Markets and Hierarchies - Organizational Coupling

GOALS • UNDERSTAND WHY ORGANIZATIONS DO THINGS THAT APPEAR “IRRATIONAL” • ORGANIZATIONAL CONNECTIVITY STRUCTURES -- MARKETS -- HIERARCHIES (INTERNAL ORGANIZATIONS) -- THE FUTURE? RELATED RESEARCHERS • MARCH OBSERVED: – COGNITIVE LIMITS ON RATIONALITY – LIMITS TO HUMAN INFORMATION PROCESSING – BOUNDED RATIONALITY • SALANCIK SUGGESTED: – ACTIONS TO FULFILL INTENTIONS WILL BE IMPERFECT IF: 1. 2. 3. 4. 5. INTENTIONS NOT CLEAR CONSEQUENCES OF ACTIONS NOT CLEAR MEANS TO TRANSFORM INTENT TO ACTION UNCLEAR INTENTIONS NOT KNOWN TO PERSON SELECTING ACTION MULTIPLE INTENTIONS MARKET VS. HIERARCHY • MARKET --SEPARATE BI-LATERAL AGREEMENTS (E.G., INDEPENDENT CORPS) • HIERARCHY --HIERARCHICALLY STRUCTURED AUTHORITY RELATIONSHIPS (E.G., DIVISION OF CORP.) PRES. VP RARE YOU RARE CONNECTIVITY IMPORTANT IN BOTH MARKET AND HIERARCHY RONALD COASE (1937): TRANSACTIONAL VIEW • VERTICAL INTEGRATION ECONOMIZES ON “COST OF NEGOTIATING AND CONCLUDING” MANY SEPARATE CONTRACTS BY USING FLEXIBLE EMPLOYMENT AGREEMENT. RONALD COASE (1972) • 1937 ARTICLE “MUCH CITED AND LITTLE USED” -- FAILURE TO MAKE ISSUES OPERATIONAL -- FAILURE TO DIFFERENTIATE SITUATIONS (MARKET VS. VERTICAL INTEGRATION) WILLIAMSON (1971) CONTRIBUTION: • MAKE “TRANSACTION” UNIT OF ANALYSIS • IDENTIFY ALTERNATE MARKET AND “CONTRACTING” MODES • IDENTIFY CRITICAL DIMENSIONS IN WHICH TRANSACTIONS DIFFERED • TRACE OUT ECONOMIC RAMIFICATIONS • MATCH MODES TO TRANSACTIONS TOM MALONE (late 1990s) … MORE LATER ... KEY ISSUES • TRANSACTION COSTS • BOUNDED RATIONALITY • OPPORTUNISM HUMAN FACTORS BOUNDED RATIONALITY ENVIRONMENTAL FACTORS UNCERTAINTY/ COMPLEXITY INFORMATION IMPACTEDNESS OPPORTUNISM SMALL NUMBERS • INFORMATION IMPACTEDNESS • ASSET SPECIFICITY • COMPLEXITY OF PRODUCT DESCRIPTION ----------------------------------------------------------------------------------------• EVOLUTION OF ELECTRONIC MARKETS AND ELECTRONIC HIERARCHIES BOUNDED RATIONALITY • HUMAN BEHAVIOR THAT IS “INTENDLY RATIONAL, BUT ONLY LIMITED SO” [SIMON, 1961] -- PHYSICAL LIMITS: PROCESSING RATE (CPU) & STORAGE LIMITS (RAM) -- LANGUAGE LIMITS (I/O): DIFFICULTY IN ARTICULATING KNOWLEDGE BY USE OF WORDS • LIMITS OF RATIONALITY REACHED UNDER CONDITIONS OF: --UNCERTAINTY --COMPLEXITY • COMPLEXITY / UNCERTAINTY FACTORS: -- SIZE OF DECISION TREE -- NOT ALL ALTERNATIVE PATHS KNOWN -- NOT ALL CONSEQUENCES KNOWN • HIERARCHY HELPS: -- REDUCES SOME UNCERTAINTY THROUGH LONG-TERM PLANS OPPORTUNISM • DISTINCTIONS: --STEWARDSHIP: --INSTRUMENTAL: --OPPORTUNISTIC: TRUST, RELATION NEUTRAL, NO SELF-INTEREST SELF-INTEREST WITH GUILE • TYPES OF INFORMATION ADVANTAGES: -- NORMAL: PRE-EXISTING AND FULLY DISCLOSED -- OPPORTUNISTIC: SELECTIVE OR DISTORTED INFORMATION DISCLOSURE (E.G., AIRLINE “ON-TIME” RECORDS) -- SELF-DISBELIEVED PROMISES (CANNOT DISTINGUISH FROM SINCERE SITUATION, E.G., “TRUST ME”) • SMALL NUMBER OF PLAYERS & INTERACTIONS --DECREASED COMPETITION & INCREASED DIFFICULTIES • HIERARCHY HELPS: -- LESS ABLE TO GAIN AT EXPENSE OF ORGANIZATION (MONOPOLY) -- MORE EFFICIENT & EFFECTIVE AUDIT -- EASIER TO RESOLVE DISPUTES INFORMATION IMPACTEDNESS (ASYMMETRIC INFO) • • • • MAIN ISSUE: TRUE UNDERLYING CIRCUMSTANCES – KNOWN TO SOME PARTIES – NOT KNOWN TO OTHERS (HARD TO DISCERN) EVEN IF IDENTICAL INFORMATION KNOWN, BUT INCOMPLETE: – EACH PARTY HAS DIFFERENT ASSUMPTIONS – COSTLY HAGGERING LATER EXAMPLES: – INSURANCE • INSUREDS KNOW RISK BETTER THAN INSURERS – FIRST-MOVER ADVANTAGE (INITIAL CONTRACT) • GAIN “LEARNING BY DOING” • MAY NOT WANT (OR ABLE TO) SHARE KNOWLEDGE LEARNED HIERARCHY HELPS: – HINDERS EXPLOITATION – ALLOWS AUDIT – SHARED LANGUAGE (CODING) – SUPERIOR ABILITY TO DO “EXPERIENCE RATING” ASSET SPECIFICITY • INVESTMENTS THAT ARE TRANSACTION SPECIFIC – UNABLE TO PUT ASSETS TO ALTERNATIVE USE – EXAMPLES: • SITE SPECIFIC (NATURAL RESOURCE, FACTORY LOCATION) • PHYSICAL ASSET SPECIFIC (SPECIAL MACHINE) • HUMAN ASSET SPECIFIC (TRAINING, HIRING) • TIME SPECIFIC (PERISHABLE GOOD: FOOD, MOVIE SEAT) MORE SPECIFIC --> MORE EFFICIENT – (FOR SPECIFIC PURPOSE) • PROBLEMS WITH ASSET SPECIFICITY – ADDITIONAL GOVERNANCE NEEDED – UNCERTAINTY INCREASED CONCERN • HIERARCHY HELPS: – LONG-RANGE PLAN COMPLEXITY OF PRODUCT DESCRIPTION • INFORMATION TO SPECIFY ATTRIBUTES OF A PRODUCT – NEEDED TO MAKE SELECTION • SIMPLE DESCRIPTIONS (STANDARDIZED, INTERCHANGEABLE) – STOCKS, COMMODITIES • COMPLEX DESCRIPTIONS (NOT INTERCHANGEABLE) – BUSINESS INSURANCE – COMPLEX MACHINERY – SOFTWARE PACKAGE • HIERARCHY HELPS: – COST OF COMMUNICATION LAYER (SHARED LANGUAGE) – LESS COORDINATION NECESSARY APPROPRIATE CIRCUMSTANCES FOR HIERARCHY • NEED TO ECONOMIZE ON BOUNDED RATIONALITY – COMPLEX UNCERTAIN SITUATION • NEED TO REDUCE OPPORTUNISM – ESPECIALLY IF SMALL NUMBERS • NEED TO REDUCE UNCERTAINTY – BY CONVERGENT EXPECTATIONS • NEED TO REDUCE TRANSACTION COSTS • NEED TO OVERCOME INFORMATION IMPACTEDNESS • NEED TO DEAL WITH – HIGH ASSET SPECIFICITY – COMPLEX PRODUCT DESCRIPTION EVOLUTION OF HIERARCHIES 1. VERTICAL INTEGRATION -- HIERARCHY -- LATE 19TH