Case 13 Philips, N.V.

Teaching Notes Copyright © Charles W.L. Hill, 1994 Synopsis

This case considers the large Dutch multinational electronics company, Philips NV,

transformation of global strategy and structure during the 1980s and early 1990s to meet

environmental competition. The case opens with the history of Philips from its founding in 1891

until the early 1980s when it evolved into a classic multi domestic company. Rapid changes took

place in the operating environment during the 1960s and 1970s, making the multi domestic

strategy inappropriate. Philips made organizational and strategic changes during the 1980s and

early 1990s to transform the company from a multi domestic to a transnational corporation.

Teaching Objectives

1. To show how changes in the competitive environment require to change company strategy and

structure.

2. To demonstrate the importance of achieving a close fit among strategy, structure, and

environment.

3. To discuss the relative merits of multidomestic, global, and transnational strategies and

structures to compete in the global marketplace.

4. To build appreciation for the difficulties of transforming the strategy and structure of an

organization as large and complex as Philips. The Philips case is best used after Chapter 3 on the

international environment. It can be an in-class discussion about global competition, global

strategies, and organizational change. Although the case is short, the discussion takes a full class

period. The best teaching plan is to identify environmental changes facing Philips in the 1970s.

Ask why Philips had low profits during the 1970s. The answer is that its strategy and structure

were no longer appropriate to its environment, and the result was poor performance. This opens

the discussion of Philips strategic and organizational changes needed to survive in the 1980s and

1990s. The conclusion is that Philips must pursue transformational change in strategy and

structure to become a transnational corporation. This leads to the next issue the impediments to

organizational and strategic change at Philips and this discussion reveals the sources of

organizational inertia.

Issues and Discussion Questions

1. How did the environment that Philips faced change during the 1960s and 1970s? What

were the implications of those changes?

A number of key changes took place in the operating environment during the 1960s and

1970s. Specifically:

A. falling trade barriers as a result of GATT and the EC paved the way for greater

international competition and facilitated the emergence of companies pursuing a global

strategy.

b. Japanese companies emerged as world-class competitors in Philip major markets.

Matsushita and Sony used a global strategy to drive down production costs and price

competitively. Matsushita originally produced its products in Japan and exported

globally. By serving the world market from a single, low-cost location, Matsushita reaped

economies of scale and location, which helped undercut Philips prices.

c. The fixed costs of developing new products rose. Amortizing these fixed costs required

companies to reap substantial scale economies, which in turn implied that a global

strategy was optimal.

d. The pace of innovation accelerated, and product life cycles became shorter. The rapid

obsolescence of products made it important to serve the world market from a single, low-

cost location to capture all possible scale economies, thereby amortizing development

costs. The increased pace of innovation in electronics requires that companies be fast and

successful innovators.

e. As global markets emerged in the electronics industry, issues of dominant design

became important. This became clear in the battle between the Betamax and VHS

formats for videocassette recorders. Setting global technological standards became a key

source of competitive advantage. These changes made the world electronics industry

more global. In the language of Chapter 8, the pressures for global integration increased

while the pressures for local responsiveness declined. At the same time, competition

based on innovation increased. To succeed in consumer electronics in the 1980s and

1990s, companies had to realize location and scale economies, amortize the fixed costs

associated with product development, establish their technology as a dominant industry

design, and excel at new product development.

2. Why did Philips have low profits during the 1970s? Why did this situation persist during the

1980s?

The basic theme here is the lack of fit among strategy, structure, and environment. Philips was a

multi domestic company in a global environment. The changes implemented during the 1980s

were only cosmetic. The basic character of Philips was still rooted in strongly independent

national organizations and a top-heavy bureaucracy in Eindhoven. Philips was not optimally

organized for product innovation as a company competing in the electronics industry needs to be.

As a result, profits were low. Specifically:

a. Philips had a global matrix structure based on national organizations and product divisions.

