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of University Sunderland Master of Business Administration (MBA) Global Corporate Strategy Published by The University of Sunderland The publisher endeavours to ensure that all its materials are free from bias or discrimination on grounds of religious or political belief, gender, race or physical ability. These course materials are produced from paper derived from sustainable forests where the replacement rate exceeds consumption. The copying, storage in any retrieval system, transmission, reproduction in any form or resale of the course materials or any part thereof without the prior written permission of the University of Sunderland is an infringement of copyright and will result in legal proceedings. University of Sunderland 2004 Every effort has been made to trace all copyright owners of material used in this module but if any have been inadvertently overlooked, the University of Sunderland Press will be please to make the necessary arrangement at the first opportunity. These materials have been produced by the University of Sunderland Business School in conjunction with Resource Development International. Global Corporate Strategy Contents How to use this workbook Introduction Unit 1 Strategy Defined and Key Concepts Introduction Definition of Strategy Levels of Strategy Strategic Concepts Strategic Thinking Strategic Models Summary 1 2 5 7 9 12 34 Unit 2 Strategic Capability Introduction The Different Management Perspectives Portfolio Management The Core competencies perspective Divestment Summary 37 38 39 48 51 57 Unit 3 Globalisation Introduction What is Globalisation The Globalisation of Markets The Globalisation of Production Drivers of Globalisation The Changing Demographics of the Global Economy The Globalisation Debate: Prosperity or Impoverishment? Managing in the Global Marketplace Summary 61 61 66 68 70 73 76 78 88 Unit 4 Altering the Boundary Alliances and Mergers Introduction Paradox of Competition and Co-operation Global Strategic Alliances Mergers and Acquisitions Summary 91 92 92 104 131 Unit 5 Value Management Introduction Paradox of Profitability and Responsibility The Concept of Value Value Management What is a Value-Driven Approach Summary 133 134 134 137 141 151 Unit 6 Corporate Governance and Ethics Introduction Corporate Governance Business Ethics Summary 155 156 173 188 Unit 7 Managing Complexity Introduction Paradox of Control and Chaos Systems Thinking Soft Systems Methodology (SSM) Strategic Control? Summary 191 192 193 200 204 207 Unit 8 Knowledge Management Introduction Theoretical Concepts on Knowledge Knowledge Knowledge Transfer Practical steps to promote Knowledge Management Summary 209 210 212 215 218 237 Global Corporate Strategy Global Corporate Strategy Contents Unit 9 Innovation Introduction Innovation strategies Innovation and established companies Conclusion Summary 239 240 241 248 255 Unit 10 Strategic IT and e-Business Introduction The Link between Business and IT Strategy IT Strategy Methodology Summary References 259 260 264 275 276 5 How to use this workbook This workbook has been designed to provide you with the course material necessary to complete Global Corporate Strategy by distance learning. At various stages throughout the module you will encounter icons as outlined below which indicate what you are required to do to help you learn. This Activity icon refers to an activity where you are required to undertake a specific task. These could include reading, questioning, writing, research, analysing, evaluating, etc. This Activity Feedback icon is used to provide you with the information required to confirm and reinforce the learning outcomes of the activity. This icon shows where the Virtual Campus could be useful as a medium for discussion on the relevant topic. This Key Point icon is included to stress the importance of a particular piece of information. It is important that you utilise these icons as together they will provide you with the underpinning knowledge required to understand concepts and theories and apply them to the business and management environment. Try to use your own background knowledge when completing the activities and draw the best ideas and solutions you can from your work experience. If possible, discuss your ideas with other students or your colleagues; this will make learning much more stimulating. Remember, if in doubt, or you need answers to any questions about this workbook or how to study, ask your tutor. i Global Corporate Strategy Preface Corporate Strategy is a very wide and all encompassing subject area. One only has to look at the relative content of individual key texts in this area (e.g. De Wit & Meyer, Lynch, Johnson & Scholes, etc.) to appreciate the volume of material that has been written over the years. However, relatively speaking, it is the newest area of management research. Initial work in strategy took place in the early sixties. In their book Strategy Safari, Mintzberg, Alhstrand and Lampel (1998) break down strategy theory development into ten schools of thought and this provides a thoughtful starting point for the study of this module. It also indicates a wide range of divergent views on the subject. The ten schools are; 1 2 3 The Design school strategy seeks to match internal capabilities to external possibilities The Planning school strategy is a formal, planned process The Positioning school only a few key strategies are desirable in any given industry (generic strategy) and these are formulated by analytical processes The Entrepreneurial school strategy is a visionary process where an organisation is responsive to the dictating individual The Cognitive school strategy is a mental process dependant upon what the strategy process means in the mind of the strategist (human cognition) The Learning school strategies emerge as people / organisations come to learn about a situation as well as their organisations capability of dealing with it The Power school the use of power and politics to negotiate strategies favourable to particular interests The Cultural school strategy as a collective process of social interaction, based on the beliefs and understandings shared by the members of an organisation The Environmental school the business environment becomes the central actor in the strategy making process the organisation must respond to these forces 4 5 6 7 8 9 iii Preface Global Corporate Strategy 10 The Configuration school strategy making is a process of leaping from one state to another with relative stability in between All of these schools have key writers. However, it would be erroneous to regard these schools as being separated or that it is right to look at these in isolation. Indeed, it is the opposite. Each perspective is inter-mingled with one another and interacts over time. Mintzberg, Alhstrand and Lampel use the analogy of an elephant to emphasise the holistic nature of strategy - one cannot get a clear picture of the elephant by looking at each separate part of its body. Hence, as a student of strategy, you must keep in mind ALL TEN schools. The ten schools can be split into two types. Schools 1-3 can be seen as prescriptive, that is to say they are based on the belief that Corporate Strategy is a planned, analytical hard data process. On the other hand, Schools 4-10 can be seen as descriptive. In these areas, writers believe that strategy is a complex, uncertain, subjective and soft data process. There is a range of theory and academic writing to support all of these perspectives. Another range of key perspectives is related to your core textbook supplied with these materials. Whereas major texts such as Johnson & Scholes, and Lynch take a linear view of strategy by presenting concepts one after the other, de Wit & Meyer (2004) analyse a series of paradoxes. They define the opposite ends of a continuum, leaving the student with the tools to analyse case studies and decide for themselves the key strategic perspective for organisations. This approach is particularly important for this module. Students will be expected to produce an academic and fully referenced argument seeking to define the key strategic perspectives of organisations. The argument, and supporting evidence, produced is key stating an appropriate school of thought or positioning an organisation in relation to a strategic paradox is not the key issue. The ability to analyse (rather than describe) strategy and coming to a reasoned judgement is the overriding objective in assessment. The paradoxes addressed by de Wit & Meyer (2004) are; The Paradox of Logic and Creativity (Strategic Thinking Rational vs. Generative). The Paradox of Deliberateness and Emergentness (Strategy Formulation Planned vs. Incremental). Change Continuous vs. Discontinuous). Strategy Outside-In vs. Inside-Out). The Paradox of Revolution and Evolution (Strategic The Paradox of Markets and Resources (Business Level iv Global Corporate Strategy Preface The Paradox of Responsiveness and Synergy (Corporate Level Strategy Portfolio vs. Core Competence). The Paradox of Competition and Co-operation (Network Level Strategy Discrete vs. Embedded Organisations). Context Industry Evolution vs. Industry Creation). Context Leadership vs. Dynamics). The Paradox of Compliance and Choice (Industry The Paradox of Control and Chaos (Organisational The Paradox of Globalisation and Localisation (International Context Global Convergence vs. International Diversity). (Organisational Purpose Shareholder Value vs. Stakeholder Values). The Paradox of Profitability and Responsibility Naturally, many of theses dichotomies can be examined in isolation but are, similarly to the schools of thought above, likely to be interrelated and so discussing and building an academic argument in respect of one will inevitably lead to another. It would be possible to provide you with a module that deals with separate areas of an organisation individually. Indeed, this type of module has been delivered many times in the past. In other words, it is possible to look at marketing, HRM, operations, finance, etc, as separate entities and reflect the strategic aspects of these areas. However, this would not give due credence to the fact that strategy is essentially a holistic subject. That is to say, corporate strategy affects the organisation as a whole. Each element of an organisation cannot be considered in isolation. Therefore, corporate strategy must be examined in an all embracing manner. One must be careful to use the word organisation. If the word business were to be used this would tend to ignore some very productive study areas in public and not for profit organisations. Much can be learned from such organisations and, although businesses are typically used to demonstrate key points, organisations whose prime objective is not related to profitability cannot be ignored. Many contemporary issues in strategy are reflected in this module. Once again, it is erroneous to regard each of the ten themes as existing in isolation or in silos. There are links between themes that, in some case, will be pointed out in the text, but in others it will be left to your own imagination and analytical ability. Individual techniques such as those employed in marketing and finance, for example, are only touched on where necessary. This would detract from the ethos of this module. v Preface Global Corporate Strategy Due to the nature of the subject area it is impossible to cover all aspects simply think about how long it would take to read one of the key texts from cover to cover! The topics omitted are still important the study time allocated to this module is not enough to cover everything. Therefore, it is in your interests to read more widely than the specified reading dictates. The module will enable you to recognise and describe many different features of organisations. However, the module will encourage you to analyse these issues and be able to understand why organisations do what they do and look critically at their strategic decisions. You should be able to recognise and understand the importance of the various aspects of strategic decision making and implementation processes. You should remember that it is a Masters level module and you will only reap the full benefits if you put in the effort. This means preparing well and fully utilizing other arrangements to enhance your learning, e.g. tutor support and contributing to remote discussion and chat via available virtual learning environments. vi Unit 1 Strategy Defined and Key Concepts LEARNING OUTCOMES Following the completion of this unit you should be able to: Explain what corporate strategy is. Evaluate the importance of strategy to a manager in an organisation. Compare the characteristics of strategic decision making. Assess the skills required to be a strategist. Assess the holistic nature of strategy. Introduction The term corporate strategy can bring to mind various aspects of corporate management. Vision, competition, competitive advantage, new markets, managing for shareholder value, moulding corporate culture, operational processes for execution, strategic plans all come to mind. But what exactly is strategy? In this unit we shall define strategy, particularly as it applies to a manager. We shall also look at the various levels of strategy, and the key role of strategic thinking within an organisation. We shall examine the role of strategic models and how they can assist organisations in breaking down the complexity of strategic thinking. In particular, we shall examine the Johnson & Scholes model. Depending on the maturity of the market that a company operates within, the maturity of the company, and the corporate management culture, organisations adopt different approaches to strategy. The approach can be classified as deliberate, emergent or incremental, and we shall examine the differences between them. 1 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Finally, we shall look at two case studies to understand how the key concepts of strategy apply practically within organisations. Definition of Strategy There is no universal definition of strategy. Strategy applies to many disparate fields such as gaming strategy, economic strategy, investment strategy, military strategy, marketing strategy and indeed corporate global strategy. Taking a conventional approach, strategy can be thought of as a long term plan of action or execution designed to achieve a particular goal, such as achieving competitive advantage for an organisation. It reflects the values, expectations and goals of those who are in power within the organisation. These logical / prescriptive ideas about strategy emanate from the prescriptive approach as advocated by early strategic writers (see Preface and the text Strategy Safari (Mintzberg et al, 1998)). Many early writers continue to be widely quoted, e.g. Michael Porter. Many recent writers have challenged this view of strategy. The study of corporate strategy has moved on into softer areas and these issues need to be kept in mind. Early thinking (1960s) could be said to be modernist in view, i.e. a unitary perspective there was a single way to perform the task of strategy. There was an idea that data (both internal and external) could be fed into an analysis machine and the answer (the strategy) could be churned out. The postmodern view refuted this, saying that a strategist view should be pluralist, i.e. take many diverse things into account and this is evidenced by a number of writers. For example, the view of planning as opposed to emergence both viewpoints are supported by a wealth of academic writing (see later discussion in this unit). However, as a starting point, we will consider some prescriptive definitions and concepts to try to begin to appreciate the complexity of this subject. Lessons from military strategy Generalising strategy can be misleading, as the context is important. However, the military definition of strategy can be very helpful in the context of business, as the approach to winning in the business environment is very similar to winning a war. Success in business requires a sharp focus, and does indeed involve winning battles and gaining competitive advantage over the enemy, in this case the competitor. Military strategy is the holistic deployment of resources in such a way that the outcome of a war is influenced. As with military strategy, it is 2 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts vital that corporate strategy is holistic to be successful. To achieve the corporate strategy, the whole organisation must be focused on the same corporate goals and must team, execute and win in the marketplace. As with a war, a razor sharp focus is required to win in the marketplace. Strategic vs. tactical An important distinction to make at this point is between the strategic and tactical. The terms feature in the military as well as in business, and it is important to understand the difference. As we have just observed, strategy must be holistic it must involve the whole organisation and its objective is to achieve the goal (or win the war) defined by the company. Tactical measures are actions or manoeuvres carried out to win individual battles, which may eventually, after a number of battles, win the war. In the context of business, a tactical measure may, for example, involve ruthless, but short-term, price-cutting, in order to grab market-share and remove a competitor. A strategic move, on the other hand, may be an acquisition in order to move into a new market area. Tactical measures are usually short-term, whereas strategy is long-term. A series of tactical measures can help achieve the long-term strategy. VIRTUAL CAMPUS Discuss with your colleagues how a tactical action in your work context furthered the companys strategy. In particular, how it influenced: Competitive position. Market share. Customer satisfaction. Short-term vs. Long term profits and margins. New opportunities. Business strategy Some definitions of business strategy that are helpful are as follows: 3 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Corporate strategy is the pattern of minor objectives, purposes or goals and essential policies or plans for achieving those goals, stated in such a way as to define what business the company is in or is to be in and the kind of company it is or is to be Andrews K (1971). Page 8, Lynch. Strategy is the direction and scope of an organisation over the long term: which achieves advantage for the organisation through its configuration of its resources within a changing environment, to meet the needs of markets and fulfil stakeholders' expectations. Page 10, Johnson and Scholes KEY POINT Characteristics of business strategy are as follows: Sets direction and scope over the long term to achieve goals. Designed to achieve competitive advantage. Directs business in a changing and evolving environment. Holistic and pervasive of the whole organisation; covering the range and depth of its activities. Achieved by teaming, executing and winning in the marketplace. Fulfills stakeholder expectations; survival as a minimum and creation of added value as a maximum. ACTIVITY Read p. 1-19 of Chapter 1 and section 2.1 of the key text, De Wit, B & Meyer, R 4 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Levels of Strategy Strategy can be distinguished by the levels at which it occurs. Refer to Figure 1.1. Operational Strategy Corporate Strategy Business Unit Strategy Business Unit Strategy Business Unit Strategy Figure 1.1: Levels of corporate strategy. Corporate Strategy: Defines the strategy for the corporation (or organisation) as a whole, and is cascaded to business units below. of the organisation. Must be holistic and define the overall purpose and scope Must be visionary in some measure. Must ensure that the different parts of the organisation add value to the overall strategy. Must meet the expectations of major stakeholders. Business Unit strategy: Must be derived and be aligned with the corporate strategy. Must be focused on how to compete in the particular markets or business areas for which the business unit has responsibility. business remit. Can be visionary and creative within the context of its Operational Strategy: Must define and deliver the operational processes required to achieve the corporate and business unit strategy. 5 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Must address the resource and resource development plans to support corporate and business unit strategy. A further level of strategy, Network level strategy, is pertinent in todays business environment. Let us examine this in more detail. Strategic alliances or strategic networks are increasingly common in many sectors to compete effectively in the marketplace. For example, in the IT sector, gone are the days of mega-organisations that play in every aspect of computing and micro-electronics. Increasingly, companies with different specialisations or areas of dominance cooperate to compete effectively in the marketplace. An example is that of the IBM corporation. A few years ago IBM competed in practically every aspect of computing and information technology; from hardware to disk storage to micro-electronic components to software to operating systems to applications software to IT services. Today, to be cost-effective and satisfy customer requirements for open standards and best of breed, IBM has strategic partnerships with specialist hardware suppliers and software vendors (e.g. for CRM). Another example is that of the Bluetooth alliance of companies that has brought to market wireless interconnectivity of computer devices. In such strategic alliances, the different members of the network operate as separate corporate entities but their strategy is influenced and aligned with that of the strategic network. Such networks involve not only other profit-making corporate entities, but can also involve standards bodies or advisory bodies. Operational Strategy Corporate Strategy Business Unit Strategy Business Unit Strategy Business Unit Strategy Corporate Entity 1 Operational Strategy Operational Strategy Corporate Strategy Corporate Strategy Business Unit Strategy Business Unit Strategy Business Unit Strategy Business Unit Strategy Business Unit Strategy Business Unit Strategy Corporate Entity 2 Corporate Entity 3 Figure 1.2. Network Strategy. 6 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts ACTIVITY Think of an example, perhaps from your own work context, of how corporate strategy translated to business unit strategy and operational strategy. Did networks or strategic alliances play a role in moulding corporate strategy? Strategy and the manager Developing and deploying strategy successfully depends on managers understanding the key and high impact aspects of strategy. Managers should: Ensure that strategies are part of the overall corporate strategy. Ensure that strategies are consistent, coherent, effective and appropriate. Ensure that strategies are sustainable and supported by operational processes. Understand an organisations business environment. Understand the attributes of the organisation and what makes it unique/distinctive. Be aware of the organisations resources, capabilities, competencies and customers. exploited. Understand how the organisations advantages can be Understand and exploit the existence of any strategic networks/alliances. Strategic Concepts A number of factors influence the type of strategy an organisation adopts. These factors include the maturity of an organisation, maturity of the market sector it operates in, its corporate management culture, and market leadership goals. There are broadly two types of strategic concepts: 7 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Strategic Fit: Strategic Fit is the matching of an organisations strategy to the environment it operates in. It is really identifying opportunities that exist in the current environment and tailoring strategy to capitalise on it. Competitive advantage is achieved by correct positioning within the existing marketplace. when an organisation pro-actively stretches its resources and competencies to create new opportunities and capitalise on them. It means identifying resources and developing competencies to pre-empt and create new opportunities in the marketplace. Competitive advantage is achieved by not only meeting existing market needs but also future market needs. It is a resource-led approach with investment from the heart of the corporate centre. Strategic Stretch: Strategic Stretch, on the other hand, is ACTIVITY Can you think of an example of strategic fit? Now can you think of a company that has or is adopting strategic stretch? ACTIVITY FEEDBACK You probably thought of many examples of strategic fit, but perhaps had more difficulty with examples of strategic stretch. One example of strategic stretch is the Waitrose/Ocado partnership in the UK, which provides on-line grocery shopping and home delivery service. Currently, in the UK, the market for on-line shopping is small. With the exception of Tesco, which makes a small profit on on-line deliveries, most companies providing this service make huge losses, and many are withdrawing from this service altogether. Waitrose/Ocado are also making losses currently. However, they are strategically stretching themselves, and investing considerable amounts to expand services. They forecast a huge market opportunity in a few years to come. Waitrose operates in wealthy, middle-class areas, where the average weekly spend, on groceries, is in excess of 150 a week. If on-line shopping takes off (as they predict it will, in approximately 2-3 years time), Waitrose/Ocado would have carved themselves a very lucrative market, indeed. 8 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Strategic Thinking Where previously (in the 1970s and 1980s) the focus was on managerial skills in strategic planning, now the emphasis is on strategic thinking. Strategic thinking has creativity at its heart, and encourages the entire organisation to be involved. It minimises the risks associated with management power over strategy. A simplistic definition of strategic thinking is finding the answers to the following: Where are we now? Where do we want to go? How do we get there? For an organisation to be successful, strategic thinking must dominate its entire corporate culture. Strategic thinking must be ingrained, be at the forefront and influence every managers daily actions. It cannot be a one off or once a year activity. The following extract from Porter (1977) is helpful in highlighting the importance of strategic thinking. There are no substitutes for strategic thinking. Improving quality is meaningless without knowing what kind of quality is relevant in competitive terms. Nurturing corporate culture is useless unless the culture is aligned with a companys approach to competing. Entrepreneurship unguided by a strategic perspective is much more likely to fail than succeed. Strategic thinking cannot occur only once a year, according to a rigid routine. It should inform a companys daily actions. Moreover the information necessary for good strategic thinking is equally vital to running a business designing marketing material, setting prices and delivery schedules. There is a dangerous tendency today to practise single-issue management. The truth, of course, is that there is no easy answer. Quality, manufacturing, corporate culture , entrepreneurship and strategic thinking are all important. Concern for one does not imply all these aspects of management. One cannot ignore strategic thinking in favour of maintaining a supportive culture, just as one cannot ignore quality no matter how elegant is the strategic plan. Porter (1977) 9 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy De Wit & Meyer discuss the paradox of Logic and Creativity. They see strategy as a wicked problem, i.e. ambiguity, complexity and uncertainty prevail in making strategic decisions. The implication is that creative (or generative) thinking is crucial to enable managers (and their organisations) to move beyond the obvious, from the comfortable to the uncomfortable to be successful. This is often termed lateral thinking or thinking out of the box. Nevertheless, a role for logic is still in place. A manager still needs to be able to think rationally and be analytical in certain circumstances. However, they are bounded by their own rational thought and so are limited in what they can achieve. ACTIVITY Learn more about Strategic Thinking by reading the introductory section to Chapter 2 (p 51-67) in your key textbook, De Wit, B & Meyer, R Information Processing, Thinking and Strategy Strategic thinking involves the processing of information by managers to define strategy. Two different modes of information processing have been described (Walsh, 1995): Bottom-up processing. Top-down processing. Bottom-up processing The characteristics of bottom-up processing, in the context of strategic thinking, are: Driven by the process of gathering detailed information from all levels. Decision making is then carried out after elaborate analysis of the strategic problem, or issue under consideration, and a review of all possible solutions. Top-down processing The characteristics of top-down processing, in the context of strategic thinking, are: 10 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Driven by the recall and application of theory/models to real-life situations encountered. of previous strategies. Strategies are derived from the experience of the success Elaborate theories are rarely applied. Simple, abstract rule-of-thumb approaches take precedence. In practice, the majority of strategic decisions are made using top-down processing, and rely on the skills and experience of top level management. Neither approach lends itself well to less routine and novel strategic decisions (such as entering a new market or bringing to market a novel product/service). Such decisions require vision, creativity as well as business realism. Another important factor in strategic decision thinking is the role of uncertainly. Uncertainties can take the form of missing information, but other times arises simply from the unknowable. Such uncertainties can pose risks as well as new business opportunities. What makes a market leader is how that organisation predicts future opportunities from an uncertain environment. Through leadership companies are able to influence and guide the market with their own ideas and thereby create new opportunities. Strategic Thinking: skills Strategic thinking has many dimensions, and demands a variety of skills, as follows: A strategist needs to understand issues at the functional, technical and unit levels, as strategy must be holistic and integrated across all levels. issues and from that knowledge project strategy into the future. data/information, analysis of issues with that of experience, knowledge and understanding to predict the future renders competitive advantage. A strategist needs to identify the significance of current A good strategist needs to balance the use of A strategist needs to be creative. Creativity in strategy The following factors strengthen strategic thinking: Relevance and realism in thinking. 11 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Rigour. A varied approach to information processing. A balance between theory and practice to cross-check validity. A critical and challenging approach. ACTIVITY It is good practice for strategic decisions to be evaluated against set criteria. From your own work experience, can you identify the criteria (in the form of bullet points) against which strategy can be judged. ACTIVITY FEEDBACK You would have come up with a number of ideas. Some of which may be specific to the industry/sector in which you operate. A good list of evaluation criteria is outlined in the key textbook, De Wit, B & Meyer, R, Criteria for Evaluation, pages 74-75. Strategic Models Strategic thinking is a complex area. As such there is a role for strategic models that can enable analysis. However, they should be used with caution, noting that theoretical models can over-simplify the practical and complex issues faced by organisations in the real world. Firstly, it is helpful to recognise that strategic thinking has three dimensions to it as shown in Figure 1.3. 12 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Context Content Process Strategy Figure 1.3. The dimensions of strategic thinking. The process, content and context of strategies define the scope of strategic thinking, and must be considered together as they are closely inter-related. Let us look at each of these in turn: Process: The actions or processes that support how the strategy is analysed, determined, implemented/executed, changed and controlled. These processes link together or interact as the strategy unfolds in what may be a changing environment. addresses the main actions of the proposed strategy. Content: The result of the strategy process is content. It Context: Concerns the business circumstances or environment in which the strategy operates or will be developed. This can be the inner context, referring to the organisational setting or corporate culture of the organisation. Or it can be the outer context, such as external economic, political, business, environmental factors. ACTIVITY Can you think of some examples of how inner context can influence strategy. Similarly, think of an example of how outer context influences an organisations strategy. 13 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy ACTIVITY FEEDBACK You may have thought of one or two examples of how inner context influences strategy. Here is another example. Shell and Exxon are giant oil corporations. However, they are organised very differently. Shell has a structure that favours and devolves power to national or regional management. Whereas, Exxon has a strong corporate focus with an emphasis on functional and product lines of structure. In the Shell structure, strategic thinking is carried out at the regional level (e.g. by operating companies such as PDO in Oman, Brunei). The corporate headquarters at The Hague does influence strategy at regional levels, but doesnt dictate business unit-level strategy. In the Exxon example, the corporate body defines strategy. Strategy is then cascaded to the functional units. Processes and standards (e.g. IT standards and software applications) are defined by the corporate body. ACTIVITY Can you now think of an example of how outer context influences an organisations strategy? ACTIVITY FEEDBACK Increasingly environmental and ethical factors strongly influence strategy. Such factors are outside the control of the organisation, but nevertheless the organisation must adhere to it. Many Western companies utilise cheap factory labour from third-world countries, such as India, Taiwan, etc. More recently, skilled jobs, such as call centre operations, have also moved to countries such as India, as it is more cost-effective. Raised environmental and ethical awareness has forced Western companies to pay fair wages and provide satisfactory working conditions in these countries. Company stakeholders often demand ethical and sound environmental practices. This is an example of outer context, where the company must comply with external influences. 14 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts ACTIVITY Reinforce your understanding of the dimensions of strategy by re-reading p.5-11 of the key text, De Wit, B & Meyer, R. Johnson & Scholes Model Johnson and Scholes developed and elaborated an approach to strategy first put forward by Argenti in 1980. Argenti identified the distinct phases in strategic management, which can be grouped as follows: STRATEGIC ANALYSIS Target Setting. Gap Analysis. Strategic Appraisal. STRATEGIC CHOICE Strategic formulation. STRATEGIC IMPLEMENTATION As the arrows indicate above, Argenti suggested that strategic analysis should precede choice, and choice precede implementation. In reality, the phases often overlap. The overlapping nature of the phases was elaborated by Johnson and Scholes. Figure 1.4 shows types of issues that should be considered within the strategy development phases. 15 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Expectations and purposes The environment Resources, competences & capabilities Strategic analysis Bases of strategic choice Strategic choice Strategic options Strategy evaluation and selection Managing strategic change Strategy implementation Resource allocation and control Organisation structure and design Figure 1.4. Johnson & Scholes Model. Deliberate, Emergent and Incremental Strategies Strategy can be described as Deliberate, Emergent or Incremental. Going back to the Johnson & Scholes Model, the order in which the phases are carried out determines whether the strategy is deliberate, emergent or incremental. Deliberate Strategy is the result of adopting a classic planning approach, where analysis leads choice and choice leads implementation. In certain situations implementation can lead choice and analysis this is Emergent Strategy. Consider for example a supermarket chain, where one store is forced to cut prices because of fierce local competition. Finding the price cuts attracts more customers, other stores in the chain copy the pattern to gain market share. This is an example of emergent strategy. In other cases, analysis, choice and implementation proceed together, with the preferred choices influencing implementation and analysis, analysis influencing choice and implementation influencing analysis and choice. This is known as Incremental Strategy. 16 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts REVIEW ACTIVITY Learn more about the above by reading the section The paradox of Deliberateness and Emergentness in your key text, De Wit, B & Meyer, R, p.111-116. Also learn about the strategic planning perspective vs. strategic incrementalism by reading p.117 123 of your key textbook, De Wit, B & Meyer, R. Now apply what you have learned in this unit to your own work context. 1. Are you aware of your organisations corporate strategy? Are you aware of your business unit strategy? How is strategy formulated in your workplace? Would you describe it as deliberate, emergent or incremental? From what you have learned, can the strategy process be improved? If so how? What do you see as the major obstacles in your organisation to strategy development and strategy execution? How can these obstacles be removed? 2. 3. 4. 5. 6. Share your thoughts on the questions above with colleagues, either on the Virtual Campus or at your workplace. Solicit their input and ideas also, especially on items 4 and 6 above. CASE STUDY 1 IKEA Read the following extract about IKEA; (Source: Johnson & Scholes; Chapter 1 pages 6,7 & 229 and Sunday Times, 22 February 1998.) In 1953, just four years after Ingvar Kamprad had produced his first mail order catalogue featuring locally produced furniture, he opened his first store in Almhult, Sweden. Since then, he and his successors have created a global network of stores in 28 countries. Initially, stores were opened only in Scandinavia, but as greater levels of success were experienced, stores were built in countries further afield where the rewards, but also the risks of failure, were much higher. In all these countries the retailing concept of Ingvar 17 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Kamprad remained the same: to offer a wide range of furnishing items of good design and function at prices so low that the majority of people can afford to buy them. In the 1980s, Anders Moberg became the chief executive. However, the influence of Ingvar Kamprad could still be found. IKEA had always been frugal in its approach. In its early years it had relocated to Denmark to escape Swedish taxation. Echoes of the same philosophy and style could be seen in Anders Moberg. He would arrive at the office in the company Nissan Primera, dressed in informal clothes, and clock in just as other employees did. When abroad he travelled on economy class air tickets and stayed in modest hotels. He expected his executives to do likewise. Such prudence was extended to the company whose shares were held in trust by a Dutch charitable foundation and not traded. Furthermore, IKEAs expansion plans envisaged only internal funding with 15% of turnover being reinvested. The 1980s saw rapid growth. IKEA benefited from changing customer attitudes, from status and designer labels to functionality, encouraged by an economic recession. It also developed a number of unique elements which came to make up IKEAs winning business formula: simple, high quality Scandinavian design, global sourcing of components, knock-down furniture kits that customers transported and assembled themselves, huge suburban stores with plenty of parking and amenities such as cafs, restaurants, wheelchairs and even supervised child-care facilities. A key feature of IKEAs concept was universal customer appeal crossing national boundaries, with both the products and shopping experience designed to support this appeal. Customers came from different lifestyles: from new homeowners to business executives needing more office capacity. They all expected well styled, high quality home furnishings, reasonably priced and readily available. IKEA met this expectation by encouraging customers to create value for themselves by taking on certain tasks traditionally done by the manufacturer and retailer, for example the assembly and delivery of products to their homes. IKEA made sure that every aspect of its business system was designed to make it easy for customers to adapt to their new role. For example, information to assist customers make their purchase decisions was provided in a 200-page glossy catalogue; during their visit to the store customers were supplied with tape measures, pens and notepaper to reduce the number of sales staff required; furniture was displayed in 100 model rooms; and sales staff were expected to involve themselves with customers only when asked. To deliver low-cost yet high-quality products consistently, IKEA also had 30 buying offices around the world whose prime purpose was to identify potential suppliers. Designers at headquarters then reviewed these to decide which would provide what for each of the products, their overall aim being to design for low cost and ease of manufacture. The most economical suppliers were always chosen over traditional suppliers, so a shirt manufacturer might be employed to produce seat covers. Although the process through which acceptance to become an IKEA supplier was not easy, it was highly coveted, for, once part of the IKEA system, suppliers gained access to global markets, and received technical assistance, leased equipment, and advice on how to bring production up to world quality standards. By the mid 1990s, IKEA was 18 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts offering a range of 12,000 items, from 1,800 suppliers in 45 countries at prices 20-40% lower than for comparable goods. However, by 1998 the means of achieving low cost was receiving some critical attention. It was reported that IKEA was sourcing its goods from suppliers in eastern Europe which paid its workers poverty level wages. IKEA was the subject of a hard-hitting article in the Sunday Times in February 1998. The article concerned the working and living conditions in Romanian furniture factories. Although IKEA did not own any of the 25 factories which produced furniture for its stores, it had provided collateral for at least one factory to be bought from the state in 1992. In fact, there were allegations from the Federation of Wood Workers that the directors of the factory used money from IKEA and disregarded the law under which Romanian employees are entitled to be given the option of buying their own factory as a cooperative. The article observed that the appalling conditions in Romania flew in the face of the politically correct image of IKEA fostered by Ingvar Kamprad who regularly wrote memos to staff which started with Dear IKEA family. The managing director of this factory admitted that he kept a competitive edge by paying employees an average of about 20p per hour (about one-fortieth of the pay levels in Sweden). IKEAs response to these issues was that it had no management responsibility for any Romanian factory. It accepted, however, that conditions were poor and that it had provided the collateral necessary for the purchase of one factory. It also restated its financial support for the Romanian furniture industry through credits which allowed new buildings with better working conditions. It believed that trade was better than aid and that it intended to continue to assist with financial and technical support and by expanding orders. Having to cope with widely dispersed sources of components and high-volume orders made it imperative for IKEA to have an efficient system for ordering its supplies, integrating them into products and delivering them to the stores. This was achieved through a world network of fourteen warehouses. These provided storage but also acted as logistical control points, consolidation centres and transit hubs, and aided the integration of supply and demand, reducing the need to store production runs for long periods, holding down unit costs by minimising the costs of inventory and helping stores to anticipate needs and eliminate shortages. By the end of the 1990s, IKEA was turning its attention to new opportunities for growth. It had opened stores in eastern Europe and the one-time Soviet republics, believing these represented great future potential. In 1997, it announced its plan to open twelve new stores a year internationally in cities such as Frankfurt, Shanghai, Chicago and Roclab in Poland and to double manufacturing capacity by building up to twenty factories in eastern Europe by 2002. There were also plans to develop new areas of business. In partnership with a building contractor, IKEA was market testing, in Sweden, flat packed housing which could be assembled by two men and a crane in a week at prices about 30% less than the going rate. It was also developing new sources of supply, entering into an agreement with a timber company to develop new wood material for furniture. However, the company was also facing problems. 19 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy IKEA was experiencing growing competition on an international front. It had decided to implement a programme of cost savings, rationalising its supply chain and product range in order to cut purchasing costs by an overall average of 10%. The company had stated the intention of cutting what had become 2,400 suppliers by one-quarter and focusing on increased volumes with a smaller range of products and fewer suppliers. In 1996, Ingvar Kamprad announced that IKEA would be split into three, comprising the retailing operations, an organisation holding the franchise and trademarks, and a third arm involved mainly in finance and banking. The first two would form the core of the group, controlled at arms length by trust-like organisations; the latters shares would be jointly owned by Kamprads three sons. The structure was devised in an effort to ensure that the privately held organisation should not be broken up or sold off in a succession battle after Ingvar Kamprad retired. He also wanted to ensure that it would not be put under the sorts of external pressures for continual growth often faced by publicly quoted companies. Internally, IKEAs strategy was managed at different levels. A committee of senior executives at headquarters in Denmark was responsible for overseeing investment in new markets and stores; responsibility for product development and purchasing lay with IKEA of Sweden; and country managers tailored the presentation and marketing of products to home territories. Questions: 1. 2. Summarise IKEAs corporate strategy. Note down the characteristics of IKEAs strategy which could be explained by the notions of: - Strategic management as environmental fit - Strategic management as the stretching of its capabilities. 3. Comment on IKEAs ethical stance (You may wish to revisit this question after you have completed Unit 6. Unit 6 covers corporate ethics in more detail) 20 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts CASE STUDY FEEDBACK Feedback on Question 1: These are some of the considerations on strategy and strategic decisions in the context of the IKEA case study. Strategic decisions affect the long-term direction of an organisation. IKEA set out along a path which was difficult to reverse. In the 1950s and 1960s the company was, essentially, a Scandinavian furnishing retailer. By the late 1990s the whole thrust of its strategy had shifted to a global scale and IKEA was facing the challenge of how to develop into the twenty-first century. In so doing it had to consider other key issues. Strategic decisions are normally about trying to achieve some advantage for the organisation, for example over competition. IKEA had been successful not because it was the same as all other furniture retailers, but because it was different and offered particular benefits which distinguished it from other retailers. Similarly, strategic advantage could be thought of as providing higher quality value-for-money services than other providers in the public sector, thus attracting support and funding from government. Strategic decisions are sometimes conceived of, therefore, as the search for effective positioning in relation to competitors so as to achieve advantage in a market or in relation to suppliers. organisations activities. Does (and should) the organisation concentrate on one area of activity, or should it have many? For example, for years IKEA had defined the boundaries of its business in terms of the type of product (furnishing items of good design and function) and mode of service (large retail outlets and mail order). While not owning its manufacturing, it did have an in-house design capability, which specified and controlled what manufacturers supplied to the company. There were signs by the late 1990s, however, that IKEA was extending its product scope from furnishings into other product areas, as with its experiments with housing. Over the years it had also substantially widened its geographical scope to become one of the few truly multinational retailers in the world. to the environment in which it operates. This is sometimes known as the search for strategic fit. While the market for furnishings was mature, with little prospect of overall growth, the management of IKEA had seen that the retail provision of furnishing in most countries did not meet the expectations of customers. Customers frequently had to wait for delivery of items, which were highly Strategic decisions are likely to be concerned with the scope of an Strategy can be seen as the matching of the activities of an organisation 21 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy priced. The market provided another opportunity. Customer tastes were relatively common in different countries except in specialised segments of the market: buyers wanted everyday furniture which was well designed and looked good, but which was reasonably priced. IKEA also knew that it faced significant differences in its markets. By the 1990s the number of countries in which IKEA was represented was a great deal larger than in the companys early days. This meant that IKEA had to understand buying habits and preferences from a much wider base, from markets close to its Swedish home, to the USA, and even to the Far East and eastern Europe. IKEA could no longer assume that its knowledge of earlier markets would necessarily apply: for example, it had found that shopping habits in the USA differed substantially from those in Europe, and this had required a change in the way it serviced the market. Therefore, while the principles of IKEAs business idea were adhered to around the world to produce a consistent product quality and shopping experience, store management had been given a greater degree of freedom to adapt to local market needs. IKEAs management had, however, decided that there were some markets, attractive though they were, where it did not make sense to try to control IKEAs operations directly. Here the company recognised that local knowledge in fine-tuning the business to local needs was vital; or the problems of long-distance control were too great to manage the operation effectively on this basis. It had, therefore, established local joint ventures through franchise arrangements. There were wider environmental issues, which affected IKEAs fortunes; for example, IKEA was less susceptible to economic downturn than many of its competitors. This may have been because its prices were often lower; but it was also because, when a customer took a purchasing decision at IKEA, he or she walked away with the goods. In other stores, since delivery was often delayed, purchase decisions were also often delayed. Economic conditions in the different countries in which IKEA operated did, however, affect its success: for example, the growth in car ownership, particularly in less highly developed countries, determined the percentage of the population which could shop at an IKEA store. Strategies may require major resource changes for an organisation. For example, the decision that IKEA took to develop its operations internationally had significant implications in terms of its need to obtain properties for development and access to funds by which to do this, sometimes for projects which might be seen as high risk for example, entering new markets in times of recession. The size of the operation in terms of numbers of people working in it, property and physical stock held had to rise significantly. The 22 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts need to control a multinational enterprise, as opposed to a national operation, also began to require skills and control systems of a different sort. It was a problem which many retailers found difficulty coping with. A major reason has been that retailers underestimate the extent to which their resource commitments rise and how the need to control them takes on quite different proportions. Strategies, then, need to be considered not only in terms of the extent to which the existing resource capability of the organisation is suited to opportunities, but also in terms of the extent to which resources can be obtained and controlled to develop a strategy for the future. Strategic decisions are likely to affect operational decisions. For example, the internationalisation of IKEA required a whole series of decisions at operational level. Management and control structures to deal with the geographical spread of the firm had to change. The way in which suppliers were controlled and the methods of developing and distributing stock required revision to deal with the extended distribution logistics. Marketing and advertising policies needed to be reviewed by country to ensure their suitability to different customer behaviours and tastes. Personnel policies and practices had to be reviewed. Store operations needed to change too. For example, in the USA, IKEA saw the need to add to the core product range from local suppliers, install serviced loading bays and erect bollards to stop the shopping trolleys being taken to all parts of the car parks, which are very large in the USA. This link between overall strategy and operational aspects of the organisation is important for two other reasons. First, if the operational aspects of the organisation are not in line with the strategy, then, no matter how well considered the strategy is, it will not succeed. Second, it is at the operational level that real strategic advantage can be achieved. IKEA has been successful not only because of a good strategic concept, but also because the detail of how the concept is put into effect the strategic architecture in terms of its logistics of buying and servicing, shop layout and merchandising to supplier and customer relations, all developed over many years, is difficult to imitate. The strategy of an organisation is affected not only by environmental forces and resource availability, but also by the values and expectations of those who have power in and around the organisation. In some respects, strategy can be thought of as a reflection of the attitudes and beliefs of those who have most influence on the organisation. Whether a company is expansionist or more concerned with consolidation, and where the boundaries are drawn for a companys activities, may say much about the values and attitudes of those who influence strategy the stakeholders of the organisation. In IKEA the insistence on internal financing influenced long-term development and the direction of the company: the influences of the founder and chief executive remained pronounced. The emphasis on frugality and simplicity clearly influenced the way the company operated. Indeed, 23 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy critics pointed to what they saw as a disregard for the well-being and welfare of the low-paid workers of suppliers in the name of keeping down costs. The conclusion from the above case study is that strategic decisions often exhibit the following characteristics: 1. Complex: especially for multinational organisations such as IKEA with a wide range of products/services. Involve uncertainty: They often involve taking decisions about the future, which is impossible for managers to be sure about. Require an integrated approach: Managers have to work across cross-functional and operational boundaries, and come to agreements with other managers who may have different interests and priorities. They also have to manage external relationships such as with suppliers, distributors and customers. Involve change: Strategic decisions often involve change. Not only is it problematic to decide upon and plan change, it is even more problematic to implement change if the organisations culture is not in line with the desired future strategy. In the case of IKEA there were the following strong influences: (i) family owned company with no shareholder/financial market influence on strategy (ii) Swedish influence, reflecting Swedish values. 2. 3. 4. Feedback on Question 2: Decisions on whether a company takes an environment led approach (fit) or a resource based approach (stretch) is often complex. IKEA is such an example where arguments can be formed to justify both. Taking a strategic fit approach means, as in the case of IKEA, trying to identify the opportunities which exist in the environment and tailoring the future strategy to capitalise on these, for example by locating in particularly favourable markets or seeking to appeal to attractive market segments. However, strategy can also be seen as building on or stretching an organisations resources and competencies to create opportunities or to capitalise on them. The product range IKEA had designed and developed was not only low cost but unique, not only because of its kit form but also in its style and image. IKEA benefited from years of design experience dedicated to its operation and markets. The logistics of the operation, from sourcing of products to control of stock and the immediate supply of the product to take away, had been learned over many years and provided not only a quite distinct way of operating, but a service greatly appreciated by customers. In short, both the resources and experience built up over the years had been consciously developed to service the evident opportunity in the market place. 24 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts IKEA then stretched its capabilities, using its experience in the furniture market, to create a different market opportunity. It set out to reinvent value, and experimented with housing in the late 1990s. It started to think about value in a new way; one in which consumers are also suppliers, suppliers are also customers, and IKEA itself is not so much a retailer but as a central hub for services, goods, design, management, support and even entertainment. In practice, organisations such as IKEA, develop strategies on the basis of environmental fit and stretch. IKEAs experiment with housing was the result of identifying a new market opportunity, but it was also an attempt to capitalise on its skills in developing kit-form products at low-cost. Feedback on Question 3: The issues to consider are: Is it good business practice to achieve high profits by lowering costs, irrespective of the ethical issues in the Romanian factories? Is the local population in Romania, grateful for having IKEAs contract? Or was IKEA exploiting low labour cost locations? IKEAs view of this is that it is a sub-contract arrangement, and it is not up to them how the workers are treated. Is this a realistic attitude? How should IKEA deal with public pressure and use its influence to improve working conditions and workers rights? Revisit this question after you have covered Unit 6. CASE STUDY 2 POWERGEN The next case study is case study 5, PowerGen: Strategy and Corporate Planning in your key textbook, De Wit, B & Meyer, R (p. 709-720). Below is the case synopsis: CASE SYNOPSIS PowerGen was vested as a British electricity generation company in 1990 as the result of the privatisation of the UK energy systems. The previous state owned Central Electricity Generating Board was split into three companies, of which PowerGen was the smallest. All three companies were asked to compete in the market, and the market was 25 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy opened for further new entrants as well. Along with the privatisation and liberalisation, the government introduced completely new mechanisms of matching supply and demand, such as an electricity pool or the creation of a separate transmission company, and the installation of new regulatory institutions. All market players needed to learn how to operate an energy market, where before there was only a central planning agency. As the name of CEGB implied, the institution from which PowerGen emerged, had strong planning instincts for fulfilling its task to supply electricity to British households and industry. Therefore, it was not surprising when PowerGen started preparations for being an independent company in 1988, that a very detailed strategic planning system was installed with the help of McKinsey consultants. However, already in 1992, only two years after the operational start of the company, a substantial reorganisation was conducted, which triggered a complete change of the strategic planning system as well. When this new planning system failed to function satisfactorily in 1993, it was substantially revised for the 1994 planning cycle. In 1996 the company underwent again a major reorganisation, adjusting the company to a number of internal and external strategic developments. That also caused the strategic planning system to be substantially revised. In particular it was now broadened to include a highly sophisticated scenario development module to be conducted on the business unit level. The corporate composition did not stabilise thereafter either. In 1998 PowerGen completed a major purchase of a regional energy distribution company, merger discussions with US partners continued on and off, government interference changed the pricing arrangements of the industry and dictated strategic directions, etc. It seemed that the planning system was always several steps behind the actual conditions of the company. On the other hand, without the planning support, how could the company have assessed its choices in the rapidly changing environment of European energy markets in the 1990s? Now read the full case study (pages 709-720 of key textbook, De Wit, B & Meyer, R) with the following learning objectives in mind: Understand the need for formal planning systems. Understand possible designs of formal planning systems. Identify the common pitfalls of formal planning systems. Conceive alternatives for formal planning systems. 26 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Questions: 1. Identify four different development stages of the strategy planning system that PowerGen was using between 1990 and 1996. Catalogue the key changes from one stage to the next. What were the reasons for these particular changes? Which reasons are attributable to foreseeable circumstances, and which reasons are attributable to unforeseeable circumstances? What were some of the major strategy decisions that were taken at PowerGen? Speculate to what extent the results of the strategic planning system were used for making these various corporate strategy decisions. Collect the hints in the case, which suggest that there is also a parallel strategy formation process in place that operates in a more incremental, emergent fashion. 2. 3. CASE STUDY FEEDBACK Feedback on Question 1: PowerGens strategy planning system developed in four different stages during the first six years of its privatisation. Phase I: Occurred in 1990 with strongly centralised formation and planning. Performed in a functional structure by the commercial division, and focused on pool operation. Context: where and by whom? In a renewed, functional structure of the organisation. Led and managed by a large, centralised planning team at the commercial division, monopolising the strategy planning and decision making within the corporation. Separated financial role within the Finance division for reviews and projection of plans. Process: how and when? Deliberate formation. 27 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy 5-stage planning process: business unit aggregation divisional plans aggregation corporate plan . Use of scenarios concerning market share, pool prices and competitor analysis for the core business. 12-month process. Content: Focus of strategy: the operation of the pool. Diversification and early internationalisation. Planning focused on resource implications of strategic decisions. Phase II Occurred in 1992. To some extent decentralised formation and planning, under responsibility of rather autonomous division directors, supported by divisionalised financial staff and a downsized corporate planning team. Context: where and by whom? From a functional structure towards three divisions with profit and cost centres. Decentralisation of (strategic) decision making and planning to the divisions, headed by empowered MDs. Replacement of the large, central planning team by business level planning staff within the divisions. Introduction of a small central strategic planning function, responsible for both corporate strategy development and corporate planning. Reallocation of financial planning support towards within the finance department. Process. how and when? Business units developed own business plans, reviewed by divisional boards, and incorporated in corporate plans; the process itself did not change too much merely the responsibilities of making up the plans had shifted profoundly. Shortened planning cycle to nine months. 28 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Content: Shift in business unit responsibility and culture: from expenditure limits towards operating results, from meeting centrally set targets to exploring their potential, with increased options and widened commercial focus. Less detailed level of planning. Reasons: Devolution and introduction of an internal market. Diversification (first attempts of internationalisation) and early verticalisation of the businesses required increased responsiveness at business unit level. Phase III Occurred in 1994, with a focus on regaining fit between strategy developments and financial priorities. Context: where and by whom? Responsibility for the plan and for managing the corporate planning process was passed to the director of finance, effectively increasing the influence of financial considerations in the planning process. Scenario development was partly delegated to business units, which became responsible for developing a number of scenarios showing how the market might develop, and the plans that followed were to be robust to those possibilities. Reasons Foreseen profit margins lower than forecasted, because of regulatory intervention (introduction of capped wholesale prices) and competition (increased market share of Nuclear Electric). Unforeseen extended planning cycle, because of massive recalculations of forecasts. Unforeseen rift between strategic decisions and financial priorities. Emanated from a strategy and planning process with few independent checks and balances from a financial point of view. Unforeseen failure of the centre to communicate (foreseen) scenario information fully. 29 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy Desire to eliminate divisional bureaucracy in managing the planning process, because of conflicts between different layers of the corporation. Phase IV Occurred in 1996 with further delegation of the strategic decision-making and planning process to business units, between which common strategic management activities were increasingly co-ordinated and increasingly emergent. Context: where and by whom? From divisional structure towards clusters of business units. Shift and separation of strategy responsibilities: BU planning process to BU finance manager; BU strategy development to other BU staff member. Strategy triangle between CEO (for corporate strategy, supported by Finance Director (for corporate financial implications) and corporate strategist & planner), group MD (responsible for business unit strategy, assisted by finance manager, who managed the planning process). Process. how and when? Strategic actions increasingly in reaction to environmental (industry dynamics and regulatory) changes, in a continuous absorption of the external perspective and its impact on strategic options. Decentralisation of scenario development: from corporate scenarios as a guideline, towards scenario development at business unit level. Horizontal co-ordination (not centralisation) between multi-units, with integratedstrategic management and organisational development (skills transfer, human resource planning, etc.). From pre-set details towards a more gradually evolving process, with ongoing examination of BU strategy, with increased scope for absorption of emergent issues into development and planning cycle. Decrease in formality of process (including debating, lobbying for and formation of coalitions for strategic options and actions between corporate and business levels). Sequenced process: first BU strategy, than BU planning. 30 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts Differentiation among guidelines for the different businesses. Five-year horizon. Content The highly increased impact of regulatory forces on PowerGen increasingly required a pattern of political bargaining with the environment. Instead of planning the future in detail, a pattern of action and reaction with environmental forces became a highly influential factor in PowerGens strategic behaviour. Organisational systems Encouragement of planning system initiatives by BUs within a corporate context (such as the multi unit scenario development). Reviews by team of BUs and corporate level. Introduction of bonus system, related to strategy process. Reasons Increase in environmental complexity and uncertainty, because of diversification, competition and new regulation. An unforeseen need for co-ordination between the different strategising activities of BU. Foreseen need for independent management of several new businesses. Need for separation and autonomy of marketing and sales, in anticipation of liberalisation of core markets. Need for even further autonomy of business units, in order to create increased focus for business units specific circumstances. Feedback on Question 2: 1. Development of generation power. PowerGen began to develop its generation capacity to better fit commercial and environmental requirements, through improving the flexibility of the coal units and developing gas-fired stations. The move to flexible production came along with the anticipated need for flexibility in the supply of energy. Before the liberalisation, the previous planning mechanism could easily foresee total demand on a yearly basis, dividing the total and allocating parts to the various generation units. But in the fresh market, the demand for energy could easily alter significantly, mainly due to the 31 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy new market mechanism: the wholesale pool. To be responsive to this new market logic, production needed to be flexible. Note, however, that the very step of introducing flexible production, actually opposed the whole idea of the formalised, long and detailed planning process that was adapted by PowerGen in 1990. Because of the electricity pool, it became much harder to forecast exact production demand. 