Corporate Strategy and Organisation Design (6011P0203Y)
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Corporate Strategy and Organisation Design summary (grade: 8.5)
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Corporate Strategy and Organisation Design (6011P0203Y)
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Universiteit Van Amsterdam (UvA)
Comprehensive summary of all content from the Corporate Strategy and Organisation Design course (MSc BA Strategy), including detailed notes from the slides, papers, case examples. Check my Stuvia page for an additional document with answers to the study questions (exam content).
Corporate Strategy and Organisation Design (6011P0203Y)
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Week 1
Transaction cost theory (the economic view and governance perspective)
The transaction cost theory focus on the costs involved in transactions to examine
questions regarding the most efficient governance form – consideration on performing
activities within the organization or using (outside) market mechanisms.
But what exactly are transaction costs?
- Search and information costs (costs of gathering market information and searching
for suppliers for goods and services)
- Bargaining and negotiating costs (costs of reaching a beneficial agreement by
negotiating for the best price)
- Contractual costs (costs of drafting contracts)
- Monitoring and enforcement costs (costs of monitoring quality to ensure that the
other party sticks to the terms of the agreement)
Why do this transaction costs exist?
One of the key insights provided by transaction cost theory is that reaching transactional
agreements between economic actors is costly because of two assumptions:
1. Bounded rationality assumption: the transaction cost theory assumes that
individuals within a firm are boundedly rational and – despite their efforts to deal
with complexity and uncertainty – have limited abilities to predict and plan for the
future and its various contingencies that may emerge.
o Consequently, boundedly rational individuals find it hard to write complete
contracts since the factors that they consider when making decisions are
limited given their lacking abilities to foresee the future. As a result, these
market contracts are assumed to be incomplete.
2. Opportunism assumption: the transaction cost theory assumes that economic actors
can be dishonest by satisfying their self-interest which causes uncertainty and
mistrust between parties.
o Consequently, since firms need to identify untrustworthy individuals to
prevent themselves from dishonest and opportunistic behavior, monitoring
and controlling mechanisms are necessary to enforce contractual
performance.
As a result of these costs of incomplete contracts (bounded rationality) and monitoring and
controlling mechanisms (opportunism) - although generally assumed that market
mechanisms are more efficient because of the costs for managing the hierarchical
organization – the costs of market mechanisms all of a sudden can become higher than the
costs for managing the hierarchical organization and surpass its prior delivered efficiencies.
,That is, transaction costs economics think of governance structures as a mean to minimize
incomplete contracts and untrustworthy behavior and its associated costs by internalizing
the transactional exchange within a hierarchical organization.
In what exact situations will transaction costs surpass the efficiency of the market form?
In general, transaction costs economics believe that there are three main factors that
influence the efficiency of governance modes:
1. Frequency factor: the extent to which the transaction is recurrent instead of
occasional
2. Uncertainty factor: the extent to which transactions are uncertain since parties
cannot make accurately predictions in situations of high uncertainty (higher levels of
uncertainty deliver a greater need of hierarchies because they can minimize the
information asymmetries and simplify the decision-making)
3. Asset specificity factor: the extent to which assets are unique and dedicated to a
particular use in which the value of the investment is much higher in the intendent
use than in its alternative use
o Site asset specificity; impossible or difficult to move to a different location
o Physical asset specificity; equipment, machinery, or software
o Human asset specificity; highly trained employees
In other words, transaction costs economics look at three main factors to determine which
governance form will be used - and believe that internalizing transactional exchanges is
more efficient if one or all of these three factors are high,
- when asset specificity and uncertainty are high, and the transaction costs are above
the cost of organizing hierarchies, internalizing the transaction is the appropriate
decision
- when asset specificity and uncertainty are low, and the transaction costs are not
above the cost of organizing hierarchies, buying the good or service on the market is
the preferred option
That is, it can be argued that corporates exists because the transaction costs of market
transactions can be higher than the costs of the internal organization by firms, given that
firms can better minimize or even avoid transaction costs.
,Important to note, however, is that transaction costs still occur within a corporate, as
transactions between departments and business units does not come for free and bounded
rationally and opportunism still exist.
These cost for hierarchical organization – also known as administration costs - however are
usually lower than transaction costs for dealing with external parties, unless one or all three
of the factors score high.
Critics of the transaction cost theory
In general, there are three main critics for the transaction cost theory
- First, the transaction cost theory neglects fairness, but people care about fairness
and can therefore affect the efficiency of governance mechanisms
- Second, the transaction cost theory has no explicit theory of knowledge and
learning, though they are very important for the effectiveness within organizations
- Third, the transaction cost theory is one of the theories that is based on the
liberalism ideology (gloomy vision) that Ghosal (2005) writes about and can
therefore be bad for managerial practice (focuses mainly on economic advantages
for shareholder value)
,The knowledge-based view (the managerial view and competence perspective)
Another way of thinking about the existence of corporates is known as the knowledge-
based view perspective.
This knowledge-based view builds upon the resource-based view of Barney (1991) and
stresses the significant importance of knowledge since its beliefs that combining knowledge
is crucial to build capabilities and achieve competitive advantages for long-term success.
That is, the knowledge-based view argues that firms exist because they are better and more
efficient in coordinating learning processes that develop knowledge.
