You are on page 1of 44

Strategy and Structure

of International Business

Introduction
Strategy and structure in International
Business
as well as in any organization,
are two inseparable realities or processes.

Terminology

organizational architecture - refers to the totality of a firms


organization, including formal organizational structure, control systems
and incentives, organizational culture, processes, and people

organizational structure - we mean three things: First, the formal


division of the organization into subunits such as product divisions,
national operations, and functions (most organizational charts display this
aspect of structure); second, the location of decision making
responsibilities within that structure (e.g., centralized or decentralized);
and third, the establishment of integrating mechanisms to coordinate the
activities of subunits including cross functional teams and or pan-regional
committees.

Control systems - are the metrics used to measure the performance of


subunits and make judgments about how well managers are running those
subunits.

Incentives - are the devices used to reward appropriate managerial behavior.

Processes - are the manner in which decisions are made and work is
performed within the organization.

Organizational culture - is the norms and value systems that are shared
among the employees of an organization.

people - mean not just the employees of the organization, but also the
strategy used to recruit, compensate, and retain those individuals and the
type of people that they are in terms of their skills, values, and orientation.

I. Organizational Architecture
The term organizational architecture refers to the totality of a firms
organization, including formal organizational structure, control systems
and incentives, organizational culture, processes, and people.
Figure 1 illustrates these different elements.
By organizational structure, we mean three things: First, the formal
division of the organization into subunits such as product divisions,
national operations, and functions (most organizational charts display
this aspect of structure); second, the location of decision making
responsibilities within that structure (e.g., centralized or decentralized);
and third, the establishment of integrating mechanisms to coordinate
the activities of subunits including cross functional teams and or panregional committees.

Control systems are the metrics used to measure the performance of


subunits and make judgments about how well managers are running
those subunits.
For example, historically Unilever measured the performance of national
operating subsidiary companies according to profitability-profitability
was the metric. Incentives are the devices used to reward appropriate
managerial behavior.

Processes are the manner in which decisions are made and work is
performed within the organization.
Examples are the processes for formulating strategy, for deciding how to
allocate resources within a firm, or for evaluating the performance of
managers and giving feedback. Processes are conceptually distinct from
the location of decision-making responsibilities within an organization,
although both involve decisions. While the CEO might have ultimate
responsibility for deciding what the strategy of the firm should be (i.e.,
the decision-making responsibility is centralized), the process he or she
uses to make that decision might include the solicitation of ideas and
criticism from lower-level managers.

Organizational culture is the norms and value systems that are shared among the
employees of an organization. Lusts as societies have cultures, so do
organizations. Organizations are societies of individuals who come together to
perform collective tasks. They have their own distinctive patterns of culture and
sub, culture. As we shall see, organizational culture can have profound impact on
how a firm performs.
People we mean not just the employees of the organization, but also the strategy
used to recruit, compensate, and retain those individuals and the type of people
that they are in terms of their skills, values, and orientation.

Figure 1: Organization Architecture

As illustrated in Figure 1, the various components of an organizations


architecture are not independent of each other:
Each component shapes, and is shaped by, other components of architecture.
An obvious example is the strategy regarding people. This can be used
proactively to hire individuals whose internal values are consistent with those
that the firm wishes to emphasize in its organization culture. Thus, the people
component of architecture can be used to reinforce (or not) the prevailing
culture of the organization.
If a firm to going to maximize its profitability, it must pay close attention to
achieving internal consistency between the various components of its
architecture.

Let us look at how structure and control systems might be inconsistent with each
other. Figure 2 shows an organizational chart for how Unilevers European
operations might be structured (this chart is hypothetical).
Note that there are several country subsidiaries, one for France, one for
Germany, one for Spain, and so on, each reporting to the European Business
Group. There are also several pan-European product divisions, one for
detergents, one for frozen food, one for margarine, and so on, again each
reporting to the European Business Group. Within this structure, responsibility
for marketing, sales, and distribution decisions might be given to the country
subsidiaries, while responsibility for product manufacturing might be given to the
product divisions. As for control systems, imagine that profitability is the metric
used to evaluate the performance of the country subsidiaries.

