporate governance—duality.
Here, the question becomes: Should the CEO also be chairman of the board of directors? In many Fortune 500 firms, the
same individual serves in both roles. However, in recent years, we have seen a trend toward separating these two
positions. The key issue is what implications CEO duality has for firm governance and performance.
A Committed and Involved Board of Directors The board of directors acts as a fulcrum between the owners and
controllers of a corporation. They are the intermediaries who provide a balance between a small group of key managers
in the firm based at the corporate headquarters and a sometimes vast group of shareholders. 69 In the United States, the
law imposes on the board a strict and absolute fiduciary duty to ensure that a company is run consistent with the long-
term interests of the owners—the shareholders. The reality, as we have seen, is somewhat more ambiguous. 70
board of directors
a group that has a fiduciary duty to ensure that the company is run consistently with the long-term interests of the
owners, or shareholders, of a corporation and that acts as an intermediary between the shareholders and management.
The Business Roundtable, representing the largest U.S. corporations, describes the duties of the board as follows:
1. Select, regularly evaluate, and, if necessary, replace the CEO. Determine management compensation. Review
succession planning.
2. Review and, where appropriate, approve the financial objectives, major strategies, and plans of the corporation.
3. Provide advice and counsel to top management.
4. Select and recommend to shareholders for election an appropriate slate of candidates for the board of directors;
evaluate board processes and performance.
5. Review the adequacy of the systems to comply with all applicable laws/regulations. 71
Given these principles, what makes for a good board of directors? 72 According to the Business Roundtable, the most
important quality is a board of directors who are active, critical participants in determining a company’s strategies. 73 That
does not mean board members should micromanage or circumvent the CEO. Rather, they should provide strong oversight
going beyond simply approving the CEO’s plans. A board’s primary responsibilities are to ensure that strategic plans
undergo rigorous scrutiny, evaluate managers against high performance standards, and take control of the succession
process. 74
Although boards in the past were often dismissed as CEO’s rubber stamps, increasingly they are playing a more active
role by forcing out CEOs who cannot deliver on performance. 75 According to the consulting firm Booz Allen Hamilton,
the rate of CEO departures for performance reasons more than tripled, from 1.3 percent to 4.2 percent, between 1995 and
2002. 76 And today’s CEOs are not immune to termination.
• In September 2010, Jonathan Klein, the president of the CNN/U.S. cable channel, was fired because CNN’s ratings
had suffered. 77
• Don Blankenship, CEO of coal mining giant Massey Energy, resigned in December 2010 after a deadly explosion
in Massey’s Upper Big Branch mine in West Virginia, a mine that had received numerous citations for safety
violations in the last few years. The blast was the worst mining disaster in the United States in 40 years and
resulted in criminal as well as civil investigations and lawsuits.
• Tony Hayward, CEO of oil and energy company British Petroleum (BP), was forced to step down in October 2010
after the Deepwater Horizon oil spill in the Gulf of Mexico led to an environmental disaster and a $20 billion
recovery fund financed by BP.
• Carol Bartz was ousted as the CEO of Yahoo after two and a half years when the board observed limited
improvement in the firm’s market position, turmoil over job cuts and secrecy during her leadership, and a flat stock
price. Similarly, Vikram Pandit was pressured to resign from his position as CEO of Citigroup after five
tumultuous years and increasing investor unhappiness over the performance of the firm.
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Increasing CEO turnover could, however, pose a major problem for many organizations. Why? It appears that boards
of directors are not typically engaged in effective succession planning. For example, only 35 percent of 1,318 executives
surveyed by Korn/Ferry International in December 2010 said their companies had a succession plan. And 61 percent of
respondents to a survey (conducted by Heidrick & Struggles and Stanford University’s Rock Center for Corporate
Governance) claimed their companies had no viable internal candidates. This issue is also true in private companies.
Only 23 percent of private firms surveyed by the National Association of Corporate Directors indicated they had
developed formal succession plans. 78
Another key component of top-ranked boards is director independence. 79 Governance experts believe that a majority
of directors should be free of all ties to either the CEO or the company. 80 That means a minimum of “insiders” (past or
present members of the management team) should serve on the board, and that directors and their firms should be barred
from doing consulting, legal, or other work for the company. 81 Interlocking directorships—in which CEOs and other top
managers serve on each other’s boards—are not desirable. But perhaps the best guarantee that directors act in the best
interests of shareholders is the simplest: Most good companies now insist that directors own significant stock in the
company they oversee. 82
Taking it one step further, research and simple observations of boards indicate that simple prescriptions, such as
having a majority of outside directors, are insufficient to lead to effective board operations. Firms need to cultivate
engaged and committed boards. There are several actions that can have a positive influence on board dynamics as the
board works to both oversee and advise management. 83
1. Build in the right expertise on the board. Outside directors can bring in experience that the management team is
missing. For example, corporations that are considering expanding into a new region of the globe may want to add
a board member who brings expertise on and connections in that region. Similarly, research suggests that firms
who are focusing on improving their operational efficiency benefit from having an external board member whose
full time position is as a chief operating officer, a position that typically focuses on operational activities.
2. Keep your board size manageable. Small, focused boards, generally with 5 to 11 members, are preferable to
larger ones. As boards grow in size, the ability for them to function as a team declines. The members of the board
feel less connected with each other, and decision making can become unwieldy.
3. Choose directors who can participate fully. The time demands on directors have increased as their
responsibilities have grown to include overseeing management, verifying the firm’s financial statements, setting
executive compensation, and advising on the strategic direction of the firm. As a result, the average number of
hours per year spent on board duties has increased to over 350 hours for directors of large firms. Directors have to
dedicate significant time to their roles—not just for scheduled meetings, but also to review materials between
meetings and to respond to time-sensitive challenges. Thus, firms should strive to include directors who are not
currently overburdened by their core occupation or involvement on other boards.
4. Balance the need to focus on the past, the present, and the future. Boards have a three-tiered role. They need to
focus on the recent performance of the firm, how the firm is meeting current milestones and operational targets,
and what the strategic direction of the firm will be moving forward. Under current regulations, boards are required
to spend a great amount of time on the past as they vet the firm’s financials. However, effective boards balance this
time and ensure that they give adequate consideration to the present and the future.
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5. Consider management talent development. As part of their future-oriented focus, effective boards develop
succession plans for the CEO but also focus on talent development at other upper echelons of the organization. In a
range of industries, human capital is an increasingly important driver of firm success, and boards should be
involved in evaluating and developing the top management core.
6. Get a broad view. In order to better understand the firm and make contact with key managers, the meetings of the
board should rotate to different operating units and sites of the firm.
7. Maintain norms of transparency and trust. Highly functioning boards maintain open, team-oriented dialogue
where information flows freely and questions are asked openly. Directors respect each other and trust that they are
all working in the best interests of the corporation.
With financial crises and corporate scandals, regulators and investors have pushed for significant changes in the
structure and actions of boards. Exhibit 9.6 highlights some of the changes seen among firms in the S&P 500.
EXHIBIT 9.6 The Changing Face of the Board of Firms in the S&P 500
Then and Now
Issue 1987 2011 Explanation
Percentage of boards
that have an average
age of 64 or older
3 37 Fewer sitting CEOs are willing to serve on the boards of other firms. As a
result, companies are raising the retirement age for directors and pulling in
retired executives to their boards.
Average pay for
directors
$36,667 $95,262 Board work has taken greater time and commitment. Additionally, the personal
liability directors face has increased. As a result, compensation has increased
to attract and retain board members.
Percentage of board
members who are
female
9 16.2 While the number of boards with women and minorities has increased, these
groups are still underrepresented. Still, companies have emphasized including
female directors in key roles. For example, over half the audit and
compensation committees of S&P 500 firms have at least one female
member.
