Managerial Economics/Organisational Structure

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An organisational structure is a framework outlining how roles, responsibilities and rules are directed through the firm to achieve objectives. Essentially, it displays the organisation's hierarchy and design-making process. The structure also determines information flow i.e. how different levels of the company interact and share information. Alongside this managerial economic principle is the centralisation or decentralisation of structure.

Centralised vs Decentralised[edit | edit source]

An organisational structure can be either centralised or decentralised.

Centralised organisations have a clearly defined chain of command. Decision making control and power is in the hands of a select few at the top of the hierarchy. Decisions are made at the highest level, and are then filtered down the hierarchy, eventually being carried out by the workers. For example, the military has a highly centralised structure where the hierarchy of subordinates and superiors is clearly defined. For example, when the US government decides to act in Syria, the decision will be made by President Trump and Secretary of Defence Esper, who will give commands that filter down the ranks to the troops who will actually be carrying the orders out. One of the disadvantage of centralized organizations is that sometimes people not at the top of the hierarchy are actually more informed, and in a better position to make decisions. For example, a general on the ground in Syria might have a better idea of an effective strategy than President Trump. Another disadvantage is a loss in flexibility of the firm given the reduction in autonomy of its staff. When staff are under direct orders from a centralised authority then they are unable to work with as much autonomy in the interests of the firm.

Conversely, a decentralised organisation has wide spread decision-making power that includes management of many levels. There may be several groups within the organization working on different things independently of one another. This fosters a high level of personal agency and allows organisations to remain adaptable and agile, as decisions can be made quickly. This structure is becoming increasingly popular, particularly with startups. The autonomy within a small firm is effective as all employees work closely together. The speed at which a startup grows is the reason as to why decentralisation is an effective organisational structure. However, there is the possibility that the different parts of the organization clash with one another, and are not pulling in the same direction.

Organisational Design: Structuring your teams and processes[edit | edit source]

Differences between Organisational (re)design and Organisational Design[edit | edit source]

Organisational (re)design is the method of dividing an organisation or a firm into different operational parts and then connecting these together to build direction, production and control through structural arrangements. In doing so, a firm is able to improve its responsiveness to external threats and opportunities, deliver to clients successfully and achieve a harmonious internal balance. Organisational (re)design may start when:

  1. There are some changes in the external environment
    • Regulations
      Changes to regulations can affect the organisation. Companies must abide by the new regulations set by the government and hence, organisation design must be done.
    • Funding
      Funding policies can affect non-profit groups and non-government organisations. Organisational design is necessary especially when resources and grants are needed by an organisation to continue its work. (e.g. if an organisation is just going through Series A or Series B funding[1])
    • Technology
      To effectively use technology for better production output of an organisation, organisation design is needed for the company to succeed. (e.g. if new technology arrives, teams within organisation can communicate better, which means the firm can actually afford teams distributed in overseas. As a result, organisational redesign is necessary.)
    • Legislation
      Legislation such as migration visas for skilled workers needed by the company or changes to casual or any part-time entitlements must be considered for the organisation to function successfully. Hence, organisation design happens.
    • Competition
      Changes in the competitive landscape may lead to new threats being faced and thus firms having to respond accordingly. For example, sometimes firms need to adopt a different way to produce different products due to competition.
  2. There is an externally imposed redesign
    • Merger
      A merger usually involves combining two companies into a single larger company. If two organisations are to be merged, it's most likely that the newly merged organisation will end up with two CEO's or CTOs (etc). Therefore organisational redesign is required.
    • Acquisition
      Similar to merger. An acquisition is when one company purchases most or all of another company's shares to gain control of that company.
    • Deconstruction
      The process of buying an organisation at low cost and deconstructing it to sell for a bigger profit. For example, if an organisation which has a shuttle service, a flight service, and a hotel service is worth $3 billion as a whole, it can be bought and then deconstructed, being sold for $2 billion each piece. This requires an organisational redesign because at the end there will be three different organisations.
  3. There is a change in the organisational strategy
    • IPO[2]. For example, product is used to direct the service delivery

Multiple Reactions[edit | edit source]

It’s easy to redesign an organisation but not easy to deal with the people inside because there are multiple reactions, commonly when you redesign the organisation you also change the organisational culture so there are a lot of people being affected.

  1. There is a new structure, now you are doing something else, so people could see this as a threat and it doesn't matter if the new jobs are perceived as being higher or lower in the job hierarchy.
  2. There are some people in the organisation that would see the change as an opportunity to get a higher position or to realise their ideas. And there could be an opportunity for the organisation itself too if some ideas were not executed due to their inefficiency or old ways of working. That is the time to look at those ideas and get a little cake of that.
  3. And, some people just don’t care about the new changes, with a reaction of flavour of the month, which looks like the mindset reaction but is actually the hardest reaction to deal with, because people don't feel like the organisational redesigns will change anything.

Also, there are a few matters needing attention in regards to organisational redesign:

  1. It needs to be top-down as strong leadership is necessary;
  2. It works far better with external consultancies. Reasons:
    • External consultants tend to be impartial.
    • External consultants are experienced - every transformation more or less resembles each other, so a person with experiences doing that before in different areas or organisations may help a lot since the organisation itself might not have equivalent amount of experiences as the consultant does.
    • A successful transformation or organisational redesign largely depends on the capability of the person who is to address those resultant fears, threats, skepticisms and so on.

