Centralization and Decentralization

Top management loves centralization. Rank and file prefer decentralization.

Why?

Imagine you are the CEO of a company with multiple teams. 

Teams need software to do their work. When the need arises for a software, someone from each of the team talks to the software company negotiates a price and procures the software. 

As a CEO, you observe this and see it as a duplication of effort – wastage of time, energy, and resources. You think you can improve efficiency by centralizing the software procurement process. Only one team will be doing the work – the software procurement team. Also, this team will be able to negotiate a better price due to multiple orders, remove redundancy, manage licenses better, and block unnecessary software spends.

Since software cost is a real expense, you can quantify the gain from this exercise.

What about the downside?

Earlier, each team could independently procure the software they saw fit. Now, the individual teams have to go through the centralized procurement team and justify the need; this leads to back and forth and delays. The delay affects the cadence of work leading to employee dissatisfaction. Employee dissatisfaction leads to reduced quality of work, which in turn negatively affects the bottom line.

It is not easy to quantify the second-order effects of centralization, sometimes impossible.

The CEO, due to the broad nature of her work, sees the duplication everywhere. She also witnesses the expenses as a result of this; it is in her face. She wants to eliminate this and bring efficiency and cost-saving to the organization. Hence, she champions centralization. 

The rank and file are hands-on; they have to deal with the management policies to do their work. They experience the second-order effects of centralization day in and out. They instinctually develop anti-centralization spidey sense. 

Unline the rank and file; the CEO does not have the ringside view of the second-order side effects of centralization. The rank and file do not see the duplications the CEO sees because they do not have the same expansive look like that of the CEO.

Centralization efforts have a quantifiable impact. If not entirely measurable, you can do some mental gymnastics to get an idea.

The downsides of centralization are unquantifiable. The unquantifiable plays a crucial role in success, sometimes much more than the quantifiable.

Morgan Housel calls this the McNamara Fallacy.

McNamara Fallacy: A belief that rational decisions can be made with quantitative measures alone, when in fact the things you can’t measure are often the most consequential. Named after Defense Secretary McNamara, who tried to quantify every aspect of the Vietnam War.

Let us flip the earlier scenario. Imagine that the centralized procurement team does bring in efficiency and reduce cost, albeit at a minor loss of productivity. The software procurement expense as a whole is never on the mind of the rank and file; the rank and file do not look at it as closely as the CEO; it is not always on their face. Hence, the rank and file still view centralization as a bane, even when it brings in advantages.

The consensus is that a decentralized way of working trumps a centralized approach; this applies to the military too. Jocko Willink, a prolific US Navy Seal, champions decentralized command. 

There are valid cases for centralization, especially when the talent required to do something is in short supply, and there are legitimate gains to be had from economies of scale. But, when you centralize, think hard of the unquantifiable second-order effects of the decision.