Organizational Structure and Its Building Blocks

What is organizational structure?

Organizational structure in general refers to the way in which individual and teamwork within an organization are coordinated. Work at an individual level needs to be coordinated and managed in order to achieve the organizational goals and objectives. When it comes to achieving coordination in an organization at the individual or the team level, the organizational structure is a highly valuable tool. The organizational structure specifies reporting relationships or who reports to whom. Without a clearly laid out organizational structure, these relationships would not be clear or no one would know to whom he should report. Apart from that, the organizational structure also lays out the formal communication channels and describes how separate actions are linked together. There are various types of organizational structures and organizations can function using anyone that suits them. There are advantages and disadvantages of each type of organizational structure which we will discuss in detail in another post. However, irrespective of the types of organizational structure, it is important that it is well managed. Without proper management, any type of organizational structure will be plagued with issues. Depending upon the type of industry environment and business operations, some organizational structures might be more suited to a specific business and others less. 

Building Blocks of Organizational Structure.

What exactly does it mean by having a clear organizational structure? Which element of the organizational structure plays the most decisive role in terms of how people behave inside the organization and how work is coordinated? In this post, we will review and analyze four distinct aspects or elements of organizational structure that frequently find mention in business literature. These elements or building blocks of organizational structure come together to form two different configurations of organizational structures which we will also later discuss in this post.

Centralization:

Centralization denotes the degree to which decision-making authority is concentrated in the hands of the people at the higher levels of the organization. With higher centralization, the decision making authority is higher in the hands of the managers at the upper levels. On the contrary, when the level of centralization is low or the company is decentralized the decision making power is in the hands of the people at the lower levels or the ones who are closer to the problem at hand. In decentralized companies, employees at the lower levels and closer to the problem can solve problems and make crucial decisions. A large number of employees feel more satisfied working in decentralized environments. The authority assigned to the lower-level employees in a decentralized environment makes them feel more empowered resulting in higher motivation and satisfaction. In such environments, decisions can be made fairly faster and employees also think that the level of integrity and fairness towards employees is higher in decentralized companies. This is why decentralized companies attract candidates in larger numbers.  Since the decision making authority is assigned mainly to the higher-level managers, the centralized companies place heavier demands on CEOs, CMOs, CFOs, and other upper-level managers. The pressure on business leaders is generally higher in centralized companies since upper-level managers have to take risky decisions. 

Many companies feel that a high degree of centralization can lead to ineffective decision making. The shiniest example of decentralization in the twenty-first century is Berkshire Hathaway. Despite being made up of several smaller companies, Berkshire Hathaway which is a holding company is highly decentralized. Each of its business units functions as a separate one and each has its own business leader with decision-making authority. One important benefit of having such a decentralized structure is that a business manager working in one of Berkshire’s business units does not always have to check with the headquarters to make a key decision. Caterpillar, the heavy equipment manufacturer had faced a similar problem during the 1980s due to the heavy degree of centralization inside the company. Later, it underwent several rounds of reorganization to overcome the problem that hindered decision making throughout the organization.

While there are shortcomings of centralization, it has some strengths too. Several times, employees may feel safer working in centralized environments. They may feel more comfortable in a business environment where their manager gives clear instructions and makes decisions more confidently. Infact, if there is extreme decentralization within an organization that can make performance and decision making suffer. The FBI has been criticized heavily for this problem many times. It has been argued that the organization needs more centralization in terms of strategy development and decision making.

For a large number of businesses, striking a balance between centralization and decentralization is a major problem. There have been many instances in history where companies have gone too far with either centralization or decentralization and that led them to stunted business growth or failure.

For example, In the case of Home Depot, CEO Robert Nardelli who joined in 2000 after leaving GE and having no previous retailing experience, the centralization approach went too far and led the company and the CEO both to a very tough situation. While his strategy of centralizing purchasing operations seemed to work initially and save the company a lot of money, later the situation grew tougher and the CEO resigned 7 years later. The case of Robert Nardelli has been a part of the business curriculum and studied in US business colleges. Nardelli’s missteps and miscalculations had very deep implications for Home Depot and the company faced a lot of external criticism for its loss of service rooted culture. 

Formalization:

Formalization denotes the degree to which the rules, regulations, procedures, and policies in a company are clearly laid out in written form or articulated explicitly. Simply put, the formalized structures are run by the rule book. In formalized organizational structures, you have too many written rules and regulations. You have to do everything according to the rule book and employees do not have much autonomy to make key decisions on a case by case basis. However, there is also an advantage of formalized organizational structure and that is it makes employee behavior more predictable. Whenever a problem arises, employees have a definite procedure or guideline before them to follow. There is higher consistency in employee behavior since employees throughout the organization follow similar rules and respond to problems in a similar manner.

However, while on the one hand, formalization sets clear directions for employees leading to less ambiguity, it is not without disadvantages. Oftentimes when employees are used to behaving in a certain manner, it leads to a lack of innovativeness and loss of creativity since deviation from the rules is generally not allowed. Inside such organizations, strategic decision making only occurs during the times of a crisis. Apart from slower decision making, other problems that are frequently associated with formalized organizational structure include reduced employee motivation and job satisfaction. In the service industry especially, a high level of formalization can give rise to severe problems. New problems arise every day in the service industry and you cannot address all of them using the rulebook. For example, a business manager may be listening to a customer’s problem but the remedy might not be specified within any rulebook or procedural guide. It is a common problem in the airline industry where very few airlines have empowered their lower-level employees to make key decisions. 

Hierarchical levels:

The next important element of organizational structure is the number of layers it has in its hierarchy. There are tall organizational structures and flat organizational structures. While the tall organizational structures have several layers of management between the top and the bottom, the number of layers in flat organizational structures is comparatively lower. 

