KEY CONCEPT

The decision as to whether or not to centralize can be a difficult one for CEOs. This Idea suggests that three critical questions can provoke thoughtful debate and help teams make better choices: 1) is it mandated?; 2) does is add significant value?; and 3) are the risks low? No to all three questions would signal to a decision-maker not to centralize, whereas yes to even one can justify centralization.

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IDEA SUMMARY

Are the gains of centralization (i.e. combining business activities) worth the pain it can cause? This is the dilemma, or the “tug of war” between centralization and decentralization faced by many CEOs. On the one hand, badly-judged centralization can stifle initiative, constrain the ability to tailor products and services locally, and burden business divisions with high costs and poor service. However, on the other hand, insufficient centralization can deny business units the economies of scale or coordinated strategies needed to win global customers or outperform rivals.

To help come to a solution, faculty from Ashridge Business School; University of St Gallen conducted 50 interviews with heads of group functions at more than 30 global companies. Based on their findings they propose a decision-making framework that embodies 3 questions that can:

• help stimulate new proposals;
• keep emerging ones practical; and
• turn political turf battles into productive conversations.

Each question defines a hurdle that a centralization proposal must meet. A decision to centralize requires a yes to at least one of them. These questions benefit companies by allowing advocates and opponents of centralization to conduct a debate in a way that helps CEOs and their senior teams make wiser choices.

This Idea also presents the case studies of European Automation and Extreme Logistics experience of working through these questions to decide if centralization was suitable for them.

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BUSINESS APPLICATION

The three questions each define a hurdle that a centralization proposal must meet, and a decision to centralize requires a yes to at least one of them. The questions are as follows:

1. Is centralization mandated? Does the company have a choice? A corporation’s annual report and consolidated accounts, for example, are required by law and must be signed by the CEO, so it is impossible to delegate this task to the business divisions. In this case, the answer is yes to centralization. On the other hand, centralization is not essential for compliance with health and safety laws; each division can manage its own compliance. So a proposal to appoint a head of group health and safety would get a no for this question and would need a yes from question two or three.
2. Does centralization add significant value - 10 per cent? If centralization is not mandated, it should be adopted only if it adds significant value. This can be difficult to judge. One option is to set a hurdle high enough so that the benefits of centralization will probably far outweigh the disadvantages, making the risks worth taking; for example, ask “does the proposed initiative add 10 per cent to the market capitalization or profits of the corporation?”
3. Are the risks low? Most centralization proposals will not pass either of the two previous hurdles: they will not be mandated and will not represent major sources of additional value. Therefore, the proposals should go forward only if the risks of these negative side effects are low.

To conclude, no to all three questions would strongly suggest not to decentralize; a proposal to centralize only needs a yes to one of these three questions. Yet they provide a high hurdle that helps managers avoid too much centralization. Moreover, they stimulate open and rational debate in this highly politicized area.

These questions help companies strike the right balance between centralization and decentralization today and to evolve their organizations successfully as conditions change over time.

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REFERENCES

To Centralize or Not to Centralize? Andrew Campbell, Sven Kunisch & Guenter Mueller-Stewens. McKinsey Quarterly (June 2011).

 

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