Conway's Law[edit | edit source]

Conway's law states that an organisation produces its products or designs that resemble its organisational structure. If you have a centralized organization, your products will be centralized. If your organization is distributed and flat, you have a flexible product. For example, Spotify is a company which allows people to access music from various singers or composers. For Spotify to update new songs every day or every minute, individuals or groups of people contribute in different sections (i.e. different songs: hard rock, pop, jazz, heavy metal or different updates or the application) which are unique from one another. These are being compiled which are then used by its consumers. The ability of the Spotify company to provide new updates and new songs to its consumers resembles the design or the actual product that the consumers can use.

Note that this is also context-based. For example, organisations producing products for Boeing 777 are expected to be rigid as their products need to be rigid as well; however organisations like Spotify should probably be more flexible to meet the ever-changing client requirements.

How to start organisational design[edit | edit source]

Organisational Design is the method of creating a responsive organisation to deliver the expected value to the clients with a viable business model. As the market changes faster and margins of business become smaller, this definition focuses more on being responsive and create value to clients instead of only focusing on production, direction and control.

To start organisational design, it is important to learn from mistakes and several steps should be taken very carefully:

  1. Get your intended strategy defined
    • Intended strategies refer to the strategies that organisations create at the right start to indicate the desired achievement in the long term. However, organisations also need to come up with emergent strategies as unexpected situations may arise in the long term and thus changes in terms of strategy are required. Emergent strategies are required to have the right channel by talking to customers, getting and collecting data. Overall, the new strategy needs to make your customers satisfied.
  2. Survey the landscape
    • Go & See: A consultant won't be able to understand an organisation or a system without seeing it. He/She needs to go and see the problems as well as to experience them by him/herself. This includes physically visiting the workplace and talking with employees.
    • Ask Questions: If you don't understand, ask questions in a respectful way. Questions should be directed towards better understanding the problem and the customers needs.
    • Show Respect: It's important to show respect when surveying the landscape, especially when people are resistant. People will be more open if they see that they are respected.
    • An example would be a Japanese style of management known as 'Kaizen' translating to "good way" by asking questions and showing respect.
  3. Focus on what you can control
    • There are things that you can't control and there are things that you can control. So instead of losing the battle by persisting in things that you can't control, it would be much better if you focus on what you can control.

Some other critical things to bear in mind when processing organisational design:

  1. Streamline the flow of the value
    • You need to create a system that uses minimum effort to move value from upstream (ideas in your mind) to downstream (what your users are using). As any idea or work that your users are not using doesn't create any value, you need to make sure that value moves from one part to another part effortlessly.
  2. Decouple your processes
    • Processes are coupled if approvals from multiple people are required to have something done in an organisation. If this entanglement process exists in the organisation, the organisation won't be able to make decisions quickly at the right time which might lead to the loss of competitive advantages. So try to make sure that you have processes as independent as possible. For example, if you have a good idea, you may need to get approval from marketing department, leading to the wrong time to make decisions.
  3. Economic efficiency
    • For the sake of economic efficiency, you shouldn't sacrifice the future because even though you can be efficient right now, you might need to pay the costs 10 to 20 times in the near future.

Waterfall vs Agile[edit | edit source]

Waterfall[edit | edit source]

Waterfall is a methodology which follows the traditional approach from:
Strategy → Marketing → Planning → Project Management → Sales

Waterfall follows a hierarchical procedure and results in the following:

Characteristic Outcome
Long feedback cycles Firms don't touch base with their customers until they start making sales, which means that they have already designed and produced the product. This makes incorporating customer feedback, difficult and expensive.
High cost of course correction Problems that arise throughout the course are expensive to fix as the cost has already been incurred.
Inability to accommodate changes in the market If a firm has already spent months developing a product, they can't simply change what you have at the instantaneously, thus may keep expending money.
Lack of touchpoints with the consumer As a result, firms may not actually know what their customer wants.
Long time to market It may take between 6 months and a year before the Waterfall process moves from Strategy to Sales (i.e. the complete delivery of a product).
Focus on process not value If an organisation is 70% of the way through their product development process and then finds that their consumers do not even like the product they have been developing, it is common for organisations to keep on developing it, which means they're essentially wasting the 30% of their budget.

It usually comes with a hierarchical organisation. This is also known as a tall organisational structure with a narrow span of control, which can delay the flow of information.

Agile[edit | edit source]

Agile is an iterative approach which places the consumer as the driving point of the process. This approach has fast delivery of its products, which often happens every 2 weeks. Compared to Waterfall which comes with a hierarchical organisation, Agile follows a flat organisation. Agile places customers as the focus, where activities such as planning, marketing, strategy and project management revolves around customers, encouraging frequent delivery.

The Agile framework completes a few factors differently to the usual waterfall approach. The Agile Framework has come to value: 1) Individuals and interactions over processes and tools 2) A working product over comprehensive documentation 3) Customer collaboration over contract negotiation 4) Responding to change over following a plan

This is all possible due to the constant iterative delivery as discussed below.

