International Business Ch13 View

Hill: International Business Competing in the Global Marketplace, Fourth Edition

Part 5 The Strategy and Structure of International Business

13. The Organization of International Business

The McGrawHill Companies, 2002

Chap

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3

TheOrganizationofInternationalBusiness





Unilever is one of the worlds oldest multina-tional corporations with extensive product offerings in thefood, detergent, and personal care businesses. It gener-ates annual revenues in excess of $50 billion and sellsmore than 1,000 branded products in virtually every coun-try. Detergents, which account for about 25 percent ofcorporate revenues, include well-known names such asOmo, which is sold in over 50 countries. Personal careproducts, which account for about 15 percent of sales, in-clude Calvin Klein Cosmetics, Pepsodent toothpastebrands, Faberge hair care products, and Vaseline skin lo-tions. Food products account for the remaining 60 percentof sales and include strong offerings in margarine (whereUnilevers market share in most countries exceeds 70 per-cent), tea, ice cream, frozen foods, and bakery products.

Historically, Unilever was organized on a decentralizedbasis. Subsidiary companies in each major national marketwere responsible for the production, marketing, sales, anddistribution of products in that market. In Europe the com-pany had 17 subsidiaries in the early 1990s, each focusedon a different national market. Each was a profit center andeach was held accountable for its own performance. Thisdecentralization was viewed as a source of strength. Thestructure allowed local managers to match product offer-ings and marketing strategy to local tastes and prefer-ences and to alter sales and distribution strategies to fitthe prevailing retail systems. To drive the localization,Unilever recruited local managers to run local organiza-tions; the U.S. subsidiary (Lever Brothers) was run byAmericans, the Indian subsidiary by Indians, and so on.

To knit together the decentralized organization, Unileverworked to build a common organizational culture amongits managers. For years, the company recruited peoplewith similar backgrounds, values, and interests. Thestated preference was for individuals with high levels ofsociability who embrace the companys values, whichemphasize cooperation and consensus building amongmanagers. It is said that the company has been so suc-cessful at this that Unilever executives recognize one an-other at airports even when they have never met before.Unilevers senior management believes this corps of like-

minded people is the reason its employees work so welltogether, despite their national diversity.

Unilever has also worked hard to periodically bring thesemanagers together. Annual conferences on company strat-egy and executive education sessions at Unilevers man-agement training center outside of London help establishconnections between managers. The idea is to build an in-formal network of equals who know one another well andusually continue to meet and exchange experiences.Unilever also moves its young managers frequently, acrossborders, products, and division. This policy starts Unileverrelationships early as well as increases know-how.

By the mid-1990s, the decentralized structure was in-creasingly out of step with a rapidly changing competitiveenvironment. Unilevers global competitors, which includethe Swiss firm Nestl and Procter & Gamble from theUnited States, had been more successful than Unilever onseveral frontsbuilding global brands, reducing cost struc-ture by consolidating manufacturing operations at a fewchoice locations, and executing simultaneous productlaunches in several national markets. Unilevers decentral-ized structure worked against efforts to build global or re-gional brands. It also meant lots of duplication, particularlyin manufacturing, a lack of scale economies, and a highcost structure. Unilever also found that it was falling be-hind rivals in the race to bring new products to market. InEurope, for example, while Nestl and Procter & Gamblemoved toward pan-European product launches, it couldtake Unilever four to five years to persuade its 17 Euro-pean operations to adopt a new product.

Unilever began to change all this in the mid-1990s. In1996, it introduced a new structure based on regionalbusiness groups. Within each business group are a num-ber of divisions, each focusing on a specific category ofproducts. Thus, within the European Business Group is adivision focusing on detergents, another on ice cream andfrozen foods, and so on. These groups and divisions havebeen given the responsibility for coordinating the activi-ties of national subsidiaries within their region to drivedown operating costs and speed up the process of devel-oping and introducing new products.

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r IntroductionOrganizational ArchitectureOrganizational Structure

Vertical Differentiation:Centralization andDecentralizationHorizontal Differentiation: TheDesign of StructureIntegrating Mechanisms

Control Systems and IncentivesTypes of Control SystemsIncentive SystemsControl Systems, Incentives,and Strategy in theInternational Business

ProcessesOrganizational Culture

How Is Organizational CultureCreated and Maintained?Organizational Culture andPerformance in theInternational Business

Synthesis: Strategy andArchitecture

Multidomestic FirmsInternational FirmsGlobal FirmsTransnational FirmsEnvironment, Strategy,Architecture, andPerformance

Organizational ChangeOrganizational InertiaImplementing OrganizationalChange

Chapter SummaryCritical Discussion QuestionsClosing Case: OrganizationalChange at Royal Dutch/Shell





Lever Europe was established to consolidate the companys detergent opera-tions. The 17 European companies now report directly to Lever Europe. Using its new-found organizational clout, Lever Europe consolidates the production of detergents inEurope in a few key locations to reduce costs and speed up new product introduction.Implicit in this new approach is a bargain: the 17 companies relinquished autonomy intheir traditional markets in exchange for opportunities to help develop and execute aunified pan-European strategy. The number of European plants manufacturing soaphas been cut from 10 to 2, and some new products will be manufactured at only onesite. Product sizing and packaging are harmonized to cut purchasing costs and to ac-commodate unified pan-European advertising. By taking these steps, Unilever esti-mates it has saved as much as $400 million a year in its European detergent operations.

Lever Europe is also attempting to speed development of new products and to syn-chronize the launch of new products throughout Europe. Nonetheless, history still im-poses constraints. While Procter & Gambles leading laundry detergent carries thesame brand name across Europe, Unilever sells its product under a variety of names.The company has no plans to change this. Having spent 100 years building these brandnames, it believes it would be foolish to scrap them in the interest of pan-Europeanstandardization.

Source: Guy de Jonquieres, Unilever Adopts a Clean Sheet Approach, Financial Times, October 21,1991, p. 13; C. A. Bartlett and S. Ghoshal, Managing across Borders (Boston: Harvard Business SchoolPress, 1989) H. Connon, Unilevers Got the Nineties Licked, The Guardian, May 24, 1998, p. 5;Unilever: A Networked Organization, Harvard Business Review, NovemberDecember 1996, p. 138;and C. Christensen, and J. Zobel, Unilevers Butter Beater: Innovation for Global Diversity, HarvardBusiness School Case # 9-698-017, March 1998.

This chapter identifies the organizational architecture that international businessesuse to manage and direct their global operations. By organizational architecture wemean the totality of a firms organization, including formal organization structure, con-trol systems and incentives, processes, organizational culture, and people. The core ar-gument outlined in this chapter is that superior enterprise profitability requires threeconditions to be fulfilled. First, the different elements of a firms organizational archi-tecture must be internally consistent. For example, the control and incentive systemsused in the firm must be consistent with the structure of the enterprise. Second, theorganizational architecture must match or fit the strategy of the firmstrategy and ar-chitecture must be consistent. For example, if a firm is pursuing a global strategy but ithas the wrong kind of architecture in place, it is unlikely that it will be able to executethat strategy effectively and poor performance may result. Third, the strategy and ar-chitecture of the firm must not only be consistent with each other, but they also mustbe consistent with competitive conditions prevailing in the firms marketsstrategy,architecture, and competitive environment must all be consistent. For example, a firm pur-suing a multidomestic strategy might have the right kind of organizational architec-ture in place. However, if it competes in markets where cost pressures are intense anddemands for local responsiveness are low, it will still have inferior performance becausea global strategy is more appropriate in such an environment.

