Overview: Organizational Theory

Summary written in 2014 based on Organizational Theory, Design and Change, Jones, 2010, 6th edition


Organizations are intangible and their essence is the grouping of people and other resources to produce goods and services. People have certain things that they desire or value and therefore they use organizations as a instrument to coordinate their actions and achieve their goals. More and more organizations arise when new technologies become available and new needs are discovered. If those needs are no longer important or are replaced by other needs organizations die or transform to fulfill the current needs. Organizations do not just appear out of thin air they are founded by people, the term to describe this is entrepreneurship. This is a process by which people see opportunities to satisfy needs and then gather and use the resources to fulfill those needs. The fastest growing organizations nowadays are related in some way to new information technology (IT).

Creating value
Value creation takes place at three stages. Firstly it is important how an organization chooses and obtains its inputs from the environment because that determines how much value is created at the input stage. Secondly we have the conversion stage. The way an organization utilizes its human resources and technology to transform inputs into outputs is  a determinant of how much value is created. The quality of an organizations skills and the way it learns from and responds to the environment is also an indicator of how much value can be created. Finally at the output stage an organization can use its earnings to obtain new inputs from the environment and the cycle begins again. An organization obtains increasing amounts of resources over time and will be able to create more and more value when it continues to satisfy people’s needs. This way their skills and capabilities will be enlarged. Each of these separate stages are influenced by the organizational environment or a set of forces beyond the organizational boundaries that affect the ability obtain resources to create value. This can be illustrated in a value-creation model (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 26, figure 1.1).
Reasons for the existence of organizations
There are five reasons for the existence of organizations.

  • When people work together they are more productive and efficient then when they work alone. For different types of productive work an organization can develop specialization and a division of labor. This way people become more specialized at what they do.
  • When using large-scale technology organizations can take advantage of economies of scale and economies of scope. Economies of scale are cost savings due to production in large volumes and automated production. Economies of scope are cost savings due to the effective usage of underutilized resources in a way that the resources can be used across a variety of products or tasks.
  • Pressures from an organization’s environment influence the ability of an organization to obtain inputs. Therefore organizations need to manage their environment and the political, social and economic pressures so that they can specialize and create more value. Individuals are not able to manage the pressures from the environment, but organizations can because they have the resources to develop specialists that can anticipate and deal with pressures from the environment. 
  • Organizations are ideal for economizing on transaction costs. When there are a lot of people working together the transaction costs can be very high. Organizations can control the exchanges between people in a way that they reduce costs associated with negotiating, governing, and monitoring also called transaction costs.
  • Finally organizations exist because they are an useful tool to exert power and control. When an organization exerts power and control it is able to make people conform to task and production requirements, this increases production efficiency. Tools to exert power and control are employment, promotion, and increased rewards. This does put pressure on individuals because instead of only addressing their own needs they also have to address the organization’s needs.

Organizational theory
Organizations function in a particular way and thereby affect and are affected by the environment in which they act, the study of this phenomenon is called organizational theory. It is important to understand how organizations operate so you can learn how to control and change organizations in a way that they become more effective. When you possess the knowledge about organizational design and change you are able to analyze organizational structures and cultures, determine problems, make changes and help the organization in achieving its goals. To be able to do that it is of great importance to understand the relationship between organizational theory, structure, culture, design, and change (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 30, figure 1.4).
Organizational structure is a formal system of task and authority relationships that control how people use organizational resources and coordinate their behavior to achieve certain organizational goals. The main factor here is control. Organizational structure controls the way in which people coordinate their actions to achieve organizational goals and it controls the means used to motivate people in achieving these goals. The structure of an organizations evolves as an organization changes and grows with the passing of time. An appropriate structure is one that enables people to effectively response to problems of coordination and motivation. An organizational structure can be managed through the process of organizational design and change.
Organizational culture and structure have resemblances. They both evolve and become more complex with the passing of time and they can both be managed through organizational design and change. In an organization there are certain shared values and norms that control the way people interact with one another and with customers, suppliers, and other people outside the organization, this is called the organizational culture. It is shaped by the people inside the organization, the ethics of the organization, employment rights and the organizational structure. Organizational culture shapes and controls the behavior of people and the way they interpret things such as the organizational environment.
Managers select certain aspects of an organization’s structure and culture that they manage in a way so they can control the activities necessary to achieve organizational goals, this is called organizational design.


The structure and culture of an organization are means to achieve goals, but organizational design is about how and why several means are chosen. The way an organization behaves is the result of its design. It is of great importance that an organization finds a balance between the external pressures from the environment and the internal pressures from the organization. When an organization achieves that it will ensure its future in the long run.
If organizations want to increase their effectiveness they will move from their current state to a different desired future, this process is called organizational change. The goal is to find new or better ways of using resources and possibilities to enlarge an organization’s ability to create value. Organizational structure and culture are tools in helping to facilitate organizational change. Organizational design and change are extremely interrelated. Large organizations face different design and redesign problems than small organizations because of different structures and cultures. It is important that managers recognize that their initial design choices will have important consequences for the future of an organization. Initial design choices are determinants of the long-run performance. When you understand the principles behind organizational design and change, it is easier to manage an organization’s structure and culture effectively. It will deepen your understanding and appreciation of the technical and social processes that determine how an organization operates.
Why are organizational design and change so important?
Due to globalization organizational design has become one of management’s top priorities. Managers search for new and better ways to coordinate and motivate employees so that they can create more value. There are several reasons why it is so important that organizational culture and structure are correctly managed through organizational design and change.
Handling contingencies. A contingency is an event that might happen and therefore must be planned for. Organizational design can determine how effectively an organization responds to pressures from its environment and obtain scarce resources. A structure can be designed in many ways to enlarge an organization’s control over its environment. Because there are so many pressures from competitors, the government, and consumers the environment is becoming increasingly complex and difficult to respond to. As a result more effective types of structure and culture are being developed and implemented. The global environment is also becoming more complex, and when a company becomes a global competitor a new organizational structure and culture is often created. Another contingency is changing technology. Internet and other advanced IT are the main methods that organizations use to manage relationships with employees, suppliers and customers. There has been a great deal of organizational change because organizations redesign their structures to make more effective use of IT. The use of IT has changed several things: the nature of the boundary of the organization, the way in which organizations coordinate people and tasks and the way many organizations operate.      
Obtaining competitive advantage. When managers from one company are able to create more value from their organizational resources than managers from another company they have a competitive advantage. Competitive advantage results from core competences, those are the skills and abilities of managers in value-creating business and they allow a company to develop a strategy to outperform competitors.



A strategy is all the specific decisions and actions a manager takes to use core competences to gain competitive advantage and outperform competitors. The way organizational structure is changed and designed is important because it determines how much value is created and that in its turn will affect how a strategy is implemented. Some sources of competitive advantage disappear quickly because they are easy to imitate. Good organizational design is not easy to imitate because culture and structure are embedded in the organization. Therefore organizational design can create long-term competitive advantage. It is important that managers keep evaluating the organizational structure and culture because organizational design and strategy must be continuously evolving to stay ahead of the competition.



Managing diversity. Organizational effectiveness and values of an organization’s culture are influenced by differences in race, gender, and national origin of employees. When managers take into consideration the different views the quality of decision making is higher. Organizational design is important because the structure and culture of an organization needs encourage people to work together. With regard to globalization organizational design can harmonize national with organizational culture.


Fostering efficiency, speed, and innovation. The capacity to create value has increased greatly over the years. The design of more efficient structures is important because there is a lot of competition from countries with low labor costs. Therefore one must become more efficient, reduce costs and increase quality. Also, to compete successfully you need to innovate and quickly introduce new technologies. Organizational design is a key factor.
The effects of bad organizational design
Managers are unaware of the factors that affect the relationship between organizational structure and culture on the one hand and the behavior of employees on the other hand. A result of bad organizational design is the decline of the organization.

Good employees leave to go to strong growing organizations, resources become harder to get and less value is created. These effects cause managers to change organizational culture an structure and in the last decade they have been appointing chief operating officers (COOs). COOs are responsible for the structure and culture of an organization. They oversee teams of managers that implement organizational design and make incremental and organization-wide changes in the strategy, structure and culture of an organization.


Measuring organizational effectiveness

Researchers have said that control, innovation and efficiency are the three most important processes managers use to measure how effectively value is created. Control means controlling the external environment and having the ability to attract customers and resources. Innovation means designing and creating new organizational structures and cultures that enhance a company’s abilities and it means developing organizational skills and capabilities. Efficiency means using technology to produce and distribute in a cost-effective manner and using techniques such as Internet-based information systems, total quality management, and just-in-time inventory systems to improve productivity. There are three approaches to measure organizational effectiveness (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 37, table 1.1).

The external resource approach (control). This is a method that managers use to evaluate how effectively an organization manages and controls its external environment. An organization is effective if it can secure scarce resources and valued skills from the environment. There are indicators to compare effectiveness of organizations such as stock price, return on investment, and profitability. Another indicator of an organization’s ability to influence and control its environment is the ability of managers to respond to changes in the environment. Stakeholders and especially shareholders have certain criteria by which they judge how well a company is controlling its environment such as entrepreneurial nature, reputation and organization’s aggressiveness.
The internal systems approach (innovation). An organization is effective if it can coordinate resources and employee skills creatively to innovate products and adapt to the need of the customer. This approach helps managers evaluate how effectively an organization functions and resources operate. There are several things an organization needs to be effective: a structure and culture that promote adaptability, and flexibility to make decisions faster. Improving internal systems that influence employee coordination and motivation will impact the organization’s ability to respond to its environment.

The technical approach (efficiency). An organization is effective is it is able to convert skills and resources efficiently into goods and services. Productivity and efficiency (the ratio of outputs to inputs) are measures of technical effectiveness. Productivity is often measured at all stages of the production process and when managers find ways to increase productivity they are rewarded. In service organizations this is done by indicators such as sales per employee or the ratio of goods sold to goods returned. There are always objective measures that organizations can use to measure productivity or performance. Employee attitude and motivation are important factors that influence productivity and efficiency.
Measuring effectiveness
Managers create goals to assess organizational performance. Official goals are stated in the annual report and other public documents, they lay out the mission of organization or why an organization exists and what it should do. Official goals legitimize an organization’s activities and allow it to obtain resources and gain the support of stakeholders. Specific long- and short-term goals that guide managers and employees are called operative goals. Operative goals are used to measure how well the environment is managed.  They are also efficient in benchmarking or comparing yourself with competitors. Managers should be careful when they develop goals to measure effectiveness on the three dimensions (control, innovation, efficiency). It is important that companies align their official and operative goals so no conflict arises between them and that they work together to enhance effectiveness.




