INSTITUTIONAL
DESIGN:
RESTRUCTURING
A FORMER STATE-OWNED ENTEPRISE
This paper analyzes the process of
restructuring of a former large state-owned enterprise in
This paper analyzes the case of
restructuring of a former large state-owned enterprise in
The most important conclusion of
this paper is that something was definitely wrong with the very approach that
the project took from the very beginning.
This approach failed to take into account the “Influenceable” institutional
environment while concentrating all its efforts on the “Controllable” elements
only. All drastic measures in terms of
restructuring, downsizing, and management training are not enough to make a
company survive and succeed in an unstable and ever changing environment. The crucial factor is to restructure not only
internal controllable factors, but also to analyze the Appreciated (or
Enabling) Environment and try to make part of it Influenceable, so that the
company becomes much more sound, stable, reliable and predictable. In addition, the lack of a common vision
inside company as well as among different outside stakeholders made the
restructuring very hard to implement.
The lack of an incentives system and a common vision among employees led
to their passivity and dependence. The
lack of a common vision among the enterprise and outside stakeholders led to
conflicts between the company on the one side and the tax police and state bank
on the other side.
This paper analyzes both
achievements and failures under the project and provides some recommendations
on how the project could have adopted a more relevant approach based on the AIC
theory of institutional design so that the results of the restructuring would
have been much more profound and sustainable.
The AIC theory builds upon the concept of institutional development and
“new institutional economics” findings.
“Institutional development is the creation or reinforcement of an
organization’s capacity to generate, allocate, and use human and financial
resources effectively to attain development objectives, public or private”
(Beatrice Buyck, 1989). This approach
recognizes the importance of institutions to development. According to “new institutional” economists,
and in particular, Nobel Prize laureate Douglass North, institutions are formal
and informal rules and their enforcement mechanisms that shape the behavior of
individuals and organizations in society (Douglass North, 1991). The role of institutions is important,
because institutions, both formal and informal, determine the level of
transaction costs in a society, and thereby the development path of nations.
“AIC” stands for Appreciated,
Influenceable, and Controllable environments.
The AIC theory elaborates the idea of institutions and goes further in
the sense that it not only explains the importance of institutions, but also
shows practical implications of this idea, e. g. how institutions relate to
their Appreciated, Influenceable, and
Controllable environments, and how organizations or projects could be designed
to achieve their objectives by understanding the relations between those
environments and creatively managing them.
The most important idea of this theory is that one should always treat
organizations, or projects, as open systems, and try to pro-actively manage not
only their Controllable (or internal) environment, but also Influenceable
elements, and even their Appreciated environments by bringing some of its elements under its influence.
The AIC theory suggests that we
should shift from mechanistic and analytical thinking of organization in which
“humans are parts, their relationship is standardized through routine, job
descriptions and bureaucratic rules and regulations” to the more “synthetic”
thinking that “demands that we take an “expansionist” view of problem solving
and systems design” and “look outside the boundaries of the problem or system
and bring the environment into equal predominance with the organization”
(William E. Smith, Francis J. Lethem, Ben A. Thoolen).
This paper tries to apply the AIC
methodology into real life and show how this theory could have made a
difference if it had been applied properly in the case of the restructuring of
a former state-owned enterprise in
Company
X employed 7,000 people in the late 1980s.
It used to be a large manufacturing plant that provided a range of
products not only for
When
restructuring was started in 1998 employment was reduced to around 1,500
people, and the company produced about 20 times less output than it used
to. The company was making losses and
was overstaffed for the current situation.
However, the products were of good quality and there was a large
competitive market for such kind of products.
In the 1990s the company was privatized, with the majority of shares
gradually concentrated in the hands of the President of the company.
