Using Decentralized Organizations to Control Operations
How Do Managers Evaluate Performance in Decentralized Organizations? Module
- Define the term decentralized organization and explain advantages and disadvantages of decentralizing.
Question: Many types of organizations decentralize operations to better manage each segment of the organization. What does it mean to decentralize operations?
Answer: The term used to describe this type of organizational structure is decentralized organizations. Decentralized organizationsOrganizations that delegate decision-making and operational responsibilities to the managers of each segment of the organization. Segments are often called divisions or subunits. delegate decision-making and operational responsibilities to the managers of each segment of the organization. (Segments are often called divisions or subunits.) For example, universities are often segmented by discipline with one manager, or dean, responsible for each discipline (physical education, social sciences, business, etc.). Retail companies are often segmented by region, with one manager responsible for each region. Service companies are often segmented by service category, with one manager responsible for each category (e.g., an accounting firm divided into audit and tax). Decentralization is not limited to a particular type of organization, and most organizations that have grown in size and complexity decentralize to some extent.
Reasons to Decentralize
Question: Why do organizations decentralize operations?
Answer: Organizations often decentralize out of necessity as they expand. The responsibility of one manager, or group of managers, to run the entire organization can become overwhelming as the number of products offered increases.
For example, Game Products, Inc., began by selling two board games to several retail stores in the northeast United States. The company did not need to decentralize at that point because it offered only two products and the geographic region in which it sold those products was limited.
A few years later, Game Products expanded sales to Canada and the southeast Unites States, while also venturing into the computer games industry by purchasing a small maker of computer games. Although operations were not decentralized at this time—all decisions were still made at headquarters—top management was beginning to feel the strain of trying to manage two segments of the company. The decision-making process was cumbersome and slow, and the company began to miss market opportunities that would have increased sales and profits.
Two years later, Game Products decided to enter the sporting goods market, and top management and the board of directors agreed that decentralization was critical to the future success of the company. As a result, they assigned a manager to run each division. This change allowed top management to concentrate on high-level issues. such as long-range strategic planning, and it placed the decision making in the hands of managers who were intimately familiar with the operations of their individual divisions.
Although Game Products ultimately decided to decentralize operations, there are advantages and disadvantages to decentralizing. Figure 11.1 "Decentralized Versus Centralized Organizations" illustrates how operations would look at Game Products, Inc., if operations were decentralized or if they remained centralized.
Figure 11.1 Decentralized Versus Centralized Organizations
Advantages of Decentralizing Operations
Question: What are the advantages of decentralizing operations for companies like Game Products, Inc.?
Answer: Organizations like Game Products tend to decentralize as their operations grow and become more complex. The advantages of decentralizing are as follows:
- Increased Expertise. Rather than having one manager, or a group of managers, trying to make decisions for a wide range of products, decentralized organizations delegate decision-making authority to local managers who have expertise in specific products.
- Quicker Decisions. By having increased expertise and decision-making authority, local managers are able to make decisions quickly without having to wait for the approval of the organization’s top management.
- Refocus of Top Management Responsibilities. With local managers focusing on issues important to the specific segment, top management is able to delegate the day-to-day decision-making responsibilities and focus on broader companywide issues, such as long-range strategic planning.
- Motivation of Local Managers. Managers who are given more responsibility, and the control necessary to manage their responsibility, tend to be more motivated than those who simply follow the orders issued by top management. In addition, a decentralized structure provides a means to train local managers for promotion to the next level of management.
Note 11.3 "Business in Action 11.1" provides a real-life example of an organization that benefitted from decentralizing.
Business in Action 11.1
Advantages of Decentralizing at a Community College
Sierra College is located in one of the fastest growing counties in California. Student enrollment has increased from 5 percent to 10 percent per year over the last decade. Prior to this rapid growth, the college held each division dean responsible for most administrative duties. For example, the dean of business and technology was responsible for administrative duties, such as hiring faculty members and developing the schedule of classes to be offered each semester.
As student enrollment increased, course offerings expanded, and faculty headcount grew into the hundreds, the administrative duties became overwhelming for each division dean. As a result, management decided to decentralize further by creating department chair positions to help with the administrative duties related directly to each department. This change gave each department (business, music, computer science, etc.) more control over day-to-day activities, and it allowed the deans to focus on larger college issues, such as strategic planning and community relations. It also allowed for quicker responses to issues, such as faculty teaching assignments and classroom space utilization.
Source: Based on the author’s experience.
Disadvantages of Decentralizing Operations
Question: What are the disadvantages of decentralizing operations for organizations, such as Game Products?
