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Firm Inefficiency (overcomingbias.com)
230 points by a3voices 344 days ago | 101 comments



This really reminds me of how Yanis Varoufakis, Valve's economist, describes most firms:

> Interestingly, however, there is one last bastion of economic activity that proved remarkably resistant to the triumph of the market: firms, companies and, later, corporations. Think about it: market-societies, or capitalism, are synonymous with firms, companies, corporations. And yet, quite paradoxically, firms can be thought of as market-free zones. Within their realm, firms (like societies) allocate scarce resources (between different productive activities and processes). Nevertheless they do so by means of some non-price, more often than not hierarchical, mechanism!

The firm, in this view, operates outside the market; as an island within the market archipelago. Effectively, firms can be seen as oases of planning and command within the vast expanse of the market. In another sense, they are the last remaining vestiges of pre-capitalist organisation within… capitalism.

The image of a firm as an island of control within a greater see of capitalism really stuck with me. I think it's a pretty good image to support Valve's style of organization. (Of course, I'm also a bit biased: I prefer that philosophy for reasons of my own besides just increasing efficiency.)

The whole article ("Why Valve? Or, what do we needcorporations for and how does Valve’s management structure fit into today’s corporate world?"[1]) is well worth a read. I think it's a very constructive look at the issue that this post is talking about.

[1]: http://blogs.valvesoftware.com/economics/why-valve-or-what-d...

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This is indeed an important question, best addressed in Ronald Coase's 1937 article "The Nature of the Firm". It is such an influential article that has its own wiki page, which is quite good: https://en.wikipedia.org/wiki/The_Nature_of_the_Firm

The short answer as to why firms exist (and why it is not markets all the way down such that every microtask is contracted out to the free market) is "transaction costs". For the long answer, I suggest you start at the wiki article, and if interested, read this Economist blog summary: http://www.economist.com/node/17730360, and if still interested, read the original article (you can find it by just googling for it).

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Thanks for pointing this out. There are many strong opinions on this subject guided by little more than naïve intuition. Having an opinion on the nature of the firm without reading Coase is like having an opinion on externalities without reading Coase [1].

[1]: http://www.jstor.org/discover/10.2307/724810?uid=3739560&uid...

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I strongly recommend the original article. It meanders for a few hundred words before hitting its stride (Coase was English and born over a century ago) but it's a real masterpiece. Many of Coase's ideas were so simple as to seem a bit trite in summary, but develops them in interesting counter-intuitive ways, and from first principles rather than relying on mathematical truisms.

also, many of his talks are on Youtube; I regret not having had the opportunity to hear him speak in person before he died recently. Great thinker.

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Heh I thought of posting the same thing after I read the article. It's good read although I remember it being written in that classic style of dense 1930s economic literature, where you have to re-read some paragraphs and sections 3 or 4 time.

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Indeed but we have computers now. Transaction costs are vastly different. The firm has changed remarkably little. Coase is not very predictive in these circumstances.

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Transaction costs are psychological and informational rather than administrative. You can send messages instantly around the world, but that does not help you know what message to send.

It's certainly got easier to hire people for work fragments (mturk etc), but that only works if you can specify the work and verify its quality. This is the problem of "outsourcing" on a small scale.

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Has it really? What about the rapidly rising number of freelancers? Or the decreasing size of firms year-after-year since 2000?

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Yanis Varoufakis is paraphrasing coase (1937).

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Have you ever seen the famous quote from Herb Simon?

Suppose that it (the visitor I'll avoid the question of its sex) approaches the Earth from space, equipped with a telescope that reveals social structures. The firms reveal themselves, say, as solid green areas with faint interior contours marking out divisions and departments. Market transactions show as red lines connecting firms, forming a network in the spaces between them. Within firms (and perhaps even between them) the approaching visitor also sees pale blue lines, the lines of authority connecting bosses with various levels of workers. As our visitor looked more carefully at the scene beneath, it might see one of the green masses divide, as a firm divested itself of one of its divisions. Or it might see one green object gobble up another. At this distance, the departing golden parachutes would probably not be visible.

No matter whether our visitor approached the United States or the Soviet Union, urban China or the European Community, the greater part of the space below it would be within the green areas, for almost all of the inhabitants would be employees, hence inside the firm boundaries. Organizations would be the dominant feature of the landscape. A message sent back home, describing the scene, would speak of "large green areas interconnected by red lines." It would not likely speak of "a network of red lines connecting green spots.

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I'm going through a review of MCDBio right now in prep for grad school (surprisingly, I actually enjoy the MCAT Bio book, as it is a good and quick review for non-bio peeps). This description is incredibly similar to that of a cell tissue, intentionally I think. From above, we see membranes and cell walls, areas that are cordoned off from another. They have internal chemistry that is separate and free inside them. Interactions between cells are controlled and directed, as in a synapse. Everything is in thermodynamic chaos, yet the membranes keep it separated and then structure can be seen. The boundaries, instead of limiting growth, provide a basis and framework for it to occur.

As I am on travel, I can see this in more than one facet of life. The boundaries between France and Switzerland are like membranes. The boundary between the ocean, shore, and sky at the tidal zone is most interesting. Where things mix, where the differences occur, then you have dynamism. You need the gradients.