Strategy → Marketing → Planning → Project Management → Sales (same as waterfall)


The Agile approach has the following characteristics:

Characteristic Outcome
Iterative delivery When an organisation has changed something or added some new functions to their products, they will release it to the market as quickly as possible. This means they're contributing value to the market every few weeks.
Short feedback cycles Products are shown to customers on a regular basis, thus organisation can get feedback from customers very often.
Ability to correct course at minimum cost If something has gone wrong, it could be identified in a short time frame so that the organisation will not continue building upon a product's preexisting problems.
Focus on value and customers As the organisation receives fortnightly feedback from customers, they can promptly make changes to the product if their consumers do not appreciate it. As a result, the focus shifts toward value and the customer rather than on the procedures.
Customer drives the process Instead of seeking to get the customer embedded in what the organisation has already developed, the organisation is developing its products and processes around its core consumers, so that the customers are driving the process.
Adaptability to changes in the market The Agile way of working allows organisation to cope and keep up with market changes as they deliver their product every 2 weeks, releasing fortnightly updates and improvements, when necessary.
Streamlined processes Data and communication flow far faster.

The most common version of an Agile framework utilised within organisational design is Scrum. Scrum is a framework within which people "can address complex adaptive problems, while productively and creatively delivering products of the highest possible value." Like all good frameworks, it is:

  • Easy to pick up.
  • Simple to understand.
  • But difficult to master.

It utilised an iterative, incremental approach, as described above, and this allows the organisation to control risk and tackle complex problems in smaller, more manageable sizes. It also allows them to stay active and adapt easier to slow and sudden changes in their industry.

Organisational Transformation[edit | edit source]

It takes extra attention for an organisation to transform from a hierarchical to a flat organisational structure, as commonly organisations have their own history, conflicts, as well as potentially different understandings of the ways the organisations are growing. Therefore, there are some suggestions:

  1. Start small and pivot
    • Do not try to change the whole organisation, because if you fail, you will fail miserably and you won't have the chance to learn. Failure is important in the learning process, but without controlled failures, the information is difficult to understand and retain. Instead of transforming the whole organisation, it would be better to just create the infrastructure for a single department first. Therefore, transforming the organisation department-by-department, and using the first transformed department as a pivot or reference.
  2. Drink your own champagne - fail fast
    • Fail fast means that if it looks like it's about to fail, just find it out and fail it fast - don't postpone it because the postponement means more resources being wasted on the ineffective process. Encouraging management to make failure visible for the organisation to learn from it.
    • Make sure that organisation fails fast and bear in mind that all the things you can get from failure is learning. Just try something else if it doesn't work and be very open about the failure.
  3. Every organisation is unique and one size does not fit all
    • Organisations differ in sizes, cultures, pays, market strategies and so forth. Find the right way of organisational transformation - experience helps, but most of the time you will figure it out when you are going through the implementation of the change.
  4. Measure your progress with the right metrics
    • Inappropriate metrics might make a company look miserable or unbelievably successful. Therefore it's vital to establish the right metrics so that you can accurately evaluate the progress. When choosing metrics to measure progress, it is key to avoid selection bias when choosing the metrics. An example would be only selecting metrics that the organisation is doing well and conclude that there is significant progress from those biased metrics.
    • One way of setting up befitting metrics: Align the metrics to your organisational goals.
  5. Both bottom-up and top-down
    • Make sure that you have the top-level support and sponsorship (e.g. the CEO), since strong leadership is necessary for a successful organisational transformation. Without this leadership, the transformation may be confined to a singular area, but you are still only as strong as your weakest link. Furthermore, this may cause the company to become overly reliant on the consultant acting as a shadow CEO, resulting in only temporary change.
    • But also the bottom-up process is important as well. The transformation works well if people don't even know you, the consultant, has left (i.e. things work without you).
  6. Vision - create your organisational myth
    • Vision refers to why an organisation exists (other than what they want to do, which refers to the organisational goals). This is commonly confused with business goals.
    • So when conflicts arise between departments, you can resolve the problem by asking if this conflict serves to the reason why your organisation exists.
  7. Leverage the champions in the organisation
    • You can't do everything yourself. You need to find out the champion(s) who can take you through the transformation, who can help you, who understands what you want to do and who sees the value.


Summary

  • How you design your organisation defines your processes
  • Your products resemble you
  • Reality is chaotic – design your organisation accordingly
  • Deliver often, course correct quickly and fail-fast
  • Focus on your customer in your organisation design

Types of Organisational Structure[edit | edit source]

An organizational structure is a system that outlines how certain activities are directed in order to achieve the goals of an organization (Investopedia, 2019), which can include aspects such as rules, roles, and responsibilities. The organizational structure also determines how information flows between levels within the company. For example, in a centralized structure, decisions flow from the top down, while in a decentralized structure, decision-making power is distributed among various levels of the organization. Having the right structure in place allows enterprises to remain efficient and focus on their strategic objectives.

Functional Organisational Structure[edit | edit source]

Functional Organisational Structure is one of the most common types of structures in an organisation. This structure takes place when employees are divided into smaller groups based on the tasks or roles that are assigned to them. Such groups include production, marketing, sales, finance, research and development, human resource management, and many more.

A firms' choice of Human Resource management and organisational structure reflects its response to a common problem: misaligned incentives (principal-agent problem).

Advantages[edit | edit source]
  • High degree of specialisation

Since employees are assigned to a specific task or role, they become experts in that particular activity, and they will perform in the most effective and efficient manner.

