Ronald Coase on the preoccupation with the monopoly problem

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Why are we always restructuring the workplace? The economics of organisational fickleness

Ok, whatever is, is efficient, but I always had my doubts when we are always restructuring wherever I worked. This continual organisational upheaval and restructuring was also a phenomena in the private sector.

What was the survival value of this continual disruption of organisational form and organisational capital in competition with rival firms with more stable internal organisational forms?

Internal reorganisations divert management time away from more profitable pursuits such as facilitating production. Managerial resources are scarce, like any other resource, and must be allocated to their highest value uses.

But as a firm grows, waste accumulates through the duplication of employee effort and the assignment of unnecessary tasks within the organisation.

Jack Nickerson and Todd Zenger wrote a great paper in 2002 on the efficiency of being fickle – of repeated reorganisations of the workplace. Their point was simple: times change and they change a lot faster than we think so organisations have to adapt to their rapidly unfolding new market conditions.

They illustrated their point about the need for regular reorganisation inside a short period of time with a case study of the alternating waves of centralisation and decentralisation in Hewlett-Packard.

Throughout the 1970s, Hewlett-Packard was a thoroughly decentralised organisation and was successful in the market. It had a remarkable record of innovation in the 1970s.

In the early 1980s, Hewlett-Packard hard found this decentralisation was starting to work against it in the rapidly evolving computer market. The Independent divisions developed computers, peripherals and components that will both incompatible with each other and competed with each other.

This redundancy between the independent divisions was costly and was confusing to consumers because they had a hodgepodge of products that really won’t related to each other. The computer industry in the early 1980s was involving very rapidly with many incompatible computers and programs, but the few that turned out to be the best became immensely profitable.

In 1984 and 1985, Hewlett-Packard hard centralise product development in headquarters and put all marketing and sales into one unit. Financial performance recovered after this reorganisation.

By 1990, Hewlett-Packard was on again in a steep financial decline. The centralisation of decision-making has slowed product development and there was a significant drop in innovation.

In 1990, computers was separated into competing products and computing systems. Individual product lines were decentralised and treated a separate business units.

In 1994, Hewlett-Packard again decentralised customer support of all computer activities. Three years later, it decentralised the same activities into three organisations. In 1999 it spun off its instruments and medical business.

Over 16 years, Hewlett-Packard, experience five fundamental ships alternating between decentralisation and centralisation. Each one of these reorganisations was greeted with the share price increase.

The reason why this fickleness in organisational form was efficient was the market changes rapidly. Organisational forms and organisational capital become obsolete rather quickly.

The form of organisation that survives in competition with actual and potential market rivals is that specific form of organisation which allows the firm to deliver the products that customers want at the lowest price while covering costs (Alchian 1950; Fama and Jensen 1983a, 1983b).

Each time Hewlett-Packard decentralised was a time in the product life cycle of their industry where there was rapid innovation. Hewlett-Packard tended to centralise in the consolidation phase of product life cycles.

New technologies are unproven and they come with much less information and prior experience to guide the top of a hierarchy in directing their successful adoption from a distance (Acemoglu, Aghion, Lelarge, Van Reenen and Zilibotti 2007). In any hierarchy, the top faces two problems with their subordinates: communicating their desires and seeing that they are carried out (Tullock 2005).

When a large firm directs major changes from the top of a hierarchy, failures of communication in the chain of command are a growing risk. More employees require more supervisors. More supervisors require more supervisors of supervisors at every tier of the hierarchy – the layers of supervision multiply (Posner 2010; Williamson 1975, 1985).

There are delay in executing orders, a loss of information and feedback on the way up, and the truncation of the directions from the top: there is a general weakening of control and coherence (Posner 2010; Williamson 1975, 1985). The daily implementation problems of new technologies cannot go up and down a hierarchy for resolution.

Firms must decentralise (rather than grow in hierarchy) to profit most from a line manager’s superior local knowledge about the implementation of the latest, more complex technologies. Delegating initiative to managers downstream is vital when a large firm introduces frontier technologies about which information flows upstream are slow and considerable learning by doing and rapid adaptation are required (Acemoglu, Aghion, Lelarge, Van Reenen and Zilibotti 2007; Jensen and Meckling 1995).

