Some Economic Aspects of Business Organization [Reprint 2016 ed.] 9781512818048

Table of contents :
Prefatory Note
Contents
I. Revolutions and Counter-Revolutions in the Theory of the Firm
II. Towards A Merger of Bureaucratic and Motivational Considerations
III. The Economics of Cohesive Bureaucracy
IV. Rigidity and Adaptability in Bureaucracy
V. Notes on Uncertainty and Dysfunctional Behavior
VI. The Construction of Organizational Knowledge
References
Index

Citation preview

Some Economic Aspects of Business Organization

Some Economic Aspects of Business Organization by

James E. McNulty Associate Professor of Industry Wharton School of Finance and Commerce University of Pennsylvania

Philadelphia

University of Pennsylvania Press

©1964 by the T r u s t e e s of the University of Pennsylvania Library of Congress Catalogue Card N u m b e r : 64-18620 Published in Great Britain, India, a n d Pakistan by the O x f o r d University Press L o n d o n , Bombay, a n d Karachi

7450 P r i n t e d in the U n i t e d States of America

To my Wife

Prefatory Note T h i s essay is an outgrowth of a graduate course which the author developed at the University of Pennsylvania. T h e purpose of the course as it was originally conceived was to provide a sort of bridge between work, in "managem e n t , " on the one hand, and work in economics, on the other. T e n years ago such an endeavor would not have been practical because of a dearth of sophisticated thinking among economists about problems of business bureacracy: the subject as a topic for endeavor in economics was almost literally regarded as laughable, even by the shrewder wits among economists. However, more recent developments have changed all of this. O n e not only can find materials for a pedagogical bridge, but also now it is essential that a bridge be built for the sake of progress in both the field of management and the field of economics. T h e intention of the present essay is to contribute to the unification and expansion of the "pure economics" of business bureaucracy using the materials provided especially by such people as Jacob Marschak and Herbert Simon who each, though in very different ways, has brought us important insights and concepts. No one has yet seemed successfully to have established the connection between recent efforts in economics concerned with the bureaucratic enterprise and the positivism of received

theory, notably that of Kaldor. W h a t is in many ways probably more important, the newer contributions themselves are manifestly disjoint such that in general wellintentioned electicism is a sterile endeavor. T h e r e is additionally the question of the nature of the relationship between the newer work which is heavily microstatic in its outlook, to such important matters as dynamics and "general e q u i l i b r i u m . " Finally the subject of what, if any, investigative procedures are appropriate to the newer efforts is one which is of interest for its own sake as well as for the light which its treatment will shed on the nature of recent developments. Clearly not all of these ambitions are going to be taken care of for all time in such a modest treatment as is contained in the chapters which follow. However, it seems not an unreasonable hope that the efforts here will generate enough emotion of the right kind such that maturity will become a more obvious characteristic of the general area denoted by the phrase "economics of business bureaucracy" than is the case now. By way of background it would seem desirable that the reader have had some contact with the general subject of business bureaucratic processes, a m i n i m u m requirement which could be fulfilled by reading one of the thinner books on business organization and management. Also of course he should be reasonably well acquainted with the basic concerns and concepts of economics at the elementary graduate level. T h e level of analysis in the study is generally not above this. And, except for picking up a few concepts and a bit of notation which seemed convenient to the writing of Chapter IV, there is nothing susbtantial required in the way of mathematical background (although such background will, as is customary, certainly be necessary for serious application of the present analysis to practical problems).

I have received an enormous amount of stimulation, as will become clear, from the work of Jacob Marschak and Herbert Simon, as well as from some others who have pioneered in the systematic analysis of organizations. T h e y of course are not responsible for the general "tack" of the analysis, especially the frequent transformation of their various ideas into a recurring quasi-marginal economic analysis of bureaucratic structure. T h e latter procedure will be seen to be a central feature of the present analysis. Despite its comparative lack of power for applied work, I have made the choice because of its comparative familiarity as well as because of its analytical utility in endeavors which have the purposes of the present discussion. A grant of money from the Ford Foundation funds administered by the Wharton School of Finance and Commerce made it possible for me to take time off to write this essay, and for this I am grateful. Various colleagues at Pennsylvania and elsewhere offered helpful criticisms, and Mrs. Helen W h i t e turned my poor handwritten copy into a typed version which looked impressive even to me. J.E.M. August, 1963

Contents Prefatory Note I Revolutions and Counter-Revolutions in t h e T h e o r y of t h e F i r m II T o w a r d s a M e r g e r of B u r e a u c r a t i c a n d Motivational Considerations I I I T h e E c o n o m i c s of C o h e s i v e B u r e a u c r a c y IV R i g i d i t y a n d A d a p t a b i l i t y in B u r e a u c r a c y V N o t e s on U n c e r t a i n t y a n d D y s f u n c t i o n a l VI

Behavior T h e C o n s t r u c t i o n of O r g a n i z a t i o n a l K n o w l e d g e References Index

Some Economic Aspects of Business Organization

I Revolutions and Counter-Revolutions in the Theory of the Firm Less than a decade ago it was generally regarded as a sign of incompetence, 01 possibly madness, f o r an economist to talk as an economist about the m a n a g e m e n t organization structure of the business enterprise. T o d a y the situation is almost completely reversed, and if one does not in his discussions of the firm pay at least polite regard to the questions of λνΐιο makes decisions, why, how, and with what consequences, the likelihood is that Iiis remarks will be passed off as being u n w o r t h y of the attention of advanced academicians and realists. T h e interesting question arises as to what has happened to bring this change in fashion. Has there been a breakthrough in the observation of h u m a n b e h a v i o r so that a completely i n f o r m e d " o t h e r - o r i e n t e d " economic m a n has been discovered to populate the typical, or "representative," business administrative organization? H a v e new tools been developed to m a k e possible theorizing by economists on the subject of organization? Or, perhaps because of the analytic rather than historical and descrip9