  • Training is simplified

An employee is only trained for the specific department that they are assigned to, which makes the training faster to accomplish and therefore, is cost-effective for the organisation. For example, if an employee is assigned in sales, then that employee will only be trained in activities related to sales and not to production or other departments.

Disadvantages[edit | edit source]
  • Interdepartmental rivalry

Since each group has been given different sets of tasks and goals to accomplish, this may create competition within the organisation. Such competition may include which group has the most tasks done or which group is the most efficient and effective in completing those tasks. This may lead to employees focusing on departmental goals which can create a conflict of interest between agents and the firm leaders.

  • Segregation

Having different departments in an organisation may lead to groups of employees being isolated from other groups. This is not beneficial for the organisation as it limits the communication and sharing of ideas between groups which may prevent innovation and slow down organisational growth.

  • Rigid

Functional Structures can adopt highly centralised forms due to the specialisation of its departments, limiting innovation and collaborative thinking.

Multidivisional Structure[edit | edit source]

Multidivisional structures are frameworks that arrange companies into different business units. This kind of structure has been growing in popularity with the increasing number of firms using diversifying strategies, including expanding market positioning in different geographical locations, products or services. Therefore, most multidivisional organisations will be composed of one parent company or headquarter, followed by separate business units or profit centres managing their own individual business activity.

Advantages[edit | edit source]

  • Diversification

Multidivisional frameworks allow organizations to diversify their business portfolio. It has been shown to improve flexibility and market responsiveness, especially when there is a geographical division looking after a local target market.

  • Facilitates Decentralisation

Multidivisional Structures can adopt decentralised forms that foster innovative and collaborative thinking.

  • Facilitates Control

By having different business units, the parent company can easily compare, evaluate and monitor the performance of each division, which also facilitates the allocation of resources.

Disadvantages[edit | edit source]

  • Doubling up Resources

On some occasions, different business units will double up resource utilisation, resulting from divisions having individual support services such as Human Resources, Finance, Marketing, and others.

  • Can Create Rivalry

Given the facility to compare the performance between the business units, rivalry for resources can create conflicts within the organisation.

Matrix Structure[edit | edit source]

Most organisations follow a conventional hierarchical system that is simple and straightforward in nature. Also known as “tree structures”, they are clearly established organisational models in which power and influence move in ascending order from entry-level positions up to the CEO or Board of Directors at the organisation’s apex. On the other end of the spectrum is the matrix organisational structure, wherein employees usually report to more than one superior due to the existence of separate chains of command.

Advantages[edit | edit source]
  • Specialisation

One of the pillars integral to the matrix structure is specialisation, thereby enabling a comprehensive expansion of knowledge and a more tailored allocation of tasks according to the project’s needs.

  • Efficiency

Despite being antithetical to the conventional organisational model, matrix structures still have a fully operating system set in place. They utilise their employees’ specialised skills in the service of large-scale projects, implementing speed and efficiency without simultaneously sacrificing the integrity of the structure.

Disadvantages[edit | edit source]
  • Complexity

Being accountable to more than one superior means the dilution of the otherwise clear chain of command.

  • Conflict

As a result, there may be a higher manager-to-worker ratio. This would mean the increase of costs and conflicting loyalties among the employees, with the uncertainty most likely making way for indecision and disorder.

Flat Structure[edit | edit source]

A flat organisational structure, as suggested by its name, has little to no hierarchy concerning its executives and staff employees. In contrast to the conventional organisational models with numerous levels separating the supervisors, managers and directors from the staff, there are hardly any differences in authority within a flat structure, thereby preventing any abuses of power by higher-ups and a more equal footing throughout.

Advantages[edit | edit source]
  • Reduced operational costs

Power and influence are not distributed incrementally as an employee rises in position within the company. Costs are allocated to more crucial matters such as marketing and advertising, as opposed to recruiting more managers with different authorities and, consequently, different pay grades. Therefore, business-making decisions and conflict resolutions come from the employees with non-executive and non-managerial roles.

  • Communication is improved

Doing away with the usual barriers to communication allow executives and staff members to cooperate with one another in a more immediate and efficient manner. The fewer the parties involved, the clearer the message.

  • Reduced micromanaging

Flat structures prevent the managers’ tendency for micromanaging every minute aspect of the business operation, as employees who experience more independence with their work unleash more creativity and therefore more efficiency.

  • Increase in motivation and satisfaction among staff

Accordingly, staff employees are more motivated to succeed when they are allowed to incorporate their personal creative endeavours into the company’s overarching goals, thereby ensuring mutual success and productivity.

Disadvantages[edit | edit source]
  • Bad decision-making

This organisational model hinges on the front-line staff’s comprehensive knowledge and creativity, as their competence or incompetence will result in either the success or failure of the company’s business operations.

  • Limit productivity

Though the flat structure functioning smoothly in theory, it cannot account for the possibility of employees working at a lower level of productivity as expected, or them even working at all. No supervision means no guarantee of efficiency.

Network Structure[edit | edit source]

A network-based structure is a hybrid matrix structure that places emphasis on digital technology and employees with specialised skills but in different, unconventional working environments.

Advantages[edit | edit source]
  • Clearer structure

According to this organisational model, a company’s ability to function does not rely on the traditional and even restrictive conditions of a working environment, but on its competency to achieve its endeavours, even while - and perhaps because - of adapting.