Percentage of boards
with 12 or fewer
members
22 83 As the strategic role and the legal requirements of the board have increased,
firms have opted for smaller boards since these smaller boards better operate
as true decision-making groups.
Percentage of the
directors that are
independent
68 84 The Sarbanes-Oxley Act and pressure from investors have led to an increase
in the number of independent directors. In fact, over half the S&P 500 firms
now have no insiders other than the CEO on the board.
Sources: Anonymous. 2011. Corporate boards: Now and then. Harvard Business Review, 89(11): 38–39; and Dalton, D. & Dalton, C. 2010. Women and
corporate boards of directors: The promise of increased, and substantive participation in the post Sarbanes-Oxley era. Business Horizons, 53: 257–268.
295
Shareholder Activism As a practical matter, there are so many owners of the largest American corporations that it
makes little sense to refer to them as “owners” in the sense of individuals becoming informed and involved in corporate
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. affairs. 84 However, even an individual shareholder has several rights, including (1) the right to sell the stock, (2) the right
to vote the proxy (which includes the election of board members), (3) the right to bring suit for damages if the
corporation’s directors or managers fail to meet their obligations, (4) the right to certain information from the company,
and (5) certain residual rights following the company’s liquidation (or its filing for reorganization under bankruptcy
laws), once creditors and other claimants are paid off. 85
Collectively, shareholders have the power to direct the course of corporations. 86 This may involve acts such as being
party to shareholder action suits and demanding that key issues be brought up for proxy votes at annual board meetings. 87
The power of shareholders has intensified in recent years because of the increasing influence of large institutional
investors such as mutual funds (e.g., T. Rowe Price and Fidelity Investments) and retirement systems such as TIAA-
CREF (for university faculty members and school administrative staff). 88 Institutional investors hold approximately 50
percent of all listed corporate stock in the United States. 89
Shareholder activism refers to actions by large shareholders, both institutions and individuals, to protect their
interests when they feel that managerial actions diverge from shareholder value maximization.
shareholder activism
actions by large shareholders to protect their interests when they feel that managerial actions of a corporation diverge
from shareholder value maximization.
Many institutional investors are aggressive in protecting and enhancing their investments. They are shifting from
traders to owners. They are assuming the role of permanent shareholders and rigorously analyzing issues of corporate
governance. In the process they are reinventing systems of corporate monitoring and accountability. 90
Consider the proactive behavior of CalPERS, the California Public Employees’ Retirement System, which manages
over $240 billion in assets and is the third largest pension fund in the world. Every year CalPERS reviews the
performance of the 1,000 firms in which it retains a sizable investment. 91 They review each firm’s short- and long-term
performance, its governance characteristics, its financial status, and market expectations for the firm. CalPERS then
meets with selected companies to better understand their governance and business strategy. If needed, CalPERS requests
changes in the firm’s governance structure and works to ensure shareholders’ rights. If CalPERS does not believe that the
firm is responsive to its concerns, they consider filing proxy actions at the firm’s next shareholders meeting and possibly
even court actions. CalPERS’s research suggests that these actions lead to superior performance. The portfolio of firms
they have included in their review program produced a cumulative return that was 11.59 percent higher than a respective
set of benchmark firms over a three-year period. Thus, CalPERS has seen a real benefit of acting as an interested owner,
rather than as a passive investor.
Perhaps no discussion of shareholder activism would be complete without mention of Carl Icahn, a famed activist
with a personal net worth of about $13 billion:
The bogeyman I am now chasing is the structure of American corporations, which permit managements and boards to rule
arbitrarily and too often receive egregious compensation even after doing a subpar job. Yet they remain accountable to no one. 92
The market appears to value the actions of activist investors. On the day it became publicly known that Icahn had taken a
10 percent ownership in Netflix, the stock price of Netflix soared 14 percent. 93
Managerial Rewards and Incentives As we discussed earlier in the chapter, incentive systems must be designed to help
a company achieve its goals. 94 From the perspective of governance, one of the most critical roles of the board of directors
is to create incentives that align the interests of the CEO and top executives with the interests of owners of the
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corporation—long-term shareholder returns. 95 Shareholders rely on CEOs to adopt policies and strategies that maximize
the value of their shares. 96 A combination of three basic policies may create the right monetary incentives for CEOs to
maximize the value of their companies: 97
1. Boards can require that the CEOs become substantial owners of company stock.
2. Salaries, bonuses, and stock options can be structured so as to provide rewards for superior performance and
penalties for poor performance.
3. Dismissal for poor performance should be a realistic threat.
In recent years the granting of stock options has enabled top executives of publicly held corporations to earn
enormous levels of compensation. In 2011, the average CEO in the Standard & Poor’s 500 stock index took home 380
times the pay of the average worker—up from 40 times the average in 1980. The counterargument, that the ratio is down
from the 514 multiple in 2000, doesn’t get much traction. 98
Many boards have awarded huge option grants despite poor executive performance, and others have made
performance goals easier to reach. However, stock options can be a valuable governance mechanism to align the CEO’s
interests with those of the shareholders. The extraordinarily high level of compensation can, at times, be grounded in
sound governance principles. 99 Research by Steven Kaplan at the University of Chicago found that firms with CEOs in
the top quintile of pay generated stock returns 60 percent higher than their direct competitors, while firms with CEOs in
the bottom quintile of pay saw their stock underperform their rivals by almost 20 percent. 100 For example, David Zaslav
CEO of Discovery Communications, took home $37.8 million in 2011, but his firm’s stock appreciated by 57 percent
over the 2011–2012 period. 101
That doesn’t mean that executive compensation systems can’t or shouldn’t be improved. Exhibit 9.7 outlines a number
of ways to build effective compensation packages for executives. 102
EXHIBIT 9.7 Six Policies for Effective TopManagement Compensation
Boards need to be diligent in building executive compensation packages that will incentivize executives to build long-term
shareholder value and to address the concerns that regulators and the public have about excessive compensation. The key
is to have open, fair, and consistent pay plans. Here are five policies to achieve that
1. Increase transparency. Principles and pay policies should be consistent over time and fully disclosed in company
documents. For example, Novartis has emphasized making their compensation policies fully transparent and not
altering the targets used for incentive compensation in midstream.
2. Build long-term performance with long-term pay. The timing of compensation can be structured to force executives
to think about the long-term success of the organization. For example, ExxonMobil times two-thirds of its senior
executives’ incentive compensation so that they don’t receive it until they retire or for 10 years, whichever is longer.
Similarly, in 2009, Goldman Sachs replaced its annual bonuses for its top managers with restricted stock grants that
executives could sell in three to five years.
3. Reward executives for performance, not simply for changes in the company’s stock price. To keep them from
focusing only on stock price, Target includes a component in its executives’ compensation plan for same-store sales
performance over time.
4. Have executives put some “skin in the game.” Firms should create some downside risk for managers. Relying
more on restricted stock, rather than stock options, can achieve this. But some experts suggest that top executives
should purchase sizable blocks of the firm’s stock with their own money.
5. Avoid overreliance on simple metrics. Rather than rewarding for short-term financial performance metrics, firms
should include future-oriented qualitative measures to incentivize managers to build for the future. Companies could
include criteria such as customer retention rates, innovation and new product launch milestones, and leadership
development criteria. For example, IBM added bonuses for executives who evidenced actions fostering global
cooperation.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 6. Increase equity between workers and executives. Top executives, with their greater responsibilities, should and will
continue to make more than front-line employees, but firms can signal equity by dropping special perks, plans, and
benefits for top managers. Additionally, companies can give employees the opportunity to share in the success of the
firm by establishing employee stock ownership plans.
Sources: George, B. 2010. Executive pay: Rebuilding trust in an era of rage. Bloomberg Businessweek, September 13: 56; and Barton, D. 2011. Capitalism for
the long term. Harvard Business Review, 89(3): 85.
297
CEO Duality: Is It Good or Bad?
