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Lecture Text1
Professor John Roberts
Organizational Design for Performance and Growth

Introduction

What I’m going to do is take you through the basics of how we now teach strategic management here
at the school:
I’m going to give you an outline of how we think about the questions of strategy and organization. Then
I’m going to offer you some conceptual tools for thinking about those problems. And then, finally, I’ll
turn to the specifics here of, how do you put together an organization that delivers current performance?
How do you put together an organization that can deliver on something new and different that’s
necessary for growth? And then, the Holy Grail of how you do both. And mostly I’ll tell you it’s hard.
But you know that.

Performance

The way we think of performance of an organization, a firm, a school, a government is that there are
three factors that determine performance:

• the environment in which you’re operating

• the strategy you adopt
• the organization you create
Good performance of an organization, which might be profitability, or lives saved in a hospital, or
whatever your measure of performance is, comes from managers finding a proper alignment between
the strategy, the organization, and the environment in which you’re operating. And then, because the
environment’s always changing, maintaining that alignment in a situation of constant change.

Environment

Environment is the stuff that in the first instance you, as a manager, don’t control.
Now, it could be that over the longer term you can affect things like the set of competitors by your
mergers. Or you can certainly affect the technology by the investments you make. But in the short run,
at least, these things are more or less given and beyond your control. Then you have to adapt to them.

1
Esta nota resume la charla introductora del curso del profesor Dr John Roberts de Stanford University, con
algunos ajustes y agregados aclaratorios. Nota preparada por los profs MBA Ing Lorena Veiga y Dr Ing Luis Silva
Domingo de Universidad ORT Uruguay.
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And, importantly, it includes not just the straight market factors2, but also these non-market factors,
which are a tremendously important element to think about in formulating strategy.

Strategy

Strategy is, How are we going to win? How are we going to get control of our destiny so that we shape
things rather than simply reacting to them?”
We differentiate between two levels of strategy:

• At the level of the individual business. “How are we going to create value in this business and get
to keep some of it?”
• At the corporate level the question is “What businesses are we in, and how are we going to create
value over and above what the free-standing businesses could do by having them under common
ownership and management?” So, it’s some theory of a business portfolio, and a theory of the role
of the corporate center.
Now, when we talk about strategy here, too, we’re usually at the level of an individual business, we try
and think of it as involving at least four parts.

• The first is a goal. We want to be the leading academic business school in the world. We want to
beat Intel. Essentially, it’s, “What does it mean to win?” The strategy’s about how are we are going
to win; the goal is a statement of what it means to win3.
• Then the scope is, what are we going to do? What products are we going to make? Where are we
going to undertake these activities? Who are our target customers? Are we going to outsource a lot,
or are we going to do a lot of production in-house? That’s the what, where, why questions of what
business are we in, and, how are we going to carry it out?4
• Then the question is, how are you going to win? How are you going to create value? Basically,
there are two ways. Either you’re going to have lower costs than anybody else, so that you can do
stuff as well as other people, but do it more cheaply and therefore you can make money. Or you
have quality that your customers perceive to be better than the competition.5
• The last part is a logic for all this. How is it that you’re going to take these competitive advantages
and cause them to actually let you achieve your goal in the scope in which you’re operating? That
was something that people forgot about in the Internet boom. Why on earth anyone would want to
buy their dog food online was something missing, even though billions of dollars went into that
business.
So that’s environment and strategy.

2
Una herramienta de rápida aproximación para los factores que influyen y determinan las transacciones en el
mercado es el análisis de las cinco fuerzas, mientras que el análisis PEST permite una revisión de los factores que
a su vez influyen en el mercado (“non-market”).
3
Esta definición estaría dentro del Sistema de creencias (Misión y Visión).
4
Decisiones de estrategia cubiertas en el modelo de negocio: mercado y cliente objetivo, definiciones de
producto, y límites de la organización.
5
Esencialmente, la orientación de estrategias competitivas genéricas de M. Porter.
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Organization

