Organization Design

First Draft: July 7, 1999 Current Draft: February 22, 2000

ORGANIZATION DESIGN

by Milton Harris and Artur Raviv1

ABSTRACT
This paper attempts to explain organization structure based on optimal coordination of interactions among activities. The main idea is that each manager is capable of detecting and coordinating interactions only within his limited area of expertise. Only the CEO cancoordinate company-wide interactions. The optimal design of the organization trades off the costs and benefits of various configurations of managers. Our results consist of classifying the characteristics of activities and managerial costs that lead to the matrix organization, the functional hierarchy, the divisional hierarchy, or a flat hierarchy. We also investigate the effect of changing thefixed and variable costs of managers on the nature of the optimal organization, including the extent of centralization.

Harris is the Chicago Board of Trade Professor of Finance and Business Economics, Graduate School of Business, University of Chicago. Raviv is the Alan E. Peterson Distinguished Professor of Finance, Kellogg Graduate School of Management, Northwestern University. We thankFranklin Allen, Sel Becker, David Besanko, Ronen Israel, Ed Zajac and participants in seminars at the Stockholm School of Economics, Michigan, CMU, Berkeley, Stanford and the 2000 Utah Winter Finance Conference for helpful comments. Address correspondence to Professor Milton Harris, Graduate School of Business, 1101 East 58th Street, Chicago, IL 60637; telephone: 773-702-2549; E-mail: milt@uchicago.edu;Web: http://gsbwww.uchicago.edu/fac/milton.harris/more/.

1

Organization Design
by Milton Harris and Artur Raviv
Organizations are observed to exist with various structures. Many organizations are designed as hierarchies with each manager reporting to one and only one manager at the next higher level. Other organizations employ a matrix structure in which each low level manager reports totwo or more superiors. Within the hierarchical structure, there is considerable variation in the number of levels and in the set of activities grouped together. The two main groupings are “divisional” and “functional.” In a divisional hierarchy, all the activities pertaining to a single product (or perhaps set of products) are grouped together into a division. For example, until the late 1980sProcter and Gamble (P & G) had a relatively flat hierarchical structure with only two levels. At the lower level were the brand managers. “Each brand – such as Tide, Crisco, Head and Shoulders and Scope – had its own brand manager who was singularly accountable for his or her brand’s performance.” [Robbins (1990, p. 295)]. The only other layer was headquarters. P & G then introduced a layer inbetween the brand managers and headquarters. This layer contains division managers for product categories, such as laundry detergents, each responsible for advertising, sales, production, research, etc. for the brands in his or her category. In a functional hierarchy, by contrast, activities pertaining to a particular function are organized into departments. For example, at Maytag, these departmentsinclude R & D, manufacturing, marketing, corporate planning, personnel, finance, labor relations, and legal [see Robbins (1990, pp. 286-87)]. In a functional hierarchy, the marketing department would, for example, coordinate marketing activities for all products. Matrix structure, which involves “dual-authority relations” [Jennergren (1981, p. 43)] can combine divisional and functional structures.For example, the manager in charge of design for project A

D:\Userdata\Research\Hierarchies\temp.wpd

1

February 22, 2000 (11:18AM)

reports both to the Project A division manager and to the head of the design engineering group. In another example of the matrix form, the president of a unit producing power transformers in Norway for Asea Brown Boveri (ABB) reports to the president of...