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Chapter 6

Supporting the Business-Level Strategy: Competitive and Cooperative Moves

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What different competitive moves are commonly used by firms?

2. When and how do firms respond to the competitive actions taken by their rivals?

3. What moves can firms make to cooperate with other firms and create mutual benefits?

Can Merck Stay Healthy?

On June 7, 2011, pharmaceutical giant Merck & Company Inc. announced the formation of a strategic

alliance with Roche Holding AG, a smaller pharmaceutical firm that is known for excellence in medical

testing. The firms planned to work together to create tests that could identify cancer patients who might

benefit from cancer drugs that Merck had under development. [1]

This was the second alliance formed between the companies in less than a month. On May 16, 2011, the

US Food and Drug Administration approved a drug called Victrelis that Merck had developed to treat

hepatitis C. Merck and Roche agreed to promote Victrelis together. This surprised industry experts

because Merck and Roche had offered competing treatments for hepatitis C in the past. The Merck/Roche

alliance was expected to help Victrelis compete for market share with a new treatment called Incivek that

was developed by a team of two other pharmaceutical firms: Vertex and Johnson & Johnson.

Experts predicted that Victrelis’s wholesale price of $1,100 for a week’s supply could create $1 billion of

annual revenue. This could be an important financial boost to Merck, although the company was already

enormous. Merck’s total of $46 billion in sales in 2010 included approximately $5.0 billion in revenues

from asthma treatment Singulair, $3.3 billion for two closely related diabetes drugs, $2.1 billion for two

closely related blood pressure drugs, and $1.1 billion for an HIV/AIDS treatment.

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Despite these impressive numbers, concerns about Merck had reduced the price of the firm’s stock from

nearly $60 per share at the start of 2008 to about $36 per share by June 2011. A big challenge for Merck

is that once the patent on a drug expires, its profits related to that drug plummet because generic

drugmakers can start selling the drug. The patent on Singulair is set to expire in the summer of 2012, for

example, and a sharp decline in the massive revenues that Singulair brings into Merck seemed

inevitable. [2]

A major step in the growth of Merck was the 2009 acquisition of drugmaker Schering-Plough. By 2011,

Merck ranked fifty-third on the Fortune 500 list of America’s largest companies. Rivals Pfizer (thirty-first)

and Johnson & Johnson (fortieth) still remained much bigger than Merck, however. Important questions

also loomed large. Would the competitive and cooperative moves made by Merck’s executives keep the

firm healthy? Or would expiring patents, fearsome rivals, and other challenges undermine Merck’s

vitality?

Friedrich Jacob Merck had no idea that he was setting the stage for such immense stakes when he took

the first steps toward the creation of Merck. He purchased a humble pharmacy in Darmstadt, Germany, in

1688. In 1827, the venture moved into the creation of drugs when Heinrich Emanuel Merck, a descendant

of Friedrich, created a factory in Darmstadt in 1827. The modern version of Merck was incorporated in

1891. More than three hundred years after its beginnings, Merck now has approximately ninety-four

thousand employees.

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Merck’s origins can be traced back more than three centuries to Friedrich Jacob Merck’s purchase

of this pharmacy in 1688.

Image courtesy of

Wikimedia,http://upload.wikimedia.org/wikipedia/commons/e/eb/ENGEL_APHOTHEKE.png.

For executives leading firms such as Merck, selecting a generic strategy is a key aspect of business-level

strategy, but other choices are very important too. In their ongoing battle to make their firms more

successful, executives must make decisions about what competitive moves to make, how to respond to

rivals’ competitive moves, and what cooperative moves to make. This chapter discusses some of the more

powerful and interesting options. As our opening vignette on Merck illustrates, often another company,

such as Roche, will be a potential ally in some instances and a potential rival in others.

[1] Stynes, T. 2011, June 7. Merck, Roche focus on tests for cancer treatments. Wall Street Journal. Retrieved from

online.wsj.com/article/SB100014240527023044323045 76371491785709756.html?mod=googlenews_wsj

[2] Statistics drawn from Standard & Poor’s stock report on Merck.

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6.1 Making Competitive Moves

Figure 6.1 Making Competitive Moves

Image courtesy of 663highland, http://en.wikipedia.org/wiki/File:Enchoen27n3200.jpg

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L E A R N I N G O B J E C T I V E S

1. Understand the advantages and disadvantages of being a first mover.

2. Know how disruptive innovations can change industries.

3. Describe two ways that using foothold can benefit firms.

4. Explain how firms can win without fighting using a blue ocean strategy.

5. Describe the creative process of bricolage.

Being a First Mover: Advantages and Disadvantages

A famous cliché contends that “the early bird gets the worm.” Applied to the business world, the cliché

suggests that certain benefits are available to a first mover into a market that will not be available to later

entrants (Figure 6.1 "Making Competitive Moves"). A first-mover advantage exists when making the

initial move into a market allows a firm to establish a dominant position that other firms struggle to

overcome. For example, Apple’s creation of a user-friendly, small computer in the early 1980s helped

fuel a reputation for creativity and innovation that persists today. Kentucky Fried Chicken (KFC)

was able to develop a strong bond with Chinese officials by being the first Western restaurant chain

to enter China. Today, KFC is the leading Western fast-food chain in this rapidly growing market.

Genentech’s early development of biotechnology allowed it to overcome many of the

pharmaceutical industry’s traditional entry barriers (such as financial capital and distribution networks)

and become a profitable firm. Decisions to be first movers helped all three firms to be successful in their

respective industries. [1]

On the other hand, a first mover cannot be sure that customers will embrace its offering, making a first

move inherently risky. Apple’s attempt to pioneer the personal digital assistant market, through its

Newton, was a financial disaster. The first mover also bears the costs of developing the product and

educating customers. Others may learn from the first mover’s successes and failures, allowing them to

cheaply copy or improve the product. In creating the Palm Pilot, for example, 3Com was able to build on

Apple’s earlier mistakes. Matsushita often refines consumer electronic products, such as compact disc

players and projection televisions, after Sony or another first mover establishes demand. In many

industries, knowledge diffusion and public-information requirements make such imitation increasingly

easy.

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One caution is that first movers must be willing to commit sufficient resources to follow through on their

pioneering efforts. RCA and Westinghouse were the first firms to develop active-matrix LCD display

technology, but their executives did not provide the resources needed to sustain the products spawned by

this technology. Today, these firms are not even players in this important business segment that supplies

screens for notebook computers, camcorders, medical instruments, and many other products.

To date, the evidence is mixed regarding whether being a first mover leads to success. One research study

of 1,226 businesses over a fifty-five-year period found that first movers typically enjoy an advantage over

rivals for about a decade, but other studies have suggested that first moving offers little or no advantages.

Perhaps the best question that executives can ask themselves when deciding whether to be a first mover

is, how likely is this move to provide my firm with a sustainable competitive advantage? First moves that

build on strategic resources such as patented technology are difficult for rivals to imitate and thus are

likely to succeed. For example, Pfizer enjoyed a monopoly in the erectile dysfunction market for five years

with its patented drug Viagra before two rival products (Cialis and Levitra) were developed by other

pharmaceutical firms. Despite facing stiff competition, Viagra continues to raise about $1.9 billion in sales

for Pfizer annually. [2]

In contrast, E-Trade Group’s creation in 2003 of the portable mortgage seemed doomed to fail because it

did not leverage strategic resources. This innovation allowed customers to keep an existing mortgage

when they move to a new home. Bigger banks could easily copy the portable mortgage if it gained

customer acceptance, undermining E-Trade’s ability to profit from its first move.

Disruptive Innovation

Some firms have the opportunity to shake up their industry by introducing a disruptive innovation—an

innovation that conflicts with, and threatens to replace, traditional approaches to competing within an

industry. The iPad has proved to be a disruptive innovation since its introduction by Apple in 2010.

Many individuals quickly abandoned clunky laptop computers in favor of the sleek tablet format offered

by the iPad. And as a first mover, Apple was able to claim a large share of the market.

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The iPad story is unusual, however. Most disruptive innovations are not overnight sensations. Typically, a

small group of customers embrace a disruptive innovation as early adopters and then a critical mass of

customers builds over time. An example is digital cameras. Few photographers embraced digital cameras

initially because they took pictures slowly and offered poor picture quality relative to traditional film

cameras. As digital cameras have improved, however, they have gradually won over almost everyone that

takes pictures. Executives who are deciding whether to pursue a disruptive innovation must first make

sure that their firm can sustain itself during an initial period of slow growth.

Footholds

In warfare, many armies establish small positions in geographic territories that they have not occupied

previously. These footholds provide value in at least two ways. First, owning a

foothold can dissuade other armies from attacking in the region. Second, owning a foothold gives an army

a quick strike capability in a territory if the army needs to expand its reach.

Similarly, some organizations find it valuable to establish footholds in certain markets. Within the context

of business, a foothold is a small position that a firm intentionally establishes within a market in which it

does not yet compete.[3] Swedish furniture seller IKEA is a firm that relies on footholds. When IKEA enters

a new country, it opens just one store. This store is then used as a showcase to establish IKEA’s brand.

Once IKEA gains brand recognition in a country, more stores are established. [4]

Pharmaceutical giants such as Merck often obtain footholds in emerging areas of medicine. In December

2010, for example, Merck purchased SmartCells Inc., a company that was developing a possible new

treatment for diabetes. In May 2011, Merck acquired an equity stake in BeiGene Ltd., a Chinese firm that

was developing novel cancer treatments and detection methods. Competitive moves such as these offer

Merck relatively low-cost platforms from which it can expand if clinical studies reveal that the treatments

are effective.

Blue Ocean Strategy

It is best to win without fighting.

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Sun-Tzu, The Art of War

A blue ocean strategy involves creating a new, untapped market rather than competing with rivals in an

existing market. [5] This strategy follows the approach recommended by the ancient master of strategy

Sun-Tzu in the quote above. Instead of trying to outmaneuver its competition, a firm using a blue ocean

strategy tries to make the competition irrelevant. Baseball legend Wee Willie Keeler offered a similar idea

when asked how to become a better hitter: “Hit ’em where they ain’t.” In other words, hit the baseball where

there are no fielders rather than trying to overwhelm the fielders with a ball hit directly at them.

Nintendo openly acknowledges following a blue ocean strategy in its efforts to invent new markets. In

2006, Perrin Kaplan, Nintendo’s vice president of marketing and corporate affairs for Nintendo of

America noted in an interview, “We’re making games that are expanding our base of consumers in Japan

and America. Yes, those who’ve always played games are still playing, but we’ve got people who’ve never

played to start loving it with titles like Nintendogs, Animal Crossing and Brain Games. These games are

blue ocean in action.” [6] Other examples of companies creating new markets include FedEx’s invention of

the fast-shipping business and eBay’s invention of online auctions.

Bricolage

Bricolage is a concept that is borrowed from the arts and that, like blue ocean strategy, stresses moves that

create new markets. Bricolage means using whatever materials and resources happen to be available as

the inputs into a creative process. A good example is offered by one of the greatest inventions in the

history of civilization: the printing press. As noted in the Wall Street Journal, “The printing press is a

classic combinatorial innovation. Each of its key elements—the movable type, the ink, the paper and the

press itself—had been developed separately well before Johannes Gutenberg printed his first Bible in the

15th century. Movable type, for instance, had been independently conceived by a Chinese blacksmith

named Pi Sheng four centuries earlier. The press itself was adapted from a screw press that was being

used in Germany for the mass production of wine.” [7] Gutenberg took materials that others had created

and used them in a unique and productive way.

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Executives apply the concept of bricolage when they combine ideas from existing businesses to create a

new business. Think miniature golf is boring? Not when you play at one of Monster Mini Golf’s more than

twenty-five locations. This company couples a miniature golf course with the thrills of a haunted house. In

April 2011, Monster Mini Golf announced plans to partner with the rock band KISS to create a “custom-

designed, frightfully fun course [that] will feature animated KISS and monster props lurking in all 18

fairways” in Las Vegas. [8]

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Braveheart meets heavy metal when TURISAS takes the stage.

Image courtesy of Cecil, http://en.wikipedia.org/wiki/File:Turisas_-_Jalometalli_2008_-

_02.JPG.

Many an expectant mother has lamented the unflattering nature of maternity clothes and the boring

stores that sell them. Coming to the rescue is Belly Couture, a boutique in Lubbock, Texas, that combines

stylish fashion and maternity clothes. The store’s clever slogan—“Motherhood is haute”—reflects the

unique niche it fills through bricolage. A wilder example is TURISAS, a Finnish rock band that has created

a niche for itself by combining heavy metal music with the imagery and costumes of Vikings. The band’s

website describes their effort at bricolage as “inspirational cinematic battle metal brilliance.” [9]No one

ever claimed that rock musicians are humble.

Strategy at the Movies

Love and Other Drugs

Competitive moves are chosen within executive suites, but they are implemented by frontline employees.

Organizational success thus depends just as much on workers such as salespeople excelling in their roles

as it does on executives’ ability to master strategy. A good illustration is provided in the 2010 film Love

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and Other Drugs, which was based on the nonfiction book Hard Sell: The Evolution of a Viagra

Salesman.

As a new sales representative for drug giant Pfizer, Jamie Randall believed that the best way to increase

sales of Pfizer’s antidepressant Zoloft in his territory was to convince highly respected physician Dr.

Knight to prescribe Zoloft rather than the good doctor’s existing preference, Ely Lilly’s drug Prozac. Once

Dr. Knight began prescribing Zoloft, thought Randall, many other physicians in the area would follow

suit.

