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What works best? A centralized, hierarchical organization or one where authority is delegated?

Amit Choudhary
May 6, 2020

Startups and incumbent organizations, small- and middle-sized enterprises, as well as industry giants all face decisions when it comes to structuring internal processes and systems. To meet customers’ ever-increasing expectations and requirements for convenience, speed, and security, today’s firms must flexibly switch gears to make product or service modifications as end-user needs pivot.

Agility and resilience are especially critical for businesses in emerging markets that seek the coveted first-mover advantage. A firm’s communication and knowledge structure can influence inventiveness and the potential for individual staff members to innovate and implement their ideas.

However, executives must also consider competitive pricing, which requires optimal productivity and substantial standardization.

The dilemma? Support an optimally decentralized operation that enables customization as per local needs, or focus on centralization and process optimization to minimize cost and effort?

In this installment of my Leadership Yin-Yang blog series, I explore these contrasting approaches.

Why centralization?

A hierarchical organization concentrates authority exclusively with one person or leadership team, so that vertical top-down communication flow allows for uniformity of action. Small businesses in which the owner manages the firm, often adopt this centralized approach. In larger centralized organizations, specific executives are held accountable for particular outcomes. To shore up interdepartmental control, a standard set of rules and procedures is applied that ensure uniform goals and objectives. Centralization can help in:

  • Safeguarding company-wide consistency by the standardization of rules and processes
  • Improving work quality as standardized procedures and better supervision will help the supervisors ensure that the output generated is uniform as well of high quality
  • Removing any ambiguity in terms of authority and delegation due to the presence of a clear chain of command, helping execute decisions in a unified manner
  • Reducing costs, if eliminating duplication of responsibilities and efforts is done well and economies of scale are leveraged well.
When things go rightSamsung’s highly centralized organizational structure allows it to make central decisions such as termination of weak products quickly and focus on a streamlined portfolio. Samsung proved this when it issued mass recall and then termination of Galaxy Note 7. Though centralizing decision making often overburdens senior managers and slows down new product decisions, it certainly quickens decisive actions in other areas. Engineers and lower level managers are usually too invested in the products and don’t have visibility across the entire portfolio, making it harder for them to make this already difficult choice.
When things go wrongOver the course of 25 years, Kraft Foods bought (and ultimately sold) Oscar Mayer, Nabisco, and Jacobs Suchard in Europe. Kraft used to have a highly centralized structure that kept all the business units it had acquired under central control. Group companies became increasingly disempowered and disenfranchised. Earnings declined, and the company stopped responding to changes in the environment quickly enough. As a result, Kraft had to pivot to a more decentralized structure, which showed improvements.

Why decentralization?

A decentralized organization allocates decision-making power across various levels of management.

Throughout the business, a team environment is encouraged. Communication flows freely and often spurs a broad range of input that generates more solutions and ideas. In contrast to remote bureaucratic leadership control, a decentralized structure helps in:

  • Meeting custom demands, especially local requirements, by ensuring a level of flexibility in the organization
  • Developing a sense of ownership and loyalty among employees as they are motivated and free to take initiative
  • Eliminating slow decision making for new ideas and initiatives by reducing the number of approvals or signoffs required and thereby improving agility
  • A decentralized organizational structure gives more independence to act and decide, and this independence promotes innovation within the organization.
A success storyIn its previous structure, Toyota operated within a strong centralized global hierarchy similar to a spoke-and-wheel configuration. Executives from the automaker’s Japan headquarters made all significant decisions. Business units did not collaborate, and headquarters directed all communication. Widely criticized, the cumbersome organizational structure took the blame for Toyota’s slow response to safety issues. Reorganized in 2013, Toyota became more decentralized and divisional, which bolstered its global presence, allowed it to respond to issues quickly, and to deliver higher quality products.
Not all fun and gamesMedium, an online publishing platform recently tried experimenting with Holacracy, a decentralized management and organizational governance that confers decision power on “circles,” and roles rather than teams and units. The structure caused large-scale efforts to become time-consuming and highly divisive. Ultimately the company dropped the philosophy.

How to decide which approach to take?

There is no one-size-fits-all answer. Instead of being two mutually exclusive options, it is more of a spectrum, and each company faces the dilemma where to place themselves in this scale to perform to the peak of its abilities and succeed. In fact, this decision needs to be made for each element/ process of a company as opposed to the overall company. Within the same company, there can be and most often should be a coexistence of centralized and decentralized processes. This decision can also change for a partilcuar process based on how the context, objectives, and maturity of that process evolve over a period of time.

Many factors merit consideration when evaluating whether a process should be centralized or decentralized. But for the sake of simplicity, let us take the criticality or importance of the process and the strategic goal of the firm.

Process criticality is measured by its impact on the overall quality of the firm’s end product or service. A strategic goal outlines whether the firm aims to provide a rapid and customized response or seeks to standardize and optimize its processes to achieve optimal efficiency. The amount of centralization in the organization’s decision making must depend on the goals it is trying to achieve as well as the importance or criticality of the process under consideration.

Organizations try to achieve high responsiveness because customers are usually willing to pay a premium for that. If that premium outweighs the cost of inefficiencies, then the organization should go for a decentralized structure.

On the other hand, when an organization looks for reliability, efficiency, and long-term applicability, it should opt for a centralized decision-making structure.

The decision to centralize or decentralize the organization is a crucial one that impacts organizational creativity, operational efficiency, and communication. In an increasingly fast-paced business environment, a careful balance of centralization and decentralization based on the organization’s specific needs in various areas can help firms operate efficiently without losing their competitive edge.

To learn more, feel free to get in touch with me on social media.

The author would like to thank Aniket Mahato, Ashish Jaiswal, and Tamara Berry for their contributions to this article.