10

S O M E E C O N O M I C ASPECTS O F BUSINESS ORGANIZATION

tive character of much current graduate training in economics, does the profession simply have a short memory so that what we have is retrogression rather than progress? In the succeeding chapters of this monograph we shall attempt to carry forward and enhance the growing use of economic analysis in the study of business bureaucracies. It seems not innappropriate therefore for us to examine briefly the evolution of thinking and research in economics concerning the nature and significance of the organized firm in order to find out what in fact has happened. T h e discussion will start with the work of Alfred Marshall and then proceed to the current explosion in thinking about economic aspects of business bureaucracy which has characterized the past decade. Our purpose is not so much to give a chronology as it is to take note of changing points of view in the "main stream" of economics. Therefore in general, especially as far as older writings are concerned, the emphasis will be on what are generally regarded as the more authoritative treatments, which either represented or established orthodoxy in the matter of organization aspects of the theory of the firm. Such a procedure should give us the background which we need. From Personal Leadership

to Inefficient

Bureaucracy

Marshall (1920), and along with him Frank Knight (1946), were quite evidently much less sanguine about the relevance of organization and communication systems to the welfare of the business enterprise than they were about the quality of its leadership. T h e r e is no real evidence that they regarded an organization structure characterized by delegation of managerial authority to subordinates as an impossibility. However, neither chose

REVOLUTIONS AND COUNTER REVOLUTIONS

11

to spend much time on this aspect of the organization of productive activity within the firm. As the following quotation suggests, Marshall's top manager is a textbook type of top executive and structuring and re-structuring a bureaucracy is just one of several concerns: The head of a large business can reserve all his strength for the broadest and most fundamental problems of his trade: he must indeed assure himself that his managers, clerks, and foremen are the right men for their work, and are doing their work well; but beyond this he need not trouble himself much about details. He can keep his mind fresh and clear for thinking out the most difficult and vital problems of his business, for studying the broader movements of the markets, the yet undeveloped results of current events at home and abroad, and for contriving how to improve the organization of the internal and external relations of his business.1 This again is not to say that Marshall was oblivious to the relationship of administrative and other systems to the operation of the modern large business (1919). Nor was he unaware of such problems as indolence and lack of communications which appear to characterize many large organizations. However, his reaction to these things was that they were points for and against large as opposed to small business. 2 T h a t is to say, he regarded organizational bureaucracies and their behavioral implications essentially as being constants and having constant coefficients, respectively. For this reason presumably the more variable quality associated with the ability to pick and lead subordinates appears to have been the center of his interest. 3 1

Principles, p. 284. 2 Ibid., p p . 2 8 4 ff. 3 Industry and Trade,

p p . 3 5 4 if.

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S O M E E C O N O M I C A S P E C T S O F BUSINESS ORGANIZATION

Like Marshall, Knight regarded the ability to pick and lead subordinates as crucial to the success of the entrepreneur: It is the margin of error in this most ultimate faculty of judging faculties whose exercise is the essence of responsible control which constitutes the only true uncertainty in the workings of the competitive organization.4 He was, however, considerably less optimistic as to how far expansion of the firm could go. Subordinates were hirelings, and ultimately the foresight and executive capacity of the entrepreneur would be overtaxed. 5 T h i s latter theme, implying diminishing returns because of a management limitation, is the one which became the orthodoxy of the economic theory of the firm until approximately a decade ago. T h e notion of a limitless personal leadership variable was dropped. T h e most important reasons for this change are probably two: first, an increased concern with "normative" static economics; and, second, the intangibility, especially for economists, of the human variables emphasized by these two writers. There were, however, some other considerations based upon observation, albeit casual, of the real world which made this diminishing returns theme a not unreasonable one. First, as we hear constantly today in discussions of automation and its requirements, the several functional parts of the modern business enterprise are distinctly interdependent and must be coordinated. Second, the pace of change in the data confronting a firm is such as to call for frequent readjustment of plans. Third, there is no a priori reason for believing that these necessary read4 6

Risk, Uncertainty Preface.

and Profit, p. 311.

REVOLUTIONS AND C O U N T E R R E V O L U T I O N S

13

justments can be classified as generally routine, such that some previously worked out decision rule may be resorted to by a subordinate to effect an optimizing adjustment. T h u s Kaldor ( 1 9 3 4 ) , who was concerned with the subject of the equilibrium of the firm and whose purpose was therefore obvious, was ready to assert: T h e fact that the firm is a productive combination under a single unit of control explains, therefore, by itself why it can not expand beyond a certain limit without encountering increasing costs . . . [ T h e ] coordinating factor . . . is concerned with the allocation of resources along the various lines of investment, with the adjustment of the productive concern to the continuous changes of economic data . . . You can not increase the supply of coordinating ble to an enterprise alongside an increase in other factors, as it is the essence of coordination gle decision should be made in comparison with sions already made or likely to be made; it must through a single brain . . , e

ability availathe supply of that every sinall other decitherefore pass

Kaldor, generally speaking, assumed divisibility for the other productive agents besides " m a n a g e m e n t . " Hence Robinson, in his book, The Structure of Competitive Industry ( 1 9 4 7 ) , was able up to a point to challenge Kaldor's implied approval of smaller firms from the standpoint of social efficiency, on the grounds that the indivisibility of some productive agents was such as to make economical operation at very large scales. In taking this position Robinson was in effect opening up the possibility of discussing alternative administrative systems since his larger-than-Kaldor-approved firms would perforce be either absolutely controlled from the top at very high cost 6

" T h e Equilibrium of the Firm," pp. 67-68.

