chakravarthy henderson wp 2007 01 level 1

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From a hierarchy to a heterarchy of strategies: Adapting to a changing context

Bala Chakravarthy and James Henderson

IMD 2007-01

Bala Chakravarthy Shell Chair Professor of Sustainable Business Growth

IMD Chemin de Bellerive 23

CH-1001 Lausanne Switzerland

Email: [email protected] Tel.: +41 21 618 0171 Fax: +41 21 618 0707

and

James Henderson

Professor of Strategy IMD

Chemin de Bellerive 23 CH-1001 Lausanne

Switzerland E-mail: [email protected]

Tel : +41 21 618 0370 Fax : +41 21 618 0707

Copyright © Bala Chakravarthy and James Henderson February 2007, All Rights Reserved

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From a hierarchy to a heterarchy of strategies: Adapting to a changing context

Bala Chakravarthy James Henderson

IMD International Institute for Management Development

Lausanne, Switzerland

Abstract Purpose of the paper: The purpose of this paper is to question the continued usefulness of the hierarchy of strategies framework and to propose a new approach. Methodology/Approach: Reviewing extant literature and theorizing a new approach. Findings: The hierarchy of strategies was a useful framework when it was first proposed, but since then a changed business context has made this framework obsolete. What is needed instead is a framework around a heterarchy of strategies. The locus of decision making is no longer hierarchical and corporate, business and functional strategies are far more interdependent and interlinked than they have been in the past. Research Limitations/Implications: Research on a hierarchy of strategies has run its course. Future empirical and theoretical work should focus on a heterarchy of strategies. Practical Implications: The paper provides a framework for managers whether from corporate, business divisions or functions to help with the continuous renewal of their firm. Originality: Prior empirical and theoretical strategy research has taken the hierarchy of strategy framework for granted. The original contribution of this paper is to propose an alternative framework around a heterarchy of strategies. Keywords: hierarchy of strategies, heterarchy of strategies, continuous renewal Article Type: Conceptual paper

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From a Hierarchy to a Heterarchy of Strategies:

Adapting to a Changing Context

Introduction

Strategic management has the ambition to be the field that informs the decisions and

actions of general managers. In pursuit of this high goal the field has from time to

time worshipped at various theoretical altars, both in economics and sociology. For

example, it has looked to industrial-organization and transaction-cost economics,

agency, network, contingency and, more recently, resource-based (or its cousin the

dynamic-capabilities-based) theories of the firm, for inspiration. While some of these

theories have helped guide general management decisions and actions, many have

been hard to operationalize. The field still lacks an actionable theory.

While theoretical anchors are seen as giving the field academic respectability,

strategic management has helped practitioners more by its frameworks and typologies.

The traditional hierarchical view of strategies: corporate, business unit and functional,

must be viewed in this light. While the hierarchical view of strategies has never had

the pretensions of being a theory, it did capture the essence of what was seen as best

practice in the 1960s and 1970s. It was a useful framework.

While the hierarchy of strategy is still often taught in business schools today, its

theoretical relevance and empirical support have been severely questioned. It does not

mirror the actual locus of decision making or the causality of strategy making in a

global firm today. In a transnational firm, the corporate office continues to drive

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corporate strategy for optimal portfolio balance. But this portfolio is defined not just

along business lines but also along geography and resource dimensions, traditional

prerogatives for business units and functions Business units and functions are run

globally and heads of these business units and functions are also corporate officers.

Strategic initiatives at a business or functional level may indeed drive the

development of corporate strategy, which, in the hierarchy of strategy, is viewed from

the top down

Corporate, business and functional strategies are not hierarchical anymore; they are

contemporaneous and interactive. Instead of a hierarchy of strategies, we should think

more in terms of a heterarchy of strategies (Hedlund, 1986). In a hierarchy every

strategic decision making node is connected to at most one parent node. In a

heterarchy, however, a node can be connected to any of its surrounding nodes without

needing to go through or get permission from some other node.

