Economics of Strategy
Seventh Edition
Besanko, Dranove, Shanley, and Schaefer
Chapter 13
Strategy and Structure
Copyright 2016 John Wiley Sons, Inc.
Strategy and Structure
The choice of organizational structure depends on
the business strategy of the firm
Organizations structure is about
how critical tasks are divided up
how managers and employees make decisions
routines and information flows that support operations
Structure Follows Strategy
Structure defines the nature of agency problems within
the firm.
The right structure provides workers with information,
coordination and incentives to implement strategy.
The importance of structure persists even in the face of
the growth of the internet, globalization and changing
demographics of the workforce.
Organizational Forms
A small group of employees within a firm can be
organized in several ways
Each member may be treated as an individual 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 & Organizational Forms
Different forms are effective 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 & Organizational Forms
In large firms hierarchy of authority may be needed.
Beyond a certain size, self managed teams may not
perform well in coordination.
Extent of control will depend on the severity of the
agency problems and the attendant influence costs.
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
Firm Boundaries & Departmentalization
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
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
Coordination and Control
Coordination involves
the flow of information to facilitate decisions that further the
organization’s objectives and
the distribution of decision making rights and rule making
authority within the organization.
Coordination and control choices will affect both
technical efficiency and agency efficiency.
Coordination, Control, & 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, & 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.
Approaches to Coordination
A firm can organize using autonomous work units with
related to operating decisions being controlled by the
manager of the unit.
A common approach is profit centers with target profit
goals.
When profit targets are not appropriate the units
become responsibility centers (Example: R & D).
Approaches to Coordination
Instead of self contained units 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.
Lateral relations become essential when coordination
among groups is needed to exploit economies of
scale/scope.
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
dimensions while being decentralized in others
For example, in a university administrative functions
may be centralized while the 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 Functional (U-form) Structure
Each department in the firm is responsible for a
particular functional area such as finance or marketing.
U-form promotes performance within the department
but makes coordination across departments difficult.
The unitary functional structure is suitable for stable
conditions when operating efficiency is the prime
consideration.
The Functional (U-form) Structure
The Multidivisional (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.
The Multidivisional (M-form) Structure
Advantages of the M-form
Measuring divisional performance is easier under M-
form.
Pay for performance schemes are easier to implement in
managerial compensation.
Divisional managers compete for funds in the internal
capital markets based on their operating performance in
the past.
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.
The demands of competing dimensions should be
roughly equal.
Matrix Structure
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.
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.
Network Structure
Network structure is designed around the worker rather
than the task.
Workers or worker groups contribute to multiple
organizational tasks.
Work groups are reconfigured when the tasks change.
Network of autonomous firms can function as a virtual
firm.
Network Structure
Network Structure
Network structure is preferred when coordination costs
do not outweigh the gains in technical efficiency.
The Japanese Keiretsu is an example of network
structure.
In high technology companies, network structure
facilitates the flow of diverse information, leading to
high level of new product development.
Network Structure
Network structures are becoming more popular as the
cost of organizing has fallen.
Internet provides a less expensive infrastructure for
network organizations than traditional means of data
exchange.
Modular Organization
A modular organization has a network structure with
subunits that are relatively self contained.
Modularity may sacrifice economies of scope.
Networks can grow and change in a piecemeal fashion
without major disruptions in the rest of the firm.
Modularity may encourage innovations at the subunit
level.
Limited Variety of Organizations Structures
Organizational design choices tend to cluster together.
One possible reason is imitation among firms.
Complementarities among design variables could be
another. (Example: product differentiation and product
design.
Design variables can also be substitutes.
Limited Variety of Organizations Structures
Interdependence between organizational design
variables will affect the structural type.
Since design variables cannot be changed independently
any “mix and match” approach will not be feasible.
Strategy-Environment Coherence
Optimal choice of structure depends on the environment
the firm is set in.
Types of environmental factors that affect the choice of
structure are
technology and task interdependence and
information processing.
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
Technology has weakened the sequential and reciprocal
interdependencies in some industries and has made
outsourcing attractive
Efficient Information Processing
When work is routine, workers can be autonomous.
Workers in the higher levels deal with more difficult
exceptions that occur less frequently.
Workers are fewer in higher levels and they posses
more expertise (pyramidal structures).
Efficient Information Processing
Technological changes reduce the cost of information
flow and increase the span of control.
The firm’s organizational structure should change
depending on the changing information needs and
technology.
Information Retrieval
The optimal structure should enable efficient
information retrieval (Stinchcombe).
Different levels of organizational structure will deal
with different types of information.
Activities that provide critical information should be
integrated into the firm.
Balancing Differentiation & 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 in the 19 th century
to exploit the economies of scale in production,
marketing and distribution.
When firms began to diversify in the 20 th century 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, & Capabilities
Critical knowledge and decision capabilities are
distributed throughout the firm in large firms
(Hammond).
Structure determines the shortlist of alternatives that
reach the top management.
Structure also induces biases in the information
reaching the top management.
Structure, Strategy, Knowledge, & Capabilities
Structure influences how strategies are implemented
and how top management is informed regarding the
implementation.
Structure also provides rules for resolving
implementation disputes.
Formal administrative control should be supplemented
by informal means of winning the cooperation from
lower levels.
Structure as Routine
Firms use routines – complex sets of behavior patterns.
The routines make it easy for the firm to respond to
complex information from the environment.
Routines are part of a firm’s competencies.
Structure as Routine
Routines evolve through experiments in the face of new
problems.
Satisfactory solutions are “remembered” as routines.
Routines also emerge in conflict resolution, incentives
and control.
Structure, Strategy, & Evolutionary Economics
Strategy and structure evolve over time through local
interactions with the environment rather than through
top management initiative.
A firm’s structure is an outcome of a long series of
adaptations.
Structure, Strategy, & Evolutionary Economics
Strategy and structure can also be viewed as high level
heuristics.
Strategy is a set of principles for managerial action.
Structure is a set of principles for coordination within
the firm.
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