Langlois, Rise of the Corporation

We begin our review of Chapter 4 "The Rise of the Corporation" of Professor Richard Langlois' book "The Dynamics of Industrial Capitalism". This chapter deals with the history and development of the corporation over the past few centuries. Prior to our review of Professor Langlois we conducted a summary review of Alfred D. Chandler, who is renowned for his work in documenting the history of the corporation. Instead of revisiting this history, I want to add to the discussion from an Information Technology (IT) point of view. Particularly with respect to the poor use of IT in the oil and gas industry. First lets set the tone of the discussion by quoting the opening paragraph of the chapter.

Industrial structure is really about two interrelated but conceptually distinct systems: the technology of production and the organizational structure that directs production. These systems jointly must solve the problem of value: how to deliver the most utility to ultimate consumers at the lowest cost. Industrial structure is an evolutionary design problem. It is also a continually changing problem, one continually posed in new ways by factors like population, real income, and the changing technology of production and transaction. It was one of the founding insights of transaction-cost economics that the technological system does not fully determine the organizational system (Williamson 1975). Organizations — governance structures — bring with them their own costs, which need to be taken into account. But technology clearly affects organization. This is essentially Chandler’s claim. The largescale, high-throughput technology of the nineteenth century “required” vertical integration and conscious managerial attention. In order to explicate this claim, we need to explore the nature of the evolutionary design problem that industrial structure must solve. p. 50

To talk about organizational structure we need to look at the information systems used by the firms and markets that make up the industry. One of the key break-through's of the Preliminary Research Report was that systems define and support organizations. To therefore change the organization requires that we build the systems to support the new organizational constructs. It is a deliberate act that needs to be carried out by those within the industry. Relying on Hayek's spontaneous order will not deliver the systems that are needed for an innovative oil and gas industry. Nothing will happen without the financial resources of the industry being dedicated to a software development capability.

On the surface this seems logical and reasonable. So what is the difficulty in securing the dedicated financial resources. Management of the bureaucracy will not fund what is counter to their best interests. They will fight to have their ways and means be the only alternative available to manage the industry. Their innovativeness and capability are developed as a result of the Chandlerian corporation. The hierarchy is a decidedly human invention that has been ably assisted by IT, not a type of organization that actively exploits the value of IT. If we look in the marketplace of the ERP systems vendor providing solution to oil and gas firms, we see nothing that has been developed in the last few decades. Many of the systems that are still operational in the marketplace are orphans of long-ago acquisitions or dispositions. The bureaucracy are not oriented, nor are they able to fully employ the types of technologies that are readily available to everyone in the Internet age. It is the modern equivalent of selling buggy whips.

Is this the type of situation that provides for the long term and substantial economic development that is needed in the oil and gas industry? Will this be the situation that the industry is operating under in 2020? With no one willing to fund the development of People, Ideas & Objects Draft Specification, it appears it will be the case. Is there an expectation that the current bureaucracy will soon see the light of IT and begin the development of the systems that will propel oil and gas forward? Will I still be writing to try and secure the necessary resources in 2020?

The fact of the matter is, the Chandlerian corporation had its day. The hierarchy was useful and productive to the point of providing the majority of the benefits that we enjoy today. It may still have some distance to travel before it fails completely, however, why should we wait for that fateful day when the alternatives are readily available? And by today I mean we could begin the development process today, the delivery of systems will be as a result of a significant effort on almost everyone's behalf.

Was it Henry Ford or the buggy-whip makers that developed the automobile? Why are we stuck in this mindset that what we have today is good enough? Do we really only respond when a crisis threatens us? We need to stop thinking that someone else will step up and solve this problem. We need to be proactive in approaching people who would be able to fund these developments and telling them they should do so. This action by everyone is the critical step that we need to take to move this project forward.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Langlois Progressive Rationalization Part I

We now have the opportunity to review Professor Richard N. Langlois book "The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy". Written in 2006, this is the book for which Langlois was awarded the 2006 Schumpeter Prize. This first post deals with the first of five chapters and is called "Progressive Rationalization".