This straightforward plan proved more difficult to execute than Randall suspected. Sales reps from Ely

Lilly and other pharmaceutical firms aggressively pushed their firm’s products, such as by providing all-

expenses-paid trips to Hawaii for nurses in Dr. Knight’s office. Prozac salesman Trey Hannigan went so

far as to beat up Randall after finding out that Randall had stolen and destroyed Prozac samples. While

assault is an extreme measure to defend a sales territory, the actions of Hannigan and the other

salespeople depicted in Love and Other Drugs reflect the challenges that frontline employees face when

implementing executives’ strategic decisions about competitive moves.

Image courtesy of Marco, http://www.flickr.com/photos/zi1217/5528068221.

K E Y T A K E A W A Y

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Firms can take advantage of a number of competitive moves to shake up or otherwise get ahead in an

ever-changing business environment. E X E R C I S E S

1. Find a key trend from the general environment and develop a blue ocean strategy that might capitalize on

that trend.

2. Provide an example of a product that, if invented, would work as a disruptive innovation. How

widespread would be the appeal of this product?

3. How would you propose to develop a new foothold if your goal was to compete in the fashion industry?

4. Develop a new good or service applying the concept of bricolage. In other words, select two existing

businesses and describe the experience that would be created by combining those two businesses.

[1] This section draws from Ketchen, D. J., Snow, C., & Street, V. 2004. Improving firm performance by matching

strategic decision making processes to competitive dynamics.Academy of Management Executive, 19(4), 29–43.

[2] Figures from Standard & Poor’s stock report on Pfizer.

[3] Upson, J., Ketchen, D. J., Connelly, B., & Ranft, A. Forthcoming. Competitor analysis and foothold

moves. Academy of Management Journal.

[4] Hambrick, D. C., & Fredrickson, J. W. 2005. Are you sure you have a strategy? Academy of Management

Executive, 19, 51–62.

[5] Kim, W. C., & Mauborgne, R. 2004, October. Blue ocean strategy. Harvard Business Review, 76–85.

[6] Rosmarin, R. 2006, February 7. Nintendo’s new look. Forbes.com. Retrieved

fromhttp://www.forbes.com/2006/02/07/xbox-ps3-revolution-cx_rr_0207nintendo.html

[7] Johnson, S. The genius of the tinkerer. Wall Street Journal. Retrieved from

http://online.wsj.com/article/SB10001424052748703989304575503730101860838.html

[8] KISS Mini Golf to rock Las Vegas this fall [Press release]. 2011, April 28. Monster Mini Golf website. Retrieved

from http://www.monsterminigolf.com/mmgkiss.html

[9] http://www.turisas.com/site/biography/

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6.2 Responding to Competitors’ Moves

L E A R N I N G O B J E C T I V E S

1. Know the three factors that determine the likelihood of a competitor response.

2. Understand the importance of speed in competitive response.

3. Describe how mutual forbearance can be beneficial for firms engaged in multipoint competition.

4. Explain two ways firms can respond to disruptive innovations.

5. Understand the importance of fighting brands as a competitive response.

In addition to choosing what moves their firm will make, executives also have to decide whether to

respond to moves made by rivals. Figuring out how to react, if at all, to a competitor’s move

ranks among the most challenging decisions that executives must make. Research indicates

that three factors determine the likelihood that a firm will respond to a competitive move:

awareness, motivation, and capability. These three factors together determine

the level of competition tension that exists between rivals.

An analysis of the “razor wars” illustrates the roles that these factors play. [1]Consider Schick’s

attempt to grow in the razor-system market with its introduction of the Quattro. This move was

widely publicized and supported by a $120 million advertising budget. Therefore, its main

competitor, Gillette, was well aware of the move. Gillette’s motivation to respond was also high.

Shaving products are a vital market for Gillette, and Schick has become an increasingly formidable

competitor since its acquisition by Energizer. Finally, Gillette was very capable of responding, given

its vast resources and its dominant role in the industry. Because all three factors were high, a strong

response was likely. Indeed, Gillette made a preemptive strike with the introduction of the Sensor 3

and Venus Devine a month before the Schick Quattro’s projected introduction.

Although examining a firm’s awareness, motivation, and capability is important, the results of a

series of moves and countermoves are often difficult to predict and miscalculations can be costly. The

poor response by Kmart and other retailers to Walmart’s growth in the late 1970s illustrates this

point. In discussing Kmart’s parent corporation (Kresge), a stock analyst at that time wrote, “While

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we don’t expect Kresge to stage any massive invasion of Walmart’s existing territory, Kresge could

logically act to contain Walmart’s geographical expansion.…Assuming some containment policy on

Kresge’s part, Walmart could run into serious problems in the next few years.” Kmart executives also

received but ignored early internal warnings about Walmart. A former member of Kmart’s board of

directors lamented, “I tried to advise the company’s management of just what a serious threat I

thought [Sam Walton, founder of Walmart] was. But it wasn’t until fairly recently that they took him

seriously.” While the threat of Walmart growth was apparent to some observers, Kmart executives

failed to respond. Competition with Walmart later drove Kmart into bankruptcy.

Speed Kills

Executives in many markets must cope with a rapid-fire barrage of attacks from rivals, such as head-to-

head advertising campaigns, price cuts, and attempts to grab key customers. If a firm is going to respond

to a competitor’s move, doing so quickly is important. If there is a long delay between an attack and a

response, this generally provides the attacker with an edge. For example, PepsiCo made the mistake of

waiting fifteen months to copy Coca-Cola’s May 2002 introduction of Vanilla Coke. In the interim, Vanilla

Coke carved out a significant market niche; 29 percent of US households had purchased the beverage by

August 2003, and 90 million cases had been sold.

In contrast, fast responses tend to prevent such an edge. Pepsi’s spring 2004 announcement of a

midcalorie cola introduction was quickly followed by a similar announcement by Coke, signaling that

Coke would not allow this niche to be dominated by its longtime rival. Thus, as former General Electric

CEO Jack Welch noted in his autobiography, success in most competitive rivalries “is less a function of

grandiose predictions than it is a result of being able to respond rapidly to real changes as they occur.

That’s why strategy has to be dynamic and anticipatory.”

So…We Meet Again

Multipoint competition adds complexity to decisions about whether to respond to a rival’s moves.

With multipoint competition, a firm faces the same rival in more than one market. Cigarette makers R. J.

Reynolds (RJR) and Philip Morris, for example, square off not only in the United States but also in many

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countries around the world. When a firm has one or more multipoint competitors, executives must realize

that a competitive move in a market can have effects not only within that market but also within others. In

the early 1990s, RJR started using lower-priced cigarette brands in the United States to gain customers.

Philip Morris responded in two ways. The first response was cutting prices in the United States to protect

its market share. This started a price war that ultimately hurt both companies. Second, Philip Morris

started building market share in Eastern Europe where RJR had been establishing a strong position. This

combination of moves forced RJR to protect its market share in the United States and neglect Eastern

Europe.

If rivals are able to establish mutual forbearance, then multipoint competition can help them be

successful. Mutual forbearance occurs when rivals do not act aggressively because each recognizes that

the other can retaliate in multiple markets. In the late 1990s, Southwest Airlines and United Airlines

competed in some but not all markets. United announced plans to form a new division that would move

into some of Southwest’s other routes. Southwest CEO Herb Kelleher publicly threatened to retaliate in

several shared markets. United then backed down, and Southwest had no reason to attack. The result was

better performance for both firms. Similarly, in hindsight, both RJR and Philip Morris probably would

have been more profitable had RJR not tried to steal market share in the first place. Thus recognizing and

acting on potential forbearance can lead to better performance through firms not competing away their

profits, while failure to do so can be costly.

Responding to a Disruptive Innovation

When a rival introduces a disruptive innovation that conflicts with the industry’s current competitive

practices, such as the emergence of online stock trading in the late 1990s, executives choose from among

three main responses. First, executives may believe that the innovation will not replace established

offerings entirely and thus may choose to focus on their traditional modes of business while ignoring the

disruption. For example, many traditional bookstores such as Barnes & Noble did not consider book sales

on Amazon to be a competitive threat until Amazon began to take market share from them. Second, a firm

can counter the challenge by attacking along a different dimension. For example, Apple responded to the

direct sales of cheap computers by Dell and Gateway by adding power and versatility to its products. The

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third possible response is to simply match the competitor’s move. Merrill Lynch, for example, confronted

online trading by forming its own Internet-based unit. Here the firm risks cannibalizing its traditional

business, but executives may find that their response attracts an entirely new segment of customers.

Fighting Brands: Get Ready to Rumble

A firm’s success can be undermined when a competitor tries to lure away its customers by charging lower

prices for its goods or services. Such a scenario is especially scary if the quality of the competitor’s

offerings is reasonably comparable to the firm’s. One possible response would be for the firm to lower its

prices to prevent customers from abandoning it. This can be effective in the short term, but it creates a

long-term problem. Specifically, the firm will have trouble increasing its prices back to their original level

in the future because charging lower prices for a time will devalue the firm’s brand and make customers

question why they should accept price increases.

The creation of a fighting brand is a move that can prevent this problem. Afighting brand is a lower-end

brand that a firm introduces to try to protect the firm’s market share without damaging the firm’s existing

brands. In the late 1980s, General Motors (GM) was troubled by the extent to which the sales of small,

inexpensive Japanese cars were growing in the United States. GM wanted to recapture lost sales, but it did

not want to harm its existing brands, such as Chevrolet, Buick, and Cadillac, by putting their names on

low-end cars. GM’s solution was to sell small, inexpensive cars under a new brand: Geo.

Interestingly, several of Geo’s models were produced in joint ventures between GM and the same

Japanese automakers that the Geo brand was created to fight. A sedan called the Prizm was built side by

side with the Toyota Corolla by the New United Motor Manufacturing Incorporated (NUMMI), a factory

co-owned by GM and Toyota. The two cars were virtually identical except for minor cosmetic differences.

A smaller car (the Metro) and a compact sport utility vehicle (the Tracker) were produced by a joint

venture between GM and Suzuki. By 1998, the US car market revolved around higher-quality vehicles, and

the low-end Geo brand was discontinued.

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The Geo brand was known for its low price and good gas mileage, not for its styling.

Image courtesy of Bull-

Doser,http://upload.wikimedia.org/wikipedia/commons/6/6a/Geo_Metro_Convertible.JPG.

Some fighting brands are rather short lived. Merck’s failed attempt to protect market share in Germany by

creating a fighting brand is an example. Zocor, a treatment for high cholesterol, was set to lose its German

patent in 2003. Merck tried to keep its high profit margin for Zocor intact until the patent expired as well

as preparing for the inevitable competition with generic drugmakers by creating a lower-priced brand,

Zocor MSD. Once the patent expired, however, the new brand was not priced low enough to keep

customers from switching to generics. Merck soon abandoned the Zocor MSD brand. [2]

Two major airlines experienced similar futility. In response to the growing success of discount airlines

such as Southwest, AirTran, Jet Blue, and Frontier, both United Airlines and Delta Airlines created

fighting brands. United launched Ted in 2004 and discontinued it in 2009. Delta’s Song had an even

shorter existence. It was started in 2003 and was ended in 2006. Southwest’s acquisition of AirTran in

2011 created a large airline that may make United and Delta lament that they were not able to make their

own discount brands successful.

Despite these missteps, the use of fighting brands is a time-tested competitive move. For example, very

successful fighting brands were launched forty years apart by Anheuser-Busch and Intel. After Anheuser-

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Busch increased the prices charged by its existing brands in the mid-1950s (Budweiser and Michelob),

smaller brewers started gaining market share. In response, Anheuser-Busch created a lower-priced brand:

Busch. The new brand won back the market share that had been lost and remains an important part of

Anheuser-Busch’s brand portfolio today. In the late 1990s, silicon chipmaker Advanced Micro Devices

started undercutting the prices charged by industry leader Intel. Intel responded by creating the Celeron

brand of silicon chips, a brand that has preserved Intel’s market share without undermining profits. Wise

strategic moves such as the creation of the Celeron brand help explain why Intel ranks thirty-second

on Fortune magazine’s list of the “World’s Most Admired Corporations.” Meanwhile, Anheuser-Busch is

the second most admired beverage firm, ranking behind Coca-Cola.

K E Y T A K E A W A Y

When threatened by the competitive actions of rivals, firms possess numerous ways to respond,

depending on the severity of the threat.

E X E R C I S E S

1. Why might local restaurants not be in the position to respond to large franchises or chains? What can

local restaurants do to avoid being ruined by chain restaurants?

2. If a new alternative fuel was found in the auto industry, what are two ways existing car manufacturers

might respond to this disruptive innovation?

3. How might a firm such as Apple computers use a fighting brand?

[1] Portions of this section are adapted from Ketchen, D. J., Snow, C., & Street, V. 2004. Improving firm

performance by matching strategic decision making processes to competitive dynamics. Academy of Management

Executive, 19(4) 29-43. Ibid.

[2] Ritson, M. 2009, October. Should you launch a fighter brand? Harvard Business Review, 65–81.