On the one hand, you can think of organization as the means through which strategy is executed.
Having a strategy implies certain activities have to be carried out to deliver on the strategy, and the
organization is what gets those activities carried out. And that leads to a view that structure or
organization follows strategy. This is a view that was popularized by Alfred Chandler, the dean of
business historians, who studied the emergence of the multidivisional form of corporation in the early
part of the 20th century at DuPont, and General Motors, and Sears, and Standard Oil, New Jersey. In
each case, these companies had spread out geographically, spread out in different product lines, and it
became much too complex to manage them as a functional organization, and they invented the
multidivisional company as a response to that. So the structure of the organization followed from the
strategy of diversification and growth.
But at the same time, your organization sets the context for strategic choice for a number of reasons.
One is that organizations don’t change easily. And if they succeed they hang around and, even if they’re
not doing so well, they still don’t change that easily. That means that your administrative heritage, who
you’ve been, constrains who you can be.
The capabilities that are often the key to your success are imbedded in the organization. They’re in the
people. What’s more, the organization shapes behavior and shapes choices. And when does strategy
become real? Strategy becomes real when it involves commitment. When it involves actions from which
there’s no easy turning back.
It’s the actions that people are taking in the organization that are determining what’s really strategic,
what’s really happening. And the organization shapes the behavior, the incentives you offer, the mindset
that you bring to it. John Browne at BP has actually said, “Our organization is our strategy.” And of
course, both viewpoints are right.
The point is that you have to think about the strategy and organization in a holistic way.
The most fundamental responsibility of a general manager is to create a strategy for her organization—
or her part of the firm—and an organization that can carry out that strategy successfully. Both parts are
crucial. You as general managers are what I call organizational designers. You’ve long thought of
yourselves as having a strategic role, but you also have an organizational design role. In some
organizations it’s much more important than the strategic one.
Why do we have organizations? The simple answer, or simple-sounding answer, is to coordinate and
motivate people in contexts where there are interdependencies. Robinson Crusoe had no organization
problem until Friday showed up. Once Friday shows up, they can do more if they specialize.
But that creates interdependencies. Because most of you, I suspect, are like most people in our
economy—on the job on a day-to-day basis, most of us don’t create a single thing that we have any use
for. What we do is we make things that are useful to other people, and they make things that are useful
to us. And then, through the wonders of the market, this all gets straightened out. But that creates huge
interdependencies.
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Organizations are meant to coordinate people so that something sensible gets done, and then to motivate
them to do their part of the coordinated solution. Well, the question is, why not use the market?6
We’ve learned over the past 20 years to worship the market, and to look on the market as the wonder
that it is, in fact. That has an implication already for the boundary of the firm.
But the fact remains that markets sometimes don’t work. In fact, for the most part, even in the United
States, the most market-oriented economy in the world, over two-thirds of all transactions, indivisible
exchanges that go on, go on within managed organizations, not through the market. In fact, though we
call ourselves a market economy, we are an organized, managed economy in many ways.

PARC model

What is organization? It’s a very rich and complex thing. I identify it is as, first of all, a set of people
who are working together for some common objective. And then features that I label as architecture,
routines, and culture. Let’s dig into a little of those a bit.

