The Organization of International Business

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Introduction

Organizational ArchitectureOrganizational StructureVertical Differentiation:Centralization andDecentralizationHorizontal Differentiation: TheDesign of StructureIntegrating MechanismsControl Systems and IncentivesTypes of Control SystemsIncentive SystemsControl Systems, Incentives,and Strategy in theInternational BusinessProcessesOrganizational CultureHow Is Organizational CultureCreated and Maintained?Organizational Culture andPerformance in theInternational BusinessSynthesis: Strategy andArchitectureMultidomestic FirmsInternational FirmsGlobal FirmsTransnational FirmsEnvironment, Strategy,Architecture, andPerformanceOrganizational ChangeOrganizational InertiaImplementing OrganizationalChangeClosing Case: OrganizationalChange at Royal Dutch/Shell

Organizational Change at UnileverUnilever is one of the world’s oldest multina-tional corpora-tions with extensive product offerings in the food, detergent,and personal care businesses. It gener-ates annual revenues inexcess of $50 billion and sells more than 1,000 branded

LESSON 3:THE ORGANIZATION OF INTERNATIONAL BUSINESS

products in virtually every coun-try. Detergents, which accountfor about 25 percent of corporate revenues, include well-knownnames such as Omo, which is sold in over 50 countries.Personal care products, which account for about 15 percent ofsales, in-clude Calvin Klein Cosmetics, Pepsodent toothpastebrands, Faberge hair care products, and Vaseline skin lo-tions.Food products account for the remaining 60 percent of salesand include strong offerings in margarine (where Unilever’smarket share in most countries exceeds 70 per-cent), tea, icecream, frozen foods, and bakery products.Historically, Unilever was organized on a decentralized basis.Subsidiary companies in each major national market wereresponsible for the production, marketing, sales, and distribu-tion of products in that market. In Europe the com-pany had17 subsidiaries in the early 1990s, each focused on a differentnational market. Each was a profit center and each was heldaccountable for its own performance. This decentralization wasviewed as a source of strength. The structure allowed localmanagers to match product offer-ings and marketing strategy tolocal tastes and prefer-ences and to alter sales and distributionstrategies to fit the prevailing retail systems. To drive thelocalization, Unilever recruited ‘local managers to run localorganiza-tions; the U.S. subsidiary (Lever Brothers) was run byAmericans, the Indian subsidiary by Indians, and so on.To knit together the decentralized organization, Unileverworked to build a common organizational culture among itsmanagers. For years, the company recruited people with similarbackgrounds, values, and interests. The stated preference wasfor individuals with high Levels of “sociability” who embracethe company’s values, which emphasize cooperation andconsensus building among managers. It is said that thecompany has been so suc-cessful at this that Unilever executivesrecognize one an-other at airports even when they have nevermet before. Unilever’s senior management believes this corps oflike-minded people is the reason its employees work so welltogether, despite their national diversity.Unilever has also worked hard to periodically bring thesemanagers together. Annual conferences on company strat-egyand executive education sessions at Unilever’s man-agementtraining center outside of London help establish connectionsbetween managers. The idea is to build an in-formal networkof equals who know one another well and usually continue tomeet and exchange experiences. Unilever also moves its youngmanagers frequently, across borders, products, and division.This policy starts Unilever relationships early as well as increasesknow-how.By the mid-1990s, the decentralized structure was in-creasinglyout of step with a rapidly changing competitive environment.Unilever’s global competitors, which include the Swiss firmNestle and Procter & Gamble from the United States, had beenmore successful than Unilever on several fronts-building global

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Tbrands, reducing cost structure by consolidating manufacturingoperations at a few choice locations, and executing simultaneousproduct launches in several national markets. Unilever’sdecentral-ized structure worked against efforts to build global orre-gional brands. It also meant lots of duplication, particularlyin manufacturing, a lack of scale economies, and a high coststructure. Unilever also found that it was falling be-hind rivalsin the race to bring new products to market. In Europe, forexample, while Nestle and Procter & Gamble moved towardpan-European product launches, it could take Unilever four tofive years to “persuade” its 17 Euro-pean operations to adopt anew product.Unilever began to change all this in the mid-1990s. In 1996, itintroduced a new structure based on regional business groups.Within each business group are a num-ber of divisions, eachfocusing on a specific category of products, Thus, within theEuropean Business Group is a division focusing on detergents,another on ice cream and frozen foods, and so on. Thesegroups and divisions have been given the responsibility forcoordinatil1g the activi-ties of national subsidiaries within theirregion to drive down operating costs and speed up the processof developing and introducing new products.“Lever Europe” was established to consolidate the company’sdetergent opera-tions. The 17 European companies now reportdirectly to Lever Europe. Using its new-found organizationalclout, Lever Europe consolidates the production of detergentsin Europe in a few key locations to reduce costs and speed upnew product introduction. Implicit in this new approach is abargain: the 17 companies relinquished autonomy in theirtraditional markets in exchange for opportunities to helpdevelop and execute a unified pan-European strategy. Thenumber of European plants manufacturing soap has been cutfrom 10 to 2, and some new products will be manufactured atonly one site. Product sizing and packaging are harmonized tocut purchasing costs and to ac-commodate unified pan-European advertising. By taking these steps, Unilever estimatesit has saved as much as $400 million a year in its Europeandetergent operations.Lever Europe is also attempting to speed development of newproducts and to syn-chronize the launch of new productsthroughout Europe. Nonetheless, history still im-posesconstraints. While Procter & Gamble’s leading laundry detergentcarries the same brand name across Europe, Unilever sells itsproduct under a variety of names. The company has no plansto change this. Having spent 100 years building these brandnames, it believes it would be foolish to scrap them in theinterest of pan-European standardization.Source: Guy de Jonquieres. “Unilever Adopts a Clean SheetApproach,” Financial Times, October 21 1991, po 13; C, A.Bartlett and S. Ghoshal, Managing across Borders (Boston:Harvard Business School Press, 1989) H. Connon, “Unilever’sGot the Nineties Licked,” The Guardian, May 24,1998, p. 5;“Unilever: A Networked Organization,” Harvard BusinessReview, November-December 1996, p. 138; and C. Christensen,and J. Zobel, “Unilever’s Butter Beater: Innovation for GlobalDiversity, “ Harvard Business School Case # 9-698-O17, March1998.

IntroductionThis chapter identifies the organizational architecture thatinternational business use to manage and direct their globaloperations. By organizational architecture we mean the totalityof a firm’s organization, including formal organizationstructure, con-trol systems and incentives, processes, organiza-tional culture, and people. The core ar-gument outlined in thischapter is that superior enterprise profitability requires threeconditions to be fulfilled. First, the different elements of afirm’s organizational architecture must be internally consistent.For example, the control and incentive systems used, in the firmmust be consistent with the structure of the enterprise, Second,the organizational architecture must match or fit the strategy ofthe firm-strategy and architecture must be, consistent. Forexample, if firm is pursuing global strategy but it has the wrongkind of architecture, in place, it is unlikely that it will be able toexecute that strategy effectively, and poor performance mayresult. Third, the strategy and architecture of the firm must notonly be consistent with each other, but they also must beconsistent with competitive conditions prevailing in the firm’smarkes-strategy, architecture, and competitive environmentmust all be consistent. For example, a firm pursuing amultidomestic strategy might have the right king of organiza-tional architecture in place. However, if it competes in marketswhere cost pressures are intense and demands for local respon-siveness are low, it will still have inferior performance because aglobal strategy is more appropriate in such an environment.The opening case on Unilever touches on some of the impor-tant issues here. His-torically Unilever has competed in marketswhere local responsiveness has been very important. Theproduction and marketing of food, detergent, and personal careproducts have traditionally been tailored to the tastes andpreferences of consumers in different nations. Unilever-satisfiedthis environmental demand for local responsiveness bypursuing a, multidomestic strategy. Its organizational architec-ture reflected this strategy. Unilever operated with a decentralizedstructure that delegated responsibil-ity for production, market-ing, sales, and distribution decisions to autonomous nationaloperating companies. This allowed local managers to configureproduct offerings, and marketing and sales activities, to theconditions prevailing in a particular nation. For a long time, thisfit between strategy and architecture served Unilever well,helping it to become a dominant consumer products enterprise.However, by the early 1990s the competitive environment waschanging. Trade barriers between countries were falling, particu-larly in the European Union following the creation of a singlemarket in 1992. This made it possible to manufacture certainitems such as detergents and margarine at favorable centrallocations in order to real-ize the benefits associated withlocation and experience curve economies. Also, new products inareas such as frozen foods and margarine were gaining regionalor even global acceptance. Unfortunately for Unilever, some ofits global competitors moved more rapidly to exploit thischange in the competitive environment. Unilever found itselfdisadvantaged by a high cost structure (caused by the duplica-tion of manufac-turing operations) and an inability tointroduce new products in several national mar-kets at once. Inother words, the competitive environment changed, but


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Unilever did not change with it. By the mid-1990s, Unilever hadrecognized its problems and changed both its strategy and itsorganizational architecture so that it better matched the newcompetitive realities. Unilever began to adopt a transnationalstrategic ori-entation, seeking to balance local responsiveness inmarketing and sales with the cen-tralization of manufacturingand product development activities to realize scale economiesand execute pan-regional product launches. To implement thisstrategy, Unilever introduced a new organizational architecturebased on’ regional business groups, each of which containedproduct divisions. These divisions were given the re-sponsibility for centralizing manufacturing and productdevelopment activities, which implied a reduction in theautonomy traditionally granted to operating subsidiaries. Toreestablish a fit between strategy, architecture, and environment,Unilever had to em-brace the difficult process of strategic andorganizational change.To explore the issues illustrated by Cases such as Unilever’s, weopen the current chapter by discussing in more detail theconcepts of organizational architecture and fit. Next we turn toa more detailed exploration of various components ofarchitecture -structure, control systems and incentives, organiza-tion culture, and processes-and explain how these componentsmust be internally consistent. After reviewing’ the variouscomponents of architecture, we look at the ways in whicharchitecture can be matched to strategy and the competitiveenvironment to achieve high performance. The chapter closeswith a discussion of organizational change, for as the Unilevercase illustrates; periodically firms have to change their organiza-tion so that it matches new strategic and compet-itive realities.

Organizational ArchitectureAs noted in the introduction, the term organizational architec-ture refers to the totality of a firm’s organization, includingformal organizational structure, control systems and incentives,organizational culture, processes, and people} Figure 3.1illustrates these different elements. By organizational structure,we mean three things: First, the formal division of the organi-zation into subunits such as product divisions, nationalopera-tions, and functions (most organizational charts displaythis aspect of structure); sec-ond, the location of decision-making responsibilities within that structure (e.g., centralized ordecentralized); and third, the establishment of integratingmechanisms to coordinate the activities of subunits includingcross functional teams and or pan-regional committees.Control systems are the metrics used to measure the perfor-mance of subunits and make judgments about how wellmanagers are running those subunits. For example, his-toricallyUnilever measured the performance of national operatingsubsidiary compa-nies according to profitability-profitability wasthe metric. Incentives are the devices used to reward appropriatemanagerial behavior.

Figure 3.1Organization Architecture

Incentives are very closely tied to performance metrics. Forexample, the incentives of a manager in charge of a national op-erating subsidiary might be linked to the performance of thatcompany. Specifically, she might receive a bonus if her subsidiaryexceeds its performance targets.Processes are the manner in which decisions are made and workis performed within the organization. Examples are theprocesses for formulating strategy, for de-ciding how to allocateresources within a firm, or for evaluating the performance ofmanagers and giving feedback. Processes are conceptuallydistinct from the location of decision-making responsibilitieswithin an organization, although both involve deci-sions.While the CEO might have ultimate responsibility for decidingwhat the strat-egy of the firm should be (i.e., the decision-making responsibility is centralized), the process he or she usesto make that decision might include the solicitation of ideasand criticism from lower-level managers. -Organizational culture is the norms and value systems that areshared among the employees of an organization. Lusts associeties have cultures, so do organizations. Organizations aresocieties of individuals who come together to perform collectivetasks. They have their own distinctive patterns of culture andsub, culture. As we shall see, organizational culture can have aprofound impact on how a firm performs. Finally, by people wemean not just the employees of the organization, but also thestrategy used to recruit, compensate, and retain those individu-als and the type of people that they are in terms of their skills,values, and orientation.As illustrated by the arrows in Figure 3.1 the various compo-nents of an organization’s architecture are not independent ofeach other: Each component shapes, and is shaped by, othercomponents of architecture. An obvious example is the strategyregarding people. This can be used proactively to hire individu-als whose internal values are consistent with those that the firmwishes to emphasize in its organization culture. Thus, thepeople component of architecture can be used to reinforce (ornot) the prevailing culture of the organization. This seems tohave been the practice at Unilever, where an effort was made tohire individuals who were sociable and placed a high value onconsensus and cooperation, values that the enterprise wished toemphasize in its own culture.

