Market vs. Organization & Strategy Flashcards
Historical Background
Adam Smith (1776):
Market transactions are the
most efficient way to organize economic life.
This early perspective left two important questions unanswered:
* If markets are the most efficient way to organize, why do firms exist?
* And given that firms exist,
how do managers decide which activities to organize within firms while using markets for others?
Why do Organizations Exist?
Coase (1937) argues:
Within a firm, market transactions are eliminated and substituted by entrepreneurial coordination.
Markets & Organizations are considered
as alternative methods of coordinating production.
Focal question of Part 1:
“But in view of the fact that it is usually argued that co-ordination will be done by the price mechanism, why is such organization necessary?” (Coase 1937, p. 388).
“In view of the fact that while economists treat the price mechanism as coordinating instrument, they also admit the coordinating function of the “entrepreneur,” it is surely important to enquire why co-ordination is the work of the price mechanism in one case and of the entrepreneur in another.”
(Coase 1937, p. 389)
Coase (1937) explains that:
* Organizing through markets involves certain costs (transaction costs).
* These may be reduced by organizing activities within firms. * This perspective on Market vs. Organization is called Transaction Cost Economics (TCE).
Transaction Cost Economics (TCE)
TCE focuses on Transactions:
Transfers of goods or services across workgroups where one stage of
economic activity ends and another begins.
According to TCE, transactions can be organized through
3 structural Alternatives:
* Markets
* Hierarchies (i.e., firms)
* Hybrids (such as alliances, franchises, and joint ventures)
Managers should select the alternative that minimizes Transaction Costs:
“(…) a firm will tend to expand until the costs of organizing an extra transaction within the firm become equal to the costs of carrying out the same transaction by means of an exchange on the open market or the costs of organizing in another firm.”
(Coase 1937, p. 395)
Defining Transaction Costs
In TCE, transactions are the unit of analysis and transaction costs are the expenses associated with:
* Searching for qualified exchange partners
* Negotiating and crafting contracts
* Monitoring performance
* Creating dispute resolution mechanisms and haggling when parties revise agreements to meet changing conditions
* Maladaptation costs (that come from being held to a contractual promise even after changing conditions make it costly to do so)
- These costs are driven by the unique attributes surrounding each transaction (i.e., asset specificity, uncertainty, and frequency).
- When transactions involve high levels of these attributes, internalizing activities within firms minimizes transaction costs.
- Otherwise, exchanging with others through markets or hybrids minimizes transaction costs.
Managers should “match” each transaction’s unique attributes to the structural alternative that minimizes transaction costs to maximize firm performance.
Human Nature and its Implications
Exchange Hazards
Williamson (1975) assumes that managers are boundedly rational:
“If information were complete and economic actors were perfectly rational, competent, and trustworthy, transaction costs would theoretically not occur because all contingencies would be known, and economic actors would willingly adjust to these contingencies as needed.”
However, bounded rationality, which stems from humans’ information processing limitations, restricts actors’ abilities to identify qualified exchange partners, establish prices, and write contracts that anticipate all contingencies and sources of potential future conflicts.
This human limitation involves 2 potential exchange hazards that drive transaction costs:
* Opportunism
* Maladaptation
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Exchange Hazards
Economic actors will not only act self-servingly, but also take advantage of others when circumstances permit.
▶️ Because managers do not know a priori which potential partners will act opportunistically, they incur transaction costs to identify the best potential partners and negotiate agreements that will protect them from opportunism.
Maladaptation:
Maladaptation arises because even when economic actors are perfectly trustworthy, circumstances sometimes change.
▶️ Maladaptation creates transaction costs because managers have to disentangle from existing agreements, search out new partners, and negotiate new agreements
= adapt to the new circumstances.
Structural Alternatives of Transactions
- Market Transactions:
Market transactions are simple pay-for-delivery or service exchanges (short-term) between buyers and sellers, sometimes called “arm’s-length” transactions.
Market transactions are often supported by formal, short-term, negotiated contracts. - Hierarchical Transactions:
Describe transactions that take place within one firm. - Hybrid Transactions:
Hybrid transactions are between two or more firms, but involve long-term, greater-than-market commitments such as in alliances, franchises, research partnerships, and joint ventures.
When Should Organizations Chose Which Alternative?
Markets are well suited for simple transactions where the need for coordination among parties is low. When conditions change, the prices adjust to new supply and demand information
(autonomous adaptation).
However, as
* transactions become more complex and
* exchange partners become exposed to potentially costly exchange hazards,
simple adaptation based on price is no longer efficient.
▶️ Value creation becomes dependent on partners’ ability to coordinate outputs. As transactions become more complex, TCE predicts that coordinated adaptation will be increasingly needed when conditions change.
