MECO 6303

ALLOCATING DECISION RIGHTS: EMPOWERMENT

Automation Consulting Services
March 6, 2010

This is one of five cases you may write up;

you’re required to write up any two of them

Case Objectives

The principal objectives of the case are to examine:

♦ what factors affect the optimal allocation of decision rights within an organization
♦ how to maintain management control of a decentralized organization without destroying
its entrepreneurial culture.

Discussion Questions

1. How should the ACS founders deal with the problems they have identified at each of
the four offices? Be as specific as possible in making recommendations for each site.
a. San Jose. Is cross-subsidizing really a problem? Should Crowley and Ross be
disciplined? Should Powerhouse be reimbursed? What type of controls
should be imposed?
b. Detroit. Why did the partners reject the client prospecting system in 1997?
Why can’t the firm rely strictly on incentives to ensure that local partners act
on the best interest of the firm? What type of control system—if any—would
you recommend?
c. Boston. Should Shapiro have been allowed to bid? What type of controls
would you recommend? Should the strategy-setting process be top-town or
consensus driven?
d. Philadelphia. What are the strengths and weaknesses of the current incentive
structure? How should expense data be handled? What are the pros and cons
of converting to profit centers?

2. What firm-wide actions, changes or controls would you implement?

Reading Assignment

Designing Organizations to Create Value, Chapter 4,

Case: Automation Consulting Services

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Control Systems

In thinking through your answer, keep in mind that there are four basic types of control
systems—two positive and two negative:

1. Belief Systems
Explicit set of shared beliefs that define basic values, purpose and direction, including (1)
how value is created; (2) the level of desired performance; and (3) human relationships.
Belief systems are created to provide momentum and guidance to opportunity-seeking
behaviors. Belief systems are embodied in an organization’s vision statements, mission
statements, credos and statements of purpose.

2. Boundary Systems
Formally stated limits and rules which must be respected. These systems allow individual
creativity within defined limits of freedom. Boundary systems are implemented through clear
rules, limits and prescriptions in codes of business conduct, strategic planning systems and
asset acquisition systems.

3. Diagnostic Control Systems

Feedback systems used to monitor organizational outcomes and correct deviations from
preset standards of performance. Common diagnostic control systems include profit plans
and budgets, explicit goals and objectives, project monitoring systems, and strategic planning
systems. These systems generally (1) allow effective resource allocation; (2) define goals; (3)
provide motivation; (4) establish guidelines for corrective action; (5) allow ex post
evaluation; and (6) free-up top management attention

4. Interactive Control Systems

Control systems that managers use to regularly and personally involve themselves in the
decision activities of subordinates. Examples of systems that can be used interactively
include profit planning systems and project management systems. Managers make a
diagnostic system interactive by:
1. ensuring that data generated by the systems is an important and recurring agenda to
discuss with subordinates;
2. ensuring the system is a focus of regular attention by operating managers throughout
the system;
3. participating in face-to-face meetings with subordinates; and
4. continually challenging and debating data, assumptions and action plans.

The purpose of making a control system interactive is to focus organizational attention on

strategic uncertainties and thereby provoke the emergence of new initiatives and strategies.

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 Background Notes
Allocating Decision Rights: Empowerment

Decision Rights

Jobs have two important dimensions:

♦ degree of decision authority
♦ variety of tasks

Each dimension should be analyzed independently. These notes focus on degree of decision
authority, or the issue of centralization vs. decentralization. Next week, we’ll look at variety
of tasks, or specialized vs. broad task assignment.

Decision Authority

Central (executive) managers have: Local (on-site) managers have:

♦ more experience ♦ less experience
♦ broader sources of information ♦ narrower sources of information
♦ less specific knowledge ♦ more specific knowledge

If industry conditions are such that strategic decision making is needed, or coordination of
activities within the firm is important, then greater centralization is preferred.

On the other hand, in a rapidly changing environment, or where responsiveness to local

conditions is important, decentralization should be the choice. Also, it should be intuitively
clear that the principal role of central management in a decentralized system is to promote the
flow of information and coordination among the decision makers.

Centralization vs. Decentralization

There are three important questions to ask in determining the appropriate degree of
decentralization:
♦ What are the costs and benefits of centralization vs. decentralization.
♦ What factors might cause the optimal allocation to change over time
♦ How does the choice affect decision management and control

Many times, the choice of whether to centralize or decentralize is made on the basis of the
personal characteristics/qualifications of a specific employee or group of employees. That’s a
bad basis on which to make a decision.

