Industrial Organization Economics

Industry economics suggests that supernormal returns are a function of a firms’ membership in an industry with favorable structural characteristics (e.g. relative bargaining power, barriers to entry, and so on). The unit of analysis is industry.
The major proposition is the SCP model (Industry structure-conduct (strategy)-performance), also called the Bain/Mason paradigm. The essence of this paradigm is that a firm’s performance in the market place depends critically on the characteristics of the industry environment in which it competes. Conduct was the firm’s choice of key decision variables. Industry structure is defined as the relatively stable economic and technical dimensions of an industry that provided the context in which competition occurred, including barriers to entry, product differentiation, overall elasticity of demand (Porter, 1997).

Assumption:    In traditional economics, we assume a perfect market, perfect information flow and equilibrium (MR=MC=P), but in industrial organization, markets are not perfect in that the monopoly, oligopoly or duopoly is the real situation. This situation is not good and we need public policies to constrain the monopoly.

The unit of analysis is: business level or one specific industry, not the entire firm. Work of IO has shifted the unit of analysis to both group of firms and the industry, such as the concept of strategic groups, mobility barriers.

Major critiques: 1) It is too static, views the firm as a free-standing entity competing in a single business. 2) IO is too limited, only including a few critical aspects of structure (concentration and entry barriers). 3) The determinism (ignore the power of management) view firm as a black box.

References:

McGAHAN, A. M., & Porter, M. E. 1997. How Much Does Industry Matter, Really? Strategic Management Journal, 18(S1): 15–30.

Summary of Bureaucracy

Weber (1978) tried to describe the prevalent organizational form – bureaucracy at that time. 

Why we have bureaucracy?
Bureaucracy emerges because of two reasons. First, Recruiting people on the basis of their social resources, such as status or power may harm the performance of the organizations. Therefore, bureaucracy is developed to provide equal opportunities to employees on the basis of their competence to improve the performance of the organizations. The standards are achieved by separating the people and their roles (Kallinikos, 2006). Firms standardize the requirements of the role performance; formalizing the process of role taking, recruitment and appointment. Any individuals that satisfy the special requirement of the job can be hired.
Second, the ends of the individuals and the organizations are not always the same. Individuals tend to achieve their own ends by using power and leverage in the organizations. How bureaucracy is built to solve this problem? Bureaucracy set up building rules and reducing rules. 1) Building rules: any parts that can be written down to reflect regular activities. 2) Reducing rules: professionalization packages all the rules in professionals and employing these profession actors can reduce the rules organizations need to make themselves. 

Four groups of main characteristics:
Weber (1978) summarizes three sets of characteristics of bureaucracy.
First, bureaucracy form through rationalization increases the use of calculation to master things through rules and instruction systems. The process of bureaucratization 1) reduces people’s freedom, initiative, power  2) trap people in the iron cage, where everyone obey the rules.3) dominant authority neutralizes other countervailing power and legitimate itself as power over its members.
Second, the ethos of bureaucracy is the idea that things are done according to rule rather than caprice. For example, Kallinikos (2006) observes that the institution of bureaucracy is an “outcome of complex cultural and social developments. These reflect, among other things, the institutional embeddedness of property rights and the employment contract an dthe legal and socio-political processes for assigning jurisdictions and laying out the rules of accountability in democratic societies.”
Third, means of rewarding efforts for bureaucracy is through fixed salaries and performances are graded by ranks.
Fourth, the bureaucracy protects individuals’ arbitrary use of power with authorities. Authority comes from the leaders. Leader is determined by knowledge (length of service, disciplinary formation, progression through a career structure). Leaders are bounded by an emotionally strong sense of duty as vocation (a mastery of technical rationality)

