Designing Structure: Vertical Differentiation

Organization structure can be thought of in terms of three dimensions:

1. Vertical differentiation, which refers to the location of decision-making responsibilities within a structure (that is, centralization or decentralization) and also to the number of layers in a hierarchy (that is, whether the organizational structure is tall or flat).

2. Horizontal differentiation, which refers to the formal division of the organization into subunits.

3. The establishment of integrating mechanisms, which are mechanisms for coordinating subunits.

Centralization and Decentralization

A firm’s vertical differentiation determines where in its hierarchy the decision-making power is concentrated. Are production and marketing decisions centralized in the offices of upper-level managers, or are they decentralized to lower-level managers? Where does the responsibility for R&D decisions lie? Are important strategic and financial decisions pushed down to operating units, or are they concentrated in the hands of top managers. There are arguments for both centralization and decentralization.

Centralization is the concentration of decision-making authority at a high level in a management hierarchy.

Decentralization vests decision-making authority in lower-level managers or other employees.

Arguments for Centralization. There are four main arguments for centralization.

First, centralization can facilitate coordination. Consider for example Microsoft. It recently reduced the number of divisions in its organization from six to three, thereby centralizing decision making in fewer senior managers, in an attempt at greater coordination. Microsoft felt that having six divisions in the company led to confused sales, marketing, and product development efforts and that greater centralization was required to harmonize efforts.

Second, centralization can help ensure that decisions are consistent with organizational objectives. When decisions are decentralized to lower-level managers, those managers may make decisions at dissonance with top managers’ goals. Centralization of important decisions minimizes the chance of this occurring. Major strategic decisions, for example, are often centralized to make sure the entire organization is pulling in the same direction. In this sense centralization is a way of controlling the organization.

Third, centralization can avoid duplication of activities by various subunits within the organization. For example, many firms centralize their R&D functions at one or two locations. Similarly, production activities may be centralized at key locations to eliminate duplication, attain economies of scale, and lower costs. The same may also be true of purchasing decisions. Wal-Mart, for example, has centralized all purchasing decisions at its headquarters in Arkansas. By possessing its enormous bargaining power, purchasing managers at the head office can drive down the costs Wal-Mart pays for the goods it sells in its stores. It then passes on those savings to consumers in the form of lower prices, which lets the company grow its market share and profits.

Fourth, by concentrating power and authority in one individual or a management team, centralization can give top-level managers the means to bring about needed major organizational changes. Often firms seeking to transform their organizations centralize power and authority in a key individual (or group) who then sets the new strategic direction for the firm and redraws organization architecture. Once the new strategy and architecture have been decided on, however, greater decentralization of decision making normally follows. Put differently, temporary centralization of decision-making power is often an important step in organizational change.

Arguments for Decentralization. There are five main arguments for decentralization.

First, top management can become overburdened when decision-making authority is centralized. Centralization increases the amount of information senior managers have to process. As a result of information overload, managers might suffer the constraints imposed by bounded rationality. Decentralization gives top management time to focus on critical issues by delegating more routine issues to lower-level managers and reducing the amount of information top managers have to process, making them less vulnerable to cognitive biases.

Second, motivational research favors decentralization. Behavioral scientists have long argued that people are willing to give more to their jobs when they have a greater degree of individual freedom and control over their work. The idea behind employee empowerment is that if you give employees more responsibility for their jobs they will work harder, which increases productivity and reduces costs.

Third, decentralization permits greater flexibility—more rapid response to environmental changes. In a centralized firm the need to refer decisions up the hierarchy for approval can significantly slow decision making and inhibit the ability of the firm to adapt to rapid environmental changes. This can put the firm at a competitive disadvantage. Managers deal with this by decentralizing decisions to lower levels within the organization. Thus at Wal-Mart, although purchasing decisions are centralized so the firm can realize economies of scale in purchasing, routine pricing and stocking decisions are decentralized to individual store managers, who set prices and choose the products to stock depending on local conditions. This enables store managers to respond quickly to changes in their local environment, such as a drop in local demand or actions by a local competitor.

Fourth, decentralization can result in better decisions. In a decentralized structure, decisions are made closer to the spot by individuals who (presumably) have better information than managers several levels up a hierarchy. It might make little sense for the CEO of Procter & Gamble to make marketing decisions for the detergent business in Germany because he or she is unlikely to have the relevant expertise and information. Instead those decisions are decentralized to local marketing managers, who are more in tune with the German market.

Fifth, decentralization can increase control. Decentralization can establish relatively autonomous, self-contained subunits within an organization.

An autonomous subunit has all the resources and decision-making power required to run its operation daily. Managers of autonomous subunits can be held accountable for subunit performance. The more responsibility subunit managers have for decisions that impact subunit performance, the fewer excuses they have for poor performance and the more accountable they are. Thus by giving store managers the ability to set prices and make stocking decisions, Wal-Mart’s top managers can hold local store managers accountable for the performance of their stores, and this increases the ability of top managers to control the organization. Just as centralization is one way of maintaining control in an organization, decentralization is another.

Date: 2015-01-12; view: 1321