Building Blocks of Organizational Structure

Components of Organizational Structure

What is a Basic Building Block?

Basic building blocks of organizational structure shape the behavior of people, functions, and divisions.

The 2 Basic Building Blocks

The basic building blocks of organizational structure are (1) differentiation and (2) integration.

Differentiation consists of the way a company divides itself into parts (functions and divisions). Integration consists of the way those parts are then combined.

Together, the two processes determine how an organizational structure will operate and how successful firms will be able to create value through their chosen strategies.

Overview on Differentiation Block

Differentiation is the way in which a company allocates people and resources to organizational tasks in order to create value.

Generally, the greater the number of different functions or divisions in an organization and the more skilled and specialized they are, the higher is the level of differentiation.

There are 2 decisions a firm must face in deciding how to differentiate the organization to create value: (1) vertical differentiation and (2) horizontal differentiation.

Vertical differentiation choices must be made when firms choose how to distribute decision-making authority in the organization to best control value creation activities.

For example, corporate managers must decide how much authority to delegate to managers at the divisional or functional level.

Horizontal differentiation choices must be made when firms choose how to divide people and tasks into functions and divisions to increase their ability to create value.

Should there be separate sales and marketing departments, for example, or should the two be combined? What is the best way to divide the sales force to maximize its ability to serve customers’ needs, by type of customer or by region in which customers are located?

Overview on Integration Block

Integration is the means by which a company seeks to coordinate people and functions to accomplish organizational tasks.

When separate and distinct value creation functions exist, they tend to pursue their own goals and objectives. An organization has to create an organizational structure that encourages the different functions and divisions to coordinate their activities.

An organization uses integrating systems to promote coordination and cooperation between functions and divisions.

Differentiation Block versus Integration Block

One of the major issues during designing organizational structure is to match differentiation with integration at the right level to meet the firm’s strategies.

Just as too much differentiation and not enough integration led to a failure of implementation, the converse is also true. The combination of low differentiation and high integration leads to an overcontrolled, bureaucratized organization in which flexibility and speed of response are reduced rather than enhanced by the level of integration.

Thus, one of the objectives for designing an organizational structure must be to decide on the optimum amount between differentiation and integration necessary for meeting the business goals and objectives.

Vertical Differentiation in Organizational Structure

The aim of vertical differentiation is to specify the reporting relationships that link people, tasks, and functions at all levels of a company.

Fundamentally, this means that management chooses (1) the appropriate number of hierarchical levels and (2) the correct span of control for implementing a company’s strategy most effectively.

The organizational hierarchy establishes the authority structure from the top to the bottom of the organization. The span of control is defined as the number of subordinates a manager directly manages.

Should activities be grouped differently? Should the authority to make key decisions be centralized at headquarters or decentralized to managers in distant locations?

Should the corporation be organized into a tall structure with many layers of management, each having a narrow span of control? Or should it be organized into a flat structure with fewer layers of management, each having a wide span of control, giving more freedom to subordinates?

Using these 2 concepts, the basic choice is whether to aim for (1) a flat structure, with few hierarchical levels and thus a relatively wide span of control, or (2) a tall structure, with many levels and thus a relatively narrow span of control.

Tall structures have many hierarchical levels relative to their size, and flat structures have relatively few. Companies choose the number of levels they need on the basis of their strategy and the functional tasks necessary to achieve this strategy.

In general, the allocation of authority and responsibility in a company must match the needs of its corporate-, business-, and functional- level strategies.

Hierarchical Level – Problems with Tall Structures

As a company grows and diversifies, the number of levels in its hierarchy of authority increases to allow it to monitor and coordinate employee activities efficiently.

In general, the number of hierarchical levels relative to company size is predictable as the size increases.

Companies with approximately 1,000 employees usually have four levels in the hierarchy: chief executive officer (CEO), departmental vice presidents, first-line supervisors, and shop-floor employees. Those with 3,000 employees normally increase their level of vertical differentiation by raising the number of levels to seven. However, even when companies grow to 10,000 employees or more, the number of hierarchical levels rarely increases beyond nine or ten.

Thus, as organizations grow, managers work to limit the number of hierarchical levels. This practice follows the principle of minimum chain of command, which states that an organization should choose a hierarchy with the minimum number of levels of authority necessary to achieve its strategy.

Managers try to keep the hierarchy as flat as possible because when companies become too tall, several problems arise that make a strategy more difficult to implement.

When companies become too tall and the chain of command becomes too long, managers tend to lose control over the hierarchy, which means that they lose control over their strategies.

Problem 1: Communication & Coordination Problems

Having too many hierarchical levels impedes communication and coordination between employees and functions and also raises costs. Communication between the top and the bottom of the hierarchy takes much longer as the chain of command lengthens.

This leads to inflexibility, and valuable time is lost in bringing a new product to market or in keeping up with technological developments.

