All businesses start with an idea. After putting the idea into action and forming the business, measuring the performance of the business is a crucial next step for the business owners. As the business begins operations, it is fairly easy for the entrepreneur to measure the performance because the owner is heavily involved in the daily activities and decisions of the business. As the business grows through increased sales volume, additional products and locations, and more employees, however, it becomes more complicated to measure the performance of the organization. Owners and managers must design organizational systems that allow for operational efficiency, performance measurement, and the achievement of organizational goals.
In this chapter, you will learn the difference between centralized and decentralized management and how that relates to decision-making. You will learn about responsibility accounting and the type of decision-making authority that may be granted through different responsibility centers. Finally, you will learn how certain types of decisions have differing effects, depending on the type of responsibility center.
Management Control System
It is important for those studying business (and accounting, in particular) to understand the concept of a management control system. A management control system is a structure within an organization that allows managers to establish, implement, and monitor progress toward the strategic goals of the organization.
Establishing strategic goals within any organization is important. Strategic goals relate to all facets of the business, including which markets to operate in, what products and services to offer to customers, and how to recruit and retain a talented workforce. It is the responsibility of the organization’s management to establish strategic goals and to ensure that all activities of the business help meet goals.
Once an organization establishes its strategic goals, it must implement them. Implementing the strategic goals of the organization requires communication and providing plans that guide the work of those in the organization.
The final factor in creating a management control system is to design mechanisms to monitor the activities of the organization to assess how well they are meeting the strategic goals. This aspect of the management control system includes the accounting system (both financial and managerial). Monitoring the performance of the organization allows management to repeat the activities that lead to good performance and to adjust activities that are not supporting the strategic goals. In addition, monitoring the activities of the organization provides feedback to management as to whether adjustments to the organization’s strategy are necessary.
Establishing a management control system is very important to an organization. Organizations must continually evaluate ways to improve and remain competitive in an ever-changing market. This requires the organization to be both forward-looking (via strategic planning) and backward-looking (by evaluating what has occurred), constantly monitoring performance and making necessary adjustments.
Centralization is a business structure in which one individual makes the important decisions (such as resource allocation) and provides the primary strategic direction for the company. Most small businesses are centralized in that the owner makes all decisions regarding products, services, strategic direction, and most other significant areas. However, a business does not have to be small to be centralized. Apple is an example of a business with a centralized management structure. Within Apple, much of the decision-making responsibility lies with the Chief Executive Officer (CEO) Tim Cook, who assumed the leadership role within Apple following the death of Steve Jobs. Apple has long been viewed as an organization that maintains a high level of centralized control over the company’s strategic initiatives such as new product development, markets to operate in, and company acquisitions. Many businesses in rapidly changing technological environments have a centralized form of management structure. The decisions made by the lower level management are limited in a centralized environment.
The advantages of centralized organizations include clarity in decision-making, streamlined implementation of policies and initiatives, and control over the strategic direction of the organization. The primary disadvantages of centralized organizations can include limited opportunities for employees to provide feedback and a higher risk of inflexibility.
Decentralization is a business structure in which the decision-making is made at various levels of the organization. Typically, decentralized businesses are divided into smaller segments or groups in order to make it easier to measure the performance of the company and the individuals within each of the sub-groups.
Advantages of Decentralized Management
Many businesses operate in markets and industries that are highly competitive. In order to be successful, a company must work hard to develop strategic competitive advantages that distinguish the company from its peers. To accomplish this, the organizational structure must allow the organization to quickly adapt and take advantage of opportunities. Therefore, many organizations adopt a decentralized management structure in order to maintain a competitive advantage.
There are numerous advantages of a decentralized management, such as:
- Quick decision and response times—it is important for decisions to be made and implemented in a timely manner. In order to remain competitive, it is important for organizations to take advantage of opportunities that fit within the organization’s strategy.
- Better ability to expand company—it is important for organizations to constantly explore new opportunities to provide goods and services to its customers.
- Skilled and/or specialized management—organizations must invest in developing highly skilled employees who are able to make sound decisions that help the organization achieve its goals.
- Increased morale of employees—the success of an organization depends on its ability to obtain, develop, and retain highly motivated employees. Empowering employees to make decisions is one way to help increase employee morale.
- Link between compensation and responsibility—promotional opportunities are often linked with a corresponding increase in compensation. In a decentralized organization, a compensation increase often corresponds to a commensurate increase in the responsibilities associated with learning new skills, increased decision-making authority, and supervision of other employees.
- Better use of lower and middle management—many tasks must be performed in order to achieve success in an organization. Decentralized organizations often rely on lower and middle management to perform many of these tasks. This allows managers to gain valuable experience and expertise in different areas.
