International Business 7e by Charles W.L. Hill McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

International Business Chapter 13 The Organization of International Business

Introduction Organizational architecture refers to the totality of a firm’s organization, including formal organization structure, control systems and incentives, processes, organizational culture, and people To be the most profitable, firms need to be sure: the different elements of the organizational architecture are internally consistent the organizational architecture matches or fits the strategy of the firm the strategy and architecture of the firm are consistent with each other, and consistent with competitive conditions

Organizational Architecture Organizational structure refers to: the formal division of the organization into subunits the location of decision-making responsibilities within that structure (centralized versus decentralized) the establishment of integrating mechanisms to coordinate the activities of subunits including cross-functional teams or pan-regional committees Control systems are the metrics used to measure performance of subunits and make judgments about how well managers are running those subunits Structure and control systems establish decision-making responsibilities and integration mechanisms.

Organizational Architecture Incentives are the devices used to reward appropriate managerial behavior Processes are the manner in which decisions are made and work is performed within the organization Organizational culture refers to the norms and value systems that are shared among the employees of an organization People refers to not just the employees of the organization, but also the strategy used to recruit, compensate, and retain those individuals and the type of people they are in terms of their skills, values, and orientation

Organizational Architecture Figure 13.1: Organizational Architecture

Classroom Performance System The norms and value systems that are shared among the employees of an organization are called a) processes b) organizational culture c) control systems d) incentives The answer is b.

Organizational Structure Organizational structure has three dimensions: 1. Vertical differentiation - the location of decision-making responsibilities within a structure 2. Horizontal differentiation - the formal division of the organization into sub-units 3. The establishment of integrating mechanisms - the mechanisms for coordinating sub-units

Vertical Differentiation: Centralization And Decentralization Vertical differentiation determines where decision-making power is concentrated Centralized decision-making: facilitates coordination ensure decisions consistent with organization’s objectives gives top-level managers the means to bring about organizational change avoids duplication of activities

Vertical Differentiation: Centralization And Decentralization Decentralized decision-making: relieves the burden of centralized decision-making has been shown to motivate individuals permits greater flexibility can result in better decisions can increase control It can be worthwhile to centralize some decisions and decentralize others

Classroom Performance System Which of the following is not an advantage of centralized decision-making? a) It facilitates coordination b) It motivates employees c) It gives top-level managers the means to bring about organizational change d) It avoids duplication of activities The answer is b.

Horizontal Differentiation: The Design Of Structure Horizontal differentiation is concerned with how the firm decides to divide itself into sub-units The decision is usually based on: function type of business geographical area

Horizontal Differentiation: The Design Of Structure Most firms begin with no formal structure As they grow, the organization is split into functions reflecting the firm’s value creation activities (functional structure) The functions are typically coordinated and controlled by top management Decision-making tends to be centralized If the firm diversifies its product line, further horizontal differentiation may be necessary Firms may switch to a product divisional structure where each division is responsible for a distinct product line Most firms begin with no formal structure and are run by a single entrepreneur or a small team of individuals. As they grow, the demands of management become too great for one individual or a small team to handle. At this point the organization is split into functions reflecting the firm’s value creation activities (e.g., production, marketing, R&D, sales). These functions are typically coordinated and controlled by top management (see Figure 13.3). Decision making in this functional structure tends to be centralized.

Horizontal Differentiation: The Design Of Structure Figure 13.2: A Typical Functional Structure

Horizontal Differentiation: The Design Of Structure Figure 13.3: A Typical Product Divisional Structure

Horizontal Differentiation: The Design Of Structure When firms expand internationally, they often group all of their international activities into an international division In time it might prove viable to manufacture the product in each country The result could be that firms with a functional structure at home would replicate the functional structure in every country in which they do business and firms with a divisional structure would replicate the divisional structure in every country in which they do business The creates the potential for conflict and coordination problems between domestic and foreign operations When firms initially expand abroad, they often group all their international activities into an international division. This has tended to be the case for firms organized on the basis of functions and for firms organized on the basis of product divisions. Regardless of the firm’s domestic structure, its international division tends to be organized on geography. Figure 13.5 illustrates this for a firm whose domestic organization is based on product divisions.

