Strategic Networks

J Carlos Jarillo

• Publisher: Routledge
• Year: 2013
• Print ISBN:
  9780750623278
• eBook ISBN:
  9781136016257
• Topic: Business
• Subtopic: Business General
• Index: Business

Strategic Networks examines the new style of industrial co-ordination which enables independent companies to work so closely together that they can sometimes present a 'single face' to the outside world. Co-ordination is not achieved by mergers and acquisitions, but through the creation of a 'strategic network' of companies working towards the same goals. Based on the author's extensive research, the book first analyses the economic arguments for industry co-ordination, and suggests in which industries it is most likely to occur. The second part of the book focuses on * managerial implications for this type of organization * impact on responsibilties * control without ownership * co-operation instead of competition * how to set up alliances and how to maintain them A wide range of international examples and cases are featured in the book. J. Carlos Jarillo is Professor of Strategy at the University of Geneva (previously Professor of General Management and International Strategy at IMD, Switzerland). His research on strategy has been widely published in more than two dozen articles and books. He also acts as senior adviser to a large number of international corporations.

Part One: Competition and Cooperation

1 A new way to compete

DOI: 10.4324/9780080517933-1

In 1956 a 60-year old native of Kentucky, known as Colonel Saunders, started selling to some of his friends the right to open restaurants to cook and sell a chicken dish after a Southern recipe that he had perfected in the previous twenty years. Just eight years later his amiable face, complete with goatee beard, presided over the entrance of 700 Kentucky Fried Chicken restaurants throughout the world, all selling approximately the same menu, to the same standards.

A few years later Mr Ray Krock, salesman to a milkshake machinery company, realized that there was a large potential in the ideas of one of his clients, Mr McDonald. After coming to an agreement with him, he started setting up ‘franchisees’ to sell the same hamburgers, made to the same rigid specifications.

Today, innumerable ‘fast food chains’ later, more than half the whole US restaurant market is controlled by franchise organizations, ranging from very inexpensive sandwich shops to more up-market chains specializing in seafood and full menus¹. This dominance, which used to be a distinctive characteristic of the American market but was somewhat derided in Europe, is now spreading worldwide. That one of the largest sellers of pizza in Europe is affiliated with an American company, ultimately owned by PepsiCo, is an irony that testifies to the success of the formula.

At about the same time these ‘chains’ were being set up a brother and sister were starting to sell brightly coloured sweaters through a rather unconventional shop in the small town of Belluno, in a remote area north of Venice. The concept behind the merchandise and the shop proved successful, and other shops based along the same principles, sporting the same Benetton name, opened quickly in Italy, and then in Europe. As in the case of ‘fast food’, the initial success of a ‘chain operation’ such as Benetton first led to some imitators, and then started to alter the whole way inexpensive clothing is made and sold.

Very far from Italy, in Japan, a series of companies were preparing themselves to begin seriously exporting their inexpensive automobiles to the rest of the world, starting with the American market, the largest and most open of all. Their products were not essentially different from those being made by American manufacturers: they were simply smaller and much cheaper. The difference lay in how they were made, using different manufacturing techniques. Among these techniques, one was startlingly different: the widespread use of subcontractors.

As Figure 1.1 shows, the proportion of value added by the Japanese manufacturers is much lower than that of their Western competitors, with the exception of small ‘niche’ producers. This has nothing to do with productivity, but with the Japanese practice of purchasing many important subsystems already finished from subcontractors. Many of the subcontractors the Japanese companies buy from, however, are not completely independent. They have exclusive supplier arrangements and even some of their equity is owned by the automobile manufacturers. These ‘group’ arrangements are so widespread in Japan that the American Department of Trade has complained that inter-dealings among companies within these ‘keiretsu’ (groups) provide the Japanese with an ‘unfair’ competitive edge, for other companies cannot penetrate, in order to buy or sell, those thick webs of relationships.²

Figure 1.1 Degree of vertical integration in the automobile industry

It is the central argument of this book that all these success stories are intimately related. Behind these successes, as behind many others I shall analyse in detail, lies a common characteristic. These successful companies do two apparently opposite things at the same time. First, they ‘control’ the whole production process, from raw materials to selling to the final consumer; and controlling means controlling — prices, volumes, levels of quality, working systems … are set by the company But, second, they do not own the units that provide them with those raw materials or subcomponents, nor the units that commercialize the finished products to the end customer. That is, these companies act simultaneously as large integrated companies, taking care of everything; and as companies that concentrate only on a few things, subcontracting the rest. As we shall see, most companies tend to do one of the two things. Few manage to do both and, in more and more circumstances, doing both is exactly the prerequisite for success.

