Trade barriers are government-induced restrictions on international trade. Man-made trade barriers come in several forms, including:
Most trade barriers work on the same principle–the imposition of some sort of cost on trade that raises the price of the traded products. If two or more nations repeatedly use trade barriers against each other, then a trade war results.
Economists generally agree that trade barriers are detrimental and decrease overall economic efficiency. This can be explained by the theory of comparative advantage. In theory, free trade involves the removal of all such barriers, except perhaps those considered necessary for health or national security. In practice, however, even those countries promoting free trade heavily subsidize certain industries, such as agriculture and steel. Trade barriers are often criticized for the effect they have on the developing world. Because rich-country players set trade policies, goods, such as agricultural products that developing countries are best at producing, face high barriers. Trade barriers, such as taxes on food imports or subsidies for farmers in developed economies, lead to overproduction and dumping on world markets, thus lowering prices and hurting poor-country farmers. Tariffs also tend to be anti-poor, with low rates for raw commodities and high rates for labor-intensive processed goods. The Commitment to Development Index measures the effect that rich country trade policies actually have on the developing world. Another negative aspect of trade barriers is that it would cause a limited choice of products and, therefore, would force customers to pay higher prices and accept inferior quality.
In general, for a given level of protection, quota-like restrictions carry a greater potential for reducing welfare than do tariffs. Tariffs, quotas, and non-tariff barriers lead too few of the economy’s resources being used to produce tradeable goods. An export subsidy can also be used to give an advantage to a domestic producer over a foreign producer. Export subsidies tend to have a particularly strong negative effect because in addition to distorting resource allocation, they reduce the economy’s terms of trade. In contrast to tariffs, export subsidies lead to an over allocation of the economy’s resources to the production of tradeable goods.
International trade is the exchange of goods and services across national borders. In most countries, it represents a significant part of gross domestic product (GDP). The rise of industrialization, globalization, and technological innovation has increased the importance of international trade, as well as its economic, social, and political effects on the countries involved. Internationally recognized ethical practices such as the UN Global Compact have been instituted to facilitate mutual cooperation and benefit between governments, businesses, and public institutions. Nevertheless, countries continue to face challenges around ethical trading and business practices, especially regarding economic inequalities and human rights violations.
Capital markets involve the raising and investing money in various enterprises. Although some argue that the increasing integration of these financial markets between countries leads to more consistent and seamless trading practices, others point out that capital flows tend to favor the capital owners more than any other group. Likewise, owners and workers in specific sectors in capital-exporting countries bear much of the burden of adjusting to increased movement of capital. The economic strains and eventual hardships that result from these conditions lead to political divisions about whether or not to encourage or increase integration of international trade markets. Moreover, critics argue that income disparities between the rich and poor are exacerbated, and industrialized nations grow in power at the expense of under-capitalized countries.
The anti-globalization movement is a worldwide activist movement that is critical of the globalization of capitalism. Anti-globalization activists are particularly critical of the undemocratic nature of capitalist globalization and the promotion of neoliberalism by international institutions such as the International Monetary Fund (IMF) and the World Bank. Other common targets of anti-corporate and anti-globalization movements include the Organisation for Economic Co-operation and Development (OECD), the WTO, and free trade treaties like the North American Free Trade Agreement (NAFTA), Free Trade Area of the Americas (FTAA), the Multilateral Agreement on Investment (MAI), and the General Agreement on Trade in Services (GATS). Meetings of such bodies are often met with strong protests, as demonstrators attempt to bring attention to the often devastating effects of global capital on local conditions.
On November 30, 1999, close to fifty thousand people gathered to protest the WTO meetings in Seattle, Washington. Labor, economic, and environmental activists succeeded in disrupting and closing the meetings due to their disapproval of corporate globalization. This event came to symbolize the increased debate and growing conflict around the ethical questions on international trade, globalization and capitalization .
It is typically more difficult to do business in a foreign country than in one’s home country, especially in the early stages when a firm is considering either physical investment in or product expansion to another country. Expansion planning requires an in-depth knowledge of existing market channels and suppliers, of consumer preferences and current purchase behavior, and of domestic and foreign rules and regulations. Language and cultural barriers present considerable challenges, as well as institutional differences among countries.
With the process of globalization and increasing global trade, it is unavoidable that different cultures will meet, conflict, and blend together. People from different cultures find it hard to communicate not only due to language barriers but also because of cultural differences.
In a survey of Texas agricultural exporting firms, Hollon (1989) found that from a firm management perspective, the initial entry into export markets was significantly more difficult than either the handling of ongoing export activities or the consideration of expansion to new export product lines or markets. From a list of 38 items in three categories (knowledge gaps, marketing aspects, and financial aspects) over three time horizons (start-up, ongoing, and expansion), the three problems rated most difficult were all start-up phase marketing items:
Two of these items, market entry and transaction complexity, remained problematic in ongoing operations and in new product market expansion. Import restrictions and export competition became more problematic in later phases, while financial problems were pervasive at all phases of the export operation.
Recognizing that different geographic regions and/or nationalities represent vastly different business operating characteristics, often due to differences in cultural predisposition, is a critical building block for successful global business leaders. As a result, various researchers in global business have generated business models to illustrate key cultural considerations between different countries. The most recognized and utilized in the field is Geert Hofstede’s Cultural Dimensions Theory, which encompasses six cultural deviations highly relevant to business managers. The figure below provides an example of this model:
As you can see in the above figure, the six dimensions underline differences in perspective in each category. Two countries (or more) are selected for comparison, at which point can identify differences in business practices based on cultural barriers. For example, Country A demonstrates lower power distance compared to Country B. This means that a resident of Country A operating in Country B must understand that lines of authority are more rigid in Country B and act accordingly.
U.S. companies, farmers, ranchers, and manufacturers increasingly encounter non-tariff trade barriers in the form of product standards, testing requirements, and other technical requirements as they seek to sell products and services around the world. As tariff barriers to industrial and agricultural trade have fallen, standards-related measures of this kind have emerged as a key concern. Governments, market participants, and other entities can use standards-related measures as an effective and efficient means of achieving legitimate commercial and policy objectives. But when standards-related measures are outdated, overly burdensome, discriminatory, or otherwise inappropriate, these measures can reduce competition, stifle innovation, and create unnecessary technical barriers to trade. These kinds of measures can pose a particular problem for small- and medium-sized enterprises (SMEs), which often do not have the resources to address these problems on their own. Significant foreign trade barriers in the form of product standards, technical regulations and testing, certification, and other procedures are involved in determining whether or not products conform to standards and technical regulations.
These standards-related trade measures, known in World Trade Organization (WTO) parlance as “technical barriers to trade,” play a critical role in shaping the flow of global trade. Standards-related measures serve an important function in facilitating global trade, including by enabling greater access to international markets by SMEs. Standards-related measures also enable governments to pursue legitimate objectives, such as protecting human health and the environment and preventing deceptive practices. But standards-related measures that are non-transparent, discriminatory, or otherwise unwarranted can act as significant barriers to U.S. trade. These kinds of measures can pose a particular problem for SMEs, which often do not have the resources to address these problems on their own.
It is asserted that trade has created jobs for foreign workers at the expense of American workers. It is more accurate to say that trade both creates and destroys jobs in the economy in line with market forces.
Economy-wide trade creates jobs in industries that have comparative advantage and destroys jobs in industries that have a comparative disadvantage. In the process, the economy’s composition of employment changes; but, according to economic theory, there is no net loss of jobs due to trade. Over the course of the last economic expansion, from 1992 to 2000, U.S. imports increased nearly 240%. Over that same period, total employment grew by 22 million jobs ,and the unemployment rate fell from 7.5% to 4.0% (the lowest unemployment rate in more than 30 years.). Foreign outsourcing by American firms, which has been the object of much recent attention, is a form of importing and also creates and destroys jobs, leaving the overall level of employment unchanged. There is no denying that with international trade there will be short-run hardship for some, but economists maintain the whole economy’s living standard is raised by such exchange. They view these adverse effects as qualitatively the same as those induced by purely domestic disruptions, such as shifting consumer demand or technological change. In that context, economists argue that easing adjustment of those harmed is economically more fruitful than protection given the net economic benefit of trade to the total economy. Many people believe that imports from countries with low wages has put downward pressure on the wages of Americans.
There is no doubt that international trade can have strong effects, good and bad, on the wages of American workers. The plight of the worker adversely affected by imports comes quickly to mind. But it is also true that workers in export industries benefit from trade. Moreover, all workers are consumers and benefit from the expanded market choices and lower prices that trade brings. Yet, concurrent with the large expansion of trade over the past 25 years, real wages (i.e., inflation adjusted wages) of American workers grew more slowly than in the earlier post-war period, and the inequality of wages between the skilled and less skilled worker rose sharply. Was trade the force behind this deteriorating wage performance? Some industries, or at least components of some industries, are vital to national security and possibly may need to be insulated from the vicissitudes of international market forces. This determination needs to be made on a case-by-case basis since the claim is made by some who do not meet national security criteria. Such criteria may also vary from case to case. It is also true that national security could be compromised by the export of certain dual-use products that, while commercial in nature, could also be used to produce products that might confer a military advantage to U.S. adversaries. Controlling such exports is clearly justified from a national security standpoint; but, it does come at the cost of lost export sales and an economic loss to the nation. Minimizing the economic welfare loss from such export controls hinges on a well- focused identification and regular re-evaluation of the subset of goods with significant national security potential that should be subject to control.
Most trade barriers work on the same principle: the imposition of some sort of cost on trade that raises the price of the traded products. If two or more nations repeatedly use trade barriers against each other, then a trade war results
Economists generally agree that trade barriers are detrimental and decrease overall economic efficiency, this can be explained by the theory of comparative advantage. In theory, free trade involves the removal of all such barriers, except perhaps those considered necessary for health or national security. In practice, however, even those countries promoting free trade heavily subsidize certain industries, such as agriculture and steel.
Trade barriers are often criticized for the effect they have on the developing world. Because rich-country players call most of the shots and set trade policies, goods, such as crops that developing countries are best at producing, still face high barriers. Trade barriers, such as taxes on food imports or subsidies for farmers in developed economies, lead to overproduction and dumping on world markets, thus lowering prices and hurting poor-country farmers. Tariffs also tend to be anti-poor, with low rates for raw commodities and high rates for labor-intensive processed goods.
If international trade is economically enriching, imposing barriers to such exchanges will prevent the nation from fully realizing the economic gains from trade and must reduce welfare. Protection of import-competing industries with tariffs, quotas, and non-tariff barriers can lead to an over-allocation of the nation’s scarce resources in the protected sectors and an under-allocation of resources in the unprotected tradeable goods industries. In the terms of the analogy of trade as a more efficient productive process used above, reducing the flow of imports will also reduce the flow of exports. Less output requires less input. Clearly, the exporting sector must lose as the protected import-competing activities gain. But, more importantly, from this perspective the overall economy that consumed the imported goods must also lose, because the more efficient production process–international trade–cannot be used to the optimal degree, and, thereby, will have generally increased the price and reduced the array of goods available to the consumer. Therefore, the ultimate economic cost of the trade barrier is not a transfer of well-being between sectors, but a permanent net loss to the whole economy arising from the barriers distortion toward the less efficient the use of the economy’s scarce resources.
14.4: International Trade Agreements & Organizations
14.4.1: Common Markets
A common market is the first stage towards a single market and may be limited initially to a free trade area.
Learning Objective
Explain the history of the European Economic Community (EEC)
Key Points
- A common market is the first stage towards a single market and may be limited initially to a free trade area, with relatively free movement of capital and of services. However, it is not to a stage where the remaining trade barriers have been eliminated.
- The European Economic Community (EEC) (also known as the Common Market in the English-speaking world and sometimes referred to as the European Community even before it was renamed as such in 1993) was an international organization created by the 1957 Treaty of Rome.
- The main aim of the EEC, as stated in its preamble, was to “preserve peace and liberty and to lay the foundations of an ever closer union among the peoples of Europe”.
Key Term
- free trade
-
International trade free from government interference, especially trade free from tariffs or duties on imports.
Example
- The European Economic Community was the first example of a both common and single market, but it was an economic union since it had additionally a customs union. The European Economic Community (EEC) was an international organization created by the 1957 Treaty of Rome. Its aim was to bring about economic integration, including a common market, among its six founding members: Belgium, France, Germany, Italy, Luxembourg and the Netherlands. Upon the entry into force of the Maastricht Treaty in 1993, the EEC was renamed the European Community (EC) to reflect that it covered a wider range of policy. This was also when the three European Communities, including the EC, were collectively made to constitute the first of the three pillars of the European Union (EU). For the customs union, the treaty provided for a 10% reduction in custom duties and up to 20% of global import quotas. Progress on the customs union proceeded much faster than the twelve years planned.
A common market is a first stage towards a single market and may be limited initially to a free trade area with relatively free movement of capital and of services, but not so advanced in reduction of the rest of the trade barriers.
The European Economic Community (EEC) (also known as the Common Market in the English-speaking world and sometimes referred to as the European Community even before it was renamed as such in 1993) was an international organization created by the 1957 Treaty of Rome. Its aim was to bring about economic integration, including a common market, among its six founding members: Belgium, France, Germany, Italy, Luxembourg, and the Netherlands.
It gained a common set of institutions along with the European Coal and Steel Community (ECSC) and the European Atomic Energy Community (EURATOM) as one of the European Communities under the 1965 Merger Treaty (Treaty of Brussels).
Upon the entry into force of the Maastricht Treaty in 1993, the EEC was renamed the European Community (EC) to reflect that it covered a wider range of policy. This was also when the three European Communities, including the EC, were collectively made to constitute the first of the three pillars of the European Union (EU), which the treaty also founded. The EC existed in this form until it was abolished by the 2009 Treaty of Lisbon, which merged the EU’s former pillars and provided that the EU would “replace and succeed the European Community. ” The main aim of the EEC, as stated in its preamble, was to “preserve peace and liberty and to lay the foundations of an ever closer union among the peoples of Europe. ” Calling for balanced economic growth, this was to be accomplished through:
- The establishment of a customs union with a common external tariff
- Common policies for agriculture, transport, and trade
- Enlargement of the EEC to the rest of Europe
For the customs union, the treaty provided for a 10% reduction in custom duties and up to 20% of global import quotas. Progress on the customs union proceeded much faster than the 12 years planned. However, France faced some setbacks due to its war with Algeria.
The six states that founded the EEC and the other two communities were known as the “inner six” (the “outer seven” were those countries who formed the European Free Trade Association). The six were France, West Germany, Italy, and the three Benelux countries: Belgium, the Netherlands, and Luxembourg. The first enlargement was in 1973, with the accession of Denmark, Ireland, and the United Kingdom. Greece, Spain, and Portugal joined in the 1980s. Following the creation of the EU in 1993, it has enlarged to include an additional 15 countries by 2007.
There were three political institutions that held the executive and legislative power of the EEC, plus one judicial institution and a fifth body created in 1975. These institutions (except for the auditors) were created in 1957 by the EEC but from 1967 on, they applied to all three communities. The council represents governments, the Parliament represents citizens, and the commission represents the European interest.
14.4.2: The Export-Import Bank of the United States
The Export-Import Bank of the United States (Ex-Im Bank) is the official export credit agency of the United States federal government.
Learning Objective
Explain the purpose of the Export-Import Bank of the United States (Ex-Im Bank)
Key Points
- The mission of the Ex-Im Bank is to create and sustain U.S. jobs by financing sales of U.S. exports to international buyers.
- Ex-Im Bank provides financing for transactions that would otherwise not take place because commercial lenders are either unable or unwilling to accept the political or commercial risks inherent in the deal.
- The Export-Import Bank of the United States focuses much of its energy and resources on providing support to U.S. small businesses for export of American-made products.
- Export Credit Insurance from Export-Import Bank of the United States provides insurance policies to U.S. companies and banks to mitigate risks of non-collection from foreign buyers and borrowers.
- The Working Capital Guarantee program provides loan guarantees to banks willing to lend to exporting companies.
Key Terms
- risk
-
To incur risk [of something].
- guarantee
-
To assume responsibility for a debt.
- credit agency
-
A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings.
Example
- The Ex-Im Bank provides two types of loans: direct loans to foreign buyers of American exports and intermediary loans to responsible parties, such as foreign government lending agencies that re-lend to foreign buyers of capital goods and related services (for example, a maintenance contract for a jet passenger plane).
The Export-Import Bank of the United States (Ex-Im Bank) is the official export credit agency of the United States federal government. It was established in 1934 by an executive order and made an independent agency in the Executive branch by Congress in 1945. Its purpose is to finance and insure foreign purchases of United States goods for customers unable or unwilling to accept credit risk.
The mission of the Ex-Im Bank is to create and sustain U.S. jobs by financing sales of U.S. exports to international buyers. Ex-Im Bank is the principal government agency responsible for aiding the export of American goods and services through a variety of loan, guarantee, and insurance programs. Generally, its programs are available to any American export firm regardless of size. The Bank is chartered as a government corporation by the Congress of the United States; it was last chartered for a five year term in 2006. Its Charter spells out the Bank’s authorities and limitations. Among them is the principle that Ex-Im Bank does not compete with private sector lenders, but rather provides financing for transactions that would otherwise not take place because commercial lenders are either unable or unwilling to accept the political or commercial risks inherent in the deal.
Ex-Im Bank provides the following services:
- The Export-Import Bank of the United States focuses much of its energy and resources on providing support to small American businesses for export of American-made products
- Export Credit Insurance provides insurance policies to U.S. companies and banks to mitigate risks of non-collection from foreign buyers and borrowers.
- The Working Capital Guarantee program provides loan guarantees to banks willing to lend to exporting companies.
- Two types of loans: direct loans to foreign buyers of American exports and intermediary loans to responsible parties, such as foreign government lending agencies that re-lend to foreign buyers of capital goods and related services (for example, a maintenance contract for a jet passenger plane).
14.4.3: The International Monetary Fund (IMF)
The IMF seeks to promote international economic cooperation, international trade, employment, and exchange rate stability.
Learning Objective
Explain how the International Monetary Fund (IMF) aids its 188 member countries
Key Points
- The International Monetary Fund (IMF) is an international organization that was created on July 22, 1944 at the Bretton Woods Conference.
- The IMF’s stated goal is to stabilize exchange rates and assist the reconstruction of the world’s international payment system after World War II.
- The IMF is run by country contributions. Money is pooled through a quota system from which countries with payment imbalances can borrow funds on a temporary basis.
- It works with developing nations to help them achieve macroeconomic stability and reduce poverty. The rationale for this is that private international capital markets function imperfectly and many countries have limited access to financial markets. Such market imperfections, together with balance of payments financing, provide the justification for official financing, without which many countries could only correct large external payment imbalances through measures with adverse effects on both national and international economic prosperity. The IMF can provide other sources of financing to countries in need that would not be available in the absence of an economic stabilization program supported by the Fund.
- Member countries of the IMF have access to information on the economic policies of all member countries, the opportunity to influence other members’ economic policies, technical assistance in banking, fiscal affairs, and exchange matters, financial support in times of payment difficulties, and increased opportunities for trade and investment. IMF conditionality is a set of policies that the IMF requires in exchange for financial resources. The IMF does not require collateral from countries for loans but rather requires the government seeking assistance to correct its macroeconomic imbalances in the form of policy reform. If the conditions are not met, the funds are withheld. Conditionality is perhaps the most controversial aspect of IMF policies.
- These loan conditions ensure that the borrowing country will be able to repay the Fund and that the country won’t attempt to solve their balance of payment problems in a way that would negatively impact the international economy. The incentive problem of moral hazard, which is the actions of economic agents maximizing their own utility to the detriment of others when they do not bear the full consequences of their actions, is mitigated through conditions rather than providing collateral; countries in need of IMF loans do not generally possess internationally valuable collateral anyway. Conditionality also reassures the IMF that the funds lent to them will be used for the purposes defined by the Articles of Agreement and provides safeguards that country will be able to rectify its macroeconomic and structural imbalances. In the judgment of the Fund, the adoption by the member of certain corrective measures or policies will allow it to repay the Fund, thereby ensuring that the same resources will be available to support other members.
- Voting power in the IMF is, like the money pool, based on a quota system. Each member has a number of “basic votes” (each member’s number of basic votes equals 5.502% of the total votes), plus one additional vote for each Special Drawing Right (SDR) of 100,000 of a member country’s quota. The Special Drawing Right is the unit of account of the IMF and represents a claim to currency. It is based on a basket of key international currencies. The basic votes generate a slight bias in favor of small countries, but the additional votes determined by SDR outweigh this bias.
- The IMF is mandated to oversee the international monetary and financial system and monitor the economic and financial policies of its 188 member countries. This activity is known as surveillance and facilitates international cooperation. Since the demise of the Bretton Woods system of fixed exchange rates in the early 1970s, surveillance has evolved largely by way of changes in procedures rather than through the adoption of new obligations. The responsibilities of the Fund changed from those of guardian to those of overseer of members’ policies.
- Some critics assume that Fund lending imposes a burden on creditor countries. However, countries receive market-related interest rates on most of their quota subscription, plus any of their own-currency subscriptions that are loaned out by the Fund, plus all of the reserve assets that they provide the Fund. Also, as of 2005 borrowing countries have had a very good track record of repaying credit extended under the Fund’s regular lending facilities with the full interest over the duration of the borrowing.
Key Terms
- collateral
-
A security or guarantee (usually an asset) pledged for the repayment of a loan if one cannot procure enough funds to repay. (Originally supplied as “accompanying” security. )
- capital market
-
The market for long-term securities, including the stock market and the bond market.
- moral hazard
-
The prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.
The International Monetary Fund (IMF) is an international organization that was created on July 22, 1944 at the Bretton Woods Conference and came into existence on December 27, 1945 when 29 countries signed the IMF Articles of Agreement. It originally had 45 members. The IMF’s stated goal was to stabilize exchange rates and assist the reconstruction of the world’s international payment system post-World War II. Countries contribute money to a pool through a quota system from which countries with payment imbalances can borrow funds on a temporary basis. Through this activity and others, such as surveillance of its members’ economies and policies, the IMF works to improve the economies of its member countries. The IMF describes itself as “an organization of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty. “
The organization’s stated objectives are to promote international economic cooperation, international trade, employment, and exchange rate stability, including by making financial resources available to member countries to meet balance of payments needs. Member countries of the IMF have access to information on the economic policies of all member countries, the opportunity to influence other members’ economic policies, technical assistance in banking, fiscal affairs, and exchange matters, financial support in times of payment difficulties, and increased opportunities for trade and investment. Voting power in the IMF is based on a quota system. Each member has a number of “basic votes” (each member’s number of basic votes equals 5.502% of the total votes), plus one additional vote for each Special Drawing Right (SDR) of 100,000 of a member country’s quota. The Special Drawing Right is the unit of account of the IMF and represents a claim to currency. It is based on a basket of key international currencies. The basic votes generate a slight bias in favor of small countries, but the additional votes determined by SDR outweigh this bias.
The IMF works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty. The rationale for this is that private international capital markets function imperfectly, and many countries have limited access to financial markets. Such market imperfections, together with balance of payments financing, provide the justification for official financing, without which many countries could only correct large external payment imbalances through measures with adverse effects on both national and international economic prosperity. The IMF can provide other sources of financing to countries in need that would not be available in the absence of an economic stabilization program supported by the fund.
The IMF is mandated to oversee the international monetary and financial system and monitor the economic and financial policies of its 188 member countries. This activity is known as “surveillance” and facilitates international cooperation. Since the demise of the Bretton Woods system of fixed exchange rates in the early 1970s, surveillance has evolved largely by way of changes in procedures rather than through the adoption of new obligations.The responsibilities of the fund changed from those of guardian to those of overseer of members’ policies. The fund typically analyzes the appropriateness of each member country’s economic and financial policies for achieving orderly economic growth, and assesses the consequences of these policies for other countries and for the global economy.
IMF conditionality is a set of policies or “conditions” that the IMF requires in exchange for financial resources. The IMF does not require collateral from countries for loans but rather requires the government seeking assistance to correct its macroeconomic imbalances in the form of policy reform. If the conditions are not met, the funds are withheld. Conditionality is the most controversial aspect of IMF policies. These loan conditions ensure that the borrowing country will be able to repay the fund and that the country won’t attempt to solve their balance of payment problems in a way that would negatively impact the international economy. The incentive problem of moral hazard, which is the actions of economic agents maximizing their own utility to the detriment of others when they do not bear the full consequences of their actions, is mitigated through conditions rather than providing collateral; countries in need of IMF loans do not generally possess internationally valuable collateral anyway. Conditionality also reassures the IMF that the funds lent to them will be used for the purposes defined by the Articles of Agreement and provides safeguards that country will be able to rectify its macroeconomic and structural imbalances. In the judgment of the fund, the adoption by the member of certain corrective measures or policies will allow it to repay the fund, thereby ensuring that the same resources will be available to support other members.
14.4.4: The North American Free Trade Agreement (NAFTA)
NAFTA is an agreement signed by Canada, Mexico, and the United States, creating a trilateral trade bloc in North America.
Learning Objective
Outline the stipulations of NAFTA
Key Points
- The North American Free Trade Agreement (NAFTA) is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America.
- NAFTA came into effect on January 1, 1994 and superseded the Canada – United States Free Trade Agreement.
- Within 10 years of the implementation of NAFTA, all U.S.-Mexico tariffs are to be eliminated except for some U.S. agricultural exports to Mexico which will be phased out within 15 years.
- Most U.S. – Canada trade was duty free before NAFTA.
- NAFTA also seeks to eliminate non-tariff trade barriers and to protect the intellectual property right of the products.
- When viewing the combined GDP of its members, as of 2010 NAFTA is the largest trade bloc in the world.
Key Terms
- tariff
-
A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.
- free trade
-
International trade free from government interference, especially trade free from tariffs or duties on imports.
- trade bloc
-
A trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminated among the participating states.
The North American Free Trade Agreement (NAFTA)
The North American Free Trade Agreement (NAFTA) is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement between the U.S. and Canada.
In terms of combined GDP of its members, the trade bloc is the largest in the world as of 2010. NAFTA has two supplements: the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC). The goal of NAFTA was to eliminate barriers to trade and investment among the U.S., Canada, and Mexico.
The implementation of NAFTA on January 1, 1994 brought the immediate elimination of tariffs on more than one-half of Mexico’s exports to the U.S. and more than one-third of U.S. exports to Mexico. Within 10 years of the implementation of the agreement, all U.S.–Mexico tariffs would be eliminated except for some U.S. agricultural exports to Mexico that were to be phased out within 15 years. Most U.S.–Canada trade was already duty free. NAFTA also seeks to eliminate non-tariff trade barriers and to protect the intellectual property right of the products.
The agreement opened the door for open trade, ending tariffs on various goods and services, and implementing equality between Canada, America, and Mexico. NAFTA has allowed agricultural goods such as eggs, corn, and meats to be tariff-free. This allowed corporations to trade freely and import and export various goods on a North American scale .
14.4.5: The World Bank
The World Bank is an international financial institution that provides loans to developing countries for various programs.
Learning Objective
Explain the role played by the World Bank in reducing poverty
Key Points
- The World Bank’s official goal is the reduction of poverty.
- According to the World Bank’s Articles of Agreement, all of its decisions must be guided by a commitment to promote foreign investment, international trade, and facilitate capital investment.
- The current President of the Bank, Jim Yong Kim, is responsible for chairing the meetings of the boards of directors and for overall management of the bank.
- Traditionally, the bank president has always been a U.S. citizen nominated by the United States, the largest shareholder in the bank. The nominee is subject to confirmation by the board of executive directors, to serve for a five-year, renewable term.
- For the poorest developing countries in the world, the bank’s assistance plans are based on poverty reduction strategies.
Key Terms
- developing
-
Of a country: becoming economically more mature or advanced; becoming industrialized.
- loan
-
A sum of money or other valuables or consideration that an individual, group, or other legal entity borrows from another individual, group, or legal entity (the latter often being a financial institution) with the condition that it be returned or repaid at a later date (sometimes with interest).
- poverty
-
The quality or state of being poor or indigent; want or scarcity of means of subsistence; indigence; need.
- World Bank
-
a group of five financial organizations whose purpose is economic development and the elimination of poverty
The World Bank is an international financial institution that provides loans to developing countries for capital programs. The World Bank’s official goal is the reduction of poverty. According to the World Bank’s Articles of Agreement (as amended effective February 16,1989), all of its decisions must be guided by a commitment to promote foreign investment, international trade, and facilitate capital investment.
The World Bank differs from the World Bank Group, in that the World Bank comprises only two institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), whereas the former incorporates these two in addition to three more: International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and International Centre for Settlement of Investment Disputes (ICSID). The curent President of the Bank, Jim Yong Kim, is responsible for chairing the meetings of the boards of directors and for overall management of the bank. Traditionally, the bank president has always been a U.S. citizen nominated by the United States, the largest shareholder in the bank. The nominee is subject to confirmation by the board of executive directors, to serve for a five-year, renewable term.
The International Bank for Reconstruction and Development (IBRD) has 188 member countries, while the International Development Association (IDA) has 172 members.Each member state of IBRD should be also a member of the International Monetary Fund (IMF), and only members of IBRD are allowed to join other institutions within the Bank (such as IDA).
For the poorest developing countries in the world, the bank’s assistance plans are based on poverty reduction strategies; by combining a cross-section of local groups with an extensive analysis of the country’s financial and economic situation, the World Bank develops a strategy pertaining uniquely to the country in question. The government then identifies the country’s priorities and targets for the reduction of poverty, and the World Bank aligns its aid efforts correspondingly. Forty-five countries pledged $25.1 billion in “aid for the world’s poorest countries,” aid that goes to the World Bank International Development Association (IDA) which distributes the loans to 80 poorer countries.
14.4.6: The European Union
The European Union (EU) is an economic and political union made up of 27 member states that are located primarily in Europe.
Learning Objective
Discuss the establishment of the European Union (EU) and the Euro
Key Points
- The European Union (EU) is an economic and political union made up of 27 member states that are located primarily in Europe.
- Members of the EU include Austria, Belgium, Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom.
- The EU operates through a system of supranational independent institutions and intergovernmental negotiated decisions by the member states.
- Within the Schengen Area (which includes EU and non-EU states) passport controls have been abolished.
- The creation of a single currency became an official objective of the European Economic Community (EEC) in 1969. On January 1, 2002 euro notes and coins were issued and national currencies began to phase out in the eurozone.
- The ECB is the central bank for the eurozone, and thus controls monetary policy in that area with an agenda to maintain price stability. It is at the center of the European System of Central Banks, which comprises all EU national central banks and is controlled by its General Council, consisting of the President of the ECB, who is appointed by the European Council, the Vice-President of the ECB, and the governors of the national central banks of all 27 EU member states.
Key Terms
- European Union
-
A supranational organization created in the 1950s to bring the nations of Europe into closer economic and political connection. At the beginning of 2012, 27 member nations were Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, United Kingdom.
- euro
-
The currency unit of the European Monetary Union. Symbol: €
- transparency
-
Open, public; having the property that theories and practices are publicly visible, thereby reducing the chance of corruption.
Example
- The euro is designed to help build a single market by easing travel of citizens and goods, eliminating exchange rate problems, providing price transparency, creating a single financial market, stabilizing prices, maintaining low interest rates, and providing a currency used internationally and protected against shocks by the large amount of internal trade within the eurozone. It is also intended as a political symbol of integration.
The European Union
The European Union (EU) is an economic and political union or confederation of 27 member states that are located in Europe, including:
Austria, Belgium, Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom.
The EU operates through a system of supranational independent institutions and intergovernmental decisions negotiated by the member states. Important institutions of the EU include the European Commission, the Council of the European Union, the European Council, the Court of Justice of the European Union, and the European Central Bank. The European Parliament is elected every five years by EU citizens. The EU has developed a single market through a standardized system of laws that apply in all member states. Within the Schengen Area (which includes EU and non-EU states) passport controls have been abolished. EU policies aim to ensure the free movement of people, goods, services, and capital, enact legislation in justice and home affairs, and maintain common policies on trade, agriculture, fisheries, and regional development. A monetary union, the eurozone, was established in 1999, and as of January 2012, is composed of 17 member states. Through the Common Foreign and Security Policy the EU has developed a limited role in external relations and defense. Permanent diplomatic missions have been established around the world. The EU is represented at the United Nations, the WTO, the G8 and the G-20.
The Euro
The creation of a single European currency became an official objective of the European Economic Community in 1969. However, it was only with the advent of the Maastricht Treaty in 1993 that member states were legally bound to start the monetary union. In 1999 the euro was duly launched by eleven of the then fifteen member states of the EU. It remained an accounting currency until 1 January 2002, when euro notes and coins were issued and national currencies began to phase out in the eurozone, which by then consisted of twelve member states. The eurozone (constituted by the EU member states that have adopted the euro) has since grown to seventeen countries, the most recent being Estonia, which joined on 1 January 2011. All other EU member states, except Denmark and the United Kingdom, are legally bound to join the euro when the convergence criteria are met, however only a few countries have set target dates for accession. Sweden has circumvented the requirement to join the euro by not meeting the membership criteria.
The euro is designed to help build a single market by easing travel of citizens and goods, eliminating exchange rate problems, providing price transparency, creating a single financial market, stabilizing prices, maintaining low interest rates, and providing a currency used internationally and protected against shocks by the large amount of internal trade within the eurozone. It is also intended as a political symbol of integration. The euro and the monetary policies of those who have adopted it in agreement with the EU are under the control of the European Central Bank (ECB). The ECB is the central bank for the eurozone, and thus controls monetary policy in that area with an agenda to maintain price stability. It is at the center of the European System of Central Banks, which comprises all EU national central banks and is controlled by its General Council, consisting of the President of the ECB, who is appointed by the European Council, the Vice-President of the ECB, and the governors of the national central banks of all 27 EU member states. The monetary union has been shaken by the European sovereign-debt crisis since 2009.
14.4.7: The Asia-Pacific Economic Cooperation
APEC is a forum for 21 Pacific Rim countries that seeks to promote free trade and economic cooperation throughout the Asia-Pacific region.
Learning Objective
Explain the role The Asia-Pacific Economic Cooperation (APEC ) plays in ensuring free trade
Key Points
- Asia-Pacific Economic Cooperation (APEC) is a forum for 21 Pacific Rim countries that seeks to promote free trade and economic cooperation.
- APEC was established in 1989 in response to the growing interdependence of Asia-Pacific economies and the advent of regional economic blocs.
- APEC member countries include Australia, Brunei, Canada, Chile, China, Hong Kong (Hong Kong, China), Indonesia, Japan, South Korea, Mexico, Malaysia, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Taiwan (Chinese Taipei), Thailand, United States, and Vietnam.
- During the meeting in 1994 in Bogor, Indonesia, APEC leaders adopted the Bogor Goals which aim for free and open trade and investment in the Asia-Pacific by 2010, for industrialized economies and by 2020, for developing economies.
Key Term
- bloc
-
A group of countries acting together for political or economic goals, an alliance (e.g., the eastern bloc, the western bloc, a trading bloc).
The Asia-Pacific Economic Cooperation (APEC) is a forum for 21 Pacific Rim countries (formally Member Economies) that seeks to promote free trade and economic cooperation throughout the Asia-Pacific region. Established in 1989 in response to the growing interdependence of Asia-Pacific economies and the advent of regional economic blocs (such as the European Union) in other parts of the world, APEC works to raise living standards and education levels through sustainable economic growth and to foster a sense of community and an appreciation of shared interests among Asia-Pacific countries.
Member countries are: Australia, Brunei, Canada, Chile, China, Hong Kong (Hong Kong, China), Indonesia, Japan, South Korea, Mexico, Malaysia, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Taiwan (Chinese Taipei), Thailand, United States, and Vietnam.
During the meeting in 1994 in Bogor, Indonesia, APEC leaders adopted the Bogor Goals that aim for free and open trade and investment in the Asia-Pacific by 2010, for industrialized economies and by 2020, for developing economies. In 1995, APEC established a business advisory body named the APEC Business Advisory Council (ABAC), composed of three business executives from each member economy. To meet the Bogor Goals, APEC carries out work in three main areas:
- Trade and investment liberalization
- Business facilitation
- Economic and technical cooperation
APEC is considering the prospects and options for a Free Trade Area of the Asia-Pacific (FTAAP), which would include all APEC member economies. Since 2006, the APEC Business Advisory Council, promoting the theory that a free trade area has the best chance of converging the member nations and ensuring stable economic growth under free trade, has lobbied for the creation of a high-level task force to study and develop a plan for a free trade area. The proposal for a FTAAP arose due to the lack of progress in the Doha round of World Trade Organization negotiations, and as a way to overcome the “spaghetti bowl” effect created by overlapping and conflicting elements of the umpteen free trade agreements. There are approximately 60 free trade agreements, with an additional 117 in the process of negotiation in Southeast Asia and the Asia-Pacific region.
14.4.8: The General Agreement on Tariffs and Trade (GATT)
The General Agreement on Tariffs and Trade (GATT) is a multilateral agreement regulating international trade.
Learning Objective
Outline the history of the creation of the General Agreement on Tariffs and Trade (GATT)
Key Points
- The General Agreement on Tariffs and Trade (GATT) is a multilateral agreement regulating international trade, the purpose of which is the “substantial reduction of tariffs and other trade barriers and the elimination of preferences, on a reciprocal and mutually advantageous basis”.
- The failure to create the International Trade Organization (ITO) resulted in the GATT negotiation at the UN Conference on Trade and Employment.
- GATT was in place from 1947-1993, when it was replaced by the World Trade Organization (WTO) in 1995.
- GATT text is still in effect under the WTO framework, subject to modifications.
- During GATT’s eight rounds, countries exchanged tariff concessions and reduced tariffs.
Key Terms
- multilateral
-
Involving more than one party (often used in politics to refer to negotiations, talks, or proceedings involving several nations).
- tariff
-
A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.
The General Agreement on Tariffs and Trade (GATT) is a multilateral agreement regulating international trade. According to its preamble, its purpose is the “substantial reduction of tariffs and other trade barriers and the elimination of preferences, on a reciprocal and mutually advantageous basis. ” GATT was negotiated during the UN Conference on Trade and Employment and was the outcome of the failure of negotiating governments to create the International Trade Organization (ITO). GATT was signed in 1947 and lasted until 1993, when it was replaced by the World Trade Organization (WTO) in 1995. The original GATT text (GATT 1947) is still in effect under the WTO framework, subject to the modifications of GATT 1994.
GATT held a total of eight rounds, during which countries exchanged tariff concessions and reduced tariffs.
In 1993, the GATT was updated (GATT 1994) to include new obligations upon its signatories. One of the most significant changes was the creation of the WTO. The 75 existing GATT members and the European Communities became the founding members of the WTO on January 1, 1995. The other 52 GATT members rejoined the WTO in the following two years, the last being Congo in 1997. Since the founding of the WTO, 21 new non-GATT members have joined and 29 are currently negotiating membership. There are a total of 157 member countries in the WTO, with Russia and Vanuatu being new members as of 2012.
Of the original GATT members, Syria and SFR Yugoslavia (SFRY) have not rejoined the WTO. Because FR Yugoslavia (later renamed Serbia and Montenegro) is not recognized as a direct SFRY successor state, its application is considered a new (non-GATT) one. The General Council of WTO, on 4 May 2010, agreed to establish a working party to examine the request of Syria for WTO membership. The contracting parties who founded the WTO ended official agreement of the “GATT 1947” terms on 31 December 1995. Serbia and Montenegro are in the decision stage of the negotiations and are expected to become the newest members of the WTO in 2012 or in the near future.
14.5: Types of International Business
14.5.1: Countertrade
Countertrade is a system of exchange in which goods and services are used as payment rather than money.
Learning Objective
Explain the various methods of countertrading
Key Points
- Countertrade is the exchange of goods or services for other goods or services. This system can be typified as simple bartering, switch trading, counter purchase, buyback, or offset.
- Switch trading: Party A and B are countertrading salt for sugar. Party A may switch its obligation to pay Party B to a third party, known as the switch trader. The switch trader gets the sugar from Party B at a discount and sells it for money. The money is used as Party A’s payment to Party B.
- Counter purchase: Party A sells salt to Party B. Party A promises to make a future purchase of sugar from Party B.
- Buyback: Party A builds a salt processing plant in Country B, providing capital to this developing nation. In return, Country B pays Party A with salt from the plant.
- Offset agreement: Party A and Country B enter a contract where Party A agrees to buy sugar from Country B to manufacture candy. Country B then buys that candy.
Key Terms
- Switch trading
-
Practice in which one company sells to another its obligation to make a purchase in a given country.
- counter purchase
-
Sale of goods and services to one company in another country by a company that promises to make a future purchase of a specific product from the same company in that country.
- barter
-
The exchange of goods or services without involving money.
Examples
- Bartering: One party gives salt in exchange for sugar from another party.
- Switch trading: Party A and Party B are countertrading salt for sugar. Party A may switch its obligation to pay Party B to a third party, known as the switch trader. The switch trader gets the sugar from Party B at a discount and sells it for money. The money is used as Party A’s payment to Party B.
- Counter purchase: Party A sells salt to Party B. Party A promises to make a future purchase of sugar from Party B.
- Buyback: Party A builds a salt processing plant in Country B, providing capital to this developing nation. In return, Country B pays Party A with salt from the plant.
- Offset agreement: Party A and Country B enter a contract where Party A agrees to buy sugar from Country B to manufacture candy. Country B then buys that candy.
Countertrade means exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money. A monetary valuation can, however, be used in counter trade for accounting purposes. Any transaction involving exchange of goods or service for something of equal value.
There are five main variants of countertrade:
- Barter: Exchange of goods or services directly for other goods or services without the use of money as means of purchase or payment.
- Switch trading: Practice in which one company sells to another its obligation to make a purchase in a given country.
- Counter purchase: Sale of goods and services to one company in aother country by a company that promises to make a future purchase of a specific product from the same company in that country.
- Buyback: This occurs when a firm builds a plant in a country, or supplies technology, equipment, training, or other services to the country, and agrees to take a certain percentage of the plant’s output as partial payment for the contract.
- Offset: Agreement that a company will offset a hard currency purchase of an unspecified product from that nation in the future. Agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation.
Countertrade also occurs when countries lack sufficient hard currency or when other types of market trade are impossible. In 2000, India and Iraq agreed on an “oil for wheat and rice” barter deal, subject to UN approval under Article 50 of the UN Persian Gulf War sanctions, that would facilitate 300,000 barrels of oil delivered daily to India at a price of $6.85 a barrel, while Iraq oil sales into Asia were valued at about $22 a barrel. In 2001, India agreed to swap 1.5 million tonnes of Iraqi crude under the oil-for-food program.
14.5.2: Direct Investment
FDI is practiced by companies in order to benefit from cheaper labor costs, tax exemptions, and other privileges in that foreign country.
Learning Objective
Explain the effects of foreign direct investment (FDI) for the investor and the host country
Key Points
- FDI is the flow of investments from one company to production in a foreign nation, with the purpose of lowering labor costs and gaining tax incentives.
- FDI can help the economic situations of developing countries, as well as facilitate progressive internal policy reforms.
- A major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions.
Key Term
- Foreign direct investment
-
investment directly into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.
Example
- Intel is headquartered in the United States, but it has made foreign direct investments in a number of Southeast Asian countries where they produce components of their products in Intel-owned factories.
Foreign direct investment (FDI) is investment into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.
FDI is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges, such as tax exemptions, offered by the country as an incentive to gain tariff-free access to the markets of the country or the region. FDI is in contrast to portfolio investment which is a passive investment in the securities of another country, such as stocks and bonds.
One theory for how to best help developing countries, is to increase their inward flow of FDI. However, identifying the conditions that best attract such investment flow is difficult, since foreign investment varies greatly across countries and over time. Knowing what has influenced these decisions and the resulting trends in outcomes can be helpful for governments, non-governmental organizations, businesses, and private donors looking to invest in developing countries.
A study from scholars at Duke University and Princeton University published in the American Journal of Political Science, “The Politics of Foreign Direct Investment into Developing Countries: Increasing FDI through International Trade Agreements,” examines trends in FDI from 1970 to 2000 in 122 developing countries to assess what the best conditions are for attracting investment. The study found the major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions. The researchers conclude that, while “democracy can be conducive to international cooperation,” the strongest indicator for higher inward flow of FDI for developing countries was the number of trade agreements and institutions to which they were party.
14.5.3: Franchising
Franchising enables organizations a low cost and localized strategy to expanding to international markets, while offering local entrepreneurs the opportunity to run an established business.
Learning Objective
Examine the benefits of international franchising
Key Points
- A franchise agreement is defined as the franchiser granting an entrepreneur or local company (the franchisee) access to its brand, trademarks, and products.
- Franchising is designed to enable large organizations rapid access to new markets with relatively low barriers to entry.
- Advantages of franchising (for the franchiser) include low costs of entry, a localized workforce (culturally and linguistically), and a high speed method of market entry.
- Disadvantages of franchising (for the franchiser) include loss of some organizational and brand control, as well as relatively lower returns than other strategic entry models (albeit, with lower risk).
Key Terms
- franchisee
-
A holder of a franchise; a person who is granted a franchise.
- franchiser
-
A franchisor, a company or person who grants franchises.
What is Franchising?
In franchising, an organization (the franchiser) has the option to grant an entrepreneur or local company (the franchisee) access to its brand, trademarks, and products.
In this arrangement, the franchisee will take the majority of the risk in opening a new location (e.g. capital investments) while gaining the advantage of an already established brand name and operational process. In exchange, the franchisee will pay a certain percentage of the profits of the venture back to the franchiser. The franchiser will also often provide training, advertising, and assistance with products.
Why Franchise
Lower Barriers to Entry
Franchising is a particularly useful practice when approaching international markets. For the franchiser, international expansion can be both complex and expensive, particularly when the purchase of land and building of facilities is necessary. With legal, cultural, linguistics, and logistical barriers to entry in various global markets, the franchising model offers and simpler, cleaner solution that can be implemented relatively quickly.
Localization
Franchising also allows for localization of the brand, products, and distribution systems. This localization can cater to local tastes and language through empowering locals to own, manage, and employ the business. This high level of integration into the new location can create significant advantages compared to other entry models, with much lower risk.
Speed
It is also worth noting that franchising is a very efficient, low cost and quickly implemented expansionary strategy. Franchising requires very little capital investment on behalf of the parent company, and the time and effort of building the stores are similar outsources to the franchisee. As a result, franchising can be a way to rapidly expand both domestically and globally.
Downsides to Franchising
Franchising has some weaknesses as well, from a strategic point of view. Most importantly, organizations (the franchisers) lose a great deal of control. Quality assurance and protection of the brand is much more difficult when ownership of the franchise is external to the organization itself. Choosing partners wisely and equipping them with the tools necessary for high levels of quality and alignment with the brand values is critical (e.g., training, equipment, quality control, adequate resources).
It is also of importance to keep the risk/return ratio in mind. While the risk of franchising is much lower in terms of capital investment, so too is the returns derived from operations (depending on the franchising agreement in place). While it is a faster and cheaper mode of entry, it ultimately results in a profit share between the franchiser and the franchisee.
14.5.4: Multinational Firms
With the advent of improved communication and technology, corporations have been able to expand into multiple countries.
Learning Objective
Explain how a multinational corporation (MNC) operates
Key Points
- Multinational corporations operate in multiple countries.
- MNCs have considerable bargaining power and may negotiate business or trade policies with success.
- A corporation may choose to locate in a special economic zone, a geographical region that has economic and other laws that are more free-market-oriented than a country’s typical or national laws.
Key Term
- Multinational corporation
-
A corporation or enterprise that operates in multiple countries.
Example
- McDonalds operates in over 119 different countries, making it a fairly large MNC by any standard
A multinational corporation (MNC) or multinational enterprise (MNE) is a corporation registered in more than one country or has operations in more than one country. It is a large corporation which both produces and sells goods or services in various countries . It can also be referred to as an international corporation. The first multinational corporation was the Dutch East India Company, founded March 20, 1602.
Corporations may make a foreign direct investment. Foreign direct investment is direct investment into one country by a company located in another country. Investors buy a company in the country or expand operations of an existing business in the country.
A corporation may choose to locate in a special economic zone, a geographical region with economic and other laws that are more free-market-oriented than a country’s typical or national laws.
Multinational corporations are important factors in the processes of globalization. National and local governments often compete against one another to attract MNC facilities, with the expectation of increased tax revenue, employment and economic activity. To compete, political powers push toward greater autonomy for corporations. MNCs play an important role in developing economies of developing countries.
Many economists argue that in countries with comparatively low labor costs and weak environmental and social protection, multinationals actually bring about a “race to the top.” While multinationals will see a low tax burden or low labor costs as an element of comparative advantage, MNC profits are tied to operational efficiency, which includes a high degree of standardization. Thus, MNCs are likely to adapt production processes in many of their operations to conform to the standards of the most rigorous jurisdiction in which they operate.
As for labor costs, while MNCs pay workers in developing countries far below levels in countries where labor productivity is high (and accordingly, will adopt more labor-intensive production processes), they also tend to pay a premium over local labor rates of 10% to 100%.
Finally, depending on the nature of the MNC, investment in any country reflects a desire for a medium- to long-term return, as establishing a plant, training workers and so on can be costly. Therefore, once established in a jurisdiction, MNCs are potentially vulnerable to arbitrary government intervention like expropriation, sudden contract renegotiation and the arbitrary withdrawal or compulsory purchase of licenses. Thus both the negotiating power of MNCs and the “race to the bottom” critique may be overstated while understating the benefits (besides tax revenue) of MNCs becoming established in a jurisdiction.
14.5.5: Offshoring
Offshoring entails a company moving a business process from one country to another.
Learning Objective
Explain the benefits of offshoring
Key Points
- Offshoring is the relocation of certain business processes from one country to the other, resulting in large tax breaks and lower labor costs.
- Offshoring can cause controversy in a company’s domestic country since it is perceived to impact the domestic employment situation negatively.
- Offshoring of a company’s services that were previously produced domestically can be advantageous in lowering operation costs, but has incited some controversy over the economic implications.
Key Terms
- offshoring
-
The location of a business in another country for tax purposes.
- outsourcing
-
The transfer of a business function to an external service provider.
- captive
-
held prisoner; not free; confined
“Offshoring” is a company’s relocation of a business process from one country to another. This typically involves an operational process, such as manufacturing, or a supporting process, such as accounting. Even state governments employ offshoring. More recently, offshoring has been associated primarily with the sourcing of technical and administrative services that support both domestic and global operations conducted outside a given home country by means of internal (captive) or external (outsourcing) delivery models.The subject of offshoring, also known as “outsourcing,” has produced considerable controversy in the United States. Offshoring for U.S. companies can result in large tax breaks and low-cost labor.
Offshoring can be seen in the context of either production offshoring or services offshoring. After its accession to the World Trade Organization (WTO) in 2001, the People’s Republic of China emerged as a prominent destination for production offshoring. Another focus area includes the software industry as part of Global Software Development and the development of Global Information Systems. After technical progress in telecommunications improved the possibilities of trade in services, India became a leader in this domain; however, many other countries are now emerging as offshore destinations.
The economic logic is to reduce costs. People who can use some of their skills more cheaply than others have a comparative advantage. Countries often strive to trade freely items that are of the least cost to produce.
Related terms include “nearshoring,” “inshoring,” and “bestshoring,” otherwise know as “rightshoring.” Nearshoring is the relocation of business processes to (typically) lower cost foreign locations that are still within close geographical proximity (for example, shifting United States-based business processes to Canada/Latin America). Inshoring entails choosing services within a country, while bestshoring entails choosing the “best shore” based on various criteria. Business process outsourcing (BPO) refers to outsourcing arrangements when entire business functions (such as Finance & Accounting and Customer Service) are outsourced. More specific terms can be found in the field of software development; for example, Global Information System as a class of systems being developed for/by globally distributed teams.
14.5.6: Joint Ventures
In a joint venture business model, two or more parties agree to invest time, equity, and effort for the development of a new shared project.
Learning Objective
Outline the dynamics of a joint venture
Key Points
- Joint business ventures involve two parties contributing their own equity and resources to develop a new project. The enterprise, revenues, expenses and assets are shared by the involved parties.
- Since money is involved in a joint venture, it is necessary to have a strategic plan in place.
- As the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project as well as the resulting profits.
Key Term
- joint venture
-
A cooperative partnership between two individuals or businesses in which profits and risks are shared.
Example
- Sony Ericsson is a joint venture between Swedish telecom corporation Ericsson and Japanese electronics manufacturer Sony to develop cellular devices.
Joint Ventures
A joint venture is a business agreement in which parties agree to develop a new entity and new assets by contributing equity. They exercise control over the enterprise and consequently share revenues, expenses and assets.
When two or more persons come together to form a partnership for the purpose of carrying out a project, this is called a joint venture. In this scenario, both parties are equally invested in the project in terms of money, time and effort to build on the original concept. While joint ventures are generally small projects, major corporations use this method to diversify. A joint venture can ensure the success of smaller projects for those that are just starting in the business world or for established corporations. Since the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project as well as the resulting profits.
Since money is involved in a joint venture, it is necessary to have a strategic plan in place. In short, both parties must be committed to focusing on the future of the partnership rather than just the immediate returns. Ultimately, short term and long term successes are both important.To achieve this success, honesty, integrity and communication within the joint venture are necessary.
A consortium JV (also known as a cooperative agreement) is formed when one party seeks technological expertise, franchise and brand-use agreements, management contracts, and rental agreements for one-time contracts. The JV is dissolved when that goal is reached. Some major joint ventures include Dow Corning, MillerCoors, Sony Ericsson, Penske Truck Leasing, Norampac, and Owens-Corning.
14.5.7: Outsourcing
Outsourcing business functions to developing foreign countries has become a popular way for companies to reduce cost.
Learning Objective
Explain why companies outsource
Key Points
- Outsourcing is the contracting of business processes to external firms, usually in developing countries where labor costs are cheaper.
- This practice has increased in prevalence due to better technology and improvements in the educational standards of the countries to which jobs are outsourced.
- The opposite of outsourcing is called insourcing, and it is sometimes accomplished via vertical integration. However, a business can provide a contract service to another business without necessarily insourcing that business process.
Key Terms
- insourcing
-
The obtaining of goods or services using domestic resources or employees as opposed to foreign.
- outsourcing
-
The transfer of a business function to an external service provider.
- offshoring
-
The location of a business in another country for tax purposes.
Example
- Corporations may outsource their helpdesk or customer service functions to 3rd party call centers in foreign countries because these skilled laborers can do these jobs at a lesser cost than their equivalents in the domestic country.
Outsourcing
Overview
Outsourcing is the contracting out of a business process, which an organization may have previously performed internally or has a new need for, to an independent organization from which the process is purchased back as a service. Though the practice of purchasing a business function—instead of providing it internally—is a common feature of any modern economy, the term outsourcing became popular in America near the turn of the 21st century. An outsourcing deal may also involve transfer of the employees and assets involved to the outsourcing business partner. The definition of outsourcing includes both foreign or domestic contracting , which may include offshoring, described as “a company taking a function out of their business and relocating it to another country. “
The opposite of outsourcing is called insourcing, and it is sometimes accomplished via vertical integration. However, a business can provide a contract service to another business without necessarily insourcing that business process.
Reasons for Outsourcing
Companies outsource to avoid certain types of costs. Among the reasons companies elect to outsource include avoidance of burdensome regulations, high taxes, high energy costs, and unreasonable costs that may be associated with defined benefits in labor union contracts and taxes for government mandated benefits. Perceived or actual gross margin in the short run incentivizes a company to outsource. With reduced short run costs, executive management sees the opportunity for short run profits while the income growth of the consumers base is strained. This motivates companies to outsource for lower labor costs. However, the company may or may not incur unexpected costs to train these overseas workers. Lower regulatory costs are an addition to companies saving money when outsourcing.
Import marketers may make short run profits from cheaper overseas labor and currency mainly in wealth consuming sectors at the long run expense of an economy’s wealth producing sectors straining the home county’s tax base, income growth, and increasing the debt burden. When companies offshore products and services, those jobs may leave the home country for foreign countries at the expense of the wealth producing sectors. Outsourcing may increase the risk of leakage and reduce confidentiality, as well as introduce additional privacy and security concerns.
14.5.8: Importing
Imports are the inflow of goods and services into a country’s market for consumption.
Learning Objective
Explain the methodology behind the selection of products to import
Key Points
- A country specializes in the export of goods for which it has a comparative advantage and imports those for which it has a comparative disadvantage. By doing so, the country can increase its welfare.
- Comparative advantage describes the ability of a country to produce one specific good more efficiently than other goods.
- A country enhances its welfare by importing a broader range of higher-quality goods and services at lower cost than it could produce domestically.
Key Terms
- import
-
To bring (something) in from a foreign country, especially for sale or trade.
- comparative advantage
-
The concept that a certain good can be produced more efficiently than others due to a number of factors, including productive skills, climate, natural resource availability, and so forth.
Example
- A country in certain tropical areas of the world has a comparative advantage at growing crops like sugar or coffee beans, but it would be much less efficient at growing wheat (due to the climate). Therefore, they should export their sugar/coffee beans and import wheat at a lower cost than trying to grow wheat themselves.
The term “import” is derived from the concept of goods and services arriving into the port of a country. The buyer of such goods and services is referred to as an “importer” and is based in the country of import whereas the overseas-based seller is referred to as an “exporter.” Thus, an import is any good (e.g. a commodity) or service brought in from one country to another country in a legitimate fashion, typically for use in trade. It is a good that is brought in from another country for sale.
Imported goods or services are provided to domestic consumers by foreign producers. An import in the receiving country is an export to the sending country. Imports, along with exports, form the basics of international trade. Import of goods normally requires the involvement of customs authorities in both the country of import and the country of export; those goods are often subject to import quotas, tariffs, and trade agreements. While imports are the set of goods and services imported, “imports” also means the economic value of all goods and services that are imported.
Imports are the inflow of goods and services into a country’s market for consumption. A country enhances its welfare by importing a broader range of higher-quality goods and services at lower cost than it could produce domestically. Comparative advantage is a concept often applied to importing and exporting. Comparative advantage is the concept that a country should specialize in the production and export of those goods and services that it can produce more efficiently than other goods and services, and that it should import those goods and services in which it has a comparative disadvantage.