We will review in this short article both the antecedents of the hierarchical view and

why it was seen to be useful followed by its limitations and growing irrelevance to the

strategic management challenges of today. We conclude the paper with a brief

description of what corporate, business and functional strategies look like in a

heterarchical world.

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Hierarchy of strategies: A framework for its time

Two of the classics in the field of strategic management, the first by Ansoff (1965)

and the other by Andrews (1971), both had Corporate Strategy in their titles. Strategy

making, at the time, was considered the sole preserve of the firm’s corporate officers;

hence the term corporate strategy. Only with the eventual democratization of strategy

making did a hierarchy of strategies begin to emerge.

The origin of the hierarchical view of strategies dates back to the 1920s when some of

the largest US firms started pursuing a strategy of diversification. At that time, these

firms were typically organized functionally. But diversified growth using these

organization structures soon led to severe coordination and resource allocation

problems. Top management, in firms such as Dupont and General Motors, responded

to this problem with the creation of the multidivisional organization structure, or the

M-Form (Chandler, 1962).

Following Chandler’s (1962) pioneering work showing how a strategy of

diversification led to the use of a multidivisional structure, other researchers sought

theoretical reasons for the emergence and adoption of the M-form organization

structure. Using transaction cost economics reasoning, Williamson (1975) argued that

the M-form was adopted because it did a better job than capital markets in allocating

scarce capital between competing investment proposals. He suggested that both the

monitoring and policing costs were also lower in the multidivisional structure when

compared to capital markets.

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However, the multidivisional structure was itself becoming unwieldy. Leading firms

like General Electric (GE) invited McKinsey & Company, one of the founders of the

now flourishing management consulting industry, to examine its corporate structure.

GE had at that time nearly 200 profit centers and 145 departments. The McKinsey

consultants advised GE’s top management to organize their firm’s businesses along

strategic lines, influenced more by external industry conditions than internal

organizational considerations (Ghemawat, 1997). GE’s profit centers and departments

were consolidated into a smaller number of Strategic Business Units (SBU).

Each SBU became a stand alone entity deserving of its own strategy and dedicated

functional support. While corporate strategy was concerned with domain selection

(the portfolio of businesses that the firm should have in order to deliver value to its

shareholders); business unit strategy was concerned with domain navigation

(competitive positioning of each of the firm’s business within its industry

environment). Finally, functional strategies specified the contributions that were

expected from each function and their relative salience to the success of the firm’s

business strategy.

Corporations also turned to consultants for answers regarding resource allocation.

Starting with BCG’s growth share matrix, numerous other consulting firms introduced

portfolio planning matrix as an answer to the resource allocation problem. The two

axes of the matrix were typically the industry’s attractiveness and the company’s

position within the industry. Each of the corporation’s strategic business units could

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be mapped onto this matrix. SBUs with strong market positions in growing industries,

the “star” businesses, were lavished with additional resources; even as SBUs with

weak positions in stagnating or declining industries, the so called “dog “ businesses,

were slated for divestment. By the mid 1970s, portfolio planning became very

popular. Indeed, by the early 1980s over half of the Fortune 500 had introduced

portfolio planning techniques (Haspeslagh, 1982).

Further, in order to bridge the multiple levels of decision making within the firm top

management needed a process. Formal planning and control systems began filling this

void. A study by Stanford Research Institute showed that a majority of US companies

used formal planning systems by 1963. Vancil and Lorange (1977) and Lorange

(1980) describe three distinct phases in a typical strategic planning process: agenda

setting, strategic programming and budgeting. Aspirations of top management when

cycled through these three phases and three layers of management (corporate,

divisional and functional) resulted in concrete budgets for business units and functions

within the firm. When the three phases were followed in a rigid sequential fashion,

the intent was frozen when strategic programs began to be developed. In turn, the

programs were non-negotiable once budgets were decided.

By the early 1980s, with the diffusion of M-form structure, the creation of SBUs, the

adoption of formal planning systems and portfolio planning techniques, the separation

of business unit and corporate strategies was complete in the US and Europe.

