Competitive Strategy UGBA 115
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quotFive Forcesquot Industry Analysis I Threat of New Entrants II Intensity of Rivalry III Bargaining Power of Suppliers IV Bargaining Power of Buyers V Threat of Substitutes o How does each force influence industry attractiveness o What factors influence the magnitude of each force quotValue Netquot Interactions between rms quotSix Segmentsquot General Environment I Sociocultural II Economic III PoliticalLegal IV Technological V Demographic VI Global PEST Analysis General Environment I Political and Legal Factors II Economic Factors III Social Factors IV Technological Factors Strategic Groups Strategy group Mapping I Price Segmentation II Quality Segmentation III Geographic area IV Extent of vertical integration V Product line breadth VI Types of distribution channels VII Degree of diversification VIII Technological approach IX Cost structure X Financial position XI Mobility Barriers How Is W IV FOL3 V Iue Inim al e a Core P rattice C mater 1 USOIEFmQ Competence Mecha msms Above Average Returns can come from Internal Sources Resource Based View Above Average Returns come from creating greater customer value How does firm create value ncreasing Willingness to Buy Decreasing Cost of Production Using what value chain activity I Business Level Strategies for creating value aka Strategic Positioning Differentiation vs Cost Leadership Broad vs Focused Segementation based on ProductCustomer ntegration DifferentiationCost Leadership Core Competence Valuable Rare Inimitable vs Resources and Capabilities Is it valuable Rare and Inimitable Why inimitable Isolating Mechanisms mpediments to imitation 0 Legal restrictions 0 Superior access to inputscustomers 0 Market size and scale economies o Intangible barriers o Causal ambiguity 0 Historical circumstances 0 Social complexity Eary mover advantage 0 Learning curve 0 Reputation and buyer uncertainty 0 Switching costs 0 Network Effects Core Competence Where do core competencies exist 0 Value Chain Fighting 3 Dominant Start Successfully Imperfect Imitability and Industry Equilibrium Source of Competitive Advantage Source of Sustainable Competitive Advatage Corporate Level Strategies In which businesses should we compete 7 Single Business 7 Dummart Busmess 7 Retatedowersttmatmn 7 Unretatedoweratmatmn Hughes Perfurmznce Retated Dwersmcztmn Ctherge mty accesarg retatedness DIvElsIllcmlon auanesateyet Strategy Cumpetmve Huw a cumpzny wtu campetewttmn zgwen busmesSprudud market Curpuratgeyet Strategy Campanywtde Whatbusmessesshuu dwecumpmem Prunessbywhmhurgentzztmnsexpzndmtumu up epruductmzrkets Relatedness Dagreeutdwerattmatmn andurdtsmbutmnmannets dassr calron by Realea n 955 Ways to mme 70mm new hnesuf buaness memzHy Why do lms myemfy Ef mencybzsedrezsunsthztban 0 Emma e tthe sharehu dersrcan be vzmecreztmg mes uf 992 s and snaps Economizing on transactions costs Internal capital markets Shareholder s diversification 0000 Identifying undervalued firms 0 Managerial based Agency problem 0 Growth may benefit managers even when it does not add value for the shareholders 0 When growth cannot be achieved through internal development diversification may be an attractive route to growth 0 When related mergers were made difficult by law conglomerate mergers became popular 0 Managers may feel secure if the firm performance mirrors the performance of the economy which will happen with diversification o Diversification will offer managers room for lateral movement and allow them to invest in firm specific skills 0 Unrelated diversification may make it easier to motivate managers with pay for performance incentives 0 Managers could be engaged in empire building and enhancing their status in their network at the expense of the shareholders Vertical Boundaries of the Firm 16 Vertical Chain 0 Begins with the acquisition of raw materials 0 Ends with the sales of the finished goodsservices 0 Includes support services such as Finance and marketing 0 Organizing the vertical chain is an important part of business strategy Vertical Boundaries of the Firm 0 Which steps of the vertical chain are to be performed inside the firm 0 Which steps of the vertical chain to be outsourced 0 Choice between the llinvisible hand of the market and the llvisible hand of the organization Make or Buy Vertically Integrated Firms o In a vertically integrated firm many of the steps in the vertical chain are performed inhouse 0 Some firms choose to outsource many of the vertical chain tasks and become vertically disintegrated 0 Example Apple and Apple Stores 0 Example Nike and Nike Stores Make versus Buy 0 Decision depends on the costs and benefits of using the market as opposed to performing the task inhouse 0 Outside specialists may perform a task better than the firm can 0 Intermediate solutions are possible Examples Strategic alliances with suppliers Joint ventures Support Services 0 Accounting 0 Finance 0 Legal Support 0 Marketing 0 Planning 0 Human Resource Management Support services can be major sources of value creation MakeorBuy and Competitive Advantage o A firm believes that a particular asset is a source of competitive advantage o It turns out the asset is easily available in the market 0 The belief