Organizational Economics - and streams

In the last blog, we discussed about the reduction of "transaction cost" if there is a trust that is built between the firms. The term "transaction cost" has been discussed multiple times thus far, and it would be apt if we describe the term - starting from this blog we begin a discussion on "organizational economics" that would continue over the next few blogs. The primary resource for our discussion over the next few blogs would be a chapter from the book "Handbook or organizational studies - S R Clegg, C hardy and W R Nords from Sage publications". In this blog, we look at the understanding the nature of organizational economics since the term is pretty new to most readers. 

Organizational Economics is a type of organizational analysis that generally relies on equilibrium analysis, assumes profit maximizing managers and uses abstract assumptions and models, but having said these we always would find exceptions to this. The real underlying commonalities in all the theories of organizational economics are 

1. The interest in structure, functioning and implication of firms

2. Relation between competition and organizations

3. The probability of organizational survival

Having said that competition is a subject matter of interest, it doesn’t preclude discussion on cooperation within and between firms. For the sake of study, literature on organizational economics has been classified into following streams

1. Transaction cost economics

2. Agency theory

3. Strategic management theory

4. Cooperative organizational economics

We shall discuss these 4 streams and the theories in them over the next few blogs.

Role of Trust in an outsourcing scenario

In the last blog, we looked at the possible reasons that could prevent a company from choosing to go ahead with outsourcing. In the current blog, we look at how the alignment of the economics related to outsourcing would change when one begins to consider the factor of trust.

It is common knowledge that Airtel has outsourced most of the network tower maintenance and equipment setting up to companies like Ericsson and IBM. Does it change anything in the equation when we have a pretty well known company to partner with? A careful look at the detail and we would begin realizing the benefits possible.

I read the following on a recent update on facebook status - "Trust is like an eraser, it becomes smaller after each mistake" I guess it’s also true that every time we adhere to what was promised the trust would grow! The brands we know today are not just a marketing head start - it is a good match of what was marketed with good operational execution. - IBM and Ericsson have built the brand this way.

When Airtel gets into an outsourcing agreement with these majors towards implementing the network - Airtel doesn’t have to really worry about hedging the opportunistic behavior to a great extent. A history of acceptable behavior by an organization generates a reputation of trustworthiness; this intern creates confidence in the companies that align with the organization. The trust that the 2 parties have on each other reduced the otherwise high "transaction cost" associated with such an outsourcing. 

In summary, it makes a lot more sense for a company to build a reputation - as a hedge against the possible opportunistic behavior. This reduces the transaction costs the 2 parties in the outsourcing would have to incur.

When not to consider outsourcing

In the last blog, we looked at the risk of possible opportunistic behavior in an outsourcing scenario. In the current blog, we look at some of the reasons why the organizations would have attempted to avoid outsourcing of tasks in spite of the economic benefits that the company would gain.

We can identify 3 possible reasons for companies to stick to carrying out these tasks in-house instead of outsourcing:

1. Knowledge Spillover
2. Poor performance by the supplier 
3. Retain and Build competency for long term competitiveness

Companies generally use contracts to ensure that the outsourced tasks could be forced, however there are many scenarios where some tacit and complex knowledge would have to be revealed to the supplier - the company that has outsourced the activity incurs the risk of such information being leaked to the competitor - this is one reason where outsourcing is not preferred. However making a sweeping statement wouldn’t be appropriate - it is again dependent on the industrial context. While in the Indian advertisement industry companies do not engage the same agency, it is pretty common for the large competing companies to engage the same consulting firm (obviously for reasons the teams working would be different on these projects)

Companies would also consider doing the task in house when poor performance by the supplier has the potential to damage other organizational resources. If companies find that food served in the cafeteria has been the reason of displeasure of its employees, there have been instances where the change of these companies has been extremely frequent and in some cases the company has initiated the step of getting the cafeteria managed in-house!

The third point of retaining and building the resources that the company feels are important for the long term survival is pretty obvious. It doesn’t need any great depth of explanation. The critical interdependence of the tasks of a company is important considerations that a company would consider while making an outsourcing decision.

Risk of Opportunistic Behavior in Outsourcing model

In the last blog, we looked at how Outsourcing enables a diversification of risk for a supplier company amongst its customers. In the current blog we continue this discussion of supplier and consumer in the context of outsourcing but moving beyond the benefits and considering the case of an opportunistic behavior by the customer.

