Chapter 11Organizational Design Structure, Culture, and Contr

Chapter 11
Organizational Design: Structure, Culture, and Control

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instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

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The AFI Strategy Framework

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Because learning changes everything.®

Learning Objectives
Define organizational design and list its three components.
Explain how organizational inertia can lead established firms to
failure.
Define organizational structure and describe its four elements.

Compare and contrast mechanistic versus organic organizations.
Describe different organizational structures and match them
with appropriate strategies.
Evaluate closed and open innovation, and derive implications
for organizational structure.
Describe the elements of organizational culture, and explain
where organizational cultures can come from and how they can
be changed.
Compare and contrast different strategic control-and-reward
systems.

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Case Study

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Zappos 10 Core Values
Deliver WOW Through Service
Embrace and Drive Change
Create Fun and A Little Weirdness
Be Adventurous, Creative, and Open-Minded
Pursue Growth and Learning
Build Open and Honest Relationships With Communication
Build a Positive Team and Family Spirit
Do More With Less

Be Passionate and Determined
Be Humble

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How specifically do these values support the strategy? Do they
think that these values would be helpful in attracting the type of
employee that Zappos needs to gain and sustain a competitive
advantage?

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Zappos
Designed to Deliver Happiness
Exceptional Customer Service → Core Competency
All customer service is done in-house.
No scripts or timed calls in the call centers
Keep its own stocked products… no drop-shipment
Flat Organizational Structure = Flexibility
Job rotation = widely trained talent
Internal promotion opportunities
Reorganized into 10 business units to manage growth

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Founder Tony Hsieh, (shay) created a culture of making
customers and employees happy which helps drive success.

Acquired by Amazon in 2009 for $1.2B and acts as a separate
business unit.

To achieve the strategic objective, Zappos developed a set of
values and integrated them into the company’s culture. This
culture can provide behavior guidelines once the employees
internalize the culture. How does Zappos deliver WOW to
customers? Zappos has a 365-day no-hassle return policy, free
upgrades to express shipping, and courteous and helpful
customer representatives, all of which help make customers
very happy.

Flexibility…Unlike other online retailers, Zappos stocks
everything it sells in its own warehouses—this is the only way
to get the merchandise as quickly as possible with 100 percent
accuracy to the customer. Strategy, therefore, is as much about
deciding what to do as it is about deciding what not to do.

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Organizational Design
The process of:
Creating, implementing, monitoring, and modifying the
structure, processes, and procedures of an organization.

Key components:
Structure.
Culture.
Control.

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Google changed its organizational structure from functional
(organized according to domain expertise) to multidivisional or
M-form (composed of a number of independent strategic
business units). Alphabet’s strategic leaders hope this new
structure will allow them to drive future radical innovation.
Moreover, since each SBU has profit and loss responsibility, the
new structure allows Alphabet to provide leadership
development opportunities for a number of its executives as
they are being groomed for larger roles in the future.
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Organizational Inertia and the Failure of Established Firms to
Respond to Shifts in the External or Internal Environments

Exhibit 11.2
Access the text alternate for slide image.

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Google changed its organizational structure from functional
(organized according to domain expertise) to multidivisional or
M-form (composed of a number of independent strategic
business units). Alphabet’s strategic leaders hope this new
structure will allow them to drive future radical innovation.
Moreover, since each SBU has profit and loss responsibility, the
new structure allows Alphabet to provide leadership
development opportunities for a number of its executives as
they are being groomed for larger roles in the future.
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Organizational Structure
Determines how efforts of individuals and teams are
orchestrated.
How resources are distributed.

Includes four building blocks:
Specialization.
Formalization.
Centralization.
Hierarchy.

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Specialization
Describes the degree to which a task is divided into separate
jobs, (aka as Division of Labor).
Larger firms: high degree of specialization.
Smaller ventures: low degree of specialization.
Requires a tradeoff between depth and breadth of knowledge.

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

U.S. military can be used as an example here because it has the
Air Force, Army, Navy, and Marines, and all of them have their
own specialties

https://www.nascar.com/video/franchise/monster-energy-nascar-
cup-highlights/no-4-team-setting-new-standard-pit-stops/

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

Pros:
Ensures consistent and predictable results.
Safety and reliability.

Cons:
Slower decision making.
Reduced innovation.
Hindered customer service.

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

McDonald’s as the example for formalization because of the
standardized operation process.

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Centralization
The degree to which decision making is concentrated at the top
of the organization.
Correlates to slow response time and reduced customer
satisfaction.
Affects strategic planning:
Top-down strategic planning takes place in highly centralized
organizations.
Planned emergence is found in more decentralized
organizations.

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Whether centralization or decentralization is more effective

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

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

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Hierarchy
The formal, position-based reporting lines:
Who reports to whom.

Span of control:
The number of employees who directly report to a manager.

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

Verizon many, many layers. CMS is flat. Direct reports,
owners. Which is most responsive?

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Hierarchy reality on chain of command

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Mechanistic vs. Organic Organizations
Mechanistic Organization:
Much specialization and formalization.
Tall hierarchies.
Centralized decision making.

Organic Organization:
Little specialization and formalization.
Flat organizational structure.
Decentralized decision making.

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Within one industry Google is an organic organization, while
Microsoft is more mechanistic.
Pixar is a more organic structure than the theme park
organization is, both within Disney.

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

Exhibit 11.3 summarizes the key features of mechanistic and
organic structures.
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Firm Strategy and Structure
The relationship between these is interdependent and dynamic.
Strategy and structure impact a firm’s performance.
Changes over time as the firm grows in size and complexity.

Different firm stages require different structures.

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

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Simple Structure
Used by small firms with low organizational complexity.
The founders usually:
Make all the strategic decisions.
Run day-to-day operations.
Professional managers and sophisticated systems are not usually
in place.
Low degree of formalization and specialization.

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Examples include entrepreneurial ventures such as Facebook in
2004, when the startup operated out of Mark Zuckerberg’s dorm

room, and professional service firms such as smaller
advertising, consulting, accounting, and law firms, as well as
family-owned businesses.

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Functional Structure
Employees are grouped into functional areas:
Based on domain expertise.
Often correspond to distinct stages in the value chain.
Leaders of functional areas report to the CEO.
The CEO coordinates and integrates the work of each function.

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Benefits of Functional Structure and Business Strategy
A functional structure works when a firm has a narrow focus
and small geographic footprint.
Cost Leadership Strategy:
Nurturing and upgrading core competencies.
Differentiation Strategy:
Incorporate decentralized decision making.
Foster innovation and creativity.
Blue Ocean Strategy:
Firm should be efficient and flexible.
Focus is on controlling costs and fostering creativity.

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Biggest disadvantage: Suboptimal communication across
departments…

Solution

: cross-functional teams.

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Multidivisional Structure
1. Used as a firm diversifies products and geography.
2. Each strategic business unit (SBU):
Has profit-and-loss (P&L) responsibility.
Operated independently.
Led by a unique CEO who is responsible for SBU strategy and
operations.
3. Widely adopted organizational structure.

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Zappos is an SBU under Amazon, which employs a
multidivisional structure.

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

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Typical Multidivisional (M-Form) Structure
Exhibit 11.7

Access the text alternate for slide image.

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M-Form and Corporate Strategy
Related Diversification:
Cooperative M-Form.
Centralized decision making.
Integrated at corporate headquarters.
Co-opetition among SBUs.

Unrelated Diversification:
Competitive M-Form.
Decentralized decision making.
Low level of integration at corporate headquarters.
Competition among SBUs for resources.

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Co-opetition—competition and cooperation at the same time.
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Disadvantages of the Multidivisional Structure
Adds another layer of corporate hierarchy.
Bureaucracy, red tape, & duplication of efforts.
Slower decision making.

SBUs competing.
Politics and turf wars over resources.
Cooperation is still needed at the same time.

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In some instances, spinning out SBUs to make them independent
companies is beneficial. The BCG growth-share matrix helps
corporate executives when making these types of decisions. In
the last few years when owned by eBay, PayPal outperformed
its parent company. PayPal’s executives (and investors) were
tired of subsidizing eBay’s stagnant business. Investors also

liked separating eBay and PayPal, giving it a valuation that is
estimated to be as high as $100 billion; eBay’s standalone
valuation is about $35 billion.

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Matrix Structure
Leverages SBU (M-form) benefits:
Domain expertise.
Economies of scale.
Efficient processing of information.

Also leverages organizational structure benefits:
Responsiveness.
Decentralized focus.

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Typical Matrix Structure with Geographic and SBU Divisions

Exhibit 11.9
Access the text alternate for slide image.

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Matrix Structure and Global Strategy
This structure fits well with a transnational strategy.
International: functional structure.
Multi-domestic: multi-divisional structure.
Global standardization: multi-divisional structure.
Transnational: global matrix structure.

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Exhibit 11.11 shows how different global strategies best match
with different organizational structures.

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Disadvantages of the Matrix Structure
Difficult to implement.
Organizational complexity.
Administrative costs.
Unclear reporting structures, (reporting to 2 bosses)

Accountability can be undermined.
Employees can have trouble reconciling goals.
Principal-agent problems.
Slower decision-making.

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Who’s who in the zoo
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Formal and Informal Building Blocks of Organizational Design
Exhibit 11.14

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Culture

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Organizational Culture
Defined as…the shared values and norms of an organization’s
members and expressed through artifacts.

Values: what is considered important.

Norms: appropriate attitudes and behaviors in day-to-day work
and interactions.

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Artifacts include elements such as the design and layout of
physical space (e.g., cubicles or private offices),
symbols (pink car, Brown)

what events are celebrated and highlighted, and how they are
celebrated (Zappos trivia nites, nerf gun battles, foosball,
karaoke).
vocabulary, what stories are told (Nord returning tires, call me
Walt)…Zappos pizza-ordering example in section 11.4)

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

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Organizational Culture - Artifacts

Physical space (cubicles).

Symbols (clothing).

Events (celebrations).

Vocabulary (stories that are told).

What do others perceive your culture to be through the artifacts
you display?

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Artifacts include elements such as the design and layout of
physical space (e.g., cubicles or private offices),
symbols (pink car, Brown)
what events are celebrated and highlighted, and how they are

celebrated (Zappos trivia nites, nerf gun battles, foosball,
karaoke).
vocabulary, what stories are told (Nord returning tires, call me
Walt)…Zappos pizza-ordering example in section 11.4)

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

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Where Do Organizational Cultures Come From?
1. Founder imprinting
Founders defined and shaped the culture

2. Company values
Values are usually linked to a reward system, which can also
lead to a bad culture
Uber, Wells Fargo, MCI, etc…

Recruit people that fit the culture
Zappos pays new hires if they want to quit!

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

with the low-cost strategy.

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How Does Organizational Culture Change?
Culture can be a strong asset, yet also a great liability.
When the environment changes:
A firm must hone, refine, and upgrade to ensure a core rigidity
doesn’t emerge.
New leadership changes in strategy and structure.
When the original core competencies turn into a liability.

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GM’s bureaucratic culture, combined with its innovative M-
form structure, was once hailed as the key to superior efficiency
and management. However, that culture became a liability when
the external environment changed following the oil-price shocks

in the 1970s and the entry of Japanese carmakers into the
United States. As a consequence, GM’s strong culture led to
organizational inertia. This resulted in a failure to adapt to
changing customer preferences for more fuel-efficient cars, and
it prevented higher quality and more innovative designs. GM
lost customers to foreign competitors that offered these
features. Mary Barra

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Culture Can Help a Firm’s Competitive Advantage If…
It makes a positive contribution to economic value creation.
It passes the VRIO principles:
Valuable, rare, difficult to imitate, the firm must be organized
to capture value.
It can adapt as the business evolves.

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It is best to develop a strong and strategically relevant culture
in the first few years of a firm’s existence. Strategy scholars
have documented that the initial structure, culture, and control

mechanisms established in a new firm can be a significant
predictor of later success.

SWA’s unique culture helps it keep costs low by turning around
its planes faster, thus keeping them flying longer hours.

Zappos’ “WOW” customer experience is accomplished by
“going the extra mile.” Long-term superior experience does
increase the company’s perceived value and its economic value
creation.

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A view from two companies

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Who’s ad seems to reflect a more exciting org culture?
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Strategic Control and Reward Systems

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Strategic Control and Reward Systems
Internal-governance mechanisms are put in place to align the
incentives of:
Principals (shareholders).
Agents (employees).
Allow managers to:
Specify goals.
Measure progress.
Provide performance feedback.

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Input Controls
Seeks to define and direct employee behavior through:
Explicit, codified rules.
Standard operating procedures.

Considered before employees make business decisions.
Example: The use of budgets is the key to input controls
Managers allocate money to R&D projects before they begin.

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In diversified companies using the M-form, corporate

headquarters determines the budgets for each division. Public
institutions, like some universities, also operate on budgets that
must be balanced each year. Their funding often depends to a
large extent on state appropriations and thus fluctuates
depending on the economic cycle. During recessions, budgets
tend to be cut, and they expand during boom periods.

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Output Controls
Guide employee behavior by:
Defining expected results (outputs), but:
Leaving the means to those results open to individual
employees, groups, or SBUs.
Intrinsic motivation is highest when an employee has:
Autonomy (about what to do).
Mastery (how to do it).
Purpose (why to do it).

© McGraw Hill

Today, 3M is best known for its adhesives and other consumer

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

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Zappos walking the walk

What would you do if a programming error cost your firm $1.6
million?
Zappos put their money where their “WOW” is.
Zappos accidentally capped the price at $49.95 for all products
sold on its subsidiary site at midnight, and the mistake was not
discovered until 6 a.m.
Consistent with their “WOW” philosophy, Zappos honored all

sales during this time period.

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© McGraw Hill

Which strategic control-and-reward system discussed in the
chapter would be most appropriate for Zappos? Output control
seems to be the appropriate control mechanism for Zappos in
this case. Customer satisfaction can be maximized, especially
for a service-oriented company, by offering fast delivery, no-
hassle returns, friendly and reasonable customer service, and
product packaging.

Do you think Zappos’ decision to honor every sale, despite its
explicit business terms and conditions that would allow it not to
do so, was a sound one? Why or why not?

Apparently Zappos was able to transform this minor crisis
(mislabeling the price tag) into a huge opportunity to maximize
customer satisfaction and secure returning customers. Simply

ask the students what they think about the way Zappos handled
the situation. Do they like it or not? That said, posting a $1.6
million dollar sales loss from six hours (from midnight to 6
a.m.!) of sales is a major financial hit for any firm. What if the
mistake had not been discovered for a full 24 hours?

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Group Exercise
Your team has been brought in to analyze a business unit. You
find significant excess headcount in accounting and purchasing.
Develop a plan to lay off 25% of those employees
You have 6 months to identify “who” and get the job done.
How do you downsize without hurting the morale of those
remaining?
What steps will you take to treat with dignity those employees
forced to leave?

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(If you have no personal experience with work-force reductions,
use an Internet search engine and look up “successful layoffs”
for some guidance.)

Make sure there is strong leadership and frequent
communication with (and education of) the employees so the
concept and message will be delivered clearly. One tendency is
for senior leadership to hide or “circle the wagons” during times
of layoffs. This sends a very poor signal to those remaining
workers. As tough as it is, managers must be especially visible
and walking the halls to look their employees in the eye and be
honest with them on their future and the future of the
organization. Even if that future is uncertain…

What steps do you take to treat with dignity those employees
forced to leave?
Well-designed benefit packages, courteous communication from
top management, and using a face-to-face approach.

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instructor use in the classroom.

