The organization of economic activity

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The organization of economic activity

• The information and service economy
• October 8, 2007
• Bob Glushko and Anno Saxenian

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Models of economic coordination (l)

• Smith invisible hand of market
• Coase market v. firm
• Williamson market v. hierarchy
• Marx class control and conflict
• Taylor scientific management

3
Models of economic organization (ll)

• The mass production economy
• Henry Ford and Fordism
• The Visible Hand of management
• Network forms of organization

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Henry Ford, Mass Production (1926)

• Mass production focuses principles of power,
  accuracy, economy, system, continuity, speed, and
  repetition on the manufacturing project.
• Managements job is to interpret these
  principles goal is productive organization that
  delivers in continuous large quantities a useful
  commodity of standard material, workmanship and
  design at minimum cost
• Mass consumption that absorbs output is the
  necessary precondition of mass production

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Limits of the factory system

• Early factory system is mere massing of men and
  tools, profit motive dominates
• Purely financial emphasis fails in
  manufacturing-- evident with labor revolt, social
  strife
• Limits of early 20th c. efficiency movement
• Dont just rationalize pig iron loading by making
  worker load 47 1/2 tons a day (rather than 12
  11/2 tons) for 1.85 rather than 1.15/day.)
• Instead use intelligent methods to make it
  unnecessary for worker to carry 106,400 lbs to
  earn 1.85

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The motor industry as a model

• Ford Motor Co as pioneer of mass production
• Start with conception of public need match
  use-convenience with price-convenience
• Service element remains utmost
• Profit and expansion are trusted to emerge
• Mass production reduces costs and permits mass
  consumption (use- and price-convenience)
• 500 increase in production allows 50 reduction
  in cost and falling selling price
• 10X the number of people can now buy it

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The principles of mass production

• Three principles of mass production
• Planned orderly and continuous progression of
  commodity through the shop
• Delivery of work instead of leaving it to
  workmans initiative to find it
• Analysis of operations into their constituent
  parts.
• Importance of consistent quality
• Small spring leaf of identical strength, finish
  curve with millions of others
• Requires automatic machinery, the most accurate
  measuring devices, pyrometer controls, etc.
• Some gauge inspections involve measurements to
  ten-millionth part of an inch

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The effects of mass production

• Increased industrial control and engineering,
  rather than financial control.
• Highest standard of quality ever attained in
  output of great quantities.
• Creation of a wide variety of single-purpose
  machines that reproduce skill of hand.
• Elimination of hard work in the form of wasteful
  and laborious burden-bearing.
• Growing need for skilled artisans and creative
  genius (e.g. skilled mechanics in construction
  and maintenance of machines)

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The effects of mass production (ll)

• Fords response to critics of mass production
• Mass production results in higher wages than any
  other method of industry--workers can earn more
  buy more.
• Mass production increases supply of human needs
  and development of new standards of living,
  enlargement of leisure.
• The problem of management is to organize
  production so that it will pay the public, the
  workmen, and the concern itself. Management that
  fails in any of these is poor management.

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Alfred D. Chandler, Jr.

• Alfred Dupont Chandler, Jr. The Managerial
  Revolution in American Business (1977) a
  Pulitzer Prize winner, business historian
• Prior work Strategy and Structure Chapters in
  the History of the Industrial Enterprise (1962)
• Examines E.I. Du Pont de Nemours and Co.,
  Standard Oil of New Jersey, General Motors, and
  Sears Roebuck and Co.
• Managerial organization developed in response to
  a corporations business strategy

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Chandler and the visible hand

• From 1950s to 1920s, formative years of modern
  capitalism, US saw the emergence of a new
  business institution and a business class.
• Growth of the modern business enterprise
• Emergence of new class of salaried managers
• Modern business enterprise replaces market
  mechanisms in coordinating economic activity and
  allocating resources the visible hand of
  management replaces the invisible hand of the
  market

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The modern business enterprise

