Disintegration of Value Chains Leif Hommen CIRCLE leif'hommencircle'lu'se

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Disintegration of Value ChainsLeif
HommenCIRCLE leif.hommen_at_circle.lu.se
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Overview

• Vertical Disintegration
• Langlois, R.N. 2003. The vanishing hand The
  changing dynamics of industrial capitalism.
  Industrial and Corporate Change 12 (2) 351
  385.
• Systems Integration
• Brusoni S., A. Prencipe, and K. Pavitt. 2001.
  Knowledge specialization, organization coupling,
  and the boundaries of the firm Why do firms know
  more than they make? Administrative Science
  Quarterly 46 (4) 597-621.
• Diffusion of New Forms of Corporate Governance
• Tylecote, A. 2006. Organizational structure and
  the diffusion of new forms of corporate
  governance in Europe. In E. Lorenz and B.-Å.
  Lundvall (eds.), How Europes economies learn
  Coordinating competing models. Oxford Oxford
  University Press. Pp. 178 200.

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Vertical Disintegration (1)

• Outsourcing has been the focus of both cases
  discussed this week
• Xerox and Abgenix XenoMouse
• In these cases, outsourcing supported higher
  levels of efficiency, profitability, and growth
  by enabling firms to
• focus on core business activities
• speed up processes of change organizational
  restructuring and new technology development
• But, as shown especially in the case of Abgenix,
  there can be a trade-off between the extent of
  outsourcing and the firms range of innovative
  capabilities
• Further, these cases offer little insight into
  the broader historical and economic context of
  outsourcing.

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Vertical Disintegration (2)

• In Langloiss (2003) account of the broader
  context outsourcing figures importantly as a key
  mechanism of unbundling or vertical
  disintegration
• Langlois contrasts Smith and Chandlers ideas
• Smith specialization (division of labour)
  increases with market size the best coordination
  mechanism for most, if not all economic activity
  is market exchange
• Chandler advanced industrial economies of the
  19th and 20th centuries required vertical
  integration key coordination mechanisms were
  internal organization and managerial authority
  (within large firms)
• Langlois claims that Chandlers managerial
  revolution is now giving way to another -- the
  rise of the new economy
• we are seeing a dramatic rise in vertical
  specialization ... affecting traditional
  Chandlerian industries as much as the high-tech
  firms

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Vertical Disintegration (3)

• Langlois argues that over the very long run,
  Smith was right about specialization and market
  exchange.
• But technology, organization and markets all
  change at different rates, creating imbalances.
• Chandlers revolution - central management of
  vertically integrated production stages
  resulted from such imbalances.
• But it is being replaced by specialization with
  further growth of markets and institutions to
  support exchange
• Langlois does not predict that managerial
  coordination and large vertically integrated
  firms will disappear
• But they are an increasingly small part of a
  landscape that features a wide variety of market
  and network forms.

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Vertical Disintegration (4)

• Industrial structure as an evolutionary design
  problem, ultimately based on the problem of
  value
• How to maximize utility for end-customers at the
  lowest cost, through two related systems
• production of technology
• organizational structure
• Technology production is affected by
  environmental factors that cause uncertainty.
• In response, organizations try to control
  uncertainty by protecting their technical cores
  with buffers.
• inventories cushion against fluctuating demand
• managers translate complex data into cognitive
  order

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Vertical Disintegration (5)

• System decomposition is another buffering
  strategy.
• Decomposablility creates stability because
  survival of the whole is less dependent on that
  of indvidual parts
• Decomposable systems are modular
• Modules have mimimal interaction and they are
  only connected by formal interfaces.
• Organisationally, what results is loose coupling
• One advantage of this kind of structure is the
  simplification of information processing tasks
• Each organization can concentrate on only the
  local relevance of information about the
  environment there is no need for it to consider
  global implications

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Vertical Disintegration (6)
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Vertical Disintegration (7)

• Consequences of modularization (loose coupling)
  for innovation
• On the demand side reduced standardization of
  products through standardization of design rules
• products can be fine-tuned to user needs
• On the supply side access to a wider range of
  external capabilities and creation of external
  economies of scope implies
• many more entry-points for new ideas
• more rapid trial-and-error learning

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Vertical Disintegration (8)

• Langlois does not claim simplistically that the
  Chandlerian firm is being completely replaced by
  pure modular systems and anonymous market
  relations.
• There are some important qualifications
• In many cases, relationships between stages will
  often be collaborative ones involving trust,
  permanence and the transfer of rich information.
• On this point, consider the case of Xerox.
• Even in highly modularized industries (e.g.,
  Dell), a core firm may exercise considerable
  administrative control over stages of production
  it does not own.
• Here, consider the case of Abgenix, which
  monitored other stages of production very closely
  and also sought to grow and develop by owning
  more of them.