Flat Versus Tall Organizations

Research shows that inside organizations with a flat organizational structure, the focus on employee need satisfaction is higher and employees achieve a higher level of self-actualization. It does not mean that flat organizations do not have any disadvantages. Research also shows that the level of role ambiguity is higher within flat organizations which is because fewer managers supervise more employees. Less direction and supervision from the managers and supervisors leads to higher role ambiguity for employees or employees feeling less clear about what is expected of them in their jobs. For the employees who need closer guidance from their managers, this might be a major disadvantage. Apart from that, the opportunities for career advancement may also be limited in organizations with a flat organization structure because the levels of management are fewer. Many times the organizations with a tall organizational structure make employees feel securer.  Generally, it is large and well-established companies that adopt tall organizational structures. Employees feel more secure with regards to their career and future while working for well-established organizations even with tall organizational structures. 

Departmentalization:

Departmentalization refers to the breaking down of organization into departments. It is further categorized into two types of structures. Departmentalized organizational structures can be divisional or functional. The organizations that use functional structure group jobs and positions on the basis of similarity in functions. Such structures may have departments like marketing, manufacturing, finance, accounting, HR, and IT. In such structures, each individual serves a specialized role and handles a large volume of transactions. 

Organizations with divisional structures have departments that represent products, services, customers, or geographic locations where the company operates.  It is why in several companies, each product that the company is producing has a unique department assigned to it.  However, functions like marketing, HR, and finance may be replicated within each department. In divisional structures, employees do not act as specialists but as generalists. They do not perform specialized tasks but perform many different tasks in the service of the product. There are several organizations that are structured according to a mix of functional and divisional structures. For example, in the case of a company with several product lines, departmentalizing by product line can help at increasing innovativeness and decrease response times. The company can centralize some operations but also retain its functional structure since that makes sense and is more cost-effective for roles like HR and IT. However, the same organization can also have geographical divisions if it is operating in several geographical markets. 

Apart from that, each type of departmentalization has its own advantages. When the number of products or services offered by the company is small and not requiring a lot of attention, functional structures tend to be more effective. However, if a company has a more diverse product line, requiring detailed attention, having a divisional structure may be more suitable in order to anticipate market changes and respond to customer demand faster. For organizations operating in stable environments that are less susceptible to change, functional structures are more suitable. In contrast, the organizations that are operating in turbulent environments find divisional structures more suitable allowing them to respond to the changing market environment faster.

Mechanistic and Organic Structures

The four elements or building blocks of organizational structure can often coexist. There are at least two different configurations that can arise from the arrangement of these building blocks. 

Mechanistic Structures:

The mechanistic structures bear a close resemblance to bureaucracies. They are highly formalized and centralized structures. Communication inside mechanistic structures follows formal channels and employees are provided with specific job descriptions that highlight their roles and responsibilities. However, a major problem with mechanistic organizations is that they have highly rigid structures and resist change. Such organizations are not agile and that renders them unsuitable for fast innovation. There are some more disadvantages of mechanistic organizational structures. They inhibit entrepreneurial action and also prevent employees from taking individual initiative. By limiting individual autonomy and self-determination, the mechanistic structures can lead to lower intrinsic motivation. 

However, despite these downsides, the mechanistic structures can operate efficiently in stable environments. Efficiency is one main advantage of mechanistic structures. For organizations that want to maximize efficiency and minimize costs, there can be advantages of having a mechanistic structure. For example, McDonald’s is known worldwide for its bureaucratic structure where clear lines of communication are established and the employees have their roles and responsibilities laid out clearly. This has several important advantages for McDonald’s. The company can produce a uniform product throughout the world and minimum costs. Moreover, mechanistic structures have important benefits for new businesses since new businesses face several problems due to lack of structure, role ambiguity, and uncertainty. Having a mechanistic structure can help a startup establish itself firmly until it has developed a suitable structure that it can operate according to.

Max Weber is first known to have used the term bureaucracy. According to him, it was a better structure than the traditional structures since everyone was treated equally and the division of labor was laid out clearly for each employee. 

Bureaucracy is defined as an organizational structure characterized by many rules, standardized processes, procedures and requirements, number of desks, a meticulous division of labor and responsibility, clear hierarchies, and professional, almost impersonal interactions between employees. Max Weber thought this structure was indispensable in large organizations that required a large number of employees to perform all tasks structurally. Technical qualification is the main basis of selection or promotion inside a bureaucratic organization.

Organic Structure:

The organic organizational structures are a lot more flexible and decentralized as compared to the mechanistic structures as well as less formalized. Communication lines are more fluid and flexible inside the organic structures as compared to the mechanistic structures. Moreover, employee job descriptions are broader inside the organic structures as compared to the mechanistic structures. Employees perform their duties according to the needs of the organization as well as their own expertise levels. For employees, organic organizational structures tend to deliver higher job satisfaction. Such structures encourage entrepreneurial behavior and innovativeness on the part of the employees. 3M is a good example of an organic structure. The company is strongly committed to decentralization. The company has several divisions, each one of which operates as a separate company, and the manager of each division can act with autonomy and is accountable for his actions and decisions. Once operations inside a division get too big or a product created by a division becomes profitable, its operations are spun off to create a separate business unit. Apart from protecting the agility of the company, it helps in maintaining the small company atmosphere.

Abhijeet Pratap

Abhijeet has been blogging on educational topics and business research since 2016. He graduated with a Hons. in English literature from BRABU and an MBA from the Asia-Pacific Institute of Management, New Delhi. He likes to blog and share his knowledge and research in business management, marketing, literature and other areas with his readers.