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University of Sunderland

Master of Business Administration (MBA)

Global Corporate
Strategy
Published by
The University of Sunderland

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Global Corporate Strategy

Contents

How to use this workbook

Introduction

Unit 1
Strategy Defined and Key Concepts
Introduction 1
Definition of Strategy 2
Levels of Strategy 5
Strategic Concepts 7
Strategic Thinking 9
Strategic Models 12
Summary 34

Unit 2
Strategic Capability
Introduction 37
The Different Management Perspectives 38
Portfolio Management 39
The Core competencies perspective 48
Divestment 51
Summary 57

Unit 3
Globalisation
Introduction 61
What is Globalisation 61
The Globalisation of Markets 66
The Globalisation of Production 68
Drivers of Globalisation 70
The Changing Demographics of the Global Economy 73
The Globalisation Debate: Prosperity or Impoverishment? 76
Managing in the Global Marketplace 78
Summary 88
Unit 4
‘Altering the Boundary’ – Alliances and Mergers
Introduction 91
Paradox of Competition and Co-operation 92
Global Strategic Alliances 92
Mergers and Acquisitions 104
Summary 131

Unit 5
Value Management
Introduction 133
Paradox of Profitability and Responsibility 134
The Concept of Value 134
Value Management 137
What is a Value-Driven Approach 141
Summary 151

Unit 6
Corporate Governance and Ethics
Introduction 155
Corporate Governance 156
Business Ethics 173
Summary 188

Unit 7
Managing Complexity
Introduction 191
Paradox of Control and Chaos 192
Systems Thinking 193
Soft Systems Methodology (SSM) 200
Strategic Control? 204
Summary 207

Unit 8
Knowledge Management
Introduction 209
Theoretical Concepts on Knowledge 210
Knowledge 212
Knowledge Transfer 215
Practical steps to promote Knowledge Management 218
Summary 237
Global Corporate Strategy Global Corporate Strategy – Contents

Unit 9
Innovation
Introduction 239
Innovation strategies 240
Innovation and established companies 241
Conclusion 248
Summary 255

Unit 10
Strategic IT and e-Business
Introduction 259
The Link between Business and IT Strategy 260
IT Strategy Methodology 264
Summary 275
References 276

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How to use this workbook
This workbook has been designed to provide you with the course
material necessary to complete Global Corporate Strategy by distance
learning. At various stages throughout the module you will encounter
icons as outlined below which indicate what you are required to do to
help you learn.

This Activity icon refers to an activity where you are required to undertake a
specific task. These could include reading, questioning, writing, research,
analysing, evaluating, etc.

This Activity Feedback icon is used to provide you with the information
required to confirm and reinforce the learning outcomes of the activity.

This icon shows where the Virtual Campus could be useful as a medium for
discussion on the relevant topic.

This Key Point icon is included to stress the importance of a particular piece
of information.

It is important that you utilise these icons as together they will provide
you with the underpinning knowledge required to understand concepts
and theories and apply them to the business and management
environment. Try to use your own background knowledge when
completing the activities and draw the best ideas and solutions you can
from your work experience. If possible, discuss your ideas with other
students or your colleagues; this will make learning much more
stimulating. Remember, if in doubt, or you need answers to any
questions about this workbook or how to study, ask your tutor.

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Global Corporate Strategy

Preface

Corporate Strategy is a very wide and all encompassing subject area.


One only has to look at the relative content of individual key texts in this
area (e.g. De Wit & Meyer, Lynch, Johnson & Scholes, etc.) to appreciate
the volume of material that has been written over the years.

However, relatively speaking, it is the newest area of management


research. Initial work in strategy took place in the early sixties. In their
book Strategy Safari, Mintzberg, Alhstrand and Lampel (1998) break
down strategy theory development into ten schools of thought and this
provides a thoughtful starting point for the study of this module. It also
indicates a wide range of divergent views on the subject. The ten schools
are;

1 The Design school – strategy seeks to match internal capabilities


to external possibilities
2 The Planning school – strategy is a formal, planned process
3 The Positioning school – only a few key strategies are desirable in
any given industry (generic strategy) and these are formulated by
analytical processes
4 The Entrepreneurial school – strategy is a ‘visionary’ process
where an organisation is responsive to the dictating individual
5 The Cognitive school – strategy is a mental process dependant
upon what the strategy process means in the mind of the
strategist (human cognition)
6 The Learning school – strategies emerge as people /
organisations come to learn about a situation as well as their
organisation’s capability of dealing with it
7 The Power school – the use of power and politics to negotiate
strategies favourable to particular interests
8 The Cultural school – strategy as a collective process of social
interaction, based on the beliefs and understandings shared by
the members of an organisation
9 The Environmental school – the business environment becomes
the central actor in the strategy making process – the organisation
must respond to these forces

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Preface Global Corporate Strategy

10 The Configuration school – strategy making is a process of


leaping from one state to another with relative stability in
between

All of these schools have key writers. However, it would be erroneous to


regard these schools as being ‘separated’ or that it is right to look at these
in isolation. Indeed, it is the opposite. Each perspective is inter-mingled
with one another and interacts over time. Mintzberg, Alhstrand and
Lampel use the analogy of an elephant to emphasise the holistic nature
of strategy - one cannot get a clear picture of ‘the elephant’ by looking at
each separate part of its body. Hence, as a student of strategy, you must
keep in mind ALL TEN schools.

The ten schools can be split into two ‘types’. Schools 1-3 can be seen as
‘prescriptive’, that is to say they are based on the belief that Corporate
Strategy is a planned, analytical hard data process. On the other hand,
Schools 4-10 can be seen as ‘descriptive’. In these areas, writers believe
that strategy is a complex, uncertain, subjective and ‘soft’ data process.
There is a range of theory and academic writing to support all of these
perspectives.

Another range of key perspectives is related to your core textbook


supplied with these materials. Whereas major texts such as Johnson &
Scholes, and Lynch take a ‘linear’ view of strategy by presenting
concepts ‘one after the other’, de Wit & Meyer (2004) analyse a series of
‘paradoxes’. They define the opposite ends of a continuum, leaving the
student with the tools to analyse case studies and decide for themselves
the key strategic perspective for organisations. This approach is
particularly important for this module.

Students will be expected to produce an academic and fully referenced


argument seeking to define the key strategic perspectives of
organisations. The argument, and supporting evidence, produced is key
– stating an appropriate school of thought or positioning an
organisation in relation to a strategic paradox is not the key issue. The
ability to analyse (rather than describe) strategy and coming to a
reasoned judgement is the overriding objective in assessment.

The paradoxes addressed by de Wit & Meyer (2004) are;

· The Paradox of Logic and Creativity (Strategic Thinking –


Rational vs. Generative).

· The Paradox of Deliberateness and Emergentness


(Strategy Formulation – Planned vs. Incremental).

· The Paradox of Revolution and Evolution (Strategic


Change – Continuous vs. Discontinuous).

· The Paradox of Markets and Resources (Business Level


Strategy – Outside-In vs. Inside-Out).

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Global Corporate Strategy Preface

· The Paradox of Responsiveness and Synergy (Corporate


Level Strategy – Portfolio vs. Core Competence).

· The Paradox of Competition and Co-operation (Network


Level Strategy – Discrete vs. Embedded Organisations).

· The Paradox of Compliance and Choice (Industry


Context – Industry Evolution vs. Industry Creation).

· The Paradox of Control and Chaos (Organisational


Context – Leadership vs. Dynamics).

· The Paradox of Globalisation and Localisation


(International Context – Global Convergence vs.
International Diversity).

· The Paradox of Profitability and Responsibility


(Organisational Purpose – Shareholder Value vs.
Stakeholder Values).

Naturally, many of theses dichotomies can be examined in isolation but


are, similarly to the schools of thought above, likely to be interrelated
and so discussing and building an academic argument in respect of one
will inevitably lead to another.

It would be possible to provide you with a module that deals with


separate areas of an organisation individually. Indeed, this type of
module has been delivered many times in the past. In other words, it is
possible to look at marketing, HRM, operations, finance, etc, as separate
entities and reflect the ‘strategic’ aspects of these areas. However, this
would not give due credence to the fact that strategy is essentially a
‘holistic’ subject. That is to say, ‘corporate strategy’ affects the
organisation as a whole. Each element of an organisation cannot be
considered in isolation. Therefore, corporate strategy must be examined
in an ‘all embracing’ manner.

One must be careful to use the word ‘organisation’. If the word


‘business’ were to be used this would tend to ignore some very
productive study areas in public and ‘not for profit’ organisations.
Much can be learned from such organisations and, although
‘businesses’ are typically used to demonstrate key points, organisations
whose prime objective is not related to profitability cannot be ignored.

Many contemporary issues in ‘strategy’ are reflected in this module.


Once again, it is erroneous to regard each of the ten ‘themes’ as existing
in isolation or in ‘silos’. There are links between themes that, in some
case, will be pointed out in the text, but in others it will be left to your
own imagination and analytical ability. Individual techniques such as
those employed in marketing and finance, for example, are only
touched on where necessary. This would detract from the ‘ethos’ of this
module.

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Preface Global Corporate Strategy

Due to the nature of the subject area it is impossible to cover all aspects –
simply think about how long it would take to read one of the key texts
from cover to cover! The topics omitted are still important – the study
time allocated to this module is not enough to cover everything.
Therefore, it is in your interests to read more widely than the specified
reading dictates.

The module will enable you to recognise and describe many different
features of organisations. However, the module will encourage you to
analyse these issues and be able to understand why organisations do
what they do and look critically at their strategic decisions. You should
be able to recognise and understand the importance of the various
aspects of strategic decision making and implementation processes.

You should remember that it is a Masters level module and you will
only reap the full benefits if you put in the effort. This means preparing
well and fully utilizing other arrangements to enhance your learning,
e.g. tutor support and contributing to remote discussion and chat via
available virtual learning environments.

vi
Unit 1

Strategy Defined and Key


Concepts

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Explain what corporate strategy is.

· Evaluate the importance of strategy to a manager in an organisation.

· Compare the characteristics of strategic decision making.

· Assess the skills required to be a strategist.

· Assess the holistic nature of strategy.

Introduction
The term corporate strategy can bring to mind various aspects of
corporate management. Vision, competition, competitive advantage,
new markets, managing for shareholder value, moulding corporate
culture, operational processes for execution, strategic plans all come to
mind. But what exactly is strategy?

In this unit we shall define strategy, particularly as it applies to a


manager. We shall also look at the various levels of strategy, and the key
role of strategic thinking within an organisation. We shall examine the
role of strategic ‘models’ and how they can assist organisations in
breaking down the complexity of strategic thinking. In particular, we
shall examine the Johnson & Scholes model.

Depending on the maturity of the market that a company operates


within, the maturity of the company, and the corporate management
culture, organisations adopt different approaches to strategy. The
approach can be classified as deliberate, emergent or incremental, and
we shall examine the differences between them.

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

Finally, we shall look at two case studies to understand how the key
concepts of strategy apply practically within organisations.

Definition of Strategy
There is no universal definition of strategy. Strategy applies to many
disparate fields such as gaming strategy, economic strategy, investment
strategy, military strategy, marketing strategy and indeed corporate
global strategy. Taking a conventional approach, strategy can be
thought of as a long term plan of action or execution designed to achieve
a particular goal, such as achieving competitive advantage for an
organisation. It reflects the values, expectations and goals of those who
are in power within the organisation.

These logical / prescriptive ideas about strategy emanate from the


‘prescriptive’ approach as advocated by early strategic writers (see
Preface and the text Strategy Safari (Mintzberg et al, 1998)). Many early
writers continue to be widely quoted, e.g. Michael Porter. Many recent
writers have challenged this view of strategy. The study of corporate
strategy has moved on into ‘softer’ areas and these issues need to be
kept in mind.

Early thinking (1960s) could be said to be ‘modernist’ in view, i.e. a


unitary perspective – there was a single way to perform the task of
strategy. There was an idea that data (both internal and external) could
be fed into an analysis machine and the answer (the strategy) could be
churned out. The ‘postmodern’ view refuted this, saying that a strategist
view should be ‘pluralist’, i.e. take many diverse things into account and
this is evidenced by a number of writers. For example, the view of
‘planning’ as opposed to ‘emergence’ – both viewpoints are supported
by a wealth of academic writing (see later discussion in this unit).

However, as a starting point, we will consider some ‘prescriptive’


definitions and concepts to try to begin to appreciate the complexity of
this subject.

Lessons from military strategy


Generalising strategy can be misleading, as the context is important.
However, the military definition of strategy can be very helpful in the
context of business, as the approach to winning in the business
environment is very similar to winning a war. Success in business
requires a sharp focus, and does indeed involve winning battles and
gaining competitive advantage over the ‘enemy’, in this case the
competitor.

Military strategy is the ‘holistic’ deployment of resources in such a way


that the outcome of a war is influenced. As with military strategy, it is

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

vital that corporate strategy is ‘holistic’ to be successful. To achieve the


corporate strategy, the whole organisation must be focused on the same
corporate goals and must team, execute and win in the marketplace. As
with a war, a razor sharp focus is required to win in the marketplace.

Strategic vs. tactical


An important distinction to make at this point is between the strategic
and tactical. The terms feature in the military as well as in business, and
it is important to understand the difference.

As we have just observed, strategy must be holistic – it must involve the


whole organisation and its objective is to achieve the goal (or win the
‘war’) defined by the company. Tactical measures are actions or
manoeuvres carried out to win individual battles, which may
eventually, after a number of battles, win the ‘war’.

In the context of business, a tactical measure may, for example, involve


ruthless, but short-term, price-cutting, in order to grab market-share
and remove a competitor. A strategic move, on the other hand, may be
an acquisition in order to move into a new market area. Tactical
measures are usually short-term, whereas strategy is long-term. A series
of tactical measures can help achieve the long-term strategy.

VIRTUAL CAMPUS
Discuss with your colleagues how a tactical action in your work context
furthered the company’s strategy. In particular, how it influenced:

· Competitive position.

· Market share.

· Customer satisfaction.

· Short-term vs. Long term profits and margins.

· New opportunities.

Business strategy
Some definitions of business strategy that are helpful are as follows:

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

‘Corporate strategy is the pattern of minor objectives,


purposes or goals and essential policies or plans for
achieving those goals, stated in such a way as to define
what business the company is in or is to be in and the kind
of company it is or is to be’
Andrews K (1971). Page 8, Lynch.
‘Strategy is the direction and scope of an organisation over
the long term: which achieves advantage for the
organisation through its configuration of its resources
within a changing environment, to meet the needs of
markets and fulfil stakeholders' expectations.’
Page 10, Johnson and Scholes

KEY POINT
Characteristics of business strategy are as follows:

· Sets direction and scope over the long term to achieve goals.

· Designed to achieve competitive advantage.

· Directs business in a changing and evolving environment.

· Holistic and pervasive of the whole organisation; covering the


range and depth of its activities.

· Achieved by teaming, executing and winning in the


marketplace.

· Fulfills stakeholder expectations; survival as a minimum and


creation of added value as a maximum.

ACTIVITY
Read p. 1-19 of Chapter 1 and section 2.1 of the key text, De Wit, B & Meyer, R

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

Levels of Strategy
Strategy can be distinguished by the levels at which it occurs. Refer to
Figure 1.1.

Operational Strategy
Corporate Strategy

Business Business Business


Unit Strategy Unit Strategy Unit Strategy

Figure 1.1: Levels of corporate strategy.

Corporate Strategy:

· Defines the strategy for the corporation (or organisation)


as a whole, and is cascaded to business units below.

· Must be holistic and define the overall purpose and scope


of the organisation.

· Must be visionary in some measure.


· Must ensure that the different parts of the organisation
add value to the overall strategy.

· Must meet the expectations of major stakeholders.

Business Unit strategy:

· Must be derived and be aligned with the corporate


strategy.

· Must be focused on how to compete in the particular


markets or business areas for which the business unit has
responsibility.

· Can be visionary and creative within the context of its


business remit.

Operational Strategy:

· Must define and deliver the operational processes


required to achieve the corporate and business unit
strategy.

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

· Must address the resource and resource development


plans to support corporate and business unit strategy.

A further level of strategy, ‘Network level strategy’, is pertinent in


today’s business environment. Let us examine this in more detail.

Strategic alliances or strategic networks are increasingly common in


many sectors to compete effectively in the marketplace. For example, in
the IT sector, gone are the days of mega-organisations that ‘play’ in
every aspect of computing and micro-electronics. Increasingly,
companies with different specialisations or areas of dominance
cooperate to compete effectively in the marketplace. An example is that
of the IBM corporation. A few years ago IBM competed in practically
every aspect of computing and information technology; from hardware
to disk storage to micro-electronic components to software to operating
systems to applications software to IT services. Today, to be
cost-effective and satisfy customer requirements for open standards
and ‘best of breed’, IBM has strategic partnerships with specialist
hardware suppliers and software vendors (e.g. for CRM). Another
example is that of the Bluetooth alliance of companies that has brought
to market wireless interconnectivity of computer devices. In such
strategic alliances, the different members of the network operate as
separate corporate entities but their strategy is influenced and aligned
with that of the strategic network. Such networks involve not only other
profit-making corporate entities, but can also involve standards bodies
or advisory bodies.
Operational Strategy

Corporate Strategy

Business Business Business


Unit Strategy Unit Strategy Unit Strategy

Corporate Entity 1
Operational Strategy

Operational Strategy

Corporate Strategy Corporate Strategy

Business Business Business Business Business Business


Unit Strategy Unit Strategy Unit Strategy Unit Strategy Unit Strategy Unit Strategy

Corporate Entity 2 Corporate Entity 3

Figure 1.2. Network Strategy.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

ACTIVITY
Think of an example, perhaps from your own work context, of how corporate
strategy translated to business unit strategy and operational strategy.

Did networks or strategic alliances play a role in moulding corporate strategy?

Strategy and the manager


Developing and deploying strategy successfully depends on managers
understanding the key and high impact aspects of strategy. Managers
should:

· Ensure that strategies are part of the overall corporate


strategy.

· Ensure that strategies are consistent, coherent, effective


and appropriate.

· Ensure that strategies are sustainable and supported by


operational processes.

· Understand an organisation’s business environment.


· Understand the attributes of the organisation and what
makes it unique/distinctive.

· Be aware of the organisation’s resources, capabilities,


competencies and customers.

· Understand how the organisation’s advantages can be


exploited.

· Understand and exploit the existence of any strategic


networks/alliances.

Strategic Concepts
A number of factors influence the type of strategy an organisation
adopts. These factors include the maturity of an organisation, maturity
of the market sector it operates in, its corporate management culture,
and market leadership goals.

There are broadly two types of strategic concepts:

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

· Strategic ‘Fit’: Strategic Fit is the matching of an


organisation’s strategy to the environment it operates in.
It is really identifying opportunities that exist in the
current environment and tailoring strategy to capitalise
on it. Competitive advantage is achieved by correct
positioning within the existing marketplace.

· Strategic ‘Stretch’: Strategic Stretch, on the other hand, is


when an organisation pro-actively stretches its resources
and competencies to create new opportunities and
capitalise on them. It means identifying resources and
developing competencies to pre-empt and create new
opportunities in the marketplace. Competitive advantage
is achieved by not only meeting existing market needs but
also future market needs. It is a resource-led approach
with investment from the heart of the corporate centre.

ACTIVITY
Can you think of an example of strategic fit?

Now can you think of a company that has or is adopting strategic stretch?

ACTIVITY FEEDBACK
You probably thought of many examples of strategic fit, but perhaps had more
difficulty with examples of strategic stretch.

One example of strategic stretch is the Waitrose/Ocado partnership in the


UK, which provides on-line grocery shopping and home delivery service.
Currently, in the UK, the market for on-line shopping is small. With the
exception of Tesco, which makes a small profit on on-line deliveries, most
companies providing this service make huge losses, and many are withdrawing
from this service altogether. Waitrose/Ocado are also making losses currently.
However, they are strategically stretching themselves, and investing
considerable amounts to expand services. They forecast a huge market
opportunity in a few years to come. Waitrose operates in wealthy,
middle-class areas, where the average weekly spend, on groceries, is in excess
of £150 a week. If on-line shopping takes off (as they predict it will, in
approximately 2-3 years time), Waitrose/Ocado would have carved
themselves a very lucrative market, indeed.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

Strategic Thinking
Where previously (in the 1970s and 1980s) the focus was on managerial
skills in strategic planning, now the emphasis is on strategic thinking.
Strategic thinking has creativity at its heart, and encourages the entire
organisation to be involved. It minimises the risks associated with
management power over strategy.

A simplistic definition of strategic thinking is finding the answers to the


following:

· Where are we now?


· Where do we want to go?
· How do we get there?

For an organisation to be successful, strategic thinking must dominate


its entire corporate culture. Strategic thinking must be ingrained, be at
the forefront and influence every manager’s daily actions. It cannot be a
‘one off’ or ‘once a year’ activity.

The following extract from Porter (1977) is helpful in highlighting the


importance of strategic thinking.

‘There are no substitutes for strategic thinking. Improving


quality is meaningless without knowing what kind of
quality is relevant in competitive terms. Nurturing
corporate culture is useless unless the culture is aligned
with a company’s approach to competing. Entrepreneurship
unguided by a strategic perspective is much more likely to
fail than succeed.
Strategic thinking cannot occur only once a year, according
to a rigid routine. It should inform a company’s daily
actions. Moreover the information necessary for good
strategic thinking is equally vital to running a business –
designing marketing material, setting prices and delivery
schedules.
There is a dangerous tendency today to practise single-issue
management. The truth, of course, is that there is no easy
answer. Quality, manufacturing, corporate culture ,
entrepreneurship and strategic thinking are all important.
Concern for one does not imply all these aspects of
management. One cannot ignore strategic thinking in
favour of maintaining a supportive culture, just as one
cannot ignore quality no matter how elegant is the strategic
plan.’
Porter (1977)

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

De Wit & Meyer discuss the paradox of Logic and Creativity. They see
strategy as a ‘wicked’ problem, i.e. ambiguity, complexity and
uncertainty prevail in making strategic decisions. The implication is that
creative (or generative) thinking is crucial to enable managers (and their
organisations) to move beyond the obvious, from the comfortable to the
uncomfortable to be successful. This is often termed ‘lateral’ thinking or
‘thinking out of the box’.

Nevertheless, a role for ‘logic’ is still in place. A manager still needs to be


able to think rationally and be analytical in certain circumstances.
However, they are ‘bounded’ by their own rational thought and so are
limited in what they can achieve.

ACTIVITY
Learn more about Strategic Thinking by reading the introductory section to
Chapter 2 (p 51-67) in your key textbook, De Wit, B & Meyer, R

Information Processing, Thinking and Strategy


Strategic thinking involves the processing of information by managers
to define strategy. Two different modes of information processing have
been described (Walsh, 1995):

· Bottom-up processing.
· Top-down processing.

Bottom-up processing
The characteristics of bottom-up processing, in the context of strategic
thinking, are:

· Driven by the process of gathering detailed information


from all levels.

· Decision making is then carried out after elaborate


analysis of the strategic problem, or issue under
consideration, and a review of all possible solutions.

Top-down processing
The characteristics of top-down processing, in the context of strategic
thinking, are:

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

· Driven by the recall and application of theory/models to


real-life situations encountered.

· Strategies are derived from the experience of the success


of previous strategies.

· Elaborate theories are rarely applied. Simple, abstract


rule-of-thumb approaches take precedence.

In practice, the majority of strategic decisions are made using top-down


processing, and rely on the skills and experience of top level
management.

Neither approach lends itself well to less routine and novel strategic
decisions (such as entering a new market or bringing to market a novel
product/service). Such decisions require vision, creativity as well as
business realism.

Another important factor in strategic decision thinking is the role of


uncertainly. Uncertainties can take the form of missing information, but
other times arises simply from the unknowable. Such uncertainties can
pose risks as well as new business opportunities. What makes a market
leader is how that organisation predicts future opportunities from an
uncertain environment. Through leadership companies are able to
influence and guide the market with their own ideas and thereby create
new opportunities.

Strategic Thinking: skills


Strategic thinking has many dimensions, and demands a variety of
skills, as follows:

· A strategist needs to understand issues at the functional,


technical and unit levels, as strategy must be holistic and
integrated across all levels.

· A strategist needs to identify the significance of current


issues and from that knowledge project strategy into the
future.

· A good strategist needs to balance the use of


data/information, analysis of issues with that of
experience, knowledge and understanding to predict the
future

· A strategist needs to be creative. Creativity in strategy


renders competitive advantage.

The following factors strengthen strategic thinking:

· Relevance and realism in thinking.

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

· Rigour.
· A varied approach to information processing.
· A balance between theory and practice to cross-check
validity.

· A critical and challenging approach.

ACTIVITY
It is good practice for strategic decisions to be evaluated against set criteria.
From your own work experience, can you identify the criteria (in the form of
bullet points) against which strategy can be judged.

ACTIVITY FEEDBACK
You would have come up with a number of ideas. Some of which may be
specific to the industry/sector in which you operate. A good list of evaluation
criteria is outlined in the key textbook, De Wit, B & Meyer, R, ‘Criteria for
Evaluation’, pages 74-75.

Strategic Models
Strategic thinking is a complex area. As such there is a role for strategic
‘models’ that can enable analysis. However, they should be used with
caution, noting that theoretical models can over-simplify the practical
and complex issues faced by organisations in the real world.

Firstly, it is helpful to recognise that strategic thinking has three


dimensions to it as shown in Figure 1.3.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

Context

Content

Process
Strategy

Figure 1.3. The dimensions of strategic thinking.

The process, content and context of strategies define the scope of


strategic thinking, and must be considered together as they are closely
inter-related. Let us look at each of these in turn:

· Process: The actions or processes that support how the


strategy is analysed, determined, implemented/executed,
changed and controlled. These processes link together or
interact as the strategy unfolds in what may be a
changing environment.

· Content: The result of the strategy process is content. It


addresses the main actions of the proposed strategy.

· Context: Concerns the business circumstances or


environment in which the strategy operates or will be
developed. This can be the ‘inner’ context, referring to the
organisational setting or corporate culture of the
organisation. Or it can be the ‘outer’ context, such as
external economic, political, business, environmental
factors.

ACTIVITY
Can you think of some examples of how inner context can influence strategy.

Similarly, think of an example of how outer context influences an


organisation’s strategy.

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

ACTIVITY FEEDBACK
You may have thought of one or two examples of how inner context influences
strategy. Here is another example.

Shell and Exxon are giant oil corporations. However, they are organised very
differently. Shell has a structure that favours and devolves power to national or
regional management. Whereas, Exxon has a strong corporate focus with an
emphasis on functional and product lines of structure.

In the Shell structure, strategic thinking is carried out at the regional level (e.g.
by operating companies such as PDO in Oman, Brunei). The corporate
headquarters at The Hague does influence strategy at regional levels, but
doesn’t dictate business unit-level strategy.

In the Exxon example, the corporate body defines strategy. Strategy is then
cascaded to the functional units. Processes and standards (e.g. IT standards and
software applications) are defined by the corporate body.

ACTIVITY
Can you now think of an example of how outer context influences an
organisation’s strategy?

ACTIVITY FEEDBACK
Increasingly environmental and ethical factors strongly influence strategy. Such
factors are outside the control of the organisation, but nevertheless the
organisation must adhere to it.

Many Western companies utilise cheap factory labour from third-world


countries, such as India, Taiwan, etc. More recently, skilled jobs, such as call
centre operations, have also moved to countries such as India, as it is more
cost-effective. Raised environmental and ethical awareness has forced
Western companies to pay fair wages and provide satisfactory working
conditions in these countries. Company stakeholders often demand ethical
and sound environmental practices. This is an example of outer context,
where the company must comply with external influences.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

ACTIVITY
Reinforce your understanding of the dimensions of strategy by re-reading
p.5-11 of the key text, De Wit, B & Meyer, R.

Johnson & Scholes Model


Johnson and Scholes developed and elaborated an approach to strategy
first put forward by Argenti in 1980. Argenti identified the distinct
phases in strategic management, which can be grouped as follows:

STRATEGIC ANALYSIS

· Target Setting.
· Gap Analysis.
· Strategic Appraisal.

¯
STRATEGIC CHOICE

· Strategic formulation.

¯
STRATEGIC IMPLEMENTATION

As the arrows indicate above, Argenti suggested that strategic analysis


should precede choice, and choice precede implementation. In reality,
the phases often overlap. The overlapping nature of the phases was
elaborated by Johnson and Scholes. Figure 1.4 shows types of issues that
should be considered within the strategy development phases.

15
Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

Expectations
and purposes
Resources,
The competences
environment & capabilities

Strategic
analysis

Bases of Organisation
strategic structure
choice and design

Strategic Strategy
choice implementation

Resource
Strategic
allocation
options
and control
Strategy Managing
evaluation strategic
and selection change

Figure 1.4. Johnson & Scholes Model.

Deliberate, Emergent and Incremental


Strategies
Strategy can be described as Deliberate, Emergent or Incremental.
Going back to the Johnson & Scholes Model, the order in which the
phases are carried out determines whether the strategy is deliberate,
emergent or incremental.

Deliberate Strategy is the result of adopting a classic planning


approach, where analysis leads choice and choice leads
implementation.

In certain situations implementation can lead choice and analysis – this


is Emergent Strategy. Consider for example a supermarket chain,
where one store is forced to cut prices because of fierce local
competition. Finding the price cuts attracts more customers, other stores
in the chain copy the pattern to gain market share. This is an example of
emergent strategy.

In other cases, analysis, choice and implementation proceed together,


with the preferred choices influencing implementation and analysis,
analysis influencing choice and implementation influencing analysis
and choice. This is known as Incremental Strategy.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

REVIEW ACTIVITY
Learn more about the above by reading the section ‘The paradox of
Deliberateness and Emergentness’ in your key text, De Wit, B & Meyer, R,
p.111-116.

Also learn about the strategic planning perspective vs. strategic incrementalism
by reading p.117 – 123 of your key textbook, De Wit, B & Meyer, R.

Now apply what you have learned in this unit to your own work context.

1. Are you aware of your organisation’s corporate strategy? Are you


aware of your business unit strategy?

2. How is strategy formulated in your workplace?

3. Would you describe it as deliberate, emergent or incremental?

4. From what you have learned, can the strategy process be improved? If
so how?

5. What do you see as the major obstacles in your organisation to


strategy development and strategy execution?

6. How can these obstacles be removed?

Share your thoughts on the questions above with colleagues, either on the
Virtual Campus or at your workplace. Solicit their input and ideas also,
especially on items 4 and 6 above.

CASE STUDY 1 – IKEA


Read the following extract about IKEA;

(Source: Johnson & Scholes; Chapter 1 pages 6,7 & 229 and Sunday Times, 22
February 1998.)

In 1953, just four years after Ingvar Kamprad had produced his first mail order
catalogue featuring locally produced furniture, he opened his first store in
Almhult, Sweden. Since then, he and his successors have created a global
network of stores in 28 countries. Initially, stores were opened only in
Scandinavia, but as greater levels of success were experienced, stores were
built in countries further afield where the rewards, but also the risks of failure,
were much higher. In all these countries the retailing concept of Ingvar

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

Kamprad remained the same: ‘to offer a wide range of furnishing items of good
design and function at prices so low that the majority of people can afford to
buy them’.

In the 1980s, Anders Moberg became the chief executive. However, the
influence of Ingvar Kamprad could still be found. IKEA had always been frugal in
its approach. In its early years it had relocated to Denmark to escape Swedish
taxation. Echoes of the same philosophy and style could be seen in Anders
Moberg. He would arrive at the office in the company Nissan Primera, dressed
in informal clothes, and clock in just as other employees did. When abroad he
travelled on economy class air tickets and stayed in modest hotels. He
expected his executives to do likewise. Such prudence was extended to the
company whose shares were held in trust by a Dutch charitable foundation and
not traded. Furthermore, IKEA’s expansion plans envisaged only internal
funding with 15% of turnover being reinvested.

The 1980s saw rapid growth. IKEA benefited from changing customer
attitudes, from status and designer labels to functionality, encouraged by an
economic recession. It also developed a number of unique elements which
came to make up IKEA’s winning business formula: simple, high quality
Scandinavian design, global sourcing of components, knock-down furniture kits
that customers transported and assembled themselves, huge suburban stores
with plenty of parking and amenities such as cafés, restaurants, wheelchairs and
even supervised child-care facilities. A key feature of IKEA’s concept was
universal customer appeal crossing national boundaries, with both the
products and shopping experience designed to support this appeal. Customers
came from different lifestyles: from new homeowners to business executives
needing more office capacity. They all expected well styled, high quality home
furnishings, reasonably priced and readily available. IKEA met this expectation
by encouraging customers to create value for themselves by taking on certain
tasks traditionally done by the manufacturer and retailer, for example the
assembly and delivery of products to their homes.

IKEA made sure that every aspect of its business system was designed to make
it easy for customers to adapt to their new role. For example, information to
assist customers make their purchase decisions was provided in a 200-page
glossy catalogue; during their visit to the store customers were supplied with
tape measures, pens and notepaper to reduce the number of sales staff
required; furniture was displayed in 100 model rooms; and sales staff were
expected to involve themselves with customers only when asked.

To deliver low-cost yet high-quality products consistently, IKEA also had 30


buying offices around the world whose prime purpose was to identify potential
suppliers. Designers at headquarters then reviewed these to decide which
would provide what for each of the products, their overall aim being to design
for low cost and ease of manufacture. The most economical suppliers were
always chosen over traditional suppliers, so a shirt manufacturer might be
employed to produce seat covers. Although the process through which
acceptance to become an IKEA supplier was not easy, it was highly coveted,
for, once part of the IKEA system, suppliers gained access to global markets,
and received technical assistance, leased equipment, and advice on how to
bring production up to world quality standards. By the mid 1990s, IKEA was

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

offering a range of 12,000 items, from 1,800 suppliers in 45 countries at prices


20-40% lower than for comparable goods. However, by 1998 the means of
achieving low cost was receiving some critical attention. It was reported that
IKEA was sourcing its goods from suppliers in eastern Europe which paid its
workers poverty level wages.

IKEA was the subject of a hard-hitting article in the Sunday Times in February
1998. The article concerned the working and living conditions in Romanian
furniture factories. Although IKEA did not own any of the 25 factories which
produced furniture for its stores, it had provided collateral for at least one
factory to be bought from the state in 1992. In fact, there were allegations from
the Federation of Wood Workers that the directors of the factory used
money from IKEA and disregarded the law under which Romanian employees
are entitled to be given the option of buying their own factory as a cooperative.

The article observed that the appalling conditions in Romania flew in the face of
the politically correct image of IKEA fostered by Ingvar Kamprad who regularly
wrote memos to staff which started with ‘Dear IKEA family’.

The managing director of this factory admitted that he kept a competitive edge
by paying employees an average of about 20p per hour (about one-fortieth of
the pay levels in Sweden). IKEA’s response to these issues was that it had no
management responsibility for any Romanian factory. It accepted, however,
that conditions were poor and that it had provided the collateral necessary for
the purchase of one factory. It also restated its financial support for the
Romanian furniture industry through credits which allowed new buildings with
better working conditions. It believed that trade was better than aid and that it
intended to continue to assist with financial and technical support and by
expanding orders.

Having to cope with widely dispersed sources of components and high-volume


orders made it imperative for IKEA to have an efficient system for ordering its
supplies, integrating them into products and delivering them to the stores. This
was achieved through a world network of fourteen warehouses. These
provided storage but also acted as logistical control points, consolidation
centres and transit hubs, and aided the integration of supply and demand,
reducing the need to store production runs for long periods, holding down
unit costs by minimising the costs of inventory and helping stores to anticipate
needs and eliminate shortages.

By the end of the 1990s, IKEA was turning its attention to new opportunities
for growth. It had opened stores in eastern Europe and the one-time Soviet
republics, believing these represented great future potential. In 1997, it
announced its plan to open twelve new stores a year internationally in cities
such as Frankfurt, Shanghai, Chicago and Roclab in Poland and to double
manufacturing capacity by building up to twenty factories in eastern Europe by
2002. There were also plans to develop new areas of business. In partnership
with a building contractor, IKEA was market testing, in Sweden, ‘flat packed’
housing which could be assembled by two men and a crane in a week at prices
about 30% less than the going rate. It was also developing new sources of
supply, entering into an agreement with a timber company to develop new
wood material for furniture. However, the company was also facing problems.

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

IKEA was experiencing growing competition on an international front. It had


decided to implement a programme of cost savings, rationalising its supply
chain and product range in order to cut purchasing costs by an overall average
of 10%. The company had stated the intention of cutting what had become
2,400 suppliers by one-quarter and focusing on increased volumes with a
smaller range of products and fewer suppliers.

In 1996, Ingvar Kamprad announced that IKEA would be split into three,
comprising the retailing operations, an organisation holding the franchise and
trademarks, and a third arm involved mainly in finance and banking. The first
two would form the core of the group, controlled at arm’s length by trust-like
organisations; the latter’s shares would be jointly owned by Kamprad’s three
sons. The structure was devised in an effort to ensure that the privately held
organisation should not be broken up or sold off in a succession battle after
Ingvar Kamprad retired. He also wanted to ensure that it would not be put
under the sorts of external pressures for continual growth often faced by
publicly quoted companies. Internally, IKEA’s strategy was managed at
different levels. A committee of senior executives at headquarters in Denmark
was responsible for overseeing investment in new markets and stores;
responsibility for product development and purchasing lay with IKEA of
Sweden; and country managers tailored the presentation and marketing of
products to home territories.

Questions:
1. Summarise IKEA’s corporate strategy.

2. Note down the characteristics of IKEA’s strategy which could be


explained by the notions of:

- Strategic management as ‘environmental fit’

- Strategic management as the ‘stretching’ of its


capabilities.

3. Comment on IKEA’s ethical stance

(You may wish to revisit this question after you have completed Unit 6. Unit 6
covers corporate ethics in more detail)

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

CASE STUDY FEEDBACK


Feedback on Question 1:

These are some of the considerations on strategy and strategic decisions in the
context of the IKEA case study.

· Strategic decisions affect the long-term direction of an organisation.


IKEA set out along a path which was difficult to reverse. In the
1950s and 1960s the company was, essentially, a Scandinavian
furnishing retailer. By the late 1990s the whole thrust of its strategy
had shifted to a global scale and IKEA was facing the challenge of
how to develop into the twenty-first century. In so doing it had to
consider other key issues.

· Strategic decisions are normally about trying to achieve some


advantage for the organisation, for example over competition. IKEA
had been successful not because it was the same as all other
furniture retailers, but because it was different and offered
particular benefits which distinguished it from other retailers.
Similarly, strategic advantage could be thought of as providing higher
quality value-for-money services than other providers in the public
sector, thus attracting support and funding from government.
Strategic decisions are sometimes conceived of, therefore, as the
search for effective positioning in relation to competitors so as to
achieve advantage in a market or in relation to suppliers.

· Strategic decisions are likely to be concerned with the scope of an


organisation’s activities. Does (and should) the organisation
concentrate on one area of activity, or should it have many? For
example, for years IKEA had defined the boundaries of its business
in terms of the type of product (‘furnishing items of good design and
function’) and mode of service (large retail outlets and mail order).
While not owning its manufacturing, it did have an in-house design
capability, which specified and controlled what manufacturers
supplied to the company. There were signs by the late 1990s,
however, that IKEA was extending its product scope from
furnishings into other product areas, as with its experiments with
housing. Over the years it had also substantially widened its
geographical scope to become one of the few truly multinational
retailers in the world.

· Strategy can be seen as the matching of the activities of an organisation


to the environment in which it operates. This is sometimes known as
‘the search for strategic fit.’ While the market for furnishings was
mature, with little prospect of overall growth, the management of
IKEA had seen that the retail provision of furnishing in most
countries did not meet the expectations of customers. Customers
frequently had to wait for delivery of items, which were highly

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

priced. The market provided another opportunity. Customer


tastes were relatively common in different countries except in
specialised segments of the market: buyers wanted everyday
furniture which was well designed and looked good, but which
was reasonably priced.

IKEA also knew that it faced significant differences in its markets. By


the 1990s the number of countries in which IKEA was represented
was a great deal larger than in the company’s early days. This meant
that IKEA had to understand buying habits and preferences from a
much wider base, from markets close to its Swedish home, to the
USA, and even to the Far East and eastern Europe.

IKEA could no longer assume that its knowledge of earlier markets


would necessarily apply: for example, it had found that shopping habits
in the USA differed substantially from those in Europe, and this had
required a change in the way it serviced the market. Therefore, while
the principles of IKEA’s business idea were adhered to around the
world to produce a consistent product quality and shopping
experience, store management had been given a greater degree of
freedom to adapt to local market needs.

IKEA’s management had, however, decided that there were some


markets, attractive though they were, where it did not make sense to
try to control IKEA’s operations directly. Here the company
recognised that local knowledge in fine-tuning the business to local
needs was vital; or the problems of long-distance control were too
great to manage the operation effectively on this basis. It had,
therefore, established local joint ventures through franchise
arrangements.

There were wider environmental issues, which affected IKEA’s


fortunes; for example, IKEA was less susceptible to economic
downturn than many of its competitors. This may have been because
its prices were often lower; but it was also because, when a customer
took a purchasing decision at IKEA, he or she walked away with the
goods. In other stores, since delivery was often delayed, purchase
decisions were also often delayed. Economic conditions in the
different countries in which IKEA operated did, however, affect its
success: for example, the growth in car ownership, particularly in less
highly developed countries, determined the percentage of the
population which could shop at an IKEA store.

· Strategies may require major resource changes for an


organisation. For example, the decision that IKEA took to
develop its operations internationally had significant
implications in terms of its need to obtain properties for
development and access to funds by which to do this,
sometimes for projects which might be seen as high risk – for
example, entering new markets in times of recession. The size
of the operation in terms of numbers of people working in it,
property and physical stock held had to rise significantly. The

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

need to control a multinational enterprise, as opposed to a national


operation, also began to require skills and control systems of a
different sort. It was a problem which many retailers found difficulty
coping with. A major reason has been that retailers underestimate
the extent to which their resource commitments rise and how the
need to control them takes on quite different proportions.
Strategies, then, need to be considered not only in terms of the
extent to which the existing resource capability of the organisation
is suited to opportunities, but also in terms of the extent to which
resources can be obtained and controlled to develop a strategy for
the future.

· Strategic decisions are likely to affect operational decisions. For


example, the internationalisation of IKEA required a whole series of
decisions at operational level. Management and control structures
to deal with the geographical spread of the firm had to change. The
way in which suppliers were controlled and the methods of
developing and distributing stock required revision to deal with the
extended distribution logistics. Marketing and advertising policies
needed to be reviewed by country to ensure their suitability to
different customer behaviours and tastes. Personnel policies and
practices had to be reviewed. Store operations needed to change
too. For example, in the USA, IKEA saw the need to add to the
core product range from local suppliers, install serviced loading bays
and erect bollards to stop the shopping trolleys being taken to all
parts of the car parks, which are very large in the USA.

This link between overall strategy and operational aspects of the


organisation is important for two other reasons. First, if the
operational aspects of the organisation are not in line with the
strategy, then, no matter how well considered the strategy is, it will
not succeed. Second, it is at the operational level that real strategic
advantage can be achieved. IKEA has been successful not only because
of a good strategic concept, but also because the detail of how the
concept is put into effect – the strategic architecture – in terms of its
logistics of buying and servicing, shop layout and merchandising to
supplier and customer relations, all developed over many years, is
difficult to imitate.

The strategy of an organisation is affected not only by environmental


forces and resource availability, but also by the values and expectations
of those who have power in and around the organisation. In some
respects, strategy can be thought of as a reflection of the attitudes and
beliefs of those who have most influence on the organisation.
Whether a company is expansionist or more concerned with
consolidation, and where the boundaries are drawn for a company’s
activities, may say much about the values and attitudes of those who
influence strategy – the stakeholders of the organisation. In IKEA the
insistence on internal financing influenced long-term development and
the direction of the company: the influences of the founder and chief
executive remained pronounced. The emphasis on frugality and
simplicity clearly influenced the way the company operated. Indeed,

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

critics pointed to what they saw as a disregard for the well-being and
welfare of the low-paid workers of suppliers in the name of keeping
down costs.

The conclusion from the above case study is that strategic decisions often
exhibit the following characteristics:

1. Complex: especially for multinational organisations such as IKEA


with a wide range of products/services.

2. Involve uncertainty: They often involve taking decisions about the


future, which is impossible for managers to be sure about.

3. Require an integrated approach: Managers have to work across


cross-functional and operational boundaries, and come to agreements
with other managers who may have different interests and priorities.
They also have to manage external relationships such as with suppliers,
distributors and customers.

4. Involve change: Strategic decisions often involve change. Not only is


it problematic to decide upon and plan change, it is even more
problematic to implement change if the organisation’s culture is not in
line with the desired future strategy. In the case of IKEA there were
the following strong influences: (i) family owned company with no
shareholder/financial market influence on strategy (ii) Swedish
influence, reflecting Swedish values.

Feedback on Question 2:

Decisions on whether a company takes an environment led approach (fit) or a


resource based approach (stretch) is often complex. IKEA is such an example
where arguments can be formed to justify both.

Taking a strategic fit approach means, as in the case of IKEA, trying to identify
the opportunities which exist in the environment and tailoring the future
strategy to capitalise on these, for example by locating in particularly
favourable markets or seeking to appeal to attractive market segments.

However, strategy can also be seen as building on or ‘stretching’ an organisation’s


resources and competencies to create opportunities or to capitalise on them.

The product range IKEA had designed and developed was not only low cost
but unique, not only because of its kit form but also in its style and image. IKEA
benefited from years of design experience dedicated to its operation and
markets. The logistics of the operation, from sourcing of products to control
of stock and the immediate supply of the product to take away, had been
learned over many years and provided not only a quite distinct way of
operating, but a service greatly appreciated by customers. In short, both the
resources and experience built up over the years had been consciously
developed to service the evident opportunity in the market place.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

IKEA then ‘stretched’ its capabilities, using its experience in the furniture
market, to create a different market opportunity. It set out to reinvent value,
and experimented with housing in the late 1990s. It started to think about
value in a new way; one in which consumers are also suppliers, suppliers are
also customers, and IKEA itself is not so much a retailer but as a central hub for
services, goods, design, management, support and even entertainment.

In practice, organisations such as IKEA, develop strategies on the basis of


environmental ‘fit’ and ‘stretch’. IKEA’s experiment with housing was the
result of identifying a new market opportunity, but it was also an attempt to
capitalise on its skills in developing kit-form products at low-cost.

Feedback on Question 3:

The issues to consider are:

· Is it good business practice to achieve high profits by lowering costs,


irrespective of the ethical issues in the Romanian factories?

· Is the local population in Romania, grateful for having IKEA’s


contract? Or was IKEA exploiting low labour cost locations?

· IKEA’s view of this is that it is a ‘sub-contract’ arrangement, and it is


not up to them how the workers are treated. Is this a realistic
attitude?

· How should IKEA deal with public pressure and use its influence to
improve working conditions and workers rights?

Revisit this question after you have covered Unit 6.

CASE STUDY 2 – POWERGEN


The next case study is case study 5, PowerGen: Strategy and Corporate
Planning’ in your key textbook, De Wit, B & Meyer, R (p. 709-720).

Below is the case synopsis:

CASE SYNOPSIS

PowerGen was vested as a British electricity generation company in


1990 as the result of the privatisation of the UK energy systems. The
previous state owned “Central Electricity Generating Board” was split
into three companies, of which PowerGen was the smallest. All three
companies were asked to compete in the market, and the market was

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

opened for further new entrants as well. Along with the privatisation
and liberalisation, the government introduced completely new
mechanisms of matching supply and demand, such as an electricity pool
or the creation of a separate transmission company, and the
installation of new regulatory institutions. All market players needed
to learn how to operate an energy market, where before there was
only a central planning agency.

As the name of CEGB implied, the institution from which PowerGen


emerged, had strong planning instincts for fulfilling its task to supply
electricity to British households and industry. Therefore, it was not
surprising when PowerGen started preparations for being an
independent company in 1988, that a very detailed strategic planning
system was installed with the help of McKinsey consultants. However,
already in 1992, only two years after the operational start of the
company, a substantial reorganisation was conducted, which triggered
a complete change of the strategic planning system as well. When this
new planning system failed to function satisfactorily in 1993, it was
substantially revised for the 1994 planning cycle.

In 1996 the company underwent again a major reorganisation,


adjusting the company to a number of internal and external strategic
developments. That also caused the strategic planning system to be
substantially revised. In particular it was now broadened to include a
highly sophisticated scenario development module to be conducted on
the business unit level.

The corporate composition did not stabilise thereafter either. In 1998


PowerGen completed a major purchase of a regional energy
distribution company, merger discussions with US partners continued
on and off, government interference changed the pricing arrangements
of the industry and dictated strategic directions, etc. It seemed that the
planning system was always several steps behind the actual conditions
of the company. On the other hand, without the planning support,
how could the company have assessed its choices in the rapidly
changing environment of European energy markets in the 1990s?

Now read the full case study (pages 709-720 of key textbook, De Wit, B &
Meyer, R) with the following learning objectives in mind:

· Understand the need for formal planning systems.

· Understand possible designs of formal planning systems.

· Identify the common pitfalls of formal planning systems.

· Conceive alternatives for formal planning systems.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

Questions:
1. Identify four different development stages of the strategy planning
system that PowerGen was using between 1990 and 1996. Catalogue
the key changes from one stage to the next. What were the reasons
for these particular changes? Which reasons are attributable to
foreseeable circumstances, and which reasons are attributable to
unforeseeable circumstances?

2. What were some of the major strategy decisions that were taken at
PowerGen? Speculate to what extent the results of the strategic
planning system were used for making these various corporate
strategy decisions.

3. Collect the hints in the case, which suggest that there is also a parallel
strategy formation process in place that operates in a more
incremental, emergent fashion.

CASE STUDY FEEDBACK


Feedback on Question 1:

PowerGen’s strategy planning system developed in four different stages during


the first six years of its privatisation.

Phase I:

Occurred in 1990 with strongly centralised formation and planning. Performed


in a functional structure by the commercial division, and focused on pool
operation.

Context: where and by whom?

· In a renewed, functional structure of the organisation.

· Led and managed by a large, centralised planning team at the


commercial division, monopolising the strategy planning and
decision making within the corporation.

· Separated financial role within the Finance division for reviews and
projection of plans.

Process: how and when?

· Deliberate formation.

27
Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

· 5-stage planning process: business unit – aggregation –


divisional plans – aggregation – corporate plan .

· Use of scenarios concerning market share, pool prices and


competitor analysis for the core business.

· 12-month process.

Content:

· Focus of strategy: the operation of the pool.

· Diversification and early internationalisation.

· Planning focused on resource implications of strategic


decisions.

Phase II

Occurred in 1992. To some extent decentralised formation and planning,


under responsibility of rather autonomous division directors, supported by
divisionalised financial staff and a downsized corporate planning team.

Context: where and by whom?

· From a functional structure towards three divisions with profit


and cost centres.

· Decentralisation of (strategic) decision making and planning to


the divisions, headed by empowered MDs.

· Replacement of the large, central planning team by business


level planning staff within the divisions.

· Introduction of a small central strategic planning function,


responsible for both corporate strategy development and
corporate planning.

· Reallocation of financial planning support towards within the


finance department.

Process. how and when?

· Business units developed own business plans, reviewed by


divisional boards, and incorporated in corporate plans; the
process itself did not change too much – merely the
responsibilities of making up the plans had shifted profoundly.

· Shortened planning cycle to nine months.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

Content:

· Shift in business unit responsibility and culture: from expenditure


limits towards operating results, from meeting centrally set targets
to exploring their potential, with increased options and widened
commercial focus.

· Less detailed level of planning.

Reasons:

· Devolution and introduction of an internal market.

· Diversification (first attempts of internationalisation) and early


verticalisation of the businesses required increased responsiveness
at business unit level.

Phase III

Occurred in 1994, with a focus on regaining fit between strategy developments


and financial priorities.

Context: where and by whom?

· Responsibility for the plan and for managing the corporate planning
process was passed to the director of finance, effectively increasing
the influence of financial considerations in the planning process.

· Scenario development was partly delegated to business units, which


became responsible for developing a number of scenarios showing
how the market might develop, and the plans that followed ‘were to
be robust to those possibilities’.

Reasons

· Foreseen profit margins lower than forecasted, because of


regulatory intervention (introduction of capped wholesale prices)
and competition (increased market share of Nuclear Electric).

· Unforeseen extended planning cycle, because of massive


recalculations of forecasts.

· Unforeseen rift between strategic decisions and financial priorities.


Emanated from a strategy and planning process with few
independent checks and balances from a financial point of view.

· Unforeseen failure of the centre to communicate (foreseen)


scenario information fully.

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

· Desire to eliminate divisional bureaucracy in managing the


planning process, because of conflicts between different layers
of the corporation.

Phase IV

Occurred in 1996 with further delegation of the strategic decision-making and


planning process to business units, between which common strategic management
activities were increasingly co-ordinated and increasingly emergent.

Context: where and by whom?

· From divisional structure towards clusters of business units.

· Shift and separation of strategy responsibilities: BU planning


process to BU finance manager; BU strategy development to
other BU staff member.

· Strategy triangle between CEO (for corporate strategy,


supported by Finance Director (for corporate financial
implications) and corporate strategist & planner), group MD
(responsible for business unit strategy, assisted by finance
manager, who managed the planning process).

Process. how and when?

· Strategic actions increasingly in reaction to environmental


(industry dynamics and regulatory) changes, in a continuous
absorption of the external perspective and its impact on
strategic options.

· Decentralisation of scenario development: from corporate


scenarios as a guideline, towards scenario development at
business unit level.

· Horizontal co-ordination (not centralisation) between


multi-units, with integratedstrategic management and
organisational development (skills transfer, human resource
planning, etc.).

· From pre-set details towards a more gradually evolving


process, with ongoing examination of BU strategy, with
increased scope for absorption of emergent issues into
development and planning cycle.

· Decrease in formality of process (including debating, lobbying


for and formation of coalitions for strategic options and
actions between corporate and business levels).

· Sequenced process: first BU strategy, than BU planning.

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

· Differentiation among guidelines for the different businesses.

· Five-year horizon.

Content

· The highly increased impact of regulatory forces on PowerGen


increasingly required a pattern of political bargaining with the
environment. Instead of planning the future in detail, a pattern of
action and reaction with environmental forces became a highly
influential factor in PowerGen’s strategic behaviour.

Organisational systems

· Encouragement of planning system initiatives by BUs within a


corporate context (such as the multi unit scenario development).

· Reviews by team of BUs and corporate level.

· Introduction of bonus system, related to strategy process.

Reasons

· Increase in environmental complexity and uncertainty, because of


diversification, competition and new regulation.

· An unforeseen need for co-ordination between the different


strategising activities of BU.

· Foreseen need for independent management of several ‘new’


businesses.

· Need for separation and autonomy of marketing and sales, in


anticipation of liberalisation of core markets.

· Need for even further autonomy of business units, in order to


create increased focus for business units’ specific circumstances.

Feedback on Question 2:

1. Development of generation power. PowerGen began to develop its


generation capacity to better fit commercial and environmental
requirements, through improving the flexibility of the coal units and
developing gas-fired stations. The move to flexible production came
along with the anticipated need for flexibility in the supply of energy.
Before the liberalisation, the previous planning mechanism could easily
foresee total demand on a yearly basis, dividing the total and allocating
parts to the various generation units. But in the fresh market, the
demand for energy could easily alter significantly, mainly due to the

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

new market mechanism: the wholesale pool. To be responsive to this


new market logic, production needed to be flexible.

