1. Explain why organizations exist and the purposes they serve. 2. Describe the relationship between organizational theory and organizational design and change, and differentiate between organizational structure and culture. 3. Understand how managers can utilize the principles of organizational theory to design and change their organizations to increase organizational effectiveness. 4. Identify the three principal ways in which managers assess and measure organizational effectiveness. 5. Appreciate the way in which several contingency factors influence the design of organizations.
This chapter discusses organizations, organizational theory, and the importance of organizational design. An organization is a tool that people use to coordinate their actions to obtain something they desire or value—to achieve their goals. Organizational theory is the study of how organizations function and how they affect and are affected by the environment in which they operate. Organizational structure is the formal system of task and authority relationships that control how people coordinate their actions and use resources to achieve an organization’s goals. Organizational culture is the set of shared values and norms that control organizational members’ interactions with each other and with suppliers, customers, and other people outside the organization.
Organizations are value-creation systems that take inputs from the environment and use skills and knowledge to transform these inputs into finished goods and services. The use of an organization allows people jointly to increase specialization and division of labor, use large-scale technology, manage the organizational environment, economize on transaction costs, and exert power and control—all of which increase the value the organization can create.
Organizational design is the process by which managers select and manage aspects of structure and culture so an organization can control the activities necessary to achieve its goals. Organizational design has important implications for a company’s competitive advantage, its ability to deal with contingencies and manage diversity, its efficiency, its ability to generate new goods and services, its control of the environment, its coordination and motivation of employees, and its development and implementation of strategy.
Organizational change is the process by which organizations redesign and transform their structures and cultures to move from their present state to some desired future state to increase their effectiveness. The goal of organizational change is to find new or improved ways of using resources and capabilities to increase an organization’s ability to create value and hence performance.
Managers can use three approaches to evaluate organizational effectiveness: the external resource approach, the internal systems approach, and the technical approach. Each approach is associated with a set of criteria that can be used to measure effectiveness and a set of organizational goals.
1.1 What is an Organization?
Organizations are extremely important in today’s world. Though organizations are intangible, they have a role to play in all areas of our life. A grouping of people and other resources to produce goods and services is the essence of organizing. An organization is a tool people use to coordinate their actions to obtain something they desire or value—that is, to achieve their goals. Today organizations are rapidly growing in number as they seek to respond to the changing tastes and needs of consumers. Entrepreneurship is the term used to describe the process by which people recognize opportunities to satisfy needs and then gather and use resources to meet those needs.
How Does an Organization Create Value?
Value creation takes place at three stages: input, conversion, and output. The way a given organization uses human resources and technology to transform inputs into outputs determines how much value is created at the conversion stage. Each stage is affected by the environment in which the organization operates. The organizational environment is the set of forces and conditions that operate beyond an organization’s boundaries but affect its ability to acquire and use resources to create value. (Refer to Figure 1.1)
Focus on New Information Technology: Amazon.com, Part 1
The success story of Amazon.com depicts how Jeff Bezos recognized the immense entrepreneurial opportunity in the rapid growth of the Internet and used it optimally to become extremely successful in the new electronic virtual marketplace.
Question: What was the realization that prompted Jeff Bezos’ entrepreneurial effort?
Answer: Bezos realized that compared to a real bricks-and-mortar bookstore, an online bookstore would be able to offer a much larger and more diverse selection of books. Additionally, a virtual bookstore would enable customers to browse, review, and access book recommendations. This prompted him to set up Amazon.com.
The result of the conversion process is an output of finished goods and services that the organization releases to its environment, where they are purchased and used by customers to satisfy their needs. A value-creation model can be used to describe the activities of most kinds of organizations.
1.2 Why do Organizations Exist?
The production of goods and services most often takes place in an organizational setting because people working together to produce goods and services usually can create more value than people working separately.
There are five reasons for the existence of organizations. (Refer to Figure 1.3)
1. To Increase Specialization and the Division of Labor: The collective nature of organizations allows individuals to focus on a narrow area of expertise, which allows them to become more skilled or specialized at what they do. 2. To Use Large-Scale Technology: Economies of scale are cost savings that result when goods and services are produced in large volume on automated production lines. Economies of scope are cost savings that result when an organization is able to use underutilized resources more effectively because they can be shared across several different products or tasks.