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6.3 Making Cooperative Moves

L E A R N I N G O B J E C T I V E S

1. Know the four types of cooperative moves.

2. Understand the benefits of taking quick and decisive action.

In addition to competitive moves, firms can benefit from cooperating with one another. Cooperative

moves such as forming joint ventures and strategic alliances may allow firms to enjoy successes that

might not otherwise be reached. This is because cooperation enables firms to share (rather than duplicate)

resources and to learn from one another’s strengths. Firms that enter cooperative relationships

take on risks, however, including the loss of ontrol over operations, possible transfer of valuable secrets

to other firms, and possibly being taken advantage of by partners.[1]

Joint Ventures

A joint venture is a cooperative arrangement that involves two or more organizations each contributing to

the creation of a new entity. The partners in a joint venture share decision-making authority, control of

the operation, and any profits that the joint venture earns.

Sometimes two firms create a joint venture to deal with a shared opportunity. In April 2011, a joint

venture was created between Merck and Sun Pharmaceutical Industries Ltd., an Indian pharmaceutical

company. The purpose of the joint venture is to create and sell generic drugs in developing countries. In a

press release, a top executive at Sun stressed that each side has important strengths to contribute: “This

joint venture reinforces [Sun’s] strategy of partnering to launch products using our highly innovative

delivery technologies around the world. Merck has an unrivalled reputation as a world leading,

innovative, research-driven pharmaceutical company.” [2] Both firms contributed executives to the new

organization, reflecting the shared decision making and control involved in joint ventures.

In other cases, a joint venture is designed to counter a shared threat. In 2007, brewers SABMiller and

Molson Coors Brewing Company created a joint venture called MillerCoors that combines the firms’ beer

operations in the United States. Miller and Coors found it useful to join their US forces to better compete

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against their giant rival Anheuser-Busch, but the two parent companies remain separate. The joint

venture controls a wide array of brands, including Miller Lite, Coors Light, Blue Moon Belgian White,

Coors Banquet, Foster’s, Henry Weinhard’s, Icehouse, Keystone Premium, Leinenkugel’s, Killian’s Irish

Red, Miller Genuine Draft, Miller High Life, Milwaukee’s Best, Molson Canadian, Peroni Nastro Azzurro,

Pilsner Urquell, and Red Dog. This diverse portfolio makes MillerCoors a more potent adversary for

Anheuser-Busch than either Miller or Coors would be alone.

Strategic Alliances

A strategic alliance is a cooperative arrangement between two or more organizations that does not involve

the creation of a new entity. In June 2011, for example, Twitter announced the formation of a strategic

alliance with Yahoo! Japan. The alliance involves relevant Tweets appearing within various functions

offered by Yahoo! Japan. [3] The alliance simply involves the two firms collaborating as opposed to

creating a new entity together.

The pharmaceutical industry is the location of many strategic alliances. In January 2011, for example, a

strategic alliance between Merck and PAREXEL International Corporation was announced. Within this

alliance, the two companies collaborate on biotechnology efforts known as biosimilars. This alliance could

be quite important to Merck because the global market for biosimilars has been predicted to rise from

$235 million in 2010 to $4.8 billion by 2015. [4]

Colocation

Colocation occurs when goods and services offered under different brands are located close to one

another. In many cities, for examples, theaters and art galleries are clustered together in one

neighborhood. Auto malls that contain several different car dealerships are found in many areas.

Restaurants and hotels are often located near on another too. By providing customers with a variety of

choices, a set of colocated firms can attract a bigger set of customers collectively than the sum that could

be attracted to individual locations. If a desired play is sold out, a restaurant overcrowded, or a hotel

overbooked, many customers simply patronize another firm in the area.

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Because of these benefits, savvy executives in some firms colocate their own brands. The industry that

Brinker International competes within is revealed by its stock ticker symbol: EAT. This firm often sites

outlets of the multiple restaurant chains it owns on the same street. Marriott’s Courtyard and Fairfield Inn

often sit side by side. Yum! Brands takes this clustering strategy one step further by locating more than

one of its brands—A&W, Long John Silver’s, Taco Bell, Kentucky Fried Chicken, and Pizza Hut—within a

single store.

Co-opetition

Although competition and cooperation are usually viewed as separate processes, the concept of co-

opetition highlights a complex interaction that is becoming increasingly popular in many industries. Ray

Noorda, the founder of software firm Novell, coined the term to refer to a blending of competition and

cooperation between two firms. As explained in this chapter’s opening vignette, for example, Merck and

Roche are rivals in some markets, but the firms are working together to develop tests to detect cancer and

to promote a hepatitis treatment. NEC (a Japanese electronics company) has three different relationships

with Hewlett-Packard Co.: customer, supplier, and competitor. Some units of each company work

cooperatively with the other company, while other units are direct competitors. NEC and Hewlett-Packard

could be described as “frienemies”—part friends and part enemies.

Toyota and General Motors provide a well-known example of co-opetition. In terms of cooperation,

Toyota and GM vehicles were produced side by side for many years at the jointly owned New United

Motor Manufacturing Incorporated (NUMMI) in Fremont, California. While Honda and Nissan used

wholly owned plants to begin producing cars in the United States, NUMMI offered Toyota a lower-risk

means of entering the US market. This entry mode was desirable to Toyota because its top executives were

not confident that Japanese-style management would work in the United States. Meanwhile, the venture

offered GM the chance to learn Japanese management and production techniques—skills that were later

used in GM’s facilities. NUMMI offered both companies economies of scale in manufacturing and the

chance to collaborate on automobile designs. Meanwhile, Toyota and GM compete for market share

around the world. In recent years, the firms have been the world’s two largest automakers, and they have

traded the top spot over time.

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In their book titled, not surprisingly, Co-opetition, A. M. Brandenberger and B. J. Nalebuff suggest that

cooperation is generally best suited for “creating a pie,” while competition is best suited for “dividing it

up.” [5] In other words, firms tend to cooperate in activities located far in the value chain from customers,

while competition generally occurs close to customers. The NUMMI example illustrates this tendency—

GM and Toyota worked together on design and manufacturing but worked separately on distribution,

sales, and marketing. Similarly, a research study focused on Scandinavian firms found that, in the mining

equipment industry, firms cooperated in material development, but they competed in product

development and marketing. In the brewing industry, firms worked together on the return of used bottles

but not in distribution. [6]

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Joseph Addison, an eighteenth-century poet, is often credited with coining the phrase “He who hesitates

is lost.” This proverb is especially meaningful in today’s business world. It is easy for executives to become

paralyzed by the dizzying array of competitive and cooperative moves available to them. Given the fast-

paced nature of most industries today, hesitation can lead to disaster. Some observers have suggested that

competition in many settings has transformed into hypercompetition, which involves very rapid and

unpredictable moves and countermoves that can undermine competitive advantages. Under such

conditions, it is often better to make a reasonable move quickly rather than hoping to uncover the perfect

move through extensive and time-consuming analysis.

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The importance of learning also contributes to the value of adopting a “get moving” mentality. This is

illustrated in Miroslav Holub’s poem “Brief Thoughts on Maps.” The discovery that one soldier had a map

gave the soldiers the confidence to start moving rather than continuing to hesitate and remaining lost.

Once they started moving, the soldiers could rely on their skill and training to learn what would work and

what would not. Similarly, success in business often depends on executives learning from a series of

competitive and cooperative moves, not on selecting ideal moves.

K E Y T A K E A W A Y

Cooperating with other firms is sometimes a more lucrative and beneficial approach than directly

attacking competing firms.

E X E R C I S E S

1. How could a family jewelry store use one of the cooperative moves mentioned in this section?? What

type of organization might be a good cooperative partner for a family jewelry store?

2. Why is it that “any old map will do” sometimes in relation to strategic actions?

[1] Portions of this section are adapted from Ketchen, D. J., Snow, C., & Street, V. 2004. Improving firm

performance by matching strategic decision making processes to competitive dynamics. Academy of Management

Executive, 19(4), 29-43. Ibid.

[2] Merck & Co., Inc., and Sun Pharma establish joint venture to develop and commercialize novel formulations

and combinations of medicines in emerging markets [Press release]. 2011, April 11. Merck website. Retrieved

fromhttp://www.merck.com/licensing/our-partnership/sun-partnership.html

[3] Rao, L. 2011, June 14. Twitter announces “strategic alliance” with Yahoo Japan [Blog post]. Techcrunch website.

Retrieved fromhttp://www.techcrunch.com/2011/06/14/twitter-announces-firehose-partnership-with-yahoo-

japan

[4] Global biosimilars market to reach US$4.8 billion by 2015, according to a new report by Global Industry

Analysts, Inc. [Press release]. 2011, February 15. PRWeb website. Retrieved

from http://www.prweb.com/releases/biosimilars/human_growth _hormone/prweb8131268.htm

[5] Brandenberger, A. M., & Nalebuff, B. J. 1996. Co-opetition. New York, NY: Doubleday.

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[6] Bengtsson, M., & Kock, S. 2000. “Coopetition” in business networks—to cooperate and compete

simultaneously. Industrial Marketing Management, 29(5), 411–426.

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6.4 Conclusion

This chapter explains competitive and cooperative moves that executives may choose from when

challenged by competitors. Executives may choose to act swiftly by being a first mover in their

market, and their firms may benefit if they are offering disruptive innovations to an industry.

Executives may also choose a more conservative route by establishing a foothold within an area that

can serve as a launching point or by avoiding existing competitors overall by using a blue ocean

strategy. When firms are on the receiving end of a competitive attack, they are likely to retaliate to

the extent that they possess awareness, motivation, and capability. While responding quickly is often

beneficial, mutual forbearance can also be an effective approach. When firms encounter a potentially

disruptive innovation, they might ignore the threat, confront it head on, or attack along a different

dimension. Executives may also react to competitive attacks by using fighting brands. Rather than

engaging in a head-to-head battle with competitors, executives may also choose to engage in a

cooperative strategy such as a joint venture, strategic alliance, colocation, or co-opetition. Regardless

of the decision executives make, in many cases any attempt to act on a viable road map will result in

progress that will get the firm moving in the right direction.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group should select a

different industry. Find examples of competitive and cooperative moves that you would recommend if

hired as a consultant for a firm in that industry.

2. What types of cooperative moves could your college or university use to partner with local, national, and

international businesses? What benefits and risks would be created by making these moves?

I Academy of Management Executive, 1990 Vol. 4 No. 1

Concentrated growthstrategies

John A. Pearce II, George Mason UniversityJames W. Harvey, George Mason University

Executive Overview 'Thi'his article offers a critical assessment of the merits of concentrated growth asthe centerpiece of a business strategy. It includes an analysis of theenvironmental conditions that favor concentrated growth and why it often leadsto superior performance. It also reviews methods by which innovation andexpansion ccmjie managed at reasonable levels of risk to complement the iirm'sbasic focuSyThese guidelines make it possible to compare a firm's corecharacteristics with the knowledge and capabilities in technology andmarketing that are necessary for profit and growth. The most important aspectsof formulating and implementing concentrated growth strategies are analyzedand examples of current practice show specific instances when those aspectshave resulted in success.

Article Many victims of merger mania were once mistakenly convinced that the best wayto achieve company objectives was to pursue unrelated diversification in thesearch for financial opportunity and synergy, only to see corporate performancefall well below expectation. By rejecting that "conventional wisdom," MartinMarietta, Kentucky Fried Chicken, Compaq, Avon, Hyatt Legal Services, andTenant have demonstrated the advantages of what is increasingly proving to besound business strategy.

Pursuing a Concentrated Growth StrategyThese companies are just a few of the majority of American business firms thatcompete by focusing on a specific product and market combination. Yet, little hasbeen written about—and perhaps as little thought given to—the concentratedgrowth strategy.

Concentrated growth is the strategy of the firm that directs its resources to theprofitable growth of a single product, in a single market, with a single dominanttechnology. The main rationale for this approach, sometimes called a marketpenetration or concentration strategy, is that the firm thoroughly develops andexploits its expertise in a delimited competitive arena.'

Despite the popularity and success of concentrated growth strategies, managershave been left without guidelines to help them determine when their firm shouldemploy concentrated growth and how they should go about maximizing theadvantages of the strategy. Furthermore, current adopters of the concentratedgrowth strategy are frequently tempted to expand into unrelated areas withoutfully understanding the consequences. The enticements to stray from this strategyinclude impatience to grow, pressure to use idle capacity, need to meet short-termgoals, and underestimating current opportunities.^ Fascination with new productdevelopment and expansion into new markets should be tempered with the factthat new products fail at an average rate of 40% for consumer goods, 20% forindustrial products, and 18% for services.^

A further enticement is to accelerate focused growth through horizontal

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integration. While such a strategy offers the advantage of enabling the firm toretain its basic product and market orientation, it exposes the company to a widerange of financially threatening complications. These potential problems includeextended debt involvement; geographic variations in unions, worker contracts,and conditions of employment; added complexity in strategic planning andmanagement coordination; and difficulties owing to multiple suppliers, localcompetitors, and governmental agencies. So numerous and great are thesecomplications that their discussion is beyond the scope of this article. We restrictour attention to challenges confronted by managers who undertake aconcentrated growth strategy through reliance on internal development.

Diversity and Perlormance"Stick to the knitting" is the phrase used by Peters and Waterman to describe oneof several characteristics of successful corporations. "* Staying with what the firmdoes best and avoiding areas of operation of undeveloped skills are the bases fortheir endorsement of concentrated growth.

