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To define the organizational environment and organizational domain. (3.1)

To distinguish between the specific and general environment. (3.1)
To discuss the sources of uncertainty in the environment: complexity, dynamism, and richness. (3.1)
To review resource dependence theory. (3.2)
To examine strategies for managing symbiotic resource interdependencies. (3.4)
To examine strategies for managing competitive interdependencies. (3.5)
To review transaction cost theory. (3.6)

An organizations domain includes its goods and services and its customers. An organization must cope
with forces in the specific and general environments. Specific environmental forces include outside
stakeholder groups that directly impact the ability to obtain resources: customers, distributors, unions, the
government, competitors, and suppliers. General environmental forces include: economic, international,
technological, demographic and cultural, political, and environmental forces. Complexity, dynamism, and
richness determine the extent of environmental uncertainty. A simple, stable, rich environment has some
uncertainty, but a complex, dynamic, poor environment is highly uncertain. The global marketplace
makes the environment highly uncertain.

Transaction cost theory considers the costs of interorganizational linkage mechanisms. An organization
should choose the linkage that provides the greatest transaction cost savings at the lowest bureaucratic
costs. Sources of transaction costs include: environmental uncertainty, bounded rationality, need to
prevent opportunism, and risk involved with specific asset investments. Because formal linkage
mechanisms increase bureaucratic costs, an organization should use informal linkages when transaction
costs are low. Mechanisms to minimize transaction costs and avoid bureaucratic costs include: keiretsu,
franchise, and outsourcing.


How can the environment be managed? Resource dependence theory states that an organization should
minimize its dependence on scarce resources. In the specific environment, organizations have symbiotic
and competitive interdependencies. Strategies for managing symbiotic resource interdependencies
include: developing a good reputation; co-optation; strategic alliances to include long-term contracts,
networks, minority ownership, and joint ventures; and mergers and takeovers. Strategies for managing
competitive interdependencies include: collusion and cartels; third-party linkage mechanisms; strategic
alliances; and mergers and takeovers.



What Is the Organizational Environment?

The resources surrounding an organization, such as raw materials and skilled workers, comprise the
organizational environment, and an organization conducts transactions to obtain these resources for
production. Resource procurement is impacted by competition, changes in technology, and input prices.
The organizational domain refers to the goods and services offered and the customers and other
stakeholders served; an organization designs transactions to enlarge its domain. An organization operates
in both specific and general environments. One way to enlarge the domain is to expand internationally.
The specific environment contains outside stakeholder groups who have a direct effect on obtaining
resources. Changes in the kinds of customers or in consumer tastes affect an organization. Strategies to
attract customers change to meet new customer needs. (Fig. 3.1)
Outside stakeholder groups include customers, distributors, suppliers, unions, competitors, and the
government. An organization deals with each group to attain resources for survival, protection, and
enlargement of its domain.
The general environment contains forces that affect all organizations and shape the specific
Q. Name the forces in the general environment.
A. Technological forces, including new production methods, impact operations.
Political and environmental forces impact government policy toward business and stakeholders,
and affect production costs.
Demographic, cultural, and social forces, including birthrates, age, and lifestyle of a nations
people influence demand.
By managing these environments effectively, a firm gains resources and the domain grows. Poor
environmental management shrinks a firms domain.

Refer to discussion question 1 here to give an example of the specific and general environments.

Organizational Insight 3.1 GEs U.S. Managers Stumble in Hungary

This case illustrates the complexities associated with expanding globally. In this case, there were
dramatically different expectations between workers and managers. This case also illustrates how
important it is to manage both the specific and general environmental forces in order to take advantage of
the global marketplace.