• First of all, the people. What are their skills? What are their capabilities? What can they do? What
motivates them? Are they in there for the money? Or are they in there to change the world? Or are
they in there for self-actualization? Or all of the above? Or none of the above? What are they afraid
of? What are their attitudes toward life, and work, and risk? What are their professional and personal
interests? These things matter a lot to how the organization functions. Having the right people is
the start, and maybe the finish. So, people.
• Then, architecture. Usually when the term reorganization is used, it means redrawing the
architecture. The architecture’s the formal stuff. It’s, first of all, how jobs are classified and created,
how departments and units and divisions are put together. What’s the hierarchy? All the stuff that’s
on the org chart. It also includes things like the boundaries of the firm: “What’s outsourced, and
what do we do inside?”7 It includes the financing and the ownership and governance, which
obviously affect behavior inside the firm and, therefore, performance. We’ve become very much
aware of that in the last years. All of those are hard mechanical things, contractual things. Crucially,
it also involves the informal networks amongst the people in the organization that are so often the
way that work actually does get done.
• Routines. How work gets done. How do we collect information? How do we make decisions? How
do we allocate resources? How do we measure performance? How do we reward it? What sorts of
formal and informal incentives do we have? So, this is how work gets done. How stuff gets done in
the organization. And some of those are formal and documented, and some of them are not.
Sometimes the formal documented way is the way it’s actually done, and sometimes it’s not. You
all know that.
• Then, culture. For an economist, culture used to be something that I felt kind of vague about. I
thought it was too vague to understand, but the more time I spend with companies, the more I come
to believe that it is crucial. So, what is it? Well, it can be a lot of things. It’s shared values. It’s
shared mental models. Do you interpret the world the way an engineer does or the way a sociologist

6
Esta es la pregunta fundamental detrás de la Teoría de Costos de Transacción, que brinda elementos clave para
decidir si debemos realizar una actividad dentro de la empresa o debemos apelar a un tercero (externalizar o
internalizar una actividad).
7
Dentro del modelo PARC, las decisiones sobre las fronteras de la organización son, sin duda, parte de la
Arquitectura. Sin embargo, es conveniente observar las decisiones de los límites de la organización fuera del
modelo PARC, dejándolo a éste como una herramienta para el diseño de lo que queda dentro de la organización.
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does? Do you see outsiders as enemies, or potential collaborators? Do you see your colleagues
around you as competitors or friends? It’s language, given that it affects behavior and performance.
And it´s norms—shared expectations about what the right way to behave is. These are tremendously
powerful motivators, because they are a social control system.
So, organization, strategy and environment.

Design Problem for performance

You, as organizational designers, actually can work all of those levers. You can obviously change the
architecture. There are computer programs that’ll generate new org charts for you, and the conference
board will sell you books of org charts. So, that’s not a trick. You can change your capital budgeting
procedures, maybe not quite as quickly. You can change your incentive schemes. You can actually work
on the culture. And you can, over time, change the people.
The problem is that all these pieces interact.
You have to understand those interrelationships in your context and then achieve alignment amongst
PARC elements, and alignment with the strategy and the environment. And if you can get them all
working together, you really have something tremendously powerful. Because there are these
interactions and getting them lined up right is the key to getting performance.
Well, how do you even begin to think about that? From microeconomics, from price theory, the idea of
complementarity. Two things are complements if having one makes having the other more valuable to
you. Having a left shoe of this design and size makes having a right shoe more valuable. Extreme
example, but a clean one.
That means when you have complements, you want to have both, do both the things or probably neither
of them. You don’t want just the left shoe. If you’re going to have the left shoe, you want the right shoe,
too. Maybe you don’t want either of them. But you either want both or neither.
Another example. If you’re trying to motivate someone to do multiple tasks, then probably you want to
make the incentives comparably intense, so that either they’re all strong, or they’re all weak. Because
if you give me most of my incentives for making sales versus building customer relationships for the
long run, or bringing information back into the firm about what customers need, I’m going to spend my
time selling. I’m not going to spend my time trying to find out what customers want and then explain it
to the R&D people.
You only get the full effects by doing the whole package. And you can easily spread out over many,
many elements of organization. That means imitation will be hard. That leads you to understand that
organization can be a source of sustainable competitive advantage. If you can put together an
organization that’s hard to imitate and that works well, you can be a winner just from that.
In the early 1920s Ford created the most important industry of the 20th century. At one point, more than
one-half the cars in the world were Ford Model Ts. It was a huge success by any stretch of the
imagination. Ford, as you may recall, had a rather narrow product line. He would sell you any car you
wanted, as long as it was a black Model T. And he had a production facility that was completely geared
to making black Model Ts. When they finally went over to the Model A, they had to scrap every bit of
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capital equipment they had. Nothing survived. Completely inflexible, very narrow product line, fit like
a glove.
Toyota in the ’90s and into this century is certainly the most effective car company, maybe the best
manufacturing company in the world. A lot of people think it is. I visited an engine plant of theirs in
Japan a number of years ago. There was a single assembly line. What was coming off the line everyday
were more than 350 different variants of engine drive transmission fuel system combinations, including
both single- and dual-overhead cam engines coming off the same line. So, 350 variants coming off in
batches of one. Each one that came off the line was different from the one before. So, very great breadth
and very flexible. They can switch over instantly.
You can be in the other place. And, in fact, GM was. General Motors during the 1980s spent more than
the combined market values of Toyota and Nissan on flexible automation and robots, but they didn’t
change any of the other things. They didn’t change their product development strategy; they didn’t
change their HR strategy. They didn’t change their production strategy, even the scheduling of stuff on
the line. As you may recall, at the end of the decade of the ’80s, they set a new world record for losses
by a corporation. Wasn’t all because of this, but this certainly helped. The next year they broke that
record. It’s only in the last couple of years that they’ve started coming back. And I really think that this
was a part of it.