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SOME E C O N O M I C ASPECTS O F BUSINESS ORGANIZATION

or imperfectly controlled at lower cost, the choice depending upon the consequences for profits. T o make a discussion of alternative administrative systems other than trivial it is clearly necessary to establish that there are alternatives between absolute coordination and no coordination at all, and this Robinson did not do. Hence the Kaldor position remained a very sturdy one, to be shaken only by rather radical changes in views of the real world. One such change would be to assume that problems arising from interdependence among the divisions of the typical business enterprise can be made the exception rather than the rule. Another even more radical alternative would be to drop the assumption that the firm actually exists as a joint preference ordering of its members and thereby make irrelevant the whole edifice of the classical theory of the firm. As it happens each of these directions has been explored. T h e current fashion of discussing economical administrative arrangements is one result. Feasible

Decentralization

What has turned out ultimately to be a turning point in the attitude of economists towards discussing questions of bureaucratic structure in the business enterprise did not begin as an attack on Kaldor's strictures. As a matter of fact, the change did not occur in the field of enterprise economics initially. T h e reference here is to the ideas developed in the decade of the thirties for operating a decentralized socialist economy using the market price system as the determinant of production. (Lange and Taylor, 1938) Eventually the implicit model was used for the analysis of other types of economic organizations, including the business enterprise. (Koopmans, 1951) At

REVOLUTIONS AND COUNTER REVOLUTIONS

15

this point contemporary economic analysis of business bureaucratic processes really began. T h e socialist model in its application to business organization has been well-discussed elsewhere. (March and Simon, 1958) As has been pointed out the model, even when its assumptions are accepted, does not make a clear case for decentralization over centralization — this is a matter which depends upon other data such as the reaction times of the participants in organization, and then only under restrictive assumptions concerning system behavior a n d / o r the states of the world. (T. Marschak, 1959) On the other hand, the model by virtue of having come into existence does prove the existence of at least one non-trivial alternative to Kaldor's "single brain." Such an alternative under certain conditions will prove to be efficient in a Pareto optimum sense. This latter fact has been of crucial importance to the renaissance of economic discussions of the organization of economic units and therefore to the present discussion. T h e conditions initially assumed by the socialists were very stringent. They have been shown most importantly to include (1) non-interdependence of the sub-units of an economic system, (2) strict convexity of production and consumption sets, and (3) compactness of these sets. (Koopmans, 1957) There is also the underlying assumption of a joint preference ordering so that incentives are not a problem. If these conditions are met, then it can be shown that the simple decision rules of elementary price theory can be used by the sub-units of an economic system with competitive equilibrium and a Pareto optimum for the system resulting. From the standpoint of the practical value of the socialist model of decentralization either all of the assumptions

16

SOME E C O N O M I C ASPECTS O F BUSINESS ORGANIZATION

have to be verified or else the model embellished to take into consideration important alternative postulates. Verification of the assumptions seems quite clearly a generally unlikely prospect from a substantive viewpoint. Hence it is not surprising that most of the activity has been concerned with developing models based on intuitively more acceptable assumptions. One would expect that economists steeped in the received theory of the firm would be more concerned with interdependence and non-strict-convexity conditions than they would be with compactness of sets and lack of a joint preference ordering among participants in an organization. And so it has been, although, as will be discussed below, there have been beginnings in the analysis of the implications of such less orthodox ideas as the lack of a joint preference ordering among participants in a bureaucracy too. Cross elasticity concepts and multi-market analysis were found to be useful in the formulation of decision rules for organizations characterized by interdependence among their functional, geographic and product parts. (Hirshleifer, 1956) Much remains to be done in this area. However, the importance of the discoveries to date is that they have raised hopes for a comprehensive set of decision rules to include all organizational situations. These analyses also, as has the analysis of a convexity as opposed to a strict convexity assumption for production sets, showed the need for communication among the parts of the firm beyond the simple announcements of price information which characterized the pristine socialist model and its derivatives. 7 As a result it has now come to be regarded as a useful line of endeavor in economics to T

Koopmans

( 1 9 5 7 ) , p p . 3 6 ff.