People who have an interest, stake, or claim in an organization and its performance are called stakeholders. Stakeholders participate in organizations if they receive inducements that surpass the value of their contributions. Inducements are rewards like money and power. Contributions are the skills, expertise, and knowledge that organizations demand of their members in performing their tasks. There are two groups of organizational stakeholders: inside stakeholders and outside stakeholders (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 51, table 2.1).
Inside stakeholders are shareholders, managers, and the workforce. They are the people who are closest to an organization and have the strongest claim on organizational resources. Shareholders own the organization, their claim is considered to be superior to the claims of other inside stakeholders. They invest money (contribution) in the organization by buying stock or shares and expect to earn on their investment in the form of increases in the price of stock and dividends (inducement). This is risky because there is no guarantee of a return. Mutual fund companies are there to protect the interests of their shareholders and as a result they try to influence top managers in their decision-making. They monitor the salaries and bonuses managers give themselves and react to accounting scandals. Managers are the employees responsible for coordinating organizational resources and pursuing organizational goals. They are the employees of shareholders because they are indirectly appointed by shareholders through a board of directors. Managers contribute skills and knowledge and as a reward they receive money, status, and power. The workforce exists of all nonmanagerial employees and they contribute skills and knowledge and receive wages, bonuses, and promotion. Their motivation is often a function of inducements (rewards and punishments).
Outside stakeholders do not own the organization and are not employed by it, but they do have some claim or interest in it. Customers are normally the biggest outside stakeholder group. The contribution of a customer is the money he or she pays to buy a product and customers will continue to buy a company’s products if they believe that the price of a product is equal to or less than its value. The sales revenue of an organization reflects the value that customers believe they are getting. Suppliers provide component parts and raw materials that allow organizations to reduce uncertainty in its technical or production operations and ultimately reduce their production costs. Therefore, a supplier has a direct effect on an organization’s efficiency and an indirect effect on its ability to attract customers. If suppliers provide high-quality inputs than organizations are able to make high-quality products, attract more customers and as a result order more high-quality inputs. The government wants companies to compete in a fair manner, obey the rules of free competition and obey agreed-on rules and laws concerning the payment and treatment of employees. They standardize regulations so they apply to all companies and they have the power to punish any company that brakes these rules by taking legal action against it. The nature of the relationship between a trade union and an organization has a direct effect on both its productivity and effectiveness. A good relationship between managers and the union can lead to positive long-term outcomes, but traditionally the management-union relationship has been a hostile one.

Local communities have an interest in an organization’s performance because employment and the general economic well-being depends on the success or failure of local business. The general public is happy when organizations do well against overseas competitors because the present and future wealth of a country depends on the success of its business and economic institutions. They also expect organizations to act in a socially responsible way and take into account the needs of the other stakeholders.

Satisfying stakeholders
Each stakeholder group contributes to an organization to meet their own personal goals and they also assess the organization’s effectiveness by how well it has met their specific goals. These goals often conflict and stakeholder groups are forced to bargain over the balance between the contributions that are being made and the inducements they get in return for that. Organizations are the alliances or coalitions that bargain with the groups and use their power and influence to alter the balance of contributions and inducements in their favor. An organization is viable if the dominant coalition of stakeholders possesses enough inducements. A coalition view of organizations means that not all stakeholder groups are equally satisfied, the goal is to minimally satisfy the interests of all the groups. That way a group does not withdraw its support and the organization’s performance does not get injured. When all stakeholder interests are minimally satisfied, the relative power of a stakeholder group will determine how an organization attempts to satisfy different stakeholder goals and how stakeholders will judge organizational effectiveness. As an organization tries to win stakeholders’ approval it faces different problems: competing goals, the allocation of rewards, and the balancing of long-term and short-term goals.
An organization’s choice of which stakeholders’ goals to pursue has political and social complications. Shareholders delegate the right to coordinate and use organizational skills and resources to managers and therefore a divorce of ownership and control occurs. In theory shareholders are the employers of managers but in practice managers have the real control over the organization. This can result in a situation that managers pursue their own interests, they may prefer to maximize short-term profits and do not take the long-term view. There are also managers that prefer a quiet life, pursue low-risk strategies and are not entrepreneurial because they control their own salaries and these salaries are closely correlated with organizational size. As a result the goals of managers and shareholders are not compatible and shareholders goals are not likely to be followed. Even if all stakeholders agreed on which goals to follow, it is not an easy task to select goals that enhance an organization’s chances of survival. To be effective you have to make more right than wrong choices. An organization that does not take into account the needs of its stakeholders and minimally satisfying them is doomed to fail. Another problem that managers face is deciding which inducements each group should receive, thus the allocation of rewards. When all needs are minimally satisfied, they have to allocate the ‘extra’ rewards. People often claim that managerial rewards should be determined by the organization’s effectiveness. The allocation of rewards is important for the organizational effectiveness because it determines the motivation (the form and level of their contributions in the future) of stakeholders. Top managers and the board of directors are important because they determine the allocation of the rewards.

Organizational authority
When you have the power to influence what people do, how they do it and hold them accountable for their actions you have authority (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 59, figure 2.1). Shareholders have the ultimate authority over an organization’s resources, they own the company and exercise control through the board of directors (their representatives). The board of directors has the most authority in an organization and monitors corporate managers’ activities, rewards managers who pursue activities to satisfy stakeholder goals, hire and fire management and act as trustees to protect the interests of shareholders and other stakeholders. Through the executive committee (most important directors and top managers) the board of directors monitors and evaluates the way corporate managers use organizational resources. The salary committee determines the salaries and term of employment for corporate managers. There are two kinds of directors. Inside directors are full-time employees of the corporation and outside directors are professional objective directors who hold positions on the board of many companies or are executives of other companies who sit on other companies’ boards.

In practice inside directors are dominant and influence decision making in management’s favor because of an information advantage, outside managers tend to be passive. Corporate-level management sets company goals and objectives, allocate organizational resources and design the organization’s structure. This system of hierarchical reporting relationships is called the chain of command. If you order organizational roles in a vertical manner according to relative authority you create a hierarchy.

The Chief Executive Officer (CEO) sets the organizational strategy and policy. He or she reports to the chair of the board but is essentially the most powerful person in the organization because he or she controls the allocation of resources. Often the same person is both CEO and chair of the board and therefore has a lot of power that directly links the board to corporate management. A CEO influences organizational effectiveness and decision making in five ways. Firstly, the CEO sets organizational goals and designs its structure. Secondly, he or she selects key executives for the top levels of the managerial hierarchy. By choosing these people the CEO determines the culture, values, and norms of an organization. Thirdly, the CEO determines the rewards of top management. This way he or she can influence the motivation of top managers to pursue organizational goals in an effective way. Fourthly, he or she allocates scarce resources among the organization’s functional areas. This control gives the CEO great power over the future value creation activities of an organization. Finally, the reputation of the CEO impacts the inside and outside stakeholders’ views of the organization and its ability to attract resources from its environment.
Top-management team
The COO (chief operating officer) reports to the CEO and has the responsibility for managing the organization’s internal operations. The CEO manages the organizational relationship with external stakeholders and plans the long-term strategic objectives of the organization. The COO can also oversee the operation of a company’s most important business divisions. After the CEO and the COO there are executive vice presidents, they oversee a company’s most important line and staff responsibilities. Managers who have a direct responsibility for the production of goods and services have a line role.


When managers are responsible for a specific organizational function they have a staff role, they may only advise but do possess enormous influence on decision making. The CEO, the COO, and the executive vice presidents form a top-management team, this is a group of managers that report to the CEO and help the CEO set a company’s strategy and its long-term goals. They are all corporate managers that set the strategy for a company as a whole. The CEO and the board of directors appoint people to the top-management team, this is a vital task. The successor of the CEO is carefully selected and appointment to the top-management team is the first step of becoming a CEO.
Other managers
After the executive vice presidents are the senior vice presidents and vice presidents, they are corporate-level managers in line and staff functions. In practice, general managers are called CEO of their division because they are responsible for their division’s performance. They do net set policy for the whole organization and thus they are called divisional managers, not corporate managers. Functional managers develop functional skills and capabilities that provide core competences that give an organization its competitive advantage.         
Agency problem
When one person (the principal: shareholders) delegates decision-making authority to another (the agent: top management) an agency relation is created. As a result a problem arises in determining managerial accountability, the agency problem.


It is difficult to hold managers accountable for what they do because they have more knowledge then the shareholders and their performance can only be evaluated after considerable time has elapsed.  The problem is that shareholders are at an information disadvantage and that the goals of top management and shareholders may diverge.
Moral hazard problem
When it is very difficult to evaluate how well an agent has performed because the principal is at an information disadvantage and when the agent pursues goals that are different from the principal’s, a moral hazard problem exists. Corporate managers who take advantage of their position to act in their own interests are guilty of self-dealing.
Solutions for the agency problem
To overcome the agency problem governance mechanisms are used, they are forms of control that align the interests of principal and agent so that they can work together. There are many forms of government mechanisms. The board of directors control top management’s activities, question their decision making, and intervene when it is required. An important task is the development of the organization’s code of ethics. To align the goals of managers and shareholders the right set of incentives is needed. To do this managers’ rewards should be contingent on the outcomes of their decisions, this means that they are contingent on organizational performance. There are several ways of doing this. Giving managers their rewards in the form of stocks or stock options that are linked to the organization’s performance is one way, this is called stock-based compensation. Managers become stockholders and this way goals are aligned. Organizations can also choose to have ‘promotion tournaments’, that way promotion is linked to performance and managers will focus on long-term instead of short-term objectives. The reward from promotion includes monetary compensation, power, status and intrinsic satisfaction.


It is complex to design corporate governance mechanisms to ensure long-term effectiveness and it is currently creating big debates.
Organizational ethics
A very important mechanism of corporate governance is that managers follow ethical guidelines when confronted with an ethical dilemma. An ethical dilemma arises when people have to decide to act in a way that helps a person or a group because it is the ‘right’ thing to do, even though it is not in their own best interest. It can also be a choice between two interest and that a decision can harm one and benefit the other. Moral scruples, or the thoughts and feelings that tell a person what is right and what is wrong, come into play when faced with an ethical dilemma. To decide on a course of action people use ethics, those are the inner-guiding moral principles, values, and beliefs. Because there are not any rules that determine if an action is ethical or not, it is not easy to make a decision. But using the political and legal process, society as a whole can specify what organizations can and cannot do. Different groups lobby for their own interests and the group that gets the most support is able to pass the laws that align with their beliefs. Neither laws nor ethics are fixed principles because they alter and change as time passes. This means that ethical and legal rules are relative and that legal behavior isn’t necessarily ethical.
Organizational stakeholders
Ethics help managers decide how to respond to the different interests of various stakeholders. There are three models that determine whether a decision is ethical (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 68, table 2.3). The utilitarian model is used when an ethical decision is made based on the greatest good for the greatest number of people. According to the moral rights model an ethical decision is made when it protects and maintains the fundamental rights and privileges of people. Finally, the justice model determines that an ethical decision is one that gives advantages and disadvantages among stakeholders in a fair and unbiased manner.



Because the interests of different stakeholders collide, it is difficult for managers to make a decision based on the three models. For this reason experts have created a guide to determine if a decision is ethical. If a manager can answer ‘yes’ to the three following questions than he can make an acceptable decision on ethical grounds:

  • Does the decision fall within accepted values or standards?       
  • Can the decision be made public to all stakeholders?
  • Would people with whom I have a personal relationship approve the decision?

Ethics develop through, negotiation, compromise, conflict, and competition between stakeholders. Over time unethical behavior becomes illegal due to laws.
Sources of ethics
There are three sources of organizational ethics. Societal ethics are internalized by many people and are followed automatically. They appear in the legal system, customs, practices, and in unwritten norms and values. Often ethics are codified in the law and it is the responsibility of managers that their employees obey the law for they are hold accountable. Professional ethics or group ethics are the moral rules and values a group of people use when they perform a task. Most professional groups can enforce the ethics of their profession and they internalize them. Individual ethics are personal and moral standards used by individuals.


People differ in their opinions about what is ethical and what not. Personal ethics are the result of the law, religious membership, friends, family, and people’s upbringing, they influence how a person acts in an organization. Organizational ethics are the standards or rules used by organizational members in their interaction with stakeholders. Organizations are expected to behave ethically because it produces advantages for a society and its members.


Reasons why ethical rules develop
Ethical rules slow down the pursuit of self-interest and strive to protect a society’s collective interests. They also help make decisions that produce the most good and they reduce transaction costs between people. Those are the costs that arise when people negotiate and come to agreements. When organizations follow ethical rules they develop a reputation effect that also reduces transaction costs. If an organization behaves unethically their employees come to be branded with the same reputation. Behaving ethically makes people feel good, it promotes the good of a society, and more value is created.


