The organization of

economic activity

The information and service economy

October 8, 2007
Bob Glushko and Anno Saxenian
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
Models of economic organization (ll)

 The mass production economy

 Henry Ford and “Fordism”
 The “Visible Hand” of management

 Network forms of organization

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
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
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
The principles of mass production
 Three principles of mass production:
1. Planned orderly and continuous progression of
commodity through the shop;
2. Delivery of work instead of leaving it to workman’s
initiative to find it;
3. 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
The effects of mass production
1. Increased industrial control and engineering,
rather than financial control.
2. Highest standard of quality ever attained in
output of great quantities.
3. Creation of a wide variety of single-purpose
machines that reproduce skill of hand.
4. Elimination of hard work in the form of
wasteful and laborious burden-bearing.
5. Growing need for skilled artisans and
creative genius (e.g. skilled mechanics in
construction and maintenance of machines)
 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.”
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
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
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
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
 Chandler’s general propositions
1. 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.
2. Advantage of internalizing activities of multiple
business units into a single enterprise can’t be
realized without creation of managerial hierarchy
General propositions, continued
3. 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.
Professional management
5. 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
6. 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.
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.
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
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.)”
 Fortune 500 industrial corporations

Sales ($B) Share of GNP (%) Jobs (M)

1954 137 37 8
1969 445 46 15 (3/4of mfg LF)

1970 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
What changed?

1. Macroeconomic instability
2. International competition intensifies
3. Accelerating pace of technological change

Undermines stability required for LT

investment and corporate planning: costs
fluctuate, consumers unpredictable, new
competitors
 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
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
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
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)
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)
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
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.
Organizational design: info exchange

 Market: price mechanism/transaction as

mode of exchange; radical decentralization,
unpredictable info flows
 Firm: formal administrative channels enforce
centralized vertical flows of information,
creates silos and subject to severe
bottlenecks
Organizational design trade-offs

complex
Hierarchy Network

Product

Market
simple

Stable, Dynamic,
predictable uncertain
Environment
 Hierarchical organization
Line employees
High

Access to
relevant Middle
information managers

Senior managers
Low

Strategic Operational

Information
 Hierarchical organization
Line employees
High

Access to
relevant Middle
information managers

Senior managers
Low

Strategic Operational

Information
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.
Supply chain as self-similar
pyramid

Prime contractor

Self-similar
pyramid
across scale

Nishiguchi and Beaudet, 1998

Fractal link design: a cognitive
map

SUPPLIER

SUPPLIER

CUSTOMER
supplier customer

supplier customer
SUPPLIER
SUPPLIER
Nishiguchi and Beaudet, 1998