Organizational Structure and Perpetual Innovation: A Computational Model of a Retail Chain

A computational model of a retail chain is developed in which store managers continually search for better practices through innovation. The search is carried out over a rugged landscape defined over the space of store practices with profit being determined by the interaction of a store's current practices and the distribution of consumer preferences in its market. Given a fixed process by which new ideas are generated, organizational structure influences the process by which new ideas become new practices. The main objective of this research is to compare the relative performance of centralized and decentralized organizational structures in terms of profit generated over the short run and long run. When the market environment is fixed over time, centralization is found to outperform decentralization in the short run when markets are relatively homogeneous and consumers are sufficiently sensitive to store practices. The primary force at work is that the centralized retail chain induces uniformity in store practices. By keeping stores at the same point on the landscape, this promotes interstore learning; what is uncovered and passed along by one store is apt to be of value to other stores. Centralization then promotes effective sharing of ideas and this results in a rapid convergence to an optimum. The superior performance of centralization for some market environment is restricted, however, to the short run because the global optimum under centralization in inherently inferior to that under decentralization as a result of restricting stores to having the same practices. Under decentralization, each store can, in the long run, more effectively tailor its practices to its own market and thereby this organizational form eventually outperforms a more centralized organization. When the analysis is extended to accommodate the possibility of a changing market environment, the short-run superiority of a centralized retail chain can be extended to the long run. With the market environment continually changing, the spillovers between stores that is promoted under centralization becomes a dominant force. Quite contrary to the usual claim that volatility in markets requires a more flexible decentralized form, we find that it is the centralized organization with coordinated search that is more effective in responding to a new environment.