REVOLUTIONS AND COUNTER REVOLUTIONS

17

discuss business bureaucracy as a problem of choosing the best rules of decision and communication, given bounded sets of such rules, given the probability distributions over the set of pertinent "states of the world," and given the costs of communication of various kinds of information, including decision rules, among the participants in the bureaucracy. Most of the original work in this vein is that of J. Marschak (1954; 1955). T h e r e have also been some well-considered applications of Marschak's "theory of teams," which illustrate its usefulness, and especially its strongly operational character in certain situations. (Beckmann, 1958) It would be an exaggeration to assert that this decision theory approach to the problem of achieving an economical bureaucracy overcomes the considerations out of which Kaldor developed his equilibrium model of the firm. Nor does the approach completely break out of the restrictive set of assumptions on which the socialist model of decentralization via a price system was first developed. Some progress has clearly been made in developing decision rules which can be used in the decentralized administration of economic systems characterized by interdependence among sub-units. These routines nevertheless are still relatively few in n u m b e r and also have been criticized as being pertinent, for a variety of reasons, only to highly routine problems involving everyday operations. (Simon, 1961) Also the team model does not involve any relaxation of the joint preference ordering assumption characteristic of the socialist model. Hence it is of limited usefulness in problems where diverse preference orderings among the participants are likely to occur. New concepts, which make possible the inclusion of interactions among human

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participants and the features of a bureaucratic system, may serve to be more desirable in meeting the problem of diverse preference orderings than radically different approaches to the analysis of organizations. This will be argued presently. However, in the absence of such new concepts it is clear that an important objection to the usefulness of the socialist model has not been met. On the other hand, the progress made to date in the development of alternative bureaucratic procedures is not to be taken as insignificant. Further exploration of procedural rules is certainly now a legitimate activity for economists. Also exploration of the massive computational problems which are associated with the application of these procedures, where such application is appropriate, represents a legitimate field of endeavor for those economists with an interest in applied mathematics. (McGuire; 1959; Radner, 1959) It might be remarked in passing that there are likely to be complications involving special interactions and uncertainties, especially in the case of larger organizational units. These problems will have to be coped with conceptually, and we shall turn to a consideration of them in the third and fifth chapters of the present essay. This caveat does not invalidate immediate computational research, since computation becomes difficult even with relatively small and simplified models. Organization

Equilibrium

Besides the interest in decision rules and communication another, somewhat less dominant, strain of thinking has crept into articles on business organization appearing in economic journals. This is the notion that primary attention should be given not to the structuring of bureaucra-

REVOLUTIONS AND COUNTER REVOLUTIONS

19

cies but rather to the achievement through appropriate inducements of a joint preference ordering which will get the work of the enterprise done. T h e idea, which stems especially from h u m a n relations thinking on organization questions, is associated mainly with the n a m e of Herbert Simon and his concept of organization equilibrium (1951 ; 1958). It obviously entails a somewhat different view of the firm than has been customary in economics with the possible exception of wage theory. Reinforcement of the doctrine in its negative aspects, which have to do with the possible triviality of questions involving the proper pre-planning of bureaucratic structure, appears to have come from accounts of some recent experimental work published in the operations research literature. (Christie, 1956; Guetzkow and Bowes, 1957) T h e prospect raised by this experimental work is that organizational groups may heuristically achieve structure more efficiently by themselves than by direction from above. Direction from above manifestly is contemplated to some degree by the decision theory approach which has been discussed in the preceding section of this chapter. As has been suggested, the organizational equilibrium doctrine, if it is reasonable, reduces the topic of organization to a perhaps esoteric problem in the field of labor markets. Recent discussions which have been h u n g on such an interpretation thus must be regarded as something Qther than completely unfamiliar from one standpoint at least, but they are certainly different as discussions of organizational questions. T h e question of reasonableness as a theory of organization is essentially "beyond the pale" of economic theory. Besides the possible affirmations of the doctrine which were mentioned above there have been questions raised in

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the psychological literature. (Thibault and Kelley 1959) T h e heart of the matter here i- whether or not task groups structure themselves more or less automatically, such that normative thinking about organization and related matters becomes a relatively poor use of one's time. T h e organization equilibrium doctrine does, nevertheless, have potential importance to those who for one reason or another insist on speculating on questions of organization structure and who want to pick u p the challenge of the joint preference ordering problem. T h e framework developed by Simon and discussed in this section, taken together with the vein of discussion which has been treated in the preceding section of this chapter, can, as we shall see in the next chapter, be made to result in an enriched decision theory model of business bureaucracy, provided that a n u m b e r of problems of both conceptual and a substantive nature are met. In addition, the corollary notion of heuristic solutions to organization questions may well be of use in the exploration of more advanced models of organization than we have developed to date. Even such restricted models as the team models of Marschak and his colleagues get computationally involved rather quickly, as has been suggested above. If explicit human variables are introduced, for example, in connection with questions of joint preference orderings, we may well find ourselves hard-put to provide computational algorithms for use in applications and logical development of our hypotheses. Hence, the study of heuristic techniques, which seems somewhat far removed from the concern of economists now, may not seem so in the future. In these two senses the discussions of organization set off by Simon are likely to turn out to

REVOLUTIONS AND COUNTER REVOLUTIONS

21

be of great significance for f u t u r e work in the field. Organization

and Game

Theory

A m u c h more widely discussed and seemingly provocative idea about business bureaucracy in contemporary economics is the possibility that business organization can be treated as analogous to an n-person game. (Shubik, 1959; Cyert and March, 1959; Schelling, 1960) Like the socialist and the organizational e q u i l i b r i u m models this development had its initial fillip from a source outside of the field of entrepreneurial economics. However, it seems q u i t e clear from the uses to which it has been put, notably policy formation within the firm, that it represents an intended attack at one of the vitals of Kaldorian orthodoxy. T h i s is m u c h more so than in the case of the organizational e q u i l i b r i u m model. T h e latter we have indicated can be interpreted in its economic aspects as an extension of the received theory of the firm. W i t h the n-person game analogy the monolithic tradition of the firm in economic theory is replaced by the essentially pluralistic concept of the coalition. Schelling's notion of a "coordination game" represents something of an exception to this assertion since he conceives of the organization as a g r o u p of people who are not in conflict b u t w h o are faced with the strategical problem of picking a p p r o p r i a t e communications; effectively and efficiently they must i m p l e m e n t their joint preference ordering. 8 T h i s clearly is a formulation of the organization problem very similar to that of Marschak. T h e more usual use of the n-person game analogy, however, postulates a g r o u p of individuals, the participants in an "organization," who must form a coalition on 8 The

Strategy

of Conflict,

p p . 84 ff.