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 Costs and Benefits of Decentralization

Benefits of decentralization are:

♦ makes more effective use of local specific knowledge. Granting decision rights to local
managers links decision-making authority with local specific knowledge. This promotes
more rapid decision making and quicker response times (or at least it should).
♦ reduces information transfer costs
♦ promotes the training and development of younger managers by providing them with
decision-making experience. This tends to attract more talented people who aspire to
advance in the organization

Costs of decentralization are:

♦ reduces effective use of central information and experience. Local managers generally
have more limited experience.
♦ makes internal coordination more difficult.
♦ increases agency costs the further from executive management the decision rights are
placed

Agency Relationship

An agency relationship consists of an agreement under which one party, the principal,
engages another party, the agent, to perform some service on the principal’s behalf, e.g.
♦ shareholders engage boards
♦ boards engage executive management
♦ executive management engages lower level management.
♦ managers engage employees

This type of “chain of command” decentralization creates economic costs, called agency
costs.

Agency Costs

Agency costs arise because agents have incentives to take actions that increase their well-
being at the expense of the principals. They occur in any type of cooperative undertaking.
And they grow worse the farther down in the organization decision rights are pushed.

The two methods available to the principal to limit agency costs are:
♦ direct monitoring
♦ incentive compensation

The dollar cost of either/both of these actions constitute agency costs.

If you decide to push decision-making further down in your department or organization,

you’ll have to deal with increased agency costs, i.e., change the performance measurement
and reward system.

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 Factors Affecting Optimal Allocation of Decision Rights

♦ Pace of environmental change. The general trend over past decade has been toward
greater decentralization as global competition and deregulation have dramatically increased
the need to improve quality, customer service and efficiency. Information necessary to do
this is often located lower in the organization
♦ Degree of product diversification. As the firm becomes more diversified across many
product markets, people lower in the organization have better knowledge of customer
demands and competitor offerings. Alternatively, as firms strip back to core competencies
and reduce their product offerings, the impetus is toward greater centralization.
♦ Costs of information transfer. New technologies have reduced the cost of information
transfer from headquarters to field (reducing the need for middle managers). However, it can
also reduce the cost from field to headquarters, leading to greater centralization (WalMart).
♦ Need for coordination or strategic re-direction. An extreme example is a turnaround or
workout situation.
♦ Level of industry regulation. The greater the degree of regulation, the greater is the need
for centralized knowledge.

The question is not always centralizing or decentralizing decision authority to individuals.

Often the choice is whether they should be assigned to individuals or to teams.

Assigning Decision Rights to Teams vs. Individuals

There are costs and benefits to assigning decision rights to teams:

Benefits include:
♦ improved use of dispersed specific knowledge/information
♦ improved employee buy-in

Costs include:
♦ collective action problems (group subject to manipulation, and agency problems if large
enough).
♦ free-rider problem.

Sometimes decision rights are assigned neither to individuals nor teams, but rather by
bureaucratic rules.

Assigning Decision Rights by Bureaucratic Rules

Influence (lobbying) costs can be a major cost when decision making authority is
decentralized. Firms can use bureaucratic rules to purposefully limit these costs. They tend
to do so when firm profits are largely unaffected by decisions which greatly impact employee
welfare, i.e., the marginal cost of the decision (influence costs) is high relative to the
marginal benefit (impact on firm profits). An example is allocating routes to flight attendants
based on seniority.

Decision Management and Control

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 The decision making process can be divided into four distinct steps:
♦ initiation of a proposal or plan of action
♦ ratification of the decision initiative to be implemented
♦ implementation of the ratified decision
♦ monitoring of subsequent performance

The first and third are decision management. The second and fourth are decision control.
Decision management and decision control should never be assigned to the same individual or
group of employees. Decision management should be assigned to one group, and decision
control to another.

They should always be separated except in those cases where the decision maker also tends to
be a major residual claimant (owner) and bears the wealth effect of his actions. Absent this
condition, granting both management and control rights to the same individual/team can lead
to serious agency problems.

Don’t confuse empowerment (decentralization) with decision control. Empowerment should

not mean that an employee has all rights to a particular decision. An empowered employee
might have explicit rights to initiate and implement; but he should not also have the right to
ratify and monitor. This is a very important point. (Think about what caused the rampant
financial fraud at so many former high-flyers over the past few years).