Corporate Strategy Mba Sunder Land

University of SunderlandMaster of Business Administration (MBA)

Global CorporateStrategy

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Global Corporate Strategy

Contents

How to use this workbook

Introduction

Unit 1Strategy Defined and Key Concepts

Introduction 1Definition of Strategy 2Levels of Strategy 5Strategic Concepts 7Strategic Thinking 9Strategic Models 12Summary 34

Unit 2Strategic Capability

Introduction 37The Different Management Perspectives 38Portfolio Management 39The Core competencies perspective 48Divestment 51Summary 57

Unit 3Globalisation

Introduction 61What is Globalisation 61The Globalisation of Markets 66The Globalisation of Production 68Drivers of Globalisation 70The Changing Demographics of the Global Economy 73The Globalisation Debate: Prosperity or Impoverishment? 76Managing in the Global Marketplace 78Summary 88

Unit 4‘Altering the Boundary’ – Alliances and Mergers

Introduction 91Paradox of Competition and Co-operation 92Global Strategic Alliances 92Mergers and Acquisitions 104Summary 131

Unit 5Value Management

Introduction 133Paradox of Profitability and Responsibility 134The Concept of Value 134Value Management 137What is a Value-Driven Approach 141Summary 151

Unit 6Corporate Governance and Ethics

Introduction 155Corporate Governance 156Business Ethics 173Summary 188

Unit 7Managing Complexity

Introduction 191Paradox of Control and Chaos 192Systems Thinking 193Soft Systems Methodology (SSM) 200Strategic Control? 204Summary 207

Unit 8Knowledge Management

Introduction 209Theoretical Concepts on Knowledge 210Knowledge 212Knowledge Transfer 215Practical steps to promote Knowledge Management 218Summary 237

Unit 9Innovation

Introduction 239Innovation strategies 240Innovation and established companies 241Conclusion 248Summary 255

Unit 10Strategic IT and e-Business

Introduction 259The Link between Business and IT Strategy 260IT Strategy Methodology 264Summary 275References 276

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Global Corporate Strategy Global Corporate Strategy – Contents

How to use this workbook

This workbook has been designed to provide you with the coursematerial necessary to complete Global Corporate Strategy by distancelearning. At various stages throughout the module you will encountericons as outlined below which indicate what you are required to do tohelp you learn.

This Activity icon refers to an activity where you are required to undertake aspecific task. These could include reading, questioning, writing, research,analysing, evaluating, etc.

This Activity Feedback icon is used to provide you with the informationrequired to confirm and reinforce the learning outcomes of the activity.

This icon shows where the Virtual Campus could be useful as a medium fordiscussion on the relevant topic.

This Key Point icon is included to stress the importance of a particular pieceof information.

It is important that you utilise these icons as together they will provideyou with the underpinning knowledge required to understand conceptsand theories and apply them to the business and managementenvironment. Try to use your own background knowledge whencompleting the activities and draw the best ideas and solutions you canfrom your work experience. If possible, discuss your ideas with otherstudents or your colleagues; this will make learning much morestimulating. Remember, if in doubt, or you need answers to anyquestions about this workbook or how to study, ask your tutor.

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Global Corporate Strategy

Preface

Corporate Strategy is a very wide and all encompassing subject area.One only has to look at the relative content of individual key texts in thisarea (e.g. De Wit & Meyer, Lynch, Johnson & Scholes, etc.) to appreciatethe volume of material that has been written over the years.

However, relatively speaking, it is the newest area of managementresearch. Initial work in strategy took place in the early sixties. In theirbook Strategy Safari, Mintzberg, Alhstrand and Lampel (1998) breakdown strategy theory development into ten schools of thought and thisprovides a thoughtful starting point for the study of this module. It alsoindicates a wide range of divergent views on the subject. The ten schoolsare;

1 The Design school – strategy seeks to match internal capabilitiesto external possibilities

2 The Planning school – strategy is a formal, planned process

3 The Positioning school – only a few key strategies are desirable inany given industry (generic strategy) and these are formulated byanalytical processes

4 The Entrepreneurial school – strategy is a ‘visionary’ processwhere an organisation is responsive to the dictating individual

5 The Cognitive school – strategy is a mental process dependantupon what the strategy process means in the mind of thestrategist (human cognition)

6 The Learning school – strategies emerge as people /organisations come to learn about a situation as well as theirorganisation’s capability of dealing with it

7 The Power school – the use of power and politics to negotiatestrategies favourable to particular interests

8 The Cultural school – strategy as a collective process of socialinteraction, based on the beliefs and understandings shared bythe members of an organisation

9 The Environmental school – the business environment becomesthe central actor in the strategy making process – the organisationmust respond to these forces

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10 The Configuration school – strategy making is a process ofleaping from one state to another with relative stability inbetween

All of these schools have key writers. However, it would be erroneous toregard these schools as being ‘separated’ or that it is right to look at thesein isolation. Indeed, it is the opposite. Each perspective is inter-mingledwith one another and interacts over time. Mintzberg, Alhstrand andLampel use the analogy of an elephant to emphasise the holistic natureof strategy - one cannot get a clear picture of ‘the elephant’ by looking ateach separate part of its body. Hence, as a student of strategy, you mustkeep in mind ALL TEN schools.

The ten schools can be split into two ‘types’. Schools 1-3 can be seen as‘prescriptive’, that is to say they are based on the belief that CorporateStrategy is a planned, analytical hard data process. On the other hand,Schools 4-10 can be seen as ‘descriptive’. In these areas, writers believethat strategy is a complex, uncertain, subjective and ‘soft’ data process.There is a range of theory and academic writing to support all of theseperspectives.

Another range of key perspectives is related to your core textbooksupplied with these materials. Whereas major texts such as Johnson &Scholes, and Lynch take a ‘linear’ view of strategy by presentingconcepts ‘one after the other’, de Wit & Meyer (2004) analyse a series of‘paradoxes’. They define the opposite ends of a continuum, leaving thestudent with the tools to analyse case studies and decide for themselvesthe key strategic perspective for organisations. This approach isparticularly important for this module.

Students will be expected to produce an academic and fully referencedargument seeking to define the key strategic perspectives oforganisations. The argument, and supporting evidence, produced is key– stating an appropriate school of thought or positioning anorganisation in relation to a strategic paradox is not the key issue. Theability to analyse (rather than describe) strategy and coming to areasoned judgement is the overriding objective in assessment.

The paradoxes addressed by de Wit & Meyer (2004) are;

� The Paradox of Logic and Creativity (Strategic Thinking –Rational vs. Generative).

� The Paradox of Deliberateness and Emergentness(Strategy Formulation – Planned vs. Incremental).

� The Paradox of Revolution and Evolution (StrategicChange – Continuous vs. Discontinuous).

� The Paradox of Markets and Resources (Business LevelStrategy – Outside-In vs. Inside-Out).

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Preface Global Corporate Strategy

� The Paradox of Responsiveness and Synergy (CorporateLevel Strategy – Portfolio vs. Core Competence).

� The Paradox of Competition and Co-operation (NetworkLevel Strategy – Discrete vs. Embedded Organisations).

� The Paradox of Compliance and Choice (IndustryContext – Industry Evolution vs. Industry Creation).

� The Paradox of Control and Chaos (OrganisationalContext – Leadership vs. Dynamics).

� The Paradox of Globalisation and Localisation(International Context – Global Convergence vs.International Diversity).

� The Paradox of Profitability and Responsibility(Organisational Purpose – Shareholder Value vs.Stakeholder Values).

Naturally, many of theses dichotomies can be examined in isolation butare, similarly to the schools of thought above, likely to be interrelatedand so discussing and building an academic argument in respect of onewill inevitably lead to another.

It would be possible to provide you with a module that deals withseparate areas of an organisation individually. Indeed, this type ofmodule has been delivered many times in the past. In other words, it ispossible to look at marketing, HRM, operations, finance, etc, as separateentities and reflect the ‘strategic’ aspects of these areas. However, thiswould not give due credence to the fact that strategy is essentially a‘holistic’ subject. That is to say, ‘corporate strategy’ affects theorganisation as a whole. Each element of an organisation cannot beconsidered in isolation. Therefore, corporate strategy must be examinedin an ‘all embracing’ manner.

One must be careful to use the word ‘organisation’. If the word‘business’ were to be used this would tend to ignore some veryproductive study areas in public and ‘not for profit’ organisations.Much can be learned from such organisations and, although‘businesses’ are typically used to demonstrate key points, organisationswhose prime objective is not related to profitability cannot be ignored.

Many contemporary issues in ‘strategy’ are reflected in this module.Once again, it is erroneous to regard each of the ten ‘themes’ as existingin isolation or in ‘silos’. There are links between themes that, in somecase, will be pointed out in the text, but in others it will be left to yourown imagination and analytical ability. Individual techniques such asthose employed in marketing and finance, for example, are onlytouched on where necessary. This would detract from the ‘ethos’ of thismodule.

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Global Corporate Strategy Preface

Due to the nature of the subject area it is impossible to cover all aspects –simply think about how long it would take to read one of the key textsfrom cover to cover! The topics omitted are still important – the studytime allocated to this module is not enough to cover everything.Therefore, it is in your interests to read more widely than the specifiedreading dictates.

The module will enable you to recognise and describe many differentfeatures of organisations. However, the module will encourage you toanalyse these issues and be able to understand why organisations dowhat they do and look critically at their strategic decisions. You shouldbe able to recognise and understand the importance of the variousaspects of strategic decision making and implementation processes.

You should remember that it is a Masters level module and you willonly reap the full benefits if you put in the effort. This means preparingwell and fully utilizing other arrangements to enhance your learning,e.g. tutor support and contributing to remote discussion and chat viaavailable virtual learning environments.

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Preface Global Corporate Strategy

Unit 1

Strategy Defined and KeyConcepts

LEARNING OUTCOMES

Following the completion of this unit you should be able to:

� Explain what corporate strategy is.

� Evaluate the importance of strategy to a manager in an organisation.

� Compare the characteristics of strategic decision making.

� Assess the skills required to be a strategist.

� Assess the holistic nature of strategy.

Introduction

The term corporate strategy can bring to mind various aspects ofcorporate management. Vision, competition, competitive advantage,new markets, managing for shareholder value, moulding corporateculture, operational processes for execution, strategic plans all come tomind. But what exactly is strategy?

In this unit we shall define strategy, particularly as it applies to amanager. We shall also look at the various levels of strategy, and the keyrole of strategic thinking within an organisation. We shall examine therole of strategic ‘models’ and how they can assist organisations inbreaking down the complexity of strategic thinking. In particular, weshall examine the Johnson & Scholes model.

Depending on the maturity of the market that a company operateswithin, the maturity of the company, and the corporate managementculture, organisations adopt different approaches to strategy. Theapproach can be classified as deliberate, emergent or incremental, andwe shall examine the differences between them.

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Finally, we shall look at two case studies to understand how the keyconcepts of strategy apply practically within organisations.

Definition of Strategy

There is no universal definition of strategy. Strategy applies to manydisparate fields such as gaming strategy, economic strategy, investmentstrategy, military strategy, marketing strategy and indeed corporateglobal strategy. Taking a conventional approach, strategy can bethought of as a long term plan of action or execution designed to achievea particular goal, such as achieving competitive advantage for anorganisation. It reflects the values, expectations and goals of those whoare in power within the organisation.

These logical / prescriptive ideas about strategy emanate from the‘prescriptive’ approach as advocated by early strategic writers (seePreface and the text Strategy Safari (Mintzberg et al, 1998)). Many earlywriters continue to be widely quoted, e.g. Michael Porter. Many recentwriters have challenged this view of strategy. The study of corporatestrategy has moved on into ‘softer’ areas and these issues need to bekept in mind.

Early thinking (1960s) could be said to be ‘modernist’ in view, i.e. aunitary perspective – there was a single way to perform the task ofstrategy. There was an idea that data (both internal and external) couldbe fed into an analysis machine and the answer (the strategy) could bechurned out. The ‘postmodern’ view refuted this, saying that a strategistview should be ‘pluralist’, i.e. take many diverse things into account andthis is evidenced by a number of writers. For example, the view of‘planning’ as opposed to ‘emergence’ – both viewpoints are supportedby a wealth of academic writing (see later discussion in this unit).

However, as a starting point, we will consider some ‘prescriptive’definitions and concepts to try to begin to appreciate the complexity ofthis subject.

Lessons from military strategy

Generalising strategy can be misleading, as the context is important.However, the military definition of strategy can be very helpful in thecontext of business, as the approach to winning in the businessenvironment is very similar to winning a war. Success in businessrequires a sharp focus, and does indeed involve winning battles andgaining competitive advantage over the ‘enemy’, in this case thecompetitor.

Military strategy is the ‘holistic’ deployment of resources in such a waythat the outcome of a war is influenced. As with military strategy, it is

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Unit 1 – Strategy Defined and Key Concepts Global Corporate Strategy

vital that corporate strategy is ‘holistic’ to be successful. To achieve thecorporate strategy, the whole organisation must be focused on the samecorporate goals and must team, execute and win in the marketplace. Aswith a war, a razor sharp focus is required to win in the marketplace.

Strategic vs. tactical

An important distinction to make at this point is between the strategicand tactical. The terms feature in the military as well as in business, andit is important to understand the difference.

As we have just observed, strategy must be holistic – it must involve thewhole organisation and its objective is to achieve the goal (or win the‘war’) defined by the company. Tactical measures are actions ormanoeuvres carried out to win individual battles, which mayeventually, after a number of battles, win the ‘war’.

In the context of business, a tactical measure may, for example, involveruthless, but short-term, price-cutting, in order to grab market-shareand remove a competitor. A strategic move, on the other hand, may bean acquisition in order to move into a new market area. Tacticalmeasures are usually short-term, whereas strategy is long-term. A seriesof tactical measures can help achieve the long-term strategy.

VIRTUAL CAMPUS

Discuss with your colleagues how a tactical action in your work contextfurthered the company’s strategy. In particular, how it influenced:

� Competitive position.

� Market share.

� Customer satisfaction.

� Short-term vs. Long term profits and margins.

� New opportunities.

Business strategy

Some definitions of business strategy that are helpful are as follows:

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Global Corporate Strategy Unit 1 – Strategy Defined and Key Concepts

‘Corporate strategy is the pattern of minor objectives,purposes or goals and essential policies or plans forachieving those goals, stated in such a way as to definewhat business the company is in or is to be in and the kindof company it is or is to be’

Andrews K (1971). Page 8, Lynch.

‘Strategy is the direction and scope of an organisation overthe long term: which achieves advantage for theorganisation through its configuration of its resourceswithin a changing environment, to meet the needs ofmarkets and fulfil stakeholders' expectations.’

Page 10, Johnson and Scholes

KEY POINT

Characteristics of business strategy are as follows:

� Sets direction and scope over the long term to achieve goals.

� Designed to achieve competitive advantage.

� Directs business in a changing and evolving environment.

� Holistic and pervasive of the whole organisation; covering therange and depth of its activities.

� Achieved by teaming, executing and winning in themarketplace.

� Fulfills stakeholder expectations; survival as a minimum andcreation of added value as a maximum.

ACTIVITY

Read p. 1-19 of Chapter 1 and section 2.1 of the key text, De Wit, B & Meyer, R

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Levels of Strategy

Strategy can be distinguished by the levels at which it occurs. Refer toFigure 1.1.

Corporate Strategy:

� Defines the strategy for the corporation (or organisation)as a whole, and is cascaded to business units below.

� Must be holistic and define the overall purpose and scopeof the organisation.

� Must be visionary in some measure.

� Must ensure that the different parts of the organisationadd value to the overall strategy.

� Must meet the expectations of major stakeholders.

Business Unit strategy:

� Must be derived and be aligned with the corporatestrategy.

� Must be focused on how to compete in the particularmarkets or business areas for which the business unit hasresponsibility.

� Can be visionary and creative within the context of itsbusiness remit.

Operational Strategy:

� Must define and deliver the operational processesrequired to achieve the corporate and business unitstrategy.

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BusinessUnit Strategy



Corporate StrategyO

perational Strategy

Figure 1.1: Levels of corporate strategy.

� Must address the resource and resource developmentplans to support corporate and business unit strategy.

A further level of strategy, ‘Network level strategy’, is pertinent intoday’s business environment. Let us examine this in more detail.

Strategic alliances or strategic networks are increasingly common inmany sectors to compete effectively in the marketplace. For example, inthe IT sector, gone are the days of mega-organisations that ‘play’ inevery aspect of computing and micro-electronics. Increasingly,companies with different specialisations or areas of dominancecooperate to compete effectively in the marketplace. An example is thatof the IBM corporation. A few years ago IBM competed in practicallyevery aspect of computing and information technology; from hardwareto disk storage to micro-electronic components to software to operatingsystems to applications software to IT services. Today, to becost-effective and satisfy customer requirements for open standardsand ‘best of breed’, IBM has strategic partnerships with specialisthardware suppliers and software vendors (e.g. for CRM). Anotherexample is that of the Bluetooth alliance of companies that has broughtto market wireless interconnectivity of computer devices. In suchstrategic alliances, the different members of the network operate asseparate corporate entities but their strategy is influenced and alignedwith that of the strategic network. Such networks involve not only otherprofit-making corporate entities, but can also involve standards bodiesor advisory bodies.

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Corporate Strategy

Operational Strategy

Corporate Entity 1




Corporate Strategy


Corporate Entity 3




Corporate Strategy


Corporate Entity 2

Figure 1.2. Network Strategy.

ACTIVITY

Think of an example, perhaps from your own work context, of how corporatestrategy translated to business unit strategy and operational strategy.

Did networks or strategic alliances play a role in moulding corporate strategy?

Strategy and the manager

Developing and deploying strategy successfully depends on managersunderstanding the key and high impact aspects of strategy. Managersshould:

� Ensure that strategies are part of the overall corporatestrategy.

� Ensure that strategies are consistent, coherent, effectiveand appropriate.

� Ensure that strategies are sustainable and supported byoperational processes.

� Understand an organisation’s business environment.

� Understand the attributes of the organisation and whatmakes it unique/distinctive.

� Be aware of the organisation’s resources, capabilities,competencies and customers.

� Understand how the organisation’s advantages can beexploited.

� Understand and exploit the existence of any strategicnetworks/alliances.

Strategic Concepts

A number of factors influence the type of strategy an organisationadopts. These factors include the maturity of an organisation, maturityof the market sector it operates in, its corporate management culture,and market leadership goals.

There are broadly two types of strategic concepts:

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� Strategic ‘Fit’: Strategic Fit is the matching of anorganisation’s strategy to the environment it operates in.It is really identifying opportunities that exist in thecurrent environment and tailoring strategy to capitaliseon it. Competitive advantage is achieved by correctpositioning within the existing marketplace.

� Strategic ‘Stretch’: Strategic Stretch, on the other hand, iswhen an organisation pro-actively stretches its resourcesand competencies to create new opportunities andcapitalise on them. It means identifying resources anddeveloping competencies to pre-empt and create newopportunities in the marketplace. Competitive advantageis achieved by not only meeting existing market needs butalso future market needs. It is a resource-led approachwith investment from the heart of the corporate centre.

ACTIVITY

Can you think of an example of strategic fit?

Now can you think of a company that has or is adopting strategic stretch?

ACTIVITY FEEDBACK

You probably thought of many examples of strategic fit, but perhaps had moredifficulty with examples of strategic stretch.

One example of strategic stretch is the Waitrose/Ocado partnership in theUK, which provides on-line grocery shopping and home delivery service.Currently, in the UK, the market for on-line shopping is small. With theexception of Tesco, which makes a small profit on on-line deliveries, mostcompanies providing this service make huge losses, and many are withdrawingfrom this service altogether. Waitrose/Ocado are also making losses currently.However, they are strategically stretching themselves, and investingconsiderable amounts to expand services. They forecast a huge marketopportunity in a few years to come. Waitrose operates in wealthy,middle-class areas, where the average weekly spend, on groceries, is in excessof £150 a week. If on-line shopping takes off (as they predict it will, inapproximately 2-3 years time), Waitrose/Ocado would have carvedthemselves a very lucrative market, indeed.

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Strategic Thinking

Where previously (in the 1970s and 1980s) the focus was on managerialskills in strategic planning, now the emphasis is on strategic thinking.Strategic thinking has creativity at its heart, and encourages the entireorganisation to be involved. It minimises the risks associated withmanagement power over strategy.

A simplistic definition of strategic thinking is finding the answers to thefollowing:

� Where are we now?

� Where do we want to go?

� How do we get there?

For an organisation to be successful, strategic thinking must dominateits entire corporate culture. Strategic thinking must be ingrained, be atthe forefront and influence every manager’s daily actions. It cannot be a‘one off’ or ‘once a year’ activity.

The following extract from Porter (1977) is helpful in highlighting theimportance of strategic thinking.

‘There are no substitutes for strategic thinking. Improvingquality is meaningless without knowing what kind ofquality is relevant in competitive terms. Nurturingcorporate culture is useless unless the culture is alignedwith a company’s approach to competing. Entrepreneurshipunguided by a strategic perspective is much more likely tofail than succeed.

Strategic thinking cannot occur only once a year, accordingto a rigid routine. It should inform a company’s dailyactions. Moreover the information necessary for goodstrategic thinking is equally vital to running a business –designing marketing material, setting prices and deliveryschedules.

There is a dangerous tendency today to practise single-issuemanagement. The truth, of course, is that there is no easyanswer. Quality, manufacturing, corporate culture ,entrepreneurship and strategic thinking are all important.Concern for one does not imply all these aspects ofmanagement. One cannot ignore strategic thinking infavour of maintaining a supportive culture, just as onecannot ignore quality no matter how elegant is the strategicplan.’

Porter (1977)

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De Wit & Meyer discuss the paradox of Logic and Creativity. They seestrategy as a ‘wicked’ problem, i.e. ambiguity, complexity anduncertainty prevail in making strategic decisions. The implication is thatcreative (or generative) thinking is crucial to enable managers (and theirorganisations) to move beyond the obvious, from the comfortable to theuncomfortable to be successful. This is often termed ‘lateral’ thinking or‘thinking out of the box’.

Nevertheless, a role for ‘logic’ is still in place. A manager still needs to beable to think rationally and be analytical in certain circumstances.However, they are ‘bounded’ by their own rational thought and so arelimited in what they can achieve.

ACTIVITY

Learn more about Strategic Thinking by reading the introductory section toChapter 2 (p 51-67) in your key textbook, De Wit, B & Meyer, R

Information Processing, Thinking and Strategy

Strategic thinking involves the processing of information by managersto define strategy. Two different modes of information processing havebeen described (Walsh, 1995):

� Bottom-up processing.

� Top-down processing.

Bottom-up processing

The characteristics of bottom-up processing, in the context of strategicthinking, are:

� Driven by the process of gathering detailed informationfrom all levels.

� Decision making is then carried out after elaborateanalysis of the strategic problem, or issue underconsideration, and a review of all possible solutions.

Top-down processing

The characteristics of top-down processing, in the context of strategicthinking, are:

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� Driven by the recall and application of theory/models toreal-life situations encountered.

� Strategies are derived from the experience of the successof previous strategies.

� Elaborate theories are rarely applied. Simple, abstractrule-of-thumb approaches take precedence.

In practice, the majority of strategic decisions are made using top-downprocessing, and rely on the skills and experience of top levelmanagement.

Neither approach lends itself well to less routine and novel strategicdecisions (such as entering a new market or bringing to market a novelproduct/service). Such decisions require vision, creativity as well asbusiness realism.

Another important factor in strategic decision thinking is the role ofuncertainly. Uncertainties can take the form of missing information, butother times arises simply from the unknowable. Such uncertainties canpose risks as well as new business opportunities. What makes a marketleader is how that organisation predicts future opportunities from anuncertain environment. Through leadership companies are able toinfluence and guide the market with their own ideas and thereby createnew opportunities.

Strategic Thinking: skills

Strategic thinking has many dimensions, and demands a variety ofskills, as follows:

� A strategist needs to understand issues at the functional,technical and unit levels, as strategy must be holistic andintegrated across all levels.

� A strategist needs to identify the significance of currentissues and from that knowledge project strategy into thefuture.

� A good strategist needs to balance the use ofdata/information, analysis of issues with that ofexperience, knowledge and understanding to predict thefuture

� A strategist needs to be creative. Creativity in strategyrenders competitive advantage.

The following factors strengthen strategic thinking:

� Relevance and realism in thinking.

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� Rigour.

� A varied approach to information processing.

� A balance between theory and practice to cross-checkvalidity.

� A critical and challenging approach.

ACTIVITY

It is good practice for strategic decisions to be evaluated against set criteria.From your own work experience, can you identify the criteria (in the form ofbullet points) against which strategy can be judged.

ACTIVITY FEEDBACK

You would have come up with a number of ideas. Some of which may bespecific to the industry/sector in which you operate. A good list of evaluationcriteria is outlined in the key textbook, De Wit, B & Meyer, R, ‘Criteria forEvaluation’, pages 74-75.

Strategic Models

Strategic thinking is a complex area. As such there is a role for strategic‘models’ that can enable analysis. However, they should be used withcaution, noting that theoretical models can over-simplify the practicaland complex issues faced by organisations in the real world.

Firstly, it is helpful to recognise that strategic thinking has threedimensions to it as shown in Figure 1.3.

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The process, content and context of strategies define the scope ofstrategic thinking, and must be considered together as they are closelyinter-related. Let us look at each of these in turn:

� Process: The actions or processes that support how thestrategy is analysed, determined, implemented/executed,changed and controlled. These processes link together orinteract as the strategy unfolds in what may be achanging environment.

� Content: The result of the strategy process is content. Itaddresses the main actions of the proposed strategy.

� Context: Concerns the business circumstances orenvironment in which the strategy operates or will bedeveloped. This can be the ‘inner’ context, referring to theorganisational setting or corporate culture of theorganisation. Or it can be the ‘outer’ context, such asexternal economic, political, business, environmentalfactors.

ACTIVITY

Can you think of some examples of how inner context can influence strategy.

Similarly, think of an example of how outer context influences anorganisation’s strategy.

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Context

StrategyProcess

Content

Figure 1.3. The dimensions of strategic thinking.

ACTIVITY FEEDBACK

You may have thought of one or two examples of how inner context influencesstrategy. Here is another example.

Shell and Exxon are giant oil corporations. However, they are organised verydifferently. Shell has a structure that favours and devolves power to national orregional management. Whereas, Exxon has a strong corporate focus with anemphasis on functional and product lines of structure.

In the Shell structure, strategic thinking is carried out at the regional level (e.g.by operating companies such as PDO in Oman, Brunei). The corporateheadquarters at The Hague does influence strategy at regional levels, butdoesn’t dictate business unit-level strategy.

In the Exxon example, the corporate body defines strategy. Strategy is thencascaded to the functional units. Processes and standards (e.g. IT standards andsoftware applications) are defined by the corporate body.

ACTIVITY

Can you now think of an example of how outer context influences anorganisation’s strategy?

ACTIVITY FEEDBACK

Increasingly environmental and ethical factors strongly influence strategy. Suchfactors are outside the control of the organisation, but nevertheless theorganisation must adhere to it.

Many Western companies utilise cheap factory labour from third-worldcountries, such as India, Taiwan, etc. More recently, skilled jobs, such as callcentre operations, have also moved to countries such as India, as it is morecost-effective. Raised environmental and ethical awareness has forcedWestern companies to pay fair wages and provide satisfactory workingconditions in these countries. Company stakeholders often demand ethicaland sound environmental practices. This is an example of outer context,where the company must comply with external influences.

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ACTIVITY

Reinforce your understanding of the dimensions of strategy by re-readingp.5-11 of the key text, De Wit, B & Meyer, R.

Johnson & Scholes Model

Johnson and Scholes developed and elaborated an approach to strategyfirst put forward by Argenti in 1980. Argenti identified the distinctphases in strategic management, which can be grouped as follows:

STRATEGIC ANALYSIS

� Target Setting.

� Gap Analysis.

� Strategic Appraisal.

�STRATEGIC CHOICE

� Strategic formulation.

�STRATEGIC IMPLEMENTATION

As the arrows indicate above, Argenti suggested that strategic analysisshould precede choice, and choice precede implementation. In reality,the phases often overlap. The overlapping nature of the phases waselaborated by Johnson and Scholes. Figure 1.4 shows types of issues thatshould be considered within the strategy development phases.

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Deliberate, Emergent and IncrementalStrategies

Strategy can be described as Deliberate, Emergent or Incremental.Going back to the Johnson & Scholes Model, the order in which thephases are carried out determines whether the strategy is deliberate,emergent or incremental.

Deliberate Strategy is the result of adopting a classic planningapproach, where analysis leads choice and choice leadsimplementation.

In certain situations implementation can lead choice and analysis – thisis Emergent Strategy. Consider for example a supermarket chain,where one store is forced to cut prices because of fierce localcompetition. Finding the price cuts attracts more customers, other storesin the chain copy the pattern to gain market share. This is an example ofemergent strategy.

In other cases, analysis, choice and implementation proceed together,with the preferred choices influencing implementation and analysis,analysis influencing choice and implementation influencing analysisand choice. This is known as Incremental Strategy.

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Strategicanalysis

Strategyimplementation

Strategicchoice

Bases ofstrategicchoice

Strategicoptions

Strategyevaluation

and selection

Organisationstructureand design

Resourceallocation

and control

Managingstrategicchange

Expectationsand purposes

Theenvironment

Resources,competences& capabilities

Figure 1.4. Johnson & Scholes Model.

REVIEW ACTIVITY

Learn more about the above by reading the section ‘The paradox ofDeliberateness and Emergentness’ in your key text, De Wit, B & Meyer, R,p.111-116.

Also learn about the strategic planning perspective vs. strategic incrementalismby reading p.117 – 123 of your key textbook, De Wit, B & Meyer, R.

Now apply what you have learned in this unit to your own work context.

1. Are you aware of your organisation’s corporate strategy? Are youaware of your business unit strategy?

2. How is strategy formulated in your workplace?

3. Would you describe it as deliberate, emergent or incremental?

4. From what you have learned, can the strategy process be improved? Ifso how?

5. What do you see as the major obstacles in your organisation tostrategy development and strategy execution?

6. How can these obstacles be removed?

Share your thoughts on the questions above with colleagues, either on theVirtual Campus or at your workplace. Solicit their input and ideas also,especially on items 4 and 6 above.

CASE STUDY 1 – IKEA

Read the following extract about IKEA;

(Source: Johnson & Scholes; Chapter 1 pages 6,7 & 229 and Sunday Times, 22February 1998.)

In 1953, just four years after Ingvar Kamprad had produced his first mail ordercatalogue featuring locally produced furniture, he opened his first store inAlmhult, Sweden. Since then, he and his successors have created a globalnetwork of stores in 28 countries. Initially, stores were opened only inScandinavia, but as greater levels of success were experienced, stores werebuilt in countries further afield where the rewards, but also the risks of failure,were much higher. In all these countries the retailing concept of Ingvar

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Kamprad remained the same: ‘to offer a wide range of furnishing items of gooddesign and function at prices so low that the majority of people can afford tobuy them’.

In the 1980s, Anders Moberg became the chief executive. However, theinfluence of Ingvar Kamprad could still be found. IKEA had always been frugal inits approach. In its early years it had relocated to Denmark to escape Swedishtaxation. Echoes of the same philosophy and style could be seen in AndersMoberg. He would arrive at the office in the company Nissan Primera, dressedin informal clothes, and clock in just as other employees did. When abroad hetravelled on economy class air tickets and stayed in modest hotels. Heexpected his executives to do likewise. Such prudence was extended to thecompany whose shares were held in trust by a Dutch charitable foundation andnot traded. Furthermore, IKEA’s expansion plans envisaged only internalfunding with 15% of turnover being reinvested.

The 1980s saw rapid growth. IKEA benefited from changing customerattitudes, from status and designer labels to functionality, encouraged by aneconomic recession. It also developed a number of unique elements whichcame to make up IKEA’s winning business formula: simple, high qualityScandinavian design, global sourcing of components, knock-down furniture kitsthat customers transported and assembled themselves, huge suburban storeswith plenty of parking and amenities such as cafés, restaurants, wheelchairs andeven supervised child-care facilities. A key feature of IKEA’s concept wasuniversal customer appeal crossing national boundaries, with both theproducts and shopping experience designed to support this appeal. Customerscame from different lifestyles: from new homeowners to business executivesneeding more office capacity. They all expected well styled, high quality homefurnishings, reasonably priced and readily available. IKEA met this expectationby encouraging customers to create value for themselves by taking on certaintasks traditionally done by the manufacturer and retailer, for example theassembly and delivery of products to their homes.

IKEA made sure that every aspect of its business system was designed to makeit easy for customers to adapt to their new role. For example, information toassist customers make their purchase decisions was provided in a 200-pageglossy catalogue; during their visit to the store customers were supplied withtape measures, pens and notepaper to reduce the number of sales staffrequired; furniture was displayed in 100 model rooms; and sales staff wereexpected to involve themselves with customers only when asked.

To deliver low-cost yet high-quality products consistently, IKEA also had 30buying offices around the world whose prime purpose was to identify potentialsuppliers. Designers at headquarters then reviewed these to decide whichwould provide what for each of the products, their overall aim being to designfor low cost and ease of manufacture. The most economical suppliers werealways chosen over traditional suppliers, so a shirt manufacturer might beemployed to produce seat covers. Although the process through whichacceptance to become an IKEA supplier was not easy, it was highly coveted,for, once part of the IKEA system, suppliers gained access to global markets,and received technical assistance, leased equipment, and advice on how tobring production up to world quality standards. By the mid 1990s, IKEA was

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offering a range of 12,000 items, from 1,800 suppliers in 45 countries at prices20-40% lower than for comparable goods. However, by 1998 the means ofachieving low cost was receiving some critical attention. It was reported thatIKEA was sourcing its goods from suppliers in eastern Europe which paid itsworkers poverty level wages.

IKEA was the subject of a hard-hitting article in the Sunday Times in February1998. The article concerned the working and living conditions in Romanianfurniture factories. Although IKEA did not own any of the 25 factories whichproduced furniture for its stores, it had provided collateral for at least onefactory to be bought from the state in 1992. In fact, there were allegations fromthe Federation of Wood Workers that the directors of the factory usedmoney from IKEA and disregarded the law under which Romanian employeesare entitled to be given the option of buying their own factory as a cooperative.

The article observed that the appalling conditions in Romania flew in the face ofthe politically correct image of IKEA fostered by Ingvar Kamprad who regularlywrote memos to staff which started with ‘Dear IKEA family’.

The managing director of this factory admitted that he kept a competitive edgeby paying employees an average of about 20p per hour (about one-fortieth ofthe pay levels in Sweden). IKEA’s response to these issues was that it had nomanagement responsibility for any Romanian factory. It accepted, however,that conditions were poor and that it had provided the collateral necessary forthe purchase of one factory. It also restated its financial support for theRomanian furniture industry through credits which allowed new buildings withbetter working conditions. It believed that trade was better than aid and that itintended to continue to assist with financial and technical support and byexpanding orders.

Having to cope with widely dispersed sources of components and high-volumeorders made it imperative for IKEA to have an efficient system for ordering itssupplies, integrating them into products and delivering them to the stores. Thiswas achieved through a world network of fourteen warehouses. Theseprovided storage but also acted as logistical control points, consolidationcentres and transit hubs, and aided the integration of supply and demand,reducing the need to store production runs for long periods, holding downunit costs by minimising the costs of inventory and helping stores to anticipateneeds and eliminate shortages.

By the end of the 1990s, IKEA was turning its attention to new opportunitiesfor growth. It had opened stores in eastern Europe and the one-time Sovietrepublics, believing these represented great future potential. In 1997, itannounced its plan to open twelve new stores a year internationally in citiessuch as Frankfurt, Shanghai, Chicago and Roclab in Poland and to doublemanufacturing capacity by building up to twenty factories in eastern Europe by2002. There were also plans to develop new areas of business. In partnershipwith a building contractor, IKEA was market testing, in Sweden, ‘flat packed’housing which could be assembled by two men and a crane in a week at pricesabout 30% less than the going rate. It was also developing new sources ofsupply, entering into an agreement with a timber company to develop newwood material for furniture. However, the company was also facing problems.

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IKEA was experiencing growing competition on an international front. It haddecided to implement a programme of cost savings, rationalising its supplychain and product range in order to cut purchasing costs by an overall averageof 10%. The company had stated the intention of cutting what had become2,400 suppliers by one-quarter and focusing on increased volumes with asmaller range of products and fewer suppliers.

In 1996, Ingvar Kamprad announced that IKEA would be split into three,comprising the retailing operations, an organisation holding the franchise andtrademarks, and a third arm involved mainly in finance and banking. The firsttwo would form the core of the group, controlled at arm’s length by trust-likeorganisations; the latter’s shares would be jointly owned by Kamprad’s threesons. The structure was devised in an effort to ensure that the privately heldorganisation should not be broken up or sold off in a succession battle afterIngvar Kamprad retired. He also wanted to ensure that it would not be putunder the sorts of external pressures for continual growth often faced bypublicly quoted companies. Internally, IKEA’s strategy was managed atdifferent levels. A committee of senior executives at headquarters in Denmarkwas responsible for overseeing investment in new markets and stores;responsibility for product development and purchasing lay with IKEA ofSweden; and country managers tailored the presentation and marketing ofproducts to home territories.

Questions:

1. Summarise IKEA’s corporate strategy.

2. Note down the characteristics of IKEA’s strategy which could beexplained by the notions of:

� Strategic management as ‘environmental fit’

� Strategic management as the ‘stretching’ of itscapabilities.

3. Comment on IKEA’s ethical stance

(You may wish to revisit this question after you have completed Unit 6. Unit 6covers corporate ethics in more detail)

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CASE STUDY FEEDBACK

Feedback on Question 1:

These are some of the considerations on strategy and strategic decisions in thecontext of the IKEA case study.

� Strategic decisions affect the long-term direction of an organisation.IKEA set out along a path which was difficult to reverse. In the1950s and 1960s the company was, essentially, a Scandinavianfurnishing retailer. By the late 1990s the whole thrust of its strategyhad shifted to a global scale and IKEA was facing the challenge ofhow to develop into the twenty-first century. In so doing it had toconsider other key issues.

� Strategic decisions are normally about trying to achieve someadvantage for the organisation, for example over competition. IKEAhad been successful not because it was the same as all otherfurniture retailers, but because it was different and offeredparticular benefits which distinguished it from other retailers.Similarly, strategic advantage could be thought of as providing higherquality value-for-money services than other providers in the publicsector, thus attracting support and funding from government.Strategic decisions are sometimes conceived of, therefore, as thesearch for effective positioning in relation to competitors so as toachieve advantage in a market or in relation to suppliers.

� Strategic decisions are likely to be concerned with the scope of anorganisation’s activities. Does (and should) the organisationconcentrate on one area of activity, or should it have many? Forexample, for years IKEA had defined the boundaries of its businessin terms of the type of product (‘furnishing items of good design andfunction’) and mode of service (large retail outlets and mail order).While not owning its manufacturing, it did have an in-house designcapability, which specified and controlled what manufacturerssupplied to the company. There were signs by the late 1990s,however, that IKEA was extending its product scope fromfurnishings into other product areas, as with its experiments withhousing. Over the years it had also substantially widened itsgeographical scope to become one of the few truly multinationalretailers in the world.

� Strategy can be seen as the matching of the activities of an organisationto the environment in which it operates. This is sometimes known as‘the search for strategic fit.’ While the market for furnishings wasmature, with little prospect of overall growth, the management ofIKEA had seen that the retail provision of furnishing in mostcountries did not meet the expectations of customers. Customersfrequently had to wait for delivery of items, which were highly

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priced. The market provided another opportunity. Customertastes were relatively common in different countries except inspecialised segments of the market: buyers wanted everydayfurniture which was well designed and looked good, but whichwas reasonably priced.

IKEA also knew that it faced significant differences in its markets. Bythe 1990s the number of countries in which IKEA was representedwas a great deal larger than in the company’s early days. This meantthat IKEA had to understand buying habits and preferences from amuch wider base, from markets close to its Swedish home, to theUSA, and even to the Far East and eastern Europe.

IKEA could no longer assume that its knowledge of earlier marketswould necessarily apply: for example, it had found that shopping habitsin the USA differed substantially from those in Europe, and this hadrequired a change in the way it serviced the market. Therefore, whilethe principles of IKEA’s business idea were adhered to around theworld to produce a consistent product quality and shoppingexperience, store management had been given a greater degree offreedom to adapt to local market needs.

IKEA’s management had, however, decided that there were somemarkets, attractive though they were, where it did not make sense totry to control IKEA’s operations directly. Here the companyrecognised that local knowledge in fine-tuning the business to localneeds was vital; or the problems of long-distance control were toogreat to manage the operation effectively on this basis. It had,therefore, established local joint ventures through franchisearrangements.

There were wider environmental issues, which affected IKEA’sfortunes; for example, IKEA was less susceptible to economicdownturn than many of its competitors. This may have been becauseits prices were often lower; but it was also because, when a customertook a purchasing decision at IKEA, he or she walked away with thegoods. In other stores, since delivery was often delayed, purchasedecisions were also often delayed. Economic conditions in thedifferent countries in which IKEA operated did, however, affect itssuccess: for example, the growth in car ownership, particularly in lesshighly developed countries, determined the percentage of thepopulation which could shop at an IKEA store.

� Strategies may require major resource changes for anorganisation. For example, the decision that IKEA took todevelop its operations internationally had significantimplications in terms of its need to obtain properties fordevelopment and access to funds by which to do this,sometimes for projects which might be seen as high risk – forexample, entering new markets in times of recession. The sizeof the operation in terms of numbers of people working in it,property and physical stock held had to rise significantly. The

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need to control a multinational enterprise, as opposed to a nationaloperation, also began to require skills and control systems of adifferent sort. It was a problem which many retailers found difficultycoping with. A major reason has been that retailers underestimatethe extent to which their resource commitments rise and how theneed to control them takes on quite different proportions.Strategies, then, need to be considered not only in terms of theextent to which the existing resource capability of the organisationis suited to opportunities, but also in terms of the extent to whichresources can be obtained and controlled to develop a strategy forthe future.

� Strategic decisions are likely to affect operational decisions. Forexample, the internationalisation of IKEA required a whole series ofdecisions at operational level. Management and control structuresto deal with the geographical spread of the firm had to change. Theway in which suppliers were controlled and the methods ofdeveloping and distributing stock required revision to deal with theextended distribution logistics. Marketing and advertising policiesneeded to be reviewed by country to ensure their suitability todifferent customer behaviours and tastes. Personnel policies andpractices had to be reviewed. Store operations needed to changetoo. For example, in the USA, IKEA saw the need to add to thecore product range from local suppliers, install serviced loading baysand erect bollards to stop the shopping trolleys being taken to allparts of the car parks, which are very large in the USA.

This link between overall strategy and operational aspects of theorganisation is important for two other reasons. First, if theoperational aspects of the organisation are not in line with thestrategy, then, no matter how well considered the strategy is, it willnot succeed. Second, it is at the operational level that real strategicadvantage can be achieved. IKEA has been successful not only becauseof a good strategic concept, but also because the detail of how theconcept is put into effect – the strategic architecture – in terms of itslogistics of buying and servicing, shop layout and merchandising tosupplier and customer relations, all developed over many years, isdifficult to imitate.

The strategy of an organisation is affected not only by environmentalforces and resource availability, but also by the values and expectationsof those who have power in and around the organisation. In somerespects, strategy can be thought of as a reflection of the attitudes andbeliefs of those who have most influence on the organisation.Whether a company is expansionist or more concerned withconsolidation, and where the boundaries are drawn for a company’sactivities, may say much about the values and attitudes of those whoinfluence strategy – the stakeholders of the organisation. In IKEA theinsistence on internal financing influenced long-term development andthe direction of the company: the influences of the founder and chiefexecutive remained pronounced. The emphasis on frugality andsimplicity clearly influenced the way the company operated. Indeed,

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critics pointed to what they saw as a disregard for the well-being andwelfare of the low-paid workers of suppliers in the name of keepingdown costs.

The conclusion from the above case study is that strategic decisions oftenexhibit the following characteristics:

1. Complex: especially for multinational organisations such as IKEAwith a wide range of products/services.

2. Involve uncertainty: They often involve taking decisions about thefuture, which is impossible for managers to be sure about.

3. Require an integrated approach: Managers have to work acrosscross-functional and operational boundaries, and come to agreementswith other managers who may have different interests and priorities.They also have to manage external relationships such as with suppliers,distributors and customers.

4. Involve change: Strategic decisions often involve change. Not only isit problematic to decide upon and plan change, it is even moreproblematic to implement change if the organisation’s culture is not inline with the desired future strategy. In the case of IKEA there werethe following strong influences: (i) family owned company with noshareholder/financial market influence on strategy (ii) Swedishinfluence, reflecting Swedish values.


Decisions on whether a company takes an environment led approach (fit) or aresource based approach (stretch) is often complex. IKEA is such an examplewhere arguments can be formed to justify both.

Taking a strategic fit approach means, as in the case of IKEA, trying to identifythe opportunities which exist in the environment and tailoring the futurestrategy to capitalise on these, for example by locating in particularlyfavourable markets or seeking to appeal to attractive market segments.

However, strategy can also be seen as building on or ‘stretching’ an organisation’sresources and competencies to create opportunities or to capitalise on them.

The product range IKEA had designed and developed was not only low costbut unique, not only because of its kit form but also in its style and image. IKEAbenefited from years of design experience dedicated to its operation andmarkets. The logistics of the operation, from sourcing of products to controlof stock and the immediate supply of the product to take away, had beenlearned over many years and provided not only a quite distinct way ofoperating, but a service greatly appreciated by customers. In short, both theresources and experience built up over the years had been consciouslydeveloped to service the evident opportunity in the market place.

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IKEA then ‘stretched’ its capabilities, using its experience in the furnituremarket, to create a different market opportunity. It set out to reinvent value,and experimented with housing in the late 1990s. It started to think aboutvalue in a new way; one in which consumers are also suppliers, suppliers arealso customers, and IKEA itself is not so much a retailer but as a central hub forservices, goods, design, management, support and even entertainment.

In practice, organisations such as IKEA, develop strategies on the basis ofenvironmental ‘fit’ and ‘stretch’. IKEA’s experiment with housing was theresult of identifying a new market opportunity, but it was also an attempt tocapitalise on its skills in developing kit-form products at low-cost.


The issues to consider are:

� Is it good business practice to achieve high profits by lowering costs,irrespective of the ethical issues in the Romanian factories?

� Is the local population in Romania, grateful for having IKEA’scontract? Or was IKEA exploiting low labour cost locations?

� IKEA’s view of this is that it is a ‘sub-contract’ arrangement, and it isnot up to them how the workers are treated. Is this a realisticattitude?

� How should IKEA deal with public pressure and use its influence toimprove working conditions and workers rights?

Revisit this question after you have covered Unit 6.

CASE STUDY 2 – POWERGEN

The next case study is case study 5, PowerGen: Strategy and CorporatePlanning’ in your key textbook, De Wit, B & Meyer, R (p. 709-720).

Below is the case synopsis:

CASE SYNOPSIS

PowerGen was vested as a British electricity generation company in1990 as the result of the privatisation of the UK energy systems. Theprevious state owned “Central Electricity Generating Board” was splitinto three companies, of which PowerGen was the smallest. All threecompanies were asked to compete in the market, and the market was

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opened for further new entrants as well. Along with the privatisationand liberalisation, the government introduced completely newmechanisms of matching supply and demand, such as an electricity poolor the creation of a separate transmission company, and theinstallation of new regulatory institutions. All market players neededto learn how to operate an energy market, where before there wasonly a central planning agency.

As the name of CEGB implied, the institution from which PowerGenemerged, had strong planning instincts for fulfilling its task to supplyelectricity to British households and industry. Therefore, it was notsurprising when PowerGen started preparations for being anindependent company in 1988, that a very detailed strategic planningsystem was installed with the help of McKinsey consultants. However,already in 1992, only two years after the operational start of thecompany, a substantial reorganisation was conducted, which triggereda complete change of the strategic planning system as well. When thisnew planning system failed to function satisfactorily in 1993, it wassubstantially revised for the 1994 planning cycle.

In 1996 the company underwent again a major reorganisation,adjusting the company to a number of internal and external strategicdevelopments. That also caused the strategic planning system to besubstantially revised. In particular it was now broadened to include ahighly sophisticated scenario development module to be conducted onthe business unit level.

The corporate composition did not stabilise thereafter either. In 1998PowerGen completed a major purchase of a regional energydistribution company, merger discussions with US partners continuedon and off, government interference changed the pricing arrangementsof the industry and dictated strategic directions, etc. It seemed that theplanning system was always several steps behind the actual conditionsof the company. On the other hand, without the planning support,how could the company have assessed its choices in the rapidlychanging environment of European energy markets in the 1990s?

Now read the full case study (pages 709-720 of key textbook, De Wit, B &Meyer, R) with the following learning objectives in mind:

� Understand the need for formal planning systems.

� Understand possible designs of formal planning systems.

� Identify the common pitfalls of formal planning systems.

� Conceive alternatives for formal planning systems.

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Questions:

1. Identify four different development stages of the strategy planningsystem that PowerGen was using between 1990 and 1996. Cataloguethe key changes from one stage to the next. What were the reasonsfor these particular changes? Which reasons are attributable toforeseeable circumstances, and which reasons are attributable tounforeseeable circumstances?

2. What were some of the major strategy decisions that were taken atPowerGen? Speculate to what extent the results of the strategicplanning system were used for making these various corporatestrategy decisions.

3. Collect the hints in the case, which suggest that there is also a parallelstrategy formation process in place that operates in a moreincremental, emergent fashion.

CASE STUDY FEEDBACK


PowerGen’s strategy planning system developed in four different stages duringthe first six years of its privatisation.

Phase I:

Occurred in 1990 with strongly centralised formation and planning. Performedin a functional structure by the commercial division, and focused on pooloperation.

Context: where and by whom?

� In a renewed, functional structure of the organisation.

� Led and managed by a large, centralised planning team at thecommercial division, monopolising the strategy planning anddecision making within the corporation.

� Separated financial role within the Finance division for reviews andprojection of plans.

Process: how and when?

� Deliberate formation.

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� 5-stage planning process: business unit – aggregation –divisional plans – aggregation – corporate plan .

� Use of scenarios concerning market share, pool prices andcompetitor analysis for the core business.

� 12-month process.

Content:

� Focus of strategy: the operation of the pool.

� Diversification and early internationalisation.

� Planning focused on resource implications of strategicdecisions.

Phase II

Occurred in 1992. To some extent decentralised formation and planning,under responsibility of rather autonomous division directors, supported bydivisionalised financial staff and a downsized corporate planning team.


� From a functional structure towards three divisions with profitand cost centres.

� Decentralisation of (strategic) decision making and planning tothe divisions, headed by empowered MDs.

� Replacement of the large, central planning team by businesslevel planning staff within the divisions.

� Introduction of a small central strategic planning function,responsible for both corporate strategy development andcorporate planning.

� Reallocation of financial planning support towards within thefinance department.

Process. how and when?

� Business units developed own business plans, reviewed bydivisional boards, and incorporated in corporate plans; theprocess itself did not change too much – merely theresponsibilities of making up the plans had shifted profoundly.

� Shortened planning cycle to nine months.

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Content:

� Shift in business unit responsibility and culture: from expenditurelimits towards operating results, from meeting centrally set targetsto exploring their potential, with increased options and widenedcommercial focus.

� Less detailed level of planning.

Reasons:

� Devolution and introduction of an internal market.

� Diversification (first attempts of internationalisation) and earlyverticalisation of the businesses required increased responsivenessat business unit level.

Phase III

Occurred in 1994, with a focus on regaining fit between strategy developmentsand financial priorities.


� Responsibility for the plan and for managing the corporate planningprocess was passed to the director of finance, effectively increasingthe influence of financial considerations in the planning process.

� Scenario development was partly delegated to business units, whichbecame responsible for developing a number of scenarios showinghow the market might develop, and the plans that followed ‘were tobe robust to those possibilities’.

Reasons

� Foreseen profit margins lower than forecasted, because ofregulatory intervention (introduction of capped wholesale prices)and competition (increased market share of Nuclear Electric).

� Unforeseen extended planning cycle, because of massiverecalculations of forecasts.

� Unforeseen rift between strategic decisions and financial priorities.Emanated from a strategy and planning process with fewindependent checks and balances from a financial point of view.

� Unforeseen failure of the centre to communicate (foreseen)scenario information fully.

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� Desire to eliminate divisional bureaucracy in managing theplanning process, because of conflicts between different layersof the corporation.

Phase IV

Occurred in 1996 with further delegation of the strategic decision-making andplanning process to business units, between which common strategic managementactivities were increasingly co-ordinated and increasingly emergent.


� From divisional structure towards clusters of business units.

� Shift and separation of strategy responsibilities: BU planningprocess to BU finance manager; BU strategy development toother BU staff member.

� Strategy triangle between CEO (for corporate strategy,supported by Finance Director (for corporate financialimplications) and corporate strategist & planner), group MD(responsible for business unit strategy, assisted by financemanager, who managed the planning process).

Process. how and when?

� Strategic actions increasingly in reaction to environmental(industry dynamics and regulatory) changes, in a continuousabsorption of the external perspective and its impact onstrategic options.

� Decentralisation of scenario development: from corporatescenarios as a guideline, towards scenario development atbusiness unit level.

� Horizontal co-ordination (not centralisation) betweenmulti-units, with integratedstrategic management andorganisational development (skills transfer, human resourceplanning, etc.).

� From pre-set details towards a more gradually evolvingprocess, with ongoing examination of BU strategy, withincreased scope for absorption of emergent issues intodevelopment and planning cycle.

� Decrease in formality of process (including debating, lobbyingfor and formation of coalitions for strategic options andactions between corporate and business levels).

� Sequenced process: first BU strategy, than BU planning.

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� Differentiation among guidelines for the different businesses.

� Five-year horizon.

Content

� The highly increased impact of regulatory forces on PowerGenincreasingly required a pattern of political bargaining with theenvironment. Instead of planning the future in detail, a pattern ofaction and reaction with environmental forces became a highlyinfluential factor in PowerGen’s strategic behaviour.

Organisational systems

� Encouragement of planning system initiatives by BUs within acorporate context (such as the multi unit scenario development).

� Reviews by team of BUs and corporate level.

� Introduction of bonus system, related to strategy process.

Reasons

� Increase in environmental complexity and uncertainty, because ofdiversification, competition and new regulation.

� An unforeseen need for co-ordination between the differentstrategising activities of BU.

� Foreseen need for independent management of several ‘new’businesses.

� Need for separation and autonomy of marketing and sales, inanticipation of liberalisation of core markets.

� Need for even further autonomy of business units, in order tocreate increased focus for business units’ specific circumstances.


