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31
Mar

When to Ignore Expert Advice

Entrepreneurs are encouraged to seek the advice of experts in areas in which the founder has little or no personal experience.  It is impossible for one person to know everything about each issue or activity that is crucial to the success of a business during the start-up stage or later when the company is growing and looking to expand capacity and/or move into new markets or product/service areas.  However, the dilemma that often arises for the entrepreneur is determining when he or she should override the opinions of experts when making a particular decision.  The answer depends on several factors including the level of experience and training that the entrepreneur has with the subject matter of the expert advice and how much experience the entrepreneur has in a general management capacity.  For example, an entrepreneur that has participated in product development projects in the past may have seen and heard enough to critically evaluate the opinions of marketing experts about the design and promotion of the start-up company’s new product.  General management experience is a much more difficult hurdle for many entrepreneurs to overcome since they often have spent most of their careers in a single functional area and may struggle when they are suddenly called upon to oversee the whole range of value-creation activities.  In the entrepreneur has little or no general management background he should consult trusted advisors with appropriate experience to gather input on the consequences of accepting or rejecting tendered expert advice.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

31
Mar

Outsourcing Non-Disclosure Agreements

As companies grow larger the number of requests for non-disclosure agreements (“NDA”) also increases.  A prospective customer may be unwilling to disclose information regarding its product requirements and strategic plans to the sales department without an NDA and creation of a new relationship with a vendor may also be delayed until NDA is in place that allows the parties to exchange sensitive information regarding products and distribution channels.  In order to expedite the process of drafting and executing an NDA companies with sufficient volume of these types of contracts are turning to technology-based outsourcing solutions.  For example, using an outside contractor that offers a secure website and the necessary software a company can direct any employee needing an NDA to the website where the employee will be asked a standard set of questions regarding the content of the NDA and the business relationship to which it will pertain.  Assuming that there are no special concerns the answers to the questions will be used to prepare the NDA form and send it via e-mail to the employee or to the other company or person who is being asked to execute and deliver the NDA.  If the answers to the standard questions uncover an issue the software will automatically arrange for a member of the in-house legal department to be notified so that the lawyer can work directly with the employee to create a customized form for the situation.  Once implemented this solution can streamline the time required to get an NDA in place and create a central record of all background information for each NDA.

The content in this post has been adapted from material that will appear in California Transactions Forms (Fall 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

27
Mar

Contract Review & Approval Procedures Part II

In my previous post I discussed the importance of contract review and approval procedures as part of a company’s overall control environment. As companies get larger and the scope of possible contracts expands they opt for a fairly comprehensive form of contract review and signature authority policy.  Such a policy might cover the following areas:

  • Overview of the contracting procedures;
  • Responsibilities of parties initiating contracts;
  • Requirements regarding formal bidding procedures (i.e., requests for proposals);
  • Subject matter and funding approvals;
  • Legal department approval;
  • Risk management issues including use of insurance and indemnification provisions;
  • Time frames for review and approval process;
  • Contracting authority;
  • Board of directors’ actions and documents evidencing board actions;
  • Processing of funding requirements for contracts;
  • Retention of contracts and recordkeeping requirements; and
  • Contract administration and performance review.

The policy should emphasize that contract review is much more than simply following a series of formal steps and procedures and it is essential that all officers, managers and employees initiating a contract be held personally responsible for reviewing and understanding the proposed terms of the contract and ensuring that appropriate insurance requirements and indemnification provisions are included therein.  In addition, every effort should be made to remove undue pressure from the review process and persons initiating a new contract should allow sufficient lead time to allow for completion of any required review and approval process described in the policy.  In many cases a complex contract may require several months of negotiation and preparation and departments that may be impacted by a contract should be notified well in advance of the expected start date for the contract.  As a general rule, six to eight weeks should be set aside for legal review and review by other departments.

