Citizen Murdoch-A Case Study in the Paradox of Economic Efficiency

Freedman, Craig, Journal of Economic Issues

Success has ruined many a man.

- Benjamin Franklin

Rupert Murdoch, mephisto of the media, disciple of the global village, personifies the modern corporate entrepreneur. He seems to embody the condition of alertness that Kirzner [1979] considers to be synonymous with the entrepreneur's motive role in a market economy. As a premier opportunist, Murdoch has displayed an uncanny ability to seize the economic moment in his quest for greater market penetration and growth. Unhindered by the usual corporate constraints, the trademark of his rise has been speed of decision and efficient use of resources. Yet in 1990, Murdoch found himself teetering on the brink of economic disaster, at the mercy of a very nervous lot of creditors.

Such a stunning reversal of fortune would seem to focus attention almost exclusively on the entrepreneurial psychology driving Rupert Murdoch's ambition. If we see his creation, News Corporation, as a simple reflection of his own desires, then the force of Murdoch's personality should make any mere economic explanation of events woefully inadequate. Appearances though are misleading.

The difficulties that News Corporation faced had more to do with the way markets operate than with Murdoch's psychology. His internal devils may have exacerbated the underlying problems, as did a governance structure that relied too heavily on one person's vision. These did not, however, create the problem. The market forces that constrained the development of News Corporation caused it to face problems that were no different in kind, though perhaps in degree, than those that plague other firms. To evaluate this claim, we need to develop an appropriate analytic framework.

The Use of Appropriate Metaphors

. . . in most economic problems the best starting point is to be found in the motives that affect the individual regarded not indeed as an isolated atom, but as a member of some particular trade or industrial group [Marshall, quoted in Mental and Maital 1984, 19].

The problem of understanding the firm involves a choice of paradigms; the biological, favored by Marshall but rarely pursued, or the mechanical, more amenable to the calculus of individual choice than noteworthy for its compelling assumptions or rhetoric.(1)

The choice of an organic approach necessarily implies the study of growth and decay, a sequence of ordered events. By their very nature, these are events constrained to unfold in a limited, though not necessarily predictable, manner. This does not rule out random events, but it does imply path dependence. A developmental sequence eliminates certain options and makes others more difficult to achieve.(2)

The specific actions needed to prosper under one set of circumstances may be detrimental to continuing success, given an unanticipated set of future events.(3) Firms too well adapted to a specific environment find that they lose their ability to adjust to unforeseen changes in that environment. These firms are then at a competitive disadvantage similar to that suffered by badly managed firms - those that fail to use their available resources to seize present opportunities. Either over- or under-committing resources can yield equally regrettable results. A firm that is successful over time must steer a course somewhere between these extremes.

A firm is a set of defining relationships. The various groups that define the firm, both internally and externally, and their interconnections are analogous to so many political constituencies.(4) The process of making and meeting commitments to constituents conveys the political, rather than the legal, nature of the firm. In a sense, the firm must perform like a political ward-healer, meshing together disparate constituencies into one smoothly functioning operation. All the multi-hued and conflicting interests of these groups must be addressed to some degree if a firm is to survive.(5)

In a market economy, a firm must make a set of contractual commitments (explicit or implicit) before production can proceed. If all has gone as planned, those demands are met, and the life of the firm continues. Balancing conflicting interests requires a firm to match commitments to demands. As a result, the share awarded to each constituency must be bargained for and allotted. The firm is not a simple reflection of any individual or group of decision makers. It instead represents, at any given moment, the result of this political process, the current relation of the firm's managers, both to themselves and to their associated constituents, as well as the firm's relationship to the market environment in which it operates.

Given this understanding, the lifeblood of any firm must be its cash flow. The firm's operations are designed to generate sufficient cash to provide the means to satisfy its myriad constituencies. Failure to do so endangers the possibility of successfully negotiating a new set of commitments. This in turn threatens a firm's continuing viability.

Defining the Market Environment

Here's the rule for bargains. Do other men, for they would do you. That's the true business concept. - Charles Dickens, 1975.

Firms struggle for market share in an uncertain(6) environment. In a strictly operational sense, what they need to do in order to meet their commitments is to make use of their available resources efficiently. Otherwise, they risk becoming uncompetitive.(7) This translates into a loss of market share and a subsequent drop in cash flow. The other major imperative is to be flexible. Flexibility(8) measures a firm's ability to adjust to a change either anticipated or unanticipated. The distinction is between making provision for potential, but not certain, change (risk adjustment) and more general set asides for unforeseeable eventualities.

Flexibility includes both the explicit cost of adjustment and the implicit cost of opportunities lost as adjustment times lengthen. Speeding up this process involves reducing implicit costs by increasing explicit ones. The key to flexibility lies in the long-term cost of adjustment, not merely in the time factor alone. Firms may be able to accomplish the same required adjustment with equal expediency but with varying degrees of cost.

Since a firm must allocate its available resources between these mutually exclusive goals, by definition there must be a trade-off between flexibility and efficiency.(9) Achieving any proposed level of flexibility cannot be accomplished costlessly. Whether to meet anticipated or unanticipated change, flexibility requires the use of resources, e.g., in the form of expanded working capital or liquid assets that provides a margin for error. If, for the moment, we rule out the possibility of innovation, such resources become unavailable for alternative uses such as increased efficiency.

The Efficiency/Flexibility Trade-off

"A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!" - Lewis Carroll, 1974.

This theory of the firm brings in uncertainty not as a market aberration, but rather as a core principle of analysis. A foundation, built upon uncertainty, overlaid with increasing competition, makes a careful consideration of the trade-off between efficiency and flexibility unavoidable.

In a simple sense, a firm's resources are parcelled out between these two broad necessities, part being used to improve and possibly increase production, the rest attempting to keep a firm's options open. But as competition increases, the temptation grows to shift resources from providing for flexibility to applications that augment environment-specific efficiency. Operating under conditions of uncertainty, it is impossible to discern what the optimal mix of efficiency to flexibility might be even if we presuppose some obtainable goal and a given degree of risk averseness.

Under the stress of competition, companies bargain for current gains at the risk of attracting future adversity. If they fail to do so, present setbacks may make future difficulties a moot point. It is quite rational for firms to discount the future in this way. For the most part, the nearer the event, the more certain the outcome. This is not so much myopia as the realization that the present must dominate an unknown future. Current demands by constituents, being a known quantity, carry more weight than any vague intimations concerning future requirements.

By becoming environmentally specific, efficient under a limited set of circumstances, a firm loses some of its ability to respond to an unanticipated future. The condition of uncertainty, which creates the competitive pressure to substitute efficiency for …

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Publication information: Article title: Citizen Murdoch-A Case Study in the Paradox of Economic Efficiency. Contributors: Freedman, Craig - Author. Journal title: Journal of Economic Issues. Volume: 30. Issue: 1 Publication date: March 1996. Page number: 223+. © 1999 Association for Evolutionary Economics. COPYRIGHT 1996 Gale Group.

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