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Because each division operates independently, the divisional managers in charge of each individual division can choose which organizational structure (e.g., a prod- uct, matrix, or market structure), control systems, and culture to adopt to implement its business model and strategies most effectively. Figure 13.1 illustrates how this process works. It shows that managers of the oil division have chosen a functional structure (the one that is the least costly to operate) to pursue a cost- leadership strat- egy. The pharmaceuticals division has adopted a product-team structure that allows each separate product-development team to focus their efforts on the speedy devel- opment of new drugs. And, managers of the plastics division have chosen to imple- ment a matrix structure that promotes cooperation between teams and functions and allows for the continuous innovation of improved plastic products that suit the changing needs of customers. These two divisions are pursuing differentiation based on a distinctive competence in innovation.

The CEO famous for employing the multidivisional structure to great advan- tage was Alfred Sloan, GM’s first CEO, who implemented a multidivisional struc- ture in 1921, noting that GM “needs to find a principle for coordination without losing the advantages of decentralization.” Sloan placed each of GM’s different car brands in a self-contained division so it possessed its own functions—sales, pro- duction, engineering, and finance. Each division was treated as a profit center and evaluated upon its return on investment. Sloan was clear about the main advantage of decentralization: it made it much easier to evaluate the performance of each division. And, Sloan observed, it: (1) “increases the morale of the organization by placing each operation on its own foundation . . . assuming its own responsibility

Corporate Headquarters Staff

CEO

Typical Chemical Company

Oil division (functional structure)

Pharmaceuticals division (product-team structure)

Plastics division (matrix structure)

Figure 13.1 Multidivisional Structure

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and contributing its share to the final result”; (2) “develops statistics correctly reflecting . . . the true measure of efficiency”; and (3) “enables the corporation to direct the placing of additional capital where it will result in the greatest benefit to the corporation as a whole.”4

Sloan recommended that exchanges or handoffs between divisions be set by a transfer-pricing system based on the cost of making a product plus some agreed- upon rate of return. He recognized the risks that internal suppliers might become inefficient and raise the cost structure, and he recommended that GM should bench- mark competitors to determine the fair price for a component. He established a centralized headquarters management staff to perform these calculations. Corporate management’s primary role was to audit divisional performance and plan strategy for the entire organization. Divisional managers were to be responsible for all com- petitive product-related decisions.

Advantages of a Multidivisional Structure When managed effectively at both the corporate and the divisional levels, a multi- divisional structure offers several strategic advantages. Together, they can raise cor- porate profitability to a new peak because they allow a company to more effectively implement its multibusiness model and strategies.

Enhanced Corporate Financial Control The profitability of different business divisions is clearly visible in the multidivisional structure.5 Because each division is its own profit center, financial controls can be applied to each business on the basis of profit- ability criteria such as ROIC. Corporate managers establish performance goals for each division, monitor their performance on a regular basis, and intervene selectively if a division starts to underperform. They can then use this information to identify the divisions in which investment of the company’s financial resources will yield the greatest long-term ROIC. As a result, they can allocate the company’s funds among competing divisions in an optimal way, that is, a way that will maximize the profit- ability of the whole company. Essentially, managers at corporate headquarters act as “internal investors” who channel funds to high-performing divisions in which they will produce the most profits.

Enhanced Strategic Control The multidivisional structure makes divisional managers responsible for developing each division’s business model and strategies; this allows corporate managers to focus on developing the multibusiness model, which is their main responsibility. The structure gives corporate managers the time they need to contemplate wider long-term strategic issues and develop a coordinated response to competitive changes, such as quickly changing industry boundaries. Teams of man- agers at corporate headquarters can also be created to collect and process crucial information that leads to improved functional performance at the divisional level. These managers also perform long-term strategic and scenario planning to find new ways to increase the performance of the entire company, such as evaluating which of the industries they compete in will likely be the most profitable in the future. Then managers can decide which industries they should expand into and which they should exit.

Profitable Long-Term Growth The division of responsibilities between corporate and divisional managers in the multidivisional structure allows a company to overcome

Profit center When each self-contained division is treated as a separate financial unit and financial controls are used to establish performance goals for each division and measure profitability.