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SOME ECONOMIC ASPECTS OF BUSINESS ORGANIZATION

objectives and their implementation. (Cyert and March, 1959) Once this has been done and, since this may be a continuous process, while it is being done, organization and communications are used by the participants to provide a control, or check, on the side payments promised for their joining the coalition. Presumably those acts which are of no interest to other members of the coalition are completely within the discretion of individual members of the bureaucracy. Aside from the problems concerned with the normative and predictive analysis of coalition formation, this approach to organization manifestly calls for a rather different view of organizational structure and intra-firm communications. These now become a factor in the maintenance of coalitions. Shubik has in this vein suggested, for example, that "information cost puts bounds at least upon short-run coalition possibilities." 9 Conversely, instead of decision and communication rules for profit maximization we now have a situation in which there may be some important additional constraints. These are not entirely unfamiliar ideas in either the field of organization theory or the field of economic decision theory applied, in the sense identified earlier, to problems of bureaucracy. (Alt, 1949) However, their present conceptual foundation raises again the whole set of questions posed by Kaldor concerning the efficacy and efficiency of business bureaucracy. T h e bureaucracy will not necessarily implement its (coalition) aims, and, even if it does, the outcome will not necessarily be efficient in either the Kaldor sense or in that of the pristine socialist model discussed earlier. 9

Strategy

and

Market

Structure,

p . 167.

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23

G r a n t i n g the premise of the organizational game model, one would still have to concede that there will have to be m u c h m o r e progress in giving form and substance to the present skeletal ideas of n-person game theory t h a n there has been to date. As L u c e and Raiffa have suggested, this branch of game theory awaits the necessary sociological insight to make it something less tentative in its implications. (1957) In their discussion of Arrow's work on the possibility of a "social welfare f u n c t i o n " in g r o u p decision processes (1951) , Luce and Raiffa also cite his impossibility theorem as regards achieving a non-imposed, non-dictatorial welfare function, characterized by transitivity of the preference orderings. T h i s will not occur unless the d o m a i n of these orderings by the individual members of the g r o u p is restricted rather severely. At face value the Arrow theorem is certainly a challenge to the meaningfulness of present n-person game models which contemplate achieving a transitive joint preference ordering through side-payments. It would indeed be u n i m p o r t a n t if the preference orderings of the individual members of the desired coalition were typically very similar (as has been alleged with respect to business bureaucracies in William Whyte's The Organization Man). However, in this event the question arises as to the necessity of using, except as possibly a c o m p u t a t i o n a l device, the n-person game analogy with all its extra analytical baggage in place of a monolithicallyoriented model, such as that of Marschak. In o t h e r words, if the essential premise of n-person game model is shown to be a fiction, the use of the model for any b u t procedural purposes will be hard to justify.

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Conclusions

and

Evaluation

From the review which has been conducted above one concludes that the developing interest of economists in problems associated with business bureaucracy is not an irrational interest nor one based entirely on highly questionable premises concerning the real world. T h e position taken by Kaldor concerning the significance of interdependent business decisions certainly needed to be taken. Now later developments, especially those associated with relaxing the assumptions of the socialist model of decentralization via the price system and with facing up with the new problems arising therefrom, have cast some doubt on the dogmatic side of Kaldor's position which rules out bureaucratic structure as a fruitful subject for investigation by economists. Essentially these developments like the earlier work have been of a conceptual nature. In general they have not been fostered by any substantial amount of systematic empirical research. Such key concepts in current discussions as decision and communications rules and organizational equilibrium, as well as such less well-established notions as the organization coalition, are deductive contractions from "self-evident" propositions concerning the states of the physical and economic world and, especially, human motivation and behavior. There indeed can be no a priori prejudice against the validity of the concepts (since the self-evident propositions on which at least some of them are based may well be correct) . But it is nevertheless clear that more attention should be given now to their empirical foundations, if only because of the conflicts which we have observed to exist among some of the competing models.

REVOLUTIONS AND COUNTER REVOLUTIONS

25

T h e operationality of some of the new concepts is quite obvious, of some not so obvious. It would appear that more tests of hypotheses can now be r u n than could be r u n earlier, when the field of testing in economics at least was effectively restricted to studies of administrative cost behavior for an administratively non-homogeneous set of firms of varying size. (Melman, 1951; McNulty, 1956) T h e possibilities in this respect will be taken u p in the last chapter of the present monograph. Besides the problem of empirical investigation, however, our review suggests the need for additional model development. As we have seen, the decision and communications model of Marschak proceeds from the premise of a joint preference ordering. Kven though those models which make the achievement of such an ordering the central problem of bureaucracy to the exclusion of its structure may be criticized, it would be surprising indeed to find that this problem of a joint preference ordering is in fact no problem at all. T h e expectation therefore is that there will have to be an amalgamation of two of the important strands of thinking which have been developed above. Similarly a suitably enriched model of the many-person bureaucracy needs to be thought about. J. Marschak has taken steps in this direction with his preliminary consideration of the "n-person team." (Marschak, 1960) Some analyses of economic network problems have an obvious relevance. (Beckmann, 1959; McGuire, 1960; Quandt, 1960) T h e chief concern of the latter type of work, however, appears to be with computation, rather than with an exploration of what might be called "bureaucratic general equilibrium." N o n e of the work, moreover, incorporates human behavior data, especially group

