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Alternatives to decline, threat or scarcity: exit, voice, loyalty and institutional response.

Introduction

This paper examines alternative strategies facing firms subject to decline, threat or scarcity. Four alternative strategies are suggested: exit, voice, loyalty and institutional reorganisation. These strategies apply both to internal activities (within the firm) and to external relationships, most particularly with suppliers and customers.

The following section presents the perspective and background to the analysis. This is followed by an overview of the alternative strategies and then by an analysis of each strategy in turn.

This paper is unusual in that it examines exit, voice, loyalty and reorganisation as active strategies of the company, not simply as responses to external pressure.

The Analytical Perspective

The key concepts of the analysis derive from Albert Hirschman's pathbreaking work Exit, Voice and Loyalty (1970), in which the three key concepts were introduced as responses to decline in firms, organisations and states. This paper attempts to tie in these concepts to notions of organisational change. It also examines both the internal and external implementation and ramifications of the key management strategies.

The critical innovation made by Hirschman was to focus attention on repairable lapses of economic actors. Economists had hitherto paid little attention to this because of the key assumption of "fully and undeviatingly rational behaviour or, at the very least an unchanging level of rationality on the part of the economic actors" (1970, p. 1). But, as well as changes in demand and supply conditions, there could also be some "loss of maximising aptitude or energy" within the firm. The question is how can such a loss be repaired? In addition, given the assumption of a competitive economy, recovery from any lapse is not essential - a new firm or other existing firm will take up the slack. Resources are reallocated in accordance with the new conditions and equilibrium is restored. Competition and the exit mechanism thus is one major mechanism of recuperation.

However, there is another key mechanism. Effective "voice" means that management searches for possible cures for dissatisfaction. The firm's customers, suppliers or workers express this dissatisfaction through voice and management can engage in negotiations leading to remedial action.

The presence of loyalty makes exit less likely to the extent that (1) customers, members or suppliers are willing to trade off the certainty of exit against the uncertainties of an improvement in the deterioration of product, service or conditions and (2) the estimate that customers, members or suppliers have of their ability to influence the organisation. Hirschman notes "in the choice between voice and exit, voice will often loose out, not necessarily because it would be less effective than exit, but because its effectiveness depends on the discovery of new ways of exerting influence and pressure towards recovery. However "easy" such a discovery may look in retrospect the chances for it are likely to be heavily discounted in ex ante estimates, for creativity always comes as a surprise. Loyalty then helps to redress the balance by raising the cost of exit. Loyalty or specific institutional barriers to exit are therefore particularly functional whenever the effective use of voice requires a great deal of social inventiveness while exit is an available, yet not wholly effective, option." (1970, p. 80). Loyalty thus raises the cost of exit. Its usefulness depends on the closeness of the available substitute. If the gap between two firms (price and quality) is huge, there is a great deal of scope for the use of voice in the course of the progressive deterioration of one of them before exit occurs. Thus, there is not much need for loyalty. However, the closer are the substitution possibilities between two firms, a small deterioration in one of them will result in exit (of customers and members). Therefore "loyalty is at its most functional when it looks most irrational, when loyalty means strong attachment to an organisation that does not seem to warrant such attachment because it is so much like another one that is also available" (Hirschman 1970, p. 81).

The interactions between exit, voice and loyalty thus require careful consideration. The reorganisation of companies, particularly their formal control systems, might be regarded as a fourth response to decline, threat or scarcity. It also contains elements of the other three strategies. The key issue, which this fourth dimension adds, is the connectedness of activities. Given interdependencies between different areas of the firm, voice might prevail over exit not only because of loyalty, but because activities are intimately connected. On the other hand if the exit options is overwhelming, then connectedness may bring other activities down with it.

The Model

The model used to analyse the strategies open to firms is in two stages. In the first stage, an archetypal external relationship with a key customer is analysed. In the second stage internal relationships are examined.

The Firm and its Customer

We begin with a stable state scenario. "Our" firm is supplying a large key customer which may be incorporating our output into its production or it may be a key service user (perhaps it is a government body).

Then, a shock occurs. This may be because our management gets the quality wrong and underperforms in its delivery of the required quality of output. Alternatively, the customer retools, incorporates new technology or simply no longer requires our inputs into its improved processes.

The question now is, what strategies will the customer adopt towards our firm? The above analysis suggests three choices: exit, voice, loyalty (Table 1) (See also Helper 1995). Exit is straightforward - the customer simply shifts its purchases to a competitor of ours. Voice is defined, following Hirschman (1970, p. 30) as "any attempt at all to change, rather than to escape from, an objectionable state of affairs, whether through individual or collective petition to the management directly in charge, through appeal to a higher authority with the intention of forcing a change in management, or through various types of actions or protests, including those that are meant to mobilise public opinion". This is the political dimension of action.