No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®
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Running head: NOKIA TECHNOLOGY COMPANY1

NOKIA TECHNOLOGY COMPANY3

Nokia Technology Company

Student's Name

Institutional Affiliation
Course Title
Date

Nokia Technology Company
Nokia Technology Company is one of the oldest and most
renowned mobile manufacturers in the world. Although the
company's performance has slightly been impacted by global
trends and increasing competition from companies such as
Samsung and Apple, it still maintains its position as one of the
world's most iconic mobile phone companies. Nokia
Corporation was established in 1865 in Espoo, Finland
("Nokia," n.d.). The company managed to achieve considerable
growth and expansion over the years due to implementing the
right strategies. As of 2018, the Nokia corporation was
employing approximately 103 000 people sourced from about
100 countries (Kapko, 2021). The company had operations in
130 countries around the world. Nokia also reported annual
sales of around 23 billion pounds.
Nokia technology started as a pulp mill before moving into the
rubber and cable industries. It was not until the 1990s when the
company ventured into large-scale telecommunication
infrastructure (Wang, Hedman, & Tuunainen, 2016). The
company focused on technology development and licensing,
contributing immensely to the mobile telephony sector. Over the

years, the company has managed to release different Nokia
phone brands, most of which were revolutionary. In 2014, Nokia
sold its mobile phone business to Microsoft, creating Microsoft
mobile (Wang et al., 2016). The sale of its mobile business
enabled the company to focus more on its telecommunications
infrastructure business and improve the internet of things
technologies (IoT). The company further diversified into other
areas such as virtual reality and digital health (Wang et al.,
2016). Despite exploring new horizons in technology, the
company was still struggling to make profits. Its dwindling
profits forced the company to lay-off hundreds of employees
and closed various operations in different countries. In 2016,
Nokia announced the Nokia brand's return after reviewing the
opportunities existing in the mobile phone industry (Simon,
2016). A licensing arrangement with HMD Global facilitated
the return of the Nokia mobile phone.
The company's success over the years and the ability to
persevere through time can be attributed to its motto and vision.
Nokia's mission statement is to connect people. The company's
vision statement states that Nokia wants to create a new world,
to transform a big planet into a small village. The company's
vision is to create, build, and encourage people from all
countries to communicate with each other to create a world
where everybody is connected ("Nokia," n.d.). Nokia states that
its culture is driven forward based on its values such as respect,

challenge, achievement, and renewal ("Nokia," n.d.). The
vision, mission, and values serve as an anchor to Nokia and
maintain positive performance even during tough economic
times. Although the company has suffered major setbacks in the
past, it has overcome its challenges and bounces back even
stronger than before.
Some of Nokia's major competitors are Apple, Samsung,
Huawei, Blackberry, Sony mobile, and Palm. Nokia has to
constantly come up with effective competitive strategies to
ensure that it stays in the market and maintain sits competitive
advantage.
Challenges Affecting Nokia
A decline in business in 2020 forced Nokia to lay off more than
6,000 employees which is approximately 6.4% of its workforce.
In 2019, the company had laid off another 5,000 employees
representing approximately 4.6% of its workforce (Kapko,
2021). The company ended 2020 with 92,039 employees after
cutting off approximately 6,283 jobs in the same year. There are
indications that the company will lay off more workers in the
coming years as part of its three year turnaround plan which
was started by CEO Pekka Lundmark (Kapko, 2021). The CEO
also increased pressure on various business units in the
company to grow in their respective segments or face cuts. The
job cuts are consequences of the poor performance posted by the
company in recent years. Much of the company's decline has

been attributed to poor leadership that lacked the courage to
make important decisions (Kapko, 2021). The previous
leadership at the company forced various business segments to
come up with technologies under pressure to perform. As a
result, the company could not come up with competitive
innovations to compete with other companies like Samsung and
apple. In a bid to cut operational costs, the company embarked
on a program to reduce its workforce. In 2020, the company
also reduced the size of its executive from 17 to 11 people
(Kapko, 2021). The company further relocated 14,000
employees from corporate functions to its four business groups.
Kapko (2021) states that poor leadership strategies and a lack of
innovation are among the reasons that caused Nokia to lose its
competitive advantage and control of the mobile phone market.
The company needs to attract young and innovative leaders with
a proven track record if it has to bounce back and reclaim its
market share.
The analysis of Nokia's history and recent performance reveals
that it is an important player in the technology industry. The
company needs to come up with strategies that can enable it be
a leader in mobile innovation and other technologies. The
company could also borrow a leaf from what other companies
like Samsung and Apple are doing.
References
Kapko, M. (2021 March 6). Nokia slashed more than 6,000 jobs

in 2020. SDX Central. Retrieved from
https://www.sdxcentral.com/articles/news/nokia-slashed-more-
than-6000-jobs-in-2020/2021/03/
Wang, J., Hedman, J., & Tuunainen, V. K. (2016). Path
creation, path dependence and breaking away from the path: Re-
examining the case of nokia. Journal of Theoretical and Applied
Electronic Commerce Research, 11(2), 16-27.
doi:http://dx.doi.org/10.4067/S0718-18762016000200003
Simon, J. P. (2016). How to catch a unicorn? an exploration of
the universe of tech companies with high market
capitalization. Communications & Strategies, (104), 99-
116,127.
Nokia (n.d.). About us. Retrieved from
https://www.nokia.com/about-us/

Chapter 10
Global Strategy: Competing Around the World
© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®

The AFI Strategy Framework

2

Because learning changes everything.®

Learning Objectives
Define globalization, multinational enterprise (MNE), foreign
direct investment (FDI), and global strategy.
Explain why companies compete abroad and evaluate the
advantages and disadvantages of going global.
Apply the CAGE distance framework to guide MNE decisions
on which countries to enter.

Compare and contrast the different options MNEs have to enter
foreign markets.
Apply the integration-responsiveness framework to evaluate the
four different strategies MNEs can pursue when competing
globally.
Apply Porter’s diamond framework to explain why certain
industries are more competitive in specific nations than in
others.

© McGraw Hill

Hollywood and Globalization
Hollywood movie: The quintessential American product
However, non-U.S. sales increased: 50% in 2000, 70% in 2012,
but slowing in 2016, (accounted for $39B in sales)
Altered global strategic focus
Movies that fit the global market by adapting foreign scripts,
hiring international actors/actresses
Two versions of Iron Man 3 in 2013 (one just for China)
Treat emerging markets as focal targets
Not just filmmaking industries, but also electronics industry
(ex: Korea, China), and auto industry (ex: India)

4

© McGraw Hill

All Time World Box Office

5

© McGraw Hill

2018 Operation Red Sea $1.5M in US, $579M in China

Avenger End Game,
Domestic: $858,373,000 30.7%+ Foreign: $1,937,901,401 69.
3%= Worldwide: $2,796,274,401

5

What is Globalization?
A process…
…that provides closer integration and exchange…
…between countries and peoples worldwide.
Made possible by:
Falling trade and investment barriers.
Advances in telecommunications.
Reductions in transportation costs.
Importance of MNEs and FDIs

© McGraw Hill

Combined, these factors reduce the costs of doing business
around the world, opening the doors to a much larger market
than any one home country. Globalization also allows
companies to source supplies at lower costs, to learn new
competencies, and to further differentiate products.

Consequently, the world’s market economies are becoming more
integrated and interdependent.
6

Global Strategy
Part of a firm’s corporate strategy to:
Gain and sustain a competitive advantage.
Compete against foreign and domestic companies.
Foreign direct investment:
Investments in value chain activities abroad.
Multinational enterprise:
Deploys resources and capabilities in two countries or more.

© McGraw Hill

Instructors can ask students where their sneakers (especially
Nike) are being made. The answer will highly likely be a place
outside the U.S., and most probably in Asia. Then ask students
why the sneakers are made in Asia.

7

Global Strategy
Multi-National Enterprises, (MNE’s) - make up less than 1% of
the number of total U.S. companies, but they:
Account for 11 percent of private-sector employment growth
since 1990.
Employ 19 percent of the work force.
Pay 25 percent of the wages.
Provide for 31 percent of the U.S. gross domestic product
(GDP).
Make up 74 percent of private-sector
R&D spending.

© McGraw Hill

8

Stages of Globalization

Globalization 1.0: 1900 to 1941:
Sales, operations, and some procurement.
Strategy flowed from headquarters to international sites.
Globalization 2.0: 1945 to 2000:
To reconstruct damage from the war.
Focus on European countries, Japan, and Australia.
Greater local responsiveness.
Headquarters set goals and international sites influenced tactics.
Globalization 3.0: 21st Century:
Business function locations are based on costs, capabilities, and
PESTEL factors.
Companies can operate 24/7, 365 days a year.

© McGraw Hill

9

The Current State of Globalization
The world only semi-globalized:
The level of globalization is at 10-25% total.

Evidence:
2% of all voice-calling minutes are cross-border.
3% of world’s population are immigrants.
9% of investments are foreign direct investments.
15% of patents list at least one foreign inventor.
18% of Internet traffic crosses national borders.
Retrenchment may occur in the future:
There has been a rise of nationalism.

© McGraw Hill

Continued economic development across the globe has two
consequences for MNEs. First, rising wages and other costs are
likely to negate any benefits of access to low-cost input factors.
Second, as the standard of living rises in emerging economies,
MNEs are hoping that increased purchasing power will enable
workers to purchase the products they used to make for export
only.

10

Globalization has two consequences for MNE’s
Rising wages and other costs…may negate any benefits of
access to low-cost input factors, (but someone is always willing
to go lower).
As the standard of living rises in emerging economies…MNEs
are hoping that increased purchasing power will enable workers
to purchase the products they used to make for export only.

11

© McGraw Hill

China’s labor costs are steadily rising in tandem with improved
standard of living. Wages have increased 50% since 2005.
Rising wages and fewer workers, (due to one-child-per–family)
along with China’s currency appreciation will lessen the
economic advantage.

China is now using Africans for manufacturing.

The people making the iphone want to own the iphone. They
probably care less about…

11

And they probably don’t care about…

12

© McGraw Hill

And they probably care less about…whoopee cushions,
Halloween stuff, metal chickens and all the other crap we buy…

Home Goods motto should be “Nothing you need to own”

12

MAGA realities

13

© McGraw Hill

That boat has sailed…we are never going back to being a
manufacturing country.
13

Advantages and Disadvantages of International Expansion
Exhibit 10.5

Access the text alternate for slide image.

© McGraw Hill

14

Advantages of Going Global
Gain access to a larger market.
Gain access to low-cost input factors.
Develop new competencies.

© McGraw Hill

15

Advantage #1: Gain Access to a Larger Market
Helps multinational enterprises with economies of scale and
scope.
Participating in a much larger market.
Opportunities to outcompete local rivals.
Helps firms in smaller economies:

Achieve growth.
Gain and sustain competitive advantage.

© McGraw Hill

16

Advantage #2: Access to Low-Cost Input Factors
Helps multinational enterprises that pursue a low-cost
leadership strategy.
Examples of low-cost raw materials: lumber, iron ore, oil, and
coal.
Has been a key driver of globalization:
Lower labor costs is the main focus now.
India provides well-educated English-speaking young people.
China provides low labor costs and an efficient infrastructure.

© McGraw Hill

Example: INDIA
India carved out a competitive advantage in business process
outsourcing (BPO), not only because of low-cost labor but
because of an abundance of well-educated, English-speaking
young people. Infosys, TCS, and Wipro are some of the more
well-known Indian IT service companies. Taken together, these
companies employ more than 250,000 people and provide
services to many of the Global Fortune 500. Many MNEs have
close business ties with Indian IT firms. Some, such as IBM, are
engaged in foreign direct investment through equity alliances or
building their own IT and customer service centers in India.
More than a quarter of Accenture’s work force, a consultancy
specializing in technology and outsourcing, is now in
Bangalore, India.

17

Advantage #3: Develop New Competencies
Helps multinational enterprises that pursue a differentiation

strategy.
Access to:
Communities of learning.
Specific geographic regions.
Location economies.
Locating value chain activities in optimal geographies.

© McGraw Hill

AstraZeneca, a Swiss-based pharmaceutical company, relocated
its research facility to Cambridge, Massachusetts, to be part of
the Boston biotech cluster, in hopes of developing new R&D
competencies in biotechnology. Cisco invested more than $1.6
billion to create an Asian headquarters in Bangalore and support
other locations in India, in order to be in the middle of India’s
top IT location. Unilever’s new-concept center is located in
downtown Shanghai, China, attracting hundreds of eager
volunteers to test the firm’s latest product innovations on-site,
while Unilever researchers monitor consumer reactions.

Many MNEs now are replacing the one-way innovation flow
from Western economies to developing markets with a
polycentric innovation strategy—a strategy in which MNEs now
draw on multiple, equally important innovation hubs throughout
the world characteristic of Globalization 3.0; see Exhibit 10.3.
18

Disadvantages of Going Global
Liability of foreignness.
Loss of reputation.
Loss of intellectual property.

© McGraw Hill

19

Disadvantage #1: Liability of Foreignness
Unfamiliar cultural environment.

Unfamiliar economic environment.
Coordinating across geographic distances.
All can result in additional costs.

© McGraw Hill

What works in US does not mean it will work in other
countries…and viceversa…Fresh and Easy

Walmart’s problems in several international markets are in large
part because of the liability of foreignness. In particular,
Walmart failed in Germany and experienced a similar fate in
South Korea, where it also exited in 2006. In addition, Walmart
has tried for many years to successfully enter the fast-growing
markets in Russia and India, but with little or no success.
Walmart’s success recipe that worked so well domestically
didn’t work in Germany, South Korea, Russia, or India.

Walmart underestimated its liability of foreignness when
entering and competing in Germany, and how it is now facing
the German grocery industry disruptors, Aldi and Lidl, on its
home turf.

20

Disadvantage #2: Loss of Reputation
Reputation is one of the most valuable resources.
Reputation dimensions can include innovation, customer
service, brand reputation.
Loss of reputation can diminish competitiveness.
Low wages, long hours, and poor conditions.
Local government may be corrupt.
Safety standards may not be enforceable.

21

© McGraw Hill

Apple’s brand, for example, stands for innovation and superior
customer experience. Apple’s brand reputation is also one of its
most important resources. Apple’s brand is valued at $230

billion, making it the most valuable in the world.

However, low wages, long hours, and poor working and living
conditions contributed to a spate of suicides at Foxconn,
Apple’s main supplier in China. The Taiwanese company, which
employs more than a million people, manufactures computers,
tablets, smartphones, and other consumer electronics for Apple
and other leading consumer electronics companies. The
backlash against alleged sweatshop conditions in Foxconn
prompted Apple to work with its main supplier to improve
working conditions and wages. Tim Cook, Apple’s CEO, visited
Foxconn in China to personally inspect its manufacturing
facility and workers’ living conditions. Although conditions at
Foxconn have been improving, Apple started to diversify its
supplier base by adding Pegatron, another Taiwanese original
equipment manufacturer (OEM).
21

Disadvantage #3: Loss of Intellectual Property
It can be difficult to protect IP in foreign markets.
Particularly software, movies, and music.
Copyright infringements can occur.

Some countries are known for partnering initially, but then
reverse-engineering capabilities.

Intellectual property exposure.

How many of you use a pirated textbook?

© McGraw Hill

Theft and reverse engineered to then compete. China is biggest
abuser. That is why they release movies simultaneously now.
Trumps’s trade war is part of this discussion.

1 in 5 CEO’s say there company has experience IP theft from
China in 2019.
22

The CAGE Distance Framework
Distance is the main cost and risk of expansion.
CAGE is an acronym for different types of distance:
Cultural.
Administrative and political.
Geographic.
Economic.

Guides multinational enterprise decisions on which countries to
enter.

© McGraw Hill

Although absolute metrics such as country wealth or market size
matter to some extent—as we know, for example, that a 1
percent increase in country wealth leads to a 0.8 percent
increase in international trade—the relative factors captured by
the CAGE distance model matter more. For instance, countries
that are 5,000 miles apart trade only 20 percent of the amount
traded among countries that are 1,000 miles apart. Cultural
distance matters even more. A common language increases trade
between two countries by 200 percent over country pairs
without one.

23

Cultural Distance
Disparity between a firm’s home and host country, specifically

social norms and morals, beliefs, and values.
Made up of:
Power distance.
Individualism.
Masculinity–femininity.
Uncertainty avoidance.
Long-term orientation.
Indulgence.

© McGraw Hill

Cultural differences find their expression in language, ethnicity,
religion, and social norms. They directly affect customer
preferences (see Exhibit 10.5). Because of religious beliefs, for
example, Hindus do not eat beef, while Muslims do not eat
pork. In terms of content-intensive service, cultural and
language differences are also the reason global internet
companies such as Amazon or Google offer country-specific
variations of their sites.

Bribery is acceptable in other countries…are you willing to
play?

24

Administrative and Political Distance
Captured in factors such as:
Shared monetary or political associations.
Political hostilities.
Weak or strong legal and financial institutions.
Political and administrative barriers include:
Tariffs, quotas and restrictions.

