Chapter 13 Outline

Organizational Change at Royal Dutch/Shell

Introduction

Vertical Differentiation

Arguments for Centralization

Arguments for Decentralization

Strategy and Centralization in an International Business

Horizontal Differentiation

The Structure of Domestic Firms

The International Division

Worldwide Area Structure

Worldwide Product Division Structure

Global Matrix Structure

Integrating Mechanisms

Strategy and Coordination in the International Business

Impediments to Coordination

Formal Integrating Mechanisms

Informal Integrating Mechanisms

Summary

Control Systems

Types of Control Systems

Control Systems and Strategy in the International Business

Synthesis: Strategy and Structure

Multidomestic Firms

International Firms

Global Firms

Transnational Firms

Environment, Strategy, Structure, and Performance

Chapter Summary

Critical Discussion Questions

Organizational Change at Unilever

Organizational Change at Royal Dutch/Shell

The Anglo-Dutch company Royal Dutch/Shell is the world's largest non-state-owned oil company with activities in more than 130 countries and 1997 revenues of $128 billion. From the 1950s until 1994, Shell operated with a matrix structure invented for it by McKinsey & Company, a management consulting firm that specializes in organizational design. Under this matrix structure, the head of each operating company reported to two bosses. One boss was responsible for the geographical region or country in which the operating company was based, while the other was responsible for the business activity that the operating company was engaged in (Shell's business activities included oil exploration and production, oil products, chemicals, gas, and coal). For example, the head of the local Shell chemical company in Australia reported both to the head of Shell Australia and to the head of Shell's chemical division, who was based in London. In theory, both bosses had equal influence and status within the organization.

This matrix structure had two very visible consequences at Shell. First, because each operating company had two bosses to satisfy, decision making typically followed a pattern of consensus building, with differences of perspective between country (or regional) heads and the heads of business divisions being worked out through debate. Although this process could be slow and cumbersome, it was seen as a good thing in the oil industry where most big decisions are long-term ones that involve substantial capital expenditures and where informed debate can help to clarify the pros and cons of issues, rather than hinder decision making. Second, because the decision-making process was slow, it was reserved for only the most important decisions (such as major new capital investments). The result was substantial decentralization by default to the heads of the individual operating companies, who were largely left alone to run their own operations. This decentralization helped Shell respond to local differences in government regulations, competitive conditions, and consumer tastes. Thus, for example, the head of Shell's Australian chemical company was given the freedom to determine pricing practices and marketing strategy in the Australian market. Only if he wished to undertake a major capital investment, such as building a new chemical plant, would the consensus-building decision-making system be invoked.

As desirable as this matrix structure seemed, Shell announced in 1995 a radical plan to dismantle it. The primary reason given by top management was continuing slack demand for oil and weak oil prices, which had put pressure on Shell's profit margins. Although Shell had traditionally been among the most profitable oil companies in the world, its relative performance began to slip in the early 1990s as other oil companies, such as Exxon, adapted more rapidly to low oil prices by sharply cutting their overhead costs and consolidating production in efficient scale facilities. Consolidating production at these companies often involved serving the world market from a smaller number of large-scale refining facilities and shutting down smaller facilities. In contrast, Shell still operated with a large head office in London that contained 3,000 people, which was required to effect coordination within Shell's matrix structure, and substantial duplication of oil and chemical refining facilities across operating companies, each of which typically developed the facilities required to serve its own market.

In 1995, Shell's senior management decided that lowering operating costs required a sharp reduction in head office overhead and the elimination of any unnecessary duplication of facilities across countries. To achieve these goals, they decided to reorganize the company along divisional lines. Shell now operates with five main global product divisions-exploration and production, oil products, chemicals, gas, and coal. Each operating company reports to whichever global division is the most relevant. Thus, the head of the Australian chemical operation now reports directly to the head of the global chemical division. The thinking is that this will increase the power of the global chemical division and enable that division to eliminate any unnecessary duplication of facilities across countries. Eventually, production may be consolidated in larger facilities that serve an entire region, rather than a single country, enabling Shell to reap greater scale economies.

The country (or regional) chiefs remain but their roles and responsibilities have been reduced. Now their primary responsibility is coordination between operating companies within a country (or region) and relations with the local government. Also, there is a solid line of reporting and responsibility between the heads of operating companies and the global divisions and only a dotted line between the heads of operating companies and country chiefs. Thus, for example, the ability of the head of Shell Australia to shape the major capital investmentdecisions of Shell's Australian chemical operation has been substantially reduced as a result of these changes. Furthermore, the simplified reporting system has reduced the need for a large head office bureaucracy, and Shell announced plans to cut the work force of its London head office by 1,170, which should help drive down Shell's cost structure.

