Week 1

Economics:

Study of how we allocate scarce resources. A formalized, mathematical way of thinking, that focuses on the forces of supply and demand in setting prices and quantities in a market

Psychology:

Looks at human behaviour at the individual level

Sociology:

Deals with the collective (looks at social behaviour within groups)

Anthropology:

Study of culture - Organisational Behaviour, Marketing

Mathematics:

Finance, Decision Sciences

“Big ideas come from the unconscious. This is true in art, in science and in advertising. But your unconscious has to be well informed, or your idea will be irrelevant. Stuff your conscious mind with information, then unhook your rational thought process. You can help this process by going for a long walk, or taking a hot bath, or drinking half a pint of claret. Suddenly, if the telephone line from your unconscious is open, a big idea wells up within you.” 

David Ogilvy

One answer: Adam Smith: The Wealth of Nations (1776)

4 Key ideas:

1. The Division of labour and specialisation

2. This requires markets (division of labour and specialisation, and so increases in wealth, are only possible if you have some way to exchange these products)

3. Self-interest drives the system:

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessity but of their advantages.”

4. The “invisible hand” of the market

Nicholas Murray Butler:

“The limited liability corporation is the greatest single discovery of modern times…Even steam and electricity…would be reduced to comparative impotence without it.”

1. An organisation engaged in business

   This covers everything from informal Assyrian trading arrangements to a modern leveraged buyout

2. The limited-liability joint stock company

   A distinct legal entity endowed by the state with certain collective rights and responsibilities

   
   

The Companies act of 1862 (UK) brought together the three big ideas behind the modern limited liability company:

1. That it could be an artificial person – with the same ability to do business as a real person

2. That it could issue tradable shares to any number of investors

3. That these investors could have limited liability, that is they could only lose the money that they had committed to the firm

Revolutionary aspect: it was no longer necessary to get special sanction from parliament to set up a company, or to limit its business to a specific worthy aim

Invisible hand of the market (Smith) vs. Visible hand of management (Chandler)

Reflected in two disciplines:

Economics is primarily about markets

Management is primarily about what goes on inside the boundary of the firm

Economic history is concerned with how societies have solved the problem of production and allocation of resources

Three Fundamental solutions to the economic problem:

1. Tradition

2. Command

3. Markets

All societies use a mix of some fo the above

We have moved from a world in which markets were incidental to one in which they are absolutely central

1. Rested on an agricultural foundation: All societies depend on agriculture – the difference is the percentage of the population that can be supported by food growers to do other things.

These were subsistence economies, largely cashless

1. Cities: They were vibrant, and goods were traded. But were tiny in comparison to the agricultural population

2. Slave labour: Huge reliance on slave labour

3. Power: In ancient times wealth generally was the reward for political, religious or military power – not for economic activity

Politically a very diverse period. Hard to make generalisations

The fall of Rome – destabilising – made long distance trade difficult

New basic unit of economic organisation: The manorial estate (feudalism)

Serfdom: not quite slaves but tied to the manor (reciprocal bonds)

Money still largely (but not completely) absent – the Manor supplied itself and perhaps a nearby town

Towns and Fairs: Increasingly the laws and customs of the towns distanced themselves from Manorial laws. In addition, there were Fairs - a kind of travelling market.  

Guilds: Small centres of “industrial” production

What changes needed to happen in order to see the shift from a society in which markets exist, to what might be described as a true market economy?

1. A new attitude towards economic activity

2. The monetisation of economic life will have to proceed to its ultimate conclusion

3. The free play of supply and demand will have to take over the regulation of the economic tasks of society

Forces for this change:

Itinerant merchants

Growing urbanization

Growth of national power

Change in religious climate

Breakdown of the Manorial system

The invention of double entry bookkeeping

Ultimately this was to lead to the industrial revolution – but first – the development of chartered companies

Three prompts for change:

1. Technological: The voracious need for capital (railroads, canals, water companies)

2. Legal: In 1819 the supreme court found that corporations of all sorts possessed private rights, and that the state could not rewrite their charters capriciously

3. Political: Regulatory competition between the states: local politicians (grudgingly) began to offer greater freedoms to comapnies in order to attract and keep their business

The Industrial Revolution was accompanied with the growth of large capitalist firms

And the growth of management to coordinate these new giant organisations…

(Link to Chandler’s thesis that the 20th C saw the emergence of middle and top managers are a new class of businessperson.

He argues that as late as 1840 there were no middle managers in the US – that is there were no managers who supervised the work of other managers, and in turn reported to senior executives, who were themselves salaried managers (he refers to this as a new ‘subspecies of economic man – the salaried manager” (p.4). But by WWI this type of firm had become common. )

Social scientists sought to address, both descriptively and prescriptively, how these new large organisations operated and how they were impacting society

And managers needed a body of knowledge to help them know what to do.