© McGraw Hill

Many foreign (target) countries also erect other political and
administrative barriers, such as tariffs, trade quotas, FDI
restrictions, and so forth, to protect domestic competitors. In
many instances, China, for example, requests the sharing of

technology in a joint venture when entering the country.

The 19 European countries in the eurozone not only share the
same currency but also integrate politically to some extent. It
should come as no surprise then that most cross-border trade
between European countries takes place within the EU.
Germany, one of the world’s largest exporters, conducts roughly
75 percent of its cross-border business within the EU.

25

Geographic Distance
More than just physical distance.
Measured by:
Physical size (Canada versus Singapore).
Within-country distances to its borders.
Topography.
Time zones.
Whether the countries are contiguous.
Access to waterways and the ocean.
Infrastructure
Roads, power, and telecommunications.

© McGraw Hill

Geographic distance is particularly relevant when trading
products with low value-to-weight ratios, such as steel, cement,
or other bulk products, and fragile and perishable products, such
as glass or fresh meats and fruits.
26

Economic Distance
Wealth and per capita income of consumers.
Wealthy countries engage in more cross-border trade.
Wealthy countries trade with wealthy countries.
Economies of experience, scale, scope, and standardization
Similar infrastructure and resources.
Wealthy countries trade with poor countries.
Access to low-cost input factors (economic arbitrage).

© McGraw Hill

Although Walmart in Canada is a virtual carbon copy of the
Walmart in the United States, Walmart in China is quite
different.

27

Modes of Foreign-Market Entry along the Investment and
Control Continuum
Exhibit 10.7

Access the text alternate for slide image.

© McGraw Hill

Exporting—producing goods in one country to sell in another—
is one of the oldest forms of internationalization (part of
Globalization 1.0).

It is often used to test whether a foreign market is ready for a
firm’s products. When studying vertical integration and
diversification (in Chapter 8), there are different forms along
the make-or-buy continuum. Chapter 9 outlined how strategic

alliances (including licensing, franchising, and joint ventures)
and acquisitions are popular vehicles for entry into foreign
markets. These organizational arrangements were discussed in
detail in previous chapters.

Vz-Vodaphone

28

Cost Reductions vs. Local Responsiveness
Two opposing forces in global competition:
Cost reductions: key competitive weapon.
Local responsiveness: tailoring to specific preferences.

Globalization hypothesis:
Consumer needs and preferences are converging.
Food, music, movies, clothing.
Examples: McDonalds, Coca-Cola, rock music, Greek salad,
Hollywood movies, Levi jeans.

© McGraw Hill

29

The Integration-Responsiveness Framework: Global Strategy
Positions and Representative MNEs

Access the text alternate for slide image.

© McGraw Hill

30

International Strategy
Sells the same products or services in both domestic and foreign
markets.
Low-cost reductions / low-local responsiveness:
Leverages home-based core competencies.
Sells the same products domestically and abroad.

Often used successfully by MNE’s with:
Large domestic markets.
Strong reputations and brand names.

© McGraw Hill

A strength of the international strategy—its limited local
responsiveness—is also a weakness in many industries. For
example, when an MNE sells its products in foreign markets
with little or no change, it leaves itself open to the
expropriation of intellectual property (IP). Looking at the
MNE’s products and services, pirates can reverse-engineer the
products to discover the intellectual property embedded in them.

Harley, Rolex. Selling the same products or services in both
domestic and foreign markets

Starbucks would probably be international, but could also fit
into multidomestic. Low pressure for cost reduction and local
support

31

Multidomestic Strategy
Low-cost reductions / high-local responsiveness:
Local consumers ideally perceive products as local.
Can be costly and inefficient:
Duplication of business functions across countries.
Common in:
Consumer products industry.
Food industry.

© McGraw Hill

Nestle, Bridgestone, Philips, (Swiss, Japanese, Dutch).
Consumers will perceive them to be domestic companies.
Differentiation but local…

32

Global-Standardization Strategy
High-cost reductions / low-local responsiveness:
Economies of scale and location economies.
Achieved through global division of labor.
Based on wherever capabilities have lowest cost.
Price, the main competitive weapon:
Minimal local adaptation.

© McGraw Hill

Lenovo, the Chinese computer manufacturer, is the maker of the
ThinkPad line of laptops, which it acquired from IBM in 2005.
To keep track of the latest developments in computing,
Lenovo’s research centers are located in Beijing and Shanghai
in China, in Raleigh, North Carolina (in the Research Triangle
Park), and in Japan. To benefit from low-cost labor and to be
close to its main markets to reduce shipping costs, Lenovo’s

manufacturing facilities are in Mexico, India, and China. The
company describes the benefits of its global-standardization
strategy insightfully: “Lenovo organizes its worldwide
operations with the view that a truly global company must be
able to quickly capitalize on new ideas and opportunities from
anywhere. By forgoing a traditional headquarters model and
focusing on centers of excellence around the world, Lenovo
makes the maximum use of its resources to create the best
products in the most efficient and effective way possible.”

33

Transnational Strategy
High-cost reductions / high-local responsiveness:
“Think globally, act locally.”
Best practices, ideas, and innovations used everywhere.
Used by multinational enterprises that pursue a blue ocean
strategy.
Difficult to implement:
Duplication of efforts.
Organizational complexity.

© McGraw Hill

Strong local competition for conglomerates…

34

Dynamic Strategic Positioning: Google’s YouTube

Access the text alternate for slide image.

© McGraw Hill

Intl -Red was available in US and select English speaking
countries, (Aus, NZ), but kept the content US-based.
Multidomestic-Premium launch allowed search engines to
customize to country and culture preferences.
Trans – Will allow search engine to find content for you
WHEREVER your are…

35

National Competitive Advantage
High-performing firms for certain industries are concentrated in
specific countries.

United States: biotechnology, software, internet
China and Taiwan: computer manufacturing
South Korea and Japan: consumer electronics
Australia: mining
India: business process outsourcing
Germany: engineering and cars
Italy: fashion
France: wine

36

© McGraw Hill

The Death of Distance Hypothesis is the assumption that
geographic location shouldn’t lead to firm-level competitive

advantage because firms are able to source inputs globally, and
this assumption is inaccurate.

36

Porter’s Diamond of National Competitive Advantage
Exhibit 10.11
Source:. Adapted from M.E. Porter (1990, March–April), “The
competitive advantage of nations,” Harvard Business Review:
78.

© McGraw Hill

37

Factor Conditions
A country’s endowments:
Natural, human, and other resources.
Resource-rich: focus on commerce.
Resource-lacking: focus on human capital.

Other important factors:
Capital markets, institutional frameworks,
research universities, public infrastructure.
Airports, roads, schools, health care system, etc.

© McGraw Hill

Resource-rich countries: Afghanistan, Iran, Iraq, Russia, Saudi
Arabia, and Venezuela…but not home to any world’s leading
companies.
Countries that lack natural resources: Denmark, Finland, Israel,
Japan, Singapore, South Korea, Switzerland, Taiwan, and the
Netherlands…but have large corps in country

Natural resources are not needed because competitive advantage
is often based on human capital and know how.

38

Demand Conditions
Characteristics of demand in a firm’s domestic market.
Customers hold companies to standards of value creation:
Developments in research.
Cost containment.
New commercial applications for the market.

© McGraw Hill

For example, due to dense urban living conditions, hot and
humid summers, and high energy costs, it is not surprising that
Japanese customers demand small, quiet, and energy-efficient

air conditioners. In contrast to the Japanese, Finns have a sparse
population living in a more remote countryside. A lack of
landlines for telephone service has resulted in the Finnish
demand for high-quality wireless services, combined with
reliable handsets (and long-life batteries) that can be operated
in remote, often hostile, environments. Cell phones have long
been a necessity for survival in rural areas of Finland. This
situation enabled Nokia to become an early leader in cell
phones.
39

Competitive Intensity in a Focal Industry
Competitive environments lead to better performance.

Example: German car industry:
Fierce domestic competition,
Demanding customers,
Results in top-notch engineering.

© McGraw Hill

German car companies such as Volkswagen (which also owns
Audi and Porsche), BMW, and Daimler.
40

Related and Supporting Industries/Complementors
Leadership in related and supporting industries fosters
complementors in downstream industries:
Firms that provide an additional good or service.
Combined with the primary product.
Leads customers to value the firm’s offering more.
Further strengthens national competitive advantage.

© McGraw Hill

Toyota’s global success in the 1990s and early 2000s was based

to a large extent on a network of world-class suppliers in Japan.
This tightly knit network allowed for fast two-way knowledge
sharing—this in turn improved Toyota’s quality and lowered its
cost, which it leveraged into a successful blue ocean strategy at
the business level.
41

The World’s Most Profitable Retailer

© McGraw Hill

Toyota’s global success in the 1990s and early 2000s was based
to a large extent on a network of world-class suppliers in Japan.
This tightly knit network allowed for fast two-way knowledge
sharing—this in turn improved Toyota’s quality and lowered its
cost, which it leveraged into a successful blue ocean strategy at
the business level.
42

IKEA
Sweden based
28 Countries
$35B

CSR firm

Core competency: Designing and offering modern and
functional home furnishings in a unique retail experience
resulting in a low cost structure.

© McGraw Hill

Asia accounts for 9% of sales, but 35% of its inputs
43

What type of business is IKEA?

© McGraw Hill

44

What type of business is IKEA?

© McGraw Hill

Started as Global but moved to Transnational…

Adapted to countries need for smaller locations
Click and collect stores, more online
Redesigns for more urban…customization.
Adding delivery and installation services as some people are
less inclined to self build with minimal instructions

Localization aka Multidomestic…

45

Are you what you eat?
In your groups, interview each other about your experiences
with ethnic food. Answer the following:
What is your favorite ethnic food?
How often do you eat it?
Is it part of your family heritage or did someone else introduce
it to you?
Was it through social media or a personal recommendation?
(who?)

© McGraw Hill

46

Are you what you eat? - Debrief
What specific connections between food and culture have you
found in your daily lives?
How do you see food and culture as it impacts your

workplace/school life?
Have you learned anything about cultures through food related
traditions or beliefs?
Do you feel diversity in the workplace/school have impacted the
types of food you seek to enjoy?

© McGraw Hill

47

End of Main Content
© 2019 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®
www.mheducation.com

Chapter 12
Corporate Governance and Business Ethics
© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®

1

The AFI Strategy Framework

2

Because learning changes everything.®

Learning Objectives
Describe the shared value creation framework and its
relationship to competitive advantage.
Explain the role of corporate governance.
Apply agency theory to explain why and how companies use
governance mechanisms to align interests of principals and
agents.
Evaluate the board of directors as the central governance
mechanism for public stock companies.
Evaluate other governance mechanisms.
Explain the relationship between strategy and business ethics.

© McGraw Hill

Case Study-Uber
Travis Kalanick founded the company in 2009 in SF
Disrupted taxi service as “ride hailing”
Market cap of $70B in 2017
Hertz w/ 500M cars, 150k employees = 1% of that value

Avoids the taxes of other cab companies
Gig economy job = freedom, but not benefits
Forced to resign in 2017 after fallout from investigation and
video of him going off on Uber driver.

4

© McGraw Hill

New CEO, Dara Khosrowshahi formerly of Expedia…apology
tour.

4

Case Study -Uber
Ethically Challenged?
Early disregard for laws, rules and regulations
Dynamic pricing
Punking the competition
Punking their own drivers

Attacking critics
Culture of sexual harassment/gender discrimination
Waymo lawsuit

5

© McGraw Hill

Flaunting local laws and ignoring injunctions
Surge pricing vs. price gouging, (snowstorms, etc)…matching
supply with demand.
Uber ordered Lyft rides and then cancelled, causing lost
business from legitimate customers
Lied to their drivers about laws preventing drivers from
working for both Lyft and Uber
Poached/targeted Lyft drivers
Google’s sued Uber for trade secret theft. Waymo alleged one
of its former engineers stole confidential trade secrets before
leaving to form his own startup, Otto, in 2016. Waymo alleged
Uber used that information to help advance Uber's self-driving

tech once Otto was acquired in August 2016.

5

Public Stock Company: Four Benefits
Limited liability for investors.
Transferability of investor ownership through stock.
Legal personality, with rights and obligations.
Separation of legal ownership and management control.

6

© McGraw Hill

Only liable for what you invest
Easily transfer of stocks
Public domain vs. family run…public firms has rights and
obligations
Stockholders are owners who delegate authority.

For publicly held firms, in particular, it is important for
management to keep in mind that it is acting as stewards for

other people’s money and has public responsibilities.

6

The Public Stock Company: Hierarchy of Authority
Exhibit 12.1

Access the text alternate for slide image.

© McGraw Hill

7

Two Viewpoints
Traditional View: (Friedman)
Shareholder capitalism: shareholders – the providers of the
necessary risk capital and the legal owners of public companies
– have the most legitimate claim on profits.

Shared Value View: (Porter)
Creating Shared Value, (CSV): obligations extend beyond the

economic responsibility and include legal, ethical, and
philanthropic societal expectations

8

© McGraw Hill

Freidman-”There is one and only one social responsibility of
business-to use its resources and engage in activities designed
to increase its profits so long as it stays within the rules of the
game, which is to say, engages in open and free competitions
without deception of fraud.”

Porter-”The purpose of the corporation must be redefined as
creating shared value, not just profit per se. This will drive the
next wave of innovation and productivity growth in the global
economy.”

Discuss in your group the contrasting perspectives of
“shareholder versus stakeholder” governance. What benefits and

drawbacks can you find in each view? Students need to
understand the difference between shareholders and
stakeholders. Shareholders focus on self-interest and
profitability, while stakeholders emphasize responsibilities and
all the parties involved. They must also realize that national and
cultural differences play a role when designing the governance
structure. What are the differences within countries in regards
to layoffs?

8

“The social responsibility of business is to increase its profits.”
A survey was created:
For the (degreed) top 25% of income earners.
To assess various countries.
To inquire whether they agree with Friedman.
The results…

© McGraw Hill

9

Global Survey of Attitudes toward Business Responsibility

Access the text alternate for slide image.

© McGraw Hill

10

The Shared Value Creation Framework
Provides guidance to managers.
Helps reconcile gaining and sustaining competitive advantage
with corporate social responsibility.
Creates a larger “pie” to benefit shareholders and stakeholders.

11

© McGraw Hill

11

Creating Shared Value
Executives shouldn’t concentrate only on increasing firm
profits.
Rather, they should focus on creating shared value.
- Economic value (for shareholders).
- Social value (address society’s needs and challenges).

© McGraw Hill

Video on CSV image

The shared value creation framework provides help in making
connections between economic needs and social needs in a way

that transforms into a business opportunity.

What does this sound like?

Starbucks had the vet program 25k hires, refugee 10k hires,
youth 10k hires. Rust proof plants for farmers

GE, for example, has strengthened its competitiveness by
creating a profitable business with its “green” Ecomagination
initiative. Ecomagination is GE’s strategic initiative to provide
cleaner and more efficient sources of energy, provide abundant
sources of clean water anywhere in the world, and reduce
emissions. Jeffrey Immelt, GE’s former CEO, would often say,
“Green is green,” meaning that addressing ecological needs
offers the potential of gaining and sustaining a competitive
advantage for GE.
12

Reconnecting Economic and Societal Needs
Reconceiving products and markets. Expand the customer base
to bring in nonconsumers, (the largest and poorest groups).
Companies can meet customer needs while better serving
society, within existing markets, accessing new ones, or
lowering costs through innovation

Redefining productivity in your value chain. Expand traditional
internal firm value chains to include more nontraditional
partners.
For example, nongovernmental organizations (NGOs)
Companies can improve the quality, quantity, cost, and
reliability of inputs and distribution while they simultaneously
act as a steward for essential natural resources and drive
economic and social development.

Focus on creating new regional clusters.
Look at ways to support industries related to your own
Chilecon Valley and Bangalore

© McGraw Hill

Porter argues that these strategic actions will lead to a larger
pie of revenues and profits that can be distributed among a
company’s stakeholders.

CSV is about creating new business opportunities that create
new markets, improve profitability and strengthen competitive
positioning….Value

CSR is about responsibility…they overlap.

CSR is viewed more as a cost center, not a profit center,
Porter’s is identify the profit capability in CSV.

13

One firm’s view

14

© McGraw Hill

Corporate Governance
The mechanisms to:
Direct and control an enterprise.
Ensure that it pursues strategic goals successfully and legally.