14.5.9: Licensing
When considering strategic entry into an international market, licensing is a low-risk and relatively fast foreign market entry tactic.
Learning Objective
Identify the benefits and risks associated with licensing as a foreign market entry model
Key Points
- Foreign market entry options include exporting, joint ventures, foreign direct investment, franchising, licensing, and various other forms of strategic alliance.
- Of these potential entry models, licensing is relatively low risk in terms of time, resources, and capital requirements.
- Advantages of licensing include localization through a foreign partner, adherence to strict international business regulations, lower costs, and the ability to move quickly.
- Disadvantages to this entry mode include loss of control, potential quality assurance issues in the foreign market, and lower returns due to lower risk.
- When deciding to license abroad, careful due diligence should be done to ensure that the licensee is a strong investment for the licensor and vice versa.
Key Terms
- licensee
-
In a licensing relationship, the buyer of the produce, service, brand or technology being licensed.
- licensor
-
In a licensing relationship, the owner of the produce, service, brand or technology being licensed.
When considering entering international markets, there are some significant strategic and tactical decisions to be made. Exporting, joint ventures, direct investment, franchising, licensing, and various other forms of strategic alliance can be considered as market entry modes. Each entry mode has different pros and cons, addressing issues like cost, control, speed to market, legal barriers, and cultural barriers with different degrees of efficiency.
What is Licensing
A licensor (i.e. the firm with the technology or brand) can provide their products, services, brand and/or technology to a licensee via an agreement. This agreement will describe the terms of the strategic alliance, allowing the licensor affordable and low risk entry to a foreign market while the licensee can gain access to the competitive advantages and unique assets of another firm. This is potentially a strong win-win arrangement for both parties, and is a relatively common practice in international business.
Let’s consider an example. The licensor is a company involved in energy health drinks. Due to food import regulations in Japan, the licensor cannot sell the product at local wholesalers or retailers. In order to circumvent this strategic barrier, the licensor finds a local sports drink manufacturer to license their recipe to. In exchange, the licensee sells the product locally under a local brand name and kicks back 15% of the overall revenues to the licensor.
The Pros and Cons
Before deciding to use licensing as an entry strategy, it’s important to understand in which situations licensing is best suited.
Advantages
Licensing affords new international entrants with a number of advantages:
- Licensing is a rapid entry strategy, allowing almost instant access to the market with the right partners lined up.
- Licensing is low risk in terms of assets and capital investment. The licensee will provide the majority of the infrastructure in most situations.
- Localization is a complex issue legally, and licensing is a clean solution to most legal barriers to entry.
- Cultural and linguistic barriers are also significant challenges for international entries. Licensing provides critical resources in this regard, as the licensee has local contacts, mastery of local language, and a deep understanding of the local market.
Disadvantages
While the low-cost entry and natural localization are definite advantages, licensing also comes with some opportunity costs:
- Loss of control is a serious disadvantage in a licensing situation in regards to quality control. Particularly relevant is the licensing of a brand name, as any quality control issue on behalf of the licensee will impact the licensor’s parent brand.
- Depending on an international partner also creates inherent risks regarding the success of that firm. Just like investing in an organization in the stock market, licensing requires due diligence regarding which organization to partner with.
- Lower revenues due to relying on an external party is also a key disadvantage to this model. (Lower risk, lower returns.)
14.5.10: Contract Manufacturing
In contract manufacturing, a hiring firm makes an agreement with the contract manufacturer to produce and ship the hiring firm’s goods.
Learning Objective
Compare the benefits and risks of employing a contract manufacturer (CM)
Key Points
- A hiring firm may enter a contract with a contract manufacturer (CM) to produce components or final products on behalf of the hiring firm for some agreed-upon price.
- There are many benefits to contract manufacturing, and companies are finding many reasons why they should be outsourcing their production to other companies.
- Production outside of the company does come with many risks attached. Companies must first identify their core competencies before deciding about contract manufacture.
Key Terms
- Contract manufacturing
-
a business model where a firm hires another firm to produce components or products
- Contract manufacturing
-
Business model in which a firm hires a contract manufacturer to produce components or final products based on the hiring firm’s design.
A contract manufacturer (“CM”) is a manufacturer that enters into a contract with a firm to produce components or products for that firm. It is a form of outsourcing. In a contract manufacturing business model, the hiring firm approaches the contract manufacturer with a design or formula. The contract manufacturer will quote the parts based on processes, labor, tooling, and material costs. Typically a hiring firm will request quotes from multiple CMs. After the bidding process is complete, the hiring firm will select a source, and then, for the agreed-upon price, the CM acts as the hiring firm’s factory, producing and shipping units of the design on behalf of the hiring firm.
Benefits
Contract manufacturing offers a number of benefits:
- Cost Savings: Companies save on their capital costs because they do not have to pay for a facility and the equipment needed for production. They can also save on labor costs such as wages, training, and benefits. Some companies may look to contract manufacture in low-cost countries, such as China, to benefit from the low cost of labor.
- Mutual Benefit to Contract Site: A contract between the manufacturer and the company it is producing for may last several years. The manufacturer will know that it will have a steady flow of business at least until that contract expires.
- Advanced Skills: Companies can take advantage of skills that they may not possess, but the contract manufacturer does. The contract manufacturer is likely to have relationships formed with raw material suppliers or methods of efficiency within their production.
- Quality: Contract Manufacturers are likely to have their own methods of quality control in place that help them to detect counterfeit or damaged materials early.
- Focus: Companies can focus on their core competencies better if they can hand off base production to an outside company.
- Economies of Scale: Contract Manufacturers have multiple customers that they produce for. Because they are servicing multiple customers, they can offer reduced costs in acquiring raw materials by benefiting from economies of scale. The more units there are in one shipment, the less expensive the price per unit will be.
Risks
Balanced against the above benefits of contract manufacturing are a number of risks:
- Lack of Control: When a company signs the contract allowing another company to produce their product, they lose a significant amount of control over that product. They can only suggest strategies to the contract manufacturer; they cannot force them to implement those strategies.
- Relationships: It is imperative that the company forms a good relationship with its contract manufacturer. The company must keep in mind that the manufacturer has other customers. They cannot force them to produce their product before a competitor’s. Most companies mitigate this risk by working cohesively with the manufacturer and awarding good performance with additional business.
- Quality: When entering into a contract, companies must make sure that the manufacturer’s standards are congruent with their own. They should evaluate the methods in which they test products to make sure they are of good quality. The company has to ensure the contract manufacturer has suppliers that also meet these standards.
- Intellectual Property Loss: When entering into a contract, a company is divulging their formulas or technologies. This is why it is important that a company not give out any of its core competencies to contract manufacturers. It is very easy for an employee to download such information from a computer and steal it. The recent increase in intellectual property loss has corporate and government officials struggling to improve security. Usually, it comes down to the integrity of the employees.
- Outsourcing Risks: Although outsourcing to low-cost countries has become very popular, it does bring along risks such as language barriers, cultural differences, and long lead times. This could make the management of contract manufacturers more difficult, expensive, and time-consuming.
- Capacity Constraints: If a company does not make up a large portion of the contract manufacturer’s business, they may find that they are de-prioritized over other companies during high production periods. Thus, they may not obtain the product they need when they need it.
- Loss of Flexibility and Responsiveness: Without direct control over the manufacturing facility, the company will lose some of its ability to respond to disruptions in the supply chain. It may also hurt their ability to respond to demand fluctuations, risking their customer service levels.
14.5.11: Exporting
Exporting is the practice of shipping goods from the domestic country to a foreign country.
Learning Objective
Explain how exports are accounted for in international trade
Key Points
- This term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country.
- In national accounts “exports” consist of transactions in goods and services (sales, barter, gifts or grants) from residents to non-residents.
- Statistics on international trade do not record smuggled goods or flows of illegal services. A small fraction of the smuggled goods and illegal services may nevertheless be included in official trade statistics through dummy shipments that serve to conceal the illegal nature of the activities.
Key Terms
- export
-
to sell (goods) to a foreign country
- import
-
To bring (something) in from a foreign country, especially for sale or trade.
- exporting
-
the sale of capital, goods, and services across international borders or territories
- exporting
-
the act of selling to a foreign country
Example
- When individuals from Country A purchase goods from Country B, this process is known as exporting for Country B (since their goods are being sold) and importing for Country A (since they are buying the goods).
This term “export” is derived from the concept of shipping goods and services out of the port of a country . The seller of such goods and services is referred to as an “exporter” who is based in the country of export whereas the overseas based buyer is referred to as an “importer”. In international trade, exporting refers to selling goods and services produced in the home country to other markets.
Export of commercial quantities of goods normally requires the involvement of customs authorities in both the country of export and the country of import. The advent of small trades over the internet such as through Amazon and eBay has largely bypassed the involvement of customs in many countries because of the low individual values of these trades. Nonetheless, these small exports are still subject to legal restrictions applied by the country of export. An export’s counterpart is an import.
In national accounts, exports consist of transactions in goods and services (sales, barter, gifts, or grants) from residents to non-residents.The exact definition of exports includes and excludes specific “borderline” cases. A general delimitation of exports in national accounts is as follows: An export of a good occurs when there is a change of ownership from a resident to a non-resident; this does not necessarily imply that the good in question physically crosses any border. However, in specific cases, national accounts impute changes of ownership even though in legal terms no change of ownership takes place (e.g. cross border financial leasing, cross border deliveries between affiliates of the same enterprise, goods crossing the border for significant processing to order or repair). Smuggled goods must also be included in the export measurement.
Export of services consist of all services rendered by residents to non-residents. In national accounts, any direct purchases by non-residents in the economic territory of a country are recorded as exports of services; therefore, all expenditure by foreign tourists in the economic territory of a country is considered part of the export of services of that country. International flows of illegal services must also be included.
National accountants often need to make adjustments to the basic trade data in order to comply with national accounts concepts; the concepts for basic trade statistics often differ in terms of definition and coverage from the requirements in the national accounts:
Data on international trade in goods is mostly obtained through declarations to customs services. If a country applies the general trade system, all goods entering or leaving the country are recorded. If the special trade system (e.g., extra-EU trade statistics) is applied, goods which are received into customs warehouses are not recorded in external trade statistics unless they subsequently go into free circulation in the country of receipt.
14.6: The Global Corporation
14.6.1: Definition and Challenges of a Global Corporation
Global corporations operate in two or more countries and face many challenges in their quest to capture value in the global market.
Learning Objective
Identify the most meaningful challenges encountered by multinational corporations (MNCs) when pursuing global markets and efficiencies
Key Points
- A multinational corporation (MNC) is present in several countries, which improves the company’s ability to maintain market share and earn higher profits.
- As GDP growth migrates from mature economies, such as the US and EU member states, to developing economies, such as China and India, it becomes highly relevant to capture growth in higher growth markets.
- Despite the general opportunities a global market provides, there are significant challenges in penetrating these markets. These consist of public relations, ethics, corporate structure, and leadership.
- Combining these challenges with the inherent opportunities a global economy presents, companies are encouraged to pursue high value opportunities while carefully controlling the risks involved.
Key Terms
- economies of scope
-
Lowering average cost for a firm in producing two or more products through the common and recurrent use of proprietary know-how or an indivisible physical asset.
- economies of scale
-
The characteristics of a production process in which an increase in the scale of the firm causes a decrease in the long run average cost of each unit.
- value-chain
-
The series of operations necessary for a business to operate.
Global Corporations
A global company is generally referred to as a multinational corporation (MNC). An MNC is a company that operates in two or more countries, leveraging the global environment to approach varying markets in attaining revenue generation. These international operations are pursued as a result of the strategic potential provided by technological developments, making new markets a more convenient and profitable pursuit both in sourcing production and pursuing growth.
International operations are therefore a direct result of either achieving higher levels of revenue or a lower cost structure within the operations or value-chain. MNC operations often attain economies of scale, through mass producing in external markets at substantially cheaper costs, or economies of scope, through horizontal expansion into new geographic markets. If successful, these both result in positive effects on the income statement (either larger revenues or stronger margins), but contain the innate risk in developing these new opportunities.
Opportunities
As gross domestic product (GDP) growth migrates from mature economies, such as the US and EU member states, to developing economies, such as China and India, it becomes highly relevant to capture growth in higher growth markets. is a particularly strong visual representation of the advantages a global corporation stands to capture, where the darker green areas reppresent where the highest GDP growth potential resides. High growth in the external environment is a strong opportunity for most incumbents in the market.
Challenges
However, despite the general opportunities a global market provides, there are significant challenges MNCs face in penetrating these markets. These challenges can loosely be defined through four factors:
- Public Relations: Public image and branding are critical components of most businesses. Building this public relations potential in a new geographic region is an enormous challenge, both in effectively localizing the message and in the capital expenditures necessary to create momentum.
- Ethics: Arguably the most substantial of the challenges faced by MNCs, ethics have historically played a dramatic role in the success or failure of global players. For example, Nike had its brand image hugely damaged through utilizing ‘sweat shops’ and low wage workers in developing countries. Maintaining the highest ethical standards while operating in developing countries is an important consideration for all MNCs.
- Organizational Structure: Another significant hurdle is the ability to efficiently and effectively incorporate new regions within the value chain and corporate structure. International expansion requires enormous capital investments in many cases, along with the development of a specific strategic business unit (SBU) in order to manage these accounts and operations. Finding a way to capture value despite this fixed organizational investment is an important initiative for global corporations.
- Leadership: The final factor worth noting is attaining effective leaders with the appropriate knowledge base to approach a given geographic market. There are differences in strategies and approaches in every geographic location worldwide, and attracting talented managers with high intercultural competence is a critical step in developing an efficient global strategy.
Combining these four challenges for global corporations with the inherent opportunities presented by a global economy, companies are encouraged to chase the opportunities while carefully controlling the risks to capture the optimal amount of value. Through effectively maintaining ethics and a strong public image, companies should create strategic business units with strong international leadership in order to capture value in a constantly expanding global market.
14.7: Managing International Corporations
14.7.1: Considerations when Managing a Global Corporation
Strong global management skills, intercultural competence, and a sensitivity to cultural issues are necessities for global managers.
Learning Objective
Recognize the considerations global managers are faced with as they integrate into a broader and more globalized business environment
Key Points
- As multinational corporations grow in both size and quantity, the inherent managerial implications of a fully globalized economy demonstrate higher levels of relevance and importance within global corporations.
- Global management skills are largely based in developing cultural intelligence, or a high cultural quotient (CQ), which delineates an individual’s general understanding and adaptability of foreign cultures.
- Once managers attain the appropriate levels of cultural intelligence, it becomes necessary to apply this to the corporate framework.
- Geographic and demographic expansions underline the critical importance of managers to understanding the illusive concept of localization.
- It is also critical in cross-cultural endeavors to maintain one’s own sense of values and ethics.
- To summarize these concepts, managers of global corporations are faced with substantial opportunities for growth alongside significant threats in cultural differences.
Key Terms
- localization
-
Act or process of making a product suitable for use in a particular country or region.
- globality
-
The end result of globalization, an economy entirely without geographic borders.
- cross-cultural knowledge
-
Expertise in varying cultures across the globe.
Considerations of Global Managers
As multinational corporations grow in both size and quantity, the inherent managerial implications of a fully globalized economy demonstrate higher levels of relevance and importance within global corporations. The development of global management skills, as well as the intercultural competence to identify and develop sensitivity to cultural issues, becomes a larger factor in the overall success of these business models. Through identifying the necessary global skill set and effectively implementing these global managers within the business structure, multinational corporations can attain competitive advantage through cross-cultural knowledge.
Cultural Intelligence
Global management skills are largely based in developing cultural intelligence, or a high cultural quotient (CQ), which delineates an individual’s general understanding and adaptability of foreign cultures. This is best achieved through understanding what constitutes a high level of intercultural competence and leveraging this confidence to achieve the desire results in global management (see Boundless’s “Cultural Intelligence” section). To summarize the concept of intercultural competence, the basics necessary for effectively developing this is a linguistic understanding, a cultural understanding (religion, ethics, values, etc.), and regional expertise (ethnicity/geography).
Localization
Once managers attain the appropriate levels of cultural intelligence, it becomes necessary to apply this to the corporate framework. Global management requires a high level of corporate strategy to effectively implement, as not only is the workforce developing in diversity but so is the customer base. Geographic and demographic expansions underline the critical importance of managers to understanding the illusive concept of localization, which in short defines the way in which a company’s product or service should be adapted to fill the specific needs of a particular culture, demography, or geographic region. Researching the failure of companies, such as Best Buy and Home Depot in China, and bench-marking this against the success of Pizza Hut or BMW, provides substantial insights as to the importance of localization to global managers.
What localization truly highlights is the need to hold a highly developed sensitivity to cultural issues, norms, and values. It is also critical in cross-cultural endeavors to maintain one’s own sense of values and ethics, particularly as differences in standards of living, GDP per capita, economic growth rates, and political environments come into play. The figure (see ) highlights the remarkable growth rates in developing economies such as China, but fails to note the human rights and legal complications for multinationals in approaching these markets in an ethical manner. With lower standards of livings in certain regions, as well as differences in capitalistic philosophies and legalities, sensitivity to cultural differences is absolutely crucial in sidestepping the pitfalls of merging cultures that contradict one another.
To summarize these concepts, managers of global corporations are faced with substantial opportunities for growth alongside significant threats in cultural differences. Sensitivity to important cultural considerations and the development of a highly perceptive intercultural competency is a prerequisite for any global corporations considering geographic expansion into a new market. With theories, such as globality underlining the trajectory of global inter-dependency, this opportunity is a necessary consideration to any multinational corporation hoping to remain a competitor in a fully globalized economy.
Example
Researching the failure of companies, such as Best Buy and Home Depot in China, and bench-marking this against the success of Pizza Hut or BMW, provides substantial insights as to the importance of localization to global managers.
13.1: Ethics, an Overview
13.1.1: Defining Ethics
Ethics are the set of moral principles that guide a person’s behavior.
Learning Objective
Define ethics and how it applies to organizations
Key Points
- Ethical behavior is based on written and unwritten codes of principles and values held in society.
- Ethics reflect beliefs about what is right, what is wrong, what is just, what is unjust, what is good, and what is bad in terms of human behavior.
- Ethical principles and values serve as a guide to behavior on a personal level, within professions, and at the organizational level.
Key Terms
- behavior
-
The way a living creature acts.
- ethics
-
The study of principles relating to right and wrong conduct.
- values
-
A collection of guiding principles; what one deems to be correct, important, and desirable in life, especially regarding personal conduct.
Ethics are the set of moral principles that guide a person’s behavior. These morals are shaped by social norms, cultural practices, and religious influences. Ethics reflect beliefs about what is right, what is wrong, what is just, what is unjust, what is good, and what is bad in terms of human behavior. They serve as a compass to direct how people should behave toward each other, understand and fulfill their obligations to society, and live their lives.
While ethical beliefs are held by individuals, they can also be reflected in the values, practices, and policies that shape the choices made by decision makers on behalf of their organizations. The phrases business ethics and corporate ethics are often used to describe the application of ethical values to business activities. Ethics applies to all aspects of conduct and is relevant to the actions of individuals, groups, and organizations.
In addition to individual ethics and corporate ethics there are professional ethics. Professionals such as managers, lawyers, and accountants are individuals who exercise specialized knowledge and skills when providing services to customers or to the public. By virtue of their profession, they have obligations to those they serve. For example, lawyers must hold client conversations confidential and accountants must display the highest levels of honest and integrity in their record keeping and financial analysis. Professional organizations, such as the American Medical Association, and licensing authorities, such as state governments, set and enforce ethical standards.
Example
The concept of corporate social responsibility emphasizes ethical behavior in that it requires organizations to understand, identify, and eliminate unethical economic, environmental, and social behaviors.
13.1.2: Ethics Training
Moral reasoning is the process in which an individual tries to determine what is right and what is wrong.
Learning Objective
Explain the role of ethical moral reasoning in the business environment
Key Points
- There are four components of moral behavior: moral sensitivity, moral judgment, moral motivation, and moral character.
- To make moral assessments, one must first know what an action is intended to accomplish and what its possible consequences will be on others.
- Studies have uncovered four skill sets that play a decisive role in the exercise of moral expertise: moral imagination, moral creativity, reasonableness, and perseverance.
Key Terms
- goodwill
-
The ability of an individual or business to exert influence within a community, club, market, or another type of group, without having to resort to the use of an asset (such as money or property).
- ethics
-
The study of principles relating to right and wrong conduct.
Moral reasoning is the process in which an individual tries to determine the difference between what is right and what is wrong in a personal situation by using logic. To make such an assessment, one must first know what an action is intended to accomplish and what its possible consequences will be on others. People use moral reasoning in an attempt to do the right thing. People are frequently faced with moral choices, such as whether to lie to avoid hurting someone’s feelings, or whether to take an action that will benefit some while harming others. Such judgements are made by considering the objective and the likely consequences of an action. Moral reasoning is the consideration of the factors relevant to making these types of assessments.
According to consultant Lynn W. Swaner, moral behavior has four components:
-
Moral sensitivity, which is “the ability to see an ethical dilemma, including how our actions will affect others.”
-
Moral judgment, which is “the ability to reason correctly about what ‘ought’ to be done in a specific situation.”
-
Moral motivation, which is “a personal commitment to moral action, accepting responsibility for the outcome.”
-
Moral character, which is a “courageous persistence in spite of fatigue or temptations to take the easy way out.”
The ability to think through moral issues and dilemmas, then, requires an awareness of a set of moral and ethical values; the capacity to think objectively and rationally about what may be an emotional issue; the willingness to take a stand for what is right, even in the face of opposition; and the fortitude and resilience to maintain one’s ethical and moral standards.
Realizing good conduct, being an effective moral agent, and bringing values into one’s work, all require skills in addition to a moral inclination. Studies have uncovered four skill sets that play a decisive role in the exercise of moral expertise.
-
Moral imagination: The ability to see the situation through the eyes of others. Moral imagination achieves a balance between becoming lost in the perspectives of others and failing to leave one’s own perspective. Adam Smith terms this balance “proportionality,” which we can achieve in empathy.
-
Moral creativity: Moral creativity is closely related to moral imagination, but it centers on the ability to frame a situation in different ways.
-
Reasonableness: Reasonableness balances openness to the views of others with commitment to moral values and other important goals. That is, a reasonable person is open, but not to the extent where he is willing to believe just anything and/or fails to keep fundamental commitments.
-
Perseverance: Perseverance is the ability to decide on a moral plan of action and then to adapt to any barriers that arise in order to continue working toward that goal.
Example
William LeMesseur designed the Citicorp Building in New York. When a student identified a critical design flaw in the building during a routine class exercise, LeMesseur responded not by shooting the messenger but by developing an intricate and effective plan for correcting the problem before it resulted in drastic real-world consequences.
13.1.3: Culture and Ethics
Culture reflects the moral values and ethical norms governing how people should behave and interact with others.
Learning Objective
Explain the role of culture in shaping moral and ethical behavior
Key Points
- Culture refers to the outlook, attitudes, values, goals, and practices shared by a group, organization, or society.
- Interpretation of what is moral is influenced by cultural norms, and different cultures can have different beliefs about what is right and wrong.
- According to the theory of cultural relativism, there is no singular truth on which to base ethical or moral behavior, as our interpretations of truths are influenced by our own culture.
Key Terms
- norms
-
Rules or laws that govern a group’s or a society’s behaviors.
- moral relativism
-
Refers to any of several philosophical positions concerned with the differences in moral judgments among different people and across different cultures.
- ethnocentric
-
Of the idea or belief that one’s own culture is more important than, or superior to, other cultures.
Culture describes a collective way of life, or way of doing things. It is the sum of attitudes, values, goals, and practices shared by individuals in a group, organization, or society. Cultures vary over time periods, between countries and geographic regions, and among groups and organizations. Culture reflects the moral and ethical beliefs and standards that speak to how people should behave and interact with others.
Cultural norms are the shared, sanctioned, and integrated systems of beliefs and practices that are passed down through generations and characterize a cultural group. Norms cultivate reliable guidelines for daily living and contribute to the health and well-being of a culture. They act as prescriptions for correct and moral behavior, lend meaning and coherence to life, and provide a means of achieving a sense of integrity, safety, and belonging. These normative beliefs, together with related cultural values and rituals, impose a sense of order and control on aspects of life that might otherwise appear chaotic or unpredictable.
This is where culture intersects with ethics. Since interpretations of what is moral are influenced by cultural norms, the possibility exists that what is ethical to one group will not be considered so by someone living in a different culture. According to cultural relativists this means that there is no singular truth on which to base ethical or moral behavior for all time and geographic space, as our interpretations of truths are influenced by our own culture. This approach is in contrast to universalism, which holds the position that moral values are the same for everyone. Cultural relativists consider this to be an ethnocentric view, as the universal set of values proposed by universalists are based on their set of values. Cultural relativism is also considered more tolerant than universalism because, if there is no basis for making moral judgments between cultures, then cultures have to be tolerant of each other.
Example
The French and Americans have different views on whistle-blowing. Compared to the French, American companies consider it to be a natural part of business. So natural, in fact, that they set up anonymous hotlines. The French, on the other hand, tend to view whistle-blowing as undermining solidarity among coworkers.
13.1.4: The Manager’s Role in Ethical Conduct
Employees can more easily make ethical decisions that promote a company’s values when their personal values match the company’s norms.
Learning Objective
Explain the role of personal values in influencing behavior in organizations
Key Points
- Personal values provide an internal reference for what is good, beneficial, important, useful, beautiful, desirable, and constructive.
- Personal values take on greater meaning in adulthood as they are meant to influence how we carry out our responsibilities to others.
- To make ethical and moral choices, one needs to have a clear understanding of one’s personal values.
Key Terms
- value
-
A standard by which an individual determines what is good or desirable; a measure of relative worth or importance.
- norms
-
According to sociologists, social norms are the laws that govern society’s behaviors.
Personal values provide an internal reference for what is good, beneficial, important, useful, beautiful, desirable, and constructive. Over time, the public expression of personal values has laid the foundations of law, custom, and tradition. Personal values in this way exist in relation to cultural values, either in agreement with or divergent from prevailing norms.
Personal values are developed in many different ways:
- The most important influence on our values comes from the families we grow up with. The family is responsible for teaching children what is right and wrong long before there are other influences. It is thus said that a child is a reflection of his or her parents.
- Teachers and classmates help shape the values of children during the school years.
- Religion (or a lack thereof) also plays a role in teaching children values.
Personal values take on greater meaning in adulthood as they are meant to influence how we carry out our responsibilities to others. This is true in the workplace, especially for managers and leaders, who are charged with overseeing resources for the benefit of others. Because of their authority structures, social norms, and cultures, organizations can have a powerful influence on their employees. Employers do their best to hire individuals who match match well with the organization’s norms and values. In this way they seek to promote their standards of ethical behavior.
Conversely, conflicts can occur between an individual’s moral values and what she perceives to be those of others in their organization. Since moral judgments are based on the analysis of the consequences of behavior, they involve interpretations and assessments. One might be asked to do something that violates a personal belief but is considered appropriate by others. To make ethical and moral choices, one needs to have a clear understanding of one’s personal values. Without that awareness, it can be difficult to justify a decision on ethical or moral grounds in a way that others would find persuasive.
Example
If you value equal rights for all and you go to work for an organization that treats its managers much better than it does its workers, you may form the attitude that the company is an unfair place to work; consequently, you may not produce well or may even leave the company. It is likely that if the company had a more egalitarian policy, your attitude and behaviors would have been more positive.
13.1.5: Blurring Ethical Lines
Ethical decisions involve judgments of facts and situations that are subject to interpretation and other influences.
Learning Objective
Analyze the gray areas of ethical expectations within the context of corporate decision making and ethical business practice
Key Points
- Identifying the ethical choice can be difficult, since many situations are ambiguous and facts are subject to interpretation.
- In organizations, employees can look to the code of ethics or the statement of values for guidance about how to handle ethical gray areas.
- Individual ethical judgement can be clouded by rationalizations to justify one’s actions.
Key Terms
- business ethics
-
The branch of ethics that examines questions of moral right and wrong arising in the context of business practice or theory.
- norms
-
According to sociologists, social norms are the laws that govern society’s behaviors.
Law and ethics are not the same thing. Both exist to influence behavior, but complying with the law is mandatory, while adhering to an ethical code is voluntary. Laws define what is permissible, while ethics speak to what is right, good, and just. Lawyers and judges are responsible for clarifying the meaning of a law when there is ambiguity or when a matter is subject to interpretation. Where ethics are concerned, that responsibility lies with each individual. In organizations, employees can look to the code of ethics or the statement of values for guidance about how to handle ethical gray areas.
Even when an individual has a clear sense of right and wrong, or good and bad, it can be difficult to know what is ethical in a given situation. Ethical choices involve judgment because they involve weighing the potential consequences of one’s actions for other people. One analyzes ethical issues by asking questions such as: What could happen? How likely is it happen? What might the harm be? Who might be hurt? The answers are not always clear cut.
Individual judgments can be influenced, even clouded, by a number of factors. A study by Professor Robert Prentice suggests that self-image can influence an individual’s decision-making process, making him or her feel justified in taking shortcuts or doing things that could be seen as ethically questionable. In addition, there are times when people believe that the ends justify the means. In other words, if the result of an action is good, then it is okay if the action itself is unethical.
There is a saying that a good person is one who does good deeds when no one is looking. The same goes with ethical decisions. People who are ethical follow their beliefs even when they believe no one will find out about what they have done. In many cases of ethical breaches in organizations, those who acted unethically likely believed that they wouldn’t be discovered. Others may have thought that if the issues were discovered, the actions wouldn’t be traced back to them. They had the opportunity to be ethical but chose not to be.
Business Ethics Around the Globe
Social norms aren’t identical in different countries, and ethical standards can vary as well. A business may operate in a country that permits actions that would be considered unethical under that business’s ethical code. How will employees working in that country handle that situation, especially if something that could be considered unethical in one place is actually thought to be important to business success in the other? For instance, in some cultures it is customary for business partners and customers to be invited to weddings, with the expectation that guests will give a cash gift to the bride and groom. A company might consider the gift an unethical bribe in exchange for a customer’s business, yet it may be essential to enter a new market. Adhering to ethical standards in such instances can be difficult.
Example
American companies are often criticized for the treatment of workers who produce their products in China. However, rules concerning the rights of workers are much more relaxed in China than in the United States. Does an American company have the right to order factory owners in China to change their way of doing business? That is one example of an ethical gray area in today’s globalized economy.
13.2: Business Stakeholders
13.2.1: Internal Stakeholders
Internal stakeholders, primarily employees, owners and managers, are directly involved in the operations and strategy of the organization.
Learning Objective
Differentiate between internal and external stakeholders.
Key Points
- Internal stakeholders are individuals or groups who are directly and/or financially involved in the operational process.
- External stakeholders are indirectly influenced by the organization’s operations.
- Employees and managers are internal stakeholders impacted by organizational strategy and success, with some influence on the organization’s decisions.
- Owners have a larger impact on organizational management, and take a larger amount of accountability compared to managers and employees.
Key Term
- stakeholders
-
People or organizations with a legitimate interest in a given situation, action, or enterprise.
Stakeholder Theory
Organizational management is largely influenced by the opinions and perspectives of internal and external stakeholders. A stakeholder is any group, individual, or community that is impacted by the operations of the organization, and therefore must be granted a voice in how the organization functions. External stakeholders have no financial stake in the organization, but are indirectly influenced by the organization’s operations.
Internal Stakeholders
Internal stakeholders are individuals or groups who are directly and/or financially involved in the operational process. This includes employees, owners, and managers. Each of these groups is potentially rewarded directly for the success of the firm.
Employees
Employees are primary internal stakeholders. Employees have significant financial and time investments in the organization, and play a defining role in the strategy, tactics, and operations the organization carries out. Well run organizations take into account employee opinions, concerns, and values in shaping the strategy, vision, and mission of the firm.
Managers
Managers play a substantial role in determining the strategy of the organization, and a significant voice in operational decisions. Managers are also accountable for the decisions made, and act as a point of contact between shareholders, the board of directors, and the organization itself.
Owners
Owners (who in publicly traded organizations can include shareholders) are the individuals who hold significant shares of the firm. Owners are liable for the impacts the organization has, and have a significant role in strategy. Owners often make substantial decisions regarding both internal and external stakeholders.
13.2.2: External Stakeholders
Integrating businesses into society results in a wide variety of interactions with a number of different external stakeholder groups.
Learning Objective
Identify the various external stakeholders that may be impacted by business operations
Key Points
- Understanding the impacts (positive or negative) of the organization upon the broader external environment is more easily accomplished when different groups of stakeholders are identified.
- Customers, suppliers, and governments are all directly impacted by the operations carried out in a financial way. As a result, these stakeholder groups tend to be quite closely in tune with business operations.
- Local and global communities are less directly impacted (financially) by business, but no less relevant when it comes to stakeholder-based decision-making.
- Businesses can have severely negative impacts on the local and global environment, and so must carefully consider how operational functioning can affect the well-being of the individuals in these communities.
Key Term
- stakeholder theory
-
A theory of organizational management and business ethics that addresses morals and values in managing an organization.
Business are complex pieces in the social ecosystem, both impacted by and impacting a wide variety of groups in the external environment. As a leader or manager at an organization, understanding both internal and external stakeholder needs is a central responsibility. Decisions should be made in a way that ensures all stakeholders are considered.
External Stakeholders
There are quite a few external stakeholders for businesses to keep in mind when making decisions and carrying out operations. These include but are not limited to customers, suppliers, creditors, communities, governments, and society at large:
Customers
The primary purpose of providing goods and services is to fill needs. Understanding the needs of an organization’s core customer base, and optimizing operations to best fill those needs, is therefore a significant part of managing a business. Interacting with customers through social media, emails, storefronts, user testing groups, and the delivery of services and goods is an important aspect of maintaining a strong community (and a strong sense of what customers want from the organization).
Nowadays, big data plays a significant role in determining what users want. By understanding trends, habits, and trajectories in user data, organizations can anticipate the needs of users and refine their value proposition.
Suppliers
Suppliers and other strategic alliances are interdependent, where the success of one will impact the success of another. As a result, suppliers are closely related to organizations as key external stakeholders. Timely payments, shipments, communication, and operational processes are key to maintaining a strong relationship with this stakeholder group.
Local community
A business can be a great benefit to a community, providing tax money, local access to unique goods and services, jobs, and community development programs. However, a business can also be a drain on a community by increasing traffic, creating pollution, hurting small businesses, and altering real estate prices. As a result, businesses must look at the needs of the community, and ensure that negative repercussions are minimized while community engagement is maximized.
Government
Governments tax businesses, and therefore have a firm stake in their success. Governments can in fact be considered primary stakeholders, considering the profit motive involved. Governments also provide regulatory oversight, ensuring that accounting procedures, ethical practices, and legal concerns are being handled responsibly by business representatives.
Broader Society
As a result of the digital and global economy, a business can have a significant impact on society at large. Companies such as Airbnb and Uber have transformed entire industries, creating dynamically different economies with a wider variety of participants than ever. Walmart has substantially impacted the viability of small businesses in many regions. The food that is sold at fast food chains has huge impacts on global health. Manufacturing facilities in developing nations are transforming entire ecosystems. Social networks are collecting vast amounts of data. All of these concepts aren’t intrinsically good or bad, but managing them to ensure outcomes are positive for society as a whole is a critical responsibility.
Other
While other stakeholder groups could be discussed at length, these are a few of the key pillars in stakeholder theory.
13.3: Maintaining Ethical Standards
13.3.1: Ethical Decision Making
Ethical decision making is the process of assessing the moral implications of a course of action.
Learning Objective
Identify the elements of decision making that are directly affected by ethical considerations and social expectations
Key Points
- All business decisions have an ethical or moral dimension because they have an effect on stakeholders.
- Ethical decisions cannot be made solely through objective analysis or consideration of data and information, but must rely on judgment and interpretation.
- Making ethical decisions also involves choice about who should be involved in the process and how the decision should be made.
Key Terms
- ethics
-
The study of principles relating to right and wrong conduct.
- cognitive
-
Of the mental functions that deal with logic, as opposed to affective functions, which deal with emotion.
- decision
-
A choice or judgement.
Ethics are moral principles that guide a person’s behavior. These morals are shaped by social norms, cultural practices, and religious influences. Ethical decision making is the process of assessing the moral implications of a course of action. All decisions have an ethical or moral dimension for a simple reason—they have an effect on others. Managers and leaders need to be aware of their own ethical and moral beliefs so they can draw on them when they face difficult decisions.
Ethical decisions can involve several determinations. The field of ethics, also known as moral philosophy, shows that there are various ways of systematizing, defending, and recommending concepts of right and wrong conduct. For example, from a consequentialist standpoint, a morally right action is one that produces a good outcome, or consequence. A utilitarian perspective takes the position that the proper course of action is one that maximizes overall happiness.
Most ethical decisions exist in a gray area where there is no clear-cut or obvious decision that can be determined solely through quantitative analysis or consideration of objective data or information. Ethical decision making requires judgment and interpretation, the application of a set of values to a set of perceptions and estimates of the consequences of an action. Sometimes ethical decisions involve choosing not between good and bad, but between good and better or between bad and worse.
Making ethical decisions also involves choice about who should be involved in the process and how the decision should be made. For example, if a decision will have a significant impact on the local community, leaders may feel obligated to invite a representative of the community to participate in discussions. Similarly, decisions with a significant ethical dimension may benefit from being made by consensus rather than by fiat—to demonstrate that the choice is consistent with an organization’s espoused values.
13.3.2: Training Ethical Decision Making
Organizations use compliance and ethics programs to demonstrate and reinforce their commitment to ethical practices.
Learning Objective
Recognize the value in ensuring that managers are trained in business ethics and legal standards, particularly in light of the growing complexity of legal factors
Key Points
- Organizations use compliance and ethics programs to clarify and communicate their ethical standards to employees and help develop their ethical decision-making skills.
- A compliance and ethics program can identify the boundaries of legal and ethical behavior and establish a system to alert management when the organization is getting close to (or crossing) a boundary or approaching an obstacle that prevents the achievement of a business objective.
- Ethics training inside corporations is aimed at helping employees address the moral dimension of business decisions.
Key Terms
- governance
-
The implementation of policies, processes, and rights.
- ethics
-
The study of principles relating to right and wrong conduct.
Many organizations implement compliance and ethics programs to help guide the decision making and behavior of employees. Compliance with regulatory requirements and the organization’s own policies are a critical component of effective risk management. Monitoring and maintaining compliance is not just to keep the regulators happy—it is one of the most important ways for an organization to maintain its ethical health, support its long-term prosperity, and preserve and promote its values.
On a more practical level, a compliance and ethics program supports the organization’s business objectives, identifies the boundaries of legal and ethical behavior, and establishes a system to alert management when the organization is getting close to (or crossing) a legal or ethical boundary. Once an issue is detected, management must be prepared to respond quickly and appropriately to minimize the impact on the organization. The presence of compliance and ethics programs demonstrates an organization’s commitment to creating a work environment and corporate culture that values doing what is right, good, and just.
Ethics training inside corporations is aimed at helping employees address the moral dimension of business decisions. Training for ethical decision making can include workshops, guest lectures, and manager/employee discussions. Most ethics training focuses on clarifying and communicating an organization’s ethical code so employees understand what is expected. Some learning opportunities go beyond this to focus on how to take action when ethics are involved in a decision. Discussions of scenarios and role-playing exercises simulate real decision-making situations and provide practice in how to think through ethical considerations. Some ethics training will also cover the resources available to help employees when they face an ethical dilemma or suspect that someone in the organization has made an ethical breach.
13.3.3: Whistleblower Protection
Whistle-blower protection provides safeguards against retaliation for those who report suspected legal or ethical violations.
Learning Objective
Outline the methods with which the U.S. government seeks to protect whistle-blowers to maintain an equitable workplace
Key Points
- A whistle-blower is a person who tells the public or someone in authority about alleged misconduct occurring in a government department, private company, or organization.
- Many organizations establish internal processes through which employees can come forward if they suspect an ethical or legal violation has occurred.
- In the United States, several protections are in place for whistle-blowers, such as the Whistleblower Protection Act for government workers and the Dodd-Frank Wall Street Reform and Consumer Protection Act for employees in the securities industry.
Key Term
- disclosure
-
The act of revealing something.
A whistle-blower tells the public and/or the authorities about alleged misconduct occurring in a government department, private company, or organization. The alleged misconduct may take a variety of forms; for example, a violation of a law, rule, or regulation, or a direct threat to public interest, such as fraud, health and safety violations, or corruption. Whistle-blowers may make their allegations internally (to other people within the affected organization) or externally (to regulators, law-enforcement agencies, the media, or groups concerned with the issues).
Many organizations establish internal processes through which employees can come forward if they suspect an ethical or legal violation has occurred. In some cases the processes allow for anonymity. Some organizations have an ombudsperson who handles such matters on a confidential basis and advises the employee about their options should they wish to take formal steps to report the breach to the appropriate internal or external authorities.
Legal Protections for Whistle-Blowers in the United States
In the United States several protections are in place for whistle-blowers. The Whistleblower Protection Act safeguards government employees from management retaliation. The No Fear Act prohibits federal managers and supervisors from engaging in unlawful discrimination and retaliation. The Sarbanes-Oxley Act requires that an individual blow the whistle on an employee who they have evidence has violated the law. Securities whistle-blowers are provided expanded incentives and protection by the Dodd-Frank Wall Street Reform and Consumer Protection Act. This legislation authorizes the Securities and Exchange Commission (SEC) to reward whistle-blowers (at companies that are required to report to the SEC) who provide information concerning violations of the federal securities laws. The Freedom of Information Act can be used by a whistle-blower to gather evidence that the public’s right to know has been violated.
13.3.4: Managers Role in Ethical Conduct
Managers are responsible for upholding the ethical code and helping others to do so as well.
Learning Objective
Outline the role managers must play in implementing internal ethical standards and aligning the organization with external standards
Key Points
- Managers hold positions of authority that make them accountable for the ethical conduct of those who report to them.
- Managers monitor the behavior of employees in accordance with the organization’s expectations of appropriate behavior, and they have a duty to respond quickly and appropriately to minimize the impact of suspected ethical violations.
- Managers may be responsible for creating and/or implementing changes to the ethical codes or guidelines of an organization.
- Managers may also be subject to a particular code of professional ethics, depending on their position and training. Fiduciary duty is an example that applies to some managerial roles.
Key Terms
- fiduciary
-
One who holds a thing in trust for another; a trustee.
- compliance
-
The department of a business that ensures all government regulations are met.
- accountability
-
The state of being responsible for something.
Managers hold positions of authority that make them accountable for the ethical conduct of those who report to them. They fulfill this responsibility by making sure employees are aware of the organization’s ethical code and have the opportunity to ask questions to clarify their understanding. Managers also monitor the behavior of employees in accordance with the organization’s expectations of appropriate behavior. They have a duty to respond quickly and appropriately to minimize the impact of suspected ethical violations. Lastly, managers make themselves available as a resource to counsel and assist employees who face ethical dilemmas or who suspect an ethical breach.
Of course, managers are responsible for upholding ethical standards in their own actions and decisions. In addition to following the organization’s ethical code, managers may be obligated to follow a separate professional code of ethics, depending on their role, responsibilities, and training. Fiduciary duty is an example that applies to some managerial roles. A fiduciary must put the interests of those to whom he is accountable ahead of any interests, and must not profit from his position as a fiduciary unless the principal consents.
Many managers have responsibility for interacting with external stakeholders such as customers, suppliers, government officials, or community representatives. In those encounters, managers may be called on to explain a decision or a planned action in terms of ethical considerations. The stakeholders will be interested to hear how the organization took ethics into account, and in those cases it is the manager’s duty to speak on the company’s behalf.
Additionally, managers may be responsible for creating and/or implementing changes to an organization’s ethical codes or guidelines. These changes may be in response to an internal determination based on the experience of employees; for instance, additional clarification may be needed about what constitutes nepotism or unfair bias in hiring. Alternatively, new regulations, altered public perceptions and concerns, or other external factors may require the organization to make adjustments.
13.3.5: Codes of Conduct
Organizations adopt codes of conduct to guide employees’ actions and decisions.
Learning Objective
State the importance of utilizing a code of conduct to outline and maintain ethical business standards within an organization
Key Points
- Ethical codes are adopted by organizations to assist members in understanding the difference between right and wrong and how to apply it to their decisions.
- A code of business ethics may set out general principles about an organization’s beliefs on matters such as mission, quality, and the environment. It may delineate proper procedures to determine whether a violation of the code of ethics has occurred and, if so, what remedies should be imposed.
- A code of conduct for employees sets out the procedures that should be used in specific ethical situations. It also delineates the procedures required to determine whether a violation of the code of conduct has occurred and, if so, what remedies should be imposed.
- A code of professional practice discusses common issues and difficult decisions that often arise in a profession, and provides a clear account of what behavior is considered ethical, correct, or right in certain circumstances.
Key Terms
- code
-
Any system of principles, rules or regulations relating to one subject.
- conduct
-
The manner of guiding or carrying one’s self; personal deportment; mode of action; behavior.
As part of comprehensive compliance and ethics programs, many companies formulate policies pertaining to the ethical conduct of employees. These policies can be simple exhortations in broad, highly generalized language, or they can be more detailed directives containing specific behavioral requirements. Ethical codes are adopted by organizations to assist members in understanding the difference between right and wrong and applying that understanding to their decisions and actions. They are generally meant to identify the company’s expectations of workers and to offer guidance on handling some of the more common ethical problems that might arise in the course of doing business.
There are three types of ethical codes: codes of business ethics, codes of conduct for employees, and codes of professional practice.
Code of Business Ethics
A code of business ethics often focuses on social issues. It may set out general principles about an organization’s beliefs on matters such as mission, quality, privacy, and the environment. It may delineate procedures that should be used to determine whether a violation of the code of ethics has occurred and, if so, what remedies should be pursued. The effectiveness of such codes of ethics depends on the extent to which management supports and enforces them.
Code of Conduct for Employees
A code of conduct for employees sets out the procedures to be used in specific ethical situations, such as conflicts of interest or the acceptance of gifts. It may include specific lists of dos and don’ts, or it may provide questions to ask to help determine the proper course of action. Codes of conduct typically delineate the proper procedures for determining whether a violation has occurred and for reporting suspected violations.
Code of Practice
A code of practice is adopted to regulate a particular profession. It may be styled as a code of professional responsibility that covers common scenarios and decisions and provides a guide to what behavior is considered ethical, correct, or right in certain circumstances.
13.4: Corporate Social Responsibility
13.4.1: Introduction to Corporate Social Responsibility
Corporate social responsibility is a company’s sense of obligation towards social and physical environments in which it operates.
Learning Objective
Explain the purpose and types of corporate social responsibility
Key Points
- Corporate social responsibility (CSR) can be described as embracing responsibility and encouraging a positive impact through the company’s activities related to the environment, consumers, employees, communities, and other stakeholders.
- Corporate social responsibility may include philanthropic efforts, employee volunteering, and core strategies. Companies may benchmark their CSR performance relative to peers and may also report on CSR policies or undergo social audits.
- Proponents of CSR argue that socially responsible practices can have a positive impact on the bottom line and may also argue for the recognition of a “triple bottom line” that rewards social, environmental, and financial returns.
- Critics argue that CSR competes with shareholder value maximization and may be prone to “greenwashing”.
Key Terms
- benchmark
-
A standard by which something is evaluated or measured.
- shareholder
-
One who owns shares of stock in a business.
- stakeholder
-
A person or organization with a legitimate interest in a given situation, action, or enterprise.
Corporate Social Responsibility (CSR), also referred to as corporate citizenship or socially responsible business, is a form of corporate self-regulation integrated into a business model. The interest in CSR has grown with the spread of socially responsible investing, the attention of nongovernmental organizations (NGOs), and ethics training within organizations. Recent incidents of ethics-based corporate scandals have also increased awareness of CSR. Organizations that embrace CSR hold themselves accountable to others for their actions and seek to make a positive impact on the environment, their communities, and the larger society.
Corporate social responsibility may include philanthropic efforts such as charitable donations or programs that encourage employee volunteerism by providing paid time off for such activities. Many organizations seek to have an even greater impact through CSR initiatives that integrate social values into operational and business strategies. For example, to protect scarce natural resources, a firm may make a commitment to use only recycled materials in its packaging of consumer goods.
Many organizations promote their CSR efforts as a way of shaping public perceptions, attracting customers, and building good will with stakeholders. Public companies often report CSR policies and activities in their annual reports; some create separate documents or use their websites to describe and publicize their CSR-related efforts. Organizations and interested external third parties assess CSR performance by comparing, or benchmarking, the activities and their results with competitors or other sets of organizations. Measures include amount of expenditures or investment, degree of executive engagement, impact of implementation, and CSR outcomes relative to objectives.
The scale and nature of the benefits of CSR to an organization can be difficult to quantify. Those driven by strategic and operational choices may result in higher or lower costs, but directly linking CSR initiatives to revenue increases is not always possible. Many organization use non-financial measures to assess the benefits of CSR. For example, socially responsible practices can improve employee recruitment and retention efforts, be a means of managing risk, and provide brand differentiation. Some business critics of CSR, however, argue that too often it competes with a duty to maximize shareholder value. Others cast the CSR efforts of companies as “greenwashing” efforts to draw attention away from unpopular practices such as polluting the environment or outsourcing jobs overseas.
13.4.2: Arguments for and against Corporate Social Responsibility
Most arguments both for and against CSR are based on how a company’s attempts to be socially responsible affect its bottom line.
Learning Objective
Contrast the views in favor of and opposing corporate social responsibility
Key Points
- Proponents of corporate social responsibility (CSR) argue that socially responsible practices can have a positive impact on the bottom line.
- While some evidence links CSR to financial performance, its proponents also point to non-financial rewards as well as to benefits to the environment and social welfare.
- Some critics see CSR as unrelated to the primary aim of the business: making a profit for its shareholders.
- Critics may also see some CSR efforts as attempts at public manipulation or greenwashing.
Key Terms
- shareholder
-
One who owns shares of stock in a business.
- bottom line
-
The final balance; the amount of money or profit left after everything has been tallied.
Corporate social responsibility, also referred to as CSR, can be described as embracing responsibility for a company’s actions and encouraging a positive impact through its activities on the environment, consumers, employees, communities, and other stakeholders.
While some evidence links CSR practices to business performance, most organizations point to the non-financial benefits of their efforts. Proponents of CSR argue that socially responsible practices can have a positive impact on the organization by improving employee recruitment and retention, managing environmental risks by reducing harmful accidents, and differentiating brand to achieve greater consumer loyalty. CSR proponents may also argue for the recognition of a “triple bottom line” performance that includes not only financial returns for owners but also social and environmental benefits for the greater society.
Milton Friedman and other conservative critics have argued against CSR, stating that a corporation’s purpose is to maximize returns to its shareholders (or shareholder value) and that it does not have responsibilities to society as a whole. Part of the critics’ argument is that managers should not select social causes on behalf of a diverse set of owners. Rather, CSR opponents believe that corporations benefit society best by distributing profits to owners, who can then make charitable donations or take other socially responsible actions as they see fit.
Other critics, rather than targeting the concept of CSR, point to examples of weak CSR programs. For example, the term greenwashing refers to instances where businesses have spent significantly more resources advertising being “green“ (that is, operating with consideration for the environment) than investing in the environmentally sound practices themselves. Critics view these as misleading, even cynical, attempts to shape public perception about a company without its actually having to benefit the environment.
13.4.3: Social Responsibility Audits
Social responsibility audits are a process of evaluating a corporation’s social responsibility performance.
Learning Objective
Apply the general concept of auditing to the larger framework of social responsibility within organizations
Key Points
- Social responsibility audits rely on a process of accounting known by various names, including social accounting, sustainability accounting, corporate social responsibility (CSR) reporting, environmental and social governance (ESG) reporting, and triple-bottom-line accounting.
- Most social, environmental, and sustainability reports are produced voluntarily by corporations themselves and are not held to the same external standards as financial reporting. The practice of hiring independent social responsibility audit firms, however, is growing.
- Little consensus exists about how to define and use metrics of social performance, making social audits different from financial audits, for which there are generally accepted standards.
Key Terms
- responsibility
-
A duty, obligation, or liability for which someone is held accountable.
- audit
-
An independent review of records and activities to assess system controls, to ensure compliance with established policies and procedures, and to recommend changes in controls, policies, or procedures.
An audit is a systematic independent examination of data, statements, records, operations, and performance (financial or otherwise) of a process or enterprise for a stated purpose. The purpose of an audit is to provide third-party assurance to various stakeholders that the subject matter is free from material misstatement and represents a true and accurate depiction of actions and events. Areas of business that are commonly audited include financial performance, internal controls, quality management, project management, water management, and energy conservation.
Social responsibility audits are a process of reviewing and evaluating a corporation’s social responsibility (CSR) performance. As with financial audits, social responsibility audits involve accounting processes. This type of accounting originated in the early 1990s and is known by various names, including social accounting, sustainability accounting, CSR reporting, environmental and social governance (ESG) reporting, and triple-bottom-line accounting (encompassing social and environmental as well as financial reporting). Social accounting is the process of communicating the social and environmental effects of an organization’s economic actions to particular interest groups within society—including investors, customers, and NGOs—as well as to society at large.
In most countries, existing legislation regulates only a fraction of accounting for socially relevant corporate activity. In consequence, most social, environmental, and sustainability reports are produced voluntarily by corporations themselves and are not held to the same legal standards as financial reporting, for example. Organizations may also hire external firms to conduct CSR audits; these often have more credibility than an internally generated report. Having third-party groups conduct social audits is one way that corporations are held accountable for their CSR performance.
Little consensus exists about the definition and use of metrics to evaluate social impact. The lack of clearly defined standards makes social audits different from financial audits, for which there are generally accepted standards. Environmental-related accounting might address pollution emissions, resources used, or wildlife habitats damaged or re-established. Social aspects considered might include worker conditions or community investment. An audit for economic and governance responsibilities might look at transparency and the use of practices such as independent board members and separation of the roles of CEO and board chairman.
13.4.4: Types of Social Responsibility: Sustainability
One type of corporate social responsibility focuses on three key dimensions of sustainability—environmental, social, and economic.
Key Points
- Sustainability generally refers to a company’s capacity to endure over the long term through renewal, maintenance, and sustenance. From an organizational perspective, it includes stewardship for sustaining not just the organization but also its various stakeholders.
- While a universally accepted definition of sustainability remains elusive, according to a common definition, sustainability has three key dimensions: environmental, social, and economic.
- Tracking sustainability measures can be performed through sustainability accounting, in which a corporation discloses its performance with respect to activities directly affect the social, environmental, and economic performance of an organization.
- Environmental aspects can relate to water, land, and atmospheric impact, including energy and chemical use. Social sustainability can include human and worker rights and community issues. Economic aspects can include financial transparency and accountability and corporate governance.
Key Terms
- impact
-
A significant or strong influence; an effect.
- stewardship
-
The act of caring for or improving with time.
Many efforts to show corporate social responsibility, or CSR, focus on environmental, social, and economic sustainability. Sustainability is the capacity to endure over the long term through renewal, maintenance, and sustenance. From an organizational perspective, sustainability is a criteria used to make decisions about business conduct and to evaluate outcomes.
Environmental sustainability involves efforts to protect air, water, and land from any harmful effects. It also encompasses stewardship for natural resources, such as trees and wildlife. Sustainable business practices consider not only the use of resources in production, but also the assurance that those resources can be replenished for future use. Energy is another area of interest in environmental sustainability. Reducing greenhouse gasses harmful to the atmosphere and embracing alternative, renewable fuel sources such as wind and energy are examples of business practices in this area.
The social dimension of sustainability addresses concerns such as peace and social justice. Efforts to improve education, to expand worker rights, to minimize the use of child labor, and to increase the political empowerment of women, especially in developing countries, are examples of social sustainability practices. Reducing poverty by helping people develop the skills to earn their own livelihoods is another example of social sustainability. Projects that provide access to clean water and sanitation are also aimed at improving social sustainability by reducing illness and mortality rates.
Economic sustainability refers to business practices that do not diminish the prospects of future persons to enjoy levels of consumption, wealth, utility, or welfare comparable to those enjoyed in the present. This means companies’ operational practices reduce environmental damage and resource depletion. Efforts to influence business practices toward economic sustainability include pricing mechanisms, such as carbon taxes, that pass on the cost of environmental impact to the users of those resources.
Tracking sustainability measures can be performed using sustainability accounting, in which a corporation discloses its performance with respect to activities that have a direct impact on the societal, environmental, and economic performance of an organization. According to common definitions, sustainability has three key dimensions: environmental, social, and economic. The three pillars—also known as the “triple bottom line”—have served as a common ground for numerous sustainability standards and certification systems in recent years, though a universally accepted definition of sustainability remains elusive.
13.4.5: Types of Social Responsibility: Philanthropy
Philanthropic corporate social responsibility involves donating funds, goods, or services.
Learning Objective
Describe philanthropy through the lens of corporate social responsibility
Key Points
- Philanthropic corporate social responsibility involves donating funds, goods, or services to another organization or cause. For example, the local branch of a bank might donate money to fund the purchase of uniforms for a school sports team, or a health care company might donate to the city opera.
- Some critique organizational philanthropy for not being incorporated directly into an organization’s core business plan. Philanthropic activity is not always tracked as part of social accounting, making it difficult for these efforts to be audited or held accountable to external benchmarks.
- Corporations increasingly hold charities accountable for the use of donations and for measuring performance relative to their mission.
Key Terms
- core
-
The most important part of a thing; the essence.
- impact
-
A significant or strong influence; an effect.
A company that practices corporate social responsibility (CSR) embraces responsibility for its actions and, through its activities, positively affects the environment, society, consumers, employees, communities, and other stakeholders. One type of CSR is philanthropic giving. The roots of corporate philanthropy in the United States date back to the rise of industry in the 19th and early 20th century, when pioneering businessmen like Henry Ford and John D. Rockefeller established a number of philanthropic foundations. Today, corporate philanthropy can involve donating funds, goods, or services to another organization or cause. For example, the local branch of a bank might donate money to fund the purchase of uniforms for a school sports team, or a health care company might donate to the city opera.
