Organization Architecture - Principles of Management

The term organization architecture refers to the totality of a firm’s organization, including formal organization structure, control systems, incentive systems, organizationalculture, and people. Figure illustrates these different elements.

By organization structure we mean three things: the location of decision -making responsibilities in thefirm (centralized or decentralized); the formal division of the organization into subunitssuch as functions, product divisions, and national operations; and the establishment ofintegrating mechanisms to coordinate the activities of subunits (such as cross-functionalteams).

Controls are the metrics used to measure the performance of subunits and judge howwell managers are running those subunits. Incentives are the devices used to encouragedesired employee behavior. Incentives are closely tied to performance metrics. For example,the incentives of a manager in charge of General Electric’s lighting business might be linkedto the performance of that division.

Organizational culture refers to the values and assumptions that are shared among the employees of an organization. Just as societies have cultures, so do organizations. Organizations are societies of individuals who come together to perform collective tasks.They have their own distinctive patterns of culture and subculture.

Finally, by people we mean not just the employees of the organization,but also the strategy used to recruit, compensate, motivate, and retain those individuals andthe type of people they are in terms of their skills, values, and orientation—in other words,their human capital.

As illustrated by the arrows in Figure , the various components of organization architectureare not independent of each other: Each component shapes the others. An obviousexample is the strategy regarding people. This can be used proactively to hire individualswhose internal values are consistent with those the firm wishes to emphasize in its organizationalculture. The people component of architecture can be used to reinforce the prevailingculture of the organization.

If a business enterprise to going to attain a competitive advantage and maximize its performance, it must pay close attention to achieving internal consistency between thevarious components of its architecture, and the architecture must support the strategy andoperations of the firm. For illustration, let’s return to the example of Nucor Corporation.

As noted earlier, Nucor operates in a very tough industry that has been characterized bydecades of sluggish demand, excess capacity, and price competition. Whereas many U.S.steelmakers have gone bankrupt in the last decade, Nucor’s performance has been exemplary.Between 1994 and 2005 sales revenues grew from $2.9 billion to$12.7 billion;earnings per share increased from $1.30 to$8.26; and the company’s profitability, measuredby ROIC, has averaged around 13.5 percent. How did Nucor achieve this strong performancein such a hostile environment?

The short answer is that Nucor has the lowest operating costs in the industry due to the successfulimplementation of a low-cost strategy. What is particularly interesting is how its organization architecture helped Nucor attain this position. Nucor is a minimill: It uses electric arcfurnaces to smelt scrap steel. It has some 25 steelmaking plants, each of which is organized asa stand-alone division.

There are only three management layers in each plant—a divisionalgeneral manager, a department manager, and a supervisor. The divisional general managerreports directly to Nucor’s small head office. The workforce in each plant is organized into20–30 person self-managing teams that are responsible for an entire work process and that canschedule work and develop process improvements. Each plant has about 300 employees. Thus Nucor has a very flat organization, which lowers costs, and a high level of decentralization. From a control perspective, each plant is assigned a profitability target, and each workgroup a productivity goal. Due to the decentralized nature of the organization, the plant managersand work groups are responsible for their own performance, which is quite visible. Thismakes accountability and control relatively easy.

Senior managers monitor performanceagainst goals, intervening only when goals are not met. These control systems are linked toaggressive performance-based incentive pay systems. Nucor’s philosophy is to tie pay closelyto performance. Employees in the work groups are paid weekly performance bonuses basedon their ability to meet and exceed productivity goals. Although Nucor’s base pay is lowerthan the steel industry average, the bonuses can total 80–150 percent of an employee’s basepay, making take-home pay significantly above the average.

To get bonuses, however, employeeshave to work productively, which lowers Nucor’s costs and helps make the firmcompetitive. Similar incentive plans are in place for department managers and general managers.The bonus pay of general managers is linked to that of Nucor as a whole.

As a result,if employees within a division find ways to improve production processes over time (whichtheir incentives encourage them to do), lowering the costs of the division, the general managerhas an incentive to quickly share these with other divisions because that will boost theperformance of Nucor as a whole and hence his or her bonus pay. Thus the bonus pay systemcreates an incentive for sharing knowledge across divisions.

Nucor’s pay-for-performance systems and high levels of decentralization are not foreverybody. Nucor’s managers realize that self-reliant, goal-oriented individuals will do best inits organization, so its human resource professionals try to hire individuals that have thisparticular profile (they give prospective employees psychometric tests to identify theirpersonality profiles).

Nucor’s culture is focused on cost minimization, commitment to employees, and an egalitarianethos. The culture of the organization was largely shaped by the former CEO, KenIverson. Iverson engaged in significant symbolic behavior that sent strong signals to allemployees that cost containment was important. Iverson drove an old car, had a low base salary(much of his pay was performance linked), answered his own phone, flew in coach class,stayed in inexpensive hotels when traveling, and would walk rather than take a taxi if that waspossible.

At the head office there are no assigned parking spaces and no executive diningroom (the dining room is a delicatessen across the road from the head office). Nucor operateswith an “open book” philosophy, so all employees know how their work groups, divisions, andthe company are doing. Nucor has had a long-standing commitment to all employees thatwhen demand turns down in this cyclical industry, no one will be laid off.

Instead employeeswork fewer hours, and managers take cuts in their base pay! The culture shaped by theseactions creates an atmosphere within which employees recognize the importance of costcontainment and are motivated to reduce costs because the organization is committed to itsemployees.

In sum, Nucor’s flat decentralized organization structure, simple but powerful control systems, aggressive pay-for-performance systems, hiring practices, and organizational culture combine to create an organization architecture that encourages employees to work in a productive manner (which lowers the cost structure of Nucor) and to discover and share ways of improving work process to attain higher productivity (thereby pushing out the efficiency frontier in the industry). Organization architecture, in other words, is a key to Nucor’s competitive advantage.

As the Nucor example illustrates, organization architecture is the bedrock upon which efficient operations and effective strategy implementation are built. However, the organization that works for Nucor might not make sense for a business that is pursuing a different strategyin a different industry. A retail business like Nordstrom, for example, which competes through differentiation (in Nordstrom’s case superior in-store customer service), may need a different type of organization architecture.

A crucial task of managers, therefore, is to design an organization architecture that makes sense for the market in which an enterprise competes and the basic strategic positioning it is trying to achieve. The start of this process is to design the correct organization structure.