1

Firms and MarketsLegal DeveloprnentOrganizational Devcloprnent

Specialization and Division ofLabor

The Cooperation Problem1‘he Coordination Problem

1

1

OUI.L.I.NF.

Organizarional Change since the 19 SOs

CHAPTER 7 ORGAN IZATION STRUCTURE AM) MANAGEMENT SYSTEMS 175

iVlatrix StructuresHierarchy as Coordination: Modularity Beyond Hierarchy?Hierarcliy as Control: BureaucraCyContingency Approaches to Organizational

DesignRethinking Hierarchy Information Systems

Strategie Planning SystemsFinancial Planning and Control SystemsHuman Resource Management Systems

Defining Organizational Units Corporate Culture as a ControlMechanism

Integrating Different ControlMechanisms

Other Factors lnfluencing the Definition ofOrganizational Units

The Functional StructureThe 4uIticIivisionaI Structure

IntroductiOfl and Objectives

‘Great strategy; lousy implementatiOfl“ is an epithet that has been applied toorganizational failures from Philip II of Spain‘s attempted invasion of England with theSpanish Armada in 15881 to the dismal outcome of the 2006 merger between Alcateland Lucent that created “a new global leader in telecommUniCatiOn equipment“.2Theidea that the formulation of strategy can be separated from its implementatiOn hasbecome institutionalized by the numerous strategic management texts that devoteseparate sections to strategy formulation and strategy implementatiOn.

This supposed division between formulation and implementation is fiction. At themost obvious level, formulating a strategy without taking into account the conditionsunder which it will be implemented will result in a poorly designed strategy. Afundamental flaw in the corporate planning systems of 25 years ago was separatingstrategy formulation—the task of corporate executives and strategic planners—frOm itsimplementatiOn by divisional heads and middle managers.

The design of organization structure and management form key componentS ofstrategy implementation. Hence, the view of strategy formulation and strategyimplementation as a sequential process is summed up in the adage “structure followsstrategy.“ Yet, management guru Tom Peters argues the reverse: if capabilities are theprimary basis of strategy, and if capabilities are a product of organizatioflal structUre,then strategy follows structure.3 The key point, however, is not whether strategy or

176 PART II TuE TOOLS OF STRATEGY ANALYSIS

structure takes precedence but the recognition that the two are closely interdependent4For Domino‘s Pizza with its global network of 8000 franchised outlets, or Amway, withits pyramid of commission-based, independent distributors, the structure is the strategy.

Having established that the way in which a company organizes itseif is fundamentalto its strategy and performance, the goal of this chapter is to introduce the key conceptsand ideas necessary to understand and design companies‘ structures and systems. Theapproach is concise and selective. 1 do not intend to offer a potted overview oforganizational theory. My aim 15 to introduce some basic principles of organizationaldesign and to apply these to key aspects of firm structure. The principles outlined herewill be further developed in later chapters when we consider strategies within particularbusiness contexts. For example, Chapter 12 considers the organizational conditionsconducive to innovation; Chapter 13 considers organization and organizational changewithin mature industries; Chapter 14 discusses vertical structures and outsourcing;Chapter 1 5 examines the structure and systems of the multinational corporation; andChapter 16 deals with organizing the multibusiness company.

By the time you have completed this chapter you will be able to:

recognize the key organizational innovations that have shaped the evolutionof the modern corporation;

understand the basic principles that determine the structural characteristicsof complex human organizations;

apply the principles of organizational design to recommend the types oforganizational structure suited to particular tasks and particular businessenvironments;

understand the role of information systems, strategic planning, financialcontrol, and human resource management in the coordination and controlof corporations;

appreciate the forces that are causing companies to seek new organizationalstructures and management systems.