How to apply this to capitalism? Well the Valley sure is. You have boundaries everywhere there. There are cells (startups) all over. And you also get a sense they are prokaryotic (no nucleus) and have a strong cell wall, not just a membrane (stealth mode). The trick you get into is how the signaling between bound areas works. The signaling provides the goal, so to speak. With neurons, you signal in certain ways and to certain other cells to provide a way to have the organism process information and survive better. The France-Swiss border signals are there to make sure war doesn't break out, diseases are semi-contained, politics are separated, etc. The tidal border is natural, but gives a flow of chemicals, elements, and solar radiation that gives life a easier time to survive in. So, you need bound areas (companies, cells, tidal zones, etc) that are self consistent internally. The signaling from there is goal directed (profit, mitosis or homeostasis, chemical gradient producing, etc).

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I actually think that's an important aspect of capitalism's success. It only (metaphorically) claims to be a good global organization scheme. Within that framework, experimentation and variation is permitted. Do you want a hippie commune? Sure. Coop? Sure. Conventional corporation? Yup. One dude in a garage? Sure. National-scale non-profit? Go for it. And they're all different organizations that can freely live and die as the situation warrants. It may not be perfect, but it can evolve without breaking.

Contrast that with a State-Uber-Alles philosophy like Communism, and you get a situation where you've got what is putatively the same organization trying to organize the strategy for keeping the borders secure with nuclear weapons also trying to manage the local school bake sale. It's a fragile setup if it isn't perfect, and of course it isn't perfect. And lo, Communist governments that fall tend to fall hard and shatter their whole society, economy, country, and all in the process. All the eggs, you might say.

And let me highlight the issue of resiliency and fragility as being my main point, rather than any particular local issue of efficiency on this point or that. Capitalist societies hardly blink if a 100-person organizations proves unable to make a profit. It might be locally annoying, even devastating to some people, but globally it tends to work out for the best. (And those 100 people tend to be able to move on to something else too.) By contrast a centralized command-and-control system may keep this net-negative organization going for a long time for any number of reasons, but all of them, in the end, meaning that a net-negative organization lives on, draining the society it lives in. (Bear in mind the meaning of "net negative"... the entire point is that whatever benefits it may have, it is still net negative in my discussion here.) The summation of such decisions is incredibly destructive.

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It's interesting to me that firms do some of these things internally (e.g., maintaining a 100 person organization unable to make a profit) but firms have an outside source of discipline such as the market, whereas the Communist society doesn't.

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Communist leaders face political discipline - ie. dissatisfied people may strike/riot/rebel, and your competitors within the political establishment will take advantage of your failures.

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Some may say that the outside world work as a discipline, as the market is the outside world for firms ...

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Pravin J Jain wrote an essay about how Enron was exactly this kind of firm:

"One of the most novel elements of Enron’s design was to compel employees to promote their deals inside the company, simply to gain access to company resources. No one was entitled to anything. Support groups such as legal and finance could allocate their efforts based on their own estimation of a deal. If they chose right and supported a high-stakes deal that succeeded, they made a lot of money when the dealmaker handed out his rewards. This created interesting dynamics about trust—how could you sell a deal without giving away control and still make it attractive enough to gain coveted resources? The net overall effect of these dynamics was the awesome competitive energy generated in every part of the company. Manipulating others, devising spins and stories, doing whatever it took to move a deal forward were all part of this ruthless, tribal, capitalistic culture."

http://s3.amazonaws.com/a.nnotate/docs/2010-01-29/iDbfJu4yot...

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Markets can't solve everything. If "the market" creates massive firms, maybe some things need massive central planning? See http://krugman.blogs.nytimes.com/2013/07/16/john-galt-and-th...

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Most of the time big firms exist because only large businesses can deal with the immense regulations in their field. Big business loves regulations because it actually decreases the competition.

See: healthcare, finance, insurance.

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Speaking from personal experience (high-tech manufacturing, dealing with SOX-404, FDA CFR11 Part 2, ISO/TUV/CE/..., NATO, and DoD regulations), a lot of this bureaucracy is self-created by people who are ignorant of the actual requirements but in positions powerful enough to overcome that barrier and force other employees to do needless busywork, resulting in self-imposed regulations that don't need to exist for any legal reason, but which once emplaced are nearly impossible to eliminate.

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aka The Iron Law of Bureaucracy

http://www.jerrypournelle.com/reports/jerryp/iron.html

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If the solution is massive central planning, and markets create massive centrally-planned entities, then is the market not solving the problem?

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The important difference is that if a firm accumulates too many of these organizational pathologies it can be allowed to collapse and be replaced. In theory you could do that with government departments, but I've never heard of that actually happening. Goodness knows the US Department of the Interior could use something like this.

Democratic accountability helps to keep the "parasite load" down, but only so much and only to the extent that problems capture the attention of the public (see again about the Department of the Interior). To the extent that the government does more stuff there's less democratic oversight on any particular thing that it does.

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In that case I say we nationalize them. There's no need for more than one State.

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As per the comments on the article Peter Klein has done work on this.

Market forces give prices which allow sensible and efficient economic calculation. When a firm is large and creates unique intermediate products/capital and performs intermediate services, it becomes difficult to tell if they are being done in an efficient manner because these things have no prices.

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The market between firms is not really so free either. It is constrained by a myriad of government regulations related to contracts, safety, environmental protection, employee rights, information availability, international relations, etc.

In addition, anyone who has worked in a large corporation knows that there is often intense competition within the firm. Supervisors are "customers"; their staff produce new products, campaigns, rules, markets, business models for the "customer" to choose. The price signal is some mix of actual external business results, and internal power shifts. (I would guess that the mix is likely to correlate with each firm's long-term success.)

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Peter Klein has some very interesting research showing there are limits imposed on organizations by the problem of economic calculation: http://mises.org/document/350/Economic-Calculation-and-the-L...