1. Development of generation power. PowerGen began to develop itsgeneration capacity to better fit commercial and environmentalrequirements, through improving the flexibility of the coal units anddeveloping gas-fired stations. The move to flexible production camealong with the anticipated need for flexibility in the supply of energy.Before the liberalisation, the previous planning mechanism could easilyforesee total demand on a yearly basis, dividing the total and allocatingparts to the various generation units. But in the fresh market, thedemand for energy could easily alter significantly, mainly due to the

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new market mechanism: the wholesale pool. To be responsive to thisnew market logic, production needed to be flexible.

Note, however, that the very step of introducing flexible production,actually opposed the whole idea of the formalised, long and detailedplanning process that was adapted by PowerGen in 1990. Because ofthe electricity pool, it became much harder to forecast exactproduction demand.

2. Leveraging of core competencies. PowerGen’s moved to leverage hercore competencies in other energy-related areas, both vertically andhorizontally (internationalisation). Examples include:

� Upstream: acquisition of assets in the North Sea andLiverpool Bay.

� Downstream: formation of a joint venture with Conoco,Kinetica; plans included the supply of gas to powerstations, including PowerGen’s, and large businesses;establishment of Combined Heat & Power (CHP);acquisition of East Midlands Electricity plc. (EME), ‘98.

� International: (early stage) power station and miningacquisitions in eastern Germany and Hungary, withconstruction projects in Portugal and Indonesia. Later onin the 1990s, further foreign direct investments in plantsand projects overseas.

� Commissioning of two new CHP plants.

As stated in the case, PowerGen strategy anticipated that it wouldsuffer an inevitable reduction in market share, together with pressuresfor price reduction. Consequently, the company recognised thatgrowth in the medium and longer term would require theestablishment of new income streams in other energy-related areaswhere its core competencies could create value. The case reveals dataon slow growth perspectives for PowerGen’s core industry in the UKon the one hand, and high growth forecasts in domestic energy relatedareas and increasing international demand for power on the otherhand. Probably, within the planning cycle, external industryassessments had come up with these insights, forming the basis forenvironmental scenarios. This ultimately resulted in the formulation ofstrategic options at PowerGen and the strategic choice of a path togrowth in a still standing UK market.

3. Intended sell of PowerGen North Sea (1997/1998). In the case of theacquisition of EME, it is to be assumed, that the ‘one-stop-shop’(supplying all household’s energy needs) strategy had been pushed forby strategists as the solution for ensuring long-term profitability atPowerGen. Also, the case explicates that integration of generation and

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distribution provided necessary expertise for similar futureinternational acquisitions.

4. Merging explorations with US utility groups. Clearly, from a content pointof view, the strategy and planning process focused on leveraging corecompetencies for expansion of its business. In fact, in the later ‘90sPowerGen’s challenge was to get individual business units to be moreresponsive in leveraging core competencies of PowerGen tooperations in both domestic and overseas markets. One could arguethat the planning process of PowerGen from 1996 successfullymanaged this challenge, by engaging delegated business units in thestrategic management process.

Note, that the allocation of the strategy and planning process to thecommercial division in 1990, might indeed have affected the strategicchoices made by PowerGen. Identification of strategic issues by thisdivision might be completely different when the strategic managementfunction was allocated to the finance department (as in 1992), forexample.

5. Creation of a new holding company in the US, in order to continue assessingpossibilities in the US. Intended further growth of the core businessrequired the injection of considerable capital. If the reorganisedplanning process (1996) is considered, one could argue that this sale isa direct effect of the setting of overall strategic and financial directionby the CEO, Finance Director and Group MD.

The case reveals explicitly the causes of failure of intended mergersbetween PowerGen and Cinergy and Houston, two major US utilitycompanies.

Both failures are clear cases of intended, but unrealised strategicactions, for which the causes could obviously not be caught in strategicplanning (‘strains between the two chairman’ and regulatoryintervention).

6. Focus on power generation as a core business and becoming a low-costproducer on a world-class basis.


In order to cope with the limitations of the various planning processes thatwere effective at PowerGen during the 1990s, an ‘unofficial’, parallel formationprocess emerged, on different dimensions. If the planning processes of the firstand fourth phase are compared, to some extent the planning process in itselfunderwent change. The planning process became less formal and it wasrecognised it could not be sequential. Over the years, the results of theprocess became increasingly dependent on coalition forming, lobbying and aconstant discussion between the different planning process levels ofPowerGen. The extent of freedom to business units in developing strategyincreased significantly. Whereas in the early '90s all strategy development andplanning activities were performed by almost a single department, in later

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stages entrepreneurial freedom was given to managing directors of businessunits, especially those involved in new businesses (that formed an increasingpart of the total PowerGen portfolio). Also, business units became free inchoosing appropriate techniques as means to develop strategy, and MDs weregiven considerable influence over their own revenues, including thequestioning of central purchasing of services. Scenario development toobecame increasingly incremental, due to the deployment of ‘robust’ strategydevelopment, inherently decreasing the extent of detail in business plans. Infact, the role of the Group MD became increasingly a role of shaping thecourse of action by gradually blending together initiatives into a coherentpattern of actions, rather than rigidly setting the course of action in advance.

Externally, an increased amount of effort was made to manage the interfacewith regulatory, political and environmental developments, in order tocontinually absorb external perspectives and assess its implications forstrategic options. Obviously, this level of market and environmentresponsiveness could not be incorporated into the formal planning cycle,suggesting a parallel pattern of strategic actions alongside its planning cycle.Opportunistic behaviour emerged, as a result of the numerous governmentalinterventions with great impact on strategic actions. The course of action,reaction and reconsideration that increasingly determined the pattern ofactions of PowerGen, suggest that there was indeed a parallel course alongsidethe formal planning process. The major realised strategic actions of PowerGendid not result from the planning process, but were reactions to governmentalrulings, market opportunities or emerging industry dynamics. The actualstrategic behaviour of PowerGen increasingly showed ‘logical incrementalism’,rather than the pure deployment of the formal planning cycle.

Summary

In this module we have described what corporate strategy entails. Wehave noted that strategy must be holistic, and that strategic thinkingmust dominate an organisation and influence its daily actions. Weexamined the various levels of corporate strategy, and also considerednetwork level strategy; increasingly relevant in today’s world.

We have looked at the importance of strategy to a manager, the skillsrequired to be a strategist, and the characteristics of good strategicdecision making.

We considered the role of models in strategic thinking, in particular theJohnson and Scholes model.

Finally, students have been presented with two contextual case studies(IKEA and PowerGen) to work through.

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To gain maximum benefit from this module, students are encouraged toapply the lessons learnt to their own work context.

Further reading for this unit (optional)

The following are suggested as optional reading for this unit:

1. Ref 10, Chapter 1 Pages 4-34, Chapter 2 Pages 37-75


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Unit 2

Strategic Capability

LEARNING OUTCOMES


� Assess the importance of core competencies to an organisation.

� Analyse the influence synergy can have on an organisation.

� Judge the role divestment has on organisational performance.

Introduction

Corporate strategy is the overarching strategy that applies to a numberof businesses combined within a single corporation. This is more thanaggregating the individual strategies of its various componentbusinesses. There must be definite and identifiable benefits fromcombining the businesses together in a single corporation to makecorporate strategy worthwhile.

This unit examines how businesses are combined to achieve superiorperformance. To obtain optimal corporate performance, a corporationmay increase or reduce the number of component businesses so as tocreate a more effective combination. Corporations use differentmanagement styles in achieving an optimal mix. We shall examineportfolio management and core competencies as two different styles.Portfolio management was fashionable in the 1970s and 1980s, when thefocus was purely on financial control, and it was thought that benefitscould be obtained by holding a portfolio of diverse strategic businessunits. It was also felt that this approach reduced risk for the corporation.In the 1990s corporations began to see the efficiencies and benefits offocusing simply on core business, and a greater focus has come about ondeveloping a corporation’s core competencies. Corporations thusstarted to alter their composition in order to strengthen corecompetencies. Whichever approach is adopted, executing corporatestrategy often involves acquisitions, mergers and divestments.

We shall also examine some case studies concerning strategic capability.

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The Different Management Perspectives

Corporations adopt different management styles in strategic planning,depending on the environment and business context, the corporation’sproduct/services range, its leadership style and management culture.The two extreme positions are:

� Portfolio management.

� Strategic planning by Core Competencies.

Portfolio management is a management style whereby financial controlis performed by the corporate centre, but otherwise the individualbusinesses are de-centralised and highly autonomous. Corporationsadopting this style, achieve greater responsiveness because theindividual subsidiaries are autonomous, but fail to achieve thelonger-term benefits of exploiting synergy. The Hanson group ofcompanies is a classic example.

Corporations that wish to exploit synergies between their variousbusinesses and develop a longer-term competitive advantage, generallyadopt a management style based on core competencies. Canon is a goodexample of a corporation that carries out strategic planning based oncore competencies.

In practice, many corporations try to balance responsiveness withsynergy by adopting management styles that fall between the twoperspectives of portfolio management and core competencies. This issometimes termed the ‘strategic control’ perspective. See Figure 2.1.Nestle is an example.

The paradox of responsiveness and synergy can be illustrated withreference to these three companies. Hanson PLC was well known in the1970s for portfolio management in the purest sense. They operated verymuch in line with the analogy described below – as an investor would infinancial markets to maximise returns on their investment by the buying

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Unit 2 – Strategic Capability Global Corporate Strategy

Corporate Level Strategy

Responsiveness Synergy

Hanson Nestle Canon

Figure 2.1. Corporate Level Strategy Continuum.

and selling of companies. The corporate centre had no wish to becomeinvolved in the management of the portfolio companies but sought tocontrol simply by financial investment. The advantage of thesecompanies was responsiveness to particular markets. Campbell andGould identify this ‘style’ of corporate strategy management as‘Financial Control’.

Canon had the opposite strategic approach. They use their expertise(capability) across a diverse range of products and markets. Forexample, the technology used to develop the Canon photocopier wasthe same as that used for their other optical products – hence, thetechnology is completely different in a Canon copier than, for instance, aXerox. Their advantage came from efficient (synergistic) use ofcapabilities and resources. Campbell and Gould identify this ‘style’ ofcorporate strategy management as ‘Strategic Planning’.

Nestle can be said to lie somewhere in between. Whereas it is notimportant to define the precise location on the continuum, it can be saidthat Nestle combines the two perspectives. On the one hand theymanage their geographically dispersed ‘Business Units’ as remote andautonomous, passing on strategic control to them. On the other handthey maintain strong involvement in the operation of the Business Unitsby the application of a rigid and detailed strategic planning processmanaged at the corporate centre. Hence, it can be said that Nestle is amixture of the two perspectives. Campbell and Gould identify this‘style’ of corporate strategy management as ‘Strategic Control’.

ACTIVITY

Learn about organisations and capability building by reading the following fromyour key text, De Wit, B & Meyer, R.

Readings 5.2 and 5.3: pages 267-285.

Also read Chapter 6 on Corporate Level Strategy : pages 297-318.

Portfolio Management

In portfolio management, in the strictest sense and at the very extremeposition, the corporate centre acts solely as an investor with financialstakes in the standalone businesses. The corporation’s main philosophyis to leverage financial control. See Figure 2.2. In this extreme position,there is very little co-ordination between the various business units, andthere is ‘fuzzy’ co-operation. Each business unit has its owncharacteristics and market demands.

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Global Corporate Strategy Unit 2 – Strategic Capability

Corporations that adopt the extreme portfolio management position arewell suited to diversification through acquisitions.

As we move to the right along the ‘continuum’ (see Figure 2.1), variousstrategic approaches can be described that are still essentiallyportfolio-based. But the corporate centre takes more of a ‘parenting’role, and can add value in some of the following areas: efficiencyimprovements, leverage, provision of expertise, investment andcompetence building, fostering innovation, mitigation of risk, provisionof image and networks, collaboration/co-ordination across SBUs,standards and performance measurements, vision.

With the parenting approach, the question must still be asked onwhether the corporate centre adds value or destroys value. Those whoargue the value creation case cite the following advantages:

1. Co-operation and Control:

� Information sharing

� Co-operation of directors/managers

� Real time decision making

2. Exploitation of:

� Slack (available resources)

� Synergies

� Learning

� Innovative capability

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CorporateCentre

Financial control£

SBU1 SBU2 SBU3 SBU4 SBU5 SBU6

Figure 2.2. Portfolio management and financial control.

� Common infrastructure, processes

3. Intervention in management recruitment and development

Those who argue that parenting destroys value would make the casethat SBUs would be better off on their own, because the corporate centrecreates:

1. Additional cost

2. Creates more bureaucracy

3. Delays decision making

4. Reduces responsiveness

5. Buffers SBU from investment realities

They would also argue that a powerful corporate centre leads tomanagerial ambition and empire building.

Whatever the position adopted, there must be a clear understanding ofthe corporate rationale. It is important right at the outset to establish therole of the corporate centre. This could be one of four types rangingfrom....

1. A Portfolio Manager – as a manager of a portfolio of investments(as above) which may include divestment of under-performingSBUs, acquiring under-valued assets and making them better.

2. A Restructurer – similar to 1 but managers from the corporatecentre move to re-structure to create SBU ‘fitness’ byintervention.

3. A Synergy Manager – enhancing value across SBUs by sharing ofactivities (e.g distribution networks). Knowledge transfer (seeUnit 8) and sharing of competence (see below).

4. A Parental Developer – Corporate Centre develops parentingcompetence including establishing structural and strategiccontrol linkages.

Hence, it can be seen that parenting strategy can be developed from 1(portfolio management) though 2, to 3 and then 4 which tends towards amore competence based strategic approach.

Portfolio management has strong links to the views of Michael Porter(Harvard Business School, 1980) that superior profitability derives fromthe structure of attractive industries. It suggests that superiorprofitability comes from a superior resource position relative tocompetitors. Both the Boston Consulting Group (abbreviated as BCG)and GE/McKinsey matrices position businesses according to industryattractiveness and their relative competitive position in industry.

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ACTIVITY

Study the BCG matrix and GE business screen as shown on Figure 6.2, p. 299of the key text, De Wit, B & Meyer, R .

What conclusions do you derive from it?

ACTIVITY FEEDBACK

The BCG matrix is drawn up against two orthogonal axes; relative marketshare and market growth

Relative market share indicates a business’s market power (one source ofcompetitive advantage) and this is equated with its ability to earn aboveaverage rates of return. In the extreme, higher returns derive from amonopoly (100% market share). More often, however, having a large marketshare will coincide with cost benefits from large production runs and largecumulative volumes of production.

Market growth in the BCG matrix is related to the product life-cycleconcept, which suggests that growth will be minimal or negative when aproduct is mature.

The Business Portfolio

ACTIVITY

As an introduction to this section, read the following from your key text, DeWit, B & Meyer, R.

Reading 6.1: pages 319 – 325

In portfolio management, a corporation’s business can fall into one offour categories:

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� Stars.

� Cash cows.

� Dogs.

� Question marks.

A business is categorised as one of the above, depending on its marketshare vs. growth rate characteristics. This is clearly depicted in Figure2.3.

As we see in Figure 2.3, businesses with market power in a growingmarket are stars. With proper investment these can become cash cowsgenerating significant income for the corporation. A corporation can,therefore, secure its future by combining a balanced portfolio of starsand cash cows, the latter to fund the former as they grow.

Portfolio management as the accepted means of managing corporatestrategy coincided with the growth of diversified conglomerates in the1970s. Often these conglomerates consisted of a portfolio of unrelatedbusinesses, where the management of corporate cash flows between thebusinesses was the sole underlying rationale. This period wasaccompanied by a pattern of acquisitions of unrelated businesses, oftenfollowed by the divestment or liquidation of those classified as ‘dogs’,and deemed to be of no further use in generating cash for thecorporation.

Businesses in the category of ‘Question marks’ need carefulmanagement. They exhibit the characteristics of high growth but lowmarket share. Stars usually emerge from the category of ‘question

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Stars Questionmarks

Cashcows

Dogs

Market share

Gro

wth

rate

Figure 2.3: Business portfolio.

marks’ with proper levels of investment. As such they are an importantcomponent of the business portfolio. However, because of their highgrowth characteristics they require a large injection of cash. Unless theyquickly capture market share and move into the ‘stars’ category, theyhave the propensity to absorb large amounts of cash. As growth slowsdown they become ‘dogs’.

This type of corporate behaviour still has relevance today. There isevidence of extensive merger and acquisition activity that suggests thatcompanies remain in the market for ‘valuable’ Business Units which arequite often kept separate from the corporate centre as a portfoliocompany. It is often the case that such activity is geared towards globalexpansion (see Unit 3), knowledge expansion and creation (see unit 8) orsimply is the result of a combination of desirable economic conditions(see Unit 4).

Shareholder portfolios

Many of the ideas relating to portfolio management stemmed from themanagement of shareholder portfolios in the field of finance andeconomics. In particular, risk reduction by spreading investment acrossa portfolio of shares with different patterns of dividend payments andcapital appreciation. In trying to balance stars and cows the corporatestrategy manager acts like a shareholder, reducing the unique risk thatcomes from owning one business.

Anglo-American ideas of the pre-eminence of shareholder interests incorporate strategy management also led to a focus on shareholder valueanalysis techniques as a tool for managing diversified businesses.

The manager of a diversified corporation is not, however, a shareholderinvesting in a portfolio of stocks in the market. Portfolio theory is basedon the assumption of perfect markets, and a perfect market is dependenton the availability of perfect information. Critics of corporate portfoliossubmit, however, that in a perfect market it is the task of shareholders touse that information to construct a portfolio according to their own riskreturn profiles. In a perfect market it is unclear how a corporateportfolio manager can add further value for shareholders. Indeed,diversified corporations submerge information about individualbusinesses in less informative corporate reports and add the transactioncosts of managing corporate portfolios to the costs which a shareholderhas to bear.

In situations where co-operation and co-ordination are introduced (e.g.the role of the Parental Developer, described above) betweenautonomous SBUs, a company is then ‘moving’ along the‘responsiveness / synergy continuum’ towards a more resource basedview of the company. The combining of effort leads to the creation ofgreater efficiency or ‘synergy’ in the use of resources.

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Synergy in Corporations

Synergy is often put forward as the justification for acquiring ormerging businesses.

But what is synergy in this context?

The familiar expression of synergy is the effect by which ‘the wholeexceeds the sum of the parts’. The equation ‘2+2 = 5’ is often used todemonstrate the effect.

Synergy describes a corporation’s ability to create value, by identifyingthe fit between the opportunities arising from combining activities, andthe corporation’s ability to then exploit these opportunities.

Not all corporations will seek to exploit all available synergies, nor arethey able to. Some corporations may look to exploit only certainsynergies, e.g. financial, technical, mass production, capital assets.

ACTIVITY

Can you think of an example of a corporation that, following a merger oracquisition, focused on exploiting synergies in just one area?

ACTIVITY FEEDBACK

You may have come up with a number of examples. Here is one.

The UK conglomerate Hanson is a classic example. It had no interest inachieving benefits from combining the activities of its acquired businesses. Itsfocus and main source of success stemmed from the imposition of centralisedfinancial control of its corporate headquarters upon its separate subsidiaries.

The achievement of the benefits from synergy is far from simple orautomatic. Synergy needs to be created. It requires tremendousmanagement focus. If poorly managed, the combination of acorporation’s businesses can result in negative synergy.

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Negative Synergy

Managers should be alert to the dangers of negative synergy – thepotential disadvantages and costs of a poor combination. In aninappropriate or badly handled diversification, value can be destroyed,rather than created. In these instances, the negative synergy effect can bedescribed as the sum of the parts being greater than the whole, or ‘2+2 =3’.

Many conglomerates in the late 1980s and early 1990s have beendevalued by investors to reflect such negative synergy.

MINI CASE STUDY

Hanson had a successful strategy of acquiring UK and US quotedcorporations where the value of the separate businesses exceeded thevalue of the corporation. Imperial Group, Smith Corona Machines(SCM) and Kidde Fire were all bought at prices considerably lower thanthe sum of the values that Hanson later realised from their parts, eitherby running them more effectively or by selling businesses to outsiderswho could. The most spectacular example of this strategy remains theacquisition in 1989 of SCM by Hanson for $1.3 billion. Having quicklyrecouped the purchase price by selling a number of SCM businesses for$1.5 billion, Hanson was left with SCM’s core electronic typewriterbusiness with a value subsequently estimated at $2 billion!

Synergy and the Nature of Assets

The deliberate combination of assets, resources and capabilities fromseparate businesses is a distinguishing feature of corporate strategy.Itami (1992) draws a distinction between the benefits arising from‘physical’ and ‘invisible’ assets as follows:

� Physical assets

‘Complementary’ benefits can be obtained from thesimple combination of physical assets such as factoriesand machinery. These can be achieved when physicalassets are under-utilised, incapable of being fully utilised(e.g. due to seasonal cycles), or because combining themreduces risk/uncertainty. Such benefits may includeeconomies of scale, higher capacity utilisation, improvedcash flow and improved product line and mix.

Itami quotes the example of bulk carrier vessels, whichcarry Japanese cars to the US West Coast, loading up with

46


timber from Washington and Oregon in an unrelatedtrade returning to Japan.

� Invisible assets

Invisible assets are assets such as corporate culture,technical expertise, a strong corporate or brand image, orexpert knowledge of the marketplace. It is hard toquantify in $ terms the value of these, and thiscombination benefit is described by Itami as the ‘synergyeffect’.

A recent example of synergy effect is from the IBM acquisition of thebusiness consulting group, PwC Consulting, in late 2002. IBM gainedstrong business consulting skills from PwC, exploited synergies withIBM’s complementary IT competencies and strongleadership/branding. As a result the combined consulting arm vastlyincreased global marketshare (compared with the sum of the individualmarketshare prior to the acquisition).

Synergy and Superior Corporate Performance

An important distinction between physical and invisible assets, andbetween complementary and synergy benefits, lies in the difficultycompetitors have in imitating invisible assets. Using an under-utilisedplant to produce another product will provide a reasonably certainpayoff, but these benefits are ultimately limited by the plant’s capacity.Using cash cow’s to fund stars may provide a secure source of finance,but the strategy can be copied by competitors. Complementary benefitsare unlikely to be lasting sources of superior performance for acorporation. Invisible, information-based assets, on the other hand, arecapable of being used repeatedly, and in innovative combinations, as apowerful long-term source of superior corporate performance, becausethey are more likely to remain unique to the corporation.

Synergies are also associated with time-scales. They can be dynamic orstatic.

Static combination benefits result from integrating two differentstrategies at one point in time.

Dynamic combination benefits, on the other hand, results fromintegrating two different strategies across time. It aims over a period oftime to change the set of resources and its capabilities in order to achievesuperior performance. It has an opportunity cost associate with it.

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ACTIVITY

Read the following article from your key text, De Wit, B & Meyer, R.

Reading 6.4, ‘Seeking Synergies’: pages 340 – 356.

The Core competencies perspective

In the late 1980s there was a move away from the ready acceptance ofportfolio management as the best means of managing corporatestrategy. Performance of vastly diversified companies deteriorated, andthis was coupled with the recognition that there was a largemanagement overhead in managing diverse portfolios. Divestmentsfollowed and a new paradigm followed.

Corporations began to focus increasingly on core business and corecompetencies.

Before we go on to examine the core competence approach, it isappropriate to look at the definitions of core skills, core competenciesand an organisation’s capability. These terms are often misunderstood.An organisation’s core skills, core competencies and distinctivecapability make up its strategic core. Core skills are associated with anindividual, core competencies with a team, and the organisation’scombination of core competencies make up its distinctive capability. Atits simplest, a core competence is a unique capability that affords sometype of competitive advantage to the organisation. It corresponds to abusiness process, and involves a combination of skills, functions,systems and knowledge. To determine if something is a corecompetence, one has to ask the question, “Does it give the company aunique advantage over its competitors and help make the companyprofitable?”

The elements of the strategic core should be developed, extended,protected and exploited to the full. It is an organisation’s corecompetencies that enable it to perform more effectively than itscompetitors, and offer unique advantage to the marketplace. Corecompetencies leading to an organisation’s distinctive capability are alsolikely to be persistent and not readily replicable.

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Core competencies, in contrast to physical assets, relate to humanintellectual capital. Its distinctive features (in contrast to physical assets)are summarised in Figure 2.4. Organisations adopting a corecompetence perspective seek to exploit its intellectual capital to the full.We shall examine this in more detail in the unit on KnowledgeManagement (Unit 8). Increasingly, core competencies, above productsor services, are viewed as rendering competitive advantage, andperceived by customers as adding real value in the long term. The needto focus on core competencies has never been greater, particularly in the‘new knowledge-based economy’.

ACTIVITY

Read the following paper on core competencies by Prahalad and Hamel in yourkey text, De Wit, B & Meyer, R.

Reading 6.2: pages 325- 333

Prahalad and Hamel have explored the role that competencies play incorporate strategy. They view the corporation as a collection of corecompetencies and core products, rather than a portfolio of businesses

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Resources

Resources(physical)

Held in the controlof the organisation

Tangible andintangible

Largely independent of theorganisation's members

Unaffected by culture andgovernance structure

Intellectual capital(skills, competences and

capabilities)

Affects the organisation's abilityto do things effectively

Intangible

Inherently attributable to theorganisation's members

Influenced by culture andgovernance structure

Figure 2.4: Characteristics of physical assets vs. intellectual capital.

defined by product-market boundaries. Competencies are viewed asthe root of competitiveness for the corporation across time.

The tests for core competencies are:

1. Core competencies provide potential access to a wide variety ofmarkets.

2. Core competencies make a significant contribution to theperceived customer benefits of the end-product/service.

3. Core competencies should be difficult for competitors to imitate.

VIRTUAL CAMPUS

Spend some time thinking about your organisation’s core competencies. If youfeel that the company you work for is not suitable for this activity, select aservices company, e.g. IT or Business Consulting Services (e.g. Accenture)

1. What would you consider as its core competencies? How do thesecompetencies give access to a variety of markets (e.g. global, differentindustries/sectors)?

2. How do your organisation’s core competencies (as opposed toproducts/services) benefit your customers?

3. How do your core competencies position you better for the future?

Now think about your competitors..........Consider questions 1, 2 and 3 fromthe perspective of your competitors.

In what ways are your competencies (or that of your competitors) difficult toimitate?

How can the organisation’s core competencies be developed further?

Now share your answers, where appropriate, with your colleagues on theVirtual Campus. In the interests of confidentiality, it is not necessary to namethe company you have considered.

Core competence competition

Studies of diversification have tended to discuss corporate strategy interms of end products and markets rather than core competencies.Rumelt (1974) measured the performance of seven types of diversifiedUS corporations in the period 1949-1969. The results showed that there

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was a strong correlation between superior performance and ‘relatedconstrained’ diversifications. That is, those business that ‘draw on thesame common core skill, strength or resource’ performed better.

Rumelt (1994) further developed the core competencies perspective,and established four key components of core competence competitionas follows:

1. Corporate span: core competencies span businesses and productswithin a corporation.

2. Temporal dominance: products/services are only themomentary expression of core competencies. Competencies aremore stable and evolve more slowly than products/services.

3. Learning-by-doing: Competencies are gained and enhanced byuse.

4. Competitive locus: product-market competition is merely thesuperficial expression of a deeper competition over competencies.

The power of the core competence approach is that it provides acoherent view of how superior corporate performance can be achieved,allows for the importance of the strategic actions of managers, andcaptures the dynamic nature of strategy.

Divestment

As we have seen achieving superior corporate performance often resultsin divestments – that is, the sale or disposal of one or more of acorporation’s activities. Divestments may occur when corporatesynergies no longer exist, under-utilised corporate assets can be betterdeployed elsewhere or core competencies can not be enhanced byleverage across the corporation.

Many divestments occur when subsidiary businesses show decline. Butis divestment always the correct response to failing businesses?

Decline: Divestment or Recovery?

Kathy Harrigan (1988) views declining industries as opportunities forendgame strategies. She believes that corporations must ‘flee or fight’ indeclining industries. The endgame strategies she puts forward are:

1. Leadership: a leadership strategy is dependent on achievingmarket power within the remaining attractive segments of theindustry, and controlling the process of decline in the business’sfavour. This strategy requires some investment. The expectation

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is that, as other competitors leave the industry, so the profitabilityof the firm improves.

2. Niche: niche strategies depend on the existence of defensiblemarket segments. In such a strategy the business would focus ona niche where it is competitively strong, or where demand islikely to persist longer (or at high levels) than in the rest of thesector.

3. Quick sale: a corporation should seek a quick sale when it islikely to realise greatest value from a weak competitive positionin an unfavourable market.

4. Harvest: harvesting assumes that value can be returned to acorporation from a business by continuing to run it to extract asmuch cash as possible. Further investment is not expected: theobjective is to realise the maximum cash from the business.

Other studies (notably Slatter, 1984) have shown that successfulrecovery or turnaround of declining businesses is possible. Companiesthat achieve a sharp and sustained improvement in performance aretermed ‘sharpbenders’. They invariably achieve turnaround by takingone or more of the following measures:

� Major changes in management.

� Stronger financial control.

� New product-market focus.

� Improved marketing.

� Significant reductions in production costs.

� Improved quality and service.

Studies of such companies have shown that sharpbenders succeededbecause of the effectiveness of the measures (as listed above) and timingof them. Sharpbenders rarely pursue acquisitions as a route to change.

Divestment and Core Competencies

As portfolio theory has become less influential, the rationales fordivestment have changed. The strengthening of core competencies is amajor driver in corporate strategies. As such, corporations rarely seekdivestment of activities that enhance its core competencies. Indeed, thestrengthening of core competencies is often a driver for acquisitions.

If an activity or business does not involve a core competence, acorporation should seriously consider whether it should divest thatactivity. ‘Make or buy’ tests are crucial: can the activity be more

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efficiently carried out within a corporation, or by outsidepartners/contractors.

‘Outsourcing’ is a divestment strategy which recognises that improvedeffectiveness might come from buying in non-core competencies. Acorporation’s effectiveness can be significantly improved by thesuperior skills, resources and expertise of companies for whom theactivity is core business.

ACTIVITY

Can you think of some high-profile example of outsourcing, which hasdelivered, or will deliver, massive cost savings.

ACTIVITY FEEDBACK

You may have thought of a number of examples. Many oil companies, financialinstitutions, energy companies and banks have outsourced their IT activities tothe likes of EDS, IBM, Logica.

More recently, the UK government is divesting aspects of its state activities toprivate companies, e.g. NHS patient records and data services, army logistics,etc.

CASE STUDY

Rohm, Japan – strategy in a medium-sized Japanese companysurviving in a difficult environment.

Even as the Japanese economy has been battered by one of the worst recessions inmemory, some Japanese companies have bucked the national trend. This caseexplores the Japanese company Rohm which has stood out not only for its strongperformance in a depressed market but also for its defiance of traditional Japanesecorporate behaviour.

Rohm is a manufacturer of highly specialised integrated circuits based in Kyoto.Its profits have increased steadily over the past four years at a time when mostJapanese companies have struggled to cut their losses. Rohm’s recurring

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profits in the year to March 1998 came to Y110.1 billion (US$917 million), ornearly one-third of sales at Y335.9 billion and a fivefold increase from the Y21.6billion it made in 1994.

Its return on equity, at 16.5%, would be the envy of many blue-chip Japanesecompanies for whom return on equity has tended to be a single-digit figure.Although profits were expected to be flat in 1998, Rohm intended to increaseits recurring income to sales ratio to 33.1% in 1999 from 32.8% in the yearended March 1998.

Like many of its successful neighbours, Rohm has been able to put in thisremarkable performance by maintaining the entrepreneurial spirit of itsfounder and a rigorous focus on profitable niche markets. Rohm’s strength isits company policy of focusing its resources on products that stand out andthat it can differentiate from those of its competitors, explains Nobuo Hatta,the director in charge of overseas sales. To that end the company has adoptedpolicies that are almost diametrically opposed to those that have ruled mostlarge, well-established electronics companies in Japan.

Rather than pursue mass volume businesses, such as the memory chips whichhave been huge profit-earners for the likes of Toshiba and NEC, Rohm hasbeen happy to stick to niche markets where it can offer unique products. It is apolicy to which Rohm’s founder and president, Kenichiro Sato, has steadfastlyadhered.

Mr Sato started the company 40 years ago after giving up his dream ofbecoming a professional pianist. His first successful product was a miniatureresistor he invented, not in his garage but in the family bathroom. At the timemost of the large electronics companies were making only large resistors toput into the large radios. But then the transistor boom hit and Rohm founditself ahead of the game on miniature transistors.

From that time on, Rohm has focused its energies on products that slippedthrough the net of the large electronics companies, such as customised chipparts. ‘I never fight battles I cannot win’, Mr Sato declares. That concentrationon core skills has shielded Rohm from the devastating effects of both thebubble economy and the downturn in semiconductor prices. The companyeven develops its own manufacturing facilities, not only in order to ensure itcan make profits out of small-lot customised products but to ensure that it canmake its products quickly and reliably.

Some chip parts made by the company are priced at less than Yl. This meansthat even if they sell a million of them it only generates Yl million in income.Rohm is able to make a profit on these products because it can produce themquickly, reliably and at low cost.

Also in defiance of traditional Japanese business practice, Rohm does notemploy a seniority-based system of promotion and hires as many as 20 to 30%of its employees in mid-career. Mr Hatta believes that being based in Kyoto hashelped the company. ‘Western Japan is far away from bureaucrats andpoliticians in the central government so we have been able to focus onbusiness’, he says.

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‘There is also a feeling among Kansai people that they would rather be big fishin a small pond’, he notes. ‘Many Kyoto companies have something they canclaim is number one in the world.’ In its focus on core skills, its pursuit ofprofits rather than market share and its emphasis on employee performanceover seniority and lifetime employment, Rohm may sound more like a UScompany than a company based in one of Japan’s most tradition-bound cities.But Mr Hatta, who spent some years in the USA, believes that the Japaneseemphasis on taking a long-term approach to things is one strength thatprovides Japan with an advantage over the USA. ‘We believe the model weprovide is based on the best of both worlds’, Mr Hatta says.

Note: Kansai is the western Japanese province that includes Kyoto.

Questions:

1. What were the main aspects of the environment affecting Rohm overthe last four years?

2. What strategies did Rohm adopt in order to survive and grow? Towhat extent are they more appropriate to medium-sized companies,rather than the large Japanese electronics giants such as Toshiba andNEC?

3. Summarise the key points that identify Rohms strategic perspectives.

CASE STUDY FEEDBACK

The case explores the strategies of a Japanese company that has taken a verydifferent approach to some more well-known Japanese companies like Sony,Toyota and Canon. It raises the strategic issues of how small companies growand how they survive when there is an economic downturn.


� The obvious area is the downturn in the Japanese economy overthis period, which has had an impact on every company in thatcountry.

� Additional pressure from specific competitive pressures in theJapanese electronics industry which has been particularly badly hitby a world-wide drop in prices for semi-conductors – note that thisis not something specific to Japan.

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Rohm decided that it would never be able to compete with the large basicelectronics companies in terms of costs and prices. Its chosen strategy wastherefore to avoid head-on competition with the leaders by finding nichemarkets that would not be attractive to the larger companies. It was thereforeaware of its capabilities as an organisation, and consequently its competencieswithin the groups of people working for the company – a core competenceapproach as opposed to a ‘market driven’ environmental approach.

However, the strategy went further. Rohm deliberately set out to produceproducts for its chosen niches that were reliable, low cost and availablequickly. In other words, the company set out to dominate the niche into whichit had chosen to enter. Looking at it another way, the strategy focused on‘customised’ rather than mass produced products. It was not enough just toidentify the special market opportunity: Rohm still had to perform better thanany potential competitors.

Such strategies have an obvious attraction for smaller companies whencompeting against the larger electronics giants. However, the difficulties offinding an attractive niche and then exploiting the opportunity in that niche arenot to be underestimated.


� Given the small size of the company compared to the industrygiants, Rohm had little choice in following a niche approach.However, the different path is not just about finding a nichebut also exploiting it. This has relied on the classic strategicapproach of examining what competitors are doing and thendoing something that is different.

� Rohm’s view was explained in the case by Mr. Satto whodeclared: ‘I never fight battles I cannot win.’ By this he meantthat smaller companies need to avoid taking on the largecompanies head-on. However, this conventional wisdom canbe challenged, e.g. the success of the Japanese car companyToyota, which had come from being a small national producerin the early 1950s to the third largest car company in theworld by the mid-1990s. Thus it would be over-simplistic todraw the lesson that small companies can only be involved inniche markets. If this were the case, then they would nevergrow. Nevertheless, Rohm is correct in suggesting that, at leastfor a while, smaller companies should avoid attacking majorcompetitors. The smaller enterprise should wait until it hassome form of sustainable competitive advantage: perhaps anew technology or patent, perhaps a strong alliance withanother company or whatever. It is the competitive advantagethat is the key to the success of Rohm, rather than its size.

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� However, size is an advantage to Rohm. Applying DeWit & Meyer’sparadox of Responsiveness and Synergy, the company is nimbleenough to be responsive (to customised markets) whereas stillbeing ‘synergistic’ (relying on core competence). Hence, it can gainthe benefits of both extremes of the paradox. Larger, morecumbersome organisations will find it more difficult to respond tochanges in the niche markets. Because of high overhead costs it isprobably not profitable for them to try to compete with smallercompanies like Rohm.

� Rohm had a different approach to product development, a radicallydifferent way of rewarding his managers and a different companyculture that went well beyond the conventional. This allowed himand the company to survive and prosper in bad times as well asgood.

Summary

In this unit we have looked at the different styles in corporate strategicmanagement. In particular the portfolio management and corecompetencies perspectives. We have also examined the influence ofsynergy on a corporation’s strategic decisions.

We have looked at the role of divestments and the increasing focus oncore products and core competencies. We have seen how this recenttrend has led to outsourcing.

To gain maximum benefit from this module, students are encouraged toapply the lessons learnt to their own work context.

REVIEW ACTIVITY

In the earlier Virtual Campus activity you were asked to think about what yourorganisation’s core competencies are. Now verify this by reading yourorganisation’s mission statement. Identify any references to corecompetencies. If this is absent in the mission statement, consult a broadspectrum of senior managers and identify what the core competencies are.

1. Does the official view (from mission statement or management team)on core competencies match your original view? If there is ambiguity,what steps can be taken to ensure that the organisation as a whole isclear on its core competencies.

2. Now test your own department/business unit against the corecompetencies.

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� If you feel there is a poor match, describe what sort oforganisation can benefit from your department’s capabilities.

� If there is a good match, could you further strengthen yourposition via an acquisition. Elaborate.

(Given the confidential nature of this information, you may wish to anonymise it. )



1. Ref 10, Chapter 6 – Pages 226-241



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Unit 3

Globalisation

LEARNING OUTCOMES


� Evaluate the impact drivers for change have on organisations.

� Assess the implications of globalisation for business.

� Propose solutions for managers working in a global environment.

Introduction

The phenomenon of globalisation is accelerating in pace. Globalisationhas received much publicity in recent years – both positive andpromoted by large global corporations and organisations such as theWTO, but also negative coverage from the anti-globalisation movementhighlighting some of the issues. But what exactly is globalisation? In thisunit we shall consider exactly what globalisation is. We shall considerthe globalisation of markets and the globalisation of production.

We shall consider the changing nature of multinational enterprises. Inparticular, the rise of non-US multinationals, and now increasingly agrowth in mini-multinationals.

For corporations, globalisation involves radical change. Globalisationpresents opportunities but also poses challenges for the management ofhighly distributed worldwide organisations. We shall consider some ofthese issues.

Finally we shall look at two case studies concerning Globalisation.

What is Globalisation

The concepts of ‘globalisation’, ‘global strategies’, ‘global corporations’,‘global markets’, ‘global production’, ‘global productisation’ and‘global branding’ are widely used. Sometimes these terms are usedsynonymously, and their meaning is not well understood. In this

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section, we shall briefly look at the evolution of globalisation and what itactually means.

ACTIVITY

As an introduction to this section read Chapter 10, The International Context,pages 534-556 in your key text, De Wit, B & Meyer, R.

A fundamental shift has been occurring in the world economy. Therehas been a move away from a world in which national economies wererelatively isolated from each other by barriers to cross-border trade /investment; by distance, time zones, language and by nationaldifferences in government regulation, culture and business systems.

We have been moving toward a world in which national economies aremerging into an interdependent global economic system, commonlyreferred to as globalisation. The rate at which this shift is occurring hasbeen accelerating and is set to continue to do so.

Globalisation is the phenomenon by which industries transformthemselves from multi-national to global competitive structures. Globalcompanies operate in the main markets of the world, and do so in anintegrated and co-ordinated way.

There are broadly three elements to globalisation:

1. International Scope, the spatial dimension:

� Broadest possible international scope.

� Process of international expansion on a world-wide scale.

2. International Similarity, the variance dimension:

� Homogeneity around the world.

� Process of declining international variety.

3. International Integration, the linkages dimension:

� World is viewed as one tightly linked system.

� Process of increasing international interconnectedness.

The emerging global economy raises a multitude of issues forbusinesses. It creates opportunities for businesses to expand theirrevenues, drive down their costs and boost their profits. While theglobal economy creates opportunities such as this for new

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Unit 3 – Globalisation Global Corporate Strategy

entrepreneurs and established businesses around the world, it alsogives rise to challenges and threats that yesterday’s business managersdid not have to deal with.

For example, managers now routinely have to decide how best toexpand into a foreign market.

� Should they export to that market from their home base?

� Should they invest in production facilities in that market,producing locally to sell locally?

� Should they produce in a third country where the cost ofproduction is favourable and export from that base toother foreign markets and, perhaps, to their homemarket?

Managers have to decide how to customise their product offerings,marketing policies, human resource practices and business strategies todeal with national differences in culture, language, business practices,and government regulations. In addition, managers have to decide howbest to deal with the threat posed by efficient foreign competitorsentering their home marketplace.

KEY POINT

Globalisation is the phenomenon by which industries transform themselvesfrom multi-national to global competitive structures

It refers to the shift toward a more integrated and interdependent worldeconomy and has two main components:

� The globalisation of markets.

� The globalisation of production.

Global Convergence vs. International Diversity

De Wit & Meyer propose that a paradox exists between the pressure toact globally and locally, i.e. a continuum can be said to exist with oneextreme being Globalisation and the other being Localisation.

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Global Corporate Strategy Unit 3 – Globalisation

ACTIVITY

This topic links with subjects that are to be covered in other units. At this pointbriefly scan the following sections, ahead of studing the units in detail.

Unit 6: section on Value Management

Point to note: Many companies are relocating to other countries to save costs.Classic examples of this have been in call centres. A further example has beenDyson who switched their production to Malaysia saving 25% on productioncosts. The explanation for this was to spend the money on R&D and to keepthe company afloat. However, a customer backlash resulted in a 5% reductionin the number of vacuums sold.

Unit 7: section on Ethics

Point to note: Similar behaviour by major companies has seen them fall foul ofglobalisation protestors who see such behaviour as exploitative, e.g. Nike andIkea. However, is this simply good business and in accordance with theprinciple espoused by Milton Friedman who stated that the only responsibilitya company has is to its owners.

Business success in the international context is increasingly a case offinding the right balance between the forces of globalisation vs.localisation. This balance varies depending on the industry you operate

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Micro chips Automobile Military aircraft Pharmaceuticals

Bulk chemicals

Civil aircraft Telecommunicationservices

Retail banking

Food retailing

High

Low

Low HighLocalisation forces

Glo

balis

atio

nfo

rces

Figure 3.1: Global integration vs. Local responsiveness grid for various sectors.

in. See Figure 3.1. For example, if you a microchip manufacturer,localisation bears little meaning; ‘one size fits all’ in the globalmarketplace. However, if you are a food retailer, localisation forces aresignificant and cannot be ignored.

The factor that works against globalisation is the localisation push; thedemand for flexibility to deliver customer-oriented products/servicesrapidly and in close geographical proximity to the customer.Localisation push has four main categories; cultural, commercial,technical and legal. See Figure 3.2.

Globalisation at the Micro, Meso and Macrolevels

The issues concerning globalisation can be viewed at the micro, mesoand macro levels.

At the micro level, for a company, the issues concerning globalisationare:

� The extent to which an organisation has a global strategy,structure, culture, workforce, management team andresource base.

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Localisation

Culturalfactors

e.g. attitudes,tastes, social

practices

Legalfactors

e.g. regulations

Technicalfactors

e.g. standards,e-business,

communications

Commercialfactors

e.g. customerresponsiveness,customisation,

networks

Figure 3.2: Localisation push factors.

� Globalisation of specific products and value-addingactivities.

� The globalisation of one product or activity does notnecessarily entail the globalisation of others.

At the meso level, for businesses, the issues concern markets andindustries, as follows:

� On markets, the growing similarity of customer demandglobally.

� On markets again, the growing ease of worldwideproduct flows, e.g. crude oil, foreign currency markets

� On industries, the emergence of a set of producerscompeting on a worldwide basis, e.g. automobile,consumer electronics.

Major changes from globalisation at the meso level include the moreeven distribution of Foreign Direct Investment (FDI), and waves ofcross-border mergers, acquisitions and strategic alliances. There hasalso been a notable expansion in the services sector at the expense ofmanufacturing.

At the macro level, for the world’s economies, the issues concern:

� The debate on whether the economies of the world areexperiencing a converging trend.

� Consequences of international integration in terms ofgrowth, employment, productivity, trade and foreigndirect investment.

� Political realities constraining or encouragingglobalisation.

� Dynamics of technological, institutional andorganisational convergence.

Major changes impacting the economies include the complexity andinterconnectedness of the world economy, de-industrialisation of majorpowers, financial debt of developing nations and the division of theworld into trading blocks.

The Globalisation of Markets

The globalisation of markets refers to the merging of historically distinctand separate national markets into one global marketplace. The tastesand preferences of consumers in different nations are beginning to

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converge on some global norm, thereby helping to create a globalmarket, e.g. McDonald’s hamburgers. This type of firm is more than justa benefactor of this trend; they are also instrumental in facilitating it. Byoffering a standardised product world-wide, they are helping to create aglobal market.

However, it is important to understand that national markets are notgiving way to the global market in all sectors of the economy. Significantdifferences still exist between national markets, e.g. consumer tastesand preferences, distribution channels and culturally embedded valuesystems. These differences frequently require that marketing strategies,product features and operating practices be customised to best matchconditions in a country.

ACTIVITY

Read the following article on the globalisation of markets from your key text,De Wit, B & Meyer, R.

Reading 10.1: pages 557-561

In many global markets, the same firms frequently confront each otheras competitors in nation after nation, e.g. Coca-Cola’s and Pepsi, Fordand Toyota, Boeing and Airbus, Caterpillar and Komatsu, andNintendo and Sega.

Thus, diversity is replaced by greater uniformity. As rivals follow rivalsaround the world, these multinational enterprises emerge as importantdrivers of the convergence of different national markets into a single,and increasingly homogenous, global marketplace.

ACTIVITY

Can you think of products that simply cannot be standardised for theworldwide market? Or products for which marketing attempts at globalstandardisation have failed?

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ACTIVITY FEEDBACK

You may have thought of a number of examples ranging from differing tastes incars (North America vs. Europe) to foods. One example is that of coffee,where tastes vary vastly from continent to continent. Latin Americans prefer abitter taste, Europeans like strong blends, and Americans can only ‘tolerate’weak blends. So, for example, Nescafe markets different variations under thesame brand to different countries.

Now, as a follow-on to the above activity, read the following article in your keytext, De Wit, B & Meyer, R., that critically examines the notion that success ininternational markets requires adoption of global products and brands.

Reading 10.2: pages 562-569

The Globalisation of Production

The globalisation of production refers to the tendency among firms tosource goods and services from locations around the globe to takeadvantage of national differences in the cost and quality of factors ofproduction (such as labour, energy, land and capital). By doing so,companies hope to lower their overall cost structure and / or improvethe quality or functionality of their product offering, thereby allowingthem to compete more effectively.

MINI CASE STUDY

The Boeing 777 aeroplane contains 132,500 major component parts that areproduced around the world by 545 suppliers. Eight Japanese suppliers makeparts for the fuselage, doors, and wings; a supplier in Singapore makes thedoors for the nose landing gear; three suppliers in Italy manufacture wing flaps;and so on. Part of Boeing’s rationale for outsourcing so much production toforeign suppliers is that these suppliers are the best in the world at performingtheir particular activity. The result of having a global web of suppliers is a betterfinal product, which enhances the chances of Boeing winning a greater share oftotal orders for aircraft than its global rival, Airbus. Boeing also outsourcessome production to foreign countries to increase the chance that it will winsignificant orders from airliners based in that country.

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As with markets, it is important not to emphasise the globalisation ofproduction too much. It is still difficult for firms to achieve optimaldispersion of their production activities to locations around the globe.This is due to formal and informal barriers to trade between countries,barriers to foreign direct investment, transportation costs and issuesassociated with economic and political risk.

Nevertheless, there is an increased level of globalisation of markets andproduction. Modern firms are playing a key role in this and increaseglobalisation by their actions. These firms, however, are merelyresponding in an efficient manner to changing conditions in theiroperating environment.

ACTIVITY

Can you think of an example of globalised production that has yieldedenormous cost and other business benefits?

ACTIVITY FEEDBACK

There are many examples of corporations outsourcing specific activities (e.g.call centres) to one country. For example, many financial institutions haveoutsourced their call centres to India.

There is also another aspect – the distributed globalisation of production. Thisis particularly so in the IT sector, where companies are increasingly distributingthe ‘production’ of software across geographies. Companies such as IBM runprojects where aspects of the same software is developed in China, otheraspects in India and yet others in South America. The whole system may thenbe integrated in yet another country (e.g. US). This achieves ‘round-the-clock’productivity. Not only do huge cost savings result from cheaper professionalrates from non-Western countries, but also ‘round-the-clock’ productivityenables corporations to achieve aggressive time-lines. Effectively work is beingcarried out throughout the 24-hour clock. However, this is not the panacea itsounds. There are challenges with such globally distributed production, andsuch practices require strong management control, standards and robust ITand communication infrastructures. These are some of the managementchallenges of globalisation which we shall examine later in this unit.

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Drivers of Globalisation

Two main factors seem to underlie the trend toward greaterglobalisation:

� A decline in barriers to the free flow of goods, servicesand capital has occurred since World War II.

� Technological change, particularly the dramaticdevelopments in recent years in communications,information processing and transportation technologies.

Declining Trade and Investment Barriers

After World War II, the advanced industrial nations of the Westcommitted themselves to removing barriers to the free flow of goods,services and capital between nations. This goal was enshrined in thetreaty known as the General Agreement on Tariffs and Trade (GATT).

In addition to reducing trade barriers, many countries have also beenprogressively removing restrictions to Foreign Direct Investment (FDI).The desire to facilitate FDI has also been reflected in a dramatic increasein the number of bilateral investment treaties designed to protect andpromote investment between two countries. As of January 1, 1997, therewere 1,330 such treaties in the world involving 162 countries, a threefoldincrease in five years.

The Role of Technological Change

The lowering of trade barriers made globalisation of markets andproduction a possibility. Technological change has made it a reality.Since World War II, the world has seen major advances incommunications, information processing and transportationtechnology including, most recently, the explosive emergence of theInternet and World Wide Web. Telecommunications is creating a globalaudience. Transport is creating a global village.

Microprocessors, Information Technology andtelecommunications

Perhaps the single most important innovation has been development ofthe microprocessor, which enabled the explosive growth of high-power,low-cost computing, vastly increasing the amount of information thatcan be processed by individuals and firms. The microprocessor alsounderlies many recent advances in telecommunications technology.Over the past 30 years, global communications have beenrevolutionised by developments in satellite, optical fibre and wireless

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technologies, and now the Internet and the World Wide Web. Thesetechnologies rely on the microprocessor to encode, transmit and decodethe vast amount of information. The cost of microprocessors continuesto fall, while their power increases (a phenomenon known as Moore’sLaw, that predicts that the power of microprocessor technology doublesand its cost of production halves every 18 months). As this happens, thecosts of global communications are plummeting, which lowers the costsof co-ordinating and controlling a global organisation.

An important factor and, possible the most critical factor, contributingto globalisation has been the Information Technology revolution. Theemergence of standards in IT has made our world inter-connectedthrough high-speed computers. The American defense institutionswere largely instrumental for the rise of standards and protocols incommunications, messaging and IT. Through the adoption ofstandards, heterogeneous computer systems (from India to Beijing toEurope to US) are able to communicate seamlessly and securely. Thishas led to open and interoperable applications. IT infrastructures arenow essential pre-requisites for modern global corporations. Thesedevelopments have accelerated the pace towards globalisation in manysectors of the global economy.

The Internet and World Wide Web

The phenomenal recent growth of the Internet and the World Wide Webhas now developed into the information backbone of a global economy.From virtually nothing in 1994, the value of Web-based transactions hit$7.5 billion in 1997. Included in this expanding volume of Web-basedelectronic commerce (e-commerce) is a growing percentage ofcross-border transactions. Viewed globally, the Web is emerging as agreat equaliser. It rolls back some of the constraints of location, scale,and time zones. The Web allows businesses, both small and large, toexpand their global presence at a lower cost than ever before.

Transportation technology

In addition to developments in communications technology, severalmajor innovations in transportation technology have occurred sinceWorld War II. In economic terms, the most important are probably thedevelopment of commercial jet aircraft and super-freighters and theintroduction of containerisation, which simplifies trans-shipment fromone mode of transport to another. The advent of commercial jet travel,by reducing the time needed to get from one location to another, haseffectively shrunk the globe.

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Implications of technological change forglobalisation

Firstly, let us examine the implications of technological change for theglobalisation of production. Due to containerisation, the transportationcosts associated with the globalisation of production have declined.Plus, as a result of the technological innovations, the real costs ofinformation processing and communication have fallen dramatically inthe past two decades. This makes it possible for a firm to manage aglobally dispersed production system, further facilitating theglobalisation of production. As noted earlier, a world-widecommunications network is now essential for international businesses.

MINI CASE STUDY

Texas Instruments (TI), the US electronics firm, has approximately 50 plants in19 countries. A satellite-based communications system allows TI toco-ordinate, on a global scale, its production planning, cost accounting,financial planning, marketing, customer service and personnel management.The system consists of more than 300 remote job-entry terminals, 8,000inquiry terminals and 140 mainframe computers. The system enables managersof TI’s world-wide operations to send vast amounts of information to eachother instantaneously and to co-ordinate the firm’s different plants andactivities.

Secondly, let us look at the implications of technological change for theglobalisation of markets. In addition to the globalisation of production,technological innovations have also facilitated the globalisation ofmarkets. Low cost transportation has made it more economical to shipproducts around the world, thereby helping to create global markets.Low-cost global communications networks such as the World WideWeb are helping to create electronic global marketplaces. In addition,low-cost jet travel has resulted in the mass movement of people betweencountries. This has reduced the cultural distance between countries andis bringing about some convergence of consumer tastes and preferences.At the same time, global communications networks and global mediaare creating a world-wide culture, e.g. television. In any society, themedia are primary conveyers of culture. As global media develop, wemust expect the evolution of something akin to a global culture.

