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11.3: Describe How Decision-Making Differs between Centralized and Decentralized Environments

  • Page ID
    12026
  • Businesses are organized with the intention of creating efficiency and effectiveness in achieving organizational goals. To aid in this, larger businesses use segments, uniquely identifiable components of the business. A company often creates them because of the specific activities undertaken within a particular portion of the business.1 Segments are often categorized within the organization based on the services provided (i.e., departments), products produced, or even by geographic region. The purpose of identifying distinguishable segments within an organization is to provide efficiency in decision-making and effectiveness in operational performance.

    Organizational Charts

    Many organizations use an organizational chart to graphically represent the authority for decision-making and oversight. Organizational charts are similar in appearance to flowcharts. An organizational chart for a centralized organization is shown in Figure \(\PageIndex{1}\). The middle tier represents position held by individuals or departments within the company. The lowest tier represents geographic locations in which the company operates. The lines connecting the boxes indicate the relationship among the segments and branch from the ultimate and decision-making authority. Organizational charts are typically arranged with the highest-ranking person (or group) listed at the top.

    A centralized organizational chart showing four departments reporting to the President: Sales and Marketing, Operations, Manufacturing, and Finance. Three locations report to the President: Northeast Region, Southwest Region, and Midwest Region.
    Figure \(\PageIndex{1}\): An Organizational Chart for a Centralized Organization. Centralized organizations have units that report directly to one person. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

    Notice the organization depicted in Figure \(\PageIndex{1}\) has segments based on departments as well as geographic regions. In addition, all lines connect directly to the president of the organization. This indicates that the president is responsible for the oversight and decision-making for the production and sales departments as well as the district (Northeast, Southwest, and Midwest) managers; essentially, the president has seven direct reports. In this centralized organizational structure, all decision-making responsibility resides with the president.

    Figure \(\PageIndex{2}\) shows the same organization structured as a decentralized organization.

    A decentralized organizational chart showing five divisions reporting to the President: Operations, Northeast Region, Southwest Region, Midwest Region, and Finance. Each of the regions have two divisions that report to them: Sales and Marketing, and Manufacturing.
    Figure \(\PageIndex{2}\): An Organizational Chart for a Decentralized Organization. Decentralized organizations have units that report through intermediate management layers. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

    Notice that the organization depicted in Figure \(\PageIndex{2}\) has the same segments, which represent departments and geographic regions. There are, however, noticeable differences between the centralized and decentralized structure. Instead of seven direct reports, the president now oversees five direct reports, three of which are based on geography—the Western, Southern, and Eastern regional managers. Notice, too, each regional district manager is responsible for their respective production and sales departments. In this decentralized organization, all decision-making responsibility does not reside with the president; regional decisions are delegated to the three regional managers. Understand, however, that responsibility for achieving the organization’s goals still ultimately resides with the company president.

    In a centralized environment, the major decisions are made at the top by the CEO and then are carried out by everyone below the CEO. In a decentralized environment, the CEO sets the tone for the running of the organization and provides some decision-making guidelines, but the actual decisions for the day-to-day operations are made by the managers at the various levels of the organization. In other words, the essential difference between centralized and decentralized organizations involves decision-making. While no organization can be \(100\%\) centralized or \(100\%\) decentralized, organizations generally have a well-established structure that outlines the decision-making authority within the organization.

    CONTINUING APPLICATION: Centralized vs. Decentralized Management

    Gearhead Outfitters was founded by Ted Herget in 1997 in a friend’s living room in Jonesboro, AR. By 2003, the business moved to its downtown location. In 2006, a second Jonesboro location was opened. Over the next several years, the company’s growth allowed for expansion to several different cities, miles and hours away. Eventually Little Rock, AR, Fayetteville, AR, Shreveport, LA, Springfield, MO, and Tulsa, OK became home to Gearhead branches.

    With such growth, the company faced many management challenges. Would it be best for management to remain centralized with decision-making coming from a single location, or should the process be decentralized, allowing local management the flexibility and autonomy to run individual locations? If local management is given autonomy to make their own decisions, will those decisions be in line with company, or perhaps, individual goals? How will management be evaluated? Will inventory management be a uniform process, or will people and the process have to adapt to accommodate differences in demand at each location?

    These are just some of the hurdles that Gearhead needed to address. What are some other issues which Gearheadmight have considered? Think in terms of inventory management, personnel, efficiencies, and leadership development. How could Gearhead have use decentralized management to grow and thrive? Conversely, what would the benefits of keeping all or some of the company’s management decisions more centralized be?

    How Does Decision-Making Differ in a Centralized versus a Decentralized Environment?

    The CEO of a centralized organization will determine the direction of the company and determine how to get the company to its goals. The steps necessary to reach these goals are then passed along to the lower-level managers who carry out these steps and report back to the CEO. The CEO would then evaluate the results and incorporate any necessary operational changes. On the other hand, the CEO of a decentralized organization will determine the goals of the company and either pass along the goals to the divisional managers for them to determine how to reach these goals or work with the managers to determine the strategic plans and how to meet the goals laid out by those plans. The divisional managers will then meet with the managers below them to determine the best way to reach these goals. The lower-level managers are responsible for carrying out the plan and reporting their results to the manager above them. The higher-level managers will combine the results of several managers and evaluate those results before sending them to the divisional manager.

    THINK IT THROUGH: Determining the Best Structure

    Here are some examples of decisions that every business must make:

    • Facility and equipment purchases and upgrades
    • Personnel decisions such as hiring and compensation
    • Products and services to offer, prices to charge customers, markets in which to operate

    For each decision listed, identify and explain the best structure (centralized, decentralized, or both) for each of the following types of businesses:

    • Auto manufacturer with multiple production departments
    • Florist shop (with three part-time employees) owned by a local couple
    • Law firm with four attorneys

    Footnotes

    1. In Building Blocks of Managerial Accounting, you learned that generally accepted accounting principles (GAAP)—also called accounting standards—provide official guidance to the accounting profession. Under the oversight of the Securities and Exchange Commission (SEC), GAAP are created by the Financial Accounting Standards Board (FASB). The official definition of segments as provided by FASB can be reviewed in ASC 280-10-50.