Systematic analysis of new product successes and failures further underscores therisk of deviating from company strengths. After examining 195 case histories,Calantone and Cooper identified nine new product introduction scenarios, basedon resource compatibility and product superiority.^ The type of introduction thathad the highest level of market success (72%) was described as a synergistic"close-to-home" product. These successful introductions had significant overlapwith the firm's existing products, markets, technical expertise, and productionproficiency. For example, "The Better Mousetrap with No Marketing" type of newproduct introduction had a success rate of 36%, while the "Me Too" product, withno technical or production synergy, averaged only 14%.

This study revealed that the pursuit of growth through expansion into previouslyunmastered technologies, or new markets, is done so at comparatively greatrisk. Other evidence adds support to the view that diversification, particularlyunrelated diversification, is risky.

An analysis of the 250 largest firms in America's 25 largest industries revealed thatfirms that have higher measures of concentrated growth show greater financialperformance.^

Another indictment of unrelated diversification was found in a study of America'sbest midsize businesses.^ Among the key findings was that "unrelateddiversification is a mortal enemy of winning performance." In contrast, successesoften resulted from "edging out." This term refers to strategies based on clearmission statements that are well-understood within the firm, predicated onofferings with value, and serve selected market segments while cautiously movinginto related products, related markets, or both. Success with edging out strategiesis derived from a commitment to innovation within well-known technology andwell-defined market niches.

Rationale for Superior PerformanceWhy do concentrated growth strategies lead to enhanced performance? Ananalysis of product successes and failures across multiple industries suggestsseveral reasons. This study shows that the greatest influences on market successare those characteristic of firms that implement a concentrated growth strategy.^These influences include the ability to assess market needs, knowledge of buyerbehavior, customer price sensitivity, and effectiveness of promotion. Furtherunderscoring the importance of concentrated growth-based company skills, thestudy also showed that these core capabilities are more of a determinant of

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The concentratingfirm's ability to growstems mainly from itsdevelopment of one ormore of threeimportant strategiccapabilities:marketing abilities,efficiencies of scaleand other costreductions, andproductdifferentiation.

competitive market success than are the environmental forces faced by the firm.High success rates of new products are also tied to avoiding situations that requireundeveloped skills, such as serving new customers and markets, acquiring newtechnology, building new channels, developing new promotional abilities, andfacing new competition.^

A major misconception about the concentrated growth strategy is that the firm thatpractices it will settle for little or no growth. This is certainly not true for a firm thatcorrectly utilizes the strategy. A firm employing concentrated growth grows bybuilding on its competencies and achieving a competitive edge by concentratingin the product-market segment it knows best. The firm employing this strategy isaiming for the growth that results from increased productivity, better coverage ofits actual product-market segment, and more efficient use of its technology.

The concentrating firm's ability to grow stems mainly from its development of oneor more of three important strategic capabilities: marketing abilities, efficiencies ofscale and other cost reductions, and product differentiation. Since the firm will tryto develop a specific product-market it has two alternatives to no growth: (1)stimulate increased consumption of the product through marketing-relatedactivities achieving efficiencies in production and distribution that allow the firm tocut its costs or to increase the value of the product in the consumer's mind, or (2) todevelop special attributes that brands the product as different.

Taken together, these points provide insights into why concentrated growthstrategies work. Managers should focus on well-understood markets, competitors,technology, manufacturing processes, promotion, and distribution. This approachsignificantly improves the likelihood of market success.

Conditions that Favor Concentrated GrowthThere are specific conditions in the firm's environment that are particularlyconducive to the concentrated growth strategy. The first is when the firm's industryis resistant to major technological advancements. This is usually the case in thelate growth and maturity stages of the product life cycle and in product-marketswhere product demand is stable and industry entry barriers, such ascapitalization, are high. Machinery for the paper manufacturing industry, wherethe basic technology has not changed in more than a century is a good example.

A second especially favorable condition is when the firm's target markets are notproduct saturated. Markets with competitive gaps leave the firm with alternativesfor growth in addition to taking market share away from competitors. Thesuccessful introduction of traveler services by Allstate and Amoco demonstratesthat even an organization as entrenched and powerful as AAA could not build adefensible presence in all segments of the automobile club market.

A third condition that favors concentrated growth exists when the firm'sproduct-markets are sufficiently distinctive to dissuade competitors in adjacentproduction markets from trying to invade the firm's segment. John Deere and Co.refrained from its planned growth in the construction machinery business whenmighty Caterpillar threatened to enter Deere's mainstay, the farm machinerybusiness, in retaliation. Rather than risk a costly price war on its own turf, Deerescrapped these plans for growth.

A fourth condition favorable to concentrated growth exists when the firm's inputsare reasonably stable in price and quantity and when they are available in theamounts and at the required times. Maryland-based Giant Foods is able toconcentrate in the grocery business largely due to its long-term, stablearrangements with suppliers of its private label products. Most of these suppliersare the same makers of national brands that compete against the Giant labels.

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With a high market share and aggressive retail distribution. Giant controls thenational brands' access to the consumer. Consequently, suppliers haveconsiderable incentive to honor verbal agreements, called "bookings," in whichthey commit themselves to Giant for price, quality, quantity, and timing ofshipments for a one year period.

The firm pursuing concentrated growth also benefits from being in a market withminimal seasonal or cyclical swings that would propel the firm to diversify. NightOwl Security, the Washington, D.C. market leader in home security services,commits customers to initial four-year contracts. In a town where affluentconsumers tend to be quite transient, the length of this relationship is remarkable.Further reinforcement for Night Owl's concentrated growth strategy comes fromthe company's success in getting subsequent owners of its customers' homes toextend and renew the security service contract.

The firm can also grow while concentrating when it experiences competitiveadvantages based on efficient production or distribution channels. Theseadvantages enable the firm to formulate advantageous pricing policies. Moreefficient production methods and better handling of distribution also allow the firmto achieve greater economies of scale or, in conjunction with marketing, result ina product that is differentiated in the mind of the consumer. GranitevilleCompany, the large South Carolina textile manufacturer, realized decades ofgrowth and profitability by adopting a "follower" tact as part of its concentratedgrowth strategy. By producing fabrics only after market demand was wellestablished, and by featuring products that could reflect its expertise in adoptingmanufacturing innovations and in highly efficient, long production runs,Graniteville prospered through concentrated growth.

Finally, the success of market generalists creates conditions for successfulconcentrated growth. °̂

When generalists succeed using universal appeals, they avoid making specialappeals to different groups of customers. The net result is that marketsdominated by generalists leave open many small pockets of markets wherespecialists can emerge and thrive.

For example, hardware store chains such as Stanbaugh-Thompsons andHechinger, focus primarily on routine household repair problems and offersolutions that can be easily sold on a self-service, do-it-yourself basis. Thisapproach leaves gaps at both the "semi-professional" and "neophyte" ends of themarket—in terms of the purchaser's skill at household repairs and the extent towhich available merchandise matches individual homeowner requirements.

Putting A New "Spin" on Concentrated GrowthFirms that rely primarily on concentrated growth strategies may wish to modifytheir courses of action, yet retain their bases of strength. Managerial optionsrepresent varying degrees of concentrated growth. Managers can practice "PureConcentrated Growth," edge out into related markets (let's call this "MarketExtension"), or make minor modifications in products or develop closely relatednew ones that fit within existing lines ("Product Extension"). A final opportunity forgrowth is to combine market and product extensions to form a "Hybrid Extension"strategy.

Pure Concentrated GrowthThe pure concentrated growth strategy involves product improvement, intensifyingpromotion, expanding channels, and pricing for penetration, as exhibited by

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Kentucky Fried Chicken. Using the theme "We Do Chicken Right," KFC stressesproduct specialization, limited menu, expanded distribution, and aggressiveadvertising, sales promotion, and pricing.

Tenant Corporation, MasterCard and Visa pursued pure concentrated growththrough product improvement. Tenant, a manufacturer of mechanized cleaningequipment for industrial markets, recently embarked on a major recommitment toproduct quality and performance. The results include a 60% share of the domesticmarket, a 40% share of the international market, and a rebuff to Toyota which hadplans for increasing its share of the American market. MasterCard's and Visa'sdevelopment of "affinity cards," which allows the holder to select an outsideorganization (usually nonprofit) for a contribution for each transaction, hassucceeded in stimulating the use of its credit cards.

Market ExtensionMarket extension allows companies to practice a different form of concentratedgrowth by identifying new uses for existing products and new demographically,psychographically, or geographically defined markets. Frequently, changes inmedia selection, promotional appeals, and distribution are used to initiate thisapproach. Market extension, by finding a new use for a product, was shown byDu Pont's Kevlar, an organic material used by police, security, and militarypersonnel primarily for bullet-proofing. The product is now being used to refit andmaintain wooden-hulled boats, since the material is both lighter and stronger thanglass fibers and has eleven times the strength of steel.

News in the medical industry provides other examples of new markets for existingproducts. The National Institutes of Health's report of a study showing that aspirinmay lower the incidence of heart attacks in healthy men is expected to boost salesin the $2.2 billion analgesic market. Due to the expansion of this market, it is alsopredicted that share values of non-aspirin brands, such as industry leadersTylenol and Advil, will be hurt. Product extensions currently planned include"Bayer Calendar Pak," 28-day packaging to fit the once-a-day prescription forsecond heart attack prevention.

Product ExtensionThe strategy of product extension is based on penetrating existing markets byincorporating product modifications in existing items, or developing new productswith a clear connection to the existing line. The telecommunications industryprovides an example of product extension based on product modification. Toincrease its estimated 8-10% share of the $5-6 billion corporate user market, MCICommunication Corp. augmented its product offering by extending its direct-dialservice to 146 countries, the same as AT&T, at lower average rates. The recentaddition of 79 countries to its network underscores management's belief in thismarket, estimated to grow 15-20% annually.

Other examples of expansions linked to existing lines include Gerber productsdecision to growth through general merchandise marketing to offset the flat babyfood industry. Recent introductions include 52 items, ranging from feedingaccessories to toys and children's wear.

The Hybrid ExtensionThe hybrid extension is the search for new growth opportunities by simultaneouslycombining market and product modifications. This strategy is used by NAPA, afranchise organization of auto parts aftermarket distributors serving the repairindustry and do-it-yourselfers. NAPA has expanded its operations to offerinstallation of its products. This new service is directed at the market of drivers

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who want complete services that NAPA has never served, and to thosedo-it-yourselfers who want to "trade up" to such services.

The greatest risk isthat by concentratingin a single product-market the firmis particularlyvulnerable to changesin that segment.

Overcommitment to aspecific technologyand product-marketcan hinder a firm'sability to enter a newor growing productmarket that offersmore attractivecost-benefit tradeoffsfor the firm.

Using a similar strategy, Dunkin' Donuts now offers a wider variety of breakfastitems, such as eggs, breakfast meats, and croissants, targeted at the marketsegment not previously served by its donut and coffee offering, and at existingcustomers desiring diversity. Additionally, by packaging its coffee in cans for thefirst time, Dunkin Donuts is implementing a market extension strategy aimed atnew customers who wish to serve its coffee at home or in the office.

Risks and Rewards of Concentrated GrowthUnder stable conditions, a concentrated growth strategy poses the lowest riskamong grand strategies to a firm's economic stability. However, in a changingenvironment, a firm committed to concentrated growth faces high risks. Thegreatest risk is that by concentrating in a single product-market the firm isparticularly vulnerable to changes in that segment. Slowed growth in the segmentmay jeopardize the company because its investment, competitive edge, andtechnology are deeply entrenched in a specific offering. Sudden changes by thefirm are difficult when the product is threatened by near-term obsolescence, afaltering market, new substitutes, or changes in technology or customer needs. Forexample, the manufacturers of IBM-clones faced such a problem when IBMannounced its adoption of the OS/2 operating system for its personal computerline. The change effectively made existing clones "out of date."

By entrenching in a specific industry, the concentrating firm is particularlysusceptible to changes in the economic environment of its industry, since the firmdoes not have a cushion from involvement in other industries. For example. MackTruck, the second largest truck maker in America, saw an 18 month slump in thetruck industry result in a $20 million loss for the company.

Entrenchment in a specific product-market tends to make a concentrating firmmore adept than competitors at detecting new trends. However, any failure toproperly forecast major changes in the industry can result in extraordinary losses.Numerous makers of inexpensive digital watches declared bankruptcy when theyfailed to anticipate the competition posed by Swatch, Guess, qnd other trendywatches that emerged from the fashion industry.

A firm pursuing a concentrated growth strategy is also vulnerable to highopportunity costs by remaining in a specific product-market when other optionsare ignored that could employ the firm's resources more profitably.Overcommitment to a specific technology and product-market can hinder a firm'sability to enter a new or growing product market that offers more attractivecost-benefit tradeoffs for the firm. Had Apple computers maintained its policy ofmaking equipment that did not interface with IBM equipment, it would havevoluntarily ignored the strategic options that instead have proven to be its mostprofitable.

RewardsExamples abound of concentrating firms that report exceptional returns on itsstrategy. Companies like McDonald's, Goodyear, and Apple Computers haveused first-hand knowledge and deep involvement with specific product segmentsto become powerful competitors in its markets. The strategy is even more oftenassociated with successful smaller firms that have steadily and doggedly improvedmarket position.

The limited additional resources necessary to implement concentrated growth,coupled with the limited risk involved, also make this strategy desirable for a firm

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with limited funds. For example, through a carefully devised concentrated growthstrategy, medium-sized Deere and Company was able to become a major force inthe agricultural machinery business even when competing with much bigger firmslike Ford Motor Co. While other firms were trying to exit or diversify from the farmmachinery business, Deere spent $2 billion in upgrading its machinery, boostingefficiency, and engaging in a program to strengthen its dealership system. Thisconcentrated growth strategy enabled the company to become the leader in thefarm machinery business, despite the fact that Ford was 10 times its size.

