ORGANIZATIONAL THEORY, DESIGN, AND CHANGE - Chapter 03

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CHAPTER 3 MANAGING IN A CHANGING GLOBAL ENVIRONMENT TEACHING OBJECTIVES 1. 2. 3. 5. 6. 7. 8.

To define the organizational environment and organizational domain. (3.1) To distinguish between the specific and general environment. (3.1) To discuss the sources of uncertainty in the environment: complexity, dynamism, and richness. (3.1) To review resource dependence theory. (3.2) To examine strategies for managing symbiotic resource interdependencies. (3.4) To examine strategies for managing competitive interdependencies. (3.5) To review transaction cost theory. (3.6)

CHAPTER SUMMARY An organization’s domain includes its goods and services and its customers. An organization must cope with forces in the specific and general environments. Specific environmental forces include outside stakeholder groups that directly impact the ability to obtain resources: customers, distributors, unions, the government, competitors, and suppliers. General environmental forces include: economic, international, technological, demographic and cultural, political, and environmental forces. Complexity, dynamism, and richness determine the extent of environmental uncertainty. A simple, stable, rich environment has some uncertainty, but a complex, dynamic, poor environment is highly uncertain. The global marketplace makes the environment highly uncertain.

Transaction cost theory considers the costs of interorganizational linkage mechanisms. An organization should choose the linkage that provides the greatest transaction cost savings at the lowest bureaucratic costs. Sources of transaction costs include: environmental uncertainty, bounded rationality, need to prevent opportunism, and risk involved with specific asset investments. Because formal linkage mechanisms increase bureaucratic costs, an organization should use informal linkages when transaction costs are low. Mechanisms to minimize transaction costs and avoid bureaucratic costs include: keiretsu, franchise, and outsourcing.

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How can the environment be managed? Resource dependence theory states that an organization should minimize its dependence on scarce resources. In the specific environment, organizations have symbiotic and competitive interdependencies. Strategies for managing symbiotic resource interdependencies include: developing a good reputation; co-optation; strategic alliances to include long-term contracts, networks, minority ownership, and joint ventures; and mergers and takeovers. Strategies for managing competitive interdependencies include: collusion and cartels; third-party linkage mechanisms; strategic alliances; and mergers and takeovers.

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CHAPTER OUTLINE 3.1

What Is the Organizational Environment?

The resources surrounding an organization, such as raw materials and skilled workers, comprise the organizational environment, and an organization conducts transactions to obtain these resources for production. Resource procurement is impacted by competition, changes in technology, and input prices. The organizational domain refers to the goods and services offered and the customers and other stakeholders served; an organization designs transactions to enlarge its domain. An organization operates in both specific and general environments. One way to enlarge the domain is to expand internationally. The specific environment contains outside stakeholder groups who have a direct effect on obtaining resources. Changes in the kinds of customers or in consumer tastes affect an organization. Strategies to attract customers change to meet new customer needs. (Fig. 3.1) Outside stakeholder groups include customers, distributors, suppliers, unions, competitors, and the government. An organization deals with each group to attain resources for survival, protection, and enlargement of its domain. The general environment contains forces that affect all organizations and shape the specific environment. Q. Name the forces in the general environment. A. Technological forces, including new production methods, impact operations. Political and environmental forces impact government policy toward business and stakeholders, and affect production costs. Demographic, cultural, and social forces, including birthrates, age, and lifestyle of a nation’s people influence demand. By managing these environments effectively, a firm gains resources and the domain grows. Poor environmental management shrinks a firm’s domain.

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Refer to discussion question 1 here to give an example of the specific and general environments.

Organizational Insight 3.1 GE’s U.S. Managers Stumble in Hungary This case illustrates the complexities associated with expanding globally. In this case, there were dramatically different expectations between workers and managers. This case also illustrates how important it is to manage both the specific and general environmental forces in order to take advantage of the global marketplace.