Note, however, that the very step of introducing flexible production,


actually opposed the whole idea of the formalised, long and detailed
planning process that was adapted by PowerGen in 1990. Because of
the electricity pool, it became much harder to forecast exact
production demand.

2. Leveraging of core competencies. PowerGen’s moved to leverage her


core competencies in other energy-related areas, both vertically and
horizontally (internationalisation). Examples include:

- Upstream: acquisition of assets in the North Sea and


Liverpool Bay.

- Downstream: formation of a joint venture with Conoco,


Kinetica; plans included the supply of gas to power
stations, including PowerGen’s, and large businesses;
establishment of Combined Heat & Power (CHP);
acquisition of East Midlands Electricity plc. (EME), ‘98.

- International: (early stage) power station and mining


acquisitions in eastern Germany and Hungary, with
construction projects in Portugal and Indonesia. Later on
in the 1990s, further foreign direct investments in plants
and projects overseas.

- Commissioning of two new CHP plants.

As stated in the case, PowerGen strategy anticipated that it would


suffer an inevitable reduction in market share, together with pressures
for price reduction. Consequently, the company recognised that
growth in the medium and longer term would require the
establishment of new income streams in other energy-related areas
where its core competencies could create value. The case reveals data
on slow growth perspectives for PowerGen’s core industry in the UK
on the one hand, and high growth forecasts in domestic energy related
areas and increasing international demand for power on the other
hand. Probably, within the planning cycle, external industry
assessments had come up with these insights, forming the basis for
environmental scenarios. This ultimately resulted in the formulation of
strategic options at PowerGen and the strategic choice of a path to
growth in a still standing UK market.

3. Intended sell of PowerGen North Sea (1997/1998). In the case of the


acquisition of EME, it is to be assumed, that the ‘one-stop-shop’
(supplying all household’s energy needs) strategy had been pushed for
by strategists as the solution for ensuring long-term profitability at
PowerGen. Also, the case explicates that integration of generation and

32
Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

distribution provided necessary expertise for similar future


international acquisitions.

4. Merging explorations with US utility groups. Clearly, from a content point


of view, the strategy and planning process focused on leveraging core
competencies for expansion of its business. In fact, in the later ‘90s
PowerGen’s challenge was to get individual business units to be more
responsive in leveraging core competencies of PowerGen to
operations in both domestic and overseas markets. One could argue
that the planning process of PowerGen from 1996 successfully
managed this challenge, by engaging delegated business units in the
strategic management process.

Note, that the allocation of the strategy and planning process to the
commercial division in 1990, might indeed have affected the strategic
choices made by PowerGen. Identification of strategic issues by this
division might be completely different when the strategic management
function was allocated to the finance department (as in 1992), for
example.

5. Creation of a new holding company in the US, in order to continue assessing


possibilities in the US. Intended further growth of the core business
required the injection of considerable capital. If the reorganised
planning process (1996) is considered, one could argue that this sale is
a direct effect of the setting of overall strategic and financial direction
by the CEO, Finance Director and Group MD.

The case reveals explicitly the causes of failure of intended mergers


between PowerGen and Cinergy and Houston, two major US utility
companies.

Both failures are clear cases of intended, but unrealised strategic


actions, for which the causes could obviously not be caught in strategic
planning (‘strains between the two chairman’ and regulatory
intervention).

6. Focus on power generation as a core business and becoming a low-cost


producer on a world-class basis.

Feedback on Question 3:

In order to cope with the limitations of the various planning processes that
were effective at PowerGen during the 1990s, an ‘unofficial’, parallel formation
process emerged, on different dimensions. If the planning processes of the first
and fourth phase are compared, to some extent the planning process in itself
underwent change. The planning process became less formal and it was
recognised it could not be sequential. Over the years, the results of the
process became increasingly dependent on coalition forming, lobbying and a
constant discussion between the different planning process levels of
PowerGen. The extent of freedom to business units in developing strategy
increased significantly. Whereas in the early '90s all strategy development and
planning activities were performed by almost a single department, in later

33
Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

stages entrepreneurial freedom was given to managing directors of business


units, especially those involved in new businesses (that formed an increasing
part of the total PowerGen portfolio). Also, business units became free in
choosing appropriate techniques as means to develop strategy, and MDs were
given considerable influence over their own revenues, including the
questioning of central purchasing of services. Scenario development too
became increasingly incremental, due to the deployment of ‘robust’ strategy
development, inherently decreasing the extent of detail in business plans. In
fact, the role of the Group MD became increasingly a role of shaping the
course of action by gradually blending together initiatives into a coherent
pattern of actions, rather than rigidly setting the course of action in advance.

Externally, an increased amount of effort was made to manage the interface


with regulatory, political and environmental developments, in order to
continually absorb external perspectives and assess its implications for
strategic options. Obviously, this level of market and environment
responsiveness could not be incorporated into the formal planning cycle,
suggesting a parallel pattern of strategic actions alongside its planning cycle.
Opportunistic behaviour emerged, as a result of the numerous governmental
interventions with great impact on strategic actions. The course of action,
reaction and reconsideration that increasingly determined the pattern of
actions of PowerGen, suggest that there was indeed a parallel course alongside
the formal planning process. The major realised strategic actions of PowerGen
did not result from the planning process, but were reactions to governmental
rulings, market opportunities or emerging industry dynamics. The actual
strategic behaviour of PowerGen increasingly showed ‘logical incrementalism’,
rather than the pure deployment of the formal planning cycle.

Summary
In this module we have described what corporate strategy entails. We
have noted that strategy must be holistic, and that strategic thinking
must dominate an organisation and influence its daily actions. We
examined the various levels of corporate strategy, and also considered
network level strategy; increasingly relevant in today’s world.

We have looked at the importance of strategy to a manager, the skills


required to be a strategist, and the characteristics of good strategic
decision making.

We considered the role of models in strategic thinking, in particular the


Johnson and Scholes model.

Finally, students have been presented with two contextual case studies
(IKEA and PowerGen) to work through.

34
Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

To gain maximum benefit from this module, students are encouraged to


apply the lessons learnt to their own work context.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 10, Chapter 1 Pages 4-34, Chapter 2 Pages 37-75


2. Ref 7, Chapter 1 Pages 3-37, Chapter 2 Pages 43-87

35
Unit 2

Strategic Capability

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Assess the importance of core competencies to an organisation.

· Analyse the influence synergy can have on an organisation.

· Judge the role divestment has on organisational performance.

Introduction
Corporate strategy is the overarching strategy that applies to a number
of businesses combined within a single corporation. This is more than
aggregating the individual strategies of its various component
businesses. There must be definite and identifiable benefits from
combining the businesses together in a single corporation to make
corporate strategy worthwhile.

This unit examines how businesses are combined to achieve superior


performance. To obtain optimal corporate performance, a corporation
may increase or reduce the number of component businesses so as to
create a more effective combination. Corporations use different
management styles in achieving an optimal mix. We shall examine
portfolio management and core competencies as two different styles.
Portfolio management was fashionable in the 1970s and 1980s, when the
focus was purely on financial control, and it was thought that benefits
could be obtained by holding a portfolio of diverse strategic business
units. It was also felt that this approach reduced risk for the corporation.
In the 1990s corporations began to see the efficiencies and benefits of
focusing simply on core business, and a greater focus has come about on
developing a corporation’s core competencies. Corporations thus
started to alter their composition in order to strengthen core
competencies. Whichever approach is adopted, executing corporate
strategy often involves acquisitions, mergers and divestments.

We shall also examine some case studies concerning strategic capability.

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Unit 2 – Strategic Capability Global Corporate Strategy

The Different Management Perspectives


Corporations adopt different management styles in strategic planning,
depending on the environment and business context, the corporation’s
product/services range, its leadership style and management culture.
The two extreme positions are:

· Portfolio management.
· Strategic planning by Core Competencies.

Portfolio management is a management style whereby financial control


is performed by the corporate centre, but otherwise the individual
businesses are de-centralised and highly autonomous. Corporations
adopting this style, achieve greater responsiveness because the
individual subsidiaries are autonomous, but fail to achieve the
longer-term benefits of exploiting synergy. The Hanson group of
companies is a classic example.

Corporations that wish to exploit synergies between their various


businesses and develop a longer-term competitive advantage, generally
adopt a management style based on core competencies. Canon is a good
example of a corporation that carries out strategic planning based on
core competencies.

In practice, many corporations try to balance responsiveness with


synergy by adopting management styles that fall between the two
perspectives of portfolio management and core competencies. This is
sometimes termed the ‘strategic control’ perspective. See Figure 2.1.
Nestle is an example.

Responsiveness Synergy
Corporate Level Strategy

Hanson Nestle Canon

Figure 2.1. Corporate Level Strategy Continuum.

The paradox of responsiveness and synergy can be illustrated with


reference to these three companies. Hanson PLC was well known in the
1970s for portfolio management in the purest sense. They operated very
much in line with the analogy described below – as an investor would in
financial markets to maximise returns on their investment by the buying

38
Global Corporate Strategy Unit 2 – Strategic Capability

and selling of companies. The corporate centre had no wish to become


involved in the management of the portfolio companies but sought to
control simply by financial investment. The advantage of these
companies was responsiveness to particular markets. Campbell and
Gould identify this ‘style’ of corporate strategy management as
‘Financial Control’.

Canon had the opposite strategic approach. They use their expertise
(capability) across a diverse range of products and markets. For
example, the technology used to develop the Canon photocopier was
the same as that used for their other optical products – hence, the
technology is completely different in a Canon copier than, for instance, a
Xerox. Their advantage came from efficient (synergistic) use of
capabilities and resources. Campbell and Gould identify this ‘style’ of
corporate strategy management as ‘Strategic Planning’.

Nestle can be said to lie somewhere in between. Whereas it is not


important to define the precise location on the continuum, it can be said
that Nestle combines the two perspectives. On the one hand they
manage their geographically dispersed ‘Business Units’ as remote and
autonomous, passing on strategic control to them. On the other hand
they maintain strong involvement in the operation of the Business Units
by the application of a rigid and detailed strategic planning process
managed at the corporate centre. Hence, it can be said that Nestle is a
mixture of the two perspectives. Campbell and Gould identify this
‘style’ of corporate strategy management as ‘Strategic Control’.

ACTIVITY
Learn about organisations and capability building by reading the following from
your key text, De Wit, B & Meyer, R.

Readings 5.2 and 5.3: pages 267-285.

Also read Chapter 6 on Corporate Level Strategy : pages 297-318.

Portfolio Management
In portfolio management, in the strictest sense and at the very extreme
position, the corporate centre acts solely as an investor with financial
stakes in the standalone businesses. The corporation’s main philosophy
is to leverage financial control. See Figure 2.2. In this extreme position,
there is very little co-ordination between the various business units, and
there is ‘fuzzy’ co-operation. Each business unit has its own
characteristics and market demands.

39
Unit 2 – Strategic Capability Global Corporate Strategy

Corporations that adopt the extreme portfolio management position are


well suited to diversification through acquisitions.

Corporate
Centre

Financial control
£

SBU1 SBU2 SBU3 SBU4 SBU5 SBU6

Figure 2.2. Portfolio management and financial control.

As we move to the right along the ‘continuum’ (see Figure 2.1), various
strategic approaches can be described that are still essentially
portfolio-based. But the corporate centre takes more of a ‘parenting’
role, and can add value in some of the following areas: efficiency
improvements, leverage, provision of expertise, investment and
competence building, fostering innovation, mitigation of risk, provision
of image and networks, collaboration/co-ordination across SBUs,
standards and performance measurements, vision.

With the parenting approach, the question must still be asked on


whether the corporate centre adds value or destroys value. Those who
argue the value creation case cite the following advantages:

1. Co-operation and Control:

- Information sharing
- Co-operation of directors/managers
- Real time decision making
2. Exploitation of:

- Slack (available resources)


- Synergies
- Learning
- Innovative capability

40
Global Corporate Strategy Unit 2 – Strategic Capability

- Common infrastructure, processes


3. Intervention in management recruitment and development

Those who argue that parenting destroys value would make the case
that SBUs would be better off on their own, because the corporate centre
creates:

1. Additional cost
2. Creates more bureaucracy
3. Delays decision making
4. Reduces responsiveness
5. Buffers SBU from investment realities

They would also argue that a powerful corporate centre leads to


managerial ambition and empire building.

Whatever the position adopted, there must be a clear understanding of


the corporate rationale. It is important right at the outset to establish the
role of the corporate centre. This could be one of four types ranging
from....

1. A Portfolio Manager – as a manager of a portfolio of investments


(as above) which may include divestment of under-performing
SBUs, acquiring under-valued assets and making them better.
2. A Restructurer – similar to 1 but managers from the corporate
centre move to re-structure to create SBU ‘fitness’ by
intervention.
3. A Synergy Manager – enhancing value across SBUs by sharing of
activities (e.g distribution networks). Knowledge transfer (see
Unit 8) and sharing of competence (see below).
4. A Parental Developer – Corporate Centre develops parenting
competence including establishing structural and strategic
control linkages.

Hence, it can be seen that parenting strategy can be developed from 1


(portfolio management) though 2, to 3 and then 4 which tends towards a
more competence based strategic approach.

Portfolio management has strong links to the views of Michael Porter


(Harvard Business School, 1980) that superior profitability derives from
the structure of attractive industries. It suggests that superior
profitability comes from a superior resource position relative to
competitors. Both the Boston Consulting Group (abbreviated as BCG)
and GE/McKinsey matrices position businesses according to industry
attractiveness and their relative competitive position in industry.

41
Unit 2 – Strategic Capability Global Corporate Strategy

ACTIVITY
Study the BCG matrix and GE business screen as shown on Figure 6.2, p. 299
of the key text, De Wit, B & Meyer, R .

What conclusions do you derive from it?

ACTIVITY FEEDBACK
The BCG matrix is drawn up against two orthogonal axes; relative market
share and market growth

Relative market share indicates a business’s market power (one source of


competitive advantage) and this is equated with its ability to earn above
average rates of return. In the extreme, higher returns derive from a
monopoly (100% market share). More often, however, having a large market
share will coincide with cost benefits from large production runs and large
cumulative volumes of production.

Market growth in the BCG matrix is related to the product life-cycle


concept, which suggests that growth will be minimal or negative when a
product is mature.

The Business Portfolio

ACTIVITY
As an introduction to this section, read the following from your key text, De
Wit, B & Meyer, R.

Reading 6.1: pages 319 – 325

In portfolio management, a corporation’s business can fall into one of


four categories:

42
Global Corporate Strategy Unit 2 – Strategic Capability

· Stars.
· Cash cows.
· Dogs.
· Question marks.

A business is categorised as one of the above, depending on its market


share vs. growth rate characteristics. This is clearly depicted in Figure
2.3.

Stars Question
marks
Growth rate

Cash Dogs
cows

Market share

Figure 2.3: Business portfolio.

As we see in Figure 2.3, businesses with market power in a growing


market are stars. With proper investment these can become cash cows
generating significant income for the corporation. A corporation can,
therefore, secure its future by combining a balanced portfolio of stars
and cash cows, the latter to fund the former as they grow.

Portfolio management as the accepted means of managing corporate


strategy coincided with the growth of diversified conglomerates in the
1970s. Often these conglomerates consisted of a portfolio of unrelated
businesses, where the management of corporate cash flows between the
businesses was the sole underlying rationale. This period was
accompanied by a pattern of acquisitions of unrelated businesses, often
followed by the divestment or liquidation of those classified as ‘dogs’,
and deemed to be of no further use in generating cash for the
corporation.

Businesses in the category of ‘Question marks’ need careful


management. They exhibit the characteristics of high growth but low
market share. Stars usually emerge from the category of ‘question

43
Unit 2 – Strategic Capability Global Corporate Strategy

marks’ with proper levels of investment. As such they are an important


component of the business portfolio. However, because of their high
growth characteristics they require a large injection of cash. Unless they
quickly capture market share and move into the ‘stars’ category, they
have the propensity to absorb large amounts of cash. As growth slows
down they become ‘dogs’.

This type of corporate behaviour still has relevance today. There is


evidence of extensive merger and acquisition activity that suggests that
companies remain in the market for ‘valuable’ Business Units which are
quite often kept separate from the corporate centre as a portfolio
company. It is often the case that such activity is geared towards global
expansion (see Unit 3), knowledge expansion and creation (see unit 8) or
simply is the result of a combination of desirable economic conditions
(see Unit 4).

Shareholder portfolios
Many of the ideas relating to portfolio management stemmed from the
management of shareholder portfolios in the field of finance and
economics. In particular, risk reduction by spreading investment across
a portfolio of shares with different patterns of dividend payments and
capital appreciation. In trying to balance stars and cows the corporate
strategy manager acts like a shareholder, reducing the unique risk that
comes from owning one business.

Anglo-American ideas of the pre-eminence of shareholder interests in


corporate strategy management also led to a focus on shareholder value
analysis techniques as a tool for managing diversified businesses.

The manager of a diversified corporation is not, however, a shareholder


investing in a portfolio of stocks in the market. Portfolio theory is based
on the assumption of perfect markets, and a perfect market is dependent
on the availability of perfect information. Critics of corporate portfolios
submit, however, that in a perfect market it is the task of shareholders to
use that information to construct a portfolio according to their own risk
return profiles. In a perfect market it is unclear how a corporate
portfolio manager can add further value for shareholders. Indeed,
diversified corporations submerge information about individual
businesses in less informative corporate reports and add the transaction
costs of managing corporate portfolios to the costs which a shareholder
has to bear.

In situations where co-operation and co-ordination are introduced (e.g.


the role of the Parental Developer, described above) between
autonomous SBUs, a company is then ‘moving’ along the
‘responsiveness / synergy continuum’ towards a more resource based
view of the company. The combining of effort leads to the creation of
greater efficiency or ‘synergy’ in the use of resources.

44
Global Corporate Strategy Unit 2 – Strategic Capability

Synergy in Corporations
Synergy is often put forward as the justification for acquiring or
merging businesses.

But what is synergy in this context?

The familiar expression of synergy is the effect by which ‘the whole


exceeds the sum of the parts’. The equation ‘2+2 = 5’ is often used to
demonstrate the effect.

Synergy describes a corporation’s ability to create value, by identifying


the fit between the opportunities arising from combining activities, and
the corporation’s ability to then exploit these opportunities.

Not all corporations will seek to exploit all available synergies, nor are
they able to. Some corporations may look to exploit only certain
synergies, e.g. financial, technical, mass production, capital assets.

ACTIVITY
Can you think of an example of a corporation that, following a merger or
acquisition, focused on exploiting synergies in just one area?

ACTIVITY FEEDBACK
You may have come up with a number of examples. Here is one.

The UK conglomerate Hanson is a classic example. It had no interest in


achieving benefits from combining the activities of its acquired businesses. Its
focus and main source of success stemmed from the imposition of centralised
financial control of its corporate headquarters upon its separate subsidiaries.

The achievement of the benefits from synergy is far from simple or


automatic. Synergy needs to be created. It requires tremendous
management focus. If poorly managed, the combination of a
corporation’s businesses can result in negative synergy.

45
Unit 2 – Strategic Capability Global Corporate Strategy

Negative Synergy
Managers should be alert to the dangers of negative synergy – the
potential disadvantages and costs of a poor combination. In an
inappropriate or badly handled diversification, value can be destroyed,
rather than created. In these instances, the negative synergy effect can be
described as the sum of the parts being greater than the whole, or ‘2+2 =
3’.

Many conglomerates in the late 1980s and early 1990s have been
devalued by investors to reflect such negative synergy.

MINI CASE STUDY


Hanson had a successful strategy of acquiring UK and US quoted
corporations where the value of the separate businesses exceeded the
value of the corporation. Imperial Group, Smith Corona Machines
(SCM) and Kidde Fire were all bought at prices considerably lower than
the sum of the values that Hanson later realised from their parts, either
by running them more effectively or by selling businesses to outsiders
who could. The most spectacular example of this strategy remains the
acquisition in 1989 of SCM by Hanson for $1.3 billion. Having quickly
recouped the purchase price by selling a number of SCM businesses for
$1.5 billion, Hanson was left with SCM’s core electronic typewriter
business with a value subsequently estimated at $2 billion!

Synergy and the Nature of Assets


The deliberate combination of assets, resources and capabilities from
separate businesses is a distinguishing feature of corporate strategy.
Itami (1992) draws a distinction between the benefits arising from
‘physical’ and ‘invisible’ assets as follows:

· Physical assets
‘Complementary’ benefits can be obtained from the
simple combination of physical assets such as factories
and machinery. These can be achieved when physical
assets are under-utilised, incapable of being fully utilised
(e.g. due to seasonal cycles), or because combining them
reduces risk/uncertainty. Such benefits may include
economies of scale, higher capacity utilisation, improved
cash flow and improved product line and mix.
Itami quotes the example of bulk carrier vessels, which
carry Japanese cars to the US West Coast, loading up with

46
Global Corporate Strategy Unit 2 – Strategic Capability

timber from Washington and Oregon in an unrelated


trade returning to Japan.

· Invisible assets
Invisible assets are assets such as corporate culture,
technical expertise, a strong corporate or brand image, or
expert knowledge of the marketplace. It is hard to
quantify in $ terms the value of these, and this
combination benefit is described by Itami as the ‘synergy
effect’.

A recent example of synergy effect is from the IBM acquisition of the


business consulting group, PwC Consulting, in late 2002. IBM gained
strong business consulting skills from PwC, exploited synergies with
IBM’s complementary IT competencies and strong
leadership/branding. As a result the combined consulting arm vastly
increased global marketshare (compared with the sum of the individual
marketshare prior to the acquisition).

Synergy and Superior Corporate Performance


An important distinction between physical and invisible assets, and
between complementary and synergy benefits, lies in the difficulty
competitors have in imitating invisible assets. Using an under-utilised
plant to produce another product will provide a reasonably certain
payoff, but these benefits are ultimately limited by the plant’s capacity.
Using cash cow’s to fund stars may provide a secure source of finance,
but the strategy can be copied by competitors. Complementary benefits
are unlikely to be lasting sources of superior performance for a
corporation. Invisible, information-based assets, on the other hand, are
capable of being used repeatedly, and in innovative combinations, as a
powerful long-term source of superior corporate performance, because
they are more likely to remain unique to the corporation.

Synergies are also associated with time-scales. They can be dynamic or


static.

Static combination benefits result from integrating two different


strategies at one point in time.

Dynamic combination benefits, on the other hand, results from


integrating two different strategies across time. It aims over a period of
time to change the set of resources and its capabilities in order to achieve
superior performance. It has an opportunity cost associate with it.

47
Unit 2 – Strategic Capability Global Corporate Strategy

ACTIVITY
Read the following article from your key text, De Wit, B & Meyer, R.

Reading 6.4, ‘Seeking Synergies’: pages 340 – 356.

The Core competencies perspective


In the late 1980s there was a move away from the ready acceptance of
portfolio management as the best means of managing corporate
strategy. Performance of vastly diversified companies deteriorated, and
this was coupled with the recognition that there was a large
management overhead in managing diverse portfolios. Divestments
followed and a new paradigm followed.

Corporations began to focus increasingly on core business and core


competencies.

Before we go on to examine the core competence approach, it is


appropriate to look at the definitions of core skills, core competencies
and an organisation’s capability. These terms are often misunderstood.
An organisation’s core skills, core competencies and distinctive
capability make up its strategic core. Core skills are associated with an
individual, core competencies with a team, and the organisation’s
combination of core competencies make up its distinctive capability. At
its simplest, a core competence is a unique capability that affords some
type of competitive advantage to the organisation. It corresponds to a
business process, and involves a combination of skills, functions,
systems and knowledge. To determine if something is a core
competence, one has to ask the question, “Does it give the company a
unique advantage over its competitors and help make the company
profitable?”

The elements of the strategic core should be developed, extended,


protected and exploited to the full. It is an organisation’s core
competencies that enable it to perform more effectively than its
competitors, and offer unique advantage to the marketplace. Core
competencies leading to an organisation’s distinctive capability are also
likely to be persistent and not readily replicable.

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Global Corporate Strategy Unit 2 – Strategic Capability

Resources

Resources Intellectual capital


(physical) (skills, competences and
capabilities)
Held in the control
of the organisation Affects the organisation's ability
to do things effectively
Tangible and
intangible Intangible

Largely independent of the Inherently attributable to the


organisation's members organisation's members
Unaffected by culture and Influenced by culture and
governance structure governance structure

Figure 2.4: Characteristics of physical assets vs. intellectual capital.

Core competencies, in contrast to physical assets, relate to human


intellectual capital. Its distinctive features (in contrast to physical assets)
are summarised in Figure 2.4. Organisations adopting a core
competence perspective seek to exploit its intellectual capital to the full.
We shall examine this in more detail in the unit on Knowledge
Management (Unit 8). Increasingly, core competencies, above products
or services, are viewed as rendering competitive advantage, and
perceived by customers as adding real value in the long term. The need
to focus on core competencies has never been greater, particularly in the
‘new knowledge-based economy’.

ACTIVITY
Read the following paper on core competencies by Prahalad and Hamel in your
key text, De Wit, B & Meyer, R.

Reading 6.2: pages 325- 333

Prahalad and Hamel have explored the role that competencies play in
corporate strategy. They view the corporation as a collection of core
competencies and core products, rather than a portfolio of businesses

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Unit 2 – Strategic Capability Global Corporate Strategy

defined by product-market boundaries. Competencies are viewed as


the root of competitiveness for the corporation across time.

The tests for core competencies are:

1. Core competencies provide potential access to a wide variety of


markets.
2. Core competencies make a significant contribution to the
perceived customer benefits of the end-product/service.
3. Core competencies should be difficult for competitors to imitate.

VIRTUAL CAMPUS
Spend some time thinking about your organisation’s core competencies. If you
feel that the company you work for is not suitable for this activity, select a
services company, e.g. IT or Business Consulting Services (e.g. Accenture)

1. What would you consider as its core competencies? How do these


competencies give access to a variety of markets (e.g. global, different
industries/sectors)?

2. How do your organisation’s core competencies (as opposed to


products/services) benefit your customers?

3. How do your core competencies position you better for the future?

Now think about your competitors..........Consider questions 1, 2 and 3 from


the perspective of your competitors.

In what ways are your competencies (or that of your competitors) difficult to
imitate?

How can the organisation’s core competencies be developed further?

Now share your answers, where appropriate, with your colleagues on the
Virtual Campus. In the interests of confidentiality, it is not necessary to name
the company you have considered.

Core competence competition


Studies of diversification have tended to discuss corporate strategy in
terms of end products and markets rather than core competencies.
Rumelt (1974) measured the performance of seven types of diversified
US corporations in the period 1949-1969. The results showed that there

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Global Corporate Strategy Unit 2 – Strategic Capability

was a strong correlation between superior performance and ‘related


constrained’ diversifications. That is, those business that ‘draw on the
same common core skill, strength or resource’ performed better.

Rumelt (1994) further developed the core competencies perspective,


and established four key components of core competence competition
as follows:

1. Corporate span: core competencies span businesses and products


within a corporation.
2. Temporal dominance: products/services are only the
momentary expression of core competencies. Competencies are
more stable and evolve more slowly than products/services.
3. Learning-by-doing: Competencies are gained and enhanced by
use.
4. Competitive locus: product-market competition is merely the
superficial expression of a deeper competition over competencies.

The power of the core competence approach is that it provides a


coherent view of how superior corporate performance can be achieved,
allows for the importance of the strategic actions of managers, and
captures the dynamic nature of strategy.

Divestment
As we have seen achieving superior corporate performance often results
in divestments – that is, the sale or disposal of one or more of a
corporation’s activities. Divestments may occur when corporate
synergies no longer exist, under-utilised corporate assets can be better
deployed elsewhere or core competencies can not be enhanced by
leverage across the corporation.

Many divestments occur when subsidiary businesses show decline. But


is divestment always the correct response to failing businesses?

Decline: Divestment or Recovery?


Kathy Harrigan (1988) views declining industries as opportunities for
endgame strategies. She believes that corporations must ‘flee or fight’ in
declining industries. The endgame strategies she puts forward are:

1. Leadership: a leadership strategy is dependent on achieving


market power within the remaining attractive segments of the
industry, and controlling the process of decline in the business’s
favour. This strategy requires some investment. The expectation

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Unit 2 – Strategic Capability Global Corporate Strategy

is that, as other competitors leave the industry, so the profitability


of the firm improves.
2. Niche: niche strategies depend on the existence of defensible
market segments. In such a strategy the business would focus on
a niche where it is competitively strong, or where demand is
likely to persist longer (or at high levels) than in the rest of the
sector.
3. Quick sale: a corporation should seek a quick sale when it is
likely to realise greatest value from a weak competitive position
in an unfavourable market.
4. Harvest: harvesting assumes that value can be returned to a
corporation from a business by continuing to run it to extract as
much cash as possible. Further investment is not expected: the
objective is to realise the maximum cash from the business.

Other studies (notably Slatter, 1984) have shown that successful


recovery or turnaround of declining businesses is possible. Companies
that achieve a sharp and sustained improvement in performance are
termed ‘sharpbenders’. They invariably achieve turnaround by taking
one or more of the following measures:

· Major changes in management.


· Stronger financial control.
· New product-market focus.
· Improved marketing.
· Significant reductions in production costs.
· Improved quality and service.

Studies of such companies have shown that sharpbenders succeeded


because of the effectiveness of the measures (as listed above) and timing
of them. Sharpbenders rarely pursue acquisitions as a route to change.

Divestment and Core Competencies


As portfolio theory has become less influential, the rationales for
divestment have changed. The strengthening of core competencies is a
major driver in corporate strategies. As such, corporations rarely seek
divestment of activities that enhance its core competencies. Indeed, the
strengthening of core competencies is often a driver for acquisitions.

If an activity or business does not involve a core competence, a


corporation should seriously consider whether it should divest that
activity. ‘Make or buy’ tests are crucial: can the activity be more

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Global Corporate Strategy Unit 2 – Strategic Capability

efficiently carried out within a corporation, or by outside


partners/contractors.

‘Outsourcing’ is a divestment strategy which recognises that improved


effectiveness might come from buying in non-core competencies. A
corporation’s effectiveness can be significantly improved by the
superior skills, resources and expertise of companies for whom the
activity is core business.

ACTIVITY
Can you think of some high-profile example of outsourcing, which has
delivered, or will deliver, massive cost savings.

ACTIVITY FEEDBACK
You may have thought of a number of examples. Many oil companies, financial
institutions, energy companies and banks have outsourced their IT activities to
the likes of EDS, IBM, Logica.

More recently, the UK government is divesting aspects of its state activities to


private companies, e.g. NHS patient records and data services, army logistics,
etc.

CASE STUDY
Rohm, Japan – strategy in a medium-sized Japanese company
surviving in a difficult environment.

Even as the Japanese economy has been battered by one of the worst recessions in
memory, some Japanese companies have bucked the national trend. This case
explores the Japanese company Rohm which has stood out not only for its strong
performance in a depressed market but also for its defiance of traditional Japanese
corporate behaviour.

Rohm is a manufacturer of highly specialised integrated circuits based in Kyoto.


Its profits have increased steadily over the past four years at a time when most
Japanese companies have struggled to cut their losses. Rohm’s recurring

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Unit 2 – Strategic Capability Global Corporate Strategy

profits in the year to March 1998 came to Y110.1 billion (US$917 million), or
nearly one-third of sales at Y335.9 billion and a fivefold increase from the Y21.6
billion it made in 1994.

Its return on equity, at 16.5%, would be the envy of many blue-chip Japanese
companies for whom return on equity has tended to be a single-digit figure.
Although profits were expected to be flat in 1998, Rohm intended to increase
its recurring income to sales ratio to 33.1% in 1999 from 32.8% in the year
ended March 1998.

Like many of its successful neighbours, Rohm has been able to put in this
remarkable performance by maintaining the entrepreneurial spirit of its
founder and a rigorous focus on profitable niche markets. Rohm’s strength is
its company policy of focusing its resources on products that stand out and
that it can differentiate from those of its competitors, explains Nobuo Hatta,
the director in charge of overseas sales. To that end the company has adopted
policies that are almost diametrically opposed to those that have ruled most
large, well-established electronics companies in Japan.

Rather than pursue mass volume businesses, such as the memory chips which
have been huge profit-earners for the likes of Toshiba and NEC, Rohm has
been happy to stick to niche markets where it can offer unique products. It is a
policy to which Rohm’s founder and president, Kenichiro Sato, has steadfastly
adhered.

Mr Sato started the company 40 years ago after giving up his dream of
becoming a professional pianist. His first successful product was a miniature
resistor he invented, not in his garage but in the family bathroom. At the time
most of the large electronics companies were making only large resistors to
put into the large radios. But then the transistor boom hit and Rohm found
itself ahead of the game on miniature transistors.

From that time on, Rohm has focused its energies on products that slipped
through the net of the large electronics companies, such as customised chip
parts. ‘I never fight battles I cannot win’, Mr Sato declares. That concentration
on core skills has shielded Rohm from the devastating effects of both the
bubble economy and the downturn in semiconductor prices. The company
even develops its own manufacturing facilities, not only in order to ensure it
can make profits out of small-lot customised products but to ensure that it can
make its products quickly and reliably.

Some chip parts made by the company are priced at less than Yl. This means
that even if they sell a million of them it only generates Yl million in income.
Rohm is able to make a profit on these products because it can produce them
quickly, reliably and at low cost.

Also in defiance of traditional Japanese business practice, Rohm does not


employ a seniority-based system of promotion and hires as many as 20 to 30%
of its employees in mid-career. Mr Hatta believes that being based in Kyoto has
helped the company. ‘Western Japan is far away from bureaucrats and
politicians in the central government so we have been able to focus on
business’, he says.

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Global Corporate Strategy Unit 2 – Strategic Capability

‘There is also a feeling among Kansai people that they would rather be big fish
in a small pond’, he notes. ‘Many Kyoto companies have something they can
claim is number one in the world.’ In its focus on core skills, its pursuit of
profits rather than market share and its emphasis on employee performance
over seniority and lifetime employment, Rohm may sound more like a US
company than a company based in one of Japan’s most tradition-bound cities.
But Mr Hatta, who spent some years in the USA, believes that the Japanese
emphasis on taking a long-term approach to things is one strength that
provides Japan with an advantage over the USA. ‘We believe the model we
provide is based on the best of both worlds’, Mr Hatta says.

Note: Kansai is the western Japanese province that includes Kyoto.

Questions:
1. What were the main aspects of the environment affecting Rohm over
the last four years?

2. What strategies did Rohm adopt in order to survive and grow? To


what extent are they more appropriate to medium-sized companies,
rather than the large Japanese electronics giants such as Toshiba and
NEC?

3. Summarise the key points that identify Rohms strategic perspectives.

CASE STUDY FEEDBACK


The case explores the strategies of a Japanese company that has taken a very
different approach to some more well-known Japanese companies like Sony,
Toyota and Canon. It raises the strategic issues of how small companies grow
and how they survive when there is an economic downturn.

Feedback on Question 1:

· The obvious area is the downturn in the Japanese economy over


this period, which has had an impact on every company in that
country.

· Additional pressure from specific competitive pressures in the


Japanese electronics industry which has been particularly badly hit
by a world-wide drop in prices for semi-conductors – note that this
is not something specific to Japan.

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Unit 2 – Strategic Capability Global Corporate Strategy

Feedback on Question 2:

Rohm decided that it would never be able to compete with the large basic
electronics companies in terms of costs and prices. Its chosen strategy was
therefore to avoid head-on competition with the leaders by finding niche
markets that would not be attractive to the larger companies. It was therefore
aware of its capabilities as an organisation, and consequently its competencies
within the groups of people working for the company – a core competence
approach as opposed to a ‘market driven’ environmental approach.

However, the strategy went further. Rohm deliberately set out to produce
products for its chosen niches that were reliable, low cost and available
quickly. In other words, the company set out to dominate the niche into which
it had chosen to enter. Looking at it another way, the strategy focused on
‘customised’ rather than mass produced products. It was not enough just to
identify the special market opportunity: Rohm still had to perform better than
any potential competitors.

Such strategies have an obvious attraction for smaller companies when


competing against the larger electronics giants. However, the difficulties of
finding an attractive niche and then exploiting the opportunity in that niche are
not to be underestimated.

Feedback on Question 3:

· Given the small size of the company compared to the industry


giants, Rohm had little choice in following a niche approach.
However, the different path is not just about finding a niche
but also exploiting it. This has relied on the classic strategic
approach of examining what competitors are doing and then
doing something that is different.

· Rohm’s view was explained in the case by Mr. Satto who


declared: ‘I never fight battles I cannot win.’ By this he meant
that smaller companies need to avoid taking on the large
companies head-on. However, this conventional wisdom can
be challenged, e.g. the success of the Japanese car company
Toyota, which had come from being a small national producer
in the early 1950s to the third largest car company in the
world by the mid-1990s. Thus it would be over-simplistic to
draw the lesson that small companies can only be involved in
niche markets. If this were the case, then they would never
grow. Nevertheless, Rohm is correct in suggesting that, at least
for a while, smaller companies should avoid attacking major
competitors. The smaller enterprise should wait until it has
some form of sustainable competitive advantage: perhaps a
new technology or patent, perhaps a strong alliance with
another company or whatever. It is the competitive advantage
that is the key to the success of Rohm, rather than its size.

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Global Corporate Strategy Unit 2 – Strategic Capability

· However, size is an advantage to Rohm. Applying DeWit & Meyer’s


paradox of Responsiveness and Synergy, the company is nimble
enough to be responsive (to customised markets) whereas still
being ‘synergistic’ (relying on core competence). Hence, it can gain
the benefits of both extremes of the paradox. Larger, more
cumbersome organisations will find it more difficult to respond to
changes in the niche markets. Because of high overhead costs it is
probably not profitable for them to try to compete with smaller
companies like Rohm.

· Rohm had a different approach to product development, a radically


different way of rewarding his managers and a different company
culture that went well beyond the conventional. This allowed him
and the company to survive and prosper in bad times as well as
good.

Summary
In this unit we have looked at the different styles in corporate strategic
management. In particular the portfolio management and core
competencies perspectives. We have also examined the influence of
synergy on a corporation’s strategic decisions.

We have looked at the role of divestments and the increasing focus on


core products and core competencies. We have seen how this recent
trend has led to outsourcing.

To gain maximum benefit from this module, students are encouraged to


apply the lessons learnt to their own work context.

REVIEW ACTIVITY
In the earlier Virtual Campus activity you were asked to think about what your
organisation’s core competencies are. Now verify this by reading your
organisation’s mission statement. Identify any references to core
competencies. If this is absent in the mission statement, consult a broad
spectrum of senior managers and identify what the core competencies are.

1. Does the official view (from mission statement or management team)


on core competencies match your original view? If there is ambiguity,
what steps can be taken to ensure that the organisation as a whole is
clear on its core competencies.

2. Now test your own department/business unit against the core


competencies.

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Unit 2 – Strategic Capability Global Corporate Strategy

· If you feel there is a poor match, describe what sort of


organisation can benefit from your department’s capabilities.

· If there is a good match, could you further strengthen your


position via an acquisition. Elaborate.

(Given the confidential nature of this information, you may wish to anonymise it. )

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 10, Chapter 6 – Pages 226-241


2. Ref 7, Chapter 4 – Pages 149-193
3. Ref 13, Chapter 1 – Pages 3-24

58
Unit 3

Globalisation

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Evaluate the impact drivers for change have on organisations.

· Assess the implications of globalisation for business.

· Propose solutions for managers working in a global environment.

Introduction
The phenomenon of globalisation is accelerating in pace. Globalisation
has received much publicity in recent years – both positive and
promoted by large global corporations and organisations such as the
WTO, but also negative coverage from the anti-globalisation movement
highlighting some of the issues. But what exactly is globalisation? In this
unit we shall consider exactly what globalisation is. We shall consider
the globalisation of markets and the globalisation of production.

We shall consider the changing nature of multinational enterprises. In


particular, the rise of non-US multinationals, and now increasingly a
growth in mini-multinationals.

For corporations, globalisation involves radical change. Globalisation


presents opportunities but also poses challenges for the management of
highly distributed worldwide organisations. We shall consider some of
these issues.

Finally we shall look at two case studies concerning Globalisation.

What is Globalisation
The concepts of ‘globalisation’, ‘global strategies’, ‘global corporations’,
‘global markets’, ‘global production’, ‘global productisation’ and
‘global branding’ are widely used. Sometimes these terms are used
synonymously, and their meaning is not well understood. In this

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Unit 3 – Globalisation Global Corporate Strategy

section, we shall briefly look at the evolution of globalisation and what it


actually means.

ACTIVITY
As an introduction to this section read Chapter 10, The International Context,
pages 534-556 in your key text, De Wit, B & Meyer, R.

A fundamental shift has been occurring in the world economy. There


has been a move away from a world in which national economies were
relatively isolated from each other by barriers to cross-border trade /
investment; by distance, time zones, language and by national
differences in government regulation, culture and business systems.

We have been moving toward a world in which national economies are


merging into an interdependent global economic system, commonly
referred to as globalisation. The rate at which this shift is occurring has
been accelerating and is set to continue to do so.

Globalisation is the phenomenon by which industries transform


themselves from multi-national to global competitive structures. Global
companies operate in the main markets of the world, and do so in an
integrated and co-ordinated way.

There are broadly three elements to globalisation:

1. International Scope, the spatial dimension:

· Broadest possible international scope.


· Process of international expansion on a world-wide scale.
2. International Similarity, the variance dimension:

· Homogeneity around the world.


· Process of declining international variety.
3. International Integration, the linkages dimension:

· World is viewed as one tightly linked system.


· Process of increasing international interconnectedness.

The emerging global economy raises a multitude of issues for


businesses. It creates opportunities for businesses to expand their
revenues, drive down their costs and boost their profits. While the
global economy creates opportunities such as this for new

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Global Corporate Strategy Unit 3 – Globalisation

entrepreneurs and established businesses around the world, it also


gives rise to challenges and threats that yesterday’s business managers
did not have to deal with.

For example, managers now routinely have to decide how best to


expand into a foreign market.

· Should they export to that market from their home base?


· Should they invest in production facilities in that market,
producing locally to sell locally?

· Should they produce in a third country where the cost of


production is favourable and export from that base to
other foreign markets and, perhaps, to their home
market?

Managers have to decide how to customise their product offerings,


marketing policies, human resource practices and business strategies to
deal with national differences in culture, language, business practices,
and government regulations. In addition, managers have to decide how
best to deal with the threat posed by efficient foreign competitors
entering their home marketplace.

KEY POINT
Globalisation is the phenomenon by which industries transform themselves
from multi-national to global competitive structures

It refers to the shift toward a more integrated and interdependent world


economy and has two main components:

· The globalisation of markets.

· The globalisation of production.

Global Convergence vs. International Diversity


De Wit & Meyer propose that a paradox exists between the pressure to
act globally and locally, i.e. a continuum can be said to exist with one
extreme being Globalisation and the other being Localisation.

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Unit 3 – Globalisation Global Corporate Strategy

ACTIVITY
This topic links with subjects that are to be covered in other units. At this point
briefly scan the following sections, ahead of studing the units in detail.

Unit 6: section on Value Management

Point to note: Many companies are relocating to other countries to save costs.
Classic examples of this have been in call centres. A further example has been
Dyson who switched their production to Malaysia saving 25% on production
costs. The explanation for this was to spend the money on R&D and to keep
the company afloat. However, a customer backlash resulted in a 5% reduction
in the number of vacuums sold.

Unit 7: section on Ethics

Point to note: Similar behaviour by major companies has seen them fall foul of
globalisation protestors who see such behaviour as exploitative, e.g. Nike and
Ikea. However, is this simply good business and in accordance with the
principle espoused by Milton Friedman who stated that the only responsibility
a company has is to its owners.

High
Micro chips Automobile Military aircraft Pharmaceuticals

Bulk chemicals
Globalisation forces

Civil aircraft Telecommunication


services

Retail banking

Food retailing

Low
Low Localisation forces High

Figure 3.1: Global integration vs. Local responsiveness grid for various sectors.

Business success in the international context is increasingly a case of


finding the right balance between the forces of globalisation vs.
localisation. This balance varies depending on the industry you operate

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Global Corporate Strategy Unit 3 – Globalisation

in. See Figure 3.1. For example, if you a microchip manufacturer,


localisation bears little meaning; ‘one size fits all’ in the global
marketplace. However, if you are a food retailer, localisation forces are
significant and cannot be ignored.

The factor that works against globalisation is the localisation push; the
demand for flexibility to deliver customer-oriented products/services
rapidly and in close geographical proximity to the customer.
Localisation push has four main categories; cultural, commercial,
technical and legal. See Figure 3.2.

Cultural
factors
e.g. attitudes,
tastes, social
practices

Technical Commercial
factors factors
e.g. standards, Localisation e.g. customer
e-business, responsiveness,
communications customisation,
networks

Legal
factors
e.g. regulations

Figure 3.2: Localisation push factors.

Globalisation at the Micro, Meso and Macro


levels
The issues concerning globalisation can be viewed at the micro, meso
and macro levels.

At the micro level, for a company, the issues concerning globalisation


are:

· The extent to which an organisation has a global strategy,


structure, culture, workforce, management team and
resource base.

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Unit 3 – Globalisation Global Corporate Strategy

· Globalisation of specific products and value-adding


activities.

· The globalisation of one product or activity does not


necessarily entail the globalisation of others.

At the meso level, for businesses, the issues concern markets and
industries, as follows:

· On markets, the growing similarity of customer demand


globally.

· On markets again, the growing ease of worldwide


product flows, e.g. crude oil, foreign currency markets

· On industries, the emergence of a set of producers


competing on a worldwide basis, e.g. automobile,
consumer electronics.

Major changes from globalisation at the meso level include the more
even distribution of Foreign Direct Investment (FDI), and waves of
cross-border mergers, acquisitions and strategic alliances. There has
also been a notable expansion in the services sector at the expense of
manufacturing.

At the macro level, for the world’s economies, the issues concern:

· The debate on whether the economies of the world are


experiencing a converging trend.

· Consequences of international integration in terms of


growth, employment, productivity, trade and foreign
direct investment.

· Political realities constraining or encouraging


globalisation.

· Dynamics of technological, institutional and


organisational convergence.

Major changes impacting the economies include the complexity and


interconnectedness of the world economy, de-industrialisation of major
powers, financial debt of developing nations and the division of the
world into trading blocks.

The Globalisation of Markets


The globalisation of markets refers to the merging of historically distinct
and separate national markets into one global marketplace. The tastes
and preferences of consumers in different nations are beginning to

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Global Corporate Strategy Unit 3 – Globalisation

converge on some global norm, thereby helping to create a global


market, e.g. McDonald’s hamburgers. This type of firm is more than just
a benefactor of this trend; they are also instrumental in facilitating it. By
offering a standardised product world-wide, they are helping to create a
global market.

However, it is important to understand that national markets are not


giving way to the global market in all sectors of the economy. Significant
differences still exist between national markets, e.g. consumer tastes
and preferences, distribution channels and culturally embedded value
systems. These differences frequently require that marketing strategies,
product features and operating practices be customised to best match
conditions in a country.

ACTIVITY
Read the following article on the globalisation of markets from your key text,
De Wit, B & Meyer, R.

Reading 10.1: pages 557-561

In many global markets, the same firms frequently confront each other
as competitors in nation after nation, e.g. Coca-Cola’s and Pepsi, Ford
and Toyota, Boeing and Airbus, Caterpillar and Komatsu, and
Nintendo and Sega.

Thus, diversity is replaced by greater uniformity. As rivals follow rivals


around the world, these multinational enterprises emerge as important
drivers of the convergence of different national markets into a single,
and increasingly homogenous, global marketplace.

ACTIVITY
Can you think of products that simply cannot be standardised for the
worldwide market? Or products for which marketing attempts at global
standardisation have failed?

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Unit 3 – Globalisation Global Corporate Strategy

ACTIVITY FEEDBACK
You may have thought of a number of examples ranging from differing tastes in
cars (North America vs. Europe) to foods. One example is that of coffee,
where tastes vary vastly from continent to continent. Latin Americans prefer a
bitter taste, Europeans like strong blends, and Americans can only ‘tolerate’
weak blends. So, for example, Nescafe markets different variations under the
same brand to different countries.

Now, as a follow-on to the above activity, read the following article in your key
text, De Wit, B & Meyer, R., that critically examines the notion that success in
international markets requires adoption of global products and brands.

Reading 10.2: pages 562-569

The Globalisation of Production


The globalisation of production refers to the tendency among firms to
source goods and services from locations around the globe to take
advantage of national differences in the cost and quality of factors of
production (such as labour, energy, land and capital). By doing so,
companies hope to lower their overall cost structure and / or improve
the quality or functionality of their product offering, thereby allowing
them to compete more effectively.

MINI CASE STUDY


The Boeing 777 aeroplane contains 132,500 major component parts that are
produced around the world by 545 suppliers. Eight Japanese suppliers make
parts for the fuselage, doors, and wings; a supplier in Singapore makes the
doors for the nose landing gear; three suppliers in Italy manufacture wing flaps;
and so on. Part of Boeing’s rationale for outsourcing so much production to
foreign suppliers is that these suppliers are the best in the world at performing
their particular activity. The result of having a global web of suppliers is a better
final product, which enhances the chances of Boeing winning a greater share of
total orders for aircraft than its global rival, Airbus. Boeing also outsources
some production to foreign countries to increase the chance that it will win
significant orders from airliners based in that country.

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Global Corporate Strategy Unit 3 – Globalisation

As with markets, it is important not to emphasise the globalisation of


production too much. It is still difficult for firms to achieve optimal
dispersion of their production activities to locations around the globe.
This is due to formal and informal barriers to trade between countries,
barriers to foreign direct investment, transportation costs and issues
associated with economic and political risk.

Nevertheless, there is an increased level of globalisation of markets and


production. Modern firms are playing a key role in this and increase
globalisation by their actions. These firms, however, are merely
responding in an efficient manner to changing conditions in their
operating environment.

ACTIVITY
Can you think of an example of globalised production that has yielded
enormous cost and other business benefits?

ACTIVITY FEEDBACK
There are many examples of corporations outsourcing specific activities (e.g.
call centres) to one country. For example, many financial institutions have
outsourced their call centres to India.

There is also another aspect – the distributed globalisation of production. This


is particularly so in the IT sector, where companies are increasingly distributing
the ‘production’ of software across geographies. Companies such as IBM run
projects where aspects of the same software is developed in China, other
aspects in India and yet others in South America. The whole system may then
be integrated in yet another country (e.g. US). This achieves ‘round-the-clock’
productivity. Not only do huge cost savings result from cheaper professional
rates from non-Western countries, but also ‘round-the-clock’ productivity
enables corporations to achieve aggressive time-lines. Effectively work is being
carried out throughout the 24-hour clock. However, this is not the panacea it
sounds. There are challenges with such globally distributed production, and
such practices require strong management control, standards and robust IT
and communication infrastructures. These are some of the management
challenges of globalisation which we shall examine later in this unit.

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Drivers of Globalisation
Two main factors seem to underlie the trend toward greater
globalisation:

· A decline in barriers to the free flow of goods, services


and capital has occurred since World War II.

· Technological change, particularly the dramatic


developments in recent years in communications,
information processing and transportation technologies.

Declining Trade and Investment Barriers


After World War II, the advanced industrial nations of the West
committed themselves to removing barriers to the free flow of goods,
services and capital between nations. This goal was enshrined in the
treaty known as the General Agreement on Tariffs and Trade (GATT).

In addition to reducing trade barriers, many countries have also been


progressively removing restrictions to Foreign Direct Investment (FDI).
The desire to facilitate FDI has also been reflected in a dramatic increase
in the number of bilateral investment treaties designed to protect and
promote investment between two countries. As of January 1, 1997, there
were 1,330 such treaties in the world involving 162 countries, a threefold
increase in five years.

The Role of Technological Change


The lowering of trade barriers made globalisation of markets and
production a possibility. Technological change has made it a reality.
Since World War II, the world has seen major advances in
communications, information processing and transportation
technology including, most recently, the explosive emergence of the
Internet and World Wide Web. Telecommunications is creating a global
audience. Transport is creating a global village.

Microprocessors, Information Technology and


telecommunications
Perhaps the single most important innovation has been development of
the microprocessor, which enabled the explosive growth of high-power,
low-cost computing, vastly increasing the amount of information that
can be processed by individuals and firms. The microprocessor also
underlies many recent advances in telecommunications technology.
Over the past 30 years, global communications have been
revolutionised by developments in satellite, optical fibre and wireless

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technologies, and now the Internet and the World Wide Web. These
technologies rely on the microprocessor to encode, transmit and decode
the vast amount of information. The cost of microprocessors continues
to fall, while their power increases (a phenomenon known as Moore’s
Law, that predicts that the power of microprocessor technology doubles
and its cost of production halves every 18 months). As this happens, the
costs of global communications are plummeting, which lowers the costs
of co-ordinating and controlling a global organisation.

An important factor and, possible the most critical factor, contributing


to globalisation has been the Information Technology revolution. The
emergence of standards in IT has made our world inter-connected
through high-speed computers. The American defense institutions
were largely instrumental for the rise of standards and protocols in
communications, messaging and IT. Through the adoption of
standards, heterogeneous computer systems (from India to Beijing to
Europe to US) are able to communicate seamlessly and securely. This
has led to open and interoperable applications. IT infrastructures are
now essential pre-requisites for modern global corporations. These
developments have accelerated the pace towards globalisation in many
sectors of the global economy.

The Internet and World Wide Web


The phenomenal recent growth of the Internet and the World Wide Web
has now developed into the information backbone of a global economy.
From virtually nothing in 1994, the value of Web-based transactions hit
$7.5 billion in 1997. Included in this expanding volume of Web-based
electronic commerce (e-commerce) is a growing percentage of
cross-border transactions. Viewed globally, the Web is emerging as a
great equaliser. It rolls back some of the constraints of location, scale,
and time zones. The Web allows businesses, both small and large, to
expand their global presence at a lower cost than ever before.

Transportation technology
In addition to developments in communications technology, several
major innovations in transportation technology have occurred since
World War II. In economic terms, the most important are probably the
development of commercial jet aircraft and super-freighters and the
introduction of containerisation, which simplifies trans-shipment from
one mode of transport to another. The advent of commercial jet travel,
by reducing the time needed to get from one location to another, has
effectively shrunk the globe.

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Implications of technological change for


globalisation
Firstly, let us examine the implications of technological change for the
globalisation of production. Due to containerisation, the transportation
costs associated with the globalisation of production have declined.
Plus, as a result of the technological innovations, the real costs of
information processing and communication have fallen dramatically in
the past two decades. This makes it possible for a firm to manage a
globally dispersed production system, further facilitating the
globalisation of production. As noted earlier, a world-wide
communications network is now essential for international businesses.

MINI CASE STUDY


Texas Instruments (TI), the US electronics firm, has approximately 50 plants in
19 countries. A satellite-based communications system allows TI to
co-ordinate, on a global scale, its production planning, cost accounting,
financial planning, marketing, customer service and personnel management.
The system consists of more than 300 remote job-entry terminals, 8,000
inquiry terminals and 140 mainframe computers. The system enables managers
of TI’s world-wide operations to send vast amounts of information to each
other instantaneously and to co-ordinate the firm’s different plants and
activities.

