Strategy and organization of corrporate banking

On April 2nd 1998 Deutsche Bank announced a new "restructuring torise revenues substantially" according to the principle of "gear business tocustomers' expectations"; this led to the cre

of Corporate Banking

Inno-Cataloging-in-Publication Data

Library of Congress Control Number: 2004112290

ISBN 3-540-22797-0 Springer Berlin Heidelberg New York

This work is subject to copyright All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illus- trations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag Violations are liable for prosecution under the German Copyright Law.

Springer is a part of Springer Science+Business Media

publica-Hardcover-Design: Erich Kirchner, Heidelberg

SPIN 11310839 42/3130-5 4 3 2 1 0 - Printed on acid-free paper

Reinhard H Schmidt

The impressive development of the finance literature with its emphasis onasset pricing and the formal modeling of incentive systems during the pastthree decades, has largely relegated the business and operational aspects ofbanking as an industry from the agenda of academic research Though this

is understandable, it is especially regrettable in view of the dynamic opments in the banking industry which have started about a decade agoand are currently in full swing Fortunately, there are now signs of achange to the effect that banking is back on the research agenda The pre-sent book by Professor De Laurentis and his co-authors is a highly innova-tive and interesting manifestation of this reorientation

devel-Banking is an important part of any financial system, and it is especiallyimportant in the financial systems of the countries of Continental Europe,such as Italy, France, and Germany, which have been bank-based for dec-ades and which are, in my view, likely to remain bank-based for the fore-seeable future There are many reasons, based on empirical and theoreticalconsiderations, to believe that strong banks are not only important for thebanking industry itself, but also for the respective national economies.This situation makes it highly important to deal with the question ofhow banks of a given country can and do face the competitive pressureswhich come from the banks of other countries, from truly global banks,from "non-bank banks" and, last but not least, from the capital markets,and adapt to the new structures in the corporate world In particular in asubfield of banking which one can call corporate banking there is a needfor banks to find new and appropriate ways of meeting the demands oftheir clients If they fail in this respect, they will lose these clients to theircompetitors

But banking is more than a part of the respective country's financial tem It is also an industry, and industries under pressure are forced to adapt

sys-to changing circumstances It is the common ground between the fields ofindustrial organization, strategic management and organization whichholds considerable promise to help banks in this situation Fortunately, in-dustrial organization and strategic management are currently developing in

a way which seems to lead to a fruitful synergy Moreover, there is now acloser relationship than there has ever been between the thinking on strat-egy and on organization An established doctrine in the three overlapping

areas, which goes back to the seminal writings of Raymond Chandler, isthat "structure follows strategy" This view suggests a linear or hierarchi-cal relationship of what determines what It sees strategy in the leading po-sition and suggests an adaptation of the organizational design to strategy,and it assumes that strategy is determined by factors which are beyond theinfluence of individual organization and that, moreover, it is largely clearwhat the optimal strategies are.

With due respect to Chandler and those like Oliver Williamson whohave built on his foundations, one can take issue with this view Banking is

an industry in which the strategic imperatives are anything but clear, andthis holds all the more with respect to banking services for business or cor-porate clients Therefore, it would be a delicate matter to take bank strat-egy as the conceptual starting point

As an alternative and more modest view one can argue that, in order to

be successful, a number of strategic options are available to large and portant banks But what ever the option may be which is finally selected -with strategy selection being a difficult issue in itself, and one which hasalso not received the attention which it deserves - one thing is imperative

im-to understand: strategy and organizational design are complementary ments of a business system: there is a relationship of mutual determination

ele-In order to be successful, any large economic institution needs to createand maintain consistency between strategy and organization as two coreelements of its value-creating system In simple words, consistency isgiven if the elements of a system are such that they fit together well in thesense that they mutually reinforce their respective positive effects andmitigate their negative effects

Complementarity is a relationship which has in recent years been covered" in a number of fields, including some which are of primary im-portance to the topic of the present book These fields include strategy, asemphasized recently by Michael Porter; business systems, as elaboratedextensively by Milgrom and Roberts; organizational design, as arguedconvincingly by Brickley, Smith and Zimmerman; and finally financialsystems, as Hackethal, Tyre 11 and myself have tried to show In all of theseareas, complementarity is very important, and consistency seems to be anindispensable requirement for success To me the present book offers am-ple support for this "systemic" approach and its main lesson: It may bemore important whether strategy and organizational design of a bank areconsistent than the choice of strategy itself

"dis-In their book, Professor De Laurentis and his co-authors take only a tious look at the banks' choice of strategy Though they use strategy as apoint of reference, they do not regard it as the overarching determinant of

cau-organization, and they take the declared strategic choices of the large ian and European banks in their sample as given instead of arguing whichstrategy would seem best to them Not surprisingly, they find a wide vari-ety of strategic orientations in large Italian banks Instead of on strategy,their focus is on the macro- and micro-level organization of the banks andthe way in which, and the extent to which, strategies and organizationaldesigns are consistent As the individual chapters demonstrate in great de-tail and supported by their extensive empirical research, the authors comeaway with rather sobering results: The banks in their sample seem to agreethat in general divisionalization is the right approach to accommodate cor-porate banking better than in the past, but disagree widely on the specificform and the extent to which lines of business are in fact separated Even

Ital-on the normative level, the optimal form and degree of divisiItal-onalizatiItal-on is

an open issue After all, there are certainly merits in not going too far insplitting up different functions and business areas and instead maintainingelements of a universal bank not only for the large banking groups as awhole but also on the operational level

Even for various forms and degrees of divisionalization, the authors findagain and again that the individual banks which they have investigated atgreat length do not fully appreciate the importance of properly aligning -

or creating consistency between - strategies and the way in which the bank

as a whole and its subunits and its processes are organized It is very good

to have this documented in a sober academic study, even though I do notthink that this critical assessment should be all that surprising After all,the need to adjust organizations to - possibly new - strategies is a very re-cent challenge and the strategy-adjusted organization of banks is an area inwhich neither banking practice nor academic research have yet come upwith convincing and general rules and recommendations

In view of this situation, one should not take it as a criticism of thebanks that one can observe a great deal of experimentation in the way inwhich large banks in Italy and many other parts of the world reorganizetheir structures and processes It is indeed a highly worthwhile academicundertaking to observe and critically but cautiously comment on these ex-periments We can learn a lot from the kind of clinical studies which Pro-fessor De Laurentis has summarized in this book, and hopefully this learn-ing will eventually make a contribution to improved business policies

Reinhard H Schmidt Professor of International Banking Goethe-Universitat, Frankfurt, Germany

Frankfurt, July 2004

Giacomo De Laurentis

The needs for better "customer orientation" and for distinguishing retailbanking from corporate banking activities were already clear to bank man-agers during the Eighties However, only in the second half of the Nineties

it became apparent, on one side, that in the bank industry real customerorientation could be achieved only by changing the macro and micro, hardand soft profiles of the organization and, on the other side, that corporatebanking should not be confined to the small number of very large corpora-tions but should be extended to medium-size customers

On April 2nd 1998 Deutsche Bank announced a new "restructuring torise revenues substantially" according to the principle of "gear business tocustomers' expectations"; this led to the creation of 5 market divisions: re-tail and private clients (with two different business areas), corporate bank-ing and real estate (designed for small/medium-size companies, for whichthe bank intended to become a sort of 'financial family doctor'), globalcorporations and institutions (for the specifically aimed control of individ-ual product lines and special important customers which might enablethem to reach a top-five position within three years), asset management,transaction banking (for technologically assisted services)

The creation of a dedicated organization division nowadays representsthe most relevant evolution being carried out by big and medium-sizebanks in corporate banking This phenomenon marks a clear shift in or-ganization structures, i.e from a functional configuration (with a geo-graphically extended distribution network) to a divisional configuration,which is characterized by the presence of more product and/or customersegment specialized divisions

Such evolutionary trend in the organization structures has been long served in the sector of non-financial firms (mainly in the Sixties), but forthe banking sector the phenomenon is far more recent In the past fiveyears, a relevant number of banks have been pursuing this course ofchange under the strong pressure of top management and consulting firms.Despite the large number of banks involved in this process, it is not yetclear whether they have embraced a rationalistic approach requiring theanalysis and formulation of the strategy and the planning of the organiza-

ob-tion in accordance with their "declared strategy" or simply acknowledgedthe presence of an "emerging strategy" in the diversification of client re-quirements and product/process solutions due to technological and finan-cial innovation.

