Decentralization

Learning Objective 2 Describe the benefits and costs of decentralization

Until the mid-20th century, many firms were organized in a centralized, hierarchical fashion. Centralization is an organizational structure in which power is concentrated at the top and there is relatively little freedom for managers at the lower levels to make decisions. Perhaps the most famous example of a highly centralized structure is the Soviet Union, prior to its collapse in the late 1980s.

Today, organizations are largely decentralized and many companies have pushed decision-making authority down to subunit managers. Decentralization is an organizational structure that gives managers at lower levels the freedom to make decisions. Autonomy is the degree of freedom to make decisions. The greater the freedom, the greater the autonomy. As we discuss the issues of decentralization and autonomy, we use the term subunit to refer to any part of an organization below the top. A subunit may be a large division, such as the refining division of ExxonMobil, or a small group, such as a two-person advertising department of a local clothing chain.

Examples of firms with decentralized structures include Nucor, the U.S. steel giant, which gives the general managers of its plants a substantial amount of operational autonomy, and Tesco, Britain’s largest retailer, which offers great latitude to its store managers. Of course, no firm is completely decentralized. Nucor’s top managers are still responsible for the firm’s overall strategic planning, financing, setting of base salary levels and bonus targets, and so on. How much decentralization is optimal? Companies try to choose the degree of decentralization that maximizes benefits over costs. We next discuss the key benefits and costs of decentralization.

Benefits of Decentralization

Proponents of decentralizing decision making argue that granting responsibilities to managers of subunits has the following benefits:

  1. CREATES GREATER RESPONSIVENESS TO THE NEEDS OF A SUBUNIT’S CUSTOMERS, SUPPLIERS, AND EMPLOYEES. Good decisions cannot be made without good information. Compared with top managers, subunit managers are better informed about their units’ competitors, suppliers, and employees, as well as about local factors that affect performance, such as ways to decrease costs, improve quality, and better respond to customers. Flex, a global supply chain solutions company, uses decentralization to reduce bureaucracy and increase responsiveness. Managers can use the company’s worldwide information technology to solve a local customer’s problem or send a project to other managers without going through red tape.
  2. LEADS TO GAINS FROM FASTER DECISION MAKING BY SUBUNIT MANAGERS. Decentralization speeds decision making, creating a competitive advantage over centralized organizations. Centralization slows down decision making because decisions must be pushed upward through layer after layer of management before they are finalized. Interlake Mecalux, a leading provider of materials-handling solutions and storage products, cites this benefit of decentralization: “We have distributed decision-making powers more broadly to the cutting edge of product and market opportunity.” Interlake’s storage system solutions must often be customized to fit the needs of customers. Delegating decision making to the sales force allows Interlake to respond faster to changing customer requirements.
  3. ASSISTS MANAGEMENT DEVELOPMENT AND LEARNING. Subunit managers are more motivated and committed when they can exercise initiative. Moreover, giving managers more responsibility helps a company develop an experienced pool of talent to fill higher-level management positions and weed out people unlikely to be successful top managers. According to Tektronix, an electronics company based in Oregon, “Decentralized units provide a training ground for general managers and a visible field of combat where product champions can fight for their ideas.”
  4. SHARPENS THE FOCUS OF SUBUNIT MANAGERS AND BROADENS THE REACH OF TOP MANAGEMENT. In a decentralized setting, the manager of a subunit has a concentrated focus. The head of Facebook Indonesia, for example, can develop country-specific knowledge and expertise (about local advertising trends, cultural norms, payment forms, and so on) and focus on maximizing Facebook’s profits in Indonesia. At the same time, this relieves Facebook’s senior executives at its Menlo Park, California, headquarters from the burden of controlling day-to-day operating decisions in Indonesia. They can spend more time and effort on strategic planning for the entire organization.