Secondly, let us look at the implications of technological change for the


globalisation of markets. In addition to the globalisation of production,
technological innovations have also facilitated the globalisation of
markets. Low cost transportation has made it more economical to ship
products around the world, thereby helping to create global markets.
Low-cost global communications networks such as the World Wide
Web are helping to create electronic global marketplaces. In addition,
low-cost jet travel has resulted in the mass movement of people between
countries. This has reduced the cultural distance between countries and
is bringing about some convergence of consumer tastes and preferences.
At the same time, global communications networks and global media
are creating a world-wide culture, e.g. television. In any society, the
media are primary conveyers of culture. As global media develop, we
must expect the evolution of something akin to a global culture.

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The Changing Demographics of the


Global Economy
Hand in hand with the trend toward globalisation has been a fairly
dramatic change in the demographics of the global economy over the
past 30 years or so. As late as the 1960s, the following four facts
described the demographics of the global economy:

· US dominance in the world economy and world trade


picture.

· US dominance in world foreign direct investment.


· The dominance of large, multinational US firms on the
international business scene.

· Roughly half the globe, the centrally planned economies


of the Communist world, was off-limits to Western
international businesses.

All four of these qualities either have changed or are now changing
rapidly. Refer to Table 3.1 for the changes in world output and trade, for
example.

Country Share of World Output, Share of World Output, Share of World Exports,
1963 1996 1997

United States 40.3% 20.8% 12.6%

Japan 5.5% 8.3% 7.76%

Germany 9.7% 4.8% 9.9%

France 6.3% 3.5% 5.46%

United Kingdom 6.5% 3.2% 4.94%

Italy 3.4% 3.2% 4.76%

Canada 3% 1.7% 3.81%

China NA 11.3% 2.85%

South Korea NA 1.7% 2.45%

Table 3.1. Changing World Output and Trade (Source: Export data from World Trade Organisation, International Trade Trends
and Statistics, 1996. World Output data from CIA Factbook).

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ACTIVITY
Read the following article from your key text, De Wit, B & Meyer, R.

Reading 10.3, ‘The Competitive Advantage of Nations’, pages 569-577

Changes in Foreign Direct Investment


Over the past thirty years, US dominance in export markets has waned
as Japan, Germany and a number of newly industrialised countries such
as South Korea and China have taken a larger share of world exports.

In 1997 and 1998 the dynamic economies of the Asian Pacific region
were hit by a serious financial crisis that threatened to slow their
economic growth rates for several years. Despite this, their powerful
growth may continue over the long run, as will that of several other
important emerging economies in Latin America (e.g. Brazil) and
Eastern Europe (e.g. Poland). Thus, a further relative decline in the
share of world output and world exports for long-established
developed nations seems likely.

Most forecasts now predict a rapid rise in the share of world output
from developing nations such as China, India, Indonesia, Thailand,
South Korea and Brazil, and a commensurate decline in the share
enjoyed by rich industrialised countries such as Britain, Germany, Japan
and the United States.

MINI CASE STUDY – Toyota


Toyota, the Japanese automobile company, rapidly increased its investment in
automobile production facilities in the United States and Britain during the late
1980s and early 1990s. Toyota executives believed that an increasingly strong
Japanese yen would price Japanese automobile exports out of foreign markets.
Therefore, production in the most important foreign markets, as opposed to
exports from Japan, made sense. Toyota also undertook these investments to
head off growing political pressures in the United States and Europe to restrict
Japanese automobile exports into those markets.

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The Changing Nature of Multinational Enterprise


A multi-national enterprise is any business that has productive
activities in two or more countries. Since the 1960s, there have been two
notable trends in the demographics of the multinational enterprise:

1. The Rise of Non-US multi-nationals

There has been a notable rise in non-US multinationals, particularly


Japanese multinationals such as the Sony Corporation, Toyota, etc.

In 1973, 48.5 percent of the world’s 260 largest multinationals were US


firms. The second-largest source country was Great Britain, with 18.8
percent of the largest multinationals. Japan accounted for only 3.5
percent of the world’s largest multinationals at the time. The large
number of US multinationals reflected US economic dominance in the
three decades after World War II, while the large number of British
multinationals reflected that country’s industrial dominance in the early
decades of the 20th century.

By 1997, however, US firms accounted for 32.4 percent of the world’s 500
largest multinationals, followed closely by Japan with 25.2 percent.
France was a distant third with 8.4 percent. Although the two sets of
figures are not strictly comparable (the 1973 figures are based on the
largest 260 firms, whereas the 1997 figures are based on the largest 500
firms), they illustrate the trend. The globalisation of the world economy
together with Japan’s rise to the top rank of economic powers have
resulted in a relative decline in the dominance of US (and, to a lesser
extent, British) firms in the global marketplace. Looking to the future,
the growth of new multinational enterprises from the world’s
developing nations is inevitable. Indeed companies such as the Tata
conglomerate in India are already multi-national players, and have
activities ranging from IT to cars to heavy engineering.

2. The Rise of Mini-Multinationals

Another trend in international business has been the growth of


medium-sized and small multinationals (mini-multinationals). When
people think of international businesses they tend to think of large,
complex multinational corporations with operations that span the
globe. Although most international trade and investment is still
conducted by large firms, many medium-sized and small businesses are
becoming increasingly involved in international trade and investment.

These mini-multinationals often operate in specialist areas and are


increasingly powerful. An example in point, is Accenture Consulting – a
highly focused business consulting firm with a global presence, and
great influence – indeed setting the pace for much of the globalisation
paradigm.

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The Changing World Order


Between 1989 and 1991, a series of remarkable democratic revolutions
swept the communist world. Following the political changes, many of
the former communist nations of Europe and Asia have now adopted
free market economics. These countries which were previously closed
to Western international businesses, now present a host of export and
investment opportunities. For example, the oil industry, in the former
Soviet Union, has been opened up and many foreign companies operate
licences there now.

In addition, more quiet revolutions have been occurring in China and


Latin America. Their implications for international businesses may be
just as profound as the collapse of communism in Eastern Europe. The
potential consequences for Western international business are
enormous. With a population of 1.2 billion people, China represents a
huge and largely untapped market.

On the other hand, China’s new firms are proving to be very capable
competitors, and they could take global market share away from
Western and Japanese enterprises. We see evidence of this already.
Thus, the changes in China are creating both opportunities and threats
for established international businesses.

For decades many Latin American countries were ruled by dictators.


They viewed Western international businesses as instruments of
imperialist domination. Accordingly, they restricted direct investment
by foreign firms. Also, the poorly managed economies of Latin America
were characterised by low growth, high debt and hyperinflation, all of
which discouraged investment by international businesses. Now all this
seems to be changing. Throughout most of Latin America, debt and
inflation are down, governments are selling state-owned enterprises to
private investors, foreign investment is welcomed and the region’s
economies are growing rapidly. These changes have increased the
attractiveness of Latin America, both as a market for exports and as a
site for foreign direct investment

The Globalisation Debate: Prosperity or


Impoverishment?
Globalisation continues to be an emotive issue. Many influential
economists, politicians and business leaders promote the shift towards a
more integrated and interdependent global economy. They promote the
view that international trade and investment is driving the global
economy towards greater prosperity, and that globalisation will
stimulate economic growth and help create jobs in all countries that
choose to participate in the global trading system. Many of these
proponents are business leaders from global companies; companies that

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Global Corporate Strategy Unit 3 – Globalisation

are agents of globalisation – companies that have the most to gain from
globalisation. Some of these companies (e.g. Starbucks, Nike) have
become front-line targets of critics who blame globalisation for a variety
of ethical and social issues, e.g. global warming, pollution, exploitation
of labour in poor countries, encroachment on human rights, etc.
Globalisation is challenged on grounds that it widens the gap between
the rich and the poor.

ACTIVITY
To read the arguments for and against globalisation, refer to the following
websites:

The website of the World Trade Organisation (WTO) for pro-globalisation


viewpoints:

www.wto.org

For anti-globalisation viewpoints refer to the following websites:

www.southcentre.org
www.wtowatch.org

There is no doubt that globalisation has deep social, political and


environmental consequences, as you will have noted from the previous
student activity. Leaving aside the social and ethical issues that we have
illuded to above, there are a number of other criticisms of the impact of
globalisation:

1. Impact on jobs and incomes

One frequently voiced concern is that far from creating jobs, falling
barriers to international trade actually destroy manufacturing jobs in
wealthy advanced economies such as the United States and United
Kingdom. Falling trade barriers can allow firms to move their
manufacturing activities offshore to countries where wage rates are
much lower. Supporters of globalisation argue that the benefits
outweigh the costs. They argue that free trade results in countries
specialising in the production of those goods and services that they can
produce most efficiently, while importing goods that they cannot
produce as efficiently.

2. Labour Policies and the Environment

A second source of concern is that free trade encourages firms from


advanced nations to move manufacturing facilities to less developed

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countries. Countries that lack adequate regulations to protect labour


and the environment from abuse by the unscrupulous. Adhering to
labour and environmental regulations significantly increases the costs
of manufacturing enterprises and puts them at a competitive
disadvantage in the global marketplace compared with firms based in
developing nations that do not have to comply with such regulations.

Supporters of free trade argue that firms are not the amoral
organisations that critics suggest. While there may be a few exceptions,
the vast majority of enterprises are committed to ethical behaviour.
They would be unlikely to move production offshore just so they could
pump more pollution into the atmosphere or exploit labour.

3. National Sovereignty

A final concern is that in today’s increasingly interdependent global


economy, economic power is shifting away from national governments
and toward supranational organisations such as the World Trade
Organisation, the European Union and the United Nations. It can be
perceived that un-elected bureaucrats are now able to impose policies
on the democratically elected governments of nation-states, thereby
undermining the sovereignty of those states. In this manner, the
national state’s ability to control its own destiny is being limited.

VIRTUAL CAMPUS
Globalisation on the one hand can have a levelling-down effect, and on the
other hand a levelling-up effect. So for instance, in the outsourcing context
(e.g. call centres) there is a view that Western countries (e.g. UK and US) have
lost out in this sector, whereas developing countries such as India have
benefited.

From your organisation’s viewpoint and also geographical viewpoint, identify


on the Virtual Campus whether globalisation has had a levelling-up or
levelling-down effect. Elaborate.

Now look at the opposing views (posted on the Virtual Campus) and try to
understand their perspective from a rational viewpoint. Assess whether your
viewpoint has changed.

Managing in the Global Marketplace


As organisations increasingly engage in cross-border trade and
investment, managers need to recognise that the task of managing an
international business differs from that of managing a purely domestic

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business in many ways. Let us examine some of the differences and


complexities:

1. Country differences

At the most fundamental level, managing in the global marketplace


requires an understanding and appreciation of the simple fact that
countries are different. Countries differ in their cultures, political
systems, economic systems, legal systems and levels of economic
development. Many of these differences are very profound and
enduring. A lack of appreciation of these country differences has led to
the failure of many American companies in expanding into foreign
territories.

2. Complexity of international and distributed businesses

A further way in which international business differs from domestic


business is the greater complexity of managing an international and
distributed business. A manager in an international business is
confronted with a range of issues that the manager in a domestic
business never faces. A business must decide where in the world to site
its production activities to minimise costs and to maximise value added.
Then it must decide how best to co-ordinate, monitor and control its
globally dispersed production activities.

3. Choice of markets to compete in

Decisions about which foreign markets to enter and which to avoid


must be made. Also the appropriate mode for entering a particular
foreign country must be chosen as it has major implications for the
long-term health of the firm. Is it best to;

· Export its product to the foreign country?


· Allow a local company to produce its product under
licence in that country?

· Enter into a joint venture with a local firm to produce its


product in that country?

· Set up a wholly owned subsidiary to serve the market in


that country?

4. Compliance with international trading and investment rules

Conducting business transactions across national borders requires


understanding the rules governing the international trading and
investment system. Managers in an international business must also
deal with government restrictions on international trade and
investment and find ways to work within the limits imposed by specific
governmental interventions.

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5. Cross-border transactions and currency risk

Cross-border transactions require that money be converted from the


firm’s home currency into a foreign currency, and vice versa. Since
currency exchange rates vary in response to changing economic
conditions, an international business must develop policies for dealing
with exchange rate movements. A firm that adopts a wrong policy can
lose large amounts of money.

6. Complexity of a global organisational structure

Global organisations, inevitably require more complex, matrix


organisational structures. In particular, the management roles are quite
different and require higher calibre managers. Global organisations
generally have four types of differentiated management roles:

· Global business managers; responsibility for strategy.


· Country managers; expert knowledge on opportunities,
threats and competitive landscape in local geography.

· Functional managers; responsibility for new


developments and knowledge sharing and leverage
across the global company.

· Corporate managers; overall organisational leadership.

7. Operational processes

A much greater degree of operational co-ordination is required to


achieve global leverage and efficiency. Global organisations require
robust operational processes and standards to support inter-working,
customer relationships, knowledge management and sharing of
intellectual capital. Processes must cover decision making, resource
allocation, intellectual capital reuse, policies enacted, rewards,
sanctions, management escalation and control. It should be recognised,
however, that local variations will be required to comply with local
issues, e.g. local employment laws.

An efficient IT and communications infrastructure is also a pre-requisite


to support such operational processes. Many of these operational
processes will be e-business processes.

ACTIVITY
Read the following article from your key text, De Wit, B & Meyer, R.

Reading 10.4, ‘Transnational Management’, pages 577-586

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Global Corporate Strategy Unit 3 – Globalisation

CASE STUDY 1 – GLOBALISATION AT


GIANT BICYCLES
Giant Bicycles are Taiwanese owned, but designed in the USA and made in the
Netherlands – a global company. This case reports on an interview with the chief
executive, Mr Antony Lo, about the company’s global strategy.

The Giant Bicycles Company is based in Taiwan and is one of the world’s
biggest bicycle manufacturers with annual sales of around US$400 million, 93%
outside Taiwan. According to Mr Lo:

“Because of the small market for bicycles in Taiwan, we don’t have any choice –
we have to be a global company. The biggest markets are in Europe and the US,
which account for just over half our sales. We started manufacturing in the
Netherlands because of the attractive market in Europe, where we expected
to sell more than 400,000 bikes in 1997. That’s out of a demand for bikes in
Europe of about 15 million annually.

To start with, we will be making just 100,000 bikes a year from our European
factory, but we envisage this climbing threefold by early next century. The main
reason for transferring some production from the Far East to the Netherlands
is to increase flexibility.

Fashions are changing quickly and market trends must be followed closely.
Having a production base next to the market means that we should be able to
satisfy our customers better. Wage costs in the Netherlands are 60% higher
than in Taiwan but because we should get better productivity in Europe, this
will not affect overall costs too much.

We are considering opening another plant in the US; we expect to decide on


this around year 2000. Our Taiwan plant makes about 1 million bikes a year out
of a total 2.5 million bikes for our company – including bikes produced by a
joint venture in China. I expect the proportion of Taiwanese bikes to decline
over the next few years as we switch production away from Asia.

Developing new products is as important as manufacturing. Bicycles are as


much a fashion item as a piece of machinery. We sell bikes in several thousand
variations. In the early 1990s we introduced up to three new products every
year. Today, however, that figure has grown to between five and ten reflecting
increased demands by customers. One of our strengths is the ability to
introduce regional product lines, within the context of an international
approach. About three-quarters of the products we sell around the world are
the same – but for the remaining 25% we give our regional people freedom to
specify products they think will appeal locally.

Worldwide, we have 65 designers and development engineers. We spend 2%


of our annual sales on design. Forty five of the designers are in Taiwan, the rest
are based in China, Japan, the US and the Netherlands. Through the global
design approach we aim to pool many different concepts – the people in China

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Unit 3 – Globalisation Global Corporate Strategy

and Japan concentrate on commuting bikes, the designers in the Netherlands


contribute ideas from the European racing bike tradition, while in the US they
are more likely to be working on variants of mountain bikes. In Taiwan, we try
to incorporate all of the ideas, working on new materials such as carbon fibre
to reduce the weight of the frame. Our designers can talk on the phone and
swop ideas using computer-aided design, but they get together twice a year in
Taiwan to review their work. The common language we use is English.

One of the developments we are particularly enthusiastic about is electric


battery-powered bikes, which we have been selling from mid-1998. We
expected to sell around 2000 in the first year with considerably more
afterwards, particularly in Europe. There’s an increasing environmental need
for such machines to reduce traffic congestion. At the same time, they make
the job of a cyclist easier. During normal travel they should have a range of
about 40km. And when the battery runs out, it’s not a huge problem – all you
have to do is pedal home."

Questions:
1. What benefits does the company gain from its global strategy? And
what have been the problems?

2. The opening paragraph of the case states that Giant Bicycles is a


‘global’ company. Do you agree with the statement within the
definitions explored in the lecture?

CASE STUDY FEEDBACK


This short case summarises many of the reasons for global expansion and the
problems that then arise. Bicycles operate in a relatively mature market
without the benefit of special, even unique technologies or patents to provide
the basis for global expansion. Other medium-sized companies that have
reached maturity of sales in their home markets will look with interest at the
achievement of Giant Bicycles so far.

Other companies possessing economies of scale and scope will also be


attracted by the arguments concerning the increased scale of international
operations and the ability to recover the costs of research and development
across an increased sales volume.

They will also learn a little about the increased complexity and costs of
international operations and selling. However, few details are given on this in
the case and, in any event, the details will probably vary with each company and
its type of business. In addition, some aspects of the company’s international
development remain essentially obscure. How did they start internationally?

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Global Corporate Strategy Unit 3 – Globalisation

Why did they pick Europe rather than the USA? (The high usage of bicycles in
Holland makes it clear why they would pick this market within Europe.) How
did they cope with the great geographical distances and the selling task in their
chosen country? And so on.

Thus other medium-sized companies can learn something from Giant Bicycles
but the full case for international expansion remains unclear.

Feedback on Question 1:

Benefits include:

· Global economies of scale in production: reduced costs of some


items.

· Higher sales than would be possible in Taiwan alone.

· Ability to keep in contact with different market trends and latest


designs.

· Production from high-efficiency workforces, e.g. Netherlands.

· R&D costs spread over much wider base of sales than just Taiwan.

Problems include:

· Complexity and cost of co-ordination across many countries: this is


not fully explained in the case.

· Higher costs of producing local variations, rather than a


standardised product.

· Higher wage costs in some countries, e.g. Netherlands.

Feedback on Question 2:

In this unit we established three main definitions of ‘global’:

· Geographical coverage (broad international scope).

· International similarity of demand (standardised products).

· Interconnectedness of the world (increased linkages between


countries, seeing the globe as a single market).

With the above definitions in mind, one could consider a range of issues;

· Giant bicycles are commonplace around the world – from children’s


mountain bikes to professional cyclists in the Tour de France
(geographical coverage).

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Unit 3 – Globalisation Global Corporate Strategy

· Presence in major economic blocks (Europe, USA, Asia)


(geographical coverage).

· 75/25 split of localised / standardised products – is this


therefore a global company? Should it be 100% to be regarded
as global? (standardised products)

· Centralised R&D facilities (but with designers out in the field


to gain knowledge of local markets and fashion trends) – again
a dichotomy. (standardised products)

· Are Giant exploiting increased technological advancement in


transport & communications by having two production
facilities? This needs to be balanced with increased complexity
of running 2 factories. (increased linkages between countries)

· Would a truly global company have one factory, thus


increasing economies of scale and reducing management
complexity. (seeing the globe as a single market)

CASE STUDY 2 – CITIGROUP: BUILDING A


GLOBAL FINANCIAL SERVICES GIANT
In the largest merger ever in the financial services business, Citicorp joined
forces with Travelers Group in the autumn of 1998. The combined group has
revenues of close to $50 billion, assets in excess of $700 billion, and global
reach.

Before the merger, Travelers Group was the largest property-casualty and life
insurance business in the United States. In addition, Travelers had considerable
investment banking, retail brokerage and asset management operations.
Travelers’ insurance operations were almost exclusively domestic in their
focus, although its investment banking and asset management business had
some foreign exposure.

Citicorp was one of the world’s most global banks. Citicorp had two main legs
to its business, its corporate banking activities and its consumer banking
activities. The corporate banking side of Citicorp focused on providing a wide
range of financial services to 20,000 corporations in 75 emerging economies
and 22 developed economies. This business, which always had an international
focus, generated revenues of $8.0 billion in 1997, over half of which came from
activities in the world’s emerging economies. What captured the attention of
many observers, however, was the rapid growth of Citicorp’s global consumer
banking business. The consumer banking business focuses on providing basic
financial services to individuals, including checking accounts, credit cards and

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Global Corporate Strategy Unit 3 – Globalisation

personal loans. In 1997 this business served 50 million consumers in 56


countries through a global network of 1,200 retail branches and generated
revenues of $15 billion.

The merger talks were initiated by Travelers' CEO, Sandy Weill. Given the
rapid globalisation of the world economy, Weill felt it was important for
Travelers to start selling its insurance products in foreign countries. Until
recently, the barriers to cross-border trade and investment in financial
services were such that this would have been difficult. However, under the
terms of a deal brokered by the World Trade Organisation in December 1997,
over 100 countries agreed to open their banking, insurance and securities
markets to foreign competition. The deal, which was scheduled to take effect
on March 1, 1999, included all developed nations and many developing nations.
The deal would allow insurance companies such as Travelers to sell their
products in foreign markets for the first time. To take advantage of this
opportunity, however, Travelers needed a global retail distribution system,
which is where Citicorp came in. For the past 20 years, the central strategy of
Citicorp has been to build just such a distribution channel.

The architect of Citicorp’s global retail banking strategy was its longtime CEO,
John Reed (Reed is now co-CEO of Travelers, a position he shares with Weill).
Reed has been on a quest to establish “Citicorp” as a global brand, positioning
the bank as the Coca-Cola or McDonald’s of financial services. The basic belief
underpinning Reed’s consumer banking strategy is that people everywhere
have the same financial needs—needs that broaden as they pass through
various life stages and levels of affluence. At the outset customers need the
basics—a checking account, a credit card and perhaps a loan for college. As
they mature financially, customers add a mortgage, car loan and investments
(and insurance). As they accumulate wealth, portfolio management and estate
planning become priorities. Citicorp aimed to provide these services to
customers around the globe in a standardised fashion, in much the same way as
McDonald’s provides the same basic menu of fast food to consumers
everywhere. With the merger with Travelers, the company will be able to push
this concept further than ever, cross-selling insurance products and asset
management services through its global retail distribution system.

Reed believes that global demographic, economic and political forces strongly
favour such a strategy. In the developed world, ageing populations are buying
more financial services. In the rapidly growing economies of many developing
nations, Citigroup is targeting the emerging middle classes, whose needs for
consumer banking services and insurance are rising with their affluence. This
world view got Citicorp into many developing economies years ahead of its
slowly awakening rivals. As a result, Citigroup is today the largest credit card
issuer in Asia and Latin American, with 7 million cards issued in Asia and 9
million in Latin America. As for political forces, the world-wide movement
toward greater deregulation of financial services allowed Citigroup to set up
consumer banking operations in countries that only a decade ago did not allow
foreign banks into their markets. Examples in the fast-growing Asian region
include India, Indonesia, Japan, Taiwan, Vietnam and the biggest potential prize
of them all, China.

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A key element of Citigroup’s global strategy for its consumer bank is the
standardisation of operations around the globe. This has found its most visible
expression in the so-called model branch. Originally designed in Chile and
refined in Athens, the idea is to give the company’s mobile customers the same
retail experience everywhere in the world, from the greeter by the door to the
standard blue sign overhead to the ATM machine to the gilded doorway
through which the retail-elite “Citi-Gold” customers pass to meet with their
“personal financial executives.” By the end of 1997 this model branch was in
place at 600 of Citicorp’s 1,200 retail locations, and it is being rapidly
introduced elsewhere. Another element of standardisation, less obvious to
customers, is Citigroup’s emphasis on the uniformity of a range of back-office
systems throughout its branches, including the systems to manage checking
and savings accounts, mutual fund investments and so on. According to
Citigroup, this emphasis on uniformity makes it much easier for the company
to roll out branches in a new market. Citigroup has also taken advantage of its
global reach to centralise certain aspects of its operations to realise savings
from economies of scale. For example, in Citigroup’s fast-growing European
credit card business, all credit cards are manufactured in Nevada; printing and
mailing are done in the Netherlands; and data processing is done in South
Dakota. Within each country, credit card operations are limited to marketing
people and two staff units; customer service and collections.

Questions:
1. What is the rationale for the merger between Travelers and Citicorp?
How will this merger create value for (a) the stockholders of Citigroup
and (b) the customers of Citigroup’s global retail bank?

2. In 1997 the World Trade Organisation brokered an agreement to


liberalise cross-border trade and investment in global financial
services. What will be the impact of this deal on competition in
national markets? What would you expect to see occur?

3. Does the 1997 WTO agreement represent an opportunity for


Citigroup or a threat?

4. How is Citigroup trying to build a global retail brand in financial


services? What assumptions is this strategy based on? Do you think
the assumptions and strategy make sense?

Reference: Chapter 1 – International Business in the Global Marketplace (2000) by


Charles W.L. Hill

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Global Corporate Strategy Unit 3 – Globalisation

CASE STUDY FEEDBACK


Feedback on Question 1:

The reasons for the merger are quite clear;

· The companies have complementary resources. Products of the two


companies are generally mutually exclusive.

· It is a ‘merger of equals’ – a graph within the case study in unit 4 in


the module guide shows the convergence of the share prices of
both companies.

· Citicorp have established a global network of branches and


Travelers Group’s products would be sold in these branches, i.e. for
no increase in fixed costs, more turnover would be generated –
hence, the stockholders would experience an increase in value in
share price and dividend.

· Customers would be able to access a wider range of products at the


same location, for example insurance.

Feedback on Question 2:

· An increase in global competition with major world players


competing in the newly liberated countries – moving from country
to country (e.g. car industry).

· Perhaps waves of merger/acquisition/alliance activity across borders


(link to Unit 4) as financial companies try to gain access to the new
markets.

Feedback on Question 3:

· An opportunity due to Citicorp’s core capability in overseas


expansion into developing markets

· Also a threat due to increased competition (as in first bullet point


on feedback to question 2 above).

Feedback on Question 4:

Standardisation of everything such as:

· Cross selling of products to all customers (regardless of wealth).

· Standard livery of banks.

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Unit 3 – Globalisation Global Corporate Strategy

· Staff uniforms.

· Standards of service the same globally.

· Also (not mentioned in case) standardised training and staff


development.

Assumptions based upon:

· Standard service designed is acceptable to customers.

· Globalised product implies a global strategy and, therefore,


decreases cost due to ‘homogenised’ product.

· World travelers want the same service wherever they go.

· Creation of global ‘brand’ is positive.

Does it make sense?

· What about ‘localisation’ issues, e.g. law, culture?

· The company openly try to attract ‘wealthier’ customers. If


you have lots of money, will you not require a ‘personal’
service?

· Is it necessary (in considering Global Integration / Local


Responsiveness Grid) to have a ‘global’ product in Financial
Services?

Summary
In this unit we have considered the impact of globalisation on
multinational enterprises. We have looked at the definition of
globalisation, and have considered the different dimensions –
globalisation of markets and globalisation of production.

We have considered the drivers of globalisation, the changing world


order and the implications for businesses from the globalisation
phenomenon. We have also touched on the globalisation debate
considering the opposing views. Finally, we have looked at the
particular challenges faced by managers when managing in the global
marketplace.

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Global Corporate Strategy Unit 3 – Globalisation

REVIEW ACTIVITY
Consider the following situation. Imagine that your organisation is reviewing
its strategy, and that you have been seconded by the team to focus and report
on the ‘impact of globalisation’. You have to carry out the necessary research
and prepare a paper (in no more than 1000 words).

Your paper should address the following:

1. Your current global capability.

2. The impact globalisation has had on your organisation with respect to


production (including supply chain), markets, operations and
management processes.

3. Global competition.

4. A SWOT analysis in the context of globalisation.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 13, Chapter 2 pages 29-43


2. Ref 10, Chapter 19 pages 689-731

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Unit 4

‘Altering the Boundary’ –


Alliances and Mergers

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Evaluate available options for global expansion.

· Analyse strategy for forming and making alliances work in a global


environment.

· Explain the terminology associated with business combinations.

· Assess the factors which influence success or failure of M&A activity.

· Propose a process for the successful integration of different


organisations.

Introduction
Globalisation and the advent of the new economy, has led to big
changes in today’s business landscape. Consolidation through mergers
and acquisitions is rife in many industries, as corporations seek to
increase their global reach and competitiveness. There is a recognition
that to compete effectively in the global market, cross-border alliances,
sometimes with competitors, is necessary. This has also led to a rise in
global strategic alliances.

In this unit we shall look at strategic alliances, and mergers and


acquisitions; the two vehicles through which many organisations aim to
globalise.

Mergers and Acquisition (abbreviated as M&A) activity has grown in


pace since the 1990s. In this unit we shall look at some of the
terminology used in the context of M&A. We shall then look at some of
the drivers for M&A activity and potential benefits. We shall then assess
the factors that give rise to successful mergers and acquisitions, and
briefly consider an integration process.

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Paradox of Competition and


Co-operation
De Wit and Meyer present this paradox by defining the extreme cases.
Companies that follow the traditional view of neo-classical economics
are said to follow the d iscrete organisation perspective and as such see
competition as a natural state of affairs and see themselves as
independent entities competing with others in a hostile environment.
Co-operation is seen as weakness on the one hand, or alternatively as a
cynical approach to distort competition in a market, e.g. if companies A
and B collaborate in order to destroy competitor C. Of course,
governments legislate to prevent this happening, e.g. The UK
Competition Commission.

The alternative view is one of the em bed d ed organisation perspective


where some companies see collaboration and partnership as the
predominant way of working. Many companies follow this perspective
as a matter of preference or are forced along this path by the industry in
which they operate, e.g. the airline industry.

However, some companies follow both perspectives at the same time


depending on the economic and market conditions in a global context.
For example, Hewlett Packard can been seen as being in a highly
competitive environment with Canon in many locations around the
world, but are also seen to collaborate with them in other initiatives
elsewhere.

We will now examine collaborative arrangements in more detail.

Global Strategic Alliances


Strategic alliances refer to co-operative agreements between potential or
actual competitors. In this unit we shall focus mainly on strategic
alliances between firms from different countries. However, most of the
principles apply to domestic alliance arrangements also.

The motives for entering strategic alliances are varied, but they often
include market access. The biggest danger is that a company will give
away more to its ally than it receives. However, firms can build alliances
that benefit both partners.

Decisions regarding Strategic Alliances are influenced by three closely


related topics;

(1) The decision of which foreign markets to enter, when to enter


them, and on what scale
(2) The choice of entry method

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Global Corporate Strategy Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers

(3) The role of strategic alliances.

Any firm contemplating foreign expansion must first decide which


foreign markets to enter, and the timing and scale of entry. This choice
should be driven by an assessment of relative long-term growth and
profit potential.

What are the objectives of International Strategic Alliances? Preece put


forward a framework that examined the reasons for alliances. The 6 ‘Ls’
gave a range of reasons that a company may wish to enter into such
arrangements as follows:

· Learning – to acquire needed know how, e.g. technology,


market access. This is related to knowledge management
techniques (see Unit 8).

· Leaning – to replace value-chain activities or fill in parts


of missing infrastructure.

· Leveraging – to integrate operations of partners to create


scope and / or size advantages.

· Linking – to create closer links with suppliers and


customers.

· Leaping – to pursue a radically new area of endeavour.


· Locking out – to reduce competitive pressure from non
partners and maintain existing competitive position.

ACTIVITY
See how collaboration with competitors can result in a win-win scenario by
reading p. 383-387, Reading 7.1, in your key textbook, De Wit, B & Meyer, R.

Read p. 388-396, Reading 7.2, in you key textbook, De Wit, B & Meyer, R, to
see how companies like Sun Microsystems have been able to achieve high
market growth by working with (and effectively managing) a web of alliances.

KEY POINT
The term ‘strategic alliance’ refers to an arrangement, generally between
actual or potential competitors, to co-operate.

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An alliance can involve two or more companies.

Companies in a strategic alliance co-operate by sharing capabilities to enhance


their competitive edge and creating new business opportunities.

Companies in an alliance will retain their own strategic autonomy.

ACTIVITY
Read p. 359 – 382 (Network level strategy) in your key textbook, De Wit, B &
Meyer, R, to learn more about how companies in strategic alliances co-operate
together, and co-ordinate their strategies to work as a team.

Which Foreign Markets?


All countries do not hold the same potential for a firm contemplating
foreign expansion. The attractiveness of a country depends on
balancing the benefits, costs and risks associated with doing business in
that country.

The long-term economic benefits of doing business in a country depend


on;

· The size of the market (in terms of demographics).


· The present wealth (purchasing power) of consumers in
that market.

· The likely future wealth of consumers.

While some markets are very large when measured by numbers of


consumers (e.g., China and India), low living standards may provide
limited purchasing power and a relatively small market when
measured in economic terms. In addition, the costs and risks associated
with doing business in a foreign country are typically lower in
economically advanced and politically stable democratic nations and
they are greater in less developed and politically unstable nations.

Another issue is considering the value a business can create in a foreign


market. If a business can offer a product that has not been widely
available in that market the value of that product to consumers is likely
to be much greater.

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Timing of entry
Entry is early when a business enters a foreign market before other
foreign firms and late when it enters after other international businesses
have already established themselves.

There are the following advantages associated with entering a market


early, known as first-mover advantages;

· Pre-empting rivals and capturing demand by establishing


a strong brand name.

· Building sales volume in a country, giving the early


entrant a cost advantage over later entrants.

· Enabling price cutting below the higher cost structure of


later entrants, thereby driving them out of the market.

· Create switching costs that tie customers into your


products or services.

The disadvantage in entering a foreign market before other


international businesses is that pioneering costs may be incurred. These
are costs that an early entrant has to bear that a later entrant can avoid. A
late entrant may benefit by learning from the mistakes made by others.

Scale of entry and strategic commitment


Entering a market on a large scale involves the commitment of
significant resources. It is a major strategic commitment, with a
long-term impact. It is a decisions that is difficult to reverse. Major
commitment to an overseas market can limit the company’s strategic
flexibility.

Balanced against large-scale entry are the benefits of a small-scale entry.


Small-scale entry allows a firm to learn about a foreign market while
limiting the firm’s exposure to that market. Small-scale entry can be
seen as a way to gather information about a foreign market before
deciding whether to enter on a significant scale and how best to enter.

Entry Methods
The choice of method for entering a foreign market is another major
issue. Options are;

· Exporting.
· Turnkey Projects.

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Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers Global Corporate Strategy

· Licensing.
· Franchising.
· Joint Ventures.
· Wholly owned subsidiaries.

Each of these options has advantages and disadvantages. The optimal


entry method varies from situation to situation depending on a variety
of factors including transport costs, economic risks, political risks, trade
barriers and corporate strategy.

Let us now examine each of the entry methods.

Exporting
Advantages

· Avoids the substantial costs of establishing operations


(particularly so for manufacturing) in the host country.

· Helps a firm achieve location economies. By


manufacturing the product in a centralised location and
exporting it to other national markets, the firm may
realise substantial scale economies from its global sales
volume.

Disadvantages

· Exporting may not be appropriate if there are lower-cost


locations for manufacturing the product abroad.

· High transport costs can make exporting uneconomical,


particularly for bulk products

· Tariff barriers can make exporting uneconomical.


· Problems arise if a company delegates its marketing
activities in each country to a local agent. Foreign agents
often carry the products of competing firms and so have
divided loyalties.

Turnkey projects
In a turnkey project, the contractor agrees to handle every detail of the
project for the client, including the training of operating personnel. At
completion of the contract, the client is handed the “key” to a plant that
is ready for full operation. This is a means of exporting process
technology to other countries. Turnkey projects are most common in the
chemical, pharmaceutical, petroleum refining and metal refining

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industries, all of which use complex, expensive production


technologies.

Advantages

· The ability to assemble and run a technologically complex


process (e.g. refining petroleum), and obtain good
economic returns. The strategy is particularly useful
where Foreign Direct Investment (FDI) is limited by
host-government regulations.

· A turnkey strategy can also be less risky than


conventional FDI. In a country with unstable political and
economic environments, a longer-term investment might
expose the firm to unacceptable political and/or
economic risks (e.g. the risk of nationalisation or of
economic collapse).

Disadvantages

· The firm will have acquired no long-term skills,


experience and customer relationships in the foreign
country.

· A turnkey project may inadvertently create a competitor,


e.g. Western firms that sold oil refining technology to
Middle East countries now find themselves competing
with these firms in the world oil market

· Selling technology through a turnkey project is selling


competitive advantage to potential and/or actual
competitors.

Licensing
A licensing agreement is an arrangement whereby a licensor grants the
rights to intangible property to another entity (the licensee) for a
specified period. In return the licensor receives a royalty fee from the
licensee. Intangible property includes patents, inventions, formulas,
processes, designs, copyrights and trademarks.

MINI CASE STUDY


To enter the Japanese market, Xerox, inventor of the photocopier, established
a joint venture with Fuji Photo that is known as Fuji-Xerox. Xerox then
licensed its xerographic know-how to Fuji-Xerox. In return, Fuji-Xerox paid
Xerox a royalty fee equal to 5 percent of the net sales revenue that Fuji-Xerox
earned from the sales of photocopiers based on Xerox’s patented know-how.
In the Fuji-Xerox case, the licence was originally granted for 10 years, and it has

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Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers Global Corporate Strategy

been renegotiated and extended several times since. The licensing agreement
between Xerox and Fuji-Xerox also limited Fuji-Xerox’s direct sales to the
Asian Pacific region (although Fuji-Xerox does supply Xerox with
photocopiers that are sold in North America under the Xerox label).

Advantages

· The licensee meets most of the costs associated with sales.


Hence the firm does not bear the development costs and
risks associated with opening a foreign market.

· Licensing can be attractive when a firm is unwilling to


commit substantial financial resources to an unfamiliar or
politically volatile foreign market.

· Licensing is often used when a firm wishes to participate


in a foreign market but is prohibited from doing so by
barriers to investment.

· Licensing is frequently used when a firm possesses some


intangible property that might have business
applications, but it does not want to develop those
applications itself (e.g. software components).

Disadvantages

· Licensing does not give a firm the tight control over


manufacturing, marketing and strategy that is required
for realising experience curve and location economies.
Licensing typically involves each licensee setting up its
own production operations.

· Competing in a global market may require a firm to


co-ordinate strategic moves across countries by using
profits earned in one country to support competitive
attacks in another. By its nature, licensing limits a firm’s
ability to do this.

· There is a risk associated with licensing technological


know-how to foreign companies. Technological
know-how constitutes the basis of many multinational
firms’ competitive advantage. Most firms wish to
maintain control over how their know-how is used, and a
firm can quickly lose control over its technology by
licensing it.

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Global Corporate Strategy Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers

MINI CASE STUDY


RCA Corporation once licensed its colour TV technology to Japanese firms
including Matsushita and Sony. The Japanese firms quickly assimilated the
technology, improved on it and used it to enter the US market. Now the
Japanese firms have a bigger share of the US market than the RCA brand

Franchising
Franchising is similar to licensing but involves longer-term
commitments. Franchising is basically a specialised form of licensing in
which the franchiser not only sells intangible property to the franchisee
(normally a trademark), but also insists that the franchisee agree to
abide by strict rules as to how it does business.

The franchiser will also often assist in running the business on an


ongoing basis. As with licensing, the franchiser typically receives a
royalty payment, which amounts to some percentage of the franchisee’s
revenues. Franchising is used mainly by service firms. McDonald’s is a
good example of a firm using a franchising strategy.

Advantages

The advantages of franchising as an entry method are very similar to


those of licensing. The firm is relieved of many of the costs and risks of
opening a foreign market on its own. Instead, the franchisee typically
assumes those costs and risks. This creates a good incentive for the
franchisee to build profitable operation as quickly as possible. Using a
franchising strategy, a service firm can build up a global presence
quickly and at a relatively low cost and risk.

Disadvantages

The disadvantages are less than licensing. Since franchising is used


mainly by service companies, experience curve and location economies
are less of an issue. But franchising may inhibit the firm’s ability to take
profits out of one country to support competitive attacks in another.

A more significant disadvantage of franchising is quality control. The


foundation of franchising is that the firm’s brand name conveys a
message about the quality of the firm’s product. This can be overcome
by setting up a subsidiary in each country (wholly owned company or
joint venture). The subsidiary assumes the rights and obligations to
establish franchises throughout the particular country or region, e.g.
McDonald’s establishes a ‘master franchisee’ in many countries. Further
examples are Kentucky Fried Chicken and Hilton International.

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Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers Global Corporate Strategy

Joint Ventures
A joint venture means establishing a firm that is jointly owned by two or
more otherwise independent firms. Fuji-Xerox, for example, was set up
as a joint venture between Xerox and Fuji Photo. Establishing a joint
venture with a foreign firm has long been a popular method for entering
a new market. The most typical joint venture is a 50/50 venture.
However, some firms have sought joint ventures in which they have a
majority share and tighter control.

Advantages

· Benefits from a local partner’s knowledge of the host


country’s competitive conditions, culture, language,
political systems and business systems.

· If development costs and/or risks of opening a foreign


market are high, a firm might gain by sharing these costs
and/or risks with a local partner.

· In many countries, political considerations make joint


ventures the only feasible entry method. Research
suggests joint ventures with local partners face a low risk
of being subject to nationalisation or other forms of
government interference. This appears to be because local
equity partners, who may have some influence on
host-government policy, have a vested interest in
speaking out against nationalisation or government
interference.

Disadvantages

· As with licensing, a joint venture risks giving control of


technology to a partner. However, joint venture
agreements can be constructed to minimise this risk.

· A joint venture does not give a firm the tight control over
subsidiaries that it might need to realise experience curve
or location economies.

· The shared ownership arrangement can lead to conflicts


and battles for control between the investing firms if their
goals and objectives change or if they take different views
as to what the strategy should be.

Wholly Owned Subsidiaries


In a wholly owned subsidiary the firm owns 100 percent of the stock.
This can be achieved either by setting up a new operation in that
country, or by acquiring an established firm and using that firm to
promote its products.

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Global Corporate Strategy Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers

Advantages

· When a firm’s competitive advantage is based on


technological competence, a wholly owned subsidiary
arrangement reduces the risk of losing control over that
competence.

· Tight control over operations in different countries that is


necessary for engaging in global strategic co-ordination is
maintained (i.e. using profits from one country to support
competitive attacks in another).

· A wholly owned subsidiary may be required if a firm is


trying to realise location and experience curve economies
(as firms pursuing global and trans-national strategies try
to do).

Disadvantages

· Generally this is the most costly method of serving a


foreign market. Firms doing this must bear the full costs
and risks of setting up overseas operations. The risks
associated with learning to do business in a new culture
are less if the firm acquires an established host-country
enterprise. However, acquisitions raise additional
problems, e.g. marrying divergent corporate cultures.

Making Alliances Work


The failure rate for international strategic alliances is quite high. A
recent study of 49 international strategic alliances found that 66% ran
into serious managerial and financial troubles within two years of their
formation and 33% were ultimately rated as failures by the parties
involved.

The success of an alliance seems to be a function of following three main


factors:

1. Partner selection
2. Alliance structure
3. Alliance management

Let us look at these in turn.

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Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers Global Corporate Strategy

Partner selection
The partner selection process must consider whether a potential
partnership is viable and whether it actually adds value. The following
assessments are pertinent in this regard:

· Is there a strategic fit?


· Is there a capabilities fit?
· Is there an organisational fit?
· Is there a cultural fit?

A good partner;

· Helps the firm achieve its strategic goals, whether market


access, sharing the costs and risks of new-product
development, or gaining access to critical core
competencies. The partner must have capabilities that the
firm lacks and that it values.

· Shares the firm’s vision for the purpose of the alliance. If


two firms approach an alliance with radically different
agendas, the relationship will most likely fail.

· Is unlikely to try to exploit the alliance for its own ends,


e.g. to steal the firm’s technological know-how while
giving little in return. Therefore, firms with reputations
for “fair play” make the best allies.

Alliance Structure
Having selected a partner, the alliance should be structured so that the
firm’s risks of giving too much away to the partner are reduced to an
acceptable level.

· Alliances can be designed to make it difficult (if not


impossible) to transfer technology not meant to be
transferred. For example, in the case of software
applications, ‘shrink-wrapped’, ‘black box’ packaging.

· Contractual safeguards can be written into an alliance


agreement to guard against the risk of opportunism by a
partner, e.g. IPR protection.

· Both parties to an alliance can agree in advance to swap


skills and technologies that the other covets, thereby
ensuring a chance for equitable gain. Cross-licensing
agreements are one way to achieve this.

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Global Corporate Strategy Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers

· The risk of opportunism by an alliance partner can be


reduced if the firm extracts a significant credible
commitment from its partner in advance.

MINI CASE STUDY


TRW Inc., has three strategic alliances with large Japanese auto component
suppliers to produce seat belts, engine valves and steering gears for sale to
Japanese-owned auto assembly plants in the United States. TRW has clauses in
each of its alliance contracts that bar the Japanese firms from competing with
TRW to supply US-owned auto companies with component parts. By doing
this, TRW protects itself against the possibility that the Japanese companies
are entering into the alliances merely as a means of gaining access to the North
American market to compete with TRW in its home market

Alliance Management
Many alliances fail because the issues concerning the management of
the alliance have been underestimated. The key issues include;

· Managing cultural differences.


· Building Trust ; building interpersonal relationships
between the firms’ managers. The resulting friendships
help build trust and facilitate harmonious relations
between the two firms. Personal relationships also foster
an informal management network.

· Learning from Partners; a firm must try to learn from its


partner and then apply the knowledge within its own
organisation.

Reference: Internatio nal Business in the Glo bal Mark etp lace (2000) by
Charles W.L. Hill

ACTIVITY
As further background to this section read p. 402-409, Reading 7.4, ‘How to
make strategic alliances work’, in your key textbook De Wit, B & Meyer, R.

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Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers Global Corporate Strategy

ACTIVITY
For up-to-date articles and thinking on alliances go to the McKinsey Quarterly
website:

http://www.mckinseyquarterly.com/

Select ‘Alliances’ under the Function menu on the home page. (Registration to
this site is free, and many articles can be accessed free of charge)

Mergers and Acquisitions


Mergers and acquisitions (or ‘business combinations’) have become a
significant source of economic activity in the world economy totalling
$3.4 trillion in 1999. Consolidation, through mergers and acquisitions, is
rife in many mature industries. We have seen the emergence of
mega-mergers in the oil industry (Chevron, Texaco), in the
pharmaceutical industry (Glaxo Smith Kline and Beechams), in banking
and in telecoms.

By mergers and acquisitions, corporations seek to create economic value


through economies of scale, economies of scope, access to global
market, improved target management, tax benefits or the availability of
low cost financing for financially constrained targets. Growth is
generally viewed as vital to the well-being of a firm.

However, mergers and acquisitions can pose serious risks for acquiring
firms. These arise from uncertainties about the value of the target
company’s assets and liabilities and unanticipated challenges in
integrating the target to achieve planned synergies. The big advantage
of M&A, in the context of global expansion, is that it gives companies
ready market access, particularly in new geographies. However, in
comparison to strategic alliances and internal expansion, it poses
serious financial and cultural risks. See Figures 4.1 and 4.2 for a
comparison of risks for the options of strategic alliances, M&A and
internal expansion. Recent studies indicate that, as a result of these risks,
approximately 50% of all M&A combinations do not create value for the
acquiring firm’s shareholders.

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High
Financial vs. Cultural risk M&A
Cultural risk

Strategic
alliances

Internet development
Low
Low Financial risk High

Figure 4.1: Financial vs. Cultural risk for expansion options.

M&A – If this fails, as there is a permanence to the transaction, it risks


putting the whole organisation in trouble.

Alliances – agreements can apportion financial risks between partners,


but the rewards are also shared.

Internal Development (organic) – there is a level of flexibility to the


amount of money invested – this can be gradual and re-appraised over
time.

High
Market failure vs. Cultural risk
M&A
Cultural risk

Strategic
alliances

Internet
development
Low
Low Market-entry risk High

Figure 4.1: Market failure vs. Cultural risk for expansion options.

M&A – there is a finality to this linkage of companies and so the cultural


risk is large. However, this should be balanced against a low risk of
market entry as the purchase normally relates to a package which is
established and proven in the market.

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Alliances – there is a level of optionality to these – the ‘package’ may be


unproven but when partners work together they should reduce the risk.

Internal Development – there is a low cultural risk as it is their own


culture (organic growth). However, an unproven package and a lack of
relevant experience leads to high market entry risk.

Mergers
A merger is defined as the joining of two or more companies to form a
single legal entity. Generally, the assets of the smaller company are
merged into those of the larger, surviving company and shareholders of
the target company are either bought out or become shareholders in the
acquiring corporation. A merger usually requires approval by the
shareholders of both the acquiring corporation and the target entity.

There are several types of merger:

· Horizontal mergers involve two firms operating in the


same kind of business.

· Vertical mergers involve different stages of production


and operations.

· Conglomerate mergers involve firms engaged in


unrelated business activity.

Acquisitions
An acquisition is the purchase of more than 50% of the voting shares of
one firm by another. Following the acquisition the two companies can
continue as separate legal entities, with the acquiring company referred
to as the parent company and the target as a subsidiary. The parent
company can be termed a Holding Company.

Acquisitions are sometimes described as ‘mergers’ to be politically


correct. This is especially so in the early stages of a merger.

ACTIVITY
Identify examples of a horizontal merger, a vertical merger and a conglomerate
merger. In this context, you may use acquisition synonymously with merger.
Identify the benefits resulting from the merger/acquisition.

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ACTIVITY FEEDBACK
Here are a few examples..........

IBM Corporation/PwC Consulting:

The merger (or in reality, acquisition) of PwC Consulting by IBM Corporation


in 2002 is often thought of as a horizontal merger, but is more accurately a
vertical merger. Although both companies overlapped in a significant part of
their business (IT services and consulting), it could be argued that IBM had little
business consulting skills – an area of high value and top of the value chain in
services contracts. By acquiring PwC Consulting, IBM gained first-class and
global business consulting skills and also PwC’s existing lucrative contracts.
PwC gained the IBM brand, as well as access to the breadth of IBM’s product
and IT skills to facilitate the implementation and delivery of projects following a
consulting engagement.

HSBC/Midland Bank, UK

The acquisition of the UK’s Midland Bank by HSBC is an example of a


horizontal merger. The acquisition gave the HSBC bank a significant UK
presence.

BP/Amoco/Arco:

The merger of BP, Amoco and Arco was a billion-dollar horizontal merger.
The driver for the merger was the search for economies of scale. Following
consolidation and completion of the integration phase, huge cost savings have
been achieved in capital-intensive areas such as refining, and exploration and
production activities. Cost savings have also been achieved in aligning their
respective IT strategies and having a common IT and centralised services
infrastructure.

SONY/Columbia:

In the late 1980s SONY acquired Columbia Pictures in the US for $3.4 billion.
This is an example of a conglomerate merger, pursued for purposes of
diversification by SONY. Columbia operated in a totally different business
sector. However, the management at SONY felt there were synergies to be
exploited between SONY’s highly profitable VCR manufacturing business and
Columbia’s film-making business. Columbia is still part of Sony’s business, but
the integration of Columbia into Sony was plagued with several problems. In
practice, there were huge differences between running a hardware
manufacturing company and a film studio. These issues were further
compounded by enormous organisational and cultural differences between the
two companies.

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Other Terminology
There are a number of other terms associated with ‘M&A’ activity.

Leveraged buy-outs
Leveraged buy-outs (LBOs) involve the purchase of the entire public
stock interest of a firm, or division of a firm, financed primarily with
debt.

Management buy-out (abbreviated as MBO)


If the transaction is by management, it is referred to as a management
buy-out (MBO). If the shares are owned exclusively by the acquiring
party, rather than third-party investors, the transaction is called ‘going
private’ and its shares are no longer publicly traded.

Joint Ventures
Joint ventures involve the joining together of two or more firms in a
project or enterprise. In these cases, equity participation and control are
decided by mutual agreement.

Sell-offs
Sell-offs are considered the opposite of mergers and acquisitions. The
two major types of sell-offs are spin-offs and divestitures.

· In a Spin-off, a separate new legal entity is formed with


its shares distributed to existing shareholders of the
parent company in the same proportions as in the parent
company.

· In contrast, Divestitures involve the sale of a portion of


the firm to an outside party with cash or equivalent
consideration received by the divesting firm.

ACTIVITY
Can you think of examples of other M&A related transactions, and identify the
possible motivation for the transaction and benefits (if any).

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ACTIVITY FEEDBACK
Here are a few examples.

Joint Venture:

The Airbus consortium, established in 1970, is an example of a successful Joint


Venture. The European consortium of French, German and later, Spanish and
U.K. companies was established, as it became clear that only by co-operating
would European aircraft manufacturers be able to compete effectively with the
U.S. giants. By overcoming national divides, sharing development costs,
collaborating in the interests of a greater market share and even agreeing a
common set of measurements and a common language, Airbus changed the
face of the business and brought airlines, passengers and crews the benefits of
real competition.

In 2001, thirty years after its creation, Airbus formally became a single
integrated company. The European Aeronautic Defence and Space Company
(EADS), (resulting from the merger between Aerospatiale Matra SA of France,
Daimler Chrysler Aerospace AG of Germany and Construcciones
Aeronauticas SA of Spain), and BAE SYSTEMS of the UK, transferred all of
their Airbus-related assets to the newly incorporated company. In exchange,
they became shareholders in Airbus with an 80 per cent and 20 per cent stake.

Spin Off:

MOBILE phone giant mmO2, was part of British Telecom until it was spun-off
in 2001. The spinoff was the result of the breakup of the BT monopoly. Today,
mmO2 is Europe’s sixth-largest mobile network operator. As well as its core
UK market called O2, the group runs mobile services in Germany and Ireland,
and has a joint venture with supermarket giant Tesco. It has just posted its
financial results, with maiden pre-tax profits of £95 million.

Divestiture:

Perhaps the most famous example of a divestiture is the divestiture of the


Telecoms giant AT&T, from Bell Labs. The divestiture was forced by the US
Department of Justice following an anti-trust suit against Bell Labs for illegal
actions to perpetuate a monopoly in telephone service and equipment. The
United States woke up on January 1, 1984 to discover that its telephones
worked just as they had the day before. But AT&T started the day a new
company, having been divested from Bell Labs. Of the $149.5 billion in assets it
had the day before, it retained $34 billion. Of its 1,009,000 employees it
retained 373,000.

Success required the most drastic change in corporate culture ever


undertaken by a major American corporation. The old AT&T – the Bell System
– as a regulated monopoly had been largely insulated from market pressures
for most of its history. Its culture venerated service, technological excellence,
reliability and innovation within a non-competitive, internally-driven

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framework of taking however much time and money it took to get things done
right. The new AT&T had to learn how to find out and deliver what its
customers wanted, when its customers wanted it, in competition with others
who sought to fill the same customers’ needs. Although AT&T had great
technological and personnel strengths upon which to build, the transition
proved far more complex than anyone imagined in 1984.

M&A Activity

Drivers for M&A activity


M&A activity is rife in many industry sectors today, e.g. finance &
banking, oil exploration & production, telecoms, IT services,
pharmaceuticals, car manufacturing. There are ‘push’ and ‘pull’ factors
driving M&A activity. Push factors arise from stakeholders who may
have concerns about the company’s strategic direction or its
management, and view an acquisition or a merger as a solution. ‘Pull’
factors arise from companies making strategic moves to increase
marketshare or increase shareholder value.