Answer: The results of decentralizing operations are not always positive. Three disadvantages of decentralizing are as follows:
- Duplication of Services. Organizations that decentralize often duplicate administrative services, such as accounting and computer support. That is, each segment may have its own accounting department and computer support department when these services might be provided more efficiently through one companywide department.
- Conflict of Interest. Managers who are evaluated solely with respect to their divisions have no incentive to make a decision that benefits the organization as a whole at the expense of the manager’s division. For example, a local manager may decide to purchase raw materials from an outside supplier even though another division within the company can produce the same materials at a lower cost. (To make matters worse, the other division’s manager may refuse to sell the materials at a reduced price because she is evaluated based on her division’s profits!) The appendix to this chapter discusses this issue in greater detail.
- Loss of Control. Perhaps one of the most difficult decisions facing small, fast-growing organizations is whether to continue to expand and decentralize or to limit growth and remain highly centralized. Decentralization will lead to a loss of control at top management levels, which can have negative consequences for the organization’s reputation if local managers struggle to maintain the level of quality that customers expect. Decentralized organizations are only as good as the local managers who are given decision-making authority.
Business in Action 11.2
Disadvantage of Decentralizing an Accounting Firm
Arthur Andersen was a large, decentralized accounting firm with offices located throughout the world. One or more partners operated each office independently. In 2002, Arthur Andersen had 85,000 employees worldwide. The firm was indicted in March 2002, and later found guilty, for obstructing justice by shredding tons of documents related to its audit work for Enron Corporation. As a result, Arthur Andersen agreed to cease its accounting practice in the United States in August 2002. By 2005, only 200 employees remained at Arthur Andersen to wrap up the dissolution of the firm.
Although the entire firm was indicted and found guilty of obstruction of justice, the decision to shred documents was made at the Houston office, where the bulk of the shredding took place. This serves as an extreme example of the disadvantage of decentralizing an organization. Decisions left to the division managers (“partners” in this case) can have a negative effect on the entire organization.
Note that the U.S. Supreme Court overturned the guilty verdict of the U.S. District Court in June 2005, but the damage was done and the firm did not survive.
Source: Charles Lane, “Justices Overturn Andersen Conviction,” Washington Post, June 1, 2005, http://www.washingtonpost.com.
- Decentralized organizations delegate decision-making and operational responsibilities to the managers of each segment, or division, of the organization. Advantages of decentralized organizations include increased expertise at each division, quicker decisions, better use of time at top management levels, and increased motivation of division managers. Disadvantages include duplication of services, such as accounting and computer support; potential increase in conflicts between division manager goals and companywide goals; and loss of control at the top management level.
Review Problem 11.1
Landscaping Services, Inc., founded and operated by Ed Barnes, has seen revenues double each year for the past three years. Although Ed has hired several laborers to ease the workload, he is still working seven days a week, 10 hours a day. Ed would like to hire a manager to assist in managing landscaping projects and has asked for your advice.
- What concerns might you have about Ed’s plan to decentralize operations?
- How might decentralizing operations benefit Landscaping Services, Inc.?
Solution to Review Problem 11.1
There are several potential disadvantages to decentralizing. Two examples follow:
- For a relatively small company, such as Landscaping Services, Inc., the biggest concern is losing control over quality. Presumably Ed is successful because he provides excellent service. He must instill the importance of maintaining quality to the new manager.
- Ed must establish a compensation system that encourages the new manager to make decisions in the best interest of the organization. For example, if the new manager encounters an opportunity to pick up a new customer, there must be an incentive to pursue this opportunity. If the new manager is simply given a monthly salary, there is no incentive to increase the workload! One approach is to offer part ownership in the company and therefore rights to a percentage of the company’s profits.
There are several potential advantages to decentralizing. A few examples follow:
- Ed can hire a manager with expertise in an area outside of Ed’s expertise, which can lead to additional business and a higher level of quality.
- Clients will no longer have to wait for Ed to arrive before a decision is made on how to proceed with the work.
- Ed can put more time into obtaining new customers.
- Chapter Introduction
- Using Decentralized Organizations to Control Operations
- Maintaining Control over Decentralized Organizations
- Comparing Segmented Income for Investment Centers
- Using Return on Investment (ROI) to Evaluate Performance
- Using Residual Income (RI) to Evaluate Performance
- Using Economic Value Added (EVA) to Evaluate Performance
- Wrap-Up of Game Products, Inc.
- Appendix: Transfer Prices between Divisions