The national organizations were responsible for day-to-day operations (manufacturing and

marketing) and strategy implementation, whereas product strategy was determined jointly by

worldwide product divisions and national organizations. The product divisions were responsible

for new product development although some R&D was undertaken within major national

organizations.

b. In practice, within this global matrix structure, national organizations were dominant. This is

shown by the U.S. national organization decision to reject Philips own V2000 VCR format in

favor of Matsushita VHS format, despite protest by the product division. Managers from national

organizations populated Philips10-person board. Although the board was to arbitrate disputes

between worldwide product divisions and national organizations, it was biased toward the

national organizations.

c. The dominance of the national organizations over the product divisions resulted in duplication

of manufacturing facilities and a lack of coordinated global strategy for new products. This

duplication led to a lack of location and scale economies plus high operating costs. The lack of

global coordination limited Philips ability to establish worldwide technological standards,

putting it at a competitive disadvantage Matsushita and Sony. Marketing was carried out in the

national organizations, while R&D was carried out in the product divisions, leaving a

coordination gap between the two functions. This gap harmed product development (i.e.,

products were poorly commercialized).

d. For historical reasons, the technical and commercial sides of the business were split.

Competition between technical and commercial managers paralleled the lack of integration

between production and R&D hand and marketing. The consequences were poorly

commercialized products and slowness in bringing products to market. Since product innovation

is important in this industry, this aspect of Philips structure and administrative heritage could

explain the low profit rate. e. A further organizational drain on efficiency was the top-heavy

headquarters bureaucracy. Most of the head office staff had experience with and were loyal to

the national organizations. They were out of touch with customers and protected their own

interests rather than value creation. They prevented a shift in the matrix from national

organizations to product divisions. The root cause of Philips poor performance is a dysfunctional

structure, poorly aligned with its environment.

2. What must Philips do to survive?

Philips must adopt a transnational strategy and manage its global matrix and structure better.

Strategically, Philips must do the following. a. Reduce costs by eliminating duplication and

enhancing location and scale economies. It should serve the world market from a few choice

manufacturing plants based in optimal locations (from a factor cost perspective). The company

probably still needs local responsiveness. There may be a need for some customization of

marketing strategy and, perhaps, product attributes. b. The company must become more

innovative, introduce products more quickly, engineer simultaneous worldwide product

introductions to establish technical standards, and better commercialize its technology. c. The

company should seek strategic alliances with other major consumer electronics companies to

achieve three goals:

(1) Share the costs and risks associated with developing new products,

(2) Improve core competences

(3) Help achieve new technical standards. With regard to structure, Philips needs to do the

following:

A. the product divisions should have the most power in the global matrix. Under Van de Klugt

and Timmer, the company has moved rapidly in this direction. When the product divisions

dominate the organization, Philips can rationalize production and eliminate duplication. Making

product divisions major units can build ties between marketing and R&D. This should improve

the new product development process. When product divisions dominate, the company will

engineer worldwide simultaneous new product introductions, necessary for technical standards.

b. Demands for local responsiveness particularly in consumer electronics indicate that the

company must retain its national organizations. The national organizations need some control

over marketing and national strategies. Philips needs a matrix, but one in which the product

divisions dominate.

c. The company must reduce its headquarters bureaucracy.

d. Somehow the company must eliminate the damaging intra company conflict between product

divisions and national organizations and between the commercial and technical sides of the

business. It must build a culture of shared values. This requires management education

(reeducation) on a massive scale within Philips. (Philips is currently pursuing just such a

management education program.)

