ORGANIZATION THEORY

An organization, by its most basic definition, is an assembly of people working

together to achieve common objectives through a division of labor. People
form organizations because individuals have limited abilities. An organization
provides a means of using individual strengths within a group to achieve more
than can be accomplished by the aggregate efforts of group members working
individually. Business organizations (in market economies) are formed to profit
by delivering a good or service to consumers.
Over the years there have been countless theories and models of how
business organizations function and what their essential characteristics are.
One widely held view, for example, is that at their core organizations are
information processing systems, where information includes knowledge about
products, markets, production methods, management techniques, finance,
laws, and the many other factors involved in running a business. A successful
organization, the theory goes, acts on relevant information and ignores the
irrelevant. Ultimately, the organization that excels at processing information
facilitates learning and the development of new knowledge. Other models of
organizations focus on traits such as power and subordination, culture and
adaptation, and efficiency.
Organization theory is examined here primarily from a historical perspective
that briefly summarizes its evolution. The open-systems theorythe dominant
school of thought throughout most of the 20th centuryis examined in
greatest detail, while organizational characteristics and structures are also
reviewed.

BACKGROUND
Modem organization theory is rooted in concepts developed during
the Industrial Revolution in the late 19th and early 20th centuries. Of import
during that period was the research of Max Weber (1864-1920), a German
sociologist. Weber believed that bureaucracies, staffed by bureaucrats,

represented the ideal organizational form. Weber based his model

bureaucracy on legal and absolute authority, logic, and order. In it,
responsibilities for workers are clearly defined and behavior is tightly
controlled by rules, policies, and procedures. In effect, Weber's bureaucracy
was designed to function like a machine; the organization was arranged into
specific functions, or parts, each of which worked in concert with the other
parts to form a streamlined process.
Weber's theories of organizations, like others of the period, reflected an
indifferent and impersonal attitude toward the people in the organization.
Indeed, personal aspects of human behavior were considered unreliable and
were viewed as a potential detriment to the efficiency of any system. Humans
were likened to a bundle of skills that could be inserted into the system like a
cog in a machine. Although his theories are now considered mechanistic and
outdated, Weber's views on bureaucracy provided important insight into
process efficiency, division of labor, and hierarchy of authority.
Another important contributor to organization theory in the early 1900s was
Henri Fayol. He is credited with identifying four basic managerial functions that
characterize successful organizations:
1. Planningthinking before acting
2. Organizingsetting up policies and procedures that regulate employee
behavior
3. Staffingrecruiting a suitable work force
4. Controllingmotivating workers to pursue the goals of the organization
Weber's and Fayol's theories found broad application in the early and mid-20th
century, largely as a result of the work of Frederick W. Taylor (1856-1915). In a
1911 book entitled Principles of Scientific Management, Taylor outlined his
theories and eventually implemented them on American factory floors. Taylor's
theory of scientific management mimicked the four basic managerial functions
identified by Fayol, and adopted the same basic attitudes about process
efficiency championed by Weber. Although elements of Taylor's research and

findings have been criticized, he is credited with helping to define the role of
training, wage incentives, employee selection, and work standards in
organizational performance.

HUMAN-CENTERED APPROACHES.
Researchers began to adopt a less mechanical view of organizations and to
pay more attention to human influences in the 1930s. This development was
motivated by several studies, particularly the Hawthorne experiments, that
shed light on the function of human fulfillment in organizations. Primarily under
the direction of Harvard University researcher Elton Mayo, the Hawthorne
Experiments were conducted in the mid 1920s and 1930s at a Western
Electric Company plant known as the Hawthorne Works. The company wanted
to determine the degree to which working conditions affected output.
Surprisingly, the studies failed to show any significant positive correlations
between workplace conditions and productivity. In one study, for example,
worker productivity escalated when lighting was increased, but it also
increased when illumination was decreased. The results of the studies
demonstrated that innate forces of human behavior may have a greater
influence on organizations than do mechanistic incentive systems. The legacy
of the Hawthorne studies and other organizational research efforts of that
period was an emphasis on the importance of individual and group interaction,
humanistic management skills, and social relationships in the workplace.
The focus on human influences in organizations was reflected most noticeably
by the integration of Abraham Maslow's "hierarchy of human needs" into
organization theory. Maslow's theories had two important implications for
organization theory: (1) people have different needs and are therefore
motivated by different incentives to achieve organizational objectives; and (2)
people's needs change predictably over time, meaning that as the needs of
people lower in the hierarchy are met, new needs arise. These assumptions
led to the recognition, for example, that assembly-line workers could be more
productive if more of their personal needs were met, whereas past theories
suggested that monetary rewards were the sole, or primary, motivators.

