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CHAPTER 11

Organizational Design: Structure, Culture, and Control

©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom.  No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.

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Be sure to see the NEW Teacher’s Resource Manual located in the Connect Library under Instructor’s Resources.

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The AFI Strategy Framework

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Learning Objectives

LO 11-1 Define organizational design and list its three components.

LO 11-2 Explain how organizational inertia can lead established firms to failure.

LO 11-3 Define organizational structure and describe its four elements.

LO 11-4 Compare and contrast mechanistic versus organic organizations.

LO 11-5 Describe different organizational structures and match them with appropriate strategies.

LO 11-6 Evaluate closed and open innovation, and derive implications for organizational structure.

LO 11-7 Describe the elements of organizational culture, and explain where organizational cultures can come from and how they can be changed.

LO 11-8 Compare and contrast different strategic control-and-reward systems.

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Organizational Design

The process of:

Creating, implementing, monitoring, and modifying…

The structure, processes, and procedures of an organization

Key components:

Structure

Culture

Control

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Featured in the Chapter Case, Zappos provides an example of a company with flexible organizational structure. Unlike other online retailers, Zappos stocks everything it sells in its own warehouses—this is the only way to get the merchandise as quickly as possible with 100 percent accuracy to the customer. Strategy, therefore, is as much about deciding what to do as it is about deciding what not to do.

Instructors:

The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on building competitive advantage through organizational processes. (LO 11-2).

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Organizational Inertia Results from Failure to Adjust to Shifts in the Environment

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To implement a formulated business strategy successfully, structure must accommodate strategy, not the other way around. In reality, however, a firm’s strategy often follows its structure. Inertia, a firm’s resistance to change the status quo, can set the stage for the firm’s subsequent failure. Successful firms often plant the seed of subsequent failure: They optimize their organizational structure to the current situation. That tightly coupled system can break apart when internal or external pressures occur.

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Organizational Structure

Determines how efforts of individuals and teams are orchestrated

How resources are distributed

Includes four building blocks:

Specialization

Formalization

Centralization

Hierarchy

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#1: Specialization

Describes the degree to which a task is divided into separate jobs

Larger firms: high degree of specialization

Smaller ventures: low degree of specialization

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An accountant for a large firm may specialize in only one area (e.g., internal audit), whereas an accountant in a small firm needs to be more of a generalist and take on many different things (e.g., internal auditing, plus payroll, accounts receivable, financial planning, and taxes).

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#2: Formalization

The extent to which employee behavior is guided by rules and procedures

Pros:

Ensures consistent and predictable results

Cons:

Slower decision making

Reduced innovation

Hindered customer service

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Airlines, for instance, must rely on a high degree of formalization to instruct pilots on how to fly their airplanes to ensure safety and reliability. Yet a high degree of formalization can slow decision making, reduce creativity and innovation, and hinder customer service. Most customer service reps in call centers, for example, follow a detailed script. This is especially true when call centers are outsourced to overseas locations. Zappos deliberately avoided this approach when it made customer service its core competency.

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#3: Centralization

The degree to which decision making is concentrated at the top of the organization

Affects strategic planning:

Top-down strategic planning takes place in highly centralized organizations.

Planned emergence is found in more decentralized organizations.

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Whether centralization or decentralization is more effective depends on the specific situation. During the Gulf of Mexico oil spill in 2010, BP’s response was slow and cumbersome because key decisions were initially made in its UK headquarters and not onsite. In this case, centralization reduced response time and led to a prolonged crisis.

In contrast, the FBI and the CIA were faulted in the 9/11 Commission report for not being centralized enough.1 The report concluded that although each agency had different types of evidence that a terrorist strike in the United States was imminent, their decentralization made them unable to put together the pieces to prevent the 9/11 attacks.

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#4: Hierarchy

The formal, position-based reporting lines

Who reports to whom

Span of control:

The number of employees who directly report to a manager

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In tall organizational structures, the span of control is narrow. In flat structures, the span of control is wide, meaning one manager supervises many employees. In recent years, firms have de-layered by reducing the headcount (often middle managers), making the organizations flatter and more nimble.