Undoubtedly the wide range and the frequently renewed formulation ofstrategies and organization models that are actually implemented in corpo-rate banking by almost all banks highlight four facts:

a) the persistent attempt to understand the real nature of the business and

to optimize production units and distribution channels,

b) the absence of both an established theoretical framework and a nant model (even within specific territorial contexts),

domi-c) the huge risk of misalignment of strategy, market policies,macro/micro and hard/soft organizational profiles, for not a short pe-riod of time,

d) the increasing pressure that such changes impose on banks' managersand clerks who have to reshape their skills and competencies as well as

to accept career patterns that are less clear and less consolidated than

in the past

Consequently a lot of questions arise

Causes of the organizational structure evolution Are bank

divisionali-zation drivers to be identified in the diversification and correlation degree

of the different businesses as well as in the implementation of performancevaluation and control systems, as is the case for non-financial firms (Wil-liamson 1975)? What are the determinants of divisionalization by geo-graphical area, product, and client segment? Is bank divisionalizationdriven by verified different customer needs? Take note that when divisionsare specialized according to identifiable groups of customers we'll say thatthey are built around client or market segments

Vision, mission and strategy of corporate banking Is this business area

centered on customization or commoditization philosophies? In terms ofthe basic competitive strategies (Porter 1980), should banks pursue cost-leadership or differentiation based on the ability to establish broad, privi-leged and long-term customer relationships? Will the relationship-orientedoffer model prevail on the commoditization trend of the lending business?

If the community bank business model that emphasizes personalized vice and relationships based on soft information is likely to be viable in thelong run (De Young et al 2003), is bank divisionalization a way for largerbanks to penetrate the community banks traditional markets?

ser-Segmentation philosophy What is the fundamental variable in the

seg-mentation model for the banking business? Is it the specialty of ucts/services, the transactions-based or relationship-based business ap-proach, the dimensions of operations and/or customers? How is corporatebanking positioned with respect to investment banking and commercialbanking (Holland 2001)?

prod-The organization structure of the corporate area What is the best

or-ganization model for the corporate area within the banking group? Is tribution channel specialization sufficient or should divisionalization in-volve all production, distribution and management structures (in otherwords is bank divisionalization "true" divisionalization)? Does the highlyinterrelated production of bank services involve a lower degree of divi-sionalization than that of non-financial firms?

dis-Existence of a dominant organization model Does there exist an

evolu-tionary cycle of corporate banking strategies and a "dominant" modelwhich, as a result of its ability to generate value, might represent the finalstage of the evolutionary cycle? On the contrary, can highly different or-ganizations and strategies co-exist lastingly?

Configuration of the specialized corporate banking branches What

kind of organization characterizes the units in contact with corporate ents (e.g unit structure, extension of reference territory, number of clients,territorial distribution criteria, sector specialization, product range, relationwith other commercial/product units, risk-return responsibilities, etc.)?

cli-The role of the corporate banker (the client manager) On the basis of

which factors is the corporate banker able to generate value for the bankand for the customers (wide-ranging and deep professional competencies,availability of decision supporting systems for customer advisory services,performance valuation and incentive criteria)? Is the corporate banker nec-essarily relationship oriented?

Credit risk management Is the introduction of credit ratings

condition-ing the pursuit of consistency between corporate bankcondition-ing vision and sion, sales strategy and credit risk management? Is information productionchanging in credit relationships due to the increasing use of internal ratingsystems (Brunner et al 2000)? Is the corporate banker involved in creditrating issuing, reviewing and control and what is the nature of the ratingassignment process? This is a key issue if "the technology of relationshiplending is based on the accumulation of information over time throughcontact with firm, its owner, and its local community on a variety of di-mensions The information is often "soft" data that may be difficult toquantify, verify, and transmit through the layers of management and own-ership of a banking organization" (Berger and Udell 2002)

mis-Organization soft aspects: operating mechanisms in the corporate sion What are the specific profiles of the operating mechanisms (delega-

divi-tions, performance valuation systems, incentive schemes), the managerialand professional competencies, the operational and managerial informationsystems? Given Mintzberg's five coordination mechanisms, which is char-acterizing the corporate banking area and the corporate banker's role(Mintzberg 1983)?

Information technology How to achieve a virtuous alignment, for a

last-ing competitive advantage in corporate banklast-ing, among strategy, tion model, operating roles configuration, and information systems?The analysis carried out in this book will try to answer these questionsand will allow identifying, in the conclusions, the rate of consistency of thechoices made by the individual banks in the various surveyed fields as well

organiza-as the critical organiza-aspects which might be responsible for the success or thefailure of the pursued strategy Moreover, it will enable to verify if de-clared strategies are coherently shaping the organization and if banks'quest of the competitive advantage is inducing them to differentiate theirstrategy and organization to a greater degree than in the past In fact, de-clared strategies are not always followed by the expected decisions on theorganizational side and there is indeed a continuum in the "rate of divi-sionalization" of banks from very low levels to the meta-divisionalization

of Unicredito (this leading Italian bank on January, 1 2003 merged itsseven commercial banks focused on different regions and created three dif-ferent banks specialized by customer segments; see Fig 1)

This book is designed for different groups of readers:

a) researchers, who need to verify whether general theories of tion apply to business-specific contexts and to find ways to measure therate of consistency among the numerous (macro and micro, hard andsoft) aspects of organization that actually determine the success or fail-ure of many strategies;

organiza-b) bank managers and bank consultants, who need to identify the mostsuitable model of divisionalization among the many alternatives and toassist banks in shaping their strategy and organization more consciouslyand more firmly;

c) bank professionals, who need to understand the driving force ofchanges, the kind of environment they are going to live in, what skillsand competencies are expected from them and what their typical careerpath is going to be;

d) students, who often need to bridge theoretical concepts with the actualevolution of firms

The research carried out in this book is primarily focused on the zation rather than the strategy of corporate banking for the following rea-sons:

organi-a) the strategy/organization interaction usually observed in the industrialsector (Chandler 1962) is even stronger in financial intermediaries(Norman 1984): banks, in fact, are service firms and their services andstrategies are strongly conditioned by their organization;

b) we thought it wiser to start by analyzing the bank organizationalchoices and then proceed with the strategy so as to compare the "de-clared strategies" with the "achievable strategies" in such organiza-tional structures;

c) the literature on bank strategies and organizations has been developingsince the mid-seventies and has privileged the strategic profiles con-nected with macro-organization structures (e.g Channon 1977, 1986,1988); it was only in the nineties that researchers turned their attention

to the micro and soft aspects of the organization as well as to their sistency with business specific strategies (Baravelli 1997; Eisendardtand Galunic 1994; Smith and Walter 1997), though their studies weregrounded on a quite restricted empirical basis

con-The new organizational model and the implied strategy have to beevaluated more on the level of the theoretical coherence of the design than

on the safer grounds of the empirical analysis of the profitability of theirchoices because, up to now, no bank seems to have fully accomplished thestrategic and organizational change leading to corporate banking divisionsfor a time long enough to allow a meaningful assessment of the resultingprofitability.

