strategy execution - Southern Methodist University

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Strategy Execution - Chapter 4 in
Strategic Thinking
A Strategic Management Textbook
Gordon Walker
Professor
Cox School of Business
Southern Methodist University
Dallas TX 75275
Introduction
How firms build and maintain resources and capabilities is the key to
understanding strategy execution. Firms in an industry typically cluster into distinct
market positions and at the same time to differ in how well they execute their strategies.
Within a cluster of highly similar market positions, based on a set of value and cost
drivers, one firm may perform well and another relatively poorly. This variation in the
ability to execute emerges over time as the industry develops and firms experiment with
alternative dynamic growth paths, some of which succeed better than others.
Examples of interfirm differences in the ability to execute are present in every
industry. For instance, in the late 1980’s and 1990’s Bank of America developed a
distinctly different and ultimately more successful set of capabilities from Banc One in
the race to dominate national commercial banking through acquisition. Southwest
Airlines succeeded in taking over the California low-cost market previously controlled by
PSA, from whom it originally learned the low cost model. And Dell’s growth and
economic performance surpasses other top tier personal computer firms, all of whom
have attempted to copy its model, albeit unsuccessfully.
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Resources. A resource is a relatively stable, observable asset that gives the firm
a sustained advantage over rivals. Examples of resources are:
 a patent or combination of patents
 ownership of an abundant or especially valuable natural resource
 an established brand
 a dedicated distribution network.
Some resources, such as a patent or geographical location, can retain their value over
time with little managerial attention. Other resources, such as a brand or specialized
distribution channel, need to be husbanded through the ongoing execution of specialized
capabilities.
To provide an economic advantage, a firm’s resource must contribute to the
firm’s value or cost drivers, leading to increased revenues or lower costs, and be difficult
for competitors to imitate or to neutralize through substitution. Consider two stone
quarries at different distances from a construction project. The closer quarry is a more
valuable resource in that its location lowers transportation costs and there is no possibility
of imitation or direct substitution. So the higher profits the quarry makes are sustainable.
Some resources can be critical to a firm’s economic performance. Coca-Cola has
built a large global presence in soft drinks on the basis of Coke’s taste, which comes from
the special syrup whose formula the company owns. The firm closely guards the syrup’s
secret ingredients to prevent competitors from imitating it. Without this syrup, it is not at
all clear that Coca-Cola could have achieved such a wide acceptance of its product. Nor
could this acceptance have been sustainable.
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Resources are typically not a target for major innovative activity. In fact,
innovation may actually degrade the value of the resource, as the introduction of New
Coke confused customers and led to a decline in sales. When Coca-Cola realized their
mistake, New Coke was withdrawn.
Resources are typically tradeable in the sense that they can be put up for sale by
the firm and valued by potential buyers. However, as we will see below, the value of a
resource depends on how much its contribution to economic performance is independent
from other aspects of the owner. In the case of the stone quarry, the lower transportation
costs would accrue to its owning firm, no matter who it was. But in the case of CocaCola, it is not clear whether other Coke resources and capabilities - in activities such as
operations, logistics, marketing and distribution –complement the formula to make it
more valuable. How much the value of a resource depends on other resources and
capabilities in the selling organization is therefore a key question when a resource is put
up for sale.
Capabilities. A capability denotes the ability of a firm to accomplish tasks that
are linked to higher economic performance. These tasks are performed over time through
the coordinated efforts of teams whose memberships change even as the practices
involved persist and improve. These practices are generally highly specific to each firm
and therefore hard to describe in detail. Nonetheless there is often little controversy about
the contribution specific capabilities make to the firm’s economic performance. Intel’s
superior ability to innovate within its microprocessor platform is widely perceived as a
key element in building its market dominance. Intel’s major rival, AMD, has had to
develop a comparable expertise in innovation in order to stay in the market. The process
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Intel uses to produce new product versions entails extensive interunit coordination and is
not separable from Intel as an organization. The firm’s capability therefore cannot be
traded as one might buy and sell the patents the capability produces.
In contrast to a resource, a capability is likely to be both less stable and less
fungible. It is less stable since it is developed and sustained through the coordinated
efforts of individuals, who may change over time. Capabilities are thus dynamic,
improving or declining as a firm grows, reorganizes, or gains or loses key personnel. A
capability cannot be traded like a resource, since it is embedded in the firm’s processes.
So if another organization wanted to buy the capability, it would have to buy the
organization itself, or at least the unit in which the activities that defined the capability
were performed.
Some capabilities can contribute to economic performance without being attached
to a resource, as long as the people who enable the capability are inalienable from it.
When organizations focus on building expertise in a specific domain of activity, this
expertise itself, independent of the firm’s resources, can constitute a source of sustained
economic gain. As the sidebar discusses, a deceptively simple activity such as forecasting
itself can be a significant input to economic performance.
***************************
(begin sidebar)
Forecasting Ability as a Capability1
Just as the effective use of better information improves the ability of a firm to
pick resources, forecasting in general is used in a broad array of activities within the firm
such as the development of new products, personnel hiring, capacity planning, and
pricing. Every function in the firm, from marketing research to human resources to
technology development to the controller’s office, requires some estimate or expectation
of the way the future will look.
For forecasting to be a capability, it must contribute to an economic surplus for
the firm. Moreover, the firm should appropriate this surplus, specifically by not passing it
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on to customers as a result of competition in the product market. Also, these benefits
should lead to the firm’s growth so that the capability is developed further through
reinvestment from an expanding pool of resources.
Forecasting ability can be measured through the relationship between a firm’s
investments and subsequent market trends that affect the value of those investments. A
simple example of this type of relationship is the prediction of short-term interest rates by
money market mutual funds. When interest rates go up, the value of debt securities goes
down; and when interest rates go down, the value of debt securities goes up. Therefore, if
a money market fund could forecast interest rates accurately, its best policy would be to
invest in short-term maturity debt when interest rates were about to rise and long-term
maturity debt when rates were about to fall. Do some money funds do this systematically
better than others? The answer is yes.
On average, money market funds do not forecast interest rates well. But some
funds beat the average by a wide margin. The more accurate a fund’s forecasting, the
more money it makes. If a fund could forecast rates perfectly, its gross (but not net) yield
would increase 25 basis points, a very large amount of money in the trillion-dollar world
of short-term debt. Since net yield is what fund shareholders receive, funds tend to keep
the economic rents better forecasting gives them. Forecasting accuracy also increases the
fund’s net assets, and fund size predicts better forecasting. So forecasting accuracy in
money market funds is a capability in that it is:
1) specific to each organization;
2) determined by organizational processes as well as individual ability;
3) predictive of economic returns that the organization keeps; and
4) related to organizational growth, both as a cause and a consequence.
One could speculate that other types of forecasting would also be capabilities. In
theory, to show that one of these types, or any other activity for that matter, is in fact a
capability, one would want to be able to measure it and relate it to performance over time,
just as has been done for forecasting ability in money market funds. In practice, however,
this can be quite hard to do. In the absence of clear measures and methods, we typically
make sensible guesses about which activities define capabilities in an organization and
about how strongly they are related to performance.
