To Centralize Or Not To Centralize?

One of the more common issues faced by business executives is whether or not to centralize a key function or process. Divisional and general managers, sales leaders and HR executives face this on a regular basis each year.

In this article, McKinsey Quarterly summarizes fifty interviews with key managers and comes up with three questions to guide the decision:

1. Is centralization mandated? 
2. Can it add significantly to a corporation’s value? 
3. Can it be implemented without negative side effects?

The article provides two cases that demonstrate the questions in action. If there isn’t a clear “yes” to at least one of these questions a centralization proposal shouldn’t go ahead.

McKinsey’s default position is that centralization carries risks to the organization that are best avoided.  The risks include bureaucratization, rigidity and loss of contact with the customer. They also recognize that too little centralization can mean lost opportunities to capture economies of scale, failure to coordinate resources effectively and difficulty in maintaining consistent quality.

The questions set a high bar that would generally work against most centralization proposals.

In our work, we don’t see that there should be a clear bias either for or against centralization. The McKinsey article doesn’t provide evidence either way. An equally good argument could be made that centralization should be the default position since it frees up the customer facing units to concentrate on what they do that their customers uniquely value.

We think a better formulation of their questions would be to start with whatever the status quo is, whether centralized or decentralized. Then ask of any change proposal:

1. Is the change mandated? 
2. Can it add significantly to a corporation’s value? 
3. Can it be implemented without negative side effects?

In McKinsey’s formulation if there isn’t a clear yes to at least one of their questions the high bar for centralization isn’t passed and the process or function should probably be decentralized. As we formulate the three questions a high bar is set for changing the status quo, and if there isn’t a clear yes to at least one of the questions time and resources should probably be better utilized elsewhere.

What we like about McKinsey’s approach is that they started by asking executives how they went about making centralization decisions. They came up with their questions by making the thought processes of the executives simple and transparent. The questions are easily applied by anyone.

We think the questions would work best when facilitated skillfully probably by an independent party. A senior and credible HR executive could use the questions to help their peers with centralization decisions. A CEO could bring in an outside consultant for the short and focused task of structuring the discussions and summarizing the issues.

Getting executives to openly debate the questions helps take the politics out of centralization decisions and drives accountability.