* Managers will move toward hybrid exchanges and eventually hierarchy because they are willing to trade off the incentive power and autonomous adaptation of markets for enhanced authority and coordinated adaptation.
Determining the Choice Between Market and Organization
Williamson (1985) identifies three main transaction attributes that raise the complexity of transacting, give rise to exchange hazards, and drive managers toward hierarchy:
1. Assetspecificityreferstothelevelofuniqueinvestmentsupporting a transaction.
Highly specific assets
(e.g., tooling used to manufacture vs a single product), which are costly
to redeploy without loss in value.
Nonspecific assets
(e.g., a pickup truck), which can be sold or otherwise redeployed without loss.
- Researchers investigated three types of uncertainty:
- Volume Uncertainty
regarding future demand levels - Technological Uncertainty
unknown future trajectory surrounding and emerging technology - Behavioral Uncertainty
managers are unable to evaluate the quality of activities
- Frequency refers to the extent to which transactions reoccur.
Asset Specificity+Uncertainty+Frequency ▶️ Hierarchies
According to Williamson (1985), each of these transaction attributes increases transaction costs and thus leads managers from
Market ▶️Hybrid ▶️Hierarchy
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Examples
- Under conditions of Asset Specificity, Uncertainty (i.e., volume, technological, and behavioral), and Frequency, firms are exposed to potentially costly exchange hazards in markets because there are few authoritative controls. Disputes may be expensive and time consuming to resolve.
- Volume and Technological Uncertainty raise transaction costs by limiting managers’ abilities to anticipate and specify contingencies in contracts. If an unforeseen event requires coordination among parties, one party might exploit the other, or might simply be unable to deliver as needed.
Theoretical Foundations of Organizational Theories
Organizational Theories
[A] Classical Approaches
[A1] Bureaucracy Approach
[A2] Admin. Approach
[A3] Scientific Management
[B] Neoclassical Approaches
[B1] Human Relations Approach
[B2] Incentive Contribution Theory
[C] Modern Approaches
[C1] Human Resource Approach
[C2] Structuralist Approach
[C3] Decision Theory Approaches
[C4] Systems Theory Approach [C5] Postmodern Approaches
Organizational Theories
A. Characteristics of Classical Approaches
A1. Bureaucracy Approach
A2. Administrative Approach
- Organizational orders are the central coordination mechanism for organizations:
The behavior of organizational members can only be coordinated by organizational orders and hierarchy. - Deviations from organizational orders are regarded as disturbance: Deviations should be eliminated by supervision of organizational members
- Stable working conditions:
Homogenous job requirements enable the application of (inflexible) rules. - Organizational research focusses on inner-organizational factors: The optimization of inner-organizational structures ignores environmental influences.
- Employees agree to predetermined organizational order
(labor contract):
Relationships between employees and superiors are characterized by instructions and allegiance.
A1. Bureaucracy Approach
Weber’s (1864-1920) central thesis is that bureaucratic structures are the most efficient tool to coordinate large and capital-based organizations and to ensure the allegiance of organizational members.
- Weber considers organizations as a union consisting of commands & allegiance.
Organizations are not a group of people, but a combination of roles and tasks:
* Ligation of rules
* Strict delimitation of authority and responsibility: Division of labor * Fixed system of under- and super-orders (hierarchy)
* Documentation of all administrative proceedings
* Administrative impersonality
A bureaucracy should run like a “well-oiled machine” and its members should perform with the precision of a highly trained military unit.
A2. Administrative Approach: What Managers Do
Fayol (1841 – 1925) made management visible by defining it and describing what managers should do in a normative way:
* Planning means predicting and drawing up a course of action to meet the planned goals.
* Organizing consists of allocating the materials and organizing the people.
* Leading describes giving directions and orders to employees
* Coordination mainly refers to meetings with the departmental heads to
harmonize the different departments into one unit.
* Controlling means the supervision to what extent the goals were met
and if everyone is following orders rigorously.
Based on these managing activities, Fayol defines 8 organizational principles as instructions for designing efficient organizations.
1. Labor division leads to specialization advantages.
2. Authority & Responsibility should be concentrated.
3. Discipline is the core element of organizations:
members should dutifully respect all organizational conventions.
4. Unity of Command means that every organizational member should be subordinate to exact 1 superior.
5. Unity of Management describes that all efforts,coordination,and orders should be directed at a common objective.
6. Centralization means that decisions should be made at a central place within the organization. The optimal degree of centralization depends on the individual organization.
7. Hierarchy describes the structural arrangement of positions within organizations.
8. Order means that all employees & objects should be organized at a fixed location.
Organizational Theories
B. Neoclassical Approaches
B1. Human Relations Approach
- Classical approaches of organizational theories focus mainly on scientifically- optimized operational processes within organizations.