The opening case on Unilever touches on some of the important issues here. His-torically Unilever has competed in markets where local responsiveness has been veryimportant. The production and marketing of food, detergent, and personal care prod-ucts have traditionally been tailored to the tastes and preferences of consumers in dif-ferent nations. Unilever satisfied this environmental demand for local responsivenessby pursuing a multidomestic strategy. Its organizational architecture reflected thisstrategy. Unilever operated with a decentralized structure that delegated responsibil-ity for production, marketing, sales, and distribution decisions to autonomous nationaloperating companies. This allowed local managers to configure product offerings, andmarketing and sales activities, to the conditions prevailing in a particular nation. For

434 Part 5 The Strategy and Structure of International Business

Introduction





a long time, this fit between strategy and architecture served Unilever well, helping itto become a dominant consumer products enterprise.

However, by the early 1990s the competitive environment was changing. Tradebarriers between countries were falling, particularly in the European Union followingthe creation of a single market in 1992. This made it possible to manufacture certainitems such as detergents and margarine at favorable central locations in order to real-ize the benefits associated with location and experience curve economies. Also, newproducts in areas such as frozen foods and margarine were gaining regional or evenglobal acceptance. Unfortunately for Unilever, some of its global competitors movedmore rapidly to exploit this change in the competitive environment. Unilever founditself disadvantaged by a high cost structure (caused by the duplication of manufac-turing operations) and an inability to introduce new products in several national mar-kets at once. In other words, the competitive environment changed, but Unilever didnot change with it. By the mid-1990s, Unilever had recognized its problems andchanged both its strategy and its organizational architecture so that it better matchedthe new competitive realities. Unilever began to adopt a transnational strategic ori-entation, seeking to balance local responsiveness in marketing and sales with the cen-tralization of manufacturing and product development activities to realize scaleeconomies and execute pan-regional product launches. To implement this strategy,Unilever introduced a new organizational architecture based on regional businessgroups, each of which contained product divisions. These divisions were given the re-sponsibility for centralizing manufacturing and product development activities, whichimplied a reduction in the autonomy traditionally granted to operating subsidiaries. Toreestablish a fit between strategy, architecture, and environment, Unilever had to em-brace the difficult process of strategic and organizational change.

To explore the issues illustrated by cases such as Unilevers, we open the currentchapter by discussing in more detail the concepts of organizational architecture and fit.Next we turn to a more detailed exploration of various components of architecturestructure, control systems and incentives, organization culture, and processesandexplain how these components must be internally consistent. (We discuss the peo-ple component of architecture in Chapter 18, when we discuss human resource strat-egy in the multinational firm.) After reviewing the various components ofarchitecture, we look at the ways in which architecture can be matched to strategy andthe competitive environment to achieve high performance. The chapter closes with adiscussion of organizational change, for as the Unilever case illustrates, periodicallyfirms have to change their organization so that it matches new strategic and compet-itive realities.

As noted in the introduction, the term organizational architecture refers to the totalityof a firms organization, including formal organizational structure, control systems andincentives, organizational culture, processes, and people.1 Figure 13.1 illustrates thesedifferent elements. By organizational structure, we mean three things: First, the formaldivision of the organization into subunits such as product divisions, national opera-tions, and functions (most organizational charts display this aspect of structure); sec-ond, the location of decision-making responsibilities within that structure (e.g.,centralized or decentralized); and third, the establishment of integrating mechanismsto coordinate the activities of subunits including cross functional teams and or pan-regional committees.

Control systems are the metrics used to measure the performance of subunits andmake judgments about how well managers are running those subunits. For example, his-torically Unilever measured the performance of national operating subsidiary compa-nies according to profitabilityprofitability was the metric. Incentives are the devices

Chapter 13 The Organization of International Business 435

Organizational Architecture





used to reward appropriate managerial behavior. Incentives are very closely tied to per-formance metrics. For example, the incentives of a manager in charge of a national op-erating subsidiary might be linked to the performance of that company. Specifically, shemight receive a bonus if her subsidiary exceeds its performance targets.

Processes are the manner in which decisions are made and work is performedwithin the organization. Examples are the processes for formulating strategy, for de-ciding how to allocate resources within a firm, or for evaluating the performance ofmanagers and giving feedback. Processes are conceptually distinct from the location ofdecision-making responsibilities within an organization, although both involve deci-sions. While the CEO might have ultimate responsibility for deciding what the strat-egy of the firm should be (i.e., the decision-making responsibility is centralized), theprocess he or she uses to make that decision might include the solicitation of ideas andcriticism from lower-level managers.

Organizational culture is the norms and value systems that are shared among theemployees of an organization. Just as societies have cultures (see Chapter 3 for details),so do organizations. Organizations are societies of individuals who come together toperform collective tasks. They have their own distinctive patterns of culture and sub-culture.2 As we shall see, organizational culture can have a profound impact on how afirm performs. Finally, by people we mean not just the employees of the organization,but also the strategy used to recruit, compensate, and retain those individuals and thetype of people that they are in terms of their skills, values, and orientation (discussedin depth in Chapter 18).

As illustrated by the arrows in Figure 13.1, the various components of an organiza-tions architecture are not independent of each other: Each component shapes, and isshaped by, other components of architecture. An obvious example is the strategy re-garding people. This can be used proactively to hire individuals whose internal valuesare consistent with those that the firm wishes to emphasize in its organization culture.Thus, the people component of architecture can be used to reinforce (or not) the pre-vailing culture of the organization. This seems to have been the practice at Unilever,where an effort was made to hire individuals who were sociable and placed a high valueon consensus and cooperation, values that the enterprise wished to emphasize in itsown culture.

If a firm to going to maximize its profitability, it must pay close attention to achiev-ing internal consistency between the various components of its architecture. Let us lookat how structure and control systems might be inconsistent with each other. Figure13.2 shows an organizational chart for how Unilevers European operations might be

Figure 13.1Organization Architecture


ControlsAnd

IncentivesProcesses

Structure

People

Culture





structured (this chart is hypothetical). Note that there are several country subsidiaries,one for France, one for Germany, one for Spain, and so on, each reporting to the Eu-ropean Business Group. There are also several pan-European product divisions, one fordetergents, one for frozen food, one for margarine, and so on, again each reporting tothe European Business Group. Within this structure, responsibility for marketing,sales, and distribution decisions might be given to the country subsidiaries, while re-sponsibility for product manufacturing might be given to the product divisions. As forcontrol systems, imagine that profitability is the metric used to evaluate the perfor-mance of the country subsidiaries.

One problem with this set of arrangements is that the profitability of the countrysubsidiaries depends on manufacturing costs and new product development, and yetthe managers running the various country subsidiaries are not responsible for those im-portant functionsresponsibility resides in the product divisions! Thus, if the man-agers of the product divisions do not do their job properly, production costs may riseand the profitability of the country subsidiaries might fall. In other words, the man-agers of the country subsidiaries are being evaluated according to a metric over whichthey do not have total control. If the performance of a subsidiary declines, they mayargue that this is not their fault; it was due to the inability of the managers in the pan-European product divisions to drive down manufacturing costs. Thus, there is a po-tential conflict between structure and the control systems used; they are potentiallyinconsistent.

Some inconsistency is a fact of life in organizations. Perfection in the design of or-ganization architecture is very difficult to achieve. Nevertheless, the inconsistency be-tween different components of an organizations architecture can be minimized throughintelligent design. In the example just given, if the performance of each product divi-sion were assessed on the basis of manufacturing costs, it would give the managers ofthe product division the incentive to optimize manufacturing efficiency. The problemmight be further alleviated if the heads of both the country subsidiaries and the Euro-pean product divisions were rewarded according to the profitability of the entire Euro-pean Business Group (for example, by having their bonus pay linked to the profitabilityof the entire group). This would give the heads of the divisions a further reason to re-duce manufacturing costs, and it would create an incentive for the heads of each sub-sidiary and division to share any best practices developed in their operation withcolleagues across Europe to the betterment of the entire European Business Group.

