Emphasizing Institutions and Cultures Dr. Ellen A. Drost Adapted from Mike Peng, Global Strategy, 2006

Outline Understanding institutions An institution-based view of strategy The strategic role of cultures The strategic role of ethics A strategic response framework Implications for strategists

Opening Case: Cut Salaries or Cut Jobs? Questions: What to do in economic downturn? The case of Japan 3

Opening Case: Cut Salaries or Cut Jobs? Institutions and Cultures Institution-based answer: What about the formal role of different governments? What about the informal norms of acceptable prices and practices around the world? What about the values and influences of various stakeholders? 3

Understanding Institutions Informal definition: “Rules of the game” Formal definition: “Humanly devised constraints that structure human interaction” (North) Institutions affect individual and firm behaviors An institution-based view of strategy: Covering institutions, cultures, and ethics Strategists need to appreciate the “big picture” in which competition around the globe takes place. 3

Understanding Institutions (cont’d) An Institutional Framework Formal and informal institutions that govern individual and firm behavior These formal and informal institutions are supported by three “pillars” (Scott) Table 4.2 4

What Do Institutions Do? Institutions Reducing uncertainty Signaling conduct as acceptable or not, which constrains the range of acceptable actions. Uncertainty can lead to transactions costs Transaction costs: Costs associated with economic transactions—costs of doing business A major source of transaction costs: Opportunism Self-interest seeking by misleading, cheating and/or confusing other parties The possibility of opportunism introduces uncertainty 4

Why Is It Important to Reduce Uncertainty? Without stable institutional frameworks— Transaction costs may be so high (e.g., extensive opportunism) that certain transactions would not take place. Example: If credible institutional frameworks are absent, investors may choose to put money abroad (e.g., capital flight from Russia). What happened in Kenya’s Flower Industry? Page 95. Violence versus stability. 4

How to Reduce Uncertainty? Two kinds of institutions—informal and formal Relational contracting: based on informal institutions Informal, relationship-based, personalized exchange (Figure 4.1) Benefits outweigh costs, up to a certain point. Arm’s-length transaction: based on formal institutions Formal, rule-based, impersonal exchange with third-party enforcement (Figure 4.2) Benefits outweigh costs, when the scale and scope of the economy become very large 4

Informal Institutions Informal institutions suggest expected behaviors Everyone knows these unwritten “rules” (drinking with colleagues) If formal constraints fail, informal constraints play a larger role in reducing uncertainty 4

Formal Institutions Formal Institutions An expensive legal and regulatory framework of courts, police, lawyers, regulators, and other mechanisms that enforce laws and regulations to facilitate the widening of markets Benefits of Formal Institutions Support arm’s-length transactions by bringing distant parties (strangers) together. Foster rule-based transactions that attract new players into a global economy that cannot operate on informal institutions alone. Facilitate economic expansion and growth 4

An Institution-Based View of Strategy Institutions are more than background conditions Institutions provide guidelines to firms as to how they can act, and what can be done with legal or other guarantees. Institutions directly impact a firm’s formulation and implementation of strategy (Figure 4.4). In two words: Institutions matter. The key question: How do they matter? 4

Institutions, Firms, and Strategic Choices Sources: Adapted from (1) M. W. Peng, 2000, Business Strategies in Transition Economies (p. 45), Thousand Oaks, CA: Sage Publishing.; (2) M. W. Peng, 2002, Towards an institution-based view of business strategy (p. 253), Asia Pacific Journal of Management, 19 (2): 251–267. Figure 4.4

Two Core Propositions Informal constraints play an important in transition economies (e.g. during institutional transitions) Fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect organizations as players “Transition economies such as China, Russia, countries in Eastern Europe The importance of quanxi and blat during China’s and Russia’s recent institutional transitions, respectively. 4

The Strategic Role of Culture “The collective programming of the mind which distinguishes the members of one group or category of people from another” (Hofstede) Is the most informal and least codified part of a country’s institutional framework. Impacts the strategy of firms. Firms must understand cultural rule sets

Hofstede’s Five Dimensions of Cultural Values Power Distance Distinguishes the levels of hierarchy accepted by the society. Individualism versus Collectivism Focuses on the importance of the individual versus the group in social and business situations. Masculinity versus femininity Measures the degree of gender role differentiation and quality of life issues Uncertainty Avoidance Identifies the tolerance for ambiguity. Long-term Orientation Emphasizes perseverance and savings for future betterment.

