The Rise of the Functional Structure

Specialization and horizontal differentiation within a company’s organizational structure begins with the first assignment of a person to perform a specialized role.  As more role assignments are made the company gradually evolves toward a functional structure in which employees are grouped based on common skills or expertise and/or the need to rely on and use the same resources.  For example, scientists and accountants may become part of the research and development and accounting functions, respectively, based on their common skills and the resources that they use in performing their roles on behalf of the company.  Horizontal differentiation based on the creation of functional groups allows companies to be more effective in achieving their primary business goals and objectives—producing the highest quality products and services at competitive prices while still making an acceptable profit—and should ultimately lead to improvement in the skills of the company’s employees to the point where the company develops and maintains a core competency in one or more functional areas. 

The creation of new functions, and the accompanying increase in horizontal differentiation, occurs as the company grows and its activities become more complex and senior management wishes to develop the company’s own internal skills and resources for a crucial functional area.  For example, when a company is first launched it may rely on outside contractors to skilled inputs in certain areas, such as accounting and marketing; however, as time goes by and the company achieves certain growth milestones—completion of development of its first product and/or sale contracts with its initial customers—it becomes more efficient to have employees perform the activities that have been outsourced.  As more and more functions are added to the organizational structure further differentiation occurs within each function as functional sub-groups are formed to carry out specialized tasks and activities.  In fact, each function eventually develops it own specific hierarchy and division of labor.

The path taken by companies to develop their particular functional structure depends on a variety of factors and often seems to be unplanned and reactive to unpredictable events in the company’s organizational environment.  However, the founders and other senior managers can and should be able to develop a general idea of the initial functional structure that will be needed in order for the company to fully launch its activities and then focus on acquiring the human and other resources that are necessary in order for the structure to be effectively deployed.  For example, a company formed to create and operate an online retail “store” will need to have functional groups that cover all of the steps necessary to interact with, and sell and deliver products to, its target customers. This generally means, at a minimum, that the organizational structure will need to include functional groups for software development and testing (R&D), design and maintenance of the website (IT), procurement of products or third party fulfillment of orders (Logistics/Operations), advertising and promotion (Marketing), and processing of payments from customers and to vendors (Finance).  The outline of the organizational structure is determined by stepping back and looking at all of the tasks and activities required in order for the company to create, promote and sell its products and services and then identifying the functional core competencies that will be needed.  The founders can then set about recruiting experienced functional managers to build these competencies and this larger group (i.e., founders and the senior managers overseeing the functional groups) can eventually turn their attention to strategic planning to set the direction for continued future growth.

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