This is an application of Mises' work on economic calculation in socialist economies and why it is so problematic for such economies to allocate capital without squandering it.

At scale I think this affects companies like Microsoft which, as they grow, find it harder and harder to allocate resources without an internal price function. E.g., how many engineers do you put on infrastructure versus Xbox? The answer isn't obvious because you can't directly measure the profitability of the infrastructure team. When teams are small (such as in startups) the leader can kind of guess this stuff, and successful leaders do it well, while bad ones go out of business. Some companies try create internal markets to allocate capital but that has problems too, because it causes some level of friction in the process of how capital is internally allocated.

This is why I think Ycombinator's model is potentially very useful. Instead of a monolithic structure where capital is essentially moved between divisions based on the judgment of a single person (the CEO), there is a syndicate of companies which tend to produce goods that the others need, while still maintaining a market so that prices can be established and used as a guide for which projects should receive more (or less) capital.

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That is interesting. I like Mises' work on economic calculation, and I tend to use that model to interpret most large-scale government regulation and economic planning, but I never thought of its application to firms. It's perhaps the most obvious and fundamental example of a diseconomy of scale.

http://en.wikipedia.org/wiki/Diseconomies_of_scale

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I may have missed something - are you saying that ycombinator requires all it's startups to use say Dropbox and not pay Box? I had not heard this.

If this is just informal is it measurable?

I don't doubt it is effective however - it suggests alumni networks or diaspora like family networks (strongly suggested in China and India for example)

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I don't quite grasp the Y Combinator analogy, but in the syndicate situation, each company would be expected to at least try to procure services from the sister, but not required, and each company would be free to sell its services to the wider world.

I know of at least one (non-software) corporation that spun off its IT shop, and that shop ended up doing rather well as an IT consultancy in it's own right.

Also, if you can reasonably spin off a division in this way, it isn't part of your competitive advantage, and it then has the benefit of allowing you to focus more on that.

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I'm not aware of any mainstream economic theory that describes a limited network in which everyone is both a customer and a trader.

(I suspect 'hamsters on wheels' comes closest, but it's not very mainstream.)

I think of YC as the modern equivalent of the old music business model: money gets advanced to potential talent, most of it disappears, some of it returns as a big hit.

The fact that the talent may be trading with other talent doesn't appear to alter that dynamic, because the money stays in the system, and you don't get a big hit until money starts coming in from outside the system.

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I probably didn't make my point very clearly. I'm thinking of groups of companies like Virgin (I'm not sure if it's properly considered a "syndicate").

I doubt any of the companies are formally bound to do business with any other by virtue of being in the Virgin group, but it would make sense that the companies enjoy some kind of (if only informal) "preferred vendor" relation with each other.

There's no need to describe it in theory as anything else than a number of independent companies, only with common ownership and perhaps a slightly above average interconnectedness.

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Virgin are primarily a brand, not a syndicate.

Branson owns Virgin Management who are the central VC/Management corp. He has varying stakes in the other companies which vary from outright ownership, majority holding, minority holding, to brand licensing deals with occasional informal management input but no shareholding.

Bottom line is the different businesses are independent. Branson probably gets perks like free travel, and maybe some of the Virgin execs do. But I'm not aware of any loose internal market or preferred vendor relationship.

I'm trying and failing to think of an example of the model you're suggesting. (Which doesn't mean there isn't one - just that I'm not familiar with it. Maybe the recent Apple/IBM deal?)

It's an interesting model, but I'm not sure how well it works when customers can also be potential competitors. AFAIK syndication traditionally works better when relationships are distant and there's no immediate danger of competition.

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It is not a requirement, but companies within batches, and within Ycombinator in general have a unique insight into the demands and pain-points of their fellow companies. This is why each batch usually has a handful of companies working on products specifically designed for other companies (e.g., MailGun, SendHub, Heroku, Mixpanel etc). Some of the companies pivot toward building tools if/when they discover their original idea isn't getting traction.

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Also Parse, Apptimize, Taplytics, ZeroCater, Disqus, Optimizely, Authy, HireArt, ZenPayroll, etc.

For a startup doing B2SmallB, getting into YCombinator gives you ready access to a large network of customers. It's not just about access to investors, sometimes you can get very direct customer feedback by selling to your batchmates.

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The market pressures faced by firms (which, I'm assuming, are responsible for anything you might view as "firm efficiency") are similar to evolutionary pressures faced by any living creature. Evolution doesn't create "perfect" or "efficient" creatures, but predominantly creatures that are just "good enough." If you can live long enough to reproduce and pass on your genes, you're in the club.

An animal with no natural predators, for instance, may get bigger and less adept at fighting off potential threats (after some generations,) which is kind of similar to the stagnation of a monopoly.

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On the inside, firms are usually set up as something like communist autocracies (formally everyone subordinate to the CEO, no internal prices, budgets set by fiat, etc). This has the advantage of reducing transaction costs (which in classical theory of the firm, is why they exist in the first place) but results in some of the same pathologies.

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Including a Cult of Personality, in too many cases.

Even if it's not always wreathed around individuals, the role has been mythologized to an unhealthy, even a ridiculous extent which has allowed many CEOs to ignore consequences and accountability.

But my suspicion is that in the general case, all systems tend towards aristocracy and oligarchy, no matter how they dress on the outside, and that every system evolves its own Theory of Social Privilege to legitimise and promote certain kinds of relationships and transactions and prevent others.

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Indeed, we see entire industries rewarding failure.

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> communist autocracies

That's a pretty crazy misuse of the term "communist". Just say "autocracies", the inside setup of typical firms really has nothing to do whatsoever with communism.