Sources of Uncertainty in the Organizational Environment

Because all organizations face uncertainty, managers cannot predict resource supply. Uncertainty stems
from complexity, dynamism, and richness of the environment. (Fig. 3.2)
Environmental complexity is a function of the strength, number, and interconnectedness of specific and
general forces. The greater the number and differences among them, the more complex, uncertain, and
difficult to manage is the environment. Managing 100 suppliers is easier than 1,000. Producing different
products for different customers increases complexity. The more interconnected the forces in specific and
general environment, the more uncertainty a firm faces.
Environmental dynamism is determined by how much and how fast specific and general environmental
forces change.
Q. When is an environment stable?
A. Stability means that environmental forces affect resource supply in a predictable way.
Q. When is an environment unstable and dynamic?
A. Dynamism means that environmental forces change quickly and unpredictably.
Environmental richness depends on the quantity of resources available for an organizations domain.
Q When is an environment rich?
A. Rich means abundant resources and low uncertainty.
Q. What makes an environment poor?
A. A poor environment is not only located in a poor country or region, but faces intense competition and
battles for resources.
Uncertainty is low in a simple, stable, and rich environment and high in a complex, unstable, and poor
environment. After determining its environmental forces, an organization plans environmental

A. In most industries, the global marketplace makes the environment more complex, dynamic, and rich.

Focus on New Information Technology:, Part 2 changed the whole nature of the bookselling environment.
Q. Describe the traditional environment for booksellers.


Q. How do global markets affect environmental stability?


A. Before Amazon, book publishers sold indirectly to wholesalers, who supplied small bookstores or
large chains like Barnes & Noble. In this stable, simple, and rich environment, uncertainty was low, and
large and small companies were profitable.
Q. How has changed the global environment?
A. By offering quick access to all books in print at a discount, Amazon created a higher level of industry
competition and made the industry environment poorer. Direct negotiation with publishers led to
increased environmental complexity because publishers, wholesalers, stores, and customers became more
closely linked. Information technology made the environment more unstable and resources harder to
secure. Small bookstores have closed, large bookstores compete online, and online bookstores do battle
in price wars, making the environment more uncertain and competitive.

Refer to discussion question 2 here for examples of environmental uncertainty.

Managerial Implications: Analyzing the Environment

Managers should analyze the organizational environment and identify sources of uncertainty. They
should chart these forces in the specific and general environments and plan how to deal with


Resource Dependence Theory

Resource supply is contingent on the complexity, dynamism, and richness of the environment. A poor
environment faces scarce resources. Resource dependence theory proposes that an organizations goal is
to minimize its reliance on other organizations for the supply of scarce resources. Two facets of resource
dependence must be managed: An organization must exert influence to get resources and respond to the
needs and demands of others in its environment.
Q. What causes dependence on another organization for a specific resource?


A. Dependence is contingent on two factors: how essential the input is to survival and the degree to
which others control the resource. An organization is more dependent if the resource is critical to
survival and tightly controlled.


Organizational Insight 3.2: Mighty Microsoft

Microsoft dominates the operating system market, a valuable input in producing effective applications
software. This makes Microsoft extremely powerful, and the company was found to have an unfair
advantage in a court of law.
Q. How does Microsoft manage resource dependence?
A. Microsoft is not dependent on others for resources. It controls the development of computer operating
systems, so companies depend on Microsoft. The control of this resource has increased Microsofts
market share.



Refer to discussion question 3 to review resource dependence theory.


Interorganizational Strategies for Managing Resource Dependencies.

The specific environment contains symbiotic and competitive interdependencies. Symbiotic

interdependencies occur when the outputs of one organization serve as the inputs for another, an
organization and its suppliers.
Q. What companies have symbiotic interdependencies?
A. Intel supplies chips for computer manufacturers such as Compaq. Auto manufacturers distribute cars
through dealers.



Strategies for Managing Symbiotic Resource Interdependencies

Cooperation is greater if strategy is formal. Four strategies for managing symbiotic resource
interdependencies include: developing a good reputation, co-optation, strategic alliance, and merger and
takeover. (Fig. 3.3)


Competitive interdependencies exist among organizations that compete for scarce resources.
An organization manages interdependencies through interorganizational strategies. Linkage mechanisms
connect companies and require coordinated actions, with a loss of freedom for independent action. A
contract requires compliance even if a firm can negotiate a better offer. The best interorganizational
strategy reduces uncertainty and provides the least loss of control.