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Mechanistic vs. Organic Organizations

Mechanistic Organization

Much specialization and formalization

Tall hierarchies

Centralized decision making

Organic Organization

Little specialization and formalization

Flat organizational structure

Decentralized decision making

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Mechanistic example: The fast food chain McDonald’s fits this description quite well. Each step of every job such as deep-frying fries is documented in minute detail (e.g., what kind of vat, the quantity of oil, how many fries, what temperature, how long, and so on). Decision power is centralized at the top of the organization: McDonald’s headquarters provides detailed instructions to each of its franchisees so that they provide comparable quality and service across the board although with some local menu variations. Communication and authority lines are top-down and well defined. To ensure standardized operating procedures and consistent food quality throughout the world, McDonald’s operates Hamburger University, a state-of-the-art teaching facility in a Chicago suburb, where 50 full-time instructors teach courses in chemistry, food preparation, and marketing. In 2010, McDonald’s opened a second Hamburger University campus in Shanghai, China.

Organic example: See Strategy Highlight 11.1

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Mechanistic vs. Organic Organizations: A Comparison

Strategy Mechanistic Organizations Organic Organizations
Specialization High degree of specialization Rigid division of labor Employees focus on narrowly defined tasks Low degree of specialization Flexible division of labor Employees focus on “bigger picture”
Formalization Intimate familiarity with rules, policies, and processes necessary Deep expertise in narrowly defined domain required Task-specific knowledge valued Clear understanding of organization’s core competencies and strategic intent Domain expertise in different areas Generalized knowledge of how to accomplish strategic goals valued
Centralization Decision power centralized at top Vertical (top-down) communication Distributed decision making Vertical (top-down and bottom-up) as well as horizontal communication
Hierarchy Tall structures Low span of control Clear lines of authority Command and control Flat structures High span of control Horizontal as well as two-way vertical communication Mutual adjustment
Business Strategy Cost-leadership strategy Examples: McDonald’s; Walmart Differentiation strategy Examples: W.L. Gore, Zappos

Exhibit 11.3

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Although at first glance organic organizations may appear to be more attractive than mechanistic ones, their relative effectiveness depends on context. McDonald’s, with its some 37,000 restaurants across the globe, would not be successful with an organic structure. Similarly, a mechanistic structure would not allow Zappos or W.L. Gore to develop and hone their respective core competencies in customer service and product innovation.

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Firm Strategy & Structure

Are interdependent

Impact a firm’s performance

Changes over time as the firm grow in:

Size

Complexity

Different firm stages require different structures

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Successful new ventures generally grow first by increasing sales, then by obtaining larger geographic reach, and finally by diversifying through vertical integration and entering into related and unrelated businesses.

Instructors:

The digital companion to this book McGraw-Hill Connect has a brief case exercise on this section of the textbook. It builds student confidence on the connections between strategy and organizational structure using a short case on W.L. Gore. (LO 11-5).

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Types of Organizational Structure

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The important and interdependent relationship between strategy and structure directly impacts a firm’s performance. Moreover, the relationship is dynamic—changing over time in a somewhat predictable pattern as firms grow in size and complexity. Successful new ventures generally grow first by increasing sales, then by obtaining larger geographic reach, and finally by diversifying through vertical integration and entering into related and unrelated businesses.

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Simple Structure

Used by small firms with low organizational complexity

The founders usually

Make all the strategic decisions.

Run day-to-day operations.

Professional managers and sophisticated systems are not usually in place.

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Examples include entrepreneurial ventures such as Facebook in 2004, when the startup operated out of Mark Zuckerberg’s dorm room, and professional service firms such as smaller advertising, consulting, accounting, and law firms, as well as family-owned businesses.

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Functional Structure

Employees are grouped into functional areas.

Based on domain expertise

Often correspond to distinct stages in the value chain

Leaders of functional areas report to the CEO.

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Typical Functional Structure

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W.L. Gore began as a company by operating out of Bill Gore’s basement and using a simple structure. Two years after its founding, the company received a large manufacturing order for high-tech cable that it could not meet with its ad hoc basement operation. At that point, W.L. Gore reorganized itself into a functional structure. A simple structure could not provide the effective division, coordination, and integration of work required to accommodate future growth.

A business school student generally majors in one of these functional areas such as finance, accounting, IT, marketing, operations, or human resources, and is then recruited into a corresponding functional group.

