Functional Organizational Structure

As the name implies, roles in the functional organizational structure are organized according to the various functions that must be performed to achieve the entity's overall mission. In a small manufacturing firm, for example, the following functions are typically found: (1) engineering, (2) manufacturing, (3) sales, (4) human resources, and (5) finance. In addition to these basic functions, there may be a variety of other functions found in the structure, depending on the size of the organization. The functional structure is illustrated in Figure 7.1.

As can be seen in Figure 7.1, the functional type of organization is basically a system in which managers of specific functional areas (for example, manufacturing or sales) report to a senior executive who is responsible for coordinating the overall operations of the company. The senior executive has the ultimate responsibility for the organization's results and its management.

A variation of the functional structure that is typically found in small entrepreneurial organizations we term a prefunctional organizational structure. This structure is most prevalent in the earliest entrepreneurial stages of development where there are relatively few people, and the firm has not yet differentiated and specialized into various functions; rather, the same individual may perform a number of functions or parts of functions. Accordingly, if we were to try to diagram an entrepreneurial organization at Stage I as a functional organization, we might find the same individual occupying several functions in the organization, as illustrated in Figure 7.2. For example, the president, Mark Booth, occupies three positions at Plastic Molding Corporation. He performs both the marketing and R&D functions, while simultaneously functioning as president.

The primary strength of a functional structure is that it provides for greater specialization of function, allowing people to develop very specialized skills in each area. It also allows for the recruitment of people with predeveloped specialized skills in given functional areas. Accordingly, rather than have an individual with only a general familiarity with manufacturing as its head, an organization can recruit an executive who is highly experienced and specialized in that area.

Many large organizations continue to operate under a functional structure. However, as the size of an organization increases, the many advantages of a functional structure tend to be offset by certain critical disadvantages. One primary disadvantage is that as the operation increases in size and number of products, the focus of its most senior executives (who are responsible for the entire enterprise) is spread so thin that certain products receive considerable attention while others receive significantly less. A related problem is that as the size of the organization increases, the primary concern is with the overall efficiency of each functional area (such as manufacturing or sales), rather than with a particular product segment and its related customer groups. The functions may be efficiently producing products that are out of touch with the marketplace. Large companies, ranging from Kodak to Microsoft (prior to 2000) to homebuilders like Pardee Homes (whose structure management process is described later in this chapter) have experienced these problems to such a degree that they have changed from functional structures to different forms in recent years. Because of these problems, a different type of organizational structure has developed that strives to take advantage of key aspects of the functional system while also dealing with the problems of reduced focus and lack of in-depth concern for a particular product and customer grouping. This is known as the divisional structure.

Divisional Organizational Structure

As suggested earlier, the divisional organizational structure tends to group together related clusters of products and customers. A division may be set up to focus on a particular customer segment and to produce and market products that are designed for that group. Divisions can also be structured around different technologies. A classic example of divisional structure was the one built by General Motors under the leadership of Alfred P. Sloan. Sloan, who was an MIT-trained engineer, guided General Motors to supremacy in the automobile industry, replacing Ford as the number-one automobile producer in the mid-twentieth century.¹ The basic structural concept that Sloan used was to organize General Motors into several related divisions—Chevrolet, Pontiac, Buick, Cadillac, and so on—with each division focusing on a different customer market segment. The idea was to grow customers from one General Motors product to the next, up to the ultimate, which was produced by the Cadillac division. Each division had some of its own functional aspects, but there were certain overall functions performed for the divisions by the organization as a whole.

When Steve Ballmer became CEO at Microsoft, he “recognized that the company had become unwieldy and over-centralized.”² To help the company continue moving forward, he created seven divisions, each with profit-and-loss responsibility. In late 2005, the company was again reorganized. Three divisions—Platform Products & Services, Business Division, and Entertainment & Devices Division—were created. Each had a president and, according to the Microsoft press release, the structural change was intended to “drive greater agility in the execution of (the company's) software and services strategy”³ (a clear reflection of the need to align strategy with structure). The company was again restructured in 2013 into a dozen operating groups that would, according to Ballmer, “enable us to innovate with greater speed, efficiency, and capability in a fast-changing world.”⁴ The statements made by Ballmer in both cases suggest that Microsoft understands and is managing their structure so that it supports their strategic goals.

As illustrated by these examples, the basic concept of the divisionalized structure is to create divisions that focus on particular customer segments to drive results. In most cases, divisions are provided certain common services at the corporate level. Typically, these include capital allocation, finance, legal, and administrative services, among others. An example of a classic divisional structure is presented in Figure 7.3. As shown in the figure, InfoEnterprise is a producer of computer hardware and software, and provides consulting services to its customers. A general manager heads each division, and each division uses its own functional structure. The corporate services group also reports to the president.

