Organizational Design in Response to an Exogenous Shock

All organizations have hierarchies. The nature of corporate hierarchies has long been the subject of organizational design research. Among other things, hierarchies are useful for command and control (e.g., the “chain of command” in the military), functional segmentation (e.g., divisions and departments in a corporation), structured communication (e.g., cascading messages through a large organization), and information sensing (e.g., assembling data gathered from disparate sources).

In an article in the October issue of the American Economic Journal: Applied Economics, Maria Guadalupe of Columbia Business School and Julie Wulf of Harvard Business School present an interesting thesis on how the external market affects organizational design.

They examine two aspects of organizational structure: the number of management levels (“depth”) and the CEO’s span of control (“span of control”).

Their thesis is that increased competition in the product market (i.e., the market for the goods that they produce) leads to flatter firms. In response to competitive pressure, firms reduce the number of positions between CEO and division managers (i.e., reduce depth) and increase the number of positions reporting directly to the CEO (i.e., increase span of control).

Cleverly, they make use of a quasi-natural experiment – the liberalization of trade brought about by the 1989 Canada-United States Free Trade Agreement. Using a 14-year panel data set of US manufacturing companies between 1986 and 1999, the authors examine how organizational structure changes, taking into consideration a number of variables to control for alternative explanations.

Why would firms flatten their hierarchies in response to competition? Here are some of the explanations provided:

  • Improve the speed of responding to market changes
  • Minimize the distortion of information across levels
  • Exploit increased returns to decentralized decision making in a competitive environment
  • Eliminate slack and cut costs
  • Respond to changes in scope and location (i.e., what they produce and where they produce it).

In summary, “[The authors] show that following an exogenous shock to their competitive environment, firms redesign their organizations to “fit” the environment in which they operate, and simultaneously reorganize along several dimensions: flattening the hierarchy by increasing span and reducing depth, changing their scope, and changing the structure of compensation.]

Compensation surveys offer a possible data set for exploring some of these notions further.  Participating firms supply organizational parameters and compensation levels. Over a large enough population of firms and over a sufficient period of time plus information on relevant economic trends, we might be able to extract quite a few insights about the dynamics of organization design, compensation and the external market environment.


About thenelsontouch

Amit is the founder and managing director of Nelson Touch Consulting, a management consultancy that specializes in maximizing the return on human capital through strategy, incentives and analytics.
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