Download Organize to Compete

7/14/2008
Organize to Compete
July 2008
Ricardo Alonso
University of Southern California
Wouter Dessein
Columbia University
Niko Matouschek
Northwestern University
Motivation
• Impact of competitive environment on organizational design
• Focus on multi-divisional firms
– dominate large sectors in the economy (Chandler 1977)
– organization design (somewhat) observable
– coordination and dispersed information
• Why link organization to competitive environment?
– contingency theory (Lawrence and Lorsch 1967):
optimal internal organization of a firm depends on
its external environment.
– empirical evidence
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Motivation
•
Bloom, Van Reenen, Sadun (2007)
“Decentralization positively linked with stronger product
market competition.”
•
Acemoglu, Aghion, Lelarge, Van Reenen and Zilibotti (2008)
“Robust positive association of competition and decentralization.”
• Guadalupe and Wulf (2007)
Effect of foreign competition on organizational design.
Motivation
•
Standard argument:
Competition increases the value of information  decentralization
•
–
What about the costs of decentralization?
–
Competition makes mistakes more costly, but so are biased decisions
Our argument:
Competition affects externalities between divisions
–
Externalities between divisions depend on profit margins (-)
–
Competition may affect perceived differentiation between
products of divisions (+)
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Result Preview (II)
• Downward shifts in demand (“size effect”)
– only reduction in profit margins
– results in more decentralization
• Rotation of demand (“price pressure effect”)
 competition may favor centralization
– despite fact that information becomes more valuable
Motivation
• Key ingredients (Alonso, Dessein and Matouschek 2008):
– adaptation-coordination trade-off
– the organization lacks commitment
– dispersed information & strategic communication
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Plan of Talk
• The Model
• Decision Making
• Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
The Model
Profits:
Managers:
Division 1
Division 2
1  p1q1
 2  p2q2
0
1   1   2
1   2
1  1    2
HQ
Own division bias    12 ,1
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Demand
Division 1
Division 2
p2  a  2  q2   q1
p1  a  1  q1   q2
intercept with
cross effect with
a  s and
1  U s / 2, s / 2
q1 
1
1 
2
intercept with
2  U s / 2, s / 2
1    1
a  1  p1   a  2  p2 
q2 
1
1  2
a  2  p2   a  1  p1 
The Model
Profits:
Managers:
Information:
Division 1
Division 2
1  p1q1
 2  p2q2
0
1  1    2
1   1   2
1   2
1
1  U s / 2, s / 2
1  U s / 2, s / 2
2  U s / 2, s / 2
2
2  U s / 2, s / 2
HQ
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Competition
Division 1
Division 2
p1  a  1  q1   q2  q f 1
p2  a  2  q2   q1  q f 2
Competitive fringe
Competitive fringe
p f 1  1  q f 1  q1  c f
p f 2  1  q f 2  q2  c f
Competition
Division 1



Division 2

p1  a   1  c f  1  1   2 q1  q2




p2  a   1  c f   2  1   2 q2  q1
Competitive fringe
Competitive fringe
p f 1  1  q f 1  q1  c f
p f 2  1  q f 2  q2  c f
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Competition- Size effect
Division 1



Division 2

p1  a   1  c f  1  1   2 q1  q2
cf
p1




p2  a   1  c f   2  1   2 q2  q1
p2
q1
q2
Competition- Price Pressure
Division 1



Division 2

p1  a   1  c f  1  1   2 q1  q2

p1
q1




p2  a   1  c f   2  1   2 q2  q1
p2
q2
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Demand
Division 1


Division 2


p1  a   1  c f  1  1   2 q1  q2
1
2
2




p2  a   1  c f   2  1   2 q2  q1
q1
2
 q2
Measure of (horizontal) product differentiation
Decentralization
message
Division 1
Division 2
quantity
price p1q1
quantity
price p2q2
message
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Centralization
HQ
message
quantities
prices p1q&
p2q2
1&
Division 1
message
Division 2
The Model
• More general linear demand structures:
p1  a1  1  b1q1   q2   f 1q f 1
p2  a2  2  b2 q2   q1   f 2 q f 2
p f 1  a f 1  b f 1q f 1   f 1q1
p f 2  a f 2  b f 2 q f 2   f 2 q2
• Demand uncertainty  cost uncertainty
• Demand interdependence  cost interdependence
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Plan of Talk
• The Model
• Decision Making
• Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
Price Setting – Centralization
max p1 , p2 E 1   2 m1, m2 
1
p1C  E 1 m1 
2
1
p2C  E  2 m2 
2
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Price Setting – Decentralization
Manager 1
Manager 2
max p1 E  1  1    2 1, m1, m2 
max p2 E 1    1   2  2, m1, m2 
p1D 
1

1 
2
2
 
1

 E  2  p2D m1, m2  






p2D 
1

2 
2
2
1
p1C  E 1 m1 
2
 
1

 E 1  p1D m1, m2  






1
p2C  E 2 m2 
2
Quantity Setting – Centralization
max q1 ,q2 E 1   2 m1, m2 
q1C 


