Organizational Structure

If you’ve ever worked in a job where you weren’t sure who to report to, or found yourself stuck waiting for approval from three different people, you’ve felt the effects of organizational structure. In this chapter, we’ll explore how organizations are physically built through systems of authority, communication, and responsibility. You’ll learn how formalization, centralization, hierarchy, and departmentalization shape employees’ daily experiences. We’ll also look at the difference between rigid, rule-driven organizations (mechanistic structures) and more flexible, adaptive ones (organic structures), including the pros and cons of each.

You’ll discover what working in a matrix, boundaryless, or learning organization means and how these models influence communication, collaboration, and innovation. Understanding structure will help you see why some workplaces feel empowering while others feel restrictive, and how leaders can design better systems to support people and performance.

Building Blocks of Structure

What exactly do we mean by organizational structure? In other words, which elements of a company’s structure make a difference in how we behave and coordinate our work? We will review four aspects of structure frequently studied in the literature. We view these four elements as the building blocks of a company’s structure. We will then examine how these building blocks come together to form two distinct configurations of structures.

Centralization

Centralization is the degree to which decision-making authority is concentrated at higher organizational levels. In centralized companies, many important decisions are made at higher levels of management. In contrast, in decentralized companies, decisions are made and problems are solved at lower levels by employees who are closer to the problem.

As an employee, where would you feel more comfortable and productive? If your answer is “decentralized,” you are not alone. Decentralized companies give more authority to lower-level employees, resulting in a sense of empowerment. Decisions are often faster, and employees believe that decentralized companies provide greater procedural fairness to employees. Job candidates are more likely to be attracted to decentralized organizations. Because centralized organizations assign decision-making responsibility to higher-level managers, there are greater demands on the mental and physical capabilities of CEOs and other high-level managers. Despite many perceived disadvantages, centralization may lead to more efficient operations, particularly if the company is operating in a stable environment (Ambrose & Cropanzano, 2000; Miller, Droge, & Toulouse, 1988; Oldham & Hackman, 1981; Pierce & Delbecq, 1977; Schminke, Ambrose, & Cropanzano, 2000; Turban & Keon, 1993; Wally & Baum, 1994).

Many companies find that centralizing operations leads to inefficiencies in decision-making. For example, in the 1980s, Caterpillar Inc. suffered the consequences of centralized decision-making. At the time, all pricing decisions were made in the corporate headquarters in Peoria, Illinois. This meant that when a sales representative working in Africa wanted to give a discount on a product, they needed to check with headquarters. The headquarters did not always have accurate or timely information about the subsidiary markets, which hindered effective decision-making. The dramatic reorganization of the company sought to avoid problems such as these (Nelson & Pasternack, 2005). At the other end of the spectrum, organizations can suffer from extreme decentralization. For example, some analysts believe that the Federal Bureau of Investigation (FBI) faces challenges because its entire structure and systems are based on the assumption that crime needs to be caught after it has occurred. Over time, this assumption led to a situation in which each unit was completely decentralized, rather than following an overarching strategy, and field agents determined how investigations should be pursued. It has been argued that the FBI needs to gather accurate intelligence before committing a crime, given the shift in crime patterns, which necessitates more centralized decision-making and strategy development (Brazil, 2007).

Hitting the right balance between decentralization and centralization is challenging for many organizations. At Home Depot Inc., the retail giant with over 2,000 stores across the United States, Canada, Mexico, and China, one of the significant changes made by its former CEO, Robert Nardelli, was centralizing most of its operations. Before the transition, Home Depot store managers made several decisions autonomously, and each store had an entrepreneurial culture. Nardelli’s changes initially saved the company a lot of money. For example, for a company of that size, centralizing purchasing operations resulted in considerable cost savings, as the company could negotiate significant discounts from suppliers. At the same time, many analysts believe that centralization has gone too far, resulting in the loss of a service-oriented culture at the stores (Charan, 2006; Marquez, 2007).

