Organizing for Advantage

Charles W.L. Hill

Copyright © Charles W. L. Hill, 2020

 Organizing
• Why does organization matter?
– Strategy is implemented through activities at the
functional level and through organization
– Organization can create the context within which:
• The attainment of functional excellence occurs
• Rent yielding factors of production are created and developed
– Organization itself can be a rent yielding factor of
production (Nucor, 3M)
– Adverse organizational factors can destroy value
• Organization can be a source of dysfunctional
– Microsoft Windows Org and Vista
• Organizational factors can result in inertia

Copyright © Charles W. L. Hill, 2020

 Organizing
• Organization should be match to strategy in
discriminating ways
– High tech firms (Apple) should be organized
differently than steel makers (Nucor)
– Diversified enterprises (3M) should be organized
differently than single businesses (Nordstrom)
• Alignment or fit is a key concept in strategy
– Strategy-organization-functional activities should
be aligned
Copyright © Charles W. L. Hill, 2020
 An Economic Perspective on
Organizing: The Principle-Agent
Problem

Copyright © Charles W. L. Hill, 2020

 The Agency Problem in Organizations
• The principle-agency problem is endemic within
organization
• Organizational design should seek to limit this.
• Principle-agency relationships
– Principles hire agents to perform tasks for them
• Stockholders hire the board of directors
• The board hires the CEO
• The CEO hires subordinates
• And so on down the chain…..
– This involves delegation of decision-making power
from principles to agents.

Copyright © Charles W. L. Hill, 2020

 The Agency Problem in Organizations
• Agency problem arises because principles and
agents may have different utility functions
• Stockholders want the CEO to maximize the value of the
enterprise.
• The CEO may want to maximize their personal income,
power, status, job security, etc….including expense paid trips
to Hawaii on the corporate jet
• The CEO may want subordinates to maximize their
productivity
• Subordinates may want to maximize their on-the-job
consumption of organizational perks, leisure time, etc….
• Subordinates may want to free ride on the efforts of others
(and take credit for their achievements)

Copyright © Charles W. L. Hill, 2020

 Agency Problem in Organizations
• Agency problem is compounded by information asymmetries
– Agent knows more than principle about their marginal productivity
• CEO knows more than stockholders about the state of the firm and their
productivity
• Subordinates know more than the CEO about the productivity of tasks under
their control.
• Subcontractor my know more than firm about the state of a contract (Boeing
and Vought Aircraft Industries).
– Agents may distort information to misrepresent their marginal
productivity.
• Wave of accounting fraud in late 1990s
• Agency problem compounded by cronyism
– Agents may seek to populate the organization with allies
• CEO appointing friends to board.
• Nepotism

Copyright © Charles W. L. Hill, 2020

 Agency Problem in Organizations
• Agency problem can result in serious consequences including
– Adverse selection
• Difficult to identify someone's true type. Hire, promote and reward those who best
misrepresent themselves
– Moral Hazard
• Agents may engage in risky behaviors knowing that the principle may shoulder the
consequences of negative outcomes, while they benefit from positive outcomes
• Writing risky mortgages
• Bailing out big banks
• Other people’s money
– Resource misallocation
• Resources goes to those best at misrepresentation
• Resources not directed to highest value use
– Systematic productivity losses
• Productivity sinks that benefit agents raise the costs of the enterprise
• Agency Costs: The losses that result from agents acting in a way that is not
in the best interests of principles

Copyright © Charles W. L. Hill, 2020

 Solving the Agency Problem
• Reducing (economizing) agency costs through organizational design
– Organize for performance visibility
• Reduce performance ambiguity through decentralization and organizational
decomposition
• Increase accountability and reduce scope for shirking, free riding, on the job
consumption, etc…..
– Principles must bear monitoring costs (collect information)
• Assign measurable goals
• Pick the “right” measures
• Monitor outputs against goals
• Audit agent activities
– Align incentives through rewards
• Pay for performance
• Nonpecuniary rewards
– Shape the utility functions of agents through organization culture
• Socialize agents into the firm’s culture
• Self control and peer control

Copyright © Charles W. L. Hill, 2020

 Solving the Agency Problem
• Strategy can constrain the ability of principles to
reduce agency costs
• Strategy can require coordination between
organization units
• Output of that strategy is a product of “joint effort”
that may be difficult to separate out.
• Strategic imperatives can create performance
ambiguities.
• For example
– Close coordination between R&D, manufacturing and
marketing may be required for new product development.
– If product fails, who is responsible?