CFIAPTER 7 ORGANIZATION STRUCTURE AND MANAGEMENT SYSTEMS 177

The Evolution of the Corporation

This book is concerned with the strategy of business organizations—entities that 1have referred to, more or less synonymously, as flrms, companies or enterprises.Firms are the dominant feature of the capitalist economy—it is through them thatwe obtain our food, ciothing and shelter and they provide US with the income toenjoy this consumption. Yet despite their central role, economists have paid themlimited attention. Their focus has been upon the rolc of markets. In practice, firmsand markets are twin institutions that organize the capitalist economy. Markets arcorganized by the “invisible hand“ of the price mechanism; firms arc organized by the“visible hand“ of management.5

One reason for economists‘ neglect of firms is that they arc of recent origin. Atthe beginning of the nineteenth century, most production—even in Britain, the mostindustrially advanced econorny of the time—was undertaken by individuals and byfamilies. Woolen textile production—upon which much British prosperity wasbased—involved networks of selfemployed workers producing in their own homes.Mechanization and the risc of the factory system changcd all this; however, most ofdie new factorics were owner-proprictorships employing small numbers of workers.In the United States, the biggest business organizations in the mid-nineteenthcentury, in terms of numbers of employees, were family-owned farms—especiallysomc of the large plantations of the South.6

The modern firm—the business corporation—is one of the greatest innovations of

modern socicty. Its emergence is the result of two developments: legal andorganizational.

A corporation is an organization that has a legal identity—it can own propcrty, entercontacts, sue and be sued. Such a legal identity is essential to the operation of abusiness enterprise that involves more than a few people. Corporations wereoriginally created by royal decrec of acts of legislation. Some of the first businesscorporations were the colonial trading companies—the British East India Company(1600), thc Dutch hast India Company (1602), the Virginia Company of London(1606) and Eludson‘s Bay Company (1670) which were given monopoly rights overdevelopment and trade with specific coloHes. Because corporatiuns were legallydistinct from their owncrs, this means that they could have large numbers of owners(sharebolders) and ownership could be transferred.

Britain‘s joint Stock Companies Act of 1844 allowed corporations to becstablished without the need for a royal decree or act of parliament. The LimitedLiability Act of 1844 established that shareholders of corporations were not liablefor the debts of a corporation beyond the share capital they owned—this opened upthe potential for Iargc-scale financing of industry.7

Until thc late nineteenth century, the world‘s only large-scale organizations—apart frorn colonial trading companies die aforementioned were the Roman

178 PART II TuE TOOLS OF STRATEGY ANALYSIS

Catholic Church and national armies. Most ideas about organizing largecompanies derived from die organizational structure of armies. lndeed, prior tothe development of business cducation, the role of the rnilitarv as the trainingground for most business leaders meant that a large proportion of managementprinciples derived from the rnilitary. General Von Moltke‘s reorganization of thePrussian army into divisions and a functionally specialized general staff during the1860s provided the basic mode! for large industrial corporations und! weil intothe twentieth century.8

The emergence of the modern corporation occurred in thc U.S. in what hasbeen termed “the Second Industrial Revolution.“ Business historian, AlfredChandler, identifies the modern corporation as a result of two “critical organizationaltransformations.“9

Until the mid-nineteenth century, companies werelocated in just one place—lack of transportation piaced limits on firms‘ marketreach; lack of communication prevented firms from operating in multiple locations.The railroad and the telegraph changed all that. In the U.S., the railroad companieswere die first to create geographicallv separate operating units rnanaged hv anadministrative headquarters. This line-andsta[f structure divided emplovees intothose allocated to operational tasks within operating units (li;ie) and administratorsand functionai specialists iocated at head office (staff).

By the end of the late ninetecnth century, simple line-and-staff structures baddeveloped into more complex functional structures—conipanies such as DuPont,Sears Roebuck & Co. and Shell Transport and Trading managed a number ofseparate operating units with large functional departments that conducted sales,finance, R&D, legal affairs and other specialist activities.

The other organizational form for large business enterprises was the holdingcompany. Standard Qil (of the U.S.), Mitsui (of Japan), and the British South AfricaCompany were flnancial enterprises created by a series of acquisitions in which theparent bought controlling equity stakes in a numher of subsidiary companies. Themanagement structure of these holding companies was primitive: the parentappomted the board of directors of the subsidiaries and received dividends, hutotherwise there was little integration or overall managerial control.

The second critical transformation was theemergence during the 1920s of the divisionalized corporation, which, over urne,replaced hoth the ccntralized, functionai structures that characterized most industrialcorporations and the loose-knit holding companies created in the merger wave of theearly twentieth century. The pioneers were DuPont and General Motors.