Structure

Controls And People Processes Incentives

Culture


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TIf a firm to going to maximize its profitability, it must pay closeattention to achieving internal consistency between the variouscomponents of its architecture. Let us look at how structureand control systems might be inconsistent with each other.Figure 3.2 shows an organizational chart for how Unilver’sEuropean operations might be structured (this chart is hypo-thetical). Note that there are several country subsidiaries, one forFrance, one for Germany, one for Spain, and so on, eachreporting to the Eur-opean Business Group. There are alsoseveral pan-European product divisions, one for detergents,one for frozen food, one for margarine, and so on, again eachreporting to the European Business Group. Within thisstructure, responsibility for marketing, sales, and distributiondecisions might be given to the country subsidiaries, whileresponsibility for product manufacturing might be given to theproduct divisions. As for control systems, imagine thatprofitability is the metric used to evaluate the perfor-mance ofthe country subsidiaries.One problem with this set of arrangements is that the profit-ability of the country subsidiaries depends on manufacturingcosts and new product development, and yet the managersrunning the various country subsidiaries are not responsible forthose im-portant functions-responsibility resides in the productdivisions! Thus, if the man-agers of the product divisions donot do their job properly, production costs may rise and theprofitability of the country subsidiaries might fall. In otherwords, the managers of the country subsidiaries are beingevaluated according to a metric over which they do not havetotal control.

Figure 3.2Fictional organizational Structure at Unilever

If the performance of a subsidiary declines, they may argue thatthis is not their fault; it was due to the inability of the managersin the pan-European product divisions to drive down manufac-turing costs. Thus, there is a po-tential conflict betweenstructure and the control systems used; they are potentiallyinconsistent.Some inconsistency is a fact of life in organizations. Perfectionin the design of or-ganization architecture is very difficult toachieve. Nevertheless, the inconsistency be-tween differentcomponents of an organization’s architecture can be minimizedthrough intelligent design. In the example just given, if theperformance of each product divi-sion were assessed on the

basis of manufacturing costs, it would give the managers of theproduct division the incentive to optimize manufacturingefficiency. The problem might be further alleviated if the headsof both the country subsidiaries and the Euro-pean productdivisions were rewarded according to the profitability of theentire Euro-pean Business Group (for example, by having theirbonus pay linked to the profitability of the entire group). Thiswould give the heads of the divisions a further reason to re-duce manufacturing costs, and it would create an incentive forthe heads of each sub-sidiary and division to share any bestpractices developed in their operation with colleagues acrossEurope to the betterment of the entire European BusinessGroup.Internal consistency is a necessity but not a sufficient conditionfor high perfor-mance. Consistency between architecture and thestrategy of the organization is also required; architecture mustfit strategy. When Unilever began to emphasize cost re-ductionas a major strategic goal, the firm had to change its architectureto match this new strategic reality. It had to move away from astructure based primarily on stand-alone operating subsidiariesin each country and toward one that looks more like thestructure depicted in Figure 3.2. Unilever had to create someentity, in this case the product divisions, that could reduce theduplication of manufacturing operations across countrysubsidiaries and consolidate manufacturing at a few choicelocations. Such change is easier said than done. It is relativelyeasy for senior managers to an-nounce a radical change instrategy, but it is much harder to actually put that change intoaction. Doing so requires a change in architecture. Strategy isimplemented through architecture, and changing architecture ismuch more difficult than announcing a change in strategy. Weshall discuss why it is hard to change architecture later in thischapter. As we shall see, a prime reason is that organizationstend to be relative inert; they are by nature difficult to change.Even with internal consistency and a fit between strategy andarchitecture, high performance is not guaranteed. The firm mustalso ensure that the fusion between its strategy and architectureis consistent with the competitive demands of the market, ormarkets, in which the firm competes. In the 1980s Unilever hada good fit between its strategy and architecture-it was pursuing amultidomestic strategy. A decentralized architecture composedof self-contained country subsidiaries was well suited to imple-menting this strategy. However, by the 1990s the strategy nolonger made much sense due to a change in the competitiveenvironment. Trade barriers between nations had fallen andmore efficient global competitors were emerging. Unilever’sstrategy no longer fit the environment in which it competed, soit had to change both its strategy and architecture to match thenew reality. This type of organizational challenge is not unusual;markets rarely stand still, and firms often have to adjust theirstrategy and ar-chitecture to match new competitive realities.

Organizational structureOrganizational structure means three things: (1) the formaldivision of the organization- into subunits, which we shall referto as horizontal differentiation;(2) the location of decision-making responsibilities within that structure, which we shallrefer to as vertical differentiation; and (3) the establishment of

European Business Group

Frozen Detergents Food Margarine

France

Germany

Spain


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integrating mechanisms. We begin by discussing verticaldifferentiation, then horizontal differentiation, and thenintegrating mechanisms.

Vertical Differentiation: Centralization andDecentralizationA firm’s vertical differentiation determines where in its hierarchythe decision-making power is concentrated. Are production andmarketing decisions centralized in the of-fices of upper-levelmanagers, or are they decentralized to lower-level managers?Where does the responsibility for R&D decisions lie? Arestrategic and financial con-trol responsibilities pushed down tooperating units, or are they concentrated in the hands of topmanagement? And so on. There are arguments for centraliza-tion and other arguments for decentralization.

Arguments for CentralizationThere are four main arguments for centralization. First,centralization can facilitate co-ordination. For example, considera firm that has a component manufacturing opera-tion inTaiwan and an assembly operation in Mexico. The activities ofthese two operations may need to be coordinated to ensure asmooth flow of products from the component operation tothe assembly operation. This might be achieved by centralizingproduction scheduling at the firm’s head office. Second,centralization can help ensure that decisions are consistent withorganizational objectives. When decisions are decentralized tolower-level managers, those managers may make decisions atvariance with top management’s goals. Centralization ofimportant decisions minimizes the change of this occurring.Third, by concentrating power and authority in one individualor a management team, centralization can give top-levelmanagers the means to bring about needed major organiza-tional changes. Fourth, centralization can avoid the duplicationof activities that occurs when similar activities are carried on byvarious subunits within the organization. For example, manyinternational firms centralize their R&D functions at one or twolocations to ensure that R&D work is not duplicated. Produc-tion activ-ities may be centralized at key locations for the samereason.

Arguments for DecentralizationThere are five main arguments for decentralization. First, topmanagement can become overburdened when decision-makingauthority is centralized, and this can result in poor decisions.Decentralization gives top management time to focus on criticalis sues by delegating more routine issues to lower-levelmanagers. Second, motivational research favors decentralization.Behavioral scientists have long argued that people are willing togive more to their jobs when they have a greater degree ofindividual freedom and control over their work. Third,decentralization permits greater flexibility- more rapid responseto environmental changes-because decisions do not have to be“referred” up the hierarchy” unless they are exceptional innature. Fourth, decentralization can result in better decisions. Ina decentralized structure, decisions are made closer to the spotby individuals who (presumably) have better information thanman-agers several levels up in a hierarchy. Fifth, decentralizationcan increase control. Decentralization can be used to establishrelatively autonomous, self-contained subunits within an

organization. Subunit managers can then be held accountablefor subunit performance. The more responsibility subunitmanagers have for decisions that impact subunit performance,the fewer alibis they have for poor performance.

Strategy and Centralization in an InternationalBusinessThe choice between centralization and decentralization is notabsolute. Frequently it makes sense to centralize some decisionsand to decentralize others, depending on the type of decisionand the firm’s strategy. Decisions regarding overall firm strategy,major financial expenditures, financial objectives, and the like aretypically centralized at the firm’s headquarters. However,operating decisions, such as those relating to production,marketing, R&D, and human resource management, mayor maynot be centralized depending on the firm’s internationalstrategy.Consider firms pursuing a global strategy. They must decidehow to disperse the various value creation activities around theglobe so location and experience economies can be realized. Thehead office must make the decisions about where to locateR&D, production, marketing, and so on. In addition, theglobally dispersed web of value creation activities that facilitatesa global strategy must be coordinated. All of this cre-atespressures for centralizing some operating decisions.In contrast, the emphasis on local responsiveness inmultidomestic firms creates strong pressures for decentralizingoperating decisions to foreign subsidiaries. In the classicmultidomestic firm, foreign subsidiaries have autonomy inmost production and marketing decisions. International firmstend to maintain centralized control over their core competencyand to decentralize other decisions to foreign subsidiaries. Thistypically centralizes control over R&D and/or marketing in thehome country and decentralizes operating decisions to theforeign subsidiaries. For example, Microsoft Corporation,Which fits the international mode, centralizes its productdevelopment activities (where its core competencies lie) at theRedmond, Washington, headquarters and decentralizesmarketing activity to various foreign subsidiaries. Thus, whileproducts are developed at home, managers in the variousforeign subsidiaries have significant latitude for formulatingstrategies to market those products in their particular settings.The situation in transnational firms is more complex. The needto realize location and experience curve economies requiressome degree of centralized control over -global productioncenters (as it does in global firms). However, the need for localresponsiveness dictates the decentralization of many operatingdecisions, particularly for marketing, to foreign subsidiaries.Thus, in transnational firms, some operating decisions arerelatively centralized, while others are relatively decentralized. Inaddition, global learning based on the multidirectional transferof skills between subsidiaries and between subsidiaries and thecorporate center, is a central feature of a firm pursuing atransnational strategy. The concept of global learning ispredicated on the notion that foreign subsidiaries within amultinational firm have significant freedom to -develop theirown skills and competencies. Only then can these be leveragedto benefit other parts of the organization. A substantial degree


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Tof decentralization is required if subsidiaries are going to havethe freedom to do this. For this reason too, the pursuit of atransnational strategy requires a high degree of decentralization.

Horizontal Differentiation: The design of StructureHorizontal differentiation is concerned with how the firmdecides to divide itself into subunits. The decision is normallymade on the basis of function, type of business or geographicalarea. In many firms, just one of these predominates, but morecomplex solutions are adopted in others. This is particularlylikely in the case of international firms, where the conflictingdemands to organize the company around different products(to realize location and experience curve economies) anddifferent national mar-kets (to remain locally responsive) mustbe reconciled. One solution to this dilemma is to adopt amatrix structure that divides the organization on the basis ofboth products and national markets (as Unilever apparently didin Europe). In this section we look at different ways firmsdivide themselves into subunits.

The Structure of Domestic Firms

Most firms begin with no formal structure and are run by asingle entrepreneur or a small team of individuals. As theygrow, the demands of management become too great for oneindividual or a small team to handle. At this point the organiza-tion is split into functions reflecting the firm’s value creationactivities (e.g., production, marketing, R&D, sales). Thesefunctions are typically coordinated and controlled by topmanagement (see Figure 3.3). Decision making in this func-tional structure tends to be centralized.Further horizontal differentiation may be required if the firmsignificantly diversifies its product offering, which takes the firminto different business areas. For exam-ple, Dutch multina-tional Philips NY began as a lighting company, butdiversification took the company into consumer electronics (e.g.,visual and audio equipment), in-dustrial electronics (integratedcircuits and other electronic components), and medical systems(CT scanners and ultrasound systems).In such circumstances, afunc-tional structure can be too clumsy. Problems of coordina-tion and control arise when different business areas aremanaged within the framework of a functional structure. Forone thing, it becomes difficult to identify the profitability ofeach distinct business area. For another, it is difficult to run afunctional department, such as production or marketing, if it issupervising the value creation activities of several business areas.To solve the problems of coordination and control, at thisstage most firms switch to a product divisional structure (seeFigure 3.4). With a product divisional structure, each division isresponsible for a distinct product line (business area). Thus,Philips created divisions for lighting, consumer electronics,industrial electronics, and med-ical systems. Each productdivision is set up as a self-contained, largely autonomous entitywith its own functions.

Figure 3.3A typical Functional Structure

Buying Units Plants Branch Sales Units Accounting Units

Top Management

Purchasing Manufacturing Marketing Finance

The responsibility for operating decisions is typically decentral-ized to product divisions, which are then held accountable fortheir perfor-mance. Headquarters is responsible for the overallstrategic development of the firm and for the financial controlof the various divisions.