regarding competitive advantage will have to be reevaluated Outsourcing and Cost o It should not matter if the costs of performing an activity are incurred by the firm Make or by the supplier Buy 0 The relevant consideration is whether it is more efficient to make or to buy Technical Efficiency 0 Using the market leads to higher technical efficiency compared to vertical integration power of market discipline 0 The difference in technical efficiency of market over vertical integration AT depends on the nature of the assets involved in production 0 The difference in technical efficiency of market over vertical integration AT declines with greater asset specificity De nitions 0 Relationshipspecific Asset An investment made to support a given transaction aka Asset Specificity o Holdup Problem when one party exploits the other parties vulnerability due to relationship specific assets Agency Ef ciency 0 Organizing exchange transactions to minimize coordination agency and transaction costs MARKET 7 Coordination costs costs associated with ensuring that activities fit or come together in the desired fashion 7 Transaction costs costs associated with negotiating writing and enforcing contracts VERTICAL INTEGRATION 7 Agency costs when managers and workers do not work in the best interest of their costs 39 Iwith quot39 gthat organization slack effort the behavior 7 Influence Costs the costs associated with understanding the true performance of divisions Managers may attempt to overinflate their performance in order to maximize their internal capital market allocation At high levels of asset speci city differential agency efficiency of market over vertical integration AA is negative 0 Le vertical integration is more favorable When specialized assets are involved potential for a holdup is high and the result is higher transactions costs At low levels of asset speci city differential agency efficiency of market over vertical integration AA is likely to be positive Without the holdup problem market exchange could be more agency efficient than in house production Ef ciency Tradeoff o The combined market over vertical integration differential efficiency AC will be negatively related to asset specificity 0 At high levels of assets specificity vertical integration is more efficient 0 At low levels of asset specificity outsourcing wins Ef ciency Tradeoff and Scale 0 When the scale of production increases the vertically integrated firm enjoys better economies of scale 0 With increased scale the differential technical efficiency decreases for every level of asset specificity 0 With an increase in scale the differential agency efficiency becomes more sensitive to asset specificity 0 Differential agency efficiency market over vertical integration will increase with scale for low asset specificity 0 With high asset specificity differential agency efficiency decreases with scale 0 The combined differential efficiency AC sharply declines for low asset specificity o The degree of asset specificity at which market is just competitive with vertical integration declines 0 Vertical integration is preferred to market exchange over a larger range of asset specificity Conclusions from the Ef ciency Tradeoff Model 0 Inputs in the firm of routine products and services are likely to be procured in the market supplier s economies of scale 0 When a firm s product market activities is large in scale it is likely to be vertically integrated 0 Presence of relationshipspecific assets will tilt the advantage in favor of vertical integration Vertical Integration and Asset Ownership GHM Theory 0 Makeorbuy decision is essentially a decision regarding ownership rights 0 If contracts were complete it will not matter who owned the assets in the vertical chain 0 With incomplete contracts ownership pattern determines the willingness of each party to make relationshipspecific investments Key Takeaways 16 The choice between market exchange and vertical integration is driven by the tradeoff of the potential benefits of lower production costs in the market technical efficiency and lower coordination agency and transaction costs agency efficiency through vertical integration Greater asset specificity tends to reduce the cost advantage of the market and favor the reduction in agency costs through vertical integration As companies grow larger vertical integration becomes more favorable They achieve greater economies of scale and therefore the benefit of lower production cost in the market declines in importance Given that most contracts are incomplete ownership of key value creating assets can drive the vertical integration andor alliance decision making process G HM Theory Multiple alternatives between market exchange and vertical integration 0 Tapered Integration Making some and buying the rest 0 A firm may sell part of its output through in house sales efforts and sell the rest through independent distributors Alliancesinvolves coordination and information sharing for a joint project while the participating firms continue to be independent 0 Joint Ventures Alliance where a new independent organization is created and jointly owned by the promoting firms Joint Ventures involve the creation of a new standalone entity Competitors and Competition 19 