CEO duality is one of the most controversial issues in corporate governance. It refers to the dual leadership structure
where the CEO acts simultaneously as the chair of the board of directors. 103 Scholars, consultants, and executives who are
interested in determining the best way to manage a corporation are divided on the issue of the roles and responsibilities of
a CEO. Two schools of thought represent the alternative positions:
Unity of Command Advocates of the unity of command perspective believe when one person holds both roles, he or she
is able to act more efficiently and effectively. CEO duality provides firms with a clear focus on both objectives and
operations as well as eliminates confusion and conflict between the CEO and the chairman. Thus, it enables smoother,
more effective strategic decision making. Holding dual roles as CEO/chairman creates unity across a company’s
managers and board of directors and ultimately allows the CEO to serve the shareholders even better. Having leadership
focused in a single individual also enhances a firm’s responsiveness and ability to secure critical resources. This
perspective maintains that separating the two jobs—that of a CEO and that of the chairperson of the board of
directors—may produce all types of undesirable consequences. CEOs may find it harder to make quick decisions. Ego-
driven chief executives and chairmen may squabble over who is ultimately in charge. The shortage of first-class business
talent may mean that bosses find themselves second-guessed by people who know little about the business. 104 Companies
like Coca-Cola, JPMorgan Chase, and Time Warner have refused to divide the CEO’s and chairman’s jobs and support
this duality structure.
Agency Theory Supporters of agency theory argue that the positions of CEO and chairman should be separate. The case
for separation is based on the simple principle of the separation of power. How can boards discharge their basic
duty—monitoring the boss—if the boss is chairing its meetings and setting its agenda? How can a board act as a
safeguard against corruption or incompetence when the possible source of that corruption and incompetence is sitting at
the head of the table? CEO duality can create a conflict of interest that could negatively affect the interests of the
shareholders.
Duality also complicates the issue of CEO succession. In some cases, a CEO/chairman may choose to retire as CEO
but keep his or her role as the chairman. Although this splits up the roles, which appeases an agency perspective, it
nonetheless puts the new CEO in a difficult position. The chairman is bound to question some of the new changes put in
place, and the board as a whole might take sides with the chairman they trust and with whom they have a history. This
conflict of interest would make it difficult for the new CEO to institute any changes, as the power and influence would
still remain with the former CEO. 105
Duality also serves to reinforce popular doubts about the legitimacy of the system as a whole and evokes images of
bosses writing their own performance reviews and setting their own salaries. One of the first things that some of
America’s troubled banks, including Citigroup, Washington Mutual, Wachovia, and Wells Fargo, did when the financial
crisis hit in 2007–2008 was to separate the two jobs. Firms like Siebel Systems, Disney, Oracle, and Microsoft have also
decided to divide the roles between the CEO and chairman and eliminate duality. Finally, more than 90 percent of S&P
500 companies with CEOs who also serve as chairman of the board have appointed “lead” or “presiding” directors to act
as a counterweight to a combined chairman and chief executive.
Research suggests that the effects of going from having a joint CEO/Chairman to separating the two positions is
contingent on how the firm is doing. When the positions are broken apart, there is a clear shift in the firm’s performance.
If the firm has been performing well, its performance declines after the separation. If the firm has been doing poorly, it
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experiences improvement after separating the two roles. This research suggests that there is no one correct answer on
duality, but that firms should consider its current position and performance trends when deciding whether to keep the
CEO and Chairman position in the hands of one person. 106
External Governance Control Mechanisms
Thus far, we’ve discussed internal governance mechanisms. Internal controls, however, are not always enough to ensure
good governance. The separation of ownership and control that we discussed earlier requires multiple control
mechanisms, some internal and some external, to ensure that managerial actions lead to shareholder value maximization.
Further, society-at-large wants some assurance that this goal is met without harming other stakeholder groups. Now we
discuss several external governance control mechanisms that have developed in most modern economies. These
include the market for corporate control, auditors, governmental regulatory bodies, banks and analysts, media, and public
activists.
external governance control mechanisms
methods that ensure that managerial actions lead to shareholder value maximization and do not harm other stakeholder
groups that are outside the control of the corporate governance system.
The Market for Corporate Control Let us assume for a moment that internal control mechanisms in a company are
failing. This means that the board is ineffective in monitoring managers and is not exercising the oversight required of
them and that shareholders are passive and are not taking any actions to monitor or discipline managers. Under these
circumstances managers may behave opportunistically. 107 Opportunistic behavior can take many forms. First, they can
shirk their responsibilities. Shirking means that managers fail to exert themselves fully, as is required of them. Second,
they can engage in on the job consumption. Examples of on the job consumption include private jets, club memberships,
expensive artwork in the offices, and so on. Each of these represents consumption by managers that does not in any way
increase shareholder value. Instead, they actually diminish shareholder value. Third, managers may engage in excessive
product-market diversification. 108 As we discussed in Chapter 6 , such diversification serves to reduce only the
employment risk of the managers rather than the financial risk of the shareholders, who can more cheaply diversify their
risk by owning a portfolio of investments. Is there any external mechanism to stop managers from shirking, consumption
on the job, and excessive diversification?
The market for corporate control is one external mechanism that provides at least some partial solution to the
problems described. If internal control mechanisms fail and the management is behaving opportunistically, the likely
response of most shareholders will be to sell their stock rather than engage in activism. 109 As more stockholders vote with
their feet, the value of the stock begins to decline. As the decline continues, at some point the market value of the firm
becomes less than the book value. A corporate raider can take over the company for a price less than the book value of
the assets of the company. The first thing that the raider may do on assuming control over the company will be to fire the
underperforming management. The risk of being acquired by a hostile raider is often referred to as the takeover
constraint. The takeover constraint deters management from engaging in opportunistic behavior. 110
market for corporate control
an external control mechanism in which shareholders dissatisfied with a firm’s management sell their shares.
takeover constraint
the risk to management of the firm being acquired by a hostile raider.
Although in theory the takeover constraint is supposed to limit managerial opportunism, in recent years its
effectiveness has become diluted as a result of a number of defense tactics adopted by incumbent management (see
Chapter 6 ). Foremost among them are poison pills, greenmail, and golden parachutes. Poison pills are provisions adopted
by the company to reduce its worth to the acquirer. An example would be payment of a huge one-time dividend, typically
financed by debt. Greenmail involves buying back the stock from the acquirer, usually at an attractive premium. Golden
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. parachutes are employment contracts that cause the company to pay lucrative severance packages to top managers fired
as a result of a takeover, often running to several million dollars.
299
Auditors Even when there are stringent disclosure requirements, there is no guarantee that the information disclosed will
be accurate. Managers may deliberately disclose false information or withhold negative financial information as well as
use accounting methods that distort results based on highly subjective interpretations. Therefore, all accounting
statements are required to be audited and certified to be accurate by external auditors. These auditing firms are
independent organizations staffed by certified professionals who verify the firm’s books of accounts. Audits can unearth
financial irregularities and ensure that financial reporting by the firm conforms to standard accounting practices.
However, these audits often fail to catch accounting irregularities. In the past, auditing failures played an important
part in the failures of firms such as Enron and WorldCom. A recent study by the Public Company Accounting Oversight
Board (PCAOB) found that audits conducted by the Big 4 accounting firms were often deficient. For example, 20 percent
of the Ernst & Young audits examined by the PCAOB failed. And this was the best of the Big 4! The PCAOB found fault
with 45 percent of the Deloitte audits it examined. Why do these reputable firms fail to find all of the issues in audits they
conduct? First, auditors are appointed by the firm being audited. The desire to continue that business relationship
sometimes makes them overlook financial irregularities. Second, most auditing firms also do consulting work and often
have lucrative consulting contracts with the firms that they audit. Understandably, some of them tend not to ask too many
difficult questions, because they fear jeopardizing the consulting business, which is often more profitable than the
auditing work.