One of the areas that we will be concentrating on in this review is the firm. By the firm I mean the oil and gas producer who holds a variety of interests in multiple Joint Operating Committee's (JOC's). These are the firms that own the oil and gas leases, facilities and production. The organizations that have the specialized engineering and earth science talents that are focused on building value through expanding their oil and gas reserves and deliverability. We will continue to focus on the market, particularly with the concepts of Industrial Districts, Small Knowledge Intensive Enterprises, Business Groups or our Community of Independent Service Providers however, I want to balance this discussion across both the firm and markets. To begin, Langlois starts off with an appropriate quotation from Joseph Schumpeter.

As soon as we go into details and inquire into the individual items in which progress was most conspicuous, the trail leads not to the doors of those firms that work under conditions of comparatively free competition but precisely to the doors of the large concerns – which, as in the case of agricultural machinery, also account for much of the progress in the competitive sector – and a shocking suspicion dawns upon us that big business may have had more to do with creating [the modern] standard of life than with keeping it down. (Schumpeter 1950 [1976, p. 82].) p. 2

This statement has certainly been the case in the oil and gas industry. Without the size and scale of the current large International Oil Companies (IOC's) we would not produce the volumes of energy we produce today. To list the number of $1 billion plus projects currently being undertaken in oil and gas is impressive. This is the nature of the industry, and to a large extent it will continue on in this fashion. To drill a well in the Gulf of Mexico may require the market capitalization of $20 billion or greater. So how is it that I reconcile these facts with the abundant criticism that I have tossed in the direction of management and the bureaucracy.

My argument is more about the velocity at which these firm's can move. Their pace is too slow and cumbersome to meet the market demands for energy. Particularly in the very near future. Just because the industry has such large scale and scope does not mean that it has to be slow and pondering. The large IOC was developed in an era that was consistent with the time frame of Professor Schumpeter's quotation, in 1950. That was several generations ago, and although the quotation is still valid today, it does not preclude us from developing innovative forms of economic organization.

Through our review of Langlois' paper on Business Groups. We learned of the "gap filling" that is the discovery mechanism for new and innovative product and services. Filling gaps is the way that people can rely on their entrepreneurial skills to provide the product or service that is needed. We also discovered that the mechanism that is necessary for filling gaps is a strong governance model. And the Draft Specification provides that governance mechanism through the Military Command & Control Metaphor (MCCM). It is through the implementation of the Draft Specification and the MCCM that the large oil and gas firm will be able to continue on with the development of their large projects. However at greater velocity and innovativeness, due to the fact that each one of these projects is a Joint Operating Committee.

Institutions may be the ultimate drivers of economic growth, but organizational change is the proximate cause. As Smith tells us in the first sentence of The Wealth of Nations, what accounts for “the greatest improvement in the productive power of labour” is the continual subdivision of that labor (Smith 1976, I.i.1). Growth in the extent of the market makes it economical to specialize labor to tasks and tools, which increases productivity – and productivity is the real wealth of nations. As the benefits of the resulting increases in per capita output find their way into the pockets of consumers, the extent of the market expands further, leading to additional division of labor – and so on in a self-reinforcing process of organizational change and learning (Young 1928; Richardson 1975). p. 3

I can also legitimately argue that the economic output of the oil and gas industry has stagnated since 2005. Commodity prices have accommodated for the lack of supply growth. As the global economy continues to demand more energy production to fuel its growth, will these large producers have the velocity and innovativeness to provide those markets? If not, who will voluntarily reduce their energy consumption? Although our large firms have the capacity to undertake the scope and scale of large projects, they are failing us by not meeting the demand for energy. Langlois points out that;

Economic growth is about the evolution of a complex structure (Langlois 2001). p. 6

The status quo is failing because there is no evolution from the Chandlerian corporation! The bureaucracy is inefficiently efficient and is poorly designed to meet the demands of the prospective energy consumer. We also know in our advanced organizations, software defines and supports the organization. Therefore to change the organization requires that we change the software first. Management have distorted this knowledge by realizing, if they never changed the software, their domain would never be challenged. Langlois notes this general trend.