Functional strategies had to be subservient to the business strategies that they

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supported, and business strategies in turn had to be aligned with the firm’s corporate

strategy.

Furthermore, this hierarchical view of strategy was also mapped on to levels of

management within the firm. The locus of decision making for each strategy was thus

clearly specified. The corporate office was the primary architect of strategy.

Divisional managers helped in a more restricted fashion by detailing their business

strategy within strict corporate guidelines. Functional managers supported their

divisional heads with well aligned functional strategies.

It was assumed then that this unidirectional causality and hierarchically determined

locus of decision making was the sine qua non for superior firm performance. No

theoretical basis was provided for this assertion. Nor were there systematic empirical

studies conducted to verify this claim. The assumption was that since the framework

emerged from the practices of high performing companies like General Motors,

Dupont, ITT and GE, it had to have universal appeal. It appeared to be a useful

framework in practice and that seemed to have sufficed.

However, the hierarchical view of strategies has since unraveled because of both

empirical and theoretical developments on corporate, business and functional

strategies. It has also lost its relevance today mostly because strategic management

has changed dramatically due to an increasingly turbulent business context

(Chakravarthy, 1997). Strategy making in a transnational corporation cannot afford to

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be hierarchical. It has to be more inclusive and heterarchical. We will examine next

these challenges to the hierarchical view of strategies.

The empirical challenge

The portfolio planning models used in diversified firms were severely criticized on

several grounds. First, industry growth as a proxy of industry attractiveness or relative

market share as a proxy for company position, were seen as too simplistic. Second,

these matrices were also open to multiple interpretations leading to the same business

being variously described as a dog, cash cow or even star (Wind et al, 1983). Third,

portfolio planning tools stated nothing about the potential synergies that obtained

across the firm’s business units. Finally, they provided the corporation’s business

units meaningless directives (such as “grow,” “harvest,” or “divest”) for dealing with

their competitive realities (Gluck and Kauffman, 1979).

Academic researchers also began focusing on the links between diversification

strategy and firm performance (see Ramanujam and Varadarajan, 1989 for a review.)

The research tended to show that corporations with a portfolio of unrelated businesses

(e.g. conglomerates) or set of vertically integrated businesses performed far worse

than corporations with a portfolio of related businesses (Rumelt, 1982). Unless the

firm’s corporate strategy explicitly worked for synergies across the firm’s businesses,

its shareholders gained very little by trusting the firm’s top management to allocate

resources on their behalf.

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The linear and top-down view of strategy making was also challenged, notably by the

work done by strategy process scholars. One of the pioneering studies on strategy

process showed that strategy making was not top down as suggested by the

hierarchical view of strategies but was essentially bottom up (Bower, 1970). In a

detailed field study, Bower found that strategy originated from the “discrepancies”

(something needed to change) experienced by functional managers, then given

impetus by business divisional managers and finally approved by top management.

Another influential researcher, Mintzberg (1994), had similarly argued against the

over reliance on planned strategies and the linear top down conceptualization of

strategy making. He provided numerous empirical examples of strategies that had

“emerged” with apparently little planning. Additional studies in strategy process kept

chipping way at the hierarchical view of strategies (Chakravarthy and White, 2001).

Following Simon (1945), Bower (1970) suggested that the role of top management

was not so much to make strategic decisions, but rather to set the premises for these

decisions by shaping the strategic and organizational context of the firm. More recent

research on strategic planning and control systems (Chakravarthy and Lorange, 1991;

Lorange, 1980; Simons, 1994) has sought to describe how strategic planning systems

can themselves set such a context. These newer studies suggest that the degree of

interactions and iterations in a firm’s planning system have an important role in

determining whether the strategies its managers pursue will explore new strategy

frontiers and seek new competencies or exploit existing markets and competencies

(March, 1991).

