The organization of economic activity

1. The organization of economic activity The information and service economy October 8, 2007 Bob Glushko and Anno Saxenian

2. 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

4. Henry Ford, Mass Production (1926) • Mass production focuses principles of power, accuracy, economy, system, continuity, speed, and repetition on the manufacturing project. • Management’s 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

5. 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” • Don’t 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

6. 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

7. 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 workman’s 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

8. 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)

9. The effects of mass production (ll) Ford’s 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.”

10. 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 corporation’s business strategy

11. 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

12. 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

13. 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

14. Chandler’s 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 can’t be realized without creation of managerial hierarchy

15. 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.

16. 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.

17. 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.

18. 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

19. 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 planning…and (thanks to) this planning—control of supply, control of demands, provision of capital, minimization of risk—there is no clear limit to the desirable size (of the company.)”

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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)

26. 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)

27. 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

28. 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.

29. Organizational design: info exchange • Market: price mechanism/transaction as mode of exchange; radical decentralization, unpredictable info flows • Firm: formal administrative channels enforce centralizedverticalflows of information, creates silos and subject to severe bottlenecks

30. Organizational design trade-offs complex Hierarchy Network Product Market simple Stable, predictable Dynamic, uncertain Environment

31. Hierarchical organization Line employees High Access to relevant information Middle managers Senior managers Low Strategic Operational Information

32. Hierarchical organization Line employees High Access to relevant information Middle managers Senior managers Low Strategic Operational Information

33. 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.

34. Supply chain as self-similar pyramid Prime contractor Self-similar pyramid across scale Nishiguchi and Beaudet, 1998

35. Fractal link design: a cognitive map SUPPLIER SUPPLIER CUSTOMER supplier customer supplier customer SUPPLIER SUPPLIER Nishiguchi and Beaudet, 1998