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S O M E E C O N O M I C ASPECTS O F BUSINESS ORGANIZATION

interactions, so that it is potentially subject to some of the same criticism as that which was levelled at the "personnel assignment problem" models of the operations research literature. (Votaw and Orden, 1953; Von Neumann, 1953; March and Simon, 1958) In addition, the almost complete absence of thinking on problems of the dynamic adjustment of bureaucracy to changes in the data is conspicuous in our review of the present chapter. T . Marschak's summary (1959) of this facet of recent thinking suggests that what there has been in the way of dynamic analysis has been almost exclusively concerned with price adjustments under the postulates of the socialist model. Adjustment problems of other bureaucratic systems, including, for example, the kind envisaged by Simon and characterized by initially incomplete cognition concerning the set of alternatives seem to have received no attention. (Simon, 1955) Finally, there is a series of questions concerning the effects on bureaucratic processes and structure of uncertainty, both in the external environment and in the behavior of bureaucratic participants. Environmental uncertainty has received considerable attention in various decision models of economics and operations research. T h e implications for bureaucracy have, however, proved difficult to explore. (T. Marschak, 1959) In addition, uncertainty as a characteristic of the behavior of bureaucratic participants has, as might be expected, not been decisively treated in the analytical literature of economics. Fortunately, however, the subject has received considerable attention in the sociological literature on bureaucracy. (March and Simon, 1958) From this work, it is clear that there is a need for further development of economic models of bureaucracy in order

R E V O L U T I O N S AND C O U N T E R R E V O L U T I O N S

27

that the latter may take explicit cognizance of the behavioral phenomena apparently involved. T h e above list of theoretical topics constitutes the content of the interior chapters of the present monograph, and we shall take them up in the order of their presentation. Following this we shall devote some time to a general discussion of appropriate testing procedures for the hypotheses used and developed.

II Towards a Merger of Bureaucratic and Motivational

Considerations

In the organizational literature outside of economics the concept of the organization man as a robot is slowly but surely disappearing. Economists, however, perhaps because of an inherent distaste for the concept not obviously "operational," have had relatively little patience in dealing with the reported complexities of the human character. T h u s in the case of many of the better models of business bureaucracy w h i c h have been developed recently initial desires are taken as equivalent to ultimate motivation. If a j o i n t preference ordering is not assumed from the beginning, it is the usual thing to assert that this can be simply achieved through the payment of financial incentives to the organizational participants to get them to d o what is expected of them. Both the statics and dynamics of h u m a n motivation are 28

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29

still highly tentative subjects, as a look at recent relevant literature will quickly show. (Miller, Galanter, and Pribram, 1960) It is generally agreed, however, that what a person sees in the way of alternatives and states of the world pertinent to these alternatives has something to do, along with any initial desires which he might have, with the actions he takes or does not take. One particularization of this view to problems of organization is that when people get involved in structured bureaucracies they develop a desire for status gained through participation in management decision-making activities. This idea is a dominant consideration in "human relatons" approaches to the organization and management subject. It appears also in some of the better eclectic treatments. T h u s March and Simon identify a variable which they term "felt participation" and which they assert is a factor in organizational participation. (1958) In the present chapter we shall be concerned with achieving and exploring a method for relaxing the initial joint preference ordering assumption made in decisionoriented models of bureaucracy. We shall pick up the notion of motivation through participation in management decision-making and use it as a case in point. It will be assumed that the index of this participation is the decision-making authority that a person has in his bureaucracy. 1 We assume also that the extent of this decision-making authority can be derived from the set of decision and communication rules which characterize the bureaucracy in question. 1

Even though we are aware that some, we think unreasonably, have s u g g e s t e d that o r g a n i z a t i o n a l p a r t i c i p a n t s u s u a l l y c a n b e m a d e t o f e e l t h a t they h a v e a u t h o r i t y w h e n a c t u a l l y they d o n o t .

30

S O M E E C O N O M I C A S P E C T S O F BUSINESS ORGANIZATION

Similarly since our purpose is essentially exploratory rather than definitive we shall further restrict our attention to the area of organization for pricing in the business enterprise. T h i s topic has already been partially explored in its purely decision theory aspects by Hirshleifer (1956) and Weintraub (1949) . It is of interest especially because of the development by these authors of decision rules to cope with interdependence of marketing and production units of a firm. Finally, our attention in this chapter will be confined generally speaking to relationships between one superior and one (directly) subordinate echelon (level). T h a t is to say, we assume that these relationships are not constrained in light of interactions with other parts of the business bureaucracy. In the chapter which follows this assumption will be weakened somewhat. T h e general implications of our assumptions thus far are, as often happens, reasonably clear. T o a certain extent, moreover, our results have been anticipated by Simon's notion of "organizational equilibrium." However, the equilibrium attributes of the latter construction for a bureaucratic structure model are not obvious. Nor are the specific choices in the matter of bureaucratic arrangement and the consequences of such devices clear from the assumptions which have been made thus far. Conceptual