Banks and Analysts Commercial and investment banks have lent money to corporations and therefore have to ensure
that the borrowing firm’s finances are in order and that the loan covenants are being followed. Stock analysts conduct
ongoing in-depth studies of the firms that they follow and make recommendations to their clients to buy, hold, or sell.
Their rewards and reputation depend on the quality of these recommendations. Their access to information, knowledge of
the industry and the firm, and the insights they gain from interactions with the management of the company enable them
to alert the investing community of both positive and negative developments relating to a company.
It is generally observed that analyst recommendations are often more optimistic than warranted by facts. “Sell”
recommendations tend to be exceptions rather than the norm. Many analysts failed to grasp the gravity of the problems
surrounding failed companies such as Lehman Brothers and Countrywide till the very end. Part of the explanation may
lie in the fact that most analysts work for firms that also have investment banking relationships with the companies they
follow. Negative recommendations by analysts can displease the management, who may decide to take their investment
banking business to a rival firm. Otherwise independent and competent analysts may be pressured to overlook negative
information or tone down their criticism.
Regulatory Bodies The extent of government regulation is often a function of the type of industry. Banks, utilities, and
pharmaceuticals are subject to more regulatory oversight because of their importance to society. Public corporations are
subject to more regulatory requirements than private corporations. 111
All public corporations are required to disclose a substantial amount of financial information by bodies such as the
Securities and Exchange Commission. These include quarterly and annual filings of financial performance, stock trading
by insiders, and details of executive compensation packages. There are two primary reasons behind such requirements.
First, markets can operate efficiently only when the investing public has faith in the market system. In the absence of
disclosure requirements, the average investor suffers from a lack of reliable information and therefore may completely
stay
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away from the capital market. This will negatively impact an economy’s ability to grow. Second, disclosure of
information such as insider trading protects the small investor to some extent from the negative consequences of
information asymmetry. The insiders and large investors typically have more information than the small investor and can
therefore use that information to buy or sell before the information becomes public knowledge.
The failure of a variety of external control mechanisms led the U.S. Congress to pass the Sarbanes-Oxley Act in 2002.
This act calls for many stringent measures that would ensure better governance of U.S. corporations. Some of these
measures include: 112
• Auditors are barred from certain types of nonaudit work. They are not allowed to destroy records for five years.
Lead partners auditing a client should be changed at least every five years.
• CEOs and CFOs must fully reveal off-balance-sheet finances and vouch for the accuracy of the information
revealed.
• Executives must promptly reveal the sale of shares in firms they manage and are not allowed to sell when other
employees cannot.
• Corporate lawyers must report to senior managers any violations of securities law lower down.
Media and Public Activists The press is not usually recognized as an external control mechanism in the literature on
corporate governance. There is no denying that in all developed capitalist economies, the financial press and media play
an important indirect role in monitoring the management of public corporations. In the United States, business magazines
such as Bloomberg Businessweek and Fortune, financial newspapers such as The Wall Street Journal and Investors
Business Daily, as well as television networks like Fox Business Network and CNBC are constantly reporting on
companies. Public perceptions about a company’s financial prospects and the quality of its management are greatly
influenced by the media. Food Lion’s reputation was sullied when ABC’s Prime Time Live in 1992 charged the company
with employee exploitation, false package dating, and unsanitary meat handling practices. Bethany McLean of Fortune
magazine is often credited as the first to raise questions about Enron’s long-term financial viability. 113
Similarly, consumer groups and activist individuals often take a crusading role in exposing corporate malfeasance. 114
Well-known examples include Ralph Nader and Erin Brockovich, who played important roles in bringing to light the
safety issues related to GM’s Corvair and environmental pollution issues concerning Pacific Gas and Electric Company,
respectively. Ralph Nader has created over 30 watchdog groups, including: 115
• Aviation Consumer Action Project. Works to propose new rules to prevent flight delays, impose penalties for
deceiving passengers about problems, and push for higher compensation for lost luggage.
• Center for Auto Safety. Helps consumers find plaintiff lawyers and agitate for vehicle recalls, increased highway
safety standards, and lemon laws.
• Center for Study of Responsive Law. This is Nader’s headquarters. Home of a consumer project on technology,
this group sponsored seminars on Microsoft remedies and pushed for tougher Internet privacy rules. It also took on
the drug industry over costs.
• Pension Rights Center. This center helped employees of IBM, General Electric, and other companies to organize
themselves against cash-balance pension plans.
As we have noted above, some public activists and watchdog groups can exert a strong force on organizations and
influence decisions that they may make. Strategy Spotlight 9.4 provides two examples of this phenomenon.
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STRATEGY SPOTLIGHT 9.4
TWO EXAMPLES OF POWERFUL EXTERNAL CONTROL MECHANISMS
McDonald’s
After years of fending off and ignoring critics, McDonald’s has begun working with them. In 1999, People for the
Ethical Treatment of Animals (PETA) launched its “McCruelty” campaign asking the company to take steps to
alleviate the suffering of animals killed for its restaurants. Since then, PETA has switched tactics and is cooperating
with the burger chain to modernize the company’s animal welfare standards and make further improvements.
Following pressure from PETA, McDonald’s used its influence to force egg suppliers to improve the living conditions
of hens and cease debeaking them. PETA has publicly lauded the company for its efforts. Recently, McDonald’s
also has required beef and pork processors to improve their handling of livestock prior to slaughter. The company
conducts regular audits of the packing plants to determine whether the animals are being treated humanely and will
suspend purchases from slaughterhouses that don’t meet the company’s standards. The company’s overall image
appears to have improved. According to the global consulting firm Reputation Institute, McDonald’s overall global
brand ranking has risen from 27th in 2007 to 14th in 2012.
Nike
In January 2009, 1,800 laborers lost their jobs in Honduras when two local factories that made shirts for the U.S.
sports-apparel giant Nike suddenly closed their doors and did not pay workers the $2 million in severance and other
unemployment benefits they were due by law. Following pressure from U.S. universities and student groups, Nike
announced that it was setting up a $1.5 million “workers’ relief fund” to assist the workers. Nike also agreed to
provide vocational training and finance health coverage for workers laid off by the two subcontractors.
The relief fund from Nike came after pressure by groups such as the Worker Rights Consortium, which informed
Nike customers of the treatment of the workers. The Worker Rights Consortium also convinced scores of U.S.
universities whose athletic programs and campus shops buy Nike shoes and clothes to threaten cancellation of
those lucrative contracts unless Nike did something to address the plight of the Honduran workers. Another labor
watchdog, United Students Against Sweatshops, staged demonstrations outside Nike shops while chanting “Just
Pay It,” a play on Nike’s commercial slogan, “Just Do It.” The University of Wisconsin cancelled its licensing
agreement with the company over the matter and other schools, including Cornell University and the University of
Washington, indicated they were thinking of following suit. The agreement is the latest involving overseas apparel
factories in which an image-conscious brand like Nike responded to campaigns led by college students, who often
pressure universities to stand up to producers of college-logo apparel when workers’ rights are threatened.
Sources: Kiley, D. & Helm, B. 2009. The Great Trust Offensive. Bloomberg Businessweek, September 28: 38—42; Brasher, P. 2010. McDonald’s Orders
Improvements in Treatment of Hens. abcnews.com , August 23: np; Glover, K. 2009. PETA vs. McDonald’s: The Nicest Way to Kill a Chicken. www.bnet.com .
February 20: np; www.mccruelty.com ; Greenhouse, S. 2010. Pressured, Nike to Help Workers in Honduras. The New York Times, July 27: B1; Padgett, T. 2010.
Just Pay It: Nike Creates Fund for Honduran Workers. www.time.com , July 27: np; and Bustillo, M. 2010. Nike to Pay Some $2 Million to Workers Fired by
Subcontractors. www. online.wsj.com , July 26: np; and rankingthebrands.com .