History is never kind to historicists, of course; and the facts of the last quarter century have made life uncomfortable for those who would project the Schumpeter-Chandler model into the present. It has become exceedingly clear that the late twentieth (and now early twenty-first) centuries are witnessing a revolution at least as important as, but quite different from, the one Berle and Means decried and Schumpeter and Chandler extolled. Strikingly, the animating principle of this new revolution is precisely an unmaking of the corporate revolution. Rather than seeing the continued dominance of multi-unit firms in which managerial control spans a large number of vertical stages, we are seeing a dramatic increase in vertical specialization — a thoroughgoing “de-verticalization” that is affecting traditional industries as much as the high-tech firms of the late twentieth century. In this respect, the visible hand, understood as managerial coordination of multiple stages of production within a corporate framework, is fading into a ghostly translucence. p. 7

and

Schumpeter and Chandler have given us triumphalist accounts of the rise of the large corporation. But what to do with triumphalist accounts of something no longer triumphant? The menu of intellectual alternatives is short. One could reject the account as having been wrong from the start. One could deny that the large corporation is less successful and superior today than it was in the past. Or, most interestingly, one could attempt to reinterpret Schumpeter and Chandler in a way that preserves the essence of their contributions while placing those contributions in a frame large enough to accommodate both the rise and the (relative) fall of the large managerial enterprise. This last alternative – if done right – has the great advantage of preserving many of the insights of these remarkable and profound authors while at the same time extending our understanding of economic growth and of the economic theory of organization. pp. 7 - 8

People, Ideas & Objects, through our review of Langlois and others, have determined that the Joint Operating Committee is the key organizational construct of the innovative oil and gas producer. It is the legal, financial, operational decision making, communication and cultural framework of the industry. None of the existing ERP vendors even recognize that the JOC exists. Their systems are focused on the compliance to royalty, tax and SEC requirements that have nothing to do with the business of the oil and gas business. Compliance is a fall out as a result of conducting the business. By adopting the Draft Specification People, Ideas & Objects are suggesting that the industry move towards its culture of partnerships. Recognizing those partnerships within the ERP systems and aligning the business and technologies to facilitate velocity and innovation.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Langlois on Chandler Part I

We move on to a review of Professor Richard N. Langlois and his research's application to People, Ideas & Objects. Langlois' research has been in the areas of the boundaries of firms and markets, modularity, transaction cost economics, the division of labor, capabilities and his "vanishing hand" theories. These are areas that were important in developing the Draft Specification, and as I recently noted both Professor's Carlota Perez and Richard Langlois' research have been critical in the development of People, Ideas & Objects. This review will highlight some of the key areas of Professor Langlois' research, we'll also look at a number of his recent papers that we have not discussed before, and review in detail his slide presentation.

We recently completed a review of Professor Alfred D. Chandler, and what better document to start our review of Professor Langlois then a look at his 2004 essay "Chandler in a Larger Frame: Markets, Transaction Costs and Organizational Form in History". Langlois begins;

In 1977, when Alfred D. Chandler's pathbreaking book The Visible Hand appeared, the large, vertically integrated, "Chandlerian" corporation had dominated the organizational landscape for nearly a century. In some interpretations, possibly including Chandler's own, The Visible Hand and subsequent works constitute a triumphalist account of the rise of that organizational form: the large, vertically integrated firm arose and prospered because of its inherent superiority, in all times and places, to more decentralized, market-oriented production arrangement. A quarter century later, however, the Chandlerian firm no longer dominates the landscape. It is under siege from a panoply of decentralized and market-like forms that often resemble some of the "inferior" nineteenth-century structures that the managerial enterprise had replaced. p. 355

The decline of the bureaucracy is of course the other major economic initiative that People, Ideas & Objects builds off of. Yesterday in our final review of Professor Carlota Perez' paper we defined the scope of the problem facing People, Ideas & Objects and its associated communities as being within our grasp or remaining rather distant. It is these large economic changes, the decline of the Chandlerian corporation, the great surge expected from the deployment phase of the financial crisis, that make the seemingly impossible tasks that we face, possible. Add to these economic times the impact of the Information & Communications Technology Revolution (ICTR) and we see the scope of our ambition may not be that far-reaching after all.