ACTIVITY
From what you have learnt so far, try to identify some of the drivers for M&A
activities. Why do companies pursue external expansion, through mergers and
acquisitions, over internal growth?

ACTIVITY FEEDBACK
Here are some of the drivers. The list, although not exhaustive, does indicate
the principal reasons for external expansion through M&A activities.

· A firm may be able to acquire certain desirable assets at a


lower cost by combining with another firm than it could if it
purchased the assets directly. When the market value of a
company’s common stock is below its book value (or, more
important, below the replacement value of the firm’s net
assets) or its potential future earnings (PE ratio) is below the

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sector average, the company frequently becomes a “takeover


candidate.”

· A firm may be able to achieve greater economies of scale by


merging with another firm; this is particularly true in the case of a
horizontal merger. If the net income for the combined companies
after merger exceeds the sum of the net incomes prior to the
merger, synergy is said to exist.

· A firm that is concerned about its sources of raw materials,


dependencies upstream or end-product markets might acquire
other firms in the supply chain. These are vertical mergers, and
are often undertaken to limit risk.

· A firm may desire to diversify its product lines and businesses in an


attempt to reduce its business risk by smoothing out cyclical
movements in its earnings, e.g. a capital equipment manufacturer
might achieve steadier earnings by expanding into the replacement
parts business. During a recession, expenditures for capital
equipment may slow down, but expenditures on maintenance and
replacement parts may increase.

· A firm that has suffered losses and has a tax-loss carry forward may
be a valuable merger candidate to a company that is generating
taxable income. If the two companies merge, the losses may be
deductible from the profitable company’s taxable income and hence
lower the combined company’s income tax payments.

· Another ‘push’ driver from stakeholders results from, what is


termed, agency problems. An agency problem arises when
managers or agents acting on behalf of the shareholders have a
limited equity stake in the company. This partial ownership may
cause managers to work less vigorously than otherwise and/or
consume more perquisites (also known as “perks’, e.g. lavish trips,
expense accounts, club memberships) because the majority of the
owners bear most of the cost. There are two theories that emerge
from the agency problem:

- The threat of a takeover may mitigate the agency problem by


substituting for the need of individual shareholders to monitor
the managers.

- If the managers have a stake in the business, they will do what


is best for the company, thus doing what is best for all
shareholders.

· Another driver for horizontal mergers, in particular, is that it will


result in increased market share. If a company acquires one of
its competitors, then it will have a greater share of the market. For
example, the Mercedes merge with the Chrysler corporation
increased marketshare for the merged company in the US. This was

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the principal driver for Mercedes who had limited marketshare


in the US. There is also the perception that the increased
marketshare will give rise to market dominance thus enabling
increased profitability. Hence, shareholder value often
increases.

Revaluation
It is not uncommon during merger negotiations or joint venture
planning, for the revaluation of the ownership of shares to occur. The
revaluation arises as a result of new information generated during
negotiations. For example:

1. Management may be stimulated to implement a higher-valued


operating strategy.
2. Negotiations or tendering activity may involve the dissemination
of new information or lead the market to judge that the bidders
have superior information. The market may then re-value
previously “undervalued” shares.

Potential benefits of M&A


In successful and well managed mergers and acquisitions, some of the
drivers do turn into benefits. So in addition to the obvious benefits such
as lower unit costs and stronger purchasing power, many of the drivers
noted above (under the previous Activity Feedback) are potential
benefits.

One of the key benefits that shareholders often look for is in sharper
management. Management efficiencies can arise from:

· Management rationalisation, and transfer of general


management capability.

· Differentiated efficiency. The theory behind differentiated


efficiency is as follows: If the management of firm A is
more efficient than the management of firm B, after firm
A acquires firm B, the efficiency of firm B is brought up to
the level of efficiency of firm A. Efficiency represents the
real gain in merging businesses.

· Another source of improvement can be from what is


termed Inefficient Management theory. This simply puts
forward the view that when management is not
performing or is inept in some absolute sense, that
absolutely anyone (resulting from an M&A activity)
could do better.

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· Deployment of better management systems, controls,


planning and budgeting.

Factors affecting M&A activity


In order to successfully complete an M&A transaction, a number of
factors must come together.

· Corporate will (the company’s goals and strategy).


· Funding.
· Relative values of the two companies.
· A conducive economic environment.

Factors affecting M&A activity can be categorised as external and


internal.

Global M&A activities tend to occur in waves, in response to external


factors – see Figure 4.3. External factors include monetary policy,
general economic activity, political issues and regulatory policy
(competition policy, foreign investment policy).

Here we go again?
Global M&A*, announced deals, $bn

United states Rest of the world


Britain, France Japan
and Germany

1,750

1,500

1,250

1,000

750

500

250

0
95 96 97 98 99 2000 01 02 03 04**
Source: Dealogic * By country of target
** To Feb 17th annualised

Figure 4.3: Recent waves of global M&A activities.

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Monetary policy affects M&A activity because, generally speaking,


when interest rates are high, stocks are out of favour (valuations are
low) and well-funded companies can buy others at a good price.

The internal factors (e.g. management capabilities, type of product, etc.)


vary from company to company and from industry to industry.
Combining the internal and external factors results in an M&A cycle.
The predominant influence at any one peak or trough may differ.
However, typically a peak is a time when company valuations are low,
interest rates are low and bank financing is available.

Why do Mergers Succeed or Fail?


Studies of M&A suggest that the probability of increasing shareholders’
wealth via M&A is low. Jensen and Ruback (1983) summarised results
from mergers and acquisitions over a period of eleven years.

· The average return (around the time of the


announcement) to shareholders of the acquired company
is 20% while the average return to the acquiring company
is 0%.

· Where a tender offer for take-over has occurred (i.e. a


company makes a public offer to the shareholders of a
target company), the acquired company’s shareholders
receive an average return of 30%, while the shareholders
of the acquiring company receive 4%.

In an analysis conducted by McKinsey consultants (1994) of 116


acquisition programs undertaken between 1972 and 1983, 61% were
failures, 23% were successes and 16% unknown. (An acquisition was
deemed successful if it earned its cost of equity capital or better on funds
invested in the acquisition program.)

If the successes and failures are probed further by looking at the rates by
type of acquisition, a company acquiring another company in a related
business has a greater chance of success than one acquiring a company
in an unrelated business.

Therefore, statistics suggest high failure rates of mergers and


acquisitions. There are a number of reasons for the failure of
acquisitions (McKinsey, 1994 and Balmer & Dinnie, 1999). Success or
failure arises from the quality of the pre-acqusition and post-acquisition
processes.

The pre-acquisition process includes the following:

· How companies make the M&A decision (including


target selection).

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· Due diligence.
· The value creation logic (how is it valued?).
· Negotiation of the deal.

The post-acquisition process is about how the integration is managed.


This is considered the most important source of success or failure.

ACTIVITY
With the increase in globalisation, and a push to achieve marketshare quickly in
foreign markets, cross-border M&A activity is on the rise.

What are some of the challenges for cross-border M&A activities. How would
you expect the success rate for cross-border acquisitions to differ from the
overall figures quoted above?

ACTIVITY FEEDBACK
Cross-border M&A are more complex, and pose further management
challenges for successful execution and post-merger integration. The
complexities arise in both the pre- and post-acquisition phases.

At the pre-acquisition phase, due diligence and valuation are particularly


complex. Emerging markets, in particular, suffer from the problem of
unreliable marketing and strategic information, and the due diligence may not
be entirely accurate in this respect. Furthermore, local accounting standards
may not be compatible with international standards. Political and nationalistic
attitudes may also make an unbiased assessment difficult.

In the post-acquisition phase, transition management and integration


management are the biggest challenges because of the geographical
distribution.

Despite the compounded problems of cross-border M&A, studies focusing just


on cross-border M&As suggest that the success rate is no worse than
domestic, and, if anything, slightly better. John Kitching (in 1973) looking at
cross-border acquisitions in Europe, found that 25% were straight failures and
25% not worth doing, giving a success rate of 50%. A further study by
McKinsey focusing just on cross-border M&As found a 57% rate of success.
The slightly higher success rate may be simply because most cross-border
acquisitions are horizontal (i.e. in core business) and all studies show that
horizontal acquisitions tend to be more successful than others.

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Listed below are many of the common reasons for failure in M&A:

1. Acquirers pay too much. This happens for a variety of reasons:

- Acquirers are over optimistic in their assumptions.


Assumptions, such as rapid growth continuing
indefinitely, a market rebounding from a cyclical
slump or a company “turning around,” can
sometimes lead acquirers to overpay.

- Over-estimation of the synergies that the merged


company will experience.

- Simply that the acquiring company overbids. In the


heat of the deal, the acquirer may find it all too easy
to bid up the price beyond the limits of reasonable
valuations.

- Poor post-acquisition integration. Integration can be


difficult and during this time, relationships with
customers, employees, and suppliers can easily be
disrupted during the process, and this disruption
may cause damage to the value of the business.
2. Corporate identity and corporate communication issues are not
properly managed:

- Undue attention is given to short-term financial and


legal issues, at the expense of communication.

- Inadequate recognition of the impact of leadership


issues during M&A process.

- Unresolved ‘naming’ issues.


- Integrated identity and communication structures
are rarely in place early in the M&A process.

- Consultants are brought in too late.


- Dominant players give little attention to cultural
issues, particularly at the outset.
3. Failure to secure good will of a wide range of stakeholder
groups in both companies.
4. Potential conflict between individual and corporate objectives
is not given sufficient recognition and isn’t managed.
5. Reputations can be damaged, maintained or enhanced during
the merger process.

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VIRTUAL CAMPUS
Microsoft revealed recently that it tried to buy SAP, the German software
giant, in late 2003. If the merger had been successful it would have made
Microsoft a dominant force in the enterprise software market, dealing a blow
to Oracle and even IBM. However, the merger attempt failed.

Research this failed merger attempt (Internet, FT article under Comments &
Analysis on 14 June 2004, company statements, etc).

Now divide yourselves into two groups. Those with last name beginning A-M
should wear the Microsoft hat, and the others the SAP hat. Now carry out the
following on the Virtual Campus:

1. Microsoft group: put forward to SAP management the benefits of the


merger to SAP. Consider the various SAP stakeholders in putting
forward the benefits.

2. SAP group: counter the Microsoft proposals, where appropriate.

3. Both groups: analyse why the merger went wrong (cultural, political,
other issues). Could Microsoft have handled it better.

(This Virtual Campus activity also interlocks with the units on Innovation and Strategic
IT & e-business)

Successful execution of M&A


McKinsey suggests a five-step program for successful mergers and
acquisitions:

1. Management of the pre-acquisition phase. It is important during


the pre-acquisition phase that employees maintain the secrecy of
the deal. If the secrecy is not maintained and there are rumours of
a take-over attempt, the share price of the target will increase,
potentially killing the deal. It is also important that managers
evaluate their own company, understand its strengths and
weaknesses, and understand the industry structure. Once this is
done, then managers can begin to identify the value-adding
approach that will work best for their company.
2. Screen candidates. Public companies, divisions of companies,
and privately held companies should be considered when
developing a list of potential targets. In this step, McKinsey
suggests that a list of “knock-out criteria” be developed. These
criteria allow managers to eliminate those companies which do

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not “fit” with their own company (i.e. too big, too small,
availability.)
3. Valuation. The objective for the acquiring company should be to
pay only marginally more than the value to the next highest
bidder and an amount that is less than the value to the acquirer.
In determining the value to the acquirer, McKinsey suggests that
the value of the acquiring company be added to the value of the
target company “as is.” The value of realistic synergies must then
be added while taking into account how long it will take to
capture them. The transaction costs for doing the deal are then
subtracted. The result is the value of the combined post-merger
company. The value gain is the combined value less the value of
the acquiring company.
4. Negotiate. A key point in this part of the process is for the
acquiring company to decide on a maximum reservation price
and to stick to it. A negotiation strategy is established by
considering the following factors:

- acquisition value to the acquirer


- value of the target to the existing owners and other
potential buyers

- financial condition of the existing owners and other


potential acquirers

- strategy and motivation of the existing owners and


other potential acquirers

- potential impact of anti-take-over provisions.


5. Management of post-merger integration. McKinsey noted that
most acquirers destroy rather than create value after the
acquisition. Prior to being acquired, 24% of the companies
studied were performing better than the industry average and
another 53% were performing better than 75% of their industry
average. Post-acquisition, these percentages dropped to 10% and
15%, respectively.

CASE STUDY 1 – Lojack and the Micrologic


Alliance
The next case study is case study 13, (“LoJack and the MicroLogic Alliance”) on
Pages 818-826 of your key text, De Wit & Meyer.

Below is the case synopsis:

The case describes the rise and development of the LoJack Corporation
(NASDAQ: LOJN), the acknowledged global leader in stolen vehicle recovery

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technology, headquartered in Westwood, Massachusetts. The company was


founded in 1978 by former Navy pilot Bill Reagan, who unable to sleep one
night, conceived a unique patented system, designed to assist law enforcement
personnel in locating, tracking and recovering stolen vehicles. Lacking the
specific knowledge and technical skills for his concept to materialise, Bill
Reagan turned to MicroLogic, a product development firm which specialised in
developing electronics products for others. MicroLogic helped refine the
LoJack product specifications, designed the entire system and worked with
various government agencies to obtain the appropriate approvals. When
everything was in place, a contract was signed for MicroLogic to manufacture
the police tracking computers. It made MicroLogic the technical backbone of
LoJack and hence, this product development firm became a significant ally and
an instrumental partner in the success of LoJack. But as time progressed,
LoJack separated somewhat; in-house people were hired to do a lot of the
work formerly handled by MicroLogic and eventually the LoJack Corporation
ended up doing much of their own work, with the exception of brand new
design work or work on the base software that MicroLogic designed originally.

The challenge presented in this case has to do with a defining moment in the
alliance, examining the issue of continuing value creation if the relationship
between LoJack and MicroLogic is pursued. The management of the LoJack
Corporation is committed to a growth strategy of geographic expansion of its
historically successful system, while MicroLogic has changed its strategy and is
now committed to entering a new marketplace with its own products and
services. LoJack is asked to join and supply both marketing capability and
capital to finance Micro Logic’s expansion. The key issue for LoJack is now
whether it should revise its strategy, grasp this opportunity and build on what
had been a very successful alliance, or whether it should seek new strategic
partners and move forward on its own. The LoJack management team needs to
determine whether the new alliance with MicroLogic would leverage to the
utmost LoJacks’ strengths and whether this alliance would again be successful,
given MicroLogic’s new strategy.

Points to Highlight
(extracted from Teaching Note 13, Lojack and the MicroLogic Alliance, Leonard
Zyistra)

This case, used in conjunction with Chapter 7 and Readings 7.1-7.4 of your key
text, De Wit & Meyer, can be used to understand the following key points:

· Differences between horizontal and vertical alliances. The LoJack –


MicroLogic relationship is an example of an upstream vertical
(supplier) alliance. Therefore, this case can be used to understand
the differences between horizontal and vertical alliances, as well as
the difference between indirect and direct horizontal co-operation
(link to Introduction of Chapter 7).

· The spectrum of relational arrangements between market and hierarchy.


The stolen vehicle recovery system (hereafter: SVR-system) needed
the approval of the Federal Communications Commission (FCC) as
well as the support of law enforcement agencies (and often

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executive and legislative bodies). Car dealerships would sell


the system as an option, providing a high margin add-on to any
car sale. Licensees in countries outside the United States
would use the stolen vehicle recovery system technology.
Motorola was asked to manufacture the police tracking
computers and had to agree to a long-term payment plan.
Financial institutions and insurance companies were involved in
designing joint offerings. In order for the LoJack system to be
manufactured and find its way to the customer, LoJack and
MicroLogic had to define the business ecosystem in which it
would flourish and design several relational arrangements,
determining the level of co-operation they wished to pursue.
This allows for a discussion on the various relational
arrangements that can be implemented and the different levels
of inter-organisational dependence that they entail (link to
Introduction and Reading 7.3, James Moore).

· The objectives of strategic alliances. The original LoJack –


MicroLogic alliance was primarily intended to develop the
necessary base software and equipment and to obtain FCC
approved technology for the SVR system. With a change in the
strategic intentions of the two, the objectives of each partner
to continue the alliance are different now. This allows for a
discussion on the variety of objectives that can be pursued by
means of alliance (link to all sections of Chapter 7).

· The disadvantages of strategic alliances. After the success of the


first alliance between LoJack and MicroLogic, and knowing and
trusting each other so well, it is tempting to engage in a second
alliance. However, given the different strategies of the
partners, they are forced to recognise that a new alliance also
has inherent disadvantages. You may wish to identify these
using this case (link to Introduction, Reading 7.1, Hamel, Doz
and Prahalad and Reading 7.4, Dyer, Kale and Singh).

· The paradox of competition and co-operation. The partners in the


LoJack-alliance experience a shift of focus when their
relationship matures. MicroLogic used to be the technical
backbone of the LoJack corporation. As time progressed,
LoJack separated somewhat; they hired in-house people and
took over the mundane, day to day tasks of MicroLogic, ‘as it
was neither interesting for MicroLogic nor cost effective for
LoJack to continue to have MicroLogic do “standard stuff. This
case, therefore, illustrates how alliances combine competitive
and cooperative behaviour, applying flexibility in the
relationship to continue to balance the two conflicting forces
(link to all).

· Discrete and embedded organisation perspectives. The main


challenge for LoJack in the case is whether, after a successful
alliance with MicroLogic for years, it should renew this

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relationship. Both parties had become more independent over time


and had benefited from this growing independence. Both parties
however, were also tempted to explore new market opportunities
on the basis of the stolen vehicle recovery technology. They could
go separate ways, each pursuing their own strategic direction, but
the question is, had they become independent enough to be
successful without the old alliance partner? To answer this question
in an affirmative way, this view would be in line with the discrete
organisation perspective. However, a number of issues should be
taken into consideration as well, such as the opportunity to leverage
some of LoJacks’ strengths or the fact that, from a (shareholder)
value creation perspective, the MicroLogic new market entry could
be more successful and rewarding. This view would be in line with
the embedded organisation perspective (link to all).

Questions:
1. (i) Which are the relational actors relevant to the technical and
commercial success of the Stolen Vehicle Recovery System?
(ii)Which relational objectives, power positions and arrangements
exist between LoJack corporation and the actors?

2. Do you think the arrangements between LoJack and MicroLogic


changed their competitive advantage over time?

3. What advice would you give the LoJack management team on the joint
venture proposal by MicroLogic to join them in introducing a new
monitoring and maintenance system for construction equipment?

CASE STUDY FEEDBACK


Feedback on Question 1:

Part i

In the case quite a number of actors are mentioned, each playing an


instrumental role in the success of the SVR-System. Apply Figure 7.2 to draw
the relations. (See textbook, Be Wit, B & Meyer, R (2004)).`

· MicroLogic. When the original founder of LoJack, Bill Reagan, met for
the first time with Sheldon Apsell, founder and president of
MicroLogic, it was still a small product development firm, which
specialised in developing electronics products for others. Reagan
and Apsell immediately hit it off. With only a hand-shake to

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consummate the deal, MicroLogic helped refine the product


specifications, designed the entire system, worked with various
governments agencies to obtain the appropriate approval and
performed the required fieldwork to prove to the FCC that
the assigned radio frequency would not interfere with that
assigned to a television channel. With everything in place, a
contract was finally signed for MicroLogic to manufacture the
police tracking computers. (Upstream vertical relation)

· Car Dealership: Marketing and sales of the LoJack system took


place via a distribution network. Car dealerships would sell the
system as an option, providing a high margin add-on to any car
sale. (Downstream vertical relation)

· Motorola: Was asked to manufacture the police tracking


computers and had to agree to a long-term payment plan.
Later on it was also engaged in developing and manufacturing
the third generation of the LoJack system. (Upstream vertical
relation)

· Local police: Were using the ‘Police Tracking System’ that


allowed police to locate the stolen car. LoJack offered the
devices for free, in exchange the police will support the
system. Very often, first the law enforcement agency (and
often executive and legislative bodies) had to be persuaded to
support the system. (Downstream vertical relation and political
actor)

· FCC. Being a regulatory actor, the stolen vehicle recovery


system needed the approval of the Federal Communications
Commission (FCC), establishing that the radio frequency used
by the system would not interfere with other radio
communications. (Regulatory actor)

· Financial institutions and insurance companies: Complementors


were involved in designing joint offerings with financing
schemes that included the purchase of the LoJack system and
discounts for the car insurance premium. (Indirect horizontal
relation)

· Competitors: There were many, claiming to have stolen vehicle


recovery features similar to those of the LoJack system. None,
however, were operated or actively monitored by law
enforcement agencies, giving the LoJack system a unique selling
point. (Direct horizontal relation)

Part ii

· Arrangements and power positions: The relational arrangements,


dependencies and alliance objectives between LoJack and
MicroLogic changed over time, as the companies grew and

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their relationship matured. At first, in return for its initial


contribution, MicroLogic received a total of $350,000 and 90,000
shares of LoJack. A contract was signed for MicroLogic to
manufacture the police tracking computers. This type of
arrangement between LoJack and MicroLogic can be described as
that of a bilateral combination of Equity-based and contractual
arrangements. The intent of these; the contracts will organise
procedures and routines at MicroLogic to manufacture the
computer, constituting advantages of hierarchy, while the
equity-based part places MicroLogic in the situation where it has an
entrepreneurial incentive. Conducive to spurring risk-taking,
innovation and change. This worked like the benefits of the market.
The alliance can therefore be seen as a nice example of
co-specialisation, where LoJack is focusing on marketing and sales,
while MicroLogic focuses on manufacturing and technology
development in the area of tracking and positioning. This
co-specialisation had progressed to the point where LoJack hired a
MicroLogic engineer. Over time, while the relationship was still
trusting, it became more and more ‘business like’ with more written
documents and formal contracts because there were more people
involved. The MicroLogic role changed also and the companies
became far more independent. MicroLogic was no longer involved in
all the technical decisions and LoJack had its own technical staff.
However, MicroLogic was still involved in the long term technology
strategy, and there to pitch in when LoJack staff needed help. Later
on, MicroLogic and LoJack had entered into a joint venture to
develop the third generation of the LoJack system. However,
MicroLogic had difficulty meeting some of the initial specifications of
the product. The direction of the project was altered and Motorola
was engaged.

· Relational objectives and factors: MicroLogic provided LoJack


technology and, one could add, also labor and entrepreneurship – it
had embraced the initial idea of Reagan and had been willing to risk
as much as LoJack – as it was still not certain that the product
would become a success. Nor could MicroLogic bank on the fact
that it would be asked by LoJack to become its first-tier supplier.
The initial phase of the cooperation can be described as
learning-oriented, as it had been the objective to develop new
technology required for the SVR-System. When the cooperation
matured, one could say that it became more linking-oriented. LoJack
started hiring a former MicroLogic engineer for instance. As
Sheldon Apsell of MicroLogic had put it sometime: ‘LoJack should
take over the mundane, day to day tasks, as it was neither cost
effective for LoJack nor interesting for MicroLogic to do standard
stuff. Legitimacy played an important role in the alliance. Although
the inter-firm relationship was still trusting, it had become more
‘business like’ with more written documents and formal contracts.
And when there had been conflict at the lower level of the
organisations, it did not impair the cooperation because of the
strong relationship at the top where corrective action was taken
before things got completely out of hand. The alliance also proved

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strong on flexibility and the ability to adapt to changing


circumstances when early predictions did not come out.

Although LoJack was resource dependent on MicroLogic to develop and test


the technology at the beginning of their relationship, it could be viewed that
this relationship was still in balance, because ultimately it was LoJack which
held the patent of the system. Without that, MicroLogic could not do anything
with the concept or the technology. Their relationship can therefore be
described as balanced interdependence. Moreover, LoJack had ordered
Motorola to manufacture other parts, ensuring it became not entirely
dependent of MicroLogic. Alternatively, as we do not know the alternatives
available to Bill Reagan back in 1978, it could also be argued that the
relationship initially was based on unbalanced dependence in favour of
MicroLogic. For LoJack, the technology was key to the success of the system
and hence to its value proposition, for MicroLogic it was just one contract. So
MicroLogic was independent to the extent that it did not infringe the patent
(limitations) and LoJack was dependent but able to steer the product
specifications (influence).

Feedback on Question 2:

While the cooperation between LoJack and MicroLogic evolved over time,
MicroLogic shifted its strategic focus and decided that the company should
develop and market its own products. After a number of false starts, the
management finally settled on an information service business which would
initially provide information about the location and operating parameters of
expensive construction equipment. Other potential market segments to be
attacked after construction equipment included other mobile high-value assets
such as vehicle fleets, rail cars and trailers. The system would produce
standard reports or use sophisticated mapping software to produce easily
understandable graphic information that could be communicated to personal
computers. The original tracking and positioning technology, developed for
the LoJack system, formed the backbone. Up to this point, MicroLogic had self
funded the product development, testing and marketing of the new business
while continuing to operate the traditional business. However, MicroLogic’s
decision to change the essence of the organisation had brought marketing and
sales of the original product development business to a halt. Cash flow would
soon be inadequate to support further development and marketing.
Meanwhile, the competitive landscape was changing. Many more companies
were entering the construction equipment asset management marketplace.
MicroLogic viewed this activity with mixed feelings. On the one hand,
excitement in the industry about such a system validated MicroLogic’s concept
and educated potential customers. On the other hand, it narrowed the
window of opportunity for capturing a large enough share of the market to
make implementation worthwhile. Additional capital and marketing capability
were essential if MicroLogic was going to be the market leader. Analysing how
MicroLogic had changed its strategy and finding itself in the situation as
described above, would lead to the conclusion that the company had been
successful in developing concepts for new markets, but in essence remained a
product development firm. To introduce a new concept successfully, it needed
LoJack to supply capital and marketing capability. This situation we recognise
from the start of their alliance.

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For LoJack, things developed also in a different way. While expansion of the
LoJack System into new geographic areas and markets with improved
marketing efforts and strengthening the sales force was a logical growth
strategy, the development of a new generation LoJack system was necessary to
reduce the cost of the hardware and improve efficiency of the installation
process. The success of this third generation system would allow LoJack to
enter the highly competitive market for stolen vehicle recovery. The cost of
hardware had been dropping fast and improvements in technology such as GPS
had encouraged new entrants that also offered total asset management
capabilities. LoJack management hoped that they could stay in this market with
its new unit that would be compatible for application in a non-powered
environment at a pricing attractive to the industry. Alternatively, LoJack was
also exploring cellular and satellite technologies to enhance its opportunities in
this market. But all in all, its competitive edge was no longer the same as it had
been when the first LoJack system was introduced to the market. LoJack
management, therefore, thought that there might be even greater
opportunities in leveraging LoJack’s connections with law enforcement agencies,
reputation, brand awareness and distribution muscle. All this could be leveraged in
the mobile asset management-market, starting with construction equipment.
This could be done in a joint venture with MicroLogic, but also with a new
partner or may be go it alone.

Analysing this opportunity for LoJack and comparing it with the company in the
late '70s, it can be concluded that its competitive advantage had changed,
broadening its commercial capabilities.

Feedback on Question 3:

Basically, LoJack has three major issues that it should contemplate:

1. Will further development of the third generation LoJack system, exploring


new geographic markets and improved marketing and strengthened sales
force, become profitable enough in the long run and create sustained
shareholder value or should a new marketplace be sought? Considering the
highly competitive market for stolen vehicle recovery with more and
more pressure on margins and distribution channels.

2. Will the new alliance leverage to the utmost LoJacks’s strengths or is its
marketing capability only of limited use in this new marketplace? Also,
considering MicroLogic’s changed strategy to develop and market its
own products, is the compatibility in objectives not only temporary
and predominantly focused on obtaining the LoJack’s venture capital?

3. Will the concept that was developed by MicroLogic for the construction
equipment asset marketplace be competitive enough? Will it secure the
alliance to capture a large enough share of the market to make
investment and implementation worthwhile? Considering that other
major competitors were well positioned in the consolidation and
outsourcing trends and given the business model that MicroLogic
wanted to employ (short term revenues, by selling equipment at
break-even or a very small profit, and long term revenues and the

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majority of profits from monthly fees plus individual charges for special
services).

CASE STUDY 2 – CITIGROUP


Merger Brief – The Economist, 26th August 2000

First among equals

This merger brief shows why true mergers of equals are rare. The union of Citicorp
and Travelers, initially equal partners, became a takeover as one of its co-chief
executives took sole command

IT WAS the most extraordinary merger ever, or so it seemed back in April


1998. The marriage of two financial-services giants, Citicorp and Travelers,
was the biggest to date, with a combined market capitalisation of $84 billion on
the day it was announced. The vision behind it was just as large: the newly
created Citigroup would be an entirely new sort of global business, a
financial-services supermarket selling every financial product under the sun to
individual, corporate and government customers in every corner of the earth.

As if that were not enough, the marriage was structured as a genuine “merger
of equals” – a phrase often used, but usually only to soothe the ego of the boss
of a company that is being taken over. In this case, every effort was made to
ensure that both sides really were equal partners, starting at the top, with the
bosses of the two merging firms becoming co-chairman and co-chief executive.

But the omens were bad. Announcing the merger, Sandy Weill (of Travelers)
quipped that he was used to “sharing power and responsibility as I’ve been
married to my wife for 43 years”. This metaphor may have jarred on John
Reed, who had divorced in 1991 and married a stewardess on the Citi
corporate jet.

Barely 15 months after the deal was done, the two co-heads agreed, under
pressure from shareholders, to separate their roles. Divorce followed in April
this year, when Mr. Reed retired, at the request of the board, leaving Mr. Weill
as lone chief executive.

For the moment, Citigroup is an undeniable success: in the first quarter of


2000, it was the world’s most profitable company. But the power struggle at
the top delayed integration and discouraged “cross-selling” the financial
products of one part of the merged firm to customers of another, one of the
key goals of the merger strategy. It has also prevented the emergence of a
strong Internet strategy.

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Mr. Weill admits only that “we have taken longer to get places than we might
have.” In fact, the costs may have been greater than that implies, not least in
missed opportunities. Citigroup’s management is now dominated by people
from Travelers. The loss of the Citibank talent may yet cause problems,
especially outside America. The stellar performance hoped for by the
stockmarket may not happen.

Citi and Travelers came to the altar with different experiences of mergers. In
the 1990s Citi, which traces its origins back to 1812, went from near
bankruptcy to being the leading global consumer bank. But big mergers were
not central to this success. Indeed, the mergers it undertook went badly –
notably the acquisition of Quotron, a securities data firm.

By contrast, a knack for acquisitions enabled Mr. Weill to build up Shearson


Loeb Rhodes, a brokerage, which he merged with American Express in 1981.
He quit in 1985, after falling out with James Robinson, the boss of Amex,
thereby learning a valuable lesson: do not be the junior partner in a merger. In
1986, he bought Commercial Credit, a small consumer-lending firm, which
through mergers became Travelers, an insurance and brokerage
conglomerate. And even as the merger with Citi was announced, the recently
acquired Salomon Brothers investment bank was still being integrated with
Travelers’ Smith Barney. In June 1998, Mr. Weill added a stake in and a joint
venture with Nikko Securities, a Japanese stockbroker.

Mr. Weill’s merger technique was based on having a clear strategy – including
cutting fat out of under-managed businesses – and implementing it fast. He
tried to minimise cancerous uncertainty by selecting the management team to
run the merged businesses as soon as possible, usually on merit and loyalty to
him.

Yet integrating Citigroup was never going to be straightforward. Citibank was


not flabby or under-managed – or, at least, did not see itself that way. It was
possible that the merger would be called off by regulators, a danger that
fostered hesitancy over integration. In the event, the Citigroup merger helped
secure the scrapping of America’s Glass-Steagall Act, which had separated
commercial banks, insurers and investment banks. But above all loomed the
problem of this being a genuine merger of equals.

Two heads better than one?

The to-be-merged company quickly adopted a “Noah’s Ark” approach to top


management- everything in twos. As well as Messrs Weill and Reed, half the
new board’s members came from Citibank and half from Travelers. The global
consumer business was headed by Bob Lipp (Travelers), and William Campbell
(Citi). The global corporate and investment banks had three heads – Victor
Menezes (Citi), Deryck Maughan (Salomon Smith Barney) and Jamie Dimon
(Travelers), long regarded as Mr. Weill’s heir apparent.

As a result, every decision became a lengthy philosophical discussion. This


partly reflected the personalities of the two co-chief executives. Mr. Reed is
the sort who loves to discuss management with academics. A loner in
leadership, he tended to invite people into his inner management circle only to

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expel them soon after. Mr. Weill is guided more by gut instinct than by briefing
papers, and relies on a small group of loyal managers.

Indecision at the top soon led to trouble in the global corporate and
investment bank: Travelers’ Salomon Smith Barney investment bank, plus Citi’s
corporate relationship bank. Integration had been half-hearted: SSB’s well-paid
investment bankers regarded their new colleagues as stuffy corporate folk.
Staff in the Citi operation were proud of the 1,500 leading global firms that
were their main customers, and looked down on traders at Salomon, with
their lower-grade corporate-bond clients. They wanted their services to
continue under the Citi brand, not to be switched to SSB. They were aghast at
the huge losses run up by Salomon during the financial-market crisis in 1998.
Meanwhile, Salomon itself resented Mr. Weill’s decision to close its American
bond-arbitrage operation only a few months after buying the firm.

Things came to a head in late October 1998 at a weekend of golf and spouses in
West Virginia, where senior executives complained about how the merger was
proceeding. Scuffles broke out. The two leaders reacted with unusual
decisiveness. A week later, a new management team was appointed. Mr.
Dimon left the company, his ambition having reportedly annoyed Mr. Weill.
Mr. Menezes was joined as co-head of global corporate and investment banking
by Michael Carpenter, a Weill loyalist. The pair at once set about fully
integrating the two businesses, selecting a new top management team and
identifying a dozen big issues that needed urgent action.

In July, after Citi’s biggest shareholder, Prince Alwaleed bin Talal of Saudi
Arabia, fretted in public about the relationship between the firm’s co-heads,
Mr. Weill took charge of day-to-day operations. Mr. Reed was left with
strategy. In October 1999, Robert Rubin, a former Treasury secretary and
co-head of Goldman Sachs, was appointed to the “office of the chairman”,
apparently to broker peace between the two bosses.

By now, the tensions at the top were public. Mr. Reed had told the Academy of
Management that, although the “wisdom of the merger is even more
compelling” than when it began, it “is not 100% clear to me that it will
necessarily be successful”. He drew telling comparisons with step-parenting.
“Sandy and I both have the problem that our ‘children’ look up to us as they
never did before, and reject the other parent with equal vigour, saying ‘Sandy
wouldn’t want to do this, so what do I care about what John wants?”’

The reality was that Sandy’s children were increasingly winning the top jobs,
and John’s were quitting in droves. Citigroup was rapidly becoming Mr. Weill’s
creature. One top-notch Travelers person did leave, however: Heidi Miller,
Citi’s chief finance officer, quit for Priceline, an e-commerce firm. Mr. Weill
blamed her departure on irritation with Mr. Reed. But that was the last straw:
the board asked Mr. Reed, 61, to retire. The 67-year-old Mr. Weill became
sole boss, supported by Mr. Rubin. All Mr. Reed salvaged was a promise (which
few now believe) that Mr. Weill would go within two years, and that the search
would begin for a successor.

Mr. Weill soon completed his domination of Citi. In July, the last of the
post-merger top-job splits ended. Mr. Carpenter became sole head of the

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global corporate and investment bank; Mr. Menezes, the last remaining
Citibanker at the top, was packed off to head corporate and consumer banking
in emerging markets. Mr. Lipp, another Weill loyalist and head of consumer
banking, joined the office of the chairman, with a brief to co-ordinate
cross-selling.

As for cross-selling, the vision that ostensibly motivated the merger, this has
worked better in some parts of
Before and after the merged company than in
Citicorp Citigroup others. The greatest success has
Travellers been achieved where it was least
Employees Net profit expected – in corporate and
'000 $bn investment banking. Wall Street
180 10 analysts initially hated the
decision to axe Mr. Dimon and
160
to promote Mr. Carpenter. In
8
140 the event, it proved inspired.
Aided by the link with Nikko
120 Securities and a merger with
6 Schroders, a British investment
100
bank, in January 2000, the now
80 Schroders Salomon Smith
4 Barney has moved from being a
60 middle-ranking firm to the brink
of – or even into – the so-called
40 2 “bulge bracket” of top global
20 investment banks.

0 0 Blurred vision?
1997 1999 1997 1999

Source: Company Reports Mr. Carpenter says his business


was involved in some 300
transactions during 1999 that
both Citi and Salomon folk agree could not have been done without each
other, and that the firm is now in the top four in every product category, in
every geographical region of the world. This may be stretching it – SSSB is still
not a first-tier adviser on mergers and acquisitions, for example, though it is
gaining on rivals such as Goldman Sachs and Morgan Stanley by using its huge
balance sheet to offer corporate clients credit lines during mergers.

The potential for cross-selling was supposedly greatest in consumer finance.


Citi’s strong global brand provided a superb platform for selling Travelers and
Salomon Smith Barney products through its branch network, which spans over
100 countries, and to Citi’s 42m credit-card account-holders (more than any
other credit-card provider). But cross-selling is something that many financial
institutions, across the globe, have attempted, with little success.

Citi claims a few modest achievements. Some wealthy Salomon Smith Barney
customers have been given 100% mortgages by Citibank, secured against their
brokerage accounts. Salomon Smith Barney mutual funds have been sold to
Citibank branch customers. Within months of the merger announcement,

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Travelers annuities were selling in the Citibank branch network, and now
generate revenues of $750m a year.

Travelers has now “pre-underwritten” all of Citi’s credit-card customers, and


whenever somebody with an attractive risk profile calls to discuss his credit
card – there are 80m such calls a year – he is invited to buy a Travelers home
or car insurance policy. Travelers says that sales by this channel have minimal
incremental cost, making them particularly profitable. It now sells almost 5,000
policies a month, and expects $200m in premiums by 2002 (6% of current
revenues).

Travelers has started to expand abroad, primarily in emerging markets rather


than in the already highly competitive continental European market. Once only
a domestic American insurer, Travelers now expects to win the lion’s share of
the $400m a year in commissions currently earned by the global Citibank
branch network from selling competitors’ products.

According to Mr. Weill, integration in the corporate and investment-banking


business happened faster than in retail because it had to. “If we’d gone slower,
we would have lost a lot of people." There have been huge technology
challenges, such as incompatible computer systems. Citi remains confident that
retail cross-selling will bear more fruit, but progress has been slow. It has been
hard to integrate systems, and business units have warred over which brands
to cross-sell and which to ditch.

The value of a deal


Share prices, October 8th 1998 = 100
350

300
Citigroup
MERGER

250

200
Citicorp
150

100
Travellers
50

0
1996 97 98 99 2000

Source: Primark Datastream

Adding to the frustration has been the group’s muddled Internet strategy. Mr.
Reed, who took sole charge of it in July 1999, believed that Citi’s Internet
potential would best be fulfilled by developing from scratch an entirely
self-contained, state-of-the-art online retail financial-services provider. More

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Global Corporate Strategy Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers

than $500m was spent developing “e-Citi” – a classic example of the big-bang
innovation strategy pursued by Mr. Reed decades earlier when he installed
thousands of ATMs, in Citi branches, and transformed the way people used
their bank.

E-Citi attracted few customers, and was resented by Citi’s established


businesses. Since Mr. Reed’s retirement, it has been downgraded to a sort of
incubator, and 1400 of its employees have been despatched to other Citigroup
brand businesses. Now, ownership of Internet strategy is left with the top
executives in individual businesses. This caution may be a mistake. Asked in
June whether Mr. Weill could take Citi into the Internet age, Mr. Reed said,
“This isn’t Sandy’s deal. He is not going to personally design the Internet
company that is going to do this.” Mr. Reed’s boldness might eventually have
brought rewards – as did his huge spending on ATMs, which initially meant
huge losses.

Despite the infighting, strategic mishaps and delays in integration, Citigroup has
prospered, with both profits and the share price soaring. Mr. Weill has, as
usual, cut costs and made under-managed assets sweat. New managers from
Travelers have instilled a more aggressive sales culture in Citibank branches.

But the Travelers people who now lead Citibank lack experience in overseas
markets, where the group expects its main growth. Citibank’s institutional
memory, which gave some protection from bad lending decisions, has gone. So
has Mr. Reed’s vision. Mr. Weill is skilled at fixing and then expanding
under-managed companies. But he has yet to show that he can fix and expand
an already successful global giant.

Questions:
1. What are the problems that have become apparent after the merger?

2. What impact have these problems had on the core competences of


the newly formed organisation?

3. How do you think the company could have overcome these problems?

4. Do you think this merger has been successful?

Summary
In this unit we have considered the options available for global
expansion; strategic alliances and mergers and acquisitions (M&A).

Firstly we considered the role of strategic alliances, and the paradox of


co-operation and competition. We noted the advantages arising from

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pooled resources, know-how and shared risk, but also noted that there
can be conflicting goals and there is the potential loss of know-how.

We then considered mergers and acquisitions, and other M&A related


transactions. We saw how M&A can give ready-access to markets,
know-how and management capability. We looked at some of the drivers
for M&A activity. Noting the high rate of failure of M&A, we identified
some of the common pitfalls of M&A, and finally concluded with the
McKinsey five-step program for successful mergers and acquisitions.

REVIEW ACTIVITY
We have noted that one of the main pitfalls in M&A is the integration phase.
When a company acquires another, what is the best recipe for assimilation?

· Does the acquiring company impose its culture on the


acquired company?

· Is there sometimes merit in preserving intact the culture and


working practices of the acquired company?

· How can the right balance be struck between the need for
organisational autonomy vs. strategic interdependence.

Prepare your responses to the above, and then read p.334 (Reading 6.3) in the
key textbook De Wit, B & Meyer, R.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 4*, Chapter 8 Pages 166-195, Chapter 16 Pages 374-407


2. Ref 13, Chapter 7 Pages 151-174, Chapter 14 Pages 337-357

*Highly recommended

130
Unit 5

Value Management

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Analyse the concept of value from a stakeholder’s perspective.

· Assess strategy from a value creation perspective.

· Explain the principles relating to EVA and its impact on strategy.

· Debate the validity of adopting a value driven approach.

Introduction
The term value can bring to mind different things. It can mean one thing
in the public sector and have a different focus in the private sector.
Economists think of value in quantitative terms, in a strict monetary
context. Shareholders think of future potential. Increasingly, and
particularly in the knowledge-based economy, there is an emphasis on
intangible and intellectual capital assets.

Whichever business context you operate in, value should be determined


by your key stakeholders. In commercial organisations, the key
stakeholders are the company’s shareholders. Increasingly executives
and managers are overhauling their understanding of shareholder
value. There is now the recognition that what was thought to be true
about valuation is, in fact, only situationally true. Traditional
approaches can, in fact, be misleading in certain contexts – particularly
in the knowledge-based economy, in the area of new and emerging
technologies.

In this unit we shall look at the concept of value from a stakeholder’s


perspective. We shall look at current thinking with regard to the
creation of value and consider the merits of a corporation adopting a
value-driven approach.

Two case studies are also presented to highlight the issues.

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Paradox of Profitability and


Responsibility
It is important for companies to understand their purpose in business. Is
it to maximise profit for the owners (a shareholder value approach) or is
it to meet the requirements of society at large (a stakeholders values
approach)? Examples of such companies are Body Shop, and Ben and
Jerry’s.

Does a company seek to satisfy the needs of as many stakeholders as


possible in conducting its business, or is it duty bound to maximise its
profits in favour of the owners? It costs money to be socially conscious!

This unit looks at the ‘shareholder’ extreme of de Wit’s paradox


continuum. Unit 6 will examine the opposite end by exploring
Corporate Governance and Ethics.

The Concept of ‘Value’


What is ‘value’? What does it mean in relation to business, or more
importantly, to strategy?

Value as a concept means something different to private and public


organisations. However, regardless of the organisation type, value is
very difficult to define and quantify.

ACTIVITY
Consider the definition of ‘Value’ in the context of an organisation. Draw up a
list of the different aspects of the word ‘value’, e.g. value-added.

ACTIVITY FEEDBACK
Your list may have included some of the following:

· Value for Money.

· Shareholder Value.

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· Value Chain.

· Value System.

· Value Cycles.

· Value Management.

· Stakeholder Value.

We shall look at some of these concepts in more detail in this unit.

Stakeholder Value
Whether in the private sector or public sector, value should be judged
by the organisation’s key stakeholders.

In this unit we shall focus our attention mainly on commercial


organisations. However we shall now briefly look at some of the
differences between the private and public sectors in relation to value.

Public Sector
Strategic management is, of course, just as important to the public sector
as it is to commercial entities. For example, the notion of competition for
a public organisation is usually concerned with competition for scarce
resource inputs, typically in a political arena. However, the emphasis on
value concepts can be different in the public and private sectors. The
overarching need is for public bodies (e.g. central government, local
government, health service organisations) to demonstrate Value for
Money in outputs. Many of the developments in management practices
and theories in the public sector (e.g. changes to internal markets,
performance indicators, competitive tendering) have been used to
attempt to introduce competition to encourage improvements in value
for money.

Overall, the role of ‘ideology’ in strategy development in the public


sector is probably greater than that in a commercial organisation. This is
because the type, range and position power of Stakeholders interested
in an organisation’s strategic choice is greater. Therefore, the
acceptability to stakeholders of strategic choice is probably of greater
significance in the public sector than in the commercial sector.

The measurement of value to stakeholders in the public sector is


difficult to quantify, because it is essentially a perception by the
stakeholder of the ‘value for money’ in the service they have received.

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Private Sector
Stakeholder value is a critical factor for strategy and management in the
private sector.

Theoretically, all managerial actions should be carried out only when


they can add value to the company. This introduces the concept of the
Value Chain in an organisation, i.e. the internal linkages that exist
within the boundaries of an organisation. In addition to this, to fully
understand the concept of value, linkages to the entire supply chain,
upstream with suppliers and downstream with distributors and
customers, must be taken into account. This overall picture of value to
an organisation can be termed the Value System.

Clearly, the value system can be different from company to company


depending upon their strategic choice. Value chains and systems can
establish significant competitive advantage. For example, two
competing firms with equivalent internal value chains can be
differentiated in terms of value by better suppliers and/or distributors.
The ‘value system’ is therefore better for that company. Some
organisations, particularly those with several business units, have very
complex value chains and systems making strategic analysis difficult
and time consuming.

The key work in this area of strategy was carried out by Michael E Porter
in 1985 and 1990.

Key Stakeholders
It could be argued that the key stakeholders to any commercial
organisation are the shareholders (particularly where the company is
publicly owned). If shareholders become disenchanted with a company
and sell their shares in sufficient quantities, the law of supply and
demand dictates that the share price will fall. The ultimate consequence
of this is that the market capitalisation (the value of the company on the
stock market) falls to such a level that the company finds it more
difficult to borrow money or may be taken over by another organisation
who buys up a majority of the shares.

For this reason, companies try to avoid shareholder dissatisfaction and


regard shareholders as key stakeholders. This is logical as the
shareholders own the company and employees have traditionally
answered to the owners. All employees have a ‘fiduciary’ duty to
preserve and build upon the owner’s investment in the firm. This raises
the issues of Value Management – how can a company manage itself
(strategically) to maximise shareholder value? In addition to that, how
can shareholder value be measured?

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Value Management
How do companies adopt strategies to deliver shareholder value. What
is value? Business models and definitions of value that worked well
until the early 1990s, are now being challenged. Why is sensitivity to
stock price now a critical lever for managing the future?

There is an increasing recognition that the market, over time, represents


a brutally honest evaluator of performance. This has led to the
recognition that management, and indeed employees at large, need to
view their company from the outside in. They need to act like long-term
shareholders themselves, and feel the pressure from the marketplace in
order to deploy assets and adopt strategies wisely. To achieve this,
value-based corporations are increasingly basing compensation
packages on value-based parameters.

Value-based corporations place customers at the heart of their business


(the view from the outside in). Value chains and value cycles are
pertinent in this discussion. Increasingly companies are adopting a
value cycle approach, as opposed to the traditional value chain
approach. A value chain is seen to deliver value to the customer,
whereas a value cycle approach views the process as an interaction with
the customers. Many forward-looking companies view their key
customers as critical partners in setting business direction.

ACTIVITY
As background to the next sections, learn about the shareholder value
approach by reading, ‘Shareholder value and corporate purpose’, Reading 11.1,
p. 610-615 in your key text, De Wit, B & Meyer, R.

Creation of Value
Value is added to a firm when profits increase, operational or financial
risks are reduced or when greater efficiencies are produced. Decisions
which add value to a company, add value to the shareholders – either in
the form of dividends, value of the share holdings or both.

Various ratios and tools have been introduced into business for
analysing financial statements, e.g. Return on Capital Employed
(ROCE). But any measure of shareholder value must include the
following considerations:

· Cash flow.

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· ‘Time value’ of cash.


· Opportunity cost of capital.
· ‘Net present value’.

As one of the great proponents of the Shareholder Value philosophy,


Alfred Rappaport, said “Profit is an opinion. Cash is fact”

Economic Value Added (EVA)


Corporations adopting value-based management principles are
increasingly using a measure called Economic Value Added, commonly
shortened as EVA. EVA is used as a measure of value, and is used as a
key parameter in promoting shareholder value within management
ranks and employees at large. It should be emphasised that EVA is NOT
a strategy – it is a measure of performance. The strategies a company
uses are geared to increasing EVA so as to demonstrate to markets that
they use capital efficiently. However, it is a very popular tool and is
used widely by major companies – to even suggest that it will be used
has been know to increase share price overnight!

EVA is the difference between the Return o n Cap ital Em p lo yed and the
Co st o f Cap ital Em p lo yed by a company. A simple, but flawed, analogy
is to compare the annual cost of your mortgage with the annual increase
in value of your house. If your house has risen in value by 10% and your
mortgage is only costing 6%, then you are ahead. The same logic applies
with a company. If it gets more out of its capital than it is paying for it
then it is adding value.

The move towards value-based management in large companies is


based on two assumptions:

· The main aim of any business in a market economy is to


maximise shareholder value.

· Markets are too competitive for companies to create such


value by accident. They must plan for it. And that means
having the right culture, systems and processes in place
so managers make decisions in ways that deliver better
returns to shareholders.

Corporate functions must be informed by value-based thinking –


planning, capital allocation, operating budgets, performance
measurement, incentive compensation and corporate communication.
EVA is a tool for measuring performance. When implemented properly,
and especially if tied to management compensation, it is a powerful way
to promote shareholder value.

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What is EVA
EVA is a measure of profit, but not the accounting profit seen in a
corporate profit and loss account. It is profit as economists define it.
Both are measured net of operating expenses but they differ in the
treatment of capital costs. While accountants (in P&Ls) recognise only
out-of-pocket costs, such as the interest paid to bankers, EVA recognises
all capital costs, including the o p p o rtunity cost of shareholder funds.

The value of any business must equal its net assets (the sum of fixed
assets, cash and net working capital) plus the present (in other words,
discounted) value of future EVAs. Therefore, as stock market
expectations of corporate EVA increase, so too do share prices.

Companies can therefore use EVA targets to motivate managers to


deliver the financial results the stock market wants. This approach is
especially useful for executives one or two levels below top
management who have little direct influence over share price and for
whom stock options are less effective. Their compensation and bonus
schemes can be tied to specific financial objectives and can be cascaded
down to employees all the way down the company.

CASE STUDY – SPX


SPX is a large US auto parts and industrial products company. It was a chronic
underperformer in the early 1990s, with low profits and a languishing share
price. After John Blystone took over as chief executive in 1995, the company
ushered in a series of actions designed to reverse its poor performance. The
company’s 1995 annual report proclaimed: “One of the most important of
these actions has been the decision to move ahead as quickly as possible to
implement EVA.” Formal adoption took place at the end of 1995, and by the
end of the following year, a dramatic improvement in performance was
evident.

Senior managers were put on an EVA bonus plan. Within a year, 4,700
managers were in the programme, including non-executive directors. By 1999,
SPX was transformed into an EVA company, with a positive effect on the share
price. When EVA was implemented, SPX’s share price was under $16. Within
five years of implementation it was selling for $180. What makes this
company’s experience instructive is that it was able to create a culture that put
value creation at the centre of management systems. As the company
explained in its 1998 annual report: “EVA is the foundation of everything we
do. It is a common language, a mindset, and the way we do business.”

SPX witnessed dramatic improvements in asset efficiency. In the year after


adopting EVA, inventories were cut by 15 per cent, despite higher sales. To
improve performance, the company focused its operating units on quality and
operating excellence. One such unit began a next-day delivery policy that
helped it to achieve market leadership. Such efficiencies, combined with

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sourcing initiatives, caused a 12.5% improvement in operating profit in 1997


(the second year after EVA was implemented).

SPX divested several businesses that were profitable, but strategic reviews
revealed the businesses were worth more to others, and therefore should be
sold. Of course, well-managed companies have always done this, but
EVA-based compensation systems create stronger incentives for managers to
seek such opportunities.

EVA’s most important contribution to the turnaround was its central role in
management compensation. The actions taken by SPX to improve
performance were neither unusual nor dramatic. The key lesson to be learned
from SPX is not whether managers are capable of delivering superior
performance, but whether they are motivated to do so.

How is EVA calculated?


EVA is after-tax operating profit minus capital costs, with capital costs
equal to net assets multiplied by the weighted-average cost of capital (or
WACC). When operating profit is divided by net assets, it yields a
measure called Return On Net Assets (RONA). The difference between
RONA and the WACC, or the “EVA spread”, multiplied by net assets,
equals EVA:

EVA = (RONA – WACC) x NET ASSETS

How does EVA relate to the value of a company?


The value of a company is defined as:

Value of Company = Net Assets + Present Value of future EVAs

The net assets are the sum of all fixed assets, cash and working capital.
Note the EVA component is the present value of future EVAs; it is
discounted back.

Growth of Value Management Concepts


Value Management concepts are becoming more widespread on the
back of a number of developments. Companies are responding to a
changing corporate environment. In particular,

· Greater competition for capital, driven by the


globalisation of capital markets.

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Global Corporate Strategy Unit 5 – Value Management

· The growing trend towards ‘professional’ shareholders


and, in particular, the influence of institutional investors.

· The emergence of a market for ‘corporate control’ i.e. the


high potential for company acquisitions.

What is a Value-Driven Approach


What sort of things do ‘value driven’ companies have to do to design
and implement value management?

Methodology:

· Take a long term rather than short term perspective.


· Take a company specific rather than a ‘generalised’
approach.

· Use suitable performance measurement targets in


planning and control.

Mistakes made in one or all of the following areas can lead to


inaccuracies in management information and can have a serious effect
on the overriding goal of value management – that is, to improve
corporate control.

Reward Systems:

· Implement effective compensation and incentive


schemes.

· Review traditional dividend policy.

If reward systems to employees and shareholders are rigidly


maintained for historical reasons and not reviewed in the light of a value
management approach, the introduction of a value driven strategy is
done ‘half-heartedly’.

Implementation:

If a company fails to involve all parties then the value management


strategy will meet with resistance and delays. A successful
implementation must:

· Take account of all stakeholders.


· Be in full consultation with employees.

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ACTIVITY
Value innovation is said to be the essence of strategy in the knowledge
economy. Learn more about this by reading ‘Strategy, value innovation and the
knowledge economy’ in your key textbook, De Wit, B & Meyer, R.

