Topic 10; Decision Rights (2017)

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Universidad Universidad Pompeu Fabra (UPF)
Grado International Business Economics - 1º curso
Asignatura Business economics
Año del apunte 2017
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Fecha de subida 02/08/2017
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TOPIC 10: DECISION RIGHTS Either you can decide in a centralized way, where the people in "the top" make all the decisions and the people under them hardly have any decisions to make (centralized), or you give decision rights to your employees, without having them to always ask the principal for permission every time (decentralized) LEVELS OF DECISION-MAKING If there is a high level of coordination and centralization, then is hard to change and adapt to consumer needs, because probably he local managers are only responsible of execution, and the more you go up, the more strategic are the responsibilities and the planning.
Through the process of designing the organization, specific jobs are created. Jobs have at least two important dimensions, the variety of tasks that the employee is asked to complete and the decision authority to determine when and how best to complete those tasks.
The problem of partitioning tasks into jobs is extremely complex. It involves the assignment of thousands of tasks and decision rights and simultaneous consideration of other corporate policies such as performance evaluation and compensation policy.
The issue of centralization vs decentralization focuses on which level of firms' hierarchy to place the decision rights. The firm is said to have centralized decision making if the right is assigned to the CEO and decentralized if the right is assigned to lower managers.
THE FUNDAMENTAL TENSION Information relevant for decision making is dispersed and difficult to extract e.g. local tastes, feasibility of R&D program, how to operate complex machine Ideally, those with the relevant information should make the decision. But as we have seen, the combination of preference conflict and incomplete contracting leads to incentive problems. The basic argument is that because delegation facilitates informational rents and worker opportunism, the incremental gain from making use of expert knowledge should equal the incremental costs from loss of control.
People behave opportunistically if you give them power to do so, if you give them power, they will use it to maximize their output to benefit themselves, and this might harm the company.
CENTRALIZATION VS. DECENTRALIZATION Information is transmitted from the periphery to the centre. There are different levels of centralization / decentralization. The centre delegates decision making to the periphery.
The Spain manager has the decision control rights, and the regional managers have the decision management rights. Still, the Spain manager must decide how much leeway to give to the regional manager in setting prices: Should they be set within a narrow or wide band? Should one regional manager set the price for both regions? Should the mangers work as a team and set both regional prices together? BENEFITS OF DECENTRALIZATION Effective use of local knowledge Local managers are likely to have important information about local markets. This information is costly to transfer. If the CEO makes all pricing decision, the firm either incurs information transfer costs or bears he cost of making decisions absent relevant knowledge. Decentralizing decision rights links decision-making authority to local specific knowledge and can reduce the costs of information transfer and processing. More effective use of local information is thus one of the central benefits of decentralization.
Also, granting decision rights to the local manager promotes more rapid decision making and quicker responses to changing market conditions.
Conservation of management time Often, is better to decentralize operating decisions to local managers and focus senior managers' attention on strategic decisions.
Training and Motivation for Local Managers Is important for firms to attract talented employees and to train them as eventual replacements for senior management. Decentralizing decision rights promotes both objectives. Granting responsibility helps attract and retain talented, ambitious local managers who are likely to value this aspect of the job. It also provides experience in decision making that is important for more senior positions. Decentralization increases the operating managers' level of commitment to their projects, also.
COSTS OF DECENTRALIZATION Incentive problems Coordination Duplication of research costs Price competition Local optimum ≠ global optimum Either loss of information from central headquarters, or cost of transmitting it Agency costs in general Incentive problems Decentralizing decision rights marries authority with local specific knowledge. However, local managers do not necessarily have strong incentives to act to maximize a firms' value.
Developing an effective control system to motivate desired actions is not always easy or inexpensive.
Also, there is certain residual loss because generally it doesn't pay to resolve incentive problems completely. Incentive problems usually are larger the further down in the organization decision rights are placed.
The firm cannot use such things as pay-for-performance to solve this incentive problems, because is difficult to identify the effect of individual decisions on the value of the firm.
The firm can use other mechanisms, such as direct monitoring, to reduce incentive problems, but none of this techniques is costless and none will resolve this problems completely.
Coordination costs and failures If the two local managers set prices independently, they might ignore important interaction effects, for example, if one of the stores lowers prices, they might be sealing clients from the other manager, or making both managers conduct the same type of market analysis if their markets are similar.
Less Effective Use of Central information Often, central managers obtain important information from observing the effects of various policies implemented through time and across multiple locations. In contrast, local managers generally have more limited experience and obtain direct information form only one location. Some decisions , also, might be better just taking them once (with centralised decision-making) rather than multiple times.