There is wide variation in the way organizations implement the divisional concept. Some organizations have large corporate staffs that are involved to varying degrees in the affairs of the divisions, including helping to set the strategic direction for the division and reviewing its performance. It might also include ensuring that all divisions have cultures that are aligned with the overall company culture and ensuring that divisions effectively develop their management capabilities. This may be termed the M-type divisional structure because of the active management from the corporate staff. This model is used by many large enterprises, such as Johnson & Johnson, Bristol-Myers Squibb, Allied Lyons, GE, and Pfizer. Sometimes companies use this structure so that they can get clarity of operational results. For example, in 2014, Pfizer, the giant pharmaceutical enterprise, began disclosing the financial results of operations for three business units: generics, branded drugs, and vaccines.⁵

At the other end of the spectrum, the corporation operates as a holding company, or in a certain sense as a “vertical bank.” By this we mean that the larger corporation is essentially an investor, in that it buys businesses and allows them to operate in a very independent manner. In return, the businesses must meet certain performance standards, such as return on investment or cash generation. A classic model of this style is Berkshire Hathaway—a company that prides itself on having a relatively lean corporate staff. It accomplishes this because Berkshire Hathaway is essentially an “investor-type” corporate structure (I-type divisional structure), in which the various divisions are essentially part of a portfolio of investments. Similarly, Teledyne Technologies is an investor in many small entrepreneurially oriented companies, and the basic criterion for their maintenance is the ability to generate cash for the overall holding company.

Both of these divisional structure models (the I-type or the M-type) may be used, and both can be effective—as long as the structure is aligned with the specific company's strategy.

The primary strength of the divisional form is that it creates a focus on specific market or product segments. The primary disadvantage is that it results in duplication of functions in different divisions and creates the need for coordination among divisions. This is what leads to additional corporate staff. The divisional structure can also lead to intense competition among the general managers of each division. Therefore, it is important that if an organization decides to adopt a divisional structure, it must invest in growing true general managers who understand not only how to run a “business within a business” but also how to be an effective member of the overall corporate management team.

Matrix Organization Structure

The final “pure” type of organizational structure has been termed the matrix. This structure was originally developed in the aerospace industry, although similar forms might have existed elsewhere for quite some time. In concept, the matrix approach is an attempt to achieve the best of both the functional and the divisional structures. As shown in Figure 7.4, the matrix organization structure lists the various programs, projects, or products in the far left column of the matrix organizational chart.

Each of these programs has a program manager. When the organization is large enough, there is a manager who is responsible for coordinating all of the programs. On the other side of the matrix, over the vertical columns, we have the various functional areas. Each of these functional areas, such as engineering design, manufacturing, and so on, is headed by an executive who is responsible for the functional specialization. The matrix operates by having the program managers “borrow” people from the various functional areas to work on their programs. When the program is finished, the people are returned to the functional pool. For example, a large aerospace company that is involved with the design of a new aircraft for the U.S. Department of Defense will borrow engineers and assign them to that particular project. When the responsibilities of those engineers are completed, they will return to the overall engineering pool to be reassigned. In this structure, an engineer might be simultaneously involved in more than one project.

The basic strength of the matrix structure is that it permits a focus on the customer and the product, and also allows functional specialization. The major disadvantage or limitation of the matrix structure is that it requires a high degree of coordination to be effective. The keys to successfully operating a matrix structure are conducting regularly scheduled meetings to review the status of work and having the ability to deal with the inevitable conflict that arises when employees are accountable to more than one supervisor (a program supervisor and a functional supervisor) and possibly involved in more than one program (where they now report to multiple supervisors). Accordingly, the matrix structure requires a considerable amount of training in work-related interpersonal skills to ensure its smooth operation.

While having many advantages, a matrix structure is quite difficult to execute effectively in practice. It is a very complex structure that requires a great deal of coordination and communication to make it function properly. An organization that believes a matrix structure is best for its long-term development must be willing to invest in helping both managers and technical professionals develop the skills (for example, meeting management and team decision making) needed to help the structure function properly.

One company that has done this well as it transformed from an entrepreneurship to a professionally managed firm is Pardee Homes. Initially, Pardee was organized in a functional structure, with departments such as land development, purchasing, construction, marketing and sales, and finance reporting to a CEO and COO, who functioned as “super project managers.” However, as the company grew in size, the CEO and COO found themselves spread too thin. The solution was to change the organization's structure. Over a period of about 10 years, the company evolved toward a matrix structure, as described in the section on case studies in organizational structure.

To What Extent Does the Current (or Proposed) Structure Support the Organization's Strategy?

As stated previously, this is the most basic principle on which an organization's structure should be based; that is, form should follow function. Addressing this question involves developing an understanding of what the company's strategic mission and key objectives are. Then the existing structure (including the macro structure, micro structure, and supporting systems) should be evaluated for the extent to which it will help the organization achieve these goals. For example, if a company wants to move beyond offering only one product or product line and is functionally organized, it might want to consider moving toward a divisional structure. Another alternative, however, is to redesign its planning and performance management systems (supporting systems) so that they promote focusing adequate attention on developing the new product line.

To What Extent Does Each Function Add Value? What New Functions Will We Need to Better Support Our Goals?

This involves examining the roles and responsibilities of the different functions that make up the macro structure. The outcome of this analysis is to determine the contribution that each function is making to the goals of the organization. Based on this analysis, some organizations may find that certain functions have become obsolete. In one company, for example, the sole role of one functional unit was to ensure that the data input by another department was correct. As technology had evolved over time, there was no longer the need for such a control mechanism (that is, the probability that mistakes would be made in data input had become practically zero). Therefore, this unit was providing no true value to the organization. The decision was made to eliminate it and redeploy personnel to other areas.

In other cases, organizations will find that, as they grow, they need to develop new functions to better meet their needs. By the time an organization reaches Stage III, for example, it will typically find that it needs some type of formal marketing function (if it has not already developed one). Many Stage III and Stage IV businesses also find that they need to develop a formal human resource function that has responsibilities beyond payroll, recruiting, and hiring.