The research relies on two fundamental methodological and informativegrounds:

1 the identification in literature of the long-term drivers leading the esses of organization divisionalization and market specialization in fi-nancial institutions;

proc-2 the empirical survey of strategic choices, organization models and ating mechanisms in seven leading Italian banking groups and five largeEuropean banks (Table 1)

oper-Table 1 Key figures of the banks examined in the research

83,033.2140,916.018,995.6277,418.0128,729.9203,773.0213,339.3556,018.0580,795.0758,355.0710,305.0319,030.4

Number ofbranches

868

1.954

545

4.2771.8643.2224.1763.0007.2301.7112.2009.281

Number ofemployees20.49931.2414.87471.50127.51745.65065.555107.41696.50077.44287.685104.178

ROE

-1,82%-7,99%13,05%1,85%8,82%8,30%14,74%14,39%7,32%1,08%11,99%11,00%The decision to include Italian and "other European banks" in our sur-vey results from the need to make reference to an industrial and financialcontext which, despite the numerous differences, is sufficiently homoge-neous in terms of corporate banking management As for Italy, we havesurveyed six leading groups (Banca Nazionale del Lavoro, Capitalia,Banca Intesa, Banca Monte dei Paschi di Siena, SanPaolo-Imi, Unicredito)and Credem, on account of the organization innovations it has already ex-perienced and now consolidated in the corporate segment As for continen-tal Europe, the survey has involved four large-size banks (ABN Amro,

Credit Agricole, Paribas, Santander), which propose the model of the versal bank and develop the business area of Corporate & InvestmentBanking according to a Pan-European selection strategy; Deutsche Bankhas also been considered despite its broader global player's strategy as ithas been long developing organization innovations in corporate banking,which are comparable to some choices now being made by a large number

uni-of banks

The above banks have been interviewed by researchers on one or moreoccasions, on the basis of a questionnaire which had been prepared andtested during the initial stage of the research At the same time public in-formation has been collected from the press and the web Banks are men-tioned either explicitly when public information is being provided or by anidentification letter - unvaried throughout the book - when the confiden-tial nature of information has to be guaranteed

The survey was carried out in the second half of 2002 and in 2003 though a number of choices might have been modified or rather imple-mented by banks since then, the basic features pertaining to the examinedtrends and to the expressed evaluations represent structural elements thatare bound to remain valid in the medium term

Al-The book includes four sections:

1 definition of the research subject and structure (introduction, Giacomo

De Laurentis);

2 the analysis of the literature, the foundations of the organization theoryand the drivers of divisionalization in industrial firms and banks (chap-ter 1, Ozlem Yildirim);

3 the empirical survey of bank strategic and (macro and micro) tional choices as per the following:

organiza-a) chapter 2: product, market and channel strategies in the corporatearea (Stefano Caselli);

b) chapter 3: organization structures: in the quest of an integratedmodel (Paola Schwizer);

c) chapter 4: the corporate banker's role and credit risk management(Giacomo De Laurentis);

d) chapter 5: operating mechanisms in the corporate area (PaolaSchwizer);

e) chapter 6: information systems in the corporate area (SeverinoMeregalli);

4 conclusions about divisionalization drivers, implementation choices(market segmentation, re-organization of structures, changes in man-agement roles, innovation of operating mechanisms and informationsystems), consistency of the overall divisionalization process (chapter 7,Giacomo De Laurentis).

Chapters from 2 to 5 are structured in a fairly similar way: they startwith an introductory section synthetically describing the objectives of thechapter and conclude by identifying the critical aspects which might be re-sponsible for the success or the failure of corporate strategies Chapter 6,dedicated to information technology, utilizes previously acquired data andcompares the emerging needs with the implemented organizational andtechnological solutions The conclusions summarize the main results andprovide a unitary interpretation

Ozlem Yildirim

1.1 Chapter Outline

This chapter aims at analyzing the theoretical drivers of divisionalizationaccording to market segments and its long-term indications for corporatebanking from an organizational point of view Section 2 briefly discussesthe main approaches and streams of literature in organizational theory.Section 3 explains the characteristics of Williamson's three basic organiza-tional structures: unitary form, holding form and multidivisional structurewith an emphasis on the last one, followed by a comparison of bankinggroups and universal banks Section 4 describes the stages in the transition

to the pure divisionalized form and goes through some studies on the lution of divisionalization in industrial segments Section 5 explains threeways of divisionalizing into units: according to geography, product andmarket segments Section 6 elaborates on divisionalization according tomarket segments Section 7 makes up the link between interdependency ofdivisions and performance measurement in divisionalized form Section 8concludes by identifying the drivers of divisionalization and future trends

evo-in bankevo-ing organizational change

Various theories - such as neoclassical economics, agency theory, action cost theory and the resource-based view of a firm - constitute thefoundations of organizational theory to understand a firm and its activities

trans-In addition, a number of researchers have explored the relationship tween organizational structure, strategy and performance showing how anappropriate organizational structure correlates with superior profitability incompetitive markets The strategy-structure-performance paradigm is asub-stream of research on structural contingency theory, which maintainsthat organizational performance depends on the extent of alignment be-tween organizational structure and various contingency factors such as en-vironmental condition, size, technology and strategy The better the fit be-tween structural components and these contingency factors, the better theperformance of the organization In the case of banks, the passage from afunctional structure to a divisional form recalls the same contingency fac-tors as non-financial firms Therefore, the contingency approach is essen-

be-tial in understanding the link between environmental and strategic tion of banks (Baravelli 2003).

evolu-The theorists of the strategy-structure-performance paradigm have phasized the relationship between strategy and structure and its effect onperformance The paradigm can be categorized in three levels of analysis(Eisendardt and Galunic 1994): corporate context of multidivisional or-ganizations, strategic business unit (SBU) context, intra-corporate context

em-of relations among SBUs themselves and between SBUs & corporateheadquarters The corporate level of analysis studies the fit between thestrategy of the corporation as a whole and its organizational structure Thesecond level of analysis examines the fit at the strategic business unit level

In other words, it focuses on the fit between the strategy of SBUs and ternal structures and processes The third level of analysis examines the

in-"intra-corporate fit" of SBUs within the organization

At the corporate level of analysis the major work is Chandler's (1962)study of the strategy-structure relationship where he argues that structurefollows strategy and the correct fit between strategy and structure is whatleads to performance Chandler's (1962) study of organizational changehas been an important theme in the organization literature and subsequentresearchers (Lawrence and Lorsch 1967, 1969; Wrigley 1970; Rumelt1974; Galbraith 1973, 1977, 1983) have developed Chandler's work invarious respects The research by Eisenhardt and Galunic (1994) suggeststhat at all the levels of the analysis, strategy-structure fit tends to improveperformance

