Economics of Strategy

Seventh Edition
Besanko, Dranove, Shanley, and Schaefer

Chapter 13

Strategy and Structure

Copyright  2016 John Wiley  Sons, Inc.

 Strategy and Structure

 The choice of organizational structure depends on

the business strategy of the firm

 Organizations structure is about

 how critical tasks are divided up

 how managers and employees make decisions

 routines and information flows that support operations

 Structure Follows Strategy

Structure defines the nature of agency problems within

the firm.

The right structure provides workers with information,

coordination and incentives to implement strategy.

The importance of structure persists even in the face of

the growth of the internet, globalization and changing
demographics of the workforce.
 Organizational Forms

A small group of employees within a firm can be

organized in several ways
 Each member may be treated as an individual and is rewarded
based on his/her output

 The group can be a self managed team and individual rewards

will be wholly or partly based on team performance

 Hierarchy of authority may be used with one member of the

group coordinating and monitoring the activities of others
 Nature of Tasks & Organizational Forms

Different forms are effective in different situations

depending on the nature of the tasks.

When tasks do not require coordination employees can

be treated as individuals.

When coordination is essential and individual

contribution is difficult to measure, team approach will
be used.
 Nature of Tasks & Organizational Forms

In large firms hierarchy of authority may be needed.

Beyond a certain size, self managed teams may not

perform well in coordination.

Extent of control will depend on the severity of the

agency problems and the attendant influence costs.
 Complex Hierarchy

Large firms tend to have multiple groups and multiple

levels of groupings

Complex hierarchies are designed to address the

following two issues
 Departmentalization
 Coordination and control
 Firm Boundaries & Departmentalization

A firm’s decisions regarding vertical and horizontal

boundaries will influence its choice of organizing
dimensions
 Diversifying into a new business area will expand the set of
formal groupings
 Decision to outsource will contract a firm’s structure
 Departmentalization

Formal groupings in large organizations can be based

on functional areas, geography, products, types of
customers and so on

A firm should decide on the organizing dimensions

based on
 economies of scale and scope
 transactions costs and

 agency costs
 Coordination and Control

Coordination involves
 the flow of information to facilitate decisions that further the
organization’s objectives and
 the distribution of decision making rights and rule making
authority within the organization.

Coordination and control choices will affect both

technical efficiency and agency efficiency.
 Coordination, Control, & Technical Efficiency

Coordination affects the technical efficiency by the

provision of information needed to exploit economies of
scale and scope.

To accomplish improvements in technical efficiency,

decision making rights should be allocated to those who
have the best and timely information.
 Coordination, Control, & Agency Efficiency

Allocating decision rights to individuals will affect

agency efficiency since the decision makers will have
the opportunity for selfish behavior.

A balance must be struck between technical and agency

efficiencies in the allocation of decision rights.
 Approaches to Coordination

A firm can organize using autonomous work units with

related to operating decisions being controlled by the
manager of the unit.

A common approach is profit centers with target profit

goals.

When profit targets are not appropriate the units

become responsibility centers (Example: R & D).
 Approaches to Coordination

Instead of self contained units a firm may also organize

itself into units that have strong lateral relationships.

These lateral relationships can be formalized into

structure (Matrix Organization) or remain informal.

Lateral relations become essential when coordination

among groups is needed to exploit economies of
scale/scope.
 Centralization and Decentralization

Authority becomes more centralized (decentralized) as

decision making moves to higher (lower) levels

It is possible for a firm to be centralized in some

dimensions while being decentralized in others

For example, in a university administrative functions

may be centralized while the teaching function is
decentralized
 Organizational Structure

Organizational structure of large businesses can be

classified as follows:
 The unitary functional structure (U-form)

 The multidivisional structure (M-form)

 The matrix structure

 The network structure

 The Functional (U-form) Structure

Each department in the firm is responsible for a

particular functional area such as finance or marketing.

U-form promotes performance within the department

but makes coordination across departments difficult.

The unitary functional structure is suitable for stable

conditions when operating efficiency is the prime
consideration.
The Functional (U-form) Structure
 The Multidivisional (M-form) Structure

The multidivisional firm is organized along such

dimensions as
 product line
 geography or

 type of customers

Divisional managers will be responsible for operating

decisions and the top management will handle strategic
decisions.
The Multidivisional (M-form) Structure
 Advantages of the M-form

Measuring divisional performance is easier under M-

form.

Pay for performance schemes are easier to implement in

managerial compensation.

Divisional managers compete for funds in the internal

capital markets based on their operating performance in
the past.
 Matrix Structure

A firm that uses a matrix structure is organized along

two (or more) dimensions - for example, product line
and geography.

In a two-dimensional matrix, an employee belongs to

two hierarchies and has two bosses.