To evaluate whether a business has developed all of the functional units needed to support its goals or whether certain units are no longer making the contribution that they should involves determining the extent to which all key result areas are reflected within existing organizational units. For example, one key result area may be customer service. This does not necessarily mean that the organization must have a customer service unit; however, the organization must in some way have an individual or group of people who are directly responsible for the performance of customer service.

When key result areas are not effectively incorporated into the roles or functions of organizational units, they will tend to be neglected in favor of other tasks that may seem more pressing. Examples of this phenomenon have occurred in the key result area of product development, which has led to the divisionalization of many organizations. For example, Medco Enterprises, a $20 million medical manufacturing firm discussed in Chapter 1 experienced difficulty using the functional form of organizational structure because coordination problems emerged with respect to new product development. Rather than having a unit focused on a particular market segment, Medco had separate functional units for engineering, sales, and manufacturing, which created a variety of problems with respect to the timeliness and appropriateness of new products. The company ultimately shifted to an organizational structure in which one key organizational unit was responsible for the combined functions of design, manufacturing, and sales. This change shifted the focus of product development and sales to a single unit rather than require the coordination of three separate units with differing responsibilities for a much wider range of products.

To What Extent Do Individual Roles Support the Achievement of the Organization's Goals? Are There Any Changes That Need to Be Made in Existing Roles or New Roles That Need to Be Created to Assist Us in More Effectively Meeting Our Goals?

To address these questions, there must first be a clear understanding of what people's roles are. Formal, written job or role descriptions are typically used for this purpose. In some organizations, the first problem is that there are no written job descriptions. In other cases, there may be job descriptions, but they are so out of date that they no longer adequately reflect what the incumbent is expected to do. In still other cases, there are written job descriptions, but they are only used by the human resource function as tools for hiring and evaluation. They are not used as guides for individual behavior. Finally, there are cases where job descriptions are developed, based on the capabilities of the people who are currently on the team instead of being developed to reflect what the company needs to effectively achieve its goals. As is true of other aspects of organizational structure, the structure should be designed to support the company's strategy.

Effective job or role descriptions should provide those occupying a particular position with the information they need to understand what is expected of them. Therefore, each position-holder should have a copy of his or her job or role description and use it as a guide for behavior. Traditional job descriptions, however, are not necessarily designed to promote effective goal-directed behavior. Most traditional job descriptions provide the position-holder with sometimes very lengthy lists of key responsibilities. These key responsibilities appear as sentences in the job description, and sometimes there are several pages full of this type of information, with no or limited organization. In one small entrepreneurial firm (under $1 million in revenues), the office manager had an eight-page job description! The problem with developing job descriptions in this format is that important information and key responsibilities can be too easily lost as the incumbent struggles to determine what he or she should be doing.

Our approach to developing role descriptions helps clearly identify what is expected of each position-holder on the team and does so in a way that the person occupying the role can understand and use this information as a guide or a playbook. In our approach—which has been successfully used by organizations of all sizes and in all industries—individual role descriptions (and we purposely call them this to distinguish them from the more traditional “job description”) are designed to mirror the format used in corporate or departmental planning (discussed in Chapter 6). In brief, they identify the mission, key result areas, and objectives for each position. (Goals are not included in the role description but are, instead, developed for each person who occupies each role in the context of the individual performance management system, which is described in more detail in Chapter 8.)

In our approach, the mission answers the questions: “Why does this position exist?” and “What is its basic purpose?” For example, the mission for the role of president might be something like, “To manage and profitably grow the overall business.” Key result areas for individual positions define the categories of activities that the position-holder needs to focus on to be successful in his or her role. As was true at the corporate and departmental levels of the company, key result areas are stated in one, two, or three words. Further, each role should have between five and nine key result areas for which the position-holder is held accountable. The rationale for having between five and nine key result areas is that research suggests that most people can remember only five to nine things at any one time.⁶ Therefore, to maximize the probability that people will be focused on those areas that will maximize results, we want to present this information in a manner that it can be remembered—hence, the “5 to 9” guideline. Key result areas for the role of president might include strategic planning, profitability management, new business development, supervision (people development and management), external relations, and organizational development.

Clearly defining key result areas, however, is only part of what effective role descriptions should do. They should also provide information on how people should be allocating their time among these key result areas in order to maximize results (measured in terms of the ability to achieve their own goals and help the organization achieve its goals). Finally, role descriptions should provide a description, in the form of objectives or ongoing responsibilities, of what the position-holder should be spending his or her time on in each key result area. Examples of objectives or ongoing responsibilities for the key result area of supervision might include the following:

• Recruits and selects direct reports.
• Works with direct reports to create annual goals and regularly monitors performance against these goals.
• Coaches direct reports.
• Provides annual performance appraisals to direct reports.

Evaluating structure with respect to roles begins with:

• Determining the extent to which there are existing written role descriptions.
• Evaluating the effectiveness of these written role descriptions in terms of the methodology used and in terms of the extent to which they actually reflect what each position-holder should do.
• Evaluating the extent to which the organization uses its role or job descriptions as guides for employee behavior.