4. Identify the sources of inertia within Philips. How can inertia be overcome?

To change its strategy and its structure, Philips must overcome internal inertia. Inertia forces

within Philips have slowed the change process and contributed to poor performance. The inertia

forces are:

a. The Eindhoven bureaucracy. Large, entrenched, and with close ties to the national

organizations, the headquarters bureaucracy has stifling change at Philips. Resistance by the

Eindhoven bureaucracy to change makes sense managers have the most to lose from a company

realignment that increases the power of the product divisions.

b. Administrative heritage. The administrative heritage of Philips includes a value system that

pits the technical and commercial sides of the business against each other. It rates experience in

the national organizations over experience in the product divisions. This value system and

cognitive biases act as a barrier to change.

c. Organizational Design. Until the mid-1980s, at least, Philips administrative heritage was

reinforced by a design that gave the heads of national organizations more power and influence

than divisional heads. The heads of national organizations would resist a decrease in their power

and an increase in that of product division managers.

d. Lack of new blood. Although Philips has a global reach, the company is really run by the so-

called Dutch Mafia. The top managers are all Dutch, and most have a long history of service at

Philips. As a consequence of this inbreeding, Philips managers lack the ability to see things from

a different perspective. Their existing cognitive schemes prevent change. Overcoming these

inertia forces requires a number of steps:

A. bold leadership and vision. All studies of organizational change emphasize the importance of

leadership for transformational change. Philips needs to change its culture, starting at the top.

The appointment of Timmer as CEO in 1990 signaled change. Timmer was the first Philips CEO

to have come from the product divisions an important symbolic change. Note though that even

Timmer was reluctant to introduce significant restructuring until the investment community

insisted.

b. Cultural change. Philips must change its culture, which is based on its own heritage. Managers

need a massive reeducation program to socialize them into a new value system that stresses

cooperation between the technical and commercial side and emphasizes the dominance of the

product divisions. New blood from outside Philips must be added plus promotion of non-Dutch

nationals to senior management positions.

c. Structural change. Philips must change its structure, and this has been the greatest area of

progress. In 1987 Van de Klugt initiated a restructuring that increased the power of the product

divisions by placing product division heads in the main management group and removing the

heads of national organizations.

d. Downsize the Eindhoven bureaucracy. This is a must, yet Philips has been slow in this area.

This bureaucracy is a major source of resistance to change. Its power must be cut by downsizing

and reassigning staff personnel to product divisions.

CASE 3

CONTINENTAL CAN COMPANY OF CANADA, LTD.

Teaching Notes Copyright Gareth R. Jones 1994 Synopsis

The case allows an in-depth analysis of a mechanistic structure and allows students to apply the

organizational theory concepts from Chapters 4, 5, and 6. It should be used after Chapter 6, and

the TRW Systems case should follow (a two-class sequence) to illustrate the workings of an

organic matrix structure. This sequence exposes the meaning and significance of the

mechanistic-organic distinction and provides an example of contingency theory. CCC is in a

stable environment, uses a mass-production technology, has simple tasks, and uses a mechanistic

structure, while TRW is a high-tech company, employs highly skilled people, operates an

intensive technology in a dynamic, changing environment, and uses an organic structure.

Students should not be asked to provide a written report on this or the TRW case. These cases

should be presented by the instructor to bring out interesting and valuable implications and

protect their teaching value. Continental Can Company of Canada, Ltd. (CCC) is about a routine

mass-production organization that is experiencing conflict between the manufacturing and sales

departments. Manufacturing has all the power, and managers are rewarded for reducing costs and

increasing efficiency. They have no incentive to be responsive to the needs of the sales

department. Sales are declining somewhat and quality is going down. The issue is how to change

the way the company operates and improve its effectiveness.

Teaching Objectives

1. 2. 3. 4. 5. To use organizational theory concepts to analyze an organization. To show the

design choices that create a mechanistic structure. To link organizational design to the

contingency approach. To demonstrate a classic example of production-sales conflict. To show

the power of a budget in shaping expectations and behavior.

Use this case after United Products, Inc. or Bennett Machine Shop. It takes about an hour to

analyze the issues and see how organizational structure operates.

Pop Quiz Questions

1. What structure does the St. Laurent plant use? Answer: Functional structure

2. What structure does the Continental Can Company as a whole use? Answer: Geographic

structure

Issues and Discussion Questions

1. What kinds of organizational design choices has CCC made about the four design challenges?

a. Vertical Differentiation:

There are six levels in the hierarchy, including shop floor employees, and 500

employees. This means that CCC has a relatively tall structure. Fox, the plant manager,

has a span of control of 8 subordinates and Andrews, the assistant plant manager, has a

span of control of 15 subordinates (there are three shifts). Is this too big? No,

subordinates are all doing similar, routine work, and they are all in manufacturing-related

functions, so it is easy to monitor and evaluate activities. Is CCC centralized or

decentralized? CCC is highly centralized: Fox and Andrews solve problems at the top.

