MBA Programme 2012 Period 3 – January/February 2012 Strategy, Structure and Incentives Professor: Douglas Frank SSI.mailbox@insead.edu Office: EW 1.05, Ext 83035 Assistant: Jessica Verin SSI.mailbox@insead.edu Office: EW 1.15, Ext 83427 Course Objectives A skilled architect can look at a building’s blueprint and know instantly whether the building will stand or collapse. A skilled manager must be able to look at a company’s “blueprint”—its organisational structure and incentive systems—and know instantly whether the company will succeed or struggle in executing its strategy. In this course, you will learn a framework and tools for rapidly diagnosing an organisation’s key strengths and vulnerabilities. We focus on the organisation’s formal structures and systems—the “hard wiring”—and how they shape employees’ incentives to work toward the organisation’s strategic goals. We develop our framework around the three essential questions that top managers must answer when organising for performance and growth: Question Strategy: What business should we be in? Structure: Who should make key decisions? Incentives: How should we measure and reward performance? Sample Topics Covered Vertical Integration Horizontal Expansion Coherent Organisation Design Prototypical Organisation Structures Individual Reward Systems Group Reward Systems Our framework, based on cutting-edge research from organisational economics, synthesizes and deepens concepts from across the core curriculum, from courses as diverse as Prices & Markets, Leading Organisations, Financial Markets & Valuation, and Uncertainty, Data & Judgment. You will learn, for example: • • • The basic elements common to all incentive systems, and why they often fail; The one thing that all organisation structures try to accomplish but never do (and why); What “synergies” really are and why they should drive your organisational design. Along with Industry & Competitive Analysis (ICA), Strategy, Structure and Incentives (SSI) is part of a two-course strategy sequence that explores in depth how firms create and capture value. SSI’s focus is internal (organisational “architecture”); ICA’s is external (market competition). Note that neither course is a prerequisite for the other; students may take them in any order. Who Should Take This Course? This course is ideal for students seeking careers in general management or management consulting. Students pursuing financial careers (e.g., valuation of business strategies) may also find it useful. Summary of Course Content What is the purpose of an organisation? Simply put, it is to encourage employees to make coordinated decisions that create maximum value for the firm’s owners. We explore the implications of this idea in three parts: 1. Incentives: We discuss the main ways organisations hold employees and business units accountable for their decisions. We examine in depth the pros and cons of using Key Performance Indicators (KPIs) as the basis for an incentive system. We explore other levers firms can use to motivate performance. 2. Internal Structure: We discuss the real meaning of synergy and how this drives the need for coherence in the organisation’s activities. We present the main ways of structuring activities in organisations and explain how decisions about structure and incentives are related. 3. Scope of Operation: We take a critical look at common justifications for changing the firm’s scope of activity. We consider how issues of internal structure and incentives affect the scope decision. We examine how the firm can create value through informal partnerships. IMPORTANT TO KNOW!!!! • Attendance at the first session is mandatory. There are no exceptions. Make sure that you schedule your travel plans accordingly. • There is an assignment due for Session 1. This assignment is required. It will be posted on the course web page (http://faculty.insead.edu/frank/ssi/index.html) at least one week in advance. • This is a course about organisations, but it is not an OB course! This course introduces you to a new way of thinking about organisations that complements—but is quite different from—the traditional OB approach. • I regret that I cannot admit auditors to this course. Required or Recommended Textbook(s) There is no required textbook. However, I highly recommend one book. The Modern Firm, by John Roberts, is an excellent treatment of this subject aimed at the educated layperson. In selecting it as the best book about business in 2004, The Economist hailed it as a book that “deserves to be a classic.” If you are serious about this subject, it is a book you should own. Description of Other Readings Readings consist of case studies and articles. Most of these are in the course packet, although I may occasionally distribute some in class. Readings are required unless otherwise noted. To help you use your reading time efficiently and focus on the most important issues, each reading assignment is accompanied by a set of “Guided Reading” questions. I expect you to be ready to discuss both the readings and the