1.2 Foundations of Organization Theory - Main

Approaches

The theory of neoclassical economics was developed on the main tion that an economic subject is rational and understands the economictransaction perfectly According to this theory, an individual maximizes itsutility and the firm maximizes its profit on the basis of unbounded ration-ality whereas more recent theories are based on the assumption of boundedrationality and opportunism (Simon 1945; Williamson 1975, 1985) Neo-classical economics views a firm as a mere production function that dealswith the relationship between input and output The issue of dynamism isseen as the problem of finding the equilibrium The firm itself is treated as

assump-a blassump-ack box where assump-activities inside the firm assump-are of no concern to neoclassump-assi-cal economists

neoclassi-The resource-based view of the firm does look inside the firm and seesthe firm in terms of the resources it owns Looking at the firm from thisperspective leads to different insights than traditional product perspectives.The aim of the firm is "to create a situation where its own resource posi-tion directly or indirectly makes it more difficult for others to catch up"(Wernerfelt 1984) Machine capacity, customer loyalty, production experi-ence and technological leads are, as Wernerfelt regards, the "attractive re-sources" that can give the firm a competitive edge Types of resources thatlead to high profits can be identified and they can be associated with re-source position barriers Importance of managerial capacity to determinethe efficiency of diversification choice can also be seen as one of the re-sults of resource based view In this respect, the fundamental task of themanager is to transfer the old resources into new combinations of productsfor competitive advantage so that the process of diversification contributes

to the distinctive competencies of the firm The advantages of related versification can be explained with the concepts of resource based view ofthe firm, in particular with the possibility of allocation of fixed costs to dif-ferent products, transfer of managerial know-how from traditional to newmarkets and realizing economies in the process of buying raw materialsthat will be utilized by various products Recently, the concept of related-ness is associated with sharing intangible resources such as managerialknow-how, valuation systems and in more general terms the management

di-of the firm, that all together constitute core competencies that cannot easily

be replicated, so "unique" to bring competitive advantage for the company(Schwizer 1996)

Agency theory has its origins in the risk-sharing literature, but it focuses

on determining the most efficient contract in a relationship where oneparty (the agent) acts on behalf of the other (the principal) Given the or-ganizational assumptions of the theory (information asymmetry, goal con-flict among participants) and the human assumptions (self-interest, riskaversion), the agency problem arises when the goals of the agent and theprincipal are in conflict and it is costly and/or difficult for the principal tocontrol the actions of the agent Another problem that can arise within thiscontext is the risk-sharing problem due to different degrees of risk-aversion of the principal and the agent In other words, risk-neutral princi-pal shoulders all the risk by paying a fixed wage to the risk-averse agent.Agency theory has been used in finance (e.g., Fama 1980), organizationalbehavior (e.g., Eisenhardt 1985) and many other areas such as accounting,economics, marketing, political science and sociology One of the contri-butions of the theory is its implications for the information systems in or-der to control agent opportunism Another contribution is its extension ofthe organizational thinking by bringing the concept of uncertainty and im-

plications for risk The general consensus is that agency theory is a usefulcontribution to organizational theory through its ideas on incentives, in-formation systems, risk, and outcome uncertainty When complementedwith other theoretical perspectives the agency theory is supported also byempirical evidence (Eisenhardt 1989).

Another stream of literature is the transaction-cost literature where theunit of analysis is the economic transaction and the central paradigm iswhether to undertake the transaction via the market or within the firm.When the transaction is undertaken via the market, the transaction difficul-ties that may appear in the exchange process of negotiating, monitoringand enforcement between two parties cause transaction costs The six mainsources of transaction difficulties are: bounded rationality, opportunism,uncertainty and complexity, small numbers, information asymmetry andasset specificity (Hill and Jones 1988) Corporate strategy is a means to re-duce transaction costs by internalizing up to the point where relative bene-fits of intemalization equal its bureaucratic costs which can be identifiedusing the agency theory Agency theory points out that transaction costs donot disappear when the firm chooses to internalize completely because theuse of hierarchy, delegation of control to lower level employees, causessome loss of control in the system (Leibowitz and Tollison 1980) In thehierarchy context, headquarter (the principal) has to develop a controlstructure to detect the actions of divisional managers (the agents) Bureau-cratic and production controls such as rules and budgets to monitor divi-sional performance are sources of information that will enable headquarter

to detect divisional managers and this kind of information is a bureaucraticcost to the firm Williamson (1975) sees divisionalization as a response tothe problem of transaction costs Increasing size and diversity create com-plexities and bring problems of control to the companies that are function-ally organized Divisionalization, reducing the scale and internal complex-ity of each division, contains transaction costs However, the effectiveness

of such a solution depends on solving the agency problem: ensuring thatdivisional managers act as specified by headquarters

The strategy-structure literature has focused on three main strategies torealize economic benefits These are vertical integration, related diversifi-cation and unrelated diversification In each of these strategies, firms musttrade-off the economic gains against the bureaucratic costs According toThompson's (1967) model, the ease of monitoring decreases when divi-sions share the resources in order to realize economies because in this case

it is difficult to measure each division's marginal product Given that dependencies are a function of the linkages between the head office andthe divisions as well as the linkages between divisions themselves, higherinterdependence increases bureaucratic costs This analysis implies that,

inter-everything equal, lower bureaucratic costs are associated with tional structures where each division functions as a self-contained unit.

organiza-1.3 Characteristics of Basic Organizational Structures and the Multidivisional Form

According to Williamson's analysis there are three basic organizationalstructures: the unitary form, the holding form and the multi-divisionalform Other organizational structures are a combination of these three ba-sic structures

The U-form organizations are commonly known as functional tions and they are organized around business functions such as finance,marketing, and manufacturing Collaboration is needed across all of thesespecialized functions of the organization because these functions alonecannot conduct an entire business The decision-making authority is con-cerned with both the development of strategy and operating activities Thegeneral manager, who has the access to information from all the functionsand has the company-wide point of view, provides coordination among theunits As long as the firm is relatively small and in a relatively narrowbusiness, senior management is able to provide the required direction andcoordination However, the functional organization begins to lose its effi-ciency when the firm grows in size and complexity (Barney and Ouchi1986)

organiza-As Williamson (1970, 1975) points out, radial expansion of the U-formenterprise 1) causes cumulative control effects, which have internal effi-ciency consequences, and 2) alters the character of the strategic decisionmaking process in ways that favor attending to other-than-profit objectives(operational sub goals) The expanding U-form enterprises face conse-quences of information impactedness and bounded rationality and there-fore require the introduction of additional hierarchical levels In the flow

of information, data are summarized and interpreted as they move up andinstructions are operationalized as they move down (Arrow 1974) Bothprocesses can provide control losses and they may occur also in uninten-tional ways These bounded rationality consequences occur even if themanagement acts in a stewardship manner If managers are given to be-have opportunistically, bounded rationality causes further consequences.The difficulties experienced by an expanding functionally organized enter-prise can be summarized as "indecomposability, incommensurably, non-operational goal specification and the confounding of strategic and operat-ing decisions" (Armour and Teece 1978)

In financial intermediation, the functional form creates similar problems

as dimensions, competitive pressure and diversification increase As thebank grows in size and complexity (it diversifies its geographical presenceand range of products), the efficiency of the functional form decreases andthe general management busy with operating burdens can loose its focus

on strategic decisions At this point, the bank demonstrates more tainty, resistance and delay for change than industrial sectors do and thisdelay affects innovation and in turn brings weakness in economic perform-ance (Baravelli 2003) Gardener (1994) views that organizational struc-tures may be changed to help induce innovation and respond to externalinnovation demands, however he also mentions the cautions (Mottura1986) about "misguided attempts" to "force" an operating organization togenerate innovation

uncer-The functional model in banking has become problematic due to thegrowth and diversification strategy that undervalued the importance of co-herence between structural model, dimension and diversification In thebanking field - as in industrial sectors - it is necessary to meet the in-creased competition and diversification of activities with the appropriatestructure and the prospect of passage is the one to the multidivisional formthat demonstrates more adequacy to manage the process of diversification(Baravelli 2003)

The H-form (holding form) company typically diversifies into a largenumber of unrelated businesses Each business is a profit center and a gen-eral manager is given profit responsibility of that center Each profit centermay be a U-form organization and the divisions are often affiliated withthe parent company through a subsidiary relationship The role of the cor-porate staff is usually limited to allocating corporate capital, balancing theportfolio of businesses and evaluating financial performance (Barney andOuchi 1986)