Implications

Mix and match different patterns does not work.

That means you have to beware of consultants coming around selling you best practice. What works in
one company may well work because of other things in that company's organizational design.
Having multiple models in a single organization is a problem. Ford of the '20s and Toyota of the '90s
in the same organization would be a problem. It would be fine to run them separately, but it's natural
that you're going to have to allocate resources between them, human and financial. How do you make
comparisons? And then you're going to have the politics. “Why can't we have their nice, simple jobs
and our pay that's tied to our very complex jobs?” So, it's likely to lead to confusion and conflict.
You can move from one pattern to another. But getting from one coherent pattern to another typically
means you're going to have some period when you don't have good alignment, and performance is going
to suffer before it gets better. An attempt of organizational change.

Organizational Learning

Both performance and growth innovation require organizations to learn, to do something different, to
figure out how to do something different. The organization scholars have come to think about
organizational learning as involving three conceptually distinct stages. The labels they put on them are
borrowed from ecology, and, if you think about it, in a population of cells or animals or whatever,
change there comes through mutation and natural selection.
There's a mutation. If it's a good one, it'll win the battle of natural selection. It'll be more successful in
reproducing and it'll become the dominant form. What we're trying to do is to get from our present
competitive situation to a better one.
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• Variation is identifying new ways of doing things. It might come out of benchmarking against
someone else, it might just come out of people in the field doing their jobs, coming up with solutions
to problems, and you get something different from what you're doing now.
• Selection is determining if they're improvements. Does performance improve? Yeah? Then it's a
better thing to do. Is this new product something that's going to meet customer needs better than
what we're doing, better than what the competition's doing?
• Then retention is sharing and implementing the new way. Some mechanism that leads to the better
ways being institutionalized, being spread through the company, becoming a part of the DNA of
the organization.
The other part of it is the logic of adaptation—that, as the environment changes, the relationship
between strategy and organization and the environment's going to change. You get new competitors, it
changes things. You get new technologies, that changes things. Over time, you have to track that,
adjusting your strategy, adjusting your organization to stay on top.
Searching broadly is a variation that would try things way out here and see if they're better. Searching
outside the current context or the current agenda, outside our competencies, outside our experience
range is very risky, very uncertain, but that's how you're going to get to really something different.

Exploitation and Exploration

Jim March has looked at those two kinds of activities and labeled them, rather effectively, exploitation
and exploration.