Reasons why unethical behavior occurs
Personal ethics can be a source of unethical behavior because people learn ethical principles as they mature as individuals. Personal ethics come from family, friends, professional training, and organizations. Unethical behavior can also occur because of self-interest. Organizations who are doing badly are the ones most likely to adopt unethical behavior to survive. Finally, outside pressure can cause unethical behavior. It is very tempting for organizations to engage in unethical and illegal anticompetitive behavior. The social costs of unethical behavior are hard to measure, but in the long run organizational performance drops.
Designing an ethical organization
A manager can design an ethical organization by putting in place incentives for people who behave ethically. The board and top managers establish the ethical culture of an organization because they set the policy. A manager can also allocate organizational resources to pursue policies based on an organization’s ethical position. The mission statement of an organization can guide employees in behaving ethically and the organizational structure is often designed to reduce incentives for people to behave unethically. Whistle-blowing happens when an employee informs an outside person or agency about illegal or immoral behavior. Organizations can make whistle-blowing an accepted activity by establishing ethics committees and ethics officers. Neither culture nor structure can make an organization ethical if top managers and employees do not behave ethical.

Shareholders prefer an ethical organization, otherwise the investment is too risky. Pressure from outside stakeholders is important in promoting ethical organizational behavior.




Organizational environment

The set of pressures and forces that surround an organization and affect the way organizations operate and acquire scarce resources is called the environment. To maximize the ability to obtain scarce resources organizations try to manage their environment. The organizational domain exists of the goods and services an organization produces and the customers and other stakeholders it serves. When an organization decides how to manage the forces in its environment, it establishes its domain. To protect and enlarge its domain organizations try to structure their transactions with the environment, this way they can create more value. One way of doing this is to expand internationally. There are two kinds of forces that affect the organization: forces from the specific environment and forces from the general environment (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 82, figure 3.1).
The specific environment consists of forces from outside stakeholders (customers, the government, suppliers, distributors, competitors, unions) that have a direct influence on an organization’s ability to secure resources. Resources become more scarce and valuable when there is greater competition over them and they become more difficult to obtain. Customers’ tastes change and therefore organizations should adapt their strategy to manage their relationships with customers and attract their support. It is more difficult to satisfy customers in the global environment because they differ from country to country. Organizations have to choose how to manage relationships with suppliers and distributors to obtain the required resources. They can do this with the help of global supply chain management. This is a global process whereby supply and distribution activities are carefully planned and controlled. An organization has to manage these activities effectively to create a stable supply of inputs and dispose of its products in a timely manner. Supplies of inputs can be obtained from any country in the world and can give companies their competitive advantage by lowering production costs. Organizations face more challenges associated with distributing and marketing products in the global environment. This is because the tastes of customers vary from country to country. In Japan and other countries domestic producers strongly control distribution systems, this makes it very hard for companies to enter the market. When customers need a lot of information to use a complex product global distribution also becomes more difficult. Companies therefore have to carefully plan the global distribution process. With regard to outside stakeholders such as the government, unions, and consumer interest groups it is essential that organizations follow legal rules and adapt their management style to fit the expectations of the local workforce. Sometimes business rules are standardized across countries (the European Union). In sum, organizations must deal with all of the forces in the environment to obtain resources.

The general environment consists of different forces that form the specific environment and affect the ability to obtain resources. Economic forces (interest rates, unemployment rate) determine the price of inputs and the level of demand for products. Organizations normally fabricate their products in countries with low labor or raw-materials costs. National differences in interest rate, wage levels, and exchange rates affects they way organizations operate internationally.


Technical forces (development of new production techniques and new information-processing equipment) influence many aspects of an organization’s operations (for example, productivity). Investments in advanced research and development activities changes how organizations interact with each other and the way they design their structures. When an organization outsources its activities it is important to transfer the technology so the organization maintains its competitive advantage. Organizations must be able to learn about and have access to technological developments in other countries to gain low-cost or differentiation advantages. Political, ethical, and environmental forces have an effect on government policy regarding organizations and their stakeholders.



When countries do little to protect the environment other countries take advantage of the lax regulations to set up low-cost operations and the result is increased pollution. Demographic, cultural, and social forces shape an organization’s managers, employees, and customers. They are sources of uncertainty in the global environment because they affect the tastes and needs of customers. When doing business oversees it is important to understand the business methods and practices, and also the ethical standards.
Sources of uncertainty
All of the forces discussed above cause uncertainty for organizations and create difficulty in obtaining resources. These forces cause uncertainty because they affect the complexity, dynamism, and richness of the environment. Environmental complexity (simple to complex) is dependent on the strength, number, and interconnectedness of the specific and general forces that an organization manages. The greater the number, and the greater the differences between them, the more uncertain the environment and the more difficult to predict and control. When a company produces a wide variety of products for different groups of customers complexity increases. Complexity also increases when forces begin to interact so their effects become less predictable. Environmental dynamism (stable to unstable) is dependent on how much and how fast forces in the general and specific environment change over time and thus increase uncertainty. If an organization cannot predict the way forces will change than an environment is unstable and dynamic. When companies compete both at home and abroad, the environment becomes increasingly complex and increasingly dynamic. Environmental richness (rich to poor) is dependent on the amount of available resources to support an organization’s domain. In a rich environment uncertainty is low because there are enough resources and organizations do not have to compete over them. Environments can be poor because the organization is located in a poor region or there is a high level of competition over the resources between organizations.
It is important that managers analyze the organizational environment periodically to identify sources of uncertainty. If they want to manage the transactions with the environment effectively, they should chart the forces that affect the organization, the linkages between these forces, how fast the forces change, and the extent and nature of the competition. They should also plan how to deal with contingencies. Managers can do this by designing interorganizational strategies to control and secure access to scarce resources.


Resource dependence theory
The supply of resources depends on the complexity, dynamism, and richness of the environment. According to the resource dependence theory organizations try to minimize their dependence on other organizations for the supply of scarce resources and find ways of influencing them to make resources available. Thus an organization has to influence other organizations to obtain resources and it has to respond to the needs and demands of the organizations in its environment. The strength of an organization’s dependence on another for resources is a function of two factors: the importance of the resource to an organization’s survival and the extent to which other organizations control the resource. Organizations develop strategies to manage their resource dependence and control their access to scarce resources. By managing interdependencies in the specific and general environment, organizations are able to protect and enlarge their domain.
Interorganizational strategies
There are two basic types of interdependencies that cause uncertainty in the specific environment: symbiotic and competitive. When the outputs of one organization are the inputs for another (generally with an organization and its suppliers and distributors) symbiotic interdependencies exist. If organizations compete for scarce in- and outputs competitive interdependencies exist. Organizations can use several linkage mechanisms to control symbiotic and competitive interdependencies, this requires the actions of the linked organizations to be coordinated. This coordination reduces organization’s freedom to act independently and perhaps in its own best interests. Normally organizations choose the strategy that reduces the most uncertainty for the least loss of control.



Managing symbiotic interdependencies

There are four interorganizational strategies to manage symbiotic interdependencies: reputation, cooptation, strategic alliance, and merger and takeover. The more formal the strategy, the greater the cooperation between organizations. The strategies are in order of increasing formality. 
Reputation is the state in which an organization is held in high regard and they are trusted because they maintain honest business practices. This is the most common linkage mechanism because organizations that behave dishonestly are often unsuccessful.


Cooptation neutralizes problematic forces in the environment. Organizations give opponents a stake or claim on what it does to get them on their side, they make them inside stakeholders. Cooptation is a political tool and if stakeholders do not like the way things are going an organization can choose to give them a role in changing the way things are. To bring outsiders inside organizations can bribe people (illegal in many countries) or they can use an interlocking directorate, this is a linkage created by bringing in a director from one company to sit on the board of another company.


Strategic alliances are a common mechanism for managing symbiotic (and competitive) interdependencies. When two organizations share their resources to develop joint new business opportunities they form a strategic alliance.


There are different types of strategic alliances (long-term contracts, networks, minority ownership, joint ventures) and the more formal the arrangement, the stronger the linkage between organizations. The different types of strategic alliances are in order of increasing formality. Organizations tend to choose a more formal alliance when uncertainty is high to protect their access to scarce resources. The purpose of long-term contracts is to reduce costs by sharing resources and sharing the risk of research and development, marketing, and other activities. This is very informal because the only link is an agreement in a contract that can be oral or written, casual, shared or implicit. A network or a network structure is a cluster of various organizations that coordinate their actions through contracts and agreements. They work closely together to share manufacturing, marketing, or R&D skills to become more efficient, reduce costs, and increase product quality. Minority ownership makes organizations very interdependent and creates strong cooperative bonds. Keiretsu is a Japanese system of minority ownership. It is a group of organizations, each of which owns shares in the other organizations in the group, and they work together to benefit from each other. There are two forms of keiretsu: capital and financial. Capital keiretsu are used to control in- and output linkages. Financial keiretsu are used between different companies and normally have at their center a large bank. A joint venture is a strategic alliance between two or more organizations that agree to set up and share the ownership of a new business. This is the most formal strategic alliance because the rights and responsibilities are bound by a legal agreement. The shared ownership reduces problems of managing complex interorganizational relationships that would have arisen when using a less formal strategic alliance. The new organization is free to develop an organizational structure that best suits its needs so problems with managing interdependencies between the parent companies are reduced. A joint venture can also allow the founding companies to remain small.



Merging with or taking over a supplier or distributor is the most formal strategy for managing symbiotic (and competitive) interdependencies. As a result, organizations cannot be held hostage by a powerful customer or supplier and resource exchanges now take place within an organization instead of between organizations. Organizations adopting this strategy incur great expenses and face problems with managing the new business. Organizations only take over a supplier if there is a great need to control resources or manage an important interdependency.


Managing competitive interdependencies

There are four interorganizational strategies to manage competitive interdependencies: collusion and cartels, third-party linkage mechanism, strategic alliances, and merger and takeover (they are in order of increasing formality). The more formal the strategy, the greater the attempt to coordinate competitors’ activities. Some of these strategies are illegal but there are companies that use them.
A collusion is a secret arrangement between competitors to share information for an illegal purpose. A cartel is an association of organizations that agree to coordinate their activities. Collusions and cartels are illegal in the United States, but they reduce the complexity of relations between competitors and increase the stability and richness of an organization’s environment. Competitors can conspire by determining industry standards, these function like rules of conduct. For organizations it is more profitable to collectively coordinate their activities than to compete, as a result customers have to pay more.


Organizations can also conspire and form a cartel by signaling their intentions to each other through public announcements about their future strategy.
A third-party linkage mechanism is a regulatory body that allows companies to regulate the way they compete and share information. A trade association is an example of a third-party linkage mechanism. It represents organizations in the same industry and helps competitors to share information and monitor one another’s activities. This arrangement reduces the fear that one company deceives another. Trade associations have collective resources that help lobby for government policies that protect industry’s interests. Third-party linkage mechanisms increase the richness of the environment because they provide rules and standards that stabilize industry competition. Organizations are able to react easier to changes in the environment because third-party linkage mechanisms increase the flow of information. In sum, they are a way for competitors to manage resource interdependencies and reduce uncertainty.