3. To Manage the Organizational Environment: Organizations are complex structures involving many economic, social, and political pressures that affect their ability to function optimally. Managing complex environments like these is a task beyond the abilities of most individuals, but an organization has the resources to develop specialists to anticipate or attempt to influence the many pressures from the environment.
4. To Economize on Transaction Costs: The costs associated with negotiating, monitoring, and governing exchanges between people to solve the numerous transaction difficulties are called transaction costs. Organizations’ ability to control the exchanges between people reduces the transaction costs associated with these exchanges. 5. To Exert Power and Control: To get a job done efficiently, people must come to work in a predictable fashion, behave in the interests of the organization, and accept the authority of the organization and its managers. All these requirements make production less costly and more efficient but put a burden on individuals who must conform to organizational goals.
1.3 Organizational Theory, Design, and Change
Organizational theory is the study of how organizations function and how they affect and are affected by the environment in which they operate. There is a close relationship between organizational theory, structure, culture, design, and change. (Refer to Figure 1.4)
Organizational structure is the formal system of task and authority relationships that control how people coordinate their actions and use resources to achieve organizational goals. The principal purpose of organizational structure is one of control: to control the way people coordinate their actions. For any organization, an appropriate structure is one that facilitates effective responses to problems of coordination and motivation.
Organizational culture is the set of shared values and norms that controls organizational members’ interactions with each other and with suppliers, customers, and other people outside the organization. An organization’s culture is shaped by the people inside the organization, by the ethics of the organization, by the employment rights given to employees, and by the type of structure used by the organization. The cultures of organizations that provide essentially the same goods and services can be very different.
Organizational design is the process by which managers select and manage aspects of structure and culture so an organization can control the activities necessary to achieve its goals. Organizational structure and culture are the means the organization uses to achieve its goals; organizational design is about how and why various means are chosen. Organizational design helps organizational members to view and respond to the outside environment in different ways and puts pressure on work groups
and individuals to behave in certain ways.
Organizational change is the process by which organizations move from their present state to some desired future state to increase their effectiveness. The goal of organizational change is to find new or improved ways of using resources and capabilities to increase an organization’s ability to create value, and hence its performance. Organizational change can be understood as the process of organizational redesign and transformation.
Organizational Insight 1.1: How Steve Jobs Learned How to Organize and Control Apple
This case study shows that though people who start new organizations may initially lack the kinds of skills or knowledge to manage an organization’s structure and culture effectively, they can develop these skills over time. An understanding of the principles behind organizational design and change helps in this learning process and deepens appreciation for the many subtle technical and social processes that determine how organizations operate.
Question: What were the consequences of Jobs’ managerial style which he employed initially at Apple?
Answer: Jobs’ arbitrary and overbearing style of management led to fierce competition, misunderstanding, and growing distrust among workers. He often resorted to favoritism and his strained relationship with Sculley (CEO of Apple) led to Jobs losing control of the company.
Question: What was the first step taken by Jobs when he returned to Apple in 1997?
Answer: Jobs’ first step was to create a clear vision and goals to energize and motivate Apple employees. He did this by introducing new equipment, delegating work, setting challenging goals, and ensuring that time schedules for different projects were met.
The Importance of Organizational Design and Change
Today managers are searching for new and better ways to coordinate and motivate their employees to increase the value their organizations can create. Managers have recognized the implications that organizational design and change have in increasing employee effectiveness, dealing with contingencies, gaining a competitive edge and managing diversity. Increased global competitive pressures and the increasing use of advanced IT has provided impetus to this trend too.
Dealing with Contingencies
A contingency is an event that might occur and must be planned for. An organization can design its structure in many ways to increase control over its environment. One part of the organizational environment that is becoming more important and more complex is the global environment.