- During the 1950s, organizational research shifted its focus and began to analyze the relationship between individuals and the organization.
- Behavioral-scientific approaches led to a re-orientation of organizational theories. * Behavioral scientists conducting on-the-job research call for more attention to the
human factor. - Many insights of neoclassical approaches are based on the
“Hawthorne-Studies”, conducted between 1924 and 1932.
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Hawthorne Studies
Background:
* Until the 1920s, the scientific management approach was very successful as it provided solutions to the often chaotic business atmosphere.
* At the same time, concerns arose due its disregard of employee needs:
* Trade unions rebelled against the principles of scientific management.
* As a consequence, time-and-motion studies (the fundament of scientific management) and piecework rate systems were forbidden.
* But: Lack of empirical data to justify paying more attention to human factors.
Empirical Hawthorne Studies:
On-the-job experiments at the Hawthorne plant, a manufacturing subsidiary of AT&T.
Failing expectations:
- Purpose: Examine relationship between the environment & worker efficiency
- Original hypothesis:Improved light increases productivity
- Different light levels: Tests were conducted in 3 different departments
- Result: Productivity increased in all investigated departments.
No relationship between productivity and lighting levels - Conclusion: Other factors drive productivity across departments. In subsequent studies, researchers analyze the influence of many other variables (e.g., length of the workday, temperature).
But after one year, the researchers fail to find any correlation between working conditions and output. - Insight: Being part of experiment = personal interest in well-being drives productivity increase.
Main Results:
Managers & Researchers recognize the powerful effect of * individualneeds,
* supportivesupervision,&
* groupdynamicsonjobperformance.
Increase in productivity was influenced by the motivating effect of * Special status of being investigated
* Participation subjects were informed about the experiment
* Supervision by an experimenter
* Support of & mutual dependence within their working group
Later research at the same plant revealed 2 additional insights:
* Informal working groups exist within formal working groups. Members of informal groups do not necessarily belong to the same formal group.
* Workers were more responsive to the social forces of their peer group than to the controls and incentives of management.
B1. Human Relations Approach
- Based on Hawthorne-Studies, the human relations approach focusses on
- socio-emotional factors influencing the
- performance of organizational members.
- In contrast to classical approaches, this perspective proposes that the performance is determined not only by compensation and working conditions, but also by human relations.
Advocates claim that the higher productivity realized in the Hawthorne-Studies is the result of a change in social relationships between the investigated subjects:
▶️ Employees are proud to be included in the experiment, being supervised by a researcher, and are involved in improving their own working conditions
- The human relations approach is the first approach to recognize and include informal relationships between organizational members.
▶️ Emotions, for decades considered a negatively interfering factor,
is now regarded as a positive source of productivity.
Organizational Theories
C. Modern Approaches
C1. Human Resource Approach
In contrast to classical & neoclassical approaches, these modern approaches are
* comparatively heterogeneous,
* integrate manifold perspectives on organizations, and * partially compete against each other.
▶️ There is no coherent framework integrating all modern approaches.
Following slides contain an (initial) overview on modern
approaches.
C1. Human Resource Approach
The human resource approach is based on the principles of the neoclassical human relations approach, which treats organizational structures as fixed surrounding conditions.
Recap:
* The human relations approach (neoclassic) gave rise to the integration of socio-economic factors driving the productivity of organizational members.
* Management needs to consider socio-economic factors to influence activities of organizational members within predetermined organizational structures.
Distinguishing feature of the human resource movement:
▶️ Organizational structures are no longer regarded as fixed settings, but subject to structural change to promote the motivation of organizational members.
C1. Human Resource Approach (III): Focal assumption
Traditional organizational structures prevent employees from developing initiative and a sense of responsibility as they emphasize dependency and naïve allegiance:
* Strong division of labor and specialization * Unity lines of command
* Separation of planning and execution
Ultimately, inflexible structures lead to a waste of human resources.
C1. Human Resource Approach (IV)
The human resource approach accentuates the development of new organizational structures, which
* consider human needs, and
* allow a more efficient use of human resources.
▶️ Organizational structures have to be efficient & human at the same time.
▶️ Organizational structures should allow and support the matching of organizational & individual objectives.
C1. Human Resource Approach (V)
Organizational structures should promote:
- opportunities for the individual development of organizational members
- participative decision making
- confidence in interpersonal relationships
- manifold communication mechanisms
- team work
- self-control (in contrast to external control by superiors)
Management Summary (I)
- At the beginning of analyzing entrepreneurial firms, organizations need to trade off whether activities should be executed within the boundaries of organizations (hierarchies), outside of these boundaries (market), or in hybrid forms.