Key Takeaways Too often firms develop strategies in isolation of other firms in a vacuum Instead when companies are developing their strategies it is essential to take into account the potential actions and reactions of competitors Competition in an oligopolistic industry can be based on capacity Cournot or price Bertrand Bertrand competition results in prices comparable to pure competition Cournot competition results in prices that are higher than pure competition but lower than fully cooperative oligopolists monopoly price As the number of firms in an industry increases prices adjust toward the purely competitive prices Indentifying Competitors Anyone who produces a substitute for a firm s product is its competitor How good a substitute is one product for another is measured by the cross price elasticity of demand 0 A firm may have competitors in several input markets and output markets at the same time 0 Mergers with all the competitors should lead to a significant nontransitory increase in price DOJ guideline In practice two firms can be said to compete if a price increase by one rm drives its customers to the other firm Direct and Indirect Competitors 0 Direct competitors Strategic choice of one firm directly affects the performance of the other 0 Indirect competitors Strategic choice of one firm affects the performance of the other because of a strategic reaction by a third firm Characteristics of Substitutes 0 Two products tend to be close substitutes when 7 They have similar performance characteristics 7 They have similar occasion for use and 7 They are sold in the same geographic area Performance Characteristics 0 Listing of performance characteristics is a subjective but useful exercise 0 Products that belong to the same genre or fall under the same SIC need not be substitutes Example Mercedes and Hyundai if their performance characteristics are vastly different Occasion of Use 0 Products may share characteristics but may differ in the way they are used 0 Orange juice and cola are beverages but used in different occasions 0 Another example could be hiking shoes versus court shoes Geographic Area 0 Identical products in two different geographic markets will not be substitutes due to lltransportation costsquot 0 Bulky products like cement cannot be transported over long distances to benefit from geographic price difference Two Step Approach to Indentifying Competitors in the Area First step is to find out where the customers come from the catchment area The second step is to find out where the customers from the catchment area shop With the technological innovations some products like books and drugs are sold over the internet bringing in virtual competitors Market Structure 0 Markets are often described by the degree of concentration Slide 33 Deck 19 Monopoly is one extreme with the highest concentration one seller 0 Perfect competition is the other extreme with innumerable sellers Market Structure and Competition 0 A monopoly market may produce the same outcomes as a competitive market threat of entry 0 A market with as few as two firms can lead to fierce competition 0 With monopolistic competition how well differentiated the products are will determine the intensity of price competition Conditions for Fierce Price Competition 0 Even if the ideal conditions are not present price competition can be fierce when two or more of the following conditions are met 7 There are many sellers 7 Customers perceive the product to be homogenous 7 There is excess capacity Homogenous Product 0 For firms that cut prices customers switching from a competitor are likely to be the largest source of revenue gain 0 Customers are more likely to price shop when the product is perceived to be homogenous and hence sellers are more likely to compete on price Excess Capacity 0 When a firm is operating below full capacity it can price below average cost as price covers the variable cost 0 If industry has excess capacity prices fall below average cost and some firms may choose to exit I If exit is not an option capacity is industw specific excess capacity and losses will persist for a while Oligopoly I Market has a small number of sellers I Pricing and output decisions by each firm affects the price and output in the industw I Oligopoly models Cournot Bertrand focus on how firms react to each other s moves Cournot Duopoly In the Cournot model each ofthe two firms pick the quantities C11 and Q to be produced Each firm takes the otherfirm39s output as given and chooses the output that maximizes its profits The price that emerges clears the market demand supply Cournot Equilibrium fthe two firms are identical to begin with their outputs will be equal Each firm expects its rival to choose the Cournot equilibrium output If one ofthe firms is off the equilibrium both firms will have to adjust their outputs Equilibrium is the point where adjustments will not be needed Bertrand Duopoly In the Bertrand model each firm selects its price and stands ready to sell whatever quantity is demanded at that price Each firm takes the price set by its rival as a given and sets its own price to maximize its profits In equilibrium each firm correctly predicts its rivals price decision NU Finn 1 5 reaction function rlum Bertrand