Moving to the Joint Operating Committee as the key organizational construct of the innovative oil and gas producer. Is a necessity to deal with the expanding earth science and engineering effort represented in each barrel of oil equivalent. Using the JOC we take the common-sense approach of aligning the bureaucracies compliance and governance frameworks with the legal, financial, operational decision making, cultural and communication frameworks of the JOC. In a world dominated by the network model of organization, why would you not integrate these frameworks in this fashion.

Critical to the success of People, Ideas & Objects is the tacit knowledge held in the user communities and Community of Independent Service Providers. To enable this knowledge requires that it be accessible in more efficient means. Tacit knowledge can not be codified and is resident only within the people who work within the oil and gas industry. Networks and tacit knowledge need to be combined through a software development capability such as that considered by People, Ideas & Objects.

Much knowledge - including, importantly, much knowledge about production - is tacit and can be acquired only through a time-consuming process of learning by doing. Moreover, knowledge about production is often essentially distributed knowledge: that is to say, knowledge that is only mobilized in the context of carrying our a multi-person productive task, that is not possessed by any single agent, and that normally requires some sort of qualitative coordination - for example, through direction and command - for its efficient use. p. 359

In People, Ideas & Objects version of an innovative oil and gas producer. Acquisition of the necessary tacit knowledge is through the marketplace metaphor represented in the Resource Marketplace Module. Langlois also notes the critical nature of tacit knowledge as a competitive advantage.

In a world of tacit and distributed knowledge - that is, of differential capabilities - having the same blueprints as one competitors is unlikely to translate into having the same costs of production. Generally, in such a world, firms will not confront the same production costs for the same type of productive activity. Moreover, the costs that can make transacting difficult, and may lead to internalization, can go beyond those that arise in the course of safeguarding against opportunism or damping moral hazard through monitoring or incentive contracts. In such a world, economic activity may be afflicted with "dynamic transaction costs," the costs that arise in real time in the process of acquiring and coordinating productive knowledge. Members of one firm may quite literally not understand what another firm wants from them (for example, in supplier contracts) or is offering them (for example, in license contracts). In this setting, the costs of making contacts with potential partners, of educating potential licensees and franchisees, of teaching suppliers what it is one needs from them, and the like become very real factors determining where the boundaries between firms will emerge. pp. 359 - 360

I have extended this situation to include each participant of a JOC may effectively apply their own strategy to the assets. This strategy may not be known by any of its partners, and indeed, only in unique situations would each producer have the same assets in the region. For example, one producer may have surplus capacity in a near-by gas plant that is their key priority to optimize, whereas another may only have an interest in the producing gas wells.

To Langlois point about the tacit knowledge and the development of capabilities. One of the problems in oil and gas is that technical capabilities are developed within each bureaucracy to deal with any and all contingencies. With BP's current environmental PR efforts, we see that this containment within the bureaucracy is a failed application of capabilities. We need to also consider that the increase in scientific demands per barrel of oil requires more tacit knowledge from a constrained resource. The Draft Specification considers that these capabilities be dynamically generated through the service industry and the human resources of the working interest partners of the JOC. Only then will the future demand on these finite engineering and science based resources approach reasonable levels.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Our review of Alfred D. Chandler

We have now completed our review of the material of Professor Alfred D. Chandlers work. These posts can be aggregated by selecting the Chandler label. This review has provided us with some interesting breakthroughs and shown that we are on the right path to solving the issues we face in oil and gas. With this post I want to mark the completion of our review of the primary research. Summarize what we have learned, and indicate that this review of Chandler brings us back to Professor Richard N. Langlois. Much of the Draft Specification is based on the research that Professor Langlois has conducted. A quick review of Langlois' work will provide us with an understanding of many of the key differences in the Draft Specification. We will emphasize his work on the "Vanishing Hand" and review his presentation slides.

What did we learn that is directly applicable to People, Ideas & Objects and the Community of Independent Service Providers. Here are a few points;

• "Strategy follows Structure". Therefore by establishing the Joint Operating Committee as the key organizational construct of the innovative producer, strategy can be set for each unique asset.
  
• Schumpeter "Innovation drives economic development". For our global economy to grow, greater supply of energy is required. To meet this demand the energy producers must innovate.
  