Firms that remain within a chosen product-market often extract the most fromtechnology and market knowledge and minimize the risks associated withunrelated diversification. The reason for the success of a concentration strategylies with the firm's superior insights into its technology, product, and customer, asa means of obtaining a sustainable competitive advantage. Superior performanceon these aspects of corporate strategy has a significant positive effect on marketsuccess.

ConclusionFirms that are tempted to seek revenue streams through commitment to unrelatedtechnology and markets or to lessen their dependence on mature products, mustfully understand the risks of such actions. The enticement to develop new productsand to expand into new markets must be tempered with the knowledge of highnew product failure rates. When assessing strategic options, managers shouldconsider the merits of concentrated growth. While building from a basis of stabilityand experience, concentrated growth strategies can also provide innovation andexpansion at manageable levels of risk.

Endnotes ' For a more detailed and comprehensivedescription oi alternative business strategies,refer to John A. Pearce II. "Selecting AmongAlternative Grand Strategies." CalUoiniaManagement Review, 30(2). Spring. 1982. 23-31.

^ A more complete list of nine reasons forabandoning a concentrated growth strategy isprovided by M. Lauenstein and W. Skinner."Formulating a Strategy of Superior Resources."Jouinal of Business Stiategy, Summer. 1980.4-10.

' These results were reported in New ProductsManagement for the 1980s, New York: Booz.Allen & Hamilton. 1982.

* The top selling book in which the term firstappeared is T.J. Peters and R.H. Waterman. InSearch of Excellence: Lessons From America'sBest Run Companies, New York: Harper. 1982.

^ For details on this study, see RogerCalantone and Robert G. Cooper. "New ProductScenarios: Prospects for Success." Journal ofMarketing, 45. Spring. 1981. 48-60.

° The complete findings of the study arereported in P. Varadarajan. "Product Diversity

and Firm Performance: An EmpiricalInvestigation."/ournai o/Mariefing, 50. July.1986. 43-57.

' A comprehensive and indepth presentationof the study appears a s Donald K. Clifford. Jr.and Richard E. Cavanagh. The WinningPerformance: How America's High-GrowthMidsize Companies Succeed, New York: BantamBooks. 1985.

° The original presentation of the study andits results appeared in Robert G. Cooper,"Identifying Industrial New Product Success:Project NewProd." Industrial MarketingManagement, 8(2). April. 1979, 124-135.

^ For a complete description and analysis ofthe study, see Robert G. Cooper. "The Impact ofNew Product Strategies." Industrial MarketingManagement, 12(4). October. 1983. 243-256.

'° For a provocative discussion of thecorporate strengths of specialists andgeneralists. see Glenn R. Carroll. "TheSpecialist Strategy." California ManagementReview, 26(3). Spring. 1984. 126-137.

About the Author John A. Pearce II, Ph.D. is the holder of the Eakin Endowed Chair in StrategicManagement in the School of Business Administration at George MasonUniversity and chairman of the school's Management Department. Dr. Pearce ispresident of the Southern Management Association, and past chairman of theAcademy's Entrepreneurship division. A State of Virginia Eminent Scholar, Dr.

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Pearce is a frequent leader of executive development programs and an activeconsultant to business and industry.

James W. Harvey is an associate professor of marketing at George MasonUniversity in Fairfax, Virginia. His research interests include philanthropy,healthcare services, and strategic marketing. Dr. Harvey has served asconsultant and executive development instructor for various organizations,including National Institutes of Health, Department of Health and HumanServices, United Way of America, and National Academy for Voluntarism.

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Chapter 9

Executing Strategy through Organizational Design

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What are the basic building blocks of organizational structure?

2. What types of structures exist, and what are advantages and disadvantages of each?

3. What is control and why is it important?

4. What are the different forms of control and when should they be used?

5. What are the key legal forms of business, and what implications does the choice of a business form have

for organizational structure?

Can Oil Well Services Fuel Success for GE?

Chapter 9 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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General Electric’s logo has changed little since its creation in the 1890s, but the company has grown to become the

sixth largest in the United States.

Image courtesy of The General Electric Company,

http://en.wikipedia.org/wiki/File:Early_General_Electric_logo_1899.png.

In February 2011, General Electric (GE) reached an agreement to acquire the well-support division of

John Wood Group PLC for $2.8 billion. This was GE’s third acquisition of a company that provides

services to oil wells in only five months. In October 2010, GE added the deepwater exploration capabilities

of Wellstream Holdings PLC for $1.3 billion. In December 2010, part and equipment maker Dresser was

acquired for $3 billion. By spending more than $7 billion on these acquisitions, GE executives made it

clear that they had big plans within the oil well services business.

While many executives would struggle to integrate three new companies into their firms, experts expected

GE’s leaders to smoothly execute the transitions. In describing the acquisition of John Wood Group PLC,

for example, one Wall Street analyst noted, “This is a nice bolt-on deal for GE.”[1] In other words, this

analyst believed that John Wood Group PLC could be seamlessly added to GE’s corporate empire. The

way that GE was organized fueled this belief.

GE’s organizational structure includes six divisions, each devoted to specific product categories: (1)

Energy (the most profitable division), (2) Capital (the largest division), (3) Home & Business Solutions,

(4) Healthcare, (5) Aviation, and (6) Transportation. Within the Energy division, there are three

subdivisions: (1) Oil & Gas, (2) Power & Water, and (3) Energy Services. Rather than having the entire

organization involved with integrating John Wood Group PLC, Wellstream Holdings PLC, and Dresser

into GE, these three newly acquired companies would simply be added to the Oil & Gas subdivisions

within the Energy division.

In addition to the six product divisions, GE also had a division devoted to Global Growth & Operations.

This division was responsible for all sales of GE products and services outside the United States. The

Global Growth & Operations division was very important to GE’s future. Indeed, GE’s CEO Jeffrey Immelt

expected that countries other than the United States will account for 60 percent of GE’s sales in the

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future, up from 53 percent in 2010. To maximize GE’s ability to respond to local needs, the Global Growth

& Operations was further divided into twelve geographic regions: China, India, Southeast Asia,

Latin/South America, Russia, Canada, Australia, the Middle East, Africa, Germany, Europe, and Japan. [2]

Finally, like many large companies, GE also provided some centralized services to support all its units.

These support areas included public relations, business development, legal, global research, human

resources, and finance. By having entire units of the organization devoted to these functional areas, GE

hoped not only to minimize expenses but also to create consistency across divisions.

Growing concerns about the environmental effects of drilling, for example, made it likely that GE’s oil well

services operations would need the help of GE’s public relations and legal departments in the future.

Other important questions about GE’s acquisitions remained open as well. In particular, would the

organizational cultures of John Wood Group PLC, Wellstream Holdings PLC, and Dresser mesh with the

culture of GE? Most acquisitions in the business world fail to deliver the results that executives expect,

and the incompatibility of organizational cultures is one reason why.

GE fits a dizzying array of businesses into a relatively simple organizational chart.

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Adapted from company document posted at

http://www.ge.com/pdf/company/ge_organization_chart.pdf

The word executing used in this chapter’s title has two distinct meanings. These meanings were cleverly

intertwined in a quip by John McKay. McKay had the misfortune to be the head coach of a hapless

professional football team. In one game, McKay’s offensive unit played particularly poorly. When McKay

was asked after the game what he thought of his offensive unit’s execution, he wryly responded, “I am in

favor of it.”

In the context of business, execution refers to how well a firm such as GE implements the strategies that

executives create for it. This involves the creation and operation of both an appropriate organizational

structure and an appropriate organizational control processes. Executives who skillfully orchestrate

structure and control are likely to lead their firms to greater levels of success. In contrast, those executives

who fail to do so are likely to be viewed by stakeholders such as employees and owners in much the same

way Coach McKay viewed his offense: as worthy of execution.

[1] Layne, R. 2011, February 14. GE agrees to buy $2.8 billion oil-service unit; shares surge. Bloomsberg

Businessweek. Retrieved fromhttp://www.businessweek.com/news/2011-02-14/ge-agrees-to-buy-2-8-billion-oil-

service-unit-shares-surge.html

[2] GE names vice chairman John Rice to lead GE Global Growth & Operations [Press release]. 2010, November 8.

GE website. Retrieved from http://www.genewscenter.com/ Press-Releases/GE-Names-Vice-Chairman-John-Rice-

to-Lead-GE-Global-Growth-Operations-2c8a.aspx

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9.1 The Basic Building Blocks of Organizational Structure

L E A R N I N G O B J E C T I V E S

1. Understand what division of labor is and why it is beneficial.

2. Distinguish between vertical and horizontal linkages and know what functions each fulfills in an

organizational structure.

Division of Labor

General Electric (GE) offers a dizzying array of products and services, including lightbulbs, jet engines,

and loans. One way that GE could produce its lightbulbs would be to have individual employees work on

one lightbulb at a time from start to finish. This would be very inefficient, however, so GE and most other

organizations avoid this approach. Instead, organizations rely ondivision of labor when creating their

products. Division of labor is a process of splitting up a task (such as the creation of lightbulbs)

into a series of smaller tasks, each of which is performed by a specialist.

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The leaders at the top of organizations have long known that division of labor can improve efficiency.

Thousands of years ago, for example, Moses’s creation of a hierarchy of authority by delegating

responsibility to other judges offered perhaps the earliest known example.

In the eighteenth century, Adam Smith’s book The Wealth of Nations quantified the

tremendous advantages that division of labor offered for a pin factory. If a worker performed all the

various steps involved in making pins himself, he could make about twenty pins per day. By breaking the

process into multiple steps, however, ten workers could make forty-eight thousand pins a day. In other

words, the pin factory was a staggering 240 times more productive than it would have been without

relying on division of labor. In the early twentieth century, Smith’s ideas strongly influenced Henry Ford

and other industrial pioneers who sought to create efficient organizations.

Division of labor allowed eighteenth-century pin factories to dramatically increase their efficiency.

While division of labor fuels efficiency, it also creates a challenge—figuring out how to coordinate

different tasks and the people who perform them. The solution is organizational structure, which is

defined as how tasks are assigned and grouped together with formal reporting relationships. Creating a

structure that effectively coordinates a firm’s activities increases the firm’s likelihood of success.

Meanwhile, a structure that does not match well with a firm’s needs undermines the firm’s chances of

prosperity.

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Division of labor was central to Henry Ford’s development of assembly lines in his automobile

factory. Ford noted, “Nothing is particularly hard if you divide it into small jobs.”

Image courtesy of the Ford Company, http://en.wikipedia.org/wiki/File:A-line1913.jpg.

Vertical and Horizontal Linkages

Most organizations use a diagram called an organizational chart to depict their structure. These

organizational charts show how firms’ structures are built using two basic building blocks: vertical

linkages and horizontal linkages.Vertical linkages tie supervisors and subordinates together. These

linkages show the lines of responsibility through which a supervisor delegates authority to subordinates,

oversees their activities, evaluates their performance, and guides them toward improvement when

necessary. Every supervisor except for the person at the very top of the organization chart also serves as a

subordinate to someone else. In the typical business school, for example, a department chair supervises a

set of professors. The department chair in turn is a subordinate of the dean.

Most executives rely on the unity of command principle when mapping out the vertical linkages in an

organizational structure. This principle states that each person should only report directly to one

supervisor. If employees have multiple bosses, they may receive conflicting guidance about how to do

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their jobs. The unity of command principle helps organizations to avoid such confusion. In the case of

General Electric, for example, the head of the Energy division reports only to the chief executive officer. If

problems were to arise with executing the strategic move discussed in this chapter’s opening vignette—

joining the John Wood Group PLC with GE’s Energy division—the head of the Energy division reports

would look to the chief executive officer for guidance.

Horizontal linkages are relationships between equals in an organization. Often these linkages are called

committees, task forces, or teams. Horizontal linkages are important when close coordination is needed

across different segments of an organization. For example, most business schools revise their

undergraduate curriculum every five or so years to ensure that students are receiving an education that

matches the needs of current business conditions. Typically, a committee consisting of at least one

professor from every academic area (such as management, marketing, accounting, and finance) will be

appointed to perform this task. This approach helps ensure that all aspects of business are represented

appropriately in the new curriculum.

Organic grocery store chain Whole Foods Market is a company that relies heavily on horizontal linkages.

As noted on their website, “At Whole Foods Market we recognize the importance of smaller tribal

groupings to maximize familiarity and trust. We organize our stores and company into a variety of

interlocking teams. Most teams have between 6 and 100 Team Members and the larger teams are divided

further into a variety of sub-teams. The leaders of each team are also members of the Store Leadership

Team and the Store Team Leaders are members of the Regional Leadership Team. This interlocking team

structure continues all the way upwards to the Executive Team at the highest level of the

company.” [1] This emphasis on teams is intended to develop trust throughout the organization, as well as

to make full use of the talents and creativity possessed by every employee.

Informal Linkages

Informal linkages refer to unofficial relationships such as personal friendships, rivalries, and politics. In

the long-running comedy series The Simpsons, Homer Simpson is a low-level—and very low-performing—

employee at a nuclear power plant. In one episode, Homer gains power and influence with the plant’s

owner, Montgomery Burns, which far exceeds Homer’s meager position in the organization chart, because

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Mr. Burns desperately wants to be a member of the bowling team that Homer captains. Homer tries to use

his newfound influence for his own personal gain and naturally the organization as a whole suffers.

