Decision Rights: Who Gives the Green Light?
Four steps to ensure that the right decisions are made by the right people. HBS professor emeritus Michael C. Jensen explains in Harvard Management Update.
How a company decides who is authorized to make what types of decisions can have a profound effect on its business, both in terms of everyday effectiveness and the bottom line.
Consider the experience of one global conglomerate that recently shifted to its U.S. headquarters final decision authority for the pricing of bids made by its foreign subsidiaries. The company believed that its U.S.-based executives would be more effective in making pricing decisions because they had a broader purview of the company's needs. But the time needed to transfer the relevant information to headquarters, and for executives there to absorb and react to it, reduced the company's ability to respond to bid requests on a timely basis. Alert to this change, a European rival added a 24-hour limit to its competing bids, forcing quick decisions from clients—and winning new business as a result.
Such a scenario "happens all too often," says Michael Jensen, professor emeritus at Harvard Business School and managing director of Cambridge, Massachusetts-based Monitor Group's organizational strategy practice. "Allocating decision rights in ways that maximize organizational performance is an extraordinarily difficult and controversial management task."
And therein lies a big problem, because how effective an organization is at making high-quality decisions consistent with its mission and objectives, the experts note, is a prime determinant of its ability to compete in the marketplace.
To better understand how the distribution of decision rights drives performance and what companies can do to allocate them more effectively, we spoke with several leading authorities and practitioners. We found that while the barriers to effective decision-rights distribution can be high, several best practices promise to lower them.
Weighing the costs
There are two types of costs that must be considered in allocating decision rights. In their 1990 paper, "Specific and General Knowledge, and Organizational Structure" (Journal of Applied Corporate Finance, Summer 1995), Jensen and the late William H. Meckling note these issues:
- The cost of delegating decision rights to those who have the relevant information but whose motivations and goals don't align with those of the company.
- The cost of accurately transferring the relevant information from the source to the decision maker.
Placing decision rights where these combined costs are minimal, the authors write, should lead to optimal decision-making efficiency and therefore better performance.
Allocating decision rights in ways that maximize organizational performance is an extraordinarily difficult and controversial management task.
— Michael Jensen
"If I know someone in the organization's lower levels can make a tough call that won't affect other parts of the company, then it's their call," says Nick Pudar, director of planning and strategic initiatives at General Motors.
But finding the organizational spot where decision costs are minimal is only part of the battle. You still must deal with the fact that those imbued with decision authority are invariably motivated by their own sets of personal and professional goals—some of which inevitably are inconsistent with those of the organization.
Overcoming these hurdles begins with the following steps:
1. Routinely review and update how decision authority is distributed
Because organizations, what they do, and the environment in which they operate continually change, decision-rights updates must become routine.
A review should examine carefully where in the organization various types of decisions are being made and whether those particular points are still the most efficient. Keith Leslie, a partner at McKinsey and Company's London office, says his firm recently advised one client to eliminate an entire management layer after such a review.
"Because they lacked sufficient information," he says, "these managers were making highly disruptive decisions about work allocation and subsequently had to spend much of their time quelling the resultant flare-ups. Those they managed were much better positioned to make such decisions themselves."
2. Avoid too much centralization—and too much democracy
Overcentralizing decision making is the biggest error companies make, Jensen says. Often as a leader, "you think you can make better calls," but decision rights must be collocated with the relevant information, and raising the level of decision-making authority thus requires transferring information upward as well. And companies often forget to do the latter or simply don't because the cost is too high.
You also need to avoid bringing too many people into the decision process, which can grind things to a halt. But be sure to involve all the key stakeholders.
To address these concerns, GM's Pudar employs an innovative approach to consensus building. Prior to making major decisions about a new initiative, he says, "I meet individually with each group involved and ask three questions: 'What specific results will your organization deliver toward our goals?' 'What actions will you take to make it happen?' And, 'What do you expect other groups will contribute?' I then convene the group leaders and tell them all what they told me. The greatest differences are always their expectations of what other groups will do.
"While there has never been perfect alignment," he says, "this process enables us to rapidly identify and address the inconsistencies."
3. Assign decision rights unequivocally
Ambiguity about who has decision rights is a common problem. Misunderstandings about which individuals or groups have the right to make which decisions frequently carries a high cost for the organization, Jensen notes, whether through duplicated or counterproductive efforts, or through the failure of the parties to act.
Although this often is diagnosed as a communication breakdown, it's really a decision-rights assignment problem, says Jensen. Occasionally, managers forget entirely to inform those to whom they have given decision authority.
4. Don't confuse a particular outcome with the process itself
Good decisions occasionally produce bad outcomes. Kimberly Rucker, of Dallas-based TXU, says management is sometimes too quick to blame the decision makers or the process itself when results are not as expected. If decision rights are well allocated, then reallocating them because of a bad outcome will only make matters worse.
The experts agree that redistributing decision authority in any organization is a difficult task fraught with controversy and organizational politics. Yet, it is also one in which organizations must routinely engage to maintain a competitive edge and maximize shareholder value.
"As a company, we've recognized that good decisions don't just happen," says Rucker. "There is a science to it—a bit of art but a lot of science."
Reprinted by permission from "Put the Right Decisions in the Right Hands," Harvard Management Update, Vol. 10, No. 5, May 2005.
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