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The theoretical challenge

The changing definition of corporate strategy

Agency theory began questioning the wisdom of trusting corporate managers to make

the right resource allocation decisions on behalf of the firm’s shareholders. In the mid

eighties, shareholder activism and leveraged buyouts opened up a market for

corporate control (see Jensen, 1989 for a review). Questions were raised as to who

was the right corporate parent for the businesses in a firm’s portfolio.

At the same time, the development of the resource based view of the firm showed that

synergy benefits did not come from the relatedness across product markets but from

the underlying competencies across businesses. Indeed, Wernerfelt and Montgomery

(1988) showed how a corporation was constrained in terms of its diversification

distance not because of product-market relatedness but because of the specificity of

the underlying resources and their transferability into different businesses.

Corporations with more general resources seemed to diversify across a wider variety

of industries.

Thus, the definition of corporate strategy expanded to not only include which

businesses to be in but also how to manage those businesses: through coordination,

control and organization such that the total value of the corporation was greater than

the sum of each business unit value as a standalone entity (see Collis and

Montgomery, 1995 or Goold and Campbell, 1987 for a review).

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The ascendance of business strategy

By the early 1980s, heightened competition especially from Germany and Japan,

shifted top management attention to competition, competitive strategy, and

competitive advantage. Corporations, such as GE, became less fixated on synergy and

more interested in making each of their businesses #1 or # 2 in market position vis-à-

vis their global competitors. Academic research picked up on these concerns rather

quickly. Building on Industrial Organization research, Porter’s (1980) work on

industry analysis and competitive strategy came as a big relief. Business strategy was

elevated to the same if not greater level of importance than corporate strategy..

Growing importance of functional strategies

Competitive advantage, according to Porter (1985) stemmed from the “fit” of the

discrete activities that a firm performed in designing, producing, marketing, delivering

with its business unit strategy. The disaggregation of businesses into their component

activities in Porter’s value chain heightened the importance of functions to

competitive success. This led to the emergence of specialized functional consulting

firms in marketing strategy, supply chain strategy, manufacturing strategy, and the

like.

Research on “functional strategies” started to appear in the academic literature (see

for example: Wheelwright, 1984, Swamidass and Newell, 1987 for manufacturing

strategy; Varadarajan and Jayachandran, 1999, Dickson and Ginter, 1985, for

marketing strategy, Dyer, 1984, Lengnick-Hall and Lengnick-Hall, 1989 for human

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resource strategy, Johnson, 1984, Miller, 1995 for R&D strategy). Functional

strategies were not merely subservient to business and corporate strategies but in their

own right were important to the competitive success of the firm. Indeed functions

were the homes of many of the firm’s distinctive competencies.

Towards a heterarchy

The hierarchy of strategy has become irrelevant. Empirical studies have shown that

the traditional role of corporate strategy – portfolio planning – does not lead to higher

performance and the causality of strategy formulation is not always top down.

Furthermore, advances in agency, industrial organization, resource based theories

(including others) have shaped our thinking on what the new roles, causality and locus

of decision making in corporate, business unit and functional strategies could be.

Faced with the turbulent environment that confronts a typical firm today, we should

thus view corporate, business and functional strategies not as a top down hierarchy

with very separate roles and responsibilities but as an interdependent network or

heterarchy with the fundamental challenge, for all levels of strategy, being continuous

renewal (Chakravarthy, 1996).

Continuous renewal

The continuous renewal challenge can be best understood through a simple

framework (See Figure 1) (Chakravarthy and Lorange, 2007). The matrix is defined

by the two traditional dimensions of markets that a firm currently participates in or

wishes to; and the distinctive competencies that it has or seeks to access in order to

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defend its presence in these chosen markets. These correspond to the traditional

product-market axis and the more recent resource and capabilities axis.