THEORY X AND THEORY Y.

Douglas McGregor contrasted the organization theory that emerged during the
middle of the 20th century with previous views. In the 1950s, McGregor
offered his renowned Theory X and Theory Y to explain the differences. In a
nutshell, Theory X depicts the old, repressive, pessimistic view of workers. It
assumes that people are lazy and have to be coerced to produce with tangible
rewards. In fact, McGregor argued that the old view assumed that workers
preferred to be directed, wanted to avoid responsibility, and cherished financial
security (i.e., jobs) above all else.
McGregor believed that organizations that embraced Theory Y were generally
more productive. Theory Y adopted a more optimistic view of human nature.
Among other things, it theorized that (1) humans can learn to accept and seek
responsibility; (2) most people possess a high degree of imaginative and
problem-solving ability; (3) employees will selfgovern, or direct themselves
toward goals to which they are committed; and, importantly, (4) satisfaction of
ego and self-actualization are among the most important needs that have to
be met by (profit-maximizing) organizations.

OPEN-SYSTEMS THEORY
Traditional theories regarded organizations as closed systemsautonomous
and isolated from the outside world. In the 1960s, these mechanistic
organization theories, such as scientific management, were spurned in favor
of more holistic and humanistic ideologies. Recognizing that traditional theory
had failed to take into account many environmental influences that affected the
efficiency of organizations, most theorists and researchers embraced an
open-systems view of organizations.
The term "open systems" reflected the newfound belief that all organizations
are unique and should therefore be structured to accommodate unique
problems and opportunities. For example, research during the 1960s showed
that traditional bureaucratic organizations generally failed to succeed in
environments where technologies or markets were rapidly changing. They

also failed to realize the importance of regional cultural influences in

motivating workers.
Environmental influences that affect open systems can be described as either
specific or general. The specific environment is a network of suppliers,
distributors, government agencies, and competitors. An organization is simply
one element of that network. To succeed, or profit, the organization must
interact with these influences. They use suppliers, for example, when they
purchase materials from other producers, hire workers from the labor force, or
secure credit from banks or other companies.

CULTURAL INFLUENCES.
The general environment encompasses four influences that emanate from the
geographic area in which the organization operates. The first is cultural
values, which determine views about what is right or wrong, good or bad, and
important or trivial. Companies in the United States will likely be influenced by
the values of individualism, democracy, individual rights and freedoms, and a
puritan work ethic, among many others. In addition, regional and local values
will affect organizations. For instance, workers and consumers in southern and
northwestern states are more likely to be ideologically conservative.

ECONOMIC CONDITIONS.
Economic conditions make up the second cluster of general environmental
influences on open systems. These influences include economic upswings,
recessions, regional unemployment, and many other factors that affect a
company's ability to grow and prosper. Economic influences may also partially
dictate an organization's role in the economy. For example, as the economy
grows the organization will likely become not only larger but more specialized.

POLITICAL CONDITIONS.
A third influence on organizations is the legal/political environment, which
effectively helps to allocate power within a society and to enforce laws. The

legal and political system in which an open system operates determines, most
importantly, the long-term stability and security of the organization's future. For
instance, a national government can add stability by maintaining a strong
defense force. But legal and political mechanisms can also hamper a
company's success by burdening it with regulations, taxes, employee rights
laws, and other rules. In general, the larger and more powerful the local,
regional, or national government, the less attractive will be the general
environment to nongovernment organizations.