The explanation, at its most simple, is as follows. Current competitive circumstances simultaneously demand levels of quality, low cost, innovation and fast response times that traditionally organized companies cannot deliver. By traditionally organized I mean companies that either try to make most things in-house or rely on a series of ‘arm's-length’ subcontractors for components or distribution. Companies that make most things in-house (called by economists vertically integrated companies) often find it hard to deliver in time, at low costs.

General Motors or IBM are paradigmatic. They are not only the largest and most integrated in their industries — they are also the highest cost producers. This has led to an insistence on ‘restructuring’ or ‘modularization’. ³ But companies that do go for a narrow span of activity and ‘subcontract’ the rest find themselves very often cut off from innovation, fast reactions or high quality levels. This is because they lack direct contact with the final customer, or basic understanding of the underlying technologies. In any case they risk being ‘sandwiched’ between companies that keep the sources of innovation (subcontractors) and the sources of inspiration (distributors, those with direct contact with the customer). Moreover, coordinating hundreds of external organizations to deliver fast, cheap, and on time, is certainly not an easy task.

Yet it seems that the only way to meet the current competitive requirements, in many industries, is to ‘control’ a large span of all the activities that end up in a product or service, while avoiding the ills of vertically integrated companies: bureaucratization, lack of innovation, bloated costs, unresponsiveness. This feat of combining the best of both worlds is being achieved by more and more companies in more and more industries. In fact it is becoming so important that it can be said to have originated a third way to organize a business. That third kind of organization I call a strategic network. In a strategic network one company takes the role of ‘central controller’ and organizes the flow of goods and information among many other independent companies, making sure the final client gets exactly what he or she is supposed to get, in an efficient way.

An example is given by a chain such as McDonald's. From a point of view of organization, McDonald's acts as a vertically integrated company: it decides even the potato seeds that will be used to raise the raw materials for its fries worldwide. It also decides things as removed in the ‘business chain’ as the cap to be worn by salespeople or, within legal bounds, the final retail price of all its products. But these are not McDonald's’ products! The company does not own the producers of raw materials, it (in most cases) does not own the restaurants, nor the makers of the specialized equipment crucial to ensuring quality and success. From the point of view of ownership, McDonald's is not an integrated company. But, of course, one cannot really conceive of McDonald's without its franchisees and its closely tied suppliers: the essence of McDonald's is its ‘system’. Thus the whole system has to be considered together, for it acts together.

This is a strategic network: an arrangement by which companies set up a web of close relationships that form a veritable system geared to providing product of services in a coordinated way. These networks are becoming dominant in more and more industries, and the reason is that they can meet the current competitive requirements better than old ways of organizing economic activity.

Current competitive requirements

It can probably be said that competition has always been strong. But the current widespread comments about the special intensity of competition are clearly warranted. The speed at which change is happening in the business world is certainly accelerating, because the impact of technology is a cumulative one: every improvement in information technology, in transportation systems, in management systems builds upon the previous ones, thus generating an exponential rate of growth. Figure 1.2 shows different time-lags between scientific innovation and its commercial application.

Figure 1.2 Time from scientific discovery to market innovation

Another example is provided by the shortening development time in the automobile industry, as shown in Figure 1.3. These examples point in one direction: it is more and more frequent that even successful companies cannot sit back for a while and catch their breath. They must be innovating all the time, facing constant pressure from competitors to do so faster.

Figure 1.3 Shortening development times in the automobile industry

This quickening pace of innovation has been accompanied by a generalized drop in prices. Thus companies must cut their costs constantly, finding new ways to produce, trying to work smarter, not harder; and, to compound these two problems, quality expectations have been raised in most industries. What used to be ‘good enough’ in now simply unacceptable. ‘Zero-defect quality’ is a level aimed at by more and more companies.

Most (not all) of these pressures stem from the single most important economic development of the past forty years: the globalization of competition. The entry of US multinationals into Europe provoked a ‘revolution’ similar to the entry of Japanese products into the US.⁴ The old competitive status quo was suddenly shattered, and companies had to adjust to the newcomers, to decide to buck past trends. Today dozens of countries are trying to enter the world economic stage at once, bringing such low costs and strong determination as no established, ‘developed’ company could have imagined 20 years ago.