Corporate Governance: An International Perspective
The topic of corporate governance has long been dominated by agency theory and based on the explicit assumption of the
separation of ownership and control. 116 The central conflicts are principal-agent conflicts between shareholders and
management. However, such an underlying assumption seldom applies outside of the United States and the United
Kingdom. This is particularly true in emerging economies and continental Europe. Here, there is often concentrated
ownership, along with extensive family ownership and control, business group structures, and weak legal protection for
minority shareholders. Serious conflicts tend to exist between two classes of principals: controlling shareholders and
minority shareholders. Such conflicts can be called principal-principal (PP) conflicts, as opposed to principal-agent
conflicts (see Exhibits 9.8 and 9.9).
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. principal-principal conflicts
conflicts between two classes of principals—controlling shareholders and minority shareholders—within the context of a
corporate governance system.
Strong family control is one of the leading indicators of concentrated ownership. In East Asia (excluding China),
approximately 57 percent of the corporations have board chairmen and CEOs from the controlling families. In
continental Europe, this number is 68 percent. A very common practice is the appointment of family members as board
chairmen, CEOs, and other top executives. This happens because the families are controlling (not
302
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necessarily majority) shareholders. In 2003, 30-year-old James Murdoch was appointed CEO of British Sky Broadcasting
(BSkyB), Europe’s largest satellite broadcaster. There was very vocal resistance by minority shareholders. Why was he
appointed in the first place? James’s father just happened to be Rupert Murdoch, who controlled 35 percent of BSkyB
and chaired the board. Clearly, this is a case of a PP conflict.
EXHIBIT 9.8 Traditional Principal-Agent Conflicts versus Principal-Principal Conflicts: How They Differ
along Dimensions
Principal-Agent Conflicts Principal-Principal Conflicts
Goal Incongruence Between shareholders and professional
managers who own a relatively small portion of
the firm’s equity.
Between controlling shareholders and minority
shareholders.
Ownership Pattern Dispersed—5%—20% is considered
“concentrated ownership.”
Concentrated—Often greater than 50% of equity is
controlled by controlling shareholders.
Manifestations Strategies that benefit entrenched managers at
the expense of shareholders in general (e.g.,
shirking, pet projects, excessive compensation,
and empire building).
Strategies that benefit controlling shareholders at
the expense of minority shareholders (e.g.,
minority shareholder expropriation, nepotism, and
cronyism).
Institutional
Protection of
Minority
Shareholders
Formal constraints (e.g., judicial reviews and
courts) set an upper boundary on potential
expropriation by majority shareholders. Informal
norms generally adhere to shareholder wealth
maximization.
Formal institutional protection is often lacking,
corrupted, or un-enforced. Informal norms are
typically in favor of the interests of controlling
shareholders ahead of those of minority investors.
Source: Adapted from Young, M., Peng, M. W., Ahlstrom, D., & Bruton, G. 2002. Governing the Corporation in Emerging Economies: A Principal-Principal
Perspective. Academy of Management Best Papers Proceedings, Denver.
EXHIBIT 9.9 Principal-Agent Conflicts and Principal-Principal Conflicts: A Diagram
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Source: Young, M. N., Peng, M. W., Ahlstrom, D., Bruton, G. D., & Jiang, 2008. Principal–Principal Conflicts in Corporate Governance. Journal of
Management Studies 45(1):196–220; and Peng, M. V. 2006. Global Strategy. Cincinnati: Thomson South-Western. We are very appreciative of the helpful
comments of Mike Young of Hong Kong Baptist University and Mike Peng of the University of Texas at Dallas.
303
In general, three conditions must be met for PP conflicts to occur:
• A dominant owner or group of owners who have interests that are distinct from minority shareholders.
• Motivation for the controlling shareholders to exercise their dominant positions to their advantage.
• Few formal (such as legislation or regulatory bodies) or informal constraints that would discourage or prevent the
controlling shareholders from exploiting their advantageous positions.
The result is often that family managers, who represent (or actually are) the controlling shareholders, engage in
expropriation of minority shareholders, which is defined as activities that enrich the controlling shareholders at the
expense of minority shareholders. What is their motive? After all, controlling shareholders have incentives to maintain
firm value. But controlling shareholders may take actions that decrease aggregate firm performance if their personal
gains from expropriation exceed their personal losses from their firm’s lowered performance.
expropriation of minority shareholders
activities that enrich the controlling shareholders at the expense of the minority shareholders.
Another ubiquitous feature of corporate life outside of the United States and United Kingdom are business groups
such as the keiretsus of Japan and the chaebols of South Korea. This is particularly dominant in emerging economies. A
business group is “a set of firms that, though legally independent, are bound together by a constellation of formal and
informal ties and are accustomed to taking coordinated action.” 117 Business groups are especially common in emerging
economies, and they differ from other organizational forms in that they are communities of firms without clear
boundaries.
business groups
a set of firms that, though legally independent, are bound together by a constellation of formal and informal ties and are
accustomed to taking coordinated action.
Business groups have many advantages that can enhance the value of a firm. They often facilitate technology transfer
or intergroup capital allocation that otherwise might be impossible because of inadequate institutional infrastructure such
as excellent financial services firms. On the other hand, informal ties—such as cross-holdings, board interlocks, and
coordinated actions—can often result in intragroup activities and transactions, often at very favorable terms to member
firms. Expropriation can be legally done through related transactions, which can occur when controlling owners sell firm
assets to another firm they own at below market prices or spin off the most profitable part of a public firm and merge it
with another of their private firms.
ISSUE FOR DEBATE
CEO Pay: Appropriate Incentives or Always Dealing the CEO a Winning Hand
Alpha Natural Resources had its worst ever financial performance in 2011. The firm shut six mines, laid off over 1,500
workers, and saw its stock price drop by 66 percent. Still, the board of directors granted the firm’s CEO a $528,000 bonus
on top of his over $6 million pay package, noting his “tremendous efforts” to improve worker safety. Stories like these
leave commentators questioning if the game is stacked to ensure that CEOs receive high pay regardless of their firm’s
performance.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Most large firms structure the pay packages of their top executives so that the CEO and other senior executives’ pay is
tied to firm performance. A large part of their pay is
304
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 304
stock-based. The value of the stock options they receive go up and down with the price of the firm’s stock. Their annual
bonuses are conditional on meeting preset performance targets. However, boards often change the rules if the firm performs
poorly. If the stock price drops, leaving the options held by the CEO “underwater” and worthless, they often reprice the options
the CEO holds to a lower price, making them potentially much more valuable to the CEO if the stock price bounces back. As
noted above, boards also often find reasons to grant bonuses to CEOs even if the firm underperforms.
At first blush, this suggests the boards of directors are ineffective and serve to meet the desires of the CEO. But there is a
logical reason why boards reprice options and grant bonuses when firms perform poorly. Boards may reprice options or change
the goals that justify bonuses as a means to protect CEOs from being harmed by events out of their control. For example, if a
spike in fuel prices hurts the performance of an airline or a major hurricane results in a loss for an insurance firm, the boards of
these firms may argue that underperformance isn’t the fault of the CEO and shouldn’t result in less pay.
However, critics of this practice argue that it’s wrong to protect CEOs from bad luck but not withhold benefits if the firm
benefits from good luck. Boards rarely, if ever, raise the standards on CEO pay when the firm benefits from an unanticipated
event. A study by researchers at Claremont Graduate School and Washington University found that executives lost less pay
when their firms experienced bad luck than they gained when the firm experienced good luck. Additionally, critics point out
that most workers, such as the 1500 who were laid off by Alpha, don’t receive the same protection from adverse events that the
CEO did.