The policy should clearly delineate the responsibilities of everyone involved in the contract process.  For example, all officers, managers and employees initiating a contract:

  • Are responsible for reviewing and understanding the proposed terms of the contract and ensuring that: the language in the contract accurately reflects the business goals and objectives of the company and the department or unit initiating the contract; the contract is in the best interest of the company; the company will be able to fulfill all of its obligations under the contract in a cost-effective and timely fashion; and the language in the contract is clear and consistent and addresses all material contingencies that can be reasonably foreseen for the life of the contract.
  • Are responsible for ensuring that all of the necessary approvals described herein are obtained and that sufficient time is allocated to allow all persons involved in the review and approval process to fulfill their responsibilities in an orderly fashion.
  • Should, before the company invests time and resources in the contract review process, prepare a description of the business case for the contract, including the goals and purposes of the contract, the reasons for contracting with the particular party, and the expected benefits and costs associated with performance of the contract.

All departments involved in performing the company’s obligations in a contract should be responsible for timely and full review of the proposed contract.  Among other things, authorized representations of each department should be responsible for reviewing and understanding the proposed terms of the contract and ensuring that the department will be able to fulfill all of its obligations under the contract in a cost-effective and timely fashion and the language in the contract relating to the duties and obligations of the department is clear and consistent and addresses all material contingencies that can be reasonably foreseen for the life of the contract.  In addition, all departments are responsible for complying with all other company policies and procedures relating to post-signing administration of contracts and fulfillment of contractual obligations.

The content in this post has been adapted from material that will appear in Business Counsel Update (Summer 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

24
Mar

Contract Review & Approval Procedures Part I

One of the most important elements of the control environment is any business is the establishment and use of formal policies and procedures for reviewing and approving contractual arrangements with third parties that will create legal rights and obligations for the company. 

Ideally some sort of contract review and signature authority policy will be put in place very early in the company’s existence since contracts of various types will be needed from the time that the company first opens its doors.  Many times all of the contracts under consideration during the start-up phase will be discussed by all of the founders because it easy to do so in light of their close proximity and the absence of layers of management personnel when the company is still small.  The problems begin to arise, however, when founders and other senior managers start to assume more responsibility for particular areas of the business and the input from other founders and managers becomes more limited due to the lack of time, problems with communication and the fact that the other persons are themselves preoccupied with their own projects. 

While the senior managers in a particular functional or business area presumably have the most skill and experience with respect to contracts that they initiate it is nonetheless important to have some independent review of the business case for the contract and the potential risks to the company of assuming the legal and operational obligations included in the contract.  For example, all functional areas that might be involved in fulfilling the company’s duties under the contract should be consulted in advance to verify that they will be able to perform as anticipated.  Contract review is also necessary to avoid conflicts with commitments that someone else in the company may have already made with other parties.  Finally, contract review is needed to be sure that independent parties are reviewing the terms of each proposed transaction and that persons initiating a contract do not have some “vested interest” in the selection and use of the contract partner.

Procedures for contract review and signature authority should accomplish at least two main purposes—establish the process for the review and approval of proposed contracts by various departments (e.g., legal, finance and other departments involved in the fulfillment of obligations created under the contract) and identifying which persons within the company have the authority to approved specified transactions or activities and thus execute a proposed contract on behalf of the company.  Ideally the contract review process will also provide an opportunity for evaluating the proposed contract in the context of the company’s overall business strategy.  This can and should occur through the creation of a business case for each proposed contractual arrangement (or at least those contracts that are “material” in light of the company’s business) that describes the key rewards and risks associated with the contract, explains why the contract is important to the company’s business plan, establishes performance milestones, and suggests procedures for monitoring performance under the contract after it is executed.  The business case process forces the initiating party to think through each proposed contract and become an informed internal champion for the relationship and also serves as an important information and communication tool for senior management to the extent that they are being kept in the loop as to the specific activities and tactics that are being used to further the company strategy that has been established at the top of the hierarchy.

