Organizing to Implement Diversification Chapter 8 Organizing to Implement Diversification

The Strategic Management Process External Analysis Strategic Choice Strategy Implementation Competitive Advantage Mission Objectives Internal Analysis Implementing Corporate Diversification

Implementation Issues How Information Flows Where and By Whom are Decisions Made How to Influence the Behavior of People • how can the interests of employees be aligned with the interests of the firm?

The Need for Organizational Structure Information Processing Requirements • as organizations become larger and more complex, information processing requirements exceed individual capacity • bounded rationality • satisficing • organizational structure divides information processing into manageable blocks (span of control)

M-Form Structure Board of Directors Senior Executive Division Division Corporate Human Resources Corporate R&D Corporate Finance Strategic Planning Corporate Marketing Division Division Division Finance Production Engineering Accounting Sales & Marketing Human Resources

Interests of Owners and The Agency Relationship A Trade Off M-Form Structure Divides Information Processing Requirements Into Manageable Blocks Divides Owners From Managers Interests of Owners and Managers May Diverge

The Agency Relationship Managing Agency Monitors Principals Agents Division General Managers Individual Shareholders Senior Executives Board Of Directors Shared Activity Managers Institutional Shareholders Corporate Staff Dual Role

The Office of the President One Person Two People Three People Chairman of the Board (monitoring) Chairman CEO COO Chairman CEO COO Chairman CEO COO Chief Executive Officer (strategy formulation) Chairman CEO COO Chief Operating Officer (strategy implementation)

The Office of the President Information Filtering • information about the divisions’ businesses is filtered as it rises to the senior executive • the senior executive can ‘manage’ the information flow • information flow should not exceed the bounded rationality of managers at any level in the organization • information should flow should be matched with decision-making authority

Division General Managers Senior Executive Corporate Human Resources Corporate R&D Corporate Finance Strategic Planning Corporate Marketing Division Division Division Finance Production Engineering Accounting Sales & Marketing Human Resources

Shared Activity Managers Division Division Division Finance Production Finance Production Engineering Engineering Human Resources Sales & Marketing Cost Centers Shared Activities Profit Centers

Management Controls 3 Issues Evaluating Divisional Performance Allocating Capital Transferring Intermediate Products Measurement: Playing Games: Setting Prices: • accounting • managers want to look good • negotiation • economic value added (EVA) • cost • zero-based budgeting • market-based Ambiguity: • dual pricing • allocating costs & revenues

Compensation Policies Compensation Committee In theory… • represents interests of owners in setting compensation of top executive team • sets compensation based on performance or market In practice… • sometimes appear to be beholden to executives • compensation decisions often bear little relationship to performance

Compensation Policies Aligning Incentives Research shows… Theory predicts… Tied to Performance Stock Options Long Time Horizon Stock Grants Cash Bonus Short Time Horizon Not Tied to Performance Salary

Refocusing Corporate level strategy may call for exiting a business • a conglomeration discount may exist • the corporation may lack necessary skills • expected economies of scope may not exist • the corporation may need funds for core activities MBO Divest Assets Spin-off or, IPO

Summary Successful implementation is a matter of: • appropriately breaking information processing into manageable blocks • aligning the interests of owners and managers These can be accomplished through: • Organizational Structure • Management Controls • Compensation Policies

End of lecture segment

Segment 2 Implementation issues in related versus unrelated diversification

Unrelated Diversification For unrelated diversification, the multibusiness model is based on general managerial capabilities in entrepreneurship, organizational design, or strategy. Operates as a ‘portfolio’ of independent businesses Divisions have considerable autonomy No integration among divisions is necessary Businesses bought & sold as conditions change Idea of ‘corporate culture’ is meaningless No exchanges or linkages among divisions Easiest and cheapest strategy to manage Lowest level of bureaucratic costs Controls to evaluate divisional performance easily and accurately Each division evaluated by output controls, e.g. ROIC Sophisticated accounting controls 1. Because there are no linkages between divisions, unrelated diversification is the easiest and cheapest strategy to manage, with the lowest level of bureaucratic costs. a) Normally, a multidivisional structure is used for this strategy and the corporate headquarters tends to be small because the need for integration among divisions is low. b) The control used is principally financial control and corporate headquarters uses measures such as ROIC as the main means of evaluating each division’s performance. They treat the corporation’s businesses as an investment portfolio, attempting to allocate resources so as to realize the greatest profitability. c) Divisions are completely autonomous, thus, the idea of corporate culture is meaningless.

Vertical Integration The vertically integrated company requires the centralized control – in order to achieve the benefits from the sequential flow of resources from one division to the next. Bureaucratic costs are more complex and expensive than unrelated diversification Multidivisional structure provides necessary controls to achieve benefits from the control of resource transfers Must strike balance between centralized and decentralized control Divisions must have input regarding resource transfer Integration is managed through a combination of corporate and divisional controls Vertical integration is the next most expensive strategy to coordinate. Bureaucratic costs are higher because corporate headquarters must control sequential resource transfers from one division to the next. a) By adopting the multidivisional structure, a vertically integrated company gains centralized control, and corporate managers can control resource transfers between divisions. b) Market and behavior controls are also applied as the company seeks to standardize resource transfers and to use budgets, as well as ROIC, to evaluate divisional performance. The company also uses rules as a control mechanism. c) In addition, handling resource transfers increases the need for integration, and task forces are likely to be established to guide interdivisional coordination.

Related Diversification Principle benefits of related diversification come from transferring, sharing, or leveraging functional resources or skills and some exchange of distinctive competencies across divisions. Gains derived from the transfer, sharing, or leveraging across divisions Output control difficult as businesses share resources Integration and control at divisional level required Incentives and rewards for cooperation necessary 3. Related diversification increases the number of linkages between divisions that have to be managed, making this strategy the most expensive. a) Output control is difficult to measure due to extensive cooperation, so culture control is used more frequently. b) Integrating roles and teams are required to integrate the work of multiple divisions. c) Reward systems must be carefully designed to ensure that managers have an incentive to share resources. Problem: We know there needs to be integration, but we do not know how much

Corporate Strategy and Structure and Control