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The Changing Demographics of theGlobal Economy

Hand in hand with the trend toward globalisation has been a fairlydramatic change in the demographics of the global economy over thepast 30 years or so. As late as the 1960s, the following four factsdescribed the demographics of the global economy:

� US dominance in the world economy and world tradepicture.

� US dominance in world foreign direct investment.

� The dominance of large, multinational US firms on theinternational business scene.

� Roughly half the globe, the centrally planned economiesof the Communist world, was off-limits to Westerninternational businesses.

All four of these qualities either have changed or are now changingrapidly. Refer to Table 3.1 for the changes in world output and trade, forexample.

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Country Share of World Output,1963

Share of World Output,1996

Share of World Exports,1997

United States 40.3% 20.8% 12.6%

Japan 5.5% 8.3% 7.76%

Germany 9.7% 4.8% 9.9%

France 6.3% 3.5% 5.46%

United Kingdom 6.5% 3.2% 4.94%

Italy 3.4% 3.2% 4.76%

Canada 3% 1.7% 3.81%

China NA 11.3% 2.85%

South Korea NA 1.7% 2.45%

Table 3.1. Changing World Output and Trade (Source: Export data from World Trade Organisation, International Trade Trendsand Statistics, 1996. World Output data from CIA Factbook).

ACTIVITY


Reading 10.3, ‘The Competitive Advantage of Nations’, pages 569-577

Changes in Foreign Direct Investment

Over the past thirty years, US dominance in export markets has wanedas Japan, Germany and a number of newly industrialised countries suchas South Korea and China have taken a larger share of world exports.

In 1997 and 1998 the dynamic economies of the Asian Pacific regionwere hit by a serious financial crisis that threatened to slow theireconomic growth rates for several years. Despite this, their powerfulgrowth may continue over the long run, as will that of several otherimportant emerging economies in Latin America (e.g. Brazil) andEastern Europe (e.g. Poland). Thus, a further relative decline in theshare of world output and world exports for long-establisheddeveloped nations seems likely.

Most forecasts now predict a rapid rise in the share of world outputfrom developing nations such as China, India, Indonesia, Thailand,South Korea and Brazil, and a commensurate decline in the shareenjoyed by rich industrialised countries such as Britain, Germany, Japanand the United States.

MINI CASE STUDY – Toyota

Toyota, the Japanese automobile company, rapidly increased its investment inautomobile production facilities in the United States and Britain during the late1980s and early 1990s. Toyota executives believed that an increasingly strongJapanese yen would price Japanese automobile exports out of foreign markets.Therefore, production in the most important foreign markets, as opposed toexports from Japan, made sense. Toyota also undertook these investments tohead off growing political pressures in the United States and Europe to restrictJapanese automobile exports into those markets.

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The Changing Nature of Multinational Enterprise

A multi-national enterprise is any business that has productiveactivities in two or more countries. Since the 1960s, there have been twonotable trends in the demographics of the multinational enterprise:

1. The Rise of Non-US multi-nationals

There has been a notable rise in non-US multinationals, particularlyJapanese multinationals such as the Sony Corporation, Toyota, etc.

In 1973, 48.5 percent of the world’s 260 largest multinationals were USfirms. The second-largest source country was Great Britain, with 18.8percent of the largest multinationals. Japan accounted for only 3.5percent of the world’s largest multinationals at the time. The largenumber of US multinationals reflected US economic dominance in thethree decades after World War II, while the large number of Britishmultinationals reflected that country’s industrial dominance in the earlydecades of the 20th century.

By 1997, however, US firms accounted for 32.4 percent of the world’s 500largest multinationals, followed closely by Japan with 25.2 percent.France was a distant third with 8.4 percent. Although the two sets offigures are not strictly comparable (the 1973 figures are based on thelargest 260 firms, whereas the 1997 figures are based on the largest 500firms), they illustrate the trend. The globalisation of the world economytogether with Japan’s rise to the top rank of economic powers haveresulted in a relative decline in the dominance of US (and, to a lesserextent, British) firms in the global marketplace. Looking to the future,the growth of new multinational enterprises from the world’sdeveloping nations is inevitable. Indeed companies such as the Tataconglomerate in India are already multi-national players, and haveactivities ranging from IT to cars to heavy engineering.

2. The Rise of Mini-Multinationals

Another trend in international business has been the growth ofmedium-sized and small multinationals (mini-multinationals). Whenpeople think of international businesses they tend to think of large,complex multinational corporations with operations that span theglobe. Although most international trade and investment is stillconducted by large firms, many medium-sized and small businesses arebecoming increasingly involved in international trade and investment.

These mini-multinationals often operate in specialist areas and areincreasingly powerful. An example in point, is Accenture Consulting – ahighly focused business consulting firm with a global presence, andgreat influence – indeed setting the pace for much of the globalisationparadigm.

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The Changing World Order

Between 1989 and 1991, a series of remarkable democratic revolutionsswept the communist world. Following the political changes, many ofthe former communist nations of Europe and Asia have now adoptedfree market economics. These countries which were previously closedto Western international businesses, now present a host of export andinvestment opportunities. For example, the oil industry, in the formerSoviet Union, has been opened up and many foreign companies operatelicences there now.

In addition, more quiet revolutions have been occurring in China andLatin America. Their implications for international businesses may bejust as profound as the collapse of communism in Eastern Europe. Thepotential consequences for Western international business areenormous. With a population of 1.2 billion people, China represents ahuge and largely untapped market.

On the other hand, China’s new firms are proving to be very capablecompetitors, and they could take global market share away fromWestern and Japanese enterprises. We see evidence of this already.Thus, the changes in China are creating both opportunities and threatsfor established international businesses.

For decades many Latin American countries were ruled by dictators.They viewed Western international businesses as instruments ofimperialist domination. Accordingly, they restricted direct investmentby foreign firms. Also, the poorly managed economies of Latin Americawere characterised by low growth, high debt and hyperinflation, all ofwhich discouraged investment by international businesses. Now all thisseems to be changing. Throughout most of Latin America, debt andinflation are down, governments are selling state-owned enterprises toprivate investors, foreign investment is welcomed and the region’seconomies are growing rapidly. These changes have increased theattractiveness of Latin America, both as a market for exports and as asite for foreign direct investment

The Globalisation Debate: Prosperity orImpoverishment?

Globalisation continues to be an emotive issue. Many influentialeconomists, politicians and business leaders promote the shift towards amore integrated and interdependent global economy. They promote theview that international trade and investment is driving the globaleconomy towards greater prosperity, and that globalisation willstimulate economic growth and help create jobs in all countries thatchoose to participate in the global trading system. Many of theseproponents are business leaders from global companies; companies that

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are agents of globalisation – companies that have the most to gain fromglobalisation. Some of these companies (e.g. Starbucks, Nike) havebecome front-line targets of critics who blame globalisation for a varietyof ethical and social issues, e.g. global warming, pollution, exploitationof labour in poor countries, encroachment on human rights, etc.Globalisation is challenged on grounds that it widens the gap betweenthe rich and the poor.

ACTIVITY

To read the arguments for and against globalisation, refer to the followingwebsites:

The website of the World Trade Organisation (WTO) for pro-globalisationviewpoints:

www.wto.org

For anti-globalisation viewpoints refer to the following websites:

www.southcentre.orgwww.wtowatch.org

There is no doubt that globalisation has deep social, political andenvironmental consequences, as you will have noted from the previousstudent activity. Leaving aside the social and ethical issues that we haveilluded to above, there are a number of other criticisms of the impact ofglobalisation:

1. Impact on jobs and incomes

One frequently voiced concern is that far from creating jobs, fallingbarriers to international trade actually destroy manufacturing jobs inwealthy advanced economies such as the United States and UnitedKingdom. Falling trade barriers can allow firms to move theirmanufacturing activities offshore to countries where wage rates aremuch lower. Supporters of globalisation argue that the benefitsoutweigh the costs. They argue that free trade results in countriesspecialising in the production of those goods and services that they canproduce most efficiently, while importing goods that they cannotproduce as efficiently.

2. Labour Policies and the Environment

A second source of concern is that free trade encourages firms fromadvanced nations to move manufacturing facilities to less developed

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countries. Countries that lack adequate regulations to protect labourand the environment from abuse by the unscrupulous. Adhering tolabour and environmental regulations significantly increases the costsof manufacturing enterprises and puts them at a competitivedisadvantage in the global marketplace compared with firms based indeveloping nations that do not have to comply with such regulations.

Supporters of free trade argue that firms are not the amoralorganisations that critics suggest. While there may be a few exceptions,the vast majority of enterprises are committed to ethical behaviour.They would be unlikely to move production offshore just so they couldpump more pollution into the atmosphere or exploit labour.

3. National Sovereignty

A final concern is that in today’s increasingly interdependent globaleconomy, economic power is shifting away from national governmentsand toward supranational organisations such as the World TradeOrganisation, the European Union and the United Nations. It can beperceived that un-elected bureaucrats are now able to impose policieson the democratically elected governments of nation-states, therebyundermining the sovereignty of those states. In this manner, thenational state’s ability to control its own destiny is being limited.

VIRTUAL CAMPUS

Globalisation on the one hand can have a levelling-down effect, and on theother hand a levelling-up effect. So for instance, in the outsourcing context(e.g. call centres) there is a view that Western countries (e.g. UK and US) havelost out in this sector, whereas developing countries such as India havebenefited.

From your organisation’s viewpoint and also geographical viewpoint, identifyon the Virtual Campus whether globalisation has had a levelling-up orlevelling-down effect. Elaborate.

Now look at the opposing views (posted on the Virtual Campus) and try tounderstand their perspective from a rational viewpoint. Assess whether yourviewpoint has changed.

Managing in the Global Marketplace

As organisations increasingly engage in cross-border trade andinvestment, managers need to recognise that the task of managing aninternational business differs from that of managing a purely domestic

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business in many ways. Let us examine some of the differences andcomplexities:

1. Country differences

At the most fundamental level, managing in the global marketplacerequires an understanding and appreciation of the simple fact thatcountries are different. Countries differ in their cultures, politicalsystems, economic systems, legal systems and levels of economicdevelopment. Many of these differences are very profound andenduring. A lack of appreciation of these country differences has led tothe failure of many American companies in expanding into foreignterritories.

2. Complexity of international and distributed businesses

A further way in which international business differs from domesticbusiness is the greater complexity of managing an international anddistributed business. A manager in an international business isconfronted with a range of issues that the manager in a domesticbusiness never faces. A business must decide where in the world to siteits production activities to minimise costs and to maximise value added.Then it must decide how best to co-ordinate, monitor and control itsglobally dispersed production activities.

3. Choice of markets to compete in

Decisions about which foreign markets to enter and which to avoidmust be made. Also the appropriate mode for entering a particularforeign country must be chosen as it has major implications for thelong-term health of the firm. Is it best to;

� Export its product to the foreign country?

� Allow a local company to produce its product underlicence in that country?

� Enter into a joint venture with a local firm to produce itsproduct in that country?

� Set up a wholly owned subsidiary to serve the market inthat country?

4. Compliance with international trading and investment rules

Conducting business transactions across national borders requiresunderstanding the rules governing the international trading andinvestment system. Managers in an international business must alsodeal with government restrictions on international trade andinvestment and find ways to work within the limits imposed by specificgovernmental interventions.

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5. Cross-border transactions and currency risk

Cross-border transactions require that money be converted from thefirm’s home currency into a foreign currency, and vice versa. Sincecurrency exchange rates vary in response to changing economicconditions, an international business must develop policies for dealingwith exchange rate movements. A firm that adopts a wrong policy canlose large amounts of money.

6. Complexity of a global organisational structure

Global organisations, inevitably require more complex, matrixorganisational structures. In particular, the management roles are quitedifferent and require higher calibre managers. Global organisationsgenerally have four types of differentiated management roles:

� Global business managers; responsibility for strategy.

� Country managers; expert knowledge on opportunities,threats and competitive landscape in local geography.

� Functional managers; responsibility for newdevelopments and knowledge sharing and leverageacross the global company.

� Corporate managers; overall organisational leadership.

7. Operational processes

A much greater degree of operational co-ordination is required toachieve global leverage and efficiency. Global organisations requirerobust operational processes and standards to support inter-working,customer relationships, knowledge management and sharing ofintellectual capital. Processes must cover decision making, resourceallocation, intellectual capital reuse, policies enacted, rewards,sanctions, management escalation and control. It should be recognised,however, that local variations will be required to comply with localissues, e.g. local employment laws.

An efficient IT and communications infrastructure is also a pre-requisiteto support such operational processes. Many of these operationalprocesses will be e-business processes.

ACTIVITY


Reading 10.4, ‘Transnational Management’, pages 577-586

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CASE STUDY 1 – GLOBALISATION ATGIANT BICYCLES

Giant Bicycles are Taiwanese owned, but designed in the USA and made in theNetherlands – a global company. This case reports on an interview with the chiefexecutive, Mr Antony Lo, about the company’s global strategy.

The Giant Bicycles Company is based in Taiwan and is one of the world’sbiggest bicycle manufacturers with annual sales of around US$400 million, 93%outside Taiwan. According to Mr Lo:

“Because of the small market for bicycles in Taiwan, we don’t have any choice –we have to be a global company. The biggest markets are in Europe and the US,which account for just over half our sales. We started manufacturing in theNetherlands because of the attractive market in Europe, where we expectedto sell more than 400,000 bikes in 1997. That’s out of a demand for bikes inEurope of about 15 million annually.

To start with, we will be making just 100,000 bikes a year from our Europeanfactory, but we envisage this climbing threefold by early next century. The mainreason for transferring some production from the Far East to the Netherlandsis to increase flexibility.

Fashions are changing quickly and market trends must be followed closely.Having a production base next to the market means that we should be able tosatisfy our customers better. Wage costs in the Netherlands are 60% higherthan in Taiwan but because we should get better productivity in Europe, thiswill not affect overall costs too much.

We are considering opening another plant in the US; we expect to decide onthis around year 2000. Our Taiwan plant makes about 1 million bikes a year outof a total 2.5 million bikes for our company – including bikes produced by ajoint venture in China. I expect the proportion of Taiwanese bikes to declineover the next few years as we switch production away from Asia.

Developing new products is as important as manufacturing. Bicycles are asmuch a fashion item as a piece of machinery. We sell bikes in several thousandvariations. In the early 1990s we introduced up to three new products everyyear. Today, however, that figure has grown to between five and ten reflectingincreased demands by customers. One of our strengths is the ability tointroduce regional product lines, within the context of an internationalapproach. About three-quarters of the products we sell around the world arethe same – but for the remaining 25% we give our regional people freedom tospecify products they think will appeal locally.

Worldwide, we have 65 designers and development engineers. We spend 2%of our annual sales on design. Forty five of the designers are in Taiwan, the restare based in China, Japan, the US and the Netherlands. Through the globaldesign approach we aim to pool many different concepts – the people in China

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and Japan concentrate on commuting bikes, the designers in the Netherlandscontribute ideas from the European racing bike tradition, while in the US theyare more likely to be working on variants of mountain bikes. In Taiwan, we tryto incorporate all of the ideas, working on new materials such as carbon fibreto reduce the weight of the frame. Our designers can talk on the phone andswop ideas using computer-aided design, but they get together twice a year inTaiwan to review their work. The common language we use is English.

One of the developments we are particularly enthusiastic about is electricbattery-powered bikes, which we have been selling from mid-1998. Weexpected to sell around 2000 in the first year with considerably moreafterwards, particularly in Europe. There’s an increasing environmental needfor such machines to reduce traffic congestion. At the same time, they makethe job of a cyclist easier. During normal travel they should have a range ofabout 40km. And when the battery runs out, it’s not a huge problem – all youhave to do is pedal home."

Questions:

1. What benefits does the company gain from its global strategy? Andwhat have been the problems?

2. The opening paragraph of the case states that Giant Bicycles is a‘global’ company. Do you agree with the statement within thedefinitions explored in the lecture?

CASE STUDY FEEDBACK

This short case summarises many of the reasons for global expansion and theproblems that then arise. Bicycles operate in a relatively mature marketwithout the benefit of special, even unique technologies or patents to providethe basis for global expansion. Other medium-sized companies that havereached maturity of sales in their home markets will look with interest at theachievement of Giant Bicycles so far.

Other companies possessing economies of scale and scope will also beattracted by the arguments concerning the increased scale of internationaloperations and the ability to recover the costs of research and developmentacross an increased sales volume.

They will also learn a little about the increased complexity and costs ofinternational operations and selling. However, few details are given on this inthe case and, in any event, the details will probably vary with each company andits type of business. In addition, some aspects of the company’s internationaldevelopment remain essentially obscure. How did they start internationally?

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Why did they pick Europe rather than the USA? (The high usage of bicycles inHolland makes it clear why they would pick this market within Europe.) Howdid they cope with the great geographical distances and the selling task in theirchosen country? And so on.

Thus other medium-sized companies can learn something from Giant Bicyclesbut the full case for international expansion remains unclear.


Benefits include:

� Global economies of scale in production: reduced costs of someitems.

� Higher sales than would be possible in Taiwan alone.

� Ability to keep in contact with different market trends and latestdesigns.

� Production from high-efficiency workforces, e.g. Netherlands.

� R&D costs spread over much wider base of sales than just Taiwan.

Problems include:

� Complexity and cost of co-ordination across many countries: this isnot fully explained in the case.

� Higher costs of producing local variations, rather than astandardised product.

� Higher wage costs in some countries, e.g. Netherlands.


In this unit we established three main definitions of ‘global’:

� Geographical coverage (broad international scope).

� International similarity of demand (standardised products).

� Interconnectedness of the world (increased linkages betweencountries, seeing the globe as a single market).

With the above definitions in mind, one could consider a range of issues;

� Giant bicycles are commonplace around the world – from children’smountain bikes to professional cyclists in the Tour de France(geographical coverage).

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� Presence in major economic blocks (Europe, USA, Asia)(geographical coverage).

� 75/25 split of localised / standardised products – is thistherefore a global company? Should it be 100% to be regardedas global? (standardised products)

� Centralised R&D facilities (but with designers out in the fieldto gain knowledge of local markets and fashion trends) – againa dichotomy. (standardised products)

� Are Giant exploiting increased technological advancement intransport & communications by having two productionfacilities? This needs to be balanced with increased complexityof running 2 factories. (increased linkages between countries)

� Would a truly global company have one factory, thusincreasing economies of scale and reducing managementcomplexity. (seeing the globe as a single market)

CASE STUDY 2 – CITIGROUP: BUILDING AGLOBAL FINANCIAL SERVICES GIANT

In the largest merger ever in the financial services business, Citicorp joinedforces with Travelers Group in the autumn of 1998. The combined group hasrevenues of close to $50 billion, assets in excess of $700 billion, and globalreach.

Before the merger, Travelers Group was the largest property-casualty and lifeinsurance business in the United States. In addition, Travelers had considerableinvestment banking, retail brokerage and asset management operations.Travelers’ insurance operations were almost exclusively domestic in theirfocus, although its investment banking and asset management business hadsome foreign exposure.

Citicorp was one of the world’s most global banks. Citicorp had two main legsto its business, its corporate banking activities and its consumer bankingactivities. The corporate banking side of Citicorp focused on providing a widerange of financial services to 20,000 corporations in 75 emerging economiesand 22 developed economies. This business, which always had an internationalfocus, generated revenues of $8.0 billion in 1997, over half of which came fromactivities in the world’s emerging economies. What captured the attention ofmany observers, however, was the rapid growth of Citicorp’s global consumerbanking business. The consumer banking business focuses on providing basicfinancial services to individuals, including checking accounts, credit cards and

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personal loans. In 1997 this business served 50 million consumers in 56countries through a global network of 1,200 retail branches and generatedrevenues of $15 billion.

The merger talks were initiated by Travelers' CEO, Sandy Weill. Given therapid globalisation of the world economy, Weill felt it was important forTravelers to start selling its insurance products in foreign countries. Untilrecently, the barriers to cross-border trade and investment in financialservices were such that this would have been difficult. However, under theterms of a deal brokered by the World Trade Organisation in December 1997,over 100 countries agreed to open their banking, insurance and securitiesmarkets to foreign competition. The deal, which was scheduled to take effecton March 1, 1999, included all developed nations and many developing nations.The deal would allow insurance companies such as Travelers to sell theirproducts in foreign markets for the first time. To take advantage of thisopportunity, however, Travelers needed a global retail distribution system,which is where Citicorp came in. For the past 20 years, the central strategy ofCiticorp has been to build just such a distribution channel.

The architect of Citicorp’s global retail banking strategy was its longtime CEO,John Reed (Reed is now co-CEO of Travelers, a position he shares with Weill).Reed has been on a quest to establish “Citicorp” as a global brand, positioningthe bank as the Coca-Cola or McDonald’s of financial services. The basic beliefunderpinning Reed’s consumer banking strategy is that people everywherehave the same financial needs—needs that broaden as they pass throughvarious life stages and levels of affluence. At the outset customers need thebasics—a checking account, a credit card and perhaps a loan for college. Asthey mature financially, customers add a mortgage, car loan and investments(and insurance). As they accumulate wealth, portfolio management and estateplanning become priorities. Citicorp aimed to provide these services tocustomers around the globe in a standardised fashion, in much the same way asMcDonald’s provides the same basic menu of fast food to consumerseverywhere. With the merger with Travelers, the company will be able to pushthis concept further than ever, cross-selling insurance products and assetmanagement services through its global retail distribution system.

Reed believes that global demographic, economic and political forces stronglyfavour such a strategy. In the developed world, ageing populations are buyingmore financial services. In the rapidly growing economies of many developingnations, Citigroup is targeting the emerging middle classes, whose needs forconsumer banking services and insurance are rising with their affluence. Thisworld view got Citicorp into many developing economies years ahead of itsslowly awakening rivals. As a result, Citigroup is today the largest credit cardissuer in Asia and Latin American, with 7 million cards issued in Asia and 9million in Latin America. As for political forces, the world-wide movementtoward greater deregulation of financial services allowed Citigroup to set upconsumer banking operations in countries that only a decade ago did not allowforeign banks into their markets. Examples in the fast-growing Asian regioninclude India, Indonesia, Japan, Taiwan, Vietnam and the biggest potential prizeof them all, China.

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A key element of Citigroup’s global strategy for its consumer bank is thestandardisation of operations around the globe. This has found its most visibleexpression in the so-called model branch. Originally designed in Chile andrefined in Athens, the idea is to give the company’s mobile customers the sameretail experience everywhere in the world, from the greeter by the door to thestandard blue sign overhead to the ATM machine to the gilded doorwaythrough which the retail-elite “Citi-Gold” customers pass to meet with their“personal financial executives.” By the end of 1997 this model branch was inplace at 600 of Citicorp’s 1,200 retail locations, and it is being rapidlyintroduced elsewhere. Another element of standardisation, less obvious tocustomers, is Citigroup’s emphasis on the uniformity of a range of back-officesystems throughout its branches, including the systems to manage checkingand savings accounts, mutual fund investments and so on. According toCitigroup, this emphasis on uniformity makes it much easier for the companyto roll out branches in a new market. Citigroup has also taken advantage of itsglobal reach to centralise certain aspects of its operations to realise savingsfrom economies of scale. For example, in Citigroup’s fast-growing Europeancredit card business, all credit cards are manufactured in Nevada; printing andmailing are done in the Netherlands; and data processing is done in SouthDakota. Within each country, credit card operations are limited to marketingpeople and two staff units; customer service and collections.

Questions:

1. What is the rationale for the merger between Travelers and Citicorp?How will this merger create value for (a) the stockholders of Citigroupand (b) the customers of Citigroup’s global retail bank?

2. In 1997 the World Trade Organisation brokered an agreement toliberalise cross-border trade and investment in global financialservices. What will be the impact of this deal on competition innational markets? What would you expect to see occur?

3. Does the 1997 WTO agreement represent an opportunity forCitigroup or a threat?

4. How is Citigroup trying to build a global retail brand in financialservices? What assumptions is this strategy based on? Do you thinkthe assumptions and strategy make sense?

Reference: Chapter 1 – International Business in the Global Marketplace (2000) byCharles W.L. Hill

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CASE STUDY FEEDBACK


The reasons for the merger are quite clear;

� The companies have complementary resources. Products of the twocompanies are generally mutually exclusive.

� It is a ‘merger of equals’ – a graph within the case study in unit 4 inthe module guide shows the convergence of the share prices ofboth companies.

� Citicorp have established a global network of branches andTravelers Group’s products would be sold in these branches, i.e. forno increase in fixed costs, more turnover would be generated –hence, the stockholders would experience an increase in value inshare price and dividend.

� Customers would be able to access a wider range of products at thesame location, for example insurance.


� An increase in global competition with major world playerscompeting in the newly liberated countries – moving from countryto country (e.g. car industry).

� Perhaps waves of merger/acquisition/alliance activity across borders(link to Unit 4) as financial companies try to gain access to the newmarkets.


� An opportunity due to Citicorp’s core capability in overseasexpansion into developing markets

� Also a threat due to increased competition (as in first bullet pointon feedback to question 2 above).


Standardisation of everything such as:

� Cross selling of products to all customers (regardless of wealth).

� Standard livery of banks.

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� Staff uniforms.

� Standards of service the same globally.

� Also (not mentioned in case) standardised training and staffdevelopment.

Assumptions based upon:

� Standard service designed is acceptable to customers.

� Globalised product implies a global strategy and, therefore,decreases cost due to ‘homogenised’ product.

� World travelers want the same service wherever they go.

� Creation of global ‘brand’ is positive.

Does it make sense?

� What about ‘localisation’ issues, e.g. law, culture?

� The company openly try to attract ‘wealthier’ customers. Ifyou have lots of money, will you not require a ‘personal’service?

� Is it necessary (in considering Global Integration / LocalResponsiveness Grid) to have a ‘global’ product in FinancialServices?

Summary

In this unit we have considered the impact of globalisation onmultinational enterprises. We have looked at the definition ofglobalisation, and have considered the different dimensions –globalisation of markets and globalisation of production.

We have considered the drivers of globalisation, the changing worldorder and the implications for businesses from the globalisationphenomenon. We have also touched on the globalisation debateconsidering the opposing views. Finally, we have looked at theparticular challenges faced by managers when managing in the globalmarketplace.

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REVIEW ACTIVITY

Consider the following situation. Imagine that your organisation is reviewingits strategy, and that you have been seconded by the team to focus and reporton the ‘impact of globalisation’. You have to carry out the necessary researchand prepare a paper (in no more than 1000 words).

Your paper should address the following:

1. Your current global capability.

2. The impact globalisation has had on your organisation with respect toproduction (including supply chain), markets, operations andmanagement processes.

3. Global competition.

4. A SWOT analysis in the context of globalisation.



1. Ref 13, Chapter 2 pages 29-43


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Unit 4

‘Altering the Boundary’ –Alliances and Mergers

LEARNING OUTCOMES


� Evaluate available options for global expansion.

� Analyse strategy for forming and making alliances work in a globalenvironment.

� Explain the terminology associated with business combinations.

� Assess the factors which influence success or failure of M&A activity.

� Propose a process for the successful integration of differentorganisations.

Introduction

Globalisation and the advent of the new economy, has led to bigchanges in today’s business landscape. Consolidation through mergersand acquisitions is rife in many industries, as corporations seek toincrease their global reach and competitiveness. There is a recognitionthat to compete effectively in the global market, cross-border alliances,sometimes with competitors, is necessary. This has also led to a rise inglobal strategic alliances.

In this unit we shall look at strategic alliances, and mergers andacquisitions; the two vehicles through which many organisations aim toglobalise.

Mergers and Acquisition (abbreviated as M&A) activity has grown inpace since the 1990s. In this unit we shall look at some of theterminology used in the context of M&A. We shall then look at some ofthe drivers for M&A activity and potential benefits. We shall then assessthe factors that give rise to successful mergers and acquisitions, andbriefly consider an integration process.

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Paradox of Competition andCo-operation

De Wit and Meyer present this paradox by defining the extreme cases.Companies that follow the traditional view of neo-classical economicsare said to follow the discrete organisation perspective and as such seecompetition as a natural state of affairs and see themselves asindependent entities competing with others in a hostile environment.Co-operation is seen as weakness on the one hand, or alternatively as acynical approach to distort competition in a market, e.g. if companies Aand B collaborate in order to destroy competitor C. Of course,governments legislate to prevent this happening, e.g. The UKCompetition Commission.

The alternative view is one of the embedded organisation perspectivewhere some companies see collaboration and partnership as thepredominant way of working. Many companies follow this perspectiveas a matter of preference or are forced along this path by the industry inwhich they operate, e.g. the airline industry.

However, some companies follow both perspectives at the same timedepending on the economic and market conditions in a global context.For example, Hewlett Packard can been seen as being in a highlycompetitive environment with Canon in many locations around theworld, but are also seen to collaborate with them in other initiativeselsewhere.

We will now examine collaborative arrangements in more detail.

Global Strategic Alliances

Strategic alliances refer to co-operative agreements between potential oractual competitors. In this unit we shall focus mainly on strategicalliances between firms from different countries. However, most of theprinciples apply to domestic alliance arrangements also.

The motives for entering strategic alliances are varied, but they ofteninclude market access. The biggest danger is that a company will giveaway more to its ally than it receives. However, firms can build alliancesthat benefit both partners.

Decisions regarding Strategic Alliances are influenced by three closelyrelated topics;

(1) The decision of which foreign markets to enter, when to enterthem, and on what scale

(2) The choice of entry method

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Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers Global Corporate Strategy

(3) The role of strategic alliances.

Any firm contemplating foreign expansion must first decide whichforeign markets to enter, and the timing and scale of entry. This choiceshould be driven by an assessment of relative long-term growth andprofit potential.

What are the objectives of International Strategic Alliances? Preece putforward a framework that examined the reasons for alliances. The 6 ‘Ls’gave a range of reasons that a company may wish to enter into sucharrangements as follows:

� Learning – to acquire needed know how, e.g. technology,market access. This is related to knowledge managementtechniques (see Unit 8).

� Leaning – to replace value-chain activities or fill in partsof missing infrastructure.

� Leveraging – to integrate operations of partners to createscope and / or size advantages.

� Linking – to create closer links with suppliers andcustomers.

� Leaping – to pursue a radically new area of endeavour.

� Locking out – to reduce competitive pressure from nonpartners and maintain existing competitive position.

ACTIVITY

See how collaboration with competitors can result in a win-win scenario byreading p. 383-387, Reading 7.1, in your key textbook, De Wit, B & Meyer, R.

Read p. 388-396, Reading 7.2, in you key textbook, De Wit, B & Meyer, R, tosee how companies like Sun Microsystems have been able to achieve highmarket growth by working with (and effectively managing) a web of alliances.

KEY POINT

The term ‘strategic alliance’ refers to an arrangement, generally betweenactual or potential competitors, to co-operate.

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Global Corporate Strategy Unit 4 – ‘Altering the Boundary’ – Alliances and Mergers

An alliance can involve two or more companies.

Companies in a strategic alliance co-operate by sharing capabilities to enhancetheir competitive edge and creating new business opportunities.

Companies in an alliance will retain their own strategic autonomy.

ACTIVITY

Read p. 359 – 382 (Network level strategy) in your key textbook, De Wit, B &Meyer, R, to learn more about how companies in strategic alliances co-operatetogether, and co-ordinate their strategies to work as a team.

Which Foreign Markets?

All countries do not hold the same potential for a firm contemplatingforeign expansion. The attractiveness of a country depends onbalancing the benefits, costs and risks associated with doing business inthat country.

The long-term economic benefits of doing business in a country dependon;

� The size of the market (in terms of demographics).

� The present wealth (purchasing power) of consumers inthat market.

� The likely future wealth of consumers.

While some markets are very large when measured by numbers ofconsumers (e.g., China and India), low living standards may providelimited purchasing power and a relatively small market whenmeasured in economic terms. In addition, the costs and risks associatedwith doing business in a foreign country are typically lower ineconomically advanced and politically stable democratic nations andthey are greater in less developed and politically unstable nations.

Another issue is considering the value a business can create in a foreignmarket. If a business can offer a product that has not been widelyavailable in that market the value of that product to consumers is likelyto be much greater.

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Timing of entry

Entry is early when a business enters a foreign market before otherforeign firms and late when it enters after other international businesseshave already established themselves.

There are the following advantages associated with entering a marketearly, known as first-mover advantages;

� Pre-empting rivals and capturing demand by establishinga strong brand name.

� Building sales volume in a country, giving the earlyentrant a cost advantage over later entrants.

� Enabling price cutting below the higher cost structure oflater entrants, thereby driving them out of the market.

� Create switching costs that tie customers into yourproducts or services.

The disadvantage in entering a foreign market before otherinternational businesses is that pioneering costs may be incurred. Theseare costs that an early entrant has to bear that a later entrant can avoid. Alate entrant may benefit by learning from the mistakes made by others.

Scale of entry and strategic commitment

Entering a market on a large scale involves the commitment ofsignificant resources. It is a major strategic commitment, with along-term impact. It is a decisions that is difficult to reverse. Majorcommitment to an overseas market can limit the company’s strategicflexibility.

Balanced against large-scale entry are the benefits of a small-scale entry.Small-scale entry allows a firm to learn about a foreign market whilelimiting the firm’s exposure to that market. Small-scale entry can beseen as a way to gather information about a foreign market beforedeciding whether to enter on a significant scale and how best to enter.

Entry Methods

The choice of method for entering a foreign market is another majorissue. Options are;

� Exporting.

� Turnkey Projects.

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� Licensing.

� Franchising.

� Joint Ventures.

� Wholly owned subsidiaries.

Each of these options has advantages and disadvantages. The optimalentry method varies from situation to situation depending on a varietyof factors including transport costs, economic risks, political risks, tradebarriers and corporate strategy.

Let us now examine each of the entry methods.

Exporting

Advantages

� Avoids the substantial costs of establishing operations(particularly so for manufacturing) in the host country.

� Helps a firm achieve location economies. Bymanufacturing the product in a centralised location andexporting it to other national markets, the firm mayrealise substantial scale economies from its global salesvolume.

Disadvantages

� Exporting may not be appropriate if there are lower-costlocations for manufacturing the product abroad.

� High transport costs can make exporting uneconomical,particularly for bulk products

� Tariff barriers can make exporting uneconomical.

� Problems arise if a company delegates its marketingactivities in each country to a local agent. Foreign agentsoften carry the products of competing firms and so havedivided loyalties.

Turnkey projects

In a turnkey project, the contractor agrees to handle every detail of theproject for the client, including the training of operating personnel. Atcompletion of the contract, the client is handed the “key” to a plant thatis ready for full operation. This is a means of exporting processtechnology to other countries. Turnkey projects are most common in thechemical, pharmaceutical, petroleum refining and metal refining

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industries, all of which use complex, expensive productiontechnologies.

Advantages

� The ability to assemble and run a technologically complexprocess (e.g. refining petroleum), and obtain goodeconomic returns. The strategy is particularly usefulwhere Foreign Direct Investment (FDI) is limited byhost-government regulations.

� A turnkey strategy can also be less risky thanconventional FDI. In a country with unstable political andeconomic environments, a longer-term investment mightexpose the firm to unacceptable political and/oreconomic risks (e.g. the risk of nationalisation or ofeconomic collapse).

Disadvantages

� The firm will have acquired no long-term skills,experience and customer relationships in the foreigncountry.

� A turnkey project may inadvertently create a competitor,e.g. Western firms that sold oil refining technology toMiddle East countries now find themselves competingwith these firms in the world oil market

� Selling technology through a turnkey project is sellingcompetitive advantage to potential and/or actualcompetitors.

Licensing

A licensing agreement is an arrangement whereby a licensor grants therights to intangible property to another entity (the licensee) for aspecified period. In return the licensor receives a royalty fee from thelicensee. Intangible property includes patents, inventions, formulas,processes, designs, copyrights and trademarks.

MINI CASE STUDY

To enter the Japanese market, Xerox, inventor of the photocopier, establisheda joint venture with Fuji Photo that is known as Fuji-Xerox. Xerox thenlicensed its xerographic know-how to Fuji-Xerox. In return, Fuji-Xerox paidXerox a royalty fee equal to 5 percent of the net sales revenue that Fuji-Xeroxearned from the sales of photocopiers based on Xerox’s patented know-how.In the Fuji-Xerox case, the licence was originally granted for 10 years, and it has

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been renegotiated and extended several times since. The licensing agreementbetween Xerox and Fuji-Xerox also limited Fuji-Xerox’s direct sales to theAsian Pacific region (although Fuji-Xerox does supply Xerox withphotocopiers that are sold in North America under the Xerox label).

Advantages

� The licensee meets most of the costs associated with sales.Hence the firm does not bear the development costs andrisks associated with opening a foreign market.

� Licensing can be attractive when a firm is unwilling tocommit substantial financial resources to an unfamiliar orpolitically volatile foreign market.

� Licensing is often used when a firm wishes to participatein a foreign market but is prohibited from doing so bybarriers to investment.

� Licensing is frequently used when a firm possesses someintangible property that might have businessapplications, but it does not want to develop thoseapplications itself (e.g. software components).

Disadvantages

� Licensing does not give a firm the tight control overmanufacturing, marketing and strategy that is requiredfor realising experience curve and location economies.Licensing typically involves each licensee setting up itsown production operations.

� Competing in a global market may require a firm toco-ordinate strategic moves across countries by usingprofits earned in one country to support competitiveattacks in another. By its nature, licensing limits a firm’sability to do this.

� There is a risk associated with licensing technologicalknow-how to foreign companies. Technologicalknow-how constitutes the basis of many multinationalfirms’ competitive advantage. Most firms wish tomaintain control over how their know-how is used, and afirm can quickly lose control over its technology bylicensing it.

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MINI CASE STUDY

RCA Corporation once licensed its colour TV technology to Japanese firmsincluding Matsushita and Sony. The Japanese firms quickly assimilated thetechnology, improved on it and used it to enter the US market. Now theJapanese firms have a bigger share of the US market than the RCA brand

Franchising

Franchising is similar to licensing but involves longer-termcommitments. Franchising is basically a specialised form of licensing inwhich the franchiser not only sells intangible property to the franchisee(normally a trademark), but also insists that the franchisee agree toabide by strict rules as to how it does business.

The franchiser will also often assist in running the business on anongoing basis. As with licensing, the franchiser typically receives aroyalty payment, which amounts to some percentage of the franchisee’srevenues. Franchising is used mainly by service firms. McDonald’s is agood example of a firm using a franchising strategy.

Advantages

The advantages of franchising as an entry method are very similar tothose of licensing. The firm is relieved of many of the costs and risks ofopening a foreign market on its own. Instead, the franchisee typicallyassumes those costs and risks. This creates a good incentive for thefranchisee to build profitable operation as quickly as possible. Using afranchising strategy, a service firm can build up a global presencequickly and at a relatively low cost and risk.

Disadvantages

The disadvantages are less than licensing. Since franchising is usedmainly by service companies, experience curve and location economiesare less of an issue. But franchising may inhibit the firm’s ability to takeprofits out of one country to support competitive attacks in another.

A more significant disadvantage of franchising is quality control. Thefoundation of franchising is that the firm’s brand name conveys amessage about the quality of the firm’s product. This can be overcomeby setting up a subsidiary in each country (wholly owned company orjoint venture). The subsidiary assumes the rights and obligations toestablish franchises throughout the particular country or region, e.g.McDonald’s establishes a ‘master franchisee’ in many countries. Furtherexamples are Kentucky Fried Chicken and Hilton International.

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Joint Ventures

A joint venture means establishing a firm that is jointly owned by two ormore otherwise independent firms. Fuji-Xerox, for example, was set upas a joint venture between Xerox and Fuji Photo. Establishing a jointventure with a foreign firm has long been a popular method for enteringa new market. The most typical joint venture is a 50/50 venture.However, some firms have sought joint ventures in which they have amajority share and tighter control.

Advantages

� Benefits from a local partner’s knowledge of the hostcountry’s competitive conditions, culture, language,political systems and business systems.

� If development costs and/or risks of opening a foreignmarket are high, a firm might gain by sharing these costsand/or risks with a local partner.

� In many countries, political considerations make jointventures the only feasible entry method. Researchsuggests joint ventures with local partners face a low riskof being subject to nationalisation or other forms ofgovernment interference. This appears to be because localequity partners, who may have some influence onhost-government policy, have a vested interest inspeaking out against nationalisation or governmentinterference.

Disadvantages

� As with licensing, a joint venture risks giving control oftechnology to a partner. However, joint ventureagreements can be constructed to minimise this risk.

� A joint venture does not give a firm the tight control oversubsidiaries that it might need to realise experience curveor location economies.

� The shared ownership arrangement can lead to conflictsand battles for control between the investing firms if theirgoals and objectives change or if they take different viewsas to what the strategy should be.

Wholly Owned Subsidiaries

In a wholly owned subsidiary the firm owns 100 percent of the stock.This can be achieved either by setting up a new operation in thatcountry, or by acquiring an established firm and using that firm topromote its products.

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Advantages

� When a firm’s competitive advantage is based ontechnological competence, a wholly owned subsidiaryarrangement reduces the risk of losing control over thatcompetence.

� Tight control over operations in different countries that isnecessary for engaging in global strategic co-ordination ismaintained (i.e. using profits from one country to supportcompetitive attacks in another).

� A wholly owned subsidiary may be required if a firm istrying to realise location and experience curve economies(as firms pursuing global and trans-national strategies tryto do).

Disadvantages

� Generally this is the most costly method of serving aforeign market. Firms doing this must bear the full costsand risks of setting up overseas operations. The risksassociated with learning to do business in a new cultureare less if the firm acquires an established host-countryenterprise. However, acquisitions raise additionalproblems, e.g. marrying divergent corporate cultures.

Making Alliances Work

The failure rate for international strategic alliances is quite high. Arecent study of 49 international strategic alliances found that 66% raninto serious managerial and financial troubles within two years of theirformation and 33% were ultimately rated as failures by the partiesinvolved.

The success of an alliance seems to be a function of following three mainfactors:

1. Partner selection

2. Alliance structure

3. Alliance management

Let us look at these in turn.

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Partner selection

The partner selection process must consider whether a potentialpartnership is viable and whether it actually adds value. The followingassessments are pertinent in this regard:

� Is there a strategic fit?

� Is there a capabilities fit?

� Is there an organisational fit?

� Is there a cultural fit?

A good partner;

� Helps the firm achieve its strategic goals, whether marketaccess, sharing the costs and risks of new-productdevelopment, or gaining access to critical corecompetencies. The partner must have capabilities that thefirm lacks and that it values.

� Shares the firm’s vision for the purpose of the alliance. Iftwo firms approach an alliance with radically differentagendas, the relationship will most likely fail.

� Is unlikely to try to exploit the alliance for its own ends,e.g. to steal the firm’s technological know-how whilegiving little in return. Therefore, firms with reputationsfor “fair play” make the best allies.

Alliance Structure

Having selected a partner, the alliance should be structured so that thefirm’s risks of giving too much away to the partner are reduced to anacceptable level.

� Alliances can be designed to make it difficult (if notimpossible) to transfer technology not meant to betransferred. For example, in the case of softwareapplications, ‘shrink-wrapped’, ‘black box’ packaging.

� Contractual safeguards can be written into an allianceagreement to guard against the risk of opportunism by apartner, e.g. IPR protection.

� Both parties to an alliance can agree in advance to swapskills and technologies that the other covets, therebyensuring a chance for equitable gain. Cross-licensingagreements are one way to achieve this.

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� The risk of opportunism by an alliance partner can bereduced if the firm extracts a significant crediblecommitment from its partner in advance.

MINI CASE STUDY

TRW Inc., has three strategic alliances with large Japanese auto componentsuppliers to produce seat belts, engine valves and steering gears for sale toJapanese-owned auto assembly plants in the United States. TRW has clauses ineach of its alliance contracts that bar the Japanese firms from competing withTRW to supply US-owned auto companies with component parts. By doingthis, TRW protects itself against the possibility that the Japanese companiesare entering into the alliances merely as a means of gaining access to the NorthAmerican market to compete with TRW in its home market

Alliance Management

Many alliances fail because the issues concerning the management ofthe alliance have been underestimated. The key issues include;

� Managing cultural differences.

� Building Trust ; building interpersonal relationshipsbetween the firms’ managers. The resulting friendshipshelp build trust and facilitate harmonious relationsbetween the two firms. Personal relationships also fosteran informal management network.

� Learning from Partners; a firm must try to learn from itspartner and then apply the knowledge within its ownorganisation.

Reference: International Business in the Global Marketplace (2000) byCharles W.L. Hill

ACTIVITY

As further background to this section read p. 402-409, Reading 7.4, ‘How tomake strategic alliances work’, in your key textbook De Wit, B & Meyer, R.

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ACTIVITY

For up-to-date articles and thinking on alliances go to the McKinsey Quarterlywebsite:

http://www.mckinseyquarterly.com/

Select ‘Alliances’ under the Function menu on the home page. (Registration tothis site is free, and many articles can be accessed free of charge)

Mergers and Acquisitions

Mergers and acquisitions (or ‘business combinations’) have become asignificant source of economic activity in the world economy totalling$3.4 trillion in 1999. Consolidation, through mergers and acquisitions, isrife in many mature industries. We have seen the emergence ofmega-mergers in the oil industry (Chevron, Texaco), in thepharmaceutical industry (Glaxo Smith Kline and Beechams), in bankingand in telecoms.

By mergers and acquisitions, corporations seek to create economic valuethrough economies of scale, economies of scope, access to globalmarket, improved target management, tax benefits or the availability oflow cost financing for financially constrained targets. Growth isgenerally viewed as vital to the well-being of a firm.

However, mergers and acquisitions can pose serious risks for acquiringfirms. These arise from uncertainties about the value of the targetcompany’s assets and liabilities and unanticipated challenges inintegrating the target to achieve planned synergies. The big advantageof M&A, in the context of global expansion, is that it gives companiesready market access, particularly in new geographies. However, incomparison to strategic alliances and internal expansion, it posesserious financial and cultural risks. See Figures 4.1 and 4.2 for acomparison of risks for the options of strategic alliances, M&A andinternal expansion. Recent studies indicate that, as a result of these risks,approximately 50% of all M&A combinations do not create value for theacquiring firm’s shareholders.

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M&A – If this fails, as there is a permanence to the transaction, it risksputting the whole organisation in trouble.

Alliances – agreements can apportion financial risks between partners,but the rewards are also shared.

Internal Development (organic) – there is a level of flexibility to theamount of money invested – this can be gradual and re-appraised overtime.

M&A – there is a finality to this linkage of companies and so the culturalrisk is large. However, this should be balanced against a low risk ofmarket entry as the purchase normally relates to a package which isestablished and proven in the market.

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Internet development

High

Low

Low HighFinancial risk

Cul

tura

lris

k

Strategicalliances

Financial vs. Cultural risk M&A

Figure 4.1: Financial vs. Cultural risk for expansion options.

Internetdevelopment

High

Low

Low HighMarket-entry risk

Cul

tura

lris

k

Strategicalliances

Market failure vs. Cultural riskM&A

Figure 4.1: Market failure vs. Cultural risk for expansion options.

Alliances – there is a level of optionality to these – the ‘package’ may beunproven but when partners work together they should reduce the risk.

Internal Development – there is a low cultural risk as it is their ownculture (organic growth). However, an unproven package and a lack ofrelevant experience leads to high market entry risk.

Mergers

A merger is defined as the joining of two or more companies to form asingle legal entity. Generally, the assets of the smaller company aremerged into those of the larger, surviving company and shareholders ofthe target company are either bought out or become shareholders in theacquiring corporation. A merger usually requires approval by theshareholders of both the acquiring corporation and the target entity.

There are several types of merger:

� Horizontal mergers involve two firms operating in thesame kind of business.

� Vertical mergers involve different stages of productionand operations.

� Conglomerate mergers involve firms engaged inunrelated business activity.

Acquisitions

An acquisition is the purchase of more than 50% of the voting shares ofone firm by another. Following the acquisition the two companies cancontinue as separate legal entities, with the acquiring company referredto as the parent company and the target as a subsidiary. The parentcompany can be termed a Holding Company.

Acquisitions are sometimes described as ‘mergers’ to be politicallycorrect. This is especially so in the early stages of a merger.

ACTIVITY

Identify examples of a horizontal merger, a vertical merger and a conglomeratemerger. In this context, you may use acquisition synonymously with merger.Identify the benefits resulting from the merger/acquisition.

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ACTIVITY FEEDBACK

Here are a few examples..........

IBM Corporation/PwC Consulting:

The merger (or in reality, acquisition) of PwC Consulting by IBM Corporationin 2002 is often thought of as a horizontal merger, but is more accurately avertical merger. Although both companies overlapped in a significant part oftheir business (IT services and consulting), it could be argued that IBM had littlebusiness consulting skills – an area of high value and top of the value chain inservices contracts. By acquiring PwC Consulting, IBM gained first-class andglobal business consulting skills and also PwC’s existing lucrative contracts.PwC gained the IBM brand, as well as access to the breadth of IBM’s productand IT skills to facilitate the implementation and delivery of projects following aconsulting engagement.

HSBC/Midland Bank, UK

The acquisition of the UK’s Midland Bank by HSBC is an example of ahorizontal merger. The acquisition gave the HSBC bank a significant UKpresence.

BP/Amoco/Arco:

The merger of BP, Amoco and Arco was a billion-dollar horizontal merger.The driver for the merger was the search for economies of scale. Followingconsolidation and completion of the integration phase, huge cost savings havebeen achieved in capital-intensive areas such as refining, and exploration andproduction activities. Cost savings have also been achieved in aligning theirrespective IT strategies and having a common IT and centralised servicesinfrastructure.

SONY/Columbia:

In the late 1980s SONY acquired Columbia Pictures in the US for $3.4 billion.This is an example of a conglomerate merger, pursued for purposes ofdiversification by SONY. Columbia operated in a totally different businesssector. However, the management at SONY felt there were synergies to beexploited between SONY’s highly profitable VCR manufacturing business andColumbia’s film-making business. Columbia is still part of Sony’s business, butthe integration of Columbia into Sony was plagued with several problems. Inpractice, there were huge differences between running a hardwaremanufacturing company and a film studio. These issues were furthercompounded by enormous organisational and cultural differences between thetwo companies.

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Other Terminology

There are a number of other terms associated with ‘M&A’ activity.

Leveraged buy-outs

Leveraged buy-outs (LBOs) involve the purchase of the entire publicstock interest of a firm, or division of a firm, financed primarily withdebt.

Management buy-out (abbreviated as MBO)

If the transaction is by management, it is referred to as a managementbuy-out (MBO). If the shares are owned exclusively by the acquiringparty, rather than third-party investors, the transaction is called ‘goingprivate’ and its shares are no longer publicly traded.

Joint Ventures

Joint ventures involve the joining together of two or more firms in aproject or enterprise. In these cases, equity participation and control aredecided by mutual agreement.

Sell-offs

Sell-offs are considered the opposite of mergers and acquisitions. Thetwo major types of sell-offs are spin-offs and divestitures.

� In a Spin-off, a separate new legal entity is formed withits shares distributed to existing shareholders of theparent company in the same proportions as in the parentcompany.

� In contrast, Divestitures involve the sale of a portion ofthe firm to an outside party with cash or equivalentconsideration received by the divesting firm.

ACTIVITY

Can you think of examples of other M&A related transactions, and identify thepossible motivation for the transaction and benefits (if any).

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ACTIVITY FEEDBACK

Here are a few examples.

Joint Venture:

The Airbus consortium, established in 1970, is an example of a successful JointVenture. The European consortium of French, German and later, Spanish andU.K. companies was established, as it became clear that only by co-operatingwould European aircraft manufacturers be able to compete effectively with theU.S. giants. By overcoming national divides, sharing development costs,collaborating in the interests of a greater market share and even agreeing acommon set of measurements and a common language, Airbus changed theface of the business and brought airlines, passengers and crews the benefits ofreal competition.

In 2001, thirty years after its creation, Airbus formally became a singleintegrated company. The European Aeronautic Defence and Space Company(EADS), (resulting from the merger between Aerospatiale Matra SA of France,Daimler Chrysler Aerospace AG of Germany and ConstruccionesAeronauticas SA of Spain), and BAE SYSTEMS of the UK, transferred all oftheir Airbus-related assets to the newly incorporated company. In exchange,they became shareholders in Airbus with an 80 per cent and 20 per cent stake.

Spin Off:

MOBILE phone giant mmO2, was part of British Telecom until it was spun-offin 2001. The spinoff was the result of the breakup of the BT monopoly. Today,mmO2 is Europe’s sixth-largest mobile network operator. As well as its coreUK market called O2, the group runs mobile services in Germany and Ireland,and has a joint venture with supermarket giant Tesco. It has just posted itsfinancial results, with maiden pre-tax profits of £95 million.

Divestiture:

Perhaps the most famous example of a divestiture is the divestiture of theTelecoms giant AT&T, from Bell Labs. The divestiture was forced by the USDepartment of Justice following an anti-trust suit against Bell Labs for illegalactions to perpetuate a monopoly in telephone service and equipment. TheUnited States woke up on January 1, 1984 to discover that its telephonesworked just as they had the day before. But AT&T started the day a newcompany, having been divested from Bell Labs. Of the $149.5 billion in assets ithad the day before, it retained $34 billion. Of its 1,009,000 employees itretained 373,000.

Success required the most drastic change in corporate culture everundertaken by a major American corporation. The old AT&T – the Bell System– as a regulated monopoly had been largely insulated from market pressuresfor most of its history. Its culture venerated service, technological excellence,reliability and innovation within a non-competitive, internally-driven

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framework of taking however much time and money it took to get things doneright. The new AT&T had to learn how to find out and deliver what itscustomers wanted, when its customers wanted it, in competition with otherswho sought to fill the same customers’ needs. Although AT&T had greattechnological and personnel strengths upon which to build, the transitionproved far more complex than anyone imagined in 1984.

M&A Activity

Drivers for M&A activity

M&A activity is rife in many industry sectors today, e.g. finance &banking, oil exploration & production, telecoms, IT services,pharmaceuticals, car manufacturing. There are ‘push’ and ‘pull’ factorsdriving M&A activity. Push factors arise from stakeholders who mayhave concerns about the company’s strategic direction or itsmanagement, and view an acquisition or a merger as a solution. ‘Pull’factors arise from companies making strategic moves to increasemarketshare or increase shareholder value.

ACTIVITY

From what you have learnt so far, try to identify some of the drivers for M&Aactivities. Why do companies pursue external expansion, through mergers andacquisitions, over internal growth?

ACTIVITY FEEDBACK

Here are some of the drivers. The list, although not exhaustive, does indicatethe principal reasons for external expansion through M&A activities.

� A firm may be able to acquire certain desirable assets at alower cost by combining with another firm than it could if itpurchased the assets directly. When the market value of acompany’s common stock is below its book value (or, moreimportant, below the replacement value of the firm’s netassets) or its potential future earnings (PE ratio) is below the

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sector average, the company frequently becomes a “takeovercandidate.”

� A firm may be able to achieve greater economies of scale bymerging with another firm; this is particularly true in the case of ahorizontal merger. If the net income for the combined companiesafter merger exceeds the sum of the net incomes prior to themerger, synergy is said to exist.