2. Leveraging of core competencies. PowerGens moved to leverage her core competencies in other energy-related areas, both vertically and horizontally (internationalisation). Examples include: - Upstream: acquisition of assets in the North Sea and Liverpool Bay. - Downstream: formation of a joint venture with Conoco, Kinetica; plans included the supply of gas to power stations, including PowerGens, and large businesses; establishment of Combined Heat & Power (CHP); acquisition of East Midlands Electricity plc. (EME), 98. - International: (early stage) power station and mining acquisitions in eastern Germany and Hungary, with construction projects in Portugal and Indonesia. Later on in the 1990s, further foreign direct investments in plants and projects overseas. - Commissioning of two new CHP plants. As stated in the case, PowerGen strategy anticipated that it would suffer an inevitable reduction in market share, together with pressures for price reduction. Consequently, the company recognised that growth in the medium and longer term would require the establishment of new income streams in other energy-related areas where its core competencies could create value. The case reveals data on slow growth perspectives for PowerGens core industry in the UK on the one hand, and high growth forecasts in domestic energy related areas and increasing international demand for power on the other hand. Probably, within the planning cycle, external industry assessments had come up with these insights, forming the basis for environmental scenarios. This ultimately resulted in the formulation of strategic options at PowerGen and the strategic choice of a path to growth in a still standing UK market. 3. Intended sell of PowerGen North Sea (1997/1998). In the case of the acquisition of EME, it is to be assumed, that the one-stop-shop (supplying all households energy needs) strategy had been pushed for by strategists as the solution for ensuring long-term profitability at PowerGen. Also, the case explicates that integration of generation and 32 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts distribution provided necessary expertise for similar future international acquisitions. 4. Merging explorations with US utility groups. Clearly, from a content point of view, the strategy and planning process focused on leveraging core competencies for expansion of its business. In fact, in the later 90s PowerGens challenge was to get individual business units to be more responsive in leveraging core competencies of PowerGen to operations in both domestic and overseas markets. One could argue that the planning process of PowerGen from 1996 successfully managed this challenge, by engaging delegated business units in the strategic management process. Note, that the allocation of the strategy and planning process to the commercial division in 1990, might indeed have affected the strategic choices made by PowerGen. Identification of strategic issues by this division might be completely different when the strategic management function was allocated to the finance department (as in 1992), for example. 5. Creation of a new holding company in the US, in order to continue assessing possibilities in the US. Intended further growth of the core business required the injection of considerable capital. If the reorganised planning process (1996) is considered, one could argue that this sale is a direct effect of the setting of overall strategic and financial direction by the CEO, Finance Director and Group MD. The case reveals explicitly the causes of failure of intended mergers between PowerGen and Cinergy and Houston, two major US utility companies. Both failures are clear cases of intended, but unrealised strategic actions, for which the causes could obviously not be caught in strategic planning (strains between the two chairman and regulatory intervention). 6. Focus on power generation as a core business and becoming a low-cost producer on a world-class basis. Feedback on Question 3: In order to cope with the limitations of the various planning processes that were effective at PowerGen during the 1990s, an unofficial, parallel formation process emerged, on different dimensions. If the planning processes of the first and fourth phase are compared, to some extent the planning process in itself underwent change. The planning process became less formal and it was recognised it could not be sequential. Over the years, the results of the process became increasingly dependent on coalition forming, lobbying and a constant discussion between the different planning process levels of PowerGen. The extent of freedom to business units in developing strategy increased significantly. Whereas in the early '90s all strategy development and planning activities were performed by almost a single department, in later 33 Unit 1 Strategy Defined and Key Concepts Global Corporate Strategy stages entrepreneurial freedom was given to managing directors of business units, especially those involved in new businesses (that formed an increasing part of the total PowerGen portfolio). Also, business units became free in choosing appropriate techniques as means to develop strategy, and MDs were given considerable influence over their own revenues, including the questioning of central purchasing of services. Scenario development too became increasingly incremental, due to the deployment of robust strategy development, inherently decreasing the extent of detail in business plans. In fact, the role of the Group MD became increasingly a role of shaping the course of action by gradually blending together initiatives into a coherent pattern of actions, rather than rigidly setting the course of action in advance. Externally, an increased amount of effort was made to manage the interface with regulatory, political and environmental developments, in order to continually absorb external perspectives and assess its implications for strategic options. Obviously, this level of market and environment responsiveness could not be incorporated into the formal planning cycle, suggesting a parallel pattern of strategic actions alongside its planning cycle. Opportunistic behaviour emerged, as a result of the numerous governmental interventions with great impact on strategic actions. The course of action, reaction and reconsideration that increasingly determined the pattern of actions of PowerGen, suggest that there was indeed a parallel course alongside the formal planning process. The major realised strategic actions of PowerGen did not result from the planning process, but were reactions to governmental rulings, market opportunities or emerging industry dynamics. The actual strategic behaviour of PowerGen increasingly showed logical incrementalism, rather than the pure deployment of the formal planning cycle. Summary In this module we have described what corporate strategy entails. We have noted that strategy must be holistic, and that strategic thinking must dominate an organisation and influence its daily actions. We examined the various levels of corporate strategy, and also considered network level strategy; increasingly relevant in todays world. We have looked at the importance of strategy to a manager, the skills required to be a strategist, and the characteristics of good strategic decision making. We considered the role of models in strategic thinking, in particular the Johnson and Scholes model. Finally, students have been presented with two contextual case studies (IKEA and PowerGen) to work through. 34 Global Corporate Strategy Unit 1 Strategy Defined and Key Concepts To gain maximum benefit from this module, students are encouraged to apply the lessons learnt to their own work context. Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. Ref 10, Chapter 1 Pages 4-34, Chapter 2 Pages 37-75 Ref 7, Chapter 1 Pages 3-37, Chapter 2 Pages 43-87 35 Unit 2 Strategic Capability LEARNING OUTCOMES Following the completion of this unit you should be able to: Assess the importance of core competencies to an organisation. Analyse the influence synergy can have on an organisation. Judge the role divestment has on organisational performance. Introduction Corporate strategy is the overarching strategy that applies to a number of businesses combined within a single corporation. This is more than aggregating the individual strategies of its various component businesses. There must be definite and identifiable benefits from combining the businesses together in a single corporation to make corporate strategy worthwhile. This unit examines how businesses are combined to achieve superior performance. To obtain optimal corporate performance, a corporation may increase or reduce the number of component businesses so as to create a more effective combination. Corporations use different management styles in achieving an optimal mix. We shall examine portfolio management and core competencies as two different styles. Portfolio management was fashionable in the 1970s and 1980s, when the focus was purely on financial control, and it was thought that benefits could be obtained by holding a portfolio of diverse strategic business units. It was also felt that this approach reduced risk for the corporation. In the 1990s corporations began to see the efficiencies and benefits of focusing simply on core business, and a greater focus has come about on developing a corporations core competencies. Corporations thus started to alter their composition in order to strengthen core competencies. Whichever approach is adopted, executing corporate strategy often involves acquisitions, mergers and divestments. We shall also examine some case studies concerning strategic capability. 37 Unit 2 Strategic Capability Global Corporate Strategy The Different Management Perspectives Corporations adopt different management styles in strategic planning, depending on the environment and business context, the corporations product/services range, its leadership style and management culture. The two extreme positions are: Portfolio management. Strategic planning by Core Competencies. Portfolio management is a management style whereby financial control is performed by the corporate centre, but otherwise the individual businesses are de-centralised and highly autonomous. Corporations adopting this style, achieve greater responsiveness because the individual subsidiaries are autonomous, but fail to achieve the longer-term benefits of exploiting synergy. The Hanson group of companies is a classic example. Corporations that wish to exploit synergies between their various businesses and develop a longer-term competitive advantage, generally adopt a management style based on core competencies. Canon is a good example of a corporation that carries out strategic planning based on core competencies. In practice, many corporations try to balance responsiveness with synergy by adopting management styles that fall between the two perspectives of portfolio management and core competencies. This is sometimes termed the strategic control perspective. See Figure 2.1. Nestle is an example. Responsiveness Corporate Level Strategy Synergy Hanson Nestle Canon Figure 2.1. Corporate Level Strategy Continuum. The paradox of responsiveness and synergy can be illustrated with reference to these three companies. Hanson PLC was well known in the 1970s for portfolio management in the purest sense. They operated very much in line with the analogy described below as an investor would in financial markets to maximise returns on their investment by the buying 38 Global Corporate Strategy Unit 2 Strategic Capability and selling of companies. The corporate centre had no wish to become involved in the management of the portfolio companies but sought to control simply by financial investment. The advantage of these companies was responsiveness to particular markets. Campbell and Gould identify this style of corporate strategy management as Financial Control. Canon had the opposite strategic approach. They use their expertise (capability) across a diverse range of products and markets. For example, the technology used to develop the Canon photocopier was the same as that used for their other optical products hence, the technology is completely different in a Canon copier than, for instance, a Xerox. Their advantage came from efficient (synergistic) use of capabilities and resources. Campbell and Gould identify this style of corporate strategy management as Strategic Planning. Nestle can be said to lie somewhere in between. Whereas it is not important to define the precise location on the continuum, it can be said that Nestle combines the two perspectives. On the one hand they manage their geographically dispersed Business Units as remote and autonomous, passing on strategic control to them. On the other hand they maintain strong involvement in the operation of the Business Units by the application of a rigid and detailed strategic planning process managed at the corporate centre. Hence, it can be said that Nestle is a mixture of the two perspectives. Campbell and Gould identify this style of corporate strategy management as Strategic Control. ACTIVITY Learn about organisations and capability building by reading the following from your key text, De Wit, B & Meyer, R. Readings 5.2 and 5.3: pages 267-285. Also read Chapter 6 on Corporate Level Strategy : pages 297-318. Portfolio Management In portfolio management, in the strictest sense and at the very extreme position, the corporate centre acts solely as an investor with financial stakes in the standalone businesses. The corporations main philosophy is to leverage financial control. See Figure 2.2. In this extreme position, there is very little co-ordination between the various business units, and there is fuzzy co-operation. Each business unit has its own characteristics and market demands. 39 Unit 2 Strategic Capability Global Corporate Strategy Corporations that adopt the extreme portfolio management position are well suited to diversification through acquisitions. Corporate Centre Financial control SBU1 SBU2 SBU3 SBU4 SBU5 SBU6 Figure 2.2. Portfolio management and financial control. As we move to the right along the continuum (see Figure 2.1), various strategic approaches can be described that are still essentially portfolio-based. But the corporate centre takes more of a parenting role, and can add value in some of the following areas: efficiency improvements, leverage, provision of expertise, investment and competence building, fostering innovation, mitigation of risk, provision of image and networks, collaboration/co-ordination across SBUs, standards and performance measurements, vision. With the parenting approach, the question must still be asked on whether the corporate centre adds value or destroys value. Those who argue the value creation case cite the following advantages: 1. Co-operation and Control: - Information sharing - Co-operation of directors/managers - Real time decision making 2. Exploitation of: - Slack (available resources) - Synergies - Learning - Innovative capability 40 Global Corporate Strategy Unit 2 Strategic Capability - Common infrastructure, processes 3. Intervention in management recruitment and development Those who argue that parenting destroys value would make the case that SBUs would be better off on their own, because the corporate centre creates: 1. 2. 3. 4. 5. Additional cost Creates more bureaucracy Delays decision making Reduces responsiveness Buffers SBU from investment realities They would also argue that a powerful corporate centre leads to managerial ambition and empire building. Whatever the position adopted, there must be a clear understanding of the corporate rationale. It is important right at the outset to establish the role of the corporate centre. This could be one of four types ranging from.... 1. A Portfolio Manager as a manager of a portfolio of investments (as above) which may include divestment of under-performing SBUs, acquiring under-valued assets and making them better. A Restructurer similar to 1 but managers from the corporate centre move to re-structure to create SBU fitness by intervention. A Synergy Manager enhancing value across SBUs by sharing of activities (e.g distribution networks). Knowledge transfer (see Unit 8) and sharing of competence (see below). A Parental Developer Corporate Centre develops parenting competence including establishing structural and strategic control linkages. 2. 3. 4. Hence, it can be seen that parenting strategy can be developed from 1 (portfolio management) though 2, to 3 and then 4 which tends towards a more competence based strategic approach. Portfolio management has strong links to the views of Michael Porter (Harvard Business School, 1980) that superior profitability derives from the structure of attractive industries. It suggests that superior profitability comes from a superior resource position relative to competitors. Both the Boston Consulting Group (abbreviated as BCG) and GE/McKinsey matrices position businesses according to industry attractiveness and their relative competitive position in industry. 41 Unit 2 Strategic Capability Global Corporate Strategy ACTIVITY Study the BCG matrix and GE business screen as shown on Figure 6.2, p. 299 of the key text, De Wit, B & Meyer, R . What conclusions do you derive from it? ACTIVITY FEEDBACK The BCG matrix is drawn up against two orthogonal axes; relative market share and market growth Relative market share indicates a businesss market power (one source of competitive advantage) and this is equated with its ability to earn above average rates of return. In the extreme, higher returns derive from a monopoly (100% market share). More often, however, having a large market share will coincide with cost benefits from large production runs and large cumulative volumes of production. Market growth in the BCG matrix is related to the product life-cycle concept, which suggests that growth will be minimal or negative when a product is mature. The Business Portfolio ACTIVITY As an introduction to this section, read the following from your key text, De Wit, B & Meyer, R. Reading 6.1: pages 319 325 In portfolio management, a corporations business can fall into one of four categories: 42 Global Corporate Strategy Unit 2 Strategic Capability Stars. Cash cows. Dogs. Question marks. A business is categorised as one of the above, depending on its market share vs. growth rate characteristics. This is clearly depicted in Figure 2.3. Stars Growth rate Question marks Cash cows Dogs Market share Figure 2.3: Business portfolio. As we see in Figure 2.3, businesses with market power in a growing market are stars. With proper investment these can become cash cows generating significant income for the corporation. A corporation can, therefore, secure its future by combining a balanced portfolio of stars and cash cows, the latter to fund the former as they grow. Portfolio management as the accepted means of managing corporate strategy coincided with the growth of diversified conglomerates in the 1970s. Often these conglomerates consisted of a portfolio of unrelated businesses, where the management of corporate cash flows between the businesses was the sole underlying rationale. This period was accompanied by a pattern of acquisitions of unrelated businesses, often followed by the divestment or liquidation of those classified as dogs, and deemed to be of no further use in generating cash for the corporation. Businesses in the category of Question marks need careful management. They exhibit the characteristics of high growth but low market share. Stars usually emerge from the category of question 43 Unit 2 Strategic Capability Global Corporate Strategy marks with proper levels of investment. As such they are an important component of the business portfolio. However, because of their high growth characteristics they require a large injection of cash. Unless they quickly capture market share and move into the stars category, they have the propensity to absorb large amounts of cash. As growth slows down they become dogs. This type of corporate behaviour still has relevance today. There is evidence of extensive merger and acquisition activity that suggests that companies remain in the market for valuable Business Units which are quite often kept separate from the corporate centre as a portfolio company. It is often the case that such activity is geared towards global expansion (see Unit 3), knowledge expansion and creation (see unit 8) or simply is the result of a combination of desirable economic conditions (see Unit 4). Shareholder portfolios Many of the ideas relating to portfolio management stemmed from the management of shareholder portfolios in the field of finance and economics. In particular, risk reduction by spreading investment across a portfolio of shares with different patterns of dividend payments and capital appreciation. In trying to balance stars and cows the corporate strategy manager acts like a shareholder, reducing the unique risk that comes from owning one business. Anglo-American ideas of the pre-eminence of shareholder interests in corporate strategy management also led to a focus on shareholder value analysis techniques as a tool for managing diversified businesses. The manager of a diversified corporation is not, however, a shareholder investing in a portfolio of stocks in the market. Portfolio theory is based on the assumption of perfect markets, and a perfect market is dependent on the availability of perfect information. Critics of corporate portfolios submit, however, that in a perfect market it is the task of shareholders to use that information to construct a portfolio according to their own risk return profiles. In a perfect market it is unclear how a corporate portfolio manager can add further value for shareholders. Indeed, diversified corporations submerge information about individual businesses in less informative corporate reports and add the transaction costs of managing corporate portfolios to the costs which a shareholder has to bear. In situations where co-operation and co-ordination are introduced (e.g. the role of the Parental Developer, described above) between autonomous SBUs, a company is then moving along the responsiveness / synergy continuum towards a more resource based view of the company. The combining of effort leads to the creation of greater efficiency or synergy in the use of resources. 44 Global Corporate Strategy Unit 2 Strategic Capability Synergy in Corporations Synergy is often put forward as the justification for acquiring or merging businesses. But what is synergy in this context? The familiar expression of synergy is the effect by which the whole exceeds the sum of the parts. The equation 2+2 = 5 is often used to demonstrate the effect. Synergy describes a corporations ability to create value, by identifying the fit between the opportunities arising from combining activities, and the corporations ability to then exploit these opportunities. Not all corporations will seek to exploit all available synergies, nor are they able to. Some corporations may look to exploit only certain synergies, e.g. financial, technical, mass production, capital assets. ACTIVITY Can you think of an example of a corporation that, following a merger or acquisition, focused on exploiting synergies in just one area? ACTIVITY FEEDBACK You may have come up with a number of examples. Here is one. The UK conglomerate Hanson is a classic example. It had no interest in achieving benefits from combining the activities of its acquired businesses. Its focus and main source of success stemmed from the imposition of centralised financial control of its corporate headquarters upon its separate subsidiaries. The achievement of the benefits from synergy is far from simple or automatic. Synergy needs to be created. It requires tremendous management focus. If poorly managed, the combination of a corporations businesses can result in negative synergy. 45 Unit 2 Strategic Capability Global Corporate Strategy Negative Synergy Managers should be alert to the dangers of negative synergy the potential disadvantages and costs of a poor combination. In an inappropriate or badly handled diversification, value can be destroyed, rather than created. In these instances, the negative synergy effect can be described as the sum of the parts being greater than the whole, or 2+2 = 3. Many conglomerates in the late 1980s and early 1990s have been devalued by investors to reflect such negative synergy. MINI CASE STUDY Hanson had a successful strategy of acquiring UK and US quoted corporations where the value of the separate businesses exceeded the value of the corporation. Imperial Group, Smith Corona Machines (SCM) and Kidde Fire were all bought at prices considerably lower than the sum of the values that Hanson later realised from their parts, either by running them more effectively or by selling businesses to outsiders who could. The most spectacular example of this strategy remains the acquisition in 1989 of SCM by Hanson for $1.3 billion. Having quickly recouped the purchase price by selling a number of SCM businesses for $1.5 billion, Hanson was left with SCMs core electronic typewriter business with a value subsequently estimated at $2 billion! Synergy and the Nature of Assets The deliberate combination of assets, resources and capabilities from separate businesses is a distinguishing feature of corporate strategy. Itami (1992) draws a distinction between the benefits arising from physical and invisible assets as follows: Physical assets Complementary benefits can be obtained from the simple combination of physical assets such as factories and machinery. These can be achieved when physical assets are under-utilised, incapable of being fully utilised (e.g. due to seasonal cycles), or because combining them reduces risk/uncertainty. Such benefits may include economies of scale, higher capacity utilisation, improved cash flow and improved product line and mix. Itami quotes the example of bulk carrier vessels, which carry Japanese cars to the US West Coast, loading up with 46 Global Corporate Strategy Unit 2 Strategic Capability timber from Washington and Oregon in an unrelated trade returning to Japan. Invisible assets Invisible assets are assets such as corporate culture, technical expertise, a strong corporate or brand image, or expert knowledge of the marketplace. It is hard to quantify in $ terms the value of these, and this combination benefit is described by Itami as the synergy effect. A recent example of synergy effect is from the IBM acquisition of the business consulting group, PwC Consulting, in late 2002. IBM gained strong business consulting skills from PwC, exploited synergies with IBMs complementary IT competencies and strong leadership/branding. As a result the combined consulting arm vastly increased global marketshare (compared with the sum of the individual marketshare prior to the acquisition). Synergy and Superior Corporate Performance An important distinction between physical and invisible assets, and between complementary and synergy benefits, lies in the difficulty competitors have in imitating invisible assets. Using an under-utilised plant to produce another product will provide a reasonably certain payoff, but these benefits are ultimately limited by the plants capacity. Using cash cows to fund stars may provide a secure source of finance, but the strategy can be copied by competitors. Complementary benefits are unlikely to be lasting sources of superior performance for a corporation. Invisible, information-based assets, on the other hand, are capable of being used repeatedly, and in innovative combinations, as a powerful long-term source of superior corporate performance, because they are more likely to remain unique to the corporation. Synergies are also associated with time-scales. They can be dynamic or static. Static combination benefits result from integrating two different strategies at one point in time. Dynamic combination benefits, on the other hand, results from integrating two different strategies across time. It aims over a period of time to change the set of resources and its capabilities in order to achieve superior performance. It has an opportunity cost associate with it. 47 Unit 2 Strategic Capability Global Corporate Strategy ACTIVITY Read the following article from your key text, De Wit, B & Meyer, R. Reading 6.4, Seeking Synergies: pages 340 356. The Core competencies perspective In the late 1980s there was a move away from the ready acceptance of portfolio management as the best means of managing corporate strategy. Performance of vastly diversified companies deteriorated, and this was coupled with the recognition that there was a large management overhead in managing diverse portfolios. Divestments followed and a new paradigm followed. Corporations began to focus increasingly on core business and core competencies. Before we go on to examine the core competence approach, it is appropriate to look at the definitions of core skills, core competencies and an organisations capability. These terms are often misunderstood. An organisations core skills, core competencies and distinctive capability make up its strategic core. Core skills are associated with an individual, core competencies with a team, and the organisations combination of core competencies make up its distinctive capability. At its simplest, a core competence is a unique capability that affords some type of competitive advantage to the organisation. It corresponds to a business process, and involves a combination of skills, functions, systems and knowledge. To determine if something is a core competence, one has to ask the question, Does it give the company a unique advantage over its competitors and help make the company profitable? The elements of the strategic core should be developed, extended, protected and exploited to the full. It is an organisations core competencies that enable it to perform more effectively than its competitors, and offer unique advantage to the marketplace. Core competencies leading to an organisations distinctive capability are also likely to be persistent and not readily replicable. 48 Global Corporate Strategy Unit 2 Strategic Capability Resources Resources (physical) Held in the control of the organisation Tangible and intangible Largely independent of the organisation's members Unaffected by culture and governance structure Intellectual capital (skills, competences and capabilities) Affects the organisation's ability to do things effectively Intangible Inherently attributable to the organisation's members Influenced by culture and governance structure Figure 2.4: Characteristics of physical assets vs. intellectual capital. Core competencies, in contrast to physical assets, relate to human intellectual capital. Its distinctive features (in contrast to physical assets) are summarised in Figure 2.4. Organisations adopting a core competence perspective seek to exploit its intellectual capital to the full. We shall examine this in more detail in the unit on Knowledge Management (Unit 8). Increasingly, core competencies, above products or services, are viewed as rendering competitive advantage, and perceived by customers as adding real value in the long term. The need to focus on core competencies has never been greater, particularly in the new knowledge-based economy. ACTIVITY Read the following paper on core competencies by Prahalad and Hamel in your key text, De Wit, B & Meyer, R. Reading 6.2: pages 325- 333 Prahalad and Hamel have explored the role that competencies play in corporate strategy. They view the corporation as a collection of core competencies and core products, rather than a portfolio of businesses 49 Unit 2 Strategic Capability Global Corporate Strategy defined by product-market boundaries. Competencies are viewed as the root of competitiveness for the corporation across time. The tests for core competencies are: 1. 2. 3. Core competencies provide potential access to a wide variety of markets. Core competencies make a significant contribution to the perceived customer benefits of the end-product/service. Core competencies should be difficult for competitors to imitate. VIRTUAL CAMPUS Spend some time thinking about your organisations core competencies. If you feel that the company you work for is not suitable for this activity, select a services company, e.g. IT or Business Consulting Services (e.g. Accenture) 1. What would you consider as its core competencies? How do these competencies give access to a variety of markets (e.g. global, different industries/sectors)? How do your organisations core competencies (as opposed to products/services) benefit your customers? How do your core competencies position you better for the future? 2. 3. Now think about your competitors..........Consider questions 1, 2 and 3 from the perspective of your competitors. In what ways are your competencies (or that of your competitors) difficult to imitate? How can the organisations core competencies be developed further? Now share your answers, where appropriate, with your colleagues on the Virtual Campus. In the interests of confidentiality, it is not necessary to name the company you have considered. Core competence competition Studies of diversification have tended to discuss corporate strategy in terms of end products and markets rather than core competencies. Rumelt (1974) measured the performance of seven types of diversified US corporations in the period 1949-1969. The results showed that there 50 Global Corporate Strategy Unit 2 Strategic Capability was a strong correlation between superior performance and related constrained diversifications. That is, those business that draw on the same common core skill, strength or resource performed better. Rumelt (1994) further developed the core competencies perspective, and established four key components of core competence competition as follows: 1. 2. Corporate span: core competencies span businesses and products within a corporation. Temporal dominance: products/services are only the momentary expression of core competencies. Competencies are more stable and evolve more slowly than products/services. Learning-by-doing: Competencies are gained and enhanced by use. Competitive locus: product-market competition is merely the superficial expression of a deeper competition over competencies. 3. 4. The power of the core competence approach is that it provides a coherent view of how superior corporate performance can be achieved, allows for the importance of the strategic actions of managers, and captures the dynamic nature of strategy. Divestment As we have seen achieving superior corporate performance often results in divestments that is, the sale or disposal of one or more of a corporations activities. Divestments may occur when corporate synergies no longer exist, under-utilised corporate assets can be better deployed elsewhere or core competencies can not be enhanced by leverage across the corporation. Many divestments occur when subsidiary businesses show decline. But is divestment always the correct response to failing businesses? Decline: Divestment or Recovery? Kathy Harrigan (1988) views declining industries as opportunities for endgame strategies. She believes that corporations must flee or fight in declining industries. The endgame strategies she puts forward are: 1. Leadership: a leadership strategy is dependent on achieving market power within the remaining attractive segments of the industry, and controlling the process of decline in the businesss favour. This strategy requires some investment. The expectation 51 Unit 2 Strategic Capability Global Corporate Strategy is that, as other competitors leave the industry, so the profitability of the firm improves. 2. Niche: niche strategies depend on the existence of defensible market segments. In such a strategy the business would focus on a niche where it is competitively strong, or where demand is likely to persist longer (or at high levels) than in the rest of the sector. Quick sale: a corporation should seek a quick sale when it is likely to realise greatest value from a weak competitive position in an unfavourable market. Harvest: harvesting assumes that value can be returned to a corporation from a business by continuing to run it to extract as much cash as possible. Further investment is not expected: the objective is to realise the maximum cash from the business. 3. 4. Other studies (notably Slatter, 1984) have shown that successful recovery or turnaround of declining businesses is possible. Companies that achieve a sharp and sustained improvement in performance are termed sharpbenders. They invariably achieve turnaround by taking one or more of the following measures: Major changes in management. Stronger financial control. New product-market focus. Improved marketing. Significant reductions in production costs. Improved quality and service. Studies of such companies have shown that sharpbenders succeeded because of the effectiveness of the measures (as listed above) and timing of them. Sharpbenders rarely pursue acquisitions as a route to change. Divestment and Core Competencies As portfolio theory has become less influential, the rationales for divestment have changed. The strengthening of core competencies is a major driver in corporate strategies. As such, corporations rarely seek divestment of activities that enhance its core competencies. Indeed, the strengthening of core competencies is often a driver for acquisitions. If an activity or business does not involve a core competence, a corporation should seriously consider whether it should divest that activity. Make or buy tests are crucial: can the activity be more 52 Global Corporate Strategy Unit 2 Strategic Capability efficiently carried out partners/contractors. within a corporation, or by outside Outsourcing is a divestment strategy which recognises that improved effectiveness might come from buying in non-core competencies. A corporations effectiveness can be significantly improved by the superior skills, resources and expertise of companies for whom the activity is core business. ACTIVITY Can you think of some high-profile example of outsourcing, which has delivered, or will deliver, massive cost savings. ACTIVITY FEEDBACK You may have thought of a number of examples. Many oil companies, financial institutions, energy companies and banks have outsourced their IT activities to the likes of EDS, IBM, Logica. More recently, the UK government is divesting aspects of its state activities to private companies, e.g. NHS patient records and data services, army logistics, etc. CASE STUDY Rohm, Japan strategy in a medium-sized Japanese company surviving in a difficult environment. Even as the Japanese economy has been battered by one of the worst recessions in memory, some Japanese companies have bucked the national trend. This case explores the Japanese company Rohm which has stood out not only for its strong performance in a depressed market but also for its defiance of traditional Japanese corporate behaviour. Rohm is a manufacturer of highly specialised integrated circuits based in Kyoto. Its profits have increased steadily over the past four years at a time when most Japanese companies have struggled to cut their losses. Rohms recurring 53 Unit 2 Strategic Capability Global Corporate Strategy profits in the year to March 1998 came to Y110.1 billion (US$917 million), or nearly one-third of sales at Y335.9 billion and a fivefold increase from the Y21.6 billion it made in 1994. Its return on equity, at 16.5%, would be the envy of many blue-chip Japanese companies for whom return on equity has tended to be a single-digit figure. Although profits were expected to be flat in 1998, Rohm intended to increase its recurring income to sales ratio to 33.1% in 1999 from 32.8% in the year ended March 1998. Like many of its successful neighbours, Rohm has been able to put in this remarkable performance by maintaining the entrepreneurial spirit of its founder and a rigorous focus on profitable niche markets. Rohms strength is its company policy of focusing its resources on products that stand out and that it can differentiate from those of its competitors, explains Nobuo Hatta, the director in charge of overseas sales. To that end the company has adopted policies that are almost diametrically opposed to those that have ruled most large, well-established electronics companies in Japan. Rather than pursue mass volume businesses, such as the memory chips which have been huge profit-earners for the likes of Toshiba and NEC, Rohm has been happy to stick to niche markets where it can offer unique products. It is a policy to which Rohms founder and president, Kenichiro Sato, has steadfastly adhered. Mr Sato started the company 40 years ago after giving up his dream of becoming a professional pianist. His first successful product was a miniature resistor he invented, not in his garage but in the family bathroom. At the time most of the large electronics companies were making only large resistors to put into the large radios. But then the transistor boom hit and Rohm found itself ahead of the game on miniature transistors. From that time on, Rohm has focused its energies on products that slipped through the net of the large electronics companies, such as customised chip parts. I never fight battles I cannot win, Mr Sato declares. That concentration on core skills has shielded Rohm from the devastating effects of both the bubble economy and the downturn in semiconductor prices. The company even develops its own manufacturing facilities, not only in order to ensure it can make profits out of small-lot customised products but to ensure that it can make its products quickly and reliably. Some chip parts made by the company are priced at less than Yl. This means that even if they sell a million of them it only generates Yl million in income. Rohm is able to make a profit on these products because it can produce them quickly, reliably and at low cost. Also in defiance of traditional Japanese business practice, Rohm does not employ a seniority-based system of promotion and hires as many as 20 to 30% of its employees in mid-career. Mr Hatta believes that being based in Kyoto has helped the company. Western Japan is far away from bureaucrats and politicians in the central government so we have been able to focus on business, he says. 54 Global Corporate Strategy Unit 2 Strategic Capability There is also a feeling among Kansai people that they would rather be big fish in a small pond, he notes. Many Kyoto companies have something they can claim is number one in the world. In its focus on core skills, its pursuit of profits rather than market share and its emphasis on employee performance over seniority and lifetime employment, Rohm may sound more like a US company than a company based in one of Japans most tradition-bound cities. But Mr Hatta, who spent some years in the USA, believes that the Japanese emphasis on taking a long-term approach to things is one strength that provides Japan with an advantage over the USA. We believe the model we provide is based on the best of both worlds, Mr Hatta says. Note: Kansai is the western Japanese province that includes Kyoto. Questions: 1. What were the main aspects of the environment affecting Rohm over the last four years? What strategies did Rohm adopt in order to survive and grow? To what extent are they more appropriate to medium-sized companies, rather than the large Japanese electronics giants such as Toshiba and NEC? Summarise the key points that identify Rohms strategic perspectives. 2. 3. CASE STUDY FEEDBACK The case explores the strategies of a Japanese company that has taken a very different approach to some more well-known Japanese companies like Sony, Toyota and Canon. It raises the strategic issues of how small companies grow and how they survive when there is an economic downturn. Feedback on Question 1: The obvious area is the downturn in the Japanese economy over this period, which has had an impact on every company in that country. Additional pressure from specific competitive pressures in the Japanese electronics industry which has been particularly badly hit by a world-wide drop in prices for semi-conductors note that this is not something specific to Japan. 55 Unit 2 Strategic Capability Global Corporate Strategy Feedback on Question 2: Rohm decided that it would never be able to compete with the large basic electronics companies in terms of costs and prices. Its chosen strategy was therefore to avoid head-on competition with the leaders by finding niche markets that would not be attractive to the larger companies. It was therefore aware of its capabilities as an organisation, and consequently its competencies within the groups of people working for the company a core competence approach as opposed to a market driven environmental approach. However, the strategy went further. Rohm deliberately set out to produce products for its chosen niches that were reliable, low cost and available quickly. In other words, the company set out to dominate the niche into which it had chosen to enter. Looking at it another way, the strategy focused on customised rather than mass produced products. It was not enough just to identify the special market opportunity: Rohm still had to perform better than any potential competitors. Such strategies have an obvious attraction for smaller companies when competing against the larger electronics giants. However, the difficulties of finding an attractive niche and then exploiting the opportunity in that niche are not to be underestimated. Feedback on Question 3: Given the small size of the company compared to the industry giants, Rohm had little choice in following a niche approach. However, the different path is not just about finding a niche but also exploiting it. This has relied on the classic strategic approach of examining what competitors are doing and then doing something that is different. Rohms view was explained in the case by Mr. Satto who declared: I never fight battles I cannot win. By this he meant that smaller companies need to avoid taking on the large companies head-on. However, this conventional wisdom can be challenged, e.g. the success of the Japanese car company Toyota, which had come from being a small national producer in the early 1950s to the third largest car company in the world by the mid-1990s. Thus it would be over-simplistic to draw the lesson that small companies can only be involved in niche markets. If this were the case, then they would never grow. Nevertheless, Rohm is correct in suggesting that, at least for a while, smaller companies should avoid attacking major competitors. The smaller enterprise should wait until it has some form of sustainable competitive advantage: perhaps a new technology or patent, perhaps a strong alliance with another company or whatever. It is the competitive advantage that is the key to the success of Rohm, rather than its size. 56 Global Corporate Strategy Unit 2 Strategic Capability However, size is an advantage to Rohm. Applying DeWit & Meyers paradox of Responsiveness and Synergy, the company is nimble enough to be responsive (to customised markets) whereas still being synergistic (relying on core competence). Hence, it can gain the benefits of both extremes of the paradox. Larger, more cumbersome organisations will find it more difficult to respond to changes in the niche markets. Because of high overhead costs it is probably not profitable for them to try to compete with smaller companies like Rohm. Rohm had a different approach to product development, a radically different way of rewarding his managers and a different company culture that went well beyond the conventional. This allowed him and the company to survive and prosper in bad times as well as good. Summary In this unit we have looked at the different styles in corporate strategic management. In particular the portfolio management and core competencies perspectives. We have also examined the influence of synergy on a corporations strategic decisions. We have looked at the role of divestments and the increasing focus on core products and core competencies. We have seen how this recent trend has led to outsourcing. To gain maximum benefit from this module, students are encouraged to apply the lessons learnt to their own work context. REVIEW ACTIVITY In the earlier Virtual Campus activity you were asked to think about what your organisations core competencies are. Now verify this by reading your organisations mission statement. Identify any references to core competencies. If this is absent in the mission statement, consult a broad spectrum of senior managers and identify what the core competencies are. 1. Does the official view (from mission statement or management team) on core competencies match your original view? If there is ambiguity, what steps can be taken to ensure that the organisation as a whole is clear on its core competencies. Now test your own department/business unit against the core competencies. 2. 57 Unit 2 Strategic Capability Global Corporate Strategy If you feel there is a poor match, describe what sort of organisation can benefit from your departments capabilities. If there is a good match, could you further strengthen your position via an acquisition. Elaborate. (Given the confidential nature of this information, you may wish to anonymise it. ) Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. 3. Ref 10, Chapter 6 Pages 226-241 Ref 7, Chapter 4 Pages 149-193 Ref 13, Chapter 1 Pages 3-24 58 Unit 3 Globalisation LEARNING OUTCOMES Following the completion of this unit you should be able to: Evaluate the impact drivers for change have on organisations. Assess the implications of globalisation for business. Propose solutions for managers working in a global environment. Introduction The phenomenon of globalisation is accelerating in pace. Globalisation has received much publicity in recent years both positive and promoted by large global corporations and organisations such as the WTO, but also negative coverage from the anti-globalisation movement highlighting some of the issues. But what exactly is globalisation? In this unit we shall consider exactly what globalisation is. We shall consider the globalisation of markets and the globalisation of production. We shall consider the changing nature of multinational enterprises. In particular, the rise of non-US multinationals, and now increasingly a growth in mini-multinationals. For corporations, globalisation involves radical change. Globalisation presents opportunities but also poses challenges for the management of highly distributed worldwide organisations. We shall consider some of these issues. Finally we shall look at two case studies concerning Globalisation. What is Globalisation The concepts of globalisation, global strategies, global corporations, global markets, global production, global productisation and global branding are widely used. Sometimes these terms are used synonymously, and their meaning is not well understood. In this 59 Unit 3 Globalisation Global Corporate Strategy section, we shall briefly look at the evolution of globalisation and what it actually means. ACTIVITY As an introduction to this section read Chapter 10, The International Context, pages 534-556 in your key text, De Wit, B & Meyer, R. A fundamental shift has been occurring in the world economy. There has been a move away from a world in which national economies were relatively isolated from each other by barriers to cross-border trade / investment; by distance, time zones, language and by national differences in government regulation, culture and business systems. We have been moving toward a world in which national economies are merging into an interdependent global economic system, commonly referred to as globalisation. The rate at which this shift is occurring has been accelerating and is set to continue to do so. Globalisation is the phenomenon by which industries transform themselves from multi-national to global competitive structures. Global companies operate in the main markets of the world, and do so in an integrated and co-ordinated way. There are broadly three elements to globalisation: 1. International Scope, the spatial dimension: Broadest possible international scope. Process of international expansion on a world-wide scale. 2. International Similarity, the variance dimension: Homogeneity around the world. Process of declining international variety. 3. International Integration, the linkages dimension: World is viewed as one tightly linked system. Process of increasing international interconnectedness. The emerging global economy raises a multitude of issues for businesses. It creates opportunities for businesses to expand their revenues, drive down their costs and boost their profits. While the global economy creates opportunities such as this for new 60 Global Corporate Strategy Unit 3 Globalisation entrepreneurs and established businesses around the world, it also gives rise to challenges and threats that yesterdays business managers did not have to deal with. For example, managers now routinely have to decide how best to expand into a foreign market. Should they export to that market from their home base? Should they invest in production facilities in that market, producing locally to sell locally? Should they produce in a third country where the cost of production is favourable and export from that base to other foreign markets and, perhaps, to their home market? Managers have to decide how to customise their product offerings, marketing policies, human resource practices and business strategies to deal with national differences in culture, language, business practices, and government regulations. In addition, managers have to decide how best to deal with the threat posed by efficient foreign competitors entering their home marketplace. KEY POINT Globalisation is the phenomenon by which industries transform themselves from multi-national to global competitive structures It refers to the shift toward a more integrated and interdependent world economy and has two main components: The globalisation of markets. The globalisation of production. Global Convergence vs. International Diversity De Wit & Meyer propose that a paradox exists between the pressure to act globally and locally, i.e. a continuum can be said to exist with one extreme being Globalisation and the other being Localisation. 61 Unit 3 Globalisation Global Corporate Strategy ACTIVITY This topic links with subjects that are to be covered in other units. At this point briefly scan the following sections, ahead of studing the units in detail. Unit 6: section on Value Management Point to note: Many companies are relocating to other countries to save costs. Classic examples of this have been in call centres. A further example has been Dyson who switched their production to Malaysia saving 25% on production costs. The explanation for this was to spend the money on R&D and to keep the company afloat. However, a customer backlash resulted in a 5% reduction in the number of vacuums sold. Unit 7: section on Ethics Point to note: Similar behaviour by major companies has seen them fall foul of globalisation protestors who see such behaviour as exploitative, e.g. Nike and Ikea. However, is this simply good business and in accordance with the principle espoused by Milton Friedman who stated that the only responsibility a company has is to its owners. High Micro chips Automobile Military aircraft Pharmaceuticals Globalisation forces Bulk chemicals Civil aircraft Telecommunication services Retail banking Food retailing Low Low Localisation forces High Figure 3.1: Global integration vs. Local responsiveness grid for various sectors. Business success in the international context is increasingly a case of finding the right balance between the forces of globalisation vs. localisation. This balance varies depending on the industry you operate 62 Global Corporate Strategy Unit 3 Globalisation in. See Figure 3.1. For example, if you a microchip manufacturer, localisation bears little meaning; one size fits all in the global marketplace. However, if you are a food retailer, localisation forces are significant and cannot be ignored. The factor that works against globalisation is the localisation push; the demand for flexibility to deliver customer-oriented products/services rapidly and in close geographical proximity to the customer. Localisation push has four main categories; cultural, commercial, technical and legal. See Figure 3.2. Cultural factors e.g. attitudes, tastes, social practices Technical factors e.g. standards, e-business, communications Commercial factors Localisation e.g. customer responsiveness, customisation, networks Legal factors e.g. regulations Figure 3.2: Localisation push factors. Globalisation at the Micro, Meso and Macro levels The issues concerning globalisation can be viewed at the micro, meso and macro levels. At the micro level, for a company, the issues concerning globalisation are: The extent to which an organisation has a global strategy, structure, culture, workforce, management team and resource base. 63 Unit 3 Globalisation Global Corporate Strategy Globalisation of specific products and value-adding activities. The globalisation of one product or activity does not necessarily entail the globalisation of others. At the meso level, for businesses, the issues concern markets and industries, as follows: On markets, the growing similarity of customer demand globally. On markets again, the growing ease of worldwide product flows, e.g. crude oil, foreign currency markets competing on a worldwide basis, e.g. automobile, consumer electronics. On industries, the emergence of a set of producers Major changes from globalisation at the meso level include the more even distribution of Foreign Direct Investment (FDI), and waves of cross-border mergers, acquisitions and strategic alliances. There has also been a notable expansion in the services sector at the expense of manufacturing. At the macro level, for the worlds economies, the issues concern: The debate on whether the economies of the world are experiencing a converging trend. Consequences of international integration in terms of growth, employment, productivity, trade and foreign direct investment. globalisation. Political realities constraining or encouraging Dynamics of technological, institutional and organisational convergence. Major changes impacting the economies include the complexity and interconnectedness of the world economy, de-industrialisation of major powers, financial debt of developing nations and the division of the world into trading blocks. The Globalisation of Markets The globalisation of markets refers to the merging of historically distinct and separate national markets into one global marketplace. The tastes and preferences of consumers in different nations are beginning to 64 Global Corporate Strategy Unit 3 Globalisation converge on some global norm, thereby helping to create a global market, e.g. McDonalds hamburgers. This type of firm is more than just a benefactor of this trend; they are also instrumental in facilitating it. By offering a standardised product world-wide, they are helping to create a global market. However, it is important to understand that national markets are not giving way to the global market in all sectors of the economy. Significant differences still exist between national markets, e.g. consumer tastes and preferences, distribution channels and culturally embedded value systems. These differences frequently require that marketing strategies, product features and operating practices be customised to best match conditions in a country. ACTIVITY Read the following article on the globalisation of markets from your key text, De Wit, B & Meyer, R. Reading 10.1: pages 557-561 In many global markets, the same firms frequently confront each other as competitors in nation after nation, e.g. Coca-Colas and Pepsi, Ford and Toyota, Boeing and Airbus, Caterpillar and Komatsu, and Nintendo and Sega. Thus, diversity is replaced by greater uniformity. As rivals follow rivals around the world, these multinational enterprises emerge as important drivers of the convergence of different national markets into a single, and increasingly homogenous, global marketplace. ACTIVITY Can you think of products that simply cannot be standardised for the worldwide market? Or products for which marketing attempts at global standardisation have failed? 65 Unit 3 Globalisation Global Corporate Strategy ACTIVITY FEEDBACK You may have thought of a number of examples ranging from differing tastes in cars (North America vs. Europe) to foods. One example is that of coffee, where tastes vary vastly from continent to continent. Latin Americans prefer a bitter taste, Europeans like strong blends, and Americans can only tolerate weak blends. So, for example, Nescafe markets different variations under the same brand to different countries. Now, as a follow-on to the above activity, read the following article in your key text, De Wit, B & Meyer, R., that critically examines the notion that success in international markets requires adoption of global products and brands. Reading 10.2: pages 562-569 The Globalisation of Production The globalisation of production refers to the tendency among firms to source goods and services from locations around the globe to take advantage of national differences in the cost and quality of factors of production (such as labour, energy, land and capital). By doing so, companies hope to lower their overall cost structure and / or improve the quality or functionality of their product offering, thereby allowing them to compete more effectively. MINI CASE STUDY The Boeing 777 aeroplane contains 132,500 major component parts that are produced around the world by 545 suppliers. Eight Japanese suppliers make parts for the fuselage, doors, and wings; a supplier in Singapore makes the doors for the nose landing gear; three suppliers in Italy manufacture wing flaps; and so on. Part of Boeings rationale for outsourcing so much production to foreign suppliers is that these suppliers are the best in the world at performing their particular activity. The result of having a global web of suppliers is a better final product, which enhances the chances of Boeing winning a greater share of total orders for aircraft than its global rival, Airbus. Boeing also outsources some production to foreign countries to increase the chance that it will win significant orders from airliners based in that country. 66 Global Corporate Strategy Unit 3 Globalisation As with markets, it is important not to emphasise the globalisation of production too much. It is still difficult for firms to achieve optimal dispersion of their production activities to locations around the globe. This is due to formal and informal barriers to trade between countries, barriers to foreign direct investment, transportation costs and issues associated with economic and political risk. Nevertheless, there is an increased level of globalisation of markets and production. Modern firms are playing a key role in this and increase globalisation by their actions. These firms, however, are merely responding in an efficient manner to changing conditions in their operating environment. ACTIVITY Can you think of an example of globalised production that has yielded enormous cost and other business benefits? ACTIVITY FEEDBACK There are many examples of corporations outsourcing specific activities (e.g. call centres) to one country. For example, many financial institutions have outsourced their call centres to India. There is also another aspect the distributed globalisation of production. This is particularly so in the IT sector, where companies are increasingly distributing the production of software across geographies. Companies such as IBM run projects where aspects of the same software is developed in China, other aspects in India and yet others in South America. The whole system may then be integrated in yet another country (e.g. US). This achieves round-the-clock productivity. Not only do huge cost savings result from cheaper professional rates from non-Western countries, but also round-the-clock productivity enables corporations to achieve aggressive time-lines. Effectively work is being carried out throughout the 24-hour clock. However, this is not the panacea it sounds. There are challenges with such globally distributed production, and such practices require strong management control, standards and robust IT and communication infrastructures. These are some of the management challenges of globalisation which we shall examine later in this unit. 67 Unit 3 Globalisation Global Corporate Strategy Drivers of Globalisation Two main factors seem to underlie the trend toward greater globalisation: A decline in barriers to the free flow of goods, services and capital has occurred since World War II. Technological change, particularly the dramatic developments in recent years in communications, information processing and transportation technologies. Declining Trade and Investment Barriers After World War II, the advanced industrial nations of the West committed themselves to removing barriers to the free flow of goods, services and capital between nations. This goal was enshrined in the treaty known as the General Agreement on Tariffs and Trade (GATT). In addition to reducing trade barriers, many countries have also been progressively removing restrictions to Foreign Direct Investment (FDI). The desire to facilitate FDI has also been reflected in a dramatic increase in the number of bilateral investment treaties designed to protect and promote investment between two countries. As of January 1, 1997, there were 1,330 such treaties in the world involving 162 countries, a threefold increase in five years. The Role of Technological Change The lowering of trade barriers made globalisation of markets and production a possibility. Technological change has made it a reality. Since World War II, the world has seen major advances in communications, information processing and transportation technology including, most recently, the explosive emergence of the Internet and World Wide Web. Telecommunications is creating a global audience. Transport is creating a global village. Microprocessors, Information Technology and telecommunications Perhaps the single most important innovation has been development of the microprocessor, which enabled the explosive growth of high-power, low-cost computing, vastly increasing the amount of information that can be processed by individuals and firms. The microprocessor also underlies many recent advances in telecommunications technology. Over the past 30 years, global communications have been revolutionised by developments in satellite, optical fibre and wireless 68 Global Corporate Strategy Unit 3 Globalisation technologies, and now the Internet and the World Wide Web. These technologies rely on the microprocessor to encode, transmit and decode the vast amount of information. The cost of microprocessors continues to fall, while their power increases (a phenomenon known as Moores Law, that predicts that the power of microprocessor technology doubles and its cost of production halves every 18 months). As this happens, the costs of global communications are plummeting, which lowers the costs of co-ordinating and controlling a global organisation. An important factor and, possible the most critical factor, contributing to globalisation has been the Information Technology revolution. The emergence of standards in IT has made our world inter-connected through high-speed computers. The American defense institutions were largely instrumental for the rise of standards and protocols in communications, messaging and IT. Through the adoption of standards, heterogeneous computer systems (from India to Beijing to Europe to US) are able to communicate seamlessly and securely. This has led to open and interoperable applications. IT infrastructures are now essential pre-requisites for modern global corporations. These developments have accelerated the pace towards globalisation in many sectors of the global economy. The Internet and World Wide Web The phenomenal recent growth of the Internet and the World Wide Web has now developed into the information backbone of a global economy. From virtually nothing in 1994, the value of Web-based transactions hit $7.5 billion in 1997. Included in this expanding volume of Web-based electronic commerce (e-commerce) is a growing percentage of cross-border transactions. Viewed globally, the Web is emerging as a great equaliser. It rolls back some of the constraints of location, scale, and time zones. The Web allows businesses, both small and large, to expand their global presence at a lower cost than ever before. Transportation technology In addition to developments in communications technology, several major innovations in transportation technology have occurred since World War II. In economic terms, the most important are probably the development of commercial jet aircraft and super-freighters and the introduction of containerisation, which simplifies trans-shipment from one mode of transport to another. The advent of commercial jet travel, by reducing the time needed to get from one location to another, has effectively shrunk the globe. 69 Unit 3 Globalisation Global Corporate Strategy Implications of technological change for globalisation Firstly, let us examine the implications of technological change for the globalisation of production. Due to containerisation, the transportation costs associated with the globalisation of production have declined. Plus, as a result of the technological innovations, the real costs of information processing and communication have fallen dramatically in the past two decades. This makes it possible for a firm to manage a globally dispersed production system, further facilitating the globalisation of production. As noted earlier, a world-wide communications network is now essential for international businesses. MINI CASE STUDY Texas Instruments (TI), the US electronics firm, has approximately 50 plants in 19 countries. A satellite-based communications system allows TI to co-ordinate, on a global scale, its production planning, cost accounting, financial planning, marketing, customer service and personnel management. The system consists of more than 300 remote job-entry terminals, 8,000 inquiry terminals and 140 mainframe computers. The system enables managers of TIs world-wide operations to send vast amounts of information to each other instantaneously and to co-ordinate the firms different plants and activities. Secondly, let us look at the implications of technological change for the globalisation of markets. In addition to the globalisation of production, technological innovations have also facilitated the globalisation of markets. Low cost transportation has made it more economical to ship products around the world, thereby helping to create global markets. Low-cost global communications networks such as the World Wide Web are helping to create electronic global marketplaces. In addition, low-cost jet travel has resulted in the mass movement of people between countries. This has reduced the cultural distance between countries and is bringing about some convergence of consumer tastes and preferences. At the same time, global communications networks and global media are creating a world-wide culture, e.g. television. In any society, the media are primary conveyers of culture. As global media develop, we must expect the evolution of something akin to a global culture. 