Figure 2: Financial Organizational Structure at


Unilever

One problem with this set of arrangements is that the profitability of


the country subsidiaries depends on manufacturing costs and new product
development, and yet the managers running the various country subsidiaries are
not responsible for those important functions-responsibility resides in the
product divisions! Thus, if the managers of the product divisions do not do their
job properly, production costs may rise and the profitability of the country
subsidiaries might fall. In other words, the managers of the country subsidiaries
are being evaluated according to a metric over which they do not have total
control.
If the performance of a subsidiary declines, they may argue that this is not
their fault; it was due to the inability of the managers in the pan-European
product divisions to drive down manufacturing costs. Thus, there is a potential
conflict between structure and the control systems used; they are potentially
inconsistent.

Some inconsistency is a fact of life in organizations. Perfection in the design


of organization architecture is very difficult to achieve. Nevertheless, the
inconsistency between different components of an organizations architecture
can be minimized through intelligent design. In the example just given, if the
performance of each product division were assessed on the basis of
manufacturing costs, it would give the managers of the product division the
incentive to optimize manufacturing efficiency. The problem might be further
alleviated if the heads of both the country subsidiaries and the European
product divisions were rewarded according to the profitability of the entire
European Business Group (for example, by having their bonus pay linked to
the profitability of the entire group). This would give the heads of the
divisions a further reason to reduce manufacturing costs, and it would create
an incentive for the heads of each subsidiary and division to share any best
practices developed in their operation with colleagues across Europe to the
betterment of the entire European Business Group.

Internal consistency is a necessity but not a sufficient condition for high


performance. Consistency between architecture and the strategy of the
organization is also required; architecture must fit strategy. When Unilever
began to emphasize cost reduction as a major strategic goal, the firm had to
change its architecture to match this new strategic reality. It had to move
away from a structure based primarily on standalone operating subsidiaries in
each country and toward one that looks more like the structure depicted in
Figure 2. Unilever had to create some entity, in this case the product divisions
that could reduce the duplication of manufacturing operations across country
subsidiaries and consolidate manufacturing at a few choice locations. Such
change is easier said than done. It is relatively easy for senior managers to
announce a radical change in strategy, but it is much harder to actually put
that change into action. Doing so requires a change in architecture. Strategy
is implemented through architecture, and changing architecture is much more
difficult than announcing a change in strategy. We shall discuss why it is hard
to change architecture later in this chapter. As we shall see, a prime reason is
that organizations tend to be relative inert; they are by nature difficult to
change.

A. Organizational Structure
Organizational structure means three things: (1) the
formal division of the organization into subunits, which we
shall refer to as horizontal differentiation; (2) the location
of decision making responsibilities within that structure,
which we shall refer to as vertical differentiation; and (3)
the establishment of integrating mechanisms. We begin by
discussing vertical differentiation, then horizontal
differentiation, and then integrating mechanisms.

1. Vertical Differentiation: Centralization and


Decentralization

A firms vertical differentiation determines where in its hierarchy the


decision-making power is concentrated. Are production and marketing
decisions centralized in the offices of upper-level managers, or are
they decentralized to lower-level managers? Where does the
responsibility for R&D decisions lie? Are strategic and financial control
responsibilities pushed down to operating units, or are they
concentrated in the hands of top management? And so on. There are
arguments for centralization and other arguments for
decentralization.

a. Arguments for Centralization


1.

Centralization can facilitate coordination.

2.

centralization can help ensure that decisions are consistent with


organizational objectives.

3.

By concentrating power and authority in one individual or a management


team, centralization can give top-level managers the means to bring about
needed major organizational changes.

4.

Centralization can avoid the duplication of activities that occurs when similar
activities are carried on by various subunits within the organization.

b. Arguments for Decentralization

Top management can become overburdened when decision making authority is centralized, and this can
result in poor decisions. Decentralization gives top management time to focus on critical is issues by
delegating more routine issues to lower-level managers.