[TABULAR DATA FOR TABLE 1 OMITTED]

Exit

Exit requires the closure of facilities. This may be a minor part of the firm under threat or it may involve the whole firm. Generally speaking, this will usually result in laying off members of the firm - although it may be possible in multi-product firms to transfer them to divisions of the firm not facing similar pressures (this strategy was the preferred scenario in large Japanese firms). The exit option can also be exercised by members of the firm - switching to other employers or even [TABULAR DATA FOR TABLE 2 OMITTED] leaving the employment market altogether. In the case of key workers, in scarce supply, this may have extremely deleterious effects on the company and may ultimately threaten its existence. The responses of members of the firm under the three strategies open to them are shown in Table 2.

Exit will have an impact on suppliers and customers. For suppliers, two exit cases can be envisaged - 'involuntary exit' where the principal switches suppliers, moves to in-house production by internalising the intermediate market or substitutes an alternative input, often as the result of technological change. Voluntary exit will be contrasted with the use of voice later. For customers, exit means that supply is ended. They have to move to the closest available substitute. Closure of one product offering in multiproduct companies can have a negative knock-on effect, through loss of goodwill, on other product lines. Customers may be wary of purchasing from a company which has a reputation for interrupting, or ending supply.

Voice

The exercise of voice by the customer gives our management the opportunity to improve - to implement quality improving strategies and/or to reorganise. It may be, however, that our customer will go even further than the voice option in giving us an opportunity to put our house in order. They may give us time to put things straight. In an extreme from of loyalty they may even accept some of the costs of the quality improvement of our production. Thus loyalty could involve a voluntary shifting of the costs onto the customer. This loyalty will have been earned by our past relationship and good performance.

The customer's response may well be conditioned by the type of contract between the firms. In the simple case ((which is fairly rare) Buckley and Chapman 1997)) of arms length contracting, then exit, severance of the purchasing relationship, will be the only option. Exit of a major customer may require the closure of facilities. It may result in the ending of a product line in a multi-product facility. Closure of one product offering in a multiproduct company can have a negative knock-on effect, through the loss of goodwill, on other product lines. Customers may be wary of purchasing from a company which has a reputation for ending the supply of one of its products.

The voice option allows our management the time to sort itself our in contrast to exit, where it is already too late. In connection with a supply contract, voice involves a response to an offer to renegotiate or recontract. Sato (1993) called this relationship 'obligational contracting' as opposed to arm's length contracting. Indeed, it is alleged that Japanese superiority in supply chain management is the result of a greater use of obligational contracting than in Western (European and American) dealings with suppliers. Practically voice provides an opportunity for management to put things right, although the sanction of exit remains.

Management can only indulge itself if, in the past, it has created loyalty. With loyalty, customers will (temporarily) allow lapses from agreed levels of performance. The role of loyalty is to hold exit at bay and to activate voice. There is, however, often a price to be paid for excessive (or misplaced) loyalty, in that below average firms can be retained when they should exit.

The Firm and its Members

The second stage of the analysis examines the internal aspects of an external shock. A company can only provide a good service and retain good customers if it has good employees. If this is the case and then an external shock, such as the loss (or threat of a loss) of a large external contract occurs, the company is faced with a similar strategy threat by its employees. Key workers and subcontractors can be particularly influential in affecting the company's prospects.

However, if workers choose voice rather than exit, then the company can begin to search for cures to the dissatisfaction. Internal negotiations can take place, rewards can be redistributed - perhaps in return for new working practices and the workplace relations can be reorganised. The voice option requires the managers of the firm (or the owners in negotiation with the managers) to listen and to take remedial action. Voice has implications for management style. Consultation, negotiation and attention to the needs of members of the firm are essential if the voice option is to be effective and is to be seen to be effective. The exit of key workers and managers may seriously threaten the company's competitiveness. The cost of exit of scarce workers may be prohibitive, hence the importance of voice. In situations of scarcity of key groups of workers (international managers, research scientists, for example) bargaining and responding to 'voice' may be a constant process for the firm, until its costs exceed the exit option.

It should be noted at this point that although the 'voice' strategies presented here have a good feel to them, they could proceed in parallel with policies of raising switching costs. Thus the firm can reduce the exit option by tying employees in with pension schemes, bonuses and team building. Similarly suppliers can be tied in by being required to invest in specific assets, technology and skills where are largely non-transferable to other principals. This can be reinforced by tied loans, cross shareholdings and management control so that switching becomes near impossible by the supplier. Customers too can face increased switching costs where branding is used, where product compatibility requires using the whole of one company's product line, and where tied retail and distribution outlets restrict choice.