While individual philanthropists use their own resources to change the world for the better according to their interests, corporate philanthropy directs organizational resources to support a worthy cause or address a societal need. The practice is not without its critics; some complain that philanthropic CSR is not directly related to an organization’s core business. For instance, many large arts organizations receive funding from corporations in completely different industries simply because their executives happen to love music and wish to support a local symphony. Although philanthropic CSR may provide public relations or branding advantages to a business, these benefits are difficult to measure and track.
A business’s philanthropic activity does not occur without oversight. Since the early 2000’s, corporations have sought to hold charities accountable for how they use donations. As a result, many nonprofit groups have adopted business practices for measuring their own performance. In this way, these beneficiaries of philanthropy demonstrate both a responsible use of the funds they have received and evidence of their performance relative to their mission. Companies engaging in philanthropic CSR can then use those results to measure the impact of their own efforts to support social causes.
13.4.6: Types of Social Responsibility: Ecocentric Management
According to the ecocentric model of CSR, environmental protection and sustainability are more important than economic or social benefits.
Learning Objective
Explain the concept of ecocentric corporate social responsibility and how it relates to other forms of CSR
Key Points
- Ecocentric CSR seeks to protect and improve the quality of the natural environment, regardless of the economic benefits to an organization.
- Ecocentric CSR reflects an organization’s commitment to the environment as the primary core value for conducting business.
- As a core business activity, ecocentric management may also incorporate life-cycle assessment, a technique aimed at assessing the environmental impacts associated with all stages of a product’s life, from raw material extraction to disposal or recycling.
Key Term
- ecology
-
The branch of biology dealing with the relationships of organisms with their environment and with each other.
Corporate social responsibility, also referred to as CSR, can be described as a business’s efforts to assume responsibility for its actions and to encourage a positive impact through its activities on the environment, consumers, employees, communities, and other stakeholders. Ecocentric management is one type of CSR that adopts a deeply ecological view of business.
The ecocentric model differs from more human-centered interpretations of sustainability or responsibility. “Deep” ecology is a form of environmentalism that seeks to protect and improve the quality of the natural environment. It values environmental good above economic or even social benefits. For this reason, ecocentric CSR activities, more than any other type of CSR efforts, are not expected to provide business benefits. Instead, they reflect an organization’s commitment to the environment as the primary core value for conducting business.
Ecocentric supporters believe that low-impact technology and self-reliance are more desirable than technological control over nature. As a result, the ecocentric manager may argue against using ecologically damaging products, such as pesticides and nuclear power, even if these products benefit people. In this way, the ecocentric approach contrasts with that of a more traditional CSR environmental sustainability, which seeks to maintain economic performance while reducing the impact of those products or making parallel investments in alternatives.
Ecocentric CSR activities are typically integrated with business operations. For example, they may incorporate life-cycle assessment, a technique aimed at assessing the environmental impacts associated with all the stages of a product’s life, from raw material extraction through materials processing, manufacture, distribution, use, repair and maintenance, and disposal or recycling. The more environmentally harmful stages can be identified and targeted for improvement so that every part of the value chain demonstrates the paramount importance of ecocentric CSR.
13.4.7: The Financial Value of Social Responsibility
CSR provides a financial return in the form of lower costs, higher revenue, and returns to investors.
Learning Objective
Discuss the argument that the short-term costs of social responsibility generate long-term revenues exceeding those costs
Key Points
- Evidence links socially responsible business practices to improved financial performance.
- Socially focused investors also see a financial return in socially responsible business practices, pointing to competitive returns for socially responsible indices and to the belief in returns from investing in a company’s long-term potential to compete and succeed.
- The shared value model takes a long-term view on financial return of corporate social responsibility (CSR), maintaining that the competitiveness of a company and the health of the communities around it are mutually dependent.
Key Terms
- externalities
-
Something that indirectly affects something else. In economics, a cost or benefit that is not captured in the price mechanism.
- triple bottom line
-
A means of measuring a company’s success based on its economic returns, its effect on its environment, and its impact on the community.
- shared value model
-
Idea that corporate success and social welfare relate; that a company succeeds and competes in a better society because it needs a healthy, educated workforce and sustainable resources.
Evidence links socially responsible business practices to improved financial performance. This is attributable to lower costs or increased revenue from customers who want to support business that reflects their personal values. An organization’s CSR practices might also increase employee loyalty, which lowers the cost of turnover; it also helps attract potential employees willing to work for less for a company whose values they share. Some CSR actions, such as investing in renewable energy, can provide tax benefits or lead to technology innovations that create competitive advantage.
Harvard professors Michael Porter and Mark Kramer introduced the notion of “creating shared value” (CSV) as a way of thinking about the benefits of corporate social responsibility. CSV is based on an idea that the competitiveness of a company and the health of the communities around it are mutually dependent. By focusing on creating shared value, an organization helps to shape the context in which it competes to its advantage. In this way, the shared value model takes a long-term perspective on the financial benefits of corporate social responsibility.
Other financial benefits from CSR accrue directly to shareholders. Socially conscious investors may prefer to own shares of a company that demonstrates good CSR, which can lead to higher share prices. Some mutual funds have portfolios exclusively made up of companies that rate highly on independent CSR measures. Proponents of these funds point to competitive returns for socially responsible indices, such as the Domini 400 (now the MSCI KLD 400). Similarly, academic studies have shown that excluding stocks from companies with poor CSR records does not adversely effect financial returns of a fund.
13.5: Ethical Responsibilities of Management
13.5.1: Ethical Conflicts
An ethical dilemma is a conflict between two moral imperatives.
Learning Objective
Discuss the innate contradictions that often arise in an ethical dilemma, where two or more different moral imperatives conflict
Key Points
- An ethical dilemma is the mental conflict between moral imperatives.
- Conflict arises when the need to follow one moral imperative will result in disobedience to another.
- Three principles by which to resolve ethical dilemmas are utilitarianism, justice, and the common good.
Key Term
- ethical dilemma
-
A complex situation that often involves an apparent mental conflict between moral imperatives, in which obeying one means transgressing another.
A person who must choose between competing moral imperatives faces an ethical dilemma. In such a situation, following the actions required by one obligation would mean violating a different obligation. For instance, a manager might have a duty to keep an upcoming layoff secret until plans for severance pay and outplacement for those affected can be outlined. Yet at the same time, that manager might feel an obligation to let staff members know they will soon be out of a job, so they can get a head start finding another one.
Making a choice in the face of two compelling alternatives requires a principle by which to distinguish between them. Several ideas from political philosophy can guide managers in resolving an ethical dilemma:
- Utilitarianism: A utilitarian approach seeks to provide the most good or do the least harm. In the example above, a manager might ask if the employees will be better off receiving advance word about the layoffs while facing uncertainty about what benefits they may receive. In other words, the manager would gauge how much harm will waiting to inform the staff cause compared to the benefit of minimizing anxiety among employees.
- Justice: Another way to consider an ethical dilemma is by considering the principle that all people should be treated equally. If the manager informs his staff, is that fair to the other employees whose managers did not reveal the information early? Does that manager also have an obligation to those other employees?
- Common good: Finally, resolving an ethical dilemma might mean considering whether one choice is more in keeping with the long-term welfare of all affected parties. In this example, assume the manager, some of his employees, and their peers will not be part of the layoff. Will the manager’s ability to be effective in the future be made better or worse by taking one action rather than the other? It it better for those who will remain to withhold the information or to disclose it? Moreover, is one option less consistent with the organization’s values? If that option were chosen, would it undermine employees’ belief in the company or the company’s credibility as it related to its espoused ethics?
By adopting a principle-based method of weighing the advantages and disadvantages of both alternatives in an ethical dilemma, managers can face two competing values and reach a decision.
12.1: Strategic Management
12.1.1: What is Strategy?
A strategy is a plan of action designed to achieve a specific goal or series of goals within an organizational framework.
Learning Objective
Define strategy within the context of a business and their organizational goals
Key Points
- Strategic management is the process of building capabilities that allow a firm to create value for customers, shareholders, and society while operating in competitive markets.
- Strategy entails: specifying the organization’s mission, vision, and objectives; developing policies and plans to execute the vision; and allocating resources to implement those policies and plans.
- Strategy is largely about using internal assets to create a value-added proposition. This helps to capture opportunities in the competitive environment while avoiding threats.
- Experts in the field of strategy define the potential components of strategy and the different forms strategy can take.
Key Terms
- balanced scorecard
-
A strategic performance management tool used by managers to track the execution of activities within their control and monitor the consequences of these actions.
- strategic management
-
The art and science of formulating, implementing, and evaluating cross-functional decisions that will enable an organization to achieve its objectives.
- strategy
-
A plan of action intended to accomplish a specific goal.
Strategy involves the action plan of a company for building competitive advantage and increasing its triple bottom line over the long-term. The action plan relates to achieving the economic, social, and environmental performance objectives; in essence, it helps bridge the gap between the long-term vision and short-term decisions.
Strategic Management
Strategic management is the process of building capabilities that allow a firm to create value for customers, shareholders, and society while operating in competitive markets (Nag, Hambrick & Chen 2006). It entails the analysis of internal and external environments of firms to maximize the use of resources in relation to objectives (Bracker 1980). Strategic management can depend upon the size of an organization and the proclivity to change the organization’s business environment.
The process of strategic management entails:
- Specifying the organization’s mission, vision, and objectives
- Developing policies and plans that are designed to achieve these objectives
- Allocating resources to implement these policies and plans
As an example, let’s take a company that wants to expand its current operations to producing widgets. The company’s strategy may involve analyzing the widget industry along with other businesses producing widgets. Through this analysis, the company can develop a goal for how to enter the market while differentiating from competitors’ products. It could then establish a plan to determine if the approach is successful.
Keeping Score
A balanced scorecard is a tool sometimes used to evaluate a business’s overall performance. From the executive level, the primary starting point will be stakeholder needs and expectations (i.e., financiers, customers, owners, etc.). Following this, inputs such as objectives, operations, and internal processes will be developed to achieve these expectations.
Another way to keep score of a strategy is to visualize it using a strategy map. Strategy maps help to illustrate how various goals are linked and provide trajectories for achieving these goals.
Common Approaches to Strategy
Richard Rumelt
In 2011, Professor Richard P. Rumelt described strategy as a type of problem solving. He outlined a perspective on the components of strategy, which include:
-
Diagnosis: What is the problem being addressed? How do the mission and objectives imply action?
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Guiding Policy: What framework will be used to approach the operations? (This, in many ways, should be the decision of a given competitive advantage relative to the competition.)
-
Action Plans: What will the operations look like (in detail)? How will the processes be enacted to align with the guiding policy and address the issue in the diagnosis?
Michael Porter
In 1980, Michael Porter wrote that formulation of competitive strategy includes the consideration of four key elements:
- Company strengths and weaknesses
- Personal values of the key implementers (i.e., management or the board)
- Industry opportunities and threats
- Broader societal expectations
Henry Mintzberg
Henry Mintzberg stated that there are prescriptive approaches (what should be) and descriptive approaches (what is) to strategic management. Prescriptive schools are “one size fits all” approaches that designate best practices, while descriptive schools describe how strategy is implemented in specific contexts. No single strategic managerial method dominates, and the choice between managerial styles remains a subjective and context-dependent process. As a result, Mintzberg hypothesized five strategic types:
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Strategy as plan: a directed course of action to achieve an intended set of goals; similar to the strategic planning concept
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Strategy as pattern: a consistent pattern of past behavior with a strategy realized over time rather than planned or intended (where the realized pattern was different from the intent, Mintzberg referred to the strategy as emergent)
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Strategy as position: locating brands, products, or companies within the market based on the conceptual framework of consumers or other stakeholders; a strategy determined primarily by factors outside the firm
-
Strategy as ploy: a specific maneuver intended to outwit a competitor
-
Strategy as perspective: executing strategy based on a “theory of the business” or a natural extension of the mindset or ideological perspective of the organization
Example
A company wants to expand its current operations to produce widgets. The company’s strategy may involve analyzing the widget industry along with other businesses producing widgets. Through this analysis, the company can develop a goal for how to enter the market while differentiating from competitors’ products. It could then establish a plan to determine if the approach is successful.
12.1.2: The Importance of Strategy
Strategic management is critical to organizational development as it aligns the mission and vision with operations.
Learning Objective
Evaluate the implications of the three key questions defining strategic planning
Key Points
- Strategic management seeks to coordinate and integrate the activities of the various functional areas of a business in order to achieve long-term organizational objectives.
- The initial task in strategic management is typically the compilation and dissemination of the vision and the mission statement. This outlines, in essence, the purpose of an organization.
- Strategies are usually derived by the top executives of the company and presented to the board of directors in order to ensure they are in line with the expectations of the stakeholders.
- The implications of the selected strategy are highly important. These are illustrated through achieving high levels of strategic alignment and consistency relative to both the external and internal environment.
- All strategic planning deals with at least one of three key questions: “What do we do?” “For whom do we do it?” and “How do we excel?” In business strategic planning, the third question refers more to beating or avoiding competition.
Key Terms
- mission statement
-
A declaration of the overall goal or purpose of an organization.
- board of directors
-
A group of people elected by stockholders to establish corporate policies and make managerial decisions.
Strategic management is critical to the development and expansion of all organizations. It represents the science of crafting and formulating short-term and long-term initiatives directed at optimally achieving organizational objectives. Strategy is inherently linked to a company’s mission statement and vision; these elements constitute the core concepts that allow a company to execute its goals. The company strategy must constantly be edited and improved to move in conjunction with the demands of the external environment.
Strategy and Management
As a result of its importance to the business or company, strategy is generally perceived as the highest level of managerial responsibility. Strategies are usually derived by the top executives of the company and presented to the board of directors in order to ensure they are in line with the expectations of company stakeholders. This is particularly true in public companies, where profitability and maximizing shareholder value are the company’s central mission.
The implications of the selected strategy are also highly important. These are illustrated through achieving high levels of strategic alignment and consistency relative to both the external and internal environment. In this way, strategy enables the company to maximize internal efficiency while capturing the highest potential of opportunities in the external environment.
Key Strategic Questions
The initial task in strategic management is to compile and disseminate the organization’s vision and mission statement. These outline, in essence, the purpose of the organization. Additionally, they specify the organization’s scope of activities. Strategic planning is the formal consideration of an organization’s future course, and all strategic planning deals with at least one of three key questions:
- What do we do?
- How do we do it?
- How do we excel?
In business-related strategic planning, the third question refers more to beating or avoiding competition.
Strategic management is the art, science, and craft of formulating, implementing, and evaluating cross-functional decisions that will enable an organization to achieve its long-term objectives. It involves specifying the organization’s mission, vision, and objectives; developing policies and plans to achieve these objectives; and then allocating resources to implement the policies and plans. Strategic management seeks to coordinate and integrate the activities of a company’s various functional areas in order to achieve long-term organizational objectives.
12.1.3: Making Strategy Effective
Effective strategies must be suitable, feasible, and acceptable to stakeholders.
Learning Objective
Apply the three criteria for strategic efficacy identified by Johnson, Scholes and Whittington and the 11 forces that should be incorporated into strategic consideration as argued by Will Mulcaster
Key Points
- Johnson, Scholes, and Whittington suggest evaluating strategic options based on three key criteria: suitability, feasibility, and acceptability.
- Suitability refers to the overall rationale of the strategy and its fit with the organization’s mission.
- Feasibility refers to whether or not the organization has the resources necessary to implement the strategy.
- Acceptability is concerned with stakeholder expectations and the expected outcomes of implementing the strategy.
- Will Mulcaster provides an additional 11 strategic forces which may impact the effectiveness of a given strategy.
Key Terms
- effectiveness
-
The capability of producing a desired result.
- strategy
-
A plan of action intended to accomplish a specific goal.
Effectiveness is the capability to produce a desired result. Strategy is considered effective when short-term and long-term objectives are accomplished and are in line with the mission, vision, and stakeholder expectations. This requires upper management to recognize how each organizational component combines to create a competitive operational process.
Suitability, Feasibility, and Acceptability
With the above framework in mind, a number of academics have proposed perspectives on strategic effectiveness. Johnson, Scholes, and Whittington suggest evaluating the potential success of a strategy based on three criteria:
-
Suitability deals with the overall rationale of the strategy. One method of assessing suitability is using a strength, weakness, opportunity, and threat (SWOT) analysis. A suitable strategy fits the organization’s mission, reflects the organization’s capabilities, and captures opportunities in the external environment while avoiding threats. A suitable strategy should derive competitive advantage(s).
-
Feasibility is concerned with whether or not the organization has the resources required to implement the strategy (such as capital, people, time, market access, and expertise). One method of analyzing feasibility is to conduct a break-even analysis, which identifies if there are inputs to generate outputs and consumer demand to cover the costs involved.
-
Acceptability is concerned with the expectations of stakeholders (such as shareholders, employees, and customers) and any expected financial and non-financial outcomes. It is important for stakeholders to accept the strategy based on the risk (such as the probability of consequences) and the potential returns (such as benefits to stakeholders). Employees are particularly likely to have concerns about non-financial issues such as working conditions and outsourcing. One method of assessing acceptability is through a what-if analysis, identifying best and worst case scenarios.
Mulcaster’s Managing Forces Framework
Will Mulcaster argued that while research has been devoted to generating alternative strategies, not enough attention has been paid to the conditions that influence the effectiveness of strategies and strategic decision-making. For instance, it can be seen in retrospect that the financial crisis of 2008 and 2009 could have been avoided if banks had paid more attention to the risky nature of their investments. However, knowing in hindsight cannot address how banks should change the ways they make future decisions.
Mulcaster’s Managing Forces Framework addresses this issue by identifying 11 forces that should be taken into account when making strategic decisions and implementing strategies:
- Time
- Opposing forces
- Politics
-
Perception
- Holistic effects
- Adding value
-
Incentives
- Learning capabilities
- Opportunity cost
- Risk
- Style
While this is quite a bit to consider, the key is to be as circumspect as possible when analyzing a given strategy. In many ways it is similar to the potential issues a scientist faces. A scientist must always be objective and conduct experiments without a bias toward a specific outcome. Scientists don’t prove something to be true; they test hypotheses. Similarly, strategists must not create a strategy to get to an end point; they must instead create a series of likely endpoints based on organizational inputs and operational approaches. Uncertainty is key, allowing strategic improvement for higher efficacy.
Example
A firm may perform a break-even analysis to determine if a strategy is feasible. The break-even point (BEP) is the point at which costs or expenses and revenue are equal: there is no net loss or gain, so the company has “broken even.” For example, if a business sells fewer than 200 tables each month, it will make a loss; if it sells more, it will make a profit. With this information, managers could determine if they expected to be able to make and sell 200 tables per month and then implement a strategy that is in accordance with their projections.
12.1.4: Differences Between Strategic Planning at Small Versus Large Firms
The effectiveness of a strategy is heavily dependent upon the size of the organization.
Learning Objective
Apply the size of a firm to the basic strategic management theories
Key Points
- Size is highly relevant to organizational strategy and structure, and understanding the influencing factors is important for management to elect optimal strategic plans.
- A global or transnational organization may employ a more structured strategic management model due to its size, scope of operations, and need to encompass stakeholder views and requirements.
- A small or medium enterprise may employ an entrepreneurial approach due to its comparatively smaller size and scope of operations and its limited access to resources.
- Smaller firms also tend to focus more on differentiation due to an inability to achieve scale economies. Similarly, larger firms tend to have more cost-sensitive strategic capabilities.
- No single strategic managerial method dominates, and the choice of managerial style remains a subjective and context-dependent process.
Key Terms
- structured interview
-
A quantitative research method commonly employed in survey research where each potential employee is asked the same questions in the same order.
- entrepreneurial
-
Having the spirit, attitude or qualities of a person who organizes and operates a business venture.
- structured
-
The state of being organized.
Strategic management can depend on the size of an organization and the proclivity of change in its business environment. In the U.S., an SME (small and medium enterprise) refers to an organization with 500 employees or less, while an MNE (multinational enterprise) refers to a global organization with a much larger operational scope. Size is highly relevant to organizational strategy and structure, and understanding the influencing factors is important for management to elect optimal strategic plans.
Strategic Management in Large Organizations
MNEs (multinational enterprises) may employ a more structured strategic management model due to its size, scope of operations, and need to encompass stakeholder views and requirements. MNEs are tasked with aligning complex and often dramatically different processes, demographic considerations, employees, legal systems, and stakeholders. Due to the wide variance and high volume of business, upper management needs stringent control systems embedded in the managerial strategy to enable predictability and conformity to mission, vision, and values.
For example, McDonald’s operates restaurants all over the globe. They have different menus in China than in France due to differing consumer tastes. They also have different hiring standards, regulations, and sourcing methods. How does management create a strategy that doesn’t confine these geographic regions (and lose localization) yet still maintains each region’s alignment with the mission, vision, and branding of McDonald’s?
Low-cost Strategy
Ideally, McDonald’s can construct careful strategic models and systems which control the critical components of the operations without hindering the localization. From a strategic point of view, this involves creating a system of quality control, reporting, and localization that maintains the competitive advantage of scale economies and strong branding. Large firms such as McDonald’s often achieve better scale economies and thus can pursue low-cost strategies. This requires enormous managerial competency with meticulously crafted strategies at various levels in the organization (including corporate, functional, and regional).
Strategic Management in Small Firms
SMEs (small and medium enterprises) may employ an entrepreneurial approach due to its comparatively smaller size and scope of operations and limited access to resources. A smaller organization needs to be agile, adaptable, and flexible enough to develop new strengths and capture niche opportunities within a competitive industry with bigger players. This requires fluidity in strategy while simultaneously maintaining a predetermined vision and mission statement.
Achieving this requires a great deal of balance; it often requires a strategy that is created to enable multiple paths to the same objectives. Small firm strategies often incorporate flexibility to capture new opportunities as they arise, as opposed to maintaining an already well-established competitive advantage.
Differentiation
In most cases, low-cost strategies require substantial economies of scale. Because of this constraint, smaller firms most often use differentiation strategies that focus on innovation over efficiency. Enabling creativity and innovation is strategically difficult to do as it requires a hands-off approach that empowers autonomy over structure. Innovate ideas are primarily trial and error, and so instilling creativity into a strategic process is also a high-risk approach.
12.1.5: The Impact of External and Internal Factors on Strategy
Analysis of both internal factors and external conditions is central to creating effective strategy.
Learning Objective
Examine the discrepancies between internal proficiency and external factors to capture strategic value
Key Points
- Strategic management is the managerial responsibility to achieve competitive advantage through optimizing internal resources while capturing external opportunities and avoiding external threats.
- While different businesses have different internal conditions, it is easiest to view these potential attributes as generalized categories. A value chain is a common tool used to accomplish this.
- A value chain identifies the supporting activities (employee skills, technology, infrastructure, etc.) and the primary activities (acquiring inputs, operations, distribution, sales, etc.) that can potentially create profit.
- The external environment is even more diverse and complex than the internal environment, and there are many effective models to discuss, measure, and analyze it (i.e., Porter’s Five Force, SWOT Analysis, PESTEL framework, etc.).
- With both the internal value chain and external environment in mind, upper management can reasonably derive a set of strategic principles which internally leverage strengths and externally capture opportunities to create profits.
Key Term
- analysis
-
The process of breaking down a substance into its constituent parts, or the result of this process.
Strategic management is the managerial responsibility to achieve competitive advantage through optimizing internal resources while capturing external opportunities and avoiding external threats. This requires carefully crafting a structure, series of objectives, mission, vision, and operational plan. Recognizing the way in which internally developed organizational attributes will interact with the external competitive environment is central to successfully implementing a given strategy—and thus creating profitability.
Internal Conditions
The internal conditions are many and varied depending on the organization (just as the external factors in any given industry will be). However, management has some strategic control over how these various internal conditions interact. The achievement of synergy in this process derives competitive advantage. While different businesses have different internal conditions, it is easiest to view these potential attributes as generalized categories.
A value chain is a common tool used to identify each moving part. It is a useful mind map for management to fill in during the derivation of internal strengths and weakness. A value chain includes supports activities and primary activities, each with its own components.
Supports Activities
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Firm infrastructure: the organizational structure, mission, hierarchy and upper management
- Human resource management: the skills embedded in the organization through human resources
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Technology: the technological strengths and weaknesses (such as patents, machinery, IT, etc.)
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Procurement: a measure of assets, inventory, and sourcing
Primary Activities
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Inbound logistics: deriving inputs for operational process
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Operations: running inputs through organizational operations
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Outbound logistics: shipping, warehousing, and inventorying final products
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Marketing and sales: building a brand, selling products, and identifying retail strategies and opportunities
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Service: following up with customers to ensure satisfaction, provide and fulfill warranties, etc.
External Opportunities and Threats
The external environment is even more diverse and complex than the internal environment. There are many effective models to discuss, measure, and analyze the external environment (such as Porter’s Five Force, SWOT Analysis, PESTEL framework, etc.). For the sake of this discussion, we will focus on the following general strategic concerns as they pertain to opportunities and threats:
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Markets (customers): Demographic and socio-cultural considerations, such as who the customers are and what they believe, are critical to capturing market share. Understanding the needs and preferences of the markets is essential to providing something that will have a demand.
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Competition: Knowing who else is competing and how they are strategically poised is also key to success. Consider the size, market share, branding strategy, quality, and strategy of all competitors to ensure a given organization can feasibly enter the market.
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Technology: Technological trajectories are also highly relevant to success. Does the manufacturing process of the product have new technologies which are more efficient? Has a disruptive technology filled the need that was currently being filled?
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Supplier markets: Suppliers have great power as they control the necessary inputs to an organization’s operational process. For example, smartphones require rare earth materials; if these materials are increasingly scarce, the price points will rise.
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Labor markets: Acquiring key talent and satisfying employees (relative to the competition) is critical to success. This requires an understanding of unions and labor laws in regions of operation.
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The economy: Economic recessions and booms can change spending habits drastically, though not always as one might expect. While most industries suffer during recession, some industries thrive. It is important to know which economic factors are opportunities and which are threats.
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The regulatory environment: Environmental regulations, import/export tariffs, corporate taxes, and other regulatory concerns can poise high costs on an organization. Integrating this into a strategy ensures feasibility.
While there are many other external considerations one could take into account during the strategic planning process, this list gives a good outline of what must be considered in order to minimize unexpected threats or missed opportunities.
Strategic Analysis
With both the internal value chain and external environment in mind, upper management can reasonably derive a set of strategic principles that internally leverage strengths while externally capturing opportunities to create profits—and hopefully advantages over the competition.
12.2: External Inputs to Strategy
12.2.1: Porter’s Five Forces
Michael Porter, a leading business analyst and professor, identified five critical external factors that affect strategy in any industry.
Learning Objective
Apply Porter’s Five Forces to the external landscape to derive optimal strategies
Key Points
- Porter’s Five Forces include: threat of new entrants (also know as barriers to entry), threat of substitutes, rivalry, bargaining power of suppliers, and bargaining power of buyers.
- Managers use the Five Forces model to help identify opportunities and threats or to evaluate decisions in the context of their organization’s environment.
- Attractiveness refers to the overall industry profitability. An “unattractive” industry is one in which the combination of the Five Forces drives down overall profitability.
- In analyzing these five factors, it is useful to rate each category as an external risk factor (i.e., low, medium, or high). Ideal industries have low threats from each of these forces (i.e., low buy power, low rivalry, low risk of new entrants, etc.).
- This model is a useful for the strategic derivation of managers; it allows them to narrow down their focus on specific key issues within a given industry.
Key Terms
- substitute
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A replacement or stand-in for something that achieves a similar result or purpose.
- entrant
-
Participant.
Michael Porter, a leading business analyst and professor at Harvard Business School, has identified five key forces that affect the strategy of any industry. His list, Porter’s Five Forces, draws upon industrial organization (IO) economics to derive forces that determine the competitive intensity—and therefore attractiveness—of a market.
Industry Attractiveness
Attractiveness refers to the overall industry profitability. An “unattractive” industry is one in which the combination of the Five Forces drives down overall profitability. A very unattractive industry would be one approaching “pure competition.” In this state, available profits for all firms are driven to normal profit rates. In analyzing the following five factors, it is useful to rate each category as an external risk factor (i.e., low, medium, or high). Ideal industries will have low threats from each of these forces (i.e., low buy power, low rivalry, low risk of new entrants, etc.).
The Five Forces
Porter’s Five Forces include:
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Threat of new entrants (or barriers to entry): From the view of current incumbents, profitable markets that yield high returns will attract new firms. This results in many new competitors and eventually decreases profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will tend toward zero (also known as “perfect competition”). From the perspective of new entrants, high barriers to entry mean that the capital costs of getting into the industry make it difficult to compete with current incumbents.
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Threat of substitute products or services: The existence of products outside of the realm of the common product boundaries, which fulfill the same need, increases the propensity of customers to switch to alternatives. This should not be confused with competitors’ similar products; it is instead a different product that fills the same need. Take transportation as an example: General Motors (GM) would view city subways as a substitute to someone buying a new car.
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Rivalry: For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry. This involves how many firms are in the industry and how their competitive dynamics reduce profitability. Airlines have extremely high rivalry, for example.
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Bargaining power of buyers: The bargaining power of customers is also described as the market of outputs. It is the ability of customers to put the firm under pressure, which also affects the customer’s sensitivity to price changes. Picture a supply and demand curve: if the supply greatly outstrips the demand, the buyers have more power than the suppliers.
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Bargaining power of suppliers: The bargaining power of suppliers is also described as the market of inputs. When there are few substitutes, suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm. Suppliers can refuse to work with the firm or charge excessively high prices for unique resources. Similar to power of buyers, this bargaining power relies on scarcity and basic economics of supply and demand.
Strategic Implications
Managers use the Five Forces model to help identify opportunities or evaluate decisions in the context of the environment. Often, the Five Forces are mapped against a SWOT analysis to develop a corporate strategy. To complete a Five Forces analysis, it is often best to build a grid on a piece of paper and label each section. Filling in each section to develop a view of the industry can help managers determine if the industry is truly competitive, a monopoly, or an oligopoly. An important question to ask is: “What will make a company able to compete in this environment? “
12.2.2: Limitations of the Five-Forces View
Like most models, Porter’s Five Forces has advantages and limitations when applied to strategic planning processes.
Learning Objective
Employ Porter’s Five Forces in a meaningful strategic way, with a thorough understanding of the potential limitations
Key Points
- Strategy consultants will use Porter’s Five Forces framework when making a qualitative evaluation of a firm’s strategic position; however, it is only one tool of many and is not infallible.
- According to Porter, the Five Forces model should be used at the broader level of an entire industry; it is not designed to be used at a smaller group or market level.
- Another limitation, which Porter’s model shares with most competitive frameworks, is that of chronological thinking. Porters model is inherently static, representing only aspects of the present day.
- The purpose of the model is brainstorming: a thinking exercise to demonstrate the subjective attractiveness of a given industry landscape. It is not designed to decide optimal industries with certainty.
Key Terms
- Porter’s Five Forces Model
-
A business tool to qualitatively measure business framework.
- framework
-
A basic conceptual structure.
Strategy consultants will use Porter’s Five Forces framework when making a qualitative evaluation of a firm’s strategic position; however, it is only one tool of many and is not infallible. The framework is only a starting point or checklist. Like most models, Porter’s Five Forces has advantages and limitations when applied to strategic planning processes; one must understand how it is designed to be used and recognize its limitations.
Single Industry vs. Multiple Industry Operation
According to Porter, the Five Forces model is best used at the broader level of an entire industry. Assessing at the smaller levels of sectors, competitive groups, or general markets will not yield strategically relevant information. Porter’s factors are specifically determined based on the industry level. Large organizations analyzing markets that are too broad and smaller organizations focusing on specific sectors need to keep this limitation in mind when using this framework.
Some firms operate in only one industry, while others operate in multiple industries. A firm that competes in a single industry will realistically only need to assess the industry it is in (and perhaps other supporting industries depending upon the situation). For diversified companies, however, the first fundamental issue in corporate strategy is the selection of industries (lines of business) in which the company should focus. Following this, each line of business should develop its own industry-specific Five Forces analysis. The average Global 1,000 company competes in approximately 52 industries (lines of business). These large firms require a diversified series of analyses.
Adaptability and Evolution
Another limitation—which Porter’s model shares with most competitive frameworks—is that of chronological thinking. Porters model is inherently static, representing only aspects of the present day (and perhaps those that are easily predicted within the short term). As strategic planning involves long-term objectives and the pursuit of adaptability, Porter’s model is too static to be relied upon outside of short- to medium-term objectives.
Uncertainty
It has been noted that conclusions from the Five Forces model are highly debatable. This is deliberate, as models are designed to spark discussion and underline key concerns. However, false conclusions can be reached when models are taken as certain. The purpose of the model is brainstorming: a thinking exercise to demonstrate the subjective attractiveness of a given industry landscape. It is not designed to decide optimal industries with certainty. In short, conclusions should be taken in the context of the broader strategic discussion and not as opposed to a stand-alone recommendation.
12.2.3: The PESTEL and SCP Frameworks
PESTEL and SCP frameworks are models for understanding different industry and market factors that impact strategic management.
Learning Objective
Apply PESTEL and SCP frameworks to industries in which incumbents operate
Key Points
- A PESTEL analysis looks at the six most common macro-environmental factors (political, economic, social, technological, environmental, and legal) in order to understand their interaction with the organization.
- A PESTEL analysis is a part of the external strategic analysis when conducting market research; it gives an overview of the different macro-environmental factors that the company has to take into consideration.
- According to the structure-conduct-performance (SCP) approach, an industry’s performance depends on the conduct of its firm, which is dependent on its structure.
- Components that make up the SCP model for industrial organization include: basic conditions, structure, conduct, performance, and government policy.
- While the PESTEL and SCP models share many similarities, it is useful for managers to view the industry from both frameworks as they decide upon optimal operating strategies.
Key Term
- environmental scanning
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The study and interpretation of the political, economic, social, and technological events and trends that influence a business, an industry, or even a total market
PESTEL Analysis
A PESTEL analysis looks at the six most common macro-environmental factors to understand their interactions. The acronym stands for political, economic, social, technological changes, ecology, and legislation. A PESTEL analysis is a useful strategic tool for understanding market growth or decline, business position, potential, and direction for operations. The basic premise behind this framework, from a strategy perspective, is to identify opportunities and threats in the market.
PESTEL Factors
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Political factors include how, and to what degree, a government intervenes in the economy. Specifically, political factors include areas such as tariffs, political instability, and other policy-based obstacles that businesses encounter in a given region.
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Economic factors include economic growth, interest rates, exchange rates, and the rate of inflation. Economic factors are by far the easiest to quantify, and they provide a basic framework for capital exchange and consumer purchasing ability.
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Social factors include the cultural aspects of the environment, such as health consciousness, population growth rate, age distribution, career attitudes, and emphasis on safety. Often referred to socio-demographic factors, they largely consist of preferences and attitudes displayed by different groups of individuals within a given market. Social factors can be very difficult to measure with certainty.
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Technological factors include research and development (R&D), automation, technology incentives, and the rate of technological change. Disruptive innovations can dramatically alter an industry and change who is best poised for competition. Carefully monitoring these factors on a daily basis is crucial to a company’s success and has grown in importance over the years.
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Environmental factors include ecological and environmental aspects such as weather, climate, and climate change. Industries like tourism, farming, and insurance are especially affected by these factors. Growing awareness of the potential impacts of climate change is affecting how companies operate and the products they offer, both creating new markets and diminishing or destroying existing ones.
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Legal factors include discrimination laws, consumer laws, antitrust laws, employment laws, and health and safety laws. These factors can affect how a company operates, its costs, and the demand for its products.
SCP Analysis
According to the structure-conduct-performance (SCP) approach, an industry’s performance (or the success of an industry in producing benefits for the consumer) depends on the conduct of its firm. The conduct of the firm, in turn, is dependent on its structure (or factors that determine the competitiveness of the market).
The structure of the industry depends on basic conditions such as technology and demand for a product. This creates a linear relationship of sorts, where the structural inputs can impact the conduct and strategy of the firm, leading to better (or worse) performance.
Taken into account alongside the PESTEL framework, management should carefully consider and define the structure of a given industry. This structure will provide critical inputs for the broader industry, which in turn will impact the conduct of the organization through strategic integration. If this process is accomplished effectively—and management has integrated the external structure with the internal conduct strategically—higher performance can then be derived.
12.2.4: Competitive Dynamics
Crafting an effective strategy requires understanding the competitive dynamics of the space in which the business operates.
Learning Objective
Identify critical competitive components that directly influence strategic development
Key Points
- Competitor analysis is an assessment of the strengths and weaknesses of current and potential competitors. This analysis provides both an offensive and defensive strategic context in order to identify opportunities and threats.
- Competitor analysis requires the specific selection of key success factors within an industry; it also requires the qualitative measurement of accomplishing these for both the firm and its key competitors.
- Competitor profiling coalesces all of the relevant sources of competitor analysis into one framework to support efficient and effective strategy formulation, implementation, monitoring, and adjustment.
- By identifying key competitors and relative strengths and weaknesses, organizations can react more quickly and effectively from a strategic perspective.
Key Terms
- assessment
-
An appraisal or evaluation.
- dynamic
-
Changeable; active; in motion, usually as the result of an external force.
Competition in Business
Merriam-Webster defines competition in business as “the effort of two or more parties acting independently to secure the business of a third party by offering the most favorable terms.” The competition is a moving-target, ever-evolving and adapting to better capture market share and profitability; therefore competition is a critical area of analysis for strategic managers. Observing and predicting competitive movements and dynamics is a key to success and a primary responsibility of upper management.
The Dynamic Model of Competition
The dynamic model of the strategy process is a way of understanding how strategic actions occur. It recognizes that strategic planning is dynamic; that is, strategy-making involves a complex pattern of actions and reactions. It is partially planned and partially unplanned. Competitive dynamics thus looks at how competitive firms act and react.
Competitive Dynamics
In marketing and strategic management, competitor analysis is an assessment of the strengths and weaknesses of current and potential competitors. This analysis provides both an offensive and defensive strategic context in order to identify opportunities and threats. Competitor profiling coalesces all of the relevant sources of competitor analysis into one framework to support efficient and effective strategy formulation, implementation, monitoring, and adjustment.
Components of Competitor Analysis
Competitor analysis is an essential component of corporate strategy. It is argued that most firms do not conduct this type of analysis systematically enough. Instead, many enterprises operate on conjectures and informal impressions gathered from information received about competitors. As a result, traditional environmental scanning places many firms at risk of dangerous competitive “blind spots” due to a lack of robust competitor analysis.
Competitor analysis requires the specific selection of key success factors within an industry. It also requires the qualitative measurement of accomplishing these for both the firm and its key competitors. For example, consider that customer service, quality, and brand perception are the key success factors in retail fashion. In this case, Ralph Lauren should identify key competitors (Liz Claiborne, Calvin Klein, etc.) and provide a numeric score of their success or failure in each category. Through this competitive analysis, Ralph Lauren can improve its competition.
Competitor profiling facilitates this strategic objective in three important ways:
- First, profiling can reveal strategic weaknesses in rivals that the firm may exploit.
- Second, the proactive stance of competitor profiling can allow the firm to anticipate its rivals’ strategic response to the firm’s planned strategies, the strategies of other competing firms, and changes in the environment.
- Third, this proactive knowledge can give the firm strategic agility. Offensive strategy can be implemented more quickly in order to exploit opportunities and capitalize on strengths. Similarly, defensive strategy can be employed more deftly in order to counter the threat of rival firms exploiting the firm’s own weaknesses.
12.3: Internal Analysis Inputs to Strategy
12.3.1: The Mission Statement
A mission statement defines the fundamental purpose of an organization or enterprise.
Learning Objective
Outline the appropriate content necessary to construct a comprehensive mission statement
Key Points
- A mission statement is generated to retain consistency in overall strategy and to communicate core organizational goals to all stakeholders.
- The business’s owners and upper managers develop the mission statement and uphold it as a standard across the organization. It provides a strategic framework by which the organization is expected to abide.
- In a best-case scenario, an organization conducts internal and external assessments relative to the mission statement to ensure it is being upheld.
- A mission statement informs the key market, contribution, and distinction of an organization. It describes what the organization does, why it does so, and how it excels.
Key Terms
- stakeholder
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A person or organization with a legitimate interest in a given situation, action, or enterprise.
- mission
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A set of tasks that fulfills a purpose or duty; an assignment set by an employer.
A mission statement defines the purpose of a company or organization. The mission statement guides the organization’s actions, spells out overall goals, and guides decision making. The mission statement is generated to retain consistency in overall strategy and to communicate core organizational goals to all stakeholders. The business’s owners and upper managers develop the mission statement and uphold it as a standard across the organization. It provides a strategic framework by which the organization is expected to abide.
In a best-case scenario, an organization conducts internal and external assessments relative to the mission statement. The internal assessment should focus on how members inside the organization interpret the mission statement. The external assessment, which includes the business’s stakeholders, is valuable since it offers a different perspective. Discrepancies between these two assessments can provide insight into the effectiveness of the organization’s mission statement.
Contents
Effective mission statements start by articulating the organization’s purpose. Mission statements often include the following information:
- Aim(s) of the organization
- The organization’s primary stakeholders, including clients/customers, shareholders, congregation, etc.
- How the organization provides value to these stakeholders, that is, by offering specific types of products or services
- A declaration of an organization’s core purpose
According to business professor Christopher Bart, the commercial mission statement consists of three essential components:
- Key market – Who is your target client/customer? ( generalize if necessary)
- Contribution – What product or service do you provide to that client?
- Distinction – What makes your product or service so unique that the client would choose you?
Assimilation
To be truly effective, an organizational mission statement must be assimilated into the organization’s culture (as the theory states). Leaders have the responsibility of communicating the vision regularly, creating narratives that illustrate the vision, acting as role-models by embodying the vision, creating short-term objectives compatible with the vision, and encouraging employees to craft their own personal vision that is compatible with the organization’s overall vision.
12.3.2: Porter’s Competitive Strategies
Michael Porter classifies competitive strategies as cost leadership, differentiation, or market segmentation.
Learning Objective
Discuss the value of using Porter’s competitive strategies of cost leadership, differentiation, and market segmentation
Key Points
- Michael Porter defines three strategy types that can attain competitive advantage. These strategies are cost leadership, differentiation, and market segmentation (or focus).
- Cost leadership is about achieving scale economies and utilizing them to produce high volume at a low cost. Margins may be narrower, but quantity is larger, enabling high revenue streams.
- Differentiation is creating a unique service or product offering, either through good branding or strong internal skills. This strategy aims at offering something difficult to copy and is strongly associated with an organization’s brand.
- Market segmentation strategy is narrower in scope. Both cost leadership and differentiation are relatively broad in market scope and can encompass both strategic advantages on a smaller scale.
- Porter warns that companies who try to accomplish both cost leadership and differentiation may fall into the “hole in the middle”; he notes that specializing is the ideal strategic approach.
Key Terms
- Market Share
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Percentage of a specific market held by a company.
- competitive advantage
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Something that places a company or a person above the competition.
Michael Porter described a category scheme consisting of three general types of strategies commonly used by businesses to achieve and maintain competitive advantage. These three strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope is a demand-side dimension and considers the size and composition of the market the business intends to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm.
Porter identifies two competencies as most important: product differentiation and product cost (efficiency). He originally ranked each of the three dimensions (level of differentiation, relative product cost, and scope of target market) as either low, medium, or high and juxtaposed them in a three-dimensional matrix. That is, the category scheme was displayed as a 3x3x3 cube; however, most of the twenty-seven combinations were not viable.
Cost Leadership, Differentiation, and Market Segmentation
Porter simplified the scheme by reducing it to the three most effective strategies: cost leadership, differentiation, and market segmentation (or focus). He characterizes each as the following:
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Cost leadership pertains to a firm’s ability to create economies of scale though extremely efficient operations that produce a large volume. Cost leaders include organizations like Procter & Gamble, Walmart, McDonald’s and other large firms generating a high volume of goods that are distributed at a relatively low cost (compared to the competition).
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Differentiation is less tangible and easily defined, yet still represents an extremely effective strategy when properly executed. Differentiation refers to a firm’s ability to create a good that is difficult to replicate, thereby fulfilling niche needs. This strategy can include creating a powerful brand image, which allows the organization to sell its products or services at a premium. Coach handbags are a good example of differentiation; the company’s margins are high due to the markup on each bag (which mostly covers marketing costs, not production).
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Market segmentation is narrow in scope (both cost leadership and differentiation are relatively broad in scope) and is a cross between the two strategies. Segmentation targets finding specific segments of the market which are not otherwise tapped by larger firms.
Avoiding the “Hole in the Middle”
Empirical research on the profit impact of marketing strategy indicates that firms with a high market share are often quite profitable, but so are many firms with low market share. The least profitable firms are those with moderate market share. This is sometimes referred to as the “hole-in-the-middle” problem. Porter explains that firms with high market share are successful because they pursue a cost-leadership strategy, and firms with low market share are successful because they employ market segmentation or differentiation to focus on a small but profitable market niche. Firms in the middle are less profitable because of the lack of a viable generic strategy.
12.3.3: SWOT Analysis
A SWOT analysis allows businesses to assess internal strengths and weaknesses in relation to external opportunities and threats.
Learning Objective
Explain how a SWOT analysis can be used as a tool in strategic decision making
Key Points
- SWOT analysis is a strategic planning method used to evaluate a business’s strengths, weaknesses, opportunities, and threats.
- The goal of a SWOT analysis is to analyze the business environment to develop a strategic plan of action that captures opportunities using internal strengths (and avoids threats while addressing weaknesses).
- Businesses set objectives after the SWOT analysis has been performed, which allows the organization to define achievable goals.
Key Term
- environment
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The surroundings of, and influences on, a particular item of interest.
A method of analyzing the environment in which businesses operate is referred to as a context analysis. One of the most recognized of these is the SWOT (strengths, weaknesses, opportunities, and threats) analysis. Performing a SWOT analysis allows a business to gain insights into its internal strengths and weaknesses and to relate these insights to the external opportunities and threats posed by the marketplace in which the business operates. The main goal of a context analysis, SWOT or otherwise, is to analyze the business environment in order to develop a strategic plan.
SWOT and Strategy
A SWOT analysis is a strategic planning method used to evaluate the strengths, weaknesses, opportunities, and threats related to a project or business venture. A SWOT assessment involves specifying the business’s objective and then identifying the internal and external factors that are favorable and unfavorable toward the business’s ability to achieve its objective. Setting the objective, in terms of moving from strategy planning to strategy implementation, should be done after the SWOT analysis has been performed. Doing so allows the organization to set achievable goals and objectives.
Components of SWOT
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Strengths: internal characteristics of the business that give it an advantage over competitors
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Weaknesses: internal characteristics that place the business at a disadvantage against competitors
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Opportunities: external chances to improve performance in the overall business environment
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Threats: external elements in the environment that could cause trouble for the business
Identifying SWOTs is essential, as subsequent stages of planning can be derived from the analysis. Decision makers first determine whether an objective is attainable, given the SWOTs. If the objective is not attainable, a different objective must be selected, and then the process can be repeated. Users of SWOT analysis must ask and answer questions that generate meaningful information for each category to maximize the benefits of the evaluation and identify the organization’s competitive advantages.
12.3.4: Forecasting
Forecasting is the process of making statements about expected future events, based upon evidence, research, and experience.
Learning Objective
Demonstrate the value and role of effective forecasting in the development of successful strategies
Key Points
- An important aspect of forecasting is the relationship it holds with planning. Forecasting can be described as predicting what the future will look like, whereas planning predicts what the future should look like.
- As part of the implementation of policies and strategies, the forecasting method develops a reliable picture of the company’s expected future environment.
- Quantitative forecasting generally employs statistical confidence intervals and historical data to project potential future trends that are based upon the criteria being analyzed.
- Qualitative approaches are the opposite: they rely on logical premises, expertise, or past experience to generate estimates of future circumstances.
- Forecasting enables a manager to look at the current environment and identify likely scenarios, each of which may require a deviation from the overall strategy.
Key Terms
- scenario
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An outline or model of an expected or supposed sequence of events.
- forecast
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An estimation of a future condition.
- planning
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The act of formulating a course of action or of drawing up plans.
Forecasting is the process of making statements about expected future events based upon evidence, research, and experience. For example, a business might estimate the exchange rate between the U.S. and the EU one year from now to determine the real financial cost of a project.
An important and often overlooked aspect of forecasting is the relationship it holds with planning. Forecasting can be described as predicting what the future will look like, whereas planning predicts what the future should look like. While both are managerial functions, forecasting is rife with external uncertainty while planning is hindered by internal uncertainty.
Forecasting Methods
Forecasting can be accomplished in a variety of different ways, some more statistically reliable than others. Following are a few critical points of differentiation and specific strategies to keep in mind when forecasting.
Quantitative vs. Qualitative
One of the simplest points of differentiation between methods is the reliance on numbers for accuracy. Quantitative forecasting generally uses statistical confidence intervals and historical data to project potential future trends that are based upon the criteria being analyzed. In this format, results are expressed in certainty intervals (i.e., how confident can we be that this will be the case?) and often rely on financial data (exchange rates, industry growth, etc.).
Qualitative approaches are the opposite; they rely on logical premises or past experience to generate estimates about future circumstances. The inherent problem with the qualitative approach is simple: subjectivity. While quantitative measure use data to express objective results, qualitative approaches do not have this luxury. Generally this type of forecast will include the opinions of experts, upper management, and market research.
Causal Forecasting
Another method of forecasting, which is likely to be both quantitative and qualitative, is the causal/econometric approach. This strategy tasks managers with identifying cause and effect relationships of past instances by defining a series of if/then statements that express the likelihood of the outcome which follows. For example, if consumer spending is down in Q2, then it is likely that gross domestic product (GDP) growth will be down in Q3. Whether or not this is true would have to be supported with data, but the forecast is that Q2 consumer spending results could forecast Q3 GDP growth.
Implications of Forecasting
Keeping these methods in mind, it is important to understand how management uses these forecasts to draw conclusions. Forecasting plays a role in the implementation of policies and strategies. The practice helps businesses create plans for different situations, in addition to contingency plans for adapting if and when necessary.
Forecasting enables a manager to look at the current environment and identify likely scenarios, each of which may require a deviation from the overall strategy. As the management team implements the broader strategy, it must continuously monitor the current environment for deviations and use forecasting to adapt both the primary strategy and contingency plans for potential shifts.
To summarize, forecasts enable businesses to prepare new strategies or reinforce the existing strategy, based upon the projections made.
12.3.5: The Resource-Based View
In the resource-based view (RBV), strategic planning uses organizational resources to generate a viable strategy.
Learning Objective
Describe the intrinsic competitive advantage defined by the resource-based view strategy
Key Points
- Strategic approaches are wide and varied, and the resource-based view is a commonly cited strategic approach to attaining competitive advantage.
- To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources be varied in nature and not perfectly mobile. They also must not be easily imitated or substituted without great effort.
- The RBV theory involves first identifying the firm’s potential key resources and deriving a strategy to apply them to create synergy.
- If key resources are valuable, rare, inimitable, and non-substitutable (VRIN), they may enable a strategy for achieving competitive advantage.
Key Terms
- heterogeneous
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Diverse in kind or nature; composed of diverse parts.
- imitable
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Capable of being copied.
- substitutable
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Capable of being replaced.
The resource-based view (RBV) of strategy holds company assets as the primary input for overall strategic planning, emphasizing the way in which competitive advantage can be derived via rare resource combinations. To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources are heterogeneous in nature and not perfectly mobile. Effectively, this principle translates into valuable resources that are cannot be either imitated or substituted without great effort. If the firm’s strategy emphasizes and accomplishes this goal, its resources can help it sustain above-average returns.
Applicability to Strategy
In many ways, business strategy aims to achieve competitive advantage through the proper use of organizational resources. As a result, the resource-based view offers some insight as to what defines strategic resources and furthermore what enables them to generate above-average returns (profit). Upper management must carefully consider what resources are at the company’s disposal and how these assets may equate to operational value through strategic processes.
The VRIN Characteristics
In achieving a competitive advantage, the resource-based view defines characteristics which make a competitive process sustainable. These characteristics are described as valuable, rare, inimitable, and non-substitutable, referred to as VRIN:
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Valuable – A resource must enable a firm to employ a value-creating strategy by either outperforming its competitors or reducing its own weaknesses. The value factor requires that the costs invested in the resource remain lower than the future rents demanded by the value-creating strategy.
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Rare – To be of value, a resource must be rare by definition. In a perfectly competitive strategic factor market for a resource, the price of the resource will reflect expected future above-average returns.
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Inimitable – If a valuable resource is controlled by only one firm, it can be a source of competitive advantage. This advantage can be sustained if competitors are not able to duplicate this strategic asset perfectly. Knowledge-based resources are “the essence of the resource-based perspective.”
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Non-substitutable – Even if a resource is rare, potentially value-creating and imperfectly imitable, of equal importance is a lack of substitutability. If competitors are able to counter the firm’s value-creating strategy with a substitute, prices are driven down to the point that the price equals the discounted future rents, resulting in zero economic profits.
A company should care for and protect resources that possess these characteristics, because doing so can improve organizational performance. The VRIN characteristics mentioned are individually necessary, but each is insufficient on its own to sustain competitive advantage. Within the framework of the RBV, the chain is as strong as its weakest link, and therefore requires the resource to display each of the four characteristics to be a viable strategy for competitive advantage.
12.4: Creating Strategy: Common Approaches
12.4.1: Strategic Management
Strategic management entails five steps: analysis, formation, goal setting, structure, and feedback.
Learning Objective
Identify the five general steps that allow businesses to develop a strategic process
Key Points
- Strategic management analyzes the major initiatives, involving resources and performance in external environments, that a company’s top management takes on behalf of owners.
- The first three steps in the strategic management process are part of the strategy formulation phase. These include analysis, strategy formulation, and goal setting.
- The final two steps in strategic management constitute implementation. These steps include creating the structure (internal environment) and obtaining feedback from the process.
- By integrating these steps into the strategic management process, upper management can ensure resource allocation and processes align with broader organizational purpose and values.
Key Terms
- implementation
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The process of moving an idea from concept to reality. In business, engineering, and other fields, implementation refers to the building process rather than the design process.
- objectives
-
The goals of an organization.
Strategic management analyzes the major initiatives, involving resources and performance in external environments, that a company’s top management takes on behalf of owners. It entails specifying the organization’s mission, vision, and objectives, as well as developing policies and plans which allocate resources to drive growth and profitability. Strategy, in short, is the overarching methodology behind the business operations.
Five Steps of Strategic Management
As strategic management is a large, complex, and ever-evolving endeavor, it is useful to divide it into a series of concrete steps to illustrate the process of strategic management. While many management models pertaining to strategy derivation are in use, most general frameworks include five steps embedded in two general stages:
Formulation
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Analysis – Strategic analysis is a time-consuming process, involving comprehensive market research on the external and competitive environments as well as extensive internal assessments. The process involves conducting Porter’s Five Forces, SWOT, PESTEL, and value chain analyses and gathering experts in each industry relating to the strategy.
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Strategy Formation – Following the analysis phase, the organization selects a generic strategy (for example, low-cost, differentiation, etc.) based upon the value-chain implications for core competence and potential competitive advantage. Risk assessments and contingency plans are also developed based upon external forecasting. Brand positioning and image should be solidified.
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Goal Setting – With the defined strategy in mind, management identifies and communicates goals and objectives that correlate to the predicted outcomes, strengths, and opportunities. These objectives include quantitative ways to measure the success or failure of the goals, along with corresponding organizational policy. Goal setting is the final phase before implementation begins.
Implementation
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Structure – The implementation phase begins with the strategy in place, and the business solidifies its organizational structure and leadership (making changes if necessary). Leaders allocate resources to specific projects and enact any necessary strategic partnerships.
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Feedback – During the final stage of strategy, all budgetary figures are submitted for evaluation. Financial ratios should be calculated and performance reviews delivered to relevant personnel and departments. This information will be used to restart the planning process, or reinforce the success of the previous strategy.
12.4.2: Combining Internal and External Analyses
Using combined external and internal analyses, companies are able to generate strategies in pursuit of competitive advantage.
Learning Objective
Apply a comprehensive understanding of internal and external analyses to the effective formation of new strategic initiatives
Key Points
- Organizations must carefully consider what internal assets are available that will differentiate them from the competition, within the same competitive environment.
- Similarly, organizations must understand the context in which they operate if they aspire to acquire competitive advantage over other incumbents.
- By understanding how internal and external factors relate, companies can piece together the ideal way in which their strengths can capture opportunities while offsetting threats and rectifying weaknesses.
- Implementing strategies that take into account both the internal and external environments will likely achieve competitive advantage and improve an organization’s ability to adapt. This is profit-generating strategic thinking.
Key Terms
- external
-
Concerned with the public affairs of a company or other organization.
- internal
-
Concerned with the non-public affairs of a company or other organization.
Organizations must carefully consider what internal assets will differentiate them from the competition, within the same competitive environment. This internal analysis requires careful consideration of the following models and factors:
- Core mission
- Overall strategy
- Porter’s competitive strategies
- SWOT analysis
-
Forecasts
- Resource-based view
Similarly, organizations must understand the context in which they operate if they aspire to acquire competitive advantage over other incumbents. Models such as the following outline these concerns effectively:
- Porter’s five forces (and limitations)
- PESTEL and SCP
- Competitive dynamics
Merging Analyses for Competitive Advantage
These inputs generally outline each of the specific analyses a company should conduct to understand its internal and external environments. Combining these two constitutes context analysis, which is a method of analyzing the environment in which a business operates. Environmental scanning focuses mainly on the macro-environment of a business. Context analysis considers the entire environment of a business, both internal and external.
Using context analysis, alongside the necessary external and internal inputs, companies are able to generate strategies which actively capitalize on this knowledge in pursuit of competitive advantage. This strategic development requires companies to understand the opportunities and threats in the external environment and benchmark these against the strengths and weaknesses of their internal environment. By understanding how internal and external factors relate, companies can piece together the ideal way in which their strengths can capture opportunities while offsetting threats and rectifying weaknesses.