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Systems Integration (1)

• Langlois sketches a landscape that features a
  wide variety of market and network forms.
• But he does not provide a very detailed map of
  it.
• In particular, Langlois does not provide a
  framework that can account fully for the cases
  discussed this week
• Xerox and Abgenix-XenoMouse
• In each case, the firms considered outsourcing
  strategies or options that did not conform to the
  model of modular networks or systems.
• Do these cases represent transitions or
  alternatives?
• Moreover, options considered by these firms had
  important implications for their evolution,
  especially in terms of
• Core business activities
• Innovative capabilities
• Organizational boundaries and structures

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Systems Integration (2)

• Brusoni et al.s article takes an important step
  towards a more detailed map of the new economy
  landscape.
• Their point of departure is the linkage between
  types of innovation or innovative
  capabilities and organizational structure
• More specifically, they refer to Henderson and
  Clarks (1990) typology of product innovation,
  according to which innovation can occur either at
• System level e.g. architectural, (in
  relationships among components) or
• Component level e.g., modular (in the core
  design concepts of components)

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Systems Integration (3)
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Systems Integration (4)

• HCs scheme should be applicable to the
  specialized roles of particular firms within
  networks of innovation,
• But within such networks specific bodies of
  technological knowledge can not be mapped
  tidily on to well-identified components and
  subsystems
• Instead, we find a different pattern, especially
  in multi-technology firms that deliver complex
  products ...
• their knowledge boundaries stretch beyond their
  production boundaries (they know more than they
  do)
• evolution of their knowledge and product domains
  unfolds according to different principles
• Examples include aircraft engine manufacture,
  electronics, the food industry, and chemical
  engineering design construction activities

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Systems Integration (5)

• Traditional explanations of firm boundaries
  include transaction costs analysis (TCA) and the
  modularity approach (MA)
• TCA identifies two key problems with
  knowledge-intensive products
• transferring partly tacit knowledge
• appropriating collaborative RD output
• For these reasons, firms resort to vertical
  integration (keeping production and fundamental
  RD in-house)
• MA argues that these problems can be solved by
  the adoption of modular product architectures and
  modular forms of network organization
• But neither TCA nor MA recognizes that there may
  be a gap between what firms do and what they
  know

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Systems Integration (6)

• Brusoni et al. studied the development of
  aircraft engine control systems as complex
  multi-technology products, in order to
• analyse the boundaries of firms with respect to
  their networks of suppliers
• take into account uneven rates of change in
  component technologies
• capture boundary adjustments to technical
  imbalances at the system level
• They found that all three of the prime
  companies in their study had responded
  differently to a systemic shift (from
  hydromechanical to digital technology) in control
  systems
• Firm A sold off its internal supplier opted for
  outsourcing
• Firm B maintained tight control over its internal
  supplier
• Firm C maintained arms length relations with
  suppliers

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Systems Integration (7)

• Despite different responses in terms of
  organization production boundaries, though, all
  3 firms had similar responses in terms of
  knowledge boundaries
• All three firms either maintained or developed
  in-house capabilities in the design and
  integration of control systems
• They also invested in monitoring digital
  electronics
• A detailed analysis of patents held by the 3
  firms shows a significant gap between their
  respective production and knowledge profiles
• Firm C is an especially interesting case
• Despite specialization in terms of division of
  labour, Firm C showed an increasingly diversified
  pattern of knowledge

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Systems Integration (8)

• Brusoni et al. start to explain these results by
  pointing totechnical imbalances within complex
  product systems
• i.e., uneven rates of development in component
  technologies, which require the use of of
  coordinating mechanisms for systemic adjustments
• Their key puzzle arises from evidence of
  non-modularity
• i.e., coexistence of elements of specialization
  and integration in all three cases.
• They propose two key determinants of appropriate
  organizational solutions or inter-firm
  relationships
• predicability of product and component interfaces
• unevenness in relative rates of change in
  component technologies