Gaining Competitive Advantage
Competitive advantage is the ability of one company to outperform another because its managers are able to create more value from the resources at their disposal. Competitive advantage springs from core competences or managers’ skills and abilities that allow a company to develop a strategy to outperform competitors and produce better products, or produce the same products but at a lower cost. Strategy is the specific pattern of decisions and actions that managers take to use core competences to achieve a competitive advantage and outperform competitors. An organization’s strategy is always changing in response to changes in the environment; organizational design must be a continuously evolving managerial activity for a company to stay ahead of the competition.
Organizational Insight 1.2: Groupon Forges Ahead
Groupon developed a strategy that aimed at leveraging its members’ collective buying power to obtain deals from companies supplying goods and services that were hard to resist. This enabled Groupon to capture customers and retain its competitive advantage.
Question: Why does Mason believe that investing in sales and marketing for Groupon is worthy?
Answer: Any new startup can easily imitate Groupon’s strategy, but being the first mover is a major advantage. Mason believes that pouring money into sales and marketing to make Groupon the global leader is worth the effort as it would enable them to reap the benefits of their innovative strategies.
Question: What is the power that Groupon gives individuals?
Answer: Groupon gives individuals the bargaining power they need to deal with large companies. It also looks at protecting its users by promising a refund if consumers are dissatisfied.
Today organizations have people from different races, genders, nationalities, minority groups, and even immigrant populations working for them. Such a workforce requires care, attention, and advance planning so the needs and concerns of all minorities are addressed. An organization needs to design a structure and control system to make optimal use of the talents of a diverse workforce and to develop an organizational culture that encourages employees to work together.
Promoting Efficiency, Speed, and Innovation
The capacity of organizations to create value increases enormously as organizations introduce better ways of producing and distributing goods and services. This can be achieved through specialization and the use of modern technology and newer and more efficient organizational structures. Organizational design plays an important role in innovation, which is closely linked to competitive advantage in organizations.
The Consequences of Poor Organizational Design
Organizational design affects company performance, yet employee roles are often neglected until a crisis hits. One reason for decline is a loss of control over organizational structure and culture. Talented employees leave, acquiring resources becomes difficult, and the value creation process slows down. Managers are forced to change elements of structure and culture that derail strategy.
Organizational Insight 1.3: How Diverse Manufacturing Managers Can Help Increase Product Quality
Hiring female employees in the automotive manufacturing industry that is a predominantly male occupation is an unusual recruitment choice for Ford. However, it has strengthened the company by changing the values and norms of its manufacturing culture, suggesting that diversity of workforce has a role to play in organizational efficiency.
Question: How has hiring a growing number of women employees benefited Ford?
Answer: Hiring a growing number of women employees has changed the values and norms of Ford’s manufacturing culture. Not only has it reduced the level of conflict between managers and workers, it has promoted cooperation and helped promote Ford’s focus on increasing product quality, which is one of its major competitive advantages in the automotive manufacturing market today.
1.4 How do Managers Measure Organizational Effectiveness?
Because managers are responsible for utilizing organizational resources in a way that maximizes an organization’s ability to create value, it is
important to understand how they evaluate organizational performance. Control, innovation, and efficiency are the three most important processes managers use to evaluate how effectively the organization is creating value.
Control means having control over the external environment and having the ability to attract resources and customers.
Innovation means developing an organization’s skills and capabilities so the organization can discover new products along with creating new organizational structures and cultures to adapt to change.
Efficiency means developing modern production facilities using new information technologies that can produce and distribute a company’s products in a timely and cost-effective manner.
There are three approaches by which an organization’s efficiency can be measured. (Refer to Table 1.1)
The External Resource Approach: Control
This is a method used by managers to evaluate how effectively an organization manages and controls its external environment. Managers use indicators such as stock price, profitability, and return on investment, which compare the performance of their organization with the performance of other organizations. Top management’s ability to perceive and respond to changes in the environment or to initiate change and be first to take advantage of a new opportunity is another indicator of an organization’s ability to influence and control its environment.
