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What Is Organizational Structure?

Organizational Structure is how power and authority are distributed in a vertical hierarchy. All organizations have some structure, even the flattest of organizations.

"Structure" Refers to The Org Chart

When we talk about organizational structure, we're mostly talking about the formal org chart. Niels Plfaeging proposes that there are actually three different organizational structures:

The Formal Structure (Org Chart hierarchy)

Informal Structure - Influence and power between people

Value Creation Structure - How work actually gets done between people and teams.

The important point in differentiating between structures is that power isn't fully explained in an org chart and work doesn't get done solely through a vertical hierarchy. We make too much of organizational structure and not enough of the Informal Structures or "Lateral Processes" (as discussed in organizational design).

Messing with your org chart doesn't necessarily solve for power and doesn't necessarily change the value you create for customers.

Why Do We Need Hierarchy?

We don't need hierarchy, but it's awfully convenient to have it. Hierarchy allows us to move quickly, with fewer rules and processes. Hierarchies help us break ties when consensus can't be formed. Hierarchies are comfortable and familiar to us. Building products and services that people want is hard enough. Removing hierarchy introduces another level of complexity into an organization.

"First, decisions are made in a hierarchy in order to coordinate the behavior of a large number of people who cannot otherwise make timely decisions among themselves. Second, it is a path of escalation in order to resolve disputes among people about the direction of the enterprise." - Jay R. Galbraith (Source: Designing Organizations)

On Flat Orgs

"Flat" organizational models like holocracy and sociocracy are gaining steam. Flat orgs aren't truly flat - they're overseen by a leader or group of leaders who create the rules of the game, uphold the rules, and break ties when needed. So, instead of "no hierarchy," flat orgs are organizations without middle management. Instead of middle managers, they're upheld by rules and processes.

In practice, flat org models are difficult to execute, requiring lots of processes, rules, training, and a willingness on the part of employees to handle traditional "management" work in addition to their specialized roles. There's a risk of a highly political, shadow hierarchy developing to take place of an official hierarchy. Large-scale change seems damn near impossible in a flat org of significant size.

We don't need to trade the benefits of middle management to build a more networked, principled organization. Middle management buys us the ability to move quickly, and with clarity.

More on Flat Orgs: 10 Progressive Organizational Structures Developed By Real Companies, Reinventing Organizations

Design ≠ Structure

Structure Is Visible On an Org Chart

Organizational structure is easy to see and visualize, and every organization has an org chart, the tool we use to visualize structures. Because of our reliance on the org chart as the "blueprint" of the organization, we tend to view organizational structure as the primary component of organizational design.

Structure is usually seen as who-reports-to-who and who works with who. Structure, as the most legible and simple form of design, is important for understanding an organization. Structure lends clarity to how an organization is organized, but it's not everything.

When organizations with interesting structures perform well, we tend to attribute their success to their structure. When organizations that use interesting models perform poorly, their structures are the first thing we criticize.

"Because organization (org) structures appear to be easily distilled down to simple graphs, it is frequently the case that when a company is doing well a given org structure serves as a model for others to follow; and when things are not going well there’s a chorus to change to some obvious alternative." - Steven Sinofsky (Source: Functional Versus Unit Organizations)

Structure Feels Like a First Domino

Companies that grow quickly often look to Re-Org to solve myriad problems. When you triple in size, processes start to break down. The same processes and procedures that worked at a smaller scale no longer work. You can decide to work more broadly on organizational design, or you can reorganize everyone. Sometimes, rebuilding your organizational backbone is critical, and other times it's a false panacea.

Reorganizations are becoming more common, a mainstay in organizational life. But < 25% succeed, and 44% start and then never get completed.

The first rule of reorganization is that you must articulate the problem you're solving for. If you can't clearly communicate with your Leadership Team the exact problem that you're solving, it's likely you'll mastermind a restructure that serves as a panacea for multiple organizational problems. The project will be doomed from the start.

It's tempting when things are not going well - customers aren't being serviced well, people aren't being trained well, and people complain about bottlenecks and wait times, to assume that changing the structure will address all of your problems.

There is no perfect structure. Some structures are better than others for certain types of organizations, but all structures have tradeoffs. The structure that best matches your strategy is likely the right one.

"If the structure makes doing some things so difficult that there is a conflict between structure and strategy, the structure will win. So if you are serious about the strategy, in the case of conflict you have to change the structure." - Stephen Bungay (Source: The Art of Action)

The Two Basic Structures

Functional Vs. Division/Unit Structures

There are two basic types of organizational structures - Functional Structures and Divisions, or Unit Structures. Ultimately, large organizations end up with some sort of hybrid structure that blends both basic structures.

What's a Functional Structure?