Formalization

Formalization is the extent to which policies, procedures, job descriptions, and rules are written and explicitly articulated. In other words, formalized structures are those in which numerous written rules and regulations exist. These structures control employee behavior using written rules, and employees have little autonomy to make decisions on a case-by-case basis. Formalization makes employee behavior more predictable. Whenever a problem arises, employees know to turn to a handbook or a procedure guideline. Therefore, employees respond to problems similarly across the organization, resulting in consistent behavior.

While formalization reduces ambiguity and provides direction to employees, it has disadvantages. A high degree of formalization may lead to reduced innovativeness because employees are used to behaving in a particular manner. Strategic decision making in such organizations often occurs only during a crisis. A formalized structure is associated with reduced motivation and job satisfaction, as well as a slower pace of decision-making (Fredrickson, 1986; Oldham & Hackman, 1981; Pierce & Delbecq, 1977; Wally & Baum, 1994). The service industry is particularly susceptible to problems associated with high levels of formalization. Sometimes, employees listening to a customer’s issues may need to take action, but the answer may not be specified in any procedural guidelines or rulebook. For example, while a handful of airlines, such as Southwest Airlines Company, do a good job of empowering their employees to handle complaints, many airlines limit the power of lower-level employees to resolve customer problems and constrain them by stringent rules that outline a limited number of acceptable responses.

Hierarchical Levels

Another essential element of a company’s structure is the number of levels in the hierarchy. Keeping the organization’s size constant, tall structures have several layers of management between frontline employees and the top level, while flat structures consist of a few layers. A closely related concept is span of control, which refers to the number of employees reporting to a single manager. In tall structures, a span of control tends to be smaller, resulting in greater opportunities for managers to supervise and monitor employee activities. In contrast, flat structures involve a wider span of control. In such a structure, managers will be relatively unable to provide close supervision, leading to greater freedom of action for each employee. Research indicates that flat organizations provide greater need satisfaction for employees and greater levels of self-actualization (Ghiselli & Johnson, 1970; Porter & Siegel, 2006). Companies such as the IKEA Group, a Swedish furniture manufacturer and retailer, successfully utilize flat structures to foster an employee mentality of job involvement and ownership. At the same time, flat structures may also present some challenges.

In flat structures, employees will not have many opportunities to receive supervision and guidance from the manager, making it necessary for employees to be self-reliant. Research shows that when managers supervise a large number of employees, which is more likely to occur in flat structures, employees experience greater role ambiguity (Chonko, 1982). This may be a disadvantage for employees who need closer guidance from their managers. Moreover, advancement opportunities will be more limited in a flat structure because there are fewer management layers. Finally, while employees report that flat structures are better at satisfying their higher-order needs, such as self-actualization, they also report that tall structures are better at satisfying the security needs of employees (Porter & Lawler, 1964). Because tall structures are typically associated with large and well-established companies, it is possible that employees working in such organizations may feel a greater sense of job security.

Departmentalization

Organizational structures differ in terms of departmentalization. Organizations using functional structures group jobs based on similarity in functions. Such structures may include departments for marketing, manufacturing, finance, accounting, human resources, and information technology. Each person serves a specialized role in these structures and handles large transactions. For example, a marketing employee working in a functional structure may serve as an event planner, planning promotional events for all the company’s products. In organizations using divisional structures, departments represent the unique products, services, customers, or geographic locations the company serves. In other words, each unique product or service the company produces will have its department.

Within each department, marketing, manufacturing, and other roles are replicated. In these structures, employees act like generalists rather than specialists. Instead of performing specialized tasks, employees are responsible for a wide range of functions in support of the product. For example, a marketing employee in this structure may be responsible for planning promotions, coordinating relationships with advertising agencies, and planning and conducting marketing research.

In reality, many structures are a hybrid of functional and divisional forms. For example, departmentalizing by product may increase innovativeness and reduce response times if the company has multiple product lines. Each department may have dedicated marketing, manufacturing, and customer service employees serving the specific product. Yet, the company may also find that centralizing some operations and retaining the functional structure makes sense and is more cost-effective for roles such as human resources management and information technology. The same organization may also create geographic departments serving different countries.