Informal linkages such as this one do not appear in organizational charts, but they nevertheless can have

(and often do have) a significant influence on how firms operate.

K E Y T A K E A W A Y

The concept of division of labor (dividing organizational activities into smaller tasks) lies at the heart of

the study of organizational structure. Understanding vertical, horizontal, and informal linkages helps

managers to organize better the different individuals and job functions within a firm.

E X E R C I S E S

1. How is division of labor used when training college or university football teams? Do you think you could

use a different division of labor and achieve more efficiency?

2. What are some formal and informal linkages that you have encountered at your college or university?

What informal linkages have you observed in the workplace?

[1] John Mackey’s blog. 2010, March 9. Creating the high trust organization [Web blog post]. Retrieved fromhttp://www2.wholefoodsmarket.com/blogs/jmackey/2010/03/09/creating-the-high-trust-organization/

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9.2 Creating an Organizational Structure

L E A R N I N G O B J E C T I V E S

1. Know and be able to differentiate among the four types of organizational structure.

2. Understand why a change in structure may be needed.

Within most firms, executives rely on vertical and horizontal linkages to create a structure that they

hope will match the needs of their firm’s strategy. Four types of structures are available to executives:

(1) simple, (2) functional, (3) multidivisional, and (4) matrix. Like snowflakes, however, no two

organizational structures are exactly alike. When creating a structure for their firm, executives will

take one of these types and adapt it to fit the firm’s unique circumstances. As they do this,

executives must realize that the choice of structure will influence their firm’s strategy in the future.

Once a structure is created, it constrains future strategic moves. If a firm’s structure is designed to

maximize efficiency, for example, the firm may lack the flexibility needed to react quickly

to exploit new opportunities.

Simple Structure

Many organizations start out with a simple structure. In this type of structure, an organizational chart is

usually not needed. Simple structures do not rely on formal systems of division of labor.

If the firm is a sole proprietorship, one person performs all the tasks the organization

needs to accomplish. For example, on the TV series The Simpsons, both bar owner Moe Szyslak and the

Comic Book Guy are shown handling all aspects of their respective businesses.

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There is a good reason most sole proprietors do not bother creating formal organizational charts.

If the firm consists of more than one person, tasks tend to be distributed among them in an informal

manner rather than each person developing a narrow area of specialization. In a family-run restaurant or

bed and breakfast, for example, each person must contribute as needed to tasks, such as cleaning

restrooms, food preparation, and serving guests (hopefully not in that order). Meanwhile, strategic

decision making in a simple structure tends to be highly centralized. Indeed, often the owner of the firm

makes all the important decisions. Because there is little emphasis on hierarchy within a simple structure,

organizations that use this type of structure tend to have very few rules and regulations. The process of

evaluating and rewarding employees’ performance also tends to be informal.

The informality of simple structures creates both advantages and disadvantages. On the plus side, the

flexibility offered by simple structures encourages employees’ creativity and individualism. Informality

has potential negative aspects, too. Important tasks may be ignored if no one person is specifically

assigned accountability for them. A lack of clear guidance from the top of the organization can create

confusion for employees, undermine their motivation, and make them dissatisfied with their jobs. Thus

when relying on a simple structure, the owner of a firm must be sure to communicate often and openly

with employees.

Functional Structure

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As a small organization grows, the person in charge of it often finds that a simple structure is no longer

adequate to meet the organization’s needs. Organizations become more complex as they grow, and this

can require more formal division of labor and a strong emphasis on hierarchy and vertical links. In many

cases, these firms evolve from using a simple structure to relying on a functional structure.

Within a functional structure, employees are divided into departments that each handle activities related

to a functional area of the business, such as marketing, production, human resources, information

technology, and customer service. Each of these five areas would be headed up by a manager

who coordinates all activities related to her functional area. Everyone in a company that works on marketing

the company’s products, for example, would report to the manager of the marketing department. The marketing

managers and the managers in charge of the other four areas in turn would report to the chief executive officer.

An example of a functional structure

Reproduced with permission

Using a functional structure creates advantages and disadvantages. An important benefit of adopting a

functional structure is that each person tends to learn a great deal about his or her particular function. By

being placed in a department that consists entirely of marketing professionals, an individual has a great

opportunity to become an expert in marketing. Thus a functional structure tends to create highly skilled

specialists. Second, grouping everyone that serves a particular function into one department tends to keep

costs low and to create efficiency. Also, because all the people in a particular department share the same

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background training, they tend to get along with one another. In other words, conflicts within

departments are relatively rare.

Using a functional structure also has a significant downside: executing strategic changes can be very slow

when compared with other structures. Suppose, for example, that a textbook publisher decides to

introduce a new form of textbook that includes “scratch and sniff” photos that let students smell various

products in addition to reading about them. If the publisher relies on a simple structure, the leader of the

firm can simply assign someone to shepherd this unique new product through all aspects of the

publication process.

If the publisher is organized using a functional structure, however, every department in the organization

will have to be intimately involved in the creation of the new textbooks. Because the new product lies

outside each department’s routines, it may become lost in the proverbial shuffle. And unfortunately for

the books’ authors, the publication process will be halted whenever a functional area does not live up to its

responsibilities in a timely manner. More generally, because functional structures are slow to execute

change, they tend to work best for organizations that offer narrow and stable product lines.

The specific functional departments that appear in an organizational chart vary across organizations that

use functional structures. In the example offered earlier in this section, a firm was divided into five

functional areas: (1) marketing, (2) production, (3) human resources, (4) information technology, and (5)

customer service. In the TV show The Office, a different approach to a functional structure is used at the

Scranton, Pennsylvania, branch of Dunder Mifflin. As of 2009, the branch was divided into six functional

areas: (1) sales, (2) warehouse, (3) quality control, (4) customer service, (5) human resources, and (6)

accounting. A functional structure was a good fit for the branch at the time because its product line was

limited to just selling office paper.

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Multidivisional Structure

Many organizations offer a wide variety of products and services. Some of these organizations sell their

offerings across an array of geographic regions. These approaches require firms to be very responsive to

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customers’ needs. Yet, as noted, functional structures tend to be fairly slow to change. As a result, many

firms abandon the use of a functional structure as their offerings expand. Often the new choice is

a multidivisional structure. In this type of structure, employees are divided into departments based on

product areas and/or geographic regions.

General Electric (GE) is an example of a company organized this way. As shown in the organization chart

that accompanies this chapter’s opening vignette, most of the company’s employees belong to one of six

product divisions (Energy, Capital, Home & Business Solutions, Health Care, Aviation, and

Transportation) or to a division that is devoted to all GE’s operations outside the United States (Global

Growth & Operations).

A big advantage of a multidivisional structure is that it allows a firm to act quickly. When GE makes a

strategic move such as acquiring the well-support division of John Wood Group PLC, only the relevant

division (in this case, Energy) needs to be involved in integrating the new unit into GE’s hierarchy. In

contrast, if GE was organized using a functional structure, the transition would be much slower because

all the divisions in the company would need to be involved. A multidivisional structure also helps an

organization to better serve customers’ needs. In the summer of 2011, for example, GE’s Capital division

started to make real-estate loans after exiting that market during the financial crisis of the late

2000s. [1] Because one division of GE handles all the firm’s loans, the wisdom and skill needed to decide

when to reenter real-estate lending was easily accessible.

Of course, empowering divisions to act quickly can backfire if people in those divisions take actions that

do not fit with the company’s overall strategy. McDonald’s experienced this kind of situation in 2002. In

particular, the French division of McDonald’s ran a surprising advertisement in a magazine called Femme

Actuelle. The ad included a quote from a nutritionist that asserted children should not eat at a McDonald’s

more than once per week. Executives at McDonald’s headquarters in suburban Chicago were concerned

about the message sent to their customers, of course, and they made it clear that they strongly disagreed

with the nutritionist.

Another downside of multidivisional structures is that they tend to be more costly to operate than

functional structures. While a functional structure offers the opportunity to gain efficiency by having just

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one department handle all activities in an area, such as marketing, a firm using a multidivisional structure

needs to have marketing units within each of its divisions. In GE’s case, for example, each of its seven

divisions must develop marketing skills. Absorbing the extra expenses that are created reduces a firm’s

profit margin.

GE’s organizational chart highlights a way that firms can reduce some of these expenses: the

centralization of some functional services. As shown in the organizational chart, departments devoted to

important aspects of public relations, business development, legal, global research, human resources, and

finance are maintained centrally to provide services to the six product divisions and the geographic

division. By consolidating some human resource activities in one location, for example, GE creates

efficiency and saves money.

An additional benefit of such moves is that consistency is created across divisions. In 2011, for example,

the Coca-Cola Company created an Office of Sustainability to coordinate sustainability initiatives across

the entire company. Bea Perez was named Coca-Cola’s chief sustainability officer and was put in charge of

the Office of Sustainability. At the time, Coca-Cola’s chief executive officer Muhtar Kent noted that Coca-

Cola had “made significant progress with our sustainability initiatives, but our current approach needs

focus and better integration.” [2] In other words, a department devoted to creating consistency across

Coca-Cola’s sustainability efforts was needed for Coca-Cola to meet its sustainability goals.

Matrix Structure

Within functional and multidivisional structures, vertical linkages between bosses and subordinates are

the most elements. Matrix structures, in contrast, rely heavily on horizontal relationships. [3] In particular,

these structures create cross-functional teams that each work on a different project. This offers several

benefits: maximizing the organization’s flexibility, enhancing communication across functional lines, and

creating a spirit of teamwork and collaboration. A matrix structure can also help develop new managers.

In particular, a person without managerial experience can be put in charge of a relatively small project as

a test to see whether the person has a talent for leading others.

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Using a matrix structure can create difficulties too. One concern is that using a matrix structure violates

the unity of command principle because each employee is assigned multiple bosses. Specifically, any given

individual reports to a functional area supervisor as well as one or more project supervisors. This creates

confusion for employees because they are left unsure about who should be giving them direction.

Violating the unity of command principle also creates opportunities for unsavory employees to avoid

responsibility by claiming to each supervisor that a different supervisor is currently depending on their

efforts.

The potential for conflicts arising between project managers within a matrix structure is another concern.

Chances are that you have had some classes with professors who are excellent speakers while you have

been forced to suffer through a semester of incomprehensible lectures in other classes. This mix of

experiences reflects a fundamental reality of management: in any organization, some workers are more

talented and motivated than others. Within a matrix structure, each project manager naturally will want

the best people in the company assigned to her project because their boss evaluates these managers based

on how well their projects perform. Because the best people are a scarce resource, infighting and politics

can easily flare up around which people are assigned to each project.

Given these problems, not every organization is a good candidate to use a matrix structure. Organizations

such as engineering and consulting firms that need to maximize their flexibility to service projects of

limited duration can benefit from the use of a matrix. Matrix structures are also used to organize research

and development departments within many large corporations. In each of these settings, the benefits of

organizing around teams are so great that they often outweigh the risks of doing so.

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Strategy at the Movies

Office Space

How much work can a man accomplish with eight bosses breathing down his neck? For Peter Gibbons, an

employee at information technology firm Initech in the 1999 movie Office Space, the answer was zero.

Initech’s use of a matrix structure meant that each employee had multiple bosses, each representing a

different aspect of Initech’s business. High-tech firms often use matrix to gain the flexibility needed to

manage multiple projects simultaneously. Successfully using a matrix structure requires excellent

communication among various managers—however, excellence that Initech could not reach. When

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Gibbons forgot to put the appropriate cover sheet on his TPS report, each of his eight bosses—and a

parade of his coworkers—admonished him. This fiasco and others led to Gibbons to become cynical about

his job.

Simpler organizational structures can be equally frustrating. Joanna, a waitress at nearby restaurant

Chotchkie’s, had only one manager—a stark contrast to Gibbons’s eight bosses. Unfortunately, Joanna’s

manager had an unhealthy obsession with the “flair” (colorful buttons and pins) used by employees to

enliven their uniforms. A series of mixed messages about the restaurant’s policy on flair led Joanna to

emphatically proclaim—both verbally and nonverbally—her disdain for the manager. She then quit her job

and stormed out of the restaurant.

Office Space illustrates the importance of organizational design decisions to an organization’s culture and

to employees’ motivation levels. A matrix structure can facilitate resource sharing and collaboration but

may also create complicated working relationships and impose excessive stress on employees. Chotchkie’s

organizational structure involved simpler working relationships, but these relationships were strained

beyond the breaking point by a manager’s eccentricities. In a more general sense, Office Spaceshows that

all organizational structures involve a series of trade-offs that must be carefully managed.

Boundaryless Organizations

Most organizational charts show clear divisions and boundaries between different units. The value of a

much different approach was highlighted by former GE CEO Jack Welch when he created the term

boundaryless organization. A boundaryless organization is one that removes the usual barriers between

parts of the organization as well as barriers between the organization and others. [4] Eliminating all

internal and external barriers is not possible, of course, but making progress toward being boundaryless

can help an organization become more flexible and responsive. One example is W.L. Gore, a maker of

fabrics, medical implants, industrial sealants, filtration systems, and consumer products. This firm avoids

organizational charts, management layers, and supervisors despite having approximately nine thousand

employees across thirty countries. Rather than granting formal titles to certain people, leaders with W.L.

