Joanna Tyrowicz

Limits of an enterprise

Institutional Economics

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“But I thought you were going to talk about econometrics?!”

Two minutes on transaction cost economics (TCE) and the theory of the firm Capabilities/competencies and theory of the firm Intersection of competencies and TCE Problem solving perspective

New perspectives and new questions Correcting for endogeneity Bringing the market inside the firm

Example of research: truck transport industry in US

Conclusions

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What do we think about an enterprise?

Behavioral assumptions Actors want to be rational but there are limits:

Boundedly rational Actors attempt to be far-sighted

Actors may behave opportunistically Asset specificity is the “big locomotive”

Investments that produce cost savings or quality benefits for a one or small number of potential customers (quasi-rents)

Frequency and uncertainty also matter Main focus is on ex post maladaptation problems

Hold-up Underinvestment Measurement issues are implicated

Fundamental (intertemporal) transformation alters exchange from market to bilateral monopoly

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Three organizational archetypes Markets – the use of contracts Hierarchy

Authority-based hierarchy (ABH): Vertical communication and codes “Design rules” Direction to subordinates—manager orders trials

Consensus-based hierarchy: Horizontal communication and codes Commonality of goal Group decision making—groups order trials

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Markets

Hayek—markets are a “marvel” for transferring knowledge. Instruments support directional not heuristic search.

High-powered incentives to specialize and exploit knowledge.

Weak supports for investments in knowledge sharing or language to facilitate knowledge sharing.

Weak conflict resolution (classical contract law) over trial ordering.

Markets are efficient for decomposable problems but fail as landscapes become increasingly complex.

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Authority-based hierarchy

Demsetz—“authority … serves to economize on the transmission and handling of knowledge.”

Instruments moderately support directional and heuristic search. Low-powered incentives attenuate knowledge

appropriation hazard. Supports vertical (not horizontal) communication

channels and codes to facilitate central figure acquiring, accumulating, and applying knowledge to guide search.

Conflict resolution through authority dampens strategic knowledge accumulation hazard.

ABH is efficient for nearly decomposable problems.

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ABH failure ABH fails for non-decomposable problems because

central figure can not acquire, accumulate, and apply requisite knowledge to develop necessary heuristics.

it does not support horizontal communication channels. central figure contaminates trial ordering due to

meddling. ABH fails for decomposable problems because

number of knowledge sets is beyond manager’s cognition.

central figure contaminates trial ordering due to meddling.

weak incentives limit specialized knowledge formation. excessive costs of knowledge sharing.

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Consensus-based hierarchy Arrow—consensus utilizes specialized knowledge sets housed within the firm

and can substitute for authority. Consensus arises when knowledge transfer is inexpensive and actors

have an overriding commonly valued purpose. Instruments support heuristic not directional search.

Low-powered incentives attenuate knowledge appropriation hazard. Supports horizontal communication channels and codes (and commonly

valued purpose) for knowledge sharing. Conflict resolution through social relations, which attenuates strategic

knowledge accumulation hazard. CBH is efficient for non-decomposable problems. CBH fails for problems with moderate to low complexity because

of excessive costs of maintaining communication channels. social attachments may misguide and bias search. social attachments may limit the firm’s capacity to absorb new forms of

knowledge and hence lead to inferior solutions.

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Alignment of discrete alternatives

Market Hybrid HierarchyGovernance Costs

k1 k2 Asset Specificity

Market Hybrid Hierarchy

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A Wiliamsonian firm

k = 0k > 0 k » 0

k » 0

k » 0k = 0k » 0

k » 0

Vertically Integrate

k » 0

k » 0

k » 0k » 0

k » 0

k > 0Complex Contract

Simple Contract

k = 0

k = 0

Core of the Firm

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Comparative assessment of discrete structural alternatives

Governance Mode

Market Hybrid Hierarchy

Instruments

Incentive intensity

Administrative Controls

Contract Law

Performance Attributes

Adaptation (A)

Adaptation (C)

++ strong, + semi-strong, 0 weak, Williamson (1996, 103)

