Internal Organizations and External Environments

1. Stability and Complexity

In the last section, we addressed external factors organizations should consider. In addition to understanding these factors, organizational leaders also look at their industry, internal complexity, and other aspects of the internal environment to help them better understand how to make business decisions.

The table below illustrates how well industries align with different types of environments. The top left box represents the least amount of uncertainty, and the bottom right represents thenlare highest degree of uncertainty.

The two dimensions of this figure represent environmental complexity and stability. Complexity is the number of elements in the environment which affect the organization, such as competitors, suppliers, and customers. Organizations are described as simple (fewer elements) or complex (more elements). Stability is how frequently the factors in the environment change. Organizations are described as stable (slow and infrequent change) or unstable (rapid and frequent change). How available monetary and financial resources are to support an organization’s growth is also an important element in this framework.

• Certain industries fit and align more effectively in a simple-stable environment; that is, they are in a relatively unchanging environment and are affected by few external factors.
  
  

  EXAMPLE

  One famously stable industry is funeral homes, which are often family-owned and “recession-proof.”
  
  Of course, unpredicted conditions, such as global and international turmoil, economic downturns, and so on, could affect the most stable industry, but generally, these alignments have served as an ideal type and starting point for understanding the “fit” between environment and industries.

• In a complex-stable environment, an organization has a high number of external factors but relative stability.
  
  

  EXAMPLE

  A university has a large number of stakeholders, including students, faculty, other staff, alumni, government, the community, and more, but even with this complexity, have relatively stable environments.

• In a simple-unstable environment, industries are impacted by only a few factors but are extremely volatile, such as fashion, music, and toys, where changing tastes can make sales unpredictable.
  
  

  EXAMPLE

  A gaming company has only five full-time employees, with predictable expenses, but sales are volatile and hard to predict. They have to manage their finances so the flush years can pay for the downturns.

• Finally, in a complex-unstable environment, companies are affected by a number of factors, and those factors change quickly and frequently; this describes industries like airlines, telecommunications, broadcast media, and tech companies. You may notice that these are also some of the most high-profile and profitable industries.
  
  

  EXAMPLE

  The airline industry is a highly complex and unstable industry with large and diverse staff and is affected by numerous environmental factors from municipal zoning laws to fuel prices to bad weather.

This model is only a starting point for diagnosing the “fit” between types of external environments and industries. As conditions change, industries and organizations must adapt or face consequences. There are many examples of companies that did not adapt. For example, although Kodak invented the digital camera in 1975, they ditched the idea, fearing it would negatively impact their sales of film cameras (Gann, 2016). In 2012, Kodak filed for bankruptcy as their rivals harnessed opportunities around digital photography. In another example, Nokia invested in research and development of smartphones in the late 1990s but did not adapt to the external environment in terms of understanding the importance of phone software like demand for apps, so they had to eventually sell their business (Ross, 2021).

terms to know

Complexity (Simple/Complex)

The number of elements in the environment which affect the organization, such as competitors, suppliers, and customers. Organizations are described as simple (fewer elements) or complex (more elements).

Stability (Stable/Unstable)

How frequently the factors in the environment change. Organizations are described as stable (slow and infrequent change) or unstable (rapid and frequent change).

2. Internal Complexity

So far, we have only described the complexity of the organization’s environment where the organization operates. There is also internal complexity, describing the organization’s structure and processes, human resources, technologies used to do business, products, and other factors.

Some strategies call for managing organizational complexity at the internal level while nurturing it at the external level, depending on internal and external factors. For example, a retailer might simultaneously try to streamline operations within their stores while opening online shopping options.

Here are three tips from organizational practitioners Alberto Felice De Toni and Giovanni De Zan for managing internal complexity after you have diagnosed the nature of the external complexity (Eisenhardt & Sull, 2001).