Company Specific Approach


To be successful in deploying value-management, a company specific
approach must be adopted. A good approach is to leverage general
value management tools, but to adapt to your specific industry and fine
tune for company specific factors. Figure 5.1 summarises the essential
components.

General Industry specific Company specific


value-management factors factors Company specific
tools strategy
(select suitable tools) (adapt to industry) (fine-tune for company)
Industry-specific success
Valuation models Opportunities and threats Value system/corporate factors
+ + philosophy and policy
=
Cost of capital calculations Structure and dynamics
of industry Strategy Specific tools
Portfolio management
Value drivers Organisation/structures
Controlling tools Tailored implementation
Product cycles Production processes
Success factors Resources

Figure 5.1. A company-specific approach to value-management.

Components of a value-driven approach


The components of a value-driven approach are summarised in Figure
5.2.

Let us examine each in turn:

Identify value performance and value drivers


It is clearly essential for a company to be able to assess their value and
measure progress to identify their Value Performance. In other words,
the company needs to verify that they are actually creating value for

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Global Corporate Strategy Unit 5 – Value Management

their stakeholders. This can be achieved by creating a computer based


financial model containing all of the key value management variables.

In adopting a Value Management strategy, the method of corporate


valuation must be ‘Discounted Cash Flow’ (DCF) which sees the value
of a company as being the sum of the cash flows it will earn in the future,
discounted back to the present value. This reflects the fact that on the
purchase of a company, the purchaser acquires the right to future cash
flows.

The whole process is based on careful Business Planning, which should


reflect a forecast horizon of at least five, but preferably ten years. Each
strategic business unit (SBU) should be calculated separately with a
summarising routine to reflect overall portfolio value.

Value drivers can be identified by using the above computer based


financial model by changing core assumptions and observing the
impact on shareholder value. This develops a tool for Sensitivity
Analysis, which identifies and evaluates key value drivers.

Step 5: Step 1:
Inform stakeholders Identify value
and develop investor performance
relations and value drivers

Increase
shareholder
Step 4: Step 2:
Adapt value Implement
compensation value creation
systems programmes

Step 3:
Extend
management and
control systems

Figure 5.2. Components of a value driven approach.

Implement value creation programmes


Having laid the foundation for value management by establishing a
financial model it is necessary to develop or expand a portfolio of value
creating business units. Refer back to Unit 2 for a review of the portfolio
management approach to strategy.

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Unit 5 – Value Management Global Corporate Strategy

A value portfolio chart plotting potential market returns (adjusted for


risk) against strategic ‘fit’ with corporate vision is recommended. See
Figure 5.3. The portfolio distinguishes between stars and dogs;

· Further growth or holding strategy with no strategic


investment for the ‘stars’.

· Optimisation / Discontinuation / Sale of the ‘dogs’.

This represents the results of the analysis carried out above for each
SBU. From this, the following questions can be answered;

· How is a particular SBU to be positioned into the value


portfolio?

· What actions are needed to increase the Value of the


portfolio?

+ Retain without strategic investment


SBU 1
Pursue further growth

E.g. can profitability be E.g. what growth


maintained without further options are available?
investment?
"Stars"

SBU 4
Deviation SBU 7
from risk-
adjusted Sell Optimise or discontinue
market SBU 3
returns E.g. have all efficiency
E.g. has this unit enhancement options
achieved critical been exhausted?
mass?
E.g. would this unit not SBU 2 "Dogs"
be better off in someone
else's hands?
SBU 8
- SBU 6
Low High
Cirecle diameter = capital employed Strategic fit with corporate vision

Figure 5.3. Value portfolio chart, Ref: Stefan Botzel & Andreas Schwilling, Managing for Value
1999.

The ‘Stars’ in the value portfolio are those businesses that create
shareholder value by;

· Sustained cash flow growth achieved by engaging in


activities in attractive industries, for example, or by
attaining an excellent competitive position.

· Optimised management of investments (intangible assets,


financial assets, property, plant and machinery, working
capital) and how they are financed (cost of capital).

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Global Corporate Strategy Unit 5 – Value Management

· Consistent risk management.

The ‘Dogs’ do exactly the opposite.

The position on the ‘x’ axis is determined by a pragmatic scoring system,


which will be developed by each individual company.

The position on the ‘y’ axis is determined by considering the


comparison between return on investment with the cost of capital.
(Clearly value is created only when return > cost).

Strategic management

Analysing the value portfolio must be combined with the strategic


management of the company;

· Only SBUs which yield shareholder value should be


retained in the portfolio.

· ‘Dogs’ should only be retained until transformed into


value creating ‘Stars’ or sold off.

· Consistency is vital – decisions must be based on hard


figures produced by value management, not emotive,
personal satisfaction, etc.

· If the portfolio cannot guarantee to generate the target


level of value creation then the company needs to
restructure through acquisitions, alliances, new ventures.

· The ‘mix’ of capital allocated to each SBU could be


changed.

Let us now deal with each ‘window’ of the value portfolio in turn;

‘Stars’ that fit the corporate vision:

· Cash producers and value drivers.


· The goal of corporate strategy should be to position core
businesses in this window.

· Growth should be promoted.


· Funding will need to be allocated to maintain and / or
improve the company’s position.

· Capitalisation on areas of competence.

‘Stars’ that DO NOT fit the corporate vision

· May be non-core or niche markets, but still create value.

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Unit 5 – Value Management Global Corporate Strategy

· SBUs retained but without further investment.


· Focus on risks attached to the poor corporate ‘fit’.
· Possibly look to sell to harmonise corporate vision.
· Possibly adapt corporate strategy to remain attractive to
the market and adopt a growth strategy.

‘Dogs’ that fit the corporate vision

· These SBUs destroy value because of;


- Low cash flow due to thin margins, low sales growth
- Investment has been excessive or inappropriate
- Cost of capital is too high
· Strategically, need to be optimised or run down.
· Money to be invested only if the returns are above cost of
capital.

‘Dogs’ that DO NOT fit the corporate vision

· These SBUs destroy value.


· Generally, such SBUs should be sold, to lay a solid
foundation for successful growth strategies.

In summary, a value creation strategy must seek to:

· Increase Revenues.
· Increase Margins.
· Optimise Investments.
· Minimise the cost of capital through Financial
Engineering.

Extend management and control systems


A uniform system of planning and measuring business success that
makes the creation and destruction of value transparent must be
established based upon;

· A forward looking approach based on future cash flows.


· A focus on cash flows rather than numbers in financial
statements.

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Global Corporate Strategy Unit 5 – Value Management

· A view which acknowledges the time value of money.


· Reflection of the risk faced by different SBUs in capital
rates.

Management control processes and communication systems must be


clearly defined and capable of being used as a basis for a Value Based
Compensation System. Management reports must be ‘recipient based’
and include value measurements.

Strategic Planning and Control

European countries tend to base strategic planning upon traditional


metrics such as market share, competitive position, sales growth and
results. Value management dictates that increasing the value of the
company in its SBUs is the single most important measure.

For example, a sales growth of, say, 10% is not a valid strategic goal (as
far as VM is concerned) because;

· Corporate value could still be destroyed despite this high


figure – the investment needed to achieve this growth
would may not bring in sufficient returns to cover the
cost of capital.

· 10% may not be enough if value creation based on a


higher sales target appears realistic.

Adapt compensation schemes


Compensation systems are a key factor in value based company
management. The principle is simple – managers' salaries should be
linked to value generation for shareholders. Examples of this are;

Genuine Participation Models:

· Stocks.
· Stock options.
· Convertible bonds.

Artificial Participation Models:

· Bonuses.
· Combined forms.

The variety of value based incentive schemes possible means that a


scheme can be devised for any level of management – it doesn’t have to
be the same across the whole company.

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Unit 5 – Value Management Global Corporate Strategy

EVA bonus plans don’t just motivate managers to think about current
EVA. If they did, managers would focus entirely on short-term
performance at the expense of the future. Value-creating investments
might be avoided because their immediate effects on EVA are negative.
The solution is to give managers a direct economic stake in future EVA,
not just the current period. The figure above shows how such an
approach can work.

Remember that the value of the company (that is, the value of debt and
equity) equals net assets plus the present value of future EVAs. This
means that the market capitalisation of a company’s shares is based on
expectations of future EVA performance. Share price increases when
these expectations are exceeded.

This insight yields the first principle of EVA-linked compensation: the


key performance measure is not EVA itself, but excess improvement. To
derive this measure, companies must first set targets based on market
expectations. Then, a target bonus, usually stated as a percentage of
salary, is paid if the target level of EVA improvement derived from the
company’s share price is earned.

Note, however, that the payout is not capped. This is the second basic
principle of EVA-linked compensation. If manager and shareholder
interests are to be aligned, management pay should more closely
resemble payouts received by owners.

As a result, there is no ceiling on the EVA bonus, but there is also a


downside. The bonus earned in any year is the sum of the target bonus
plus a fixed percentage of excess EVA improvement (which can be
positive or negative). This bonus is credited to a bonus bank, and the
bonus bank balance, rather than the current year bonus earned,
determines the payout.

Typically, the payout rule for the bonus bank is the full bonus bank
balance (if positive), up to the target bonus, plus one-third of the bank
balance in excess of the target bonus. When the bonus bank is negative
(which is possible if under performance is great enough), no bonus is
paid. The EVA interval determines the sensitivity of the bonus earned to
excess EVA improvement, and is chosen by senior managers based on
the degree of upside potential and downside risk they wish to inject into
the plan.

The bonus bank component adds a critical dimension to the scheme by


extending managerial planning horizons beyond the short term. The
bank allows for a negative bonus, wiping out at least a portion of EVA
bonuses earned in previous years. This practice forces managers to
think not only about what they need to do in the short term to boost
performance but also what they must do to increase it in future years.
Otherwise, part of the bonuses they earn in the current year might be
forfeited. In other words, the bonus bank provides medium-term
incentives for value creation, in addition to the short-term incentives

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Global Corporate Strategy Unit 5 – Value Management

from annual payouts. Stock options add to the EVA bonus plan by
providing long-term incentives.

CASE STUDY – Herman Miller


In 1995, Herman Miller, a US office furniture manufacturer, had a rich history
and culture, great products and talented employees. The economy was strong,
the furniture industry was growing and sales were growing at a fast rate.

But something was missing. The results weren’t showing up on the bottom line
and so the company decided that a tool was needed to help focus their efforts.
They implemented EVA as a measurement and management tool.

Employing the same amount of capital as in 1995, sales moved from $1 billion
to $1.5 billion. In 1997, EVA was $40 million – an increase of nearly 300% over
the $10 million generated in 1996. The share price has gone from a low of $11
at the end of 1995 to a high of $36 at year-end 1997.

Herman Miller has valued employee participation since company inception


nearly 75 years ago. EVA was seen to build on that historic strength, allowing
employee-owners to better understand the impact of their actions, resulting in
better decisions for customers and general business.

EVA analysis enables the company to identify waste in both costs and use of
capital. Inventories across the country reduced by 24% or $17.2 million from
1995.

Outstanding accounts receivable (that is, the money owed by customers) have
been reduced 22% from 55 days in 1995 to 43 days at the end of 1997. Over
the past two years, sales have increased 38%. The cut in receivables is
especially interesting because the impetus for this came from operating
managers, not the accountants.

The 13% operating margin is much improved from five years ago with scope
for further improvement. At the same time, the total square footage of building
space has been reduced by more than 15%.

EVA analysis demonstrated that debt capital was cheaper than equity capital.
So the board set a new debt to capital ratio of 30% to 35% and $100 million
was raised in a private placement. In 1997, $110 million was returned to
shareholders in share repurchases and dividends.

Using EVA, Miller’s business has grown and people have grown in their
commitment and contribution. EVA is the backbone of the company-wide
incentive and bonus system.

As one observer explains: “When they went on EVA and began focusing on
capital costs like receivables, Miller employees in the divisions attacked the late
payment problem on their own and discovered that the cause of overdue

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receivables was incomplete orders. When an order arrived missing a piece or


two, the customer would withhold all payments until the last items arrived. So
the ‘Millerites’ got receivables down by speeding up production of missing
items and making sure shipments were complete as well as on time. The result:
improvements in EVA and customer satisfaction.

Inform stakeholders; develop investor relations


Of all stakeholders, the investors are the ones who probably play the
most important role. If returns are poor, they may sell their shares and
invest in something more profitable.

What does “Investor Relations” mean? Investors will only be interested


in a company if it promises to be a good investment. Therefore, a
company must put a value on itself so that an informed decision can be
taken. This is the essence of investor relations. It is not, however, a one
off exercise. It is a long term process of positive opinion building. In fact,
about 10-15% of a company’s value development can be ascribed to the
influence of professional investor relations.

Communication tools may be split into direct and indirect with varying
degrees of importance to investors, e.g. Annual Reports are more
indirect whereas meetings and presentations are direct communication
tools.

Is EVA Appropriate?
All companies can benefit from the shareholder value perspective and
the value-creating incentives offered by EVA, but some are more likely
to benefit than others.

An important part of EVA is that it can provide value creation incentives


for divisional managers, not just for top executives. This suggests that
companies with autonomous business units benefit more than
companies that operate as one large unit. Also, matrix organisations
tend to derive fewer benefits because of the difficulty of establishing
accountability.

Companies with substantial shared resources are less likely to benefit


from EVA. For example, if common manufacturing facilities or sales
staff serve multiple business units, and if these units are not forced to
“buy” this capacity, investment accountability, EVA measurement and
management incentives can be undermined.

Another difference between successful and unsuccessful users is that


the former rely on strong managerial wealth incentives tied to business

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unit performance. The latter tend to place heavier emphasis on stock


options. Successful EVA companies use stock options, but recognise
that the strongest incentives for divisional managers come from
measures based on divisional performance, not corporate measures
such as stock price. Unsuccessful users are also more inclined to exercise
discretion in paying managers. In other words, they override the bonus
plan, probably because of low tolerance for differences in business unit
compensation.

In successful EVA users, the chief executive is an enthusiastic advocate,


whereas in unsuccessful users, the CEO may not have realised what he
or she signed up for. Maybe the CEO thought EVA was what the
markets wanted. Or perhaps there was a failure to appreciate the effort
needed for full implementation. As a result, implementation is erratic.

Another feature of successful users is that they try to establish and


maintain accountability for business unit heads. This, in turn, requires
that these managers stay put for extended periods. In unsuccessful
adopters, job tenure for business unit managers is short. This difference
is crucial because if managers move around, there is no long-term
accountability. Without accountability, deferred compensation is not
possible. Deferred compensation, in the form of a bonus bank, plays a
critical role in ensuring the EVA bonus plan forces managers to think
beyond the current year.

EVA is no panacea, and it is no substitute for sound corporate strategies.


But when EVA is at the centre of a company’s performance
measurement system, and when management bonuses are linked,
alignment between the interests of managers and shareholders
improves. The effect is that when managers make important decisions,
they are more likely to do so in ways that deliver superior returns for
shareholders.

Reference m anaging fo r Value (1999) by Bo tzel S. & Schw illing A

Summary
In this unit we have looked at the concept of value, what it means to
different stakeholders, and how our ideas of value and its measurement
are changing.

We have looked at EVA as a measure of value, and have seen how EVA
is influencing the management philosophy of value-based companies.
We have also looked at the components of a value-driven approach.

We have noted that EVA is no panacea, or substitute for sound


corporate strategies. We have considered the characteristics of
companies for which the shareholder value perspective and
value-creation incentives offered by EVA is most likely to succeed. We

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have looked at two case studies where EVA has made a significant
impact.

REVIEW ACTIVITY
In the late 1990s high-tech stocks soared in value, and there seemed to be an
unsustainable wave of dot.com mania. The dot.coms invaded every sector of
commerce; e-business seemed be to overturning established relationships, and
attacking long-established price points. The year 2000, however, saw the
collapse of many dot.com shares. What went wrong?

1. Consider what went wrong. What are the lessons to be learned?

2. Now identify a survivor from the dot.com period. Spend some time
researching the company. Find out about its strategy, during the
dot.com period – specifically with regard to e-business. Comment on
its market valuation during the dot.com period and on what premise
these valuations were made. Identify the hallmarks of their success

REVIEW ACTIVITY FEEDBACK


Here is some feedback on the first part of the question.

The valuation of a company has two equally important components. Net


assets, as well as the present value of future EVAs. For most dot.com
companies the net assets were very low, but the valuation of the second
component (EVA) was extremely high – unrealistically high.

Based on nothing more than a website, companies with no earnings and no


prospects of operating in the black were awarded market valuations that
exceeded many of the world’s most respected companies. Business metrics
like profit and cash flow went out of the window. Unrealism and hysteria took
over the market.

In effect, many of the dot.com management were guilty of hyping the worth of
future EVAs. Market analysts egged on the hysteria; some cynics go as far as to
say that some market analysts materially benefited from this deception (an area
of on-going investigation).

The EVA situation resolved itself over time, and many of the dot.com stocks
crashed.

The lesson from the crash is that there are no shortcuts in business. For many
dot.coms, the “e” in e-business came to stand for “easy”; easy money, easy

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success, easy life. A real business is serious work and must have a realistic
business plan for break-even and profitability thereafter; profitability in the
not-too-distant future. In addition to future potential (and by future potential is
meant realistic future EVA) profits and cash flow do matter.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 10*, Chapter 6 pages 212-226


2. Ref 4, Chapter 13 pages 327-335
3. Ref 15

*Highly recommended

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Unit 6

Corporate Governance and


Ethics

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Assess the advantages and disadvantages of an ethical approach in


organisations.

· Develop the principle of global corporate governance by examining


recent UK developments in this area.

· Explain the attributes of good corporate governance.

· Appreciate the attributes of an ethical organisation.

Introduction
Globalisation has heightened the awareness of social responsibility.
There has been much debate about its adverse impact on social, political
and environmental issues. Furthermore, recent high-profile corporate
scandals, such as Enron, Worldcom and Parmalat, have led to an
increased focus on corporate governance and the tightening of
accounting procedures.

What is clear is that companies can no longer pay lip-service to good


corporate governance and business ethics. Profitability cannot be the
sole corporate driver. Undoubtedly, there is a paradox between
profitability and stakeholder responsibility. See Figure 6.1. Profitability
will always be driven by the shareholder view, and guided by value
management principles. But stakeholder responsibility must also be a
part of organisational purpose. Stakeholder responsibility is not just
responsibility to the shareholders, but to the stakeholders (including
employees, suppliers, customers and the community) at large.
Stakeholder responsibility must be guided by good corporate
governance and business ethics.

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Profitability Responsibility
Organisational purpose

Shareholder value Shareholder value


perspective perspective

Value management Corporate governance


principles and ethics

Figure 6.1: Paradox of profitability and responsibility

It should be noted, however, that in today’s business/political


environment with very powerful lobby groups, profitability and
responsibility are not always paradoxical; profitability can indeed be
adversely affected by the apparent lack of social responsibility. Shell
found this to their great cost with the Brent Spar episode where Shell
appeared to go against their own stated ecological and environmental
stance.

Also, investors who invest for the longer term may expect the company
to be profitable and also behave ethically, showing good standards of
corporate governance.

In this unit we shall look at the area of corporate governance, and


examine recent developments in the UK relating to this. We shall then
consider the area of business ethics. We shall look at the benefits arising
from adopting strong ethical principles, and look at the factors that set
apart a highly ethical organisation.

Corporate Governance
The term ‘corporate governance’ has been used in a variety of contexts,
particularly in relation to the boards of companies listed on a stock
exchange. Governance is at the heart of the role that all boards of
directors play. The range of issues is varied, e.g. company performance,
individual performance, role of directors, roles of shareholders.

Corporate governance came to the fore in the early 1980s in the United
States during extensive corporate take-over activity. Perceiving little
support from their institutional shareholders, numerous company
boards began to introduce protective practices to ward off undesirable
take-over bids. These measures were seen by some shareholders,
especially public pension funds, as acting against their best interest.
Accordingly, shareholders began to take a greater interest in their
investments. Out of this, corporate governance was born.

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As mentioned in the introduction, there is undoubtedly a paradox


between profitability and stakeholder responsibility. Conflicting
demands, between economic profitability and social responsibility, are
placed on a company by its shareholders, employees, suppliers,
customers, governments and communities.

ACTIVITY
How does a company achieve its organisational purpose by balancing the often
conflicting demands of profitability and stakeholder responsibility? Learn about
this and the paradox of profitability and responsibility by reading the following:

1. p. 590-609 of Chapter 11 in your key text, De Wit, B & Meyer, R.

2. p. 616-638, Readings 11.2-11.4, in your key text, De Wit, B & Meyer,


R.

The problems associated with the split between shareholders and


company directors were first raised by Berle and Means, in their 1932
book, The Mo d ern Co rp o ratio n and Private Pro p erty. The issue of the
‘agency problem’ was highlighted, i.e. the tension created when the
directors running the company were not the major shareholders. In the
1980s, institutional (professional) shareholders were much more likely
to address these issues and debate possible solutions.

Corporate activity is under a more intensive media spotlight today.


Board decisions are more public and annual meetings can be
high-profile as shareholder activists raise questions about board
decisions.

In the UK, the corporate governance debate started to receive emphasis


due to several high-profile corporate failures such as Polly Peck and
Coloroll. World-wide, and in the last three years, there have been
further dramatic and spectacular failures including Enron, Worldcom
and Parmalat. Directors were seen as acting against the shareholders’
interests and in dereliction of their duties to the company. As a result of
failures such as the ones mentioned, investors are willing to pay a
premium for companies with good corporate governance.

To understand the workings of governance ‘systems’, it is important to


be able to identify the different types that exist globally. Often,
governance systems are developed from tradition and ideology. In
recent years, it has become more difficult to generalise about the
different types of system. For example, there is possibly a trend in
central Europe to move towards a more ‘Anglo Saxon’ approach. The
different types of governance system are;

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Unit 6 – Corporate Governance and Ethics Global Corporate Strategy

1. The Anglo Saxon Model (e.g. in the UK, USA and Australia)
which is a single tier structure and often reflects a widespread
number of small shareholders alongside large investment houses
who are intermediaries owning shares on behalf of investors.
This limits the power of the individual shareholder and heightens
that of organisations such as pension funds. This can lead to a
short term approach as investors seek to obtain a quick return on
investment.
2. The European Model (e.g. Germany) comprises a two tier
structure where the upper tier is supervisory over the lower tier.
Share ownership is normally in the hands of institutions who use
protective mechanisms such as preference shares. This system
has strengths and weaknesses. The two tier system is seen as a
‘counterbalance’ to management power where the single tier is
dominated by senior management. However, whereas the system
has long term views, it suffers from slower decision making and
a lack of flexibility.
3. The Asian Model (e.g. Japan) is single tier but ownership is very
different to the Anglo Saxon model. Banks and other companies
own most of the shares. Hence the larger companies hold shares
in each other and co-operate very closely (known as a ‘kieretsu’).
Composition of boards is heavily in favour of executive
managers. In fact, it is in effect the top layer of management.
Accordingly, the share ownership patterns can lead to weak
accountability and secretive governance procedures.

Average %
30

28
Venezuela
Indonesia
26 Columbia Thailand
Malaysia
24
Brazil Korea
22 Italy
Mexico
Argentina Germany
Taiwan
20 Chile France
Japan
Spain
18 US
Switzerland
UK
•0
Latin America Asia Continental Anglo-Saxon
Europe
Source: McKinsey

Figure 6.2: Average premiums investors would be willing to pay for a well-governed
company

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Global Corporate Strategy Unit 6 – Corporate Governance and Ethics

Figure 6.2 suggests that investors are willing to pay more for shares
where the perception is that the companies are ‘governed’ in a sound
and ethical way. It can be seen as a measure of perceived ‘ethical’
governance.

Scrutiny in the area of governance (as we shall see in the next sections)
has led to the establishment of strategic principles relating to corporate
governance. These include:

· Selection and conduct of senior officers, and their


relationship with stakeholders.

· Responsible use of power assigned to senior officers.


· Responsible conduct in relation to information relayed to
stakeholders.

· Further checks by way of appointment of non-executive


directors who have no commercial interest in the
company.

· Focus on principles of conduct rather than hiding behind


simple rules.

· Equitable distribution amongst stakeholders of the value


of assets generated by the company.

Key developments in the UK


Let us now examine key developments in the UK relating to corporate
governance.

The Cadbury Committee


In the aftermath of these cases, a committee, chaired by Sir Adrian
Cadbury, was formed in 1991 to examine the financial aspects of
corporate governance in publicly quoted UK companies. The
subsequent Cadbury Report, The Financial Aspects of Corporate
Governance, published in December 1992, focused the corporate
governance debate in four main areas:

· The responsibilities of directors for reviewing and


reporting on performance to shareholders.

· The case for establishing audit committees.


· The principal responsibilities of auditors.
· The links between shareholders, boards of directors and
auditors.

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The report contained a Code of Best Practice, most of which was


adopted as part of the London Stock Exchange’s Listing Rules for all
quoted companies. The report states that “Corporate governance is the
system by which companies are directed and controlled.”

Whereas the corporate governance debate in the US had focused on


shareholder rights, the emphasis in the UK was on structure and
processes. Despite the report’s own definitions, the aspects of
governance relating to control dominated the debate in the UK and
added little to the issues of best performance.

The Greenbury Committee


The Cadbury Report focused on financial governance. Following a
series of highly publicised large pay awards to directors, notably in the
privatised utilities, a committee was set up to examine directors’
remuneration, chaired by Sir Richard Greenbury. The committee
reported in July 1996 and again produced a Code of Best Practice that
focused primarily on listed companies. Remuneration packages appear
to many as one of the most obvious means by which the interests of the
directors can be aligned with those of the shareholders.

The Code made a series of recommendations on the role of


remuneration committees, disclosure of directors’ remuneration and
provisions for approval of long-term incentive schemes, corporate
remuneration policy, the length of directors’ service contracts and the
compensation paid to directors when these contracts come to an end. As
with Cadbury, many of the recommendations have since become part of
the Stock Exchange’s Listing Rules requirements.

The focus was again on the systems and structures which could control
directors, ensuring that, as far as possible, their interests were aligned
with those of the shareholders. Both Cadbury and Greenbury, therefore,
focused most of their work on the elements of the debate relating to
accountability, not enterprise.

The Hampel Committee


The latest report on corporate governance in the UK, the Hampel
Report, from the Committee on Corporate Governance chaired by Sir
Ronnie Hampel, attempts to address the distinction head on:

The directors’ relationship with the shareholders is different


in kind from their relationship with other stakeholder
interests. The shareholders elect the directors. As the
[Confederation of British Industry] put it in their evidence
to us, the directors are responsible for relations with
stakeholders; but they are accountable to the shareholders.

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The report has identified the friction created when talking of


accountability and business prosperity;

The importance of corporate governance lies in its


contribution both to business prosperity and to
accountability. In the UK the latter has pre-occupied much
public debate over the past few years. We would wish to see
the balance corrected
(Final Report from the Committee on
Corporate Governance, 1998)

This raises the question, ‘what is the difference between accountability


and responsibility’? Some have used these words as being synonymous.
However, their distinct meaning is important in developing the issues
relating to governance.

The Combined Code


In June 1998, the London Stock Exchange published the Principles of
Good Governance and Code of Best Practice (‘the Combined Code’)
which embraces the work of the Cadbury, Greenbury and Hampel
Committees and became effective in respect of accounting periods
ending on or after 31 December 1998. The Combined Code established
fourteen Principles of Good Governance and forty five Best Practice
provisions, upon which, companies were required to state their
compliance throughout their accounting period

The 1998 Combined Code has since been superseded by a version


published in July 2003. The July 2003 Combined Code became effective
for reporting periods on or after 1 November 2003.

ACTIVITY
Read the latest version of the Combined Code on the following website:

http://www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf

The Higgs Review


For non-executive directors, a boardroom seat had been seen as
providing a comfortable sinecure ahead of retirement. Most boards of
large companies comprised the ageing great and good in the City, often
retired executives. Clubby consensus, rather than challenges to
management, was the order of the day. Some of that culture still lingers.

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The Higgs Review was commissioned by the Chancellor and the


Secretary of Sate for Industry to review the role and effectiveness of
non-exec directors, and the report was published in January 2003.

ACTIVITY
Read the Summary and Recommendations section of the Higgs Review from
the following website:

http://www.dti.gov.uk/cld/non_exec_review/pdfs/higgsreport.pdf

As the Higgs review makes clear, the boardroom remains largely a


preserve of ageing white men. Mr Higgs’ package of reforms will see
non-executives take a much more active role and become far more
accountable in carrying out their duties.

The changes will represent a fundamental shift in the boardroom. The


power of executives on the board will be balanced by independent
non-executives providing a check on management. At least half the
board will comprise independent non-executives. This goes far beyond
previous requirements that a third of the board be non-executives,
independent or otherwise.

The chairman, playing a pivotal role and potentially holding the balance
of power, will be required to be independent at the time of his
nomination but it is assumed he will “go native”, given the time spent
working closely with the management.

The review says: “A non-executive is considered independent when the


board determines that the director is independent and there are no
relationships which could affect, or appear to affect, the director’s
judgement.” Factors that could affect independence include
employment with the company in the past five years, having a material
business relationship in the past three years, family ties, receiving
additional remuneration apart from a director’s fee, and participation in
the company’s share option or pension scheme.

The review also recommends that a senior independent director be


appointed to act as a conduit for shareholders to raise issues if they are
not resolved through the chairman or through the chief executive. This
proposal, more than anything else in the review, has concerned
business. The concern is that if the senior non-executive holds separate
discussions with shareholders it could lead to mixed messages
emerging from the board. Mr Higgs is at pains to point out that senior
non-executives will not be champions of shareholder interests but will
be more a “listening post”. They will attend meetings with

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Global Corporate Strategy Unit 6 – Corporate Governance and Ethics

shareholders, largely only to listen to shareholder concerns. In addition,


if problems arise with a chairman and chief executive, they could be a
contact point for shareholders.

Other measures ensure that boards do not become bound by


personalities or tradition. These include requiring the chief executive
not becoming chairman.

Non-executive directors should normally be expected to serve a tenure


of two three-year terms, although a longer term would be appropriate in
exceptional circumstances. After nine years, annual re-election of
non-executives is appropriate, and after 10 years on a board a
non-executive is not considered independent. Non-executive directors
also should meet at least once a year without the chairman or other
executive directors present.

To widen the gene pool of talent in the boardroom, Mr Higgs


recommends a more formal, transparent recruitment process. Research
by the review showed that 48% of non-executive directors were
recruited through personal contact with a board.

No individual should chair more than one large company nor should a
full-time executive take on more than one non-executive role.

No limit has been set for the number of roles that non-executives can
hold, though individuals should make sure they have enough time to
fulfil their duties.

The Smith Report


The report says that a Company Audit Committee’s primary role is to
ensure the integrity of the company’s financial reporting, and warns it
must be prepared if necessary to take an adversarial approach with
management.

“If things are going seriously wrong the committee may have no
alternative but to explore the issues exhaustively. ”If the audit
committee is drawn into a line of questioning about the handling of a
controversial issue, it cannot let go until it is satisfied with the answers."

The Smith report says at least three independent non-execs should serve
on the audit committee, and suggests that they should get extra pay to
reflect the importance of their work.

It says at least one member should ideally have a professional


accounting qualification, together with recent and relevant financial
expertise, possibly as an auditor or company finance director. The other
members should have a degree of financial literacy.

The Smith report will lead to revisions to the best practice code on
corporate governance for listed companies.

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Director Accountability
Placing accountability at the heart of corporate governance inevitably
led the general debate on the issues of to whom are directors
accountable. Developing the Cadbury definition of corporate
governance a similar committee set up in Canada suggested a wider
definition:

‘Corporate governance’ means the process and structure


used to direct and manage the business and affairs of the
corporation with the objective of enhancing shareholder
value, which includes ensuring the financial viability of the
business. The process and structure define the division of
power and establish mechanisms for achieving
accountability among shareholders, the board of directors
and management. The direction and management of the
business should take in account the impact on other
stakeholders such as employees, customers, suppliers and
communities.
Where w ere the d irecto rs? To ro nto Sto ck Exchange (1994)

This definition retains Cadbury’s systems focus, but suggests that the
structures and processes chosen by directors must take into account
parties other than shareholders.

The Role of Corporate Governance


The UK’s National Association of Pension Funds (NAPF) suggest in
their report, Go o d Co rp o rate Go vernance (1996), that corporate
governance should concentrate on two issues:

· Board integrity ; ensuring that accounting and other


statutory concerns are addressed.

· Enterprise; encouraging boards to drive businesses


forward in the long-term interests of the shareholders.

Ensuring good governance


NAPF highlights another element of corporate governance. At the
centre of the issue is the role of the board of directors – direction, control,
ensuring shareholder value.

“It is the board’s responsibility to ensure good governance


and to account to shareholders for their record in this
regard.”

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Global Corporate Strategy Unit 6 – Corporate Governance and Ethics

Bringing together many of the themes raised in the corporate


governance field, the Institute of Directors’ report, Stand ard s fo r the
Bo ard (1995) states that:

The key purpose of the board is to ensure the company’s


prosperity by collectively directing its affairs and meeting
the legitimate interests of the shareholders and other
interested parties.

The report highlights four key tasks for the board:

· Establishing vision, mission and values.


· Setting strategy and structure.
· Delegation to management.
· Exercising responsibility to shareholders and other
interested parties.

All of the elements of the governance debate highlighted above are


reflected in these tasks.

Individual directors must be aware of the role they play in determining


the company’s future and in setting the strategy and structure to meet
desired objectives. They must also be aware of the issues raised under
the guise of corporate governance which, as stated at the beginning, are
many and varied.

However, if the board is to be the guardian of good governance, as


proposed by Hampel, a more appropriate starting point for defining
corporate governance may be the role of the board. Perhaps a new
definition might be:

Corporate governance focuses the board on its key purpose:


to ensure the company’s prosperity by collectively directing
its affairs and meeting the legitimate interests of the
shareholders and other interested parties. It must account to
shareholders for its record in this regard.

This definition implies that, in essence, corporate governance should


highlight the corporate responsibilities of a board of directors, and
distinguish the directors’ role from those of shareholders and managers.

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CASE STUDY: Enron


Here is an article from FT.com on the Enron scandal.

The Board Game


FT.com site; Dec 06, 2002
By Charles W. Calomiris

Enron and other high-profile scandals have highlighted problems with corporate
governance. How can boards be actively encouraged to challenge managers?

Charles W. Calomiris is the Paul M. Montrone Professor of Finance and


Economics at Columbia University’s Graduate School of Business, a Professor
of International and Public Affairs at Columbia’s School of International and
Public Affairs, and Chairman of the Board of Greater Atlantic Financial
Corporation.

Enron and other corporate scandals have crippled market confidence in US


corporate governance. Enron’s deceptive accounting practices were so
convoluted, involved such obvious conflicts of interest with Enron officers, and
occurred on such a scale, that one can only marvel at the failure of the Enron
board and audit committee to detect and prevent such abuse. Its members
failed to perform their primary task, which is to protect the corporation’s
stockholders from abuses by managers.

With the dawn of the modern large-scale corporation in the second industrial
revolution of the late nineteenth century, there came a new potential for
managerial abuse, as corporate stockholding in such large entities became
fragmented and detached from management. Stockholders’ interests were not
automatically aligned with those of managers.

In their 1932 classic on corporate governance, Adolf Berle and Gardiner


Means identified these potential conflicts of interest. In modern parlance,
managers can extract “control rents” – value that does not represent an
appropriate market reward for their actions, but rather the ill-gotten gains
from being able to operate in conflict with stockholders’ objectives. Managers
may redirect funds for themselves and their friends; they may shirk their
duties; or they may prolong their employment against the interests of
shareholders.

The board, as the representative of the stockholders and the source of


managerial authority, is supposed to prevent such abuse. But board actions
depend on individual board members’ skills, diligence and willingness to
oppose management. Without all three ingredients, boards will fall short of
their leadership mandate.

Why did the Enron board fail, and what does that failure tell us about possible
reforms that could improve corporate governance? One idea that has been
popular among some is the need for board “independence”. Independent
board members – that is, board members who are not involved in company

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Global Corporate Strategy Unit 6 – Corporate Governance and Ethics

management – should be able to exert more effective oversight since they are
disinterested parties.

Able, perhaps, but not necessarily willing. Independent board members are
busy people; they are chosen because of their name recognition, not because
they have either the time or the inclination to discipline management, or the
technical knowledge to perform adequate audits. And their very independence
may be compromised if their seat on the board depends on continuing
management support, as it often does.

Enron’s board was almost entirely “independent”, and composed largely of


highly skilled and experienced corporate managers. It included chair Robert
Jaedicke, a professor of accounting and dean of Stanford Business School, and
Wendy Gramm, former Chair of the Commodity Futures Trading
Commission. Yet they and their colleagues seem to have been asleep at the
switch.

Evidence is mixed on the question of whether the independence of directors


improves corporate governance. Recent studies suggest that board
independence may matter, but that effective independence (measured by the
board’s ability to restrain executive compensation) is influenced by a variety of
other board attributes, including the size of the board (smaller is better), the
number of boards on which board members serve (fewer is better), the age of
board members (younger is better), and whether the independent member
was chosen by the chief executive (which reduces effectiveness).

How can we establish a process for selecting and rewarding board members
that will place stockholders’ interests above those of managers? Here,
economics teaches us that incentives are as important as skills. The key to
effective board leadership is establishing a process that selects board members
who have both the ability and the incentive to be dogged pursuers of the
stockholders’ interest. There are three approaches to ensuring such a process
of board selection.

1. Concentration of ownership

First, if board members and managers both own sufficiently large amounts of
stock, the conflict of interest between managers and stockholders may be
largely overcome by the direct incentives of board members to protect their
own wealth. The positions of board members with sufficiently large
stockholdings are secure, and they have strong incentives to discipline
managers to pursue value maximisation.

A 2002 study found that countries with the weakest legal protections for
outsider stockholders also saw the greatest concentration of stock in the
hands of insiders. In both the US and UK, where legal protections are relatively
strong, the median insider ownership share of the largest 150 corporations is 1
per cent. In France and Germany, where legal protections of stockholders are
weak, the proportions are 55 per cent and 61 per cent.

During the first industrial revolution of the early nineteenth century, when the
scale of manufacturing production was relatively small, ownership and

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management were typically closely aligned. Naomi Lamoreaux’s study of the


period shows that industrial insiders also leveraged their equity financing by
using banks that they controlled to sponsor industrial growth. Banks operated
like industrial credit co-operatives for their board members. Because the same
group of people owned and controlled the industrial borrowers and the banks,
interests were closely aligned, and companies and banks, along with their
outside investors, prospered together. Managerial opportunism was
constrained by the direct oversight of investors with a material vested interest
in the value of the company.

But concentration of ownership in the hands of insiders can be very costly,


especially in a modern industrial economy. When owner-managers and
directors hold most or all of their wealth in the stock of one company, they
suffer from extreme lack of diversification. Consequently, they will pay less for
corporate stock and require much higher managerial compensation if they
must hold such an undiversified portfolio, which will limit corporate growth
opportunities.

Also, the supply of billionaires is somewhat limited. If many corporations have


natural economies of scale that warrant global reach, it will be hard to staff all
of them with billionaires. And, those lucky billionaires may lack the skills that
are needed to best guide the corporations. The best managers typically don’t
begin life as billionaires.

Finally, there are enormous social benefits from broad public participation in
stock ownership. Those benefits transcend the obvious social gains from
portfolio diversification, and include the political economy benefits that come
from a broad alignment of interests between large corporations and the public,
which encourages growth-oriented tax and regulatory policies. The booming
“investor class” in the US in recent decades, for example, has restrained
populist impulses in public policy toward corporations, and spurred
constructive reforms of accounting, disclosure and governance regulation.

2. Intermediaries

A second approach to aligning the incentives of board members and


stockholders is to rely on third-party intermediaries to aggregate the voting
power of stockholders and thus provide a formidable counterweight to
incumbent managers. Historically, during the second industrial revolution,
Germany and the US both used this approach to corporate governance,
although its use in the US was much more limited in its scope.

In Germany, nationwide universal banks that combined lending, deposit-taking,


underwriting and trust account management in a novel way were able to
support growing industrial companies. They did so first with credit, financed by
deposits, but, later in the company’s life cycle, by underwriting stock offerings
that were placed in the internal networks of accounts managed by those
universal banks. Through their management of trust accounts, universal banks
retained authority over stockholders’ proxies and thus controlled boards of
directors of their industrial clients.

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Scholars have argued that the relationships between German universal banks
and client companies, and the discipline over management provided by
bankers, permitted industries to access external finance easily and thus grow
rapidly, especially in new product areas that required large minimum efficient
scale of operation (such as electricity generation). Although postwar Germany
has been known for its reliance on debt as the main source of external finance,
that was not true of pre-First World War Germany; in fact, equity finance was
much larger a proportion of industrial funding there than in the US prior to the
First World War.

In the US, banking regulations limited the geographic scope of banks, and
therefore also the scale of banks. Those regulations constrained the role of
banks in financing industrial growth by large-scale corporations during the
second industrial revolution. As the scale and geographic scope of industry
increased, industry outgrew banks, and bankers turned mainly to commercial
finance. Commercial banks were also constrained from participating in
underwriting, not by law prior to 1933, but rather by their small size and
regional isolation, which made it hard for them to operate German-style
networks for the sale of shares or the aggregation of voting rights.

Thus, US-style “finance capitalism” – typified by J.P. Morgan’s famous network


of partners who held seats on various boards of directors – was a very limited
phenomenon reserved for the largest, established companies, which usually
became “Morgan companies” as the result of consolidations of mature
companies, rather than through public underwriting of equity to finance new
investments. Morgan’s role was typically as a reorganiser or a bond, not a
stock, underwriter, and its authority came from the network of influential
stockholders that relied on its advice and corporate governance skills.
Research by Bradford DeLong and others argues that corporate chief
executives who “wore the Morgan collar” wore it proudly and to great effect.
They were better able to finance their growth and to weather financial storms
than their competitors.

Despite its benefits, and even though its role in the economy was quite limited,
J.P. Morgan’s brand of finance capitalism was too much for populist US
sentiment against the concentration of power. Successive acts of legislation
constrained investment bankers’ abilities to establish control through
networks of skilled partners acting as disciplinarian board directors, and forced
the separation of commercial and investment banking.

The role of intermediaries in controlling corporate boards took a third form in


postwar Japan, as part of the keiretsu system, in which a company surrounds
itself with a permanent structure of subsidiaries, banks and suppliers. Main
banks of keiretsus controlled blocks of a client company’s shares, both directly
and through other companies in which they owned interests, and acted as an
effective check on managers. By 1990, many US academics were writing paeans
to the virtue of Japanese corporate governance, praising the high level of
managerial turnover and the fact that bank-sponsored corporate governance
helped companies economise on the costs of external finance.

Yet the postwar history of Germany and the past decade in Japan suggest that
concentrating stockholder influence by means of universal banks and main

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bank-controlled keiretsus may also hinder corporate governance. That is


especially true when banking systems become non-competitive. The managers
of a highly concentrated and non-competitive banking system may collude to
feather their own nests at the expense of both the stockholders and the
managers of client companies.

The role of the Japanese bank system in resisting corporate reform over the
past decade is one case. Another is the change in the role of German banks in
the postwar era. The largest German banks used their network of trust
accounts to engineer mutual control over their own stocks. They control, as a
group, more than 50 per cent of any one large bank’s stock. That lack of
competition may help explain why postwar German banks have played such a
small role in equity underwriting, or in spurring innovation and new industrial
growth, in the postwar era, compared to the role they played prior to the First
World War.

The history of Japanese and German financial systems suggests that financial
system concentration during the later stage of industrialisation may offset the
benefits of corporate discipline that result from the concentration of
stockholder power in those intermediaries during earlier stages of
development. The policy lesson seems to be that vigorous antitrust policy
toward the financial sector should be pursued in order to ensure the
continuing benefits of good corporate governance that concentration of
control through intermediaries permits.

To what extent can intermediaries such as pension funds and mutual funds
substitute for the Morgan collar, the universal bank or the Japanese main bank?
So far, in the US, they have played a limited role. There is some evidence that
institutional investor holdings of stock can improve corporate governance, but
most commentators view these influences as weak and unreliable.

Franklin Edwards and Glenn Hubbard point out that legal impediments limit
the amount of institutional ownership in any one company, and legal and
regulatory risks to fund managers limit their incentives to own concentrated
blocks of shares or to join boards of directors.

Further, fund managers’ incentives to discipline companies may be weak and


regulation of their fee structures discourages shareholder activism. In a perfect
world, the efforts of fund managers to discipline portfolio companies’
managers would be rewarded by their account holders. But regulation
effectively prevents setting mutual fund and pension fund managers’ fees to rise
with profits. Thus, the fund managers’ rewards are small and indirect, confined
to increased asset inflows into funds in response to corporate profits.

Poland is an interesting case of a country that, during privatisation, consciously


designed its network of institutional investors to improve corporate
governance in newly privatised companies. Authorities there saw the
desirability of concentrating some voting power for any portfolio company in
the hands of a small number of intermediaries.

In 1993, Poland created 15 National Investment Funds (NIFs) to own 60 per


cent of the shares in 512 medium- to large-scale enterprises and to help

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oversee the restructuring of those enterprises. Each NIF was given a lead role
(and a 33 per cent stake) in approximately 30 companies. Shares in NIFs were
allocated to the public and traded. Although the privatisation process was
bumpy in Poland, as elsewhere, observers tend to regard its successes as partly
reflecting the positive role of NIF managers in rationalising the restructuring
process.

3. Hostile takeovers

A third approach to disciplining directors and managers is the threat of a


hostile takeover. In the presence of a credible threat, managers know that if
managerial rent seeking gets sufficiently large, it will pay raiders to buy up
shares to unseat them. That, in turn, encourages better corporate governance;
and there is evidence that the hostile takeovers of the 1980s did, in fact,
improve governance in target companies. The social gains from these
takeovers were even larger, as many companies were encouraged to avoid
takeovers by reducing managerial rent extraction.

But recently enacted legal obstacles to takeovers have protected managers and
captive boards of directors from that external discipline. Takeovers were
never easy, even during the 1980s. Acquirers had long been required by law to
announce their intention of purchasing the company through tender offers,
thereby reducing the gain to acquirers of improving corporate efficiency, and
thus discouraging some efficient takeovers.

In the 1980s, in response to many successful takeovers, incumbent managers


developed “poison pills” (corporate charter clauses that dilute the stock of
hostile acquirers), which have succeeded in discouraging hostile takeovers.
Courts in the US have upheld these techniques, while various states’
“stakeholder statutes” have also served to discourage takeovers. In effect, the
broadening of corporate goals makes it impossible to hold managers
accountable to stockholders, or to any other constituency, for that matter.

The alternative means to wrest control from incumbent managers – a proxy


fight – is no more attractive to would-be acquirers, owing to the many
obstacles that boards can use to reduce the chance of success. The most
popular of these is the staggering of board terms, which often limit the number
of board members coming up for re-election at any one time to only a third or
a fourth of the board. Would-be acquirers have to be willing to fight many
proxy battles over many years before being able to take control of the target.

Conclusion

It is unrealistic to expect board members to serve the function of disciplining


management and protecting shareholders’ investments when we have
designed a system that prevents boards from having the incentive to do so. The
central problem limiting the effectiveness of boards, and of corporate
governance more generally, is the lack of political will to place the interests of
stockholders first when considering the rules under which corporate
governance occurs.

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Populist revulsion to concentrations of power, and special interest politics,


have often resulted in the political decision to hobble the financial system as an
instrument for disciplining corporate managers. The first step toward avoiding
future Enrons is deciding that the overriding objective of the board is to
maximise the value of the company. The second step is to enact laws that hold
managers and board members accountable to that objective, and that
encourage the concentration of stock in the hands of those who would ensure
that the voices of stockholders are heard in the boardroom and, if necessary,
in the courtroom.

QUESTION:
1. How do you think the Enron scandal (and indeed Worldcom and
Parmalat) could have been avoided?

CASE STUDY FEEDBACK


Feedback on Question:

The following measures in the US would have helped avoid such a scandal:

1. Tougher regulations; accounting and auditing practices.

2. Better regulatory framework to police corporate activities and detect


fraud early.

3. Enforce personal accountability as a deterrent.

4. Empower intermediaries (e.g. Fund Managers) to probe business


operations (requires legislative change particularly in the US), e.g. to
stop companies exploiting the ‘Delaware’ loophole.

5. Ensure that a certain percentage of the Board are independent,


non-exec directors who themselves will have personal responsibility
(and liabilities).

Some of the above measures (and many more) are receiving attention by the
Securities and Exchange Commisison, New York Stock Exchange, NASDAQ,
Public Company Accounting Oversight Board in the US. Some rules have
already been enacted and others are at the proposal/discussion stage. Details
may be found in the paper ‘The Post Enron Corporate Governance
Environment: Where are We Now? ‘ found on:

http://www.ffhsj.com/cmemos/031017_post_enron.pdf

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Other articles that you will find helpful in this area are:

Benston, G.J. and Hartgraves, A.L. (2002) “Enron: what happened and what we
can learn from it”, Journal of Accounting and Public Policy 21, 105-27.

Himmelberg, C., Hubbard, R.G. and Love, I. (2002) “Investor Protection,


Ownership, and the Cost of Capital”, World Bank Finance, Development
Research Group Working Paper, 2834, April.

Edwards, F. and Hubbard, R.G. (2000) “The growth of institutional stock


ownership: a promise unfulfilled”, Journal of Applied Corporate Finance 13,
92-104.

Baums, T. and Scott, K. (2002) “Taking shareholder protection seriously:


corporate governance in the United States and Germany”, working paper,
Stanford Law School, October.

Business Ethics

What is Business Ethics?


Ethics involves learning what is right or wrong, and then doing the right
thing. However ‘the right thing’ is not straightforward. Most ethical
dilemmas in the workplace do not comprise a simple set of issues,
decisions and choices.

Many ethicists say that there is always a right thing to do based on moral
principle and others believe the right thing to do depends on the
situation. Ultimately it’s up to the individual. Many philosophers
consider ethics to be the ‘science of conduct.’ Ethics includes the
fundamental ground rules by which people live their lives.

Many ethicists consider emerging ethical beliefs to be related to future


legal matters, i.e. what is an ethical guideline today is often later
translated to a law, regulation or rule. Values that guide how we ought
to behave are considered moral values, e.g. respect, honesty, fairness,
responsibility, etc. Statements around how these values are applied are
sometimes called moral or ethical principles.

Business ethics has come to mean various things to various people.


Generally, it’s coming to know what is right or wrong in the workplace,
and doing what’s right. This is in regard to effects of products/services
and in relationships with stakeholders.

Business ethics are critical during times of fundamental change. This is


because there may be no clear moral compass to guide leaders through

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complex dilemmas about what is right or wrong. Attention to ethics in


the workplace sensitises leaders and staff to how they should act. Also,
ethics help ensure that when leaders and managers are struggling in
times of crises and confusion, they retain a strong moral compass.

Many people do not take business ethics seriously saying that business
ethics only states the obvious (“be good,” “don’t lie,” etc.). These
‘principles of the obvious’ disappear during times of stress.

Two Broad Areas of Business Ethics


The two broad areas of business ethics relate to:

1. Managerial mischief.
2. Moral mazes

Madsen and Shafrits, in their book Essentials o f Business Ethics


(Penguin Books, 1990) explain that managerial mischief includes
“illegal, unethical or questionable practices of individual managers or
organisations, as well as the causes of such behaviours and remedies to
eradicate them.”

Moral mazes of management refer to the numerous ethical problems


that managers must deal with on a daily basis, e.g. potential conflicts of
interest, wrongful use of resources, mismanagement of contracts and
agreements, etc.

Business ethics has come to be considered a management discipline,


especially since the birth of the social responsibility movement in the
1960s. In that decade, social awareness movements raised expectations
of businesses to use their massive financial and social influence to
address social problems such as poverty, crime, environmental
protection, equal rights, public health and improving education. An
increasing number of people asserted that because businesses were
making a profit from using our country’s resources, these businesses
owed it to our country to work to improve society. Many researchers,
business schools and managers have recognised this broader definition
and in their planning and operations have replaced the word
“stockholder” with “stakeholder,” meaning to include employees,
customers, suppliers and the wider community.

Organisations have realised that they needed to manage a more positive


image to the public and so the recent discipline of public relations was
born. Organisations realised they needed to better manage their human
resources and so the recent discipline of human resources was born. As
commerce became more complicated and dynamic, organisations
realised they needed more guidance to ensure their dealings supported
the common good and did not harm others — and so business ethics
was born.

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Ethics in the workplace is managed through use of codes of ethics, codes


of conduct, roles of ethicists and ethics committees, policies and
procedures, procedures to resolve ethical dilemmas, ethics training, etc.

Business ethics in the workplace is about prioritising moral values for


the workplace and ensuring behaviours are aligned with those values.
Many people are used to reading or hearing of the moral benefits of
attention to business ethics. However, there are other types of benefits,
as well, such as:

· Attention to business ethics has substantially improved


society.

· Ethics programs help maintain a moral course in


turbulent times.

· Ethics programs cultivate strong teamwork and


productivity.

· Ethics programs support employee growth.


· Ethics programs help ensure that policies are legal.
· Ethics programs help avoid criminal acts “of omission”.
· Ethics programs help manage values associated with
quality management, strategic planning and diversity.

· Ethics programs promote a strong public image.


· Managing ethical values in the workplace legitimises
managerial actions, strengthens the coherence and
balance of the organisation’s culture, improves trust in
relationships between individuals and groups, supports
greater consistency in standards and qualities of
products, and cultivates greater sensitivity to the impact
of the enterprise’s values and messages.

CASE STUDY – Business Learns the Value


of Good Works
Corporate Philanthropy: US Companies Have For Many Years Made
A Connection Between Social Responsibility And The Bottom Line.
Nokia has:
Financial Times; Dec 19, 2000 By Jimmy Burns

When Nokia hosted a media lunch in a small London restaurant last week, the
aim was not to publicise its latest mobile telephones but gently to draw
attention to the time its employees are devoting to schoolchildren in need
around the world.

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Nokia’s Make a Connection campaign, launched this year, is about to make its
presence felt in some UK schools. The Finnish telecommunications company
has entered a global partnership with the International Youth Foundation, to
provide teaching packages to children with learning difficulties, and to offer
volunteers from its own workforce.

The campaign is operating in South Africa, China, Mexico, Brazil and Germany,
as well as in the UK. It is tailored to local needs, with social exclusion and
education the predominant themes.

Projects range from internet-related newspaper schemes among aspiring


young journalists in China to mentoring programmes in East Germany.

Nokia has not ruled out giving employees time off to participate but it has
apparently assured the IYF that hundreds of its employees will use their flexible
working arrangements to take part in the scheme.

“Involvement could range from giving time to organise fundraising events, to


having our engineers help set up websites and CD-Roms,” says David
Stoneham, Nokia UK’s senior communications manager.

Nokia plans to spend £7.5m on the campaign during the next three years and
says it should help up to 1m children and young people. The campaign will not
feature the Nokia brand or free mobile phones, the company insists. But it
raises questions about whether behind it lies a subtle ploy to use good works
to strengthen its market position among the younger generation.

Mr Stoneham puts a different business case for Nokia’s campaign: “We hope
people will see this as a sincere community issue. Sustainable global success
demands respect for our stakeholders – our staff, current and potential, want
to see good citizenship and our investors and customers want us to behave
ethically,” he says.

The US still leads the way in philanthropy, with foundations holding more than
$330bn (£224bn) in assets and contributing more than $20bn annually to
educational, humanitarian and cultural organisations.