(end of sidebar)
*****************************************
Relating Resources and Capabilities. It is common for capabilities to
contribute to the firm’s performance by supporting resources, as alluded to in the
example of Coca-Cola above. Consider companies that market fashion goods, such as
Esprit and Polo, are organized to build and maintain their brands. To do so, these firms
have developed highly effective techniques for selecting and managing their suppliers.
These techniques are directed at maintaining a high level of quality in the firm’s branded
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goods at an appropriate cost level. Without the capability in supplier management, there
would be higher variance in product quality and the brand’s value would decline.
Caterpillar Tractor’s distribution network is another example of crucial resource
supported by a key capability. Cat’s dealers are a central part of their sales and service
activities. Many dealers have been in place since World War II, building their franchises
as the global post-war economy grew. They provided fast, expert service to contractors
working under deadlines. Without this rich and highly competent network, it is not clear
that Cat would be able to withstand the competitive pressure of rivals such as Komatsu.
Yet it is Cat’s activities in managing and supporting its dealers - through incentives,
component supply, and marketing programs - that maintains the value of the dealers to
the company.
Returning to the discussion above regarding resource valuation, it is clear that a
firm’s expertise in exploiting a resource determines its value. When firms bid against
each other for an asset, the winner’s ability to extract a higher economic return from it
determines in large part the amount paid (see the sidebar below). The winning firm’s
projected economic returns from purchasing it are simply higher, assuming the bids are
based on valid information. Successful U.S. bank holding companies, such as Banc One,
Nationsbank and First Union grew during the 1980’s and 90’s by developing effective
methods for turning around small to medium sized local banks. The premium paid for
these targets reflected expected long run gains based on acquirer abilities to integrate the
new bank and improve its return on assets. Cisco has pursued a similar acquisition
strategy to broaden and refresh its product line in the telecommunications hardware
market. For the banks, the primary resources acquired are the target’s book of business
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and relationships with customers. For Cisco, Nortel and their competitors, the resources
are the target’s technology and people. In both cases, the firm’s ability to exploit the
resource by integrating it with existing systems justifies in part how much the firm pays
to buy it.
*********
(Begin sidebar on Makadok’s model relating resources and capabilities)
Richard Makadok2 has explored three fundamentally different ways a firm can
become more profitable than its competitors. His framework is the context of two firms
bidding for a resource, such as a plot of land or piece of machinery, in an auction. The
three ways are:
 When the asset is more complementary with the resources of one
firm than the resources of the other;
 When one firm has a stronger ability, over its competitor, to
forecast the value of the asset post-acquisition;
 When one firm has capabilities that contribute more strongly,
relative to the capabilities of the competitor, to the asset’s
performance post-acquisition.
Resource complementarity. The degree of complementarity between the asset
being auctioned and the existing resource bases of the bidding firms determines the lower
bound for each firm’s offer. A higher level of complementarity produces a higher
expected value of the asset to the firm and therefore a higher bid. For example, when
American Airlines bought TWA’s assets in a bankruptcy sale in 2001, its bid exceeded
other airlines (and had more credibility) largely because TWA’s hub cities and route
structure complemented American’s routes very nicely. TWA’s St. Louis hub was
geographically well placed between the American hubs in Chicago and Dallas. Also, the
overlap between the routes of the two airlines was quite small – only about 12%.
Consequently, the acquisition did not cannibalize American’s current routes, and there
was little basis for an antitrust suit. American’s expected profit for TWA was therefore
simply higher than the values assigned to it by Continental and Northwest, the competing
bidders.
Forecasting. The second factor – more effective forecasting –improves the profits
of the firm whether it acquires the resource or not. Makadok calls this factor “resource
picking.” The idea is that better forecasting - based on the firm’s more reliable
information sources– produces a more accurate expected value of the asset.3 When it has
a more accurate valuation compared to its competitor, the firm neither buys the asset with
a bid that is too high nor loses the auction with a bid that is too low. By not overbidding,
the firm makes more money since its acquisition cost is lower. On the other hand, by not
underbidding, the firm does not lose the profits it would gain from owning the resource.
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Returning to the example of the American-TWA acquisition, American had extensive
knowledge of TWA’s assets based on a long history of previous transactions between the
two airlines and on a detailed due diligence beginning three months before TWA filed for
bankruptcy. This information sharpened American’s valuation of TWA compared to
other the other bidding airlines.
Capabilities. The third and last factor is the firm’s capabilities to the value of the
resource after it is bought. The higher the contribution of these capabilities to the profits
produced by the asset, the more the resource is worth to the firm. Using the AmericanTWA acquisition as an example for a third time, American had developed a very strong
expertise – called yield management - in achieving a high average revenue per seat.
Because TWA’s revenue per seat was substantially lower, one of American’s motivations
for acquiring TWA was to apply its yield management capability to TWA’s routes,
thereby increasing their profitability. Interestingly, the costs of the two airlines were
about the same, so there was little American could do to improve TWA’s efficiency after
the acquisition.
Which factor is more important? To begin, investing in any of the factors will
always produce higher return from the asset. However, how much of a return each factor
produces is contingent on an important condition. In Makadok’s approach, a firm’s
resource complementarity with the target asset is fixed and establishes the baseline price
the firm is willing to pay for a new asset. But the difference in complementarity between
the firms plays a critical role in determining the relative importance of investing in
forecasting or capabilities.
In general, capabilities increase expected profitability, whereas the benefit of
resource picking skill is contingent on the distribution of resource complements between
the two bidders. When there is a large difference between the two firms, investing in
forecasting is not so important, since the firm with the larger complementarity will buy
the asset anyway. On the other hand, when no firm has a distinct edge in resource
complements, it is a good idea to invest in forecasting since it increases the chances that
the firm will make the most profitable bid. Capabilities in turn become increasingly
important as the likelihood of acquiring the asset increases. This is so since the
contribution of capabilities is not realized unless the firm wins the auction. So when a
firm has strong resource complements with the asset, relative to competitors, forecasting
ability is not very important but capabilities are. On the contrary, when the firm has
relatively weak complements, an investment in capabilities raises the asset’s expected
value to the firm, making the value closer to that of the competitor and therefore
increasing the importance of forecasting. Note however that the investment in improving
capabilities is warranted only if better forecasting increases the likelihood that the asset
will be bought.
(end of sidebar)
*********************
Building Capabilities
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To be useful as a concept, a capability must be associated with specific activities
and programs within the organization. Superior customer service, for example, requires
personnel selection, training and recognition programs and in many cases supporting
information systems that provide solutions to customer problems quickly. The design,
implementation and monitoring of these programs and systems obviously entails
management’s understanding of their economic value and the use of technical and
administrative expertise. The major dimensions of this expertise in developing
capabilities in general can be summarized as follows (see Figure 1):
 Consistency or complementarity among the firm’s resources, tasks and
policies is achieved when they are jointly aligned with the requirements of the
firm’s market position. A useful way to think about the combination of the
firm’s tasks and resources is as an activity system that develops over time,
more or less consistently, to position the firm in its market.
