Thursday, April 23, 2009

The Matrix and the Balanced Scorecard

Toyota, more famous for its production system than its organizational structure, has operated a highly successful matrix or "cross-functional" organization since the early 1960s. Theoretically, matrix organizations should be better at solving complex problems requiring a multidisciplinary approach. Toyota uses its matrix to routinely reduce its operating costs as well as solve quality problems. Royal Dutch Shell famously abandoned its matrix structure in the 1990s, presumably to cut costs. Why should Toyota find the matrix tenable while Shell did not?

The answer may be the "balanced scorecard," or what in Japan is known as "hoshin kanri." (Actually, the balanced scorecard is a much-watered-down version of hoshin kanri, of which more in future posts.) Japanese authors claim that while Japanese companies experimented with cross-functional or "matrix" organizational structures, it was not until the adoption of hoshin kanri that they were able to make the matrix work. Why might this be true?

The answer to this question lies in transaction cost economics. Transaction cost economics is based upon the idea that the fundamental unit of organizational analysis is the contract. Organizations arise because management hierarchies, by creating standards of communication and behavior, offer a more cost effective way than free markets of concluding and enforcing the various contracts needed to do business (management contracts, labor contracts, contracts with suppliers, contracts with customers). If human beings were infinitely intelligent and markets perfectly efficient, we could conclude and enforce the same contracts in less time and at lower cost through the one-on-one bargaining of the marketplace. Actually, if the assumptions of traditional microeconomics were true, markets would clear in an instant. But, alas, human beings have small, slow brains, and markets periodically melt down, as we know all too well. Thus the management hierarchies of business frequently offer a quicker, cheaper way to get business done (i.e., conclude and enforce all those contracts).

So what does this have to do with matrix organizations and hoshin kanri?

Well, the matrix is complicated. Some people believe that although it promises to make organizations good at solving problems, it isn't worth the effort. A common complaint is that within a matrix organization I have more than one boss. It is not clear who is in charge and thus my reporting relationships present a control problem. (One of my clients, once a player on Wall Street, was fearful that the matrix violated Sarbanes Oxley.) Implicit in this argument, however, is an assumption that the cost of an effective cross-functional agreement between my two or three bosses as to my priorities outweighs the benefits of my being on a cross-functional team. In other words, in practice the matrix is so expensive to control, that it is better to resort to the traditional command-and-control structure, even though command-and-control isn't very good at solving complex problems. More simply, the cost of solving complex problems in a command-and-control stucture is less than the cost of controlling a matrix organization.

This is where hoshin kanri comes into play. Hoshin kanri greatly reduces the transaction costs of concluding and enforcing agreements and thus enables more complicated, and more effective matrix structures. At its core, hoshin kanri is all about contracts or, as we know them, team charters, or, more recently, as A3s (hence, The A3 Post). The hoshin system is essentially a system of A3s (the contracts) that, through a painstaking process of negotiation known as "catchball," completely specifies the operative relationships between all managers, both vertically (top down/bottom up) and horizontally (cross-functional). At Toyota, for example, even supervisors and suppliers are included in this process of specifying the organization's structure.

In addition to creating a completely specified matrix structure, hoshin kanri produces contracts that are less costly to enforce. Although the catchball or negotiation process is not perfectly voluntary, it has many of the same features as a free market negotiation. Let's say that I am a supervisor negotiating my A3 contract with my manager. My manager tells me "what" to do by deploys a target to me that is pretty much nonnegotiable. It is an offer I can't refuse. In response, however, I am permitted--in fact I am encouraged--to recommend "how" I plan to achieve that target and to specify the resources I will require to do so. We might say that the A3 contract is "quasi-voluntary" because it results in a meeting of the minds. By leaving the negotiation open ended, my manager gets me to "buy in" to the agreement.

Now we can see how hoshin kanri enables matrix organizations. Matrix organizations that do not employ hoshin kanri risk creating organizational structures that are not completely specified and, therefore, in which important relationships are open to interpretation by managers with small slow brains. Mischief will ensure, because, given a choice, a choice created by lack of clarity, managers will pursue their own agendas rather than the organization's. Also, the unclear relationships are usually the cross-functional ones that would help us solve complex problems, because the traditional management hierarchy makes top down/bottom up relationships crystal clear. In addition, matrix organizations in which command-and-control managers mandate both "what" and "how" risk creating involuntary or, shall we say, "quasi-inconscienable" contracts that are, predictably expensive to enforce, because there is no buy-in. So, without hoshin kanri, a matrix organization inflicts a double whammy upon itself. First, the incomplete specification of the contracts that define the organization leaves too much to guesswork; organizational focus is lost. Second, the involuntary nature of command-and-control contracts makes it less likely that subordinates will adhere to the contracts voluntarily, thus creating the need for extra controls. It's no wonder Shell Oil abandoned the matrix! Much better to be a dull, plodding command-and-control organization....

Meanwhile, Toyota's ascendancy demonstrates that, with the right management control system--viz., hoshin kanri, the matrix organization can deliver on its promise of flexibility and adaptability in practice as well as theory.

Tom Jackson
Martinez, California
April 23, 2009

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