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OPERATING MODEL

10/24/2019

The operating model is the bridge between corporate strategy and execution. It serves as the blueprint for managing activities and processes in an orderly fashion.

The optimal operating model for your business is determined by your corporate strategy and will consist of four elements, which together impact the function of all business processes and interactions.

DECISION RIGHTS

First is decision rights. To ensure that decisions are made in a timely and efficient manner, roles must be simple and clear. Fama (Nobel prize winner) and Jensen (1983) divide decisions into four steps: initiation, ratification, implementation and monitoring. It is important to distinguish decision management (initiation and implementation) and decision control (ratification and monitoring) to allow for effective ownership and oversight.

CAPABILTIES

Second is capabilities. Organizational processes must be supported by the right capabilities to promote effective decision-making. Capabilities must be valuable, rare, inimitable, and organized to warrant investment within the organization. This concept, called VRIO, and introduced by Jay Barney (1995), is used to explain how companies can maximize shareholder value.

VRIO has implications for a company’s competitive position. As a company builds each of the V, R, I, and O components, its competitive advantage grows. If all are in place, a company is argued to have a sustained competitive advantage.

INFORMATION

Third is information. Information flow must align with decisions and should not serve as a barrier to effective decision-making. This requires systems to be in place for managing data as well as clear channels for communication of information.

STRUCTURE

Fourth is structure. As companies grow in size, they realize both economies and diseconomies of scale. The challenge is in maximizing economies while mitigating diseconomies of scale. According to Nobel prize winner Williamson (1975, 1985), there are four types of diseconomies of scale:

In mitigating these diseconomies of scale, the level of centralization or decentralization of the company’s structure must be managed smartly. Centralization is effective for leveraging economies of scale and can reduce agency issues. However, it can worsen atmospheric consequences of demotivation.

Decentralization allows for decisions to be made by those who are closer to the information. This allows for fact-based decision making, greater organizational agility, and empowerment of employees. However, it can decrease the benefits of economies of scale and requires incentive structures to be well-developed.

PERFORMANCE INDICATORS

Spanning across all four design elements are the organization’s performance indicators. Selecting the right performance indicators ensures that management can monitor the progress of the business as it relates to its strategic goals. As strategy shifts, so should performance indicators.

SUMMARY

In sum, the operating model must be aligned with corporate strategy to facilitate execution of business processes. It should be optimized across four elements: decision rights, capabilities, information, and structure.

 

References:

Fama, E., & Jensen, M. (1983). Separation of Ownership and Control. The Journal of Law & Economics, 26(2), 301-325.

Barney, J. (1995). Looking inside for Competitive Advantage. The Academy of Management Executive (1993-2005), 9(4), 49-61.

Williamson, O. E. (1975). Markets and Hierarchies: Analysis and Antitrust Implications. New York: Free Press.

Williamson, O. E. (1985). The Economic Institutions of Capitalism. New York: Free Press.

Staffan Canback; Phillip Samouel and David Price, (2003), Strategy and structure in interaction: What determines the boundaries of the firm?, Industrial Organization, University Library of Munich, Germany