 Control and coordination systems are the infrastructure through which tasks
are designed and executed. Without the direction of these systems, capabilities
could not emerge and endure within the firm.
 The firm’s compensation and reward systems focus attention on strategically
important tasks. These systems direct ability and effort towards achieving the
firm’s goals in its market position.
 The selection and development of the firm’s people through its formal
procedures and the strength of the firm’s culture are key components of
capability building and effective decision-making. If the right skills for
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decision-making are missing in important areas within the organization, no
market position can be sustained for long.
From the perspective of strategy execution, these four factors are managed to support the
specific capabilities necessary for success in the firm’s market position.
Complementarity and Consistency. Complementarity and consistency have
similar but not identical meanings. Two or more resources may be complementary in that
together they produce a more effective outcome than either produces independently. 4
Complementary resources and capabilities reinforce each other in support of achieving
economic goals. An activity may be consistent with the firm’s strategy without
interacting directly other activities. To compete in a market, every business requires the
execution of a combination of activities - such as technology development, operations,
marketing and financial control. The concept of consistency or fit implies that the policies
and practices of each activity are aligned with the demands of the firm’s market position.
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Consistency applies to all activities, whether performed in-house or sourced from
market suppliers. For example, an extensive warranty program may signal commitment
to product quality for a firm differentiating itself on this competitive dimension.
Alternatively, a procurement policy with a stringent purchase price variance target would
be consistent with the strategy of a cost leader.
*******
(Begin sidebar on channel complementarity in internet retailing)
The rise of internet retailing provides an interesting and useful case for examining
the potential for complementarity between types of marketing channel within firms. In
the 1990’s many retailers began to accept e-commerce as a means of attracting
customers, as internet startups selling almost every type of good entered the market. The
incumbent retailers came in three varieties. One group, like Lands End, sold through
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catalogues. A second group, like the Gap, sold through stores. Finally a third group, like
J.C. Penney, sold through both a catalogue and stores.
As the “pure play” internet retailers began to fail in the early 21st century, a
growing consensus emerged in the management press that multi-channel retailers would
in general outperform startups and come to dominate the internet. One rationale for this
assertion was that multi-channel retailers had established brands, enabling them to earn
higher margins on more frequent purchases and to promote their internet channel more
effectively. A second argument for the success of multi-channel retailers online was that
they could leverage their existing infrastructure to enable order fulfillment and facilitate
the processing of orders and returns.
Interestingly, while both catalogue and “bricks and mortar” firms both had brand
equity, the types of infrastructure they brought to their internet operations were quite
different. Catalogue companies typically have a larger number of products, more
extensive order-processing capability, a network of distribution centers, and an ability to
forecast sales for catalogue items, which are typically those that are sold on the firm’s
website. Companies with stores only have a transportation network for carrying goods.
Not surprisingly, then an analysis of internet sales for incumbent retailers shows
that those firms that have catalogue operations experience a significantly greater growth
than those firms that have only stores. But, interestingly, the companies that have both
catalogue and stores do better than catalogue only. These findings hold up even when the
size of the firm is included in the analysis.
The implication then is that the catalogue channel for a retailer is an important
complement to the internet and that stores add value to internet sales only in the presence
of catalogue operations. This channel complementarity captures the interaction among
both resources and capabilities across the firm. The interaction is based first on the added
value to the internet of specific operational assets and practices in the catalogue business
and second on the shared marketing benefits provided by catalogue and stores together.6
(end sidebar)
****************
The Value Chain. A useful way to analyze a firm’s consistency and examine
impact of activities on strategy execution is Porter’s value chain diagram.7 As shown in
Figure 2, the value chain is composed of nine activities. Five of these – inbound logistics,
operations, outbound logistics, marketing (which includes distribution and sales) and
service - are primary in the sense that they represent a flow of goods and services from
inputs (inbound logistics) to the sale and service of final outputs (marketing and service).
The remaining four activities – technology development (in both products and processes),
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procurement, human resource management, and infrastructure (which includes the
organization’s reporting structure as well as accounting and control systems) – are
secondary in that they can be part of each of the primary activities. For example,
technology development – when viewed as process innovation - can be found in all five
primary activities. In many organizations, process improvements occur continuously in
both inbound and outbound logistics, in operations, in marketing and in customer service.
As product innovation, technology development can be located in research and
development or a product-engineering unit.
In many cases, the value chain of a specific firm is likely to be broader and more
detailed than Porter’s framework. There may be sub-activities that are important to
emphasize - such as fulfillment, a distribution activity, that is important in retail internet
companies, or ERP software systems, a key infrastructure component for manufacturing
and processing firms. However, the simple value chain shown in Figure 2 is often a
useful representation of a single business since it captures the basic functions that need to
be performed to deliver a product or service to a customer.
The value chain is also helpful for discussing the execution challenges found
among firms in the same industry. Firms will differ on how strongly they have invested in
any value chain activity, even firms in the same market position. There are also likely to
be differences among firms in how they coordinate investments across activities. Firms in
an industry are likely to differ in whether they perform a value chain activity or whether
an outside supplier performs the activity for them, as discussed in Chapter Five.
Activity Systems. A broader framework for describing the firm’s components for
strategy execution is an activity system.8 Activity systems are composed of any aspect of
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an organization that contributes to its key value and cost drivers. Such a system can
contain policies in value chain activities, general characteristics of the firm’s structure
and culture, product attributes and key resources such as technologies and brands. The
benefit of understanding and mapping a firm’s activity system is that it shows how
extensively these elements relate to and reinforce each other. Further, when the mapping
is made over time, one can observe whether consistency is increasing or not (see the
sidebar below).
*******
(sidebar on the evolution of consistent activities at Vanguard)
Nicolaj Siggelkow has mapped the activity system of Vanguard, the mutual fund
company, over time in order to identify how it evolved.9 The system is important for
understanding the emergence of Vanguard’s achievement of a significant cost advantage
over other mutual fund companies. The system’s elements include value chain activities,
such as service (high quality), investment management (outsourced at low fees),
distribution (direct), human resource management (college graduates, no Wall Street
veterans, no perks for management) and infrastructure (fund administration in-house).
Vanguard was very careful in how it handled or outsourced each activity in order to
achieve higher value at lower cost. The activity system also includes cultural attributes,
such as candid communication, a zeal to restructure the industry through Vanguard’s
innovations, high esprit de corps, and the significant influence of John Bogle (Vanguard’s
chief executive) on the company. At the center of Siggelkow’s map of Vanguard are a
group of core elements such as its emphasis on low operating cost and its focus on a
broad product line of conservatively managed funds. The elements of the system
reinforce each other to produce a high economic contribution to the customer, primarily
driven by low costs.