Requirements

Our particular problem in the "forced marriage" which we propose is to formalize a set of interactions which appear to exist among four variables: profits, which we assume are to be maximized; the economic states of the world; bureaucratic structure; and participant motiva-

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31

don. 2 Implied in our earlier statements is that the latter two variables interact with each other in a way such that on occasion the effect on profits might be offsetting. T h e r e are obviously many ways in which we could represent these interactions. However, on the assumption that the traditional amenities of the theory of the firm are worth preserving, the method which suggests itself for the present purpose is one which allows us to focus on the competition between bureaucratic arrangements which seem to satisfy the first two of our variables of interest and those which satisfy the fourth variable listed. Hence we shall invent two constructs immediately—an "organization utility function" and a "participant utility function." T h e first will be seen to be somewhat analogous to a firm's labor demand function in that it reflects the utility of a certain kind of service, namely, participation in decision-making, to the firm. Similarly the second is derived from a labor supply function which asserts that the supply of personnel to the firm is dependent both on money wages and ability to participate in decisionmaking and that the latter two inducements are limited substitutes for each other. T h e detailed development of the two functions and the static equilibrium which they determine follows in the next two sections. Subsequently we shall explore certain dynamic aspects of the model, 2 As has already been emphasized, we recognize in this chapter and in the whole monograph the complexity of the forces which influence the behavior of organizational participants. However, the sharp-eyed reader will note that we do not drop the assumption of participant rationality in a more or less conventional sense: our organizational participants are responsive to other stimuli besides money, but they do attempt to maximize their satisfaction. T h e assumption is to be borne in mind now that the evidence is beginning to come in on this very sticky matter. (Lanzetta and K a n a r e S , 1962)

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S O M E E C O N O M I C A S P E C T S O F BUSINESS ORGANIZATION

the implications of the reasoning for some current questions in the field of business organization, and very briefly, certain questions which would arise in working with the model. The Utility of Organization in Product Pricing

and

Communication

Consider the pricing organization problem of a firm making and selling several products, each in substantial volume. O n the assumption that the choice exists, i.e., that appropriate decision rules have been developed, it must be decided how much discretionary authority to give, or delegate, to " l o c a l " sales or marketing managers. Each of the local managers presumably is in a position to observe that part of the external environment of the firm with which he has direct contact, e.g., actions of competitors. Hence, in the absence of an announced "vector of prices" as was postulated in the pristine socialist model, each possibly has data of importance to a correct pricing (and output) decision. If competitors do change their prices and if the relevant price elasticities are greater than zero (as of course is implied by the classical notion of competition) , a local sales manager for a firm has, by virtue of what he observes of this, a claim to be the decision-maker for the pricing of the product which he oversees. T o make an optimal pricing decision the local manager ordinarily also must have information on changes in other factors (such as the behavior of consumer income) which promise to influence his local demand, on the present state of and changes in supply of the firm's products to him for sale, and on any " p o l i c y " constraints to be applied

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33

to short-run profit maximization. In the case of multiple products where the relevant cross elasticities of demand are greater than zero, the local manager must have a reasonably precise notion of the interactions among product demands and supply and also of course information on price changes effected for any reason by other local sales managers. As a result of these additional requirements for information the observer status of any given local manager is likely to be a limited one in relation to the total observational requirements for a good pricing decision. O t h e r observers in the firm are also likely to have an observational claim to pricing. In the most straightforward kind of situation, where all relevant information is to be communicated, an obvious means of resolving the organizational issue is to consider the relative gains from transferring information to the several possible decision-makers. Decision-making authority is then delegated to the observer most favored on the basis of these gains from information transfer, that is to say, the communications system which promises the greatest gain. 3 Given a world characterized by uncertainty, one has to consider, in making this calculation, not only the sensitivity of profits to changes in the states of observed variables (an obvious key to "value of information") , but also the distributions of states of observed variables. T h e demand function facing a local sales manager may be generally invariant because of competitors' "administered" price policies. In this case the expected costs of transferring information relevant to pricing away s We neglect costs of information processing by decision-makers, as we do the possibilities suggested by coding languages. These have been dealt with carefully elsewhere. ( T . Marschak, 1959: J . Marschak, 1954, 1955)

34

S O M E E C O N O M I C ASPECTS O F BUSINESS ORGANIZATION

from the local sales manager to some other decision center in the firm will be lower than it would be with a different competitor price policy. T h u s there might well be a lower expected information transfer cost associated with decision-making in one of these other places in the bureaucracy with consequent higher gains for the alternative decision center. T h e results of this type of treatment will speak against decentralization of pricing authority to a local sales manager under certain market conditions. Such would tend to be the case with stable demands, whether because of invariant general economic circumstances or because of the absence of competition. A similar result would be expected with unstable demands where the advent of the instability is predictable, for example, by a forecasting g r o u p in the enterprise. More interesting problems of pricing organization occur in market situations which are characterized by relatively active and unpredictable price competition. A local sales manager, under our assumptions concerning his area of cognition, will be a continuing source of information for pricing decisions. On the other hand, if the firm's cost function or its strategy for dealing with competitors is subject to frequent change, other observers in the enterprise are likely just as frequently to have information which will bear in an important way on the profitability of pricing decisions. In the latter instance it would not be surprising, for example, to learn that an oligopolist firm operating in a market characterized by frequent price wars gives relatively limited pricing authority to its local managers. T h e reason would be a more or less continuing need for re-evaluation of strategies by top management. Such results are in fact suggested by the work of Cassady