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organizational problems, such as communication problems and information overload. Divisional managers work to enhance their divisions’ profitability; teams of managers at corporate headquarters devote their time to finding opportunities to expand or diversify its existing businesses so that the entire company enjoys profit- able growth. Communication problems are also reduced because corporate manag- ers use the same set of standardized accounting and financial output controls to evaluate all divisions. Also, from a behavior control perspective, corporate managers can implement a policy of management by exception, which means that they inter- vene only when problems arise.

Stronger Pursuit of Internal Efficiency As a single-business company grows, it often becomes difficult for top managers to accurately assess the profit contribution of each functional activity because their activities are so interdependent. This means that it is often difficult for top managers to evaluate how well their company is performing relative to others in its industry—and to identify or pinpoint the spe- cific source of the problem. As a result, inside one company, considerable degrees of organizational slack—that is, the unproductive use of functional resources—can go undetected. For example, the head of the finance function might employ a larger staff than is required for efficiency to reduce work pressures inside the department and to bring the manager higher status. In a multidivisional structure, however, corporate managers can compare the performance of one division’s cost structure, sales, and the profit it generates against another. The corporate office is, therefore, in a better position to identify the managerial inefficiencies that result in bureaucratic costs; divisional managers have no excuses for poor performance.

Problems in Implementing a Multidivisional Structure Although research suggests large companies that adopt multidivisional structures outperform those that retain functional structures, multidivisional structures have their disadvantages as well.6 Good management can eliminate some of these disad- vantages, but some problems are inherent in the structure. Corporate managers must continually pay attention to the way they operate and detect problems.

Establishing the Divisional-Corporate Authority Relationship The authority rela- tionship between corporate headquarters and the subordinate divisions must be correctly established. The multidivisional structure introduces a new level in the management hierarchy: the corporate level. Corporate managers face the problem of deciding how much authority and control to delegate to divisional managers, and how much authority to retain at corporate headquarters to increase long-term profitability. Sloan encountered this problem when he implemented GM’s multidivi- sional structure.7 He found that when corporate managers retained too much power and authority, the managers of its business divisions lacked the autonomy required to change its business model to meet rapidly changing competitive conditions; the need to gain approval from corporate managers slowed down decision making. On the other hand, when too much authority is delegated to divisions, managers may start to pursue strategies that benefit their own divisions, but add little to the whole company’s profitability. Strategy in Action 13.1 describes the problems Andrea Jung experienced as Avon recentralized control over its functional operations to U.S. corporate managers from overseas divisional managers under order to overcome this problem.

Organizational slack The unproductive use of functional resources by divisional managers that can go undetected unless corporate managers monitor their activities.

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After a decade of profitable growth, Avon suddenly be- gan to experience falling global sales in the mid-2000s, both at home and in developing markets abroad. After spending several months visiting the managers of its worldwide divisions, Andrea Jung, Avon’s CEO, decided that Avon had lost the balance between centralization and decentralization of authority. Managers abroad had gained so much authority to control operations in their respective countries and world regions that they had made decisions to benefit their own divisions, and these decisions had hurt the performance of the whole com- pany. Specifically, Avon’s operating costs were out of con- trol, and it was losing both low-cost and differentiation advantages. Avon’s country-level managers from Poland to Mexico ran their own factories, made their own prod- uct development decisions, and spearheaded their own advertising campaigns. These decisions were often based on poor marketing knowledge and with little concern for operating costs because the goal was to increase sales as rapidly as possible.

Also, when too much authority is decentralized to managers lower in an organization’s hierarchy, these managers often recruit more and more managers to help them build their country “empires.” The result was that Avon’s global hierarchy had exploded—it had risen from 7 levels to 15 levels of managers in a decade as tens of thousands of additional managers were hired around the globe! Because Avon’s profits were rising fast, Jung and her top management team had not paid enough atten- tion to the way Avon’s organizational structure was be- coming taller and taller—and how this was taking away its competitive advantage.

Once Jung recognized this problem she had to con- front the need to lay off thousands of managers and re- structure the hierarchy. She embarked on a program to take away the authority of Avon’s country-level managers and to transfer authority to regional and corporate head- quarters managers to streamline decision making and re- duce costs. She cut out 7 levels of management and laid off 25% of Avon’s global managers in its 114 worldwide markets. Then, using teams of expert managers from corporate headquarters, she embarked on a detailed

examination of all Avon’s functional activities, country by country, to find out why its costs had risen so quickly, and what could be done to bring them under control. The duplication of marketing efforts in countries around the world was one source of these high costs. In Mexico, one team found that country managers’ desire to expand their empires led to the development of a staggering 13,000 different products! Not only had this caused prod- uct development costs to soar, it had led to major mar- keting problems, for how could Avon’s Mexican sales reps learn about the differences between 13,000 products— and then find an easy way to tell customers about them?