1. Create self-managing teams or autonomous business units with a responsibility to the larger organization.
2. Find and develop simple rules to drive creativity and innovation … to keep the infrastructure and processes simple, while encouraging complex outputs and behaviors.
3. Build on the organization’s strengths. If companies attempt to do too much, it may lead to chaos. Some strategies to build on a company’s strengths include:
   1. Promote cooperation and integration.
   2. Advance your brand and reputation.
   3. Share values, vision, strategy, organizational processes, and knowledge, through the development of trust in leaders at all levels.

IN CONTEXT: CASE STUDY

The Lego Group has been part of childhood for several generations around the globe because of their toy construction kits. But when sales flagged in the 1990s due to new challenges and competition, the company diversified in an attempt to adapt, and nearly diversified itself into oblivion. By entering realms like theme parks, video games, direct-to-DVD movies, and clothing lines, the company took on massive new costs and enterprises they did not have the institutional wisdom to operate.

To turn things around, then-CEO Kjeld Kirk Kristiansen, grandson of the inventor and founder, stepped down and handed the reins of the company to Jørgen Vig Knudstorp. Knudstrop began his role by simplifying the company internally, identifying areas at The Lego Group which could be shut down or sold. For example, he eliminated a resource-intensive project called Darwin, where people could use an online tool to design their own kits, but which had not engaged users. He sold Lego’s theme parks to an outside company that had more experience running theme parks. He cut down the number of colors Lego bricks came in, which had grown substantially since the company’s founding. The variety of colors made them especially vulnerable to supply chain issues, which created inventory issues.

But as Knudstrop simplified the organization internally, he made it more complex externally by engaging new audiences. For example, Lego introduced the Friends line, the first Lego kits to be targeted specifically to girls. Lego also began catering more to the adult audience, with lines like Architecture, featuring famous buildings and structures. One more innovation was the Inventions line, which are kits created by Lego users and posted online for other fans to rate; the most highly rated kits are manufactured and sold. This engaged the online audience in an exciting new way. Through Knudstorp, Lego also launched the Lego movie series, in which movie rights were sold to professional film making companies but nevertheless, grew the Lego brand.

These actions demonstrate all three of the rules proposed by De Toni and De Zan. While these changes initially meant lower profits for The Lego Group, they helped reestablish and even improve upon the Lego brand and reputation, as the new products were still familiar and “[felt] like Lego” (Davis, 2017; Ringen, 2015).

term to know

Internal Complexity

An organization’s structure and processes, human resources, technologies used to do business, products, and other factors.

3. Open Systems Theory

At a basic level of understanding how internal organizations respond to environments, consider the open systems theory, introduced by David Katz and Robert Kahn in The Social Psychology of Organizations, a keystone text in organizational theory first published in 1966.

Katz and Kahn viewed healthy organizations as open systems that take in resources and raw materials at the “input” phase from the environment in a number of forms, depending on the nature of the organization, industry, and its business. Whatever the input resource (information, raw materials, students entering a university), those resources will be transformed by the internal processes of the organization. The internal organizational systems then process and transform the input material, which is called the “throughput” phase, and move the changed material (resources) to the “outputs” and back into the environment as products, services, graduates, etc.

Organizations, according to this theory, are considered as either open or closed systems (or relatively opened or closed), depending on the organization’s sensitivity to the environment. Closed systems are less sensitive to environmental resources and possibilities, and open systems are more responsive and adaptive to environmental changes.

EXAMPLE

During the 1980s, Japanese auto sales hit the U.S. like a shockwave. At the time, U.S. automakers had become closed or at least insensitive to changing trends in the industry and were unwilling to change manufacturing processes. Major U.S. manufacturers experienced slumping sales, plant closures, and employee layoffs.

An organization defines itself and its niche in an environment by the choice of its domain, the sector or field of the environment it will use its technology, products, and services to compete in and serve. Organizations respond to external environments not only through their structures, but also by the domains they choose and the internal dimensions and capabilities they select. Some of the major sectors of a task environment include marketing, technology, government, financial resources, and human resources.

