Organizational Design: A Complete Guide
Organizational design is as much an art as it is a science. The process of creating a system in which people can work together to achieve common goals is highly complex and there is no one way to do it right. In this article, we will explain what organizational design is, what drives organizational design, how to design an organization, and how an effective design can be measured in terms of organizational effectiveness. Let’s dive in!
What is organizational design? A definition
To start with a technical definition: Organizational design is the administration and execution of an organization’s strategic plan. This means that the organization’s strategy determines the optimal organizational design. In addition, it also means that there aren’t really any organizational design best practices. Organizational design is more about creating the best fit between the strategic choices of the organization and the organizational setting.
This is represented in the figure below. Organizational design is determined by the strategic direction of the company, a.k.a. the vision, mission, and goals of the company. These lead to strategies that the company competes on which are enabled through the organizational design.
For example, Company A operates in an established market and is looking to maintain its position. This company will have a low-cost leadership strategy focused on efficiency. In terms of organizational design, this company will have a strong, centralized authority, tight control, and many standard operating procedures.
Company B is an innovative and fast-growing organization that emphasizes learning. This company will have a more fluid and flexible design, a much more decentralized structure, loose control, employees are working directly with customers, and are rewarded for creativity and risk-taking.
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In company A, risk-taking and failing are punished while in company B, it is much more likely to be rewarded, evaluated, and learnings from the failed project will be used as a stepping stone for a new project.
The 5 organizational design principles
One of the most difficult things in organizational design is about what we are designing. The obvious answer would be “the organization”. However, what exactly is it that we are designing about the organization? This is where the five organizational design principles come in.
Our starting point for this is Goold & Campbell’s book Designing Effective Organizations. Goold and Campbell propose five organizational design principles. Organizational design is a tug of war between these five principles. Each principle has its own test to see if the current situation is valid.
This will be slightly complicated, so hang in there! We will make it more concrete with different examples later on.
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- Specialization principle. This principle states that boundaries should exist to encourage the development of specialist skills. The test here is if any specialist cultures, which are entities that have to be different from the rest of the organization, have sufficient protection from the influence of the dominant culture.
- Co-ordination principle. This principle states that activities that are done should be coordinated in a single unit. This unit can be a business unit, business function, (horizontally coordinating) overlay unit, sub-business, core resource unit, shared service unit, project unit, or parent unit. The test here is if there needs to be coordination between departments that is hard to do. These ‘difficult links’ are links where normal networking will not provide coordination benefits. In that case, coordination should be made easier, or responsibility should be put in within a single unit. There are many different units that can be used in organizational design, as we will show below.
- Knowledge and competence principle. This principle states that responsibilities should be allocated to the person or team best fit to do them. This means that tasks are retained by higher levels based on their knowledge and competitive advantage. If this is not the case, they should be positioned lower in the organization.
This means that the CEO should not be involved in every decision – especially not decisions that involve specialists with much more subject-matter knowledge. The CEO is there for the big picture and to balance complex decisions that impact the organization and strategy.
- Control and commitment principle. This principle is about having effective control on the one hand while maintaining engagement and commitment on the other hand. This is always a balance. The test here is to have a control process that is aligned with the unit’s responsibility, cost-efficient to implement, and motivating for the people in the unit.
This means that the CEO is not giving the ‘go’ on the purchase decision for a $30 keyboard – this would be highly demotivating and control on such small expenditures should be put lower in the organization to be adaptive anyway.
- Innovation and adaptation principle. This principle states that organizational structures should be sufficiently flexible to adapt to an ever-changing world. The test here is that the organizational design will help the development of new strategies and to adapt to future changes. Later in this article, we will give a case study of an organization that was unable to adapt to a rapidly changing environment, hurting its internal processes and bottom line.
These five principles are affected by different factors in the internal and external environment of the organization. Earlier, we spoke about strategy. The previously mentioned Company A aimed at maintaining its market share and optimizing its profit margin. This company will benefit from (1) higher specialization to reduce inefficiencies, (2) lower coordination, (3 & 4) responsibility and control lies higher in the organization, and (5) the organizational structure will be more rigid.
These five principles enable an organizational designer to (re)design and align the organization with the key factors that affect the organizational design.
Five factors affecting organizational design
There are five factors that greatly impact organizational design. These factors are:
- Strategy. Strategy dictates the strategic priorities of an organization. This is the most important influencing factor of organizational structure and design.