preparation questions when you come to class. After each session, I will post links to further readings and resources related to the day’s topic. These are for the benefit of interested students and are purely optional. The Grading Scheme Your final grade will be weighted as follows: Class Participation E-Book Contribution Group Project Group Assignments 40% 10% 30% 20% Description of Grade Components Class Participation: Your class participation grade is based on how much you contribute to your classmates’ learning. You can contribute in many ways: through your preparation (readings, preparation questions, pre-class surveys), pertinent questions or comments in class, and observance of the INSEAD code of conduct (see below). All of these are factored into your grade. E-Book Contribution: For one session, you will contribute a short essay about an organization from (a) your own work experience; or (b) a news article you have read. The essay should discuss how the organization illustrates one or more key takeaways from the session. I will compile all the contributions and distribute them as a PDF book at the end of the course. Group Project: I will assign a case that describes an organisation facing a strategic threat or opportunity. Your job is to create a plan to match the organisation’s strategy and structure to its environment. You will work in groups of four or five. We will discuss the projects in Session 16. Group Assignments: There are two group assignments, one short and one a bit longer. These are designed to reinforce concepts introduced in class and to give some practice in applying them to realistic business situations. INSEAD Code of Conduct The INSEAD MBA Code of Conduct applies in our class, with some modifications (noted in italics): • • • • Attend all sessions of every course, in the section assigned to you. (Attendance at session 1 is required. More than 3 absences may result in failure. Section swaps are allowed in exceptional circumstances only; requests should be sent to the course mailbox at least 24 hours in advance.) Sit according to the seating chart provided. (You will choose your seat in session 1.) Arrive on time and remain in class until the end of the session. Only use mobile devices (laptops, phones, etc.) when directly relevant to class. (These should be switched off and put away at all times.) • • Dress and behave appropriately (no disruptive activities, no food or drink). (Food and drink are acceptable during classes that meet over the lunch hour. Please remove all trash.) Behave tolerantly and with respect towards peers and faculty. Participate actively without being offensive. Outline of Class Sessions Notes: • All readings are required unless otherwise indicated. • An asterisk (*) next to the session number indicates a required poll for that session. Session 1* Introduction: Strategy and Organisation Readings • Besanko, David, David Dranove, Mark Shanley and Scott Schaefer, “Introduction: Strategy and Economics,” in Economics of Strategy, pp. 1-8. Guided Reading Questions 1. On p. 1, the authors give several definitions of strategy. Which of these definitions do you think was in use at your last firm? Based on your experience, why is it hard for firms to achieve their strategic goals? 2. In the section titled “A Need for Principles,” the authors explain why they think the study of strategy should be based on principles rather than “best practices.” Do you agree? How does their view match with your own objectives for taking this course? Part I: Incentives Session 2* Case • • Performance-Based Reward Systems Performance Pay at Safelite Auto Glass (A), HBS Case 9-800-291. Performance Pay at Safelite Auto Glass (B), HBS Case 9-800-292. (Distributed in class) Readings • Besanko, David, David Dranove, Mark Shanley and Scott Schaefer, “The Principal/Agent Framework,” in Economics of Strategy, pp. 455-464. Guided Reading Questions 1. (Case) Why was the productivity of Safelite installers so low? 2. (Case) Does the proposed plan address the problems described in question 1? 3. (Case) If you were in charge at Safelite, what would you do: (a) implement PPP with the reduced guarantee; (b) implement PPP with no reduction in the guarantee; (c) not implement PPP? 4. (Besanko et al.) What examples of a principal/agent relationship can you think of from your own experience? What are the sources of hidden action and/or information that affected the relationship? 5. (Besanko et al.) On p. 458, the authors mention the distinction between (a) hours worked and (b) hours during which the employee puts forth high effort. Thinking of your own previous job, how difficult was it for your supervisor to tell the difference between the two? Session 3* Case • Application: Incentives in a Professional Services Firm Family Feud: Andersen vs. Andersen (A), HBS Case 9-800-064. Guided Reading Questions 1. Why did Andersen go into consulting? (Do not write “to make money.” I want to know why Andersen thought it could make economic profits in this market.) 