The role of loyalty is to hold exit at bay and activate voice. Policies to foster loyalty include involving employees in decision making, "fair dealing" and fostering trust and a reputation for trustworthiness. Similar attributes are necessary to keep suppliers and 'customer care' programmes are an attempt to retain customers. There is a premium on retaining employees. "Loyal workers build long-term relationship with their customers. Loyal customers, in turn, enable businesses to keep their employees, partly by paying above the market average" (Economist 6.1.96 "Two Cheers for Loyalty"). Training costs and the loss of the tacit knowledge of employees are two key reasons for retaining staff. New staff also imposes heavy search and recruitment costs. There is, however, often a price to be paid for excessive (or misplaced) loyalty, in that below average firm members and suppliers can be retained when they should exit (or be exited).

We can thus construct a two stage analysis using exit, voice and loyalty as responses to decline (a) from the point of view of a firm in response to a threat [here from withdrawal of a key customer] and (b) from the point of view of an employee within a firm where that firm faces decline.

Reorganisation

On Reorganization

"We trained hard, but it seemed that every time we were beginning to form up in teams we would be recognized. I was to learn later in life that we tend to meet any new situation by reorganizing and a wonderful method it can be for creating the illusion of progress, whilst producing confusion, inefficiency and demoralization ". Petronius Arbiter Governor of Bithynia Died (by his own hand) AD 65

In observing modern business practice, it is difficult not to notice the response of reorganisation to threat and decline. Successive waves of reorganisation have involved divisionalisation, the use of matrix structures and strategic business units and business process redesign (Buckley and Casson 1992). Changes in formal control mechanisms are seen as a key response to external challenges by many companies. Many of these strategies are complex and involve a mix of exit and voice. They all risk damaging the loyalty of members, suppliers and customers through potential disruption. However, they recognise that the firm needs to pay attention to the complementarity of activities. Perhaps the best example of attention to complementarities in business is business process redesign (formerly business process reengineering). The crucial observation underlying this programme is that complementary activities in companies are frequently separated by organisational barriers arising from the firm's administrative heritage.

One of the critical organisational barriers in multinational firms is the divide between national subsidiaries. This barrier is both organisational and cultural and the two issues (organisational structure and cultural distance) often reinforce the problems of the firm. Many firms are currently tackling this issue as a matter of prime importance and the building of effective cross national teams is seen as a crucial issue in achieving international competitiveness (Buckley/Carter 1998). Partly, this is a question of combining the complementary knowledge within the firm in an optimal fashion, partly it is a question of a constant search for an organisational form which best matches external threats and opportunities (Buckley/Carter 1996, 1997).

Conclusion

Exit, voice, loyalty and institutional reorganisation can be analysed as alternative active strategies facing firms. This framework applies to both the firm's external relationships, with suppliers and customers, for instance, and to management's relationship with employees. This paper has presented simple models of strategies using Hirshman's framework. It is clearly capable of future development. In particular, the approach is capable of linking models of knowledge management with analyses of entrepreneurship and innovation.

Notes

1 I would like to thank Mark Casson and participants at the 1996 Academy of International Meeting, Banff, Canada, for comments on an earlier draft.

References

Buckley, P. J./Carter, M. J., The Economics of Business Process Design: Motivation, Information and Coordination within the Firm, International Journal of the Economics of Business, 3, 1, 1996, pp. 5-24.

Buckley, P. J./Carter, M. J., The Economics of Business Process in Multinational Firms, in Ricketts, M./Mudambi, R. (eds.), The Organisation of the Firm: International Business Perspectives, London: Routledge 1997. Buckley, P. J./Carter, M. J., Managing Cross-Border Complementary Knowledge, International Studies of Management and Organization, (forthcoming 1998).

Buckley, P. J./Casson, M., Organising for Innovation: The Multinational Enterprise in the Twenty-First Century, in Buckley, P. J./Casson, M. (eds.), Multinational Enterprises in the World Economy, Cheltenham: Edward Elgar 1992.

Buckley, P. J./Chapman, M., The Perception and Measurement of Transaction Cost, Cambridge Journal of Economics, 21, 2, March 1997, pp. 127-145.

Economist - 6.1.96: Two Cheers for Loyalty 1996, p. 57.

Helper, S., An exit-voice analysis of supplier relations: the case of the US automobile industry, in Grabher, G. (ed.), The Embedded Firm: On the Socio-economics of Industrial Networks, London: Routledge 1995.

Hirshman, A. O., Exit, Voice and Loyalty: Responses to Decline in Firms, Organisations and States. Cambridge, MA: Harvard University Press 1970.

Sato, M., Prices, Quality and Trust, Oxford: Oxford University Press 1993.
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Title Annotation:The Organisational Evolution of the Multinational Enterprise - A Tribute to Gunnar Hedlund
Author:Buckley, Peter J.
Publication:Management International Review
Date:Apr 15, 1999
Words:2862
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