Figure 3.4A Typical Product Divisional Structure

Buying Units Plants Branch Sales Units Accounting Units

Headquarters

Division product line A

Department Purchasing

Department Manufacturing

Department Marketing

Department Finance

Division Product Line C Division Product Line B

The International DivisionWhen firms initially expand abroad, they often group all-theirinternational activities into an international division. This hastended to be the case for firms organized on the basis offunctions and for firms organized on the basis of productdivisions. Re-gardless of the firm’s domestic structure, itsinternational division tends to be organized on geography.Figure3.5 illustrates this for a firm whose domestic organizationis based on product divisions.Many manufacturing firms expanded internationally byexporting the product manufactured at home to foreignsubsidiaries to sell. Thus, in the firm illustrated in Figure 3.5,the subsidiaries in Countries 1 and 2 would sell the productsmanufactured by Divisions A, B, and C. In time, however, itmight prove viable to manufacture the product in each country,and so production facilities would be added on a country-bycountry basis. For firms with a functional structure at home,this might mean repli-cating the functional structure in everycountry in which the firm does business. For firms with adivisional structure, this might mean replicating the divisionalstructure in every country in which the firm does business.This structure has been widely used; according to a Harvardstudy, 60 percent of all firms that have expanded internationallyhave initially adopted it. Nonetheless, it gives rise to problems.The dual structure it creates contains inherent potential forconflict and coordination problems between domestic and


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foreign operations. One problem with the structure is that theheads of foreign subsidiaries are not given as much voice in theorganization as the heads of domestic functions (in the case offunctional firms) or divisions (in the case of divisional firms).Rather, the head of the international division is presumed to beable to represent the interests of all countries to headquarter.This effectively relegates each country’s manager to the secondtier of the firm’s hierarchy, which is inconsistent with a strategyof trying to expand internationally and build a true multina-tional organization.Another problem is the implied lack of coordination betweendomestic operations and, foreign operations, which are isolatedfrom each other in separate parts of the structural hierarchy.This can inhibit the worldwide introduction of new products,the transfer of core competencies between domestic and foreignoperations, and the consolidation of global production at keylocations so as to realize location and experience curve econo-mies. These problems are illustrated in the Management Focusthat looks at the experience of Abbott Laboratories with aninternational divisional structure.

Figure 3.5One Company’s International Divisional Structure

Functional units

As a result of such problems, most firms that continue toexpand international abandon this structure and adopt one ofthe worldwide structures we discuss next. The two initialchoices are a worldwide product divisional structure, whichtends to be adopted by diversified firms that have domesticproduct divisions, and a worldwide area structure, which tendsto be adopted by undiversified firms whose domestic structuresare based on functions. These two alternative paths of develop-ment are illustrated in Figure 3.6. The model in the figure isreferred to as the international structural stages model and wasdeveloped by John Stopford and Louis Wells.

Worldwide Area StructureA worldwide area structure tends to be favored by firms with alow degree of diversification and a domestic structure based onfunction (see Figure 3.7). Under this structure, the world isdivided into geographic areas. An are may be a country (if themarket is large enough) or a group of countries. Each area tendsto be a self-contained, largely autonomous entity with its ownset of value creation activities (e.g., its own production,marketing, R&D, human resources, and finance functions).Operations authority and strategic decision relating to each ofthese activities are typically decentralized to each area, withheadquarters retaining authority of all overall strategic directionof the firm and financial control.This structure facilitates local responsiveness. Because decision-making responsilities are decentralized, each area can customizeproduct offerings, marketing strategy, and business strategy tothe local conditions. However, this structure en-couragesfragmentation of the organization into highly autonomousentities. This can make it difficult to transfer core competenciesand skills between areas and to realize location and experiencecurve economies. In other words, the structure is consistentwith a multidomestic strategy but with little else. Firmsstructured on this basis may encounter significant problems iflocal responsiveness is less critical than reducing costs ortransferring core competencies for establishing a competitiveadvantage.

Figure 3.6The International Structural Stage Model

World Wide Product Division Global Matrix Foreign (“Grid”) Product Diversity Alternate Paths Of Development

International Division Area Division

Source: Adapted from John M.Stopford and Louis T. Wells,Strategy and Structure of the Multinational Enterprise (NewYork: Basic Books, 1972).

Figure 3.7A Worldwide area structure

Headquarters

North America European Area Area

Latin America Middle Eastern - Far East Area Africa Area Area

Case Study

The international Division at Abbott LaboratoriesWith sales of about $14 billion in 2000, Abbott Laboratories isone of the world’s largest health care companies. The companysplit itself into three divisions-pharmaceuticals, hospital pro-ducts, and nutritional products—in the 1960s, a structure that

Functional units

Headquarters

Domestic Division General Manager Product Line A

Domestic Division General Manager Product Line B

Domestic Division General Manager Product Line C

International Division General Manager Area line

Country 1 General Manager (Product A, B, C)

Country 2 General Manager (Product A, B, C)


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Tstill exists. Each division oper-ates as a profit center, and each isrelatively au-tonomous and self-contained, with its own R&D,manufacturing, and marketing functions. By the late 1960sAbbott’s foreign sales were growing rapidly; the company addedan international division to handle the firm’s non-U.S. opera-tions on geographic rather than product lines.Alongside these four divisions, however, a new busi-ness hasgrown up that is organized differently. Abbott’s diagnosticsbusiness was established in the 1970s and became a worldleader with global sales of $3 billion in 2000. Unlike the otherdivisions, the diagnostics business is organized on a globalbasis, operating in foreign countries through its own staff,rather than through the international division. Thus, Abbotthandles global sales in two different ways-through an interna-tional division and through a global product division (thediagnostics business organization). The company is debatingthe best way of organizing international operations.This debate is being informed by two changes oc-curring inAbbott’s environment, changes that are pulling the company indifferent directions. One change is a shift toward global productdevelopment in the health care industry. To quickly recapture thecosts of developing new products, which for pharmaceuticalscan sometimes top $500 million, companies are trying tointroduce new products as rapidly as possible world-wide.Abbott has found that developing products first for the U.S.market and then modifying those products for foreign custom-ers is a slow and expensive process. Instead, across all four ofthe company’s businesses, Abbott is trying to build globalproducts that can be launched simultaneously around theworld. This change is pulling Abbott toward adopting globalproduct divisions for all four of its busi-nesses. Some arguethat only global product divisions would give Abbott the tightcontrol over product development and product launch strategythat is deemed necessary.On the other hand, bigger organizations with greater purchas-ing leverage, such as large hospital groups and healthmaintenance organizations, are coordinating their buying acrossa rang of product lines in both the United States and elsewhere.These powerful customers prefer to have a single con-tact pointat Abbott. Abbott develops stronger relations with keycustomers by having a single marketing orga-nization in eachcountry in which the company does businesses. This organiza-tion sells the products from each of Abbott’s four productdivisions.Executives at Abbott’s international division sup-port main-taining the geographic organization, while the heads of theproduct divisions favor a shift toward four global productdivisions, Top management seems to have decided there is noperfect solution to the company’s organizational problems, andthat imper-fect as the current structure is, it works too well tocontemplate a major change.Sources: R. Walters, “Two’s Company,” Financial Times, July 7,1995, p, 12; Abbott Laboratories 2000 Annual Report; and M.Santoli, “Patient Reviving,” Barron’s, February 28, 2000, pp, 24-26.

Worldwide Product Divisional Structure

A worldwide product division structure tends to be adopted byfirms-that are reasonably diversified and, accordingly, originallyhad domestic structures based on product divisions. As withthe domestic product divisional structure, each division is a self-contained, largely autonomous entity with full responsibility forits own value creation activities. The headquarters retainsresponsibility for the overall strategic development and financialcontrol of the firm (see Figure3.8).Underpinning the organization is a belief that the value creationactivities of each product division should be coordinated bythat division worldwide. Thus, the worldwide productdivisional structure is designed to help overcome the coordina-tion problems that arise with the international division andworldwide area structures (see the Management Focus onAbbott Laboratories for a detailed example). This structure pro-vides an-organizational context that enhances the consolidationof value creation activities at key locations- necessary for realizinglocation and experience curve economies. It also facilitates thetransfer of core competencies within a division’s worldwideoperations and the simultaneous worldwide introduction ofnew products. The main problem with the structure is thelimited voice it gives to area of country m-anagers, since they areseen as subservient to product division managers. The resultcan be a lack of local responsiveness.

Global Matrix StructureBoth the worldwide area structure and the worldwide productdivisional structure have strengths and weaknesses. Theworldwide area structure facilitates local responsiveness, but itcan inhibit the realization of location and experience curveeconomies and the transfer of core competencies between areas.The worldwide product division structure provides a betterframework for pursuing location and experience curve econo-mies and for transferring core competencies, but it is weak inlocal responsiveness. Other things being equal, this suggeststhat a worldwide area structure is more approiate if the firm’sstrategy is multidomestic, while a worldwide product divisionalstructure is more appropriate for firms pursuing global orinternational strategies. However, other things are not equal. AsBartlett and Ghoshal have argued, to survive in some indus-tries, firms must adopt a transnational strategy. That is, theymust focus simultaneously on realizing location and experiencecurve economies, on local responsiveness, and on the internaltransfer of core competencies (worldwide learning).

Figure 3.8A Worldwide Product Headquarters Division Structure

Functional Units Functional Units

Worldwide Product Group or Division A

Worldwide Product Group or Division B

Worldwide Product Group or Division C

Area 1 (Domestic)

Area 2 (International)


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Figure 3.9A Global Matrix Structure

Many firms have attempted to cope with the conflictingdemands of a transnational strategy by using a matrix structure(see Figure 3.2). In the classic global matrix structure, horizontaldifferentiation proceeds along two dimensions: productdivision and geographic area (see Figure 3.9). The philosophy isthat responsibility for operating decisions pertaining to aparticular product should be shared by the product division andthe various areas of the firm. Thus, the nature of the productoffering, the mar-keting strategy, and the business strategy to bepursued in Area 1 for the products pr0-duced by Division A aredetermined by conciliation between Division A and Area 1management. It is believed that this dual decision-makingresponsibility should enable the firm to simultaneously achieveits particular objectives. In a classic matrix struc-ture, givingproduct divisions and geographical areas equal status within theorganiza-tion reinforces the idea of dual responsibility. Indi-vidual managers thus belong to two hierarchies (a divisionalhierarchy and an area hierarchy) and have two bosses (a di-visional boss and an area boss).The reality of the global matrix structure is that it often doesnot work anywhere near as well as the theory predicts. Inpractice, the matrix often is clumsy and bureaucratic. It canrequire so many meetings that it is difficult to get any workdone. The need to get an area and a product division to reach adecision can slow decision making and produce an inflexibleorganization unable to respond quickly to market shifts or toinnovate. The dual-hierarchy structure can lead to conflict andperpetual power struggles between the areas and the productdivisions, catching many managers in the middle. To makematters worse, it can prove difficult to ascertain accountability inthis structure. When all critical decisions are the product ofnegotiation between divisions and areas, one side can alwaysblame the other when things go wrong. As a manager in oneglobal matrix structure, reflecting on a failed product launch,said, to the author, “Had we been able to do things our way,instead of having to accommodate those guys from theproduct division, this would never have happened.” (Amanager in the product division expressed similar sentiments.)The result of such finger-pointing can be that accountability iscompromised, conflict is enhanced, and headquarters losescontrol over the organization.

In light of these problems, many transnational firms are nowtrying to build “flexible” matrix structures based more onfirmwide networks and a shared culture and vi-sion than on arigid hierarchical arrangement. Dow Chemical, profiled in thataccompanying Management Focus, is one such firm. Withinsuch companies the in-formal structure plays a greater role thanthe formal structure. We discuss this issue when we considerinformal integrating mechanisms in the next section.

Integrating MechanismsIn the previous section, we explained that firms divide them-selves into subunits. Now we need to examine some means ofcoordinating those subunits. One way of achieving coordina-tion is through centralization. If the coordination task iscomplex, how-ever, centralization may not be very effective.Higher-level managers responsible for -achieving coordinationcan soon become overwhelmed by the volume of work requiredto coordination the activities of various subunits, particularly ifthe subunits are large, diverse, and/or geographically dispersed.When, this is the case, firms look toward integrating mecha-nisms, both formal and informal, to help achieve coordination.In this section, we introduce the various integrating mecha-nisms that international businesses can use. Before doing so,however, let us explore the need for coordination in interna-tional firms and some, impediments to coordination.

Strategy and Coordination in the InternationalBusinessThe need for coordination between subunits varies with thestrategy of the firm. The need for coordination is lowest inmultidomestic companies, is higher in interna-tional compa-nies, higher still in global companies, and highest of all intransnational companies. Multidomestic firms are primarilyconcerned with local responsiveness. Such firms are likely tooperate with a worldwide area, structure in which each area hasconsiderable autonomy and its own set of value creationfunctions. Since each area is established as a stand-alone entity,the need for coordination between areas is minimized.The need for coordination is greater in firms pursuing aninternational strategy- and trying to profit from the transfer ofcore competencies and skills between units at home and abroad.Coordination is necessary to support the transfer of skills andproduct of-ferings between units. The need for coordination isalso great in firms trying to profit from location and experiencecurve economies; that is, in firms pursuing global strate-gies.Achieving location and experience economies involves dispers-ing value creation activities to various locations around theglobe. The resulting global web of activities must be coordi-nated to ensure the smooth flow of inputs into the value chain,the smooth flow of semifinished products through the valuechain, and the smooth flow of finished products to marketsaround the world.The need for coordination is greatest in transnational firms,which simultaneously pur-sue location and experience curveeconomies, local responsiveness, and the multidirec-tionaltransfer of core competencies and skills among all of the firm’ssubunits (referred to as global learning). As in global compa-nies, coordination is required to ensure the smooth flow ofproducts through the global value chain. As in international

Manager Here Belongs to Division And Area 2

Headquarters

Area 1 Area 2 Area 3

Product Division A

Product Division B

Product Division C


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Tcompanies, coordi-nation is required for ensuring the transferof core competencies to subunits. However, the transnationalgoal of achieving multidirectional transfer of competenciesrequires much greater coordination than in international firms.In addition, transnationals require co-ordination betweenforeign subunits and the firm’s globally dispersed value creationac-tivities (e.g., production, R&D, marketing) to ensure that anyproduct offering and marketing strategy is sufficiently custom-ized to local conditions.