Functional structures tend to be effective when an organization has a limited number of products and services that require special attention. When a company has a diverse product line, each product will have unique demands, making traditional structures less effective for promptly addressing customer needs and anticipating market changes. Functional structures are also more effective in stable environments that change slowly. In contrast, organizations using product departments are more agile and can perform better in turbulent environments. The type of employee who will succeed under each structure is also different. Research indicates that when employees work in product departments in turbulent environments, characterized by diverse and complex activities, their performance depends on their general mental abilities (Hollenbeck et al., 2002).

Two Configurations: Mechanistic and Organic Structures

The various elements of organizational structures, including formalization, centralization, the number of hierarchical levels, and departmentalization, often coexist. As a result, depending on how these elements are arranged, we can talk about two configurations of organizational structures.

Mechanistic structures are similar to bureaucracies, which are highly formalized and centralized. Communication follows formal channels, and employees are assigned specific job descriptions that delineate their roles and responsibilities. Mechanistic organizations are often rigid and resistant to change, making them unsuitable for innovation and swift action. These forms have the downside of inhibiting entrepreneurial action and discouraging employees from using their initiative. Not only do mechanistic structures have disadvantages for innovativeness, they also limit individual autonomy and self-determination, which will likely lead to lower levels of intrinsic motivation on the job (Burns & Stalker, 1961; Covin & Slevin, 1988; Schollhammer, 1982; Sherman & Smith, 1984; Slevin & Covin, 1990). Despite these downsides, mechanistic structures have advantages when the environment is more stable. The main advantage of a mechanistic structure is its efficiency. Therefore, mechanistic structures provide advantages in organizations trying to maximize efficiency and minimize costs.

For example, McDonald’s Corporation has a famously bureaucratic structure in which employee jobs are highly formalized, with clear lines of communication and precise job descriptions. This structure is advantageous for McDonald’s because it enables the company to produce uniform products worldwide at a minimum cost. Moreover, mechanistic structures tend to be beneficial for new ventures. New businesses often suffer from a lack of structure, role ambiguity, and uncertainty. A mechanistic structure is related to firm performance in new ventures (Sine, Mitsuhashi, & Kirsch, 2006).

Organic structures are flexible, decentralized structures with low levels of formalization. Communication lines are more fluid and adaptable. Employee job descriptions are broader, and employees are asked to perform duties based on the specific needs of the organization at the time, as well as their level of expertise. Organic structures tend to be associated with higher job satisfaction levels among employees. These structures are conducive to entrepreneurial behavior and innovativeness (Burns & Stalker, 1961; Covin & Slevin, 1988). An example of a company that has an organic structure is 3M. The company is firmly committed to decentralization. At 3M, there are close to 100 profit centers, with each division feeling like a small company. Each division manager acts autonomously and is accountable for their actions. As operations within each division get too big and a product created by a division becomes profitable, the operation is spun off to create a separate business unit. This is done to protect the company’s agility and maintain a small-company atmosphere (Adair, 2007).

Contemporary Forms of Organizational Structures

Matrix Organizations

Matrix organizations cross a traditional functional structure with a product structure. Specifically, employees reporting to department managers are also pooled together to form project or product teams. As a result, each person reports to a department manager and a project or product manager. In this structure, product managers have control and say over product-related matters. Matrix structures are created in response to the uncertainty and dynamism of the environment and the need to give particular attention to specific products or projects. Instead of completely switching to a product-based structure, a company may utilize a matrix structure to balance the benefits of a product-based and traditional functional structure.

Using a matrix structure instead of product departments may increase communication and cooperation among departments, as project managers must coordinate their actions with department managers. Research indicates that matrix structures enhance the frequency of both informal and formal communication within an organization (Joyce, 1986). Matrix structures also have the benefit of providing quick responses to technical problems and customer demands. The existence of a project manager keeps the focus on the product or service that is being provided.