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Systems Integration (9)
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Systems Integration (10)

• With the framework shown above, Brusoni et al.
  can account for the patterns of coupling found in
  two main technological trajectories in aircraft
  engine control systems
• Hydromechanical control systems
• Movement of two firms (A C) towards a decoupled
  or modular system of production
• Digital electronic control systems
• Movement of two firms (A C) towards loose
  coupling and systems integration
• Brusoni et al. can also use the same framework to
  account for patterns of organization in other
  industries characterized by complex
  multi-technology products

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Systems Integration (11)
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Diffusion of New Forms of Corporate Governance (1)

• Brusoni et al have shown that technology and,
  more fundamentally, knowledge can impose
  strong constraints on the spread of modularity
  as a new form of industrial organization
• A further implication is that there are definite
  limits to the extent to which markets can serve
  as the main coordination mechanisms of the new
  economy.
• Tylecote offers another critical perspective on
  the new economy
• In this case, it is a story about changes in
  patterns of corporate governance linked to
  globalization of production and innovation plus
  the diffusion of ICT.
• However, the implications are very similar.

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Diffusion of New Forms of Corporate Governance (2)

• Corporate Governance
• the relationships and mechanisms of control over
  firms
• Two main alternative forms
• Anglo-American Shareholder Model
• Shareholder interest steers the firm costs and
  benefits of innovation restricted to
  shareholders.
• European Japanese Stakeholder Model
• Employee involvement cross-shareholding by
  firms, close ties with suppliers and customers.
  Trusting relationships with various stakeholders
  who contribute to and benefit from innovation.

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Diffusion of New Forms of Corporate Governance (3)

• Economic Globalization favours the Anglo-American
  Shareholder Model because
• Stakeholder models depend on national laws and
  are difficult to operate on a multinational scale
• Global competition often requires domestic
  employees and suppliers to be sacrificed and it
  is far simpler to make these choices under the
  Shareholder Model

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Diffusion of New Forms of Corporate Governance (5)

• The ICT Techno-Economic Paradigm favours
  Shareholder Models because
• Rapid reconfiguration is required e.g.,
  agile, not lean manufacturing
• Knowledge is increasingly codified and protected
  as IP, and globalized shareholder firms are
  more prone and better equipped to
  commercialize knowledge

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Diffusion of New Forms of Corporate Governance (6)

• Some further reasons why the ICT Techno-Economic
  Paradigm favours Shareholder Models
• ICT entails increasing reliance of firm
  learning on IT consultants and software
  providers, plus internal IT staff
• ICT thereby disrupts the skill formation systems
  that are a main foundation of stakeholder systems
  of employment and labour market regulation.

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Diffusion of New Forms of Corporate Governance (7)

• Three clichés of structural change related to
  adoption and use of ICT
• Flatter organizations with less middle management
• Closer and quicker connections among functions
  (sales, production, development and design,
  purchasing, etc.)
• Closer and quicker connections with suppliers and
  customers
• These changes are more likely to be implemented
  by shareholder firms, but
• They place heavy demands on employees and
  suppliers for competence and responsibility,
  which stakeholder firms are better able to
  guarantee.
• Hence,actual practice may not conform to these
  clichés.

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Diffusion of New Forms of Corporate Governance (8)

• Another cliché of organizational change related
  to ICT
• Closer and quicker connections of different
  divisions within the firm
• Subdivision of firms into profit centres is
  consistent with the shareholder model, ensuring
  inter-functional coordination via financial
  control (profits dividends)
• But such subdivision obstructs horizontal
  learning between profit centres divisions of the
  firm have strong incentives to compete, but none
  to collaborate

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Diffusion of New Forms of Corporate Governance (9)

• For these reasons, academic management
  accountants now argue for long-term and flexible
  financial controls and performance targets
• The beyond budgeting movements stongest
  theoretical expressions have originated from UK
  universities.
• However, practical examples come primarily from
  Scandinavia Borealis (Denmark) and
  Handelsbanken (Sweden)

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Diffusion of New Forms of Corporate Governance
(10)

• Hybrid corporate governance and implications
  for modes of learning
• Shareholder firms are better suited to coping
  with globalization.
• However, it appears that neither Shareholder nor
  Stakeholder firms can readily exploit the ICT
  paradigm.
• For these reasons, some sort of hybrid solution
  may be necessary.

