ORGANIZATIONAL ARCHITECTURE ELEVENTH LECTURE April 17, 2012 William R. Eadington, Ph.D. Professor of Economics, College of Business Director, Institute for the Study of Gambling and Commercial Gaming University of Nevada, Reno

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 = B  D Costs of decentralization =(A  D)+(C  D 2 ) Where A  D represents contracting costs C  D 2 represents coordination/information costs

DETERMINING THE LEVEL OF DECENTRALIZATION Objective: maximize net benefits NB=BD-AD-CD 2 which occurs when D*=(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 Total costs and benefits (in dollars) $ 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 EMPOWERMENT Assigning 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 Jobs Many Few Narrow Decision authority Broad Variety of tasks

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 Product OrganizationGeographic 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