The content in this post has been adapted from material that will appear in Business Counsel Update (Summer 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

20
Mar

Market-Focused Divisional Structures

In addition to the product-focus and geographic-focused divisional structures that I have been discussing companies may select a market-focused structure that organizes operations—functional skills and activities—by reference to the specific requirements of particular customer groups (i.e., markets).  For example, a market-based organizational structure might have different business units for marketing and sales of products to customers in the following general categories: commercial, consumer, government and corporate.  The primary distinguishing focus of these business units is marketing rather than manufacturing, and managers within each division will be responsible for identifying, developing, selling and supporting products that provide the highest level of functionality and utility to customers in the particular market.  Each market-based business unit will have access to the resources of centralized support functions such as engineering and manufacturing—engineering will be responsible for customizing the company’s products to suit specific market requirements and manufacturing will build products to meet the customer-specific specifications provided by each division.  The success of a market-based structure depends on the company’s ongoing ability to recognize changes in customer requirements and quickly deploy the organizational resources necessary to cope with changing conditions.

Companies often shift from a product structure to a market structure in order to introduce customers to a broader line of products and services, increase sales by offering customers a wider array of solutions to their problems and build stronger relationships with customers.  In product structures the primary focus of each division is commercialization of its own products and maximizing sales of those products.  In many cases, however, the relatively narrow product focus causes companies to miss, or simply ignore, opportunities to generate additional business with customers by introducing them to products offered by other divisions that might fill a different need for those customers.  Moreover, since managers of product divisions are generally rewarded solely based on the performance of their product lines there is little incentive for cooperation between divisions and often real fear that introducing a customer to another division will lead to loss of control of that customer and ultimately a reduction in sales revenue for the division that had the original relationship with the customer. A market structure overcomes the inherent limitations of a product structure by focusing the efforts of everyone involved in marketing and sales in understanding all of the requirements of the customer and making sure each customer has knowledge of, and offered the opportunity to purchase, the full line of the company’s products and services.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

17
Mar

Geography-Focused Divisional Structures

While control issues for growing companies are generally product-based, which leads them to adopt some form of “product structure” that I have been discussing in previous posts, there are situations where control is best asserted through organizing operations based on location.  In this case companies may opt for a geographic divisional structure, which calls for divisions to be established and operated based on certain specific and relatively localized requirements identified for different geographic locations in which the company has significant operations.  Typically, a geographic structure will be a careful mix of centralization and decentralization—certain core functions will continue to be managed out of the headquarters office, where the CEO and other members of the senior executive team will be located, while other functions are placed and managed in facilities established to focus primarily on operating a particular geographically-defined area (e.g., a country or group of countries or a region of a specific country).

While a geographic division is usually created to align the core competencies of the company with the localized requirements of customers in a particular country or region (i.e., by customizing marketing and sales activities and product characteristics) a plant or other type of facility may be placed in particular location in order to gain access to important strategic advantages and resources.  For example, manufacturing operations may be moved to countries where low-cost, yet skilled, labor is available even though sales opportunities in those countries are not significant.  Similarly, R&D activities may be pursued in small countries like Finland and Switzerland to tap into their local knowledge bases in cutting-edge technologies even though products developed through such activities will ultimately be marketed and sold worldwide.  Setting up a geographic-focused division in China or India offers a number of advantages—access to low-cost manufacturing, skilled scientists and engineers and dynamic and growing consumer markets.

The most common use of a geographic division is when the customer base of a company grows beyond the immediate proximity of the headquarters office and the company needs to customize its products and sales and marketing strategies to the needs and expectations of customers in new and distant geographic markets while still retaining the advantages of centralization that are available in functional areas such as procurement and R&D.  For example, a retailer might group stores into regional units that are each overseen by a regional office that is principally responsible for making sure that the products available in the stores under its control are aligned with tastes and needs in the particular region which may be determined by divergent factors such as weather, income levels and other demographic factors—a clothing retailer would, during the winter months, stock more coats and gloves in the Midwest while feature swimwear in Southern California and Florida.  While regional offices are responsible for setting priorities for their particular product lines and communicating their needs to the corporate level, final decisions regarding company-wide purchasing are still made at the headquarters office in order to achieve cost savings through volume purchasing.  Done well, companies organized by geographic divisions can offer lower prices to all of its customers while being responsive to parochial customer requirements and acting like a local business.