Horizontal Differentiation: The Design Of Structure Figure 13.4: One Company’s International Divisional Structure Management Focus: The International Division at Wal-Mart Summary This feature explores Wal-Mart’s organizational architecture. When Wal-Mart initially expanded into international markets, it established an international division. Over time, however, this structure proved to be problematic, and was abandoned. Discussion of the feature can revolve around the following questions: 1. Why did the centralization of decisions at the headquarters of Wal-Mart’s international division create problems for the company’s different national operations? Has Wal-Mart’s response been appropriate? Answer: When Wal-Mart began its international expansion, it set up an international division to handle all foreign operations. However, over time, this approach proved to be challenging. Managers in foreign countries had to get permission from Bentonville before they could make any changes in strategy or operations. Not only did this approach slow decision-making, also meant that decisions were being made by managers who were removed from the local situation. Wal-Mart began to change this approach when it acquired Britain’s ASDA supermarket chain. Today, the company has given greater responsibility to local managers particularly in merchandising and operations. 2. Do you think that having an international division is the best structure for managing Wal-Mart’s foreign operations? What problems might arise with this structure? What other structure might work? Answer: Most students will probably suggest that while the international division may have been a good strategy at the beginning of Wal-Mart’s expansion into foreign markets, as foreign revenues have grown, approach no longer works. Many students will probably suggest that Wal-Mart consider moving towards a transnational approach where it could respond to local markets and at the same time, respond to the pressure to minimize costs. Another Perspective: To learn more about Wal-Mart’s foreign operations, go to the company’s web site at {http://www.walmart.com}.

Horizontal Differentiation: The Design Of Structure Many firms that continue to expand will abandon their international division structure and move to either a: Worldwide product divisional structure - tends to be adopted by diversified firms that have domestic product division Worldwide area structure - tends to be adopted by undiversified firms whose domestic structures are based on functions Many firms that continue to expand internationally abandon this structure and adopt one of the worldwide structures we discuss next. The two initial choices are a worldwide product divisional structure, which tends to be adopted by diversified firms that have domestic product divisions, and a worldwide area structure, which tends to be adopted by undiversified firms whose domestic structures are based on functions. These two alternative paths of development are illustrated in Figure 13.6. The model in the figure is referred to as the international structural stages model and was developed by John Stopford and Louis Wells.

Horizontal Differentiation: The Design Of Structure Figure 13.5: The International Structural Stages Model

Horizontal Differentiation: The Design Of Structure The worldwide area structure: is favored by firms with low degree of diversification and a domestic structure based on function divides the world into autonomous geographic areas decentralizes operational authority facilitates local responsiveness can result in a fragmentation of the organization is consistent with a localization strategy

Horizontal Differentiation: The Design Of Structure The worldwide product division structure: is adopted by firms that are reasonably diversified allows for worldwide coordination of value creation activities of each product division helps realize location and experience curve economies facilitates the transfer of core competencies does not allow for local responsiveness

Horizontal Differentiation: The Design Of Structure Figure 13.6: A Worldwide Product Divisional Structure

Horizontal Differentiation: The Design Of Structure The global matrix structure is an attempt to minimize the limitations of the worldwide area structure and the worldwide product divisional structure The global matrix structure: allows for differentiation along two dimensions - product division and geographic area has dual decision–making - product division and geographic area have equal responsibility for operating decisions can be bureaucratic and slow can result in conflict between areas and product divisions can result in finger-pointing between divisions when something goes wrong

Horizontal Differentiation: The Design Of Structure Figure 13.7: A Global Matrix Structure Management Focus: The Rise and Fall of Dow Chemical’s Matrix Structure Summary This feature explores the organization architecture at Dow Chemical. For years, despite having difficulties when it was initially implemented, the company relied on a matrix structure. However, when the company changed its strategy, its structure had to change as well. Discussion of the feature can revolve around the following questions: 1. Why did Dow first adopt a matrix structure? What were the problems with this structure? Do you think these problems are typical of matrix structures? Answer: Dow Chemical initially adopted the matrix structure because it would allow the company to be responsive to both local market needs and corporate objectives. However, when it was first adopted, the structure did not work well. The dual chain of control led to turf battles and a lack of accountability, however, Dow felt that by making the structure more flexible it could still work. The company had moved into the pharmaceuticals business where local responsiveness was important as was the need to conscious of costs. Many students will probably agree that the dual chain of command associated with the matrix structure makes it challenging, however at least according to Dow, there are ways to make it work. In fact, Dow credits the structure for much of its success prior to the mid-1990s. b) What drove the shift away from the matrix structure in the late 1990s? Does Dow’s structure now make sense given the nature of its businesses and the competitive environment it competes in? In the mid-1990s, Dow divested itself of its pharmaceuticals activities, and changed its structure to reflect its new strategy. The company shifted to global business divisions as way to reduce costs and streamline decision-making. Dow felt that given its new focus on bulk chemicals, the new structure would work better. Another Perspective: To find out more about Dow Chemical’s current strategy and organizational architecture, go to the company’s web site at {http://www.dowchemical.com}.

Classroom Performance System Most firms begin their international expansion with a(n) ________ structure. a) Matrix b) Worldwide product division c) Worldwide area division d) International division The answer is d.

Classroom Performance System Which type of organization structure has a dual decision-making system? a) Matrix b) Worldwide product division c) Worldwide area division d) International division The answer is a.

