Organizations and Environments MBA 540 Summer 2006

Essential Features of Organizations Open system: input, transformation, output Subsystems: boundary spanning, production, maintenance, adaptation, management Domains: range of products and services produced for serving markets and customers Environmental transactions: dealing with factors outside the organizational boundaries

Open Systems View of Organization ENVIRONMENT Raw Materials Resources Products Services Transformation Output Input Organization Production Maintenance Adaptation Management Boundary Spanning Boundary Spanning Subsystems

Let’s Consider Hasbro Toy industry's growth prospects appear to be maturing Increasing competition from video games, children's changing tastes, and consolidation of the industry's retail customer base. Toy companies are increasingly dependent on movies and TV shows for product tie-ins What are the major external challenges facing Hasbro? www.hasbro.com

Changing Environments Environmental Change Environmental Complexity Resource Scarcity Uncertainty External environments are all events outside a company that have the potential to influence or affect it.

Environmental Change Environmental change is the rate at which a company’s environments change stable environments dynamic environments Punctuated equilibrium theory companies cycle through stable and dynamic environments The rate of environmental change affects many organizational aspects, particularly decision making. In stable environments, the rate of environmental change is slow - decision makers can be more deliberate. In dynamic environments, the rate of environmental change is fast - decision makers must be nimble and quick. The fast-paced world of EA Sports is a good example of a dynamic environment. While it would seem that companies would either be in stable external environments or dynamic external environments, recent research suggests that companies often experience both stable and dynamic external environments. Punctuated equilibrium theory says that companies go through long, simple periods of stability (equilibrium), followed by short, complex periods of dynamic, fundamental change (revolutionary periods), finishing with a return to stability (new equilibrium).

Punctuated Equilibrium As shown in Exhibit 2.1, one example of punctuated equilibrium is the U.S. airline industry. Three times in the last 25 years, the U.S. airline industry has experienced revolutionary periods. The first, from mid-1979 to mid-1982, occurred immediately after airline deregulation in 1978. Prior to deregulation, the federal government controlled where airlines could fly, when they could fly, and the number of flights they could have on a particular route. After deregulation, these choices were left up to the airlines. The large financial losses during this period clearly indicate that the airlines had trouble adjusting to the intense competition that occurred after deregulation. However, by mid-1982, profits returned to the industry and held steady until mid-1989. Then, after experiencing record growth and profits, U.S. airlines lost billions of dollars between 1989 and 1993 as the industry went through dramatic changes. Key expenses, like jet fuel and employee salaries, which had held steady for years, suddenly increased. Furthermore, revenues, which had grown steadily year after year, suddenly dropped because of dramatic changes in the airlines’ customer base. Business travelers, who typically pay full-priced fares, comprised more than half of all passengers during the 1980s. But now, the largest group is leisure travelers who, in contrast to business travelers, want the cheapest flights they can get. With expenses suddenly up and revenues suddenly down, the airlines responded to these changes in their business environment by laying off 5-10 percent of all workers, canceling orders for new planes, and getting rid of routes that were not profitable. Starting in 1993 and lasting until 1998, these changes helped profits return even stronger. The industry began to stabilize, if not flourish, just as punctuated equilibrium theory predicts. Source: “Annual Operating and Net Earnings: U.S. Scheduled Airlines—All Services,” Air Transport Association, [Online] Available http://www.air-transport.org/public/industry/display1.asp?nid=1034, 6 February 2003.

Environmental Complexity Environmental complexity: the number of external factors in the environment that affect organizations Simple environments have few environmental factors Example? Complex environments have many environmental factors The more complex an organization’s environment is, the more difficult it is for its managers to make decisions. Increasing complexity means that managers must track and deal with more environmental factors. The changing nature of Kellogg’s environment is a good example of an organization dealing with an increasingly complex environment. Cereal companies face more competition, have been forced to make price cuts, and have been threatened by cheaper private-label store brands, such as those by Wal-Mart.