Functional structures are organized by job function. Each function is siloed - i.e. the Marketing Department, the Sales Department, the Finance Department, the People (HR) Department.

Value delivery doesn't happen ONLY through functions - Finance, for example, can't deliver an end-to-end project. So, in functional structures, people in functions have to work cross-functionally in teams that cut across the org chart. Successful functional organizations are exceptional at executing lateral processes (see: Organizational Design)

Functional structures utilize cross-functional teams working with one another to accomplish singular organizational goals. Instead of individual divisions working independently to drive their own financial results, the whole functional organization is managed under one P&L. This puts the CEO front and center as the key strategic decision-maker and owner of the P&L.

"There is usually no ownership for a product’s P&L. Instead, everything accrues to the company’s all-up P&L, including compensation." - Ben Thompson (Source: Why Microsoft's Reorganization Is a Bad Idea)

What's a Division Structure?

Divisional structures are organized into Divisions. Different products may have their own Marketing department, Sales department, and Finance department. Products essentially become their own mini-businesses, with their own P&Ls and fully-formed teams operating to deliver financial results.

The division structure is scalable as organizations grow and add products, geographies, and customer segments. Instead of layering on complex lateral processes across each of those features, the organization adds new divisions.

What Is a "Matrix" Organization?

A Matrix organization is organized around functions AND profit centers. In Matrix organizations, people report to multiple stakeholders. The Matrix is built when Integrators - say, a Product Manager - becomes a second manager to a person they work with. The formal reporting structure is added to give the Product Manager hierarchical power to drive accountability.

Do Matrix Structures Work?

Matrix Structures are complex and require personnel who can collaborate with others and use interpersonal influence to get things done.

"They frequently spend inordinate amounts of time arguing over solid lines and dotted lines of authority" - Jay R. Galbraith (Source: Designing Organizations)

Reporting to two different leaders in an organization can create issues. First, managers must be constantly aligned. Second, the direct report must have very clear priorities from that alignment. Clear prioritization of Rocks/OKRs is critical to making the Matrix work.

"By achieving clarity about the number one priority in an organization, and by clearly identifying the defining and standard operating objectives that contribute to it, companies will give their employees far less reason to fear being pulled apart at the seams." - Patrick Lencioni (Source: Silos, Politics and Turf Wars)

How Structures Form

Evolving From Structureless Startup

Intentionally Flat

Structure is an early impediment to getting things done in a startup. Early startup hires are generalists who "wear many hats" and respond to new challenges as they arise. As specialists are added to a growing organization, some structure becomes necessary to organize talent and get things done.

Adding Managers & Specialists

As the startup grows from a handful of employees to a few dozen, the talent becomes more specialized and managers are hired or promoted internally to oversee people the growing headcount.

Complexity increases as multiple specialists need to coordinate their behavior, often across functions, and with managers overseeing them. Teams become harder to coordinate, and Leadership must make a decision about how to organize to manage the increased complexity.

Departments & Resistance at 100 Team Members

Departments & Subcultures

As organizations hire and add new specialties to the staff, functions are built out, and the organization takes on a functional structure. In the new functional structure, a Marketing Manager manages a Marketing Coordinator, a Controller oversees a bookkeeper, and so on.

As departments are built out, company culture ceases to be a monolith and subcultures emerge. These subcultures have their own jargon and lingo, and communicating across departments becomes more difficult. Management has to work through these communication issues with cross-functional processes.

Founder & Early Employee Resistance

Cultures that were previously fast, loose, and autonomous start to lose those features. Founders/CEOs who felt they had total visibility and a feeling of control feel like they've lost both. The "family-like" features of an organization of 0-20 disappear as things become more "formal." Early employees often fight formalized processes, SOPs, and a more formal structure.

Entrepreneurial founders and CEOs often resist this stage. They can feel that the informal style that created their initial success was lost and that the spirit won't be recaptured through more formal structures.

"Transitions from one type of organization to another are often resisted by the founders. It's as if success at one stage leads to resistance to change to go to the next stage...The founders like the original garage-like atmosphere that they believe is responsible for their initial success." - Jay R. Galbraith (Source: Designing Organizations)

Organizing 150 Team Members

When team size grows past 50, the structure of the organization is formalized, and management is built out. Still, every employee can know everyone else and get things done through those personal connections. At the least, everyone looks familiar and we tend to know what departments (Functions) they sit in. Beyond 150 employees, it's not possible for everyone to know everyone else.

If Founders/CEO controlled decisions tightly through a "hub-and-spoke" model of management, they're generally forced to let go of the reins as specialized, more tactically knowledgeable talent works with one another to make decisions on the details.

Formality increases as formal processes and procedures continue to be built out, changed, and updated.

