BUS 374 – Session 2 Organization theory

1. BUS 374 – Session 2Organization theory Session 2: Why do organizations exist?

2. Agenda • Reallocation of teams • Trial Memo presentation #1 • Trial Memo discussion #1 • Trial Memo presentation #2 • Trial Memo discussion #2 • Why do (capitalist) organizations exist?

3. Marxian view of a capitalist organization • What if capitalist means of production was absent? • Each laborer produces on his/her own

4. What is the problem with it? • Cost of setting up workshops for each laborer is higher than the average cost of setting it up for a lot of laborers • Cost of consumables will be higher for each laborer • Willingness to cooperate will be limited or even absent, but complex tasks need cooperation • When employed in a firm the average productivity increases as less productive workers and more productive workers will average out.

5. Who is a capitalist (read entrepreneur)? • Someone who has expertise in a production process • Someone who could hire labor to produce in larger quantities

6. Why does capitalist organizations (i.e., firms) exist? • To use the capitalist’s expertise to produce large quantities of a good • So that laborers cooperate in this production process • Even if it be merely working side-by-side using the same supplies • Capitalists have the surplus capital to employ more than one laborer on a production process

7. So what is the objective of the firm • “The directing motive, the end and aim of capitalist production, is to extract the greatest possible amount of surplus value” – Marx • Does this ring a bell? • Didn’t Milton Freedman said something like this? • “There is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits”

8. So what is Marx’s issue with capitalism? • That the capitalist pays only each laborer the amount that he/she would have earned had he/she been an independent worker… • i.e., the workers do not get a cut of the surplus • And that the capitalist gets more than his fare share of the surplus… • And, the laborers enter into a contract with the capitalist but not with one another… causing all this. • BUT THAT IS A DEBATE FOR A DIFFERENT DAY 

9. Coasian view of the firm • What would be the alternative to the firm? • The price mechanism (aka the market)

10. What is the problem with the price mechanism? • A neoclassical view holds that the economy is not an organization that needs to be managed but an organism that manages itself through price mechanism • But price discovery can be costly (i.e., search costs) • Uncertainty can add to it. • Requires a lot of costly contracts to ensure certainty • Even more exorbitant when it is not a spot market transaction but a serial transaction.

11. Why do firms exist? • Entrepreneur substitutes the price mechanism through fiat • i.e., The primary difference between the market and the firm is price mechanism vs. entrepreneurial coordination respectively • Reduced contracting costs • Greater certainty • Anther peripheral reasons could be • transfer pricing advantages (i.e., lesser taxes for sales between units) • Volume discounts from suppliers to firms than to market participants (Marx also considers marketing advantages – i.e., monopoly rents)

12. What can be the limits of the firm? • Organizing costs can increase with each additional transaction that comes under a firm’s management • This is why transactions are carried out by various firms and not by one big firm (as in a communist economy) • So while Marx considers firm size as a function of capital outlay, Coase considers the cost of organizing. • While Marx consider the role of managers in a capitalist setting, her doesn’t consider agency costs that come out of it. Coase does not bring this to the discussion at all.

13. That’s is for today • For our next session we will try to answer: • “WHY ARE THERE SO MANY DIFFERENT TYPES OF ORGANIZATIONS?”