Discussion Questions
1. Is it appropriate for firms to insulate their CEOs’ pay from bad luck?
2. How can firms restructure pay to ensure that the CEOs also don’t benefit from good luck?
Sources: Mider, Z. & Green, J. 2012. Heads or tails, some CEOs win the pay game. Bloomberg Businessweek, October 8: 23; and Devers, C., McNamara, G.,
Wiseman, R., & Arrfelt, M. 2008. Moving closer to the action: Examining compensation design effects on firm risk. Organization Science, 19: 548–566.
Reflecting on Career Implications …
Behavioral Control: What types of behavioral control does your organization employ? Do you find these
behavioral controls helping or hindering you from doing a good job? Some individuals are comfortable with
and even desire rules and procedures for everything. Others find that they inhibit creativity and stifle
initiative. Evaluate your own level of comfort with the level of behavioral control and then assess the match
between your own optimum level of control and the level and type of control used by your organization. If
the gap is significant, you might want to consider other career opportunities.
Setting Boundaries and Constraints: Your career success depends to a great extent on you monitoring
and regulating your own behavior. Setting boundaries and constraints on yourself can help you focus on
strategic priorities, generate short-term objectives and action plans, improve efficiency and effectiveness,
and minimize improper conduct. Identify the boundaries and constraints you have placed on yourself and
evaluate how each of those contributes to your personal growth and career development. If you do not have
boundaries and constraints, consider developing them.
Rewards and Incentives: Is your organization’s reward structure fair and equitable? On what criteria do
you base your conclusions? How does the firm define outstanding performance and reward it? Are these
financial or nonfinancial rewards? The absence of rewards that are seen as fair and equitable can result in
the long-term erosion of morale, which may have long-term adverse career implications for you.
Culture: Given your career goals, what type of organizational culture would provide the best work
environment? How does your organization’s culture deviate from this concept? Does your organization have
a strong and effective culture? In the long run, how likely are you to internalize the culture of your
organization? If you believe that there is a strong misfit between your values and the organization’s culture,
you may want to reconsider your relationship with the organization.
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summary
For firms to be successful, they must practice effective strategic control and corporate governance. Without such
controls, the firm will not be able to achieve competitive advantages and outperform rivals in the marketplace. We began
the chapter with the key role of informational control. We contrasted two types of control systems: what we termed
“traditional” and “contemporary” information control systems. Whereas traditional control systems may have their place
in placid, simple competitive environments, there are fewer of those in today’s economy. Instead, we advocated the
contemporary approach wherein the internal and external environment are constantly monitored so that when surprises
emerge, the firm can modify its strategies, goals, and objectives.
Behavioral controls are also a vital part of effective control systems. We argued that firms must develop the proper
balance between culture, rewards and incentives, and boundaries and constraints. Where there are strong and positive
cultures and rewards, employees tend to internalize the organization’s strategies and objectives. This permits a firm to
spend fewer resources on monitoring behavior, and assures the firm that the efforts and initiatives of employees are more
consistent with the overall objectives of the organization.
In the final section of this chapter, we addressed corporate governance, which can be defined as the relationship
between various participants in determining the direction and performance of the corporation. The primary participants
include shareholders, management (led by the chief executive officer), and the board of directors. We reviewed studies
that indicated a consistent relationship between effective corporate governance and financial performance. There are also
several internal and external control mechanisms that can serve to align managerial interests and shareholder interests.
The internal mechanisms include a committed and involved board of directors, shareholder activism, and effective
managerial incentives and rewards. The external mechanisms include the market for corporate control, banks and
analysts, regulators, the media, and public activists. We also addressed corporate governance from both a United States
and an international perspective.
SUMMARY REVIEW QUESTIONS
1. Why are effective strategic control systems so important in today’s economy?
2. What are the main advantages of “contemporary” control systems over “traditional” control systems? What are the
main differences between these two systems?
3. Why is it important to have a balance between the three elements of behavioral control—culture; rewards and
incentives; and, boundaries?
4. Discuss the relationship between types of organizations and their primary means of behavioral control.
5. Boundaries become less important as a firm develops a strong culture and reward system. Explain.
6. Why is it important to avoid a “one best way” mentality concerning control systems? What are the consequences of
applying the same type of control system to all types of environments?
7. What is the role of effective corporate governance in improving a firm’s performance? What are some of the key
governance mechanisms that are used to ensure that managerial and shareholder interests are aligned?
8. Define principal–principal (PP) conflicts. What are the implications for corporate governance?
key terms
strategic control
traditional approach to strategic control
informational control
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. behavioral control
organizational culture
reward system
boundaries and constraints
corporate governance
corporation
agency theory
board of directors
shareholder activism
external governance control mechanisms
market for corporate control
takeover constraint
principal-principal conflicts
expropriation of minority shareholders
business groups
experiential exercise
McDonald’s Corporation, the world’s largest fast-food restaurant chain, with 2012 revenues of $28 billion, has recently
been on a “roll.” Its shareholder value rose by over 50% from May 2010 to May 2013. Using the Internet or library
sources, evaluate the quality of the corporation in terms of management, the board of directors, and shareholder activism.
Are the issues you list favorable or unfavorable for sound corporate governance?
application questions & exercises
1. The problems of many firms may be attributed to a “traditional” control system that failed to continuously monitor
the environment and make necessary changes in their strategy and objectives.
306
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What companies are you familiar with that responded appropriately (or inappropriately) to environmental change?
2. How can a strong, positive culture enhance a firm’s competitive advantage? How can a weak, negative culture
erode competitive advantages? Explain and provide examples.
3. Use the Internet to research a firm that has an excellent culture and/or reward and incentive system. What are this
firm’s main financial and nonfinancial benefits?
4. Using the Internet, go to the website of a large, publicly held corporation in which you are interested. What
evidence do you see of effective (or ineffective) corporate governance?
ethics questions
1. Strong cultures can have powerful effects on employee behavior. How does this create inadvertent control
mechanisms? That is, are strong cultures an ethical way to control behavior?
2. Rules and regulations can help reduce unethical behavior in organizations. To be effective, however, what other
systems, mechanisms, and processes are necessary?
references
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 13. For a colorful example of behavioral control in an organization, see: Beller, P. C. 2009. Activision’s unlikely hero. Forbes. February 2: 52
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35. This section draws on Dess & Picken, op. cit.: chap. 5.
36. Anonymous. 2012. Nestle set to buy Pfizer unit. Dallas Morning News, April 19: 10D.
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38. This section draws upon Dess, G. G. & Miller, A. 1993. Strategic management. New York: McGraw-Hill.
39. For a good review of the goal-setting literature, refer to Locke, E. A. & Latham, G. P. 1990. A theory of goal setting and task performance.
Englewood Cliffs, NJ: Prentice Hall.
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Tom Siebel of Siebel Systems: High tech the old fashioned way. Harvard Business Review, 79(3): 118–130.
41. Thompson, A. A. Jr. & Strickland, A. J., III. 1998. Strategic management: Concepts and cases (10th ed.): 313. New York: McGraw-Hill.
42. Ibid.
43. Teitelbaum, R. 1997. Tough guys finish first. Fortune, July 21: 82–84.
44. Weaver, G. R., Trevino, L. K., & Cochran, P. L. 1999. Corporate ethics programs as control systems: Influences of executive commitment
and environmental factors. Academy of Management Journal, 42(1): 41–57.
45. www.singaporeair.com/pdf/media-centre/anti-corruption-policy-procedures.pdf .
46. Weber, J. 2003. CFOs on the hot seat. BusinessWeek, March 17: 66–70.
47. William Ouchi has written extensively about the use of clan control (which is viewed as an alternate to bureaucratic or market control). Here,
a powerful culture results in people aligning their individual interests with those of the firm. Refer to Ouchi, op. cit. This section also draws
on Hall, R. H. 2002. Organizations: Structures, processes, and outcomes (8th ed.). Upper Saddle River, NJ: Prentice Hall.