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Sources of Uncertainty in the Organizational Environment Because all organizations face uncertainty, managers cannot predict resource supply. Uncertainty stems from complexity, dynamism, and richness of the environment. (Fig. 3.2) Environmental complexity is a function of the strength, number, and interconnectedness of specific and general forces. The greater the number and differences among them, the more complex, uncertain, and difficult to manage is the environment. Managing 100 suppliers is easier than 1,000. Producing different products for different customers increases complexity. The more interconnected the forces in specific and general environment, the more uncertainty a firm faces. Environmental dynamism is determined by how much and how fast specific and general environmental forces change. Q. When is an environment stable? A. Stability means that environmental forces affect resource supply in a predictable way. Q. When is an environment unstable and dynamic? A. Dynamism means that environmental forces change quickly and unpredictably. Environmental richness depends on the quantity of resources available for an organization’s domain. Q When is an environment rich? A. Rich means abundant resources and low uncertainty. Q. What makes an environment poor? A. A poor environment is not only located in a poor country or region, but faces intense competition and battles for resources. Uncertainty is low in a simple, stable, and rich environment and high in a complex, unstable, and poor environment. After determining its environmental forces, an organization plans environmental management.

A. In most industries, the global marketplace makes the environment more complex, dynamic, and rich. Notes____________________________________________________________________________

Focus on New Information Technology: Amazon.com, Part 2 Amazon.com changed the whole nature of the bookselling environment. Q. Describe the traditional environment for booksellers.

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Q. How do global markets affect environmental stability?

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A. Before Amazon, book publishers sold indirectly to wholesalers, who supplied small bookstores or large chains like Barnes & Noble. In this stable, simple, and rich environment, uncertainty was low, and large and small companies were profitable. Q. How has Amazon.com changed the global environment? A. By offering quick access to all books in print at a discount, Amazon created a higher level of industry competition and made the industry environment poorer. Direct negotiation with publishers led to increased environmental complexity because publishers, wholesalers, stores, and customers became more closely linked. Information technology made the environment more unstable and resources harder to secure. Small bookstores have closed, large bookstores compete online, and online bookstores do battle in price wars, making the environment more uncertain and competitive. •

Refer to discussion question 2 here for examples of environmental uncertainty.

Managerial Implications: Analyzing the Environment Managers should analyze the organizational environment and identify sources of uncertainty. They should chart these forces in the specific and general environments and plan how to deal with contingencies.

3.2

Resource Dependence Theory

Resource supply is contingent on the complexity, dynamism, and richness of the environment. A poor environment faces scarce resources. Resource dependence theory proposes that an organization’s goal is to minimize its reliance on other organizations for the supply of scarce resources. Two facets of resource dependence must be managed: An organization must exert influence to get resources and respond to the needs and demands of others in its environment. Q. What causes dependence on another organization for a specific resource?

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A. Dependence is contingent on two factors: how essential the input is to survival and the degree to which others control the resource. An organization is more dependent if the resource is critical to survival and tightly controlled.

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Organizational Insight 3.2: Mighty Microsoft Microsoft dominates the operating system market, a valuable input in producing effective applications software. This makes Microsoft extremely powerful, and the company was found to have an unfair advantage in a court of law. Q. How does Microsoft manage resource dependence? A. Microsoft is not dependent on others for resources. It controls the development of computer operating systems, so companies depend on Microsoft. The control of this resource has increased Microsoft’s market share. Notes_________________________________________________________________________

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3.3

Refer to discussion question 3 to review resource dependence theory. _________________________________________________________________________________ _________________________________________________________________________________

Interorganizational Strategies for Managing Resource Dependencies.

The specific environment contains symbiotic and competitive interdependencies. Symbiotic interdependencies occur when the outputs of one organization serve as the inputs for another, an organization and its suppliers. Q. What companies have symbiotic interdependencies? A. Intel supplies chips for computer manufacturers such as Compaq. Auto manufacturers distribute cars through dealers.

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Strategies for Managing Symbiotic Resource Interdependencies

Cooperation is greater if strategy is formal. Four strategies for managing symbiotic resource interdependencies include: developing a good reputation, co-optation, strategic alliance, and merger and takeover. (Fig. 3.3)

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Competitive interdependencies exist among organizations that compete for scarce resources. An organization manages interdependencies through interorganizational strategies. Linkage mechanisms connect companies and require coordinated actions, with a loss of freedom for independent action. A contract requires compliance even if a firm can negotiate a better offer. The best interorganizational strategy reduces uncertainty and provides the least loss of control.