Case Study

Dow chemical’s Matrix StructureA handful of major players compete head to head around theworld in the chemical in-dustry. These companies are DowChemical and Du Pont of the United States, Great Britain’s ICI,and the German trio of BASF, Hoechst AG, and Bayer. Thebarriers to the free flow of chemical products between na-tionslargely disappeared in the 1970s. This along with the commod-ity nature of most bulk chemicals and a severe recession in theearly 1980s ushered in a prolonged period of intense pricecompetition. In such an environment, the company that winsthe competitive race is the one with the lowest costs, and inrecent years the clear winner has been Dow.Dow’s managers insist that part of the credit must be placed atthe feet of its much maligned “matrix” organization. Doworganizational matrix has three interacting elements: functions(e.g., R&D, manufac-turing, marketing), businesses (e.g.,ethylene, plas-tics, pharmaceuticals), and geography (e.g., Spain,Germany, Brazil). Managers’ job titles incorporate all threeelements-for example, plastics marketing man-ager for Spain-and most managers report to at least two bosses. The plasticsmarketing manager in Spain -might report to both the head ofthe worldwide plastics business and the head of the Spanishoperations. The intent of the matrix was to, make Dowoperations re-sponsive to both local market needs and corpo-rate ob-jectives. Thus, the plastics business might be chargedwith minimizing Dow’s global plastics production costs, whilethe Spanish operation might be charged with determining howbest to sell plastics in the Span-ish market.When Dow introduced this structure, the results were less thanpromising; multiple reporting channels led to confusion andconflict. The large number of bosses made for an unwieldybureaucracy. The overlap-ping responsibilities resulted in turfbattles and a lack of accountability. Area managers disagreedwith managers overseeing business sectors about which plantsshould be built and where. In short, the structure didn’t work.Instead of abandoning the structure, however, Dow de-cidedto see if it could be made more flexible.Dow’s decision to keep its matrix structure was prompted by itsmove into the pharma-ceuticals industry. The company realizedthat the pharmaceutical business is very differ-ent from the bulkchemicals business. In bulk chemicals, the big returns comefrom achieving economies of scale in production. This dictatesestablishing large plants in key locations from which regional orglobal markets can be served. But in pharmaceuticals, regulatoryand marketing requirements for drugs vary so much fromcountry to country that local needs are far more important thanreducing manufacturing costs through scale economies. A high

degree of local responsive-ness is essential. Dow realized itspharmaceutical busi-ness would never thrive if it were managedby the same priorities as its mainstream chemicalDow’s decision to keep its matrix structure was prompted by itsmove into the pharma-ceuticals industry. The company realizedthat the pharmaceutical business is very differ-ent from the bulkchemicals business. In bulk chemicals, the big returns comefrom achieving economies of scale in production. This dictatesestablishing large plants in key locations from which regional orglobal markets can be served. But in pharmaceuticals, regulatoryand marketing requirements for drugs vary so much fromcountry to country that local needs are far more important thanreducing manufacturing costs through scale economies. A highdegree of local responsive-ness is essential. Dow realized itspharmaceutical busi-ness would never thrive if it were managedby the same priorities as its mainstream chemical operations.Accordingly, instead of abandoning its matrix, Dow decided tomake it more flexible so it could better ac-commodate thedifferent businesses, each with its own priorities, with in asingle management system. A small team of senior executivesat headquarters now helps set the priorities for each type ofbusiness. Af-ter priorities are identified for each business sector,one of the three elements of the matrix-function, business, orgeographic area-is given primary authority in decision-making.Which element takes the lead varies according to the type ofdecision and the market or location in which the company iscompet-ing. Such flexibility requires that all employees under-stand what is occurring in the rest of the matrix. Although thismay seem confusing, Dow claims this flexible system workswell and credits much of its success to the quality of thedecisions it facilitates.Source: “Dow Draws Its Matrix Again, and Again, and Again,”The Economist, August 5, 1989. pp. 55-56.

Impediments to CoordinationManagers of the various subunits have different orientations,partly because they have different tasks. For example, produc-tion managers are typically concerned with pro-duction issuessuch as capacity utilization, cost control, and quality control,whereas marketing managers are concerned with marketingissues such as pricing, promotions, distribution, and marketshare. These differences can inhibit communication between themanagers. Quite simply, these managers often do not even“speak the same language.” There may also be a lack of respectbetween subunits (e.g., marketing managers “looking downon” production managers, and vice versa), which furtherinhibits the communication required to achieve cooperation andcoordination.Differences in subunits’ orientations also arise from theirdiffering goals. For exam-ple, worldwide product divisions of amultinational firm may be committed to cost goals that-requireglobal production of a standardized product, whereas a foreignsub-sidiary may be committed to increasing its market share inits country, which will re-quire a nonstandard product. Thesedifferent goals can lead to conflict.Such impediments to coordination are not unusual in any firm,but they can be par-ticularly problematic in the multinationalenterprise with its profusion of subunits at home and abroad.


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Differences in subunit orientation are often reinforced inmultina-tionals by the separations of time zone, distance, andnationality between managers of the subunits.For example, until recently the Dutch company Philips had anorganization comprising worldwide product divisions andlargely autonomous national organiza-tions. The company haslong had problems getting its product divisions and na-tionalorganizations to cooperate on such things as new productintroductions. When Philips developed a VCR format, theV2000 system, it could not get its North American subsidiary tointroduce the product. Rather, the North American unitadopted the rival VHS format produced by Philip’s globalcompetitor, Mat-sushita. Unilever experienced a similar problemin its detergents business. The need to resolve disputes betweenUnilever’s many national organizations and its productdivisions extended the time necessary for introducing a newproduct across Europe to several years. This denied Unilever thefirst-mover advantage crucial to building a strong marketposition.

Formal lntegrating MechanismsThe formal mechanisms used to integrate subunits vary incomplexity from simple di-rect contact and liaison roles, toteams, to a matrix structure (see Figure 1.10). In gen-eral, thegreater the need for coordination, the more complex the formalintegrating mechanisms need to be.Direct contact between subunit managers is the simplestintegrating mechanism. By this “mechanism,” managers of thevarious subunits simply contact each other whenever they have acommon concern. Direct contact may not be effective if themanagers have differing orientations that act to impedecoordination, as pointed out in the previous subsection.

Figure 3.10Formal Integrating Mechanisms

Liaison roles are a bit more complex. When the volume ofcontacts between sub-units increases, coordination can beimproved by giving a person in each subunit re-sponsibility forcoordinating with another subunit on a regular basis. Through

Direct Contact

Liaison Roles

Teams

Matrix Structure

Increasing Complexity Of Integrating Mechanism

these roles, the people involved establish a permanent relation-ship. This helps attenuate the impediments to coordinationdiscussed in the previous subsection.When the need for coordination is greater still, firms tend touse temporary or permanent teams composed of individualsfrom the subunits that need to achieve coordination. They aretypically used to coordinate product development and in-troduction, but they are useful when any aspect of operationsor strategy requires the cooperation of two or more subunits.Product development and introduction teams are typicallycomposed of personnel from R&D, production, and marketing.The re-sulting coordination aids the development of productsthat are tailored to consumer needs and that can be produced ata reasonable cost (design for manufacturing).When the need for integration is very high, firms may institute amatrix structure, in which all roles are viewed as integratingroles. The structure is designed to facilitate maximum integra-tion among subunits. The most common matrix inmultinational firms is based on geographical areas and world-wide product divisions. This achieves a high level of integrationbetween the product divisions and the areas so that, in the-ory,the firm can pay close attention to both local responsivenessand the pursuit of lo-cation and experience curve economies.In some multinationals, the matrix is more complex still,structuring the firm into geographical areas, worldwide productdivisions, and functions, all of which report di-rectly toheadquarters. Thus, within a company such as Dow Chemical(see the Man-agement Focus) each manager belongs to threehierarchies (e.g., a plastics marketing manager in Spain is q.member of the Spanish subsidiary, the plastics productdivision, and the marketing function). In addition to facilitatinglocal responsiveness and loca-tion and experience curveeconomies, such a matrix fosters the transfer of core compe-tencies within the organization. This occurs because corecompetencies tend to reside in functions (e.g., R&D, marketing).A structure such as Dow’s facilitates the transfer of competen-cies existing in functions from division to division and fromarea to area.However, as discussed earlier, such matrix solutions to coordi-nation problems in multinational enterprises can quicklybecome bogged down in a bureaucratic tangle that creates asmany problems as it solves. Matrix structures tend to bebureaucratic, inflexible, and characterized by conflict rather thanthe hoped-for cooperation. As in the case of Dow Chemical, forsuch a structure to work it needs to be somewhat flex-ible andto be supported-by informal integrating mechanisms.

Figure 3.11A Simple Management Network

G E B

C D

A F


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TInformal Integrating Mechanism: ManagementNetworksIn attempting to alleviate or avoid the problems associated withformal integrating mechanisms in general, and matrix structuresin particular, firms with a high need for integration have beenexperimenting with an informal integrating mechanism:management networks that are supported by an organizationculture that values teamwork and cross-unit cooperation, Amanagement network is a system of informal contacts betweenmanagers within an enterprise, The great strength of a networkis that it can be used as a nonbureaucratic conduit for knowl-edge flows within a multinational enterprise. For a network toexist, managers at different locations within the organizationmust be linked to each other at least indirectly. For example,Figure 3.11 shows the simple network relationships betweenseven managers within a multinational firm. Managers A, B,and C all know each other personally, as do Managers D, E, andF. Although Manager B does not know Manager F personally,they are linked through common acquaintances (Managers Cand D). Thus, we can say that Managers A through F are all partof the network, and also that Manager G is not.Imagine Manager B is a marketing manager in Spain and needsto know the solution to a technical problem to better serve animportant European customer. Manger F, an R&D manager inthe United States, has the solution to Manager B’s problem.Manager B mentions her problem to all of her contacts,including Manager C, and asks if they know of anyone whomight be able to provide a solution. Manager C asks Manger D,who tells Manager F, who then calls Manager B with thesolution. In this way coordination is achieved informallythrough the network, rather than by formal integratingmechanisms such as teams or a matrix structure,For such a network to function effectively, however, it mustembrace as many managers as possible. For example, ifManager G had a problem similar to manager B’s he -wouldpot be able to utilize the informal network to find a solution;he would have to resort to more formal mechanisms. Estab-lishing firmwide networks is difficult, and although networkenthusiasts speak of networks as the “glue” that bindsmultinational companies together, it is far from clear howsuccessful firms have been at building companywide networks.Two techniques being used to establish networks are informa-tion -systems and management development policies.Firms are using their computer and telecommunicationsnetworks to provide the physical foundation for informalinformation systems networks. Electronic mail,videoconferencing, and high-speed data systems make it mucheasier for mangers scattered over the globe to get to know eachother. Without an existing network of -personal contacts,however, worldwide information systems are unlikely to meet afirm’s need for integration.Firms are using their management development programs tobuild informal works. Tactics include rotating managersthrough various subunits on a regular basis -they build theirown informal network and using management educationprograms to bring managers of subunits together in a singlelocation so they can became acquainted. Both of these tactics are

used at Unilever to build its informal management Network(see the opening case for details).Management networks by themselves may not be sufficient toachieve coordination if subunit managers persist in pursuingsubgoals that are at variance with firmwide goa1s. For amanagement network to function properly-and for a formalmatrix structure to work, also-managers must share a strongcommitment the same goals. To appreciate the nature of theproblem, consider again the case of Manager B and Manager F.As before, Manager F nears about Manager B’s problemthrough the network. However, solving Manager B’s problemwould require Manager F to devote consider-able time to thetask. Insofar as this would divert Manager F away from his ownregu-lar tasks-and the pursuit of subgoals that differ fromthose of Manager B-he may be unwilling to do it. Thus,Manager F may not call Manager B, and the informal networkwould fail to provide a solution to Manager B’s problem.To eliminate this flaw, organization’s managers must adhere toa common set of norms and values that override differingsubunit orientations. In other words, the firm must have astrong organizational culture that promotes teamwork andcooperat-ion. When this is the case, a manager is willing andable to set aside the interests of his own subunit when doingso benefits the firm as a whole. If Manager B and Man-ger F arecommitted to the same organizational norms and valuesystems, and if these organizational norms and values place theinterests of the firm as a whole above the interests of anyindividual subunit, Manager F should be willing to cooperatewith manger B on solving her subunit’s problems.

