Decision Rights - Who Gives the Green Light?

Published: August 8, 2005

Author: Peter Jacobs

Executive Summary:

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.

Michael C. Jensen is the Jesse Isidor Straus Professor of Business Administration, Emeritus, at
Harvard Business School.

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."

Avoid the Org-Chart Trap

by Peter Jacobs

Organization charts oversimplify the distribution of decision responsibility, say Michael Jensen and
Keith Leslie. They make it much too easy to drop people into neat, interconnected boxes and to shift
those boxes around with too little thought about the often far-reaching consequences. Carl Spetzler,
co-founder and chairman of Strategic Decisions Group in Palo Alto, California says, "I've seen many
companies become dysfunctional by paying too much attention to their org charts and too little to
the quality of decision making." Spetzler counsels clients to avoid thinking too much about decision
"rights" and org charts because these emphasize power and judgment rather than decision quality.

Another problem with charts, he believes, is the mindset they create—one in which subordinates
present supervisors with recommendations, and supervisors simply approve or reject whatever is
presented. In this case, subordinates effectively become decision makers by choosing which
alternatives to present. Though organization charts are helpful when creating operating efficiency
and effectiveness, they are detrimental to cross-organizational strategic decisions.
About the author

Peter Jacobs is a freelance business writer based in Wellesley, Mass. He can be reached at
MUOpinion@hbsp.harvard.edu.

Reprinted by permission from "Put the Right Decisions in the Right Hands," Harvard Management
Update, Vol. 10, No. 5, May 2005.