  • Reduced costs

The main advantage of the network-based structure is the company’s capacity to outsource their project needs to other specialised, expert firms.

  • Flexibility

This results in the company’s proficiency in implementing technological changes, improving its production techniques, quantity and designs without disrupting its main operations.

Disadvantages[edit | edit source]
  • Reduced control

Outsourcing to other companies means a slacker grip on the finer details of the company’ projects and therefore their outcomes.

  • Reduced profit

The company will not be able to keep the profits from the projects within its confines, as it will have to relinquish what the other firms have earned when they performed certain aspects of production.

  • Lack of secrecy

Confidentiality regarding the company’s business operations is not guaranteed, resulting in other competitors uncovering any advantage the company may have over them.

Why is Organisational Structure Important?[edit | edit source]

Organisational structure is a critical aspect in organisations as it facilitates and supports the implementation of strategic actions within companies. Thus, it is paramount to have the appropriate structural framework that aligns with the vision and mission of the organisation to successfully create a productive synergy between the multiple departments within an enterprise. As an example, several organisations adopting functional approaches will also aim for cost-leadership strategies. The heavy repetitive tasks of functional approaches support the organisation objectives. On the other hand, multidivisional organisations might adopt differentiation strategies that require intensive research and development and slight modifications according to the geographical target market.

Misaligned Incentives: Principal Agent Framework[edit | edit source]

A firm’s choice of human resource management and organisational structure reflects its response to a common problem: misaligned incentives (i.e. Principal-agent problem). This is whereby one party's actions affect but are not observed by the other party[3].

There is often an incentive conflict between CEOs and Managers. Principals (CEOs) want agents (managers) to work in the principals' best interests. But a conflict of interest can arise between agents and principals when there isn't proper authority and monitoring in place to align agents' incentives with the goals of the principal. There are two ways to resolve this conflict:

  1. Centralised authority and monitoring. Potential problems:
    • Paying for performance can be costly;
    • It can be hard for CEOs to check what everyone is doing on the hand, as they don't have enough cognitive capacity as well as the time or energy to do so;
    • The lack of information to check whether the managers are doing what they should be doing: if managers are very specialised, they know the products or the customers a lot better than the CEO does.
  2. Delegation of authority and trust.

The principal-agent problem commonly occurs when the agents make decisions on behalf of the principal, bearing any potential losses onto the principal. This can lead to problems of moral hazard where the agent makes irrational decisions from bearing no consequences from the actions made, leading to a conflict of interest. Principals also may be misinformed of the agent's performance level due to asymmetric information between the two parties.

Example: An example would be if a firm's shareholders acting as the principal want their company stock prices to increase. However, if the CEO acting as the agent choose to give away extra bonuses. This would cause the principals to feel that their goals are misaligned. This problem can be resolved by modifying the contract clause of the agent, such as tying their pay to stock prices and having a diversified board of directors acting as a control mechanism.

The moral hazard in incentives conflict can be further described by the following attributes:

  • Asymmetric information - this is whereby one party has better information in a particular situation and the other party does not. This leads to an unfair advantage in favour of the party that has more information.
  • Economic inefficiency - this is a situation wherein one party does not maximise their capacity or net benefit, and as such does not deliver the most economically efficient contribution.
  • The degree of moral hazard - this is measured as the difference between the economically efficient action and the action chose by the party subject to moral hazard[4].

Authority[edit | edit source]

Authority within an organization is fundamental because it allows the company to grow. Studies conducted have proven that the lack of authority on organizations disrupts with the development and performance of a company (Stevenson & Jarrillo-Mossi,1986). Within any organisation, there are two main types of authority, formal and real

Formal Authority[edit | edit source]

  • Formal authority is allocated contractually. The representatives of an organisation, such as management, are granted certain authority by, for example, the board of directors, according to their roles and job titles, with which they can control resources and direct a team. The authority is usually provided by the organisation to individuals (team managers or leaders), which enables the particular individual to act in accordance with its own will without consulting others. [5]. Formal authority therefore complements decentralised management.
    • For example, a manager is provided with formal authority over a group of employees, in accordance with their role, the manager is given the rights to discipline or motivate employees under their contractual control.
  • In other words, formal authority of an agent in a firm is stated in the employment contract prior to being an employee at the firm. Employees would know the formal relationship and leadership through the organisation chart. Employees given formal authority over others have a degree of decision making power in accordance to his own will without consulting others.
  • Formal authority has the potential to intrinsically and extrinsically motivate employees. The clear hierarchy associated with formal authority provides clear measurement of improvement, where employees can aim for promotions and attain more authority. Increased authority may be accompanied by a higher salary (extrinsic motivation) or internal satisfaction (intrinsic motivation).