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Resource allocations are set by fiat and there are no price signals or "private property" per se (the accounting department doesn't "own" their computers, they're allocated them, and if that department is outsourced they'll be allocated to someone else). Departments don't technically control their own investments; any revenues they bring in are the company's as a whole and redistributed as they see fit.

Seems apt to me; what would you call it?

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The article's logic is flawed. It lists 19 inefficiencies but such a list is not as persuasive as the author thinks.

What we ultimately care about is the net efficiency of the firm. Does the elimination of internal transaction costs outweigh the other inefficiencies the author points out? Internal economic exchanges as explicit transaction costs don't exist within the firm (e.g. acct dept does not send an invoice to the CTO for CPA work relating to budgeting the capital purchases of rack servers. And IT does not charge acct dept for upgrading the desktops web browser from IE6 to IE9.)

To prove the author's idea, the comparison would be something like:

A firm of 100 employees with those 19 inefficiencies underperforms and is less profitable than a loose confederation of 100 freelancers with their particular inefficiencies. (The 100 freelancers would also have a unique list of inefficiencies -- because nothing is perfect.)

We could also itemize 20 "inefficiencies" of the biological family unit. E.g. the child learns the language of his parents -- maybe Portugese -- instead of learning the most marketable and global language such as Chinese or English. The child eats some meals from grandmother's recipes instead of eating a scientifically designed diet for peak growth. And so on. Does such a list of inefficiencies convince society that Plato's idea of taking all children from parents and assigning them government custody is a better idea? That's the type of logic I see in the article.

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I don't know. The list seems pretty compelling. Almost every one of those items seems like it has to hurt productivity (except for the first; being "more productive in a crisis" can simply indicate non-sustainable practices, and/or a higher tolerance for risk taking that may or may not be healthy long-term).

And at least where I'm working now, most (all?) of those inefficiencies are minimized, and the stock price (and revenue, for that matter) just keeps going up.

On the other hand, the comment in the article that implies government oversight might be a good idea is laughable. I'm not an anti-government libertarian, but I can't imagine any government doing a good job of micromanaging business decision. And that includes theoretically optimal governments.

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> Almost every one of those items seems like it has to hurt productivity

Sure they do. Nobody is disputing that. We even enjoy Dilbert cartoons that mock many of the items in the article.

But the author is talking about inefficiencies in absolute terms. I'm saying for his argument to work, he has to instead consider inefficiency in relative terms. Relative to what? Relative to hypothetical alternatives such as:

100 freelancers with an explosion of external transaction costs & inefficiencies.

Or 100-employee firm managed by Federal bureaucrats instead of the shareholders. The bureaucrats also come with their own baggage and inefficiencies.

Every alternative organizational scheme will also have a list of 20+ "inefficiencies" because nothing is perfect. What really matters is whether the productivity gained outweighs the unavoidable inefficiencies.

The author made no concrete attempt at quantifying the alternatives and compare relative net efficiency.

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There's another problem with gov. organizations. They're typically monopolies, so a bad boss acts as a bottleneck for the whole country, while a bad boss in a company can only ruin that company... a good reason to legislate against monopolies actually.

The sum of companies for a country might be seen as a terribly wasteful redundancy, but mitigates the risk of bad management.

Efficiency? I think quality of life is a more interesting measure.

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> he has to instead consider inefficiency in relative terms

And I pointed out that, relatively speaking, the (big!) company I work for seems to have eliminated those inefficiencies, and that it does seem to perform better than companies that haven't.

From what I've heard, Microsoft is one that hasn't, for example. With up to 18 layers of management and mountains of deadwood middle management at this point, it seems the classic example. And Microsoft is thrashing at this point; I won't say death throes, because they have so much market power still, but it may be early indications of eventual failure.

No one (but you) is saying that a group of unmanaged freelancers (i.e., ANARCHY) should be compared to good management. All of the items in the list are things that can be changed in a traditional organization; they just often degrade to the state described in the list.

Seems like you're building up and tearing down a strawman. Sure the terrible state of companies like Microsoft is better than 40000 freelancers in a loose organization, but the state of Microsoft isn't as good as a company that size could be. And that's his point.

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>No one (but you) is saying that a group of unmanaged freelancers (i.e., ANARCHY) should be compared to good management.

I'm not saying anarchy. Some of the freelancers could be "managers" of other freelancers. That's what today's film director is. He's a freelance manager (hired by the producer) of other freelancers (actors, stuntment, etc,). Movies used to be made almost top to bottom by "employees"[1] of a movie studio. That has changed. In today's freelance system, they lost some efficiencies (movies cranked out quickly) but also gained some (hire desired actors directly without dealing with other studios that have them under contract to "borrow" them.) Maybe the world's internet and government reforms could evolve and remove so much transactional friction that a legitimate high-volume freelance model could beat the corporate firm (at least in some industries.)

>All of the items in the list are things that can be changed in a traditional organization;

Many of those items are accumulated side effects of human foibles. They also exist at a family owned restaurant. Every mature company has those issues. Yes, those items can be improved but I contend they cannot be completely eliminated. Human beings are imperfect.

>... Microsoft isn't as good as a company that size could be. And that's his point.

But that's describing almost every mature company in existence (not HN startups). We already know all that (see Dilbert cartoons). Therefore, his laundry list is not interesting. What would be interesting is if he was making a case against Theory of Firm[2] with his thought experiments. He made a minor attempt with a hypothetical government oversight/regulation. There just isn't much substance to his essay.