SummaryThe message contained in this section is crucial to understand-ing the problems of managing the multinational firm.Multinationals need integration-particularly if they are pursuingglobal, international, or transnational strategies-but it can bedifficult to achieve due to the impediments to coordination wediscussed. Firms traditionally have tried to achieve coordinationby adopting formal integrating mechanisms. These do notalways work, however, since they tend to be bureaucratic and donot necessarily address the problems that arise from differingsubunit orientations. This is particularly likely with a complexmatrix structure, and yet, a complex matrix structure is requiredfor si-multaneously achieving location and experience curveeconomies, local responsive-ness, and the multidirectionaltransfer of core competencies within the organization. Thesolution to this dilemma seems twofold. First, the firm musttry to establish an in-formal management network that can domuch of the work previously undertaken by a formal matrixstructure. Second, the firm must build a common culture.Neither of these-partial solutions, however, is easy to achieve.

Control Systems and IncentivesA major task of a firm’s leadership is to control the varioussubunits of the firm-whether they be defined on the basis offunction, product division, or geographic area-to ensure theiractions are consistent with the firm’s overall strategic andfinancial objectives. Firms achieve this with various control andincentive systems. In this section, we first review the varioustypes of control systems firms use to control their subunits.


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Then we briefly discuss incentive systems. Then we will look athow the appropriate control and incen-tive systems varyaccording to firms’ international strategies.

Type of control systemFour main types of control systems are used in multinationalfirms: personal controls, bureaucratic controls, output controls,and cultural controls. In most firms, all four are used, but theirrelative emphasis varies with the strategy of the firm.

Personal ControlsPersonal control is control by personal contact with subordi-nates. This type of control tends to be most widely used insmall firms, where it is seen in the direct supervision ofsubordinates’ actions. However, it also structures the relation-ships between mangers at different levels in multinationalenterprises. For example, the CEO may use a great deal ofpersonal control to influence the behavior of his or herimmediate subordinates, such as the heads of worldwideproduct divisions or major geographic areas. In turn, theseheads may use personal control to influence the behavior oftheir subordinates, and so on down through the organization.For-example, Jack Welsh the longtime CEO of General Electricwho retired in 2001, had regular one-on-one meetings with theheads of all of GE’s major businesses (most of which areinternational). He used these meetings to “probe” the managersabout the strategy, structure, and fi-nancial performance of theiroperations. In doing so, he essentially exercised personal controlover these managers and, undoubtedly, over the strategies thatthey favored.

Bureaucratic ControlsBureaucratic control is control through a system of rules andprocedures that directs the actions of subunits. The mostimportant bureaucratic controls in subunits within multina-tional firms are budgets and capital spending rules. Budgets areessentially a set -of rules for allocating a firm’s financial re-sources. A subunit’s budget specifies with some precision howmuch the subunit may spend. Headquarters uses budgets toinfluence the behavior of subunits. For example, the R&Dbudget normally specifies how much cash the R&D unit mayspend on product development. R&D managers known that ifthey spend too much on one project, they will have less tospend on other projects, so they modify their behavior to staywithin the budget. Most budgets are set by negotiation betweenheadquarters management and subunit management. Head-quarters management can encourage the growth of certainsubunits and restrict the growth -of others by manipulatingtheir budgets.Capital spending rules require headquarters management toapprove any capital expenditure by a subunit that exceeds acertain amount (at GE, $50,000). A budget allows headquartersto specify the amount a subunit can spend in a given year, andcapital spending rules give headquarters additional control overhow the money is -spent. Headquarters can be expected to denyapproval for capital spending requests that are at variance withoverall firm objectives and to approve those that are con- gruentwith firm objectives.

Output ControlsOutput controls involve setting goals for subunits to achieveand expressing those goals in terms of relatively objectiveperformance metrics such as profitability, productivity, growth,markets share, and quality. The performance of subunitmanagers is than Judged by their ability to achieve the goals. Ifgoals are met or exceeded, subunit managers will be rewarded.If goals are not met, top management will normally interveneto find out why and take appropriate corrective action. Thus,control is achieved by comparing actual performance againsttargets and intervening selectively to take corrective action.Subunits’ goals depend on their role in the firm. Self containedproduct divisions or national subsidiaries are typically givengoals for profitability, sales growth, and markets share. Func-tions are more likely to be given goals related to their particularactivity. Thus, R&D will be given product development goals,production will be given productivity and quality goals,marketing will be given market share goals, and so on.As with budgets, goals are normally established throughnegotiation between subunits and headquarters. Generally;headquarters tries to set goals that are challenging but realistic,so subunit managers are forced to look for ways to improvetheir operations but are not so pressured that they will resort todysfunctional activities to do so (such as short-run profitmaximization). Output controls foster a system of “manage-ment by exception,” in that so long as subunits “meet theirgoals, they are left alone. If a subunit fails to attain its goals,however, headquarters managers are likely to ask some toughQuestions. If they don’t get satisfactory answers, they are likelyto intervene proactively in a subunit, replacing top managementand looking for ways to improve efficiency.

Cultural ControlsCultural controls exist when employees “buy into” the normsand value systems of the firm. When this occurs, employeestend to control their own behavior, which reduces the need fordirect supervision. In a firm with a strong culture, self-controlcan reduces the need for other control systems. We shall discussorganizational culture later. Mc- Donald’s actively promotesorganizational norms and values, referring to its franchisees andsuppliers as partners and emphasizing its long-term commit-ment to them. This commitment is not just a public relationsexercise; it is backed by actions, including a willingness to helpsuppliers and franchisees improve their operations by providingcapital and/or management assistance when needed. Inresponse, McDonald’s Franchisees and suppliers are integratedinto the firm’s culture and thus become com-mitted to helpingMcDonald’s succeed. One result is that McDonald’s can devoteless time than would otherwise be necessary to controlling itsfranchisees and suppliers.

Incentive SystemsIncentives refer to the devices used to reward appropriateemployee behavior. Many employees receive incentives in theform of annual bonus pay. Incentives are usually closely tied tothe performance, metrics used for output controls. Forexample, setting targets linked to profitability might be used tomeasure the performance of a subunit, such as a global productdivision. To create positive incentives for employees to work


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Thard to exceed those targets, they maybe given a share of anyprofits over above those targeted. If a subunit has set a goal ofattaining a 15 percent return on investment and it actuallyattains a 20 percent return, unit employees may be given a sharein the prof-its generated in excess of the 15 percent target in theform of bonus pay.First, the type of incentive used often varies depending on theemployees and their task. Incentivesfor employees working on the factory floor may be verydifferent from the incentives used for senior managers. Theincentives used must be matched to the type of work beingperformed. The employees on the factory floor of a manufac-turing plant may be broken into teams of 20 to 30 individuals,and they may have their bonus pay tied to the ability of theirteam to hit or exceed targets for output and product quality. Incontrast, the senior manager of the plant may be rewardedaccording to metrics linked to the output of the entire opera-tion. The basic principle is to make sure the incentive scheme foran individual employee is linked to an output target that he orshe has some control over and can influence. The individualemployees on the factory floor may not be able to exercise muchinfluence over the performance of the entire operation-, butthey can influence the performance of their team, so incentivepay is tied to output at this level.Second, the successful execution of strategy in the multinationalfirm often requires significant cooperation between managers indifferent subunits. For example, a noted earlier, some multina-tional firms operate with matrix structures where a countrysubsidiary might be responsible for marketing and sales in anation, while a global product division might be responsible formanufacturing and product development. The managers ofthese different units need to cooperate closely with each other ifthe firm is to be successful. One way of encouraging themanagers to cooperate is to link incentives to performance at ahigher level in the organization. Thus, the senior managers ofthe country subsidiaries and global product divisions might be -rewarded according to the profitability of the entire firm. Thethinking here is that boosting the profitability of the entire firmrequires managers in the country subsidiaries and productdivisions to cooperate with each other on strategy implementa-tion and linking incentive systems to the next level up in thehierarchy encourages this. Most firms use a formula forincentives that links a portion of incentive pay to the perfor-mance of the subunit in which a manager or employee worksand a portion -to the performance of the entire firm, or someother higher-level organizational unit. The goal is to encourageemployees to improve the efficiency of their unit and tocooperate with other units in the organization. .Third, the incentive systems used within a multinationalenterprise often have to be adjusted to account for nationaldifferences in institutions and culture. Incentive systems thatwork in the United States might not work, or even be allowed,in other countries. For example, Lincoln Electric, a leader in themanufacture of arc welding -equipment, has used an incentivesystem for its employees based on piecework rates in itsAmerican factories (under a piecework system, employees arepaid according to the amount they produce). While this system

has worked very well in the United States, Lincoln has foundthat the system is difficult to introduce in other countries. Insome countries, such as Germany, piecework systems are illegal,while in others the prevailing national culture is antagonistic to asystem where performance is so closely tied to individual effort.For further details, see the accompanying Management Focus.Finally, it is important for managers to recognize that incentivesystems can have unintended consequences, Managers need tocarefully think through exactly what be-havior certain incentivesencourage. For example, if employees in a factory are rewardedsolely on the basis of how many units of output they produce,with no attention paid to the quality of that output, they mayproduce as possible to boost their incentive pay, but the qualityof those units may be poor.

Control Systems, Incentives, and StrategyThe key to understanding the relationship between interna-tional strategy, control systems, and incentive systems is theconcept of performance ambiguity.

Performance AmbiguityPerformance ambiguity exists when the causes of a subunit’spoor performance are not clear. This is not uncommon when asubunit’s performance is partly dependent on the performanceof other subunits; that is; when there is a high degree ofinterdependence between subunits within the organization.Consider the case of a French subsidiary of a U.S. firm thatdepends on another subsidiary, a manufacturer based in Italy,for the products it sells. The French subsidiary is failing toachieve its sales goals, and the U.S. management asks themanagers to explain. They reply that they are receiving poor -quality goods from the Italian subsidiary. So the U.S.management asks the managers of the Italian operation whatthe problem is. They reply that their product quality is excellent-the best in the industry, in fact-and that the French simply don’tknow how to sell a good product. Who is right, the French orthe Italians? Without more in -formation, top managementcannot tell. Because they are dependent on the Italians for theirproduct, the French have an “alibi” for poor performance. U.S.management needs to have more information to determinewho is correct. Collecting this information is expensive and timeconsuming and will divert attention away from other issues. Inother words, performance ambiguity raises the costs of control.Consider how different things would be if the French opera-tion were self-contained, with its own manufacturing,marketing, and R&D facilities. The French operation would lacka convenient alibi for its poor performance; the French manag-ers would stand or fall on their own merits. They could notblame the Italians for their poor sales. The level of performanceambiguity, therefore, is a function of the interdependence ofsubunits in an organization

Case Study

Organizational Culture and Incentive Systems at LincolnElectricLincoln Electric is one of the leading compa-nies in the globalmarket for arc welding equipment. Lincoln’s success has beenbased on extremely high levels of employee productivity. Thecompany attributes its pro-ductivity to a strong organizational


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culture and an incentive scheme based on piece-work. Lincoln’sorganizational culture dates back to James Lincoln, who in 1907joined the company that his brother had established a few yearsearlier. Lincoln had a strong re-spect for the ability of theindividual and believed that, correctly motivated, ordinarypeople could achieve extraordinary performance. He emphasizedthat Lincoln should be a meritocracy where people wererewarded for their individual effort. Strongly egalitarian, Lincolnremoved barriers to communication between “workers” and“managers,” practicing an open-door policy. He made sure thatall who worked for the company were treated equally; forexample, everyone ate in the same cafeteria, there were noreserved parking places for “managers,” and so on. Lincoln alsobelieved that any gains in productivity should be shared withconsumers in the form of lower prices, with employees in theform of higher pay, and with shareholders in the form ofhigher dividends.The organizational culture that grew out of James Lincoln’sbeliefs was reinforced by the company’s incentive system.Production workers receive no base salary but are paid accordingto the number of pieces they produce. The piecework rates atthe company enable an employee working at a normal pace toearn an income equivalent to the average wage for manufactur-ing workers in the area where a factory is based. Workers haveresponsibility for the quality of their output and must repairany defects spotted by quality inspectors before the pieces areincluded in the piecework- calculation. Since 1934, productionworkers have been awarded a semiannual bonus based on meritratings. These ratings are based on objective criteria (such as anemployee’s level and quality of output) and subjective criteria(such as an employee’s attitudes toward cooperation and his orher dependability). These systems give Lincoln’s employees anincentive to work hard and to generate innovations that boostproductivity, for doing so influences their level of pay. Lincoln’sfactory workers have been able to earn a base pay that oftenexceeds the average manufacturing wage in the area by morethan 50 per-cent and receive pay bonus on top of this that ingood years could double their base pay. De-spite high employeecompensation, the workers are so productive that Lincoln has alower cost structure than its competitors.While this organizational culture and set of incentives workswell in the United States, where it is compatible with the indi-vidualistic culture of the country, it did not translate easily intoforeign operations. In the 1980s and early 1990s, Lincolnexpanded aggressively into Europe and Latin America, acquiringa number of local arc welding manufacturers. Lincoln left localmanagers in place, believing that they knew local con-ditionsbetter than Americans. However, the local managers had littleworking knowledge of Lincoln’s strong organizational cultureand were unable or un-willing to impose that culture on theirunits, which had their own long-established organizationalcultures. Nevertheless, Lincoln told local managers to introduceits incentive systems in acquired companies. They fre-quently raninto legal and cultural roadblocks. In many countries, pieceworkis viewed as an exploitive com-pensation system that forcesemployees to work ever harder. In Germany, where Lincolnmade an acquisi-tion, it is actually illegal. In Brazil, a bonus paidfor more than two years becomes a legal entitlement! In many,

other countries, both managers and workers were op-posed tothe idea of piecework. Lincoln found that many Europeanworkers valued extra leisure more highly than extra income andwere not prepared to work as hard as their American counter-parts. Many of the acquired companies were also unionized,and the local unions vigorously opposed the introduction ofpiecework. As a result, Lincoln was not able to repli-cate thehigh level of employee productivity that it had achieved in theUnited States, and its expansion pulled down the performanceof the entire company.Sources: J. O’Connell, “Lincoln Electric: Venturing Abroad.”Har-vard Business School Case, # 9-398-095. April 1998, andwww.lincolnelectric.com.