70 Global Corporate Strategy Unit 3 Globalisation The Changing Demographics of the Global Economy Hand in hand with the trend toward globalisation has been a fairly dramatic change in the demographics of the global economy over the past 30 years or so. As late as the 1960s, the following four facts described the demographics of the global economy: US dominance in the world economy and world trade picture. US dominance in world foreign direct investment. The dominance of large, multinational US firms on the international business scene. Roughly half the globe, the centrally planned economies of the Communist world, was off-limits to Western international businesses. All four of these qualities either have changed or are now changing rapidly. Refer to Table 3.1 for the changes in world output and trade, for example. Country United States Japan Germany France United Kingdom Italy Canada China South Korea Share of World Output, 1963 40.3% 5.5% 9.7% 6.3% 6.5% 3.4% 3% NA NA Share of World Output, 1996 20.8% 8.3% 4.8% 3.5% 3.2% 3.2% 1.7% 11.3% 1.7% Share of World Exports, 1997 12.6% 7.76% 9.9% 5.46% 4.94% 4.76% 3.81% 2.85% 2.45% Table 3.1. Changing World Output and Trade (Source: Export data from World Trade Organisation, International Trade Trends and Statistics, 1996. World Output data from CIA Factbook). 71 Unit 3 Globalisation Global Corporate Strategy ACTIVITY Read the following article from your key text, De Wit, B & Meyer, R. Reading 10.3, The Competitive Advantage of Nations, pages 569-577 Changes in Foreign Direct Investment Over the past thirty years, US dominance in export markets has waned as Japan, Germany and a number of newly industrialised countries such as South Korea and China have taken a larger share of world exports. In 1997 and 1998 the dynamic economies of the Asian Pacific region were hit by a serious financial crisis that threatened to slow their economic growth rates for several years. Despite this, their powerful growth may continue over the long run, as will that of several other important emerging economies in Latin America (e.g. Brazil) and Eastern Europe (e.g. Poland). Thus, a further relative decline in the share of world output and world exports for long-established developed nations seems likely. Most forecasts now predict a rapid rise in the share of world output from developing nations such as China, India, Indonesia, Thailand, South Korea and Brazil, and a commensurate decline in the share enjoyed by rich industrialised countries such as Britain, Germany, Japan and the United States. MINI CASE STUDY Toyota Toyota, the Japanese automobile company, rapidly increased its investment in automobile production facilities in the United States and Britain during the late 1980s and early 1990s. Toyota executives believed that an increasingly strong Japanese yen would price Japanese automobile exports out of foreign markets. Therefore, production in the most important foreign markets, as opposed to exports from Japan, made sense. Toyota also undertook these investments to head off growing political pressures in the United States and Europe to restrict Japanese automobile exports into those markets. 72 Global Corporate Strategy Unit 3 Globalisation The Changing Nature of Multinational Enterprise A multi-national enterprise is any business that has productive activities in two or more countries. Since the 1960s, there have been two notable trends in the demographics of the multinational enterprise: 1. The Rise of Non-US multi-nationals There has been a notable rise in non-US multinationals, particularly Japanese multinationals such as the Sony Corporation, Toyota, etc. In 1973, 48.5 percent of the worlds 260 largest multinationals were US firms. The second-largest source country was Great Britain, with 18.8 percent of the largest multinationals. Japan accounted for only 3.5 percent of the worlds largest multinationals at the time. The large number of US multinationals reflected US economic dominance in the three decades after World War II, while the large number of British multinationals reflected that countrys industrial dominance in the early decades of the 20th century. By 1997, however, US firms accounted for 32.4 percent of the worlds 500 largest multinationals, followed closely by Japan with 25.2 percent. France was a distant third with 8.4 percent. Although the two sets of figures are not strictly comparable (the 1973 figures are based on the largest 260 firms, whereas the 1997 figures are based on the largest 500 firms), they illustrate the trend. The globalisation of the world economy together with Japans rise to the top rank of economic powers have resulted in a relative decline in the dominance of US (and, to a lesser extent, British) firms in the global marketplace. Looking to the future, the growth of new multinational enterprises from the worlds developing nations is inevitable. Indeed companies such as the Tata conglomerate in India are already multi-national players, and have activities ranging from IT to cars to heavy engineering. 2. The Rise of Mini-Multinationals Another trend in international business has been the growth of medium-sized and small multinationals (mini-multinationals). When people think of international businesses they tend to think of large, complex multinational corporations with operations that span the globe. Although most international trade and investment is still conducted by large firms, many medium-sized and small businesses are becoming increasingly involved in international trade and investment. These mini-multinationals often operate in specialist areas and are increasingly powerful. An example in point, is Accenture Consulting a highly focused business consulting firm with a global presence, and great influence indeed setting the pace for much of the globalisation paradigm. 73 Unit 3 Globalisation Global Corporate Strategy The Changing World Order Between 1989 and 1991, a series of remarkable democratic revolutions swept the communist world. Following the political changes, many of the former communist nations of Europe and Asia have now adopted free market economics. These countries which were previously closed to Western international businesses, now present a host of export and investment opportunities. For example, the oil industry, in the former Soviet Union, has been opened up and many foreign companies operate licences there now. In addition, more quiet revolutions have been occurring in China and Latin America. Their implications for international businesses may be just as profound as the collapse of communism in Eastern Europe. The potential consequences for Western international business are enormous. With a population of 1.2 billion people, China represents a huge and largely untapped market. On the other hand, Chinas new firms are proving to be very capable competitors, and they could take global market share away from Western and Japanese enterprises. We see evidence of this already. Thus, the changes in China are creating both opportunities and threats for established international businesses. For decades many Latin American countries were ruled by dictators. They viewed Western international businesses as instruments of imperialist domination. Accordingly, they restricted direct investment by foreign firms. Also, the poorly managed economies of Latin America were characterised by low growth, high debt and hyperinflation, all of which discouraged investment by international businesses. Now all this seems to be changing. Throughout most of Latin America, debt and inflation are down, governments are selling state-owned enterprises to private investors, foreign investment is welcomed and the regions economies are growing rapidly. These changes have increased the attractiveness of Latin America, both as a market for exports and as a site for foreign direct investment The Globalisation Debate: Prosperity or Impoverishment? Globalisation continues to be an emotive issue. Many influential economists, politicians and business leaders promote the shift towards a more integrated and interdependent global economy. They promote the view that international trade and investment is driving the global economy towards greater prosperity, and that globalisation will stimulate economic growth and help create jobs in all countries that choose to participate in the global trading system. Many of these proponents are business leaders from global companies; companies that 74 Global Corporate Strategy Unit 3 Globalisation are agents of globalisation companies that have the most to gain from globalisation. Some of these companies (e.g. Starbucks, Nike) have become front-line targets of critics who blame globalisation for a variety of ethical and social issues, e.g. global warming, pollution, exploitation of labour in poor countries, encroachment on human rights, etc. Globalisation is challenged on grounds that it widens the gap between the rich and the poor. ACTIVITY To read the arguments for and against globalisation, refer to the following websites: The website of the World Trade Organisation (WTO) for pro-globalisation viewpoints: www.wto.org For anti-globalisation viewpoints refer to the following websites: www.southcentre.org www.wtowatch.org There is no doubt that globalisation has deep social, political and environmental consequences, as you will have noted from the previous student activity. Leaving aside the social and ethical issues that we have illuded to above, there are a number of other criticisms of the impact of globalisation: 1. Impact on jobs and incomes One frequently voiced concern is that far from creating jobs, falling barriers to international trade actually destroy manufacturing jobs in wealthy advanced economies such as the United States and United Kingdom. Falling trade barriers can allow firms to move their manufacturing activities offshore to countries where wage rates are much lower. Supporters of globalisation argue that the benefits outweigh the costs. They argue that free trade results in countries specialising in the production of those goods and services that they can produce most efficiently, while importing goods that they cannot produce as efficiently. 2. Labour Policies and the Environment A second source of concern is that free trade encourages firms from advanced nations to move manufacturing facilities to less developed 75 Unit 3 Globalisation Global Corporate Strategy countries. Countries that lack adequate regulations to protect labour and the environment from abuse by the unscrupulous. Adhering to labour and environmental regulations significantly increases the costs of manufacturing enterprises and puts them at a competitive disadvantage in the global marketplace compared with firms based in developing nations that do not have to comply with such regulations. Supporters of free trade argue that firms are not the amoral organisations that critics suggest. While there may be a few exceptions, the vast majority of enterprises are committed to ethical behaviour. They would be unlikely to move production offshore just so they could pump more pollution into the atmosphere or exploit labour. 3. National Sovereignty A final concern is that in todays increasingly interdependent global economy, economic power is shifting away from national governments and toward supranational organisations such as the World Trade Organisation, the European Union and the United Nations. It can be perceived that un-elected bureaucrats are now able to impose policies on the democratically elected governments of nation-states, thereby undermining the sovereignty of those states. In this manner, the national states ability to control its own destiny is being limited. VIRTUAL CAMPUS Globalisation on the one hand can have a levelling-down effect, and on the other hand a levelling-up effect. So for instance, in the outsourcing context (e.g. call centres) there is a view that Western countries (e.g. UK and US) have lost out in this sector, whereas developing countries such as India have benefited. From your organisations viewpoint and also geographical viewpoint, identify on the Virtual Campus whether globalisation has had a levelling-up or levelling-down effect. Elaborate. Now look at the opposing views (posted on the Virtual Campus) and try to understand their perspective from a rational viewpoint. Assess whether your viewpoint has changed. Managing in the Global Marketplace As organisations increasingly engage in cross-border trade and investment, managers need to recognise that the task of managing an international business differs from that of managing a purely domestic 76 Global Corporate Strategy Unit 3 Globalisation business in many ways. Let us examine some of the differences and complexities: 1. Country differences At the most fundamental level, managing in the global marketplace requires an understanding and appreciation of the simple fact that countries are different. Countries differ in their cultures, political systems, economic systems, legal systems and levels of economic development. Many of these differences are very profound and enduring. A lack of appreciation of these country differences has led to the failure of many American companies in expanding into foreign territories. 2. Complexity of international and distributed businesses A further way in which international business differs from domestic business is the greater complexity of managing an international and distributed business. A manager in an international business is confronted with a range of issues that the manager in a domestic business never faces. A business must decide where in the world to site its production activities to minimise costs and to maximise value added. Then it must decide how best to co-ordinate, monitor and control its globally dispersed production activities. 3. Choice of markets to compete in Decisions about which foreign markets to enter and which to avoid must be made. Also the appropriate mode for entering a particular foreign country must be chosen as it has major implications for the long-term health of the firm. Is it best to; Export its product to the foreign country? Allow a local company to produce its product under licence in that country? Enter into a joint venture with a local firm to produce its product in that country? that country? Set up a wholly owned subsidiary to serve the market in 4. Compliance with international trading and investment rules Conducting business transactions across national borders requires understanding the rules governing the international trading and investment system. Managers in an international business must also deal with government restrictions on international trade and investment and find ways to work within the limits imposed by specific governmental interventions. 77 Unit 3 Globalisation Global Corporate Strategy 5. Cross-border transactions and currency risk Cross-border transactions require that money be converted from the firms home currency into a foreign currency, and vice versa. Since currency exchange rates vary in response to changing economic conditions, an international business must develop policies for dealing with exchange rate movements. A firm that adopts a wrong policy can lose large amounts of money. 6. Complexity of a global organisational structure Global organisations, inevitably require more complex, matrix organisational structures. In particular, the management roles are quite different and require higher calibre managers. Global organisations generally have four types of differentiated management roles: Global business managers; responsibility for strategy. Country managers; expert knowledge on opportunities, threats and competitive landscape in local geography. developments and knowledge sharing and leverage across the global company. Functional managers; responsibility for new Corporate managers; overall organisational leadership. 7. Operational processes A much greater degree of operational co-ordination is required to achieve global leverage and efficiency. Global organisations require robust operational processes and standards to support inter-working, customer relationships, knowledge management and sharing of intellectual capital. Processes must cover decision making, resource allocation, intellectual capital reuse, policies enacted, rewards, sanctions, management escalation and control. It should be recognised, however, that local variations will be required to comply with local issues, e.g. local employment laws. An efficient IT and communications infrastructure is also a pre-requisite to support such operational processes. Many of these operational processes will be e-business processes. ACTIVITY Read the following article from your key text, De Wit, B & Meyer, R. Reading 10.4, Transnational Management, pages 577-586 78 Global Corporate Strategy Unit 3 Globalisation CASE STUDY 1 GLOBALISATION AT GIANT BICYCLES Giant Bicycles are Taiwanese owned, but designed in the USA and made in the Netherlands a global company. This case reports on an interview with the chief executive, Mr Antony Lo, about the companys global strategy. The Giant Bicycles Company is based in Taiwan and is one of the worlds biggest bicycle manufacturers with annual sales of around US$400 million, 93% outside Taiwan. According to Mr Lo: Because of the small market for bicycles in Taiwan, we dont have any choice we have to be a global company. The biggest markets are in Europe and the US, which account for just over half our sales. We started manufacturing in the Netherlands because of the attractive market in Europe, where we expected to sell more than 400,000 bikes in 1997. Thats out of a demand for bikes in Europe of about 15 million annually. To start with, we will be making just 100,000 bikes a year from our European factory, but we envisage this climbing threefold by early next century. The main reason for transferring some production from the Far East to the Netherlands is to increase flexibility. Fashions are changing quickly and market trends must be followed closely. Having a production base next to the market means that we should be able to satisfy our customers better. Wage costs in the Netherlands are 60% higher than in Taiwan but because we should get better productivity in Europe, this will not affect overall costs too much. We are considering opening another plant in the US; we expect to decide on this around year 2000. Our Taiwan plant makes about 1 million bikes a year out of a total 2.5 million bikes for our company including bikes produced by a joint venture in China. I expect the proportion of Taiwanese bikes to decline over the next few years as we switch production away from Asia. Developing new products is as important as manufacturing. Bicycles are as much a fashion item as a piece of machinery. We sell bikes in several thousand variations. In the early 1990s we introduced up to three new products every year. Today, however, that figure has grown to between five and ten reflecting increased demands by customers. One of our strengths is the ability to introduce regional product lines, within the context of an international approach. About three-quarters of the products we sell around the world are the same but for the remaining 25% we give our regional people freedom to specify products they think will appeal locally. Worldwide, we have 65 designers and development engineers. We spend 2% of our annual sales on design. Forty five of the designers are in Taiwan, the rest are based in China, Japan, the US and the Netherlands. Through the global design approach we aim to pool many different concepts the people in China 79 Unit 3 Globalisation Global Corporate Strategy and Japan concentrate on commuting bikes, the designers in the Netherlands contribute ideas from the European racing bike tradition, while in the US they are more likely to be working on variants of mountain bikes. In Taiwan, we try to incorporate all of the ideas, working on new materials such as carbon fibre to reduce the weight of the frame. Our designers can talk on the phone and swop ideas using computer-aided design, but they get together twice a year in Taiwan to review their work. The common language we use is English. One of the developments we are particularly enthusiastic about is electric battery-powered bikes, which we have been selling from mid-1998. We expected to sell around 2000 in the first year with considerably more afterwards, particularly in Europe. Theres an increasing environmental need for such machines to reduce traffic congestion. At the same time, they make the job of a cyclist easier. During normal travel they should have a range of about 40km. And when the battery runs out, its not a huge problem all you have to do is pedal home." Questions: 1. What benefits does the company gain from its global strategy? And what have been the problems? The opening paragraph of the case states that Giant Bicycles is a global company. Do you agree with the statement within the definitions explored in the lecture? 2. CASE STUDY FEEDBACK This short case summarises many of the reasons for global expansion and the problems that then arise. Bicycles operate in a relatively mature market without the benefit of special, even unique technologies or patents to provide the basis for global expansion. Other medium-sized companies that have reached maturity of sales in their home markets will look with interest at the achievement of Giant Bicycles so far. Other companies possessing economies of scale and scope will also be attracted by the arguments concerning the increased scale of international operations and the ability to recover the costs of research and development across an increased sales volume. They will also learn a little about the increased complexity and costs of international operations and selling. However, few details are given on this in the case and, in any event, the details will probably vary with each company and its type of business. In addition, some aspects of the companys international development remain essentially obscure. How did they start internationally? 80 Global Corporate Strategy Unit 3 Globalisation Why did they pick Europe rather than the USA? (The high usage of bicycles in Holland makes it clear why they would pick this market within Europe.) How did they cope with the great geographical distances and the selling task in their chosen country? And so on. Thus other medium-sized companies can learn something from Giant Bicycles but the full case for international expansion remains unclear. Feedback on Question 1: Benefits include: Global economies of scale in production: reduced costs of some items. Higher sales than would be possible in Taiwan alone. Ability to keep in contact with different market trends and latest designs. Production from high-efficiency workforces, e.g. Netherlands. R&D costs spread over much wider base of sales than just Taiwan. Problems include: Complexity and cost of co-ordination across many countries: this is not fully explained in the case. Higher costs of producing local variations, rather than a standardised product. Higher wage costs in some countries, e.g. Netherlands. Feedback on Question 2: In this unit we established three main definitions of global: Geographical coverage (broad international scope). International similarity of demand (standardised products). Interconnectedness of the world (increased linkages between countries, seeing the globe as a single market). With the above definitions in mind, one could consider a range of issues; Giant bicycles are commonplace around the world from childrens mountain bikes to professional cyclists in the Tour de France (geographical coverage). 81 Unit 3 Globalisation Global Corporate Strategy Presence in major economic blocks (Europe, USA, Asia) (geographical coverage). 75/25 split of localised / standardised products is this therefore a global company? Should it be 100% to be regarded as global? (standardised products) Centralised R&D facilities (but with designers out in the field to gain knowledge of local markets and fashion trends) again a dichotomy. (standardised products) Are Giant exploiting increased technological advancement in transport & communications by having two production facilities? This needs to be balanced with increased complexity of running 2 factories. (increased linkages between countries) Would a truly global company have one factory, thus increasing economies of scale and reducing management complexity. (seeing the globe as a single market) CASE STUDY 2 CITIGROUP: BUILDING A GLOBAL FINANCIAL SERVICES GIANT In the largest merger ever in the financial services business, Citicorp joined forces with Travelers Group in the autumn of 1998. The combined group has revenues of close to $50 billion, assets in excess of $700 billion, and global reach. Before the merger, Travelers Group was the largest property-casualty and life insurance business in the United States. In addition, Travelers had considerable investment banking, retail brokerage and asset management operations. Travelers insurance operations were almost exclusively domestic in their focus, although its investment banking and asset management business had some foreign exposure. Citicorp was one of the worlds most global banks. Citicorp had two main legs to its business, its corporate banking activities and its consumer banking activities. The corporate banking side of Citicorp focused on providing a wide range of financial services to 20,000 corporations in 75 emerging economies and 22 developed economies. This business, which always had an international focus, generated revenues of $8.0 billion in 1997, over half of which came from activities in the worlds emerging economies. What captured the attention of many observers, however, was the rapid growth of Citicorps global consumer banking business. The consumer banking business focuses on providing basic financial services to individuals, including checking accounts, credit cards and 82 Global Corporate Strategy Unit 3 Globalisation personal loans. In 1997 this business served 50 million consumers in 56 countries through a global network of 1,200 retail branches and generated revenues of $15 billion. The merger talks were initiated by Travelers' CEO, Sandy Weill. Given the rapid globalisation of the world economy, Weill felt it was important for Travelers to start selling its insurance products in foreign countries. Until recently, the barriers to cross-border trade and investment in financial services were such that this would have been difficult. However, under the terms of a deal brokered by the World Trade Organisation in December 1997, over 100 countries agreed to open their banking, insurance and securities markets to foreign competition. The deal, which was scheduled to take effect on March 1, 1999, included all developed nations and many developing nations. The deal would allow insurance companies such as Travelers to sell their products in foreign markets for the first time. To take advantage of this opportunity, however, Travelers needed a global retail distribution system, which is where Citicorp came in. For the past 20 years, the central strategy of Citicorp has been to build just such a distribution channel. The architect of Citicorps global retail banking strategy was its longtime CEO, John Reed (Reed is now co-CEO of Travelers, a position he shares with Weill). Reed has been on a quest to establish Citicorp as a global brand, positioning the bank as the Coca-Cola or McDonalds of financial services. The basic belief underpinning Reeds consumer banking strategy is that people everywhere have the same financial needsneeds that broaden as they pass through various life stages and levels of affluence. At the outset customers need the basicsa checking account, a credit card and perhaps a loan for college. As they mature financially, customers add a mortgage, car loan and investments (and insurance). As they accumulate wealth, portfolio management and estate planning become priorities. Citicorp aimed to provide these services to customers around the globe in a standardised fashion, in much the same way as McDonalds provides the same basic menu of fast food to consumers everywhere. With the merger with Travelers, the company will be able to push this concept further than ever, cross-selling insurance products and asset management services through its global retail distribution system. Reed believes that global demographic, economic and political forces strongly favour such a strategy. In the developed world, ageing populations are buying more financial services. In the rapidly growing economies of many developing nations, Citigroup is targeting the emerging middle classes, whose needs for consumer banking services and insurance are rising with their affluence. This world view got Citicorp into many developing economies years ahead of its slowly awakening rivals. As a result, Citigroup is today the largest credit card issuer in Asia and Latin American, with 7 million cards issued in Asia and 9 million in Latin America. As for political forces, the world-wide movement toward greater deregulation of financial services allowed Citigroup to set up consumer banking operations in countries that only a decade ago did not allow foreign banks into their markets. Examples in the fast-growing Asian region include India, Indonesia, Japan, Taiwan, Vietnam and the biggest potential prize of them all, China. 83 Unit 3 Globalisation Global Corporate Strategy A key element of Citigroups global strategy for its consumer bank is the standardisation of operations around the globe. This has found its most visible expression in the so-called model branch. Originally designed in Chile and refined in Athens, the idea is to give the companys mobile customers the same retail experience everywhere in the world, from the greeter by the door to the standard blue sign overhead to the ATM machine to the gilded doorway through which the retail-elite Citi-Gold customers pass to meet with their personal financial executives. By the end of 1997 this model branch was in place at 600 of Citicorps 1,200 retail locations, and it is being rapidly introduced elsewhere. Another element of standardisation, less obvious to customers, is Citigroups emphasis on the uniformity of a range of back-office systems throughout its branches, including the systems to manage checking and savings accounts, mutual fund investments and so on. According to Citigroup, this emphasis on uniformity makes it much easier for the company to roll out branches in a new market. Citigroup has also taken advantage of its global reach to centralise certain aspects of its operations to realise savings from economies of scale. For example, in Citigroups fast-growing European credit card business, all credit cards are manufactured in Nevada; printing and mailing are done in the Netherlands; and data processing is done in South Dakota. Within each country, credit card operations are limited to marketing people and two staff units; customer service and collections. Questions: 1. What is the rationale for the merger between Travelers and Citicorp? How will this merger create value for (a) the stockholders of Citigroup and (b) the customers of Citigroups global retail bank? In 1997 the World Trade Organisation brokered an agreement to liberalise cross-border trade and investment in global financial services. What will be the impact of this deal on competition in national markets? What would you expect to see occur? Does the 1997 WTO agreement represent an opportunity for Citigroup or a threat? How is Citigroup trying to build a global retail brand in financial services? What assumptions is this strategy based on? Do you think the assumptions and strategy make sense? 2. 3. 4. Reference: Chapter 1 International Business in the Global Marketplace (2000) by Charles W.L. Hill 84 Global Corporate Strategy Unit 3 Globalisation CASE STUDY FEEDBACK Feedback on Question 1: The reasons for the merger are quite clear; The companies have complementary resources. Products of the two companies are generally mutually exclusive. It is a merger of equals a graph within the case study in unit 4 in the module guide shows the convergence of the share prices of both companies. Citicorp have established a global network of branches and Travelers Groups products would be sold in these branches, i.e. for no increase in fixed costs, more turnover would be generated hence, the stockholders would experience an increase in value in share price and dividend. Customers would be able to access a wider range of products at the same location, for example insurance. Feedback on Question 2: An increase in global competition with major world players competing in the newly liberated countries moving from country to country (e.g. car industry). Perhaps waves of merger/acquisition/alliance activity across borders (link to Unit 4) as financial companies try to gain access to the new markets. Feedback on Question 3: An opportunity due to Citicorps core capability in overseas expansion into developing markets Also a threat due to increased competition (as in first bullet point on feedback to question 2 above). Feedback on Question 4: Standardisation of everything such as: Cross selling of products to all customers (regardless of wealth). Standard livery of banks. 85 Unit 3 Globalisation Global Corporate Strategy Staff uniforms. Standards of service the same globally. Also (not mentioned in case) standardised training and staff development. Assumptions based upon: Standard service designed is acceptable to customers. Globalised product implies a global strategy and, therefore, decreases cost due to homogenised product. World travelers want the same service wherever they go. Creation of global brand is positive. Does it make sense? What about localisation issues, e.g. law, culture? The company openly try to attract wealthier customers. If you have lots of money, will you not require a personal service? Is it necessary (in considering Global Integration / Local Responsiveness Grid) to have a global product in Financial Services? Summary In this unit we have considered the impact of globalisation on multinational enterprises. We have looked at the definition of globalisation, and have considered the different dimensions globalisation of markets and globalisation of production. We have considered the drivers of globalisation, the changing world order and the implications for businesses from the globalisation phenomenon. We have also touched on the globalisation debate considering the opposing views. Finally, we have looked at the particular challenges faced by managers when managing in the global marketplace. 86 Global Corporate Strategy Unit 3 Globalisation REVIEW ACTIVITY Consider the following situation. Imagine that your organisation is reviewing its strategy, and that you have been seconded by the team to focus and report on the impact of globalisation. You have to carry out the necessary research and prepare a paper (in no more than 1000 words). Your paper should address the following: 1. 2. Your current global capability. The impact globalisation has had on your organisation with respect to production (including supply chain), markets, operations and management processes. Global competition. A SWOT analysis in the context of globalisation. 3. 4. Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. Ref 13, Chapter 2 pages 29-43 Ref 10, Chapter 19 pages 689-731 87 Unit 4 Altering the Boundary Alliances and Mergers LEARNING OUTCOMES Following the completion of this unit you should be able to: Evaluate available options for global expansion. Analyse strategy for forming and making alliances work in a global environment. Explain the terminology associated with business combinations. Assess the factors which influence success or failure of M&A activity. Propose a process for the successful integration of different organisations. Introduction Globalisation and the advent of the new economy, has led to big changes in todays business landscape. Consolidation through mergers and acquisitions is rife in many industries, as corporations seek to increase their global reach and competitiveness. There is a recognition that to compete effectively in the global market, cross-border alliances, sometimes with competitors, is necessary. This has also led to a rise in global strategic alliances. In this unit we shall look at strategic alliances, and mergers and acquisitions; the two vehicles through which many organisations aim to globalise. Mergers and Acquisition (abbreviated as M&A) activity has grown in pace since the 1990s. In this unit we shall look at some of the terminology used in the context of M&A. We shall then look at some of the drivers for M&A activity and potential benefits. We shall then assess the factors that give rise to successful mergers and acquisitions, and briefly consider an integration process. 89 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Paradox of Competition and Co-operation De Wit and Meyer present this paradox by defining the extreme cases. Companies that follow the traditional view of neo-classical economics are said to follow the d iscrete organisation perspective and as such see competition as a natural state of affairs and see themselves as independent entities competing with others in a hostile environment. Co-operation is seen as weakness on the one hand, or alternatively as a cynical approach to distort competition in a market, e.g. if companies A and B collaborate in order to destroy competitor C. Of course, governments legislate to prevent this happening, e.g. The UK Competition Commission. The alternative view is one of the em bed d ed organisation perspective where some companies see collaboration and partnership as the predominant way of working. Many companies follow this perspective as a matter of preference or are forced along this path by the industry in which they operate, e.g. the airline industry. However, some companies follow both perspectives at the same time depending on the economic and market conditions in a global context. For example, Hewlett Packard can been seen as being in a highly competitive environment with Canon in many locations around the world, but are also seen to collaborate with them in other initiatives elsewhere. We will now examine collaborative arrangements in more detail. Global Strategic Alliances Strategic alliances refer to co-operative agreements between potential or actual competitors. In this unit we shall focus mainly on strategic alliances between firms from different countries. However, most of the principles apply to domestic alliance arrangements also. The motives for entering strategic alliances are varied, but they often include market access. The biggest danger is that a company will give away more to its ally than it receives. However, firms can build alliances that benefit both partners. Decisions regarding Strategic Alliances are influenced by three closely related topics; (1) (2) The decision of which foreign markets to enter, when to enter them, and on what scale The choice of entry method 90 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers (3) The role of strategic alliances. Any firm contemplating foreign expansion must first decide which foreign markets to enter, and the timing and scale of entry. This choice should be driven by an assessment of relative long-term growth and profit potential. What are the objectives of International Strategic Alliances? Preece put forward a framework that examined the reasons for alliances. The 6 Ls gave a range of reasons that a company may wish to enter into such arrangements as follows: Learning to acquire needed know how, e.g. technology, market access. This is related to knowledge management techniques (see Unit 8). of missing infrastructure. Leaning to replace value-chain activities or fill in parts Leveraging to integrate operations of partners to create scope and / or size advantages. customers. Linking to create closer links with suppliers and Leaping to pursue a radically new area of endeavour. Locking out to reduce competitive pressure from non partners and maintain existing competitive position. ACTIVITY See how collaboration with competitors can result in a win-win scenario by reading p. 383-387, Reading 7.1, in your key textbook, De Wit, B & Meyer, R. Read p. 388-396, Reading 7.2, in you key textbook, De Wit, B & Meyer, R, to see how companies like Sun Microsystems have been able to achieve high market growth by working with (and effectively managing) a web of alliances. KEY POINT The term strategic alliance refers to an arrangement, generally between actual or potential competitors, to co-operate. 91 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy An alliance can involve two or more companies. Companies in a strategic alliance co-operate by sharing capabilities to enhance their competitive edge and creating new business opportunities. Companies in an alliance will retain their own strategic autonomy. ACTIVITY Read p. 359 382 (Network level strategy) in your key textbook, De Wit, B & Meyer, R, to learn more about how companies in strategic alliances co-operate together, and co-ordinate their strategies to work as a team. Which Foreign Markets? All countries do not hold the same potential for a firm contemplating foreign expansion. The attractiveness of a country depends on balancing the benefits, costs and risks associated with doing business in that country. The long-term economic benefits of doing business in a country depend on; The size of the market (in terms of demographics). The present wealth (purchasing power) of consumers in that market. The likely future wealth of consumers. While some markets are very large when measured by numbers of consumers (e.g., China and India), low living standards may provide limited purchasing power and a relatively small market when measured in economic terms. In addition, the costs and risks associated with doing business in a foreign country are typically lower in economically advanced and politically stable democratic nations and they are greater in less developed and politically unstable nations. Another issue is considering the value a business can create in a foreign market. If a business can offer a product that has not been widely available in that market the value of that product to consumers is likely to be much greater. 92 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers Timing of entry Entry is early when a business enters a foreign market before other foreign firms and late when it enters after other international businesses have already established themselves. There are the following advantages associated with entering a market early, known as first-mover advantages; Pre-empting rivals and capturing demand by establishing a strong brand name. Building sales volume in a country, giving the early entrant a cost advantage over later entrants. Enabling price cutting below the higher cost structure of later entrants, thereby driving them out of the market. products or services. Create switching costs that tie customers into your The disadvantage in entering a foreign market before other international businesses is that pioneering costs may be incurred. These are costs that an early entrant has to bear that a later entrant can avoid. A late entrant may benefit by learning from the mistakes made by others. Scale of entry and strategic commitment Entering a market on a large scale involves the commitment of significant resources. It is a major strategic commitment, with a long-term impact. It is a decisions that is difficult to reverse. Major commitment to an overseas market can limit the companys strategic flexibility. Balanced against large-scale entry are the benefits of a small-scale entry. Small-scale entry allows a firm to learn about a foreign market while limiting the firms exposure to that market. Small-scale entry can be seen as a way to gather information about a foreign market before deciding whether to enter on a significant scale and how best to enter. Entry Methods The choice of method for entering a foreign market is another major issue. Options are; Exporting. Turnkey Projects. 93 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Licensing. Franchising. Joint Ventures. Wholly owned subsidiaries. Each of these options has advantages and disadvantages. The optimal entry method varies from situation to situation depending on a variety of factors including transport costs, economic risks, political risks, trade barriers and corporate strategy. Let us now examine each of the entry methods. Exporting Advantages Avoids the substantial costs of establishing operations Helps a firm achieve location economies. By (particularly so for manufacturing) in the host country. manufacturing the product in a centralised location and exporting it to other national markets, the firm may realise substantial scale economies from its global sales volume. Disadvantages Exporting may not be appropriate if there are lower-cost locations for manufacturing the product abroad. particularly for bulk products High transport costs can make exporting uneconomical, Tariff barriers can make exporting uneconomical. Problems arise if a company delegates its marketing activities in each country to a local agent. Foreign agents often carry the products of competing firms and so have divided loyalties. Turnkey projects In a turnkey project, the contractor agrees to handle every detail of the project for the client, including the training of operating personnel. At completion of the contract, the client is handed the key to a plant that is ready for full operation. This is a means of exporting process technology to other countries. Turnkey projects are most common in the chemical, pharmaceutical, petroleum refining and metal refining 94 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers industries, all technologies. Advantages of which use complex, expensive production The ability to assemble and run a technologically complex process (e.g. refining petroleum), and obtain good economic returns. The strategy is particularly useful where Foreign Direct Investment (FDI) is limited by host-government regulations. A turnkey strategy can also be less risky than conventional FDI. In a country with unstable political and economic environments, a longer-term investment might expose the firm to unacceptable political and/or economic risks (e.g. the risk of nationalisation or of economic collapse). Disadvantages The firm will have acquired no long-term skills, experience and customer relationships in the foreign country. e.g. Western firms that sold oil refining technology to Middle East countries now find themselves competing with these firms in the world oil market competitive advantage to potential and/or actual competitors. A turnkey project may inadvertently create a competitor, Selling technology through a turnkey project is selling Licensing A licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity (the licensee) for a specified period. In return the licensor receives a royalty fee from the licensee. Intangible property includes patents, inventions, formulas, processes, designs, copyrights and trademarks. MINI CASE STUDY To enter the Japanese market, Xerox, inventor of the photocopier, established a joint venture with Fuji Photo that is known as Fuji-Xerox. Xerox then licensed its xerographic know-how to Fuji-Xerox. In return, Fuji-Xerox paid Xerox a royalty fee equal to 5 percent of the net sales revenue that Fuji-Xerox earned from the sales of photocopiers based on Xeroxs patented know-how. In the Fuji-Xerox case, the licence was originally granted for 10 years, and it has 95 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy been renegotiated and extended several times since. The licensing agreement between Xerox and Fuji-Xerox also limited Fuji-Xeroxs direct sales to the Asian Pacific region (although Fuji-Xerox does supply Xerox with photocopiers that are sold in North America under the Xerox label). Advantages The licensee meets most of the costs associated with sales. Hence the firm does not bear the development costs and risks associated with opening a foreign market. Licensing can be attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market. in a foreign market but is prohibited from doing so by barriers to investment. intangible property that might have business applications, but it does not want to develop those applications itself (e.g. software components). Licensing is often used when a firm wishes to participate Licensing is frequently used when a firm possesses some Disadvantages Licensing does not give a firm the tight control over manufacturing, marketing and strategy that is required for realising experience curve and location economies. Licensing typically involves each licensee setting up its own production operations. co-ordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another. By its nature, licensing limits a firms ability to do this. know-how to foreign companies. Technological know-how constitutes the basis of many multinational firms competitive advantage. Most firms wish to maintain control over how their know-how is used, and a firm can quickly lose control over its technology by licensing it. Competing in a global market may require a firm to There is a risk associated with licensing technological 96 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers MINI CASE STUDY RCA Corporation once licensed its colour TV technology to Japanese firms including Matsushita and Sony. The Japanese firms quickly assimilated the technology, improved on it and used it to enter the US market. Now the Japanese firms have a bigger share of the US market than the RCA brand Franchising Franchising is similar to licensing but involves longer-term commitments. Franchising is basically a specialised form of licensing in which the franchiser not only sells intangible property to the franchisee (normally a trademark), but also insists that the franchisee agree to abide by strict rules as to how it does business. The franchiser will also often assist in running the business on an ongoing basis. As with licensing, the franchiser typically receives a royalty payment, which amounts to some percentage of the franchisees revenues. Franchising is used mainly by service firms. McDonalds is a good example of a firm using a franchising strategy. Advantages The advantages of franchising as an entry method are very similar to those of licensing. The firm is relieved of many of the costs and risks of opening a foreign market on its own. Instead, the franchisee typically assumes those costs and risks. This creates a good incentive for the franchisee to build profitable operation as quickly as possible. Using a franchising strategy, a service firm can build up a global presence quickly and at a relatively low cost and risk. Disadvantages The disadvantages are less than licensing. Since franchising is used mainly by service companies, experience curve and location economies are less of an issue. But franchising may inhibit the firms ability to take profits out of one country to support competitive attacks in another. A more significant disadvantage of franchising is quality control. The foundation of franchising is that the firms brand name conveys a message about the quality of the firms product. This can be overcome by setting up a subsidiary in each country (wholly owned company or joint venture). The subsidiary assumes the rights and obligations to establish franchises throughout the particular country or region, e.g. McDonalds establishes a master franchisee in many countries. Further examples are Kentucky Fried Chicken and Hilton International. 97 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Joint Ventures A joint venture means establishing a firm that is jointly owned by two or more otherwise independent firms. Fuji-Xerox, for example, was set up as a joint venture between Xerox and Fuji Photo. Establishing a joint venture with a foreign firm has long been a popular method for entering a new market. The most typical joint venture is a 50/50 venture. However, some firms have sought joint ventures in which they have a majority share and tighter control. Advantages Benefits from a local partners knowledge of the host countrys competitive conditions, culture, language, political systems and business systems. If development costs and/or risks of opening a foreign market are high, a firm might gain by sharing these costs and/or risks with a local partner. ventures the only feasible entry method. Research suggests joint ventures with local partners face a low risk of being subject to nationalisation or other forms of government interference. This appears to be because local equity partners, who may have some influence on host-government policy, have a vested interest in speaking out against nationalisation or government interference. In many countries, political considerations make joint Disadvantages As with licensing, a joint venture risks giving control of technology to a partner. However, joint venture agreements can be constructed to minimise this risk. A joint venture does not give a firm the tight control over subsidiaries that it might need to realise experience curve or location economies. and battles for control between the investing firms if their goals and objectives change or if they take different views as to what the strategy should be. The shared ownership arrangement can lead to conflicts Wholly Owned Subsidiaries In a wholly owned subsidiary the firm owns 100 percent of the stock. This can be achieved either by setting up a new operation in that country, or by acquiring an established firm and using that firm to promote its products. 98 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers Advantages When a firms competitive advantage is based on technological competence, a wholly owned subsidiary arrangement reduces the risk of losing control over that competence. necessary for engaging in global strategic co-ordination is maintained (i.e. using profits from one country to support competitive attacks in another). trying to realise location and experience curve economies (as firms pursuing global and trans-national strategies try to do). Tight control over operations in different countries that is A wholly owned subsidiary may be required if a firm is Disadvantages Generally this is the most costly method of serving a foreign market. Firms doing this must bear the full costs and risks of setting up overseas operations. The risks associated with learning to do business in a new culture are less if the firm acquires an established host-country enterprise. However, acquisitions raise additional problems, e.g. marrying divergent corporate cultures. Making Alliances Work The failure rate for international strategic alliances is quite high. A recent study of 49 international strategic alliances found that 66% ran into serious managerial and financial troubles within two years of their formation and 33% were ultimately rated as failures by the parties involved. The success of an alliance seems to be a function of following three main factors: 1. 2. 3. Partner selection Alliance structure Alliance management Let us look at these in turn. 99 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Partner selection The partner selection process must consider whether a potential partnership is viable and whether it actually adds value. The following assessments are pertinent in this regard: Is there a strategic fit? Is there a capabilities fit? Is there an organisational fit? Is there a cultural fit? A good partner; Helps the firm achieve its strategic goals, whether market access, sharing the costs and risks of new-product development, or gaining access to critical core competencies. The partner must have capabilities that the firm lacks and that it values. two firms approach an alliance with radically different agendas, the relationship will most likely fail. Shares the firms vision for the purpose of the alliance. If Is unlikely to try to exploit the alliance for its own ends, e.g. to steal the firms technological know-how while giving little in return. Therefore, firms with reputations for fair play make the best allies. Alliance Structure Having selected a partner, the alliance should be structured so that the firms risks of giving too much away to the partner are reduced to an acceptable level. Alliances can be designed to make it difficult (if not impossible) to transfer technology not meant to be transferred. For example, in the case of software applications, shrink-wrapped, black box packaging. agreement to guard against the risk of opportunism by a partner, e.g. IPR protection. skills and technologies that the other covets, thereby ensuring a chance for equitable gain. Cross-licensing agreements are one way to achieve this. Contractual safeguards can be written into an alliance Both parties to an alliance can agree in advance to swap 100 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers The risk of opportunism by an alliance partner can be reduced if the firm extracts a significant credible commitment from its partner in advance. MINI CASE STUDY TRW Inc., has three strategic alliances with large Japanese auto component suppliers to produce seat belts, engine valves and steering gears for sale to Japanese-owned auto assembly plants in the United States. TRW has clauses in each of its alliance contracts that bar the Japanese firms from competing with TRW to supply US-owned auto companies with component parts. By doing this, TRW protects itself against the possibility that the Japanese companies are entering into the alliances merely as a means of gaining access to the North American market to compete with TRW in its home market Alliance Management Many alliances fail because the issues concerning the management of the alliance have been underestimated. The key issues include; Managing cultural differences. Building Trust ; building interpersonal relationships between the firms managers. The resulting friendships help build trust and facilitate harmonious relations between the two firms. Personal relationships also foster an informal management network. partner and then apply the knowledge within its own organisation. Learning from Partners; a firm must try to learn from its Reference: Internatio nal Business in the Glo bal Mark etp lace (2000) by Charles W.L. Hill ACTIVITY As further background to this section read p. 402-409, Reading 7.4, How to make strategic alliances work, in your key textbook De Wit, B & Meyer, R. 101 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy ACTIVITY For up-to-date articles and thinking on alliances go to the McKinsey Quarterly website: http://www.mckinseyquarterly.com/ Select Alliances under the Function menu on the home page. (Registration to this site is free, and many articles can be accessed free of charge) Mergers and Acquisitions Mergers and acquisitions (or business combinations) have become a significant source of economic activity in the world economy totalling $3.4 trillion in 1999. Consolidation, through mergers and acquisitions, is rife in many mature industries. We have seen the emergence of mega-mergers in the oil industry (Chevron, Texaco), in the pharmaceutical industry (Glaxo Smith Kline and Beechams), in banking and in telecoms. By mergers and acquisitions, corporations seek to create economic value through economies of scale, economies of scope, access to global market, improved target management, tax benefits or the availability of low cost financing for financially constrained targets. Growth is generally viewed as vital to the well-being of a firm. However, mergers and acquisitions can pose serious risks for acquiring firms. These arise from uncertainties about the value of the target companys assets and liabilities and unanticipated challenges in integrating the target to achieve planned synergies. The big advantage of M&A, in the context of global expansion, is that it gives companies ready market access, particularly in new geographies. However, in comparison to strategic alliances and internal expansion, it poses serious financial and cultural risks. See Figures 4.1 and 4.2 for a comparison of risks for the options of strategic alliances, M&A and internal expansion. Recent studies indicate that, as a result of these risks, approximately 50% of all M&A combinations do not create value for the acquiring firms shareholders. 102 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers High Financial vs. Cultural risk M&A Cultural risk Strategic alliances Internet development Low Low Financial risk High Figure 4.1: Financial vs. Cultural risk for expansion options. M&A If this fails, as there is a permanence to the transaction, it risks putting the whole organisation in trouble. Alliances agreements can apportion financial risks between partners, but the rewards are also shared. Internal Development (organic) there is a level of flexibility to the amount of money invested this can be gradual and re-appraised over time. High M&A Market failure vs. Cultural risk Cultural risk Strategic alliances Low Low Market-entry risk Internet development High Figure 4.1: Market failure vs. Cultural risk for expansion options. M&A there is a finality to this linkage of companies and so the cultural risk is large. However, this should be balanced against a low risk of market entry as the purchase normally relates to a package which is established and proven in the market. 103 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Alliances there is a level of optionality to these the package may be unproven but when partners work together they should reduce the risk. Internal Development there is a low cultural risk as it is their own culture (organic growth). However, an unproven package and a lack of relevant experience leads to high market entry risk. Mergers A merger is defined as the joining of two or more companies to form a single legal entity. Generally, the assets of the smaller company are merged into those of the larger, surviving company and shareholders of the target company are either bought out or become shareholders in the acquiring corporation. A merger usually requires approval by the shareholders of both the acquiring corporation and the target entity. There are several types of merger: Horizontal mergers involve two firms operating in the same kind of business. and operations. Vertical mergers involve different stages of production Conglomerate mergers involve firms engaged in unrelated business activity. Acquisitions An acquisition is the purchase of more than 50% of the voting shares of one firm by another. Following the acquisition the two companies can continue as separate legal entities, with the acquiring company referred to as the parent company and the target as a subsidiary. The parent company can be termed a Holding Company. Acquisitions are sometimes described as mergers to be politically correct. This is especially so in the early stages of a merger. ACTIVITY Identify examples of a horizontal merger, a vertical merger and a conglomerate merger. In this context, you may use acquisition synonymously with merger. Identify the benefits resulting from the merger/acquisition. 104 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers ACTIVITY FEEDBACK Here are a few examples.......... IBM Corporation/PwC Consulting: The merger (or in reality, acquisition) of PwC Consulting by IBM Corporation in 2002 is often thought of as a horizontal merger, but is more accurately a vertical merger. Although both companies overlapped in a significant part of their business (IT services and consulting), it could be argued that IBM had little business consulting skills an area of high value and top of the value chain in services contracts. By acquiring PwC Consulting, IBM gained first-class and global business consulting skills and also PwCs existing lucrative contracts. PwC gained the IBM brand, as well as access to the breadth of IBMs product and IT skills to facilitate the implementation and delivery of projects following a consulting engagement. HSBC/Midland Bank, UK The acquisition of the UKs Midland Bank by HSBC is an example of a horizontal merger. The acquisition gave the HSBC bank a significant UK presence. BP/Amoco/Arco: The merger of BP, Amoco and Arco was a billion-dollar horizontal merger. The driver for the merger was the search for economies of scale. Following consolidation and completion of the integration phase, huge cost savings have been achieved in capital-intensive areas such as refining, and exploration and production activities. Cost savings have also been achieved in aligning their respective IT strategies and having a common IT and centralised services infrastructure. SONY/Columbia: In the late 1980s SONY acquired Columbia Pictures in the US for $3.4 billion. This is an example of a conglomerate merger, pursued for purposes of diversification by SONY. Columbia operated in a totally different business sector. However, the management at SONY felt there were synergies to be exploited between SONYs highly profitable VCR manufacturing business and Columbias film-making business. Columbia is still part of Sonys business, but the integration of Columbia into Sony was plagued with several problems. In practice, there were huge differences between running a hardware manufacturing company and a film studio. These issues were further compounded by enormous organisational and cultural differences between the two companies. 105 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Other Terminology There are a number of other terms associated with M&A activity. Leveraged buy-outs Leveraged buy-outs (LBOs) involve the purchase of the entire public stock interest of a firm, or division of a firm, financed primarily with debt. Management buy-out (abbreviated as MBO) If the transaction is by management, it is referred to as a management buy-out (MBO). If the shares are owned exclusively by the acquiring party, rather than third-party investors, the transaction is called going private and its shares are no longer publicly traded. Joint Ventures Joint ventures involve the joining together of two or more firms in a project or enterprise. In these cases, equity participation and control are decided by mutual agreement. Sell-offs Sell-offs are considered the opposite of mergers and acquisitions. The two major types of sell-offs are spin-offs and divestitures. In a Spin-off, a separate new legal entity is formed with its shares distributed to existing shareholders of the parent company in the same proportions as in the parent company. the firm to an outside party with cash or equivalent consideration received by the divesting firm. In contrast, Divestitures involve the sale of a portion of ACTIVITY Can you think of examples of other M&A related transactions, and identify the possible motivation for the transaction and benefits (if any). 106 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers ACTIVITY FEEDBACK Here are a few examples. Joint Venture: The Airbus consortium, established in 1970, is an example of a successful Joint Venture. The European consortium of French, German and later, Spanish and U.K. companies was established, as it became clear that only by co-operating would European aircraft manufacturers be able to compete effectively with the U.S. giants. By overcoming national divides, sharing development costs, collaborating in the interests of a greater market share and even agreeing a common set of measurements and a common language, Airbus changed the face of the business and brought airlines, passengers and crews the benefits of real competition. In 2001, thirty years after its creation, Airbus formally became a single integrated company. The European Aeronautic Defence and Space Company (EADS), (resulting from the merger between Aerospatiale Matra SA of France, Daimler Chrysler Aerospace AG of Germany and Construcciones Aeronauticas SA of Spain), and BAE SYSTEMS of the UK, transferred all of their Airbus-related assets to the newly incorporated company. In exchange, they became shareholders in Airbus with an 80 per cent and 20 per cent stake. Spin Off: MOBILE phone giant mmO2, was part of British Telecom until it was spun-off in 2001. The spinoff was the result of the breakup of the BT monopoly. Today, mmO2 is Europes sixth-largest mobile network operator. As well as its core UK market called O2, the group runs mobile services in Germany and Ireland, and has a joint venture with supermarket giant Tesco. It has just posted its financial results, with maiden pre-tax profits of 95 million. Divestiture: Perhaps the most famous example of a divestiture is the divestiture of the Telecoms giant AT&T, from Bell Labs. The divestiture was forced by the US Department of Justice following an anti-trust suit against Bell Labs for illegal actions to perpetuate a monopoly in telephone service and equipment. The United States woke up on January 1, 1984 to discover that its telephones worked just as they had the day before. But AT&T started the day a new company, having been divested from Bell Labs. Of the $149.5 billion in assets it had the day before, it retained $34 billion. Of its 1,009,000 employees it retained 373,000. Success required the most drastic change in corporate culture ever undertaken by a major American corporation. The old AT&T the Bell System as a regulated monopoly had been largely insulated from market pressures for most of its history. Its culture venerated service, technological excellence, reliability and innovation within a non-competitive, internally-driven 107 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy framework of taking however much time and money it took to get things done right. The new AT&T had to learn how to find out and deliver what its customers wanted, when its customers wanted it, in competition with others who sought to fill the same customers needs. Although AT&T had great technological and personnel strengths upon which to build, the transition proved far more complex than anyone imagined in 1984. M&A Activity Drivers for M&A activity M&A activity is rife in many industry sectors today, e.g. finance & banking, oil exploration & production, telecoms, IT services, pharmaceuticals, car manufacturing. There are push and pull factors driving M&A activity. Push factors arise from stakeholders who may have concerns about the companys strategic direction or its management, and view an acquisition or a merger as a solution. Pull factors arise from companies making strategic moves to increase marketshare or increase shareholder value. ACTIVITY From what you have learnt so far, try to identify some of the drivers for M&A activities. Why do companies pursue external expansion, through mergers and acquisitions, over internal growth? ACTIVITY FEEDBACK Here are some of the drivers. The list, although not exhaustive, does indicate the principal reasons for external expansion through M&A activities. A firm may be able to acquire certain desirable assets at a lower cost by combining with another firm than it could if it purchased the assets directly. When the market value of a companys common stock is below its book value (or, more important, below the replacement value of the firms net assets) or its potential future earnings (PE ratio) is below the 108 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers sector average, the company frequently becomes a takeover candidate. A firm may be able to achieve greater economies of scale by merging with another firm; this is particularly true in the case of a horizontal merger. If the net income for the combined companies after merger exceeds the sum of the net incomes prior to the merger, synergy is said to exist. A firm that is concerned about its sources of raw materials, dependencies upstream or end-product markets might acquire other firms in the supply chain. These are vertical mergers, and are often undertaken to limit risk. A firm may desire to diversify its product lines and businesses in an attempt to reduce its business risk by smoothing out cyclical movements in its earnings, e.g. a capital equipment manufacturer might achieve steadier earnings by expanding into the replacement parts business. During a recession, expenditures for capital equipment may slow down, but expenditures on maintenance and replacement parts may increase. A firm that has suffered losses and has a tax-loss carry forward may be a valuable merger candidate to a company that is generating taxable income. If the two companies merge, the losses may be deductible from the profitable companys taxable income and hence lower the combined companys income tax payments. Another push driver from stakeholders results from, what is termed, agency problems. An agency problem arises when managers or agents acting on behalf of the shareholders have a limited equity stake in the company. This partial ownership may cause managers to work less vigorously than otherwise and/or consume more perquisites (also known as perks, e.g. lavish trips, expense accounts, club memberships) because the majority of the owners bear most of the cost. There are two theories that emerge from the agency problem: - The threat of a takeover may mitigate the agency problem by substituting for the need of individual shareholders to monitor the managers. - If the managers have a stake in the business, they will do what is best for the company, thus doing what is best for all shareholders. Another driver for horizontal mergers, in particular, is that it will result in increased market share. If a company acquires one of its competitors, then it will have a greater share of the market. For example, the Mercedes merge with the Chrysler corporation increased marketshare for the merged company in the US. This was 109 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy the principal driver for Mercedes who had limited marketshare in the US. There is also the perception that the increased marketshare will give rise to market dominance thus enabling increased profitability. Hence, shareholder value often increases. Revaluation It is not uncommon during merger negotiations or joint venture planning, for the revaluation of the ownership of shares to occur. The revaluation arises as a result of new information generated during negotiations. For example: 1. 