Critics and future development
There are mainly five critics of bureaucracy.
First, bureaucracy is inflexible and inefficiency reaction to the environment. Therefore, bureaucracy is inefficient with inefficient administration, pettifogging legalism, red tape. (Osborne and Plastrik, 1997) Bureaucracy is inactive in responding to massive change, environmental dynamism and considerable uncertainty are the norm. Power does not represent interests with multiple stakeholders.
Second, it stifles the spontaneity, freedom, and self-realization of their employees (Perrow, 1973). Therefore, entrepreneurship should decentralize the decision making process and empower employees.
Third, treat informal control as abnormal phenomenon of organizations, which is later complemented by institution theory.
Fourth, discrepancy between expertise of the subordinate and that of his superior
Fifth, Most of the new phenomena cannot be fully explained. For example, post bureaucracy organizations show three main characteristics: 1) Most of the organizations start to outsource their activities. 2) Recompose: network form organizations (keep the institutional part but throw away the organizational form part) 3) Role and individual properties are separated. One individual has different roles at the same time.
To address these new changes, detailed theories have been developed. First, a typology of bureaucracy is developed by arguing that there are two kinds of formalizations, one is enabling, where employees’ potentials are encouraged. The other is coercive, where employees’ behaviors are forced (Adler and Borys, 1996).  Factors that influence the two process: 1) asymmetries of power in the organizations 2) the absence of reality checks: external stimuli is the key to keep adaptive adjustment. (driven by demanding customers or clients )
Why enabling logic will be more prevalent?
First, the enabling logic has considerable and growing legitimacy in the broader culture. Second, demand from the task environment and competition change the distribution of power. Third, automation increases enabling formalization because routine jobs are incorporated into the automatic system, leaving the operators with a higher proportion of learning tasks to doing tasks. Firms design jobs that need more skill and discretion

By Kate Jue Wang

References: 

Adler, P., & Borys, B. (1996). Two types of bureaucracy: Enabling and coercive. Administrative Science Quarterly, 41(1), 61–89.

Weber, Max, (1978) Economy and Society. Berkeley, CA: University of California Press
 
Kallinikos, Jannis. "The institution of bureaucracy: administration, pluralism, democracy." Economy and Society 35.4 (2006): 611-627.

Perrow, C. (1973). The short and glorious history of organizational theory. Organizational Dynamics, (2), 3–15.

Summary of Institution Theory

Institution theory views organizations as organisms that survive in the organizational field. Organizational field is defined as collectives of organizations, who share common meaning systems and relate and influence each other closely compared to the outsiders of the field (Scott, 2001). Institution theory takes a holistic view of the organizations and examine the affiliation, competition, shared membership, social relationships that shape and being shaped by the overall institutions. Institutions are defined as configurations of interrelationships that actors claim to gain or sustain their positions in the field. Culture, structures and routines are the containers and transporters of institutions. Institution theory has developed through three phases. 1) Organizations are filled with value and organizations can change and survive if they change their value. 2) Organizations tend to become similar to each other because of isomorphism. 3) New organizational forms can come from institutional logic or sense-making processes.

 

First Stage of institution theory

Institution theory started from Selznick’s (1957) Leadership in Administration. The starting point is the functional school in sociology, which argues that organizations’ structure is determined by their functions. Institution theory argues that organization should be analyzed as a whole rather than as separate elements. Organizations are organisms with values that grow and make sense of their environment. When the environment changes, organizations have to change their value to grow again or die. One example is Tennessee Valley Authority (TVA). TVA was established in 1930s and is utilize waterways (building ports, producing power, etc). The program turned to be a failure because its goal was subverted by local political and business organizations by different groups tending to seek their own interests. (such as Department of agriculture, farm bureau Federation, granted college and universities, etc.) Another example is Burton Clark shows that because of low ability of the students, the college in question was designed in a way that student could repeat eleventh and twelfth grades of high school and some vocational training.  One limitation of the early institutional theory is that it is ex pose, which means it explain the phenomena as it is rather than provide reasons. The contribution of the early institution theory is two-folded. 1) it take care of the environment 2) Morality and community value. The study of Crown-Zellerbach Corporation, who care only about the benefit of the minority of white community and ignored the black and poor communities adapted quite slowly to federal governments’ legal action about work segregation. And also the study of TVA shows that there was no community value, but only group interest. Therefore, there is no social value but corporate interest. 

