Divisional Structure of Organization

What is a Divisional (Multidivisional) Structure?

The divisional structure consists of a corporate office and operating divisions, each operating division representing a separate business or profit center. Each division represents a distinct, self-contained business with its own functional hierarchy.

The divisional structure starts with the corporation grows and diversifies its product lines in numerous industries. In this type of structure, employees are divided into departments based on product/service areas or geographic regions.

Thus, the divisional structure introduces a new level in the management hierarchy, the corporate level.

The organization now moves to a divisional structure with a central headquarters and decentralized operating divisions. This results in the decentralization of decision-making authority.

In a divisional structure, an office of corporate headquarters staff is created to monitor divisional activities and exercise financial control over each of the divisions. This staff contains corporate managers who delegate and oversee the day-to-day operations and business-unit strategy of divisional and functional managers. Thus, the design constitutes an additional level of the organizational structure, and hence, increases the level of vertical differentiation.

Functional structures tend to be fairly slow to change. Thus, as organizations start to offer a wider variety of products and services, this structure constraints firms from being timely responsive to customer’s needs. As a result, many firms have to abandon the use of a functional structure as their offerings expand. Some form of divisional structure generally now becomes necessary to motivate employees, control operations, and compete successfully in diverse geographic areas, with different products and services.

With a divisional structure, functional activities are performed both centrally and in each separate division.

This form of organizational structure is used to support the implementation of related and unrelated diversification strategies. The divisional structure can be viewed as an innovative response to coordination and control problems that surfaced in the functional structures.

Divisional–Corporate Authority Relationship

In a divisional structure, the authority relationship between corporate headquarters and the divisions must be correctly established.

The problem for corporate managers is to decide how much authority and control to assign to the operating divisions and how much authority to retain at corporate headquarters.

When corporate managers retained too much power and authority, the managers of operating divisions lacked sufficient autonomy to develop the business strategy that might best meet the needs of the division.

On the other hand, when too much authority is delegated to divisions, managers may start to pursue strategies that benefit their own divisional objectives but add little value to the corporation as a whole.

Thus, this balance of authority must be decided by each company, taking into account the nature of its business- and corporate-level strategies. As the environment changes or a company alters its strategies over time, the optimal balance between centralization and decentralization of authority will also change.

4 Types of Divisional Structure

The divisional structure can be organized in one of four ways. They are by (1) geographic area, (2) product or service, (3) customer, or (4) process.

Divisional Type 1: Geographic Structure

When a company is organized geographically, geographic regions become the basis for the grouping of organizational activities. A divisional structure by geographic area is appropriate for organizations whose strategies need to be tailored to fit the particular needs and characteristics of customers in different geographic areas.

For example, a company may divide up its manufacturing operations and establish manufacturing plants in different regions of the country. Similarly, service organizations such as store chains and banks may organize their sales and marketing activities on a regional, rather than national, level to get closer to their customers.

This type of structure can be most appropriate for organizations that have similar branch facilities located in widely dispersed areas. A divisional structure by geographic area allows local participation in decision-making and improved coordination within a region.

A geographic structure provides more control than a functional structure because there are several regional hierarchies carrying out the work previously performed by a single centralized hierarchy. At the same time, because the purchasing function remains centralized, one central organization can buy for all regions. Thus, a company both achieves economies of scale in buying and distribution and reduces coordination and communication problems.

However, the usefulness of a geographic structure depends on the size of the company and its range of products and regions. If a company starts to diversify into unrelated products or to integrate vertically into new industries, the product structure will not be capable of handling the increased diversity. The reason is that it does not allow managers to coordinate the company’s value creation activities effectively. It is not complex enough to deal with the needs of a large, multi-business company.

Divisional Type 2: Product Structure

In the product structure, activities are grouped by product line. This divisional structure by products (or services) is most effective for implementing strategies when (1) specific products or services need special emphasis, or when (2) an organization’s products or services differ substantially.