2. Management may be stimulated to implement a higher-valued operating strategy. Negotiations or tendering activity may involve the dissemination of new information or lead the market to judge that the bidders have superior information. The market may then re-value previously undervalued shares. Potential benefits of M&A In successful and well managed mergers and acquisitions, some of the drivers do turn into benefits. So in addition to the obvious benefits such as lower unit costs and stronger purchasing power, many of the drivers noted above (under the previous Activity Feedback) are potential benefits. One of the key benefits that shareholders often look for is in sharper management. Management efficiencies can arise from: Management rationalisation, and transfer of general management capability. Differentiated efficiency. The theory behind differentiated efficiency is as follows: If the management of firm A is more efficient than the management of firm B, after firm A acquires firm B, the efficiency of firm B is brought up to the level of efficiency of firm A. Efficiency represents the real gain in merging businesses. termed Inefficient Management theory. This simply puts forward the view that when management is not performing or is inept in some absolute sense, that absolutely anyone (resulting from an M&A activity) could do better. Another source of improvement can be from what is 110 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers Deployment of better management systems, controls, planning and budgeting. Factors affecting M&A activity In order to successfully complete an M&A transaction, a number of factors must come together. Corporate will (the companys goals and strategy). Funding. Relative values of the two companies. A conducive economic environment. Factors affecting M&A activity can be categorised as external and internal. Global M&A activities tend to occur in waves, in response to external factors see Figure 4.3. External factors include monetary policy, general economic activity, political issues and regulatory policy (competition policy, foreign investment policy). Here we go again? Global M&A*, announced deals, $bn United states Britain, France and Germany Rest of the world Japan 1,750 1,500 1,250 1,000 750 500 250 0 95 96 97 98 99 2000 01 02 03 04** Source: Dealogic * By country of target ** To Feb 17th annualised Figure 4.3: Recent waves of global M&A activities. 111 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Monetary policy affects M&A activity because, generally speaking, when interest rates are high, stocks are out of favour (valuations are low) and well-funded companies can buy others at a good price. The internal factors (e.g. management capabilities, type of product, etc.) vary from company to company and from industry to industry. Combining the internal and external factors results in an M&A cycle. The predominant influence at any one peak or trough may differ. However, typically a peak is a time when company valuations are low, interest rates are low and bank financing is available. Why do Mergers Succeed or Fail? Studies of M&A suggest that the probability of increasing shareholders wealth via M&A is low. Jensen and Ruback (1983) summarised results from mergers and acquisitions over a period of eleven years. The average return (around the time of the announcement) to shareholders of the acquired company is 20% while the average return to the acquiring company is 0%. company makes a public offer to the shareholders of a target company), the acquired companys shareholders receive an average return of 30%, while the shareholders of the acquiring company receive 4%. Where a tender offer for take-over has occurred (i.e. a In an analysis conducted by McKinsey consultants (1994) of 116 acquisition programs undertaken between 1972 and 1983, 61% were failures, 23% were successes and 16% unknown. (An acquisition was deemed successful if it earned its cost of equity capital or better on funds invested in the acquisition program.) If the successes and failures are probed further by looking at the rates by type of acquisition, a company acquiring another company in a related business has a greater chance of success than one acquiring a company in an unrelated business. Therefore, statistics suggest high failure rates of mergers and acquisitions. There are a number of reasons for the failure of acquisitions (McKinsey, 1994 and Balmer & Dinnie, 1999). Success or failure arises from the quality of the pre-acqusition and post-acquisition processes. The pre-acquisition process includes the following: How companies make the M&A decision (including target selection). 112 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers Due diligence. The value creation logic (how is it valued?). Negotiation of the deal. The post-acquisition process is about how the integration is managed. This is considered the most important source of success or failure. ACTIVITY With the increase in globalisation, and a push to achieve marketshare quickly in foreign markets, cross-border M&A activity is on the rise. What are some of the challenges for cross-border M&A activities. How would you expect the success rate for cross-border acquisitions to differ from the overall figures quoted above? ACTIVITY FEEDBACK Cross-border M&A are more complex, and pose further management challenges for successful execution and post-merger integration. The complexities arise in both the pre- and post-acquisition phases. At the pre-acquisition phase, due diligence and valuation are particularly complex. Emerging markets, in particular, suffer from the problem of unreliable marketing and strategic information, and the due diligence may not be entirely accurate in this respect. Furthermore, local accounting standards may not be compatible with international standards. Political and nationalistic attitudes may also make an unbiased assessment difficult. In the post-acquisition phase, transition management and integration management are the biggest challenges because of the geographical distribution. Despite the compounded problems of cross-border M&A, studies focusing just on cross-border M&As suggest that the success rate is no worse than domestic, and, if anything, slightly better. John Kitching (in 1973) looking at cross-border acquisitions in Europe, found that 25% were straight failures and 25% not worth doing, giving a success rate of 50%. A further study by McKinsey focusing just on cross-border M&As found a 57% rate of success. The slightly higher success rate may be simply because most cross-border acquisitions are horizontal (i.e. in core business) and all studies show that horizontal acquisitions tend to be more successful than others. 113 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Listed below are many of the common reasons for failure in M&A: 1. Acquirers pay too much. This happens for a variety of reasons: - Acquirers are over optimistic in their assumptions. Assumptions, such as rapid growth continuing indefinitely, a market rebounding from a cyclical slump or a company turning around, can sometimes lead acquirers to overpay. company will experience. - Over-estimation of the synergies that the merged - Simply that the acquiring company overbids. In the heat of the deal, the acquirer may find it all too easy to bid up the price beyond the limits of reasonable valuations. difficult and during this time, relationships with customers, employees, and suppliers can easily be disrupted during the process, and this disruption may cause damage to the value of the business. - Poor post-acquisition integration. Integration can be 2. Corporate identity and corporate communication issues are not properly managed: - Undue attention is given to short-term financial and legal issues, at the expense of communication. issues during M&A process. - Inadequate recognition of the impact of leadership - Unresolved naming issues. - Integrated identity and communication structures are rarely in place early in the M&A process. - Consultants are brought in too late. - Dominant players give little attention to cultural issues, particularly at the outset. 3. 4. 5. Failure to secure good will of a wide range of stakeholder groups in both companies. Potential conflict between individual and corporate objectives is not given sufficient recognition and isnt managed. Reputations can be damaged, maintained or enhanced during the merger process. 114 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers VIRTUAL CAMPUS Microsoft revealed recently that it tried to buy SAP, the German software giant, in late 2003. If the merger had been successful it would have made Microsoft a dominant force in the enterprise software market, dealing a blow to Oracle and even IBM. However, the merger attempt failed. Research this failed merger attempt (Internet, FT article under Comments & Analysis on 14 June 2004, company statements, etc). Now divide yourselves into two groups. Those with last name beginning A-M should wear the Microsoft hat, and the others the SAP hat. Now carry out the following on the Virtual Campus: 1. Microsoft group: put forward to SAP management the benefits of the merger to SAP. Consider the various SAP stakeholders in putting forward the benefits. SAP group: counter the Microsoft proposals, where appropriate. Both groups: analyse why the merger went wrong (cultural, political, other issues). Could Microsoft have handled it better. 2. 3. (This Virtual Campus activity also interlocks with the units on Innovation and Strategic IT & e-business) Successful execution of M&A McKinsey suggests a five-step program for successful mergers and acquisitions: 1. Management of the pre-acquisition phase. It is important during the pre-acquisition phase that employees maintain the secrecy of the deal. If the secrecy is not maintained and there are rumours of a take-over attempt, the share price of the target will increase, potentially killing the deal. It is also important that managers evaluate their own company, understand its strengths and weaknesses, and understand the industry structure. Once this is done, then managers can begin to identify the value-adding approach that will work best for their company. Screen candidates. Public companies, divisions of companies, and privately held companies should be considered when developing a list of potential targets. In this step, McKinsey suggests that a list of knock-out criteria be developed. These criteria allow managers to eliminate those companies which do 2. 115 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy not fit with their own company (i.e. too big, too small, availability.) 3. Valuation. The objective for the acquiring company should be to pay only marginally more than the value to the next highest bidder and an amount that is less than the value to the acquirer. In determining the value to the acquirer, McKinsey suggests that the value of the acquiring company be added to the value of the target company as is. The value of realistic synergies must then be added while taking into account how long it will take to capture them. The transaction costs for doing the deal are then subtracted. The result is the value of the combined post-merger company. The value gain is the combined value less the value of the acquiring company. Negotiate. A key point in this part of the process is for the acquiring company to decide on a maximum reservation price and to stick to it. A negotiation strategy is established by considering the following factors: 4. - acquisition value to the acquirer - value of the target to the existing owners and other potential buyers - financial condition of the existing owners and other potential acquirers - strategy and motivation of the existing owners and other potential acquirers - potential impact of anti-take-over provisions. 5. Management of post-merger integration. McKinsey noted that most acquirers destroy rather than create value after the acquisition. Prior to being acquired, 24% of the companies studied were performing better than the industry average and another 53% were performing better than 75% of their industry average. Post-acquisition, these percentages dropped to 10% and 15%, respectively. CASE STUDY 1 Lojack and the Micrologic Alliance The next case study is case study 13, (LoJack and the MicroLogic Alliance) on Pages 818-826 of your key text, De Wit & Meyer. Below is the case synopsis: The case describes the rise and development of the LoJack Corporation (NASDAQ: LOJN), the acknowledged global leader in stolen vehicle recovery 116 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers technology, headquartered in Westwood, Massachusetts. The company was founded in 1978 by former Navy pilot Bill Reagan, who unable to sleep one night, conceived a unique patented system, designed to assist law enforcement personnel in locating, tracking and recovering stolen vehicles. Lacking the specific knowledge and technical skills for his concept to materialise, Bill Reagan turned to MicroLogic, a product development firm which specialised in developing electronics products for others. MicroLogic helped refine the LoJack product specifications, designed the entire system and worked with various government agencies to obtain the appropriate approvals. When everything was in place, a contract was signed for MicroLogic to manufacture the police tracking computers. It made MicroLogic the technical backbone of LoJack and hence, this product development firm became a significant ally and an instrumental partner in the success of LoJack. But as time progressed, LoJack separated somewhat; in-house people were hired to do a lot of the work formerly handled by MicroLogic and eventually the LoJack Corporation ended up doing much of their own work, with the exception of brand new design work or work on the base software that MicroLogic designed originally. The challenge presented in this case has to do with a defining moment in the alliance, examining the issue of continuing value creation if the relationship between LoJack and MicroLogic is pursued. The management of the LoJack Corporation is committed to a growth strategy of geographic expansion of its historically successful system, while MicroLogic has changed its strategy and is now committed to entering a new marketplace with its own products and services. LoJack is asked to join and supply both marketing capability and capital to finance Micro Logics expansion. The key issue for LoJack is now whether it should revise its strategy, grasp this opportunity and build on what had been a very successful alliance, or whether it should seek new strategic partners and move forward on its own. The LoJack management team needs to determine whether the new alliance with MicroLogic would leverage to the utmost LoJacks strengths and whether this alliance would again be successful, given MicroLogics new strategy. Points to Highlight (extracted from Teaching Note 13, Lojack and the MicroLogic Alliance, Leonard Zyistra) This case, used in conjunction with Chapter 7 and Readings 7.1-7.4 of your key text, De Wit & Meyer, can be used to understand the following key points: Differences between horizontal and vertical alliances. The LoJack MicroLogic relationship is an example of an upstream vertical (supplier) alliance. Therefore, this case can be used to understand the differences between horizontal and vertical alliances, as well as the difference between indirect and direct horizontal co-operation (link to Introduction of Chapter 7). The spectrum of relational arrangements between market and hierarchy. The stolen vehicle recovery system (hereafter: SVR-system) needed the approval of the Federal Communications Commission (FCC) as well as the support of law enforcement agencies (and often 117 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy executive and legislative bodies). Car dealerships would sell the system as an option, providing a high margin add-on to any car sale. Licensees in countries outside the United States would use the stolen vehicle recovery system technology. Motorola was asked to manufacture the police tracking computers and had to agree to a long-term payment plan. Financial institutions and insurance companies were involved in designing joint offerings. In order for the LoJack system to be manufactured and find its way to the customer, LoJack and MicroLogic had to define the business ecosystem in which it would flourish and design several relational arrangements, determining the level of co-operation they wished to pursue. This allows for a discussion on the various relational arrangements that can be implemented and the different levels of inter-organisational dependence that they entail (link to Introduction and Reading 7.3, James Moore). The objectives of strategic alliances. The original LoJack MicroLogic alliance was primarily intended to develop the necessary base software and equipment and to obtain FCC approved technology for the SVR system. With a change in the strategic intentions of the two, the objectives of each partner to continue the alliance are different now. This allows for a discussion on the variety of objectives that can be pursued by means of alliance (link to all sections of Chapter 7). The disadvantages of strategic alliances. After the success of the first alliance between LoJack and MicroLogic, and knowing and trusting each other so well, it is tempting to engage in a second alliance. However, given the different strategies of the partners, they are forced to recognise that a new alliance also has inherent disadvantages. You may wish to identify these using this case (link to Introduction, Reading 7.1, Hamel, Doz and Prahalad and Reading 7.4, Dyer, Kale and Singh). The paradox of competition and co-operation. The partners in the LoJack-alliance experience a shift of focus when their relationship matures. MicroLogic used to be the technical backbone of the LoJack corporation. As time progressed, LoJack separated somewhat; they hired in-house people and took over the mundane, day to day tasks of MicroLogic, as it was neither interesting for MicroLogic nor cost effective for LoJack to continue to have MicroLogic do standard stuff. This case, therefore, illustrates how alliances combine competitive and cooperative behaviour, applying flexibility in the relationship to continue to balance the two conflicting forces (link to all). Discrete and embedded organisation perspectives. The main challenge for LoJack in the case is whether, after a successful alliance with MicroLogic for years, it should renew this 118 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers relationship. Both parties had become more independent over time and had benefited from this growing independence. Both parties however, were also tempted to explore new market opportunities on the basis of the stolen vehicle recovery technology. They could go separate ways, each pursuing their own strategic direction, but the question is, had they become independent enough to be successful without the old alliance partner? To answer this question in an affirmative way, this view would be in line with the discrete organisation perspective. However, a number of issues should be taken into consideration as well, such as the opportunity to leverage some of LoJacks strengths or the fact that, from a (shareholder) value creation perspective, the MicroLogic new market entry could be more successful and rewarding. This view would be in line with the embedded organisation perspective (link to all). Questions: 1. (i) Which are the relational actors relevant to the technical and commercial success of the Stolen Vehicle Recovery System? (ii)Which relational objectives, power positions and arrangements exist between LoJack corporation and the actors? Do you think the arrangements between LoJack and MicroLogic changed their competitive advantage over time? What advice would you give the LoJack management team on the joint venture proposal by MicroLogic to join them in introducing a new monitoring and maintenance system for construction equipment? 2. 3. CASE STUDY FEEDBACK Feedback on Question 1: Part i In the case quite a number of actors are mentioned, each playing an instrumental role in the success of the SVR-System. Apply Figure 7.2 to draw the relations. (See textbook, Be Wit, B & Meyer, R (2004)).` MicroLogic. When the original founder of LoJack, Bill Reagan, met for the first time with Sheldon Apsell, founder and president of MicroLogic, it was still a small product development firm, which specialised in developing electronics products for others. Reagan and Apsell immediately hit it off. With only a hand-shake to 119 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy consummate the deal, MicroLogic helped refine the product specifications, designed the entire system, worked with various governments agencies to obtain the appropriate approval and performed the required fieldwork to prove to the FCC that the assigned radio frequency would not interfere with that assigned to a television channel. With everything in place, a contract was finally signed for MicroLogic to manufacture the police tracking computers. (Upstream vertical relation) Car Dealership: Marketing and sales of the LoJack system took place via a distribution network. Car dealerships would sell the system as an option, providing a high margin add-on to any car sale. (Downstream vertical relation) Motorola: Was asked to manufacture the police tracking computers and had to agree to a long-term payment plan. Later on it was also engaged in developing and manufacturing the third generation of the LoJack system. (Upstream vertical relation) Local police: Were using the Police Tracking System that allowed police to locate the stolen car. LoJack offered the devices for free, in exchange the police will support the system. Very often, first the law enforcement agency (and often executive and legislative bodies) had to be persuaded to support the system. (Downstream vertical relation and political actor) FCC. Being a regulatory actor, the stolen vehicle recovery system needed the approval of the Federal Communications Commission (FCC), establishing that the radio frequency used by the system would not interfere with other radio communications. (Regulatory actor) Financial institutions and insurance companies: Complementors were involved in designing joint offerings with financing schemes that included the purchase of the LoJack system and discounts for the car insurance premium. (Indirect horizontal relation) Competitors: There were many, claiming to have stolen vehicle recovery features similar to those of the LoJack system. None, however, were operated or actively monitored by law enforcement agencies, giving the LoJack system a unique selling point. (Direct horizontal relation) Part ii Arrangements and power positions: The relational arrangements, dependencies and alliance objectives between LoJack and MicroLogic changed over time, as the companies grew and 120 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers their relationship matured. At first, in return for its initial contribution, MicroLogic received a total of $350,000 and 90,000 shares of LoJack. A contract was signed for MicroLogic to manufacture the police tracking computers. This type of arrangement between LoJack and MicroLogic can be described as that of a bilateral combination of Equity-based and contractual arrangements. The intent of these; the contracts will organise procedures and routines at MicroLogic to manufacture the computer, constituting advantages of hierarchy, while the equity-based part places MicroLogic in the situation where it has an entrepreneurial incentive. Conducive to spurring risk-taking, innovation and change. This worked like the benefits of the market. The alliance can therefore be seen as a nice example of co-specialisation, where LoJack is focusing on marketing and sales, while MicroLogic focuses on manufacturing and technology development in the area of tracking and positioning. This co-specialisation had progressed to the point where LoJack hired a MicroLogic engineer. Over time, while the relationship was still trusting, it became more and more business like with more written documents and formal contracts because there were more people involved. The MicroLogic role changed also and the companies became far more independent. MicroLogic was no longer involved in all the technical decisions and LoJack had its own technical staff. However, MicroLogic was still involved in the long term technology strategy, and there to pitch in when LoJack staff needed help. Later on, MicroLogic and LoJack had entered into a joint venture to develop the third generation of the LoJack system. However, MicroLogic had difficulty meeting some of the initial specifications of the product. The direction of the project was altered and Motorola was engaged. Relational objectives and factors: MicroLogic provided LoJack technology and, one could add, also labor and entrepreneurship it had embraced the initial idea of Reagan and had been willing to risk as much as LoJack as it was still not certain that the product would become a success. Nor could MicroLogic bank on the fact that it would be asked by LoJack to become its first-tier supplier. The initial phase of the cooperation can be described as learning-oriented, as it had been the objective to develop new technology required for the SVR-System. When the cooperation matured, one could say that it became more linking-oriented. LoJack started hiring a former MicroLogic engineer for instance. As Sheldon Apsell of MicroLogic had put it sometime: LoJack should take over the mundane, day to day tasks, as it was neither cost effective for LoJack nor interesting for MicroLogic to do standard stuff. Legitimacy played an important role in the alliance. Although the inter-firm relationship was still trusting, it had become more business like with more written documents and formal contracts. And when there had been conflict at the lower level of the organisations, it did not impair the cooperation because of the strong relationship at the top where corrective action was taken before things got completely out of hand. The alliance also proved 121 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy strong on flexibility and the ability to adapt to changing circumstances when early predictions did not come out. Although LoJack was resource dependent on MicroLogic to develop and test the technology at the beginning of their relationship, it could be viewed that this relationship was still in balance, because ultimately it was LoJack which held the patent of the system. Without that, MicroLogic could not do anything with the concept or the technology. Their relationship can therefore be described as balanced interdependence. Moreover, LoJack had ordered Motorola to manufacture other parts, ensuring it became not entirely dependent of MicroLogic. Alternatively, as we do not know the alternatives available to Bill Reagan back in 1978, it could also be argued that the relationship initially was based on unbalanced dependence in favour of MicroLogic. For LoJack, the technology was key to the success of the system and hence to its value proposition, for MicroLogic it was just one contract. So MicroLogic was independent to the extent that it did not infringe the patent (limitations) and LoJack was dependent but able to steer the product specifications (influence). Feedback on Question 2: While the cooperation between LoJack and MicroLogic evolved over time, MicroLogic shifted its strategic focus and decided that the company should develop and market its own products. After a number of false starts, the management finally settled on an information service business which would initially provide information about the location and operating parameters of expensive construction equipment. Other potential market segments to be attacked after construction equipment included other mobile high-value assets such as vehicle fleets, rail cars and trailers. The system would produce standard reports or use sophisticated mapping software to produce easily understandable graphic information that could be communicated to personal computers. The original tracking and positioning technology, developed for the LoJack system, formed the backbone. Up to this point, MicroLogic had self funded the product development, testing and marketing of the new business while continuing to operate the traditional business. However, MicroLogics decision to change the essence of the organisation had brought marketing and sales of the original product development business to a halt. Cash flow would soon be inadequate to support further development and marketing. Meanwhile, the competitive landscape was changing. Many more companies were entering the construction equipment asset management marketplace. MicroLogic viewed this activity with mixed feelings. On the one hand, excitement in the industry about such a system validated MicroLogics concept and educated potential customers. On the other hand, it narrowed the window of opportunity for capturing a large enough share of the market to make implementation worthwhile. Additional capital and marketing capability were essential if MicroLogic was going to be the market leader. Analysing how MicroLogic had changed its strategy and finding itself in the situation as described above, would lead to the conclusion that the company had been successful in developing concepts for new markets, but in essence remained a product development firm. To introduce a new concept successfully, it needed LoJack to supply capital and marketing capability. This situation we recognise from the start of their alliance. 122 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers For LoJack, things developed also in a different way. While expansion of the LoJack System into new geographic areas and markets with improved marketing efforts and strengthening the sales force was a logical growth strategy, the development of a new generation LoJack system was necessary to reduce the cost of the hardware and improve efficiency of the installation process. The success of this third generation system would allow LoJack to enter the highly competitive market for stolen vehicle recovery. The cost of hardware had been dropping fast and improvements in technology such as GPS had encouraged new entrants that also offered total asset management capabilities. LoJack management hoped that they could stay in this market with its new unit that would be compatible for application in a non-powered environment at a pricing attractive to the industry. Alternatively, LoJack was also exploring cellular and satellite technologies to enhance its opportunities in this market. But all in all, its competitive edge was no longer the same as it had been when the first LoJack system was introduced to the market. LoJack management, therefore, thought that there might be even greater opportunities in leveraging LoJacks connections with law enforcement agencies, reputation, brand awareness and distribution muscle. All this could be leveraged in the mobile asset management-market, starting with construction equipment. This could be done in a joint venture with MicroLogic, but also with a new partner or may be go it alone. Analysing this opportunity for LoJack and comparing it with the company in the late '70s, it can be concluded that its competitive advantage had changed, broadening its commercial capabilities. Feedback on Question 3: Basically, LoJack has three major issues that it should contemplate: 1. Will further development of the third generation LoJack system, exploring new geographic markets and improved marketing and strengthened sales force, become profitable enough in the long run and create sustained shareholder value or should a new marketplace be sought? Considering the highly competitive market for stolen vehicle recovery with more and more pressure on margins and distribution channels. Will the new alliance leverage to the utmost LoJackss strengths or is its marketing capability only of limited use in this new marketplace? Also, considering MicroLogics changed strategy to develop and market its own products, is the compatibility in objectives not only temporary and predominantly focused on obtaining the LoJacks venture capital? Will the concept that was developed by MicroLogic for the construction equipment asset marketplace be competitive enough? Will it secure the alliance to capture a large enough share of the market to make investment and implementation worthwhile? Considering that other major competitors were well positioned in the consolidation and outsourcing trends and given the business model that MicroLogic wanted to employ (short term revenues, by selling equipment at break-even or a very small profit, and long term revenues and the 2. 3. 123 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy majority of profits from monthly fees plus individual charges for special services). CASE STUDY 2 CITIGROUP Merger Brief The Economist, 26th August 2000 First among equals This merger brief shows why true mergers of equals are rare. The union of Citicorp and Travelers, initially equal partners, became a takeover as one of its co-chief executives took sole command IT WAS the most extraordinary merger ever, or so it seemed back in April 1998. The marriage of two financial-services giants, Citicorp and Travelers, was the biggest to date, with a combined market capitalisation of $84 billion on the day it was announced. The vision behind it was just as large: the newly created Citigroup would be an entirely new sort of global business, a financial-services supermarket selling every financial product under the sun to individual, corporate and government customers in every corner of the earth. As if that were not enough, the marriage was structured as a genuine merger of equals a phrase often used, but usually only to soothe the ego of the boss of a company that is being taken over. In this case, every effort was made to ensure that both sides really were equal partners, starting at the top, with the bosses of the two merging firms becoming co-chairman and co-chief executive. But the omens were bad. Announcing the merger, Sandy Weill (of Travelers) quipped that he was used to sharing power and responsibility as Ive been married to my wife for 43 years. This metaphor may have jarred on John Reed, who had divorced in 1991 and married a stewardess on the Citi corporate jet. Barely 15 months after the deal was done, the two co-heads agreed, under pressure from shareholders, to separate their roles. Divorce followed in April this year, when Mr. Reed retired, at the request of the board, leaving Mr. Weill as lone chief executive. For the moment, Citigroup is an undeniable success: in the first quarter of 2000, it was the worlds most profitable company. But the power struggle at the top delayed integration and discouraged cross-selling the financial products of one part of the merged firm to customers of another, one of the key goals of the merger strategy. It has also prevented the emergence of a strong Internet strategy. 124 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers Mr. Weill admits only that we have taken longer to get places than we might have. In fact, the costs may have been greater than that implies, not least in missed opportunities. Citigroups management is now dominated by people from Travelers. The loss of the Citibank talent may yet cause problems, especially outside America. The stellar performance hoped for by the stockmarket may not happen. Citi and Travelers came to the altar with different experiences of mergers. In the 1990s Citi, which traces its origins back to 1812, went from near bankruptcy to being the leading global consumer bank. But big mergers were not central to this success. Indeed, the mergers it undertook went badly notably the acquisition of Quotron, a securities data firm. By contrast, a knack for acquisitions enabled Mr. Weill to build up Shearson Loeb Rhodes, a brokerage, which he merged with American Express in 1981. He quit in 1985, after falling out with James Robinson, the boss of Amex, thereby learning a valuable lesson: do not be the junior partner in a merger. In 1986, he bought Commercial Credit, a small consumer-lending firm, which through mergers became Travelers, an insurance and brokerage conglomerate. And even as the merger with Citi was announced, the recently acquired Salomon Brothers investment bank was still being integrated with Travelers Smith Barney. In June 1998, Mr. Weill added a stake in and a joint venture with Nikko Securities, a Japanese stockbroker. Mr. Weills merger technique was based on having a clear strategy including cutting fat out of under-managed businesses and implementing it fast. He tried to minimise cancerous uncertainty by selecting the management team to run the merged businesses as soon as possible, usually on merit and loyalty to him. Yet integrating Citigroup was never going to be straightforward. Citibank was not flabby or under-managed or, at least, did not see itself that way. It was possible that the merger would be called off by regulators, a danger that fostered hesitancy over integration. In the event, the Citigroup merger helped secure the scrapping of Americas Glass-Steagall Act, which had separated commercial banks, insurers and investment banks. But above all loomed the problem of this being a genuine merger of equals. Two heads better than one? The to-be-merged company quickly adopted a Noahs Ark approach to top management- everything in twos. As well as Messrs Weill and Reed, half the new boards members came from Citibank and half from Travelers. The global consumer business was headed by Bob Lipp (Travelers), and William Campbell (Citi). The global corporate and investment banks had three heads Victor Menezes (Citi), Deryck Maughan (Salomon Smith Barney) and Jamie Dimon (Travelers), long regarded as Mr. Weills heir apparent. As a result, every decision became a lengthy philosophical discussion. This partly reflected the personalities of the two co-chief executives. Mr. Reed is the sort who loves to discuss management with academics. A loner in leadership, he tended to invite people into his inner management circle only to 125 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy expel them soon after. Mr. Weill is guided more by gut instinct than by briefing papers, and relies on a small group of loyal managers. Indecision at the top soon led to trouble in the global corporate and investment bank: Travelers Salomon Smith Barney investment bank, plus Citis corporate relationship bank. Integration had been half-hearted: SSBs well-paid investment bankers regarded their new colleagues as stuffy corporate folk. Staff in the Citi operation were proud of the 1,500 leading global firms that were their main customers, and looked down on traders at Salomon, with their lower-grade corporate-bond clients. They wanted their services to continue under the Citi brand, not to be switched to SSB. They were aghast at the huge losses run up by Salomon during the financial-market crisis in 1998. Meanwhile, Salomon itself resented Mr. Weills decision to close its American bond-arbitrage operation only a few months after buying the firm. Things came to a head in late October 1998 at a weekend of golf and spouses in West Virginia, where senior executives complained about how the merger was proceeding. Scuffles broke out. The two leaders reacted with unusual decisiveness. A week later, a new management team was appointed. Mr. Dimon left the company, his ambition having reportedly annoyed Mr. Weill. Mr. Menezes was joined as co-head of global corporate and investment banking by Michael Carpenter, a Weill loyalist. The pair at once set about fully integrating the two businesses, selecting a new top management team and identifying a dozen big issues that needed urgent action. In July, after Citis biggest shareholder, Prince Alwaleed bin Talal of Saudi Arabia, fretted in public about the relationship between the firms co-heads, Mr. Weill took charge of day-to-day operations. Mr. Reed was left with strategy. In October 1999, Robert Rubin, a former Treasury secretary and co-head of Goldman Sachs, was appointed to the office of the chairman, apparently to broker peace between the two bosses. By now, the tensions at the top were public. Mr. Reed had told the Academy of Management that, although the wisdom of the merger is even more compelling than when it began, it is not 100% clear to me that it will necessarily be successful. He drew telling comparisons with step-parenting. Sandy and I both have the problem that our children look up to us as they never did before, and reject the other parent with equal vigour, saying Sandy wouldnt want to do this, so what do I care about what John wants? The reality was that Sandys children were increasingly winning the top jobs, and Johns were quitting in droves. Citigroup was rapidly becoming Mr. Weills creature. One top-notch Travelers person did leave, however: Heidi Miller, Citis chief finance officer, quit for Priceline, an e-commerce firm. Mr. Weill blamed her departure on irritation with Mr. Reed. But that was the last straw: the board asked Mr. Reed, 61, to retire. The 67-year-old Mr. Weill became sole boss, supported by Mr. Rubin. All Mr. Reed salvaged was a promise (which few now believe) that Mr. Weill would go within two years, and that the search would begin for a successor. Mr. Weill soon completed his domination of Citi. In July, the last of the post-merger top-job splits ended. Mr. Carpenter became sole head of the 126 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers global corporate and investment bank; Mr. Menezes, the last remaining Citibanker at the top, was packed off to head corporate and consumer banking in emerging markets. Mr. Lipp, another Weill loyalist and head of consumer banking, joined the office of the chairman, with a brief to co-ordinate cross-selling. As for cross-selling, the vision that ostensibly motivated the merger, this has worked better in some parts of Before and after the merged company than in Citigroup Citicorp others. The greatest success has Travellers been achieved where it was least expected in corporate and Employees Net profit '000 $bn investment banking. Wall Street 10 180 analysts initially hated the decision to axe Mr. Dimon and 160 to promote Mr. Carpenter. In 8 the event, it proved inspired. 140 Aided by the link with Nikko 120 Securities and a merger with 6 Schroders, a British investment 100 bank, in January 2000, the now Schroders Salomon Smith 80 4 Barney has moved from being a 60 middle-ranking firm to the brink of or even into the so-called 40 2 bulge bracket of top global investment banks. 20 1997 1999 0 1997 1999 0 Blurred vision? Mr. Carpenter says his business was involved in some 300 transactions during 1999 that both Citi and Salomon folk agree could not have been done without each other, and that the firm is now in the top four in every product category, in every geographical region of the world. This may be stretching it SSSB is still not a first-tier adviser on mergers and acquisitions, for example, though it is gaining on rivals such as Goldman Sachs and Morgan Stanley by using its huge balance sheet to offer corporate clients credit lines during mergers. Source: Company Reports The potential for cross-selling was supposedly greatest in consumer finance. Citis strong global brand provided a superb platform for selling Travelers and Salomon Smith Barney products through its branch network, which spans over 100 countries, and to Citis 42m credit-card account-holders (more than any other credit-card provider). But cross-selling is something that many financial institutions, across the globe, have attempted, with little success. Citi claims a few modest achievements. Some wealthy Salomon Smith Barney customers have been given 100% mortgages by Citibank, secured against their brokerage accounts. Salomon Smith Barney mutual funds have been sold to Citibank branch customers. Within months of the merger announcement, 127 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy Travelers annuities were selling in the Citibank branch network, and now generate revenues of $750m a year. Travelers has now pre-underwritten all of Citis credit-card customers, and whenever somebody with an attractive risk profile calls to discuss his credit card there are 80m such calls a year he is invited to buy a Travelers home or car insurance policy. Travelers says that sales by this channel have minimal incremental cost, making them particularly profitable. It now sells almost 5,000 policies a month, and expects $200m in premiums by 2002 (6% of current revenues). Travelers has started to expand abroad, primarily in emerging markets rather than in the already highly competitive continental European market. Once only a domestic American insurer, Travelers now expects to win the lions share of the $400m a year in commissions currently earned by the global Citibank branch network from selling competitors products. According to Mr. Weill, integration in the corporate and investment-banking business happened faster than in retail because it had to. If wed gone slower, we would have lost a lot of people." There have been huge technology challenges, such as incompatible computer systems. Citi remains confident that retail cross-selling will bear more fruit, but progress has been slow. It has been hard to integrate systems, and business units have warred over which brands to cross-sell and which to ditch. The value of a deal Share prices, October 8th 1998 = 100 350 MERGER Citigroup 300 250 200 150 Citicorp Travellers 100 50 1996 Source: Primark Datastream 97 98 99 2000 0 Adding to the frustration has been the groups muddled Internet strategy. Mr. Reed, who took sole charge of it in July 1999, believed that Citis Internet potential would best be fulfilled by developing from scratch an entirely self-contained, state-of-the-art online retail financial-services provider. More 128 Global Corporate Strategy Unit 4 Altering the Boundary Alliances and Mergers than $500m was spent developing e-Citi a classic example of the big-bang innovation strategy pursued by Mr. Reed decades earlier when he installed thousands of ATMs, in Citi branches, and transformed the way people used their bank. E-Citi attracted few customers, and was resented by Citis established businesses. Since Mr. Reeds retirement, it has been downgraded to a sort of incubator, and 1400 of its employees have been despatched to other Citigroup brand businesses. Now, ownership of Internet strategy is left with the top executives in individual businesses. This caution may be a mistake. Asked in June whether Mr. Weill could take Citi into the Internet age, Mr. Reed said, This isnt Sandys deal. He is not going to personally design the Internet company that is going to do this. Mr. Reeds boldness might eventually have brought rewards as did his huge spending on ATMs, which initially meant huge losses. Despite the infighting, strategic mishaps and delays in integration, Citigroup has prospered, with both profits and the share price soaring. Mr. Weill has, as usual, cut costs and made under-managed assets sweat. New managers from Travelers have instilled a more aggressive sales culture in Citibank branches. But the Travelers people who now lead Citibank lack experience in overseas markets, where the group expects its main growth. Citibanks institutional memory, which gave some protection from bad lending decisions, has gone. So has Mr. Reeds vision. Mr. Weill is skilled at fixing and then expanding under-managed companies. But he has yet to show that he can fix and expand an already successful global giant. Questions: 1. 2. What are the problems that have become apparent after the merger? What impact have these problems had on the core competences of the newly formed organisation? How do you think the company could have overcome these problems? Do you think this merger has been successful? 3. 4. Summary In this unit we have considered the options available for global expansion; strategic alliances and mergers and acquisitions (M&A). Firstly we considered the role of strategic alliances, and the paradox of co-operation and competition. We noted the advantages arising from 129 Unit 4 Altering the Boundary Alliances and Mergers Global Corporate Strategy pooled resources, know-how and shared risk, but also noted that there can be conflicting goals and there is the potential loss of know-how. We then considered mergers and acquisitions, and other M&A related transactions. We saw how M&A can give ready-access to markets, know-how and management capability. We looked at some of the drivers for M&A activity. Noting the high rate of failure of M&A, we identified some of the common pitfalls of M&A, and finally concluded with the McKinsey five-step program for successful mergers and acquisitions. REVIEW ACTIVITY We have noted that one of the main pitfalls in M&A is the integration phase. When a company acquires another, what is the best recipe for assimilation? Does the acquiring company impose its culture on the acquired company? Is there sometimes merit in preserving intact the culture and working practices of the acquired company? How can the right balance be struck between the need for organisational autonomy vs. strategic interdependence. Prepare your responses to the above, and then read p.334 (Reading 6.3) in the key textbook De Wit, B & Meyer, R. Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. Ref 4*, Chapter 8 Pages 166-195, Chapter 16 Pages 374-407 Ref 13, Chapter 7 Pages 151-174, Chapter 14 Pages 337-357 *Highly recommended 130 Unit 5 Value Management LEARNING OUTCOMES Following the completion of this unit you should be able to: Analyse the concept of value from a stakeholders perspective. Assess strategy from a value creation perspective. Explain the principles relating to EVA and its impact on strategy. Debate the validity of adopting a value driven approach. Introduction The term value can bring to mind different things. It can mean one thing in the public sector and have a different focus in the private sector. Economists think of value in quantitative terms, in a strict monetary context. Shareholders think of future potential. Increasingly, and particularly in the knowledge-based economy, there is an emphasis on intangible and intellectual capital assets. Whichever business context you operate in, value should be determined by your key stakeholders. In commercial organisations, the key stakeholders are the companys shareholders. Increasingly executives and managers are overhauling their understanding of shareholder value. There is now the recognition that what was thought to be true about valuation is, in fact, only situationally true. Traditional approaches can, in fact, be misleading in certain contexts particularly in the knowledge-based economy, in the area of new and emerging technologies. In this unit we shall look at the concept of value from a stakeholders perspective. We shall look at current thinking with regard to the creation of value and consider the merits of a corporation adopting a value-driven approach. Two case studies are also presented to highlight the issues. 131 Unit 5 Value Management Global Corporate Strategy Paradox of Profitability and Responsibility It is important for companies to understand their purpose in business. Is it to maximise profit for the owners (a shareholder value approach) or is it to meet the requirements of society at large (a stakeholders values approach)? Examples of such companies are Body Shop, and Ben and Jerrys. Does a company seek to satisfy the needs of as many stakeholders as possible in conducting its business, or is it duty bound to maximise its profits in favour of the owners? It costs money to be socially conscious! This unit looks at the shareholder extreme of de Wits paradox continuum. Unit 6 will examine the opposite end by exploring Corporate Governance and Ethics. The Concept of Value What is value? What does it mean in relation to business, or more importantly, to strategy? Value as a concept means something different to private and public organisations. However, regardless of the organisation type, value is very difficult to define and quantify. ACTIVITY Consider the definition of Value in the context of an organisation. Draw up a list of the different aspects of the word value, e.g. value-added. ACTIVITY FEEDBACK Your list may have included some of the following: Value for Money. Shareholder Value. 132 Global Corporate Strategy Unit 5 Value Management Value Chain. Value System. Value Cycles. Value Management. Stakeholder Value. We shall look at some of these concepts in more detail in this unit. Stakeholder Value Whether in the private sector or public sector, value should be judged by the organisations key stakeholders. In this unit we shall focus our attention mainly on commercial organisations. However we shall now briefly look at some of the differences between the private and public sectors in relation to value. Public Sector Strategic management is, of course, just as important to the public sector as it is to commercial entities. For example, the notion of competition for a public organisation is usually concerned with competition for scarce resource inputs, typically in a political arena. However, the emphasis on value concepts can be different in the public and private sectors. The overarching need is for public bodies (e.g. central government, local government, health service organisations) to demonstrate Value for Money in outputs. Many of the developments in management practices and theories in the public sector (e.g. changes to internal markets, performance indicators, competitive tendering) have been used to attempt to introduce competition to encourage improvements in value for money. Overall, the role of ideology in strategy development in the public sector is probably greater than that in a commercial organisation. This is because the type, range and position power of Stakeholders interested in an organisations strategic choice is greater. Therefore, the acceptability to stakeholders of strategic choice is probably of greater significance in the public sector than in the commercial sector. The measurement of value to stakeholders in the public sector is difficult to quantify, because it is essentially a perception by the stakeholder of the value for money in the service they have received. 133 Unit 5 Value Management Global Corporate Strategy Private Sector Stakeholder value is a critical factor for strategy and management in the private sector. Theoretically, all managerial actions should be carried out only when they can add value to the company. This introduces the concept of the Value Chain in an organisation, i.e. the internal linkages that exist within the boundaries of an organisation. In addition to this, to fully understand the concept of value, linkages to the entire supply chain, upstream with suppliers and downstream with distributors and customers, must be taken into account. This overall picture of value to an organisation can be termed the Value System. Clearly, the value system can be different from company to company depending upon their strategic choice. Value chains and systems can establish significant competitive advantage. For example, two competing firms with equivalent internal value chains can be differentiated in terms of value by better suppliers and/or distributors. The value system is therefore better for that company. Some organisations, particularly those with several business units, have very complex value chains and systems making strategic analysis difficult and time consuming. The key work in this area of strategy was carried out by Michael E Porter in 1985 and 1990. Key Stakeholders It could be argued that the key stakeholders to any commercial organisation are the shareholders (particularly where the company is publicly owned). If shareholders become disenchanted with a company and sell their shares in sufficient quantities, the law of supply and demand dictates that the share price will fall. The ultimate consequence of this is that the market capitalisation (the value of the company on the stock market) falls to such a level that the company finds it more difficult to borrow money or may be taken over by another organisation who buys up a majority of the shares. For this reason, companies try to avoid shareholder dissatisfaction and regard shareholders as key stakeholders. This is logical as the shareholders own the company and employees have traditionally answered to the owners. All employees have a fiduciary duty to preserve and build upon the owners investment in the firm. This raises the issues of Value Management how can a company manage itself (strategically) to maximise shareholder value? In addition to that, how can shareholder value be measured? 134 Global Corporate Strategy Unit 5 Value Management Value Management How do companies adopt strategies to deliver shareholder value. What is value? Business models and definitions of value that worked well until the early 1990s, are now being challenged. Why is sensitivity to stock price now a critical lever for managing the future? There is an increasing recognition that the market, over time, represents a brutally honest evaluator of performance. This has led to the recognition that management, and indeed employees at large, need to view their company from the outside in. They need to act like long-term shareholders themselves, and feel the pressure from the marketplace in order to deploy assets and adopt strategies wisely. To achieve this, value-based corporations are increasingly basing compensation packages on value-based parameters. Value-based corporations place customers at the heart of their business (the view from the outside in). Value chains and value cycles are pertinent in this discussion. Increasingly companies are adopting a value cycle approach, as opposed to the traditional value chain approach. A value chain is seen to deliver value to the customer, whereas a value cycle approach views the process as an interaction with the customers. Many forward-looking companies view their key customers as critical partners in setting business direction. ACTIVITY As background to the next sections, learn about the shareholder value approach by reading, Shareholder value and corporate purpose, Reading 11.1, p. 610-615 in your key text, De Wit, B & Meyer, R. Creation of Value Value is added to a firm when profits increase, operational or financial risks are reduced or when greater efficiencies are produced. Decisions which add value to a company, add value to the shareholders either in the form of dividends, value of the share holdings or both. Various ratios and tools have been introduced into business for analysing financial statements, e.g. Return on Capital Employed (ROCE). But any measure of shareholder value must include the following considerations: Cash flow. 135 Unit 5 Value Management Global Corporate Strategy Time value of cash. Opportunity cost of capital. Net present value. As one of the great proponents of the Shareholder Value philosophy, Alfred Rappaport, said Profit is an opinion. Cash is fact Economic Value Added (EVA) Corporations adopting value-based management principles are increasingly using a measure called Economic Value Added, commonly shortened as EVA. EVA is used as a measure of value, and is used as a key parameter in promoting shareholder value within management ranks and employees at large. It should be emphasised that EVA is NOT a strategy it is a measure of performance. The strategies a company uses are geared to increasing EVA so as to demonstrate to markets that they use capital efficiently. However, it is a very popular tool and is used widely by major companies to even suggest that it will be used has been know to increase share price overnight! EVA is the difference between the Return o n Cap ital Em p lo yed and the Co st o f Cap ital Em p lo yed by a company. A simple, but flawed, analogy is to compare the annual cost of your mortgage with the annual increase in value of your house. If your house has risen in value by 10% and your mortgage is only costing 6%, then you are ahead. The same logic applies with a company. If it gets more out of its capital than it is paying for it then it is adding value. The move towards value-based management in large companies is based on two assumptions: The main aim of any business in a market economy is to maximise shareholder value. Markets are too competitive for companies to create such value by accident. They must plan for it. And that means having the right culture, systems and processes in place so managers make decisions in ways that deliver better returns to shareholders. Corporate functions must be informed by value-based thinking planning, capital allocation, operating budgets, performance measurement, incentive compensation and corporate communication. EVA is a tool for measuring performance. When implemented properly, and especially if tied to management compensation, it is a powerful way to promote shareholder value. 136 Global Corporate Strategy Unit 5 Value Management What is EVA EVA is a measure of profit, but not the accounting profit seen in a corporate profit and loss account. It is profit as economists define it. Both are measured net of operating expenses but they differ in the treatment of capital costs. While accountants (in P&Ls) recognise only out-of-pocket costs, such as the interest paid to bankers, EVA recognises all capital costs, including the o p p o rtunity cost of shareholder funds. The value of any business must equal its net assets (the sum of fixed assets, cash and net working capital) plus the present (in other words, discounted) value of future EVAs. Therefore, as stock market expectations of corporate EVA increase, so too do share prices. Companies can therefore use EVA targets to motivate managers to deliver the financial results the stock market wants. This approach is especially useful for executives one or two levels below top management who have little direct influence over share price and for whom stock options are less effective. Their compensation and bonus schemes can be tied to specific financial objectives and can be cascaded down to employees all the way down the company. CASE STUDY SPX SPX is a large US auto parts and industrial products company. It was a chronic underperformer in the early 1990s, with low profits and a languishing share price. After John Blystone took over as chief executive in 1995, the company ushered in a series of actions designed to reverse its poor performance. The companys 1995 annual report proclaimed: One of the most important of these actions has been the decision to move ahead as quickly as possible to implement EVA. Formal adoption took place at the end of 1995, and by the end of the following year, a dramatic improvement in performance was evident. Senior managers were put on an EVA bonus plan. Within a year, 4,700 managers were in the programme, including non-executive directors. By 1999, SPX was transformed into an EVA company, with a positive effect on the share price. When EVA was implemented, SPXs share price was under $16. Within five years of implementation it was selling for $180. What makes this companys experience instructive is that it was able to create a culture that put value creation at the centre of management systems. As the company explained in its 1998 annual report: EVA is the foundation of everything we do. It is a common language, a mindset, and the way we do business. SPX witnessed dramatic improvements in asset efficiency. In the year after adopting EVA, inventories were cut by 15 per cent, despite higher sales. To improve performance, the company focused its operating units on quality and operating excellence. One such unit began a next-day delivery policy that helped it to achieve market leadership. Such efficiencies, combined with 137 Unit 5 Value Management Global Corporate Strategy sourcing initiatives, caused a 12.5% improvement in operating profit in 1997 (the second year after EVA was implemented). SPX divested several businesses that were profitable, but strategic reviews revealed the businesses were worth more to others, and therefore should be sold. Of course, well-managed companies have always done this, but EVA-based compensation systems create stronger incentives for managers to seek such opportunities. EVAs most important contribution to the turnaround was its central role in management compensation. The actions taken by SPX to improve performance were neither unusual nor dramatic. The key lesson to be learned from SPX is not whether managers are capable of delivering superior performance, but whether they are motivated to do so. How is EVA calculated? EVA is after-tax operating profit minus capital costs, with capital costs equal to net assets multiplied by the weighted-average cost of capital (or WACC). When operating profit is divided by net assets, it yields a measure called Return On Net Assets (RONA). The difference between RONA and the WACC, or the EVA spread, multiplied by net assets, equals EVA: EVA = (RONA WACC) x NET ASSETS How does EVA relate to the value of a company? The value of a company is defined as: Value of Company = Net Assets + Present Value of future EVAs The net assets are the sum of all fixed assets, cash and working capital. Note the EVA component is the present value of future EVAs; it is discounted back. Growth of Value Management Concepts Value Management concepts are becoming more widespread on the back of a number of developments. Companies are responding to a changing corporate environment. In particular, Greater competition for capital, driven by the globalisation of capital markets. 138 Global Corporate Strategy Unit 5 Value Management The growing trend towards professional shareholders and, in particular, the influence of institutional investors. high potential for company acquisitions. The emergence of a market for corporate control i.e. the What is a Value-Driven Approach What sort of things do value driven companies have to do to design and implement value management? Methodology: Take a long term rather than short term perspective. Take a company specific rather than a generalised approach. Use suitable performance measurement targets in planning and control. Mistakes made in one or all of the following areas can lead to inaccuracies in management information and can have a serious effect on the overriding goal of value management that is, to improve corporate control. Reward Systems: Implement effective compensation and incentive schemes. Review traditional dividend policy. If reward systems to employees and shareholders are rigidly maintained for historical reasons and not reviewed in the light of a value management approach, the introduction of a value driven strategy is done half-heartedly. Implementation: If a company fails to involve all parties then the value management strategy will meet with resistance and delays. A successful implementation must: Take account of all stakeholders. Be in full consultation with employees. 139 Unit 5 Value Management Global Corporate Strategy ACTIVITY Value innovation is said to be the essence of strategy in the knowledge economy. Learn more about this by reading Strategy, value innovation and the knowledge economy in your key textbook, De Wit, B & Meyer, R. Company Specific Approach To be successful in deploying value-management, a company specific approach must be adopted. A good approach is to leverage general value management tools, but to adapt to your specific industry and fine tune for company specific factors. Figure 5.1 summarises the essential components. General value-management tools (select suitable tools) Valuation models Cost of capital calculations Portfolio management Controlling tools Industry specific factors (adapt to industry) Company specific factors (fine-tune for company) Company specific strategy Industry-specific success factors Specific tools Tailored implementation + Opportunities and threats Structure and dynamics of industry Value drivers Product cycles Success factors + Value system/corporate philosophy and policy Strategy Organisation/structures Production processes Resources = Figure 5.1. A company-specific approach to value-management. Components of a value-driven approach The components of a value-driven approach are summarised in Figure 5.2. Let us examine each in turn: Identify value performance and value drivers It is clearly essential for a company to be able to assess their value and measure progress to identify their Value Performance. In other words, the company needs to verify that they are actually creating value for 140 Global Corporate Strategy Unit 5 Value Management their stakeholders. This can be achieved by creating computer a based financial model containing all of the key value management variables. In adopting a Value Management strategy, the method of corporate valuation must be Discounted Cash Flow (DCF) which sees the value of a company as being the sum of the cash flows it will earn in the future, discounted back to the present value. This reflects the fact that on the purchase of a company, the purchaser acquires the right to future cash flows. The whole process is based on careful Business Planning, which should reflect a forecast horizon of at least five, but preferably ten years. Each strategic business unit (SBU) should be calculated separately with a summarising routine to reflect overall portfolio value. Value drivers can be identified by using the above computer based financial model by changing core assumptions and observing the impact on shareholder value. This develops a tool for Sensitivity Analysis, which identifies and evaluates key value drivers. Step 5: Inform stakeholders and develop investor relations Step 1: Identify value performance and value drivers Step 4: Adapt compensation systems Increase shareholder value Step 2: Implement value creation programmes Step 3: Extend management and control systems Figure 5.2. Components of a value driven approach. Implement value creation programmes Having laid the foundation for value management by establishing a financial model it is necessary to develop or expand a portfolio of value creating business units. Refer back to Unit 2 for a review of the portfolio management approach to strategy. 