New Institution Theory

This stage was started by Meyer and Rowan (1977) and DiMaggio and Powell (1983). The key research question is: as organizations serve different functions, why they become so similar to each other. Legitimacy is the core concept and isomorphic processes are the core mechanisms under this theory. 

Legitimacy is defined as a signal showing that the organizations have easy access to resources and markets, which indicates high rate of survival (Scott, 1995). There are two kinds of legitimacy – cognitive legitimacy (defined as spread of knowledge of new entities, such as rationalized rules) and sociopolitical legitimacy (defined as profession’s shared knowledge about new entities) (Meyer and Rowan, 1977). The subject of legitimacy can be social entities, structures, actions and ideas, etc. The sources of legitimacy include internal and external audiences, such as legitimacy-granting authorities, media, social relations, etc. Media not only serves as ways to legitimize but also as signals of legitimate. 

The process for organizations to gain legitimacy is legitimation and the source for legitimation comes from three sources: coercive, mimetic and normative pressures (DiMaggio and Powell, 1983). A large stream of research about the diffusion process flows from the isomorphic argument.  

Neo Institution Theory

Besides isomorphism, scholars start to ask where the new organizational forms come from? The research has diverged into two streams – institutional logic and sense-making processes. 

Institution logic

Institution logic takes a holistic view of the society and organizations are just part of the whole society. It focus on the cultural side of society, which means symbols, values, beliefs will be brought back, besides current focus on concrete practices and routines (Friedland and Alford, 1991). It comes from Fligstein three conceptions of control: manufacturing, marketing and finance conceptions governs the intra-organizational power struggles, field-level struggle to control market, competition, contest state legislation.

Institutional logic is defined as “Socially constructed, historical patterns of material practices, assumptions, values, beliefs, and rules by which individuals produce and reproduce their material subsistence, organize time and space, and provide meaning to their social reality.” (Thornton and Ocasio, 2008).  I interpret it as the configurations of beliefs and associated routines that the participations in the field agree on. Institution logic is the brain of institutions. Logic govern how the material and symbolic practices are arranged to produce and reproduce actors’ lives and meanings.

Institutional logic is categorized in different ways. One way is to focus on different sectors in the society: capitalism, state bureaucracy, and political democracy as three contending institutional orders which have different practices and beliefs that shape how individuals engage political struggles. Another way comes from institutions of society- the capitalist market, the bureaucratic state, families, democracy, and religion – each has a central logic that constrains both the means and ends of individual behaviors, constitutes individual identities, organizations and society.

There are two basic assumptions for institutional logic theory. First, agencies are embedded. The interests, identities, values and assumptions of individuals and organizations are embedded within prevailing institutional logics. Decision outcomes are results of interplay between individual agency (embedded with institutional logic) and institutional structure. Second, logics can influence individuals, organizations and institutions - individuals competing and negotiating, organizations in conflict and coordination, and institutions in contradiction and interdependency with different logics.

Institutional logic can shape individuals, organizations and institutions through four mechanisms. First, individuals, organizations tend to identify themselves with collectives of same logics (Tajfel and Turner, 1979). This is termed as collective identity. Collective identity is defined as “the cognitive, normative, and emotional connection experienced by members of a social group because of their perceived common status with other members of the social group “ (Polleta and Jasper, 2001). It emerges from social interactions, communications between members of social group (White, 1992). When collective identity is institutionalized, they develop their own institutional logic, these logics prevail within the social group (Jackall, 1998). 