Internal consistency is a necessity but not a sufficient condition for high perfor-mance. Consistency between architecture and the strategy of the organization is also

Figure 13.2Fictional OrganizationalStructure at Unilever


France

MargarineFrozenFoodDetergents

Germany

Spain

European BusinessGroup





required; architecture must fit strategy. When Unilever began to emphasize cost re-duction as a major strategic goal, the firm had to change its architecture to match thisnew strategic reality. It had to move away from a structure based primarily on stand-alone operating subsidiaries in each country and toward one that looks more like thestructure depicted in Figure 13.2. Unilever had to create some entity, in this case theproduct divisions, that could reduce the duplication of manufacturing operationsacross country subsidiaries and consolidate manufacturing at a few choice locations.Such change is easier said than done. It is relatively easy for senior managers to an-nounce a radical change in strategy, but it is much harder to actually put that changeinto action. Doing so requires a change in architecture. Strategy is implemented througharchitecture, and changing architecture is much more difficult than announcing a change instrategy. We shall discuss why it is hard to change architecture later in this chapter.As we shall see, a prime reason is that organizations tend to be relative inert; they areby nature difficult to change.

Even with internal consistency and a fit between strategy and architecture, highperformance is not guaranteed. The firm must also ensure that the fusion between itsstrategy and architecture is consistent with the competitive demands of the market, ormarkets, in which the firm competes. In the 1980s Unilever had a good fit between itsstrategy and architectureit was pursuing a multidomestic strategy. A decentralizedarchitecture composed of self-contained country subsidiaries was well suited to imple-menting this strategy. However, by the 1990s the strategy no longer made much sensedue to a change in the competitive environment. Trade barriers between nations hadfallen and more efficient global competitors were emerging. Unilevers strategy nolonger fit the environment in which it competed, so it had to change both its strategyand architecture to match the new reality. This type of organizational challenge is notunusual; markets rarely stand still, and firms often have to adjust their strategy and ar-chitecture to match new competitive realities.

Organizational structure means three things: (1) the formal division of the organiza-tion into subunits, which we shall refer to as horizontal differentiation; (2) the loca-tion of decision-making responsibilities within that structure, which we shall refer toas vertical differentiation; and (3) the establishment of integrating mechanisms. Webegin by discussing vertical differentiation, then horizontal differentiation, and thenintegrating mechanisms.

|Vertical Differentiation: Centralization and Decentralization

A firms vertical differentiation determines where in its hierarchy the decision-makingpower is concentrated.3 Are production and marketing decisions centralized in the of-fices of upper-level managers, or are they decentralized to lower-level managers?Where does the responsibility for R&D decisions lie? Are strategic and financial con-trol responsibilities pushed down to operating units, or are they concentrated in thehands of top management? And so on. There are arguments for centralization andother arguments for decentralization.

Arguments for Centralization

There are four main arguments for centralization. First, centralization can facilitate co-ordination. For example, consider a firm that has a component manufacturing opera-tion in Taiwan and an assembly operation in Mexico. The activities of these twooperations may need to be coordinated to ensure a smooth flow of products from thecomponent operation to the assembly operation. This might be achieved by central-


Organizational Structure





izing production scheduling at the firms head office. Second, centralization can helpensure that decisions are consistent with organizational objectives. When decisionsare decentralized to lower-level managers, those managers may make decisions at vari-ance with top managements goals. Centralization of important decisions minimizesthe chance of this occurring.

Third, by concentrating power and authority in one individual or a managementteam, centralization can give top-level managers the means to bring about needed ma-jor organizational changes. Fourth, centralization can avoid the duplication of activi-ties that occurs when similar activities are carried on by various subunits within theorganization. For example, many international firms centralize their R&D functionsat one or two locations to ensure that R&D work is not duplicated. Production activ-ities may be centralized at key locations for the same reason.

Arguments for Decentralization

There are five main arguments for decentralization. First, top management can be-come overburdened when decision-making authority is centralized, and this can resultin poor decisions. Decentralization gives top management time to focus on critical is-sues by delegating more routine issues to lower-level managers. Second, motivationalresearch favors decentralization. Behavioral scientists have long argued that people arewilling to give more to their jobs when they have a greater degree of individual free-dom and control over their work. Third, decentralization permits greater flexibilitymore rapid response to environmental changesbecause decisions do not have to bereferred up the hierarchy unless they are exceptional in nature. Fourth, decentral-ization can result in better decisions. In a decentralized structure, decisions are madecloser to the spot by individuals who (presumably) have better information than man-agers several levels up in a hierarchy. Fifth, decentralization can increase control. De-centralization can be used to establish relatively autonomous, self-contained subunitswithin an organization. Subunit managers can then be held accountable for subunitperformance. The more responsibility subunit managers have for decisions that impactsubunit performance, the fewer alibis they have for poor performance.

Strategy and Centralization in an International Business

The choice between centralization and decentralization is not absolute. Frequently itmakes sense to centralize some decisions and to decentralize others, depending on thetype of decision and the firms strategy. Decisions regarding overall firm strategy, ma-jor financial expenditures, financial objectives, and the like are typically centralizedat the firms headquarters. However, operating decisions, such as those relating to pro-duction, marketing, R&D, and human resource management, may or may not be cen-tralized depending on the firms international strategy.

Consider firms pursuing a global strategy. They must decide how to disperse the var-ious value creation activities around the globe so location and experience economiescan be realized. The head office must make the decisions about where to locate R&D,production, marketing, and so on. In addition, the globally dispersed web of value cre-ation activities that facilitates a global strategy must be coordinated. All of this cre-ates pressures for centralizing some operating decisions.

In contrast, the emphasis on local responsiveness in multidomestic firms createsstrong pressures for decentralizing operating decisions to foreign subsidiaries. In the clas-sic multidomestic firm, foreign subsidiaries have autonomy in most production and mar-keting decisions. International firms tend to maintain centralized control over their corecompetency and to decentralize other decisions to foreign subsidiaries. This typicallycentralizes control over R&D and/or marketing in the home country and decentralizesoperating decisions to the foreign subsidiaries. For example, Microsoft Corporation,which fits the international mode, centralizes its product development activities (whereits core competencies lie) at its Redmond, Washington, headquarters and decentralizesmarketing activity to various foreign subsidiaries. Thus, while products are developed at






home, managers in the various foreign subsidiaries have significant latitude for formu-lating strategies to market those products in their particular settings.4

The situation in transnational firms is more complex. The need to realize locationand experience curve economies requires some degree of centralized control overglobal production centers (as it does in global firms). However, the need for local re-sponsiveness dictates the decentralization of many operating decisions, particularly formarketing, to foreign subsidiaries. Thus, in transnational firms, some operating deci-sions are relatively centralized, while others are relatively decentralized. In addition,global learning based on the multidirectional transfer of skills between subsidiaries,and between subsidiaries and the corporate center, is a central feature of a firm pursu-ing a transnational strategy. The concept of global learning is predicated on the no-tion that foreign subsidiaries within a multinational firm have significant freedom todevelop their own skills and competencies. Only then can these be leveraged to ben-efit other parts of the organization. A substantial degree of decentralization is requiredif subsidiaries are going to have the freedom to do this. For this reason too, the pursuitof a transnational strategy requires a high degree of decentralization.5

|Horizontal Differentiation: The Design of StructureHorizontal differentiation is concerned with how the firm decides to divide itself intosubunits.6 The decision is normally made on the basis of function, type of business, orgeographical area. In many firms, just one of these predominates, but more complexsolutions are adopted in others. This is particularly likely in the case of internationalfirms, where the conflicting demands to organize the company around different prod-ucts (to realize location and experience curve economies) and different national mar-kets (to remain locally responsive) must be reconciled. One solution to this dilemmais to adopt a matrix structure that divides the organization on the basis of both prod-ucts and national markets (as Unilever apparently did in Europe). In this section welook at different ways firms divide themselves into subunits.

