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Decision-Making Costs & Spatial Organization

(http://faculty.washington.edu/krumme/systems/decentral.html)


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Among the few attempts to create viable conceptual links between organization theory and spatial organization theory, Isard's model stands out in that it goes beyond strictly economic variables.

"We shall attempt to probe into the optimal allocation of decision-making authority among the nodes of a set of interdependent organizations which are component units of a society." (p.57) Centralization / Decentralization of decision-making authority shall be defined here on the basis of three types criteria, namely those which are (1)"functional", (2) based on the structure of communication channels and (3) "morphological". In particular, we are interested in
  1. the extent to which relatively important, strategic decisions are made at relatively high (low) levels in an organizational hierarchy;
  2. the extent to which communication is restricted to vertical exchanges (=centralization) or lateral / horizontal communication is permitted across hierarchically segmenting boundaries (=decentralization). Spatial centralization / decentralization (McNulty)
  3. the ratio of organizational distance to the span of control, i.e. the degree to which the hierarchy is long and narrow (centralization) or wide and flat (=decentralization)

Walter Isard (1969) suggests that there are three particularly important dimensions in a decision-making oriented design of organizational structures in space, namely

  1. The Participation Potential of an individual or a population of individuals in any given decision or all decisions of a system
  2. Information, Communication, and Other Decision-Making Costs
  3. The Overview Advantage and Disadvantage

I. Participation Potential:

The inclusion of this component concept is based on the belief that participation in decision-making (with the assumption of greater responsibility) increases an individual's or population's productivity by increasing the individual's enthusiasm or a group's morale.. (pp.76-7)


II. Cost of Information and Communication, and Other Decision-Making and Transaction Costs

Here we are referring to what Williamson and others would call "transactional efficiency", namely the costs associated with
  1. Information collection: Each node collects information within its own hinterland.
    • If most of the information needed for a decision is collected locally, and
    • if a large fraction of such information is (costlessly) visible to locals, and if
    • this visibility is rapidly falling off with distance
    then: the greater the distance between a node and the decision-node, the more information has to be formally collected (incurring costs), and the more the organization could save by shifting decision authority to the local level and benefit from local visibility. In general (and ceteris paribus), the cost of collecting information would increase with the degree of spatial centralization.

  2. Information Processing (inclusive of computing and research costs) Depending on the existence and extent of scale economies in processing information, processing costs would decrease with the degree of spatial centralization. This advantage of centralization could be reduced by the availability of free computer time and volunteer labor at the local level.

  3. Information transmission costs between nodes: Total transmission costs between will increase with spatial centralization due to
    1. intervening distance. The precise cost/distance function will be influenced by
      1. terminal transmission costs (incl. coding and decoding)
      2. scale economies in transmission (larger or smaller data sets)
    2. the larger amount of formal information which has to be transmitted (subject to above scale economies)

  4. Cost of managerial and executive time and other resources spent on decision-making Two counter-directional situations can be distinguished:
    1. Without decision-making slack at local levels, decision costs would tend to decrease with centralization due to "scale economies"
    2. However, with slack time available at local levels ("we need some managers at the local level anyway, they might as well be involved in some decision-making -- without having to pay them higher salaries") centralized decision-making might suffer from executive redundancies.

  5. Costs associated with writing and enforcing contracts
    Here we would follow transaction-cost-theoretical argumentation separately from decision-making executive costs (see above). We suggest that distance and spatial decentralization (ceteris paribus)
    1. make it more necessary, but also more difficult and costly to
      1. write contracts
        1. more contracts have to be written, since less transaction can be left to the "hand-shake" between people; there would be less ability to exploit locally developed trust making formal contracts unnecessary)
        2. contracts become more complex due to differences in laws and cultures
      2. enforce contracts ("opportunism" could be expected to be more wide-spread in decentralized organizations due to costs of monitoring and control.)
    2. On the other hand, spatial centralization may benefit from the "internalization" ("playing the cards closer to of one chest") as well as from the routinization of transactions, superior lawyers at headquarters and other

III. Overview Advantage and Disadvantage

Decision-makers at the main (HQ) node can potentially make "better decisions" due to being able to be consistent (over time and with respect to overall organizational goals and objectives) and , coordinated (avoiding conflicts).


Conclusions

In real organizations, one would expect advantages of spatial centralization and decentralization be combined with aspatial organizational (centralized and decentralized) structures. In addition, one would expect modern information technologies to enable decision-makers to get speedy access to information from afar, to monitor distant operation closely from HQ through integrated computer systems (e.g. via overnight downloads of daily records), and, precisely because of the fast-turn-around oversight from distant HQ, allocating significant decision-making power to local managers who have gained local trust and are familiar with local environments. Regular visits by HQ executives using modern means of transport, intermittently complemented by frequent faxes and Emails make sure that spatially decentralized decision-makers are aware of overall organizational objectives while informing the HQ executives sufficiently about local peculiarities to be able to coordinate and control the outer fringes of the organization.

Literature:

Isard, Walter. General Theory: Social, Political, Economic and Regional. M.I.T. Press, 1969. [Chapter 3: "The Spatial Pattern of Decision-Making Authority and Organization,", pp.57ff.]

Marschak, Thomas, "Centralization and Decentralization in Economic Organizations," Econometrica 27, July 1959, 399-430.

McNulty, James E., Some Economic Aspects of Business Organization. University of Pennsylvania Press, 1964.

Mookherjee, Dilip and Reichelstein, Stefan, "Incentives and Coordination in Hierarchies", Advances in Theoretical Economics: 1(1), 2001,

The internal organization of large firms as well as procurement and regulation contexts frequently involve a hierarchical nexus of contracts, with substantial delegation of decision making across layers. Such hierarchical delegation of decision making creates problems of aligning incentives of vertically related agents, and coordinating the actions of different branches of the hierarchy....

Williamson, Oliver E., The New Institutional Economics: Taking Stock, Looking Ahead," Journ. of Economic Literature, 38(3), Sept. 2000, 595-613.

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2001 [econgeog@u.washington.edu]