- Environment. The environment a company operates in influences its strategy but also dictates how it positions itself. In a rapidly-changing environment, the organization has to design for more flexibility, or adaptability, while in a stable environment the organization can optimize for efficiency.
- Technology. Information technology is a key enabler for decision making. The state of IT impacts organizational design as well. When systems are in place and decision making is based on data, the organizational structure and design – including the potential for hierarchical control – will be different from an organization where most of the data is stored in unorganized Excel sheets.
- Size & life cycle. The organizational size and life cycle also impact the organizational structure and design. A 20-person company has very different challenges when it comes to design compared to a 200,000-person company.
- Culture. The organizational culture is another key element that impacts organizational structure and design – and, vice versa, design also impacts culture.
When an organization is structured and designed in a way that fits its purpose, it will result in organizational effectiveness. Organizational effectiveness includes obtaining resources that the company competes on (i.e. the company has the capabilities to be competitive), efficiency (i.e. optimization of the resources required to reach goals, meaning there is a smooth operational process with little wastage), and effectiveness (i.e. strategic goal attainment).
In the following section, we will go over each of these five factors, explaining how these impact organizational design.
The organizational strategy is the most important starting point for the organizational structure and design. It goes beyond the scope of this article to explain how a strategy is created – we have a great article on HR strategy in case you want to check this out.
Michael E. Porter proposed that organizations can compete through lower cost or through the ability to offer distinctive products and services which command a premium price. The second step is to determine whether the organization has a narrow or broad scope. This means that the organization either competes in many or in select customer segments.
This resulted in Porter’s Competitive Strategies framework, in which four competitive strategies are identified: cost leadership, cost focus, differentiation, and focused differentiation.
Different strategies justify a different organizational design. For example, take a beverage company that sells premium whiskey liquor. The focus here is a specific market segment (well-off customers who drink whiskey) with differentiation strategies involving strong branding.
In this organization, production may be a specialized business unit focused on one thing: producing a specialist technological product for DJs. There is some specialization in the production department but the real innovation happens within specialized product teams in which R&D and marketing are in constant touch with customers to develop new features and products the market needs.
Similarly, sales and marketing are business units. They have different, cooperative, horizontally coordinating overlay units under them – e.g. branding and sponsorships, digital marketing, public relations, video/multimedia. These units are highly collaborative with each other and are constantly in touch with the market, leading to high coordination. Specialists have high responsibility and although there is a formal sign-off procedure for marketing campaigns, many of the campaigns happen in decentralized project teams that consist of people from multiple overlay units that communicate with each other frequently as the market is a niche market in which marketing needs to be well-coordinated.
Compare this to a low-cost, broad target cost leadership strategy. We take a soap production company as an example. They produce hundreds of soaps – and although they do some marketing and sales to retail stores for a few of their lines, most of the soaps are produced for external brands. The organizational setup is highly siloed and not expected to change.
When we apply this to the five organizational design principles, there is: (1) high specialization between production and sales, (2) low coordination is required, (3 & 4) knowledge and control lie relatively high in the organization and there is (5) little collaboration required between departments. Indeed, when a new soap line is introduced, the specifics are communicated to the production department and after a few test runs, the company is set to produce that soap for years to come.
The environment also impacts organizational structure and design. The industry, raw materials, (labor) market, (international) governmental, and sociocultural influences all shape the required design to different degrees.
The most important factor is environmental stability. There are two dimensions that influence environmental stability:
- Simple-complex dimension. This refers to the degree to which external factors influence the organization and competition. These are multiple for large companies such as AT&T and British Telecom, where all previously mentioned factors act on. In comparison, a family-owned hardware store in a suburb faces low environmental complexity.
- Stable-unstable dimension. This refers to the elements in the environment that are dynamic. Big consumer brands like McDonald’s are influenced by online media. They are highly visible on platforms like Twitter, Instagram, and TikTok, and a single tweet or blog post can greatly damage a brand. On the other hand, public utility companies have been stable for a long time. Take public libraries in the US between the 1970s and 2000s. These were funded by the local city, county, state, and federal government.
A highly stable and similar environment justifies standardized and non-dynamic organizational processes. Examples include soap producers or container manufacturers. On the other hand, a highly unstable and complex environment requires the organization to constantly adapt. Examples include chip makers and aerospace firms.
Technology greatly influences organizational design. We saw this through the COVID-crisis where many companies effortlessly went digital and some even closed their offices.
WordPress, a popular blogging platform, has a 100% remote workforce. This is possible through the extensive use of technology and technology-driven collaboration.