Offers checks and balances.

Attempts to address the principal-agent problem, (next slide)

15

© McGraw Hill

The separation of ownership and control is one of the major
advantages of the public stock companies. This benefit,
however, is also the source of the principal–agent problem. In
publicly traded companies, the stockholders are the legal
owners of the company, but they delegate decision-making
authority to professional managers. The conflict arises if the
agents pursue their own personal interests, which can be at odds
with the principals’ goals. For their part, agents may be more
interested in maximizing their total compensation, including
benefits, job security, status, and power. Principals desire
maximization of total returns to shareholders.

15

The Principal-Agent Problem

© McGraw Hill

Managers, executives, and board members tend to have access
to private information concerning important company
developments that outsiders, especially investors, are not privy
to. Often this informational advantage is based on timing—
insiders are the first to learn about important developments
before the information is released to the public. Although
possessing insider information is not illegal and indeed is part
of an executive’s job, what is illegal is acting upon it through
trading stocks or passing on the information to others who
might do so…this is known as information asymmetry.

The company's officers and board of directors, including
Chairman Kenneth Lay, CEO Jeffrey Skilling and CFO Andy
Fastow, were selling their Enron stock at higher prices due to
false accounting reports that made the stock seem more valuable
than it truly was.

Goldman Sachs and Real estate bubble. Another agency problem
occurs when financial analysts invest against the best interests
of their clients.

16

The Principal-Agent Problem

While the stockholders call on the managers to take care of the
company, the managers may look to their own needs first.

© McGraw Hill

P-A problem occurs when one person or entity (the "agent") is
able to make decisions and/or take actions on behalf of, or that
impact, another person or entity: the "principal". This dilemma
exists in circumstances where agents are motivated to act in
their own best interests, which are contrary to those of their
principals

17

Agency Theory
A theory that views the firm as a nexus of legal contracts.
Conflicts that arise should be resolved legally.
The firm needs to design work tasks, incentives, and
employment contracts…
To minimize opportunism by agents.
18

© McGraw Hill

Senior executives, such as the CEO, face agency problems when
they delegate authority. Employees who perform the actual
operational labor are agents who work on behalf of the
managers. Such frontline employees often enjoy an
informational advantage over management. They may tell their
supervisor that it took longer to complete a project or serve a
customer than it actually did, for example. Some employees
may be tempted to use such informational advantage for their
own self-interest (e.g., spending time on Facebook during work
hours, watching YouTube videos, or using the company’s
computer and internet connection for personal business).

18

Adverse Selection and Moral Hazard
Both caused by information asymmetry.
Adverse Selection
An increased likelihood of selecting inferior alternatives.
Moral Hazard
When one party is incentivized to take undue risks or shirk
responsibilities,
The costs are incurred to the other party.

© McGraw Hill

19

The Board of Directors
Centerpiece of corporate governance.
Represent the interests of shareholders.
Tasked with providing oversight.

Consist of inside and outside directors.
Inside directors: usually consist of CEO, COO, CFO.
Outside directors: senior execs from other firms.
Are elected by the shareholders.
Shareholders vote to determine who is elected.

© McGraw Hill

20

Responsibilities of the Board of Directors
Strategic oversight and guidance.
CEO selection, evaluation, compensation, succession.
Guide executive compensation.
Review, monitor, evaluate, and approve strategic initiatives.
Risk assessment and mitigation.
Ensuring financial statements are accurate.
Ensuring compliance with laws and regulations.

© McGraw Hill

When Facebook acquired Instagram, the CEO, Mark
Zuckerberg, did not even inform the board about the deal until
it was done. Working on his own was undoubtedly faster than
engaging the board and seeking their advice and approval, and
speed may have made the difference in gaining the target. On
the other hand, how well were the shareholders served in the
absence of board oversight in the negotiations process? Ask
students to debate the pros and cons of Mr. Z’s actions.

The practice of CEO/chairperson duality—holding both the role
of CEO and chairperson of the board—has been declining
somewhat in recent years. Among the largest 500 publicly
traded companies in the United States, about 70 percent of firms
had the dual CEO-chair arrangement in 2005 (before the global
financial crisis), but this number had declined to some 50
percent of companies in 2018 (post global financial crisis).
High-profile examples of the same person serving as CEO and
chair of the board include Jeff Bezos (Amazon), Mark
Zuckerberg (Facebook), Robert Iger (Disney), Mary Barra

(GM), and Virginia Rometty (IBM).
21

Boys Club?

22

© McGraw Hill

Why has representation by women on U.S. boards not increased
over the past 10 years? What actions could be taken by
companies to increase participation? What actions could be
taken by women who seek to be directors?
Part of the problem is that women continue to be under-
represented in the C-Suite executive offices.
22

Other Governance Mechanisms
Used to align incentives between principals and agents:
Executive compensation.

The market for corporate control.

Financial statement auditors, government regulators, and
industry analysts.

© McGraw Hill

23

1. Executive Compensation
Stock options are often part of compensation.
2019 Average CEO pay was about $21M.
The avg ratio of CEO to employee pay is 280:1
In 1980 it was 40:1
About 2/3 of CEO pay is linked to firm performance.
Incentives can negatively affect performance
Overall pay has gone up, but not necessarily performance

24

© McGraw Hill

CEO pay has increased 940% since 1978
What are the potentially negative effects of this increasing
disparity in CEO pay? Do you believe that current executive pay
packages are justified? Why or why not?

Based on a survey of CEOs in the S&P 500 by The Wall Street
Journal, the median annual compensation was about $11
million. The five highest paid CEOs were Thomas Rutledge of
Charter Communications ($98.5 million), Fabrizio Freda of
Estée Lauder ($48.4 million), Mark Parker of Nike ($47.6
million), Alex Molinaroli of Johnson Controls ($46.4 million),
and Robert Iger of Disney ($43.9 million). Noteworthy are also
the two lowest paid CEOs in the S&P 500: Warren Buffett of
Berkshire Hathaway ($470,000) and Larry Page of Alphabet
($1, the minimum payment required).

24

CEO Pay 2019
Highest in 2019:
Elon Musk – Tesla, SpaceX ($2.2B)Patrick Smith – Axon
Enterprise ($248M) David Zaslav – Discovery Comm

($128M)John Legere – T-Mobile ($66M) Robert Iger of Disney
($65M)
Lowest in 2019
Warren Buffet of Berkshire Hathaway ($100k)
Larry Page of Alphabet ($1.00)
Jeff Bezos of Amazon ($1.7M)
Craig Jelinek of Costco, ($934,000)

25

© McGraw Hill

Obviously these guys make more in Stock, but their base pay is
low relatively.
25

2. The Market for Corporate Control
An external corporate-governance mechanism.

Activist investors who:
Seek to gain control of an underperforming corporation.

Buy shares of its stock in the open market through buy-outs.
Defended by poison pill

26

© McGraw Hill

In a leveraged buyout (LBO), a single investor or group of
investors buys, with the help of borrowed money (leveraged
against the company’s assets), the outstanding shares of a
publicly traded company in order to take it private. In short, an
LBO changes the ownership structure of a company from public
to private. The expectation is often that the private owners will
restructure the company and eventually take it public again
through an initial public offering (IPO).

To avoid being taken over against their consent, some firms put
in place a poison pill. These are defensive provisions that kick
in should a buyer reach a certain level of share ownership
without top management approval.

(Carl Icahn, Daniel Loeb, Wm. Ackman)

Whole foods was one such target and chose to “merge” with
Amazon vs. investor driven change.
26

3. Auditors, Regulators and Industry Analysts
External-governance mechanisms.
To avoid misrepresentation of financial results:
Public financial statements must follow GAAP:
Generally accepted accounting principles.
Financial statements must be audited.
Industry analysts often base their buy, hold, or sell
recommendations on:
Financial statements filed with the SEC.
Business news (WSJ, Forbes, CNBC, etc.)

© McGraw Hill

Corporate-governance mechanisms play an important part in

aligning the interests of principals and agents. They enable
closer monitoring and controlling, as well as provide incentives
to align interests of principals and agents. An industry has
sprung up around assessing the effectiveness of corporate
governance in individual firms. Research outfits, such as GMI
Ratings, provide independent corporate governance ratings. The
ratings from these external watchdog organizations inform a
wide range of stakeholders, including investors, insurers,
auditors, regulators, and others.

27

Ethics Scandals

28

© McGraw Hill

Ethical decision making depends on the organization

Enron-Power Utilities – creating an inflated share price at any
cost, employees observed and followed the behavior set by
leaders. Ken Lay died weeks before entering prison, other C-
levels imprisoned
Worldcom-Telecom – Bernie Ebbers imprisoned
Tyco-Security systems – Dennis Kowsloski imprisoned
Valeant/Turin – Pharma, CEO believed its sole purpose was to
the shareholder, orphan drugs. Shreli in prison, Thompson free
HSBC – The drug cartel’s bank, money laundering. Paid a $2B
fine, make 38B/yr.
Payday loan – legal loan shark, Scott Tucker in prison

28

Apology tours

29

© McGraw Hill

Why are these ads being run? Unethical behavior
Has it changed your mind about using any of these companies?

WF https://www.youtube.com/watch?v=CjWnHmFYbEg
Fb https://youtu.be/Q4zd7X98eOs
Uber https://www.youtube.com/watch?v=WMZyw5lPKgE

29

Two Questions
Why does this unethical behavior happen repeatedly in the
business world?

Is there a difference between Ethics and Business Ethics?

30

© McGraw Hill

Does crime pay?
How many people go to jail for destroying trust, companies and
people? Very few if any
Just because it is legal, does it make it right? Valeant buys
smaller monopolistic drug companies to raise the price.

How to you rectify “business ethics”.

30

Business Ethics
An agreed-upon code of conduct in business
Provides training for:
Behavior that is consistent with the principles, norms, and
standards of business practice that have been agreed upon by
society.
Can differ in various cultures around the globe.
Universal norms include fairness, honesty, and reciprocity.

© McGraw Hill

Law and ethics, however, are not synonymous. This distinction
is important and not always understood by the general public.
Staying within the law is a minimum acceptable standard. A
note of caution is therefore in order: A manager’s actions can be
completely legal, but ethically questionable.
31

When Facing an Ethical Dilemma
Is the action within acceptable norms of professional behavior?
As outlined in the organization’s code of conduct.
As defined by the profession at large.

Would you feel comfortable explaining and defending the
decision in public?
How would the media react?
How would the company’s stakeholders feel about it?

© McGraw Hill

32

Bad Apples vs. Bad Barrels
Bad Apples.
Individuals who act opportunistically.

Bad Barrels.
An unethical organizational climate.
To set the ethical tone, leaders must:
Set clear ethical expectations.
Put structure, culture and control systems in place.
Formal and informal culture must be aligned.
Executive behavior must adhere to the company vision and
values.

© McGraw Hill

33

The MBA OathAs a business leader I recognize my role in
society.My purpose is to lead people and manage resources to
create value that no single individual can create alone.My
decisions affect the well-being of individuals inside and outside
my enterprise, today and tomorrow.Therefore, I promise that:I
will manage my enterprise with loyalty and care, and will not
advance my personal interests at the expense of my enterprise
or society.I will understand and uphold, in letter and spirit, the
laws and contracts governing my conduct and that of my
enterprise.I will refrain from corruption, unfair competition, or
business practices harmful to society.I will protect the human
rights and dignity of all people affected by my enterprise, and I
will oppose discrimination and exploitation.I will protect the
right of future generations to advance their standard of living
and enjoy a healthy planet. I will report the performance and
risks of my enterprise accurately and honestly.I will invest in
developing myself and others, helping the management
profession continue to advance and create sustainable and
inclusive prosperity.In exercising my professional duties

according to these principles, I recognize that my behavior must
set an example of integrity, eliciting trust and esteem from
those I serve. I will remain accountable to my peers and to
society for my actions and for upholding these standards.This
oath I make freely, and upon my honor.
Exhibit 12.4
Developed by Harvard Business School students:
Helps anchor future managers to professional values.
A guideline for integrity in business.
Source: MBA Oath and Max Anderson.

© McGraw Hill

The MBA Oath
As a business leader I recognize my role in society. My purpose
is to lead people and manage resources to create value that no
single individual can create alone.
My decisions affect the well-being of individuals inside and
outside my enterprise, today and tomorrow.
Therefore, I promise that: I will manage my enterprise with
loyalty and care, and will not advance my personal interests at
the expense of my enterprise or society.
I will understand and uphold, in letter and spirit, the laws and
contracts governing my conduct and that of my enterprise.

I will refrain from corruption, unfair competition, or business
practices harmful to society.
I will protect the human rights and dignity of all people affected
by my enterprise, and I will oppose discrimination and
exploitation.
I will protect the right of future generations to advance their
standard of living and enjoy a healthy planet.
I will report the performance and risks of my enterprise
accurately and honestly.
I will invest in developing myself and others, helping the
management profession continue to advance and create
sustainable and inclusive prosperity.
In exercising my professional duties according to these
principles, I recognize that my behavior must set an example of
integrity, eliciting trust and esteem from those I serve. I will
remain accountable to my peers and to society for my actions
and for upholding these standards.
This oath I make freely, and upon my honor.

34

End of Main Content
© 2019 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the

prior written consent of McGraw Hill.

Because learning changes everything.®
www.mheducation.com

The Paradox of Business Ethics:
Nailing Jello to a Wall
or Just Plain Common Sense?

36

Ethics on campus
“Pressure to succeed leading more students to cheat”
“Social Deviance Among Students”
“3 ways cheaters have scammed the college admissions game”
“86 percent of college students say they've cheated”
“Why Paying Bribes to Get Your Child Into College Is a Crime”

https://www.10tv.com/article/pressure-succeed-leading-more-

students-cheat
37

Midterms 2017 Spring-Seattle Univ
Two classes of 4890
What is the purpose of a midterm?

To determine how the class is tracking on the lessons and to
provide feedback to the teacher that they are able to correctly
communicate the information

Canvas - Decided to use the technology

None of the other teachers were using this tool, hmmmm
38

Exam results
Scores came in and they were awesome. Some had perfect
scores. (I am a great teacher!)

I started re-reading the answers and discovered things were not
looking correct in the answers.

Students using words like thus, therefore, and hence. Not words
I found in their other course work.
Some of the answers were verbatim to the Power point and
textbooks, including punctuation and fonts

Reached out to Canvas and learned you can activate “Quiz
logs”.
Verified students were leaving Canvas numerous times.
Validated students were cutting and pasting answers directly
from the textbook and other sources via the 7 sec screen shots
views

to see when students were leaving Canvas, (why would you
need to leave Canvas?). This showed that people were leaving
the exam numerous times. I was also able to verify that people
were cutting and pasting answers directly from the textbook and
other sources via the 7 sec screen shots views, (apparently some
people can type 60 words a minute, but…)
39

Response
Share findings with Class

Written spot quiz, (5 questions)

End class
a. Grade quizzes and compared to mid-term
b. Performed forensics on who/what/how
c. Discovered 35% of each class was cheating
d. Get pissed

Discuss with Dept head
- Cheating is apparently common, who knew? Rossen reports

Rethink my desire to teach

No one was aware that Canvas has the quiz log feature, so that
was eye-opening.
I then performed a written spot quiz of 5 questions to see how
they compared with the Canvas results. I dismissed the class so
I could grade them immediately. The spot quiz results were not
the same as Canvas exam for about 35% of the class.

I spent a lot of time on the validation.

https://www.today.com/video/rossen-reports-underground-
world-of-college-cheating-31797315879

At this point I was feeling very depressed and disillusioned.
Oh, this happened in both Spr classes.

40

Questions
Was there any value to my midterm feedback?

How important are grades to these students?

Is it more important to learn stuff than get the grade?

Are we creating a nation of cheaters?

What is the impact on society?, (Is this the new “sign of
times”?)

If this is so prevalent, is Seattle U part of the problem?

How damaging is groupthink?

It is more important to me that you are getting the information
than getting the grades. I believe I am allowing you the
opportunity to get a good grade, but now I am worried about
what type of people are graduating into this world.