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Functional Structure & Business Strategy

A functional structure works when a firm has

A narrow focus and small geographic footprint

It pairs well with:

Cost Leadership Strategy

Differentiation Strategy

Blue Ocean Strategy

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Exhibit 11.6 presents a detailed match between different business strategies and their corresponding functional structures.

Cost Leadership Strategy

Using a functional structure allows the cost leader to:

Nurture and constantly upgrade core competencies

Differentiation Strategy

Using a functional structure allows a differentiator to:

Incorporate decentralized decision making

Foster and incentivize continuous innovation and creativity

Blue Ocean Strategy

To implement a functional blue ocean strategy:

The firm must be both efficient and flexible

The firm must control costs & foster creativity

Mitigate the disadvantages of this approach

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Disadvantages of Functional Structure

Suboptimal communication across departments

Solution: cross-functional teams

Cannot effectively address greater diversification

This is needed to ensure firm growth.

Firms encountering this adopt a different structure.

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Strategy Highlight 11.1 outlines how W.L. Gore employs cross-functional teams successfully.

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Multidivisional Structure

Used as a firm diversifies products and geography

Each strategic business unit (SBU):

Has profit-and-loss (P&L) responsibility

Operated independently

Led by a unique CEO who is:

Responsible for SBU strategy

Responsible for day-to-day operations

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Zappos is an SBU under Amazon, which employs a multidivisional structure. Also, W.L. Gore uses a multidivisional structure to administer its differentiation and related diversification strategies. It has four product divisions (electronic products, industrial products, medical products, and fabrics division) with manufacturing facilities in the United States, China, Germany, Japan, and Scotland, and business activities in 30 countries across the globe.

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Typical Multidivisional Structure

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In this example, the company has four SBUs, each led by a CEO. Corporations may use SBUs to organize around different businesses and product lines or around different geographic regions. Each SBU represents a self-contained business with its own hierarchy and organizational structure. Note that SBU 2 is organized using a functional structure, while SBU 4 is organized using a matrix structure. The CEO of each SBU must determine which organizational structure is most appropriate to implement the SBU’s business strategy.

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M-Form & Corporate Strategy

Related Diversification

Cooperative M-Form

Centralized decision making

Integrated at corporate headquarters

Co-opetition among SBUs

Unrelated Diversification

Competitive M-Form

Decentralized decision making

Low level of integration at corporate headquarters

Competition among SBUs for resources

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Co-opetition—competition and cooperation at the same time. Exhibit 11.8 matches different corporate strategies and their corresponding organizational structures.

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Disadvantages of the Multidivisional Structure

Adds another layer of corporate hierarchy

Bureaucracy, red tape, & duplication of efforts

Slower decision making

SBUs competing

Politics and turf wars over resources

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In some instances, spinning out SBUs to make them independent companies is beneficial. The BCG growth-share matrix helps corporate executives when making these types of decisions. In the last few years when owned by eBay, PayPal outperformed its parent company. PayPal’s executives (and investors) were tired of subsidizing eBay’s stagnant business. Investors also liked separating eBay and PayPal, giving it a valuation that is estimated to be as high as $100 billion; eBay’s standalone valuation is about $35 billion

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Matrix Structure

Leverages SBU (M-form) benefits:

Domain expertise

Economies of scale

Efficient processing of information

Also leverages organizational structure benefits

Responsiveness

Decentralized focus

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Typical Matrix Structure

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The horizontal and vertical reporting lines between SBUs and geographic areas intersect, creating nodes in the matrix. One employee in this structure is highlighted, represented by a large dot and called out by an arrow. This employee works in a group with other employees in SBU 2. This employee has two bosses—the CEO of the SBU and the general manager (GM) for the Europe division. Both supervisors report to corporate headquarters, which is led by the president of the corporation (indicated by the reporting lines from the SBUs and geographic units to the president).

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Matrix Structure & Global Strategy

This structure fits well with a transnational strategy.

International: functional structure

Multi-domestic: multi-divisional structure

Global Standardization: multi-divisional structure

Transnational: global matrix structure

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Exhibit 11.10 shows how different global strategies best match with different organizational structures.

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Disadvantages of the Matrix Structure

Difficult to implement

Organizational complexity

Administrative costs

Unclear reporting structures

Accountability can be undermined.

Employees can have trouble reconciling goals.