Williamson's last primary structure is the M-form, multidivisional ture It consists of a set of partially diversified business divisions The de-gree of diversification in M-form organizations is between functional formand holding form As in the H-form, also M-form divisional managers aregiven profit responsibility However, unlike H-form case, in a typical M-form organization there are many interdependencies and synergies betweendivisions Therefore, the profit and loss statement of each division is notperfectly unambiguous (see Sect 1.7) This interdependence necessitatesthat the corporate manager should carefully balance the intradepartmentalcompetition (for capital gain and recognition) and cooperation (to benefitfrom the synergies and realize economies of scope) According to Barneyand Ouchi (1986), M-forms that are able to find this balance will outper-form both large functional structures and all H-forms

struc-Mintzberg (1983) observes that the corporate office in related fied firms has to detain some control over the common functions of divi-sions in order to ensure coordination Coordination between divisions re-quires some degree of centralization and integrating mechanisms toachieve communication between divisions (Hill 1988) The M-form struc-ture is the one that combines the internal control and strategic decision-making capability with the divisionalization concept The research by Eis-enhardt and Galunic (1994) suggests that at the intra-corporate level SBUsshould be custom-managed according to their individual strategies and po-sitions within the firm More innovative and important SBUs should bemanaged with more openness, socialization and greater autonomy It is no-table that the general management of the M-form usually requires the sup-port of a specialized staff in order to discharge its functions effectively.Whittington and Mayer (2000) summarize the essential differences ofthe multidivisional form in a strategy-operation dimension as shown be-low.

Centralised Decentralised

Fig 1.1 Harvard types of organizational structures

From an organizational point of view, the divisional structure resolvesthe complexity of the large, diversified corporation by dividing it into ana-lyzable and manageable chunks (Whittington and Mayer 2000) Character-istics and advantages of the M-form can be formalized as follows (Wil-liamson 1970, p 120-121):

1 The responsibility for operating decisions is assigned (essentially contained) to operating divisions.

self-2 The staff attached to the general office performs both advisory and diting functions Both activities have the effect of securing greater con-trol over operating division behavior

au-3 The general office is principally concerned with strategic decisions volving planning, appraisal, and control, including the allocation of re-sources among the (competing) operating divisions

in-4 The separation of the general office from operations provides generaloffice executives with the psychological commitment to be concernedwith the overall performance of the organization rather than to becomeabsorbed in the affairs of the functional parts

5 The resulting structure displays both rationality and synergy: thewhole is greater than the sum of the parts

In addition, Scott (1971) pointed out that multidivisional organizationsact as a "built-in school of management, training middle level generalmanagers in the problems and opportunities associated with economic re-sponsibility As a result, this form of organization provides a pool oftrained talent from which to draw, a pool from which a new group may beformed in a few days or weeks to take over and manage a new activity"

"In September, 1921, the Du Pont Company put into effect this newstructure of autonomous, multi-departmental divisions and a general of-fice with staff specialists and general executives Each division had itsfunctional departments and its own central office to administer the centraldepartments Unencumbered by operating duties, the senior executives atthe general office now had the time, information, and more of a psycho-logical commitment to carry on the entrepreneurial activities and make thestrategic decisions necessary to keep the over-all enterprise alive andgrowing and to coordinate, appraise, and plan for the work of the divi-sions" (Chandler 1962, p.l 11)

Divisionalized banking groups demonstrate allocation of tasks and sponsibilities (at headquarter and division level) in parallel with William-son's formalization of characteristics of the M-form for industrial sectors

re-In divisional structures, the general management of the banking group hasthe function of defining the overall strategy of the bank, allocating portfo-lio of investments, coordinating single divisions through planning and con-trolling, acquiring financial resources and allocating them on the basis ofdivisional performances At senior management levels, there may be sup-porting functions for the management of common divisional processes -

such as strategic planning - or for the coordination of activities managed

by the divisions (e.g personnel management) The higher the encies between divisions, the more numerous the central unit is Each divi-sion, then, can be considered as a separate firm that can manage its ownproduct/market/client combination and represents an autonomous profitcenter (Schwizer 2000)

interdepend-Banking groups and universal banks can be compared in terms of width

of diversification and level of control (Fig 1 2.)

Banking group

Fig.l 2 Width of diversification and level of control on activities

In economic terms, the main advantages of the banking group with spect to the universal bank are the following (Schwizer 2000):

re-• it eases the task of general management and production distributionprocess due to independent internal units with single homogenous com-binations of product/market/technology Advantage of speed in possibleentrance or exit decisions, acquisition or closing of the unit respectively;

• the possibility of finding specific equity or non equity partners for singlebusiness units;

• professional development and motivation at managerial levels due toempowerment of functional managers to quasi-autonomous units withhigher responsibilities Diffusion of culture and entrepreneurship;

• more effective competitiveness as products and services are focused onsingle markets;

• limitation of eventual conflicts that emerge in the process of industrialre-conversion;

• no effect on organizational units that are not directly involved

At the organizational level, however, the efficiency of the group withrespect to the universal bank is limited by certain elements and these can

be summarized as coordination cost, integration cost between productionand distribution functions, controlling cost, fewer opportunities of econo-mies of scale from production, difficulty to realize cross-subsidization.The picture emerging from the comparison of the banking group and theuniversal bank in various aspects reveals that diversification can beachieved more conveniently by the group structure In terms of strategicprofile, the group is the optimal form to realize diversification choices inthe short-term and on a large scale The production cost, however, ishigher for the group than for the universal bank which can eliminate possi-ble cost duplication for the structure and the management of single units

1.4 Divisionalization and its Evolution in Industrial

Segments

Stages in the transition to the divisionalized form are defined by Mintzberg(1979) as: the integrated form (pure functional), by-product form, related-product form and the conglomerate form (pure divisional) The firm passesthrough these stages as the integration of its product chain breaks downand the intermediate products throughout the process gains more impor-tance As can be seen from Fig 1.3, when the production process of thefirm relies on one integrated product chain, it has a pure functional struc-ture As it begins to market some intermediate products, it makes the firstshift to the divisional form and its structure is called, by-product form Inthe following stage, by-products become more important than the endproduct, the structure comes closer to a divisional one and it is called re-lated-product form Finally in the last stage related products have no rela-tion with each other due to the complete breakdown in the productionchain and the structure of the firm becomes pure divisional

Divisionalized form is typically found in industrial sectors and fromMintzberg's five ideal types of organizations, it fits best with Machine Bu-reaucracy Configuration, whose major characteristic is the routine operat-ing work with the greatest part of it rather simple and repetitive This leads

to sharp division of labor in the operating core that is specialized bothhorizontally and vertically The divisional form results from "centraliza-tion" of independent organizations that operate in different markets(Mintzberg, 1979)

Integrated form (pure functional)

By-product Form

V I

Related Product Form

Conglomerate Form (pure divisional)

Fig.l 3 From pure functional to pure divisional forms (Source: Mintzberg 1979)