Environmental Uncertainty Simple -Complex Dimension Number of elements and their similarity Family restaurant vs. automobile manufacturer Determines what information you need Stability-Change Dimension how fast and unpredictably elements change Universities vs. telecommunications Determines how often you need to collect information

Environmental Uncertainty Rate of Change Low High Low Uncertainty Moderate Uncertainty Low (Information known and available) (Constantly need new information) Complexity Moderate Uncertainty High Uncertainty High (Information overload) (Information needs unknown)

Resource Scarcity Resource scarcity (vs. munificence) is the degree to which an organization’s external environment has an abundance or scarcity of critical organizational resources The third characteristic of external environments is resource scarcity: the degree to which an organization’s external environment has an abundance or scarcity of critical organizational resources. From 1995 to 2000, qualified employees were scarce in many industries. The reason was simple: Demand for job applicants exceeded the supply. In fact, the number of job openings at companies was five times greater than the number of layoffs. Consequently, employers had to work harder to find and attract skilled employees, especially in technological and professional jobs. For example, Cisco Systems started a “Friends” program to help recruit more engineers. When potential job applicants visit Cisco’s Internet home page to read about job openings, they would visit the “Friends” page, where they would electronically submit their resumes. When this happened, an e-mail would automatically be forwarded to a Cisco employee who had volunteered to be a “Friend.” That “Friend” would then call the job applicant within 24 hours. The program, which was an overwhelming success, helped Cisco solve the problem of job applicant scarcity. However, there’s no longer a scarcity of job applicants. In the last two years, unemployment has risen and jobs are being eliminated. Cisco has put its “Friends” program on hold. The bad news is good news for companies wishing to attract qualified workers. It is now easier to find and hire qualified employees, who are no longer as scarce as they were just a few years ago.

Environmental Uncertainty Uncertainty is how well managers can understand or predict the external changes and trends affecting their businesses More Uncertainty More Complexity More Change Scarcer Resources + +

Types of Environmental Factors Exhibit 2.3 shows the two kinds of external environments that influence organizations: the general environment and the specific environment. The general environment consists of the economy and the technological, sociocultural, and political/legal trends that indirectly affect all organizations. Changes in any sector of the general environment eventually affect most organizations. For example, most businesses benefit when the Federal Reserve lowers its prime lending rate, because banks and credit card companies will then lower the interest rates they charge for loans. Consumers, who can then borrow money more cheaply, will borrow more money to buy homes, cars, refrigerators, and large-screen TVs. By contrast, each organization has a specific environment that is unique to that firm’s industry and directly affects the way it conducts day-to-day business. The specific environment, includes customers, competitors, suppliers, industry regulation, and advocacy groups. Specific factors directly impinge on particular organization General factors affect all companies within an industry

Organization-Environment Interface Task (specific) factors Customers Suppliers Distributors Regulatory agencies Competitors Unions Partners Special Interest Groups General factors Economic International Political/legal Technology Demographic Cultural/social Physical/natural resources Example: Home Depot

Theories of Organization-Environment Relationships Contingency Theory Resource Dependence Strategic Choice Population Ecology Institutional Theory Transaction Cost Theory

Contingency Theory Most effective way to organize is contingent on complexity and change in environment Stable environments: Mechanistic structures (specialization, formality, hierarchy) Changing environments: Organic structures (less specialization, informality, lateral relations)

Resource Dependence Organizations obtain scarce and valued resources from environments Desire to control these resources to minimize dependencies Processes and transactions used to obtain resources develop dependencies Balancing act of maintaining autonomy and recognizing dependencies

Strategic choice Managers perceive environments Make strategy and design structure Re-strategize when changes are perceived Managers enact environments through their decision-making choices Since managers perceive differently, they bring organizations in different directions Example: Sears vs. Montgomery Ward

Population Ecology Focus is on whole population of organizations (e.g., gasoline stations in Canada; wine industry in California) Natural selection processes: Variation Selection Retention Unsuccessful organizational forms die out Environmental determinism

Institutional Theory Societal institutions are powerful forces for ensuring control and order In responding to institutional pressures, organizations develop isomorphic (similar) strategies, structures, and systems Normative, coercive, and mimetic forces make “all organizations look the same” Goal is to obtain social legitimacy Example: banks, universities, discount stores

Transaction Cost Theory Organizations try to reduce monitoring, negotiating, and governing exchanges with environmental elements (transaction costs) Environmental uncertainty, opportunism, bounded rationality, small numbers bargaining, asset specificity, and risk levels increase transaction costs Transaction and bureaucratic costs balanced

What specific adaptation devices do organizations use? Structural Responses Develop new positions or units Boundary-spanning activities Buffering roles and units Planning Groups Forecasting Management Information Systems

Specific Adaptation Devices Inter-organizational Linkages: Symbiotic interdependencies Benefit both organizations Competitive interdependencies Direct competition for scarce resources

Symbiotic Interdependencies Good reputation Cooptation Interlocking directorates Strategic alliances Long-term Contracts Equity ownership in other firms Joint ventures Mergers, acquisitions, and takeovers Licensing Consortia Marketing or distribution agreements Franchising

Competitive Interdependencies Collusions Signaling Cartels Trade associations Regulatory bodies Competitive strategic alliances Networking