Many a time, when it comes to the decision of making it in-house or buying it from outside - we rush through our decisions. Is there a possible framework for these things? Yes there is definitely when you consider the whole process in economic terms - however that is not what we shall discuss here - In case someone might be interested in this, it is best to read the whole paper "Outsourcing: Practice in search of a Theory - by Prof Sourav Mukherji and Prof J Ramachandran". In this blog we focus on the possibility of an opportunistic behavior in an outsourcing transaction.

A specialized supplier would be more efficient at producing than the organization producing it in-house. The underlying premise is that there would be a strong binding contract that could be well enforced. However if there is lot of information asymmetry, uncertainty and almost no competition, the transactions might not get through pretty well. It is in these situations that the opportunistic behavior - "self seeking behavior with guile". This would also need to be factored in while drafting the contract.

In a supplier makes a "transaction specific investment" to meet the buyer's demand then the possibility of opportunistic behavior is higher. The supplier in such situations where he makes a transaction specific investment would ask for a price premium over the competitive rates to guard himself from the opportunistic behavior. 

So the next time you intend to look out at an investment that is transaction specific do look at the possibility of an opportunistic behavior and hedge yourself.

Looking at Outsourcing from the angle of risk

In the last blog, we looked at outsourcing from the ability of the organization to leverage the resources for the better. In today's blog we look at the concept of outsourcing from the aspect of risk.

To understand this, let’s begin with a small example. Let us assume a bank decides to set up a small team towards building a system to handle all the banking related tasks that could be automated. The estimated time for the project for a team of 100 people was 20 months. Around 6 months after starting off the project, there is a huge banking slump and the bank now has issues which threaten its very existence. The project of computerization of its activities invariably would take the back seat. If the software system being developed was done by a larger software company - the risk of the banking slump wouldn’t be too high for the software company. The software company possibly has a larger portfolio of clients and would be able to manage these sorts of risks better than the bank that took up the project of developing the software system in house!

To summarize the learning - a supplier aggregates demand from multiple customers and therefore can diversify risk better than the customer can on their own - creating higher value for the customers. The supplier's ability to aggregate demand across businesses and industries would have to be a set of uncorrelated risk profiles. This uncorrelated risk profiles of the suppliers create a portfolio of companies which resemble in many ways to a mutual fund. The fund mitigates the unsystematic risk of an organization or an industry by associating it with customer-portfolio diversification.

An organization would have to think if would increase its risk by keeping the function in house or would be better off by outsourcing the function.

How outsourcing assists organizations leverage their resources better

In the last blog we looked at the access to resource that outsourcing enables. In today's blog we look at how organizations are able to better leverage their existing resources and there by create an advantage for themselves.

To understand what resource leverage means, let’s begin with a small example - having almost every established company today has an HR department within itself - catering to the various human resource related issues. Some leading organizations today have looked at their human resource department more from a value adding angle and have decided to outsource of the non-value adding aspects. Pay roll processing for example is an activity of the HR department, however this is one aspect that is extremely standardized but still consumes a lot of time. These sorts of activities are now being outsourced to other companies offering these sorts of services; this doesn’t just add in the lower cost factor but frees the HR department of these large organizations towards addressing the more challenging tasks that are more organization specific say - cultural transformation or building the leadership pipeline etc. 

In the above discussion we saw that in addition to cost minimization, the companies have now begun looking at the task that could be outsourced as a value-maximization perspective. By outsourcing the "non-critical" functions that the organization performs, the organization sharpens it focus, channelizes the resources it has towards achieving excellence in the "crucial" functions. 

This ability of organizations to leverage their resources also provides a long term benefit of channelizing the research in the crucial aspects of business and gain a competitive advantage of the future.

Resource Access as a reason for outsourcing

In the last blog, we attempted to understand the rationale of outsourcing from the dimension of cost minimization. In today's blog we look at the second dimension of the logic of companies outsourcing - Resource Access.

To understand this aspect of resource access, let’s assume a product company is intending to enter a new market territory. When a company makes at attempt to enter this new territory it has 2 primary tasks to take care of 

• creating the brand awareness
• having a good support of the distribution network

If the company is to be really successful in the new market, both these aspects have to be dealt along well. What the company would always aim to do is to enter the market quickly - its focus would be a very short time to market - and it is this that would be the key to its success. If the company attempts to do both the tasks in-house, it is extremely possible that the business could be slower to enter into the market! So it is seen that companies find logic to outsource one of these 2 tasks from its kitty. 

In outsourcing of such a nature discussed above, it is also that the company is able to access the resources that their partner company would have already created. This could potentially give rise to a win-win situation to both the parties involved in the outsourcing agreement.