At DuPont, increasing size and a widening product range straincd the functionalstructure and overloaded top management:

• . . the operations of the enterprise became too complex and the problems ofcoordination, appraisal and policv formulation too intricate for a small numberof top officers to handle hoth long-run, entrepreneurial and short-run,operational administrative activities. 10

The solution devised by Pierre Du Pont was to decentralize: teii product divisionswere created, each with their own sales. R&D, and support activities. The corporate

CHAP‘rER 7 ORGANIZATION STRUCTt RE AND MAN •GEMENT SYSTEMS 179

FIGURE 7.1

Board of Directors

1President Executive Committee

Financial

______

GM Acceptance Legal GeneralStaff Corporation Department Advisory Staff

Chevrolet Sheridan Oldsmobile Buick Cadillac GM ExportDivision Division Division Division Division Company

CanadianDivision

GM Truck Samson Qakland Inter- ScrippsDivision Tractor Division company Booth

Division Parts Corp.Division

Source

A. 5 Sloan, My Years weh General Motors (Orbe Publishing, 1972): 57. c 1963 by Alfred P. Sloan. c

renewed 1991, Alfred P Sloan Foundation. Reproduced with permission.

head office headed 1w an Executive Committee took responsibilitv für coordination,strategy, and reseurce allocation.11

General Motors, whicb bad grown bv acquisition into a Ioose holding companv,adopted a similar structure as a solutlün to the problems of sveak financial controland a confused product line. The new structure (shown in Figure 7. 1) divideddecision making responsibility between the chief executives of the divisions whowere responsible für their divisions‘ Operation and performance and tbe presidentwho headed the general office and was responsihle für the development and controlof the corporation as a whole. 2

Tbe risc of the public (i.e. stock market listed), divisionalized corporation as tbedominant organizational form in large-scale American business was followed hv itsdiffusion internationallv. This diffusion was accelerated, first, bv the succcss ofAmerican multi nationals os erseas and, second, by international politicaldevclopments—including the U.S. occupation of Japan after the Second World War.tbc collapse of the Soviet Union and China‘s transition to capitalisrn.

At the same urne, tbe organizational forms of business enterprise bave continuedto evolvc. If tbe divisionalized cürporation representcd a fundamental hreakthough

180 PART!! TFIETOOLS OF STRXfECY ANALYSIS -----

in the problem of how to reconcile overall coordination with tlexibilitv andresponsiveness, subsequent developments have addressed the same problem. Ascompanies have diversified, expanded internationally and dcveloped greaterfunctional sophistication, so their coordination challenges have increased. Inresponse, they have cleveloped matrix organizations—where separate hierarchiescoordinate within products, functions and geographical arcas. Simultaneouslv,increased need for flexibilitv and responsiveness has resulted in the delavering ofhierarchies, the shift from functionally organized headquarters staff to sbaredservices organizatrons and the creation of porous organizarional houndaries throughalliances and outsourcing partnerships.

Within these structures considerable progress has heen made in designing thesystems through which companies are managed. These include operational andcapital expenditure budgeting, strategic planning, performance managementsystems, and information and knowledge management systems.

Despite the existence of some general trends in the wavs in which businessenterprises organize themselves, the critical challenge is for companies to designstructures and systems that match the particular circumstances of their own businesssituations. In the same way that strategic management is a quest for unique solutionsto the matching of internal resources and capabilities to external business opportunity,so organizational design is about seiecting structures, systems and management stylesthat can best implernent such strategies. To establish principles, guidelines and criteriafor desigriing business organizations we need to consider the fundamental challengesof orgamzing.

The Organi.zationai Proh1em ReconeilinSpecia.llzation with Coordination and Cooperation

To design a firm we must first recognize what it is supposed to do. According toHenry Mintzberg:

Everv organized human activity—from making pots to placing a man on themoon—gives risc to two fundamental and opposing requirements: die divisionof labor into various tasks, and the coordination of these tasks to accomplishthe activity. The structure of the organization can be defined simply as die waysin which labor is divided into distinct tasks and coordination is achieved amongthese tasks)3

Firms exist hecause thev arc efficient institutions for the organization of economicactivities, particularly the production of goods and services. The fundamental sourceof efficiency in production is specialization through the division of labor intoseparate tasks. The classic statement on the gains due to specialization is AdamSmith‘s description of pin man ufacture:

One man draws out the wire, another straightens it, a third cuts it, a fourthpoints it, a tifth grinds it at the top for receiving the head; to make die head

CHAPTER 7 ORGANIZATION STRUCTURE ANI) MANAGEMENT SYSTEMS 181

requires two er three distinct operations; to put it on is a peculiar business, towhiten the pins is another; lt is even a trade hy itself to put them tnto diepapers.14

Smith‘s pin makers produced about 4 800 pins per person each day. “But if theyhad all wrought separately and independently, and without any of them having beeneducated to this peculiar business, thev certainiv could not each have made 20,perhaps not one pin, in a dav.“ Similarlv, Henry Ford achieved huge productivitygains hv bis assemhly-line system, which assigned individuals to highlv specific tasks.Between the end of 1912 and earlv 1914 the time taken to assemble a Model T felltrom 106 hours to six hours.

But specialization comes at a cost. The more a production process is dividedbetween different specialists, the more complex is the challenge of integrating theefforts of individual specialists. The more volatile and unstahle the externalenvironment, the greater the number of decisions that need to be made and the greaterarc these coordination costs. Hence. the more stahle is the environment. the greater isthe optimal division of labor. This is true both for firms and for entire societies.Civilizations arc built on increased division of labor, which is oniv possible throughstabilitv. As the strife-torn parts of Sornalia, Haiti, and the Congo bave demonstratedso tragically, once chaos reigns, societies regress toward subsistence mode where eachfamily unit must be self-sufficient.

Integrating the efforts of specialist individuals involves two orgamzational problems:there is the cooperation problem—that of aligning the interests of individuals whobave divergent goals—and courdinatiun problem—even in the absence of goalcontlict, how do individuals barmonize their different activities?

The economics literature analyzes cooperation problems arising from goalmisalignment as the problem of agency. 15 An agency relationship exists when oneparty (the principal) contracts witb another party (the agent) to act on behalf of theprincipal. The problem is ensuring that the agent acts in the principal‘s interest.\Vithin the firm, the major agencv problem is hetween owners (shareholders) andmanagers. The problem of ensuring that managers operate companies to maximizeshareholder wealth is at the center of the corporate governance dehate. During the1 990s, changes in top management rernuneration—in particular the increasingemphasis given to stock options—were intendcd to align the interests of managerswith those of shareholders. 16 However, at Enron, WorldCom, and other companies,these incentives induced managers to manipulate reported earnings rathcr than towork for long-term profltahilitv.

Agencv problems exist throughout die hierarchv. For individual employees,systems of incentives, monitoring and appraisal arc designed to encourage pursuitof organizational ohjectives and overcome ernployees‘ tendency to do their ownthing or simply shirk. The organization structure may create its own problems.Organizational departments create their own suhgoals that do not align withone another. The classic conflicts arc between different functions: sales wishesto please customers, production wishes to maxirnize output, R&D wants tointroduce mind-blowing new products, while nance worries about profit andloss.

182 R\RT II TUE TOOLS OS ST[1ATEGY \ALVSIS

Several mechanisms arc available to management for achieving goal alignmentwithin organizations:

Control inechanisms typically operate through hicrarchical supervision.\lanagers supervise the hehavior and performance ot subordinates who mustseek approval for actions that lie outside their defined arca of discretion.Control is entorced through positive and negative incentives: the primanpositive incentive is the opporrunitv for promotion up die hierarchv; negativeIncentives arc dismissal and demotion.

Perforniance incentives link rewards to output: thev include piece-rates forproduction workers and profit bonuses for executives. Such performancerelated incentives have two main benefits: first, they arc high powered—thcyrelate rewards directly to output—and second, thcy economize on the ncedfor costly monitoring and supervision of cmployecs. Pav-for-performancebecomes more difficult whcrc emplovees work in teams er on activities whereoutput is difficult to measure.