The
company signed a contract with an EC technical assistance agency in order to
reconstruct the enterprise. Under this
agreement the project would provide technical expertise to the company, develop
a restructuring plan, and follow up with implementation within 1-year after
project completion. The company went
first through a process of detailed diagnosis of past performance. Following the initial diagnosis, a diagnosis
of future possibilities and a strategic planning exercise were carried out
through team work in order to get all managers to take part in this
process. Such a participative process
proved to be against the management style of the company, and therefore was
later abandoned. The project’s staff
identified and prioritized the areas where assistance was needed, adopted
action plans, and designed a change strategy.
Then, the consultants together with the company’s employees implemented
action plans in such areas as sales, budgeting, product costing, production management,
management information systems and quality improvement.
With
the help of the project, the company was downsized, production facilities
rationalized, the role of the marketing function was increased, changes were
introduced in quality control functions, product costing, management
information systems (MIS), accounting and budgeting.
The restructuring of the company
resulted in a doubling of sales within one year. This result was basically achieved by
training the company’s sales staff on sales missions and by designing more
efficient marketing strategies and an aggressive product costing. As a result of the increase in sales,
employment was maintained at roughly 1,500 employees -- which was an important
factor in terms of employment objectives.
According to the import
substitution policy adopted by the government, the enterprise was included in
the list of companies to receive loans.
These loans were to be managed through the state bank. Though the funds for the company were in fact
earmarked, the bank did not seem willing to give out the credit; officially
this was because the enterprise did not have a business plan for the earmarked
amount of money. But since the
enterprise needed the money for its working capital and not capital
investments, the bank’s argument did not seem logical and its real reasons for
withholding the funds were unclear.
In addition, the tax
authorities began to visit the company regularly and audit all the accounting
records. This behavior actually was
against laws that said that such audits could be made only once a year. The tax authorities claimed that the company
had evaded taxes by registering domestic sales as foreign ones to avoid having
to pay the value added tax (VAT). It was
the company who had to prove that it did not break the law, instead of the tax
authorities having to prove that the company did something wrong.
The central government
included the company on the list of recipients of state loans under
import-substitution policy. The city administration was interested in
maintaining the employment level and recovering some tax arrears from the company.
The project managed to maintain the employment at reasonable levels at
pre-project levels. In addition, it made
an agreement to pay its taxes past due by transferring some of the company’s
assets to the city.
III.
PROBLEM IDENTIFICATION
All
the problems that the restructuring project faced can be classified into three
categories in accordance with the AIC framework: problems related to the Appreciated,
Influenceable, and Controllable Environments.
Therefore, in order to identify the institutional problems, we should
systematically check how sound the characteristics of the enterprise were with
respect to each type of environment.
A.
APPRECIATED ENVIRONMENT
The
enterprise for many years operated under the command economy of the Soviet
economic system. That means that the
management style, mentality, work habits, and organizational structure were
designed to meet the nature of that policy and institutional environment. Basically the implications of the past
environment were the following: no need for any marketing functions, no
customer focus, and production plans laid down by central authorities. The main objective was a production plan, and
that the level of output be achieved.
The reward system reflected this bias towards production related
objectives.
Since
independence,
The
project managers and the president of the company understood that these new
realities demanded drastic changes on the organization’s part. What they did not take into account was the
importance of achieving a common vision among the stakeholders and of the human
factor. From the very beginning,
according to the AIC methodology, it was very important to identify key
stakeholders and try to reach a common vision with them and get them to buy
into the restructuring process, thereby getting legitimacy for the reorganized
company. This had been demonstrated by
the case history of a family planning program in
Stable
relationships and agreements should also have been established with suppliers
and customers, who are also stakeholders in our case, in order to maintain
trustful and mutually beneficial relations in the long run. Unfortunately, these objectives were not
fulfilled either (these issues are discussed in the following section).
In
addition, the company lacked a committed leadership. Only its President really understood the need
for the restructuring and was committed to it.