How did this system evolve? Siggelkow shows that the evolution involved four
distinct processes: patching, thickening, coasting, and trimming. Patching involved the
addition of a new core element to the system. In the 1970’s, for example, Vanguard
brought distribution in-house to lower costs and added an emphasis on high quality
service as core policies to improve its market position. Thickening occurred when
Vanguard added activities around a core element. For example, to remain faithful to its
focus on low cost, a central element of the system, Vanguard instituted a “partnership
plan” for employees, rewarding them improvements in the company’s expense ratio
relative to the industry average. Coasting entailed the continuation of the activity system
without changes. And trimming meant the deletion of a core element, and the elements
attached to it, when they failed to fit the direction of the other parts of the activity system.
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At Vanguard, no core element ever became inconsistent with the others, so trimming was
not observed.
Consistency, value advantage and cost advantage. The two end points of the
spectrum of market positions in an industry – extreme value and cost advantage – require
consistent execution. Successful value and cost leaders endure because their policies are
designed and executed within a single strategic framework. It is in these extreme market
positions that consistency makes the most sense. Exemplary cost leaders, such as
Vanguard in mutual funds and Southwest Airlines, set policies and design their activities
within a single framework of keeping expenses low. The activities support the strategy by
keeping their own costs down and by lowering systemic costs through effective
coordination. Value leaders, such as Mercedes-Benz, are consistent in their emphasis on
the key factors that make their products or services different and worth the premium
customers pay for them. The Mercedes unit of Daimler-Chrysler has built an organization
of skilled workers for making and installing a wide variety of high-grade materials and
components, using robots for only 30% of the fabrication and assembly, compared to
70% in the plants producing lower cost Chrysler cars.
The internal consistency of firms with successful value or cost-based market
positions constitutes a formidable barrier to less developed organizations. The alignment
of the policies and activities with each other, which is only partially observable, is
typically the result of extensive learning that cannot be replicated. The ability of a firm to
build and maintain fit among activities in order to support a market position represents a
capability in itself.
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The pitfall of consistency. A high level of consistency provides superior
economic returns for well-positioned firms in markets that have stable structures of
competition. However, the more consistent an organization’s activities, the more difficult
they are to change. The reason for this effect is that consistency is driven by and fosters
adherence to a few decision rules that together define the organizing principles of the
firm. When customer preferences change or new technology enters the market, the firm
may face shrinking demand in its segment and be required to change its market position.
A high level of consistency in its activities will make this shift more difficult to achieve.
Kodak suffered as a differentiator when Fuji aggressively entered the U.S. market for
film with low prices, drawing customers away from the traditional brand. Kodak’s
transformation into a more aggressive, lower-cost firm has taken many years as its
commitments to differentiation were broken. Johnson & Johnson, a highly consistent
differentiator in health care products, has faced similar challenges as its market shifted
towards lower priced goods.
Control and Coordination Systems. Building capabilities entails
developing procedural systems and systems of authority and cooperation. To be effective,
these systems should be focused on the specific capabilities needed to achieve high
performance within the firm’s market position. The stronger this focus, the more
effectively the firm executes its strategy. The more diffuse the focus, the less effective the
execution and the more likely other firms will have higher returns and be able to control
industry development.
A firm’s formal control systems for managing and allocating financial resources,
such as its budgeting and financial reporting systems, determine which capabilities will
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be built and sustained. These systems contain the spreadsheets managers focus on in
order to achieve objectives for revenues and expenses. No firm can survive for long
without setting viable and integrated financial targets at each management level.
However, the strategic significance of the specific line items for which targets are set
needs to be established and well understood so that specific investments are tied to
capabilities for strategy execution.
For example, in a host of service businesses, such as insurance, investments,
transportation, and telecommunications, managing the complex interface with customers
has become an important task in achieving a high level of customer retention. Customer
retention on average lowers the cost per customer, smoothes cash flow, and perhaps
increases revenues through cross-selling. The customer interface commonly involves
contact points across sales, marketing, and operations, with significant support from
information systems. Activities in each of these functions contribute to building a
customer retention capability. However, such a capability is vulnerable to tradeoffs
between enhancing the quality of interaction with current customers and the alternative of
achieving other strategic goals, such as market penetration. These tradeoffs are reflected
in how managers allocate resources over time. Managers are unlikely to invest in building
a capability to increase retention unless the firm has committed to it as an important part
of its strategy.
Coordination systems in turn determine how projects will be executed, using the
assets of the firm's various units. Without effective coordination within and across units,
no market position can be sustained for long. Coordination entails aligning the work of
units to achieve higher performance, where the amount of interaction depends on how
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closely coordinated the units need to be. The alignment is achieved through shared
information and influence within and across projects and through the exercise of top
management authority.
Galbraith presents five mechanisms for achieving interunit coordination, in
addition to the use of hierarchical authority: 1) standardized procedures, 2) joint
planning, 3) liaison personnel, 4) task forces with members from both groups, and 5)
teams joining the units. 10 These mechanisms are effective in managing different levels of
information processing requirements, which increase with the complexity and rate of
change of information. Procedures work when interunit coordination is highly
predictable, but they break down when changes in specifications become frequent. Joint
planning then emerges to set targets and resolve inconsistencies between current
procedures and coordination requirements. Planning in turn becomes less effective as
uncertainty increases, leading to liaison assignments to manage ongoing changes in
transfers or asset sharing. If the scope of coordination is larger than the capacity of a
liaison role, interunit task forces are instituted, and then if necessary teams, which have
greater permanence and depth. As new coordination mechanisms are added to handle the
increments in information processing requirements, the earlier mechanisms typically
remain in place. Thus, as the complexity and dynamics of information transfer between
two units rise, the interface between the units becomes more complex.
Within a single business, increasing information requirements between units is
justified if it leads to creating capabilities that raise firm performance. Just as financial
control systems determine how resources are invested in capabilities, coordination
mechanisms enable their development. Specifying the sources of complexity and change
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is therefore a key task in strategy execution. If these sources are consistent with the firm’s
strategy, then investing in additional coordination mechanisms is necessary. If they are
not consistent with the strategy, however, they signal that the units are attending either to
non-strategic issues or to shifts in the market that are beyond the strategy’s definition.
Both cases require top management action, either to realign the units with the firm’s
strategic direction or to assess the market change and the firm’s viability.
Galbraith’s model of organization design contains an additional mechanism for
handing conflicts in interunit relationships; that is hierarchical referral – sending the
problem up the chain of authority. Hierarchy is typically the last resort for managers
unable to resolve their differences, no matter what other coordination mechanisms are in
place. As such, it is crucial to appreciate how the reporting hierarchy is structured, since
this structure will determine how conflicts are resolved and therefore which capabilities
are most likely to be developed in the firm.