Gore emerge based on performance and they attract followers to their ideas over time. As one employee

noted, “We vote with our feet. If you call a meeting, and people show up, you’re a leader.” [5]

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The boundaryless approach to structure embraced by W.L. Gore drives the kind of creative

thinking that led to their most famous product, GORE-TEX.

Image courtesy of adifansnet, http://www.flickr.com/photos/adifans/3706215019.

An illustration of how removing barriers can be valuable has its roots in a very unfortunate event. During

2005’s Hurricane Katrina, rescue efforts were hampered by a lack of coordination between responders

from the National Guard (who are controlled by state governments) and from active-duty military units

(who are controlled by federal authorities). According to one National Guard officer, “It was just like a

solid wall was between the two entities.” [6]Efforts were needlessly duplicated in some geographic areas

while attention to other areas was delayed or inadequate. For example, poor coordination caused the

evacuation of thousands of people from the New Orleans Superdome to be delayed by a full day. The

results were immense human suffering and numerous fatalities.

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In 2005, boundaries between organizations hampered rescue efforts following Hurricane Katrina.

Image courtesy of Kyle Niemi,

http://upload.wikimedia.org/wikipedia/commons/3/3d/KatrinaNewOrleansFlooded_edit2.jpg.

To avoid similar problems from arising in the future, barriers between the National Guard and active-duty

military units are being bridged by special military officers called dual-status commanders. These

individuals will be empowered to lead both types of units during a disaster recovery effort, helping to

ensure that all areas receive the attention they need in a timely manner.

Reasons for Changing an Organization’s Structure

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Creating an organizational structure is not a onetime activity. Executives must revisit an organization’s

structure over time and make changes to it if certain danger signs arise. For example, a structure might

need to be adjusted if decisions with the organization are being made too slowly or if the organization is

performing poorly. Both these problems plagued Sears Holdings in 2008, leading executives to reorganize

the company.

Although it was created to emphasize the need for unity among the American colonies, this famous 1754 graphic by

Ben Franklin also illustrates a fundamental truth about structure: If the parts that make up a firm do not work

together, the firm is likely to fail.

Image courtesy of Wikipedia, http://upload.wikimedia.org/wikipedia/commons/9/9c/Benjamin_Franklin_-

_Join_or_Die.jpg.

Sears’s new structure organized the firm around five types of divisions: (1) operating businesses (such as

clothing, appliances, and electronics), (2) support units (certain functional areas such as marketing and

finance), (3) brands (which focus on nurturing the firm’s various brands such as Lands’ End, Joe Boxer,

Craftsman, and Kenmore), (4) online, and (5) real estate. At the time, Sears’s chairman Edward S.

Lampert noted that “by creating smaller focused teams that are clearly responsible for their units, we

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[will] increase autonomy and accountability, create greater ownership and enable faster, better

decisions.” [7] Unfortunately, structural changes cannot cure all a company’s ills. As of July 2011, Sears’s

stock was worth just over half what it had been worth five years earlier.

Sometimes structures become too complex and need to be simplified. Many observers believe that this

description fits Cisco. The company’s CEO, John Chambers, has moved Cisco away from a hierarchical

emphasis toward a focus on horizontal linkages. As of late 2009, Cisco had four types of such linkages. For

any given project, a small team of people reported to one of forty-seven boards. The boards averaged

fourteen members each. Forty-three of these boards each reported to one of twelve councils. Each council

also averaged fourteen members. The councils reported to an operating committee consisting of

Chambers and fifteen other top executives. Four of the forty-seven boards bypassed the councils and

reported directly to the operating committee. These arrangements are so complex and time consuming

that some top executives spend 30 percent of their work hours serving on more than ten of the boards,

councils, and the operating committee.

Because it competes in fast-changing high-tech markets, Cisco needs to be able to make competitive

moves quickly. The firm’s complex structural arrangements are preventing this. In late 2007, Hewlett-

Packard (HP) started promoting a warranty service that provides free support and upgrades within the

computer network switches market. Because Cisco’s response to this initiative had to work its way

through multiple committees, the firm did not take action until April 2009. During the delay, Cisco’s

share of the market dropped as customers embraced HP’s warranty. This problem and others created by

Cisco’s overly complex structure were so severe that one columnist wondered aloud “has Cisco’s John

Chambers lost his mind?” [8] In the summer of 2011, Chambers reversed course and decided to return

Cisco to a more traditional structure while reducing the firm’s workforce by 9 percent. Time will tell

whether these structural changes will boost Cisco’s stock price, which remained flat between 2006 and

mid-2011.

K E Y T A K E A W A Y

Executives must select among the four types of structure (simple, functional, multidivisional, and matrix)

available to organize operations. Each structure has unique advantages, and the selection of structures

involves a series of trade-offs.

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E X E R C I S E S

1. What type of structure best describes the organization of your college or university? What led you to

reach your conclusion?

2. The movie Office Space illustrates two types of structures. What are some other scenes or themes from

movies that provide examples or insights relevant to understanding organizational structure?

[1] Jacobius, A. 2011, July 25. GE Capital slowly moving back into lending waters. Pensions & Investments.

Retrieved fromhttp://www.pionline.com/article/20110725/PRINTSUB/110729949

[2] McWilliams, J. 2011, May 19. Coca-Cola names Bea Perez chief sustainability officer.Atlantic-Journal

Constitution. Retrieved from http://www.ajc.com/business/coca-cola-names-bea-951741.html

[3] This discussion of matrix structures is adapted from Ketchen, D. J., & Short, J. C. 2011. Separating fads from

facts: Lessons from “the good, the fad, and the ugly.” Business Horizons, 54, 17–22.

[4] Askenas, R., Ulrich, D., Jick, T., & Kerr, S. 1995. The boundaryless organization: Breaking down the chains of

organizational structure. San Francisco, CA: Jossey-Bass.

[5] Hamel, G. 2007, September 27. What Google, Whole Foods do best. CNNMoney. Retrieved from

http://money.cnn.com/2007/09/26/news/companies/management_hamel. fortune/index.htm

[6] Elliott, D. 2011, July 3. New type of commander may avoid Katrina-like chaos. Yahoo! News. Retrieved from

http://news.yahoo.com/type-commander-may-avoid-katrina-chaos-153 143508.html

[7] Sears restructures business units. Retail Net. Retrieved from http://www.retailnet.com /story.cfm?ID=41613.

[8] Blodget, H. 2009, August 6. Has Cisco’s John Chambers lost his mind? Business Insider. Retrieved

from http://www.businessinsider.com/henry-blodget-has-ciscos-john- chambers-lost-his-mind-2009-8

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9.3 Creating Organizational Control Systems

L E A R N I N G O B J E C T I V E S

1. Understand the three types of control systems.

2. Know the strengths and weaknesses of common management fads.

In addition to creating an appropriate organizational structure, effectively executing strategy

depends on the skillful use of organizational control systems. Executives create strategies to try to

achieve their organization’s vision, mission, and goals. Organizational control systems allow

executives to track how well the organization is performing, identify areas of concern, and then take

action to address the concerns. Three basic types of control systems are available to executives: (1)

output control, (2) behavioral control, and (3) clan control. Different organizations emphasize

different types of control, but most organizations use a mix of all three types.

Output Control

Output control focuses on measurable results within an organization. Examples from the business world

include the number of hits a website receives per day, the number of microwave ovens an assembly line

produces per week, and the number of vehicles a car salesman sells per month (Figure 9.6 "Output

Controls"). In each of these cases, executives must decide what level of performance is acceptable,

communicate expectations to the relevant employees, track whether performance meets expectations, and

then make any needed changes. In an ironic example, a group of post office workers in Pensacola, Florida,

were once disappointed to learn that their paychecks had been lost—by the US Postal Service! The

corrective action was simple: they started receiving their pay via direct deposit rather than through the

mail.

Many times the stakes are much higher. In early 2011, Delta Air Lines was forced to face some facts as

part of its use of output control. Data gathered by the federal government revealed that only 77.4 percent

of Delta’s flights had arrived on time during 2010. This performance led Delta to rank dead last among the

major US airlines and fifteenth out of eighteen total carriers. [1] In response, Delta took important

corrective steps. In particular, the airline added to its ability to service airplanes and provided more

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customer service training for its employees. Because some delays are inevitable, Delta also announced

plans to staff a Twitter account called Delta Assist around the clock to help passengers whose flights are

delayed. These changes and others paid off. For the second quarter of 2011, Delta enjoyed a $198 million

profit, despite having to absorb a $1 billion increase in its fuel costs due to rising prices. [2]

Output control also plays a big part in the college experience. For example, test scores and grade point

averages are good examples of output measures. If you perform badly on a test, you might take corrective

action by studying harder or by studying in a group for the next test. At most colleges and universities, a

student is put on academic probation when his grade point average drops below a certain level. If the

student’s performance does not improve, he may be removed from his major and even dismissed. On the

positive side, output measures can trigger rewards too. A very high grade point average can lead to

placement on the dean’s list and graduating with honors.

While most scholarships require a high GPA, comedian David Letterman created a scholarship for

a “C” student at Ball State University. Ball State later named a new communications and media

building after its very famous alumnus.

Image courtesy of Kyle

Flood,http://upload.wikimedia.org/wikipedia/commons/e/eb/David_Letterman_building.jpg.

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Behavioral Control

While output control focuses on results, behavioral control focuses on controlling the actions that

ultimately lead to results. In particular, various rules and procedures are used to standardize or to dictate

behavior. In most states, for example, signs are posted in restaurant bathrooms reminding employees

that they must wash their hands before returning to work. The dress codes that are enforced within

many organizations are another example of behavioral control. To try to prevent employee theft, many firms

have a rule that requires checks to be signed by two people. And in a somewhat bizarre example, some automobile

factories dictate to workers how many minutes they can spend in restrooms during their work shift.

Behavioral control also plays a significant role in the college experience. An illustrative (although perhaps

unpleasant) example is penalizing students for not attending class. Professors grade attendance to dictate

students’ behavior; specifically, to force students to attend class. Meanwhile, if you were to suggest that a

rule should be created to force professors to update their lectures at least once every five years, we would

not disagree with you.

Outside the classroom, behavioral control is a major factor within college athletic programs. The National

Collegiate Athletic Association (NCAA) governs college athletics using a huge set of rules, policies, and

procedures. The NCAA’s rulebook on behavior is so complex that virtually all coaches violate its rules at

one time or another. Critics suggest that the behavioral controls instituted by the NCAA have reached an

absurd level. Nevertheless, some degree of behavioral control is needed within virtually all organizations.

Creating an effective reward structure is key to effectively managing behavior because people tend to focus

their efforts on the rewarded behaviors. Problems can arise when people are rewarded for behaviors that

seem positive on the surface but that can actually undermine organizational goals under some

circumstances. For example, restaurant servers are highly motivated to serve their tables quickly because

doing so can increase their tips. But if a server devotes all his or her attention to providing fast service,

other tasks that are vital to running a restaurant, such as communicating effectively with managers, host

staff, chefs, and other servers, may suffer. Managers need to be aware of such trade-offs and strive to align

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rewards with behaviors. For example, waitstaff who consistently behave as team players could be assigned

to the most desirable and lucrative shifts, such as nights and weekends.

Although some behavioral controls are intended for employees and not customers, following them

is beneficial to everyone.

Image courtesy of Sterilgutassistentin,

http://en.wikipedia.org/wiki/File:Manhattan_New_York_City_2009_PD_20091130_209.JPG.

Clan Control

Instead of measuring results (as in outcome control) or dictating behavior (as in behavioral

control), clan control is an informal type of control. Specifically, clan control relies on shared traditions,

expectations, values, and norms to lead people to work toward the good of their organization.

Clan control is often used heavily in settings where creativity is vital, such as many high-

tech businesses. In these companies, output is tough to dictate, and many rules are not appropriate. The

creativity of a research scientist would be likely to be stifled, for example, if she were given a quota of

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patents that she must meet each year (output control) or if a strict dress code were enforced (behavioral

control).

Google is a firm that relies on clan control to be successful. Employees are permitted to spend 20 percent

of their workweek on their own innovative projects. The company offers an ‘‘ideas mailing list’’ for

employees to submit new ideas and to comment on others’ ideas. Google executives routinely make

themselves available two to three times per week for employees to visit with them to present their ideas.

These informal meetings have generated a number of innovations, including personalized home pages

and Google News, which might otherwise have never been adopted.

As part of the team-building effort at Google, new employees are known as Noogles and are given

a propeller hat to wear.

Image courtesy of Tduk Alex Lozupone,http://en.wikipedia.org/wiki/File:Noogler.png.

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Some executives look to clan control to improve the performance of struggling organizations. In 2005,

Florida officials became fed up with complaints about surly clerks within the state’s driver’s license

offices. The solution was to look for help with training employees from two companies that are well-

known for friendly, engaged employees and excellent customer service. The first was The Walt Disney

Company, which offers world-famous hospitality at its Orlando theme parks. The second was regional

supermarket chain Publix, a firm whose motto stressed that “shopping is a pleasure” in its stores. The goal

of the training was to build the sort of positive team spirit Disney and Publix enjoy. The state’s highway

safety director summarized the need for clan control when noting that “we’ve just got to change a little

culture out there.” [3]

Clan control is also important on many college campuses. Philanthropic and social organizations such as

clubs, fraternities, and sororities often revolve around shared values and team spirit. More broadly, many

campuses have treasured traditions that bind alumni together across generations. Purdue University, for

example, proudly owns the world’s largest drum. The drum is beaten loudly before home football games

to fire up the crowd. After athletic victories, Auburn University students throw rolls of toilet paper into

campus oak trees. At Clark University, Rollins College, and Emory University, time-honored traditions

that involve spontaneously canceling classes surprise and delight students. These examples and

thousands of others spread across the country’s colleges and universities help students feel like they

belong to something special.