Real Authority[edit | edit source]

  • Real authority is exerted by the party which has access to information. Information is not only important in terms of who gets the information but depends on the structure of how information goes through. Real authority is the ability to make decisions based on information. This authority may sometimes lie with the party which has formal authority but not always.[5]
    • For example, a subordinate employee may be able to exert authority over a manager if they are more informed on an issue. They can use their superior information to provide a better solution to a problem, ultimately becoming the higher authority on the issue.
  • Real authority requires knowledge of relevant information and the ability to utilise the information to make informed decisions. This information is gathered by the agent through time, experience and effort.[5]
  • Increasing the span of control is one way in which a manager can give subordinates more real authority and subsequently encourage more initiative. An increase in an agent's real authority promotes initiative but results in a loss of control for the principle.
  • How the organisation is designed as well as how formal decision rights are given, can affect the way in which real authority is distributed (through the information flow) within the firm.[5]
    • How quickly the information goes through the organisation is affected by the organisational structure.

Span of Control[edit | edit source]

The choice of the optimal span of control by the principal is subject to the trade-off between the principal’s loss of control and the agents’ initiatives. There are many different organisational factors that can affect the desired span of control.

This trade-off underlies other features of organizational design, such as the role of intermediaries, the costs and benefits of having multiple principals on some activities, or the optimal combination of tasks within teams.

The main factors to be reviewed in determining the appropriate span of control within an organization include:

- Organizational size: In general, large organizations tend to have a narrower scope of control, while small organizations tend to have a wider scope of control. This difference is usually due to the cost of more managers involved and the financial resources available to the organization. If someone who manages through multiple levels, the communication speed may be slower and the span will be narrower.

- Workforce skill level: The complexity or simplicity of the task performed by the employee will affect the number of direct reports required. Generally,, routine tasks involving repetition have less oversight and control over managers, allowing for greater scope of control, while complex tasks or dynamic work environments may best fit within the narrower scope of control, where managers can provide more personalized attention.

- Organizational culture: When designing the span of control, the organization needs to determine the culture required. Flexible workplaces often have more control because employees have more autonomy and flexibility in the production of their jobs.

- Manager’s responsibility: Review whether the organization's expectations allow managers to effectively use the number of direct reports they have, especially those related to individual responsibilities, departmental planning, and training. For example, executives tend to have fewer direct reports than other managers in the organization.

Type of control[edit | edit source]

Span of control is associated with the organisational structure and its hierarchy. Smaller or larger span of control describes the 'width' of the organisational structure. Levels of hierarchy in the organisation can be described as flat or tall, which in turn describes the 'height' of the hierarchy.

  • Firstly, firms with a flat organisational structure usually have a wide span of control. Managers in these organisational structures have more employees under their supervision, which can encourage delegation of work. As the organisational structure is flat, lesser layers in the management hierarchy, information flow travels faster. May have opportunity to reduce cost as fewer managerial roles are needed. This organisational structure assist in emphasising on work autonomy. However, a wide span of control is subjected to trade-offs as span of control decreases as this structure is highly dependent on workers' autonomy.
  • Secondly, firms with a tall organisational structure have a narrow span of control. There is more divisions of specialty leading to smaller groups. This structure further increases opportunity for promotions that can lead to more competition between divisions. Since managers have fewer employees to manage, this increases the control in the divisions which leads to the trade-off where control is high and employee initiative is low as they feel powerless.

Delegation of Authority[edit | edit source]

When delegating formal authority the principal must weigh up the costs and benefits associated with delegation. The greater the degree that the principal's preferences coincide with the agent's, the lower the cost associated with delegation. This is known as congruence. Definition: a delegation of authority includes sharing the authority downwards to the subordinates and checking their efficiency by making them accountable for their actions. The lower level is distributed with certain responsibilities and authority to reduce the manager's burden.

The costs and benefit of authority delegation can be characterised by two effects: the loss of control effect and the initiative effect. Which effect dominates is dependent on how aligned the principal and agents' interests are, i.e. the congruence between the two parties' preferences.

Loss of control effect:[edit | edit source]

When delegating authority to an agent the principal loses a degree of control over what the agent will produce. Giving full autonomy to a subordinate to complete a project however they see fit is a risk because it is possible that the subordinates ideas do not align with the boss, or do not have the skillset or creative vision to carry it out to the required standard.

Initiative Effect[edit | edit source]

The initiative effect is a possible benefit of delegating authority. This is because the delegation of formal authority to agents encourages the agent to invest more time and effort into gaining information that will make them an authority figure on the issue. For example if an agent is told they are the head of research for a new project that is beginning they will put in more effort into research compared to if they were simply given a list of topics and told to research them.

Delegating real authority[edit | edit source]

When the principal delegates real authority to an agent, the principal can also retract and take back the authority. Principals will, however, be reluctant to retract granted real authority as doing so can cause a loss of trust between the agents and the principal. Principals aim to establish positive relationship over time to gain the trust of agents and ensure credible control transfers in the future. It can be noted as well that the delegation of authority is often the best way to elicit the agent’s private information.

preferred project.

Taking back control from an agent causes the agent to experience a greater feeling of loss than the value they gained from receiving the authority (see topic 3 'Managerial Decision Making' for more information on loss aversion), this loss may push the agent to grieve and take on unobservable actions that are damaging the firm.

