From: Team 1 Peter Fugiel, Helen Lin, and Andy Lai

Memo

To: Rajiv Krishnan Kozhikode

From: Team 1 Peter Fugiel, Helen Lin, and Andy Lai

Date: July 5, 2013

Re. Structural Inertia and Organizational Change

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Introduction

In the article, “Structural Inertia and Organizational Change”, Michael T. Hannan and John Freeman (1984) argue that structural inertia can be used to explain how organizations evolve. Their proposed theory “treats high level of structural inertia as a consequence of a selection process rather than a precondition” (Hannan and Freeman, 1984, p 149). Each organization is subject to inertial forces and the strength of these forces varies with age, size, and complexity. In this memo, we will first examine the key assumptions of the article. Then, we shall identify and evaluate two current organizational phenomena, and identify areas in which the arguments can be improved. Last, we will offer a model to show our view on how organizations evolve.

How do organizations evolve?

When organizations face new environmental fluctuations, they must either adapt to new environments or be selected. Organizations do not change in a perfect alignment with managerial motives nor with the environment (Hannan and Freeman, 1984, p 151). Also, Hannan and Freeman suggest that organizations must change at the same rate as the environment to adapt successfully. This rarely happens because all organizations are subject to inertial forces. Thus, Hannan and Freeman argue that selection is more applicable in explaining how organizations evolve.

Key Assumptions and Theorems

Organizations must demonstrate reliability and accountability for them to survive the selection process. It is required that an organization “continually reproduce its structure” (Hannan and Freeman, 1984, p 154) for it to be reliable and accountable. This reproducibility generates structural inertia. The higher the reproducibility of an organizational structure, the more inertial pressures the organization generates. For these reasons, Hannan and Freeman propose that “selection favours organization[s] that [have] high inertia[l] forces” (Hannan and Freeman, 1984, p 155).

Accordingly, because the reproducibility of an organization’s structure increases with age, death rate decreases with age (Hannan and Freeman, 1984, p 157). Also, organizational death rate has a negative correlation with structural inertia, and inertia increases with size. So, an organization’s death rate decreases with size (Hannan and Freeman, 1984, p 159). Finally, as organizations attempt to reorganize, their reliability decreases. The longer the reorganization attempt is, the higher the death rate. Organizational complexity increases the time required to reorganize. Thus, complexity increases the death rate due to reorganization.

Real Life Examples

There is a connection between the structural inertia theory and the idea of “consumer inertia” (Fishmana, 2003, p 25). His theorem supports that organizations that are larger, older, and well established are better equipped to withstand “idiosyncratic shocks”(Fishmana, 2003, p 25). The probability that firms exit markets due to these shocks is reduced as they achieve their “critical size” (Hannan and Freeman, 1984, p 158). The difference in Fishmana’s theory is that he takes a cost-centric view of firms. Therefore, firms with high inertia can manage the costs of environmental shocks due to a large amount of resources and an active R&D department that smaller firms might not have. Also, his theory builds on more than just the selection process of organizations with high inertial structures. Organizations that are older and larger will likely have a loyal customer base with consumer inertia: a dedicated set of repeat customers that face large “search costs” (Fishmana, 2003, p 25) to seek substitutions. Further, Tony Bradley adds that established companies has the benefit of “ecosystem inertia”(Bradley, 2013). An example is Microsoft’s dominance of PC operating systems: Windows. Bradley states that “ [t]he world is so heavily invested in the Windows ecosystem that jumping ship to another platform is a massive undertaking”(Bradley, 2013). This is a fascinating extension of Hannan and Freeman’s theorem. It both supports the structural inertia view and emphasizes how powerful it is. While Hannan and Freeman discuss how companies evolve and adapt amongst populations of their peers, evidences suggest that companies that face strong inertial forces do more than just surviving and evolving. Such companies can build consumer ecosystems that are also resistant to ongoing changes from both a business and consumer standpoint. Microsoft is an ideal example that supports Hannan and Freeman’s theory. It shows that facing high inertial forces will help companies to stay successful in the long run.