Developing a Good Reputation

An organization can build a good reputation in the eyes of customers and suppliers through fairness and
honesty, high-quality goods and services, and prompt payment of bills. A dishonest company will be
unsuccessful in the long term. Developing a good reputation is the most frequently used linkage
mechanism for managing symbiotic interdependencies.
Co-optation is used to counter problematic forces in the specific environment. An organization brings
adversaries inside the organization.
Q. How can outsiders be brought inside the organization?
A. In many countries bribery is used, but it illegal in the United States. Some use an interlocking
directorate, a linkage whereby a director from one company sits on the board of another.
Strategic alliances, sharing of resources by several companies, are popular for managing
interdependencies. Alliances include: long-term contracts, networks, minority ownership, and joint
venture. The more formal agreements provide stronger linkages and tighter control over joint activities.
As environmental uncertainty increases, companies rely on formal alliances. (Fig. 3.4)
Long-term contracts reduce costs by sharing resources or spreading the risk associated with activities
such as marketing and R&D. Contracts, both written or verbal, are the most informal kind of alliance,
because the only connection is the agreement.
A network is a group that coordinates activities via contract. A network is more formal than a contract
because more ties connect members who share competencies such as R&D skills with partners. Partners
use those skills to increase efficiency and reduce the core organizations costs and size. A company can
perform design work and have partners produce the product.

Toyota is a capital keiretsu with a minority stake in suppliers; Toyota works with suppliers to improve
quality. A financial keiretsu is an interlocking directorate with members serving on the banks board. At
the Fuyo keiretsu. Fuji Bank is the center with members such as Nissan, Hitachi, and Canon. Members
have other companies with minority ownership in suppliers. (Fig. 3.5)
Joint ventures are formal strategic alliances among two or more companies to establish and share
ownership in a new business; a formal legal agreement defines rights and responsibilities. Each
organization sends managers to the new company. (Fig. 3.6)
Q. Name the advantages of joint ventures.
A. Participants can pool distinctive competences, design a new structure, keep parent companies small,
and reduce the difficulty of managing parent company interdependencies.


Minority Ownership occurs when organizations buy a stake in each other, forming a more formal
alliance. The Japanese keiretsu is a group of organizations, each of which owns shares in the other
organizations and works to further group interests. Japan has two types of keiretsu: Capital keiretsu to
manage input and output linkages and financial keiretsu for linkages among different companies, usually
with a bank at the center.


Mergers and takeovers are the most formal strategies for managing interdependencies. A merger or
takeover results in resource exchanges within organizations and prevents control by a powerful supplier
or customer. However, mergers and takeovers are costly, and problems arise in managing a new business.
This strategy is used if a company must control a critical resource or manage a significant


Strategies for Managing Competitive Resource Interdependencies

Competition increases uncertainty, but organizations can use strategies to manage competitive resource
interdependencies: collusion and cartels; third-party linkage mechanisms; strategic alliances; and mergers
and takeovers. A more formal strategy is an explicit attempt to coordinate a competitors activities. Some
strategies are illegal in the United States. (Fig. 3.7)

Collusion and Cartels

Collusion, a secret pact among competitors to share data for an illegal purpose, reduces competitive
uncertainty. A cartel, a group that coordinates activities, increases the stability and richness of an
organizations environment and reduces uncertainty.
Q. Give an example of a cartel.
A. The OPEC cartel controls the price of oil.
Although collusion and cartels are illegal in the United States, competitors still plot to coordinate
Q. How do companies collude in the United States?
A. Collusion includes: setting industry standards on pricing and product specifications; making
artificially high prices industry standards (a leader sets the price and competitors conform); and
signaling, a cue to competitors about price hikes and strategies through announcements.

An indirect way to coordinate activities is through a third-party linkage mechanism, a regulatory body
such as a trade association that shares information and governs competitive practices.
Advantages: Interaction decreases the concern about deceptive organizational practices. The association
can lobby the government for favorable industry policies. Third-party linkages assist in managing
resource interdependencies and reducing uncertainties. An increased information flow allows an easier
response. These linkage mechanisms let companies co-opt themselves and benefit from coordination.
Strategic alliances manage both symbiotic and competitive interdependencies. By cooperating in a joint
venture, competitors save money, deter new entrants, or harm competitors (e.g., developing technology
and obtaining a patent).


