Introduction
Advanced students of commerce and other disciplines often come across the terms centralisation and decentralisation in the course of study. These are generally socio-economic and political decisions and are impacted by reigning economic theories of an era.
You must understand these terms thoroughly before you can proceed to the broader aspects of the Indian and other global economies.
Centralisation and Decentralisation Explained
Both these terms can also apply to any organisation, leaving aside broader economic scales. Simply put, centralisation happens when only the top management of an enterprise are involved in decision-making, creating strategies and setting goals. These individuals have all the powers vested in themselves and they alone control the fortunes of that enterprise.
Decentralisation is its polar opposite. Decision-making and other endeavours are delegated by the top management to subordinates, who in turn are the mid-tier management authorities. Delegation is the key to decentralisation.
Once lower and mid-level management takes decisions which may impact an entire entity, employee empowerment enters the act. The mid-level employees and management have more at stake, and their attention and responsibilities increase automatically.
The primary difference between centralisation and decentralisation lies in how decision-making and strategy-shaping occurs in an organisation. There are various merits and demerits to these two opposing approaches, some of which are discussed below.
For advanced students: Find out how organisations used to work in India prior to 1991 and economic reforms. You will see a wider degree of decentralisation post-1991. Relate it to how the modern economic climate is shaping up.
For foreign examples, you can study the economy of China and that of Venezuela during and post the presidency of Hugo Chavez.
Advantages of Centralisation
The merits of centralisation and decentralisation in management have been discussed by eminent economists for several decades. There are inherent advantages and disadvantages to both ideas. The primary elements in favour of centralisation are the following.
There is greater uniformity in policy and procedures when an organisation is centralised. Several different departments have to work in conformity. There is a top-down approach in decision-making which creates no room for confusion.
Centralisation has been effective in saving costs and unnecessary overheads since any overlapping or duplicate activities are eliminated. Given that cost-saving is one of the many targets of any organisation and that various companies approach the principles of management centralisation and decentralisation differently, it is a great advantage.
The control on operations is outstanding in centralised entities because the mechanism of decision-making is in a single core. This reduces internal wastage and jettisons unwarranted activities.
Lastly, centralised entities can recognise outstanding talent and enable preferred promotions or other sops to deserving employees. In decentralised companies, merit may go unrecognised.
Advantages of Decentralisation
When it comes to centralisation vs decentralisation, the latter approach boasts these advantages in its favour.
Both mid and low-level management are involved in a decision-making process of a decentralised company. It boosts morale, helps employees and managers take independent calls on slippery real-world business situations and also helps delegation of duties.
Very importantly, decentralisation improves the quality of management in any company. If there is rapid employee attrition in company ‘A’, for example, the blame often lies with the immediate management. Weeding out any problems is thus easier.
There is enough data from research to suggest that decentralised companies take better decisions in crucial situations. The same idea is also true for an entire economy.
The Task for Students
Form 2 different groups among yourselves and pretend that Group A owns a centralised company while Group B has a decentralised entity. Start with Rs 1000 and try selling home-made lemonade, for example.
You will have a tough time finding customers initially, so Vedantu suggests you approach people you know in your neighbourhood. Inform them you are participating in a real-world study for your knowledge.
You will likely get a taste of the difference between centralised and decentralised approaches within 1-2 week of ‘operations.’
Factors Determining the Degree of Decentralization
Although there are multiple factors that can influence the decision of decentralization, here is a common list of major factors:
Importance of the decision-making process
Decisions can be costly to the concerned organization, especially in terms of money, goodwill of the company, and employee morale. In such cases, for the decisions that are significant to the organization, a centralized approach at the top levels of the organization is beneficial.
Therefore, even in a decentralized organization, these decisions are increasingly made in a centralized manner even if the argument does not fully support logic. One must remember that even high-level managers are prone to faulty decision-making and can commit mistakes.
Even in such cases, it is expected by the enterprise that they would commit fewer and less-critical mistakes because of their good training, experience, expertise in handling controversial situations, and ability to use the right information and arrive at the best possible deal.
From several real-world observations, it has become obvious that the main reason behind centralizing a company's authority is the heavy burden of responsibility since delegating power in a company does not automatically imply delegating responsibility for it.