- Transaction Cost Economics (TCE) is the most famous theoretical foundation of this trade off.
Management Summary (II)
- Since 1900s, organizational researchers developed manifold organizational theories, which can be classified into
- Classical approaches
- Neoclassical approaches * Modern approaches
- These organizational theories are the foundation of the analysis of modern organizational structures, which are the focus of the next sessions.
- We will structure the content of the next lectures based on the following framework.
Strategy
Alternative Views of Strategy
The Implicit Strategy Model of the Past Decade
- Ideal competitive position in the
industry - Benchmarking of all activities and achieving best practice
- Aggressive outsourcing and partnering to gain efficiencies
- Advantages rest on a few key success factors, critical resources, and core competencies
- Flexibility and rapid responses to all
competitive and market changes
Sustainable Competitive Advantage
- Unique competitive position for the firm
- Activities tailored to strategy
- Operational effectiveness a given
- Clear trade-offs and choices vis-à-vis
competitors - Competitive advantage arises from
fit across activities - Sustainability originates from the
systematic activities, not its parts
Strategy
What is Strategy?
Strategy can be considered as a collection internal guidelines defining the relationship between a firm and its environment.
Strategy is the creation of a position which is
* unique
* valuable
* sustainable
What is Strategy? (II): Strategy requires trade-offs on competing
It requires also choosing what not to do:
* Some competitive activities are incompatible with each other;
thus, gains in one area can be achieved only at the expense of another area.
For example, Neutrogena soap is positioned more as a medical product than as a cleansing agent. The company says “no” to sales based on deodorizing, gives up large volume, and sacrifices scale in manufacturing efficiencies
What is Strategy? (III): Strategy involves creating a “fit”
- Fit describes the ways a firm’s activities interact and reinforce each other
- Fit reinforces both competitive advantage and sustainability:
when activities mutually reinforce each other, competitors cannot imitate them easily. - Decisions on which target group of customers and needs to serve requires discipline, the ability to set limits, and straight communication.
▶️ Hence, strategy and leadership are inextricably linked.
For example, Vanguard Group aligns all of its activities around
a low-cost strategy; it distributes funds directly to consumers
and minimizes portfolio turnover.
Overview: What is Strategy?
These basics of strategy lead to the following three key elements that are considered the foundation of strategic positioning:
1. StrategyRestsonUniqueActivities
2. ASustainableStrategicPositionRequiresTrade-Offs
3. StrategicFitDrivesBothCompetitiveAdvantageandSustainability
strategy
Unique Activities (I)
- Competitive strategy is about being different. It means deliberately choosing a different set of activities to deliver a unique value.
For example, IKEA, the global furniture retailer, has a unique and obvious strategic positioning. IKEA targets young furniture buyers who want style at low cost. What turns this marketing concept into a strategic positioning is the tailored set of activities that make it work.
Unique Activities (II)
There are three Origins of Strategic Positions
a. Variety-based positioning
b. Needs-basedpositioning
c. Access-based positioning
Unique Activities: (a) Variety-Based Positioning
Based on the choice of product or service varieties rather than customer segments.
Variety-based positioning makes economic sense when a firm can produce particular products or services best using a distinctive set of activities.
For example, Jiffy Lube International specializes in automotive lubricants and does not offer other car repair or maintenance services.
Unique Activities: (b) Needs-Based Positioning
Closer to targeting a specific segment of customers. It arises when there are groups of customers with differing needs, and when a tailored set of activities can serve specific needs best.
▶️ Needs-based positioning is effective when groups of customers with differing needs exist in the market, and when a tailored set of activities can serve those needs best.
For example, in private banking, Bessemer Trust Company targets families with a minimum of $5 million in investable assets who want capital preservation combined with
wealth accumulation.
Unique Activities: (c) Access-Based Positioning
Access can be based on customer geography or of anything that requires a different set of activities to reach customers in the best way. Segmenting by access is less common and less well understood than the other two sources.
▶️ Access-based positioning makes economic sense when customer needs are similar but a different set of activities can be used to reach them.
For example, Carmike Cinemas operates movie theatres
exclusively in cities and towns with populations
below 200,000.
Unique Activities: Summary (I)
- Positioning is not only about carving out a niche. A position emerging from any of the 3 different sources can be broad or narrow.
- A focused competitor, such as IKEA, targets the special needs of a subset of customers and designs its activities accordingly.
- Regardless of the source or definition - variety, needs, access, or some combination of the three, positioning requires and rests on a tailored set of activities. This specific set of activities is a function of differences on the supply side; that is, of differences in activities.
- However, positioning is not always a function of differences on the demand-side (customers). Variety and access positioning, in particular, do not rely on any customer differences.