Problem 2: Information Distortion

More subtle, but just as important, are the problems of information distortion that occur as the hierarchy of authority lengthens. Going down the hierarchy, managers at different levels may misinterpret information, either through accidental garbling of messages or on purpose to suit their own interests. In either case, information from the top may not reach its destination intact.

For instance, a request to share divisional knowledge to achieve gains from synergy may be overlooked or ignored by divisional managers who perceive it as a threat to their autonomy and power.

Information transmitted upward in the hierarchy may also be distorted. Subordinates may transmit to their superiors only the information that enhances their own standing in the organization. The greater the number of hierarchical levels, the more scope subordinates have to distort facts and, as a consequence, the costs of managing the hierarchy increase.

Problem 3: Motivational Problems

As the number of levels in the hierarchy increases, the amount of authority possessed by managers at each hierarchical level diminishes.

For example, consider the situation of two organizations of identical size, one of which has three levels in its hierarchy and the other seven. Managers in the flat structure have much more authority, and greater authority increases their motivation to perform effectively and take responsibility for the organization’s performance.

Besides, when there are fewer managers, their performance is more visible, so they can expect greater rewards when the business does well.

By contrast, the ability of managers in a tall structure to exercise authority is limited, and their decisions are constantly scrutinized by their superiors. As a result, managers tend to pass the buck and refuse to take the risks that are often necessary when new strategies are pursued. This increases the costs of coordination because more managerial time must be spent coordinating task activities.

Problem 4: High Management Costs

Another drawback of tall structures is that having many hierarchical levels implies having many middle managers and employing managers is expensive.

Also, when companies grow and are successful, they often hire personnel and create new positions without much regard for the effect of these actions on the organizational hierarchy. Later, when managers review that structure, they frequently act to reduce the number of levels because of the disadvantages.

Span of Control – Centralization or Decentralization?

Authority is centralized when managers at the upper levels of the organizational hierarchy retain the authority to make the most important decisions.

Authority is decentralized when managers delegate it to divisions, functions, and managers and workers at lower levels in the organization.

Managing the relationship between strategy and organizational structure when the number of hierarchical levels becomes too great is difficult and expensive. Depending on a company’s situation, the problems of tall hierarchies can be reduced by decentralization.

By delegating authority in this fashion, managers can avoid communication and coordination problems because information does not have to be constantly sent to the top of the organization for decisions to be made.

Decentralization of structure can sometimes be viewed as centralized policy determination, coupled with decentralized operating management. After top management has developed a strategy for the entire corporation, each division is free to select its strategy implementation. Return on investment is used as financial control.

Decentralization has 3 main advantages.

First, when strategic managers delegate operational decision-making responsibility to middle and first-level managers, they reduce information overload, enabling them to spend more time on strategic decision-making. Consequently, they can make more effective decisions.

Second, when managers in the bottom layers of the organization become responsible for adapting the organization to local conditions, their motivation and accountability increase.

The result is that decentralization promotes organizational flexibility because lower-level managers are authorized to make on-the-spot decisions. This can often provide a company with a significant competitive advantage.

Third, when lower-level employees are given the right to make important decisions, fewer managers are needed to oversee their activities and tell them what to do. And fewer managers mean lower costs.

Centralization also has its advantages.

First, centralized decision-making facilitates coordination of the organizational activities needed to pursue a company’s strategy. If managers at all levels can make their own decisions, overall planning becomes extremely difficult, and the company may lose control of its decision-making.

Second, centralization also means that decisions fit broad organizational objectives. Companies may centralize R&D responsibility at the corporate level to provide a more directed corporate strategy and to lower operating costs across its growing number of operating divisions.

Horizontal Differentiation in Organizational Structure

Horizontal differentiation is about deciding how best to group organizational tasks and activities to meet the objectives of a company’s strategies.

One of the reasons for horizontal differentiation to exist is that as firms grow and diversify, it is difficult to operate effectively without either becoming too tall or decentralized. Thus, horizontal differentiation comes as another organizational arrangement to achieve a firm’s strategies.

Some of the most common arrangements are functional and divisional structures.

A company must have an appropriate form of horizontal differentiation to achieve its strategic objectives, otherwise, it may face problems such as low employee morale, employee conflicts, or poor delegation of authority.

Meeting these problems may indicate that the company has outgrown its structure. It needs to invest resources in developing another organizational structure that can meet the needs of its current strategy. This investment might be expensive, but as long as the value a company can create is greater than the costs, it makes sense to adopt such an organizational structure.

A company must continually evaluate and adjust its mix of vertical and horizontal differentiation if it is to perform effectively the organizational tasks that will enhance its competitive advantage.

Integration in Organizational Structure

The level of integration in organizational structure is the extent to which the firm seeks to coordinate its value creation activities and make them interdependent.