More precisely, Kogut & Zander (1992), argue that a firm exists because they can better
facilitate knowledge sharing and transferring within an organizations since firms provide a
structure for cooperation that goes beyond individual capabilities.
This structure for cooperation - knowledge sharing and transferring – in which firms as a
collective are more than the sum of the individuals within it comes from firms’ combinative
capabilities. These combinative capabilities are about the ability to integrate, combine and
transform different pieces of existing knowledge to create new applications and innovations
(very similar to dynamic capabilities).
,Comparison of governance versus competence perspective
If we compare these governance perspective and competence perspective, the competence
perspective gives a very different answer to the question of why firms exists than the
governance perspective did.
Whereas the governance perspective and its associated transaction costs theory are
focusing on minimizing bounded rationality and mitigating opportunism to increase the
efficiency by arguing that firms exist because they can better minimize and avoid transaction
costs under particular circumstances, the competence theory, instead, argues that firms
exists because they are better in coordinating collective learning processes as they facilitate
a cooperative structure for knowledge sharing and transferring.
That is, we can say that the knowledge-based view widens the cost-efficiency view and
prominence to economic theory, given that the knowledge-based view gives greater
prominence to organization theory.
Last, we can say that the transaction cost theory is focusing on achieving a positive
(organizational learning) instead of avoiding a negative (transaction costs).
,Ghoshal, S. (2005). Bad Management Theories are Destroying Good Management Practices.
The paper of Ghoshal (2005) argues that academic research, that is based on an overly
scientific approach that excludes of human intent (pretense of knowledge) and negative
liberalism ideology about people and institutions (gloomy vision), has negatively affected
management practices by providing amoral theories that are self-fulfilling in nature.
Ghosal (2005) argues that business academics over the last 50 years has increasingly
adopted the scientific research approach - known as the pretense of knowledge - that is
associated with physical science methods and demands theorizing based on partial analysis
and the exclusion of human intentionality, ignoring the unique aspects of social sciences.
1. This scientific research approach, given that morality and ethics are inseparable
from human intentionality, however, automatically denied moral and ethical
considerations within their theories given its excluding of human intentionality.
2. In addition, the liberalism ideology - known as the gloomy vision - that is grounded
in a set of pessimistic assumptions, and focuses on restricting the social costs arising
from human imperfections, penetrated the disciplines in which management
theories are rooted.
As a result, this combination of the (1) pretense of knowledge and (2) gloomy vision
management research increasingly made excessive truth-claims based on partial analysis
and biased assumptions. The key idea of Ghosal (2005) is that this truth-claims based on
biased assumptions, given that management is associated with social sciences, becomes
extremely problematic given its self-fulfilling nature.
,Whereas a theory within psychical sciences – if wrong and based on unrealistic assumptions
- does not actually change the behavior of the psychics, a social theory associated with
management based on false assumptions actually does change the behavior of the
managers.
That is, converting the excessive truth-claims within the management practice because its
self-fulfilling nature, has led the management field to multiple problematic elements.
1. First, the management field is currently primarily motivated by self-interest, which
undermines the potential for cooperation, trust, and ethical behavior within
organizations.
2. Second, the management field is currently primarily focused on shareholder value,
which neglects the broader dimensions of management about the well-being of all
stakeholders, including employees, customers, and society as a whole.
3. Third, the management field is currently dehumanizing employees as mere
resources or costs to be minimized instead of a more human-centered approach to
management
4. Last, the management field is currently fails to consider the context in which
organizations operate by providing simplistic one-size-fits-all solutions that don't
account for the unique challenges and circumstances of organizations.
In summary, Ghoshal's paper, criticizes existing management theories and calls for a more
humane, holistic, ethical and socially responsible approach to management.
, Week 2
Diversification stands for increasing the variety of products and services by expanding
beyond the firm’s single market to achieve growth.
That is, the idea of diversification derived from the growth imperative in which firms
constantly need to grow to survive. But why do firms constantly need to grow?
In general, there are five reasons why firms need to grow (growth imperative):
§ Growth can increase its profitability
§ Growth can lower its costs (economies of scale)
§ Growth can reduce risks (economies of scope)
§ Growth can increase its market power and bargaining power
§ Growth keeps its stakeholders, in particular management and employees, motivated
What are the benefits of diversification?
These five reasons of why growth is important for firms and diversification is used can be
associated to four main motives to diversify:
1. Economies of scale: by economies of scale, firms can reduce the costs by decreasing
their average cost per unit (related to cost-savings)
2. Economies of scope: by economies of scope, firms can reduce the costs by sharing
resources and capabilities across multiple business units (related to synergies)
3. Internalizing transactions by internal capital and labor markets: by diversifying,
firms can reduce the costs by providing units with internal capital and fundings
(flexible capital formation) and internal labor markets by hiring and transferring
employees from other units that have prior knowledge (enhance employee-job fit).
4. Portfolio effects: by diversifying, firms can reduce risk by increasing revenue stability
trough engagement in different businesses and markets that are uncorrelated (i.e.,
Marlboro buying Kraft as co-insurance of risks which is similar to spreading
investments in stock markets)
What are the cost of diversification?
1. Cost of coordination: by diversifying, firms can grow the strain on the top
management (related to workload)
2. Cost of influence: by diversifying, firms can cause costs due to political maneuvering
3. Cost from inefficiencies: by diversifying, firms can cause costs due to conflicting
dominant logics
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