Management hierarchies in a single business are typically organized along one or
more of the following dimensions: function, geographical region, customer and perhaps
to a small degree, product. Function means R & D, operations, marketing, service, and
the other activities in the firm’s value chain that are performed in-house. A functional
organization is therefore one in which the CEO’s or general manager’s direct reports are
functional managers – vice presidents of R & D, of operations, of marketing. In a similar
vein, the direct reports of the CEO of a firm organized primarily by geography are the
vice presidents of the Eastern region, the Southern region, the Western region, and so on.
Likewise, in a customer-based organization, CEO direct reports are associated with types
of customer, for example, belonging to specific industries or to size classes. For example,
18
until 1999 Cisco was organized by customer types: Enterprise, Small/Medium Business
and Service Provider. Since organizing around products lines implies multiple businesses,
and we are focusing on single business firms here, we will forgo a discussion of these
firms until Chapter 9, which discusses managing the multibusiness firm. However, in
some organizations with a broad product line, some activities, such as marketing, may be
broken out by product groups that are differentiated by technology.
The importance of how the firm is organized on these dimensions is obvious
when we focus its implications for capability development. Each of the alternative
managerial hierarchies represents a different set of priorities regarding how and which
capabilities are built. These priorities are clearly determined by the ordering of the
dimensions in the hierarchy. Three simple types of structure – functional, geographical,
and customer - are easily understood in this way.
For example, a manager in charge of a function, such as engineering, focuses on
developing and implementing engineering programs; marketing managers design and
execute marketing programs. But regional managers are concerned with the special
characteristics of their geographical territories, particularly customers, suppliers and
competitors. Customer account managers are responsible for programs that serve the
needs of an assigned set of customers, which may be categorized by industry or a
differentiating attribute such as size.
In general the higher the location in the hierarchy of the managers responsible for
a type of program, the more important those programs are (or should be) for the
execution of the firm’s strategy. In one business, for example, the CEO’s direct reports
may each be in charge of different functions, such as marketing, operations and research
19
and development. Here programs that are function-specific and generalize across regions
and customers are the most important to design and execute. In another business,
competing within the same industry, the CEO’s direct reports may be in charge of
separate geographical regions. In this case, regional programs that generalize across
functions and customers within each region are paramount. The capabilities of these two
firms will therefore develop along different paths, creating alternative market positions.
Functional Organizations. In functional organizations, coordination among units
is ultimately guided by the aims of the functions themselves. Consequently, building
capabilities within R&D, marketing or operations has priority over projects related to a
specific geographical region or type of customer. Because regional and customer
managers report to executives within each functional unit, they expend greater resources
developing capabilities focused on regional or customer-specific market opportunities.
However, the types of capability that can be built within functional structures are
numerous and important.
First, for most activities, organizing by function leads to an ability to reduce costs
through economies of scale and learning. Lower costs are achieved by
1) reduced overhead by combining common tasks;
2) simplification through standardized procedures;
3) continuous process innovation tailored to specific requirements within each
function (especially in human resources, information technology, operating
procedures, and procurement);
4) greater market power, particularly in procurement, due to increased scale.
20
Second, a functional organization enables the ability to develop function-specific
expertise, such as
1) specific technology development programs within R&D;
2) skills in sales and marketing research;
3) quality and cost improvements in operations.
Third, a functional structure provides a mechanism for firm growth through
1) the development of new products with roughly similar technological and
market requirements;
2) centralized functions facilitate the continuous introduction of new products.
Geographical Organizations. The benefits to organizing by geographical region
emerge when the regions are markedly different in their strategic requirements. Customer
preferences may differ sufficiently by region that competing with local firms requires
specialized management. For example, Coca-Cola competes strongly against Dr. Pepper
in Texas where it is perceived as a fruit drink. If Texas were an independent country, it
would be the sixth largest for Coke as a national territory. But Coke does not decentralize
operations to its Texas franchise, preferring instead to run Texas policy from Atlanta,
which designates Dr. Pepper as a root beer. As a result, Coke does not achieve its
potential in the Texas market.
There may also be regionally specific suppliers that require unique policies and
procedures best managed locally. Local suppliers may have lower prices and better
delivery times than large scale suppliers selected by corporate purchasing. Attempts to
realize these benefits often create conflict between local and corporate management,
exposing unresolved tradeoffs in growth strategy of the firm.
21
Finally, the conditions of local competition may be unique, requiring management
to develop a specialized position in order to achieve financial goals. Local firms may
have strategies that are effective as long as the firm does not decentralize and tailor its
investments to local competition. Large centralized firms managed through corporate
policy frequently have difficulty penetrating a local market because of their inability to
align with the local business practices.
Customer-based Organizations. Just as geographically organized firms are
designed to develop capabilities that are specific to local markets, firms organized around
customers are focused on delivering products and services that are specialized to welldefined customer segments. These segments must be sufficiently different in their
requirements to warrant dedicated management. An excellent example is the design of
professional service organizations, such as consulting or accounting firms. These firms
are typically structured according to industry sectors, such as telecommunications,
financial services, transportation, and energy. Although the needs of customers in these
sectors have many common components, clients value and seek professionals with
special knowledge of their industry. Deep industry knowledge is therefore developed
through the way the service firm is organized.
The Matrix Form. Firms often make tradeoffs among the benefits provided by
different organizing dimensions. To mitigate these tradeoffs and avoid the problems of
subordinating one mode of organizing to the other, firms will often be structured along
more than one dimension, such as the combination of function and geography, or of
customer and geography. These problems arise when both dimensions are critical
strategically and require equal weighting in strategic decision-making. Such a structure is
22
called a matrix. Matrix structures are typically a sign that the firm has internalized
competing forces in the market, such as the need for both customer specialization and
low costs, and is trying to satisfy both demands. How the industry structure evolves, as
competitors occupy dedicated positions, will determine the success of the matrix
structure.
Compensation and Reward Systems. Employees must be compensated and
otherwise rewarded in such a way that they can exert and direct their activities towards
the firm’s strategic goals. The compensation system of a firm is therefore a critical
component of how it executes its strategy. The clearest and most direct policy for linking
compensation to strategy execution is pay for the amount of output produced over a
period of time. This compensation system, called piece-rate, focuses the worker’s
attention on his or her productivity over the pay period, since pay is directly related to
how much is produced.11 Commonly, higher productivity per worker translates into
higher volume spread over the same fixed assets and so results in lower costs. But cost
need not be the only focus of strict pay for performance. The firm can reward specific
behavior that is most closely tied to strategy execution – whether it is producing highly
engineered widgets, developing large customer accounts, selling tract houses, or flying
airplanes on long routes.
The conditions under which a piece rate system in a manufacturing organization
can be implemented effectively are the following: First, employees must be able to
control the pace of production. If elements of the production process, such as automated
equipment, are programmed to override the discretion of employees in choosing their
rates of productivity, then it makes little sense to reward workers on how much they have
23
produced. Whatever their effort and ability, they have no control over the amount of work
completed.
