Why top-down companies can underperform their peers

Robert Sharoff | Jun 07, 2017

Sections Economics

When a company’s sales start to fall, a regional manager may know it’s time to shift marketing dollars from one product or advertising medium to another well before that news has reached company headquarters. This is an example of business decentralization, and research suggests that such decentralization is key to surviving economic downturns.

This finding runs counter to traditional management theory, which says that during recessions, top-down control of resources and strategy is key. But detailed data from manufacturing companies, gathered before and after the 2007–10 financial crisis in the United States and in Europe, reveal that decentralized companies outperformed their peers in terms of sales growth, productivity, and profits.

“Just as the US military has become more decentralized, letting soldiers on the ground in Afghanistan and Iraq make more decisions than they would have in Korea or in Vietnam, so are the best firms decentralizing in times of economic conflict,” says Stanford’s Nicholas Bloom, who conducted the research with College of France’s Philippe Aghion, Stanford PhD candidate Brian Lucking, Harvard’s Raffaella Sadun, and MIT’s John Van Reenen.

Using data from two management surveys involving 30,000 US manufacturing plants and 1,000 European companies, the researchers were able to establish which firms were decentralized prior to the crisis. The surveys outlined how much responsibility local plant managers had for capital spending, hiring, new product introductions, and sales and marketing. The researchers then looked at how each company performed before and after the financial crisis.

“America was founded by people who wanted to escape the rule of distant kings, and US firms continue to reflect that culture.”

Decentralized companies in the US outperformed their more-centralized peers by 20–25 percent. The researchers also estimate that countries with high levels of decentralization had up to 16 percent more GDP growth in the years after the crisis.

Among the lessons learned: having and applying detailed knowledge of local economic conditions is critical during a recession. But also, decentralization is just one part of why companies do well: those in the surveys that did best coupled decentralization with higher levels of innovation in products and services.

The data also suggest that US companies in general tend to be more decentralized than European ones—for reasons that include higher levels of trust in the US legal system, as well as cultural differences that date back to the country’s settlement by the English. “America was founded by people who wanted to escape the rule of distant kings, and US firms continue to reflect that culture,” says Bloom.

Although the surveys were aimed at manufacturing companies, the results may also have meaning for other sectors, such as retail and business services, and the broader economy.

The results are less clear about whether the advantages of decentralization also apply to noncrisis situations. “You gain flexibility from decentralization but you lose the advantage of scale,” says Bloom. “The best firms reshape their organizational form to fit their circumstances.”