In Avon’s new structure the focus is now upon central- izing all new major product development; Avon develops over 1,000 new products per year, but in the future, the input from different country managers would be used to customize products to country needs including fragrance, packaging and so on, and R&D would be performed in the United States. Similarly, the future goal is to develop marketing campaigns targeted at the average “global” customer, but that can also be easily customized to any country. Using the appropriate language, or changing the nationality of the models used to market the products, for example, could be used in these campaigns. Other initia- tives have been to increase the money spent on global marketing and a major push to increase the number of Avon representatives in developing nations in order to attract more customers. By 2011, Avon recruited another 400,000 reps in China alone!

Country-level managers now are responsible for man- aging this army of Avon reps and for ensuring that mar- keting dollars are being directed to the right channels for maximum impact. However, they no longer have any au- thority to engage in major product development or build new manufacturing capacity—or to hire new managers without the agreement of regional- or corporate-level managers. The balance of control has changed at Avon, and Jung and all her managers are now firmly focused on making operational decisions that lower its costs or increase its differentiation advantage in ways that serve the best interests of the whole company—and not only the country in which its cosmetics are sold.

Why Avon Needed to Change the Balance Between Centralization and Decentralization

StrAtegy In ACtIon13.1

Source: www.avon.com, 2011.

As this example suggests, the most important issue in managing a multidivisional structure is how much authority should be centralized at corporate headquarters and how much should be decentralized to the divisions—in different industries or countries. Corporate managers must consider how their company’s multibusiness

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model and strategies will be affected by the way they make this decision now and in the future. There is no easy answer because every company is different. In addition, as the environment changes or a company alters its multibusiness model, the optimal balance between centralization and decentralization of authority will also change.

Restrictive Financial Controls Lead to Short-Run Focus Suppose corporate managers place too much emphasis on each division’s individual profitability, for example, by establishing very high and stringent ROIC targets for each division. Divisional managers may engage in information distortion, that is, they manipulate the facts they supply to corporate managers to hide declining divisional performance, or start to pursue strategies that increase short-term profitability but reduce future profitability. For example, divisional managers may attempt to make the ROIC of their division look better by cutting investments in R&D, product development, or marketing—all of which increase ROIC in the short run. In the long term, however, cutting back on the investments and expenditures necessary to maintain the division’s performance, particularly the crucial R&D investments that lead a stream of innovative products, will reduce its long-term profitability. Hence, corporate managers must carefully control their interactions with divisional managers to ensure that both the short- and long-term goals of the business are being met. In sum, a problem can stem from the use of financial controls that are too restrictive; Chapter 11 discusses the “balanced scorecard” approach that helps solve it.

Competition for Resources The third problem of managing a multidivisional struc- ture is that when the divisions compete among themselves for scarce resources, this rivalry can make it difficult—or sometimes impossible—to obtain the gains from transferring, sharing, or leveraging distinctive competencies across business units. For example, every year the funds available to corporate managers to allocate or distribute to their divisions is fixed, and, usually, the divisions that have obtained the highest ROIC proportionally receive more of these funds. In turn, because managers have more money to invest in their business, this usually will raise the company’s per- formance the next year so strong divisions grow ever stronger. This is what leads to competition for resources and reduces interdivisional coordination; there are many recorded instances in which one divisional manager tells another: “You want our new technology? Well you have to pay us $2 billion to get it.” When divisions battle over transfer prices, the potential gains from pursuing a multibusiness model are lost.

Transfer Pricing As just noted, competition among divisions may lead to battles over transfer pricing, that is, conflicts over establishing the fair or “competitive” price of a resource or skill developed in one division that is to be transferred and sold to other divisions that require it. As Chapter 9 discusses, a major source of bureaucratic costs are the problems that arise from handoffs or transfers between divisions to obtain the benefits of the multibusiness models when pursuing a vertical integration or re- lated diversification strategy. Setting prices for resource transfers between divisions is a major source of these problems, because every supplying division has the incentive to set the highest possible transfer price for its products or resources to maximize its own profitability. The “purchasing” divisions realize the supplying divisions’ at- tempts to charge high prices will reduce their profitability; the result is competition between divisions that undermines cooperation and coordination. Such competition can completely destroy the corporate culture and turn a company into a battle- ground; if unresolved, the benefits of the multibusiness model will not be achieved. Hence, corporate managers must be sensitive to this problem and work hard with

Information distortion The manipulation of facts supplied to corporate managers to hide declining divisional performance.