Strategy, Interdependence, and AmbiguityNow let us consider the relationship among internationalstrategy, interdependence, and performance ambiguity. Inmultidomestic firms, each national operation is a stand-aloneentity and can be judged on its own merits. The level ofperformance ambiguity is low. In an international firm, the levelof interdependence is somewhat higher. Integration is requiredto facilitate the transfer of core competencies and skills. -Sincethe success of a foreign operation is partly dependent on thequality of the competency transferred from the home country,performance ambiguity can exist.In global firms, the situation is still more complex. Recall thatin a pure global firm the pursuit of location and experiencecurve economies leads to the development of a -global web ofvalue creation activities. Many of the activities in a global firmare interdependent. A French subsidiary’s ability to sell aproduct does depend on how well other operations in othercountries perform their value creation activities. Thus, the levelsof interdependence and performance ambiguity are high inglobal companies.The level of performance ambiguity is highest of all intransnational firms. Transnational firms suffer from the sameperformance ambiguity problems that global firms do. Inaddition, since they emphasize the multidirectional transfer ofcore competences, they also suffer from the problems character-istic of firms pursuing an international strategy. The extremelyhigh level of integration within transnational firms implies a -high degree of joint decision making, and the resultinginterdependencies create plenty of alibis for poor performance.There is lots of room for finger-pointing in transnational firms.

Implications for Control and IncentivesThe arguments of the previous section, along with theimplications for the costs of control, are summarized in Table3.1. The costs of control can be defined as the amount of timetop management must devote to monitoring and evaluatingsubunits performance. This is greater when the amount ofperformance ambiguity is greater. When performance ambiguityis low, management can use output controls and a system ofmanagement by exception; when it is high, managers have nosuch luxury. Output controls do not provide totally unambigu-ous signals of a subunit’s efficiency when the performance ofthat subunit is dependent on the performance of another -subunit within the organization. Thus, management must


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Tdevote time to resolving the problems that arise from perfor-mance ambiguity, with a corresponding rise in the costs ofcontrol.Table 3.1 reveals a paradox. We see that due to the high level ofinterdependence, the costs of controlling transnational firms arehigher than the costs of controlling firms that pursue otherstrategies. Unless there is some way of reducing these costs, thehigher profitability associated with a transnationalTable 3.1Interdependence, Performance Ambiguity, and the Costsof control for the Four International Business Strategies

Performance

Strategy Interdependence Ambiguity Costs of Control

Multidomestic Low Low Low

International Moderate Moderate Moderate

Global High High High

Transnational Very high Very high Very high

Strategy could be canceled out by the higher costs of control.The same point, although to a lesser extent, can be made withregard to global firms. Although firms pursuing a globalstrategy can reap the cost benefits of location and experiencecurve economies, they must cope with a higher level ofperformance ambiguity, and this raises the costs of control (incomparison with firms pursuing an international ormultidomestic strategy).This is where control systems and incentives come in. When wesurvey the systems that corporations use to control theirsubunits, we find that irrespective of their strategy, multina-tional firms all use output and bureaucratic controls. However,in firms pursuing either global or transnational strategies, theusefulness of output controls is limited by substantial perfor-mance ambiguities. As a result, these firms place greateremphasis on cultural controls. Cultural control-by encouragingmanagers to want to assume the organization’s norms andvalue systems-gives managers of interdependent subunits anincentive to look for ways to work out problems that arisebetween them. The result is a reduction in finger-pointing and,accordingly, in the costs of control. The development ofcultural controls may be a precondition for the successfulpursuit of a transnational strategy and perhaps of a globalstrategy as well. As for incentives, the material discussed earliersuggests that the conflict between different subunits can bereduced and the potential for cooperation enhanced, if incentivesystems are tied in some way to a higher level in the hierarchy.When performance ambiguity makes it difficult to judge theperformance of subunits as stand-alone entities, linking theincentive pay of senior managers to the entity to which bothsubunits belong can reduce the resulting problems.

ProcessesWe defined processes as the manner in which decisions aremade and work is performed with in the organization. Pro-cesses can be found at many different levels within anorganization. There are processes for formulating strategy,

processes for allocating resources, processes for evaluating newproduct ideas, processes for handling customer inquiries andcomplaints, processes for improving product quality, processesfor evaluating employee performance, and so on. Often, thecore competencies or valuable skills of a firm are embedded inits processes. Efficient and effective processes can lower the costsof value creation and add additional value to a product. Forexample, the global success of many Japanese manufacturingenterprises in the 1980s was based in part on their earlyadoption of processes for improving product quality andoperating efficiency, including total quality management andjust-in-time inventory systems. Today, the competitive successof General Electric can in part be attributed to a number ofprocesses that have been widely promoted within the company.These include the company’s six-sigma process for qualityimprovement, its process for “digitalization” of business(using corporate intranets and the Internet to automateactivities and reduce operating costs), and its process for newidea generation, referred to within the company as “workouts,”where managers and employees get together for intensivesessions, over several days to identify and commit to ideas forimproving productivity.An organization’s processes can be summarized by means of aflow chart, which illustrates the various steps and decisionpoints involved in performing work. Many processes cut acrossfunctions, or divisions, and require cooperation betweenindividuals in different subunits. For example, productdevelopment processes require em-ployees from R&D, manu-facturing, and marketing to work together in a cooperativemanner to make sure new products are developed with marketneeds in mind and de-signed in such a way that they can hemanufactured at a low cost. Because they cut across organiza-tional boundaries, performing processes effectively oftenrequires the establishment of formal integrating mechanismsand incentives for cross-unit cooperation.However, it is important to make two basic remarks aboutmanaging processes, particularly in the context of an interna-tional business. The first is that in a multinational enterprise,many processes cut not only across organizational boundaries,embracing several different subunits, but also across nationalboundaries. Designing a new product may require the coopera-tion of R&D personnel located in California, production peoplelocated in Taiwan, and marketing located in Europe, America,and Asia. The chances of pulling this off are greatly enhanced ifthe processes are embedded in an organizational cul-ture thatpromotes cooperation between individuals from differentsubunits and nations, if the incentive systems of the organiza-tion explicitly reward such cooperation, and if formal andinformal integrating mechanisms are used to facilitate coordina-tion between subunits.Second, it is particularly important for a multinational enterpriseto recognize that valuable new processes that might lead to acompetitive advantage can be developed anywhere within theorganization’s global network of operations. New processesmay be developed by a local operating subsidiary in response toconditions pertaining to its market. Those processes might thenhave value to other parts of the multinational en-terprise. For


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example, in response to competition in Japan and a localobsession with product quality, Japanese firms were at theleading edge of developing processes for total quality manage-ment (TQM) in the 1970s. Because few American firms hadJapanese subsidiaries at the time, they were relatively ignorantof the trend until the 1980s when high-quality Japaneseproducts began to make big inroads into the United States. Anexception to this generalization was Hewlett- Packard, whichhad a very successful operating company in Japan, YokogwaHewlett-Packard (YHP). YHP was a pioneer of the total qualitymanagement process in Japan and won the prestigious DemingPrize for its achievements in improving product quality.Through YHP, Hewlett-Packard learned about the qualitymovement ahead of many of its U.S. peers and was one of thefirst Western companies to introduce TQM processes into itsworldwide operations. Not only did Hewlett-Packard’s Japaneseoperation give the company access to a valuable process, but thecompany also transferred this knowledge within its globalnetwork of operations, raising the performance of the entirecompany. The ability to create valuable processes matters, but itis also important to leverage I those processes. This requiresboth formal and informal integrating mechanisms such asmanagement networks.

Organizational CultureCulture, however, is a social construct ascribed to societies,including organizations. Thus, we can speak of orga-nizationalculture and organizational subculture. The basic definition ofculture re-mains the same, whether we are applying it to a largesociety such as a nation-state or a small society such as anorganization or one of its subunits. Culture refers to a systemof values and norms that are shared among people. Values areabstract ideas about what a group believes to be good, right,and desirable. Norms mean the social rules and guidelines thatprescribe appropriate behavior in particular situations. Valuesand norms express themselves as the behavior patterns or styleof an organization that new employees are automaticallyencouraged to follow by their fellow employees. Al-though anorganization’s culture is rarely static, it tends to change relativelyslowly.

How Is Organizational Culture Created andMaintained?An organization’s culture comes from several sources. First,there seems to be wide agreement that founders or importantleaders can have a profound impact on an or-ganization’sculture, often imprinting their own values on the culture. Thiswas certainly the case with Lincoln Electric where the values ofJames Lincoln became the f: values of Lincoln Electric (see theManagement Focus). Another famous example a strongfounder effect concerns the founder of die Japanese firmMatsushita, Konosuke Matsushita, whose almost Zen-likepersonal business philosophy was codified -in the “SevenSpiritual Values” of Matsushita that all new employees stilllearn v. These values are (1) national service through industry,(2) fairness, (3) harmony and cooperation, (4) struggle forbetterment, (5) courtesy and humility, (6) adjustment andassimilation, and (7) gratitude. A leader does not have to be thefounder to have a profound influence on organizational culture.

Jack Welsh is widely credited with having changed the culture ofGE, primarily by emphasizing when he first became CEO acounterculture set of values, such as risk taking, entrepreneur-ship, steward-ship and boundaryless behavior. It is moredifficult for a leader, however forceful, to change an establishedorganizational culture than it is to create one from scratch in anew venture.Another important influence on organizational culture is thebroader social culture of the nation where the firm wasfounded. In the United States, for example, the com-petitiveethic of individualism looms large and there is enormous socialstress on pro-ducing winners. Many American firms find waysof rewarding and motivating individuals so that they seethemselves as winners. The values of American firms of-tenreflect the values of American culture. Similarly, the cooperativevalues found in many Japanese firms have been argued to reflectthe values of traditional Japanese society-, with its emphasis ongroup cooperation, reciprocal obligations, and harmony. Thusalthough it may be a generalization, there may be something tothe argument that organizational culture is influenced bynational culture.A third influence on organizational culture is the history of theenterprise, which over time may come to shape the values ofthe organization. In the language of historians, organizationalculture is the path-dependent product of where the organiza-tion has been through time. For example, Philips NV, theDutch multinational, long operated with a culture that placed ahigh value on the independence of national operating compa-nies. This culture was shaped by the history of the company.During World War II, Holland was occupied by the Germans.With the head office in occupied territories, power was devolvedby default to various foreign operating companies, such asPhilips subsidiaries in the United States and Great Britain. Afterthe war ended, these subsidiaries continued to operate in ahighly autonomous fashion. A belief that this was the rightthing to do became a core value of the company.Decisions that subsequently result in high performance tend tobecome institutionalized in the values of a firm. In the 1920s,3M was primarily a manufacturer of sandpaper. Richard Drew,who was a young laboratory assistant at the time, came up withwhat he thought would be a great new product; a glue-covered,strip of paper, which he called “sticky tape.” Drew saw applica-tions for the product in the automobile industry; where it couldbe used to mask parts of a vehicle during painting. He pre-sented the idea to the company’s president, William McKnight.An unimpressed McKnight suggested that Drew drop theresearch. Drew didn’t; instead he developed the “sticky tape”and then went out and got endorsements from potentialcustomers in the auto industry. Armed with this information,he approached McKnight again. A chastened McKnight reversedhis position and gave Drew the go-ahead to start developingwhat was to become one of 3M’s main product lines-stickytape-a business it dominates to this day. From then on,McKnight emphasized the importance of giving researchers at3M free rein to explore their own ideas and experiment withproduct offerings. This soon became a core value at 3M and wasenshrined in the company’s famous”15 percent rule,” which


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Tstated that researchers could spend 15 percent of the companytime working on ideas of their own choosing. Today, newemployees are often told the Drew story, which is used toillustrate the value of allowing individuals to explore their ownideas.Culture is maintained by a variety of mechanisms. Theseinclude: (1) hiring and promotional practices of the organiza-tion, (2) reward strategies, (3) socialization processes, and (4)communication strategy. The goal is to recruit people whosevalues are consistent with those of the company. LincolnElectric, for example, hires individuals who are very self-reliant,which is necessary in the company’s individualistic culture. Tofurther reinforce values, a company may promote individualswhose be-havior is consistent with the core values of theorganization. Merit review processes may also be linked to acompany’s values, which further reinforces cultural norms.Thus, at Lincoln Electric, the merit review process rewardspeople for behavior that is consistent with the attainment ofhigh productivity.Socialization can be formal, such as training programs foremployees that educate them in the core values of the organiza-tion. Informal socialization may be friendly ad-vice from peersor bosses or may be implicit in the actions of peers andsuperiors to-ward new employees. As for communicationstrategy, many companies with strong cultures devote a lot ofattention to framing their key values in corporate mission state-ments, communicating them often to employees, and usingthem to guide difficult de-cisions. Stories and symbols are oftenused to reinforce important values (e.g., the Drew andMcKnight story at 3M).