If an industry conditions are such that rapid decision making involving central information is important, benefits of centralization are even greater. Also, transferring information to local managers might be costly. The value of coordination and central information will be lower if the local units are more independent.
STRUCTURE OF DECISION MAKING What is the right balance of decentralization? Some parts are more centralized than others. A company chooses for each activity.
Separating the one who make the decisions and the ones who operate them is wht most companies do nowadays, they choose specialization of the different jobs. The ratification takes place when the boss decides if the decision made by the employees can or cannot go ahead .
DECISIONS PREVIOUS TO DELEGATING How much do I delegate decisions to my employees? An example of the VW group.
Designs of cars, for example, are really centralized in this company, while production isn't.
Decentralized means more specialization, so then transformation costs go down. This allows the use of scale economies. On the contrary, design cannot use economies of scale.
ARCHITECTURAL DETERMINES: Everything we talked about, they fit together in a big picture, that you can break down into details.
What did we talked about? In business economics 1, we talked about markets and strategy, and firm boundaries → this is external specialization, how much should I do in the company and how much in the market.
In the company, in the headquarters, there is people that decide the architecture of the company, they organize the organizational structure, they are the ones that decide them.
there are three main pillars of the "chair": 1. Decision rights assignments: who has the power, how much power is concentrated in the top and how much is delegated 2. Reward system: how do you reward your people, you have to create a system to reward your employees 3. Performance evaluation system: it depends on your decision rights assignments and the reward system, how you want to analyze your employees All of this is organizational architecture. Firms want to maximize the firm value by finding the optimal organisational architecture. For a competitive advantage over the other firms, is necessary to have profits, is about profitability, return of sales and investments.
Competitive advantage is to compare a firm to the average results of the firms in the market, and this firm we are comparing is better than the average, it all depends on the returns of investments, how profitable am i.
Management Implications: We expect that the net benefits of decentralization will be the highest in rapidly evolving environments. Within unregulated industries where the market changes quickly, the timely use of local knowledge is likely to be particularly important. In more stable environments, companies can use centralized decision making and concentrate in gaining economies of scale.
In a firm offers a broad array of products, it's less likely that senior managers have the specific knowledge to select the most appropriate operating decisions across it's various business. Decentralization frequently will be more important for firms following a strategy in which they develop differentiated products. Such strategy asks for effective information on customer demands and competitor offerings. Often, this information is held by people lower in the organization.
Another element of strategy is the level of vertical integration. We expect as the firm becomes larger, the appropriate level of decentralization will increase. As firms' size increase, more decisions have to be made. Time and mental-processing constraints simply will prevent central management form making all major decisions.
Recent trends Global competition has increased within many industries. This competition has placed pressures on firms to cut costs, produce higher quality products and meet the demands of customers in a more timely fashion. This information is located lower in the organization.
Thus, this competitive pressures have increased the benefits of decentralization.
Technology also has motivated changes in the level of decentralization, because the rate of technological innovation has increased dramatically. Firms must either respond quickly to the resulting changes in the market or lose profit. Also, new technologies have altered the costs information transfer substantially. In some cases , this changes promoted decentralization (e.g. less costly to transfer information), but sometimes, the effect has gone in the opposite direction.: Local information has become less expensive to transfer to global headquarters, favouring a more centralized decision making.
Also, technological advances have allowed many firms to flatten their management structures, suppressing the roles of middle managers.
TASK ASIGNEMENT We focus now on the bundling of tasks.
SPECIALIZED VS. BROAD TASK ASSIGNMENT: Broad task assignment: to have each employee (or group of employees) specialize in one function (selling, service, advertisement…) to a all consumers.
Broad task assignment: to have employees provide all the services to a particular group of consumers.
BENEFITS OF SPECIALIZED TASK ASSIGNMENT: Exploiting Comparative Advantage: Specialized task assignment allows the firm to match people with jobs based on skills and training and because of that it has employees concentrate in their particulate specialities. The principle of comparative advantage suggest that this specialization often will produce higher output than having individuals perform a broad set of tasks.
Lower Cross-Training Expenses: With specialize task assignment, each employee is trained to complete one basic function, while with broad task assignment, employees are trained to compete more than one function, which can be expensive.
COSTS OF SPECIALIZED TASK ASSIGNMENT Forgone Complementarities Across Tasks: Sometimes performing one task can lower the cost of having the same person perform another task. For example, important information about a customer's service requirements might be gained through sales effort.