The next step in evaluating roles is to look at the components of an individual's role, both separately and in relation to other roles in the organization. This is done to determine the “value-added” of each individual role to the organization. In essence, then, this analysis focuses on the contribution made by individual roles, as well as the relationship between these roles. As an organization grows, the roles that people occupy will undoubtedly change. Most of this change occurs in an ad hoc fashion. Accordingly, it is periodically necessary to do a systematic analysis of each role, both individually and in relation to the other roles that make up the organizational structure. When we have conducted such analyses, we have frequently found superfluous positions and levels within an organization, which leads to reduced efficiency and profitability.

Finally, the analysis should turn to determining whether new roles will be needed to support the organization's long-term goals. As the organization grows, for example, it will need to move from a “prefunctional” to a functional structure. This will mean the creation of new roles.

To What Extent Are Reporting Relationships Clearly Defined, and Does Each Position Holder Have The Authority Needed to Effectively Execute His or Her Role? How Should Reporting Relationships Be Defined, and What Authority Do Position-Holders Need to Support Our Long-Term Goals?

The organization chart should clearly define reporting relationships. As stated previously, however, some organizations have no organizational charts. In this case, reporting relationships need to be identified through discussions with key personnel. Even if an organization chart exists, there can be a problem with using it as the primary mechanism for understanding reporting relationships because it may not accurately reflect how the company really works. In one $100 million distribution firm, for example, while the structure on paper suggested that each middle manager reported to a specific vice president, in reality, everyone reported to the two owners of the firm. Whatever the owners asked a person to do, regardless of level within the firm, was the priority.

A further analysis of reporting relationships involves identifying the underlying rationale behind them and how they support the effective achievement of the company's goals. Reporting relationships should be clearly defined in individual role descriptions and should be designed in a way that creates a highly functional organization. When these relationships are poorly designed or defined, problems can arise. In a $500 million manufacturing firm, for example, there were a number of new product development teams that had been created by bringing in people from different functions within the company. One of the company's primary goals was to develop and launch new products, so the product teams made sense. However, each new product team reported to a different senior manager. In other words, there was no single product champion among the senior management team (which was functionally organized). Reporting relationships, in this case, were detracting from the company's ability to effectively design and release new products.

As a general rule, decision-making authority should be distributed to the lowest possible management level within a company in order to maximize its efficiency. The “lowest possible” level depends on the nature of the company and the skill levels of the management team. If, however, a company has reached Stage III and all major decisions are still being made by the president of the firm, chances are that there are opportunities to improve in this area.

In designing a new structure, both reporting relationships and the decision-making authority of each position should be carefully considered. The objective is to create an organization structure in which everyone knows what they are responsible for and understands to whom they report.

What Is the Appropriate Span of Control and Number of Levels That Should Exist within the Company to Facilitate the Effective and Efficient Achievement of Its Goals?

Span of control is defined as the number of people who report directly to a given manager. The greater the manager's span of control, the lower the cost of supervision of individual employees. The cost of supervision (per employee) decreases as the span of control increases, because supervisory costs are allocated over a greater base of employees. However, in the absence of an extremely well-developed performance management system (the subject of Chapter 8), a manager is limited in the number of employees that can be supervised before he or she begins to do an inefficient job. Conversely, it is expensive to employ more managers than is necessary. An effective span of control balances the decreasing per-employee supervisory costs against the increasing costs of managerial inefficiency.

Traditional management thought suggests that if a position has fewer than three direct reports, it is likely to be unnecessary; if it has more than nine direct reports, effective supervision is not likely to occur unless the manager is very experienced and uses sophisticated leadership methods. There are, however, exceptions to this rule of thumb. If an organization or functional unit employs highly skilled and highly motivated individuals and if there is a well-developed planning process and comprehensive performance management system, the number of people who can be supervised effectively by an individual manager might exceed nine. There are cases where managers operate effectively and achieve acceptable results while supervising 20 or more individuals. Again, however, these tend to be the exception, rather than the rule.

Span of control and the number of layers that exist within a company tend to be inversely related: The larger the span of control, the fewer the number of layers; the smaller the span of control, the greater the number of layers.

Any organization structure can also be viewed in terms of the number of levels of roles that have been aggregated to make up the structure. An organizational level consists of a group of positions that are comparable in terms of the nature of the work done. There are basically five pure (or distinct) types of levels of work in organizations, shown in Figure 7.5, and these create an organizational hierarchy. Each of these organizational levels is described briefly.

The first or entry level in the organizational hierarchy is the level at which technical or individual contributor work is performed. People who occupy this level of the organizational hierarchy are focused on performing technical work or “doer” work like computer programming, sales, production, data entry, or clerical tasks.

The next level may be termed the first-line supervisory level. People at this level may still be doing a certain amount of technical work, but a significant amount of their time needs to be devoted to supervising the technicians or individual contributors (“doers”) that report to them. In performing the supervisory part of their role, they need to focus on activities like goal setting, coaching, providing feedback and planning. Individuals who are first-line supervisors have no other managerial employees reporting to them, only technical or individual contributors.

The third level in the organizational hierarchy can be termed the middle-management level. The function of middle management is to supervise one or more levels of other managers, which may include first-line supervisors or other middle managers. Organizations can ultimately have a number of levels of middle management. However, regardless of the number, the primary function for the middle managers is a supervisory and coordinating function, and a liaison between first-line supervision and senior management. Individuals in roles at this level need to spend time on activities like planning for their areas of responsibility, organizing their teams, providing coaching and feedback to the managers that report to them, and identifying ways to improve and enhance the effectiveness of their unit's operational systems.