___________________________________

Insert Figure 1 Here

___________________________________

Markets refer to the customer sectors and geographies that a firm participates in. Each

market has a defined set of customers and competitors. Firms also operate globally

and can define their markets by the countries in which they operate. Whichever

markets the firm competes in there are always new markets that are open to it. Some

of these may have to be discovered de novo by the firm (Hamel and Prahalad, 1994),

but others may already exist and are merely new to the firm. Distinctive competencies

are the second dimension. These may be in the form of firm’s tangible assets like raw

material reserves, financial resources, plant, equipment, distribution channels,

logistical assets, patents etc. as well as in its intangible assets like brand name and

customer relations. They could also be in the firm’s know-how and skills, which are

embedded in its people and processes. Any element of the firm’s value chain is a

potential source of distinction; whether it is procurement, R&D, operations, logistics,

selling or even support-activities like Information Technology. Since competencies

eventually lose their distinction, new distinctive competencies are needed both to

protect the core business of the firm and to provide a platform to enter new markets.

Renewal is not only a matter of positioning the firm in a more attractive opportunity

space but is equally about accumulating new distinctive competencies that will allow

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a defense of these new found positions. In fact there is a growing body (Barney, 1986;

Barney 1991, Collis and Montgomery, 1995; Peteraf, 1993; Prahalad and Hamel,

1990; Teece, et. al., 1997) of research in strategic management that extols the virtues

of the competence dimension (sometimes to the exclusion of the equally important

product-market dimension). We believe that market positioning and distinctive

competencies are complementary dimensions in defining a renewal initiative.

Continuous renewal must involve market positioning and distinctive competencies

simultaneously. It is about exploiting existing market positions and distinctive

competencies, as well as exploring new markets and competencies – not one or the

other but one and the other.

The lower left hand cell in Figure 1 describes the present core of the firm, the markets

that it participates in and the distinctive competencies that it currently has. Protecting

and extending the core is the obvious first renewal initiative. The other initiative is

competing for the future by proactively migrating to new markets and acquiring new

competencies (migrating to the upper right hand cell in Figure 1). This migration is

transforming the core. Chakravarthy and Lorange (2007) propose two other renewal

initiatives that link these two: leverage and build. The upper left hand cell in Figure 1

describes new markets that the firm can enter by leveraging the existing competencies

that it already has. But this is just the initial step. Complementary new competencies

will have to be added in order for the firm to compete successfully in these new

markets. Similarly, the lower right hand cell describes the new distinctive

competencies that the firm must build in order to protect its existing market franchise.

But this too cannot be a dead end initiative. The new competencies that are built must

allow for future leverage into new markets. Both leverage and build should logically

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lead to the other (hence the bent arrows for leverage and build in Figure 1). If the two

are linked systematically, it can help the firm migrate to new markets and new

competence platforms progressively over time.

A new blend of strategies

Strategy is about commitments (Ghemawat, 1991) and yet it is also about learning.

The resources on which a firm commits to a strategy may not be as distinctive as first

assumed, or it may lead to newer opportunities that are far more attractive.

Commitments have to be flexible as well. This may sound like an oxymoron, but this

is precisely what the challenge is in continuous renewal. The portfolio choice here is

not just in terms of the market dimension but also the competence dimension.

Actively monitoring the Protect and Extend, Build, Leverage and Transform

initiatives in the firm’s portfolio is a key element of corporate strategy in a

transnational firm. Instead of managing a portfolio of businesses or resources, the new

corporate role is to manage a portfolio of renewal initiatives.

Top management also has to focus on deliberate and controlled experiments. It has to

be the prime mover in Transform initiatives, either setting these up as corporate

ventures or by creating the right platform through targeted acquisitions. It may also

prompt Build and Leverage initiatives but should generally rely on the business and

functional divisions to propose these. Build and Leverage are initiatives that call for a

partnership between top management and business/functional heads.

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The business division head in a transnational company is the corporate officer

responsible for its major markets. This manager is typically the prime mover for the

Protect and Extend initiative. In contrast with the role assigned to this manager under

the hierarchical view of strategies, the business divisional head is also expected to

explore for new markets and competencies and not just be responsible for strategy

execution. In this capacity this manager does shape corporate strategy.