Shared values. Some organizations arc ahle to achieve high levels ofcooperation and bw levels of goal conflict without extensive controlmechanisms or perfermance-related incentives. Churches, charities, cluhsand voluntary organizations typically display a commonality of purpose andvalues among members. Similarly with firms: the presence of shared corevalues appears to be a key influence on sustained success.17 The role ofculture as a control mechanisrn that is an alternative to bureaucratic controlor the pricc rnechanism is central to Bill Ouchi‘s concepr of cian control. 8

The role of shared values and hehavioral norms arnong organizationalmembers is a powerful force aligning individual actions with companvsrrategy. The key advantages of culture as a control device arc, first, it ischeap: it saves on costs of monitoring and providing financial incenrives;second, it pcrmits fiexihilirv: when individuals internalize the goals andprinciples of the organization, they can be allowed te use their initiative andcreativity in their work. 1-lowever, to view corporate culture as a tod ofmanagement control fails to recognize that culture is a property of theorganization as a whole, which is not amenable to top managementmanipulation. At the British bank NatWest during the 1990s, John Weeksidentified a “culture of complaining“, which was resistant to top-downcultural change initiatives. 19

The desire to cooperate is not enough to ensure that organizational memhersintcgrate their efforts—it is not lack of a common goal tliat causes Olvmpic relayteams to drop die baton. Unless individuals can find ways of coordinate their efforts,production doesn‘t happen. As we have already seen in our discussion oforganizational capabilities, the exceptional performance of Wal-Mart, the Cirque duSoleil, and the U.S. Marine Corp Band derives less from the skills of the individualmembers as frorn superb coorditiation between them. Among thc mechamsm foreoordination, the following can he found in all firms:

Rules and directives. A basic feature of the firm is die existence of generalemplovment contracts wider xvhicli individual agree to perform a range of

(‘HAPTER 7 ORGAMZATION STRU(‘T( RE AND ‘aANAGEMENT SYSTEMS 183

duties as required hv their employer. This allows managers to exerciseauthoritv hy means of general mies (“Secret agents on overseas missions willhave essential expenses reimbursed oniy 011 production of original receipts“)and specific directives (“Miss Moneypenny, show Mr. Bond his new cigarettecase with 4G communication and a concealed death ray“).Rontines. \X7here activities arc performed recu rrentiv, coordination based onmutual adiustment and rules hecomes institutionalized within organizationalroutines. As we noted in the previous chapter, these “regular and predictabiesequences of coordmated actions by individuals“ are the foundation oforganizationai capabiiity. If organizations arc to perform complex activities atextreme levels of efticiency and reliahility, coordination hy ruies, directivcs,or mutual adjustment is not enough—coordination must hecome emheddedin routines.

Ä4utual adjustment. The simplest form of coordination involves the mutualadjustment of individuals engaged in reiated tasks. In soccer or doubles tennis,each playcr coordinates with feliow team members without any authorityrelationship arnong them. Such mutual adjustment occurs in leaderless teamsand is espcciallv suited to novel tasks where routinization is not feasible.

hie relative roles of these different coordination devices depend on the tvpes ofacnvity being performcd and the intensiry of coilahoration requircd. Rules tend tuwork weil for activities where standardized outcomes arc required and the decisionmaking abihties of the operatives invoived may be limited—rnost quality controlprocedures involve the application of simple rules. Routines form the basis forcoordination in most activities where dose interdependence exists hetween individuals,whether a basic production task (supph‘ing customers at Starbucks) or a more cornplexactivity (performing a heart bvpass Operation or implementing a systems integrationprojeut for a multmational corporation). Mutual adjustment works best where theindividuais i volved arc well-informed of the actions of their co-workers, eitherbecause they arc in dose visuai contact (a chef dc cuisine and her sous-chefs), orthrough information exchange (designers using interactive CAD software).

IIie ai Ii in (h 1lii/a(1oiiaI De%1Il

Hierarchy is the fundamental feature of organizationai structure. lt is the primarymeans hy which companies achieve speciahzation, coordination, and cooperation.Despite the negati‘ e images that hierarchv often stimuiates, 1 shall arguc thathierarchical structures arc essential for cfficiencv and tlexibiiitv in firms. The criticalissue is not whether or not to organize bv hierarchv—there is little alternative—huthos the hierarchy should be structurcd and how die various parts shouid be linked.

Hierarchv is a feature, not only of human organizations but of almost all complcxSystems:

The human hody which is hierarchy of cells, organs and subsystems such asthe respiratory system, ncrvous system, digestive system and so on.