2. The Firm’s Coordination of Plans and Activities Prof. Phillip J. Bryson Marriott School Brigham Young University

3. Part I Abstract Prices as a coordination mechanism. Prices supply information and incentives, so that they could be the basis of intra-firm economics. One division of the firm could sell its production to another division. But price coordination may work too slowly within the firm, where direct coordination is possible through planning and managerial instructions.

4. Coordination of the firm If there really were some basic intrinsic advantage to a system which employed prices as planning instruments, we would expect to observe many organizations operating with this mode of control, especially among multidivisional business firms in a competitive environment….

5. Coordination of the firm Yet the allocation of resources within private companies (not to mention governmental or nonprofit organizations) is almost never controlled by setting administered transfer prices on commodities and letting self- interested profit maximization do the rest. The price system as an allocator of internal resources does not pass the market test. Martin Weitzman

6. Coordination of the firm What is Weizman saying here? Managers could let the divisions of their corporations buy from and sell to each other on the basis of market relations. But usually they don’t. Why not?

7. Coordination of the firm Using the market for coordination is essential when we speak of a large, national economy. The information for detailed direction of the economy is too voluminous and complex to manage, and it is difficult to motivate a nation of economic agents to interact properly. The market does better.

8. Coordination of the firm The firm is smaller and more easily managed. In fact, managers believe that they can use planning and issue instructions that will coordinate more precisely, more quickly, and more flexibly than market sources would.

9. Why is the price system so important? Prices can provide automatically the necessary information for control in reasonably competitive, market environments. Why is the price system effective where it functions?

10. Why is the price system so important? It coordinates without requiring communication (beyond that information communicated about basic economic realities in market prices).

11. Why is the price system so important? Also, it does not require individuals to do more than what they deem to be in their own interests. Price relationships provide the incentive for action.

12. When Prices Don’t Work Where prices don’t provide the appropriate information and incentives, what must be done? Someone must organize and plan. “Routines are developed, and administrative processes and procedures are instituted to guide activity.” (Milgrom and Roberts, p. 89)

13. When Prices Don’t Work Even where markets function, other means of coordination are also applied. Some governments, for example, prefer to use direct orders. In some countries (e.g., Japan and South Korea), governments have targeted industries for expansion and new technologies for development, coordinating the implementation of plans in those industries.

14. Some Coordination Problems: Coordination and Design Attributes We will now consider some of the coordination problems of resource allocation through non-price mechanisms. We will look at particular attributes of allocation that make one or another system of coordination effective.

15. Some Coordination Problems: Coordination and Design Attributes Allocation problems have design attributes where there is a lot of planning information available and where the most costly error is failure to achieve the right relationship among variables (we speak of the right “design” when the pieces of the puzzle fit together well).

16. Assignment Problems Assignments to coordinate activities are made, so goals can be accomplished without duplication of effort.

17. Assignment Problems An example of coordination assignments. Calling for an ambulance and having the dispatcher assign the nearest one to come.

18. Assignment Problems Should the dispatchers attempt to determine a system of prices to establish which vehicle and crew could provide the most appropriate service at the best price? No, they just send one.

19. Assignment Problems But notice the less time-pressured question of the purchase of ambulances.

20. Synchronization Problems The Cockswain and the Rowing Crew (Choosing the pace and rowing in unison) Try using prices here: the price equals the value of additional effort to the team.

21. Synchronization Problems How might one determine individual prices to get the right efforts and communicate the prices to the individual team members. Price negotiations with the rowers would be too slow, and everyone might not pull together.

22. Developing Organizational Routines Where organization routines develop, there is no need for the more expensive reliance on centralized direction (cockswain or dispatcher). Organizations can establish routines that help decentralized agents solve recurrent design problems.

23. Developing Organizational Routines Actions are decentralized when they are left to individuals at lower levels of the organization to make independently. The price system is decentralized. But leaving all decisions to individuals who actually take the actions means the decisions might be uncoordinated.

24. Problems in Designing Organization Routines The problem is to determine: At which levels agents will participate in decisions? what information should be communicated to help the individual decision makers?

25. Problems in Designing Organization Routines which parts of the decision should be centralized? who should make the centralized decision, and

26. Problems in Designing Organization Routines what information should they use? In other words, Who won’t drop the ball?

27. The Role of Management: Ensure Coordination The organization can succeed only if coordination is accomplished by carrying out a feasible plan of action.

28. The Role of Management: Ensure Coordination The plan will promote the organization’s goals; it must be adjusted through time to remain feasible as circumstances change. Coordination must ensure that the members of the organization are properly motivated.

29. The Role of Management: Ensure Coordination Efficient organization must leave workers and supervisors at lower organizational levels considerable autonomy in implementing their parts of the plan

30. Brittleness of the Plan In deciding what and how to communicate, two characteristics are important: the costs of information transfer and the brittleness of the corresponding planning system: How badly does performance deteriorate when information is imperfect?

31. Brittleness of the Plan Senior management usually must determine and communicate the firm’s overall strategy, but lower levels retain responsibility for implementation where they have the necessary information available.

32. Innovation Attributes We speak of innovation attributes when a problem needs to be solved for which no information or experience is available to lower decision levels in the organization. A decentralized approach won’t work in such cases, e.g., introducing a new product, entering a new market, or adopting a new manufacturing technique. Care must be taken to get the information and incentives generated and communicated properly.