There is also another dimension, if we have a careful look at the possible reason for outsourcing. Though might not be the case with all outsourcing of the nature of resource access - in some cases it could be seen that the resource these companies would need to use for the specific task is only transient in nature. It would definitely be efficient to outsource a sporadic or one-off activity given that the recovery of the overhead expenses could be difficult when conducted in-house

Cost Minimization and Organizational Innovation

In the last blog we began understanding the relation between innovation and outsourcing. In this blog we move to discuss the first of the various factors that influence the outsourcing choice - Cost Minimization.

Cost minimization is one of the most common motivations towards cost minimization. Cost minimization is derived from economies of scale which help spread the large fixed across a larger customer base. It works best when the market has a large number of buyers and seller - indicating that there is high competition in the market. The market therefore would have a large pool to choose from for the vendor who would give them the product at the least cost and therefore benefit from outsourcing.

One would also need to think of a globalized context in the present context. The globalization in the present context enables the companies to source the product from a larger pool and also benefit from the lower cost of factors of production the not so developed locations of the world - This is how the IT Enabled services industry has developed. The large fixed cost that these companies incur is spread across the large number of clients that these companies serve.

Let us take the example of Bharat Forge and understand this better - 

Bharat forge is an Indian company focused on forging - it is the second largest in the world. It has made significant investments in fully automating the forging processes and has instituted an IT enabled knowledge management system to capture and leverage the intellectual capabilities of its engineers and brought about improvements in the forging process that enabled it produce superior products at competitive prices.

The above example also indicates an additional advantage that a company that invests in cost minimization through specialization - by aggregating the demand of multiple customers - the company also begins to innovate. By doing a relatively narrow set of tasks, the company would be in a better position to figure out superior ways of performing the task and hence are able to innovate greater than a generalist organization. 

Innovation and Outsourcing

In the last blog, we summarized the various classifications of theories that we had discussed over the last few weeks. In the current blog we begin looking at a very interesting study conducted by 2 Professors at IIMB on the concept of Outsourcing and the decision making process associated with it.

Through the blogs on innovation, we haven’t explicitly mentioned the underlying common understanding - It is specialization that eventually enables innovation. The range of activities that an organization has to take is pretty broad and, this makes innovation a difficult task for organizations. But it is essential for the organizations to innovate constantly to stay ahead of competition. Given this need to innovate and the pre-requisite of innovation in organization the company would like to focus on a specific activity while procuring the remaining from the market. In other words - "Outsourcing". It is important to understand that specialization and outsourcing are complementary business imperatives.

The generally held opinion about outsourcing that companies generally outsource activities that are "non-core" while conduct the "core" functionalities of the company in house. The opinion should be reconsidered if we look at the choices that companies like "Nike", "Dell" and even "Bharti Airtel" have done. While "Bharti" and "Nike" have decided to focus on "marketing" as a core area "Dell" has focused on "Supply Chain Management". 

In order to understand the manner in which the organizations can make a choice we would have to look at the decision made on the following:

1. Cost Minimization 
2. Resource Access
3. Resource Leverage
4. Risk Diversification

Summarizing our understanding of Organizational innovation

In last blog we attempted an understanding of the strategic adaptation theory and its implications to organizational change. In this blog we would attempt to gain a summary of some of the discussions we have had on organization change and innovation. 

A careful look at the kind of words we have used over the last few blogs would get you to realize that we have dabbled between organizational change and innovation at various points. This blog primarily looks at this question. 

"Organizational innovation" as a term is pretty ambiguous. The meaning is pretty broad and means innovation or innovative behavior in organization or organizational adaptation of innovation. The relation between organization and innovation is complex, dynamic and multilevel so getting a precise definition is pretty difficult. The concept of organizational innovation is pretty loose and slippery too!

In the discussion this far - we have looked at 3 interrelated approaches to understanding organizational innovation. 

The first focused on understanding the effects of organizational structure on the organizations ability to learn, create knowledge and generate technological innovation. The approach however, doesn’t continue the aspects of internal organizational dynamics or environmental forces factored in. The second approach used the organizational learning and knowledge creation was an approach to understand the possibility of organizational innovation. And the third approach focused on the organization's capacity for change and adaptation. 

It would be good to note here that none of these approaches individually help understand the concept of organizational innovation completely. It is very important to have an overall perspective of these approaches and apply it when the situation requires it.

Strategic Adaptation and Continuous Change

In the last blog we attempted to understand the punctuated equilibrium model and attempted to associate the organizational innovation component to it. In today's blog we look at Strategic Adaptation and Continuous Change. 

The theories of Strategic Organizational Adaptation and change emphasize on the role of managerial action. The strategic choices that managers make shape the organizational change. It is the choice of the actors that decide the outcome rather than passively accepting the environmental selection. Though we cannot claim that the organizational actors have a complete autonomy, the theory talks about a "bounded autonomy". These organizational actors through their actions and "enactments” are capable of redefining and modifying structures that open up new possibilities for the future.

