Do You Know Why Your Organizational Costs Are Rising?

The costs associated with organizational alignment deal with two functions:  coordination and administration.  Coordination costs include resources dedicated to facilitating information sharing, knowledge transfer, and communication.  These resources may comprise teams, committees, or formal lateral units depending on the complexity of the organization.  Administrative costs include the top management functions for executive control and direction over all personnel, departments, facilities, and activities such as human resources, accounting, finance, public relations, contract administration, and legal.  Over time, organizational costs increase if for no other reason than business growth and to compensate for cost of living adjustments.  In some cases, however, organizational costs increase well above the expected norm. The question is why.

 

THE DRIVERS OF ORGANIZATIONAL COSTS

Growth initiatives place a burden on the organization and add significant complexity to the administration of the business. Here is why.

Drivers of Organizational Costs

  • Product line expansion.  As the number of product lines increases, the need for coordination of the various products across all functions increases.  As a result, the costs of coordination, scheduling, and administrative complexity get larger with a wider product line.
  • New market expansion.  A strategy of new market expansion or diversification increases the costs of coordination across units.  The main reason is that the structural response to a successful expansion will require greater focus on the market being served and a higher degree of autonomy and self-containment by the unit.
  • Micro-segmentation. Micro-segmentation prescribes splitting the market into finer segments for greater penetration. The structural impact of successful micro-segmentation is often the creation of a greater number of small units, necessary to follow the market closely and to take pro-active initiatives quickly.  Consequently, the costs of coordination and administrative complexity get larger.
  • Vertical integration.  Vertical integration indicates expansion of the business across the value chain, with or without more productive capacity.  Therefore, the organization grows in size without diversifying into different products or businesses.  Clearly, such organizational growth adds cost to the business.
  • Merger integration. The choice of structure depends on strategic rationale for the acquisition:  i.e. expansion, business redefinition, or industry transformation.   Invariably, the usual cost objective calls for fusing two organizations to reduce redundancies and derive cost synergies. While this sounds straightforward in principle, in practice the process is not easy.  Unless, the organization is redesigned, the benefits of cost cutting and avoiding duplications usually go unrealized.

It is important to be aware of these issues, if for no other reason than to understand cause and effect on your company’s cost structure. This is not to say that growth initiatives should not be undertaken – on the contrary.  But during development, growth initiatives should draw attention to the organizational design to ensure cost efficiency. Important basic organizing decisions include the number of management layers, span of control, division of labor, job definition, and operating procedures.

 

TAKING A HELICOPTER VIEW

It may just be true that your organization can live with escalating organizational costs, particularly if profitable growth is sufficient to offset them. But if that is not the case, you might want to take a closer look.  Given the load placed on the organization, you might ask yourself if this is the best way to be organized:

–       Does the organizational model follow our strategy?
–       Does the structure of the organization make the strategy easier?
–       Is the organizational design in place simply an accumulation of unresolved issues?
–       Can we make it better?
–       How long can the business continue to operate this way? Is this sustainable?

Ultimately, if there are organizational design issues, they need to be addressed. No matter the strategy, process reengineering, Overhead Value Analysis programs, staff reductions, or any other cost reduction approach, the organizational issues will not go away until they are resolved.  The design of the organization must serve the company in deploying its strategy.

To learn more about strategy execution and the role of organizational alignment, view our white paper: “Organizational Alignment:  Deploying for Strategy.”

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Selected References

Hrebiniak, Lawrence, and William Joice. “Implementing Strategy.” MacMillan Publishing Company, 1984