� A firm that is concerned about its sources of raw materials,dependencies upstream or end-product markets might acquireother firms in the supply chain. These are vertical mergers, andare often undertaken to limit risk.

� A firm may desire to diversify its product lines and businesses in anattempt to reduce its business risk by smoothing out cyclicalmovements in its earnings, e.g. a capital equipment manufacturermight achieve steadier earnings by expanding into the replacementparts business. During a recession, expenditures for capitalequipment may slow down, but expenditures on maintenance andreplacement parts may increase.

� A firm that has suffered losses and has a tax-loss carry forward maybe a valuable merger candidate to a company that is generatingtaxable income. If the two companies merge, the losses may bedeductible from the profitable company’s taxable income and hencelower the combined company’s income tax payments.

� Another ‘push’ driver from stakeholders results from, what istermed, agency problems. An agency problem arises whenmanagers or agents acting on behalf of the shareholders have alimited equity stake in the company. This partial ownership maycause managers to work less vigorously than otherwise and/orconsume more perquisites (also known as “perks’, e.g. lavish trips,expense accounts, club memberships) because the majority of theowners bear most of the cost. There are two theories that emergefrom the agency problem:

� The threat of a takeover may mitigate the agency problem bysubstituting for the need of individual shareholders to monitorthe managers.

� If the managers have a stake in the business, they will do whatis best for the company, thus doing what is best for allshareholders.

� Another driver for horizontal mergers, in particular, is that it willresult in increased market share. If a company acquires one ofits competitors, then it will have a greater share of the market. Forexample, the Mercedes merge with the Chrysler corporationincreased marketshare for the merged company in the US. This was

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the principal driver for Mercedes who had limited marketsharein the US. There is also the perception that the increasedmarketshare will give rise to market dominance thus enablingincreased profitability. Hence, shareholder value oftenincreases.

Revaluation

It is not uncommon during merger negotiations or joint ventureplanning, for the revaluation of the ownership of shares to occur. Therevaluation arises as a result of new information generated duringnegotiations. For example:

1. Management may be stimulated to implement a higher-valuedoperating strategy.

2. Negotiations or tendering activity may involve the disseminationof new information or lead the market to judge that the biddershave superior information. The market may then re-valuepreviously “undervalued” shares.

Potential benefits of M&A

In successful and well managed mergers and acquisitions, some of thedrivers do turn into benefits. So in addition to the obvious benefits suchas lower unit costs and stronger purchasing power, many of the driversnoted above (under the previous Activity Feedback) are potentialbenefits.

One of the key benefits that shareholders often look for is in sharpermanagement. Management efficiencies can arise from:

� Management rationalisation, and transfer of generalmanagement capability.

� Differentiated efficiency. The theory behind differentiatedefficiency is as follows: If the management of firm A ismore efficient than the management of firm B, after firmA acquires firm B, the efficiency of firm B is brought up tothe level of efficiency of firm A. Efficiency represents thereal gain in merging businesses.

� Another source of improvement can be from what istermed Inefficient Management theory. This simply putsforward the view that when management is notperforming or is inept in some absolute sense, thatabsolutely anyone (resulting from an M&A activity)could do better.

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� Deployment of better management systems, controls,planning and budgeting.

Factors affecting M&A activity

In order to successfully complete an M&A transaction, a number offactors must come together.

� Corporate will (the company’s goals and strategy).

� Funding.

� Relative values of the two companies.

� A conducive economic environment.

Factors affecting M&A activity can be categorised as external andinternal.

Global M&A activities tend to occur in waves, in response to externalfactors – see Figure 4.3. External factors include monetary policy,general economic activity, political issues and regulatory policy(competition policy, foreign investment policy).

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Source: Dealogic

95 96 97 98 99 2000 01 02 03 04**0

250

500

750

1,000

1,250

1,500

1,750

United states

Britain, Franceand Germany

Rest of the world

Japan

* By country of target** To Feb 17th annualised

Here we go again?

Global M&A*, announced deals, $bn

Figure 4.3: Recent waves of global M&A activities.

Monetary policy affects M&A activity because, generally speaking,when interest rates are high, stocks are out of favour (valuations arelow) and well-funded companies can buy others at a good price.

The internal factors (e.g. management capabilities, type of product, etc.)vary from company to company and from industry to industry.Combining the internal and external factors results in an M&A cycle.The predominant influence at any one peak or trough may differ.However, typically a peak is a time when company valuations are low,interest rates are low and bank financing is available.

Why do Mergers Succeed or Fail?

Studies of M&A suggest that the probability of increasing shareholders’wealth via M&A is low. Jensen and Ruback (1983) summarised resultsfrom mergers and acquisitions over a period of eleven years.

� The average return (around the time of theannouncement) to shareholders of the acquired companyis 20% while the average return to the acquiring companyis 0%.

� Where a tender offer for take-over has occurred (i.e. acompany makes a public offer to the shareholders of atarget company), the acquired company’s shareholdersreceive an average return of 30%, while the shareholdersof the acquiring company receive 4%.

In an analysis conducted by McKinsey consultants (1994) of 116acquisition programs undertaken between 1972 and 1983, 61% werefailures, 23% were successes and 16% unknown. (An acquisition wasdeemed successful if it earned its cost of equity capital or better on fundsinvested in the acquisition program.)

If the successes and failures are probed further by looking at the rates bytype of acquisition, a company acquiring another company in a relatedbusiness has a greater chance of success than one acquiring a companyin an unrelated business.

Therefore, statistics suggest high failure rates of mergers andacquisitions. There are a number of reasons for the failure ofacquisitions (McKinsey, 1994 and Balmer & Dinnie, 1999). Success orfailure arises from the quality of the pre-acqusition and post-acquisitionprocesses.

The pre-acquisition process includes the following:

� How companies make the M&A decision (includingtarget selection).

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� Due diligence.

� The value creation logic (how is it valued?).

� Negotiation of the deal.

The post-acquisition process is about how the integration is managed.This is considered the most important source of success or failure.

ACTIVITY

With the increase in globalisation, and a push to achieve marketshare quickly inforeign markets, cross-border M&A activity is on the rise.

What are some of the challenges for cross-border M&A activities. How wouldyou expect the success rate for cross-border acquisitions to differ from theoverall figures quoted above?

ACTIVITY FEEDBACK

Cross-border M&A are more complex, and pose further managementchallenges for successful execution and post-merger integration. Thecomplexities arise in both the pre- and post-acquisition phases.

At the pre-acquisition phase, due diligence and valuation are particularlycomplex. Emerging markets, in particular, suffer from the problem ofunreliable marketing and strategic information, and the due diligence may notbe entirely accurate in this respect. Furthermore, local accounting standardsmay not be compatible with international standards. Political and nationalisticattitudes may also make an unbiased assessment difficult.

In the post-acquisition phase, transition management and integrationmanagement are the biggest challenges because of the geographicaldistribution.

Despite the compounded problems of cross-border M&A, studies focusing juston cross-border M&As suggest that the success rate is no worse thandomestic, and, if anything, slightly better. John Kitching (in 1973) looking atcross-border acquisitions in Europe, found that 25% were straight failures and25% not worth doing, giving a success rate of 50%. A further study byMcKinsey focusing just on cross-border M&As found a 57% rate of success.The slightly higher success rate may be simply because most cross-borderacquisitions are horizontal (i.e. in core business) and all studies show thathorizontal acquisitions tend to be more successful than others.

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Listed below are many of the common reasons for failure in M&A:

1. Acquirers pay too much. This happens for a variety of reasons:

� Acquirers are over optimistic in their assumptions.Assumptions, such as rapid growth continuingindefinitely, a market rebounding from a cyclicalslump or a company “turning around,” cansometimes lead acquirers to overpay.

� Over-estimation of the synergies that the mergedcompany will experience.

� Simply that the acquiring company overbids. In theheat of the deal, the acquirer may find it all too easyto bid up the price beyond the limits of reasonablevaluations.

� Poor post-acquisition integration. Integration can bedifficult and during this time, relationships withcustomers, employees, and suppliers can easily bedisrupted during the process, and this disruptionmay cause damage to the value of the business.

2. Corporate identity and corporate communication issues are notproperly managed:

� Undue attention is given to short-term financial andlegal issues, at the expense of communication.

� Inadequate recognition of the impact of leadershipissues during M&A process.

� Unresolved ‘naming’ issues.

� Integrated identity and communication structuresare rarely in place early in the M&A process.

� Consultants are brought in too late.

� Dominant players give little attention to culturalissues, particularly at the outset.

3. Failure to secure good will of a wide range of stakeholdergroups in both companies.

4. Potential conflict between individual and corporate objectivesis not given sufficient recognition and isn’t managed.

5. Reputations can be damaged, maintained or enhanced duringthe merger process.

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VIRTUAL CAMPUS

Microsoft revealed recently that it tried to buy SAP, the German softwaregiant, in late 2003. If the merger had been successful it would have madeMicrosoft a dominant force in the enterprise software market, dealing a blowto Oracle and even IBM. However, the merger attempt failed.

Research this failed merger attempt (Internet, FT article under Comments &Analysis on 14 June 2004, company statements, etc).

Now divide yourselves into two groups. Those with last name beginning A-Mshould wear the Microsoft hat, and the others the SAP hat. Now carry out thefollowing on the Virtual Campus:

1. Microsoft group: put forward to SAP management the benefits of themerger to SAP. Consider the various SAP stakeholders in puttingforward the benefits.

2. SAP group: counter the Microsoft proposals, where appropriate.

3. Both groups: analyse why the merger went wrong (cultural, political,other issues). Could Microsoft have handled it better.

(This Virtual Campus activity also interlocks with the units on Innovation and StrategicIT & e-business)

Successful execution of M&A

McKinsey suggests a five-step program for successful mergers andacquisitions:

1. Management of the pre-acquisition phase. It is important duringthe pre-acquisition phase that employees maintain the secrecy ofthe deal. If the secrecy is not maintained and there are rumours ofa take-over attempt, the share price of the target will increase,potentially killing the deal. It is also important that managersevaluate their own company, understand its strengths andweaknesses, and understand the industry structure. Once this isdone, then managers can begin to identify the value-addingapproach that will work best for their company.

2. Screen candidates. Public companies, divisions of companies,and privately held companies should be considered whendeveloping a list of potential targets. In this step, McKinseysuggests that a list of “knock-out criteria” be developed. Thesecriteria allow managers to eliminate those companies which do

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not “fit” with their own company (i.e. too big, too small,availability.)

3. Valuation. The objective for the acquiring company should be topay only marginally more than the value to the next highestbidder and an amount that is less than the value to the acquirer.In determining the value to the acquirer, McKinsey suggests thatthe value of the acquiring company be added to the value of thetarget company “as is.” The value of realistic synergies must thenbe added while taking into account how long it will take tocapture them. The transaction costs for doing the deal are thensubtracted. The result is the value of the combined post-mergercompany. The value gain is the combined value less the value ofthe acquiring company.

4. Negotiate. A key point in this part of the process is for theacquiring company to decide on a maximum reservation priceand to stick to it. A negotiation strategy is established byconsidering the following factors:

� acquisition value to the acquirer

� value of the target to the existing owners and otherpotential buyers

� financial condition of the existing owners and otherpotential acquirers

� strategy and motivation of the existing owners andother potential acquirers

� potential impact of anti-take-over provisions.

5. Management of post-merger integration. McKinsey noted thatmost acquirers destroy rather than create value after theacquisition. Prior to being acquired, 24% of the companiesstudied were performing better than the industry average andanother 53% were performing better than 75% of their industryaverage. Post-acquisition, these percentages dropped to 10% and15%, respectively.

CASE STUDY 1 – Lojack and the MicrologicAlliance

The next case study is case study 13, (“LoJack and the MicroLogic Alliance”) onPages 818-826 of your key text, De Wit & Meyer.


The case describes the rise and development of the LoJack Corporation(NASDAQ: LOJN), the acknowledged global leader in stolen vehicle recovery

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technology, headquartered in Westwood, Massachusetts. The company wasfounded in 1978 by former Navy pilot Bill Reagan, who unable to sleep onenight, conceived a unique patented system, designed to assist law enforcementpersonnel in locating, tracking and recovering stolen vehicles. Lacking thespecific knowledge and technical skills for his concept to materialise, BillReagan turned to MicroLogic, a product development firm which specialised indeveloping electronics products for others. MicroLogic helped refine theLoJack product specifications, designed the entire system and worked withvarious government agencies to obtain the appropriate approvals. Wheneverything was in place, a contract was signed for MicroLogic to manufacturethe police tracking computers. It made MicroLogic the technical backbone ofLoJack and hence, this product development firm became a significant ally andan instrumental partner in the success of LoJack. But as time progressed,LoJack separated somewhat; in-house people were hired to do a lot of thework formerly handled by MicroLogic and eventually the LoJack Corporationended up doing much of their own work, with the exception of brand newdesign work or work on the base software that MicroLogic designed originally.

The challenge presented in this case has to do with a defining moment in thealliance, examining the issue of continuing value creation if the relationshipbetween LoJack and MicroLogic is pursued. The management of the LoJackCorporation is committed to a growth strategy of geographic expansion of itshistorically successful system, while MicroLogic has changed its strategy and isnow committed to entering a new marketplace with its own products andservices. LoJack is asked to join and supply both marketing capability andcapital to finance Micro Logic’s expansion. The key issue for LoJack is nowwhether it should revise its strategy, grasp this opportunity and build on whathad been a very successful alliance, or whether it should seek new strategicpartners and move forward on its own. The LoJack management team needs todetermine whether the new alliance with MicroLogic would leverage to theutmost LoJacks’ strengths and whether this alliance would again be successful,given MicroLogic’s new strategy.

Points to Highlight(extracted from Teaching Note 13, Lojack and the MicroLogic Alliance, LeonardZyistra)

This case, used in conjunction with Chapter 7 and Readings 7.1-7.4 of your keytext, De Wit & Meyer, can be used to understand the following key points:

� Differences between horizontal and vertical alliances. The LoJack –MicroLogic relationship is an example of an upstream vertical(supplier) alliance. Therefore, this case can be used to understandthe differences between horizontal and vertical alliances, as well asthe difference between indirect and direct horizontal co-operation(link to Introduction of Chapter 7).

� The spectrum of relational arrangements between market and hierarchy.The stolen vehicle recovery system (hereafter: SVR-system) neededthe approval of the Federal Communications Commission (FCC) aswell as the support of law enforcement agencies (and often

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executive and legislative bodies). Car dealerships would sellthe system as an option, providing a high margin add-on to anycar sale. Licensees in countries outside the United Stateswould use the stolen vehicle recovery system technology.Motorola was asked to manufacture the police trackingcomputers and had to agree to a long-term payment plan.Financial institutions and insurance companies were involved indesigning joint offerings. In order for the LoJack system to bemanufactured and find its way to the customer, LoJack andMicroLogic had to define the business ecosystem in which itwould flourish and design several relational arrangements,determining the level of co-operation they wished to pursue.This allows for a discussion on the various relationalarrangements that can be implemented and the different levelsof inter-organisational dependence that they entail (link toIntroduction and Reading 7.3, James Moore).

� The objectives of strategic alliances. The original LoJack –MicroLogic alliance was primarily intended to develop thenecessary base software and equipment and to obtain FCCapproved technology for the SVR system. With a change in thestrategic intentions of the two, the objectives of each partnerto continue the alliance are different now. This allows for adiscussion on the variety of objectives that can be pursued bymeans of alliance (link to all sections of Chapter 7).

� The disadvantages of strategic alliances. After the success of thefirst alliance between LoJack and MicroLogic, and knowing andtrusting each other so well, it is tempting to engage in a secondalliance. However, given the different strategies of thepartners, they are forced to recognise that a new alliance alsohas inherent disadvantages. You may wish to identify theseusing this case (link to Introduction, Reading 7.1, Hamel, Dozand Prahalad and Reading 7.4, Dyer, Kale and Singh).

� The paradox of competition and co-operation. The partners in theLoJack-alliance experience a shift of focus when theirrelationship matures. MicroLogic used to be the technicalbackbone of the LoJack corporation. As time progressed,LoJack separated somewhat; they hired in-house people andtook over the mundane, day to day tasks of MicroLogic, ‘as itwas neither interesting for MicroLogic nor cost effective forLoJack to continue to have MicroLogic do “standard stuff. Thiscase, therefore, illustrates how alliances combine competitiveand cooperative behaviour, applying flexibility in therelationship to continue to balance the two conflicting forces(link to all).

� Discrete and embedded organisation perspectives. The mainchallenge for LoJack in the case is whether, after a successfulalliance with MicroLogic for years, it should renew this

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relationship. Both parties had become more independent over timeand had benefited from this growing independence. Both partieshowever, were also tempted to explore new market opportunitieson the basis of the stolen vehicle recovery technology. They couldgo separate ways, each pursuing their own strategic direction, butthe question is, had they become independent enough to besuccessful without the old alliance partner? To answer this questionin an affirmative way, this view would be in line with the discreteorganisation perspective. However, a number of issues should betaken into consideration as well, such as the opportunity to leveragesome of LoJacks’ strengths or the fact that, from a (shareholder)value creation perspective, the MicroLogic new market entry couldbe more successful and rewarding. This view would be in line withthe embedded organisation perspective (link to all).

Questions:

1. (i) Which are the relational actors relevant to the technical andcommercial success of the Stolen Vehicle Recovery System?(ii)Which relational objectives, power positions and arrangements

exist between LoJack corporation and the actors?

2. Do you think the arrangements between LoJack and MicroLogicchanged their competitive advantage over time?

3. What advice would you give the LoJack management team on the jointventure proposal by MicroLogic to join them in introducing a newmonitoring and maintenance system for construction equipment?

CASE STUDY FEEDBACK


Part i

In the case quite a number of actors are mentioned, each playing aninstrumental role in the success of the SVR-System. Apply Figure 7.2 to drawthe relations. (See textbook, Be Wit, B & Meyer, R (2004)).`

� MicroLogic. When the original founder of LoJack, Bill Reagan, met forthe first time with Sheldon Apsell, founder and president ofMicroLogic, it was still a small product development firm, whichspecialised in developing electronics products for others. Reaganand Apsell immediately hit it off. With only a hand-shake to

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consummate the deal, MicroLogic helped refine the productspecifications, designed the entire system, worked with variousgovernments agencies to obtain the appropriate approval andperformed the required fieldwork to prove to the FCC thatthe assigned radio frequency would not interfere with thatassigned to a television channel. With everything in place, acontract was finally signed for MicroLogic to manufacture thepolice tracking computers. (Upstream vertical relation)

� Car Dealership: Marketing and sales of the LoJack system tookplace via a distribution network. Car dealerships would sell thesystem as an option, providing a high margin add-on to any carsale. (Downstream vertical relation)

� Motorola: Was asked to manufacture the police trackingcomputers and had to agree to a long-term payment plan.Later on it was also engaged in developing and manufacturingthe third generation of the LoJack system. (Upstream verticalrelation)

� Local police: Were using the ‘Police Tracking System’ thatallowed police to locate the stolen car. LoJack offered thedevices for free, in exchange the police will support thesystem. Very often, first the law enforcement agency (andoften executive and legislative bodies) had to be persuaded tosupport the system. (Downstream vertical relation and politicalactor)

� FCC. Being a regulatory actor, the stolen vehicle recoverysystem needed the approval of the Federal CommunicationsCommission (FCC), establishing that the radio frequency usedby the system would not interfere with other radiocommunications. (Regulatory actor)

� Financial institutions and insurance companies: Complementorswere involved in designing joint offerings with financingschemes that included the purchase of the LoJack system anddiscounts for the car insurance premium. (Indirect horizontalrelation)

� Competitors: There were many, claiming to have stolen vehiclerecovery features similar to those of the LoJack system. None,however, were operated or actively monitored by lawenforcement agencies, giving the LoJack system a unique sellingpoint. (Direct horizontal relation)

Part ii

� Arrangements and power positions: The relational arrangements,dependencies and alliance objectives between LoJack andMicroLogic changed over time, as the companies grew and

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their relationship matured. At first, in return for its initialcontribution, MicroLogic received a total of $350,000 and 90,000shares of LoJack. A contract was signed for MicroLogic tomanufacture the police tracking computers. This type ofarrangement between LoJack and MicroLogic can be described asthat of a bilateral combination of Equity-based and contractualarrangements. The intent of these; the contracts will organiseprocedures and routines at MicroLogic to manufacture thecomputer, constituting advantages of hierarchy, while theequity-based part places MicroLogic in the situation where it has anentrepreneurial incentive. Conducive to spurring risk-taking,innovation and change. This worked like the benefits of the market.The alliance can therefore be seen as a nice example ofco-specialisation, where LoJack is focusing on marketing and sales,while MicroLogic focuses on manufacturing and technologydevelopment in the area of tracking and positioning. Thisco-specialisation had progressed to the point where LoJack hired aMicroLogic engineer. Over time, while the relationship was stilltrusting, it became more and more ‘business like’ with more writtendocuments and formal contracts because there were more peopleinvolved. The MicroLogic role changed also and the companiesbecame far more independent. MicroLogic was no longer involved inall the technical decisions and LoJack had its own technical staff.However, MicroLogic was still involved in the long term technologystrategy, and there to pitch in when LoJack staff needed help. Lateron, MicroLogic and LoJack had entered into a joint venture todevelop the third generation of the LoJack system. However,MicroLogic had difficulty meeting some of the initial specifications ofthe product. The direction of the project was altered and Motorolawas engaged.

� Relational objectives and factors: MicroLogic provided LoJacktechnology and, one could add, also labor and entrepreneurship – ithad embraced the initial idea of Reagan and had been willing to riskas much as LoJack – as it was still not certain that the productwould become a success. Nor could MicroLogic bank on the factthat it would be asked by LoJack to become its first-tier supplier.The initial phase of the cooperation can be described aslearning-oriented, as it had been the objective to develop newtechnology required for the SVR-System. When the cooperationmatured, one could say that it became more linking-oriented. LoJackstarted hiring a former MicroLogic engineer for instance. AsSheldon Apsell of MicroLogic had put it sometime: ‘LoJack shouldtake over the mundane, day to day tasks, as it was neither costeffective for LoJack nor interesting for MicroLogic to do standardstuff. Legitimacy played an important role in the alliance. Althoughthe inter-firm relationship was still trusting, it had become more‘business like’ with more written documents and formal contracts.And when there had been conflict at the lower level of theorganisations, it did not impair the cooperation because of thestrong relationship at the top where corrective action was takenbefore things got completely out of hand. The alliance also proved

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strong on flexibility and the ability to adapt to changingcircumstances when early predictions did not come out.

Although LoJack was resource dependent on MicroLogic to develop and testthe technology at the beginning of their relationship, it could be viewed thatthis relationship was still in balance, because ultimately it was LoJack whichheld the patent of the system. Without that, MicroLogic could not do anythingwith the concept or the technology. Their relationship can therefore bedescribed as balanced interdependence. Moreover, LoJack had orderedMotorola to manufacture other parts, ensuring it became not entirelydependent of MicroLogic. Alternatively, as we do not know the alternativesavailable to Bill Reagan back in 1978, it could also be argued that therelationship initially was based on unbalanced dependence in favour ofMicroLogic. For LoJack, the technology was key to the success of the systemand hence to its value proposition, for MicroLogic it was just one contract. SoMicroLogic was independent to the extent that it did not infringe the patent(limitations) and LoJack was dependent but able to steer the productspecifications (influence).


While the cooperation between LoJack and MicroLogic evolved over time,MicroLogic shifted its strategic focus and decided that the company shoulddevelop and market its own products. After a number of false starts, themanagement finally settled on an information service business which wouldinitially provide information about the location and operating parameters ofexpensive construction equipment. Other potential market segments to beattacked after construction equipment included other mobile high-value assetssuch as vehicle fleets, rail cars and trailers. The system would producestandard reports or use sophisticated mapping software to produce easilyunderstandable graphic information that could be communicated to personalcomputers. The original tracking and positioning technology, developed forthe LoJack system, formed the backbone. Up to this point, MicroLogic had selffunded the product development, testing and marketing of the new businesswhile continuing to operate the traditional business. However, MicroLogic’sdecision to change the essence of the organisation had brought marketing andsales of the original product development business to a halt. Cash flow wouldsoon be inadequate to support further development and marketing.Meanwhile, the competitive landscape was changing. Many more companieswere entering the construction equipment asset management marketplace.MicroLogic viewed this activity with mixed feelings. On the one hand,excitement in the industry about such a system validated MicroLogic’s conceptand educated potential customers. On the other hand, it narrowed thewindow of opportunity for capturing a large enough share of the market tomake implementation worthwhile. Additional capital and marketing capabilitywere essential if MicroLogic was going to be the market leader. Analysing howMicroLogic had changed its strategy and finding itself in the situation asdescribed above, would lead to the conclusion that the company had beensuccessful in developing concepts for new markets, but in essence remained aproduct development firm. To introduce a new concept successfully, it neededLoJack to supply capital and marketing capability. This situation we recognisefrom the start of their alliance.

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For LoJack, things developed also in a different way. While expansion of theLoJack System into new geographic areas and markets with improvedmarketing efforts and strengthening the sales force was a logical growthstrategy, the development of a new generation LoJack system was necessary toreduce the cost of the hardware and improve efficiency of the installationprocess. The success of this third generation system would allow LoJack toenter the highly competitive market for stolen vehicle recovery. The cost ofhardware had been dropping fast and improvements in technology such as GPShad encouraged new entrants that also offered total asset managementcapabilities. LoJack management hoped that they could stay in this market withits new unit that would be compatible for application in a non-poweredenvironment at a pricing attractive to the industry. Alternatively, LoJack wasalso exploring cellular and satellite technologies to enhance its opportunities inthis market. But all in all, its competitive edge was no longer the same as it hadbeen when the first LoJack system was introduced to the market. LoJackmanagement, therefore, thought that there might be even greateropportunities in leveraging LoJack’s connections with law enforcement agencies,reputation, brand awareness and distribution muscle. All this could be leveraged inthe mobile asset management-market, starting with construction equipment.This could be done in a joint venture with MicroLogic, but also with a newpartner or may be go it alone.

Analysing this opportunity for LoJack and comparing it with the company in thelate '70s, it can be concluded that its competitive advantage had changed,broadening its commercial capabilities.


Basically, LoJack has three major issues that it should contemplate:

1. Will further development of the third generation LoJack system, exploringnew geographic markets and improved marketing and strengthened salesforce, become profitable enough in the long run and create sustainedshareholder value or should a new marketplace be sought? Considering thehighly competitive market for stolen vehicle recovery with more andmore pressure on margins and distribution channels.

2. Will the new alliance leverage to the utmost LoJacks’s strengths or is itsmarketing capability only of limited use in this new marketplace? Also,considering MicroLogic’s changed strategy to develop and market itsown products, is the compatibility in objectives not only temporaryand predominantly focused on obtaining the LoJack’s venture capital?

3. Will the concept that was developed by MicroLogic for the constructionequipment asset marketplace be competitive enough? Will it secure thealliance to capture a large enough share of the market to makeinvestment and implementation worthwhile? Considering that othermajor competitors were well positioned in the consolidation andoutsourcing trends and given the business model that MicroLogicwanted to employ (short term revenues, by selling equipment atbreak-even or a very small profit, and long term revenues and the

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majority of profits from monthly fees plus individual charges for specialservices).

CASE STUDY 2 – CITIGROUP

Merger Brief – The Economist, 26th August 2000

First among equals

This merger brief shows why true mergers of equals are rare. The union of Citicorpand Travelers, initially equal partners, became a takeover as one of its co-chiefexecutives took sole command

IT WAS the most extraordinary merger ever, or so it seemed back in April1998. The marriage of two financial-services giants, Citicorp and Travelers,was the biggest to date, with a combined market capitalisation of $84 billion onthe day it was announced. The vision behind it was just as large: the newlycreated Citigroup would be an entirely new sort of global business, afinancial-services supermarket selling every financial product under the sun toindividual, corporate and government customers in every corner of the earth.

As if that were not enough, the marriage was structured as a genuine “mergerof equals” – a phrase often used, but usually only to soothe the ego of the bossof a company that is being taken over. In this case, every effort was made toensure that both sides really were equal partners, starting at the top, with thebosses of the two merging firms becoming co-chairman and co-chief executive.

But the omens were bad. Announcing the merger, Sandy Weill (of Travelers)quipped that he was used to “sharing power and responsibility as I’ve beenmarried to my wife for 43 years”. This metaphor may have jarred on JohnReed, who had divorced in 1991 and married a stewardess on the Citicorporate jet.

Barely 15 months after the deal was done, the two co-heads agreed, underpressure from shareholders, to separate their roles. Divorce followed in Aprilthis year, when Mr. Reed retired, at the request of the board, leaving Mr. Weillas lone chief executive.

For the moment, Citigroup is an undeniable success: in the first quarter of2000, it was the world’s most profitable company. But the power struggle atthe top delayed integration and discouraged “cross-selling” the financialproducts of one part of the merged firm to customers of another, one of thekey goals of the merger strategy. It has also prevented the emergence of astrong Internet strategy.

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Mr. Weill admits only that “we have taken longer to get places than we mighthave.” In fact, the costs may have been greater than that implies, not least inmissed opportunities. Citigroup’s management is now dominated by peoplefrom Travelers. The loss of the Citibank talent may yet cause problems,especially outside America. The stellar performance hoped for by thestockmarket may not happen.

Citi and Travelers came to the altar with different experiences of mergers. Inthe 1990s Citi, which traces its origins back to 1812, went from nearbankruptcy to being the leading global consumer bank. But big mergers werenot central to this success. Indeed, the mergers it undertook went badly –notably the acquisition of Quotron, a securities data firm.

By contrast, a knack for acquisitions enabled Mr. Weill to build up ShearsonLoeb Rhodes, a brokerage, which he merged with American Express in 1981.He quit in 1985, after falling out with James Robinson, the boss of Amex,thereby learning a valuable lesson: do not be the junior partner in a merger. In1986, he bought Commercial Credit, a small consumer-lending firm, whichthrough mergers became Travelers, an insurance and brokerageconglomerate. And even as the merger with Citi was announced, the recentlyacquired Salomon Brothers investment bank was still being integrated withTravelers’ Smith Barney. In June 1998, Mr. Weill added a stake in and a jointventure with Nikko Securities, a Japanese stockbroker.

Mr. Weill’s merger technique was based on having a clear strategy – includingcutting fat out of under-managed businesses – and implementing it fast. Hetried to minimise cancerous uncertainty by selecting the management team torun the merged businesses as soon as possible, usually on merit and loyalty tohim.

Yet integrating Citigroup was never going to be straightforward. Citibank wasnot flabby or under-managed – or, at least, did not see itself that way. It waspossible that the merger would be called off by regulators, a danger thatfostered hesitancy over integration. In the event, the Citigroup merger helpedsecure the scrapping of America’s Glass-Steagall Act, which had separatedcommercial banks, insurers and investment banks. But above all loomed theproblem of this being a genuine merger of equals.

Two heads better than one?

The to-be-merged company quickly adopted a “Noah’s Ark” approach to topmanagement- everything in twos. As well as Messrs Weill and Reed, half thenew board’s members came from Citibank and half from Travelers. The globalconsumer business was headed by Bob Lipp (Travelers), and William Campbell(Citi). The global corporate and investment banks had three heads – VictorMenezes (Citi), Deryck Maughan (Salomon Smith Barney) and Jamie Dimon(Travelers), long regarded as Mr. Weill’s heir apparent.

As a result, every decision became a lengthy philosophical discussion. Thispartly reflected the personalities of the two co-chief executives. Mr. Reed isthe sort who loves to discuss management with academics. A loner inleadership, he tended to invite people into his inner management circle only to

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expel them soon after. Mr. Weill is guided more by gut instinct than by briefingpapers, and relies on a small group of loyal managers.

Indecision at the top soon led to trouble in the global corporate andinvestment bank: Travelers’ Salomon Smith Barney investment bank, plus Citi’scorporate relationship bank. Integration had been half-hearted: SSB’s well-paidinvestment bankers regarded their new colleagues as stuffy corporate folk.Staff in the Citi operation were proud of the 1,500 leading global firms thatwere their main customers, and looked down on traders at Salomon, withtheir lower-grade corporate-bond clients. They wanted their services tocontinue under the Citi brand, not to be switched to SSB. They were aghast atthe huge losses run up by Salomon during the financial-market crisis in 1998.Meanwhile, Salomon itself resented Mr. Weill’s decision to close its Americanbond-arbitrage operation only a few months after buying the firm.

Things came to a head in late October 1998 at a weekend of golf and spouses inWest Virginia, where senior executives complained about how the merger wasproceeding. Scuffles broke out. The two leaders reacted with unusualdecisiveness. A week later, a new management team was appointed. Mr.Dimon left the company, his ambition having reportedly annoyed Mr. Weill.Mr. Menezes was joined as co-head of global corporate and investment bankingby Michael Carpenter, a Weill loyalist. The pair at once set about fullyintegrating the two businesses, selecting a new top management team andidentifying a dozen big issues that needed urgent action.

In July, after Citi’s biggest shareholder, Prince Alwaleed bin Talal of SaudiArabia, fretted in public about the relationship between the firm’s co-heads,Mr. Weill took charge of day-to-day operations. Mr. Reed was left withstrategy. In October 1999, Robert Rubin, a former Treasury secretary andco-head of Goldman Sachs, was appointed to the “office of the chairman”,apparently to broker peace between the two bosses.

By now, the tensions at the top were public. Mr. Reed had told the Academy ofManagement that, although the “wisdom of the merger is even morecompelling” than when it began, it “is not 100% clear to me that it willnecessarily be successful”. He drew telling comparisons with step-parenting.“Sandy and I both have the problem that our ‘children’ look up to us as theynever did before, and reject the other parent with equal vigour, saying ‘Sandywouldn’t want to do this, so what do I care about what John wants?”’

The reality was that Sandy’s children were increasingly winning the top jobs,and John’s were quitting in droves. Citigroup was rapidly becoming Mr. Weill’screature. One top-notch Travelers person did leave, however: Heidi Miller,Citi’s chief finance officer, quit for Priceline, an e-commerce firm. Mr. Weillblamed her departure on irritation with Mr. Reed. But that was the last straw:the board asked Mr. Reed, 61, to retire. The 67-year-old Mr. Weill becamesole boss, supported by Mr. Rubin. All Mr. Reed salvaged was a promise (whichfew now believe) that Mr. Weill would go within two years, and that the searchwould begin for a successor.

Mr. Weill soon completed his domination of Citi. In July, the last of thepost-merger top-job splits ended. Mr. Carpenter became sole head of the

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global corporate and investment bank; Mr. Menezes, the last remainingCitibanker at the top, was packed off to head corporate and consumer bankingin emerging markets. Mr. Lipp, another Weill loyalist and head of consumerbanking, joined the office of the chairman, with a brief to co-ordinatecross-selling.

As for cross-selling, the vision that ostensibly motivated the merger, this hasworked better in some parts ofthe merged company than inothers. The greatest success hasbeen achieved where it was leastexpected – in corporate andinvestment banking. Wall Streetanalysts initially hated thedecision to axe Mr. Dimon andto promote Mr. Carpenter. Inthe event, it proved inspired.Aided by the link with NikkoSecurities and a merger withSchroders, a British investmentbank, in January 2000, the nowSchroders Salomon SmithBarney has moved from being amiddle-ranking firm to the brinkof – or even into – the so-called“bulge bracket” of top globalinvestment banks.

Blurred vision?

Mr. Carpenter says his businesswas involved in some 300transactions during 1999 that

both Citi and Salomon folk agree could not have been done without eachother, and that the firm is now in the top four in every product category, inevery geographical region of the world. This may be stretching it – SSSB is stillnot a first-tier adviser on mergers and acquisitions, for example, though it isgaining on rivals such as Goldman Sachs and Morgan Stanley by using its hugebalance sheet to offer corporate clients credit lines during mergers.

The potential for cross-selling was supposedly greatest in consumer finance.Citi’s strong global brand provided a superb platform for selling Travelers andSalomon Smith Barney products through its branch network, which spans over100 countries, and to Citi’s 42m credit-card account-holders (more than anyother credit-card provider). But cross-selling is something that many financialinstitutions, across the globe, have attempted, with little success.

Citi claims a few modest achievements. Some wealthy Salomon Smith Barneycustomers have been given 100% mortgages by Citibank, secured against theirbrokerage accounts. Salomon Smith Barney mutual funds have been sold toCitibank branch customers. Within months of the merger announcement,

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Source: Company Reports

0

20

40

60

80

100

120

140

CiticorpTravellers

Before and after

160

180

Employees'000

1997 19990

2

4

6

8

10

Net profit$bn

1997 1999

Citigroup

Travelers annuities were selling in the Citibank branch network, and nowgenerate revenues of $750m a year.

Travelers has now “pre-underwritten” all of Citi’s credit-card customers, andwhenever somebody with an attractive risk profile calls to discuss his creditcard – there are 80m such calls a year – he is invited to buy a Travelers homeor car insurance policy. Travelers says that sales by this channel have minimalincremental cost, making them particularly profitable. It now sells almost 5,000policies a month, and expects $200m in premiums by 2002 (6% of currentrevenues).

Travelers has started to expand abroad, primarily in emerging markets ratherthan in the already highly competitive continental European market. Once onlya domestic American insurer, Travelers now expects to win the lion’s share ofthe $400m a year in commissions currently earned by the global Citibankbranch network from selling competitors’ products.

According to Mr. Weill, integration in the corporate and investment-bankingbusiness happened faster than in retail because it had to. “If we’d gone slower,we would have lost a lot of people." There have been huge technologychallenges, such as incompatible computer systems. Citi remains confident thatretail cross-selling will bear more fruit, but progress has been slow. It has beenhard to integrate systems, and business units have warred over which brandsto cross-sell and which to ditch.

Adding to the frustration has been the group’s muddled Internet strategy. Mr.Reed, who took sole charge of it in July 1999, believed that Citi’s Internetpotential would best be fulfilled by developing from scratch an entirelyself-contained, state-of-the-art online retail financial-services provider. More

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Source: Primark Datastream

19960

50

100

150

200

250

300

350

The value of a dealShare prices, October 8th 1998 = 100

97 98 99 2000

Citicorp

Travellers

Citigroup

MER

GER

than $500m was spent developing “e-Citi” – a classic example of the big-banginnovation strategy pursued by Mr. Reed decades earlier when he installedthousands of ATMs, in Citi branches, and transformed the way people usedtheir bank.

E-Citi attracted few customers, and was resented by Citi’s establishedbusinesses. Since Mr. Reed’s retirement, it has been downgraded to a sort ofincubator, and 1400 of its employees have been despatched to other Citigroupbrand businesses. Now, ownership of Internet strategy is left with the topexecutives in individual businesses. This caution may be a mistake. Asked inJune whether Mr. Weill could take Citi into the Internet age, Mr. Reed said,“This isn’t Sandy’s deal. He is not going to personally design the Internetcompany that is going to do this.” Mr. Reed’s boldness might eventually havebrought rewards – as did his huge spending on ATMs, which initially meanthuge losses.

Despite the infighting, strategic mishaps and delays in integration, Citigroup hasprospered, with both profits and the share price soaring. Mr. Weill has, asusual, cut costs and made under-managed assets sweat. New managers fromTravelers have instilled a more aggressive sales culture in Citibank branches.

But the Travelers people who now lead Citibank lack experience in overseasmarkets, where the group expects its main growth. Citibank’s institutionalmemory, which gave some protection from bad lending decisions, has gone. Sohas Mr. Reed’s vision. Mr. Weill is skilled at fixing and then expandingunder-managed companies. But he has yet to show that he can fix and expandan already successful global giant.

Questions:

1. What are the problems that have become apparent after the merger?

2. What impact have these problems had on the core competences ofthe newly formed organisation?

3. How do you think the company could have overcome these problems?

4. Do you think this merger has been successful?

Summary

In this unit we have considered the options available for globalexpansion; strategic alliances and mergers and acquisitions (M&A).

Firstly we considered the role of strategic alliances, and the paradox ofco-operation and competition. We noted the advantages arising from

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pooled resources, know-how and shared risk, but also noted that therecan be conflicting goals and there is the potential loss of know-how.

We then considered mergers and acquisitions, and other M&A relatedtransactions. We saw how M&A can give ready-access to markets,know-how and management capability. We looked at some of the driversfor M&A activity. Noting the high rate of failure of M&A, we identifiedsome of the common pitfalls of M&A, and finally concluded with theMcKinsey five-step program for successful mergers and acquisitions.

REVIEW ACTIVITY

We have noted that one of the main pitfalls in M&A is the integration phase.When a company acquires another, what is the best recipe for assimilation?

� Does the acquiring company impose its culture on theacquired company?

� Is there sometimes merit in preserving intact the culture andworking practices of the acquired company?

� How can the right balance be struck between the need fororganisational autonomy vs. strategic interdependence.

Prepare your responses to the above, and then read p.334 (Reading 6.3) in thekey textbook De Wit, B & Meyer, R.



1. Ref 4*, Chapter 8 Pages 166-195, Chapter 16 Pages 374-407


*Highly recommended

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Unit 5

Value Management

LEARNING OUTCOMES


� Analyse the concept of value from a stakeholder’s perspective.

� Assess strategy from a value creation perspective.

� Explain the principles relating to EVA and its impact on strategy.

� Debate the validity of adopting a value driven approach.

Introduction

The term value can bring to mind different things. It can mean one thingin the public sector and have a different focus in the private sector.Economists think of value in quantitative terms, in a strict monetarycontext. Shareholders think of future potential. Increasingly, andparticularly in the knowledge-based economy, there is an emphasis onintangible and intellectual capital assets.

Whichever business context you operate in, value should be determinedby your key stakeholders. In commercial organisations, the keystakeholders are the company’s shareholders. Increasingly executivesand managers are overhauling their understanding of shareholdervalue. There is now the recognition that what was thought to be trueabout valuation is, in fact, only situationally true. Traditionalapproaches can, in fact, be misleading in certain contexts – particularlyin the knowledge-based economy, in the area of new and emergingtechnologies.

In this unit we shall look at the concept of value from a stakeholder’sperspective. We shall look at current thinking with regard to thecreation of value and consider the merits of a corporation adopting avalue-driven approach.

Two case studies are also presented to highlight the issues.

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Paradox of Profitability andResponsibility

It is important for companies to understand their purpose in business. Isit to maximise profit for the owners (a shareholder value approach) or isit to meet the requirements of society at large (a stakeholders valuesapproach)? Examples of such companies are Body Shop, and Ben andJerry’s.

Does a company seek to satisfy the needs of as many stakeholders aspossible in conducting its business, or is it duty bound to maximise itsprofits in favour of the owners? It costs money to be socially conscious!

This unit looks at the ‘shareholder’ extreme of de Wit’s paradoxcontinuum. Unit 6 will examine the opposite end by exploringCorporate Governance and Ethics.

The Concept of ‘Value’

What is ‘value’? What does it mean in relation to business, or moreimportantly, to strategy?

Value as a concept means something different to private and publicorganisations. However, regardless of the organisation type, value isvery difficult to define and quantify.

ACTIVITY

Consider the definition of ‘Value’ in the context of an organisation. Draw up alist of the different aspects of the word ‘value’, e.g. value-added.

ACTIVITY FEEDBACK

Your list may have included some of the following:

� Value for Money.

� Shareholder Value.

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Unit 5 – Value Management Global Corporate Strategy

� Value Chain.

� Value System.

� Value Cycles.

� Value Management.

� Stakeholder Value.

We shall look at some of these concepts in more detail in this unit.

Stakeholder Value

Whether in the private sector or public sector, value should be judgedby the organisation’s key stakeholders.

In this unit we shall focus our attention mainly on commercialorganisations. However we shall now briefly look at some of thedifferences between the private and public sectors in relation to value.

Public Sector

Strategic management is, of course, just as important to the public sectoras it is to commercial entities. For example, the notion of competition fora public organisation is usually concerned with competition for scarceresource inputs, typically in a political arena. However, the emphasis onvalue concepts can be different in the public and private sectors. Theoverarching need is for public bodies (e.g. central government, localgovernment, health service organisations) to demonstrate Value forMoney in outputs. Many of the developments in management practicesand theories in the public sector (e.g. changes to internal markets,performance indicators, competitive tendering) have been used toattempt to introduce competition to encourage improvements in valuefor money.

Overall, the role of ‘ideology’ in strategy development in the publicsector is probably greater than that in a commercial organisation. This isbecause the type, range and position power of Stakeholders interestedin an organisation’s strategic choice is greater. Therefore, theacceptability to stakeholders of strategic choice is probably of greatersignificance in the public sector than in the commercial sector.

The measurement of value to stakeholders in the public sector isdifficult to quantify, because it is essentially a perception by thestakeholder of the ‘value for money’ in the service they have received.

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Global Corporate Strategy Unit 5 – Value Management

Private Sector

Stakeholder value is a critical factor for strategy and management in theprivate sector.

Theoretically, all managerial actions should be carried out only whenthey can add value to the company. This introduces the concept of theValue Chain in an organisation, i.e. the internal linkages that existwithin the boundaries of an organisation. In addition to this, to fullyunderstand the concept of value, linkages to the entire supply chain,upstream with suppliers and downstream with distributors andcustomers, must be taken into account. This overall picture of value toan organisation can be termed the Value System.

Clearly, the value system can be different from company to companydepending upon their strategic choice. Value chains and systems canestablish significant competitive advantage. For example, twocompeting firms with equivalent internal value chains can bedifferentiated in terms of value by better suppliers and/or distributors.The ‘value system’ is therefore better for that company. Someorganisations, particularly those with several business units, have verycomplex value chains and systems making strategic analysis difficultand time consuming.

The key work in this area of strategy was carried out by Michael E Porterin 1985 and 1990.

Key Stakeholders

It could be argued that the key stakeholders to any commercialorganisation are the shareholders (particularly where the company ispublicly owned). If shareholders become disenchanted with a companyand sell their shares in sufficient quantities, the law of supply anddemand dictates that the share price will fall. The ultimate consequenceof this is that the market capitalisation (the value of the company on thestock market) falls to such a level that the company finds it moredifficult to borrow money or may be taken over by another organisationwho buys up a majority of the shares.

For this reason, companies try to avoid shareholder dissatisfaction andregard shareholders as key stakeholders. This is logical as theshareholders own the company and employees have traditionallyanswered to the owners. All employees have a ‘fiduciary’ duty topreserve and build upon the owner’s investment in the firm. This raisesthe issues of Value Management – how can a company manage itself(strategically) to maximise shareholder value? In addition to that, howcan shareholder value be measured?

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Value Management

How do companies adopt strategies to deliver shareholder value. Whatis value? Business models and definitions of value that worked welluntil the early 1990s, are now being challenged. Why is sensitivity tostock price now a critical lever for managing the future?

There is an increasing recognition that the market, over time, representsa brutally honest evaluator of performance. This has led to therecognition that management, and indeed employees at large, need toview their company from the outside in. They need to act like long-termshareholders themselves, and feel the pressure from the marketplace inorder to deploy assets and adopt strategies wisely. To achieve this,value-based corporations are increasingly basing compensationpackages on value-based parameters.

Value-based corporations place customers at the heart of their business(the view from the outside in). Value chains and value cycles arepertinent in this discussion. Increasingly companies are adopting avalue cycle approach, as opposed to the traditional value chainapproach. A value chain is seen to deliver value to the customer,whereas a value cycle approach views the process as an interaction withthe customers. Many forward-looking companies view their keycustomers as critical partners in setting business direction.

ACTIVITY

As background to the next sections, learn about the shareholder valueapproach by reading, ‘Shareholder value and corporate purpose’, Reading 11.1,p. 610-615 in your key text, De Wit, B & Meyer, R.

Creation of Value

Value is added to a firm when profits increase, operational or financialrisks are reduced or when greater efficiencies are produced. Decisionswhich add value to a company, add value to the shareholders – either inthe form of dividends, value of the share holdings or both.

Various ratios and tools have been introduced into business foranalysing financial statements, e.g. Return on Capital Employed(ROCE). But any measure of shareholder value must include thefollowing considerations:

� Cash flow.

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� ‘Time value’ of cash.

� Opportunity cost of capital.

� ‘Net present value’.

As one of the great proponents of the Shareholder Value philosophy,Alfred Rappaport, said “Profit is an opinion. Cash is fact”

Economic Value Added (EVA)

Corporations adopting value-based management principles areincreasingly using a measure called Economic Value Added, commonlyshortened as EVA. EVA is used as a measure of value, and is used as akey parameter in promoting shareholder value within managementranks and employees at large. It should be emphasised that EVA is NOTa strategy – it is a measure of performance. The strategies a companyuses are geared to increasing EVA so as to demonstrate to markets thatthey use capital efficiently. However, it is a very popular tool and isused widely by major companies – to even suggest that it will be usedhas been know to increase share price overnight!

EVA is the difference between the Return on Capital Employed and theCost o f Capital Employed by a company. A simple, but flawed, analogyis to compare the annual cost of your mortgage with the annual increasein value of your house. If your house has risen in value by 10% and yourmortgage is only costing 6%, then you are ahead. The same logic applieswith a company. If it gets more out of its capital than it is paying for itthen it is adding value.

The move towards value-based management in large companies isbased on two assumptions:

� The main aim of any business in a market economy is tomaximise shareholder value.

� Markets are too competitive for companies to create suchvalue by accident. They must plan for it. And that meanshaving the right culture, systems and processes in placeso managers make decisions in ways that deliver betterreturns to shareholders.

Corporate functions must be informed by value-based thinking –planning, capital allocation, operating budgets, performancemeasurement, incentive compensation and corporate communication.EVA is a tool for measuring performance. When implemented properly,and especially if tied to management compensation, it is a powerful wayto promote shareholder value.

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What is EVA

EVA is a measure of profit, but not the accounting profit seen in acorporate profit and loss account. It is profit as economists define it.Both are measured net of operating expenses but they differ in thetreatment of capital costs. While accountants (in P&Ls) recognise onlyout-of-pocket costs, such as the interest paid to bankers, EVA recognisesall capital costs, including the opportunity cost of shareholder funds.

The value of any business must equal its net assets (the sum of fixedassets, cash and net working capital) plus the present (in other words,discounted) value of future EVAs. Therefore, as stock marketexpectations of corporate EVA increase, so too do share prices.

Companies can therefore use EVA targets to motivate managers todeliver the financial results the stock market wants. This approach isespecially useful for executives one or two levels below topmanagement who have little direct influence over share price and forwhom stock options are less effective. Their compensation and bonusschemes can be tied to specific financial objectives and can be cascadeddown to employees all the way down the company.

CASE STUDY – SPX

SPX is a large US auto parts and industrial products company. It was a chronicunderperformer in the early 1990s, with low profits and a languishing shareprice. After John Blystone took over as chief executive in 1995, the companyushered in a series of actions designed to reverse its poor performance. Thecompany’s 1995 annual report proclaimed: “One of the most important ofthese actions has been the decision to move ahead as quickly as possible toimplement EVA.” Formal adoption took place at the end of 1995, and by theend of the following year, a dramatic improvement in performance wasevident.

Senior managers were put on an EVA bonus plan. Within a year, 4,700managers were in the programme, including non-executive directors. By 1999,SPX was transformed into an EVA company, with a positive effect on the shareprice. When EVA was implemented, SPX’s share price was under $16. Withinfive years of implementation it was selling for $180. What makes thiscompany’s experience instructive is that it was able to create a culture that putvalue creation at the centre of management systems. As the companyexplained in its 1998 annual report: “EVA is the foundation of everything wedo. It is a common language, a mindset, and the way we do business.”

SPX witnessed dramatic improvements in asset efficiency. In the year afteradopting EVA, inventories were cut by 15 per cent, despite higher sales. Toimprove performance, the company focused its operating units on quality andoperating excellence. One such unit began a next-day delivery policy thathelped it to achieve market leadership. Such efficiencies, combined with

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sourcing initiatives, caused a 12.5% improvement in operating profit in 1997(the second year after EVA was implemented).

SPX divested several businesses that were profitable, but strategic reviewsrevealed the businesses were worth more to others, and therefore should besold. Of course, well-managed companies have always done this, butEVA-based compensation systems create stronger incentives for managers toseek such opportunities.

EVA’s most important contribution to the turnaround was its central role inmanagement compensation. The actions taken by SPX to improveperformance were neither unusual nor dramatic. The key lesson to be learnedfrom SPX is not whether managers are capable of delivering superiorperformance, but whether they are motivated to do so.

How is EVA calculated?

EVA is after-tax operating profit minus capital costs, with capital costsequal to net assets multiplied by the weighted-average cost of capital (orWACC). When operating profit is divided by net assets, it yields ameasure called Return On Net Assets (RONA). The difference betweenRONA and the WACC, or the “EVA spread”, multiplied by net assets,equals EVA:

EVA = (RONA – WACC) x NET ASSETS

How does EVA relate to the value of a company?

The value of a company is defined as:

Value of Company = Net Assets + Present Value of future EVAs

The net assets are the sum of all fixed assets, cash and working capital.Note the EVA component is the present value of future EVAs; it isdiscounted back.

Growth of Value Management Concepts

Value Management concepts are becoming more widespread on theback of a number of developments. Companies are responding to achanging corporate environment. In particular,

� Greater competition for capital, driven by theglobalisation of capital markets.

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� The growing trend towards ‘professional’ shareholdersand, in particular, the influence of institutional investors.

� The emergence of a market for ‘corporate control’ i.e. thehigh potential for company acquisitions.

What is a Value-Driven Approach

What sort of things do ‘value driven’ companies have to do to designand implement value management?

Methodology:

� Take a long term rather than short term perspective.

� Take a company specific rather than a ‘generalised’approach.

� Use suitable performance measurement targets inplanning and control.

Mistakes made in one or all of the following areas can lead toinaccuracies in management information and can have a serious effecton the overriding goal of value management – that is, to improvecorporate control.

Reward Systems:

� Implement effective compensation and incentiveschemes.

� Review traditional dividend policy.

If reward systems to employees and shareholders are rigidlymaintained for historical reasons and not reviewed in the light of a valuemanagement approach, the introduction of a value driven strategy isdone ‘half-heartedly’.

Implementation:

If a company fails to involve all parties then the value managementstrategy will meet with resistance and delays. A successfulimplementation must:

� Take account of all stakeholders.

� Be in full consultation with employees.

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ACTIVITY

Value innovation is said to be the essence of strategy in the knowledgeeconomy. Learn more about this by reading ‘Strategy, value innovation and theknowledge economy’ in your key textbook, De Wit, B & Meyer, R.

Company Specific Approach

To be successful in deploying value-management, a company specificapproach must be adopted. A good approach is to leverage generalvalue management tools, but to adapt to your specific industry and finetune for company specific factors. Figure 5.1 summarises the essentialcomponents.

Components of a value-driven approach

The components of a value-driven approach are summarised in Figure5.2.

