University:
Stanford University
Course:
ECON 202 | Microeconomics I
Academic year:

2023
Views:

191

Pages:

2
Author:

T. Elton

Internal Performance Measurement Decentralization In any organizational structure, some authority will be delegated to lower-level management. In this sense therefore almost every firm could be described as "decentralized'. However, the term is usually reserved for those firms which give individual managers responsibility for profit, and not just costs or revenues. Decentralization will normally be based on geographical location, or a specific business activity, such as the production and sale of a particular product or group of related products. A number of advantages are claimed for this approach: • More informed decision making. The manager who is directly involved in the day-to-day running of the business is able to apply his first-hand knowledge to the decision (which also has behaviourial implications). Furthermore, experience of decision making at a decentralized level gives good career training to management. • Speed of decision making. Decisions can be made more rapidly when delegated to the local level. In the modern business environment, this can give a competitive edge to the firm. • Specialization. If a decentralized management is left to concentrate on the operating decisions, top management has more time to devote to the broader policy and strategic issues facing the organization as a whole. In highly decentralized organizations, the operating units often called divisions) are more or less autonomous, and it is the degree of autonomy enjoyed by divisional managers that creates the four basic problems associated with this form of structure: a) Obtaining a sufficient number of competent divisional managers to operate the system successfully. b) Selecting an appropriate system of performance measurement. c) Ensuring that divisional management will operate in a way which is consistent with the goals of the organization as a whole. d) Transfer pricing. A discussion of the first of these lies beyond the scope of this book, and we shall direct our attention to the second and third of the problems, which are clearly interrelated: an inappropriate performance measure can motivate managers to act in a dysfunctional and suboptimal manner, and vice versa. The reader should be aware that evaluating the performance of a division is not the same thing as evaluating the performance of its manager. For example, a highly efficient and effective manager could be put into an ailing division to improve its performance, and might succeed in increasing its profitability by, say, 200 per cent; this may well reflect a brilliant effort on the part of the manager, but if the improved profitability still falls below a given standard level, the performance of the division could still be unacceptable. There are two commonly used measures of divisional performance: return on investment (ROI) and residual income (RI), with the former enjoying much greater currency. We shall consider each in turn.