• Traditional American business a single-unit,
  single product, single location enterprise, with
  one or small number of owner/ managers, governed
  by market and price mechanisms.
• The modern business enterprise, by contrast
• Many operating units, each with distinct
  administrative office multi-product,
  multi-location enterprise
• Units are hierarchically ordered and monitored
  and coordinated by full-time middle and top
  salaried managers

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The modern business enterprise

• The modern business enterprise, by act of
  coordination across multiple units, brings
  imperfect competition, misallocates resources.
• At odds with economic theory, with perfect
  competition and the invisible hand as most
  efficient way to coordinate activities and
  allocate resources.
• Historians focus primarily on entrepreneurs, not
  on the institution of the business enterprise
  itself
• By WWII modern business enterprise was most
  powerful institution in US economy, managers most
  influential economic decision-makers

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Chandlers general propositions

• Key to the modern business enterprise not just
  reduction of transaction costs, but
  administrative coordination that permits greater
  productivity, lower costs, higher profits
• Internalization reduces costs of transactions
• Administrative coordination of flow of goods from
  one unit to the other
• Effective scheduling of flows achieves more
  intensive use of facilities and personnel,
• Administrative coordination insures cash flow and
  more rapid payment for services.
• Advantage of internalizing activities of multiple
  business units into a single enterprise cant be
  realized without creation of managerial hierarchy

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General propositions, continued

• Modern business enterprise appeared when volume
  of economic activities reached level that made
  administrative coordination more efficient,
  profitable than market coordination.
• When volume of activity increases due to new
  technology and expanding markets
• 4. Once managerial hierarchy formed and
  successfully carried out its function of
  administrative coordination, the hierarchy became
  a source of power, permanence, and continued
  growth.

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Professional management

• The careers of managers directing these
  hierarchies became increasingly technical and
  professional
• Education, training, and experience become source
  of advancement and replace family relationships
  or money
• As multiunit business enterprise grew in size and
  diversity, the management of the enterprise is
  separated from its ownership.
• Widely dispersed stockholders replace personal,
  bank, or family ownership they lack the
  knowledge, influence, experience, or commitment
  to control firm, so current operations and future
  planning lies in hands of managers.

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Modern business enterprise

• 7. Career managers prefer stability and growth of
  the enterprise over maximization of profits.
• Salaried managers make decisions that preserve
  their own lifetime careers seek to protect
  sources of supplies, markets take on new
  products and services to insure full use of
  existing facilities and personnel reinvest
  profits rather than pay out dividends.
• Desire of managers to keep organization fully
  employed became force for its continued growth.
• 8. As large enterprises grew to dominate major
  sectors of the economy, they altered the basic
  structure of sectors and the whole economy.

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The managerial revolution

• New enterprises take over from the market the
  coordination and integration of the flow of goods
  and services from raw materials through
  production to sale to end consumer.
• Emergence of a relatively small number of large
  mass producing, large mass retailing, and large
  mass transporting enterprises in which the
  salaried managers coordinated production and
  distribution and allocation in major sectors of
  the American economy

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The mass production economy

• John Kenneth Galbraith The New Industrial State
  (1957)
• The size of General Motors is in the service not
  of monopoly of the economies of scale but
  planningand (thanks to) this planningcontrol of
  supply, control of demands, provision of capital,
  minimization of riskthere is no clear limit to
  the desirable size (of the company.)

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Fortune 500 industrial corporations

• Sales (B) Share of GNP () Jobs (M)
• 1954 137 37 8
• 445 46 15 (3/4of mfg LF)
• 1,400 58 16.2
• 1989 2,200 42 12.5
• 1970s Discovery that small firms are big job
  generators
• 1980s Discovery of Italian and Japanese model
• 1990s Discovery of dynamism of Silicon Valley

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What changed?