EDUCATIONAL CONDITIONS.
The fourth general environmental influence on open systems is educational
conditions. For example, businesses that operate in countries or regions with
a high education level will have a better chance of staffing a complex
organization that requires specialized skills and a precise division of labor.

KATZ AND KAHN

Daniel Katz and Robert L. Kahn developed a framework for open-systems
theory that encompasses: (1) energic inputs into the organizations; (2) the
transformation of those inputs within the system; (3) energic outputs; and (4)
recycling. Energic inputs, or external influences, include familiar resources like
employees, raw materials, and capital. However, they also include intangible
external influences, such as status, recognition, satisfaction, or other personal
rewards.
The transformation process involves using energies, or inputs, to (in the
business context) create products or services. Energic outputs are simply the
products or services that are distributed to consumers. Finally, recycling refers
to the fact that outputs are indirectly recycled back into the organization. For
instance, when a company sells a toaster the revenue becomes an input into
the organization that is used, for example, to pay workers or buy materials.
In addition to identifying the four phases of an open system, Katz and Kahn
cataloged several other organizational characteristics that support the

opensystems theory and have implications for the design of successful

organizations. For example, they recognized the universal law of entropy,
which holds that all organizations move toward disorganization or death.
However, an open system can continue to thrive by importing more energy
from the environment than it expends, thus achieving negative entropy. For
example, a failing company might be able to revitalize itself by bringing in a
new chief executive who improves the way the company transforms energic
inputs.
Another characteristic of organizations is dynamic homeostasis, which infers
that all successful organizations must be able to achieve balance between
subsystems. For example, a sales department might grow very quickly if it is
very successful or demand for its products jumps. But if the manufacturing
arm of the company is unable to keep pace with sales activity, the entire
organization could break down. Thus, subgroups must maintain a rough state
of balance as they adapt to external influences.
Katz and Kahn also characterize open systems by equifiniality. This concept
suggests that organizations can reach the same final state by a number of
different paths. In fact, the course is not fixed and may develop organically as
both internal and external influences intervene.

SUBSYSTEMS
Open-systems theory assumes that all large organizations are comprised of
multiple subsystems, each of which receives inputs from other subsystems
and turns them into outputs for use by other subsystems. The subsystems are
not necessarily represented by departments in an organization, but might
instead resemble patterns of activity.
An important distinction between open-systems theory and traditional
organization theory is that the former assumes a subsystem hierarchy,
meaning that not all of the subsystems are equally essential. Furthermore, a
failure in one subsystem will not necessarily thwart the entire system. By
contrast, traditional mechanistic theories imply that a malfunction in any part of

a system would have an equally quashing effect. This could be likened to

pulling one cotter pin from the wheel of a go-cart; doing so would make the
entire vehicle inoperable.
At least five subsystems identified by Katz and Kahn are important to the
success of any business organization. Each of these subsystems may also be
comprised of subsystems. For example, production subsystems are the
components that transform inputs into outputs. In a manufacturing company
this subsystem would be represented by activities related to production. In
most business organizations, all other subsystems are built around the
production subsystem.
Maintenance subsystems maintain the social involvement of employees in an
organization. Activities in this group include providing benefits and
compensations that motivate workers, creating favorable work conditions,
empowering employees, and fulfilling other employee needs.
Adaptive subsystems serve to gather information about problems and
opportunities in the environment and then respond with innovations that allow
the organization to adapt. A firm's research lab or a product development
department would both be part of an adaptive subsystem.
Supportive subsystems perform acquisition and distribution functions within an
organization. Acquisition activities include securing resources, such as
employees and raw materials, from the external environment. Human
resources and purchasing divisions are typically included in this group.
Distribution, or disposal, activities encompass efforts to transfer the product or
service outside of the organization. Supportive subsystems of this type include
sales and marketing divisions, public relations departments, and lobbying
efforts.
Managerial subsystems direct the activities of other subsystems in the
organization. These managerial functions set goals and policies, allocate
resources, settle disputes, and generally work to facilitate the efficiency of the
organization.