A company may also establish a geographic structure when it trades in products that are too costly to transfer long distances to get to customers located far away from the place where the products are manufactured.  For example, a company that specializes in making containers (i.e., cans and bottles) used by customers in the soft drink, fruit and vegetable markets may locate its manufacturing facilities in locations in close proximity to those customers since containers can be bulky and thus very expensive to ship.  This structure allows the company to be price competitive and also encourages the development of close and strong relationships with customers.  Each facility would have its own functional resources in key areas such as manufacturing, purchasing, sales and quality control; however, the headquarters office would retain primary responsibility for R&D, engineering and finance.  A similar strategy can be used in order to place manufacturing activities near suppliers of key components and/or raw materials.  As an aside, decentralizing manufacturing allows the company to seek and achieve the optimal level of production efficiency and economies of scale for each plant. 

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

13
Mar

Make Sure Your Contracting Policy Flows Smoothly

This is the last of several posts I have been writing on contracting policies and procedures.  Companies should attempt to implement policies and procedures that provide managers and employees with a clear flow of the steps that need to be taken in order to complete the appropriate level of review for a proposed contract and the procedures for having the contract executed and delivered for safekeeping as required under the terms of the company’s records retention policies and procedures. In general, any person needing a contract should first determine who has the authority to sign the particular type of contract by referring to the then-current delegation of authority promulgated by the president and chief executive officer of the company.  Once the person needing a contract has determined who has the authority to sign the particular type of contract a determination should be made as to whether the signing party has his or her own requirements with respect to contracts that are to be entered into by a specific department or unit of the company. These requirements would be in addition to requirements that are established in any delegation of authority and would typically be designed to ensure that a contract fulfills the goals and objectives of the department or unit, that funds are available and have been properly encumbered, and that other resources necessary for the completion of the contract will be available.  Among other things, a determination should be made as to whether or not the subject matter of the contract requires completion of any company requirements relating to use of a formal bidding process.  In the event that bidding is required, the person needing a contract should work with all the departments involved in implementation of the proposed to contract to develop a comprehensive request-for-proposal.

The person needing a contract and the person who has the authority to sign the particular type of contract, referred to in this discussion as the “sponsoring parties”, should determine what, if any, additional approvals may be required before the signing party is permitted to execute the contract.  Depending on the circumstances, a particular contract may require as many as three separate types of approval, including subject matter approval (i.e., approvals must be obtained from all departments that will be involved in the fulfillment of the obligations of the company under a particular contract), funding approval (i.e., approvals from senior management and finance department because of the amount of money involved in fulfilling the company’s obligations under the contract) and legal approval.  The sponsoring parties should prepare a business case relating to the proposed contract and present it to the president, chief executive officer or any officer who has been delegated authority to review and approve a business case.  Among other things the process of review and approval of the business case should include identification of required subject matter, funding and legal approvals.  The sponsoring parties should consult with all departments that would be involved in the fulfillment of obligations under any contract covered by the business case to identify material issues and concerns that should be addressed during the contract negotiation and drafting process.  Once the business case has been approved a copy should be submitted to the legal department along a list of departments from which approvals of the contract will be sought.  As a general rule, approvals must be obtained from all departments that will be involved in the fulfillment of the obligations of the company under a particular contract (i.e., the “subject matter approvals” referred to above).