The Structure of Domestic Firms

Most firms begin with no formal structure and are run by a single entrepreneur or asmall team of individuals. As they grow, the demands of management become too greatfor one individual or a small team to handle. At this point the organization is split intofunctions reflecting the firms value creation activities (e.g., production, marketing,R&D, sales). These functions are typically coordinated and controlled by top man-agement (see Figure 13.3). Decision making in this functional structure tends to becentralized.

Further horizontal differentiation may be required if the firm significantly diversi-fies its product offering, which takes the firm into different business areas. For exam-ple, Dutch multinational Philips NV began as a lighting company, but diversificationtook the company into consumer electronics (e.g., visual and audio equipment), in-

Figure 13.3A Typical FunctionalStructure


Buying Units Plants Branch Sales Units Accounting Units

Purchasing Manufacturing Marketing Finance

TopManagement





dustrial electronics (integrated circuits and other electronic components), and med-ical systems (CT scanners and ultrasound systems). In such circumstances, a func-tional structure can be too clumsy. Problems of coordination and control arise whendifferent business areas are managed within the framework of a functional structure.7

For one thing, it becomes difficult to identify the profitability of each distinct businessarea. For another, it is difficult to run a functional department, such as production ormarketing, if it is supervising the value creation activities of several business areas.

To solve the problems of coordination and control, at this stage most firms switchto a product divisional structure (see Figure 13.4). With a product divisional structure,each division is responsible for a distinct product line (business area). Thus, Philipscreated divisions for lighting, consumer electronics, industrial electronics, and med-ical systems. Each product division is set up as a self-contained, largely autonomousentity with its own functions. The responsibility for operating decisions is typically de-centralized to product divisions, which are then held accountable for their perfor-mance. Headquarters is responsible for the overall strategic development of the firmand for the financial control of the various divisions.

The International Division

When firms initially expand abroad, they often group all their international activitiesinto an international division. This has tended to be the case for firms organized onthe basis of functions and for firms organized on the basis of product divisions. Re-gardless of the firms domestic structure, its international division tends to be organizedon geography. Figure 13.5 illustrates this for a firm whose domestic organization isbased on product divisions.

Many manufacturing firms expanded internationally by exporting the productmanufactured at home to foreign subsidiaries to sell. Thus, in the firm illustrated inFigure 13.5, the subsidiaries in Countries 1 and 2 would sell the products manufacturedby Divisions A, B, and C. In time, however, it might prove viable to manufacture theproduct in each country, and so production facilities would be added on a country-by-country basis. For firms with a functional structure at home, this might mean repli-cating the functional structure in every country in which the firm does business. Forfirms with a divisional structure, this might mean replicating the divisional structurein every country in which the firm does business.

This structure has been widely used; according to a Harvard study, 60 percent of allfirms that have expanded internationally have initially adopted it. Nonetheless, it givesrise to problems.8 The dual structure it creates contains inherent potential for conflictand coordination problems between domestic and foreign operations. One problemwith the structure is that the heads of foreign subsidiaries are not given as much voicein the organization as the heads of domestic functions (in the case of functional firms)

Figure 13.4A Typical ProductDivisional Structure


Buying Units Plants Branch Sales Units Accounting Units

DepartmentPurchasing

DepartmentMarketing

DepartmentManufacturing

DepartmentFinance

Division Product Line B Division Product Line CDivision Product Line A

Headquarters





or divisions (in the case of divisional firms). Rather, the head of the international divi-sion is presumed to be able to represent the interests of all countries to headquarters.This effectively relegates each countrys manager to the second tier of the firms hierar-chy, which is inconsistent with a strategy of trying to expand internationally and builda true multinational organization.

Another problem is the implied lack of coordination between domestic operationsand foreign operations, which are isolated from each other in separate parts of thestructural hierarchy. This can inhibit the worldwide introduction of new products, thetransfer of core competencies between domestic and foreign operations, and the con-solidation of global production at key locations so as to realize location and experiencecurve economies. These problems are illustrated in the Management Focus that looksat the experience of Abbott Laboratories with an international divisional structure.

As a result of such problems, most firms that continue to expand internationallyabandon this structure and adopt one of the worldwide structures we discuss next. Thetwo initial choices are a worldwide product divisional structure, which tends to beadopted by diversified firms that have domestic product divisions, and a worldwidearea structure, which tends to be adopted by undiversified firms whose domestic struc-tures are based on functions. These two alternative paths of development are illus-trated in Figure 13.6. The model in the figure is referred to as the internationalstructural stages model and was developed by John Stopford and Louis Wells.9

Worldwide Area Structure

A worldwide area structure tends to be favored by firms with a low degree of diversifi-cation and a domestic structure based on function (see Figure 13.7). Under this struc-ture, the world is divided into geographic areas. An area may be a country (if themarket is large enough) or a group of countries. Each area tends to be a self-contained,largely autonomous entity with its own set of value creation activities (e.g., its ownproduction, marketing, R&D, human resources, and finance functions). Operations


Figure 13.5One Companys International Divisional Structure

Country 1

General Manager(Product A, B,and/or C)

Country 2

General Manager(Product A, B,and/or C)

Functional units

Functional units

Headquarters

Domestic Division

General ManagerProduct Line A

Domestic Division

General ManagerProduct Line B

Domestic Division

General ManagerProduct Line C

International Division

General ManagerArea Line





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The International Division at Abbott Laboratories

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for the U.S. market and then modifying those productsfor foreign customers is a slow and expensive process.Instead, across all four of the companys businesses,Abbott is trying to build global products that can belaunched simultaneously around the world. Thischange is pulling Abbott toward adoptingglobal product divisions for all four of its busi-nesses. Some argue that only global productdivisions would give Abbott the tight controlover product development and productlaunch strategy that is deemed necessary.

On the other hand, bigger organizationswith greater purchasing leverage, such as largehospital groups and health maintenance organiza-tions, are coordinating their buying across a range ofproduct lines in both the United States and elsewhere.These powerful customers prefer to have a single con-tact point at Abbott. Abbott develops stronger relationswith key customers by having a single marketing orga-nization in each country in which the company doesbusinesses. This organization sells the products fromeach of Abbotts four product divisions.

Executives at Abbotts international division sup-port maintaining the geographic organization, whilethe heads of the product divisions favor a shift towardfour global product divisions. Top management seemsto have decided there is no perfect solution to thecompanys organizational problems, and that imper-fect as the current structure is, it works too well tocontemplate a major change.

Sources: R. Walters, Twos Company, Financial Times, July 7,1995, p. 12; Abbott Laboratories 2000 Annual Report; and M.Santoli, Patient Reviving, Barrons, February 28, 2000,pp. 2426.

With sales of about $14 billion in 2000, AbbottLaboratories is one of the worlds largest healthcare companies. The company split itself intothree divisionspharmaceuticals, hospital pro-ducts, and nutritional productsin the 1960s,a structure that still exists. Each division oper-ates as a profit center, and each is relatively au-tonomous and self-contained, with its ownR&D, manufacturing, and marketing functions.By the late 1960s Abbotts foreign sales weregrowing rapidly; the company added an inter-

national division to handle the firms non-U.S. operationson geographic rather than product lines.

Alongside these four divisions, however, a new busi-ness has grown up that is organized differently. Abbottsdiagnostics business was established in the 1970s andbecame a world leader with global sales of $3 billion in2000. Unlike the other divisions, the diagnostics busi-ness is organized on a global basis, operating in foreigncountries through its own staff, rather than through theinternational division. Thus, Abbott handles global salesin two different waysthrough an international divisionand through a global product division (the diagnosticsbusiness organization). The company is debating thebest way of organizing international operations.

