Managerial Economics and Organizational Architecture, 5e Managerial Economics and Organizational Architecture, 5e Chapter 12: Decision Rights: The Level of Empowerment Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved. McGraw-Hill/Irwin

Managerial Economics and Organizational Architecture, 5e Assigning Tasks and Decision Rights Production process involves tasks bundled into jobs Job dimensions –variety of tasks few or many –decision authority limited or broad 12-2

Managerial Economics and Organizational Architecture, 5e Dimensions of Job Design Many Few Narrow Decision authority Broad Variety of tasks

Managerial Economics and Organizational Architecture, 5e Centralization vs Decentralization Determines which level of the firms’ hierarchy to place the decision right 12-4

Managerial Economics and Organizational Architecture, 5e Benefits of Decentralization Effective use of local knowledge –local tastes and preferences –price sensitivities of particular customers Conservation of management time –senior management focus on strategy Training and motivation for local managers 12-5

Managerial Economics and Organizational Architecture, 5e 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 12-6

Managerial Economics and Organizational Architecture, 5e AutoMart Example AutoMart sells autos in two cities Hierarchy includes CEO and two local managers Which decisions are retained by CEO (centralization) and which are delegated to local managers (decentralization)? 12-7

Managerial Economics and Organizational Architecture, 5e Determining Level of Decentralization D is the degree of decentralization B is a positive constant Benefits of decentralization = B  D Costs of decentralization =(A  D)+(C  D 2 ) Where AD represents contracting costs CD represents coordination/information costs 12-8

Managerial Economics and Organizational Architecture, 5e Determining the Level of Decentralization Objective: maximize net benefits NB=BD-AD-CD 2 which occurs when D*=(B-A)/2C (which required a bit of calculus) 12-9

Managerial Economics and Organizational Architecture, 5e Determining the Level of Decentralization Decentralization D* D Total costs and benefits (in dollars) $ Costs Benefits 12-10

Managerial Economics and Organizational Architecture, 5e 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 12-11

Managerial Economics and Organizational Architecture, 5e Management Implications The net benefits of decentralization will be highest in rapidly changing environments Benefits of decentralization increases as a firm enters more markets with a broader array of products –Information become more important Vertical integration increases the net benefits of decentralization 12-12

Managerial Economics and Organizational Architecture, 5e 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 12-13

Managerial Economics and Organizational Architecture, 5e 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 12-14

Managerial Economics and Organizational Architecture, 5e 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 12-15

Managerial Economics and Organizational Architecture, 5e Decision Management and Control Four steps occur: Initiation –Generation of proposals for resources utilization and structuring of contracts Ratification –Choice of decision initiatives to be implemented Implementation Monitoring 12-16

Managerial Economics and Organizational Architecture, 5e Decision Management and Control The ideas above explain why boards of directors have the ability to ratify decisions made by CEOs Boards also have monitoring authority Monitoring authority is also held by large shareholders Explains the use of hierarchies 12-17

Managerial Economics and Organizational Architecture, 5e Decision Rights and Knowledge Creation Decentralization gives employees incentives to experiment and innovate Successful experiments must be: –identified –reasons for their success understood –codified –implemented by others in the firm 12-18

Managerial Economics and Organizational Architecture, 5e Influence Costs Employees have incentives to influence managerial decisions Influence activities may entail costs time away from the job dysfunctional activities 12-19

Managerial Economics and Organizational Architecture, 5e Influence Costs 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 likely 12-20