Equil39 I If the two firms are identical to begin with they will be setting the same price as each other I The price will equal marginal cost same as perfect competition since otherwise each firm will have the incentive to undercut the other Cournot and Bertrand Compared I If the firms can adjust the output quickly Bertrand type competition will ensue I If the output cannot be increased quickly capacity decision is made ahead of actual production Cournot competition is the result I In Bertrand competition two firms are sufficient to produce the same outcome as infinite number of firms Bertrand Competition with Differentiation I When the products ofthe rival firms are differentiated the demand curves are different for each firm and so are the reaction functions I The equilibrium prices are different for each firm and they exceed the respective marginal costs I When products are differentiated price cutting is not as effective a way to stealing business I At some point prices still above marginal costs reduced contribution margin from price cuts will not be offset by increased volume by customers switching Multipoint Competition 0 When firms compete against each other simultaneously in several markets Karnani amp Wernerfelt 1985 7 Geographic Markets or 7 Product Markets 0 Reduces ability to crosssubsidize across markets Strategic Commitment 21 Key Takeaways 0 Making credible commitments can alter the strategic interactions between competitors 7 Visible 7 Understandable 7 Credible irreversibility helps 0 The relationships between the following determine the outcome of the strategic interactions 7 Soft vs tough commitments 7 Strategic complements vs strategic substitutes 7 Capacity Cournot vs Price Bertrand competition 0 Soft commitments strategic actions which benefit the competitor might not always be bad Changingthe 39 of quot 39 39 39 vs39 can I u I I I potentially influence competitive outcomes 0 Game Theory rigid application or useful metaphor Strategic Commitment 0 Strategic commitments are decisions that have long run impact and are hard to reverse Example Installation ofadditional production capacity 0 These differ from tactical moves which are easy to reverse and have only a short run impact Example A store cutting the price on certain items 0 To achieve the desired result the commitment should be 0 Visible Understandable Credible To be credible the commitment should be irreversible Commitment Value ofAnnouncemems 0 If a firm has an established reputation at stake even announcement of intention to act can have commitment value 0 If the firm fails to match actions to words its reputation will suffer Smaller and newer firms cannot use announcements to indicate commitment Strategic Commitment and Competition 0 Strategic complements and strategic substitutes are concepts on how a firm reacts to pricequantity change by a competitor Tough commitments and soft commitments are concepts that capture actions by a firm that puts its competitors at a disadvantage Strategic Substitutes 0 When a firm s action causes the rival to take the opposite action then the actions are strategic substitutes 0 For example in Cournot duopoly model one firms decision to increase output will cause the other to reduce its output 0 In the Cournot model output decisions are strategic substitutes Strategic Complement 0 When a firm s action causes the rival to take the some action then the actions are strategic complements 0 For example in Bertrand duopoly model one firms decision to increase the price will cause the other to increase the price as well 0 In the Bertrand model price decisions are strategic complements Soft Commitments and tough Commitments forcingthe rivalto lower its price the strategic effects Two effects of Commitments I A commitment may have a direct unaffected bythe commitment The strategic effect is the further rival adjusting its tactics The Value of Soft Commitment on its profitability Ifthe optimal response of the riva Cournot after Soft Commitment The immediate effect of a tough commitment is an adverse impact on the rival Example Afirm invests in a new process that reduces unit cost so that it can lower its price Tough commitment conforms to the traditional View of competition The immediate effect of a soft commitment is a favorable impact on the rival To understand why soft commitments may make sense we need to look at both the direct and and a strategic effect on the firm39s profitability Direct effect is the change in the present value of profits assumingthat the rival39s tactics are change in the present value of the firm39s profits due to the A firm that makes a soft commitment to raise its price may experience a negative direct effect I is to raise its price the strategic effect can be beneficial Ifthe strategic effect is sufficiently large the net benefit from the commitmentwill be positive Cumnot alum mm my Cournot equilibrium helm mm R li Firm 1 shifts its reaction function to the left committingto produce less than precommitment level for every level of rival39s output Rival39s reaction hurts Firm 1 by making its output fall further Firm 2 produces more than what it produced without Firm 139s soft commitment Bertrand after Soft Commitment m Ri mm m T Bertrand equilibrium R1 after