This melding of internal and external factors in pursuit of competitive advantage is an ongoing process, as the company must evolve and change in concert with the environment. As a result, strategic management is the process of constantly assessing both environments to ensure that the company retains a unique competitive position in which to generate value for stakeholders and customers. This implementation of strategies that take into account both the internal and external environments eventually achieves dynamic capabilities for the companies involved.
Change is costly, so firms must develop processes to find low pay-off changes. The ability to change depends on the ability to scan the environment, evaluate markets, and quickly accomplish reconfiguration and transformation ahead of the competition. These actions can be supported by decentralized structures, local autonomy, and strategic alliances.
12.4.3: Implementing Strategy
Strategic planning involves managing the implementation process, which translates plans into action.
Learning Objective
Define the necessary processes involved in executing and implementing a newly created strategy
Key Points
- The implementation process requires establishing or modifying the organizational hierarchy, allocation of resources, accountability, and control processes.
- Depending on industry and geographic location, implementation often requires integrating an organization with other firms via strategic partnerships (suppliers, joint ventures, acquisitions, etc.).
- To implement a strategy requires moving beyond the theoretical and research-based view. This demands practical pragmatism on the part of senior strategists.
- Action plans that describe the way processes are transformed into tangible operations are a critical success factor and often a point of difficulty for conceptual strategists.
Key Terms
- hierarchy
-
An arrangement of items in which the items are represented as being “above,” “below,” or “at the same level as” one another.
- implementation
-
The process of moving an idea from concept to reality. In business, engineering, and other fields, implementation refers to the building process rather than the design process.
- execute
-
To carry out; to put into effect.
The implementation process requires establishing or modifying an organizational hierarchy so the company can achieve its objectives. The following stages constitute the strategic implementation process:
- Allocating and managing sufficient resources (financial, personnel, operational support, time, technology support)
- Establishing a chain of command or some alternative structure (such as cross-functional teams)
- Assigning responsibility of specific tasks or processes to specific individuals or groups. Accountability is critical to the action plan process.
- Creating a feedback loop for control processes
Strategy implementation also involves managing the overall process. Process management comprises monitoring results, measuring benchmarks, following best practices, evaluating the efficacy and efficiency of the process, controlling for variances, and making adjustments to the process as necessary. When an organization implements specific programs, it must acquire the requisite resources, develop the process, train, and perform process testing, documentation, and integration with legacy processes.
Additionally, businesses must consider the exact means of implementing a strategy, which may entail:
- Alliances with other firms to fill capability/technology/resource/legal gaps
- Investment in internal development
- Mergers/acquisitions of products or firms to reduce time to market
- Doing business with protectionist countries such as India and China, which require market entrants to operate via partnerships with local firms
Executing a Strategic Plan
One of the core goals when drafting a strategic plan is to develop it in a way that is easily translated into action plans. Most strategic plans address high-level initiatives and overarching goals but are not always translated into the day-to-day projects and tasks required to achieve the plan.
Poor terminology or word choice and the wrong level of writing are both examples of ways to fail to translate a strategic plan so that it makes sense and is executable. Often, plans are filled with conceptual terms that do not connect to day-to-day realities for the staff that is expected to carry out the plans. Strategists need to be both practical and pragmatic when devising strategy for effective implementation.
Put simply, walking the talk is easy to say and difficult to accomplish. Strategy formulation must always consider the implementation phase as the primary framework. Action plans that describe the way processes are transformed into tangible operations are a critical success factor and often a point of difficulty for conceptual strategists.
12.4.4: Maintaining Control
Controlling requires taking an aerial view of operational processes, identifying gaps and weaknesses to improve efficiency.
Learning Objective
Apply the concept of maintaining control to planning and strategy
Key Points
- Dissonance is often present between the way in which the company ideally wants to operate from a strategic perspective and the way it actually does.
- Planning and controlling are closely linked. Planning is the benchmark which controlling uses to outline deviations. In this sense, they are two sides of the same strategic process of improvement.
- Once a company designs a strategic plan parallel with the corporate mission and vision, the implementation process requires both control and planning to ensure it is appropriately communicated and executed.
- Managers are tasked with ensuring that the organizational processes reflect the mission statement and vision as closely as possible, controlling aspects of the operations in pursuit of this goal.
Key Terms
- controlling
-
To exercise influence over, to suggest or dictate the behavior of.
- planning
-
The act of formulating a course of action, or of drawing up plans.
Controlling is one of the primary theoretical managerial functions (alongside planning, organizing, staffing, and directing). Maintaining control is about identifying deviations from intended results and improving the process to achieve desired outcomes. According to modern concepts, control is a foreseeing action; an earlier concept of control identified it as chiefly detecting errors.
Control in management means setting standards, measuring actual performance, and taking corrective action. Control thus comprises three main questions: Where are we now? Where did we plan to be? How can we bridge the gap between the two? Control is inherently cyclical.
Robert J. Mockler on Control
Robert J. Mockler presented a more comprehensive definition of managerial control. He defined it as a systematic effort by business management to compare performance to predetermined standards, plans, or objectives to assess whether performance is in line with these standards and presumably to take any remedial action required. According to Mockler, the purpose of control is to ensure that human and other corporate resources are being used in the most effective and efficient way possible in achieving corporate objectives.
Relationship Between Planning and Controlling
Mockler’s definition shows the close link between planning and controlling. Planning is a process which establishes an organization’s objectives and the methods to achieve those objectives. Controlling is a process that measures and directs the actual performance against the planned goals of the organization. Thus, goals and objectives are often referred to as Siamese twins of management: managing and correcting performance to make sure that enterprise objectives and the goals designed to attain them are accomplished.
Application to Strategy
Control, relative to strategy, defines the latter stage of overall strategy. Once a company designs a strategic overview parallel with the corporate mission and vision, the implementation process requires control to ensure that strategy is appropriately communicated and executed. The direction of organizational control derives from the strategic plan of the organization. Control is an active process that evaluates current performance against this strategic backdrop to ascertain how closely the operations represent the desired functioning of the company.
Dissonance is often present between the way in which the company ideally wants to operate from a strategic perspective and the way it actually does. This is where control comes into play. Managers are tasked with ensuring that the organizational processes reflect the mission statement and vision as closely as possible, controlling aspects of the operations in pursuit of this goal. As a result, maintaining control is a constant responsibility that keeps the business as close as possible to its core strategies.
12.5: Common Types of Corporate Strategies
12.5.1: Growth Strategy
Growth platforms are specifically named initiatives selected by a business organization to fuel revenue and earnings growth.
Learning Objective
Distinguish between the varying integrations and diversifications that allow businesses to pursue strategic growth
Key Points
- Strategic growth platforms are long-term initiatives for high-scale revenue increases. Generic examples of commonly selected strategic-growth platforms include pursuing specific and new product areas or entering new distribution channels.
- Diversification is a form of corporate strategy that seeks to increase profitability through greater sales volume obtained from new products or new markets.
- Market development strategy entails expanding the current incumbent market through new users or new uses.
- Market penetration occurs when a company penetrates a market in which current products already exist, enabling the business to compete head to head with incumbents in the market.
- New product development (NPD) is the internal process of bringing a new product to market.
- Integration, either horizontal or vertical, is a merger or acquisition process of entering new, related industries (for example, acquiring a supplier or a competitor in a related industry).
Key Terms
- vertical integration
-
The integrating of successive stages in the production and marketing process under the ownership or control of a single management organization.
- diversification
-
A corporate strategy in which a company acquires or establishes a business other than that of its current product.
- horizontal integration
-
The merger or acquisition of new business operations.
Growth platforms are specifically named initiatives selected by a business organization to fuel revenue and earnings growth. Growth platforms may be strategic or tactical. Strategic growth platforms are longer-term initiatives for high-scale revenue increases. Generic examples of commonly selected strategic growth platforms include pursuit of specific and new product areas, entry into new distribution channels, vertical or horizontal integration, and new product development. Illustrative examples of growth platforms include:
- Apple Computer’s targeting of “personal music systems” to accelerate growth faster than with its personal computer business alone.
- IBM’s coining of the term “e-business,” and its subsequent use as the organizing theme for all that the company did in the late 1990s.
- Google’s entry into the operating system and laptop realms.
Types of Strategies
There are a number of different growth strategies, but the most common are:
- Horizontal integration – The merger or acquisition of new business operations. An example of horizontal integration would be Apple entering the search-engine market or a new industry related to laptops and smartphones.
- Vertical integration – Integrating successive stages in the production and marketing process under the ownership or control of a single management organization. An example might include a gas-station company acquiring a oil refinery.
- Diversification – A corporate strategy in which a company acquires or establishes a business other than that of its current product. Diversification can occur either at the business-unit level or at the corporate level. At the business-unit level, diversification is most likely to involve expansion into a new segment of an industry in which the business already competes. At the corporate level, it generally means entrance into a promising business outside the scope of the existing business unit.
Other Product / Market Growth Types
Market Penetration
Market penetration occurs when a company penetrates a market in which current products already exist. This strategy generally requires great competitive strength, a strong brand, or both, as most market penetrations demand actively taking market share from current incumbents. It is an aggressive and often risky approach to growth.
Market Development Strategy
Market development strategy entails expanding the potential market through new users or new uses for a product. The strategy is best accomplished through identifying unique niche needs in a specific type of user and filling those needs. Market research is critical in development strategies. New users can be defined as new geographic segments, new demographic segments, new institutional segments, or new psychographic segments.
New Product Development
In business and engineering, new product development (NPD) is the process of developing, researching, and bringing a new product to market. A product is a set of benefits offered for exchange and can be tangible (that is, something physical you can touch) or intangible (for example, a service, experience, or belief). Identifying new needs or new ways of filling them and developing a new process or product that accomplishes this aim are the goal of this growth strategy. NPD requires investment in research and development, usually over the long term, and extensive trial and error.
12.5.2: Consolidation Strategy
In business, consolidation refers to the mergers and acquisitions of many smaller companies into much larger ones for economic benefit.
Learning Objective
Explain the relevance of consolidation from a strategic management perspective
Key Points
- Mergers and acquisitions (M&A) is an aspect of corporate strategy dealing with the buying, selling, dividing, and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location, or acquire new sectors or locations.
- Consolidation occurs when two companies combine to form a new enterprise altogether, eliminating competition and creating broader economies of scale or scope.
- Generally speaking, a merger is a combination of organizations which each abandons its previous brand and business models, creating a new organization with the combined capacities of each.
- In an acquisition, one organization buys out another, with the acquired business usually placing its processes under the brand name of the acquirer.
- The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. However, on average and across most commonly studied variables, M&A activity does necessarily not improve financial performance.
- Because of the costs involved, consolidation is a very high-level strategic decision. All stakeholders on both ends should be consulted, and agreements will often take many months or years to conclude.
Key Terms
- acquisition
-
The act or process of acquiring.
- consolidation
-
The act or process of consolidating, making firm, or uniting; the state of being consolidated; solidification; combination.
- merger
-
The legal union of two or more corporations into a single entity, with assets and liabilities typically assumed by the buying party.
Consolidation (or amalgamation) is the act of merging two or more organizations into one. In strategic management, it often refers to the mergers and acquisitions of many smaller companies into much larger ones. Consolidation occurs when two companies combine to form a new enterprise altogether; neither of the previous companies survives independently. The logic driving consolidation is the creation of economies of scale, economies of scope, new locations, new technology, or some other form of increased competitive capacity.
Mergers and Acquisitions
Mergers and acquisitions (M&A) are aspects of corporate strategy, corporate finance, and management that deal with the buying, selling, dividing, and combining of different companies and similar entities. This activity can help an enterprise grow rapidly in its sector or location of origin or expand into a new field or new location. M&A is different from joint ventures and other forms of strategic alliance, as mergers or acquisitions aim to create a single organization.
The distinction between a “merger” and an “acquisition” has become increasingly blurred in various respects (particularly in terms of the ultimate economic outcome), although it has not completely disappeared. Generally speaking, a merger is a combination of organizations in which each abandons its previous brand and business models, creating a new organization with the combined capacities of each one. In an acquisition, one organization buys out another, with the acquired company usually placing its processes under the brand name of the acquirer.
Merger Dynamics
In the pure sense of the term, a merger happens when two firms, often about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a “merger of equals.” Both companies’ stocks are surrendered and new company stock is issued in its place. For example, in the 1999 merger of Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist independently; a new company, GlaxoSmithKline, was created.
The classic example of consolidation is the merger of Bell Atlantic with GTE, out of which resulted Verizon Communications. Not every merger with a new name is successful. By consolidating into YRC Worldwide, the combined company lost the considerable value of both Yellow Freight and Roadway Corp.
Rationale
The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance: economy of scale, economy of scope, increased revenue or market share, cross-selling, synergy, taxation, geographical or other diversification, resource transfer, vertical integration, and hiring.
However, on average and across the most commonly studied variables, acquiring firms’ financial performance does not positively change as a function of their acquisition activity (King, D. R.; Dalton, D. R.; Daily, C. M.; Covin, J. G. 2004. “Meta-analyses of Post-acquisition Performance: Indications of Unidentified Moderators.” Strategic Management Journal 25 (2): 187–200. doi:10.1002/smj.371). Other motives for merger and acquisition that may not add shareholder value include diversification, manager overconfidence, empire-building, and management compensation.
Managerial Implications
Because of the costs involved, consolidation is a very high-level strategic decision. All stakeholders in both organizations should be consulted, and agreements will often take many months or years to conclude. Cultural conflicts between two different organizations are not uncommon, as the mission, vision, and values of the individuals and groups within them are likely to differ. Managing this type of change strategically is complex and rife with conflict. Mismanagement during these processes can minimize the potential synergistic gains and reduce the efficacy of the new strategic plan.
12.5.3: Global Strategy
Global strategy, as defined in business terms, is an organization’s strategic guide to pursuing various geographic markets.
Learning Objective
Explain the concept of global strategy within the context of international business and a globalized economy
Key Points
- A global strategy may be appropriate in industries where firms face strong pressures to reduce costs but weak pressures for local responsiveness, allowing these firms to sell a standardized product worldwide.
- Companies using a global strategy may achieve economies of scale to improve margins or low price points.
- Globalization is not limited to cost leadership. Differentiation strategies also enable economies of scope, either fulfilling different needs in different markets with a similar series of products, or developing new products based upon the needs and consumption habits of a new market.
- Other primary strategic reasons for globalization are to build supplier relationships, to improve access to raw materials (unique to a given region), and to cut costs by relying on other regions’ specializations.
- With global markets in mind, strategic managers must expand their perspective and use varied models to generate different strategies for different places.
Key Terms
- fixed costs
-
A cost of business which does not vary with output or sales; overheads.
- centralized
-
Having power concentrated in a single, central authority.
- multinational
-
Operating, or having subsidiary companies in multiple countries (especially more than two).
Global strategy, as defined in business terms, is an organization’s strategic guide to pursuing various geographic markets. A global strategy should address the following questions: What should be the extent of an organization’s market presence in the world’s major markets? How can the organization build the necessary global presence? What are the optimal locations around the world for the various value-chain activities? How can the organization turn a global presence into global competitive advantage?
When to Go Global
Cost Leadership
A global strategy may be appropriate in industries where firms face strong pressures to reduce costs but weak pressures to respond locally; globalization therefore allows these firms to sell a standardized product worldwide. By expanding to a broader consumer base, these firms can take advantage of scale economies (cost advantages that an enterprise obtains due to expansion) and learning-curve effects because they are able to mass-produce a standard product that can be exported (providing that demand is greater than the costs involved).
Market Expansion
Globalization is not limited to cost leadership, however. Differentiation strategies also enable economies of scope, either fulfilling different needs in different markets with a similar series of products, or developing new products based upon the needs and consumption habits of a new market. Differentiation as part of a global strategy will often require localization, as organizations must adapt to consumer tastes better to compete in the new country. For example, Coca Cola tastes different depending on the country where it is bought because of differences in local preferences.
Sourcing
Other popular and primary strategic reasons for globalization include building supplier relationships, improving access to raw materials (unique to a given region), and cutting costs by using other regions’ specializations. Starbucks sources coffee beans from all over the world, as climate dramatically affects the type and quality of the bean. The globalization strategy of Starbucks—while it includes selling in many countries—is hugely depending on global sourcing, and strategic managers must carefully monitor this process for costs and benefits.
Global strategies require firms to coordinate tightly their product and pricing strategies across international markets and locations; therefore, firms that pursue a global strategy are typically highly centralized.
Corporate Strategy Implications
With global markets in mind, strategic managers must expand their perspective and use varied models to generate different strategies for different places. For example, companies must now conduct a PESTEL analysis for each region in which they operate and recognize expense and competition deviations between regions. For example, tariffs in country A may be much higher than country B, but country B has fewer individuals willing to pay a high price for the good the organization is selling. Managers must conduct a cost/benefit analysis to identify which country actually offers the best profit potential. These analyses are how strategists incorporate global concerns into strategic management.
12.5.4: Cooperative Strategy
A strategic alliance is a cooperation where each member expects the benefit from cooperation will outweigh the cost of individual efforts.
Learning Objective
Identify the steps involved in forming a strategic alliance to employ cooperative strategies
Key Points
- A strategic alliance is a relationship between two or more parties to pursue a set of agreed-upon goals or to meet a critical business need while remaining independent organizations. This form of cooperation lies between mergers and acquisitions and organic growth.
- Partners may provide the strategic alliance with resources such as products, distribution channels, manufacturing capability, project funding, capital equipment, knowledge, expertise, or intellectual property.
- Upper management is tasked with the complex process of identifying good partners and generating agreements of mutual benefit. Strategic alliances can be high-cost, complex strategic components.
- Strategic alliances allow each partner to concentrate on its own best capabilities, learn and develop other competences, and assure adequate suitability of resources and competencies.
Key Term
- alliance
-
The state of being allied; the act of allying or uniting; a union or connection of interests between families, states, parties, etc.
A strategic alliance is a relationship between two or more parties to pursue a set of agreed-upon goals or to meet a critical business need while remaining independent organizations. This form of cooperation lies between mergers and acquisitions (M&A) and organic growth.
Reasons for Strategic Alliance
The alliance is a cooperation or collaboration that aims for a synergy where each partner hopes that the benefits from the alliance will be greater than those from individual efforts. Partners may provide the strategic alliance with resources such as products, distribution channels, manufacturing capability, project funding, capital equipment, knowledge, expertise, or intellectual property.
The alliance often involves technology transfer (access to knowledge and expertise), economic specialization (David C. Mowery, Joanne E. Oxley, Brian S. Silverman. Strategic Alliances and Interfirm Knowledge Transfer. Winter 1996. Strategic Management Journal, Vol. 17, Special Issue: Knowledge and the Firm, pp. 77-91), shared expenses, and shared risk.
Cooperative sourcing is a collaboration or negotiation between different companies with similar business processes. To save costs, the competitor with the best production capability can insource the business process of the other competitors. This practice is especially common in IT-oriented industries as a result of low to no variable costs, e.g. banking. Since all of the negotiating parties can be outsourcers or insourcers, the main challenge in this collaboration is to find a stable coalition and the company with the best production function. High switching costs, costs for searching potential cooperative sourcers, and negotiating may result in inefficient solutions.
Forming a Strategic Alliance
Upper management is tasked with the developing complex interactive strategies when entering a strategic alliance. Aligning stakeholders from different businesses and ensuring the costs do not outweigh the benefits requires careful managerial consideration. The following steps highlight key aspects of the strategic alliance process:
-
Strategy development involves studying the alliance’s feasibility, objectives, and rationale; it also entails focusing on the major issues and challenges and development of resource strategies for production, technology, and people. It requires aligning alliance objectives with the overall corporate strategy.
-
Partner assessment involves analyzing a potential partner’s strengths and weaknesses; creating strategies to accommodate all partners’ management styles; preparing appropriate partner selection criteria; understanding a partner’s motives for joining the alliance; and addressing resource capability gaps that may exist for a partner.
-
Contract negotiation involves determining whether all parties have realistic objectives; forming high-caliber negotiating teams; defining each partner’s contributions and rewards as well as protecting any proprietary information; addressing termination clauses and penalties for poor performance; and highlighting the degree to which arbitration procedures are clearly stated and understood.
-
Alliance operations comprise addressing senior management’s commitment; finding the caliber of resources devoted to the alliance; linking budgets and resources to strategic priorities; measuring and rewarding alliance performance; and assessing the performance and results of the alliance.
-
Alliance termination entails winding down the alliance—for instance, when its objectives have been met or cannot be met or when a partner adjusts priorities or reallocates resources elsewhere.
Potential Benefits of Strategic Alliances
Benefits of strategic alliances vary according to each business’s strengths and objectives and may include:
- Pooling expensive resources and share development or R & D costs on new products
- Locking in supply chains
- Building credibility with customers (“Our strategic partners include…”)
- Allowing each partner to concentrate on activities that best match its capabilities
- Learning from partners and developing competencies that may be more widely exploited elsewhere
- Creating adequate suitability of resources and competencies for an organization to survive
12.5.5: E-Business Strategy
In the emerging global economy, e-business has become an increasingly necessary component of business strategy.
Learning Objective
Define and explain the general value chain of an e-business strategy and its advantages
Key Points
- The integration of information and communications technology (ICT) has revolutionized relationships within organizations and among organizations and individuals. It has also enhanced productivity, encouraged greater customer participation, enabled mass customization, and reduced costs.
- Companies use ICT to enhance e-business, which includes any process that a business organization (either a for-profit, governmental, or non-profit entity) conducts over a computer-mediated network.
- E-business enhances three primary processes: those related to production, customer focus, and internal management.
Key Terms
- e-business
-
A business that operates partially or primarily over the Internet, usually providing services to other businesses.
- e-learning
-
An online platform for training modules, whether internal or external to an organization.
- e-commerce
-
Commercial activity conducted via the Internet.
The term electronic business (commonly referred to as E-business or e-business) is sometimes used interchangeably with e-commerce. In fact, e-business encompasses a broader definition that includes not only e-commerce, but customer relationship management (CRM), business partnerships, e-learning, and electronic transactions within an organization.
Electronic-business methods enable companies to link their internal and external data-processing systems more efficiently and flexibly, to work more closely with suppliers and partners, and to better satisfy the needs and expectations of customers. In practice, e-business is more than just e-commerce. While e-business refers to a strategic focus with an emphasis on the functions that occur using electronic capabilities, e-commerce is a subset of an overall e-business strategy.
E-Business Process
E-business involves business processes that span the entire value chain: electronic purchasing and supply-chain management, electronic order processing, customer service, and business partner collaboration. Special technical standards for e-business facilitate the exchange of data between companies. E-business software allows the integration of intrafirm and interfirm business processes. E-business can be conducted using the Internet, intranets, extranets, or some combination of these.
In the emerging global economy, e-commerce and e-business have become increasingly necessary components of business strategy and strong catalysts for economic development. The integration of information and communications technology (ICT) in business has revolutionized relationships within organizations and those among organizations and individuals. Specifically, the use of ICT in business has enhanced productivity, encouraged greater customer participation, and enabled mass customization.
Advantages of E-Commerce
E-business enhances three primary processes:
-
Production processes including procurement, ordering and replenishment of stocks; processing of payments; electronic access to suppliers; and production control processes
-
Customer-focused processes including promotional and marketing efforts, Internet sales, customer purchase orders and payments, and customer support
-
Internal management processes including employee services, training, internal information-sharing, videoconferencing, and recruiting. Electronic applications enhance information flow between production and sales forces to improve sales-force productivity. ICT improves the efficiency of work-group communications and electronic publishing of internal business information.
12.6: The Planning Process
12.6.1: Defining Strategic Planning
Strategic planning is concerned with defining company goals and determining the resources needed to achieve them.
Learning Objective
Assess the definition of planning in context with strategy and the various planning process approaches
Key Points
- To determine the direction of the organization, it is necessary to understand its current position and the possible avenues through which it can pursue a particular course of action.
- There are many approaches to strategic planning, but typically either the situation-target-proposal approach or the draw-see-think-plan approach is used to generate a plan’s structure.
- The primary purpose of planning is to create universal buy-in and understanding of the objectives, and to put operational processes in place to guide the organization towards their achievement.
Key Terms
- plan
-
A set of intended actions, usually mutually related, through which one expects to achieve a goal.
- allocate
-
To distribute according to a plan.
- strategy
-
A plan of action intended to accomplish a specific goal.
Strategic planning is an organization’s process of defining its strategy and making decisions on how to allocate resources to pursue that strategy. To determine the direction of the organization, it is necessary to understand its current position and the possible avenues through which it can pursue a particular course of action. Strategic planning generally deals with at least one of three key questions:
- What do we do?
- For whom do we do it?
- How do we excel?
In many organizations, this is viewed as a process for determining where the organization is going over the next year or, more typically, three to five years, although some extend their vision to 20 years. The last question—how do we excel?—is critical to achieving competitive advantage, and it should be answered clearly and practically in the planning process prior to extensive investment in resources.
Components of a Strategic Plan
Planning is concerned with defining goals for a company’s future direction and determining the resources required to achieve those goals. To meet the goals, managers will develop marketing and operational plans inclusive of key organizational values (vision, mission, culture, etc.).
Common components of a business plan include external and internal analyses, marketing and branding, investments, debt, resource allocation, suppliers, production processes, competition, and research and development. While different business models include different components in their planning, based on unique organizational or industry needs, the central theme is that all aspects of the strategy should be researched and discussed prior to incurring the costs of operations.
Planning Process
There are many approaches to strategic planning, but typically one of the following approaches is used.
Situation-Target-Proposal
This method involves the following steps:
- Situation: Evaluate the current situation and how it came about.
- Target: Define goals and objectives (sometimes called ideal state).
- Proposal: Map a possible route to the goals and objectives.
Draw-See-Think-Plan
This method involves addressing the following questions:
- Draw: What is the ideal state or the desired end state?
- See: What is today’s situation? What is the gap between today’s situation and the ideal state, and why?
- Think: What specific actions must be taken to close the gap between today’s situation and the ideal state?
- Plan: What resources are required to execute these specific actions?
12.6.2: Benefits of Strategic Planning: Focus, Action, Control, Coordination, and Time Management
Planning enables companies to achieve efficiency and accuracy by coordinating efforts and managing time effectively.
Learning Objective
Identify the critical benefits derived through utilizing business and marketing plans in strategic management
Key Points
- Planning is a management process concerned with defining goals for a company’s future direction and determining the resources required to achieve those goals. Managers may develop a variety of plans (business plan, marketing plan, etc.) during the planning process.
- Achieving a vision requires coordinated efforts that adhere to a broader organizational plan. This is enabled through consistent strategies that are supported by staff at all levels.
- Planning enables increased focus on, and coordinated action toward, competitive strategies, while minimizing wasted time and ensuring there are benchmarks for the control process.
- Planning typically offers a unique opportunity for information-rich and productively focused discussions between the various managers involved. The plan and the discussions that arise from it provide an agreed context for subsequent management activities.
Key Terms
- business plan
-
A summary of how a business owner, manager, or entrepreneur intends to organize an endeavor and implement activities necessary and sufficient to achieve success.
- time management
-
The management of time in order to make the most of it.
- planning
-
The act of formulating a course of action.
The planning process is concerned with defining a company’s goals and determining the resources necessary to achieve those goals. Achieving a vision requires coordinated efforts that adhere to a broader organizational plan. This is enabled through consistent strategies that are supported by staff at all levels. To meet business goals, managers develop business plans not only to reach targets but also to strengthen and change public perception of the company’s brand.
Since they have achieved defined goals through the planning process, managers and employees can focus and control their efforts and their resources, follow determined plans of action, coordinate activities between divisions, and use time management to meet specific goals. Planning helps to achieve these goals or targets by efficiently and effectively using available time and resources. In short, planning, if executed properly, should lead to the following benefits:
Focus
There are a wide variety of activities an organization (or the individuals within the organization) might viably pursue. While there is value in the pursuit of many activities, understanding which ones the organization should focus on to leverage organizational competencies and align with market research requires careful planning and delegation. This is how planning achieves focus.
Coordinated Action
If department A is reliant on inputs from department B, department A cannot utilize department B’s work without coordination. If department B has too much work and department A too little, there is poor interdepartmental coordination. This is alleviated through detail-oriented planning processes.
Control
The control process is based on benchmarks, which is to say that controlling requires a standard of comparison when viewing the actual operational results. Control relies on the planning process to set viable objectives, which can then be worked towards through controlling operations.
Time Management
Time management underlines the importance of maximizing the use of time to minimize the cost of production. If a full-time employee can accomplish their work within 32 hours, the planning process can find meaningful use for their remaining time. Costs can be lowered and productivity increased by ensuring that each element in the operational process functions according to ideal time constraints.
The Process Itself
Perhaps the most important benefit of developing business and marketing plans is the nature of the planning process itself. This typically offers a unique opportunity, a forum, for information-rich and productively focused discussions between the various managers involved. The plan and the discussions that arise from it provide an agreed context for subsequent management activities, even those not described in the plan itself.
12.6.3: Overview of Inputs to Strategic Planning
Strategic plans can take the form of business or marketing plans, and consultants and industry experts are used in their development.
Learning Objective
Review the various tools for effective plan development, including stakeholder input, consultants, and data collection
Key Points
- In most corporations, there are several levels of management, including the corporate, business, functional, and strategic levels.
- Strategic management is the highest of these levels in the sense that it is the broadest—it applies to all parts of the firm and incorporates the longest time horizon.
- A marketing plan is a written document that details the actions necessary to achieve one or more marketing objectives.
- A business plan is a formal statement of a set of business goals, the reasons they are attainable, and the plan for reaching them.
- Available business resources for creating a plan include industry experts, consultants, and stakeholder input, which can help enable an objective and comprehensive view of internal and external factors.
Key Term
- tactical planning
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An organization’s process of determining how to optimize current resources and operations.
Strategy Hierarchy
In most corporations, there are several levels of management. Strategic management is the highest of these levels in the sense that it is the broadest—it applies to all parts of the firm and incorporates the longest time horizon. It gives direction to corporate values, corporate culture, corporate goals, and corporate missions. Under the broad corporate strategy are business-level competitive strategies and functional unit strategies.
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Corporate strategy refers to the overarching strategy of the diversified firm.
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Business strategy refers to the aggregated strategies of a single business firm or a strategic business unit (SBU) in a diversified corporation.
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Functional strategies include marketing strategies, new-product development strategies, human resource strategies, financial strategies, legal strategies, supply-chain strategies, and information-technology management strategies. The emphasis is on short-term and medium-term plans and is limited to the domain of each department’s functional responsibility. Each functional department attempts to do its part to meet overall corporate objectives, so to some extent their strategies are derived from broader corporate strategies.
Many companies feel that a functional organizational structure is not an efficient way to organize activities, so they often re-engineer according to processes or SBUs. A strategic business unit is a semi-autonomous unit that is usually responsible for its own budgeting, new product decisions, hiring decisions, and price setting. An SBU is treated as an internal profit center by corporate headquarters.
Business Plans
A business plan is a formal statement of a set of business goals, the reasons they are attainable, and the plan for reaching them. It may also contain background information about the organization or team attempting to reach those goals.
For example, a business plan for a nonprofit might discuss the fit between the business plan and the organization’s mission. Banks are quite concerned about defaults, so a business plan for a bank loan will build a convincing case for the organization’s ability to repay the loan. Venture capitalists are primarily concerned about initial investment, feasibility, and exit valuation. A business plan for a project requiring equity financing will need to explain why current resources, upcoming growth opportunities, and sustainable competitive advantage will lead to a high exit valuation.
Preparing a business plan draws on a wide range of knowledge from many different business disciplines: finance, human resource management, intellectual-property management, supply-chain management, operations management, and marketing. It can be helpful to view the business plan as a collection of subplans, one for each of the main business disciplines.
Marketing Plans
A marketing plan is a written document that details the actions necessary to achieve one or more marketing objectives. It can be for a product, a service, a brand, or a product line. Marketing plans span between one and five years.
A marketing plan may be part of an overall business plan. Solid strategy is the foundation of a well-written marketing plan, and one way to achieve this is by using a method known as the seven Ps (product, place, price, promotion, physical environment, people, and process). A product-oriented company may use the seven Ps to develop a plan for each of its products. A market-oriented company will concentrate on each market. Each will base its plans on the detailed needs of its customers and on the strategies chosen to satisfy those needs.
Tools for Planning
Often discussed in tools for planning are models that measure the internal and external environments (e.g. Porter’s Five Forces, SWOT, Value Chain, etc.). These models create forward-looking projections based on past and present data; therefore, they are useful only once enough data have been collected. Because of this, tools for planning largely focus on generating enough data to construct valid recommendations. These tools can include:
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Industry experts: Whether internal employees or external consultants, a few individuals with extensive experience in a given industry are valuable resources in the planning process. These industry experts can move beyond the PESTEL and Porter’s Five Forces frameworks, making intuitive leaps as to the trajectory of the industry.
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Consultants: Consultants are commonly brought in during strategy formulation and for a variety of other reasons. Most important of these would be providing an objective lens for internal affairs. It is difficult to see the whole house from inside the house, and upper management can utilize an external opinion to ensure they are seeing operations clearly and objectively.
- Inclusion of stakeholders: Upper management will want as much information as possible from everyone involved. Some examples include consumer surveys on satisfaction, supplier projections for costs over a given time frame, consumer inputs on needs still unfilled, and shareholder views. The inclusion of stakeholders offers a variety of tools, each of which may or may not be a useful input depending on the context of the plan.
12.6.4: Responding to Uncertainty in Strategic Planning
Uncertainty exists when there is more than one possible outcome; it is best managed using scenario-planning tools.
Learning Objective
Recognize the inevitability of uncertainty in strategic planning, alongside planning for effective responses to these uncertainties
Key Points
- Strategic management is having a clear view, based on the best available evidence and on defensible assumptions, of what is possible to accomplish within the constraints of a given set of circumstances.
- Initial ideas about corporate objectives may have to be altered if there is no feasible implementation plan that will meet with a sufficient level of acceptance among stakeholders, or if the necessary resources are not available, or both.
- Scenario planning starts by separating things believed to be known, at least to some degree, from those considered uncertain or unknowable.
Key Terms
- uncertainty
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A state of having limited knowledge such that it is impossible to exactly describe an existing state or future outcomes or to determine which of several possible outcomes will happen.
- tactical planning
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An organization’s process of determining how to optimize current resources and operations.
- qualitative
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Described in terms of characteristics and attributes rather than numbers and quantities.
Uncertainty
Management specialists define uncertainty as a state of having limited knowledge such that it is impossible to exactly describe an existing state or future outcomes or to determine which of several possible outcomes will happen. It is still possible, however, to measure uncertainty—by assigning a probability to each possible state or outcome to estimate its likelihood.
In the past, strategic plans have often considered only the “official future,” which was usually a straight-line graph of current trends carried into the future. Often the trend lines were generated by the accounting department and lacked discussions of demographics or qualitative differences in social conditions. These simplistic guesses can be good in some ways, but they fail to consider qualitative social changes that can affect an organization.
Instead of just following trend lines, scenarios focus on the collective impact of many factors. Scenario planning helps to understand how the various strands of a complex tapestry move if one or more threads are pulled. A list of possible causes, like a fault-tree analysis, tends to downplay the impact of isolated factors. When factors are explored together, certain combinations magnify the impact or likelihood of other factors. For instance, an increased trade deficit may trigger an economic recession, which in turn creates unemployment and reduces domestic production.
Responding to Uncertainty
Organizations need to cope with issues that are too complex to be fully understood, yet significant decisions need to be made that are based on a limited understanding or limited information. There are several ways of dealing with this.
Be Iterative
The process of developing organizational strategy must be iterative. That is, it should involve toggling back and forth between questions about objectives, implementation planning, and resources. For example, an initial plan for a project may have to be adjusted if the budget changes.
Use Scenario Planning
Scenario planning starts by separating things believed to be known, at least to some degree, from those considered uncertain or unknowable. The first component, knowledge, includes trends, which cast the past forward, recognizing that the world possesses considerable momentum and continuity. The second component, uncertainties, involves indeterminable factors such as future interest rates, outcomes of political elections, rates of innovation, fads in markets, and so on. The art of scenario planning lies in blending the known and the unknown into a limited number of internally consistent views of the future that span a very wide range of possibilities.
Numerous organizations have applied scenario planning to a broad range of issues, from relatively simple, tactical decisions to the complex process of strategic planning and vision building. Scenario planning for business was originally established by Royal Dutch/Shell, which has used scenarios since the early 1970s as part of its process for generating and evaluating strategic options. Shell has been consistently better in its oil forecasts than other major oil companies, and predicted the overcapacity in the tanker business and Europe’s petrochemicals earlier than its competitors.
Accept Uncertainty
It serves little purpose to pretend to anticipate every possible consequence of a corporate decision, every possible constraining or enabling factor, and every possible point of view. What matters for the purposes of strategic management is having a clear view, based on the best available evidence and on defensible assumptions, of what is possible to accomplish within the constraints of a given set of circumstances. As the situation changes, some opportunities for pursuing objectives will disappear and others will arise. Some implementation approaches will become impossible, while others, previously impossible or unimagined, will become viable. Strategic management adds little value, and may do harm, if organizational strategies are designed to be used as detailed and infallible blueprints for managers.
12.7: Types of Plans
12.7.1: Overview of Types of Strategic Plans
The broader overview of strategic plans, as well as the five subgroups within strategic planning, provide businesses with direction.
Learning Objective
Differentiate between the five general planning frames and recognize considerations that must be made prior to planning
Key Points
- Strategic plans are what communicate the corporate strategy, direction, and resource allocation. There are generally five subgroups of strategic plans.
- Short-range plans generally constitute a specific time frame in which a specific series of operations will be carried out, assessed, and measured.
- Long-range plans are arguably the most crucial to the continued success of a business, ultimately highlighting the way in which operations interact to achieve long-term profitability and returns on investment.
- Operational plans comprise the most specific subgroup of strategic planning, describing the specific objectives and milestones a business should consider in executing each particular operation. Operational plans are often used by control professionals.
- Standing plans are based on the operations that must be repeated indefinitely within a business or corporation.
- As opposed to standing plans, single-use plans cover a specific operation or process that is an outlier to normal operations.
Key Terms
- strategic planning
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An organization’s process of defining its direction and making decisions on allocating resources to pursue that direction.
- single-use plans
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A strategy for achieving an objective that can only be used in one situation.
- standing plan
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A strategy for achieving an objective that can be continually used or modified.
Strategic management is primarily concerned with the planning and execution processes that lead to the effective operations of a business. Strategic management leverages strategic planning in order to design and execute a variety of plans specifically created to approach various facets of the business and competitive environment. It is worth analyzing the broader overview of strategic plans, as well as the five subgroups within strategic planning that provide businesses with an outline of their strategic direction.
Strategic plans are what communicate the corporate strategy, direction, and resource allocation.
Specific Types of Plans
Following the generation of a vision and mission statement, and the subsequent operations that will allow these to be achieved, smaller facets of the planning process begin to come into play. These include five general planning frames, which can be applied to different aspects of the operational process:
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Short-range plans: Short-range plans generally apply to a specific time frame in which a specific series of operations will be carried out, assessed, and measured. The standard short-range plan will represent annual or semiannual operations with a short-term deliverable. These short-term plans cover the specifics of each day-to-day operation.
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Long-range plans:Long-range plans are arguably the most crucial to the continued success of a business, ultimately highlighting the way in which operations interact to achieve long-term profitability and returns on investment. As corporations grow in size and complexity, so do the long-range plans that constitute the interaction of individual processes. Long-range plans are those most closely related to the overall strategic-planning process.
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Operational plans:Operational plans are the most specific subset of strategic planning, describing the specific objectives and milestones a business should consider in executing each particular operation. Operational plans establish both the budgetary resources necessary for execution and the tangible and easily assessed objectives that can define the success of any given project.
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Standing plans:Standing plans are based on the operations that must be repeated indefinitely within a business or corporation. Standing plans govern the processes that occur regularly, providing an overview for consistent activities.
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Single-use plans:As opposed to standing plans, single-use plans cover a specific operation or process that is an outlier to normal operations. In all likelihood, a single-use plan will never need to be repeated and will simply cover the content involved in one circumstance.
By combining all of these plans—often a few of each subgroup, depending on the scale and complexity of a business—a general strategic overview can be obtained. The interaction of all of these plans constitute the overall strategic trajectory of a business, measuring profitability and efficiency as the company executes operations.
12.8: Planning Tools
12.8.1: Overview of Strategic Planning Tools
Strategists have developed a large array of tools useful in plan formulation, all of which provide unique insights and advantages.
Learning Objective
Outline the wide array of useful tools to improve upon the scope and effectiveness of the planning process within the context of strategic management
Key Points
- Forecasting, consisting of the basic concept of projecting future outcomes, is the most common tool in the strategic tool belt.
- Scenario planning is where strategists construct various scenarios to test out the potential trajectories of a specific operational plan.
- Contingency planning can be simply described as the back-up plan, while participatory planning is the primary plan. If (or, more likely, when) things do not go according to plan, a contingency plan should be in place.
- Management by objectives (MBO) is the process of defining, disseminating, and implementing the objectives that an organization has identified as strategic.
- The SMART model identifies specific goals, measures inputs and outputs, ensures that the goals are attainable and relevant to the mission of the company, and constructs a timeline.
- Incorporating concepts such as forecasting and benchmarking in conjunction with larger corporate-strategy frameworks such as SMART goals and MBO will equip strategists with a strong short-term and long-term approach.
Key Terms
- forecasting
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Estimating how a condition will be in the future.
- benchmark
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A standard that allows a manager to compare metrics, such as quality, time, and cost, across an industry and against competitors.
- contingency plan
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An alternative to be put into operation if needed, especially in case of an emergency or if a primary plan fails.
Strategists have developed a large array of tools useful in the assessment of strategic planning, all of which provide unique insights into the feasibility and profitability of a given operational project. Identifying these tools, and selecting which are most appropriate for determining the effectiveness or efficiency of a project, is a central responsibility of a strategic-management team.
Listed below are the main tools available for consideration along with a brief description of how each tool is useful.
Forecasting
Forecasting is the the most common strategic tool and it should be considered whenever projects are being designed. Forecasting, simply put, is projecting the future of a project by leveraging all of the available knowledge to generate a likelihood of success. It is useful to construct pro forma financial statements, which illustrate expected costs and revenues.
Scenario Planning
Scenario planning is an interesting tool with which strategists construct various scenarios to test out the potential trajectories of specific operational plans. One popular scenario application is called the zero-sum game, where the costs and revenues are equated to see at what level of cost or what level of revenue a zero-sum bottom line can be achieved. By benchmarking this situation against reality, strategists can see in which situations value can be captured.
Benchmarking
Benchmarking can be done qualitatively or quantitatively, and it is a comparative approach to strategy. Benchmarking usually requires the identification of a close competitor with similar strategic prerogatives so that the strategist can compare and contrast the two companies’ strengths and weaknesses, identifying strategies for improvements or competitive advantages.
Participatory and Contingency Planning
Contingency planning can be simply described as the back-up plan, while participatory planning is the primary plan. An excellent tool for strategists pursuing a particularly risky venture is to develop the primary objectives and strategy while simultaneously constructing a contingency plan that will limit the negative effects of failure. This offsets risk through finding various ways to achieve value regardless of the success of the overall venture. This requires creativity and a degree of adaptability.
Goal Setting
Goal setting, similar to MBO and SMART, is a simple method for strategists to establish and enforce specific goals within the organization or strategic business unit (SBU). Goal setting creates incentives for employees by identifying achievable end results, which drives the direction of the company towards commonly established goals. This theory was developed by Edwin A. Locke in the 1960s and is considered an “open” theory, which implies that new thoughts and developments may be layered on top of the original goal-setting framework.
Management by Objectives
MBO is the process of defining, disseminating, and implementing the objectives that an organization has identified as strategic. Objectives provide factual and achievable strategies that align with employee and manager goals in order to ensure that all participants are on the same page. It is also useful to set goals and a timeline to assess progress and ensure that each individual is achieving their segment of the plan.
SMART Goals
The SMART model aims to design goals that are specific, measurable, achievable, realistic, and time-targeted (SMART).
The SMART model identifies specific goals, measures inputs and outputs, ensures that the goals are attainable and relevant to the mission of the company, and constructs a timeline.
Though there are many other potential tools for strategists, these seven provide a strong framework for further development of strategic methodologies. Incorporating concepts such as forecasting and benchmarking in conjunction with larger corporate strategy frameworks such as SMART goals and MBO will equip strategists with a strong short-term and long-term approach.
12.9: The Planning Cycle
12.9.1: Planning a Project
Identifying stages in a project plan, complete with objectives, implementation, and assessment, is a primary responsibility of strategists.
Learning Objective
Outline the five basic stages in the planning cycle as derived within the field of strategic management
Key Points
- The initiation stage includes generating ideas, assessing the feasibility and profitability of the project, conceptualizing the operational benefits and bottom line, and getting approval and resources.
- Planning and design follows the initiation stage, bringing the project under the microscope to assess the smaller details. Planning predicts the time investment, costs, and specific resources required.
- The simplest stage in theory, and perhaps the most complicated in practice, is the execution stage. This requires integrating all of the identified inputs from the planning-and-design phase to construct the actual end product or service.
- In the monitoring and controlling phase, analysis of the efficiency and quality of the project cycle from a strategic perspective allows for the optimization of the operational process itself.
- At the end of the project-management cycle, the closing phase determines that the project no longer captures value and should be harvested or divested.
- This cycle is iterative, and, unless the project is harvested or divested, should be continuously assessed and altered whenever deemed necessary.
Key Terms
- optimization
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The design and operation of a system or process to make it as good as possible in some defined sense.
- feasibility
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The state of being possible.
- forecast
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An estimation of a future condition.
The stages of a project within the strategic-planning discipline provide a step-by-step approach to generating and implementing an effective strategy, for either a corporation or a strategic business unit (SBU). Implementing a framework for generating a project-planning cycle, complete with strategic objectives, implementation methods, and assessment, is a primary responsibility of strategic managers.
The Steps in Strategic Planning
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Initiation: The initiation stage includes generating the idea, assessing the feasibility and profitability of the project, conceptualizing the operational benefits and the bottom line, and getting approval and resources. This stage should determine the scope of the operation.
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Planning and design: Planning and design brings the project under the microscope by assessing the smaller details. This stage includes predicting the time investment, costs, specific resources required, and the necessary inputs to achieve the outputs forecasted in the initiation stage. This stage is the most strategic in nature, mapping out the business processes in sufficient detail to effectively accomplish the required objectives.
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Executing: The simplest stage in theory, and perhaps the most complicated in practice, is the execution stage. It involves the integration of all inputs identified in the planning-and-design stage to construct the actual end product or service. This integration should be in line with the framework established in the first two stages.
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Monitoring and controlling: This can be thought of as the perfecting stage, in which analyzing the efficiency and quality of the project cycle from a strategic perspective allows for the optimization of operational processes. Monitoring the operation for ways to increase value can redirect the strategic-planning cycle back to the planning-and-design stage. This stage allows the process to run internally in a cyclical fashion, constantly adding improvements to capture more value.
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Closing: The project-management cycle ends with the determination that the project no longer captures value and should be harvested or divested. This stage is the other possible result from the monitoring and controlling phase—that is, instead of being redirected back to the planning-and-design phase, the assessment shows that value is now being lost and it is no longer profitable to continue the process. Therefore, the project cycle is closed.
This step-by-step process highlights each feasible stage in the project-management cycle. By appropriately incorporating each stage of the model into the planning process, managers can effectively forecast the deliverable, and they can avoiding losing value by accurately assessing the margins that will be produced in a given strategic initiative. This allows for informed and knowledgeable decisions to be made at each relevant point in the operation.
11.1: Understanding Communication
11.1.1: Defining Communication
Communication is conveying messages by exchanging thoughts and information.
Learning Objective
Outline the inherent dimensions and semiotic rules relevant to basic business communication
Key Points
- Communication is conveying of messages by exchanging thoughts or information via speech, visuals, signals, writing, or behavior.
- Business communication is the transmission and exchange of information between people in an organization to facilitate business activities.
- Communication requires a sender, a message, a form and channel, and a recipient.
- Communication can be described as information transmission governed by three levels of semiotic rules.
Key Terms
- communication
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The concept or state of information exchange.
- semiotic
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Of or relating to semantics (words).
Communication is the conveying of messages by exchanging thoughts or information via speech, visuals, signals, writing, or behavior. Communication requires a sender, a message, and a recipient, although the receiver may not be present or aware of the sender’s intent to communicate at the time of communication. Communication requires that the communicating parties share some area of commonality. The communication process is complete once the receiver has understood the message of the sender.
Perhaps the most time-honored form of communication is storytelling. People have told each other stories for ages to help make sense of the world, anticipate the future, and certainly to entertain. The art of storytelling draws on your understanding of yourself, your message, and how you communicate it to an audience that is simultaneously communicating back to you. Your anticipation, reaction, and adaptation to the process determine how successfully you are able to communicate.
Communication involves actions that confer knowledge and experience, give advice and commands, and ask questions. These actions may take many forms depending on the abilities and resources of the individual communicators. Together, content and form make messages that are sent towards a destination. The destination can be oneself, another person, or another entity (such as a corporation or group of people).
Business Communication Basics
Business communication is the transmission and exchange of information between people in an organization to facilitate business activities. Business communication encompasses marketing, brand management, customer relations, consumer behavior, advertising, public relations, corporate communication, community engagement, reputation management, interpersonal communication, employee engagement, and event management. It is closely related to the fields of professional and technical communication.
Business communication takes place within an organization and across organizational boundaries. Many organizations have a communications director who oversees internal communications and crafts messages sent to employees. It is vital that these internal communications are clear and managed in a timely way. Poorly crafted or managed communications could misdirect employee effort, cause confusion, and even foster distrust or hostility.
Dimensions of Communication
Communication has four primary components:
- Message (the content being communicated)
- Source (who the message comes from)
- Form and channel (through which medium)
- Destination/receiver/target (to whom)
Wilbur Schram, an authority on mass communications, argued that it is important to examine both the desired and the unintentional impact a message may have on its target.
Levels of Semiotic Rules
Communication can be described as information transmission governed by three levels of semiotic rules for making meaning:
- Syntactic (formal properties of signs and symbols such as letters or numbers)
- Pragmatic (concerned with the relations between signs/expressions and their users)
- Semantic (relationships between signs and symbols and what their meaning)
Communication is social interaction that requires at least two people who share a common set of signs and semiotic rules. Note that this does not apply to intrapersonal communication such as diaries or self-talk that occurs without interactions with others.
Example
Perhaps the most time-honored form of communication is storytelling. People have told each other stories for ages to help make sense of the world, anticipate the future, and certainly to entertain. The art of storytelling draws on your understanding of yourself, your message, and how you communicate it to an audience that is simultaneously communicating back to you. Your anticipation, reaction, and adaptation to the process determine how successfully you are able to communicate.
11.1.2: The Nature of Effective Communication
Effective communication avoids distorting messages during the communication processes.
Learning Objective
Define effective communication in the context of organizational challenges and barriers
Key Points
- Effective communication generates, maintains, and increases a desired effect.
- Barriers to effective communication distort, obscure, or misrepresent the message and fail to achieve the desired effect.
- Barriers to effective communication can be physical, system or process related, attitudinal, and caused by ambiguity.
Key Terms
- effective
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Having the power to produce a required effect or effects.
- Barriers
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A structure that bars passage; an obstacle or impediment; a boundary or limit.
Effective communication takes place when information is shared accurately between two or more people or groups of people and provokes the desired response. Effective communication should generate and maintain the desired effect, and offer the potential to increase the effect of the message. The goal of communication is usually to generate action, inform, create understanding, or communicate a certain idea or point of view.
Barriers to Effective Communication
Barriers to effective communication distort, obscure, or misrepresent the message and and fail to achieve the desired effect. Barriers to successful communication include message overload (when a person receives too many messages at the same time) and message complexity. Another barrier is “knowledge-appropriate” communication–using ambiguous legal words or medical jargon with another person who doesn’t understand them. Effective communication only happens when the words and symbols used create a common level of understanding for both parties.
Other common barriers to effective communication include the following:
- Physical barriers like distance, inferior technology, or staff shortages that reduce information processing capacity.
- System design faults like ambiguous definition of roles that can lead to confusion about message targets; lack of oral and written communication skills; and poor information technology infrastructure, including networks and applications.
- Attitudinal barriers presented by individuals. One person may want information compressed to bullet points, another may demand granular detail. Personality conflicts can lead people to delay or refuse to communicate, and dissatisfaction with the style of a message can result in its being ignored or misinterpreted.
- Ambiguous words/phrases that sound the same but have different meanings. Here the communicator must ensure that the receiver receives the intended meaning through careful word choice that avoids the possibility of multiple interpretations.
- Individual linguistic ability is important to consider: will intended targets understand industry-specific jargon, complex words, or colloquialisms? Using words that recipients can’t understand is inappropriate and counter-productive, resulting in confusion and alienation.
- Physiological barriers like ill health, poor eyesight, or hearing difficulties. Even a common cold can impact someone’s ability to compose or understand a message.
- The format and delivery of information is important. Communications have to take the potential barriers of an audience into account and tailor the message to reach them.
11.1.3: The Nature of Efficient Communication
Efficient communication achieves its desired effect with the least amount of effort and resources.
Learning Objective
Analyze the key considerations one should keep in mind in the business world to optimize their communicative capacity
Key Points
- A clear communication strategy and process can make developing and transmitting messages more efficient.
- There are two approaches to structuring an argument: direct and indirect.
- Visual elements like pictures, charts, and tables can help recipients more easily understand the main ideas being communicated.
Key Terms
- jargon
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A technical terminology unique to a particular subject.
- indirect
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Roundabout; deceiving; setting a trap; confusing.
- direct
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Straight, constant, without interruption.
Efficient communication conveys a message and achieves a desired effect using the least possible effort and resources. A key element of effective communication is having a clear process for developing and disseminating information. To create effective oral and written communication one should consider the audience, the format and content, and the channel or mode of transmission. A communication strategy speaks to each of these elements and guides how messages and information are developed and shared.
Communication Strategy
Good communicators begin by analyzing a given situation to develop a strategy for delivering their message. They consider the target audience and its level of knowledge and awareness. Does the audience have the background information it needs to understand the message? Which delivery mode is best suited to their understanding (i.e., a visual presentation or a written report)? These are all important points to consider when crafting a communication strategy.
Next they consider the purpose of their communication. Are they supposed to inform, persuade, or ask the audience to do something? The purpose informs choices of style and tone such as whether or not to use technical language or industry jargon. An authoritative tone denotes credibility and is more persuasive than tentative language.
There are two approaches to structuring a message: direct and indirect. Direct arguments are easier to follow because they present a main point and then offer supporting evidence. Indirect arguments provide the evidence first and then the main point. Both approaches summarize key points and use headers or other types of formatting to make it easier to understand the communication’s purpose and content.
Visual aids complement strategy and structure in oral or witten communications. Visual aids can clarify difficult points, draw attention to important ideas, and help the audience absorb information faster and more fully. Visual elements like pictures, charts, and tables can make communication more efficient.
11.1.4: The Nature of Persuasive Communications
Persuasion presents arguments that move, motivate, or change an audience.
Learning Objective
Assess the value and appropriate uses of persuasive communication tactics in an organizational framework
Key Points
- Persuasion attempts to influence people’s beliefs, attitudes, intentions, motivations, or behaviors in relation to an event, idea, object, or other person(s).
- Persuasive communication achieves five things: stimulation, convincing, call to action, increasing consideration, and tolerance for alternative perspectives.
- Different types of calls to action are adoption, discontinuance, deterrence, and continuance.
Key Term
- motivation
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Willingness to perform an action, especially a behavior; an incentive or reason for doing something.
Persuasion attempts to influence people’s beliefs, attitudes, intentions, motivations, or behaviors in relation to an event, idea, object, or other person(s). Persuasion is achieved through written or spoken communication that conveys information, thoughts, emotions, logic, and arguments. Effective business communication often involves persuasion. Salespeople, lawyers, and politicians make their living attempting to persuade others, and persuasion is an important part of the work of managers and leaders as well.
Persuasive communication achieves five things:
- Stimulation
- Convincing
- Call to action
- Increase consideration
- Tolerance of alternate perspectives
Stimulation
Persuasive communication reinforces, intensifies, and prioritizes existing beliefs. The purpose may be to spur action, build group cohesion, or develop commitment to a shared set of goals. This approach may begin by acknowledging areas of common ground and then introducing new information that helps the audience value this commonality even more.
Convincing
Sometimes a message is meant to convince an audience of the rightness of a certain choice or course of action. This often involves getting people to change their minds. The use of evidence and logical reasoning are effective techniques for accomplishing this type of persuasion.
Call to Action
Persuasive argument is often a call to action. This type of speech is not purely about stimulating interest to reinforce and accentuate beliefs, or convincing an audience of a viewpoint. Its intention is to get people to do something (often to change their behavior). Calls to action are commonly part of implementing decisions.
There are several types of calls to action: adoption, discontinuance, deterrence, and continuance. Adoption means the speaker wants to persuade the audience to accept a new way of thinking or adopt a new idea that influences their behavior. Discontinuance is the opposite: it involves the speaker persuading audience members to stop doing something (like quit smoking). Deterrence is a call to action that focuses on persuading the audience not to start something if they haven’t already started. Continuance means the speaker wants to persuade the audience to continue doing what they have been doing, such as reelect a candidate, keep buying a product, or stay in school to get an education.
Increase Consideration
Persuasive communicators also work to increase audience awareness and willingness to consider their position. Effective persuasion requires a target that is open to persuasion, and often this depends on how a message is framed and delivered. For example, an audience that is unmoved by appeals to emotion may be more willing to listen to rational arguments and facts.
Tolerance for Alternative Perspectives
The final key to creating a persuasive argument is helping the audience develop a tolerance for alternative perspectives. Perhaps the audience is interested in purchasing a certain type of car; as the lead salesperson on that model, the speaker has to listen and perform informal audience analysis to learn that horsepower and speed are important values to this customer.
11.1.5: Types of Communication: Verbal, Written, and Nonverbal
There are three main vehicles for communication: verbal, written, and non-verbal.
Learning Objective
Recognize the main ways in which individuals communicate and the pros, cons, and methods associated with each
Key Points
- Types of communication include verbal, written, and nonverbal.