Competitors can form a joint venture (strategic alliance) to discourage new entrants, harm existing competitors or develop a new technology that they can then protect from other competitors by getting patents. Competitors can also form a joint venture to develop a technology that will save a lot of money, even though they will be in competition for customers when their products are brought to the market.
Mergers and takeovers improve an organization’s competitive position by strengthening and enlarging its domain so an organization can produce a wider range of products for more customers. Many organizations want to use merger to become a monopoly (sole player in the market), but in many developed countries it is illegal. Despite cartels, collusion, and other anticompetitive practices, new entrants will be able to enter an industry in the long run. Organizations that reduce competition among themselves will become ineffective competitors and unable to meet the challenges of the rapidly changing environment.
Managers should find a way to manage each resource transaction to maintain an adequate supply of resources. When they decide to use an interorganizational strategy it is important to study the benefits and costs. To maximize an organization’s freedom of action managers should choose an informal linkage mechanism over a formal one, unless the uncertainty of the situation warrants it. When forming a strategic alliance with other organizations it is important that managers identify future problems and choose an informal rather than a formal alliance. Finally, managers should use transaction cost theory (see later) to identify the costs and benefits of various linkage mechanisms that help manage interdependencies.
Transaction cost theory
Transaction costs
are to costs of monitoring, negotiating, and governing exchanges between people. According to the transaction cost theory, companies try to minimize the costs associated with exchanging resources in the environment and the costs of managing exchanges inside the company. Organizations try to find mechanisms that make interorganizational transactions more efficient and they try to minimize transaction costs and bureaucratic costs so their productive capacity will not diminish.


There are three combinations of human and environmental factors that cause transaction costs: environmental uncertainty and bounded rationality, opportunism and small numbers, and risk and specific assets. There is a lot of uncertainty and complexity in the environment, but people only have a limited ability to process information. Because of this bounded rationality transactions between organizations become more difficult to manage as uncertainty in the environment increases. Organizations resort to more formal linkages to lower transaction costs when environmental uncertainty makes transaction costs very high. There are organizations that behave opportunistically, that means cheating and exploiting other forces or stakeholders in the environment. When organizations are dependent on one supplier or on a small number of trading partners, the possibility for opportunism is great. Suppliers know it when organizations are dependent on them and they can take advantage of that by supplying inferior inputs to reduce costs and increase profit. When the chance of opportunism is great and there are a small number of suppliers, organizations have to expend resources to negotiate and make agreements with its suppliers. Specific assets are investments (in machinery, skills, information, and knowledge) that create value in a particular exchange relationship, but have no value in others. When organizations invest money in developing specific assets for a particular relationship with another organization there is a high level of risk.
Transaction costs
Organizations choose interorganizational linkage mechanisms based on the level of transaction costs involved in exchange relationships. Transaction costs are low when organizations exchange nonspecific goods and services, uncertainty is low, and there are a lot of potential exchange partners. In this case, organizations use relatively informal linkage mechanisms. Transaction costs are high when organizations begin to exchange more specific goods and services, uncertainty increases, and the number of potential exchange partners drops. Organizations begin to feel that they cannot trust other organizations and feel inclined to use more formal linkages. Organizations have more control over each other’s behavior when they use a more formal linkage mechanism. A more formal linkage mechanism also minimizes transaction costs associated with reducing opportunism, risk, and uncertainty. Internal transaction costs are called bureaucratic costs. Companies can use a formal linkage mechanism to reduce transaction costs, but bringing the transactions inside a company minimizes them and does not eliminate them.


Choosing an interorganizational strategy
The transaction cost theory can help managers choose an interorganizational strategy. They weigh the savings in transaction costs achieved from using a linkage mechanism against the bureaucratic costs of operating the linkage mechanism. The transaction cost theory is better able to make predictions than the resource dependence theory about when and why an organization chooses an interorganizational strategy because it visualizes the costs of the different linkages. Managers should do several things to decide on a strategy: determining the sources if transaction costs that may affect an exchange relationship and deciding how high the costs are likely to be; estimating the transaction cost savings from using different linkage mechanisms; estimating the bureaucratic costs of the different linkages; and choosing the linkage mechanism that saves the most transaction costs at the lowest bureaucratic cost.


To minimize transaction costs and avoid bureaucratic costs organizations can use three linkage mechanisms: keiretsu, franchising, and outsourcing. Keiretsu achieves the benefit of a formal linkage without incurring the costs. Owning a minority stake in a supplier’s company gives substantial control over an exchange relationship and avoids the bureaucratic costs of owning and managing the supplier. A franchise is a business authorized to sell an organization’s products in a certain region. Franchisers sell the right to use their resources to a person or group in return for a share of the profit or a fixed fee. The relationship between franchiser and franchisee is symbiotic. Outsourcing means moving a value creation activity from the inside of a company to the outside, where it is done by another organization. When the extra value that an organization obtains from performing its own marketing or information processing exceeds the extra bureaucratic costs of managing such functions, they will develop their own function otherwise they outsource the activity. The method that a company adopts to control the outsourcing process will be the one that most effectively decreases the uncertainty involved in the exchange. This way it can improve quality, protect valuable proprietary technology, and ensure a stable supply of components.            






While organizations grow, managers have to decide how to manage and coordinate the activities that are required for an organization to create value. The main design challenge is managing differentiation in order to achieve organizational goals. Differentiation is the allocation of people and resources to organizational tasks and the establishment of task and authority relationships so an organization can accomplish its goals. It is the process of determining and controlling a division of labor, or the degree of specialization. If you chart the problems of an organization as it tries to achieve its goals, you can examine why differentiation occurs and why it poses a design challenge. Differentiation is low in simple organizations because the division of labor is low. When organizations grow, they become more complex and differentiation and the division of labor are high (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 115, figure 4.1).
Building blocks of differentiation

Organizational roles are the basic building blocks of differentiation (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 117, figure 4.2). Organizational roles are certain task-related behaviors demanded of a person by of his or her position in a company. When the division of labor increases as organizations grow, managers begin to specialize in certain roles and hire people to specialize in others. Specialization is one of an organization’s core competences because people develop their individual knowledge and abilities. The structure of an organization is based on a system of interlocking roles and some roles require people to oversee the behavior of others. When a person possesses such power he or she has the authority to hold people accountable for their actions and make decisions about the usage of resources. Differentiation results in clear authority and responsibility requirements for each role. Control (the ability to motivate and coordinate people to work in the organization’s interests) is achieved when people understand the responsibilities of their roles and what superiors can require of them.
People with related roles are usually grouped into subunits, the main subunits that develop in organizations are functions and divisions. A function or department is composed of people who work together, possess similar skills, and use the same kind of knowledge, techniques, or tools to perform their jobs. A division consists of functions that share responsibility for producing a good or a service. The degree of differentiation or complexity is determined by the number of different functions and divisions in an organization. Differentiation enhances an organization’s control over its activities and allows the organization to accomplish its tasks more effectively. Organizations differentiate into five different functions as they grow in size. Support functions (purchasing, sales and marketing, and public relations and legal affairs) help organizations control their relations with their environment and stakeholders. Production functions (production operations, production control, and quality control) control and better the efficiency of an organization’s conversion process in such a way that more value is created. Maintenance functions (personnel, engineering, and janitorial services) help keep an organization’s departments in operation. Adaptive functions (research and development, market research, and long-range planning) help an organization adjust to changes in its environment.


Managerial functions (acquisition of, investment in, and control of resources) support the coordination and control of activities within and between functions. Top management formulates the strategy and establishes policies to control the environment. Middle managers control organizational resources to achieve goals and lower-level managers oversee and manage the activities of the workforce.
Large organizations have self-contained divisions because each division has its own set of the five basic functions. The five organizational functions can give a company its competitive advantage.
Organizational chart
An organizational chart displays the end result of organizational differentiation (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 119, figure 4.3). Each box represents a role or function, and each role has a vertical and horizontal dimension. Vertical differentiation means designing a hierarchy of authority and creating reporting relationships to link organizational roles and subunits. Managers have to decide how many levels an organization should have. Vertical differentiation gives an organization more control over its activities and increases its ability to create value. Horizontal differentiation means grouping organizational tasks into roles and roles into subunits. It establishes a division of labor and helps people to become more specialized and productive and increases an organization’s ability to create value.



Design challenges
There are three more design challenges. The first one is the question of how to link and coordinate activities (balancing differentiation and integration). The second one is deciding who will make the decisions (balancing centralization and decentralization). The third and final one is choosing which mechanisms are best suited for controlling specific employee roles and tasks (balancing standardization and mutual adjustment). The choices managers make when they handle the four design challenges determine the effectiveness of the organization.

Everyone in an organization should draw an organizational chart to identify the distribution of authority and the division of labor. Managers should analyze everyone’s role and the relationship between the roles to make sure that the division of labor is best for performing the tasks. When you supervise more than one function, you should analyze the relationships between them in order to decide if the division of labor best suits the organization’s mission.
Design challenge: Differentiation and integration
Horizontal differentiation helps people specialize an become more productive but it restrains communication between subunits and it prevents them from learning from each other. As a result they develop a subunit orientation, which is a tendency to view your role in the organization strictly from the perspective of the goals, interpersonal orientations, and time frame of your subunit. Organizations try to find better and new ways of integrating functions to avoid communication problems. There can also be a lack of coordination and communication because managers do not choose the right mechanisms and techniques to integrate subunits. Integration is the coordination of functions, divisions, and tasks so they work together, not at cross purposes.


There are seven integrating mechanisms or techniques that managers use as the level of differentiation increases (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 122, table 4.1). They are discussed in order of increasing complexity. A hierarchy of authority differentiates people by the amount of authority they possess. It dictates who reports to whom and coordinates organizational roles. To promote coordination managers have to carefully divide and allocate authority within one function and between functions. There are more problems associated with effectively using direct contact than the hierarchy of authority. The problem is that a manager in one function has no authority over a manager in another function. To overcome the problems that arise because of different subunit orientations it is important to establish personal and professional relationships between employees at all levels in different functions. In case of a dispute there has to be a common superior to talk to who is not far removed from the scene of the problem. People who hold liaison roles coordinate with managers from other subunits on behalf of their own subunit and develop in-depth relationships (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 122, figure 4.5). When organizations increase in size and complexity task forces are created to get two subunits to work together. They are temporary committees that handle a specific problem.


One or a few members of each function join the task force to find a solution for the problem. They take the solutions back to their functions to get input and approval. Often someone who is not a member of the functions chairs the meetings, this increases effectiveness. Task forces become a team when they are dealing with an ongoing administrative or strategic issue that becomes permanent. Teams promote face-to-face contact and continual adjustment to deal effectively with complex issues. But sometimes teams become ineffective when team membership remains unchanged and organizational problems do change. If an organization grows and becomes more complex, communication barriers between functions increase. To overcome these barriers integrating roles are created, those are full-time managerial positions to improve communication between divisions (a liaison role is not full time, but just one of the many tasks of a manager). When an organization has a lot of employees in integrating roles, it creates a integrating department. Employees with integrating roles are often senior managers that focus on company-wide integration and chair important task forces and teams.

The design challenge for managers is to find the right balance between differentiation that builds the core competences that give an organization its competitive advantage and integration so subunits can work together in strengthening the core competences. Complex organizations that are highly differentiated need a high level of integration. Differentiation and integration are expensive if you look at the number of managers employed and the amount of time that is spent on coordinating activities.

Design challenge: centralization and decentralization
When a hierarchy exists, employees look to their superiors for direction and do not take any risks. If no one takes responsibility, decision making becomes slow and the organization becomes inflexible (unable to change and adapt). The design challenge here is how to delegate decision-making authority to each level in the organization. Authority is highly centralized when it is retained by managers at the top of the hierarchy. When the authority to make important decisions is delegated to managers at all levels in the hierarchy, authority is highly decentralized.