Second, the contests between different logic for power and status generate new institutions and change organizational forms. The social status is constituted by institutional logics. But it is different from resource and structural positions. (Weber). Therefore, institutional logics influences informal status and power structures, but not formal organizational forms (Thornton and Ocasio, 1999; Lounsbury, 2002; Zhou, 2005)

Third, institutional logic shapes individuals’ cognitions through social classification and categorization.  Cognitive psychologists emphasize the importance of categories in shaping individual cognition (Rosch, 1975; Medin, 1989). The classification of social and organization categories are defined by institutions (Douglas, 1986; Searle, 1995). Institutionalization of the categories render individuals to take the categories of organizing activities for granted. Categories, as basic unit of cognition, do not imply mindless cognition, as do schemas and scripts, but are a necessary component of all mindful agentive behaviors. Changes in intuitional logics lead to the creation of new categories (Rao et al, 2003) and to changes in meaning of existing categories (Ruef, 1999; Ocasio and Joseph, 2005). 

Forth, individuals and organizations’ attention will be changed by institutional logic. Institutional logics focus the attention of decision makers on issues and solutions that are consistent with prevailing logics.  Resource competition and dependencies are not universal effect, but are contingent on organizational attention to market forces that are salient under market logics.

Practically, institutional logic is operationalized through two ways. First, institutional entrepreneurs are those who create new institutions by combining different institutional logics. The research questions can be:  how does institutional change create entrepreneurial opportunities (Sine and David, 2003). How do entrepreneurs seize the opportunities (Sine et al, 2005)? How do entrepreneurs modify or create institutions to advance their interests (Lawrence, 1999)? Second, merge and acquisition can change the combine different logics together and create something new. 

Sense-making 

Sense-making aims to understand how individuals’ or organizations’ interpretations will influence how they act (Weick, 1995). There are three basic assumptions: 1) organizations are open systems 2) organizations have their own cognitive and memory system 3) strategic managers formulate the interpretation process.

The process of sense-making has three stages. First, people assign meaning to who they are (identity) and what is the environment (enactment). Second, people choose the mental model to accept and constrain their behaviors (Weick, Sutcliffe, and Obstfeld, 2005: 409).

The whole process is rational in that it considers both the self and other’s perception, as well as the scripted interactions in relation to others’ expectations (Goffman, 1974). For example, Weick (1993) describe the Mann Gulch fire disaster as a situation, where the firefighters fail to consider the others’ perceptions, role structure and the environment, which led to a crisis of the whole organization. Another example is Scott Snook's (2000) examination of the 1991 ‘friendly fire’ incident when US F-15 fighter pilots shot down their own Black Hawk helicopters in peacetime over the Persian Gulf

Different sense-making processes determine different organizational forms and actions. On the basis of their definition of the nature of the organizations, two dimensions – environmental analyzability and intrusiveness of the organization- determine the design of the organizations (Undirected viewing, enacting, conditioned viewing, discovering). Organization behaviors are explained on the basis of their sense-making processes (predictions on scanning, interpretation, decision-making process).

There are three biases in the sense-making processes: uncertainty, ambiguouity, equivolcal . Uncertain means the actors cannot anticipate the consequences of current actions. Ambiguity means the information is not described in a clear way. Equivocality means that categories, routines and practices are open to different interpretations. Therefore, sense-making process can be influenced by different factors. Whiteman and Cooper (2011) focus on network constrains and argue that ecological embeddedness will influence the sense-making process. First, they argue that some actors are more aware of and know more about the ecological environment than other actors. Those that are more embedded in the ecological system will interpret the environment in a knowledgeable way and change the organizations’ behaviors in a different way from those disembedded actors.  Besides the network constrains, representativeness and size of other organizations can also influence the process of interpretation, especially when trying to identify competitive rivalries (Porac, et al.,1995). Technology can also change the interpretation process by defining new institutional roles and interaction patterns (Barley, 1986).

Corporate social responsibility is an area where the sense-making process can be important, because of two reasons. First, the activities firms choose to show their social responsibility is uncertain and largely determined by how the firms give meanings to themselves. Therefore, the report of the corporate social responsibility report should evolve with the identity of the firms.  