Motivational research favors decentralization. Behavioral scientists have long argued that people are
willing to give more to their jobs when they have a greater degree of individual freedom and control
over their work.

decentralization permits greater flexibility more rapid response to environmental changes-because


decisions do not have to be referred up the hierarchy unless they are exceptional in nature.

decentralization can result in better decisions. In a decentralized structure, decisions are made closer
to the spot by individuals who (presumably) have better information than managers several levels up in
a hierarchy.

decentralization can increase control. Decentralization can be used to establish relatively autonomous,
self-contained subunits within an organization. Subunit managers can then be held accountable for
subunit performance. The more responsibility subunit managers have for decisions that impact subunit
performance, the fewer alibis they have for poor performance.

Strategy and Centralization in an International Business

The choice between centralization and decentralization is not absolute.


Frequently it makes sense to centralize some decisions and to decentralize
others, depending on the type of decision and the firms strategy. Decisions
regarding overall firm strategy, major financial expenditures, financial
objectives, and the like are typically centralized at the firms headquarters.
However, operating decisions, such as those relating to production,
marketing, R&D, and human resource management, mayor may not be
centralized depending on the firms international strategy.

Consider firms pursuing a global strategy. They must decide how to disperse
the various value creation activities around the globe so location and
experience economies can be realized. The head office must make the
decisions about where to locate R&D, production, marketing, and so on. In
addition, the globally dispersed web of value creation activities that
facilitates a global strategy must be coordinated. All of this creates pressures
for centralizing some operating decisions.

In contrast, the emphasis on local responsiveness in multi-domestic firms


creates strong pressures for decentralizing operating decisions to foreign
subsidiaries. In the classic multi-domestic firm, foreign subsidiaries have
autonomy in most production and marketing decisions. International firms
tend to maintain centralized control over their core competency and to
decentralize other decisions to foreign subsidiaries. This typically centralizes
control over R&D and/or marketing in the home country and decentralizes
operating decisions to the foreign subsidiaries.

While products are developed at home, managers in the various foreign


subsidiaries have significant latitude for formulating strategies to market
those products in their particular settings.

The situation in transnational firms is more complex. The need to realize


location and experience curve economies requires some degree of centralized
control over global production centers (as it does in global firms).

However, the need for local responsiveness dictates the decentralization of


many operating decisions, particularly for marketing, to foreign subsidiaries.
Thus, in transnational firms, some operating decisions are relatively
centralized, while others are relatively decentralized. In addition, global
learning based on the multidirectional transfer of skills between subsidiaries
and between subsidiaries and the corporate center, is a central feature of a
firm pursuing a transnational strategy. The concept of global learning is
predicated on the notion that foreign subsidiaries within a multinational firm
have significant freedom to develop their own skills and competencies. Only
then can these be leveraged to benefit other parts of the organization. A
substantial degree of decentralization is required if subsidiaries are going to
have the freedom to do this. For this reason too, the pursuit of a
transnational strategy requires a high degree of decentralization.

2. Horizontal Differentiation: The Design


of Structure

Horizontal differentiation is concerned with how the firm decides to divide


itself into subunits. The decision is normally made on the basis of function,
type of business or geographical area. In many firms, just one of these
predominates, but more complex solutions are adopted in others. This is
particularly likely in the case of international firms, where the conflicting
demands to organize the company around different products (to realize
location and experience curve economies) and different national markets (to
remain locally responsive) must be reconciled. One solution to this dilemma is
to adopt a matrix structure that divides the organization on the basis of both
products and national markets (as Unilever apparently did in Europe). In this
section we look at different ways firms divide themselves into subunits.

The Structure of Domestic Firms:

Most firms begin with no formal structure and are run by a single
entrepreneur or a small team of individuals. As they grow, the demands
of management become too great for one individual or a small team to
handle. At this point the organization is split into functions reflecting the
firms value creation activities (e.g., production, marketing, R&D, sales).
These functions are typically coordinated and controlled by top
management (see Figure 3). Decision making in this functional structure
tends to be centralized.