B. INFLUENCEABLE
ENVIRONMENT
The
project staff and the company’s management did not pay attention at all to the
Influenceable environment. They failed
to understand that for an organization design process to succeed, it was not
enough for them to understand (a) the Appreciated environment, which they saw
as something outside the company that needs to be appreciated, but is
completely outside of their control and, (b) the company’s Controllable
environment, which they saw as the area where they were going to make a
difference. Such lack of understanding
led to substantial problems with input prices and relationship with customers,
and with other outside stakeholders such as the tax inspectorate and the
state-owned bank.
The most important mistake
was indeed a failure to recognize that the Influenceable environment was a
distinct organizational dimension, which should be included in their
strategy. In the company’s and project
staff’s opinion, the Influenceable area was synonymous with the controllable
area, which in turn was equated with the company’s internal arrangements. This misconception was reflected especially
in their conduct of a classical SWOT.
The classical SWOT analysis focuses on Internal Strengths and
Weaknesses; and External Opportunities and Threats. In other words, such analysis focuses on
internal factors taking the external environment as given, and is designed to
help decide how the internal Controllable environment could be changed in order
to reflect changes in the Appreciated environment. The outcome of the analysis
should be a determination of the company’s mission, strategy, and objectives;
an identification of the gap between vision and present reality and of the
options that make sense in terms of structures, resources -- physical, financial,
people skills, culture, management style, values and finally of an appropriate
implementation plan. Actually while such
an analysis is indeed useful, it should be seen as a necessary, but not a
sufficient condition to ensure that a company will be viable in the long
run. The company should have taken a
more pro-active position and attempted to influence some of the components of
the appreciated environment, such as its relations with stakeholders, customers,
and suppliers. “Clearly there is a level
between the organization and the ‘uncontrolled’ environment, which is external
to the organization but is subject to influence by the organization’s
management” (William E. Smith, Francis J. Lethem, Ben A. Thoolen).
In
addition, the company’s management and the project’s managers overlooked the
importance of external relationships and linkages. They failed to establish good relations and
understanding between themselves and other key stakeholders such as the tax
police and a state bank. Failure to establish
proper relationships with the tax police resulted in interruptions of the
company’s activities due to a series of disrupting audits. And the absence of linkage with the state
bank in turn meant inability of the company to obtain resources, i.e. financing. All these stakeholders were treated
exclusively as elements of the appreciated environment over which the company
had no influence whatsoever. In
retrospect, it is clear that it would have been possible to influence these two
stakeholders. It could have been done in
two ways.
The
management of the company could have solved the problems with the state bank
and tax police by working closely with the mass media. At that time the new Minister of Industry of
the country had launched a campaign to promote an import-substitution policy
and support domestic producers. Leaving
aside whether such a policy was correct or not and going to achieve its
declared targets, the management could have more actively and pro-actively
utilized this fact by trying to publicly claim that the policy of the tax
police and the bank were inconsistent with, and actually against the official
government policy.
Furthermore,
the management of the project could have exerted some pressure on these two
stakeholders by convincing the local representative of the EC (their financier)
to intervene on their behalf. For
instance, they could have tried to get across the idea that all restructuring
efforts by the enterprise, which was important to the country’s industrial base
and employment, was undermined by the counterproductive policy of the above
organizations. In other words, certain
elements of the appreciated environment are not always as uninfluenceable as
they might seem at first sight.
Other
areas which the company failed to consider as potentially under its
Influenceable, rather than its Appreciated environment, were its relationships
with its suppliers and the resulting input prices, and with its customers. The restructuring of the company resulted in
a doubling of sales within one year with a resulting profit expected for year
2000. The project’s staff and members
of the Sales and Marketing Department worked hard to push sales in
In
retrospect, the company’s management and the project’s staff should not have
treated the supply of inputs as a factor purely in the Appreciated environment,
which would have been quite reasonable in the Soviet past, under the former
command economy. They should have
instead tried to convert this area into the influenceable part of their
environment. They could have done it by
working more closely with the suppliers of inputs, building long-term
relationships and long-term contracts.