Once the sponsoring parties have received an initial draft of the contract they should review the contract to determine whether it conforms to any specific requirements included in the approved business case.  If there is a conflict between the contract terms and the business case the sponsoring parties should attempt to resolve those conflicts with the other party before a draft of the contract is circulated to other departments for subject matter approval.  Once the sponsoring parties have a draft of the contract that they wish to circulate for subject matter approval it should be submitted to the legal department for review and circulation.  The legal department should circulate the contract to all involved departments for subject matter review and approval and will collect comments from all departments; however, the sponsoring parties remain primarily responsible for ensuring that all departments respond on a timely basis. The legal department should collect and consolidate all comments and transmit them to the sponsoring parties for review and further action.

The sponsoring parties should be primarily responsible for reviewing and clearing all comments received from other departments through consultation with those departments and with the other party.  The sponsoring parties should arrange for a revised contract and will provide an explanation in writing to the legal department of how each of the comments has been cleared.  The legal department should circulate the revised contract and explanation to all departments and request their review and approval.  In the event that comments remain outstanding after the process described above has been completed the sponsoring parties and the parties responsible for the outstanding comments should meet with the president and chief executive officer (or the officer to whom they have delegated authority with respect to such contract) to determine what action the company should take with respect to the contract on the terms offered and a written record of the decision should be prepared and transmitted to the legal department.

If, after following the procedures described above, the person authorized to sign the contract has determined that company should enter into the contract the sponsoring parties should transmit a final version of the contract to the legal department.  The legal department will review the document and if it fulfills the requirements of these procedures will arrange for the contract to be signed and transmitted to the other party.  As a general rule, prior to the execution of any contract by any manager, employee or other agent of company, there should be approval as to legal form and validity by the legal department. When the approval of the legal department is required, it must determine that: the contract does not violate any law, regulation or company policy, or conflict with any other contractual obligation of company; the individual signing it has the authority to do so; and any risk management concerns associated with the proposed contract have been considered by the signing party.  When required, the approval of the legal department should be endorsed on the contract. 

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

13
Mar

Product Team Structure

The multidivisional structure that I have been discussing in the last several posts arises in response to the competitive requirements of the marketplace which demand increased speed and efficiency in the product development and launch process; however, a structure in which each division has its own group of support functions can be expensive to operate and create impediments to the dissemination of information and innovations throughout the company.  In order to overcome some of the disadvantages of a multidivisional structure while retaining a product-based focus companies often consider using a “product team structure,” which combines elements of the product division—centralized support functions—and multidivisional structures—dedicated support function resources for each product.  Specifically, when a product team structure is used the company creates product development teams that include representatives from each support function who specialize in the development and manufacturing requirements of a single product or a group of related products.  For example, a product team might include designers, product and manufacturing engineers, procurement specialists, marketers, salespersons, and financial analysts.  The primary loyalty of members of each product team will be to the team and not to any functional group and each team will be managed by a product team manager who will oversee all of the operational activities of the team.  Authority for all key decisions relating to product development and manufacturing is delegated to the team and team members will bear the ultimately responsibility for the success or failure of its efforts.

A simple organizational chart for a product team structure would be similar to the chart for a product division structure and would have three levels of management personnel as follows from top to bottom: the CEO; the senior executives (i.e., vice president or chief functional officer) for each support function (e.g., sales and marketing, research and development, finance, and procurement), each reporting to the CEO; and the product development teams for each important product or related group of products, each managed by a product team manager and composed of product-focused specialists from each support function.  The senior executives at the second level are responsible for overall coordination of their respective functions; however, most of the functional resources will be assigned to the product development teams and functional specialists are allowed to make decisions on their own based on the needs of their teams without interference or delays from the functional executive.  The use of self-contained product development teams that include all of the functional resources necessary for team to complete its operations obviously improves the level of integration in the organizational hierarchy and facilitates the type of quick decision making required in order to satisfy the rapidly changing requirements of customers.  In that way the product development teams are similar to the product divisions in a multidivisional structure.

