In 1891, Philips started with manufacturing lightbulbs. The company became one of the world's leading technological concerns and this week, 123 years after its creation, Philips announced that the company will split in two seperate companies: Philips Healthtech (combining the former consumer lifestyle and health care divisions) and Philips Lighting.
Figure 1: source
In this post, I will try to explain the decision for this division by rationality as well as bounded rationality.
Rationality
Philips has been struggling over the last couple of years. In health care, the effects of the crisis are profound: hospitals postpone purchase of new devices and equipment, because of the large budgetary cuts they are facing. In consumer lifestyle the popular brand is suffering from severe competition and fake copies enter the markets in East Asia. In lighting, the margins on consumer light bulbs are thinner than ever, so that Philips has been forced to focus more on the maintenance and construction of complex lighting plans for public buildings or cities.
Philips' CEO, Frans van Houten, claims that this split will enable the separate firms to focus more on their core businesses, hereby creating more value for their customers and shareholders. Furthermore, the new structure of the company should lead to a saving of 100 million euros in 2015 and 200 million euros in 2016.
In decision making theory, rationality is a quite simplistic approach to explain decision making behaviour. Decisions are based on (economic) models, without any interference of emotions. You can view this kind of decision making as calculating. Philips' CEO states that he expects to save money now and earn more money in future by this decision - this sounds like a completely rational line of reasoning.
Bounded rationality
However, it might be a little short-sighted to assume that Philips acts 100% out of rationality. In decision making theory the notion of 'bounded rationality' was introduced. In this section I will first explain bounded rationality and then link it to the Philips case.In his review on bounded rationality, Jones (2003) explains how processes that limit rationality within organizational decision making should and could be taken into account. Traditional theories of rationality do not work well with large uncertainties and imperfect information. Huge organizational decisions like the one Philips just announced can hardly be based solely on facts and calculations.
Jones explains how an organization is shaped by (unconscious) routines and structures that employees participate in. Throughout the years an employee works for a company, he or she will make decision based on earlier events, thus creating an 'organizational memory'. Parallel processing makes sure that employees can work on multiple streams of input simultaneously, thus allowing a company to expand.
However, there might be an unexpected change in the market that outdates these routines and structures. Parallel processing can than be replaced by serial processing, or centralized decision making. Serial processing allows for top-down implementation of new strategies within organizations that are more change-averse due to this routinization. Emotional contagion, where management actively convince employees of the changed strategy, is of vast importance in the process.
This theoretical framework can be easily translated to the case of Philips. Apparantly, the old routines were not sufficient to cope with market changes. Therefore, top-down decision making took place, where Philips' CEO Van Houten emphasizes the importance of the split, in order to get the (emotional) support of shareholders and employees. This is thus an example of a change from parallel to serial processing.
Conclusion
Figure 2: source
The figure above shows the evolution of Philips' light bulbs. It's a clear illustration of the fact that the company has been able to anticipate on changes in the market for over a century. The recently announced split, that can either be explained by rational arguments or by bounded rationality in organizations, is Philips' latest strategical move. Let's see what it will mean for the survival of the company in the 21st century.
I feel that bounded rationality offers a way more advanced framework to explain decision making behaviour. Even in very simple situations, game theory has showed that human beings hardly ever behave rational.
An organization like Philips is very large and very complex. Relationships between employees, management and other firms in the supply chain all shape the decision making process. I feel that only bounded rationality can take these processes into account.
I feel that bounded rationality offers a way more advanced framework to explain decision making behaviour. Even in very simple situations, game theory has showed that human beings hardly ever behave rational.
An organization like Philips is very large and very complex. Relationships between employees, management and other firms in the supply chain all shape the decision making process. I feel that only bounded rationality can take these processes into account.
Hello Maja,
BeantwoordenVerwijderenIn general I liked your post about Phillips split; it was comprehensible and precise enough without being redundant at all. As far as the structure of the post is concerned, it is well done by highlighting with brief title your paragraphs and enabling the reader to easily follow your argumentation flow. However I have some remarks about your content. Firstly, even though I really like the analogy as a reasoning method to approach the Philips decision through B rationality decision-making, I think that in the B rationality part, in the first 3 paragraphs, you try to analyse Jones’ thinking instead of going on to explain the analogy between Jones’ theory and the actual decision-making of Philips. In the end, I have to say that one can understand (especially if he/she has been informed on the newsitem) your point of linking B rationality steps with Philips actions but you could elaborate a little more on that in order to make your reasoning more complete. Last but not least in my opinion you could make some comments on the two Rationalities models and maybe try to assess which one has the better approach in assessing decision-making and why.
Hope my feedback was helpful to you. Any inquiry should you come up with concerning my feedback, let me know.
Hello Maja,
BeantwoordenVerwijderenThis was an interesting post. It is a major game shift in the electronics world and these decisions are extremely difficult. That’s why I think this is a good choice as newsitem. I like the structure you used, especially the intermediate explanation on the theory of Jones (2003). Finally, the use of layout made the post easy to read.
I have one critique, however. The explanation using both rationality as bounded rationality seem the same to me. In both cases, the CEO (or board or executive team) takes a rational decision to split up the company. Even if, like you pointed out, bounded rationality can explain this with a deeper level by calling it serial processing, it is still a rational decision made by the top of the company. Therefore, I agree with your conclusion that ‘an organization like Philips is very large and complex’ and that ‘human beings hardly ever behave rational’, but I must add that in this situation it seems unlikely that bounded rationality explains more than comprehensive rationality in this case.