In fact this idea lies behind the Total Quality Management (TQM) concept
developed by W. Edwards Deming. This
concept stresses the importance of the quality of processes, not merely
products as conventional wisdom holds.
That means that companies should not only secure quality processes
inside the enterprise, but also build relationships with their suppliers (and
even customers) to ensure that they would adhere to the same principles so that
the quality of products and services is consistently ensured from the beginning
to the end of the production chain.
Alternatively,
the enterprise could have secured the input prices by making forward contracts
at input exchanges. All these actions
directed towards influencing what formerly was the company’s Appreciated
environment would have secured a much more stable and predictable supply of
inputs and, thus a sustainable performance for the company. Such an approach would have helped to avoid a
situation where the company incurred losses even though it in fact doubled the
sales volume.
The
second part of the problem was the company’s attitude towards its
customers. Despite the project’s
recommendations and pressure, the company’s management still considered the
clients essentially in its Appreciated environment. That attitude stemmed from their past
experience, when a customer focus was simply a waste of time and effort, for
every level of output would have been purchased and absorbed by the command
economy. In contrast, clients today
should be treated as an influenceable factor, because the producers can
influence the stability and resilience of his customer base by trying to
influence his relationships with them, improving post-sales service, and
providing consistent and predictable quality of products. When the company began to experience a
shortage of working capital, it did not deliver on some contracts. Instead of explaining to the clients the
problems it was experiencing and trying to keep good relationships, the
company’s management preferred not to respond to their clients’ calls, faxes,
and e-mails. That led to serious
problems in the short run, and is likely to lead to even worse problems in the
long run: for once the reputation of the company is affected in Europe, it will
be hard, if not impossible, to regain it.
C. CONTROLLABLE ENVIRONMENT
1.
Participation and incentives systems
Under its new external environment, the company needed a
new value system stressing “the need for people to become involved in and
committed to what they undertake in the community” (E.L.Trist, 1978). The company did not have a proper incentive
system so as to improve all employee’s commitment to greater economic
productivity, not to mention their participation and involvement in the
company’s processes.
One of the most important obstacles
to the company’s restructuring was the capability and willingness to change on
the part of its management. They were
generally not motivated towards any change and had no incentive to do so. Another major obstacle was their lack of understanding
of the role of strategy, marketing, and financial management in a market
economy. Probably the most important
problem was the old mentality of all employees who had been used to work at the
same enterprise for decades under the past Soviet system, including the
President of the company. Even the
President, who had actually become the principal owner of the company, was
still tied up to his long standing relationships with key managers, and was
thus unwilling to replace them when necessary.
Participation
is a very important element of the AIC process.
The participation approach builds on the assumption that by reaching a
common purpose among all stakeholders one can achieve much more and at lower
cost. Unfortunately the project did not
achieve its objectives in this regard.
The principal owner of the enterprise (and the incumbent President of
the company) was probably the only person at the enterprise who really
understood the need for restructuring and was committed to implementing
it. All other employees did not have any
incentives to support the restructuring plan.
In addition, they did not understand that the change in the company’s
overall Appreciated (enabling) environment required a new organizational
structure, new work relations, new approaches, and a more pro-active
participation on the part of all employees, from the President of the company
to the floor supervisors and workers.
The company maintained its old mechanistic organizational structure,
which is characterized by high complexity, high formalization, and a limited
information network (mostly downward communication). The company’s structure looked like “the
rigid pyramid-shaped organization”, which relied on “authority and well-defined
hierarchy to facilitate coordination” (W. Richard Scott, Organizations:
Rational, Natural, and Open Systems).
All decisions, even those with little importance had to be made by the
President. And all managers were used to
passive roles and preferred to do what they were told to do.
The
biggest problem was that the consultants financed by the EC had not helped to
develop the new incentive systems that would reflect the new objectives,
motivate employees, and make them buy into the restructuring process. As a result, all the employees felt estranged
from and threatened by the changes, fearing that they could only lead to
negative results for them, such as lay offs.