Organizational Culture and Performance in theInternational BusinessManagement authors often talk about “strong cultures. In astrong culture, almost all managers share a relatively consistentset of values and norms that have a clear im-pact on the waywork is performed. New employees adopt these values veryquickly, and employees that do not fit in with the core valuestend to leave. In such a culture, a new executive is just as likelyto be corrected by his subordinates as by his superiors if heviolates the values and norms of the organizational culture.Firm’s with a strong Culture are normally seen by outsiders ashaving a certain style or way of doing things. Lincoln Electric,profiled in the Management Focus, is an example of a firm witha strong culture. Lincoln’s organizational culture places a highvalue on individual achievements, meritocracy, and egalitarianbehavior. Unilever, profiled in the opening case, is anotherexample of a firm with a strong culture. Unilever places a highvalue on sociability, cooperation, and consensus-buildingbehavior among its employees.Strong does not necessarily mean good. A culture can be strongbut bad. The culture of the Nazi Party in Germany was certainlystrong, but it was most definitely not good. Nor does it followthat a strong culture leads to high performance. One studyfound that General Motors had a “strong culture,” but it was astrong culture that discour-aged lower-level employees fromdemonstrating initiative and taking risks, which the authorsargued was dysfunctional and led to low performance at OM.

Also, a strong culture might be beneficial at one point, leadingto high performance, but inappropri-ate at another time. Theappropriateness of the culture depends on the context. In the1970s and early 1980s, when IBM was performing very well,several management au-thors sang the praises of its strongculture, which among other things placed a high value onconsensus-based decision making. 3O These authors argued thatsuch a decision-making process was appropriate given thesubstantial financial investments that IBM routinely made innew technology. However, this process turned out to be aweakness in the fast-moving computer industry of the late1980s and 1990s.Consensus-based decision making was slow,bureaucratic, and not particularly conducive to cor-porate risktaking. While this was fine in the 1970s, IBM needed rapiddecision making and entrepreneurial risk taking in the 1990s,but its culture discouraged such behavior. IBM found itselfoutflanked by then-small enterprises such as Microsoft andCompaq Computer.One academic study concluded that firms that exhibited highperformance over a prolonged period tended to have strong but“adaptive cultures.” According to this study, in an adaptiveculture most managers care deeply about and value customers,stockholders, and employees. They also strongly value peopleand processes that cre-ate useful change in a firm. While this isinteresting, it does reduce the issue to a very high level ofabstraction; after all, what company would say that it doesn’tcare deeply about customers, stockholders, and employees? Asomewhat different perspective is to argue that the culture ofthe firm must match the rest of the architecture of the organi-zation, the firm’s strategy, and the demands of the competitiveenvironment, for superior performance to be attained. All theseelements must be consistent with each other. Lincoln Electricprovides another useful example. Lincoln competes in abusiness that is very competitive, where cost minimization is akey source of competitive advantage. Lincoln’s culture andincentive systems both encourage employees to strive for highlevels of productivity, which translates into the low costs thatare critical for Lincoln’s success.The Lincoln example also demonstrates another importantpoint for international businesses: A culture that leads to highperformance in the firm’s home nation may not be easy toimpose on foreign subsidiaries! Lincoln’s culture has clearlyhelped the firm to achieve superior performance in the U.S.market, but this same culture is very “American” in its form anddifficult to implement in other countries. The managers andemployees of several of Lincoln’s European subsidiaries foundthe culture to be alien to their own values and were reluctant toadopt it. The result was that Lincoln found it very difficult toreplicate in foreign markets the success it has had in the UnitedStates. Lincoln compounded die problem by acquiring estab-lished enterprises that already had their own organizationalculture. Thus, in trying to impose its culture on foreignoperating subsidiaries, Lincoln had to deal with two problems:howl to change the established organizational culture of thoseunits, and how to introduce an organizational culture whosekey values might be alien to the values held by members of thatsociety. These problems are not unique to Lincoln; many


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international businesses have to deal with exactly the sameproblems.The solution Lincoln has adopted is to establish new subsidiar-ies, lather than acquiring and trying to transform an enterprisewith its own culture. It is much easier to establish a set ofvalues in a new enterprise than it is to change the values of anestab-lished enterprise. A second solution is to devote a lot oftime and attention to transmitting the firm’s organizationalculture to its foreign operations. This was something Lincolnoriginally omitted. Other firms make this an important part oftheir strategy for internationalization. When MTV Networksopens an operation in a new country, it initially staffs thatoperation with several expatriates. The job of these expatriate’sis to hire local employees whose values are consistent with theMTV culture and to socialize those individuals into values aridnorms that underpin MTV’s unique way of doing things. Oncethis has been achieved, the expatriates move on to their nextassignment, and local employees run the operation. A thirdsolution is to recognize that it may be necessary to change someaspects of a firm’s culture so that it better fits the culture of thehost nation. For example, many Japanese firms use symbolicbehav-ior, such as company songs and morning group exercisesessions, to reinforce coopera-tive values and norms. However,such symbolic behavior does not go down well in westerncultures, where it is seen as odd, so many Japanese firms havenot used such practices in Western subsidiaries.The need for a common organizational culture that is the sameacross a multinational’s global network of subsidiaries probablyvaries with the strategy of the firm. Shared norms and valuescan facilitate coordination and cooperation between indi-vidualsfrom different subunits. A strong common culture may lead togoal congru-ence and can attenuate the problems that arise frominterdependence, performance ambiguities, and conflict amongmanagers from different subsidiaries. As noted ear-lier, a sharedculture may help informal integrating mechanisms such asmanagement networks to operate more effectively. As such, acommon culture may be of greater value in a multinational thatis pursuing a strategy that requires cooperation and coordina-tion between globally dispersed subsidiaries. This suggests thatit is more im-portant to have a common culture in firmsemploying a transnational strategy than a multidomesticstrategy, with global and international strategies falling betweenthese two extremes.

Synthesis: Strategy and ArchitectureSo far in this chapter we have looked at several: aspects oforganization architecture, and we have discussed the interrela-tionships be-tween these dimensions and strategies. Now it istime to synthesize this material (see Table 3.2).

Multidomestic FirmsFirms pursuing a multidomestic strategy focus on localresponsiveness. Table 3.2 shows that multidomestic firms tendto operate with worldwide area structures within whichoperating decisions are decentralized to functionally self-contained country subsidiaries. The need for coordinationbetween subunits (areas and coun-try subsidiaries) is low. Thissuggests that multidomestic firms do not have a high need forintegrating mechanisms, either formal or informal, to knit

together differ-ent national operations. The lack of interdepen-dence implies that the level of per-formance ambiguity inmultidomestic concerns is low, as (by extension) are the costs ofcontrol. Thus, headquarters can manage foreign operations byrelying primarily on output and bureaucratic controls and apolicy of management by exception. In-centives can be linked toperformance metrics at the level of country subsidiaries. Sincethe need for integration and coordination is low, the need forcommon processes and organization culture is also quite low.Were it not for the fact that these firms are unable to profitfrom the realization of location and experience curve econo-mies, or from the transfer of core competencies, theirorganizational simplicity would make this an attractive strategy.

Table 3.2A Synthesis of Strategy, Structure, and Control Systems

International FirmsFirms pursuing an international strategy attempt to create valueby transferring core competencies from home to foreignsubsidiaries. If they are diverse, as most of them are these firmsoperate with a worldwide product division structure. Headquar-ters typically maintains centralized control over the source of thefirm’s core competency, which is most typically found in theR&D and/or marketing functions of the firm. All otheroperating decisions are decentralized within the firm tosubsidiary operations in each country (which in diverse firmsreport to worldwide product divisions).The need for coordination is moderate in such firms, reflectingthe need to trans-fer core competencies. Thus, although suchfirms operate with some integrating mechanisms, they are notthat extensive. The relatively low level of interdependence thatresults translates into a relatively low level of performanceambiguity. These firms can generally get by with output andbureaucratic controls and with incentives that are focused onperformance metrics at the level of country subsidiaries. Theneed for a common organizational culture and commonprocesses is not that great. An important exception to this iswhen the core skills or competencies of the firm are em-beddedin processes and culture, in which case the firm needs to payclose attention to transferring those processes and associatedculture from the corporate center to country subsidiaries.Overall, although the organization of international firms ismore complex than that of multidomestic firms, the increase inthe level of complexity is not that great.

Strategy

Structure and Control

Multidomestic

International Global Transnational

Vertical differentiation

Decentralized

Core Competency Centralize; rest decentral ize

Some Centralized

Mixed centralized and decentralized

Horizontal differentiation

Worldwide area Structure

Worldwide Product division

Worldwide product division

Informal matrix

Need for coordination

Low Moderate High Very high

Integrating mechanisms

None Few Many Very many

Performance ambiguity


Need for cultural controls



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TGlobal FirmsFirms pursuing a global strategy focus on the realization oflocation and-experience curve economies. If they are diverse, asmost of them are, these firms operate with a worldwideproduct division structure. To coordinate the firm’s globallydispersed web of value creation activities, headquarters typicallymaintains ultimate control over most operating decisions. Ingeneral, global firms are more centralized than enterprisespursuing a multidomestic or international strategy. Reflectingthe need for coordina-tion of the various Stages of the firms’globally dispersed value chains, the need for integration in thesefirms also is high. Thus, these firms tend to operate with anarray of formal and, informal integrating mechanisms. Theresulting interdependencies can lead to significant performanceambiguities. As a result, in addition to output and bu-reaucraticcontrols, global firms tend to stress the need to build a strongorganizational culture that can facilitate coordination andcooperation. They also tend to use incentive systems that arelinked to performance metrics at the corporate level, giving themanagers of different operations a strong incentive to cooperatewith each other to in-crease the performance of the entirecorporation. On average, the organization of global firms ismore complex than that of multidomestic and internationalfirms.

Transnational FirmsFirms pursuing a transnational strategy focus on the simulta-neous attainment of loca-tion and experience curve economies,local responsiveness, and global learning (the multidirectionaltransfer of core competencies or skills). These firms may operatewith matrix-type structures in which both product divisionsand geographic areas have sig-nificant influence. The need tocoordinate a globally dispersed value chain and to transfer corecompetencies creates pressures for centralizing some operatingdecisions (particularly production and R&D). At the same time,the need to be locally respon-sive creates pressures for decentral-izing other operating decisions to national operations(particularly marketing). Consequently, these firms tend to mixrelatively high degrees of centralization for some operatingdecisions with relative high degrees of de-centralization forother operating decisions.The need for coordination is particularly high in transnationalfirms. This is re-flected in the use of an array of formal andinformal integrating mechanisms, includ-ing formal matrixstructures and informal management networks. The high levelof interdependence of subunits implied by such integration canresult in significant per-formance ambiguities, which raise thecosts of control. To reduce these, in addition to output andbureaucratic controls, transnational firms need to cultivate astrong culture and to establish incentives that promotecooperation between subunits.

Environment, Strategy, Architecture, andPerformanceUnderlying the scheme outlined in Table 3.2 is the notion that a“fit” between strat-egy and architecture is necessary for a firm toachieve high performance. For a firm to succeed, two conditionsmust be fulfilled. First, the firm’s strategy must be consistentwith the environment in which the firm operates and noted

that in some industries a global strategy is most viable, inothers an in-ternational or transnational strategy may be mostviable, and in still others a multido-mestic strategy may be mostviable (although the number of multidomestic industries is onthe decline). Second, the firm’s organization architecture mustbe consistent with its strategy.If the strategy does not fit the environment, the firm is likely toexperience signif-icant performance problems. If the architecturedoes not fit the strategy, the firm is also likely to experienceperformance problems. Therefore, to survive, a firm must striveto achieve a fit of its environment, its strategy, and its organiza-tional architecture. You will recall that we saw the importance ofthis concept in the opening case. Philips NV, the Dutchelectronics firm, provides another illustration of the need forthis fit. For reasons rooted in the history of the firm, Philipsoperated until recently with an orga-nization typical of amultidomestic enterprise in which operating decisions were de-centralized to largely autonomous foreign subsidiaries.Historically, electronics markets were segmented from each otherby high trade barriers, so an organization consistent with amultidomestic strategy made sense. However, by the mid-1980s, the industry in which Philips competed had beenrevolutionized by declining trade barri-ers, technological change,and the emergence of low-cost Japanese competitors thatutilized a global strategy. To survive, Philips needed to adopt aglobal strategy itself. The firm recognized this and tried toadopt a global posture, but it did little to change its organiza-tional architecture. The firm nominally adopted a matrixstructure based on worldwide product divisions and national-areas. In reality, however, the nationalAreas continued to dominate the organization, and the productdivisions had little more than an advisory role. As a result,Philips’ architecture did not fit the strategy, and by the early1990s Philips was losing money. It was only after four years ofwrench-ing change and large losses that Philips was finally ableto tilt the balance of power in its matrix toward the productdivisions. By 1995, the fruits of this effort to realign thecompany’s strategy and architecture with the demands of itsoperating environment were beginning to show up in im-proved financial performance.

