Organizational Portfolio Theory: Performance-Driven Organizational Change
Donaldson, Lex, Contemporary Economic Policy
LEX DONALDSON [*]
The article outlines some of the main ideas of a new organizational theory: organizational portfolio theory. The literature has empirically established that organizations tend not to make needed adaptive changes until they suffer a crisis of low organizational performance. Organizational portfolio theory takes this idea and constructs a theory of the conditions under which organizational performance becomes low enough for adaptive organizational change to occurs. The focus is on the interaction between organizational misfit and the other causes of organizational performance. To model these interactions use is made of the concepts of risk and portfolio. (JEL D23)
Organizational portfolio theory is a new theory that treats the organization as a portfolio of causes of organizational performance. There are various internal and external causes that affect organizational performance. In turn, organizational performance feeds back to drive organizational change so that the organization moves into fit with its situation. Adaptive organizational change tends to occur when organizational performance is low so that there is a crisis. Such low performance comes about through misfit of the organization to its situation combining with other causes that depress organizational performance. The theory states how each of these causes interacts with organizational misfit to determine the level of organizational performance. Variations of these causes over time define the performance fluctuations that are the motors of organizational change. These causes can reinforce misfit so that organizational performance is driven to the low value that triggers adaptive change. However, the causes can also nullify the effect on performance of misfit so that no change happens. Organizational portfolio theory explains how these different outcomes occur. The purpose of this article is to give a succinct presentation of this new theory and invite its testing in future empirical research.
The paper proceeds in four parts. Section II defines organizational fit. Section III states the theory that organizational performance drives organizational adaptive change. Section IV states organizational portfolio theory. Section V briefly outlines the role of each organizational portfolio factor, that is, each cause of organizational performance, within the theory (for a fuller statement of the theory see Donaldson, 1999). The final section presents conclusions and policy implications.
II. ORGANIZATIONAL FIT
Organizations possess many internal characteristics, such as their structures and their human resource management systems. The contingency theory of organizations holds that the organizational characteristics need to fit the level of the contingency variables of the organization for that organization to have high performance (e.g., Burns and Stalker, 1961; Donaldson, 1995; Thompson, 1967; Woodward, 1965). For example, a functional structure fits the low level of the contingency of diversification, and a divisional structure fits the high level of diversification; conversely, a divisional structure misfits the low level of the contingency of diversification, and a functional structure misfits the high level of diversification (Chandler, 1962). Misfit leads to lower organizational performance than fit. For example, misfit between functional structure and the diversification contingency leads to lower financial performance of firms (Donaldson, 1987; Hamilton and Shergill, 1992). Adaptive organizational change o ccurs when an organization moves by changing its characteristic from one that misfits the contingency to one that fits it. For example, when a diversified firm with a functional structure changes to a divisional structure, that is a move from misfit into fit, so that the change is adaptive and restores performance. Conceptually, organizational performance is how far the organization attains its goals. …