For example, the manufacturing function is broken down into different product lines based on the similarities and differences among the products. Because different product groupings now exist, the degree of horizontal differentiation in this structure is higher than that in the functional structure.

The specialized support functions, such as accounting and sales, are centralized at the top of the organization, but each support function is divided in such a way that personnel tend to specialize in one of the different product categories to avoid communication problems. Thus, there may be different groups of accountants, one for each of the three product categories.

In sales, separate sales forces dealing with the different product lines may emerge, but because maintaining a single sales function brings economies of scale to selling and distribution, these groups will coordinate their activities.

This structure type has one more level in the hierarchy than the functional structure.

This level of product line management increases the vertical differentiation of organizational structure. It allows managers at the level of the production line to concentrate on day-to-day operations and gives top managers more time to develop the company’s competitive advantage.

This type of divisional structure has certain advantages and disadvantages.

Advantages of this type of divisional structure are that it (1) reduces the problem of control and coordination associated with the functional structure, (2) pushes aside barriers among functions because the product line now becomes the focus of attention, rather than each individual function, (3) identifies clearly the profit contribution of each product line, and (4) allocates resources more efficiently.

Disadvantages of this type of divisional structure are that it (1) requires a more skilled management force, (2) reduces top management control, (3) and requires a high level of operating costs.

Divisional Type 3: Customer Structure

The divisional structure by the customer can be the most effective way to implement strategies when a few major customers are of paramount importance and many different services are provided to these customers.

This structure allows an organization to cater effectively to the requirements of clearly defined customer groups.

Divisional Type 4: Process Structure

The divisional structure by process is similar to a functional structure because activities are organized according to the way work is actually performed.

A key difference between these two designs is that functional departments are not accountable for profits or revenues, whereas divisional process departments are evaluated on these criteria.

The divisional structure by process can be particularly effective in achieving objectives when distinct production processes represent the thrust of competitiveness in the industry.

Advantages of a Divisional Structure

Advantage 1: Enhanced Corporate Financial Control

The profitability of different divisions is clearly visible in the divisional structure. Because each division is its own profit center, financial controls can be applied to each business on the basis of profit criteria.

Corporate managers establish performance goals for each division, monitor their performance on a regular basis, and selectively intervene when problems arise. They can then use this information to identify the divisions in which investment of the company’s financial resources will yield the greatest value.

As a result, they can allocate the company’s funds among competing divisions in a way that will maximize the profitability of the whole company. Essentially, managers at corporate headquarters act as internal investors who channel funds to high-performing divisions in which they will produce the most profits.

Advantage 2: Enhanced Strategic Control

In a divisional structure, divisional management is responsible for day-to-day operations. The structure frees corporate managers from operating responsibilities.

The corporate headquarters staff, including members of the board of directors as well as top executives, thus gain more time for contemplating wider long-term strategic issues and for developing responses to environmental changes. Such a combination of self-contained divisions with centralized corporate management represents a higher level of both vertical and horizontal differentiation.

The divisional structure also enables corporate headquarters to obtain the information it needs to perform strategic planning functions.

Advantage 3: Facilitation of Growth

The divisional structure lets the company overcome an organizational limit to its growth. By reducing information overload at the center, corporate managers can handle a greater number of businesses. They can consider opportunities for further growth and diversification.

Communication problems are reduced because the same set of standardized accounting and financial control techniques can be used to evaluate all divisions. Corporate managers are also able to implement a policy of management by exception, which means that they intervene only when problems arise.

Advantage 4: Stronger Pursuit of Internal Efficiency

In a divisional structure, the individual efficiency of each autonomous division can be directly observed and measured in terms of the profit it generates. Autonomy makes divisional managers accountable, and they can have no excuses for poor performance. Thus, the corporate office is in a better position to identify inefficiencies.

Because a divisional structure is based on extensive delegation of authority, managers and employees can easily see the results of their good or bad performances. Employee morale is generally higher.

Whether within a functional structure, the interdependence of functional departments means that the individual performance of each function inside a company cannot be measured by objective criteria. This often means that within the functional structure, considerable degrees of organizational slack—that is, functional resources that are being used unproductively—can go undetected.