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Developing a Good Reputation An organization can build a good reputation in the eyes of customers and suppliers through fairness and honesty, high-quality goods and services, and prompt payment of bills. A dishonest company will be unsuccessful in the long term. Developing a good reputation is the most frequently used linkage mechanism for managing symbiotic interdependencies. Co-optation is used to counter problematic forces in the specific environment. An organization brings adversaries inside the organization. Q. How can outsiders be brought inside the organization? A. In many countries bribery is used, but it illegal in the United States. Some use an interlocking directorate, a linkage whereby a director from one company sits on the board of another. Strategic alliances, sharing of resources by several companies, are popular for managing interdependencies. Alliances include: long-term contracts, networks, minority ownership, and joint venture. The more formal agreements provide stronger linkages and tighter control over joint activities. As environmental uncertainty increases, companies rely on formal alliances. (Fig. 3.4) Long-term contracts reduce costs by sharing resources or spreading the risk associated with activities such as marketing and R&D. Contracts, both written or verbal, are the most informal kind of alliance, because the only connection is the agreement. A network is a group that coordinates activities via contract. A network is more formal than a contract because more ties connect members who share competencies such as R&D skills with partners. Partners use those skills to increase efficiency and reduce the core organization’s costs and size. A company can perform design work and have partners produce the product.

Toyota is a capital keiretsu with a minority stake in suppliers; Toyota works with suppliers to improve quality. A financial keiretsu is an interlocking directorate with members serving on the bank’s board. At the Fuyo keiretsu. Fuji Bank is the center with members such as Nissan, Hitachi, and Canon. Members have other companies with minority ownership in suppliers. (Fig. 3.5) Joint ventures are formal strategic alliances among two or more companies to establish and share ownership in a new business; a formal legal agreement defines rights and responsibilities. Each organization sends managers to the new company. (Fig. 3.6) Q. Name the advantages of joint ventures. A. Participants can pool distinctive competences, design a new structure, keep parent companies small, and reduce the difficulty of managing parent company interdependencies.

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Minority Ownership occurs when organizations buy a stake in each other, forming a more formal alliance. The Japanese keiretsu is a group of organizations, each of which owns shares in the other organizations and works to further group interests. Japan has two types of keiretsu: Capital keiretsu to manage input and output linkages and financial keiretsu for linkages among different companies, usually with a bank at the center.

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Mergers and takeovers are the most formal strategies for managing interdependencies. A merger or takeover results in resource exchanges within organizations and prevents control by a powerful supplier or customer. However, mergers and takeovers are costly, and problems arise in managing a new business. This strategy is used if a company must control a critical resource or manage a significant interdependency. Notes________________________________________________________________________________ ____________________________________________________________________________________ ____________________________________________________________________________________

3.5

Strategies for Managing Competitive Resource Interdependencies

Competition increases uncertainty, but organizations can use strategies to manage competitive resource interdependencies: collusion and cartels; third-party linkage mechanisms; strategic alliances; and mergers and takeovers. A more formal strategy is an explicit attempt to coordinate a competitor’s activities. Some strategies are illegal in the United States. (Fig. 3.7)

Collusion and Cartels Collusion, a secret pact among competitors to share data for an illegal purpose, reduces competitive uncertainty. A cartel, a group that coordinates activities, increases the stability and richness of an organization’s environment and reduces uncertainty. Q. Give an example of a cartel. A. The OPEC cartel controls the price of oil. Although collusion and cartels are illegal in the United States, competitors still plot to coordinate activities. Q. How do companies collude in the United States? A. Collusion includes: setting industry standards on pricing and product specifications; making artificially high prices industry standards (a leader sets the price and competitors conform); and signaling, a cue to competitors about price hikes and strategies through announcements.

An indirect way to coordinate activities is through a third-party linkage mechanism, a regulatory body such as a trade association that shares information and governs competitive practices. Advantages: Interaction decreases the concern about deceptive organizational practices. The association can lobby the government for favorable industry policies. Third-party linkages assist in managing resource interdependencies and reducing uncertainties. An increased information flow allows an easier response. These linkage mechanisms let companies co-opt themselves and benefit from coordination. Strategic alliances manage both symbiotic and competitive interdependencies. By cooperating in a joint venture, competitors save money, deter new entrants, or harm competitors (e.g., developing technology and obtaining a patent).