Third-Party Linkage Mechanisms


Mergers and takeovers strengthen a competitive position by increasing a firms domain and ability to
broaden its product range. Some companies use mergers to become the sole player in the marketplace, a
monopoly, which is illegal in the United States and most other developed countries.
Q. Why are cartels, collusion, and other anticompetitive practices bad for companies?
A. Competitors enter the industry due to changes in technology or government policies, and because
monopolies have faced no competition, their tall, mechanized structures make it hard to compete in a
dynamic environment.
Q. What companies faced this problem?
A. GM controlled its environment for a long time and then suffered greatly when the environment
changed. IBM and Xerox are similar examples.

Managerial Implications: Resource Dependence Theory

Managers should study each resource transaction and decide how to manage it. Managers should aim for
an informal linkage mechanism yet identify the purpose and problems of a strategic alliance to choose
between a formal or informal linkage mechanism. Transaction cost theory is useful for identifying the
costs and benefits of each linkage mechanism.


Transaction Cost Theory

Interorganizational strategies provide control over forces in the specific and general environments, and
large companies use them for environmental change. Transaction cost theory addresses why and when
organizations choose and change strategies.


Transaction costs are associated with negotiating, monitoring, and governing exchanges between people.
Transaction cost theory proposes that organizations should aim to minimize transaction costs for inside
dealings and outside transactions. Transaction costs reduce productivity; time spent monitoring and
negotiating exchanges could have created value.


Sources of Transaction Costs

Environmental uncertainty and bounded rationality: People have a limited ability, known as bounded
rationality, to process data and understand their environment. Bounded rationality makes it costly to
manage transactions in uncertain environments. To reduce transaction costs, organizations use formal
linkage mechanisms like minority ownership.
Opportunism and small numbers: The potential for opportunism is high when relying on one supplier
or a few trading partners. So, organizations increase transaction costs by using resources to enforce
agreements for protection.
Risk and specific assets: Investing in specific assets, one exchange relationship, is risky. After the
company invests, a customer may buy products at a lower price.
Transaction Costs and Linkage Mechanisms
Interorganizational linkage mechanisms depend on transaction costs. Transaction costs are low when
nonspecific goods and services are exchanged, uncertainty is low, and many exchange partners exist.
Companies use informal linkage mechanisms, such as reputation and unwritten contracts.
Transaction costs increase when more specific goods and services are exchanged, uncertainty increases,
and potential exchange partners decrease. Companies do not trust each other, so they use formal linkages,
such as contracts.
A rise in transaction costs leads to more formal linkage mechanisms to gain control. Joint venture
partners favor activities that create value for both parties. Merger partners seek mutual success, because
one firm owns the other. Transaction cost theory attributes the move from less to more formal linkage to
reducing transaction costs.

Using Transaction Cost Theory to Choose an Interorganizational Strategy

Transaction cost theory considers the costs of linkage mechanisms and forecasts when and why a strategy
should be selected. When choosing a strategy, managers must: Identify the sources of and level of
transaction costs; estimate the savings from using different linkage mechanisms; estimate the
bureaucratic costs, and select the linkage that achieves cost savings at the lowest level of bureaucratic

Organizational Insight 3.3: Ekco and its Suppliers

The Ekco Group offers a wide product range, including bakeware products, kitchen tools, household
plastic products, and pest control devices.
Q. How does Ekco Group manage interorganizational relationships?
A. The Ekco Group reduces customer transaction costs by offering a wide range of products, so
customers save by dealing with one supplier. Ekco has a new computer system that provides a just-intime inventory service to retailers that simplifies ordering and inventory tracking.


Bureaucratic Costs
Formal linkage mechanisms reduce transaction costs but may not be used because internal or
bureaucratic transaction costs are still incurred. Integration and communication are costly, whereas time
spent in a meeting could have created value.