2. What problems did the firm suffer from prior to the 1989 reorganisation? 3. What were the elements of the 1989 reorganisation (the Dallas and Florida Accords)? How well did these changes address the difficulties present? What new problems were created? Session 4 Limitations of Performance-Based Reward Systems: Risk Readings • Kohn, Alfie, “Why Incentive Plans Cannot Work,” Harvard Business Review, SeptemberOctober, 1993. Guided Reading Questions 1. Why does Kohn think incentive plans can’t work? 2. What do you think of his reasons? Session 5* Case • Limitations of Performance-Based Reward Systems: Multitasking Managing Knowledge and Learning at NASA and JPL, HBS Case 9-603-062. Readings • “3M + GE = ?” Fortune, July 21, 2002. • “Milwaukee Firm Fined $20,000 in Two Pap Smear Deaths,” Chicago Tribune, February 23, 1996. Guided Reading Questions 1. (Case) What are the signs that NASA and JPL have a knowledge management problem? 2. (Case) What are the NASA/JPL knowledge management initiatives? Which one do you think will have the greatest positive impact and why? 3. (Case) Jeanne Holm says that NASA needs to change its knowledge sharing culture. If you were a consultant to NASA, how would you recommend that it do this? 4. (Fortune) What is the 30% rule at 3M? What is it supposed to do, and how well was it working at the time? 5. (Chicago Tribune) How did June Fricano’s incentive system contribute to the problems discussed in the article? How might you have designed her incentives differently to avoid these problems? Session 6* Case • Subjective and Team-Based Systems Continental Airlines: The Go Forward Plan, INSEAD Case 10/2009-5565. Readings • “Incentive Confrontation,” CFO Magazine, January 1, 2003. • Baron, James N. and David M. Kreps, “Reciprocity and Reputation in Repeated Interactions,” in Strategic Human Resources: Frameworks for General Managers, pp. 548565. (Note: This material should be familiar to you from your Prices & Markets course. This reading is provided as a convenient review in case you need it. If you do need it, read just the section titled “Theory,” which ends on p. 559.) Guided Reading Questions 1. (Case) If you were an hourly employee at Continental, how would you respond to the ontime bonus the company is offering? How would you expect your fellow hourly employees to respond? 2. (Case) If you were a Continental shareholder, would you think that the bonus is a good use of your money? Why or why not? 3. (CFO Magazine) What is the source of the problems between Corey White and Idea Integration Corp.? 4. (Baron and Kreps) Describe in your own words the concept of a Nash equilibrium. How is it different from the concept of a dominant strategy? 5. (Baron and Kreps) On pages 551-552, the authors compare the expected payoffs to COL of always cooperating versus finking in the first round, given the strategy described for ROW in the middle of page 551. If the probability of going on to the next round is only 0.2, which strategy yields higher payoffs for COL? Interpret this result. (Hint: What is the benefit to COL of finking in the first round? What is the cost? How does the probability of continuation affect this tradeoff?) 6. (Baron and Kreps) In the section beginning on page 555, the authors demonstrate how A can sustain cooperation through repeated interactions, even if B is a different person each time. Extend this logic to a firm and its employees. Can you think of any reasons why this simplified model of firm-employee interactions is not realistic? Session 7 • Incentives and the Cultural Environment No reading Part II: Internal Structure Session 8* Case • Coherent Organisation Lincoln Electric Co., HBS Case o9-376-028. (Note: You have probably seen this company in your core courses. Don’t worry, we will look at it from a different perspective.) Guided Reading Questions 1. What are the key components of Lincoln’s compensation system? How are they supported by other Lincoln policies/practices? 2. If you were a competitor to Lincoln, what strategy would you adopt? Where does the case indicate that Lincoln is vulnerable? 3. Suppose that Lincoln decides to pre-empt this competitor by adopting the same strategy you just described. Imagine that you are now the CEO of Lincoln. Would your organization change? If so, how? Session 9 Hierarchical Organisation Forms Readings • Rogers, Paul and Marcia Blenko, “Who Has the D? How Clear Decision Roles Enhance Organisational Performance,” Harvard Business Review, January 1, 2006, pp. 1-11. • “The Un-Carly,” Forbes, March 12, 2007. (Note: Focus on the discussion of HP’s organisational change beginning on p. 86.) • “Discounts for Biggest Users are Aimed at Keeping Software Rivals at Bay: Microsoft Sticks with Tough Tactics,” International Herald Tribune, May 15, 2003. Guided Reading Questions 1. (Rogers and Blenko) The authors describe four decision-making “bottlenecks” in organisations. What are they, and what examples do they give for each? Can you think of examples of each from your own experience? 