The extension of standardization beyond the operating core was tioned by Worthy (1959, pp 75-76) as "to organize the work of the shop,but no sooner was everything under control there than influences from out-side the shop, from other segments of the enterprise (e.g., sales, finance),began to impinge upon and upset their neatly contrived arrangements.Thus the scientific managers soon began to be concerned with the neces-sity for extending their control to the entire enterprise" Similarly, Whit-tington and Mayer (2000) makes a similarity between Taylorism and divi-sionalization as the former partitioned the tasks of the blue-collar workers

men-in the first of part of the century, the latter partitioned the roles of the agement

man-Organizational structure of the firm would not matter unless the ties performed by the local units generated positive spillover (Baron andBasenko 2001) The fact that the shift from unitary form to "multi-divisional structure" creates problems illustrates the proposition that "thesystem cannot be derived from the parts, the system is an independentframework in which the parts are placed" (Angyal 1969, p.29)

activi-Optimum divisionalization involves (Williamson 1975): (1) identifyingseparable economic activities within the firm, (2) assigning each of themquasi-autonomous standing (usually that of a profit center), (3) monitoringthe efficiency performance of each division, (4) awarding incentives, (5)allocating cash flows to high yield uses, and (6) performing strategic plan-ning (diversification, acquisition and related activities) in other respects.Change is a normal condition of organizational life because the organi-zation is a pattern made of, shaped by and emerging from change (Tsoukasand Chia 2002) In the body of literature that focuses on the structuralchanges that accompanied diversification, it is shown that firms evolve in afairly predictable fashion from a functional to a multi-divisional form oforganization as they grow from single-business to multi-business Scott(1971) has developed a model of stages of corporate development, viewingthe corporation as moving from a small functionally organized company tothe multidivisional structure as its product-market complexity increases(Table 1.1)

"The strategy of an enterprise evolves in response to and in anticipation

of trends in its environment" (Channon 1973) In the case of the British dustrial environment in the postwar era, the forces that have guided theemerging patterns of the corporate strategy are: the changing pattern ofdemand, the growth in competition, the rise in U.S investment, the growth

in-in in-international competition, changes in-in market in-institutions, the impact oftechnology and the changing pattern of supply

Table 1.1 Three stages of organizational development

Company

Characteris-tics

Stages2

1 Product

line

1 Singleproduct orsingle line

3 Specialization based

on function

3 Specializationbased on product-market

per-6.Personalcontrol ofboth strate-gic and op-erating deci-sions

5 Increasingly sonal using technicaland/or cost criteria

imper-6 Personal control ofstrategic decisions, withincreasing delegation ofoperating decisionsbased on policy

5 Increasingly personal using mar-ket criteria

im-6 Delegation ofproduct-market deci-sions within existingbusinesses with indi-rect control based onanalysis of "result"

Certain influences were more important than others, but the major cause

of strategic change was clearly from the marketplace, which transformedthe pattern of the competitive advantage In turn, strategic changes broughtabout structural transformations (Channon 1973) Channon examined theevolution of the population of the largest 100 British manufacturing com-panies over the 20 year-period 1950-1970 Analysis of the evolutionarytrends revealed a significant growth in strategies of diversification withinthe population Adoption of the diversification strategy was associatedwith a change in the structure of a firm from a traditional functional form

of organization to either a holding company or multidivisional structure.The holding-company structure was found to be initially the prevalentform of organization probably because the companies were not able to in-novate the more sophisticated control and planning mechanisms that themultidivisional system necessitates However, especially during the 1960s,the multidivisional structure was rapidly adopted and superseded many ofthe holding company structures

Organizational homogeneity theory predicts large organizations to semble each other due to three kinds of pressures from their environments(DiMaggio and Powell, 1983) These are cultural expectation of competi-tors, suppliers, or the state to conform structurally, uncertainty in the envi-ronment that would cause the firms self-consciously mimic other success-ful organizations and finally promotion of multidivisional form by leadingbusiness schools as an important organizational tool In fact, some studiesassociate the spread of M-form to American political and economic he-gemony (Djelic, 1998), promotion of leading American business schoolsand consulting firms (Servan-Schreiber, 1967; Channon, 1973) and politi-cally motivated program of "Americanization" of European management(Guillen, 1994; Djelic, 1998)

re-Williamson (1970) has regarded the decentralized multidivisional form

as "American capitalism's most important single innovation of the eth century" The Harvard group regarded it as "eminently exportable" and

twenti-as the multidivisional form spread around the world, its evident superioritywould soon drive the other organizational forms out of existence WhileRumelt (1974) had found advanced level of divisionalization in the U.S.,Scott (1973) predicted that Western Europe would steadily catch up

In Scale and Scope (1990) Chandler attempts to measure the responses

to the challenges of large-scale business He found that USA and Germanyresponded through related diversification and by building administrativehierarchies as efficient organizational structures Chandler (1990) sug-gested that there might be country-specific factors within Europe since theconglomerate has been predominantly an Anglo-Saxon phenomenon Thisargument suggests that Germany and UK are likely to be at opposite sides

However, the study of Mayer and Whittington (2000) - where they ine the original Chandlerian model of corporate development in the light ofthe recent experience of large French, German and British firms - revealsthat despite the broadly stable and distinctive institutional backgrounds,European corporations have been transforming their strategies and struc-tures steadily and in very similar ways during the whole post-war period.They extend existing studies of the post-war period to the 1990s andprovide an opportunity for longitudinal and international comparison Theemerging picture suggests that throughout the post-war period French,German and British corporations have steadily converged on the division-alized model of the U.S (Table 1.2.).

exam-Table 1.2 Structures of large industrial firms in post-war Europe (%)

4540140

_ 6

1960

4030245

2953144

_ 22

1970

18241642

27191440

811874

1983

5.48.117.668.9

10.023.310.056.7

4.01.35.389.3

1993

1.59.113.675.8

3.214.312.769.8

1.509.089.5Source: Mayer and Whittington 2000

Table 1.2 shows that in France, Germany and UK the trend of tional structure in the post-war period is steadily towards increasing divi-sionalization In Germany and France, there is a substantial increase in theproportion of firms with divisional organizational structures in both peri-ods 1970-1983 and 1983-1993 In the UK, in the second period there is avery high level of divisionalization, with a rate which is even higher thanthat of American business at the end of the 60s in the US (Table 1.3 andTable 1.4)

organiza-Table 1.3 and organiza-Table 1.4 show that in both of the time periods, divisionalstructure emerges as the most stable organizational structure This impliesthat the divisional form did not emerge only as a result of American post-war economic and political domination, but it has been steadily absorbed

by European mainstream also after the 1970s As the population-ecologytheory sees it, the divisionalized company is the survivor of an evolution-ary struggle between competing organizational forms

Table 1.3 Structural stability for the period 1970-1983 - all of the three countries

Not stable

Stable

Functional89.310.7

Count (%

holding81.818.2

Functional-of structure)Holding72.028.0

Multidivisional15.584.5Source: Mayer and Whittington 2000

Table 1.4 Structural stability for the period 1983-1993, all of the three countries

Count (% of structure)Functional Functional- Holding Multidivisional

holdingNot stable 57.1 62.5 53.3 9

Source: Mayer and Whittington 2000

1.5 Types of Divisionalization

The key organizational choice faced by the firm in the process of

division-alization is how to re-organize units into divisions (Baron and Basenko

2001) A firm or a bank can divisionalize with respect to its geographicalpresence, its product lines or market segments

In geographical divisionalization, functions with a common geographyconstitute a separate unit reducing bank structural costs through manage-rial synergies Channon (1986) points out that the geography variable plays

a major role in branch based banking systems and in international banking,where time zone, language, currency and national boundaries all influencestructure

In geographically divisionalized banks, area managers are in charge ofthe production and administrative functions of their decentralized periph-eral unit Apart from improving the relation between distribution channelsand central unit, area managers' task consists in strengthening market ori-

entation and bank differentiation consistently with territorial diversity(Baravelli 2003) Regional areas can function as profit centers where areamanagers have the task of direction, coordination and control of the distri-bution channels of their zones.

