Economics of Strategy

Slide show prepared by

Richard PonArulCalifornia State University, Chico

John Wiley Sons, Inc.

Chapter 16

Strategy and Structure

Besanko, Dranove, Shanley and Schaefer, 3rd Edition

Structure Follows Strategy

According to Alfred Chandler, the choice of organizational structure depends on the business strategy being pursued

Structure of an organization affects– how division of labor is used to organize tasks– how information flow is facilitated– how agency problems are dealt with

Organizational Forms

A small group of employees within a firm can be organized in several ways– Each member may be treated as a unit and is

rewarded based on his/her output– The group can be a self managed team and individual

rewards will be wholly or partly based on team performance

– Hierarchy of authority may be used with one member of the group coordinating and monitoring the activities of others

Nature of Tasks and Organizational Forms

Firms may use different forms in different situations depending on the nature of the tasks

When tasks do not require coordination employees can be treated as individuals

When coordination is essential and individual contribution is difficult to measure, team approach will be used

Nature of Tasks and Organizational Forms

Beyond a certain size, self managed teams may not perform well in coordination and hierarchy of authority may be needed

The same firm may use different approaches for different tasks

A given employee may perform certain tasks as an individual, others as part of self managed teams and yet others subject to hierarchical control

Coordination and Hierarchy

If a group has n members, the number of possible interactions is

As n increases, hierarchies can be created to keep the number of interactions within manageable limits

When the number of relations for a supervisor goes beyond the optimal span of control a new layer of hierarchy can be created

( 1)

2

n n

Coordination and Hierarchy

Complex Hierarchy

Large firms tend to have multiple groups and multiple levels of groupings

Complex hierarchies are designed to address the following two issues– Departmentalization– Coordination and control

Departmentalization

Formal groupings in large organizations can be based on functional areas, geography, products, types of customers and so on

A firm should decide on the organizing dimensions based on– economies of scale and scope– transactions costs and– agency costs

Firm Boundaries and Structure

A firm’s decisions regarding vertical and horizontal boundaries will influence its choice of organizing dimensions– Diversifying into a new business area will expand

the set of formal groupings– Decision to outsource will contract a firm’s

structure

Coordination and Control

Coordination involves the flow of information to facilitate decisions

Control involves the distribution of decision making rights and rule making authority within the organization

Coordination, Control and Technical Efficiency

Coordination affects the technical efficiency by the provision of information needed to exploit economies of scale and scope

To accomplish improvements in technical efficiency, decision making rights should be allocated to those who have the best and timely information

Coordination, Control and Agency Efficiency

Allocating decision rights to individuals will affect agency efficiency since the decision makers will have the opportunity for selfish behavior

A balance must be struck between technical and agency efficiencies in the allocation of decision rights

Approached to Coordination

When a firm consists of self contained units, information related to operating decisions are controlled by the manage of the unit

A firm may also organize itself into units that have strong lateral relationships

These lateral relationships can be formalized into structure (Matrix Organization) or remain informal

Centralization and Decentralization

Authority becomes more centralized (decentralized) as decision making moves to higher (lower) levels

It is possible for a firm to be centralized in some dimension while being decentralized in others

For example, a university’s administrative functions may be centralized while its teaching function is decentralized

Organizational Structure

Organizational structure of large businesses can be classified as follows:– The unitary functional structure (U-form)– The multidivisional structure (M-form)– The matrix structure– The network structure

The U-form structure

The U-form structure

Each department in the firm is responsible for a particular functional area such as finance or marketing

The unitary functional structure is suitable for stable conditions when operating efficiency is the prime consideration

The M-form structure

The M-form structure

The multidivisional firm is organized along such dimensions as– product line– geography or– type of customers

Divisional managers will be responsible for operating decisions and the top management will handle strategic decisions

Advantages of the M-form

Measuring divisional performance is easier under M-form

Divisional managers compete for funds in the internal capital markets based on their operating performance in the past

Pay for performance schemes are easier to implement in managerial compensation

Matrix Structure

Matrix Structure

A firm that uses a matrix structure is organized along two (or more) dimensions - for example, product line and geography