- Verbal communication provides immediate feedback and so it is best for conveying emotions and maintaining interpersonal relationships; it can involve storytelling and crucial conversations.
- Written communication requires appropriate use of grammar, word choice, structure, and punctuation to be effective.
- Non-verbal communication is the process of sending and receiving wordless (mostly visual) cues.
Key Term
- nonverbal
-
A form other than written or spoken words, like gestures, facial expressions, or body language.
The most common vehicles for communication are oral, non-verbal, written, and electronic.
Oral communication describes the verbal exchange of information, emotions, thoughts, and perceptions. It includes speeches, presentations, conversations, and discussions. Body language and tone of voice play a significant role in how oral communication is perceived. Since oral communication almost always involves the simultaneous transmission and receipt of a message, feedback from the audience is immediate.
Written communication includes e-mail, memos, and reports. There is usually a gap of time and space between creation/transmission of a written message and its receipt. Written communication can include non-verbal elements like handwriting style, spatial arrangement of words, or the format and physical layout of a page that can effect how it is understood. However, the absence of aural cues such as tone of voice make careful word choice, grammar, structure, and punctuation essential for effective written communication.
Electronic communication uses a variety of digital technologies to carry messages between senders and recipients. Both oral and written communication can be conveyed electronically. For example, telephone and web conferencing are two modes of oral communication, while e-mail and text messaging are examples of written communication.
Non-Verbal Communication
Social psychologist Michael Argyle said that while spoken language is normally used to communicate information about external events that impact the speakers, non-verbal codes establish and maintain interpersonal relationships. Argyle concluded there are five primary functions of non-verbal bodily behavior in human communication:
- Express emotions
- Express interpersonal attitudes
- Work with speech to manage the cues of interaction between speakers and listeners
- Present one’s personality
- Conduct rituals (greetings)
Humans communicate interpersonal closeness through series of non-verbal actions known as immediacy behaviors. Examples of immediacy behaviors are smiling, touching, open body positions, and eye contact. Cultures that display these immediacy behaviors are considered high-contact cultures.
11.2: Management and Communication
11.2.1: Downward Communication
Downward communication is managers communicating to their subordinates.
Learning Objective
Justify the process and benefits of effectively communicating to employees in the workplace
Key Points
- Downward communication is the flow of information and messages from a higher level inside an organization to a lower one.
- Effective downward communication is crucial to an organization’s success.
- Creating concise communications and maintaining a respectful tone help ensure effective downward communication; making sure that employees clearly understand the information is also crucial.
- Differences in experience, knowledge, levels of authority, and status can lead to misunderstandings and misinterpretations.
Key Term
- internal
-
Concerned with the non-public affairs of a company or other organization.
When leaders and managers share information with lower-level employees, it is called downward, or top-down, communication. While downward communication may sometimes invite a response, it is usually one-directional rather than reciprocal–the higher-level communicator does not invite or expect a response from the lower-level recipient.
Examples of downward communication include explaining an organization’s mission and strategy or explaining the organizational vision. Effective downward communication gives employees a clear understanding of the message they have received. Whether informative or persuasive, effective downward communication results in the recipients taking action or otherwise behaving in accord with the communicators’ expectation.
In the workplace, directives from managers to employees are the most basic form of downward communication. These can be written manuals, handbooks, memos, and policies, or oral presentations. Another example of downward communication is a board of directors instructing management to take a specific action.
Business communication experts John Anderson and Dale Level identified five benefits of effective downward communication:
- Better coordination
- Improved individual performance through the development of intelligent participation
- Improved morale
- Improved consumer relations
- Improved industrial relations
Ensuring effective downward communication is not necessarily an easy task. Differences in experience, knowledge, levels of authority, and status can make it more likely that sender and recipient do not share the same assumptions or understanding of context, which can result in messages being misunderstood or misinterpreted. Creating clearly worded and non-ambiguous communications and maintaining a respectful tone can overcome these issues and increase effectiveness.
11.2.2: Upward Communication
Upward communication moves from lower to higher levels within an organization.
Learning Objective
Evaluate the value created through ensuring upwards communication is accessible and encouraged by upper management
Key Points
- Upward communication is the transmission of information from lower levels of an organization to higher ones.
- Upward communication often comes in response to downwardly communicated requests for information, opinions, or actions.
- The channel used to share upward communication (e.g., face-to-face, over the telephone, writing) can influence its effectiveness.
- Upward communication can be an important source of information that informs management’s decision-making.
Key Terms
- vigilance
-
Close and continuous attention to someone or something.
- subordinate
-
Someone or something placed in a lower class, rank, or position.
- upward communication
-
The flow of information from lower levels of a hierarchy to higher levels.
Upward communication is the transmission of information from lower levels of an organization to higher ones; the most common form is employees communicating with managers. Managers who are open to and encourage upward communication foster cooperation, gains support, and reduces frustration among their employees. The content of such communication can include judgments, estimations, propositions, complaints, grievances, appeals, reports, and any other information directed from subordinates to superiors. Upward communication is often made in response to downward communication; for instance, employees answering a question from their manager. In this way, upward communication indicates the effectiveness of a company’s downward communication.
The communication channel, or mode of sharing information, strongly influences the upward communication process. Information sharing can be face-to-face, over the phone, or in writing. Subordinates should make an effort to identify the preferred means of receiving communication from their manager or other higher-ups. For instance, sending a written report to someone who prefers to receive information in the form of a concise email is less likely to bring about the desired effect.
The availability of communication channels affects employees’ overall satisfaction with upward communication. For example, an open-door policy sends the signal to employees that the manager welcomes impromptu conversations and other communication. This is likely to make employees feel satisfied with their level of access to channels of upward communication and less apprehensive about communicating upward.
For management, upward communication is an important source of information that can inform business decisions. It helps to alert management of new developments, levels of performance, and other issues that may require their attention. Whistle-blowing involves upward communication when employees communicate directly with top management about matters requiring attention or discipline (e.g., harassment from another employee), including perceived ethical or legal breaches.
11.2.3: Horizontal Communication
Horizontal communication is the flow of messages across individuals and groups on the same level of an organization.
Learning Objective
Justify the value of promoting internal communication between employees occupying the same functional areas and levels
Key Points
- Horizontal communication refers to the flow of messages across functional areas on the same level of an organization.
- Effective use of horizontal communication in the workplace can enhance productivity by making information sharing, problem solving, collaboration, and conflict resolution more efficient.
- Problems with horizontal communication can arise from territoriality, rivalry, specialization, lack of motivation, and rivalry.
Key Terms
- horizontal communication
-
The flow of messages across functional areas on the same level of an organization.
- lateral
-
Situated at the side of or next to something else.
Horizontal communication, also called lateral communication, involves the flow of messages between individuals and groups on the same level of an organization. Horizontal communication does not involve relaying information up or down across levels. Sharing information, solving problems, and collaborating horizontally is often more timely, direct, and efficient than up or down communication. Horizontal communication can produce a higher quality of information exchange since it occurs directly between people working in the same environment. Communication within a team is an example of horizontal communication; members coordinate tasks, work together, and resolve conflicts. Horizontal communication occurs formally in meetings, presentations, and formal electronic communication, and informally in other, more casual exchanges within the office.
Challenges of Horizontal Communication
Some barriers to horizontal communication are differences in style, personality, or roles amongst co-workers. According to Professor Michael Papa, horizontal communication problems can occur because of territoriality, rivalry, specialization, and simple lack of motivation. Territoriality occurs when members of an organization regard other people’s involvement in their area as inappropriate or unwelcome. Rivalry between individuals or teams can lead to reluctance to cooperate and share information. Specialization is a problem that occurs when there is a lack of uniform knowledge or vocabulary within or between departments. Finally, horizontal communication often fails simply because organization members are unwilling to expend the additional effort to reach out beyond their immediate team to others at the same level.
An organization that has relied on rigid, formal styles of communication in the past may find it difficult to switch to more employee-directed, horizontal communication. Lingering expectations from the old system can significantly inhibit the implementation of horizontal communication. For example, employees may be reluctant to initiate communications if they are used to conversations being started only by management. Finally, corporations that operate in different geographic locations, particularly internationally, may struggle with horizontal communication across time zones as the confront the barriers of local idioms, customs, and languages.
11.2.4: Informal Communication
Informal communication occurs outside of an organization’s established channels.
Learning Objective
Explain the role and benefits of informal communication within an organization
Key Points
- Informal communication occurs outside an organization’s established channels of sending and receiving messages.
- Informal communication frequently crosses boundaries within an organization and is commonly separate from work flows.
- Informal communication has become increasingly important in maintaining the interpersonal relationships and networks that facilitate getting work done.
Key Terms
- interpersonal
-
Between two or more people.
- communication channel
-
The method or medium by which one conveys information; e.g., through the exchange of thoughts, messages, or information via speech, visuals, signals, writing, or behavior.
- informal
-
Not formal or ceremonious; casual.
Informal communication occurs outside an organization’s established channels for conveying messages and transmitting information. While formal communication follows practices shaped by hierarchy, technology systems, and official policy, informal communication faces fewer restrictions. Formal communication usually involves documentation, while informal communication usually leaves no recorded trace for others to find or share. Informal communication frequently crosses boundaries within an organization and is commonly separate from work flows. That is, it often occurs between people who do not work together directly but share an affiliation or a common interest in the organization’s activities and/or a motivation to perform their jobs well.
In the past, many organizations considered informal communication (generally associated with interpersonal, horizontal communication) a hindrance to effective organizational performance and tried to stamp it out. This is no longer the case. The maintenance of personal networks and social relationships through information communication is understood to be a key factor in how people get work done.
Formal communications in traditional organizations are frequently “one-way”: they are initiated by management and received by employees. Their content is perceived as authoritative because it originates from the highest levels of the company. Informal communication, on the other hand, can occur in any direction and take place between individuals of different status and roles.
While informal communication is important to an organization, it also may have disadvantages. When it takes the form of a “rumor mill” spreading misinformation, informal communication is harmful and difficult to shut down because its sources cannot be identified by management. Casual conversations are often spontaneous, and participants may make incorrect statements or promulgate inaccurate information. Less accountability is expected from informal communications, which can cause people to be careless in their choice of words, indiscreet, or disclosing sensitive information.
11.3: Barriers to Effective Communication
11.3.1: Choosing the Type of Communication
The medium, or channel, of business communication influences its effectiveness.
Learning Objective
Classify the advantages of using the varying communication channels
Key Points
- Being able to determine the most appropriate channel of communication is critical to effectively communicating.
- Communication channels vary from richer to leaner depending on their degree of interaction.
- Oral communication tends to be richer than most written communication.
Key Term
- oral
-
Spoken rather than written.
In communications, a channel is the means of passing information from a sender to a recipient. Determining the most appropriate channel, or medium, is critical to the effectiveness of communication. Channels include oral means such as telephone calls and presentations, and written modes such as reports, memos, and email.
Communications differ along a scale from richer to leaner. Rich media are more interactive than lean media and provide opportunities for immediate two-way communication. For instance, a face-to-face conversation is a rich medium because the receiver can ask questions and respond to the message as they process it. The main channels are grouped below from richest to leanest:
- Richest channels: face-to-face meeting; in-person oral presentation
- Rich channels: online meeting; videoconference
- Lean channels: teleconference; phone call; voice message; video
- Leanest channels: blog; report; brochure; newsletter; flier; email
Oral communications tend to be richer channels because information can be conveyed through speech as well as nonverbally through tone of voice and body language. Oral forms of communication can range from a casual conversation with a colleague to a formal presentation in front of many employees. Richer media are well suited to complex messages, as well as disturbing messages, since they can provide opportunities to clarify meaning, reiterate information, and display emotions.
While written communication does not have the advantage of immediacy and interaction, it can be the most effective means of conveying large amounts of information. Written communication is an effective channel when context, supporting data, and detailed explanations are necessary to inform or persuade others. One drawback to written communications is that they can be misunderstood or misinterpreted by an audience that does not have subsequent opportunities to ask clarifying questions or otherwise respond.
Here are some examples of different communication channels and their advantages:
- Web-based communication, such as video conferencing, allows people in different locations to hold interactive meetings.
- Emails provide an instantaneous medium of written communication.
- Reports document the activities of any department.
- Presentations usually involve audiovisual material, like copies of reports, or material prepared in Microsoft PowerPoint or Adobe Flash.
- Telephone meetings allow for long-distance interaction.
- Message boards allow people to instantly post information to a centralized location.
- Face-to-face meetings are personal and should be succeeded by a written follow-up.
11.3.2: Quality of Written and Oral Expression
The quality of written and oral communication depends on the effective use of language and communication channels.
Learning Objective
Describe the central importance and value in having high-quality written and oral communication abilities in a professional environment
Key Points
- The quality of written and oral expression determines how effective communication will be in achieving its objectives.
- In both written and oral communication, the use of language is the primary determinant of quality of expression.
- Oral communication can also employ visual aids and nonverbal elements, such as body language, to convey meaning.
Key Term
- effective
-
Having the power to produce the required or desired effect.
The quality of written and oral expression determines how effective communication will be in achieving its objectives. Whether to inform, provoke, or persuade, communication’s primary purpose is to assign and convey meaning in order to create shared understanding. We can assess the quality of expression by considering such factors as content and use of communication medium.
In both written and oral communication, the use of language is the primary determinant of quality of expression. This includes grammar, word choice and vocabulary, sentence structure, and organization. Another important factor is how well thought out the message is. A common adage states, “Good writing is good thinking.” In other words, it is difficult to express yourself well without first knowing what you want to say. Communication that is easier for the audience to understand and follow is more likely to achieve its aim than is expression that is confused, poorly organized, or vague.
In addition to word use, communicators can employ visual and nonverbal elements to convey meaning. Pictures, charts, or tables can provide value when expressing complex ideas by synthesizing and focusing on the most important points. Body language, eye contact, and tone of voice can play significant roles in face-to-face communication, and may even have a greater impact on the listener than the words actually spoken.
The communication medium is the channel through which information flows from sender to recipient. Channels include email, telephone, written reports, and oral presentations. One’s skill level in using the chosen medium is an aspect of quality of expression. For instance, without training or experience using web conferencing it may be difficult to connect with the audience in ways that effectively convey meaning and understanding.
11.3.3: Nonverbal Communication
Nonverbal elements supplement the use of words to convey meaning during communication.
Learning Objective
Recognize the importance of the nonverbal factors involved in communication
Key Points
- Nonverbal communication refers to meaning conveyed in the absence of words.
-
Voluntary nonverbal communication refers to intentional movement, gestures, and poses.
- Involuntary nonverbal communication gives cues about what one is really thinking or feeling.
- Regardless of what is said verbally, it is important to be aware of the nonverbal messages communicated through body language.
Key Terms
- nonverbal
-
Not using words; of communication such as gestures, facial expressions, and body language.
- body language
-
Nonverbal communication by means of facial expressions, eye behavior, gestures, posture, and the like; often thought to be involuntary.
Nonverbal communication refers to meaning conveyed in the absence of words. Information conveyed nonverbally can be perceived through any of the five senses: sight, sound, smell, touch, and taste. There are two types of nonverbal communication—voluntary and involuntary.
Voluntary Nonverbal Communication
Voluntary nonverbal communication refers to intentional movements, gestures, and poses. These include smiling, hand movement, eye contact, or imitation, and are generally intended to reinforce or clarify meaning being communicated verbally. These actions are made willingly and usually with conscious awareness.
Involuntary Nonverbal Communication
Involuntary nonverbal communication gives cues about what one is really thinking or feeling but may not be expressing in words.
There are many elements of involuntary body language that we use and experience commonly without being aware we are doing so. For example, many people will raise their eyebrows as one approaches them face-to-face as an indication of recognition, esteem, or surprise. If a person walking down the street encounters a stranger, then the chances are that neither person will raise their eyebrows. If they recognize each other, however, even if they do not greet each other, then eyebrows will likely raise and lower. However, if a person is known but not highly regarded by another person, the second person may not raise his or her eyebrows.
Involuntary nonverbal communication can betray one’s true beliefs, feelings, or motives. When angry or upset, often someone’s body language can communicate more intensity than their words alone. Similarly, when we perceive someone as being physically uncomfortable during a conversation, they are sending a message that may not be consistent with what they are saying.
Effective communication relies on being aware of nonverbal aspects of interactions with others. It is equally important to be aware of one’s own nonverbal behaviors and be sensitive to how they may be perceived. For instance, maintaining eye contact when communicating indicates interest. Staring out the window or around the room is often perceived as boredom or disrespect. Another simple nonverbal technique to facilitate good communication is the act of mirroring. Mirroring involves mimicking others’ gestures and ideas. This is especially helpful for making outsiders feel comfortable sharing ideas or for minimizing status differences.
11.3.4: Differences in Status
Social status can influence how an individual’s communication is perceived.
Learning Objective
Discuss the potential communication barriers created by differences in status, rank or organizational hierarchy within an organization
Key Points
- Social status refers to the relative rank or standing that an individual has in the eyes of others; it is shaped by one’s background, education, reputation, perceived power, and position in an organization’s hierarchy.
- Achieved status can include what an individual acquires during his or her lifetime as a result of accumulated knowledge, inherent ability, skill, and perseverance.
- Credibility and legitimacy can be gained by demonstrating competence, reliability, and identification with shared interests.
Key Term
- Social Status
-
The honor or prestige attached to one’s position in society.
Among the many organizational and individual factors that can influence the effectiveness of business communication, social status is one of the most challenging to address. Social status refers to the relative rank or standing that an individual has in the eyes of others. Position in the organization’s hierarchy, background, education, reputation, and power all contribute to those perceptions of prestige.
There are two elements of social status—those attributes we are born with and those we achieve. Ascribed status is determined at birth and includes characteristics such as sex, age, race, ethnic group, and family background. Achieved status is what an individual acquires as a result of the exercise of knowledge, ability, talent, skill, and/or perseverance. Employment and occupation are primary factors in social status, and one’s role in an organization is especially relevant within the boundaries of that organization.
Implications of Social Status on Communication
People often have difficulty navigating status differences when trying to inform or persuade others. To many, social status is an indicator of credibility and legitimacy, and this effects how seriously others take what one communicates. Key elements that are involved in an audience’s evaluation include title, reputation, and the extent to which people can identify with the communicator’s motives and objectives. Status differences can create a bias against those with the perceived lower status. For example, a junior or lower-level employee asked to make a presentation to a group of more senior upper-level managers may have difficulty keeping their attention at first even if his information and presentation skills are solid. Outsider status can also be a challenge in communication. This is commonly experienced by salespeople, vendors, and even potential employees.
In such situations, those with perceived lower status need to build good will by demonstrating competence and reliability and identifying with common interests.
11.3.5: Noise as a Barrier to Communication
The efficacy of communication is impacted by how much noise there is in the communication channel.
Learning Objective
Evaluate the risk of distractions and noise reducing communication effectiveness
Key Points
- Communication involves a sender transmitting a message to a recipient, who then decodes and interprets that message. This means there are multiple points in the communication process where misinterpretation and distraction are possible.
- There are certain barriers to effective communication that every organization faces. These potential interruptions of the flow of information are referred to as “noise”.
- Communicative problems (i.e., noise) can be categorized into three groups: technical, semantic, or efficacy-related.
- Examples of noise include environmental noise, physiological-impairment noise, semantic noise, syntactical noise, organizational noise, cultural noise, and psychological noise.
Key Terms
- semantic
-
Related to meaning.
- noise
-
Various sounds, usually unwanted.
- Syntactical
-
Related to the set of rules that govern how words are combined into meaningful phrases and sentences.
The Communicative Process
Mathematicians Claude Shannon and Warren Weaver defined communication as comprising the following five general components:
- An information source (i.e., sender). This produces a message; in an oral conversation, the information source is simply the speaker.
- A transmitter. This encodes the message into signals.
- A channel. Signals are adapted to this channel for transmission.
- A receiver. This “decodes” (i.e., reconstructs) the message from the received signals.
- A destination. This is where the message arrives; in an oral conversation, the destination is simply the listener.
Distractions—i.e., noise—can disrupt the flow of information between any of these five stages. That is to say, issues in communication pertaining to distraction could affect the sender, the message itself, the channel it is being sent through, or the recipient of that message.
Communicative Interference
Every organization faces certain barriers to communication. Shannon and Weaver argue there are three particular layers of communication problems:
- Technical: How accurately can the message be transmitted?
- Semantic: How precisely can the meaning be conveyed?
- Efficacy-related: How effectively does the received meaning affect behavior?
These layers relate to a variety of types of noise that can interfere with communication.
Environmental Noise
Environmental noise is noise that physically disrupts communication, such as very loud speakers at a party or the sounds from a construction site next to a classroom.
Physiological-Impairment Noise
Physical conditions such as deafness or blindness can impede effective communication and interfere with messages being clearly and accurately received.
Semantic Noise
Semantic noise refers to when a speaker and a listener have different interpretations of the meanings of certain words. For example, the word “weed” can be interpreted as an undesirable plant in a yard or as a euphemism for marijuana.
Syntactical Noise
Communication can be disrupted by mistakes in grammar, such as an abrupt change in verb tense during a sentence.
Organizational Noise
Poorly structured messages can also be a barrier. For example, a receiver who is given unclear, badly worded directions may be unable to figure out how to reach their destination.
Cultural Noise
Making stereotypical assumptions, such as unwittingly offending a non-Christian person by wishing them a “Merry Christmas,” can also detract from communication. Because of this, it is important that each side of a conversation understands the culture of the other party.
Psychological Noise
Certain attitudes can also make communication difficult. For instance, significant anger or sadness may cause someone to lose focus on the present moment.
By acknowledging and adjusting to noise, a communicator can make it more likely that their message will be received as intended.
11.3.6: Gender and Diversity
Diversity, while an important part of a strong workforce, can contribute to misconceptions that may impede communication.
Learning Objective
Recognize how diversity and gender may complicate communication in an organization
Key Points
- Differences in gender, race, religion, cultural background, age, and sexual orientation can be barriers to effective communication.
- Gender communication issues can strongly affect team interactions. Gender communication issues can range from differences in communication styles and perceptions to sexual harassment.
- Cultural issues can affect team interactions through differences in communication conventions.
- Intercultural competence—the ability to communicate effectively and appropriately with individuals of another culture—requires regional expertise, empathy, and linguistic proficiency.
- Addressing gender and diversity from a communicative standpoint requires a high degree of empathy and understanding. A good communicator must be able to see things from the perspective of the intended recipient.
Key Terms
- Diversity
-
The quality of being different.
- selective perception
-
The tendency to not notice and more quickly forget stimuli that cause emotional discomfort and contradict our prior beliefs.
- Intercultural Competence
-
The ability to communicate effectively and appropriately with people of other cultures.
Diversity and Barriers
Barriers to effective communication can distort a message and its intention, which may result in failure of the communication process or damage to a relationship. These barriers include filtering, selective perception, information overload, emotions, language, silence, communication apprehension, gender differences, and political correctness.
By definition, diversity brings a wider range of views, and having a wide range of views is essential to an organization’s success. In addition, as teams are becoming increasingly global, diversity can help an organization or team understand its place in its surroundings.
But a diverse team environment can also cause challenges. Some individuals’ views may challenge those of the larger team. Preconceived notions about differences in other people—such as racism, sexism, ageism, homophobia, etc.—disrupt work processes and can prevent teams from achieving their goals. Because of this, diverse teams must keep several important considerations in mind at all times to ensure effective communication.
Communicating in Diverse Teams
The main benefit of a diverse background is that it fosters a creative environment. The main pitfall is that differences between team members can lead to destructive conflict, most often due to communicative failures. As a result, companies must equip their employees with the tools to prevent potential conflicts before they ever arise.
The most effective way to ensure proper communicative efficiency in diverse teams is to improve intercultural competence. Intercultural competence is simply the ability to communicate with different groups and cultures effectively and appropriately—”effectively” meaning that shared goals are being accomplished, and “appropriately” meaning doing so without violating the values, norms, relationships, or expectations of others.
Intercultural competence is a widely studied area of organizational communications and behavior. One model outlines the three following components as being at the core of a culture-savvy individual: regional expertise, language proficiency, and cross-cultural competence.
Other Issues in Diversity
Of course, intercultural considerations are only some of the issues that arise in diverse teams. Further differences such as sexual orientation, gender, political views, age, and special needs are also highly relevant and are critical to consider for communicative success.
The greatest takeaway here should be the power of empathy. The ability to recognize someone else’s perspective (and therefore how they may interpret what you say) is absolutely central to avoiding issues in communication between different groups. In any communicative setting, whether you are speaking or writing or listening or reading, keep in mind the possible interpretations of individuals whose perspectives and predispositions may differ from yours.
11.4: Improving Communication Effectiveness
11.4.1: Learning to Speak
Sending effective communication requires skill and an understanding of the audience.
Learning Objective
Explain the difficulty of sending communications, with a particular focus on improving and enhancing’s one’s ability to communicate accurately and concisely
Key Points
- The ability to communicate clearly in speaking and in writing is one of the most valuable professional skills.
- Communicating effectively relies on credibility, which is undermined by grammar and spelling mistakes, incompleteness, and errors in logic.
- When sending a message, the communicator must keep in mind the target audience.
Key Terms
- brevity
-
The quality of being brief in duration.
- clarity
-
The state, or measure of being clear, either in appearance, thought or style; lucidity.
The ability to communicate effectively in speech and in writing is one of the most valuable professional skills. Sending messages and information so they are understood as intended and produce the desired effect demands certain technical competencies and interpersonal capabilities. Fortunately, these can be learned and honed through practice.
Communicating effectively relies on credibility. Mistakes in grammar and spelling, incompleteness, and errors in logic can have a negative impact on the audience’s perception of the sender’s credibility. As a result, the communicator’s ability to persuade or otherwise influence the recipient is diminished. Effective ways to learn precise, professional oral and written communication skills include:
- having others, such as a supervisor, provide feedback on strengths and weaknesses as a communicator.
- analyzing the strengths and techniques of excellent communicators.
- imitating strong communicators.
Communicating in the Workplace
When sending a message, communicators must think of the target audience, being sure to use terms and phrases that readers or listeners will understand. For example, texts or e-mails should avoid using abbreviations that the receiver may not recognize. To respect others’ time, communication should aim for brevity and concision without sacrificing clarity and completeness. Using e-mail effectively poses particular challenges. Often, messages are poorly structured, missing specific subject lines, slow in getting to the point, or too long to warrant being read in their entirety.
It can be challenging to strike the right tone or avoid the wrong one in electronic communication. The absence of non-verbal cues, such as tone of voice or body language, means that written communication can be more easily misinterpreted and even cause offense. Consequently, important communications may warrant review by someone who can assess the tone and content and provide feedback.
11.4.2: Learning to Listen
Using active and reflective listening skills can help improve the effectiveness of oral communication.
Learning Objective
Explain active and reflective listening as techniques for improving the effectiveness of oral communication
Key Points
- Communication is an activity that involves a both sender and an audience, or receiver. While the sender must focus on making sure the message is clear, the receiver has to show that the message is received and understood.
- Active listening is a process of attending carefully to what is being said and how the speaker says it.
- Reflective listening focuses on personal elements of communication rather than the abstract ideas. It deals with the emotional content of communication.
Key Terms
- receiver
-
A person who receives a signal.
- active listening
-
The process of attending carefully to what a speaker is saying, involving such techniques as accurately paraphrasing the speaker’s remarks.
- Interpretation
-
An act of explaining what is obscure.
Effective oral communication is the responsibility of both the sender and the recipient. While the sender must focus on making sure the message is clear, the receiver has to show that the message is received and understood. For the sender, content, channel choice, and understanding of the audience matter most. For the recipient, listening skills are paramount. Listening is an interaction between speaker and listener. The listener’s use of active and reflective listening skills can help improve communication effectiveness.
Active Listening
Active listening is a process of attending carefully to what is being said. It also involves the listener observing the speaker’s behavior and body language. One way to demonstrate this attention is for the listener to show understanding by paraphrasing what the speaker has said. Paraphrasing can confirm the accuracy of the listener’s interpretation or identify the need for clarification. Conversely, when individuals show disinterest or distraction when someone is speaking, it reveals an absence of listening that can frustrate, annoy, and even anger the speaker.
Reflective Listening
Reflective listening focuses on personal elements of the communication rather than the abstract ideas. Reflective listening should be feeling-oriented and responsive. The listener should show empathy and concern for the person communicating. A good reflective listener concentrates on the discussion at hand while allowing the speaker to lead the communication. Verbal response is essential for reflective listening. Listeners should make statements that paraphrase what is said, clarify what appears to be implicit, and reflect the emotion or feeling they sense from the speaker. Being able to understand and articulate the meaning behind the words helps receivers better interpret the information and messages they hear.
11.4.3: Learning to Communicate Nonverbally
Nonverbal communication is the process of conveying meaning through sending and receiving wordless cues.
Learning Objective
Identify key facets of nonverbal communication and gain awareness of how to interpret and use them
Key Points
- Oral and written communications contain nonverbal elements that can reinforce or contradict what is being expressed verbally.
- Nonverbal communication represents two-thirds of all communication. For this reason, learning to identify and read nonverbal cues is an important communication skill.
- Nonverbal communication can enhance a spoken message through gestures, eye contact, and posture.
Key Term
- nonverbal
-
Of communication: a form other than written or spoken words, like gestures, facial expressions, or body language.
Nonverbal communication is the process of sending and receiving wordless (mostly visual) messages between people. Oral and written communication has nonverbal elements that can reinforce or contradict what is being expressed verbally. Messages can be communicated through gestures and touch, by body language or posture, or by facial expression and eye contact. Speech also contains nonverbal elements, known as paralanguage, that include voice quality, rate, pitch, volume, and speaking style, as well prosodic features such as rhythm, intonation, and stress.
Likewise, written texts have nonverbal elements such as handwriting style, spatial arrangement of words, or the physical layout of a page. However, much of the study of nonverbal communication has focused on face-to-face interaction, in which nonverbal cues are classified into three principal areas: environmental conditions, where communication takes place; physical characteristics of the communicators; and behaviors of communicators during interaction.
Nonverbal communication can enhance a spoken message through body signals. Body language contains numerous elements, including physical features (both changeable and unchangeable); gestures and signals (both conscious and unconscious); and spatial relations. The listener might perceive an unintended message if the body language conveyed by the speaker does not match the verbal message. Nonverbal communication is an important component when making a first impression with a new acquaintance or business contact. Body language, stance, and voice inflection or tone can have a stronger impact than the content of an initial communication itself.
Nonverbal communication represents two-thirds of all communication. For this reason, learning to identify and read nonverbal cues is an important communication skill. While listening, try to observe the speaker’s posture, clothing, gestures, and eye contact. These convey information about the speaker as well as his or her message.
Posture
Posture or a person’s bodily stance can communicate a variety of messages. Some of the many types of posture include: slouching, towering, legs spread, jaw thrust, shoulders forward, and arm crossing. These nonverbal behaviors can indicate feelings and attitudes toward another person. Posture can be used to determine a participant’s degree of attention or involvement; the difference in status between communicators; and the level of fondness a person has for the other communicator, depending on body openness. For instance, a person who displays a forward lean or decreases a backward lean signifies positive sentiment during communication.
Clothing
Clothing is one of the most common forms of nonverbal communication. The study of clothing and other objects as a means of nonverbal communication is known as artifact or object. These studies indicate that the types of clothing an individual wears convey nonverbal clues about personality, background and financial status, and how others will respond. An individual’s clothing style can demonstrate level of confidence, cultural origin or preference, interests, age, level of authority, values and beliefs.
Gestures
Gestures may be made with the hands, arms, or body and also include movements of the head, face, and eyes, such as winking, nodding, or eye-rolling. Facial expressions, more than anything, serve as a practical means of communication. With all the various muscles that precisely control mouth, lips, eyes, nose, forehead, and jaw, human faces are estimated to be capable of more than ten thousand different expressions. This versatility makes nonverbal messages of the face extremely efficient and honest, unless they are deliberately manipulated. In addition, many emotions, including happiness, sadness, anger, fear, surprise, disgust, shame, anguish, and interest are universally recognized.
Eye Contact
When two people look at each other’s eyes at the same time, they are making eye contact. It is the primary nonverbal way of indicating engagement, interest, attention, and involvement. Studies have found that people use their eyes to indicate interest. This includes frequently recognized actions of winking and movements of the eyebrows. Disinterest is highly noticeable when individuals make little or no eye contact in a social setting. Generally speaking, the longer the established eye contact between two people, the greater the intimacy levels.
11.4.4: Delivering Constructive Feedback
Constructive feedback, both positive and negative, can help individuals learn and improve their performance.
Learning Objective
Employ constructive feedback in conjunction with the varying control functions available to managers in an organization
Key Points
- Positive and negative feedback can be constructive when it addresses factors directly related to performance over which someone has control.
- Constructive feedback serves as motivation for many people in the workplace.
- A performance appraisal or performance evaluation is a systematic, periodic process that assesses an individual employee’s job performance and productivity in relation to established criteria and organizational objectives.
- In human resources or industrial psychology, 360-degree feedback, also known as multi-rater feedback, multi-source feedback, or multi-source assessment, is feedback from members of an employee’s immediate work circle.
Key Terms
- feedback
-
Critical assessment on information produced,
- constructive
-
Carefully considered and meant to be helpful.
Critical assessments are essential to learning and performance improvement. Individuals often rely on external measures, such as exams or feedback from others, to determine strengths and weaknesses. Praise and compliments are welcome reassurance of a person’s abilities, but negative assessments can hurt unless clearly supported by observations and thoughtfully delivered. Whether positive or negative, feedback can be constructive when it addresses factors directly related to performance over which someone has control.
Knowing how to deliver constructive feedback is an important skill for a manager and leader. Constructive feedback motivates many who use it to change their behavior, study new things, or adopt new attitudes. After receiving constructive feedback, an individual decides whether and how to put it to use. Joseph Folkman, an expert in the use of the 360-degree feedback technique, comments that those who want to achieve the greatest level of success possible should learn how to accept any kind of feedback, analyze it in the most positive manner possible, and use it to influence future choices.
Feedback in Organizations
Feedback is given in organizations in a variety of ways. Some are informal, as when a colleague offers a compliment or critique after hearing a presentation or reading a report. Others feedback mechanisms are more formal and part of a process created for the explicit purpose of delivering performance assessments.
Performance Appraisal
A performance appraisal (PA) or performance evaluation is a systematic and periodic process that assesses an individual employee’s job performance and productivity in relation to certain established criteria and organizational objectives. Other aspects of employee performance are considered as well, such as organizational citizenship behavior, accomplishments, potential for future improvement, strengths and weaknesses, etc. While performance appraisals are documented in writing, usually a manager will meet to provide and discuss feedback with an employee. Using specific examples of each behavior to support each assessment is helpful in indicating what someone needs to do differently or improve.
360-Degree Feedback
In human resources, 360-degree feedback, also known as multi-rater feedback, multi-source feedback, or multi-source assessment, is feedback that comes from members of an employee’s immediate work circle. Most often, 360-degree feedback will include opinions from an employee’s subordinates, peers, and supervisor(s), as well as a self-evaluation. In some cases, it can also include feedback from external sources, such as customers and suppliers or other interested stakeholders. The 360-degree assessment may be contrasted with “upward feedback,” where managers are given feedback only by their direct reports, or with a traditional performance appraisal, in which employees are most often reviewed only by their managers.
After-Action Reviews
At the end of a project, team members benefit from reviewing how they worked together, how well they met the project objectives, and whether they achieved the planned outcome. This after-action review entails a candid analysis of work product, communication practices, individual effort, coordination and planning, and other key aspects related to the project. The goal of this form of feedback is to apply lessons learned from one project to subsequent ones. Constructive feedback in this context is best delivered by focusing on actions and outcomes rather than on blaming individuals when things did not go as planned.
11.4.5: The Impact of the Office Environment on Employee Communication
The main purpose of an office environment is to support its occupants in performing their job at minimum cost and with maximum satisfaction.
Learning Objective
Identify types and functions of physical spaces that organizations use to control information, work processes, and social interactions
Key Points
- Effective communication among team members and others requires a physical environment that facilitates interaction.
- There are three types of office spaces, each with distinct purposes and functions: work spaces, meeting spaces, and support spaces.
- Decisions about the physical environment shape information flow, work processes, and social interactions.
Key Terms
- accommodate
-
To render fit, suitable, or correspondent; to adapt; to conform.
- cubicle
-
A small separate part or one of the compartments of a room.
The main purpose of an office environment is to support its occupants in performing their job, preferably at minimum cost and with maximum satisfaction. In most organizations, work is accomplished by teams of people. Effective communication among team members and others requires a physical environment that facilitates interaction so individuals can coordinate activities, discuss and plan tasks, and manage interpersonal relationships effectively and efficiently. For this reason, the design of work spaces can be an important element in organizational performance.
A more open physical space can encourage casual communication since people work in close proximity with few barriers between them. Creating clear lines of sight and facilitating easy access make it easier for individuals to know who is present and available for interaction and to engage with them as needed. On the other hand, more private spaces, such as offices with doors, can create a more formal climate that distinguished between roles and status. Highly desirable corner offices occupied by an executive are an example. Individual offices can also preserve confidentiality and discretion as needed, which is especially useful for meetings between managers and their team members or when personnel matters are discussed.
Work places are typically divided into three physical areas: work spaces, meeting spaces, and support spaces. Each has it distinct function and purpose. The design of an organization’s physical environment requires a series of decisions about how the spaces will be used, by whom, and under what circumstances. Together, these choices can shape the flow of information, work processes, and interpersonal relationships.
Work Spaces
Work spaces in an office are typically used for conventional office activities such as reading, writing, and computer work. There are nine generic types of work space, each supporting different activities. These include:
- Open office – An open space for more than ten people, suitable for activities that demand frequent communication or routine activities needing relatively little concentration
- Team space – A semi-enclosed space for two to eight people, suitable for teamwork that demands frequent internal communication and a medium level of concentration
- Cubicle – A semi-enclosed space for one person, suitable for activities that demand medium concentration and medium interaction
- Private office – An enclosed space for one person, suitable for activities that are confidential, demand a lot of concentration, or include many small meetings
- Shared office – An enclosed space for two or three people, suitable for semi-concentrated work and collaborative work in small groups
- Team room – An enclosed space for four to ten people, suitable for teamwork that may be confidential and demands frequent internal communication
- Study booth – An enclosed space for one person, suitable for short-term activities that demand concentration or confidentiality
- Work lounge – A lounge-like space for two to six people, suitable for short-term activities that demand collaboration and allow impromptu interaction
- Touch down – An open space for one person, suitable for short-term activities that require little concentration and low interaction
Meeting Spaces
Meeting spaces are also an important facet to consider when improving and building work places. Following are some types of meeting spaces:
- Small meeting room – An enclosed space for two to four persons, suitable for both formal and informal interaction
- Large meeting room – An enclosed space for five to twelve people, suitable for formal interaction
- Small meeting space – An open or semi-open space for two to four persons, suitable for short, informal interaction
- Large meeting space – An open or semi-open space for five to twelve people, suitable for short, informal interaction
- Brainstorm room – An enclosed space for five to twelve people, suitable for brainstorming sessions and workshops
- Meeting point – An open area for two to four persons such as a sitting area, suitable for ad hoc, informal meetings
Support Spaces
Support spaces in an office are typically used for secondary activities such as filing documents or taking a break. There are twelve generic types of support space, each supporting different activities. These include:
- Filing space – An open or enclosed space for storing frequently used files and documents
- Storage space – An open or enclosed space for storing commonly used office supplies
- Print and copy area – An open or enclosed space with facilities for printing, scanning, and copying
- Mail area – An open or semi-open space where employees can pick up or deliver mail or packages
- Pantry area – An open or enclosed space where people can get coffee and tea as well as soft drinks and snacks
- Break area – A semi-open or enclosed space where employees can take a break from their work
- Locker area – An open or semi-open space where employees can store their personal belongings
- Library – A semi-open or enclosed space for reading and storing books, journals, and magazines
- Games room – An enclosed space where employees can interact in recreational activities (for example, video games or ping-pong) during breaks from work
- Waiting area – An open or semi-open space where visitors can be received and can wait for their appointment
- Circulation space – Space which is required for circulation on office floors, linking all major functions
11.4.6: Setting Transparency Norms
Transparency in organizations is the extent to which its actions are observable by outsiders.
Learning Objective
Define transparency and identify how it is determined by organizations’ communication strategies and practices
Key Points
- Being transparent means operating in such a way that an organization’s actions are visible to outsiders.
- An organization’s communication norms and practices determine its degree of transparency.
- Transparency has three primary dimensions: information disclosure, clarity, and accuracy.
Key Term
- transparency
-
Figuratively, openness and accessibility.
Transparency in organizations is the extent to which its actions are observable by outsiders. It is a consequence of regulation, social expectations, and explicit policies that establish the degree of openness to employees, shareholders, other stakeholders, and the general public. Transparency is an essential part of accountability since it allows for judgments about whether an organization is achieving its objectives and living up to its obligations and espoused values. Because transparency is the perceived quality of intentionally shared information, an organization’s communication practices and norms play an important role in shaping the visibility of its actions.
Transparency has three primary dimensions: information disclosure, clarity, and accuracy.
Information Disclosure
Information disclosure includes choices about what types of information is shared and with whom, the content of what is communicated, and the timing of the release of information. For example, managers who voluntarily share with environmental activists information related to the firm’s ecological impact are practicing disclosure. Information can be a source of power, so people may hoard it to increase their influence over others; this tactic reduces the amount of transparency. Some information is private, such as personnel matters, or commercially sensitive, like strategic business plans. Norms and policies about disclosure focus on criteria such as relevance and appropriateness to determine who should have access to what information.
Clarity
Clarity refers to how easily comprehended the information or communication is. Managers who limit the use of technical terminology, fine print, or complicated mathematical notations in their correspondence with suppliers and customers are employing clarity. Communication practices that value quality of expression, attention to the needs of different audiences, and sensitivity to cultural and other differences can help make an organization more transparent.
Accuracy
Accuracy means that available information has integrity, is truthful, and faithfully represents organizational decisions, policies, and practices. Where there is transparency, managers do not bias, embellish, or otherwise distort facts with the aim of misleading or misrepresenting reality. Organizations that value honesty, trust, and ethical practices encourage accuracy and thereby increase their transparency.
Examples of Corporate Transparency
Examples of decisions to increase corporate transparency include when a firm voluntarily shares information about their ecological impact with environmental activists; actively limiting the use of technical terminology, fine print, or complicated mathematical notations in the firm’s correspondence with suppliers and customers; and avoiding bias, embellishment, or other distortions of known facts in the firm’s communications with investors.
Wage disclosure is one particular area in which companies can practice corporate transparency. For example, in the UK, employees outside the boardroom are currently granted anonymity regarding pay levels. In 2009, UK city minister Lord Myners proposed that the pay and identity of up to 20 of the highest-paid employees at British companies be disclosed; he also called for employees’ salary ranges to be disclosed. Following these guidelines would increase transparency: the public would have access to compensation information now kept from public view. Similar proposals have become increasingly common as high executive pay levels have come under increasing scrutiny. In this case, it is unlikely that disclosure will be made a legal requirement in the UK; the hope is that companies would voluntarily accept this higher level of transparency.
11.4.7: Using Technology to Communicate
Communication technologies support many types of messaging and information sharing in organizations.
Learning Objective
Explain the role of technology in supporting communication in organizations
Key Points
- Business communication often relies on the use of technology to connect and facilitate the flow of information among individuals, groups, and organizations.
- Technology can enable real-time interaction or delayed response, that is, asynchronous with gaps in time between when a sender transmits a message and when the recipient processes it.
- Communication technologies can support unidirectional information sharing or more interactive and collaborate work.
Key Terms
- Delayed Response
-
In communication, pertaining to the ability to respond at a later time (the opposite of real-time, such as speaking).
- Unidirectional
-
Communication designed to provided information or data that does not require a response.
- real-time
-
Communication occurring in that instant, necessitating immediate response and engagement (i.e. conference call, business meeting, etc.)
Business communication often relies on the use of technology to connect and facilitate the flow of information among individuals, groups, and organizations. Technologies for e-mailing, messaging, video conferencing, and document-sharing in most organizations are fully integrated into how work is conducted and how people interact.
Some technologies support simultaneous, or real-time, interaction, including among individuals in different locations. In these cases, interaction is immediate and direct. Examples of this type of technology include teleconferences and web chats. Other communication tools are asynchronous, meaning messages may be transmitted by senders and processed by recipients at different times. E-mail and digital documents, such as spreadsheets and presentations, are examples of asynchronous tools. Responses from recipients may be delayed, which means the sender must wait for confirmation that the message has been interpreted as intended and resulted in the desired action. Many mobile apps used on tablets and smartphones allow for both real-time and asynchronous communication.
Communication mediated by technology can be unidirectional, flowing from a sender to one or more individuals, groups, or organizations. Unidirectional communication is typical when the sender primarily seeks to inform or influence the recipient(s). Electronic memos that are e-mailed or documents shared via computer servers are examples. Alternatively, communication can be intended as reciprocal and interactive. A collaboration tool such as Google Docs is an example.
Organizations use communication technology to support and drive their business activities. Some examples of technology used to communicate in business include:
- E-mail among employees, management, and customers
- Social media sites used to communicate with customers
- Video conferencing used to hold meetings with remote workers
- SMS (texting) among employees
- Internet marketing as way to advertise products and services to customers
- Mobile marketing strategies to advertise products to customers based on their current location
- Mobile applications such as QR codes and Shazaam offering additional information to customers about a company or service
The predominance of communication technologies in organizational life means it is vital that employees have the skills to use them. Many organizations make training available, but increasingly employers expect prospective employees to be experienced users of desktop and even mobile technologies.
11.4.8: The Importance of Sensitivity and Etiquette in Business Communication
Following the norms and practices of etiquette is an important factor in effective business communication.
Learning Objective
Explain the importance of identifying and considering different etiquette and cultural customs in business communication
Key Points
- Business etiquette is the code of expected professional behavior regarding manners, courtesy, and politeness.
- Etiquette is dependent on culture; what is excellent etiquette in one society may shock in another.
- A failure to understand, be sensitive to, and adjust to different etiquette expectations can impede successful communication.
Key Term
- etiquette
-
Forms required by good breeding or prescribed by authority, to be observed in social or official life; conventional decorum; ceremonial code of polite society.
We use forms of etiquette in interactions with co-workers, business colleagues, customers, suppliers, and other types of stakeholders. These norms are typically unwritten rules learned through socialization and experience, although some organizations have explicit written rules of conduct that speak to matters of etiquette. Practicing etiquette demonstrates respect, and effective communication requires that message are sent and received in ways that are consistent with the norms of etiquette.
Business etiquette can vary significantly by country and geographic area. Etiquette is a core aspect of most cultures, which represent the values that guide how people live and interact. Differences in etiquette can create challenges for cross-cultural communication in business. What is excellent etiquette in one society may shock another. For example, conflict between expectations of etiquette can arise in meetings held during meals. In China, a person who takes the last item of food from a common plate or bowl without first offering it to others at the table may be viewed as a glutton who is insulting the host’s generosity. Traditionally, guests who do not have leftover food in front of them at the end of a meal in China have dishonored their host. Conversely, in the United States of America, guest are expected to eat all of the food given to them as a compliment to the quality of the cooking. However, there too it is considered polite to offer food from a common plate or bowl to others at the table. If both parties are aware of and sensitive to differences in etiquette, they can avoid misinterpreting behavior or giving the wrong impression.
A failure to understand, be sensitive to, and adjust to different etiquette expectations can impede successful communication. Credibility is essential in the ability to persuade, and perceived displays of disrespect can make it difficult to influence others. Etiquette reflects shared expectations of behavior, and thus it is an important basis of developing good interpersonal relationships that facilitate effective communication. The ability to use proper etiquette is an important quality of professionalism; it is therefore vital for employees to learn the norms and practices of etiquette in the organizations and cultures in which they work.
10.1: Decision Making in Management
10.1.1: Defining Decision Making
Decision making is the mental process of selecting a course of action from a set of alternatives.
Learning Objective
Identify the steps and analyze alternatives in a decision-making process
Key Points
- Decision making is a process of choosing between alternatives.
- Problem solving and decision making are distinct but related activities.
- Time pressure and personal emotions can affect the quality of decision-making outcomes.
Key Term
- Problem
-
A difficulty that has to be resolved or dealt with.
Decision making is the mental process of choosing from a set of alternatives. Every decision-making process produces an outcome that might be an action, a recommendation, or an opinion. Since doing nothing or remaining neutral is usually among the set of options one chooses from, selecting that course is also making a decision.
Difference Between Problem Analysis and Decision Making
While they are related, problem analysis and decision making are distinct activities. Decisions are commonly focused on a problem or challenge. Decision makers must gather and consider data before making a choice. Problem analysis involves framing the issue by defining its boundaries, establishing criteria with which to select from alternatives, and developing conclusions based on available information. Analyzing a problem may not result in a decision, although the results are an important ingredient in all decision making.
Steps in Decision Making
Decision making comprises a series of sequential activities that together structure the process and facilitate its conclusion. These steps are:
- Establishing objectives
- Classifying and prioritizing objectives
- Developing selection criteria
- Identifying alternatives
- Evaluating alternatives against the selection criteria
- Choosing the alternative that best satisfies the selection criteria
- Implementing the decision
Analysis of Alternatives
A major part of decision making involves the analysis of a defined set of alternatives against selection criteria. These criteria usually include costs and benefits, advantages and disadvantages, and alignment with preferences. For example, when choosing a place to establish a new business, the criteria might include rental costs, availability of skilled labor, access to transportation and means of distribution, and proximity to customers. Based on the relative importance of these factors, a business owner makes a decision that best meets the criteria.
The decision maker may face a problem when trying to evaluate alternatives in terms of their strengths and weaknesses. This can be especially challenging when there are many factors to consider. Time limits and personal emotions also play a role in the process of choosing between alternatives. Greater deliberation and information gathering often takes additional time, and decision makers often must choose before they feel fully prepared. In addition, the more that is at stake the more emotions are likely to come into play, and this can distort one’s judgment.
10.1.2: Decision-Making Styles
Decisions are driven by psychological, cognitive, and normative styles, each of which take into account varying influences on the final decision.
Learning Objective
Recognize the various factors which influence a leader’s decision-making style
Key Points
- The ability to make effective decisions that are rational, informed, and collaborative can greatly reduce opportunity costs while building a strong organizational focus.
- A psychological style to decision-making favors individual values, desires, and needs to determine the best course of action.
- A cognitive style to decision-making is heavily influenced by external factors and repercussions, such as how a given course of action will impact the broader environment in which the organization functions.
- Normative decision-making relies on logic and communicative rationality, aligning people based upon a logical progression from premises to conclusion.
- Regardless of the style or perspective, managers, and leaders must create organizational alignment in decision-making through building consensus.
Key Term
- communicative rationality
-
A theory or set of theories which describes human rationality as a necessary outcome of successful communication.
Why Decision-making Matters
Decision-making is a truly fascinating science, incorporating organizational behavior, psychology, sociology, neurology, strategy, management, philosophy, and logic. The ability to make effective decisions that are rational, informed, and collaborative can greatly reduce opportunity costs while building a strong organizational focus. As a prospective manager, effective decision-making is a central skill necessary for success. This requires the capacity to weigh various paths and determine the optimal trajectory of action.
Decision-making Styles
There are countless perspectives and tactics to effective decision-making. However, there are a few key points in decision-making theory that are central to understanding how different styles may impact organizational trajectories. Decision-making styles can be divided into three broad categories:
- Psychological: Decisions derived from the needs, desires, preferences, and/or values of the individual making the decision. This type of decision-making is centered on the individual deciding.
- Cognitive: This is an integrated feedback system between the individual/organization making a decision, and the broader environment’s reactions to those decisions. This type of decision-making process involves iterative cycles and constant assessment of the reactions and impacts of the decision.
- Normative: In many ways, decision making (particularly in groups, such as within an organization) is about communicative rationality. This is to say that decisions are derived based on the ability to communicate and share logic, using firms premises and conclusions to drive behavior.
Cognitive Theories
While the above styles give a general sense of the logic that drives choices, it is more useful to recognize that each of these three styles can play a role in any individual’s decision-making process. From the cognitive perspective, there are a few specific stylistic models that are useful to keep in mind:
Optimizing vs. Satisficing
Decision-making is limited to the finite amount of information an individual has access to. With limitations on information, true objectivity is impossible. Decisions are therefore intrinsically flawed. A satisficer will recognize this necessary imperfection, and prefer faster but less perfect decisions while a maximizer will take a longer time trying to find the optimal choice. This can be viewed as a spectrum, and each decision (depending on the risk of a mistake) can be viewed with varying levels of perfection.
Intuitive vs. Rational
Daniel Kahneman puts forward the idea of two separate minds that compete for influence within each of us. One way to describe this is a conscious and a subconscious perspective. The subconscious mind (referred to as System 1) is automatic and intuitive, rapidly consolidating data and producing a decision almost immediately. The conscious mind (referred to as System 2) requires more effort and input, utilizing logic and rationale to make an explicit choice.
Combinatorial vs. Positional
This relationship was put forward by Aron Katsenelinboigen based on how the game of chess is played, and an individual’s relationship with uncertainty. A combinatorial player has a final outcome, making a series of decisions that try to link the initial position with the final outcome in a firm, narrow, and concrete way (i.e. certainty). The positional decision-making approach is ‘looser’, with a sense of setting up for an uncertain future as opposed to pursuing a concrete object. Each move from this type of player would maximize options as opposed to pursue an outcome.
10.1.3: Types of Decisions
Three approaches to decision making are avoiding, problem solving and problem seeking.
Learning Objective
Differentiate between the three primary decision-making approaches: avoiding, problem solving, and problem seeking
Key Points
- One approach to decision making is to not make a choice—that is, to avoid making a decision altogether.
- Identifying and selecting a solution to a problem is a frequent type of decision outcome.
- Sometimes decision making results in the need to restate the purpose and subject of the choice; this is known as problem seeking.
Key Terms
- problem solving
-
Problem solving involves using generic or ad hoc methods, in an orderly manner, for finding solutions to specific problems.
- problem seeking
-
The process of clarifying, understanding, and restating the problem.
Every decision-making process reaches a conclusion, which can be a choice to act or not to act, a decision on what course of action to take and how, or even an opinion or recommendation. Sometimes decision making leads to redefining the issue or challenge. Accordingly, three decision-making processes are known as avoiding, problem solving, and problem seeking.
Avoiding
One decision-making option is to make no choice at all. There are several reasons why the decision maker might do this:
- There is insufficient information to make a reasoned choice between alternatives.
- The potential negative consequences of selecting any alternative outweigh the benefits of selecting one.
- No pressing need for a choice exists and the status quo can continue without harm.
- The person considering the alternatives does not have the authority to make a decision.
One example of avoiding a decision occurs routinely at the Supreme Court of the United States (as well as other appellate courts). The Supreme Court will decline to hear a case because, in their judgment, the issues have not been sufficiently considered in lower courts.
Problem Solving
Most decisions consists of problem-solving activities that end when a satisfactory solution is reached. In psychology, problem solving refers to the desire to reach a definite goal from a present condition. Problem solving requires problem definition, information analysis and evaluation, and alternative selection.
Problem Seeking
On occasion, the process of problem solving brings the focus or scope of the problem itself into question. It may be found to be poorly defined, of too large or small a scope, or missing a key dimension. Decision makers must then step back and reconsider the information and analysis they have brought to bear so far. We can regard this activity as problem seeking because decision makers must return to the starting point and respecify the issue or problem they want to address.
10.2: Rational and Nonrational Decision Making
10.2.1: Rational Decision Making
Rational decision making is a multi-step process, from problem identification through solution, for making logically sound decisions.
Learning Objective
Explain the characteristics of the rational decision-making process
Key Points
- Rational decision making favors objective data and a formal process of analysis over subjectivity and intuition.
- The model of rational decision making assumes that the decision maker has full or perfect information about alternatives; it also assumes they have the time, cognitive ability, and resources to evaluate each choice against the others.
- This model assumes that people will make choices that will maximize benefits for themselves and minimize any cost.
Key Terms
- perfect information
-
A situation in which all data that is relevant to a particular decision is known and available to the decision maker.
- Rational decision making
-
A logical, multi-step model for choosing between alternatives that follows an orderly path from problem identification through solution.
The Process of Rational Decision Making
Rational decision making is a multi-step process for making choices between alternatives. The process of rational decision making favors logic, objectivity, and analysis over subjectivity and insight. The word “rational” in this context does not mean sane or clear-headed as it does in the colloquial sense.
The approach follows a sequential and formal path of activities. This path includes:
- Formulating a goal(s)
- Identifying the criteria for making the decision
- Identifying alternatives
- Performing analysis
- Making a final decision.
Assumptions of the Rational Decision-Making Model
The rational model of decision making assumes that people will make choices that maximize benefits and minimize any costs. The idea of rational choice is easy to see in economic theory. For example, most people want to get the most useful products at the lowest price; because of this, they will judge the benefits of a certain object (for example, how useful is it or how attractive is it) compared to those of similar objects. They will then compare prices (or costs). In general, people will choose the object that provides the greatest reward at the lowest cost.
The rational model also assumes:
- An individual has full and perfect information on which to base a choice.
- Measurable criteria exist for which data can be collected and analyzed.
- An individual has the cognitive ability, time, and resources to evaluate each alternative against the others.
The rational-decision-making model does not consider factors that cannot be quantified, such as ethical concerns or the value of altruism. It leaves out consideration of personal feelings, loyalties, or sense of obligation. Its objectivity creates a bias toward the preference for facts, data and analysis over intuition or desires.
10.2.2: Problems with the Rational Decision-Making Model
Critics of the rational model argue that it makes unrealistic assumptions in order to simplify possible choices and predictions.
Learning Objective
Summarize the inherent flaws and arguments against the rational model of decision-making within a business context
Key Points
- Critics of the rational decision-making model say that the model makes unrealistic assumptions, particularly about the amount of information available and an individual’s ability to processes this information when making decisions.
- Bounded rationality is the idea that an individual’s ability to act rationally is constrained by the information they have, the cognitive limitations of their minds, and the finite amount of time and resources they have to make a decision.