New technologies usually bug-ridden and require considerable refinement, adaptation and consumer feedback on their use before the mature product emerges (Greenwood 1999; Greenwood and Yorukoglu 1997). This costly process of learning, improvisation and product and process re-design explains the multi-decade long 10-90 lag in technology diffusion across firms in the same industry and the slow rate of consumer acceptance of new products.

Larger firms may struggle with striking the most profitable balance between greater local managerial discretion and effective corporate governance of a large diverse organisation with professional managers and diffuse ownership structures.

A risk of greater local managerial discretion in a large firm is less effective governance (Williamson 1975, 1985; Fama and Jensen 1983a, 1983b). The risks of separating of ownership from control and the distortions to knowledge flows in hierarchies drives the internal organisation of large firms and the division of decision control and decision management rights between the board and management (Fama and Jensen 1983a, 1983b; Williamson 1985).

The separation of decision management rights, vested in hired managers, from decision control rights, vested in the board of directors, is a common governance safeguard against conflicts of interest in business, professional and non-profit organisations, large and small (Fama and Jensen 1983a, 1983b).

Decision management rights cover the initiation and the implementation of decisions. Decision control rights involve the ratification and the monitoring of decisions. Managers and division heads carry out the production decisions, budgets and policies on wages, hours, staffing and job designs developed by head office and which are ratified by the board of directors (Fama and Jensen 1983b, 1985).

Competition between different sizes, shapes and internal organisational forms of firms all vying for sales, cheaper sources of supply and investor support sifts out the keener priced, lower cost, and more innovative enterprises (Alchian 1950; Stigler 1958). These lower-cost firms will be able to under-sell their higher cost rivals.

The winning firm size and internal organisational shape is that configuration which meets any and all problems the firm is actually facing and seizes more of the entrepreneurial opportunities that are within its grasp (Stigler 1958; Alchian 1950).

Large firms invest heavily in mimicking the nimbleness of small firms. Some firms re-create some of the advantages of being small by organising into M-form hierarchies made up of product divisions to improve performance monitoring, identify managerial slack, encourage mutual monitoring, promote competition within the firm for top-level management positions and facilitate comparisons of compliance with the policies of head office (Klein 1999; Fama and Jensen 1983a, 1983b; Williamson 1975, 1985).

Large firms must develop organisational architectures to assign decision rights, reward employees, and evaluate the performance of employees and business units. The aim is to empower subordinates with the requisite local knowledge with the power to act swiftly and the incentive to make good decisions. The organisational architecture of a firm encompasses the assignment of decision rights within the firm, the methods of rewarding individual employees, and the structure of the systems that evaluate the performance of individual employees and business units.

Poor cost control, budgetary excess and any lack of innovation and initiative over products designs and pricing, input mixes and wage and employment policies will reflect in relative divisional performances and overall corporate profits.

Any news of less promising current and future net cash flows will feed into share prices and into the labour market prospects of both career managers and the members of boards of directors (Manne 1965; Jensen and Meckling 1976; Fama and Jensen 1983a, 1983b; Demsetz 1983; Demsetz and Lehn 1985). To survive, managerial firms must balance delegation with more centralised control (Fama and Jensen 1983a; McKenzie and Lee 1998).

One way of balancing delegation with centralised control is simply to reorganise the firm on a regular basis as market circumstances change and entrepreneurial judgements about the future are updated. This regular reorganisation of the firm may seem fickle, but the firm must adapt or die. Firms must be efficiently fickle in their organisational forms.

Not only is whatever is, is efficient, any attempt to change whatever is, is efficient, because otherwise it wouldn’t be attempted. Of course, these reorganisations are entrepreneurial ventures that are never guaranteed success.

 

 

Ronald Coase on monopoly as the default explanation for perplexing business practices

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Some economics of zero hours contracts – part 1: concepts, definitions and initial puzzles

Unions say New Zealand employers are following trends overseas and adopting zero hour contracts: workers have to be available for work, but have no hours guaranteed. Unite Union national director Mike Treen said:

McDonald’s, KFC, Pizza Hut, Starbucks, Burger King, Wendy’s – all of the contracts have no minimum hours, and so people can be – and are – rostered anywhere from three to 40 hours a week, or sometimes 60 hours a week, and it depends a lot on how you get on with your manager.