Despite these potential benefits, matrix structures are not without costs. In a matrix, each employee reports to at least two managers. In other words, the matrix organization violates the unity of command principle, which is often prevalent in traditional organizations. In organizations with unity of command, each person reports to a single manager. As a result, communication flows through predictable lines, and coordination is easier. Because matrix organizations do not follow the unity of command principle, conflict is ripe. Because multiple managers are responsible for guiding the behaviors of each employee, there may be power struggles or turf wars among managers. The managers are more interdependent than in a traditional or product-based structure and must spend more effort coordinating their work. From the employee’s perspective, there is potential for interpersonal conflict with team members and leaders. The presence of multiple leaders may create role conflict. Working with a team of employees with different functional backgrounds increases the potential for task conflict at work (Ford & Randolph, 1992). Solving these problems will require a great deal of patience and proactivity on the part of the employee.

The matrix structure is used in many information technology companies engaged in software development. Refer to the following figure for an example of a matrix structure in an IT company. Nike Inc. is another company that utilizes the matrix organization successfully. New product introduction is a task shared by regional managers and product managers. While product managers decide how to launch a product, regional managers can make modifications based on the region (Anand & Daft, 2007).

Boundaryless organization is a term coined by Jack Welch of General Electric Company. It refers to an organization that eliminates traditional barriers between departments and between the organization and the external environment. Many different types of boundaryless organizations exist. One form is the modular organization, where all the nonessential functions are outsourced. The idea behind this format is to retain only the value-generating and strategic functions in-house, while outsourcing the rest of the operations to multiple suppliers. An example of a company doing this is Toyota. By managing relationships with hundreds of suppliers, Toyota achieves efficiency and quality in its operations. Strategic alliances constitute another form of boundaryless design. Here, similar to a joint venture, two or more companies identify an area of collaboration and combine their efforts to create a mutually beneficial partnership. In this form, the traditional boundaries between two competitors may be broken.

For example, Starbucks Corporation formed a highly successful collaboration with PepsiCo Inc. to market its Frappuccino cold drinks. Starbucks has immediate brand name recognition in the cold coffee drink market. Still, its desire to capture shelf space in supermarkets required marketing savvy and experience that Starbucks lacked. By partnering with PepsiCo, Starbucks gained a vital head start in the marketing and distribution of this product. Finally, boundaryless organizations may involve eliminating the barriers separating employees, such as traditional management layers or walls between different departments. Structures such as self-managing teams create an environment where employees coordinate their efforts and adapt their roles to suit the demands of the situation, rather than insisting that something is “not my job” (Dess et al., 1995; Rosenbloom, 2003).

Learning Organizations

A learning organization is one where acquiring knowledge and changing behavior resulting from the newly gained knowledge are part of the organization’s design. These structures’ norms involve experimentation, learning, and reflecting on new knowledge. At the same time, many procedures and systems facilitate learning at the organizational level.

Experimentation and testing of potentially better operational methods are encouraged in learning organizations. This is true not only in response to environmental threats, but also in identifying future opportunities. 3M is one company that institutionalized experimenting with new ideas by allowing each engineer to spend one day a week working on a personal project. At IBM Corporation, this is achieved by assigning highly successful business managers to lead emerging business opportunities (EBOs). IBM is a company that consistently generates new ideas, as evidenced by the numerous patents it holds. However, commercializing these ideas has been a challenge in the past, mainly due to an emphasis on short-term results. To change this situation, the company began experimenting with EBOs. The company took a significant step toward becoming a learning organization by establishing a structure that tolerates failure and encourages risk-taking (Deutschman, 2005).

Learning organizations are also adept at learning from experience, whether their own or that of a competitor. Companies conduct a thorough analysis of their past mistakes to learn from them. Some companies conduct formal retrospective meetings to analyze the challenges encountered and areas for improvement. To learn from others, these companies conduct thorough studies of competitors, market leaders in various industries, clients, and customers. By benchmarking against industry best practices, they continually seek ways to improve their operations. Learning organizations are also good at studying customer habits to generate ideas. For example, Xerox Corporation employs anthropologists to gain insights into how customers utilize their office products (Garvin, 1993). By using these techniques, learning organizations facilitate innovativeness and make it easier to achieve organizational change.