E 1 m1  2q2C
2
q2C 


E  2 m2  2q1C
2
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Quantity Setting – Decentralization
Manager 1
Manager 2
max q1 E 1  1     2 1, m1, m2 
max q2 E 1    1   2 2 , m1, m2 
q1D 



1  2E q2D m  2  1  

E q2D m

2
 2  
q1C 


q2D 

E 1 m1  2q2C

q2C 
2


 2  2E q1D m  2  1  

E q1D m

2
 2  



E  2 m2  2q2C
2
Plan of Talk
• The Model
• Decision Making
• Communication
- Vertical Communication
- Horizontal Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
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Incentives to Misrepresent – Price Setting
• Suppose Manager 1 can choose Manager HQ’s posterior 1  E 1 m1 
max 1 E2 1  1     2  s.t. p1  p1C and p2  p2C
1*  1  
2  1 
E 2   b
2 
• Similarly for Manager 2:
2*   2  
2  1 
E1  b
2 
Incentives to Misrepresent – Quantity Setting
• Suppose Manager 1 can choose Manager HQ’s posterior 1  E 1 m1 
max 1 E2 1  1     2  s.t. q1  q1C and q2  q2C
1*  1  b
• Similarly for Manager 2:
2*   2  b
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Vertical Communication Equilibria – Price Setting
1

Managers 1 & 2
send messages

a   1 c f  s / 2
Manager HQ
updates beliefs



a   1 c f  s / 2
a   1 c f  s / 2

2


a   1 c f  s / 2
Manager HQ
sets prices
ai  ai 1 4b  ai 1  ai
Vertical Communication Equilibria – Quantity Setting
1

Managers 1 & 2
send messages

a   1 c f  s / 2
Manager HQ
updates beliefs



a   1 c f  s / 2
a   1 c f  s / 2


2

a   1 c f  s / 2
Manager HQ
sets quantities
ai  ai 1 4b  ai 1  ai
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Quality of Vertical Communication
s2
3N
ViC  Emi  i  
2


b2 2
N 1
3

s2
3
if N N  1 
if b 
s
 N N  1
b
s
2
Vi C
0 .3 0
0 .2 5
0 .2 0
0 .1 5
0 .1 0
0 .0 5
0 .1
0 .2
0 .3
0 .4
0 .5
b
Plan of Talk
• The Model
• Decision Making
• Communication
- Vertical Communication
- Horizontal Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
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Communication Equilibria – Decentralization
• Price competition (for example substitutes):
• a higher realization of 1 has two opposite effects on optimal p2:
• direct effect: decreases quantity q2
• indirect effect: reaction to change in p1
• For HQ both effects cancel each other
• First Best p2 does not depend on 1
• Manager 1 puts more weight on indirect effect
• Manager 1 would like to raise p2
• Manager 2 puts more weight on the direct effect
• Manager 2 would like to lower p2
• Given this lack of congruence between managers:
– no communication for any    12 ,1
Communication Equilibria – Decentralization
• Quantity competition:
• changes in 1 have no direct effect on optimal q2
only indirect effect
• Both managers agree on the sign of the change in q2
– some communication for   12  
• Horizontal communication degrades very quickly with 
– no communication for λ = 1
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Plan of Talk
• The Model
• Decision Making
• Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
The Costs and Benefits from Decentralization
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

coordination effect
loss of control
gain in information
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The Costs and Benefits from Decentralization
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

gain in information
Gain in information: C  I P   C  IC 



1
VC
2

  

2  1  
 
 


 


 Increases in |/| and residual variance
 Independent of nature of products or
mode of competition.
 Any difference across cases will owe to
how other gains/losses behave.
The Costs and Benefits from Decentralization
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

loss of control
Loss of control:
 Increases in |/| and E[].
 Substitutes: higher when prices than quantities
 Complements: higher when quantities than prices
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The Costs and Benefits from Decentralization
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

coordination effect
coordination effect:
Quantity competition: coordination effect < 0
Price competition: coordination effect > 0
Substitutes and Bertrand-Complements
  1/ 2  
• Delegation Principle holds (Delegation always optimal)
• Competition does not affect choice of organizational structure
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Bertrand
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

coordination effect
loss of control
gain in information
• Loss of control and coordination effect second order wrt 
Bertrand
 D  C 
C  I P    C  IC  


gain in information
• Loss of control and coordination effect second order wrt 
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Substitutes and Cournot Competition
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

coordination effect
loss of control
gain in information
• Loss of control second order wrt , but coordination effect first order.
Substitutes and Cournot Competition
 D  C   D  I D    D  I P  


 C  I P   C  IC 
coordination effect
gain in information
• Loss of control second order wrt , but coordination effect first order.
• However, gain in information outweighs coordination effect.
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Focused Managers (=1) - Bertrand
s
E  
1 .0
0 .9
0 .8
0 .7
0 .6
0 .5
Decentralization
0 .4
0 .3
0 .2
0 .1
Centralization
-1 .0
-0 .8
-0 .6
-0 .4
- 0 .2
Centralization
0 .0
0 .2
0 .4
0 .6
0 .8
1 .0