What are you going to be doing in your careers? Look, the real
world is not fair, but if we are grooming a society of cheaters
and unethical people, where will that lead us? Some of you will
succeed as cheaters, yes. Some of you have grown up with an
unethical culture and those are the life lessons you have
accepted as normal. You believe it is OK. You pay people to
write your papers, you use pirated textbooks and the school
turns a blind eye, why? Cuz they want your money…

41

Seattle U Academic Integrity Policy

A student found to have violated the Academic Integrity Policy
shall be subject to penalties imposed by the faculty member
reporting the violation and any additional penalties that may be
imposed by the dean or the provost. Penalties include:

No class credit

Reprimand
Probation
Suspension
Expulsion
Denial of Recommendation

Options for Joe?
Let everything ride. (This allows the cheaters to succeed at the
expense of the students who did their own work).

Ask for confessions and provide immunity, (0 points for
midterm vs. failing class)

Throw the whole thing out and move the points to the final.

Redo the midterm in handwritten form

Retake on Canvas with observers, no one sits in the back. (How
would that make you feel?)

The only person who’s test results I was sure were accurate is
the student who took the test in the proctor center.

43

Options for Joe?
Let everything ride. (This allows the cheaters to succeed at the
expense of the students who did their own work).

Ask for confessions and provide immunity, (0 points for
midterm vs. failing class)

Throw the whole thing out and move the points to the final.

Redo the midterm in handwritten form

Retake on Canvas with observers, no one sits in the back. (How
would that make you feel?)

I had spent too much time doing detective work and we needed
to move forward.

44

Results
28 Students from both classes “confessed” and apologized.
Phone calls
Meetings
We wiped the slate clean and moved on, (0 was given as the
grade).
Groupthink was a big factor in “why?” Students saw others
cheating and didn’t want to be penalized for doing their own
work.
Student reaction:
Some were mad at the cheaters who caused all this chaos
Some got away with it, (jerks will always be jerks).
Most realized it as a teachable moment because this occurred
during Ethics Week

Trust was not an issue moving forward, but the final was on
paper =)

I was thoroughly heartened by the student reaction. It
impressed me, as the meetings with tears and smiles showed
they truly cared. “You did not deserve this”
45

Business Ethics in a Nutshell
“The really creative part of business ethics is discovering ways
to do what is morally right and socially responsible without
ruining your career and company.”

Joanne B. Ciulla, Business Ethics as Moral Imagination in
Business Ethics: The State of the Art

Vehicles
Expenses
Theft
Winning Business

The continual saga of well-paid people who make poor
choices…and lose their jobs.

The continual saga of well paid people who make poor choices.

Cars, (Sheppard, Brazille, Hicks, Carozza, Cross)
Expenses, (Eccard, Spriggs)
Stealing, (Dumaines, Hester)
Winning Business, (Dreamworks, UCSF/Karl)

So due to a few bad apples, everyone gets punished. Company
cars, corporate credit cards, customer entertainment---all lost
due to the stupidity of selfish employees. Unethical behavior
override ethical

47

5 Simple Rules for Business Ethics
Thomas Hoolihan
What would your Mother say? (or Google, YouTube or the NY
Times)

Tell the Truth – its Easier to Remember

It’s not the Crime – it’s the Cover-up

Be Nice and Respect Others, (sexual harassment,
discrimination)

Don’t be a Whore, (what is your price?)

Story/Joke Everyone would agree to do anything for money, if
the price was high enough. `Surely not, she said.' `Oh yes,' he
said. `Well, I wouldn't,' she said. `Oh yes you would,' he said.
`For instance,' he said, `would you sleep with me for... for a
million pounds?' `Well,' she said, `maybe for a million I would,
yes.' `Would you do it for ten shillings?' said Bernard Shaw.
`Certainly not!' said the woman `What do you take me for? A
prostitute?' `We've established that already,' said Bernard Shaw.
`We're just trying to fix your price now!' “

The bottom line is “you aren’t that smart, most everyone gets
caught”
48

There are a few things you own in life:

your choices…and the consequences that come about from those
choices

your attitude…on how you deal with the challenges thrown at
you in life
your integrity… is who you are, the person you present to the
world.

49

Ethics Exercise
Scenario: You see someone in the class remove another
student’s wallet from their backpack and put it into their own.

1. Do you report it to professor?

2. What it is one of your friends, do you
report it?

3. What if it is your sister/brother or
significant other, do you report it?

Close you eyes and raise your hands. Tally up on the board.

…or poll
50

Chapter 8
Corporate Strategy: Vertical Integration and Diversification

© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®

1

The AFI Strategy Framework

2

Because learning changes everything.®

Learning Objectives
Define corporate strategy and describe the three dimensions
along which it is assessed.
Describe the two types of vertical integration along the industry
value chain: backward and forward vertical integration.
Identify and evaluate benefits and risks of vertical integration.
Describe and evaluate different types of corporate
diversification.
Apply the core competence-market matrix to derive different

diversification strategies.
Explain when a diversification strategy creates a competitive
advantage and when it does not.

© McGraw Hill

3

Case Study - Amazon

4

© McGraw Hill

The Chapter Case discusses Amazon’s diversification over time.
Bezos also decided to customize certain country-specific
websites despite the instant global reach of ecommerce firms.
With this strategic decision, he decided where to compete

globally in terms of different geographies beyond the United
States. In short, Bezos determined where Amazon competes
geographically (question 3).

4

Amazon’s Corporate Strategy
Originally was an online book seller:
Started in a garage in a Seattle suburb.
Then entered strategic alliances to expand products offered.
Is now a widely diversified technology company.
Amazon has diversified:
Prime Air uses drones to drop off packages.
Amazon Campus, co-branded University websites.
Electronics such as Echo, Alexa.
Continues to innovate:
In a competitive battle with Apple, Facebook, Alphabet,
Walmart, and Alibaba.
2017 acquisition of Whole Foods.
Streaming content.
Amazon Web Services.

© McGraw Hill

5

What’s next?

6

© McGraw Hill

6

Why Firms Need to Grow
To increase profits and shareholder returns.
To lower costs and achieve economies of scale.
To increase market power.
To reduce risk through diversification.

To motivate management.

© McGraw Hill

Increase profits – results in shareholder returns.
Lower costs – growth enables efficiency.
Increase market power – fewer competitors, more bargaining
power, higher profitability.
Reduce risk – low performance in one SBU can be compensated
by another.
Motivate management – job security.
7

Corporate Strategy
The decisions and goal-directed actions that leaders make to
address the quest for competitive advantage while competing in
multiple markets and industries simultaneously…whew!

It answers the question: where to compete?

It addressed the boundaries of the firm:
Vertical integration.
Diversification.
Geographic scope.

© McGraw Hill

Vertical integration: In what stages of the industry value chain
should the company participate? The industry value chain
describes the transformation of raw materials into finished
goods and services along distinct vertical stages.
Diversification: What range of products and services should the
company offer?
Geographic scope: Where should the company compete
geographically in terms of regional, national, or international
markets?

8

Three Dimensions of Corporate Strategy
Vertical integration, (where in the value chain should the

company participate)
Diversification, (what range of products/services offered)
Geographic scope, (regional, national, international)
Underlying concepts that guide these:
Core Competencies – unique strengths that differentiate and
create value
Economies of Scale - avg cost per unit decreases
Economies of Scope – savings producing two or more outputs
Transaction Costs - cost effectiveness of vertical integration
vs. diversification.

© McGraw Hill

The Chapter Case discusses Amazon’s diversification over time.
Bezos also decided to customize certain country-specific
websites despite the instant global reach of ecommerce firms.
With this strategic decision, he decided where to compete
globally in terms of different geographies beyond the United
States. In short, Bezos determined where Amazon competes
geographically (question 3).

Core Competencies (Ch4):
Economies of Scale (Ch6):
Economies of Scope (Ch6)

9

Transaction Costs
Associated with an economic exchange.
External transaction costs:
Searching for contractors.
Negotiating, monitoring, and enforcing contracts.
Internal transaction costs:
Recruiting and retaining employees.
Setting up a shop floor.

© McGraw Hill

Internal transaction costs include costs pertaining to organizing
an economic exchange within a firm—for example, the costs of
recruiting and retaining employees; paying salaries and

benefits; setting up a shop floor; providing office space and
computers; and organizing, monitoring, and supervising work.
Internal transaction costs also include administrative costs
associated with coordinating economic activity between
different business units of the same corporation such as transfer
pricing for input factors, and between business units and
corporate headquarters including important decisions pertaining
to resource allocation, among others. Internal transaction costs
tend to increase with organizational size and complexity.
10

Transaction Costs

© McGraw Hill

In many ways, we face make-or-buy decisions all the time and
choose based on our often unexpressed understanding of the
trade-offs. “I will stop to buy fast food on the way home from

school because I want to spend my time at home making study
cards for my upcoming exam.” In essence, “It is a better use of
my time and resources to buy my dinner vs. buying the
groceries and making my dinner for this one task, (studying),
which will produce a better outcome, (exam score).

11

Make or Buy?
If Cin-house < Cmarket…then vertically integrate (make) by
owning production of the needed inputs or the channels for the
distribution of outputs.

If firms are more efficient in organizing economic activity than
the markets, which rely on contracts from many independent
players, firms should vertically integrate.

If Cin-house > Cmarket…then outsource, (buy).

© McGraw Hill

Google does mostly in house due to 1. captured costs, 2.
economies of scale and 3. IP protection.

Ford outsources its tires and windshields because it can
determine the quality better and more cost efficiently vs.
making them in-house.

12

Alternatives on the Make-or-Buy Continuum
Exhibit 8.4

Access the text alternate for slide image.

© McGraw Hill

This just illustrates how involved you are in the make or buy
continuum:

Short-term contacts: Competitive bidding process: RFP, Less
than one-year term, Lower prices = cost advantages

Strategic alliances: Facilitate investment without administrative

costs, Ex: Short term contracts, (somewhat risky as there is no
buy-in for long term performance), Long-term contacts,
(franchising or licensing) and equity alliances or joint ventures,
(construction projects)

Parent–subsidiary relationship: Most integrated alternative,
Parent companies have command and control, Ex: GM owns
Opel and Vauxhall in Europe

13

Vertical Integration
The ownership of inputs or distribution channels.
“What percentage of a firm’s sales is generated within the
firm’s boundaries?”
Backward Vertical Integration:
Owning inputs of the value chain.
Forward Vertical Integration:
Owning activities closer to the customer.
------------------------------------------------------------
Full Vertical Integration:

Owns forests, mills, and distribution to retailers

© McGraw Hill

Ford created subsidiaries that produced glass, rubber and metal
to ensure supply. Ford helped eliminate shortages or stoppages
in materials by owning the plants that produced. They feed the
manufacturer to make a product.

Disney opened their own retail stores to capture revenues from
merchandise sales.
“Disney designed” to create value added stores to help capture
more revenues from the tie in promos and merchandise-retail
They feed the consumer from the parent.

The degree of vertical integration tends to correspond to the

number of industry value chain stages in which a firm directly
participates.

14

Backward and Forward Vertical Integration along an Industry
Value Chain
Exhibit 8.5
Access the text alternate for slide image.

© McGraw Hill

15

The Vertical Value Chain of Your Cell Phone
Raw materials:
Chemicals, ceramics, metals, oil for plastic.
Intermediate goods and components:
Integrated circuits, displays, touchscreens, cameras, and
batteries.
Final Assembly and manufacturing:
Assembly.

Marketing, sales, after-sales service and support:
Pick a service provider.
Get wireless data and voice service.

© McGraw Hill

1. Raw materials, (chemicals, ceramics, metals, oil for plastic
are commodities). Commodity businesses such as Dupont,
BASF, Kyocera and Exxon Mobile, respectively.
2. Intermediate goods/Components such as integrated circuits,
displays, touchscreens, cameras and batteries are provided by
ARM Holdings, Jabil Circuit, Intel, LG, Altek and BYD
3. OEM’s such as Flextronics and Foxconn assemble the phones
under contract from Consumer Electronics firms such as Nokia,
Motorola, Samsung and Apple.
4..Wireless carriers are the final piece as service providers to
enable the cell phone to work.

16

Benefits and Risk of Vertical Integration
Benefits:
Securing critical supplies
Lowering costs & improving quality
Facilitating investments in specialized assets

Risks:
Increasing costs & reducing quality
Reducing flexibility
Increasing the potential for legal repercussions

17

© McGraw Hill

Specialized assets have a high opportunity cost: They have
significantly more value in their intended use than in their next-
best use. They can come in several forms:

▪ Site specificity—assets required to be co-located, such as the
equipment necessary for mining bauxite and aluminum smelting.
▪ Physical-asset specificity—assets whose physical and
engineering properties are designed to satisfy a particular

customer. Examples include the bottling machinery for E&J
Gallo. Given the many brands of wine offered by E&J Gallo,
unique equipment, such as molds and a specific production
process, is required to produce the different and trademarked
bottle shapes.
▪ Human-asset specificity—investments made in human capital
to acquire unique knowledge and skills, such as mastering the
routines and procedures of a specific organization, which are
not transferable to a different employer.

Amazon, featured in the Chapter Case, is facing potential legal
repercussions because of its increasing scale and scope. Amazon
now accounts for roughly one-half of all internet retail spending
in the United States. In addition, with AWS, physical retail
stores, and drone deliveries, Amazon is increasingly becoming a
fully vertically integrated enterprise. Many argue that Amazon
is much like a utility, providing the backbone for internet
commerce, both in the business-to-consumer (B2C) as well as in
the business-to-business (B2B) space. This paints a future
picture in which rivals are depending more and more on
Amazon’s products and services to conduct their own business.
Amazon’s tremendous scale and scope can bring it increasingly
into conflict with governments. Antitrust enforcers such as the
Department of Justice might train their sights on Amazon.

17

When Does Vertical Integration Make Sense?
When there are issues with raw materials.
Example: Henry Ford ran mining operations.
To enhance the customer experience.
Eliminate annoyances and poor interfaces.
Vertical market failure: when transactions are too risky or
costly.

© McGraw Hill

In the early days of automobile manufacturing, Ford Motor Co.
was frustrated by shortages of raw materials and the limited
delivery of parts suppliers. In response, Henry Ford decided to
own the whole supply chain, so his company soon ran mining
operations, rubber plantations, freighters, blast furnaces,
glassworks, and its own parts manufacturer…Unfortunately, he
did not own the railroad to ship it!

China tries to close the market on rare earth materials as they
become more and more important for electronics.

18

Alternatives to Vertical Integration
Taper Integration:
Backward or forward integrated.
Plus reliance on outside firms such as suppliers or distributors.

Strategic Outsourcing:
Moving internal value chain activities.
To other firms.
Example: HR management system.

© McGraw Hill

Taper integration has several benefits:
▪ It exposes in-house suppliers and distributors to market
competition so that performance comparisons are possible.
Rather than hollowing out its competencies by relying too much
on outsourcing, taper integration allows a firm to retain and
fine-tune its competencies in upstream and downstream value
chain activities.
▪ Taper integration also enhances a firm’s flexibility. For
example, when adjusting to fluctuations in demand, a firm could
cut back on the finished goods it delivers to external retailers
while continuing to stock its own stores.
▪ Using taper integration, firms can combine internal and
external knowledge, possibly paving the path for innovation.

19

Vertical Integration in Entertainment

7

© McGraw Hill

39

Frozen all inhouse with Disney, (movie, theme parks,

merchandise, live theatre

HP: Warner Bros, Electronic Arts games, Comcast theme park,
licenses for Mattel, Lego, Hasbro.

Diversification and Geographic Scope
Diversification is one of the strategies pursued by firms wishing
to grow in newer markets and by launching newer products…
…Diversification addresses what range of products/services are
to be offered
…Geographic scope determines where we are going to market
those products/services; regional, national or international.

© McGraw Hill

21

Diversification at Disney

22

© McGraw Hill

What is Disney’s Geographic Scope?
22

Types of Diversification
Product Diversification:
Increase in variety of products / services.
Active in several product markets.
Geographic Diversification:
Increase in variety of markets / geographic regions.
Regional, national, or international markets.
Product-Market Diversification:
Product and geographic diversification.

© McGraw Hill

product–market diversification strategy
Corporate strategy in which a firm is active in several different
product markets and several different countries.

23

Diversification: Tale of two companies

24

© McGraw Hill

Coca-Cola, for example, focuses on soft drinks and thus on a
single product market. Its archrival PepsiCo competes directly
with Coca-Cola by selling a wide variety of soft drinks and
other beverages, and also offering different types of chips such
as Lay’s, Doritos, and Cheetos, as well as Quaker Oats products

such as oatmeal and granola bars. Although PepsiCo is more
diversified than Coca-Cola, it has reduced its level of
diversification in recent years. Used to own
TacoBell/KFC/PizzaHut.

