Responsibility Accounting and Decentralization

52 Describe How Decision-Making Differs between Centralized and Decentralized Environments

Businesses are organized with the intention of creating efficiency and effectiveness in achieving organizational goals. To aid in this, larger businesses use segments, uniquely identifiable components of the business. A company often creates them because of the specific activities undertaken within a particular portion of the business.1 Segments are often categorized within the organization based on the services provided (i.e., departments), products produced, or even by geographic region. The purpose of identifying distinguishable segments within an organization is to provide efficiency in decision-making and effectiveness in operational performance.

Organizational Charts

Many organizations use an organizational chart to graphically represent the authority for decision-making and oversight. Organizational charts are similar in appearance to flowcharts. An organizational chart for a centralized organization is shown in (Figure). The middle tier represents position held by individuals or departments within the company. The lowest tier represents geographic locations in which the company operates. The lines connecting the boxes indicate the relationship among the segments and branch from the ultimate and decision-making authority. Organizational charts are typically arranged with the highest-ranking person (or group) listed at the top.

An Organizational Chart for a Centralized Organization. Centralized organizations have units that report directly to one person. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

A centralized organizational chart showing four departments reporting to the President: Sales and Marketing, Operations, Manufacturing, and Finance. Three locations report to the President: Northeast Region, Southwest Region, and Midwest Region.

Notice the organization depicted in (Figure) has segments based on departments as well as geographic regions. In addition, all lines connect directly to the president of the organization. This indicates that the president is responsible for the oversight and decision-making for the production and sales departments as well as the district (Northeast, Southwest, and Midwest) managers; essentially, the president has seven direct reports. In this centralized organizational structure, all decision-making responsibility resides with the president.

(Figure) shows the same organization structured as a decentralized organization.

An Organizational Chart for a Decentralized Organization. Decentralized organizations have units that report through intermediate management layers. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

A decentralized organizational chart showing five divisions reporting to the President: Operations, Northeast Region, Southwest Region, Midwest Region, and Finance. Each of the regions have two divisions that report to them: Sales and Marketing, and Manufacturing.

Notice that the organization depicted in (Figure) has the same segments, which represent departments and geographic regions. There are, however, noticeable differences between the centralized and decentralized structure. Instead of seven direct reports, the president now oversees five direct reports, three of which are based on geography—the Western, Southern, and Eastern regional managers. Notice, too, each regional district manager is responsible for their respective production and sales departments. In this decentralized organization, all decision-making responsibility does not reside with the president; regional decisions are delegated to the three regional managers. Understand, however, that responsibility for achieving the organization’s goals still ultimately resides with the company president.

In a centralized environment, the major decisions are made at the top by the CEO and then are carried out by everyone below the CEO. In a decentralized environment, the CEO sets the tone for the running of the organization and provides some decision-making guidelines, but the actual decisions for the day-to-day operations are made by the managers at the various levels of the organization. In other words, the essential difference between centralized and decentralized organizations involves decision-making. While no organization can be 100% centralized or 100% decentralized, organizations generally have a well-established structure that outlines the decision-making authority within the organization.

Centralized vs. Decentralized Management

Gearhead Outfitters was founded by Ted Herget in 1997 in a friend’s living room in Jonesboro, AR. By 2003, the business moved to its downtown location. In 2006, a second Jonesboro location was opened. Over the next several years, the company’s growth allowed for expansion to several different cities, miles and hours away. Eventually Little Rock, AR, Fayetteville, AR, Shreveport, LA, Springfield, MO, and Tulsa, OK became home to Gearhead branches.

With such growth, the company faced many management challenges. Would it be best for management to remain centralized with decision-making coming from a single location, or should the process be decentralized, allowing local management the flexibility and autonomy to run individual locations? If local management is given autonomy to make their own decisions, will those decisions be in line with company, or perhaps, individual goals? How will management be evaluated? Will inventory management be a uniform process, or will people and the process have to adapt to accommodate differences in demand at each location?