Size of the Enterprise
The size of the organization is another crucial factor that can change the degree of decentralization. In a larger firm more and quicker decisions are needed for its survival. Coordinating between various departments and managerial levels and then consulting several specialists and executives can take a lot of time for one decision, delaying the whole process in turn.
And delayed decisions tend to cost more in a fast-paced dynamic world. Therefore, segregation of the organization into smaller decentralized units can make them efficient and act as a superb cost-cutting strategy.
The Attitude and Philosophy of the Management
Decentralization is the dispersal of authority in an organization and if the central and senior manager level authorities are averse to decentralization, it is more likely there will be a lack of free will in the company. Generally, senior executives with a traditional mindset hold less welcoming opinions about decentralizing authority.
While executives with a rational managerial temperament encourage a healthy participative approach to do work. These executives try to make the best out of individual initiatives and opt for greater levels of decentralization.
Control Techniques
Many small and large organizations prefer constancy for some vital aspects like the price of the product, credit offered, etc., and stress on a uniform company policy.
This can be easily achieved with the help of centralization. This then prevents regional heads from making any formative change that may be suitable to the particular branch. One can not fully ignore the positive side of such uniformity. However, the organizations must not overlook the costs involved in all the decisions that are made in a centralized manner.
Also, low and mid-level managers can feel demotivated as their initiatives are arrested and see fewer opportunities to grow within the rigid organization.
Differences Between Centralisation and Decentralisation
To fully grasp the concept of centralised and decentralised entities, you must analyse them on level terms. To keep it simple, we have tabulated these elements of comparison.
Delegation Versus Decentralisation
There is considerable difference between decentralisation and delegation. Only the prime elements of difference have been tabulated below.
For Commerce Students
Track how the management of PSUs like Indian Oil Corporation Limited, SBI, and National Thermal Power Corporation functions. Then compare it against how proprietary, private, and partnership firms operate.
It will be an exercise to identify real-world differences between delegation and decentralisation. You can also read up on the New Economic Policy (NEP) which came into existence after 1991 on our website, or access the study material via Vedantu app.
FAQs on Centralization vs. Decentralization
1. Is Centralisation More Effective than Decentralisation?
It depends on the nature, operations, and financial conditions of a firm. There is no blanket rule in place. Some firms function better under centralized command, others do not. Both of these methods can be effective in different cases. For example, centralisation can make the decision-making process quick and prove beneficial in times of crisis where the employees seek guidance and appreciate leadership skills in their seniors. It also reduces the total incurred cost during damage control (for faulty decisions). However, decentralisation is beneficial at other times, when employees seek to actively participate (and want to be more than mere onlookers) and provide constructive input in the way the company works. Teamwork is achieved when they can fully participate.
2. Is the Indian Economy Open to Decentralisation?
In a post-liberalization nation like India, decentralisation is the need of the hour to address the pressing concerns of our times. It can help bring positive reforms at the grass root levels and improve the delivery of economic and social services. It also helps bind the organization into a dynamic structure, which is less likely to fall apart than when power and authority rest in the hands of few. Decentralization also helps reduce the obvious elitism and ensure transparency of matters that can affect the low-level employees the most.
3. What are the risks associated with decentralisation?
There are some major risks associated with complete decentralisation. Firstly there is a high cost of each decision taken, as it becomes very time consuming to approach each and every department and individual of the company. It can show a lack of leadership within the organisation. It can compromise the quality of decisions as even the uninformed individual’s opinions are to be considered in a decentralised firm. Lastly, the firm may lack uniformity in its policies.
4. What is the philosophy behind the centralisation process in a company?
The main philosophy is to avert the cost of bad decisions within an organization. It offers a fast-paced efficient way of making decisions by eliminating a multi-step approach to pressing concerns. There is authoritative control for restraining any compromise in a company's image and relationship with its end users. Many large firms have a strong centralisation of power and authority for this reason.
5. Does the decentralisation process encourage more reform and innovation?
Yes, the process of decentralisation can introduce many grassroots level reforms which will ultimately be beneficial for the company. It addresses hurdles of transparency, accountability, and association with its lowest-level employees. The low and mid-level managers can bring fresh input and perspective and feel heard and accepted and expect to grow within the firm.
