Even small companies need to decentralize. The key is knowing when to split what

Many years ago, when I was working as a management consultant, I had a client who owned a successful record store in an upscale college town. He thought the road to further success was to clone that first store, so he expanded by establishing identical stores in nearby metro areas. He was wrong. From a single, very profitable store, the company became a cash-and-profit sinkhole, losing thousands of dollars daily.

My analysis revealed that the client had made a classic expansion mistake: he had tried to keep centralized control of a key activity that should have been decentralized. It turned out that the buyer at the original store was holding a tight rein on stock in all the stores. And although the buyer was closely attuned to the needs of customers in the university community, he didn't have a clue about what people outside that area wanted to hear. The new stores had the traffic, but they didn't have the music that customers wanted to buy.

I advised the owner to staff each store with managers and salespeople who understood the tastes of the neighborhood, to put the buying decisions into the hands of the new managers, to give those managers the information tools they needed to find out what was selling in similar areas around the country and to monitor the profitability of their stores, and to supply them with an E-mail system to communicate among themselves. Within six months the chain began turning a profit.

That record business stayed out of bankruptcy court by using on-line databases, E-mail, and some of the other tools of virtual companies. More important, the company's makeover entailed a change in organizational philosophy -- an understanding of which activities and, in particular, which areas of decision making could be divided and decentralized, and which needed to remain centralized.

Virtual-company concepts aren't just for high-tech businesses or for companies that have staff scattered around the world. Almost any type of business can benefit from them. And because a virtual company is by definition decentralized, it can serve as a model for managing the dynamic tension between centralization and decentralization. Organizations that are too heavily centralized fail, but too much decentralization can turn into anarchy. The trick is to find the right balance.

The U.S. Constitution recognizes the fragile balance that must be maintained between centralization and decentralization. It gives specific powers to a central government and all other powers to the states. An excellent discussion of which powers belong where is presented in "The Federalist Papers," a group of newspaper articles written -- under pseudonyms -- in 1787 and 1788 by several of America's founders. I heartily recommend a read-through for CEOs who are struggling to decide how to divide work and decision making.

To determine which business functions should be centralized and which should be decentralized, I find it helpful to begin by imagining that everything is decentralized. I start from that perspective because most managers, already trained in the techniques of control, are more comfortable with everything centralized -- and that comfort restricts their creativity. For example, in the information-systems area at VeriFone Inc., the virtual company I helped found, we began by examining what would happen if each of our 40-plus offices was allowed to select its own type of local area network (LAN). Because we believe that every employee should be able to exchange E-mail and other files electronically with every other employee, we decided that having a different LAN in each office would quickly cause chaos. So we opted for a single system. Likewise, having each business unit run a different accounting program could create nightmares during consolidation.

However, we did give each group an enormous amount of latitude to get the job done within the corporate standards we had chosen. For example, we have a corporate compensation committee that sets overall compensation plans. But those plans are just general guidelines; within those guidelines each business unit can choose how to reward those who do the best work. As long as each unit meets its planned performance indicators, operates according to certain corporate principles (say, fostering open communication and promoting workplace ethics), and follows a few corporate standards (for example, adhering to the compensation plans), it is free to do whatever it needs to without first asking the permission of a centralized authority at headquarters.

Another way to determine the centralization-decentralization balance is to ask yourself what business objectives you are trying to achieve and which would be better met through centralization or decentralization. In our 14 years of operating as a virtual company, we've learned at VeriFone that decentralization can help us complete projects, use our collective knowledge to solve problems, establish closer customer contact and wider customer outreach, understand what's happening in the market, harness employees' unique skills, reduce the costs of office space, and meet employees' individual needs. Centralization, on the other hand, is best when there's a need for control -- when a company has to choose a single computer system, when a crisis arises, or when a new manager takes over a group. In the long run, however, tight control usually isn't effective.

When VeriFone was a fledgling company, just beginning to compete with global corporations (we provide equipment to verify credit and to automate payment processing), we decentralized to put our people close to our customers geographically. We identified that strategy very early on because all our major competitors were highly centralized and slow to respond to customers' needs. Assigning the work of meeting customers' needs to a separate group located near the customer, giving that group the decision-making responsibility for those customers, and providing the tools to get the job done helped build our company. For example, we opened an office in Dallas to be near petroleum companies so that we could be more responsive to retail oil and gas operations. We staffed that office with a wide range of technical and nontechnical support people, and we allowed them to make their own decisions for their business units in the field.

After you've decided on the business objectives you think are most critical for your company, you need to evaluate your present practices honestly. For example, if you have a policy that requires your sales staff to get signatures from two senior executives for any price-quote deviation, the business process you have in place is probably not conducive to fast sales. If you believe your company needs to be more responsive to customers, you may want to decentralize the decision-making process more.

Of course not all work can be decentralized effectively. Perhaps you've decided that a key strategic objective for your company is to speed up the project-delivery process by having workers in different time zones do different parts of the job. That approach works in certain situations but not in others. Asking software programmers in different locations to work on the same module, for example, can create major problems. A better approach might be for each location to work on a different module using clear, unambiguous interface specifications.

Even if you've determined that a particular activity should be decentralized, you may need to bring people together at the start of a project -- to establish personal ties and set a common agenda -- and at important milestones. Not all project members have to be present, only one or two members from each team. And those who come together don't have to be the team leaders. In fact, having team members attend those meetings often helps them develop a stronger bond with the overall project: everyone comes to feel that he or she is crucial to the process. And rotating the location of face-to-face meetings helps generate broader involvement and ultimately a better team.

Something else we learned: to decentralize effectively, managers need special skills. They have to trust their staff. (No phone calls to be sure workers are at their desks.) They have to know when to use which communication tool. (Sometimes E-mail just isn't the right medium for the message.) Above all, they have to be able to communicate effectively.

The tools and the organizational philosophy of the virtual organization can help any business prosper. My years at VeriFone have taught me that dividing work is the best way to unify the whole.

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William R. Pape (will_p@verifone.com) is a cofounder of VeriFone Inc., with headquarters in Redwood City, Calif. He was the company's first chief information officer.