[1]http://en.wikipedia.org/wiki/Studio_system

[2]http://en.wikipedia.org/wiki/Theory_of_the_firm#Transaction_...

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> That has changed. In today's freelance system, they lost some efficiencies (movies cranked out quickly) but also gained some (hire desired actors directly without dealing with other studios that have them under contract to "borrow" them.)

OK, now I'm understanding you, I think.

You're saying that a hierarchy of freelancers would potentially be a market-driven system that could potentially compare favorably to a company with monopolistic control.

I can buy that. I tried to run my own company that way for a long time, though now I'm working for The Man.

>But that's describing almost every mature company in existence

I'm working for a very mature company (in the Fortune 100) that it doesn't describe (at least that can be said for most of the items in the list). It may describe most companies on the Fortune 500, but it doesn't describe all of them.

And that's my point. It can be better, even if human foibles tend to make it the way it is.

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https://bookofbadarguments.com/

What you're doing is called equivocation, and it's bad. He was talking about efficiency relative to a theoretical maximum where everything is as efficient as absolutely possible. You're either not reading the article or you're consciously trying to alter the meaning of the words in the debate so that you're right. Please stop.

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I suspect the confusion is due to the term "efficient", which has two meanings: 1. (technical) creating minimum waste 2. (common) effective.

In the real world, firms are undeniably effective compared to most/all real organization schemes. This article is simply saying that there are things that firms do which generate waste (meaning they are not "efficient"). This is a little silly in a way. Unicorns are also better than dogs (and all other real pets).

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If you're going to deride my native language, at least spell Portuguese right.

Portuguese is actually quite an interesting native language. It is Latin based, so you pick up French, Spanish, Italian and Romanian easily. Plus, since it is a periphery language, it has evolved less and is thus complex. Impossible grammar, irregular verbs all around and lots of phonemes. Top it off with a stress timed prosody and unstressed vowel suppression. If you grok European Portuguese, you can grok anything.

(anything other than German. "Das Mädchen". Seriously? Das???)

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> (anything other than German. "Das Mädchen". Seriously? Das???)

It certainly seems silly, but this is actually an example of one of the few rules in German. The "chen" in "Mädchen" means that it is a diminutive form (of the same word that is known as "maid" in English), and diminutive forms are always neutral in German.

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I know the reasoning. Das Mädchen is one of my pet peeves, largely because of personal cultural bias. Portuguese has no neutral gender, and I got introduced to neutral genders when learning English. Because of English, my association is that neutral is for inanimate stuff (and, strangely, pets). It fits poorly on little girls :-)

Now, imagine the fun in Portuguese, without neutrals: Every noun is either masculine or feminine, with near zero rules. A bike is feminine, a car is masculine, as is a plane or a boat, but a speedboat is feminine. Bottle is feminine, but glass isn't. Fork is masculine, unlike knife. I couldn't learn this today if I hadn't learned as a toddler.

For all the cursing I say at German when learning, we're in no position to criticize...

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i don't think he was deriding it. he just doesn't understand that 260M people speak it and that, given that, it was a bad example.

French (74M) or Italian (60M) would have been a better examples.

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>i don't think he was deriding it. he just doesn't understand that 260M people speak it

Right, I wasn't deriding anything. It was just an analogy comparing something quantitative. I know Portuguese is spoken by many millions but it's still much less than 1 billion Chinese or English. I probably chose Portuguese at random instead of Swedish or Swahili because of the recent World Cup.

In any case, my point is that measuring economic reach of Portuguese in isolation as "inefficient" is absurd because there are other efficiencies of parenting (unrelated to whatever language they happen to speak) that wasn't counted.

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You did deride it, albeit without any ill intention. I also do not feel overly offended by your argument, which is not totally baseless. My comment, read with some distance, came out too harsh.

It's just that the metric of speaker headcount/native economic power is not the sole metric for universal language selection, and it is one I do not think is the best.

Headcount would have us all speaking mandarin, a language with little really global world reach, and really foreign to all westerners because of its tonal characteristic.

English is probably the best option. Huge cultural reach globally via Hollywood, easy phonology and an easy grammar. If spelling could be simplified (or at least made sane) it'd be almost perfect.

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> (anything other than German. "Das Mädchen". Seriously? Das???)

Die Kartoffel.

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Except that individual departments do bill each other internally. It's how major corporation accounting works.

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Internal cost accounting, activity-based costing, chargebacks to departments for Xerox photocopies, etc isn't what I'm talking about.

The CFO & acct dept does not send a literal invoice to the IT department where the CTO has his own mini accounting staff handle the invoice and cut a check back to the CFO. When corporate counsel reviews a Terms of Agreement for the IT dept's web service API, they don't send an invoice for $400/hour for "legal services". Not dealing with thousands of such "transactions" as explicit costs is one of the reasons firms exists (so the theory goes.) Internal operations do not send purchase orders to each other. They don't remit checks to each other. Each sub department doesn't have their own sales team haggling internal prices & discounts with other department heads. Etc, etc. It's the external companies' interactions that have all those costlier transactions.

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In particularly large and decentralized organizations some of these more costly transactions do exist. I routinely prepare invoices for services we provide other departments and their accounting staff (yes we each have our own accounting staff x.x) cut an [electronic] check to my account.

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> Each sub department doesn't have their own sales team haggling internal prices & discounts with other department heads.

Yes they do. I'm working for a fairly large company (several thousand employees) where projects often covers several business units on different physical locations and each department bill their hours to the next down the factory line.

For example my team seldom deal with external clients, however our sales man has to fight tooth and nail to protect our margin against other internal dep.

