Strategy - Chapter 11: Organizational Design: Structure, Culture, and Control How to Organize for Competitive Advantage?

Organizational design is the process of creating, implementing, monitoring and modifying the structure, processes, and procedures of an organization. The key components of organizational design are structure, culture and control. The goal is to design an organization that allows managers to effectively translate their chosen strategy into a realized one. Since strategy implementation transforms theory into strategic action and business models, it often requires changes within the organization. However, strategy implementation often fails because managers are unable to make the necessary changes due to its effects on resource allocation and power distribution within an organization.

Organizational Inertia and the Failure of Established Firms In reality, a firm's strategy often follows its structure. This reversal implies that some managers consider only strategies that do not change existing organizational structures, they do not want to confront the inertia that exists in established organizations. Successful firms often plant the seed of subsequent failure when they optimize their organizational structure to the current situation. Firm also often defines and measures success by financial metrics, with a focus on short term performance. In addition, the firm also puts in place metrics and systems to accommodate and manage increasing firm size due to continued success. Organizational strategy and structure are not static, but dynamic.

The Key Elements of Organizational Structure Organizational structure determines how the work efforts of individuals and teams are orchestrated and how resources are distributed. The structure determines how the work efforts of individuals and teams are orchestrated and how resources are distributed.

An organizational structure defines how jobs and tasks are divided and integrated, delineates the reporting relationships within the hierarchy, defines formal communication channels and prescribes how individuals and teams coordinate their work efforts. The key building blocks of an organizational structure are specialization, formalization, centralization and hierarchy. Specialization describes the degree to which a task is divided into separate jobs - that is, the division of labour. Larger firms have high degree of specialization while smaller ventures tend to have a low degree of specialization. Specialization requires a trade-off between breadth versus depth of knowledge. While a high degree of division of labour increases productivity, it can have unintended side-effects such as reduced employee job satisfaction due to repetition of tasks. Formalization captures the extent to which employee behaviour is controlled by explicit and codified rules and procedures. Formalized structures are characterized by detailed written rules and policies of what to do in specific situations. These are often codified in employee handbooks. Formalization should not necessarily be considered bad; often it is necessary to achieve consistent and predictable results. Yet a high degree of formalization can slow decision making, reduce creativity and innovation and hinder customer service. Centralization refers to the degree to which decision making is concentrated at the top of the organization. Centralized decision making often correlates with slow response time and reduced customer satisfaction. In decentralized organizations, decisions are made and problems solved by empowered lower level employees who are closer to sources of the issues. Whether centralization or decentralization is more effective depends on the specific situation. Hierarchy determines the formal, position-based reporting lines and thus stipulates who reports to whom. The number of levels of hierarchy determines the managers' span of control - how many employees directly report to a manager.

Assembling the Pieces: Mechanistic vs Organic Organizations Organic organizations have a low degree of specialization and formalization, a flat organizational structure and decentralized decision making. Organic structures tend to be correlated with the following: a fluid and flexible information flow among employees in both horizontal and vertical directions; faster decision making; and higher employee motivation, retention, satisfaction and creativity. Organic organizations also typically exhibit a higher rate of entrepreneurial behaviours and innovation. Organic structures allow firms to foster R&D and/or marketing as a core competency. Firms that pursue a differentiation strategy at the business level frequently employ an organic structure. Organic organizations also uses virtual teams due to information technology such as email and instant messaging.

Mechanistic organizations are characterized by a high degree of specialization and formalization and a tall hierarchy that relies on centralized decision making. Mechanistic organizations have tall hierarchy, communication and authority lines are topdown and well defined. Mechanistic structures allow for standardization and economies of scale, and thus often are used when the firm pursues a cost-leadership strategy at the business level.

To gain and sustain competitive advantage, not only must structure follow strategy, but also the chosen organizational form must match the firm's business strategy.

Matching Strategy and Structure Simple Structure A simple structure is generally used by small firms with low organizational complexity. In such firms, the founders tend to make all the important strategic decisions and run the dayto-day operations. Simple structures are flat hierarchies operated in a decentralized fashion. They exhibit a low degree of formalization and specialization. No professional management structures nor sophisticated systems are in place, often leading to an overload for the founder and/or CEO when the firms experience growth.