This information Is less likely to be used if sales and service are conducted b separate people, because it might be costly to transfer this information to other individuals.
Coordination Costs: Activities of specialized employees have to be coordinated, and you might have to appoint a new manager to do that.
Functional Myopia: With specialized task assignment, employees tend to concentrate on their individual function rather than on the overall process of providing good sales and service to customers.
Reduced Flexibility: Failure to cross-train employees has costs as well as benefits. Having only one person trained to do a particular job can place the firm a disadvantage while bargaining with the employee over salary or other benefits. These problems are likely to be greatest at smaller companies.
Incentive Issues: With broad task assignement, the firm is concerned not only with how hard employees work but also how they allocate effort among tasks. Designing an evaluation and compensation scheme that motivates a n appropiate balance of effort is complicated by the fact that the effort exerted on some tasks often is more easily measured than for other tasks. However, this could lead to employees only focusing in the tasks that are rewarded/controlled. One potential solution to this is using specialized task assignment.
In some cases, producing output requires the coordinated execution of several separate tasks that individually are difficult to asses. Here, it can make sense to asing all the tasks to a dingle individual → (broad task assignment) Productive Bundling of Tasks: One variable that is likely to be of particular importance in making decisions is the relative degree of complementarity among tasks within, versus across, functional areas.
Ultimately, the degree of complementarity depends on how specialized knowledge is created and how costly is to transfer it.
BUNDLING OF JOBS INTO SUBUNITS Grouping people together within a subunit lowers the communication and coordination costs among the people within the subunit. Employees are more likely to form closer working relationships if they share the same workplace—especially if they are evaluated and compensated on subunit performance. Managers, however, must devise methods of coordinating activities across the subunit. There's a trade-off between the benefits that come from grouping people together and the costs of coordinating their activities with those performed within other subunits. There are two methods for grouping people into subunits.
GROUPING JOBS BY FUNCTION: CEO SALES SERVICE Department Department One common method of grouping people together is y functional speciality (sales, finances….) → Unitary form (U form) of organization. This places each primary function in one major subunit, rather than in multiple subunits. Senior management plays an important role in defining the architecture, coordinating activities across departments, making key operating decisions and setting strategy. Rules and procedures are established for coordinating the activities across functions.
GROUPING JOBS BY PRODUCT OR GEOGRAPHY This is called the multidivisional form (M form), in which groups are grouped into a collection of business units based on product or geographic area. Operating decisions such as product offerings and pricing are decentralized to business unit level. Senior management of the firm is responsible for major strategic decisions.
CEO SALES SERVICE Department Department TRADE-OFFS BETWEEN FUNCTIONAL AND PRODUCT/GEOGRAPHIC SUBUNITS BENEFIT OF FUNCTIONAL SUBUNITS There are three major benefits: 1. Helps remote effective coordination within the functional area. It also is frequently easier for functional specialists to share information if they work in the same department.
2. This grouping helps promote functional expertise . Individuas focus on developing specific functional skills and are directly supervised by knowledgeable individuals who can assist and support this development.
3. THere is a well-defined promotion path. Employees work up within their functional departments, which reduces employee uncertainty and thus makes less expensive to attrack and retain employees.
Problems with functional subunits: 1. Opportunity cost of using seior management's time coordinating functions and making operating decisions.
2. Significant, time-consuming coordination problems across departments Moreover, important information can be lost in these transfers between departments.
3. Employees sometimes concentrate on their functional specialities rather than in the rocess f satisfying customers.
Benefits of Product/Geographic areasHere, decisions rights are assigned to individuals lower in he organization, here relevant specific knowledge is locates. E: G: information required for the effective coordinating of functions might depend on local information that would be expensive to transfer to senior management. Decentralizing these decisions to the local managers of a geographic subunit helps ensure that this local informantio nwill be used more effectively. Managers of business units are compensated based of the performance of their teams; which provides and incentive to use this information properly.
It also frees senior management, to concentrate in other strategic issues, and lets them focus on the overall performance of their corporation.
Problems with Produc or Geographic Subunits Business-unit managers tend to focus on the performance of their own unit. This is consisten with the maximization of the firm's value as long as product demands and costs are independent across business units. In this case firm value is simply the sum of the values of the subunits. Frequently, there are important interdependencies among subunits that must be taken into account for a firm value to be maximized.
This problem might be mitigated by forming groups of interrelated business units ansd basing a component of unit managers' compensation on the overall group performance.