++ + 0

Classical Neoclassical Forbearance

++ + 0

0 + ++

0 + ++

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Comparative assessment of alternatives

Governance Mode

Hierarchy

Market ABH CBH

Instruments

Incentive intensity

Communication codes and channels

Dispute resolution regime

Performance Attributes

Directional search

Heuristic search

++ 0 0*

Contract law Authority Relational

++ + 0

0 + ++

0 Vertical Horizontal

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Implications for firm performance Main predictions:

Vertically integrate in response to deep co-specialization Hybrid in response to moderate levels of co-specialization Market in response to low levels of co-specialization

Aligning transactions in an economizing way yields superior firm performance (profitability, survival)

Firms presumably invest in asset specificity because it creates value

Capabilities/competences What are capabilities? How do capabilities arise? What is the capabilities-based theory of the firm? How do capabilities influence firm performance?

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What are capabilities? Capabilities = dynamic capabilities = competences

Knowledge-based view of the firm (KBV)

Resources = KH (tradedable), financial or physical assets, HC.

Capabilities = the capacity to deploy resources.

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What are capabilities? Main assumptions: Bounded rationality <=> knowledge is

“sticky”. Two views:

Myopic view Passive spillovers from tacit and endogenous

learning-by-doing processes. Path-dependent evolutionary process. Largely informal processes of accumulation.

Farsighted view Deliberate and sustained investment of financial

and managerial resources generate capabilities. Largely formal processes of accumulation.

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What is the KBV theory of the firm?

Theory of firm derives from knowledge-based considerations… not the incentives, opportunism, and transaction costs hierarchy is a “creator of a positive” not only an “avoider of

a negative.” Main prediction: internalize activities that can be carried out at

lower (production) cost than other firms “Dynamic transaction costs” => teaching is costly Internalize those activities that rely on “core competencies”

Firms economise on the exchange of knowledge not on opportunism. Two competing claims:

Hierarchy economizes on knowledge transfer Authority avoids the need to transfer knowledge

Hierarchy facilitates knowledge transfer Shared language and identity facilitate transfer

Capabilities lead to firm heterogeneity

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Accounting for pre-existing capabilities:

The “shift” parameter

Market Hybrid HierarchyGovernance Costs

k1 k2 Asset Specificity

“Positive” capabilities reduce sum of transaction and production costs.

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Discriminating alignment of Governance alternatives

Market ABH CBHExpected cost of finding a valuable solution

K1 K2 Complexity

Market ABH CBH

*Holding N constant

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How to assemble and organise knowledge?

Problem complexity

Complex contractingComplex

contracting Authority-based

hierarchy

Authority-based

hierarchy

Consensus-based

hierarchy

Consensus-based

hierarchySimple

contractingSimple

contracting

Opportunity cost of acquiring knowledge

Firm BoundaryJoint-

venturesJoint-

ventures

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Example: US truck transport industry

Paper by Hamilton and Nickerson (ASQ) Compare LT and LTL, for-hire trucks in US

How they differ LTL hub-and-spoke => large investment needs, LT

door-to-door => less... LT as one-to-one, LTL as one-to-many solutions

(more need for coordination in LTL) LTL should be one, LT can be dispersed (little

benefits from internalisation) Question: how is profitability affected by driver

missalignment? Answer: those, who misalign have lower profits

ceteris paribus

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Bringing the market inside the firm

Baker, Gibbons and Murphy (AER) Theoretical model:

Upstream party, downstream party and assets Transaction contains contractible (court-enforceable) and

noncontractible (bargaining, hold-up, etc.) components Compare spot employment and spot outsourcing

Conclusions: Informal spot markets cannot be replicated within firm Relational employment can improve both spot alternatives via

providing adequate incentive structure (separating equilibrium) Why important?

Selective intervention can provide a viable alternative to „infinitely huge” firms

Sometimes selective intervention impossible Relational contracts are important inside firms because they

improve on market outcomes (and not because they replicate spot-market payoffs)