eman equilibrium R2 before 4 I P1 Firm 1 commits to charge a higher than the precommitment level price for evew price level picked by the rival Firm 239s reaction provides a even higher price for both firms Both firms benefit from Firm 139s soft commitment Cournot after Tough Commitment Inumm slimlilu39lmn helm39c Cournut uqullibiium mu Firm 1 commits to a higher than previous output for every output choice of the rival Firm 2 s reaction function makes the equilibrium output of Firm 1 even higher 0 Firm 2 produces less than what it produced without the tough commitment from Firm 1 Bertrand after Tough Commitment Il39ur p R1 Rllrcl39nrc v Bertrand equilibrium before Bertrand equilibrium 0 Firm 1 commits to a lower price by shifting its reaction function to the left 0 Firm 239s reaction further lowers the equilibrium price Both firms end up hurt by Firm 1 s tough commitment Strategic Effects of the Commitments Firm 1 s Commitment 2quotd Stage Competition Strategic Effect on Firm 1 Soft Cournot Negative Soft Bertra nd Positive Tough Cournot Positive Tough Bertra nd Negative Taxonomy of Strategic Commitment When 2nd stage actions are strategic substitutes Firm 1 s Strategy Commitment Posture Commitment Action TopDog Strategy Tough Make Submissive Underdog Tough Refrain Suicidal Siberian Soft Make Lean and Hungry Look Soft Refrain When 2nd stage actions are strategic complements Firm 1 s Strategy Commitment Posture Commitment Action Mad dog Tough Make PuppyDog Play Tough Refrain FatCat Effect Soft Ma ke Weak Kitten Soft Refrain Factors that Influence the Strategic Effect In general commitments that lead to less aggressive behavior from the rivals will have beneficial strategic effect If the rival is a potential entrant rather than an existing firm a tough commitment to price aggressively may deter entry If the rivals is an existing firm and there is excess capacity in the industry aggressive pricing may invite retaliation If the products are horizontally differentiated the strategic effect may be relatively less important since the rival does not have the incentive to react Framework for Analyzing Commitments Positioning Analysis 0 Positioning analysis is akin to the determination of the direct effect of commitment o The focus is on whether the firm operates with lower costs than its competitors or offers superior benefits to its customers Sustainability Analysis 0 39 analysis of the strategic effect o It analyzes the response by competitors and potential entrants o It also looks at the market imperfections that protect the firm s competitive advantage Flexibility analysis iv Flexibility analysis incorporates uncertainty and option value 0 A key determinant of the option value is the ratio of the quotlearn ratequot to the llburn ratequot of the firm 0 The rate at which a firm receives new information that allows it adjust its strategy is termed the lllearn ratequot 0 The rate at which the firm makes irreversible investments in support of its strategy is the llburn ratequot 0 A high learn to burn ratio indicates that the option value of delay is low 0 Firms can increase their learn to burn ratios through experimentation and pilot programs Judgment Analysis 0 Judgment analysis involves looking at the organizational and managerial factors to ensure that incentives exist to support the optimal strategy 0 Hierarchical decision making may create a bias towards Type errors rejecting good projects 0 Decentralized decision making may result in higher incidence of Type II errors accepting unprofitable projects 0 Managers should be cognizant of the biases imparted by the structure of the organization and its politics and culture Origins of Competitive Advantage 25 Key Takeaways Creative Disruption The process by which new technologies broadly defined supplant existing technologies 7 May lead to monopoly profits for disruptor 7 Extremely difficult for incumbents to adjust l39 39 39 7F where change is rapid and building a sustainable W I I competitive advantage is not possible Evolutionary Economics Processes of natural selection quotselectquot organizations whose routines best fit those favored by the external environment assumes a more limited role for management Change can be incremental or disruptive 7 The nature of which determines the required form or innovation incremental or radical advantages t N d uptmnschusemnthepzsl 39 e Advantage Entyepyenemship and camper dtamnttndtttea Huva t t t estabhgnedunes Campetttweadvartage ansesfrum z rm sentrepreneunz zbmtytu exp mt market shacks and dtscurttnmttes Hu p t t a tneestabhsnedunes nnpurtant tnan dynamo etndency new farms uf urgzmzztmn tnan frum prme cumpetttmn cveatwe Demmum and Competitive Am antage advantage wtu nut be pennanent 39 e Advantage me cycle 01 camper Ecarmmc mm Deve apmem nne Strategic Intent and Strategic Stretch 0 According to Hamel and Prahalad successful firms like CNN SONYand Honda tend to have strategic intent an obsession with global dominance in their industries 0 For these firms there is a gap strategic stretch between their strategic intent and their current resources and capabilities Hype rcompetition 0 Firms are said to enter a state of hypercompetition state when competitive advantages can only be sustained for very short