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.
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).
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].
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.
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.
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.
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.
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.
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).
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.
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.
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.
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."
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.
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.
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.
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.
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.)
> 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...