How Competition Affects Organizational Structures

Title: The Flattening Firm and Product Market Competition: The Effect of Trade Liberalization (PDF)
Authors: Maria Guadalupe and Julie M. Wulf
Publisher: Harvard Business School, Working Paper No. 09-067
Date published: October 2008

For years, researchers have watched as U.S. corporations shed organizational layers, giving new responsibilities to junior managers while flattening corporate hierarchies. Although the reasons for this trend are still being debated, the authors of this paper, by studying hundreds of U.S. manufacturing firms, identified one potential cause. They believe that increased competition as a result of the liberalization of global trade policies may be responsible for the flattening of U.S. manufacturing companies.

To measure how expanded trade affects organizational structure, the authors analyzed the Canada–United States Free Trade Agreement of 1989, which governs one of the largest trading relationships in the world. They studied more than 10 years of data — including job descriptions, reporting relationships, and levels of senior and middle management positions at more than 300 publicly traded U.S. companies — from periods both before and after the agreement. To measure “flatness,” the researchers examined how many managers reported directly to the CEO and how many layers of management separated the CEO and a division manager, the lowest management position most commonly found across all the studied firms. On average, they found that between 1989 and 1999 the firms in the sample increased the number of managers reporting to the CEO by 0.32 positions and decreased the layers of management between the CEO and division manager by 0.15 positions. Moreover, companies in traditionally high-tariff industries (which faced an influx of competition after the passage of free trade agreements) flattened more than those in low-tariff industries. Although the authors did not look directly at how cutting layers and increasing the chief executive officer’s span of control affected profitability, they did notice that these changes were put in place to improve response times by decentralizing decision-making authority and empowering lower-level managers.

The research also showed that a reduction in organizational layers was not simply a cost-cutting effort on the part of companies facing increased competition. In fact, the pay of division managers and those in other management positions increased, as organizations attempted to reward and retain key managers.

Bottom Line: Increased competition following trade liberalization leads to flatter firms, as companies look to increase their responsiveness to new competitive threats.