141 Unit 5 Value Management Global Corporate Strategy A value portfolio chart plotting potential market returns (adjusted for risk) against strategic fit with corporate vision is recommended. See Figure 5.3. The portfolio distinguishes between stars and dogs; Further growth or holding strategy with no strategic investment for the stars. Optimisation / Discontinuation / Sale of the dogs. This represents the results of the analysis carried out above for each SBU. From this, the following questions can be answered; How is a particular SBU to be positioned into the value portfolio? What actions are needed to increase the Value of the portfolio? + Retain without strategic investment E.g. can profitability be maintained without further investment? SBU 1 Pursue further growth E.g. what growth options are available? "Stars" Deviation from riskadjusted market returns SBU 7 Sell SBU 4 Optimise or discontinue SBU 3 E.g. has this unit achieved critical mass? E.g. have all efficiency enhancement options been exhausted? E.g. would this unit not be better off in someone else's hands? SBU 2 SBU 8 High "Dogs" Cirecle diameter = capital employed SBU 6 Low Strategic fit with corporate vision Figure 5.3. Value portfolio chart, Ref: Stefan Botzel & Andreas Schwilling, Managing for Value 1999. The Stars in the value portfolio are those businesses that create shareholder value by; Sustained cash flow growth achieved by engaging in activities in attractive industries, for example, or by attaining an excellent competitive position. Optimised management of investments (intangible assets, financial assets, property, plant and machinery, working capital) and how they are financed (cost of capital). 142 Global Corporate Strategy Unit 5 Value Management Consistent risk management. The Dogs do exactly the opposite. The position on the x axis is determined by a pragmatic scoring system, which will be developed by each individual company. The position on the y axis is determined by considering the comparison between return on investment with the cost of capital. (Clearly value is created only when return > cost). Strategic management Analysing the value portfolio must be combined with the strategic management of the company; Only SBUs which yield shareholder value should be retained in the portfolio. Dogs should only be retained until transformed into value creating Stars or sold off. Consistency is vital decisions must be based on hard figures produced by value management, not emotive, personal satisfaction, etc. If the portfolio cannot guarantee to generate the target level of value creation then the company needs to restructure through acquisitions, alliances, new ventures. changed. The mix of capital allocated to each SBU could be Let us now deal with each window of the value portfolio in turn; Stars that fit the corporate vision: Cash producers and value drivers. The goal of corporate strategy should be to position core businesses in this window. Growth should be promoted. Funding will need to be allocated to maintain and / or improve the companys position. Capitalisation on areas of competence. Stars that DO NOT fit the corporate vision May be non-core or niche markets, but still create value. 143 Unit 5 Value Management Global Corporate Strategy SBUs retained but without further investment. Focus on risks attached to the poor corporate fit. Possibly look to sell to harmonise corporate vision. Possibly adapt corporate strategy to remain attractive to the market and adopt a growth strategy. Dogs that fit the corporate vision These SBUs destroy value because of; - Low cash flow due to thin margins, low sales growth - Investment has been excessive or inappropriate - Cost of capital is too high Strategically, need to be optimised or run down. Money to be invested only if the returns are above cost of capital. Dogs that DO NOT fit the corporate vision These SBUs destroy value. Generally, such SBUs should be sold, to lay a solid foundation for successful growth strategies. In summary, a value creation strategy must seek to: Increase Revenues. Increase Margins. Optimise Investments. Minimise the cost of capital through Financial Engineering. Extend management and control systems A uniform system of planning and measuring business success that makes the creation and destruction of value transparent must be established based upon; A forward looking approach based on future cash flows. A focus on cash flows rather than numbers in financial statements. 144 Global Corporate Strategy Unit 5 Value Management A view which acknowledges the time value of money. Reflection of the risk faced by different SBUs in capital rates. Management control processes and communication systems must be clearly defined and capable of being used as a basis for a Value Based Compensation System. Management reports must be recipient based and include value measurements. Strategic Planning and Control European countries tend to base strategic planning upon traditional metrics such as market share, competitive position, sales growth and results. Value management dictates that increasing the value of the company in its SBUs is the single most important measure. For example, a sales growth of, say, 10% is not a valid strategic goal (as far as VM is concerned) because; Corporate value could still be destroyed despite this high figure the investment needed to achieve this growth would may not bring in sufficient returns to cover the cost of capital. higher sales target appears realistic. 10% may not be enough if value creation based on a Adapt compensation schemes Compensation systems are a key factor in value based company management. The principle is simple managers' salaries should be linked to value generation for shareholders. Examples of this are; Genuine Participation Models: Stocks. Stock options. Convertible bonds. Artificial Participation Models: Bonuses. Combined forms. The variety of value based incentive schemes possible means that a scheme can be devised for any level of management it doesnt have to be the same across the whole company. 145 Unit 5 Value Management Global Corporate Strategy EVA bonus plans dont just motivate managers to think about current EVA. If they did, managers would focus entirely on short-term performance at the expense of the future. Value-creating investments might be avoided because their immediate effects on EVA are negative. The solution is to give managers a direct economic stake in future EVA, not just the current period. The figure above shows how such an approach can work. Remember that the value of the company (that is, the value of debt and equity) equals net assets plus the present value of future EVAs. This means that the market capitalisation of a companys shares is based on expectations of future EVA performance. Share price increases when these expectations are exceeded. This insight yields the first principle of EVA-linked compensation: the key performance measure is not EVA itself, but excess improvement. To derive this measure, companies must first set targets based on market expectations. Then, a target bonus, usually stated as a percentage of salary, is paid if the target level of EVA improvement derived from the companys share price is earned. Note, however, that the payout is not capped. This is the second basic principle of EVA-linked compensation. If manager and shareholder interests are to be aligned, management pay should more closely resemble payouts received by owners. As a result, there is no ceiling on the EVA bonus, but there is also a downside. The bonus earned in any year is the sum of the target bonus plus a fixed percentage of excess EVA improvement (which can be positive or negative). This bonus is credited to a bonus bank, and the bonus bank balance, rather than the current year bonus earned, determines the payout. Typically, the payout rule for the bonus bank is the full bonus bank balance (if positive), up to the target bonus, plus one-third of the bank balance in excess of the target bonus. When the bonus bank is negative (which is possible if under performance is great enough), no bonus is paid. The EVA interval determines the sensitivity of the bonus earned to excess EVA improvement, and is chosen by senior managers based on the degree of upside potential and downside risk they wish to inject into the plan. The bonus bank component adds a critical dimension to the scheme by extending managerial planning horizons beyond the short term. The bank allows for a negative bonus, wiping out at least a portion of EVA bonuses earned in previous years. This practice forces managers to think not only about what they need to do in the short term to boost performance but also what they must do to increase it in future years. Otherwise, part of the bonuses they earn in the current year might be forfeited. In other words, the bonus bank provides medium-term incentives for value creation, in addition to the short-term incentives 146 Global Corporate Strategy Unit 5 Value Management from annual payouts. Stock options add to the EVA bonus plan by providing long-term incentives. CASE STUDY Herman Miller In 1995, Herman Miller, a US office furniture manufacturer, had a rich history and culture, great products and talented employees. The economy was strong, the furniture industry was growing and sales were growing at a fast rate. But something was missing. The results werent showing up on the bottom line and so the company decided that a tool was needed to help focus their efforts. They implemented EVA as a measurement and management tool. Employing the same amount of capital as in 1995, sales moved from $1 billion to $1.5 billion. In 1997, EVA was $40 million an increase of nearly 300% over the $10 million generated in 1996. The share price has gone from a low of $11 at the end of 1995 to a high of $36 at year-end 1997. Herman Miller has valued employee participation since company inception nearly 75 years ago. EVA was seen to build on that historic strength, allowing employee-owners to better understand the impact of their actions, resulting in better decisions for customers and general business. EVA analysis enables the company to identify waste in both costs and use of capital. Inventories across the country reduced by 24% or $17.2 million from 1995. Outstanding accounts receivable (that is, the money owed by customers) have been reduced 22% from 55 days in 1995 to 43 days at the end of 1997. Over the past two years, sales have increased 38%. The cut in receivables is especially interesting because the impetus for this came from operating managers, not the accountants. The 13% operating margin is much improved from five years ago with scope for further improvement. At the same time, the total square footage of building space has been reduced by more than 15%. EVA analysis demonstrated that debt capital was cheaper than equity capital. So the board set a new debt to capital ratio of 30% to 35% and $100 million was raised in a private placement. In 1997, $110 million was returned to shareholders in share repurchases and dividends. Using EVA, Millers business has grown and people have grown in their commitment and contribution. EVA is the backbone of the company-wide incentive and bonus system. As one observer explains: When they went on EVA and began focusing on capital costs like receivables, Miller employees in the divisions attacked the late payment problem on their own and discovered that the cause of overdue 147 Unit 5 Value Management Global Corporate Strategy receivables was incomplete orders. When an order arrived missing a piece or two, the customer would withhold all payments until the last items arrived. So the Millerites got receivables down by speeding up production of missing items and making sure shipments were complete as well as on time. The result: improvements in EVA and customer satisfaction. Inform stakeholders; develop investor relations Of all stakeholders, the investors are the ones who probably play the most important role. If returns are poor, they may sell their shares and invest in something more profitable. What does Investor Relations mean? Investors will only be interested in a company if it promises to be a good investment. Therefore, a company must put a value on itself so that an informed decision can be taken. This is the essence of investor relations. It is not, however, a one off exercise. It is a long term process of positive opinion building. In fact, about 10-15% of a companys value development can be ascribed to the influence of professional investor relations. Communication tools may be split into direct and indirect with varying degrees of importance to investors, e.g. Annual Reports are more indirect whereas meetings and presentations are direct communication tools. Is EVA Appropriate? All companies can benefit from the shareholder value perspective and the value-creating incentives offered by EVA, but some are more likely to benefit than others. An important part of EVA is that it can provide value creation incentives for divisional managers, not just for top executives. This suggests that companies with autonomous business units benefit more than companies that operate as one large unit. Also, matrix organisations tend to derive fewer benefits because of the difficulty of establishing accountability. Companies with substantial shared resources are less likely to benefit from EVA. For example, if common manufacturing facilities or sales staff serve multiple business units, and if these units are not forced to buy this capacity, investment accountability, EVA measurement and management incentives can be undermined. Another difference between successful and unsuccessful users is that the former rely on strong managerial wealth incentives tied to business 148 Global Corporate Strategy Unit 5 Value Management unit performance. The latter tend to place heavier emphasis on stock options. Successful EVA companies use stock options, but recognise that the strongest incentives for divisional managers come from measures based on divisional performance, not corporate measures such as stock price. Unsuccessful users are also more inclined to exercise discretion in paying managers. In other words, they override the bonus plan, probably because of low tolerance for differences in business unit compensation. In successful EVA users, the chief executive is an enthusiastic advocate, whereas in unsuccessful users, the CEO may not have realised what he or she signed up for. Maybe the CEO thought EVA was what the markets wanted. Or perhaps there was a failure to appreciate the effort needed for full implementation. As a result, implementation is erratic. Another feature of successful users is that they try to establish and maintain accountability for business unit heads. This, in turn, requires that these managers stay put for extended periods. In unsuccessful adopters, job tenure for business unit managers is short. This difference is crucial because if managers move around, there is no long-term accountability. Without accountability, deferred compensation is not possible. Deferred compensation, in the form of a bonus bank, plays a critical role in ensuring the EVA bonus plan forces managers to think beyond the current year. EVA is no panacea, and it is no substitute for sound corporate strategies. But when EVA is at the centre of a companys performance measurement system, and when management bonuses are linked, alignment between the interests of managers and shareholders improves. The effect is that when managers make important decisions, they are more likely to do so in ways that deliver superior returns for shareholders. Reference m anaging fo r Value (1999) by Bo tzel S. & Schw illing A Summary In this unit we have looked at the concept of value, what it means to different stakeholders, and how our ideas of value and its measurement are changing. We have looked at EVA as a measure of value, and have seen how EVA is influencing the management philosophy of value-based companies. We have also looked at the components of a value-driven approach. We have noted that EVA is no panacea, or substitute for sound corporate strategies. We have considered the characteristics of companies for which the shareholder value perspective and value-creation incentives offered by EVA is most likely to succeed. We 149 Unit 5 Value Management Global Corporate Strategy have looked at two case studies where EVA has made a significant impact. REVIEW ACTIVITY In the late 1990s high-tech stocks soared in value, and there seemed to be an unsustainable wave of dot.com mania. The dot.coms invaded every sector of commerce; e-business seemed be to overturning established relationships, and attacking long-established price points. The year 2000, however, saw the collapse of many dot.com shares. What went wrong? 1. 2. Consider what went wrong. What are the lessons to be learned? Now identify a survivor from the dot.com period. Spend some time researching the company. Find out about its strategy, during the dot.com period specifically with regard to e-business. Comment on its market valuation during the dot.com period and on what premise these valuations were made. Identify the hallmarks of their success REVIEW ACTIVITY FEEDBACK Here is some feedback on the first part of the question. The valuation of a company has two equally important components. Net assets, as well as the present value of future EVAs. For most dot.com companies the net assets were very low, but the valuation of the second component (EVA) was extremely high unrealistically high. Based on nothing more than a website, companies with no earnings and no prospects of operating in the black were awarded market valuations that exceeded many of the worlds most respected companies. Business metrics like profit and cash flow went out of the window. Unrealism and hysteria took over the market. In effect, many of the dot.com management were guilty of hyping the worth of future EVAs. Market analysts egged on the hysteria; some cynics go as far as to say that some market analysts materially benefited from this deception (an area of on-going investigation). The EVA situation resolved itself over time, and many of the dot.com stocks crashed. The lesson from the crash is that there are no shortcuts in business. For many dot.coms, the e in e-business came to stand for easy; easy money, easy 150 Global Corporate Strategy Unit 5 Value Management success, easy life. A real business is serious work and must have a realistic business plan for break-even and profitability thereafter; profitability in the not-too-distant future. In addition to future potential (and by future potential is meant realistic future EVA) profits and cash flow do matter. Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. 3. Ref 10*, Chapter 6 pages 212-226 Ref 4, Chapter 13 pages 327-335 Ref 15 *Highly recommended 151 Unit 6 Corporate Governance and Ethics LEARNING OUTCOMES Following the completion of this unit you should be able to: Assess the advantages and disadvantages of an ethical approach in organisations. Develop the principle of global corporate governance by examining recent UK developments in this area. Explain the attributes of good corporate governance. Appreciate the attributes of an ethical organisation. Introduction Globalisation has heightened the awareness of social responsibility. There has been much debate about its adverse impact on social, political and environmental issues. Furthermore, recent high-profile corporate scandals, such as Enron, Worldcom and Parmalat, have led to an increased focus on corporate governance and the tightening of accounting procedures. What is clear is that companies can no longer pay lip-service to good corporate governance and business ethics. Profitability cannot be the sole corporate driver. Undoubtedly, there is a paradox between profitability and stakeholder responsibility. See Figure 6.1. Profitability will always be driven by the shareholder view, and guided by value management principles. But stakeholder responsibility must also be a part of organisational purpose. Stakeholder responsibility is not just responsibility to the shareholders, but to the stakeholders (including employees, suppliers, customers and the community) at large. Stakeholder responsibility must be guided by good corporate governance and business ethics. 153 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Profitability Organisational purpose Responsibility Shareholder value perspective Value management principles Shareholder value perspective Corporate governance and ethics Figure 6.1: Paradox of profitability and responsibility It should be noted, however, that in todays business/political environment with very powerful lobby groups, profitability and responsibility are not always paradoxical; profitability can indeed be adversely affected by the apparent lack of social responsibility. Shell found this to their great cost with the Brent Spar episode where Shell appeared to go against their own stated ecological and environmental stance. Also, investors who invest for the longer term may expect the company to be profitable and also behave ethically, showing good standards of corporate governance. In this unit we shall look at the area of corporate governance, and examine recent developments in the UK relating to this. We shall then consider the area of business ethics. We shall look at the benefits arising from adopting strong ethical principles, and look at the factors that set apart a highly ethical organisation. Corporate Governance The term corporate governance has been used in a variety of contexts, particularly in relation to the boards of companies listed on a stock exchange. Governance is at the heart of the role that all boards of directors play. The range of issues is varied, e.g. company performance, individual performance, role of directors, roles of shareholders. Corporate governance came to the fore in the early 1980s in the United States during extensive corporate take-over activity. Perceiving little support from their institutional shareholders, numerous company boards began to introduce protective practices to ward off undesirable take-over bids. These measures were seen by some shareholders, especially public pension funds, as acting against their best interest. Accordingly, shareholders began to take a greater interest in their investments. Out of this, corporate governance was born. 154 Global Corporate Strategy Unit 6 Corporate Governance and Ethics As mentioned in the introduction, there is undoubtedly a paradox between profitability and stakeholder responsibility. Conflicting demands, between economic profitability and social responsibility, are placed on a company by its shareholders, employees, suppliers, customers, governments and communities. ACTIVITY How does a company achieve its organisational purpose by balancing the often conflicting demands of profitability and stakeholder responsibility? Learn about this and the paradox of profitability and responsibility by reading the following: 1. 2. p. 590-609 of Chapter 11 in your key text, De Wit, B & Meyer, R. p. 616-638, Readings 11.2-11.4, in your key text, De Wit, B & Meyer, R. The problems associated with the split between shareholders and company directors were first raised by Berle and Means, in their 1932 book, The Mo d ern Co rp o ratio n and Private Pro p erty . The issue of the agency problem was highlighted, i.e. the tension created when the directors running the company were not the major shareholders. In the 1980s, institutional (professional) shareholders were much more likely to address these issues and debate possible solutions. Corporate activity is under a more intensive media spotlight today. Board decisions are more public and annual meetings can be high-profile as shareholder activists raise questions about board decisions. In the UK, the corporate governance debate started to receive emphasis due to several high-profile corporate failures such as Polly Peck and Coloroll. World-wide, and in the last three years, there have been further dramatic and spectacular failures including Enron, Worldcom and Parmalat. Directors were seen as acting against the shareholders interests and in dereliction of their duties to the company. As a result of failures such as the ones mentioned, investors are willing to pay a premium for companies with good corporate governance. To understand the workings of governance systems, it is important to be able to identify the different types that exist globally. Often, governance systems are developed from tradition and ideology. In recent years, it has become more difficult to generalise about the different types of system. For example, there is possibly a trend in central Europe to move towards a more Anglo Saxon approach. The different types of governance system are; 155 Unit 6 Corporate Governance and Ethics Global Corporate Strategy 1. The Anglo Saxon Model (e.g. in the UK, USA and Australia) which is a single tier structure and often reflects a widespread number of small shareholders alongside large investment houses who are intermediaries owning shares on behalf of investors. This limits the power of the individual shareholder and heightens that of organisations such as pension funds. This can lead to a short term approach as investors seek to obtain a quick return on investment. The European Model (e.g. Germany) comprises a two tier structure where the upper tier is supervisory over the lower tier. Share ownership is normally in the hands of institutions who use protective mechanisms such as preference shares. This system has strengths and weaknesses. The two tier system is seen as a counterbalance to management power where the single tier is dominated by senior management. However, whereas the system has long term views, it suffers from slower decision making and a lack of flexibility. The Asian Model (e.g. Japan) is single tier but ownership is very different to the Anglo Saxon model. Banks and other companies own most of the shares. Hence the larger companies hold shares in each other and co-operate very closely (known as a kieretsu). Composition of boards is heavily in favour of executive managers. In fact, it is in effect the top layer of management. Accordingly, the share ownership patterns can lead to weak accountability and secretive governance procedures. 2. 3. Average % 30 28 26 24 Brazil 22 20 18 0 Latin America Source: McKinsey Asia Continental Europe Anglo-Saxon Mexico Argentina Chile Korea Italy Taiwan Japan Germany France Spain Switzerland US UK Venezuela Columbia Indonesia Thailand Malaysia Figure 6.2: Average premiums investors would be willing to pay for a well-governed company 156 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Figure 6.2 suggests that investors are willing to pay more for shares where the perception is that the companies are governed in a sound and ethical way. It can be seen as a measure of perceived ethical governance. Scrutiny in the area of governance (as we shall see in the next sections) has led to the establishment of strategic principles relating to corporate governance. These include: Selection and conduct of senior officers, and their relationship with stakeholders. Responsible use of power assigned to senior officers. Responsible conduct in relation to information relayed to stakeholders. Further checks by way of appointment of non-executive directors who have no commercial interest in the company. simple rules. Focus on principles of conduct rather than hiding behind Equitable distribution amongst stakeholders of the value of assets generated by the company. Key developments in the UK Let us now examine key developments in the UK relating to corporate governance. The Cadbury Committee In the aftermath of these cases, a committee, chaired by Sir Adrian Cadbury, was formed in 1991 to examine the financial aspects of corporate governance in publicly quoted UK companies. The subsequent Cadbury Report, The Financial Aspects of Corporate Governance, published in December 1992, focused the corporate governance debate in four main areas: The responsibilities of directors for reviewing and reporting on performance to shareholders. The case for establishing audit committees. The principal responsibilities of auditors. The links between shareholders, boards of directors and auditors. 157 Unit 6 Corporate Governance and Ethics Global Corporate Strategy The report contained a Code of Best Practice, most of which was adopted as part of the London Stock Exchanges Listing Rules for all quoted companies. The report states that Corporate governance is the system by which companies are directed and controlled. Whereas the corporate governance debate in the US had focused on shareholder rights, the emphasis in the UK was on structure and processes. Despite the reports own definitions, the aspects of governance relating to control dominated the debate in the UK and added little to the issues of best performance. The Greenbury Committee The Cadbury Report focused on financial governance. Following a series of highly publicised large pay awards to directors, notably in the privatised utilities, a committee was set up to examine directors remuneration, chaired by Sir Richard Greenbury. The committee reported in July 1996 and again produced a Code of Best Practice that focused primarily on listed companies. Remuneration packages appear to many as one of the most obvious means by which the interests of the directors can be aligned with those of the shareholders. The Code made a series of recommendations on the role of remuneration committees, disclosure of directors remuneration and provisions for approval of long-term incentive schemes, corporate remuneration policy, the length of directors service contracts and the compensation paid to directors when these contracts come to an end. As with Cadbury, many of the recommendations have since become part of the Stock Exchanges Listing Rules requirements. The focus was again on the systems and structures which could control directors, ensuring that, as far as possible, their interests were aligned with those of the shareholders. Both Cadbury and Greenbury, therefore, focused most of their work on the elements of the debate relating to accountability, not enterprise. The Hampel Committee The latest report on corporate governance in the UK, the Hampel Report, from the Committee on Corporate Governance chaired by Sir Ronnie Hampel, attempts to address the distinction head on: The directors relationship with the shareholders is different in kind from their relationship with other stakeholder interests. The shareholders elect the directors. As the [Confederation of British Industry] put it in their evidence to us, the directors are responsible for relations with stakeholders; but they are accountable to the shareholders. 158 Global Corporate Strategy Unit 6 Corporate Governance and Ethics The report has identified the friction created when talking of accountability and business prosperity; The importance of corporate governance lies in its contribution both to business prosperity and to accountability. In the UK the latter has pre-occupied much public debate over the past few years. We would wish to see the balance corrected (Final Report from the Committee on Corporate Governance, 1998) This raises the question, what is the difference between accountability and responsibility? Some have used these words as being synonymous. However, their distinct meaning is important in developing the issues relating to governance. The Combined Code In June 1998, the London Stock Exchange published the Principles of Good Governance and Code of Best Practice (the Combined Code) which embraces the work of the Cadbury, Greenbury and Hampel Committees and became effective in respect of accounting periods ending on or after 31 December 1998. The Combined Code established fourteen Principles of Good Governance and forty five Best Practice provisions, upon which, companies were required to state their compliance throughout their accounting period The 1998 Combined Code has since been superseded by a version published in July 2003. The July 2003 Combined Code became effective for reporting periods on or after 1 November 2003. ACTIVITY Read the latest version of the Combined Code on the following website: http://www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf The Higgs Review For non-executive directors, a boardroom seat had been seen as providing a comfortable sinecure ahead of retirement. Most boards of large companies comprised the ageing great and good in the City, often retired executives. Clubby consensus, rather than challenges to management, was the order of the day. Some of that culture still lingers. 159 Unit 6 Corporate Governance and Ethics Global Corporate Strategy The Higgs Review was commissioned by the Chancellor and the Secretary of Sate for Industry to review the role and effectiveness of non-exec directors, and the report was published in January 2003. ACTIVITY Read the Summary and Recommendations section of the Higgs Review from the following website: http://www.dti.gov.uk/cld/non_exec_review/pdfs/higgsreport.pdf As the Higgs review makes clear, the boardroom remains largely a preserve of ageing white men. Mr Higgs package of reforms will see non-executives take a much more active role and become far more accountable in carrying out their duties. The changes will represent a fundamental shift in the boardroom. The power of executives on the board will be balanced by independent non-executives providing a check on management. At least half the board will comprise independent non-executives. This goes far beyond previous requirements that a third of the board be non-executives, independent or otherwise. The chairman, playing a pivotal role and potentially holding the balance of power, will be required to be independent at the time of his nomination but it is assumed he will go native, given the time spent working closely with the management. The review says: A non-executive is considered independent when the board determines that the director is independent and there are no relationships which could affect, or appear to affect, the directors judgement. Factors that could affect independence include employment with the company in the past five years, having a material business relationship in the past three years, family ties, receiving additional remuneration apart from a directors fee, and participation in the companys share option or pension scheme. The review also recommends that a senior independent director be appointed to act as a conduit for shareholders to raise issues if they are not resolved through the chairman or through the chief executive. This proposal, more than anything else in the review, has concerned business. The concern is that if the senior non-executive holds separate discussions with shareholders it could lead to mixed messages emerging from the board. Mr Higgs is at pains to point out that senior non-executives will not be champions of shareholder interests but will be more a listening post. They will attend meetings with 160 Global Corporate Strategy Unit 6 Corporate Governance and Ethics shareholders, largely only to listen to shareholder concerns. In addition, if problems arise with a chairman and chief executive, they could be a contact point for shareholders. Other measures ensure that boards do not become bound by personalities or tradition. These include requiring the chief executive not becoming chairman. Non-executive directors should normally be expected to serve a tenure of two three-year terms, although a longer term would be appropriate in exceptional circumstances. After nine years, annual re-election of non-executives is appropriate, and after 10 years on a board a non-executive is not considered independent. Non-executive directors also should meet at least once a year without the chairman or other executive directors present. To widen the gene pool of talent in the boardroom, Mr Higgs recommends a more formal, transparent recruitment process. Research by the review showed that 48% of non-executive directors were recruited through personal contact with a board. No individual should chair more than one large company nor should a full-time executive take on more than one non-executive role. No limit has been set for the number of roles that non-executives can hold, though individuals should make sure they have enough time to fulfil their duties. The Smith Report The report says that a Company Audit Committees primary role is to ensure the integrity of the companys financial reporting, and warns it must be prepared if necessary to take an adversarial approach with management. If things are going seriously wrong the committee may have no alternative but to explore the issues exhaustively. If the audit committee is drawn into a line of questioning about the handling of a controversial issue, it cannot let go until it is satisfied with the answers." The Smith report says at least three independent non-execs should serve on the audit committee, and suggests that they should get extra pay to reflect the importance of their work. It says at least one member should ideally have a professional accounting qualification, together with recent and relevant financial expertise, possibly as an auditor or company finance director. The other members should have a degree of financial literacy. The Smith report will lead to revisions to the best practice code on corporate governance for listed companies. 161 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Director Accountability Placing accountability at the heart of corporate governance inevitably led the general debate on the issues of to whom are directors accountable. Developing the Cadbury definition of corporate governance a similar committee set up in Canada suggested a wider definition: Corporate governance means the process and structure used to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business. The process and structure define the division of power and establish mechanisms for achieving accountability among shareholders, the board of directors and management. The direction and management of the business should take in account the impact on other stakeholders such as employees, customers, suppliers and communities. Where w ere the d irecto rs? To ro nto Sto ck Exchange (1994) This definition retains Cadburys systems focus, but suggests that the structures and processes chosen by directors must take into account parties other than shareholders. The Role of Corporate Governance The UKs National Association of Pension Funds (NAPF) suggest in their report, Go o d Co rp o rate Go vernance (1996), that corporate governance should concentrate on two issues: Board integrity ; ensuring that accounting and other statutory concerns are addressed. Enterprise; encouraging boards to drive businesses forward in the long-term interests of the shareholders. Ensuring good governance NAPF highlights another element of corporate governance. At the centre of the issue is the role of the board of directors direction, control, ensuring shareholder value. It is the boards responsibility to ensure good governance and to account to shareholders for their record in this regard. 162 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Bringing together many of the themes raised in the corporate governance field, the Institute of Directors report, Stand ard s fo r the Bo ard (1995) states that: The key purpose of the board is to ensure the companys prosperity by collectively directing its affairs and meeting the legitimate interests of the shareholders and other interested parties. The report highlights four key tasks for the board: Establishing vision, mission and values. Setting strategy and structure. Delegation to management. Exercising responsibility to shareholders and other interested parties. All of the elements of the governance debate highlighted above are reflected in these tasks. Individual directors must be aware of the role they play in determining the companys future and in setting the strategy and structure to meet desired objectives. They must also be aware of the issues raised under the guise of corporate governance which, as stated at the beginning, are many and varied. However, if the board is to be the guardian of good governance, as proposed by Hampel, a more appropriate starting point for defining corporate governance may be the role of the board. Perhaps a new definition might be: Corporate governance focuses the board on its key purpose: to ensure the companys prosperity by collectively directing its affairs and meeting the legitimate interests of the shareholders and other interested parties. It must account to shareholders for its record in this regard. This definition implies that, in essence, corporate governance should highlight the corporate responsibilities of a board of directors, and distinguish the directors role from those of shareholders and managers. 163 Unit 6 Corporate Governance and Ethics Global Corporate Strategy CASE STUDY: Enron Here is an article from FT.com on the Enron scandal. The Board Game FT.com site; Dec 06, 2002 By Charles W. Calomiris Enron and other high-profile scandals have highlighted problems with corporate governance. How can boards be actively encouraged to challenge managers? Charles W. Calomiris is the Paul M. Montrone Professor of Finance and Economics at Columbia Universitys Graduate School of Business, a Professor of International and Public Affairs at Columbias School of International and Public Affairs, and Chairman of the Board of Greater Atlantic Financial Corporation. Enron and other corporate scandals have crippled market confidence in US corporate governance. Enrons deceptive accounting practices were so convoluted, involved such obvious conflicts of interest with Enron officers, and occurred on such a scale, that one can only marvel at the failure of the Enron board and audit committee to detect and prevent such abuse. Its members failed to perform their primary task, which is to protect the corporations stockholders from abuses by managers. With the dawn of the modern large-scale corporation in the second industrial revolution of the late nineteenth century, there came a new potential for managerial abuse, as corporate stockholding in such large entities became fragmented and detached from management. Stockholders interests were not automatically aligned with those of managers. In their 1932 classic on corporate governance, Adolf Berle and Gardiner Means identified these potential conflicts of interest. In modern parlance, managers can extract control rents value that does not represent an appropriate market reward for their actions, but rather the ill-gotten gains from being able to operate in conflict with stockholders objectives. Managers may redirect funds for themselves and their friends; they may shirk their duties; or they may prolong their employment against the interests of shareholders. The board, as the representative of the stockholders and the source of managerial authority, is supposed to prevent such abuse. But board actions depend on individual board members skills, diligence and willingness to oppose management. Without all three ingredients, boards will fall short of their leadership mandate. Why did the Enron board fail, and what does that failure tell us about possible reforms that could improve corporate governance? One idea that has been popular among some is the need for board independence. Independent board members that is, board members who are not involved in company 164 Global Corporate Strategy Unit 6 Corporate Governance and Ethics management should be able to exert more effective oversight since they are disinterested parties. Able, perhaps, but not necessarily willing. Independent board members are busy people; they are chosen because of their name recognition, not because they have either the time or the inclination to discipline management, or the technical knowledge to perform adequate audits. And their very independence may be compromised if their seat on the board depends on continuing management support, as it often does. Enrons board was almost entirely independent, and composed largely of highly skilled and experienced corporate managers. It included chair Robert Jaedicke, a professor of accounting and dean of Stanford Business School, and Wendy Gramm, former Chair of the Commodity Futures Trading Commission. Yet they and their colleagues seem to have been asleep at the switch. Evidence is mixed on the question of whether the independence of directors improves corporate governance. Recent studies suggest that board independence may matter, but that effective independence (measured by the boards ability to restrain executive compensation) is influenced by a variety of other board attributes, including the size of the board (smaller is better), the number of boards on which board members serve (fewer is better), the age of board members (younger is better), and whether the independent member was chosen by the chief executive (which reduces effectiveness). How can we establish a process for selecting and rewarding board members that will place stockholders interests above those of managers? Here, economics teaches us that incentives are as important as skills. The key to effective board leadership is establishing a process that selects board members who have both the ability and the incentive to be dogged pursuers of the stockholders interest. There are three approaches to ensuring such a process of board selection. 1. Concentration of ownership First, if board members and managers both own sufficiently large amounts of stock, the conflict of interest between managers and stockholders may be largely overcome by the direct incentives of board members to protect their own wealth. The positions of board members with sufficiently large stockholdings are secure, and they have strong incentives to discipline managers to pursue value maximisation. A 2002 study found that countries with the weakest legal protections for outsider stockholders also saw the greatest concentration of stock in the hands of insiders. In both the US and UK, where legal protections are relatively strong, the median insider ownership share of the largest 150 corporations is 1 per cent. In France and Germany, where legal protections of stockholders are weak, the proportions are 55 per cent and 61 per cent. During the first industrial revolution of the early nineteenth century, when the scale of manufacturing production was relatively small, ownership and 165 Unit 6 Corporate Governance and Ethics Global Corporate Strategy management were typically closely aligned. Naomi Lamoreauxs study of the period shows that industrial insiders also leveraged their equity financing by using banks that they controlled to sponsor industrial growth. Banks operated like industrial credit co-operatives for their board members. Because the same group of people owned and controlled the industrial borrowers and the banks, interests were closely aligned, and companies and banks, along with their outside investors, prospered together. Managerial opportunism was constrained by the direct oversight of investors with a material vested interest in the value of the company. But concentration of ownership in the hands of insiders can be very costly, especially in a modern industrial economy. When owner-managers and directors hold most or all of their wealth in the stock of one company, they suffer from extreme lack of diversification. Consequently, they will pay less for corporate stock and require much higher managerial compensation if they must hold such an undiversified portfolio, which will limit corporate growth opportunities. Also, the supply of billionaires is somewhat limited. If many corporations have natural economies of scale that warrant global reach, it will be hard to staff all of them with billionaires. And, those lucky billionaires may lack the skills that are needed to best guide the corporations. The best managers typically dont begin life as billionaires. Finally, there are enormous social benefits from broad public participation in stock ownership. Those benefits transcend the obvious social gains from portfolio diversification, and include the political economy benefits that come from a broad alignment of interests between large corporations and the public, which encourages growth-oriented tax and regulatory policies. The booming investor class in the US in recent decades, for example, has restrained populist impulses in public policy toward corporations, and spurred constructive reforms of accounting, disclosure and governance regulation. 2. Intermediaries A second approach to aligning the incentives of board members and stockholders is to rely on third-party intermediaries to aggregate the voting power of stockholders and thus provide a formidable counterweight to incumbent managers. Historically, during the second industrial revolution, Germany and the US both used this approach to corporate governance, although its use in the US was much more limited in its scope. In Germany, nationwide universal banks that combined lending, deposit-taking, underwriting and trust account management in a novel way were able to support growing industrial companies. They did so first with credit, financed by deposits, but, later in the companys life cycle, by underwriting stock offerings that were placed in the internal networks of accounts managed by those universal banks. Through their management of trust accounts, universal banks retained authority over stockholders proxies and thus controlled boards of directors of their industrial clients. 166 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Scholars have argued that the relationships between German universal banks and client companies, and the discipline over management provided by bankers, permitted industries to access external finance easily and thus grow rapidly, especially in new product areas that required large minimum efficient scale of operation (such as electricity generation). Although postwar Germany has been known for its reliance on debt as the main source of external finance, that was not true of pre-First World War Germany; in fact, equity finance was much larger a proportion of industrial funding there than in the US prior to the First World War. In the US, banking regulations limited the geographic scope of banks, and therefore also the scale of banks. Those regulations constrained the role of banks in financing industrial growth by large-scale corporations during the second industrial revolution. As the scale and geographic scope of industry increased, industry outgrew banks, and bankers turned mainly to commercial finance. Commercial banks were also constrained from participating in underwriting, not by law prior to 1933, but rather by their small size and regional isolation, which made it hard for them to operate German-style networks for the sale of shares or the aggregation of voting rights. Thus, US-style finance capitalism typified by J.P. Morgans famous network of partners who held seats on various boards of directors was a very limited phenomenon reserved for the largest, established companies, which usually became Morgan companies as the result of consolidations of mature companies, rather than through public underwriting of equity to finance new investments. Morgans role was typically as a reorganiser or a bond, not a stock, underwriter, and its authority came from the network of influential stockholders that relied on its advice and corporate governance skills. Research by Bradford DeLong and others argues that corporate chief executives who wore the Morgan collar wore it proudly and to great effect. They were better able to finance their growth and to weather financial storms than their competitors. Despite its benefits, and even though its role in the economy was quite limited, J.P. Morgans brand of finance capitalism was too much for populist US sentiment against the concentration of power. Successive acts of legislation constrained investment bankers abilities to establish control through networks of skilled partners acting as disciplinarian board directors, and forced the separation of commercial and investment banking. The role of intermediaries in controlling corporate boards took a third form in postwar Japan, as part of the keiretsu system, in which a company surrounds itself with a permanent structure of subsidiaries, banks and suppliers. Main banks of keiretsus controlled blocks of a client companys shares, both directly and through other companies in which they owned interests, and acted as an effective check on managers. By 1990, many US academics were writing paeans to the virtue of Japanese corporate governance, praising the high level of managerial turnover and the fact that bank-sponsored corporate governance helped companies economise on the costs of external finance. Yet the postwar history of Germany and the past decade in Japan suggest that concentrating stockholder influence by means of universal banks and main 167 Unit 6 Corporate Governance and Ethics Global Corporate Strategy bank-controlled keiretsus may also hinder corporate governance. That is especially true when banking systems become non-competitive. The managers of a highly concentrated and non-competitive banking system may collude to feather their own nests at the expense of both the stockholders and the managers of client companies. The role of the Japanese bank system in resisting corporate reform over the past decade is one case. Another is the change in the role of German banks in the postwar era. The largest German banks used their network of trust accounts to engineer mutual control over their own stocks. They control, as a group, more than 50 per cent of any one large banks stock. That lack of competition may help explain why postwar German banks have played such a small role in equity underwriting, or in spurring innovation and new industrial growth, in the postwar era, compared to the role they played prior to the First World War. The history of Japanese and German financial systems suggests that financial system concentration during the later stage of industrialisation may offset the benefits of corporate discipline that result from the concentration of stockholder power in those intermediaries during earlier stages of development. The policy lesson seems to be that vigorous antitrust policy toward the financial sector should be pursued in order to ensure the continuing benefits of good corporate governance that concentration of control through intermediaries permits. To what extent can intermediaries such as pension funds and mutual funds substitute for the Morgan collar, the universal bank or the Japanese main bank? So far, in the US, they have played a limited role. There is some evidence that institutional investor holdings of stock can improve corporate governance, but most commentators view these influences as weak and unreliable. Franklin Edwards and Glenn Hubbard point out that legal impediments limit the amount of institutional ownership in any one company, and legal and regulatory risks to fund managers limit their incentives to own concentrated blocks of shares or to join boards of directors. Further, fund managers incentives to discipline companies may be weak and regulation of their fee structures discourages shareholder activism. In a perfect world, the efforts of fund managers to discipline portfolio companies managers would be rewarded by their account holders. But regulation effectively prevents setting mutual fund and pension fund managers fees to rise with profits. Thus, the fund managers rewards are small and indirect, confined to increased asset inflows into funds in response to corporate profits. Poland is an interesting case of a country that, during privatisation, consciously designed its network of institutional investors to improve corporate governance in newly privatised companies. Authorities there saw the desirability of concentrating some voting power for any portfolio company in the hands of a small number of intermediaries. In 1993, Poland created 15 National Investment Funds (NIFs) to own 60 per cent of the shares in 512 medium- to large-scale enterprises and to help 168 Global Corporate Strategy Unit 6 Corporate Governance and Ethics oversee the restructuring of those enterprises. Each NIF was given a lead role (and a 33 per cent stake) in approximately 30 companies. Shares in NIFs were allocated to the public and traded. Although the privatisation process was bumpy in Poland, as elsewhere, observers tend to regard its successes as partly reflecting the positive role of NIF managers in rationalising the restructuring process. 3. Hostile takeovers A third approach to disciplining directors and managers is the threat of a hostile takeover. In the presence of a credible threat, managers know that if managerial rent seeking gets sufficiently large, it will pay raiders to buy up shares to unseat them. That, in turn, encourages better corporate governance; and there is evidence that the hostile takeovers of the 1980s did, in fact, improve governance in target companies. The social gains from these takeovers were even larger, as many companies were encouraged to avoid takeovers by reducing managerial rent extraction. But recently enacted legal obstacles to takeovers have protected managers and captive boards of directors from that external discipline. Takeovers were never easy, even during the 1980s. Acquirers had long been required by law to announce their intention of purchasing the company through tender offers, thereby reducing the gain to acquirers of improving corporate efficiency, and thus discouraging some efficient takeovers. In the 1980s, in response to many successful takeovers, incumbent managers developed poison pills (corporate charter clauses that dilute the stock of hostile acquirers), which have succeeded in discouraging hostile takeovers. Courts in the US have upheld these techniques, while various states stakeholder statutes have also served to discourage takeovers. In effect, the broadening of corporate goals makes it impossible to hold managers accountable to stockholders, or to any other constituency, for that matter. The alternative means to wrest control from incumbent managers a proxy fight is no more attractive to would-be acquirers, owing to the many obstacles that boards can use to reduce the chance of success. The most popular of these is the staggering of board terms, which often limit the number of board members coming up for re-election at any one time to only a third or a fourth of the board. Would-be acquirers have to be willing to fight many proxy battles over many years before being able to take control of the target. Conclusion It is unrealistic to expect board members to serve the function of disciplining management and protecting shareholders investments when we have designed a system that prevents boards from having the incentive to do so. The central problem limiting the effectiveness of boards, and of corporate governance more generally, is the lack of political will to place the interests of stockholders first when considering the rules under which corporate governance occurs. 169 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Populist revulsion to concentrations of power, and special interest politics, have often resulted in the political decision to hobble the financial system as an instrument for disciplining corporate managers. The first step toward avoiding future Enrons is deciding that the overriding objective of the board is to maximise the value of the company. The second step is to enact laws that hold managers and board members accountable to that objective, and that encourage the concentration of stock in the hands of those who would ensure that the voices of stockholders are heard in the boardroom and, if necessary, in the courtroom. QUESTION: 1. How do you think the Enron scandal (and indeed Worldcom and Parmalat) could have been avoided? CASE STUDY FEEDBACK Feedback on Question: The following measures in the US would have helped avoid such a scandal: 1. 2. Tougher regulations; accounting and auditing practices. Better regulatory framework to police corporate activities and detect fraud early. Enforce personal accountability as a deterrent. Empower intermediaries (e.g. Fund Managers) to probe business operations (requires legislative change particularly in the US), e.g. to stop companies exploiting the Delaware loophole. Ensure that a certain percentage of the Board are independent, non-exec directors who themselves will have personal responsibility (and liabilities). 3. 4. 5. Some of the above measures (and many more) are receiving attention by the Securities and Exchange Commisison, New York Stock Exchange, NASDAQ, Public Company Accounting Oversight Board in the US. Some rules have already been enacted and others are at the proposal/discussion stage. Details may be found in the paper The Post Enron Corporate Governance Environment: Where are We Now? found on: http://www.ffhsj.com/cmemos/031017_post_enron.pdf 170 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Other articles that you will find helpful in this area are: Benston, G.J. and Hartgraves, A.L. (2002) Enron: what happened and what we can learn from it, Journal of Accounting and Public Policy 21, 105-27. Himmelberg, C., Hubbard, R.G. and Love, I. (2002) Investor Protection, Ownership, and the Cost of Capital, World Bank Finance, Development Research Group Working Paper, 2834, April. Edwards, F. and Hubbard, R.G. (2000) The growth of institutional stock ownership: a promise unfulfilled, Journal of Applied Corporate Finance 13, 92-104. Baums, T. and Scott, K. (2002) Taking shareholder protection seriously: corporate governance in the United States and Germany, working paper, Stanford Law School, October. Business Ethics What is Business Ethics? Ethics involves learning what is right or wrong, and then doing the right thing. However the right thing is not straightforward. Most ethical dilemmas in the workplace do not comprise a simple set of issues, decisions and choices. Many ethicists say that there is always a right thing to do based on moral principle and others believe the right thing to do depends on the situation. Ultimately its up to the individual. Many philosophers consider ethics to be the science of conduct. Ethics includes the fundamental ground rules by which people live their lives. Many ethicists consider emerging ethical beliefs to be related to future legal matters, i.e. what is an ethical guideline today is often later translated to a law, regulation or rule. Values that guide how we ought to behave are considered moral values, e.g. respect, honesty, fairness, responsibility, etc. Statements around how these values are applied are sometimes called moral or ethical principles. Business ethics has come to mean various things to various people. Generally, its coming to know what is right or wrong in the workplace, and doing whats right. This is in regard to effects of products/services and in relationships with stakeholders. Business ethics are critical during times of fundamental change. This is because there may be no clear moral compass to guide leaders through 171 Unit 6 Corporate Governance and Ethics Global Corporate Strategy complex dilemmas about what is right or wrong. Attention to ethics in the workplace sensitises leaders and staff to how they should act. Also, ethics help ensure that when leaders and managers are struggling in times of crises and confusion, they retain a strong moral compass. Many people do not take business ethics seriously saying that business ethics only states the obvious (be good, dont lie, etc.). These principles of the obvious disappear during times of stress. Two Broad Areas of Business Ethics The two broad areas of business ethics relate to: 1. 2. Managerial mischief. Moral mazes Madsen and Shafrits, in their book Essentials o f Business Ethics (Penguin Books, 1990) explain that managerial mischief includes illegal, unethical or questionable practices of individual managers or organisations, as well as the causes of such behaviours and remedies to eradicate them. Moral mazes of management refer to the numerous ethical problems that managers must deal with on a daily basis, e.g. potential conflicts of interest, wrongful use of resources, mismanagement of contracts and agreements, etc. Business ethics has come to be considered a management discipline, especially since the birth of the social responsibility movement in the 1960s. In that decade, social awareness movements raised expectations of businesses to use their massive financial and social influence to address social problems such as poverty, crime, environmental protection, equal rights, public health and improving education. An increasing number of people asserted that because businesses were making a profit from using our countrys resources, these businesses owed it to our country to work to improve society. Many researchers, business schools and managers have recognised this broader definition and in their planning and operations have replaced the word stockholder with stakeholder, meaning to include employees, customers, suppliers and the wider community. Organisations have realised that they needed to manage a more positive image to the public and so the recent discipline of public relations was born. Organisations realised they needed to better manage their human resources and so the recent discipline of human resources was born. As commerce became more complicated and dynamic, organisations realised they needed more guidance to ensure their dealings supported the common good and did not harm others and so business ethics was born. 172 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Ethics in the workplace is managed through use of codes of ethics, codes of conduct, roles of ethicists and ethics committees, policies and procedures, procedures to resolve ethical dilemmas, ethics training, etc. Business ethics in the workplace is about prioritising moral values for the workplace and ensuring behaviours are aligned with those values. Many people are used to reading or hearing of the moral benefits of attention to business ethics. However, there are other types of benefits, as well, such as: Attention to business ethics has substantially improved society. Ethics programs help maintain a moral course in turbulent times. productivity. Ethics programs cultivate strong teamwork and Ethics programs support employee growth. Ethics programs help ensure that policies are legal. Ethics programs help avoid criminal acts of omission. Ethics programs help manage values associated with Ethics programs promote a strong public image. Managing ethical values in the workplace legitimises managerial actions, strengthens the coherence and balance of the organisations culture, improves trust in relationships between individuals and groups, supports greater consistency in standards and qualities of products, and cultivates greater sensitivity to the impact of the enterprises values and messages. quality management, strategic planning and diversity. CASE STUDY Business Learns the Value of Good Works Corporate Philanthropy: US Companies Have For Many Years Made A Connection Between Social Responsibility And The Bottom Line. Nokia has: Financial Times; Dec 19, 2000 By Jimmy Burns When Nokia hosted a media lunch in a small London restaurant last week, the aim was not to publicise its latest mobile telephones but gently to draw attention to the time its employees are devoting to schoolchildren in need around the world. 173 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Nokias Make a Connection campaign, launched this year, is about to make its presence felt in some UK schools. The Finnish telecommunications company has entered a global partnership with the International Youth Foundation, to provide teaching packages to children with learning difficulties, and to offer volunteers from its own workforce. The campaign is operating in South Africa, China, Mexico, Brazil and Germany, as well as in the UK. It is tailored to local needs, with social exclusion and education the predominant themes. Projects range from internet-related newspaper schemes among aspiring young journalists in China to mentoring programmes in East Germany. Nokia has not ruled out giving employees time off to participate but it has apparently assured the IYF that hundreds of its employees will use their flexible working arrangements to take part in the scheme. Involvement could range from giving time to organise fundraising events, to having our engineers help set up websites and CD-Roms, says David Stoneham, Nokia UKs senior communications manager. Nokia plans to spend 7.5m on the campaign during the next three years and says it should help up to 1m children and young people. The campaign will not feature the Nokia brand or free mobile phones, the company insists. But it raises questions about whether behind it lies a subtle ploy to use good works to strengthen its market position among the younger generation. Mr Stoneham puts a different business case for Nokias campaign: We hope people will see this as a sincere community issue. Sustainable global success demands respect for our stakeholders our staff, current and potential, want to see good citizenship and our investors and customers want us to behave ethically, he says. The US still leads the way in philanthropy, with foundations holding more than $330bn (224bn) in assets and contributing more than $20bn annually to educational, humanitarian and cultural organisations. Traditionally, Europe has lagged behind the US. This is partly because the state has tended to play a more central role and partly because the act of giving has never been regarded as conferring high status. This may be changing, however, as the European Commission encourages business to form social partnerships and the UK government implements tax changes to increase donations. The notion of corporate citizenship has developed during the past decade in both the US and Europe as more companies address social accountability, social auditing, social investment, corporate governance and business ethics. According to the Institute of Directors, the potential for enhancing corporate reputation and, in turn, business competitiveness is being recognised by some of the largest UK companies. 