Copyright © Charles W. L. Hill, 2020

Organization Architecture

Copyright © Charles W. L. Hill, 2020

 Organization Architecture

Structure

Controls/ Human
Processes
Incentives Capital

Culture

Copyright © Charles W. L. Hill, 2020

 Organization Architecture

Structure

Controls/ Human
Processes
Incentives Capital

Culture

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Organization structure has four dimensions
– Centralization versus Decentralization
– Tall versus flat
– Structural form (division of org into subunits).
– Integrating Mechanisms

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Centralization v Decentralization
– Arguments for centralization
• Facilitates coordination
• Ensures consistency
– 26 different IS systems at Microsoft pre Herbold
• Avoids duplication
• Enables the realization of economies of scale
• Concentrates power
– Arguments for Decentralization
• Reduces management information overload
• Allows senior managers to focus on important issues (e.g. strategy)
• Increases performance visibility and accountability
• Can have motivational benefits
• Increases local responsiveness and reduces response time
• Reduces organization politicking
• Can encourage entrepreneurial behavior

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Choice between Centralization v Decentralization
– Logical to centralize some decision and decentralize others
– Important firm wide decisions should be centralized
• Capital allocation, major enterprise strategy decisions
– Centralization my be required to attain scale economies
• E.g. Centralized purchasing
– When local adaptation is important, decentralization is favored
• Merchandizing decisions at Wal-Mart
– Decentralization favored rapidly changing environments
• Grant lower level employees the opportunity to develop new product/business
ideas.
– Decentralization favored with a highly educated workforce

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Tall versus Flat
– Tall: Many layers, relatively small spans of control
– Flat: few layers, wider spans of control
• Problems in Tall Hierarchies
– Deliberate and accidental information distortions
– Political behavior can become endemic
– Expensive – many mid level managers
– Lack of performance visibility and accountability
– Mid layers can be a source of inertia
– High agency costs
– Microsoft Windows org while developing Vista
Copyright © Charles W. L. Hill, 2020
 A tall hierarchy has
Many layers and
narrow spans of
control

A flat hierarchy
has few layers
and wide
spans of
control

Tall Hierarchy Flat Hierarchy

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Flattening the organization
– Allows for decentralization and associated
benefits
– Increases performance visibility
– Increases performance accountability
– Reduces scope for political behavior
– Reduces internal inertia forces
– Reduces overhead costs
– Reduces agency costs

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Functional Structure
– Appropriate for single businesses
– Problems arise in multi-product/multi-business firms that
are functionally organized
• Multidivisional Structure
– Standard form for multi-product or diversified enterprises
• Head office polices efficiency of businesses, allocates capital,
makes major strategy decisions
• Divisions run businesses
– Increases performance visibility of each business/product
– Reduce agency costs
– Allows for realization of productivity benefits from efficient
internal governance

Copyright © Charles W. L. Hill, 2020

 Organization Structure
• Matrix Structure
– Used when high need for integration between sub units (functions or
divisions).
– Product development in single businesses
• Need to coordinate R&D, production, marketing so that…
– Products designed with market in mind
– Products designed for ease of manufacture and/or delivery
– Reduces time to market
– Coordination between business in the diversified enterprise
• Economies of scope in production or sales
• Leveraging processes
• Ensuring technological consistency
– Performance the result of “team production” between tightly coupled units.
– Creates problems associated with performance ambiguity
– Agency costs can be a serious issue
– Requires more complex control systems
– Should only use when needs for coordination are high

Copyright © Charles W. L. Hill, 2020

 Functional Structure
CEO & Top Develops strategy and
Management manages subordinates
Team

Human
Purchasing Production Sales R&D
Marketing Resource
Manager Manager Manager Manager
Manager

Develops
Purchases Schedules and Goes on Develops Hires
material and executes sales calls new employees
inputs manages marketing products
production plan.

Copyright © Charles W. L. Hill, 2020

 Multidivisional Structure
Each business is
placed into its own Head Office The HQ controls
division the divisions

Division 1 Division 2 Division 3

R&D Production Marketing Sales

Each division
has its own
Copyright © Charles W. L. Hill, 2020 functions
 Matrix Structure in a High Tech Firm
Sales not part
of team/
matrix
CEO

Development
Teams R&D Manufacturing Marketing Sales

Product
development
Team 1

Product
development
Team 2

Product
development
Team 3
Copyright © Charles W. L. Hill, 2020
 Matrix Structure in a Multiproduct Firm

CEO

Integrates
Technology
Product 1 Product 2 Product 3 Product 4

R&D
Integrates
production
Production
Coordinates
selling
Marketing &
Sales
Copyright © Charles W. L. Hill, 2020
 Integrating Mechanisms
Matrix
Structure

s
st
High

Co
cy
en
Ag
Favored by firms in

d
Teams

an
rapidly changing and
Need for Coordination

ity
high technology

gu
environments
bi
Am
Liaison
Roles
ce
an
rm
rfo
Pe

Direct
Contact Favored by firms in
stable and low
technology
environments
Centralization

Low

Simple Complex

Integrating
Copyright © Charles W.Mechanisms
L. Hill, 2020
 Organization Architecture