Traditionally, Europe has lagged behind the US. This is partly because the state
has tended to play a more central role and partly because the act of giving has
never been regarded as conferring high status.

This may be changing, however, as the European Commission encourages


business to form social partnerships and the UK government implements tax
changes to increase donations.

The notion of corporate citizenship has developed during the past decade in
both the US and Europe as more companies address social accountability,
social auditing, social investment, corporate governance and business ethics.

According to the Institute of Directors, the potential for enhancing corporate


reputation – and, in turn, business competitiveness – is being recognised by
some of the largest UK companies.

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Such an approach is a far cry from that of the corporate citizens of the late 19th
and early 20th centuries, when the personal considerations of the donor,
rather than a cost-benefit analysis, were the main impetus for giving.

According to Jamie Camplin, author of The Rise of the Rich: “Hospitals,


libraries and museums were the main objects: all built in a style that re-affirmed
the principles of conspicuous waste rather than public benefit.”

A survey conducted towards the end of last year by Environics International,


the Toronto-based consultancy group, in co-operation with the Prince of
Wales Business Leaders Forum, highlighted the fact that business is no longer
only about personal aggrandisement or simply making profits.

It found that six out of 10 consumers form impressions of a company based on


broader responsibilities such as labour practices, business ethics, responsibility
to society at large and environmental effects.

Doug Miller, managing director of Environics, says companies are being forced
to market themselves differently in response to changing attitudes and a new
“aspirational agenda”: “We are living in a period of great expectations, with
people expecting to improve the quality of their lives and believing they can get
it all.”

He says businesses have to be seen to be responding to the agenda set by aid


agencies after “black eyes” over issues such as child labour and environmental
disasters.

“I visit 75 boardrooms a year and I can tell you, the members of the board are
living in fear of getting their corporate reputations blown away in two months
on the Internet,” he says.

While Nokia has encountered no negative publicity from its socially


responsible efforts, the same cannot be said for Shell, a company that has
received more than one “black eye” from the media. Last October Anita
Roddick, founder of the Body Shop, attacked Shell’s ethical advertising
campaign. Ms Roddick publicly denounced the “vast gap” between the
company’s humane image and the reality of human rights violations in Nigeria.

For Shell, still smarting from the adverse publicity of the 1995 Brent Spar
fiasco, the effect of this further blow was to make the company even more
determined to project a caring image. In a guide sponsored by the company,
Tim Hollins, head of group social investment, wrote: “The challenge for the
21st Century Company is to bring all the developments in corporate
citizenship together . . . into a coherent framework of practice that makes
good business sense as well as benefiting society.”

In fairness, Shell had committed itself in its Business Principles to sustainable


development well before Ms Roddick’s outburst. It had reorganised and
changed reporting processes in 1997 so that environmental and social
achievements sat alongside financial data in the annual report.

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The group has chosen to continue its high-profile campaign and to risk attacks
by organised pressure groups. Last month, it circulated the latest information
about the activities of the Shell Foundation, a UK-registered charity established
in June with the aim of “supporting efforts worldwide to advance the goal of
sustainable development”.

Yet for aid agencies such as the World Development Movement, much more
has to be done before hardened campaigners can be convinced that
enlightened self-interest is delivering results in a way that truly benefits society.

Barry Coates, director of WDM, feels too many companies fall outside the
new ethical agenda and stand to take advantage of unregulated markets.

“If corporate social responsibility is to prove sustainable in the long term,


governments must meet their responsibilities and regulate to provide an
ethical framework,” he says.

Save the Children recently outlined the measures a socially responsible


company and its suppliers could take to tackle the issue of child labour, which
caused an outcry in the 1990s and dented Nike’s reputation.

The charity recommends in a new report that social responsibility criteria


should be incorporated into management processes and procedures,
specifically into job competences and performance assessments.

But a study last year of 78 FTSE 350 companies and non-quoted companies of
equivalent size, conducted by Arthur Andersen and the London Business
School, showed that one in five companies with a code of ethical conduct had
not issued the code to all its staff and nearly half had failed to make the code
publicly available on request.

According to Mr Miller, some companies worry about taking a bigger


leadership role than governments in the area of social responsibility: “There is
a concern that the high-profile philanthropic approach might backfire and that
the public might begin to look at business [as if it were] the new feudalism.”
Nokia’s discreet lunch last week and its insistence that its marketing of mobile
telephones is kept separate from its social work may be a reflection of this.

Characteristics of a highly ethical organisation


The following points characterise a highly ethical organisation:

· They are at ease interacting with diverse internal and


external stakeholder groups.

· They are obsessed with fairness.

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· Responsibility is individual rather than collective, with


individuals assuming personal responsibility for actions
of the organisation.

· They see their activities in terms of purpose. This purpose


is a way of operating that members of the organisation
highly value. And purpose ties the organisation to its
environment.

· There is a clear vision and picture of integrity throughout


the organisation.

· The vision is owned and embodied by top management.


· The reward system is aligned with the vision of integrity.
· Policies and practices of the organisation are aligned with
the vision; no mixed messages.

· It is understood that every significant management


decision has ethical value dimensions.

CASE STUDY – Nike and the University of


Oregon
The next case study is case study 22, (“Nike and the University of Oregon”) on
Pages 933-940 of your key text, De Wit & Meyer.

Below is the case synopsis:

Case Synopsis

Philipp H. Knight founded Nike’s predecessor company in 1963. The basic


business formula of the company has not changed much since then. Nike is
designing and marketing high quality sports shoes and sports apparel around
the world. It builds its brand appeal through savvy marketing and sophisticated
product R&D. The company has never owned production of the goods it sells,
instead from the very beginning has been importing the products from the
Asian Far East. In 2000, Nike enjoyed 45% global market share, had close to $9
billion of sales and put Knight among the top ten richest individuals in United
States. The company directly employed 20,000 people, but had a workforce of
an estimated half a million labouring for them in 565 contract factories in 46
countries – making it one of the largest private company de facto employers in
the world.

Labour conditions in Nike’s contract factories were not even close to any
labour laws and compensation practices in the industrialised countries, let
alone the US. Work there meant 70-hour workweeks performing hazardous
and/or monotonous routines under abusive supervision and with appalling
equipment. Until the early l990s, Nike never felt that to be its responsibility.

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Ever since the early 19th century in England, industrial development started
with large scale textile factories. Workers there would stay for two to three
years and then either return to the countryside or “graduate” on to higher
value added, more sophisticated factories such as household goods
production, followed by machinery assembly and ultimately followed by
precision machining for high tech goods. This pattern remained remarkably
unchanged over almost two centuries: throughout all times and places of
industrial development, textile factories have served the critical function of
“breaking in” the poor, illiterate and non-urbanised farm surplus workers into
the industrial age. The alternative would usually be starvation in the
countryside. And ever since Charles Dickinson and Emile Zola, this course of
events has always attracted the ire of many whose fortune of life it was to grow
up in the more economically advanced part of society.

Confronted with such a bout of consumer activism supported by American


unions in the early '90s, Nike began to take a few halfhearted measures to
improve standards at its suppliers. But Nike had already become the lightning
rod of a fervent labour practices movement and kept on being pilloried for
being an imperialist profiteer. With the campaigns beginning to have an impact
on Nike, Nike became one of the founding members of the Apparel Industry
Partnership launched by President Clinton, encompassing several textile
companies, unions and humanitarian NGOs. In long drawn negotiations the
ALP attempted to establish industry-wide accountable minimum standards for
supplier factory conditions.

Eventually the differences proved too far to bridge between the members. The
group split into a Fair Labour Association, carried by the textile companies,
espousing a certain set of minimum conditions, and the student-led, union
supported Workers Rights Consortium, who wanted measures to be a lot
more stringent and better controlled. The key stick that the WRC could wield
was to convince universities to purchase their $2.5 billion of sports apparel
(2% of the US textile market) for their varsity teams only from WRC approved
vendors. If WRC was successful it could harm profits at the textile companies,
including Nike quite seriously, because production costs would probably rise
significantly.

In April 2000, a committee comprised of students, professors and


administration of the University of Oregon, voted that UO should join the
WRC for one year, under the condition that WRC would give companies a
voice in its operations. It had been a very difficult decision for the university,
because Phil Knight was alumni of UG and had been a generous benefactor of
his alma mater. He had given more than $ 50 million to the school, and was
about to donate his largest contribution yet for renovating the football
stadium. After the decision of UO, Knight broke off all contact with the
university saying “the bonds of trust have been shredded”. The university had
lost a major source of discretionary income!

Points to Highlight

(extracted from Teaching Note 22, Nike and the University of Oregon, Peer Ederer
and Jaco Lok)

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· The paradox of profitability and responsibility. Nike and University of


Oregon is a typical case where stakeholder interests seem
insolvably squared off against shareholder interests. The nice thing
about the case is that the conflict is suffered by four participants in
equal measure: Nike, University of Oregon, the Asian producers
and the WRC. Each one of them simply cannot afford to run their
business under financial consideration alone anymore, because their
respective customers might break business relations with them as a
result. At the same time, each one of them has only very limited
influence to materially improve the conditions as required by their
customers. Somebody needs to start taking responsibility for the
“non-financial” currencies in which companies trade, but who and
how?

· Shareholder value and stakeholder values perspectives. The case gives


enough information to illuminate the validity and presence of both
perspectives. Note how the perspectives differ, and also how
neither perspective will get very far, if it does not seek to
accomplish a synthesis.

· Use of the stakeholder framework to identify strategic problems and


possible solutions. Depending on one’s own personal bias, reading the
case will quickly lead to a judgement on who is right and who is
wrong. However, assignment of blame will not solve the strategic
problem at hand, which the four main participants have. Employing a
stakeholder analysis will yield a map of the conflicting interests, and
may eventually also lead to resolution.

Questions:
1. Identify the four main protagonists. What are the financial interests of
their owners and/or sponsors?

2. Identify the other stakeholder interests involved, including customers,


employees, suppliers, governments, competitors and any other
stakeholders that you find relevant.

3. What seems to be the core problem behind the fact that 500,000
human individuals are working under such poor conditions, even as
their input to the overall value of the final product is only 4%?
Wouldn’t just a little more to them, say 5% or 6% do tremendous
good to them, while being barely noticeable to the final consumer?

4. Did Nike do enough with supporting FLA to solve its stakeholder


problems? How much does Nike stand to lose, if the issue enters, say,
American presidential elections and trade restrictions are introduced?

5. With 45% global market share, is there an option for Nike to recreate
the industry rules for a better deal to all stakeholders? What might
that option look like?

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CASE STUDY FEEDBACK


Feedback on Question 1:

· Nike. The main interest of Nike’s owners is to maximise Nike’s


financial success in the long run. As margins in the industry are
not particularly high (e.g. around 9% on a pair of Nike Air
Pegasus shoes) Nike has always relied on outsourced
production in Asia where wage rates are low, continuously
shifting production locations within the region to the lowest
cost countries. Nike’s owners did not feel responsible for the
work practices adopted by its suppliers, as exemplified by the
fact that in 1995 a proposal by shareholder activists to review
labour practices by its subcontractors only gathered 3 percent
of the shareholder vote. However, since the mid-90s Nike and
its owners have been forced to recognise that its
responsibilities for the welfare of employees involved in its
supply chain extend beyond the boundaries of the firm itself.
Nike and its owners have come to see that the continuation of
exploitative labour practices in Asia would do severe damage
to its reputation and brand and could eventually harm its
bottom line (if for example universities would boycott its
products). From 1995 onwards, Nike thus became more active
in improving labour practices throughout the supply chain, first
by hiring independent monitors and ending the use of child
labour in Pakistan, and later by raising the minimum age,
achieving higher air quality standards, and improving worker
safety by substituting harmful chemicals and by training
personnel. These efforts were made in the context of Nike’s
participation in the FLA whose “sweatshop-free” service mark
could help convince Nike’s customers that it was indeed a
socially responsible manufacturer. Nike and its owners
however continued to protect their financial bottom-line by
opposing WRC’s demands for paying a living wage instead of
the legally required minimum wage, and by opposing WRC’s
monitoring methods, preferring instead to keep the monitoring
results behind closed doors. Nike’s main owner, Philip H.
Knight, did not shy away from using his financial power over
the University of Oregon to protect these interests.

· Fair Labour Association. The Fair Labour Association (FLA)


originated out of the Apparel Industry Partnership on
Workplace Standards (ALP), which was launched by the
Clinton administration in August 1996, and comprised of 18
organisations, including several leading manufacturers, labour
unions, several human rights, consumer, and shareholder
organisations. ALP’s goal was to ensure anti-sweat conditions
in the industry through certification of participating
manufacturers. However, after agreeing on a Workplace Code

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of Conduct in April 1997 progress slowed as disagreement arose


over the monitoring process and over workers’ rights to bargain
collectively. A subgroup of nine centrist participants including Nike
began meeting separately in an effort to move forward and
announced an agreement on a monitoring system in November
1998, which was quickly endorsed by the Clinton Administration.
They then formed the FLA to oversee compliance with its
Workplace Code of Companies. The FLA was funded by
participating companies and by affiliated colleges and universities,
who both stood to benefit from participation. Manufacturers could
benefit through 3-year FLA certification and institutional buyers,
such as universities, could warrant to their students that the apparel
and athletic gear they used and sold were manufactured according
to fair labour standards. It is clear then that the FLA mainly
represented the (financial) interests of manufacturers and colleges
and universities, which both had to convince their customers that
their products were “sweat free”.

· University of Oregon. The University of Oregon was caught in the


middle between its activist student and staff body on the one hand
and Philip H. Knight as the university’s most important financial
benefactor on the other. Knight had already contributed over $50
million to the school and was considering making his biggest
donation yet to renovate the football stadium. Financially the
University was both dependent on its students as well as its
sponsors, and it is not surprising therefore to see that it tried to
reach a compromise: it would join WRC for one year, conditional
on the consortium’s agreement to give companies a voice in its
operations. Unfortunately for the University this compromise was
not good enough for Knight who spoke of the shredding of the
bonds of trust and stopped his donations to the University. The
University of Oregon subsequently changed its mind and joined the
FLA instead (see ‘What happened after the case?’).

· Workers Rights Consortium. The WRC comprised exclusively of


student activists who felt that the FLA did not go far enough. It
proposed a more independent monitoring system and demanded
that companies pay a living wage, adequate to provide the basic
needs of an average family. Students convinced their universities and
colleges, who were important sports wear buyers and who were
(financially) dependent on their students’ support, to join the WRC
and to fund its operations. WRC did not permit corporations to
join and gave human rights organisations and unions an advisory
role. This union involvement led Knight to accuse the WRC of
supporting the unions’ hidden political agenda, which was to bring
apparel jobs back to the U.S. WRC’s interests, according to Knight,
thus went beyond the mere improvement of labour practices in
Asia.

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Feedback on Question 2:

· Customers. It is clear that many of Nike’s customers, especially


in the U.S., have grown increasingly concerned about its
(ab)use of cheap labour in Asia ever since Nike’s methods
started attracting a lot of negative publicity in the early
nineties. In 1996 ‘bad labour practices’ was the top third
perception of Nike as a company amongst young people aged
13 to 25. Customers do not only expect good value for their
money, but also increasingly expect manufacturers to be
socially responsible. Yet Nike maintained that its sales were
never affected by all the bad publicity. This may be explained
by the fact that Nike sells its products globally, and that the
percentage share of its customer base that would actually be
willing to boycott Nike’s products is very low. After all, how
many teenagers really would choose to forego on the
opportunity to look cool in order to be socially responsible?
Furthermore, who is to say that the alternatives are actually
manufactured under better conditions? Without information
on who is and who is not a socially responsible manufacturer,
customers are likely to even the playing field and continue
buying Nike’s products. In purchasing their goods, Nike’s
customers are likely to continue to be price as well as trend
sensitive, and most of them are unlikely to consider the
company’s labour practices when making the actual purchasing
decision. Only when watching news programs would they feel
temporarily uncomfortable. Only the activist student body,
which represented a significant, but by no means a dominant
share of Nike’s total market, was willing and able to pressure
Nike by threatening a boycott. To protect this market and to
avoid possible repercussions in the rest of its markets, Nike
was forced to act, and changed its practices without needing to
comply fully with the student activists’ demands, because they
did not represent all of its customers.

· Nike‘s own employees. The case does not analyse the situation
from the perspective of Nike’s own employees in the U.S., but
we can imagine that it is not a lot of fun to work for a
company that is widely known to exploit labour in developing
countries. Imagine the number of times Nike employees will
have been forced to justify their company’s actions by their
friends and families during dinner parties and social events at a
time when Nike’s exploitative practices were all over the
news! Although their own work environment may actually be
very satisfactory, we can therefore reasonably assume that it
was in the personal interest of many Nike employees to
oppose their company’s work practices in Asia. Only those
who fully believed in minimising the cost price of Nike’s
products in the face of Nike’s aggressive competitors could be
expected not to buckle under the social pressures in their
private lives.

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· Subcontractor employees. The case makes it clear that although many


of the work conditions in Nike’s subcontractor factories were
indeed appalling, there was no shortage of applicants for the work,
because alternatives would be even worse. In Nike’s Vietnamese
factories, for example, the average annual income for factory
workers was double the national average, despite the wages being
the lowest of all countries where Nike manufactured. Most of the
young, female workers in the Vietnamese factories considered the
jobs to be transitional – a way to earn money for a dowry or to
experience living in a larger city for two or three years.

· Although the employees themselves, unlike the WRC, did not


perceive of the wages as particularly low and therefore chose to
work at Nike’s subcontractors, they were often unaware of the
health risks they were exposed to. Workers in the chemical
sections were thought to have high rates of respiratory illnesses,
choosing not to wear their protective gear because it was too hot
and humid in the plant. Nike was also caught using child labour in
Pakistan and children, of course, can hardly be said to have
voluntarily chosen to work at Nike’s subcontractors. Given these
employee interests it is not surprising that Nike only addressed the
latter practices, raising the minimum age and improving safety
standards. It did not need to raise its pay levels at its
subcontractors, because despite continuing to live in poverty,
employees seemed satisfied with their pay as their alternatives were
worse.

· South Korean and Taiwanese suppliers. When Nike moved from one
location to another, often its Taiwanese and South Korean factory
operators followed, bringing their management expertise with them.
Subcontractors, of course, generally had no choice but to follow
Nike, because they were highly dependent on Nike financially. Nike
used over 500 different suppliers and could easily switch suppliers
who were operating in a highly competitive market across the
whole of South East Asia. Of course, it was in the Taiwanese and
South Korean owners’ interests to maximise the financial returns
from their businesses by deploying low cost, mass production
systems using cheap, manual labour. Ensuring consistent, high output
quality was of crucial importance in maintaining the supply
relationship with Nike. Because of the intense regional competition
between different suppliers with low barriers to entry, suppliers
could not be expected to improve labour practices on their own
accord, if that meant increasing their cost price and thus risking
their relationship with Nike. Both local governments and local
employees welcomed their presence as an important source of jobs.

· Asian governments. Nike’s shoes and other factories made up 5


percent of Vietnam’s total exports alone. As such local Asian
governments were dependent on Nike’s presence in their economy
and were well aware of Nike’s practice to move to the lowest wage
countries if wages became too high. Attracting Foreign Direct

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Investment in the labour intensive textile industry is generally


seen as one of the first and necessary steps in the economic
development of a country, and it can therefore be expected
that local governments would not do anything that would
make it more difficult for manufacturers to set up shop in their
countries. The increase in minimum wages for example, which
the WRC desired, could not be expected to be supported by
local Asian governments as they risked undermining the base
of their efforts to develop their economies by risking to lose
not only textile manufacturers but also other industries that
relied on cheap labour.

· Nike‘s competitors. With a global market share of over 40%


Nike justifiably attracted most of the negative attention. This
meant that many of its competitors could hide behind Nike
and could wait to see whether they could perhaps capitalise on
Nike’s increased vulnerability. Despite being such a dominant
player, Nike could ill afford to raise its cost price unilaterally
by paying higher wages, because of the price sensitivity of many
of the sportswear customers (brand loyalty can quickly fade
when prices are not on par with main competitors). It would,
therefore, be difficult for Nike to transfer the increased cost
price on to higher store prices, which means the increased
wages would have to be paid for by Nike’s shareholders. Since
most shareholders are interested in maximising the returns on
their investments, they are not likely to accept unilateral action
by Nike without being convinced that this made sense from a
long-term business perspective. This is why it was of crucial
importance to Nike that its main competitors would also
support the FLA, so that the increased cost of improved
labour practices would be shared amongst its main
competitors. However, some companies remained opposed to
the FLA’s proposed monitoring system and did not join (e.g.
Warnaco left the FLA, and the AAMA scoffed at the whole
idea of monitoring).

Feedback on Question 3:

The core problem seems to be that the responsibility for improving the plight
of the thousands of workers in developing countries can and is constantly being
shifted from one party to the next. The customer can relieve him or herself of
responsibility by claiming that he/she doesn’t have any real choice and that it
can’t be up to them to know how all the goods that they buy are produced to
ensure that their manufacturers are socially responsible. They should be able
to rely on the manufacturers and on the government to ensure products are
safe and “non sweat shop”. Furthermore, why should they have to pay more
for their product when manufacturers and their retailers make multi-billion
profits? These manufacturers, of course, can point to the pressure they are
under from shareholders to maximise financial returns, and to their
competitors for making it impossible to initiate changes unilaterally in a price
sensitive market. They can also shift the responsibility to the local Asian
governments, claiming that it is their responsibility to ensure that minimum

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wages amount to living wages. These governments, of course, are also in


competition with one another, and know that if they were to unilaterally
increase their minimum wages this could seriously harm their economy,
meaning that their people would be even worse off. Of course, a redistribution
of wealth from richer to poorer nations would do billions of people around the
world a lot of good, without necessarily affecting the living standards of the
richer nations all that much. However, the global capitalist system in which we
live does not provide the clear means to make this possible. The ability for
constituents to shift the responsibility on to other links in the complex chain
makes it very difficult to make even the smallest improvements.

Feedback on Question 4:

By reversing its ‘hands-off attitude towards labour practices deployed by its


subcontractors to a more pro-active stance, actively pushing for better
standards in its industry, Nike has come a long way in solving its stakeholder
problems. It managed to secure the backing of many of the more centrist
participants of the AIL for its FLA proposal, including the U.S. government and
many universities. It can effectively use this backing to defend itself against
continued criticism from activists who believe Nike is not going far enough. It is
also likely that customers, who already did not appear to be overly ready to
change their purchasing behaviour, will be more than happy with the
government backed FLA seal to quiet their conscience, whether WRC agrees
with the FLA label or not.

However, the real damage to Nike’s reputation was done in the 1990s and
cannot be easily reversed. Therefore, for a long time to come, it will therefore
always be relatively easy for activists to attack Nike and gain some popular
support by triggering the old, well-established image of Nike as the abusive
imperialist. Thus, although Nike has probably done enough to appease its most
important customer segments, it should not make the mistake of
underestimating the influence of a relatively small group of activists again, and
should still do as much as possible to prove to them that it is doing everything
that can be reasonably expected of them to improve the livelihoods of its
workers in developing countries.

Nike should also make sure that it continues to receive government backing
for its FLA initiatives. If the unions are successful in pressuring the government
to make it difficult for companies like Nike to rely on cheap foreign labour
through the use of tariffs, then Nike could be severely damaged. In the
American market its competitors may well face the same problems as Nike,
but globally foreign competitors would continue to use cheap labour and could
thus easily out compete Nike.

Feedback on Question 5:

Being such a dominant player in the industry, one could argue that Nike should
have the power to recreate the rules of the industry to improve the plight of all
of the stakeholders involved in the supply chain. However, the bottom line is
that the lives of Nike’s subcontractor employees can only be improved if
profits are distributed differently in which case shareholders of either Nike, its

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retailers and/or its suppliers pay, or if the customer is willing to pay more for
Nike products.

Nike could use its marketing muscle and expertise to try to convince
customers to pay more for “non sweatshop” sportswear. However, it is
questionable whether the Nike branding people would want to explicitly
associate their brand with the way its products are produced. If Nike
nevertheless were to succeed in convincing its customers to pay more without
harming its ‘cool’ brand image, major competitors may not try to undercut the
new higher prices since they could also stand to gain from charging higher
prices. Of course, Nike can’t formally agree with its competitors to raise prices
because that would amount to illegal price collusion. In fact, depending on the
nature and intensity of price competition in the industry, there is no guarantee
that competitors will follow suit, and they may instead choose to capture
market share by selling socially responsible products at the old prices. In this
case, of course, both Nike’s communications campaign and higher
subcontractor prices would have to be paid for by its shareholders. Therefore,
only in the (unfortunately unlikely) case of Nike convincing its customers to
pay more for its products and preventing competitors from undercutting these
prices at the same time, can the situation potentially be improved for all
stakeholders.

Unless, of course, shareholders themselves become more actively involved in


the way their funds are invested. If pension and insurance holders were to
collectively demand their fund trustees to invest in socially responsible
companies even if that means lower returns on their investments, then it
would also allow companies like Nike to improve their practices without
running the risk of financial harm. Of course, no matter how dominant Nike
may be in terms of market share in its own industry, it is in no position
whatsoever to convince individual investors across the country to demand and
pay for more socially responsible investments.

Summary
In this unit we have considered the importance of corporate
governance, and have looked at recent developments in the UK in this
area.

We have also considered business ethics; particularly relating to


managerial mischief and moral mazes. We have seen the importance of
prioritising moral values and aligning behaviour with those values. In
addition to complying with legal requirements there are business
benefits arising from adopting strong business ethics. We have looked
at these benefits, and at what characterises a highly ethical organisation.

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REVIEW ACTIVITY
Consider your own organisation (private or public sector). How do you rate
your organisation’s ethical code of business conduct against the characteristics
identified in the section ‘Characteristics of a highly ethical organisation’? Also
look again at the benefits listed in the section ‘Two broad areas of business
ethics’.

Now consider the following:

1. Does your organisation have a written code of business conduct?

2. Do employees explicitly sign up to the code of business conduct on


joining the organisation?

3. Do they annually renew their commitment (by signature) to the code


of business conduct, and agree to abide by any changes?

4. Are independent escalation, and complaints and grievances


procedures in place?

Where your answers have been negative, what changes can be made? Will this
require a management culture change? Can it be accomplished within the
current organisational structure?

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 7, Chapter 5 Pages 201-224


2. Ref 10, Chapter 10 Pages 374-381

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Unit 7

Managing Complexity

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Explain the usefulness of systems thinking in managing complexity.

· Apply the principles of a systems methodology to a given scenario.

· Assess the validity of the application of chaos theory to


organisations.

· Appreciate the importance of Performance Measurement.

· Apply a contemporary methodology of strategic control.

Introduction
With the tremendous change facing organisations and increasing
complexity of relationships in an organisation, some companies are
beginning to adopt systems thinking in organisational management. It
is playing a role in organisational design, diagnosis and problem
solving.

Systems thinking can help managers look at organisations from a


broader perspective and take a holistic view to help interpret patterns
and events. It models an organisation as a system; an interdependent
network of units forming a unified pattern.

Too often in organisations, management break down complexity by


decomposing the system and dealing with its individual units
separately. Thus, managers have focused on and scrutinised a particular
part of the organisation (perhaps a poorly performing unit) before
moving on to the next unit and so on. System thinking reminds us that
even if units can be ‘perfected’ by themselves this does not imply that
they integrate well together. It encourages managers to diagnose
problems by looking at larger patterns of interaction within the
organisation, and the process interdependencies.

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In this unit we shall look at the role systems analysis has in managing
complexity in organisations. We shall examine the principles of systems
thinking, understand the difference between hard and soft
methodologies, and focus on a contemporary soft system methodology.

Paradox of Control and Chaos


Organisations can be seen as essentially logical hierarchical structures
that can be controlled by a series of performance measures. De Wit
terms it ‘the organisational leadership perspective’ and can be regarded
as the extreme end of a continuum where control is exerted in a
systematic fashion. A contemporary example of this is the Balanced
Scorecard which is outlined in the latter part of this unit.

Alternatively, organisations can be seen as complex human activity


systems that exhibit properties of compliance with complexity theory,
the ideas of which were born in mathematics and science, and have been
applied to organisations. De Wit calls this the ‘organisational dynamics
perspective’ and can be regarded as the opposing end of the control /
chaos continuum.

The ideas generated by the consideration are central to some of the


themes considered in this module. The principles of emergent strategy
are to an extent explained by an understanding of chaos and complexity
(see Unit 2). In addition, an explanation of how a learning organisation
functions (see Unit 8) can be achieved by an understanding of these
principles, as well as an ‘experimental’ view of innovation (see Unit 9).

Key opposing perspectives can be explained by the following table;

Control Chaos

Authoritarian Style Democratic Style

Top Down Bottom Up

Structural Design Self Organisation

Leadership, Vision & Skill Political, Cultural, Learning –


Team Dynamics

Controllable Process Evolutionary Process

Organisation follows strategy Strategy follows organisation

In both perspectives, organisations need to be controlled – therefore


chaos does not imply lack of control, rather an organisation is in a
constant state of flux. The application of complexity theory to
organisations states that simple ‘deterministic rules’ apply, i.e. there is a
clear objective that the organisation (or system) is trying to achieve.

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Understanding these rules enables control and makes the complex


‘simple’.

It can be said that the dynamic of success is ‘chaotic’, i.e. turbulent in


nature. If this is true then long term planning is ineffective (see
Mintzberg) and managers tend to develop strategies to react to
unexpected and unanticipated events. This leads to emergence and
organisational learning.

Systems Thinking

A Brief History
Systems thinking is not a new subject area. It can be traced back to
Aristotle and Plato. However, the 1940s saw the emergence of various
formal systems thinking disciplines such as general systems theory
(GST), systems analysis and systems engineering.

One of the most prominent early pioneers of GST was Ludwig Von
Bertalanffy. He referred to a system’s openness, i.e. the degree to which
a system interacts with its environment, – an open system takes or
receives things from its environment and/or provides things into its
environment. Therefore, there is clear applicability to business in terms
of the recognition of the role of market forces, the supply chain,
intervention by government institutions, etc.

Systems analysis grew simultaneously with systems engineering


throughout the 1950s. Systems analysis as an approach and a
methodology is closely associated with the RAND (Research and
Development) Corporation. It emerged from a post-war contract
between the US Army Air Forces and the Douglas Aircraft Co. The
RAND Corporation, established in 1948, was funded by the Ford
Foundation and several banks. It began as a non-profit advisory
organisation.

Over the 1950s and 1960s RAND influenced systems thinking through
its publications on strategy and methodology in systems analysis.
RAND, in developing its advisory role, expected its clients to take into
account the social issues like welfare economics. However, the
methodology was criticised due to the lack of interest in people by
systems analysts. This may explain some of the reasons why computer
systems analysts took little account of the user during their analysis, as
the computer analysts adopted the RAND style methodology in
ignorance of this original but fundamental omission.

The Operational Research and systems ideas of the 1940s and 1950s
influenced the way engineers tackled their problems and accordingly
there has been increasing reference to “systems engineering”. Systems

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engineers have been involved in the provision of many civilian


applications such as communication, transportation and manufacturing
systems.

Cybernetics is another discipline that developed about the same time


and was defined as “the science of control and communication in the
animal and the machine”. It introduced control systems ideas such as
positive and negative feedback.

ACTIVITY (optional))
As background to this unit it is suggested that you source the following book
Stacey, R.D. (2000) Strategic Management & Organisational Dynamics – The
Challenge of Complexity (3rd Edition) – Published by: Financial Times Prentice
Hall (ISBN 0-273-64212-X), and read the following:

Chapter 8 - pages 155-166

Chapter 11 - pages 255-273

Application in the Business Context


An organisation in itself may be viewed as a system; an interdependent
group of units forming a unified pattern to achieve its business goals
and objectives. A system has inputs, outputs, processes and outcomes. It
can be composed of positive and negative feedback loops. If one of the
units of the system is removed or altered the nature of the entire system
is changed. This theory can be applied to organisations, and systems
thinking is influencing organisational change management.

When a complex network of work units is organised to do some


activities then the result may not provide entirely what was expected.
For example, if a company was benchmarked against its competitors
and the best operational divisions in each were identified and combined
to make a new organisation, there is no guarantee that it would work
any better than the original company. It is quite possible that the new
organisation could perform worse.

Boundaries and Purpose


Systems thinking suggests that a system has a boundary. Defining this
boundary in business can be problematic.

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The business modelled as a system is a “purposeful” system.


“Purposeful” systems include education systems, political systems,
transportation system and communication systems, etc. The purpose of
an education system may be to provide for the development of the
individual, e.g. understanding and analysis of facts, principles and
theories or the application of skills. A political system may provide for
the management of the affairs and resources of a community (local or
national).

Clearly an organisation is “purposeful” with business goals and


objectives. But who sets these goals? For whose purpose and why?
These are some of the issues addressed by contemporary methodologies
when applied to management.

In business the system boundary is often blurred. The complexity of


relationships (supply chain, customer, stakeholders, competitors) and
often multiple roles in relationships add to the blurring. For example,
companies may have employees working in Brussels monitoring the
European Union’s activities. Others may have a good trading
partnership with the main companies in their supply chain, or major
customers, all of which blur the view of the boundary of an
organisation. There may be complexity implicit in investment options.
For example, shareholders of a company may invest in their main
competitors in order to know what they are doing. Yet this company
could be both a competitor and a main supplier or customer.

The Purpose of a System and Synergy


Systems thinkers take a holistic view of the system in question and try to
determine the emergent (the resulting synergy) purpose of the system,
postponing an investigation of its sub-systems.

Systems thinking addresses some of the problems of functional


organisations, and counters the silo phenomenon of departments and
managers working in isolation. It encourages managers to diagnose
problems by looking at the larger patterns of organisational interaction,
rather than examining and ‘fixing’ separate, individual pieces of the
organisation.

As an example, it may be that the sales department of a company is not


working as well as desired. However, focusing solely on the sales
department, ‘tweaking things’ and introducing novel procedures may
not successfully increase its performance. The sales department has
vital dependencies and patterns of interaction with other units and with
its supply chain. Production may not be able to meet the demand, or
warehousing of finished stock may have insufficient space, goods
inward may not be able to deal with the deliveries, or suppliers may be
inadequate in terms of lead time or quantities. To compound this it is
likely to be some combination of these which will ‘emerge’ over time.

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World Views
Systems thinking promotes the expression of different world-views, in
order to enrich information in the problem domain. By ‘World View’ we
mean the particular perspective of an individual on the problem. (We
shall look at World Views in more detail later in this unit). In the
business context, one would identify the different business actors and
elicit their views of the system. So for perspectives on the purpose of the
organisation itself, the following business actors may view the system
from different and sometimes conflicting perspectives. See Table 7.1.

Business Actor View(s)

Manager Profit-making system


Revenue-generation system
Growth-potential system
...

Customer Supply (products & services) system


Value system
...

Supplier Client system

Employee Employment system

Shareholder Profit making system


Growth-potential system
Share value management system

Table 7.1: Business Actors and Worldviews.

The above table of world views is very broad-brush and simplistic. In


reality, capturing the business actor’s world view is not as
straightforward as it may seem. It is sometimes necessary to adopt
formal methodologies (and mapping tools such as UML) to map
individual business actor ideas into their perceived real-world. This is
an iterative process for complex problems. See Figure 7.1

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Perceived
used in
METHODOLOGY
Ideas real world

generates

Figure 7.1: Iterative process for world views.

The Notion of Hierarchy


A system is made up of interacting parts or sub-systems that can be
studied as systems themselves. This is called the notion of hierarchy and
is an advantage for the analyst because the same system's ideas can be
used. Each of these sub-systems will have emergent properties that will
define its purpose. If the purposes of any sub-system conflict with the
purpose of the overall system then the system displays
sub-optimisation or ‘negative’ synergy. A paradox in systems thinking
is that any chosen system cannot be understood without knowing its
emergent characteristics and something about the features of its
sub-systems. Every problem is different and the same solution cannot
always be applied to similar, or even apparently exactly similar,
problems. Systems methodologies investigate each problem critically.

Implications for Business

Sharing views for clarification


The future is a mystery. Individual’ specialisations of marketing,
finance, production, etc., give assurance and confidence about a
“specialist” explanation of the world. Yet each is unsatisfactory in
isolation. Cross-functional meetings, discussions, debates and
dialogues present richer pictures of the problems faced providing a
more broad brush solution than would otherwise be obtained.

How stable is an organisation?


In the context of stability and adaptability, it is necessary to introduce
the concept of a homeostatic system. A homeostatic system is one which
adapts to produce a state of internal equilibrium so it can continue and
progress, i.e. it can adapt in a disturbed environment. An example is a
human being who can walk out of centrally-heated buildings into the

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cold of winter and the body’s metabolism can use up existing calories
converting fats into sugars in order to keep the temperature at around
o
37 C.

Do businesses then have to emulate homeostatic systems? In a tactical


way an organisation already does so. Once aware of a particular entity
in the environment causing turbulence a company finds ways to
measure the effects and take action accordingly. The company tends to
adapt or influence the causes of the turbulence, if known.
Unfortunately, symptoms rather than causes are identified and the
wrong things are measured in total ignorance of what should be
measured. But, unlike the physical problems such as that bull elephant
in the parable, companies are dealing with abstractions, concepts and
expectations which cannot be touched and for which there are poor
measurements.

A homeostatic system reacts to its environment and adapts to “survive”.


This “reactive” approach is not strategic but tactical; strategic ideas are
based on proaction not reaction.

Professor Max Boisot, a leading figure in strategic thinking, states that


there are two assumptions within strategic planning:

1. Environmental data can be captured and processed, and that


action can be taken faster than it changes.
2. Turbulence is only minor fluctuations in an otherwise stable
environment which will hold up to rational analysis. That is to
say, turbulence is “noise” or “interference”, as if somewhere
behind such fluctuations is an unchanging order; some universal,
objective truth.

How stable then is an organisation? If it is a homeostatic system in


dynamic equilibrium with its environment then learning and
adaptation should occur naturally, and keep the organisation in overall
balance. However, this applies, if and only if, the fluctuations are
relatively small or short-lived. There is a cybernetics principle called the
law of requisite variety which says that rate at which a system learns
must match or be better than the rate of change in the system’s
environment.

ACTIVITY
Chaos Theory is another discipline that is being used in organisational
management. The modern notion of chaos describes irregular and highly
complex structures in time and in space that follow deterministic laws and
equations.

Read the following article about the validity of the application of chaos theory
to organisations.

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‘Strategy as order emerging from chaos’, Reading 9.2, p. 500-505 in your key
text, De Wit, B & Meyer, R

Performance Measures
We have noted that if an organisation is a homeostatic system, then it
learns and adapts to environmental changes, thereby keeping the
overall system in balance. In the context of a business, learning and
adaptation will result in adjustments to business outputs such as
strategic plans, policies and operational systems.

In order to decide on appropriate performance measures, it is crucial to


understand the complex relationships of cause and effect, delay,
feedback and so on. From this understanding, key performance drivers
can be identified and a performance measurement strategy devised. The
Balanced Scorecard Approach for measuring performance is
particularly pertinent in this context, and will be examined later in this
unit in the section on Strategic Control.

Corporate planning can also exploit methods such as SWOT analysis to


evaluate corporate performance and the contributions of each
individual unit against defined objectives such as profitability,
market-share, deployment of knowledge assets, etc.

Following performance analysis, if problem areas are identified then the


principles of systems thinking (e.g. openness, eliciting world views,
etc.) can be applied again to the problem domain, and objectives
revised, where appropriate.

Consolidation of Systems Thinking


Early systems thinking did not really address the social issues.
Therefore the early methods are not entirely appropriate in a business
context. These early approaches paid little regard to human activities
and interactions. Their objectives were relatively simple, targeting
systems composed of potential technologies, most of which were
dedicated to a specific task or set of tasks.

Systems with well defined objectives are classed by Checkland as


“hard” systems, whereas those systems whose objectives are difficult to
define or whose end-to-be-achieved cannot be taken as given, are
referred to as “soft” systems. Human activity systems are such soft
systems.

If sub-systems are combined, emergent properties are produced which


add or detract value (called sub-optimality in hard systems thinking

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and negative synergy by some soft systems thinkers) from the purpose
of the whole. If we wish to reduce sub-optimality, or negative synergy,
the sub-systems’ purposes must in some way be congruent with that of
the whole system.

In business one fundamental resource, itself a soft system, is a person.


Individual views or discipline-oriented views are somewhat blinkered
and narrow in scope. The shared view provides a richer picture. If there
is dialogue rather than a missive about the systems purpose; if the
individuals involved in the dialogue participate in the derivation of the
systems purpose, perhaps negative synergy will be reduced, perhaps
the emergent properties of the whole will be value added, providing
creative advantage or positive synergy. As learning or adaptive systems
appear to be of a higher order than others, then the more the people in
the organisation continue learning, the more likely the emergent
purpose of the business will reflect this. If every employee “sees” the
turbulence in a learned way, the more likely, through dialogue, the
company will clarify its position with regard to the turbulence and
progress.

As mentioned earlier, soft systems thinking focuses on human activity


systems. The problem, recognised by Checkland and so many others, is
that each person has his/her own world view or “weltanschauung” of
the problem area and that such views must be shared in an open way in
order that a deeper understanding of the problem can be realised.

Soft Systems Methodology (SSM)


SSM has been developed at Lancaster University over the last 25 years,
through action research. Professor Peter Checkland is the best known
member of the team in the Department of Systems and Information
Management involved. As more experience was gained dealing with
different sorts of problem situations, the learning was analysed and
incorporated into the methodology. This has led to a generic
methodology that can be adapted to any given situation.

SSM deals with problem formulation at the strategic level. It partly aims
to structure previously unstructured situations, rather than to solve
well-structured problems. It deals with “fuzzy” problem situations –
situations where people are viewed not as passive objects, but as active
subjects, where objectives are unclear or where multiple objectives may
exist.

SSM is concerned with human activity systems (HAS). These are


different from natural systems (physical systems), or designed systems
(these can be both physical, such as bridges, and abstract, such as
mathematical). A HAS is defined as a collection of activities, in which
people are purposefully engaged and the relationships between the
activities. The boundary around a system is drawn to encompass that

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group of activities that would give the system some emergent


properties. SSM does not attempt to analyse sections of the whole that
are considered to be particularly relevant to the study, but uses the
concept of the whole being more than the sum of its parts. Therefore,
once the emergent properties are identified, the set of activities required
becomes clear. If just one activity is removed from the system, the
emergent properties are lost.

The Checkland methodology, or the seven-stage model, is considered


by most people to be the SSM. However, SSM covers a range of
methodologies developed to deal with different situations.

The Checkland Methodology

1 6
Problem situation Change and action
unstructured to improve

2 5
Problem situation Real/systems
expressed world comparison
REAL WORLD

SYSTEM WORLD
4
3 Conceptual models
Root definition of
relevant systems

Source: Patching 1990

Figure 7.2: The Checkland Methodology.

The seven stages are:

1. The problem situation unstructured


2. The problems situation expressed
3. Root definitions of relevant systems
4. Deriving conceptual models
5. Comparing conceptual models with the “real” world
6. Defining feasible, desirable changes
7. Taking action

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Stages 1,2,5,6 and 7 can be regarded as working in the real world, while
stages 3 and 4 can be considered to be systems thinking about the real
world. Refer to Figure 7.2.

Let us now consider the various stages:

Stages One and Two


The problem situation can be expressed as a “rich picture”. The idea is to
represent pictorially all the relevant information and relationships. This
is simply to aid the modeller or consultant to gain an understanding of
the situation. The rich picture should not be used as a tool to
communicate with the client. Where there is a team of consultants, the
rich picture is a way of consolidating understanding of the problem
situation. This reduces the possibility of opposing perceptions of the
real world hindering the modelling process later on. The rich picture
will reveal one or more HAS.

Stage Three
“Root definitions” are constructed for the relevant HAS identified in
stages one and two. The root definition should encompass the emergent
properties of the system in question. To define the emergent properties
one needs to consider the mnemonic CATWOE:

C: customer (people affected by the system, beneficiaries or victims);

A: actor (people participating in the system);

T: transformation (the core of the root definition – the transformation


carried out by the system);

W: Weltanschauung (“world view”);

O: ownership (the person(s) with the authority to decide on the future of


the system);

E: environment (the wider system).

The CATWOE mnemonic can be used as a checklist to ensure that the


root definition is complete. Alternatively, the root definition can be
formulated from the components of the CATWOE mnemonic. Either
way, the root definition will be a short paragraph that will contain all the
necessary information to describe the system. Several root definitions
can be constructed for each of the relevant HAS identified. Each root
definition will encompass a different “world view”. Different
individuals will perceive the same event in different ways according to
their view of the world, based on their experiences, personality and
situation. These different views result in inferences being made that are

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not explicit. However, these different views from different individuals


must be appreciated and incorporated where possible.

Stage Four
Each root definition will result in a conceptual model. The conceptual
model identifies the minimum necessary activities for that HAS. In
addition, it represents the relationships between the activities. The
conceptual model must be derived from the root definition alone. It is an
intellectual model and must not be clouded by knowledge of the “real”
world. All of the elements of the CATWOE mnemonic must be included
somewhere in the conceptual model, otherwise the conceptual model is
incomplete. It should not be possible to take out words from the root
definition without affecting the conceptual model.

Stage Five and Six


The conceptual model identifies which activities need to be included in
that particular HAS. It is not concerned with how these activities will be
carried out. The conceptual model will be compared with the real world
to highlight possible changes in the real world. It may be that activities
in the conceptual model do not exist in the real world. This would then
be a recommendation for change. Differences between the two must
never result in a change to the conceptual model. The conceptual model,
if constructed correctly, encompasses all the activities necessary for the
emergent properties of the system. Removal of activities from the
conceptual model would result in those emergent properties being lost.
Conversely, it may be the case that activities appear in the real world
that do not fit into the conceptual model. These activities are either
unnecessary, or are included in the conceptual model in a different
form.

Stage Seven
Recommendations for change will be implemented. It is important to
appreciate that once these changes have been implemented, the
problem situation will be modified. In other words, the process is
cyclical. It is recognised that nothing remains static and that mere
intervention by the consultant will affect the organisation.

ACTIVITY (including case study)


Go to the following website and read the report on SSM by a team from the
University of Calgary:

http://sern.ucalgary.ca/courses/seng/613/F97/grp4/ssmfinal.html

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The article includes details of a case study which Checkland took part in, with
the Shell Group. It led to a major rethink of one of Shell’s Manufacturing
functions in the late 1980s.

SSM Summary
SSM deals with problems of a fuzzy nature where objectives are unclear,
and where there may be several different perceptions of the problem.
Indeed, SSM can be applied where there is simply an area of concern,
where no particular problem has been identified, but where it is felt that
some improvement can be achieved. SSM does not aim to solve the
problems in one fell swoop but to make incremental improvements.

SSM is often used as a front end to a hard methodology. Hard systems


assume that the problem can be clearly defined with an agreed goal and
that a standard format can be applied to reach a solution. SSM
recognises that different individuals will have different perceptions of
the situation and different preferable outcomes. Trying to work through
these differences from the outset will go some way towards ensuring
that the results of the intervention will be acceptable to all parties
concerned. Hard methodologies, where the problem is assumed to be
clearly defined, and where the individuals who will be affected have no
means of involvement in the solution process, often result in resentment
and rejection of the solution.

Using SSM as a front end provides a means for as many individuals who
have an interest in the outcome as possible, to express their perceptions
of the area of concern. These concerns can then be accommodated in the
definition of the problem area, before a hard methodology is applied.
SSM has been used in a variety of organisations ranging from a
company dealing with food products to British Airways. It has been
used to assist in a range of problem situations, such as deriving
recommendations for improvement, reorganisation and role analysis.
Given the flexibility of the methodology, it can be seen that the range of
situations to which SSM can be applied is vast. The only limitations of
SSM are the capability and adaptability to new situations, of the
consultant.

Strategic Control?
Strategic control is the process by which managers monitor the ongoing
activities of an organisation and its members to evaluate whether
activities are being performed efficiently and effectively, and to take
corrective action accordingly. Strategic control is also about keeping
employees motivated, focused on the important problems confronting

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an organisation now and in the future, and working together to find


solutions to improve the corporation’s performance over time.

ACTIVITY
However well managed an organisation may be, for effective strategic control,
it is also necessary from time to time to conduct an assessment of an
organisation’s state of health. This is necessary to identify the organisation’s
strengths and weaknesses and uncover information that may be essential for
the organisation’s strategy.

Read the following article on the web (by David Hussey, Visiting professor,
Nottingham Business School) about an approach to company analysis:

http://www.environmental-expert.com/magazine/wiley/1086-1718/pdf5.pdf

The Balanced Scorecard Approach


Traditionally strategic managers have relied on financial measures of
performance such as profit and return on investment to evaluate
organisational performance. The balanced scorecard approach
recognises that financial information, though important, is not enough
by itself. The building blocks of competitive advantage, need to be
measured. The building blocks of competitive advantage are:

· Efficiency.
· Quality.
· Innovation.
· Responsiveness.

Measuring the above, informs managers of how the organisation is


likely to perform in the future. Whereas a focus purely on financial
information, informs managers of the results of decisions that they have
already taken.

R. S. Kaplan and D. P. Norton were the developers of this approach and


they have described it as such:

‘Think of the balanced scorecard as the dials and indicators


in an airplane cockpit. For the complex task of navigating
and flying an airplane, pilots need detailed information
about many aspects of the flight. They need information on
fuel, airspeed, altitude, destination and other indicators that

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summarise the current and predicted environment. Reliance


on one instrument can be fatal. Similarly, the complexity of
managing an organisation today requires that managers be
able to view performance in several areas simultaneously.’

In the context of the balanced scorecard approach, the building blocks of


competitive advantage are controlled and measured in this way:

1. Efficiency: how efficiently resources are used. There must be a


management control system that allows the measure of
productivity. Efficiency is measured by the level of production
costs, number, grade and rates of human resources used, number
of hours needed to produce a product or deliver service, the cost
of raw materials, etc. It compares the units of input (resources,
raw materials etc) vs. the units of output (e.g. product, services
etc).
2. Quality: Quality is now recognised as a key competitive factor.
Managers must be able to measure quality in the form of the
number of rejects, errors, software bugs, the number of defective
products returned from the customer, product reliability over
time and customer satisfaction. Focusing on and measuring
quality promotes continuous improvements.
3. Innovation: Innovation can be measured by the number of new
products introduced, the time taken to develop the next
generation of new products in comparison with the competition,
and the expense and cost of product development. Successful
innovation occurs when managers create an organisational
setting in which employees are empowered to be creative, and in
which authority is decentralised to employees so that they feel
able to innovate and take risks.
4. Responsiveness to customers: responsiveness can be measured
by the number of repeat customers, the level of on-time delivery
to customers, and level of customer service. Control systems to
allow managers to evaluate how employees interact with
customers can help. Monitoring employees’
performance/behaviour with customers can help identify areas
for education and training. Furthermore, employees who know
their behaviour is being monitored have more incentive to be
helpful and consistent in the way they act towards customers.

The above competitive advantage measures, together with financial


measures such as cash flow, quarterly sales growth, increase in market
share, and return on investment or equity, give a complete picture of
organisational performance.

Based on the complete set of measures in the balanced scorecard,


strategic managers are in a good position to re-evaluate the company’s
mission and goals. They can also take corrective action or exploit new
opportunities by changing the organisation’s strategy and structure –
which is the purpose of strategic control.

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Summary
In this unit we have looked at the role of systems thinking in managing
organisational complexity. We have considered the principles of
systems methodologies, and have looked at its applicability in a
business context. We have noted the differences between hard and soft
methodologies and have examined in detail the Checkland
Methodology.

Finally we looked at strategic control and examined the importance of


performance measurements to judge the health of an organisation, and
focused on a contemporary methodology of strategic control, the
balanced scorecard method.

REVIEW ACTIVITY
Now turn your attention to the organisation you work for and focus on its
culture.

1. From what you have learned, can systems thinking be applied


successfully in your organisation? Elaborate.

2. If your answer to 1 is ‘Yes’,

- What benefits might you achieve? How will you measure


success or failure?

If your answer to 1 is ‘No’,

- Why might it not work?

REVIEW ACTIVITY FEEDBACK


It all depends on the culture of your organisation. If you have a collaboration
culture then the deployment of SSM could be a natural part of organisational
management. If your organisation exhibits a Control Culture (“stick with the
plan!”), it is unlikely to succeed. On the other hand, one could argue that
attempts at deploying SSM in itself could bring about positive change in control
type cultures.

Critics of the system's methodologies express concerns that the open-ended


nature of the methodology makes it difficult to manage and measure success.

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For example, such a methodology does not lend itself to traditional project
management practices. Checkland himself stated that there is no way of telling
whether a SSM project is a success or failure. Most companies will not be able
to justify costly endeavours where there are no clear success criteria.

Another criticism of SSM is that it ignores the issues of power and hierarchy
within an organisation. SSM assumes that managers and employees alike can
openly discuss and influence organisational issues. This is rarely the case in
most organisations. Thus, critics from the business world discard SSM on the
basis that its values of openness and equality are unrealistic in the real world,
and confine systems thinking to academic analysis.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Stacey, R.D. (2000) Strategic Management & Organisational


Dynamics – The Challenge of Complexity (3rd Edition) –
Published by: Financial Times Prentice Hall (ISBN
0-273-64212-X), Chapter 8 – pages 155-166, Chapter 11 – pages
255-273
2. Patching D. (1990) Practical Soft Systems Analysis -ISBN
0-273-03237-2
3. Flood R.L. & Carson E.R. (1993) Dealing With Complexity – An
Introduction to the Theory and Application of Systems Science
(ISBN 0-306-44299-X)
4. Flood R.L. & Jackson M.C (1991) Creative Problem Solving –
Total Systems Intervention (ISBN 0-471-93052-0)

* Highly recommended

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Unit 8

Knowledge Management

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Compare opposing theoretical concepts regarding knowledge in


organisations.

· Understand the principles of knowledge transfer in organisations.

· Appraise the methods available to apply knowledge management


principles.

Introduction
The global business environment is changing rapidly. As organisations
grow in size, complexity and geographical distribution, intellectual
capital is becoming an increasingly important asset of the enterprise. By
managing its knowledge assets astutely, and rapidly deploying
knowledge gained in one geographical area or one industry across
another, corporations can improve their competitiveness, and
adaptability. Re-cycling knowledge know-how is now key to
competitiveness, particularly in the knowledge economy. In some
sectors (e.g. professional services) knowledge management is a matter
of survival.

In practical terms, the focus on knowledge management can be


attributed to two developments. Firstly, capital and labour-intensive
industries in developed economies have continued to decline. Secondly,
the relative importance of technology and information-intensive
industries has increased. Rapid advances in information technology
have enabled companies in even the most traditional industries to
develop sophisticated systems for capturing new sources of information
and disseminating and exploiting this information more effectively.

When defining knowledge management, some emphasise the human


interaction and psychological factors that impact knowledge sharing,
whereas others stress the enabling infrastructure and knowledge
management system. A successful deployment of knowledge
management must recognise that views of knowledge are

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fundamentally human views. People are different from one another,


and exhibit different temperaments. Some of these differences are
profound and influence collaboration and knowledge sharing. Building
intellectual capital is based on the existence of communication channels
between people, on relationships that build trust and a sense of mutual
obligation, and on a common language and context.