These are just some of the hurdles that Gearhead needed to address. What are some other issues which Gearhead might have considered? Think in terms of inventory management, personnel, efficiencies, and leadership development. How could Gearhead have use decentralized management to grow and thrive? Conversely, what would the benefits of keeping all or some of the company’s management decisions more centralized be?

How Does Decision-Making Differ in a Centralized versus a Decentralized Environment?

The CEO of a centralized organization will determine the direction of the company and determine how to get the company to its goals. The steps necessary to reach these goals are then passed along to the lower-level managers who carry out these steps and report back to the CEO. The CEO would then evaluate the results and incorporate any necessary operational changes. On the other hand, the CEO of a decentralized organization will determine the goals of the company and either pass along the goals to the divisional managers for them to determine how to reach these goals or work with the managers to determine the strategic plans and how to meet the goals laid out by those plans. The divisional managers will then meet with the managers below them to determine the best way to reach these goals. The lower-level managers are responsible for carrying out the plan and reporting their results to the manager above them. The higher-level managers will combine the results of several managers and evaluate those results before sending them to the divisional manager.

Determining the Best Structure

Here are some examples of decisions that every business must make:

  • Facility and equipment purchases and upgrades
  • Personnel decisions such as hiring and compensation
  • Products and services to offer, prices to charge customers, markets in which to operate

For each decision listed, identify and explain the best structure (centralized, decentralized, or both) for each of the following types of businesses:

  • Auto manufacturer with multiple production departments
  • Florist shop (with three part-time employees) owned by a local couple
  • Law firm with four attorneys

Key Concepts and Summary

  • Segments are uniquely identifiable components of the business that facilitate the effective and efficient operation of the business.
  • Organizational charts are used to graphically represent the authority structure of an organization.
  • The CEO of a centralized organization will establish the strategy and make decisions that will be implemented throughout the organization.
  • The CEO of a decentralized organization will establish strategic goals and empower managers to achieve the goals.

(Figure)Segments are uniquely identifiable components of the business and can be categorized by all of the following except ________.

  1. products produced
  2. services provided
  3. geographical location
  4. number of employees

(Figure)Organizational charts ________.

  1. list the salaries of all employees
  2. outline the strategic goals of the organization
  3. show the structure of an organization
  4. help management measure financial performance

C

(Figure)In a centralized organization, where are goals established?

  1. at the lower level of the organization and promoted upward
  2. outside the organization based on best practices in the industry
  3. by each segment of the organization
  4. at the highest level of the organization and promoted downward

(Figure)Managers in decentralized organizations make decisions relating to all of the following except ________.

  1. the company’s stock price
  2. equipment purchases
  3. personnel
  4. prices to charge customers

A

(Figure)Define segments and describe how identifying segments within a business might help manage the business.

(Figure)Choose a company and describe how a specific issue, policy, or procedure (for example, granting merchandise returns, establishing sales prices) might look if the business is structured as a centralized business.

Answers will vary. Sample answer: McDonald’s might have a policy that all stores must sell items at a price set by the company. The purpose of this is to prevent stores from competing with each other based on price and causing confusion or frustration with customers.

(Figure)Choose a company and explain how a specific issue, policy, or procedure (for example, granting merchandise returns, establishing sales prices) might look if the business is structured as a decentralized business.

(Figure)Assume you are the manager of a local Starbucks. What factors do you feel would be relevant to hiring workers (including pay), assuming Starbucks is a decentralized organization?

Answers will vary. Responses should include factors relating to establishing a competitive pay rate based on the local economy, hiring experienced workers, investing in training, and other factors necessary to ensure the store’s success.

(Figure)Assume you are the manager of a local Starbucks. What factors do you feel would be relevant to hiring workers (including pay), assuming Starbucks is a centralized organization?