2. (Rogers and Blenko) The authors propose a specific solution to these bottlenecks. Imagine that you have hired them as consultants. What questions might you ask before signing off on their solution? 3. (Forbes) What did Hewlett-Packard’s organisation look like under Carly Fiorina? Why did she set it up the way she did? 4. (Forbes) What did HP’s organisation look like after Mark Hurd took over? Why did he set it up the way he did? 5. (IHT) Why might Microsoft be willing to incur losses to “defeat” Linux in a particular country or region? 6. (IHT) If pricing decisions are delegated to country or region sales managers, explain how the fund described in the third paragraph might increase Microsoft’s overall profits. Session 10* Case • Distributed Organisation Forms Executive Decision Making at General Motors, HBS Case 9-305-026. Readings • “The Man Who Caused Chaos,” The Times (London), May 7, 1998. Guided Reading Questions 1. (Case) How have GM’s strategy, structure, and decision-making processes evolved over time? How well aligned were they in each of the three major eras? 2. (Case) What are the challenges of managing a matrix organisation like GM’s “basketweave”? How does GM address these challenges? 3. (Case) What is your evaluation of the ASB’s decision to centralize responsibility for product development and engineering budgets? 4. (The Times) How would you describe Oticon’s organisational structure under Lars Kolind? Functional form? Multidivisional form? Matrix? 5. (The Times) Do you think that Oticon’s “spaghetti” would work at your old organisation? Session 11* Case • Application: Redesigning a Multinational Organisation Jacobs Suchard: Reorganising for 1992, HBS Case 9-489-106. Guided Reading Questions 1. What are the benefits of coordination for Jacobs Suchard? What are the benefits of entrepreneurship? How are these changed by the integration of the European market? 2. The case mentions two proposals for Suchard’s new organisation: one from the Issenmann Task Force and one from the Harvard Managing Change Team. As a shareholder, which one would you prefer and why? As a Suchard country manager, which one would you prefer and why? 3. Can you think of an organisation that is better than either of the two proposals mentioned in question 2? What would it look like? Part III: Scope of the Organisation Session 12 Horizontal Scope: What Businesses Are We In? Readings • “Behind GE's Interest in Vivendi: A Changing Media Landscape,” The Wall Street Journal, August 29, 2003. • “Revamp Still Intrigues Analysts – Case Study Bayer,” Financial Times, September 21, 2005. Guided Reading Questions 1. (WSJ) Why would acquiring Vivendi create value for GE’s shareholders? 2. (FT) Why would spinning off Lanxess create value for Bayer shareholders? Session 13* Case • Application: Diversified Conglomerates – Value Destroyers? Tyco International (A), HBS Case 9-798-061. Readings • Franko, Lawrence G., “The Death of Diversification? The Focusing of the World's Industrial Firms, 1980-2000,” Business Horizons, 47/4 July-August 2004, pp. 41-50. Guided Reading Questions 1. (Case) How does Tyco evaluate potential acquisition targets? What makes a “good” target, according to Tyco's standards? 2. (Case) At the time of the case, Tyco had 300 individual profit centers. Why is the company better off as a single firm rather than 300 independent firms? 3. (Case) The firm also had six operating divisions. Why is the company better as one firm rather than six independent firms? 4. (Franko) What is the “conglomerate discount,” and where does it come from? 5. (Franko) The author suggests that Tyco is destroying value as a conglomerate. Do you agree? Why or why not? Session 14 Vertical Scope: The Make vs. Buy Decision Readings • Stuckey, John and David White, “When and When Not to Vertically Integrate,” Sloan Management Review, Spring, 1993, pp. 71-83. Guided Reading Questions 1. What, according to the authors, are valid and invalid reasons for vertically integrating? 2. What is asset specificity? Give an example of a specific asset from your own work experience. How does asset specificity relate to the vertical integration decision? 3. Relate the authors’ discussion of “Defending against Market Power” (p. 75) to topics we discussed in Session 12. 4. Relate the authors’ discussion of “Quasi-Integration Strategies” (p. 78) to topics we discussed in Session 12. Session 15* Case • Hybrid Organisational Forms: Alternatives to Make vs. Buy Crown Equipment Corporation: Design Services Strategy, Design Management Institute Case 9-991-031. Guided Reading Questions 1. Why did Crown initially decide to outsource design? 2. How important is the design function to Crown's competitive positioning? Does the “importance” of the input matter for outsourcing decisions? If so, why? 3. How are Fitch's interests different from those of the previous RS owners? Should this matter to Crown? 4. Although Crown is vertically “disintegrated” with respect to design, it is highly integrated with respect to manufacturing. Does each of these scope choices make sense for Crown? Session 16 Group Project Discussion