Integrating Mechanisms Regardless of the type of structure, firms need a mechanism to integrate subunits The need for coordination is lowest in firms with a localization strategy and highest in transnational firms Coordination can be complicated by differences in subunit orientation and goals The simplest formal integrating mechanism is direct contact between subunit managers, followed by liaisons Temporary or permanent teams composed of individuals from each subunit is the next level of formal integration Finally, the matrix structure allows for all roles to be integrating roles Managers A, B, and C all know each other personally, as do managers D, E, and F. Although manager B does not know manager F personally, they are linked through common acquaintances (managers C and D). Thus, we can say that managers A through F are all part of the network, and also that manager G is not. Imagine manager B is a marketing manager in Spain and needs to know the solution to a technical problem to better serve an important European customer. Manager F, an R&D manager in the 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 who might be able to provide a solution. Manager C asks manager D, who tells manager F, who then calls manager B with the solution. In this way, coordination is achieved informally through the network, rather than by formal integrating mechanisms such as teams or a matrix structure.

Integrating Mechanisms Figure 13.8: Formal Integrating Mechanisms

Integrating Mechanisms Many firms are using informal integrating mechanisms A knowledge network is a network for transmitting information within an organization that is based not on formal organization structure, but on informal contacts between managers within an enterprise and on distributed information systems A knowledge network is a non bureaucratic conduit for knowledge flows To be successful, a knowledge network must embrace as many managers as possible and managers must adhere to a common set of norms and values that override differing subunit orientations

Integrating Mechanisms Figure 13.9: A Simple Management Network

Controls Systems And Incentives A firm’s leaders need to ensure that the actions of subunits are consistent with the firm’s overall strategic and financial objectives This is achieved through control and incentive systems A major task of a firm’s leadership is to control the various subunits of the firm—whether they be defined on the basis of function, product division, or geographic area—to ensure their actions are consistent with the firm’s overall strategic and financial objectives. Firms achieve this with various control and incentive systems.

Types Of Control Systems There are four main types of control systems: 1. Personal controls – control by personal contact with subordinates Most widely used in small firms 2. Bureaucratic controls – control through a system of rules and procedures that directs the actions of subunits The most important bureaucratic controls are budgets and capital spending rules

Types Of Control Systems 3. Output controls – setting goals for subunits to achieve and expressing those goals in terms of relatively objective performance metrics Control is achieved by comparing actual performance against targets and intervening selectively to take corrective action 4. Cultural controls – exist when employees “buy into” the norms and value systems of the firm Firms with strong culture have less need for other forms of control

Classroom Performance System Which is not one of the four types of control systems? a) Cultural control b) Personal control c) Input control d) Bureaucratic control The answer is c.

Incentive Systems Incentives are the devices used to reward behavior Incentives are usually closely tied to performance metrics used for output controls Incentives: should vary depending on the employee and the nature of the work being performed should promote cooperation between managers in sub-units should reflect national differences in institutions and culture can have unintended consequences

Control Systems, Incentives, And Strategy In The International Business The key to understanding the relationship between international strategy, control systems and incentive systems is performance ambiguity - which exists when the causes of a subunit’s poor performance are not clear The cost of control rises as performance ambiguity increases The costs of control can be defined as the amount of time top management must devote to monitoring and evaluating subunits’ performance. This is greater when the amount of performance ambiguity is greater. When performance ambiguity is low, management can use output controls and a system of management by exception; when it is high, managers have no such luxury. Output controls do not provide totally unambiguous signals of a subunit’s efficiency when the performance of that subunit is dependent on the performance of another subunit within the organization. Thus, management must devote time to resolving the problems that arise from performance ambiguity, with a corresponding rise in the costs of control. Table 13.1 reveals a paradox. We saw in Chapter 12 that a transnational strategy is desirable because it gives a firm more ways to profit from international expansion than do localization, international, and global standardization strategies. But now we see that due to the high level of interdependence, the costs of controlling transnational firms are higher than the costs of controlling firms that pursue other strategies. Unless there is some way of reducing these costs, the higher profitability associated with a transnational strategy could be canceled out by the higher costs of control.