Organizational ChangeMultinational firms periodically have to alter their architecture sothat it conforms to the changes in the environment in whichthey are competing and the strategy they are pursuing. To beprofitable, Philips NV had to alter its strategy and architecture inthe 1990s so that both matched the demands of the competi-tive environment in the elec-tronics industry, which had shiftedfrom a multidomestic to a global industry

Organizational InertiaOrganizations are difficult to change. Within most organiza-tions, there are strong inertia forces. These forces come from anumber of sources. One source of inertia is the existingdistribution of power and influence within an organization.The power and influence enjoyed by individual managers is inpart a function of their role in the organizational hierarchy, asdefined by structural position. By definition, most substantivechanges in an organization require a change in structure and, by


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extension; a change in the distribution of power and influencewithin the organization. Some individuals will see their powerand influence increase as a result of or-ganizational change, andsome will see the converse. For example, in the 1990s, PhilipsNV increased the roles and responsibilities of its global productdivisions and decreased the roles and responsibilities of itsforeign subsidiary companies. This meant the managersrunning the global product divisions saw their power and in-fluence increase, while the managers running the foreignsubsidiary companies saw their power and influence decline. Asmight be expected, some managers of foreign subsidiarycompanies did not like this change and resisted it, which slowedthe pace of change. Those whose power and influence arereduced as a consequence of orga-nizational change can beexpected to resist it, primarily by arguing that the change mightnot work. To the extent that they are successful, this constitutesa source of organizational inertia that might slow or stopchange.Another source of organizational inertia is the existing culture,as expressed in norms and value systems. Value systems reflectdeeply held beliefs, and as such, they can be very hard to change.If the formal and informal socialization mechanisms within anor-ganization have been emphasizing a consistent set of valuesfor a prolonged period, and if hiring, promotion, and incentivesystems have all reinforced these values, then sud-denlyannouncing that those values are no longer appropriate andneed to be changed can produce resistance and dissonanceamong employees. For example, Philips NV his-torically placeda very high value on local autonomy. The changes of the 1990simplied a reduction in the autonomy enjoyed by foreignsubsidiaries, which was counter to the established values of thecompany and thus resisted.Organizational inertia might also derive from senior managers’preconceptions about the appropriate business model orparadigm. When a given paradigm has worked well in the past,managers might have trouble accepting that it is no longerappropri-ate. At Philips, granting considerable autonomy toforeign subsidiaries had worked very well in the past, allowinglocal managers to tailor product and business strategy to theconditions prevailing in a given country. Since this paradigm hadworked so well, it was difficult for many managers to under-stand why it no longer applied. Con-sequently, they haddifficulty accepting a new or business model and tended to fallback on their established paradigm and ways of doing things.This made change diffi-cult, for it required managers to let goof long- held assumptions about what worked and what didn’twork, which was something many of them couldn’t do.Institutional constraints might also act as a source of inertia.National regulations including local content rules and policiespertaining to layoffs might make it difficult for a multinationalto alter its global value chain. As with Unilever (see the openingcase), a multinational might wish to take control for manufac-turing away from local subsidiaries, transfer that control toglobal product divisions, and consolidate manu-facturing at afew choice locations. However, if local content rules re-quiresome degree of local production and if regulations regardinglayoffs make it difficult or expensive for a multinational to closeoperations in a country, a multina-tional may find that these

constraints make it very difficult to adopt the most effectivestrategy and architecture.

Implementing Organizational ChangeAlthough all organizations suffer from inertia, the complexityand global spread of many multinationals might make itparticularly difficult for them to change their strat-egy andarchitecture to match new organizational realities. Yet at thesame time, the trend toward globalization in many industrieshas made it more critical than ever that many multinationals dojust that. In industry after industry, declining barriers to cross-border trade and investment have led to a change in the natureof the competitive environment. Cost pressures have increased,requiring multinationals to respond by streamlining theiroperations to realize economic benefits associated with locationand experience curve economies and with the transfer ‘ofcompetencies and skills within the organization. At the sametime, local responsiveness remains an important source ofdifferentiation. To survive in this emerging competitiveenvironment, multina-tionals must not only change theirstrategy, but they must also change their architec-ture so that itmatches strategy in discriminating ways. The basic principles forsuccessful organizational change can be summarized as follows:(1) unfreeze the orga-nization through shock therapy, (2) movethe organization to a new state through proactive change in thearchitecture, and (3) refreeze the organization in its new state.

Unfreezing the OrganizationBecause of inertia forces, incremental change is often no change.Those whose power is threatened by change can too easily resistincremental change. This leads to the big bang theory ofchanger, which maintains that effective change requires takingbold ac-tion early to “unfreeze” the established culture of anorganization and to change the distribution of power andinfluence. Shock therapy to unfreeze the organization mightinclude the closure of plants deemed uneconomic or theannouncement of a dramatic structural reorganization. It is alsoimportant to realize that change will not occur un-less seniormanagers are committed to it. Senior managers must clearlyarticulate the need for change so employees understand bothwhy it is being pursued and the bene-fits that will flow fromsuccessful change. Senior managers must also practice what theypreach and take the necessary bold steps. If employees seesenior managers preaching the need for change but notchanging their own behavior or making sub-stantive changes inthe organization, they will soon lose faith in the change effort,which will flounder as a result.

Moving to the New StateOnce an organization has been unfrozen, it must be moved toits new state. Movement requires taking action—closingoperations; reorganizing the structure; reassigning re-sponsibilities; changing control, incentive, and reward systems;redesigning processes: and letting people go who are seen as animpediment to change. In other words, move-ment requires asubstantial change in the form of a multinational’s organizationar-chitecture so that it matches the desired new strategic posture.For movement to be successful, it must be done with sufficientspeed. Involving employees in the change effort is an excellentway to get them to appreciate and buy into the needs for change


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Tand to help with rapid movement. For example, a firm mightdelegate substantial responsibility for designing operatingprocesses to lower-level employees. If enough of their recom-mendations are then acted on, the employees will see theconsequences of their efforts and consequently buy into thenotion that change really occurring.

Refreezing the OrganizationRefreezing the organization takes longer. It may require that anew culture be estab-lished, while the old one is being dis-mantled. Thus, refreezing requires that employees be socializedinto the new way of doing things. Companies will often usemanagement education programs to achieve this. At GeneralElectric, where longtime CEO Jack Welsh instituted a majorchange in the culture of the company, management educa-tionprograms were used as a proactive tool to communicate newvalues to organization members. On their own, however,management education programs are not enough. Hiringpolicies must be changed to reflect the new realities, with anempha-sis on hiring individuals whose own values are consis-tent with that of the new culture the firm is trying to build.Similarly, control and incentive systems must be consistent withthe new realities of the organization, or change will never take.Senior management must recognize that changing culture takesa long time. Any letup in the pressure to change may allow theold culture to reemerge as employees fall back into familiar waysof doing things. The communication task facing seniormanagers, therefore, is a long-term endeavor that requiresmanagers to be relentless and persistent in their pursuit ofchange. One striking feature of Jack Welsh’s two-decade tenureat GE, for example, is that he never stopped pushing hischange agenda. It was a consistent theme of his tenure. He wasalways thinking up new programs and initiatives to keeppushing the culture of the organization along the desiredtrajectory.

Case Study

Organizational Change at Royal Dutch/ShellThe Anglo-Dutch company Royal Dutch/Shell is the world’slargest nonstate-owend oil company with activities in more than130 countries and 1997 revenues of $128 billion. From the1950s until 1994, Shell operated with a “Matrix structure”invented for it by McKinsey, a management consulting firm thatspecializes in organizational design. Under this matrix struc-ture, the head of each operating company reported to twobosses. One boss was responsible for the geographical region orcountry in which the operating company was based, while theother was responsible for the business activity that the operat-ing company was engaged in (Shell’s business activities includedoil exploration and production, oil products, chemicals, gas, andcoal). Thus, for example, the head of the local shell chemicalcompany in Australia reported both to the head of Shell’s entirechemical division, what was based in London. Both bosses hadequal influence and status with in the organizational.This matrix structure had two very visible consequences at shell.First, because each operating company had two bosses to satisfy,decision-making typically followed a pattern of consensusbuilding, with differences of perspective between country (orregional) heads on the one hand and the heads of business

divisions on the other being worked out through debate.Although this process could be slow and cumbersome, it wasseen as a good thing in the oil industry where most bigdecisions are long-term ones that involve substantial capitalexpenditures and where informed debate between differentviewpoints can clarify the pros and cons of issues, rather thanhinder decision- making process was slow, it was reserved foronly the most important decision (such as major new capitalinvestment). The result was substantial decentralization bydefault to the heads of the individual operating companies,who were largely left alone to run their own operations. Thisdecentralization helped shall respond to local differences ingovernment regulations, competitive conditions, and head ofShell’s Australian chemical company was given the freedom todetermine pricing practices and marketing strategy in theAustralian market. Only if shell wished to undertake a majorcapital investment, such as building a new chemical plant,would the consensus-building decision-making system beinvoked.As desirable as this matrix structure seemed to many, in 1995shell announced a radical plan to dismantle it. The primaryreason given by top management for the shift was continuingslack demand for oil and weak oil price, which had put pressureon shell’s profit margins. Although shell had traditionally beenamong the most profitable oil companies in the world, in theearly 1990’s its relative performance began to slip as other oilcompanies, such as Exxon, adapted more rapidly to a world oflow oil prices by sharply cutting overhead costs and consolidat-ing production in efficient facilities. Consolidating production atthese companies often involved serving the world market froma smaller number of large-scale refining facilities and shuttingdown smaller facilities. In contrast, Shell still operated with alarge head office, which was required to effect coordination withShell’s matrix structure, and substantial duplication of oil andchemical refining facilities across operating companies, each ofwhich typically developed the facilities required to serve its ownmarket.In 1995, Shell’s senior management realized that loweringoperating costs required a sharp reduction in head officeoverhead and, where appropriate, the elimination of unneces-sary duplication of facilities across countries. To achieve thesegoals, top executives decided to reorganize the company alongdivisional lines. Shell now operates with five main globalproduct divisions-exploration and production, oil products,chemical, gas and coal. Each operating company reports towhichever global division is the most relevant. Thus, the headof the Australian chemical operation now reports directly to thehead of the global chemical division. The thinking is that thiswill increase the power of the global chemical division andenable that division to eliminate any unnecessary duplicationmay be consolidated in large facilities that serve an entire region,rather than a single country, thereby enabling shall to reapgreater scale economies.The country (or regional) chiefs remain but their roles andresponsibility is reduced. Now their primary responsibility iscoordination between operating companies within country (orregion) and relation with the local government. There is a solidline of reporting and responsibility between the heads of


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operating companies and the global divisions and a dotted linebetween the head of operating companies and country chiefs.Thus, for example, the ability of the head of shell Australia toshape the major capital investment decision of Shell’s Austra-lian chemical operation was substantially reduced as a result ofthese changes. Furthermore, the simplified reporting systemreduced the need for a large head office bureaucracy, and Shelltrimmed the work force at its London head office by 1,170,driving down Shell’s cost structure.Sources: “shell on the Rocks,” The Economist, June 24, 1995,pp. 57-58; D. Lascelles, “Barons Swept out of Fiefdoms,”Financial Times, March 30, 1995, p. 15; C. Lorenz, “End of aCorporate Era,” Financial Times, March 30, 1995, p. 15; R.Corzine, “Shell Discovers Time and Tide Wait for No Man,“Financial Times, March 10, 1998, p. 17; and R. Corzine, “Oilingthe Group’s Wheels of Change,” Financial Times, April 1, 1998,p. 12.

Case discussion questions

1. What are the benefits of the matrix structure at Shell? Whatwere the drawbacks? Did the matrix structure fit theenvironment of the global oil and chemical industries in the1980’s?

2. What shift occurred in Shell’s operating environment in the1990’s? How did this shift affect the financial performanceof the firm? What does suggest about the fit betweenstrategy and architecture?

3. What kind of structure did Shell adopt in 1995? In whatways did the architecture of Shell’s organization after 1995differ from that before 1995?

4. Comment on the fit between operating environment,strategy, and organizational architecture at Shell after the 1995reorganization. Did the change lead to enhanced fit?

The Organization of International Business

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