• Professor William Lazonick "The optimizing firm is not an innovating firm, indeed it can be characterised as an un-innovating firm."
• The costs of innovation are an investment. However, the source of the funds to support innovation are from revenues not profits, equity or debt.
• Professor William Lazonick's "Social Conditions of Innovative Enterprise".
• Winter "To me the really powerful things in his story are path dependence and the organizational embededness of competencies and capabilities".
• Velocity, or "organizational speed" enabled size. Size does not necessarily enable speed. 
• Capital Started everything. Chandler's review of corporate history shows the role of the merchants. Investing their capital and skills, merchants were the ones that started the ball rolling.
  
• Management have no stake in the firm. If a crisis were to strike a firm, the management would resume elsewhere. It is the investor and debt holders who will shoulder the costs.
  
• Management currently hold the reigns, and are mindful that their options may lay elsewhere. Ownership, in the same fashion as the Merchants needs to start over. Starting over begins with supporting People, Ideas & Objects and the Community of Independent Service Providers.
• Chandler noted that management have failed before. During the great depression, a time when government had to increase its involvement in the economy. Management may not see the more global picture, and therefore, may fail again.
  

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Encana's Form of Corporate Socialism

This past week we saw a number of 2009 annual reports being published. The majority of them reflecting the difficulty in the oil and gas business during the "great recession". One particular company, Encana Corporation caught my attention. There are a family of 800 pound Gorilla's in their report, one issue stands above the rest, which ties into a paper that I recently read. The paper is written by Professor David Bardolet of Bocconi University, Professor Dan Lovallo of the University of Sydney, and Professor Richard Rummelt of UCLA. The paper is entitled "The Hand of Corporate Management in Capital Allocations: patterns of investment in multi- and single- business firms." This is another paper from the April 2010 edition of the Oxford Journal of Industrial and Corporate Change .

So why does Encana get singled out for this special treatment? Simply this issue needs to be addressed, and they did everything they could to avoid addressing it. Looking at the report their is no discussion of this issue in the message from the CEO. There is no discussion of the issue in the Management Discussion and Analysis. Only in the notes to the financial statements will the issue be brought up, and none of the press releases reflect the point.

The issue is that for U.S. Generally Accepted Accounting Principles (GAAP) their is a $14.6 billion write down of the assets. This creates a $5.5 billion loss for all of 2009. However, as a Canadian company they have the option to report under Canadian GAAP rules and these show a profit of $1.862 billion. Just a small variance. Those that understand accounting for oil and gas will appreciate the ceiling test under Full Cost accounting. Both countries apply the same general principles for the ceiling test, the U.S. system has fewer exceptions and that is the cause of the $14.6 billion difference. What the management don't seem to realize is they will need to be explaining this anomaly in their reporting until such time as the timing differences in the Canadian reporting system expire. That could be as little as one year, or as much as the natural life of the firm, who knows, apparently not the management.

Reviewing the other Canadian firms that may report similar differences in the timing of their ceiling test write downs. I found no other material anomalies between Canada and U.S. reporting. So why has Encana been affected so materially whereas their peers have no such effect? Is it because they are "un-conventional" gas producers? Is there something inherently different in that classification that would cause these write-downs? We'll never know. As the management, led by the CEO, have taken the opportunity to be completely silent as to the anomaly. Why not take this as a teaching moment to inform and educate your investors as to why their assets have been impaired? Management doesn't think that way. They prefer to cower in the corner hoping that no one notices.

Encana defines it's strategy as a "low cost, margin maximizing natural gas producer". Whatever that means. The point of this post, and the branding of Encana as a form of corporate socialism, is based on the one size fits all strategy of this large bureaucracy. I will assert that the write down of $14.6 billion of its assets is a major hit to the firm. One that places them in the position of having to seriously address their asset base. An asset base where  its natural gas production declined by 3%. If "non-conventional" gas is such a lucrative and valuable business model, why are the reserve valuations and production in such decline. From the paper.

One possibility is that our study of “averages” misses the blockbusters. That is, multi-business firms might subsidize CNU businesses because, once in a while, one of them really takes off. We cannot completely discount this possibility or measure precisely the extent of this phenomenon. However, our study of the dynamics of these segments in Section VI suggests that multi-business firms are really not that successful in finding and nurturing these blockbusters. p. 19

By using the Joint Operating Committee as the key organizational construct, strategy can be set at the asset level. If the "low cost, margin maximizing natural gas producer" strategy doesn't fit the asset, a more appropriate one can be set for that asset. This assumes that we build the Draft Specification for the innovative oil and gas producer. Enabling them to manage their assets in that fashion. The use of generic global strategies is what firms did in the twentieth century, not today.