In geographical divisionalization, the administrative structure of thebank becomes differentiated:

• branch managers focus on their specific market and specific short-termobjectives;

• area managers deal with operational coordination and can contribute tothe development of competencies such as identification of opportunities;

• general management can concentrate on strategy making

In product divisionalization each product line constitutes a separate vision The product-division implies the existence of at least two levels ofmanagement and a higher number of management roles than that of a func-tion-organization Strategic decisions and responsibilities at the productmarket level are assigned to division managers, who have the informationpertinent to those strategic decisions

di-In long vertical product chains, various elements in the sequence come separate business units and each of these businesses or divisions in adecentralized organization becomes a profit center The companies thatface product classes that require high degree of sensitivity to changingmarket conditions tend to divisionalize and rely on product and brandmanagers In these cases a divisional organization is typically the most ef-fective way to assign the required authority and associated profit responsi-bility

be-In banking industry, the introduction of new services may necessitatedifferentiated production functions (centralized or decentralized) The bankproduction is characterized by technical diversity (with respect to produc-tion, distribution and managerial competency profile), which leads divi-sionalization according to the activity of intermediation and its specificcomponents High heterogeneity of new services may require internal dif-ferentiation of production-distribution processes and this can give way to amultidivisional model for products If the introduction of a new prod-uct/service requires a specific resource, the functional form needs addi-tional managerial or operational competency that does not contain econo-mies of scope In this case, the functional structure can be maintained byintegrating only the introduction of product manager roles into the model(Baravelli 2003)

A third possible choice is market segment divisionalization nition of business unit emphasizes that each division is a profit centerwithin the corporate organization, which sells services or products to dis-tinct market segments where it could compete effectively (Ceccarelli andRoberts 2002).

PIMS'defi-In fact, what happened in the most famous example of divisionalization

- Alfred P Sloan's restructuring of General Motors in the 1920s - was thecentralization of a set of independent organizations in different markets Inthis typical case of General Motors, the product market was increasinglysegmented into well-defined price classes and this development createdtwo major problems: monitoring (figuring out how the company was per-forming in each segment) and appropriate allocation of company resourceswith respect to this divisional performance The adopted solution was there-organization of the company into divisions corresponding to each mar-ket segment (Chandler 1977)

1.6 Role of Divisionalization by Market Segments

Segmentation rests on the assumption that differences among buyers arerelated to meaningful differences in market behavior

What makes a segment meaningful depends on certain characteristics(D'Amico and Zikmund 1993): (1) the market segment has characteristicsthat distinguish it from the overall market; (2) the market segment has amarket potential of significant size, that is large enough to be profitable;(3) the market is accessible through distribution efforts or reachablethrough promotional efforts; (4) the market segment has a unique marketneed and the likelihood that the market segment will favorably respond to

a marketing mix tailored to this specialized need is high; (5) the segment'smarket potential should be measurable

Ease of measurement is desirable because it facilitates effective targetmarketing by helping to identify and quantify group purchasing power and

to indicate the differences among market segments In planning the targetmarket strategy, a firm decides on the target market approach to pursue(Berman and Evans 1992) This can be a mass marketing approach (aims

at a large, broad consumer market), a concentrated marketing approach(concentrates on one group of consumers with a distinct set of needs, dif-ferentiated marketing approach) or a multiple segmentation approach (aim-

1

PIMS: Profit Impact of Marketing Strategy; a study of business strategy initiallysponsored by the Marketing Science Institute

ing at two or more different market segments, each of which has a distinctset of needs).

In the banking system there has been a general trend towards a moremarketing-oriented (demand-determined) strategy and supply-led bankinghas been increasingly replaced by much more pro-active banking (Gar-dener 1994) In this respect, Gardener mentions the relevant research: acase study (Clarke at al 1988) on the strategic marketing orientation andrespective changes in the organizational design of a large UK bank demon-strates the marketing-induced organizational changes and the commitment

of the very senior management towards a marketing orientation

The research by Feeney (1989) - which employed case study, participantobservation and survey methods - emphasized the market (demand) orien-tation of modern corporate banking Penrose (1959) and Abraham andLierman (1991), however, point out that while changing the organizationaldesign, too much focus on being demand-oriented may also cause negativeoutcomes

Main factors that lead banks to re-structure themselves into well-definedsegments can be summarized as: competition, more and more segmentbased investor analysis, sustainability of performance and growth options,demand for dedicated services at a good price, increased importance ofservice quality in customers' choice, critical mass in all market segments,accountability and higher visibility of each business line, potential tostreamline holding structures

Segmentation in financial intermediation is an important part of strategyformulation and it develops onto two fundamental levels In the scope ofindividual (personal) banking, private banking - which targets high networth individuals - is distinguished from corporate banking, which aims atcorporate clients On the second level (SBU level), both of them have theircustomer base subject to further segmentation in order to gain competitiveadvantage by building comprehensive product offer and specific services

In private banking, the main challenge is to precisely segment worth individuals and affluent market clients and understand their differ-ences in profiles and needs In order to develop customized products andservices, private banks - apart from using criteria such as age group, socialbackground and lifestyle - are enhancing their client segmentation with abehavioral approach by using criteria such as risk profile, investment in-volvement, loyalty, usage of special services Due to the dynamic nature ofwell-structured information about the client (e.g history of transactions inclient portfolio), customer segmentation itself is dynamic and requires apro-active approach

high-net-In corporate banking, the segmentation of small and medium size firms

is strictly linked to the definition of the business area of the bank and to the

system of offered products and services It means that segmentation is rectly related with the range of services offered to small and medium sizecorporates, the level of coordination of services with respect to clientneeds, the level of continuity of the exchange process between the bankand the client firm through time (Caselli 2001).

di-The selection of segmentation criteria is not easy as it seeks for ables that maximize the homogeneity of the segment within itself and het-erogeneity among segments The segmentation model approach can offermanagement an effective support in terms of accessibility, measurabilityand importance of each segment and requires the identification of the ob-jectives and pursued benefits of the segmentation process followed byanalyses for served client portfolios In this sense, market segmentation ismore difficult and complicated for corporate than for private clients due tooverlapping and interdependent determinants of firms, such as the charac-teristics of management, structure and financial characteristics of the firm(Caselli 2001)

vari-The evolution of segmentation models for small-medium size corporateclients can be divided into four categories (Caselli 2001): 1) poor segmen-tation, 2) defensive segmentation, 3) complex segmentation, and 4) proac-tive segmentation

In a two dimensional model (level of market analysis of client firms andlevel of market analysis of offered services), the evolution of above mod-els shows a diagonal movement from low to high with respect to both di-mensions Therefore proactive or competitive segmentation models are su-perior in terms of innovation and completeness compared to rich anddefensive segmentation models The analysis reveals that proactive seg-mentation fulfills the product-market matrix by focusing on the descriptiveaspects of the target market and on the characteristics of the companieswith which the bank is developing a relationship

The application of proactive segmentation recognizes a source of petitive advantage in environmental diversity as the significantly differentcorporate segment enables the bank to differentiate itself by meeting thespecific needs of the segment with its system of services and defends itsmarket position against competitive forces

com-The construction of a proactive segmentation model requires a strongfocus on the concepts of offered service and target market In this approachany segmentation process starts by identifying a range of offered productsand a possible group of companies that represent the target market of thebank (Caselli 2001)

