Academic journal article The McKinsey Quarterly

The New Economics of Organization

Academic journal article The McKinsey Quarterly

The New Economics of Organization

Article excerpt

In their purest forms, markets motivate and hierarchies coordinate

Have we learned to combine the best of both?

Two challenges for the corporations of the future: entrepreneurialism and knowledge

In a classical microeconomic theory, a company is a "black box," a purposeful entity whose inner workings cannot be observed and whose behavior is determined almost entirely by the markets in which it competes. Executives and management practitioners, on the other hand, tend to behave as though changing the internal design and operation of a company can profoundly affect its performance.

Can the views of economists and managers be reconciled? Which innovations in corporate design are likely to succeed in the business environment of the next decade? We undertook a two-year research program to find out.

First, we analyzed the advantages and problems of today's largest corporations. Second, we examined the strategies and organizational designs of innovative and successful firms. These are few in number, and many of them are small. For that reason, they cannot act as a ready source of best practices for giant corporations to adopt. Yet they do offer a landscape attractive to executives for whom innovation and entrepreneurialism are aspirations rather than everyday realities.

Since the grounds for future competitive success cannot be understood solely on the basis of current practice, we also drew on the discipline of organizational economics, which analyzes organizational actions as outcomes of strategic interplay among individuals as they respond to incentives or otherwise pursue their own interests.

Organizational economics thus looks inside the "black box" of the corporation by examining the task of motivating and coordinating human activity. Though not in the mainstream of economic thought, the field has matured rapidly, and several of its leading exponents have won Nobel prizes.(*) The work of such thinkers as Ronald Coase, Oliver Williamson, and Herbert Simon informs many contemporary practices in strategy and organization.(**)

Unlike classical microeconomics, organizational economics is not at odds with a managerial view of strategy and organization. Indeed, it complements it, giving us tools for designing and changing organizations with less recourse to such ambiguous concepts as "community," "trust," and "culture." There is nothing intrinsically wrong with these ideas, which may have a central part to play in the design of effective organizations. But they are difficult to define and can impede managers' communication.

With its focus on such ideas as ownership, decision rights, and incentives, organizational economics offers a practical tool in designing companies capable of responding to the business challenges of the twenty-first century.

What organizations do

Organizations exist to motivate their members and coordinate their activities. In general, corporate performance suffers when there is a lack of motivation, coordination, or both.

For many companies, the chief challenge is insufficient entrepreneurialism: a failure to motivate top talent to seize opportunities and make the most of them. For others, the problem is an inability to develop, apply, and capture value from new technologies and practices, and to forge value-creating linkages between processes, business units, and core functions. We might think of this as primarily a knowledge challenge, or a lack of coordination.

Frederick Winslow Taylor, the father of scientific management, described the classic command-and-control organization thus: "Each employee should receive every day clear-cut, definite instructions as to just what he is to do and how he is to do it, and these instructions should be exactly carried out, whether they are right or wrong."(**) Here, coordination is a matter of centrally dictating employees' activities in great detail. Treatment of this sort may easily lead to demotivation, as the discipline and monitoring put in place to ensure that work gets done also ensure that only minimum requirements are met. …

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