Second, when a group of employees, rewarded on the basis of piece rate, sets the
pace of production, as opposed to each individual member, it is best if they have roughly
the same preferences for expending effort to achieve productivity goals. Conflict within
the group about appropriate levels of effort can undermine the advantages of individual
accountability. The selection of group members and the ongoing management of their
relationships with each other are key elements in an effective piece-rate program.
Third, the standard rate of production assigned to a job must be perceived as fair.
Developing a fair rate takes experience with the job. This means that piece-rate is
difficult to apply in situations where new jobs are introduced frequently or there is
significant variation in a job requiring unexpected effort. Standard-setting is thus a
critical part of any compensation system focused on individual accountability.
Fourth, rewarding productivity requires an explicit lower bound on the quality of
output. Anyone getting paid according to his or her production over a period of time will
tend to lower the quality of the product in order to raise the number produced. So careful
monitoring of product quality is required in addition to a policy of no pay for substandard
work. The cost of monitoring quality needs to be considered, however, since it may
exceed to benefits of piece-rate compensation.
Fifth, it is rare when an employee’s performance is due to his or her own effort
alone. Most often, cooperation is required to achieve the desired level of output. One way
to induce cooperative effort is to offer a group bonus on top of piece-rate compensation.
In this scheme, small groups work better than large groups since small size improves the
24
visibility of effort and reduces slacking. Moreover, group pressure to perform is more
efficient than monitoring by a superior, so rewarding cooperative effort requires that
group members be carefully selected.
Sixth, tying an employee’s pay to productivity is complicated by factors that are
outside the control of the individual, such as poor quality materials or late deliveries, but
influence his or her performance. Almost always, there is at least some uncertainty about
what these factors are and how strongly they affect performance. If uncertainty is
significant, piece-rate alone becomes infeasible if the employee is risk-averse. In this
case, the firm typically absorbs some of the risk by providing a base wage in addition to
piece-rate compensation.
The problem of risk and who bears it raises an interesting set of questions for
strategy execution. It is common that employees are on average less interested in taking
risks than the firm. This is so simply because the firm has more ventures to spread its risk
over: if the employee fails, both income and employment may disappear, whereas the
firm has other projects fall back on. Given this difference, an obvious mechanism to
induce greater risk taking by employees is to reward it. For example, if large accounts are
riskier to get but provide a higher return over the long term than a range of smaller
accounts, a salesperson might be rewarded disproportionately more the larger the account
sold.
Because of the complicating factors discussed above, it is rare to find firms that
have implemented piece-rate consistently. The outstanding example of a firm that has
committed itself over its history to piece-rate compensation is Lincoln Electric, a
manufacturing firm that produces arc-welding equipment. Lincoln Electric’s strategy
25
centers on having the lowest costs and therefore the lowest prices in its markets, coupled
with strong technical sales and service. Consequently, employee compensation focuses
on productivity to keep costs low, with no pay for poor quality. The sidebar below
describes Lincoln Electric’s development of administrative practices to support its piecerate system as well as the company’s recent problems in expanding globally.
****************************************************
(insert sidebar on Lincoln Electric)
Lincoln Electric, a dominant firm in the arc-welding equipment industry, is a
classic example of a company run on the piece-rate incentive system to achieve
sustainable low costs. Although it sells and services its products aggressively, Lincoln
views itself as predominately a manufacturing firm. The company has endured for
roughly 100 years in a highly competitive industry by keeping prices low. It also provides
excellent technical service. From its beginning, Lincoln has focused on developing
administrative and operational procedures in manufacturing to achieve low costs without
degrading quality. These policies complement the piece-rate system by neutralizing
problems that would make this system infeasible. The policies are:
1) compensation for piece work only, no hourly wages, except for those jobs
where measuring output per employee has been shown to be infeasible;
2) a yearly bonus based on four factors: dependability, output, quality and ideas,
and cooperation, each rated by a different department in the organization;
3) a very active stock purchase plan for employees;
4) guaranteed employment;
5) continuous improvement in work methods by staff engineering and workers;
6) employee guarantee of quality;
7) price and volume targets to produce a planned financial return to the firm and
to workers;
8) a policy of not hiring additional workers to increase production when demand
increases;
8) open discussion of job and employee ratings;
9) a system of consultation between workers and management including an
Advisory Board that meets twice a month, a top-management open-door policy, and
extensive informal contact between management and workers on the shop floor;
10) extensive employee ownership of the corporation through stock purchase
plans;
12) a policy of promotion from within;
13) a flat hierarchy, keeping access of the top to the bottom easy; and
14) a strenuous trial period for new employees which many do not pass
The development of the company’s routines was based on substantial practical
knowledge about the details of effective interpersonal relationships in a piece-rate
system. These aspects of the organization’s culture are not easily replicable by other
26
firms. For example, it would be difficult for another organization to replicate the cohort
of senior workers that serve as role models for younger employees.
Because of Lincoln’s rigid adherence to procedures in operations, expanding
production in periods of rapid expansion is difficult, leading to a loss in customers. The
assumption is that these customers will be won back when expansion subsides due to
Lincoln’s superior price, quality and service. Whether this is valid depends on the relative
ability of competitors to keep prices low as Lincoln follows its deliberate growth path
and tries to recapture volume. To the extent rivals retain customers as the business cycle
slows down, Lincoln loses market share due to its capacity planning and pricing policies.
In the past decade, Lincoln has expanded into international markets by
establishing facilities in Europe, Asia and Latin and South America. One reason for this
expansion is to prevent ESAB, a large Swedish competitor, from dominating the global
industry. ESAB has deep pockets and is able to penetrate new markets with low prices.
Lincoln’s global expansion has threatened its core compensation system in two
ways. First, the company has learned that what works in Cleveland does not work in
Brazil, France and other non-U.S. locations because of local laws and traditions. So
Lincoln’s top management must be able to compete internationally with a variety of
production and marketing systems, not just piece-rate. Second, to expand into other
countries, Lincoln had to increase its debt; and the bankers who made loans to the
company were not necessarily committed to maintaining its compensation system
through a system of financial rewards. This has meant that in some periods, workers have
not gotten the bonus they expected because of debt payments.
The point here is that, although piece-rate is an almost ideal compensation system
for rewarding effort and Lincoln Electric has carefully developed a set of procedures that
sustain piece-rate compensation, it is virtually impossible to protect the system from the
forces of competition. Finely tuned compensation systems based on piece-rate need to be
buffered from environmental change. But even the most well designed buffers fail at
some point, and the system degrades.
(end of sidebar on Lincoln Electric)
*********************************************************************
At the other end of the spectrum from piece-rate, employees are rewarded on the
basis of a base wage or salary with perhaps a bonus based on group performance. In
professional service firms, such as investment banks and consulting firms, an employee’s
bonus can be based in part on the evaluations of the peers involved in the same projects.
Since cooperation in teams is often a critical part of professional practice, noncooperative behavior, as indicated by peer evaluations, should not be rewarded.