The principle is the higher a company’s level of differentiation (vertical and/or horizontal), the higher the level of integration needed to make the organizational structure work effectively.

Thus, if a company adopts a more complex form of differentiation, it requires a more complex form of integration to accomplish its goals.

There is a series of integrating mechanisms a company can use to increase its level of integration as its level of differentiation increases.

Like increasing the level of differentiation, increasing the level of integration is also expensive. There are high costs associated with using managers to coordinate value creation activities. Hence, a company uses more complex integrating mechanisms to coordinate its activities only to the extent necessary to implement its strategy effectively.

Integration Form 1: Direct Contact

The aim behind establishing direct contact among managers is to set up a context within which managers from different divisions or functions can work together to solve mutual problems.

Managers from different functions have different goals and interests but equal authority, so they may tend to compete rather than cooperate when conflicts arise.

In a typical functional structure, for example, the heads of each of the functions have an equal authority; the nearest common point of authority is the CEO. Consequently, when disputes arise, no mechanism exists to resolve the conflicts except the authority of the CEO.

One sign of conflict in organizations is the number of problems sent up the hierarchy for upper-level managers to solve. This wastes management time and effort, retards strategic decision-making, and makes it difficult to create a cooperative culture in the company.

For this reason, companies generally choose more complex integrating mechanisms to coordinate inter-functional and divisional activities.

Integration Form 2: Interdepartmental Liaison Roles

When the volume of contacts between two departments or functions increases, one of the ways of improving coordination is to give one manager in each division or function the responsibility for coordinating with the other function.

These managers may meet daily, weekly, monthly, or as needed. The responsibility for coordination is part of a manager’s full-time job, but through these roles a permanent relationship forms between the managers involved, greatly easing strains between departments.

Furthermore, liaison roles offer a way of transferring information across the organization, which is important in large, anonymous organizations whose employees may not know anyone outside their immediate department.

Integration Form 3: Temporary Task Forces

When more than two functions or divisions share common problems, direct contact and liaison roles are of limited value because they do not provide enough coordination. In today’s competitive environment, many companies have been forced to find better ways of coordinating their supporting functions in order to bring their products to market more rapidly and protect their competitive advantage. Thus, a new way to do this is to use a task force.

A task force is a solution to adopt this complex integrating mechanism. One member of each function or division is assigned to a task force created to solve a specific problem.

Essentially, task forces are ad hoc committees, and members are responsible for reporting to their departments on the issues addressed and the solutions recommended.

Task forces are temporary because once the problem has been solved, members return to their normal roles in their own departments or are assigned to other task forces. Taskforce members also perform many of their normal duties while serving on the task force.

Integration Form 4: Permanent Teams

In many cases, the issues addressed by a task force recur. To deal with these issues effectively, an organization must establish a permanent integrating mechanism, such as a permanent team.

An example of a permanent team is a new-product development committee, which is responsible for the choice, design, and marketing of new products. Such an activity obviously requires a great deal of integration among functions if new products are to be successfully introduced.

In organizations that use this committee, task activities are divided along product lines to reduce costs and increase management’s ability to monitor and control the process. Specialists are taken from the various support functions and assigned to work on the product.

These teams are formed right at the beginning of the product development process. In this way, any problems that arise can be resolved early, before they lead to major redesign problems. When all functions have direct input from the beginning, design costs and subsequent manufacturing costs can be kept low. Moreover, the use of this committee can speed innovation and responsiveness to customers, because authority is decentralized to the team and decisions can be made more quickly.

The importance of teams in the management of the organizational structure cannot be overemphasized. Essentially, permanent teams are the organization’s standing committees, and much of the strategic direction of the organization is formulated in their meetings.

The reason is not bureaucracy but rather that integration is possible only in intensive, face-to-face sessions, in which managers can understand others’ viewpoints and develop a cohesive organizational strategy.

The more complex the company, the more important these teams become. The product-team structure is based on the use of cross-functional teams to speed products to market. These teams assume the responsibility for all aspects of product development. Their goal is to increase coordination and integration among functions.

Integration Form 5: Integrating Roles

The only function of the integrating role is to prompt integration among divisions or departments. It is staffed by an independent expert, who is normally a senior manager with a great deal of experience in the joint needs of the two departments.

This role is independent of the subunits or divisions being integrated. The job is to coordinate the decision process among departments or divisions in order to reap synergetic gains from cooperation.

Once again, the more differentiated the company, the more common are these roles. Often people in these roles take the responsibility for chairing task forces and teams, and this provides additional integration.

Sometimes the number of integrating roles becomes so high that a permanent integrating department is established at corporate headquarters. Normally, this occurs only in large, diversified corporations that see the need for integration among divisions.

Resources

Related Concepts

Organizational Structure in Strategy Implementation

References

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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