48. Poundstone, W. 2003. How would you move Mount Fuji? New York: Little, Brown: 59.
49. Abby, E. 2012. Woman sues over personality test job rejection. abcnews.go.com , October 1: np.
50. Interesting insights on corporate governance are in: Kroll, M., Walters, B. A., & Wright, P. 2008. Board vigilance, director experience, and
corporate outcomes. Strategic Management Journal, 29(4): 363–382.
PRINTED BY: [email protected]. Printing is for personal, private use only. No part of this book may be
reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 51. For a brief review of some central issues in corporate governance research, see: Hambrick, D. C., Werder, A. V., & Zajac, E. J. 2008. New
directions in corporate governance research. Organization Science, 19(3): 381–385.
52. Monks, R. & Minow, N. 2001. Corporate governance (2nd ed.). Malden, MA: Blackwell.
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54. Maurer, H. & Linblad, C. 2009. Scandal at Satyam. BusinessWeek, January 19: 8; Scheck, J. & Stecklow, S. 2008. Brocade ex-CEO gets 21
months in prison. The Wall Street Journal, January 17: A3; Levine, D. & Graybow, M. 2010. Mozilo to pay millions in Countrywide
settlement. finance. yahoo.com . October 15: np; Ellis, B. 2010. Countrywide’s Mozilo to pay $67.5 million settlement. cnnmoney.com .
October 15: np; Frank, R., Efrati, A., Lucchetti, A. & Bray, C. 2009. Madoff jailed after admitting epic scam. The Wall Street Journal.
March 13: A1; and Henriques, D. B. 2009. Madoff is sentenced to 150 years for Ponzi scheme. www.nytimes.com . June 29: np.
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56. Corporate governance and social networks are discussed in: McDonald, M. L., Khanna, P., & Westphal, J. D. 2008. Academy of
Management Journal. 51(3): 453–475.
57. This discussion draws upon Monks & Minow, op. cit.
58. For an interesting perspective on the politicization of the corporation, read: Palazzo, G. & Scherer, A. G. 2008. Corporate social
responsibility, democracy, and the politicization of the corporation. Academy of Management Review, 33(3): 773–774.
308
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59. Eisenhardt, K. M. 1989. Agency theory: An assessment and review. Academy of Management Review, 14(1): 57–74. Some of the seminal
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60. Nyberg, A. J., Fulmer, I. S., Gerhart, B. & Carpenter, M. 2010. Agency theory revisited: CEO return and shareholder interest alignment.
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61. Managers may also engage in “ shirking”—that is, reducing or withholding their efforts. See, for example, Kidwell, R. E., Jr. & Bennett, N.
1993. Employee propensity to withhold effort: A conceptual model to intersect three avenues of research. Academy of Management Review,
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63. The relationship between corporate ownership structure and export intensity in Chinese firms is discussed in: Filatotchev, I., Stephan, J., &
Jindra, B. 2008. Ownership structure, strategic controls and export intensity of foreign-invested firms in transition economies. Journal of
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66. Anonymous. 2013. Too early for the worst footnote of 2013? footnoted.com , January 18: np.
67. For an insightful, recent discussion of the academic research on corporate governance, and in particular the role of boards of directors, refer
to Chatterjee, S. & Harrison, J. S. 2001. Corporate governance. In Hitt, M. A., Freeman, R. E., & Harrison, J. S. (Eds.). Handbook of
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68. For an interesting theoretical discussion on corporate governance in Russia, see: McCarthy, D. J. & Puffer, S. M. 2008. Interpreting the
ethicality of corporate governance decisions in Russia: Utilizing integrative social contracts theory to evaluate the relevance of agency
theory norms. Academy of Management Review, 33(1): 11–31.
69. Haynes, K. T. & Hillman, A. 2010. The effect of board capital and CEO power on strategic change. Strategic Management Journal, 31(110):
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70. This opening discussion draws on Monks & Minow, op. cit. 164, 169; see also Pound, op. cit.
71. Business Roundtable. 1990. Corporate governance and American competitiveness, March: 7.
72. The director role in acquisition performance is addressed in: Westphal, J. D. & Graebner, M. E. 2008. What do they know? The effects of
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73. Byrne, J. A., Grover, R., & Melcher, R. A. 1997. The best and worst boards. BusinessWeek, November 26: 35–47. The three key roles of
boards of directors are monitoring the actions of executives, providing advice, and providing links to the external environment to provide
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74. Pozen, R. C. 2010. The case for professional boards. Harvard Business Review, 88(12): 50–58.
75. The role of outside directors is discussed in: Lester, R. H., Hillman, A., Zardkoohi, A., & Cannella, A. A. Jr. 2008. Former government
officials as outside directors: The role of human and social capital. Academy of Management Journal, 51(5): 999–1013.
76. McGeehan, P. 2003. More chief executives shown the door, study says. New York Times, May 12: C2.
77. The examples in this paragraph draw upon Helyar, J. & Hymowitz, C. 2011. The recession is gone, and the CEO could be next. Bloomberg
Businessweek. Februrary 7-February 13: 24–26; Stelter, B. 2010. Jonathan Klein to leave CNN. mediadecoder.blogs.nytimes.com .
September 24: np; Silver, A. 2010. Milestones. TIME Magazine. December 20: 28; www.bp.com and Mouawad, J. & Krauss, C. 2010. BP
is expected to replace Hayward as chief with American. The New York Times. July 26: A1.
78. Stoever, H. 2012. NACD highlights growing need for succession planning and diversity in the boardroom. nacdonline.org , March 22: np.
79. For an analysis of the effects of outside directors’ compensation on acquisition decisions, refer to Deutsch, T., Keil, T., & Laamanen, T.
2007. Decision making in acquisitions: The effect of outside directors’ compensation on acquisition patterns. Journal of Management, 33
(1): 30–56.
80. Director interlocks are addressed in: Kang, E. 2008. Director interlocks and spillover effects of reputational penalties from financial
reporting fraud. Academy of Management Journal, 51(3): 537–556.
81. There are benefits, of course, to having some insiders on the board of directors. Inside directors would be more aware of the firm’s strategies.
Additionally, outsiders may rely too often on financial performance indicators because of information asymmetries. For an interesting
discussion, see Baysinger, B. D. & Hoskisson, R. E. 1990. The composition of boards of directors and strategic control: Effects on
corporate strategy. Academy of Management Review, 15: 72–87.
82. Hambrick, D. C. & Jackson, E. M. 2000. Outside directors with a stake: The linchpin in improving governance. California Management
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December: np; Evans, B. 2007. Six steps to building an effective board. Inc.com , np; Beatty, D. 2009. New challenges for corporate
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. governance. Rotman Magazine, Fall: 58–63; and Krause, R., Semadeni, M., & Cannella, A. 2013. External COO/presidents as expert
directors: A new look at the service role of boards. Strategic Management Journal. In press.
84. A discussion on the shareholder approval process in executive compensation is presented in: Brandes, P., Goranova, M., & Hall, S. 2008.
Navigating shareholder influence: Compensation plans and the shareholder approval process. Academy of Management Perspectives, 22(1):
41–57.
85. Monks and Minow, op. cit.: 93.
86. A discussion of the factors that lead to shareholder activism is found in Ryan, L. V. & Schneider, M. 2002. The antecedents of institutional
investor activism. Academy of Management Review, 27(4): 554–573.
309
87. For an insightful discussion of investor activism, refer to David, P., Bloom, M., & Hillman, A. 2007. Investor activism, managerial
responsiveness, and corporate social performance. Strategic Management Journal, 28(1): 91–100.
88. There is strong research support for the idea that the presence of large block shareholders is associated with value-maximizing decisions. For
example, refer to Johnson, R. A., Hoskisson, R. E., & Hitt, M. A. 1993. Board of director involvement in restructuring: The effects of board
versus managerial controls and characteristics. Strategic Management Journal, 14: 33–50.