Focused Managers (=1) - Cournot and Substitutes
s
E  
1 .0
0 .9
0 .8
0 .7
0 .6
0 .5
0 .4
Decentralization
0 .3
0 .2
Centralization
0 .1
0 .0
0 .2
0 .4
0 .6
0 .8
1 .0


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“Size effect”- Bertrand
s
E  
cf
1 .0
0 .9
0 .8
0 .7
0 .6
0 .5
0 .4
0 .3
0 .2
0 .1
-1 .0
-0 .8
-0 .6
-0 .4
- 0 .2
0 .0
0 .2
0 .4
0 .6
0 .8
1 .0


“Size effect”
cf
• Downward shift in demand reduces FB price-cost margins E[]
• Gain in information: Does not affect the value of information
but improves vertical communication
 Force towards centralization
• Loss of control: Reduces intra-firm conflict:
• Coordination effect: Improves horizontal communication (Cournot)
 Force towards decentralization
• Second and third effect dominate:
 More intense price pressure leads to more decentralization
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“Price pressure” - Bertrand
1
s
E  
1 .0
0 .9
0 .8
0 .7
0 .6
0 .5
0 .4
0 .3
0 .2
0 .1
-1 .0
-0 .8
-0 .6
-0 .4
- 0 .2
0 .0
0 .2
0 .4
0 .6
0 .8
1 .0


• For small
high levels
levelsofofcompetition,
competition,imitation
imitationpressure
pressurefavors
favorscentralization
decentralization
Price Pressure

• Price pressure has two effects.
• Reduces FB price-cost margins E[] (similar to price pressure)
• Reduces differentiation between products (increases |/|).
• Second effect:
• Gain in information: Increases value of information
(mistakes are more costly) and worsens vertical communication.
 Force towards decentralization
• Loss of control: Less differentiation increases intra-firm conflict
• Coordination: Increases importance of coordination
 Force towards centralization
 Overall the second effect leads to more centralization
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Price Pressure
• Higher price pressure will lead to more decentralization
whenever the first effect dominates.
• For small levels of competition, an increase in price pressure
… improves communication to HQ…
… but also reduces intra-firm conflict.
 more competition favors decentralization
• For high levels of competition, an increase in price pressure
… makes mistakes more costly…
… but increases the coordination effect…
… and also leads to more intra-firm conflict.
 more competition favors centralization
Summary
• If division managers are very aligned
• decentralization dominates (delegation principle)
• level of competition does not affect organizational structure
• A decrease in FB profit margins unambiguously favors decentralization
• An increase in price pressure:
 Favors decentralization for low levels of competition
 Favors centralization if intense competition
• More likely to decentralize with higher uncertainty and more product
differentiation for any level of competitive pressure.
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Plan of Talk
• The Model
• Decision Making
• Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
Cournot- Complements
  1/ 2  
s
E  
1 .0
0 .9
0 .8
0 .7
0 .6
0 .5
Centralization
Decentralization
0 .4
0 .3
0 .2
0 .1


- 1 .0
- 0 .8
- 0 .6
- 0 .4
- 0 .2
0 .0
• Delegation principle fails
– For complements and high |t| always better to centralize
in spite of negligible conflict.
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Cournot- Complements
 D  C   D  I D    D  I P     D  I P    C  I P    C  I P    C  IC  

 
 

loss of control
coordination effect
gain in information
• Loss of control second order wrt , but coordination effect first order.
Cournot- Complements
 D  C   D  I D    D  I P  


 C  I P   C  IC 
coordination effect
gain in information
• Loss of control second order wrt , but coordination effect first order.
– gain in information:
– coordination effect:

VC
 2


 VD
2 2   2   2 
2 2  2
– Ability of agents to coordinate proportional to how well agents
communicate horizontally
– Gain in information proportional to how well agents communicate
vertically
– Coordination effect relatively more important with |/|
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=0.51– Cournot Complement
0 .2 0
Centralization
Decentralization
s
E  
0 .1 5
0 .1 0
Centralization
Decentralization
0 .0 5
0 .0 0
-0 .5
-0 .4
- 0 .3
-0 .2
-0 .1
0 .0


• Decrease in FB profit margins can lead to centralization
Summary – Cournot Complements
• If division managers are very aligned (almost team theory case):
• centralization may dominate (delegation principle fails)
• level of competition affects organizational structure
• A decrease in FB profit margins can lead to centralization
• An increase in price pressure:
 Can favor centralization for low levels of competition
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7/14/2008
Plan of Talk
• The Model
• Decision Making
• Communication
• Competition and Organizational Structure
• Case: Cournot-Complements
• Conclusions
Conclusions
• Internal organization of multi-divisional firms
• Internal organization  market structure
• Competition can affect the gain in information but also internal
conflict and ability of managers to coordinate.
• Reduction of profit margins favors decentralization
• Price pressure exacerbates conflict and can favor centralization.
• Even if Managers are very aligned centralization maybe optimal
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