Transaction cost theory suggests that formal linkage mechanisms are appropriate when transaction costs
are high. Otherwise, informal mechanisms with lower bureaucratic costs should be selected.
Three mechanisms minimize transaction costs while avoiding bureaucratic costs:
Keiretsu offers the benefits of ownership without the costs. Toyota has a minority interest in its suppliers
for control and reduced uncertainty, but without ownership and the management costs.
Franchising allows for marketing a companys products in a particular area.
Q. How does a franchise reduce transaction costs without incurring bureaucratic costs?
A. The franchiser gives a franchisee the rights to use resources in exchange for a flat fee or a percentage
of the profits. The franchiser provides the inputs to the franchisee, who makes exchanges with the
customer. The relationship is symbiotic. Franchisers give rights to franchisees because the bureaucratic
costs of managing their businesses are too high.
An organization considers transaction costs when deciding on product distribution. For a complex
product, a company will have formal control over franchisees or distribution outlets. Auto manufacturers
control franchised auto repair dealers, but products such as groceries require less control and can be sold
through retailers.
Outsourcing, buying a specialized service, is another strategy for managing interdependencies. The
decision to make or outsource products depends on whether value exceeds bureaucratic costs.
The transaction cost approach considers why and how organizations choose different linkage
mechanisms. The optimal mechanism minimizes transaction and bureaucratic costs.

Organizational Insight 3.4: Li & Fungs Global Supply Chain Management

This insight, in addition to illustrating transaction cost theory, really shows how complex the global
environment is. It also illustrates how organizations operating in the global environment really need to
specialize and be very efficient at what they do.

Refer to discussion question 5 here to review transaction cost theory.



1. Pick an organization, such as a local travel agency or supermarket. Describe its organizational
domain; then draw a map of the forces in its general and specific environments that affect the way it





Answers will vary. For a local supermarket, the domain includes neighborhood customers. Specific
environmental forces include customers, unions, competitors, suppliers, and the government. Customer
preference influences store offerings. Unions ensure fair wages and good working conditions. Suppliers
must provide high-quality items. The government ensures that FDA, employment, and safety
requirements are met. General environmental forces are economic, technological, demographic and
cultural, and environmental. High unemployment dictates low-margin items. Technology facilitates
convenience and fast checkout. Demographic and cultural forces determine the food offered (baby food,
ethnic food). Environmental issues ensure recycling plastic bags.

What are the major sources of uncertainty in the environment? Discuss how these sources of
uncertainty affect a small biotechnology company and a large carmaker.

Sources of environmental uncertainty include complexity, dynamism, and richness. An organization is

complex and uncertain if there are many, strong, interrelated outside stakeholders. The environment is
dynamic and uncertain if forces change significantly or quickly. It is poor and uncertain in a poor country
or where resource competition is high.
Answers will vary. A small biotechnology firm has low complexity because of few stakeholder groups,
no union, a few suppliers, and a few customers. In the growth stage, competition is not intense and
competitors are small. The environment is dynamic as forces change. (Technology may change. Health
care regulation could affect operations.) General uncertainties affect specific outside stakeholders such as
suppliers and customers. This company has a rich environment in large cities with supplies of scientists
and a medium level of uncertainty. It can obtain resources without high complexity, but operates in a
dynamic environment.
A large carmaker has high complexity because of the relationship between many, different outside
stakeholders, including a union, the government, competitors, suppliers, and distributors. The
environment is stable because forces affect resources predictably. The industry is mature, with changes
foreseen, but recession reduces demand. International forces are strong. The environment is poorer due to
competition, but resources are secured by managing outside stakeholders. The carmaker is complex and
operates in stable environment, between rich and poor. Uncertainty is kept low by managing complex
relationships with outside stakeholders.
According to resource dependence theory, what motivates organizations to form
interorganizational linkages? What is the advantage of strategic alliances as a way of exchanging

Resource dependence theory states that interorganizational linkages minimize dependence on other
organizations for scarce resources and influence them to make resources available. Strategic alliances
allow for symbiotic and competitive interdependencies and ensure a supply of high-quality, low-cost
inputs. Strategic alliances require resource sharing, reducing risks and costs. Partners can pool distinctive
competences to produce a competitive product.

According to transaction cost theory, what motivates organizations to form interorganizational

linkages? Under what conditions would a company prefer a more formal linkage mechanism to a
less-formal one?

Transaction cost theory states that interorganizational linkages minimize transaction and bureaucratic
costs. An organization chooses a more formal linkage mechanism as transaction costs increase. Formal
linkage mechanisms should be used when the transaction cost savings outweigh bureaucratic costs.





5. What interorganizational strategies might work most successfully as a company expands

globally? Why?
The key to this question is to make sure that students understand that to manage the environment, they
must match the strategy needed with the level of complexity in the environment. For example, a starting
point for expanding globally is to build a good reputation. A more complex situation may call for
something much more complex, such as a long-term contract or a joint venture.