The information gives the impression that foremen have a high level of decision-making

authority, and some students will argue that this implies decentralization. The point is to

look at where important or significant decisions are made in the hierarchy, and this is

always higher up in CCC. People lower in the hierarchy handle only routine problems.

CCC is tall and centralized.

b. Horizontal Differentiation:

Inside the St. Laurent plant, is there a high or a low level of horizontal differentiation

division of labor and specialization? There are many different departments shown in

Exhibit 1, but all are manufacturing oriented no sales, research and development, or

finance. There is a low level of horizontal differentiation; it is a simple organization or a

low level of complexity. What kind of structure is it? A functional structure: The main

function is manufacturing. CCC makes a wide variety of different kinds of cans; the other

functions are manufacturing support functions like production control and quality control.

At the company level, it uses a geographic structure because different plants are located

in different parts of Canada. Why does it have many plants? Why not just one big

functional structure?

There are high costs of transporting bulk commodities like cans. The needs of regional markets

differ. There is a large variety of different products. To obtain economies of scale; one large

plant might experience diseconomies.

So, the St. Laurent plant has a tall, simple, centralized functional structure, and CCC has a

geographic structure.

c. Integration Mechanisms:

Integrating mechanisms include:

Budget Bi-weekly production control meetings at which quality control is not present Formal

once-a-month budget meeting Some unscheduled meetings

Conventional integrating mechanisms fit the low level of differentiation when a company has a

low level of differentiation; it requires only a low level of integration.

d. Standardization Mutual Adjustment:

Rules and procedures, including the budget, control the manufacturing process. There is

a high level of standardization, and little use of mutual adjustment. Manufacturing

managers share a common language of efficiency and economy.

e. Formal-Informal Organization:

The informal organization parallels the formal. Social networks among managers are

based on the ability to influence and affect the manufacturing process, and the budget

gives all the power to manufacturing. There is little cross-functional communication.

2. Given these design choices. How would you describe CCC approach to coordinating and

motivating employees?

With its tall, highly centralized, highly standardized, and simple functional structure, the

company has created a mechanistic structure to coordinate and motivate employees. The

emphasis is on top-down communication, roles and authority relationships are clearly

defined, and there is a high level of personal supervision and control.

3. Are CCC organizational structure and design choices appropriate?

The company has specific problems, but in general the mechanistic structure is appropriate,

given efficiency-driven approach. From a contingency perspective it matches:

Its routine mass-production technology. This is the typical structure for a mass-production

setting. Its relatively routine, stable environment. Its low-cost strategy The low level of skills and

participation it expects from its workforce.

The material on technology and the environment has not been covered yet, so this discussion can

only be brief. However, if the case is used late in the course, the contingency approach can be

drawn out in more detail. With the structure identified and the reasons why it is appropriate

outlined, the analysis can consider the company problems and how its structure contribute to

them.

4. What problems are occurring in the St. Laurent plant?

The basic problems are:

High level of conflict and lack of integration between manufacturing and sales Falling

sales and a lack of response to customer needs Deteriorating product quality Lack of

cooperation and trust between foreman and schedulers

5. Why are these problems occurring?

a. Subunit orientation. Managers at the St. Laurent plant have a manufacturing subunit

orientation. This orientation results from their interests, backgrounds, and experience; they have

little interest in sales. b. The budget. The St. Laurent plant is organized as a profit center, and a

strict budget is used to evaluate plant performance. All the manufacturing managers yearly

bonuses are linked to targets set in the budget. The result is that the budget limits their behavior

because they must meet the budget and reduce costs. Customer responsiveness and quality are

not rewarded only reducing costs so managers have no incentive to respond to the needs of sales.