Management Fads: Out of Control?

Don’t chase the latest management fads. The situation dictates which approach best accomplishes the

team’s mission.

– Colin Powell

The emergence and disappearance of fads appears to be a predictable aspect of modern society. A fad

arises when some element of popular culture becomes enthusiastically embraced by a group of people.

Over the past few decades, for example, fashion fads have included leisure suits (1970s), “Members Only”

jackets (1980s), Doc Martens shoes (1990s), and Crocs (2000s). Ironically, the reason a fad arises is also

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usually the cause of its demise. The uniqueness (or even outrageousness) of a fashion, toy, or hairstyle

creates “buzz” and publicity but also ensures that its appeal is only temporary. [4]

Fads also seem to be a predictable aspect of the business world. As with cultural fads, many

provocative business ideas go through a life cycle of creating buzz, captivating a group of

enthusiastic adherents, and then giving way to the next fad. Bookstore shelves offer a seemingly

endless supply of popular management books whose premises range from the intriguing to

the absurd. Within the topic of leadership, for example, various books promise to reveal the “leadership

secrets” of an eclectic array of famous individuals such as Jesus Christ, Hillary Clinton, Attila the Hun,

and Santa Claus.

Beyond the striking similarities between cultural and business fads, there are also important differences.

Most cultural fads are harmless, and they rarely create any long-term problems for those that embrace

them. In contrast, embracing business fads could lead executives to make bad decisions. As our quote

from Colin Powell suggests, relying on sound business practices is much more likely to help executives to

execute their organization’s strategy than are generic words of wisdom from Old St. Nick.

Many management fads have been closely tied to organizational control systems. For example, one of the

best-known fads was an attempt to use output control to improve

performance. Management by objectives (MBO) is a process wherein managers and employees work

together to create goals. These goals guide employees’ behaviors and serve as the benchmarks for

assessing their performance. Following the presentation of MBO in Peter Drucker’s 1954 book The

Practice of Management, many executives embraced the process as a cure-all for organizational problems

and challenges.

Like many fads, however, MBO became a good idea run amok. Companies that attempted to create an

objective for every aspect of employees’ activities eventually discovered that this was unrealistic. The

creation of explicit goals can conflict with activities involving tacit knowledge about the organization.

Intangible notions such as “providing excellent customer service,” “treating people right,” and “going the

extra mile” are central to many organizations’ success, but these notions are difficult if not impossible to

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quantify. Thus, in some cases, getting employees to embrace certain values and other aspects of clan

control is more effective than MBO.

Quality circles were a second fad that built on the notion of behavioral control. Quality circles began in

Japan in the 1960s and were first introduced in the United States in 1972. A quality circle is a formal

group of employees that meets regularly to brainstorm solutions to organizational problems. As the name

“quality circle” suggests, identifying behaviors that would improve the quality of products and the

operations management processes that create the products was the formal charge of many quality circles.

While the quality circle fad depicted quality as the key driver of productivity, it quickly became apparent

that this perspective was too narrow. Instead, quality is just one of four critical dimensions of the

production process; speed, cost, and flexibility are also vital. Maximizing any one of these four dimensions

often results in a product that simply cannot satisfy customers’ needs. Many products with perfect quality,

for example, would be created too slowly and at too great a cost to compete in the market effectively. Thus

trade-offs among quality, speed, cost, and flexibility are inevitable.

Improving clan control was the aim of sensitivity-training groups (or T-groups) that were used in many

organizations in the 1960s. This fad involved gatherings of approximately eight to fifteen people openly

discussing their emotions, feelings, beliefs, and biases about workplace issues. In stark contrast to the

rigid nature of MBO, the T-group involved free-flowing conversations led by a facilitator. These

discussions were thought to lead individuals to greater understanding of themselves and others. The

anticipated results were more enlightened workers and a greater spirit of teamwork.

Research on social psychology has found that groups are often far crueler than individuals. Unfortunately,

this meant that the candid nature of T-group discussions could easily degenerate into accusations and

humiliation. Eventually, the T-group fad gave way to recognition that creating potentially hurtful

situations has no place within an organization. Hints of the softer side of T-groups can still be observed in

modern team-building fads, however. Perhaps the best known is the “trust game,” which claims to build

trust between employees by having individuals fall backward and depend on their coworkers to catch

them.

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Improving clan control was the basis for the fascination with organizational culture that was all the rage

in the 1980s. This fad was fueled by a best-selling 1982 book titled In Search of Excellence: Lessons from

America’s Best-Run Companies. Authors Tom Peters and Robert Waterman studied companies that they

viewed as stellar performers and distilled eight similarities that were shared across the companies. Most

of the similarities, including staying “close to the customer” and “productivity through people,” arose from

powerful corporate cultures. The book quickly became an international sensation; more than three million

copies were sold in the first four years after its publication.

Soon it became clear that organizational culture’s importance was being exaggerated. Before long, both

the popular press and academic research revealed that many of Peters and Waterman’s “excellent”

companies quickly had fallen on hard times. Basic themes such as customer service and valuing one’s

company are quite useful, but these clan control elements often cannot take the place of holding

employees accountable for their performance.

The history of fads allows us to make certain predictions about today’s hot ideas, such as empowerment,

“good to great,” and viral marketing. Executives who distill and act on basic lessons from these fads are

likely to enjoy performance improvements. Empowerment, for example, builds on important research

findings regarding employees—many workers have important insights to offer to their firms, and these

workers become more engaged in their jobs when executives take their insights seriously. Relying too

heavily on a fad, however, seldom turns out well.

Just as executives in the 1980s could not treat In Search of Excellence as a recipe for success, today’s

executives should avoid treating James Collins’s 2001 best-selling book Good to Great: Why Some

Companies Make the Leap…and Others Don’t as a detailed blueprint for running their companies.

Overall, executives should understand that management fads usually contain a core truth that can help

organizations improve but that a balance of output, behavioral, and clan control is needed within most

organizations. As legendary author Jack Kerouac noted, “Great things are not accomplished by those who

yield to trends and fads and popular opinion.”

K E Y T A K E A W A Y

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Organizational control systems are a vital aspect of executing strategy because they track performance

and identify adjustments that need to be made. Output controls involve measurable results. Behavioral

controls involve regulating activities rather than outcomes. Clan control relies on a set of shared values,

expectations, traditions, and norms. Over time, a series of fads intended to improve organizational control

processes have emerged. Although these fads tend to be seen as cure-alls initially, executives eventually

realize that an array of sound business practices is needed to create effective organizational controls.

E X E R C I S E S

1. What type of control do you think works most effectively with you and why?

2. What are some common business practices that you predict will be considered fads in the future?

3. How could you integrate each type of control intro a college classroom to maximize student learning?

[1] Yamanouchi, K. 2011, February 10. Delta ranks near bottom in on-time performance.Atlanta-Journal

Constitution. Retrieved from http://www.ajc.com/business/delta-ranks-near-bottom-834380.html

[2] Yamanouchi, K. 2011, July 27. Delta has $198 million profit, says 2,000 took buyouts.Atlanta-Journal

Constitution. Retrieved from http://www.ajc.com/business/delta-has-198-million-1050461.html

[3] Bousquet, S. 2005, September 23. For surly license clerks. a pound of charm. St Petersburg Times. Retrieved

fromhttp://www.sptimes.com/2005/09/23/State/For_surly_license _cle.shtml

[4] This discussion of management fads is adapted from Ketchen, D. J., & Short, J. C. 2011. Separating fads from

facts: Lessons from “the good, the fad, and the ugly.” Business Horizons, 54, 17–22.

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9.4 Legal Forms of Business

L E A R N I N G O B J E C T I V E S

1. Know the three basic legal forms of business.

2. Know the two specialized types of corporations.

Choosing a Form of Business

The legal form a firm chooses to operate under is an important decision with implications for how a firm

structures its resources and assets. Several legal forms of business are available to executives. Each

involves a different approach to dealing with profits and losses (Figure 9.10 "Business Forms").

There are three basic forms of business. A sole proprietorship is a firm that is owned by one person. From

a legal perspective, the firm and its owner are considered one and the same. On the plus side, this means

that all profits are the property of the owner (after taxes are paid, of course). On the minus side, however,

the owner is personally responsible for the firm’s losses and debts. This presents a tremendous risk. If a

sole proprietor is on the losing end of a significant lawsuit, for example, the owner could find his personal

assets forfeited. Most sole proprietorships are small and many have no employees. In most towns, for

example, there are a number of self-employed repair people, plumbers, and electricians who work alone

on home repair jobs. Also, many sole proprietors run their businesses from their homes to avoid expenses

associated with operating an office.

In a partnership, two or more partners share ownership of a firm. A partnership is similar to a sole

proprietorship in that the partners are the only beneficiaries of the firm’s profits, but they are also

responsible for any losses and debts. Partnerships can be especially attractive if each person’s expertise

complements the others. For example, an accountant who specializes in preparing individual tax returns

and another who has mastered business taxes might choose to join forces to offer customers a more

complete set of tax services than either could offer alone.

From a practical standpoint, a partnership allows a person to take time off without closing down the

business temporarily. Sander & Lawrence is a partnership of two home builders in Tallahassee, Florida.

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When Lawrence suffered a serious injury a few years ago, Sander was able to take over supervising his

projects and see them through to completion. Had Lawrence been a sole proprietor, his customers would

have suffered greatly. However, a person who chooses to be part of a partnership rather than operating

alone as a sole proprietor also takes on some risk; your partner could make bad decisions that end up

costing you a lot of money. Thus developing trust and confidence in one’s partner is very important.

Most large firms, such as Southwest Airlines, are organized as corporations. A key difference between

a corporation on the one hand and a sole proprietorship and a partnership on the other is that

corporations involve the separation of ownership and management. Corporations sell shares of ownership

that are publicly traded in stock markets, and they are managed by professional executives. These

executives may own a significant portion of the corporation’s stock, but this is not a legal requirement.

Another unique feature of corporations is how they deal with profits and losses. Unlike in sole

proprietorships and partnerships, a corporation’s owners (i.e., shareholders) do not directly receive

profits or absorb losses. Instead, profits and losses indirectly affect shareholders in two ways. First, profits

and losses tend to be reflected in whether the firm’s stock price rises or falls. When a shareholder sells her

stock, the firm’s performance while she has owned the stock will influence whether she makes a profit

relative to her stock purchase. Shareholders can also benefit from profits if a firm’s executives decide to

pay cash dividends to shareholders. Unfortunately, for shareholders, corporate profits and any dividends

that these profits support are both taxed. This double taxation is a big disadvantage of corporations.

A specialized type of corporation called an S corporation avoids double taxation. Much like in a

partnership, the firm’s profits and losses are reported on owners’ personal tax returns in proportion with

each owner’s share of the firm. Although this is an attractive feature, an S corporation would be

impractical for most large firms because the number of shareholders in an S corporation is capped,

usually at one hundred. In contrast, Southwest Airlines has more than ten thousand shareholders. For

smaller firms, such as many real-estate agencies, the S corporation is an attractive form of business.

A final form of business is very popular, yet it is not actually recognized by the federal government as a

form of business. Instead, the ability to create a limited liability company (LLC) is granted in state laws.

LLCs mix attractive features of corporations and partnerships. The owners of an LLC are not personally

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responsible for debts that the LLC accumulates (like in a corporation) and the LLC can be run in a flexible

manner (like in a partnership). When paying federal taxes, however, an LLC must choose to be treated as

a corporation, a partnership, or a sole proprietorship. Many home builders (including Sander &

Lawrence), architectural businesses, and consulting firms are LLCs.

K E Y T A K E A W A Y

The three major forms of business in the United States are sole proprietorships, partnerships, and

corporations. Each form has implications for how individuals are taxed and resources are managed and

deployed. E X E R C I S E S

1. Why are so many small firms sole proprietorships?

2. Find an example of a firm that operates as an LLC. Why do you think the owners of this firm chose this

form of business over others?

3. Why might different forms of business be more likely to rely on a different organizational structure?

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9.5 Conclusion

This chapter explains elements of organizational design that are vital for executing strategy. Leaders

of firms, ranging from the smallest sole proprietorship to the largest global corporation, must make

decisions about the delegation of authority and responsibility when organizing activities within their

firms. Deciding how to best divide labor to increase efficiency and effectiveness is often the starting

point for more complex decisions that lead to the creation of formal organizational charts. While

small businesses rarely create organization charts, firms that embrace functional, multidivisional,

and matrix structures often have reporting relationships with considerable complexity. To execute

strategy effectively, managers also depend on the skillful use of organizational control systems that

involve output, behavioral, and clan controls. Although introducing more efficient business practices

to improve organizational functioning is desirable, executives need to avoid letting their firms

become “out of control” by being skeptical of management fads. Finally, the legal form a business

takes is an important decision with implications for a firm’s organizational structure.

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E X E R C I S E S

1. The following chart is an organizational chart for the US federal government. What type of the four

structures mentioned in this chapter best fits what you see in this chart?

2. How does this structure explain why the government seems to move at an incredibly slow pace?

3. What changes could be made to speed up the government? Would they be beneficial?