Presently, several environmental domains that once were considered stable have become more complex and unstable, such as public utilities and the U.S. Postal Service. Even domains are changing. For example, the traditionally stable and somewhat unchanging domain of higher education has become more complex with the entry of for-profit educational institutions, free online courses through organizations like Khan Academy, internal company “universities,” and other certification and degree programs outside traditional private and public institutions. Sharing-economy companies such as Uber and Airbnb have redefined the transportation and hospitality domains, respectively.

terms to know

Open Systems Theory

A theory describing organizations in terms of inputs (resources), throughputs (processes), and outputs (products); the open systems model describes organizational process as a constant feedback loop within the environment.

Open/Closed System

How responsive an organization is to environmental change. An open system is more responsive and considered healthier in open systems theory.

Domain

The geographic area, sector, or field of the environment an organization will use its technology, products, and services to compete in and serve.

4. How Organizations Respond to a Changing Environment

With a chosen domain in which to operate, owners and leaders must organize internal dimensions to compete in and serve their markets. For example, hierarchies of authority and chain of command are used by owners and top-level leaders to develop and implement strategic and enterprise decisions; managers are required to provide technologies, training, accounting, legal oversight, and other infrastructure resources; and cultures still count to establish and maintain norms, relationships, legal and ethical practices, and the reputation of organizations.

Recall that it is the CEO and other top-level leaders who scan the external environment. A related process is a SWOT analysis, for strengths, weaknesses, opportunities, and threats. This analysis helps the executives to define the vision, mission, goals, and strategies of the organization. Another example of an external tool is a PESTLE analysis (or PEST analysis), which stands for political, economic, social (sociocultural), technological, legal, and environmental inventories. As the name suggests, the PESTLE analysis is more attuned to the organization’s return impact on the environment (in both senses of the word). Using either tool, managers are able to get a clear picture of what external factors might impact their business. Once the enterprise goals and strategies are developed based on these analyses, the organizational culture, structure, and other systems and policies can be established (human resources, technologies, accounting and finance, and so on).

learn more

You can read a thorough SWOT analysis here. How might the McDonald’s organization respond structurally to respond to these environmental forces?

Read more about PESTLE analysis here.

While the above models show the range of factors that affect organizations and the internal factors that respond to them, the more detailed model below shows the process of responding to the findings from an analysis.

As this more detailed model shows, after a CEO and the top-level team identify opportunities and threats in the environment, they then determine the domain and purpose of the organization from which strategies, organizational capabilities, resources, and management systems must be mobilized to support the enterprise’s purpose.

In practice, no internal organizational alignment with its external environment is perfect or permanent. Quite the opposite. Companies and organizations change leadership and strategies and make structural and systems changes to meet changing competition, market forces, and customers' and end users’ needs and demands. This makes organizations themselves dynamic and ever-changing, particularly those that have a high degree of uncertainty.

terms to know

SWOT Analysis

A method for analyzing the internal and external environment, identifying the organization’s strengths, weaknesses, opportunities, and threats.

PESTLE Analysis

A newer form of analysis that stands for political, economic, social (sociocultural), technological, legal, and environmental inventories.

REFERENCES

Davis, J. (2017, June 4). How Lego clicked: the super brand that reinvented itself. The Guardian. www.theguardian.com/lifeandstyle/2017/jun/04/how-lego-clicked-the-super-brand-that-reinvented-itself

Gann, D. (2016, June 23). Kodak invented the digital camera - then killed it. Why innovation often fails. World Economic Forum. www.weforum.org/agenda/2016/06/leading-innovation-through-the-chicanes/

Eisenhardt, K. M., & Sull, D. N. (2001). Strategy as simple rules. Harvard Business Review 79(1): 106-119.

Ringen, J. (2015, January 8). How Lego Became The Apple Of Toys. Fast Company. www.fastcompany.com/3040223/when-it-clicks-it-clicks

Ross, L. (2021, June 18). 7 Companies That Failed to Adapt to Disruption and Paid the Ultimate Price. Thomas Insights. www.thomasnet.com/insights/7-companies-that-failed-to-adapt-to-disruption-and-paid-the-ultimate-price/