How We Analyze Organizations & Define Terms
When we discuss strategy, we don’t mention dogs or cash cows or stars or anything else quite that is simplistic. (We do, however, have a weakness for lemon models.) No BS and no pre-packaged solutions. Just three basic questions.
1. What do you want to do?
2. How can you do it?
3. What’s stopping or limiting you from doing what you want?
The answers give us the organization’s (1) goal; (2) strategies and controls; and (3) environmental constraints, and that’s the framework that we use to model the issue and create potential solutions.
We think of these answers as components of constrained optimization math problems and in the past enjoyed trying to get MBAs to solve such problems in Mathcad, but we know that most people don’t share our tastes, and that’s for good reason.
So, we discuss organizations in terms of goals, strategies, strategic controls, structures, and managerial controls. However, we have particular notions in mind when we use these words, and think it is worthwhile to share our definitions.
We usually discuss these terms from top down, as shown in the accompanying triangle, but it is worth noting—even before we define the words—that given an organization’s goal, the optimal choices of strategies, structures, and controls should be made simultaneously, especially the choices of its structure and managerial controls. 1
Definitions:
Goal or Objective – the aim, intent, desire of the organization–its reason for existing. For example, we define a firm (or business or company or corporation) as an organization with the goal to maximize the wealth of the owners. Not-for-profits have very different objectives.
Strategic Control – the process of ensuring that the organization’s goal or objective is accomplished.
Strategy – the general approach(es) or method(s) or way(s) that the organization will to accomplish its goal, including the choice(s) of markets, production, and delivery methods.
Structure – the level or degree or centralization (or conversely) decentralization; the degree to which decision rights are delegated to subordinates; the degree of autonomy.
Managerial Controls or Control Mechanisms – the policies, procedures, and devices used to ensure that human resources act in accordance to the organization’s goals. Their selection is highly dependent upon the choice of structure and vice versa.
Tactics – the operating decisions and other specific decisions made (hopefully) in support strategy. Our goal is to eliminate the need for hope.
Centralization – a type of structure in which top-down decision-making is applied; there is little or no autonomy for subordinates; subordinates only carry-out orders or complete well-specified tasks; effort is observed or can be easily inferred by superiors; subordinates possess no private information. 2
Decentralization – decision rights are delegated to subordinates; subordinates act autonomously (but are influenced by the organization’s managerial controls and policies, including the performance measurement system); subordinates’ efforts cannot be perfectly inferred, usually because both effort and random or unknown factors affect output or available signals.
Incentives – the issue of motivation in decentralized structures; given autonomy, a subordinate need not act in the organization’s interest; so, problems may exist when the individual’s interests differ from the organization’s. These differences may arise due to differences in preferences, like risk aversion or patience; endowments, planning horizons, and information. 3
A few of our interests and observations:
We are interested in how strategies and structures and controls interact with the organization’s environment and whether managerial controls and information systems support the organization’s goal and strategic directions.
Strategies are generally harder to change than structures or controls, which often must adapt to changing parameters (environmental variables), including laws, costs, and technologies.
We focus on (1) strategic consistency and (2) managerial discipline within decentralized organizations and will have much to write on those topics. 4 Strategic Consistency involves the degree to which your actual tactical decisions support your stated strategy. Managerial Discipline involves the self-control required to allow subordinates to behave autonomously in (what is supposed to be) a decentralized organizational structure. If that seems abstract, consider that both the same discipline as maintaining a diet.
With the ever present caveat of “all things equal,” we provide a few characteristics of different organizational structures.
Characteristics of Centralized Organizations – we generally expect higher information system costs, more layers of supervision, and very detailed, top-down budgets or plans. Moreover, for closely monitored employees in these types of firms, we see no objective-maximizing reason to pay bonuses. 5
Characteristic of Decentralized Organizations - we generally expect to see more participative budgeting, less uniformity, the greater use of performance measures, higher average compensation, more dysfunctional behavior, and more arguments, disagreements, and hard feelings in decentralized organizations. 6
The (marginal) benefits of decentralization derive from that autonomy:
- Subordinates can make better decisions because they have better information (about, say, their local environment–internal or external).
- Subordinates can make better decisions because they have more expertise and knowledge.
- Subordinates can respond quicker and decide faster than (a monolithic) centralized authority.
- Subordinates may be better motivated and may better understand the relationship of their actions to their organization’s goals and environment.
- Information system costs may be lower as less data collection and aggregation is necessary.
The marginal costs of decentralization relate to:
- Selfishness or other behavior–including kindness–that results from a divergence of interests. These costs are referred to as agency costs, and they result from incentive problems. Incentive problems occur when there is asymmetric information, or when one party knows something that another party doesn’t. An incentive problem is called a moral hazard problem when an agent’s effort is hidden or partially hidden from his or her superior, and it’s known as an adverse selection problem when a subordinate posesses relevant–valuable–information about the internal or external environment that the superior does not know. In either case, the subordinate selfishly do what is best for themselves (or what’s best for others) rather than for the organization that they represent. (This abuse or misuse of autonomy should be expected but cannot be eliminated without destroying the above-mentioned benefits.)
- Ignorance–simply not knowing what’s best for the organization because the subordinate or agent acts locally and thus may lack a broader perspective. Ignorance can lead to higher transaction costs, including those that result from a lack of coordination among subordinates, i.e., duplication of effort and resources, including synchronization and assignment problems.
Copyright © 2008-09 Spero Consulting.
Footnotes:
- In fact, the choice of structure is in many ways equivalent to the choice of managerial control mechanisms. ↩
- Without hidden effect or private information, incentive problems are negligible. ↩
- Thus, the study of information economics and asymmetries in the form of adverse selection and moral hazard problems. ↩
- We will try to remember to provide links here. ↩
- We would be happy to explain. ↩
- We find it interesting that managers wanting “decentralization” and “autonomy” for their subordinates often attempt to eliminate any instances of dysfunctional behavior and/or disagreements yet expect to receive any benefits from being “decentralized.” We file this under managerial discipline. ↩