- Because decision-makers lack the ability and resources to arrive at optimal solutions, they often seek a satisfactory solution rather than the optimal one.
Key Terms
- Rational choice theory
-
A framework for understanding and often formally modeling social and economic behavior.
- bounded rationality
-
The idea that decision-making is limited by the information available, the decision-maker’s cognitive limitations, and the finite amount of time available to make a decision.
- satisficer
-
One who seeks a satisfactory solution rather than an optimal one.
Critiques of the Rational Model
Critics of rational choice theory—or the rational model of decision-making—claim that this model makes unrealistic and over-simplified assumptions. Their objections to the rational model include:
- People rarely have full (or perfect) information. For example, the information might not be available, the person might not be able to access it, or it might take too much time or too many resources to acquire. More complex models rely on probability in order to describe outcomes rather than the assumption that a person will always know all outcomes.
- Individual rationality is limited by their ability to conduct analysis and think through competing alternatives. The more complex a decision, the greater the limits are to making completely rational choices.
- Rather than always seeking to optimize benefits while minimizing costs, people are often willing to choose an acceptable option rather than the optimal one. This is especially true when it is difficult to precisely measure and assess factors among the selection criteria.
Alternative Theories of Decision-Making
Prospect Theory
Alternative theories of how people make decisions include Amos Tversky’s and Daniel Kahneman’s prospect theory. Prospect theory reflects the empirical finding that, contrary to rational choice theory, people fear losses more than they value gains, so they weigh the probabilities of negative outcomes more heavily than their actual potential cost. For instance, Tversky’s and Kahneman’s studies suggest that people would rather accept a deal that offers a 50% probability of gaining $2 over one that has a 50% probability of losing $1.
Bounded Rationality
Other researchers in the field of behavioral economics have also tried to explain why human behavior often goes against pure economic rationality. The theory of bounded rationality holds that an individual’s rationality is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. This theory was proposed by Herbert A. Simon as a more holistic way of understanding decision-making. Bounded rationality shares the view that decision-making is a fully rational process; however, it adds the condition that people act on the basis of limited information. Because decision-makers lack the ability and resources to arrive at the optimal solution, they instead apply their rationality to a set of choices that have already been narrowed down by the absence of complete information and resources.
10.2.3: Non-Rational Decision Making
People frequently employ alternative, non-rational techniques in their decision making processes.
Learning Objective
Examine alternative perspectives on decision making, such as that of Herbert Simon and Gerd Gigerenzer, which outline non-rational decision-making factors
Key Points
- The rationality of individuals is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision.
- Simon defined two cognitive styles: maximizers and satisficers. Maximizers try to make an optimal decision, whereas satisficers simply try to find a solution that is “good enough” for the situation.
- Some research has shown that simple heuristics frequently lead to better decisions than the theoretically optimal procedure.
- Emotion appears to aid the decision-making process; decisions often occur in the face of uncertainty about whether one’s choices will lead to benefit or harm.
- Robust Decision Making (RDM) is a particular set of methods and tools that is designed to support decision making under conditions of uncertainty.
Key Terms
- cognitive
-
The part of mental functions that deals with logic, as opposed to affective functions, which deal with emotion.
- rational
-
Logically sound; not contradictory or otherwise absurd.
- heuristic
-
An experience-based technique for problem solving, learning, and discovery; examples include using a rule of thumb, an educated guess, an intuitive judgment, or common sense.
The rational model of decision making holds that people have complete information and can objectively evaluate alternatives to select the optimal choice. The rationality of individuals is limited, however, by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. To account for these limitations, alternative models of decision making offer different views of how people make choices.
Herbert A. Simon
American psychology and economics researcher Herbert A. Simon defined two cognitive styles: maximizers and satisficers. Maximizers try to make an optimal decision, whereas satisficers simply try to find a solution that is “good enough.” Maximizers tend to take longer making decisions due to the need to maximize performance across all variables and make trade-offs carefully. They also tend to regret their decisions more often (perhaps because they are more able than satisficers to recognize when a decision has turned out to be sub-optimal). On the other hand, satisficers recognize that decision makers lack the ability and resources to arrive at an optimal solution. They instead apply their rationality only after they greatly simplify the choices available. Thus, a satisficer seeks a satisfactory solution rather than an optimal one.
Gerd Gigerenzer
German psychologist Gerd Gigerenzer goes beyond Simon in dismissing the importance of optimization in decision making. He argues that simple heuristics—experience-based techniques for problem-solving—can lead to better decision outcomes than more thorough, theoretically optimal processes that consider vast amounts of information. Where an exhaustive search is impractical, heuristic methods are used to speed up the process of finding a satisfactory solution.
The Role of Emotion
Emotion is a factor that is typically left out of the rational model; however, it has been shown to have an influential role in the decision-making process. Because decisions often involve uncertainty, individual tolerance for risk becomes a factor. Thus, fear of a negative outcome might prohibit a choice whose benefits far outweigh the chances of something going wrong.
Robust Decision Making
Robust decision making (RDM) is a particular set of methods and tools developed over the last decade—primarily by researchers associated with the RAND Corporation—that is designed to support decision making and policy analysis under conditions of deep uncertainty. RDM focuses on helping decision makers identify and develop alternatives through an iterative process. This process takes into account new information and considers multiple scenarios of how the future will evolve.
10.3: Conditions for Making Decisions
10.3.1: Evidence-Based Decision Making
The practice of evidence-based decision making involves using current information to make empirically supported decisions.
Learning Objective
Describe the concept and strategic implications of evidence-based decision making in management (EBMgt)
Key Points
- Evidence-based protocols have been adopted in fields such as business, education, and law enforcement, demonstrating the usefulness of this approach.
- Evidence-based decision making in management (EBMgt) requires that managers and their organizations procure and organize enough empirical and objective data to implement a scientific decision-making process.
- Critics argue that evidence-based approaches do not take ethics into consideration. As a result, managers must take an active role in implementation.
- Overall, EBMgt is a useful tool for managers to generate informed and intelligent perspectives, decisions, and strategies as they lead a company.
Key Term
- EBMgt
-
A management practice that emphasizes a rational, objective, and empirical approach to addressing business issues.
Defining Evidence-Based Decision Making
Evidence-based management entails making decisions and creating organizational practices that are informed by analyzing the best available data. The practice of evidence-based decision making in management (often abbreviated as EBMgt) evolved from medicine and emphasizes a rational, objective, and empirical approach to addressing business issues. It is analogous to the scientific method which uses experiments and data collection to advance knowledge.
The EBMgt Collaborative—sponsored by a number of universities and foundations throughout the U.S., U.K., and Canada—is an organization devoted to expanding the practice of EBMgt. The EBMgt Collaborative’s mission statement includes a comprehensive definition of the practice:
Evidence-Based Management (EBMgt) enhances the overall
quality
of organizational decisions and practices through deliberative use of relevant and best available scientific evidence. EBMgt combines conscientious, judicious use of best evidence with individual expertise; ethics; valid, reliable business and organizational facts; and consideration of
impact
on
stakeholders
.
Pros and Cons of EBMgt
Evidence-based protocols have been adopted in non-scientific fields such as business, education, and law enforcement, demonstrating usefulness of this approach. Because the evidence approach examines outcomes, it supports the careful consideration of the relationship between cause and effect. Managers can have more confidence in their choices when they can point to data that supports the likelihood of that choice leading to desired results.
The adoption of EBMgt also creates advantages in how an organization operates. The formal processes of EBMgt require managers and other decision makers to be disciplined and organized in their decision-making process. The degree of structure in collecting and analyzing data helps create a working environment that favors facts over intuition or guess-work.
Critics of EBMgt argue that evidence may not always be complete or appropriately measured; they also argue that analysis is not always neutral or without bias. It is not always possible to agree on what counts as credible evidence; even if data on a certain factor is desirable, it may not exist or be readily available. The idea of objectivity is obscured because data is subject to interpretation, and those with different levels of experience or backgrounds can reach different conclusions about the implication of a given set of findings. Critics also argue that evidence-based approaches do not take ethics into consideration.
Though it has its limitations, EBMgt can be an effective approach to informing the decisions of managers. By acquiring sufficient data that support conclusions, EBMgt can help decision makers distinguish between alternatives and choose the most promising option. It can also help influence others to support a decision once it has been made.
10.3.2: The Value of Analytics in Decision Making
Analytics help decision makers determine risk, weigh outcomes, and quantify costs and benefits associated with decisions.
Learning Objective
Recognize the decision-making value of utilizing statistics and analytics to create accurate predictions
Key Points
- Predictive and descriptive analytics are two methods of using data to inform and evaluate alternatives during decision making. They can also be used to explain performance outcomes.
- Predictive analytics encompass a variety of statistical techniques (such as modeling, machine learning, and data mining) that analyze current and historical facts to make predictions about future events.
- Descriptive analytics focus on developing new insights and understanding of business performance based on data and statistical methods; these analytics are then used to make strategic decisions for the company.
Key Term
- analytics
-
The use of skills, technologies, and practices to explore and investigate past performance, gain insight, and drive business decision making.
Analytics refer to the use of skills, technologies, and practices to explore and investigate past performance, gain insight, and drive business decision making. Predictive and descriptive analytics are two methods of using data and statistical methods to assess actual outcomes against target standards and goals. These types of analysis can explain the relationship between factors that influence outcomes; they can also help prioritize improvement and other planning efforts. Companies can use their analytic capabilities to create advantages over competitors and better perform in the marketplace.
Predictive Analytics and Decision Making
Predictive analytics encompass a variety of statistical techniques (such as modeling, machine learning, and data mining) that analyze current and historical facts to make estimates about future events. Models capture relationships among many factors, allowing an assessment of risk or potential associated with a particular set of conditions. This helps to guide decision making for candidate transactions. Data mining draws on large numbers of records to identify patterns that can then be identified as opportunities or risks. For example, by analyzing grades for an entire class of first-year students, academic advisers can predict which students are most likely to struggle in the class.
Predictive analytics help decision makers to predict the outcome(s) of a decision before it is implemented. Using these probabilities, decision makers can calculate the expected value of alternatives once risks and benefits are taken into account. Predictive analytics are particularly useful when there is a high degree of uncertainty. By carefully considering what is not known, decision makers can build confidence in the estimates that inform their choices. Forecasting consumer behavior in response to a new product or marketing initiative are examples of the use of predictive analytics.
Descriptive Analytics and Decision Making
Descriptive analytics answer the questions, “What happened and why did it happen?” This approach seeks to understand past performances by using historical data to analyze the reasons behind past success or failure. Understanding cause and effect can help refine business and operational strategies. Most management reporting—such as sales, marketing, operations, and finance—uses this type of analysis. Descriptive analytics are used in quality management techniques and other methods of statistical process control.
Analytics in the Modern Business World
Descriptive and predictive analytics have increased greatly in popularity due to advances in computing technology, techniques for data analysis, and mathematical modeling. Desktop tools can easily create reports and summaries of analytic results that help decision makers readily understand the findings and their implications. These tools create tables, charts, and graphs to present the data visually, which can help to clearly communicate the meaning of the data.
10.3.3: Making Decisions Under Conditions of Risk and Uncertainty
Conditions of risk and uncertainty frame most decisions rendered by management.
Learning Objective
Outline the various risks that influence the decision-making process
Key Points
- Uncertainty and risk are not the same thing. Whereas uncertainty deals with possible outcomes that are unknown, risk is a certain type of uncertainty that involves the real possibility of loss. Risks can be more comprehensively accounted for than uncertainty.
- Decision-making under conditions of risk should seek to identify, quantify, and absorb risk whenever possible.
- The quantity of risk is equal to the sum of the probabilities of a risky outcome (or various outcomes) multiplied by the anticipated loss as a result of the outcome.
- A firm’s ability to absorb, transfer, and manage risk will often define management’s risk appetite; once risks are identified and quantified, decisions may be made as to what extent risky outcomes may be tolerated.
Key Terms
- hedge
-
A contract or arrangement reducing one’s exposure to risk.
- force majeure
-
An unavoidable catastrophe, especially one that prevents someone from fulfilling a legal obligation; an unforeseeable act of nature.
Uncertainty is a state of having limited knowledge of current conditions or future outcomes. It is a major component of risk, which involves the likelihood and scale of negative consequences. Managers often deal with uncertainty in their work; to minimize the risk that their decisions will lead to undesired outcomes, they must develop the skills and judgment necessary for reducing this uncertainty. Managing uncertainty and risk also involves mitigating or even removing things that inhibit effective decision-making or adversely effect performance.
One cause of uncertainty is proximity: things that are about to happen are easier to estimate than those further out in the future. One approach to dealing with uncertainty is to put off decisions until data become more accessible and reliable. Of course, delaying some decisions can bring its own set of risks, especially when the potential negative consequences of waiting are great.
Identifying Risks
Managing uncertainty in decision-making relies on identifying, quantifying, and analyzing the factors that can affect outcomes. This enables managers to identify likely risks and their potential impact. Types of risk include:
- Strategic risks: These are risks that arise from the investments an organization makes to pursue its mission and objectives. They are often associated with competition and can include macroeconomic risks (the alignment of buyers and sellers consistent with the principles of supply and demand), transaction risks (the operational risks from merger and acquisition activity, divestitures, or partnerships), and investor relations risk (the risks associated with communicating effectively or ineffectively with the investment community).
-
Financial risks: These relate to potential economic losses that can result from poor allocation of resources, changes in interest rates, shifts in tax policy, increases or decreases in the price of commodities, or fluctuations in the value of currency.
-
Operational risks: These risks can arise due to choices about design and use of processes to create and deliver goods and services. They can include production errors, substandard raw materials, and technology malfunctions.
-
Legal risks: These risks stem from the threat of litigation or ambiguity in applicable laws and regulations (including whether they are likely to change); these threats create uncertainty in the steps an organization should take to address its obligations to customers, employees, suppliers, stockholders, communities, and governments.
-
Other risks: Risks are very commonly associated with force majeure, or events beyond the control of the organization. These can include weather disasters, floods, earthquakes, and war or other hostilities.
Quantifying Risks
Once management has identified the appropriate risk category that may impact a certain decision, it may go about quantifying these risks. In other words, management will ascertain the costs incurred if a risky outcome were to happen. This can be mathematically daunting for many types of risk, especially financial risk. Generally speaking, however, risk is equal to the sum of the probabilities of a risky outcome (or various outcomes) multiplied by the anticipated loss as a result of the outcome. This is similar to performing a sensitivity analysis if the universe of outcomes is known.
Managing Risks
The ability of a firm to absorb, transfer, and manage risk is critical in management’s decision-making process when risky outcomes are involved. This will often define management’s risk appetite and help to determine, once risks are identified and quantified, whether risky outcomes may be tolerated. For example, many financial risks can be absorbed or transferred through the use of a hedge, while legal risks might be mitigated through unique contract language. If managers believe that the firm is suited to absorb potential losses in the event the negative outcome occurs, they will have a larger appetite for risk given their capabilities to manage it.
10.4: Decision Making Process
10.4.1: Identify and Define the Problem
Identifying, defining, and understanding a problem is essential to analyzing and choosing between alternatives.
Learning Objective
Express the importance of properly framing and defining the problem prior to pursuing a decision
Key Points
- Decision makers must first make sure that they completely understand the problem.
- It is a good idea to be able to look at a decision from multiple perspectives. This can be accomplished through selecting a group of people who will look at and define the problem from different perspectives.
- Data should be gathered on how the current problem is affecting people now. Some examples of important data to gather include efficiency levels, satisfaction levels, and output metrics.
Key Term
- Output metrics
-
Standards or data points that showm the rate and speed of production over a certain period of time.
Decision making is a central responsibility of managers and leaders. It requires defining the issue or the problem and identifying the factors related to it. Doing so helps create a clear understanding of what needs to be decided and can influence the choice between alternatives.
An important aspect of any decision is its purpose, or objective. This is different from identifying a specific decision outcome; rather, it has to do with the motivation to make the decision in the first place. For instance, customer complaints can imply the need to change aspects of how service is delivered, so decisions must be made to address them. Factors that are not related to service delivery would not be in consideration in that decision.
There are a number of ways to define a problem, such as creating a team to tackle it and gathering relevant data by interviewing employees and customers.
Developing a Group to Define the Problem
It is a good idea to be able to approach decision definition from different perspectives. Doing so can capture dimensions of the issue that might otherwise have been overlooked. Involving two or more people can bring different information, knowledge, and experience to a decision. This can be accomplished through forming a group to consider and define the problem or issue, and then to frame the decision based on their collective ideas. Having a shared definition and understanding of a decision helps the decision-making process by creating focus for discussions and making them more efficient.
Gathering Data to Define the Decision
Most decisions require a good understanding of the current state in order to understand all implications of the potential choices. For this reason it can be valuable to consider the views of all parties that will be affected by the decision. These may include customers, employees, or suppliers. Data should be gathered on how the current problem is affecting people now. Some examples of important data to gather include efficiency levels, satisfaction levels, and output metrics. Interviews, focus groups, or other qualitative methods of data collection can be used to identify existing conditions that may be connected to the decision in question. As much information as possible should be gathered to build confidence that a decision has been accurately and appropriately formulated before additional analysis and assessment of alternatives begin.
10.4.2: Generate Alternatives
Identifying a range of potential choices is essential to any decision-making process.
Learning Objective
Discuss methods for identifying alternatives and why doing so is an important part of decision making.
Key Points
- Decision makers should identify the many alternative choices they face before beginning to conduct analysis for a decision.
- A decision tree is a decision support tool that uses a tree-like graph or model of decisions and their possible consequences, including chance event outcomes and resource costs. A decision tree can help lay out the alternatives and determine the best ones to consider.
- When dealing with information in decision analysis, there are often biases and errors in judgment, such as the fact that people pay more attention to information that is easily available.
- It is important for a decision maker to receive plenty of input from others to avoid any bias.
Key Terms
- bias
-
An inclination towards something; predisposition, partiality, prejudice, preference, predilection.
- decision tree
-
A visualization of a complex decision-making situation in which the possible decisions and their likely outcomes are organized in the form of a graph that resembles a tree.
Once a decision has been defined, the next step is to identify the alternatives for decision makers to select from. It is rare for there to be only one alternative; in fact, a goal should be to identify as many different alternatives as possible without making too narrow a distinction between them. The decision maker can then narrow the list based on analysis, resource limitations, or time constraints. Often, doing nothing is an alternative worthy of consideration.
Brainstorming
Brainstorming is a good technique for identifying alternatives. Making lists of possible combinations of actions can generate ideas that can be shaped into alternatives. Often this is best done with a small group of people with different perspectives, knowledge, and experience. A formal approach to capturing the results of brainstorming can help make sure options are not overlooked.
Another way to evaluate alternatives is through a decision tree.
Decision Trees
A decision tree is a decision support tool that uses a structured graphical depiction of alternatives. This method creates a visual depiction of choices so decision makers can have a clearer understanding of them. Decision trees help divide larger decisions into smaller ones and are useful for uncovering all available options.
Decision trees have a starting point and then branch out, with each branch representing a different event, action, or outcome. Resource costs, benefits, and probabilities can be recorded by each option.
Decision trees have three types of nodes at each part of the diagram:
- Decision nodes: these are the alternatives themselves and represent the point where a decision must be made.
- Change nodes: these are points where choices must be made; in their simplest form these may be represented by Yes/No or Go/No Go options.
- Conclusion or end nodes: these are the points that appear when there are no more alternatives or choices to be made, and they state the outcome of a particular decision branch.
When generating alternatives, decision makers use information gathered by defining the problem. The list of alternatives can then only be as good, complete, and accurate as the quality of that data. Overlooking factors or dimensions of an issue or problem can mean missing viable alternatives. The alternatives identified become the basis for subsequent analysis and ultimately the decision itself.
10.4.3: Evaluate Alternatives
In order to eliminate bias in a decision, one can use tools such as influence diagrams and decision trees to evaluate alternatives.
Learning Objective
Model potential decision alternatives through utilizing pro/con analysis, influence diagrams, decision trees and Bayesian networks
Key Points
- There are a few tools available to decision makers that can be used to help quantify the potential alternatives to and outcomes of a decision. These tools include a simple pro-and-con analysis, an influence diagram, and a decision tree.
- A decision tree is used to lay out the alternatives and then assign a utility, or a relative value of importance, to a particular alternative.
- Another tool that decision makers can use to quantify a decision is an influence diagram, which is a compact graphical and mathematical representation of a decision situation.
Key Terms
- Bayesian network
-
A probabilistic model that represents a set of random variables and their conditional dependencies (e.g., a Bayesian network could calculate the probabilities between symptoms and a disease).
- decision tree
-
A visualization of a complex decision-making situation in which the possible decisions and their likely outcomes are organized in the form of a graph that resembles a tree.
When a decision maker has successfully and accurately defined the problem and generated alternatives, he or she can then conduct analysis useful to evaluating and assessing each. This typically involves analysis of quantitative data such as costs or revenues. Qualitative data is also used to be sure that considerations such as consistency with strategy, effects on relationships, or ethical implications are taken into account.
A first step in analysis is identifying all the sources of data needed to understand the various alternatives and their potential outcomes. Finding this data often involves research if relevant data do not exist. The results of data analysis are typically gathered, summarized, and synthesized as the basis for discussions and deliberations by decision makers.
There are a few approaches that can be used to help structure the analysis and assessment of potential decision alternatives. These range from simple tools such as lists of pros and cons to more complex models such as decision trees and influence diagrams, which can capture more variables and include more data.
A decision tree specifies alternatives visually and creates paths of subdecisions to be made or uncertainties to be considered in order to estimate the outcome of a given choice. It includes a value for each alternative, such as a financial outcome, and notes the probabilities that each outcome will occur. Decision trees sometime include the results of financial analysis such as net present value, which determines the present or current value of a stream of incoming cash flows that a project will bring in sometime in the future. One limitation to using decision trees is that they can become highly complicated as decisions become more complex or outcomes involve greater numbers of variables.
Another tool that decision makers can use to analyze alternatives is an influence diagram. An influence diagram is a compact graphical and mathematical representation of a decision situation. It groups sets of variables into things that are known and factors that are uncertain and links them to the choice to be made and the criteria for assessing it. Influence diagrams are directly applicable in group decisions because they allow incomplete sharing of information among team members to be modeled and for estimates to be made explicitly.
In the scenario depicted by the influence diagram above, a person is choosing between vacation alternatives. Her goal is a satisfactory vacation, which will be influenced by how good the weather is. She cannot have direct knowledge at the time of the decision what the weather will be, but she can gather information on the weather forecast or other climate patterns to help her make the choice of vacation location.
10.4.4: Determine a Course
A good decision maker will always try to eliminate personal biases and understand his personal risk tolerance when determining a course.
Learning Objective
Evaluate the importance of bias and prospect theory in effectively ensuring decision makers arrive at the ideal option
Key Points
- Decision makers should use clear selection criteria to evaluate and choose among alternatives.
- Bias is inherent in making decisions, but decision makers should do their best to identify emotional and other personal factors that may affect their judgment and adjust their deliberations to take biases into account.
- Prospect theory identifies aversion to loss as a common bias that can cause people to overstate the downside of alternatives.
Key Term
- bias
-
The human tendency to make systematic decisions in certain circumstances based on cognitive factors rather than evidence; an inclination or prejudice toward something.
Once decision alternatives have been identified and analyzed, the decision maker is ready to make a choice. To do so it is important to have a set of criteria against which to evaluate and even rank the alternatives. Selection criteria might include total cost, time to implement, risk, and the organization’s ability to successfully implement the decision. Categorizing criteria in terms of importance helps to differentiate between options that might have similar disadvantages but different advantages, or vice versa. For example, consider two alternatives that are equally risky, but one will cost more and the other will take longer to implement. In this case, the decision would depend on whether cost or time is more important. On occasion, decision makers may believe they do not have sufficient information about a particular alternative, so additional analysis may be needed.
Decision makers should do their best to minimize their biases, or preconceived ideas about which alternative is preferable, until they complete the analysis. The benefit of using data to support decisions is that when analysis is done correctly it is objective and factual, not based on emotions or subjective preferences. While it is natural to have biases based on experience or feelings, it is important for managers and leaders to recognize them and take steps to keep them from butting their judgment. People may be unable to eliminate all of their biases, especially when it comes to their tolerance for risk. It is therefore important to be explicit about assumptions and biases to the extent possible, so that people involved in making the decision are aware of them and can adjust their deliberations accordingly.
Bias and Prospect Theory
One of the best-known theories about bias in decision making is Kahneman and Tversky’s prospect theory. Prospect theory is based on the notion that people think about decisions in terms of potential gains and losses and tend to be more averse to losses than they are favorable to gains. This means that decision makers may overstate the downside of an alternative, since they have a greater fear of negative consequences. As a result, people are biased toward less risky decisions, even when the benefits of a different alternative would outweigh the risks of the chosen one. Prospect theory also suggests that people consider how others would benefit or be hurt by the outcome of their decision. This contradicts traditional economic theory, which states that individuals make decisions based only on their own well-being.
10.4.5: Implement the Course
Implementing a decision requires the decision maker to make and execute a plan of action.
Learning Objective
Describe the three central steps to effectively implementing a decision upon the selection of a particular perspective or course
Key Points
- Three essential actions to implementing a decision include creating an implementation plan, informing stakeholders, and executing the plan.
- It is common to adjust a plan once the work of implementing a decision begins. Throughout the implementation of the decision, there may be situations and issues that the decision maker did not consider initially.
- During the implementation phase, decision makers should be aware that they may be persuaded by pressures from stakeholders and employees to change the decision that they have made or to reconsider their decision.
Key Term
- stakeholder
-
A person or group that affects or can be affected by an organization’s actions.
After all of the alternatives have been analyzed and one has been selected, it is time to implement the decision. Three essential actions to implementing a decision are: developing a plan, communicating with stakeholders, and executing the plan (which includes assessing outcomes and making adjustments as needed).
Developing a Plan
A decision is reached with a certain objective in mind. Once it is made, managers identify the steps needed to reach that objective. These can include listing necessary actions and activities, considering required financial and other resources, and making a schedule for completing the work. The more thought that goes into developing a plan, the less likely it is that important factors will be overlooked.
Communicating with Stakeholders
An implementation plan requires the involvement of different people, and the consequences of decisions affect various stakeholders. For these reasons it is important to have a plan for communicating important information related to the decision and its implementation. This usually involves talking with employees, but may also mean letting customers or suppliers know about the decision and any effects it may have on them.
Executing the Plan
Accomplishing the decision’s objective requires completing the steps outlined in the implementation plan. Once this work is underway, managers assess progress and may identify areas for improvement. Circumstances can change or new issues might arise that had not been thought of during the planning process. These may require additions to, or other changes in, the plan. Because most decisions are made under conditions of uncertainty, as time passes what was once unknown can become known. Where estimates were incorrect or the unexpected happens, adjustments need to be made to the implementation plans. If the new facts are significant enough, it can even require reconsideration of the decision.
During the implementation phase, decision makers should be aware that they may be persuaded by pressures from stakeholders and employees to change their decision, or to reconsider. A few of these pressures include coercive pressures and normative pressures. Coercive pressures come from the social sanctions that can be applied if one does not act in socially legitimate ways. Normative pressures arise from broad social values, and they concern what people think they should do. Both coercive and normative pressures will likely be felt by the decision maker during the implementation of the decision, especially if the decision is an unpopular one. However, the decision maker should fall back on the analyses that originally brought them to the decision and strive not to be swayed by these pressures.
10.4.6: Evaluate the Results
Decision makers must evaluate the results of a decision to improve the processes and outcomes of future decisions.
Learning Objective
Recognize the appraisal stage and the development of future insights as the final stage in the decision-making process
Key Points
- Evaluation is the final step of the formal decision process. Evaluating outcomes may help the decision maker learn lessons that will improve her decision-making abilities.
- Self-esteem is an important factor in evaluating results because it may lead to decision makers viewing the results of their decision with favorable bias. This can cause people to filter out or discount information that might show the decision in an unfavorable light.
- It can also be valuable to assess the process by which a decision was made to make future decisions more effective.
Key Terms
- appraisal
-
A judgment or assessment—especially a formal one—of the value of something.
- insight
-
An extended understanding of a subject resulting from identification of relationships and behaviors within a model, context, or scenario.
After a decision has been made and implemented it is important to assess both the outcome of the decision and the process by which the decision was reached. Doing so confirms whether the decision actually led to the desired outcomes and also provides important information that can benefit future decision making. Learning from experience is important to continuous improvement and effectiveness.
Evaluating Outcomes
The objective of evaluating outcomes is for the decision maker to develop insight into the decision. Many of the lessons developed in this stage come out of examining the implications of the decision. Insight can be obtained by referencing key business metrics such as increased revenue, lowered costs, larger market share, or greater consumer awareness. One can also consider whether a decision had the desired effect. For example, a decision to hold additional training seminars may have been intended to make it more convenient for people to learn a new technology. However, if overall attendance did not increase, then the decision may not have addressed the underlying cause of why people did not go to training events. Once the outcome of a decision is known, the results may imply a need to revise the decision and try again.
When decision outcomes are not clearly measurable or have ambiguous results—some parts good, some bad—is not uncommon for people to emphasize the favorable data and discount the negative. Maintaining self-esteem also may cause decision makers to attribute good outcomes to their actions and bad outcomes to factors outside their control. This type of bias can limit an honest assessment of what went right and what didn’t, and thus reduce what can be learned by carefully evaluating outcomes.
Appraising the Decision Process
It can also be valuable for decision makers to step back and examine the process by which a decision was made. Often they can learn lessons that will benefit future decisions. If the decision was made by a group, having a conversation with all participants is often worthwhile. Whether enough information was gathered and whether its quality was high enough are two questions that should be considered. How the decision maker dealt with uncertainty or bias can be examined in the face of the results that have transpired. If estimates were off, or it becomes clear that emotions played too large a role in making a choice, it is important to learn from those mistakes so they won’t happen again. Finally, it is important to question whether all the relevant parties contributed information and knowledge needed for the decision, and whether everyone who should have been involved was given the chance to participate.
10.5: Considering Ethics in Decision Making
10.5.1: Moral Principles in Management
Business ethics deals with the beliefs and principles that guide management decisions.
Learning Objective
Recognize the importance of ethics in the business environment, particularly how individual managers should employ these principles
Key Points
- Business ethics concerns the duties and obligations an organization has to its stakeholders, including employees, customers, suppliers, and communities.
- The corporate world has taken steps to improve ethical compliance in the workplace after major corporate scandals like WorldCom, Tyco, and Enron.
- While compliance with laws is coerced trough the threat of sanctions or litigation, ethical behavior is voluntary.
- It is the duty of all managers to see that their organization maintains ethical practices and behaviors.
Key Terms
- ethics
-
The study of principles relating to right and wrong conduct.
- moral
-
Of or relating to principles of right and wrong in behavior, especially for teaching right behavior.
Morality (from the Latin moralitas, meaning “manner, character, proper behavior”) is the differentiation of intentions, decisions, and actions between those that are good (or right) and those that are bad (or wrong). Ethics, also known as moral philosophy, is a branch of philosophy that involves systematizing, defending, and recommending concepts of right and wrong conduct.
Business Ethics
Business ethics (also corporate or professional ethics) is a form of applied ethics that examines the principles and moral beliefs that guide management decisions. Ethical issues include the obligations a company has to its employees, suppliers, customers and neighbors. In particular, business ethics is concerned with situations when those obligations are inconsistent with economic or strategic choices, or are in conflict with each other. Legal obligations are not the same as ethical ones; laws are enforced through the threat or imposition of punishment by a government or through civil litigation. All individuals and organizations must follow the law, but complying with ethical beliefs is voluntary, not coerced.
Business ethics applies to all aspects of business conduct by individuals and organizations as a whole. Ethical behavior is conduct that follows one’s personal beliefs or shared organizational or institutional values. When individuals take action on behalf of an organization, they represent its ethics to society. Businesses are dependent on their reputations, so it is important for them to have clear and consistent expectations regarding ethical standards to guide employee behavior. Many employees prefer to work for organizations that share their own moral beliefs. A company’s ethical practices can thus have an effect on the recruitment and retention of employees.
In recent decades there has been widespread attention to business ethics due to highly visible cases of corporate malfeasance, such as the WorldCom, Enron, and Tyco scandals. To protect their reputations, companies have begun to form more comprehensive corporate policies concerning ethics. These policies generally offer guidance to employees and state the expectations of the company. Some companies require that employees sign a contract stating that they will follow the procedures within the handbook.
To be viewed by the public as having high moral standards, many companies have created a position called the corporate ethics officer or the corporate compliance officer. This person ensures their organization has statements of ethical principals, clear guideline about acceptable and unacceptable practices, and means of reporting ethical breaches. These executives also have the specific responsibility of monitoring ethical behavior and addressing breaches.
Promoting an Ethical Business Climate
There are at least four elements that create an atmosphere conducive to ethical behavior within an organization:
- A written code of ethics and standards
- Ethics training for executives, managers, and employees
- Availability for advice on ethical situations (i.e., advice lines or offices)
- Systems for confidential reporting
It is the duty of all managers to see that their organization maintains ethical practices and behaviors. Good leaders strive to create a better and more ethical organization. Promoting an ethical climate in an organization is critical, since it is a key component in addressing many other issues facing the organization.
10.5.2: Applying the Ethical Decision Tree
Decision trees are useful analytic tools for considering the ethical dimensions of a decision.
Learning Objective
Define the concept of a decision tree as it applies to the ethical dimensions of a decision.
Key Points
- Decision trees are used to identify alternatives and estimate their likely outcomes.
- Managers can use decision-tree analysis to consider the effect of each alternative on stakeholders such as employees, customers, shareholders, and communities.
- Decision-tree analysis can help identify or uncover the potential impacts of alternatives so that a decision maker can select the option that is most consistent with her ethical and moral beliefs.
Key Terms
- ethics
-
The study of principles relating to right and wrong conduct.
- decision tree
-
A visualization of a complex decision-making situation in which the possible decisions and their likely outcomes are organized in the form of a graph that resembles a tree.
Ethics are moral principles that guide a person’s behavior. These morals are shaped by social norms, cultural practices, and religious influences. All decisions have an ethical or moral dimension for a simple reason—they have an effect on others. Managers and leaders need to be aware of their own ethical and moral beliefs so they can draw on them when they face decisions. They can then effectively think through an ethical issue with the same types of approaches they use for other decisions.
Decision Trees
Decision trees are graphical representations of alternatives and possible outcomes. The decisions are represented by the branches of the tree. Organizations and individuals often use decision trees as part of their decision-making process because they are a means for adding formal structure to information about a decision. Identifying the range of possibilities and their potential consequences helps clarify the decision and facilitates selection of an alternative.
Decision trees can be applied to ethical matters as well. If confronted with an ethical dilemma, creating a decision tree is a useful method for analyzing what the potential outcomes of each action would be, and ultimately, how to proceed. It is a particularly useful tool for considering stakeholders such as employees, customers, shareholders, and communities. The answers to questions about what stakeholders will be affected and what the effects will be help build the case for or against each alternative. Often there will be competing interests, or situations in which two different values are in competition. For instance, a decision to close a coal mine because coal contributes to global warming may be positive for society at large, but it imposes high costs on the employees who will lose their jobs. Decision-tree analysis can help identify or uncover the potential impacts of alternatives so that a decision maker can select the one that is most consistent with her ethical and moral beliefs.
10.5.3: Applying the Decision Tree
Decision tree analysis can be a useful tool for evaluating ethical decisions.
Learning Objective
Express decision factors in an organized and structured view, allowing for systematic, ethical, and logical decision making
Key Points
- Decision tree analysis can be a useful tool for evaluating choices involved in ethical decisions.
- Laying out each consideration, potential action, and potential outcome can be useful in deciding which alternative is most likely to be consistent with your ethical and moral beliefs and values.
- Decision tree analysis should capture both quantitative and qualitative consequences of each alternative.
Key Terms
- utility
-
In economics, utility is a representation of preferences over some set of goods and services. Preferences have a utility representation so long as they are transitive, complete, and continuous.
- decision tree
-
A visualization of a complex decision-making situation in which the possible decisions and their likely outcomes are organized in the form of a branched graph.
Decision tree analysis provides a visual tool to help individuals quantify and weigh options against one another when making a decision. A decision tree calculates the expected values of competing alternative. This tells the decision maker which decision has the highest utility (i.e., is the most preferred) to the decision maker.
Creating a Decision Tree
A decision tree consists of 3 types of nodes:
- Decision nodes: These are commonly represented by squares. Decision nodes are used when a decision needs to be made between at least two alternatives.
- Chance nodes: These may be represented by circles. Chance nodes represent points on the decision tree where there is uncertainty about outcomes (so there must be at least two possible outcomes represented).
- End nodes: These may be represented by triangles. An end node is where a decision is made and its value or utility is identified.
Applications of Decision Trees
Decision trees can be applied to ethical considerations. Consider an ethical dilemma involving a colleague. You are considering three options: report your colleague to a superior, confront the colleague yourself, or ignore the situation completely. The top box of the decision tree would state “Colleague Dilemma.”
The next three nodes would then read: “Report colleague to superiors,” “Confront colleague,” and “Ignore situation. ” Each of these nodes would then have a “Yes” arrow and a “No” arrow. For each “Yes” and “No,” you would list what the outcome would be, realizing that in some cases the nodes may need to continue to account for potential outcomes, some of which may link back to previous options. For example, a “Yes” decision arrow for “Report colleague to superiors” may result in the situation being taken care of—or, it could result in an investigation that would impact your standing within the company and with your peers. If you chose to ignore the colleague and his unethical behavior is discovered in the future, you could end up in trouble for choosing not to act earlier.
A decision tree for a tough problem allows the decision maker to visually lay out each scenario and make a detailed consideration. Decision trees therefore support the evaluation process and can help clarify often-complex ethical dilemmas.
10.6: Barriers to Decision Making
10.6.1: Cognitive Biases as a Barrier to Decision Making
Individual cognitive biases will influence decision making.
Learning Objective
Examine the complex individual influences central to the way in which decision making is pursued, most notably the cognitive, normative, and psychological perspectives
Key Points
- Decision making is shaped by individual personality and behavioral characteristics.
- Subjective biases can influence decisions by disrupting objective judgments.
- Common cognitive biases include confirmation, anchoring, halo effect, and overconfidence.
Key Term
- dichotomies
-
Two elements, often mutually exclusive, that stand in juxtaposition to one another.
Decision making is inherently a cognitive activity, the result of thinking that may be either rational or irrational (i.e., based on assumptions not supported by evidence). Individual characteristics including personality and experience influence how people make decisions. As such, an individual’s predispositions can either be an obstacle or an enabler to the decision-making process.
From the psychological perspective, decisions are often weighed against a set of needs and augmented by individual preferences. Abraham Maslow’s work on the needs-based hierarchy is one of the best known and most influential theories on the topic of motivation—according to his theory, an individual’s most basic needs (e.g., physiological needs such as food and water; a sense of safety) must be met before an individual will strongly desire or be motivated by higher-level needs (e.g., love; self-actualization.
The Myers-Briggs Type Indicator (MBTI) is a widely used diagnostic for identifying personality characteristics. By categorizing individuals in terms of four dichotomies—thinking and feeling, extroversion and introversion, judging and perception, and sensing and intuition—the MBTI provides a map of the individual’s orientation toward decision making.
Types of Cognitive Bias
Biases in how we think can be major obstacles in any decision-making process. Biases distort and disrupt objective contemplation of an issue by introducing influences into the decision-making process that are separate from the decision itself. We are usually unaware of the biases that can affect our judgment. The most common cognitive biases are confirmation, anchoring, halo effect, and overconfidence.
1. Confirmation bias: This bias occurs when decision makers seek out evidence that confirms their previously held beliefs, while discounting or diminishing the impact of evidence in support of differing conclusions.
2. Anchoring: This is the overreliance on an initial single piece of information or experience to make subsequent judgments. Once an anchor is set, other judgments are made by adjusting away from that anchor, which can limit one’s ability to accurately interpret new, potentially relevant information.
3. Halo effect: This is an observer’s overall impression of a person, company, brand, or product, and it influences the observer’s feelings and thoughts about that entity’s overall character or properties. It is the perception, for example, that if someone does well in a certain area, then they will automatically perform well at something else regardless of whether those tasks are related.
4. Overconfidence bias: This bias occurs when a person overestimates the reliability of their judgments. This can include the certainty one feels in her own ability, performance, level of control, or chance of success.
10.6.2: Time Pressure as a Barrier to Decision Making
Time pressure forces decision makers to shift from logical processes (ideal) to intuitive processes (sub-ideal).
Learning Objective
Explain the way in which time pressure can influence decision making
Key Points
- Time pressure can distort decision-making processes and individual judgment and make them less objective and more influenced by intuition.
- Heuristics, or mental shortcuts, can deliver workable decisions under time pressure and in the absence of logical decision-making processes.
- Decision makers who feel as though they have ample time tend to arrive at more logically crafted, higher quality decisions than those who felt as though they had insufficient amounts of time, even if confronted by similar time pressure in real terms.
- While generally considered a barrier to decision making, time pressures may also have the opposite effect in terms of creating organizational motivation to render decisions and move on. In this way time pressure, real or perceived, may act as a deadline and encourage organizational dexterity.
Key Term
- heuristic
-
A “shortcut” method of problem solving that makes assumptions based on past experiences. Examples include going by “rule of thumb,” when you apply your experience of something having happened a certain way enough times that it’s likely to continue happening that way. It is not guaranteed to be accurate every single time, but it cuts out processing time by avoiding detailed analysis of every particular situation.
Just as individual characteristics and cognitive biases can shape decision making, time pressure can also distort how we consider and choose between alternatives. Severe time constraints can make decision processes and individual judgment less objective and more influenced by intuition as more formal and rigorous approaches are ignored. All decisions are time-bound in the sense that we do not have an infinite amount of time to make a selection. Still, firm and proximate deadlines and limited resources are common causes of time pressure. Information overload is another. While considering all relevant factors is important to build support for the decision, data collection can eat up time better spent analyzing alternatives and making the decision itself.
There are some effective approaches to dealing with time pressure. Clearly defining the decision and its parameters early on can reduce ambiguity and make it easier to hone in on relevant data. Setting clear boundaries on matters such as who will participate and how long discussions will continue can similarly manage the amount of time given to a decision. In many instances, the use of heuristics can be applied to complex decisions to serve as shortcuts in conducting analysis and weighing alternatives.
There is evidence that suggests the perception of time pressure may impact decision quality. Decision makers who believe they have ample time to make a decision tend to arrive at more logically crafted decisions than those who feel as though they have an insufficient amount of time. While time pressure is generally perceived as being a barrier to effective decision making, it may also have the exact opposite effect. A limited time frame can focus mental energy and effort to bring the appropriate resources to bear on a decision more quickly and efficiently than otherwise might have been the case.
10.6.3: Group Conflict as a Barrier to Decision Making
Group dynamics, which involves the influence of social behavior, is the primary determining factor in the success of group outcomes.
Learning Objective
Recognize the value and potential drawbacks of group dynamics in making decisions
Key Points
- Interpersonal and group dynamics can make it difficult for groups to make decisions effectively.
- The presence of well-developed group cohesiveness, often achieved through healthy levels of dissent, typically results in preferable outcomes, while groupthink can lead to avoiding dissent and thus to premature consensus.
- The leader’s behavior, group norms, and how the decision-making process is structured can help prevent groupthink.
Key Terms
- groupthink
-
The psychological phenomenon wherein a desire for conformity within a group results in them making an irrational decision; by actively suppressing dissenting viewpoints in the interest of minimizing conflict, group members reach a consensus without critically evaluating alternative viewpoints.
- Synergy
-
Benefits resulting from combining two different groups, people, objects, or processes.
- group
-
A number of things or persons in some relation to one another.
Delegating key decision making to groups, teams, or committees occurs often within organizations. Decisions made by groups can be better informed by broader perspectives and different sources of information and expertise than those made by an individual decision maker. Along with these advantages, however, interpersonal and group dynamics presents dilemmas that can make it more difficult for groups to make effective choices.
Group cohesion, or positive feelings between individuals and productive working relationships, contributes to effective group decision making. In cohesive groups information is more easily shared, norms of trust mean it is easier to challenge ideas, and common values help focus decisions around shared goals. Encouraging constructive disagreements and even conflict can result in more-creative ideas or more solutions that are easier to implement.
Groupthink
One of the greatest inhibitors of effective group decision making is groupthink. Groupthink is a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity results in an irrational or dysfunctional decision-making outcome. By isolating themselves from outside influences and actively suppressing dissenting viewpoints in the interest of minimizing conflict, group members reach a consensus decision without critical evaluation of alternative viewpoints.
Loyalty to the group requires individuals to avoid raising controversial issues or alternative solutions, and there is a loss of individual creativity, uniqueness, and independent thinking. The dysfunctional group dynamics of the in-group produces an illusion of invulnerability (an inflated certainty that the right decision has been made). Thus the in-group significantly overrates its own decision-making abilities and significantly underrates the abilities of its opponents (the out-group). Furthermore, groupthink can produce dehumanizing actions against the out-group.
Psychologist Irving Janus, the leading theorist of groupthink, identified ways of preventing it:
- Leaders should assign each member the role of “critical evaluator.” This allows each member to freely air objections and doubts.
- Leaders should not express an opinion when assigning a task to a group.
- Leaders should absent themselves from many of the group meetings to avoid excessively influencing the outcome.
- The organization should set up several independent groups working on the same problem.
- All effective alternatives should be examined.
- Each member should discuss the group’s ideas with trusted people outside of the group.
- The group should invite outside experts into meetings. Group members should be allowed to discuss with and question the outside experts.
- At least one group member should be assigned the role of devil’s advocate. This should be a different person for each meeting.
.
10.7: Managing Group Decision Making
10.7.1: Advantages and Disadvantages of Group Decision Making
Group decision making can lead to improved outcomes, but only if a variety of conditions pertaining to group chemistry are satisfied.
Learning Objective
Assess the advantages and disadvantages that should be considered in leveraging collaborative decision-making
Key Points
- Group decisions involve two or more people, are participatory, and result in choices that are the responsibility of the group rather than any individual.
- Group decision making is subject to social influences that can provide advantages as well as disadvantages in decision outcomes.
- There are a number of potential advantages in group decision making—chief among them are shared information and more favorable outcomes achieved through synergy. Both of these advantages rely on the power of many minds undertaking a single decision.
- Disadvantages of group decision making include diffusion of responsibility and inefficiency.
Key Terms
- groupthink
-
The psychological phenomenon wherein a desire for conformity within a group results in them making an irrational decision; by actively suppressing dissenting viewpoints in the interest of minimizing conflict, group members reach a consensus without critically evaluating alternative viewpoints.
- Homogeneity
-
In the context of group decision making, homogeneity refers to a set of consistent and uniform ideas, prejudices, and beliefs held by all members within a group.
Group decision making (also known as collaborative decision making) is when individuals collectively make a choice from the alternatives before them. Such decisions are not attributable to any single individual, but to the group as a whole. By definition, group decisions are participatory, and often a member’s contribution is directly proportional to the degree to which a particular decision would affect him or her. Group decisions are subject to factors such as social influence, including peer pressure, and group dynamics. These social elements can affect the process by which decisions are reached and the decision outcomes themselves. A group can make decisions by consensus, in which all members come to agreement, or it may take a majority-rules approach and select the alternative favored by most members.
Advantages of Group Decision Making
Group decision making provides two advantages over decisions made by individuals: synergy and sharing of information. Synergy is the idea that the whole is greater than the sum of its parts. When a group makes a decision collectively, its judgment can be keener than that of any of its members. Through discussion, questioning, and collaboration, group members can identify more complete and robust solutions and recommendations.
The sharing of information among group members is another advantage of the group decision-making process. Group decisions take into account a broader scope of information since each group member may contribute unique information and expertise. Sharing information can increase understanding, clarify issues, and facilitate movement toward a collective decision.
Disadvantages of Group Decision Making
Diffusion of Responsibility
One possible disadvantage of group decision making is that it can create a diffusion of responsibility that results in a lack of accountability for outcomes. In a sense, if everyone is responsible for a decision, then no one is. Moreover, group decisions can make it easier for members to deny personal responsibility and blame others for bad decisions.
Lower Efficiency
Group decisions can also be less efficient than those made by an individual. Group decisions can take additional time because there is the requirement of participation, discussion, and coordination among group members. Without good facilitation and structure, meetings can get bogged down in trivial details that may matter a lot to one person but not to the others.
Groupthink
One of the greatest inhibitors of effective group decision making is groupthink. Groupthink is a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity results in an irrational or dysfunctional decision-making outcome. By isolating themselves from outside influences and actively suppressing dissenting viewpoints in the interest of minimizing conflict, group members reach a consensus decision without critical evaluation of alternative viewpoints.
Loyalty to the group requires individuals to avoid raising controversial issues or alternative solutions, and there is a loss of individual creativity, uniqueness, and independent thinking. The dysfunctional group dynamics of the in-group produces an illusion of invulnerability (an inflated certainty that the right decision has been made). Thus the in-group significantly overrates its own decision-making abilities and significantly underrates the abilities of its opponents (the out-group). Furthermore, groupthink can produce dehumanizing actions against the out-group.
10.7.2: The Manager’s Role in Group Decisions
The manager’s role in group decision making is to create a supportive context for the group.
Learning Objective
Describe the roles managers must play in supporting effective group decision-making
Key Points
- The manager’s role is to establish the conditions for an effective group-decision outcome.
- Managers can help promote effective decision making by effectively choosing group members, framing the decision, and organizing the decision process.
- Productive steps a manger can take to assist group decision making include the following: define a goal, create positive working conditions, establish expectations, provide adequate resources, and give group members ample space and latitude.
Key Term
- norms
-
Behaviors or standards regarded as typical.
Decisions are often delegated to groups when members have the experience and information needed to arrive at the appropriate choice. Managers and leaders can take actions that support group decision making and lead to good decision outcomes. Managers can help promote effective decision making by effectively choosing group members, framing the decision, and organizing the decision process.
In order to maximize the potential of a group decision process, managers should take the following important steps:
- Establish the team goal: By articulating the dimensions of the decision, including its importance, a manager can reduce ambiguity and help group members focus their analysis, discussions, and deliberations. A clear statement of the question to be resolved can help unify the group and create cohesion that engages members and improves collaboration.
- Facilitate a working environment: After the decision goal is established, the working environment must allow for meaningful, honest, and open communication among group members. The manager can help establish norms about how members will interact with each other to foster constructive discourse.
- Set clear expectations and responsibilities: By setting expectations, managers help team members understand their decision tasks and parameters (for example, deadlines). Managers might assign roles to help structure the decision process, establish a sense of accountability for parts of the group’s work, and clarify responsibilities.
- Provide resources: Managers must be mindful that the group has adequate resources to evaluate alternatives and make its decision. Necessary adjustments may include providing additional staff, giving more time, or freeing members from other work assignments so they can fully participate in the decision-making process.
- Get out of the way: After the manager has established the context for the group to make its decision, the best thing to do is step back and let the team perform. The most useful role at this point is that of coach, such as if the group needs help managing interpersonal relationships or if additional clarity is needed about an alternative.
10.7.3: Employee Involvement in Decision Making
Involving employees in key decisions gives managers access to unique skills and tells the employees that their contributions are valued.
Learning Objective
Distinguish the importance and inherent value of ensuring employee involvement as much as possible in the decision-making process
Key Points
- From a managerial standpoint, employee involvement is an effective way to leverage human resources and give employees a voice in something meaningful.
- Employee participation in decisions can lead to increased job satisfaction, organizational commitment, individual motivation, and job performance.
- To effectively contribute to group decisions, individuals must have relevant skills and experiences.
Key Term
- motivation
-
An incentive or reason for doing something.
Group decisions can lead to better decision outcomes by bringing to bear a broader range of perspectives. By delegating a decision to a group, an organization can make effective use of the skills and knowledge of its employees.
Another of the benefits of group decision making in an organization is its effect on employee motivation. Providing opportunities to participate in decisions is a way to give employees a voice in something meaningful. Doing so can have positive effects on job satisfaction, organizational commitment, individual motivation, and job performance.
Most commonly employees are involved in decisions that directly affect how their work is done. For instance, many quality-control practices include opportunities for workers to discuss and select ways to improve how they produce goods or deliver services. Self-managed teams have even broader responsibilities for decisions, such as how their work is organized, scheduled, and assigned.
To effectively participate in group decisions, employees must have the necessary skills and experience. Without relevant knowledge, participants in group decision making may not grasp the issues, know how to analyze alternatives, or be able to determine which option to choose. For instance, it would not be reasonable to expect the same level of contribution from a new recruit fresh out of college as from a more experienced employee familiar with the organization and its business priorities.
10.7.4: Techniques for Reaching a Group Consensus
Reaching consensus typically requires identifying and addressing the underlying concerns of group members.
Learning Objective
Define consensus and the varying ways in which it can be achieved in a group dynamic
Key Points
- Consensus decision making aims to reach agreement through collaboration, cooperation, inclusivity, and participation.
- Seeking consensus is not always ideal, since it can take additional time and result in suboptimal choices.
- Two approaches to making group decisions by consensus are the Quaker model and the consensus-oriented decision-making (CODM) model.
Key Term
- consensus
-
A process of decision-making that seeks widespread agreement among group members.
Consensus decision making aims to reach agreement through collaboration, cooperation, inclusivity, and participation. Group decisions made by consensus seek resolutions that are satisfactory to all group members and meet all of their concerns. Consensus decision making is not adversarial or competitive, but rather seeks to do what is best for the group. Group members treat each other equally and solicit the input of all participants.
Making decisions by consensus is not necessarily ideal or even desirable. In an effort to please everyone, the decision may satisfy the least common denominator but not produce the best outcomes. Developing a consensus can be time consuming, and is thus more difficult to achieve when there is urgency, significant time constraints, or resource limitations.
Another way to think about consensus is as the absence of objections. In order to arrive at a group consensus, majority opinion holders must overcome any unwillingness of group members to accept a given choice. While group members may be willing to go along with a proposal, they do not actually need to favor it above another choice.
One approach to consensus building is the Quaker model. It provides a way to structure a decision process that emphasizes listening among group members. The Quaker model calls for members to refrain from speaking twice until after all group members have been heard from, the effect of which is to neutralize dominating personality types. Another key feature of the Quaker model is that it relies on a single person to act as the facilitator, or moderator, who makes sure the discussion flows according to an empathetic process. By articulating the emerging consensus, members can be clear on the decision as it emerges, and, since their views have been taken into account, will be likely to support it.
Another formal technique for consensus building comes from the consensus-oriented decision-making (CODM) model. It has seven key steps:
- Framing the topic
- Open discussion
- Identifying underlying concerns
- Collaborative proposal building
- Choosing a direction
- Synthesizing a final proposal
- Closure
The CODM model outlines a process of how proposals can be collaboratively built with the full participation of all stakeholders. This model lets groups be flexible enough to make decisions when they need to, while still following a format based on the primary values of consensus decision making.
9.1: Defining Leadership
9.1.1: Leadership
Leadership is the process by which an individual mobilizes people and resources to achieve a goal.
Learning Objective
Describe the relationship between leaders and followers
Key Points
- Leadership is the process by which an individual motivates others and mobilizes resources to achieve a goal.
- Leadership is both a set of behaviors that can be learned and a set of traits that can be nurtured.
- Leadership is a relationship between followers and those who inspire and provide direction for them. It involves emotional ties and commitments.
Key Term
- Transformational Leadership
-
A theory of leading that enhances the motivation, morale, and performance of followers through a variety of mechanisms.
Defining Leadership
Leadership is the process by which an individual mobilizes people and resources to achieve a goal. It requires both a set of skills that can be learned as well as certain attributes that can be nurtured. Leaders inspire, challenge, and encourage others. They can persuade and influence, and they show resilience and persistence. All aspects of society have leaders. The concept of leader may call to mind a CEO, a prime minister, a general, a sports team captain, or a school principal; examples of leadership exist across a variety of organizations.
Leaders motivate others to aspire to achieve and help them to do so. They focus on the big picture with a vision of what could be and help others to see that future and believe it is possible. In this way, leaders seek to bring about substantive changes in their teams, organizations, and societies.
Leadership is a relationship between followers and those who inspire them and provide direction for their efforts and commitments. It affects how people think and feel about their work and how it contributes to a larger whole. Effective leaders can mean the difference between increasing a team’s ability to perform or diminishing its performance, between keeping efforts on track or encountering disaster, and even between success or failure.
Leadership and Management
Leadership is one of the most important concepts in management, and many researchers have proposed theories and frameworks for understanding it. Some have distinguished among types of leadership such as charismatic, heroic, and transformational leadership. Other experts discuss the distinctions between managers and leaders, while others address the personality and cognitive factors most likely to predict a successful leader. The many dimensions of leadership indicate how complex a notion it is and how difficult effective leadership can be.
9.1.2: Management versus Leadership
Though they have traits in common, leadership and management both have unique responsibilities that do not necessarily overlap.
Learning Objective
Distinguish between managerial roles and responsibilities and leadership roles and responsibilities
Key Points
- Many view leaders as those who direct the organization through vision and inspiration; managers are results-oriented and more focused on task organization and efficiency.
- Managers sustain current systems and processes for accomplishing work, while leaders challenge the status quo and make change happen.
- Such distinctions may create a negative concept of managers. “Leader” brings to mind heroic figures rallying people together for a cause, while “manager” suggests less charismatic individuals focusing solely on efficiency.
Key Terms
- leadership
-
A process of social influence in which one person enlists the aid and support of others in accomplishing a common task.
- management
-
The act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively.
Leaders vs. Managers
The terms “management” and “leadership” have been used interchangeably, yet there are clear similarities and differences between them. Both terms suggest directing the activities of others. In one definition, managers do so by focusing on the organization and performance of tasks and by aiming at efficiency, while leaders engage others by inspiring a shared vision and effectiveness. Managerial work tends to be more transactional, emphasizing processes, coordination, and motivation, while leadership has an emotional appeal, is based on relationships with followers, and seeks to transform.
One traditional way of understanding differences between managers and leaders is that people manage things but lead other people. More concretely, managers administrate and maintain the systems and processes by which work gets done. Their work includes planning, organizing, staffing, leading, directing, and controlling the activities of individuals, teams, or whole organizations for the purpose of accomplishing a goal. Basically, managers are results-oriented problem-solvers with responsibility for day-to-day functions who focus on the immediate, shorter-term needs of an organization.