Functional Structure

As sales increase, firms generally adopt a functional structure, which groups employees into distinct functional areas based on domain expertise. These functional areas often correspond to distinct stages in the company value chain such as R&D, engineering and manufacturing, and marketing and sales, as well as supporting areas such as human resources, finance and accounting. The department head of each functional area reports to the CEO, who coordinates and integrates the work of each function. A functional structure allows for an efficient top-down and bottom-up communication chain between the CEO and the functional departments, and thus relies on a relatively flat structure. The drawback of the functional strategy is that although it facilitates rich and extensive communication between members of the same department, it frequently lacks effective communication channels across departments. The lack of linkage between functions is the reason why R&D managers do not communicate with marketing managers. To overcome lack of cross departmental collaboration in a functional structure, a firm can set up cross functional teams. In these teams, members come from different functional areas to work on a specific project. A second drawback of functional structure is that it cannot effectively address a higher level of diversification which often stems from further growth. In such a situation, firms should move on to adopt a multidivisional or matrix structure.

Use with Various Business Strategy (Functional) A functional structure is recommended when a firm has a fairly narrow focus in terms of product/service offerings combined with a small geographic footprint. It matches well, therefore, with the different business level strategies such as cost leadership, differentiation and integration. Although a functional structure is the preferred method for implementing business strategy, different variations and contexts require careful modifications in each case. Cost Leadership o The goal of cost leadership is to create a competitive advantage by reducing the firm's cost below that of competitors while offering acceptable value. o To effectively implement a cost leadership strategy, therefore, managers must create a functional structure that contains the organizational elements of a mechanistic structure - one that is centralized, with well defined lines of authority up and down the hierarchy. o Using a functional structure allows the cost leader to focus on and constantly upgrade necessary core competencies in manufacturing and logistics. Differentiation o The goal of a differentiation strategy is to create a competitive advantage by offering products or services at a higher perceived value, while controlling costs. o To effectively implement a differentiation strategy, managers rely on a functional structure that resembles an organic organization. o Decision making tends to be decentralized to foster and incentivize continuous innovation and creativity as well as flexibility and mutual adjustment across areas.

Using a functional structure with an organic organization allows the differentiator to focus on and constantly upgrade necessary core competencies in R&D, innovation and marketing. o The functional structure should be set up to allow the firm to reap economies of scope from its core competencies such as by leveraging its brand name across different products. Integration o A successful integration strategy requires reconciliation of the trade-offs between differentiation and low cost. o The integrator must balance centralization and decentralization. o Managers must combine the advantages of the functional structure variations used for cost leadership and differentiation while mitigating their disadvantages. o It must further focus on product and process innovation in an attempt to reap economies of scale and scope. o However, integration strategy, while attractive, is difficult to implement given the range of important trade-offs that must be addressed. o To transform a functional structure into an ambidextrous organization, the CEO must personally take responsibility for the integration and coordination across different functional areas. Multidivisional Structure The multidivisional structure (M form) consists of several distinct SBUs, each with its own P&L responsibility. Each SBU is operated more or less independently from one another and each is led by a CEO who is responsible for the unit's business strategy or day to day operations. Most large firms are diversified to some extent across different product lines and geographies, the M-form is widely adopted.

Use of M-form with various corporate strategies To achieve optimal match between strategy and structure, different corporate level strategies require different organizational structure. Related Diversification

Managers using the M-form to support related diversification strategy should ideally concentrate decision making at the top of the organization. o Doing so enables a high level of integration and allows corporate headquarters to help leverage and transfer across different SBUs core competencies that form the basis for a related diversification. o Co-opetition among SBUs is both inevitable and necessary. They compete with one another for resources such as managerial talent but they also need to cooperate to share competencies. Unrelated Diversification o Managers using M form in an unrelated diversification strategy should decentralize decision making. o Doing so allows general managers to respond to specific circumstances and leads to low level of integration at corporate headquarters. o Since each SBU is evaluated as a standalone P&L centre, SBUs end up in competition with each other, a high performing SBU might be rewarded with greater capital budget and strategic freedoms while a low performing SBU might be spun off.

Matrix Structure To reap benefits of both the M form and the functional structure, many firms employ a mix of both these two organizational forms, called a matrix structure. In it, the firm is organized according to SBUs along a horizontal axis, and a second dimension of organization structure, along the vertical axis. In this case, the second dimension consists of different geographic areas, each of which generally would house a full set of functional activities. The idea is to combine the benefits of the M-form (domain expertise, economies of scale and efficient processing of information), with those of the functional structure (responsiveness and decentralized focus). The matrix structure is versatile, because managers can assign different groupings along the vertical and horizontal axis. In a traditional matrix structure, cross functional teams work together on different projects. The matrix structure is difficult to implement, implementing two layers of organizational structure creates significant organizational complexity and increases administrative costs. Also, reporting structures in a matrix are often not clear. Employees can have trouble reconciling goals presented by their two or more supervisors. Less clear reporting structures can undermine accountability and can make performance appraisals more difficult. Adding a layer of hierarchy can also slow decision making processes and increase bureaucratic costs. Given the advances in technology, some firms have replaced the more rigid matrix structure with a network structure. A network structure allows the firm to connect to centres of excellence whatever their global location. The firm thus benefits from communities of practice, which store important organizational learning and expertise.