24

Types of Corporate Diversification
Single business: low level of diversification.
Dominant business: additional business activity pursued.
Related diversification:
Constrained: all businesses share competencies.
Linked: some businesses share competencies.
Unrelated diversification (conglomerate): no businesses share
competencies.

© McGraw Hill

Examples of the four main types of diversification:
Single business - Coca-Cola, Google, Facebook
Dominant business - Harley Davidson, Nestle, UPS
Related diversification - Related Constrained: ExxonMobile,
Nike; Related Linked: Amazon, Disney
Unrelated diversification: (conglomerate) - Berkshire Hathaway
(BNSF, Heinz, Geico, Sees Candies, DQ)

A related-diversification strategy entails two types of costs:
coordination and influence costs. Coordination costs are a
function of the number, size, and types of businesses that are
linked. Influence costs occur due to political maneuvering by
managers to influence capital and resource allocation and the
resulting inefficiencies stemming from suboptimal allocation of
scarce resource.
25

The Core Competence–Market Matrix

Access the text alternate for slide image.

© McGraw Hill

To survive and prosper, companies need to grow. This mantra
holds especially true for publicly owned companies because
they create shareholder value through profitable growth.
Strategic leaders respond to this relentless growth imperative by
leveraging their existing core competencies to find future
growth opportunities. Gary Hamel and C.K. Prahalad advanced
the core competence–market matrix, depicted in Exhibit 8.9, as
a way to guide managerial decisions in regard to diversification
strategies. The first task for managers is to identify their
existing core competencies and understand the firm’s current
market situation. When applying an existing or new dimension
to core competencies and markets, four quadrants emerge, each
with distinct strategic implications.

Nations Bank CC was selecting, acquiring and integrating
commercial banks to grow geographically
BofA leveraged CC of acquiring and moving into wealth
management.

Coke competed with Pepsi’s Gatorade, (75% markshare)…tried
with Powerade, (17) and moved into Body Armor (3+)
Salesforce leveraged leading CRM cloud based into PaaS to
allow people to build own platforms.
26

How Diversification Can Enhance Firm Performance
Provides economies of scale (reduces costs).
Exploits economies of scope (increases value).
Reduces costs and increase value.

© McGraw Hill

27

Restructuring
Reorganizing and divesting business units and activities.
Helps refocus a company.
Helps leverage core competencies more fully.

Helpful restructuring tool: BCG growth-share matrix.
Guides portfolio planning.
Each category warrants a different strategy.

© McGraw Hill

Corporate executives can restructure the portfolio of their
firm’s businesses, much like an investor can change a portfolio
of stocks.

28

Restructuring
The process of reorganizing and divesting business units and
activities to help refocus a company and leverage core
competencies more fully:
GE, (General Electric), exited TV, Appliances and Electronics
and moved more into services.
InBev sold Busch Gardens and SeaWorld to focus on core
business of beverages/beer.
Verizon sold off landline business to focus on Wireless.

Wall Street loves “restructuring” as it means layoffs, which
equate to financial savings.

© McGraw Hill

Corporate executives can restructure the portfolio of their
firm’s businesses, much like an investor can change a portfolio
of stocks.

29

Boston Consulting Group Matrix
A tool to determine growth vs. market share
Exhibit 8.13

Access the text alternate for slide image.

© McGraw Hill

Corporate executives can restructure the portfolio of their
firm’s businesses, much like an investor can change a portfolio
of stocks. One helpful tool to guide corporate portfolio planning
is the Boston Consulting Group (BCG) growth–share matrix.
The firm plots its SBUs into one of four categories in the
matrix: dog, cash cow, star, and question mark. Each category
warrants a different investment strategy. All four categories
shape the firm’s corporate strategy.

SBUs identified as dogs are relatively easy to identify: They are
the underperforming businesses. Dogs hold a small market share
in a low-growth market; they have low and unstable earnings or
negative cash flows. The strategic recommendations are either
to divest the business or to harvest it.
Cash cows are SBUs that compete in a low-growth market but
hold considerable market share. Their earnings and cash flows
are high and stable. The recommendation is to invest enough
into cash cows to hold their current position and to avoid having
them turn into dogs.
Stars hold a high market share in a fast-growing market. Their
earnings are high and either stable or growing. The
recommendation is to invest sufficient resources to hold the
star’s position or even increase investments for future growth.
Question marks: It is not clear whether they will turn into dogs
or stars. Their earnings are low and unstable, but they might be

growing. The cash flow is negative. Ideally, corporate
executives want to invest in question marks to increase their
relative market share so they turn into stars.

30

BCG in real life…
In small groups, identify the BCG model for the Apple product
portfolio:
Macbook
iPhone
iPad
iPod
Watch
Apple TV
iTunes
Apple Music

31

© McGraw Hill

31

Apple Products

32

Apple TV

iTunes

© McGraw Hill

Internal Capital Markets
Can be a source of value creation in diversification strategy.
A way to allocate capital at a lower cost, if more efficient than
external markets.
A related-diversification strategy can enhance corporate
performance.
Consider coordination and influence costs.

© McGraw Hill

Coordination costs are a function of the number, size, and types
of businesses that are linked. Influence costs occur due to
political maneuvering by managers to influence capital and
resource allocation and the resulting inefficiencies stemming
from suboptimal allocation of scarce resources.

Until recently, GE Capital brought in close to $70 billion in
annual revenues and generated more than half of GE’s profits.
In combination with GE’s triple-A debt rating, having access to
such a large finance arm allowed GE to benefit from a lower
cost of capital, which in turn was a source of value creation in
itself. In 2009, at the height of the global financial crises, GE
lost its AAA debt rating. The lower debt rating and the smaller
finance unit are likely to result in a higher cost of capital, and
thus a potential loss in value creation through internal capital
markets. GE subsequently sold its GE Capital business unit.

As of 2018, the company operates through the following
segments: aviation, healthcare, power, renewable energy, digital
industry, additive manufacturing, venture capital and finance,
lighting, and oil and gas. GE was once a power house but is now
retrenching. Formerly the poster child for diversification.

33

The Diversification-Performance Relationship

Access the text alternate for slide image.

© McGraw Hill

High and low levels of diversification are generally associated
with lower overall performance, while moderate levels of
diversification are associated with higher firm performance.
This implies that companies that focus on a single business, as
well as companies that pursue unrelated diversification, often
fail to achieve additional value creation. Firms that compete in
single markets could potentially benefit from economies of
scope by leveraging their core competencies into adjacent

markets.
34

Does Diversification Lead to Superior Performance?
The critical question to ask…are the individual businesses
worth more under the company’s management than if each were
managed in separate firms? (history says…“not much”)

Diversification is like sex…attractions are obvious, often
irresistible, yet the experience is often disappointing.

35

© McGraw Hill

Many times the reason for diversification is not related to
improving the business, but more into CEO ego or “me-too”
beliefs that everyone else is doing it, so I don’t want to get left
behind.
35

Team Exercise???

36

© McGraw Hill

36

End of Main Content
© 2019 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®
www.mheducation.com

Chapter 7
Business Strategy: Innovation, Entrepreneurship, and Platforms

© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®

Learning Objectives
Outline the four-step innovation process from idea to imitation.
Apply strategic management concepts to entrepreneurship and
innovation.
Describe the competitive implications of different stages in the
industry life cycle.
Derive strategic implications of the crossing-the-chasm
framework.
Categorize different types of innovations in the markets-and-
technology framework.
Explain why and how platform businesses can outperform
pipeline businesses.

© McGraw Hill

The AFI Strategy Framework

3

© McGraw Hill

Innovation Is a Competitive Weapon
Innovation can create and destroy value.
Innovation often comes in waves:
Many firms dominated an early wave of innovation and are
challenged by the next wave.
Traditional networks vs. cable providers.
Cable providers vs. streaming content.
Typewriters to PC’s to mobile devices.

“Creative destruction” – Joseph Schumpeter

© McGraw Hill

Initial innovations are foundational for other rapid innovation.

Disruption video: https://hbr.org/video/2688242135001/the-
explainer-disruptive-innovation

4

Case Study: Netflix - Disrupter of Cable TV
Founded in 1997 by Reed Hastings with online rentals of DVD’s
via the mail, (because Blockbuster pissed him off over $40 in
late fees).
1999: moved to unlimited DVD rental for one monthly rate
2000 approached BB to become their online partner, BB
declined
2002 Netflix turned profitable, went public

2004 4M subscribers, (BB started online, but lost 75% of market
share, Bk by 2010)
2007: Streaming content over the internet,12M subscribers
2010: Not viewed as a threat by TV, “rerun TV”…Hulu
2013: Started streaming online original content: (House of Card,
Orange is the New Black, The Crown)
2017: 100M worldwide subscribers, $9B in Revenue, $60B
Market Cap, Stock up 4200%
2020: Market Cap $230B, 73M US subscribers, 167M
worldwide, (Covid related?)

5

© McGraw Hill

Case Study: Netflix - Disrupter of Cable TV
How did they disrupt?

Delivery of content streamed online, bypassing networks/cable,

less $$$
Access created “binge watching”, create demand and buzz, older
movies/TV shows
Management via algorithms, no “pilots” needed

6

© McGraw Hill

Users build movie queues, which allowed future demand.
Personalized recommendation engine allows for “older” content
to be requested, lowering demand on new, but providing fresh
revenues to other studios, (until everyone else wants into the
game).

6

Case Study: vs.
Disney enters streaming services with intro price of $6.99/mo,
undercutting Netflix, (free for VzW customers).
Removes Disney content from Netflix, (Disney movie library,
Marvel, Star Wars, etc…)

Adds 20th Century Fox library, (Simpsons) and own Hulu and
ESPN
Disney+ has 60M subscribers and doing well…

7

© McGraw Hill

Aug 2020 - Disney stock soared as much as 10% on Wednesday
as investors cheered strong growth at Disney Plus last quarter,
boosting the entertainment giant's market cap by about $21
billion to $234 billion. Theme parks crashing, but streaming
huge. Disney+ has 60M subscribers.
7

Cable vs. Streaming, where is the future?

8

© McGraw Hill

Small group discussion
8

Accelerating Speed of Technological Change
Exhibit 7.1
Source:. Depiction of data from the U.S. Census Bureau, the
Consumer Electronics Association, Forbes, and the National
Cable and Telecommunications Association.

Access the text alternate for the slide image.

© McGraw Hill

This image shows how many years it took for different
technological innovations to reach 50 percent of the U.S.
population (either through ownership or usage). For example, it

took 84 years for half of the U.S. population to own a car, but
only 28 years for half the population to own a TV. The pace of
the adoption rate of recent innovations continues to accelerate.
It took 19 years for the PC to reach 50 percent ownership, but
only 6 years for MP3 players to accomplish the same diffusion
rate.
9

The Four I’s: Idea, Invention, Innovation, and Imitation
Exhibit 7.2

© McGraw Hill

10

Idea, Invention, Innovation and Imitation
Idea:
Abstract concepts or research findings.
Invention:
Transformation of an idea into a product.
The modification and recombination of products.
Innovation:

Commercialization of an invention.
Imitation:
Copying a successful innovation.

11

© McGraw Hill

Idea: basic research to discover new knowledge. Wireless
technology today was first talked about in WWII with Albert
Einstein and actress Heddy Lamar

Invention: Patents are for useful, novel and non-obvious
inventions, Intellectual Property

Innovation: this is where entrepreneurs come into play. They
bring the products to life. Think Shark Tank. Quirky.

Imitation: If your product is successful, others will copy.
(scholarpedia is competitor to Wiki, but strict quality control by
scholars), Samsung to Apple.

11

What is Innovation?

A Novel and Useful Idea That Is Successfully Implemented

© McGraw Hill

12

Entrepreneurs
The process by which change agents undertake economic risk to
innovate.
Create new products, processes, and organizations.
Create value for society.
Commercialize ideas and inventions.

Reed Hastings: Netflix.

Elon Musk: Tesla Motors, Solar City, SpaceX, PayPal.

© McGraw Hill

Reed Hastings – Netflix.
Volunteered in the Peace Corps for 2 years.
Educated at Stanford where he first learned about the
entrepreneurial model, net worth is now $1B.
Elon Musk – Tesla Motors, Solar City, SpaceX, PayPal.
An engineer and serial entrepreneur.
Deep passion to solve environmental, social, and economic
challenges.
13

Strategic and Social Entrepreneurship
Strategic Entrepreneurship:
Pursuit of innovation using strategic tools and concepts.
Combining entrepreneurial actions.

Creating new opportunities.
Exploiting existing opportunities.

Social Entrepreneurship:
The pursuit of social goals while creating profitable businesses.
Evaluate performance by financial, ecological and social
contribution metrics.

© McGraw Hill

Jimmy Wales: goal is to provide knowledge on a very large
scale.
14

The Industry Lifecycle
Over time:
The number and size of competitors change.
Different types of consumers enter the market.
The supply and demand sides of the market change.
Different competencies are needed for the firm to perform well.

The stages:
Introduction.
Growth.
Shakeout.
Maturity.
Decline.

© McGraw Hill

15

Industry Life Cycle: The Smartphone Industry in Emerging and
Developed Economies
Exhibit 7.4

Access the text alternate for slide image.

© McGraw Hill

16

Introduction Stage
Core competency: research and development.
Necessary to create a product category that will attract
customers.
Can be very capital-intensive (high costs).
Barriers to entry are high.
Strategic objective: market acceptance & future growth.

© McGraw Hill

The emphasis is on uniqueness and performance in this stage.
The initial market size is small, growth is slow, and barriers to
entry are high.

17

Leveraging Network Effects to Drive Demand: Apple’s iPhone
Network effects: The more people use the product or service,
the more the demand

Access the text alternate for slide image.

© McGraw Hill

Increased value creation is positively related to demand, which
in turn increases the installed base, meaning the number of
people using an iPhone. As the installed base of iPhone users
further increases, this incentivizes software developers to write
even more apps. Making apps widely available strengthened
Apple’s position in the smartphone industry. Based on positive
feedback loops, a virtuous cycle emerges where one factor
positively reinforces another.
18

Growth Stage
Demand increases rapidly.
First-time buyers rush to purchase.
Proof of concept has been demonstrated.
Product / service standards emerge.
A common set of features and design choices.
Can emerge from competition or imposed by government or
agencies.

Product innovation:
New / recombined aspects of a product.
Process innovation:
New ways to produce a product.

© McGraw Hill

Core competencies of focus during this stage are in
manufacturing and marketing.

Process innovations are made possible through advances such as
the internet, lean manufacturing, Six Sigma, biotechnology,
nanotechnology, and so on.

19

Product and Process Innovation throughout an Industry Life
Cycle
Exhibit 7.7

Access the text alternate for slide image.

© McGraw Hill

20

Shakeout Stage
The rate of growth declines.
Firms begin to intensely compete.
Weaker firms forced out.
Industry consolidation.
Only the strongest competitors survive.
Price is an important competitive weapon.

© McGraw Hill

The winners in this increasingly competitive environment are
often firms that stake out a strong position as cost leaders. Key
success factors at this stage are the manufacturing and process
engineering capabilities that can be used to drive costs down.
The importance of process innovation further increases (albeit
at diminishing marginal returns), while the importance of

product innovation further declines.

21

Maturity Stage
Only a few large firms remain.
They enjoy economies of scale.
Process innovation has reached a maximum.
Demand: replacement or repeat purchases.
Market has reached maximum size.
Industry growth is zero or negative.

© McGraw Hill

The domestic airline industry has been in the maturity stage for
a long time. The large number of bankruptcies as well as the
wave of mega-mergers, such as those of Delta and Northwest,
United and Continental, and American Airlines and US
Airways, are a consequence of low or zero growth in a mature
market characterized by significant excess capacity.

22

Decline Stage
Demand falls rapidly.
Innovation efforts cease.
If a breakthrough emerges, it leads to a new industry or resets
the life cycle.
Strong pressure on prices.

Four strategic options to pursue:
Exit: bankruptcy / liquidation.
Harvest: reduce further investments.
Maintain: support at a given level.
Consolidate: buy rivals.

