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Yet today, according to Gallup, we’ve lost our faith in large institutions, including government, religious organizations and labor unions (though we never had much faith in big business). Many attribute this trend to high profile scandals and the financial crisis, but the reality is that the decline is longstanding. In truth, large organizations are fundamentally broken.
The Industrial Revolution And The Emergence Of Bureaucracy
The industrial revolution created enormous increases in scale. Production, rather than dispersed among cottage industries and guilds, became centralized in large factories. No longer would productivity depend on the skill of artisans, but the efficiencies of organizations.
In the early 20th century, the eminent German sociologist Max Weber theorized that this increase in scale would lead to the creation of large bureaucracies to manage it all. Jobs would be broken down into small, specific tasks and be governed by a system of hierarchy, authority and responsibility.
The Rise And Fall Of Strategic Planning
In 1937, a young economist named Ronald Coase sought to make sense of the transition from artisanal to industrial production in his famous essay, The Nature of the Firm. He argued that the function of a firm was to reduce transaction costs, especially information costs, and that firms would grow until the increase in organizational costs canceled out efficiency gains.
Later, Michael Porter created the concept of a value chain, which laid out all the activities a firm or industry would undertake in order to produce a product or service. The idea was that by optimizing efficiencies in each component of the chain, efficiency could be maximized, conferring competitive advantage on effective practitioners.
Porter also posited that corporations had three viable strategies available to them: Cost leadership, differentiation and strategies focused on a particular niche. The work of Porter and others led to the development of strategic planning, which would streamline the process of transforming inputs into outputs.
Yet much like the organizations themselves, the strategic planning process became a victim of its own success. In striving for ever greater efficiency, it became more granular and cumbersome. As Jack Welch put it:
Our planning system was dynamite when we first put it in. The thinking was fresh; the form mattered little. It was idea oriented. We then hired a head of planning, and he hired two vice presidents, and then he hired a planner; and the books got thicker, and the printing more sophisticated, and the covers got harder, and the drawings got better.Unfortunately, none of the added complexity made the organizations run any better. In fact, as informational technology became increasingly cheap and pervasive, large enterprises would find themselves at a distinct disadvantage.
How Coase Got Turned On His Head
When Coase wrote his famous paper in 1937, transaction costs were a much greater concern than organizational costs. Corporations, governments and other institutions at the time were still relatively small and infrastructure still sparse (there were, for example, no interstate highways). So firms that could wring out inefficiencies could grow substantially.
Today, however, we live in an information economy. Competitiveness is no longer determined by how efficiently we move around men and materiel, but in how we connect to informational resources. More specifically, we use platforms to access ecosystems in order to create movements that may or may not reside within one particular organization.
So, in effect, the Coasean model has been turned on its head. Technology has minimized transaction costs, while organizational costs have become a heavy burden. Nimble startups can access access manufacturing resources, talent, financing, computing power and just about anything else you can imagine and still be price competitive with the big guys.
And that’s the dilemma large enterprises find themselves in at the moment. They need to manage huge organizational resources, but no longer derive the same scale advantages they used to. New strategies, such as open innovation can help mitigate the problem, but can’t eliminate it entirely.
That leaves executives with a dilemma. They still wield significant authority, but what to they do with it?
The Tony Soprano Problem
In the famous TV show The Sopranos, mafia boss Tony Soprano ruled his crew with an iron hand. Sensing that there was more to life than murder and extortion, he often sought out enlightenment from his therapist, Dr. Jennifer Melfi. Yet after listening to her advice on taking a more collaborative approach, he asked, “But then how do I get people to do what I want?”
Most executives today have some version of the Tony Soprano problem. Many are acutely aware of the transformative power of platforms ecosystems and movements, but in the course of everyday operations, they need to get people to execute according to plans—in effect to do what they want them to.
While often brushed aside, this is a serious concern. Everybody would like to think more about the long term, but unless you can solve everyday problems, you’ll never get there. However, control is an illusion and always has been. When large organizations had a monopoly on resources, it was a workable fiction. It no longer is.