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So iso20022 could well save the world ! Glad to hear it :-)

(Sorry sarcasm, spent too long working with ebXML a decade ago and occasionally watch history repeat itself - idea is to achieve "straight through processing" where invoices, tw and CS and so on are international standarss and digitised.

It's a nice pipe dream - but the goal is to make a cloud of 100 freelancers as efficient as a firm

I can't see it though

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This would not eliminate the effort involved in service/vendor selection, negotiation on terms etc.

The invoicing and payment processing part is small compared to the other costs and risks of doing a deal.

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Actually they are hopin a lot of it will be eliminated - you set a series of limits and vendors can be selected automatically.

Seems dubious I agree

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> My working hypothesis to explain these inefficiencies is that the people and supporting coalitions closest to them tend to gain from them, and that selection pressures on political coalitions are often much stronger than selection pressures on firms.

Economists have a term for this, the principal-agent problem: http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem. It is a key issue in understanding why corporations deviate from the efficient ideal. Most of the examples listed boil down to principal-agent problems.

Consider, for example, poison pills. A company might adopt a poison pill because its executives and board feel that they might get replaced in a takeover. On the flip side, they may realize that the acquisition will be disastrous, and the other company's executives may be pushing for it because it feathers their own nests.

I don't think any economist thinks that firms are actually efficient. They use it as an idealized model for analysis, just as an engineer might use an idealized linear model of a more complex physical system.

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In case you weren't aware, the author of that post, Robin Hanson, is indeed an economist. So I imagine he is well aware of the principal-agent problem.

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In essence, this is quite a simple matter. Here's Theory of the Firm 101 for you:

In the real world, pure free market economies are inefficient. (If you think otherwise, you've never tried to co-ordinate a complex project with multiple independent contractors.)

In the real world, pure bureaucracies are inefficient. (Think North Korea, or the old Soviet Union.)

But they are inefficient in different ways. It turns out that we can improve efficiency if we have islands of bureaucracy (firms) in a sea of free market competition. And, since these firms get to keep some of that efficiency gain for themselves, that's what happens: one way or another, people organize themselves into firms, and reap the benefits.

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It's really import to look for ways to make your organization more efficient (and these are good starting points) -- but I think there's a common misunderstanding between this sort of efficiency and the efficiency that economists talk about in relation to firms.

Correct me if I'm wrong, but economists don't mean firms are "smooth flowing". They are saying that firms are more efficient relative to other firms and one-on-one marketplaces.

E.g., it's inefficient for individuals to go directly to a marketplace to buy parts for a printer and then to find someone to assemble those parts. It's much more efficient for a firm to step in and handle the sourcing of the parts and to create a single place where people can buy them.

That doesn't mean the firm has to be completely without internal friction.

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Many things (and not just in a corporate world) seem to be inefficient until you understand the undercurrents, hidden factors and incentive structure.

Take for example hiring consultants. Why would you want to hire someone to get the watch off of your hand and tell you the time, as the joke goes? One factor is that consultants are used as the way to spread responsibility for important decisions. Consulting firms know that they may take (part of the) fall for someone and everyone plays this game. Another thing is that department or division may need to spend the budget, lest next year they are allocated less money.

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The behaviour is understandable. But it is still inefficient in the economically sense of the term.

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I have an interesting hypothesis: firm inefficiency leads to greater income inequality.

Think about it. Generally, smaller, newer firms are more efficient than older, larger firms. Greater firm inefficiency means that more older firms will be replaced by newer firms (whether by market position or outright bankruptcy). Average consumers can only invest in older, established firms, and, indeed, many 401k's are tied-up in stocks of 50+ year old companies. Millionaires, however, by being certified investors, can invest in many startups, a small portion of which will eventually become large, established firms in the future. This causes the rich to gain money, and others to loose it.

Let me give a (contrived) example. Let's say you wanted to invest in a car company in 2005. If you were an average investor, you may have put your money in (old) GM, whose stock is now worthless. If you were a billionaire, you could have split your money between Tesla, ZAP, and Project Better Place. ZAP and PBP are now defunct, but you would have made a boatload of money off of Tesla.

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How does that square with the observation that venture capital returns aren't actually that good?

http://pando.com/2013/07/30/ouch-ten-year-venture-returns-st... http://avc.com/2013/02/venture-capital-returns/

What percentage of certified investors actually do invest in startups, instead of just index funds or fancy managed funds that invest in established companies?

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That's good point, but if that's the effect, the cause isn't inefficient firms, it's the regulation that forbids "regular people" from investing in startups.

https://en.wikipedia.org/wiki/Accredited_investor

Realistically, though, some of your 401k fund is likely invested in startups, it's just highly diversified because it's very high risk, and you don't want to gamble with your pension pot.

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According to this article in the Economist, large firms are more efficient.

"Big firms are generally more productive, offer higher wages and pay more taxes than small ones. Economies dominated by small firms are often sluggish."

"A recent study of American businesses found that the link between company size and jobs growth disappears once the age of firms is controlled for."

http://www.economist.com/node/21548945

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That reads more like an opinion piece than a researched article. Not that the OP is different.

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Income equality has been around for longer than the whole certified investor business (or even the US).

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one major inefficiency hinted at but not directly named is the coordination problem (a la mythical man month). the tech startup ecosystem addresses that by having each startup "do one thing well" and having a simple way to coordinate efficiently (monetary payments in exchange for products/services).

there are a number of business school case studies that talk about addressing coordination inefficiencies in large firms -- toyota (TPS/kanban) and haier (OEC/SST - http://zaipul.wikispaces.com/file/view/The+Haier%27s+Tao+of+...) come to mind.