33. Innovation Attributes Procedure: the center and people in operating positions must gather new information, possibly from outside the organization. Plans must be developed and communicated to lower levels or departments. New roles and tasks must be clearly motivated and explained, taught, or illustrated. A price system (relying on the local knowledge and incentives of individuals at all levels in the organization) will not allocate resources optimally here.

34. Judging Coordination Systems We use three criteria to compare how well different systems perform in solving economic problems. First, if all reports were honest and accurate and all information processed costlessly and accurately, could the system achieve efficient outcomes? (With good information is the system efficient?)

35. Judging Coordination Systems  Second, how much information must be communicated? (Could other systems do as well with less information?)  Third, how brittle is the system? If there is too little information or it has some inaccuracies, how badly will the system’s performance deteriorate ?

36. Choosing a specific system This is like the evaluation of most kinds of investment projects, public or private.

37. Choosing a specific system No magic required. We must simply compare: The net benefits offered vs. Information costs.

38. ADMINISTRATIVE COORDINATION RATHER THAN PRICES Why administrative coordination rather than prices? Where line managers know about local production operations and capabilities,

39. ADMINISTRATIVE COORDINATION RATHER THAN PRICES But where line managers don’t know about new technologies, new markets, new business partners, or new forms of organization, (i.e., where strategic decisions have innovation attributes),

40. ADMINISTRATIVE COORDINATION RATHER THAN PRICES and where economies of scale (especially in manufacturing) require direct communication and coordination,… Use administrative coordination!

41. COORDINATION AND BUSINESS STRATEGY Operational scale is itself a part of the design of a firm. If a large sales volume is anticipated, the firm’s size must be planned -- production capacity, size of sales force, distribution equipment and facilities.

42. COORDINATION AND BUSINESS STRATEGY If actions are to be coherent, during growth the marketing, production, personnel and procurement managers must have a shared view of the growth.

43. COORDINATION AND BUSINESS STRATEGY The scale of operations affects more than just the scale of each of the firms’ organizational parts; it also determines what degree of specialization should be adopted by the firm.

44. COORDINATION AND BUSINESS STRATEGY Various economies of scale permit costs to be smaller and prices to be lower. That encourages greater quantities to be demanded and, in turn, supports an increased scale of operations.

45. Scale Economies of scope are enjoyed when firms can produce their several different, but related products together at lower cost than a group of single- product firms could

46. “Economies of scope exist when the cost of jointly producing a set of products within one firm is less than the cost of producing the products separately across independent firms.” Brickley, Smith, Zimmerman, p. 118.

47. “Joint production can produce cost savings…from common use of production facilities, coordinated marketing programs, …sharing management systems,” and using the natural byproducts (mutton and wool) that sometimes exist.” Brickley, Smith, Zimmerman, p. 119.

48. With economies of scope, firms can produce components used in each of several products (e.g., small electric motors used in numerous, related appliances and products). In producing that component part, economies of scale may be experienced. Then again, they may not. Economies of scale and scope are independent phenomena.

49. Coordination needs exist where there are economies of scope, just as strongly as in economies of scale, and may be more complex as managers responsible for different products must be coordinated.

50. Core Competencies Core competencies are scale economies resulting from the development of new products. Generalized expertise is developed in those skills important for the design and marketing of new products in a set of related markets or in using a set of related technologies. Economies here result from technological and organizational strengths.

51. The cost of building a competency of some new product is shared with a series of products that doesn’t yet exist. As the firm adjusts to using the new system, it prepares to deal with a whole generation of products not yet even imagined. An Italian Core Competency

52. Prices of new products must be low to maintain strong sales volume (even if there are losses), since the firm is investing in capabilities needed for future products. An Italian Core Competency

53. Compare this problem to the national one in Japan -- developing numerous technologies for HDTV, high definition television expected in the 90s, a massive project requiring national coordination. An Italian Core Competency

54. Complementarities and Design Decision Activities are mutually complementary if engaging in one increases, or at least doesn’t reduce, the profitability of any other complementary activity in the group.

55. Complementarities and Design Decision High levels of activity will go together for all elements of a group of complementary activities. But associated with this is the high cost of failure to coordinate the parts that fit together.

56. Produce a wide range of related products for customers with specialized needs. Is this all manufacturing is?

57. Retain high flexibility. Produce small quantities so you need not set up specialized production lines for each product. Is this all manufacturing is?

58. Retain high flexibility. Produce small quantities so you need not set up specialized production lines for each product. Is this all manufacturing is?

59. Avoid holding inventories. Sales staff communicate quickly and more often with the factory. Make more frequent, smaller production runs.

60. Main Issues of This Presentation Slides 1-6. Market relations vs. hierarchical relations and a corporate plan for the divisions of a modern corporation. Slides 7-9. What prices can do (coordinate automatically on the basis of price info). Slides 10-11. Prices can’t coordinate with sufficient speed and precision. Problems of coordination in organizations (hierarchy)

61. Main Issues of This Presentation Slide 12 “Design Attributes” Slides 13-17. Coordination by assignment (or by a dispatcher, not by prices). Slides 18, 19. Synchronization by cockswain. Slides 20-24. Designing organizational routines. Slides 25-27. Coordination and management. Slides 28, 29. Brittleness of the Plan Slides 30, 31 Innovation Attributes (introducing innovations).

62. Main Issues of This Presentation Slides 36-38. When to use administrative action in firm coordination. Slides 43-47. Economies of scale and scope. Slides 48-51. Core competencies Slides 54-57. Modern manufacturing strategy.