© McGraw Hill

Exit. Some firms are forced to exit the industry by bankruptcy
or liquidation.
Harvest. In pursuing a harvest strategy, the firm reduces
investments in product support and allocates only a minimum of
human and other resources.

Maintain. Philip Morris, on the other hand, is following a
maintain strategy with its Marlboro brand, continuing to support
marketing efforts at a given level despite the fact that U.S.
cigarette consumption has been declining.
Consolidate. Although market size shrinks in a declining
industry, some firms may choose to consolidate the industry by
buying rivals.

23

The Crossing-the-Chasm Framework
Exhibit 7.8
Source: Adapted from G.A. Moore (1991), Crossing the Chasm:
Marketing and Selling Disruptive Products to Mainstream
Customers (New York: HarperCollins), 17.

Access the text alternate for slide image.

© McGraw Hill

There is a big gulf or chasm into which companies and their
innovations frequently fall. Only companies that recognize
these differences and are able to apply the appropriate

competencies at each stage of the industry life cycle will have a
chance to transition successfully from stage to stage.
24

Technology Enthusiasts
Enter the market during the introductory stage.
Smallest market segment, 2.5% of the total market potential.
Have an engineering mind.
Proactively pursue new technology.
Enjoy using beta versions.
Tinker with product imperfections.
Provide free feedback and suggestions.

© McGraw Hill

A recent example of an innovation that appeals to technology
enthusiasts is Google Glass, a mobile computer that is worn like
a pair of regular glasses. Instead of a lens, one side displays a
small, high-definition computer screen. Google Glass allows the
wearer to use the Internet and smartphone-like application.
However, the company was never able to close the gap between

technology enthusiasts (who rushed to sign up for testing the
glasses) and early adopters.
25

Early Adopters
Enter the market during the growth stage.
13.5% of the total market potential.
Demand is driven by imagination and creativity.
Ask themselves, “What can this new product do for me or my
business?”
To capture these customers:
Directly communicate the product’s potential.

© McGraw Hill

For instance, early adopters are the people that put down
thousands of dollars in deposits to reserve a new Tesla Model S
or Model X when first introduced, without having been able to
test-drive the vehicle or even seen it other than on the internet.
They then often needed to wait a significant amount of time

before receiving the new vehicle.
26

Early Majority
Enter the market during the shakeout stage.
34% of the total market potential.
Decision criteria, a strong sense of practicality.
“What Can This Do For Me?”
Weigh the benefits and costs carefully.
Rely on endorsements of others.
This group is key to catching the growth wave.

© McGraw Hill

Fisker Automotive, a California-based designer and
manufacturer of premium plug-in hybrid vehicles, fell into the
chasm because it was unable to transition to early adopters, let
alone the mass market. Between its founding in 2007 and 2012,
Fisker sold some 1,800 of its Karma model, a $100K sports car,
to technology enthusiasts. It was unable, however, to follow up

with a lower-cost model to attract the early adopters into the
market. In addition, technology and reliability issues for the
Karma could not be overcome. By 2013, Fisker had crashed into
a chasm, filing for bankruptcy. The assets of Fisker Automotive
were purchased by Wanxiang, a Chinese auto parts maker.
In contrast, Tesla Motors, the maker of all-electric vehicles, and
a fierce rival of Fisker at one time, was able to overcome some
of the early chasms.

27

Late Majority
Enter the market during the maturity stage.
34% of the total market potential.
Not as confident in their ability to master the technology:
Wait until standards have emerged.
Do not like uncertainty.
Represent the majority of the market.
Buy from well-established firms with a strong brand.

© McGraw Hill

28

Laggards
Enter the market during the decline stage.
16% of total market potential.
Adopt a new product only if necessary (reluctant).
Generally don’t want new technology.
Typically not pursued as future customers.
Demand is small.
Early and late majority are at this time moving on to different
products and services.

© McGraw Hill

29

Crossing the Chasm: The Mobile Phone Industry

Exhibit 7.9

Access the text alternate for slide image.

© McGraw Hill

30

Crossing the Chasm Illustrated

31

© McGraw Hill

Dancing man Sasquatch 2009

No voiceover version
https://www.youtube.com/watch?v=GA8z7f7a2Pk&t=114s

:55 Tech Enthusiasts
1:15 Early Adopters
1:35 CHASM JUMPED Early Majority
2:00 Late Majority
2:40 Laggards, (some people may never join)

Dancing man - “Crossing the Chasm in Consumer Markets: A
Visual Example by Geoffrey Moore” is an engaging and
humorous 4 minute video to illustrate the concept of the
industry life cycle and crossing the chasm. The video link is
here: https://www.youtube.com/watch?v=izP5n1SBEaI

31

Types of Innovation: Combining Markets and Technologies
Exhibit 7.11

Access the text alternate for slide image.

© McGraw Hill

Incremental: Established knowledge base with steady
improvement of a product or service. Incumbent
firms…Examples: Gillette now 6-bladed razors, Intel 386, 486,
x86 processors
Radical: Novel methods or materials targeting new markets with
new technology. New firms. …Examples: Mass production,
(Ford Model T), Genetic engineering
Architectural: Reconfigure known components to create new
markets…Example: Canon user-friendly copiers vs. Xerox Pro
Svcs , GPS to handheld consumer devices like Garmin
Disruptive: Novel technologies serving existing markets from
bottom up. Captures current customers typically with initially
lower cost & performance…Examples: Uber, Japanese autos,
Digital photography, Dollar shave club. Stealthy and
sometimes you need to disrupt yourself,

32

Incremental vs. Radical Innovation
Incremental Innovation:
Builds on established knowledge.
Results from steady improvement.

Radical Innovation:
Novel methods & materials.
Entirely new knowledge base or recombination of existing
knowledge.
Targets new markets and technology.

© McGraw Hill

In 1903, entrepreneur King C. Gillette invented and began
selling the safety razor with a disposable blade. This radical
innovation launched the Gillette Co. (now a brand of Procter &
Gamble). To sustain its competitive advantage, Gillette not only

made sure that its razors were inexpensive and widely available
by introducing the “razor and razor blade” business model, but
also continually improved its blades.

In a classic example of a string of incremental innovations,
Gillette kept adding an additional blade with each new version
of its razor until the number had gone from one to six! Though
this innovation strategy seems predictable, it worked. Gillette’s
newest razor, the Fusion ProGlide with Flexball technology, a
razor handle that features a swiveling ball hinge, costs $11.49
(and $12.59 for a battery-operated one) per razor!

Examples of radical innovation: the iPhone, the Ford Model T,
the x-ray machine, the airplane, genetic engineering, and
decoding of the human genome.

33

Why Incumbent Firms Tend to Focus on Incremental Innovation
Economic Incentives:
They must defend their position.
Organizational Inertia:
They have formalized processes and structures.
Innovation Ecosystem:
They rely on certain suppliers, buyers, complementors.

© McGraw Hill

Iphone is both radical and now incremental
34

Architectural vs. Disruptive Innovation
Architectural Innovation:
Existing technology leveraged into a new market.
Known components, existing technology, used in a novel way.

Disruptive Innovation:
Leverages new technologies in existing markets.
New product / process meets existing customer needs.

© McGraw Hill

Examples of Disruptive Innovation include digital photography
(which has improved over time to result in higher definition
pictures, and has largely replaced film photography) and
laptops, (which disrupted desktops…although now tablets and
large screen phones are disrupting laptops).

35

How to Respond to Disruptive Innovation
Continue to innovate to stay ahead of the competition.
Guard against disruptive innovation by protecting the low end
of the market.
Disrupt yourself rather than wait for others to disrupt you.

“Reverse innovation”

© McGraw Hill

Reverse Innovation: An innovation that was developed for
emerging economies before being introduced in developed
economies. Sometimes also called frugal innovation. Apple is

xlnt at this process. The next thing.

36

Pipeline vs. Platform Businesses
Platform Business:
Enables interaction between producers and consumers.
Its overarching purpose is to enable matches among users.
Provides infrastructure and sets governance conditions.

Pipeline Business:
Linear transformation through the value chain.
Research and development, then design, then manufacture, then
sell.

© McGraw Hill

The five most valuable companies globally (Apple, Alphabet,
Microsoft, Amazon, and Facebook) all run platform business
models.

37

Advantages of the Platform Business Model
They scale more efficiently by eliminating gatekeepers.
They unlock new sources of value creation and supply.
They benefit from community feedback.

© McGraw Hill

New sources of value creation and supply—To grow, traditional
competitors such as Marriott or Hilton would need to add
additional rooms to their existing stock. To add new hotel room
inventory to their chains, they would need to find suitable real
estate, develop and build a new hotel, furnish all the rooms, and
hire and train staff to run the new hotel. This often takes years,
not to mention the multimillion-dollar upfront investments
required and the risks involved. In contrast, Airbnb faces no
such constraints because it does not own any real estate, nor
does it manage any hotels. Just like Marriott or Hilton,
however, it uses sophisticated pricing and booking systems to
allow guests to find a large variety of rooms pretty much
anywhere in the world to suit their needs.

Community feedback: TripAdvisor, a travel website, derives
significant value from the large amount of quality reviews
(including pictures) by its users of hotels, restaurants, and so
on. This enables TripAdvisor to consummate more effective
matches between hotels and guests via its website, thus creating
more value for all participants.

Network effects: Growing its user base is critical for Netflix to
sustain its competitive advantage. Netflix has been hugely
successful in attracting new users: As of 2017 it had some 95
million subscribers worldwide. Yet, while providing a large
selection of high-quality streaming content is a necessity of the
Netflix business model, this element can and has been easily
duplicated by others such as Amazon, Hulu, and premium
services on Google’s YouTube. To lock in its large installed
base of users, however, Netflix has begun producing and
distributing original content such as the hugely popular shows
House of Cards and Orange Is the New Black. To sustain its
competitive advantage going forward, Netflix needs to rely on
its core competencies, including its proprietary recommendation
engine, data-driven content investments, and network
infrastructure management.

38

The Players in a Platform Ecosystem
Exhibit 7.13
Access the text alternate for slide image.

© McGraw Hill

From a value chain perspective, producers create or make
available a product or service that consumers use. The owner of
the platform controls the platform IP address and controls who
may participate and in what ways. The providers offer the
interfaces for the platform, enabling its accessibility online.
39

Netflix Business Model: Leveraging Network Effects to Drive
Demand
Network effect: a phenomenon whereby a product or service
gains additional value as more people use it.

© McGraw Hill

As Netflix acquires additional streaming content, it increases
the value of its subscription service to customers, resulting in
more people signing up. With more customers, Netflix could
then afford to provide more and higher-quality content, further
increasing the value of the subscription to its users. This
created a virtuous cycle that increased the value of a Netflix
subscription as more subscribers signed up.
40

Uber’s Business Model: Leveraging Network Effects to Increase
Demand

Access the text alternate for slide image.

© McGraw Hill

Uber provides incentives for drivers to sign up (such as
extending credit so that potential drivers can purchase vehicles)
and also charges lower than market rates for its rides. As more

and more drivers sign up in each city and thus coverage density
rises accordingly, the service becomes more convenient. This
drives more demand for its services as more riders choose Uber,
which in turn brings in more drivers.
41

Uber’s Network Effects with Feedback Loop
Exhibit 7.16

Access the text alternate for slide image.

© McGraw Hill

To entice more drivers to work during this time, Uber has to pay
them more. Higher pay will bring more drivers onto the
platform. Some users complain about surge pricing, but it
allows Uber to match supply and demand in a dynamic fashion.
As surge pricing kicks in, fewer people will demand rides,
eventually bringing supply and demand back into an
equilibrium.
42

Breakout Room Exercise
You will be assigned a “problem area” for discussion.

Identify what you see as an issue in that area.

What sort of creative ideas can you come up with to solve that
problem?.

Brainstorm within your group and make sure everyone gets an
opportunity to share.

Present your solution to the class.

43

© McGraw Hill

Group exercise: Transportation, Higher Education, Politics,
Foods, Electronic Devices, Social Media
43

End of Main Content
© 2019 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®
www.mheducation.com

Chapter 9
Corporate Strategy: Strategic Alliances, Mergers and
Acquisitions

© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®

The AFI Strategy Framework

2

Because learning changes everything.®

Learning Objectives
Apply the build-borrow-or-buy framework to guide corporate
strategy.
Define strategic alliances, and explain why they are important
to implement corporate strategy and why firms enter into them.
Describe three alliance governance mechanisms and evaluate
their pros and cons.
Differentiate between mergers and acquisitions, and explain
why firms would use either to execute corporate strategy.
Define horizontal integration and evaluate the advantages and
disadvantages of this option to execute corporate-level strategy.
Explain why firms engage in acquisitions.

© McGraw Hill

What you had was a combination of Mergers and Acquisitions,
as well as Joint Ventures to build this Fortune 50 company.
5

How Firms Achieve Growth
A strategist has three options to drive firm growth:
Organic growth through internal development
External growth through alliances
External growth through acquisition

The build-borrow-or-buy framework:
Aids strategists in deciding whether to pursue internal
development (build)
Enter a contract arrangement or strategic alliance (borrow)
Acquire new resources, capabilities, and competencies (buy)

© McGraw Hill

When acquiring a firm, you buy an entire “resource bundle,” not
just a specific resource. This resource bundle, if obeying VRIO
principles and successfully integrated, can then form the basis
of competitive advantage.

6

Guiding Corporate Strategy:
The Build-Borrow-or-Buy Framework

.

© McGraw Hill

7

Main Issues in the Build-Borrow-Buy Framework
Relevancy:
Can the firm’s existing internal resources solve the resource
gap?
Tradability:

How tradable are the targeted resources that may be available
externally?
Closeness:
How close do you need to be to your external resource partner?
Integration:
How well can you integrate the targeted firm into your firm?

© McGraw Hill

As shown in Exhibit 9.1, the answers to these questions lead to
a recommended action or the next question.
8

Relevance/Tradability
Relevance…Are the firm’s internal resources highly relevant?
If so, the firm should develop internally.
Internal resources are relevant if:
They are similar to those the firm needs.
They are superior to those of competitors.
They pass the VRIO Framework
Tradability…The firm creates a contract to:

Transfer ownership
Allow use of the resource
Contracts support borrowing resources
Ex. Licensing and franchising

© McGraw Hill

If a resource is highly tradable, then the resource should be
borrowed via a licensing agreement or other contractual
agreement. If the resource in question is not easily tradable,
then the firm needs to consider either a deeper strategic alliance
through an equity alliance or a joint venture, or an outright
acquisition

9

Closeness/Integration
Closeness…M&As are complex and costly.
Used only when extreme closeness is needed
Closeness can be achieved through alliances.
Equity alliances

Joint ventures
This enables resource borrowing
Integration…Conditions for integrating the target firm:
Low relevancy, low tradability, high need for closeness
Consider other options first
Examples of post integration failures abound

10

© McGraw Hill

Mergers and acquisitions are the most costly, complex, and
difficult to reverse strategic option. This implies that only if
extreme closeness to the resource partner is necessary to
understand and obtain its underlying knowledge should M&A be
considered the buy option. Regardless, the firm should always
first consider borrowing the necessary resources through
integrated strategic alliances before looking at M&A.

Multibillion-dollar failures include the Daimler-Chrysler
integration, AOL and Time Warner, HP and Autonomy, and

Bank of America and Merrill Lynch. More than cultural
differences were involved in Microsoft’s 2015 decision to write
down $7.6 billion in losses (or more than 80 percent) on its $9.4
billion acquisition of Nokia some 15 months earlier.

10

Strategic Alliances

9-‹#›

© McGraw Hill

A strategic alliance has the potential to help a firm gain and
sustain a competitive advantage when it joins together resources
and knowledge in a combination that obeys the VRIO
principles.

Next slide explains why SA’s are attractive.

11

STRATEGIC ALLIANCE

STRATEGIC CRITERIA

RATIONAL VIEW OF COMPET ITIVE ADVANTAGE

A voluntary arrangement between firms that involves the
sharing of knowledge, resources, and capabilities with the intent
of developing processes, products, or services

An alliance qualifies as strategic only if it has the potential to
affect a firm’s competitive advantage.