Principal-agent problems

Slower decision-making

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The development pattern of how organizational structures tend to change in time as firms grow in size and complexity is fairly predictable: Starting with a simple structure, then moving to functional structure, and finally implementing a multidivisional or matrix structure. As featured in the Chapter Case, Zappos even went a step further. Rapid growth and increasing complexity triggered Zappos’ move away from a multidivisional structure with different business units to the radically new organizational structure, holacracy, with its nonhierarchical, overlapping employee circles.

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Organizing for Innovation

Closed Innovation

Products developed internally

Costly and time consuming

Open Innovation

Ideas and innovation also arise from external sources

Customers, suppliers, universities, etc.

Leverages licensing agreements, strategic alliances, joint ventures, and acquisitions

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Exhibit 11.13 compares and contrasts open innovation and closed innovation principles.

Several factors led to a shift in the knowledge landscape from closed innovation to open innovation. They include:

▪ The increasing supply and mobility of skilled workers.

▪ The exponential growth of venture capital.

▪ The increasing availability of external options (such as spinning out new ventures) to commercialize ideas that were previously shelved or insource promising ideas and inventions.

▪ The increasing capability of external suppliers globally.

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Open vs. Closed Innovation

Exhibit 11.12

Source: Adapted from H. Chesbrough (2003), “The area of open innovation,” MIT Sloan Management Review, Spring: 35–41.

Jump to Appendix 7 long image description

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The horizontal and vertical reporting lines between SBUs and geographic areas intersect, creating nodes in the matrix. One employee in this structure is highlighted, represented by a large dot and called out by an arrow. This employee works in a group with other employees in SBU 2. This employee has two bosses—the CEO of the SBU and the general manager (GM) for the Europe division. Both supervisors report to corporate headquarters, which is led by the president of the corporation (indicated by the reporting lines from the SBUs and geographic units to the president).

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Organizational Culture

Shared values and norms of an organization’s members

Values: what is considered important

Norms: appropriate attitudes and behaviors

Expressed through artifacts:

Physical space

Symbols

Events

Vocabulary

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Artifacts include elements such as the design and layout of physical space (e.g., cubicles or private offices), symbols (e.g., the type of clothing worn by employees), vocabulary, what stories are told (see the Zappos pizza-ordering example in section 11.4), what events are celebrated and highlighted, and how they are celebrated (e.g., a formal dinner versus a casual barbecue when the firm reaches its sales target).

Instructors:

The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on organizational culture using Zappos as an example. (LO 11-6).

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The Elements of Organizational Culture

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The most important yet least visible element—values—is in the center. As we move outward in the figure, from values to norms to artifacts, culture becomes more observable. Understanding what organizational culture is, and how it is created, maintained, and changed, can help you be a more effective manager. A unique culture that is strategically relevant can also be the basis of a firm’s competitive advantage.

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Where Do Organizational Cultures Come From?

Founder imprinting

Examples: Steve Jobs, Walt Disney, Michael Dell, Oprah Winfrey, Martha Stewart, Bill Gates

Beware of groupthink

When individuals don’t challenge a leader’s opinion

Values

Should be linked to a reward system

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Founder imprinting: Steve Jobs (Apple), Walt Disney (Disney), Michael Dell (Dell), Sergey Brin and Larry Page (Google), Oprah Winfrey (Harpo Productions and OWN, the Oprah Winfrey Network), Bill Gates (Microsoft), Larry Ellison (Oracle), Ralph Lauren (Polo Ralph Lauren), Martha Stewart (Martha Stewart Living Omnimedia), and Herb Kelleher (Southwest Airlines).

Walmart founder Sam Walton personified the retailer’s cost-leadership strategy. At one time the richest man in America, Sam Walton drove a beat-up Ford pickup truck, got $5 haircuts, went camping for vacations, and lived in a modest ranch home in Bentonville, Arkansas. Everything Walton did was consistent with the low-cost strategy.

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How Does Organizational Culture Change?

When the environment changes

A firm must hone, refine, and upgrade

To ensure a core rigidity doesn’t emerge

New leadership

Changes in strategy and structure

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GM’s bureaucratic culture, combined with its innovative M-form structure, was once hailed as the key to superior efficiency and management. However, that culture became a liability when the external environment changed following the oil-price shocks in the 1970s and the entry of Japanese carmakers into the United States. As a consequence, GM’s strong culture led to organizational inertia. This resulted in a failure to adapt to changing customer preferences for more fuel-efficient cars, and it prevented higher quality and more innovative designs. GM lost customers to foreign competitors that offered these features.