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Diffusion of New Forms of Corporate Governance
(11)

• An alternative to arms length relations that
  do not work, institutional shareholders can
  engage with management and build industry
  specific expertise
• through, e.g., non-executive directors on the
  board.
• Two alternative investor postures
• Outsider Engagement with Liquidity
• Insider Engagement without Liquidity

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Diffusion of New Forms of Corporate Governance
(12)

• Outsider Engagement with Liquidity
• Small shareholdings in a large firm enable
  investors to exit but allow them to secure
  influence in the firm
• Coalitions of engaged shareholders can be
  formed.
• Insider Engagement with Liquidity
• In a small firm, investors must purchase large
  blocks of shares and cannot exit easily. Hence,
  they require influence via non-executive seats on
  the board.

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Diffusion of New Forms of Corporate Governance
(13)

• Employee shareholding is a third possible type of
  shareholder engagement
• Here, there is often no representation for
  individual employee shareholders, but commitment
  is still strengthened.
• However, collective holdings e.g. ESOPs in the
  US confer power.

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Diffusion of New Forms of Corporate Governance
(13)

• Some implications of the argument
• Engaged forms of corporate governance and the
  corresponding changes in learning -- are most
  likely to be supported by new institutional
  shareholders (pension funds, mutual funds, etc.)
  and employees
• These devlopments are most likely to occur in
  large, high-tech firms small, low-tech firms are
  better suited to family control.

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Diffusion of New Forms of Corporate Governance
(14)

• Different national trajectories can be found in
  EU countries UK, Germany, France, Sweden and the
  Netherlands
• Three countries with well-established funded
  pension systems
• UK, Sweden and The Netherlands
• Another three countries without well-established
  funded pension systems
• Germany, France and Italy

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Diffusion of New Forms of Corporate Governance
(15)

• UK, Sweden and The Netherlands
• In the UK the ground is clear
• no traditions of shareholder engagement or
  employee participation, so new forms of
  engagement may spread
• The Netherlands may be receptive
• Management has been sheltered from the market for
  corporate control. All this is now in question
  and under attack but the Anglo-American model
  doesnt fit with Dutch culture.
• Sweden may take some time to adjust
• Old, engaged shareholders (Investor and
  Industrivärden) have lost influence, and the new
  institutional investors (pension funds, etc.)
  have made a point of being disengaged.
• Sweden does have established forms of employee
  participation

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Diffusion of New Forms of Corporate Governance
(16)

• France, Germany, and Italy
• France may be most receptive of all to the
  unmodified Anglo-American model
• A tradition of individualism plus strong
  hierarchy leads executives to resist outsider
  engagement.
• Employee participation is highly confrontational.
• Germany entrenched traditions may delay adoption
  of new forms of engagement
• shareholder engagement backed by non-executive
  directorships, plus old-style employee
  participation (co-determination)
• Italy the least promising prospects of all?
• Entrepreneurial families have gained importance
  and new institutions are weak. Firms are
  hierarchical and employee participation is
  confrontational.

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Diffusion of New Forms of Corporate Governance
(17)

• Summing up Tylecotes argument
• Globalization favours a market-based form of
  governance (the Anglo-American Shareholder Model)
• At first glance, so does ICT
• However, ICT also requires modifications that
  have a great deal in common with key features of
  the alternative Stakeholder Model

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Diffusion of New Forms of Corporate Governance
(18)

• In stakeholder countries the emerging hybrid
  will probably be
• A relatively flexible form of shareholder
  capitalism, with the emphasis on employee
  inclusion through stock options and/or
  profit-based bonuses
• IT skills will be a key means for top management
  to reconfigure firms and operate within the
  reformed structures
• But IT is by now far too important to be left to
  the IT specialists alone, and will require broad
  participation by line mangement and employees

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Diffusion of New Forms of Corporate Governance
(19)

• To conclude
• As with vertical disintegration, there are limits
  to the universal adoption of shareholder
  governance
• These limits are connected with technology (IT)
  and more specifically, with knowledge
  requirements
• These requirements have been discussed by
  Tylecote as learning needs.