Reasons why the principal can't revert her decision:

  1. Information transfer
    • When the principal delegates her authority, she also transfers information to the agents to help them make decisions that are best for the company. With the information transfer being irreversible, the transfer of control is most likely to be irreversible as well. It can create a commitment on the part of the principal.
  2. Reputation
    • If the principal constantly takes back the given decision rights, the next time she delegates the authority, the agents might think that it's the fake authority which is not worth investing. Thus they are reluctant to collect information or even though they have some information, they refuse to communicate it because they're not empowered to make the decisions. Therefore, principals may want to establish a reputation for not reverting control allocation decisions over time, precisely to keep the option of credible control transfers in the future.
  3. Aggravation and shading
    • Taking away the given authority can be worse than not giving it in the first place because people get annoyed and feel mistrusted, which can actually lead to shading and sabotaging behaviour which is damaging to the firm. The agents might start doing things that are not in line with the best interests of the company in secret because they don't trust the principal anymore, which can be quite costly.

The Principal Agent Framework[edit | edit source]

The principle agent framework is a problem that arises when there is a disagreement between a person or group (principal) and the representative assigned to make decisions on their behalf (agent). The problem occurs when the agent acts in way that is against the wishes of the principal. The goals of principal and agent must be aligned as well as the processes to follow in achieving that goal. Situations in which the principle-agent problem occurs include disagreements between stockholders and CEOs, CEOs and managers. The agent is given a degree of control over assets owned by the principal, while the principal retains any liabilities, as a consequence of the agent’s decisions. As the principal cannot constantly monitor the agent, there is the possibility of the agent making the wrong decision, or act against the wishes of the principal. The consequences of the agent’s actions that are against the wished of the principal are called agency costs. In order to reduce agency costs, it is the principal’s responsibility to introduce incentives for the agent to act in favour of the principal.

Decentralization and skilled workers[edit | edit source]

Decentralization means that the transfer of authority and responsibility for functions from the central organisation to subordinate or lower levels of the administrative system.

Decentralization is complementary with the skills of the agents(employees)[edit | edit source]

  1. Skilled worker are better able to analyse and synthesise new pieces of knowledge, thus enhancing the advantages of local information processing.
    • Working in a decentralised organisation requires individuals to be able to process information because they have more authority actually to act on this information and make decisions. More skilled agents will be better suited to be hired in such organisations as they don't need to monitor or someone to quality control every little thing they do.
  2. Skills workers are better at communicating, which reduces the risk of doubling up on information.
    • If an employee who learns things through his or her analysis, research, or conversations with customers (etc) is unable to write a good short report on them, then other employees wouldn't be able to learn what he or she has just learnt. So workers need to be able to communicate in an efficient and understandable way with others.
  3. The cost of training them for multi-tasking is lower, and they are more autonomous and less likely to make mistakes. Thus assisting with keeping the costs of the firm as low as possible.
    • We live in a world where technology is changing a lot. Hence companies need to learn new skills every year and keep updating their knowledge and skills. Thus firms often need to train their workers or mentor them so they can catch up with how the companies work. If workers are highly skilled, the cost of training them would also be lower, so they could fit better for the decentralised firms.
  4. Well-educated workers are more likely to enjoy job enrichment, partly because they expect more from their jobs in terms of satisfaction.
    • Though it can be seen as a good thing to be given authority, this can also come with costs as you would be responsible, and you need to make decisions that might have some terrible consequences. So having power can be stressful, and people might see this responsibility as a burden. But high-skilled workers might feel this as a reward that increases their enjoyment of the jobs.

Main implications:[edit | edit source]

  1. Decentralization leads to upgrading of skills within the companies since the return to new work practices is greater when the skill level of the workforce is higher.
    • If a firm is decentralising and coming through organisational design or redesign process, it would hire more skilled employees and train their employees to become more skilled.
  2. A lower price of skilled labor will accelerate the introduction of organisational changes.
    • If the wages of high-skilled workers are flat and going down, firms will be able to hire more such workers and go through the decentralisation process more easily. But if there are limits on matters like skilled visas or skilled migrants, such changes must be slowed down.
  3. Skill intensive companies will experience greater productivity growth when decentralising.
    • Empirically, these predictions seem to hold as well.

Measurement[edit | edit source]

Measuring centralisation[edit | edit source]

The process of decision-making within organisations will vary between a centralised decision-making process and decentralised decision-making process. Centralisation is the degree to which the authority of decision is concentrated in one part of an organisation’s hierarchy. Organisations that have a highly centralised structure will rely on the top management in most of its key decisions, where low-level employees tend to have a minimal influence upon the decision-making process. The concept of centralisation can also reflect on the products of the organisation in which centralised organisation will tend to have a centralised products. Decentralisation, on the other hand, is the degree in which decisions are spread amongst all levels of management including low-level employees. That also reflects on its products in which decentralised organisation are more likely to have a flexible product.

To empirically measure centralisation, we could look at the organization charts and data as a graphical representation of the formal authority structure. Looking into the firms’s structure will ultimately give us an idea concerning the process of decision-making and whether the firm is centralised or decentralised.

We can also count the number of people/employees who directly report to the CEO as a measure of the 'span of control’. Furthermore, measuring the ease of employees to take different roles within the firm and counting the number of movements and transfers between different departments can be another way to measure centralisation. Looking into the number of approvals within each department and measuring the processing time of decisions to get approved and/or implemented is a valid way to measure centralisation.

Measuring real authority[edit | edit source]

Measuring centralisation might be effective to examine the structure of firms but is not a determinant of real authority. Formal authority is different than real authority (the organogram may not reflect where real power lies) and there are certain ways in which we can measure real authority.