Organization as a way to meet strategic demands

All these pressures, which have just started, call for two characteristics in companies wanting to succeed. Efficiency to deliver better and better products at lower costs, and flexibility to do so in always different ways, learning constantly to do things differently and to do different things. Most companies under competitive pressure try desperately to cut costs, only to realize that this seriously impairs their ability to innovate. The only solution is to adopt radical change: companies must organize themselves in radically different ways, and grow beyond their current organizational constraints, for the way a company organizes itself has a huge impact on its results.

Organization drives performance because it lays down, among other things, incentive systems and the ways in which people interact, thus determining their motivation and their ability to learn, to develop new, creative ways of doing things. Different strategic goals require different organizational characteristics, and the organization that is better suited to the specific strategic needs of its time and its industry wins out. That is why, in many mature industries, one finds a remarkable organizational similarity among competitors: over the years, they have all converged on the ‘ideal’ organization for their business. In this sense one can think of the introduction of organizational forms as a sort of Darwinian process: over time, new forms emerge, in this case thanks to the creativity of people (or just by chance), not to some genetic alteration. Most of these new ideas never get very far or, if they do, are dependent on the personal characteristics of the organizer, and cannot be transferred. But, from time to time, one sees new forms that are both clearly superior in terms of performance and transferable. These forms become the ‘accepted way to do business’. Competitors either adopt the new form or disappear in front of the better organized companies.

The functional organization that informed practically every business up to the Second World War was, over time, increasingly supplanted by the divisional organization, where a company that competes in several businesses ‘cuts across’ functional lines to create full divisions, with their own functions. After General Motors and Du Pont ‘invented’ the divisional form, it was just a matter of time before all large corporations adopted it, for it was a clearly superior way of meeting the different competitive requirements that these large, diversified companies were facing, i.e. how to maintain a business focus inside what had become a huge, unresponsive, and more and more unspecialized bureaucracy.⁵ Interestingly enough, the traditional functional organization is still the most efficient way to organize most small and medium-sized companies, and those that have imitated the large ones by adopting the divisional organization have suffered as a result, and have gone back to the simpler forms — or died under their self-inflicted inefficiency.

The idea of arranging organizational activities around the business (something relatively external) as opposed to the functions (internal) better to meet competitive demands has kept progressing, and companies have taken further steps such as product managers, key client accounts, even activity-based costing, which is a way to break down the functional organization into what the company really does from the point of view of customers. Once an organization innovation proves its superiority, it is always adopted. Thus one can see that practically all professional service firms (accounting, consulting, law) are organized as partnerships; that all investment banks were partnerships, until they decided to go to the capital markets; that most consumer goods companies are organized along product management lines; etc. There may indeed be a component of imitation in that similarity, but there is no question that some ways to organize a company are better to meet some strategic requirements than others, and the superior forms are quickly adopted in a competitive environment.

The central thesis of this book is that the strategic network is such an organizational innovation, and that it is winning over in more and more industries, because it is able to capture the main advantages of two organizations considered mutually exclusive, so exclusive that, in fact, they can be conceived as the two different ways of organizing any economic transaction. By capturing that uniquely new set of advantages, this form of organization can respond better to a uniquely new set of competitive pressures.

The two basic ways to organize economic activity: vertical integration and subcontracting

Practically any economic activity requires sub-activities: in order to produce and sell a car, somebody has to perform a huge number of operations, from the design of the car, to the design of thousands of individual parts, the production and delivery of those parts, the assembly, the market promotion, etc. Obviously each of these activities has to be coordinated with the rest: only so many parts are needed, and they must be of a specific kind, delivered at a specific date and location, for instance. This task of coordination is absolutely impressive, if one stops to think about it. To continue with the example of a car, thousands of different pieces, most of them model-specific, have to be assembled in a rigid sequence, in a matter of a few hours (only fifteen in the case of the most efficient manufacturers). It does not take an expert in the automobile industry to realize that i...

Table of contents

• Cover Page
• Half Title Page
• Dedication
• Title Page
• Copyright Page
• Contents
• Preface
• Part One: Competition and Cooperation
• Part Two The Three Ways to Organize a Business System
• Part Three How to Set Up and Manage a Strategtic Network
• Bibliography
• Index