Disadvantages of a Divisional Structure

Disadvantage 1: Distortion of Information

If corporate headquarters puts too much emphasis on divisional return on investment—for instance, by setting very high and stringent return-on-investment targets—divisional managers may choose to distort the information they supply top management and paint a rosy picture of the present situation at the expense of future profits.

That is, divisions may start to pursue strategies that increase short-run profitability but reduce future profitability.

The problem stems from too tight financial control. Managing the corporate-divisional interface requires coping with subtle power issues. Hence, corporate managers must carefully control their interactions with divisional managers to ensure that both the short- and long-term goals of the business are being met.

Disadvantage 2: Competition for Resources

The divisions themselves may compete for resources, and this rivalry prevents synergy gains or economies of scope from emerging.

Competition between divisions may become so intense that it is dysfunctional and leads to limited sharing of ideas and resources for the common good of the firm. Divisional structure creates vertical communication channels that insulate organizational units and prevents them from sharing their strengths with one another.

Generally, the divisions that can demonstrate the highest return on investment will get the lion’s share of the money. In turn, because they have more money to invest in their business, this usually will raise their performance the next year so strong divisions grow ever stronger. Consequently, divisions may actively compete for resources and, by doing so, reduce interdivisional coordination.

Disadvantage 3: Transfer Pricing

Divisional competition may also lead to battles over transfer pricing. One of the main challenges that vertical integration or related diversification imposes is the need to set the prices at which products are transferred between divisions.

Rivalry among divisions increases the problem of setting fair prices. Each supplying division tries to set the highest price for its outputs to maximize its own profitability. Such competition can completely undermine the corporate culture and make the company a battleground.

Many companies have a history of competition among divisions. Some, of course, may encourage competition if managers believe that it leads to maximum performance.

Disadvantage 4: Focus on Short-Term Research and Development

If extremely high profitability targets are set by corporate headquarters, the danger arises that the divisions will cut back on research and development expenditures to improve the financial performance of the division.

Although this inflates divisional performance in the short term, it reduces a division’s ability to develop new products and leads to a fall in the stream of long-term profits.

Hence, corporate headquarters personnel must carefully control their interactions with the divisions to ensure that both the short-term and long-term goals of the business are being achieved.

Disadvantage 5: High Operating Costs

Divisional structures tend to be more costly to operate than functional structures. While a functional structure offers the opportunity to gain efficiency by having just one department handle all activities in an area, such as marketing, a firm using a divisional structure needs to have marketing units within each of its divisions.

Because each division possesses its own specialized functions, such as finance and R&D, divisional structures are expensive to run and manage. R&D is especially costly, so some companies centralize such functions at the corporate level to serve all divisions. Functional specialists may also be needed centrally at headquarters to coordinate divisional activities.

The size of the corporate staff is a major expense, and companies today make major efforts to keep their number of managers to a minimum.

The use of divisions with each of them has its own specialists is also a major expense. However, the duplication of specialist services is not a problem if the gains from having separate specialist functions outweigh the costs. Strategic managers must decide whether duplication is financially justified.

Managers must also be well qualified because the divisional design forces delegation of authority. And better-qualified individuals require higher salaries.

Activities (particularly advisory services and planning functions) are often centralized in times of downturn or recession. Divisions, however, are retained as profit centers.

Resources

Related Concepts

References

Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2019). Strategic Management: Concepts and Cases: Competitiveness and Globalization (MindTap Course List) (13th ed.). Cengage Learning.
Hill, C. W. L., & Jones, G. R. (2011). Essentials of Strategic Management (Available Titles CourseMate) (3rd ed.). Cengage Learning.
Mastering Strategic Management. (2016, January 18). Open Textbooks for Hong Kong.
Wheelen, T. L. (2021). Strategic Management and Business Policy: Toward Global Sustainability 13th (thirteenth) edition Text Only. Prentice Hall.

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