• Macroeconomic instability
• International competition intensifies
• Accelerating pace of technological change
• Undermines stability required for LT investment
  and corporate planning costs fluctuate,
  consumers unpredictable, new competitors

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Network forms of organization

• Network organization typified by reciprocal
  communication and exchange, interdependent
• Market spontaneous coordination of
  self-interested individuals and firms via prices,
  
• Hierarchy administrative coordination with
  managerial authority, internal transactions
• Not points along a continuum, but a distinct and
  viable organizational model with historic
  antecedents

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Networks

• Norm of complementary strengths
• Relational communications
• Reciprocity as norm, reputation
• Less flexible than market, more than hierarchy
• Medium to high level of commitment
• Open ended commitment, mutual benefit
• Interdependent actors
• Multiple partners

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Network forms of organization

• Artisanal and crafts industries
• Publishing
• Construction
• Hollywood
• Regional economies and industrial districts
• Emilia Romagna
• Silicon Valley
• Strategic alliances and partnerships
• International joint ventures
• Biotechnology

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Fordism in US auto industry

• The big three postwar oligopoly
• vertical integration of production,
• low trust, arms-length relations with dependent
  suppliers,
• cost-minimization as goal.
• Closed, hierarchical, secretive.
• Overwhelmed when product cycles shorten
  competition intensifies
• Inflexibility of tight technological coupling of
  production
• No internal ability to innovate due to cost
  cutting
• No autonomy to suppliers for innovation,
  experimentation, capability building
• Womack, Jones and Roos The Machine that Changed
  the World The Story of Lean Production (1991)

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Japanese autos lean production

• Toyota vertical disintegration and long term
  relationships with suppliers, collaborative risk
  sharing, cost sharing, information sharing.
  Flexible, open.
• Suppliers have autonomy to experiment, innovate
• Partners jointly improve quality, productivity
• Other elements from Taylor and Ford
• Benchmarking, design for manufacturability
• Concurrent, simultaneous engineering
• Just-in-time-manufacture, error correction and
  detection
• Total quality management, etc.
• Toyota System relies on pull feature for
  production scheduling (not push driven by sales
  targets)

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Network organization

• Fragmentation of production into distinctive,
  complementary specialist units (firms or teams)
• Information-sharing and joint problem solving
  across unit boundaries, vertically and
  horizontally
• Concurrent engineering, iterated co-design
• Reciprocal risk sharing w/ multiple partners
• Open search networks and routines
• Entrepreneurship
• Creation of localized ecosystems of specialized
  skills and know-how that support joint
  experimentation and learning i.e. Silicon Valley,
  Toyota City, Bangalore

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Network organization revisited

• Network organization long term informal and
  formal relationships between specialized teams/
  firms provides local autonomy, facilitate
  inter-unit knowledge sharing, collaboration, and
  co-design but also provide mechanism for
  monitoring.
• Studied trust, not blind trust
• Mutual orientation and co-evolution of network
  members without lock-in.

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Organizational design info exchange

• Market price mechanism/transaction as mode of
  exchange radical decentralization, unpredictable
  info flows
• Firm formal administrative channels enforce
  centralized vertical flows of information,
  creates silos and subject to severe bottlenecks

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Organizational design trade-offs
complex
Hierarchy
Network
Product
Market
simple
Stable, predictable
Dynamic, uncertain
Environment
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Hierarchical organization
Line employees
High
Access to relevant information
Middle managers
Senior managers
Low
Strategic
Operational
Information
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Hierarchical organization
Line employees
High
Access to relevant information
Middle managers
Senior managers
Low
Strategic
Operational
Information
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Networks as fractal design

• In colloquial usage, a fractal is a shape that
  is recursively constructed or self-similar, that
  is, a shape that appears similar at all scales of
  magnification and is often referred to as
  "infinitely complex." See below, the Mandelbrot
  set.

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Supply chain as self-similar pyramid
Prime contractor
Self-similar pyramid across scale
Nishiguchi and Beaudet, 1998
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Fractal link design a cognitive map
SUPPLIER
SUPPLIER
CUSTOMER
supplier
customer
supplier
customer
SUPPLIER
SUPPLIER
Nishiguchi and Beaudet, 1998
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