In a two-dimensional matrix, an employee belongs to two hierarchies and has two bosses

Advantages of Matrix Structure

Matrix structure can help exploit economies of scale and scope

A firm may need national coordination to achieve economies of scale for manufacturing a particular product and regional coordination to negotiate with large buyers for different products

Advantages of Matrix Structure

Matrix structure allows a firm to economize on scarce human resources

Having a firm wide engineering department (or marketing department) will be more efficient than maintaining a separate engineering group for each product group

Network Structure

Network Structure

Workers or worker groups contribute to multiple organizational task

Work groups are reconfigured when the tasks change

Relationships among groups are governed by the requirements of the task

Network Structure

Coordination costs will be a major concern in Network Structure

The Japanese Keiretsu is a variety of network structure

In high technology companies, network structure facilitates information flows, leading to high level of product development

Modular Organization

Modular organization is a network structure with subunits that are relatively self contained

Subunits are tied together via standardized linkages

Modularity may sacrifice economies of scope If may encourage innovations at the subunit

level

Contingency Theory

Contingency theory suggests that a particular structure will not be the optimal structure for a firm under all circumstances

Contingency theory focuses on three factors that affect the efficiency of a structure– Technology and task interdependence– Information flows– Tension between differentiation and integration

Technology and Task Interdependence

There can be three modes of task interdependence– Reciprocal - when two workers (or work groups)

depend on each other– Sequential - when one worker (or work group) has

a one way dependence on another– Pooled - when there is no direct dependence, but

indirect dependence exists because of common goals

Technology and Task Interdependence

Changes in technology will cause the nature of task independence to change

The organizational structure may need to be changed in response to the change in task interdependence

Example: Technology has weakened the sequential and reciprocal interdependencies in some industries and has made outsourcing attractive

Information Flows

When work is routine, workers can be autonomous

When exceptions need to be handled, higher level hierarchies are involved and information flow becomes important

The firm’s organizational structure should enable the desired amount and speed of information flow to occur

Information Flows

Workers in the higher levels deal with more difficult exceptions that occur less frequently

Higher levels have fewer workers with larger human capital

Technological changes reduce the cost of information flow and increase the span of control (flatter organization)

Information Retrieval

According to Arthur Stinchcombe, the optimal structure should enable efficient information retrieval

Different levels of structure will deal with different types of information

To make information retrieval efficient, the firm should integrating into the firm activities that provide critical information

Balancing Differentiation and Integration

If the organizational structure does not sufficiently differentiate, the firm may inefficiently use a “one size fits all” approach to all products (and regions)

For integrated planning and control, too much differentiation can be an impediment

The optimal structure should balance differentiation and integration

Structure Follows Strategy

The U-form structure allowed firms to exploit the economies of scale in production, marketing and distribution

When firms began to diversify, the U-form became cumbersome and M-form emerged as a better alternative

Structure Follows Strategy

The M-form lead to duplication of activities when firms expanded globally and created “international divisions”

As firms try to balance local responsiveness with global economies, a mix of matrix form and network form help create flexible organizations

Structure, Strategy, Knowledge and Capabilities

Critical knowledge and decision capabilities are distributed throughout the firm in large firms

Structure determines the shortlist of alternatives that reach the top management

Organizations enable generation and manipulation of new knowledge for strategic uses (knowledge-based view of the firm)

Structure, Strategy Knowledge and Capabilities

Structure induces biases in the information reaching the top management

Structure also influences how strategies are implemented and how top management is informed regarding the implementation

Formal administrative control should be supplemental by informal means of winning the cooperation from lower levels

Evolutionary Economics and Structure-Strategy

Evolutionary economics offer two new views on structure-strategy relationship– Structure and strategy evolve over time through

local external interactions rather than through top management initiative

– Strategy and structure are higher level heuristics that enable the management to respond quickly to difficult and unusual problems

Implications of the Evolutionary Economics View

Strategy and structure changes will be evolutionary rather than revolutionary

Large scale strategy changes and comprehensive reorganizations will be rare

Current decision regarding strategy and structure will be constrained by past decisions