This debate is being informed by two changes oc-curring in Abbotts environment, changes that arepulling the company in different directions. One changeis a shift toward global product development in thehealth care industry. To quickly recapture the costs ofdeveloping new products, which for pharmaceuticalscan sometimes top $500 million, companies are tryingto introduce new products as rapidly as possible world-wide. Abbott has found that developing products first

authority and strategic decisions relating to each of these activities are typically de-centralized to each area, with headquarters retaining authority for the overall strate-gic direction of the firm and financial control.

This structure facilitates local responsiveness. Because decision-making respon-sibilities are decentralized, each area can customize product offerings, marketingstrategy, and business strategy to the local conditions. However, this structure en-courages fragmentation of the organization into highly autonomous entities. Thiscan make it difficult to transfer core competencies and skills between areas and torealize location and experience curve economies. In other words, the structure isconsistent with a multidomestic strategy but with little else. Firms structured onthis basis may encounter significant problems if local responsiveness is less criticalthan reducing costs or transferring core competencies for establishing a competi-tive advantage.





Worldwide Product Divisional Structure

A worldwide product division structure tends to be adopted by firms that are reason-ably diversified and, accordingly, originally had domestic structures based on productdivisions. As with the domestic product divisional structure, each division is a self-contained, largely autonomous entity with full responsibility for its own value creationactivities. The headquarters retains responsibility for the overall strategic develop-ment and financial control of the firm (see Figure 13.8).

Underpinning the organization is a belief that the value creation activities of eachproduct division should be coordinated by that division worldwide. Thus, the world-wide product divisional structure is designed to help overcome the coordination prob-lems that arise with the international division and worldwide area structures (see theManagement Focus on Abbott Laboratories for a detailed example). This structure pro-vides an organizational context that enhances the consolidation of value creation ac-tivities at key locations necessary for realizing location and experience curveeconomies. It also facilitates the transfer of core competencies within a divisions world-wide operations and the simultaneous worldwide introduction of new products. Themain problem with the structure is the limited voice it gives to area or country man-agers, since they are seen as subservient to product division managers. The result canbe a lack of local responsiveness, which, as we saw in Chapter 12, can be a fatal flaw.

Global Matrix Structure

Both the worldwide area structure and the worldwide product divisional structure havestrengths and weaknesses. The worldwide area structure facilitates local responsive-


Figure 13.6The International StructuralStages Model

Source: Adapted from John M.Stopford and Louis T. Wells, Strategyand Structure of the MultinationalEnterprise (New York: Basic Books,1972).

ForeignProductDiversity

Foreign Sales as a Percentage of Total Sales

Alternate Pathsof Development

WorldwideProductDivision Global Matrix

("Grid")

AreaDivisionInternational

Division

Figure 13.7A Worldwide AreaStructure

Headquarters

North AmericanArea

Latin AmericanArea

EuropeanArea

Middle Eastern-African Area

Far EastArea





ness, but it can inhibit the realization of location and experience curve economies andthe transfer of core competencies between areas. The worldwide product divisionstructure provides a better framework for pursuing location and experience curveeconomies and for transferring core competencies, but it is weak in local responsive-ness. Other things being equal, this suggests that a worldwide area structure is moreappropriate if the firms strategy is multidomestic, while a worldwide product divi-sional structure is more appropriate for firms pursuing global or international strate-gies. However, as we saw in Chapter 12, other things are not equal. As Bartlett andGhoshal have argued, to survive in some industries, firms must adopt a transnationalstrategy. That is, they must focus simultaneously on realizing location and experiencecurve economies, on local responsiveness, and on the internal transfer of core compe-tencies (worldwide learning).10

Many firms have attempted to cope with the conflicting demands of a transnationalstrategy by using a matrix structure (see Figure 13.2). In the classic global matrix struc-ture, horizontal differentiation proceeds along two dimensions: product division andgeographic area (see Figure 13.9). The philosophy is that responsibility for operatingdecisions pertaining to a particular product should be shared by the product division


Figure 13.8A Worldwide ProductDivisional Structure

Functional Units Functional Units

Headquarters

WorldwideProduct Groupor Division A

WorldwideProduct Groupor Division B

WorldwideProduct Groupor Division C

Area 1

(Domestic)

Area 2

(International)

Figure 13.9A Global Matrix StructureHeadquarters

Area 1 Area 2 Area 3

ProductDivision A

ProductDivision B

ProductDivision C

Manager HereBelongs to Division B and Area 2





and the various areas of the firm. Thus, the nature of the product offering, the mar-keting strategy, and the business strategy to be pursued in Area 1 for the products pro-duced by Division A are determined by conciliation between Division A and Area 1management. It is believed that this dual decision-making responsibility should enablethe firm to simultaneously achieve its particular objectives. In a classic matrix struc-ture, giving product divisions and geographical areas equal status within the organiza-tion reinforces the idea of dual responsibility. Individual managers thus belong to twohierarchies (a divisional hierarchy and an area hierarchy) and have two bosses (a di-visional boss and an area boss).

The reality of the global matrix structure is that it often does not work anywherenear as well as the theory predicts. In practice, the matrix often is clumsy and bureau-cratic. It can require so many meetings that it is difficult to get any work done. Theneed to get an area and a product division to reach a decision can slow decision mak-ing and produce an inflexible organization unable to respond quickly to market shiftsor to innovate. The dual-hierarchy structure can lead to conflict and perpetual powerstruggles between the areas and the product divisions, catching many managers in themiddle. To make matters worse, it can prove difficult to ascertain accountability in thisstructure. When all critical decisions are the product of negotiation between divisionsand areas, one side can always blame the other when things go wrong. As a managerin one global matrix structure, reflecting on a failed product launch, said to the author,Had we been able to do things our way, instead of having to accommodate those guysfrom the product division, this would never have happened. (A manager in the prod-uct division expressed similar sentiments.) The result of such finger-pointing can bethat accountability is compromised, conflict is enhanced, and headquarters loses con-trol over the organization.

In light of these problems, many transnational firms are now trying to build flexi-ble matrix structures based more on firmwide networks and a shared culture and vi-sion than on a rigid hierarchical arrangement. Dow Chemical, profiled in theaccompanying Management Focus, is one such firm. Within such companies the in-formal structure plays a greater role than the formal structure. We discuss this issuewhen we consider informal integrating mechanisms in the next section.

|Integrating MechanismsIn the previous section, we explained that firms divide themselves into subunits. Nowwe need to examine some means of coordinating those subunits. One way of achiev-ing coordination is through centralization. If the coordination task is complex, how-ever, centralization may not be very effective. Higher-level managers responsible forachieving coordination can soon become overwhelmed by the volume of work re-quired to coordinate the activities of various subunits, particularly if the subunits arelarge, diverse, and/or geographically dispersed. When this is the case, firms look to-ward integrating mechanisms, both formal and informal, to help achieve coordination.In this section, we introduce the various integrating mechanisms that internationalbusinesses can use. Before doing so, however, let us explore the need for coordinationin international firms and some impediments to coordination.

Strategy and Coordination in the International Business

The need for coordination between subunits varies with the strategy of the firm. Theneed for coordination is lowest in multidomestic companies, is higher in interna-tional companies, higher still in global companies, and highest of all in transnationalcompanies. Multidomestic firms are primarily concerned with local responsiveness.Such firms are likely to operate with a worldwide area structure in which each areahas considerable autonomy and its own set of value creation functions. Since eacharea is established as a stand-alone entity, the need for coordination between areas isminimized.






