Complex business structures

Businesses increasingly rely on relationships with external partners to perform critical business processes. Relationships such as outsourcing and collaboration allow business processes to be performed better or more cost effectively, or without the need for investment in expensive production capacity. Various terms have been used to describe the complex relationships that have developed, such as virtual organisations, hollow organisation and network organisations.

In Virtual Organisations and Beyond (1), Hedberg, Dahlgren, Hansson and Olve describe how the Swedish clothes retailer GANT operates. The centre of operations is a Swedish company, Pyramid Sportswear AB, which has eight employees. Pyramid Sportswear owns the rights to use the brand name, selects the designers, performs quality control of production, arranges advertising, and organises the shipping of clothes from the factories to the retailers. Design and production of the clothes are outsourced, and the clothes are sold through independent retailers. To the customer it appears that there is one organisation, the GANT Company, which performs all these activities but in reality no such organisation exists. This group of independent companies, working together, coordinated by Pyramid Sportswear is described as an ‘imaginary organisation’ by Hedberg et al although the term ‘hollow organisation’ has been used by others to describe similar arrangements. Pyramid Sportswear is the core of this imaginary organisation, and it coordinates the other organisations; the partners.

A virtual organisation is one that has little or no physical premises, but where employees and managers work remotely (typically from home) and are connected using IT, such as emails, video conferencing, extranet and intranets. The organisation appears to the outside world to be just like any traditional style organisation. Customers and suppliers are linked using IT systems which adds to the impression that they are all part of the organisation. The classic example is Amazon, the online retailer. Most orders placed on Amazon’s web site are forwarded to suppliers, who then send the goods directly to the customer.

Collaboration is also an important element in many business chains. Organisations such as Apple rely on a network of independent programmers who develop apps for their products. While these programmers work independently, they rely on Apple sharing technical information with them about its operating systems, and through Apple’s developer conference, they become part of the Apple family.

For the rest of this article, all these different arrangements will be referred to as complex business structures. They include a core enterprise (such as Pyramid Sportswear) that coordinates the activities of the partners in the structure.

Performance Management

In complex business structures the core enterprise needs to manage the performance not only of its own activities, but also those of the partners to some extent. The obvious problem is that the core enterprise does not usually own the partners, so has no legal right to try to manage them. Performance management issues must therefore be agreed with each partner as part of the terms of business.

Typically a contract or service level agreement will specify what activities are expected of each partner, what the minimum standards are in terms of quality, and the price that will be paid. These agreements may also describe reporting requirements, whereby partners are required to report their own performance using agreed metrics, such as % of late deliveries, and number of customer complaints. There may also be fines for repeated failure to achieve some of the standards.

Planning

In traditional organisations, planning and control is based on the budget. The process of preparing the budget requires the different parts of the organisation to coordinate their activities for the following year, and this requires some central coordination. Budgets also aim to ensure that costs of production are controlled. At the end of each accounting period, actual results are compared with budgets and action taken to remedy any significant variances.

In a complex business structure, the core organisation does not need to have a detailed analysis of costs incurred by the business partners. From a financial point of view, the core is only interested the prices that partners will charge, and these will already have been agreed in the service level agreement. The core does need to be sure that suppliers will have the capacity to meet its demand on time, even though it may not be possible to specify how much that demand will be at the start of the year. Some type of planning will therefore be required to ensure that all parts of the structure have the flexibility and capacity to meet the potential demand from the core organisation.

Control

The core is mainly interested in non-financial aspects of the performance of the partners. Quality of goods or services are obvious areas. Other aspects may include delivery times, quality of customer service and ethical behaviour. Several large multinational companies have had their reputations damaged by the behaviour of partners in third world countries who employ child labour for example, or operate sweat shop style operations where employees are paid subsistence wages, and made to work long hours. Poor ethical behaviour of such partners can harm the reputation of the whole structure.

Expected standards must be specified in service level agreements. If a partner is required to fulfil sales orders to customers for example, there may be requirements about the minimum period within which such orders must be completed. The service level agreement may also require compliance with a corporate code of ethics. Partners will be expected to provide performance reports showing appropriate measures of performance and must allow inspections and audits to be performed by the core organisation.

Monitoring the workforce

Where the structure makes use of freelance workers and employees who work from home, traditional methods of control over the work force become less useful. It is not possible to clock employees in each morning when they work from home, for example, and they cannot be watched to ensure that they are working diligently. One solution is to simply pay by results. Remuneration may be based on quantitative measures of the output such as number of customer queries dealt with. Trust is likely to be a key factor in any such relationship, and the use of cultural controls, which involves employing people who are self-motivated.

Information technology can also be used to keep tabs on employees. System logs can record what time employees log onto and off the system, although there is of course no guarantee that they are being productive all of the time they are logged in.

Performance management problems

While performance measures and expected targets will be specified in the service level agreements, there can still be disagreements when things go wrong. Disagreements can arise about the value of metrics calculated. In the exam question Callisto Retail (June 2012 – see ‘Related links’), there was disagreement about the amount of days inventory held by one of the wholesalers, and this required detailed reconciliation to be performed. Disagreement may also arise over who is to blame when things go wrong. If customers are not happy about the service they receive, there could be a number of partners who are potentially to blame.

Confidentiality of information becomes a risk, due to the fact that the core organisation is sharing key information with its partners. This may include commercially sensitive information such as production methods, or names and addresses of customers. Procedures need to be in place to ensure that such information is secure. This would include requirements relating to the security surrounding the information systems.

Motivation can also be an issue. Where all business processes are carried out in house, it can be easier to motivate employees using reward systems. Where the processes are carried out by an outside partner, it may not be so easy to motivate them. It is essential therefore that all partners share the same objectives and understand how they contribute to the success of the whole organisation. In some relationships, there is an element of profit share or bonus paid to the partners to motivate them to perform well.

Role of IT

Information systems often play a crucial role in complex business structures. The core organisation may invest in the development of an information system that it requires all partners to use. This can mitigate many of the challenges relating to performance management discussed above. Its role in monitoring the work of employees has already been noted above. Having one system used by all partners means that everyone is using the same data. There should be less difficulty collecting information about the performance of partners since the information will all be stored on one system. The core party has greater control over the security of data, and communication between the parties will be much more fluid allowing greater coordination.

Conclusion

The greater use of business partners to perform crucial business processes may lead to lower costs and greater specialisation. However, the reliance on external partners can lead to additional challenges for performance management. These must be considered in drafting of contracts with the partners. The use of shared IT systems can also assist in many of the challenges.