Let us examine each in turn:

Identify value performance and value drivers

It is clearly essential for a company to be able to assess their value andmeasure progress to identify their Value Performance. In other words,the company needs to verify that they are actually creating value for

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Generalvalue-management

tools(select suitable tools)

Valuation models

Cost of capital calculations

Portfolio management

Controlling tools

Industry specificfactors

(adapt to industry)

Opportunities and threats

Structure and dynamicsof industryValue drivers

Product cycles

Company specificfactors

(fine-tune for company)

Value system/corporatephilosophy and policyStrategy

Organisation/structures

Production processes

Company specificstrategy

Industry-specific successfactors

Specific tools

Tailored implementation

Success factors Resources

+ + =

Figure 5.1. A company-specific approach to value-management.

their stakeholders. This can be achieved by creating a computer basedfinancial model containing all of the key value management variables.

In adopting a Value Management strategy, the method of corporatevaluation must be ‘Discounted Cash Flow’ (DCF) which sees the valueof a company as being the sum of the cash flows it will earn in the future,discounted back to the present value. This reflects the fact that on thepurchase of a company, the purchaser acquires the right to future cashflows.

The whole process is based on careful Business Planning, which shouldreflect a forecast horizon of at least five, but preferably ten years. Eachstrategic business unit (SBU) should be calculated separately with asummarising routine to reflect overall portfolio value.

Value drivers can be identified by using the above computer basedfinancial model by changing core assumptions and observing theimpact on shareholder value. This develops a tool for SensitivityAnalysis, which identifies and evaluates key value drivers.

Implement value creation programmes

Having laid the foundation for value management by establishing afinancial model it is necessary to develop or expand a portfolio of valuecreating business units. Refer back to Unit 2 for a review of the portfoliomanagement approach to strategy.

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Increaseshareholder

value

Step 1:Identify valueperformance

and value drivers

Step 2:Implement

value creationprogrammes

Step 3:Extend

management andcontrol systems

Step 4:Adapt

compensationsystems

Step 5:Inform stakeholdersand develop investor

relations

Figure 5.2. Components of a value driven approach.

A value portfolio chart plotting potential market returns (adjusted forrisk) against strategic ‘fit’ with corporate vision is recommended. SeeFigure 5.3. The portfolio distinguishes between stars and dogs;

� Further growth or holding strategy with no strategicinvestment for the ‘stars’.

� Optimisation / Discontinuation / Sale of the ‘dogs’.

This represents the results of the analysis carried out above for eachSBU. From this, the following questions can be answered;

� How is a particular SBU to be positioned into the valueportfolio?

� What actions are needed to increase the Value of theportfolio?

The ‘Stars’ in the value portfolio are those businesses that createshareholder value by;

� Sustained cash flow growth achieved by engaging inactivities in attractive industries, for example, or byattaining an excellent competitive position.

� Optimised management of investments (intangible assets,financial assets, property, plant and machinery, workingcapital) and how they are financed (cost of capital).

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Retain without strategic investment Pursue further growth

Optimise or discontinueSell

Deviationfrom risk-adjustedmarketreturns

Strategic fit with corporate visionCirecle diameter = capital employed

Low High

-

+

"Dogs"

"Stars"

SBU 3

SBU 6

SBU 7

SBU 1

SBU 4

SBU 2

SBU 8

E.g. can profitability bemaintained without furtherinvestment?

E.g. what growthoptions are available?

E.g. would this unit notbe better off in someoneelse's hands?

E.g. has this unitachieved criticalmass?

E.g. have all efficiencyenhancement optionsbeen exhausted?

Figure 5.3. Value portfolio chart, Ref: Stefan Botzel & Andreas Schwilling, Managing for Value1999.

� Consistent risk management.

The ‘Dogs’ do exactly the opposite.

The position on the ‘x’ axis is determined by a pragmatic scoring system,which will be developed by each individual company.

The position on the ‘y’ axis is determined by considering thecomparison between return on investment with the cost of capital.(Clearly value is created only when return > cost).

Strategic management

Analysing the value portfolio must be combined with the strategicmanagement of the company;

� Only SBUs which yield shareholder value should beretained in the portfolio.

� ‘Dogs’ should only be retained until transformed intovalue creating ‘Stars’ or sold off.

� Consistency is vital – decisions must be based on hardfigures produced by value management, not emotive,personal satisfaction, etc.

� If the portfolio cannot guarantee to generate the targetlevel of value creation then the company needs torestructure through acquisitions, alliances, new ventures.

� The ‘mix’ of capital allocated to each SBU could bechanged.

Let us now deal with each ‘window’ of the value portfolio in turn;

‘Stars’ that fit the corporate vision:

� Cash producers and value drivers.

� The goal of corporate strategy should be to position corebusinesses in this window.

� Growth should be promoted.

� Funding will need to be allocated to maintain and / orimprove the company’s position.

� Capitalisation on areas of competence.

‘Stars’ that DO NOT fit the corporate vision

� May be non-core or niche markets, but still create value.

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� SBUs retained but without further investment.

� Focus on risks attached to the poor corporate ‘fit’.

� Possibly look to sell to harmonise corporate vision.

� Possibly adapt corporate strategy to remain attractive tothe market and adopt a growth strategy.

‘Dogs’ that fit the corporate vision

� These SBUs destroy value because of;

� Low cash flow due to thin margins, low sales growth

� Investment has been excessive or inappropriate

� Cost of capital is too high

� Strategically, need to be optimised or run down.

� Money to be invested only if the returns are above cost ofcapital.

‘Dogs’ that DO NOT fit the corporate vision

� These SBUs destroy value.

� Generally, such SBUs should be sold, to lay a solidfoundation for successful growth strategies.

In summary, a value creation strategy must seek to:

� Increase Revenues.

� Increase Margins.

� Optimise Investments.

� Minimise the cost of capital through FinancialEngineering.

Extend management and control systems

A uniform system of planning and measuring business success thatmakes the creation and destruction of value transparent must beestablished based upon;

� A forward looking approach based on future cash flows.

� A focus on cash flows rather than numbers in financialstatements.

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� A view which acknowledges the time value of money.

� Reflection of the risk faced by different SBUs in capitalrates.

Management control processes and communication systems must beclearly defined and capable of being used as a basis for a Value BasedCompensation System. Management reports must be ‘recipient based’and include value measurements.

Strategic Planning and Control

European countries tend to base strategic planning upon traditionalmetrics such as market share, competitive position, sales growth andresults. Value management dictates that increasing the value of thecompany in its SBUs is the single most important measure.

For example, a sales growth of, say, 10% is not a valid strategic goal (asfar as VM is concerned) because;

� Corporate value could still be destroyed despite this highfigure – the investment needed to achieve this growthwould may not bring in sufficient returns to cover thecost of capital.

� 10% may not be enough if value creation based on ahigher sales target appears realistic.

Adapt compensation schemes

Compensation systems are a key factor in value based companymanagement. The principle is simple – managers' salaries should belinked to value generation for shareholders. Examples of this are;

Genuine Participation Models:

� Stocks.

� Stock options.

� Convertible bonds.

Artificial Participation Models:

� Bonuses.

� Combined forms.

The variety of value based incentive schemes possible means that ascheme can be devised for any level of management – it doesn’t have tobe the same across the whole company.

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EVA bonus plans don’t just motivate managers to think about currentEVA. If they did, managers would focus entirely on short-termperformance at the expense of the future. Value-creating investmentsmight be avoided because their immediate effects on EVA are negative.The solution is to give managers a direct economic stake in future EVA,not just the current period. The figure above shows how such anapproach can work.

Remember that the value of the company (that is, the value of debt andequity) equals net assets plus the present value of future EVAs. Thismeans that the market capitalisation of a company’s shares is based onexpectations of future EVA performance. Share price increases whenthese expectations are exceeded.

This insight yields the first principle of EVA-linked compensation: thekey performance measure is not EVA itself, but excess improvement. Toderive this measure, companies must first set targets based on marketexpectations. Then, a target bonus, usually stated as a percentage ofsalary, is paid if the target level of EVA improvement derived from thecompany’s share price is earned.

Note, however, that the payout is not capped. This is the second basicprinciple of EVA-linked compensation. If manager and shareholderinterests are to be aligned, management pay should more closelyresemble payouts received by owners.

As a result, there is no ceiling on the EVA bonus, but there is also adownside. The bonus earned in any year is the sum of the target bonusplus a fixed percentage of excess EVA improvement (which can bepositive or negative). This bonus is credited to a bonus bank, and thebonus bank balance, rather than the current year bonus earned,determines the payout.

Typically, the payout rule for the bonus bank is the full bonus bankbalance (if positive), up to the target bonus, plus one-third of the bankbalance in excess of the target bonus. When the bonus bank is negative(which is possible if under performance is great enough), no bonus ispaid. The EVA interval determines the sensitivity of the bonus earned toexcess EVA improvement, and is chosen by senior managers based onthe degree of upside potential and downside risk they wish to inject intothe plan.

The bonus bank component adds a critical dimension to the scheme byextending managerial planning horizons beyond the short term. Thebank allows for a negative bonus, wiping out at least a portion of EVAbonuses earned in previous years. This practice forces managers tothink not only about what they need to do in the short term to boostperformance but also what they must do to increase it in future years.Otherwise, part of the bonuses they earn in the current year might beforfeited. In other words, the bonus bank provides medium-termincentives for value creation, in addition to the short-term incentives

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from annual payouts. Stock options add to the EVA bonus plan byproviding long-term incentives.

CASE STUDY – Herman Miller

In 1995, Herman Miller, a US office furniture manufacturer, had a rich historyand culture, great products and talented employees. The economy was strong,the furniture industry was growing and sales were growing at a fast rate.

But something was missing. The results weren’t showing up on the bottom lineand so the company decided that a tool was needed to help focus their efforts.They implemented EVA as a measurement and management tool.

Employing the same amount of capital as in 1995, sales moved from $1 billionto $1.5 billion. In 1997, EVA was $40 million – an increase of nearly 300% overthe $10 million generated in 1996. The share price has gone from a low of $11at the end of 1995 to a high of $36 at year-end 1997.

Herman Miller has valued employee participation since company inceptionnearly 75 years ago. EVA was seen to build on that historic strength, allowingemployee-owners to better understand the impact of their actions, resulting inbetter decisions for customers and general business.

EVA analysis enables the company to identify waste in both costs and use ofcapital. Inventories across the country reduced by 24% or $17.2 million from1995.

Outstanding accounts receivable (that is, the money owed by customers) havebeen reduced 22% from 55 days in 1995 to 43 days at the end of 1997. Overthe past two years, sales have increased 38%. The cut in receivables isespecially interesting because the impetus for this came from operatingmanagers, not the accountants.

The 13% operating margin is much improved from five years ago with scopefor further improvement. At the same time, the total square footage of buildingspace has been reduced by more than 15%.

EVA analysis demonstrated that debt capital was cheaper than equity capital.So the board set a new debt to capital ratio of 30% to 35% and $100 millionwas raised in a private placement. In 1997, $110 million was returned toshareholders in share repurchases and dividends.

Using EVA, Miller’s business has grown and people have grown in theircommitment and contribution. EVA is the backbone of the company-wideincentive and bonus system.

As one observer explains: “When they went on EVA and began focusing oncapital costs like receivables, Miller employees in the divisions attacked the latepayment problem on their own and discovered that the cause of overdue

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receivables was incomplete orders. When an order arrived missing a piece ortwo, the customer would withhold all payments until the last items arrived. Sothe ‘Millerites’ got receivables down by speeding up production of missingitems and making sure shipments were complete as well as on time. The result:improvements in EVA and customer satisfaction.

Inform stakeholders; develop investor relations

Of all stakeholders, the investors are the ones who probably play themost important role. If returns are poor, they may sell their shares andinvest in something more profitable.

What does “Investor Relations” mean? Investors will only be interestedin a company if it promises to be a good investment. Therefore, acompany must put a value on itself so that an informed decision can betaken. This is the essence of investor relations. It is not, however, a oneoff exercise. It is a long term process of positive opinion building. In fact,about 10-15% of a company’s value development can be ascribed to theinfluence of professional investor relations.

Communication tools may be split into direct and indirect with varyingdegrees of importance to investors, e.g. Annual Reports are moreindirect whereas meetings and presentations are direct communicationtools.

Is EVA Appropriate?

All companies can benefit from the shareholder value perspective andthe value-creating incentives offered by EVA, but some are more likelyto benefit than others.

An important part of EVA is that it can provide value creation incentivesfor divisional managers, not just for top executives. This suggests thatcompanies with autonomous business units benefit more thancompanies that operate as one large unit. Also, matrix organisationstend to derive fewer benefits because of the difficulty of establishingaccountability.

Companies with substantial shared resources are less likely to benefitfrom EVA. For example, if common manufacturing facilities or salesstaff serve multiple business units, and if these units are not forced to“buy” this capacity, investment accountability, EVA measurement andmanagement incentives can be undermined.

Another difference between successful and unsuccessful users is thatthe former rely on strong managerial wealth incentives tied to business

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unit performance. The latter tend to place heavier emphasis on stockoptions. Successful EVA companies use stock options, but recognisethat the strongest incentives for divisional managers come frommeasures based on divisional performance, not corporate measuressuch as stock price. Unsuccessful users are also more inclined to exercisediscretion in paying managers. In other words, they override the bonusplan, probably because of low tolerance for differences in business unitcompensation.

In successful EVA users, the chief executive is an enthusiastic advocate,whereas in unsuccessful users, the CEO may not have realised what heor she signed up for. Maybe the CEO thought EVA was what themarkets wanted. Or perhaps there was a failure to appreciate the effortneeded for full implementation. As a result, implementation is erratic.

Another feature of successful users is that they try to establish andmaintain accountability for business unit heads. This, in turn, requiresthat these managers stay put for extended periods. In unsuccessfuladopters, job tenure for business unit managers is short. This differenceis crucial because if managers move around, there is no long-termaccountability. Without accountability, deferred compensation is notpossible. Deferred compensation, in the form of a bonus bank, plays acritical role in ensuring the EVA bonus plan forces managers to thinkbeyond the current year.

EVA is no panacea, and it is no substitute for sound corporate strategies.But when EVA is at the centre of a company’s performancemeasurement system, and when management bonuses are linked,alignment between the interests of managers and shareholdersimproves. The effect is that when managers make important decisions,they are more likely to do so in ways that deliver superior returns forshareholders.

Reference managing for Value (1999) by Botzel S. & Schwilling A

Summary

In this unit we have looked at the concept of value, what it means todifferent stakeholders, and how our ideas of value and its measurementare changing.

We have looked at EVA as a measure of value, and have seen how EVAis influencing the management philosophy of value-based companies.We have also looked at the components of a value-driven approach.

We have noted that EVA is no panacea, or substitute for soundcorporate strategies. We have considered the characteristics ofcompanies for which the shareholder value perspective andvalue-creation incentives offered by EVA is most likely to succeed. We

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have looked at two case studies where EVA has made a significantimpact.

REVIEW ACTIVITY

In the late 1990s high-tech stocks soared in value, and there seemed to be anunsustainable wave of dot.com mania. The dot.coms invaded every sector ofcommerce; e-business seemed be to overturning established relationships, andattacking long-established price points. The year 2000, however, saw thecollapse of many dot.com shares. What went wrong?

1. Consider what went wrong. What are the lessons to be learned?

2. Now identify a survivor from the dot.com period. Spend some timeresearching the company. Find out about its strategy, during thedot.com period – specifically with regard to e-business. Comment onits market valuation during the dot.com period and on what premisethese valuations were made. Identify the hallmarks of their success

REVIEW ACTIVITY FEEDBACK

Here is some feedback on the first part of the question.

The valuation of a company has two equally important components. Netassets, as well as the present value of future EVAs. For most dot.comcompanies the net assets were very low, but the valuation of the secondcomponent (EVA) was extremely high – unrealistically high.

Based on nothing more than a website, companies with no earnings and noprospects of operating in the black were awarded market valuations thatexceeded many of the world’s most respected companies. Business metricslike profit and cash flow went out of the window. Unrealism and hysteria tookover the market.

In effect, many of the dot.com management were guilty of hyping the worth offuture EVAs. Market analysts egged on the hysteria; some cynics go as far as tosay that some market analysts materially benefited from this deception (an areaof on-going investigation).

The EVA situation resolved itself over time, and many of the dot.com stockscrashed.

The lesson from the crash is that there are no shortcuts in business. For manydot.coms, the “e” in e-business came to stand for “easy”; easy money, easy

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success, easy life. A real business is serious work and must have a realisticbusiness plan for break-even and profitability thereafter; profitability in thenot-too-distant future. In addition to future potential (and by future potential ismeant realistic future EVA) profits and cash flow do matter.



1. Ref 10*, Chapter 6 pages 212-226


3. Ref 15

*Highly recommended

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Unit 6

Corporate Governance andEthics

LEARNING OUTCOMES


� Assess the advantages and disadvantages of an ethical approach inorganisations.

� Develop the principle of global corporate governance by examiningrecent UK developments in this area.

� Explain the attributes of good corporate governance.

� Appreciate the attributes of an ethical organisation.

Introduction

Globalisation has heightened the awareness of social responsibility.There has been much debate about its adverse impact on social, politicaland environmental issues. Furthermore, recent high-profile corporatescandals, such as Enron, Worldcom and Parmalat, have led to anincreased focus on corporate governance and the tightening ofaccounting procedures.

What is clear is that companies can no longer pay lip-service to goodcorporate governance and business ethics. Profitability cannot be thesole corporate driver. Undoubtedly, there is a paradox betweenprofitability and stakeholder responsibility. See Figure 6.1. Profitabilitywill always be driven by the shareholder view, and guided by valuemanagement principles. But stakeholder responsibility must also be apart of organisational purpose. Stakeholder responsibility is not justresponsibility to the shareholders, but to the stakeholders (includingemployees, suppliers, customers and the community) at large.Stakeholder responsibility must be guided by good corporategovernance and business ethics.

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It should be noted, however, that in today’s business/politicalenvironment with very powerful lobby groups, profitability andresponsibility are not always paradoxical; profitability can indeed beadversely affected by the apparent lack of social responsibility. Shellfound this to their great cost with the Brent Spar episode where Shellappeared to go against their own stated ecological and environmentalstance.

Also, investors who invest for the longer term may expect the companyto be profitable and also behave ethically, showing good standards ofcorporate governance.

In this unit we shall look at the area of corporate governance, andexamine recent developments in the UK relating to this. We shall thenconsider the area of business ethics. We shall look at the benefits arisingfrom adopting strong ethical principles, and look at the factors that setapart a highly ethical organisation.

Corporate Governance

The term ‘corporate governance’ has been used in a variety of contexts,particularly in relation to the boards of companies listed on a stockexchange. Governance is at the heart of the role that all boards ofdirectors play. The range of issues is varied, e.g. company performance,individual performance, role of directors, roles of shareholders.

Corporate governance came to the fore in the early 1980s in the UnitedStates during extensive corporate take-over activity. Perceiving littlesupport from their institutional shareholders, numerous companyboards began to introduce protective practices to ward off undesirabletake-over bids. These measures were seen by some shareholders,especially public pension funds, as acting against their best interest.Accordingly, shareholders began to take a greater interest in theirinvestments. Out of this, corporate governance was born.

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Unit 6 – Corporate Governance and Ethics Global Corporate Strategy

Profitability ResponsibilityOrganisational purpose

Shareholder valueperspective

Value managementprinciples

Shareholder valueperspective

Corporate governanceand ethics

Figure 6.1: Paradox of profitability and responsibility

As mentioned in the introduction, there is undoubtedly a paradoxbetween profitability and stakeholder responsibility. Conflictingdemands, between economic profitability and social responsibility, areplaced on a company by its shareholders, employees, suppliers,customers, governments and communities.

ACTIVITY

How does a company achieve its organisational purpose by balancing the oftenconflicting demands of profitability and stakeholder responsibility? Learn aboutthis and the paradox of profitability and responsibility by reading the following:

1. p. 590-609 of Chapter 11 in your key text, De Wit, B & Meyer, R.

2. p. 616-638, Readings 11.2-11.4, in your key text, De Wit, B & Meyer,R.

The problems associated with the split between shareholders andcompany directors were first raised by Berle and Means, in their 1932book, The Modern Corporation and Private Property. The issue of the‘agency problem’ was highlighted, i.e. the tension created when thedirectors running the company were not the major shareholders. In the1980s, institutional (professional) shareholders were much more likelyto address these issues and debate possible solutions.

Corporate activity is under a more intensive media spotlight today.Board decisions are more public and annual meetings can behigh-profile as shareholder activists raise questions about boarddecisions.

In the UK, the corporate governance debate started to receive emphasisdue to several high-profile corporate failures such as Polly Peck andColoroll. World-wide, and in the last three years, there have beenfurther dramatic and spectacular failures including Enron, Worldcomand Parmalat. Directors were seen as acting against the shareholders’interests and in dereliction of their duties to the company. As a result offailures such as the ones mentioned, investors are willing to pay apremium for companies with good corporate governance.

To understand the workings of governance ‘systems’, it is important tobe able to identify the different types that exist globally. Often,governance systems are developed from tradition and ideology. Inrecent years, it has become more difficult to generalise about thedifferent types of system. For example, there is possibly a trend incentral Europe to move towards a more ‘Anglo Saxon’ approach. Thedifferent types of governance system are;

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Global Corporate Strategy Unit 6 – Corporate Governance and Ethics

1. The Anglo Saxon Model (e.g. in the UK, USA and Australia)which is a single tier structure and often reflects a widespreadnumber of small shareholders alongside large investment houseswho are intermediaries owning shares on behalf of investors.This limits the power of the individual shareholder and heightensthat of organisations such as pension funds. This can lead to ashort term approach as investors seek to obtain a quick return oninvestment.

2. The European Model (e.g. Germany) comprises a two tierstructure where the upper tier is supervisory over the lower tier.Share ownership is normally in the hands of institutions who useprotective mechanisms such as preference shares. This systemhas strengths and weaknesses. The two tier system is seen as a‘counterbalance’ to management power where the single tier isdominated by senior management. However, whereas the systemhas long term views, it suffers from slower decision making anda lack of flexibility.

3. The Asian Model (e.g. Japan) is single tier but ownership is verydifferent to the Anglo Saxon model. Banks and other companiesown most of the shares. Hence the larger companies hold sharesin each other and co-operate very closely (known as a ‘kieretsu’).Composition of boards is heavily in favour of executivemanagers. In fact, it is in effect the top layer of management.Accordingly, the share ownership patterns can lead to weakaccountability and secretive governance procedures.

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Average %

18

20

22

24

26

28

30

•0

Anglo-Saxon

USUK

ContinentalEurope

Italy

Switzerland

Germany

France

Spain

Latin America

Chile

ArgentinaMexico

Brazil

Columbia

Venezuela

Taiwan

Asia

Japan

Indonesia

Korea

Thailand

Malaysia

Source: McKinsey

Figure 6.2: Average premiums investors would be willing to pay for a well-governedcompany

Figure 6.2 suggests that investors are willing to pay more for shareswhere the perception is that the companies are ‘governed’ in a soundand ethical way. It can be seen as a measure of perceived ‘ethical’governance.

Scrutiny in the area of governance (as we shall see in the next sections)has led to the establishment of strategic principles relating to corporategovernance. These include:

� Selection and conduct of senior officers, and theirrelationship with stakeholders.

� Responsible use of power assigned to senior officers.

� Responsible conduct in relation to information relayed tostakeholders.

� Further checks by way of appointment of non-executivedirectors who have no commercial interest in thecompany.

� Focus on principles of conduct rather than hiding behindsimple rules.

� Equitable distribution amongst stakeholders of the valueof assets generated by the company.

Key developments in the UK

Let us now examine key developments in the UK relating to corporategovernance.

The Cadbury Committee

In the aftermath of these cases, a committee, chaired by Sir AdrianCadbury, was formed in 1991 to examine the financial aspects ofcorporate governance in publicly quoted UK companies. Thesubsequent Cadbury Report, The Financial Aspects of CorporateGovernance, published in December 1992, focused the corporategovernance debate in four main areas:

� The responsibilities of directors for reviewing andreporting on performance to shareholders.

� The case for establishing audit committees.

� The principal responsibilities of auditors.

� The links between shareholders, boards of directors andauditors.

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The report contained a Code of Best Practice, most of which wasadopted as part of the London Stock Exchange’s Listing Rules for allquoted companies. The report states that “Corporate governance is thesystem by which companies are directed and controlled.”

Whereas the corporate governance debate in the US had focused onshareholder rights, the emphasis in the UK was on structure andprocesses. Despite the report’s own definitions, the aspects ofgovernance relating to control dominated the debate in the UK andadded little to the issues of best performance.

The Greenbury Committee

The Cadbury Report focused on financial governance. Following aseries of highly publicised large pay awards to directors, notably in theprivatised utilities, a committee was set up to examine directors’remuneration, chaired by Sir Richard Greenbury. The committeereported in July 1996 and again produced a Code of Best Practice thatfocused primarily on listed companies. Remuneration packages appearto many as one of the most obvious means by which the interests of thedirectors can be aligned with those of the shareholders.

The Code made a series of recommendations on the role ofremuneration committees, disclosure of directors’ remuneration andprovisions for approval of long-term incentive schemes, corporateremuneration policy, the length of directors’ service contracts and thecompensation paid to directors when these contracts come to an end. Aswith Cadbury, many of the recommendations have since become part ofthe Stock Exchange’s Listing Rules requirements.

The focus was again on the systems and structures which could controldirectors, ensuring that, as far as possible, their interests were alignedwith those of the shareholders. Both Cadbury and Greenbury, therefore,focused most of their work on the elements of the debate relating toaccountability, not enterprise.

The Hampel Committee

The latest report on corporate governance in the UK, the HampelReport, from the Committee on Corporate Governance chaired by SirRonnie Hampel, attempts to address the distinction head on:

The directors’ relationship with the shareholders is differentin kind from their relationship with other stakeholderinterests. The shareholders elect the directors. As the[Confederation of British Industry] put it in their evidenceto us, the directors are responsible for relations withstakeholders; but they are accountable to the shareholders.

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The report has identified the friction created when talking ofaccountability and business prosperity;

The importance of corporate governance lies in itscontribution both to business prosperity and toaccountability. In the UK the latter has pre-occupied muchpublic debate over the past few years. We would wish to seethe balance corrected

(Final Report from the Committee onCorporate Governance, 1998)

This raises the question, ‘what is the difference between accountabilityand responsibility’? Some have used these words as being synonymous.However, their distinct meaning is important in developing the issuesrelating to governance.

The Combined Code

In June 1998, the London Stock Exchange published the Principles ofGood Governance and Code of Best Practice (‘the Combined Code’)which embraces the work of the Cadbury, Greenbury and HampelCommittees and became effective in respect of accounting periodsending on or after 31 December 1998. The Combined Code establishedfourteen Principles of Good Governance and forty five Best Practiceprovisions, upon which, companies were required to state theircompliance throughout their accounting period

The 1998 Combined Code has since been superseded by a versionpublished in July 2003. The July 2003 Combined Code became effectivefor reporting periods on or after 1 November 2003.

ACTIVITY

Read the latest version of the Combined Code on the following website:

http://www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf

The Higgs Review

For non-executive directors, a boardroom seat had been seen asproviding a comfortable sinecure ahead of retirement. Most boards oflarge companies comprised the ageing great and good in the City, oftenretired executives. Clubby consensus, rather than challenges tomanagement, was the order of the day. Some of that culture still lingers.

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The Higgs Review was commissioned by the Chancellor and theSecretary of Sate for Industry to review the role and effectiveness ofnon-exec directors, and the report was published in January 2003.

ACTIVITY

Read the Summary and Recommendations section of the Higgs Review fromthe following website:

http://www.dti.gov.uk/cld/non_exec_review/pdfs/higgsreport.pdf

As the Higgs review makes clear, the boardroom remains largely apreserve of ageing white men. Mr Higgs’ package of reforms will seenon-executives take a much more active role and become far moreaccountable in carrying out their duties.

The changes will represent a fundamental shift in the boardroom. Thepower of executives on the board will be balanced by independentnon-executives providing a check on management. At least half theboard will comprise independent non-executives. This goes far beyondprevious requirements that a third of the board be non-executives,independent or otherwise.

The chairman, playing a pivotal role and potentially holding the balanceof power, will be required to be independent at the time of hisnomination but it is assumed he will “go native”, given the time spentworking closely with the management.

The review says: “A non-executive is considered independent when theboard determines that the director is independent and there are norelationships which could affect, or appear to affect, the director’sjudgement.” Factors that could affect independence includeemployment with the company in the past five years, having a materialbusiness relationship in the past three years, family ties, receivingadditional remuneration apart from a director’s fee, and participation inthe company’s share option or pension scheme.

The review also recommends that a senior independent director beappointed to act as a conduit for shareholders to raise issues if they arenot resolved through the chairman or through the chief executive. Thisproposal, more than anything else in the review, has concernedbusiness. The concern is that if the senior non-executive holds separatediscussions with shareholders it could lead to mixed messagesemerging from the board. Mr Higgs is at pains to point out that seniornon-executives will not be champions of shareholder interests but willbe more a “listening post”. They will attend meetings with

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shareholders, largely only to listen to shareholder concerns. In addition,if problems arise with a chairman and chief executive, they could be acontact point for shareholders.

Other measures ensure that boards do not become bound bypersonalities or tradition. These include requiring the chief executivenot becoming chairman.

Non-executive directors should normally be expected to serve a tenureof two three-year terms, although a longer term would be appropriate inexceptional circumstances. After nine years, annual re-election ofnon-executives is appropriate, and after 10 years on a board anon-executive is not considered independent. Non-executive directorsalso should meet at least once a year without the chairman or otherexecutive directors present.

To widen the gene pool of talent in the boardroom, Mr Higgsrecommends a more formal, transparent recruitment process. Researchby the review showed that 48% of non-executive directors wererecruited through personal contact with a board.

No individual should chair more than one large company nor should afull-time executive take on more than one non-executive role.

No limit has been set for the number of roles that non-executives canhold, though individuals should make sure they have enough time tofulfil their duties.

The Smith Report

The report says that a Company Audit Committee’s primary role is toensure the integrity of the company’s financial reporting, and warns itmust be prepared if necessary to take an adversarial approach withmanagement.

“If things are going seriously wrong the committee may have noalternative but to explore the issues exhaustively. ”If the auditcommittee is drawn into a line of questioning about the handling of acontroversial issue, it cannot let go until it is satisfied with the answers."

The Smith report says at least three independent non-execs should serveon the audit committee, and suggests that they should get extra pay toreflect the importance of their work.

It says at least one member should ideally have a professionalaccounting qualification, together with recent and relevant financialexpertise, possibly as an auditor or company finance director. The othermembers should have a degree of financial literacy.

The Smith report will lead to revisions to the best practice code oncorporate governance for listed companies.

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Director Accountability

Placing accountability at the heart of corporate governance inevitablyled the general debate on the issues of to whom are directorsaccountable. Developing the Cadbury definition of corporategovernance a similar committee set up in Canada suggested a widerdefinition:

‘Corporate governance’ means the process and structureused to direct and manage the business and affairs of thecorporation with the objective of enhancing shareholdervalue, which includes ensuring the financial viability of thebusiness. The process and structure define the division ofpower and establish mechanisms for achievingaccountability among shareholders, the board of directorsand management. The direction and management of thebusiness should take in account the impact on otherstakeholders such as employees, customers, suppliers andcommunities.

Where were the d irectors? Toronto Stock Exchange (1994)

This definition retains Cadbury’s systems focus, but suggests that thestructures and processes chosen by directors must take into accountparties other than shareholders.

The Role of Corporate Governance

The UK’s National Association of Pension Funds (NAPF) suggest intheir report, Good Corporate Governance (1996), that corporategovernance should concentrate on two issues:

� Board integrity ; ensuring that accounting and otherstatutory concerns are addressed.

� Enterprise; encouraging boards to drive businessesforward in the long-term interests of the shareholders.

Ensuring good governance

NAPF highlights another element of corporate governance. At thecentre of the issue is the role of the board of directors – direction, control,ensuring shareholder value.

“It is the board’s responsibility to ensure good governanceand to account to shareholders for their record in thisregard.”

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Bringing together many of the themes raised in the corporategovernance field, the Institute of Directors’ report, Standards for theBoard (1995) states that:

The key purpose of the board is to ensure the company’sprosperity by collectively directing its affairs and meetingthe legitimate interests of the shareholders and otherinterested parties.

The report highlights four key tasks for the board:

� Establishing vision, mission and values.

� Setting strategy and structure.

� Delegation to management.

� Exercising responsibility to shareholders and otherinterested parties.

All of the elements of the governance debate highlighted above arereflected in these tasks.

Individual directors must be aware of the role they play in determiningthe company’s future and in setting the strategy and structure to meetdesired objectives. They must also be aware of the issues raised underthe guise of corporate governance which, as stated at the beginning, aremany and varied.

However, if the board is to be the guardian of good governance, asproposed by Hampel, a more appropriate starting point for definingcorporate governance may be the role of the board. Perhaps a newdefinition might be:

Corporate governance focuses the board on its key purpose:to ensure the company’s prosperity by collectively directingits affairs and meeting the legitimate interests of theshareholders and other interested parties. It must account toshareholders for its record in this regard.

This definition implies that, in essence, corporate governance shouldhighlight the corporate responsibilities of a board of directors, anddistinguish the directors’ role from those of shareholders and managers.

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CASE STUDY: Enron

Here is an article from FT.com on the Enron scandal.

The Board GameFT.com site; Dec 06, 2002By Charles W. Calomiris

Enron and other high-profile scandals have highlighted problems with corporategovernance. How can boards be actively encouraged to challenge managers?

Charles W. Calomiris is the Paul M. Montrone Professor of Finance andEconomics at Columbia University’s Graduate School of Business, a Professorof International and Public Affairs at Columbia’s School of International andPublic Affairs, and Chairman of the Board of Greater Atlantic FinancialCorporation.

Enron and other corporate scandals have crippled market confidence in UScorporate governance. Enron’s deceptive accounting practices were soconvoluted, involved such obvious conflicts of interest with Enron officers, andoccurred on such a scale, that one can only marvel at the failure of the Enronboard and audit committee to detect and prevent such abuse. Its membersfailed to perform their primary task, which is to protect the corporation’sstockholders from abuses by managers.

With the dawn of the modern large-scale corporation in the second industrialrevolution of the late nineteenth century, there came a new potential formanagerial abuse, as corporate stockholding in such large entities becamefragmented and detached from management. Stockholders’ interests were notautomatically aligned with those of managers.

In their 1932 classic on corporate governance, Adolf Berle and GardinerMeans identified these potential conflicts of interest. In modern parlance,managers can extract “control rents” – value that does not represent anappropriate market reward for their actions, but rather the ill-gotten gainsfrom being able to operate in conflict with stockholders’ objectives. Managersmay redirect funds for themselves and their friends; they may shirk theirduties; or they may prolong their employment against the interests ofshareholders.

The board, as the representative of the stockholders and the source ofmanagerial authority, is supposed to prevent such abuse. But board actionsdepend on individual board members’ skills, diligence and willingness tooppose management. Without all three ingredients, boards will fall short oftheir leadership mandate.

Why did the Enron board fail, and what does that failure tell us about possiblereforms that could improve corporate governance? One idea that has beenpopular among some is the need for board “independence”. Independentboard members – that is, board members who are not involved in company

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management – should be able to exert more effective oversight since they aredisinterested parties.

Able, perhaps, but not necessarily willing. Independent board members arebusy people; they are chosen because of their name recognition, not becausethey have either the time or the inclination to discipline management, or thetechnical knowledge to perform adequate audits. And their very independencemay be compromised if their seat on the board depends on continuingmanagement support, as it often does.

Enron’s board was almost entirely “independent”, and composed largely ofhighly skilled and experienced corporate managers. It included chair RobertJaedicke, a professor of accounting and dean of Stanford Business School, andWendy Gramm, former Chair of the Commodity Futures TradingCommission. Yet they and their colleagues seem to have been asleep at theswitch.

Evidence is mixed on the question of whether the independence of directorsimproves corporate governance. Recent studies suggest that boardindependence may matter, but that effective independence (measured by theboard’s ability to restrain executive compensation) is influenced by a variety ofother board attributes, including the size of the board (smaller is better), thenumber of boards on which board members serve (fewer is better), the age ofboard members (younger is better), and whether the independent memberwas chosen by the chief executive (which reduces effectiveness).

How can we establish a process for selecting and rewarding board membersthat will place stockholders’ interests above those of managers? Here,economics teaches us that incentives are as important as skills. The key toeffective board leadership is establishing a process that selects board memberswho have both the ability and the incentive to be dogged pursuers of thestockholders’ interest. There are three approaches to ensuring such a processof board selection.

1. Concentration of ownership

First, if board members and managers both own sufficiently large amounts ofstock, the conflict of interest between managers and stockholders may belargely overcome by the direct incentives of board members to protect theirown wealth. The positions of board members with sufficiently largestockholdings are secure, and they have strong incentives to disciplinemanagers to pursue value maximisation.

A 2002 study found that countries with the weakest legal protections foroutsider stockholders also saw the greatest concentration of stock in thehands of insiders. In both the US and UK, where legal protections are relativelystrong, the median insider ownership share of the largest 150 corporations is 1per cent. In France and Germany, where legal protections of stockholders areweak, the proportions are 55 per cent and 61 per cent.

During the first industrial revolution of the early nineteenth century, when thescale of manufacturing production was relatively small, ownership and

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management were typically closely aligned. Naomi Lamoreaux’s study of theperiod shows that industrial insiders also leveraged their equity financing byusing banks that they controlled to sponsor industrial growth. Banks operatedlike industrial credit co-operatives for their board members. Because the samegroup of people owned and controlled the industrial borrowers and the banks,interests were closely aligned, and companies and banks, along with theiroutside investors, prospered together. Managerial opportunism wasconstrained by the direct oversight of investors with a material vested interestin the value of the company.

But concentration of ownership in the hands of insiders can be very costly,especially in a modern industrial economy. When owner-managers anddirectors hold most or all of their wealth in the stock of one company, theysuffer from extreme lack of diversification. Consequently, they will pay less forcorporate stock and require much higher managerial compensation if theymust hold such an undiversified portfolio, which will limit corporate growthopportunities.

Also, the supply of billionaires is somewhat limited. If many corporations havenatural economies of scale that warrant global reach, it will be hard to staff allof them with billionaires. And, those lucky billionaires may lack the skills thatare needed to best guide the corporations. The best managers typically don’tbegin life as billionaires.

Finally, there are enormous social benefits from broad public participation instock ownership. Those benefits transcend the obvious social gains fromportfolio diversification, and include the political economy benefits that comefrom a broad alignment of interests between large corporations and the public,which encourages growth-oriented tax and regulatory policies. The booming“investor class” in the US in recent decades, for example, has restrainedpopulist impulses in public policy toward corporations, and spurredconstructive reforms of accounting, disclosure and governance regulation.

2. Intermediaries

A second approach to aligning the incentives of board members andstockholders is to rely on third-party intermediaries to aggregate the votingpower of stockholders and thus provide a formidable counterweight toincumbent managers. Historically, during the second industrial revolution,Germany and the US both used this approach to corporate governance,although its use in the US was much more limited in its scope.

In Germany, nationwide universal banks that combined lending, deposit-taking,underwriting and trust account management in a novel way were able tosupport growing industrial companies. They did so first with credit, financed bydeposits, but, later in the company’s life cycle, by underwriting stock offeringsthat were placed in the internal networks of accounts managed by thoseuniversal banks. Through their management of trust accounts, universal banksretained authority over stockholders’ proxies and thus controlled boards ofdirectors of their industrial clients.

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Scholars have argued that the relationships between German universal banksand client companies, and the discipline over management provided bybankers, permitted industries to access external finance easily and thus growrapidly, especially in new product areas that required large minimum efficientscale of operation (such as electricity generation). Although postwar Germanyhas been known for its reliance on debt as the main source of external finance,that was not true of pre-First World War Germany; in fact, equity finance wasmuch larger a proportion of industrial funding there than in the US prior to theFirst World War.

In the US, banking regulations limited the geographic scope of banks, andtherefore also the scale of banks. Those regulations constrained the role ofbanks in financing industrial growth by large-scale corporations during thesecond industrial revolution. As the scale and geographic scope of industryincreased, industry outgrew banks, and bankers turned mainly to commercialfinance. Commercial banks were also constrained from participating inunderwriting, not by law prior to 1933, but rather by their small size andregional isolation, which made it hard for them to operate German-stylenetworks for the sale of shares or the aggregation of voting rights.

Thus, US-style “finance capitalism” – typified by J.P. Morgan’s famous networkof partners who held seats on various boards of directors – was a very limitedphenomenon reserved for the largest, established companies, which usuallybecame “Morgan companies” as the result of consolidations of maturecompanies, rather than through public underwriting of equity to finance newinvestments. Morgan’s role was typically as a reorganiser or a bond, not astock, underwriter, and its authority came from the network of influentialstockholders that relied on its advice and corporate governance skills.Research by Bradford DeLong and others argues that corporate chiefexecutives who “wore the Morgan collar” wore it proudly and to great effect.They were better able to finance their growth and to weather financial stormsthan their competitors.

Despite its benefits, and even though its role in the economy was quite limited,J.P. Morgan’s brand of finance capitalism was too much for populist USsentiment against the concentration of power. Successive acts of legislationconstrained investment bankers’ abilities to establish control throughnetworks of skilled partners acting as disciplinarian board directors, and forcedthe separation of commercial and investment banking.

The role of intermediaries in controlling corporate boards took a third form inpostwar Japan, as part of the keiretsu system, in which a company surroundsitself with a permanent structure of subsidiaries, banks and suppliers. Mainbanks of keiretsus controlled blocks of a client company’s shares, both directlyand through other companies in which they owned interests, and acted as aneffective check on managers. By 1990, many US academics were writing paeansto the virtue of Japanese corporate governance, praising the high level ofmanagerial turnover and the fact that bank-sponsored corporate governancehelped companies economise on the costs of external finance.

Yet the postwar history of Germany and the past decade in Japan suggest thatconcentrating stockholder influence by means of universal banks and main

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bank-controlled keiretsus may also hinder corporate governance. That isespecially true when banking systems become non-competitive. The managersof a highly concentrated and non-competitive banking system may collude tofeather their own nests at the expense of both the stockholders and themanagers of client companies.

The role of the Japanese bank system in resisting corporate reform over thepast decade is one case. Another is the change in the role of German banks inthe postwar era. The largest German banks used their network of trustaccounts to engineer mutual control over their own stocks. They control, as agroup, more than 50 per cent of any one large bank’s stock. That lack ofcompetition may help explain why postwar German banks have played such asmall role in equity underwriting, or in spurring innovation and new industrialgrowth, in the postwar era, compared to the role they played prior to the FirstWorld War.

The history of Japanese and German financial systems suggests that financialsystem concentration during the later stage of industrialisation may offset thebenefits of corporate discipline that result from the concentration ofstockholder power in those intermediaries during earlier stages ofdevelopment. The policy lesson seems to be that vigorous antitrust policytoward the financial sector should be pursued in order to ensure thecontinuing benefits of good corporate governance that concentration ofcontrol through intermediaries permits.

To what extent can intermediaries such as pension funds and mutual fundssubstitute for the Morgan collar, the universal bank or the Japanese main bank?So far, in the US, they have played a limited role. There is some evidence thatinstitutional investor holdings of stock can improve corporate governance, butmost commentators view these influences as weak and unreliable.

Franklin Edwards and Glenn Hubbard point out that legal impediments limitthe amount of institutional ownership in any one company, and legal andregulatory risks to fund managers limit their incentives to own concentratedblocks of shares or to join boards of directors.

Further, fund managers’ incentives to discipline companies may be weak andregulation of their fee structures discourages shareholder activism. In a perfectworld, the efforts of fund managers to discipline portfolio companies’managers would be rewarded by their account holders. But regulationeffectively prevents setting mutual fund and pension fund managers’ fees to risewith profits. Thus, the fund managers’ rewards are small and indirect, confinedto increased asset inflows into funds in response to corporate profits.

Poland is an interesting case of a country that, during privatisation, consciouslydesigned its network of institutional investors to improve corporategovernance in newly privatised companies. Authorities there saw thedesirability of concentrating some voting power for any portfolio company inthe hands of a small number of intermediaries.

In 1993, Poland created 15 National Investment Funds (NIFs) to own 60 percent of the shares in 512 medium- to large-scale enterprises and to help

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oversee the restructuring of those enterprises. Each NIF was given a lead role(and a 33 per cent stake) in approximately 30 companies. Shares in NIFs wereallocated to the public and traded. Although the privatisation process wasbumpy in Poland, as elsewhere, observers tend to regard its successes as partlyreflecting the positive role of NIF managers in rationalising the restructuringprocess.

3. Hostile takeovers

A third approach to disciplining directors and managers is the threat of ahostile takeover. In the presence of a credible threat, managers know that ifmanagerial rent seeking gets sufficiently large, it will pay raiders to buy upshares to unseat them. That, in turn, encourages better corporate governance;and there is evidence that the hostile takeovers of the 1980s did, in fact,improve governance in target companies. The social gains from thesetakeovers were even larger, as many companies were encouraged to avoidtakeovers by reducing managerial rent extraction.

But recently enacted legal obstacles to takeovers have protected managers andcaptive boards of directors from that external discipline. Takeovers werenever easy, even during the 1980s. Acquirers had long been required by law toannounce their intention of purchasing the company through tender offers,thereby reducing the gain to acquirers of improving corporate efficiency, andthus discouraging some efficient takeovers.

In the 1980s, in response to many successful takeovers, incumbent managersdeveloped “poison pills” (corporate charter clauses that dilute the stock ofhostile acquirers), which have succeeded in discouraging hostile takeovers.Courts in the US have upheld these techniques, while various states’“stakeholder statutes” have also served to discourage takeovers. In effect, thebroadening of corporate goals makes it impossible to hold managersaccountable to stockholders, or to any other constituency, for that matter.

The alternative means to wrest control from incumbent managers – a proxyfight – is no more attractive to would-be acquirers, owing to the manyobstacles that boards can use to reduce the chance of success. The mostpopular of these is the staggering of board terms, which often limit the numberof board members coming up for re-election at any one time to only a third ora fourth of the board. Would-be acquirers have to be willing to fight manyproxy battles over many years before being able to take control of the target.

Conclusion

It is unrealistic to expect board members to serve the function of discipliningmanagement and protecting shareholders’ investments when we havedesigned a system that prevents boards from having the incentive to do so. Thecentral problem limiting the effectiveness of boards, and of corporategovernance more generally, is the lack of political will to place the interests ofstockholders first when considering the rules under which corporategovernance occurs.

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Populist revulsion to concentrations of power, and special interest politics,have often resulted in the political decision to hobble the financial system as aninstrument for disciplining corporate managers. The first step toward avoidingfuture Enrons is deciding that the overriding objective of the board is tomaximise the value of the company. The second step is to enact laws that holdmanagers and board members accountable to that objective, and thatencourage the concentration of stock in the hands of those who would ensurethat the voices of stockholders are heard in the boardroom and, if necessary,in the courtroom.

QUESTION:

1. How do you think the Enron scandal (and indeed Worldcom andParmalat) could have been avoided?

CASE STUDY FEEDBACK

Feedback on Question:

The following measures in the US would have helped avoid such a scandal:

1. Tougher regulations; accounting and auditing practices.

2. Better regulatory framework to police corporate activities and detectfraud early.

3. Enforce personal accountability as a deterrent.

4. Empower intermediaries (e.g. Fund Managers) to probe businessoperations (requires legislative change particularly in the US), e.g. tostop companies exploiting the ‘Delaware’ loophole.

5. Ensure that a certain percentage of the Board are independent,non-exec directors who themselves will have personal responsibility(and liabilities).

Some of the above measures (and many more) are receiving attention by theSecurities and Exchange Commisison, New York Stock Exchange, NASDAQ,Public Company Accounting Oversight Board in the US. Some rules havealready been enacted and others are at the proposal/discussion stage. Detailsmay be found in the paper ‘The Post Enron Corporate GovernanceEnvironment: Where are We Now? ‘ found on:

http://www.ffhsj.com/cmemos/031017_post_enron.pdf

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Other articles that you will find helpful in this area are:

Benston, G.J. and Hartgraves, A.L. (2002) “Enron: what happened and what wecan learn from it”, Journal of Accounting and Public Policy 21, 105-27.

Himmelberg, C., Hubbard, R.G. and Love, I. (2002) “Investor Protection,Ownership, and the Cost of Capital”, World Bank Finance, DevelopmentResearch Group Working Paper, 2834, April.

Edwards, F. and Hubbard, R.G. (2000) “The growth of institutional stockownership: a promise unfulfilled”, Journal of Applied Corporate Finance 13,92-104.

Baums, T. and Scott, K. (2002) “Taking shareholder protection seriously:corporate governance in the United States and Germany”, working paper,Stanford Law School, October.

Business Ethics

What is Business Ethics?

Ethics involves learning what is right or wrong, and then doing the rightthing. However ‘the right thing’ is not straightforward. Most ethicaldilemmas in the workplace do not comprise a simple set of issues,decisions and choices.

Many ethicists say that there is always a right thing to do based on moralprinciple and others believe the right thing to do depends on thesituation. Ultimately it’s up to the individual. Many philosophersconsider ethics to be the ‘science of conduct.’ Ethics includes thefundamental ground rules by which people live their lives.

Many ethicists consider emerging ethical beliefs to be related to futurelegal matters, i.e. what is an ethical guideline today is often latertranslated to a law, regulation or rule. Values that guide how we oughtto behave are considered moral values, e.g. respect, honesty, fairness,responsibility, etc. Statements around how these values are applied aresometimes called moral or ethical principles.

Business ethics has come to mean various things to various people.Generally, it’s coming to know what is right or wrong in the workplace,and doing what’s right. This is in regard to effects of products/servicesand in relationships with stakeholders.

Business ethics are critical during times of fundamental change. This isbecause there may be no clear moral compass to guide leaders through

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complex dilemmas about what is right or wrong. Attention to ethics inthe workplace sensitises leaders and staff to how they should act. Also,ethics help ensure that when leaders and managers are struggling intimes of crises and confusion, they retain a strong moral compass.

Many people do not take business ethics seriously saying that businessethics only states the obvious (“be good,” “don’t lie,” etc.). These‘principles of the obvious’ disappear during times of stress.

Two Broad Areas of Business Ethics

The two broad areas of business ethics relate to:

1. Managerial mischief.

2. Moral mazes

Madsen and Shafrits, in their book Essentials o f Business Ethics(Penguin Books, 1990) explain that managerial mischief includes“illegal, unethical or questionable practices of individual managers ororganisations, as well as the causes of such behaviours and remedies toeradicate them.”

Moral mazes of management refer to the numerous ethical problemsthat managers must deal with on a daily basis, e.g. potential conflicts ofinterest, wrongful use of resources, mismanagement of contracts andagreements, etc.

Business ethics has come to be considered a management discipline,especially since the birth of the social responsibility movement in the1960s. In that decade, social awareness movements raised expectationsof businesses to use their massive financial and social influence toaddress social problems such as poverty, crime, environmentalprotection, equal rights, public health and improving education. Anincreasing number of people asserted that because businesses weremaking a profit from using our country’s resources, these businessesowed it to our country to work to improve society. Many researchers,business schools and managers have recognised this broader definitionand in their planning and operations have replaced the word“stockholder” with “stakeholder,” meaning to include employees,customers, suppliers and the wider community.

Organisations have realised that they needed to manage a more positiveimage to the public and so the recent discipline of public relations wasborn. Organisations realised they needed to better manage their humanresources and so the recent discipline of human resources was born. Ascommerce became more complicated and dynamic, organisationsrealised they needed more guidance to ensure their dealings supportedthe common good and did not harm others — and so business ethicswas born.

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Ethics in the workplace is managed through use of codes of ethics, codesof conduct, roles of ethicists and ethics committees, policies andprocedures, procedures to resolve ethical dilemmas, ethics training, etc.

Business ethics in the workplace is about prioritising moral values forthe workplace and ensuring behaviours are aligned with those values.Many people are used to reading or hearing of the moral benefits ofattention to business ethics. However, there are other types of benefits,as well, such as:

� Attention to business ethics has substantially improvedsociety.

� Ethics programs help maintain a moral course inturbulent times.

� Ethics programs cultivate strong teamwork andproductivity.

� Ethics programs support employee growth.

� Ethics programs help ensure that policies are legal.

� Ethics programs help avoid criminal acts “of omission”.

� Ethics programs help manage values associated withquality management, strategic planning and diversity.

� Ethics programs promote a strong public image.

� Managing ethical values in the workplace legitimisesmanagerial actions, strengthens the coherence andbalance of the organisation’s culture, improves trust inrelationships between individuals and groups, supportsgreater consistency in standards and qualities ofproducts, and cultivates greater sensitivity to the impactof the enterprise’s values and messages.

CASE STUDY – Business Learns the Valueof Good Works

Corporate Philanthropy: US Companies Have For Many Years MadeA Connection Between Social Responsibility And The Bottom Line.Nokia has:Financial Times; Dec 19, 2000 By Jimmy Burns

When Nokia hosted a media lunch in a small London restaurant last week, theaim was not to publicise its latest mobile telephones but gently to drawattention to the time its employees are devoting to schoolchildren in needaround the world.

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Nokia’s Make a Connection campaign, launched this year, is about to make itspresence felt in some UK schools. The Finnish telecommunications companyhas entered a global partnership with the International Youth Foundation, toprovide teaching packages to children with learning difficulties, and to offervolunteers from its own workforce.

The campaign is operating in South Africa, China, Mexico, Brazil and Germany,as well as in the UK. It is tailored to local needs, with social exclusion andeducation the predominant themes.

Projects range from internet-related newspaper schemes among aspiringyoung journalists in China to mentoring programmes in East Germany.

Nokia has not ruled out giving employees time off to participate but it hasapparently assured the IYF that hundreds of its employees will use their flexibleworking arrangements to take part in the scheme.

“Involvement could range from giving time to organise fundraising events, tohaving our engineers help set up websites and CD-Roms,” says DavidStoneham, Nokia UK’s senior communications manager.

Nokia plans to spend £7.5m on the campaign during the next three years andsays it should help up to 1m children and young people. The campaign will notfeature the Nokia brand or free mobile phones, the company insists. But itraises questions about whether behind it lies a subtle ploy to use good worksto strengthen its market position among the younger generation.

Mr Stoneham puts a different business case for Nokia’s campaign: “We hopepeople will see this as a sincere community issue. Sustainable global successdemands respect for our stakeholders – our staff, current and potential, wantto see good citizenship and our investors and customers want us to behaveethically,” he says.

The US still leads the way in philanthropy, with foundations holding more than$330bn (£224bn) in assets and contributing more than $20bn annually toeducational, humanitarian and cultural organisations.

Traditionally, Europe has lagged behind the US. This is partly because the statehas tended to play a more central role and partly because the act of giving hasnever been regarded as conferring high status.

This may be changing, however, as the European Commission encouragesbusiness to form social partnerships and the UK government implements taxchanges to increase donations.

The notion of corporate citizenship has developed during the past decade inboth the US and Europe as more companies address social accountability,social auditing, social investment, corporate governance and business ethics.