Framework where critical resources and capabilities are
embedded in strategic alliances that span firm boundaries

Why Do Firms Enter Strategic Alliances?
1. Strengthen competitive position
Change industry structure, influence standards
2. Enter new markets

Product, service, or geographic markets
3. Hedge against uncertainty
Real options perspective
Breaks down investment into smaller decisions
Staged sequentially over time
4. Access critical complementary assets
Marketing, manufacturing, after-sale service
Helps complete the value chain
5. Learn new capabilities
Co-opetition: cooperation among competitors
Learning curve races: getting up to speed as fast as possible to
exit the alliance quickly

© McGraw Hill

12

Why Strategic Alliances Are Attractive
Firm goals can be achieved faster and at lower costs.
Complement or augment the value chain

Less complex legally
Can help a firm gain and sustain a competitive advantage
Valuable
Rare
Difficult to imitate
Organized to capture the value

13

© McGraw Hill

In support of this perspective, over 80 percent of Fortune 1000
CEOs indicated in a survey that more than one-quarter of their
firm’s revenues were derived from strategic alliances.

13

Strategic Alliances with
Tesla alliance with Panasonic was to gain access to critical
complementary assets…batteries
Tesla alliance with Daimler was to strengthen competitive

position thru cash and engineering expertise. Daimler wanted
to hedge against uncertainty of all-electric cars.
Tesla alliance with Toyota provided a manufacturing plant and
expertise thru NUMMI site.

14

© McGraw Hill

Strategic Alliances Can Be Governed By:
Non-Equity Alliances:
Partnerships based on contracts.
IBM/Microsoft licensing agreement
Equity Alliances:
One partner takes partial ownership in the other.
GM invested $500M in Lyft
Joint Ventures:

A standalone organization which is jointly owned by two or
more companies.
Hulu is jointly owned by Comcast and Disney

© McGraw Hill

Exhibit 9.2 provides an overview of the key characteristics of
the three alliance types, including their advantages and
disadvantages.

Examples of non-equity alliances: supply agreements,
distribution agreements, and licensing agreements

15

Alliance Management Capability
Exhibit 9.3

© McGraw Hill

16

Partner Selection and Alliance Formation
Expected benefits must exceed the costs.
Five reasons for alliance formation:
Strengthen competitive position.
Enter new markets.
Hedge against uncertainty.
Access critical complementary resources.
Learn new capabilities.

Partners must be compatible and committed.

© McGraw Hill

Partner compatibility captures aspects of cultural fit between

different firms. Partner commitment concerns the willingness to
make available necessary resources and to accept short-term
sacrifices to ensure long-term rewards.

GM invested $500M into Lyft
GM and Waymo partnerships strengthen competitive position of
Lyft compared to Uber for self driving cars
GM taps into the 2nd largest mobile transportation network
globally
Lyft is number 2, so GM is hitching their wagon to them
Lyft may need to manage a fleet of cars that they may own, GM
has that experience with rentals.

17

Alliance Design and Governance
Governance mechanisms:
Contractual agreement.
Equity alliances.
Joint venture.

Inter-organizational trust is a critical dimension of alliance
success.

© McGraw Hill

In a study of over 640 alliances, researchers found that the
joining of specialized complementary assets increases the
likelihood that the alliance is governed hierarchically. This
effect is stronger in the presence of uncertainties concerning the
alliance partner as well as the envisioned tasks.

18

Post Formation Alliance Management
To be a source of competitive advantage, the partnership has to
create VRIO resource combinations:
Make relation-specific investments.
Establish knowledge-sharing routines.
Build interfirm trust.
Build capability through repeated experiences over time.

© McGraw Hill

19

How to Make Alliances Work
Exhibit 9.4
Source:. Adapted from J.H. Dyer and H. Singh (1998), “The
relational view: Cooperative strategy and the sources of
intraorganizational advantage,” Academy of Management
Review 23: 660–679.

Access the text alternate for slide image.

© McGraw Hill

That said, it is still very difficult and cultural differences
remain the biggest hurdle.
20

Mergers and Acquisitions
Merger:
The joining of two independent companies.
Forms a combined entity.
Tends to be friendly. (Bell Atlantic/GTE, “merger of equals”)

Acquisition:
Purchase of one company by another.
Can be friendly…Disney buying Pixar
Can be unfriendly…RJ Reynolds buying Nabisco.
Considered a hostile takeover when the target firm does not
wish to be acquired.

© McGraw Hill

Ernst and Whinney merged with Arthur Young, GTE/Bell
Atlantic Mergers of equals

RJReynolds tobacco buys Nabisco, Barbarians at the gate.
LBO.

21

Why Do Firms Merge?
Horizontal integration is the process of merging with a
competitor, (who’s at same stage of the value chain)
HP buys Compaq in 2002.
Pfizer buys Wyeth in 2009.
Live Nation buys Ticketmaster in 2010.
Sirius buys XM in 2007
Three main benefits:
Reduction in competitive intensity
Lower costs
Increased differentiation

© McGraw Hill

In particular, competitors in the same industry such as airlines,
banking, telecommunications, pharmaceuticals, or health
insurance frequently merge to respond to changes in their
external environment and to change the underlying industry
structure in their favor.

22

Why Do Firms Acquire Other Firms?
To access new markets & distribution channels.
To overcome entry barriers which allows you access to a new
customer set.
Kraft bought Cadbury for entry into European markets via their
distribution network
Access to a new capability or competency
Intel bought Altera to gain access to mobile chipsets
To preempt rivals.

© McGraw Hill

Example: Facebook acquired: Instagram (photo & video
sharing), WhatsApp (text messaging service), Oculus (virtual
reality headsets).

Example: Google acquired: YouTube (video sharing), Motorola
(mobile technology), Waze (interactive mobile maps).
23

M&A and Competitive Advantage
Many M&As actually destroy shareholder value! (Due to
anticipated synergies never materializing)
Value creation generally accrues to the shareholders of the firm
that is taken over, (acquirers often pay a premium when buying
the target company).
M&A’s are a popular vehicle for corporate-level strategy
implementation for three reasons:
because of principal–agent problems
the desire to overcome competitive disadvantage
the quest for superior acquisition and integration capability.

24

© McGraw Hill

Examples of mergers that destroyed significant shareholder
value (as measured one year after the deal closed) include:
Bayer - Monsanto (down 47 percent); Bank of America -
Countrywide (down 45 percent); Alcatel - Lucent (down 39
percent); AOL - Time Warner (down 37 percent), and Sprint -
Nextel (down 30 percent).

24

Motives for Mergers and Acquisitions
Managerial
C-level compensation based on size vs. profitability
C-level ego, (MA confers power and celebrity)
FOMO, imitation, everyone else is doing it
Financial
Stock market inefficiencies, undervalued or overvalued
manipulation. (Berkshire Hathaway/Heinz)

Tax savings by moving HQ offshore (Burger King/Tim Hortons)
Strategic
Horizontal: EOS, competition and market power, (Sirius/XM)
Geographic: access to overseas market, (Kraft/Cadbury)
Vertical: acquire a supplier or customer, (Apple/Corning)
Diversification: enter a new area of business, (Kering/Puma)

25

© McGraw Hill

BH saw that Heinz was undervalued and bought to help grow
the business
BK moved HQ to Canada for better taxes than UK
Sirius bought out the only other competitor of Satellite based
radio.
Kraft bought Cadbury Candies solely for European distribution
channel
Apple needs Corning for Gorilla glass, (largest investor)
Kering owns various luxury goods brands, including Gucci,
Yves Saint Laurent, Balenciaga, Alexander McQueen, Bottega

Veneta, Boucheron and Brioni, as well as Puma and Volcom in
its Sport & Lifestyle portfolio.

25

Principal-Agent Problems with M&A
Managers incentives to acquire:
To build a larger empire
To receive prestige, power, and pay

Managerial hubris:
A form of self-delusion
Managers convince themselves of their superior skills
They see themselves as exceptions to the rule

© McGraw Hill

Quaker Oats Co. acquired Snapple because its managers thought
Snapple was another Gatorade, which was a successful previous

acquisition. The difference was that Gatorade had been a
standalone company and was easily integrated, but Snapple
relied on a decentralized network of independent distributors
and retailers who did not want Snapple to be taken over and
who made it difficult and costly for Quaker Oats to integrate
Snapple. The acquisition failed—and Quaker Oats itself was
taken over by PepsiCo. Snapple was spun out and eventually
ended up being part of the Dr. Pepper Snapple Group.
26

Small Group Exercise

27

© McGraw Hill

End of Main Content
© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®
www.mheducation.com

Chapter 11
Organizational Design: Structure, Culture, and Control

© 2021 McGraw Hill. All rights reserved. Authorized only for
instructor use in the classroom.
No reproduction or further distribution permitted without the
prior written consent of McGraw Hill.

Because learning changes everything.®

1

The AFI Strategy Framework

2

Because learning changes everything.®

Learning Objectives
Define organizational design and list its three components.
Explain how organizational inertia can lead established firms to
failure.
Define organizational structure and describe its four elements.
Compare and contrast mechanistic versus organic organizations.
Describe different organizational structures and match them
with appropriate strategies.
Evaluate closed and open innovation, and derive implications
for organizational structure.
Describe the elements of organizational culture, and explain
where organizational cultures can come from and how they can
be changed.
Compare and contrast different strategic control-and-reward
systems.

© McGraw Hill

3

Case Study

4

© McGraw Hill

Zappos 10 Core Values
Deliver WOW Through Service
Embrace and Drive Change
Create Fun and A Little Weirdness
Be Adventurous, Creative, and Open-Minded
Pursue Growth and Learning
Build Open and Honest Relationships With Communication
Build a Positive Team and Family Spirit

Do More With Less
Be Passionate and Determined
Be Humble

5

© McGraw Hill

How specifically do these values support the strategy? Do they
think that these values would be helpful in attracting the type of
employee that Zappos needs to gain and sustain a competitive
advantage?

5

Zappos
Designed to Deliver Happiness
Exceptional Customer Service → Core Competency
All customer service is done in-house.
No scripts or timed calls in the call centers

Keep its own stocked products… no drop-shipment
Flat Organizational Structure = Flexibility
Job rotation = widely trained talent
Internal promotion opportunities
Reorganized into 10 business units to manage growth

6

© McGraw Hill

Founder Tony Hsieh, (shay) created a culture of making
customers and employees happy which helps drive success.

Acquired by Amazon in 2009 for $1.2B and acts as a separate
business unit.

To achieve the strategic objective, Zappos developed a set of
values and integrated them into the company’s culture. This
culture can provide behavior guidelines once the employees
internalize the culture. How does Zappos deliver WOW to
customers? Zappos has a 365-day no-hassle return policy, free
upgrades to express shipping, and courteous and helpful

customer representatives, all of which help make customers
very happy.

Flexibility…Unlike other online retailers, Zappos stocks
everything it sells in its own warehouses—this is the only way
to get the merchandise as quickly as possible with 100 percent
accuracy to the customer. Strategy, therefore, is as much about
deciding what to do as it is about deciding what not to do.

6

Organizational Design
The process of:
Creating, implementing, monitoring, and modifying the
structure, processes, and procedures of an organization.

Key components:
Structure.
Culture.
Control.

© McGraw Hill

Google changed its organizational structure from functional
(organized according to domain expertise) to multidivisional or
M-form (composed of a number of independent strategic
business units). Alphabet’s strategic leaders hope this new
structure will allow them to drive future radical innovation.
Moreover, since each SBU has profit and loss responsibility, the
new structure allows Alphabet to provide leadership
development opportunities for a number of its executives as
they are being groomed for larger roles in the future.
7

Organizational Inertia and the Failure of Established Firms to
Respond to Shifts in the External or Internal Environments

Exhibit 11.2
Access the text alternate for slide image.

© McGraw Hill

Google changed its organizational structure from functional
(organized according to domain expertise) to multidivisional or

M-form (composed of a number of independent strategic
business units). Alphabet’s strategic leaders hope this new
structure will allow them to drive future radical innovation.
Moreover, since each SBU has profit and loss responsibility, the
new structure allows Alphabet to provide leadership
development opportunities for a number of its executives as
they are being groomed for larger roles in the future.
8

Organizational Structure
Determines how efforts of individuals and teams are
orchestrated.
How resources are distributed.

Includes four building blocks:
Specialization.
Formalization.
Centralization.
Hierarchy.

© McGraw Hill

9

Specialization
Describes the degree to which a task is divided into separate
jobs, (aka as Division of Labor).
Larger firms: high degree of specialization.
Smaller ventures: low degree of specialization.
Requires a tradeoff between depth and breadth of knowledge.

© McGraw Hill

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

financial planning, and taxes).

U.S. military can be used as an example here because it has the
Air Force, Army, Navy, and Marines, and all of them have their
own specialties

https://www.nascar.com/video/franchise/monster-energy-nascar-
cup-highlights/no-4-team-setting-new-standard-pit-stops/

10

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

Pros:
Ensures consistent and predictable results.
Safety and reliability.

Cons:
Slower decision making.

Reduced innovation.
Hindered customer service.

© McGraw Hill

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

McDonald’s as the example for formalization because of the
standardized operation process.

11

Centralization
The degree to which decision making is concentrated at the top
of the organization.
Correlates to slow response time and reduced customer
satisfaction.
Affects strategic planning:
Top-down strategic planning takes place in highly centralized
organizations.
Planned emergence is found in more decentralized
organizations.

© McGraw Hill

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

In contrast, the FBI and the CIA were faulted in the 9/11
Commission report for not being centralized enough.1 The

report concluded that although each agency had different types
of evidence that a terrorist strike in the United States was
imminent, their decentralization made them unable to put
together the pieces to prevent the 9/11 attacks.

12

Hierarchy
The formal, position-based reporting lines:
Who reports to whom.

Span of control:
The number of employees who directly report to a manager.

© McGraw Hill

In tall organizational structures, the span of control is narrow.
In flat structures, the span of control is wide, meaning one
manager supervises many employees. In recent years, firms

have de-layered by reducing the headcount (often middle
managers), making the organizations flatter and more nimble.

Verizon many, many layers. CMS is flat. Direct reports,
owners. Which is most responsive?

13

Hierarchy reality on chain of command

14

© McGraw Hill

Mechanistic vs. Organic Organizations
Mechanistic Organization:
Much specialization and formalization.
Tall hierarchies.
Centralized decision making.

Organic Organization:
Little specialization and formalization.
Flat organizational structure.
Decentralized decision making.

© McGraw Hill

Within one industry Google is an organic organization, while
Microsoft is more mechanistic.
Pixar is a more organic structure than the theme park
organization is, both within Disney.

McDonald’s fits this description quite well. Each step of every
job such as deep-frying fries is documented in minute detail
(e.g., what kind of vat, the quantity of oil, how many fries, what
temperature, how long, and so on). Decision power is

centralized at the top of the organization: McDonald’s
headquarters provides detailed instructions to each of its
franchisees so that they provide comparable quality and service
across the board although with some local menu variations.
Communication and authority lines are top-down and well
defined. To ensure standardized operating procedures and
consistent food quality throughout the world, McDonald’s
operates Hamburger University, a state-of-the-art teaching
facility in a Chicago suburb, where 50 full-time instructors
teach courses in chemistry, food preparation, and marketing. In
2010, McDonald’s opened a second Hamburger University
campus in Shanghai, China.

Exhibit 11.3 summarizes the key features of mechanistic and
organic structures.
15

Firm Strategy and Structure
The relationship between these is interdependent and dynamic.
Strategy and structure impact a firm’s performance.
Changes over time as the firm grows in size and complexity.

Different firm stages require different structures.

16

© McGraw Hill

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

16

Simple Structure
Used by small firms with low organizational complexity.
The founders usually:
Make all the strategic decisions.
Run day-to-day operations.
Professional managers and sophisticated systems are not usually
in place.
Low degree of formalization and specialization.

© McGraw Hill

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

17

Functional Structure
Employees are grouped into functional areas:
Based on domain expertise.
Often correspond to distinct stages in the value chain.
Leaders of functional areas report to the CEO.
The CEO coordinates and integrates the work of each function.

© McGraw Hill

18

Benefits of Functional Structure and Business Strategy
A functional structure works when a firm has a narrow focus
and small geographic footprint.
Cost Leadership Strategy:
Nurturing and upgrading core competencies.
Differentiation Strategy:
Incorporate decentralized decision making.
Foster innovation and creativity.
Blue Ocean Strategy:
Firm should be efficient and flexible.
Focus is on controlling costs and fostering creativity.

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