Practicing Organizational Theory: Protecting Your Domain
Small groups of students are entrepreneurs who have marketed a new kind of root beer. Each group
wants to widen its geographical regions. Students decide how to protect and expand the companys
domain. Students consider the types of strategic alliances and recommend a way to carve a niche in the
soda market.

The Ethical Dimension

This case deals with organizations that purchase products from organizations that employ women and
children is sweatshops. They generally work long hours for only a few dollars per day. This was also
dealt with in Chapter 2 (Insight 2.5). Have students debate and discuss this again, but make the basis for
discussion the environmental principles discussed in this chapter, such as resource dependency.
1. When and under what conditions is it right for companies to buy their inputs from suppliers that
do employ women and children?
This is a complex question. On the surface it seems easy to simply not do business with these types of
organizations. When students say this, start a discussion about competition and remaining competitive in
a global economy. In other words, if an organization refuses to do business with these sweatshops, and
then cant remain competitive, has the right decision been made?
2. What kinds of interorganizational strategies could U.S. companies use to enforce any ethical
codes that they develop?

Making the Connection

Students find an example of a company using a specific interorganizational strategy, such as a joint
venture, and explain why the company selected the mechanism, using resource dependence theory or
transaction cost theory.


Students define their organizations domain, analyze the factors of uncertainty, and determine if the
structure is designed to reflect environmental uncertainty. They list the interorganizational linkage


This also is a complex question because each culture has different norms and values. A good example to
use is Johnson and Johnson and their ethics credo (from Chapter 2).



mechanisms and use resource dependence theory and transaction cost theory to explain why the
mechanisms were chosen.


How Ford Manages Its Environment
This case illustrates the various ways in which Ford has managed its environment over the years.

List the various ways in which Ford has attempted to manage its environment over time.

This is a good illustration of the many different ways that the environment can be managed. Early on,
Ford used contracts. As the environment got more complex, they began producing their own parts. This
is a good application of resource dependency theory in that they managed their environment by reducing
their dependency on suppliers. When the environment became even more complex in the 1980s, Ford
developed some keiretsu-type arrangements in order to manage this.

Why did Ford change the methods it used to manage the environment?

The key here is to make sure students understand that the management strategy needs to fit the
environmental situation. They didnt just change from contracts to keiretsus because it was a new
management technique, but rather they did this in response to the environment, or, in this case, the
To manage these environments, AT&T participated in strategic alliances and engaged in acquisitions; it
eventually split into three divisions.




The class is divided into three groups who work for a grocery store, a telecommunications
company, and a large auto manufacturer. Each group defines its organizational domain and lists the
forces in its specific and general environments.
Co-optation can manage symbiotic forces as seen in a role play with four students. Three students
form a management team of a manufacturing plant. One is the local union president who complains
about rules, wages, and benefits and tries to influence employee opinions. What can the
management team do? It can bring the union president inside the organization through a joint
union-management discussion committee.
In five groups, students represent organizations that vary in size and complexity. Each group selects
an interorganizational strategy and explains its choice of strategy.
Group I: A small grocery store with products from two or three suppliers. This group manages
relationship through trust; owners know suppliers well.
Group II: A medium-sized pharmaceutical manufacturer with many distributors. This company needs
long-term contracts or networks. Joint ventures and mergers may be too costly.
Group III: A large telecommunications company. This company forms joint ventures and alliances to
share risks and costs of developing new technology.
Group IV: A company that wants rapid growth but lacks capital or resources to run its organizations.
This company considers franchising.





Group V: A hotel with competition. This hotel joins a trade association to manage its competitive

Groups must weigh the cost of the strategy against the benefits.




Students review the strategies that allow organizations to minimize transaction costs without
incurring bureaucratic costs: keiretsu; franchising; and outsourcing.
Point out that Japanese stakeholders take a long-term view and deal with people they know and
trust. Ford has developed long-term relationships with suppliers and has other companies, such as a
rental car company, in its network.
Students can compare the business environment of the 1970s with that of today. The auto industry
is a good example because of both the dramatic changes that occurred, and the fact that we all drive
Have students look at Fords web site and assess changes in its organizational environment.