periods 0 According to Richard D Aveni several industries are in this state and firms in these industries can sustain their economic profits only by continually seeking new sources of competitive advantage Hype rcompetition Strategies 0 A firm s chief strategic goal should be to disrupt the existing sources of advantages including its own 0 A firm that relies solely on its existing source of advantages will be displaced by more innovative rivals 0 Firms may be able to create shocks on their own rather than waiting for them to occur Incumbent s Incentives to Innovate 0 Established firms face certain incentives to refrain from innovation 7 Sunk cost effect 7 Replacement effect 0 They also face certain incentives to become innovators 7 Efficiency effect The Sunk Cost Effect 0 For established firms costs incurred to commit to a particular technology are sunk costs 0 Established firms tend to favor the current technology Replacement Effect 0 The opportunity to innovate is assumed to be available to either an incumbent monopolist or a potential entrant If the entrant innovates it can displace the monopolist and its incentive to do so depends on the value of becoming the monopolist Monopolist s incentive will be less since it will be replacing itself Ef ciency Effect 0 If the monopolist anticipates that the entrant may get an opportunity to innovate its incentives to innovate will be stronger The monopolist can continue to be monopolist by innovating its incentives will be greater than the potential entrants 0 All three effects will work 39 to J 39 if the 39 39 will innovate or not Innovation Competition Iquot 0 Competition to innovate can be like a llwinner take al contest 0 When firms compete to develop the same product the firm that does it first will enjoy a significant advantage 0 The winner may be able to get a patent andor the advantages of a first mover Staying even slightly ahead of the rivals will produce disproportionate benefits 0 Firms engaged in a contest must anticipate the rival s efforts to formulate their own strategy Patent Race In a llwinner take all race to obtain a patent a firm should look at the following factors before deciding whether or not to increase its R amp D investment 7 Effect ofadditional investment in R amp D productivity 7 Response by the rivals to increased investment by the firm 7 The number of competitors in the field Choosing the Technology for RampD 0 When multiple R amp D methodologies are available a firm should consider the following characteristics 7 Riskiness of each methodology uncertainty about the anticipated completion date 0 A monopolist will be indifferent about risk as long as the expected completion date is the same for all methodologies 0 When firms compete each firm will end up choosing a high variance strategy over a low variance strategy if the expected completion date is the same 0 If all the other firms follow a low variance methodology a firm that follows a high variance methodology improves its odds of being the first to reach the desired outcome 0 Every firm faces the same incentive to switch to a high variance methodology and no firm will choose a low variance methodology 7 Correlation between methodologies when the uncertainties are resolved how often are the outcomes similar 0 Society benefits more if firms pursue uncorrelated methodologies compared with correlated ones since the probability of any one firm reaching the goal is higher with uncorrelated methodologies 0 It turns out that firms left to decide on their own will choose uncorrelated strategies 0 If many firms pursue the same methodology each firm will have a small probability of success 0 Any one firm will benefit by pursuing an uncorrelated methodology and increase its chance of winning 0 This incentive to deviate from the rest applies to all the firms Evolutionary Economics and Dynamic Capabilities Usually a firm s routines change slowly over time if they do change To ensure survival firms need to continuously improve their routines Firms with dynamic capabilities can adapt their resources and capabilities and exploit opportunities created by market shocks and discontinuities Factors that Limit Dynamic Capabilities 0 A firm s dynamic capabilities are inherently limited because of 7 the path dependence of competitive advantage 0 Firm s routines can only change incrementally and cannot have a clean break from the past 0 The new source of advantage will be path dependent 0 With threats from new entrants even small path dependencies can have major implications for the firm s competitiveness 7 limited availability of complementary assets and 7 llwindows of opportunity that do not stay open for long 0 Early in a product s life its design and specifications will be fluid and firms will have room for experimentation 0 Over time a narrow set of design and specifications emerge as dominant and it is hard for new firms to challenge market leaders 0 Those who do not exploit the window of opportunity get shut out Managing Innovation To ensure that entrepreneurial spirits are not stifled by bureaucracy companies have been setting up corporate venture departments Spinoffs joint ventures strategic alliances are other means of facilitating the creation of new capabilities A firm has