Decentralisation Vs Centralisation

Introduction

The choice of management structure is one of the most contentious issues in management accounting and is of huge importance for success of a company. Generally, a company will either choose centralization or decentralization structure but nowadays a large number of companies are actually decentralized. Decentralization means delegating decision making authority to lower level employees in their respective area of responsibility, on the other hand, centralization means decision making is restricted to top management only and others just implement those decisions (Mowen, Hansen, & Heitger, 2011).This essay will first give a brief explanation of why companies today prefer decentralization and then discuss the advantages and disadvantages of centralization, and which corporations are most suitable for centralization taken into account of size, product characteristics, geographical proximity of operations, business environment and leadership of the top manager. This essay will contend that there are no corporations that are absolutely centralized (they are all decentralized to some extent) and the core is to draw a balance between the two structures considering the specific business type, and change the structure accordingly if problems occur afterwards.

Reasons why the majority of companies are decentralized

A major advantage of decentralization is that local managers can adapt quicker to changes than top management since they are more exposed to day to day operations. Decentralization can also improve morale throughout the company as employees are empowered thus more likely to be committed to achieving their jobs. Besides, in decentralized corporations, top management are freed from daily operational decisions and can think more on strategic level like key drivers of future company success which is also their core competency compared with their lower level colleagues. In addition, lower level managers will get trained for decision making and will provide a talent pool for companies when the higher-level mangers retire or leave (Heflebower, 1960).

Pros of Centralization

There are several benefits of centralization. Firstly, centralization can achieve economies of scale. By sharing of equipment and factories among departments producing the same product, production costs per unit can be radically reduced. Research from the nonprofit organization APQC demonstrates that centralization leads to about 3 percent lower manufacturing costs compared with decentralization (Garrehy, 2014).

Secondly, due to design of financial measurement system, local managers tend to put their partial interests above the company’s which leads to sub-optimization. However, the top manager of a centralized company has the power to coordinate strategies, prevent excessive internal competition and maximize value of organization as a whole.

Thirdly, under circumstances where a crucial decision need to be made immediately, otherwise a big loss will be incurred, top management in centralized organization can make their choice without going through lengthy discussions with inferior managers, which could reduce the loss to a minimum level.

Fourthly, centralization can ensure consistent quality of products. This is particularly important in area of strategic importance. For example, Uchumi supermakets Ltd ( a Kenyan supermarket company) centralized its fresh food and vegetables procurement system in order to improve quality level and consistency, as quality is important for its expansion in Kenya (Neven & Reardon, 2004).

Last but not least, centralization of power makes a better utilization of the most competent and experienced personnel (particularly in administrative and technical areas) of company, ensuring the effective execution of strategies and better alignment of operations with company’s objectives.

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Cons of Centralization

There are some demerits regarding centralization also. Firstly, decisions are made at top level instead of at local. However, due to information asymmetry, local managers may actually have a better understanding of the local customer’s requirement. For example, McDonald’s introduced a local strategy which grants them a competitive advantage worldwide. In tropical markets, guava juice was added to the McDonald’s menu and in Germany, beer is sold as well as McCroissants ("McDonald’s: “think global, act local” – the marketing mix," 2001).

Secondly, too much power empowered to the top manager can be disastrous as, due to personal bias, he may not see the full picture too. But overconfidence may arise and unrealistic tasks can be set up. However, when the tasks are not fulfilled in the end, employees will get demoralized, sometimes even causing a huge monetary loss("5 common unconscious biases that lead to bad decisions," 2015).

Thirdly, centralized organization structure restricts the mobilization of initiatives and lower level employees may get demotivated and less committed as they have no decision power, resulting in lack of innovation inside the company since lower management will be reluctant to contribute anymore. In addition, junior managers are usually less well-trained without opportunity to exert their own power in daily business operations, which is extremely bad for the sustainability of a company.