The need for coordination is greater in firms pursuing an international strategy andtrying to profit from the transfer of core competencies and skills between units at homeand abroad. Coordination is necessary to support the transfer of skills and product of-ferings between units. The need for coordination is also great in firms trying to profitfrom location and experience curve economies; that is, in firms pursuing global strate-gies. Achieving location and experience economies involves dispersing value creationactivities to various locations around the globe. The resulting global web of activities

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Dow Chemicals Matrix Structure

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overseeing business sectors about which plants shouldbe built and where. In short, the structure didnt work.Instead of abandoning the structure, however, Dow de-cided to see if it could be made more flexible.

Dows decision to keep its matrix structurewas prompted by its move into the pharma-ceuticals industry. The company realized thatthe pharmaceutical business is very differ-ent from the bulk chemicals business. Inbulk chemicals, the big returns come fromachieving economies of scale in production.This dictates establishing large plants in keylocations from which regional or global marketscan be served. But in pharmaceuticals, regulatoryand marketing requirements for drugs vary so muchfrom country to country that local needs are far moreimportant than reducing manufacturing costs throughscale economies. A high degree of local responsive-ness is essential. Dow realized its pharmaceutical busi-ness would never thrive if it were managed by thesame priorities as its mainstream chemical operations.

Accordingly, instead of abandoning its matrix, Dowdecided to make it more flexible so it could better ac-commodate the different businesses, each with itsown priorities, within a single management system. Asmall team of senior executives at headquarters nowhelps set the priorities for each type of business. Af-ter priorities are identified for each business sector,one of the three elements of the matrixfunction,business, or geographic areais given primary au-thority in decision making. Which element takes thelead varies according to the type of decision and themarket or location in which the company is compet-ing. Such flexibility requires that all employees under-stand what is occurring in the rest of the matrix.Although this may seem confusing, Dow claims thisflexible system works well and credits much of itssuccess to the quality of the decisions it facilitates.

Source: Dow Draws Its Matrix Again, and Again, and Again,The Economist, August 5, 1989, pp. 5556.

A handful of major players compete head tohead around the world in the chemical in-dustry. These companies are Dow Chemicaland Du Pont of the United States, GreatBritains ICI, and the German trio of BASF,Hoechst AG, and Bayer. The barriers to thefree flow of chemical products between na-tions largely disappeared in the 1970s. Thisalong with the commodity nature of mostbulk chemicals and a severe recession in theearly 1980s ushered in a prolonged period of

intense price competition. In such an environment,the company that wins the competitive race is the onewith the lowest costs, and in recent years the clearwinner has been Dow.

Dows managers insist that part of the credit mustbe placed at the feet of its much maligned matrixorganization. Dows organizational matrix has threeinteracting elements: functions (e.g., R&D, manufac-turing, marketing), businesses (e.g., ethylene, plas-tics, pharmaceuticals), and geography (e.g., Spain,Germany, Brazil). Managers job titles incorporate allthree elementsfor example, plastics marketing man-ager for Spainand most managers report to at leasttwo bosses. The plastics marketing manager in Spainmight report to both the head of the worldwide plasticsbusiness and the head of the Spanish operations. Theintent of the matrix was to make Dow operations re-sponsive to both local market needs and corporate ob-jectives. Thus, the plastics business might be chargedwith minimizing Dows global plastics productioncosts, while the Spanish operation might be chargedwith determining how best to sell plastics in the Span-ish market.

When Dow introduced this structure, the resultswere less than promising; multiple reporting channelsled to confusion and conflict. The large number ofbosses made for an unwieldy bureaucracy. The overlap-ping responsibilities resulted in turf battles and a lack ofaccountability. Area managers disagreed with managers





must be coordinated to ensure the smooth flow of inputs into the value chain, thesmooth flow of semifinished products through the value chain, and the smooth flowof finished products to markets around the world.

The need for coordination is greatest in transnational firms, which simultaneously pur-sue location and experience curve economies, local responsiveness, and the multidirec-tional transfer of core competencies and skills among all of the firms subunits (referred toas global learning). As in global companies, coordination is required to ensure the smoothflow of products through the global value chain. As in international companies, coordi-nation is required for ensuring the transfer of core competencies to subunits. However, thetransnational goal of achieving multidirectional transfer of competencies requires muchgreater coordination than in international firms. In addition, transnationals require co-ordination between foreign subunits and the firms globally dispersed value creation ac-tivities (e.g., production, R&D, marketing) to ensure that any product offering andmarketing strategy is sufficiently customized to local conditions.

Impediments to Coordination

Managers of the various subunits have different orientations, partly because they havedifferent tasks. For example, production managers are typically concerned with pro-duction issues such as capacity utilization, cost control, and quality control, whereasmarketing managers are concerned with marketing issues such as pricing, promotions,distribution, and market share. These differences can inhibit communication betweenthe managers. Quite simply, these managers often do not even speak the same lan-guage. There may also be a lack of respect between subunits (e.g., marketing managerslooking down on production managers, and vice versa), which further inhibits thecommunication required to achieve cooperation and coordination.

Differences in subunits orientations also arise from their differing goals. For exam-ple, worldwide product divisions of a multinational firm may be committed to costgoals that require global production of a standardized product, whereas a foreign sub-sidiary may be committed to increasing its market share in its country, which will re-quire a nonstandard product. These different goals can lead to conflict.

Such impediments to coordination are not unusual in any firm, but they can be par-ticularly problematic in the multinational enterprise with its profusion of subunits athome and abroad. Differences in subunit orientation are often reinforced in multina-tionals by the separations of time zone, distance, and nationality between managers ofthe subunits.

For example, until recently the Dutch company Philips had an organizationcomprising worldwide product divisions and largely autonomous national organiza-tions. The company has long had problems getting its product divisions and na-tional organizations to cooperate on such things as new product introductions.When Philips developed a VCR format, the V2000 system, it could not get itsNorth American subsidiary to introduce the product. Rather, the North Americanunit adopted the rival VHS format produced by Philips global competitor, Mat-sushita. Unilever experienced a similar problem in its detergents business. Theneed to resolve disputes between Unilevers many national organizations and itsproduct divisions extended the time necessary for introducing a new product acrossEurope to several years. This denied Unilever the first-mover advantage crucial tobuilding a strong market position.11

Formal Integrating Mechanisms

The formal mechanisms used to integrate subunits vary in complexity from simple di-rect contact and liaison roles, to teams, to a matrix structure (see Figure 13.10). In gen-eral, the greater the need for coordination, the more complex the formal integratingmechanisms need to be.12

Direct contact between subunit managers is the simplest integrating mechanism.By this mechanism, managers of the various subunits simply contact each other






whenever they have a common concern. Direct contact may not be effective if themanagers have differing orientations that act to impede coordination, as pointed outin the previous subsection.

Liaison roles are a bit more complex. When the volume of contacts between sub-units increases, coordination can be improved by giving a person in each subunit re-sponsibility for coordinating with another subunit on a regular basis. Through theseroles, the people involved establish a permanent relationship. This helps attenuate theimpediments to coordination discussed in the previous subsection.

When the need for coordination is greater still, firms tend to use temporary orpermanent teams composed of individuals from the subunits that need to achievecoordination. They are typically used to coordinate product development and in-troduction, but they are useful when any aspect of operations or strategy requires thecooperation of two or more subunits. Product development and introduction teamsare typically composed of personnel from R&D, production, and marketing. The re-sulting coordination aids the development of products that are tailored to consumerneeds and that can be produced at a reasonable cost (design for manufacturing).

When the need for integration is very high, firms may institute a matrix structure,in which all roles are viewed as integrating roles. The structure is designed to facilitatemaximum integration among subunits. The most common matrix in multinationalfirms is based on geographical areas and worldwide product divisions. This achieves ahigh level of integration between the product divisions and the areas so that, in the-ory, the firm can pay close attention to both local responsiveness and the pursuit of lo-cation and experience curve economies.