The fourth, relatively distinct level of an organizational hierarchy is the senior-management level. This level tends to have two major responsibilities: (1) managing a major function within the company and (2) assisting the CEO or COO with the overall planning and management of the company as a whole. Individuals occupying roles at this level need to spend time on activities like developing and implementing the company's strategic plan, managing overall company and functional performance, providing coaching and feedback to the middle managers that report to them, and identifying opportunities to enhance overall and functional unit effectiveness.

The fifth level that can be distinguished is the chief executive (CEO) or chief operating officer (COO) level of the enterprise. The CEO has ultimate responsibility for the overall planning and direction of the enterprise; the COO has primary responsibility for the execution of the overall strategic plan in terms of day-to-day operations. These two positions can be treated as a single “level” of the organization to which senior managers report. Individuals occupying these two positions are spending the majority of their time on the strategic development of the business.

Organizations are not required to have all five of these levels to be effective. Small (less than $10 million in revenues) organizations may have only three levels. Larger organizations may have more than five levels.

In analyzing span of control and number of levels, the key is to determine what the optimal balance is between the two in order for the company to achieve its goals. In general, however, if a manager has less than three or more than nine people reporting to him or her, further analysis should be done to determine why. If it is the case that the organization anticipates growing a particular function, then a small span of control may be appropriate. If the organization has sophisticated planning and performance management systems in place, a span of control greater than nine may be acceptable. Generally speaking, however, organizations that operate at either extreme can have problems with respect to accomplishing their goals efficiently and effectively.

With respect to number of levels, the further removed senior management is from the customer, the higher the probability that problems will arise. If there are nine or ten levels between senior management and the organization's customers, it may be only by chance that senior management adequately understands and incorporates customer needs into their planning process. It is not impossible to stay in touch with customers when there are a large number of levels present in a company. When this is or needs to be the case—due to span of control issues—the company can develop supporting systems that provide its management team with information about customers and their needs (as well as other types of information) that can be used as input to making strategic and operational decisions.

To What Extent Do Those in Management and Technical Positions Possess the Skills Needed to Be Effective in Their Roles? What Types of Skills Need to Be Developed at Each Level of Our Company to Help Us Effectively and Efficiently Achieve Our Goals?

Answering these questions involves first determining the skill set that each position-holder should possess to effectively accomplish his or her responsibilities. Next, an assessment should be made of the extent to which existing position-holders actually possess these skills. If it is found that certain position-holders lack the skills required to be effective in their roles, then the organization may decide to provide them with training, or they may decide to move these individuals into roles that are more suited to their capabilities. The organization will then fill the open positions with people from outside the company.

It is important in examining skills that the company identify not just what it will need in the next year but what it will need over the next three to five years. Further, it is important that there be an assessment of management and leadership skills (which are different from technical skills) possessed by all levels of management. Assessment and development of management and leadership skills is the subject of Chapter 9.

To What Extent Do Interdependent Departments and Functions Effectively Coordinate with Each Other? What Types of Coordination Will Be Required to Help Us Effectively Achieve Our Goals?

Coordination (a “supporting system”) can be promoted through well-designed role descriptions, the planning process, or effective performance management systems. In brief, analyzing this dimension of structure involves identifying which units within the company need to coordinate on a regular basis and then assessing the extent to which this coordination is working effectively. In some cases, functional units can work at cross-purposes with one another, either because of poor planning or a culture that promotes what can be termed “the separate islands syndrome.” This can create problems for the company in terms of its ability to effectively achieve its goals.

In designing a new organizational structure, an organization's leadership team should determine what types of coordination need to take place and the timing of these events. Effective coordination mechanisms are particularly important (as explained earlier) if the organization is going to adopt a matrix structure.

What Supporting Systems Do We Need to Have in Place to Ensure That Our Chosen Structure Will Function Effectively?

If an organization is evaluating the effectiveness of its structure, it needs to examine how its planning process, performance management systems, management development process, operational systems, and corporate culture support its structure. For example, if the corporate culture promotes the idea that “we are an organization of separate functional teams that all do their own thing,” a functional structure in which everyone needs to pull together toward the same common goals will be ineffective. The culture, in this case, might need to be changed (see Chapter 10) to better support the structure. If an organization adopts a divisional structure but does not have a management development process in place to grow true general managers, the structure will not function properly because the management of the divisions will be ineffective.

In designing a new structure, a key principle to keep in mind is that any structure will work as long as it has the appropriate supporting systems in place. Therefore, it is important that management take the time to consider what systems, structures, and processes will be needed to support whatever structure is adopted.

Answering the questions listed here involves performing several related analyses as part of an organizational structure assessment. These questions, as stated previously, can also be used to help design a more effective structure. The bottom line is that through addressing these questions, an organization's leadership team can identify the strengths and limitations of its current structure or any other structures it is considering adopting.

Design Corporation

Figure 7.6 shows the organizational structure of Design Corporation—a Stage II company. This company specializes in interior design for industrial and commercial enterprises. As can be seen in the figure, the organization has three divisional units: downtown and suburban units that specialize in interior design, and a subsidiary organization that specializes in purchasing furnishings required for commercial and industrial organizations. At the time this organizational structure was being used, Design Corporation had approximately $3 million in annual revenues, which made it a Stage II (nearly a Stage III) company.