The advantage of centralization is that top managers are able to coordinate activities and keep the organization focused on its goals. It starts to be a problem when managers become overloaded in operational decision making about day-to-day resource issues instead of focusing on long-term strategic decision making. The advantage of decentralization is that it generates flexibility and responsiveness by permitting lower-level managers to make on-the-spot decisions. This way they stay accountable, but are able to take bigger risks and assume greater responsibility. They also get the chance to show their personal skills and competences. Too much decentralization is not good because when everybody makes their own decisions, planning and coordinating becomes very difficult. The ideal balance between centralization and decentralization of authority is achieved when middle and lower managers are allowed to make important decisions and top managers become responsible for long-term strategic decision making. When organizations change, decisions about how to distribute decision-making authority also change.
Design challenge: standardization and mutual adjustment
Important forms of behavior control are written rules, written standard operating procedures (SOPs), and unwritten values and norms. The problem is that employees follow these written and unwritten guidelines to strictly instead of adapting to the situation at hand. This can reduce innovation, creativity and imaginative responses. The design challenge is creating a structure that achieves the right balance between standardization and mutual adjustment. Standardization is the agreement on specific examples or models – defined by sets of rules and norms – that are regarded as appropriate in a given situation. It makes people’s actions routine and predictable. Mutual adjustment is when people use their judgments instead of  standardized rules to address problems, promote coordination, and guide decision making.


When the right balance is achieved, some actions are predictable so organizational goals are achieved and employees have the freedom to flexibly and creatively respond to new situations.

There is no room for mutual adjustment with formalization, that is, the use of written procedures and rules for the standardization of operations. When the level of formalization is high, authority is typically centralized. When the level of formalization is low, coordination is based on mutual adjustment, authority is decentralized, and decision making is a dynamic process where employees use their skills and abilities to solve problems.
Rules are formal written statements that spell out the appropriate means for reaching desired goals. Norms are standards of behavior that are regarded as typical for a group of people. Groups of employees can develop norms that reduce organizational effectiveness. When employees have established a group norm, they enforce it by physically and emotionally punishing violators. This can occur at any level in the organization. Organizational effectiveness is also influenced by the taken-for-granted way in which norms affect behavior. External rules become internalized norms when they are internalized and become part of people’s psychological makeup. It is very difficult for people to follow a new rule and break a familiar rule. As a consequence, they will slip back into their old behavior. Socialization is the process whereby employees learn an organization’s norms an internalize the unwritten rules of conduct. Organizations are able to encourage standardized and innovative responses

Managers have to keep in mind that people at higher levels rely more on mutual adjustment because they perform complex and uncertain tasks. Integrating mechanisms such as task forces and teams increase mutual adjustment by providing an opportunity to meet and work on improving ways of doing things. Managers can promote norms and values emphasizing change rather than stability. The right balance is achieved when organizations are effective and employees behave creatively and responsibly.
When managers are dealing with these design challenges it is important that they map the principal integrating mechanisms in use and change them if necessary. They should also check if the distribution of authority best suits the needs of their organization and change it if it does not. Another task of managers is to list all the rules and SOPs and determining their appropriateness to improve the effectiveness of the organization. They have to be aware of informal values and norms that influence the way employees work when they are doing this.
Mechanistic structure
Mechanistic structures
are designed to move people to behave in a predictable fashion. Individual specialization (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 132, figure 4.7A) is characteristic for mechanistic structures, that means that people work separately and are specialized in one clearly defined task. Simple integrating mechanisms are used, the hierarchy of authority is clearly defined and is also the major integrating mechanism. The authority to control tasks is centralized at the top and most communication is vertical. There is a lot of standardization because there are many rules and SOPs to coordinate tasks and the work process is predictable. Mechanistic structures are best suited for organizations that face a stable environment.


Organic structure
Organic structures promote flexibility, so people can initiate change and adapt quickly to changing situations. In organizations with an organic structure people are jointly specialized (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 132, figure 4.7B), they work together and coordinate their actions to find the best way of performing tasks. Complex integrating mechanisms are used, for example task forces and teams. Authority is decentralized to people at all levels.

Most communication is lateral and the organization uses mutual adjustment. The work process is relatively unpredictable and there is often face-to-face contact to coordinate tasks. Status is gained by creative leadership abilities and not by formal positions.


Contingency approach
The environment, the technology, the nature of the tasks, and the type of employees determine if an organization designs a organic or mechanistic structure. The contingency approach adjusts an organization’s structure to the sources of uncertainty facing an organization. One of the most important contingencies a structure has to respond to is the nature of the environment. According to the contingency theory, an organization must design its internal structure to control the external environment. A close fit between environment and structure leads to success. Support for the contingency theory comes from two studies of Lawrence and Lorsch and Burns and Stalker.

Lawrence and Lorsch
A functional structure emerges, in part, to deal with the complexity of the forces in the general and specific environment. The number and size of an organization’s environment determine the extent of differentiation (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 135, figure 4.9). Lawrence and Lorsch investigated how company’s in three different industries with different levels of uncertainty differentiate and integrate their structures to fit the characteristics of the industry environment in which they compete. The uncertainty was measured by the dynamism of the environment. The plastics industry experienced the greatest level of uncertainty, the container or can-manufacturing industry experienced the least amount of uncertainty, and the food-processing industry sits in the middle. They measured the degree of differentiation in the R&D, production, and sales departments. They paid attention to the different internal structures or roles and procedures of departments and differences in subunit orientations. They also looked at differences in departmental attitudes toward organizational goals and differences in the integration of functional activities. When the three departments perceived the environment as very complex and unstable, the attitudes and orientations diverged enormously and as a result differentiation between them was greater than in case of a stable environment. In unstable environments, organizations are more effective when they are less formalized, more reliant on mutual adjustment, and more decentralized. The reverse is true in a stable environment. The level of integration matched the level of differentiation in organizations (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 136, table 4.2).
Burns and Stalker
Burns and Stalker found that organizations with organic structures (complex structure, high differentiation, high integration, decentralized decision making, and mutual adjustment) were more effective in unstable and changing environments and mechanistic structures (simple structure, low differentiation, low integration, centralized decision making, and standardization) were more effective in stable environments. The conclusion was that companies should design their structures to match the uncertainty and dynamism of their environment. Mechanistic and organic structures do not exist in a pure form in real-life, the most successful organizations achieve a balance between the two. They can tend more in one direction than the other, but they should be able to behave effectively in both ways. They can design some functions in a mechanistic way and others in an organic way.  






Vertical differentiation
The shape of an organization’s hierarchy and the balance between centralized and decentralized decision making determines the effectiveness of organizational decision-making and communication systems and establish the level of vertical differentiation.

When managers have difficulty coordinating and motivating employees effectively, an organizational hierarchy begins to emerge. As organizations grow, employees increase in number and begin to specialize, the level of differentiation also increases so coordination of employees’ activities become more difficult. The division of labor and specialization produce motivational problems because it is often difficult to evaluate individual performances. Organizations do two things to coordinate and motivate its employees: increase the number of managers to evaluate, monitor, and reward employees and increase the number of levels in the managerial hierarchy. Direct supervision allows managers to influence the behavior of subordinates to pursue company goals. Personal control creates opportunities for on-the-job task learning, performing more effectively, and development of competencies. Managers lead by example, so subordinates can develop their personal management skills. Organizational performance and bonds between people are determined by personal authority relationships.

Organizational size
A tall organization has many levels in the hierarchy relative to the size of the organization. A flat organization has few levels in its hierarchy. An organization with a thousand employees has four levels, one with three thousand has seven, and one with ten thousand or more has nine or ten levels (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 144, figure 5.2). Most organizations have a pyramid-like structure with fewer managers at each level, rather than a bloated structure with more managers at each level (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 145, figure 5.3). Research pointed out that the increase in size of the managerial component is less than proportional to the increase in size of the organization (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 144, figure 5.4). Organizations actively restrain the increase in the number of managers and hierarchical levels as they grow and differentiate, because significant problems arise when a hierarchy becomes taller and taller.


Tall hierarchies

The number of managers and hierarchical levels have an impact on organizational effectiveness, so it is important to make the right choices. Those choices have an effect on communication, motivation, and bottom-line profitability. Too many hierarchical levels hinder communication. When the chain of command becomes longer, communication between managers at the top and bottom of the hierarchy takes longer. Organizational performance declines when decision making slows down. Information can also be distorted as it flows up and down the hierarchy. Managers can manipulate information to serve their own interests. When there are more than seven or eight levels, communication problems arise. As the number of levels in the hierarchy increases, the relative difference in the authority and responsibility possessed by managers at each level decreases, this can lead to motivational problems.


When there are many hierarchical levels, it is easy for managers to evade responsibility by shifting it to the managers above them. This slows down decision making and worsens communication. The more managers and hierarchical levels organizations use, the higher the bureaucratic costs (the costs of operating an organization). Because tall and bloated hierarchies are so costly, organizations often, especially during a recession, reduce the number of hierarchical levels and fire excess employees in order to reduce bureaucratic costs. When unexpected situations in the environment occur, layoffs can be unavoidable. Often dramatic changes in employment and structure are the result of bad management. When organizations do well, managers often do not recognize the need to control the hierarchy as the organization confronts new situations, or they do see it but prefer to do little or nothing. Restructuring or downsizing is the process by which managers streamline hierarchies and fir employees to reduce bureaucratic costs.
Parkinson’s law problem
Parkinson discovered that in the British Navy from 1914 to 1928 the number of ships decreased by 68%, the number of dockyard officials increased by 40%, and the number of top brass in London increased by 79%. He claimed that growth in the number of managers and hierarchical levels is controlled by two principals: (1) “An official wants to multiply subordinates, not rivals,” and (2) “Officials make work for one another.” Managers increased their ‘empire’ and status by hiring more subordinates, and as a result the hierarchy became taller and taller. More managers lead to more work. Parkinson’s principles apply to all hierarchies if they are not controlled. Parkinson’s law is: ‘Work expands so as to fill the time available.’                
Minimum chain of command
When managers want to hire a new manager, they have to look at the difference between the value added by the last manager employed and the cost of the last manager employed. There are employees that spend the organization’s money to improve their own position, but well-organized organization can control this by simple rules. An organization should choose the minimum number of hierarchical levels consistent with organizational goals and the organizational environment, according to the principle of minimum chain of command. Organizations should be kept as flat as possible, and top managers have to be evaluated for their ability to control their activities with the fewest managers possible. Organizations with flat structures have lesser communication, cost, and motivation problems than organizations with tall structures. Organizations should only choose a tall structure when they need a high level of direct control over subordinates (for example, nuclear power plants). Organizational problems produced by Parkinson’s law will be discovered by a new management team, and excess managers will be fired.
Span of control
Growing organizations have to control and monitor the actions of newly hired employees. They can do this by increasing their managers’ span of control, that is, the number of subordinates each manager directly manages. Each manager coordinates the work of more subordinates, and the organization replaces an increase in the span of control for an increase in hierarchical levels. The most important factor limiting the managerial span of control is the inability to exercise adequate supervision over subordinates when they grow in number.



An arithmetic increase in the number of subordinates is accompanied by an exponential increase in the number of subordinate relationships a manager has to control (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 150, figure 5.6). There is a limit to how wide managers’ span of control should be, because if their span of control is to wide, they lose control over subordinates and cannot hold them accountable for their actions. A manager’s ability to control subordinates’ behavior is limited by the complexity and the interrelatedness of subordinates’ tasks. When subordinates’ tasks are complex, dissimilar, and closely interrelated (the actions of one person have a direct effect on another person’s actions) a manager’s span of control should be small. When they are routine, similar, and not closely interrelated a manager’s span of control should be wide. An organization is pictured as a pyramid because tasks at higher levels in the hierarchy are more complex and interrelated, so the span of control narrows. Design choices regarding the number of hierarchical levels and the span of control determine the shape of the organizational hierarchy.