Out of this emerged theories of management and organisation.

(Social science is the branch of science devoted to the study of societies and the relationships among individuals within those societies. The term was formerly used to refer to the field of sociology, the original "science of society", established in the 19th century. In addition to sociology, it now encompasses academic disciplines such as anthropology, economics, human geography, management science, political science, psychology, and history.)

Adam smith had been an optimist. He had seen the possibility for great improvement

Marx, on the other hand, saw the horrors of the IR, and thought the point was to change it.

Many of his predictions failed to come true, and the states created in his name have been roundly discredited

But better than any of his contemporaries he identified the “endemic antagonism between boss and worker as a product of an economic logic build around inexorable competition among profit seeking firms” (DiMaggio, 2001, p.10)

Marx identifies the “endemic antagonism between boss and worker as a product of an economic logic built around inexorable competition among profit seeking firms” (DiMaggio, 2001, p.10)

It was not that employers (‘capitalists’) wanted to exploit their workers, or were bad people. They may have been, they may not have been. The point was that if any factory owner did not pay his workers the market rate (basically a subsistence wage that was just enough to keep them alive) they would go out of business.

This why Marx through revolution was not just desirable, but inevitable.

1. Western firms exported exploitation to the third world

2. Companies grew into big oligopolists – and so were somewhat insulated from the market

3. Monopoly capitalism developed (in large profitable firms) workplace systems that protected workers

4. Not all workers so lucky – those in highly competitive sectors (and in less developed world) acted as shock absorbers for the larger system

5. Professional managers (rather than owners) were less vigilant over profits (link to Chandler)

6. The state (which Marx dismissed as “the executive committee of the ruling class”) in practice passed protective legislation, and developed welfare states

Weber was interested in authority structures in organisations (why we do as we are told)

He made the classic distinction between power and authority:

1. Power: the ability to force people what to do, regardless of their resistance.

2. Authority: where orders are obeyed voluntarily by those receiving them.

   
   

Three types of legitimacy that make people obey authority:

1. Charismatic authority, based on devotion to a sacred and/or heroic individual or an order created by him or her. One follows a leader. This has a built-in instability.

2. Traditional authority, leaning on the tradition, the customs, and the submission to the legitimacy of those who exercise this authority. One obeys because it has always been this way.

3. Rational-legal authority, It is called rational because the means are expressly designed to achieve certain goals. It is legal because authority is exercised by means of rules and procedures. Power is in the hands of those who are rationally considered the most capable of exercising it (essentially because of their technical qualification).

This third type of legitimacy replaces discrimination, arbitrary power, and obedience with a new system where people obey rational and fair rules, to a function rather than an individual. This type of legitimacy is incarnated into organizations that Weber calls the bureaucratic type.

He analysed bureaucratic organisations (principally state organisations) which were increasingly run on “legal and rational” principles

Informal methods of control that had been used previously were unsuited for an age of unprecedented military and economic competition.

In both war and business, victory would come not simply to those with the biggest armies or newest technologies, but to those large-scale organisations that could harness the energies of their members to a common goal.

Weber’s model of bureaucracy not a literal description of actual bureaucracies – rather a simplified account of the central dimensions of a new technology of human control.

Weber: not blind to Bureaucracy’s dysfunctions

-Wrote about scale and the management structures of modern corporations

-Visible Hand: The Managerial Revolution in American Business

Modern business enterprise became viable “only when the visible hand of management proved to be more efficient than the invisible hand of market forces”

Chandler argues that (in the late 19th/ early 20th C) the large enterprise, administered by salaried managers, replaced the small traditional family firm as the primary instrument for managing production and distribution.

His central theme is that the modern business enterprise took the place of market mechanisms in coordinating the activities of the economy - i.e. in many sectors the visible hand replaced Adam Smith’s invisible hand of market forces.

This meant that the large business became the most powerful institution in the US economy, and its managers the most influential economic decision makers. This is what Chandler refers to as “managerial capitalism”.

Managerial Capitalism

Large business became the most powerful institution in the US economy, and its managers the most influential economic decision makers.

These firms not owned by single owners, but by hundreds of shareholders

Chandler referred to an economic system dominated by such firms “managerial capitalism”.

Modern business enterprise defined:

Chandler argues it has two distinct characteristics: many distinct operating units, that are managed by a hierarchy of salaried managers. These multi-unit orgs often operate in different locations, with different products or services. They are monitored and coordinated by salaried employees rather than market mechanisms.