The basic problem facing Design Corporation was not in the design of its macro structure but in the difficulties caused by the lack of managerial and other capabilities of various people occupying key positions in the organizational structure (supporting systems). Specifically, the basic marketing strength of the organization was in the entrepreneurial founder who occupied the role of president. The manager of the downtown office had reasonable business development capabilities but was lacking in administrative capabilities, as was the president. The manager of the suburban office was lacking in business development capabilities but was an effective administrator. The operation of the third division was reasonably successful as a stand-alone entity and is not considered further here. The net result of the various skill gaps on the part of the three key managers (the two general managers and the president) meant that each individual was trying to compensate for the inadequacies of other individuals in a different part of the organization.

For example, the president was doing a great deal of marketing for the suburban division because of the lack of business development capability on the part of that division's general manager, while the manager of the suburban division was increasingly responsible for some of the administrative work of the firm as a whole. Because the president was deeply involved in the business development of one of the divisions, he did not have sufficient time to devote to the organizational development needs of a rapidly growing company.

Although none of this could be seen from looking at the organization structure on a sheet of paper, when evaluating the appropriateness of an organizational structure for any organization, we must consider the skills of the players who occupy key positions in order to determine whether the structure truly makes sense. In other words, looking at the structure on paper alone would seem to indicate that it made sense, but when we examine the skills of the various managers in the firm, this structure is one that is clearly inappropriate for this organization.

There are several solutions to the problems described in this situation. One would be to add the role of executive vice president to the firm (a macro and micro structure solution). The executive vice president would be responsible for the day-to-day administration of the organization, which would free up the president to devote time to long-range planning, organizational development, and business development, as well as to train the general managers to do business development. This solution would add to the cost of operating the organization. Another approach might be to work with each division general manager to help develop the missing skills (a supporting system issue). This might involve bringing in an outside resource to work with these individuals or sending them to training. If it was then found that they could not perform effectively in their roles, the president might decide to fill these positions with individuals possessing more appropriate skills.

Hitek Manufacturing

Hitek Manufacturing Company was a rapidly growing Stage III manufacturing company. The firm had recently achieved revenues of approximately $75 million. Up until that time, the enterprise's revenues were approximately $50 million, and it was organized in a functional fashion. The firm had developed a number of products but was experiencing certain difficulties in the coordination of new product development and with the successful introduction of these new products into the marketplace. This was due, in part, to the fact that the existing functional structure emphasized the more successful existing products. The firm's leadership team realized that it needed to have a steady stream of new products and that one way to enhance the development of new products was to have them developed in a division that was focused on a particular product market segment. Accordingly, when Hitek reached approximately $50 million in annual revenue, a decision was made to transition from a functional to a divisional structure.

Except for the president of Hitek, all the senior managers were functional specialists in areas such as sales, marketing, manufacturing, and product development. Hitek realized that to ensure the successful transition to a divisional structure, it had to develop senior managers who were capable of operating as general managers. Accordingly, part of the company's organizational development plan was focused on the development of some of its functional managers as potential general managers. By the time the firm had reached $75 million in revenue, it had two people who were thought to be very likely candidates as general managers, and a third individual who was thought to possess the capabilities of being the general manager of a smaller division. Hitek was able to successfully introduce the divisional management structure.

GoodEats, Inc

GoodEats was a $100 million consumer-products firm, nominally organized into two divisions. One division focused on sales within the United States, while the other division sold the same product internationally. General managers headed each of the two major divisions and had profit-and-loss responsibility for their geographic territories.

As can be seen in their organizational chart presented in Figure 7.7, reporting to the general manager of the U.S. operations was manufacturing, R&D, sales, marketing, purchasing, and distribution. The general manager of the international operations had only sales, marketing, and distribution reporting to him. The general manager of international operations needed to rely on obtaining product from the manufacturing entity that reported directly to the U.S. general manager. In addition, the general manager of the international division had to rely on the R&D function that reported to the U.S. division for assistance in developing new products. In other words, while the U.S. division was a true division, the international division did not control all of the functional units that would contribute to its results.

Although this is not an optimal situation, it could have been managed by using a comprehensive planning process in which both general managers, the corporate CEO, and the head of finance and administration participated. The plan developed by this team would clearly articulate how functional areas that were shared by the two divisions should invest their time and resources for the good of the company as a whole. Unfortunately, the planning process at GoodEats was done in divisional silos: The U.S. general manager developed his plan, and the international general manager developed his plan, both in isolation from the other. This led to a situation in which the heads of manufacturing, purchasing, and R&D constantly felt that they were being pulled in different directions by two very strong horses. The problem was that when these managers needed to make a decision about whose directives to follow, they would, of course, follow those of their manager—the general manager of the U.S. operations. This contributed to a situation in which the company, as a whole, was not achieving the results that it might have achieved and in which the international division (even though it was viewed as a strong source of company growth) was treated like a second-class citizen.

Pardee Homes

Pardee Homes (a member of the TRI Pointe Group) is a multiregional real estate development company with a focus on developing master-planned communities and building single- and multifamily homes. The company was founded by George Pardee in 1921 as a builder of custom homes. In 1969, the company was acquired by Weyerhaeuser Company—a global leader in the forest products industry—and became the largest subsidiary of Weyerhaeuser Real Estate Company. In 2013, Pardee was acquired from Weyerhaeuser by the TRI Pointe Group.