174 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Such an approach is a far cry from that of the corporate citizens of the late 19th and early 20th centuries, when the personal considerations of the donor, rather than a cost-benefit analysis, were the main impetus for giving. According to Jamie Camplin, author of The Rise of the Rich: Hospitals, libraries and museums were the main objects: all built in a style that re-affirmed the principles of conspicuous waste rather than public benefit. A survey conducted towards the end of last year by Environics International, the Toronto-based consultancy group, in co-operation with the Prince of Wales Business Leaders Forum, highlighted the fact that business is no longer only about personal aggrandisement or simply making profits. It found that six out of 10 consumers form impressions of a company based on broader responsibilities such as labour practices, business ethics, responsibility to society at large and environmental effects. Doug Miller, managing director of Environics, says companies are being forced to market themselves differently in response to changing attitudes and a new aspirational agenda: We are living in a period of great expectations, with people expecting to improve the quality of their lives and believing they can get it all. He says businesses have to be seen to be responding to the agenda set by aid agencies after black eyes over issues such as child labour and environmental disasters. I visit 75 boardrooms a year and I can tell you, the members of the board are living in fear of getting their corporate reputations blown away in two months on the Internet, he says. While Nokia has encountered no negative publicity from its socially responsible efforts, the same cannot be said for Shell, a company that has received more than one black eye from the media. Last October Anita Roddick, founder of the Body Shop, attacked Shells ethical advertising campaign. Ms Roddick publicly denounced the vast gap between the companys humane image and the reality of human rights violations in Nigeria. For Shell, still smarting from the adverse publicity of the 1995 Brent Spar fiasco, the effect of this further blow was to make the company even more determined to project a caring image. In a guide sponsored by the company, Tim Hollins, head of group social investment, wrote: The challenge for the 21st Century Company is to bring all the developments in corporate citizenship together . . . into a coherent framework of practice that makes good business sense as well as benefiting society. In fairness, Shell had committed itself in its Business Principles to sustainable development well before Ms Roddicks outburst. It had reorganised and changed reporting processes in 1997 so that environmental and social achievements sat alongside financial data in the annual report. 175 Unit 6 Corporate Governance and Ethics Global Corporate Strategy The group has chosen to continue its high-profile campaign and to risk attacks by organised pressure groups. Last month, it circulated the latest information about the activities of the Shell Foundation, a UK-registered charity established in June with the aim of supporting efforts worldwide to advance the goal of sustainable development. Yet for aid agencies such as the World Development Movement, much more has to be done before hardened campaigners can be convinced that enlightened self-interest is delivering results in a way that truly benefits society. Barry Coates, director of WDM, feels too many companies fall outside the new ethical agenda and stand to take advantage of unregulated markets. If corporate social responsibility is to prove sustainable in the long term, governments must meet their responsibilities and regulate to provide an ethical framework, he says. Save the Children recently outlined the measures a socially responsible company and its suppliers could take to tackle the issue of child labour, which caused an outcry in the 1990s and dented Nikes reputation. The charity recommends in a new report that social responsibility criteria should be incorporated into management processes and procedures, specifically into job competences and performance assessments. But a study last year of 78 FTSE 350 companies and non-quoted companies of equivalent size, conducted by Arthur Andersen and the London Business School, showed that one in five companies with a code of ethical conduct had not issued the code to all its staff and nearly half had failed to make the code publicly available on request. According to Mr Miller, some companies worry about taking a bigger leadership role than governments in the area of social responsibility: There is a concern that the high-profile philanthropic approach might backfire and that the public might begin to look at business [as if it were] the new feudalism. Nokias discreet lunch last week and its insistence that its marketing of mobile telephones is kept separate from its social work may be a reflection of this. Characteristics of a highly ethical organisation The following points characterise a highly ethical organisation: They are at ease interacting with diverse internal and external stakeholder groups. They are obsessed with fairness. 176 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Responsibility is individual rather than collective, with individuals assuming personal responsibility for actions of the organisation. is a way of operating that members of the organisation highly value. And purpose ties the organisation to its environment. the organisation. They see their activities in terms of purpose. This purpose There is a clear vision and picture of integrity throughout The vision is owned and embodied by top management. The reward system is aligned with the vision of integrity. Policies and practices of the organisation are aligned with the vision; no mixed messages. It is understood that every significant management decision has ethical value dimensions. CASE STUDY Nike and the University of Oregon The next case study is case study 22, (Nike and the University of Oregon) on Pages 933-940 of your key text, De Wit & Meyer. Below is the case synopsis: Case Synopsis Philipp H. Knight founded Nikes predecessor company in 1963. The basic business formula of the company has not changed much since then. Nike is designing and marketing high quality sports shoes and sports apparel around the world. It builds its brand appeal through savvy marketing and sophisticated product R&D. The company has never owned production of the goods it sells, instead from the very beginning has been importing the products from the Asian Far East. In 2000, Nike enjoyed 45% global market share, had close to $9 billion of sales and put Knight among the top ten richest individuals in United States. The company directly employed 20,000 people, but had a workforce of an estimated half a million labouring for them in 565 contract factories in 46 countries making it one of the largest private company de facto employers in the world. Labour conditions in Nikes contract factories were not even close to any labour laws and compensation practices in the industrialised countries, let alone the US. Work there meant 70-hour workweeks performing hazardous and/or monotonous routines under abusive supervision and with appalling equipment. Until the early l990s, Nike never felt that to be its responsibility. 177 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Ever since the early 19th century in England, industrial development started with large scale textile factories. Workers there would stay for two to three years and then either return to the countryside or graduate on to higher value added, more sophisticated factories such as household goods production, followed by machinery assembly and ultimately followed by precision machining for high tech goods. This pattern remained remarkably unchanged over almost two centuries: throughout all times and places of industrial development, textile factories have served the critical function of breaking in the poor, illiterate and non-urbanised farm surplus workers into the industrial age. The alternative would usually be starvation in the countryside. And ever since Charles Dickinson and Emile Zola, this course of events has always attracted the ire of many whose fortune of life it was to grow up in the more economically advanced part of society. Confronted with such a bout of consumer activism supported by American unions in the early '90s, Nike began to take a few halfhearted measures to improve standards at its suppliers. But Nike had already become the lightning rod of a fervent labour practices movement and kept on being pilloried for being an imperialist profiteer. With the campaigns beginning to have an impact on Nike, Nike became one of the founding members of the Apparel Industry Partnership launched by President Clinton, encompassing several textile companies, unions and humanitarian NGOs. In long drawn negotiations the ALP attempted to establish industry-wide accountable minimum standards for supplier factory conditions. Eventually the differences proved too far to bridge between the members. The group split into a Fair Labour Association, carried by the textile companies, espousing a certain set of minimum conditions, and the student-led, union supported Workers Rights Consortium, who wanted measures to be a lot more stringent and better controlled. The key stick that the WRC could wield was to convince universities to purchase their $2.5 billion of sports apparel (2% of the US textile market) for their varsity teams only from WRC approved vendors. If WRC was successful it could harm profits at the textile companies, including Nike quite seriously, because production costs would probably rise significantly. In April 2000, a committee comprised of students, professors and administration of the University of Oregon, voted that UO should join the WRC for one year, under the condition that WRC would give companies a voice in its operations. It had been a very difficult decision for the university, because Phil Knight was alumni of UG and had been a generous benefactor of his alma mater. He had given more than $ 50 million to the school, and was about to donate his largest contribution yet for renovating the football stadium. After the decision of UO, Knight broke off all contact with the university saying the bonds of trust have been shredded. The university had lost a major source of discretionary income! Points to Highlight (extracted from Teaching Note 22, Nike and the University of Oregon, Peer Ederer and Jaco Lok) 178 Global Corporate Strategy Unit 6 Corporate Governance and Ethics The paradox of profitability and responsibility. Nike and University of Oregon is a typical case where stakeholder interests seem insolvably squared off against shareholder interests. The nice thing about the case is that the conflict is suffered by four participants in equal measure: Nike, University of Oregon, the Asian producers and the WRC. Each one of them simply cannot afford to run their business under financial consideration alone anymore, because their respective customers might break business relations with them as a result. At the same time, each one of them has only very limited influence to materially improve the conditions as required by their customers. Somebody needs to start taking responsibility for the non-financial currencies in which companies trade, but who and how? Shareholder value and stakeholder values perspectives. The case gives enough information to illuminate the validity and presence of both perspectives. Note how the perspectives differ, and also how neither perspective will get very far, if it does not seek to accomplish a synthesis. Use of the stakeholder framework to identify strategic problems and possible solutions. Depending on ones own personal bias, reading the case will quickly lead to a judgement on who is right and who is wrong. However, assignment of blame will not solve the strategic problem at hand, which the four main participants have. Employing a stakeholder analysis will yield a map of the conflicting interests, and may eventually also lead to resolution. Questions: 1. Identify the four main protagonists. What are the financial interests of their owners and/or sponsors? Identify the other stakeholder interests involved, including customers, employees, suppliers, governments, competitors and any other stakeholders that you find relevant. What seems to be the core problem behind the fact that 500,000 human individuals are working under such poor conditions, even as their input to the overall value of the final product is only 4%? Wouldnt just a little more to them, say 5% or 6% do tremendous good to them, while being barely noticeable to the final consumer? Did Nike do enough with supporting FLA to solve its stakeholder problems? How much does Nike stand to lose, if the issue enters, say, American presidential elections and trade restrictions are introduced? With 45% global market share, is there an option for Nike to recreate the industry rules for a better deal to all stakeholders? What might that option look like? 2. 3. 4. 5. 179 Unit 6 Corporate Governance and Ethics Global Corporate Strategy CASE STUDY FEEDBACK Feedback on Question 1: Nike. The main interest of Nikes owners is to maximise Nikes financial success in the long run. As margins in the industry are not particularly high (e.g. around 9% on a pair of Nike Air Pegasus shoes) Nike has always relied on outsourced production in Asia where wage rates are low, continuously shifting production locations within the region to the lowest cost countries. Nikes owners did not feel responsible for the work practices adopted by its suppliers, as exemplified by the fact that in 1995 a proposal by shareholder activists to review labour practices by its subcontractors only gathered 3 percent of the shareholder vote. However, since the mid-90s Nike and its owners have been forced to recognise that its responsibilities for the welfare of employees involved in its supply chain extend beyond the boundaries of the firm itself. Nike and its owners have come to see that the continuation of exploitative labour practices in Asia would do severe damage to its reputation and brand and could eventually harm its bottom line (if for example universities would boycott its products). From 1995 onwards, Nike thus became more active in improving labour practices throughout the supply chain, first by hiring independent monitors and ending the use of child labour in Pakistan, and later by raising the minimum age, achieving higher air quality standards, and improving worker safety by substituting harmful chemicals and by training personnel. These efforts were made in the context of Nikes participation in the FLA whose sweatshop-free service mark could help convince Nikes customers that it was indeed a socially responsible manufacturer. Nike and its owners however continued to protect their financial bottom-line by opposing WRCs demands for paying a living wage instead of the legally required minimum wage, and by opposing WRCs monitoring methods, preferring instead to keep the monitoring results behind closed doors. Nikes main owner, Philip H. Knight, did not shy away from using his financial power over the University of Oregon to protect these interests. Fair Labour Association. The Fair Labour Association (FLA) originated out of the Apparel Industry Partnership on Workplace Standards (ALP), which was launched by the Clinton administration in August 1996, and comprised of 18 organisations, including several leading manufacturers, labour unions, several human rights, consumer, and shareholder organisations. ALPs goal was to ensure anti-sweat conditions in the industry through certification of participating manufacturers. However, after agreeing on a Workplace Code 180 Global Corporate Strategy Unit 6 Corporate Governance and Ethics of Conduct in April 1997 progress slowed as disagreement arose over the monitoring process and over workers rights to bargain collectively. A subgroup of nine centrist participants including Nike began meeting separately in an effort to move forward and announced an agreement on a monitoring system in November 1998, which was quickly endorsed by the Clinton Administration. They then formed the FLA to oversee compliance with its Workplace Code of Companies. The FLA was funded by participating companies and by affiliated colleges and universities, who both stood to benefit from participation. Manufacturers could benefit through 3-year FLA certification and institutional buyers, such as universities, could warrant to their students that the apparel and athletic gear they used and sold were manufactured according to fair labour standards. It is clear then that the FLA mainly represented the (financial) interests of manufacturers and colleges and universities, which both had to convince their customers that their products were sweat free. University of Oregon. The University of Oregon was caught in the middle between its activist student and staff body on the one hand and Philip H. Knight as the universitys most important financial benefactor on the other. Knight had already contributed over $50 million to the school and was considering making his biggest donation yet to renovate the football stadium. Financially the University was both dependent on its students as well as its sponsors, and it is not surprising therefore to see that it tried to reach a compromise: it would join WRC for one year, conditional on the consortiums agreement to give companies a voice in its operations. Unfortunately for the University this compromise was not good enough for Knight who spoke of the shredding of the bonds of trust and stopped his donations to the University. The University of Oregon subsequently changed its mind and joined the FLA instead (see What happened after the case?). Workers Rights Consortium. The WRC comprised exclusively of student activists who felt that the FLA did not go far enough. It proposed a more independent monitoring system and demanded that companies pay a living wage, adequate to provide the basic needs of an average family. Students convinced their universities and colleges, who were important sports wear buyers and who were (financially) dependent on their students support, to join the WRC and to fund its operations. WRC did not permit corporations to join and gave human rights organisations and unions an advisory role. This union involvement led Knight to accuse the WRC of supporting the unions hidden political agenda, which was to bring apparel jobs back to the U.S. WRCs interests, according to Knight, thus went beyond the mere improvement of labour practices in Asia. 181 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Feedback on Question 2: Customers. It is clear that many of Nikes customers, especially in the U.S., have grown increasingly concerned about its (ab)use of cheap labour in Asia ever since Nikes methods started attracting a lot of negative publicity in the early nineties. In 1996 bad labour practices was the top third perception of Nike as a company amongst young people aged 13 to 25. Customers do not only expect good value for their money, but also increasingly expect manufacturers to be socially responsible. Yet Nike maintained that its sales were never affected by all the bad publicity. This may be explained by the fact that Nike sells its products globally, and that the percentage share of its customer base that would actually be willing to boycott Nikes products is very low. After all, how many teenagers really would choose to forego on the opportunity to look cool in order to be socially responsible? Furthermore, who is to say that the alternatives are actually manufactured under better conditions? Without information on who is and who is not a socially responsible manufacturer, customers are likely to even the playing field and continue buying Nikes products. In purchasing their goods, Nikes customers are likely to continue to be price as well as trend sensitive, and most of them are unlikely to consider the companys labour practices when making the actual purchasing decision. Only when watching news programs would they feel temporarily uncomfortable. Only the activist student body, which represented a significant, but by no means a dominant share of Nikes total market, was willing and able to pressure Nike by threatening a boycott. To protect this market and to avoid possible repercussions in the rest of its markets, Nike was forced to act, and changed its practices without needing to comply fully with the student activists demands, because they did not represent all of its customers. Nikes own employees. The case does not analyse the situation from the perspective of Nikes own employees in the U.S., but we can imagine that it is not a lot of fun to work for a company that is widely known to exploit labour in developing countries. Imagine the number of times Nike employees will have been forced to justify their companys actions by their friends and families during dinner parties and social events at a time when Nikes exploitative practices were all over the news! Although their own work environment may actually be very satisfactory, we can therefore reasonably assume that it was in the personal interest of many Nike employees to oppose their companys work practices in Asia. Only those who fully believed in minimising the cost price of Nikes products in the face of Nikes aggressive competitors could be expected not to buckle under the social pressures in their private lives. 182 Global Corporate Strategy Unit 6 Corporate Governance and Ethics Subcontractor employees. The case makes it clear that although many of the work conditions in Nikes subcontractor factories were indeed appalling, there was no shortage of applicants for the work, because alternatives would be even worse. In Nikes Vietnamese factories, for example, the average annual income for factory workers was double the national average, despite the wages being the lowest of all countries where Nike manufactured. Most of the young, female workers in the Vietnamese factories considered the jobs to be transitional a way to earn money for a dowry or to experience living in a larger city for two or three years. Although the employees themselves, unlike the WRC, did not perceive of the wages as particularly low and therefore chose to work at Nikes subcontractors, they were often unaware of the health risks they were exposed to. Workers in the chemical sections were thought to have high rates of respiratory illnesses, choosing not to wear their protective gear because it was too hot and humid in the plant. Nike was also caught using child labour in Pakistan and children, of course, can hardly be said to have voluntarily chosen to work at Nikes subcontractors. Given these employee interests it is not surprising that Nike only addressed the latter practices, raising the minimum age and improving safety standards. It did not need to raise its pay levels at its subcontractors, because despite continuing to live in poverty, employees seemed satisfied with their pay as their alternatives were worse. South Korean and Taiwanese suppliers. When Nike moved from one location to another, often its Taiwanese and South Korean factory operators followed, bringing their management expertise with them. Subcontractors, of course, generally had no choice but to follow Nike, because they were highly dependent on Nike financially. Nike used over 500 different suppliers and could easily switch suppliers who were operating in a highly competitive market across the whole of South East Asia. Of course, it was in the Taiwanese and South Korean owners interests to maximise the financial returns from their businesses by deploying low cost, mass production systems using cheap, manual labour. Ensuring consistent, high output quality was of crucial importance in maintaining the supply relationship with Nike. Because of the intense regional competition between different suppliers with low barriers to entry, suppliers could not be expected to improve labour practices on their own accord, if that meant increasing their cost price and thus risking their relationship with Nike. Both local governments and local employees welcomed their presence as an important source of jobs. Asian governments. Nikes shoes and other factories made up 5 percent of Vietnams total exports alone. As such local Asian governments were dependent on Nikes presence in their economy and were well aware of Nikes practice to move to the lowest wage countries if wages became too high. Attracting Foreign Direct 183 Unit 6 Corporate Governance and Ethics Global Corporate Strategy Investment in the labour intensive textile industry is generally seen as one of the first and necessary steps in the economic development of a country, and it can therefore be expected that local governments would not do anything that would make it more difficult for manufacturers to set up shop in their countries. The increase in minimum wages for example, which the WRC desired, could not be expected to be supported by local Asian governments as they risked undermining the base of their efforts to develop their economies by risking to lose not only textile manufacturers but also other industries that relied on cheap labour. Nikes competitors. With a global market share of over 40% Nike justifiably attracted most of the negative attention. This meant that many of its competitors could hide behind Nike and could wait to see whether they could perhaps capitalise on Nikes increased vulnerability. Despite being such a dominant player, Nike could ill afford to raise its cost price unilaterally by paying higher wages, because of the price sensitivity of many of the sportswear customers (brand loyalty can quickly fade when prices are not on par with main competitors). It would, therefore, be difficult for Nike to transfer the increased cost price on to higher store prices, which means the increased wages would have to be paid for by Nikes shareholders. Since most shareholders are interested in maximising the returns on their investments, they are not likely to accept unilateral action by Nike without being convinced that this made sense from a long-term business perspective. This is why it was of crucial importance to Nike that its main competitors would also support the FLA, so that the increased cost of improved labour practices would be shared amongst its main competitors. However, some companies remained opposed to the FLAs proposed monitoring system and did not join (e.g. Warnaco left the FLA, and the AAMA scoffed at the whole idea of monitoring). Feedback on Question 3: The core problem seems to be that the responsibility for improving the plight of the thousands of workers in developing countries can and is constantly being shifted from one party to the next. The customer can relieve him or herself of responsibility by claiming that he/she doesnt have any real choice and that it cant be up to them to know how all the goods that they buy are produced to ensure that their manufacturers are socially responsible. They should be able to rely on the manufacturers and on the government to ensure products are safe and non sweat shop. Furthermore, why should they have to pay more for their product when manufacturers and their retailers make multi-billion profits? These manufacturers, of course, can point to the pressure they are under from shareholders to maximise financial returns, and to their competitors for making it impossible to initiate changes unilaterally in a price sensitive market. They can also shift the responsibility to the local Asian governments, claiming that it is their responsibility to ensure that minimum 184 Global Corporate Strategy Unit 6 Corporate Governance and Ethics wages amount to living wages. These governments, of course, are also in competition with one another, and know that if they were to unilaterally increase their minimum wages this could seriously harm their economy, meaning that their people would be even worse off. Of course, a redistribution of wealth from richer to poorer nations would do billions of people around the world a lot of good, without necessarily affecting the living standards of the richer nations all that much. However, the global capitalist system in which we live does not provide the clear means to make this possible. The ability for constituents to shift the responsibility on to other links in the complex chain makes it very difficult to make even the smallest improvements. Feedback on Question 4: By reversing its hands-off attitude towards labour practices deployed by its subcontractors to a more pro-active stance, actively pushing for better standards in its industry, Nike has come a long way in solving its stakeholder problems. It managed to secure the backing of many of the more centrist participants of the AIL for its FLA proposal, including the U.S. government and many universities. It can effectively use this backing to defend itself against continued criticism from activists who believe Nike is not going far enough. It is also likely that customers, who already did not appear to be overly ready to change their purchasing behaviour, will be more than happy with the government backed FLA seal to quiet their conscience, whether WRC agrees with the FLA label or not. However, the real damage to Nikes reputation was done in the 1990s and cannot be easily reversed. Therefore, for a long time to come, it will therefore always be relatively easy for activists to attack Nike and gain some popular support by triggering the old, well-established image of Nike as the abusive imperialist. Thus, although Nike has probably done enough to appease its most important customer segments, it should not make the mistake of underestimating the influence of a relatively small group of activists again, and should still do as much as possible to prove to them that it is doing everything that can be reasonably expected of them to improve the livelihoods of its workers in developing countries. Nike should also make sure that it continues to receive government backing for its FLA initiatives. If the unions are successful in pressuring the government to make it difficult for companies like Nike to rely on cheap foreign labour through the use of tariffs, then Nike could be severely damaged. In the American market its competitors may well face the same problems as Nike, but globally foreign competitors would continue to use cheap labour and could thus easily out compete Nike. Feedback on Question 5: Being such a dominant player in the industry, one could argue that Nike should have the power to recreate the rules of the industry to improve the plight of all of the stakeholders involved in the supply chain. However, the bottom line is that the lives of Nikes subcontractor employees can only be improved if profits are distributed differently in which case shareholders of either Nike, its 185 Unit 6 Corporate Governance and Ethics Global Corporate Strategy retailers and/or its suppliers pay, or if the customer is willing to pay more for Nike products. Nike could use its marketing muscle and expertise to try to convince customers to pay more for non sweatshop sportswear. However, it is questionable whether the Nike branding people would want to explicitly associate their brand with the way its products are produced. If Nike nevertheless were to succeed in convincing its customers to pay more without harming its cool brand image, major competitors may not try to undercut the new higher prices since they could also stand to gain from charging higher prices. Of course, Nike cant formally agree with its competitors to raise prices because that would amount to illegal price collusion. In fact, depending on the nature and intensity of price competition in the industry, there is no guarantee that competitors will follow suit, and they may instead choose to capture market share by selling socially responsible products at the old prices. In this case, of course, both Nikes communications campaign and higher subcontractor prices would have to be paid for by its shareholders. Therefore, only in the (unfortunately unlikely) case of Nike convincing its customers to pay more for its products and preventing competitors from undercutting these prices at the same time, can the situation potentially be improved for all stakeholders. Unless, of course, shareholders themselves become more actively involved in the way their funds are invested. If pension and insurance holders were to collectively demand their fund trustees to invest in socially responsible companies even if that means lower returns on their investments, then it would also allow companies like Nike to improve their practices without running the risk of financial harm. Of course, no matter how dominant Nike may be in terms of market share in its own industry, it is in no position whatsoever to convince individual investors across the country to demand and pay for more socially responsible investments. Summary In this unit we have considered the importance of corporate governance, and have looked at recent developments in the UK in this area. We have also considered business ethics; particularly relating to managerial mischief and moral mazes. We have seen the importance of prioritising moral values and aligning behaviour with those values. In addition to complying with legal requirements there are business benefits arising from adopting strong business ethics. We have looked at these benefits, and at what characterises a highly ethical organisation. 186 Global Corporate Strategy Unit 6 Corporate Governance and Ethics REVIEW ACTIVITY Consider your own organisation (private or public sector). How do you rate your organisations ethical code of business conduct against the characteristics identified in the section Characteristics of a highly ethical organisation? Also look again at the benefits listed in the section Two broad areas of business ethics. Now consider the following: 1. 2. Does your organisation have a written code of business conduct? Do employees explicitly sign up to the code of business conduct on joining the organisation? Do they annually renew their commitment (by signature) to the code of business conduct, and agree to abide by any changes? Are independent escalation, and complaints and grievances procedures in place? 3. 4. Where your answers have been negative, what changes can be made? Will this require a management culture change? Can it be accomplished within the current organisational structure? Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. Ref 7, Chapter 5 Pages 201-224 Ref 10, Chapter 10 Pages 374-381 187 Unit 7 Managing Complexity LEARNING OUTCOMES Following the completion of this unit you should be able to: Explain the usefulness of systems thinking in managing complexity. Apply the principles of a systems methodology to a given scenario. Assess the validity of the application of chaos theory to organisations. Appreciate the importance of Performance Measurement. Apply a contemporary methodology of strategic control. Introduction With the tremendous change facing organisations and increasing complexity of relationships in an organisation, some companies are beginning to adopt systems thinking in organisational management. It is playing a role in organisational design, diagnosis and problem solving. Systems thinking can help managers look at organisations from a broader perspective and take a holistic view to help interpret patterns and events. It models an organisation as a system; an interdependent network of units forming a unified pattern. Too often in organisations, management break down complexity by decomposing the system and dealing with its individual units separately. Thus, managers have focused on and scrutinised a particular part of the organisation (perhaps a poorly performing unit) before moving on to the next unit and so on. System thinking reminds us that even if units can be perfected by themselves this does not imply that they integrate well together. It encourages managers to diagnose problems by looking at larger patterns of interaction within the organisation, and the process interdependencies. 189 Unit 7 Managing Complexity Global Corporate Strategy In this unit we shall look at the role systems analysis has in managing complexity in organisations. We shall examine the principles of systems thinking, understand the difference between hard and soft methodologies, and focus on a contemporary soft system methodology. Paradox of Control and Chaos Organisations can be seen as essentially logical hierarchical structures that can be controlled by a series of performance measures. De Wit terms it the organisational leadership perspective and can be regarded as the extreme end of a continuum where control is exerted in a systematic fashion. A contemporary example of this is the Balanced Scorecard which is outlined in the latter part of this unit. Alternatively, organisations can be seen as complex human activity systems that exhibit properties of compliance with complexity theory, the ideas of which were born in mathematics and science, and have been applied to organisations. De Wit calls this the organisational dynamics perspective and can be regarded as the opposing end of the control / chaos continuum. The ideas generated by the consideration are central to some of the themes considered in this module. The principles of emergent strategy are to an extent explained by an understanding of chaos and complexity (see Unit 2). In addition, an explanation of how a learning organisation functions (see Unit 8) can be achieved by an understanding of these principles, as well as an experimental view of innovation (see Unit 9). Key opposing perspectives can be explained by the following table; Control Authoritarian Style Top Down Structural Design Leadership, Vision & Skill Controllable Process Organisation follows strategy Chaos Democratic Style Bottom Up Self Organisation Political, Cultural, Learning Team Dynamics Evolutionary Process Strategy follows organisation In both perspectives, organisations need to be controlled therefore chaos does not imply lack of control, rather an organisation is in a constant state of flux. The application of complexity theory to organisations states that simple deterministic rules apply, i.e. there is a clear objective that the organisation (or system) is trying to achieve. 190 Global Corporate Strategy Unit 7 Managing Complexity Understanding these rules enables control and makes the complex simple. It can be said that the dynamic of success is chaotic, i.e. turbulent in nature. If this is true then long term planning is ineffective (see Mintzberg) and managers tend to develop strategies to react to unexpected and unanticipated events. This leads to emergence and organisational learning. Systems Thinking A Brief History Systems thinking is not a new subject area. It can be traced back to Aristotle and Plato. However, the 1940s saw the emergence of various formal systems thinking disciplines such as general systems theory (GST), systems analysis and systems engineering. One of the most prominent early pioneers of GST was Ludwig Von Bertalanffy. He referred to a systems openness, i.e. the degree to which a system interacts with its environment, an open system takes or receives things from its environment and/or provides things into its environment. Therefore, there is clear applicability to business in terms of the recognition of the role of market forces, the supply chain, intervention by government institutions, etc. Systems analysis grew simultaneously with systems engineering throughout the 1950s. Systems analysis as an approach and a methodology is closely associated with the RAND (Research and Development) Corporation. It emerged from a post-war contract between the US Army Air Forces and the Douglas Aircraft Co. The RAND Corporation, established in 1948, was funded by the Ford Foundation and several banks. It began as a non-profit advisory organisation. Over the 1950s and 1960s RAND influenced systems thinking through its publications on strategy and methodology in systems analysis. RAND, in developing its advisory role, expected its clients to take into account the social issues like welfare economics. However, the methodology was criticised due to the lack of interest in people by systems analysts. This may explain some of the reasons why computer systems analysts took little account of the user during their analysis, as the computer analysts adopted the RAND style methodology in ignorance of this original but fundamental omission. The Operational Research and systems ideas of the 1940s and 1950s influenced the way engineers tackled their problems and accordingly there has been increasing reference to systems engineering. Systems 191 Unit 7 Managing Complexity Global Corporate Strategy engineers have been involved in the provision of many civilian applications such as communication, transportation and manufacturing systems. Cybernetics is another discipline that developed about the same time and was defined as the science of control and communication in the animal and the machine. It introduced control systems ideas such as positive and negative feedback. ACTIVITY (optional)) As background to this unit it is suggested that you source the following book Stacey, R.D. (2000) Strategic Management & Organisational Dynamics The Challenge of Complexity (3rd Edition) Published by: Financial Times Prentice Hall (ISBN 0-273-64212-X), and read the following: Chapter 8 - pages 155-166 Chapter 11 - pages 255-273 Application in the Business Context An organisation in itself may be viewed as a system; an interdependent group of units forming a unified pattern to achieve its business goals and objectives. A system has inputs, outputs, processes and outcomes. It can be composed of positive and negative feedback loops. If one of the units of the system is removed or altered the nature of the entire system is changed. This theory can be applied to organisations, and systems thinking is influencing organisational change management. When a complex network of work units is organised to do some activities then the result may not provide entirely what was expected. For example, if a company was benchmarked against its competitors and the best operational divisions in each were identified and combined to make a new organisation, there is no guarantee that it would work any better than the original company. It is quite possible that the new organisation could perform worse. Boundaries and Purpose Systems thinking suggests that a system has a boundary. Defining this boundary in business can be problematic. 192 Global Corporate Strategy Unit 7 Managing Complexity The business modelled as a system is a purposeful system. Purposeful systems include education systems, political systems, transportation system and communication systems, etc. The purpose of an education system may be to provide for the development of the individual, e.g. understanding and analysis of facts, principles and theories or the application of skills. A political system may provide for the management of the affairs and resources of a community (local or national). Clearly an organisation is purposeful with business goals and objectives. But who sets these goals? For whose purpose and why? These are some of the issues addressed by contemporary methodologies when applied to management. In business the system boundary is often blurred. The complexity of relationships (supply chain, customer, stakeholders, competitors) and often multiple roles in relationships add to the blurring. For example, companies may have employees working in Brussels monitoring the European Unions activities. Others may have a good trading partnership with the main companies in their supply chain, or major customers, all of which blur the view of the boundary of an organisation. There may be complexity implicit in investment options. For example, shareholders of a company may invest in their main competitors in order to know what they are doing. Yet this company could be both a competitor and a main supplier or customer. The Purpose of a System and Synergy Systems thinkers take a holistic view of the system in question and try to determine the emergent (the resulting synergy) purpose of the system, postponing an investigation of its sub-systems. Systems thinking addresses some of the problems of functional organisations, and counters the silo phenomenon of departments and managers working in isolation. It encourages managers to diagnose problems by looking at the larger patterns of organisational interaction, rather than examining and fixing separate, individual pieces of the organisation. As an example, it may be that the sales department of a company is not working as well as desired. However, focusing solely on the sales department, tweaking things and introducing novel procedures may not successfully increase its performance. The sales department has vital dependencies and patterns of interaction with other units and with its supply chain. Production may not be able to meet the demand, or warehousing of finished stock may have insufficient space, goods inward may not be able to deal with the deliveries, or suppliers may be inadequate in terms of lead time or quantities. To compound this it is likely to be some combination of these which will emerge over time. 193 Unit 7 Managing Complexity Global Corporate Strategy World Views Systems thinking promotes the expression of different world-views, in order to enrich information in the problem domain. By World View we mean the particular perspective of an individual on the problem. (We shall look at World Views in more detail later in this unit). In the business context, one would identify the different business actors and elicit their views of the system. So for perspectives on the purpose of the organisation itself, the following business actors may view the system from different and sometimes conflicting perspectives. See Table 7.1. Business Actor Manager View(s) Profit-making system Revenue-generation system Growth-potential system ... Customer Supply (products & services) system Value system ... Supplier Employee Shareholder Client system Employment system Profit making system Growth-potential system Share value management system Table 7.1: Business Actors and Worldviews. The above table of world views is very broad-brush and simplistic. In reality, capturing the business actors world view is not as straightforward as it may seem. It is sometimes necessary to adopt formal methodologies (and mapping tools such as UML) to map individual business actor ideas into their perceived real-world. This is an iterative process for complex problems. See Figure 7.1 194 Global Corporate Strategy Unit 7 Managing Complexity Ideas used in METHODOLOGY Perceived real world generates Figure 7.1: Iterative process for world views. The Notion of Hierarchy A system is made up of interacting parts or sub-systems that can be studied as systems themselves. This is called the notion of hierarchy and is an advantage for the analyst because the same system's ideas can be used. Each of these sub-systems will have emergent properties that will define its purpose. If the purposes of any sub-system conflict with the purpose of the overall system then the system displays sub-optimisation or negative synergy. A paradox in systems thinking is that any chosen system cannot be understood without knowing its emergent characteristics and something about the features of its sub-systems. Every problem is different and the same solution cannot always be applied to similar, or even apparently exactly similar, problems. Systems methodologies investigate each problem critically. Implications for Business Sharing views for clarification The future is a mystery. Individual specialisations of marketing, finance, production, etc., give assurance and confidence about a specialist explanation of the world. Yet each is unsatisfactory in isolation. Cross-functional meetings, discussions, debates and dialogues present richer pictures of the problems faced providing a more broad brush solution than would otherwise be obtained. How stable is an organisation? In the context of stability and adaptability, it is necessary to introduce the concept of a homeostatic system. A homeostatic system is one which adapts to produce a state of internal equilibrium so it can continue and progress, i.e. it can adapt in a disturbed environment. An example is a human being who can walk out of centrally-heated buildings into the 195 Unit 7 Managing Complexity Global Corporate Strategy cold of winter and the bodys metabolism can use up existing calories converting fats into sugars in order to keep the temperature at around o 37 C. Do businesses then have to emulate homeostatic systems? In a tactical way an organisation already does so. Once aware of a particular entity in the environment causing turbulence a company finds ways to measure the effects and take action accordingly. The company tends to adapt or influence the causes of the turbulence, if known. Unfortunately, symptoms rather than causes are identified and the wrong things are measured in total ignorance of what should be measured. But, unlike the physical problems such as that bull elephant in the parable, companies are dealing with abstractions, concepts and expectations which cannot be touched and for which there are poor measurements. A homeostatic system reacts to its environment and adapts to survive. This reactive approach is not strategic but tactical; strategic ideas are based on proaction not reaction. Professor Max Boisot, a leading figure in strategic thinking, states that there are two assumptions within strategic planning: 1. 2. Environmental data can be captured and processed, and that action can be taken faster than it changes. Turbulence is only minor fluctuations in an otherwise stable environment which will hold up to rational analysis. That is to say, turbulence is noise or interference, as if somewhere behind such fluctuations is an unchanging order; some universal, objective truth. How stable then is an organisation? If it is a homeostatic system in dynamic equilibrium with its environment then learning and adaptation should occur naturally, and keep the organisation in overall balance. However, this applies, if and only if, the fluctuations are relatively small or short-lived. There is a cybernetics principle called the law of requisite variety which says that rate at which a system learns must match or be better than the rate of change in the systems environment. ACTIVITY Chaos Theory is another discipline that is being used in organisational management. The modern notion of chaos describes irregular and highly complex structures in time and in space that follow deterministic laws and equations. Read the following article about the validity of the application of chaos theory to organisations. 196 Global Corporate Strategy Unit 7 Managing Complexity Strategy as order emerging from chaos, Reading 9.2, p. 500-505 in your key text, De Wit, B & Meyer, R Performance Measures We have noted that if an organisation is a homeostatic system, then it learns and adapts to environmental changes, thereby keeping the overall system in balance. In the context of a business, learning and adaptation will result in adjustments to business outputs such as strategic plans, policies and operational systems. In order to decide on appropriate performance measures, it is crucial to understand the complex relationships of cause and effect, delay, feedback and so on. From this understanding, key performance drivers can be identified and a performance measurement strategy devised. The Balanced Scorecard Approach for measuring performance is particularly pertinent in this context, and will be examined later in this unit in the section on Strategic Control. Corporate planning can also exploit methods such as SWOT analysis to evaluate corporate performance and the contributions of each individual unit against defined objectives such as profitability, market-share, deployment of knowledge assets, etc. Following performance analysis, if problem areas are identified then the principles of systems thinking (e.g. openness, eliciting world views, etc.) can be applied again to the problem domain, and objectives revised, where appropriate. Consolidation of Systems Thinking Early systems thinking did not really address the social issues. Therefore the early methods are not entirely appropriate in a business context. These early approaches paid little regard to human activities and interactions. Their objectives were relatively simple, targeting systems composed of potential technologies, most of which were dedicated to a specific task or set of tasks. Systems with well defined objectives are classed by Checkland as hard systems, whereas those systems whose objectives are difficult to define or whose end-to-be-achieved cannot be taken as given, are referred to as soft systems. Human activity systems are such soft systems. If sub-systems are combined, emergent properties are produced which add or detract value (called sub-optimality in hard systems thinking 197 Unit 7 Managing Complexity Global Corporate Strategy and negative synergy by some soft systems thinkers) from the purpose of the whole. If we wish to reduce sub-optimality, or negative synergy, the sub-systems purposes must in some way be congruent with that of the whole system. In business one fundamental resource, itself a soft system, is a person. Individual views or discipline-oriented views are somewhat blinkered and narrow in scope. The shared view provides a richer picture. If there is dialogue rather than a missive about the systems purpose; if the individuals involved in the dialogue participate in the derivation of the systems purpose, perhaps negative synergy will be reduced, perhaps the emergent properties of the whole will be value added, providing creative advantage or positive synergy. As learning or adaptive systems appear to be of a higher order than others, then the more the people in the organisation continue learning, the more likely the emergent purpose of the business will reflect this. If every employee sees the turbulence in a learned way, the more likely, through dialogue, the company will clarify its position with regard to the turbulence and progress. As mentioned earlier, soft systems thinking focuses on human activity systems. The problem, recognised by Checkland and so many others, is that each person has his/her own world view or weltanschauung of the problem area and that such views must be shared in an open way in order that a deeper understanding of the problem can be realised. Soft Systems Methodology (SSM) SSM has been developed at Lancaster University over the last 25 years, through action research. Professor Peter Checkland is the best known member of the team in the Department of Systems and Information Management involved. As more experience was gained dealing with different sorts of problem situations, the learning was analysed and incorporated into the methodology. This has led to a generic methodology that can be adapted to any given situation. SSM deals with problem formulation at the strategic level. It partly aims to structure previously unstructured situations, rather than to solve well-structured problems. It deals with fuzzy problem situations situations where people are viewed not as passive objects, but as active subjects, where objectives are unclear or where multiple objectives may exist. SSM is concerned with human activity systems (HAS). These are different from natural systems (physical systems), or designed systems (these can be both physical, such as bridges, and abstract, such as mathematical). A HAS is defined as a collection of activities, in which people are purposefully engaged and the relationships between the activities. The boundary around a system is drawn to encompass that 198 Global Corporate Strategy Unit 7 Managing Complexity group of activities that would give the system some emergent properties. SSM does not attempt to analyse sections of the whole that are considered to be particularly relevant to the study, but uses the concept of the whole being more than the sum of its parts. Therefore, once the emergent properties are identified, the set of activities required becomes clear. If just one activity is removed from the system, the emergent properties are lost. The Checkland methodology, or the seven-stage model, is considered by most people to be the SSM. However, SSM covers a range of methodologies developed to deal with different situations. The Checkland Methodology 1 Problem situation unstructured 6 Change and action to improve 2 Problem situation expressed REAL WORLD SYSTEM WORLD 5 Real/systems world comparison 3 Root definition of relevant systems Source: Patching 1990 4 Conceptual models Figure 7.2: The Checkland Methodology. The seven stages are: 1. 2. 3. 4. 5. 6. 7. The problem situation unstructured The problems situation expressed Root definitions of relevant systems Deriving conceptual models Comparing conceptual models with the real world Defining feasible, desirable changes Taking action 199 Unit 7 Managing Complexity Global Corporate Strategy Stages 1,2,5,6 and 7 can be regarded as working in the real world, while stages 3 and 4 can be considered to be systems thinking about the real world. Refer to Figure 7.2. Let us now consider the various stages: Stages One and Two The problem situation can be expressed as a rich picture. The idea is to represent pictorially all the relevant information and relationships. This is simply to aid the modeller or consultant to gain an understanding of the situation. The rich picture should not be used as a tool to communicate with the client. Where there is a team of consultants, the rich picture is a way of consolidating understanding of the problem situation. This reduces the possibility of opposing perceptions of the real world hindering the modelling process later on. The rich picture will reveal one or more HAS. Stage Three Root definitions are constructed for the relevant HAS identified in stages one and two. The root definition should encompass the emergent properties of the system in question. To define the emergent properties one needs to consider the mnemonic CATWOE: C: customer (people affected by the system, beneficiaries or victims); A: actor (people participating in the system); T: transformation (the core of the root definition the transformation carried out by the system); W: Weltanschauung (world view); O: ownership (the person(s) with the authority to decide on the future of the system); E: environment (the wider system). The CATWOE mnemonic can be used as a checklist to ensure that the root definition is complete. Alternatively, the root definition can be formulated from the components of the CATWOE mnemonic. Either way, the root definition will be a short paragraph that will contain all the necessary information to describe the system. Several root definitions can be constructed for each of the relevant HAS identified. Each root definition will encompass a different world view. Different individuals will perceive the same event in different ways according to their view of the world, based on their experiences, personality and situation. These different views result in inferences being made that are 200 Global Corporate Strategy Unit 7 Managing Complexity not explicit. However, these different views from different individuals must be appreciated and incorporated where possible. Stage Four Each root definition will result in a conceptual model. The conceptual model identifies the minimum necessary activities for that HAS. In addition, it represents the relationships between the activities. The conceptual model must be derived from the root definition alone. It is an intellectual model and must not be clouded by knowledge of the real world. All of the elements of the CATWOE mnemonic must be included somewhere in the conceptual model, otherwise the conceptual model is incomplete. It should not be possible to take out words from the root definition without affecting the conceptual model. Stage Five and Six The conceptual model identifies which activities need to be included in that particular HAS. It is not concerned with how these activities will be carried out. The conceptual model will be compared with the real world to highlight possible changes in the real world. It may be that activities in the conceptual model do not exist in the real world. This would then be a recommendation for change. Differences between the two must never result in a change to the conceptual model. The conceptual model, if constructed correctly, encompasses all the activities necessary for the emergent properties of the system. Removal of activities from the conceptual model would result in those emergent properties being lost. Conversely, it may be the case that activities appear in the real world that do not fit into the conceptual model. These activities are either unnecessary, or are included in the conceptual model in a different form. Stage Seven Recommendations for change will be implemented. It is important to appreciate that once these changes have been implemented, the problem situation will be modified. In other words, the process is cyclical. It is recognised that nothing remains static and that mere intervention by the consultant will affect the organisation. ACTIVITY (including case study) Go to the following website and read the report on SSM by a team from the University of Calgary: http://sern.ucalgary.ca/courses/seng/613/F97/grp4/ssmfinal.html 201 Unit 7 Managing Complexity Global Corporate Strategy The article includes details of a case study which Checkland took part in, with the Shell Group. It led to a major rethink of one of Shells Manufacturing functions in the late 1980s. SSM Summary SSM deals with problems of a fuzzy nature where objectives are unclear, and where there may be several different perceptions of the problem. Indeed, SSM can be applied where there is simply an area of concern, where no particular problem has been identified, but where it is felt that some improvement can be achieved. SSM does not aim to solve the problems in one fell swoop but to make incremental improvements. SSM is often used as a front end to a hard methodology. Hard systems assume that the problem can be clearly defined with an agreed goal and that a standard format can be applied to reach a solution. SSM recognises that different individuals will have different perceptions of the situation and different preferable outcomes. Trying to work through these differences from the outset will go some way towards ensuring that the results of the intervention will be acceptable to all parties concerned. Hard methodologies, where the problem is assumed to be clearly defined, and where the individuals who will be affected have no means of involvement in the solution process, often result in resentment and rejection of the solution. Using SSM as a front end provides a means for as many individuals who have an interest in the outcome as possible, to express their perceptions of the area of concern. These concerns can then be accommodated in the definition of the problem area, before a hard methodology is applied. SSM has been used in a variety of organisations ranging from a company dealing with food products to British Airways. It has been used to assist in a range of problem situations, such as deriving recommendations for improvement, reorganisation and role analysis. Given the flexibility of the methodology, it can be seen that the range of situations to which SSM can be applied is vast. The only limitations of SSM are the capability and adaptability to new situations, of the consultant. Strategic Control? Strategic control is the process by which managers monitor the ongoing activities of an organisation and its members to evaluate whether activities are being performed efficiently and effectively, and to take corrective action accordingly. Strategic control is also about keeping employees motivated, focused on the important problems confronting 202 Global Corporate Strategy Unit 7 Managing Complexity an organisation now and in the future, and working together to find solutions to improve the corporations performance over time. ACTIVITY However well managed an organisation may be, for effective strategic control, it is also necessary from time to time to conduct an assessment of an organisations state of health. This is necessary to identify the organisations strengths and weaknesses and uncover information that may be essential for the organisations strategy. Read the following article on the web (by David Hussey, Visiting professor, Nottingham Business School) about an approach to company analysis: http://www.environmental-expert.com/magazine/wiley/1086-1718/pdf5.pdf The Balanced Scorecard Approach Traditionally strategic managers have relied on financial measures of performance such as profit and return on investment to evaluate organisational performance. The balanced scorecard approach recognises that financial information, though important, is not enough by itself. The building blocks of competitive advantage, need to be measured. The building blocks of competitive advantage are: Efficiency. Quality. Innovation. Responsiveness. Measuring the above, informs managers of how the organisation is likely to perform in the future. Whereas a focus purely on financial information, informs managers of the results of decisions that they have already taken. R. S. Kaplan and D. P. Norton were the developers of this approach and they have described it as such: Think of the balanced scorecard as the dials and indicators in an airplane cockpit. For the complex task of navigating and flying an airplane, pilots need detailed information about many aspects of the flight. They need information on fuel, airspeed, altitude, destination and other indicators that 203 Unit 7 Managing Complexity Global Corporate Strategy summarise the current and predicted environment. Reliance on one instrument can be fatal. Similarly, the complexity of managing an organisation today requires that managers be able to view performance in several areas simultaneously. In the context of the balanced scorecard approach, the building blocks of competitive advantage are controlled and measured in this way: 1. Efficiency: how efficiently resources are used. There must be a management control system that allows the measure of productivity. Efficiency is measured by the level of production costs, number, grade and rates of human resources used, number of hours needed to produce a product or deliver service, the cost of raw materials, etc. It compares the units of input (resources, raw materials etc) vs. the units of output (e.g. product, services etc). Quality: Quality is now recognised as a key competitive factor. Managers must be able to measure quality in the form of the number of rejects, errors, software bugs, the number of defective products returned from the customer, product reliability over time and customer satisfaction. Focusing on and measuring quality promotes continuous improvements. Innovation: Innovation can be measured by the number of new products introduced, the time taken to develop the next generation of new products in comparison with the competition, and the expense and cost of product development. Successful innovation occurs when managers create an organisational setting in which employees are empowered to be creative, and in which authority is decentralised to employees so that they feel able to innovate and take risks. Responsiveness to customers: responsiveness can be measured by the number of repeat customers, the level of on-time delivery to customers, and level of customer service. Control systems to allow managers to evaluate how employees interact with customers can help. Monitoring employees performance/behaviour with customers can help identify areas for education and training. Furthermore, employees who know their behaviour is being monitored have more incentive to be helpful and consistent in the way they act towards customers. 2. 3. 4. The above competitive advantage measures, together with financial measures such as cash flow, quarterly sales growth, increase in market share, and return on investment or equity, give a complete picture of organisational performance. Based on the complete set of measures in the balanced scorecard, strategic managers are in a good position to re-evaluate the companys mission and goals. They can also take corrective action or exploit new opportunities by changing the organisations strategy and structure which is the purpose of strategic control. 204 Global Corporate Strategy Unit 7 Managing Complexity Summary In this unit we have looked at the role of systems thinking in managing organisational complexity. We have considered the principles of systems methodologies, and have looked at its applicability in a business context. We have noted the differences between hard and soft methodologies and have examined in detail the Checkland Methodology. Finally we looked at strategic control and examined the importance of performance measurements to judge the health of an organisation, and focused on a contemporary methodology of strategic control, the balanced scorecard method. REVIEW ACTIVITY Now turn your attention to the organisation you work for and focus on its culture. 1. From what you have learned, can systems thinking be applied successfully in your organisation? Elaborate. If your answer to 1 is Yes, 2. - What benefits might you achieve? How will you measure success or failure? If your answer to 1 is No, - Why might it not work? REVIEW ACTIVITY FEEDBACK It all depends on the culture of your organisation. If you have a collaboration culture then the deployment of SSM could be a natural part of organisational management. If your organisation exhibits a Control Culture (stick with the plan!), it is unlikely to succeed. On the other hand, one could argue that attempts at deploying SSM in itself could bring about positive change in control type cultures. Critics of the system's methodologies express concerns that the open-ended nature of the methodology makes it difficult to manage and measure success. 205 Unit 7 Managing Complexity Global Corporate Strategy For example, such a methodology does not lend itself to traditional project management practices. Checkland himself stated that there is no way of telling whether a SSM project is a success or failure. Most companies will not be able to justify costly endeavours where there are no clear success criteria. Another criticism of SSM is that it ignores the issues of power and hierarchy within an organisation. SSM assumes that managers and employees alike can openly discuss and influence organisational issues. This is rarely the case in most organisations. Thus, critics from the business world discard SSM on the basis that its values of openness and equality are unrealistic in the real world, and confine systems thinking to academic analysis. Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. Stacey, R.D. (2000) Strategic Management & Organisational Dynamics The Challenge of Complexity (3rd Edition) Published by: Financial Times Prentice Hall (ISBN 0-273-64212-X), Chapter 8 pages 155-166, Chapter 11 pages 255-273 Patching D. (1990) Practical Soft Systems Analysis -ISBN 0-273-03237-2 Flood R.L. & Carson E.R. (1993) Dealing With Complexity An Introduction to the Theory and Application of Systems Science (ISBN 0-306-44299-X) Flood R.L. & Jackson M.C (1991) Creative Problem Solving Total Systems Intervention (ISBN 0-471-93052-0) 2. 3. 