Here is an excerpt from an article written by Herman Vantrappen and Frederic Wirtz for Harvard Business Review and the HBR Blog Network. To read the complete article, check out the wealth of free resources, obtain subscription information, and receive HBR email alerts, please click here.
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Rare is the business executive who doubts the importance of responsiveness: to be acutely alert to business opportunities and threats, and to be capable of grabbing the opportunity or fending off the threat fast and effectively. Hence, when (re-)designing the organization structure, they tend to decentralize decision-making, so that decision rights are as close as possible to the people who deal with customers, competitors, front-line employees, and other stakeholders. By doing so they avoid the delays associated with information and approvals traveling up and down the management hierarchy.
In politics, this is known as the principle of “subsidiarity” or “the principle that a central authority should … [perform] only those tasks which cannot be performed at a more local level.” But which exactly are “only those tasks”?
It is an age-old question. As Henry Mintzberg noted in The Structuring of Organizations in 1979, “The words centralization and decentralization have been bandied about for as long as anyone has cared to write about organizations.” And that is a pretty long time, at least since 400 B.C., when Jethro advised Moses to distribute responsibility to various levels in the hierarchy.
In this article, we will present a simple logic to follow when addressing the centralization versus decentralization issue. We are not presenting a new path-breaking framework – but sometimes, it pays to get back to oft-forgotten first principles.
We find it useful to start with four qualities most executives want their organizations to have: responsiveness, reliability, efficiency, and perennity (e.g., the quality of being perennial, or continuing reliably in perpetuity). When deciding on the best level at which a given task should be done, assess the impact of the decision on these four qualities. For example, the efficiency gain from centralizing payroll processing may be much more important than the possible loss of responsiveness to changes in local labor laws that would be achieved by keeping this task decentralized; the centralization of payroll processing indeed enables the harmonization of systems and procedures, hence the realization of scale effects, possibly including the outsourcing to a single external service provider.
Let’s have a systematic look at the four qualities.
1. Responsiveness through immediacy. Responsiveness is all about taking the right action quickly in response to opportunities and threats. If the sources of these opportunities and threats (e.g., customers, competitors, suppliers, employees, regulators, partners, and so on) occur at the level of the operating unit, and if these interfaces are genuinely different between operating units, it makes sense to locate the corresponding tasks (e.g., sales, procurement, recruiting, regulatory affairs) and the accountability for proper execution at that level. For example, there is quite a difference between dealing with a regulator, say, in India and one in Indonesia. Decentralization allows immediacy in time and place, hence responsiveness.
2. Reliability through compliance. For some tasks, it is desirable or necessary to have common rules across the operating units: policies, standards, methods, procedures, or systems. Think of compensation and benefits policies, product design standards, quality assurance methods, fraud reporting procedures, financial reporting systems, and the like. These rules are meant to align the operating units with the company’s overall objectives, and make the business more predictable. Some organization unit then should assume the role of guardian: defining these rules, instructing employees properly, and monitoring conformity. It usually makes sense to assign that role to a centralized unit. For some tasks there is not even a choice: they must be done by law or statute by a central independent unit. Think, for example, of the internal audit or occupational safety functions in general, or the risk management function in banks, as the Basel III regulatory framework stipulates that this function should be “under the direction of a chief risk officer (CRO), with sufficient stature, independence, resources and access to the board.”
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Here is a direct link to the complete article.