Transfer pricing The problem of establishing the fair or “competitive” price of a resource or skill developed in one division that is to be transferred and sold to another division.

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the divisions to design incentive and control systems to make the multidivisional structure work. Indeed, managing transfer pricing is one of corporate managers’ most important tasks.

Duplication of Functional Resources Because each division has its own set of value chain functions, functional resources are duplicated across divisions; thus, multidivi- sional structures are expensive to operate. R&D and marketing are especially costly functional activities; to reduce their cost structure, some companies centralize most of the activities of these two functions at the corporate level in which they service the needs of all divisions. The expense involved in duplicating functional resources does not result in major problems if the differentiation advantages that result from the use of separate sets of specialist functions are substantial. Corporate managers must decide whether the duplication of functions is financially justified. In addition, they should always be on the lookout for ways to centralize or outsource functional activities to reduce a company’s cost structure and increase long-run profitability.

In sum, the advantages of divisional structures must be balanced against the problems of implementing them, but an observant, professional set of corporate (and divisional) managers who are sensitive to the complexities involved can respond to and manage these problems. Indeed, advances in IT have made strategy implementa- tion easier, as we will discuss later in this chapter.

Structure, Control, Culture, and Corporate-Level Strategy Once corporate managers select a multidivisional structure, they must then make choices about what kind of integrating mechanisms and control systems necessary to make the structure work efficiently. Such choices depend upon whether a company chooses to pursue a multibusiness model based on a strategy of unrelated diversifica- tion, vertical integration, or related diversification.

As Chapter 9 discusses, many possible differentiation and cost advantages derive from vertical integration. A company can coordinate resource transfers between di- visions operating in adjacent industries to reduce manufacturing costs and improve quality, for example.8 This might mean locating a rolling mill next to a steel furnace to save on costs to reheat steel ingots, making it easier to control the quality of the final steel product.

The principal benefits from related diversification also derive from transferring, sharing, or leveraging functional competencies across divisions, such as sharing dis- tribution and sales networks to increase differentiation, or lowering the overall cost structure. With both strategies, the benefits to the company result from some exchange of distinctive competencies among divisions. To secure these benefits, managers must coordinate the activities of the various divisions, so an organization’s structure and control systems must be designed to manage the handoffs or transfers among divisions.

In the case of unrelated diversification, the multibusiness model is based on us- ing general strategic management capabilities, for example, in corporate finance or organizational design. Corporate managers’ ability to create a culture that supports entrepreneurial behavior that leads to rapid product development, or to restructure an underperforming company and establish an effective set of financial controls, can result in substantial increases in profitability. With this strategy, however, there are no exchanges among divisions; each division operates separately and independently. The only exchanges that need to be coordinated are those between the divisions and corporate headquarters. Structure and control must therefore be designed to allow

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each division to operate independently, while making it easy for corporate managers to monitor divisional performance and intervene if necessary.

The choice of structure and control mechanisms depends upon the degree to which a company using a multidivisional structure needs to control the handoffs and interactions among divisions. The more interdependent are divisions—that is, the more they depend on each other for skills, resources, and competencies—the greater the bureaucratic costs associated with obtaining the potential benefits from a particular corporate-level strategy.9 Table 13.1 illustrates what forms of structure and control companies should adopt to economize on the bureaucratic costs associated with the three corporate strategies of unrelated diversification, vertical integration, and related diversification.10 We examine these strategies in detail in the next sections.

Unrelated Diversification Because there are no exchanges or linkages among divisions, unrelated diversification is the easiest and cheapest strategy to manage; it is associated with the lowest level of bureaucratic costs. The primary advantage of the structure and control system is that it allows corporate managers to evaluate divisional perfor- mance accurately. Thus, companies use multidivisional structures, and each division is evaluated by output controls such as ROIC. A company also uses an IT-based system of financial controls to allow corporate managers to obtain information quickly from the divisions and compare their performance on many dimensions. UTC, Tyco, and Textron are companies well-known for their use of sophisticated financial controls to manage their structures and track divisional performance on a daily basis.