4. * Highly recommended 206 Unit 8 Knowledge Management LEARNING OUTCOMES Following the completion of this unit you should be able to: Compare opposing theoretical concepts regarding knowledge in organisations. Understand the principles of knowledge transfer in organisations. Appraise the methods available to apply knowledge management principles. Introduction The global business environment is changing rapidly. As organisations grow in size, complexity and geographical distribution, intellectual capital is becoming an increasingly important asset of the enterprise. By managing its knowledge assets astutely, and rapidly deploying knowledge gained in one geographical area or one industry across another, corporations can improve their competitiveness, and adaptability. Re-cycling knowledge know-how is now key to competitiveness, particularly in the knowledge economy. In some sectors (e.g. professional services) knowledge management is a matter of survival. In practical terms, the focus on knowledge management can be attributed to two developments. Firstly, capital and labour-intensive industries in developed economies have continued to decline. Secondly, the relative importance of technology and information-intensive industries has increased. Rapid advances in information technology have enabled companies in even the most traditional industries to develop sophisticated systems for capturing new sources of information and disseminating and exploiting this information more effectively. When defining knowledge management, some emphasise the human interaction and psychological factors that impact knowledge sharing, whereas others stress the enabling infrastructure and knowledge management system. A successful deployment of knowledge management must recognise that views of knowledge are 207 Unit 8 Knowledge Management Global Corporate Strategy fundamentally human views. People are different from one another, and exhibit different temperaments. Some of these differences are profound and influence collaboration and knowledge sharing. Building intellectual capital is based on the existence of communication channels between people, on relationships that build trust and a sense of mutual obligation, and on a common language and context. Thus, it is vital that organisations foster a collaborative culture for success. Teamwork over individual excellence should be rewarded. However, it is equally important that a corporation take a strong process perspective in establishing knowledge management, and invest in the appropriate technology to facilitate the process; knowledge creation, collaboration, sharing and deployment. Enabling technology is particularly critical for geographically distributed organisations, where opportunities for face-to-face interaction is limited. In this unit we shall look at some of the theoretical concepts relating to knowledge management, examine the principles of knowledge transfer and then focus on the methods and practical issues relating to knowledge management. ACTIVITY Now, as background to this unit, read the following from your key text, De Wit, B & Meyer, R 1. 2. Reading 9.3, Building learning organisations, p 505-512 Reading 9.4, The knowledge-doing gap, p. 512 525 Theoretical Concepts on Knowledge In theoretical terms, two developments have contributed to an increased emphasis on knowledge in looking at strategic management: The popularity of the resource-based view of the company: This clearly identifies knowledge as potentially the primary source of sustainable competitive advantage. organisations, which have challenged fundamental assumptions about the nature and meaning of knowledge within companies, industries and society as a whole. The development of post-modern perspectives on 208 Global Corporate Strategy Unit 8 Knowledge Management Resource-based view A resource-based perspective highlights the need for a fit between the external market context and its internal capabilities. In accordance with this, a companys competitive advantage derives from its ability to assemble and exploit a combination of resources. Competitive advantage is achieved by developing existing resources and creating new resources in response to changing market conditions. Writers like Robert Grant argue that knowledge represents the most important value-creating asset. The primary function of the company is to create conditions under which many individuals can integrate specialist knowledge in order to produce goods and services. The resource-based view, therefore, suggests that knowledge, like any other asset, can be stored, measured and moved around an organisation. Post-modern view Post-modern perspectives on organisations challenge the resource-based assumption. Writers like Frank Blackler argue that knowledge cannot exist in any absolute or objective sense. The recognition of knowledge and how it is applied is determined by the social and organisation context in which a company operates. An innovative proposal, which may be perfectly valid to an external observer may be rejected by those inside the organisation because it fails to conform to their mental model of what constitutes valid or useful knowledge. If knowledge is a social construct, i.e. it emerges through interaction, it follows that it cannot be formally managed. Like culture, knowledge exists only in an abstract form within organisations. Also, it is affected by managerial action and its nature can change only gradually over time, through a process of interaction between the various individuals within the organisation. There is thus a debate concerning two opposing theoretical perspectives. VIRTUAL CAMPUS Taking into account your own working experience and sphere of activity, do you support the resource-based view or post-modern view? Debate your views (relating it to using your work situation) with others on the Virtual Campus. 209 Unit 8 Knowledge Management Global Corporate Strategy ACTIVITY Here is a quote from Tony Blair from his speech at the Lord Mayors Banquet, Guildhall, London. November 1998. The ambition is to turn Britain into the leading knowledge-based economy in the world. That is our future: a knowledge-based, creative economy. In global markets, where products can be made anywhere and shipped anywhere, in which production technologies can soon be copied, we cannot base our future prosperity on the traditional building blocks of the old industrial economy: raw materials, land, machinery, cheap labour. We must base our competitiveness on distinctive assets which our competitors cannot imitate our know-how, creativity and talent. What do you consider to be the assets of your company? Does intellectual capital (know-how) currently feature as an important asset? Can your working practices and output turnaround be improved by re-cycling of knowledge (or better re-cycling of knowledge)? What opportunities does knowledge management present for your company and what are the barriers to implementation/wider take-up? Knowledge What is knowledge? In the context of strategic management, it is easier to understand knowledge in terms of what it is not. It is not data and it is not information. Data are objective facts. Data becomes information when it is categorised, analysed, interpreted, summarised and placed in context, i.e. given relevance and purpose. Information develops into knowledge when it is used to make comparisons, assess consequences, establish connections and engage in a dialogue. Knowledge can be seen as information combined with experience, judgement, intuition and values. See Figure 8.1 for a pyramid view on data, information and knowledge. Knowledge is at the top of the value chain. Data is at the bottom. Data is essentially meaningless on its own. It is raw data. Reasoning, perception and interpretation are critical in transforming data into information. In addition to reasoning, perception and interpretation, decision making (using experience, judgement, intuition and values) is key to the transformation of information into knowledge. 210 Global Corporate Strategy Unit 8 Knowledge Management Data volumes Reasoning Perception Interpretation Decision making Knowledge Value chain Reasoning Perception Interpretation Information Data Figure 8.1: Pyramid view on knowledge, information and data. One must be careful not to confuse knowledge management systems with data and information management systems. The latter are merely efficient mechanisms for capturing, organising and retrieving information. A true knowledge management system must capture, organise and retrieve information, but also systematically create associations between corporate expertise and information resources, personalise and organise knowledge for individuals and communities, and provide a place (virtual) for teams to work, make decisions and act. KEY POINT Knowledge is the result of deciphering and attaching meaning to facts and information. Knowledge management is the capability of an organisation to create, capture, combine and share knowledge amongst its members. It is the process by which an organisation generates value by using its intellectual assets. 211 Unit 8 Knowledge Management Global Corporate Strategy The nature of knowledge An individuals knowledge base is like an iceberg. Most knowledge is hidden below the surface and can be divided into two types; A limited stock of explicit knowledge, which is easy to articulate to others, e.g. books read, reports written, advice given fall into this category. The majority is tacit knowledge, which cannot be easily articulated to others, e.g. A green fingered gardener cannot explain to a novice precisely why his plants always thrive. Tacit knowledge only transfers through observation and practice. Traditional craft apprenticeships systems recognise this. However, much knowledge remains tacit because no attempt has been made to make it explicit. It is this area that presents the greatest opportunity for knowledge management within organisations. The primary goal of knowledge management systems is to identify the valuable knowledge that resides within individuals and disseminate it throughout the organisation. However, this seemingly straightforward process is in practice complex and can be fraught with difficulties. Knowledge problems Knowledge represents a source of power for an individual. Sharing valuable knowledge with colleagues is often seen as risking reduction of value of that individual to the company. There are, thus, psychological issues relating to knowledge management. Davenport and Prusak argue there are three conditions under which an individual would agree to share knowledge. Reciprocity: Will an individual receive valuable knowledge in return, either now or in the future? source of knowledge will be recognised and others will not claim the credit. self-gratification): Individuals find some subjects fascinating and want to talk to others about them. Repute: An individual will need to be certain that the Altruism (though the motives may be more akin to Davenport and Prusaks analysis leads them to argue that there is in effect, an internal market for knowledge. Knowledge is exchanged between buyers and sellers, with reciprocity, repute and altruism functioning as payment mechanisms. Trust is an essential condition for the smooth functioning of the market. This trust can exist at an 212 Global Corporate Strategy Unit 8 Knowledge Management individual level, through close working relationships between colleagues, or at an organisational level, by the creation of a cultural context which encourages and rewards knowledge sharing and discourages and penalises knowledge hoarding. Noting the above issues, for successful deployment of knowledge management in organisations, the right collaborative culture must be fostered, the individual contributor of intellectual capital recognised, and the reward system must reflect a high focus on knowledge sharing. Leading knowledge-based companies include the contribution of intellectual capital as part of the employees business objectives. Barriers to understanding It is easiest to learn about things that we already know. It is very difficult to learn from an expert if your do not have a basic grounding in the topic. The expert must take time to explain the context and translate the jargon. The barriers to communication in organisations that arise between departments typify this problem. These problems can be ascribed to differences in the content of the knowledge bases. To overcome these problems, particularly in larger global organisations engaged in diverse activities, it is necessary to establish communities of practice based on the core competencies of the organisation. Knowledge Transfer Much can be done within an organisation to encourage knowledge transfer. IT-based frameworks (e.g. Lotus Knowledge Discovery System) provide the essential infrastructure for knowledge management, but to be used effectively and achieve widespread take-up, other conditions are necessary to establish: 1. 2. Trust Face-to-face contact is important when seeking to build strong interpersonal relationships. Time exchanging information at speed may be efficient, but tacit knowledge cannot be discovered, articulated and disseminated in a hurry. Creating a common language for talking about knowledge, encouraging staff to think and talk about what they know and what they need to know 3. The first two points pose particular challenges for large, diverse, globally dispersed organisations. Establishing communities of practice (based on core competencies) is critical. Examples of such communities of practice might be Researchers, Project Managers, Quality Champions, Programmers, Research Chemists, Marketeers in a particular geography, etc. The precise communities of practice would 213 Unit 8 Knowledge Management Global Corporate Strategy depend on the sphere of activity of the corporation. It is then essential that people within communities of practice have the opportunity to meet and share knowledge, supported by the technical infrastructure, but also be able to share knowledge which technology cannot at present capture. Thus knowledge sharing through informal and formal gatherings, seminars, e-learning initiatives, networking and mentoring is critical. In the context of knowledge transfer, it should also be noted that it is not enough simply to manage existing knowledge. Competitive advantage is achieved when organisations adapt and evolve continuously in response to changing market conditions. Knowledge management can play a key role in this. The competitive edge arises when companies leverage knowledge, not just existing, but new knowledge across the global organisation; across horizontal and vertical divides, in a rapid, efficient and easy-to-use, codified form. Re-use of intellectual capital across geographies, industries and functions can yield enormous business benefit. Nonaka and Takeuchi in their book The Kno w led ge Creating Co m p any, identify four interrelated processes by which knowledge flows around the organisation and transmutes into different forms. 1. Socialisation is the process of communicating tacit knowledge to a broader organisational context. Individuals share experiences, demonstrate skills and model behaviour in such a way that they can be observed and copied by others within the organisation. Externalisation is the process of converting tacit knowledge into explicit concepts, e.g. the simplification of complex concepts in a highly simplified form using models. Externalisation may occur at an individual level or at a collective level. Once an individual has externalised tacit knowledge, it is more easily combined with the knowledge of others. Combination is the process of analysing, categorising and integrating the explicit knowledge of a set of individuals in order to create new explicit knowledge, which can be disseminated more widely within the organisation. The above processes explain how individual tacit knowledge flows until it is widely disseminated around the organisation, but it does not fully explain how new knowledge is created. The final link in the process is internalisation, whereby individuals absorb explicit knowledge to enable the development of new forms of tacit knowledge. 2. 3. 4. How can knowledge creation be encouraged? Nonaka and Takeuchi identify five key conditions; Senior management must be committed to accumulating, exploiting and renewing the knowledge base within the 214 Global Corporate Strategy Unit 8 Knowledge Management organisation and be able to create management systems that will facilitate this process. As new ideas first develop at an individual level, an individual must be given scope to follow initiatives and explore unexpected opportunities that emerge. creative chaos where flux and crisis cause reconsideration of established precepts at a fundamental level. Opportunities should actively be provided for even unrelated individuals to exchange knowledge. organisations internal diversity must match the variety and complexity of the external environment. This process of exploration can be further encouraged by Knowledge should not be rationed (or hoarded). In order to respond creatively to changing conditions, an A drawback is that the knowledge creating company Nonaka and Takeuchi describe is often far removed from organisational reality, e.g. chaos and crisis are just as likely to stifle as to promote creativity by provoking anxiety and insecurity. ACTIVITY Identify the types of intellectual capital within your organisation. ACTIVITY FEEDBACK Intellectual capital is essentially any intangible asset that has potential for re-use. The following list gives you an idea of what can be shared. Sales proposals. Market research. Client information. Competitor information. Contracts. 215 Unit 8 Knowledge Management Global Corporate Strategy Case studies. Methodologies. Project plans. Client deliverables (with confidentiality safe-guards). Interpretation methods. White papers. Practical steps to promote Knowledge Management In the previous sections we looked at the key issues relating to knowledge management but from a somewhat theoretical perspective. How do issues of trust, time and common language get addressed? What practical steps can be taken to implement knowledge management and leverage the corporations intellectual capital? It is important to emphasis that knowledge management must be at the heart of a companys strategy if it is to work. A collaboration culture must be promoted from the top of the company. Senior executives should be accountable and rewarded for encouraging knowledge sharing and knowledge enabling. Assessment of current capability Wherever you are in the deployment of knowledge management, it is important at regular intervals to evaluate your knowledge management capability, and benchmark against best practices. The company should then put in place a roadmap to target areas of weakness. A practical tool for such an assessment is to score your capability using a knowledge management spider diagram (see Figure 8.2), with the following dimensions: 1. Company strategy: Score the extent to which knowledge management is incorporated into strategy and business and operational plans. Does knowledge management feature in company-wide strategy or only in specific strategies, e.g. marketing? Is a strategy in place to address knowledge management process, issues of culture and technology? Is there 216 Global Corporate Strategy Unit 8 Knowledge Management knowledge collaboration externally across stakeholders (customers, supply chain) and business partners (e.g. through strategic alliances)? 2. Collaboration culture: Company-wide awareness of knowledge management, and level of integration into the business. Is collaboration, teamwork and knowledge sharing built into the ethos of the company? What is the level of senior management support? Are there senior roles in knowledge management? Knowledge processes: Is there a formal and unambiguous process for the creation/acquisition, organisation/storage, distribution, application, maintenance and QA of knowledge assets? Furthermore, to what extent have knowledge management practices been incorporated into core business processes, e.g. when selecting a project management methodology or developing project plans do Project Managers re-invent the wheel each time, or does the business process require them to check the Knowledge Management System first? Enabling Technology: What are the current technologies used for knowledge sharing? If there is no specialist Knowledge Management System (e.g. Lotus Knowledge Discover System), do you have other enabling technologies such as data-warehousing, business intelligence, data mining, GroupWare and messaging, electronic data management, workflow management, web-based technologies in the company? Do you have a corporate intranet? Knowledge Bases: To what extent have knowledge sources (explicit and tacit) been identified, captured and indexed? Knowledge Access: What level of accessibility is there to the knowledge sources? How easy is to search for information? What access rights and security measures are in place? Knowledge Quality: What Quality Assurance procedure are there in place? Are there reviews and sign-offs prior to intellectual capital being made public on the system? What procedures are in place to maintain up-to-date and relevant knowledge? Is knowledge catalogued by business area, and is there a flag to indicate importance/relevance. 3. 4. 5. 6. 7. You will note that the dimensions of the Web Diagram are the knowledge management success factors we identified during the course of the earlier sections. It is suggested that a company score each of the dimensions against a 10-point scale. This can be done against best industry practices, so that a score of ten relates to best practices. A score of zero will apply if that particular dimension does not feature at all in the corporation. See Figure 8.2 for an example of a knowledge management web diagram for a company. From a strategy perspective it is also useful to score your main competitors on the web diagram and then identify weaknesses/strengths. Additionally strategic partners can be scored. It may be the case that where the corporation scores weakly, a 217 Unit 8 Knowledge Management Global Corporate Strategy strategic partner scores highly. There are, therefore, wider collaboration opportunities across strategic alliances. 10 Company strategy Competitor's KM capability 10 Collaboration culture Knowledge quality 10 0 10 Knowledge processes Knowledge access 10 Corporation's KM capability Knowledge bases Figure 8.2: Knowledge Management Web Diagrams. 10 Enabling technology 10 Road Map for Improvements Having assessed your current knowledge management capabilities, a picture emerges of the gaps in access to knowledge, cultural factors and enabling technology. Based on the gaps identified, particularly in comparison to best practices and also to the competition, the organisation can then develop a picture of where it wants to be, and in what time-scales. A road map should then be prepared to get the organisation to the desired state. The where you want to be state may also be mapped on the web diagram. For those organisations relatively immature in the deployment of knowledge management, the following steps are recommended: Identify communities of practice or teams based on core competencies. For smaller organisations, business units will suffice as communities. and nominate leaders for each community. Identify a sponsor (senior executive) for each community, Train leaders in generic KM practices (e.g. virtual teamworking, knowledge creation, sharing). 218 Global Corporate Strategy Unit 8 Knowledge Management Facilitate socialisation and transitional encounters (meetings, seminars, workshops, etc) with informal agenda to allow tacit knowledge to be shared. skills in specified subject matters. Build, manage and maintain a network of staff with deep Define the KM process (covering knowledge creation/acquisition, organisation/storage, distribution, application, maintenance and QA). Define access (security, rights) model. Evaluate and implement enabling technology. Define categories and populate with generic information, e.g. yellow pages (who is who for what). sharing. Train all staff in KM process, KM system and knowledge Raise team awareness of contexts through presentations, visits, education, etc. Use knowledge proponents/developers (experts who create new content on dedicated, short-term assignments) in early stages of deployment. successes. Promote widespread deployment and publicise early Recognise and reward knowledge contributors. Ref: The Challenge o f Managing Kno w led ge by Laura Em p so n Financial Tim es 4th Octo ber 1999 ACTIVITY Research the application, impact and business benefits of knowledge management by reading some of the articles on knowledge management on the INSEAD website: http://knowledge.insead.fr/ Go to the home page and select Knowldege Management under the menu Themes. (Registration to the website is free of charge). 219 Unit 8 Knowledge Management Global Corporate Strategy CASE STUDY 1 Kao Corporation The next case study is case study 6, (Kao Corporation) on pages 721-737 of your key text, De Wit & Meyer. Case Synopsis Kao is Japans market leader in detergents and shampoos, and runner up in disposable diapers and cosmetics. In 2002 the company had sales of Y865 billion (more than US$ 6.3 billion), largely in Japan and South East Asia. However, during the 1980s and 1990s Kao has acquired a number of companies in the US and Europe and has committed itself to further internationalisation. Its strategic intent is to belong to the three or four global detergent/cosmetics/personal care companies that they believe will eventually survive. Kao is particularly interesting due to its corporate philosophy. The company believes that competitive advantage stems from the superior attainment and usage of information. Therefore information must flow freely throughout the organisation and all individuals must be equipped to continually learn from the information obtained. This concept of a learning organisation is achieved by having a very flat organisational structure, an open, non-hierarchical culture, broad participation in strategy development, extensive information systems and a state of mind that emphasises that learning is an essential never-ending process. The strategy process can be characterised as continual, largely informal, participatory, flexible and incremental. The key question raised by the case is how this strategy process and the companys learning ability can be maintained as they further internationalise. The company will grow in size and complexity, while more nationalities will become involved in strategy development. The company must learn how to remain a learning company. Point to Highlight: (extracted from Teaching Note 6, Kao Corporation, Bob de Wit, Ron Meyer and Henk van den Berg) Note this case touches on subjects wider than just knowledge management, and the learning organisation. It also touches on the area of strategy formation and globalisation (linking with Units 1, 2 and 3). Used in conjunction with chapter 3 of your key text, De Wit and Meyer, this case can be used to understand the following key points: The building of a learning organisation. This case describes the manner in which Kao has been able to transform itself into a learning organisation. The companys structure, culture, leadership and systems are described, giving insight into the circumstances that are necessary to create an organisation 220 Global Corporate Strategy Unit 8 Knowledge Management capable of continual learning. (link to Reading 3.2, Quinn, and Reading 9.3, Senge, of your key text, De Wit and Meyer) The role of leadership in a learning organisation. Of particular interest in the Kao case is the role of the CEO, Dr. Maruta. He does not play the traditional role of master planner and architect of implementation (Commander Approach or Change Approach). On the contrary, he creates the circumstances under which ideas and strategies can arise and grow within the organisation (Crescive Approach). Marutas leadership style demonstrates the influence of leadership on learning. More broadly, the impact of various leadership approaches on the strategy formation process can be explored. (link to Reading 3.2, Quinn, and Reading 9.3, Senge, of your key text, De Wit and Meyer) Learning as part of the strategy formation process. Kaos focus on learning is an integral part of their thinking about how to manage the strategy formation process. This case illudes to the link between learning and strategy formation. Advantages and disadvantages of the incrementalist perspective. Kaos strategy formation approach is strongly inclined towards the incrementalist perspective. This case highlights the strengths and weaknesses of incrementalist approaches to strategy formation. (Link to all readings.) Questions: 1. What is learning and what is a learning organisation according to Kao? How is organisational learning different from, for instance, a person learning from reading a book? How has Kao been able to build a learning organisation? What is their corporate philosophy and what type of structure, culture, systems and leadership roles has the company developed to become a learning organisation? How does Kao go about forming strategy? What are the strategy formation processs main features? What are the advantages and disadvantages of Kaos current strategy formation process? How would Kao need to adapt or change its strategy formation process to accommodate further internationalisation? What type of action would you recommend? (You may also wish to refer to Unit 3, Globalisation, before responding to this question) 2. 3. 4. 5. 221 Unit 8 Knowledge Management Global Corporate Strategy CASE STUDY FEEDBACK Feedback on Question 1: At Kao learning is simply defined as gaining a better understanding of the truth. More specifically, it is believed that organisational learning has the following characteristics: Continual. Learning does not take place at fixed moments, but is viewed as a frame of mind, a daily matter. In this way, every activity can lead to further learning. Collective. Learning is not an activity that an employee carries out individually behind a desk, but a process that takes place through open discussions and the investigation of concrete business ideas. In Kao, everyone within the organisation is expected to participate in this joint learning process, helping not only himself to learn, but also all others, whether above and below him. Intuitive. Learning is also viewed as largely intuitive by doing and discussing, managers often unknowingly internalise knowledge (the Zen Buddhists speak of kangyo ichijo, internalised intuition). This places an important emphasis on the development of tacit knowledge over the attainment of formalised/codified knowledge. Hence, a learning organisation is simply an organisation in which the process of daily, collective and largely intuitive learning is well developed. A person reading an article differs on all three counts. Reading an article is not continual, but incidental learning; it is not collective, but individual learning; and it is not intuitive, but largely formalised learning. In other words, reading an article is a long way off from organisational learning, although it can be an ingredient of the process. Feedback on Question 2: Building a learning organisation is not a matter of changing the organisational structure or tinkering with the incentive system. In isolation these actions will not result in a learning organisation, although they could be elements of a more encompassing effort to build up a companys learning ability. To really become a learning organisation, Kao has taken systematic action on a number of fronts. Mission setting. Most importantly, the company truly believes in the importance of learning. Dr. Maruta, the president of Kao, states that Kao is an educational institution in which everyone is a potential teacher. All employees, including Maruta himself, are seen as students of the truth, continually seeking new insights and better understanding. It is the companys fundamental assumption that such learning, drawn from scarce information, is the ultimate source of 222 Global Corporate Strategy Unit 8 Knowledge Management competitive advantage and therefore needs to be carefully nurtured: The company that develops a monopoly on information, and has the ability to learn from it continuously, is the company that will win, irrespective of its business. Organisational culture. Linked to this underlying philosophy is an organisational culture that reinforces the importance of information, knowledge and its acquisition through learning. To facilitate the daily, organisation-wide, and largely intuitive learning that Kao believes is essential; the companys culture emphasises a number of principles: Equality. Kao rejects authoritarianism, believing that collective learning can only take place in an organisation where people discuss matters on an equal footing. Interaction and the spread of ideas require that opinions are judged on their own merits, independent of rank and therefore the principle of equality is central to Kaos culture. Openness. Joint learning also requires the free flow of information and ideas. Therefore, Kaos culture emphasises that every employee should have full access to all information and that all discussions should be held out in the open, where everyone is free to hear what is said and to participate, if needed. Mutual assistance. Organisational learning also requires individuals and departments to take an active interest in each others problems and development. If each individual or department tries to optimise only its own learning, everyone loses, because there is no cross-fertilisation. Therefore, mutual assistance is stressed as a key principle. Individual initiative. Although the organisation must learn together, ideas are born and knowledge is spread by initiatives taken by individuals. Therefore, the collective nature of organisational learning requires a strong cultural emphasis on the good of individual initiatives. By providing individuals and teams some degree of autonomy, Kao can use the energy of intrapreneurs to stay innovative and competitive. Pro-activeness. Finally, it is a commonly held view within Kao that learning should not be solely based on previous experience. As Maruta puts it, past wisdom must not be a constraint, but something to be challenged. Yesterdays success formula is often todays obsolete dogma. The emphasis is rather on what has been learnt today that can be useful tomorrow (link to the discussion on mental models in chapter 2). In short, the values and beliefs held by managers within Kao regarding learning are very strong and are a main factor in shaping Kao as a learning organisation. However, this culture is further reinforced by other organisational elements. 223 Unit 8 Knowledge Management Global Corporate Strategy Organisational structure. To allow for the equality, openness, mutual assistance, individual initiative and proactiveness mentioned above, Kao has designed a very flat organisational structure, without significant boundaries or titles. There is relatively little hierarchy and not a strict separation of tasks the organisation functions fluidly and flexibly, with various parts interacting and assisting each other where necessary, which Kao refers to as biological self control. Information systems. As horizontally shared information is essential to Kaos organisational learning, the company has placed a strong emphasis on developing information systems so that the most up to date information is available to all members of the organisation. Everyone has access to the Logistics Information System (ordering, inventory, production and sales data) and the Market Intelligence System (market research, sales, and marketing data). Further information exchanges and networking opportunities are created through regular R&D conferences and through the open physical layout of the Kao building. Leadership roles. Finally, the way that top managers define their roles within the company has a significant impact on Kaos learning ability. As Senge (reading 9.3) argues, leaders cannot learn on behalf of their organisations, but must assist their organisations to learn. Senge identifies three critical roles of leadership in a learning organisation, each of which is also applicable to Kao: Leader as designer. Leaders must understand that learning cannot be commanded, but that a social architecture must be created that will support organisational learning. In Kao, the company leaders have designed the needed organisational structure and systems, and have fostered the essential organisational culture. Leader as teacher. Leaders should not be authoritarian experts, but must coach, guide and facilitate everyone in the organisation. In Kao this is exactly the case Dr. Maruta does not push one vision of reality, but aids employees in coming up with their own ideas. Leader as steward. Most fundamentally, leaders should not be motivated by a desire for power, but by their desire to serve other people and the organisation, so that these can function optimally. Here too, it seems that Kao fits the mould. Maruta seems very much a servant leader, who creates trust and commitment by his unselfish desire to serve others and the organisation as a whole. Feedback on Question 3: The remark about Kaos joint venture with Colgate-Palmolive on page 733 really gets to the essence of Kaos strategy process: The way the two firms decided on strategy was totally different. We [Kao] constantly adjust our strategy flexibly. They [Colgate-Palmolive] never start without a concrete and fixed strategy. We could not wait for them. In other words, 224 Global Corporate Strategy Unit 8 Knowledge Management Colgate-Palmolives approach to strategy formation was inspired by the planning perspective, while Kao approach was much more in line with the incrementalist perspective. When examined more closely, Kaos strategy formation process can be seen to have the following characteristics: Creating issue awareness. Within the open and participatory culture of Kao, it is every person's responsibility to identify the critical issues to which the organisation must respond and to bring these issues to the attention (agenda setting) of all relevant colleagues (link to chapter 2). In other words, the definition of threats and opportunities, and the focusing of organisational attention take place continuously, informally, horizontally and intuitively. There are no formalised, periodic procedures using rational analytical techniques to ensure that issue identification takes place, nor is it a task assigned to only a small number of senior managers. Developing ideas and legitimising new viewpoints. Once issues or problems have been identified, clusters of affected or interested individuals form around them (see 9.2, Stacey). Using the energy of intrapreneurs one can develop new and innovative ideas. If groups are formed, these people may meet formally or informally to exchange information and jointly develop ideas on how to proceed. At this stage there will not yet be any fixed proposals, so that discussions can be truly open, without any individual defending a predetermined point of view. Obtaining contributions, consensus, credibility and commitment. As the ideas developing in these small groups become increasingly clear, they are shared more widely. The prevailing principle at Kao is referred to as tataki-dai; present your ideas to others at 80 percent completion so that others can criticise and contribute to them before they become a proposal. Not only does this enhance the quality of the idea, but also it helps to create zoawase a common perspective or view. This is also the point at which higher management levels are involved. They too can contribute to the evolving ideas and by their participation lend weight and credibility to the plans. As consensus emerges in this fashion, all of the participants in this strategy formation process also become increasingly committed to making the strategy a success. Implementation, systematic learning and reformulation. None of Kaos managers believes that the strategy formation process is over once the initial plans have been formulated (option selection). A first set of plans is merely a snapshot in the learning process as an issue grew into an idea, which grew into a proposal, which grew into a plan, so the strategy should continue to grow as the knowledge and wisdom of the organisation continue to expand. Hence, no one expects the plans to be fully implemented as formulated. On the contrary, everyone is focused on obtaining feedback information that can lead 225 Unit 8 Knowledge Management Global Corporate Strategy to learning and can be used to adapt and further develop the strategy. The role of vision. A common vision about the organisations purpose, identity and strategic intent is both the outcome and the guiding principle in the above process. In other words, Kaos vision is not static or top-down, but is developed in the same incremental manner as described above. However, at the same time, Kaos vision is less variable than its strategies and thus acts as a guiding principle in the incremental strategy formation process. The companys vision helps managers to focus on the right issues, and points managers in certain directions where they should seek solutions and new opportunities. In short, the company vision helps to determine the pattern in the stream of organisational actions. These points underscore that incrementalism and learning are two sides of the same coin. When looking at incrementalism, the focus is on the strategy development process how organisations continually and gradually create patterns in their streams of decisions and actions. The two are wrapped up in one another, proceeding in unison. When looking at learning, the focus is on the competence development process how organisations continually and gradually obtain information and increase their knowledge and abilities. Feedback on Question 4: The advantages of Kaos current strategy formation process have become quite clear from the discussion above. Their strategy formation process is flexible, adaptive, and open to learning, which is particularly important in unpredictable environments. High participation and a crescive approach by top management led to more bottom-up information and ideas, the continual improvement of proposals, and broad understanding and commitment throughout the organisation. The case writers are particularly kind toward the company and do not mention any disadvantages encountered by using this approach. However, based on the readings in Chapter 3, of your key text, De Wit and Meyer, the following potential disadvantages can be identified: Disadvantages of finding out". Learning and incrementalism are based on the principle of feedback the results of current activities are used to adapt future activities. Feedback is also referred to as output- or error-driven, because learning is based on past successes and mistakes (we refer to this as finding out). The alternative is feed forward, whereby future activities are based on forecasts and estimates. Feed forward is also referred to as input- or forecast-driven, because estimates are made of what will likely happen (we therefore speak of figuring out). The most common problems of feedback are inefficiency and the danger of irreparable mistakes. Learning by trial and error can often be time- and resource-consuming compared to thinking things through in advance. Furthermore, some errors cannot be repaired. By trying out something in the market a company can damage its name or make investments that cannot be recovered. The main problem of feed forward, on 226 Global Corporate Strategy Unit 8 Knowledge Management the other hand, is that many things cannot be forecast or thought out in advance. Kao seems to be trying to combine both feedback and feed forward to get the best possible results. However, the threat of inefficiency and irreparable damage remains. Threat of strategic drift. Companies that employ an incremental approach to strategy formation run the risk of making adjustments that are not radical enough. Because Kao has a strong bias toward incremental action (get started and learn as you go along), they might find it more difficult to formulate and execute far-reaching plans, such as takeovers, large capital investments or shifts in technologies. The case, however, does not suggest that this is a problem. Threat of slower decision making. Above, it was argued that trial and error learning might be time-consuming. To this it can be added that the participatory decision-making system and need for consensus can also be relatively slow. Especially in circumstances where the speed of decision-making is essential (a crisis or a sudden opportunity), Kao might be at a disadvantage. In general, however, it should be recognised that the length of the decision-making process (time-to-decision) is usually less important than the length of the total decision and implementation process (time-to-results). Slower decision-making might be more than compensated by quicker implementation. Investing time during the decision-making process to produce high quality plans that are widely understood and enjoy broad acceptance often facilitates rapid action, making the total amount of time spent from issue identification, through diagnosis, to conceiving and realising less than in other firms. Threat of political infighting. An inherent threat of flat organisations with widespread participation is (as everyone at a university knows) political infighting (link to 3.3 Allison). The wide variety of opinions and the diffusion of power can easily lead to confrontational political processes, without a clear-cut source of authority to resolve disputes. Kao seems to avoid these problems by a strong, homogeneous, cooperation-oriented corporate culture and a shared strategic intent. Difficult to internationalise. As the company internationalises, keeping up the shared culture and strategic intent will be increasingly difficult. The organisation will be larger, made up of more nationalities and divided by larger physical distances. There will be fewer informal contacts and differences of interests are likely to grow. Openness, trust and commitment will be difficult to maintain under these circumstances. If ideas need to be surfaced and consensus needs to grow between people at scattered locations around the world, the ease of interaction is likely to decrease, while decision-making time is likely to increase. Furthermore, the threat of political infighting is likely to grow as well. 227 Unit 8 Knowledge Management Global Corporate Strategy Difficult to integrate acquisitions. The very particular attitude toward learning and the strategy formation process at Kao makes it very difficult for other organisational cultures to be integrated into the Kao system. At corporations with highly formalised strategic planning systems, companies that are acquired need to adapt themselves to a number of procedures and regulations governing the strategy process. The often-used metaphor is that of a new part that must be slotted into the organisational machinery. At Kao, however, learning and strategy formation have not been formalised into policies and procedures that can be easily transferred to an acquired company. The Kao way of doing things has grown out of a philosophy and is engrained in the beliefs, informal rules and tacit organisational routines prevalent throughout the company. Dr. Marutas own metaphor is that of an organism. Taking this metaphor one step further, it can be questioned whether a foreign body can be made compatible, or will be rejected if implantation is attempted. In other words, how can managers at the acquired firms be integrated into the Kao way of learning and strategy formation if their culture is radically different? The more exceptional Kaos culture, the more difficult it will be to absorb foreign cultures into the organisation (link to 6.3 Haspeslagh and Jemison). Feedback on Question 5: This is a difficult question, particularly as it goes a step further than the literature provided. You may have come up with a broad range of suggestions at this stage, varying from the obvious to the profound. The following are particularly pertinent: A Japanese or transnational company? Kao seems to believe in the transnational corporation judging by its vision that headquarters functions would be dispersed to SE Asia, the US and Europe, leaving the Tokyo headquarters the role of supporting regionally based, locally managed operations by giving strategic assistance. Compared to the current situation this would require a significant amount of decentralisation and growth of an international management cadre. The question is whether this can be achieved without destroying Kaos unique learning capability. As mentioned above, Kaos learning organisation is currently dependent on mutual trust, openness, understanding and involvement. These are maintained by a common culture, interdependence, parallel interests and frequent informal contacts attributes that are more typical of a medium-sized firm, based in one location, with a homogeneous culture. Will a bigger company, with more foreigners, spread all over the world not frustrate the companys ability to learn? Shouldnt Kao remain a Japanese company with foreign interests, with the headquarters in Tokyo remaining as the focus of its learning activities? Should 228 Global Corporate Strategy Unit 8 Knowledge Management Kao develop a diverse group of global managers from a variety of national backgrounds, or rely on a core group of Japanese expatriate managers that relate each foreign operation to Tokyo headquarters? A formal or informal company? Kao must also wonder whether its lack of hierarchy (the paperweight organisation), lack of organisational boundaries (biological self-control) and lack of formalised procedures all remain possible as the organisation grows both in volume and geographically. How can communication be as frequent and as informal as within the Tokyo headquarters? How can control be exerted over subsidiaries far away from the centre? Can this be achieved informally or are systems and procedure necessary to ensure that the foreign subsidiaries remain a part of the larger learning organisation? An acquiring or organically growing company? As mentioned in the answer to question 4, transferring Kaos learning capability to a company that has been acquired is terribly difficult. Yet, both in Europe and in the United States, Kao has staged major acquisitions as an important part of its foreign market entry strategy. The question is whether the benefits of these takeovers (instant market share, existing brand names, local management and market knowledge) really offset the costs (cultural incompatibility, difficulty to share learning, difficulty to transfer learning capability). Shouldnt Kao take the longer and rougher road of organic growth, if this eventually leads to the leveraging of Kaos learning capability? (link to Reading 6.3, Haspeslagh and Jemison) CASE STUDY 2 Developing New Knowledge at Nike Developing New Knowledge at Nike When Phil Knight founded Nike with $500 in 1964, he would have had little credibility if he had defined his purpose as being to build the worlds largest sportswear company. Yet this is what the company had become by the late 1990s. This case examines the foundations of the companys growth, especially the knowledge developed and retained within the company over the years. Early learning years Back in 1958, Phil Knight was a middle distance runner in the University of Oregons track team. He complained on number of occasions to his coach, Bill Bowerman, about the lack of good US running shoes. But he continued to study accountancy, eventually graduating and moving to teaching in his home 229 Unit 8 Knowledge Management Global Corporate Strategy town of Portland, Oregon. Then in 1964, both he and Bowerman each put up $250 to found the Nike shoe company, named after the Greek goddess of victory. To start the company, Knight used his athletics contacts to sell running shoes from a station wagon at track and field events. He bought the shoes from Japan but always felt that there was potential for a US designed shoe. By the early 1970s, Knight was working on his new design ideas. At the same time as exploring these, demand for Nike shoes was sufficient for him to consider developing his own shoe manufacture. However, he was concerned to use Japanese experience of shoe production. In 1972, he placed his first contract in Japan to begin shoe manufacture to a Nike all-American design. Over the next couple of years, the yen moved up against the dollar and Japanese labour costs continued to rise. This made Japanese shoe production more expensive. In addition, Nike itself was gaining more experience of international manufacture and making more contacts with more overseas manufacturers. In order to cut production costs, Nike switched its operations in 1975 from Japan to two newly industrialised nations, Korea and Taiwan, whose wage costs were exceptionally low at that time. Nikes costs came down dramatically, allowing the company more scope for funding further product development and marketing. In sourcing production internationally from low wage countries, Nikes approach to shoe manufacture was revolutionary for its time. The company realised that sports shoe manufacture required substantial labour input, so labour costs were potentially high and justified manufacture in countries where workers were paid much lower wages. However, there were real risks in manufacturing overseas because the greater geographical distance and different national cultures made it more difficult to control production and quality. Thus, the company only switched contracts for large scale production when it could be sure that a new manufacturing contractor was able to meet its quality standards. In this context, the company had to learn how to handle overseas production, how to brief manufacturers on new designs and models, and how to set and maintain quality standards. The decade of difficulty and renewal: The 1980s By the early 1980s, Nike was profitable and continued its role as a specialist US sports shoe manufacturer with no production facilities in its home country. Then along came competition in the form of a new sports shoe manufacturer, Reebok. From a start up company in 1981, Reebok went into battle against Nike under its founder and chief executive, Paul Fireman. Reebok launched a strong and well designed range of sports shoes with great success. By the mid 1980s, Reebok had equalled Nikes annual sales in a fierce competitive battle. In 1987, Reebok was clear market leader with sales of $991 million and a market share of 30%, compared with Nikes sales of $597 million and a share of 18%. Part of the problem and opportunity for both manufacturers was the fickle and design-conscious nature of the target market: young, hip teenagers and adults buy the latest fashions. Both Nike and Reebok realised that, in order to build 230 Global Corporate Strategy Unit 8 Knowledge Management volume, it was necessary to move from the specialist sports shoe market to wider adoption by this much larger, fashion aware teenage and young adult market. This was the battleground that was initially captured by Reebok with good products and a campaign of public relations that was highly disrespectful of Nike. Mr. Fireman criticised Phil Knight as being just a shoe guy who saw himself as a big time presence in sports. In response, Mr. Knight said that he hated his competitor and that the most innovative piece of R&D equipment they have is the copy machine. One author of a book on Nike commented that Paul Fireman was installed as a devil figure inside Nike and he remains a dark presence to this day. To hit back against Reebok, Nike then began to invest considerable sums on developing new and innovative sport shoe designs. The most successful of these was begun in the late 1980s, the Nike Air shoe. It was an intuitively simple technology to understand said John Horan, publisher of Sports Goods Intelligence, a US industry newsletter. Its obvious to consumers that if you put an airbag under the foot, it will cushion it. But it was not until 1990 that the Nike Air shoe was launched and began to deliver success for Nike. Thus the 1980s were both the decade of difficulty and the time for renewal. Nike had learned about the heat of competition and the need for innovation and continual R&D in its shoe designs. The new heights of the 1990s Coupling the new Nike Air shoe with advertising featuring Michael Jordan was a touch of marketing inspiration. The US basketball star, top of his chosen sport, was signed up to promote the new product in a multimillion-dollar deal that added a new dimension to sports sponsorship. The marketing campaign developed links between Nike and Jordans athletic ability and image. Reebok hit back with its own design, the Reebok Pump shoe, but it was forced to use Shaquille ONeal, a major basketball star but second to Michael Jordan. Thus around the turn of the decade, Nikes market share rose from 25% in 1989 to 28% in 1990 while Reeboks share dropped from 24% to 21%. Building on this success, Nike realised that such promotion provided powerful support for the brand. Over the next few years, this was enhanced by the heavy funds Nike was prepared to invest. For example, in 1995 Nike invested almost US$1 billion in sports marketing compared with Reeboks spending at around US$400 million. This investment in sports marketing was much higher than previous sums. It was developed after Nike had assessed the results of its heavy advertising campaigns earlier in the 1990s. 231 Unit 8 Knowledge Management Global Corporate Strategy Nikes sponsorship knowledge Subsequent sports sponsorship deals included the golf star Tiger Woods and, for a previously unheard-of sum, the whole Brazilian football team. By signing a ten-year deal in 1996 worth between US$200 and 400 million, Nike broke new ground in football sponsorship. It bought the television rights for five friendly games each year involving the Brazilian national team. Also, Nikes swoosh logo appeared around the world in many televised golf tournaments, and in the televised final of the 1998 Football World Cup and in the year 2000 Sydney Olympics with Brazilian footballers. But it was not just the amount of money invested in campaigns at Nike. The branding and the message were also important. During the 1980s and 1990s, the company had come to understand its target market well young, cool and competitive teenagers. The swoosh logo was highlighted on all its goods to help brand the product and the main message, just do it, was developed to express the individuality of the target group. The accompanying slogan of winning your own way captured the aggression, competition and individual success epitomised by the sports stars who were signed up. Its products were sold at high prices, e.g. over US$100 for sports shoes. Such prices led to a concerted campaign in the USA aimed at forcing Nike to pay higher wages to workers in the foreign factories of its suppliers. Although the company was sympathetic, Mr. Knight was unwilling to give way. Following its success with the Air shoe, Nike also embarked on a programme of further and extensive product development. In one year alone, some 300 new designs were launched into the US market. The company claimed that such scientific development was a major part of its success: new materials, new fabrics and new designs were developed. But it is also likely that Nike came to realise that its target group craved new products that would appear more innovative than the models of previous years. The implication was that it had to bring out new models even if the innovative content was more a surface design than a substantive change. Nike was not alone in this approach which was typical of many companies bringing out variations on models in order to capture the fashion desires of customers. During the 1990s, the levels of Nike research activity, its marketing support, its clarity in its targeting to teenagers and the breadth of Nikes coverage were all totally new in sports shoe activity. Nikes market share in the USA continued to climb. It reached 43% in 1996, compared with Reeboks 16%. Moreover, Nike had succeeded in growing the US market with sales alone exceeding US$3 billion (compared to US$597 million in 1987). However, Nike was criticised for its use of cheap labour in some countries and was forced to take steps to deal with this. The new millennium: the year 2000 Throughout the 1990s, Nike continued to develop rapidly in two further, related activities. It had been expanding its international sales for some time and these continued to grow rapidly. In addition, it was developing the Nike brand into non-shoe activities such as clothing and sports equipment. By 1996, Nikes total sales were US$9 billion and it was the biggest sports goods 232 Global Corporate Strategy Unit 8 Knowledge Management manufacturer in the world, although the company had suffered a setback as sports shoes gave way to brown shoes as fashion items for teenagers in the late 1990s. In addition, the Asian economic downturn had hit the company hard and there was heavy overstocking of its products in the US retail trade. Profits were well down and painful job cuts were necessary, but the company was still optimistic about the future. Phil Knight had become the chairman and Mr. Tom Clarke had taken over as chief executive. Mr. Clarke was quite clear: You grow a lot, then you need a period when things arent booming to ask what works and what doesnt...... Remember, were a fairly self-critical bunch. Were running the company for the long-term, not to keep people happy for the next couple of quarters. Nike had developed such a deep knowledge of sports items, clothing and branding that it was expecting to weather the storm and remain the largest in the world. Questions: 1. What knowledge has Nike acquired over the years? Use the definitions of knowledge to help you move beyond the obvious. What other resources beyond knowledge does the company possess that offer clear sustainable competitive advantage? From a consideration of this case, what conclusions can you draw on the emergent purpose of Nike in relation to its knowledge? 2. 3. Source Corporate Strategy by Lynch 2nd Edition, p475 478 CASE STUDY FEEDBACK The case traces the companys development from its origins as a small, specialist sports shoe company to the largest sportwear operation in the world. It begins by making the key point that it would have been unrealistic for Nike to have defined its purpose at its inception in 1964 in a way that would have captured its market position in 1999. Feedback on Question 1: Explicit knowledge will include: Shoe and sportswear technical design and performance. 233 Unit 8 Knowledge Management Global Corporate Strategy Shoe and sportswear fashion design and development. Ability to negotiate and place manufacturing contracts with companies outside the USA. Ability to manage such manufacturing contracts in terms of quality of product, control of costs, time to market, stock handling and transport. Marketing and selling to retail stores globally. Ability to negotiate with the representatives of major sports stars. Understanding of the target customer groups and their motives for purchase. Tacit knowledge will include many of the less formal, unrecorded aspects of many of the above areas: Experience of which combinations of technical characteristics will produce technically superior performance, which may be difficult to measure precisely. Contacts with individual fashion designers and other individuals that have been particularly fruitful in terms of creating new market trends. Knowledge of which manufacturing suppliers are particularly reliable and which individual managers within such companies are crucial to product quality and costs. Experience of which countries, workers and governments have proved especially helpful and co-operative in placing manufacturing contracts. Worldwide knowledge of different sports goods retailing, contacts with individual retail shop buyers and knowledge of their methods of operating. Experience of how to handle various sports stars and their agents: this alone must be highly valuable! Knowledge and experience of individual advertising agencies, market research companies and other marketing suppliers. The over-riding point is the interaction of the different forms of knowledge creation and transfer (in accordance with Nonaka & Takeuchi), e.g. the conversion of tacit knowledge (design ideas originating in the first instance from Philip Knight) into explicit knowledge (creation of production drawings). 234 Global Corporate Strategy Unit 8 Knowledge Management In other words, externalisation of ideas onto drawings. Link forward to innovation (Unit 9) where designers are encouraged to work together to be creative (socialisation processes to create more tacit knowledge). Feedback on Question 2: Other resources that are important to Nike include: Its swish logo and brand name. Its contracts with sports stars like the Brazilian football team. Its reputation as a leading supplier of sportswear. Its network of contacts in global sports goods retailing: architecture. Its innovative ability to generate new marketing concepts and drive forward the sports goods business. These all add up to resources that move beyond knowledge, yet provide sustainable competitive advantage. Knowledge is not the only form of advantage. Feedback on Question 3: There are three main conclusions: Purpose develops over time: the opening comments to this case make the point clearly about Nikes purpose in 1964 and 1999. Purpose needs to be seen in the context of the resources of an organisation: Nikes purpose in becoming the leading world sports goods manufacturer only had some meaning when the company already had some record of success in its home country. Purpose may not capture the full potential of an organisation if it is confined to specific and well-defined objectives: it needs to be allowed to emerge over time. If Nike had defined its early purpose in terms of profits and shareholder wealth, it might have restricted its growth to more limited objectives. Summary In this module we have looked at the vital role knowledge management can play in todays knowledge economy. We have noted that in some sectors, re-use of intellectual capital is no longer a case of gaining competitive advantage, but survival. 235 Unit 8 Knowledge Management Global Corporate Strategy We have examined what knowledge is, and have noted the differences between explicit and tacit knowledge. We have looked at the theoretical perspectives, the socialisation and technology issues, and the challenges posed to organisations. We have concluded by considering some practical steps in the implementation of KM. Students are encouraged to apply the lessons learnt to their own work context, and consider how their organisations can better exploit intellectual capital to gain competitive advantage. REVIEW ACTIVITY Consider the following scenario. You have been asked by your companys board to rate your knowledge management capability against your chief competitor and present your proposals for a realistic improvement plan. 1. Carry out a realistic assessment of your knowledge management capabilities. To do this, consult colleagues across different business areas and at different levels in the organisation. Prepare a Knowledge Management web diagram (as per Figure 8.2). Identify the likely position of your main competitor on the web diagram. Now identify areas where significant improvements can be made (within a 6-month period), and how they can be achieved. Identify the business benefits that are likely to arise from the improvement plan. Prepare your presentation (no more than 15 charts). information to their 2. 3. 4. (Students are encouraged to present this manager/colleagues, and elicit their comments.) Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. 3. Ref 10*, Chapter 11 Pages 390-398 Ref 4*, Chapter 9 Pages 196-228 Ref 12, Chapter 8 Pages 141-155, Chapter 9 Pages 167-196, Chapter 10 Pages 197-227 * Highly recommended 236 Unit 9 Innovation LEARNING OUTCOMES Following the completion of this unit you should be able to: Examine how established companies can manage disruptive technologies. Analyse the relationship between innovation and establishing a learning culture. Understand the importance of maintaining strategic flexibility. Introduction The ability to rapidly assimilate powerful new/emerging technologies and processes into products/services is now an important competitive factor in the global environment. However, disruptive technologies pose particular problems and challenges for the established corporations. When faced with disruptive technologies, management teams in blue-chip companies frequently respond by vacillation, and hide behind internal research, extensive pilot studies, lengthy internal assessments and so on. They frequently hire external consultants to give them the answers. They are so geared with managing continuous innovation within established technologies, that they cannot cope with revolutionary, new technologies. Over the last decade, innovation has gathered increasing pace, and significant venture capital has flown into start-ups. In this environment, new technologies are continually emerging; some have powerful business potential and many do not. How can established companies discover powerful disruptive technologies more quickly, and evaluate them more accurately? What are the problems faced by established organisations, and what steps can organisations take to be more responsive to innovative technologies? In this unit we shall look at some of these issues. 237 Unit 9 Innovation Global Corporate Strategy Innovation strategies Disruptive innovations, spawned by developments in emerging technologies, e.g. grid computing, wireless, genomics, nanotechnology, have the potential to consume industries and make existing strategies obsolete. Conventional wisdom says that large established companies are likely to lose out to smaller attackers when they try exploiting these breakthroughs. Why should incumbents (large established companies) encounter so much difficulty? Companies such as GE, Intel and Microsoft have embraced disruptive innovations. What can we learn from them? Established companies control substantial resources: established infrastructure and processes, scale and scope, valuable brand names and entrenched relationships. They can spend heavily on technology development and market research, although most of this money is devoted to evolutionary innovations that make their current offerings perform better in ways their customers already value. For all their advantages, incumbents are often impotent when it comes to disruptive innovations. Their size slows them down and past commitments restrict their flexibility. Equity markets expect continued growth in earnings while start-ups are valued for their prospects and rewarded with large market capitalisation they can use to fund innovation. Incumbents are disadvantaged by their structures, capabilities and outlook. Their finely honed instincts, established ways of thinking and embedded skills make it tough to deal with a disruptive innovation that requires a different approach. Many of these problems are caused by; Technological uncertainties. Ambiguous customer signals. Immature competitive structures of markets for disruptive innovations. ACTIVITY As background to this unit, read about the dimensions and paths of industry development, the drivers and inhibitors of development, and how companies can adopt an industry leadership position. Read p. 421-436 of your key text, De Wit, B & Meyer, R . 238 Global Corporate Strategy Unit 9 Innovation Innovation and established companies Disruptive innovations, posing a threat to their existing capabilities, make established companies prone to stick with what is familiar for too long. Even if this is avoided, incumbents are often unwilling to make a strong commitment to innovative technologies, and find it difficult to persist in the face of uncertainty and adversity. More recently, and particularly in the high-tech world, executives in many established and innovative companies have come to the realisation that you dont have to be an innovator to be innovative. They take the view that the little guys (start-ups) can do all the hard work with someone elses investment (venture capital), and the someone else can also bear the risk of failure (and a large percentage of start-ups are failures). If the start-up shows market potential (and timing is all critical) and their deliverables represent a key source of competitive advantage or threaten your business, then you acquire the start-up or co-opt them. This strategy is one adopted by many large corporations. Despite their large investment in R&D, large companies, including Microsoft, IBM and Cisco, have acquired many start-ups for precisely this reason. Problems for established companies Whether established companies innovate organically or by acquisition or by a combination of both (as is often the case), disruptive technologies pose threats for established companies. A pro-active stance by the management team is required to counter the threats and overcome the particular challenges faced by incumbents. Dangers occur at different points in the decision process and require different remedies. Let us now look at some of the problems: Problem 1: Delay When faced with uncertainty, it is tempting to wait. A watching brief may be assigned to an internal team that monitors families of technologies. Whether there is any value in these moves depends on whether there is anyone who can see beyond the imperfections of the first costly version, e.g. early electronic watches were bulky. It is natural to underestimate developing technologies or new approaches because they dont measure up to the familiar alternative, or appear suitable only for narrow applications. Other developments may be easy to dismiss on the grounds that their small markets will not meet the growth needs of large companies. Yet all large markets were once in an embryonic state with their origins in limited applications. 