Dr Phil Tomlinson University of Bath Email: mnsprt@management.bath.ac.uk January/February 2006

1. Dr Phil Tomlinson University of Bath Email: mnsprt@management.bath.ac.uk January/February 2006

2. This week: Consider the theory of the firm: In particular, the contributions of: ● Coase, Williamson and Transaction Cost Economics ● Cowling & Sugden and strategic decision-making approach ● Aoki’s J-mode firm

3. Recap: So far – Seen the potential problems that can afflict economies when markets are highly concentrated Contrast this with neo-classical ideal of perfect competition (upon which nearly all macro-economic models are based!): ● Firms are ‘passive agents’ (i.e. price taker) ●Firm is a ‘Black Box’: Inputs (K,L,M) → Output (Q) ●Pareto Efficiency Achieved (Allocative (P=MC) and Technical Efficiency (min AC): A situation is Pareto efficient if one cannot move from one allocation of resources to another allocation of resources if at least one person is made worse off by the move. (note: it says nothing about equity!)

4. Evidence? Markets are highly concentrated and this has implications for the economy (Cowling and Tomlinson, 2005). • Firms are ‘active’ agents in the economy (Hymer, 1976): engage strategic behaviour/seek out to enhance their market power at a national/international level • Focus upon Firms and Modern Corporations and their role in allocating scarce resources in the economy • Coase (1937) – saw firms as ‘islands of planning’ • He asked why many activities were conducted in-house (inside the firm) as opposed to being conducted externally in the market place

5. Williamson (1975,1985): Transaction Cost economics (TCE) ● Firms seek to maximise profits/minimise costs ● Constrained by imperfect information: ‘information impactedness’. ● Agents/Firms are ‘Boundedly Rational’ (Simon, 1959) ● Opportunism(‘self-seeking with guile’) ● Governance Costs: ‘the costs of the sanctions required to discipline inappropriate behaviour and of providing incentives to generate acceptable behaviour’ (note these can occur in both the firm and in the market).

6. Transaction Costs (of using the market) – negotiating contracts, monitoring performance, enforcing contractual promises, risks to reputation/brand name Management Costs (of in-house production) – Organisation, production knowledge, fixed costs with certain technologies, monitoring employees.

7. What is the contribution of TCE to the ‘Theory of the firm’? Coasian firm exists because of (and its boundaries defined by) market imperfections (information asymmetries) ‘The boundaries of the (Coasian) firm end where market exchange begins’. Choice of internal hierarchies Vs market exchange leads to an analysis of organisational form (as opposed to ‘black box’) Firm is seen as achieving Pareto efficient outcomes (Minimising (transaction) costs – firm can be seen (in many cases) a more efficient institutional structure than a set of markets)

8. Critique of TCE as a Theory of the Firm (for those interested see Pitelis’s edited volume, 1993) (1). Resource-Based Theories of the Firm: Core competencies/Synergies (2). Cowling and Sugden (1993, 1994, 1998): TCE based upon (1). False dichotomy:Markets Vs Hierarchies Concept of Control is crucial in determining a firm’s boundaries: strategic decision making approach

9. e.g. Benetton (1986): directly employs 2000 people in 8 factories, indirectly provides work for 6000 via 200 subcontractors in Northern Italy. Strict Coasian definition: consider Benetton’s boundaries ending at the 2,000 employees in 8 factories. This maybe superficial! It ignores Benetton’s strategic influence over the sub-contracting sector. Span of a firm’s control is wider than its legal boundaries! (the firm’s ambit does not end where market exchange begins!)

10. (2). False Premise: Pareto Efficiency (Pareto Efficiency: this maintains that if one moves from one allocation of resources/institutional structure (e.g. market) to another (e.g. in-house production), the move is Pareto efficient if at least one person is better off & no-one is made worse off by the move) (Marglin’s example (1974)– the change from the ‘putting-out’ system to the factory system in the industrial revolution had distributional consequences)

11. For Cowling and Sugden (1993,1994, 1998): emphasis is upon strategic decision-making and control (market power approach) . They define a firm as ‘a firm is the means of coordinating production from one centre of strategic decision-making’(1993:68, see also 1998, Manchester School paper) (The idea is that modern firms are tightly controlled by corporate hierarchies: ‘elites’) Is this notion of a firm valid/widely applicable ? Western corporations – ‘hierarchical structure’. strategic decisions Vs operational decisions

12. What about corporations from other cultures? Japanese corporations? Aoki’s Japanese Firm (J-mode) Aoki (1990) – J-mode represents a wider set of interests than Western corporations (H-mode) (This might invalidate the general applicability of the strategic-decision-making approach) Differences between H-mode and J-mode relate to organisation, employer-labour relations & finance & equity arrangements Aoki’s analysis draws extensively upon examples from the car industry

13. (1). J-mode ‘Flexibility’ and ‘customerisation’ (JIT, lean production seen as ‘novel’ & new paradigm in production techniques) Vs Western ‘mass production’ Yet earlier literature suggests that this was not so! Mixed Assembly methods & achieving diversity have long been a part of Western car industry and pre-date Japanese ‘innovations’ (see Drucker, 1955 re. Western car sector).

14. (2). Non-hierarchy in Production • a) External Relationships - Vertically de-integrated structure, close co-operation, free exchange of information/technology & mutual trust between keiretsu & main contractors. • This is seen as ‘unique’ and qualitatively different from West. • Yet in Japanese firms, vertical relations are tightly controlled by the main contractor • significant equity holdings in supply chain (see Coffey & Tomlinson, JPKE 2003) • Locus of strategic decision-making: other control levers (multi-sourcing & ‘divide & rule’, dictating contract conditions)(Ruigrok & Van Tulder, 1995))

15. b) Internal relationships: J-mode employees are seen as ‘integral’ to the firm ‘rank hierarchy’ – incentives based on length of service and good service, lifetime employment system, wide job rotation, information sharing & delegation of decision-making ‘Employees seen as most important stakeholders in the J-mode’ (Abegglen & Stalk, 1985, Miwa, 1996).

16. But note: • Employee benefits only available in the leading firms (Ruigrok & Van Tulder, 1995) • Japanese workers have had no veto on the globalising activities of Japanese TNCs over last 15-20 years (moves which have aversely affected their employment position – see later) • Need to distinguish between operational decision-making and strategic decision-making

17. To sum up: Looked at the contributions to the theory of the firm - Coase, Williamson, Cowling & Sugden and Aoki. Established the importance of strategic decision-making within modern corporations This will be important for our analysis in coming weeks.