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Third-Party Linkage Mechanisms

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Mergers and takeovers strengthen a competitive position by increasing a firm’s domain and ability to broaden its product range. Some companies use mergers to become the sole player in the marketplace, a monopoly, which is illegal in the United States and most other developed countries. Q. Why are cartels, collusion, and other anticompetitive practices bad for companies? A. Competitors enter the industry due to changes in technology or government policies, and because monopolies have faced no competition, their tall, mechanized structures make it hard to compete in a dynamic environment. Q. What companies faced this problem? A. GM controlled its environment for a long time and then suffered greatly when the environment changed. IBM and Xerox are similar examples. Notes________________________________________________________________________________ ____________________________________________________________________________________ ____________________________________________________________________________________

Managerial Implications: Resource Dependence Theory Managers should study each resource transaction and decide how to manage it. Managers should aim for an informal linkage mechanism yet identify the purpose and problems of a strategic alliance to choose between a formal or informal linkage mechanism. Transaction cost theory is useful for identifying the costs and benefits of each linkage mechanism.

3.6

Transaction Cost Theory

Interorganizational strategies provide control over forces in the specific and general environments, and large companies use them for environmental change. Transaction cost theory addresses why and when organizations choose and change strategies.

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Transaction costs are associated with negotiating, monitoring, and governing exchanges between people. Transaction cost theory proposes that organizations should aim to minimize transaction costs for inside dealings and outside transactions. Transaction costs reduce productivity; time spent monitoring and negotiating exchanges could have created value.

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Sources of Transaction Costs Environmental uncertainty and bounded rationality: People have a limited ability, known as bounded rationality, to process data and understand their environment. Bounded rationality makes it costly to manage transactions in uncertain environments. To reduce transaction costs, organizations use formal linkage mechanisms like minority ownership. Opportunism and small numbers: The potential for opportunism is high when relying on one supplier or a few trading partners. So, organizations increase transaction costs by using resources to enforce agreements for protection. Risk and specific assets: Investing in specific assets, one exchange relationship, is risky. After the company invests, a customer may buy products at a lower price. Transaction Costs and Linkage Mechanisms Interorganizational linkage mechanisms depend on transaction costs. Transaction costs are low when nonspecific goods and services are exchanged, uncertainty is low, and many exchange partners exist. Companies use informal linkage mechanisms, such as reputation and unwritten contracts. Transaction costs increase when more specific goods and services are exchanged, uncertainty increases, and potential exchange partners decrease. Companies do not trust each other, so they use formal linkages, such as contracts. A rise in transaction costs leads to more formal linkage mechanisms to gain control. Joint venture partners favor activities that create value for both parties. Merger partners seek mutual success, because one firm owns the other. Transaction cost theory attributes the move from less to more formal linkage to reducing transaction costs.

Using Transaction Cost Theory to Choose an Interorganizational Strategy Transaction cost theory considers the costs of linkage mechanisms and forecasts when and why a strategy should be selected. When choosing a strategy, managers must: Identify the sources of and level of transaction costs; estimate the savings from using different linkage mechanisms; estimate the bureaucratic costs, and select the linkage that achieves cost savings at the lowest level of bureaucratic costs.

Organizational Insight 3.3: Ekco and its Suppliers The Ekco Group offers a wide product range, including bakeware products, kitchen tools, household plastic products, and pest control devices. Q. How does Ekco Group manage interorganizational relationships? A. The Ekco Group reduces customer transaction costs by offering a wide range of products, so customers save by dealing with one supplier. Ekco has a new computer system that provides a just-intime inventory service to retailers that simplifies ordering and inventory tracking.

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Bureaucratic Costs Formal linkage mechanisms reduce transaction costs but may not be used because internal or bureaucratic transaction costs are still incurred. Integration and communication are costly, whereas time spent in a meeting could have created value.

