Ana Anjdelic responded to my latest post with some very interesting points. She commented that some of my suggestions would significantly increase transaction costs, specifically information search costs incurred by firm. Ana notes that increasing transaction costs in this way contradicts (or runs logically counter to) Coase’s view of the firm. She writes:
It’s true – knowledge “reshuffling” is key to innovation (or, as you said “when it comes to thinking, we need more disruption, not less.”) This reshuffling, however, creates a lot of “noise” (how do you know what you are looking for before you find it?), and ultimately accounts for less-than-efficient organization, because it creates crazy transaction costs.
And reduction of transaction costs is what made firms show up in the first place (in opposition to markets), as Ronald Coase would have said.
So, the very condition that’s critical for generation of new knowledge and/or recombining old and new knowledge is actually detrimental for efficiency. The question then is, how to combine organizational efficiency with innovation?
I think Ana is right to invoke Coase’s theory and to be concerned about drastically increasing transaction costs and it got me thinking.
My view: while historically firms were able to lessen the search costs associated with valuable information, this no longer applies. Firms are no longer the most efficient and effective means for collecting and sourcing innovative ideas and insights. Therefore, as Coase’s theory would predict, firms may need to go beyond their four walls an turn to the market, effectively outsourcing (or co-sourcing) a large portion of idea generation. Additionally, firms can further reduce information and search costs by leveraging technologies that tag, catalog, and organize knowledge–both within and outside firms.
The basic logic behind traditional, integrated firms is that it was cheaper to bring the various elements of production under one roof. The idea was that it made sense for firms to enter into long-term contracts with employees because it would eliminate the potentially massive transaction costs associated with, for example, search and information costs one finds in the market. In theory, when transaction costs are less within a firm than within the broader market, firms will take those items (e.g. labor, technology, distribution, etc.) in-house. When costs are less in the market, firms will choose to outsource those items.
What many firms are realizing now is that, in many cases, they don’t have the knowledge internally to problem solve and innovate effectively. The rapid and profuse rise of Open Innovation initiatives by tradional R&D stalwarts provides evidence for this shift. And even if they do have that knowledge internally, firms are quite inefficient when it comes to quickly locating and leveraging that knowledge. Firms are typically not structured to efficiently leverage the vast knowledge base they have accumulated internally in the form of their employees, especially as they grow in size and stove-pipe various functions and departments. It can take weeks, if not months, for firms to locate individuals that have specific knowledge sets that can contribute to a particular problem or project (I’ve seen it firsthand, working with various clients on this very issue).
Given that firms are no longer as efficient at collecting, organizing, and tapping into knowledge under their own roof there are three likely (and logical) outcomes:
- Firms will continue to outsource this function to minds outside of their four walls. This could take the form of Open Innovation, crowdsourcing, or partnerships with more specialized firms that have developed platforms for locating and taxonomizing expertise and knowledge holders;
- Firms will invest more heavily in software and technology that will allow them to catalog the knowledge under their roof, making search and location of that knowledge less costly. Internal social networks are one way, talent software is another.
- Firms that fail to adapt to this new reality will fail to innovate as effectively as other firms that due adapt, becoming obsolete.
Ana also brought up a simpler question–how do you know what you are looking for before you find it? To me, social media makes it quite easy to bump into new perspectives in a quasi-directional or directionaless way. You can use it to casually challenge your own views and find new and interesting ideas, or you can use it to conduct a focused search for specific experts or knowledge communities.
Filed under: Uncategorized | Tagged: Business, crowdsourcing, Innovation, Organizations, social media, social networks, transaction costs
Hey, this is becoming good.
It seems to me that, in this post, when you say a “firm”, you actually have in mind only one of its formats: hierarchical organization with centralized control and vertical chains of command. In the past 30 years (if not longer), there emerged a lot more hybrid models of the firm, which combine properties of hierarchies with markets.