Disadvantages of Decentralized Management
While a decentralized organizational structure can be an advantage for many organizations, there are also disadvantages to this type of structure, including:
- Coordination problems—it is important for an organization to be working toward a common goal. Because decision-making is delegated in a decentralized organization, it is often difficult to ensure that all segments of the company are working in a consistent manner to achieve the strategic goals of the organization.
- Increased administrative costs due to duplication of efforts—because similar decisions need to be made and activities undertaken across all divisions of an organization, decentralized organizations are susceptible to duplicating efforts, which results in inefficiency and increased costs.
- Incongruity in operations—when autonomy is dispersed throughout the organization, as is the case in decentralized organizations, division managers may be tempted to customize/alter the operations of the division in an effort to maximize efficiency and suit the best interest of the division. In this structure, it is important to ensure the shortcuts taken by one division of the organization do not conflict with or disrupt the operations of another division within the organization.
- Each department/division is often self-centered (its own fiefdom)—it is not uncommon for separate divisions within an organization to be measured on the performance of the division rather than of the entire company. In a decentralized organization, it is possible for division managers to prioritize divisional goal over organizational goals. Leaders of decentralized organizations should ensure the organization’s goals remain the priority for all divisions to attain.
- Significant, if not almost total, reliance on the divisional or department managers—because divisions within decentralized organizations have a high level of autonomy, the division may become operationally isolated from other divisions within the organization, focusing solely on the priorities of the division. If divisional or departmental managers do not have a wide breadth of experience or skills, the division may be at a disadvantage due to limited access to other expertise.
Daily and Strategic Decision-Making
An underlying assumption is that businesses possess a single structure (either centralized or decentralized) at any given point. That is not necessarily the case. For example, businesses often add employees who specialize in the various needs of the organization. Over the life of an organization, it is not uncommon for businesses to demonstrate aspects of both centralization and decentralization.
New businesses, for example, are often centralized. When a business first opens, it is common for the owner(s) to be highly involved in the day-to-day operations. In addition, the small size of a new business allows the owner to have a high level of involvement in both the daily and the strategic decisions of the business. Daily decisions are ongoing, immediate decisions that must be made in order to effectively and efficiently meet the needs of the organization’s customers. Strategic decisions, on the other hand, are made fairly infrequently and involve long-term goals of the organization. Being actively involved in the business allows new business owners to gain experience in all aspects of the business so that they can get a sense of the patterns of the daily operations and the decisions that need to be made. For example, the owner can be involved in determining the number of workers needed to meet the day’s production goal. Having too many workers would be inefficient and require the company to incur unnecessary expenses. Having too few workers, on the other hand, may result in inferior quality of products, missed shipments, or lost sales.
Additionally, an owner involved in daily operations has the opportunity to evaluate and, if necessary, alter any strategic goals that may impact the daily operations. Strategic goals relate to all facets of the business, including in which markets to operate, what products and services to offer to customers, how to recruit and retain a talented workforce, and many other aspects of the business.
If an owner is involved in daily operations, an example of a potential strategic goal could be that he or she can determine whether to pursue a cost leadership perspective. When pursuing a cost leadership perspective, companies undertake activities to eliminate costs in order to produce a product or provide a service that has a cost advantage compared to competing products or services. While providing a high-quality goods or service is important to a company pursuing a cost leadership perspective, the competitive advantage of the company is eliminating wasteful activities that add unnecessary costs, entering into strategic partnerships with suppliers and other companies, and focusing on activities that allow the organization to offer the good or service at a lower price than its competitors. Being highly involved in both the daily and strategic decisions can be very beneficial as the business is established, but it is demanding on the business owner and, without adjustments, often cannot be sustained.
As the business grows, management of a centralized organization faces a choice. Remaining highly involved in the daily decisions of the business results in a low level of involvement in the strategic decisions of the organization. While this may be effective in the short-term, the risks associated with not establishing and adjusting long-term strategic goals increase. On the other hand, remaining highly involved in the strategic decisions of the business results in a low level of involvement in the daily decisions of the business. This, too, is risky because ineffectively managing daily business decisions may have long-term, negative consequences.
ETHICAL CONSIDERATIONS: Ethically Directed Strategic Management
Managers in some organizations follow legal and regulatory requirements to operate their business at the lowest level of acceptable behavior in their business environment in order to keep costs low; however, some stakeholders may expect more than the minimum level of ethics. Stakeholders of business organizations are now insisting on higher ethical standards from their organizations. Stakeholders are any group or individual who may be affected by the organization’s business decisions. Organizations providing high-quality goods and services need to consider all of their stakeholders when developing a strategic decision-making process to direct the organization’s strategic decisions.
- Chris Argyris “Double Loop Learning in Organizations.” Harvard Business Review 55, no. 5 (1977): 115–116.
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