According to the Institute of Directors, the potential for enhancing corporatereputation – and, in turn, business competitiveness – is being recognised bysome of the largest UK companies.

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Such an approach is a far cry from that of the corporate citizens of the late 19thand early 20th centuries, when the personal considerations of the donor,rather than a cost-benefit analysis, were the main impetus for giving.

According to Jamie Camplin, author of The Rise of the Rich: “Hospitals,libraries and museums were the main objects: all built in a style that re-affirmedthe principles of conspicuous waste rather than public benefit.”

A survey conducted towards the end of last year by Environics International,the Toronto-based consultancy group, in co-operation with the Prince ofWales Business Leaders Forum, highlighted the fact that business is no longeronly about personal aggrandisement or simply making profits.

It found that six out of 10 consumers form impressions of a company based onbroader responsibilities such as labour practices, business ethics, responsibilityto society at large and environmental effects.

Doug Miller, managing director of Environics, says companies are being forcedto market themselves differently in response to changing attitudes and a new“aspirational agenda”: “We are living in a period of great expectations, withpeople expecting to improve the quality of their lives and believing they can getit all.”

He says businesses have to be seen to be responding to the agenda set by aidagencies after “black eyes” over issues such as child labour and environmentaldisasters.

“I visit 75 boardrooms a year and I can tell you, the members of the board areliving in fear of getting their corporate reputations blown away in two monthson the Internet,” he says.

While Nokia has encountered no negative publicity from its sociallyresponsible efforts, the same cannot be said for Shell, a company that hasreceived more than one “black eye” from the media. Last October AnitaRoddick, founder of the Body Shop, attacked Shell’s ethical advertisingcampaign. Ms Roddick publicly denounced the “vast gap” between thecompany’s humane image and the reality of human rights violations in Nigeria.

For Shell, still smarting from the adverse publicity of the 1995 Brent Sparfiasco, the effect of this further blow was to make the company even moredetermined to project a caring image. In a guide sponsored by the company,Tim Hollins, head of group social investment, wrote: “The challenge for the21st Century Company is to bring all the developments in corporatecitizenship together . . . into a coherent framework of practice that makesgood business sense as well as benefiting society.”

In fairness, Shell had committed itself in its Business Principles to sustainabledevelopment well before Ms Roddick’s outburst. It had reorganised andchanged reporting processes in 1997 so that environmental and socialachievements sat alongside financial data in the annual report.

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The group has chosen to continue its high-profile campaign and to risk attacksby organised pressure groups. Last month, it circulated the latest informationabout the activities of the Shell Foundation, a UK-registered charity establishedin June with the aim of “supporting efforts worldwide to advance the goal ofsustainable development”.

Yet for aid agencies such as the World Development Movement, much morehas to be done before hardened campaigners can be convinced thatenlightened self-interest is delivering results in a way that truly benefits society.

Barry Coates, director of WDM, feels too many companies fall outside thenew ethical agenda and stand to take advantage of unregulated markets.

“If corporate social responsibility is to prove sustainable in the long term,governments must meet their responsibilities and regulate to provide anethical framework,” he says.

Save the Children recently outlined the measures a socially responsiblecompany and its suppliers could take to tackle the issue of child labour, whichcaused an outcry in the 1990s and dented Nike’s reputation.

The charity recommends in a new report that social responsibility criteriashould be incorporated into management processes and procedures,specifically into job competences and performance assessments.

But a study last year of 78 FTSE 350 companies and non-quoted companies ofequivalent size, conducted by Arthur Andersen and the London BusinessSchool, showed that one in five companies with a code of ethical conduct hadnot issued the code to all its staff and nearly half had failed to make the codepublicly available on request.

According to Mr Miller, some companies worry about taking a biggerleadership role than governments in the area of social responsibility: “There isa concern that the high-profile philanthropic approach might backfire and thatthe public might begin to look at business [as if it were] the new feudalism.”Nokia’s discreet lunch last week and its insistence that its marketing of mobiletelephones is kept separate from its social work may be a reflection of this.

Characteristics of a highly ethical organisation

The following points characterise a highly ethical organisation:

� They are at ease interacting with diverse internal andexternal stakeholder groups.

� They are obsessed with fairness.

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� Responsibility is individual rather than collective, withindividuals assuming personal responsibility for actionsof the organisation.

� They see their activities in terms of purpose. This purposeis a way of operating that members of the organisationhighly value. And purpose ties the organisation to itsenvironment.

� There is a clear vision and picture of integrity throughoutthe organisation.

� The vision is owned and embodied by top management.

� The reward system is aligned with the vision of integrity.

� Policies and practices of the organisation are aligned withthe vision; no mixed messages.

� It is understood that every significant managementdecision has ethical value dimensions.

CASE STUDY – Nike and the University ofOregon

The next case study is case study 22, (“Nike and the University of Oregon”) onPages 933-940 of your key text, De Wit & Meyer.


Case Synopsis

Philipp H. Knight founded Nike’s predecessor company in 1963. The basicbusiness formula of the company has not changed much since then. Nike isdesigning and marketing high quality sports shoes and sports apparel aroundthe world. It builds its brand appeal through savvy marketing and sophisticatedproduct R&D. The company has never owned production of the goods it sells,instead from the very beginning has been importing the products from theAsian Far East. In 2000, Nike enjoyed 45% global market share, had close to $9billion of sales and put Knight among the top ten richest individuals in UnitedStates. The company directly employed 20,000 people, but had a workforce ofan estimated half a million labouring for them in 565 contract factories in 46countries – making it one of the largest private company de facto employers inthe world.

Labour conditions in Nike’s contract factories were not even close to anylabour laws and compensation practices in the industrialised countries, letalone the US. Work there meant 70-hour workweeks performing hazardousand/or monotonous routines under abusive supervision and with appallingequipment. Until the early l990s, Nike never felt that to be its responsibility.

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Ever since the early 19th century in England, industrial development startedwith large scale textile factories. Workers there would stay for two to threeyears and then either return to the countryside or “graduate” on to highervalue added, more sophisticated factories such as household goodsproduction, followed by machinery assembly and ultimately followed byprecision machining for high tech goods. This pattern remained remarkablyunchanged over almost two centuries: throughout all times and places ofindustrial development, textile factories have served the critical function of“breaking in” the poor, illiterate and non-urbanised farm surplus workers intothe industrial age. The alternative would usually be starvation in thecountryside. And ever since Charles Dickinson and Emile Zola, this course ofevents has always attracted the ire of many whose fortune of life it was to growup in the more economically advanced part of society.

Confronted with such a bout of consumer activism supported by Americanunions in the early '90s, Nike began to take a few halfhearted measures toimprove standards at its suppliers. But Nike had already become the lightningrod of a fervent labour practices movement and kept on being pilloried forbeing an imperialist profiteer. With the campaigns beginning to have an impacton Nike, Nike became one of the founding members of the Apparel IndustryPartnership launched by President Clinton, encompassing several textilecompanies, unions and humanitarian NGOs. In long drawn negotiations theALP attempted to establish industry-wide accountable minimum standards forsupplier factory conditions.

Eventually the differences proved too far to bridge between the members. Thegroup split into a Fair Labour Association, carried by the textile companies,espousing a certain set of minimum conditions, and the student-led, unionsupported Workers Rights Consortium, who wanted measures to be a lotmore stringent and better controlled. The key stick that the WRC could wieldwas to convince universities to purchase their $2.5 billion of sports apparel(2% of the US textile market) for their varsity teams only from WRC approvedvendors. If WRC was successful it could harm profits at the textile companies,including Nike quite seriously, because production costs would probably risesignificantly.

In April 2000, a committee comprised of students, professors andadministration of the University of Oregon, voted that UO should join theWRC for one year, under the condition that WRC would give companies avoice in its operations. It had been a very difficult decision for the university,because Phil Knight was alumni of UG and had been a generous benefactor ofhis alma mater. He had given more than $ 50 million to the school, and wasabout to donate his largest contribution yet for renovating the footballstadium. After the decision of UO, Knight broke off all contact with theuniversity saying “the bonds of trust have been shredded”. The university hadlost a major source of discretionary income!

Points to Highlight

(extracted from Teaching Note 22, Nike and the University of Oregon, Peer Edererand Jaco Lok)

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� The paradox of profitability and responsibility. Nike and University ofOregon is a typical case where stakeholder interests seeminsolvably squared off against shareholder interests. The nice thingabout the case is that the conflict is suffered by four participants inequal measure: Nike, University of Oregon, the Asian producersand the WRC. Each one of them simply cannot afford to run theirbusiness under financial consideration alone anymore, because theirrespective customers might break business relations with them as aresult. At the same time, each one of them has only very limitedinfluence to materially improve the conditions as required by theircustomers. Somebody needs to start taking responsibility for the“non-financial” currencies in which companies trade, but who andhow?

� Shareholder value and stakeholder values perspectives. The case givesenough information to illuminate the validity and presence of bothperspectives. Note how the perspectives differ, and also howneither perspective will get very far, if it does not seek toaccomplish a synthesis.

� Use of the stakeholder framework to identify strategic problems andpossible solutions. Depending on one’s own personal bias, reading thecase will quickly lead to a judgement on who is right and who iswrong. However, assignment of blame will not solve the strategicproblem at hand, which the four main participants have. Employing astakeholder analysis will yield a map of the conflicting interests, andmay eventually also lead to resolution.

Questions:

1. Identify the four main protagonists. What are the financial interests oftheir owners and/or sponsors?

2. Identify the other stakeholder interests involved, including customers,employees, suppliers, governments, competitors and any otherstakeholders that you find relevant.

3. What seems to be the core problem behind the fact that 500,000human individuals are working under such poor conditions, even astheir input to the overall value of the final product is only 4%?Wouldn’t just a little more to them, say 5% or 6% do tremendousgood to them, while being barely noticeable to the final consumer?

4. Did Nike do enough with supporting FLA to solve its stakeholderproblems? How much does Nike stand to lose, if the issue enters, say,American presidential elections and trade restrictions are introduced?

5. With 45% global market share, is there an option for Nike to recreatethe industry rules for a better deal to all stakeholders? What mightthat option look like?

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CASE STUDY FEEDBACK


� Nike. The main interest of Nike’s owners is to maximise Nike’sfinancial success in the long run. As margins in the industry arenot particularly high (e.g. around 9% on a pair of Nike AirPegasus shoes) Nike has always relied on outsourcedproduction in Asia where wage rates are low, continuouslyshifting production locations within the region to the lowestcost countries. Nike’s owners did not feel responsible for thework practices adopted by its suppliers, as exemplified by thefact that in 1995 a proposal by shareholder activists to reviewlabour practices by its subcontractors only gathered 3 percentof the shareholder vote. However, since the mid-90s Nike andits owners have been forced to recognise that itsresponsibilities for the welfare of employees involved in itssupply chain extend beyond the boundaries of the firm itself.Nike and its owners have come to see that the continuation ofexploitative labour practices in Asia would do severe damageto its reputation and brand and could eventually harm itsbottom line (if for example universities would boycott itsproducts). From 1995 onwards, Nike thus became more activein improving labour practices throughout the supply chain, firstby hiring independent monitors and ending the use of childlabour in Pakistan, and later by raising the minimum age,achieving higher air quality standards, and improving workersafety by substituting harmful chemicals and by trainingpersonnel. These efforts were made in the context of Nike’sparticipation in the FLA whose “sweatshop-free” service markcould help convince Nike’s customers that it was indeed asocially responsible manufacturer. Nike and its ownershowever continued to protect their financial bottom-line byopposing WRC’s demands for paying a living wage instead ofthe legally required minimum wage, and by opposing WRC’smonitoring methods, preferring instead to keep the monitoringresults behind closed doors. Nike’s main owner, Philip H.Knight, did not shy away from using his financial power overthe University of Oregon to protect these interests.

� Fair Labour Association. The Fair Labour Association (FLA)originated out of the Apparel Industry Partnership onWorkplace Standards (ALP), which was launched by theClinton administration in August 1996, and comprised of 18organisations, including several leading manufacturers, labourunions, several human rights, consumer, and shareholderorganisations. ALP’s goal was to ensure anti-sweat conditionsin the industry through certification of participatingmanufacturers. However, after agreeing on a Workplace Code

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of Conduct in April 1997 progress slowed as disagreement aroseover the monitoring process and over workers’ rights to bargaincollectively. A subgroup of nine centrist participants including Nikebegan meeting separately in an effort to move forward andannounced an agreement on a monitoring system in November1998, which was quickly endorsed by the Clinton Administration.They then formed the FLA to oversee compliance with itsWorkplace Code of Companies. The FLA was funded byparticipating companies and by affiliated colleges and universities,who both stood to benefit from participation. Manufacturers couldbenefit through 3-year FLA certification and institutional buyers,such as universities, could warrant to their students that the appareland athletic gear they used and sold were manufactured accordingto fair labour standards. It is clear then that the FLA mainlyrepresented the (financial) interests of manufacturers and collegesand universities, which both had to convince their customers thattheir products were “sweat free”.

� University of Oregon. The University of Oregon was caught in themiddle between its activist student and staff body on the one handand Philip H. Knight as the university’s most important financialbenefactor on the other. Knight had already contributed over $50million to the school and was considering making his biggestdonation yet to renovate the football stadium. Financially theUniversity was both dependent on its students as well as itssponsors, and it is not surprising therefore to see that it tried toreach a compromise: it would join WRC for one year, conditionalon the consortium’s agreement to give companies a voice in itsoperations. Unfortunately for the University this compromise wasnot good enough for Knight who spoke of the shredding of thebonds of trust and stopped his donations to the University. TheUniversity of Oregon subsequently changed its mind and joined theFLA instead (see ‘What happened after the case?’).

� Workers Rights Consortium. The WRC comprised exclusively ofstudent activists who felt that the FLA did not go far enough. Itproposed a more independent monitoring system and demandedthat companies pay a living wage, adequate to provide the basicneeds of an average family. Students convinced their universities andcolleges, who were important sports wear buyers and who were(financially) dependent on their students’ support, to join the WRCand to fund its operations. WRC did not permit corporations tojoin and gave human rights organisations and unions an advisoryrole. This union involvement led Knight to accuse the WRC ofsupporting the unions’ hidden political agenda, which was to bringapparel jobs back to the U.S. WRC’s interests, according to Knight,thus went beyond the mere improvement of labour practices inAsia.

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� Customers. It is clear that many of Nike’s customers, especiallyin the U.S., have grown increasingly concerned about its(ab)use of cheap labour in Asia ever since Nike’s methodsstarted attracting a lot of negative publicity in the earlynineties. In 1996 ‘bad labour practices’ was the top thirdperception of Nike as a company amongst young people aged13 to 25. Customers do not only expect good value for theirmoney, but also increasingly expect manufacturers to besocially responsible. Yet Nike maintained that its sales werenever affected by all the bad publicity. This may be explainedby the fact that Nike sells its products globally, and that thepercentage share of its customer base that would actually bewilling to boycott Nike’s products is very low. After all, howmany teenagers really would choose to forego on theopportunity to look cool in order to be socially responsible?Furthermore, who is to say that the alternatives are actuallymanufactured under better conditions? Without informationon who is and who is not a socially responsible manufacturer,customers are likely to even the playing field and continuebuying Nike’s products. In purchasing their goods, Nike’scustomers are likely to continue to be price as well as trendsensitive, and most of them are unlikely to consider thecompany’s labour practices when making the actual purchasingdecision. Only when watching news programs would they feeltemporarily uncomfortable. Only the activist student body,which represented a significant, but by no means a dominantshare of Nike’s total market, was willing and able to pressureNike by threatening a boycott. To protect this market and toavoid possible repercussions in the rest of its markets, Nikewas forced to act, and changed its practices without needing tocomply fully with the student activists’ demands, because theydid not represent all of its customers.

� Nike‘s own employees. The case does not analyse the situationfrom the perspective of Nike’s own employees in the U.S., butwe can imagine that it is not a lot of fun to work for acompany that is widely known to exploit labour in developingcountries. Imagine the number of times Nike employees willhave been forced to justify their company’s actions by theirfriends and families during dinner parties and social events at atime when Nike’s exploitative practices were all over thenews! Although their own work environment may actually bevery satisfactory, we can therefore reasonably assume that itwas in the personal interest of many Nike employees tooppose their company’s work practices in Asia. Only thosewho fully believed in minimising the cost price of Nike’sproducts in the face of Nike’s aggressive competitors could beexpected not to buckle under the social pressures in theirprivate lives.

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� Subcontractor employees. The case makes it clear that although manyof the work conditions in Nike’s subcontractor factories wereindeed appalling, there was no shortage of applicants for the work,because alternatives would be even worse. In Nike’s Vietnamesefactories, for example, the average annual income for factoryworkers was double the national average, despite the wages beingthe lowest of all countries where Nike manufactured. Most of theyoung, female workers in the Vietnamese factories considered thejobs to be transitional – a way to earn money for a dowry or toexperience living in a larger city for two or three years.

� Although the employees themselves, unlike the WRC, did notperceive of the wages as particularly low and therefore chose towork at Nike’s subcontractors, they were often unaware of thehealth risks they were exposed to. Workers in the chemicalsections were thought to have high rates of respiratory illnesses,choosing not to wear their protective gear because it was too hotand humid in the plant. Nike was also caught using child labour inPakistan and children, of course, can hardly be said to havevoluntarily chosen to work at Nike’s subcontractors. Given theseemployee interests it is not surprising that Nike only addressed thelatter practices, raising the minimum age and improving safetystandards. It did not need to raise its pay levels at itssubcontractors, because despite continuing to live in poverty,employees seemed satisfied with their pay as their alternatives wereworse.

� South Korean and Taiwanese suppliers. When Nike moved from onelocation to another, often its Taiwanese and South Korean factoryoperators followed, bringing their management expertise with them.Subcontractors, of course, generally had no choice but to followNike, because they were highly dependent on Nike financially. Nikeused over 500 different suppliers and could easily switch supplierswho were operating in a highly competitive market across thewhole of South East Asia. Of course, it was in the Taiwanese andSouth Korean owners’ interests to maximise the financial returnsfrom their businesses by deploying low cost, mass productionsystems using cheap, manual labour. Ensuring consistent, high outputquality was of crucial importance in maintaining the supplyrelationship with Nike. Because of the intense regional competitionbetween different suppliers with low barriers to entry, supplierscould not be expected to improve labour practices on their ownaccord, if that meant increasing their cost price and thus riskingtheir relationship with Nike. Both local governments and localemployees welcomed their presence as an important source of jobs.

� Asian governments. Nike’s shoes and other factories made up 5percent of Vietnam’s total exports alone. As such local Asiangovernments were dependent on Nike’s presence in their economyand were well aware of Nike’s practice to move to the lowest wagecountries if wages became too high. Attracting Foreign Direct

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Investment in the labour intensive textile industry is generallyseen as one of the first and necessary steps in the economicdevelopment of a country, and it can therefore be expectedthat local governments would not do anything that wouldmake it more difficult for manufacturers to set up shop in theircountries. The increase in minimum wages for example, whichthe WRC desired, could not be expected to be supported bylocal Asian governments as they risked undermining the baseof their efforts to develop their economies by risking to losenot only textile manufacturers but also other industries thatrelied on cheap labour.

� Nike‘s competitors. With a global market share of over 40%Nike justifiably attracted most of the negative attention. Thismeant that many of its competitors could hide behind Nikeand could wait to see whether they could perhaps capitalise onNike’s increased vulnerability. Despite being such a dominantplayer, Nike could ill afford to raise its cost price unilaterallyby paying higher wages, because of the price sensitivity of manyof the sportswear customers (brand loyalty can quickly fadewhen prices are not on par with main competitors). It would,therefore, be difficult for Nike to transfer the increased costprice on to higher store prices, which means the increasedwages would have to be paid for by Nike’s shareholders. Sincemost shareholders are interested in maximising the returns ontheir investments, they are not likely to accept unilateral actionby Nike without being convinced that this made sense from along-term business perspective. This is why it was of crucialimportance to Nike that its main competitors would alsosupport the FLA, so that the increased cost of improvedlabour practices would be shared amongst its maincompetitors. However, some companies remained opposed tothe FLA’s proposed monitoring system and did not join (e.g.Warnaco left the FLA, and the AAMA scoffed at the wholeidea of monitoring).


The core problem seems to be that the responsibility for improving the plightof the thousands of workers in developing countries can and is constantly beingshifted from one party to the next. The customer can relieve him or herself ofresponsibility by claiming that he/she doesn’t have any real choice and that itcan’t be up to them to know how all the goods that they buy are produced toensure that their manufacturers are socially responsible. They should be ableto rely on the manufacturers and on the government to ensure products aresafe and “non sweat shop”. Furthermore, why should they have to pay morefor their product when manufacturers and their retailers make multi-billionprofits? These manufacturers, of course, can point to the pressure they areunder from shareholders to maximise financial returns, and to theircompetitors for making it impossible to initiate changes unilaterally in a pricesensitive market. They can also shift the responsibility to the local Asiangovernments, claiming that it is their responsibility to ensure that minimum

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wages amount to living wages. These governments, of course, are also incompetition with one another, and know that if they were to unilaterallyincrease their minimum wages this could seriously harm their economy,meaning that their people would be even worse off. Of course, a redistributionof wealth from richer to poorer nations would do billions of people around theworld a lot of good, without necessarily affecting the living standards of thericher nations all that much. However, the global capitalist system in which welive does not provide the clear means to make this possible. The ability forconstituents to shift the responsibility on to other links in the complex chainmakes it very difficult to make even the smallest improvements.


By reversing its ‘hands-off attitude towards labour practices deployed by itssubcontractors to a more pro-active stance, actively pushing for betterstandards in its industry, Nike has come a long way in solving its stakeholderproblems. It managed to secure the backing of many of the more centristparticipants of the AIL for its FLA proposal, including the U.S. government andmany universities. It can effectively use this backing to defend itself againstcontinued criticism from activists who believe Nike is not going far enough. It isalso likely that customers, who already did not appear to be overly ready tochange their purchasing behaviour, will be more than happy with thegovernment backed FLA seal to quiet their conscience, whether WRC agreeswith the FLA label or not.

However, the real damage to Nike’s reputation was done in the 1990s andcannot be easily reversed. Therefore, for a long time to come, it will thereforealways be relatively easy for activists to attack Nike and gain some popularsupport by triggering the old, well-established image of Nike as the abusiveimperialist. Thus, although Nike has probably done enough to appease its mostimportant customer segments, it should not make the mistake ofunderestimating the influence of a relatively small group of activists again, andshould still do as much as possible to prove to them that it is doing everythingthat can be reasonably expected of them to improve the livelihoods of itsworkers in developing countries.

Nike should also make sure that it continues to receive government backingfor its FLA initiatives. If the unions are successful in pressuring the governmentto make it difficult for companies like Nike to rely on cheap foreign labourthrough the use of tariffs, then Nike could be severely damaged. In theAmerican market its competitors may well face the same problems as Nike,but globally foreign competitors would continue to use cheap labour and couldthus easily out compete Nike.


Being such a dominant player in the industry, one could argue that Nike shouldhave the power to recreate the rules of the industry to improve the plight of allof the stakeholders involved in the supply chain. However, the bottom line isthat the lives of Nike’s subcontractor employees can only be improved ifprofits are distributed differently in which case shareholders of either Nike, its

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retailers and/or its suppliers pay, or if the customer is willing to pay more forNike products.

Nike could use its marketing muscle and expertise to try to convincecustomers to pay more for “non sweatshop” sportswear. However, it isquestionable whether the Nike branding people would want to explicitlyassociate their brand with the way its products are produced. If Nikenevertheless were to succeed in convincing its customers to pay more withoutharming its ‘cool’ brand image, major competitors may not try to undercut thenew higher prices since they could also stand to gain from charging higherprices. Of course, Nike can’t formally agree with its competitors to raise pricesbecause that would amount to illegal price collusion. In fact, depending on thenature and intensity of price competition in the industry, there is no guaranteethat competitors will follow suit, and they may instead choose to capturemarket share by selling socially responsible products at the old prices. In thiscase, of course, both Nike’s communications campaign and highersubcontractor prices would have to be paid for by its shareholders. Therefore,only in the (unfortunately unlikely) case of Nike convincing its customers topay more for its products and preventing competitors from undercutting theseprices at the same time, can the situation potentially be improved for allstakeholders.

Unless, of course, shareholders themselves become more actively involved inthe way their funds are invested. If pension and insurance holders were tocollectively demand their fund trustees to invest in socially responsiblecompanies even if that means lower returns on their investments, then itwould also allow companies like Nike to improve their practices withoutrunning the risk of financial harm. Of course, no matter how dominant Nikemay be in terms of market share in its own industry, it is in no positionwhatsoever to convince individual investors across the country to demand andpay for more socially responsible investments.

Summary

In this unit we have considered the importance of corporategovernance, and have looked at recent developments in the UK in thisarea.

We have also considered business ethics; particularly relating tomanagerial mischief and moral mazes. We have seen the importance ofprioritising moral values and aligning behaviour with those values. Inaddition to complying with legal requirements there are businessbenefits arising from adopting strong business ethics. We have lookedat these benefits, and at what characterises a highly ethical organisation.

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REVIEW ACTIVITY

Consider your own organisation (private or public sector). How do you rateyour organisation’s ethical code of business conduct against the characteristicsidentified in the section ‘Characteristics of a highly ethical organisation’? Alsolook again at the benefits listed in the section ‘Two broad areas of businessethics’.

Now consider the following:

1. Does your organisation have a written code of business conduct?

2. Do employees explicitly sign up to the code of business conduct onjoining the organisation?

3. Do they annually renew their commitment (by signature) to the codeof business conduct, and agree to abide by any changes?

4. Are independent escalation, and complaints and grievancesprocedures in place?

Where your answers have been negative, what changes can be made? Will thisrequire a management culture change? Can it be accomplished within thecurrent organisational structure?



1. Ref 7, Chapter 5 Pages 201-224

2. Ref 10, Chapter 10 Pages 374-381

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Unit 7

Managing Complexity

LEARNING OUTCOMES


� Explain the usefulness of systems thinking in managing complexity.

� Apply the principles of a systems methodology to a given scenario.

� Assess the validity of the application of chaos theory toorganisations.

� Appreciate the importance of Performance Measurement.

� Apply a contemporary methodology of strategic control.

Introduction

With the tremendous change facing organisations and increasingcomplexity of relationships in an organisation, some companies arebeginning to adopt systems thinking in organisational management. Itis playing a role in organisational design, diagnosis and problemsolving.

Systems thinking can help managers look at organisations from abroader perspective and take a holistic view to help interpret patternsand events. It models an organisation as a system; an interdependentnetwork of units forming a unified pattern.

Too often in organisations, management break down complexity bydecomposing the system and dealing with its individual unitsseparately. Thus, managers have focused on and scrutinised a particularpart of the organisation (perhaps a poorly performing unit) beforemoving on to the next unit and so on. System thinking reminds us thateven if units can be ‘perfected’ by themselves this does not imply thatthey integrate well together. It encourages managers to diagnoseproblems by looking at larger patterns of interaction within theorganisation, and the process interdependencies.

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In this unit we shall look at the role systems analysis has in managingcomplexity in organisations. We shall examine the principles of systemsthinking, understand the difference between hard and softmethodologies, and focus on a contemporary soft system methodology.

Paradox of Control and Chaos

Organisations can be seen as essentially logical hierarchical structuresthat can be controlled by a series of performance measures. De Witterms it ‘the organisational leadership perspective’ and can be regardedas the extreme end of a continuum where control is exerted in asystematic fashion. A contemporary example of this is the BalancedScorecard which is outlined in the latter part of this unit.

Alternatively, organisations can be seen as complex human activitysystems that exhibit properties of compliance with complexity theory,the ideas of which were born in mathematics and science, and have beenapplied to organisations. De Wit calls this the ‘organisational dynamicsperspective’ and can be regarded as the opposing end of the control /chaos continuum.

The ideas generated by the consideration are central to some of thethemes considered in this module. The principles of emergent strategyare to an extent explained by an understanding of chaos and complexity(see Unit 2). In addition, an explanation of how a learning organisationfunctions (see Unit 8) can be achieved by an understanding of theseprinciples, as well as an ‘experimental’ view of innovation (see Unit 9).

Key opposing perspectives can be explained by the following table;

Control Chaos

Authoritarian Style Democratic Style

Top Down Bottom Up

Structural Design Self Organisation

Leadership, Vision & Skill Political, Cultural, Learning –Team Dynamics

Controllable Process Evolutionary Process

Organisation follows strategy Strategy follows organisation

In both perspectives, organisations need to be controlled – thereforechaos does not imply lack of control, rather an organisation is in aconstant state of flux. The application of complexity theory toorganisations states that simple ‘deterministic rules’ apply, i.e. there is aclear objective that the organisation (or system) is trying to achieve.

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Unit 7 – Managing Complexity Global Corporate Strategy

Understanding these rules enables control and makes the complex‘simple’.

It can be said that the dynamic of success is ‘chaotic’, i.e. turbulent innature. If this is true then long term planning is ineffective (seeMintzberg) and managers tend to develop strategies to react tounexpected and unanticipated events. This leads to emergence andorganisational learning.

Systems Thinking

A Brief History

Systems thinking is not a new subject area. It can be traced back toAristotle and Plato. However, the 1940s saw the emergence of variousformal systems thinking disciplines such as general systems theory(GST), systems analysis and systems engineering.

One of the most prominent early pioneers of GST was Ludwig VonBertalanffy. He referred to a system’s openness, i.e. the degree to whicha system interacts with its environment, – an open system takes orreceives things from its environment and/or provides things into itsenvironment. Therefore, there is clear applicability to business in termsof the recognition of the role of market forces, the supply chain,intervention by government institutions, etc.

Systems analysis grew simultaneously with systems engineeringthroughout the 1950s. Systems analysis as an approach and amethodology is closely associated with the RAND (Research andDevelopment) Corporation. It emerged from a post-war contractbetween the US Army Air Forces and the Douglas Aircraft Co. TheRAND Corporation, established in 1948, was funded by the FordFoundation and several banks. It began as a non-profit advisoryorganisation.

Over the 1950s and 1960s RAND influenced systems thinking throughits publications on strategy and methodology in systems analysis.RAND, in developing its advisory role, expected its clients to take intoaccount the social issues like welfare economics. However, themethodology was criticised due to the lack of interest in people bysystems analysts. This may explain some of the reasons why computersystems analysts took little account of the user during their analysis, asthe computer analysts adopted the RAND style methodology inignorance of this original but fundamental omission.

The Operational Research and systems ideas of the 1940s and 1950sinfluenced the way engineers tackled their problems and accordinglythere has been increasing reference to “systems engineering”. Systems

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Global Corporate Strategy Unit 7 – Managing Complexity

engineers have been involved in the provision of many civilianapplications such as communication, transportation and manufacturingsystems.

Cybernetics is another discipline that developed about the same timeand was defined as “the science of control and communication in theanimal and the machine”. It introduced control systems ideas such aspositive and negative feedback.

ACTIVITY (optional))

As background to this unit it is suggested that you source the following bookStacey, R.D. (2000) Strategic Management & Organisational Dynamics – TheChallenge of Complexity (3rd Edition) – Published by: Financial Times PrenticeHall (ISBN 0-273-64212-X), and read the following:

Chapter 8 - pages 155-166

Chapter 11 - pages 255-273

Application in the Business Context

An organisation in itself may be viewed as a system; an interdependentgroup of units forming a unified pattern to achieve its business goalsand objectives. A system has inputs, outputs, processes and outcomes. Itcan be composed of positive and negative feedback loops. If one of theunits of the system is removed or altered the nature of the entire systemis changed. This theory can be applied to organisations, and systemsthinking is influencing organisational change management.

When a complex network of work units is organised to do someactivities then the result may not provide entirely what was expected.For example, if a company was benchmarked against its competitorsand the best operational divisions in each were identified and combinedto make a new organisation, there is no guarantee that it would workany better than the original company. It is quite possible that the neworganisation could perform worse.

Boundaries and Purpose

Systems thinking suggests that a system has a boundary. Defining thisboundary in business can be problematic.

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The business modelled as a system is a “purposeful” system.“Purposeful” systems include education systems, political systems,transportation system and communication systems, etc. The purpose ofan education system may be to provide for the development of theindividual, e.g. understanding and analysis of facts, principles andtheories or the application of skills. A political system may provide forthe management of the affairs and resources of a community (local ornational).

Clearly an organisation is “purposeful” with business goals andobjectives. But who sets these goals? For whose purpose and why?These are some of the issues addressed by contemporary methodologieswhen applied to management.

In business the system boundary is often blurred. The complexity ofrelationships (supply chain, customer, stakeholders, competitors) andoften multiple roles in relationships add to the blurring. For example,companies may have employees working in Brussels monitoring theEuropean Union’s activities. Others may have a good tradingpartnership with the main companies in their supply chain, or majorcustomers, all of which blur the view of the boundary of anorganisation. There may be complexity implicit in investment options.For example, shareholders of a company may invest in their maincompetitors in order to know what they are doing. Yet this companycould be both a competitor and a main supplier or customer.

The Purpose of a System and Synergy

Systems thinkers take a holistic view of the system in question and try todetermine the emergent (the resulting synergy) purpose of the system,postponing an investigation of its sub-systems.

Systems thinking addresses some of the problems of functionalorganisations, and counters the silo phenomenon of departments andmanagers working in isolation. It encourages managers to diagnoseproblems by looking at the larger patterns of organisational interaction,rather than examining and ‘fixing’ separate, individual pieces of theorganisation.

As an example, it may be that the sales department of a company is notworking as well as desired. However, focusing solely on the salesdepartment, ‘tweaking things’ and introducing novel procedures maynot successfully increase its performance. The sales department hasvital dependencies and patterns of interaction with other units and withits supply chain. Production may not be able to meet the demand, orwarehousing of finished stock may have insufficient space, goodsinward may not be able to deal with the deliveries, or suppliers may beinadequate in terms of lead time or quantities. To compound this it islikely to be some combination of these which will ‘emerge’ over time.

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World Views

Systems thinking promotes the expression of different world-views, inorder to enrich information in the problem domain. By ‘World View’ wemean the particular perspective of an individual on the problem. (Weshall look at World Views in more detail later in this unit). In thebusiness context, one would identify the different business actors andelicit their views of the system. So for perspectives on the purpose of theorganisation itself, the following business actors may view the systemfrom different and sometimes conflicting perspectives. See Table 7.1.

The above table of world views is very broad-brush and simplistic. Inreality, capturing the business actor’s world view is not asstraightforward as it may seem. It is sometimes necessary to adoptformal methodologies (and mapping tools such as UML) to mapindividual business actor ideas into their perceived real-world. This isan iterative process for complex problems. See Figure 7.1

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Business Actor View(s)

Manager Profit-making system

Revenue-generation system

Growth-potential system

...

Customer Supply (products & services) system

Value system

...

Supplier Client system

Employee Employment system

Shareholder Profit making system

Growth-potential system

Share value management system

Table 7.1: Business Actors and Worldviews.

The Notion of Hierarchy

A system is made up of interacting parts or sub-systems that can bestudied as systems themselves. This is called the notion of hierarchy andis an advantage for the analyst because the same system's ideas can beused. Each of these sub-systems will have emergent properties that willdefine its purpose. If the purposes of any sub-system conflict with thepurpose of the overall system then the system displayssub-optimisation or ‘negative’ synergy. A paradox in systems thinkingis that any chosen system cannot be understood without knowing itsemergent characteristics and something about the features of itssub-systems. Every problem is different and the same solution cannotalways be applied to similar, or even apparently exactly similar,problems. Systems methodologies investigate each problem critically.

Implications for Business

Sharing views for clarification

The future is a mystery. Individual’ specialisations of marketing,finance, production, etc., give assurance and confidence about a“specialist” explanation of the world. Yet each is unsatisfactory inisolation. Cross-functional meetings, discussions, debates anddialogues present richer pictures of the problems faced providing amore broad brush solution than would otherwise be obtained.

How stable is an organisation?

In the context of stability and adaptability, it is necessary to introducethe concept of a homeostatic system. A homeostatic system is one whichadapts to produce a state of internal equilibrium so it can continue andprogress, i.e. it can adapt in a disturbed environment. An example is ahuman being who can walk out of centrally-heated buildings into the

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IdeasMETHODOLOGYused in

Perceivedreal world

generates

Figure 7.1: Iterative process for world views.

cold of winter and the body’s metabolism can use up existing caloriesconverting fats into sugars in order to keep the temperature at around37

oC.

Do businesses then have to emulate homeostatic systems? In a tacticalway an organisation already does so. Once aware of a particular entityin the environment causing turbulence a company finds ways tomeasure the effects and take action accordingly. The company tends toadapt or influence the causes of the turbulence, if known.Unfortunately, symptoms rather than causes are identified and thewrong things are measured in total ignorance of what should bemeasured. But, unlike the physical problems such as that bull elephantin the parable, companies are dealing with abstractions, concepts andexpectations which cannot be touched and for which there are poormeasurements.

A homeostatic system reacts to its environment and adapts to “survive”.This “reactive” approach is not strategic but tactical; strategic ideas arebased on proaction not reaction.

Professor Max Boisot, a leading figure in strategic thinking, states thatthere are two assumptions within strategic planning:

1. Environmental data can be captured and processed, and thataction can be taken faster than it changes.

2. Turbulence is only minor fluctuations in an otherwise stableenvironment which will hold up to rational analysis. That is tosay, turbulence is “noise” or “interference”, as if somewherebehind such fluctuations is an unchanging order; some universal,objective truth.

How stable then is an organisation? If it is a homeostatic system indynamic equilibrium with its environment then learning andadaptation should occur naturally, and keep the organisation in overallbalance. However, this applies, if and only if, the fluctuations arerelatively small or short-lived. There is a cybernetics principle called thelaw of requisite variety which says that rate at which a system learnsmust match or be better than the rate of change in the system’senvironment.

ACTIVITY

Chaos Theory is another discipline that is being used in organisationalmanagement. The modern notion of chaos describes irregular and highlycomplex structures in time and in space that follow deterministic laws andequations.

Read the following article about the validity of the application of chaos theoryto organisations.

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‘Strategy as order emerging from chaos’, Reading 9.2, p. 500-505 in your keytext, De Wit, B & Meyer, R

Performance Measures

We have noted that if an organisation is a homeostatic system, then itlearns and adapts to environmental changes, thereby keeping theoverall system in balance. In the context of a business, learning andadaptation will result in adjustments to business outputs such asstrategic plans, policies and operational systems.

In order to decide on appropriate performance measures, it is crucial tounderstand the complex relationships of cause and effect, delay,feedback and so on. From this understanding, key performance driverscan be identified and a performance measurement strategy devised. TheBalanced Scorecard Approach for measuring performance isparticularly pertinent in this context, and will be examined later in thisunit in the section on Strategic Control.

Corporate planning can also exploit methods such as SWOT analysis toevaluate corporate performance and the contributions of eachindividual unit against defined objectives such as profitability,market-share, deployment of knowledge assets, etc.

Following performance analysis, if problem areas are identified then theprinciples of systems thinking (e.g. openness, eliciting world views,etc.) can be applied again to the problem domain, and objectivesrevised, where appropriate.

Consolidation of Systems Thinking

Early systems thinking did not really address the social issues.Therefore the early methods are not entirely appropriate in a businesscontext. These early approaches paid little regard to human activitiesand interactions. Their objectives were relatively simple, targetingsystems composed of potential technologies, most of which werededicated to a specific task or set of tasks.

Systems with well defined objectives are classed by Checkland as“hard” systems, whereas those systems whose objectives are difficult todefine or whose end-to-be-achieved cannot be taken as given, arereferred to as “soft” systems. Human activity systems are such softsystems.

If sub-systems are combined, emergent properties are produced whichadd or detract value (called sub-optimality in hard systems thinking

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and negative synergy by some soft systems thinkers) from the purposeof the whole. If we wish to reduce sub-optimality, or negative synergy,the sub-systems’ purposes must in some way be congruent with that ofthe whole system.

In business one fundamental resource, itself a soft system, is a person.Individual views or discipline-oriented views are somewhat blinkeredand narrow in scope. The shared view provides a richer picture. If thereis dialogue rather than a missive about the systems purpose; if theindividuals involved in the dialogue participate in the derivation of thesystems purpose, perhaps negative synergy will be reduced, perhapsthe emergent properties of the whole will be value added, providingcreative advantage or positive synergy. As learning or adaptive systemsappear to be of a higher order than others, then the more the people inthe organisation continue learning, the more likely the emergentpurpose of the business will reflect this. If every employee “sees” theturbulence in a learned way, the more likely, through dialogue, thecompany will clarify its position with regard to the turbulence andprogress.

As mentioned earlier, soft systems thinking focuses on human activitysystems. The problem, recognised by Checkland and so many others, isthat each person has his/her own world view or “weltanschauung” ofthe problem area and that such views must be shared in an open way inorder that a deeper understanding of the problem can be realised.

Soft Systems Methodology (SSM)

SSM has been developed at Lancaster University over the last 25 years,through action research. Professor Peter Checkland is the best knownmember of the team in the Department of Systems and InformationManagement involved. As more experience was gained dealing withdifferent sorts of problem situations, the learning was analysed andincorporated into the methodology. This has led to a genericmethodology that can be adapted to any given situation.

SSM deals with problem formulation at the strategic level. It partly aimsto structure previously unstructured situations, rather than to solvewell-structured problems. It deals with “fuzzy” problem situations –situations where people are viewed not as passive objects, but as activesubjects, where objectives are unclear or where multiple objectives mayexist.

SSM is concerned with human activity systems (HAS). These aredifferent from natural systems (physical systems), or designed systems(these can be both physical, such as bridges, and abstract, such asmathematical). A HAS is defined as a collection of activities, in whichpeople are purposefully engaged and the relationships between theactivities. The boundary around a system is drawn to encompass that

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group of activities that would give the system some emergentproperties. SSM does not attempt to analyse sections of the whole thatare considered to be particularly relevant to the study, but uses theconcept of the whole being more than the sum of its parts. Therefore,once the emergent properties are identified, the set of activities requiredbecomes clear. If just one activity is removed from the system, theemergent properties are lost.

The Checkland methodology, or the seven-stage model, is consideredby most people to be the SSM. However, SSM covers a range ofmethodologies developed to deal with different situations.

The Checkland Methodology

The seven stages are:

1. The problem situation unstructured

2. The problems situation expressed

3. Root definitions of relevant systems

4. Deriving conceptual models

5. Comparing conceptual models with the “real” world

6. Defining feasible, desirable changes

7. Taking action

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1Problem situation

unstructured

2Problem situation

expressed

3Root definition ofrelevant systems

6Change and action

to improve

5Real/systems

world comparison

4Conceptual models

REAL WORLD

SYSTEM WORLD

Source: Patching 1990

Figure 7.2: The Checkland Methodology.

Stages 1,2,5,6 and 7 can be regarded as working in the real world, whilestages 3 and 4 can be considered to be systems thinking about the realworld. Refer to Figure 7.2.

Let us now consider the various stages:

Stages One and Two

The problem situation can be expressed as a “rich picture”. The idea is torepresent pictorially all the relevant information and relationships. Thisis simply to aid the modeller or consultant to gain an understanding ofthe situation. The rich picture should not be used as a tool tocommunicate with the client. Where there is a team of consultants, therich picture is a way of consolidating understanding of the problemsituation. This reduces the possibility of opposing perceptions of thereal world hindering the modelling process later on. The rich picturewill reveal one or more HAS.

Stage Three

“Root definitions” are constructed for the relevant HAS identified instages one and two. The root definition should encompass the emergentproperties of the system in question. To define the emergent propertiesone needs to consider the mnemonic CATWOE:

C: customer (people affected by the system, beneficiaries or victims);

A: actor (people participating in the system);

T: transformation (the core of the root definition – the transformationcarried out by the system);

W: Weltanschauung (“world view”);

O: ownership (the person(s) with the authority to decide on the future ofthe system);

E: environment (the wider system).

The CATWOE mnemonic can be used as a checklist to ensure that theroot definition is complete. Alternatively, the root definition can beformulated from the components of the CATWOE mnemonic. Eitherway, the root definition will be a short paragraph that will contain all thenecessary information to describe the system. Several root definitionscan be constructed for each of the relevant HAS identified. Each rootdefinition will encompass a different “world view”. Differentindividuals will perceive the same event in different ways according totheir view of the world, based on their experiences, personality andsituation. These different views result in inferences being made that are

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not explicit. However, these different views from different individualsmust be appreciated and incorporated where possible.

Stage Four

Each root definition will result in a conceptual model. The conceptualmodel identifies the minimum necessary activities for that HAS. Inaddition, it represents the relationships between the activities. Theconceptual model must be derived from the root definition alone. It is anintellectual model and must not be clouded by knowledge of the “real”world. All of the elements of the CATWOE mnemonic must be includedsomewhere in the conceptual model, otherwise the conceptual model isincomplete. It should not be possible to take out words from the rootdefinition without affecting the conceptual model.

Stage Five and Six

The conceptual model identifies which activities need to be included inthat particular HAS. It is not concerned with how these activities will becarried out. The conceptual model will be compared with the real worldto highlight possible changes in the real world. It may be that activitiesin the conceptual model do not exist in the real world. This would thenbe a recommendation for change. Differences between the two mustnever result in a change to the conceptual model. The conceptual model,if constructed correctly, encompasses all the activities necessary for theemergent properties of the system. Removal of activities from theconceptual model would result in those emergent properties being lost.Conversely, it may be the case that activities appear in the real worldthat do not fit into the conceptual model. These activities are eitherunnecessary, or are included in the conceptual model in a differentform.

Stage Seven

Recommendations for change will be implemented. It is important toappreciate that once these changes have been implemented, theproblem situation will be modified. In other words, the process iscyclical. It is recognised that nothing remains static and that mereintervention by the consultant will affect the organisation.

ACTIVITY (including case study)

Go to the following website and read the report on SSM by a team from theUniversity of Calgary:

http://sern.ucalgary.ca/courses/seng/613/F97/grp4/ssmfinal.html

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The article includes details of a case study which Checkland took part in, withthe Shell Group. It led to a major rethink of one of Shell’s Manufacturingfunctions in the late 1980s.

SSM Summary

SSM deals with problems of a fuzzy nature where objectives are unclear,and where there may be several different perceptions of the problem.Indeed, SSM can be applied where there is simply an area of concern,where no particular problem has been identified, but where it is felt thatsome improvement can be achieved. SSM does not aim to solve theproblems in one fell swoop but to make incremental improvements.

SSM is often used as a front end to a hard methodology. Hard systemsassume that the problem can be clearly defined with an agreed goal andthat a standard format can be applied to reach a solution. SSMrecognises that different individuals will have different perceptions ofthe situation and different preferable outcomes. Trying to work throughthese differences from the outset will go some way towards ensuringthat the results of the intervention will be acceptable to all partiesconcerned. Hard methodologies, where the problem is assumed to beclearly defined, and where the individuals who will be affected have nomeans of involvement in the solution process, often result in resentmentand rejection of the solution.

Using SSM as a front end provides a means for as many individuals whohave an interest in the outcome as possible, to express their perceptionsof the area of concern. These concerns can then be accommodated in thedefinition of the problem area, before a hard methodology is applied.SSM has been used in a variety of organisations ranging from acompany dealing with food products to British Airways. It has beenused to assist in a range of problem situations, such as derivingrecommendations for improvement, reorganisation and role analysis.Given the flexibility of the methodology, it can be seen that the range ofsituations to which SSM can be applied is vast. The only limitations ofSSM are the capability and adaptability to new situations, of theconsultant.

Strategic Control?

Strategic control is the process by which managers monitor the ongoingactivities of an organisation and its members to evaluate whetheractivities are being performed efficiently and effectively, and to takecorrective action accordingly. Strategic control is also about keepingemployees motivated, focused on the important problems confronting

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an organisation now and in the future, and working together to findsolutions to improve the corporation’s performance over time.

ACTIVITY

However well managed an organisation may be, for effective strategic control,it is also necessary from time to time to conduct an assessment of anorganisation’s state of health. This is necessary to identify the organisation’sstrengths and weaknesses and uncover information that may be essential forthe organisation’s strategy.

Read the following article on the web (by David Hussey, Visiting professor,Nottingham Business School) about an approach to company analysis:

http://www.environmental-expert.com/magazine/wiley/1086-1718/pdf5.pdf

The Balanced Scorecard Approach

Traditionally strategic managers have relied on financial measures ofperformance such as profit and return on investment to evaluateorganisational performance. The balanced scorecard approachrecognises that financial information, though important, is not enoughby itself. The building blocks of competitive advantage, need to bemeasured. The building blocks of competitive advantage are:

� Efficiency.

� Quality.

� Innovation.

� Responsiveness.

Measuring the above, informs managers of how the organisation islikely to perform in the future. Whereas a focus purely on financialinformation, informs managers of the results of decisions that they havealready taken.

R. S. Kaplan and D. P. Norton were the developers of this approach andthey have described it as such:

‘Think of the balanced scorecard as the dials and indicatorsin an airplane cockpit. For the complex task of navigatingand flying an airplane, pilots need detailed informationabout many aspects of the flight. They need information onfuel, airspeed, altitude, destination and other indicators that

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summarise the current and predicted environment. Relianceon one instrument can be fatal. Similarly, the complexity ofmanaging an organisation today requires that managers beable to view performance in several areas simultaneously.’

In the context of the balanced scorecard approach, the building blocks ofcompetitive advantage are controlled and measured in this way:

1. Efficiency: how efficiently resources are used. There must be amanagement control system that allows the measure ofproductivity. Efficiency is measured by the level of productioncosts, number, grade and rates of human resources used, numberof hours needed to produce a product or deliver service, the costof raw materials, etc. It compares the units of input (resources,raw materials etc) vs. the units of output (e.g. product, servicesetc).

2. Quality: Quality is now recognised as a key competitive factor.Managers must be able to measure quality in the form of thenumber of rejects, errors, software bugs, the number of defectiveproducts returned from the customer, product reliability overtime and customer satisfaction. Focusing on and measuringquality promotes continuous improvements.

3. Innovation: Innovation can be measured by the number of newproducts introduced, the time taken to develop the nextgeneration of new products in comparison with the competition,and the expense and cost of product development. Successfulinnovation occurs when managers create an organisationalsetting in which employees are empowered to be creative, and inwhich authority is decentralised to employees so that they feelable to innovate and take risks.

4. Responsiveness to customers: responsiveness can be measuredby the number of repeat customers, the level of on-time deliveryto customers, and level of customer service. Control systems toallow managers to evaluate how employees interact withcustomers can help. Monitoring employees’performance/behaviour with customers can help identify areasfor education and training. Furthermore, employees who knowtheir behaviour is being monitored have more incentive to behelpful and consistent in the way they act towards customers.

The above competitive advantage measures, together with financialmeasures such as cash flow, quarterly sales growth, increase in marketshare, and return on investment or equity, give a complete picture oforganisational performance.

Based on the complete set of measures in the balanced scorecard,strategic managers are in a good position to re-evaluate the company’smission and goals. They can also take corrective action or exploit newopportunities by changing the organisation’s strategy and structure –which is the purpose of strategic control.

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Summary

In this unit we have looked at the role of systems thinking in managingorganisational complexity. We have considered the principles ofsystems methodologies, and have looked at its applicability in abusiness context. We have noted the differences between hard and softmethodologies and have examined in detail the ChecklandMethodology.

Finally we looked at strategic control and examined the importance ofperformance measurements to judge the health of an organisation, andfocused on a contemporary methodology of strategic control, thebalanced scorecard method.

REVIEW ACTIVITY

Now turn your attention to the organisation you work for and focus on itsculture.

1. From what you have learned, can systems thinking be appliedsuccessfully in your organisation? Elaborate.

2. If your answer to 1 is ‘Yes’,

� What benefits might you achieve? How will you measuresuccess or failure?

If your answer to 1 is ‘No’,

� Why might it not work?

REVIEW ACTIVITY FEEDBACK

It all depends on the culture of your organisation. If you have a collaborationculture then the deployment of SSM could be a natural part of organisationalmanagement. If your organisation exhibits a Control Culture (“stick with theplan!”), it is unlikely to succeed. On the other hand, one could argue thatattempts at deploying SSM in itself could bring about positive change in controltype cultures.

Critics of the system's methodologies express concerns that the open-endednature of the methodology makes it difficult to manage and measure success.

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For example, such a methodology does not lend itself to traditional projectmanagement practices. Checkland himself stated that there is no way of tellingwhether a SSM project is a success or failure. Most companies will not be ableto justify costly endeavours where there are no clear success criteria.

Another criticism of SSM is that it ignores the issues of power and hierarchywithin an organisation. SSM assumes that managers and employees alike canopenly discuss and influence organisational issues. This is rarely the case inmost organisations. Thus, critics from the business world discard SSM on thebasis that its values of openness and equality are unrealistic in the real world,and confine systems thinking to academic analysis.



1. Stacey, R.D. (2000) Strategic Management & OrganisationalDynamics – The Challenge of Complexity (3rd Edition) –Published by: Financial Times Prentice Hall (ISBN0-273-64212-X), Chapter 8 – pages 155-166, Chapter 11 – pages255-273

2. Patching D. (1990) Practical Soft Systems Analysis -ISBN0-273-03237-2

3. Flood R.L. & Carson E.R. (1993) Dealing With Complexity – AnIntroduction to the Theory and Application of Systems Science(ISBN 0-306-44299-X)

4. Flood R.L. & Jackson M.C (1991) Creative Problem Solving –Total Systems Intervention (ISBN 0-471-93052-0)

* Highly recommended

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Unit 8

Knowledge Management

LEARNING OUTCOMES


� Compare opposing theoretical concepts regarding knowledge inorganisations.

� Understand the principles of knowledge transfer in organisations.

� Appraise the methods available to apply knowledge managementprinciples.

Introduction

The global business environment is changing rapidly. As organisationsgrow in size, complexity and geographical distribution, intellectualcapital is becoming an increasingly important asset of the enterprise. Bymanaging its knowledge assets astutely, and rapidly deployingknowledge gained in one geographical area or one industry acrossanother, corporations can improve their competitiveness, andadaptability. Re-cycling knowledge know-how is now key tocompetitiveness, particularly in the knowledge economy. In somesectors (e.g. professional services) knowledge management is a matterof survival.

In practical terms, the focus on knowledge management can beattributed to two developments. Firstly, capital and labour-intensiveindustries in developed economies have continued to decline. Secondly,the relative importance of technology and information-intensiveindustries has increased. Rapid advances in information technologyhave enabled companies in even the most traditional industries todevelop sophisticated systems for capturing new sources of informationand disseminating and exploiting this information more effectively.

When defining knowledge management, some emphasise the humaninteraction and psychological factors that impact knowledge sharing,whereas others stress the enabling infrastructure and knowledgemanagement system. A successful deployment of knowledgemanagement must recognise that views of knowledge are

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fundamentally human views. People are different from one another,and exhibit different temperaments. Some of these differences areprofound and influence collaboration and knowledge sharing. Buildingintellectual capital is based on the existence of communication channelsbetween people, on relationships that build trust and a sense of mutualobligation, and on a common language and context.