BUREAUCRATIC AND M O T I V A T I O N A L CONSIDERATIONS

35

in retail gasoline pricing. (1951; 1954) Similarly, in the case of multiple products, joint production of these products, together with a rising marginal production cost function, sets up an information transfer requirement between each product selling unit and the joint production unit if there are substantial differences in the marginal revenue functions for the several product markets. T h u s , even if the product demands were independent of each other, it would clearly be very costly to have price-making at the local marketing level. A rela tively complicated problem would have to be worked out between the factory, on the one hand, and the several marketing units on the other. It has been suggested that a bidding system be used, whereby each local marketing manager, previously instructed to equate his marginal costs and his marginal revenue in pricing and physical volume decisions, would make an appropriate bid to the factory. Such a system would be more economical in terms of information transfer costs than would be communication of demand functions to the factory. (Weintraub, 1949; Hirshleifer, 1956) 4 T h i s decision system, which is reminiscent of the socialist model, clearly limits the discretionary authority of local marketing managers. W e have gone into detail in discussing these several aspects of the product pricing problem and the implications for the bureaucratic structure of the firm out of a desire to illustrate some of the alternative decision systems which might be invoked. Also suggested are the implications of the choice of an alternative. It is clear that in * T h a t is to say, the stated result will o b t a i n assuming that the p a t h of a d j u s t m e n t to changes in the states of the world converges with sufficient rapidity. For a discussion of this p o i n t see T . Marschak

(1959) .

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SOME ECONOMIC ASPECTS O F BUSINESS ORGANIZATION

each case one of several systems might be used and that each is likely to have a different utility to the firm. If one were to attempt to identify and describe verbally the organizational arrangements which might be made, ranging from the ones involving least participation by subordinates in decision-making to most participation, the following arrangements might be included: (1) complete concentration of decision-making in the hands of a superior echelon with local sales units implementing pricing orders and on occasion acting as observers; (2) local marketing units required to bid for products from production divisions, then to price according to an appropriate marginal calculation; (3) local sales units setting prices on the basis of their observation of competitors and also information furnished from elsewhere in the firm; (4) local marketing units allowed to set prices with ex posto facto approval from above; (5) local sales units allowed to set prices, subject only to the knowledge that they will ultimately be judged in terms of their profit performance relative to the norms for the company and for the industry. 5 Undoubtedly there are other identifiable arrangements. It is thus possible to conceive of a function whose domain is the set of organizational alternatives in two echelon pricing organization problems and whose range is the utility space into which organization arrangements may be mapped given certain pertinent states of the world, including costs of intra-firm communication. T h u s we get our organizational utility function which is presented as a continuous ordering in Figures 1 and 2. 5

T h e last t w o a l t e r n a t i v e s obviously c o n t e m p l a t e less t h a n information transfer.

complete

BUREAUCRATIC AND MOTIVATIONAL CONSIDERATIONS

37

utility

(b) Decentralization

Figure 1

Favored

Figure 2

Figure 1 is drawn to show a set of organization utility rankings which favor relatively limited participation in decision-making by subordinates, i.e., a centralized organization. It has been asserted or implied above that such an ordering would be likely to obtain, among other cases, under oligopoly market conditions, under market conditions characterized by frequently changing demands due to factors other than unpredictable competitor action, and, in the case of several multiple products, under circumstances of generally interrelated product demands. Figure 2 is conversely a representation of utility rankings which favor a greater degree of participation. Such would possibly be the case, it has been suggested, for a single product firm under competitive market conditions or for multiple product situations with independent demand and supply functions and stable supply functions.

38

SOME E C O N O M I C ASPECTS O F BUSINESS ORGANIZATION

In both Figures 1 and 2 the organization utility function reflects the firm's possible gains under different bureaucratic arrangements, exclusive of considerations of motivating subordinates. It is drawn to cross the horizontal axis on the assumption that at some degree of decentralization the problems arising either from a lack of coordination or from the cost of information transfer to lower echelons will become so severe as to cause losses to the firm. T h e intercept is set farther to the right in Figure 2, however. Also in Figure 2 gains are taken to be positive, though not maximum, with complete centralization. T h e gains reach a maximum under more decentralized organizational arrangements because of the savings in information transfer costs which have been asserted to occur in the cases represented by Figure 2. It is clear that unless other as yet unspecified considerations are urgent the firm whose communications economy analysis leads to the utility outcomes of organizational alternatives which is portrayed in Figure 1 will be moved to choose a centralized form of pricing organization. On the other hand, the firm which develops alternatives as in Figure 2 will choose the more decentralized organization alternative having the greatest gain associated with it. T h e s e are presumably typical outcomes as far as the firm's " d e m a n d " for subordinate participation is concerned, that demand being reflected in the organization utility functions here derived.® Participant

Utility

and. Organizational

Equilibrium

In the case of the "participant utility function" we have assumed actual participation in bureaucratic decision β W e h a v e n o t i n v e s t i g a t e d the c o n d i t i o n s which will e n s u r e the "sin glc-peakedness" of our organizational utility functions.

BUREAUCRATIC AND MOTIVATIONAL CONSIDERATIONS

making dealing Also we tion as variable

39

to be our index of participation for purposes of with the asserted motivational forces involved. have taken participation and monetary compensalimited substitutes for each other in a threesupply function for managerial personnel.

Compensation offered ($) -

I