For much of its history, Pardee Homes was organized in a functional structure, but as a result of growth its CEO and COO found themselves stretched too thin and embarked on a process of structural change that would ultimately lead to a divisionalized matrix structure.⁷

In the first phase (1996–1999) of structural change, home-building projects were structured around regional cross-functional teams. These teams were led by a project manager, who functioned more like a coordinator than a manager. Team members were specialists from architecture, construction, engineering, finance, marketing, purchasing, and sales. These team members had a direct reporting relationship to the department heads and a “dotted-line” (coordinating relationship) to the project manager (team leader). Although this structure worked reasonably well and contributed to the company's ability to achieve its growth goals, there were times when certain coordination problems arose. Specifically, sometimes a project team member was pulled in different directions by the project manager and the department head (to whom he or she had a direct reporting relationship). Managers were, for the most part, able to identify and address these problems. However, there was recognition that some supporting systems, like planning and performance management, needed to be refined to support the “new” matrix structure.

The next phase of change (2000–2004) was stimulated by the desire to grow, facilitated by a favorable housing market. One of the key differences between this phase and the prior phase was the delegation of increasing authority to regional team leaders who were informally referred to as regional managers but formally held the title vice president of community development. This was a first step toward divisionalizing the company. The company also continued formalizing the matrix component of its structure—creating systems to better support its effective and efficient operation.

The final phase of the evolution from a functional structure to a divisionalized matrix structure began in 2005–2006. In 2005, the company established a pilot project in one region to treat it as a full division (with profit and loss responsibility) and determine best practices for a full roll-out in other geographic areas. Project managers retained responsibility for managing specific projects, with team members being “matrixed in” from functions, but now project managers would report directly to the head of the division versus to the company's CEO.

As can be seen, the proper implementation of this concept takes time. It also requires a variety of supporting management systems to facilitate the structural change, including well-developed planning and performance management systems.

Starbucks Coffee

In the mid-1990s when Starbucks' revenues were in the range of $350 million, the company decided to revise its structure as a result of planning being done for its future business. Until that point, the company was essentially organized in a functional structure. However, it also had some components (mail order and specialty sales) that were divisional in nature but not treated as true divisions because they were so small. For example, mail order reported to Howard Behar, who ran retail operations. Howard Schultz was CEO, and his direct reports included several functional areas – retail operations, real estate, marketing, logistics and manufacturing, finance, human resources, and legal.

As the company began its planning for the future, it became clear that two things needed to happen: (1) the company was at the point where it needed a COO, and (2) the company was moving in the direction of leveraging its brand name and creating additional businesses. In addition, the company had just experienced a growth spurt and had hired several new executives.

In revising its structure, Starbucks switched from a functional structure to a matrix. Four business units were created: (1) retail operations, (2) specialty sales, (3) mail order, and (4) international. Retail operations included all of the functions involved in setting up and managing Starbucks' retail stores. Specialty sales involved sales of Starbucks' products and distribution arrangements outside the retail system. This included Starbucks' deals with Barnes & Noble for the distribution of coffee in their stores, with UAL (United Airlines) for distribution of Starbucks coffee on all UAL flights, with PepsiCo for joint ventures involving ready-to-drink coffee-based beverages, and with Dreyer's for a joint venture involving coffee-flavored ice cream. Mail order (also known as direct response) was responsible for coffee and other products being marketed and distributed via mail. The international unit was formed to spearhead an effort by Starbucks to expand internationally. This was to be done via joint ventures involving licensing of the Starbucks name and practices to licensees. The functional components of the matrix included the same units identified earlier.

As part of this organizational restructuring, Orin Smith, who had been CFO, became COO. Howard Behar, who had headed retail operations, became the president of the international division, and Deidre Wager, who had assisted Behar, became head of retail.

This structure was designed to facilitate and support Starbucks' growth from approximately $350 million in revenue and 350 stores to at least $2 billion in revenue and 2,000 stores. By 1998, Starbucks had grown to almost $1.4 billion in revenue and more than 1,800 stores. In 2015, Starbucks' revenue exceeded $16 billion, with more than 20,000 stores (about 50% company owned and the rest licensed) throughout the United States and internationally.

Stage I

A Stage I organization usually has what we have termed a prefunctional organizational structure. This means that the typical organization at Stage I has a number of individuals who simultaneously perform a wide variety of duties. The same individual may be performing marketing and administrative tasks because the organization is not yet large enough that it can define its structure in terms of specialized functions.

Although the situation described is probably typical of most Stage I organizations, it is possible that a Stage I organization has made the transition to a functional structure. This can only be determined on a case-by-case basis, without any precise rules being given.

Stage II

A Stage II organization typically has annual revenues from $1 million to $10 million if it is a manufacturing company or from approximately $330,000 to about $3.3 million if it is a service company. Stage II organizations are usually organized according to functional specialties. They have made the transition from a prefunctional stage but are probably not yet ready for a divisionalized form of structure because their focus is usually on a single product or service line.

By the time a company reaches the mid-point of Stage II (at approximately $5 million in revenues for manufacturing companies and $1.5 million for service firms), there should be formal, written role descriptions in place that serve as guides for position-holders. There should also be a formal (written) organization chart that clearly defines reporting relationships. Finally, there should be some focus on ensuring that systems are in place to support the effective implementation of the structure.