The demands of competing dimensions should be

roughly equal.
Matrix Structure
 Advantages of Matrix Structure

Matrix structure can help exploit economies of scale and

scope.
A firm may need national coordination to achieve economies
of scale for manufacturing a particular product and regional
coordination to negotiate with large buyers for different
products.
Matrix structure allows a firm to economize on scarce human
resources
Having a firm wide engineering department (or marketing
department) will be more efficient than maintaining a separate
engineering group for each product.
 Network Structure

Network structure is designed around the worker rather

than the task.

Workers or worker groups contribute to multiple

organizational tasks.

Work groups are reconfigured when the tasks change.

Network of autonomous firms can function as a virtual

firm.
Network Structure
 Network Structure

Network structure is preferred when coordination costs

do not outweigh the gains in technical efficiency.

The Japanese Keiretsu is an example of network

structure.

In high technology companies, network structure

facilitates the flow of diverse information, leading to
high level of new product development.
 Network Structure

Network structures are becoming more popular as the

cost of organizing has fallen.

Internet provides a less expensive infrastructure for

network organizations than traditional means of data
exchange.
 Modular Organization

A modular organization has a network structure with

subunits that are relatively self contained.
Modularity may sacrifice economies of scope.
Networks can grow and change in a piecemeal fashion
without major disruptions in the rest of the firm.
Modularity may encourage innovations at the subunit
level.
 Limited Variety of Organizations Structures

Organizational design choices tend to cluster together.

One possible reason is imitation among firms.
Complementarities among design variables could be
another. (Example: product differentiation and product
design.
Design variables can also be substitutes.
 Limited Variety of Organizations Structures

Interdependence between organizational design

variables will affect the structural type.

Since design variables cannot be changed independently

any “mix and match” approach will not be feasible.
 Strategy-Environment Coherence

Optimal choice of structure depends on the environment

the firm is set in.

Types of environmental factors that affect the choice of

structure are
 technology and task interdependence and
 information processing.
 Technology and Task Interdependence

There can be three modes of task interdependence

 Reciprocal - when two workers (or work groups) depend on
each other

 Sequential - when one worker (or work group) has a one way
dependence on another

 Pooled - when there is no direct dependence, but indirect

dependence exists because of common goals
 Technology and Task Interdependence

Changes in technology will cause the nature of task

independence to change

The organizational structure may need to be changed in

response to the change in task interdependence

Technology has weakened the sequential and reciprocal

interdependencies in some industries and has made
outsourcing attractive
 Efficient Information Processing

When work is routine, workers can be autonomous.

Workers in the higher levels deal with more difficult

exceptions that occur less frequently.

Workers are fewer in higher levels and they posses

more expertise (pyramidal structures).
 Efficient Information Processing

Technological changes reduce the cost of information

flow and increase the span of control.

The firm’s organizational structure should change

depending on the changing information needs and
technology.
 Information Retrieval

The optimal structure should enable efficient

information retrieval (Stinchcombe).

Different levels of organizational structure will deal

with different types of information.

Activities that provide critical information should be

integrated into the firm.
 Balancing Differentiation & Integration

If the organizational structure does not sufficiently

differentiate, the firm may inefficiently use a “one size
fits all” approach to all products (and regions)

For integrated planning and control, too much

differentiation can be an impediment

The optimal structure should balance differentiation and

integration
 Structure Follows Strategy

The U-form structure allowed firms in the 19 th century

to exploit the economies of scale in production,
marketing and distribution.

When firms began to diversify in the 20 th century the U-

form became cumbersome and M-form emerged as a
better alternative.
 Structure Follows Strategy

The M-form lead to duplication of activities when firms

expanded globally and created “international divisions.”

 As firms try to balance local responsiveness with

global economies, a mix of matrix form and network
form help create flexible organizations.
 Structure, Strategy, Knowledge, & Capabilities

Critical knowledge and decision capabilities are

distributed throughout the firm in large firms
(Hammond).

Structure determines the shortlist of alternatives that

reach the top management.

Structure also induces biases in the information

reaching the top management.
 Structure, Strategy, Knowledge, & Capabilities

Structure influences how strategies are implemented

and how top management is informed regarding the
implementation.

Structure also provides rules for resolving

implementation disputes.

Formal administrative control should be supplemented

by informal means of winning the cooperation from
lower levels.
 Structure as Routine

Firms use routines – complex sets of behavior patterns.

The routines make it easy for the firm to respond to

complex information from the environment.

Routines are part of a firm’s competencies.

 Structure as Routine

Routines evolve through experiments in the face of new

problems.

Satisfactory solutions are “remembered” as routines.

Routines also emerge in conflict resolution, incentives

and control.
 Structure, Strategy, & Evolutionary Economics

Strategy and structure evolve over time through local

interactions with the environment rather than through
top management initiative.

A firm’s structure is an outcome of a long series of

adaptations.
 Structure, Strategy, & Evolutionary Economics

Strategy and structure can also be viewed as high level

heuristics.

Strategy is a set of principles for managerial action.

Structure is a set of principles for coordination within

the firm.
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