• Exploitation is about delivering on the opportunities that are inherent in our current strategy. It's
about, get to the top of the hill that we're climbing and stay there. Variation is search over a limited
range. Pretty clear what the selection would be because we're well experienced with all this. We
know if it's better quickly, and retention can be quick and uniform. If you're exploiting, you're
focused, you have strong, clear goals, measures, discipline. You drive out slack, get rid of any
resources that aren't devoted to delivering on the current agenda. You typically are focused on the
hard elements of architecture and routines. Lincoln Electric is an archetypal exploiter. They for 100
years have delivered on the same strategy, just doing it better and better and better.
• Exploration is about developing new strategic opportunities, new options, new things to do,
completely new products, for example. So, roaming those misty mountains and trying to find them,
find the hills. Search is much broader, much less restrained. Selection. You don't want the selection
mechanisms to be too strict, too hard, because they'll discourage risk taking and search. If you have
to meet really tough financial goals early on, you probably just won't even bother trying. So, you
want to think more in terms of milestones and things like that rather than the kind of financial and
operating measures that you'd look at in an exploitative situation. Retention may be somewhat
problematic. Slack abounds. People are doing all sorts of things that don't immediately deliver on
the current agenda. You probably celebrate failures, if they're well intentioned. 3M is one of the
ultimate explorers.
Both of them are desirable, both may even be necessary at different points in the life of a firm, but doing
both is very tough. Because of the threat that your products are going to die and the markets will die,
you have to explore from time to time. At the same time, you have to exploit. You have to deliver on
your current agenda, and so you have to be what my colleague Charles O'Reilly calls ambidextrous.
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You have to be able to do both at once. But do not charge one person or one group with doing both
tasks.
At best, you're likely to get only a very little of either, so not much performance and not much
innovation, or more likely you'll get absolutely no innovation. Fundamentally, the reason is that the two
require quite different organizational designs, especially on the side of motivation.
Lincoln gives very intense incentives for quantity and very intense incentives for quality. But that may
not be an easy thing to do, to give strong, balanced incentives. And Lincoln innovations are about the
same products and markets. Better and better.
If it's easy to measure a performance in a task, you can easily give strong incentives for it. So,
exploitation: It's fairly easy to motivate because you can measure current results and reward for them.
If you're talking about exploration, though, how do you know if they're doing a good job? The outcomes
are so random they may take years to show themselves. It's really hard to give very strong incentives
there, or you can do it but it's going to be really expensive because you're going to have to compensate
them for the risk they're bearing. You know, you may well be able to do that in a startup where
everybody believes in what you're doing, but in a big company, that's going to be hard to do.
Either you have to give weak, balanced incentives if you want them to do both—and you can do that in
a variety of ways—or you should avoid multitasking these. You should have somebody responsible for
one and somebody for the other.
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Lincoln Electric
Let me talk about another company. Lincoln Electric manufactures arc-welding equipment and the
consumables that go with them. They started making that arc-welding equipment more than 100
years ago. In their U.S. operations they have been profitable every single quarter for more than 100
years now. They have productivity growth that is breathtaking. Most of their competitors have
dropped out of the industry. A hugely successful company.

Its strategy is very simple. They’re going to have good quality, and constantly lower costs that they
will then pass on in lower prices. It’s a low-cost-for-quality strategy. And how do they get it? What do
they do? Well, they are constantly lowering their costs through employee-invented improvements in
how the employees do their jobs—process innovations that come not out of an R&D lab, or an
industrial engineering operation, but the people on the line thinking up better
ways to do their job.

Now, they have a very unusual organization. First of all, whenever they can, they pay piece rates.
So, you finish bending your piece of metal or wrapping your piece of wire, each time you do that you
get paid a certain amount of money. The more you do, the more you get paid.

They also, though, have a bonus. Basically, it’s subjectively determined. It varies tremendously from
employee to employee. But on average it doubles your take-home income. That means that Lincoln
employees make, on average, twice what people in comparable jobs and companies in Cleveland
make. The bonus is paid on the quality of your work, your cooperativeness, the ideas you come up
with, things like that.

Now, piece rates, there are a lot of good things about them. They’re clear motivators. You work
harder, you make more. They’re quite simple to understand.

They’ve largely disappeared, in part because it’s hard to use in an assembly line operation. If I work
faster, it doesn’t do any good if you’re not working faster and you’re the person next to me on the
line. Unions don’t like them because they’re afraid that if one person’s motivated to work hard by it,
everybody else will be forced to work that hard because the standards will be raised.