Structure

Controls/ Human
Processes
Incentives Capital

Culture

Copyright © Charles W. L. Hill, 2020

 Control and Incentive Systems
• Personal control
– Personal inspections and direct supervision
– Benefits
• Ensure consistency
• Individual coaching and feedback
– Drawbacks:
• Subjective and biased
• De-motivating
• Costly to implement in terms of management time
• Bureaucratic controls
– Rules and procedures
• Standards for behavior
• Budget controls, controls over capital spending, expense controls, etc
– Benefits
• Allow managers to decentralize decision making within parameters specified by rules and procedures
– Drawbacks
• Limit flexibility
• De-motivating
• Costly to enforce
• Result in unintended consequences (gaming the system – e.g. breaking up capital projects)

Copyright © Charles W. L. Hill, 2020

 Control and Incentive Systems
• Output Controls
– Identify tasks that have a measurable output
• Productivity, quality, inventory turns, safety, ROI….
– Set output goals
– Monitor performance against goal
– Intervene selectively
– Benefits
• Facilitate decentralization
• Associated with greater autonomy and accountability
• Consistent with minimizing agency costs
– Drawbacks
• Can be hard to isolate unique outputs
• You get what you measure, so be careful
• Unintended consequences can be an issue

Copyright © Charles W. L. Hill, 2020

 Control and Incentive Systems
• Market Controls
– Setting up an internal market for resources within the enterprise
– Control behavior and promote efficiency through internal competition
• Internal labor markets
• Internal capital markets
• Internal markets for the right to develop new products
– Matsushita/Panasonic, Microsoft
– Competition reduces agency costs
– Can work against trying to establish cooperation for mutual gain
• Incentive Controls
– Typically tied to output controls
– When tied to individual performance can result in self-control
– When tied to group performance can result in peer control
– All recue agency costs
– As with output control, you get what you measure/incent

Copyright © Charles W. L. Hill, 2020

 Organization Architecture

Structure

Controls/ Human
Processes
Incentives Capital

Culture

Copyright © Charles W. L. Hill, 2020

 Organization Culture
• Espoused values and norms of behavior within organizations.
– Nordstrom: “Our number one goal is to provide outstanding customer
service”
– Behavioral norms at Nordstrom include
• Don’t point, walk customers to a location.
• Walk bagged purchase to customer, don’t hand across counter
• Offer to ring up purchase (avoid standing in line)
– Taken for granted ways of behaving within an organization
• Reinforced by symbols and stories
– The tire story
– The inverted pyramid
• Often a strong founder affect on culture
– Gates at Microsoft
• Management can shape culture through structure, controls,
incentives, etc

Copyright © Charles W. L. Hill, 2020

 Organization Culture
• Culture is a means of control
– Self-control and peer control
– Reduces agency costs
• Culture can reinforce strategy
– Nordstrom has a customer service culture
– Nordstrom differentiates itself by superior customer service
• Formal versus informal Culture
– GM’s informal culture: People who show too much initiative don’t get
promoted
– Microsoft’s informal culture historically valued autonomous action
• Windows 3.0
• Internet alarm
• Office
• X Box
• The wrong culture can be dysfunctional and a source of inertia

Copyright © Charles W. L. Hill, 2020

 Organization Architecture

Structure

Controls/ Human
Processes
Incentives Capital

Culture

Copyright © Charles W. L. Hill, 2020

 Organization Processes
• Manner in which decisions are made and work is performed
– Strategy formulation processes
• 3 year rolling plan at Microsoft
– Product development processes
• Bottom up process at 3M
– Performance evaluation processes
• Stack ranking at GE and Microsoft
– Quality improvement processes
• Lean production at Toyota
– Decision making processes
• Consensus decision making processes at IBM
• Processes can create or destroy value
• Processes can be a rent yielding factor of production

Copyright © Charles W. L. Hill, 2020

 Organization Architecture

Structure

Controls/ Human
Processes
Incentives Capital

Culture

Copyright © Charles W. L. Hill, 2020

 Human Capital
• Recruitment, training, development, and
retention strategy
• People whose skill sets and behaviors and
consistent with what the organization is trying
to achieve
• Details beyond the scope of this course

Copyright © Charles W. L. Hill, 2020

 Bottom Line
• Organization should be matched to strategy in
discriminating ways
– Strategy is implement through organization
• Organization is a system
• Organization can be a rent yielding factor of
production
• Organization can be a dysfunctional and a
source of inertia

Copyright © Charles W. L. Hill, 2020

 Example: Google’s Organization
• Flat • 20% time
• Decentralized • Bottom up
• Teams Structure product
• Product divisions development

Controls/ Human
Processes
Incentives Capital

• High IQ
• High powered
incentives
Culture • Data driven
• User first
• Empowering
Copyright © Charles W. L. Hill, 2020
 Example: Nucor’s Organization
• Flat • Teams develop
• Decentralized work processes
• Self-Managing • Goals set by
Teams historic
• Each mill a division Structure
performance

Controls/ Human
Processes
Incentives Capital

• Self reliant
• Output goals • Goal orientated
• Pay for
performance
Culture
• Team based • Pain/gain sharing
incentives • Empowering
Copyright © Charles W. L. Hill, 2020