"Formal processes and activities replace the informal processes. The company begins using tools to forecast demand, uses a budget, and adopts a company-wide salary structure." - Jay R. Galbraith (Source: Designing Organizations)

Naturally, these previously-small startups have become functional organizations with cross-functional teams and lateral processes to organize people.

Complexity Beyond 200

If the organization continues to grow past 200 employees, it's often because they've added new products or services, new geographies, or new customer segments (going up-market or down-market).

This is the stage at which cross-functional work becomes even more complex. Do you improve lateral processes? Do you add Integrators? Do you switch to a division structure?

Divisions Form

To handle complexity, many organizations create divisions. If that divisional structure is successful, it becomes the blueprint for more divisions. This is commonly seen with startups who start with Enterprise Sales and then go downmarket to target SMBs. The entire go-to-market motion for SMBs changes and the functional teams are un-equipped to do both at the same time. In Ecommerce and retail, new products and product lines cause the same complexity.

Quickly, each division becomes its own mini-company, with its own P&L.

More Divisions for More Complexity

The blueprint from the original division is used for further products, or for service businesses, or when sales start taking off in new countries, or when the organization intentionally or intentionally takes on Enterprise customers who demand different.

Benefits & Drawbacks of Functional Structures

The Benefits of Functional Structures

Functional structures are best for managing a single product or a single service. There is no better way to structure a simple organization.

Simplicity In The Hierarchy

Managers can manage people whose work they understand well - i.e. Marketing Manager manages the Marketing Coordinator. Because of this, it's easy to operate with fewer managers, which reduces the amount of "general managers" overseeing people, which reduces communication overhead and keeps meetings from becoming overly bloated.

This simplicity is alluring to the operator who wants to keep the organization focused.

"The very first thing that Jobs did when he returned to Apple, even before he famously pared the product line down, was to reorganize the company functionally; then again, perhaps the distinction is meaningless — a functional organization and a simplified product line go hand-in-hand." - Ben Thompson (Source: Apple's Organizational Crossroads)

Develops The Strongest Expertise

Building out functions, where early and late career superstars can mentor, teach, train, and coach one another can lead to a level of organizational expertise that a divided, divisional structure can't match.

"Even in very large product organizations, there are some required skills that don’t have a lot of people. In a functional organization, disciplines without a lot of headcount still get brought together and create a center of gravity." - Steven Sinofsky (Source: Functional Versus Unit Organizations)

Increases Consistency Through Standardization

Different functions can develop strong processes, procedures, and ways of doing things and then train on them. The critical mass of talent means that they can do a better job of this than Divisions. Functional Structures don't run into scenarios where the same job role on two different teams are doing the same work in different ways.

"Companies like Cisco often revert to the functional structure to reduce the proliferation and duplication of systems, standards, and policies that result when independent units do not manage to share or cooperate." - Jay R. Galbraith (Source: Designing Organizations)

The Drawbacks of Functional Structures

Can't Manage Complexity

At scale, organizations end up with lots of functions juggling lots of different priorities. With the inability to focus, they don't get much done. If an organization has multiple products and market segments, decision-making from management can become overwhelming.

"Products with different GTMs, wildly different customers or sales channels, or just different ship dates are extremely difficult to manage as a functional org." - Steven Sinofsky (Source: Functional Versus Unit Organizations)

Requires Specialized Leaders

Functional Structures can't get by with career general managers, because functions require expertise. This makes the management group less plug-and-play, limiting flexibility with managers and requiring that the organization staff experts who are also leaders.

Makes New Products & Innovation Hard

It's tough to create new products within a functional structure, as creating new products requires that focus gets diverted from established cash-cow products toward less certain bets. How can you prioritize innovation if individuals are incentivized instead to manage what's already working?

Potentially Less Accountable

"Accountability" usually means that people take responsibility for the outcome of the P&L, or at a detailed level, on the delivery of a project. This works well in division structures but doesn't work in functional structures where everyone is contributing pieces toward something much bigger.

Requires Collaborative Culture

Nothing gets done unless the functions can work together effectively to deliver. If your silos are too strong, and you don't have a collaborative culture, cross-functional work won't happen and nothing will get done.

"A company organized functionally that does not have the necessary cultural ingredients for true collaboration is actually in worse shape for having tried; the disagreements will turn into conflict, and the agreements made through groupthink will arguably be worse." - Ben Thompson (Source: The Uncanny Valley of a Functional Organization)

Requires Strong Vision From Leaders

Because each function leads back up to the Leadership Team and CEO, the group at the top needs a strong vision that each function buys into. Because teams aren't delivering an end-to-end solution, it's up to the top team to create an adequately motivating vision of the future.