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Culture Can Be the Basis of a Firm’s Competitive Advantage If

It makes a positive contribution to economic value creation.

It passes the VRIO principles.

It can adapt as the business evolves.

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It is best to develop a strong and strategically relevant culture in the first few years of a firm’s existence. Strategy scholars have documented that the initial structure, culture, and control mechanisms established in a new firm can be a significant predictor of later success.

Examples related to Southwest Airlines and Zappo’s are noted in Section 11.4.

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Strategic Control & Reward Systems

Internal-governance mechanisms

Put in place to align the incentives of:

Principals (shareholders)

Agents (employees)

Allow managers to:

Specify goals

Measure progress

Provide performance feedback

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Zappos restructured its performance-evaluation system to give these values teeth: The firm rewards employees who apply the values (shown in Exhibit 11.14 ) well in their day-to-day decision making. Hsieh states, “Ideally, we want all 10 core values to be reflected in everything we do, including how we interact with each other, how we interact with our customers, and how we interact with our vendors and business partners…. Our core values should always be the framework from which we make all of our decisions.”

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Input Controls

Seeks to define & direct employee behavior through:

Explicit, codified rules

Standard operating procedures

Considered before employees make business decisions

Example: a budget

Managers allocate money to R&D projects before they begin

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The use of budgets is key to input controls. Managers set budgets before employees define and undertake the actual business activities. For example, managers decide how much money to allocate to a certain R&D project before the project begins. In diversified companies using the M-form, corporate headquarters determines the budgets for each division. Public institutions, like some universities, also operate on budgets that must be balanced each year. Their funding often depends to a large extent on state appropriations and thus fluctuates depending on the economic cycle. During recessions, budgets tend to be cut, and they expand during boom periods.

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Output Controls

Guides employee behavior by:

Defining expected results (outputs), but

Leaving the means to those results open to individual employees, groups, or SBUs

Intrinsic motivation is highest when an employee has:

Autonomy (about what to do)

Mastery (how to do it)

Purpose (why to do it)

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Today, 3M is best known for its adhesives and other consumer and industrial products. But its full name reflects its origins: 3M stands for Minnesota Mining and Manufacturing Company. Over time, 3M has relied on the ROWE framework and has morphed into a highly science-driven innovation company. At 3M, employees are encouraged to spend 15 percent of their time on projects of their own choosing. If any of these projects look promising, 3M provides financing through an internal venture capital fund and other resources to further develop their commercial potential. In fact, several of 3M’s flagship products, including Post-it Notes and Scotch Tape, were the results of serendipity. To foster continued innovation, moreover, 3M requires each of its divisions to derive at least 30 percent of their revenues from products introduced in the past four years.

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Appendices Descriptions of Visual Graphics to Support Student Accessibility Needs

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Appendix 1 The AFI Strategy Framework

The important inside circle is titled "Gaining and Sustaining a Competitive Advantage" that is at the very center of the image, with five different circles on the outside of it. Arrows go back and forth from the center circle to each of the five outer circles. The five outer circles are labeled: (1) Getting Started, (2) External and Internal Analysis, (3) Formulation: Business Strategy, (4) Formulation, Corporate Strategy, and (5) Implementation.

Each of these outer five circles have a brief description beside them to explain what the circle means:

Under the first outer circle titled "Getting Started," it says: Part 1, Strategy Analysis, "What is Strategy (Chapter 1)" and "Strategic Leadership: Managing the Strategy Process (Chapter 2)."

Under the second outer circle titled "External and Internal Analysis," it says: Part 1, Strategy Analysis, "External Analysis: Industry Structure, Competitive Forces and Strategic Groups (Chapter 3)," "Internal Analysis: Resources, Capabilities and Core Competencies (Chapter 4)," and "Competitive Advantage, Firm Performance, and Business Models (Chapter 5)."

Under the third outer circle titled "Formulation: Business Strategy," it says: Part 2, Strategy Formulation, "Business Strategy: Differentiation, Cost Leadership and Integration (Chapter 6)" and "Business Strategy, Innovation and Entrepreneurship (Chapter 7)."

