Chapter 13 Outline

Vertical Differentiation

A firm's vertical differentiation determines where in its hierarchy the decision-making power is concentrated.² For example, are production and marketing decisions centralized in the offices of upper-level managers, or are they decentralized to lower-level managers? Where does the responsibility for R&D decisions lie? Are strategic and financial control responsibilities pushed down to operating units, or are they concentrated in the hands of top management? And so on. There are arguments for centralization and other arguments for decentralization.

Arguments for Centralization

There are four main arguments for centralization. First, centralization can facilitate coordination. For example, consider a firm that has a component-manufacturing operation in Taiwan and an assembly operation in Mexico. There may be a need to coordinate the activities of these two operations to ensure a smooth flow of products from the component operation to the assembly operation. This might be achieved by centralizing production scheduling decisions at the firm's head office. Second, centralization can help ensure that decisions are consistent with organizational objectives. When decisions are decentralized to lower-level managers, those managers may make decisions at variance with top management's goals. Centralization of important decisions minimizes the chance of this occurring.

Third, by concentrating power and authority in one individual or a top-management team, centralization can give top-level managers the means to bring about needed major organizational changes. Fourth, centralization can avoid the duplication of activities that occurs when similar activities are carried on by various subunits within the organization. For example, many international firms centralize their R&D functions at one or two locations to ensure that R&D work is not duplicated. Similarly, production activities may be centralized at key locations for the same reason.

Arguments for Decentralization

There are five main arguments for decentralization. First, top management can become overburdened when decision-making authority is centralized, and this can result in poor decisions. Decentralization gives top management the time to focus on critical issues by delegating more routine issues to lower-level managers. Second, motivational research favors decentralization. Behavioral scientists have long argued that people are willing to give more to their jobs when they have a greater degree of individual freedom and control over their work. Third, decentralization permits greater flexibility--more rapid response to environmental changes--because decisions do not have to be "referred up the hierarchy" unless they are exceptional. Fourth, decentralization can result in better decisions because decisions are made closer to the spot by individuals who (presumably) have better information than managers several levels up in a hierarchy. Fifth, decentralization can increase control. Decentralization can be used to establish relatively autonomous, self-contained subunits within an organization. Subunit managers can then be held accountable for subunit performance. The more responsibility subunit managers have for decisions that impact subunit performance, the fewer alibis they have for poor performance.

Strategy and Centralization in an International Business

The choice between centralization and decentralization is not absolute. It frequently makes sense to centralize some decisions and to decentralize others, depending on the type of decision and the firm's strategy. Decisions regarding overall firm strategy, major financial expenditures, financial objectives, and the like are typically centralized at the firm's headquarters. However, operating decisions--such as those relating to production, marketing, R&D, and human resource management--may or may not be centralized depending on the firm's international strategy.

Consider firms pursuing a global strategy. They must decide how to disperse the various value creation activities around the globe so location and experience economies can be realized. The head office must decide where to locate R&D, production, marketing, and so on. In addition, the globally dispersed web of value creation activities that facilitates a global strategy must be coordinated. All this creates pressures for centralizing some operating decisions.

In contrast, the emphasis on local responsiveness in multidomestic firms creates strong pressures for decentralizing operating decisions to foreign subsidiaries. Thus, in the classic multidomestic firm, foreign subsidiaries have autonomy in most production and marketing decisions. International firms tend to maintain centralized control over their core competency and to decentralize other decisions to foreign subsidiaries. This typically centralizes control over R&D and/or marketing in the home country and decentralizes operating decisions to the foreign subsidiaries. Microsoft Corporation, which fits the international mode, centralizes its product development activities (where its core competencies lie) at its Redmond, Washington, headquarters and decentralizes marketing activity to various foreign subsidiaries. Thus, while products are developed at home, managers in the various foreign subsidiaries have significant latitude for formulating strategies to market those products in their particular settings.³

The situation in transnational firms is more complex. The need to realize location and experience curve economies requires some degree of centralized control over global production centers (as it does in global firms). However, the need for local responsiveness dictates the decentralization of many operating decisions, particularly for marketing, to foreign subsidiaries. Thus, in transnational firms, some operating decisions are relatively centralized, while others are relatively decentralized. In addition, global learning based on the multidirectional transfer of skills between subsidiaries, and between subsidiaries and the corporate center, is a central feature of a firm pursuing a transnational strategy. The concept of global learning is predicated on the notion that foreign subsidiaries within a multinational firm have significant freedom to develop their own skills and competencies. Only then can these be leveraged to benefit other parts of the organization. A substantial degree of decentralization is required if subsidiaries are going to have the freedom to develop their own skills and competencies. So for this reason too, the pursuit of a transnational strategy requires a high degree of decentralization.⁴