Strategic Resource Allocation : Top-Down, Bottom-Up, and the Value of Strategic Buckets

Every decision to pursue a strategic new product development (NPD) initiative has substantial implications for firm performance. However, at the time resource decisions are made, senior level decision makers often lack precise knowledge about the effectiveness of the firm's resources when executing the initiative. Within any hierarchical organization, key strategic decisions occur at senior levels, while more tactical knowledge resides with managers lower down in the organization. Senior management responsible for allocating resources to strategic initiatives face the choice to either employ a process that advocates control over the exact resource decision (top-down), or one that delegates the resource decision in order to exploit the knowledge of the exact characteristics of the initiative (bottom-up). We investigate the "right" decision process choice, given two important factors: (i) the asymmetry of information between stakeholders, and (ii) the organizational norms that affect managerial choices, i.e. a firm's "tolerance for failure" towards managers of NPD initiatives. We account for the respective agency setting and we explain the properties of the "right" decision process to follow when allocating resources towards strategic initiatives. Neither a bottom-up nor a top-down process is the best across all types of initiatives. Bottom-up processes are beneficial when firms exhibit a high tolerance for failure and when firms are faced with more challenging (risky) initiatives. Alternatively, a top-down process is better for more standard initiatives or when the tolerance for failure is low. Furthermore, we find that the organizational penalty imposed upon managers can have a significant effect on the scope that a firm chooses for strategic initiatives. Higher penalties drive firms to forego more open ended (broadly scoped) initiatives despite the fact that they represent a positive contribution to the profit of the firm. Additionally, we show that a "hybrid" process, commonly known in practice as strategic-buckets, combines aspects of both a top-down and bottom-up process and may achieve the first-best resource allocation. Thus, we offer a theoretical justification for the use of strategic buckets, and we also reveal an interesting side effect of organizational penalties for failure: they enable the implementation of this simple and effective hybrid process without complex incentive schemes