1.7 Performance Measurement in Divisionalized Form

The divisionalized form configuration focuses on the structural ship between headquarters and divisions The delegation of decision mak-ing in divisionalized companies is accompanied by changes in monitoringand control mechanisms As Mintzberg (1979) suggests, the only way thatheadquarters can detain control and protect divisional autonomy is bymonitoring divisional performance Each division must function as a singleintegrated system so that a set of quantitative measures of control can beimposed The division manager, to whom power is delegated by headquar-ters, must be able to impose the measures on his division The systemshould be a top-down regulated one where headquarters manage the strate-gic portfolio, allocate the overall financial resources, design the perform-ance control system, replace and appoint division managers

relation-As Ezzamel (1992) points out, the divisional organizational structurecreates an atmosphere that is intrinsically less oriented to calculations thatare created by the market Quantitative measures of the divisional per-formance are return on investment, net income and discounted cash flow.Apart from the limitations of these measures such as being short term andpast-oriented (except DCF), difficulties arise mostly due to interdependen-cies between divisions and overheads to calculate the divisional perform-ance An important observation that emerges from his analysis is that there

is a wide range of controls that can be adapted to divisional organizationsand financial control is only one of them Control mechanisms that are notonly financial in nature but also structural, contain non-financial quantita-tive indicators and qualitative elements as well These diverse types ofcontrols should not be seen as competitive, but as complementary mecha-nisms The control of divisionalized companies should be considered interms of organizational rather than management control, taking into con-sideration also organizational coherence and structural design There arevarious structured control mechanisms to monitor divisional performanceand these mechanisms include factors such as the environmental dimen-sions of the division, the characteristics of information and informationflow, divisional interdependencies, divisional autonomy in the process ofdecision making and internal audit

In Vancil and Buddrus' model, it is possible to see business diversity asthe independent variable and the character of profit measurement as a con-tinuum from partial fictional to comprehensive realistic They expect tohave variations in the character of profit measurement from realistic (in-cluding all costs and revenues in the income statement of the independentcorporation) to fictional (either because it includes only part of the costs

attributable to the business or the costs are assigned in an arbitrary ion) In their model, as business diversification increases so does theautonomy of the profit center manager and the character of profit meas-urement is closer to "comprehensive realistic" (Vancil 1979).

fash-Rumelt's (1974) assessment of separability of a particular business sists in evaluating the extent to which its basic nature and scope could bechanged without constraints from the firm's other businesses and withoutmaterially affecting the operation and strategic direction of other activities.Solomons' (1978) "genuine division" is independent from the other divi-sions and its general manager has substantial autonomy from the headquar-ters, so that the measurement of profit responsibility is "realistic" Recog-nizing the fact that the condition of "genuine divisions" does not alwayshold, Solomons highlights that "The more difficult it is, in a particularsituation, effectively to measure divisional performance by the profit test,the more circumscribed divisional freedom of decision-making is likely to

con-be The difficulty is likely to arise whenever a division's affairs cannot besufficient disentangled from other parts of the business Ultimately, a point

is reached when the division loses the right to be regarded as a genuine vision at all."

di-The study of organizational models of intermediation activities hasshown that in order to define sector contingencies better, a key aspect tounderstand is the interdependence/interrelation phenomenon between theactivities These studies confirm that the division of work into phases in fi-nancial intermediaries, i.e in the service industry, is not so efficient andeffective as it is in manufacturing companies The existence of interde-pendencies has implications not only for the microstructure, but also forthe administrative design (macro-structure) and creates coordination prob-lems between interdependent activities In the model of diversification foruniversal banks, the phenomenon of interdependencies leaves its place tothe problem of whether to manage the problem and, if so, how to manage

it The management of interdependencies implies the identification ofhorizontal strategies and introduction of horizontal organizational models.Interdependencies between clients, for example, indicate the definition ofsegment strategy and divisionalization by segments

Morison (1994) points out the pervasive nature of the interdependenciesbetween the bank different units In the case of banking, managing thenecessary flows of information between the resulting units is a more acutechallenge than grouping activities since different units have complex recip-rocal relationships and make significant use of pooled resources such ascustomer information, financial capital and computer systems Thus, abank that chooses to emphasize one of its organizational dimensions -products, customers, geographical markets - is almost inevitably bound to

face significant and complex interdependencies along one or more of thesedimensions.

1.8 Drivers of Divisionalization and Future Trends in

Banking Organizational Change

As hypothesized by Chandler, "structure follows strategy" and the correct

"fit" between strategy and structure is what leads to performance Hisoriginal argument was that when large industrial firms grow by extendingtheir resources, they manage this by decentralizing operations within divi-sional structures Chandler's argument suggests that multidivisional struc-ture is a natural outcome of the diversification process in growing firms.For the administrative coordination to be more efficient and more prof-itable than market co-ordination, the business volume had to be suffi-ciently large and what increased the business volume was the new technol-ogy and expanding markets New technology produced much biggeramounts of output, sustained movement of goods whereas enlarged mar-kets were essential to absorb such volume of output Therefore multidivi-sional enterprises appeared, grew and continued to flourish in the sectorsthat were characterized by new, advanced technology and expanding mar-kets In these new enterprises, administrative hierarchies required special-ized skills and the managers who directed these hierarchies became in-creasingly technical and professional (Chandler 1977)

"Organization not only must fit with the strategy, but it must evolve inresponse to changes in strategy Consequently, if the strategy is based oncertain drivers, organization also must be a function of the same drivers"(Baron and Besanko 2001) The major contingency factors (organizationalstates or conditions that are associated with the use of certain design pa-rameters) that Mintzberg (1979) associates with the divisionalized formare: market diversity, the technical system used by the firm in its operatingcore, various aspects of environment (notably stability, complexity, diver-sity, hostility and some of its power relationships), age and size Contin-gency theorists argue that as the firm increasingly operates in diverse mar-kets, it grows larger, older and employs divisible technologies and, thus,the M-form becomes the optimal organizational structure

Chandler (1962) argued that the M-form emerged in response to creased organizational complexity, which is caused not only by growth infirm size, but also by greater diversification into new lines of business andincreased vertical integration across widely separated geographical areas.Large size creates problems related to increased volume, but this can be

in-dealt with in one way or another for example within centralized structures

by the use of standard operating rules Diversity, however, is much more

problematic As diversity increases, technical expertise becomes more calized, as in the case of geographical diversity, and thus it becomes moredifficult for central management to make informed decisions In a divi-sionalized structure these problems can be dealt with efficiently, as centralmanagement needs to focus only on strategic decisions Similarly, accord-ing to Mintzberg, what particularly drives the organization to use the divi-sionalized form is market diversity While an organization with a single in-tegrated market cannot split itself into autonomous divisions, the one withdistinct markets has an incentive to create units to deal with each of them

lo-In this way, it can manage its strategic portfolio centrally, while givingeach component of that portfolio the "undivided attention" of one unit

Technical system - besides market diversity - is another contingency

factor of divisionalized form Divisionalization is possible only when theorganization's technical system can be efficiently separated into segments(Mintzberg 1979) Organizations that would incur a very high fixed costfor technical systems tend not to diversify their product lines in the firstplace, and so do not divisionalize (Rumelt 1974) Penrose (1959), whenstressing the importance of technological competence of a firm, argues thatwhen the firm's strength is not closely related with its technologicalstrength but rests primarily on a dominant position in important markets, it

is more difficult for the firm to enter into new areas of specialization In acompetitive and technologically progressive industry, a firm specializing

in some products can maintain its position with respect to those productsonly if it is able to develop an expertise in technology and marketing suffi-cient enough to introduce innovations that affect those products

In terms of environment, the divisionalized structure differs from the

other configurations in the sense that it has a more restricted environmentaldimension that is market and product diversity (as discussed in Sect 5).The empirical test on a survey of large UK companies (Armstrong at al.1998) suggests that there is no finding that divisionalized companies tend

to be larger than the rest However, they have found size effects on some

aspects of divisionalization Companies with intermediate levels of zation between their business units and headquarters tend to be larger thanthose that are not

organi-It is remarkable to note that, in addition to Chandler's argument thatstructure follows strategy and divisionalization is the result of strategic di-versification, Rumelt (1974) argues that the opposite relationship holds aswell That is, divisionalization encourages further diversification because

of the ease with which headquarters can add new divisions in this ture Similarly, in the banking industry activation of new developments is