In contrast, leaders take the long-term view and have responsibility for where a team or organization is heading and what it achieves. They challenge the status quo, make change happen, and work to develop the capabilities of people to contribute to achieving their shared goals. Additionally, leaders act as figureheads for their teams and organizations by representing their vision and values to outsiders. This definition of leadership may create a negative bias against managers as less noble or less important: “Leader” suggests a heroic figure, rallying people to unite under a common cause, while “manager” calls to mind less charismatic individuals who are focused solely on getting things done.
9.1.3: Sources of Power
Power is the ability to influence the behavior of others with or without resistance by using a variety of tactics to push or prompt action.
Learning Objective
Identify the six different sources of power available to organizational leaders and how leaders can employ these sources of power and influence in a meaningful and ethical way
Key Points
- Power is the ability to get things done, sometimes over the resistance of others.
- Leaders have a number of sources of power, including legitimate power, referent power, expert power, reward power, coercive power, and informational power.
- All of these sources of power can be used in combination, and people often have access to more than one of them.
- Power tactics fall along three dimensions: behavioral, rational, and structural.
Key Terms
- power
-
The ability to influence the behavior of others, with or without resistance.
- Downward Power
-
When a superior influences subordinates.
- Upward Power
-
When subordinates influence the decisions of the leader.
Power in Business
Power is the ability to get things done. Those with power are able to influence the behavior of others to achieve some goal or objective. Sometimes people resist attempts to make them do certain things, but an effective leader is able to overcome that resistance. Although people sometimes regard power as evil or corrupt, power is a fact of organizational life and in itself is neither good nor bad. Leaders can use power to benefit others or to constrain them, to serve the organization’s goals or to undermine them.
Another way to view power is as a resource that people use in relationships. When a leader influences subordinates, it is called downward power. We can also think of this as someone having power over someone else. On the other hand, subordinates can also exercise upward power by trying to influence the decisions of their leader. Indeed, leaders depend on their teams to get things done and in that way are subject to the power of team members.
The Six Sources of Power
Power comes from several sources, each of which has different effects on the targets of that power. Some derive from individual characteristics; others draw on aspects of an organization’s structure. Six types of power are legitimate, referent, expert, reward, coercive, and informational.
Legitimate Power
Also called “positional power,” this is the power individuals have from their role and status within an organization. Legitimate power usually involves formal authority delegated to the holder of the position.
Referent Power
Referent power comes from the ability of individuals to attract others and build their loyalty. It is based on the personality and interpersonal skills of the power holder. A person may be admired because of a specific personal trait, such as charisma or likability, and these positive feelings become the basis for interpersonal influence.
Expert Power
Expert power draws from a person’s skills and knowledge and is especially potent when an organization has a high need for them. Narrower than most sources of power, the power of an expert typically applies only in the specific area of the person’s expertise and credibility.
Reward Power
Reward power comes from the ability to confer valued material rewards or create other positive incentives. It refers to the degree to which the individual can provide external motivation to others through benefits or gifts. In an organization, this motivation may include promotions, increases in pay, or extra time off.
Coercive Power
Coercive power is the threat and application of sanctions and other negative consequences. These can include direct punishment or the withholding of desired resources or rewards. Coercive power relies on fear to induce compliance.
Informational Power
Informational power comes from access to facts and knowledge that others find useful or valuable. That access can indicate relationships with other power holders and convey status that creates a positive impression. Informational power offers advantages in building credibility and rational persuasion. It may also serve as the basis for beneficial exchanges with others who seek that information.
All of these sources and uses of power can be combined to achieve a single aim, and individuals can often draw on more than one of them. In fact, the more sources of power to which a person has access, the greater the individual’s overall power and ability to get things done.
Power Tactics
People use a variety of power tactics to push or prompt others into action. We can group these tactics into three categories: behavioral, rational, and structural.
Behavioral tactics can be soft or hard. Soft tactics take advantage of the relationship between person and the target. These tactics are more direct and interpersonal and can involve collaboration or other social interaction. Conversely, hard tactics are harsh, forceful, and direct and rely on concrete outcomes. However, they are not necessarily more powerful than soft tactics. In many circumstances, fear of social exclusion can be a much stronger motivator than some kind of physical punishment.
Rational tactics of influence make use of reasoning, logic, and objective judgment, whereas nonrational tactics rely on emotionalism and subjectivity. Examples of each include bargaining and persuasion (rational) and evasion and put downs (nonrational).
Structural tactics exploit aspects of the relationship between individual roles and positions. Bilateral tactics, such as collaboration and negotiation, involve reciprocity on the parts of both the person influencing and the target. Unilateral tactics, on the other hand, are enacted without any participation on the part of the target. These tactics include disengagement and fait accompli. Political approaches, such as playing two against one, take yet another approach to exert influence.
People tend to vary in their use of power tactics, with different types of people opting for different tactics. For instance, interpersonally-oriented people tend to use soft tactics, while extroverts employ a greater variety of power tactics than do introverts. Studies have shown that men tend to use bilateral and direct tactics, whereas women tend to use unilateral and indirect tactics. People will also choose different tactics based on the group situation and according to whom they are trying to influence. In the face of resistance, people are more likely to shift from soft to hard tactics to achieve their aims.
9.1.4: A Leader’s Influence
Leaders use social influence to maintain support and order with their subordinates.
Learning Objective
Differentiate between various methods of influencing others and their role in effective leadership
Key Points
- Influence occurs when other people affect an individual’s emotions, opinions, or behaviors. Leaders use influence to create the behaviors needed to achieve their goal and vision.
- Harvard psychologist Herbert Kelman identified three broad varieties of social influence: compliance, identification, and internalization.
- Compliance is people behaving as others expect.
- Identification happens when people are influenced by someone who is well-liked and respected, such as a celebrity.
- Internalization of values leads to those beliefs being reflected in behavior.
Key Terms
- social influence
-
When an individual’s emotions, opinions, or behaviors are affected by others.
- socialization
-
The process of inheriting and disseminating norms and customs of behavior along with ideologies and other beliefs.
The Role of Influence in Leadership
Influence occurs when a person’s emotions, opinions, or behaviors are affected by others. It is an important component of a leader’s ability to use power and maintain respect in an organization. Influence is apparent in the form of peer pressure, socialization, conformity, obedience, and persuasion. The ability to influence is an important asset for leaders, and it is also an important skill for those in sales, marketing, politics, and law.
In 1958, Harvard psychologist Herbert Kelman identified three broad varieties of social influence: compliance, identification, and internalization. Compliance involves people behaving the way others expect them to whether they agree with doing so or not. Obeying the instructions of a crossing guard or an authority figure is an example of compliance. Identification is when people behave according to what they think is valued by those who are well-liked and respected, such as a celebrity. Status is a key aspect of identification: when people purchase something highly coveted by many others, such as the latest smartphone, they are under the influence of identification. Internalization is when people accept, either explicitly or privately, a belief or set of values that leads to behavior that reflects those values. An example is following the tenets of one’s religion.
How Leaders Use Influence
In an organization, a leader can use these three types of influence to motivate people and achieve objectives. For example, compliance is a means of maintaining order in the workplace, such as when employees are expected to follow the rules set by their supervisors. Similarly, identification happens when people seek to imitate and follow the actions of people they look up to and respect, for example a more experienced co-worker or trusted supervisor. Internalization results when employees embrace the vision and values of a leader and develop a commitment to fulfilling them.
Leaders use these different types of influence to motivate the behaviors and actions needed to accomplish tasks and achieve goals. Individuals differ in how susceptible they are to each type of influence. Some workers may care a great deal about what others think of them and thus be more amenable to identifying the cues for how to behave. Other individuals may want to believe strongly in what they do and so seek to internalize a set of values to guide them. In organizations and in most parts of life, sources of influence are all around us. As a result, our behavior can be shaped by how others communicate with us and how we see them.
9.1.5: A Leader’s Vision
A clear and well-communicated vision is essential for a leader to gain support and for followers to understand a leader’s goals.
Learning Objective
Explain the relationship among vision, mission, and strategy as it pertains to leadership
Key Points
- Vision is defined as a clear, distinctive, and specific view of the future that is usually connected with strategic decisions for the organization.
- A thriving organization will have a vision that is succinct, understandable, and indicative of the direction that the company wants to head in the future.
- Leaders are essential for communicating the vision of the organization and promoting the vision through the decisions they make and the strategies they pursue.
Key Term
- vision
-
A clear, distinctive, and specific view of the future that is usually connected with a leader’s strategic advances for the organization.
A vision is defined as a clear, distinctive, and specific view of the future, and is usually connected with strategic advances for the organization. Effective leaders clearly define a vision and communicate it in such a way as to foster enthusiasm and commitment throughout the organization. This ability to express a vision and use it to inspire others differentiates a leader from a manager.
Many researchers believe that vision is an essential quality of effective leaders, as important as the abilities to communicate and to build trust. Effective leaders clearly communicate their vision of the organization. Their decisions and strategies reflect their view of what an enterprise can be rather than what it currently is. A strong leader builds trust in the vision by acting in ways that are consistent with it and by demonstrating to others what it takes to make the vision a reality.
Vision is an essential component of an organization’s success. A thriving organization will have a vision that is succinct, indicative of the direction that the company is heading, and widely understood throughout all levels of the organization. The more employees are aware of, understand, and believe in the vision, the more useful it is in directing their behavior on a daily basis.
Vision and mission are sometimes used interchangeably, but there is a useful distinction between the two. A vision describes an organization’s direction, while its mission defines its purpose. By focusing on the value an organization creates, the mission helps prioritize activities and provides a framework for decision-making.
Vision also plays a significant role in a leader’s strategy for the organization. By setting the direction, a vision underscores the necessity of all the areas of a business working toward the same goal. This unity of purpose often involves changing what is done and how, and aligning the activities and behavior of people is critical to fulfilling a leader’s vision. A vision reduces ambiguity and provides focus—two benefits that are especially valuable in turbulent or rapidly changing times.
9.1.6: Leadership Traits
Traits of effective leaders are conditionally dependent and have been debated for years, but researchers have identified some commonalities.
Learning Objective
Summarize the key characteristics and traits that are predictive of strong leadership capacity
Key Points
- Early findings regarding trait theory show that relationships exist between leadership and individual traits such as intelligence, adjustment, extroversion, conscientiousness, openness to experience, and general self-efficacy.
- Stephen Zaccaro, a researcher of trait theories, argues that effective leadership is derived from an integrated set of cognitive abilities, social capabilities, and dispositional tendencies, with each set of traits adding to the influence of the other.
- Zaccaro’s model points to extroversion, agreeableness, conscientiousness, openness, neuroticism, honesty/integrity, charisma, intelligence, creativity, achievement motivation, need for power, oral/written communication, interpersonal skills, general problem-solving, and decision making.
Key Terms
- Proximal
-
Located close to a reference point.
- distal
-
Located far from a reference point.
Researchers have debated the traits of a leader for many decades. Early trait theory proposed that merely a few personality traits have the ability to determine the success of a leader. Researchers have since distanced themselves from this idea and theorized that the success of a leader requires more than just a few essential traits. Researchers now attest that while trait theory may still apply, individuals can and do emerge as leaders across a variety of situations and tasks. Research findings show that significant relationships exist between leadership and a number of individual traits, among them intelligence, adjustment, extroversion, conscientiousness, openness to experience, and general self-efficacy.
One prominent researcher in trait theory, Stephen Zaccaro, proposes a number of models that show the interplay of the environmental and personality characteristics that make a good leader. These models rests on two basic premises about leadership traits. First, leadership emerges from the combined influence of multiple traits, as opposed to coming from various independent traits. In other words, Zaccaro argues that effective leadership is derived from an integrated set of cognitive abilities, social capabilities, and personal tendencies, with each set of traits adding to the influence of the other. The second premise suggests that leadership traits differ in their proximal (direct) influence on leadership. In this multistage model, certain distal or remote attributes (such as personal attributes, cognitive abilities, and motives/values) serve as precursors for the development of personal characteristics that more directly shape a leader.
Some of the inherent leadership traits in Zaccaro’s model include extroversion, agreeableness, conscientiousness, openness, neuroticism, honesty/integrity, charisma, intelligence, creativity, achievement motivation, need for power, oral/written communication, interpersonal skills, general problem-solving, decision making, technical knowledge, and management skills. Although these characteristics may resemble a laundry list of traits, Zaccaro and many other researchers have shown that they are all predictors of a successful leader.
9.1.7: Leadership Styles
Leaders may adopt several styles according to what is most appropriate in a given situation.
Learning Objective
Explain how different leadership styles may be adopted according to the demands of a given circumstance
Key Points
- There are five primary leadership styles: engaging, authoritative, laissez-faire, participative, and transformational. All five styles can be effectively used in the appropriate circumstances.
- An engaging style of leadership involves reaching out to employees and understanding their concerns and working situations.
- Under the autocratic leadership style, all decision-making powers are centralized in the leader. Leaders do not entertain any suggestions or initiatives from subordinates.
- A person using a laissez-faire style of leadership does not provide direction, instead leaving the group to fend for itself. Subordinates are given a free hand in deciding their own policies and methods.
- A participative or democratic style of leadership involves the leader’s sharing decision-making authority with group members while also promoting the interests of group members and practicing social equality.
- Transformational leadership motivates and inspires people to change their behaviors in service of a greater good.
Key Term
- laissez-faire
-
French term literally meaning “let [them] do,”; it also broadly implies “let it be,” “let them do as they will,” or “leave it alone.”
Finding the Right Style of Leadership
A leader can take a number of different approaches to leading and managing an organization. A leader’s style of providing direction, setting strategy, and motivating people is the result of his or her personality, values, training, and experience. For example, a leader with a laid-back personality may lead with a less formal style that encourages autonomy and creativity.
Engaging Leadership
Engaging styles of leadership involve reaching out to employees and understanding their concerns and working situations. Dr. Stephen L. Cohen, the senior vice president for Right Management’s Leadership Development Center of Excellence, describes the engaging leadership style as communicating relevant information to employees and involving them in important decisions. This leadership style can help retain employees for the long term.
Autocratic/Authoritarian Leadership
Under the autocratic leadership style, decision-making power is centralized in the leader. Leaders do not entertain any suggestions or initiatives from subordinates. The autocratic management is effective for quick decision making but is generally not successful in fostering employee engagement or maintaining worker satisfaction.
Laissez-faire/Free-Rein Leadership
A person may be in a leadership position without providing clear direction, leaving the group to choose its own path in achieving aims. Subordinates are given a free hand in deciding their own policies and methods. Laissez-faire is most effective when workers have the skills to work independently, are self-motivated, and will be held accountable for results.
Participative or Democratic Leadership
A participative or democratic style of leadership involves the leader’s sharing decision- making authority with group members. This approach values the perspectives and interests of individual group members while also contributing to team cohesion. Participative leadership can help employees feel more invested in decision outcomes and more committed to the choices because they have a say in them.
Transformational Leadership
The transformational leadership style emphasizes motivation and morale to inspire followers to change their behavior in service of a greater good. The concept was initially introduced by James MacGregor Burns. According to Burns, transformational leadership is when “leaders and followers make each other advance to a higher level of morality and motivation.” Researcher Bernard M. Bass used Burns’s ideas to develop his own theory of transformational leadership. Bass clarified the definition to emphasize that transformational leadership is distinguished by the effect it has on followers.
When to Use Different Styles
Different situations call for particular leadership styles. Under intense time constraints, when there is little room to engage in long discussions that seek consensus, a more directive, top-down style may be appropriate. For a highly motivated and cohesive team with a homogeneous level of expertise, a democratic leadership style may be more effective. Similarly, a participative leadership style may be most appropriate for decisions that will require changes in behavior from a large group of people.
Each style of leadership can be effective if matched with the needs of the situation and used by a skilled leader who can adopt a deft approach. The most effective leaders are adept at several styles and able to choose the one most likely to help the organization achieve its objectives.
9.1.8: Four Theories of Leadership
Theories of effective leadership include the trait, contingency, behavioral, and full-range theories.
Learning Objective
Discuss differing theories and approaches to defining and understanding leadership
Key Points
- Modern trait theory proposes that individuals emerge as leaders across a variety of situations and tasks; significant individual leadership traits include intelligence, adjustment, extroversion, conscientiousness, openness to experience, and general self-efficacy.
- Behavioral theory suggests that leadership requires a strong personality with a well-developed positive ego; self-confidence is essential.
- Contingency theory assumes that different situations call for different characteristics, and no single optimal psychological profile of a leader exists.
- According to full-range theory of leadership, four qualities are essential for leaders: individualized consideration, intellectual stimulation, inspirational motivation, and idealized influence.
Key Term
- Contingency
-
Likely to happen in connection with or as a consequence of something else.
For a number of years, researchers have examined leadership to discover how successful leaders are created. Experts have proposed several theories, including the trait, behavioral, contingency, and full-range models of leadership.
The Trait Theory of Leadership
The search for the characteristics or traits of effective leaders has been central to the study of leadership. Underlying this research is the assumption that leadership capabilities are rooted in characteristics possessed by individuals. Research in the field of trait theory has shown significant positive relationships between effective leadership and personality traits such as intelligence, extroversion, conscientiousness, self-efficacy, and openness to experience. These findings also show that individuals emerge as leaders across a variety of situations and tasks.
The Contingency Theory of Leadership
Stogdill and Mann found that while some traits were common across a number of studies, the overall evidence suggested that persons who are leaders in one situation may not necessarily be leaders in other situations. According to this approach, called contingency theory, no single psychological profile or set of enduring traits links directly to effective leadership. Instead, the interaction between those individual traits and the prevailing conditions is what creates effective leadership. In other words, contingency theory proposes that effective leadership is contingent on factors independent of an individual leader. As such, the theory predicts that effective leaders are those whose personal traits match the needs of the situation in which they find themselves. Fiedler’s contingency model of leadership focuses on the interaction of leadership style and the situation (later called situational control). He identified three relevant aspects of the situation: the quality of the leader’s relationships with others, how well structured their tasks were, and the leader’s amount of formal authority.
The Behavioral Theory of Leadership
In response to the early criticisms of the trait approach, theorists began to research leadership as a set of behaviors. They evaluated what successful leaders did, developed a taxonomy of actions, and identified broad patterns that indicated different leadership styles. Behavioral theory also incorporates B.F. Skinner’s theory of behavior modification, which takes into account the effect of reward and punishment on changing behavior. An example of this theory in action is a manager or leader who motivates desired behavior by scolding employees who arrive late to meetings and showing appreciation when they are early or on time.
The Full-Range Theory of Leadership
The full-range theory of leadership is a component of transformational leadership, which enhances motivation and morale by connecting the employee’s sense of identity to a project and the collective identity of the organization. The four major components of the theory, which cover the full range of essential qualities of a good leader, are:
- Individualized consideration: the degree to which the leader attends to each follower’s concerns and needs and acts as a mentor or coach
- Intellectual stimulation: the degree to which the leader challenges assumptions, takes risks, and solicits followers’ ideas
- Inspirational motivation: the degree to which the leader articulates a vision that is appealing and inspiring to followers
- Idealized influence: the degree to which the leader provides a role model for high ethical behavior, instills pride, and gains respect and trust
9.2: Trait Approach
9.2.1: The Trait-Theory Approach
Understanding the importance of different core personality traits can help organizations select leaders.
Learning Objective
Explain the relevance of the trait approach in defining and promoting useful leadership development in the workplace
Key Points
- According to trait leadership theory, certain integrated patterns of personal characteristics nurture consistent leader effectiveness in a group of people.
- Trait leadership tries to identify inherent attributes and acquired abilities that differentiate leaders from non-leaders.
- The traits of effective leaders can be organized into three groups: demographic, task competence, and interpersonal.
- These leadership traits motivate leaders to perform and achieve goals for the organizations they represent.
Key Term
- Trait Leadership
-
Integrated patterns of personal characteristics that nurture the ability to lead a group of people effectively.
According to trait leadership theory, effective leaders have in common a pattern of personal characteristics that support their ability to mobilize others toward a shared vision. These traits include dimensions of personality and motives, sets of skills and capabilities, and behavior in social relationships. Using traits to explain effective leadership considers both characteristics that are inherited and attributes that are learned. This approach has been used to differentiate leaders from non-leaders. Understanding the importance of these traits can help organizations select, train, and develop leaders.
Leaders’ Traits
Following studies of trait leadership, most leader traits can be organized into four groups:
- Personality: Patterns of behavior, such as adaptability and comfort with ambiguity, and dispositional tendencies, such as motives and values, are associated with effective leadership.
- Demographic: In this category, gender has received by far the most attention in terms of leadership; however, most scholars have found that gender is not a determining demographic trait, as male and female leaders are equally effective.
- Task competence: This relates to how individuals approach the execution and performance of tasks. Hoffman groups intelligence, conscientiousness, openness to experience, and emotional stability into this category.
- Interpersonal attributes:These relate to how a leader approaches social interactions. According to Hoffman and others (2011), traits such as extroversion and agreeableness are included in this category.
Proximal vs. Distal Characteristics
Trait leadership also takes into account the distinction between proximal and distal character traits. Proximal characteristics are traits that are malleable and can be developed over time. These include interpersonal skills, problem-solving skills, and communication skills. Distal characteristics are more dispositional; that is, people are born with them. These include traits such as self-confidence, creativity, and charisma. Hoffman and others (2011) found that both types of characteristics are correlated with leader effectiveness, implying that while leaders can be born, they can also be made.
Trait Integration in Effective Leaders
Zaccoro and others (2004) introduced a model of leadership that categorized and specified six types of traits that influence leader effectiveness. The model rests on two basic premises about leadership traits. The first premise states that effective leadership derives not from any one trait, but from an integrated set of cognitive abilities, social capabilities, and dispositional tendencies, with each set of traits adding to the influence of the other. The second premise maintains that the traits differ in how directly they influence leadership. The premise suggests that distal attributes (such as dispositional attributes, cognitive abilities, and motives/values) come first and then lead to the development of proximal characteristics. This model contends the following traits are correlated with strong leadership potential: extroversion, agreeableness, conscientiousness, openness, neuroticism, honesty, charisma, intelligence, creativity, achievement motivation, need for power, communication skills, interpersonal skills, problem-solving skills, decision-making skills, technical knowledge, and management skills.
9.2.2: Honesty in Leadership: Kouzes and Posner
Kouzes and Posner identify five behaviors of effective leadership, with honesty essential to each.
Learning Objective
Assess the theoretical framework devised by Kouzes and Posner in relating leadership and honesty from a business perspective
Key Points
- Leadership is a process of motivating people and mobilizing resources to accomplish a common goal.
- Honesty refers to different aspects of moral character. It indicates positive and virtuous attributes such as integrity, truthfulness, and straightforwardness.
- Honesty is essential to a leader’s legitimacy, credibility, and ability to develop trust with followers.
- Kouzes and Posner identify five behaviors of effective leaders: model the way, inspire vision, enable others, challenge the process, and encourage the heart.
- Effective leaders set strong behavioral examples while expounding upon the company vision to inspire employees to be fulfilled, and honesty is a necessary component of this behavior.
Key Terms
- micromanaging
-
The act of over-supervising or employing too much detail in delegating a task.
- Honesty
-
A facet of moral character that connotes positive and virtuous attributes such as integrity, truthfulness, and straightforwardness, along with the absence of lying, cheating, or theft.
Leadership is the ability to motivate people and mobilize resources to accomplish a common goal. In leadership, honesty is an important virtue, as leaders serve as role models for their subordinates. Honesty refers to different aspects of moral character. It indicates positive and virtuous attributes such as integrity, truthfulness, and straightforwardness. These characteristics create trust, which is critical to leaders in all positions. Honesty also implies the absence of lying, cheating, or theft.
Subordinates have faith in the leaders they follow. A leader who is not honest will lose legitimacy in the eyes of followers. Integrity and openness are essential to developing trust, and without honesty a leader cannot gain and maintain the trust needed to build commitment to a shared vision.
Leadership experts Jim Kouzes and Barry Posner find honesty to be the most important trait of effective leaders. In its absence, leaders lack credibility, and their ability to influence others is diminished. Honesty also brings a degree of transparency to a leader’s interaction with others.
For Kouzes and Posner, honesty is a critical element of the five behaviors of effective leaders.
- Model the way: Leaders must clarify their values and set an example for their employees to imitate, underscoring the importance of modeling positive characteristics such as honesty.
- Inspire vision: The vision is the emotional element of a company’s mission statement, and this vision must be communicated honestly and with passion. Promoting the company’s vision allows leaders to inspire employees.
- Enable others to act: Leaders often make the critical mistake of micromanaging, as opposed to trusting others to do their job. Trust stems from honesty, and creating an honest environment allows other employees more personal autonomy.
- Challenge the process: Leaders need to be attentive to how things are done, not just what gets done, and they must be willing to address areas that require change. These practices are essential for continuous improvement, progress toward goals, and innovation.
- Encourage the heart: Leaders must nurture the emotional dimension of their relationships with followers. Showing appreciation, creating a supportive environment, and fostering community sentiment helps build commitment to the leader’s vision.
In summary, leaders are tasked with balancing the organizational strategies of management with the social elements of leading. This requires leaders to be in tune with their employees’ emotions and concerns in a meaningful and honest way. Effective leaders set strong behavioral examples while communicating their vision to inspire employees. The need for honesty is woven throughout the primary activities of effective leaders.
9.2.3: Leadership and Gender
Studies on the role of gender in leadership success show mixed results.
Learning Objective
Discuss the relationship between gender and leadership behavior
Key Points
- Research on leadership differences between men and women shows conflicting results. Some research states that women have a different style of leadership than men, while other studies reveal no major differences in leadership behaviors between the genders.
- Areas of study have included perceptions of leadership, leadership styles, leadership practices, and leadership effectiveness.
- Some studies have found women leaders tend to demonstrate more communication, cooperation, affiliation, and nurturing than men in leadership.
- Male leaders have been shown to be be more goal- and task-oriented and less relationship- and process-focused than women.
Key Terms
- leadership
-
The capacity of someone to lead.
- gender
-
The sociocultural phenomenon of the division of people into categories of male and female, each having associated clothing, roles, stereotypes, etc.
In many areas of society, men have long dominated leadership positions. This dominance was especially apparent in business, where female members of boards of directors and corporate executives had been scarce. Over the past three decades, however, women have entered more leadership positions throughout industry. The trend has provided an opportunity to examine differences in how men and women perform in the role of leaders.
Gender Differences in Leadership
Research reveals small but significant differences in the way men and women are perceived in leadership roles, their effectiveness in such positions, and their leadership styles. Studies conducted in the 1980s and early 1990s found that women adopt participative styles of leadership and were more often transformational leaders than men, who more commonly adopted directive, transactional styles. Women in management positions tend to demonstrate the importance of communication, cooperation, affiliation, and nurturing more than do men in the same positions. The studies also showed men as more goal- and task-oriented and less relationship- and process-focused than women.
Conflicting Studies
Nonetheless, studies demonstrating distinct leadership styles between men and woman do not represent the final word. Other research has found limited evidence for significant differences between the behaviors of male and female leaders. In 2011, Anderson and Hanson found differences in decision-making styles, but none linked directly to differences in leadership effectiveness. They found no distinction in types or degree of motivation or in leadership styles overall. Other studies show similar results, challenging the notion that leaders’ sex shapes their performance as a leader. Management guru Rosabeth Moss Kanter studied men and women in a large corporation and found that differences in their behavior resulted not from gender but from organizational factors. In Kanter’s study, men and women, given the same degree of power and opportunity, behaved in similar ways.
9.2.4: The GLOBE Project
The GLOBE Research Project is an international group of social scientists and management scholars who study cross-cultural leadership.
Learning Objective
Outline the nine cultural competences found by the GLOBE project using the six GLOBE dimensions and describe how the project pertains to leadership
Key Points
- GLOBE (Global Leadership and Organizational Behavior Effectiveness Research Project) is an international group of social scientists and management scholars who study cross-cultural leadership.
- This international team collected data from 17,300 middle managers in 951 organizations and grouped 62 countries into ten geographic clusters.
- The research identified nine cultural competencies that distinguish approaches to leadership.
- The research also identified six global dimensions by which to compare and contrast leadership behaviors.
Key Term
- GLOBE project
-
Global Leadership and Organizational Behavior Effectiveness study; refers to research into aspects of cross-cultural leadership behavior.
Under the Global Leadership and Organizational Behavior Effectiveness (GLOBE) Research Project, an international group of social scientists and management scholars studied cross-cultural leadership. In 1993, Robert J. House founded the project at the University of Pennsylvania. The project looked at 62 societies with different cultures, which were studied by researchers working in their home countries. This international team collected data from 17,300 middle managers in 951 organizations. They used qualitative methods to assist their development of quantitative instruments. The research identified nine cultural competencies and grouped the 62 countries into ten geographic clusters, including Latin American, Nordic European, Sub-Saharan, and Confucian Asian.
Bases for Leadership Comparisons
The GLOBE project identified nine cultural dimensions, called competencies, with which the leadership approaches within geographic clusters can be compared and contrasted:
- Performance orientation refers to the extent to which an organization or society encourages and rewards group members for performance improvement and excellence.
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Assertiveness orientation is the degree to which individuals in organizations or societies are assertive, confrontational, and aggressive in social relationships.
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Future orientation is the degree to which individuals in organizations or societies engage in future-oriented behaviors such as planning, investing in the future, and delaying gratification.
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Human orientation is the degree to which individuals in organizations or societies encourage and reward individuals for being fair, altruistic, friendly, generous, caring, and kind to others.
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Collectivism I (institutional collectivism) is the degree to which organizational and societal institutional practices encourage and reward collective distribution of resources and collective action.
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Collectivism II (in-group collectivism) is the degree to which individuals express pride, loyalty, and cohesiveness in their organizations or families.
- Gender egalitarianism is the extent to which an organization or a society minimizes gender role differences and gender discrimination.
- Power distance is the degree to which members of an organization or society expect and agree that power should be unequally shared.
- Uncertainty avoidance is the extent to which members of an organization or society strive to avoid uncertainty by reliance on social norms, rituals, and bureaucratic practices to alleviate the unpredictability of future events.
GLOBE Leadership Dimensions
Following extensive review of the research, GLOBE participants grouped leadership characteristics into six dimensions. Researchers then made recommendations about how dimensions of culture and leadership could distinguish behavior in one country or culture from another.
Known as the six GLOBE dimensions of culturally endorsed implicit leadership, these leadership dimensions include:
- Charismatic or value-based: Characterized by integrity and decisiveness; performance-oriented by appearing visionary, inspirational, and self-sacrificing; can also be toxic and allow for autocratic commanding.
- Team-oriented: Characterized by diplomacy, administrative competence, team collaboration, and integration.
- Self-protective: Characterized by self-centeredness, face-saving, and procedural behavior capable of inducing conflict when necessary, while being conscious of status.
- Participative: Characterized by non-autocratic behavior that encourages involvement and engagement and that is supportive of those who are being led.
- Human orientation: Characterized by modesty and compassion for others in an altruistic fashion.
- Autonomous: Characterized by ability to function without constant consultation.
9.3: Behavioral Approach
9.3.1: Leadership Model: University of Michigan
The Michigan behavioral studies are an important link in the ongoing development of behavioral theory in a leadership framework.
Learning Objective
Discuss the Michigan Leadership Studies generated in the 1950s and 1960s in the broader context of behavioral approaches to leadership
Key Points
- The Michigan Leadership Studies of the 1950s and 1960s researched behavioral approaches and identification of leader relationships and group processes.
- The Michigan Leadership Studies classified leaders as either “employee-centered” or “job-centered”.
- These studies identified three critical characteristics of effective leaders: task-oriented behavior, relationship-oriented behavior, and participative leadership.
Key Term
- theory
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A coherent statement or set of ideas that explains observations or phenomena or that sets out the laws and principles of something known or observed; a hypothesis confirmed by observation, experiment.
The recognition of leaders and the development of leadership theory have evolved over centuries. Individual ideas, actions, and behaviors have been identified as indicating leadership within societal structures. This theoretical evolution has progressed over time, from identifying individual personalities or characteristics to formal studies related to what constitutes leadership and why leadership is or is not successful. Some of these studies and observations have been informal, while others have included empirical research and data.
Studies of individual leadership styles and behaviors continue to contribute to understanding what it takes to be an effective leader, one who is attuned to the needs of an organization and those it serves. Much of the evolution in the study of leadership behavior has become more connected not only to people within an organization, but also extended to those outside the organization. This extension acknowledges that an understanding of the values, beliefs, and norms of those shaping the organization have a definite effect on the evolution and growth of the organization as a whole, as well as its ultimate impact on the community and people it serves.
A Brief History of Leadership Research
Rost (1991) writes that in the 20th century, over 200 definitions for leadership were proposed. Leadership research continues as scholars observe, identify, and promote the emergence of new leadership styles and behaviors in the 21st century. A multitude of approaches have been used to identify and explain the complex factors that shape leadership and how it is practiced. These approaches include quantitative methods such as surveys, questionnaires, and diagnostic tests, as well as qualitative observational and ethnographic studies. These theories evaluate the relationship of the leader to organizational members and examine styles of leadership, adding to the general knowledge of leader behavior and effectiveness.
Michigan Leadership Studies in the 1950s and 1960s
As a leading center of social science research, the University of Michigan has produced some of the most important studies of leadership. Studies dating back to the 1950s identified two broad leadership styles: an employee orientation and a production orientation. The studies also identified three critical characteristics of effective leaders: task-oriented behavior, relationship-oriented behavior, and participative leadership. The studies concluded that an employee orientation rather than a production orientation, coupled with general instead of close supervision, led to better results. The Michigan leadership studies, along with the Ohio State University studies that took place in the 1940s, are two of the best-known behavioral leadership studies and continue to be cited to this day.
9.3.2: Leadership Model: The Ohio State University
The Ohio State University Leadership Study focused on identifying behaviors (as opposed to traits) that were indicative of a strong leader.
Learning Objective
Distill the key people-oriented and task-oriented behaviors of effective leaders
Key Points
- The core characteristics, behaviors, situations and traits that define good leaders area constant sources of study, analysis, and debate.
- Traditionally, leadership was defined from a trait-oriented perspective. In other words, certain characteristics were identified at the individual level to determine good leaders.
- The Ohio State University Leadership Study underscores two different behavioral views on leadership: people-oriented (consideration) and task-oriented (initiating structure).
Key Term
- delegation
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The act of assigning tasks to other members of the team.
Overview of Leadership
Leadership is a field of study (and core ability) that focuses on the ability of an individual or group to “lead” or guide other teams, people, or even entire organizations. The evolution of the field of leadership is quite extensive, ranging from the following perspectives:
- Trait theories
- Attribute patterns
- Behavioral and style theories
- Situational and contingency theories
- Functional theories
- Integrated psychological theories
- Transactional and transformative theories
- Leader-member exchange theories
- Emotional intelligence
Each of these schools of thought are facets of what modern leadership theories try to take into account today, as varying perspectives on leadership are useful to take into consideration the complex, global world of organizations.
Early Leadership Research
Early methods of research theory centered around trait theories. The basic premise was that certain characteristics of individuals were the ideal indicator of success in a leadership role. In other words, for example, extroverted individuals with a highly developed sense of empathy, confidence, and decisiveness would make good leaders. As you may already be thinking, this perspective on leadership is somewhat limiting, as there are various external factors and situational considerations one should consider when determining if a given individual is a strong fit for leading a specific initiative or organization.
The Ohio State University Leadership Study
While the concept of identifying good leaders based upon individual characteristics had some merit (which has been identified in later research), the Ohio State Leadership study was more interested in which specific behaviors effective leaders executed (compared to ineffective leaders). This consideration and initiating structure of behavior yielded a number of interesting results.
Method
A survey with 150 statements (narrowed down from nearly 2000 potential statements), which was titled the Leadership Behavior Description Questionnaire, was delivered to leaders to identify what types of behaviors were most effective in leading. Nine specific behaviors were identified and measured.
Conclusions
The results of this questionnaire identified two different groupings of four behaviors within the subtopics of consideration and initiating structure.
Consideration
Consideration is the extent to which a leader exhibits concern for the welfare of the members of the group.
With a focus on interpersonal relationships, mutual trust and friendship, the consideration leadership style is people-oriented. This focuses primarily on:
- Being friendly and approachable
- Maintaining equality between leaders, team members, and stakeholders
- Ensuring the personal welfare of group members
- Being accessible to group members
Initiating Structure
The second behavioral element the study identified revolves around roles, objectives, activities, planning, and delegation. Unlike the people-oriented style above, this is a task-oriented perspective that focuses on behaviors such as:
- Setting individual expectations
- Maintaining performance standards
- Scheduling and planning tasks
- Ensuring the group maintains organizational expectations
9.4: Contingency Approach
9.4.1: Leadership and Situational Context: Fiedler
The Fiedler model shows that effective leadership depends on how a leader’s traits and the surrounding context interact.
Learning Objective
Assess the value and efficacy of Fred Fiedler’s leadership model
Key Points
- Situational contingency attests that different circumstances require different leadership traits.
- The Fieldler model uses the Least Preferred Co-worker (LPC) test to measure leadership traits.
- A favorable situation for a leader has three components: good relations between the leader and follower, a highly structured task, and a powerful leadership position.
Key Terms
- Situational Contingency
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The theory that different leaders and leadership traits are required for different situations.
- Favorable Situation
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Leadership contexts with good leader-member relations, high task structure, and high leader-position power.
Fred Fiedler’s model of leadership states that different types of leaders are required for different situations. This situational contingency understanding of leaderships suggests, for instance, that a leader in a strict, task-oriented workplace would have different qualities than a leader in a more open, idea-driven workplace. Fiedler subsequently enhanced his original model to increase the number of leadership traits it analyzed. This later theory, known as Cognitive Resource Theory (CRT), identifies the conditions under which leaders and group members will use their intellectual resources, skills, and knowledge effectively.
Least Preferred Co-Worker (LPC) Test
The Fiedler situational contingency model measures leadership traits with a test that provides a leadership score corresponding to the workplace where the leader would be most suited. The Least Preferred Co-worker (LPC) test asks test takers to think of someone they least prefer working with and rate that person from one to eight on a scale of various traits. For example, the taker is asked to rate the co-worker from Unfriendly (1) to Friendly (8), or Guarded (1) to Open (8). The ratings are then averaged. Generally, a higher LPC score means the person being rated is more oriented to human relations, while a lower score means the person is more oriented to tasks.
The LPC test is not actually about the co-worker; it is a profile of the test taker. Test subjects who are more oriented to human relations generally rate their least preferred co-workers higher, and the opposite is true for task-oriented test takers. The LPC test reveals how respondents react to those that with whom they do not like working, and thereby reveals leadership contexts best suited to the test takers’ personality.
Situational Context
The Fiedler model also analyzes the situation in which the leader functions. The situation analysis has three components:
- Leader-member relations – the amount of respect, trust, and confidence between leaders and their followers
- Task structure – the degree to which group tasks, roles, and processes are specified and formalized
- Leader position power – the amount of formal authority leaders have based on their role within the group
When good leader-member relations, a highly structured task, and high leader-position power are in place, the situation is considered a “favorable situation.” Fiedler found that low-LPC leaders are more effective in extremely favorable or unfavorable situations, whereas high-LPC leaders perform best in situations with intermediate favorability. Leaders in high positions of power have the ability to distribute resources among their members, meaning they can reward and punish their followers. Leaders with low position power cannot control resources to the same extent as leaders with high position power, and so lack the same degree of situational control. For example, the CEO of a business has high position power, because she is able to increase and reduce the salary that her employees receive. On the other hand, an office worker in this same business has low position power, because although he may be the leader on a new business deal, he cannot control the situation by rewarding or disciplining colleagues with salary changes.
Criticism of the Fielder Model
Fiedler’s contingency theory has drawn criticism because it implies that the only option for a mismatch of leader orientation and unfavorable situation is to change the leader. Some have disputed the model’s validity by questioning how accurately it reflects a leader’s personality traits. Also, the contingency model does not take into account the percentage of situations that might be somewhat favorable, completely unfavorable, or even extremely favorable. For this reason, critics of the model suggest that it does not provide a complete comparison between low-LPC leaders and high-LPC leaders.
9.4.2: Leadership and Followers: Hersey and Blanchard
Hersey and Blanchard’s model defines effective leadership based on leadership style and maturity of follower(s).
Learning Objective
Compare and contrast leadership style characteristics with the follower maturity concepts as defined by Hersey and Blanchard
Key Points
- The ideal leadership style varies based on what is required of a group and that group’s level of development. The Hersey and Blanchard model measures this by categorizing leadership style and group (follower) maturity.
- Leadership styles are a mix of task behavior and relationship behavior. There are four combinations of high and low task and relationship behaviors that imply different leadership roles.
- Group maturity describes how confident group members are in the group’s ability to complete its tasks.
Key Terms
- Relationship Behavior
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The style of leadership that is concerned with guiding how people interact, instead of the mechanics of how they complete the task.
- Situational Leadership
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The theory that different leadership styles are required for different contexts.
- Task Behavior
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The style of leadership that is concerned with instructing followers what actions to take.
Paul Hersey and Ken Blanchard introduced their theory of situational leadership in the 1969 book Management of Organizational Behavior. Situational leadership states that there is no single, ideal approach to leadership because different types of leadership are required in different contexts. The Hersey and Blanchard model explains effective leadership in terms of two variables: leadership style and the maturity of the follower(s).
Task Behavior and Relationship Behavior
For Hersey and Blanchard, leadership style is determined by the mix of task behavior and relationship behavior that the leader shows. Task behavior concerns the actions required of followers and how they should be conducted. Relationship behavior concerns how people interact together to achieve a goal. The various combinations of high and low task and relationship behaviors suggest four leadership roles:
- S1 – Telling: The leader’s role is to direct the actions of the followers. The leader instructs the followers on how, what, where, and when to do a certain task. This is primarily task behavior.
- S2 – Selling: The leader is still primarily concerned with directing action but now accepts communication from followers. This communication allows the followers to feel connected to the task and buy into the mission. S2 leading is still primarily task behavior, but now it includes some relationship behavior.
- S3 – Participating: This role is similar to S2, except now the leader welcomes shared decision-making. Participating leadership shifts the balance toward relationship behavior and away from task behavior.
- S4 – Delegating: The leader simply ensures that progress is being made. Decisions involve a lot of input from the followers, and the process and responsibility now lie with followers. S4 is primarily relationship behavior.
Maturity
The other fundamental concept in the Hersey and Blanchard model is maturity of the group. Group maturity describes how confident group members are in the group’s ability to complete its tasks. This concept, too, is broken into four categories:
- M1: The group does not have the skills to do the job, and is unwilling or unable to take responsibility. This is a very low maturity level.
- M2: The group is willing to work on the job but not yet able to accept responsibility. Imagine a group of volunteers working on a house for Habitat for Humanity: the volunteers are willing to perform the work, but probably not capable of building a house on their own.
- M3: The group has experience but is not confident enough or willing to take responsibility. The main difference between M2 and M3 is that the M3 group has the skills to work effectively on the job.
- M4: The group is willing and able to work on the job. Group members have all of the skills, confidence, and enthusiasm necessary to take ownership of the task. This is a very high level of maturity.
Because maturity level varies based on the group and the task (for example, professional football players are an M4 group on the football field, but an M1 group if asked to play baseball), the leadership style must adapt based on the situation.
Effective leadership varies not only with the person or group that is being influenced but also depending on the task, job, or function that needs to be accomplished. The Hersey and Blanchard model encourages leaders to be flexible and find the right style for the task and the group maturity level. The most successful leaders are those who adapt their leadership style to the maturity of the group they are attempting to lead or influence and to that group’s purpose.
9.4.3: Leadership and Task/Follower Characteristics: House
The Path-Goal theory argues that a leader’s role is to help followers achieve both personal and organizational goals.
Learning Objective
Identify the leadership and task/follower characteristics identified by Robert House in the Path-Goal theory (1971)
Key Points
- In the Path-Goal model as defined by House, the role of the leader is to help followers define personal goals, understand organizational goals, and find a path to reach both.
- House defined four leadership styles: directive, achievement-oriented, participative, and supportive.
- Outstanding Leadership Theory is an extension of the Path-Goal model that adds leadership behaviors required to channel follower motivations and goals toward the leader’s vision.
Key Terms
- Outstanding Leadership Theory
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A model that defines ten traits that exceptional leaders possess; an expansion of the Path-Goal model.
- Path-Goal theory
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A leadership model outlining the role of the leader as helping followers define personal and organizational goals and find a path to reach those goals.
In 1971, Robert House introduced his version of a contingent theory of leadership known as the Path-Goal theory. According to House’s theory, leaders’ behavior is contingent upon the satisfaction, motivation, and performance of their subordinates. House argued that the goal of the leader is to help followers identify their personal goals as well understand the organization’s goals and find the path that will best help them achieve both. Because individual motivations and goals differ, leaders must modify their approach to fit the situation.
Leadership Styles
House defined four different leadership styles and noted that good leaders switch fluidly between them as the situation demands. He believed that leadership styles do not define types of leaders as much as they do types of behaviors. House’s leadership styles include:
- Directive, path-goal clarifying leader: The leader clearly defines what is expected of followers and tells them how to perform their tasks. The theory argues that this behavior has the most positive effect when the subordinates’ role and task demands are ambiguous and intrinsically satisfying.
- Achievement-oriented leader: The leader sets challenging goals for followers, expects them to perform at their highest level, and shows confidence in their ability to meet this expectation. Occupations in which the achievement motive was most predominant were technical jobs, salespersons, scientists, engineers, and entrepreneurs.
- Participative leader: The leader seeks to collaborate with followers and involve them in the decision-making process. This behavior is dominant when subordinates are highly personally involved in their work.
- Supportive leader: The main role of the leader is to be responsive to the emotional and psychological needs of followers. This behavior is especially needed in situations in which tasks or relationships are psychologically or physically distressing.
The Path-Goal model emphasizes the importance of the leader’s ability to interpret follower’s needs accurately and to respond flexibly to the requirements of a situation.
Outstanding Leadership Theory (OLT)
In 1994, House published Organizational Behavior: The State of the Science with Philip Podsakoff. House and Podsakoff attempted to summarize the behaviors and approaches of “outstanding leaders” that they obtained from some more modern theories and research findings. Using the Path-Goal model as a framework, their Outstanding Leadership Theory (OLT) expanded the list of leadership behaviors required to channel follower’s motivations and goals more effectively toward the leader’s vision:
- Vision: Leaders are able to communicate a vision that meshes with the values of their followers.
- Passion and self-sacrifice: Leaders believe fully in their vision and are willing to make sacrifices in order to achieve it.
- Confidence, determination, and persistence: Leaders are confident their vision is correct and take whatever action is necessary to reach it.
- Image-building: Leaders are cognizant of how they are perceived by their followers. They strive to ensure followers view them in a positive light.
- Role-modeling: Leaders seek to model qualities such as credibility and trustworthiness that their followers would seek to emulate.
- External representation: Leaders are spokespersons for their organizations (for example, Steve Jobs).
- Expectations of and confidence in followers: Leaders trust that their followers can succeed and expect them to do so.
- Selective motive-arousal: Leaders are able to hone in on specific motives in followers and use them to push their followers to reach a goal.
- Frame alignment: Leaders align certain interests, values, actions, etc. between leadership and followers to inspire positive action.
- Inspirational communication: Leaders are able to inspire followers to act using verbal and non-verbal communication.
9.4.4: Leadership and Decision Making: The Vroom-Yetton-Jago Model
The Vroom-Yetton-Jago model is a leadership theory of how to make group decisions.
Learning Objective
Apply the Vroom-Jago decision-tree model to guide leaders in a decision-making situation
Key Points
- Different tasks and situations require leaders to make different types of decisions.
- There are five different approaches to making group decisions according to the degree and type of follower participation.
- The Vroom-Yetton-Jago model employs a decision tree for determining the right mode of decision making under different conditions.
Key Terms
- Contingency Approach
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A school of thought on leadership that proposes that there is no single ideal leader or leadership style. Also known as situational leadership.
- decision tree
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A visualization of a complex decision-making situation in which the possible choices and their likely outcomes are organized in the form of a graph.
- autocratic
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Conducted alone and with sole responsibility.
The Vroom-Yetton-Jago model is a contingency approach to group decision making that is designed specifically to help leaders select the best approach to making decisions. The model identifies different ways a decision can be made by considering the degree of follower participation. It proposes a method for leaders to select the right approach to making a decision in a given set of circumstances.
Decision Types
The Vroom-Yetton-Jago model defines five different decision approaches that a leader can use. In order of participation from least to most, these are:
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AI – Autocratic Type 1: Decisions are made completely by the leader. Leaders make the decision on their own with whatever information is available.
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AII – Autocratic Type 2: The decision is still made by the leader alone, but the leader collects information from the followers. Followers play no other role in the decision-making process.
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CI – Consultative Type 1: The leader seeks input from select followers individually based on their relevant knowledge. Followers do not meet each other, and the leader’s decision may or may not reflect followers’ influence.
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CII – Consultative Type 2: Similar to CI, except the leader shares the problem with relevant followers as a group and seeks their ideas and suggestions. The followers are involved in the decision, but the leader still makes the decision.
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GII – Group-based Type 2: The entire group works through the problem with the leader. A decision is made by the followers in collaboration with the leader. In a GII decision, leaders are not at liberty to make a decision on their own.
Decision Trees
The Vroom-Yetton-Jago model also provides guidance for leaders trying to determine which approach to decision making to use (AI through GII). The model uses a decision-tree technique to diagnose aspects of the situation methodically. This technique involves answering a series of yes or no questions and following the yes path to the recommended type of decision-making approach.
- Is there a quality requirement? Is the nature of the solution critical? Are there technical or rational grounds for selecting among possible solutions?
- Do I have sufficient information to make a high-quality decision?
- Is the problem structured? Are the alternative courses of action and methods for their evaluation known?
- Is acceptance of the decision by subordinates critical to its implementation?
- If I were to make the decision by myself, is it reasonably certain that it would be accepted by my subordinates?
- Do my subordinates share the organizational goals to be met by solving this problem?
- Is conflict among subordinates likely in obtaining the preferred solution?
By answering the questions honestly, the decision tree provides the leader with the preferred decision style for the given situation.
9.5: Types of Leaders
9.5.1: Transactional Versus Transformational Leaders
Transactional leaders are concerned about the status quo, while transformational leaders are more change-oriented.
Learning Objective
Differentiate between transactional leaders and transformational leaders in a full-range approach, particularly from a behavioral perspective
Key Points
- Transactional leadership works within set established goals and organizational boundaries, while a transformational approach challenges the status quo and is more future-oriented.
- Transactional leadership emphasizes organization, performance evaluation and rewards, and is task- and outcome-oriented.
- Transformational leadership focuses on motivating and engaging followers with a vision of the future.
Key Term
- Buy-in
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In management and decision making, the commitment of interested or affected parties (often called stakeholders) to agree to support a decision, often by having been involved in its formulation.
Leadership can be described as transactional or transformational. Transactional leaders focuses on the role of supervision, organization, and group performance. They are concerned about the status quo and day-to-day progress toward goals. Transformational leaders work to enhance the motivation and engagement of followers by directing their behavior toward a shared vision. While transactional leadership operates within existing boundaries of processes, structures, and goals, transformational leadership challenges the current state and is change-oriented.
Transactional Leadership
Transactional leadership promotes compliance with existing organizational goals and performance expectations through supervision and the use of rewards and punishments. Transactional leaders are task- and outcome-oriented. Especially effective under strict time and resource constraints and in highly-specified projects, this approach adheres to the status quo and employs a form of management that pays close attention to how employees perform their tasks.
Transformational Leadership
Transformational leadership focuses on increasing employee motivation and engagement and attempts to link employees’ sense of self with organizational values. This leadership style emphasizes leading by example, so followers can identify with the leader’s vision and values. A transformational approach focuses on individual strengths and weaknesses of employees and on enhancing their capabilities and their commitment to organizational goals, often by seeking their buy-in for decisions.
Comparing Leadership Types
Transactional and transformational leadership exhibit five key differences:
- Transactional leadership reacts to problems as they arise, whereas transformational leadership is more likely to address issues before they become problematic.
- Transactional leaders work within existing an organizational culture, while transformational leaders emphasize new ideas and thereby “transform” organizational culture.
- Transactional leaders reward and punish in traditional ways according to organizational standards; transformational leaders attempt to achieve positive results from employees by keeping them invested in projects, leading to an internal, high-order reward system.
- Transactional leaders appeal to the self-interest of employees who seek out rewards for themselves, in contrast to transformational leaders, who appeal to group interests and notions of organizational success.
- Transactional leadership is more akin to the common notions of management, whereas transformational leadership adheres more closely to what is colloquially referred to as leadership.
9.5.2: Key Behaviors of Transactional Leaders
Transactional leaders focus on performance, promote success with rewards and punishments, and maintain compliance with organizational norms.
Learning Objective
Identify the different behaviors attributed to transactional leaders and how they can motivate an organization
Key Points
- Transactional leaders focus on managing and supervising their employees and on group performance. They monitor their employees’ work carefully to assess any deviation from expected standards.
- Transactional leaders promote success by doling out both rewards and punishments contingent on performance.
- Transactional leaders work within existing organizational structures and shape their work according to the current organizational culture.
Key Term
- Maslow’s Hierarchy of Needs
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A psychological theory, proposed by Abraham Maslow in the 1943 paper “A Theory of Human Motivation,” which depicts lower- and higher-level human needs in the form of a pyramid.
Transactional leaders focus on managing and supervising their employees and on facilitating group performance. The role of a transactional leader is primarily passive, in that it sets policy and assessment criteria and then intervenes only in the event of performance problems or needs for exceptions. Transactional leaders seek to maintain compliance within existing goals and expectations and the current organizational culture. They are extrinsic motivators who encourage success through the use of rewards and punishment.
Transactional leaders are expected to do the following:
- Set goals and provide explicit guidance regarding what they expect from organizational members and how they will be rewarded for their efforts and commitment
- Provide constructive feedback on performance
- Focus on increasing the efficiency of established routines and procedures and show concern for following existing rules rather than making changes
- Establish and standardize practices that will help the organization become efficient and productive
- Respond to deviations from expected outcomes and identify corrective actions to improve performance
Psychologist Abraham Maslow characterized people’s motivating factors in terms of needs. Maslow’s Hierarchy of Needs describes levels of needs ranging from the most essential, such as physiological (e.g., food and sleep) and safety, to higher levels of esteem and self-actualization. Transactional leadership satisfies lower-level needs but addresses those at a high level only to a limited degree. As such, transactional leaders’ behavior appeals to only a portion of followers’ motivating factors.
Transactional leadership can be very effective in the right settings. Coaches of sports teams are a good example of appropriate transactional leadership. The rules for a sports team allow for little flexibility, and adherence to organizational norms is key; even so, effective coaches can motivate their team members to play and win, even at risk to themselves.
9.5.3: Key Behaviors of Transformational Leaders
Transformational leaders exhibit individualized consideration, intellectual stimulation, inspirational motivation, and idealized influence.
Learning Objective
Explain the varying approaches and behaviors that define transformational leadership
Key Points
- Transformational leaders show individualized consideration to followers by paying attention to and meeting the needs of followers.
- Transformational leaders stimulate ideas and creativity from followers by creating a safe environment to challenge the status quo.
- Transformational leaders have a vision that inspires and motivates followers to achieve important goals.
- Transformational leaders serve as role models for their followers, allow them to identify with a shared organizational vision, and provide a sense of meaning and achievement.
Key Term
- Transformational Leadership
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An approach to leading that enhances the motivation, morale, and performance of followers through a variety of mechanisms.
Transformational leaders challenge followers with an attractive vision and tie that vision to a strategy for its achievement. They engage and motivate followers to identify with the organization’s goals and values. Transformational leadership comprises four types of behavior:
- Individualized consideration or compassionate leadership
- Intellectual stimulation
- Inspirational motivation
- Idealized influence or charismatic leadership
Individualized Consideration
Individualized consideration is the degree to which the leader attends to each follower’s needs, acts as a mentor or coach to the follower, and listens to the follower’s concerns. This behavior can include the following actions:
- Discussing and empathizing with the needs of individual employees
- Making interpersonal connections with employees
- Showing genuine compassion
- Encouraging ongoing professional development and personal growth of employees
Intellectual Stimulation
Transformational leaders encourage followers to be innovative and creative. Intellectual stimulation springs from leaders who establish safe conditions for experimentation and sharing ideas. They tackle old problems in a novel fashion and inspire employees to think about their conventional methods critically and share new ideas. This type of behavior includes:
- Encouraging employees’ creativity
- Challenging the status quo
- Aiming for consistent innovation
- Empowering employees to disagree with leadership
- Risk-taking when appropriate to achieve goals
Inspirational Motivation
Leaders with an inspiring vision challenge followers to leave their comfort zones, communicate optimism about future goals, and provide meaning for the task at hand. Purpose and meaning provide the energy that drives a group forward. The visionary aspects of leadership are supported by communication skills that make the vision understandable, precise, powerful, and engaging. Followers are willing to invest more effort in their tasks; they are encouraged and optimistic about the future and believe in their abilities. Behaviors that demonstrate inspirational motivation include:
- Inspiring employees to improve their outcomes
- Explaining how the organization will change over time
- Fostering a strong sense of purpose among employees
- Linking individual employee and organizational goals
- Aiding employees to succeed to an even greater extent than they expect
Idealized Influence
Transformational leaders act as role models for their followers. Transformational leaders must embody the values that the followers should be learning and internalizing. The foundation of transformational leadership is the promotion of consistent vision and values. Transformational leaders guide followers by providing them with a sense of meaning and challenge. They foster the spirit of teamwork and commitment in the following ways:
- Promoting a broad, inclusive vision
- Leading by example
- Showing strong commitment to goals
- Creating trust and confidence in employees
- Representing organizational goals, culture, and mission
9.5.4: A Blended Approach to Leadership
The full-range leadership theory blends the features of transactional and transformational leadership into one comprehensive approach.
Learning Objective
Assess the intrinsic value of blending transactional leadership behaviors with transformational leadership behaviors
Key Points
- Transactional and transformational leadership are not mutually exclusive, and leaders often demonstrate traits associated with both approaches.