A recent innovation in compensation schemes linked to strategy is the balanced
scorecard. 12 The balanced scorecard is a method of compensating managers based on
27
achieving critical performance measures within four domains: financial outcomes,
customer outcomes, internal process improvement, and learning and growth. The
scorecard broadens the scope and meaning of the metrics on which managers are
compensated beyond financial outcomes and links both financial and non-financial
variables to the company’s strategy. In a sense, the balanced scorecard is a kind of multiattribute compensation system in which rewards throughout the firm are integrated and
tied to the most important outcomes for achieving a stronger and more sustainable market
position.
Like piece-rate, the balanced scorecard has its drawbacks, and they are similar to
the vulnerabilities of the piece-rate system. Defining key metrics, conflicts over goal
setting, team effects and adjusting for non-controllable factors frequently complicate the
effectiveness of implementing the scorecard. Most vulnerable to these problems are
performance variables in the domain of learning and growth. However, these difficulties
should not dissuade a firm from the important task of rewarding employees on those
performance variables that are most closely linked to the firm’s strategy.
People and Culture
An important influence on a firm’s ability to execute its strategy is the firm’s
people and the culture they create and perpetuate. Organizational culture entails
employee mores and expressive behavior as they direct thought and activity towards or
away from the organization’s goals. Cultural content includes the official and unofficial
values which individuals espouse and act on, the stories and anecdotes that employees
hear and pass on as guides for appropriate or inappropriate behavior, the rules of thumb
regarding correct decision-making that are passed from one employee to another, and the
28
resulting common understanding of a wide range of problems and tasks that pervade the
organization over time.
Kreps argues that by creating focal points for decision-making that are widely
shared across the firm, organizational culture narrows the choices available to
individuals, simplifying choices and leading to common solutions without extensive
communication.13, 14 The development of focal points through organizational culture is
especially valuable in non-routine decision context, as when for example, employees deal
with unusual and challenging customer problems. In one firm, the implicit rule
throughout the firm is that employees should go out of their way to help a customer with
a novel problem, a practice for which both Nordstrom’s and Southwest are well known.
However, in a firm that lacks an underlying agreement to solve customer problems
aggressively, responsibility for developing a solution is more likely to be avoided.
If customer retention is a key component of the firm’s competitive advantage, and
the firm has developed a culture that perpetuates stories and rules of thumb that focus on
high customer service, then the culture supports the strategy and will improve its
execution. On the other hand, if customer retention is part of the strategy, but the firm has
not developed a culture focused on solving difficult customer problems, then the culture
and strategy are not synchronized. In this case, execution will be less effective.
***************
(begin sidebar on strong and weak cultures)
Just as firms differ in their cultures, they differ in how strong these cultures are.
Strong cultures are more enduring and create greater consistency in the behavior of
employees. Weak cultures, on the other hand, are fragile and subject to fragmentation and
violations of commonly understood rules of behavior.
29
Where does a strong culture come from? The standard explanation is that strong
cultures are the result of the kinds of processes Siggelkow observed at Vanguard in the
development of consistent activity systems. Over time, in a firm trying to develop
effective value and cost drivers, the facets of its culture are shaped through feedback
from the market. Given the frequently severe constraints markets can place on a firm to
execute effectively within its market position, it seems unlikely that a strong culture
would emerge in a firm that was performing poorly. In fact, research has shown that
firms with strong cultures tend to have higher economic performance over time,
especially in markets that are highly competitive where constraints on firm behavior are
greater. 15
As important, moreover, is the effect of culture strength on performance
variability.16 In firms with strong cultures, employees are more likely to conform more
consistently with well-understood rules of behavior. Higher conformance leads to less
deviation in the firm’s performance with customers and suppliers, reinforcing the firm’s
reputation. More consistent performance in its markets also raises the credibility of the
firm in the eyes of competitors, deterring them from making investments to
(end sidebar)
******************
Learning. As a firm’s culture provides a set of focal points for decision-making,
it also needs to provide models for effective questioning and experimentation. Without
inquiry, there is no initiative for improving how the firm’s strategy is executed; and
without experimentation, managers have little direction for improvement should.
Organizational learning is therefore necessary for adaptation to changing market
conditions.
Learning within a firm typically is guided by established routines and subject to
strong path dependence, as existing resources and capabilities provide the framework
within which innovations are developed. Within these constraints, managers set
performance targets that further direct the organization’s pattern of experimentation.17
This kind of directed inquiry is in many cases extremely effective. It is precisely this kind
of focused process of trial and error that creates a powerful dynamic capability to grow
the firm. For example, once Southwest Airlines had established its market position in
30
Texas before deregulation in the U.S. airline industry in 1978, it was able to experiment
with its practices in order to improve its economic contribution to its customers based on
low fares. The airline continued to innovate within these constraints once it began to
compete in other states after 1982.
However, effective adaptation sometimes requires investments that are
inconsistent with the organization’s traditional path of innovation. Argyris and Schon
make the distinction between single and double-loop problem solving.18 Single-loop
problem solving entails working within the given parameters of a task to reach a solution.
In this case, there is little or no questioning of the task as such; all search paths lie in
well-understood and accepted territory. Double-loop problem solving, on the contrary,
extends the problem-solving process outside the normal domain of the task and raises
questions about the task parameters themselves. Rather than finding ways to perform the
task more effectively, double-loop thinking asks why the task is configured as it is and
even whether it is the correct task to be performed at all.
Effective strategy execution clearly requires the ability to engage in both single and
double loop problem solving. Single loop learning is both necessary and sufficient to
solve routine problems. In these cases, it is simply not effective to explore outside the
box. Double loop learning becomes increasingly necessary, however, when the industry
shifts from one growth stage to another, and especially when it is threatened by
disruption due to technological or regulatory change. Developing effective double loop
learning in these circumstances can be a critical managerial task.
31
Summary Points
 The key to understanding strategy execution is how firms build and maintain
resources and capabilities.
 A resource is a relatively stable, observable asset that gives the firm a
sustained advantage over rivals.
 To provide an economic advantage, a firm’s resource must contribute to the
firm’s value or cost drivers, leading to increased revenues or lower costs, and
be difficult for competitors to imitate or to neutralize through substitution.
 Resources are typically tradeable in the sense that they can be put up for sale
by the firm and valued by potential buyers.
 A capability denotes the ability of a firm to accomplish tasks that are linked to
higher economic performance. These tasks are performed over time through
the coordinated efforts of teams whose memberships change even as the
practices involved persist and improve.
 It is common for capabilities to contribute to the firm’s performance by
supporting resources.
 Some capabilities can contribute to economic performance without being
attached to a resource, as long as the people who enable the capability are
inalienable from it.
 A firm’s expertise in exploiting a resource determines its value.
 A capability must be associated with specific activities and programs within
the organization.
 The major contributors to building and maintaining capabilities are:
consistency or complementarity among capabilities and resources; control and
coordination systems; compensation and reward systems; and people and
culture.