Thus, it is vital that organisations foster a collaborative culture forsuccess. Teamwork over individual excellence should be rewarded.However, it is equally important that a corporation take a strongprocess perspective in establishing knowledge management, and investin the appropriate technology to facilitate the process; knowledgecreation, collaboration, sharing and deployment. Enabling technologyis particularly critical for geographically distributed organisations,where opportunities for face-to-face interaction is limited.

In this unit we shall look at some of the theoretical concepts relating toknowledge management, examine the principles of knowledge transferand then focus on the methods and practical issues relating toknowledge management.

ACTIVITY

Now, as background to this unit, read the following from your key text, DeWit, B & Meyer, R

1. Reading 9.3, ‘Building learning organisations’, p 505-512

2. Reading 9.4, ‘The knowledge-doing gap’, p. 512 – 525

Theoretical Concepts on Knowledge

In theoretical terms, two developments have contributed to anincreased emphasis on knowledge in looking at strategic management:

� The popularity of the resource-based view of thecompany: This clearly identifies knowledge as potentiallythe primary source of sustainable competitive advantage.

� The development of post-modern perspectives onorganisations, which have challenged fundamentalassumptions about the nature and meaning of knowledgewithin companies, industries and society as a whole.

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Unit 8 – Knowledge Management Global Corporate Strategy

Resource-based view

A resource-based perspective highlights the need for a fit between theexternal market context and its internal capabilities. In accordance withthis, a company’s competitive advantage derives from its ability toassemble and exploit a combination of resources.

Competitive advantage is achieved by developing existing resourcesand creating new resources in response to changing market conditions.Writers like Robert Grant argue that knowledge represents the mostimportant value-creating asset. The primary function of the company isto create conditions under which many individuals can integratespecialist knowledge in order to produce goods and services. Theresource-based view, therefore, suggests that knowledge, like any otherasset, can be stored, measured and moved around an organisation.

Post-modern view

Post-modern perspectives on organisations challenge theresource-based assumption. Writers like Frank Blackler argue thatknowledge cannot exist in any absolute or objective sense.

The recognition of knowledge and how it is applied is determined bythe social and organisation context in which a company operates. Aninnovative proposal, which may be perfectly valid to an externalobserver may be rejected by those inside the organisation because it failsto conform to their mental model of what constitutes valid or usefulknowledge.

If knowledge is a social construct, i.e. it emerges through interaction, itfollows that it cannot be formally managed. Like culture, knowledgeexists only in an abstract form within organisations. Also, it is affectedby managerial action and its nature can change only gradually overtime, through a process of interaction between the various individualswithin the organisation.

There is thus a debate concerning two opposing theoreticalperspectives.

VIRTUAL CAMPUS

Taking into account your own working experience and sphere of activity, doyou support the resource-based view or post-modern view? Debate yourviews (relating it to using your work situation) with others on the VirtualCampus.

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Global Corporate Strategy Unit 8 – Knowledge Management

ACTIVITY

Here is a quote from Tony Blair from his speech at the Lord Mayors Banquet,Guildhall, London. November 1998.

‘The ambition is to turn Britain into the leading knowledge-basedeconomy in the world. That is our future: a knowledge-based,creative economy. In global markets, where products can bemade anywhere and shipped anywhere, in which productiontechnologies can soon be copied, we cannot base our futureprosperity on the traditional building blocks of the old industrialeconomy: raw materials, land, machinery, cheap labour. Wemust base our competitiveness on distinctive assets which ourcompetitors cannot imitate – our know-how, creativity andtalent.’

What do you consider to be the assets of your company? Does intellectualcapital (know-how) currently feature as an important asset? Can your workingpractices and output turnaround be improved by re-cycling of knowledge (orbetter re-cycling of knowledge)? What opportunities does knowledgemanagement present for your company and what are the barriers toimplementation/wider take-up?

Knowledge

What is knowledge?

In the context of strategic management, it is easier to understandknowledge in terms of what it is not. It is not data and it is notinformation. Data are objective facts. Data becomes information when itis categorised, analysed, interpreted, summarised and placed in context,i.e. given relevance and purpose. Information develops into knowledgewhen it is used to make comparisons, assess consequences, establishconnections and engage in a dialogue. Knowledge can be seen asinformation combined with experience, judgement, intuition andvalues.

See Figure 8.1 for a pyramid view on data, information and knowledge.Knowledge is at the top of the value chain. Data is at the bottom. Data isessentially meaningless on its own. It is raw data. Reasoning, perceptionand interpretation are critical in transforming data into information. Inaddition to reasoning, perception and interpretation, decision making(using experience, judgement, intuition and values) is key to thetransformation of information into knowledge.

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One must be careful not to confuse knowledge management systemswith data and information management systems. The latter are merelyefficient mechanisms for capturing, organising and retrievinginformation. A true knowledge management system must capture,organise and retrieve information, but also systematically createassociations between corporate expertise and information resources,personalise and organise knowledge for individuals and communities,and provide a ‘place’ (virtual) for teams to work, make decisions andact.

KEY POINT

Knowledge is the result of deciphering and attaching meaning to facts andinformation.

Knowledge management is the capability of an organisation to create, capture,combine and share knowledge amongst its members. It is the process by whichan organisation generates value by using its intellectual assets.

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Knowledge

Information

Data

ReasoningPerception

InterpretationDecision making

ReasoningPerception

Interpretation

Dat

avo

lum

es Value

chain

Figure 8.1: Pyramid view on knowledge, information and data.

The nature of knowledge

An individual’s knowledge base is like an iceberg. Most knowledge ishidden below the surface and can be divided into two types;

� A limited stock of explicit knowledge, which is easy toarticulate to others, e.g. books read, reports written,advice given fall into this category.

� The majority is tacit knowledge, which cannot be easilyarticulated to others, e.g. A green fingered gardenercannot explain to a novice precisely why his plantsalways thrive.

Tacit knowledge only transfers through observation and practice.Traditional craft apprenticeships systems recognise this. However,much knowledge remains tacit because no attempt has been made tomake it explicit. It is this area that presents the greatest opportunity forknowledge management within organisations.

The primary goal of knowledge management systems is to identify thevaluable knowledge that resides within individuals and disseminate itthroughout the organisation. However, this seemingly straightforwardprocess is in practice complex and can be fraught with difficulties.

Knowledge problems

Knowledge represents a source of power for an individual. Sharingvaluable knowledge with colleagues is often seen as risking reduction ofvalue of that individual to the company. There are, thus, psychologicalissues relating to knowledge management. Davenport and Prusakargue there are three conditions under which an individual would agreeto share knowledge.

� Reciprocity: Will an individual receive valuableknowledge in return, either now or in the future?

� Repute: An individual will need to be certain that thesource of knowledge will be recognised and others willnot claim the credit.

� Altruism (though the motives may be more akin toself-gratification): Individuals find some subjectsfascinating and want to talk to others about them.

Davenport and Prusak’s analysis leads them to argue that there is ineffect, an internal market for knowledge. Knowledge is exchangedbetween buyers and sellers, with reciprocity, repute and altruismfunctioning as payment mechanisms. Trust is an essential condition forthe smooth functioning of the market. This trust can exist at an

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individual level, through close working relationships betweencolleagues, or at an organisational level, by the creation of a culturalcontext which encourages and rewards knowledge sharing anddiscourages and penalises knowledge hoarding.

Noting the above issues, for successful deployment of knowledgemanagement in organisations, the right collaborative culture must befostered, the individual contributor of intellectual capital recognised,and the reward system must reflect a high focus on knowledge sharing.Leading knowledge-based companies include the contribution ofintellectual capital as part of the employee’s business objectives.

Barriers to understanding

It is easiest to learn about things that we already know. It is very difficultto learn from an expert if your do not have a basic grounding in thetopic. The expert must take time to explain the context and translate thejargon. The barriers to communication in organisations that arisebetween departments typify this problem. These problems can beascribed to differences in the content of the knowledge bases. Toovercome these problems, particularly in larger global organisationsengaged in diverse activities, it is necessary to establish communities ofpractice based on the core competencies of the organisation.

Knowledge Transfer

Much can be done within an organisation to encourage knowledgetransfer. IT-based frameworks (e.g. Lotus Knowledge DiscoverySystem) provide the essential infrastructure for knowledgemanagement, but to be used effectively and achieve widespreadtake-up, other conditions are necessary to establish:

1. Trust – Face-to-face contact is important when seeking to buildstrong interpersonal relationships.

2. Time – exchanging information at speed may be efficient, buttacit knowledge cannot be discovered, articulated anddisseminated in a hurry.

3. Creating a common language for talking about knowledge,encouraging staff to think and talk about what they know andwhat they need to know

The first two points pose particular challenges for large, diverse,globally dispersed organisations. Establishing communities of practice(based on core competencies) is critical. Examples of such communitiesof practice might be Researchers, Project Managers, QualityChampions, Programmers, Research Chemists, Marketeers in aparticular geography, etc. The precise communities of practice would

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depend on the sphere of activity of the corporation. It is then essentialthat people within communities of practice have the opportunity tomeet and share knowledge, supported by the technical infrastructure,but also be able to share knowledge which technology cannot at presentcapture. Thus knowledge sharing through informal and formalgatherings, seminars, e-learning initiatives, networking and mentoringis critical.

In the context of knowledge transfer, it should also be noted that it is notenough simply to manage existing knowledge. Competitive advantageis achieved when organisations adapt and evolve continuously inresponse to changing market conditions. Knowledge management canplay a key role in this. The competitive edge arises when companiesleverage knowledge, not just existing, but new knowledge across theglobal organisation; across horizontal and vertical divides, in a rapid,efficient and easy-to-use, codified form. Re-use of intellectual capitalacross geographies, industries and functions can yield enormousbusiness benefit.

Nonaka and Takeuchi in their book The Knowledge Creating Company,identify four interrelated processes by which knowledge flows aroundthe organisation and transmutes into different forms.

1. Socialisation is the process of communicating tacit knowledge toa broader organisational context. Individuals share experiences,demonstrate skills and model behaviour in such a way that theycan be observed and copied by others within the organisation.

2. Externalisation is the process of converting tacit knowledge intoexplicit concepts, e.g. the simplification of complex concepts in ahighly simplified form using models. Externalisation may occurat an individual level or at a collective level. Once an individualhas externalised tacit knowledge, it is more easily combined withthe knowledge of others.

3. Combination is the process of analysing, categorising andintegrating the explicit knowledge of a set of individuals in orderto create new explicit knowledge, which can be disseminatedmore widely within the organisation.

4. The above processes explain how individual tacit knowledgeflows until it is widely disseminated around the organisation, butit does not fully explain how new knowledge is created. The finallink in the process is internalisation, whereby individuals absorbexplicit knowledge to enable the development of new forms oftacit knowledge.

How can knowledge creation be encouraged? Nonaka and Takeuchiidentify five key conditions;

� Senior management must be committed to accumulating,exploiting and renewing the knowledge base within the

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organisation and be able to create management systemsthat will facilitate this process.

� As new ideas first develop at an individual level, anindividual must be given scope to follow initiatives andexplore unexpected opportunities that emerge.

� This process of exploration can be further encouraged by‘creative chaos’ where flux and crisis causereconsideration of established precepts at a fundamentallevel.

� Knowledge should not be rationed (or hoarded).Opportunities should actively be provided for evenunrelated individuals to exchange knowledge.

� In order to respond creatively to changing conditions, anorganisation’s internal diversity must match the varietyand complexity of the external environment.

A drawback is that the knowledge creating company Nonaka andTakeuchi describe is often far removed from organisational reality, e.g.chaos and crisis are just as likely to stifle as to promote creativity byprovoking anxiety and insecurity.

ACTIVITY

Identify the types of intellectual capital within your organisation.

ACTIVITY FEEDBACK

Intellectual capital is essentially any intangible asset that has potential forre-use. The following list gives you an idea of what can be shared.

� Sales proposals.

� Market research.

� Client information.

� Competitor information.

� Contracts.

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� Case studies.

� Methodologies.

� Project plans.

� Client deliverables (with confidentiality safe-guards).

� Interpretation methods.

� White papers.

Practical steps to promote KnowledgeManagement

In the previous sections we looked at the key issues relating toknowledge management – but from a somewhat theoreticalperspective. How do issues of trust, time and common language getaddressed? What practical steps can be taken to implement knowledgemanagement and leverage the corporation’s intellectual capital?

It is important to emphasis that knowledge management must be at theheart of a company’s strategy if it is to work. A collaboration culturemust be promoted from the top of the company. Senior executivesshould be accountable and rewarded for encouraging knowledgesharing and knowledge enabling.

Assessment of current capability

Wherever you are in the deployment of knowledge management, it isimportant at regular intervals to evaluate your knowledge managementcapability, and benchmark against best practices. The company shouldthen put in place a roadmap to target areas of weakness.

A practical tool for such an assessment is to score your capability using aknowledge management spider diagram (see Figure 8.2), with thefollowing dimensions:

1. Company strategy: Score the extent to which knowledgemanagement is incorporated into strategy and business andoperational plans. Does knowledge management feature incompany-wide strategy or only in specific strategies, e.g.marketing? Is a strategy in place to address knowledgemanagement process, issues of culture and technology? Is there

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knowledge collaboration externally – across stakeholders(customers, supply chain) and business partners (e.g. throughstrategic alliances)?

2. Collaboration culture: Company-wide awareness of knowledgemanagement, and level of integration into the business. Iscollaboration, teamwork and knowledge sharing built into theethos of the company? What is the level of senior managementsupport? Are there senior roles in knowledge management?

3. Knowledge processes: Is there a formal and unambiguousprocess for the creation/acquisition, organisation/storage,distribution, application, maintenance and QA of knowledgeassets? Furthermore, to what extent have knowledgemanagement practices been incorporated into core businessprocesses, e.g. when selecting a project managementmethodology or developing project plans do Project Managersre-invent the wheel each time, or does the business processrequire them to check the Knowledge Management System first?

4. Enabling Technology: What are the current technologies usedfor knowledge sharing? If there is no specialist KnowledgeManagement System (e.g. Lotus Knowledge Discover System), doyou have other enabling technologies such as data-warehousing,business intelligence, data mining, GroupWare and messaging,electronic data management, workflow management, web-basedtechnologies in the company? Do you have a corporate intranet?

5. Knowledge Bases: To what extent have knowledge sources(explicit and tacit) been identified, captured and indexed?

6. Knowledge Access: What level of accessibility is there to theknowledge sources? How easy is to search for information? Whataccess rights and security measures are in place?

7. Knowledge Quality: What Quality Assurance procedure arethere in place? Are there reviews and sign-offs prior tointellectual capital being made ‘public’ on the system? Whatprocedures are in place to maintain up-to-date and relevantknowledge? Is knowledge catalogued by business area, and isthere a flag to indicate importance/relevance.

You will note that the dimensions of the Web Diagram are theknowledge management success factors we identified during the courseof the earlier sections. It is suggested that a company score each of thedimensions against a 10-point scale. This can be done against bestindustry practices, so that a score of ten relates to best practices. A scoreof zero will apply if that particular dimension does not feature at all inthe corporation. See Figure 8.2 for an example of a knowledgemanagement web diagram for a company. From a strategy perspectiveit is also useful to score your main competitors on the web diagram andthen identify weaknesses/strengths. Additionally strategic partners canbe scored. It may be the case that where the corporation scores weakly, a

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strategic partner scores highly. There are, therefore, wider collaborationopportunities across strategic alliances.

Road Map for Improvements

Having assessed your current knowledge management capabilities, apicture emerges of the gaps in access to knowledge, cultural factors andenabling technology. Based on the gaps identified, particularly incomparison to best practices and also to the competition, theorganisation can then develop a picture of where it wants to be, and inwhat time-scales. A road map should then be prepared to get theorganisation to the desired state. The ‘where you want to be’ state mayalso be mapped on the web diagram.

For those organisations relatively immature in the deployment ofknowledge management, the following steps are recommended:

� Identify communities of practice or teams based on corecompetencies. For smaller organisations, business unitswill suffice as ‘communities’.

� Identify a sponsor (senior executive) for each community,and nominate leaders for each community.

� Train leaders in generic KM practices (e.g. virtualteamworking, knowledge creation, sharing).

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1010

10

1010

10

10

Company strategy

Knowledge quality

Knowledge access

Knowledge bases

Enabling technology

Knowledge processes

Collaboration culture

Competitor'sKM capability

Corporation'sKM capability

0

Figure 8.2: Knowledge Management Web Diagrams.

� Facilitate socialisation and transitional encounters(meetings, seminars, workshops, etc) with informalagenda to allow tacit knowledge to be shared.

� Build, manage and maintain a network of staff with deepskills in specified subject matters.

� Define the KM process (covering knowledgecreation/acquisition, organisation/storage, distribution,application, maintenance and QA). Define access(security, rights) model.

� Evaluate and implement enabling technology.

� Define categories and populate with generic information,e.g. yellow pages (who is who for what).

� Train all staff in KM process, KM system and knowledgesharing.

� Raise team awareness of contexts through presentations,visits, education, etc.

� Use knowledge proponents/developers (experts whocreate new content on dedicated, short-term assignments)in early stages of deployment.

� Promote widespread deployment and publicise earlysuccesses.

� Recognise and reward knowledge contributors.

Ref: The Challenge of Managing Knowledge by Laura Empson –Financial Times 4th October 1999

ACTIVITY

Research the application, impact and business benefits of knowledgemanagement by reading some of the articles on knowledge management on theINSEAD website:

http://knowledge.insead.fr/

Go to the home page and select ‘Knowldege Management’ under the menu‘Themes’. (Registration to the website is free of charge).

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CASE STUDY 1 – Kao Corporation

The next case study is case study 6, (“Kao Corporation”) on pages 721-737 ofyour key text, De Wit & Meyer.

Case Synopsis

Kao is Japan’s market leader in detergents and shampoos, and runner up indisposable diapers and cosmetics. In 2002 the company had sales of Y865 billion(more than US$ 6.3 billion), largely in Japan and South East Asia. However,during the 1980s and 1990s Kao has acquired a number of companies in the USand Europe and has committed itself to further internationalisation. Its strategicintent is to belong to the three or four global detergent/cosmetics/personal carecompanies that they believe will eventually survive.

Kao is particularly interesting due to its corporate philosophy. The companybelieves that competitive advantage stems from the superior attainment andusage of information. Therefore information must flow freely throughout theorganisation and all individuals must be equipped to continually learn from theinformation obtained. This concept of a “learning organisation” is achieved byhaving a very flat organisational structure, an open, non-hierarchical culture,broad participation in strategy development, extensive information systemsand a state of mind that emphasises that learning is an essential never-endingprocess. The strategy process can be characterised as continual, largelyinformal, participatory, flexible and incremental.

The key question raised by the case is how this strategy process and thecompany’s learning ability can be maintained as they further internationalise.The company will grow in size and complexity, while more nationalities willbecome involved in strategy development. The company must learn how toremain a learning company.

Point to Highlight:

(extracted from Teaching Note 6, Kao Corporation, Bob de Wit, Ron Meyer andHenk van den Berg)

Note this case touches on subjects wider than just knowledge management,and the learning organisation. It also touches on the area of strategy formationand globalisation (linking with Units 1, 2 and 3).

Used in conjunction with chapter 3 of your key text, De Wit and Meyer, thiscase can be used to understand the following key points:

� The building of a learning organisation. This case describes themanner in which Kao has been able to transform itself into alearning organisation. The company’s structure, culture,leadership and systems are described, giving insight into thecircumstances that are necessary to create an organisation

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capable of continual learning. (link to Reading 3.2, Quinn, andReading 9.3, Senge, of your key text, De Wit and Meyer)

� The role of leadership in a learning organisation. Of particular interestin the Kao case is the role of the CEO, Dr. Maruta. He does notplay the traditional role of master planner and architect ofimplementation (Commander Approach or Change Approach). Onthe contrary, he creates the circumstances under which ideas andstrategies can arise and grow within the organisation (CresciveApproach). Maruta’s leadership style demonstrates the influence ofleadership on learning. More broadly, the impact of variousleadership approaches on the strategy formation process can beexplored. (link to Reading 3.2, Quinn, and Reading 9.3, Senge, ofyour key text, De Wit and Meyer)

� Learning as part of the strategy formation process. Kao’s focus onlearning is an integral part of their thinking about how to managethe strategy formation process. This case illudes to the link betweenlearning and strategy formation.

� Advantages and disadvantages of the incrementalist perspective. Kao’sstrategy formation approach is strongly inclined towards theincrementalist perspective. This case highlights the strengths andweaknesses of incrementalist approaches to strategy formation.(Link to all readings.)

Questions:

1. What is learning and what is a learning organisation according to Kao?How is organisational learning different from, for instance, a personlearning from reading a book?

2. How has Kao been able to build a learning organisation? What is theircorporate philosophy and what type of structure, culture, systems andleadership roles has the company developed to become a learningorganisation?

3. How does Kao go about forming strategy? What are the strategyformation process’s main features?

4. What are the advantages and disadvantages of Kao’s current strategyformation process?

5. How would Kao need to adapt or change its strategy formationprocess to accommodate further internationalisation? What type ofaction would you recommend? (You may also wish to refer to Unit 3,Globalisation, before responding to this question)

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CASE STUDY FEEDBACK


At Kao learning is simply defined as gaining a better understanding of the truth.More specifically, it is believed that organisational learning has the followingcharacteristics:

� Continual. Learning does not take place at fixed moments, butis viewed as “a frame of mind, a daily matter.” In this way,every activity can lead to further learning.

� Collective. Learning is not an activity that an employee carriesout individually behind a desk, but a process that takes placethrough open discussions and the investigation of concretebusiness ideas. In Kao, everyone within the organisation isexpected to participate in this joint learning process, helpingnot only himself to learn, but also all others, whether aboveand below him.

� Intuitive. Learning is also viewed as largely intuitive – by doingand discussing, managers often unknowingly internaliseknowledge (the Zen Buddhists speak of kangyo ichijo,internalised intuition). This places an important emphasis onthe development of tacit knowledge over the attainment offormalised/codified knowledge.

Hence, a learning organisation is simply an organisation in which the process ofdaily, collective and largely intuitive learning is well developed. A personreading an article differs on all three counts. Reading an article is not continual,but incidental learning; it is not collective, but individual learning; and it is notintuitive, but largely formalised learning. In other words, reading an article is along way off from organisational learning, although it can be an ingredient of theprocess.


Building a learning organisation is not a matter of changing the organisationalstructure or tinkering with the incentive system. In isolation these actions willnot result in a learning organisation, although they could be elements of a moreencompassing effort to build up a company’s learning ability. To really becomea learning organisation, Kao has taken systematic action on a number of fronts.

Mission setting. Most importantly, the company truly believes in the importanceof learning. Dr. Maruta, the president of Kao, states that Kao is “an educationalinstitution in which everyone is a potential teacher.” All employees, includingMaruta himself, are seen as students of the truth, continually seeking newinsights and better understanding. It is the company’s fundamental assumptionthat such learning, drawn from scarce information, is the ultimate source of

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competitive advantage and therefore needs to be carefully nurtured: “Thecompany that develops a monopoly on information, and has the ability to learnfrom it continuously, is the company that will win, irrespective of its business.

Organisational culture. Linked to this underlying philosophy is an organisationalculture that reinforces the importance of information, knowledge and itsacquisition through learning. To facilitate the daily, organisation-wide, andlargely intuitive learning that Kao believes is essential; the company’s cultureemphasises a number of principles:

� Equality. Kao rejects authoritarianism, believing that collectivelearning can only take place in an organisation where people discussmatters on an equal footing. Interaction and the spread of ideasrequire that opinions are judged on their own merits, independentof rank and therefore the principle of equality is central to Kao’sculture.

� Openness. Joint learning also requires the free flow of informationand ideas. Therefore, Kao’s culture emphasises that every employeeshould have full access to all information and that all discussionsshould be held out in the open, where everyone is free to hear whatis said and to participate, if needed.

� Mutual assistance. Organisational learning also requires individualsand departments to take an active interest in each other’s problemsand development. If each individual or department tries to optimiseonly its own learning, everyone loses, because there is nocross-fertilisation. Therefore, mutual assistance is stressed as a keyprinciple.

� Individual initiative. Although the organisation must learn together,ideas are born and knowledge is spread by initiatives taken byindividuals. Therefore, the collective nature of organisationallearning requires a strong cultural emphasis on the good ofindividual initiatives. By providing individuals and teams some degreeof autonomy, Kao can use the energy of intrapreneurs to stayinnovative and competitive.

� Pro-activeness. Finally, it is a commonly held view within Kao thatlearning should not be solely based on previous experience. AsMaruta puts it, “past wisdom must not be a constraint, but something tobe challenged. Yesterday’s success formula is often today’s obsoletedogma.” The emphasis is rather on what has been learnt today thatcan be useful tomorrow (link to the discussion on mental models inchapter 2).

In short, the values and beliefs held by managers within Kao regarding learningare very strong and are a main factor in shaping Kao as a learning organisation.However, this culture is further reinforced by other organisational elements.

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Organisational structure. To allow for the equality, openness, mutual assistance,individual initiative and proactiveness mentioned above, Kao has designed avery flat organisational structure, without significant boundaries or titles.There is relatively little hierarchy and not a strict separation of tasks – theorganisation functions fluidly and flexibly, with various parts interacting andassisting each other where necessary, which Kao refers to as “biological selfcontrol”.

Information systems. As horizontally shared information is essential to Kao’sorganisational learning, the company has placed a strong emphasis ondeveloping information systems so that the most up to date information isavailable to all members of the organisation. Everyone has access to theLogistics Information System (ordering, inventory, production and sales data)and the Market Intelligence System (market research, sales, and marketingdata). Further information exchanges and networking opportunities arecreated through regular R&D conferences and through the open physicallayout of the Kao building.

Leadership roles. Finally, the way that top managers define their roles within thecompany has a significant impact on Kao’s learning ability. As Senge (reading9.3) argues, leaders cannot learn on behalf of their organisations, but mustassist their organisations to learn. Senge identifies three critical roles ofleadership in a learning organisation, each of which is also applicable to Kao:

� Leader as designer. Leaders must understand that learningcannot be commanded, but that a “social architecture” mustbe created that will support organisational learning. In Kao, thecompany leaders have designed the needed organisationalstructure and systems, and have fostered the essentialorganisational culture.

� Leader as teacher. Leaders should not be authoritarian experts,but must coach, guide and facilitate everyone in theorganisation. In Kao this is exactly the case – Dr. Maruta doesnot push one vision of reality, but aids employees in coming upwith their own ideas.

Leader as steward. Most fundamentally, leaders should not be motivated by adesire for power, but by their desire to serve other people and theorganisation, so that these can function optimally. Here too, it seems that Kaofits the mould. Maruta seems very much a “servant leader,” who creates trustand commitment by his unselfish desire to serve others and the organisation asa whole.


The remark about Kao’s joint venture with Colgate-Palmolive on page 733really gets to the essence of Kao’s strategy process: The way the two firmsdecided on strategy was totally different. We [Kao] constantly adjust ourstrategy flexibly. They [Colgate-Palmolive] never start without a concrete andfixed strategy. We could not wait for them. In other words,

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Colgate-Palmolive’s approach to strategy formation was inspired by theplanning perspective, while Kao approach was much more in line with theincrementalist perspective.

When examined more closely, Kao’s strategy formation process can be seento have the following characteristics:

� Creating issue awareness. Within the open and participatory cultureof Kao, it is every person's responsibility to identify the criticalissues to which the organisation must respond and to bring theseissues to the attention (agenda setting) of all relevant colleagues(link to chapter 2). In other words, the definition of threats andopportunities, and the focusing of organisational attention take placecontinuously, informally, horizontally and intuitively. There are noformalised, periodic procedures using rational analytical techniquesto ensure that issue identification takes place, nor is it a taskassigned to only a small number of senior managers.

� Developing ideas and legitimising new viewpoints. Once issues orproblems have been identified, clusters of affected or interestedindividuals form around them (see 9.2, Stacey). Using the energy ofintrapreneurs one can develop new and innovative ideas. If groupsare formed, these people may meet formally or informally toexchange information and jointly develop ideas on how to proceed.At this stage there will not yet be any fixed proposals, so thatdiscussions can be truly open, without any individual defending apredetermined point of view.

� Obtaining contributions, consensus, credibility and commitment. As theideas developing in these small groups become increasingly clear,they are shared more widely. The prevailing principle at Kao isreferred to as ‘tataki-dai’; “present your ideas to others at 80percent completion” so that others can criticise and contribute tothem before they become a proposal. Not only does this enhancethe quality of the idea, but also it helps to create ‘zoawase’ – acommon perspective or view. This is also the point at which highermanagement levels are involved. They too can contribute to theevolving ideas and by their participation lend weight and credibilityto the plans. As consensus emerges in this fashion, all of theparticipants in this strategy formation process also becomeincreasingly committed to making the strategy a success.

� Implementation, systematic learning and reformulation. None of Kao’smanagers believes that the strategy formation process is over oncethe initial plans have been formulated (option selection). A first set ofplans is merely a snapshot in the learning process – as an issue grewinto an idea, which grew into a proposal, which grew into a plan, sothe strategy should continue to grow as the knowledge and wisdomof the organisation continue to expand. Hence, no one expects theplans to be fully implemented as formulated. On the contrary,everyone is focused on obtaining feedback information that can lead

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to learning and can be used to adapt and further develop thestrategy.

� The role of vision. A common vision about the organisation’spurpose, identity and strategic intent is both the outcome andthe guiding principle in the above process. In other words,Kao’s vision is not static or top-down, but is developed in thesame incremental manner as described above. However, at thesame time, Kao’s vision is less variable than its strategies andthus acts as a guiding principle in the incremental strategyformation process. The company’s vision helps managers tofocus on the right issues, and points managers in certaindirections where they should seek solutions and newopportunities. In short, the company vision helps to determinethe pattern in the stream of organisational actions.

These points underscore that incrementalism and learning are two sides of thesame coin. When looking at incrementalism, the focus is on the strategydevelopment process – how organisations continually and gradually createpatterns in their streams of decisions and actions. The two are wrapped up inone another, proceeding in unison. When looking at learning, the focus is onthe competence development process – how organisations continually andgradually obtain information and increase their knowledge and abilities.


The advantages of Kao’s current strategy formation process have becomequite clear from the discussion above. Their strategy formation process isflexible, adaptive, and open to learning, which is particularly important inunpredictable environments. High participation and a crescive approach by topmanagement led to more bottom-up information and ideas, the continualimprovement of proposals, and broad understanding and commitmentthroughout the organisation.

The case writers are particularly kind toward the company and do not mentionany disadvantages encountered by using this approach. However, based on thereadings in Chapter 3, of your key text, De Wit and Meyer, the followingpotential disadvantages can be identified:

Disadvantages of ‘finding out". Learning and incrementalism are based on theprinciple of feedback – the results of current activities are used to adapt futureactivities. Feedback is also referred to as output- or error-driven, becauselearning is based on past successes and mistakes (we refer to this as ‘findingout’). The alternative is feed forward, whereby future activities are based onforecasts and estimates. Feed forward is also referred to as input- orforecast-driven, because estimates are made of what will likely happen (wetherefore speak of ‘figuring out’). The most common problems of feedback areinefficiency and the danger of irreparable mistakes. Learning by trial and errorcan often be time- and resource-consuming compared to thinking thingsthrough in advance. Furthermore, some “errors” cannot be repaired. By tryingout something in the market a company can damage its name or makeinvestments that cannot be recovered. The main problem of feed forward, on

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the other hand, is that many things cannot be forecast or thought out inadvance. Kao seems to be trying to combine both feedback and feed forwardto get the best possible results. However, the threat of inefficiency andirreparable damage remains.

� Threat of strategic drift. Companies that employ an incrementalapproach to strategy formation run the risk of making adjustmentsthat are not radical enough. Because Kao has a strong bias towardincremental action (get started and learn as you go along), theymight find it more difficult to formulate and execute far-reachingplans, such as takeovers, large capital investments or shifts intechnologies. The case, however, does not suggest that this is aproblem.

� Threat of slower decision making. Above, it was argued that trial anderror learning might be time-consuming. To this it can be added thatthe participatory decision-making system and need for consensuscan also be relatively slow. Especially in circumstances where thespeed of decision-making is essential (a crisis or a suddenopportunity), Kao might be at a disadvantage. In general, however, itshould be recognised that the length of the decision-making process(“time-to-decision”) is usually less important than the length of thetotal decision and implementation process (“time-to-results”).Slower decision-making might be more than compensated byquicker implementation. Investing time during the decision-makingprocess to produce high quality plans that are widely understoodand enjoy broad acceptance often facilitates rapid action, making thetotal amount of time spent from issue identification, throughdiagnosis, to conceiving and realising less than in other firms.

� Threat of political infighting. An inherent threat of flat organisationswith widespread participation is (as everyone at a university knows)political infighting (link to 3.3 Allison). The wide variety of opinionsand the diffusion of power can easily lead to confrontational politicalprocesses, without a clear-cut source of authority to resolvedisputes. Kao seems to avoid these problems by a strong,homogeneous, cooperation-oriented corporate culture and a sharedstrategic intent.

� Difficult to internationalise. As the company internationalises, keepingup the shared culture and strategic intent will be increasinglydifficult. The organisation will be larger, made up of morenationalities and divided by larger physical distances. There will befewer informal contacts and differences of interests are likely togrow. Openness, trust and commitment will be difficult to maintainunder these circumstances. If ideas need to be surfaced andconsensus needs to grow between people at scattered locationsaround the world, the ease of interaction is likely to decrease, whiledecision-making time is likely to increase. Furthermore, the threatof political infighting is likely to grow as well.

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� Difficult to integrate acquisitions. The very particular attitudetoward learning and the strategy formation process at Kaomakes it very difficult for other organisational cultures to beintegrated into the Kao system. At corporations with highlyformalised strategic planning systems, companies that areacquired need to adapt themselves to a number of proceduresand regulations governing the strategy process. The often-usedmetaphor is that of a new “part” that must be slotted into theorganisational “machinery”. At Kao, however, learning andstrategy formation have not been formalised into policies andprocedures that can be easily transferred to an acquiredcompany. The Kao way of doing things has grown out of aphilosophy and is engrained in the beliefs, informal rules andtacit organisational routines prevalent throughout thecompany. Dr. Maruta’s own metaphor is that of an organism.Taking this metaphor one step further, it can be questionedwhether a foreign body can be made compatible, or will berejected if implantation is attempted. In other words, how canmanagers at the acquired firms be integrated into the Kao wayof learning and strategy formation if their culture is radicallydifferent? The more exceptional Kao’s culture, the moredifficult it will be to absorb foreign cultures into theorganisation (link to 6.3 Haspeslagh and Jemison).


This is a difficult question, particularly as it goes a step further than theliterature provided. You may have come up with a broad range of suggestionsat this stage, varying from the obvious to the profound. The following areparticularly pertinent:

� A Japanese or transnational company? Kao seems to believe inthe transnational corporation judging by its vision that“headquarters’ functions would be dispersed to SE Asia, theUS and Europe, leaving the Tokyo headquarters the role ofsupporting regionally based, locally managed operations bygiving strategic assistance.” Compared to the current situationthis would require a significant amount of decentralisation andgrowth of an international management cadre. The question iswhether this can be achieved without destroying Kao’s uniquelearning capability. As mentioned above, Kao’s learningorganisation is currently dependent on mutual trust, openness,understanding and involvement. These are maintained by acommon culture, interdependence, parallel interests andfrequent informal contacts – attributes that are more typical ofa medium-sized firm, based in one location, with ahomogeneous culture. Will a bigger company, with moreforeigners, spread all over the world not frustrate thecompany’s ability to learn? Shouldn’t Kao remain a Japanesecompany with foreign interests, with the headquarters inTokyo remaining as the focus of its learning activities? Should

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Kao develop a diverse group of global managers from a variety ofnational backgrounds, or rely on a core group of Japanese expatriatemanagers that relate each foreign operation to Tokyo headquarters?

� A formal or informal company? Kao must also wonder whether its lackof hierarchy (the “paperweight organisation”), lack of organisationalboundaries (“biological self-control”) and lack of formalisedprocedures all remain possible as the organisation grows both involume and geographically. How can communication be as frequentand as informal as within the Tokyo headquarters? How can controlbe exerted over subsidiaries far away from the centre? Can this beachieved “informally” or are systems and procedure necessary toensure that the foreign subsidiaries remain a part of the largerlearning organisation?

� An acquiring or organically growing company? As mentioned in theanswer to question 4, transferring Kao’s learning capability to acompany that has been acquired is terribly difficult. Yet, both inEurope and in the United States, Kao has staged major acquisitionsas an important part of its foreign market entry strategy. Thequestion is whether the benefits of these takeovers (instant marketshare, existing brand names, local management and marketknowledge) really offset the costs (cultural incompatibility, difficultyto share learning, difficulty to transfer learning capability). Shouldn’tKao take the longer and rougher road of organic growth, if thiseventually leads to the leveraging of Kao’s learning capability? (linkto Reading 6.3, Haspeslagh and Jemison)

CASE STUDY 2 – Developing NewKnowledge at Nike

Developing New Knowledge at Nike

When Phil Knight founded Nike with $500 in 1964, he would have had littlecredibility if he had defined his purpose as being to build the world’s largestsportswear company. Yet this is what the company had become by the late1990s. This case examines the foundations of the company’s growth, especiallythe knowledge developed and retained within the company over the years.

Early learning years

Back in 1958, Phil Knight was a middle distance runner in the University ofOregon’s track team. He complained on number of occasions to his coach, BillBowerman, about the lack of good US running shoes. But he continued tostudy accountancy, eventually graduating and moving to teaching in his home

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town of Portland, Oregon. Then in 1964, both he and Bowerman each put up$250 to found the Nike shoe company, named after the Greek goddess ofvictory.

To start the company, Knight used his athletics contacts to sell running shoesfrom a station wagon at track and field events. He bought the shoes from Japanbut always felt that there was potential for a US designed shoe. By the early1970s, Knight was working on his new design ideas. At the same time asexploring these, demand for Nike shoes was sufficient for him to considerdeveloping his own shoe manufacture. However, he was concerned to useJapanese experience of shoe production. In 1972, he placed his first contract inJapan to begin shoe manufacture to a Nike all-American design.

Over the next couple of years, the yen moved up against the dollar andJapanese labour costs continued to rise. This made Japanese shoe productionmore expensive. In addition, Nike itself was gaining more experience ofinternational manufacture and making more contacts with more overseasmanufacturers. In order to cut production costs, Nike switched its operationsin 1975 from Japan to two newly industrialised nations, Korea and Taiwan,whose wage costs were exceptionally low at that time. Nike’s costs camedown dramatically, allowing the company more scope for funding furtherproduct development and marketing.

In sourcing production internationally from low wage countries, Nike’sapproach to shoe manufacture was revolutionary for its time. The companyrealised that sports shoe manufacture required substantial labour input, solabour costs were potentially high and justified manufacture in countries whereworkers were paid much lower wages. However, there were real risks inmanufacturing overseas because the greater geographical distance anddifferent national cultures made it more difficult to control production andquality. Thus, the company only switched contracts for large scale productionwhen it could be sure that a new manufacturing contractor was able to meet itsquality standards. In this context, the company had to learn how to handleoverseas production, how to brief manufacturers on new designs and models,and how to set and maintain quality standards.

The decade of difficulty and renewal: The 1980s

By the early 1980s, Nike was profitable and continued its role as a specialist USsports shoe manufacturer with no production facilities in its home country.Then along came competition in the form of a new sports shoe manufacturer,Reebok. From a start up company in 1981, Reebok went into battle againstNike under its founder and chief executive, Paul Fireman. Reebok launched astrong and well designed range of sports shoes with great success. By the mid1980s, Reebok had equalled Nike’s annual sales in a fierce competitive battle.In 1987, Reebok was clear market leader with sales of $991 million and amarket share of 30%, compared with Nike’s sales of $597 million and a share of18%.

Part of the problem and opportunity for both manufacturers was the fickle anddesign-conscious nature of the target market: young, hip teenagers and adultsbuy the latest fashions. Both Nike and Reebok realised that, in order to build

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volume, it was necessary to move from the specialist sports shoe market towider adoption by this much larger, fashion aware teenage and young adultmarket. This was the battleground that was initially captured by Reebok withgood products and a campaign of public relations that was highly disrespectfulof Nike. Mr. Fireman criticised Phil Knight as being ‘just a shoe guy’ who sawhimself as ‘a big time presence in sports’. In response, Mr. Knight said that he‘hated’ his competitor and that the ‘most innovative piece of R&D equipmentthey have is the copy machine’. One author of a book on Nike commented that‘Paul Fireman was installed as a devil figure inside Nike and he remains a darkpresence to this day’.

To hit back against Reebok, Nike then began to invest considerable sums ondeveloping new and innovative sport shoe designs. The most successful ofthese was begun in the late 1980s, the Nike Air shoe. ‘It was an intuitivelysimple technology to understand’ said John Horan, publisher of Sports GoodsIntelligence, a US industry newsletter. ‘It’s obvious to consumers that if you putan airbag under the foot, it will cushion it.’ But it was not until 1990 that theNike Air shoe was launched and began to deliver success for Nike. Thus the1980s were both the decade of difficulty and the time for renewal. Nike hadlearned about the heat of competition and the need for innovation andcontinual R&D in its shoe designs.

The new heights of the 1990s

Coupling the new Nike Airshoe with advertisingfeaturing Michael Jordan wasa touch of marketinginspiration. The USbasketball star, top of hischosen sport, was signed upto promote the newproduct in amultimillion-dollar deal thatadded a new dimension tosports sponsorship. Themarketing campaigndeveloped links betweenNike and Jordan’s athleticability and image. Reebok hit

back with its own design, the Reebok Pump shoe, but it was forced to useShaquille O’Neal, a major basketball star but second to Michael Jordan. Thusaround the turn of the decade, Nike’s market share rose from 25% in 1989 to28% in 1990 while Reebok’s share dropped from 24% to 21%.

Building on this success, Nike realised that such promotion provided powerfulsupport for the brand. Over the next few years, this was enhanced by theheavy funds Nike was prepared to invest. For example, in 1995 Nike investedalmost US$1 billion in sports marketing compared with Reebok’s spending ataround US$400 million. This investment in sports marketing was much higherthan previous sums. It was developed after Nike had assessed the results of itsheavy advertising campaigns earlier in the 1990s.

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Nike’s sponsorship knowledge

Subsequent sports sponsorship deals included the golf star Tiger Woods and,for a previously unheard-of sum, the whole Brazilian football team. By signing aten-year deal in 1996 worth between US$200 and 400 million, Nike broke newground in football sponsorship. It bought the television rights for five friendlygames each year involving the Brazilian national team. Also, Nike’s ‘swoosh’logo appeared around the world in many televised golf tournaments, and in thetelevised final of the 1998 Football World Cup and in the year 2000 SydneyOlympics with Brazilian footballers.

But it was not just the amount of money invested in campaigns at Nike. Thebranding and the message were also important. During the 1980s and 1990s,the company had come to understand its target market well – young, cool andcompetitive teenagers. The ‘swoosh’ logo was highlighted on all its goods tohelp brand the product and the main message, ‘just do it’, was developed toexpress the individuality of the target group. The accompanying slogan of‘winning your own way’ captured the aggression, competition and individualsuccess epitomised by the sports stars who were signed up. Its products weresold at high prices, e.g. over US$100 for sports shoes. Such prices led to aconcerted campaign in the USA aimed at forcing Nike to pay higher wages toworkers in the foreign factories of its suppliers. Although the company wassympathetic, Mr. Knight was unwilling to give way.

Following its success with the Air shoe, Nike also embarked on a programmeof further and extensive product development. In one year alone, some 300new designs were launched into the US market. The company claimed thatsuch scientific development was a major part of its success: new materials, newfabrics and new designs were developed. But it is also likely that Nike came torealise that its target group craved new products that would appear moreinnovative than the models of previous years. The implication was that it had tobring out new models even if the innovative content was more a surface designthan a substantive change. Nike was not alone in this approach which wastypical of many companies bringing out variations on models in order tocapture the fashion desires of customers.

During the 1990s, the levels of Nike research activity, its marketing support, itsclarity in its targeting to teenagers and the breadth of Nike’s coverage were alltotally new in sports shoe activity. Nike’s market share in the USA continuedto climb. It reached 43% in 1996, compared with Reebok’s 16%. Moreover,Nike had succeeded in growing the US market with sales alone exceedingUS$3 billion (compared to US$597 million in 1987). However, Nike wascriticised for its use of cheap labour in some countries and was forced to takesteps to deal with this.

The new millennium: the year 2000

Throughout the 1990s, Nike continued to develop rapidly in two further,related activities. It had been expanding its international sales for some timeand these continued to grow rapidly. In addition, it was developing the Nikebrand into non-shoe activities such as clothing and sports equipment. By 1996,Nike’s total sales were US$9 billion and it was the biggest sports goods

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manufacturer in the world, although the company had suffered a setback assports shoes gave way to brown shoes as fashion items for teenagers in the late1990s. In addition, the Asian economic downturn had hit the company hardand there was heavy overstocking of its products in the US retail trade.

Profits were well down and painful job cuts were necessary, but the companywas still optimistic about the future. Phil Knight had become the chairman andMr. Tom Clarke had taken over as chief executive. Mr. Clarke was quite clear:

You grow a lot, then you need a period when things aren’t booming to askwhat works and what doesn’t...... Remember, we’re a fairly self-critical bunch.We’re running the company for the long-term, not to keep people happy forthe next couple of quarters.

Nike had developed such a deep knowledge of sports items, clothing andbranding that it was expecting to weather the storm and remain the largest inthe world.

Questions:

1. What knowledge has Nike acquired over the years? Use thedefinitions of knowledge to help you move beyond the obvious.

2. What other resources beyond knowledge does the company possessthat offer clear sustainable competitive advantage?

3. From a consideration of this case, what conclusions can you draw onthe emergent purpose of Nike in relation to its knowledge?

Source – Corporate Strategy by Lynch 2nd Edition, p475 – 478

CASE STUDY FEEDBACK

The case traces the company’s development from its origins as a small,specialist sports shoe company to the largest sportwear operation in theworld. It begins by making the key point that it would have been unrealistic forNike to have defined its purpose at its inception in 1964 in a way that wouldhave captured its market position in 1999.


Explicit knowledge will include:

� Shoe and sportswear technical design and performance.

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� Shoe and sportswear fashion design and development.

� Ability to negotiate and place manufacturing contracts withcompanies outside the USA.

� Ability to manage such manufacturing contracts in terms ofquality of product, control of costs, time to market, stockhandling and transport.

� Marketing and selling to retail stores globally.

� Ability to negotiate with the representatives of major sportsstars.

� Understanding of the target customer groups and theirmotives for purchase.

Tacit knowledge will include many of the less formal, unrecorded aspects ofmany of the above areas:

� Experience of which combinations of technical characteristicswill produce technically superior performance, which may bedifficult to measure precisely.

� Contacts with individual fashion designers and other individualsthat have been particularly fruitful in terms of creating newmarket trends.

� Knowledge of which manufacturing suppliers are particularlyreliable and which individual managers within such companiesare crucial to product quality and costs.

� Experience of which countries, workers and governments haveproved especially helpful and co-operative in placingmanufacturing contracts.

� Worldwide knowledge of different sports goods retailing,contacts with individual retail shop buyers and knowledge oftheir methods of operating.

� Experience of how to handle various sports stars and theiragents: this alone must be highly valuable!

� Knowledge and experience of individual advertising agencies,market research companies and other marketing suppliers.

The over-riding point is the interaction of the different forms of knowledgecreation and transfer (in accordance with Nonaka & Takeuchi), e.g. theconversion of tacit knowledge (design ideas originating in the first instancefrom Philip Knight) into explicit knowledge (creation of production drawings).

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In other words, externalisation of ideas onto drawings. Link forward toinnovation (Unit 9) where designers are encouraged to work together to becreative (socialisation processes to create more tacit knowledge).


Other resources that are important to Nike include:

� Its ‘swish’ logo and brand name.

� Its contracts with sports stars like the Brazilian football team.

� Its reputation as a leading supplier of sportswear.

� Its network of contacts in global sports goods retailing: architecture.

� Its innovative ability to generate new marketing concepts and driveforward the sports goods business.

These all add up to resources that move beyond knowledge, yet providesustainable competitive advantage. Knowledge is not the only form of advantage.


There are three main conclusions:

� Purpose develops over time: the opening comments to this casemake the point clearly about Nike’s purpose in 1964 and 1999.

� Purpose needs to be seen in the context of the resources of anorganisation: Nike’s purpose in becoming the leading world sportsgoods manufacturer only had some meaning when the companyalready had some record of success in its home country.

� Purpose may not capture the full potential of an organisation if it isconfined to specific and well-defined objectives: it needs to beallowed to emerge over time. If Nike had defined its early purposein terms of profits and shareholder wealth, it might have restrictedits growth to more limited objectives.

Summary

In this module we have looked at the vital role knowledge managementcan play in today’s knowledge economy. We have noted that in somesectors, re-use of intellectual capital is no longer a case of gainingcompetitive advantage, but survival.

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We have examined what knowledge is, and have noted the differencesbetween explicit and tacit knowledge. We have looked at the theoreticalperspectives, the socialisation and technology issues, and the challengesposed to organisations. We have concluded by considering somepractical steps in the implementation of KM.

Students are encouraged to apply the lessons learnt to their own workcontext, and consider how their organisations can better exploitintellectual capital to gain competitive advantage.

REVIEW ACTIVITY

Consider the following scenario. You have been asked by your company’sboard to rate your knowledge management capability against your chiefcompetitor and present your proposals for a realistic improvement plan.

1. Carry out a realistic assessment of your knowledge managementcapabilities. To do this, consult colleagues across different businessareas and at different levels in the organisation. Prepare a KnowledgeManagement web diagram (as per Figure 8.2).

2. Identify the likely position of your main competitor on the webdiagram.

3. Now identify areas where significant improvements can be made(within a 6-month period), and how they can be achieved. Identify thebusiness benefits that are likely to arise from the improvement plan.

4. Prepare your presentation (no more than 15 charts).

(Students are encouraged to present this information to theirmanager/colleagues, and elicit their comments.)



1. Ref 10*, Chapter 11 Pages 390-398

2. Ref 4*, Chapter 9 Pages 196-228

3. Ref 12, Chapter 8 Pages 141-155, Chapter 9 Pages 167-196,Chapter 10 Pages 197-227


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Unit 9

Innovation

LEARNING OUTCOMES


� Examine how established companies can manage disruptivetechnologies.

� Analyse the relationship between innovation and establishing a‘learning’ culture.

� Understand the importance of maintaining strategic flexibility.

Introduction

The ability to rapidly assimilate powerful new/emerging technologiesand processes into products/services is now an important competitivefactor in the global environment. However, disruptive technologiespose particular problems and challenges for the establishedcorporations. When faced with disruptive technologies, managementteams in blue-chip companies frequently respond by vacillation, andhide behind internal research, extensive pilot studies, lengthy internalassessments and so on. They frequently hire external consultants to givethem the ‘answers’. They are so geared with managing continuousinnovation within established technologies, that they cannot cope withrevolutionary, new technologies.

Over the last decade, innovation has gathered increasing pace, andsignificant venture capital has flown into start-ups. In this environment,new technologies are continually emerging; some have powerfulbusiness potential and many do not. How can established companiesdiscover powerful disruptive technologies more quickly, and evaluatethem more accurately? What are the problems faced by establishedorganisations, and what steps can organisations take to be moreresponsive to innovative technologies? In this unit we shall look at someof these issues.

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Innovation strategies

Disruptive innovations, spawned by developments in emergingtechnologies, e.g. grid computing, wireless, genomics, nanotechnology,have the potential to consume industries and make existing strategiesobsolete. Conventional wisdom says that large established companiesare likely to lose out to smaller attackers when they try exploiting thesebreakthroughs. Why should incumbents (large established companies)encounter so much difficulty? Companies such as GE, Intel andMicrosoft have embraced disruptive innovations. What can we learnfrom them?

Established companies control substantial resources: establishedinfrastructure and processes, scale and scope, valuable brand namesand entrenched relationships. They can spend heavily on technologydevelopment and market research, although most of this money isdevoted to evolutionary innovations that make their current offeringsperform better in ways their customers already value.

For all their advantages, incumbents are often impotent when it comesto disruptive innovations. Their size slows them down and pastcommitments restrict their flexibility. Equity markets expect continuedgrowth in earnings while start-ups are valued for their prospects andrewarded with large market capitalisation they can use to fundinnovation. Incumbents are disadvantaged by their structures,capabilities and outlook. Their finely honed instincts, established waysof thinking and embedded skills make it tough to deal with a disruptiveinnovation that requires a different approach.

Many of these problems are caused by;

� Technological uncertainties.

� Ambiguous customer signals.

� Immature competitive structures of markets fordisruptive innovations.

ACTIVITY

As background to this unit, read about the dimensions and paths of industrydevelopment, the drivers and inhibitors of development, and how companiescan adopt an industry leadership position.

Read p. 421-436 of your key text, De Wit, B & Meyer, R .

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Unit 9 – Innovation Global Corporate Strategy

Innovation and established companies

Disruptive innovations, posing a threat to their existing capabilities,make established companies prone to stick with what is familiar for toolong. Even if this is avoided, incumbents are often unwilling to make astrong commitment to innovative technologies, and find it difficult topersist in the face of uncertainty and adversity.

More recently, and particularly in the high-tech world, executives inmany established and ‘innovative’ companies have come to therealisation that you don’t have to be an innovator to be innovative. Theytake the view that the little guys (start-ups) can do all the hard workwith someone else’s investment (venture capital), and the someone elsecan also bear the risk of failure (and a large percentage of start-ups arefailures). If the start-up shows market potential (and timing is allcritical) and their deliverables represent a key source of competitiveadvantage or threaten your business, then you acquire the start-up orco-opt them. This strategy is one adopted by many large corporations.Despite their large investment in R&D, large companies, includingMicrosoft, IBM and Cisco, have acquired many start-ups for preciselythis reason.

Problems for established companies

Whether established companies innovate organically or by acquisitionor by a combination of both (as is often the case), disruptive technologiespose threats for established companies. A pro-active stance by themanagement team is required to counter the threats and overcome theparticular challenges faced by incumbents. Dangers occur at differentpoints in the decision process and require different remedies.

Let us now look at some of the problems:

Problem 1: Delay

When faced with uncertainty, it is tempting to wait. A watching briefmay be assigned to an internal team that monitors families oftechnologies. Whether there is any value in these moves depends onwhether there is anyone who can see beyond the imperfections of thefirst costly version, e.g. early electronic watches were bulky. It is naturalto underestimate developing technologies or new approaches becausethey don’t measure up to the familiar alternative, or appear suitableonly for narrow applications. Other developments may be easy todismiss on the grounds that their small markets will not meet thegrowth needs of large companies. Yet all large markets were once in anembryonic state with their origins in limited applications.