Machines are not serviced enough, and this reduces quality and results in customer returns. c.

Incompatible goals. Some conflict between sales and manufacturing is inevitable because of

incompatible goals. Manufacturing goal is to reduce costs, by maximizing the length of

production runs to minimize the downtime to retool to produce different kinds of products.

Downtime raises costs. Attempting to maximize production runs means that manufacturing is

unresponsive to customer needs, particularly to late customers, who are out of cans. So sales

suffer when manufacturing refuses to meet customers’ requests. Manufacturing is pursuing

efficiency goals at the expense of effectiveness goals. d. Structure. In CCC, plant managers have

no incentive to respond to sales requests, and they control operations. Plant managers have all

the power in the tall, centralized hierarchy and sales have none. The low level of differentiation

at the plant level sales is not even inside the plant promotes manufacturing. The tall, centralized

functional structure and the mechanistic, production orientation compound the problem produced

by the budget and employees backgrounds. There is a power imbalance resulting in falling sales,

falling quality, and increased returns. Only manufacturing goals are pursued in the St. Laurent

plant. How can the power balance be altered? How can CCC structure and the budget encourage

a concern for sales and customer responsiveness?

6. Draw a diagram of the key roles in the plant to show where problems are occurring. Draw a

map of the key reporting relationships to illustrate where problems occur?

Andrews, the assistant plant manager, reports to Fox, the plant manager, who reports to a

corporate executive. The district sales manager is outside the plant and also reports to a corporate

executive, not to Fox. These corporate executives report to a common superior, so that the

nearest common point of authority between Fox and sales is two levels up in the corporate

hierarchy. This makes it difficult for sales to exert power over Fox. Inside the plant, Andrews

oversees the foremen who are responsible for the production process in three shifts. The other

key functions or departments are production control, headed by Whitelaw, and quality control.

Production control responsibility is to plan the manufacturing process to mediate between

manufacturing cost reduction and sales customer responsiveness. Because manufacturing has the

power, the needs of sales are not being met. Quality control is similar to production control:

Quality is falling, but Fox and Andrews want to reduce costs, meet the budget, and get their

bonuses. Whitelaw is in charge of those who schedule the production runs, and who have a

dotted-line relationship with the foreman. This means that foremen-schedulers have an informal

responsibility to coordinate activities, but no formal reporting relationships. It is easy to see that

production is in control.

Assistant plant manager

Plant manager Corporate executive

District sales manager

Common superior

7. What changes should be made to the way the St. Laurent plant is operating to solve its

problems?

a. Changing the budget. The budget is an important mechanism for maintaining cost control;

however, targets could be relaxed. Or a sales-related goal can be added. Increased product

quality could be rewarded by measuring reductions in the number of returns, or increased

customer responsiveness rewarded by measuring decreases in the time to satisfy customer

requests. Changing the budget changes the incentives and motivation of production managers. b.

Changing the structure. Students can offer suggestions about changing reporting relationships to

force Fox to pay attention to sales and to change manufacturing managers orientations. Usually,

students want to alter the hierarchy and give sales more power than production; however, this is

difficult without upsetting the balance of power. Some common suggestions include:

Have sales report to Whitelaw, the production controller. Problem this would further reduce sales

power because sales is lower in the hierarchy. Put the sales manager in charge of the whole plant.

Problem it a manufacturing plant; production people must be in control. Bring in a new plant

manager and have sales and Fox report to the new person. Problem this lengthens the hierarchy.

There is the possibility of assigning a sales manager who reports to Fox and to the district sales

manager. Making Fox responsible for sales forces him into a sales viewpoint and brings sales

into weekly and monthly meetings. Both Fox and the district sales manager report to the same

corporate executive, who can put pressure on Fox. This gives more power to sales and balances

power. Sales, production control, and quality control can band together to put emphasis on sales

and quality goals in meetings. With a new budget, production managers may change orientations,

operations, and show concern for efficiency and effectiveness.