No official figures are available on the number of people on zero hour contracts in New Zealand, but they are are available in the UK in the chart below. About 250,000 workers in the UK work on zero hours contracts.

These workers agree not to work for anyone else, but are not promised regular work at all with their new employer.

The question that must always be asked is why do people who are deemed competent to vote and drive cars sign zero hours contract? What is in it for them? David Friedman asked this question about the economics of restraint of trade agreements for employees:

…the employer who insists on an employee signing a non- competition agreement will find that he must pay, in additional wages or other terms of employment, the cost that the agreement imposes upon the employee, as measured by the employee and revealed in his actions.

It follows that the employer will insist on such an agreement only if he believes that its value to him is greater than its cost to the employee…

The contract is designed, after all, with the objective of getting the other party to sign it.

If I am designing the contract and offering it to many other parties, that may put me in a position to commit myself to insisting on terms that give me a large fraction of the benefit that the contract produces.

But it is still in my interest to maximize the size of that net benefit-which I do by only insisting on terms that are worth at least as much to me as they cost the other party.

The inherent inequality of bargaining power between employers and workers and the reserve army of the unemployed must not be all that they are cracked up to be these days if low paid workers have to sign legally enforceable restraint of trade agreements.

Obviously, the few members of the reserve army of the unemployed lucky enough to have a low pay, insecure job that offers no regular hours today have so many other job options that their employers must get them to agree not to quit and job-hop at will. Jobs must be readily available  to low paid workers for otherwise why do employers insist on this restraint of trade in employment agreements.

Why do workers sign these contracts, which can include a promise of exclusive services – not working for other employers? Several subsequent blog posts will attempt to answer this question

The inherent inequality of bargaining power between employers and workers doesn’t work too well here because  the worker is accepting this job as compared to these other options , which may include employment in an existing job.

Once a worker is on-the-job and has accumulated job specific human capital, issues of post-contractual opportunism come up on both sides.

An important function of the employment contract is to prevent attempts to renegotiate terms and conditions once one side of the other has committed to the relationship and will find it costly to go elsewhere.

Zero hours contracts are negotiated upfront, which makes them unappealing to anyone already has a job, unless the terms and conditions of a zero hour contract, including the wages paid are much more appealing than officious observers make out.

Richard Epstein made this point about the general operation of the labour market, which is of relevance to our search to the answers to the questions posed by this blog post:

Labour markets are not characterized by tricky externalities. They do not pollute streams or require the creation of public goods. They are not characterized by genuine breakdowns in information, as workers are in a position to observe the conditions of their employment on a day-to-day basis.

Left to their own devices, without explicit support from union activities, they will be highly competitive, and thus work hard to allocate scarce human capital to its most productive use.

Workers have the option to quit for higher wages, and employers can always seek out low cost techniques to reduce their labour costs.

Any short-term dislocation for firms or individuals is more than offset by the overall increase in the system productivity, spurred in part by clear signals that should increase investments in human capital.

Zero hours contracts are a new labour market phenomena . That is no reason to automatically default to monopoly explanations for their emergence, including their emergence in a highly competitive industries and highly competitive labour markets where  employees change jobs regularly.

As Coase said in the context of industrial organisation as a whole and novel business practices in particular:

One important result of this preoccupation with the monopoly problem is that if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation. And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.

The next blog post arises out of my first exposure to the labour economics of working arrangements. Specifically, how the fixed costs of employment and the fixed cost of going to work  both lead to minimum hours constraints in most employment contracts.

Most of what I know about the  labour, personnel and organisational economics of working arrangements  was about explaining  why employers would expect an employee to work as a minimum number of hours if they were to employ them at all. Always good to start with explanations as to why zero hours should not exist, but they clearly do.

Subsequent blog posts will discuss zero hours contracts in the context of the team production and organisational architecture; and zero hours contracts, equalising differentials and job sorting.

Israel Kirzner on freedom of entry as the sole condition from competition in a market

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From Sam Peltzman’s (1991) review of the handbook of industrial organisation

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Deirdre McCloskey (2001) on the state of modern industrial organisation economics

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