to contend with two opposing forces in trying to manage innovation To foster innovation creativity and entrepreneurship the organization should be sufficiently flexible However coordination of innovative activities will require formal structure and controls Strategy and Structure 26 Key Takeaways 0 Organizational structure decisions involve the division of labor the coordination of information and the centralizationdecentralization of decision making 0 Four general types of structures U M Matrix and Network 0 Each structure is suited to a particular strategy 0 Strategies are unlikely to be successful unless matched with appropriate organizational structures 0 Organizational structure may not be as quotsexyquot as organizational strategy but its importance should not be overlooked Experimentation on new organizational structures is ongoing and continual 0 No organizational structure is perfect all have their limitations llDivisions divide 0 Learn to recognize the strengths and weaknesses of different structures 0 Be wary of the seduction of the advantages of another structure the grass is sometimes just greener on the other side 7S Framework The quotHard S squot 0 Strategy a plan of an integrated set of action designed to achieve specific corporate objectives 0 According to Alfred Chandler the choice oforganizational structure depends on the business strategy being pursued 0 Structure the organization of the company Who reports to whom and how tasks are divided up and integrated 0 Structure of an organization affects 0 how division of labor is used to organize tasks 0 how information flow is facilitated 0 how agency problems are dealt with 0 Systems the processes and procedures that facilitate daily activities 0 Skills hard and soft S an organization s capabilities and competencies 0 Staff the company s people in terms of their capabilities experience and potential 39 39 39 quot 39 lmw39 39 39 39kllllEWhatl 39 andthesettingsin which they appear Shared Values the culture of the company Attitudes toward work relations among colleagues communication with leadership etc Organizational Forms A small groupof employees within a firm can be organized in several ways quot L39 L output 7 Each member Illlll 7 139quot g quot managed v Iuy or partly based on team performance Hierarchy of authority may be used with one member ofthe group coordinating and monitoring the activities of others Nature of Tasks and Organizational Forms Au 39 39 39 quot the nature ofthetasks we 39 When tasks dn nnt Wk 1 c 39I quot quot quot 39 quot 39 39 J39 39tnmeallre team approach will be used 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 0 A given employee may perform certain tasks as an individual others as part of self managed teams and yet others subject to hierarchical control Complex Hierarchy 0 Large firms tend to have multiple groups and multiple levels of groupings 0 Complex hierarchies are designed to address the following two issues 7 Departmentalization 0 Formal groupings in large organizations can be based on functional areas geography products types of customers and so on 0 A firm should decide on the organizing dimensions based on 0 economies of scale and scope transactions costs and 0 agency costs 7 Coordination and control 0 Coordination involves the flow of information to facilitate decisions 0 Control involves the distribution of decision making rights and rule making authority within the organization Firm Boundaries and Structure 0 A firm s decisions regarding vertical and horizontal boundaries will influence its choice of organizing dimensions 7 Diversifying into a new business area will expand the set of formal groupings 7 Decision to outsource will contract a firm s structure Coordination Control and Technical Efficiency 0 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 Ef ciency I quot 39 39 39 39 rights toi will have the opportunity for selfish behavior y in the decision makers vluual I A balance must be struck between technical and agency efficiencies in the allocation of decision rights Approach to Coordination I When a firm consists of self contained units information related to operating decisions are controlled by the manager ofthe unit I A firm may also organize itself into units that have strong lateral relationships I These lateral relationships can be formalized into structure Matrix Organization or remain informal Centralization and Decentralization I Authority becomes more centralized decentralized as decision making moves to higher lower levels I It is possible for a firm to be centralized in some dimension while being decentralized in others I For example a university39s administrative functions may be centralized while its teaching function is decentralized Organizational Structure r 39 39 39 structure uf39 39t39 A ll m 7 The unitary functional structure Uform Cm rmth Headquarters iv 39 person I 51d I SUFFVI 5 l l l l l l l l Gumn s Mamqu rv GM GM GM GM quot1 M 39 t v r R39 h 6 H t GM hm Purcth mmmwmg sax hugging 33333 Immu mm 7 mmonu T Funuions l Producr 7 Prullucrs 7 7 Bmmh of w Hams l Each department in the firm is responsible for a particularfunctional area such as finance or marketing The unitaw functional structure is suitable for stable conditions when operating