Second, firms also have to make sense of their environment to determine the CSR behaviors. When there are firms’ scandals, certain part of the CSR report is expect to be emphasized to reflect the attention of the firms. The change of reporting configuration also signals the firms’ intention, which attracts stakeholders’ attentions.  

Current development of sense-making in OB
One domain of research is about self construction. The main idea is that in organizations, individuals have to construct their identity according to their role in the organization. They provide possible self to guide their selection and assessment of their own behaviors. 

The other domain is about organizational  cognition. The main idea is that organizations' cognition are constellations of individuals' cognition under constrains of the organization structure. As individuals' cognition is constrained by the environmental factors, organizations' cognition cannot be analyzed without considering social environment.
 

By Kate Jue Wang

References:
Greenwood, Royston, et al., eds. The Sage handbook of organizational institutionalism. Sage, 2008. 

Friedland, R., & Alford, R. (1991). Bringing society back in: Symbols, practices and institutional contradictions. In The new institutionalism in organizational analysis.

Thornton, P., & Ocasio, W. (2008). Institutional logics. The Sage Handbook of Organizational Institutionalism, 99–129.

Dimaggio, P. P. J., & Powell, W. W. W. (1983). The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields. American Sociological Review, 48(2), 147–160.

Friedland, R., & Alford, R. (1991). Bringing society back in: Symbols, practices and institutional contradictions. In The new institutionalism in organizational analysis.

Lincoln, J. R. (1995). The new institutionalism in Organizational analysis review. Social Forces, 73(3), 1147–1148.

Meyer, J. J. W., & Rowan, B. (1977). Institutionalized organizations: Formal structure as myth and ceremony. American Journal of Sociology, 83(2), 340–363.

Tolbert, P., & Zucker, L. (1983). Institutional sources of change in the formal structure of organizations: The diffusion of civil service reform, 1880-1935. Administrative Science Quarterly, 28(1), 22–39. 

Zucker, L. (1987). Institutional theories of organization. Annual Review of Sociology, 13(1987), 443–464.   

Summary of Transaction Cost Economics

The basic research question for Transaction Cost Economics (TCE) is "How firms decide their boundaries when the firms are views as a nexus of contracts? ".  The main idea is that transactions should be organized to safeguard the contingencies of the exchange. The process to safeguard the exchange has cost (transaction cost). There are three organizational forms of transaction cost economics: market, hybrid and hierarchy. Hierarchy has advantage over market, because it more efficient in governing complex transactions. (Williamson, 1998).

Transaction cost economics have three premises, which render a contract incomplete. The incomplete contract leads to opportunism, which a potential cost for the contractors. First, Human cognition has limitations. Therefore, individuals cannot foresee the future contingencies and potential opportunism and plan well. Second, two contracting parties cannot develop a completely common language of the state of the world and possible actions. Third, the third-party, who enforces the contract, can have a hard time in understanding the contract interpreted by both of the parties. (North,1990; Williamson, 1985)

Practically, transaction cost can be manipulated by measuring three different constructs. First, higher asset specificity means higher transaction cost.  Asset specificity refers to the transferability of assets to alternative uses (Williamson, 1985). Williamson (1985) identify three types of asset specificity: 1) site specificity 2) physical specificity 3) human asset specificity. Site specificity: the situation whereby successive production stages that are immobile in nature are located close to one another. It reduces inventory and transportation costs and can lower the costs of coordinating activities (Dyer, 1996). Physical asset specificity: transaction-specific capital investments (e.g. customized machinery) that tailor processes to particular exchange partners. Physical asset specificity has been found to allow for product differentiation and may improve quality by increasing product integrity or fit (Clark and Fujimoto, 1991). Human asset specificity refers to transaction-specific know-how accumulated by contractors through long-standing relationships. The more specialized a resources becomes, the lower its value is in alternative uses. Therefore, it is harder to switch partners. The contingent value of a specialized resource exposes its owner to a greater risk of opportunism than does a general resource ( Klein et al.,1978). Firms, who develop a specific assets will face the hold-up problem, where the suppliers can extract extra rents from the consumers with opportunism, because the specified assets are of little value out of given context. Second, appropriability refers to the contracting hazards when the valuable intellectual property of the firms is exposed to expropriation (Gualti & Singh, 1998; Oxley, 1997;Pisano,1990). When firms engage in a contract in the market, they may have to exchange their proprietary information and technology. The partner firms who get the expropriate valuable technology can compete with the original firms to extract the rent from the technology. Contracts cannot fully prevent the moral hazard (Shapiro & Varian, 1999). Therefore, firms would want to internalize their transactions. Third, when the outcomes are hard to observe, the contract hazard is high (Holmstrom, 1979).