Factors affecting the shape of the hierarchy
The level of vertical differentiation in an organization is affected by four factors. The first is the strength of the informal ties and relationships that exist between organized members. The second is the level of horizontal differentiation. Horizontal differentiation leads to the emergence of specialized subunits. Each function or division has its own hierarchy. Horizontal differentiation helps an organization retain its control over employees when it cannot increase the number of hierarchical levels without encountering problems. Each function follows the principle of minimum chain of command and each function chooses the lowest number of hierarchical levels it can operate with effectively. The manufacturing function has many levels because managers tightly control subordinates and rein in production costs (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 152, figure 5.8). The sales department has fewer levels because there is a high level of standardization. The R&D function also has few levels because R&D tasks are complex and even if managers continually monitor researchers they cannot evaluate how they are performing because it takes years before results become visible. Control is generally achieved by small teams, as a result, there is another level of horizontal differentiation within a function (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 153, figure 5.9). Increasing horizontal differentiation thus increases vertical differentiation because many subunit hierarchies develop, it also helps avoid the problems that organizations with tall hierarchies face. Managers can control the problems of horizontal differentiation (development of divergent subunit orientations) by making smart decisions regarding centralization, standardization, and the influence of the informal organization. The third factor affecting the level of vertical differentiation is the level of decentralization. When hierarchies become taller, communication and coordination problems grow. Managers spend less and less time planning and goal setting, which leads to a decline in organizational effectiveness. To solve this problem they can decentralize authority so less managerial supervision is required. Decentralization does not mean that large and complex organizations do not need many hierarchical levels, but it can help tall structures to be more flexible in responses to changes in the external environment, and reduce the amount of direct supervision needed within a subunit. The fourth factor is the level of standardization.


Standardization reduces the need for direct supervision and extra levels in the hierarchy, also the manager’s span of control can be increased. It allows upper-level managers to delegate responsibility.



Managers have to control the hierarchy and match it to the current needs of the organization. They should also consider when the hierarchy has grown too tall or too centralized and adjust it if necessary. It is important that they increase control over people and resources if they have not got enough control over them. Periodical meetings in teams are best suited to design and redesign the hierarchy so an organization can create the most value at the lowest cost.

Max Weber developed six principles that help an organization design a hierarchy that effectively allocates decision-making authority and control over resources. He wanted to create a system that improved organizational effectiveness. A bureaucracy is a special form of an organizational structure. It holds people accountable for their actions because they have to follow well-specified and agreed-upon rules and SOPs. His first principle is that a bureaucracy is founded on the concept of rational-legal authority. Rational-legal authority is the authority people in an organization possess because of their position. Their attitudes and beliefs play no part. Choices have to be based on the needs of the task, and not on the needs of the person. Bureaucracies are effective when people understand that they are appointed to positions, they do not own them. The second principle is that organizational roles are held on the basis of technical competence, not because of heredity, kinship, or social status. Today, there are organizations that let ‘old-boy networks’ (personal contacts and relations) influence their decisions about who to hire, this can be harmful to an organization.


These first two principles establish the organizational role as the basic component of a bureaucratic structure. The next three principles specify how the process of differentiation have to be controlled. The third principle is that a role’s responsibility and decision-making authority and its relationship to other roles should be clearly specified. The foundation of organizational effectiveness is a clear and consistent pattern of vertical and horizontal differentiation. When roles are explicitly specified, many problems can be avoided when people interact and its easier for employees to take responsibility. Role conflict and role ambiguity can be cut down if horizontal and vertical differentiation are clear. Role conflict means that people make conflicting demands on a person because they have different views of what a that person should do. Role ambiguity occurs when people are afraid to take responsibility because their tasks or authority are not clearly defined. The fourth principle is that the organization of roles in a bureaucracy determines that each lower office in the hierarchy is under the control of a higher office. Authority should be delegated so people in certain roles can make decisions and use organizational resources. They can be held accountable for their actions and they can go to a person at a higher level if conflicts arise. The fifth principle is that rules, SOPs, and norms should be used to control the behavior and the relationship among roles in organizations. They increase the efficiency in organizations. Over time, guidelines should change because the goal is constant progress. People’s expectations about one another should be clarified so no misunderstanding about responsibility and use of power occur. Norms and rules enhance integration and coordination of organizational roles between different functions.


The sixth and last principle is that administrative acts, decisions, and rules should be formulated and put in writing so they become official. Written records ensure that people are held accountable for their decisions and that organizational history cannot be altered. 
Advantages of bureaucracy
Practically every organization has features of a bureaucracy. A bureaucracy has many advantages. It lays out the ground rules for designing an organizational hierarchy that efficiently controls interactions, individuals can be held accountable, transaction costs are reduced, the costs associated with monitoring the work of subordinates and the enforcement and evaluation of employees performance are reduced, and it separates the position form the person. The fairness of bureaucratic evaluation, selection, and reward systems motivate organizational members promote organizational stakeholders’ interests and meet organizational expectations. Bureaucracy increases core competences, improves the ability to compete in the marketplace, and fosters differentiation. It enables employees to take a long-run view of the organization and its relationship to its environment. There are also disadvantages to bureaucracies. Over time managers fail to properly control the development of the organizational hierarchy, this leads to tall, centralized organizations where decision making slows down and bureaucratic costs increase. Another disadvantage is that people rely too much on rules and SOPs, this leads to unresponsiveness to the needs of stakeholders.


Management by objectives
Management by objectives (MBO) is a system that helps managers evaluate their subordinates on their ability to achieve certain goals or performance standards and to meet operating budgets. MBO involves three steps. The first step is establishing specific goals and objectives at each level. The second step is that managers and their subordinates together determine subordinates’ goals to strengthen their commitment in achieving their goals and meeting their budgets. They can also tell managers what they can realistically achieve. The third step is that managers and their subordinates periodically meet to review the subordinates’ progress toward meeting their goals. MBO works differently when an organization has decentralized responsibility for production of goods and services to teams (especially cross-functional teams). Each team is asked to develop a set of goals and performance targets, managers then negotiate with them to establish final goals and the budget. The reward system is linked to team performance, not individual performance.

Managers and employees most follow bureaucratic principles. They should realize that they do not own their positions and that they have to use their authority and control over resources to benefit stakeholders. Managers should treat employees as fair and equitable as possible and not let personal ties or relationships influence their decisions. When employees feel that certain decision are inappropriate they have to complain to managers. Meetings must be periodically arranged to make reporting relationships clear and ensure that the rules that members are using meet the current needs. Managers and employees should question the way the organization works to uncover the taken-for-granted assumptions and beliefs on which it operates.



Informal organization
Decision making and coordination often takes place outside of the formally designed channels. A lot of the rules and norms that employees use to perform their tasks come from informal interactions. It is important that managers consider the effects of the informal organization on individual and group behavior when they make changes. When the formal structure is altered, the informal norms that make the organization work are disrupted. The informal organization is able to enhance organizational performance. Managers have to use the informal and formal structure to let people develop solutions to their problems.


Self-management teams
As a result of advances in IT, there is an increase in empowered workers, self-managed teams, cross-functional teams, and temporary workers. IT makes it much easier for managers to design a cost-effective structure and control system. The use of IT has led to the decentralization of organizations and the increasing use of teams. Empowerment is when employees are given the authority to make important decisions and have responsibility for the outcomes. Self-managed teams are formal work groups of people that jointly ensure that the team accomplishes its goals and who are empowered to lead themselves. Cross-functional teams are formal work groups of employees from different functions that are empowered to coordinate the value-creation activities required to finish different projects. The challenge for managers is to combine the best aspects of a bureaucratic structure and empowered work groups. Managers must find the right blend of mechanistic and organic structures to meet the contingencies they face. Bureaucratic principles should be used to build a mechanistic structure and empowerment and teams should be used to integrate and enhance an organization’s ability to act in an organic way. Companies increasingly employed contingent workers as their organizations flattened. Contingent workers are employed for temporary periods and receive no indirect benefits such as pensions and health insurance. The advantage for an organization is that they cost less to employ and can be let go easily. One disadvantage is the coordination and motivation problems because there is no prospect for promotion or job security. Another disadvantage is that contingent workers do not develop core competences because they do not remain with the organization for long and are not committed to it. However, the use of contingent workers is increasing.





Functional structure
The assignment of people to certain roles is the beginning of horizontal differentiation and specialization. The result of this process is a functional structure, where people are grouped into separate functions because they share the same expertise and skills or because they use the same resources (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 171, figure 6.1). Organizations group tasks into functions to increase the effectiveness with which it achieves its goal of providing high-quality products at competitive prices. When functions specialize, core competences that give organizations their competitive advantage emerge because skills and abilities improve. Organizations deal with increasingly complex task requirements, as a result different functions emerge. If an organization grows in size and complexity it develop functions internally because it is more efficient than hiring outside contractors.

Functional structures have several advantages. People can learn from one another and become more specialized and productive. An organization increases its store of skills and abilities by giving the most skilled employees the responsibility to train new recruits and promote those people to become managers and supervisors. To help control organizational activities, a hierarchy within each function develops. People grouped together in a function can control each other behavior and keep work activities on track. Peer supervision is vital when tasks are complex and rely on cooperation because supervision from above is difficult. Norms and values develop that allow employees to become more effective and committed to organizational activities. This can become a core competence of an organization.


There can be control problems in a functional structure. Successful organizations face the problem of how to keep control of increasingly complex activities as they grow. When they produce more products and become more geographically diverse, or face increasing competition, control problems make it difficult for managers to coordinate organizational activities. As different subunit orientations develop, communication problems arise. Communication problems reduce the level of coordination and mutual adjustment and make it more difficult for organizations to respond to market demands. Companies try to solve communication problems because of differentiation by using complex integrating mechanisms. Another control problem is measurement problems. Measurement is a way to control activities, it is used as a benchmark to determine how task performance changes over time. As organizations become more complex, it becomes more difficult to determine the contribution of a function to the overall profitability. The reason for this is that the cost of each function’s contribution to the development of each product becomes hard to measure. Location problems arise when companies grow and need to establish manufacturing or sales facilities in different geographic regions to serve customers better. Organizations with more locations have to develop an information system that balances the need to centralize decision-making authority with the need to decentralize authority to regional operations. Customer problems come into play as the range and quality of an organization’s products increase because more customers with different needs are attracted to the organization. It is difficult to fulfill all those needs in a functional structure. Top managers of organizations that become more complex spend too much time finding solutions to everyday coordination problems instead of focusing on longer-term strategic problems.


Sometimes these control problems can be solved by redesigning the functional structure to increase integration between functions (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 173, figure 6.2).


It is important that managers create a correct division of labor within a function and between functions. They can do this by listing the various functions and itemizing the tasks they perform. Then a diagram of task relationships within and between functions should be drawn to evaluate if an organization obtains the advantages of the functional structure or experiences the disadvantages of the functional structure. To increase effectiveness managers can experiment with different ways of changing the design of the functional structure.

Divisional structure
Many of the control problems can be solved with a functional structure when an organization produces a small number of similar products, produces those products in one or a few locations, and sells them to only one major type of customer. When organizations increase their production of goods or services, they usually do so at an increasing number of locations and for many different types of customers. Therefore, they need a structure that will increase managers’ control of their subunits so that subunits can better meet product and customer needs. The structure should also allow mangers to control and integrate the operation of the entire company to ensure the subunits meet their goals. Managers can regain control if they use a more complex structure, which is the result of three design choices. The first is an increase in vertical differentiation. This means increasing the number of hierarchical levels, deciding how much decision-making authority to centralize at the top of the organization, and determining how much to use rules, SOPs, and norms to standardize behavior. The second is an increase in horizontal differentiation. This involves overlaying a functional grouping of activities with another kind of subunit grouping. Usually this means self-contained product teams or product divisions that contain the functional resources to meet their goals. The third is an increase in integration. The higher the level of differentiation, the more complex the integrating mechanisms needed (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 174, figure 6.3).