Examples: a) industrial clusters (Marshall was the first who described them, long time ago, and today most famous industrial clusters are Hollywood, Silicon Valley, and Italian fashion districts). Clusters are composed of tightly connected firms which operate in spatial proximity to each other, and which pull in – often via informal ties – outside talent in on a project basis.
b) Then, there’s Toyota factory, which is a hybrid between hierarchy and a network organization, having its units functioning separately but also being loosely horizontally connected with each other.
c) Digital firms (digital marketing, production, and design shops) are designed as “heterarchies” (a term introduced by David Stark), with horizontal organization, lateral accountability and distributed authority. Their organizational form is directly related to digital technologies they are using – and possibilities of organizing, codifying, storing, and accessing knowledge that they offer. Today, a “digital shop” is a quite prominent – and successful – organizational format.
d) And then, there are examples as Xerox Park and Gore factories, which also experiment with organizational formats alternative to hierarchical firm. Consulting firm McKinsey&Co., more than a decade ago, devised a system of codifying and tagging its knowledge in order to make the most out of it. (For this, and other examples, see “The Biology of Business: Decoding the Natural Laws of An Enterprise” by Brook Manville).
All these innovative organizational formats emerged as attempts to overcome the shortcomings of a traditional hierarchy in organizing and accessing its own knowledge. Some, if not most of the above, are pretty successful in doing so. What they all have in common is decentralization of knowledge management. So, while hierarchical firms are, as you say, “no longer efficient and effective means for collecting and sourcing innovative ideas and insights”, I would not extend this conclusion to all firms.
And then, hierarchical firms are still the most efficient organizational forms for conducting routinized tasks.
There is something more important here, though (and I am sure you already know this): the boundaries between a firm and its environment were never really closed (as Granovetter and Marshall have shown). John Seely Brown and Paul Duguid analyzed the firm in relation to its environment as “networks of practice” and “communities of practice” (where communities of practice exist within a firm, and networks of practice span throughout firms). This is even more true today, with a networks and communities of “amateurs”. who are easy to find and mobilize. More famous examples are P&G, Dell, Netflix, Starbucks, etc. are some of the most common examples, and I am sure that you know about many, many more.
This kind of open organization found its way in advertising, too – which was a traditionally “proprietary ideas” based business: http://www.nytimes.com/2009/10/29/business/media/29adco.html?_r=1
What I find most interesting here is that firms still exist in order to organize this crowdsourced knowledge and make it part of its own production process. Communication costs are really high in crowdsourcing communities, and they need some sort of “control” (at the end of the day, firms crowdsource in order to improve their own production/knowledge/innovation, that is, they use crowdsourcing towards measurable results.) So, at the same time you’d want to increase communication and to decrease communication costs.
In contrast, a purely open source community, Linux, is a messy and often sub-optimally efficient organizational form – especially because it is a community – and not a firm. Here, communication costs are high, which results in less than optimal production efficiency (products are released quickly, but are full of “bugs” that need to be consequently corrected).
So while I am sure that in your everyday work you still encounter more of hierarchical firms than any other formats, organizational innovation like the one you describe actually started decades ago. We can only hope that digital technologies will accelerate the process.
Finally, my question “how do you know what you are looking for before you find it?” is not the one of how we make unexpected connections (which social media facilitate, as you rightly observe), but how to recognize – among all of them – the “right” solution? That is, there is a double uncertainty here: first, there is ambiguity (which is interpretative uncertainty, how do you know that what you bump into you can use for solving your problem), and then, there is “ambage” (Harrison White’s term for vagueness in social pattern). Organizational response to ambiguity is to rapidly generate a “best fit” to environmental challenge: to create a flexibly organized, soft-assembled team of highly skilled agents that can recombine their diverse knowledge in order to respond to ambiguous task (and social media and crowdsourcing software are critical here). Organizational solution to “ambage” is, however, more complex: it requires knowledge of “who knows what” – i.e. it requires a rapid search, detection and mobilization of resources required for the solution of the ambiguous environmental challenge. That is, sometimes, we just don’t have time to rely on the organizational dynamics of pure crowdsourcing.
[...] written about this topic previously, and Ridley’s perspective lies fairly close to my own. We tend to think of ideas [...]