The Internal Systems Approach: Innovation
This is a method that allows managers to evaluate how effectively an organization functions and resources operate. To be effective, an organization needs a structure and a culture that fosters adaptability and quick responses to changing conditions in the environment. Measures of an
organization’s capacity for innovation include the length of time needed to make a decision, the amount of time needed to get new products to market, and the amount of time spent coordinating the activities of different departments.
The Technical Approach: Efficiency
This is a method managers use to evaluate how efficiently an organization can convert some fixed amount of organizational resources into finished goods and services. Technical effectiveness is measured in terms of productivity and efficiency. Productivity measures are objective indicators of the effectiveness of an organization’s production operations.
Measuring Effectiveness: Organizational Goals
Managers create goals that they use to assess how well the organization is performing. Two types of goals used to evaluate organizational effectiveness are official goals and operative goals.
Official goals are guiding principles that the organization formally states in its annual report and in other public documents and usually they lay out the mission of the organization.
Operative goals are specific long- and short-term goals that guide managers and employees as they perform the work of the organization.
Organizational Insight 1.4: First Global Xpress Delivers Packages Faster, Cheaper, and Greener
This case study demonstrates how First Global Xpress, a small $10 million global package shipping company, is competing with its much bigger competitors by improving its efficiency in the global package shipping business. This is an example of the technical approach to measuring organizational efficiency.
Question: What is the “hub-and-spoke” package distribution system?
Answer: Under the “hub-and-spoke” package distribution system, a package has to go through a central hub first, where packages from all over the country are sorted for shipment to their final destination. This means that a customer’s shipment has to take two different flights—one to get to a hub and another to get to the destination.
Question: Why does FGX claim that it provides a “greener” way to transport shipments?
Answer: FGX ships its customers’ packages directly, eliminating the flight to the hub which is common with other shipping companies. Thus, it uses less fuel oil with a 30% savings in CO2 emissions, providing customers with this service “in a more socially responsible, greener way.”
DISCUSSION QUESTIONS AND ANSWERS
1. How do organizations create value? What is the role of entrepreneurship in this process?
Value is created through three stages: input, conversion, and output. At the input stage, value depends on how an organization selects and obtains the inputs; certain inputs create more value than others. At the conversion stage, value is a function of employees’ skills, including learning from and responding to the environment. Output creates value if it satisfies a need. Entrepreneurship is important to value creation by recognizing a need, gathering inputs, and transforming them into a product or service. The value creation cycle will continue if customers are satisfied; profits will generate inputs and improve the conversion process.
2. What is the relationship among organizational theory, organizational design, change, structure, and culture?
Organizational theory is the study of how organizations function and how they affect and are affected by the environment in which they operate. Organizational theory deals with the whole organization. Organizational
design entails decisions about structure and culture. Organizational structure is the formal set of task and authority relationships. Organizational culture is a set of shared values that influence behavior.
3. What is organizational effectiveness? Discuss three approaches to evaluating effectiveness and the problems of each approach.
Organizational effectiveness is the ability to use resources to create value; it includes control, innovation, and efficiency. The external resource approach evaluates a company’s ability to obtain scarce resources and valued skills. Indicators include stock prices, return on investment, and market share. These indices are compared to competitors’ indices. However, this approach fails to consider organizational culture and structure.
The internal approach reviews the organization’s ability to innovate and respond to the environment quickly. Some measures include the length of time to get a product to market, decision-making speed, and coordination time. This approach does not consider costs or the external environment. The technical approach reviews an organization’s ability to use skills and resources efficiently. This approach considers neither the environment nor structure and culture. It is important to evaluate an organization in all three areas—control, innovation, and efficiency.
4. Draw up a list of effectiveness goals that you would use to measure the performance of (a) a fast-food restaurant and (b) a school of business.
Students’ answers may vary. A fast-food restaurant’s goals will differ from a business school’s goals because a school is a nonprofit organization. (a) Some goals used to measure effectiveness at a fast-food restaurant are as follows:
•Lower the cost of meat, fries, and drinks.
•Lower the cost of labor.
•Improve the quality of the food and the skills of employees.
•Increase profits, stock price, and market share.
•Satisfy government requirements on sanitation and fair labor laws.