To avoid undue complexity, these network structures need to be supported by corporate wide procedures and policies to streamline communication, collaboration and allocation of resources.

Use with Various Global Strategy To complete the strategy structure relationship, we need to consider the global strategies that best match with different organizational structures. International Strategy o In an international strategy, the company leverages its home based core competency by moving into foreign markets. o An international strategy is advantageous when the company faces low pressure for both local responsiveness and cost reductions. The best match for an international strategy is a functional organizational structure, which allows the company to leverage its core competency most effectively. Localization Strategy o With a multinational enterprise that pursues a localization strategy, it attempts to maximize local responsiveness in the face of low pressures for cost reductions. o An appropriate match for this type of global strategy is the multidivisional organizational structure. This structure would enable the MNE to set up different divisions based on geographic regions. o The different geographic divisions operate more or less as standalone SBUs to maximize local responsiveness and decision making is decentralized. Global Standardization Strategy o The MNE attempts to reap significant economies of scale as well as location economies by pursuing a global division of labour based on wherever best of class capabilities at the lowest cost. o Since the product offered is an undifferentiated commodity, the MNE pursues a cost leadership strategy. o The optimal organizational structure match is a multidivisional structure. o Rather than focusing on geographic differences, the focus is on driving down costs due to consolidation of activities across different geographic areas.

Organizational Culture: Values, Norms and Artifacts Organizational culture describes the collectively shared values and norms of an organization's members. Values define what is considered important Norms define appropriate employee attitudes and behaviours. Employees learn about an organization's culture through socialization, a process whereby employees internalize an organization's values and norms through immersion in its day to day operations. Successful socialization allows employees to function productively and take on specific roles within the organization. Strong cultures emerge when the company's core values are widely shared among the firm's employees and when the norms have been internalized.

A unique culture that is strategically relevant can also be the basis of a firm's competitive advantage.

Where do organizational cultures come from? Often, company founders define and shape an organization's culture which can persist for many decades after their departure. This phenomenon is called founder imprinting. Firm founders set the initial strategy, structure, and culture of an organization by transforming their vision into reality. The culture that founders initially imprint is reinforced by their strong preference to recruit, retain and promote employees who subscribed to the same values. In turn, more people with similar values are attracted to that organization. As values and norms held by employees become more similar, the firm's corporate culture becomes stronger and more distinct.

How does organizational culture change? An organizational culture can turn from a core competency into a core rigidity if it is no longer a good fit. The primary avenues of culture change include bringing in new leadership and M&As. Leaders and top executives shape corporate culture in the way they set up an organization's structure, resource-allocation process and reward system.

Organizational Culture and Competitive Advantage For organizational culture to be the basis of a firm's competitive advantage, the organizational culture must satisfy the VRIO framework. Cultural impact on employee behaviour - motivates employees by appealing to their idea, strengthen employee commitment, engagement and effort Culture is vital to an organization - stronger founder imprinting leads to higher performance, effective alignment allows development and refines organizational core competency Organizational culture can help a firm gain and sustain a competitive advantage if the culture makes a positive contribution to the firm's economic value creation and obeys the other VRIO principles. Organizational culture is an especially effective lever for new ventures due to its malleability.

Strategic Control and Reward Systems Strategic control and reward systems are internal governance mechanisms put in place to align the incentives of principals and agents. Input Controls o Input controls seek to define and direct employee behaviour through a set of explicit and codified rules and standard operating procedures. o Firms use input controls when the goal is to define the ways and means to reach a strategic goal and to ensure a predictable outcome.

They are called input controls because management designs these mechanisms so they are considered before employees make any business decisions, thus they are an input into the value creation activities. o An example is the use of budgets. o Standard operating procedures or policies and rules are also a frequently used mechanism when relying on input controls. Output controls o Output controls seek to guide employee behaviour by defining expected results but leave the means to those results open to individual employees, groups or SBUs. o Firms frequently tie employee compensation and rewards to predetermined goals such as specific sales target or return on invested capital. o When factors internal to the firm determine the relationship between effort and expected performance, outcome controls are especially effective. o At corporate level, outcome controls discourage collaboration among different strategic business units, they are therefore best applied when a firm focuses on a single line of business or pursues unrelated diversification.