BASIC ORGANIZATIONAL
CHARACTERISTICS
Organizations differ greatly in size, function, and makeup. Nevertheless, three
characteristics of nearly all organizations with more than a few members are:
(1) a division of labor; (2) a decision-making structure; and (3) formal rules
and policies.
Organizations practice division of labor both vertically and horizontally. Vertical
division includes three basic levelstop, middle, and bottom. The chief
function of top managers, or executives, typically is to plan long-term strategy
and oversee middle managers. Middle managers generally guide the day-today activities of the organization and administer top level strategy. Low-level
managers and laborers put strategy into action and perform the specific tasks
necessary to keep the organization operating.
Organizations also divide labor horizontally by defining task groups, or
departments, and assigning workers with applicable skills to those groups.
Line units perform the basic functions of the business, while staff units support
line units with expertise and services. For instance, the marketing department
(line unit) might be supported by the accounting department (staff unit). In
general, line units focus on supply, production, and distribution, while staff
units deal mostly with internal operations and controls or public relations
efforts.
Decision-making structures, the second basic organizational characteristic,
are used to organize authority. They vary in their degree of centralization and
decentralization. Centralized decision structures are referred to as "tall"
organizations because important decisions usually emanate from a high level
and are passed down through several channels until they reach the lower end
of the hierarchy. Bosses at all levels have relatively few employees reporting
directly to them.
In contrast, flat organizations, which have decentralized decision making
structures, employ only a few hierarchical levels. The few bosses or authority

figures have many employees reporting directly to them. Such organizations,

however, usually practice some form of employee empowerment whereby
individuals make decisions autonomously. Decentralized structures are more
representative of humanistic organization theories, while traditional tall
organizational structures are more mechanistic. Besides meeting human
needs, flat structures yield faster response times to internal and external
influences.
Formalized rules and policies is the third standard organizational
characteristic. Rules, policies, and procedures serve as substitutes for
managerial guidance. For example, they may indicate the most efficient
means of accomplishing a task or provide standards for rewarding workers.
The benefit of formalized rules is that managers have more time to spend on
other problems and opportunities. The disadvantage of rules is that they
sometimes stifle workers' creativity and autonomy, thereby reducing their
satisfaction and effectiveness.
Thus, organizations can be categorized as informal or formal, depending on
the degree of formalization of rules. In general, formal organizations are goaloriented and rational, and the relationship between individuals and the
organization is comparatively impersonal. Subordinates have less influence
over the process in which they participate, with their duties more clearly
defined. The extreme case of a formal organization would resemble Weber's
ideal bureaucracy.
Informal organizations are those that have relatively few written rules or
policies. Instead, individuals are more likely to adopt patterns of behavior that
are influenced by a number of social and personal factors. Changes in the
organization are less often the result of authoritative dictates and more often
an outcome of collective agreement by members. Informal organizations tend
to be more flexible and more reactive to outside influences. But they may also
diminish the ability of top managers to effect rapid change.

BASIC ORGANIZATIONAL STRUCTURES

FUNCTIONAL STRUCTURE.
In addition to the three root characteristics of business organizations, there are
two main types of structures: functional and divisional. Most companies
represent an amalgam of both, and many variations exist. Functional
organizational structures are more traditional. They departmentalize the
company based on key functions. For example, activities related to production,
marketing, and finance might be grouped into three respective departments.
Within each, moreover, activities would be departmentalized into
subdepartments. Within the marketing department, for example, might be the
sales, advertising, and promotions departments.
The advantage of functionally structured organizations is that they typically
achieve an efficient specialization of labor because people with specific skills
can follow a career path within their department. In addition, this type of
structure is relatively easy for employees to comprehend. Therefore, they are
more likely to identify with their group and enjoy a sense of accomplishment
through the gains of the department. Finally, functional structures reduce
duplication of work because responsibilities are clearly defined.
On the other hand, functional structures are often divisive, causing
departments to become adversarial and employees to engage in behavior that
benefits their department at the expense of the overall organization.
Furthermore, employees in departments often become myopic, losing sight of
the goals of the entire organization. In addition, functional structures typically
fail to make full use of the talents of workers and they are often less reactive to
environmental influences.