CENTURY -- LARGE SCALE MANUFACTURING TECHNOLOGIES -- NEW DISTRIBUTION TECHNOLOGY (RAILROAD, TELEGRAPH / TELEPHONE) 2. MULTIDIVISION -- HIERARCHY -- GROWTH OF SIZE AND COMPLEXITY HURT FUNCTIONAL FIRMS -- CHANGE FROM FUNCTIONAL TO DIVISIONAL -- REMOVED TOP EXECUTIVES FROM ROUTINE ACTIVITIES -- ALLOWED TOP EXECUTIVES TO FOCUS ON LONG-TERM PLANNING • ECONOMIZE ON BOUNDED RATIONALITY (Long-term) • REDUCE OPPORTUNISM (SUB-GOAL CLEAR) GM 3. WHAT IS THE NEXT STAGE? Pontiac -- INTER-DEPENDENT FIRMS? Chevy (Near-term) -- MARKETS? --> TRANSACTION COST MAJOR FACTOR (IT HAS MAJOR IMPACT) ELECTRONIC MARKETS AND ELECTRONIC HIERARCHIES • HIERARCHIES – CONTROLLED THROUGH HIGHER LEVEL HIERARCHY – MANAGERIAL DECISIONS (NOT MARKET FORCES) – PREDETERMINED BUYER AND SELLER • MARKETS – SUPPLY AND DEMAND FORCES – BUYER SELECTS FROM CHOICES – EXTERNAL TRANSACTIONS BETWEEN PARTICIPANTS SHIFT FROM HIERARCHIES TOWARDS MARKETS • • • • TECHNOLOGY REDUCES COORDINATION AND COMMUNICATION COSTS (MAKES MARKETS MORE FAVORABLE) TECHNOLOGY FACILITATE COMPLEX PRODUCT DESCRIPTIONS (TRANSMISSION AND MANIPULATION) – E.G., AIRLINE RESERVATIONS (?) TECHNOLOGY REDUCES ASSET SPECIFICITY (FLEXIBLE MANUFACTURING) – CAN SERVE SMALL MARKETS USING HIGH-VOLUME EQUIPMENT (REDUCE RETOOLING COSTS) IMPACT OF COMPLEXITY AND SPECIFICITY ASSET SPECIFICITY LOW PRODUCT DEFINIITION COMPLEXITY LOW HIGH HIGH MARKET HIERARCHY POTENTIAL ELECTRONIC MARKET MAKERS • • PRODUCERS – FACILITATE PURCHASING BY BUYER (E.G., AA, AHS/BAXTER) BUYERS – FACILITATE SELECTION, CONTROL INVENTORY (E.G., GE SUPPLY NETWORK) • • • DISTRIBUTORS – SIMILAR MOTIVATION TO PRODUCERS & BUYERS (E.G., MCKESSON0 FINANCIAL SERVICES PROVIDERS – FINANCIAL INVOLVEMENT (CREDIT) IN MOST TRANSACTIONS ALREADY – EXTEND INVOLVEMENT (E.G., CITICORP & MCGRAW-HILL CRUDE OIL?) INFORMATION TECHNOLOGY VENDORS – ALREADY PROVIDING THE TECHNOLOGY (E.G., INTERNET) DISTRIBUTOR PRODUCER BUYER FINANCIAL IT STAGES IN EVOLUTION OF ELECTRONIC MARKETS 0. EXCLUSIVE NON-MARKET ENVIRONMENT (AA) 1. BIASED MARKET -- INITIAL PROVIDER SEEKS ADVANTAGE E.G., AIRLINE RESERVATIONS (UNITED: ONLY, AMERICAN: ALL BUT BIASED) 2. BIASED --> UNBIASED (CAB/FAA REQUIRED UNBIASED AIRLINE RESERVATIONS) 3. UNBIASED --> PERSONALIZED -- OVERWHELMED WITH ALTERNATIVES E.G., AIRLINE SELECTION CRITERIA (FARES, TIMES) WHAT’S NEXT? SUMMARY • NEED TO UNDERSTAND WHY ORGANIZATIONS DO THINGS THAT APPEAR “IRRATIONAL” -- MANY REAL REASONS • ORGANIZATIONAL CONNECTIVITY STRUCTURES -- MARKETS -- HIERARCHIES (INTERNAL ORGANIZATIONS) -- THE FUTURE?