The main advantages of a product team structure are most apparent when comparing it to some of the problems that can arise when a company relies on the product division structure and its reliance on centralized support functions.  The big concern with respect to product development under a product division structure is that the various support functions typically make their contributions sequentially with little or no coordination or collaboration—the original idea for the product may come from the R&D or design function, the engineering function will build a prototype, the inputs for the product will be selected and purchased by the procurement function, production will be handled by the manufacturing function, and sales and promotion will fall under the control of the sales and marketing function.  Unless the activities of these functions are carefully integrated conflicts will inevitably arise as functions pursue the goals that are most important to them even if they are at odds with the goals of other departments.  For example, the engineering function may want to develop a product with certain technical features regardless of the impact on production costs while the sales and marketing function may be making unreasonable demands on procurement and manufacturing to cut their costs so that the price for the product can be kept at a competitive level.  The end result is that it takes longer to launch new products and those products are more costly to manufacture and of lower quality.  The product team structure attempts to resolve these issues by organizing functional specialists around the product rather than their parochial functional groups and the anticipated advantages of the team orientation include more rapid product development, improved communication and problem solving, increased efficiency, and  better product quality.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

10
Mar

Contents of Contract Review Policies and Procedures

This week I am continuing the discussion of contract review policies and procedures that I began last week.  Policies and procedures for review and execution of contracts are generally prepared and administered by and through the legal department, although it is not strictly necessary that lawyers always be involved in contract administration, and there is always a possibility that the attorneys involved will forget that the concept of a “contract” is not all that well known to the parties subject to the policies and procedures—the officers, managers and other employees of the company.  Accordingly, the policy itself, as well as training sessions presented to introduce the policy and educate everyone how it should be used, must include a description of what a “contract” is and how it can be created. A short primer on capacity to contract, consideration and lawful subject matter can be presented; however, the most important thing to emphasize to non-lawyers is that representatives of the company that have “apparent authority” in the eyes of outsiders can bind the company to legally enforceable duties and obligations even though they have not complied with the internal procedures for review and approval of a contractual obligation.  For example, if a senior sales manager with the title of “branch manager” or “regional vice president” signs and delivers a document to a customer that describes the terms upon which certain goods will be sold and delivered to the customer the recipient of the document would be entitled as a matter of law to assume that it is in possession of a legally binding contract even if the sales manager failed to comply with the company’s own internal contract review and signature authority procedures.  The bottom line is that officers, managers and other employees need to exercise extreme caution not to take any action that might create a reasonable expectation in the mind of another party that the company is willing to be legally bound to perform specified obligations.

When preparing the policy it is important to identify the contractual obligations commonly encountered in the course of the regular business activities of the company and consider what specific steps should be taken to review and approve those types of contracts.  This generally means thinking about the best way to deal with all or most of the following general categories of contracts:

  • Agreements for the purchase or sale of goods;
  • Agreements to provide or obtain services;
  • Nondisclosure agreements;
  • Leases of personal property, including equipment, furniture and vehicles;
  • Leases, deeds, and other conveyances affecting interests in real property;
  • Promissory notes and other instruments relating to the payment of money, including security agreements and guarantees;
  • Liability waivers and releases;
  • Settlements of disputes;
  • Software licenses;
  • Maintenance agreements;
  • Memoranda or letters of understanding or cooperation;
  • Contracts with facilities that require a written agreement; and
  • Employment contracts.

As companies get larger and the scope of possible contracts expands they opt for a fairly comprehensive form of contract review and signature authority policy.  Such a policy might cover the following areas:

  • Overview of the contracting procedures;
  • Responsibilities of parties initiating contracts;
  • Requirements regarding formal bidding procedures (i.e., requests for proposals);
  • Subject matter and funding approvals;
  • Legal department approval;
  • Risk management issues including use of insurance and indemnification provisions;
  • Time frames for review and approval process;
  • Contracting authority;
  • Board of directors’ actions and documents evidencing board actions;
  • Processing of funding requirements for contracts;
  • Retention of contracts and recordkeeping requirements; and
  • Contract administration and performance review.