A new subspecies of economic man:

Middle and top managers are a new class of businessperson

Chandler argues that as late as 1840 there were no middle managers in the US – that is there were no managers who supervised the work of other managers, and in turn reported to senior executives, who were themselves salaried managers. He refers to this as a new ‘subspecies of economic man – the salaried manager” (p.4). But by WWI this type of firm had become common. These firms were not owned by single owners, but had hundreds or thousands of shareholders.

1. The modern multi-unit enterprise replaced the small traditional enterprise when administrative coordination permitted greater productivity, lower costs and higher profits than coordination by market mechanisms. (Relates to Transaction costs – more on this in session 2!)

2. Internalising the activities of many business units required a managerial hierarchy. This required managers to invent new practices and procedures which in time became standard operating methods in US business.

3. The appearance of the modern business enterprise only became viable when the volume of economic activities reached a large enough scale. This came as a result of new technology and expanding markets:

“New technology made possible an unprecedented output and movement of goods. Enlarged markets were essential to absorb such output”.

Chandler argues that those sectors where technology did not bring a sharp increase in output, and where markets remained small and specialised, administrative coordination was rarely more profitable than market coordination. In those areas modern business enterprise was late in appearing and slow in spreading.

4. Once formed this managerial hierarchy became powerful and took on a life of its own; the organisation had a life beyond that of any particular individual, employees came and went, but the institution and its offices remained

5. The careers of these professional managers became increasingly technical and professional

6. Management and ownership became separated

7. Managers preferred policies that favoured long term stability and growth of their industries to those that maximised current profit

8. As the large enterprises grew and dominated major sectors of the economy, they altered the basic structure of these sectors

1. Economies of scale and scope

2. The impact of structure (multi divisional firms)

3. The professionalisation of management

Economies of scale

Supply (or cost) side: Factors that cause the average cost of something to fall as the volume of output increases

Demand side: People may be more willing to buy a product from a large firm/ network effects

Economies of scope

Factors that make it cheaper to produce a range of products together than to produce each one of them on its own:

From sharing centralized functions, such as finance or marketing.

From interrelationships elsewhere in the business process – eg: cross-selling one product alongside another or using outputs of one business as the inputs of another

In Chandler’s words: “Structure follows strategy” (and vice versa)

The strategy of diversification (product or geography) led to divisionalisation

The U form: Firm is organised as a single unit. The U form is one in which the firm is organised as a single unit, which is specialised along functional lines such as marketing, finance, personnel.

The M Form: Multi divisional structure: Delegation of operational decision making to divisions (product or market) monitored as profit centres. M form corporations: a multi divisional structure with multiple profit centres (for example according to product or region, each with its own separate functions and autonomous management team) under a vigilant head office corporate staff. Subdivision were responsible for their own production and profit; the parent was responsible for developing the overall strategy of the business.

Thus in the M form:

Centralised control over strategic decision-making investments in new products or markets.

Delegation of operational decision making to divisions monitored as profit centres.

Advantages of the M form:

Williamson argued that the M form was likely to be more efficient as the very top managers are able to tightly control the managers of each division and make sure they do not follow non-profit goals.

After adopting the M-form, many firms showed a substantial increase in their profits compared to firms who did not adopt the M-form, for a time it was felt that the multi-divisional form was the best corporate structure for large and diversified companies.

This structure also makes it easier for firms to buy and sell parts of their companies.

By the 1960s the M form had become the accepted form of management for the most complex and diverse industrial enterprises

Multi-divisional structures permitted:

Very top managers able to monitor (and compare) division leaders

Efficient (incentivises individual division leaders)

Made it easier for firms to buy and sell parts of companies to others.

In sum combined the efficiencies of scale with efficiencies of smaller more nimble units.

More on this in week 3

Labour reaction: The consolidation of capital resulted in the consolidation of labour. This led to the growth of unions (more in week 4)

Concentration of power: In 1902 Ida Tarbell, a journalist, exposed Standard Oil, arguing that the company’s rise had been accomplished by:

‘fraud, deceit, special privilege, gross illegality, bribery, coercion, corruption, intimidation, espionage or outright terror’

The reaction: Anti –trust legislation and the growth of what we would now call corporate social responsibility

It is the key to productivity growth in the private sector: the best and easiest structure for individuals to pool their capital and talent, to refine skills and innovate, and pass all this on to future generations. We are all richer as a result. (Micklethwait & Wooldridge, 2003)

No matter how much modern businesspeople assume to the contrary, the modern company is a political creation. It was the result of a social/ political battle and not just the automatic result of technological innovation. We have decided that it can:

Be an artificial person (own assets, enter into contracts)

Can issue tradable shares

These shares have limited liability

Central debate: Is the company an essentially private association, subject to the laws of the state, but no greater obligation than making money for its owners.

Or is it a public institution that has a responsibility to act in the public interest?

In other words: Shareholder theory v stakeholder theory debate