"The vast majority of employees only ever see a piece of the product; it’s up to the CEO to set the broad vision and ensure that it is being followed." - Ben Thompson (Source: The Uncanny Valley of a Functional Organization)

Less Opportunity For Employee Advancement

In a functional organization, there are fewer general managers needed to wrangle staff, which likely means fewer management roles in general. This leads to limited advancement paths for people, as there is one functional leader per function.

"People tend to feel less opportunity because there is “one” leader of a functional area. As people grow and want to expand their scope of responsibility, there can be a feeling of limited opportunity 'managing within a discipline'...With a single discipline leader, it can feel like a tenure-track problem to more recent hires on the team." - Steven Sinofsky (Source: Functional Versus Unit Organizations)

Benefits & Drawbacks of Division Structures

The Benefits of Division Structures

Easier to Manage Products, Countries, Segments

Division structures are scalable, whereas functional structures are not. Division structures scale to many products, many countries, and many segments. If the organization's strategy is to expand in those ways, a division structure is a safe bet.

Responsive to Market Threats

Instead of tossing a mission-critical project into your functional structure and counting on a cross-functional Tiger Team to deliver, a divisional organization forms a standalone, fully-staffed unit with clear financial accountability. With resources, clear goals, and less distraction, the division structure is more likely to succeed.

"One Throat to Choke"

Divisions have a single leader who is accountable to a P&L. Performance against that P&L is clear, so there are few questions as where to accountability lies and what constitutes performance. Division heads essentially operate as mini-CEOs.

"People do what they are incentivized to do; it follows that employees who are compensated based on the performance of their division are particularly motivated to ensure the success of the product they work on." - Ben Thompson (Source: Why Microsoft’s Reorganization Is a Bad Idea)

Creates a Promotion Culture Where People Can Grow

Division structures create lots of general management roles and the scaling of divisions creates job and job rotation opportunities for people, especially early career superstars.

In Early Divisional Structures: Division Are Small, Energy Is High

In newer division structures, the divisions are still small, and this gives them more of a startup feel. That creates a lot of energy and momentum that a "larger" feeling functional structure is unlikely to match.

The Drawbacks of Division Structures

Duplication & Redundant Effort

Across divisions, some people will end up working on the same problems without knowing it. Division structures create new and different solutions to the same problem, or more likely, waste a lot of time and energy in solving problems that have already been solved elsewhere in the organization.

"Over time units tend to revise or revisit most every company process and approach. I’ve seen units that say to be successful they need to recruit differently, need different beverages, need different performance appraisal, hire a different PR firm, different furniture, and more." - Steven Sinofsky (Source: Functional Versus Unit Organizations)

Collaboration Doesn't Develop

Instead of perfecting lateral processes and cross-functional teaming, Division structures avoid the challenge and divide into separate P&Ls. Divisions have no incentives to work with one another. The structure creates strong disincentives for divisions to solve problems that cut across the organization.

Resource Allocation Is Harder

Instead of filling functional teams, divisions atomize talent so that general managers have buckets of specialization but often end up fighting over expertise. No one has enough of certain types of specialized talent. Getting more resources becomes an internal battle and can require changing the org chart.

Requires A Large Management Team

How will you source enough general managers to lead all of the teams? Divisional organizations create a promotion culture and use job rotation to get young talent exposed to many aspects of the organization so that they can become that.

Still, staffing productive general managers is expensive and difficult. This makes org charts very vertical and staffing management roles effectively, a real challenge.

What's The Right Structure?

A Functional Structure is best for a single-product organization. An organization with lots of products, or with imminent plans to go up-market or down-market, and expand to different countries, should consider a Division structure.

One key piece of Strategy is understanding how much expertise and specialization you'll need as you grow. If you need more specialization, you'll want to stick to a functional structure for as long as possible. If you can't get by with more general roles, shifting to a division structure could make sense.

Are You Creating A New Business?

One way to think about the structure decision is to ask whether your strategy calls for a new business. Targeting a tangentially different buyer persona may require some marketing choices - a different value proposition and messaging - but isn't creating a whole new business.

Adding a service "arm" to a product organization is creating a new business. Adding a software component to a hardware organization is entering into a new business.

The people who excelled in one of those businesses may not have the skills or experience to be effective in the other.

Three Structure Questions to Ask

Foundation

PurposeMissionVisionCore ValuesStrategy

Designing The Organization

Understanding CultureCultivating CultureOrganizational DesignOrganizational StructureOperating PrinciplesLeadership TeamsDesigning ManagementEffective Teams

Operating Effectively

Operating RhythmGoalsPlanningInternal CommunicationMeetingsMetricsBusiness ProcessResolving IssuesDeciding & Delegating