Companies and non-profit organizations may choose from a variety of other alternatives when creating and implementing policies and procedures relating to contract review.  For example, a university or hospital may emphasize the use of standardized contracts and create escalating approval requirements based on the dollar amount of the commitment created by a particular contract.  While standardized contracts prepared by the university or hospital legal and business affairs departments are strongly recommended, non-standardized contracts (i.e., contracts prepared and submitted by potential vendors and other business partners) may be used if they are amended to include certain “required” contract provisions and have been thoroughly reviewed and analyzed using a detailed contract review checklist. 

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

10
Mar

Disadvantages of Multidivisional Structures

In my last post I covered the advantages of using a multidivisional structure.  However, like all other forms of organizational structure, problems can also arise with a multidivisional structure that may need to be addressed:

  1. One of the ongoing issues with a multidivisional structure is striking and maintaining the proper balance of authority between the corporate managers and the division managers.  Companies may want to centralize decision making in order to reduce costs and prevent division managers from taking actions that are contrary to the long-term goals of the entire company; however, too much centralization deprives division managers of the flexibility and independence they need to operate their specific businesses and can damage the performance of the divisions to the extent that decisions are made slowly by corporate managers not directly involved with a particular issue or problem.  On the other hand, if division managers are given too much freedom through decentralization they will no incentive or motivation to operate their divisions efficiently or cooperate with corporate managers and other divisions. 
  2. A multidivisional structure makes it easier for corporate managers to compare the performance of the different divisions for purposes of determining how the company can obtain the highest rate of return on future allocations of capital and other resources.  While the resulting competition between the divisions can be healthy up to a point, there is a real possibility that rivalries will eventually become so intense that divisions cease to cooperate with one another by sharing resources and transferring information regarding innovations in technology and business processes that could be used by every division to improve the performance of the company as a whole.
  3. Another potential problem associated with transfer of technology, products and components between the product divisions is establishing a fair “transfer price”.  The “seller” will want to maximize its return on investment by obtaining the highest price possible; however, this approach often unfairly penalizes a “buyer” that is part of the same larger company and may even place the affiliated buyer at a disadvantage in relation to external competitors who are free to purchase comparable inputs at more favorable prices on the open market.  There are several ways to resolve this potential conflict of interest between the divisions.  For example, the corporate managers may be assigned the task of setting and enforcing transfer pricing based on a formula that includes the objectively verifiable costs of the seller plus a fixed and predetermined profit margin.  Another possibility is for corporate managers to set the price based on an independent analysis of the market price.  Finally, transfer price may be kept competitive by allowing divisions to purchase from external vendors if they are offering a better deal.
  4. A multidivisional structure can be quite costly to establish and operate.  For one thing, there is entirely new layer of management personnel and staff at the corporate headquarters level that must be funded.  In addition, the need to duplicate functional resources within each division creates a serious risk of inefficiency and redundancy that will drag down the overall performance of the company.  These costs and inefficiencies must be continuously compared to the benefits associated with the multidivisional structure and consideration may need to be given to modifications to the structure including reducing the size of the corporate headquarters and/or the number of divisions and finding ways to reduce the costs of the support functions through greater sharing of functional resources.
  5. While one of the main responsibilities of the corporate managers in the multidivisional structure is overseeing the activities of the product divisions, there will inevitably be communications problems caused by the very tall hierarchical structure.  For example, in cases where the company has a large number of product divisions it may be difficult to identify attempts by division managers to conceal performance issues from the corporate headquarters staff.  In addition, bottlenecks may arise when decisions are required from corporate headquarters and delays in getting approvals back to the divisions may place them at a disadvantage in relation to competitors that can move more quickly because their organizational structures are flatter and more efficient.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.