DIVISIONAL STRUCTURE.
Companies that employ a more divisional structure break the organization
down into semiautonomous units and profit centers based on activities related
to products, customers, or geography. Regardless of the activity group used to
segment the company, each unit operates as a separate business. For
example, a company might be broken down into southern, western, and

eastern divisions. Or, it might create separate divisions for consumer,

industrial, and institutional products. Again, within each division are
subdivisions.
One benefit of a divisional structure is that it facilitates expansion because the
company can easily add a new division to focus on a new profit opportunity
without having to significantly alter exiting systems. In addition, accountability
is increased because divisional performance can be measured more easily.
Furthermore, divisional structures permit decentralized decision making, which
allows managers with specific expertise to make key decisions in their area.
The potential drawbacks to divisional structures include duplication of efforts
and a lack of communication. For example, separate consumer and industrial
divisions of the same air-conditioner company may both be trying to develop a
better compressor. In addition, divisional organizations, like functionally
structured companies, may have trouble keeping all departments focused on
an overall company goal. A corollary is that top management sometimes loses
touch with the goals and inner-workings of each division.

SECTOR STRUCTURE.
A variation on the divisional structure is known as the sector structure. This is
employed typically by very large and diversified companies. One of the best
known examples is General Electric Co., which pioneered the format in the
mid-1970s. Sectors are usually broad market-defined operating areas and
they may combine several conventional divisions that produce related goods
or services. For instance, some of GE's sectors include aircraft engines,
lighting, and capital services. The logic behind the sector structure is to strike
a medium between extreme centralization and extreme decentralization. If a
company has dozens of divisions it might be impractical to have all the division
heads report directly to the CEO. On the other hand, because the company is
so large, it may not be possible or desirable to merge divisions and centralize
it more. By grouping similar divisions into coherent sectors, the sector
approach attempts to make large organizations more focused and
manageable.

MATRIX STRUCTURE.
A less traditional (and less common) approach is the matrix structure, which
emphasizes collaborative relationships between different parts of an
organization. Under a matrix structure, individuals or departments have
multiple reporting relationships, or at least multiple consulting relationships.
This is particularly useful on large projects that require inputs from many
different functional areas of the organization. For example, a company may
have a product manager for each of its product lines, and these individuals
may work both with marketing staff and with production staff in order to fulfill
their role. In addition, each may collaborate periodically with other product
managers in order to maintain a unified product strategy. If drawn on paper,
this structure would appear as a grid with reporting or consulting lines
connecting the product managers to the marketing department, the
manufacturing or production department, and each other.

INTERNATIONAL STRUCTURES.
Since the late 1980s, companies have been paying greater attention to how
their activities are organized across national borders. Interest in such
international management issues has grown as global market strategies
increasingly dominate corporate objectives. The primary issues in international
structures are local autonomy/uniqueness and how international units relate to
each other and to the headquarters.
Christopher Bartlett and Sumantra Ghoshal have done important work in this
area, summarizing their findings in the 1989 book Managing Across
Cultures, which was updated and re-released in 1998. They argue that the
oldestand least effectiveform of international structure is the "global"
structure, in which international divisions or subsidiaries follow detailed and
relatively inflexible supervision from the corporate headquarters. As a result,
the company tends to operate in a similar manner in all places following a
centrally determined formula. At the other end of the continuum, Bartlett and
Ghoshal cited the "transnational" organization, which allows local conditions

and strengths to influence both local practices and, if appropriate, worldwide

practices. In essence, the transnational enterprise tries to use all of its
resources to their fullest potential, regardless of their country of origin.
For example, if a company opens or acquires a new research facility in
another country and finds that the labor and legal conditions in that country
are ideal for research and development activities (e.g., access to a highly
skilled workforce, minimal government intervention), the company may decide
to do all of its R&D at that location. At the same time, regional marketing units
in a transnational organization have the flexibility to tailor products or
marketing to the local audience in order to ensure relevancy. Both of these
scenarios would be unlikely under the so-called global structure.

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