Finally, decentralization reduces systemic risk. In a typical bank, credit decisions are made by a comparatively small number of risk managers 12 whose decisions are bound by lending rules based on credit scores, loan-to-value limits, and other factors. Centralized credit decisions also get skewed by corporate priorities, like gaining market share with small business borrowers or reducing exposure to a particular industry. This centralized, rule-driven approach tends to concentrate rather than diversify risk.
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Researchers have identified a cluster of anomalies that corrupt this process and lead to suboptimal allocation decisions. Among the most pernicious âŚ
- DEFEND WHATâS YOURS. Leaders tend to be territorial about the resources they control and are typically reluctant to share money and talent with other units, even when the returns might be higher.
- THE RICH GET RICHER. The biggest units in a multibusiness company tend to get more than their fair share of capital, not because they offer better returns, but because the leaders of these businesses have more political clout.
- GOOD MONEY AFTER BAD. Executives tend to overinvest in struggling businesses in hopes of turning them around. Research shows that in most cases, returns would have been higher if the money had been invested in less troubled units.
- SHARE THE PAIN. When cash is short, executives tend to cut spending across the board rather than protect high-priority areas.
- ITâS WHO YOU KNOW. Senior leaders with strong internal networks typically win more resources than leaders who are less well connected, irrespective of the merits of the particular business case.
- HOME IS WHERE THE HEART IS. Senior executives are less likely to defund or divest a business in which they worked earlier in their career.
- PRETTY IT UP. In competing for funds, business unit leaders have an incentive to inflate the merits of their investment proposals. These distortions are often difficult for corporate-level executives to ferret out.
- MORE OF THE SAME. Funding decisions are often made relative to last yearâs budget. Every business or product line gets pretty much what it got the year before, plus or minus a few percentage points.
If youâre starting up your own company and your goal is innovation and flexibility, try to keep decision-making decentralized, with few interdependencies between functions, in order to nurture loose coupling from the outset. It will be a whole lot trickier to introduce once your organization has settled into a tightly coupled structure.
All this said, tight coupling does have at least one important organizational benefit. In a tightly coupled system, strategic change is easily aligned throughout the organization. If the CEO wants all departments throughout the company to focus on sustainability and ethical sourcing, then she can control that through her centralized decision-making.
This case, youâll have noticed, is by no means unique. Throughout this book weâve told stories about lower-level employees making multimillion-dollar financial decisions without getting approval from the boss. Outsiders are often puzzled about how this can work in a financially responsible organization. The answer is simple: itâs because of the alignment.
You have to integrate that into the company. The processes that you put in place to do that, they have to be very deliberate. It doesnât happen by itself. What happens [naturally] is entropy. You have to leverage scale in a way that doesnât disable entrepreneurialism, business ownership. Itâs integrative. Itâs not centralized. Centralized is a very different thing. This scale work is bringing the leaders of the businesses to work together towards a plan that not only optimizes the company, but in its best form, optimizes their category as well. As we approach a market, for instance, with multiple categories, the chance for success for each of them increases.â Going into a new emerging market with several complementary categories, rather than just one, for instance, can enable cost sharing and increase local influence, thereby increasing the chance of success in the region.
Corporations are decision-making systems, not âintelligencesâ. They have homeostatic forces which aim to maintain their equilibrium, and higher-order decision-making systems which mean they are able to reorganise themselves in order to respond to shocks beyond the scope of anything anticipated when they were designed. To attribute motivation to them is to make assumptions about the internal workings of the black box â the original intellectual sin of cybernetic analysis.