In some multinationals, the matrix is more complex still, structuring the firm intogeographical areas, worldwide product divisions, and functions, all of which report di-rectly to headquarters. Thus, within a company such as Dow Chemical (see the Man-agement Focus) each manager belongs to three hierarchies (e.g., a plastics marketingmanager in Spain is a member of the Spanish subsidiary, the plastics product division,and the marketing function). In addition to facilitating local responsiveness and loca-tion and experience curve economies, such a matrix fosters the transfer of core compe-tencies within the organization. This occurs because core competencies tend to residein functions (e.g., R&D, marketing). A structure such as Dows facilitates the transferof competencies existing in functions from division to division and from area to area.

However, as discussed earlier, such matrix solutions to coordination problems inmultinational enterprises can quickly become bogged down in a bureaucratic tanglethat creates as many problems as it solves. Matrix structures tend to be bureaucratic,inflexible, and characterized by conflict rather than the hoped-for cooperation. As inthe case of Dow Chemical, for such a structure to work it needs to be somewhat flex-ible and to be supported by informal integrating mechanisms.

Figure 13.10Formal IntegratingMechanisms


Direct Contact

Liaison Roles

Teams

Matrix Structures

Increasing Complexityof Integrating Mechanism





Informal Integrating Mechanism: Management Networks

In attempting to alleviate or avoid the problems associated with formal integratingmechanisms in general, and matrix structures in particular, firms with a high need forintegration have been experimenting with an informal integrating mechanism: man-agement networks that are supported by an organization culture that values teamworkand cross-unit cooperation.13 A management network is a system of informal contactsbetween managers within an enterprise.14 The great strength of a network is that itcan be used as a nonbureaucratic conduit for knowledge flows within a multinationalenterprise.15 For a network to exist, managers at different locations within the orga-nization must be linked to each other at least indirectly. For example, Figure 13.11shows the simple network relationships between seven managers within a multina-tional firm. Managers A, B, and C all know each other personally, as do Managers D,E, and F. Although Manager B does not know Manager F personally, they are linkedthrough common acquaintances (Managers C and D). Thus, we can say that ManagersA through F are all part of the network, and also that Manager G is not.

Imagine Manager B is a marketing manager in Spain and needs to know the solu-tion to a technical problem to better serve an important European customer. ManagerF, an R&D manager in the United States, has the solution to Manager Bs problem.Manager B mentions her problem to all of her contacts, including Manager C, and asksif they know of anyone who might be able to provide a solution. Manager C asks Man-ager D, who tells Manager F, who then calls Manager B with the solution. In this way,coordination is achieved informally through the network, rather than by formal inte-grating mechanisms such as teams or a matrix structure.

For such a network to function effectively, however, it must embrace as many man-agers as possible. For example, if Manager G had a problem similar to manager Bs, hewould not be able to utilize the informal network to find a solution; he would have toresort to more formal mechanisms. Establishing firmwide networks is difficult, and al-though network enthusiasts speak of networks as the glue that binds multinationalcompanies together, it is far from clear how successful firms have been at building com-panywide networks. Two techniques being used to establish networks are informationsystems and management development policies.

Firms are using their computer and telecommunications networks to provide thephysical foundation for informal information systems networks.16 Electronic mail,videoconferencing, and high-speed data systems make it much easier for managersscattered over the globe to get to know each other. Without an existing network ofpersonal contacts, however, worldwide information systems are unlikely to meet afirms need for integration.

Firms are using their management development programs to build informal net-works. Tactics include rotating managers through various subunits on a regular basis sothey build their own informal network and using management education programs to

Figure 13.11A Simple ManagementNetwork


A

B

F

EG

C D





bring managers of subunits together in a single location so they can become ac-quainted. Both of these tactics are used at Unilever to build its informal managementnetwork (see the opening case for details).

Management networks by themselves may not be sufficient to achieve coordinationif subunit managers persist in pursuing subgoals that are at variance with firmwidegoals. For a management network to function properlyand for a formal matrix struc-ture to work, alsomanagers must share a strong commitment to the same goals. Toappreciate the nature of the problem, consider again the case of Manager B and Man-ager F. As before, Manager F hears about Manager Bs problem through the network.However, solving Manager Bs problem would require Manager F to devote consider-able time to the task. Insofar as this would divert Manager F away from his own regu-lar tasksand the pursuit of subgoals that differ from those of Manager Bhe may beunwilling to do it. Thus, Manager F may not call Manager B, and the informal net-work would fail to provide a solution to Manager Bs problem.

To eliminate this flaw, organizations managers must adhere to a common set ofnorms and values that override differing subunit orientations.17 In other words, thefirm must have a strong organizational culture that promotes teamwork and coopera-tion. When this is the case, a manager is willing and able to set aside the interests ofhis own subunit when doing so benefits the firm as a whole. If Manager B and Man-ager F are committed to the same organizational norms and value systems, and if theseorganizational norms and values place the interests of the firm as a whole above theinterests of any individual subunit, Manager F should be willing to cooperate withManager B on solving her subunits problems.

Summary

The message contained in this section is crucial to understanding the problems of man-aging the multinational firm. Multinationals need integrationparticularly if they arepursuing global, international, or transnational strategiesbut it can be difficult toachieve due to the impediments to coordination we discussed. Firms traditionally havetried to achieve coordination by adopting formal integrating mechanisms. These do notalways work, however, since they tend to be bureaucratic and do not necessarily addressthe problems that arise from differing subunit orientations. This is particularly likelywith a complex matrix structure, and yet, a complex matrix structure is required for si-multaneously achieving location and experience curve economies, local responsive-ness, and the multidirectional transfer of core competencies within the organization.The solution to this dilemma seems twofold. First, the firm must try to establish an in-formal management network that can do much of the work previously undertaken by aformal matrix structure. Second, the firm must build a common culture. Neither ofthese partial solutions, however, is easy to achieve.18

A major task of a firms leadership is to control the various subunits of the firmwhetherthey be defined on the basis of function, product division, or geographic areato ensuretheir actions are consistent with the firms overall strategic and financial objectives. Firmsachieve this with various control and incentive systems. In this section, we first reviewthe various types of control systems firms use to control their subunits. Then we brieflydiscuss incentive systems. Then we will look at how the appropriate control and incen-tive systems vary according to firms international strategies.

|Types of Control SystemsFour main types of control systems are used in multinational firms: personal controls,bureaucratic controls, output controls, and cultural controls. In most firms, all four areused, but their relative emphasis varies with the strategy of the firm.


Control Systems and Incentives





Personal Controls

Personal control is control by personal contact with subordinates. This type of controltends to be most widely used in small firms, where it is seen in the direct supervisionof subordinates actions. However, it also structures the relationships between man-agers at different levels in multinational enterprises. For example, the CEO may use agreat deal of personal control to influence the behavior of his or her immediate sub-ordinates, such as the heads of worldwide product divisions or major geographic areas.In turn, these heads may use personal control to influence the behavior of their sub-ordinates, and so on down through the organization. For example, Jack Welsh thelongtime CEO of General Electric who retired in 2001, had regular one-on-one meet-ings with the heads of all of GEs major businesses (most of which are international).He used these meetings to probe the managers about the strategy, structure, and fi-nancial performance of their operations. In doing so, he essentially exercised personalcontrol over these managers and, undoubtedly, over the strategies that they favored.

Bureaucratic Controls

Bureaucratic control is control through a system of rules and procedures that directsthe actions of subunits. The most important bureaucratic controls in subunits withinmultinational firms are budgets and capital spending rules. Budgets are essentially a setof rules for allocating a firms financial resources. A subunits budget specifies withsome precision how much the subunit may spend. Headquarters uses budgets to influ-ence the behavior of subunits. For example, the R&D budget normally specifies howmuch cash the R&D unit may spend on product development. R&D managers knowthat if they spend too much on one project, they will have less to spend on other proj-ects, so they modify their behavior to stay within the budget. Most budgets are set bynegotiation between headquarters management and subunit management. Headquar-ters management can encourage the growth of certain subunits and restrict the growthof others by manipulating their budgets.