The early indications are that the changes are having the desired effect. For example, by looking at purchasing decisions on a global basis, the oil products division is paying significantly lower prices for inputs, such as gasoline additives, than when each national operating company purchased its own additives. In the chemical division, the changed perspective led the company to build a new polymer plant closer to customers in Louisiana instead of near the existing plant in Britain. Before the 1995 reorganization, the plant automatically would have been added to the UK fiefdom. The consequences of these changes are starting to show up in the company's financial reports. Return on capital increased to 12 percent in 1997, up from 7.9 percent in 1993.

http://www.shell.com

Source: "Shell on the Rocks," The Economist, June 24, 1995, pp. 57 - 58; D. Lascelles, "Barons Swept out of Fiefdoms," Financial Times, March 30, 1995, p. 15; C. Lorenz, "End of a Corporate Era," Financial Times, March 30, 1995, p. 15; R. Corzine, "Shell Discovers Time and Tide Wait for No Man," Financial Times, March 10, 1998, p. 17; R. Corzine, "Oiling the Group's Wheels of Change," Financial Times, April 1, 1998, p. 12; and J. Guyon, "Why Is the World's Most Profitable Company Turning Itself Inside Out?" Fortune, August 4, 1997, pp. 120 - 25.

Introduction

The objective of this chapter is to identify the organizational structures and internal control mechanisms international businesses use to manage and direct their global operations. We will be concerned not just with formal structures and control mechanisms but also with informal structures and control mechanisms such as corporate culture and companywide networks. To succeed, an international business must have appropriate formal and informal organizational structure and control mechanisms. The strategy of the firm determines what is "appropriate." Firms pursuing a global strategy require different structures and control mechanisms than firms pursuing a multidomestic or a transnational strategy. To succeed, a firm's structure and control systems must match its strategy in discriminating ways.

The opening case illustrates this. From the 1960s to the late 1980s, the matrix structure utilized by Royal Dutch Shell served the company well. It enabled Shell to respond to national differences in consumer tastes and preferences, government regulations, and competitive conditions while giving the head office control over major strategic decisions and investments. The structure was consistent with the multidomestic strategy Shell was pursuing at the time. However, this structure made sense only as long as the firm did not have to worry about high overhead costs, slow decision making, and duplication of facilities that resulted from the structure. By the early 1990s, increasing cost pressures made it imperative for Shell to look for ways to drive down its cost structure. The matrix structure became a distinct drawback. The environment had become more cost competitive, and Shell had to respond by adopting a global strategy. Implementing this strategy required a change of structure, both to reduce overhead costs and to give the corporate center the power required to minimize operating costs by eliminating unnecessary duplication of operating facilities and consolidating production in large facilities that could reap scale economies. The structure that Shell chose to adopt, which was based on global product divisions, was consistent with this new emphasis on a global strategy.  Another example of the need for a fit between strategy and structure concerns the recent history of Philips Electronics NV. One of the largest industrial companies in the world (with operations in more than 60 countries), this Dutch company has long been a dominant force in the global electronics, consumer appliances, and lighting industries. However, its performance started to slip in the 1970s, and by the early 1990s, Philips was suffering a string of record financial losses. During the 1970s and 80s, Philips's markets were attacked by Japanese companies such as Matsushita and Sony. These companies were pursuing a global strategy, using their resulting low costs to undercut Philips. To compete on an equal footing with Matsushita and Sony, Philips had to realize experience curve and location economies (see Chapter 12). Unfortunately, its attempts to do this were hindered by an organization more suited to a multidomestic strategy. Most of Philips's foreign subsidiaries were self-contained operations with their own production facilities. Like Shell, Philips desperately needed to consolidate production in a few facilities to realize location and experience curve economies, but it was hindered by resistance from its national operations and by the sheer scale of the needed reorganization. As a consequence of this misfit of structure and strategy, Philips suffered a decade of financial trouble. The company began to get its financial act together in the mid-1990s, primarily because it changed its organizational structure, moving away from a structure based on national organizations and toward one based on worldwide product divisions. This new structure was much better suited to the global strategy Philips was now trying to pursue, and it allowed the company to start driving down its cost structure.¹

To come to grips with issues of structure and control in international business, in the next four sections we consider the basic dimensions of structure and control: vertical differentiation, horizontal differentiation, integration, and control systems. Vertical differentiation is the distribution of decision-making authority within a hierarchy (i.e., centralized versus decentralized). Horizontal differentiation is the division of an organization into subunits (e.g., into functions, divisions, or subsidiaries). Integration refers to the body of mechanisms that coordinate and integrate the subunits. These mechanisms are formal and informal. Control systems are the systems that top management uses to direct and control subunits, and these also are formal and informal. Throughout these sections, we will focus on the implications of the four dimensions for the international firm. Then we will attempt to determine the optimal structures and controls for multidomestic, global, international, and transnational firms.