Thus, it is vital that organisations foster a collaborative culture for


success. Teamwork over individual excellence should be rewarded.
However, it is equally important that a corporation take a strong
process perspective in establishing knowledge management, and invest
in the appropriate technology to facilitate the process; knowledge
creation, collaboration, sharing and deployment. Enabling technology
is particularly critical for geographically distributed organisations,
where opportunities for face-to-face interaction is limited.

In this unit we shall look at some of the theoretical concepts relating to


knowledge management, examine the principles of knowledge transfer
and then focus on the methods and practical issues relating to
knowledge management.

ACTIVITY
Now, as background to this unit, read the following from your key text, De
Wit, B & Meyer, R

1. Reading 9.3, ‘Building learning organisations’, p 505-512

2. Reading 9.4, ‘The knowledge-doing gap’, p. 512 – 525

Theoretical Concepts on Knowledge


In theoretical terms, two developments have contributed to an
increased emphasis on knowledge in looking at strategic management:

· The popularity of the resource-based view of the


company: This clearly identifies knowledge as potentially
the primary source of sustainable competitive advantage.

· The development of post-modern perspectives on


organisations, which have challenged fundamental
assumptions about the nature and meaning of knowledge
within companies, industries and society as a whole.

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Resource-based view
A resource-based perspective highlights the need for a fit between the
external market context and its internal capabilities. In accordance with
this, a company’s competitive advantage derives from its ability to
assemble and exploit a combination of resources.

Competitive advantage is achieved by developing existing resources


and creating new resources in response to changing market conditions.
Writers like Robert Grant argue that knowledge represents the most
important value-creating asset. The primary function of the company is
to create conditions under which many individuals can integrate
specialist knowledge in order to produce goods and services. The
resource-based view, therefore, suggests that knowledge, like any other
asset, can be stored, measured and moved around an organisation.

Post-modern view
Post-modern perspectives on organisations challenge the
resource-based assumption. Writers like Frank Blackler argue that
knowledge cannot exist in any absolute or objective sense.

The recognition of knowledge and how it is applied is determined by


the social and organisation context in which a company operates. An
innovative proposal, which may be perfectly valid to an external
observer may be rejected by those inside the organisation because it fails
to conform to their mental model of what constitutes valid or useful
knowledge.

If knowledge is a social construct, i.e. it emerges through interaction, it


follows that it cannot be formally managed. Like culture, knowledge
exists only in an abstract form within organisations. Also, it is affected
by managerial action and its nature can change only gradually over
time, through a process of interaction between the various individuals
within the organisation.

There is thus a debate concerning two opposing theoretical


perspectives.

VIRTUAL CAMPUS
Taking into account your own working experience and sphere of activity, do
you support the resource-based view or post-modern view? Debate your
views (relating it to using your work situation) with others on the Virtual
Campus.

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ACTIVITY
Here is a quote from Tony Blair from his speech at the Lord Mayors Banquet,
Guildhall, London. November 1998.

‘The ambition is to turn Britain into the leading knowledge-based


economy in the world. That is our future: a knowledge-based,
creative economy. In global markets, where products can be
made anywhere and shipped anywhere, in which production
technologies can soon be copied, we cannot base our future
prosperity on the traditional building blocks of the old industrial
economy: raw materials, land, machinery, cheap labour. We
must base our competitiveness on distinctive assets which our
competitors cannot imitate – our know-how, creativity and
talent.’

What do you consider to be the assets of your company? Does intellectual


capital (know-how) currently feature as an important asset? Can your working
practices and output turnaround be improved by re-cycling of knowledge (or
better re-cycling of knowledge)? What opportunities does knowledge
management present for your company and what are the barriers to
implementation/wider take-up?

Knowledge

What is knowledge?
In the context of strategic management, it is easier to understand
knowledge in terms of what it is not. It is not data and it is not
information. Data are objective facts. Data becomes information when it
is categorised, analysed, interpreted, summarised and placed in context,
i.e. given relevance and purpose. Information develops into knowledge
when it is used to make comparisons, assess consequences, establish
connections and engage in a dialogue. Knowledge can be seen as
information combined with experience, judgement, intuition and
values.

See Figure 8.1 for a pyramid view on data, information and knowledge.
Knowledge is at the top of the value chain. Data is at the bottom. Data is
essentially meaningless on its own. It is raw data. Reasoning, perception
and interpretation are critical in transforming data into information. In
addition to reasoning, perception and interpretation, decision making
(using experience, judgement, intuition and values) is key to the
transformation of information into knowledge.

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Reasoning
Perception
Interpretation Knowledge
Decision making
Data volumes

Value chain
Reasoning Information
Perception
Interpretation

Data

Figure 8.1: Pyramid view on knowledge, information and data.

One must be careful not to confuse knowledge management systems


with data and information management systems. The latter are merely
efficient mechanisms for capturing, organising and retrieving
information. A true knowledge management system must capture,
organise and retrieve information, but also systematically create
associations between corporate expertise and information resources,
personalise and organise knowledge for individuals and communities,
and provide a ‘place’ (virtual) for teams to work, make decisions and
act.

KEY POINT
Knowledge is the result of deciphering and attaching meaning to facts and
information.

Knowledge management is the capability of an organisation to create, capture,


combine and share knowledge amongst its members. It is the process by which
an organisation generates value by using its intellectual assets.

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The nature of knowledge


An individual’s knowledge base is like an iceberg. Most knowledge is
hidden below the surface and can be divided into two types;

· A limited stock of explicit knowledge, which is easy to


articulate to others, e.g. books read, reports written,
advice given fall into this category.

· The majority is tacit knowledge, which cannot be easily


articulated to others, e.g. A green fingered gardener
cannot explain to a novice precisely why his plants
always thrive.

Tacit knowledge only transfers through observation and practice.


Traditional craft apprenticeships systems recognise this. However,
much knowledge remains tacit because no attempt has been made to
make it explicit. It is this area that presents the greatest opportunity for
knowledge management within organisations.

The primary goal of knowledge management systems is to identify the


valuable knowledge that resides within individuals and disseminate it
throughout the organisation. However, this seemingly straightforward
process is in practice complex and can be fraught with difficulties.

Knowledge problems
Knowledge represents a source of power for an individual. Sharing
valuable knowledge with colleagues is often seen as risking reduction of
value of that individual to the company. There are, thus, psychological
issues relating to knowledge management. Davenport and Prusak
argue there are three conditions under which an individual would agree
to share knowledge.

· Reciprocity: Will an individual receive valuable


knowledge in return, either now or in the future?

· Repute: An individual will need to be certain that the


source of knowledge will be recognised and others will
not claim the credit.

· Altruism (though the motives may be more akin to


self-gratification): Individuals find some subjects
fascinating and want to talk to others about them.

Davenport and Prusak’s analysis leads them to argue that there is in


effect, an internal market for knowledge. Knowledge is exchanged
between buyers and sellers, with reciprocity, repute and altruism
functioning as payment mechanisms. Trust is an essential condition for
the smooth functioning of the market. This trust can exist at an

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individual level, through close working relationships between


colleagues, or at an organisational level, by the creation of a cultural
context which encourages and rewards knowledge sharing and
discourages and penalises knowledge hoarding.

Noting the above issues, for successful deployment of knowledge


management in organisations, the right collaborative culture must be
fostered, the individual contributor of intellectual capital recognised,
and the reward system must reflect a high focus on knowledge sharing.
Leading knowledge-based companies include the contribution of
intellectual capital as part of the employee’s business objectives.

Barriers to understanding
It is easiest to learn about things that we already know. It is very difficult
to learn from an expert if your do not have a basic grounding in the
topic. The expert must take time to explain the context and translate the
jargon. The barriers to communication in organisations that arise
between departments typify this problem. These problems can be
ascribed to differences in the content of the knowledge bases. To
overcome these problems, particularly in larger global organisations
engaged in diverse activities, it is necessary to establish communities of
practice based on the core competencies of the organisation.

Knowledge Transfer
Much can be done within an organisation to encourage knowledge
transfer. IT-based frameworks (e.g. Lotus Knowledge Discovery
System) provide the essential infrastructure for knowledge
management, but to be used effectively and achieve widespread
take-up, other conditions are necessary to establish:

1. Trust – Face-to-face contact is important when seeking to build


strong interpersonal relationships.
2. Time – exchanging information at speed may be efficient, but
tacit knowledge cannot be discovered, articulated and
disseminated in a hurry.
3. Creating a common language for talking about knowledge,
encouraging staff to think and talk about what they know and
what they need to know

The first two points pose particular challenges for large, diverse,
globally dispersed organisations. Establishing communities of practice
(based on core competencies) is critical. Examples of such communities
of practice might be Researchers, Project Managers, Quality
Champions, Programmers, Research Chemists, Marketeers in a
particular geography, etc. The precise communities of practice would

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depend on the sphere of activity of the corporation. It is then essential


that people within communities of practice have the opportunity to
meet and share knowledge, supported by the technical infrastructure,
but also be able to share knowledge which technology cannot at present
capture. Thus knowledge sharing through informal and formal
gatherings, seminars, e-learning initiatives, networking and mentoring
is critical.

In the context of knowledge transfer, it should also be noted that it is not


enough simply to manage existing knowledge. Competitive advantage
is achieved when organisations adapt and evolve continuously in
response to changing market conditions. Knowledge management can
play a key role in this. The competitive edge arises when companies
leverage knowledge, not just existing, but new knowledge across the
global organisation; across horizontal and vertical divides, in a rapid,
efficient and easy-to-use, codified form. Re-use of intellectual capital
across geographies, industries and functions can yield enormous
business benefit.

Nonaka and Takeuchi in their book The Kno w led ge Creating Co m p any,
identify four interrelated processes by which knowledge flows around
the organisation and transmutes into different forms.

1. Socialisation is the process of communicating tacit knowledge to


a broader organisational context. Individuals share experiences,
demonstrate skills and model behaviour in such a way that they
can be observed and copied by others within the organisation.
2. Externalisation is the process of converting tacit knowledge into
explicit concepts, e.g. the simplification of complex concepts in a
highly simplified form using models. Externalisation may occur
at an individual level or at a collective level. Once an individual
has externalised tacit knowledge, it is more easily combined with
the knowledge of others.
3. Combination is the process of analysing, categorising and
integrating the explicit knowledge of a set of individuals in order
to create new explicit knowledge, which can be disseminated
more widely within the organisation.
4. The above processes explain how individual tacit knowledge
flows until it is widely disseminated around the organisation, but
it does not fully explain how new knowledge is created. The final
link in the process is internalisation, whereby individuals absorb
explicit knowledge to enable the development of new forms of
tacit knowledge.

How can knowledge creation be encouraged? Nonaka and Takeuchi


identify five key conditions;

· Senior management must be committed to accumulating,


exploiting and renewing the knowledge base within the

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organisation and be able to create management systems


that will facilitate this process.

· As new ideas first develop at an individual level, an


individual must be given scope to follow initiatives and
explore unexpected opportunities that emerge.

· This process of exploration can be further encouraged by


‘creative chaos’ where flux and crisis cause
reconsideration of established precepts at a fundamental
level.

· Knowledge should not be rationed (or hoarded).


Opportunities should actively be provided for even
unrelated individuals to exchange knowledge.

· In order to respond creatively to changing conditions, an


organisation’s internal diversity must match the variety
and complexity of the external environment.

A drawback is that the knowledge creating company Nonaka and


Takeuchi describe is often far removed from organisational reality, e.g.
chaos and crisis are just as likely to stifle as to promote creativity by
provoking anxiety and insecurity.

ACTIVITY
Identify the types of intellectual capital within your organisation.

ACTIVITY FEEDBACK
Intellectual capital is essentially any intangible asset that has potential for
re-use. The following list gives you an idea of what can be shared.

· Sales proposals.

· Market research.

· Client information.

· Competitor information.

· Contracts.

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· Case studies.

· Methodologies.

· Project plans.

· Client deliverables (with confidentiality safe-guards).

· Interpretation methods.

· White papers.

Practical steps to promote Knowledge


Management
In the previous sections we looked at the key issues relating to
knowledge management – but from a somewhat theoretical
perspective. How do issues of trust, time and common language get
addressed? What practical steps can be taken to implement knowledge
management and leverage the corporation’s intellectual capital?

It is important to emphasis that knowledge management must be at the


heart of a company’s strategy if it is to work. A collaboration culture
must be promoted from the top of the company. Senior executives
should be accountable and rewarded for encouraging knowledge
sharing and knowledge enabling.

Assessment of current capability


Wherever you are in the deployment of knowledge management, it is
important at regular intervals to evaluate your knowledge management
capability, and benchmark against best practices. The company should
then put in place a roadmap to target areas of weakness.

A practical tool for such an assessment is to score your capability using a


knowledge management spider diagram (see Figure 8.2), with the
following dimensions:

1. Company strategy: Score the extent to which knowledge


management is incorporated into strategy and business and
operational plans. Does knowledge management feature in
company-wide strategy or only in specific strategies, e.g.
marketing? Is a strategy in place to address knowledge
management process, issues of culture and technology? Is there

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knowledge collaboration externally – across stakeholders


(customers, supply chain) and business partners (e.g. through
strategic alliances)?
2. Collaboration culture: Company-wide awareness of knowledge
management, and level of integration into the business. Is
collaboration, teamwork and knowledge sharing built into the
ethos of the company? What is the level of senior management
support? Are there senior roles in knowledge management?
3. Knowledge processes: Is there a formal and unambiguous
process for the creation/acquisition, organisation/storage,
distribution, application, maintenance and QA of knowledge
assets? Furthermore, to what extent have knowledge
management practices been incorporated into core business
processes, e.g. when selecting a project management
methodology or developing project plans do Project Managers
re-invent the wheel each time, or does the business process
require them to check the Knowledge Management System first?
4. Enabling Technology: What are the current technologies used
for knowledge sharing? If there is no specialist Knowledge
Management System (e.g. Lotus Knowledge Discover System), do
you have other enabling technologies such as data-warehousing,
business intelligence, data mining, GroupWare and messaging,
electronic data management, workflow management, web-based
technologies in the company? Do you have a corporate intranet?
5. Knowledge Bases: To what extent have knowledge sources
(explicit and tacit) been identified, captured and indexed?
6. Knowledge Access: What level of accessibility is there to the
knowledge sources? How easy is to search for information? What
access rights and security measures are in place?
7. Knowledge Quality: What Quality Assurance procedure are
there in place? Are there reviews and sign-offs prior to
intellectual capital being made ‘public’ on the system? What
procedures are in place to maintain up-to-date and relevant
knowledge? Is knowledge catalogued by business area, and is
there a flag to indicate importance/relevance.

You will note that the dimensions of the Web Diagram are the
knowledge management success factors we identified during the course
of the earlier sections. It is suggested that a company score each of the
dimensions against a 10-point scale. This can be done against best
industry practices, so that a score of ten relates to best practices. A score
of zero will apply if that particular dimension does not feature at all in
the corporation. See Figure 8.2 for an example of a knowledge
management web diagram for a company. From a strategy perspective
it is also useful to score your main competitors on the web diagram and
then identify weaknesses/strengths. Additionally strategic partners can
be scored. It may be the case that where the corporation scores weakly, a

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strategic partner scores highly. There are, therefore, wider collaboration


opportunities across strategic alliances.

10
Company strategy Competitor's
10
KM capability
Collaboration culture

Knowledge quality
0
10 10
Knowledge processes

Knowledge access
10 Corporation's 10
KM capability
Enabling technology

Knowledge bases 10

Figure 8.2: Knowledge Management Web Diagrams.

Road Map for Improvements


Having assessed your current knowledge management capabilities, a
picture emerges of the gaps in access to knowledge, cultural factors and
enabling technology. Based on the gaps identified, particularly in
comparison to best practices and also to the competition, the
organisation can then develop a picture of where it wants to be, and in
what time-scales. A road map should then be prepared to get the
organisation to the desired state. The ‘where you want to be’ state may
also be mapped on the web diagram.

For those organisations relatively immature in the deployment of


knowledge management, the following steps are recommended:

· Identify communities of practice or teams based on core


competencies. For smaller organisations, business units
will suffice as ‘communities’.

· Identify a sponsor (senior executive) for each community,


and nominate leaders for each community.

· Train leaders in generic KM practices (e.g. virtual


teamworking, knowledge creation, sharing).

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· Facilitate socialisation and transitional encounters


(meetings, seminars, workshops, etc) with informal
agenda to allow tacit knowledge to be shared.

· Build, manage and maintain a network of staff with deep


skills in specified subject matters.

· Define the KM process (covering knowledge


creation/acquisition, organisation/storage, distribution,
application, maintenance and QA). Define access
(security, rights) model.

· Evaluate and implement enabling technology.


· Define categories and populate with generic information,
e.g. yellow pages (who is who for what).

· Train all staff in KM process, KM system and knowledge


sharing.

· Raise team awareness of contexts through presentations,


visits, education, etc.

· Use knowledge proponents/developers (experts who


create new content on dedicated, short-term assignments)
in early stages of deployment.

· Promote widespread deployment and publicise early


successes.

· Recognise and reward knowledge contributors.

Ref: The Challenge o f Managing Kno w led ge by Laura Em p so n –


Financial Tim es 4th Octo ber 1999

ACTIVITY
Research the application, impact and business benefits of knowledge
management by reading some of the articles on knowledge management on the
INSEAD website:

http://knowledge.insead.fr/

Go to the home page and select ‘Knowldege Management’ under the menu
‘Themes’. (Registration to the website is free of charge).

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CASE STUDY 1 – Kao Corporation


The next case study is case study 6, (“Kao Corporation”) on pages 721-737 of
your key text, De Wit & Meyer.

Case Synopsis

Kao is Japan’s market leader in detergents and shampoos, and runner up in


disposable diapers and cosmetics. In 2002 the company had sales of Y865 billion
(more than US$ 6.3 billion), largely in Japan and South East Asia. However,
during the 1980s and 1990s Kao has acquired a number of companies in the US
and Europe and has committed itself to further internationalisation. Its strategic
intent is to belong to the three or four global detergent/cosmetics/personal care
companies that they believe will eventually survive.

Kao is particularly interesting due to its corporate philosophy. The company


believes that competitive advantage stems from the superior attainment and
usage of information. Therefore information must flow freely throughout the
organisation and all individuals must be equipped to continually learn from the
information obtained. This concept of a “learning organisation” is achieved by
having a very flat organisational structure, an open, non-hierarchical culture,
broad participation in strategy development, extensive information systems
and a state of mind that emphasises that learning is an essential never-ending
process. The strategy process can be characterised as continual, largely
informal, participatory, flexible and incremental.

The key question raised by the case is how this strategy process and the
company’s learning ability can be maintained as they further internationalise.
The company will grow in size and complexity, while more nationalities will
become involved in strategy development. The company must learn how to
remain a learning company.

Point to Highlight:

(extracted from Teaching Note 6, Kao Corporation, Bob de Wit, Ron Meyer and
Henk van den Berg)

Note this case touches on subjects wider than just knowledge management,
and the learning organisation. It also touches on the area of strategy formation
and globalisation (linking with Units 1, 2 and 3).

Used in conjunction with chapter 3 of your key text, De Wit and Meyer, this
case can be used to understand the following key points:

· The building of a learning organisation. This case describes the


manner in which Kao has been able to transform itself into a
learning organisation. The company’s structure, culture,
leadership and systems are described, giving insight into the
circumstances that are necessary to create an organisation

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capable of continual learning. (link to Reading 3.2, Quinn, and


Reading 9.3, Senge, of your key text, De Wit and Meyer)

· The role of leadership in a learning organisation. Of particular interest


in the Kao case is the role of the CEO, Dr. Maruta. He does not
play the traditional role of master planner and architect of
implementation (Commander Approach or Change Approach). On
the contrary, he creates the circumstances under which ideas and
strategies can arise and grow within the organisation (Crescive
Approach). Maruta’s leadership style demonstrates the influence of
leadership on learning. More broadly, the impact of various
leadership approaches on the strategy formation process can be
explored. (link to Reading 3.2, Quinn, and Reading 9.3, Senge, of
your key text, De Wit and Meyer)

· Learning as part of the strategy formation process. Kao’s focus on


learning is an integral part of their thinking about how to manage
the strategy formation process. This case illudes to the link between
learning and strategy formation.

· Advantages and disadvantages of the incrementalist perspective. Kao’s


strategy formation approach is strongly inclined towards the
incrementalist perspective. This case highlights the strengths and
weaknesses of incrementalist approaches to strategy formation.
(Link to all readings.)

Questions:
1. What is learning and what is a learning organisation according to Kao?
How is organisational learning different from, for instance, a person
learning from reading a book?

2. How has Kao been able to build a learning organisation? What is their
corporate philosophy and what type of structure, culture, systems and
leadership roles has the company developed to become a learning
organisation?

3. How does Kao go about forming strategy? What are the strategy
formation process’s main features?

4. What are the advantages and disadvantages of Kao’s current strategy


formation process?

5. How would Kao need to adapt or change its strategy formation


process to accommodate further internationalisation? What type of
action would you recommend? (You may also wish to refer to Unit 3,
Globalisation, before responding to this question)

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CASE STUDY FEEDBACK


Feedback on Question 1:

At Kao learning is simply defined as gaining a better understanding of the truth.


More specifically, it is believed that organisational learning has the following
characteristics:

· Continual. Learning does not take place at fixed moments, but


is viewed as “a frame of mind, a daily matter.” In this way,
every activity can lead to further learning.

· Collective. Learning is not an activity that an employee carries


out individually behind a desk, but a process that takes place
through open discussions and the investigation of concrete
business ideas. In Kao, everyone within the organisation is
expected to participate in this joint learning process, helping
not only himself to learn, but also all others, whether above
and below him.

· Intuitive. Learning is also viewed as largely intuitive – by doing


and discussing, managers often unknowingly internalise
knowledge (the Zen Buddhists speak of kangyo ichijo,
internalised intuition). This places an important emphasis on
the development of tacit knowledge over the attainment of
formalised/codified knowledge.

Hence, a learning organisation is simply an organisation in which the process of


daily, collective and largely intuitive learning is well developed. A person
reading an article differs on all three counts. Reading an article is not continual,
but incidental learning; it is not collective, but individual learning; and it is not
intuitive, but largely formalised learning. In other words, reading an article is a
long way off from organisational learning, although it can be an ingredient of the
process.

Feedback on Question 2:

Building a learning organisation is not a matter of changing the organisational


structure or tinkering with the incentive system. In isolation these actions will
not result in a learning organisation, although they could be elements of a more
encompassing effort to build up a company’s learning ability. To really become
a learning organisation, Kao has taken systematic action on a number of fronts.

Mission setting. Most importantly, the company truly believes in the importance
of learning. Dr. Maruta, the president of Kao, states that Kao is “an educational
institution in which everyone is a potential teacher.” All employees, including
Maruta himself, are seen as students of the truth, continually seeking new
insights and better understanding. It is the company’s fundamental assumption
that such learning, drawn from scarce information, is the ultimate source of

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competitive advantage and therefore needs to be carefully nurtured: “The


company that develops a monopoly on information, and has the ability to learn
from it continuously, is the company that will win, irrespective of its business.

Organisational culture. Linked to this underlying philosophy is an organisational


culture that reinforces the importance of information, knowledge and its
acquisition through learning. To facilitate the daily, organisation-wide, and
largely intuitive learning that Kao believes is essential; the company’s culture
emphasises a number of principles:

· Equality. Kao rejects authoritarianism, believing that collective


learning can only take place in an organisation where people discuss
matters on an equal footing. Interaction and the spread of ideas
require that opinions are judged on their own merits, independent
of rank and therefore the principle of equality is central to Kao’s
culture.

· Openness. Joint learning also requires the free flow of information


and ideas. Therefore, Kao’s culture emphasises that every employee
should have full access to all information and that all discussions
should be held out in the open, where everyone is free to hear what
is said and to participate, if needed.

· Mutual assistance. Organisational learning also requires individuals


and departments to take an active interest in each other’s problems
and development. If each individual or department tries to optimise
only its own learning, everyone loses, because there is no
cross-fertilisation. Therefore, mutual assistance is stressed as a key
principle.

· Individual initiative. Although the organisation must learn together,


ideas are born and knowledge is spread by initiatives taken by
individuals. Therefore, the collective nature of organisational
learning requires a strong cultural emphasis on the good of
individual initiatives. By providing individuals and teams some degree
of autonomy, Kao can use the energy of intrapreneurs to stay
innovative and competitive.

· Pro-activeness. Finally, it is a commonly held view within Kao that


learning should not be solely based on previous experience. As
Maruta puts it, “past wisdom must not be a constraint, but something to
be challenged. Yesterday’s success formula is often today’s obsolete
dogma.” The emphasis is rather on what has been learnt today that
can be useful tomorrow (link to the discussion on mental models in
chapter 2).

In short, the values and beliefs held by managers within Kao regarding learning
are very strong and are a main factor in shaping Kao as a learning organisation.
However, this culture is further reinforced by other organisational elements.

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Organisational structure. To allow for the equality, openness, mutual assistance,


individual initiative and proactiveness mentioned above, Kao has designed a
very flat organisational structure, without significant boundaries or titles.
There is relatively little hierarchy and not a strict separation of tasks – the
organisation functions fluidly and flexibly, with various parts interacting and
assisting each other where necessary, which Kao refers to as “biological self
control”.

Information systems. As horizontally shared information is essential to Kao’s


organisational learning, the company has placed a strong emphasis on
developing information systems so that the most up to date information is
available to all members of the organisation. Everyone has access to the
Logistics Information System (ordering, inventory, production and sales data)
and the Market Intelligence System (market research, sales, and marketing
data). Further information exchanges and networking opportunities are
created through regular R&D conferences and through the open physical
layout of the Kao building.

Leadership roles. Finally, the way that top managers define their roles within the
company has a significant impact on Kao’s learning ability. As Senge (reading
9.3) argues, leaders cannot learn on behalf of their organisations, but must
assist their organisations to learn. Senge identifies three critical roles of
leadership in a learning organisation, each of which is also applicable to Kao:

· Leader as designer. Leaders must understand that learning


cannot be commanded, but that a “social architecture” must
be created that will support organisational learning. In Kao, the
company leaders have designed the needed organisational
structure and systems, and have fostered the essential
organisational culture.

· Leader as teacher. Leaders should not be authoritarian experts,


but must coach, guide and facilitate everyone in the
organisation. In Kao this is exactly the case – Dr. Maruta does
not push one vision of reality, but aids employees in coming up
with their own ideas.

Leader as steward. Most fundamentally, leaders should not be motivated by a


desire for power, but by their desire to serve other people and the
organisation, so that these can function optimally. Here too, it seems that Kao
fits the mould. Maruta seems very much a “servant leader,” who creates trust
and commitment by his unselfish desire to serve others and the organisation as
a whole.

Feedback on Question 3:

The remark about Kao’s joint venture with Colgate-Palmolive on page 733
really gets to the essence of Kao’s strategy process: The way the two firms
decided on strategy was totally different. We [Kao] constantly adjust our
strategy flexibly. They [Colgate-Palmolive] never start without a concrete and
fixed strategy. We could not wait for them. In other words,

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Colgate-Palmolive’s approach to strategy formation was inspired by the


planning perspective, while Kao approach was much more in line with the
incrementalist perspective.

When examined more closely, Kao’s strategy formation process can be seen
to have the following characteristics:

· Creating issue awareness. Within the open and participatory culture


of Kao, it is every person's responsibility to identify the critical
issues to which the organisation must respond and to bring these
issues to the attention (agenda setting) of all relevant colleagues
(link to chapter 2). In other words, the definition of threats and
opportunities, and the focusing of organisational attention take place
continuously, informally, horizontally and intuitively. There are no
formalised, periodic procedures using rational analytical techniques
to ensure that issue identification takes place, nor is it a task
assigned to only a small number of senior managers.

· Developing ideas and legitimising new viewpoints. Once issues or


problems have been identified, clusters of affected or interested
individuals form around them (see 9.2, Stacey). Using the energy of
intrapreneurs one can develop new and innovative ideas. If groups
are formed, these people may meet formally or informally to
exchange information and jointly develop ideas on how to proceed.
At this stage there will not yet be any fixed proposals, so that
discussions can be truly open, without any individual defending a
predetermined point of view.

· Obtaining contributions, consensus, credibility and commitment. As the


ideas developing in these small groups become increasingly clear,
they are shared more widely. The prevailing principle at Kao is
referred to as ‘tataki-dai’; “present your ideas to others at 80
percent completion” so that others can criticise and contribute to
them before they become a proposal. Not only does this enhance
the quality of the idea, but also it helps to create ‘zoawase’ – a
common perspective or view. This is also the point at which higher
management levels are involved. They too can contribute to the
evolving ideas and by their participation lend weight and credibility
to the plans. As consensus emerges in this fashion, all of the
participants in this strategy formation process also become
increasingly committed to making the strategy a success.

· Implementation, systematic learning and reformulation. None of Kao’s


managers believes that the strategy formation process is over once
the initial plans have been formulated (option selection). A first set of
plans is merely a snapshot in the learning process – as an issue grew
into an idea, which grew into a proposal, which grew into a plan, so
the strategy should continue to grow as the knowledge and wisdom
of the organisation continue to expand. Hence, no one expects the
plans to be fully implemented as formulated. On the contrary,
everyone is focused on obtaining feedback information that can lead

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to learning and can be used to adapt and further develop the


strategy.

· The role of vision. A common vision about the organisation’s


purpose, identity and strategic intent is both the outcome and
the guiding principle in the above process. In other words,
Kao’s vision is not static or top-down, but is developed in the
same incremental manner as described above. However, at the
same time, Kao’s vision is less variable than its strategies and
thus acts as a guiding principle in the incremental strategy
formation process. The company’s vision helps managers to
focus on the right issues, and points managers in certain
directions where they should seek solutions and new
opportunities. In short, the company vision helps to determine
the pattern in the stream of organisational actions.

These points underscore that incrementalism and learning are two sides of the
same coin. When looking at incrementalism, the focus is on the strategy
development process – how organisations continually and gradually create
patterns in their streams of decisions and actions. The two are wrapped up in
one another, proceeding in unison. When looking at learning, the focus is on
the competence development process – how organisations continually and
gradually obtain information and increase their knowledge and abilities.

Feedback on Question 4:

The advantages of Kao’s current strategy formation process have become


quite clear from the discussion above. Their strategy formation process is
flexible, adaptive, and open to learning, which is particularly important in
unpredictable environments. High participation and a crescive approach by top
management led to more bottom-up information and ideas, the continual
improvement of proposals, and broad understanding and commitment
throughout the organisation.

The case writers are particularly kind toward the company and do not mention
any disadvantages encountered by using this approach. However, based on the
readings in Chapter 3, of your key text, De Wit and Meyer, the following
potential disadvantages can be identified:

Disadvantages of ‘finding out". Learning and incrementalism are based on the


principle of feedback – the results of current activities are used to adapt future
activities. Feedback is also referred to as output- or error-driven, because
learning is based on past successes and mistakes (we refer to this as ‘finding
out’). The alternative is feed forward, whereby future activities are based on
forecasts and estimates. Feed forward is also referred to as input- or
forecast-driven, because estimates are made of what will likely happen (we
therefore speak of ‘figuring out’). The most common problems of feedback are
inefficiency and the danger of irreparable mistakes. Learning by trial and error
can often be time- and resource-consuming compared to thinking things
through in advance. Furthermore, some “errors” cannot be repaired. By trying
out something in the market a company can damage its name or make
investments that cannot be recovered. The main problem of feed forward, on

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the other hand, is that many things cannot be forecast or thought out in
advance. Kao seems to be trying to combine both feedback and feed forward
to get the best possible results. However, the threat of inefficiency and
irreparable damage remains.

· Threat of strategic drift. Companies that employ an incremental


approach to strategy formation run the risk of making adjustments
that are not radical enough. Because Kao has a strong bias toward
incremental action (get started and learn as you go along), they
might find it more difficult to formulate and execute far-reaching
plans, such as takeovers, large capital investments or shifts in
technologies. The case, however, does not suggest that this is a
problem.

· Threat of slower decision making. Above, it was argued that trial and
error learning might be time-consuming. To this it can be added that
the participatory decision-making system and need for consensus
can also be relatively slow. Especially in circumstances where the
speed of decision-making is essential (a crisis or a sudden
opportunity), Kao might be at a disadvantage. In general, however, it
should be recognised that the length of the decision-making process
(“time-to-decision”) is usually less important than the length of the
total decision and implementation process (“time-to-results”).
Slower decision-making might be more than compensated by
quicker implementation. Investing time during the decision-making
process to produce high quality plans that are widely understood
and enjoy broad acceptance often facilitates rapid action, making the
total amount of time spent from issue identification, through
diagnosis, to conceiving and realising less than in other firms.

· Threat of political infighting. An inherent threat of flat organisations


with widespread participation is (as everyone at a university knows)
political infighting (link to 3.3 Allison). The wide variety of opinions
and the diffusion of power can easily lead to confrontational political
processes, without a clear-cut source of authority to resolve
disputes. Kao seems to avoid these problems by a strong,
homogeneous, cooperation-oriented corporate culture and a shared
strategic intent.

· Difficult to internationalise. As the company internationalises, keeping


up the shared culture and strategic intent will be increasingly
difficult. The organisation will be larger, made up of more
nationalities and divided by larger physical distances. There will be
fewer informal contacts and differences of interests are likely to
grow. Openness, trust and commitment will be difficult to maintain
under these circumstances. If ideas need to be surfaced and
consensus needs to grow between people at scattered locations
around the world, the ease of interaction is likely to decrease, while
decision-making time is likely to increase. Furthermore, the threat
of political infighting is likely to grow as well.

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· Difficult to integrate acquisitions. The very particular attitude


toward learning and the strategy formation process at Kao
makes it very difficult for other organisational cultures to be
integrated into the Kao system. At corporations with highly
formalised strategic planning systems, companies that are
acquired need to adapt themselves to a number of procedures
and regulations governing the strategy process. The often-used
metaphor is that of a new “part” that must be slotted into the
organisational “machinery”. At Kao, however, learning and
strategy formation have not been formalised into policies and
procedures that can be easily transferred to an acquired
company. The Kao way of doing things has grown out of a
philosophy and is engrained in the beliefs, informal rules and
tacit organisational routines prevalent throughout the
company. Dr. Maruta’s own metaphor is that of an organism.
Taking this metaphor one step further, it can be questioned
whether a foreign body can be made compatible, or will be
rejected if implantation is attempted. In other words, how can
managers at the acquired firms be integrated into the Kao way
of learning and strategy formation if their culture is radically
different? The more exceptional Kao’s culture, the more
difficult it will be to absorb foreign cultures into the
organisation (link to 6.3 Haspeslagh and Jemison).

Feedback on Question 5:

This is a difficult question, particularly as it goes a step further than the


literature provided. You may have come up with a broad range of suggestions
at this stage, varying from the obvious to the profound. The following are
particularly pertinent:

· A Japanese or transnational company? Kao seems to believe in


the transnational corporation judging by its vision that
“headquarters’ functions would be dispersed to SE Asia, the
US and Europe, leaving the Tokyo headquarters the role of
supporting regionally based, locally managed operations by
giving strategic assistance.” Compared to the current situation
this would require a significant amount of decentralisation and
growth of an international management cadre. The question is
whether this can be achieved without destroying Kao’s unique
learning capability. As mentioned above, Kao’s learning
organisation is currently dependent on mutual trust, openness,
understanding and involvement. These are maintained by a
common culture, interdependence, parallel interests and
frequent informal contacts – attributes that are more typical of
a medium-sized firm, based in one location, with a
homogeneous culture. Will a bigger company, with more
foreigners, spread all over the world not frustrate the
company’s ability to learn? Shouldn’t Kao remain a Japanese
company with foreign interests, with the headquarters in
Tokyo remaining as the focus of its learning activities? Should

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Kao develop a diverse group of global managers from a variety of


national backgrounds, or rely on a core group of Japanese expatriate
managers that relate each foreign operation to Tokyo headquarters?

· A formal or informal company? Kao must also wonder whether its lack
of hierarchy (the “paperweight organisation”), lack of organisational
boundaries (“biological self-control”) and lack of formalised
procedures all remain possible as the organisation grows both in
volume and geographically. How can communication be as frequent
and as informal as within the Tokyo headquarters? How can control
be exerted over subsidiaries far away from the centre? Can this be
achieved “informally” or are systems and procedure necessary to
ensure that the foreign subsidiaries remain a part of the larger
learning organisation?

· An acquiring or organically growing company? As mentioned in the


answer to question 4, transferring Kao’s learning capability to a
company that has been acquired is terribly difficult. Yet, both in
Europe and in the United States, Kao has staged major acquisitions
as an important part of its foreign market entry strategy. The
question is whether the benefits of these takeovers (instant market
share, existing brand names, local management and market
knowledge) really offset the costs (cultural incompatibility, difficulty
to share learning, difficulty to transfer learning capability). Shouldn’t
Kao take the longer and rougher road of organic growth, if this
eventually leads to the leveraging of Kao’s learning capability? (link
to Reading 6.3, Haspeslagh and Jemison)

CASE STUDY 2 – Developing New


Knowledge at Nike
Developing New Knowledge at Nike

When Phil Knight founded Nike with $500 in 1964, he would have had little
credibility if he had defined his purpose as being to build the world’s largest
sportswear company. Yet this is what the company had become by the late
1990s. This case examines the foundations of the company’s growth, especially
the knowledge developed and retained within the company over the years.

Early learning years

Back in 1958, Phil Knight was a middle distance runner in the University of
Oregon’s track team. He complained on number of occasions to his coach, Bill
Bowerman, about the lack of good US running shoes. But he continued to
study accountancy, eventually graduating and moving to teaching in his home

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town of Portland, Oregon. Then in 1964, both he and Bowerman each put up
$250 to found the Nike shoe company, named after the Greek goddess of
victory.

To start the company, Knight used his athletics contacts to sell running shoes
from a station wagon at track and field events. He bought the shoes from Japan
but always felt that there was potential for a US designed shoe. By the early
1970s, Knight was working on his new design ideas. At the same time as
exploring these, demand for Nike shoes was sufficient for him to consider
developing his own shoe manufacture. However, he was concerned to use
Japanese experience of shoe production. In 1972, he placed his first contract in
Japan to begin shoe manufacture to a Nike all-American design.

Over the next couple of years, the yen moved up against the dollar and
Japanese labour costs continued to rise. This made Japanese shoe production
more expensive. In addition, Nike itself was gaining more experience of
international manufacture and making more contacts with more overseas
manufacturers. In order to cut production costs, Nike switched its operations
in 1975 from Japan to two newly industrialised nations, Korea and Taiwan,
whose wage costs were exceptionally low at that time. Nike’s costs came
down dramatically, allowing the company more scope for funding further
product development and marketing.

In sourcing production internationally from low wage countries, Nike’s


approach to shoe manufacture was revolutionary for its time. The company
realised that sports shoe manufacture required substantial labour input, so
labour costs were potentially high and justified manufacture in countries where
workers were paid much lower wages. However, there were real risks in
manufacturing overseas because the greater geographical distance and
different national cultures made it more difficult to control production and
quality. Thus, the company only switched contracts for large scale production
when it could be sure that a new manufacturing contractor was able to meet its
quality standards. In this context, the company had to learn how to handle
overseas production, how to brief manufacturers on new designs and models,
and how to set and maintain quality standards.

The decade of difficulty and renewal: The 1980s

By the early 1980s, Nike was profitable and continued its role as a specialist US
sports shoe manufacturer with no production facilities in its home country.
Then along came competition in the form of a new sports shoe manufacturer,
Reebok. From a start up company in 1981, Reebok went into battle against
Nike under its founder and chief executive, Paul Fireman. Reebok launched a
strong and well designed range of sports shoes with great success. By the mid
1980s, Reebok had equalled Nike’s annual sales in a fierce competitive battle.
In 1987, Reebok was clear market leader with sales of $991 million and a
market share of 30%, compared with Nike’s sales of $597 million and a share of
18%.

Part of the problem and opportunity for both manufacturers was the fickle and
design-conscious nature of the target market: young, hip teenagers and adults
buy the latest fashions. Both Nike and Reebok realised that, in order to build

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volume, it was necessary to move from the specialist sports shoe market to
wider adoption by this much larger, fashion aware teenage and young adult
market. This was the battleground that was initially captured by Reebok with
good products and a campaign of public relations that was highly disrespectful
of Nike. Mr. Fireman criticised Phil Knight as being ‘just a shoe guy’ who saw
himself as ‘a big time presence in sports’. In response, Mr. Knight said that he
‘hated’ his competitor and that the ‘most innovative piece of R&D equipment
they have is the copy machine’. One author of a book on Nike commented that
‘Paul Fireman was installed as a devil figure inside Nike and he remains a dark
presence to this day’.

To hit back against Reebok, Nike then began to invest considerable sums on
developing new and innovative sport shoe designs. The most successful of
these was begun in the late 1980s, the Nike Air shoe. ‘It was an intuitively
simple technology to understand’ said John Horan, publisher of Sports Goods
Intelligence, a US industry newsletter. ‘It’s obvious to consumers that if you put
an airbag under the foot, it will cushion it.’ But it was not until 1990 that the
Nike Air shoe was launched and began to deliver success for Nike. Thus the
1980s were both the decade of difficulty and the time for renewal. Nike had
learned about the heat of competition and the need for innovation and
continual R&D in its shoe designs.

The new heights of the 1990s

Coupling the new Nike Air


shoe with advertising
featuring Michael Jordan was
a touch of marketing
inspiration. The US
basketball star, top of his
chosen sport, was signed up
to promote the new
product in a
multimillion-dollar deal that
added a new dimension to
sports sponsorship. The
marketing campaign
developed links between
Nike and Jordan’s athletic
ability and image. Reebok hit
back with its own design, the Reebok Pump shoe, but it was forced to use
Shaquille O’Neal, a major basketball star but second to Michael Jordan. Thus
around the turn of the decade, Nike’s market share rose from 25% in 1989 to
28% in 1990 while Reebok’s share dropped from 24% to 21%.

Building on this success, Nike realised that such promotion provided powerful
support for the brand. Over the next few years, this was enhanced by the
heavy funds Nike was prepared to invest. For example, in 1995 Nike invested
almost US$1 billion in sports marketing compared with Reebok’s spending at
around US$400 million. This investment in sports marketing was much higher
than previous sums. It was developed after Nike had assessed the results of its
heavy advertising campaigns earlier in the 1990s.

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Nike’s sponsorship knowledge

Subsequent sports sponsorship deals included the golf star Tiger Woods and,
for a previously unheard-of sum, the whole Brazilian football team. By signing a
ten-year deal in 1996 worth between US$200 and 400 million, Nike broke new
ground in football sponsorship. It bought the television rights for five friendly
games each year involving the Brazilian national team. Also, Nike’s ‘swoosh’
logo appeared around the world in many televised golf tournaments, and in the
televised final of the 1998 Football World Cup and in the year 2000 Sydney
Olympics with Brazilian footballers.

But it was not just the amount of money invested in campaigns at Nike. The
branding and the message were also important. During the 1980s and 1990s,
the company had come to understand its target market well – young, cool and
competitive teenagers. The ‘swoosh’ logo was highlighted on all its goods to
help brand the product and the main message, ‘just do it’, was developed to
express the individuality of the target group. The accompanying slogan of
‘winning your own way’ captured the aggression, competition and individual
success epitomised by the sports stars who were signed up. Its products were
sold at high prices, e.g. over US$100 for sports shoes. Such prices led to a
concerted campaign in the USA aimed at forcing Nike to pay higher wages to
workers in the foreign factories of its suppliers. Although the company was
sympathetic, Mr. Knight was unwilling to give way.

Following its success with the Air shoe, Nike also embarked on a programme
of further and extensive product development. In one year alone, some 300
new designs were launched into the US market. The company claimed that
such scientific development was a major part of its success: new materials, new
fabrics and new designs were developed. But it is also likely that Nike came to
realise that its target group craved new products that would appear more
innovative than the models of previous years. The implication was that it had to
bring out new models even if the innovative content was more a surface design
than a substantive change. Nike was not alone in this approach which was
typical of many companies bringing out variations on models in order to
capture the fashion desires of customers.

During the 1990s, the levels of Nike research activity, its marketing support, its
clarity in its targeting to teenagers and the breadth of Nike’s coverage were all
totally new in sports shoe activity. Nike’s market share in the USA continued
to climb. It reached 43% in 1996, compared with Reebok’s 16%. Moreover,
Nike had succeeded in growing the US market with sales alone exceeding
US$3 billion (compared to US$597 million in 1987). However, Nike was
criticised for its use of cheap labour in some countries and was forced to take
steps to deal with this.

The new millennium: the year 2000

Throughout the 1990s, Nike continued to develop rapidly in two further,


related activities. It had been expanding its international sales for some time
and these continued to grow rapidly. In addition, it was developing the Nike
brand into non-shoe activities such as clothing and sports equipment. By 1996,
Nike’s total sales were US$9 billion and it was the biggest sports goods

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manufacturer in the world, although the company had suffered a setback as


sports shoes gave way to brown shoes as fashion items for teenagers in the late
1990s. In addition, the Asian economic downturn had hit the company hard
and there was heavy overstocking of its products in the US retail trade.

Profits were well down and painful job cuts were necessary, but the company
was still optimistic about the future. Phil Knight had become the chairman and
Mr. Tom Clarke had taken over as chief executive. Mr. Clarke was quite clear:

You grow a lot, then you need a period when things aren’t booming to ask
what works and what doesn’t...... Remember, we’re a fairly self-critical bunch.
We’re running the company for the long-term, not to keep people happy for
the next couple of quarters.

Nike had developed such a deep knowledge of sports items, clothing and
branding that it was expecting to weather the storm and remain the largest in
the world.

Questions:
1. What knowledge has Nike acquired over the years? Use the
definitions of knowledge to help you move beyond the obvious.

2. What other resources beyond knowledge does the company possess


that offer clear sustainable competitive advantage?

3. From a consideration of this case, what conclusions can you draw on


the emergent purpose of Nike in relation to its knowledge?

Source – Corporate Strategy by Lynch 2nd Edition, p475 – 478

CASE STUDY FEEDBACK


The case traces the company’s development from its origins as a small,
specialist sports shoe company to the largest sportwear operation in the
world. It begins by making the key point that it would have been unrealistic for
Nike to have defined its purpose at its inception in 1964 in a way that would
have captured its market position in 1999.

Feedback on Question 1:

Explicit knowledge will include:

· Shoe and sportswear technical design and performance.

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· Shoe and sportswear fashion design and development.

· Ability to negotiate and place manufacturing contracts with


companies outside the USA.

· Ability to manage such manufacturing contracts in terms of


quality of product, control of costs, time to market, stock
handling and transport.

· Marketing and selling to retail stores globally.

· Ability to negotiate with the representatives of major sports


stars.

· Understanding of the target customer groups and their


motives for purchase.

Tacit knowledge will include many of the less formal, unrecorded aspects of
many of the above areas:

· Experience of which combinations of technical characteristics


will produce technically superior performance, which may be
difficult to measure precisely.

· Contacts with individual fashion designers and other individuals


that have been particularly fruitful in terms of creating new
market trends.

· Knowledge of which manufacturing suppliers are particularly


reliable and which individual managers within such companies
are crucial to product quality and costs.

· Experience of which countries, workers and governments have


proved especially helpful and co-operative in placing
manufacturing contracts.

· Worldwide knowledge of different sports goods retailing,


contacts with individual retail shop buyers and knowledge of
their methods of operating.

· Experience of how to handle various sports stars and their


agents: this alone must be highly valuable!

· Knowledge and experience of individual advertising agencies,


market research companies and other marketing suppliers.

The over-riding point is the interaction of the different forms of knowledge


creation and transfer (in accordance with Nonaka & Takeuchi), e.g. the
conversion of tacit knowledge (design ideas originating in the first instance
from Philip Knight) into explicit knowledge (creation of production drawings).

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In other words, externalisation of ideas onto drawings. Link forward to


innovation (Unit 9) where designers are encouraged to work together to be
creative (socialisation processes to create more tacit knowledge).

Feedback on Question 2:

Other resources that are important to Nike include:

· Its ‘swish’ logo and brand name.

· Its contracts with sports stars like the Brazilian football team.

· Its reputation as a leading supplier of sportswear.

· Its network of contacts in global sports goods retailing: architecture.

· Its innovative ability to generate new marketing concepts and drive


forward the sports goods business.

These all add up to resources that move beyond knowledge, yet provide
sustainable competitive advantage. Knowledge is not the only form of advantage.

Feedback on Question 3:

There are three main conclusions:

· Purpose develops over time: the opening comments to this case


make the point clearly about Nike’s purpose in 1964 and 1999.

· Purpose needs to be seen in the context of the resources of an


organisation: Nike’s purpose in becoming the leading world sports
goods manufacturer only had some meaning when the company
already had some record of success in its home country.

· Purpose may not capture the full potential of an organisation if it is


confined to specific and well-defined objectives: it needs to be
allowed to emerge over time. If Nike had defined its early purpose
in terms of profits and shareholder wealth, it might have restricted
its growth to more limited objectives.

Summary
In this module we have looked at the vital role knowledge management
can play in today’s knowledge economy. We have noted that in some
sectors, re-use of intellectual capital is no longer a case of gaining
competitive advantage, but survival.

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We have examined what knowledge is, and have noted the differences
between explicit and tacit knowledge. We have looked at the theoretical
perspectives, the socialisation and technology issues, and the challenges
posed to organisations. We have concluded by considering some
practical steps in the implementation of KM.

Students are encouraged to apply the lessons learnt to their own work
context, and consider how their organisations can better exploit
intellectual capital to gain competitive advantage.

REVIEW ACTIVITY
Consider the following scenario. You have been asked by your company’s
board to rate your knowledge management capability against your chief
competitor and present your proposals for a realistic improvement plan.

1. Carry out a realistic assessment of your knowledge management


capabilities. To do this, consult colleagues across different business
areas and at different levels in the organisation. Prepare a Knowledge
Management web diagram (as per Figure 8.2).

2. Identify the likely position of your main competitor on the web


diagram.

3. Now identify areas where significant improvements can be made


(within a 6-month period), and how they can be achieved. Identify the
business benefits that are likely to arise from the improvement plan.

4. Prepare your presentation (no more than 15 charts).

(Students are encouraged to present this information to their


manager/colleagues, and elicit their comments.)

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 10*, Chapter 11 Pages 390-398


2. Ref 4*, Chapter 9 Pages 196-228
3. Ref 12, Chapter 8 Pages 141-155, Chapter 9 Pages 167-196,
Chapter 10 Pages 197-227

* Highly recommended

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Unit 9

Innovation

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Examine how established companies can manage disruptive


technologies.

· Analyse the relationship between innovation and establishing a


‘learning’ culture.

· Understand the importance of maintaining strategic flexibility.

Introduction
The ability to rapidly assimilate powerful new/emerging technologies
and processes into products/services is now an important competitive
factor in the global environment. However, disruptive technologies
pose particular problems and challenges for the established
corporations. When faced with disruptive technologies, management
teams in blue-chip companies frequently respond by vacillation, and
hide behind internal research, extensive pilot studies, lengthy internal
assessments and so on. They frequently hire external consultants to give
them the ‘answers’. They are so geared with managing continuous
innovation within established technologies, that they cannot cope with
revolutionary, new technologies.

Over the last decade, innovation has gathered increasing pace, and
significant venture capital has flown into start-ups. In this environment,
new technologies are continually emerging; some have powerful
business potential and many do not. How can established companies
discover powerful disruptive technologies more quickly, and evaluate
them more accurately? What are the problems faced by established
organisations, and what steps can organisations take to be more
responsive to innovative technologies? In this unit we shall look at some
of these issues.

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Unit 9 – Innovation Global Corporate Strategy

Innovation strategies
Disruptive innovations, spawned by developments in emerging
technologies, e.g. grid computing, wireless, genomics, nanotechnology,
have the potential to consume industries and make existing strategies
obsolete. Conventional wisdom says that large established companies
are likely to lose out to smaller attackers when they try exploiting these
breakthroughs. Why should incumbents (large established companies)
encounter so much difficulty? Companies such as GE, Intel and
Microsoft have embraced disruptive innovations. What can we learn
from them?

Established companies control substantial resources: established


infrastructure and processes, scale and scope, valuable brand names
and entrenched relationships. They can spend heavily on technology
development and market research, although most of this money is
devoted to evolutionary innovations that make their current offerings
perform better in ways their customers already value.

For all their advantages, incumbents are often impotent when it comes
to disruptive innovations. Their size slows them down and past
commitments restrict their flexibility. Equity markets expect continued
growth in earnings while start-ups are valued for their prospects and
rewarded with large market capitalisation they can use to fund
innovation. Incumbents are disadvantaged by their structures,
capabilities and outlook. Their finely honed instincts, established ways
of thinking and embedded skills make it tough to deal with a disruptive
innovation that requires a different approach.

Many of these problems are caused by;

· Technological uncertainties.
· Ambiguous customer signals.
· Immature competitive structures of markets for
disruptive innovations.

ACTIVITY
As background to this unit, read about the dimensions and paths of industry
development, the drivers and inhibitors of development, and how companies
can adopt an industry leadership position.

Read p. 421-436 of your key text, De Wit, B & Meyer, R .

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Global Corporate Strategy Unit 9 – Innovation

Innovation and established companies


Disruptive innovations, posing a threat to their existing capabilities,
make established companies prone to stick with what is familiar for too
long. Even if this is avoided, incumbents are often unwilling to make a
strong commitment to innovative technologies, and find it difficult to
persist in the face of uncertainty and adversity.

More recently, and particularly in the high-tech world, executives in


many established and ‘innovative’ companies have come to the
realisation that you don’t have to be an innovator to be innovative. They
take the view that the little guys (start-ups) can do all the hard work
with someone else’s investment (venture capital), and the someone else
can also bear the risk of failure (and a large percentage of start-ups are
failures). If the start-up shows market potential (and timing is all
critical) and their deliverables represent a key source of competitive
advantage or threaten your business, then you acquire the start-up or
co-opt them. This strategy is one adopted by many large corporations.
Despite their large investment in R&D, large companies, including
Microsoft, IBM and Cisco, have acquired many start-ups for precisely
this reason.

Problems for established companies


Whether established companies innovate organically or by acquisition
or by a combination of both (as is often the case), disruptive technologies
pose threats for established companies. A pro-active stance by the
management team is required to counter the threats and overcome the
particular challenges faced by incumbents. Dangers occur at different
points in the decision process and require different remedies.

Let us now look at some of the problems:

Problem 1: Delay
When faced with uncertainty, it is tempting to wait. A watching brief
may be assigned to an internal team that monitors families of
technologies. Whether there is any value in these moves depends on
whether there is anyone who can see beyond the imperfections of the
first costly version, e.g. early electronic watches were bulky. It is natural
to underestimate developing technologies or new approaches because
they don’t measure up to the familiar alternative, or appear suitable
only for narrow applications. Other developments may be easy to
dismiss on the grounds that their small markets will not meet the
growth needs of large companies. Yet all large markets were once in an
embryonic state with their origins in limited applications.

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Problem 2: Sticking with the familiar


Choice of technology is often clouded by uncertainty about whether
technical hurdles can be overcome and which standard will prevail.
When there are competing choices, companies are likely to base their
decision on the technology path that feels most familiar. Established
companies typically search in areas close to their current expertise, and
may not have the capability to appraise the options properly. Their
instincts may be to seek a proprietary position to lock in customers,
because that worked in their core market. Such a move makes customers
suspicious, especially in an open systems environment. Open systems is
increasingly becoming an important factor in many sectors, and
particularly in the IT sector.