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Transaction cost theory suggests that formal linkage mechanisms are appropriate when transaction costs are high. Otherwise, informal mechanisms with lower bureaucratic costs should be selected. Three mechanisms minimize transaction costs while avoiding bureaucratic costs: Keiretsu offers the benefits of ownership without the costs. Toyota has a minority interest in its suppliers for control and reduced uncertainty, but without ownership and the management costs. Franchising allows for marketing a company’s products in a particular area. Q. How does a franchise reduce transaction costs without incurring bureaucratic costs? A. The franchiser gives a franchisee the rights to use resources in exchange for a flat fee or a percentage of the profits. The franchiser provides the inputs to the franchisee, who makes exchanges with the customer. The relationship is symbiotic. Franchisers give rights to franchisees because the bureaucratic costs of managing their businesses are too high. An organization considers transaction costs when deciding on product distribution. For a complex product, a company will have formal control over franchisees or distribution outlets. Auto manufacturers control franchised auto repair dealers, but products such as groceries require less control and can be sold through retailers. Outsourcing, buying a specialized service, is another strategy for managing interdependencies. The decision to make or outsource products depends on whether value exceeds bureaucratic costs. The transaction cost approach considers why and how organizations choose different linkage mechanisms. The optimal mechanism minimizes transaction and bureaucratic costs.

Organizational Insight 3.4: Li & Fung’s Global Supply Chain Management This insight, in addition to illustrating transaction cost theory, really shows how complex the global environment is. It also illustrates how organizations operating in the global environment really need to specialize and be very efficient at what they do.

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Refer to discussion question 5 here to review transaction cost theory. _________________________________________________________________________________ _________________________________________________________________________________

DISCUSSION QUESTIONS AND ANSWERS 1. Pick an organization, such as a local travel agency or supermarket. Describe its organizational domain; then draw a map of the forces in its general and specific environments that affect the way it operates.

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Answers will vary. For a local supermarket, the domain includes neighborhood customers. Specific environmental forces include customers, unions, competitors, suppliers, and the government. Customer preference influences store offerings. Unions ensure fair wages and good working conditions. Suppliers must provide high-quality items. The government ensures that FDA, employment, and safety requirements are met. General environmental forces are economic, technological, demographic and cultural, and environmental. High unemployment dictates low-margin items. Technology facilitates convenience and fast checkout. Demographic and cultural forces determine the food offered (baby food, ethnic food). Environmental issues ensure recycling plastic bags. 2.

What are the major sources of uncertainty in the environment? Discuss how these sources of uncertainty affect a small biotechnology company and a large carmaker.

Sources of environmental uncertainty include complexity, dynamism, and richness. An organization is complex and uncertain if there are many, strong, interrelated outside stakeholders. The environment is dynamic and uncertain if forces change significantly or quickly. It is poor and uncertain in a poor country or where resource competition is high. Answers will vary. A small biotechnology firm has low complexity because of few stakeholder groups, no union, a few suppliers, and a few customers. In the growth stage, competition is not intense and competitors are small. The environment is dynamic as forces change. (Technology may change. Health care regulation could affect operations.) General uncertainties affect specific outside stakeholders such as suppliers and customers. This company has a rich environment in large cities with supplies of scientists and a medium level of uncertainty. It can obtain resources without high complexity, but operates in a dynamic environment. A large carmaker has high complexity because of the relationship between many, different outside stakeholders, including a union, the government, competitors, suppliers, and distributors. The environment is stable because forces affect resources predictably. The industry is mature, with changes foreseen, but recession reduces demand. International forces are strong. The environment is poorer due to competition, but resources are secured by managing outside stakeholders. The carmaker is complex and operates in stable environment, between rich and poor. Uncertainty is kept low by managing complex relationships with outside stakeholders. According to resource dependence theory, what motivates organizations to form interorganizational linkages? What is the advantage of strategic alliances as a way of exchanging resources?

Resource dependence theory states that interorganizational linkages minimize dependence on other organizations for scarce resources and influence them to make resources available. Strategic alliances allow for symbiotic and competitive interdependencies and ensure a supply of high-quality, low-cost inputs. Strategic alliances require resource sharing, reducing risks and costs. Partners can pool distinctive competences to produce a competitive product. 4.

According to transaction cost theory, what motivates organizations to form interorganizational linkages? Under what conditions would a company prefer a more formal linkage mechanism to a less-formal one?

Transaction cost theory states that interorganizational linkages minimize transaction and bureaucratic costs. An organization chooses a more formal linkage mechanism as transaction costs increase. Formal linkage mechanisms should be used when the transaction cost savings outweigh bureaucratic costs.

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5. What interorganizational strategies might work most successfully as a company expands globally? Why? The key to this question is to make sure that students understand that to manage the environment, they must match the strategy needed with the level of complexity in the environment. For example, a starting point for expanding globally is to build a good reputation. A more complex situation may call for something much more complex, such as a long-term contract or a joint venture.