89. For a discussion of institutional activism and its link to CEO compensation, refer to: Chowdhury, S. D. & Wang, E. Z. 2009. Institutional
activism types and CEO compensation. Journal of Management, 35(1): 5–36.
90. For an interesting perspective on the impact of institutional ownership on a firm’s innovation strategies, see Hoskisson, R. E., Hitt, M. A.,
Johnson, R. A., & Grossman, W. 2002. Academy of Management Journal, 45(4): 697–716.
91. www.calpers-governance.org .
92. Icahn, C. 2007. Icahn: On activist investors and private equity run wild. BusinessWeek, March 12: 21–22. For an interesting perspective on
Carl Icahn’s transition (?) from corporate raider to shareholder activist, read Grover, R. 2007. Just don’t call him a raider. BusinessWeek,
March 5: 68–69. The quote in the text is part of Icahn’s response to the article by R. Grover.
93. Bond, P. 2012. Netflix stock climbs after Carl Icahn takes a position. hollywoodreporter.com , October 31: np.
94. For a study of the relationship between ownership and diversification, refer to Goranova, M., Alessandri, T. M., Brandes, P., & Dharwadkar,
R. 2007. Managerial ownership and corporate diversification: A longitudinal view, Strategic Management Journal, 28(3): 211–226.
95. Jensen, M. C. & Murphy, K. J. 1990. CEO incentives—It’s not how much you pay, but how. Harvard Business Review, 68(3): 138–149.
96. For a perspective on the relative advantages and disadvantages of “duality”—that is, one individual serving as both Chief Executive Office
and Chairman of the Board, see Lorsch, J. W. & Zelleke, A. 2005. Should the CEO be the chairman? MIT Sloan Management Review, 46
(2): 71–74.
97. A discussion of knowledge sharing is addressed in: Fey, C. F. & Furu, P. 2008. Top management incentive compensation and knowledge
sharing in multinational corporations. Strategic Management Journal, 29(12): 1301–1324.
98. Sasseen, J. 2007. A better look at the boss’s pay. BusinessWeek, February 26: 44–15; and Weinberg, N., Maiello, M., & Randall, D. 2008.
Paying for failure. Forbes, May 19: 114, 116.
99. Research has found that executive compensation is more closely aligned with firm performance in companies with compensation committees
and boards dominated by outside directors. See, for example, Conyon, M. J. & Peck, S. I. 1998. Board control, remuneration committees,
and top management compensation. Academy of Management Journal, 41: 146–157.
100. Anonymous. 2012. American chief executives are not overpaid. The Economist, September 8: 67.
101. Caldwell, D. & Francolla, G. 2012. Highest paid CEOs. cnbc.com , November 19: np.
102. George, B. 2010. Executive pay: Rebuilding trust in an era of rage. Bloomberg Businessweek, September 13: 56.
103. Chahine, S. & Tohme, N. S. 2009. Is CEO duality always negative? An exploration of CEO duality and ownership structure in the Arab IPO
context. Corporate Governance: An International Review. 17(2): 123–141; and McGrath, J. 2009. How CEOs work. HowStuffWorks. com.
January 28: np.
104. Anonymous. 2009. Someone to watch over them. The Economist. October 17: 78; Anonymous. 2004. Splitting up the roles of CEO and
Chairman: Reform or red herring? Knowledge@Wharton . June 2: np; and Kim, J. 2010. Shareholders reject split of CEO and chairman jobs
at JPMorgan. FierceFinance.com . May 18: np.
105. Tuggle, C. S., Sirmon, D. G., Reutzel, C. R. & Bierman, L. 2010. Commanding board of director attention: Investigating how organizational
performance and CEO duality affect board members’ attention to monitoring. Strategic Management Journal. 31: 946–968; Weinberg, N.
2010. No more lapdogs. Forbes. May 10: 34–36; and Anonymous. 2010. Corporate constitutions. The Economist. October 30: 74.
106. Semadeni, M. & Krause, R. 2012. Splitting the CEO and chairman roles: It’s complicated … businessweek.com , November 1: np.
107. Such opportunistic behavior is common in all principal-agent relationships. For a description of agency problems, especially in the context of
the relationship between shareholders and managers, see Jensen, M. C. & Meckling, W. H. 1976. Theory of the firm: Managerial behavior,
agency costs, and ownership structure. Journal of Financial Economics, 3: 305–360.
108. Hoskisson, R. E. & Turk, T. A. 1990. Corporate restructuring: Governance and control limits of the internal market. Academy of
Management Review, 15: 459–477.
109. For an insightful perspective on the market for corporate control and how it is influenced by knowledge intensity, see Coff, R. 2003. Bidding
wars over R&D-intensive firms: Knowledge, opportunism, and the market for corporate control. Academy of Management Journal, 46(1):
74–85.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 110. Walsh, J. P. & Kosnik, R. D. 1993. Corporate raiders and their disciplinary role in the market for corporate control. Academy of Management
Journal, 36: 671–700.
111. The role of regulatory bodies in the banking industry is addressed in: Bhide, A. 2009. Why bankers got so reckless. BusinessWeek, February
9: 30–31.
112. Wishy-washy: The SEC pulls its punches on corporate-governance rules. 2003. Economist, February 1: 60.
113. McLean, B. 2001. Is Enron overpriced? Fortune, March 5: 122–125.
114. Swartz, J. 2010. Timberland’s CEO on standing up to 65,000 angry activists. Harvard Business Review, 88 (9): 39–43.
115. Bernstein, A. 2000. Too much corporate power. BusinessWeek, September 11: 35–37.
116. This section draws upon Young, M. N., Peng, M. W., Ahlstrom, D., Bruton, G. D., & Jiang, Y. 2005. Principal-principal conflicts in
corporate governance (un-published manuscript); and, Peng, M. W. 2006. Globalstrategy. Cincinnati: Thomson South-Western. We
appreciate the helpful comments of Mike Young of Hong Kong Baptist University and Mike Peng of the University of Texas at Dallas.
117. Khanna, T. & Rivkin, J. 2001. Estimating the performance effects of business groups in emerging markets. Strategic Management Journal,
22: 45–74.
310
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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
311
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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. 6Exhibit 10.1 illustrates common growth patterns of firms.
313
EXHIBIT 10.1 Dominant Growth Patterns of Large Corporations
Source: Adapted from J. R. Galbraith and R. K. Kazanjian. Strategy Implementation: Structure, Systems and Process , 2nd ed. Copyright © 1986.
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
314
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 ).
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. functional organizational structure
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.
315
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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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
316
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. industrial divisions. Since then, many firms have discovered that as they diversified into new product-market activities,
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
317
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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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. term performance. If corporate management uses quarterly profits as the key performance indicator, divisional
management may tend to put significant emphasis
318
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. strategic business unit (SBU) structure
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.
319
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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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
320
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,
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
321
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.
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The implications of a firm’s international operations for organizational structure.
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
322
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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.
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.
323
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,
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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 .
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.
324
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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.
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
325
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
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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.
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
326
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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,
327
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.”
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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.
• 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 .
328
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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,
329
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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,
330
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. • 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.
331
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,
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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.
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.
332
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. • 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.
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
333
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
334
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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.
335
• 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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. • 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.
336
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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 Tushman 65 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.
• 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
337
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
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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
338
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 …
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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
339
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.
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reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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
1.
2.
3.
340
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?
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341
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PRINTED BY: [email protected]. Printing is for personal, private use only. No part of this book may be
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342
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PRINTED BY: [email protected]. Printing is for personal, private use only. No part of this book may be
reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. 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
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65 . This section is based on O’Reilly, C. A. & Tushman, M. L. 2004. The ambidextrous organization. Harvard Business Review , 82(4): 74–81.
343
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