How Information Communications Technology is Changing the Way Firms are Organized

TSURU Kotaro
Faculty Fellow, RIETI

When considering how a firm should be organized, certain perennial problems have to be addressed. First, how does one induce the members of a firm to work toward its objectives? Second, at what level should decisions that are important to a firm be made? In other words, should authority be centralized, such that decisions are made at a level close to the chief executive officer (CEO)? Or is it better to be decentralized, such that decisions are made at a level close to employees on the floor?

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A question that has come into particular focus in the last quarter-century is what effect information communications technology (ICT) has on firm decision-making. Harvard University Professor Emeritus Michael C. Jensen et al. in the 1990s focused on the fact that (1) decisions should be based on specific information that only those on the floor can know, but getting that information up to the CEO comes with a cost (information transfer cost); and (2) if decisions are made close to the floor level, they will diverge from the CEO's objectives and intentions (conflict of interest cost).

The use of ICT helps to lower both costs. However, lowering the information transfer cost likely would encourage centralization and lowering the conflict of interest cost would encourage decentralization, so the effect is not necessarily unidirectional.

On the other hand, in a 2000 paper, London School of Economics (LSE) Professor Luis Garicano developed a theory of firm organization decision making from the perspective of knowledge acquisition. According to this theory, the optimal level for making decisions is determined by the size of the knowledge acquisition cost (the cost for workers to obtain the necessary information on their own) and the information transfer cost (the cost of relying on higher-level problem solvers). ICT lowers both costs, but lowering the latter encourages centralization and lowering the former encourages decentralization.

I should point out that under this model, whichever cost is lowered, the organization tends to become flatter. That is, insofar as possible, the superior directly oversees a larger number of subordinates and takes control of a wider scope of affairs.

A 2014 paper by LSE Professors Garicano and John Van Reenen, Stanford University Professor Nicholas Bloom, et al. gave empirical support to the aforementioned theory. Using dataset on about 1,000 firms from the United States and seven European countries including the United Kingdom, Germany, France, and Italy, the authors analyzed the impact of ICT on decision making.

Specifically, they focused on the relationship between the corporate headquarters and plant managers. They discovered that in businesses that used enterprise resource planning (ERP) software, which is considered to enhance the ability of plant managers to obtain information for themselves, there is a tendency for more authority to be delegated to the plant managers. They also found, on the other hand, that firms with intranets, which lower the cost of transferring information within the firm, tend to give less autonomy to plant managers and that decision making is more centralized.

Focusing next on the decision-making relationship between plant managers and workers, they found that firms that use computer-assisted design/manufacturing (CAD/CAM) technology, which is considered to enhance knowledge acquisition on the part of workers, tend to give more autonomy to workers as well as have more workers who report directly to the plant manager. On the other hand, the existence of an intranet does not significantly encourage centralization of authority into the hands of the plant managers.

In a 2012 paper, Harvard University Associate Professor Julie M. Wulf showed that corporate structures shifted and became flatter in more than 300 large U.S. firms from the mid-1980s to the end of the 1990s. Layers in the hierarchical structure were eliminated as the number of positions between the CEO and division heads declined, from 1.6 in 1986 to 1.2 in 1998, for example, with the elimination of the chief operation officer (COO). Moreover, during the same period, the number of positions reporting directly to the CEO increased from 4.4 to 8.2, such that the span of control widened.

Wulf emphasizes, however, that the much trumpeted delegation of authority within the organization as a result of flattening did not necessarily occur.

The increase in the number of positions reporting directly to the CEO is accounted for not by general managers but by function managers. Most particularly, the more that a firm uses IT, the more there are of functional managers at the top such as the chief financial officer (CFO) and the chief human resources officer (CHRO) (see figure), and the more that decision making tends to be made near the top.

Figure: CEO Span of Control at Large U.S. Firms
(Number of positions reporting directly to CEO, sample average)
Figure: CEO Span of Control at Large U.S. Firms
Source: Julie Wulf, "The Flattened Firm: Not as advertised," California Management Review, Vol.66, No.1, Fall 2012.

This is because the dramatic fall in the costs of ICT makes it easier for corporate-wide function managers to coordinate with each other and exploit synergies across their increasingly related interdependent businesses.

On the other hand, in terms of the CEO's decision making, structural flattening brings the CEO closer to his/her subordinates and "closer to the businesses." This does not necessarily strengthen the vertical relationships between the CEO and his/her subordinates, but the point, rather, is a team-based collaboration with more horizontal information flows and the CEO facilitating discussion.

Moreover, a look at CEO time usage shows that CEOs of flattened firms with more direct reports spend more time in meetings that have multiple participants, are planned in advance, and cross-functional in nature, and spend less time alone. CEOs facing extreme time constraints attend such meetings and make decisions themselves. Looked at this way, the drop in information transfer cost as a result of using ICT has a greater effect than predicted.

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Turning our focus to Japan, at the dawn of the IT revolution, SoftBank Corp. CEO Masayoshi Son was a rare example of using ICT to centralize decision making. In the 1990s, Son's style of collecting thorough information from his subordinates came to be called "1,000 hits," a term referring to non-stop, intensive fielding drills in baseball. Subsequently, he performed real-time analysis of more than 10,000 financial data units (daily accounting) to make management decisions.

Extending our consideration of the impact of ICT to include employee workstyles, telework is a particularly interesting example. Telework is a very flexible way of working, since employees can choose where they work. It reduces the cost of running an office and commuting, and allows employees to work in ways that fit their lifestyles and life stages.

Telework does come, however, with latent problems. A workplace cannot produce the synergy--personal exchanges, sharing of information, and teamwork--that is possible when people work at the same time in the same place. Moreover, the inability of superiors to monitor their subordinates could negatively affect worker motivation. It goes without saying, of course, that ICT has enabled email, intranets, the cloud, and other means of sharing information, which in turn encourage telework.

There are businesses that have used the evolution of ICT to create a virtual office that is not so different from the traditional workplace, in spite of the fact that their employees are mainly working from home. A good example is Telework Management, a company in the city of Kitami in Hokkaido. It provides consulting and other services related to work at home. Within the company's online virtual office, employees can click on another person's "desk" to call them and have a face-to-face conversation. They can also have meetings with multiple coworkers. This too is an initiative that greatly expands the potential for telework, which until now has been possible mainly for types of work where authority could easily be delegated.

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Large Japanese firms are frequently criticized for not yet making enough use of ICT. Considering that, traditionally, the delegation of authority to employees and the horizontal coordination of information at the employee level has progressed, there appears to be room for ICT to be used instead of using it for centralization and strengthening top management, and that ICT would greatly benefit these areas. What is needed is a change in thinking.

>> Original text in Japanese

* Translated by RIETI.

May 26, 2015 Nihon Keizai Shimbun

June 18, 2015

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