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FUNDAMENTALS OF ACCOUNTING AND MANAGEMENT –I MANAGEMENT – CONCEPTUAL FRAMEWORK

7. Centralization and Decentralization: Meaning, Advantages and Disadvantages To understand the functioning of an organization it is important to know how the organization is structured. This will help learn how information flows in an organization and how authority is delegated in various types of organizations.

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Objectives By the end of this lesson you will…

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Differentiate between centralization and decentralization Identify advantages and disadvantages of both Appreciate the importance of delegation of authority

Introduction The efficiency of decision making and functioning of the organization depends to a large measure on where the decisions are taken. Understanding the concepts of centralization and decentralization will help the student to appreciate the importance of delegation of authority. At the same time, the student will see that some important decisions need to be taken by a few people at the top of the hierarchy.

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Centralization and Decentralization: Meaning Organizations are diverse and unique. An important function of any manager in an organization is to take decisions. A typical manager has to take decisions regarding the use of available resources, budget allocations, division of responsibility etc. While in some organizations, all decisions are taken at the top level, in others decision-making powers are delegated throughout the organization. An organization, in which the managers at the top of the hierarchy have the power to make all decisions and subordinates merely take orders from the top, is said to be centralized. In this type of an organization, subordinates are accountable for how well they follow the orders and have no authority to initiate new actions or ideas. Therefore, the degree of concentration of the

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decision making process at the top is a measure of centralization. For example, in a small retail shop or a neighborhood kirana shop the decision making authority will be highly centralized. In most of these small shops, it is found that the owner has absolute authority and the duties of subordinates (in this example, salesmen, clerks, attendants or cleaners working in the shop) are limited to following the orders of the owner. They have no authority to use the shop’s resources or take decisions without consulting the owner. However, as an organization grows and the number of employees increases, communication and coordination become a problem. It then becomes impossible for the people at the top of the hierarchy to take all the decisions. Therefore, authority is delegated at various levels in the organization. When the authority to make important decisions and initiate new projects is delegated to people at all levels in the hierarchy, the organization is said to be decentralized. There might be other reasons for decentralization. Organizations and institutions may be spread across geographic areas. Many such organizations have been structured in a way that they have a main office known as Head Office (HO) and several regional offices. There is delegation of power and authority to the regional set-ups. The authority vested in the regional offices makes them empowered to take decisions with reference to all official activities on a regional basis. Regional offices are like mini HOs but in very small regional set-ups some staff functions like finance, legal, HR might not be present.

Self-Check Questions Fill in the blanks 1. An organization, in which the managers at the top of the hierarchy have the power to make all decisions and subordinates merely take orders from the top, is said to be __________. 2. When the authority to make important decisions and initiate new projects is delegated to people at all levels in the hierarchy, the organization is said to be __________. 3. As an organization grows, it is advisable for it to become more __________.

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Advantages and Disadvantages of Centralization The advantage of centralization is that since the top executives coordinate the organizational activities, the organization stays focused on its goals. It permits crucial decisions to be made by a few individuals who have the “big picture�.

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Also, common functions such as HR and Finance work more efficiently due to better reach. Studies have shown that people working on production jobs, who perform routine assembly line jobs, are less interested in decision making and hence centralization tends to work better in these types of organizations. Centralization however becomes a problem when the organization grows and the top executives become over-burdened. It may lead to a situation in which the top executives become so involved in the day-to-day activities that they are left with no time for strategic planning and decision making about the future organizational goals. In addition, since all decision making powers are concentrated at the top, decision making takes long. Moreover, lack of regional knowledge may result in inaccurate decisions being taken.

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Advantages and Disadvantages of Decentralization Organizations need to respond rapidly to the changing conditions. Decentralization facilitates speedy action since people do not have to wait for decisions from the top authorities. Delegation of authority makes individuals feel like a part of the organization. Therefore, when the decision-making authority is decentralized, managers might be motivated to perform well. This is especially true of professionals and skilled employees who are sensitive to having a say in the activities of the organization. In addition, since people who are most familiar with the issue, (for e.g. customers, geographical specifications etc.) take the decisions, decisionmaking is more fruitful and effective. Finally, since lower level managers are given the authority to make decisions, they get a chance to learn by doing. Decentralization creates an opportunity for training of the lower level managers, which prepares them for assuming greater authority as they grow in the organization. Lastly, for people in advertising or research and development, who require greater autonomy, decentralization increases their productivity. But decentralization is not always the ideal solution for organizations. Too much decentralization may lead to planning and coordination problems. As already discussed above, in certain situations, centralization is preferred. When a few individuals at the top are able to visualize the “big picture�, or in assembly line jobs where the employees are expected to do routine tasks, in such cases centralization is preferred.

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Balance between Centralization and Decentralization The above discussion of the advantages and disadvantages of both centralization and decentralization makes it clear that an organization needs a 3


right balance between the two. While managers at the scene of action should be allowed to take spot decisions, more important decisions regarding the goals, strategy planning etc. should be left to the top executives. A case in point would be Coca Cola Inc. in 1990s. Coca Cola was a highly centralized organization; the regional operations were controlled by the Atlanta Head Office. Due to this, the company could not respond quickly to needs of different regions. Decision taking took time and managers at the head office were at many times unaware of the problems faced by the people on the front line. Coca Cola then decentralized operations to each region and by the end of the decade saw significant improvement in its profits and market share. A very good example of a balance between centralization and decentralization is Procter & Gamble. In P&G, authority is centralized at the world area level. This means that there is a Vice-President in charge of global operations of each of four areas- North America, Europe, Middle East and Africa, and Asia. It is the responsibility of the Vice-President to get different areas to cooperate and share information and knowledge. However, in each country in the world that it operated, managers in each of P&G’s divisions were free to make their own decisions.

Self-check questions True or False 4. The advantage of decentralization is that since the top executives coordinate the organizational activities, the organization stays focused on its goals. 5. Too much decentralization may lead to planning and coordination problems. 6. People in advertising or research and development are more productive in a centralized set-up.

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Assignment Given above are two examples of real life companies - Coca Cola Inc. and Procter & Gamble. As an exercise, form groups of 3-4 members and choose a real life company. Now find out about the structure of decision making in that company. Is that company highly centralized, highly decentralized or a balance between the two.

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Summing Up


An organization is said to be centralized if there is a concentration of decisionmaking at the top. However, if decision-making is delegated to managers throughout the organization, it is said to be decentralized. For efficient functioning of an organization, there should be a right mix of centralization and decentralization. While people in the line of action should be allowed to take spot decisions, the more important decisions regarding the strategy planning, goals etc. may be left to the top executives.

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Answers to Self-Check Questions Centralized Decentralized Decentralized False True False

Terminal Questions

1. Define Centralization. What are its advantages and disadvantages? 2. Define Decentralization. What are its advantages and disadvantages? 3. What do you mean by “authority”? How is it related to centralization?

7.10 References 1. http://instruct1.cit.cornell.edu/courses/dea453_653/01students/asheley_jonath an/Index.html 2. http://en.wikipedia.org/wiki/Centralization 3. http://en.wikipedia.org/wiki/Decentralization

7.11 Suggested Further Reading 1. http://www.pitt.edu/~super1/lecture/lec9481/001.htm

7.12 Glossary • • • •

Authority: power to hold people accountable for their actions and the right to make decisions. Hierarchy: a system of ranking people or things Centralization: the process by which the decision-making activities of an organization are concentrated within a particular location or a group. Decentralization: the process by which the decision-making activities of an organization are dispersed closer to the point of service or action.

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Lesson-7