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This doesn't solve the problem, it just makes it invisible. When you buy something complex from other company, time spend communicating is not seen as bureaucracy, but productive work - on your company's end, communication may well be as efficient as possible. The same can be true at other company. When you sum the time/money spent on both sides, it's often worse than 'inefficient bureaucracy' at large company (which does both things internally). It may seem more inefficient just because people are able to see the entire process.

If small companies really were more efficient, they wouldn't be able to grow too much, as they would be outcompeted by already existing small companies. The reverse actually happens.

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not sure i get your point. i'm talking about the services ecosystem around tech. when i need servers, i just sign up at heroku. when i need source control, i get github. when i need agile tools, jira. need an html framework? bootstrap. analytics? email marketing? sales automation? bookkeeping? transportation? lodging? etc. etc.

it's super efficient--just go to a website and pay. i spend no time coordinating my efforts with those companies, and the price i pay tends to compare very favorably to building it ourselves.

the coordination problem is wrung out of the equation because teams are small and must compete. haier replicated this within the company with their STS model: each group in the supply chain effectively "paid" the upstream group and that became a simple metric for efficiency of coordination.

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I run a number of Capacity Planning projects for small businesses. It's really not economically feasible for them to determine all of their constraints to the nth degree, so I usually start with two figures: What is their perfect world, 100% Capacity / utilisation rate? And then what happens if we subtract 20-30% of that for 'Uncontrollables' and use that as the Real World target.

There's a bit more science behind it than just that, but the end result proves accurate and practical. Losing 20% doesn't sound like much, until you realise that's 1 day per week for every full time employee that we conclude will never be efficient for any decent length of time.

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A very interesting list to say the least.

The major component of the mega-corp money saving justification is the consolidation of overhead functions. e.g. finance, payroll, HR, media

At tiny companies, these tasks are either outsourced or done by the c-level employees. As a company scales you need departments to handle these things. A company of 50 people may need 2 HR folks but the tasks for HR can scale (especially with technology) such that if that same company scaled to 1,000 employees it wouldnt need to hire 20 HR folks (maybe just 10 total needed) thus saving 10 heads in HR of salary + benefits + office + IT assets + support. Not insignificant sums.

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I think that in most large companies the efficiencies produced by economies of scale are mostly captured by the management hierarchy (in terms of executive compensation and the support apparatus provided by consultants)

And why not? - the main shareholders are institutional investors who can't manage investments in hundreds of small companies, so it's not like they're going to take their money elsewhere.

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All models are wrong, but that doesn't mean they're not useful.

OP right in that individual firms are often quite inefficient, but the thought is that the market will take care of this in the long run: either a new competitor will arise and disrupt an existing market, or the shareholders will get rid of the management if the inefficiency is especially egregious.

The thing about macroeconomics is that you basically get to ignore the blips because on a long enough time scale, the irregularities start to smooth out. Scientific advances happen in other fields that may significantly disrupt another industry and vault progress forward, so even if for a while things were inefficient, the market catches up eventually.

Economics isn't about predicting the future with great accuracy; it's about gathering as much information as possible to be able to make decisions about what to do right now. You're playing the odds, and odds are, companies will be efficient. Sometimes they're not, which is the entire reason we have the stock market.

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Warning: this is a huge topic. For further reading:

Venkatesh Rao's series on the Gervais Principle: http://www.ribbonfarm.com/2009/10/07/the-gervais-principle-o...

My series on the same issue (organizational inefficiency): http://michaelochurch.wordpress.com/2013/02/19/gervais-princ...

In a picture: http://gapingvoid.com/2004/06/27/company-hierarchy/

Short version: firms are inefficient because organizations are innately prone to a predictable degeneracy of the group into three sets of people, none of which is capable of meeting an organizations trifecta of demands: subordination, dedication, and strategy (working on the right things). A person who is strategic in his personal life is going to either optimize for least-work/most-comfort (Macleod "Loser" strategy) or most-yield/least-subordination (Macleod "Sociopath"). By definition, those who are subordinate and dedicated are not strategic in their work lives, and probably not equipped to run a company for that reason.

Strategically subordinate but not dedicated "Losers" do the bare minimum and won't push themselves beyond how far they are managed. Among the strategic and dedicated (but not subordinate) "Sociopaths" there are some good people, but plenty of narcissists and bad actors as well. Cleaning up the messes made by their Sociopath bosses and Loser underlings are the Clueless middle managers, who are subordinate and dedicated but not strategic. For various reasons, these three sets are not good at working together but usually play against each other, with one dominant archetype characterizing the organization. (In VC-funded startups, it's Clueless; at Enron, it was the bad kind of Sociopath. In most checked-out mediocre companies, it's the Loser.)

There are "good Sociopaths" out there (e.g. "sheep dogs") and I'm probably one of them, but they're often at a disadvantage against the bad ones. Often they get sick of taking on political risk (for games whose prizes cannot be enjoyed fully by the most ethical people; power of any kind is most valuable to those who will be corrupt with it) and become Losers with age. A few might be able to start their own companies, but VC won't help them because VC-funded startups are all about Cluelessness (which is why VCs have their chicken-hawk fetishism for very young, white, upper-class men).

