ORGANIZATIONAL ARCHITECTURE

ELEVENTH LECTUREApril 17, 2012

William R. Eadington, Ph.D.Professor of Economics, College of Business

Director, Institute for the Study of Gambling and Commercial GamingUniversity of Nevada, Reno

www.unr.edu/gaming

MANAGERIAL IMPLICATIONS• Note how the market deals with

Organizational Architecture• Does the strategy fit the business

environment?• Does the current architecture fit the

business environment and strategy?– Does it effectively link specific knowledge and

decision rights?– Does it provide incentives to use information

productively?

MANAGERIAL IMPLICATIONS• Given the decision rights system, does

the control system fit?

• If any of the above questions show a problem, determine what changes in strategy or architecture are appropriate

• Determine problems that will be faced if the firm implements these changes

• Example: Century 21 Realtors

PRE-CONTRACTUAL INFORMATION PROBLEMS

• Bargaining failures– asymmetric information

• Individuals may overreach during negotiations to the point that negotiations stop, e.g. Negotiating a salary; buying a home

• Adverse selection– use of private information in manner

detrimental to trading partner• e.g. Insurance coverage on an individual with

serious health problems; sale of a car that is a “lemon”; selling a house without full disclosure of all of its flaws

CENTRALIZATION VS DECENTRALIZATION

• Determines which level of the firm’s hierarchy to place the decision right

BENEFITS OF DECENTRALIZATION

• Effective use of local knowledge– local tastes and preferences– price sensitivities of particular customers

• Conservation of management time– senior management can focus on strategy

• Training and motivation for local managers– Greater “buy-in” to the firm

COSTS OF DECENTRALIZATION

• Potential agency problems– effective control systems may be

expensive

• Coordination costs and failures– Duplication may occur in market analysis

• Less effective use of central information

AUTOMART EXAMPLE

• Jones Motors has car dealerships in two cities (Reno and Sacramento)

• Hierarchy includes CEO and two local managers

• Which decisions are retained by CEO (centralization) and which are delegated to local managers (decentralization)?

DETERMINING THE LEVEL OF DECENTRALIZATION: MODEL• D is the degree of decentralization• B is a positive constant• Benefits of decentralization = BD• Costs of decentralization =(AD)+

(CD2)• Where AD represents contracting

costs• CD2 represents

coordination/information costs

DETERMINING THE LEVEL OF DECENTRALIZATION

• Objective: maximize net benefits• NB=BD-AD-CD2

• which occurs whenD*=(B-A)/2C

(How do we get this?)

• Note how D* is affected by changes in A, B, and C

DETERMINING THE LEVEL OF DECENTRALIZATION

Decentralization

D*D

Tot

al c

osts

an

d b

enef

its (

in d

olla

rs)

$Costs

Benefits

DETERMINING THE LEVEL OF DECENTRALIZATION

• Over time, the costs and benefits will change

• Information costs and incentive costs may fall as technologies change

• Benefits may increase if the importance of local knowledge increases

MANAGEMENT IMPLICATIONS

• The net benefits of decentralization will be highest in rapidly changing environments– Silicon Valley vs. NV Energy– Walmart, Safeway: How are they organized?

• Benefits of decentralization increases as a firm enters more markets with a broader array of products– Local information becomes more important

• Vertical integration increases the net benefits of decentralization– Reduces contracting costs as well as information

costs

BENEFITS AND COSTS OF TEAM DECISION MAKING

• Benefits of team decision making• improved use of dispersed specific

knowledge• Employee buy-in

• Costs of team decision making• collective-action problems• free-rider problems

MANAGEMENT IMPLICATIONS• Team decisions are more beneficial

when• specific knowledge is dispersed• It is easy to control the costs of collective

decision making and the free-rider problem

• Optimal team size• Tradeoff between increased knowledge

base with the costs of team decision making

DECISION MANAGEMENT AND CONTROL

• Decision management is the initiation and implementation of decisions

• Decision control is the ratifying and monitoring of decisions

• Basic principle:– If decision makers do not bear the major

wealth effects of their decisions, decision management and decision control will be held by separate decision makers

DECISION RIGHTS AND KNOWLEDGE CREATION

• Decentralization gives employees incentives to experiment and innovate– When might this be desirable and when is

it not?

• Successful experiments must be:– identified– reasons for their success understood– Codified (wetware to software)– implemented by others in the firm

DECISION MANAGEMENT AND CONTROL: BOARD V. CEO

Consider a new product development. Four steps need to occur:

• Initiation (CEO & management)– Generation of proposals for resource utilization

and structuring of contracts

• Ratification (the Board)– Choice of decision initiatives to be implemented

• Implementation (CEO & management)– Undertake the production & distribution of the

product

• Monitoring (the Board)– Observe and evaluate the process

INFLUENCE COSTS• Employees have incentives to influence managerial

decisions– Discretion might lead to efforts at persuasion

• Influence activities may entail costs• time away from the job• dysfunctional activities

• Limits on managerial discretion may reduce influence costs

• When firm’s profits are unaffected by decisions that may have a major impact on individual employees, bureaucratic rules are more desirable and more likely– Assignment of flights for stewards, pilots for an airline

DECISION RIGHTS: THE LEVEL OF EMPOWERMENTAssigning Tasks and Decision Rights• Production processes involve tasks

bundled into jobs• Job dimensions

– variety of tasks• few or many

– decision authority• limited or broad

TASK ASSIGNMENTS• Specialized

– perform limited number of functions• e.g. traditional assembly line, bank teller,

accountant

• Broad– perform multiple functions

• e.g. professors, consultants, shop owner

DIMENSIONS OF JOB DESIGN: Give Some Examples of Real

JobsMany

Few

NarrowDecision authority

Broad

Var

iety

of

task

s

1

2

3

4

SPECIALIZED TASK ASSIGNMENT

• Benefits– comparative advantage– lower cross-training expense

• Costs– foregone complementarities across

tasks– coordination costs– functional myopia– reduced flexibility

METHODS OF GROUPING JOBS

• Unitary form of organization – group by functional specialty– each primary function in one major

subunit

FUNCTIONAL ORGANIZATION

Chief Executive Officer

Service DepartmentSales Department

FUNCTIONAL SUBUNITS• Advantages

– promotes effective coordination– promotes functional expertise– well-defined promotion path

• Disadvantages– opportunity cost of senior management time– coordination problems across departments– employee focus on functions, not customers

(“Not my job” syndrome)

FUNCTIONAL SUBUNITS

• Tend to work best– in small firms with homogeneous products– when technological change is slow

METHODS OF GROUPING JOBS

• Multidivisional form of organization– group by product– group by geographic area– each unit has multiple functions

PRODUCT AND GEOGRAPHIC ORGANIZATION

Chief Executive Officer Chief Executive Officer

Product Organization Geographic Organization

Business Products Division

Consumer Products Division

West Coast Division

East Coast Division

Sales Department

Service Department

Sales Department

Service Department

Sales Department

Service Department

Sales Department

Service Department

(One or the Other)

PRODUCT/GEOGRAPHIC SUBUNITS

• Advantages– decision rights tied to specific knowledge– senior management able to focus on

strategy– promotes coordination pertinent to

product/area

• Disadvantages– unit interdependencies may be ignored– economies of scale or scope may be

foregone