A divisional structure groups functions according to the specific demands of products, markets or customers. The change to a divisional structure is to create smaller, more controllable subunits within an organization. If an organization has a control problem due to the number and complexity of products, it divides its activities by product and thus uses a product structure. An organization uses a geographic structure when it has control problems due to the number of locations in which it sells and produces its products, it then divides its activities by region. When organizations experience control problems because they need to service a large number of different customer groups, they divide their activities by customer group and use a market structure.


Product structures
A product structure is a divisional structure in which products are grouped into separate divisions, based on their similarities or differences, to increase control. An organization can centralize support functions at the top of the organization so one set of support functions services the different product divisions, or it can create multiple sets of support functions, one for each product division.


Organizations that produce similar products for the same market will centralize support services and use a product division structure. Organizations that produce dissimilar products for several different markets or industries will choose a multidivisional structure. An organization that produces products that are very complex technologically or whose characteristics change fast to suit changing customer needs will choose a product team structure.


In a product division structure the manufacturing function is split into several different product divisions that have a centralized set of support functions that services the needs of all the divisions (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 176, figure 6.4). It would be too expensive to create separate support functions for all the different product divisions.


The cost could only be justified if the needs of the divisions were very diverse. Each support function is divided into product-oriented teams of functional specialists who are specialized in the needs of one product division. They can share knowledge and information because all of the R&D teams belong to the same centralized function, this increases the ability to create value (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 177, figure 6.5).


Organizations need a multidivisional structure when they have to manage complex and diverse value-creation activities. A multidivisional structure is a structure in which each product division has its own set of support functions so they become self-contained divisions (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 178, figure 6.6). A multidivisional structure has two innovations that overcome the control problems in a product division structure. It has self-contained divisions, that means that each division has its own set of support functions and controls its own value-creation activities. As a result, horizontal differentiation increases. The second innovation is that a multidivisional structure has a new level of management, a corporate headquarters staff, composed of corporate managers who are responsible for overseeing the activities of divisional managers. They perform an integrating role. As a result of the extra level in the hierarchy, vertical differentiation has increased. The divisional managers link corporate headquarters and the divisions. Because a multidivisional structure provides additional differentiation and integration it is able to control the complex activities. Each division in a multidivisional structure is essentially a different business. Each divisional manager has the responsibility to design the divisional structure that best meets the needs of the products and customers of that division. This means that independent divisions in a multidivisional structure can use a product division structure or any other structure (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 179, figure 6.7). The management hierarchy has three levels: corporate managers oversee the operations of all the divisions, divisional managers run individual divisions, and functional managers develop an organization’s core competences. A multidivisional structure has several advantages. There is a clear division of labor between corporate and divisional managers, which increases organizational effectiveness. The increased control provided by the corporate headquarters staff encourages the stronger pursuit of internal organizational efficiency by divisional managers. Corporate managers develop control systems to compare the performances of the divisions and are in a good position to intervene and correct inefficiencies when they occur.


The individual profitability of each division can be clearly identified, so corporate headquarters will know in which divisions to invest capital to get the best profitable growth. Corporate executives can oversee more different businesses and activities because of their role as monitor. Another advantage is the internal labor market, the most able divisional managers are promoted to become corporate managers. A multidivisional structure also has disadvantages. The central management problem is how to manage the corporate-divisional relationship. Managers have to find the right balance between decentralization and centralization of authority. There can also be coordination problems between divisions. Divisions may begin to compete for resources, and rivalry between them prevents them from cooperating, as a result, organizational performance decreases. Problems between divisions often revolve around the transfer price, that is, the price at which one division sells a product or information about an innovation to another division. It is important that managers establish the right integrating mechanisms to promote coordination because if a division tries to get the highest transfer price another division will be penalized, even though they belong to the same organization. Due to the extensive duplication of activities in the organization and the costs of corporate headquarters managers, the bureaucratic costs are high. Because multidivisional structures have tall hierarchies communication problems arise. The gap between the corporate center and the divisions is very large.



A product team structure is a mix of a product division structure and a multidivisional structure. In a product team structure, specialists from support functions are grouped together into product development teams that specialize in the needs of a particular product (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 183, figure 6.8). Each team is a self-contained division headed by a product team manager, this increases integration because each team becomes responsible for all the aspects of its operations. The vice presidents of the functions retain overall functional control, but decision-making authority for each product is decentralized to each team. There is close collaboration and teams are able to quickly respond to the fast-changing customer requirements.


Geographic structure
In a geographic divisional structure divisions are organized according to the requirements of the different locations in which an organization operates. Organizations develop a national customer base as they grow. The structure has to be adjusted to align the core competencies with the needs of the customers in different geographic regions. A geographic structure allows some functions to be centralized at one headquarters location and others to be decentralized to a regional level (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 186, figure 6.9). 


Market structure
A market structure aligns functional skills with the product needs of different customer groups. Marketing (not manufacturing) determines how organizational activities are grouped into divisions. Each division has to develop products that suit the needs of their specific customer group and therefore make use of centralized support functions. The organization can quickly sense changes in the market because the market structure focuses the activities of the whole organization on the needs of the customer (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 187, figure 6.11).

It is important that managers are sensitive to the need to change a functional structure to improve the control of organizational activities. They will have to weigh the benefits that will arise from a new structure against the costs that will arise from moving to a new structure.


Matrix structure

Some companies adopt a matrix structure when they seek faster and better ways to develop products and respond to customer needs. A matrix structure is an organizational design that groups people by function and by product (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 190, figure 6.12). It is a rectangular grid that shows a horizontal flow of product responsibility and a vertical flow of functional responsibility. The organization is very flat and functional employees report to the heads of their functions but do not work under their direct supervision. The work of functional personnel is mostly determined by their membership in a cross-functional product team led by a product manager. The members of the team are called two-boss employees because they report to the product team manager and the functional manager, this is the defining feature of a matrix structure. The team is the basic building block of the matrix and provides coordination and integration. Role and authority relationships are left vague because when team members are given more responsibility than they have formal authority, they are forced to cooperate. The matrix structure and product team structure differ in two ways. Team members in a product team structure have one boss and team members in a matrix structure have two bosses. Also, in a matrix structure team membership is not fixed, they move from team to team where their skills are needed.


A matrix structure has four major advantages. Firstly, the use of cross-functional teams reduce functional barriers, overcome the problem of subunit orientation, facilitate integration, and make the organization flexible so it can quickly respond to changing product and customer needs.


Secondly, communication between functional specialists is opened up so team members from different functions can learn from each other. Thirdly, specialized employees move from product to product as needed so the organization can effectively use their skills. Finally, a matrix structure promotes concern for both cost and quality because functional specialists focus on getting the highest quality and product managers focus on the cost and speed of development.


A matrix structure also has several disadvantages. It lacks the advantages of a bureaucratic structure. Because of the flat hierarchy and few rules and SOPs there is no control structure that allows employees to develop stable expectations of each other, this can lead to role ambiguity and role conflict. There can also arise conflict between functions and product teams over the use of resources because there is no clearly defined hierarchy. Matrix structures have to be carefully managed to retain their flexibility. Employees in a matrix structure can experience a vacuum of authority and responsibility, as a result they create an informal organization to give them structure and stability. The structure can become less flexible when top managers do not get the results they want and increase their control over the matrix and increase their power over decision making.


Growing companies often overlay a functional structure or a product division structure with products teams because of the many problems associated with a managing a matrix structure. IT helps this process by providing extra integration to coordinate complex value-creation activities.



Multidivisional matrix structure

When corporate center becomes very remote from divisional activities it is unable to play an integrating role. When this happens, organizations sometimes use a matrix structure at the top of the organization and create a multidivisional matrix structure to provide more integration between corporate and divisional managers and between divisional managers. Senior vice presidents at the corporate center send corporate-level specialists to each division to perform an in-depth evaluation of their performance and develop a functional action plan for each division. Divisional managers exchange knowledge and information with corporate managers and coordinate divisional activities with them.

Hybrid structure
Large complex organizations use a hybrid structure when they have many divisions that simultaneously make use of many different structures. When companies operate in one industry but choose to compete in different market segments of the industry, they can use a hybrid structure. The organizational structure can be compared to an onion. The outer layer is the overarching organizational framework (often some form of  product or market division structure) and the inner layer is the structure that each division selects (for example, a geographic or product team structure). It is easy for managers to change the structure when the need arises because the organization is broken into smaller units.


Network structure
A network structure is a cluster of different organizations that coordinate their actions by contracts and agreements, instead of by a formal hierarchy of authority. Often one organization takes the lead in creating the network as it searches for a way to increase effectiveness, for example by outsourcing activities. Network structures can become very complex when organizations form agreements with suppliers, manufacturers, and distributors to outsource many value-creation activities to produce and market goods and services. Network structures have several advantages. Firstly, production costs can be reduced if an organization can find a network partner that performs a functional activity reliably, and at a lower cost. Secondly, an organization avoids the high bureaucratic costs of operating a complex structure when it contracts with other organizations. Thirdly, network structures allow companies to act in an organic way. Fourthly, network partners can be replaced if they fail to perform up to standards. Finally, organizations gain access to low-cost overseas sources of inputs and functional expertise.


There are also disadvantages. Managers lack the means to coordinate and motivate network partners effectively, thus it is unlikely that a network structure would provide an organization the ability to control a complex value-creation process. It is difficult to obtain the ongoing learning that builds core competences because separate companies have less incentive to make such an investment. This can lead to a loss of opportunities to cut costs and increase quality. When suppliers fail to perform well, it is difficult to find reliable new suppliers that can do the job and can be trusted not to take vital information and use it themselves or give it to competitors. The more complex the value-creation activities, the more problems associate with using a network structure.



Boundaryless organization

The boundaryless organization exists of people that are connected by computers, CAD (computer-aided design) systems, faxes, and videoconferencing, and they rarely meet each other face to face. Independent functional experts come and go as they are needed, but they are not formal members of the company. Outsourcing and the development of a network organization provide opportunities for reducing costs and increasing flexibility. Designing an organizational structure becomes increasingly complex.

E-commerce is trade that takes place between companies and between individual customers and companies, using the Internet and IT. Business-to-business (B2B) commerce is trade that takes place between companies and allows them to reduce operating costs and improve product quality. A main B2B network application is the  B2B marketplace, an industry-specific trading network that connects buyers and seller using the Internet. Business-to-customer (B2C) commerce is trade between a company and its network of individual customers, using the Internet and IT. Using IT to connect to customers gives organizations increased control over their network. Companies are able to provide customers with a much wider range of products and give them more information about the products in a cost-effective way by using online storefronts.         





