Disadvantages of Multidivisional Structures

In my last post I covered the advantages of using a multidivisional structure.  However, like all other forms of organizational structure, problems can also arise with a multidivisional structure that may need to be addressed:

  1. One of the ongoing issues with a multidivisional structure is striking and maintaining the proper balance of authority between the corporate managers and the division managers.  Companies may want to centralize decision making in order to reduce costs and prevent division managers from taking actions that are contrary to the long-term goals of the entire company; however, too much centralization deprives division managers of the flexibility and independence they need to operate their specific businesses and can damage the performance of the divisions to the extent that decisions are made slowly by corporate managers not directly involved with a particular issue or problem.  On the other hand, if division managers are given too much freedom through decentralization they will no incentive or motivation to operate their divisions efficiently or cooperate with corporate managers and other divisions. 
  2. A multidivisional structure makes it easier for corporate managers to compare the performance of the different divisions for purposes of determining how the company can obtain the highest rate of return on future allocations of capital and other resources.  While the resulting competition between the divisions can be healthy up to a point, there is a real possibility that rivalries will eventually become so intense that divisions cease to cooperate with one another by sharing resources and transferring information regarding innovations in technology and business processes that could be used by every division to improve the performance of the company as a whole.
  3. Another potential problem associated with transfer of technology, products and components between the product divisions is establishing a fair “transfer price”.  The “seller” will want to maximize its return on investment by obtaining the highest price possible; however, this approach often unfairly penalizes a “buyer” that is part of the same larger company and may even place the affiliated buyer at a disadvantage in relation to external competitors who are free to purchase comparable inputs at more favorable prices on the open market.  There are several ways to resolve this potential conflict of interest between the divisions.  For example, the corporate managers may be assigned the task of setting and enforcing transfer pricing based on a formula that includes the objectively verifiable costs of the seller plus a fixed and predetermined profit margin.  Another possibility is for corporate managers to set the price based on an independent analysis of the market price.  Finally, transfer price may be kept competitive by allowing divisions to purchase from external vendors if they are offering a better deal.
  4. A multidivisional structure can be quite costly to establish and operate.  For one thing, there is entirely new layer of management personnel and staff at the corporate headquarters level that must be funded.  In addition, the need to duplicate functional resources within each division creates a serious risk of inefficiency and redundancy that will drag down the overall performance of the company.  These costs and inefficiencies must be continuously compared to the benefits associated with the multidivisional structure and consideration may need to be given to modifications to the structure including reducing the size of the corporate headquarters and/or the number of divisions and finding ways to reduce the costs of the support functions through greater sharing of functional resources.
  5. While one of the main responsibilities of the corporate managers in the multidivisional structure is overseeing the activities of the product divisions, there will inevitably be communications problems caused by the very tall hierarchical structure.  For example, in cases where the company has a large number of product divisions it may be difficult to identify attempts by division managers to conceal performance issues from the corporate headquarters staff.  In addition, bottlenecks may arise when decisions are required from corporate headquarters and delays in getting approvals back to the divisions may place them at a disadvantage in relation to competitors that can move more quickly because their organizational structures are flatter and more efficient.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

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