 Two or more resources may be complementary in that together they produce a
more effective outcome than either produces independently.
 The concept of consistency or fit implies that the policies and practices of each
activity are aligned with the demands of the firm’s market position.
 A useful way to analyze a firm’s consistency and examine impact of activities
on strategy execution is Porter’s value chain diagram.
32
 Activity systems are composed of policies in value chain activities, general
characteristics of the firm’s structure and culture, product attributes and key
resources such as technologies and brands.
 The benefit of understanding and mapping a firm’s activity system is that it
shows how extensively its elements relate to and reinforce each other.
 The two end points of the spectrum of market positions in an industry –
extreme value and cost advantage – require highly consistent execution.
 The internal consistency of firms with successful value or cost-based market
positions constitutes a formidable barrier to less developed organizations.
 The more consistent an organization’s activities, the more difficult they are to
change.
 Building capabilities entails developing procedural systems and systems of
authority and cooperation. To be effective, these systems should be focused
on the specific capabilities needed to achieve high performance within the
firm’s market position.
 A firm’s formal control systems for managing and allocating financial
resources, such as its budgeting and financial reporting systems, determine
which capabilities will be built and sustained.
 Coordination entails aligning the work of units to achieve higher performance,
where the amount of interaction depends on how closely coordinated the units
need to be.
 Galbraith presents five mechanisms for achieving interunit coordination, in
addition to the use of hierarchical authority: 1) standardized procedures, 2)
joint planning, 3) liaison personnel, 4) task forces with members from both
groups, and 5) teams joining the units.
 As the complexity and dynamics of information transfer between two units
rise, the interface between the units becomes more complex.
 Within a single business, increasing information requirements between units is
justified if it leads to creating capabilities that raise firm performance.
 Hierarchy is typically the last resort for managers unable to resolve their
differences, no matter what other coordination mechanisms are in place.
33
 Management hierarchies in a single business are typically organized along one
or more of the following dimensions: function, geographical region, customer
and perhaps to a small degree, product.
 Each of the alternative managerial hierarchies represents a different set of
priorities regarding how and which capabilities are built.
 For most activities, organizing by function leads to an ability to reduce costs
through economies of scale and learning.
 A functional organization enables the ability to develop function-specific
expertise.
 The benefits to organizing by geographical region emerge when the regions
are markedly different in their strategic requirements.
 Firms organized around customers are focused on delivering products and
services that are specialized to well-defined customer segments.
 Firms often make tradeoffs among the benefits provided by different
organizing dimensions.
 Matrix structures are typically a sign that the firm has internalized competing
forces in the market.
 Employees must be compensated and otherwise rewarded in such a way that
they can exert and direct their activities towards the firm’s strategic goals.
 The balanced scorecard is a method of compensating managers based on
achieving critical performance measures within four domains: financial
outcomes, customer outcomes, internal process improvement, and learning
and growth.
 As a firm’s culture provides a set of focal points for decision-making, it also
needs to provide models for effective questioning and experimentation.
 Organizational learning is therefore necessary for adaptation to changing
market conditions.
 Learning within a firm typically is guided by established routines and subject
to strong path dependence, as existing resources and capabilities provide the
framework within which innovations are developed.
 Effective adaptation sometimes requires investments that are inconsistent with
the organization’s traditional path of innovation.
34
 Effective strategy execution clearly requires the ability to engage in both
single and double loop problem solving.
 Organizational culture entails employee mores and expressive behavior as
they direct thought and activity towards or away from the organization’s
goals.
 By creating focal points for decision-making that are widely shared across the
firm, organizational culture narrows the choices available to individuals,
simplifying choices and leading to common solutions without extensive
communication.
35
Figure 1
Strategy Execution
Control and Coordination
Systems
Complementarities
Compensation and
Incentive Systems
Resources
Consistency
Among Activities
Capabilities
Value and Cost
Drivers
Isolating
Mechanisms
36
People and
Culture
Figure 2
Porter’s Value Chain
Procurement
Technology Development
Human Resource Management
Infrastructure
Inbound
Logistics
Operations
Outbound
Logistics
37
Marketing Service
Endnotes
See Richard Makadok and Gordon Walker, “Identifying a distinctive competence:
forecasting ability in money market industry,” Strategic Management Journal, 20: 853864, 2000.
2
See Makadok, Richard. Toward a synthesis of the resource-based and dynamic
capability views of rent creation, Strategic Management Journal, 22: 387-401.
3
See Barney, Jay. Strategic factor markets: Expectations, luck and business strategy.
Management Science, 32(10): 1231-1241, 1986.
4
See Paul Milgrom and John Roberts, “The economics of modern manufacturing:
Technology, Strategy and Organization, American Economic Review, 80:511-28, 1990;
Paul Milgrom., Y. Qian, and John Roberts, “Complementarities, Momentum and the
Evolution of Modern Manufacturing,” American Economic Review 81: 84-88, 1997;
5
See Venkatraman, N., “The Concept of Fit in Strategy Research: Toward Verbal and
Statistical Correspondence,” Academy of Management Review 14: 423-445, 1989.
6
See Edward Fox, Uday Apte and Gordon Walker, “Channel complementarity in internet
retailing,’ working paper, Cox School of Business, 2002.
7
See Michael Porter, Competitive Advantage, New York: Free Press, 1985.
8
Porter, Michael, “What is Strategy?” Harvard Business Review, 1996.
9
See Nicolaj Siggelkow, “Evolution towards fit,” Adminstrative Science Quarterly,
47:125-159, 2002.
10
See Jay Galbraith, Competing with Flexible Lateral Organizations, Reading, MA:
Addison Wesley, 1993.
11
See James Baron and David Kreps, Strategic Human Resources: Frameworks for
General Managers, New York: John Wiley, 1999, chapters 10-12.
12
See Robert S. Kaplan and David P. Norton. The Balanced Scorecard: Translating
Strategy into Action. Boston: HBS Press, 1996.
13
See Thomas Schelling, A Theory of Conflict, Cambridge, MA: Harvard University
Press, 1960
14
See David Kreps, “Corporate culture and economic theory,” in James Alt and Kenneth
Shepsle, eds., Perspectives on Positive Political Economy. New York: Cambridge
University Press. 1990.
15
See John Kotter and James Heskett, Corporate Culture and Performance, New York:
Free Press, 1992; Ronald Burt, S. M. Gabbay, G. Holt, and P. Moran, “Contingent
organization as a network theory: The culture performance contingency function,” Acta
Sociologica, 37:345-370, 1994.
16
See Jesper Sorensen, “The strength of corporate culture and the reliability of firm
performance,” Administrative Science Quarterly, 47: 70-91, 2002.
17
For a comprehensive review on this topic, see Barbara Levitt and James March,
“Organizational Learning,” Annual Review of Sociology, 14:319-40, 1988.
18
See Chris Argyris and Donald Schon, Organizational learning: A theory of action
perspective, Reading, MA: Addison Wesley.
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