This can be done by conducting a world management survey to ask mid-level managers if they can execute decisions like maximum capital investment that could be made without explicit sign off from central headquarters, hiring, marketing, and product introduction. However, this method has a limitation in the sense that answers might be dishonest and biased or show off authority and ability to take decisions. Furthermore, when measuring real authority, there could be a possible upward bias due to managers wanting to show off their power. Sampling bias may also be present. Managers of decentralised firms have the freedom to speak without needing the permission of their superiors.

Measuring congruence[edit | edit source]

Stronger rule of law supports decentralisation. This is because it facilitates more complete contracts and allows the employer to prosecute their workers if they do not abide by their contracts. Congruence between the two parties’ preferences refers to the degree to which the principal’s preferred project is also the agent’s preferred project.

  • However, contracts are never perfectly enforceable (incomplete): this may not capture the whole rule.

Trust is a proxy for congruence

  • Generalised social trust as a proxy of social capital is associated with higher growth, foreign trade and investment.

Measuring trust[edit | edit source]

Enforcement of contracts should further foster decentralization, and it has been seen that we do in fact observe more delegation where there is stronger rule of law. However, contracts are never perfectly enforceable, which leaves a role for trust to help generate more delegation.

Trust: An empirical proxy for congruence. Generalized social trust as a proxy for social capital has been found to be associated with many positive economic outcomes (e.g., see Knack and Keefer 1997, on trust and growth or Guiso et al. 2009, on trust and foreign trade and investment).

Research findings[edit | edit source]

  1. Decentralisation is higher in Scandinavia and Anglo-Saxon countries, and lower in Asia and southern Europe.
  2. Variations exist not only across countries but also within a certain country. In other words, the decentralisation rate in a certain country doesn't mean that there is only the culture of centralisation or decentralisation - there can still be some variations within that particular country.
  3. The higher the trust level of a country in which the companies are located, the more decentralised the firms are.
  4. The stronger the rule of law in a country, the more decentralised the firms are.
  5. Foreign multinational are found to be more centralised.
  6. If there is bilateral trust, the firm is more likely to have bigger size in that country
    • Bilateral trust: for a multinational company, whether the people from the country of origin trust the people living in the country where the multinational is located.
    • This can explain some differences between countries that might be seemingly similar (e.g. the UK & the US v.s. the UK & France v.s. France & Germany). Due to historical events, the trust levels are not necessarily symmetric, for example, the Dutch and the Germans may not trust each other, even though an independent country would see them equally trustworthy.

Summary[edit | edit source]

The below section aims to briefly summarize the key takeaways of the topic:

Organisational Structure: a framework outlining how roles, rules and responsibilities are directed through the firm to achieve objectives. A critical aspect of organisations that facilitate and support the implementation of strategic actions. Organisational structures are either:

  • Centralised: clearly defined chain of command, or
  • Decentralised: decision-making power spread out across many levels of management.

Organisational (re)Design: method through which firms can improve their responsiveness to external threats and opportunities, deliver to clients successfully, and achieve harmonious internal balance by; firstly, dividing itself into multiple operational parts, and secondly, integrating these processes to build production, direction and control through structural arrangements.

Conway's Law: conveys that organisations will produce designs or products that resemble their organisational structure, meaning that an organisation with a centralised structure will produce centralised products, and an organisation with a flat structure will produce flexible products.

Organisational Design: method through which firms can identify dysfunctional aspects of their systems and workflows and remodel them to fit current business realities to create responsive organisations that can deliver the expected value to clients with viable business models.

Waterfall vs Agile:

  • Waterfall: traditional methodology approach for the breakdown of project activities into several discrete linear sequential phases, with each phase depending on the deliverables of the previous one and corresponding to a specialisation of tasks. This methodology follows a hierarchical procedure and is used in tall organisations where there is a narrow span of control and delays in the flow of information.
  • Agile: iterative methodology approach that places the consumer as the driving point of the process and uses short development cycles referred to as 'sprints' to focus on continuous improvements in the development of a product or service. This methodology follows a flat organisation where communication flows are faster and more streamlined.

Types of Organisational Structures:

  1. Functional Structure: most common structure type within organisations. Splits employees into groups based on assigned role/task.
  2. Multidivisional Structure: framework dividing organisations into various departments. Growing in popularity among organisations implementing diversification strategies.

Principal Agent Framework: economic theory describing contract-based interactions between a 'principal' (i.e. an employer) and an 'agent' who acts on the principal's behalf (i.e. an employee).

Decentralisation: transfer of authority and responsibility for functions from the central organisation to subordinate/lower levels of the administrative system. A decentralised structure is complementary to the skills of an agent (i.e. employee).

Measurements:

  • Measuring Centralisation: examination of organisational charts and data as graphical representations of formal authority structures.
  • Measuring Real Authority: implementation of world management surveys to reveal the degree of managerial decision-making power given to mid-level managers. Model limitations; dishonesty and biases (i.e. sampling/upward bias).
  • Trust: an empirical proxy for congruence
  • Congruence Measurement

Reference/s[edit | edit source]

Stevenson, H. H., & Carlos Jarrillo-Mossi, J. (1986). PRESERVING ENTREPRENEURSHIP AS COMPANIES GROW. Journal of Business Strategy, 7(1), 10–23. https://doi.org/10.1108/eb039138

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