There are four main critics for transaction cost economies. First, it ignores the role of differential capabilities in structuring economic organization (Richardson 1972). This point is further developed by Resource-based Theory and Knowledge-based Theory. 

Second, it excessively focused on the assumption of opportunism. For instance, Ghoshal and Moran (1996) claimed that opportunism is not exogenous. Once the situational sources of opportunism (rather than the dispositional source) are factored in, Williamson’s prescriptions for mitigating the hazards of opportunism within organizations are likely to enhance it. Therefore, Williamson’s approach becomes a “self-fulfilling prophecy” and it thus “bad for practice”.  

Third, it views organization as instrument controlling pathological behavior, but neglects the institutional role of organizations which is embedded in the social networks (Granovetter 1985). In those critics, firms are often portrayed in rosy terms as “mini-societies” (Freeland 2002) that provide “identity” (Kogut and Zander 1996), “higher-order organizing principles” (Kogut and Zander 1992), and trust relations (Ghoshal and Moran 1996) that, purportedly, “atomistic” markets cannot provide. Firms exist because and to the extent that they not only allow managers to lower the cost and to increase the effectiveness of economic activity, but also create and sustain a context in which collaborative entrepreneurial behavior can flourish. Research, developing in this vein, has incorporate institution theories and population ecology. Hughes et al. (1997) study the contracting practices in the Welsh National Health Services (NHS) are subject to both efficiency and political influences. Study about strategic alliances between firms show that trust and relational governance partly mitigate the transaction costs (Gualti and Singh, 1998). Park and Russo (1996) find that the dissolution of joint venture is influenced both by organizational age and efficiency. 

Fourth, the uncertainty is not theorized well. Weber, L., & Mayer, K. (2014) discuss that different contractors’ cognitive framing is the source of uncertainty in contracting. Different governance forms are chosen to allow different degree of communication to align the cognitive frameworks.  

By Kate Jue Wang 

References:

Ghoshal, S., & Moran, P. (1996). Bad for Practice : a Critique O F the Transaction Cost Theory. Academy of Management Review, 21(1), 13–47.

Macher, J. T., & Richman, B. D. (2008). Transaction Cost Economics: An Assessment of Empirical Research in the Social Sciences. Business and Politics, 10(1), 1–65.

Moran, P., & Ghoshal, S. (1996). Theories of Economic Organization : the case for realism and Balance. The Academy of Management Review, 21(1), 58–72.

Willamson, O. E. (1996). Economic Organization: The Case for Candor. Academy of Management Review, 21(1), 48–57. Retrieved from

Williamson, O. E. (1979). Transaction-cost economics: the governance of contractual relations. Journal of Law and Economics, 22(2), 233.

Williamson, O. E. (1991). Comparative Economic The Analysis Organization : Analysis of Discrete Structural Alternatives. Administrative Science Quarterly, 36(2), 269–296.

Williamson, O. E. (1999). Strategy research: Governance and competence perspectives. Strategic Management Journal, 20(12), 1087–1108

Weber, L., & Mayer, K. (2014). Transaction cost economics and the cognitive perspective: Investigating the sources and governance of interpretive uncertainty. Academy of Management Review, 39(3), 344–363.