- The Multifactor Leadership Questionnaire is used in diagnosing leadership styles and for developing leadership.
- Leaders use elements of transformational and transactional leadership as the situation calls for them.
Key Terms
- Transactional Leadership
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A theory of leading that focuses on the role of supervision, organization, and group performance; leader promotes compliance through rewards and punishments. Also known as managerial leadership.
- Transformational Leadership
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A theory of leading that enhances the motivation, morale, and performance of followers through a variety of mechanisms.
The full-range theory of leadership seeks to blend the best aspects of transactional and transformational leadership into one comprehensive approach. Transactional leadership focuses on exchanges between leaders and followers. Transformational leadership deals with how leaders help followers go beyond individual interests to pursue a shared vision. These two approaches are neither mutually exclusive, nor do leaders necessarily exhibit only one or the other set of behaviors. Depending on the objectives and the situation, a leader may move from using one approach to the other as needed.
Management researcher Bernard Bass developed the Multifactor Leadership Questionnaire (MLQ), consisting of 36 items that reflect the leadership aspects associated with both approaches. The MLQ also includes several characteristics of a more passive leadership approach known as laissez-faire. Respondents are asked to think about a leader they work with and to rate how frequently the individual exhibits the leadership behaviors. The MLQ is used to help leaders discover how their followers perceive their behaviors, so they can develop their leadership abilities. The questionnaire is most effective with eight to twelve respondents, as this feedback gives leaders a broad set of perspectives from the people who interact with them.
9.6: Other Leadership Perspectives
9.6.1: Emotional Leadership
Emotional leadership is a process that leaders use to influence their followers to pursue a common goal.
Key Points
- As leadership is all about influencing people to achieve a common goal, an “emotional” approach can be a very important step of the process.
- Leaders in a positive mood can affect their group in a positive way, and vice versa. Charismatic leaders can transmit their emotions and thereby influence followers through the mechanism of “emotional contagion”.
- Group affective tone refers to mood at the group level of analysis. Groups with leaders in a positive mood have a more positive affective tone than groups with leaders in a negative mood. Group processes like coordination, effort expenditure, and task strategy also affect followers.
- Public expressions of mood influence how group members think and act relative to other group members. Group members respond to those signals cognitively and behaviorally in ways that are reflected in the group processes.
- Strong emotional leadership depends on having high levels of emotional intelligence (EI).
Key Terms
- Emotional Leadership
-
Emotional leadership is a process that leaders use to influence their followers in a common goal.
- emotional intelligence
-
the ability, capacity, or skill to perceive, assess, and manage the emotions of oneself, of others, and of groups
Leadership is a process of motivating people and mobilizing resources to accomplish common goals. Leaders direct the path to achieve the goal and lead the group to accomplish objectives along the way. The leader may or may not have formal authority. According to the trait theory of leadership, some traits play a vital role in creating leaders, such as intelligence, adjustment, extroversion, conscientiousness, openness to experience, and general self-efficacy. One key aspect of contemporary leadership theory points to emotional leadership as a possible approach to accomplishing organizational aims.
Defining Emotional Leadership
As leadership is all about influencing people to achieve a common goal, an “emotional” approach can be a very important step of the process. A leader’s mood or emotions have an effect on the group in three major ways:
- Leaders can influence followers through the mechanism of “emotional contagion.” Those in an optimistic mood can effect their group in a positive way by instilling a positive outlook. For example, a charismatic leader can inspire feelings of confidence in a group’s ability to achieve challenging goals.
- Group affective tone refers to the collective mood of individuals. Groups with leaders in a positive mood have more positive feelings toward each other than groups with leaders who convey the opposite. The perceived efficacy of group processes such as coordination, collaborative effort, and task strategy can also effect the emotions of followers.
- Public expressions of mood affect how group members think and act in relation to other group members. For example, demonstrating positive emotions such as happiness or satisfaction can signal that leaders acknowledge solid progress toward goals. Those signals influence how followers think about their work, which can benefit their work together.
Emotional Intelligence
Strong emotional leadership depends on having high levels of emotional intelligence (EI). EI is the ability to identify, assess, and control the emotions of oneself, of others, and of groups. The two most prominent approaches to understanding EI are the ability and trait EI models.
The EI ability model views emotions as useful sources of information that help a person make sense of and navigate the social environment. The model proposes that individuals vary in their ability to process information of an emotional nature and in their ability to connect those emotions to how they think. There are four key emotional skills—perceiving, using, understanding, and managing:
- Perceiving emotions – The ability to detect and decipher emotions in faces, pictures, voices, and cultural artifacts—including one’s own emotions. Perceiving emotions represents a basic aspect of emotional intelligence, as it makes all other processing of emotional information possible.
- Using emotions – The ability to harness emotions to facilitate various cognitive activities, such as thinking and problem-solving. Emotionally intelligent people can capitalize fully upon their changing moods according to the task at hand.
- Understanding emotions – The ability to comprehend emotional language and to appreciate complicated relationships among emotions. For example, understanding emotions encompasses the ability to be sensitive to slight variations between emotions, as well as the ability to recognize and describe how emotions evolve over time.
- Managing emotions – The ability to regulate emotions in both ourselves and in others. The emotionally intelligent person can harness emotions—even negative ones—and manage them to achieve intended goals.
Because the EI ability model focuses on behaviors that can be learned, it is used as the basis of leadership development activities.
The EI trait model focuses not on skills but on personality characteristics and behavioral dispositions such as empathy, consideration, and self-awareness. Trait EI refers to individuals’ self-perceptions of their emotional abilities. It is measured by looking at degrees of emotional well-being, self-control, emotionalism, and sociability. EI traits can be challenging to assess accurately because they rely on self-reporting, rather than observations of actual behaviors. Personality traits are generally believed to be resistant to significant change, so the EI trait model is used to help people better manage their emotional abilities within the constraints of existing behavioral tendencies.
9.6.2: Interactive Leadership
Interactive leadership involves leaders’ engaging followers to increase their understanding of tasks and goals.
Learning Objective
Explain the importance of interactive leadership in generating motivation and commitment to shared objectives
Key Points
- Interactive leaders engage followers in understanding goals and tasks to contribute more effectively to achieving them.
- Reaching out to employees and helping them understand different aspects of the organization serve to engage them in the organization’s goals.
- Interactive leaders demonstrate their willingness to engage others in a variety of ways, including group decision making, building trust through openness and transparency, and being visible and accessible to followers.
Key Term
- Interactive Leadership
-
Style of leading that engages employees in understanding tasks and goals so they can be effective contributors to achieving them.
Effective leadership requires communicating and engaging with followers. The interactive style of leadership makes it a priority to inform followers about important matters related to their goals and tasks and to clarify understanding. Interactive leaders are proactive in seeking information and opinions from followers. Reaching out to employees in this way helps build their commitment to achieving team and organizational goals.
Interactive leaders take the opportunity to meet with followers to explain their vision and persuade them of its value. This encounter facilitates behavior change; the better people understand what is expected of them, the more they can modify how they act. While interactive leaders may make use of technology to share information, they also seek the richer exchanges that face-to-face communication allows.
Examples of Interactive Leadership
Interactive leaders engage followers in a variety of ways. When making group decisions they may solicit information, perceptions, and even recommendations from team members. To underscore a commitment to openness and to build trust, an interactive leader freely shares information rather than keeping it as a basis of power over others.
Interactive leaders value individual contributions and maintain relationships that foster mutual respect. They also make themselves visible and accessible to followers; some maintain an “open-door” policy to signal that they are open to dialogue and hearing from others. In this way, interactive leaders are role models who exhibit the quality of reciprocal interactions they seek with others.
9.6.3: Moral Leadership
Ethical or moral leadership demonstrates responsibility for doing what is right.
Learning Objective
Apply ethical standards to leadership perspectives, explaining the relevance of integrity and responsibility to leadership
Key Points
- Ethical or moral leadership involves leading in a manner that respects the rights and dignity of others.
- The duties of leaders also include the responsibility to ensure standards of moral and ethical conduct.
- An effective leader influences a subordinate’s attitude and values. Therefore, a moral leader will stimulate a moral influence.
- The best leaders make known their values and ethics and reflect them in their leadership styles and actions.
Key Term
- moral
-
Of or relating to principles of right and wrong in behavior, especially for teaching right behavior.
Moral or ethical leadership involves the commitment to doing what is right according to societal and cultural beliefs and values about acceptable behavior. Ethical leaders distinguish themselves by making decisions in the service of long-term benefits that may be inconvenient, unpopular, and even unprofitable in the short-term. Moral leaders have a clear understanding of their own values and hold themselves accountable for them. Leaders who are ethical demonstrate a level of integrity that emphasizes their trustworthiness, and this trust enables followers to accept the leader’s vision.
Moral leadership means making decisions that respect the rights and dignity of others. Moral leaders consider the viewpoints and needs of all who have an interest in a decision’s outcomes, rather than simply the most powerful. In this way, moral leaders use their own power to convince others of the rightness of their choices.
Moral leadership is important for protecting an organization’s reputation. The ethics leaders exhibit reflects on their organizations, as well on themselves. Acting ethically preserves an organization’s legitimacy as it uses societal resources to achieve its aims.
Moral leadership goes beyond doing what is legal. Laws establish clear boundaries of what is acceptable, but ethics often involves more ambiguous questions. These dilemmas are where the judgment of a leader comes into play. The personal character of leaders influences their ability and willingness to act on moral principles. Moral leaders gain the respect of followers, who are then more likely to identify with their leaders and the goals they set.
Moral leaders also play an important role in communicating an organization’s values. They do this as role models of ethical behavior and in how they speak about the moral dimension of their decisions and actions. In this way, moral leaders take responsibility for the moral climate in their organizations and help others understand, share, and act in accordance with those values.
9.6.4: Servant Leadership
Servant leadership involves feeling responsible for the world and actively contributing to the well-being of people and communities.
Learning Objective
Define servant leadership using the behaviors and characteristics described by Larry C. Spears
Key Points
- Servant leadership is apparent in leaders who feel a responsibility for the well-being of others and their communities.
- A servant leader looks at what people need, helps them solve problems, and promotes the personal development of others.
- Larry C. Spears identified ten characteristics central to servant leaders: listening, empathy, healing, awareness, persuasion, conceptualization, foresight, stewardship, commitment to the personal growth of people, and building communities.
Key Terms
- Larry C. Spears
-
Served as president and CEO of the Robert K. Greenleaf Center for Servant Leadership.
- Servant Leadership
-
An approach to leading in which leaders take responsibility for contributing to the well-being of people and community.
Servant leadership involves taking responsibility for actively contributing to the well-being of people and communities. It begins with a feeling of wanting to work for the benefit of others. A servant leader regards people’s needs and identifies ways to help them to solve problems and promote personal development. Servant leaders focus on the well-being of others and on helping them improve their circumstances.
Characteristics of Servant Leadership
Larry C. Spears identified ten characteristics that are central to servant leadership:
- Listening: A servant leader solicits information and engages in dialogue with followers to better understand their needs.
- Empathy: Servant leaders identify with and show concern for the needs of followers. In this way they model respect.
- Healing: A servant leader is sensitive to and supports the emotional health of others.
- Awareness: Servant leaders exhibits self-knowledge of their own values, emotions, strengths, and weaknesses.
- Persuasion: Servant leaders do not take advantage of their power and status by coercing compliance; they try to influence others through reason.
- Conceptualization: A servant leader thinks beyond day-to-day realities to identify future possibilities.
- Foresight: A servant leader understands intellectually as well as through intuition how the past, present, and future are connected and uses that knowledge to identify likely outcomes.
- Stewardship: Servant leaders are mindful that they hold an organization’s resource in trust for the greater good.
- Commitment to the growth of people: A servant leader is responsible for nurturing others and for their learning and development.
- Building community: A servant leader builds a sense of unity and cohesion among individuals so they can work together for common goals.
9.6.5: Shared Leadership
Shared leadership means that leadership responsibilities are distributed within a team and that members influence each other.
Learning Objective
Describe shared leadership and the conditions needed for its success
Key Points
- Shared leadership occurs when two or more individuals in a group share responsibility for directing it toward its goals.
- Shared leadership requires team members be willing to extend their feedback to the team in a way that aims to influence and motivate the direction of the group.
- The team must overall be disposed to accept and rely on feedback from other team members.
Key Term
- Shared Leadership
-
Style of leading in which responsibilities are distributed within a team or organization, and people within that team or organization lead each other.
Unlike traditional notions of leadership that focus on the actions of an individual, shared leadership refers to responsibilities shared by members of a group. Rather than having a single designated leader, two or more members of a team with shared leadership influence the others and help drive the team’s performance toward its goals.
While by definition a team’s members share responsibility for group outcomes, shared leadership means they also hold each other accountable for setting the team’s goals and maintaining its direction. Shared leadership can involve all team members simultaneously or distribute leadership responsibilities sequentially over the group’s duration. Leadership roles may be assigned based on expertise and experience.
Requirements of Shared Leadership
Research reveals that for shared leadership to merge and succeed, two conditions must be met:
- Team members must be willing to extend their feedback to the team in a way that aims to influence and motivate the direction of the group.
- Team members as a group must be disposed to accept and rely on the feedback of each other.
Three aspects of how a group interacts can facilitate shared leadership: shared purpose, social support, and voice. Shared purpose means team members have a similar understanding of the team’s objective and collective goals. Social support means that team members contribute to each other’s emotional and psychological well-being by offering encouragement and assistance. Voice refers to the degree to which team members believe they have input into how the team carries out its activities. Taken together, these group dynamics can foster a sense of trust and willingness to collaborate in support of team leadership.
Shared leadership also benefits from coaching from a respected person outside of the group. An external coach can provide guidance and advice to the team and also help individuals develop their leadership skills. Through active encouragement and positive reinforcement of team members who demonstrate leadership, coaching can foster independence and a sense of individual self-efficacy. Coaching can also nurture collective commitment to the team and its objectives, increasing the possibility that team members will demonstrate personal initiative.
9.6.6: E-Leadership
Leaders of virtual teams face challenges communicating and building relationships.
Learning Objective
Discuss the growing importance and technological potential of integrating leadership across chronological and geographical boundaries
Key Points
- E-leadership works across time, space, and organizational boundaries, usually strengthened by communication technology.
- Communication is more difficult on virtual teams, and virtual leaders must emphasize the importance of effective communication to achieving the team’s goals.
- A virtual team leader must be particularly attentive to the development of group norms and the emergence of trust, both of which are made difficult by the geographic separation of team members.
Key Term
- E-leadership
-
Form of leading across time, space, and organizational boundaries, usually supported by networks of communication as well as technology.
Virtual teams are those whose members work across distances of time, space and organizational boundaries. Their interactions are made possible by information and communication technology. Such teams are formed to benefit from different sources of knowledge, to lower costs, or to create flexibility and responsiveness in staffing. By their nature, virtual teams have particular leadership needs.
Leaders of virtual teams face communication challenges. They do not have the benefit of many opportunities for rich, face-to-face interactions. The absence of in-person interaction has at least two consequences. It can take more effort to gather and disseminate information needed to support a group’s performance. It also makes it more difficult for a leader to develop relationships. The lack of social interaction can inhibit trust and group cohesion. The geographic distribution of virtual team members may also involve linguistic or cultural differences that can create barriers to effective communication. To address these communication challenges, e-leaders must communicate more frequently, provide more complete information, and use multiple means of communication technology effectively.
The virtual team leader must also encourage awareness of how group norms are developing. Without regular personal interactions, members may not be aware of how their behavior is perceived by others and how that behavior can affect the team’s performance. The virtual leader must make and share observations about how team members work together and encourage them to be attentive to the process by which they collaborate, rather than focus solely on tasks. Drawing explicit attention to group norms and reinforcing them by being a role model, the virtual leader can help build trust between team members and make them a more effective team.
9.7: Developing Leadership Skills
9.7.1: Developing Leadership Skills
Leadership skills can be learned, and leadership development benefits individuals and organizations.
Learning Objective
Discuss the varying perspectives and models that surround the leadership development field, as well as the importance of leadership development
Key Points
- The success of leadership development efforts has been linked to three variables: individual learner characteristics, the quality and nature of the leadership development program, and opportunities to practice new skills and receive feedback.
- Leadership development can take many forms, including formal training, 360-degree feedback, coaching, and self-directed learning.
- Leadership development refers to any activity that enhances the capability of an individual to assume leadership roles and responsibilities.
- Two recognized models in leadership development include the two-part model developed by McCauley, Van Veslor, and Ruderman and the General Electric model.
Key Terms
- leadership development
-
Any activity that enhances the quality of leadership within an individual or organization.
- leadership
-
The capacity of someone to lead.
Leadership development refers to any activity that enhances the capability of an individual to assume leadership roles and responsibilities. Examples include degree programs in management, executive education, seminars and workshops, and even internships. These types of learning opportunities focus on developing knowledge, skills, self-awareness, and abilities needed to lead effectively.
Just as not all people are born with the ability or desire to play soccer like Zinedine Zidane or sing like Luciano Pavarotti, not all people are born with the ability to lead. Personal traits and behavioral dispositions can help or hinder a person’s leadership effectiveness. While these are difficult to change, leadership is a set of behaviors and practices that can be learned through effort and experience.
Successful leadership development is the result of three things:
- Individual learner characteristics, including willingness and ability to learn
- The quality and nature of the leadership development program, including its structure and content
- Opportunities to practice new skills and receive performance feedback
Methods of Leadership Development
Leader development takes place through multiple mechanisms: formal instruction, developmental job assignments, 360-degree feedback, executive coaching, and self-directed learning. These approaches may occur independently but are more effective in combination.
Formal Training
Organizations often offer formal training programs to their leaders. Traditional styles provide leaders with required knowledge and skills in a particular area using coursework, practice, “overlearning” with rehearsals, and feedback (Kozlowski, 1998). This traditional lecture-based classroom training is useful; however, its limitations include the question of a leader’s ability to transfer the information from a training environment to a work setting.
Developmental Job Assignment
Following formal training, organizations can assign leaders to developmental jobs that target the newly acquired skills. A job that is developmental is one in which leaders learn, undergo personal change, and gain leadership skills resulting from the roles, responsibilities, and tasks involved in that job. Developmental job assignments are one of the most effective forms of leader development. A “stretch” or developmental assignment challenges leaders’ new skills and pushes them out of their comfort zone to operate in a more complex environment, one that involves new elements, problems, and dilemmas to resolve.
360-Degree Feedback
The 360-degree feedback approach is a necessary component of leader development that allows leaders to maximize learning opportunities from their current assignment. It systematically provides leaders with perceptions of their performance from a full circle of viewpoints, including subordinates, peers, superiors, and the leader’s own self-assessment. With information coming from so many different sources, the messages may be contradictory and difficult to interpret. However, when several different sources concur on a similar perspective, whether a strength or weakness, the clarity of the message increases. For this mechanism to be effective, the leader must accept feedback and be open and willing to make changes. Coaching is an effective way to facilitate 360-degree feedback and help effect change using open discussion.
Coaching
Leadership coaching focuses on enhancing the leader’s effectiveness, along with the effectiveness of the team and organization. It involves an intense, one-on-one relationship aimed at imparting important lessons through assessment, challenge, and support. Although the goal of coaching is sometimes to correct a fault, it is used more and more to help already successful leaders move to the next level of increased responsibilities and new and complex challenges. Coaching aims to move leaders toward measurable goals that contribute to individual and organizational growth.
Self-directed Learning
Using self-directed learning, individual leaders teach themselves new skills by selecting areas for development, choosing learning avenues, and identifying resources. This type of development is a self-paced process that aims not only to acquire new skills but also to gain a broader perspective on leadership responsibilities and what it takes to succeed as a leader.
Leadership Development Models
McCauley, Van Veslor, and Ruderman (2010) described a two-part model for developing leaders. The first part identifies three elements that combine to make developmental experiences stronger: assessment, challenge, and support. Assessment lets leaders know where they stand in areas of strengths, current performance level, and developmental needs. Challenging experiences are ones that stretch leaders’ ability to work outside of their comfort zone, develop new skills and abilities, and provide important opportunities to learn. Support—which comes in the form of bosses, co-workers, friends, family, coaches, and mentors—enables leaders to handle the struggle of developing.
The second part of the leader-development model illustrates that the development process involves a variety of developmental experiences and the ability to learn from them. These experiences and the ability to learn also have an impact on each other: leaders with a high ability to learn from experience will seek out developmental experiences, and through these experiences leaders increase their ability to learn.
The leader-development process is rooted in a particular leadership context, which includes elements such as age, culture, economic conditions, population gender, organizational purpose and mission, and business strategy. This environment molds the leader development process. Along with assessment, challenge and support, leadership contexts are important aspects of the leader-development model.
General Electric Model of Leadership Development
Another well-known model of leadership development is used by the General Electric Corporation. Managers with high potential are identified early in their careers. Their development is monitored and planned to include a variety of job placements to develop skills and experience, a rigorous performance-evaluation process, and formal training programs at the corporate leadership center in Crotonville, New York. For top managers, the CEO leads some of the training; the CEO also reviews performance evaluations for high-potential managers during site visits to the various subsidiary divisions.
8.1: Control Process
8.1.1: Setting Objectives and Standards
A company’s standards define its practices, while its objectives define what actions the company needs to take.
Learning Objective
Illustrate how objectives and standards define business practices and determine what actions an organization will take
Key Points
- When creating standards, it is important to consider a company’s values, vision, and mission. Standards must reflect these perspectives internally and externally.
- When creating a set of objectives, it is important for the organization to complete a self-evaluation. A SWOT analysis is one example of this.
- One model of organizing objectives uses hierarchies; Top Rank Objective (TRO), Second Rank Objective, Third Rank Objective, etc. These emphasize critical success factors.
- Managers must ensure goal congruency, or the compatibility of different goals with each other. Does goal A appear compatible with goal B? Do they fit together to form a unified strategy?
Key Terms
- standards
-
Any norm, convention, or requirement.
- objectives
-
The goals of an organization.
- SWOT Analysis
-
A SWOT analysis (strengths, weaknesses, opportunities, threats) is an exercise undertaken by organizations to understand their current status and assess how to improve.
Organizational standards and objectives are important elements in any business plan because they guide managerial decision-making. To create reachable objectives, an organization needs to understand where it is, where it wants to go, and who it is competing against. A company’s standards define how it should act, while its objectives determine what actions it will take. Combining standards and objectives allows management to create a business strategy.
Standards
Organizations are like individuals: they have values, beliefs, and goals. They want to promote a particular image to stakeholders, otherwise known as a brand. Before a company can create standards, it is important for management to clarify the mission, values, and vision. If any of these are not complete or correlative, management must redefine and re-think what the company stands for.
Once mission, values, and vision are established, the organization must set down standards (both operational and value-driven). These standards need to be enforceable and teachable and must be communicated with clarity and simplicity. It is important that employees understand the standards they are required to meet and the consequences of failing to live up to these expectations. Without employee buy-in the standards will be devoid of meaning and applicability, so management should focus a great deal of time and effort instilling standards through communication and observation.
Once standards are outlined and met by management and their subordinates, the organization can begin to apply this operational paradigm to a series of short-term and long-term objectives.
Objectives
A goal (or objective) is the desired result that an organization envisions, plans, and makes a commitment to achieve. This can be a personal or organizational end-point of development. Organizationally, goal management consists of recognizing or inferring goals for individual team members, abandoning outdated goals, identifying and resolving conflicting goals, and prioritizing goals for optimal team-collaboration and effective operations.
Self-evaluation
When creating a set of objectives, it is important for the organization to complete a self-evaluation, usually through tools like SWOT analysis (strength, weaknesses, opportunities, threats). A SWOT analysis helps the company understand where it can achieve competitive advantage by pinpointing what it does well (strengths) and where the opportunities lie with those actions. Organizations must also be aware of what they have sacrificed to achieve their goals (i.e., weaknesses), and where threats in the marketplace may reduce their ability to create profitability (threats). Objectives must take competitive advantage into account; otherwise, the organization lacks a value-added proposition.
Timeline
Once the company has a good understanding of its strengths and weaknesses, management is able to create a timeline of reachable objectives. It is important to create milestones for these objectives and identify which departments within the organization will be responsible for each one. Accountability and time-sensitivity should be explicitly stated and rigorously followed. The next question is how to set these and how to identify and delineate the importance of one objective relative to another.
Objective Setting Approaches and Considerations
One model of organizing objectives uses hierarchies. The items listed may be organized in a hierarchy of means and ends and numbered as follows: Top Rank Objective (TRO), Second Rank Objective, Third Rank Objective, etc. From any rank, the objective in a lower rank answers the question “How? ” and the objective in a higher rank answers the question “Why?” The exception is the Top Rank Objective (TRO): there is no answer to the “Why?” question. That is how the TRO is defined.
People typically pursue several goals at once. Goal congruency refers to how well the goals complement each other. Does goal A appear compatible with goal B? Do they fit together to form a unified strategy? Goal hierarchy consists of the nesting of one or more goals within other, compatible goals.
Another useful approach recommends having short-term goals, medium-term goals, and long-term goals. In this model, one can expect to attain short-term goals fairly easily: they stand just slightly out of reach. At the other extreme, long-term goals appear very difficult–almost impossible to attain. Using one goal as a stepping stone to another involves goal sequencing: achieve the easy short-term goals, then step up to the medium-term and then the long-term goals. Goal sequencing can create a goal stairway.
8.1.2: Measuring Organizational Performance
Managers must consistently update performance reports to monitor progress and measure operational success.
Learning Objective
Apply performance measurement tools and evaluation processes to optimize operations
Key Points
- Measuring performance is a vital part of assessing the value of employee and management activities.
- Performance should be measured based on an employee’s overall impact, cost efficiency, effectiveness, and ability to implement best practices.
- Organizational performance based on internal objectives and external competition should be measured using the metrics of margins, growth, market share, and customer satisfaction.
Key Terms
- benchmark
-
A standard by which something is evaluated or measured.
- performance
-
The act of carrying into execution or action; achievement; accomplishment.
- best practices
-
A method or technique that has consistently shown results superior to those achieved with other means and so therefore is used as a benchmark.
Managers must do more than simply set objectives. They must consistently monitor operations to ensure feasibility and provide guidance to get failing operations back on track. Tools for this kind of management include budgeting, determining effective management strategies, finding areas that need improvement, and determining potential areas for collaboration.
Measuring performance is a vital part of assessing the value of employee and management activities. Performance measurement provides useful insights for conducting annual reviews of managers and employees and is also important for understanding how a company is performing compared with its competitors. This requires two types of measurement: individual (employee) evaluations and organization evaluations.
Employee Evaluations
Employee performance evaluations should be done on a quarterly, semi-annual, or annual basis. This ensures that everyone in the organization understands when the next evaluation will take place, gives the company regular measures of performance, and provides opportunities to take corrective action in a timely manner (if necessary).
Measurement Tools
There are many different performance measurement tools available, such as organizational and employee performance evaluations. Some are included as part of enterprise systems and some are standalone programs. Developing performance metrics usually follows a process of:
- Establishing critical processes/customer requirements
- Identifying specific, quantifiable outputs of work
- Establishing targets against which results can be scored
Some useful attributes to consider for assessing employee and management quality include:
-
Effectiveness: Determined by outcomes: did the organization produce the required results?
-
Cost-effective: When outcomes are divided by input, how efficient was the organization’s performance?
-
Impact: What value did the organization provide?
-
Best practices: In the context of evaluating internal operations (comparing core processes to effectiveness and efficiency standards), how does current performance compare to benchmarks of past performance, performance in the industry, and political expectations?
Organizational Evaluations
For organizational information, the focus is on the outcomes of the agency’s performance, but input, output, process, and benchmark factors are important as well in creating a comparative framework for analysis. Outcomes should be directly related to the public purpose of the organization.
Measurement Tools
While there are a wide variety of perspectives on controlling performance, each more or less appropriate depending on the objectives and industry of the organization, a few key metrics exist.
-
Margins – Organizations setting objectives must carefully consider expected margins and ensure that they stay in the black (i.e., do not incur losses). Measuring profitability margins indicates the cents-per-dollar the organization makes by investing in operations.
-
Growth – Raw revenue growth is also important, as it indicates expansion and potential economies of scale and scope.
-
Market share – Generally described as a percentage, this indicates success relative to the competition. Higher market share means a deeper brand awareness.
-
Customer satisfaction and/or retention – It is much cheaper to keep existing customers than to find new ones. Customer retention rates underline brand loyalty and product quality.
8.1.3: Analyzing Organizational Performance
When comparing results it is important for an organization to look inward against historical trends and outward against competitive trends.
Learning Objective
Employ benchmarks and extensive research initiatives to effectively derive standards and expected results in the control process
Key Points
- Compare results against a history of similar trends to establish a basis for the analysis.
- If the performance measurement is for a new initiative, management should conduct research to determine if there is an industry standard already in place for the process.
- If the results far exceeded expectations, than the goals or standards may be set too low (and vice versa). Both process and strategy must be considered in charting a new course and future objectives.
Key Term
- problem solving
-
Using generic or ad hoc methods, in an orderly manner, to resolve issues.
When comparing results, it is important for an organization to look inward against historical trends and outward against competitive trends. When comparing standards, it is important to make sure that the people charged with implementation understand them and consider them achievable. Measuring the long-term success or failure of objectives is in part the process of evaluating the set of standards governing the operation. Using this benchmark, management can reconsider objectives in the context of standards set, ensuring that they are both parallel and effective.
Historical Trends
Internal Data
Compare results against a history of similar trends to establish a basis for the analysis. Accountants are tasked with tracking organizational accounts for legal and/or shareholder purposes and tracking spending for operational assessment. Accountants’ records can provide a historical backdrop to outline what the organization has accomplished in the past. This applies the benefits of hindsight to current results and future projections.
External Data
It is also important to conduct competitive research to determine who else in the market is performing the same processes. If the performance measurement is for a new initiative, management should conduct research to determine if there is an industry standard already in place for the process. If this is a new technology or research area, however, then results should be compared with financial objectives or quality standards instituted by the organization.
There are many metrics and methods for identifying industry standards, particularly for companies operating in the public sector (i.e., publicly traded). Public companies must release annual and quarterly reports, which serve as useful benchmarks for incumbents in the same industry (or new entrants). Overall industry metrics and averages are also available, though for specific applications of research the organization may want to hire or contract analysts for external data collection.
Results
If results aren’t what the company expected or are fall below expected norms, it is important to determine the root cause. It may be that the objectives weren’t realistic, or that more resources are needed to meet goals. Outside factors might have contributed to poor performance. The internal and external information above will help pinpoint the root cause. Once it is determined, corrective action is necessary to help the measured process meet expectations.
If the results far exceeded expectations, the goals or standards may be set too low. The process should be reexamined and the objectives should be increased in order to make sure the company is competitive in its market. Competitive analysis is often helpful in setting realistic but challenging goals for management, employees, or production.
8.1.4: Taking Corrective Action
Taking corrective action requires identifying the problem and implementing a potential solution.
Learning Objective
Model the problem-solving process of identifying contributing factors, taking corrective action, and assessing the effectiveness of a solution
Key Points
- Managers need to understand the contributing factors of a problem and how it impacts key processes; they must then figure out a workable solution.
- Step one in the problem-solving process is identifying the problem, which can be hard to distinguish from symptoms of the problem.
- Once the problem is identified, the manager must decide what corrective action to take. In many ways, identifying and solving a problem (the control process) is a process, not a silver bullet.
- Organizations may decide to discuss a problem and potential solutions with stakeholders.
Key Terms
- tacit
-
Not derived from formal principles of reasoning; based on induction rather than deduction.
- dichotomies
-
Two elements, often mutually exclusive, that stand in juxtaposition to one another.
Taking corrective action is one of the three essential elements of the control process. If result of the control process don’t meet company standards, then it needs to be revamped to meet organizational goals.
Managers are Problem Solvers
One key aspect of taking corrective action is problem-solving. Managers need to understand the contributing factors of a problem and how it impacts key processes; they must then figure out a workable solution. Once the solution is plotted, it is important to determine how best to implement it. This problem-solving process is the central consideration for effective corrective action.
Identify the Problem
Step one in the problem-solving process is identifying the problem, which can be hard to distinguish from symptoms of the problem: it can be easy to mistake repercussions of a problem for the problem itself. Gathering information and measuring each process carefully is prerequisite to pinpointing the problem and taking the proper corrective action.
Common Mistakes
Attempts at corrective action are often unsuccessful because of failures in the problem-solving process, like not having enough information to isolate the real problem, or a decision maker who has a stake in the process and may not want to admit that their department made an error. Another reason why a decision-making process may result in an incorrect solution is that the decision-maker was never properly trained to analyze a problem.
Outline Corrective Action Method
Once the problem is identified, and a method of corrective action is determined, it needs to be implemented as quickly as possible. A map of checkpoints and deadlines, assigned to individuals in a clear and concise manner, facilitates prompt implementation. In many ways, the control process must also be a process. Its steps can vary greatly depending on the issue being addressed, but in all cases it should be clear how the corrective actions will lead to the desired results.
Next, schedule an analysis of the effectiveness of the solution. This way if the corrective action doesn’t create the expected results, further action can be taken before the organization falls even further behind in meeting its goals. Organizations may decide to discuss a problem and potential solutions with stakeholders. It is useful to have some contingency plans in place, as employees, customers, or vendors may have unique perspectives on the problem that management lacks that can lead to a more effective solution.
8.2: Types of Control
8.2.1: Strategic, Tactical, and Operational Control
Organizational control involves using strategy, tactics, and operational oversight to monitor and improve company processes.
Learning Objective
Illustrate the varying levels of control utilized by organizations, notably strategic, tactical and operational strategy
Key Points
- Organizations are built with the goal of profitability through processes in mind. The organizational control approach incorporates goals and the strategy used to reach them.
- Strategic management is a level of managerial activity below setting goals and above tactics. Strategic management provides overall direction to an enterprise.
- A tactic is a method intended to fulfill a specific objective in the context of an overall plan.
- Operational control regulates day-to-day output relative to schedules, specifications, and costs.
- Good managers have a broad vision of the process, a series of embedded tactics for efficiency and/or differentiation, and a careful operational control for cost control.
Key Terms
- vision
-
An ideal or goal toward which one aspires.
- efficient
-
Making good, thorough, or careful use of resources; not under- or over-consuming. Making good use of time or energy.
- operational planning
-
The process of linking strategic goals and objectives to tactical goals and objectives.
Control
Organizations are built with the goal of profitability through processes in mind. The organizational control approach incorporates goals and the strategy used to reach them. These strategies and tactics are developed with the foresight of specific operational objectives, such as market share, return on investments, earnings, and cash flow. As a result, organizational control consists primarily of reviewing and evaluating overall performance against the strategies, tactics, and operations used to define the organization itself. Tactics for organizational control are developed based on existing goals and strategies to establish specific objectives in the context of an overall strategic plan. Organizational control is essentially a benchmark, moving the company toward optimal levels of operation.
Strategy
Strategic management provides overall direction to the enterprise. Strategy formulation requires examining where the company is now, deciding where it should go, and determining how to get it there. Strategic assessment involves situation analysis, self-evaluation, and competitor analysis, both internal and external, micro-environmental and macro-environmental.
Objectives are determined by the results of the strategic assessment. These objectives should run parallel on a timeline, some short-term and others long-term. This involves crafting vision statements (long-term projections for the future), mission statements (describing the organization’s role in society), overall corporate objectives (both financial and strategic), strategic business unit objectives (both financial and strategic), and tactical objectives. These objectives should suggest a strategic plan that provides details (tactics) for achieving these objectives.
Tactics
Strategy involves the future vision of the business; tactics involve the actual steps needed to achieve that vision. For example, a marketing strategy for a motel might be to develop a business package targeting travel agents that includes an e-commerce solution. Tactics are practical steps for implementing strategy. Other tactics for the travel-agent strategy might include:
- building a list of local travel agents
- preparing a business incentive scheme
- outlining how they can use the motel website to make reservations and keep up-to-date
- personally visiting the agents to follow up
- monitoring the response to determine if the sales target is met
One can see from this that strategy always comes first, followed by tactics. For example, a value-based commitment to environmentally responsible hospitality could be reflected strategically by working toward Green Globe certification and tactically by incorporating energy efficient appliances in the motel retrofit.
Operational Control
Operational control regulates the day-to-day output relative to schedules, specifications, and costs. Are product and service output high-quality and delivered on time? Are inventories of raw materials, goods-in-process, and finished products being purchased and produced in the desired quantities? Are the costs associated with the transformation process in line with cost estimates? Is the information needed in the transformation process available in the right form and at the right time? Is the energy resource being used efficiently?
Operational control can be a very big job, requiring substantial overhead for management, data collection, and operational improvement. The idea behind operational control is streamlining the process to minimize costs and work as quickly and efficiently as possible.
8.2.2: Feedback, Concurrent Control, and Feedforward
Bureaucratic control uses formal systems to influence employee behavior and help an organization achieve its goals.
Learning Objective
Define bureaucratic control and its potential advantages within an organization
Key Points
- Bureaucratic control empowers individuals relative to their position within the organizational hierarchy. For example, the chief executive officer of an organization has more power than a line manager.
- It is applied via systems of standardized rules, methods, and verification procedures.
- Control helps shape the behavior of divisions, functions, and individuals.
- Advantages of bureaucratic control include efficient decision-making, standardized operating procedures, and usage of best practices.
- Disadvantages include discouragement of creativity and innovation; dissatisfaction among employees; high employee turnover rate; and difficulty adopting to changing conditions in the marketplace, industry, or legal environment.
Key Terms
- hierarchy
-
An arrangement of items in which the items are represented as being “above,” “below,” or “at the same level as” in relation to each other.
- bureaucracy
-
Structure and regulations in place to control activity. Usually in large organizations and government operations.
Bureaucratic Control, An Overview
What Is Bureaucratic Control?
Bureaucratic control is the use of formal systems of rules, roles, records, and rewards to influence, monitor, and assess employee performance.
- Rules set the requirements for behavior and define work methods.
- Roles assign responsibilities and establish levels of authority.
- Records document activities and verify outcomes.
- Rewards provide incentives for achievement and recognize performance relative to goals or standards.
Organizations use these systems when their size and complexity make more informal practices based solely on interpersonal communication and relationships impractical, unreliable, and ineffective. Bureaucratic controls are intended to help an organization achieve its goals by shaping how employees perform, creating accountability for outcomes, tracking actual performance, and correcting behavior when necessary.
Advantage of Bureaucratic Control
The biggest advantage of bureaucratic control is that it creates a command and control cycle for the business leadership. Decision-making is streamlined when fewer individuals are involved. Since standards and best practices are usually highlighted during decision-making, bureaucratic control makes an entire organization more efficient.
Disadvantages of Bureaucratic Control
One disadvantage of bureaucratic control is that it may discourage creativity and innovation by making an organization more standardized and less flexible. Business leadership may be versatile in some organizations, but it is not possible for a few individuals to generate all possible ideas or plans. This means that bureaucratic control can narrow the scope of possible ideas and plans. Another disadvantage is that the front- line employees may feel unappreciated and dissatisfied because they are not allowed to present their ideas; this can lead to heavy employee turnover. Often organizations with strict bureaucratic control find themselves less able to adapt to changes in the marketplace, their industry, or the legal environment.
Conclusion
Though bureaucratic organizational structures may seem less desirable than flatter structures, they are necessary at times. While software development may benefit from a more autonomous structure, for example, other industries benefit from the tight controls and tall hierarchies of bureaucratic control.
8.2.3: Internal and External Control
Control uses information from the past and present and projections for the future to create effective control processes.
Learning Objective
Diagram the control process of feedback, concurrent control, and feedforward within the organizational control context
Key Points
- Feedback is a process in which information about the past or the present is used to influence the present or future.
- Concurrent control is active engagement in a current process where observations are made in real time.
- Feedforward refers to giving a control impact to a subordinate or an organization from which you are expecting an output. It is predictive because it is given before any deliberate change in output occurs.
- Monitoring and controlling is a set of processes implemented to monitor project execution to discover and solve problems or potential problems in a timely manner.
Key Terms
- feedforward
-
To respond in advance.
- concurrent
-
Happening at the same time; simultaneous.
- feedback
-
Critical assessment on information produced.
In management terms, control means setting standards, measuring actual performance, and taking corrective action. Control involves making observations about past and present control functions to make assessments of future outputs. These are called feedback, concurrent control, and feedforward, respectively.
Feedback
Feedback is a process in which information about the past or the present is used to influence the present or future. As part of a chain of cause-and-effect that forms a circuit or loop, actions are said to “feed back” into themselves.
Feedback helps an organization seeking to improve its performance make the necessary adjustments. Feedback serves as motivation for many people in the workplace. When employees receive negative or positive feedback, they decide how to apply it in their daily work. Feedback for the system as a whole also provides common points of discussion for management and allows for a holistic appraisal of how processes can be improved.
Concurrent Control
Concurrent control is active engagement in a current process where observations are made in real time. A set of processes are implemented to monitor project execution to discover and solve problems or potential problems in a timely manner. Picture a floor manager actively measuring each component of the operation with a checklist to identify issues as they occur.
Feedforward
Feedforward is a management and communication term that refers to giving a control impact to an employee or an organization from which you are expecting an output. Feedforward is not just pre-feedback, because feedback is always based on measuring an output and sending feedback on that output. Pre-feedback given without measuring output may be understood as a confirmation or just an acknowledgment of control command. Feedforward is predictive in nature. Picture an analyst statistically measuring the quality and quantity of a given output based on information gathering.
8.2.4: Internal and External
The control process can be hindered by internal and external constraints that require contingency thinking.
Learning Objective
Examine the external and internal control constraints that may limit efficiency in the control process
Key Points
- All processes are susceptible to constraints; the theory of constraints (TOC) postulates that “the chain is only as strong as its weakest link.”
- TOC asserts that throughput would be infinite if there were no constraints within a process. Therefore, constraints are a constant consideration for management control.
- Internal constraints include people, policy, and equipment issues, which can actively reduce the efficiency of specific process flows.
- External constraints include resource scarcity, contracts (i.e., suppliers or employees), and legalities.
Key Terms
- control
-
Influence or authority over someone or something.
- throughput
-
The movement of inputs and outputs through a production process.
Theory of Constraints
All processes are susceptible to constraints; the theory of constraints (TOC) postulates that “the chain is only as strong as its weakest link.” Because systems are interdependent, it makes sense that an entire set of processes within an operational paradigm can be made vulnerable to failure by a single process that is struggling.
TOC assumes that throughput, operational expense, and inventory are the three central inputs in a given system. TOC relies on the assumption that there is always room for improvement in these inputs–after all, if there was nothing preventing the system from achieving higher throughput, throughput would be infinite.
This means that any time organizations encounter substantial internal or external constraints, it is the role of management to create a strategy to circumvent them. Since throughput is never infinite, this is an ongoing process.
Internal Constraints
At the organizational level, internal control objectives concern the reliability of financial reporting, timely feedback on the achievement of operational or strategic goals, and compliance with laws and regulations. With this in mind, we can summarize internal constraints as any one or any combination of the following:
-
Equipment: The way equipment is used limits the ability of the system to produce more salable goods/services.
-
People: Lack of skilled people limits the system; mental models also cause negative behaviors that become constraints.
-
Policy: A written or unwritten policy prevents the system from making more goods/services.
The list of potential internal constraints is long: employees may not have the proper skills to use specific types of equipment, policy may organize the processes in an imperfect manner, equipment may depreciate faster than expected, employees may be absent or inefficient, policy may limit resource allocation to inventory and warehousing, etc. Internal constraints are a constant concern for the managers who must try to minimize them by continually optimizing the system. For example, if employees lack specific skills, management may want to refine its hiring policies.
External Constraints
In their attempts to maximize existing profits, business managers must consider both the short- and long-term implications of decisions made within the firm and the various external constraints that could limit the firm’s ability to achieve its organizational goals. These constraints can be organized into three categories:
- Scarcity
- Contracts
- Legalities
The first external constraint, resource scarcity, refers to the limited availability of essential inputs (including skilled labor), key raw materials, energy, specialized machinery and equipment, warehouse space, and other resources. Moreover, managers often face constraints on plant capacity that are exacerbated by limited investment funds available for expansion or modernization.
Contractual obligations also constrain managerial decisions. Labor contracts, for example, may constrain managers’ flexibility in worker scheduling and work assignments. Labor contracts may also restrict the number of workers employed at any time, thereby establishing a floor for minimum labor costs.
Finally, laws and regulations have to be observed. Legal restrictions can constrain production and marketing decisions. Examples of laws and regulations that limit managerial flexibility include: minimum wage, health and safety standards, fuel efficiency requirements, anti-pollution regulations, and fair pricing and marketing practices.
8.3: Bureaucratic and Quality Control Tools and Techniques
8.3.1: Bureaucratic Control
The quality control cycle improves processes through a continuous cycle of planning, doing, checking, and acting.
Learning Objective
Use the four central components of the quality control cycle as a quality control (QC) tool
Key Points
- The quality control cycle is a repeating cycle that evolves around the production process. In the PDCA model, this incorporates four elements: Plan, Do, Check, and Act.
- This process is essential for products developed through continuous production.
- The quality control cycle does not stop after a process has been improved. Once a product is updated, the cycle begins again for the updated product, which is subjected to the same rigorous quality control process.
Key Terms
- quality control
-
An activity, such as inspection or testing, introduced into an industrial or business process to ensure sound processes and products.
- continuous improvement
-
An ongoing effort to make products, services, or processes better.
- PDCA
-
The cycle of Plan-Do-Check-Act, four-step problem solving process typically used in quality control.
The Quality Control Life Cycle
The quality control life cycle is an ongoing cycle of planning, monitoring, assessing, comparing, correcting, and improving products or processes. It is designed to improve the quality of a product or process through continuous reinvention. Quality control is used to develop systems that ensure that the goods and services customers receive meet or exceed their expectations.
Quality control both verifies the delivery of good quality and identifies gaps and failures that need to be addressed within the process. Ultimately, it is a process that continuously evolves within the production process.
PDCA (Plan, Do, Check, Act)
PDCA (plan–do–check–act or plan–do–check–adjust) is a four-step management method used in business to control and continuously improve processes and products. It is also known as the Deming circle/cycle/wheel, Shewhart cycle, control circle/cycle, or plan–do–study–act (PDSA). Another version of this PDCA cycle is OPDCA. The added “O” stands for observation or, as some versions say, “Grasp the current condition.”
The Four Steps
-
Plan: In this step of the quality control cycle, a business establishes the objectives and processes necessary to deliver results in accordance with the expected output (the target or goals).
-
Do: In this step, a business implements the plan, executes the process, and makes the product. It also collects data for charting and analysis to be used in the following “check” and “act” steps.
-
Check: A business then compares the actual result against the expected result to find any differences.
-
Act/Adjust: After comparing results, a business takes corrective actions on any significant differences between actual and expected results. In this step, the business analyzes the differences to determine their root causes, then determines where to apply changes that will improve the process or product.
It is important to keep in mind that this quality control process is continuous and specifically designed to improve the quality of business processes on an ongoing basis. The theory underlying this is the scientific method, where observations are made and hypotheses generated, which are then tested in the next cycle.
8.3.2: The Quality Control Cycle
Quality control is used to evaluate and address the quality of the goods a business provides.
Learning Objective
Describe effective quality control processes as they are employed in the business environment
Key Points
- Quality control is used to evaluate an organization’s products or services.
- Standards of quality need to be established first, using a set of quality criteria created by the manufacturer or by the requirements of the client/customer.
- Quality assurance is preventive and process-oriented while quality control is reactive and product-oriented.
- Quality control emphasizes process, control, competence, and personal integrity.
- Quality control is very important to increasing customer satisfaction and the success of the overall business.
Key Terms
- locus of control
-
A theory in personality psychology referring to the extent to which individuals believe that they can effect or dictate how events affect them.
- quality control
-
A procedure or set of procedures intended to ensure that goods adhere to a defined set of soundness criteria or meet the requirements of the client or customer.
- quality
-
The degree to which a man-made object or system is free from bugs and flaws, as opposed to scope of functions or quantity of items.
Quality control is a business procedure used to assess the quality of a company’s products or services against benchmarks determined by the company, industry standards, or clients/customers. Quality control includes inspecting a product before it enters the marketplace to make sure it is defect-free.
Quality Control (QC) and Quality Assurance (QA)
Quality control and quality assurance have different purposes. Quality control emphasizes product testing to discover defects and report them to management, which decides how to respond (by delaying the product release date, for example). Quality assurance attempts to improve and stabilize production to prevent defects. In this way, QA is preventive and process-oriented while QC is reactive and product-oriented.
Guidelines for Quality Control
To maintain an effective quality control program, a business must follow these important guidelines:
- Decide on a specific standard for the product or service.
- Determine the extent of quality service actions.
- Collect real-world data to improve product quality and adjust the QC process.
- Submit the result to management. If the percentage of defective products is too high, management should take corrective action to improve quality.
- Most importantly, a quality control process should be an ongoing process.
Three Major Aspects of Quality Control
- Elements, like controls, job management, defined and well-managed processes, performance and integrity criteria, and identification of records.
- Competence, such as knowledge, skills, experience, and qualifications.
- Soft elements, such as personnel integrity, confidence, organizational culture, motivation, team spirit, and quality relationships. Deficiency in any of these three aspects increases the risk of inferior products or services getting to market. Quality control is one of the most important procedures for any business because it lowers that risk of customer or client dissatisfaction and prevents losses for the business.
8.3.3: Total Quality Management (TQM)
Total quality management (TQM) is the continuous management of quality in all aspects of an organization.
Learning Objective
Employ the total quality management (TQM) perspective to identify how to improve quality and efficiency on a continuous basis
Key Points
- TQM asserts that quality improvement never ends. Quality is a strategic advantage to an organization, and zero defects is the quality goal that minimizes total quality costs.
- TQM is rooted in the belief that preventing defects is cheaper than fixing them. In other words, total quality costs are minimized when managers strive to reach zero defects in the organization.
- The seven basic elements of TQM are: customer focus, continuous improvement, employee empowerment, quality tools, product design, process management, and supplier quality.
- There are several awards for outstanding TQM, such as the Malcolm Baldrige Award and the ISO 9000 award.
Key Term
- TQM
-
Total Quality Management; a process improvement method that promotes the importance of quality improvement on a continuous basis.
Quality management is the study of improving the quality of a company’s products and services. Total quality management (TQM) promotes the importance of improving quality on a continuous basis. TQM asserts that quality improvement is a consistent source of strategic advantage because it eliminates waste and creates higher consistency. TQM involves all levels of staff and management as well as facilities, equipment, labor, supplies, customers, policies, and procedures.
Cost-Benefit Analysis
An important basis for justifying TQM is its impact on total quality costs. TQM is rooted in the belief that preventing defects is cheaper than fixing them. In other words, total quality costs are minimized when managers strive to reach zero defects in the organization.
The four major types of quality costs include:
-
Prevention costs are costs created from the effort to reduce poor quality. For instance, a company may train its employees to do an effective job the first time or conduct preventive maintenance on its equipment.
- Appraisal costs include costs associated with conducting quality audits and the inspection and testing of raw materials, work-in-process, and finished goods.
- Internal failure costs include the lost productivity and waste associated with having to scrap or rework a product.
- Finally, external failure costs occur when the defect occurs after the product has reached the customer. This is the most expensive category of quality cost as it results in returns, repairs, warranty claims, and potentially lost business.
The Seven Basic Elements of TQM
These seven elements of TQM are:
-
Customer focus: Identifying customer needs and measuring customer satisfaction are key first steps for any business. Managing quality begins with delivering precisely what the customer wants.
-
Continuous improvement: There is no perfect system. Process improvements must be continuous. Constantly identifying and improving on processes to increase quality and/or lower costs is a primary responsibility of operations teams.
-
Employee empowerment: Employees are observers: ensuring familiarity with the individual components and the broader process as a whole is integral in empowering effective operations professionals.
-
Quality tools: Quality tools are mostly model-based (i.e., flowcharts, cause and effect diagrams, scatter plots, etc.) and involve manipulating output data to identify weaknesses and/or areas for improvement.
-
Product design: Design and delivery of a product is also an evolving process where product design can substantially impact costs and customer satisfaction. Operations professionals are in an ideal position to suggest design changes that will improve quality.
-
Process management: This is often seen as a the heart of TQM because improving the process itself is a goal everyone in operations should be working towards all the time. Simple process improvements like enhancing the organization of inputs or the design of the plant can have enormous cost implications.
-
Supplier quality: Finally, most companies are also customers. This means that many of the inputs for a given good will be coming in as goods themselves. Who organizations buy from significantly impacts costs and quality. This makes supplier management is a complex and highly relevant component of TQM.
All of these elements emphasize the importance of improving quality by empowering employees, providing adequate training, and building a continuous organizational culture of improvement. The idea here is to improve while continuing to fulfill customer needs through effective use of internal resources and process management.
Quality Awards Associated with TQM
There are several quality awards and standards for organizations to strive towards. Most of the organizations involved in these programs see them as tools to help improve their quality processes and move toward implementing successful TQM. Two examples are:
-
The Malcolm Baldrige Award is a United States quality award that covers an extensive list of criteria evaluated by independent judges. In many cases, organizations use the Baldrige criteria as a guide for their internal quality efforts rather than competing directly for the award.
-
The International Organization for Standardization (ISO) sponsors a certification process for organizations that seek to learn and adopt superior methods for quality practice (ISO 9000) and environmentally responsible products and methods of production (ISO 14000). These certifications are increasingly used by organizations of all sizes to compete more effectively in a global marketplace due to the wide acceptance of ISO certification as a criterion for supplier selection.
8.3.4: The RATER Model
RATER is a service quality framework that highlights five important business areas customers use to analyze strength or weaknesses.
Learning Objective
Apply Gap Analysis to the RATER model to measure current and potential performance
Key Points
- RATER assumes that customers evaluate a firm’s service quality by comparing their perceptions with their expectations.
- RATER highlights the five areas of a business: Reliability, Assurance, Tangibles, Empathy, and Responsiveness. Gap analysis of RATER results measures the difference between perception and expectation.
- RATER allows businesses to improve an individual service variable by analyzing customer data.
Key Terms
- reliability
-
The quality of being dependable or trustworthy.
- SERVQUAL
-
SERVQUAL or the RATER model is a service quality framework.
- Gap Analysis
-
A tool that helps organizations compare actual performance with potential performance. The thought process is: “Where are we now and where do we want to be?”
The RATER model is a service quality framework. It was created by professors Valarie Zeithaml, A. Parasuraman, and Leonard Berry, who introduced the framework in their 1990 book Delivering Quality Service. The model highlights five areas that customers generally consider important when they use a service, and focuses on differentiating between customer experience and expectation.
Five Areas of RATER
- Reliability: did the company provide the promised service consistently, accurately, and on a timely basis?
- Assurance: do the knowledge, skills, and credibility of the employees inspire trust and confidence?
- Tangibles: are the physical aspects of the service (offices, equipment, or employees) appealing?
- Empathy: is there a good relationship between employees and customers?
- Responsiveness: does the company provide fast, high-quality service to customers?
By measuring the quality ratings for these five areas, a business can improve areas that are lagging. RATER uses a multidimensional approach to pinpoint service shortcomings, which helps a business understand why they are happening and how to correct them.
Gap Analysis
Gap Analysis can be applied to each of the five RATER areas. Gap Analysis is a tool that helps companies compare actual performance with potential performance. The five gaps that organizations should measure, manage, and minimize are:
- Gap 1: The management perception gap, or the difference between the service customers expect and management’s perception of customer expectations. If management thinks customers expect one level of service when they really expect another, this indicates that management does not fully understand the market.
- Gap 2: The quality specification gap. This is the difference between management perception and the company’s actual specification of customer experience.
- Gap 3: The service delivery gap. This is the difference between customer-driven service design and standards and service delivery.
- Gap 4: The market communication gap. This is the gap between the experience that customers are promised and the experience they actually have.
- Gap 5: The perceived service quality gap. This is the gap between a customer’s expectation of a service and their perception of the service they received.
Addressing gaps is the ultimate goal of this process because the deviation between customer expectations and actual quality is where quality control and process improvements take place.
8.3.5: Total Quality Management Techniques
Six sigma, JIT, Pareto analysis, and the Five Whys technique are all approaches that can be used to improve overall quality.
Learning Objective
Classify the different methods of TQM available to organizations and leaders
Key Points
- Total Quality Management (TQM) is an integrative management philosophy for continuous improvement of the quality of an organization’s products and processes in order to meet or exceed customer expectations.
- Six Sigma focuses on improving the quality of process outputs by identifying and removing the causes of defects while minimizing the variability in manufacturing and business processes.
- Just-in-Time is a production strategy for improving return on investment by reducing in-process inventory and associated carrying costs.
- Pareto Analysis is a statistical technique used to identify a limited number of tasks that combine to produce a significant overall effect.
- Five Whys is a question-asking technique used to explore the cause-and-effect relationships underlying a particular problem.
Key Terms
- Pareto Analysis
-
A statistical technique that is used to select a limited number of tasks that produce significant overall effect.
- Six Sigma
-
A process improvement method that focuses on statistical methods to reduce the number of defects in a process.
- JIT
-
Just-in-Time; to perform an operation (usually compiling).
Total Quality Management (TQM) is an integrative management philosophy for continuous improvement of the quality of an organization’s products and processes in order to meet or exceed customer expectations. There are several TMQ strategies used to improve business management systems. Considering the practices of TQM as discussed in six empirical studies, Cua, McKone, and Schroeder (2001) identified the nine most common TQM practices as:
- Cross-functional product design
- Process management
- Supplier quality management
- Customer involvement
- Information and feedback
- Committed leadership
- Strategic planning
- Cross-functional training
- Employee involvement
The following sections describe some other important and widely used techniques that drew inspiration from TQM in their focus on quality and control.
Six Sigma
Six Sigma drew inspiration from the quality improvement methodologies of preceding decades, including quality control, TQM, and Zero Defects. It focuses on improving the quality of process outputs by identifying and removing the causes of defects while minimizing the variability in manufacturing and business processes Like TQM, the Six Sigma philosophy asserts that achieving sustained quality improvement requires commitment from the entire organization, particularly top-level management.