Information Technology also enables organizations to become more decentralized, improve horizontal coordination through intranets, and external collaboration becomes possible through extranets. In fact, Slack, one of the most-used collaboration tools allows internal and external collaborators to join the same team through different internal and external channels, enabling fast communication.
4. Size & life cycle
Size is another factor that impacts organizational design. Small organizations are usually responsive, flexible, flat, organic, and entrepreneurial. Large organizations create value through efficiencies, have a global reach and brand, a more stable market, and put more emphasis on managers. This leads to different organizational design choices.
As organizations grow, they go through different stages of development. Knowing which stage an organization is in helps to spot misalignment between the organizational goals and strategy and the organizational structure. In addition, it helps to identify which crisis the organization is likely to face.
Every organization has its own unique culture based on their values, assumptions, beliefs, attitudes, feelings, stories, heroes, symbols, language, and habits. These cultures are best summarized in the competing values framework.
This framework proposes that there are a number of competing values in an organization: flexibility vs. stability, and an internal vs. external focus. The values compete, meaning that it is not possible to be both stable and flexible, or both internal and external focused.
Different cultures lead to different organizational structures. An internally focused organization will have more collaboration, while an externally focused organization will have more customer-facing project groups and business units.
Similarly, a highly stable organization has clearly defined business units while a flexible organization has much more market-focused horizontal overlay units that use different specialists to create customer value.
Once you have created an organizational design appropriate for the five factors we mentioned earlier, the result is an effective organization. This means an organization that is able to reach its mission and goals.
Organizational effectiveness is hard to measure. However, when we understand it well, the signals in the organization can provide us with input on improvements for the organization. Let’s conclude this article with three approaches to measuring organizational effectiveness.
The approaches correspond with different phases of the production process. This is an input – process – output (IPO) model. At each step, organizational effectiveness can be measured.
- The first indicator of organizational effectiveness is the resource-based approach. This approach looks at the input and assesses effectiveness by evaluating whether the organization effectively obtains resources necessary for high performance.
- The Internal process approach looks at the production process and assesses effectiveness using internal health and economic efficiency. Examples include a strong culture, trustful communication, swift decision making, undistorted communication, and interaction between the organization and its parts.
- The third indicator is the goal approach. This approach assesses effectiveness by looking at how well the organization reaches it goals. Key here is to focus on operational goals, as these are easier to specify and measure.
To learn more about the finetuning of organizational effectiveness, check out our guide on organizational development.
To illustrate this, let me share this case study about a coffee bean production company. This company occasionally struggles to supply the coffee beans required for production. This leads to supply problems and after the company had missed its latest quarterly sales targets, an inquiry is launched.
It turns out that there is a misalignment between the increasingly unstable political landscape of the coffee production countries, leading to disruptions in supply, and the fixed organizational structure. Further inquiry into decision-making processes, shows that decisions to switch supply lines have to be approved at C-level, leading to a delay in decision making capabilities. These hiccups are the main reason the quarterly sales targets were missed.
To fix this, the organization decides to put the responsibility for parts of the supply chain management and procurement departments lower in the organization. This leads to faster decision-making, hence making the organization more flexible to respond to changes in the external environment.
In this case study, we saw symptoms at all three levels: the input, the process, and the output. In an ideal system, you will want to recognize these symptoms at the input or process level before they will affect the outcome. This can be done by implementing safeguards and creating an early warning system.
And that wraps up this article about organizational design, in which we reviewed the five key principles of organizational design, which are coordination, specialization, knowledge and competence, control and commitment, and innovation and adoption.
There are a series of factors influencing these principles. This includes the organizational strategy, external environment, technology, organizational size & life cycle, and culture. These factors exert pressure on the different organizational design principles.
The configuration of these five principles determines what the organization will look like. An organization high in coordination will be highly connected but at the cost of specialization. An organization high on control and commitment will be losing out on innovation and adoption.
In the end, organizational design and structure are about making balanced decisions that will give the organization a competitive edge and that will help it reach its objectives.
It is impossible to cover everything in this guide. If you have any questions or additions, feel free to comment below!
Organizational design is the administration and execution of an organization’s strategic plan. This means that the organization’s strategy determines the optimal organizational design.
There are five organizational design principles: specialization, coordination, knowledge and competence, control and commitment, and innovation and adaptation.
There are five factors that greatly impact organizational design: strategy, environment, technology, size and life cycle, and culture.