Under the fourth outer circle titled "Formulation: Corporate Strategy," it says: Part 2, Strategy Formulation, "Corporate Strategy: Vertical Integration and Diversification (Chapter 8)," "Corporate Strategy: Strategic Alliances, Mergers and Acquisitions (Chapter 9)," and "Global Strategy: Competing Around the World (Chapter 10)."

Under the fifth outer circle titled "Implementation," it says: Part 3, Strategy Implementation, "Organizational Design: Structure, Culture and Control (Chapter 11)," and "Corporate Governance and Business Ethics (Chapter 12)."

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Appendix 2 Organizational Inertia Results from Failure to Adjust to Shifts in the Environment

This image shows a large oval, which contains four smaller ovals:

1. Mastery of, and fit with, the current environment.

2. Success, usually measured by financial measurements.

3. Structures, measures, and systems to accommodate and manage size.

4. A resulting organizational inertia that tends to minimize opportunities and challenges created by shifts in the internal and external environment.

There are shorter internal arrows titled "External Shifts / PESTEL Factors" which indicate pressures on the firm. A square on the inside of the model is titled "Internal Shifts" such as accelerated growth, a change in the business model, entry into new markets, a change in the top management team (TMT), or mergers and acquisitions.

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Appendix 3 Types of Organizational Structure

This an important evolutionary pattern.

Small firm size, low organizational complexity = simple structure.

Medium firm size, medium organizational complexity = functional structure.

Large firm size, high organizational complexity = multidivisional structure or matrix structure.

As a firm diversifies into different product lines and geographies, it generally implements a multidivisional or a matrix structure.

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Appendix 4 Typical Functional Structure

This image demonstrates that while work in a functional structure tends to be specialized, it is centrally coordinated by the CEO. All positions in this image report to the CEO. A functional structure allows for an efficient top-down and bottom-up communication chain between the CEO and the functional departments, and thus relies on a relatively flat structure.

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Appendix 5 Typical Multidivisional Structure

Corporations may use SBUs to organize around different businesses and product lines or around different geographic regions. Each SBU represents a self-contained business with its own hierarchy and organizational structure. Above all of the CEOs is a president who reports to the board of directors. Also reporting to the president are the Corporate R&D team as well as the corporate HQ staff.

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Appendix 6 Exhibit 11.9 Typical Matrix Structure

The geographic divisions (North America, South America, Europe, Middle East & Africa, and Asia) are charged with local responsiveness and learning. At the same time, each SBU is charged with driving down costs through economies of scale and other efficiencies. A global matrix structure also allows the firm to feed local learning back to different SBUs and thus diffuse it throughout the organization.

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Appendix 7 Open vs. Closed Innovation

This image depicts the closed and open innovation models. In the closed innovation model (Panel A), the firm is conducting all research and development in-house, using a traditional funnel approach. The boundaries of the firm are impenetrable. Outside ideas and projects cannot enter, nor does the firm allow its own research ideas and development projects to leave the firm. Firms in the closed innovation model are extremely protective of their intellectual property. This not only allows the firm to capture all the benefits from its own R&D, but also prevents competitors from benefiting from it.

In the open innovation model, in contrast, a company attempts to commercialize both its own ideas and research from other firms. It also finds external alternatives such as spin-out ventures or strategic alliances to commercialize its internally developed R&D. The boundary of the firm has become porous, allowing the firm to spin out some R&D projects while insourcing other promising projects. Companies using an open innovation approach realize that great ideas can come from both inside and outside the company. Significant value can be had by commercializing external R&D and letting others commercialize internal R&D that does not fit with the firm’s strategy. The focus is on building a more effective business model to commercialize both internal and external R&D, rather than focusing on being first to market

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Appendix 8 The Elements of Organizational Culture

Values, norms, and artifacts are shown as concentric circles. The most important yet least visible element—values—is in the center. As we move outward in the figure, from values to norms to artifacts, culture becomes more observable. Understanding what organizational culture is, and how it is created, maintained, and changed, can help you be a more effective manager. A unique culture that is strategically relevant can also be the basis of a firm’s competitive advantage.

Return to slide

©McGraw-Hill Education.