Organizational change in this approach would be seen as a continuous process encompassing the paradoxical forces of continuity and change rather than an abrupt, discontinuous, episodic event described by the punctuated equilibrium model. The continuity maintains the sense of identity with the organizational learning, and factors in the political legitimacy and increase the acceptability of change among those who live with it.

It has also been argued by the management theorists of this school that consistently successful organizations have used a combination of "induced" and "autonomous" processes in strategy to initiate an organizational renewal. The induced initiatives work on the tasks that have an internal scope while the autonomous focus on tasks that have an external scope. 

Punctuate Equilibrium and organizational innovation

In the last blog we talked about the evolutionary model of organization and the sort of innovation that would accompany it. In today's blog we discuss how the organization's model of growth when modeled around the punctuated equilibrium would handle innovation. 

The punctuated equilibrium model proposes that organizations typically initiate a revolutionary structural change during periods of environmental turbulence. The general state of an organization would comprise of long periods of evolutionary change with certain short bursts of radical change. These short bursts of change could really transform the organizations strategy, structure, power distribution, control systems etc!

One could call the relatively stable period of growth as - "evolutionary periods" while the short radical changing periods as those of "revolutionary periods". 

Empirically it has been found that the organizations that were able to transform themselves drastically were able to perform better than those that transformed incrementally. But this study wasn’t comprehensive enough to allow us to understand the reason of the failed transitions. The implication of the concept is that the competitive environment repeatedly changes over time and the successful organizations accordingly have to initiate periodic discontinuous or revolutionary change to adapt to the environmental changes.  

The challenge here is that the organization would have to develop diverse competencies and capabilities to shape and deal with the technology cycle.

While this model explains the patterns of organizational evolution and relationship with the change well, the model fails to address the crucial question of how organizations create manifest into new forms during the revolutionary phases. It also doesn’t address the long terms survival prospects of the organization!

Evolutionary view of organizational change and Innovation

In the last blog we learnt about the classification of theories on organizational change. In today's blog we attempt to understand the relation between evolutionary view of organizational change and the associated innovation. 

When one thinks of organization's established structures, procedures, norms etc, we realize that generally these would have developed as learning from organization's response to the challenges it faced. Every time a new challenge is posed to the organization, these very systems that have been set up to handle some similar but past situations turn to be inertial force. Thus these organizations are slowed down in responding relatively to the threats and opportunities that the environment poses.

When faced by environmental change, new entrants within the industry would potentially displace the established organizations that do not react quickly enough. It has also been observed that new entrant companies play a "competence-destroying" technological innovation, while the existing companies thrive at "competence-enhancing" technological change adaptation. It would be interesting to also relate these to the discussion we had on the J-Form and adhocracy models and the innovation. We leave that as a thought exercise for the readers here.

Class of Theories relating organizational change and innovation

In the last blog, we looked at the affect of market economies on the organization's structure and there by the innovation - knowledge sharing perspective. Over the last few blogs we have covered 2 dimension of the study of organizational innovation - its relation with organization structure and its relation with organization knowledge creation & learning. Starting from today, over the next few blogs we attempt to understand the relation between organizational change and the innovation there in.

If one where to begin the journey of understanding the relation between the ways an organizational change we would first have to understand the process or perception of the way organizations change itself. It is pretty clear that organizational change happens in response to the environmental challenges or technology changes. Management theorists have classified the study of organizational adaptation and change into 3 categories

1. Incremental / Evolutionary view of Organizational change - it focuses on the way environments select organizations and how this selection process creates change in the organization form. 
2. Punctuated Equilibrium and Discontinuous Organization Transformation - treats organizational transformation as discontinuous event occurring over a short period of time
3. Strategic adaptation and Continuous Change - stresses that managerial action and organizational learning and importance of continuous change. The organization is not a passive recipient but has the power to influence and shape it.

We shall dwell into these individual streams over the next few blogs.

Organizational Innovation influenced by Societal Context

In the last blog, we looked at a short case where a new concept - Spaghetti Organization was discussed. In today's blog we look at the societal institutions influence the organization form and its innovative ability.

We have discussed 2 forms of organization in pretty detail with respect to the organization's innovative ability - The J Form and the Adhocracy. We also mentioned that organizations were said to be of J form given the structure followed in Japan. However we would require to broaden the horizon from Japan and ask if there is a larger social context that drives such organization structure. While understanding Adhocracy too we used the example of Silicon Valley to talk about labor market which is a component of society!