So, are piece rates a good thing? Probably not, on average. Because otherwise a lot more companies
would use them. Is paying a bonus that doubles your employees’ wages, and makes your pay twice
what it would be if they were at any other company? Is that a good idea? If I’m getting the bonus, it
seems that way. But not many companies do it.

But if you’re going to do the one, you better do the other. And why is that? What’s the biggest problem
with piece rates? The biggest problem with piece rates is that if you pay for quantity, you’re going to
lose quality. If I can make more stuff by skimping on quality, that’s what I’m motivated to do by being
paid piece rates.

What does Lincoln do? Lincoln says, “You have to have the quality. In fact, we will stencil your name
on each piece that you work on. And if your quality is good, you can get a big bonus. If your quality’s
bad, we’re going to dock that bonus. In fact, if something fails in inspection that was your fault, you
have to redo it on your time, no pay. And your bonus may get docked. If it fails in the field because
of your fault, you lose 10 percent of your bonus—5 percent of your income.” Just like that!

What we have are two things that are complementary. If you’re going to pay for quantity, you better
pay for quality as well.

In fact, the other thing they pay for is cooperativeness. Will you help out in an emergency, which, if
you’re being paid for quantity, you don’t want to do? Let somebody else handle that.
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These things motivate people to figure out how to do their jobs better. They’re very strongly motivated
to figure out how to do their jobs better because they’ll get better quantity and quality, and that directly
means more pay.

But one of the things you worry about is that if you keep getting better and better and better, and
more and more productive, you might just work yourself out of a job—or at least, work your buddy
out of a job. So, Lincoln has a permanent employment policy. After six months, no lay-offs. And they
have managed to hold to that through the depression of the 1930s on up to today. Maybe they won’t
be able to do it tomorrow, but they have managed to hold to it.

It takes a huge amount of trust to make a system like this work. You have to first of all trust
management that they’re not going to—as soon as you work hard—raise the quota or lower the piece
rate.

In fact, they have a whole lot of things that try and make sure that workers and management don’t
think of themselves as “us” versus “them.” Right from the time of World War I, they’ve had an open-
door policy. They’ve had workers, like worker councils, that meet with management. They do all their
promotion from within, which means the people that are doing the judging used to be these other
people. Most of the ownership is, in fact, with the employees and the founding family. And there’s a
very strong ethic that the bosses aren’t treated any differently. The CEO
of Lincoln makes about $300,000 a year.

The other place you need trust is if you’re going to have 50 percent of your income riding on a
subjective evaluation. You have to trust that your supervisor is going to treat you honestly. These
same mechanisms help build that trust.

These things all make this work better. They’re all complementary with this. So, you start thinking
about these pieces, and Lincoln is always out there talking up how it does things. Hardly anyone
copies it. The reason is that it’s very hard to get the trust from the outset.

3M
3M has multiple labs. They don't attempt to coordinate between them as to what gets done in one
lab, what gets done in another, but there are a lot of linkages directly between the scientists and
engineers and also the sales staff are linked to the R&D people and they are charged with bringing
back, “What are the problems that our customers are facing that we can solve?”

They have a policy that technology belongs to the company, even if products belong to the divisions.
If a division comes up with a new technology, other divisions are free to take it. So, something that
came up in medical products might be used in industrial products.

They have dual career ladders. To get ahead, you don't have to become a manager. You can stay a
scientist or engineer. Reward comes as recognition. They have this policy called bootlegging. You're
entitled to spend 15 percent of your time on stuff that isn't part of your job, on looking for neat things.
They tell stories about the guys who were told to give up on some idea, that it was a dead end, and
refused and carried it through.

In fact, the previous CEO used to tell explicit stories about people who he told, "Stop working on that.
It's a dead end." And they didn't. They ignored him. They carried it through and they brought it off as
a new product. You can imagine what a CEO telling a story like that, what kind of signal that sends.

They go for niche markets, which means they don't have to come up with a hydrogen bomb every
time. It's a massively innovative company.