Organizational culture
In an organization there are certain shared values and norms that control the way people interact with one another and with customers, suppliers, and other people outside the organization, this is called the organizational culture. Organizational culture controls the way members manage the environment, make decisions, what they do with information, and how they behave, as a result, culture can be used to increase organizational effectiveness. Values are general standards, criteria, or guiding principles that people use to decide what kinds of events, behavior, outcomes, and situations are desirable or undesirable. There are terminal and instrumental values. Terminal values are desired end states that people seek to achieve (for example, innovativeness). Instrumental values are desired modes of behavior (for example, working hard). Ideally, instrumental values help organizations accomplish its terminal goals. Because organizations possess different sets of terminal and instrumental values, they have different cultures. When you study an organization’s mission statement and official goals, you are able to find its terminal values. Organizations develop specific norms, rules, and SOPs, so that members understand the instrumental values. Norms are styles of behavior that are acceptable or typical for a group of people. The most crucial values of an organization are not written down, but only exist in shared beliefs, norms, and assumptions. With the passing of time employees internalize organizational values, rules, norms, and SOPs in a way that they become part of their mindsets. Cultural values help people in an organization deal with ambiguity and uncertainty inside and outside the organization. When organizations want their members to act reliably, it does not necessarily mean that they ask for obedient and passive behavior. It can also mean that they want innovative and creative behavior, or consistently cautious, attentive, and speedy behavior. On the other hand, it can also mean totally unethical behavior.
The norms and values of different countries also influence organizational culture. Cultural differences like different decision-making styles, diverse communication styles, different attitudes toward conflict, and different approaches to completing a task are factors that make coordination in outsourcing relationships that require contact between people from different countries more difficult. There are also differences between companies in the same country. Many mergers between organizations have failed because of the big differences in organizational cultures, as a result, companies acquire smaller companies as they grow. There are organizations that recognize beforehand that their cultures are to different and that a merger would be impossible. A culture can, in many ways, facilitate the intense kind of personal and team interactions that are vital for an organization’s development of core competences to obtain a competitive advantage. First, cultural values can facilitate mutual adjustment in an organization because values provide a common reference point so employees do not need to spend much time overcoming differences. Second, organizational culture is an important determinant of the way employees view their tasks and roles because it is a form of an informal organization that facilitates the workings of the organizational structure. The most common complaint is that organizational members know how certain tasks or roles could be accomplished better and should be performed in different ways, but their organizational norms and values do not permit them to advise their superiors.


As a result, some organizations have opened up lines of communication to the CEO and developed values of equity and fairness to show their commitment to reward employees who work toward organizational goals.
Socialization tactics
The ability of an organization’s culture to motivate employees and increase organizational effectiveness has an influence on the way employees learn the organizational values. Newcomers have to learn norms and values that guide existing employees’ behavior and decision making. They can learn it indirectly by observing the behavior of employees.



This is a risky method because they might observe and learn habits that are not acceptable to the organization. The most effective way is to learn it through socialization, or the process by which employees learn and internalize the organizational norms. Van Mannen and Schein developed a model of socialization that organizations can use to structure the socialization experience so newcomers learn the right values. These values affect the role orientation that newcomers adopt, that is, the characteristic way they respond to a situation. Van Mannen and Schein’s model identify twelve socialization tactics that affect a newcomer’s role orientation. The use of different sets of tactics lead to two different role orientations: institutionalized and individualized. The institutionalized role orientation means that individuals are taught to respond to a new context in the exact same way that existing employees do. The individualized role orientation means that  individuals are encouraged to be creative and to experiment with changing norms and values so an organization can better accomplish its values. The following list contrasts the tactics used to socialize newcomers to an institutional orientation with those tactics used to create an individualized orientation:

  • Collective vs. individual – Collective tactics learn newcomers to have a standardized response to a situation. Individual tactics learn that newcomers must have a new, appropriate response to each situation.
  • Formal vs. informal – Formal tactics separate newcomers from existing employees during the learning process. With informal tactics, newcomers learn on the job, as part of the team.’
  • Sequential vs. random – Sequential tactics provide exact information about the sequence in which newcomers will perform activities or occupy new roles as they advance in the company. With random tactics, individual newcomers’ training is based on their interests and needs, there is no sequence to their progress in the organization.
  • Fixed vs. variable – Fixed tactics give precise knowledge of the timetable associated with finishing each stage in the learning process. Variable tactics give no information about when newcomers reach a certain stage in the learning process, their training depends on their need and interests.
  • Serial vs. disjunctive – With serial tactics, existing employees act as role models and mentors for newcomers. With disjunctive tactics, newcomers are not told what to do, they have to figure out and develop their own way of behaving.
  • Divestiture vs. investiture – With divestiture, newcomers receive negative social support, they are taunted and ignored. Existing employees withhold support until newcomers learn the ropes and conform to established norms. With investiture, newcomers receive positive social support from other employees and are encouraged to be themselves.  

There is some evidence that if organizations combine these tactics, they can influence an individual’s role orientation. It depends on the organization’s mission if it should encourage an institutionalized or individualized role orientation. There are two dangers to institutionalized socialization: it gives top managers the power to manipulate the situation and it produces sameness under employees.


Organizational rites
The organizational cultural values are often clear in the ceremonies, stories, and language found in the organization. Organizations use different types of ceremonial rites to convey cultural values and norms (Organizational Theory, Design and Change, Jones, 2010, 6th edition, page 210, figure 7.2). Rites of passage mark individuals’ entry to, promotion in, and departure from the organization. Rites of integration build and reinforce common bonds between employees, like office parties and company cookouts. Rites of enhancement publicly recognize and reward employees’ contributions, like employee promotions and newspaper releases. It is important to provide employees with organizational experiences in common so they develop a common corporate language that bonds them together and allow them to better coordinate activities. Language and stories about organizational superstars provide important clues about cultural values and norms.


Language does not only include spoken language but also how people dress, the offices they occupy, the company cars they drive, and how they formally address one another. A lot of organizations have technical languages that facilitate mutual adjustment between employees. Ceremonies and detailed books of organization-specific rules also help people learn cultural values. Finally, organizational symbols can convey cultural values, like the size of people’s offices.


It is important that managers identify instrumental and terminal values to assess how they affect organizational behavior. They also have to assess if the goals, norms and rules effectively transmit organizational values to its employees and identify areas of improvement. The methods used to socialize new members have to be examined to see if they are effective in learning newcomers the organizational culture. It also helps to develop organizational ceremonies so employees can learn cultural values to enhance the commitment to the organization.


Sources of an organizational culture
Organizational culture develops from the interaction of four factors: the personal and professional characteristics of people within the organization, organizational ethics, the property rights that an organization gives to its employees, and the structure of the organization.


The ultimate source of organizational culture is the people inside an organization. Organizations have different cultures because they attract, select, and retain people who have different ethics, personalities, and values. The people in an organization become often more and more similar because the ones that do not fit leave. The founders of organizations have a big influence on an organization’s initial culture because of their own personal values and beliefs. They set the scene for the later development of a culture because they establish an organization’s culture and hire its first members. The culture of an organization can be strengthened and changed over time by the people who control and lead it.


Many cultural values are derived from the personality and beliefs of the founder and the top-management team and are in a way out of the control of the organization. An organization can, however, purposefully develop cultural values (for example, ethical values) to control employees’ behavior. Ethical values are the beliefs, rules, and moral values that determine the appropriate way for organizational stakeholders to deal with one another and with the organization’s environment. Top managers must constantly make decisions about the right or appropriate thing to do when they develop cultural values. When making these choices, managers depend on ethical instrumental values incorporated in an organization’s culture. A main responsibility of a top management team is to make sure that employees obey the law because top managers can be held accountable for them in certain situations. A way of doing this is instilling ethical instrumental values so that members reflexively deal with stakeholders in an ethical manner. Besides organizational ethics, personal and professional ethics also influence the way a person will act in an organization. A culture is strongly affected by the people who are in a position to establish ethical values.


The values in an organization’s culture are also determined by the way a company distributes property rights. Those are the rights an organization gives to its employees to receive and use organizational resources. They cause the development of different values, norms, and attitudes toward the organization. Because shareholders own the organization’s resources and share in its profits, they have the strongest property rights of all the inside stakeholder groups. Top managers often have strong property rights because they are given golden parachutes (which guarantee them large sums of money if they are fired or the organization is taken over), stock options, large salaries, control over organizational resources, and decision-making authority.


They are in a strong position to establish the terms of their own employment, determine the property rights received by others and thus determine what sort of culture will develop in a company. Managers are given strong property rights because if they share in the value an organization creates, they are motivated to work on behalf of the organization and its stakeholders. Some workers are given strong property rights like notification of layoffs, severance payments, lifetime employment, long-term employment, pension and benefits, involvement in employee stock ownership plans (ESOPs), and participation in decision making. The distribution of property rights determines organizational effectiveness and the culture that emerges in an organization. Employees can be given property rights that are so strong that the organization and its members are harmed over time. People in bureaucracies can come to believe that they own their positions and the rights that go with them. Property rights should be assigned on the basis of performance and in a discriminating way, otherwise conflict, power struggles, and a loss of flexibility and innovation arise due to the fact that organizational members are only preoccupied with their own interests.


Managers need to design a certain kind of organizational structure to create a certain kind of organizational culture. Mechanistic and organic structures give rise to different sets of cultural values. The mechanistic structure is likely to give rise to a culture in which stability and predictability are desired end states. An organic structure is likely to give rise to a culture where flexibility and innovation are desired end states. Values, norms, and a common organizational language can improve a team’s performance.


One reason why product development time is short and the organization is flexible in matrix structures and product team structures is that they rely on face-to-face contact between functional specialists that forces teams to quickly develop shared values. Culture improves the way structure motivates and coordinates organizational resources to help achieve organizational goals. An organization’s ability to design its structure and manage its culture so there is a good fit between them, can be a source of competitive advantage because it is hard for other organizations to imitate it. A poor fit will lead to problems.



Managing organizational culture
When managers want to understand the interplay between an organization’s culture and its effectiveness at creating value for stakeholders, they have to look at the four factors that produce culture. It is difficult to change a culture because those four factors interact and big alterations have to be made to change an organization’s values. To prevent organizations’ culture from changing in ways that reduce effectiveness as they grow, top managers continually have to redesign the structures to prevent control problems that arise with large size and complexity. Managers have to identify the sources of the values and norms of their organizations’ culture and analyze the effects that ethics, people, property rights, and structure have on their organizational culture. They have to make an action plan for redesigning the culture, taking into consideration the four factors that affect culture. The development of ethical organizational values has to be one of their main priorities.

Social responsibility
Social responsibility is a manager’s obligation to make choices that protect, nurture, enhance, and promote the welfare and well-being of stakeholders and society as a whole. The strength of organizations’ commitment to social responsibility ranges from low to high. At the low end of the range is an obstructionist approach where managers choose not to behave socially responsible but unethically and illegally. They do all they can to prevent knowledge of their behavior from reaching other organizational stakeholders and society. A defensive approach means that there is at least a commitment to ethical behavior. Managers stay within the law and meet legal requirements, but they do not exercise social responsibility beyond what the law dictates. When they make ethical choices they put the interests of the shareholders first, at the expense of the other stakeholders.


Some economists believe that managers should put the interests of the stockholders first and that society must pass laws to govern the choices managers make when their choices are not acceptable to members of society. An accommodative approach means that the need to support social responsibility is acknowledged. Organizational members are ought to behave legally and ethically and managers try to balance the interests of the different stakeholders against one another. Managers with a proactive approach actively embrace the need to behave socially responsible and go out of their way to learn about the needs of different stakeholder groups. They use organizational resources to promote the interests of stockholders and other stakeholders.



Advantages to being socially responsible
Workers and society benefit when organizations behave socially responsible because organizations (instead of the government) bear some of the costs of helping workers. The quality of life as a whole would also be higher when organizations are socially responsible. There are several management experts that claim that the way organizations behave toward their employees determines many of a society’s values and norms and the ethics of its citizens. If all organizations promoted the interests of their employees, a climate of caring would pervade the society. One issue is that shareholders may think that they are being harmed when organizational resources are used for socially responsible actions. Laws now exist to protect whistle-blowers, those are the people that report illegal or unethical behavior and take a stand against unscrupulous managers or stakeholders. Evidence suggests that managers who behave socially responsible will most benefit all stakeholders. Socially responsible organizations are less risky investments, more profitable, have better reputations, and have a more loyal workforce, which encourage stakeholders to develop long-term business relationships with them. Socially responsible companies are sought out by communities, which encourage such companies to locate in their cities and offer them incentives like property-tax reductions.          




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