A case that contradicts the theory is Blockbuster. Theorem 1, which states that “selection ... favors organizations whose structures have high inertia” (Hannan and Freeman, 1984, p 155), is challenged. We argue that Blockbuster failed because of its inherent structural inertia. In 1998, Netflix begun to develop online rental services. Two years later, Blockbuster forfeited to buy Netflix for $50 million. In 2000s, Blockbuster was a key player in its industry, but it took them six years after Netflix was established to consider providing online-rental service. In 2010, they declared bankruptcy and Netflix became the dominant force. James Taylor claims that if Blockbuster had considered relevant internal and external factors, it is likely that they would have maintained dominance (Taylor, 2013). He also believes that the cause of Blockbuster’s downfall was that the CEO failed to anticipate the technological changes and to position the company to adapt (Taylor, 2013). Hannan and Freeman, however, have a different view of technical innovation in a population of organizations. They believe that management stands in a “superordinate position” (Hannan and Freeman, 1984, p 156) and controls the available technology across a broader organizational apparatus. They also emphasize the importance of institutional characteristics as being more important than technical ones (Hannan and Freeman, 1984, p 156). However, due to structural inertia, Blockbuster chose to hold on to outdated business core values, and failed to incorporate technological innovations, which was readily available and cost effective, and lost its grasp on the market. This example shows that structural inertia can hinder an organization.

Improvement to Hannan and Freeman’s Theorems

We can see that although Hannan and Freeman’s model can be applicable most of the time, there are exceptions. Because of that, we try to identify a potential reason for these exceptions. Hannan and Freeman claim that high inertia is not a reason for organizations to pass the selection process, namely, having a lower death rate; rather, organizations which pass the selection process all happen to share this property (Hannan and Freeman, 1984, p 149). It is inconsistent when they claim that organizations’ death rates decrease when their size increase because more inertia is generated as organizations’ size increase (Hannan and Freeman, 1984, p 159). In this claim, it seems that they are using inertia as a reason, which it is not, for organizations to have a lower death rate.

Statistically speaking, high inertia and death rate may have a high negative correlation; however, if the logical relation behind this correlation is incorrect, we cannot use this correlation as an indicator of any sort. So, we believe that Hannan and Freeman’s theory can be improved upon by more clearly explaining how inertia force may and may not be a reason for organizations to be selected in different cases, perhaps, different timing, places, constrains, etc.

Conclusion

After a thorough analysis, we offer a new theory that builds on both selection and adaptation principles. It emphasizes on Hannan and Freeman’s “critical size” (Hannan & Freeman, 1984, P 158). We postulate that small organizations must keep structural inertia to a minimum and be willing to adapt to market conditions as they grow. As organizations reach a critical size, it will be subject to structural inertia. Structural inertia of large organizations can be powerful while being a positive or negative force. As shown, structural inertia can lead to a swift downfall of a company. Simultaneously, we acknowledge the powerful potential of structural inertia and its ability to influence not only a company, but also an entire population of organizations. It is at the critical size of a company that we support Hannan and Freeman’s theory of the positive benefits of strong structural inertia. However, we believe that structural inertia encompasses a greater scope than just the company in question. We propose that structural inertia extends to organization’s customer base, consumer inertia, and the market itself, eco-system inertia. A company that reaches its critical size not only has the power to withstand market shocks but to control them. That is, an organization can control the selection process. Therefore, we believe that organizations evolve based on adaptation principles to a certain extent. After the critical point, such companies are selected to be market leaders.

References

Bradley, Toney. (2013). Why Windows 8 is such a Crucial Step for Microsoft. Retrieved from

http://www.forbes.com/sites/tonybradley/2013/05/15/why-windows-8-is-such-a-crucial-step-for-microsoft/

Fishmana, Arthur. (2003). Consumer inertia, firm growth and industry dynamics. Journal of

Economic Theory.109 (1): 24-38.

Hannan, M.T., Freeman, J., (1984). Structural inertia and organizational change. American

Sociological.Review.49, 149-164

Siegler, MG. (2011). Snoozing and Losing: A Blockbuster. Failure. Retrieved from

http://techcrunch.com/2011/04/06/make-it-a-blockbuster-night/

Taylor, James. (2013). Blockbuster: How Blind Spots led to Failures. Retrieved from

http://prezi.com/vb7msogfankm/blockbuster-how-blindspots-led-to-failure/