Figure 3: A Typical Functional Structure

Further horizontal differentiation may be required if the firm


significantly diversifies its product offering, which takes the firm into
different business areas. For example, Dutch multinational Philips NY
began as a lighting company, but diversification took the company
into consumer electronics (e.g., visual and audio equipment),
industrial electronics (integrated circuits and other electronic
components), and medical systems (CT scanners and ultrasound
systems).In such circumstances, a functional structure can be too
clumsy. Problems of coordination and control arise when different
business areas are managed within the framework of a functional
structure. For one thing, it becomes difficult to identify the
profitability of each distinct business area. For another, it is difficult
to run a functional department, such as production or marketing, if it
is supervising the value creation activities of several business areas.

To solve the problems of coordination and control, at this stage most


firms switch to a product divisional structure (see Figure 4). With a
product divisional structure, each division is responsible for a distinct
product line (business area). Thus, Philips created divisions for
lighting, consumer electronics, industrial electronics, and medical
systems. Each product division is set up as a self-contained, largely
autonomous entity with its own functions.

The responsibility for operating decisions is typically decentralized to product


divisions, which are then held accountable for their performance.
Headquarters is responsible for the overall strategic development of the firm
and for the financial control of the various divisions.

Figure 4: A Typical Product Divisional Structure

The International Division


When firms initially expand abroad, they often group all-their
international activities into an international division. This has tended to
be the case for firms organized on the basis of functions and for firms
organized on the basis of product divisions. Regardless of the firms
domestic structure, its international division tends to be organized on
geography. Figure 5 illustrates this for a firm whose domestic
organization is based on product divisions.

Figure 5: One Companys International


Divisional Structure

Many manufacturing firms expanded internationally by exporting the


product manufactured at home to foreign subsidiaries to sell. Thus, in
the firm illustrated in Figure 5, the subsidiaries in Countries 1 and 2
would sell the products manufactured by Divisions A, B, and C. In
time, however, it might prove viable to manufacture the product in
each country, and so production facilities would be added on a
country-by country basis. For firms with a functional structure at
home, this might mean replicating the functional structure in every
country in which the firm does business. For firms with a divisional
structure, this might mean replicating the divisional structure in
every country in which the firm does business.

This structure has been widely used; according to a Harvard study, 60


percent of all firms that have expanded internationally have initially
adopted it.

Nonetheless, it gives rise to problems. The dual structure it creates


contains inherent potential for conflict and coordination problems
between domestic and foreign operations. One problem with the
structure is that the heads of foreign subsidiaries are not given as
much voice in the organization as the heads of domestic functions (in
the case of functional firms) or divisions (in the case of divisional
firms).

Rather, the head of the international division is presumed to be able


to represent the interests of all countries to headquarter. This
effectively relegates each countrys manager to the second tier of the
firms hierarchy, which is inconsistent with a strategy of trying to
expand internationally and build a true multinational organization.

Another problem is the implied lack of coordination between


domestic operations and, foreign operations, which are isolated from
each other in separate parts of the structural hierarchy. This can
inhibit the worldwide introduction of new products, the transfer of
core competencies between domestic and foreign operations, and the
consolidation of global production at key locations so as to realize
location and experience curve economies. These problems are
illustrated in the Management Focus that looks at the experience of
Abbott Laboratories with an international divisional structure.

As a result of such problems, most firms that continue to expand


international abandon this structure and adopt one of the worldwide
structures we discuss next. The two initial choices are a worldwide
product divisional structure, which tends to be adopted by diversified
firms that have domestic product divisions, and a worldwide area
structure, which tends to be adopted by undiversified firms whose
domestic structures are based on functions. These two alternative
paths of development are illustrated in Figure 6. The model in the
figure is referred to as the international structural stages model and
was developed by John Stopford and Louis Wells.

Figure 6: The International Structural Stage Model

Worldwide Area Structure


A worldwide area structure tends to be favored by firms with a low
degree of diversification and a domestic structure based on function (see
Figure 7). Under this structure, the world is divided into geographic
areas. An area may be a country (if the market is large enough) or a
group of countries. Each area tends to be a self-contained, largely
autonomous entity with its own set of value creation activities (e.g., its
own production, marketing, R&D, human resources, and finance
functions). Operations authority and strategic decision relating to each
of these activities are typically decentralized to each area, with
headquarters retaining authority of all overall strategic direction of the
firm and financial control.