Stage III

Organizations at Stage III, ranging from $10 million to $100 million in annual revenues for manufacturing companies and one-third of these values for service organizations, can be viewed in terms of three substage groupings: Stage III (A) from $10 million to $25 million, Stage III (B) from $25 million to $50 million, and Stage III (C) from $50 million to $100 million. During Stage III, there needs to be a continued focus on ensuring that the micro structure (formal role descriptions) and supporting systems that have been put place during Stage II continue to support the effective execution of the overall structure. This typically means revisiting and refining them.

During Stage III (A), the organization typically has a functional structure. As the company grows in size, there is an increasing need for coordination in the development of new products and services, as well as in their manufacturing and distribution. At some point, the company may begin to neglect some of its products and services. The “more important” products and services receive primary attention, while newer products, or those that are less significant in terms of current sales revenue, will be somewhat neglected. This could become a serious problem, because some of the newer products have not yet achieved significant sales revenue but may be vital to the organization's long-term development. Accordingly, sometime during this period of development, the organization may wish to consider moving toward a divisionalized structure. The primary advantage of a divisionalized structure is that it allows a group of people to focus on the development, marketing, and distribution of a common set of products and services.

For some companies, the transition from a functional structure to a divisionalized structure begins to occur during Stage III (B). (For others, this might occur much later—perhaps as late as the transition to Stage VI.) This transition involves the development of managers who will become general managers of the various divisions. Because most managers prior to this time have been technical or functional specialists in an area such as engineering, sales, or production, they now need development that will enable them to coordinate all the various functional areas. This is a task of management and leadership development, which is examined further in Chapter 9.

Another organizational problem that increasingly becomes apparent during Stage III (B) is the need for greater coordination of overall operations than is probably feasible when a single individual serves as president. Sometime during this period, the president of the organization becomes stretched very thin. This means that the individual is simultaneously involved in so many aspects of both day-to-day and long-term operations that he or she begins to feel increasingly torn apart.

What has happened is that the size of the organization and the corresponding complexity of its operations have combined to make it extremely difficult for a single individual to hold everything together. At this point the president of the organization needs to think seriously about bringing in an executive vice president or COO.

Two major transitions need to be made at this time. The first requires a role change for the president, who will give up this position to become the CEO. This involves the transition from a role focusing on both the day-to-day operational issues and the long-term development of the organization to a role in which the CEO is concerned about the organization's long-term development, strategic planning, and organizational development. The introduction of a COO who is now responsible for coordinating the day-to-day operations is the second transition.

By the time the organization reaches Stage III (C) these two transitions should be completed. This means that a COO will be in place and that the organization probably will have two or sometimes more divisions. It should be noted, however, that there are exceptions to this pattern. Many organizations reach $100 million without a COO or any divisions. There are examples of billion-dollar organizations that still have a functional organizational structure—which can be appropriate it they have a single product or service line. The continued use of a functional structure and the lack of the COO position may or may not present problems. This depends, to a great extent, on whether the structure as it is designed is aligned with the company's strategy.

Stage IV

By the time an organization reaches Stage IV, it has frequently either made the transition to a divisionalized structure or is in the process of doing so. The primary challenge at Stage IV is to consolidate the corporate culture throughout the organization. If the enterprise has become a divisionalized organization, it is necessary to consolidate the cultures in the various operating divisions, making them reasonably consistent with the overall corporate culture. These issues are further discussed in Chapter 10, which deals with the management of corporate culture.

Stage V

The focus of Stage V is diversification, either through internal development of new ventures or acquisitions. By the time a business reaches Stage V, the transition to a divisionalized structure is a “must”—that is, the transition to a divisionalized structure to accommodate the diversified enterprise it has become must be accomplished, if this has not previously been done.

Assuming that divisionalization has occurred, there needs to be a focus on clearly defining the roles and responsibilities of “corporate” and the “divisions.” Supporting systems—including planning and performance management—also need to be effectively designed and implemented to promote the effective execution of the divisional structure.

Stage VI

The challenge at Stage VI is for a divisionalized organization to consolidate the various operating divisions, making them reasonably consistent with the overall corporate structure and culture. The key structural solutions to this challenge are either the decentralized type approach of Berkshire Hathaway, the balanced approach of Johnson & Johnson, or a more centralized approach (where corporate exerts more control over the division's activities). The work begun in Stage V around clarifying corporate and divisional roles, and creating supporting systems to make the structure “work” needs to continue. At this stage, there may be a need to revisit and refine existing “supporting systems” so as to increase the overall effectiveness and efficiency of the structure.

Stage VII

The challenge at Stage VII is for a company in decline to revitalize. The structural solution for such a business will depend upon what remains after the organization does “strategic surgery.” For example, when the former International Harvester (now Navistar) revitalized, it sold off most of its business units such as farm equipment and construction and kept only its truck business. A functional structure seemed appropriate, and the company made this change.

It is not possible to make a general statement of structural appropriateness for all enterprises in revitalization. Some enterprises that are in revitalization will tend to be simplifying their businesses and, in turn, their structures. This might lead to a functional structure. Others will attempt to revitalize via acquisitions and thereby become more complex, leading to either divisional or matrix structures. One key to success in this stage, however, is to invest some time in identifying—based on the principles presented in this chapter—what the most appropriate structure will be to support the revitalization effort.