2.
Internal organizational structure
The
organizational structure is an element of the Controllable environment which
can play an important role in the success or failure of a company. “The last remaining source of truly
sustainable competitive advantage lies in what we’ve come to describe as
“organizational capabilities”- the unique ways in which each organization
structures its work and motivates its people to achieve clearly articulated
strategic objectives (David A.Nadler, Michael Trushman, 1997). The organization that understands this and
structures its work according to the changing economic environment puts itself in
a much better position than the organizations that do not. “Too many managers, for too long, have
thought about design simply in terms of rearranging the boxes and lines on the
organizational chart” (David Nadler and Michael L.Trushman, p.6, 1997).
After
the break up of the
On the other hand, the project achieved a significant
success in other areas, for example, Sales & Marketing. Sales were doubled in one year mainly due to
increases in sales to
IV. CONCLUSION & RECOMMENDATIONS
This paper discussed a number of
issues related to the restructuring of a former state-owned enterprise, and
applied the AIC framework to analyze the problems that the project’ staff and
the company’s management faced while implementing its restructuring. Based on the learning from that experience
and the AIC methodology acquired during this PIDP seminar, the paper recommends
the following steps for the design of similar restructuring projects:
1.
Understand the external institutional
environments, especially the overall macroeconomic situation, the economic
trends in general, and the industry’s trends in particular, and the political
situation.
2.
Analyze which organizations might
potentially be involved or affected by the project (stakeholders), their
political positions and incentives
3.
Try to build a common vision among them and
good relationships so that the company obtains political support and the
restructuring project acquires legitimacy.
This may require the use of specialized “process”-consultants.
1.
Based on the analysis of the external
environment, formulate a workable strategy reflecting the changes in the
appreciated environment.
2.
Based on the analysis of the appreciated
environment, try to make as many parts of it as possible subject to the
company’s influence. This could include
various kinds of stakeholders, including suppliers, customers, and so forth.
3.
Try to develop a strategy that would be
able to accommodate most unexpected changes, i.e. make the strategy flexible
and modifiable.
1.
Prepare an implementation plan (make it
workable, i.e. take into account all existing or potential constraints). Try to secure participation of employees and
develop an appropriate incentive system
at the very early stages of restructuring. Develop an organizational structure that
would reflect the newly adopted strategy (see attachment B for the recommended
organization chart). Try to have all
employees understand the importance of these changes and the logic behind this
turn-around, because otherwise this would lead to a mere mechanistic
rearranging of boxes in the organizational chart.
2.
Develop control and feedback mechanisms so
that the management is warned if something is going wrong. All planned activities should be documented
and signed by the respective responsible persons. Then periodic reviews of the restructuring progress
should be conducted with every responsible manager giving account on what has
been done.
3.
Develop an evaluation
plan to assess the project’s quantifiable deliverables against plans or laid
down in the project proposal. Such an
evaluation should also contain recommendations, e.g. to the company’s Board of
Directors, so that the leanings derived from the project’s experience would
benefit other enterprises in the country.
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Francis Lethem,
2.
The role of participation, PIDP seminar,
Francis Lethem, 2000
3.
Beatrice Buyck, The Bank’s Use of Technical
Assistance for Institutional Development, WPS, 578, Washington, D.C., World
Bank, December 1989.
4.
Douglass C. North, Institutions,
Institutional Change and Economic Performance,
5.
David A. Nadler, Michael L. Trushman with
Mark B. Nadler, Competing by Design,
6.
William E. Smith, Francis J. Lethem, Ben A.
Thoolen, The Design of Organizations for Rural Development Projects, Progress
Report, World Bank Staff Working Paper, Number 375, The World Bank, Washington,
D.C., 1980.
7.
W. Richard Scott,
8.
E.L.Trist, A new Approach to Economic
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9.
Delmora Population case, PIDP seminar,
Francis Lethem, 2000