239 Unit 9 Innovation Global Corporate Strategy Problem 2: Sticking with the familiar Choice of technology is often clouded by uncertainty about whether technical hurdles can be overcome and which standard will prevail. When there are competing choices, companies are likely to base their decision on the technology path that feels most familiar. Established companies typically search in areas close to their current expertise, and may not have the capability to appraise the options properly. Their instincts may be to seek a proprietary position to lock in customers, because that worked in their core market. Such a move makes customers suspicious, especially in an open systems environment. Open systems is increasingly becoming an important factor in many sectors, and particularly in the IT sector. ACTIVITY Microsoft currently dominates the desktop operating systems market. However, more recently there has been a rise in focus on open systems. Customers are demanding plug and play interoperability across different vendor applications, and see open systems as delivering this choice. They view themselves as being locked in by proprietary Microsoft systems/applications. This development has led to the rise of Linux as an open operating system. Linux itself was developed by a Swedish engineer as a hobby project, and was itself a disruptive technology. How is Microsoft responding to the challenge of Linux? Research this area. What options does Microsoft have to safeguard its dominance? ACTIVITY FEEDBACK Broadly, Microsoft has four options: 1. 2. Do nothing. Actively oppose and push proprietary technology as the de facto standard. Embrace and swamp; pay lip service to standards, steer open standards to their own flavour and implement. Genuinely embrace open standards, and get ahead of the competition quickly. 3. 4. 240 Global Corporate Strategy Unit 9 Innovation Problem 3: Reluctance to commit Established companies seldom commit wholeheartedly to a disruptive innovation. Instead, they are more likely to enter in stages. Many reasons explain this; Managers are concerned about changing profitable products or encountering resistance from channel partners. Prospects may appear less attractive than current business, making it difficult to justify investments, e.g. Encyclopaedia Britannica was slow to move to CD-Rom and lost 70 per cent of its revenue between 1990 and 1997. threatening technology, only four entered aggressively and three never participated at all. Managers are focused on existing customers and new technologies may seem applicable only to small market segments they dont serve or understand. This makes them vulnerable to outsiders who use disruptive innovation as their platform. so they cannot balance the demands of familiar markets with the alien requirements of a disruptive innovation. A study showed that, of 27 companies confronted with a Successful organisations are not naturally ambidextrous, These explanations reinforce each other to impair decision-making, erode enthusiasm and cause managers to hesitate. Such issues do not inhibit new entrants. Problem 4: Lack of persistence Established companies being held to earnings forecasts have little patience with adverse results, e.g. when US newspaper giant Knight-Ridders early forays into television in 1978 and cable in 1983 met setbacks, the company sold the business. Success may require patience. However, missed forecasts and dashed hopes are inevitable with disruptive innovation. Demand may not materialise as expected, competitors may crowd into the market or the technology may veer in an unexpected direction. Initial enthusiasm may be replaced with scepticism about the innovation becoming profitable. The result is that companies often withdraw from early probes and dont come back until the innovation is proven by others. At this point it is too late to achieve leadership. 241 Unit 9 Innovation Global Corporate Strategy Problem Avoidance Whilst awareness of the pitfalls described in the previous section can help avoidance, the best defence is a good offence. There are four approaches: Widen peripheral vision. Create a learning culture. Stay flexible strategically. Provide organisational autonomy. The above are ingredients from which an approach can be fashioned. Let us look at each in turn: Widen peripheral vision Disruptive innovations often signal their arrival long before they happen. Some signs may be clear to those who look; others can only be seen by the prepared mind. As the philosopher Kant noted, we can only see what we are prepared to see. Weak signals usually come from the periphery or boundary, where previously unknown competitors are making inroads, unfamiliar customers are early adopters and different standards are emerging. But the periphery is noisy, with numerous related technologies that may or may not be relevant. Background noise to one company may be a strong signal to another. The first step in deciding which signals and trends to scan is to define the significant technologies. This requires shifting the focus from the characteristics of products to features that provide benefits, e.g. customers did not want X-rays as such, but they did need more accurate images of tissues and bones to help spot problems. Companies also can study users who are ahead of the curve to see the promise of a new technology, or work jointly with lead users on the next generation of products. Once features are defined, how well the innovation can deliver features that meet customer needs and budgets, relative to competing technologies must be assessed. The relationship between performance and development expenditure is an S-curve, i.e. initially, there is little sign of progress, but then performance rises steeply for relatively little effort before levelling off. Then, the challenge is to estimate the rate of adoption and potential market size. When it is not yet apparent who customers will be and even early users have yet to experience the product, such estimates are difficult. Traditional market research is seldom applicable to embryonic markets. Sample surveys, etc. are designed for well-defined problems in existing markets. A different approach is needed when the concept is 242 Global Corporate Strategy Unit 9 Innovation ill-formed, the technology is barely ready and questions of cost, availability, and performance are unresolved. Customers may not know whether they want a new product, but they can assess how much more they value its benefits relative to present offerings. Xeroxs strategy for estimating the potential market for fax machines in the 1970s illustrates how customer benefits and functionality can be used to estimate markets. Managers measured the extent and frequency of urgent written messages, their time sensitivity and the form and size of the message. Then they contrasted the promise of fax with mail, telephone, express delivery and so on. With this approach, Xerox foresaw a business market of a million units. Choosing how to assess the market for a disruptive innovation should be guided by three principles. 1. Paint the big picture: This is not the time to ask for carefully calibrated results. The issue is simply whether the market is big enough to support development. Use multiple methods: While any one market research method will be limited or flawed in some respect, a combination may yield conclusions that are directionally sound. Focus on needs not products: prospective customers may not be able to visualise radical products, but they can be eloquent about their problems and changing needs. 2. 3. Build a learning culture The challenge is collective, not just individual. Without learning, noisy information flowing from the periphery will create confusion, not insight. Information must be absorbed, communicated and intensively discussed so its implications are understood. The organisation must possess or acquire several attributes: Openness to diverse views, within and across departments. Willingness to challenge deep-seated assumptions. A climate that encourages experimentation and rewards well-intentioned failure. Entrenched attitudes may impede thinking needed to grasp discontinuities and surprises. Changing is not easy because attitudes are grounded in experience, reinforced by commitments and protected by inertia. Before prevailing thinking can be challenged, it should be described by making the views and assumptions of managers clear. Scenario planning can help challenge deep-rooted mentalities. 243 Unit 9 Innovation Global Corporate Strategy Adapting to the vagaries of disruptive innovations requires experiment and an openness to learning from failures. Sometimes experiment requires a willingness to create diverse solutions, by endorsing parallel development activities, e.g. Shell is developing renewable energy sources. It may also mean introducing prototypes into a market segment. Learning from this quickly is vital, followed by modifying the product, and trying again in a process of successive approximation, e.g. Motorola and the cellular phone market. VIRTUAL CAMPUS 1. If this has not already been done, post on the Virtual Campus a short resume of the type of organisation you work for. Public or private sector? Large, medium or small? Sector (e.g. services, manufacturing)? Once all the resumes have been posted on the Virtual Campus, pair yourself with a partner. Choose a partner who works for an organisation which, you believe, has a very different learning culture from yours. Now describe your organisations learning culture, in the context of innovation, to your partner (in no more than 1000 words max.). Get your partner to identify the strengths and weaknesses of your learning culture in relation to emerging innovative technologies. Learn from each other. Identify what improvements can be made to your own organisations learning culture based on this exercise. 2. 3. 4. 5. Maintain strategic flexibility A paradox of disruptive innovation is that although it is prudent to make limited investments, sometimes a strong commitment leads to success. One way to reduce this dilemma is to increase organisational flexibility, so lowering the cost of making a commitment and the cost of reversing direction. Commitment might seem to be the opposite of flexibility. However, only when the commitment is irreversible, flexibility is destroyed. Microsoft is a prime example of a company maintaining flexibility. In 1988 Apple was at its peak with its superior graphical interface for the Macintosh making Microsofts DOS look a poor second. However, Microsoft was operating on several fronts. On the one hand, it was developing Windows; on another, it was developing OS/2 with IBM. At 244 Global Corporate Strategy Unit 9 Innovation the same time, Microsoft was introducing application software, including Excel and Word, for both Windows and Macintosh. Microsoft had developed a strong hand of cards to play in a variety of worlds that might emerge. In hindsight, its portfolio of options was commensurate with the uncertainties then surrounding hardware and software development. Questions of standards, features, channels and delivery modes (PCs versus servers) were still to be settled. In addition to developing a robust hand, Microsoft developed a culture that could quickly change strategy. Provide organisational autonomy A strategy to avoid the problems faced by large incumbents is to hive off the disruptive business into a separate unit. The more the initiative can operate from a smaller, entrepreneurial mindset, the less it will be held back by the inertia, controls, risk-avoidance and big-company thinking that leads to the pitfalls discussed above. By isolating, the company protects the new venture from these issues. Many large companies set up separate unit dedicated to new ideas, e.g. GMs Saturn division, IBMs PC unit. The objective of separating the new business is to enable the new group to do things differently while still permitting the transfer of resources and ideas from the parent. This also permits separate objectives, recognition of long development cycles and continuing cash drains, as well as different criteria so the performance of managers in the rest of the organisation is not jeopardised. Above all, it creates flexibility. There are many degrees of separation. Some companies take the approach as far as to create spin-offs. These may be complete companies with their own stock, board and management teams, in which the parent retains some ownership. This approach offers access to capital (via a public stock offering), strategic value from the corporate centre, operating independence, development of executive talent in smaller units and greater motivation for key personnel through stock options and operating freedom. For example, Kodaks experience with electronic imaging highlights the strategic importance of separation (in whatever form). Originally, electronic imaging activities were dispersed among Kodaks chemical imaging facilities. This had a number of bad consequences. Managers of the film business continually interfered with electronic imaging projects, which were perceived as threatening the existing customer base. The company policy that all engineers be paid the same meant Kodak could not compete for highly paid electronic engineers. Because digital imaging projects were scattered throughout the company, there was no cohesive vision and limited accountability for performance. 245 Unit 9 Innovation Global Corporate Strategy ACTIVITY Read the following article from your key text, De Wit, B & Meyer, R: Strategy, value innovation and the knowledge economy, Reading 8.4, p.464-473. Conclusion Success or survival in industries that are being created or transformed by disruptive innovations requires support from senior management, separation of the new, flexibility and a willingness to take risks and learn from experiments. There should be a diversity of opinion to challenge dominant attitudes and misleading precedents, so avoiding myopic views of new ventures. The best innovators think broadly and will entertain a wide range of possibilities before they converge on a solution. These prescriptions need considerable tailoring to match each disruptive innovation and the organisation involved. Indeed, the purpose of a template for a high-commitment organisation is to enable it to cope with the tension of uncertainty while achieving commitment to the choices made. The main point is that managing disruptive innovations constitutes a different game for established companies, with its own problems and solutions. Reference Do nt Hesitate to Inno vate by Geo rge Day and Paul Scho em ak er (Financial Tim es Oct 9, 2000) CASE STUDY 1 Oxley: Step by Step into New Market Niches A private British company has been turning military technologies into commercial applications for the last 61 years. By PETER MARSH (Financial Times; Jan 30, 2001) In rural Cumbria, an unusual group of technology specialists is working away in an airy office-cum-laboratory tacked on to a country house. The subjects of their inquiries are rather esoteric, ranging from tiny metal devices with dimensions less than 1mm to new versions of instrument displays for jet fighters. The ten experts are members of a research and development team at Oxley, a private company with a 61-year record in innovation. We use a 246 Global Corporate Strategy Unit 9 Innovation stepping stone approach to new product development, says Geoff Edwards, Oxleys managing director. We keep one foot in the areas we know about and move the other foot so we can gradually explore new ideas. Oxley is not a large company. Last year, sales came to 12m, of which about 700,000 was the profit before tax. But the companys story is relevant to many businesses because of the way it has used technological ingenuity to edge into new areas. It is a potent case study of how military technologies can be used in civil applications. This process starts with the ten experts, identified by Mr Edwards, a physicist who started at Oxley 32 years ago. We deliberately keep our researchers close to each other so they are chatting all the time, he says. From this interaction we get a marvellous source of new ideas. The disciplines covered by the group include materials science, electronics design, chemistry, manufacturing and test engineering, optics and software. Oxley employs just 240 staff, of which 50 are engaged in R&D. An example of how internal discussions lead to profitable business opportunities is Oxleys use of its knowledge of capacitor technology used in military radar and telecommunications systems to produce capacitor-based data storage devices or smart tags. These tags were first sold to the British Army, which attached them to Iraqi prisoners captured during the 1990-91 Middle East conflict. The tags were encoded with information about the prisoners identities and intelligence data. Oxley has adapted the devices for use on cows to inform the farmer, for instance, about health problems and milking record. Similar lateral thinking helped Oxley to turn capacitor-based devices made from tiny pieces of ceramic into sensors used by UK pollution inspectors to monitor water quality. At the core of Oxleys methods is its long involvement with the Ministry of Defence and large military contractors. Defence-related work accounts for 70% of sales. About a third of the companys revenue comes from outside the UK. The company was founded in 1939, just before the 2nd World War, when Freddie Oxley, an entrepreneurial engineer, hit on a way of making capacitors to be used in early radar work. To escape the attentions of German bombers, the company moved in 1942 from London to its current location in Ulverston, on the fringe of the Lake District. Mr Oxley ran the company until his death in 1988, when he held 145 patents in a range of scientific fields. His wife, Ann, chairs the company. She has 90% of the shares, with other staff members holding the remainder. Mrs Oxley refuses to consider giving up private ownership. We run this company like an extended family, she says. Oxleys products are developed rather haphazardly, with little long-term planning. But most start with military contracts. The company has several profitable product groups in this field. Mr Edwards calls them the companys eagles. Commanding high margins, they provide the cash to finance new developments. Examples include sensitive optical filters for adding to the instruments and identification lights of aircraft such as the Tornado fighter. The filters are made of glass, coated with chemicals that screen out infrared radiation. They enable pilots to use infrared night goggles without being blinded by their own aircrafts lighting. Other eagles include 247 Unit 9 Innovation Global Corporate Strategy specialist connectors such as the ones Oxley sells to the mobile telephone industry, based on principles developed for military radio applications in the early 1970s. Oxley makes millions of tiny gold-plated spheres each 1mm in diameter that fit into telecoms base stations sold by Ericsson and Motorola, the two biggest forces in the mobile phone industry. The spheres are part of miniature ball-and-socket connectors. With the ball snapping in and out of the socket at high speed, the system forms part of a switch (selling for 10p) that checks whether telecoms equipment is operating at the correct wavelength. We are the only company in the world that can make the (ball and socket) devices to this kind of precision, Mr Edwards says. Oxley also produces electromagnetic screening systems for military radios. They prevent damage to the equipment from lightning strikes or radiation from a nuclear bomb. In the next few years, the company intends to keep its military focus. As the defence industry consolidates around bigger companies, Mrs Oxley says, small, specialist companies will find a niche. We think we can continue to run between the legs of the elephants, she says. But the company is also keen to keep edging into other markets, perhaps with the help of partners with specific knowledge of new business fields. In the next five years, Mr Edwards would like the companys sales to double. We have no choice, he says. Having this kind of growth target is essential if we want to keep the company sharp and interested in new ideas. Questions: 1. Strategically, how would you categorise the stepping stone approach to product development? Link this case to other key areas studied in this module. 2. CASE STUDY FEEDBACK Feedback to Question 1 Link back to the discussion in Unit 1 about strategic fit and stretch. The stepping stone approach could be seen as stretching from military (although this is the clear focus with 70% turnover) to commercial. Exploitation of core competence (link to Unit 2) and knowledge (link to Unit 8). 248 Global Corporate Strategy Unit 9 Innovation Creation of tacit knowledge from previously created tacit and explicit knowledge. Feedback to Question 2 Core competence protection of innovative technology via patents; the company has 145 is this a lot? yes as this is a significant financial investment over the years and has a high value to the company. Emergent strategy commonplace for innovative organisations (link to the experimentation of emergent strategy) products are developed haphazardly..... Value Management Boston Consulting Group Matrix use of eagles (cash cows) to fund future innovation. Niche markets (specialist company link to reading for this session and forward link to Unit 10 the role of specialists such as IT). Strategic Alliances links to partners in specific fields to create knowledge management and transfer and technology transfer. Knowledge management as above but the company makes use of its knowledge VIRTUAL CAMPUS Further points to note, from the Oxley case study, include: The importance of keeping researchers chatting together to faciliate tacit knowledge through socialisation. The significant proportion of staff engaged in innovation; 50 of 240 staff. Now discuss with your colleagues (on the virtual campus) innovation in respect of : 1. 2. the size of the company the family owned nature 249 Unit 9 Innovation Global Corporate Strategy Post, on the Virtual Campus, what you can glean from the case study about the above two points. Share your views. Then challenge, extend, discuss. Students are advised to complete the next case study (Telepizza, where control of business innovation has been removed by being publicly owned) before undertaking this activity. The Telepizza case study has a bearing on point 2 for discussion. CASE STUDY 2 Telepizza Telepizza is a young Spanish company that combines entrepreneurial flair with real growth. This case study explores how the company has grown and raises the question of what organisational structures are likely to be required over the next few years Telepizza realised before its competitors that Spain was changing rapidly. Gone were the days of siestas and elaborate family meals. Fast food was what Spaniards wanted and needed. The company was founded in 1988 as a single pizza parlour offering home deliveries in its immediate north Madrid neighbourhood. By late 1995, it had nearly 200 centres spread out across 120 Spanish towns and cities. By the end of 1995, Telepizza expected to post consolidated profits of more than Pta 800 million (US$6 million), more than double the Pta 375 million reported in the previous year. It was forecasting sales of Pta 19 billion for 1995, up from 1994s Pta 12.3 billion. The market was zero when we started, says Mr Jose Maria Serrano, Telepizzas communications chief, but there was a terrific opportunity. Mr Leopoldo Fernandez Pujals, the companys founder, spotted the gap in the market. He owns 40% of Telepizzas shareholder capital and was its chairman until a boardroom coup in mid-1995. Mr Fernandez Pujals was formerly an executive with the healthcare multinational Johnson & Johnson. He knows a lot about marketing and consumer fads and nothing at all about fast food, but he knew what the Spanish public was prepared to buy. When he came across pizza home deliveries during a stay in the USA, he had found the product he was looking for. Market success By 1995, Telepizza had a 54% share of the pizza home deliveries market in Spain. Its success is as much the triumph of a concept as it is of a product. The companys management understood that Spain had undergone a profound sociological change that had brought young mothers out of the kitchen and into the workplace. Furthermore, office workers, like everywhere else, had begun to eat at their desks. Home deliveries, as opposed to office deliveries, make up the bulk of Telepizzas business. They are ordered both by children battling with their 250 Global Corporate Strategy Unit 9 Innovation homework while their parents are still at their jobs or by exhausted parents staggering home late because office hours in Spain can stretch into the night. Telepizza also understands that although Spaniards have belatedly come round to the concept of fast food, the domestic culture remains imbued with the tradition of good home-made cooking. This means that the company has to take special care over the quality of its product fresh ingredients are delivered daily and over the amount of choice it offers its customers. Having pioneered pizza home deliveries, Telepizza has stayed ahead of its competitors by introducing the do-it-yourself pizza: clients can summon up literally thousands of permutations of the products 15 basic ingredients. Its most recent success was the Tex-Mex pizza called the Jalisco, dreamt up by its consumer research department. Corporate culture The corporate culture and growth strategy are no less important. Telepizza believes in decentralisation and cutting out bureaucracy. This ethos has set the tone of its staff relations and franchising. Telepizza has succeeded in creating a corporate culture and with it an expansion strategy that has multiplied its rewards. Employees who deliver pizzas by motorcycle within half an hour of receiving the order are, in the companys parlance, autonomous business people responsible for their own slice of the pizza market. These employees are allotted a specific area. It is up to them to develop a relationship with their clients. Spurred on by sales incentives and bonus packages, Telepizzas representatives will spend nearly as much time promoting the company in their allotted area as they do delivering its products to customers. Although numbers vary per outlet, there are approximately ten people, including five sales representatives, employed in each pizza parlour. About half the 195 Telepizza centres in Spain are franchises. The company believes that this mix is the right one and that as it expands further franchises will, for the time being, be the property of the existing 50 or so franchise owners. For a franchise system to work, you have to love the company and what it produces, says Mr Serrano. These are exactly the sort of people that we have got now and we want them to grow with us. Investment policy Telepizza has pursued a strong investment policy, ploughing Pta 1.3 billion into new centres and equipment in 1994. It invested a further Pta 1.5 billion in 1995. One reason for the boardroom revolt that forced Mr Fernandez Pujals resignation in October 1995 was that other shareholders were clamouring for dividends and objected to the drive for expansion that he was masterminding. Firmly established in Spain, Telepizza has also tested foreign waters, again through a mixture of directly owned outlets and franchises, and has set up around 50 centres abroad. It is operating in Poland, Portugal, Greece and Belgium as well as in Mexico, Chile and Colombia. The focus is on Spain, however, and its home market is far from saturated. Source: Corporate Strategy by Lynch (Financial Times, 16 November 1995) 251 Unit 9 Innovation Global Corporate Strategy Questions: 1 To what extent does Telepizzas structure need to remain loose in order to encourage the dynamic entrepreneurial spirit that has characterised its growth? What are the problems with this approach? Is it inevitable that the company will begin to lose its entrepreneurial flair as it grows larger? How is it proposing to hold on to this approach? What is your view of the companys international growth strategy sensible expansion or a waste of scarce management resources, given the continued expansion possibilities in Spain and the resource difficulties of supervising foreign operations? 2 3 CASE STUDY FEEDBACK Feedback to Question 1 It is desirable that the organisation remains loose as long as possible in order to continue to build growth. The problems with such an approach are: The company may experience poor profit and cash control because the systems are weak. The quality of the product which is so important to its success, according to the case, may suffer if central monitoring is ignored. There might be a temptation for individual outlets to sacrifice quality for quantity and the centre would never know. Entrepreneurs might compete with each other inside a restaurant outlet on price or service, which may not be advantageous for the company. Feedback to Question 2 The evidence of Greiner in Chapter 7 would suggest that it is likely that it will become more bureaucratic: age and size will probably make the company less dynamic. Hence, as the enterprise grows, there may be a need to define more precisely the geographical territories or face the possibility that restaurants will compete against each other. This will limit the loose nature of the structure. The company is attempting to hold its growth by restricting franchises to existing holders and by funding much of its growth internally. It wanted to 252 Global Corporate Strategy Unit 9 Innovation retain the loyalty of its existing people. However, it is highly likely that some of the initial zip will go out of the company. Feedback to Question 3 Although full details are not given in the case, it is likely that significant resources are devoted to the international growth in the 50 centres operating abroad. There will inevitably come a time when further growth in Spain will be difficult: international opportunities will then maintain the momentum of the group. Moreover, international growth would be one way of offering an incentive to those individual managers unable to find new outlets in Spain. However, there is no evidence that growth has disappeared in Spain. Given its strengths in the home market, it is surprising that so much effort seems to have been devoted to international expansion with all its associated costs and pressures. Given that international expansion has now taken place, one way forward is to find a balance between the home market expansion and foreign growth. At the time of the case, it would appear that international growth should take second place to completing national expansion in Spain. However, this does not mean that international growth should stop, rather that a judgement is required on the pace of such expansion. Case note what happended later The founder, Mr Leopoldo Fernandez Pujals, reduced his shareholding from 40% to 22 % in June 1996. The well-known large Spanish bank, Banco Bilbao Vizcaya (BBV), bought 18 % of the company. This move was a prelude to the company seeking a listing on the stock market for its shares through a public offer of 40 % of its shares in September 1996: BBV was acting as co-ordinator of the share issue, with Merrill Lynch responsible for a placing of part of the shares internationally. The company was beginning to mature: the founder was selling part of his initial interest and the shareholding was becoming more widely available and institutionalised. Summary In this unit we have looked at the challenges posed by disruptive technologies, particularly on established companies. We have examined how some of the problems can be managed, and have noted the importance of cultivating a learning culture, and the importance of organisations adopting strategic flexibility. 253 Unit 9 Innovation Global Corporate Strategy To gain maximum benefit from this unit, students are encouraged to assess their own organisations approach to disruptive technologies, and identify what changes may be necessary to assess powerful disruptive technologies more quickly and respond faster to new opportunities. REVIEW ACTIVITY Consider the organisation and industry that you currently work in. As we noted in this unit, there are likely to be many signals from the periphery of your industry (or supporting sectors) from numerous emerging technologies/ideas. Some of these will be relevant to the future, others will be a complete waste of time. Identify two or three emerging/new innovations that you feel are likely to make a significant business impact on your sphere of activity. Technologies or ideas that could offer your organisation deep market potential. 1. Prioritise the technologies/ideas and explain why you have selected them. What opportunities or paradigm shift in business do they show potential for? How could your organisation exploit these technologies/ideas? What threats do they pose for your company and the products/services you market? Noting the culture of your own organisation, how would you go about assessing these innovative technologies and implementing them (where appropriate)? 2. 3. Share your findings with your Manager and colleagues in your organisation. Encourage constructive comments. Further reading for this unit (optional) The following are suggested as optional reading for this unit: 1. 2. Ref 10*, Chapter 11 pages 407-416 Ref 8, Chapter 12 (including Reading 12.1) pages 256-276, Chapter 17 (including Readings 17.1 & 2) pages 403 453 * Highly recommended 254 Unit 10 Strategic IT and e-Business LEARNING OUTCOMES Following the completion of this unit you should be able to: Examine the impact technological advances in IT are having on strategy. Consider impact of e-business on strategy. Understand the strategic implications for legacy systems. Introduction In the age of the Internet, new markets are emerging faster than ever before. As each new market goes through its development cycle, it gives power to those companies that are able to harness the power of IT and the Internet to transform their businesses, and that of their customers. Power is shifting from what was previously a trusted source of value creation towards something that was previously secondary. Information has replaced assets as the source of value. This is the new management agenda, and corporate IT strategy has become an important determinant of stock price. The strategic shift from assets to information, has also been coupled with a shift from products to services. Services offerings cannot be managed using the same IT systems as product offerings. Services offerings are much more customer-centric and this has led to an emphasis on ERP (enterprise resource planning), CRM (customer relationship management) and supply chain management. Furthermore, it is well recognised that a corporations own efficiency comes from how seamlessly data, information and knowledge flows within the company, and indeed between its supply chain and strategic partners. Unless corporate data can get to the point of decision in time to impact that decision, Information Management has failed. For all these reasons IT has become a powerful influence on corporate strategy; Strategic IT defines the very nature of the business. In this new age, IT is not about the business, it is the business; e-business. 255 Unit 10 Strategic IT and e-Business Global Corporate Strategy In this unit we shall examine the impact of technological advances in IT on strategy. We shall also look at the definition of an e-business, and consider the impact of e-business on strategy. The Link between Business and IT Strategy A core theme in business is that IT strategy should be aligned with business strategy. This is difficult to refute as investments should support real business needs. However, as companies began to depend more and more on IT in the 1980s and 1990s, it became evident that a business strategy without a matching IT strategy was no strategy at all. For this reason, general managers as much as IT executives have recognised the concept of strategic alignment. Strategic alignment is based on the premise that an organisation defines business strategy, and then an IT strategy to support it. There are obvious challenges with the strategic alignment approach, because There may be a lack of coherent or agreed business strategy in the first place. The strategy may change regularly. The strategy-making process may be more emergent than prescriptive. IT strategy, just like any other strategy, has to take into account the above, as this is a prerogative of any modern business. IT strategy has to be flexible and accommodate a fast changing world. Indeed, corporate IT systems such as Enterprise Resource Planning, Supply Change Management and Customer Relationship Management systems allow for a level of strategic flexibility for this reason. Since the emergence of e-business, in particular, the linkage between business strategy and IT strategy has been strengthened. IT strategy is no longer solely an output from business strategy, but is a fundamental input in itself. Let us explore this paradigm shift further. IT Strategy as an input to Business Strategy In todays world, IT strategy is inextricably linked with business strategy. No longer can the approach be taken of defining business strategy, and then asking what are the implications for technology, and matching it to an IT strategy? IT now affects business strategy and can be seen as an input to business strategy as well as an output. The Internet, e-business, mobile communications and digital media present 256 Global Corporate Strategy Unit 10 Strategic IT and e-Business both threats and opportunities; they pose a deep series of challenges to the business. So business strategy cannot ignore how technology is changing markets, competition and processes. Business processes, that worked well previously, break down when exposed to the self-service pressures of the web. Business processes themselves are re-engineered because of the new opportunities for efficiency that IT can deliver. A revised view of alignment is therefore necessary. In particular, it is necessary to ask the following questions: 1. 2. How does IT change business strategy? (alignment question) What IT investments does business strategy demand? (opportunity question) The iterative relationship between business strategy and IT strategy can be summarised as shown in Figure 10.1. Political factors Economic factors Social factors Technical factors Business strategy Technology/IT strategy Influence of IT strategy on business strategy Figure 10.1: Relationship between business and IT strategy. e-business The advent of e-business is having a profound impact on business strategy. The appointment of directors of e-business and the formulation of e-business strategies recognise that IT is changing the way companies do business. This clearly impacts upon business strategy; it poses opportunities and threats. There is sometimes confusion around the definition of e-business. Many confuse e-business with e-commerce. But e-business is far more than a business that carries out trade electronically (e-commerce). An e-business is an organisation that is transforming its interactions with customers, suppliers, strategic partners and employees by exploiting 257 Unit 10 Strategic IT and e-Business Global Corporate Strategy Web technologies, and extending its market reach to improve performance. This is at the core of business strategy. The supporting e-business strategy, the information business strategy, may radically transform business processes (internal and external) and will define applications (many web-driven) to support the business processes. Information sharing will be at the heart of the strategy. Information sharing may include customers, the companys supply chain and strategic partners. The Information Management Strategy must enable the company to leverage its knowledge, information and skills; the new value resources. The components of a companys e-business strategy can be broadly depicted as shown in Figure 10.2. Note the cyclic nature of the various components. This implies continual refinement and change. Leverage information and knowledge Define IT environment (security, scalability, standards, tools and applications) e-business strategy Transform business processes Figure 10.2: Cyclic nature of e-business strategy. ACTIVITY Read about the huge impact of recent technological advances (principally e-business) on organisations strategic approaches, in an extract from Geoffrey Moores book Living on the fault line. Find it on p. 451-464, Reading 8.3 in your key text, De Wit, B & Meyer, R . 258 Global Corporate Strategy Unit 10 Strategic IT and e-Business VIRTUAL CAMPUS On-demand computing or grid-computing is being touted by the major computer vendors (IBM, Sun, HP) as delivering the next paradigm shift in business. Is this hype or reality? Very simply, on demand computing harnesses a grid of machines and other resources (distributed anywhere) to rapidly process data beyond an organisations own available capacity. It is akin to an electricity grid. Organisations pay varying prices for the computing power depending on usage and demand at the time. The business benefits are potentially far-reaching. Companies embracing the on-demand concept are said to be able to adapt dynamically to whatever business challenges arise. By integrating their business processes end-to-end, not only internally, but with their entire supply chain, strategic partners and customers, organisations can exploit this technology to respond rapidly to customer needs, market opportunities or even threats. Research this area on the Internet. In particular, look at the IBM, Sun and HP websites. Discuss these developments with IT colleagues in your own organisation. Now post your views on the Virtual Campus on the following topics: Is on-demand computing just hype, or can it deliver real business benefits? Elaborate by discussing its likely impact on your business? Is on-demand computing going to impact only certain sectors of industry, or will it be pervasive? What impact might it have on an organisations IT strategy and business strategy? Read the views of others, and pick one particular viewpoint that is contrary to yours and challenge it. Try to keep a business focus. Avoid technical detail and jargon in your postings and discussions. (This virtual campus activity also interlocks with Unit 9 on Innovation) 259 Unit 10 Strategic IT and e-Business Global Corporate Strategy IT Strategy Methodology Strategy Framework Companies frequently adopt formal methodologies when developing IT strategy. There are many methodologies on the market developed by leading IT companies and professional services firms such as Accenture. The principles are the same. One that has been used by new economy organisations is the FAST methodology. The four tasks or elements that make up FAST are: Futurising. Assets. Stimulants. Threats. The FAST methodology is entirely inductive, but provides a way of addressing strategy-making. It is not the only methodology available. FAST should, in fact, be viewed as a framework to get started; by posing the right questions. It does not directly address process and implementation issues. If business strategy and IT strategy are indeed inextricably linked, then there has to be good communication and trust between the business and IT personnel. By asking radical questions on futurising, assets, stimulants and threats, the organisation can address issues of understudying, involvement, communication and buy-in from personnel from the business and IT functions. Futurising Some companies, such as the Swedish financial group Skandia, have created special teams to question what the future might bring. These teams use checklists with probing questions aimed at all parts of the business. The answers to the probing questions highlight important trends or significant uncertainties. Futurising is not just raising an alarm about new technologies and their future impact, but rather looks at the intersection of new technologies and the shift in the business environment, and asks what is changing, threatening or opportunity-rich. The PEST (political, economic, social, technological) tool for environmental analysis applies in thinking about futures, but more thorough scenarios are likely to be where these variables interact. Some companies are constructing visions, stories, pictures and dramas of what businesses might look like or what businesses could be created. The outputs could be good questions to ask, trends to watch, 260 Global Corporate Strategy Unit 10 Strategic IT and e-Business uncertainties to explore, experiments to begin or must do ideas to develop. The main point about futurising, as Skandia calls it, is to explicitly suggest that the future may not be an extrapolation of the past, that opportunities co-exist with threats, that uncertainty is inevitable and that ignoring the future is more risky than trying to create it. Assets What competencies, capabilities or assets might yield opportunities? These are assets because: They are potential sources of value creation. They should not be underestimated or left un-exploited. They may be hidden until potential is realised through e-commerce. For example, if a company has world-class fulfilment processes, then moving into e-commerce not only builds on this strength, but might also make this capability evident to the world. In other words, existing capabilities may have even more potential for value creation. Jack Welch at General Electric has said that the companys achievements in its Six Sigma quality processes are now really paying off in e-business, where cost, speed, reliability and quality matter. As an example of underestimated assets, one conglomerate realised it had several partnership opportunities and, importantly, information threads between its businesses that might allow it to restructure part of the logistics industry. Likewise, many information-rich organisations have content that is valuable to traditional and emerging businesses. Hidden assets can become evident in many ways. For example, an engineering company realised it had a valuable asset in its parts database when a business-to-business electronic market-maker approached it about building a business-to-business exchange. The database had taken 40 years to build and was now seen as an asset to protect as well as to exploit. In other words, when you re-examine a business as an information business or rethink it as a new economy business, you may discover hidden assets. Stimulants The efforts of companies that are trying to encourage entrepreneurial behaviour can be thought of as stimulants. Examples of this are internal venture capital funds and e-business divisions. Some companies measure how much of their capital budget is being allocated to new ventures and e-commerce. Some businesses are creating 261 Unit 10 Strategic IT and e-Business Global Corporate Strategy FAST-track learning schemes to move people through venture capital units and back to the mainstream business. The theory is that there are latent entrepreneurs and e-commerce ideas in companies. Strategy is not all top-down, but should reach through all levels. It is the classic let loose cycle often employed when strategic change is on the agenda: stimulating everybody to think and act as a new business. Threats The final element is to think of threats, but not only as shock treatment. If a company sees how a new entrant or rival can attack, why not attack first? This has been a philosophy at General Electric, where executive teams have been asked to think how their business could be destroyed by e-commerce. Threats stimulate survival instincts and can be more effective than looking for opportunities, which can seem optional. ACTIVITY Consider the following scenario. Assume that you are a manager in your organisation, and that your organisation has enjoyed significant market dominance in its particular sector. Now pretend that a new entrant is going to attack your market share. Envision the new entrants winning approach. What strategy, business and IT, is the new entrant likely to adopt in your sector? From the above analysis, how can your organisation retain the high-ground and modify its strategy? The above approach of envisioning competitive threats and modifying strategy has been adopted widely. It was used with great success by General Electric during Jack Welchs reign. (The above activity is quite wide in scope. For purposes of this unit, restrict it as best as possible to the impact of IT on strategy.) The combination of the four elements, futurising, assets, stimulants and threats, suggest that both IT personnel and business executives are involved and that initiatives are prompted which involve multifunctional teams. In this way, business strategy and IT strategy are integrated. 262 Global Corporate Strategy Unit 10 Strategic IT and e-Business A positive lesson to be learned from dot.com businesses is that multifunctional teams build and evolve the business with no demarcation between functions, skills and strategies. This leads to redefining IT strategy and planning. Todays Strategy Challenges In a global marketplace where technological innovations have a profound impact on corporate strategy and organisation, the IT methodology framework must be comprehensive, and flexible in incorporating new challenges and business change into core information systems. Traditional methods of IT strategy-making, whether framed as alignment, opportunity or both, were periodic (often annual), formalised, long-term and driven principally by the IT department. They allowed little flexibility for change or for the adoption of new processes and technologies. These methods are no longer satisfactory, as they were discontinuous, lacked buy-in from the business and hence implementation of strategy often lost momentum. In todays world, IT strategy cannot just be the domain of the IT department; it must engage the businesses. It must deliver real business benefits in short-time frames. New methods of IT strategy-making have the following characteristics; Continuous. Flexible. Involve learning by doing. Rapid turnaround and delivery of quick wins. A natural activity. Today, strategy integrated IT and business strategy is revisited frequently; priorities re-evaluated, new technologies assessed and incorporated where relevant to the business. Strategy can no longer be cast in stone. The pressure to launch, the need to respond to what is learnt by doing, the uncertainty of new markets and models, and the fact that on-line business evolves in real time, mean that the formal structures of traditional IT strategy-making are inappropriate. Because IT strategy-making is business development, it is a multi-functional team effort. The chief executive and technology director should be in frequent dialogue. IT people are learning to work with marketing people and vice versa. Furthermore, strategising and planning must be closely followed by implementation. Rapid Application Development methodologies are frequently adopted. Strategy making is now an evolving, continuous, ever-changing process. (See Figure 10.3). The underlying IT architectural framework must allow for change. 263 Unit 10 Strategic IT and e-Business Global Corporate Strategy IT strategy must support the entire life cycle of the organisations information systems, and enable them to evolve over time to meet changing business demands. It must adhere to a common architecture and comply with industry standards. In broad terms, the steps in developing and implementing IT strategy can be summarised as follows: 1. 2. 3. 4. 5. 6. Capture organisational strategy. Map business processes to the organisation. Link strategy, organisation and processes. Carry out process re-engineering, where appropriate. Implement and align relevant information systems. Manage all aspects of evolution, including business domains, processes, applications and third-party systems. Figure 10.3 illustrates the cyclic nature of the various stages. Capture organisational strategy Implement and align information systems Manage IT evolution Map business processes to the organisation Process re-engineering Link strategy, organisation and processes Figure 10.3: Evolutionary nature of IT strategy. Reconciling Legacy Systems with New Technologies Unless the organisation is a very young organisation, reconciling new technologies with legacy systems is a fundamental pre-requisite of a corporations IT strategy. Established companies cannot afford to take a revolutionary approach, and legacy integration is a key requirement. Therefore, the IT strategy 264 Global Corporate Strategy Unit 10 Strategic IT and e-Business must deliver a flexible architecture that allows new components and mission-critical legacy systems to be integrated and managed in harmony. Competitive pressures and the drive for increased efficiency and productivity demand that the integrated environment be a modern e-business environment. The e-business environment must leverage legacy systems, because organisations cant replace them quickly enough and still be responsive to business needs. Let us briefly examine the implications for legacy systems. Firstly, it is important to note that 70% of the worlds data still resides on legacy systems. Legacy systems are frequently fragile (due to poor documentation, loss of expertise, etc.), and changes to such systems are not only costly and time-consuming, but risky. For this reason legacy systems should be left unaltered as far as is possible. However, some changes are necessary to reconcile legacy systems with the new components and achieve integration on an e-platform. Todays business demands that customers and suppliers are provided with the most up-to-date information possible whether that be by Internet, e-mail, phone, etc. They also demand a familiar, easy-to-use interface. Consequently, legacy integration must support real-time access, and be fronted by familiar interfaces such as a web front-end. These changes are fairly minimal and can be achieved by use of Application Program Interfaces (APIs) and wrappers, but maintaining the core application logic. In conclusion, in the Internet age, most companies will find that it is more strategic than ever to adopt a flexible architecture and maintain many of their mission-critical legacy systems. Clearly new applications should be developed as genuine e-business applications. In this way, legacy systems can be reconciled with new technologies on an e-business platform. ACTIVITY Research the impact of the Internet and other IT technologies on the new economy by reading some of the articles on the following websites: www.gartner.com www.forrester.com 265 Unit 10 Strategic IT and e-Business Global Corporate Strategy CASE STUDY compuship.com/easy2ship.com Problems developing a global e-commerce concept into a viable business process. Case study from Tayeb M (2003) International Management Theories and Practices. Harlow: Pearson. (Chapter 8. E-commerce Worldwide by Brian M W Clements and Monir H Tayeb) The concept It is acknowledged by the European transport industry that there exists an inefficiency of over 30% in road haulage operations, i.e. either the vehicle is empty for 30% of its journeys or is 30% empty on every journey. In reality it is probably a combination of the two states. 30% is a minimum conservative estimate and in the USA it could be nearer 40%. Efforts are always made to reduce this inefficiency by ensuring maximum possible loading or finding return loads. Traditionally this has been difficult. Either there are problems of timing and co-ordination, or financial problems due to the unknown creditworthiness of shippers of return loads. By using e-commerce Internet connectivity, it is possible to bring together potential carriers and shippers in real time to maximise efficiency. The reduced fixed costs of the carrier should offset freight reductions offered as an inducement to the shipper as well as providing revenue for the service provider. This creates a win/win/win scenario. Additionally, by factoring the service through a bank/credit agency, the service provider can guarantee payment to the carrier within a fixed timeframe. Further benefits are the provision of cargo insurance as well as creating a new marketing channel within the transport industry. The history In 1997, an American computer reseller became unhappy with the level of service his company was receiving from the carriers he used to deliver equipment to his customers. This caused him to analyse the nature of the carriers transport operations to see if he could identify areas where their services could be improved. During his research, he discovered only one fact that struck him as being a possible area of improvement. He learned from several sources that road transport had one particular inefficiency. This was that many journeys were undertaken unladen and that many others were made with less than a full load. In fact, it appeared that the industry was running at only some 60% of its maximum capacity. 266 Global Corporate Strategy Unit 10 Strategic IT and e-Business He decided that it would be a simple matter to create an Internet exchange to manipulate a win/win situation. His belief was that the carrier would be prepared to cost price for last minute loads to fill up empty space, that shippers would benefit from lower than standard freight rates and that he would be able to charge a small margin on each transaction. He registered Compuship.com and commenced development. A year later, due to the uncontrolled and unanticipated software costs he had incurred, he lost his previously profitable computer business, his Compuship.com and the rights to the business process he had developed. Undeterred, he eventually found an entrepreneur who was developing a small Internet incubation company, I-Global.com, which was interested in developing the concept on his behalf. They joined forces and tried to re-acquire the rights to the project development already undertaken. However, they were also suffering from a lack of finance. They in turn sought external finance. Help came in the form of Ci4net.com, a Channel Island and UK incubation company, recently launched on the NASDAQ market, whose shares were priced at over $100 and who was consequently in a buoyant and acquisitive frame of mind. They purchased I-Global.com, renaming it Ci4netNA.com and financed the re-acquisition of the freight exchange for $1 million. But Ci4net.com was still unhappy about two factors in the proposed operation. First, they believed that the USA was too large and amorphous a market for the initial launch. Second, they insisted that the operation needed professional input and control by logistics industry experts. Two were hired, the CEO who was an expert in international logistics and commerce, the other in UK road haulage and marketing. A wholly owned UK company, Easy2ship.com Limited was created in early summer 2000 to complete the exchange and launch the concept into the European marketplace. The two new directors then collaborated in the creation of both business and marketing plans for the exploitation of this new exchange process. It became apparent at the same time that other companies were working on parallel developments, so a measure of urgency was necessary. A beta test and trial launch were planned for October with a full launch to follow at the end of November. The Ci4netNA.com took responsibility for the final development and the hosting of the exchange in the US. They eventually located a software development company, Techspan, who are based in Californias Silicon Valley. Then came the first major setback. After their analysis of the development work originally undertaken by Compuship.com, Techspan advised that the work completed only constituted a sketchy demonstration and lacked the technical flexibility and robustness to be developed into a commercially viable Internet exchange. 267 Unit 10 Strategic IT and e-Business Global Corporate Strategy The UK directors immediately flew to California and spent some weeks re-specifying the business processes and re-designing the structure of the exchange. This delay obviously caused the date of the beta test to be postponed for the ten weeks it was now going to take to develop a working prototype. This would time the beta test for the hectic fortnight before the Christmas holiday in the UK. It was then decided that the only option was to further delay the launch until February 2001. This delay proved fatal. If the exchange were to be launched in February, the earliest that a revenue stream could be generated would be May. The business plan reflected the fact that growth to a financially self-sustaining state would take about 18 months and that the company would require a substantial injection of cash during the first six months of operation to finance a pan-European marketing campaign and the expansion of the company structure. The problems became apparent at the end of the re-design phase of the development. Techspan wanted payment for the work to date before they were prepared to work on the final stage of development. They had contracted to undertake the work with the Ci4netNA.com and expected payment from them. The UK parent organisation, Ci4net.com, the source of all the finance, admitted some cashflow problems, but that these were temporary and would soon be resolved. At the time that Easy2ship.com was formed, the directors were advised that 9 million was available for the UK launch. Following the preparation of the business and marketing plans, this was formally increased to 25 million each for the pan-European and subsequent North American launches. However, one fact was not disclosed by Ci4net.com. This was that they had failed to secure a second round of funding in May, which was crucial to their development plans. They subsequently acknowledged that they had believed that this was a temporary setback and that the second round funding would be secured before it was needed to meet their commitments to their 50-odd subsidiaries. In reality, Ci4net.com had insufficient skilled managers to control the activities of all these subsidiaries. Their efforts to do so apparently distracted their attention from events in the worlds financial markets. Many of the Phase 3 Internet companies had burned their investors money, without having any realistic hope of developing an adequate revenue stream. Institutional investors had leapt onto the bandwagon when they had seen the immense capital gains to be made from the spectacular and much-publicised IPO capitalisation of many Dot.com companies, but the bubble had burst. Ci4net.coms shares, originally valued at over US$100 on the NASDAQ market had slumped to under US$1 by early 2001. There was no realistic possibility that they would get second round funding. They divested themselves of over 80% of their subsidiaries, keeping Easy2ship.com among five or six others. However, they were not able to meet either the development costs they had incurred with Techspan or the operational costs 268 Global Corporate Strategy Unit 10 Strategic IT and e-Business of Easy2ship.com, whose staff was laid off in December 2000 and whose UK directors resigned shortly thereafter. Case study summary The business process is viable. The concept was professionally market tested through focus groups and accepted with enthusiasm by both carriers and potential users. However, due to its failure from causes outside its direct control, as well as the current commercial suspicion of investment in E-commerce, funds are not forthcoming. This scenario has been repeated in many other commercial sectors, most of which are suffering from a lack of confidence on the part of the institutional investors. They had their fingers burned by investing heavily in E-commerce without having either made prudent checks that the business process was going to work or that there was the likelihood of the generation of an adequate revenue stream in the foreseeable future. Questions: 1. Was the development time a significant cause for the termination of the project? What would an investor need to know before making a commitment to fund such a venture? Can a win/win/win scenario really exist, or is there a commercial loser? Could the concept be limited to operation within national boundaries? What are the likely difficulties of expansion into: 2. 3. 4. 5. - Europe? - Non-European countries? CASE STUDY FEEDBACK Feedback on Question 1: In the normal course of events, the development time might have been less critical. Obviously, it is important to keep a development period to the minimum, since at this stage, outgoings may be heavy and there is no income. 269 Unit 10 Strategic IT and e-Business Global Corporate Strategy This negative cashflow is normally allowed for in the business plan, as it certainly was in this case. However, even though the directors were not aware of the parent companys funding shortfall, there was little that could be done to accelerate the process of bringing the company online. Therefore, the extended development period was a significant cause for the termination of the project, since the parent company could not survive without the income relied upon from this source. Feedback on Question 2: An investor would need to know: The track record of the management. The size of the potential market. Details of all competition. The reliability of the business process and technology. The elapsed time between the start of the project and the first income. The elapsed time between first income and financial breakeven. Critical success factors. Feedback on Question 3: A win/win/win scenario could exist as described in this case study. It is possible for the carrier, the shipper and the service provider to benefit from the business process. This is because of the size of the structural inefficiency in the current business process (30%+) and to the detriment of conventional bricks and mortar return load service providers. Feedback on Question 4: It would be impractical to attempt to limit this concept to a single state, unless the state concerned had no normal road transport access to and from neighbouring states. In the case of the UK, there is ferry transport to Scandinavia, Germany, Netherlands, Belgium, France, Spain and Ireland, as well as the Channel Tunnel. Feedback on Question 5: Difficulties for expanding into Europe: Language barriers for advertising, etc. Euro currencies. 270 Global Corporate Strategy Unit 10 Strategic IT and e-Business Dispute resolution. Hard copy documentation. Difficulties for expanding into non-European countries: Credit rating of shippers. Credit rating of carriers. Trust and confidence in all parties. Unreliable legal systems. Summary We have seen that in todays world, business strategy is inextricably linked with IT strategy. The business benefits and competitive advantages that new technologies, and e-business, can deliver are huge; a company should be constantly looking to exploit this potential. We have looked at the role of IT strategy methodologies, and have noted that methodologies need to allow for flexibility and responsiveness to changes in the business and in technology. We have briefly considered how to manage IT evolution within an organisation and the cyclic role of the various processes. We have noted that if e-business is the business, and if IT strategy cannot be separated from business strategy, the chief executive and technology director need to be working as partners. Strategic leadership, that pro-actively encourages multi-functional strategic effort, is vital as well as new concepts and practices of strategy formulation. Finally we have looked at the issue of reconciling legacy systems with the e-business paradigm. REVIEW ACTIVITY We have seen that e-business is far more than just e-commerce. Many companies, (e.g. Cisco Systems, Airbus Industrie) have achieved supply chain efficiencies and enormous cost savings by adopting electronic methods such as e-procurement. Use of enterprise resource planning systems (e.g. SAP) has also played a significant role. 271 Unit 10 Strategic IT and e-Business Global Corporate Strategy Consider your own organisation, irrespective of whether or not in operates in the new economy; and irrespective of whether or not e-commerce opportunities present itself. What impact has e-business had on your companys strategy? What is its potential? 1. 2. Consider the changes achieved over the last five years. Address the potential over the next five years, and likely business benefits. Further reading for this unit (optional) The following are suggested as optional reading for this unit: Ref 10*, Chapter 11 Pages 400-403 Ref 9, Chapter 14 Pages 381 394 Ref 13, Chapter 10 Pages 221-247 * Highly recommended References The following are the references for your key text and supporting texts: 1. Bennett R. (1999) Internatio nal Business (2nd Edition) Published by: Financial Times Pitman Publishing (ISBN 0-273-63429-1). Cummings S., Wilson D. (2003) Im ages o f Strategy Published by Blackwell Publishing (ISBN 0-631-22610-9) De Wit, B. & Meyer, R (2004) Strategy Process, Content & Context International Perspective (3rd Edition) Published by: Thomson Learning (ISBN 1-86152-964-3). (Key Text) Ferguson P.R. & Ferguson G.J. (2000) Organisatio ns A Strategic Persp ective Published by: Macmillan Press Ltd. (ISBN 0-333-74550-7). Grant R.M. (2002) Co ntem p o rary Strategic Analysis Co ncep ts, Techniques, Ap p licatio ns (4th Edition) Published by Blackwell Publishers (ISBN 0-631-23136-6) 2. 3. 4. 5. 272 Global Corporate Strategy Unit 10 Strategic IT and e-Business 6. Haberberg A., & Rieple A. (2001) The Strategic Managem ent o f Organisatio ns Published by: Financial Times Prentice Hall (ISBN 0-13-021971-1) Johnson G. & Scholes K. (1999) Exp lo ring Co rp o rate Strategy (5th Edition) Published by: Prentice Hall (ISBN 0-13-080740-0). Joyce P. & Woods A. (2001) Strategic Managem ent A Fresh Ap p ro ach to Develo p ing Sk ills, Kno w led ge and Creativity Published by Kogan Page Limited (ISBN 0 7494 3583 6) Lasserre P. (2003) Glo bal Strategic Managem ent Published by: Palgrave McMillan (ISBN 0-333-79375-7) Lynch, R. (2003) Corporate Strategy (3rd Edition) Published by: Financial Times Prentice Hall (ISBN 0-273-65854-9). (Main supporting text) Mintzberg, H., Ahlstrand B., & Lampel J. (1998) Strategy Safari Published by: Financial Times Prentice Hall (ISBN 0-273-65636-8) Stacey, R.D. (2000) Strategic Managem ent & Organisatio nal Dynam ics The Challenge o f Co m p lexity (3rd Edition) Published by: Financial Times Prentice Hall (ISBN 0-273-64212-X) Stonehouse G., Hamill J., Campbell D. & Purdie T. (2000) Glo bal and Transnatio nal Business Strategy and Managem ent Published by: John Wiley & Sons (ISBN 0-471-98819-7). Thompson A.A., Strickland A.J, (2003) Strategic Managem ent Co ncep ts and Cases Published by McGraw-Hill Irwin (ISBN 0-07-112132-3) 7. 8. 9. 10. 11. 12. 13. 14. 273 ... View Full Document

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