Capital spending rules require headquarters management to approve any capital ex-penditure by a subunit that exceeds a certain amount (at GE, $50,000). A budget al-lows headquarters to specify the amount a subunit can spend in a given year, andcapital spending rules give headquarters additional control over how the money isspent. Headquarters can be expected to deny approval for capital spending requeststhat are at variance with overall firm objectives and to approve those that are con-gruent with firm objectives.

Output Controls

Output controls involve setting goals for subunits to achieve and expressing thosegoals in terms of relatively objective performance metrics such as profitability, pro-ductivity, growth, market share, and quality. The performance of subunit managers isthen judged by their ability to achieve the goals.19 If goals are met or exceeded, sub-unit managers will be rewarded. If goals are not met, top management will normallyintervene to find out why and take appropriate corrective action. Thus, control isachieved by comparing actual performance against targets and intervening selectivelyto take corrective action. Subunits goals depend on their role in the firm. Self-contained product divisions or national subsidiaries are typically given goals for prof-itability, sales growth, and market share. Functions are more likely to be given goalsrelated to their particular activity. Thus, R&D will be given product developmentgoals, production will be given productivity and quality goals, marketing will be givenmarket share goals, and so on.

As with budgets, goals are normally established through negotiation between sub-units and headquarters. Generally, headquarters tries to set goals that are challengingbut realistic, so subunit managers are forced to look for ways to improve their opera-tions but are not so pressured that they will resort to dysfunctional activities to do so(such as short-run profit maximization). Output controls foster a system of manage-






ment by exception, in that so long as subunits meet their goals, they are left alone. Ifa subunit fails to attain its goals, however, headquarters managers are likely to ask sometough questions. If they dont get satisfactory answers, they are likely to interveneproactively in a subunit, replacing top management and looking for ways to improveefficiency.

Cultural Controls

Cultural controls exist when employees buy into the norms and value systems of thefirm. When this occurs, employees tend to control their own behavior, which reducesthe need for direct supervision. In a firm with a strong culture, self-control can reducethe need for other control systems. We shall discuss organizational culture later. Mc-Donalds actively promotes organizational norms and values, referring to its fran-chisees and suppliers as partners and emphasizing its long-term commitment to them.This commitment is not just a public relations exercise; it is backed by actions, in-cluding a willingness to help suppliers and franchisees improve their operations by pro-viding capital and/or management assistance when needed. In response, McDonaldsfranchisees and suppliers are integrated into the firms culture and thus become com-mitted to helping McDonalds succeed. One result is that McDonalds can devote lesstime than would otherwise be necessary to controlling its franchisees and suppliers.

|Incentive SystemsIncentives refer to the devices used to reward appropriate employee behavior. Manyemployees receive incentives in the form of annual bonus pay. Incentives are usuallyclosely tied to the performance metrics used for output controls. For example, settingtargets linked to profitability might be used to measure the performance of a subunit,such as a global product division. To create positive incentives for employees to workhard to exceed those targets, they may be given a share of any profits over above thosetargeted. If a subunit has set a goal of attaining a 15 percent return on investment andit actually attains a 20 percent return, unit employees may be given a share in the prof-its generated in excess of the 15 percent target in the form of bonus pay. We shall re-turn to the topic of incentive systems in Chapter 18 when we discuss human resourcestrategy in the multinational firm. For now, however, several important points need tobe made.

First, the type of incentive used often varies depending on the employees and theirtasks. Incentives for employees working on the factory floor may be very different fromthe incentives used for senior managers. The incentives used must be matched to thetype of work being performed. The employees on the factory floor of a manufacturingplant may be broken into teams of 20 to 30 individuals, and they may have their bonuspay tied to the ability of their team to hit or exceed targets for output and product qual-ity. In contrast, the senior managers of the plant may be rewarded according to met-rics linked to the output of the entire operation. The basic principle is to make surethe incentive scheme for an individual employee is linked to an output target that heor she has some control over and can influence. The individual employees on the fac-tory floor may not be able to exercise much influence over the performance of the en-tire operation, but they can influence the performance of their team, so incentive payis tied to output at this level.

Second, the successful execution of strategy in the multinational firm often re-quires significant cooperation between managers in different subunits. For example,as noted earlier, some multinational firms operate with matrix structures where acountry subsidiary might be responsible for marketing and sales in a nation, while aglobal product division might be responsible for manufacturing and product devel-opment. The managers of these different units need to cooperate closely with eachother if the firm is to be successful. One way of encouraging the managers to cooper-ate is to link incentives to performance at a higher level in the organization. Thus,






the senior managers of the country subsidiaries and global product divisions might berewarded according to the profitability of the entire firm. The thinking here is thatboosting the profitability of the entire firm requires managers in the country sub-sidiaries and product divisions to cooperate with each other on strategy implementa-tion and linking incentive systems to the next level up in the hierarchy encouragesthis. Most firms use a formula for incentives that links a portion of incentive pay tothe performance of the subunit in which a manager or employee works and a portionto the performance of the entire firm, or some other higher-level organizational unit.The goal is to encourage employees to improve the efficiency of their unit and to co-operate with other units in the organization.

Third, the incentive systems used within a multinational enterprise often have tobe adjusted to account for national differences in institutions and culture. Incentivesystems that work in the United States might not work, or even be allowed, in othercountries. For example, Lincoln Electric, a leader in the manufacture of arc weldingequipment, has used an incentive system for its employees based on piecework rates inits American factories (under a piecework system, employees are paid according to theamount they produce). While this system has worked very well in the United States,Lincoln has found that the system is difficult to introduce in other countries. In somecountries, such as Germany, piecework systems are illegal, while in others the prevail-ing national culture is antagonistic to a system where performance is so closely tied toindividual effort. For further details, see the accompanying Management Focus.

Finally, it is important for managers to recognize that incentive systems can haveunintended consequences. Managers need to carefully think through exactly what be-havior certain incentives encourage. For example, if employees in a factory are re-warded solely on the basis of how many units of output they produce, with no attentionpaid to the quality of that output, they may produce as many units as possible to boosttheir incentive pay, but the quality of those units may be poor.

|Control Systems, Incentives, and Strategy in the International Business

The key to understanding the relationship between international strategy, control sys-tems, and incentive systems is the concept of performance ambiguity.

Performance Ambiguity

Performance ambiguity exists when the causes of a subunits poor performance are notclear. This is not uncommon when a subunits performance is partly dependent on theperformance of other subunits; that is, when there is a high degree of interdependencebetween subunits within the organization. Consider the case of a French subsidiary ofa U.S. firm that depends on another subsidiary, a manufacturer based in Italy, for theproducts it sells. The French subsidiary is failing to achieve its sales goals, and the U.S.management asks the managers to explain. They reply that they are receiving poor-quality goods from the Italian subsidiary. So the U.S. management asks the managersof the Italian operation what the problem is. They reply that their product quality isexcellentthe best in the industry, in factand that the French simply dont knowhow to sell a good product. Who is right, the French or the Italians? Without more in-formation, top management cannot tell. Because they are dependent on the Italiansfor their product, the French have an alibi for poor performance. U.S. managementneeds to have more information to determine who is correct. Collecting this informa-tion is expensive and time consuming and will divert attention away from other issues.In other words, performance ambiguity raises the costs of control.

Consider how different things would be if the French operation were self-contained,with its own manufacturing, marketing, and R&D facilities. The French operationwould lack a convenient alibi for its poor performance; the French managers wouldstand or fall on their own merits. They could not blame the Italians for their poor sales.





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