Control Systems, Incentives, And Strategy In The International Business Performance ambiguity: is common when a subunit’s performance is dependent on the performance of other subunits is lowest in firms with a localization strategy higher in international firms still higher in firms with a global standardization strategy and highest in transnational firms

Control Systems, Incentives, And Strategy In The International Business Table 13.1: Interdependence, Performance Ambiguity, and the Costs of Control for the Four International Business Strategies

Processes Processes refer to the manner in which decisions are made and work is performed Many processes cut across national boundaries as well as organizational boundaries Processes can be developed anywhere within a firm’s global operations network Formal and informal integrating mechanisms can help firms leverage processes

Organizational Culture Culture refers to a systems of values and norms that are shared among people Organizations have their own values and norms that employees are encouraged to follow Organizational culture tends to change very slowly Management Focus: Culture and Incentives at Lincoln Electric Summary This feature examines the incentive system and organizational culture at Lincoln Electric. The company believes in treating everyone equally, and basing pay on individual output. Discussion of the feature can revolve around the following questions: 1 To what extent are the organization culture and incentive systems of Lincoln Electric aligned with the firm’s strategy? Answer: Lincoln Electric stresses that individuals should be rewarded for their individual efforts, and that everyone who works for the company should be treated equally. Accordingly, employee pay depends on individual output, everyone eats in the same cafeteria, parks in the same lot, and so on. Because employees can boost their pay significantly by working harder and being innovative, the company as a whole becomes more productive. 2. How was the culture at Lincoln Electric created and nurtured over time? Answer: Lincoln Electric has a long tradition of equality and fairness. Since 1934, employees have been assessed both objectively and subjectively. Objective criteria include the level and quality of an individual’s output, while subjective criteria include attitudes and dependability. Workers actually have the ability to double their base pay. Even so, because productivity is so high, Lincoln Electric is the low cost leader in the industry. 3. Why did the culture and incentive systems work well in the United States? Why did it not take in other nations? Answer: In the United States, a country that encourages individualism, Lincoln Electric’s emphasis on individual performance has been very successful. However, in other countries, this approach has met with some resistance. In some countries, Lincoln Electric’s pay-per-output approach was considered exploitative. In Germany, it was actually illegal! In addition, in some countries the incentive of more money for more output was not valued. Many European placed a greater value on more leisure time for example. In countries where Lincoln Electric expanded through acquisition, unionized employees opposed the compensation approach. Another Perspective: For additional information on Lincoln Electric, go to the company’s web site at {http://www.lincolnelectric.com}.

Creating And Maintaining Organizational Culture Organizational culture comes from: founders and important leaders national social culture the history of the enterprise decisions that resulted in high performance Organizational culture can be maintained through: hiring and promotional practices reward strategies socialization processes communication strategies

Organizational Culture And Performance In The International Business Managers in companies with a “strong” culture share a relatively consistent set of values and norms that have a clear impact on the way work is performed A “strong” culture: is not always good may not lead to high performance could be beneficial at one point, but not at another Companies with adaptive cultures have the highest performance

Synthesis: Strategy And Architecture What is the interrelationship between the four basic strategies (localization, international, global standardization, and transnational) and organization architecture?

Synthesis: Strategy And Architecture Table 13.2: A Synthesis of Strategy, Structure, and Control Systems

Localization Strategy Firms pursuing a localization strategy focus on local responsiveness. They do not have a high need for integrating mechanisms Performance ambiguity and the cost of control tends to be low The worldwide area structure is common

International Strategy Firms pursuing an international strategy create value by transferring core competencies from home to foreign subsidiaries. The need for control is moderate The need for integrating mechanisms is moderate Performance ambiguity is relatively low and so is the cost of control The worldwide product division structure is common

Global Standardization Strategy Firms pursuing a global standardization strategy focus on the realization of location and experience curve economies. Headquarters maintains control over most decisions The need for integrating mechanisms is high Strong organizational cultures are encouraged The worldwide product division is common

Transnational Strategy Firms pursuing a transnational strategy focus on simultaneously attaining location and experience curve economies, local responsiveness, and global learning. Some decisions are centralized and others are decentralized The need for coordination is high An array of formal and informal integrating mechanism are used The cost of control is high A strong culture is encouraged Matrix structures are common

Environment, Strategy, Architecture, And Performance For a firm to succeed, two conditions must be met: 1. the firm’s strategy must be consistent with the environment in which the firm operates 2. the firm’s organization architecture must be consistent with its strategy

Organizational Change Firms need to change their architecture to reflect changes in the environment in which they are operating and the strategy they are pursuing

Organizational Inertia Organizations are difficult to change Sources of inertia include: the existing distribution of power and influence the current culture senior managers’ preconceptions about the appropriate business model or paradigm institutional constraints

Implementing Organizational Change There are three basic principles for successful organization change: 1. Unfreeze the organization through shock therapy Effective change requires taking bold actions like plant closures or dramatic structural reorganizations 2. Moving the organization to a new state through proactive change in architecture Movement requires a substantial change in the form of a firm’s organizational architecture so that it matches the desired new strategic posture Movement should be done quickly 3. Refreeze the organization in its new state Refreezing requires that employees be socialized into the new way of doing things

Classroom Performance System Which type of organizational structure is often associated with a transnational strategy? a) worldwide area division b) worldwide product division c) matrix d) international division The answer is c.