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Global Corporate Strategy Unit 9 – Innovation

Problem 2: Sticking with the familiar

Choice of technology is often clouded by uncertainty about whethertechnical hurdles can be overcome and which standard will prevail.When there are competing choices, companies are likely to base theirdecision on the technology path that feels most familiar. Establishedcompanies typically search in areas close to their current expertise, andmay not have the capability to appraise the options properly. Theirinstincts may be to seek a proprietary position to lock in customers,because that worked in their core market. Such a move makes customerssuspicious, especially in an open systems environment. Open systems isincreasingly becoming an important factor in many sectors, andparticularly in the IT sector.

ACTIVITY

Microsoft currently dominates the desktop operating systems market.However, more recently there has been a rise in focus on open systems.Customers are demanding ‘plug and play’ interoperability across differentvendor applications, and see open systems as delivering this choice. They viewthemselves as being ‘locked in’ by proprietary Microsoft systems/applications.This development has led to the rise of Linux as an open operating system.Linux itself was developed by a Swedish engineer as a hobby project, and wasitself a disruptive technology.

How is Microsoft responding to the challenge of Linux? Research this area.

What options does Microsoft have to safeguard its dominance?

ACTIVITY FEEDBACK

Broadly, Microsoft has four options:

1. Do nothing.

2. Actively oppose and push proprietary technology as the ‘de facto’standard.

3. ‘Embrace’ and swamp; pay ‘lip service’ to standards, steer openstandards to their own flavour and implement.

4. Genuinely embrace open standards, and get ahead of the competitionquickly.

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Problem 3: Reluctance to commit

Established companies seldom commit wholeheartedly to a disruptiveinnovation. Instead, they are more likely to enter in stages. Manyreasons explain this;

� Managers are concerned about changing profitableproducts or encountering resistance from channelpartners.

� Prospects may appear less attractive than currentbusiness, making it difficult to justify investments, e.g.Encyclopaedia Britannica was slow to move to CD-Romand lost 70 per cent of its revenue between 1990 and 1997.

� A study showed that, of 27 companies confronted with athreatening technology, only four entered aggressivelyand three never participated at all. Managers are focusedon existing customers and new technologies may seemapplicable only to small market segments they don’tserve or understand. This makes them vulnerable tooutsiders who use disruptive innovation as theirplatform.

� Successful organisations are not naturally ambidextrous,so they cannot balance the demands of familiar marketswith the alien requirements of a disruptive innovation.

These explanations reinforce each other to impair decision-making,erode enthusiasm and cause managers to hesitate. Such issues do notinhibit new entrants.

Problem 4: Lack of persistence

Established companies being held to earnings forecasts have littlepatience with adverse results, e.g. when US newspaper giantKnight-Ridder’s early forays into television in 1978 and cable in 1983met setbacks, the company sold the business. Success may requirepatience. However, missed forecasts and dashed hopes are inevitablewith disruptive innovation. Demand may not materialise as expected,competitors may crowd into the market or the technology may veer inan unexpected direction. Initial enthusiasm may be replaced withscepticism about the innovation becoming profitable. The result is thatcompanies often withdraw from early probes and don’t come back untilthe innovation is proven by others. At this point it is too late to achieveleadership.

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Problem Avoidance

Whilst awareness of the pitfalls described in the previous section canhelp avoidance, the best defence is a good offence. There are fourapproaches:

� Widen peripheral vision.

� Create a learning culture.

� Stay flexible strategically.

� Provide organisational autonomy.

The above are ingredients from which an approach can be fashioned.Let us look at each in turn:

Widen peripheral vision

Disruptive innovations often signal their arrival long before theyhappen. Some signs may be clear to those who look; others can only beseen by the prepared mind. As the philosopher Kant noted, ‘we can onlysee what we are prepared to see’. Weak signals usually come from theperiphery or boundary, where previously unknown competitors aremaking inroads, unfamiliar customers are early adopters and differentstandards are emerging. But the periphery is ‘noisy’, with numerousrelated technologies that may or may not be relevant. Background noiseto one company may be a strong signal to another.

The first step in deciding which signals and trends to scan is to definethe significant technologies. This requires shifting the focus from thecharacteristics of products to features that provide benefits, e.g.customers did not want X-rays as such, but they did need more accurateimages of tissues and bones to help spot problems. Companies also canstudy users who are ‘ahead of the curve’ to see the promise of a newtechnology, or work jointly with lead users on the next generation ofproducts.

Once features are defined, how well the innovation can deliver featuresthat meet customer needs and budgets, relative to competingtechnologies must be assessed. The relationship between performanceand development expenditure is an S-curve, i.e. initially, there is littlesign of progress, but then performance rises steeply for relatively littleeffort before levelling off.

Then, the challenge is to estimate the rate of adoption and potentialmarket size. When it is not yet apparent who customers will be and evenearly users have yet to experience the product, such estimates aredifficult. Traditional market research is seldom applicable to embryonicmarkets. Sample surveys, etc. are designed for well-defined problems inexisting markets. A different approach is needed when the concept is

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ill-formed, the technology is barely ready and questions of cost,availability, and performance are unresolved. Customers may not knowwhether they want a new product, but they can assess how much morethey value its benefits relative to present offerings.

Xerox’s strategy for estimating the potential market for fax machines inthe 1970s illustrates how customer benefits and functionality can beused to estimate markets. Managers measured the extent and frequencyof urgent written messages, their time sensitivity and the form and sizeof the message. Then they contrasted the promise of fax with mail,telephone, express delivery and so on. With this approach, Xeroxforesaw a business market of a million units.

Choosing how to assess the market for a disruptive innovation shouldbe guided by three principles.

1. Paint the big picture: This is not the time to ask for carefullycalibrated results. The issue is simply whether the market is bigenough to support development.

2. Use multiple methods: While any one market research methodwill be limited or flawed in some respect, a combination mayyield conclusions that are directionally sound.

3. Focus on needs not products: prospective customers may not beable to visualise radical products, but they can be eloquent abouttheir problems and changing needs.

Build a learning culture

The challenge is collective, not just individual. Without learning, noisyinformation flowing from the periphery will create confusion, notinsight. Information must be absorbed, communicated and intensivelydiscussed so its implications are understood. The organisation mustpossess or acquire several attributes:

� Openness to diverse views, within and acrossdepartments.

� Willingness to challenge deep-seated assumptions.

� A climate that encourages experimentation and rewards“well-intentioned” failure.

Entrenched attitudes may impede thinking needed to graspdiscontinuities and surprises. Changing is not easy because attitudesare grounded in experience, reinforced by commitments and protectedby inertia. Before prevailing thinking can be challenged, it should bedescribed by making the views and assumptions of managers clear.Scenario planning can help challenge deep-rooted mentalities.

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Adapting to the vagaries of disruptive innovations requires experimentand an openness to learning from failures. Sometimes experimentrequires a willingness to create diverse solutions, by endorsing paralleldevelopment activities, e.g. Shell is developing renewable energysources.

It may also mean introducing prototypes into a market segment.Learning from this quickly is vital, followed by modifying the product,and trying again in a process of successive approximation, e.g. Motorolaand the cellular phone market.

VIRTUAL CAMPUS

1. If this has not already been done, post on the Virtual Campus a shortresume of the type of organisation you work for. Public or privatesector? Large, medium or small? Sector (e.g. services, manufacturing)?

2. Once all the resumes have been posted on the Virtual Campus, pairyourself with a partner. Choose a partner who works for anorganisation which, you believe, has a very different learning culturefrom yours.

3. Now describe your organisation’s learning culture, in the context ofinnovation, to your partner (in no more than 1000 words max.).

4. Get your partner to identify the strengths and weaknesses of yourlearning culture in relation to emerging innovative technologies.

5. Learn from each other. Identify what improvements can be made toyour own organisation’s learning culture based on this exercise.

Maintain strategic flexibility

A paradox of disruptive innovation is that although it is prudent tomake limited investments, sometimes a strong commitment leads tosuccess. One way to reduce this dilemma is to increase organisationalflexibility, so lowering the cost of making a commitment and the cost ofreversing direction. Commitment might seem to be the opposite offlexibility. However, only when the commitment is irreversible,flexibility is destroyed.

Microsoft is a prime example of a company maintaining flexibility. In1988 Apple was at its peak with its superior graphical interface for theMacintosh making Microsoft’s DOS look a poor second. However,Microsoft was operating on several fronts. On the one hand, it wasdeveloping Windows; on another, it was developing OS/2 with IBM. At

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the same time, Microsoft was introducing application software,including Excel and Word, for both Windows and Macintosh.

Microsoft had developed a strong hand of cards to play in a variety ofworlds that might emerge. In hindsight, its portfolio of options wascommensurate with the uncertainties then surrounding hardware andsoftware development. Questions of standards, features, channels anddelivery modes (PCs versus servers) were still to be settled. In additionto developing a robust hand, Microsoft developed a culture that couldquickly change strategy.

Provide organisational autonomy

A strategy to avoid the problems faced by large incumbents is to hive offthe disruptive business into a separate unit. The more the initiative canoperate from a smaller, entrepreneurial mindset, the less it will be heldback by the inertia, controls, risk-avoidance and big-company thinkingthat leads to the pitfalls discussed above. By isolating, the companyprotects the new venture from these issues.

Many large companies set up separate unit dedicated to new ideas, e.g.GM’s Saturn division, IBM’s PC unit. The objective of separating thenew business is to enable the new group to do things differently whilestill permitting the transfer of resources and ideas from the parent. Thisalso permits separate objectives, recognition of long development cyclesand continuing cash drains, as well as different criteria so theperformance of managers in the rest of the organisation is notjeopardised. Above all, it creates flexibility.

There are many degrees of separation. Some companies take theapproach as far as to create ‘spin-offs’. These may be completecompanies with their own stock, board and management teams, inwhich the parent retains some ownership. This approach offers access tocapital (via a public stock offering), strategic value from the corporatecentre, operating independence, development of executive talent insmaller units and greater motivation for key personnel through stockoptions and operating freedom.

For example, Kodak’s experience with electronic imaging highlights thestrategic importance of separation (in whatever form). Originally,electronic imaging activities were dispersed among Kodak’s chemicalimaging facilities. This had a number of bad consequences. Managers ofthe film business continually interfered with electronic imagingprojects, which were perceived as threatening the existing customerbase. The company policy that all engineers be paid the same meantKodak could not compete for highly paid electronic engineers. Becausedigital imaging projects were scattered throughout the company, therewas no cohesive vision and limited accountability for performance.

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ACTIVITY

Read the following article from your key text, De Wit, B & Meyer, R:

‘Strategy, value innovation and the knowledge economy’, Reading 8.4,p.464-473.

Conclusion

Success or survival in industries that are being created or transformedby disruptive innovations requires support from senior management,separation of the new, flexibility and a willingness to take risks andlearn from experiments. There should be a diversity of opinion tochallenge dominant attitudes and misleading precedents, so avoidingmyopic views of new ventures. The best innovators think broadly andwill entertain a wide range of possibilities before they converge on asolution.

These prescriptions need considerable tailoring to match eachdisruptive innovation and the organisation involved. Indeed, thepurpose of a template for a high-commitment organisation is to enable itto cope with the tension of uncertainty while achieving commitment tothe choices made. The main point is that managing disruptiveinnovations constitutes a different game for established companies,with its own problems and solutions.

Reference “Don’t Hesitate to Innovate” by George Day and PaulSchoemaker (Financial Times Oct 9, 2000)

CASE STUDY 1 – Oxley: Step by Step intoNew Market Niches

A private British company has been turning military technologies intocommercial applications for the last 61 years. By PETER MARSH (FinancialTimes; Jan 30, 2001)

In rural Cumbria, an unusual group of technology specialists is working away inan airy office-cum-laboratory tacked on to a country house. The subjects oftheir inquiries are rather esoteric, ranging from tiny metal devices withdimensions less than 1mm to new versions of instrument displays for jetfighters. The ten experts are members of a research and development team atOxley, a private company with a 61-year record in innovation. “We use a

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‘stepping stone’ approach to new product development,” says Geoff Edwards,Oxley’s managing director. “We keep one foot in the areas we know aboutand move the other foot so we can gradually explore new ideas.”

Oxley is not a large company. Last year, sales came to £12m, of which about£700,000 was the profit before tax. But the company’s story is relevant tomany businesses because of the way it has used technological ingenuity to edgeinto new areas. It is a potent case study of how military technologies can beused in civil applications. This process starts with the ten experts, identified byMr Edwards, a physicist who started at Oxley 32 years ago. “We deliberatelykeep our researchers close to each other so they are chatting all the time,” hesays. “From this interaction we get a marvellous source of new ideas.” Thedisciplines covered by the group include materials science, electronics design,chemistry, manufacturing and test engineering, optics and software. Oxleyemploys just 240 staff, of which 50 are engaged in R&D.

An example of how internal discussions lead to profitable businessopportunities is Oxley’s use of its knowledge of capacitor technology – used inmilitary radar and telecommunications systems – to produce capacitor-baseddata storage devices or “smart tags”. These tags were first sold to the BritishArmy, which attached them to Iraqi prisoners captured during the 1990-91Middle East conflict. The tags were encoded with information about theprisoners’ identities and intelligence data.

Oxley has adapted the devices for use on cows to inform the farmer, forinstance, about health problems and milking record. Similar lateral thinkinghelped Oxley to turn capacitor-based devices – made from tiny pieces ofceramic – into sensors used by UK pollution inspectors to monitor waterquality. At the core of Oxley’s methods is its long involvement with theMinistry of Defence and large military contractors. Defence-related workaccounts for 70% of sales. About a third of the company’s revenue comes fromoutside the UK.

The company was founded in 1939, just before the 2nd World War, whenFreddie Oxley, an entrepreneurial engineer, hit on a way of making capacitorsto be used in early radar work. To escape the attentions of German bombers,the company moved in 1942 from London to its current location in Ulverston,on the fringe of the Lake District. Mr Oxley ran the company until his death in1988, when he held 145 patents in a range of scientific fields. His wife, Ann,chairs the company. She has 90% of the shares, with other staff membersholding the remainder. Mrs Oxley refuses to consider giving up privateownership. “We run this company like an extended family,” she says. Oxley’sproducts are developed rather haphazardly, with little long-term planning. Butmost start with military contracts.

The company has several profitable product groups in this field. Mr Edwardscalls them the company’s “eagles”. Commanding high margins, they providethe cash to finance new developments. Examples include sensitive opticalfilters for adding to the instruments and identification lights of aircraft such asthe Tornado fighter. The filters are made of glass, coated with chemicals thatscreen out infrared radiation. They enable pilots to use infrared night goggleswithout being blinded by their own aircraft’s lighting. Other “eagles” include

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specialist connectors such as the ones Oxley sells to the mobile telephoneindustry, based on principles developed for military radio applications in theearly 1970s.

Oxley makes millions of tiny gold-plated spheres – each 1mm in diameter –that fit into telecoms base stations sold by Ericsson and Motorola, the twobiggest forces in the mobile phone industry. The spheres are part of miniatureball-and-socket connectors. With the ball snapping in and out of the socket athigh speed, the system forms part of a switch (selling for 10p) that checkswhether telecoms equipment is operating at the correct wavelength. “We arethe only company in the world that can make the (ball and socket) devices tothis kind of precision,” Mr Edwards says.

Oxley also produces electromagnetic screening systems for military radios.They prevent damage to the equipment from lightning strikes or radiationfrom a nuclear bomb. In the next few years, the company intends to keep itsmilitary focus. As the defence industry consolidates around bigger companies,Mrs Oxley says, small, specialist companies will find a niche. “We think we cancontinue to run between the legs of the elephants,” she says.

But the company is also keen to keep edging into other markets, perhaps withthe help of partners with specific knowledge of new business fields. In the nextfive years, Mr Edwards would like the company’s sales to double. “We have nochoice,” he says. “Having this kind of growth target is essential if we want tokeep the company sharp and interested in new ideas.”

Questions:

1. Strategically, how would you categorise the ‘stepping stone’ approachto product development?

2. Link this case to other key areas studied in this module.

CASE STUDY FEEDBACK

Feedback to Question 1

� Link back to the discussion in Unit 1 about strategic ‘fit’ and‘stretch’. The stepping stone approach could be seen asstretching from military (although this is the clear focus with70% turnover) to commercial.

� Exploitation of core competence (link to Unit 2) andknowledge (link to Unit 8).

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� Creation of tacit knowledge from previously created tacit andexplicit knowledge.


� Core competence – protection of innovative technology viapatents; the company has 145 – is this a lot? – yes as this is asignificant financial investment over the years and has a high value tothe company.

� Emergent strategy – commonplace for innovative organisations(link to the ‘experimentation’ of emergent strategy) “products aredeveloped haphazardly.....”

� Value Management – Boston Consulting Group Matrix – use of‘eagles’ (cash cows) to fund future innovation.

� Niche markets (specialist company – link to reading for thissession and forward link to Unit 10 – the role of specialists such asIT).

� Strategic Alliances – links to partners in specific fields to createknowledge management and transfer and technology transfer.

� Knowledge management – as above but the company makes“use of its knowledge”

VIRTUAL CAMPUS

Further points to note, from the Oxley case study, include:

� The importance of keeping researchers ‘chatting’ together tofaciliate tacit knowledge through socialisation.

� The significant proportion of staff engaged in innovation; 50 of 240staff.

Now discuss with your colleagues (on the virtual campus) innovation inrespect of :

1. the size of the company

2. the family owned nature

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Post, on the Virtual Campus, what you can glean from the case study about theabove two points. Share your views. Then challenge, extend, discuss.

Students are advised to complete the next case study (Telepizza, where control ofbusiness innovation has been removed by being publicly owned) before undertakingthis activity. The Telepizza case study has a bearing on point 2 for discussion.

CASE STUDY 2 – Telepizza

Telepizza is a young Spanish company that combines entrepreneurial flair withreal growth. This case study explores how the company has grown and raisesthe question of what organisational structures are likely to be required overthe next few years

Telepizza realised before its competitors that Spain was changing rapidly. Gonewere the days of siestas and elaborate family meals. Fast food was whatSpaniards wanted and needed. The company was founded in 1988 as a singlepizza parlour offering home deliveries in its immediate north Madridneighbourhood. By late 1995, it had nearly 200 centres spread out across 120Spanish towns and cities. By the end of 1995, Telepizza expected to postconsolidated profits of more than Pta 800 million (US$6 million), more thandouble the Pta 375 million reported in the previous year. It was forecastingsales of Pta 19 billion for 1995, up from 1994’s Pta 12.3 billion.

‘The market was zero when we started’, says Mr Jose Maria Serrano,Telepizza’s communications chief, ‘but there was a terrific opportunity.’ MrLeopoldo Fernandez Pujals, the company’s founder, spotted the gap in themarket. He owns 40% of Telepizza’s shareholder capital and was its chairmanuntil a boardroom coup in mid-1995. Mr Fernandez Pujals was formerly anexecutive with the healthcare multinational Johnson & Johnson. He knows a lotabout marketing and consumer fads and nothing at all about fast food, but heknew what the Spanish public was prepared to buy. When he came acrosspizza home deliveries during a stay in the USA, he had found the product hewas looking for.

Market success

By 1995, Telepizza had a 54% share of the pizza home deliveries market inSpain. Its success is as much the triumph of a concept as it is of a product. Thecompany’s management understood that Spain had undergone a profoundsociological change that had brought young mothers out of the kitchen andinto the workplace. Furthermore, office workers, like everywhere else, hadbegun to eat at their desks.

Home deliveries, as opposed to office deliveries, make up the bulk ofTelepizza’s business. They are ordered both by children battling with their

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homework while their parents are still at their jobs or by exhausted parentsstaggering home late because office hours in Spain can stretch into the night.Telepizza also understands that although Spaniards have belatedly come roundto the concept of fast food, the domestic culture remains imbued with thetradition of good home-made cooking. This means that the company has totake special care over the quality of its product – fresh ingredients aredelivered daily – and over the amount of choice it offers its customers. Havingpioneered pizza home deliveries, Telepizza has stayed ahead of its competitorsby introducing the do-it-yourself pizza: clients can summon up literallythousands of permutations of the product’s 15 basic ingredients. Its mostrecent success was the Tex-Mex pizza called ‘the Jalisco’, dreamt up by itsconsumer research department.

Corporate culture

The corporate culture and growth strategy are no less important. Telepizzabelieves in decentralisation and cutting out bureaucracy. This ethos has set thetone of its staff relations and franchising. Telepizza has succeeded in creating acorporate culture and with it an expansion strategy that has multiplied itsrewards. Employees who deliver pizzas by motorcycle within half an hour ofreceiving the order are, in the company’s parlance, autonomous businesspeople responsible for their own slice of the pizza market. These employeesare allotted a specific area. It is up to them to develop a relationship with theirclients. Spurred on by sales incentives and bonus packages, Telepizza’srepresentatives will spend nearly as much time promoting the company in theirallotted area as they do delivering its products to customers. Althoughnumbers vary per outlet, there are approximately ten people, including fivesales representatives, employed in each pizza parlour.

About half the 195 Telepizza centres in Spain are franchises. The companybelieves that this mix is the right one and that as it expands further franchiseswill, for the time being, be the property of the existing 50 or so franchiseowners. ‘For a franchise system to work, you have to love the company andwhat it produces’, says Mr Serrano. ‘These are exactly the sort of people thatwe have got now and we want them to grow with us.’

Investment policy

Telepizza has pursued a strong investment policy, ploughing Pta 1.3 billion intonew centres and equipment in 1994. It invested a further Pta 1.5 billion in 1995.One reason for the boardroom revolt that forced Mr Fernandez Pujal’sresignation in October 1995 was that other shareholders were clamouring fordividends and objected to the drive for expansion that he was masterminding.

Firmly established in Spain, Telepizza has also tested foreign waters, againthrough a mixture of directly owned outlets and franchises, and has set uparound 50 centres abroad. It is operating in Poland, Portugal, Greece andBelgium as well as in Mexico, Chile and Colombia. The focus is on Spain,however, and its home market is far from saturated.

Source: Corporate Strategy by Lynch (Financial Times, 16 November 1995)

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Questions:

1 To what extent does Telepizza’s structure need to remain loose inorder to encourage the dynamic entrepreneurial spirit that hascharacterised its growth? What are the problems with this approach?

2 Is it inevitable that the company will begin to lose its entrepreneurialflair as it grows larger? How is it proposing to hold on to thisapproach?

3 What is your view of the company’s international growth strategy –sensible expansion or a waste of scarce management resources, giventhe continued expansion possibilities in Spain and the resourcedifficulties of supervising foreign operations?

CASE STUDY FEEDBACK


It is desirable that the organisation remains loose as long as possible in order tocontinue to build growth. The problems with such an approach are:

� The company may experience poor profit and cash controlbecause the systems are weak.

� The quality of the product which is so important to its success,according to the case, may suffer if central monitoring isignored. There might be a temptation for individual outlets tosacrifice quality for quantity and the centre would never know.

� Entrepreneurs might compete with each other inside arestaurant outlet on price or service, which may not beadvantageous for the company.


The evidence of Greiner in Chapter 7 would suggest that it is likely that it willbecome more bureaucratic: age and size will probably make the company lessdynamic. Hence, as the enterprise grows, there may be a need to define moreprecisely the geographical territories or face the possibility that restaurantswill compete against each other. This will limit the loose nature of thestructure.

The company is attempting to hold its growth by restricting franchises toexisting holders and by funding much of its growth internally. It wanted to

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retain the loyalty of its existing people. However, it is highly likely that some ofthe initial zip will go out of the company.


Although full details are not given in the case, it is likely that significantresources are devoted to the international growth in the 50 centres operatingabroad. There will inevitably come a time when further growth in Spain will bedifficult: international opportunities will then maintain the momentum of thegroup. Moreover, international growth would be one way of offering anincentive to those individual managers unable to find new outlets in Spain.

However, there is no evidence that growth has disappeared in Spain. Given itsstrengths in the home market, it is surprising that so much effort seems to havebeen devoted to international expansion with all its associated costs andpressures.

Given that international expansion has now taken place, one way forward is tofind a balance between the home market expansion and foreign growth. At thetime of the case, it would appear that international growth should take secondplace to completing national expansion in Spain. However, this does not meanthat international growth should stop, rather that a judgement is required onthe pace of such expansion.

Case note – what happended later

The founder, Mr Leopoldo Fernandez Pujals, reduced his shareholding from40% to 22 % in June 1996. The well-known large Spanish bank, Banco BilbaoVizcaya (BBV), bought 18 % of the company. This move was a prelude to thecompany seeking a listing on the stock market for its shares through a publicoffer of 40 % of its shares in September 1996: BBV was acting as co-ordinatorof the share issue, with Merrill Lynch responsible for a placing of part of theshares internationally.

The company was beginning to mature: the founder was selling part of his initialinterest and the shareholding was becoming more widely available andinstitutionalised.

Summary

In this unit we have looked at the challenges posed by disruptivetechnologies, particularly on established companies. We have examinedhow some of the problems can be managed, and have noted theimportance of cultivating a learning culture, and the importance oforganisations adopting strategic flexibility.

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To gain maximum benefit from this unit, students are encouraged toassess their own organisation’s approach to disruptive technologies,and identify what changes may be necessary to assess powerfuldisruptive technologies more quickly and respond faster to newopportunities.

REVIEW ACTIVITY

Consider the organisation and industry that you currently work in. As wenoted in this unit, there are likely to be many signals from the periphery of yourindustry (or supporting sectors) from numerous emerging technologies/ideas.Some of these will be relevant to the future, others will be a complete waste oftime.

Identify two or three emerging/new innovations that you feel are likely to makea significant business impact on your sphere of activity. Technologies or ideasthat could offer your organisation deep market potential.

1. Prioritise the technologies/ideas and explain why you have selectedthem. What opportunities or paradigm shift in business do they showpotential for? How could your organisation exploit thesetechnologies/ideas?

2. What threats do they pose for your company and theproducts/services you market?

3. Noting the culture of your own organisation, how would you go aboutassessing these innovative technologies and implementing them(where appropriate)?

Share your findings with your Manager and colleagues in your organisation.Encourage constructive comments.



1. Ref 10*, Chapter 11 – pages 407-416

2. Ref 8, Chapter 12 (including Reading 12.1) pages 256-276,Chapter 17 (including Readings 17.1 & 2) pages 403 – 453


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Unit 10

Strategic IT and e-Business

LEARNING OUTCOMES


� Examine the impact technological advances in IT are having onstrategy.

� Consider impact of e-business on strategy.

� Understand the strategic implications for legacy systems.

Introduction

In the age of the Internet, new markets are emerging faster than everbefore. As each new market goes through its development cycle, it givespower to those companies that are able to harness the power of IT andthe Internet to transform their businesses, and that of their customers.Power is shifting from what was previously a trusted source of valuecreation towards something that was previously secondary.Information has replaced assets as the source of value. This is the newmanagement agenda, and corporate IT strategy has become animportant determinant of stock price.

The strategic shift from assets to information, has also been coupledwith a shift from products to services. Services offerings cannot bemanaged using the same IT systems as product offerings. Servicesofferings are much more customer-centric and this has led to anemphasis on ERP (enterprise resource planning), CRM (customerrelationship management) and supply chain management.Furthermore, it is well recognised that a corporation’s own efficiencycomes from how seamlessly data, information and knowledge flowswithin the company, and indeed between its supply chain and strategicpartners. Unless corporate data can get to the point of decision in time toimpact that decision, Information Management has failed. For all thesereasons IT has become a powerful influence on corporate strategy;Strategic IT defines the very nature of the business. In this new age, IT isnot about the business, it is the business; e-business.

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In this unit we shall examine the impact of technological advances in ITon strategy. We shall also look at the definition of an e-business, andconsider the impact of e-business on strategy.

The Link between Business and ITStrategy

A core theme in business is that IT strategy should be aligned withbusiness strategy. This is difficult to refute as investments shouldsupport real business needs. However, as companies began to dependmore and more on IT in the 1980s and 1990s, it became evident that abusiness strategy without a matching IT strategy was no strategy at all.For this reason, general managers as much as IT executives haverecognised the concept of “strategic alignment”.

Strategic alignment is based on the premise that an organisation definesbusiness strategy, and then an IT strategy to support it. There areobvious challenges with the strategic alignment approach, because

� There may be a lack of coherent or agreed businessstrategy in the first place.

� The strategy may change regularly.

� The strategy-making process may be more emergent thanprescriptive.

IT strategy, just like any other strategy, has to take into account theabove, as this is a prerogative of any modern business. IT strategy has tobe flexible and accommodate a fast changing world. Indeed, corporateIT systems such as Enterprise Resource Planning, Supply ChangeManagement and Customer Relationship Management systems allowfor a level of strategic flexibility for this reason.

Since the emergence of e-business, in particular, the linkage betweenbusiness strategy and IT strategy has been strengthened. IT strategy isno longer solely an output from business strategy, but is a fundamentalinput in itself. Let us explore this paradigm shift further.

IT Strategy as an input to Business Strategy

In today’s world, IT strategy is inextricably linked with businessstrategy. No longer can the approach be taken of defining businessstrategy, and then asking what are the implications for technology, andmatching it to an IT strategy? IT now affects business strategy and canbe seen as an input to business strategy as well as an output. TheInternet, e-business, mobile communications and digital media present

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Unit 10 – Strategic IT and e-Business Global Corporate Strategy

both threats and opportunities; they pose a deep series of challenges tothe business.

So business strategy cannot ignore how technology is changingmarkets, competition and processes. Business processes, that workedwell previously, break down when exposed to the self-service pressuresof the web. Business processes themselves are re-engineered because ofthe new opportunities for efficiency that IT can deliver.

A revised view of alignment is therefore necessary. In particular, it isnecessary to ask the following questions:

1. How does IT change business strategy? (alignment question)

2. What IT investments does business strategy demand?(opportunity question)

The iterative relationship between business strategy and IT strategy canbe summarised as shown in Figure 10.1.

e-business

The advent of e-business is having a profound impact on businessstrategy. The appointment of directors of e-business and theformulation of e-business strategies recognise that IT is changing theway companies do business. This clearly impacts upon businessstrategy; it poses opportunities and threats.

There is sometimes confusion around the definition of e-business. Manyconfuse e-business with e-commerce. But e-business is far more than abusiness that carries out trade electronically (e-commerce). Ane-business is an organisation that is transforming its interactions withcustomers, suppliers, strategic partners and employees by exploiting

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Global Corporate Strategy Unit 10 – Strategic IT and e-Business

Politicalfactors

Economicfactors

Socialfactors

Businessstrategy

Technicalfactors

Technology/ITstrategy

Influence of IT strategy on business strategy

Figure 10.1: Relationship between business and IT strategy.

Web technologies, and extending its market reach to improveperformance. This is at the core of business strategy.

The supporting e-business strategy, the information business strategy,may radically transform business processes (internal and external) andwill define applications (many web-driven) to support the businessprocesses. Information sharing will be at the heart of the strategy.Information sharing may include customers, the company’s supplychain and strategic partners. The Information Management Strategymust enable the company to leverage its knowledge, information andskills; the new value resources.

The components of a company’s e-business strategy can be broadlydepicted as shown in Figure 10.2. Note the cyclic nature of the variouscomponents. This implies continual refinement and change.

ACTIVITY

Read about the huge impact of recent technological advances (principallye-business) on organisations’ strategic approaches, in an extract from GeoffreyMoore’s book Living on the fault line. Find it on p. 451-464, Reading 8.3 in yourkey text, De Wit, B & Meyer, R .

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e-businessstrategy

Leverage informationand knowledge

Define IT environment(security, scalability,

standards, toolsand applications)

Transformbusiness

processes

Figure 10.2: Cyclic nature of e-business strategy.

VIRTUAL CAMPUS

On-demand computing or grid-computing is being touted by the majorcomputer vendors (IBM, Sun, HP) as delivering the next paradigm shift inbusiness. Is this hype or reality?

Very simply, on demand computing harnesses a grid of machines and otherresources (distributed anywhere) to rapidly process data beyond anorganisation’s own available capacity. It is akin to an electricity grid.Organisations pay varying prices for the computing power depending on usageand demand at the time. The business benefits are potentially far-reaching.Companies embracing the on-demand concept are said to be able to adaptdynamically to whatever business challenges arise. By integrating their businessprocesses end-to-end, not only internally, but with their entire supply chain,strategic partners and customers, organisations can exploit this technology torespond rapidly to customer needs, market opportunities or even threats.

Research this area on the Internet. In particular, look at the IBM, Sun and HPwebsites. Discuss these developments with IT colleagues in your ownorganisation.

Now post your views on the Virtual Campus on the following topics:

� Is on-demand computing just hype, or can it deliver real businessbenefits? Elaborate by discussing its likely impact on your business?

� Is on-demand computing going to impact only certain sectors ofindustry, or will it be pervasive?

� What impact might it have on an organisation’s IT strategy andbusiness strategy?

Read the views of others, and pick one particular viewpoint that is contrary toyours and challenge it.

Try to keep a business focus. Avoid technical detail and jargon in your postingsand discussions.

(This virtual campus activity also interlocks with Unit 9 on Innovation)

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IT Strategy Methodology

Strategy Framework

Companies frequently adopt formal methodologies when developingIT strategy. There are many methodologies on the market – developedby leading IT companies and professional services firms such asAccenture. The principles are the same. One that has been used by ‘neweconomy’ organisations is the FAST methodology. The four tasks orelements that make up FAST are:

� Futurising.

� Assets.

� Stimulants.

� Threats.

The “FAST” methodology is entirely inductive, but provides a way ofaddressing strategy-making. It is not the only methodology available.FAST should, in fact, be viewed as a framework to get started; by posingthe right questions. It does not directly address process andimplementation issues. If business strategy and IT strategy are indeedinextricably linked, then there has to be good communication and trustbetween the business and IT personnel. By asking radical questions onfuturising, assets, stimulants and threats, the organisation can addressissues of understudying, involvement, communication and buy-in frompersonnel from the business and IT functions.

Futurising

Some companies, such as the Swedish financial group Skandia, havecreated special teams to question what the future might bring. Theseteams use checklists with probing questions aimed at all parts of thebusiness. The answers to the probing questions highlight importanttrends or significant uncertainties.

Futurising is not just raising an alarm about new technologies and theirfuture impact, but rather looks at the intersection of new technologiesand the shift in the business environment, and asks what is changing,threatening or opportunity-rich. The PEST (political, economic, social,technological) tool for environmental analysis applies in thinking aboutfutures, but more thorough scenarios are likely to be where thesevariables interact.

Some companies are constructing visions, stories, pictures and dramasof what businesses might look like or what businesses could be created.The outputs could be good questions to ask, trends to watch,

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uncertainties to explore, experiments to begin or “must do” ideas todevelop.

The main point about “futurising”, as Skandia calls it, is to explicitlysuggest that the future may not be an extrapolation of the past, thatopportunities co-exist with threats, that uncertainty is inevitable andthat ignoring the future is more risky than trying to create it.

Assets

What competencies, capabilities or assets might yield opportunities?These are “assets” because:

� They are potential sources of value creation.

� They should not be underestimated or left un-exploited.

� They may be hidden until potential is realised throughe-commerce.

For example, if a company has world-class fulfilment processes, thenmoving into e-commerce not only builds on this strength, but might alsomake this capability evident to the world. In other words, existingcapabilities may have even more potential for value creation. JackWelch at General Electric has said that the company’s achievements inits Six Sigma quality processes are now really paying off in e-business,where cost, speed, reliability and quality matter.

As an example of underestimated assets, one conglomerate realised ithad several partnership opportunities and, importantly, informationthreads between its businesses that might allow it to restructure part ofthe logistics industry. Likewise, many information-rich organisationshave content that is valuable to traditional and emerging businesses.

Hidden assets can become evident in many ways. For example, anengineering company realised it had a valuable asset in its partsdatabase when a business-to-business electronic market-makerapproached it about building a business-to-business exchange. Thedatabase had taken 40 years to build and was now seen as an asset toprotect as well as to exploit. In other words, when you re-examine abusiness as an information business or rethink it as a new economybusiness, you may discover hidden assets.

Stimulants

The efforts of companies that are trying to encourage entrepreneurialbehaviour can be thought of as “stimulants”. Examples of this areinternal venture capital funds and e-business divisions. Somecompanies measure how much of their capital budget is being allocatedto new ventures and e-commerce. Some businesses are creating

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FAST-track learning schemes to move people through venture capitalunits and back to the mainstream business.

The theory is that there are latent entrepreneurs and e-commerce ideasin companies. Strategy is not all top-down, but should reach through alllevels. It is the classic “let loose” cycle often employed when strategicchange is on the agenda: stimulating everybody to think and act as anew business.

Threats

The final element is to think of threats, but not only as shock treatment.If a company sees how a new entrant or rival can attack, why not attackfirst? This has been a philosophy at General Electric, where executiveteams have been asked to think how their business could be destroyedby e-commerce. Threats stimulate survival instincts and can be moreeffective than looking for opportunities, which can seem optional.

ACTIVITY

Consider the following scenario.

Assume that you are a manager in your organisation, and that yourorganisation has enjoyed significant market dominance in its particular sector.

Now pretend that a new entrant is going to attack your market share. Envisionthe new entrant’s winning approach. What strategy, business and IT, is the newentrant likely to adopt in your sector?

From the above analysis, how can your organisation retain the high-ground andmodify its strategy?

The above approach of envisioning competitive threats and modifying strategyhas been adopted widely. It was used with great success by General Electricduring Jack Welch’s reign.

(The above activity is quite wide in scope. For purposes of this unit, restrict it as best aspossible to the impact of IT on strategy.)

The combination of the four elements, futurising, assets, stimulants andthreats, suggest that both IT personnel and business executives areinvolved and that initiatives are prompted which involvemultifunctional teams. In this way, business strategy and IT strategy areintegrated.

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A positive lesson to be learned from dot.com businesses is thatmultifunctional teams build and evolve the business with nodemarcation between functions, skills and strategies. This leads toredefining IT strategy and planning.

Today’s Strategy Challenges

In a global marketplace where technological innovations have aprofound impact on corporate strategy and organisation, the ITmethodology framework must be comprehensive, and flexible inincorporating new challenges and business change into coreinformation systems. Traditional methods of IT strategy-making,whether framed as ‘alignment’, ‘opportunity’ or both, were periodic(often annual), formalised, long-term and driven principally by the ITdepartment. They allowed little flexibility for change or for the adoptionof new processes and technologies. These methods are no longersatisfactory, as they were discontinuous, lacked ‘buy-in’ from thebusiness and hence implementation of strategy often lost momentum.In today’s world, IT strategy cannot just be the domain of the ITdepartment; it must engage the businesses. It must deliver real businessbenefits in short-time frames.

New methods of IT strategy-making have the following characteristics;

� Continuous.

� Flexible.

� Involve learning by doing.

� Rapid turnaround and delivery of quick ‘wins’.

� A ‘natural’ activity.

Today, strategy – integrated IT and business strategy – is revisitedfrequently; priorities re-evaluated, new technologies assessed andincorporated where relevant to the business. Strategy can no longer becast in stone. The pressure to launch, the need to respond to what islearnt by doing, the uncertainty of new markets and models, and the factthat on-line business evolves in real time, mean that the formalstructures of traditional IT strategy-making are inappropriate.

Because IT strategy-making is business development, it is amulti-functional team effort. The chief executive and technologydirector should be in frequent dialogue. IT people are learning to workwith marketing people and vice versa. Furthermore, strategising andplanning must be closely followed by implementation. RapidApplication Development methodologies are frequently adopted.Strategy making is now an evolving, continuous, ever-changingprocess. (See Figure 10.3). The underlying IT architectural frameworkmust allow for change.

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IT strategy must support the entire life cycle of the organisation’sinformation systems, and enable them to evolve over time to meetchanging business demands. It must adhere to a common architectureand comply with industry standards.

In broad terms, the steps in developing and implementing IT strategycan be summarised as follows:

1. Capture organisational strategy.

2. Map business processes to the organisation.

3. Link strategy, organisation and processes.

4. Carry out process re-engineering, where appropriate.

5. Implement and align relevant information systems.

6. Manage all aspects of evolution, including business domains,processes, applications and third-party systems.

Figure 10.3 illustrates the cyclic nature of the various stages.

Reconciling Legacy Systems with NewTechnologies

Unless the organisation is a very young organisation, reconciling newtechnologies with legacy systems is a fundamental pre-requisite of acorporation’s IT strategy.

Established companies cannot afford to take a revolutionary approach,and legacy integration is a key requirement. Therefore, the IT strategy

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ManageIT

evolution

Capture organisationalstrategy

Implement and aligninformation systems

Map business processesto the organisation

Processre-engineering

Link strategy,organisation

and processes

Figure 10.3: Evolutionary nature of IT strategy.

must deliver a flexible architecture that allows new components andmission-critical legacy systems to be integrated and managed inharmony. Competitive pressures and the drive for increased efficiencyand productivity demand that the integrated environment be a moderne-business environment. The e-business environment must leveragelegacy systems, because organisations can’t replace them quicklyenough and still be responsive to business needs.

Let us briefly examine the implications for legacy systems. Firstly, it isimportant to note that 70% of the world’s data still resides on legacysystems. Legacy systems are frequently ‘fragile’ (due to poordocumentation, loss of expertise, etc.), and changes to such systems arenot only costly and time-consuming, but risky. For this reason legacysystems should be left unaltered as far as is possible. However, somechanges are necessary to reconcile legacy systems with the newcomponents and achieve integration on an e-platform. Today’s businessdemands that customers and suppliers are provided with the mostup-to-date information possible – whether that be by Internet, e-mail,phone, etc. They also demand a familiar, easy-to-use interface.Consequently, legacy integration must support real-time access, and befronted by familiar interfaces such as a web front-end. These changesare fairly minimal and can be achieved by use of Application ProgramInterfaces (APIs) and wrappers, but maintaining the core applicationlogic.

In conclusion, in the Internet age, most companies will find that it ismore strategic than ever to adopt a flexible architecture and maintainmany of their mission-critical legacy systems. Clearly new applicationsshould be developed as ‘genuine’ e-business applications. In this way,legacy systems can be reconciled with new technologies on ane-business platform.

ACTIVITY

Research the impact of the Internet and other IT technologies on the ‘neweconomy’ by reading some of the articles on the following websites:

www.gartner.com

www.forrester.com

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CASE STUDY –compuship.com/easy2ship.com

Problems developing a global e-commerce concept into a viablebusiness process.

Case study from Tayeb M (2003) International Management Theories and Practices.Harlow: Pearson. (Chapter 8. E-commerce Worldwide by Brian M W Clements andMonir H Tayeb)

The concept

It is acknowledged by the European transport industry that there exists aninefficiency of over 30% in road haulage operations, i.e. either the vehicle isempty for 30% of its journeys or is 30% empty on every journey. In reality it isprobably a combination of the two states. 30% is a minimum conservativeestimate and in the USA it could be nearer 40%.

Efforts are always made to reduce this inefficiency by ensuring maximumpossible loading or finding return loads. Traditionally this has been difficult.Either there are problems of timing and co-ordination, or financial problemsdue to the unknown creditworthiness of shippers of return loads.

By using e-commerce Internet connectivity, it is possible to bring togetherpotential carriers and shippers in real time to maximise efficiency. The reducedfixed costs of the carrier should offset freight reductions offered as aninducement to the shipper as well as providing revenue for the serviceprovider. This creates a win/win/win scenario.

Additionally, by factoring the service through a bank/credit agency, the serviceprovider can guarantee payment to the carrier within a fixed timeframe.

Further benefits are the provision of cargo insurance as well as creating a newmarketing channel within the transport industry.

The history

In 1997, an American computer reseller became unhappy with the level ofservice his company was receiving from the carriers he used to deliverequipment to his customers. This caused him to analyse the nature of thecarriers transport operations to see if he could identify areas where theirservices could be improved.

During his research, he discovered only one fact that struck him as being apossible area of improvement. He learned from several sources that roadtransport had one particular inefficiency. This was that many journeys wereundertaken unladen and that many others were made with less than a full load.In fact, it appeared that the industry was running at only some 60% of itsmaximum capacity.

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He decided that it would be a simple matter to create an Internet exchange tomanipulate a win/win situation. His belief was that the carrier would beprepared to cost price for last minute loads to fill up empty space, that shipperswould benefit from lower than standard freight rates and that he would be ableto charge a small margin on each transaction. He registered Compuship.comand commenced development.

A year later, due to the uncontrolled and unanticipated software costs he hadincurred, he lost his previously profitable computer business, hisCompuship.com and the rights to the business process he had developed.

Undeterred, he eventually found an entrepreneur who was developing a smallInternet incubation company, I-Global.com, which was interested indeveloping the concept on his behalf. They joined forces and tried tore-acquire the rights to the project development already undertaken.However, they were also suffering from a lack of finance.

They in turn sought external finance. Help came in the form of Ci4net.com, aChannel Island and UK incubation company, recently launched on theNASDAQ market, whose shares were priced at over $100 and who wasconsequently in a buoyant and acquisitive frame of mind. They purchasedI-Global.com, renaming it Ci4netNA.com and financed the re-acquisition ofthe freight exchange for $1 million.

But Ci4net.com was still unhappy about two factors in the proposedoperation. First, they believed that the USA was too large and amorphous amarket for the initial launch. Second, they insisted that the operation neededprofessional input and control by logistics industry experts.

Two were hired, the CEO who was an expert in international logistics andcommerce, the other in UK road haulage and marketing. A wholly owned UKcompany, Easy2ship.com Limited was created in early summer 2000 tocomplete the exchange and launch the concept into the Europeanmarketplace.

The two new directors then collaborated in the creation of both business andmarketing plans for the exploitation of this new exchange process. It becameapparent at the same time that other companies were working on paralleldevelopments, so a measure of urgency was necessary. A beta test and triallaunch were planned for October with a full launch to follow at the end ofNovember.

The Ci4netNA.com took responsibility for the final development and thehosting of the exchange in the US. They eventually located a softwaredevelopment company, Techspan, who are based in California’s “SiliconValley”. Then came the first major setback. After their analysis of thedevelopment work originally undertaken by Compuship.com, Techspanadvised that the work completed only constituted a sketchy demonstrationand lacked the technical flexibility and robustness to be developed into acommercially viable Internet exchange.

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The UK directors immediately flew to California and spent some weeksre-specifying the business processes and re-designing the structure of theexchange. This delay obviously caused the date of the beta test to bepostponed for the ten weeks it was now going to take to develop a workingprototype. This would time the beta test for the hectic fortnight before theChristmas holiday in the UK. It was then decided that the only option was tofurther delay the launch until February 2001.

This delay proved fatal. If the exchange were to be launched in February, theearliest that a revenue stream could be generated would be May. The businessplan reflected the fact that growth to a financially self-sustaining state wouldtake about 18 months and that the company would require a substantialinjection of cash during the first six months of operation to finance apan-European marketing campaign and the expansion of the companystructure.

The problems became apparent at the end of the re-design phase of thedevelopment. Techspan wanted payment for the work to date before theywere prepared to work on the final stage of development. They hadcontracted to undertake the work with the Ci4netNA.com and expectedpayment from them. The UK parent organisation, Ci4net.com, the source of allthe finance, admitted “some cashflow problems”, but that these weretemporary and would soon be resolved.

At the time that Easy2ship.com was formed, the directors were advised that £9million was available for the UK launch. Following the preparation of thebusiness and marketing plans, this was formally increased to £25 million eachfor the pan-European and subsequent North American launches. However,one fact was not disclosed by Ci4net.com.

This was that they had failed to secure a second round of funding in May, whichwas crucial to their development plans. They subsequently acknowledged thatthey had believed that this was a temporary setback and that the second roundfunding would be secured before it was needed to meet their commitments totheir 50-odd subsidiaries. In reality, Ci4net.com had insufficient skilledmanagers to control the activities of all these subsidiaries. Their efforts to doso apparently distracted their attention from events in the world’s financialmarkets.

Many of the Phase 3 Internet companies had “burned” their investors’ money,without having any realistic hope of developing an adequate revenue stream.Institutional investors had leapt onto the bandwagon when they had seen theimmense capital gains to be made from the spectacular and much-publicisedIPO capitalisation of many “Dot.com” companies, but the bubble had burst.

Ci4net.com’s shares, originally valued at over US$100 on the NASDAQmarket had slumped to under US$1 by early 2001. There was no realisticpossibility that they would get second round funding. They divestedthemselves of over 80% of their subsidiaries, keeping Easy2ship.com amongfive or six others. However, they were not able to meet either thedevelopment costs they had incurred with Techspan or the operational costs

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of Easy2ship.com, whose staff was laid off in December 2000 and whose UKdirectors resigned shortly thereafter.

Case study summary

The business process is viable. The concept was professionally market testedthrough focus groups and accepted with enthusiasm by both carriers andpotential users. However, due to its failure from causes outside its directcontrol, as well as the current commercial suspicion of investment inE-commerce, funds are not forthcoming.

This scenario has been repeated in many other commercial sectors, most ofwhich are suffering from a lack of confidence on the part of the institutionalinvestors. They had their fingers burned by investing heavily in E-commercewithout having either made prudent checks that the business process wasgoing to work or that there was the likelihood of the generation of an adequaterevenue stream in the foreseeable future.

Questions:

1. Was the development time a significant cause for the termination ofthe project?

2. What would an investor need to know before making a commitmentto fund such a venture?

3. Can a win/win/win scenario really exist, or is there a commercialloser?

4. Could the concept be limited to operation within national boundaries?

5. What are the likely difficulties of expansion into:

� Europe?

� Non-European countries?

CASE STUDY FEEDBACK


In the normal course of events, the development time might have been lesscritical. Obviously, it is important to keep a development period to theminimum, since at this stage, outgoings may be heavy and there is no income.

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This negative cashflow is normally allowed for in the business plan, as itcertainly was in this case. However, even though the directors were not awareof the parent company’s funding shortfall, there was little that could be done toaccelerate the process of bringing the company online. Therefore, theextended development period was a significant cause for the termination ofthe project, since the parent company could not survive without the incomerelied upon from this source.


An investor would need to know:

� The track record of the management.

� The size of the potential market.

� Details of all competition.

� The reliability of the business process and technology.

� The elapsed time between the start of the project and the firstincome.

� The elapsed time between first income and financial breakeven.

� Critical success factors.


A win/win/win scenario could exist as described in this case study. It is possiblefor the carrier, the shipper and the service provider to benefit from thebusiness process. This is because of the size of the structural inefficiency in thecurrent business process (30%+) and to the detriment of conventional “bricksand mortar” return load service providers.


It would be impractical to attempt to limit this concept to a single state, unlessthe state concerned had no normal road transport access to and fromneighbouring states. In the case of the UK, there is ferry transport toScandinavia, Germany, Netherlands, Belgium, France, Spain and Ireland, as wellas the Channel Tunnel.


Difficulties for expanding into Europe:

� Language barriers for advertising, etc.

� Euro currencies.

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� Dispute resolution.

� Hard copy documentation.

Difficulties for expanding into non-European countries:

� Credit rating of shippers.

� Credit rating of carriers.

� Trust and confidence in all parties.

� Unreliable legal systems.

Summary

We have seen that in today’s world, business strategy is inextricablylinked with IT strategy. The business benefits and competitiveadvantages that new technologies, and e-business, can deliver are huge;a company should be constantly looking to exploit this potential.

We have looked at the role of IT strategy methodologies, and have notedthat methodologies need to allow for flexibility and responsiveness tochanges in the business and in technology. We have briefly consideredhow to manage IT evolution within an organisation and the cyclic role ofthe various processes. We have noted that if e-business is the business,and if IT strategy cannot be separated from business strategy, the chiefexecutive and technology director need to be working as partners.Strategic leadership, that pro-actively encourages multi-functionalstrategic effort, is vital as well as new concepts and practices of strategyformulation.

Finally we have looked at the issue of reconciling legacy systems withthe e-business paradigm.

REVIEW ACTIVITY

We have seen that e-business is far more than just e-commerce. Manycompanies, (e.g. Cisco Systems, Airbus Industrie) have achieved supply chainefficiencies and enormous cost savings by adopting electronic methods such ase-procurement. Use of enterprise resource planning systems (e.g. SAP) hasalso played a significant role.

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Consider your own organisation, irrespective of whether or not in operates inthe new economy; and irrespective of whether or not e-commerceopportunities present itself. What impact has e-business had on yourcompany’s strategy? What is its potential?

1. Consider the changes achieved over the last five years.

2. Address the potential over the next five years, and likely businessbenefits.



Ref 10*, Chapter 11 Pages 400-403

Ref 9, Chapter 14 Pages 381 – 394

Ref 13, Chapter 10 Pages 221-247


References

The following are the references for your key text and supporting texts:

1. Bennett R. (1999) – International Business (2nd Edition) –Published by: Financial Times Pitman Publishing (ISBN0-273-63429-1).

2. Cummings S., Wilson D. (2003) – Images of Strategy – Publishedby Blackwell Publishing (ISBN 0-631-22610-9)

3. De Wit, B. & Meyer, R (2004) – Strategy Process, Content &Context International Perspective (3rd Edition) – Published by:Thomson Learning (ISBN 1-86152-964-3). (Key Text)

4. Ferguson P.R. & Ferguson G.J. (2000) – Organisations – AStrategic Perspective – Published by: Macmillan Press Ltd. (ISBN0-333-74550-7).

5. Grant R.M. (2002) – Contemporary Strategic Analysis – Concepts,Techniques, Applications (4th Edition) – Published by BlackwellPublishers (ISBN 0-631-23136-6)

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6. Haberberg A., & Rieple A. (2001) – The Strategic Management ofOrganisations – Published by: Financial Times Prentice Hall(ISBN 0-13-021971-1)

7. Johnson G. & Scholes K. (1999) – Exploring Corporate Strategy(5th Edition) – Published by: Prentice Hall (ISBN 0-13-080740-0).

8. Joyce P. & Woods A. (2001) – Strategic Management – A FreshApproach to Developing Sk ills, Knowledge and Creativity –Published by Kogan Page Limited (ISBN 0 7494 3583 6)

9. Lasserre P. (2003) – Global Strategic Management – Published by:Palgrave McMillan (ISBN 0-333-79375-7)

10. Lynch, R. (2003) – Corporate Strategy (3rd Edition) – Publishedby: Financial Times Prentice Hall (ISBN 0-273-65854-9). (Mainsupporting text)

11. Mintzberg, H., Ahlstrand B., & Lampel J. (1998) – Strategy Safari– Published by: Financial Times Prentice Hall (ISBN0-273-65636-8)

12. Stacey, R.D. (2000) – Strategic Management & OrganisationalDynamics – The Challenge of Complexity (3rd Edition) –Published by: Financial Times Prentice Hall (ISBN 0-273-64212-X)

13. Stonehouse G., Hamill J., Campbell D. & Purdie T. (2000) – Globaland Transnational Business – Strategy and Management –Published by: John Wiley & Sons (ISBN 0-471-98819-7).

14. Thompson A.A., Strickland A.J, (2003) – Strategic Management –Concepts and Cases – Published by McGraw-Hill Irwin (ISBN0-07-112132-3)

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Documents

Corporate Strategy Mba Sunder Land