Figure 7: A Worldwide Area Structure

This structure facilitates local responsiveness. Because decision


making responsibilities are decentralized, each area can customize
product offerings, marketing strategy, and business strategy to the
local conditions. However, this structure encourages fragmentation of
the organization into highly autonomous entities. This can make it
difficult to transfer core competencies and skills between areas and
to realize location and experience curve economies. In other words,
the structure is consistent with a multi-domestic strategy but with
little else. Firms structured on this basis may encounter significant
problems if local responsiveness is less critical than reducing costs or
transferring core competencies for establishing a competitive
advantage.

Worldwide Product Divisional Structure


A worldwide product division structure tends to be adopted by firms-that are reasonably
diversified and, accordingly, originally had domestic structures based on product
divisions. As with the domestic product divisional structure, each division is a selfcontained, largely autonomous entity with full responsibility for its own value creation
activities. The headquarters retains responsibility for the overall strategic development
and financial control of the firm (see Figure 8). Underpinning the organization is a belief
that the value creation activities of each product division should be coordinated by that
division worldwide. Thus, the worldwide product divisional structure is designed to help
overcome the coordination problems that arise with the international division and
worldwide area structures (see the Management Focus on Abbott Laboratories for a
detailed example). This structure provides an-organizational context that enhances the
consolidation of value creation activities at key locations- necessary for realizing location
and experience curve economies. It also facilitates the transfer of core competencies
within a divisions worldwide operations and the simultaneous worldwide introduction of
new products. The main problem with the structure is the limited voice it gives to area of
country managers, since they are seen as subservient to product division managers. The
result can be a lack of local responsiveness.

Figure 8: A Worldwide Product Division


Structure

Many firms have attempted to cope with the conflicting demands of a


transnational strategy by using a matrix structure (see Figure 2). In the classic
global matrix structure, horizontal differentiation proceeds along two
dimensions: product division and geographic area (see Figure 9). The
philosophy is that responsibility for operating decisions pertaining to a
particular product should be shared by the product division and the various
areas of the firm. Thus, the nature of the product offering, the marketing
strategy, and the business strategy to be pursued in Area 1 for the products
pr0duced by Division A are determined by conciliation between Division A and
Area 1 management. It is believed that this dual decision-making
responsibility should enable the firm to simultaneously achieve its particular
objectives. In a classic matrix structure, giving product divisions and
geographical areas equal status within the organization reinforces the idea of
dual responsibility. Individual managers thus belong to two hierarchies (a
divisional hierarchy and an area hierarchy) and have two bosses (a divisional
boss and an area boss).

Figure 9: A Global Matrix Structure

The reality of the global matrix structure is that it often does not work
anywhere near as well as the theory predicts. In practice, the matrix often is
clumsy and bureaucratic. It can require so many meetings that it is difficult to
get any work done. The need to get an area and a product division to reach a
decision can slow decision making and produce an inflexible organization unable
to respond quickly to market shifts or to innovate. The dual-hierarchy structure
can lead to conflict and perpetual power struggles between the areas and the
product divisions, catching many managers in the middle. To make matters
worse, it can prove difficult to ascertain accountability in this structure. When
all critical decisions are the product of negotiation between divisions and areas,
one side can always blame the other when things go wrong. As a manager in one
global matrix structure, reflecting on a failed product launch, said, to the
author, Had we been able to do things our way, instead of having to
accommodate those guys from the product division, this would never have
happened. (A manager in the product division expressed similar sentiments.)
The result of such finger-pointing can be that accountability is compromised,
conflict is enhanced, and headquarters loses control over the organization.

In light of these problems, many transnational firms are now trying to


build flexible matrix structures based more on firm-wide networks
and a shared culture and vision than on a rigid hierarchical
arrangement. Dow Chemical, profiled in that accompanying
Management Focus, is one such firm. Within such companies the
informal structure plays a greater role than the formal structure.