The functional manager in a transnational company is the corporate officer

responsible for its competencies. Maintaining functional excellence, promoting its

sharing and leveraging it across the entire firm are also some of the key

responsibilities of this manager. His role is vital to the Build and Leverage initiatives

of the firm. He must also partner with the business division head on Protect and

Extend initiatives.

As Bartlett and Ghoshal (1989) so eloquently described, transnational strategy is in

part global efficiency and learning, but in part also about local responsiveness. The

strategy process has to be highly interactive and iterative. It is essentially heterarchical

in nature.

Build, Leverage and Transform initiatives require a bottom up adaptive planning

process, and in contrast a Protect & Extend initiative requires a top down integrative

planning process. While the two systems can co-exist within a firm, they have to be

administered differently by the corporate officers. Interactions in planning refer to the

levels of managers who are involved in developing the firm’s strategic plan. The

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greater this interaction, the richer are the strategic alternatives which are considered.

High interaction is crucial for exploration (Chakravarthy and Lorange, 1991).

Another consideration is the degree of iteration in the planning process. When each

phase of planning (agenda setting, strategic programming and budgeting) is seen more

as a guide to the next without rigidly constraining it, the planning process is more

iterative. For exploration, the planning process must encourage the continuous

questioning of the relevance of approved strategic programs and the appropriateness

of accepted goals.

Table 1 provides a contrast between what we propose here and the traditional

hierarchical view of strategies.

___________________________________

Insert Table 1 Here

___________________________________

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Figure 1

A Framework for Continuous Renewal

Source: Chakravarthy, B.S. and P. Lorange (2007, Forthcoming). Driving Profitable Growth: Strategies to renew your business. New York: Wharton School Publishing/Pearson

Protect & Extend

Transformation

• Improve business processes• Keep competencies distinctive • Extend product lines and services and innovate continuously• Re segment the market

New

Distinctive Competencies

Existing

NewExisting

Build new distinctive assets, know-how or skills

Enter new customerSectors and geographies

Build

LeverageCreate a new business distinct from the core

1

2

4

3

Protect & Extend

Transformation


New


Existing

NewExisting

New

Distinctive Competencies(Resources & Capabilities)

Existing

Markets(Businesses &Geographies)

NewExisting



Build


1

2

44

33

Protect & Extend

Transformation


New


Existing

NewExisting

New


Existing

NewExisting



Build


1

2

44

33

Protect & Extend

Transformation


New


Existing

NewExisting

New

Distinctive Competencies(Resources & Capabilities)

Existing

Markets(Businesses &Geographies)

NewExisting



Build


1

2

44

33

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Table 1

From Hierarchy to Heterarchy of Strategies

STRATEGY

Corporate

Business

Functional

Hierarchical View

• Product-Market Portfolio Choice• Optimal resource allocation• Domain Scope: Defines boundaries for each business in the portfolio• Sole prerogative of top management

• Domain Navigation• Exploiting Industry Opportunities• Top down: Informed by corporate strategy• Divisional mangers propose, top management approves

• Functional support• Value Chain aligned with business strategy• Functional managers propose, divisional manger approves

Heterarchical View

• Continuous Renewal• Portfolio of Renewal Strategies• Prime mover for Transform initiatives and partners in Build/Leverage initiatives

• Continuous Renewal• Exploiting & Diversifying Business Opportunities and Firm Competencies • Top down & Bottom Up: Informed by and Shapes corporate strategy• Prime mover for Protect & Extend initiatives. Partners in Build/Leverage initiatives. Contributes to Transform initiatives

• Continuous Renewal• Functional excellence, but also tailored to business strategy• Champion sharing & learning of best practice • Partners in Protect & Extend, Leverage and Build initiatives. Contributes to Transform initiatives

Corporate

Business

Function

Corporate

Business Function

STRATEGY

Corporate

Business

Functional

Hierarchical View




Heterarchical View




STRATEGY

Corporate

Business

Functional

Hierarchical View




Heterarchical View




Hierarchical View




Hierarchical View




Heterarchical View




Heterarchical View




Corporate

Business

Function

Corporate

Business Function

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