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?

Plant Corporate
manager executive
Assistant plant
manager
District sales Common
manager superior

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.
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.