ORGANIZATIONAL THEORY IN ACTION Practicing Organizational Theory: Protecting Your Domain Small groups of students are entrepreneurs who have marketed a new kind of root beer. Each group wants to widen its geographical regions. Students decide how to protect and expand the company’s domain. Students consider the types of strategic alliances and recommend a way to carve a niche in the soda market.

The Ethical Dimension This case deals with organizations that purchase products from organizations that employ women and children is sweatshops. They generally work long hours for only a few dollars per day. This was also dealt with in Chapter 2 (Insight 2.5). Have students debate and discuss this again, but make the basis for discussion the environmental principles discussed in this chapter, such as resource dependency. 1. When and under what conditions is it right for companies to buy their inputs from suppliers that do employ women and children? This is a complex question. On the surface it seems easy to simply not do business with these types of organizations. When students say this, start a discussion about competition and remaining competitive in a global economy. In other words, if an organization refuses to do business with these sweatshops, and then can’t remain competitive, has the right decision been made? 2. What kinds of interorganizational strategies could U.S. companies use to enforce any ethical codes that they develop?

Making the Connection Students find an example of a company using a specific interorganizational strategy, such as a joint venture, and explain why the company selected the mechanism, using resource dependence theory or transaction cost theory.

ANALYZING THE ORGANIZATION Students define their organization’s domain, analyze the factors of uncertainty, and determine if the structure is designed to reflect environmental uncertainty. They list the interorganizational linkage

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This also is a complex question because each culture has different norms and values. A good example to use is Johnson and Johnson and their ethics credo (from Chapter 2).

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mechanisms and use resource dependence theory and transaction cost theory to explain why the mechanisms were chosen.

CASE FOR ANALYSIS How Ford Manages Its Environment This case illustrates the various ways in which Ford has managed its environment over the years. 1.

List the various ways in which Ford has attempted to manage its environment over time.

This is a good illustration of the many different ways that the environment can be managed. Early on, Ford used contracts. As the environment got more complex, they began producing their own parts. This is a good application of resource dependency theory in that they managed their environment by reducing their dependency on suppliers. When the environment became even more complex in the 1980s, Ford developed some keiretsu-type arrangements in order to manage this. 2.

Why did Ford change the methods it used to manage the environment?

The key here is to make sure students understand that the management strategy needs to fit the environmental situation. They didn’t just change from contracts to keiretsu’s because it was a new management technique, but rather they did this in response to the environment, or, in this case, the competition. To manage these environments, AT&T participated in strategic alliances and engaged in acquisitions; it eventually split into three divisions.

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The class is divided into three groups who work for a grocery store, a telecommunications company, and a large auto manufacturer. Each group defines its organizational domain and lists the forces in its specific and general environments. Co-optation can manage symbiotic forces as seen in a role play with four students. Three students form a management team of a manufacturing plant. One is the local union president who complains about rules, wages, and benefits and tries to influence employee opinions. What can the management team do? It can bring the union president inside the organization through a joint union-management discussion committee. In five groups, students represent organizations that vary in size and complexity. Each group selects an interorganizational strategy and explains its choice of strategy. Group I: A small grocery store with products from two or three suppliers. This group manages relationship through trust; owners know suppliers well. Group II: A medium-sized pharmaceutical manufacturer with many distributors. This company needs long-term contracts or networks. Joint ventures and mergers may be too costly. Group III: A large telecommunications company. This company forms joint ventures and alliances to share risks and costs of developing new technology. Group IV: A company that wants rapid growth but lacks capital or resources to run its organizations. This company considers franchising.

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TEACHING SUGGESTIONS

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Group V: A hotel with competition. This hotel joins a trade association to manage its competitive interdependencies.

Groups must weigh the cost of the strategy against the benefits.

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Students review the strategies that allow organizations to minimize transaction costs without incurring bureaucratic costs: keiretsu; franchising; and outsourcing. Point out that Japanese stakeholders take a long-term view and deal with people they know and trust. Ford has developed long-term relationships with suppliers and has other companies, such as a rental car company, in its network. Students can compare the business environment of the 1970s with that of today. The auto industry is a good example because of both the dramatic changes that occurred, and the fact that we all drive autos. Have students look at Ford’s web site and assess changes in its organizational environment.

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