(Figure)Use Netflix’s 2017 annual report to answer the following questions. How many segments does Netflix have? What are the segments? The annual report also shows selected nonfinancial and financial information for each segment. Prepare a brief presentation listing the “Paid memberships at end of period,” “Revenues,” and “Contribution profit” (also called operating profit) for the three most recent years (2017, 2016, and 2015). In the presentation, include any observations you notice about the trends of each segment.

Netflix has three segments: Domestic Streaming, International Streaming, and Domestic DVD. Responses should present the following information:

Domestic Streaming 2017       2016       2015      
Paid memberships 54,750 47,905 43,401
Revenues $6,153,025 $5,077,307 $4,180,339
Contribution profit/(loss) $2,280,454 $1,838,686 $1,375,500
International Streaming 2017       2016       2015      
Paid memberships 62,832 41,185 27,438
Revenues $5,089,191 $3,211,095 $1,953,435
Contribution profit/(loss) $226,589 ($308,521) ($333,386)
Domestic DVD 2017       2016       2015      
Paid memberships 3,380 4,029 4,787
Revenues $450,497 $542,267 $645,737
Contribution profit/(loss) $249,972 $279,525 $321,829

Responses may note that Domestic Streaming memberships, revenues, and contribution profit are all increasing. International streaming is experiencing significant increases in memberships and revenues, but the contribution loss continues (the loss decreased from 2016 to 2017). The Domestic DVD segment is experiencing declining memberships, revenues, and contribution profit.

(Figure)Reference the Kellogg Company’s 2017 annual report to answer the following question. In “Note 18: Reportable Segments,” you will find selected financial information for segments within Kellogg Company. Prepare a brief presentation listing each segment, along with the “Net Sales,” “Operating Profit,” and “Total Assets.” For Total Assets, you should ignore Corporate and Elimination entries, and you will need to combine the U.S. divisions into a North American total. Report this information for the three most recent years (2017, 2016, and 2015). In the presentation, include any observations you notice about the trends of each segment. You may want to use Microsoft Excel or another spreadsheet application for the numerical data. This information will be used in a subsequent question.

(Figure)Lavell started out mowing lawns in the neighborhood when he was 13 years old. He did such good work that, without advertising, his business grew steadily each year. After college, Lavell decided to continue the business as a full-time career. One of his concerns, however, is the number of hours he is putting in. Once school lets out, he finds himself working long hours nearly every day of the week. Although he has added workers, his business now handles mowing, trimming, and landscaping for residential, corporate, and nonprofit clients. He is considering adding managers but is not quite sure how to structure the organization. Lavell wants to focus on building the business rather than doing the daily work, so he knows a decentralized structure will be best. He has asked you to develop a potential organizational chart to help him envision the best way to organize the business. Describe the advantages to this approach as well as any concerns he should have.

Answers will vary. Responses should include an organizational chart for a decentralized structure that includes three divisions: residential, corporate, and nonprofit. Under each of these divisions would be the mowing, trimming, and landscaping activities. Alternative responses may present three divisions: mowing, trimming, and landscaping activities with the client categories (residential, corporate, and nonprofit) below each. This is less desirable due to inefficiency. The advantage of this approach is the speed of decision-making and responding to clients. Lavell would need to ensure the quality of the services remains at a high standard.

Footnotes

  • 1 In Building Blocks of Managerial Accounting, you learned that generally accepted accounting principles (GAAP)—also called accounting standards—provide official guidance to the accounting profession. Under the oversight of the Securities and Exchange Commission (SEC), GAAP are created by the Financial Accounting Standards Board (FASB). The official definition of segments as provided by FASB can be reviewed in ASC 280-10-50.

Glossary

segment
portion of the business that management believes has sufficient similarities in product lines, geographic locations, or customers to warrant reporting that portion of the company as a distinct part of the entire company
organizational chart
graphical representations illustrating the authority for decision-making and oversight throughout an organization