efficiency is the prime consideration 7 The multidivisional structure Mform Corporate Headquarters 39 Chairperson 39 President 39 Staff VP s l Divisions o The multidivisionalfirm is organized alongsuch dimensions as 0 product line 0 geography or 0 type of customers 0 Divisional managers will be responsible for operating decisions and the top managementwill handle strategic decisions Advantages of the Mform Measuring divisional performance is easier under Mform Divisional managers compete forfunds in the internal capital markets based on their operating performance in the past Pay for performance schemes are easierto implement in managerial compensation 7 The matrix structure Project quot I A firm that uses a matrix structure is organized alongtwo or more dimensions for example product line and geography I In a twodimensional matrix an employee belongs to two hierarchies and has two bosses Advantages of Matrix Structure I Matrix structure can help exploit economies of scale and scope I 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 I Matrix structure allows a firm to economize on scarce human resources I Havinga firm quot 39 39 39 ul 39 39 39 will be more efficient than maintaining a separate engineering group foreach product group 7 The network structure I L V l I z Contact Nodes person Workers or worker groups contribute to multiple organizational task Work groups are reconfigured when the tasks change Relationships among groups are governed bythe requirements ofthe task 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 Contingency Theory 0 Contingency theory suggests that a particular structure will not be the optimal structure for a firm under all circumstances 0 Contingency theory focuses on three factors that affect the efficiency of a structure 7 Technology and task interdependence 7 Information flows 7 Tension between differentiation and integration Technology and Task Interdependence 0 There can be three modes of task interdependence 7 Reciprocal when two workers or work groups depend on each other 7 Sequential when one worker or work group has a one way dependence on another 7 Pooled when there is no direct dependence but indirect dependence exists because of common goals 0 Changes in technology will cause the nature of task independence to change 0 The organizational structure may need to be changed in response to the change in task interdependence 0 Example Technology has weakened the sequential and reciprocal interdependencies in some industries and has made outsourcing attractive Information Flows 0 When work is routine workers can be autonomous 0 When exceptions need to be handled higher level hierarchies are involved and information flow becomes important 0 The firm s organizational structure should enable the desired amount and speed of information flow to occur 0 Workers in the higher levels deal with more difficult exceptions that occur less frequently 0 Higher levels have fewer workers with larger human capital 0 Technological changes reduce the cost of information flow and increase the span of control flatter organization Information Retrieval 0 According to Arthur Stinchcombe the optimal structure should enable efficient information retrieval 0 Different levels of structure will deal with different types of information 0 To make information retrieval efficient the firm should integrating into the firm activities that provide critical information Balancing Differentiation and Integration 0 If the organizational structure does not sufficiently differentiate the firm may inefficiently use a llone size fits all approach to all products and regions 0 For integrated planning and control too much differentiation can be an impediment The optimal structure should balance differentiation and integration Structure Follows Strategy The Uform structure allowed firms to exploit the economies of scale in production marketing and distribution When firms began to diversify the Uform became cumbersome and Mform emerged as a better alternative The Mform lead to duplication of activities when firms expanded globally and created quotinternational 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 knowledgebased view of the firm 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 StructureStrategy Evolutionary economics offer two new views on structurestrategy relationship 7 Structure and strategy evolve over time through local external interactions rather than through top management initiative 7 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 7 Strategy and structure changes will be evolutionary rather than revolutionary 7 Large scale strategy changes and comprehensive reorganizations will be rare 7 Current decision regarding strategy and structure will be constrained by past decisions Cnvpnvale Infnmlalinn Organixalinn Chan China Telemm V Shuelml e Maelan macmums lt I Ramunamu cummu Baum M mman 5quotquotme Cnmmmuu I Marylin on cumulus lt quot Cnninnun I CEO I Swenmow Devlnmm A u Iquot J new Cumquot Wnnwm E mes I a T yy n e y n gt mamaquot Mnka ngDapmmem lt a I wagmug n I e quotgmquot lt quot mummnawmam W mumquot valnlDupnnmuM wag Iglu m lt N quotODIx lnnlnd quotmm mm memm mmmgmpnmm Au ilmgnwnnmem quotWAMmquot 0 hmmmmn cmmm mm mm sun hat Rusumh quotmm e RIMvan quotmm