Fixing this problem is possible, even in larger companies, but very few organizations view it as worth the cost, especially in the circa-2014 startup game where companies are built to be sold, not to last more than 5 years (in which case MacLeod-style degeneracy will just be starting to impede performance, but is unlikely to kill the thing). Why? The classical explanation (from MBAs and investors and even founders) for why they keep starting crappy companies is that they can't afford the risk of alternative organization styles (e.g. Valve's open allocation) while also innovating on product, as if there were some finite pool of risk and "all of it" had to be allocated to product innovation. I strongly disagree. I think they're full of shit and trying to justify their own mediocrity. But that's what they say.

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In my view, the elephant in the room is central banking. It's hard to know the true value of a company anymore, as the stock market it flooded with trillions of $$$$ (the dow jones is at an all time high). Surely that capital is going to be misallocated based on your criterion; power _starts_ in the hands of those sociopath VC's as the money gets created in startup valuation.

Twitter is valued at more than 30 billion dollars, yet it has never sold a single thing in its life.

Likewise, the OpenSSL folks scrape by trying to find enough capital to not make the entire economy collapse from a buffer overflow.

Haskell folks have trouble finding jobs despite being the most brilliant coders out there (some criterion: # of bugs, quality of tools).

-- sinetek, who wishes someone would listen

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Also, I'm a student of your work. Thank you for opening my post-classroom eyes, Mike.

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FWIW, someone for whom the Gervais hierarchy is interesting or novel is almost certainly in the Clueless category. The Sociopath reaction to hearing about it is "Goddamn, this is going to result in some hassles when getting people to do what I want. I better discredit or minimize it." The Loser reaction is "Well duh, I'm surprised this is news to anyone. I'm going to go over to my friend's house now."

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That's quite an interesting point, and totally agree on the reaction of the Loser and the Clueless.

Concerning the Sociopath, it's not clear to me, because I think some of them manage to themselves to genuinely think they are doing good work, for the good of the whole company. I've seen cases where I couldn't understand if they were really good comedian (or: if I could be so easily fooled :-( ) or if they really believed what they were saying.

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These are caricatures to make the point - of course most people aren't going to be twirling their evil-villain mustaches. I'd say that the defining characteristic of MacLeod Sociopaths is that they are self-interested, not that they are evil; if their interests align with yours, they're actually quite good, and most of them actively work to align their interests with a large number of people. Much easier to get things done that way.

The vast majority of MacLeod Sociopaths would just keep silent on discussions about the MacLeod hierarchy, as there's fairly little they could gain from participating in the discussion, and it just makes them look Clueless. That was my initial plan, but I'm a pretty recent Sociopath and it still doesn't quite sit right for me, so I'll indulge my momentary impulse toward Cluelessness.

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Read your article and found it extremely interesting - I guess that puts me in the 'clueless' category, though I'd like to think of myself more as a technocrat.

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I am happy to see that people are slowly rediscovering socialism.

However, the "efficiency" argument is one of the poorest arguments because "efficiency" has always been a hustle. There is no way to predict and even measure all the effects of an economic decision to make any judgement based on efficiency.

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Most of these problems are due to employees looking out for themselves and their own career. Almost all employees stand to gain nothing from a large company they work for, doing well. Even if the company does badly, any work they've done on their career whilst there will help them get a new job (salary, seniority, achivements etc.)

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Almost all employees stand to gain nothing from a large company they work for, doing well. Even if the company does badly, any work they've done on their career whilst there will help them get a new job (salary, seniority, achivements etc.)

No, the employees want their companies to do well. If you're at a place for 3 years or longer, its reputation will affect yours.

However, most of them can't really do anything that would have a significant effect on the performance of the company. On the day-to-day microtrades, they're going to do what favors themselves. No one (except an idiot, or someone with 20+ percent in stock) would get fired for his own company's sake.

The claim that employees "don't care" is off. It's always better to be at a successful company than a failing one, all else equal. They do favor their own interests, of course, when there is a conflict.

It is true that those with substantial power in an organization (who can effect its macroscopic performance) tend to be egregiously selfish and possibly toxic. There are bad actors out there, and the executive overpay of the past 30 years has only made it more profitable for executives to trash their own companies (through externalized costs, so they don't get caught) if they can bolster their careers by doing so. We're way past the point of getting increasing quality per dollar paid to executives.

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Performance wise it's still going to be the same company you joined. For example, Microsoft hasn't done well over the last few years, but people are mostly still going to be still impressed you worked there.

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To give this some context, Dr. Hanson lists a number of ways why firms go not behave as suggested by traditional economic theories. See also: https://en.wikipedia.org/wiki/Theory_of_the_firm

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There is not such a thing as a perfect company.

There are companies that are more efficient than others.

Not that big companies for example are "more efficient" because they are big enough.

For example, Apple or Google pay very low taxes, because they could move, leaving lots of highly qualified people and technology behind. No state wants that, so they have negotiation power with gobertment, and they could pay lower taxes.

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There is always a principal/agent problem in large companies. "What's in it for me?" differs from "What's in it for the company?" Much of management and leadership is related to overcoming this issue.

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Yet another blog that I want to subscribe to via email, but can't (easily). This kind of thoughtful analysis is missing from today's obsession with listicles.

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http://www.overcomingbias.com/feed + https://ifttt.com/recipes/4447-rss-mail

I made it easy :)

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why is the author so reluctant to agree these inefficiencies exist? is he afraid of biases in his own list?

Also "smart sincere people" is not a notion I am used to hearing in academic discourse. If he is going to be critical, I wonder how he characterizes this notion Is it purely from a game-theory perspective?

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See e.g. http://www.overcomingbias.com/2009/12/the-smart-sincere-synd...

He also refers to "smart sincere" people as "nerds", so you can search his blog for that as well.

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TIL: "Modeling is always a tradeoff between realism and understanding."

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