ACTIVITY
Microsoft currently dominates the desktop operating systems market.
However, more recently there has been a rise in focus on open systems.
Customers are demanding ‘plug and play’ interoperability across different
vendor applications, and see open systems as delivering this choice. They view
themselves as being ‘locked in’ by proprietary Microsoft systems/applications.
This development has led to the rise of Linux as an open operating system.
Linux itself was developed by a Swedish engineer as a hobby project, and was
itself a disruptive technology.

How is Microsoft responding to the challenge of Linux? Research this area.

What options does Microsoft have to safeguard its dominance?

ACTIVITY FEEDBACK
Broadly, Microsoft has four options:

1. Do nothing.

2. Actively oppose and push proprietary technology as the ‘de facto’


standard.

3. ‘Embrace’ and swamp; pay ‘lip service’ to standards, steer open


standards to their own flavour and implement.

4. Genuinely embrace open standards, and get ahead of the competition


quickly.

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Global Corporate Strategy Unit 9 – Innovation

Problem 3: Reluctance to commit


Established companies seldom commit wholeheartedly to a disruptive
innovation. Instead, they are more likely to enter in stages. Many
reasons explain this;

· Managers are concerned about changing profitable


products or encountering resistance from channel
partners.

· Prospects may appear less attractive than current


business, making it difficult to justify investments, e.g.
Encyclopaedia Britannica was slow to move to CD-Rom
and lost 70 per cent of its revenue between 1990 and 1997.

· A study showed that, of 27 companies confronted with a


threatening technology, only four entered aggressively
and three never participated at all. Managers are focused
on existing customers and new technologies may seem
applicable only to small market segments they don’t
serve or understand. This makes them vulnerable to
outsiders who use disruptive innovation as their
platform.

· Successful organisations are not naturally ambidextrous,


so they cannot balance the demands of familiar markets
with the alien requirements of a disruptive innovation.

These explanations reinforce each other to impair decision-making,


erode enthusiasm and cause managers to hesitate. Such issues do not
inhibit new entrants.

Problem 4: Lack of persistence


Established companies being held to earnings forecasts have little
patience with adverse results, e.g. when US newspaper giant
Knight-Ridder’s early forays into television in 1978 and cable in 1983
met setbacks, the company sold the business. Success may require
patience. However, missed forecasts and dashed hopes are inevitable
with disruptive innovation. Demand may not materialise as expected,
competitors may crowd into the market or the technology may veer in
an unexpected direction. Initial enthusiasm may be replaced with
scepticism about the innovation becoming profitable. The result is that
companies often withdraw from early probes and don’t come back until
the innovation is proven by others. At this point it is too late to achieve
leadership.

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Problem Avoidance
Whilst awareness of the pitfalls described in the previous section can
help avoidance, the best defence is a good offence. There are four
approaches:

· Widen peripheral vision.


· Create a learning culture.
· Stay flexible strategically.
· Provide organisational autonomy.

The above are ingredients from which an approach can be fashioned.


Let us look at each in turn:

Widen peripheral vision


Disruptive innovations often signal their arrival long before they
happen. Some signs may be clear to those who look; others can only be
seen by the prepared mind. As the philosopher Kant noted, ‘we can only
see what we are prepared to see’. Weak signals usually come from the
periphery or boundary, where previously unknown competitors are
making inroads, unfamiliar customers are early adopters and different
standards are emerging. But the periphery is ‘noisy’, with numerous
related technologies that may or may not be relevant. Background noise
to one company may be a strong signal to another.

The first step in deciding which signals and trends to scan is to define
the significant technologies. This requires shifting the focus from the
characteristics of products to features that provide benefits, e.g.
customers did not want X-rays as such, but they did need more accurate
images of tissues and bones to help spot problems. Companies also can
study users who are ‘ahead of the curve’ to see the promise of a new
technology, or work jointly with lead users on the next generation of
products.

Once features are defined, how well the innovation can deliver features
that meet customer needs and budgets, relative to competing
technologies must be assessed. The relationship between performance
and development expenditure is an S-curve, i.e. initially, there is little
sign of progress, but then performance rises steeply for relatively little
effort before levelling off.

Then, the challenge is to estimate the rate of adoption and potential


market size. When it is not yet apparent who customers will be and even
early users have yet to experience the product, such estimates are
difficult. Traditional market research is seldom applicable to embryonic
markets. Sample surveys, etc. are designed for well-defined problems in
existing markets. A different approach is needed when the concept is

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ill-formed, the technology is barely ready and questions of cost,


availability, and performance are unresolved. Customers may not know
whether they want a new product, but they can assess how much more
they value its benefits relative to present offerings.

Xerox’s strategy for estimating the potential market for fax machines in
the 1970s illustrates how customer benefits and functionality can be
used to estimate markets. Managers measured the extent and frequency
of urgent written messages, their time sensitivity and the form and size
of the message. Then they contrasted the promise of fax with mail,
telephone, express delivery and so on. With this approach, Xerox
foresaw a business market of a million units.

Choosing how to assess the market for a disruptive innovation should


be guided by three principles.

1. Paint the big picture: This is not the time to ask for carefully
calibrated results. The issue is simply whether the market is big
enough to support development.
2. Use multiple methods: While any one market research method
will be limited or flawed in some respect, a combination may
yield conclusions that are directionally sound.
3. Focus on needs not products: prospective customers may not be
able to visualise radical products, but they can be eloquent about
their problems and changing needs.

Build a learning culture


The challenge is collective, not just individual. Without learning, noisy
information flowing from the periphery will create confusion, not
insight. Information must be absorbed, communicated and intensively
discussed so its implications are understood. The organisation must
possess or acquire several attributes:

· Openness to diverse views, within and across


departments.

· Willingness to challenge deep-seated assumptions.


· A climate that encourages experimentation and rewards
“well-intentioned” failure.

Entrenched attitudes may impede thinking needed to grasp


discontinuities and surprises. Changing is not easy because attitudes
are grounded in experience, reinforced by commitments and protected
by inertia. Before prevailing thinking can be challenged, it should be
described by making the views and assumptions of managers clear.
Scenario planning can help challenge deep-rooted mentalities.

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Adapting to the vagaries of disruptive innovations requires experiment


and an openness to learning from failures. Sometimes experiment
requires a willingness to create diverse solutions, by endorsing parallel
development activities, e.g. Shell is developing renewable energy
sources.

It may also mean introducing prototypes into a market segment.


Learning from this quickly is vital, followed by modifying the product,
and trying again in a process of successive approximation, e.g. Motorola
and the cellular phone market.

VIRTUAL CAMPUS
1. If this has not already been done, post on the Virtual Campus a short
resume of the type of organisation you work for. Public or private
sector? Large, medium or small? Sector (e.g. services, manufacturing)?

2. Once all the resumes have been posted on the Virtual Campus, pair
yourself with a partner. Choose a partner who works for an
organisation which, you believe, has a very different learning culture
from yours.

3. Now describe your organisation’s learning culture, in the context of


innovation, to your partner (in no more than 1000 words max.).

4. Get your partner to identify the strengths and weaknesses of your


learning culture in relation to emerging innovative technologies.

5. Learn from each other. Identify what improvements can be made to


your own organisation’s learning culture based on this exercise.

Maintain strategic flexibility


A paradox of disruptive innovation is that although it is prudent to
make limited investments, sometimes a strong commitment leads to
success. One way to reduce this dilemma is to increase organisational
flexibility, so lowering the cost of making a commitment and the cost of
reversing direction. Commitment might seem to be the opposite of
flexibility. However, only when the commitment is irreversible,
flexibility is destroyed.

Microsoft is a prime example of a company maintaining flexibility. In


1988 Apple was at its peak with its superior graphical interface for the
Macintosh making Microsoft’s DOS look a poor second. However,
Microsoft was operating on several fronts. On the one hand, it was
developing Windows; on another, it was developing OS/2 with IBM. At

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the same time, Microsoft was introducing application software,


including Excel and Word, for both Windows and Macintosh.

Microsoft had developed a strong hand of cards to play in a variety of


worlds that might emerge. In hindsight, its portfolio of options was
commensurate with the uncertainties then surrounding hardware and
software development. Questions of standards, features, channels and
delivery modes (PCs versus servers) were still to be settled. In addition
to developing a robust hand, Microsoft developed a culture that could
quickly change strategy.

Provide organisational autonomy


A strategy to avoid the problems faced by large incumbents is to hive off
the disruptive business into a separate unit. The more the initiative can
operate from a smaller, entrepreneurial mindset, the less it will be held
back by the inertia, controls, risk-avoidance and big-company thinking
that leads to the pitfalls discussed above. By isolating, the company
protects the new venture from these issues.

Many large companies set up separate unit dedicated to new ideas, e.g.
GM’s Saturn division, IBM’s PC unit. The objective of separating the
new business is to enable the new group to do things differently while
still permitting the transfer of resources and ideas from the parent. This
also permits separate objectives, recognition of long development cycles
and continuing cash drains, as well as different criteria so the
performance of managers in the rest of the organisation is not
jeopardised. Above all, it creates flexibility.

There are many degrees of separation. Some companies take the


approach as far as to create ‘spin-offs’. These may be complete
companies with their own stock, board and management teams, in
which the parent retains some ownership. This approach offers access to
capital (via a public stock offering), strategic value from the corporate
centre, operating independence, development of executive talent in
smaller units and greater motivation for key personnel through stock
options and operating freedom.

For example, Kodak’s experience with electronic imaging highlights the


strategic importance of separation (in whatever form). Originally,
electronic imaging activities were dispersed among Kodak’s chemical
imaging facilities. This had a number of bad consequences. Managers of
the film business continually interfered with electronic imaging
projects, which were perceived as threatening the existing customer
base. The company policy that all engineers be paid the same meant
Kodak could not compete for highly paid electronic engineers. Because
digital imaging projects were scattered throughout the company, there
was no cohesive vision and limited accountability for performance.

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Unit 9 – Innovation Global Corporate Strategy

ACTIVITY
Read the following article from your key text, De Wit, B & Meyer, R:

‘Strategy, value innovation and the knowledge economy’, Reading 8.4,


p.464-473.

Conclusion
Success or survival in industries that are being created or transformed
by disruptive innovations requires support from senior management,
separation of the new, flexibility and a willingness to take risks and
learn from experiments. There should be a diversity of opinion to
challenge dominant attitudes and misleading precedents, so avoiding
myopic views of new ventures. The best innovators think broadly and
will entertain a wide range of possibilities before they converge on a
solution.

These prescriptions need considerable tailoring to match each


disruptive innovation and the organisation involved. Indeed, the
purpose of a template for a high-commitment organisation is to enable it
to cope with the tension of uncertainty while achieving commitment to
the choices made. The main point is that managing disruptive
innovations constitutes a different game for established companies,
with its own problems and solutions.

Reference “Do n’t Hesitate to Inno vate” by Geo rge Day and Paul
Scho em ak er (Financial Tim es Oct 9, 2000)

CASE STUDY 1 – Oxley: Step by Step into


New Market Niches
A private British company has been turning military technologies into
commercial applications for the last 61 years. By PETER MARSH (Financial
Times; Jan 30, 2001)

In rural Cumbria, an unusual group of technology specialists is working away in


an airy office-cum-laboratory tacked on to a country house. The subjects of
their inquiries are rather esoteric, ranging from tiny metal devices with
dimensions less than 1mm to new versions of instrument displays for jet
fighters. The ten experts are members of a research and development team at
Oxley, a private company with a 61-year record in innovation. “We use a

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‘stepping stone’ approach to new product development,” says Geoff Edwards,


Oxley’s managing director. “We keep one foot in the areas we know about
and move the other foot so we can gradually explore new ideas.”

Oxley is not a large company. Last year, sales came to £12m, of which about
£700,000 was the profit before tax. But the company’s story is relevant to
many businesses because of the way it has used technological ingenuity to edge
into new areas. It is a potent case study of how military technologies can be
used in civil applications. This process starts with the ten experts, identified by
Mr Edwards, a physicist who started at Oxley 32 years ago. “We deliberately
keep our researchers close to each other so they are chatting all the time,” he
says. “From this interaction we get a marvellous source of new ideas.” The
disciplines covered by the group include materials science, electronics design,
chemistry, manufacturing and test engineering, optics and software. Oxley
employs just 240 staff, of which 50 are engaged in R&D.

An example of how internal discussions lead to profitable business


opportunities is Oxley’s use of its knowledge of capacitor technology – used in
military radar and telecommunications systems – to produce capacitor-based
data storage devices or “smart tags”. These tags were first sold to the British
Army, which attached them to Iraqi prisoners captured during the 1990-91
Middle East conflict. The tags were encoded with information about the
prisoners’ identities and intelligence data.

Oxley has adapted the devices for use on cows to inform the farmer, for
instance, about health problems and milking record. Similar lateral thinking
helped Oxley to turn capacitor-based devices – made from tiny pieces of
ceramic – into sensors used by UK pollution inspectors to monitor water
quality. At the core of Oxley’s methods is its long involvement with the
Ministry of Defence and large military contractors. Defence-related work
accounts for 70% of sales. About a third of the company’s revenue comes from
outside the UK.

The company was founded in 1939, just before the 2nd World War, when
Freddie Oxley, an entrepreneurial engineer, hit on a way of making capacitors
to be used in early radar work. To escape the attentions of German bombers,
the company moved in 1942 from London to its current location in Ulverston,
on the fringe of the Lake District. Mr Oxley ran the company until his death in
1988, when he held 145 patents in a range of scientific fields. His wife, Ann,
chairs the company. She has 90% of the shares, with other staff members
holding the remainder. Mrs Oxley refuses to consider giving up private
ownership. “We run this company like an extended family,” she says. Oxley’s
products are developed rather haphazardly, with little long-term planning. But
most start with military contracts.

The company has several profitable product groups in this field. Mr Edwards
calls them the company’s “eagles”. Commanding high margins, they provide
the cash to finance new developments. Examples include sensitive optical
filters for adding to the instruments and identification lights of aircraft such as
the Tornado fighter. The filters are made of glass, coated with chemicals that
screen out infrared radiation. They enable pilots to use infrared night goggles
without being blinded by their own aircraft’s lighting. Other “eagles” include

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Unit 9 – Innovation Global Corporate Strategy

specialist connectors such as the ones Oxley sells to the mobile telephone
industry, based on principles developed for military radio applications in the
early 1970s.

Oxley makes millions of tiny gold-plated spheres – each 1mm in diameter –


that fit into telecoms base stations sold by Ericsson and Motorola, the two
biggest forces in the mobile phone industry. The spheres are part of miniature
ball-and-socket connectors. With the ball snapping in and out of the socket at
high speed, the system forms part of a switch (selling for 10p) that checks
whether telecoms equipment is operating at the correct wavelength. “We are
the only company in the world that can make the (ball and socket) devices to
this kind of precision,” Mr Edwards says.

Oxley also produces electromagnetic screening systems for military radios.


They prevent damage to the equipment from lightning strikes or radiation
from a nuclear bomb. In the next few years, the company intends to keep its
military focus. As the defence industry consolidates around bigger companies,
Mrs Oxley says, small, specialist companies will find a niche. “We think we can
continue to run between the legs of the elephants,” she says.

But the company is also keen to keep edging into other markets, perhaps with
the help of partners with specific knowledge of new business fields. In the next
five years, Mr Edwards would like the company’s sales to double. “We have no
choice,” he says. “Having this kind of growth target is essential if we want to
keep the company sharp and interested in new ideas.”

Questions:
1. Strategically, how would you categorise the ‘stepping stone’ approach
to product development?

2. Link this case to other key areas studied in this module.

CASE STUDY FEEDBACK


Feedback to Question 1

· Link back to the discussion in Unit 1 about strategic ‘fit’ and


‘stretch’. The stepping stone approach could be seen as
stretching from military (although this is the clear focus with
70% turnover) to commercial.

· Exploitation of core competence (link to Unit 2) and


knowledge (link to Unit 8).

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Global Corporate Strategy Unit 9 – Innovation

· Creation of tacit knowledge from previously created tacit and


explicit knowledge.

Feedback to Question 2

· Core competence – protection of innovative technology via


patents; the company has 145 – is this a lot? – yes as this is a
significant financial investment over the years and has a high value to
the company.

· Emergent strategy – commonplace for innovative organisations


(link to the ‘experimentation’ of emergent strategy) “products are
developed haphazardly.....”

· Value Management – Boston Consulting Group Matrix – use of


‘eagles’ (cash cows) to fund future innovation.

· Niche markets (specialist company – link to reading for this


session and forward link to Unit 10 – the role of specialists such as
IT).

· Strategic Alliances – links to partners in specific fields to create


knowledge management and transfer and technology transfer.

· Knowledge management – as above but the company makes


“use of its knowledge”

VIRTUAL CAMPUS
Further points to note, from the Oxley case study, include:

· The importance of keeping researchers ‘chatting’ together to


faciliate tacit knowledge through socialisation.

· The significant proportion of staff engaged in innovation; 50 of 240


staff.

Now discuss with your colleagues (on the virtual campus) innovation in
respect of :

1. the size of the company

2. the family owned nature

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Unit 9 – Innovation Global Corporate Strategy

Post, on the Virtual Campus, what you can glean from the case study about the
above two points. Share your views. Then challenge, extend, discuss.

Students are advised to complete the next case study (Telepizza, where control of
business innovation has been removed by being publicly owned) before undertaking
this activity. The Telepizza case study has a bearing on point 2 for discussion.

CASE STUDY 2 – Telepizza


Telepizza is a young Spanish company that combines entrepreneurial flair with
real growth. This case study explores how the company has grown and raises
the question of what organisational structures are likely to be required over
the next few years

Telepizza realised before its competitors that Spain was changing rapidly. Gone
were the days of siestas and elaborate family meals. Fast food was what
Spaniards wanted and needed. The company was founded in 1988 as a single
pizza parlour offering home deliveries in its immediate north Madrid
neighbourhood. By late 1995, it had nearly 200 centres spread out across 120
Spanish towns and cities. By the end of 1995, Telepizza expected to post
consolidated profits of more than Pta 800 million (US$6 million), more than
double the Pta 375 million reported in the previous year. It was forecasting
sales of Pta 19 billion for 1995, up from 1994’s Pta 12.3 billion.

‘The market was zero when we started’, says Mr Jose Maria Serrano,
Telepizza’s communications chief, ‘but there was a terrific opportunity.’ Mr
Leopoldo Fernandez Pujals, the company’s founder, spotted the gap in the
market. He owns 40% of Telepizza’s shareholder capital and was its chairman
until a boardroom coup in mid-1995. Mr Fernandez Pujals was formerly an
executive with the healthcare multinational Johnson & Johnson. He knows a lot
about marketing and consumer fads and nothing at all about fast food, but he
knew what the Spanish public was prepared to buy. When he came across
pizza home deliveries during a stay in the USA, he had found the product he
was looking for.

Market success

By 1995, Telepizza had a 54% share of the pizza home deliveries market in
Spain. Its success is as much the triumph of a concept as it is of a product. The
company’s management understood that Spain had undergone a profound
sociological change that had brought young mothers out of the kitchen and
into the workplace. Furthermore, office workers, like everywhere else, had
begun to eat at their desks.

Home deliveries, as opposed to office deliveries, make up the bulk of


Telepizza’s business. They are ordered both by children battling with their

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Global Corporate Strategy Unit 9 – Innovation

homework while their parents are still at their jobs or by exhausted parents
staggering home late because office hours in Spain can stretch into the night.
Telepizza also understands that although Spaniards have belatedly come round
to the concept of fast food, the domestic culture remains imbued with the
tradition of good home-made cooking. This means that the company has to
take special care over the quality of its product – fresh ingredients are
delivered daily – and over the amount of choice it offers its customers. Having
pioneered pizza home deliveries, Telepizza has stayed ahead of its competitors
by introducing the do-it-yourself pizza: clients can summon up literally
thousands of permutations of the product’s 15 basic ingredients. Its most
recent success was the Tex-Mex pizza called ‘the Jalisco’, dreamt up by its
consumer research department.

Corporate culture

The corporate culture and growth strategy are no less important. Telepizza
believes in decentralisation and cutting out bureaucracy. This ethos has set the
tone of its staff relations and franchising. Telepizza has succeeded in creating a
corporate culture and with it an expansion strategy that has multiplied its
rewards. Employees who deliver pizzas by motorcycle within half an hour of
receiving the order are, in the company’s parlance, autonomous business
people responsible for their own slice of the pizza market. These employees
are allotted a specific area. It is up to them to develop a relationship with their
clients. Spurred on by sales incentives and bonus packages, Telepizza’s
representatives will spend nearly as much time promoting the company in their
allotted area as they do delivering its products to customers. Although
numbers vary per outlet, there are approximately ten people, including five
sales representatives, employed in each pizza parlour.

About half the 195 Telepizza centres in Spain are franchises. The company
believes that this mix is the right one and that as it expands further franchises
will, for the time being, be the property of the existing 50 or so franchise
owners. ‘For a franchise system to work, you have to love the company and
what it produces’, says Mr Serrano. ‘These are exactly the sort of people that
we have got now and we want them to grow with us.’

Investment policy

Telepizza has pursued a strong investment policy, ploughing Pta 1.3 billion into
new centres and equipment in 1994. It invested a further Pta 1.5 billion in 1995.
One reason for the boardroom revolt that forced Mr Fernandez Pujal’s
resignation in October 1995 was that other shareholders were clamouring for
dividends and objected to the drive for expansion that he was masterminding.

Firmly established in Spain, Telepizza has also tested foreign waters, again
through a mixture of directly owned outlets and franchises, and has set up
around 50 centres abroad. It is operating in Poland, Portugal, Greece and
Belgium as well as in Mexico, Chile and Colombia. The focus is on Spain,
however, and its home market is far from saturated.

Source: Corporate Strategy by Lynch (Financial Times, 16 November 1995)

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Unit 9 – Innovation Global Corporate Strategy

Questions:
1 To what extent does Telepizza’s structure need to remain loose in
order to encourage the dynamic entrepreneurial spirit that has
characterised its growth? What are the problems with this approach?

2 Is it inevitable that the company will begin to lose its entrepreneurial


flair as it grows larger? How is it proposing to hold on to this
approach?

3 What is your view of the company’s international growth strategy –


sensible expansion or a waste of scarce management resources, given
the continued expansion possibilities in Spain and the resource
difficulties of supervising foreign operations?

CASE STUDY FEEDBACK


Feedback to Question 1

It is desirable that the organisation remains loose as long as possible in order to


continue to build growth. The problems with such an approach are:

· The company may experience poor profit and cash control


because the systems are weak.

· The quality of the product which is so important to its success,


according to the case, may suffer if central monitoring is
ignored. There might be a temptation for individual outlets to
sacrifice quality for quantity and the centre would never know.

· Entrepreneurs might compete with each other inside a


restaurant outlet on price or service, which may not be
advantageous for the company.

Feedback to Question 2

The evidence of Greiner in Chapter 7 would suggest that it is likely that it will
become more bureaucratic: age and size will probably make the company less
dynamic. Hence, as the enterprise grows, there may be a need to define more
precisely the geographical territories or face the possibility that restaurants
will compete against each other. This will limit the loose nature of the
structure.

The company is attempting to hold its growth by restricting franchises to


existing holders and by funding much of its growth internally. It wanted to

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Global Corporate Strategy Unit 9 – Innovation

retain the loyalty of its existing people. However, it is highly likely that some of
the initial zip will go out of the company.

Feedback to Question 3

Although full details are not given in the case, it is likely that significant
resources are devoted to the international growth in the 50 centres operating
abroad. There will inevitably come a time when further growth in Spain will be
difficult: international opportunities will then maintain the momentum of the
group. Moreover, international growth would be one way of offering an
incentive to those individual managers unable to find new outlets in Spain.

However, there is no evidence that growth has disappeared in Spain. Given its
strengths in the home market, it is surprising that so much effort seems to have
been devoted to international expansion with all its associated costs and
pressures.

Given that international expansion has now taken place, one way forward is to
find a balance between the home market expansion and foreign growth. At the
time of the case, it would appear that international growth should take second
place to completing national expansion in Spain. However, this does not mean
that international growth should stop, rather that a judgement is required on
the pace of such expansion.

Case note – what happended later

The founder, Mr Leopoldo Fernandez Pujals, reduced his shareholding from


40% to 22 % in June 1996. The well-known large Spanish bank, Banco Bilbao
Vizcaya (BBV), bought 18 % of the company. This move was a prelude to the
company seeking a listing on the stock market for its shares through a public
offer of 40 % of its shares in September 1996: BBV was acting as co-ordinator
of the share issue, with Merrill Lynch responsible for a placing of part of the
shares internationally.

The company was beginning to mature: the founder was selling part of his initial
interest and the shareholding was becoming more widely available and
institutionalised.

Summary
In this unit we have looked at the challenges posed by disruptive
technologies, particularly on established companies. We have examined
how some of the problems can be managed, and have noted the
importance of cultivating a learning culture, and the importance of
organisations adopting strategic flexibility.

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Unit 9 – Innovation Global Corporate Strategy

To gain maximum benefit from this unit, students are encouraged to


assess their own organisation’s approach to disruptive technologies,
and identify what changes may be necessary to assess powerful
disruptive technologies more quickly and respond faster to new
opportunities.

REVIEW ACTIVITY
Consider the organisation and industry that you currently work in. As we
noted in this unit, there are likely to be many signals from the periphery of your
industry (or supporting sectors) from numerous emerging technologies/ideas.
Some of these will be relevant to the future, others will be a complete waste of
time.

Identify two or three emerging/new innovations that you feel are likely to make
a significant business impact on your sphere of activity. Technologies or ideas
that could offer your organisation deep market potential.

1. Prioritise the technologies/ideas and explain why you have selected


them. What opportunities or paradigm shift in business do they show
potential for? How could your organisation exploit these
technologies/ideas?

2. What threats do they pose for your company and the


products/services you market?

3. Noting the culture of your own organisation, how would you go about
assessing these innovative technologies and implementing them
(where appropriate)?

Share your findings with your Manager and colleagues in your organisation.
Encourage constructive comments.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

1. Ref 10*, Chapter 11 – pages 407-416


2. Ref 8, Chapter 12 (including Reading 12.1) pages 256-276,
Chapter 17 (including Readings 17.1 & 2) pages 403 – 453

* Highly recommended

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Unit 10

Strategic IT and e-Business

LEARNING OUTCOMES
Following the completion of this unit you should be able to:

· Examine the impact technological advances in IT are having on


strategy.

· Consider impact of e-business on strategy.

· Understand the strategic implications for legacy systems.

Introduction
In the age of the Internet, new markets are emerging faster than ever
before. As each new market goes through its development cycle, it gives
power to those companies that are able to harness the power of IT and
the Internet to transform their businesses, and that of their customers.
Power is shifting from what was previously a trusted source of value
creation towards something that was previously secondary.
Information has replaced assets as the source of value. This is the new
management agenda, and corporate IT strategy has become an
important determinant of stock price.

The strategic shift from assets to information, has also been coupled
with a shift from products to services. Services offerings cannot be
managed using the same IT systems as product offerings. Services
offerings are much more customer-centric and this has led to an
emphasis on ERP (enterprise resource planning), CRM (customer
relationship management) and supply chain management.
Furthermore, it is well recognised that a corporation’s own efficiency
comes from how seamlessly data, information and knowledge flows
within the company, and indeed between its supply chain and strategic
partners. Unless corporate data can get to the point of decision in time to
impact that decision, Information Management has failed. For all these
reasons IT has become a powerful influence on corporate strategy;
Strategic IT defines the very nature of the business. In this new age, IT is
not about the business, it is the business; e-business.

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

In this unit we shall examine the impact of technological advances in IT


on strategy. We shall also look at the definition of an e-business, and
consider the impact of e-business on strategy.

The Link between Business and IT


Strategy
A core theme in business is that IT strategy should be aligned with
business strategy. This is difficult to refute as investments should
support real business needs. However, as companies began to depend
more and more on IT in the 1980s and 1990s, it became evident that a
business strategy without a matching IT strategy was no strategy at all.
For this reason, general managers as much as IT executives have
recognised the concept of “strategic alignment”.

Strategic alignment is based on the premise that an organisation defines


business strategy, and then an IT strategy to support it. There are
obvious challenges with the strategic alignment approach, because

· There may be a lack of coherent or agreed business


strategy in the first place.

· The strategy may change regularly.


· The strategy-making process may be more emergent than
prescriptive.

IT strategy, just like any other strategy, has to take into account the
above, as this is a prerogative of any modern business. IT strategy has to
be flexible and accommodate a fast changing world. Indeed, corporate
IT systems such as Enterprise Resource Planning, Supply Change
Management and Customer Relationship Management systems allow
for a level of strategic flexibility for this reason.

Since the emergence of e-business, in particular, the linkage between


business strategy and IT strategy has been strengthened. IT strategy is
no longer solely an output from business strategy, but is a fundamental
input in itself. Let us explore this paradigm shift further.

IT Strategy as an input to Business Strategy


In today’s world, IT strategy is inextricably linked with business
strategy. No longer can the approach be taken of defining business
strategy, and then asking what are the implications for technology, and
matching it to an IT strategy? IT now affects business strategy and can
be seen as an input to business strategy as well as an output. The
Internet, e-business, mobile communications and digital media present

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Global Corporate Strategy Unit 10 – Strategic IT and e-Business

both threats and opportunities; they pose a deep series of challenges to


the business.

So business strategy cannot ignore how technology is changing


markets, competition and processes. Business processes, that worked
well previously, break down when exposed to the self-service pressures
of the web. Business processes themselves are re-engineered because of
the new opportunities for efficiency that IT can deliver.

A revised view of alignment is therefore necessary. In particular, it is


necessary to ask the following questions:

1. How does IT change business strategy? (alignment question)


2. What IT investments does business strategy demand?
(opportunity question)

The iterative relationship between business strategy and IT strategy can


be summarised as shown in Figure 10.1.

Political
factors

Economic
factors
Business Technology/IT
strategy strategy
Social
factors

Technical
factors

Influence of IT strategy on business strategy

Figure 10.1: Relationship between business and IT strategy.

e-business
The advent of e-business is having a profound impact on business
strategy. The appointment of directors of e-business and the
formulation of e-business strategies recognise that IT is changing the
way companies do business. This clearly impacts upon business
strategy; it poses opportunities and threats.

There is sometimes confusion around the definition of e-business. Many


confuse e-business with e-commerce. But e-business is far more than a
business that carries out trade electronically (e-commerce). An
e-business is an organisation that is transforming its interactions with
customers, suppliers, strategic partners and employees by exploiting

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

Web technologies, and extending its market reach to improve


performance. This is at the core of business strategy.

The supporting e-business strategy, the information business strategy,


may radically transform business processes (internal and external) and
will define applications (many web-driven) to support the business
processes. Information sharing will be at the heart of the strategy.
Information sharing may include customers, the company’s supply
chain and strategic partners. The Information Management Strategy
must enable the company to leverage its knowledge, information and
skills; the new value resources.

The components of a company’s e-business strategy can be broadly


depicted as shown in Figure 10.2. Note the cyclic nature of the various
components. This implies continual refinement and change.

Leverage information
and knowledge

Define IT environment e-business Transform


(security, scalability, strategy business
standards, tools processes
and applications)

Figure 10.2: Cyclic nature of e-business strategy.

ACTIVITY
Read about the huge impact of recent technological advances (principally
e-business) on organisations’ strategic approaches, in an extract from Geoffrey
Moore’s book Living on the fault line. Find it on p. 451-464, Reading 8.3 in your
key text, De Wit, B & Meyer, R .

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Global Corporate Strategy Unit 10 – Strategic IT and e-Business

VIRTUAL CAMPUS
On-demand computing or grid-computing is being touted by the major
computer vendors (IBM, Sun, HP) as delivering the next paradigm shift in
business. Is this hype or reality?

Very simply, on demand computing harnesses a grid of machines and other


resources (distributed anywhere) to rapidly process data beyond an
organisation’s own available capacity. It is akin to an electricity grid.
Organisations pay varying prices for the computing power depending on usage
and demand at the time. The business benefits are potentially far-reaching.
Companies embracing the on-demand concept are said to be able to adapt
dynamically to whatever business challenges arise. By integrating their business
processes end-to-end, not only internally, but with their entire supply chain,
strategic partners and customers, organisations can exploit this technology to
respond rapidly to customer needs, market opportunities or even threats.

Research this area on the Internet. In particular, look at the IBM, Sun and HP
websites. Discuss these developments with IT colleagues in your own
organisation.

Now post your views on the Virtual Campus on the following topics:

· Is on-demand computing just hype, or can it deliver real business


benefits? Elaborate by discussing its likely impact on your business?

· Is on-demand computing going to impact only certain sectors of


industry, or will it be pervasive?

· What impact might it have on an organisation’s IT strategy and


business strategy?

Read the views of others, and pick one particular viewpoint that is contrary to
yours and challenge it.

Try to keep a business focus. Avoid technical detail and jargon in your postings
and discussions.

(This virtual campus activity also interlocks with Unit 9 on Innovation)

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IT Strategy Methodology

Strategy Framework
Companies frequently adopt formal methodologies when developing
IT strategy. There are many methodologies on the market – developed
by leading IT companies and professional services firms such as
Accenture. The principles are the same. One that has been used by ‘new
economy’ organisations is the FAST methodology. The four tasks or
elements that make up FAST are:

· Futurising.
· Assets.
· Stimulants.
· Threats.

The “FAST” methodology is entirely inductive, but provides a way of


addressing strategy-making. It is not the only methodology available.
FAST should, in fact, be viewed as a framework to get started; by posing
the right questions. It does not directly address process and
implementation issues. If business strategy and IT strategy are indeed
inextricably linked, then there has to be good communication and trust
between the business and IT personnel. By asking radical questions on
futurising, assets, stimulants and threats, the organisation can address
issues of understudying, involvement, communication and buy-in from
personnel from the business and IT functions.

Futurising
Some companies, such as the Swedish financial group Skandia, have
created special teams to question what the future might bring. These
teams use checklists with probing questions aimed at all parts of the
business. The answers to the probing questions highlight important
trends or significant uncertainties.

Futurising is not just raising an alarm about new technologies and their
future impact, but rather looks at the intersection of new technologies
and the shift in the business environment, and asks what is changing,
threatening or opportunity-rich. The PEST (political, economic, social,
technological) tool for environmental analysis applies in thinking about
futures, but more thorough scenarios are likely to be where these
variables interact.

Some companies are constructing visions, stories, pictures and dramas


of what businesses might look like or what businesses could be created.
The outputs could be good questions to ask, trends to watch,

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uncertainties to explore, experiments to begin or “must do” ideas to


develop.

The main point about “futurising”, as Skandia calls it, is to explicitly


suggest that the future may not be an extrapolation of the past, that
opportunities co-exist with threats, that uncertainty is inevitable and
that ignoring the future is more risky than trying to create it.

Assets
What competencies, capabilities or assets might yield opportunities?
These are “assets” because:

· They are potential sources of value creation.


· They should not be underestimated or left un-exploited.
· They may be hidden until potential is realised through
e-commerce.

For example, if a company has world-class fulfilment processes, then


moving into e-commerce not only builds on this strength, but might also
make this capability evident to the world. In other words, existing
capabilities may have even more potential for value creation. Jack
Welch at General Electric has said that the company’s achievements in
its Six Sigma quality processes are now really paying off in e-business,
where cost, speed, reliability and quality matter.

As an example of underestimated assets, one conglomerate realised it


had several partnership opportunities and, importantly, information
threads between its businesses that might allow it to restructure part of
the logistics industry. Likewise, many information-rich organisations
have content that is valuable to traditional and emerging businesses.

Hidden assets can become evident in many ways. For example, an


engineering company realised it had a valuable asset in its parts
database when a business-to-business electronic market-maker
approached it about building a business-to-business exchange. The
database had taken 40 years to build and was now seen as an asset to
protect as well as to exploit. In other words, when you re-examine a
business as an information business or rethink it as a new economy
business, you may discover hidden assets.

Stimulants
The efforts of companies that are trying to encourage entrepreneurial
behaviour can be thought of as “stimulants”. Examples of this are
internal venture capital funds and e-business divisions. Some
companies measure how much of their capital budget is being allocated
to new ventures and e-commerce. Some businesses are creating

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FAST-track learning schemes to move people through venture capital


units and back to the mainstream business.

The theory is that there are latent entrepreneurs and e-commerce ideas
in companies. Strategy is not all top-down, but should reach through all
levels. It is the classic “let loose” cycle often employed when strategic
change is on the agenda: stimulating everybody to think and act as a
new business.

Threats
The final element is to think of threats, but not only as shock treatment.
If a company sees how a new entrant or rival can attack, why not attack
first? This has been a philosophy at General Electric, where executive
teams have been asked to think how their business could be destroyed
by e-commerce. Threats stimulate survival instincts and can be more
effective than looking for opportunities, which can seem optional.

ACTIVITY
Consider the following scenario.

Assume that you are a manager in your organisation, and that your
organisation has enjoyed significant market dominance in its particular sector.

Now pretend that a new entrant is going to attack your market share. Envision
the new entrant’s winning approach. What strategy, business and IT, is the new
entrant likely to adopt in your sector?

From the above analysis, how can your organisation retain the high-ground and
modify its strategy?

The above approach of envisioning competitive threats and modifying strategy


has been adopted widely. It was used with great success by General Electric
during Jack Welch’s reign.

(The above activity is quite wide in scope. For purposes of this unit, restrict it as best as
possible to the impact of IT on strategy.)

The combination of the four elements, futurising, assets, stimulants and


threats, suggest that both IT personnel and business executives are
involved and that initiatives are prompted which involve
multifunctional teams. In this way, business strategy and IT strategy are
integrated.

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A positive lesson to be learned from dot.com businesses is that


multifunctional teams build and evolve the business with no
demarcation between functions, skills and strategies. This leads to
redefining IT strategy and planning.

Today’s Strategy Challenges


In a global marketplace where technological innovations have a
profound impact on corporate strategy and organisation, the IT
methodology framework must be comprehensive, and flexible in
incorporating new challenges and business change into core
information systems. Traditional methods of IT strategy-making,
whether framed as ‘alignment’, ‘opportunity’ or both, were periodic
(often annual), formalised, long-term and driven principally by the IT
department. They allowed little flexibility for change or for the adoption
of new processes and technologies. These methods are no longer
satisfactory, as they were discontinuous, lacked ‘buy-in’ from the
business and hence implementation of strategy often lost momentum.
In today’s world, IT strategy cannot just be the domain of the IT
department; it must engage the businesses. It must deliver real business
benefits in short-time frames.

New methods of IT strategy-making have the following characteristics;

· Continuous.
· Flexible.
· Involve learning by doing.
· Rapid turnaround and delivery of quick ‘wins’.
· A ‘natural’ activity.

Today, strategy – integrated IT and business strategy – is revisited


frequently; priorities re-evaluated, new technologies assessed and
incorporated where relevant to the business. Strategy can no longer be
cast in stone. The pressure to launch, the need to respond to what is
learnt by doing, the uncertainty of new markets and models, and the fact
that on-line business evolves in real time, mean that the formal
structures of traditional IT strategy-making are inappropriate.

Because IT strategy-making is business development, it is a


multi-functional team effort. The chief executive and technology
director should be in frequent dialogue. IT people are learning to work
with marketing people and vice versa. Furthermore, strategising and
planning must be closely followed by implementation. Rapid
Application Development methodologies are frequently adopted.
Strategy making is now an evolving, continuous, ever-changing
process. (See Figure 10.3). The underlying IT architectural framework
must allow for change.

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

IT strategy must support the entire life cycle of the organisation’s


information systems, and enable them to evolve over time to meet
changing business demands. It must adhere to a common architecture
and comply with industry standards.

In broad terms, the steps in developing and implementing IT strategy


can be summarised as follows:

1. Capture organisational strategy.


2. Map business processes to the organisation.
3. Link strategy, organisation and processes.
4. Carry out process re-engineering, where appropriate.
5. Implement and align relevant information systems.
6. Manage all aspects of evolution, including business domains,
processes, applications and third-party systems.

Figure 10.3 illustrates the cyclic nature of the various stages.

Capture organisational
strategy

Implement and align Manage Map business processes


information systems IT to the organisation
evolution

Link strategy,
Process
organisation
re-engineering
and processes

Figure 10.3: Evolutionary nature of IT strategy.

Reconciling Legacy Systems with New


Technologies
Unless the organisation is a very young organisation, reconciling new
technologies with legacy systems is a fundamental pre-requisite of a
corporation’s IT strategy.

Established companies cannot afford to take a revolutionary approach,


and legacy integration is a key requirement. Therefore, the IT strategy

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must deliver a flexible architecture that allows new components and


mission-critical legacy systems to be integrated and managed in
harmony. Competitive pressures and the drive for increased efficiency
and productivity demand that the integrated environment be a modern
e-business environment. The e-business environment must leverage
legacy systems, because organisations can’t replace them quickly
enough and still be responsive to business needs.

Let us briefly examine the implications for legacy systems. Firstly, it is


important to note that 70% of the world’s data still resides on legacy
systems. Legacy systems are frequently ‘fragile’ (due to poor
documentation, loss of expertise, etc.), and changes to such systems are
not only costly and time-consuming, but risky. For this reason legacy
systems should be left unaltered as far as is possible. However, some
changes are necessary to reconcile legacy systems with the new
components and achieve integration on an e-platform. Today’s business
demands that customers and suppliers are provided with the most
up-to-date information possible – whether that be by Internet, e-mail,
phone, etc. They also demand a familiar, easy-to-use interface.
Consequently, legacy integration must support real-time access, and be
fronted by familiar interfaces such as a web front-end. These changes
are fairly minimal and can be achieved by use of Application Program
Interfaces (APIs) and wrappers, but maintaining the core application
logic.

In conclusion, in the Internet age, most companies will find that it is


more strategic than ever to adopt a flexible architecture and maintain
many of their mission-critical legacy systems. Clearly new applications
should be developed as ‘genuine’ e-business applications. In this way,
legacy systems can be reconciled with new technologies on an
e-business platform.

ACTIVITY
Research the impact of the Internet and other IT technologies on the ‘new
economy’ by reading some of the articles on the following websites:

www.gartner.com

www.forrester.com

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CASE STUDY –
compuship.com/easy2ship.com
Problems developing a global e-commerce concept into a viable
business process.

Case study from Tayeb M (2003) International Management Theories and Practices.
Harlow: Pearson. (Chapter 8. E-commerce Worldwide by Brian M W Clements and
Monir H Tayeb)

The concept

It is acknowledged by the European transport industry that there exists an


inefficiency of over 30% in road haulage operations, i.e. either the vehicle is
empty for 30% of its journeys or is 30% empty on every journey. In reality it is
probably a combination of the two states. 30% is a minimum conservative
estimate and in the USA it could be nearer 40%.

Efforts are always made to reduce this inefficiency by ensuring maximum


possible loading or finding return loads. Traditionally this has been difficult.
Either there are problems of timing and co-ordination, or financial problems
due to the unknown creditworthiness of shippers of return loads.

By using e-commerce Internet connectivity, it is possible to bring together


potential carriers and shippers in real time to maximise efficiency. The reduced
fixed costs of the carrier should offset freight reductions offered as an
inducement to the shipper as well as providing revenue for the service
provider. This creates a win/win/win scenario.

Additionally, by factoring the service through a bank/credit agency, the service


provider can guarantee payment to the carrier within a fixed timeframe.

Further benefits are the provision of cargo insurance as well as creating a new
marketing channel within the transport industry.

The history

In 1997, an American computer reseller became unhappy with the level of


service his company was receiving from the carriers he used to deliver
equipment to his customers. This caused him to analyse the nature of the
carriers transport operations to see if he could identify areas where their
services could be improved.

During his research, he discovered only one fact that struck him as being a
possible area of improvement. He learned from several sources that road
transport had one particular inefficiency. This was that many journeys were
undertaken unladen and that many others were made with less than a full load.
In fact, it appeared that the industry was running at only some 60% of its
maximum capacity.

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He decided that it would be a simple matter to create an Internet exchange to


manipulate a win/win situation. His belief was that the carrier would be
prepared to cost price for last minute loads to fill up empty space, that shippers
would benefit from lower than standard freight rates and that he would be able
to charge a small margin on each transaction. He registered Compuship.com
and commenced development.

A year later, due to the uncontrolled and unanticipated software costs he had
incurred, he lost his previously profitable computer business, his
Compuship.com and the rights to the business process he had developed.

Undeterred, he eventually found an entrepreneur who was developing a small


Internet incubation company, I-Global.com, which was interested in
developing the concept on his behalf. They joined forces and tried to
re-acquire the rights to the project development already undertaken.
However, they were also suffering from a lack of finance.

They in turn sought external finance. Help came in the form of Ci4net.com, a
Channel Island and UK incubation company, recently launched on the
NASDAQ market, whose shares were priced at over $100 and who was
consequently in a buoyant and acquisitive frame of mind. They purchased
I-Global.com, renaming it Ci4netNA.com and financed the re-acquisition of
the freight exchange for $1 million.

But Ci4net.com was still unhappy about two factors in the proposed
operation. First, they believed that the USA was too large and amorphous a
market for the initial launch. Second, they insisted that the operation needed
professional input and control by logistics industry experts.

Two were hired, the CEO who was an expert in international logistics and
commerce, the other in UK road haulage and marketing. A wholly owned UK
company, Easy2ship.com Limited was created in early summer 2000 to
complete the exchange and launch the concept into the European
marketplace.

The two new directors then collaborated in the creation of both business and
marketing plans for the exploitation of this new exchange process. It became
apparent at the same time that other companies were working on parallel
developments, so a measure of urgency was necessary. A beta test and trial
launch were planned for October with a full launch to follow at the end of
November.

The Ci4netNA.com took responsibility for the final development and the
hosting of the exchange in the US. They eventually located a software
development company, Techspan, who are based in California’s “Silicon
Valley”. Then came the first major setback. After their analysis of the
development work originally undertaken by Compuship.com, Techspan
advised that the work completed only constituted a sketchy demonstration
and lacked the technical flexibility and robustness to be developed into a
commercially viable Internet exchange.

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

The UK directors immediately flew to California and spent some weeks


re-specifying the business processes and re-designing the structure of the
exchange. This delay obviously caused the date of the beta test to be
postponed for the ten weeks it was now going to take to develop a working
prototype. This would time the beta test for the hectic fortnight before the
Christmas holiday in the UK. It was then decided that the only option was to
further delay the launch until February 2001.

This delay proved fatal. If the exchange were to be launched in February, the
earliest that a revenue stream could be generated would be May. The business
plan reflected the fact that growth to a financially self-sustaining state would
take about 18 months and that the company would require a substantial
injection of cash during the first six months of operation to finance a
pan-European marketing campaign and the expansion of the company
structure.

The problems became apparent at the end of the re-design phase of the
development. Techspan wanted payment for the work to date before they
were prepared to work on the final stage of development. They had
contracted to undertake the work with the Ci4netNA.com and expected
payment from them. The UK parent organisation, Ci4net.com, the source of all
the finance, admitted “some cashflow problems”, but that these were
temporary and would soon be resolved.

At the time that Easy2ship.com was formed, the directors were advised that £9
million was available for the UK launch. Following the preparation of the
business and marketing plans, this was formally increased to £25 million each
for the pan-European and subsequent North American launches. However,
one fact was not disclosed by Ci4net.com.

This was that they had failed to secure a second round of funding in May, which
was crucial to their development plans. They subsequently acknowledged that
they had believed that this was a temporary setback and that the second round
funding would be secured before it was needed to meet their commitments to
their 50-odd subsidiaries. In reality, Ci4net.com had insufficient skilled
managers to control the activities of all these subsidiaries. Their efforts to do
so apparently distracted their attention from events in the world’s financial
markets.

Many of the Phase 3 Internet companies had “burned” their investors’ money,
without having any realistic hope of developing an adequate revenue stream.
Institutional investors had leapt onto the bandwagon when they had seen the
immense capital gains to be made from the spectacular and much-publicised
IPO capitalisation of many “Dot.com” companies, but the bubble had burst.

Ci4net.com’s shares, originally valued at over US$100 on the NASDAQ


market had slumped to under US$1 by early 2001. There was no realistic
possibility that they would get second round funding. They divested
themselves of over 80% of their subsidiaries, keeping Easy2ship.com among
five or six others. However, they were not able to meet either the
development costs they had incurred with Techspan or the operational costs

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Global Corporate Strategy Unit 10 – Strategic IT and e-Business

of Easy2ship.com, whose staff was laid off in December 2000 and whose UK
directors resigned shortly thereafter.

Case study summary

The business process is viable. The concept was professionally market tested
through focus groups and accepted with enthusiasm by both carriers and
potential users. However, due to its failure from causes outside its direct
control, as well as the current commercial suspicion of investment in
E-commerce, funds are not forthcoming.

This scenario has been repeated in many other commercial sectors, most of
which are suffering from a lack of confidence on the part of the institutional
investors. They had their fingers burned by investing heavily in E-commerce
without having either made prudent checks that the business process was
going to work or that there was the likelihood of the generation of an adequate
revenue stream in the foreseeable future.

Questions:
1. Was the development time a significant cause for the termination of
the project?

2. What would an investor need to know before making a commitment


to fund such a venture?

3. Can a win/win/win scenario really exist, or is there a commercial


loser?

4. Could the concept be limited to operation within national boundaries?

5. What are the likely difficulties of expansion into:

- Europe?

- Non-European countries?

CASE STUDY FEEDBACK


Feedback on Question 1:

In the normal course of events, the development time might have been less
critical. Obviously, it is important to keep a development period to the
minimum, since at this stage, outgoings may be heavy and there is no income.

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

This negative cashflow is normally allowed for in the business plan, as it


certainly was in this case. However, even though the directors were not aware
of the parent company’s funding shortfall, there was little that could be done to
accelerate the process of bringing the company online. Therefore, the
extended development period was a significant cause for the termination of
the project, since the parent company could not survive without the income
relied upon from this source.

Feedback on Question 2:

An investor would need to know:

· The track record of the management.

· The size of the potential market.

· Details of all competition.

· The reliability of the business process and technology.

· The elapsed time between the start of the project and the first
income.

· The elapsed time between first income and financial breakeven.

· Critical success factors.

Feedback on Question 3:

A win/win/win scenario could exist as described in this case study. It is possible


for the carrier, the shipper and the service provider to benefit from the
business process. This is because of the size of the structural inefficiency in the
current business process (30%+) and to the detriment of conventional “bricks
and mortar” return load service providers.

Feedback on Question 4:

It would be impractical to attempt to limit this concept to a single state, unless


the state concerned had no normal road transport access to and from
neighbouring states. In the case of the UK, there is ferry transport to
Scandinavia, Germany, Netherlands, Belgium, France, Spain and Ireland, as well
as the Channel Tunnel.

Feedback on Question 5:

Difficulties for expanding into Europe:

· Language barriers for advertising, etc.

· Euro currencies.

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Global Corporate Strategy Unit 10 – Strategic IT and e-Business

· Dispute resolution.

· Hard copy documentation.

Difficulties for expanding into non-European countries:

· Credit rating of shippers.

· Credit rating of carriers.

· Trust and confidence in all parties.

· Unreliable legal systems.

Summary
We have seen that in today’s world, business strategy is inextricably
linked with IT strategy. The business benefits and competitive
advantages that new technologies, and e-business, can deliver are huge;
a company should be constantly looking to exploit this potential.

We have looked at the role of IT strategy methodologies, and have noted


that methodologies need to allow for flexibility and responsiveness to
changes in the business and in technology. We have briefly considered
how to manage IT evolution within an organisation and the cyclic role of
the various processes. We have noted that if e-business is the business,
and if IT strategy cannot be separated from business strategy, the chief
executive and technology director need to be working as partners.
Strategic leadership, that pro-actively encourages multi-functional
strategic effort, is vital as well as new concepts and practices of strategy
formulation.

Finally we have looked at the issue of reconciling legacy systems with


the e-business paradigm.

REVIEW ACTIVITY
We have seen that e-business is far more than just e-commerce. Many
companies, (e.g. Cisco Systems, Airbus Industrie) have achieved supply chain
efficiencies and enormous cost savings by adopting electronic methods such as
e-procurement. Use of enterprise resource planning systems (e.g. SAP) has
also played a significant role.

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

Consider your own organisation, irrespective of whether or not in operates in


the new economy; and irrespective of whether or not e-commerce
opportunities present itself. What impact has e-business had on your
company’s strategy? What is its potential?

1. Consider the changes achieved over the last five years.

2. Address the potential over the next five years, and likely business
benefits.

Further reading for this unit (optional)


The following are suggested as optional reading for this unit:

Ref 10*, Chapter 11 Pages 400-403

Ref 9, Chapter 14 Pages 381 – 394

Ref 13, Chapter 10 Pages 221-247

* Highly recommended

References
The following are the references for your key text and supporting texts:

1. Bennett R. (1999) – Internatio nal Business (2nd Edition) –


Published by: Financial Times Pitman Publishing (ISBN
0-273-63429-1).
2. Cummings S., Wilson D. (2003) – Im ages o f Strategy – Published
by Blackwell Publishing (ISBN 0-631-22610-9)
3. De Wit, B. & Meyer, R (2004) – Strategy Process, Content &
Context International Perspective (3rd Edition) – Published by:
Thomson Learning (ISBN 1-86152-964-3). (Key Text)
4. Ferguson P.R. & Ferguson G.J. (2000) – Organisatio ns – A
Strategic Persp ective – Published by: Macmillan Press Ltd. (ISBN
0-333-74550-7).
5. Grant R.M. (2002) – Co ntem p o rary Strategic Analysis – Co ncep ts,
Techniques, Ap p licatio ns (4th Edition) – Published by Blackwell
Publishers (ISBN 0-631-23136-6)

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Global Corporate Strategy Unit 10 – Strategic IT and e-Business

6. Haberberg A., & Rieple A. (2001) – The Strategic Managem ent o f


Organisatio ns – Published by: Financial Times Prentice Hall
(ISBN 0-13-021971-1)
7. Johnson G. & Scholes K. (1999) – Exp lo ring Co rp o rate Strategy
(5th Edition) – Published by: Prentice Hall (ISBN 0-13-080740-0).
8. Joyce P. & Woods A. (2001) – Strategic Managem ent – A Fresh
Ap p ro ach to Develo p ing Sk ills, Kno w led ge and Creativity –
Published by Kogan Page Limited (ISBN 0 7494 3583 6)
9. Lasserre P. (2003) – Glo bal Strategic Managem ent – Published by:
Palgrave McMillan (ISBN 0-333-79375-7)
10. Lynch, R. (2003) – Corporate Strategy (3rd Edition) – Published
by: Financial Times Prentice Hall (ISBN 0-273-65854-9). (Main
supporting text)
11. Mintzberg, H., Ahlstrand B., & Lampel J. (1998) – Strategy Safari
– Published by: Financial Times Prentice Hall (ISBN
0-273-65636-8)
12. Stacey, R.D. (2000) – Strategic Managem ent & Organisatio nal
Dynam ics – The Challenge o f Co m p lexity (3rd Edition) –
Published by: Financial Times Prentice Hall (ISBN 0-273-64212-X)
13. Stonehouse G., Hamill J., Campbell D. & Purdie T. (2000) – Glo bal
and Transnatio nal Business – Strategy and Managem ent –
Published by: John Wiley & Sons (ISBN 0-471-98819-7).
14. Thompson A.A., Strickland A.J, (2003) – Strategic Managem ent –
Co ncep ts and Cases – Published by McGraw-Hill Irwin (ISBN
0-07-112132-3)

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