Hofstede Dimensions of Culturea a. When the scores are the same, countries are listed according to their alphabetical order. Arab countries, East Africa, and West Africa are clusters of multiple countries. Germany and Yugoslavia refer to the former West Germany and the former Yugoslavia, respectively. Sources: Adapted from G. Hosftede, 1997, Cultures and Organizations: Software of the Mind (pp. 26, 53, 84, 113, 166), New York: McGraw-Hill. Data on the first four dimensions are based on surveys of IBM employees during 1968–72, first published in G. Hosftede, 1980, Culture’s Consequences, Beverly Hills, CA: Sage Publishing. Data on the fifth dimension are based on surveys of students during the 1980s, first published in The Chinese Culture Connections, 1987, Chinese values and the search for culture-free dimensions of culture, Journal of Cross-Cultural Psychology, 18: 143–164. Table 4.3

Culture and Strategy Power Distance French and Italian managers have a penchant for centralized authority; French and Italian subsidiaries abroad are more likely to have majority ownership control. Solicitation of subordinate feedback and participation (“empowerment”), widely used in Western European and North American countries, is seen as a sign of weak leadership and low integrity in higher power distance countries (Egypt, India, Mexico, and Russia). 4

Culture and Strategy (cont’d) Individualism versus Collectivism Individualist U.S. firms often desire to find ways to differentiate, whereas collectivist Japanese firms have a tendency to converge on a defensible position. Because entrepreneurs are usually willing to take more risk, individualistic societies tend to foster relatively more entrepreneurship. Collectivism may result in relatively lower levels of entrepreneurship. Singapore and Japan currently score very low on entrepreneurship. 4

Culture and Strategy (cont’d) Masculinity versus Femininity High masculinity countries “Good” managers are typically assertive, decisive, and “aggressive” (only in masculine countries does this word carry a positive connotation) Firms may have a relative advantage in mass manufacturing (e.g., Japan). High femininity countries Managers are less visible, more intuitive Firms may have a relative advantage in small-scale, customized manufacturing, agricultural and forestry exports, and service industries (e.g., Sweden, Norway, Netherlands, and Denmark). 4

Culture and Strategy (cont’d) Uncertainty avoidance Managers in low uncertainty avoidance countries (e.g., Great Britain) rely on experience and training. Managers in high uncertainty avoidance countries (e.g., China) rely more on rules and procedures. Example: The Swissair crash (1998) U.S. commentators: Rules are there to be broken during emergencies! Swissair officials: Rules exist exactly for such emergencies! 4

Culture and Strategy (cont’d) Long-term orientation: Cultures with long-term orientation nurture firms with longer horizons in strategic planning. Japanese and Korean firms are willing to forego short-term profits to focus more on market share SIA 1.1: Matsushita’s 250-year plan Western firms focus on short-term quarterly profits Chapter 10 Closing Case: In the oil industry, there is a recent tendency to shorten the planning horizon from 10-15 years to 5 years or less. 4

The Strategic Importance of Culture Culturally naïve and ignorant firms may commit strategic blunders. Chevy Nova car – “No go” in Spanish Mitsubishi Motors in America: $34 million fine to settle sexual harassment charges in a low masculinity country (relative to Japan) See page 106 of text.

The Strategic Role of Ethics Ethics: Norms, principles, and standards of conduct governing individual and firm behavior Ethics: Not only an important part of informal institutions, but also deeply reflected in formal laws and regulations What is illegal is typically unethical What is legal may be unethical (e.g., mass lay-off downsizing) What is unethical is not always necessarily illegal Recent interest in business ethics: Fueled by unethical scandals at Enron, WorldCom, Parmalat, etc Ethics Officer Association: 12 member firms (1992)  1,000 firms (2004)

Views on Business Ethics A negative view Firms are forced to jump on the ethics “bandwagon” under social pressures while not necessarily becoming more ethical. A positive view Firms want to do it right regardless of social pressures. An instrumental view Ethics: A useful instrument for good profits The value of ethical reputation is magnified during a crisis Institution-based explanation All of the above may be accurate, for some firms See the Strategic Response Framework (Table 4.7)

Managing Ethics Overseas Ethical standards are different around the world Whistle blowers: ethical in America; unethical in Japan Microsoft’s competitive actions, after surviving U.S. legal scrutiny, are found to be unethical and illegal by the EU Ethical relativism When in Rome, do as the Romans do Ethical imperialism There is only one set of good Ethics, and we have it! Three “middle-of-the-road” guiding principles Respect for human dignity and basic rights. Respect for local traditions (e.g., gift-giving) Respect for institutional contexts

A Strategic Response Framework Sources: Based on (1) A. Carroll, 1979, A three-dimensional conceptual model of corporate social performance, Academy of Management Review, 4: 497–505; (2) M. Clarkson, 1995, A stakeholder framework for analyzing and evaluating corporate social performance, Academy of Management Review, 20: 92–117; (3) S. Wartick & P. Cochran, 1985, The evolution of the corporate social performance model, Academy of Management Review, 10: 758–769. Peng, M. Global Strategy, 2006 Table 4.5

Implications for Strategists (cont’d) What determines the international success and failure of firms? Firm performance is, in part, determined by the institutional frameworks governing strategic choices. 4