Research has indicated that there is a relation between the type of "capitalism" and the innovation stype persued. If we could classify the capitalistic economies into 

1. Coordinated Market Economies (CME) and
2. Liberal Market Economies (LME)

we begin seeing some patterns. CME and LME differ from one another in labor market organization, training systems, soceital norsm, values governing business and economic relationships.

CME is followed in countries like Japan, Germany etc. These have deleveoped institution that encourage long-term employment and business relationships, facilitating the delevopment of distinctive organizational comepetencies conducince to continuous but incremental innovation. LMEs on the other hand, are follwed in contries like the US and the UK, where a certain type of adhocracy is followed to be able to rapidly and radically innovate. It is not just the labor markets that aid these types of organization structures - the financial markets, education systems etc too play a major role. 

What one needs to remember is that the relation between instutions, organization and innovation are more complex than the simpified difference between the J-Form and Adhocracy. they are more dependent on the social context and the institutional framework that is developed. Infact the societal institutions play the dual role of creating constraints and also possibilities for the firm to evaluate the type of oganization they could evlove into

Spaghetti Organization - A story of Oticon

In the last blog, we looked at the Silicon Valley format of organizations and the related organizational learning. In this blog, we look at a unique experiment that was conducted in an organization - Oticon and the resultant term that developed called - Spaghetti Organization

Spaghetti Organization refers to a flat, loosely coupled, project based organization characterized by ambiguous job boundaries and extensive delegation of task and project responsibilities to autonomous teams. Let’s understand this with the example of Oticon.

Oticon is a Danish electronics producer operating in the space of hearing aids. It became extensively known for its s radical organizational transformation in the early 1990s. The organization was traditionally hierarchical, functional based organization, and transformed radically into a "Spaghetti Organization". It was the loss of competitive advantage in the 1980s that forced it to get into implementing this model. The advent of the digital technology had almost spelt doom on this organization. In response to this, this company underwent extensive restructuring in the 1990s - the aim was to have an entrepreneurial and creative organization. This resulted in a series of remarkable innovations in the 1990s. However, this form of organization was abandoned in 1996.

A research by Foss suggests that the reason could be the severe problems encountered in coordination and knowledge sharing due to a highly fluid and adhocratic nature of the project assignments. Employee’s commitment to the project was also another point to ponder about. Foss also argues that, the form of organization was an "internal hybrid" between elements of market autonomy and flexibility in hierarchy. It was also inherently unstable due to the motivational challenges caused by the selective intervention by the top management into project selection and coordination. The employee frustration seen due to this could have been the cause for eventual retreat of Oticon from the radical and celebrated Spaghetti Organizational model.

Understanding Adhocracy and Knowledge creation - Silicon Valley

In the last blog, we attempted understanding the J-Form of organization better. In today's blog we look at the Silicon Valley style of organization (closer in alignment with the Adhocracy concept) and see how Adhocracy has been leveraged.

The Silicon Valley has been a very dynamic and successful region where rapid innovation and commercialization of fast growing technologies. The majority of the industries in this region are microelectronics, semiconductors, computer networking, and biotechnology. These industries are characterized by frequent reconfiguration and realignment of the firms to survive a constantly changing environment spurred by innovation. There is a large pool of professional experts with known reputations in particular fields that enable the firms to quickly reconstitute their knowledge and skill base in the course of their innovative endeavors. There is high mobility of the labor force that enables not just the culture of hiring and firing, in addition when combined with the professional networks this enables rapid transmission of evolving new knowledge, - this might mostly be tacit though!.

The shared context and industry specific values ensure that the tacit knowledge is not wasted when one shifts form one organization to the other! This inherently encourages the individual to engage actively in this tacit "know-how" that he could leverage for himself. Though regional, this stability is critical to offer the sustaining of collective learning and knowledge creation within and across the firm boundaries.

Now if we were to generalize this Silicon Valley culture in terms of Adhocracy - it could be seen as an organic and adaptive form of organization that fuses the professional expertise with various knowledge and skills into adhoc project teams for solving complex and typically uncertain problems. Careers of these professionals are structured around a series of discrete projects than a firm level growth. This indicates that the organizational boundaries are pretty permeable and allow for the insertion of new ideas and knowledge from outside - through recruitment of new staff into the firm. 

The strength of Adhocracy is in being able to reconfigure the knowledge base quickly deal with high technical uncertain problems - this in many ways enable innovation in emerging new industries. They are capable of dynamic learning and radical innovation, however this model is not without its share of challenges - the toughest amongst this is that of knowledge accumulation at an organizational level.