Our results are roughly consistent with the account of “corporate socialism” developed in the corporate finance literature. Some of the work in this line (e.g. Wulf, 1999; Rajan et al., 2000; Scharfstein and Stein, 2000) stresses the agency conflict between division managers and corporate headquarters. Division managers are portrayed as rent-seeking agents that try to obtain additional compensation (in the form of extra capital allocations, among others) from corporate headquarters. They try to do so by overstating their divisions’ prospects or by engaging in direct lobbying. In turn, corporate headquarters might decide that avoiding this inefficiency in resource allocation is not worth the cost of increased monitoring or low morale and thus accede to their demands. In particular, Scharfstein and Stein (2000) make the point that managers from weaker divisions have a stronger incentive to engage in firm politics given that their demands for capital investment cannot be argued so effectively solely on the base of a prospect’s quality. Therefore, those managers end up receiving more investment capital than they should and that creates the comparative difference with their stand-alone peers in the same industry.

The corporate socialism argument rests on a complex set of relationships among various agents within the corporation. A simpler theory is offered by the literature on cognitive biases. In particular, the allocations observed in this study can be explained as a consequence of behaviors called “naive diversification” and “partition dependence”. Naive diversification (Benartzi and Thaler, 2001)—also known as the “1/n heuristic”—is the tendency for individuals to be biased toward even allocations. p. 19

Just to be clear the authors point out that this applies to oil and gas as much as it does any other business.

Partition dependence is a consequence of naive diversification when the decision-maker faces a particular partition of the set of choices. In the case of capital allocations, this partition of choices would be the organization of the business units within the company. p. 19

And here the authors make it abundantly clear how these decisions are made.

Naive diversification and partition dependence are well-observed phenomena in other fields of human decision-making. For example, Benartzi and Thaler (2001) found a similar effect in both laboratory and field data studies of investment in 401(k) plans. When asked to choose between investing in a stock or bond fund, many individuals choose to invest 50% in each. When asked to choose between two stock funds and a bond fund, many individuals choose to spread allocations equally among the three funds, which creates an aggregate investment that is more heavily weighted (2/3) to stocks. Bardolet et al. (2009) found strong naive diversification and partition dependence effects in managers facing hypothetical capital allocation tasks. The naive diversification account applied to internal capital markets would predict a tendency toward equal allocation among all the business units in a firm, thus underweighting factors that would demand more uneven allocations (such as growth rates, profitability, etc). The experimental character of Bardolet, Fox and Lovallo’s study shows that even in situations where social and political factors are not in play (i.e. a laboratory environment) those two biases are enough to cause a tendency toward even capital allocations among all business units, thus corporate socialism is a sufficient but not necessary explanation of inefficient allocations. pp. 19 - 20

What I am asserting is that the capital allocations at Encana fall within the corporate socialism phenomenon. This has led to bad capital allocation decisions being made across the organization. Either too much capital was used in the development of the reserves, or the capital spent did not develop enough reserves to support the costs. Now those chickens have come home to roost in that the capital costs are too high to support the reserves held, forcing the write down. Those familiar with the nuances of the Full Cost ceiling test will realize the material nature of Encana's problem.

Further research on the anomalies we have identified seems warranted. In particular, it seems worthwhile to try to identify the relative importance of incentives, inertia, and biases towards even allocations in driving this result. One step in this direction would be a study which included data on corporate incentive mechanisms and changes in administration. p. 20

If they wanted to study Encana, one should also study the cognitive bias towards promoting pretty young blonde's to executive vice-president positions. Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Chandler The Role of Business in the ...

Professor Alfred D. Chandler published a document entitled "The Role of Business in the United States: A Historical Survey" in the Winter 1969 version of "Perspectives on Business" from MIT Press. This paper chronicles how the economy developed. I find it surprising in many of the things that are not generally known or understood about the role and function of finance in the early years.

For a paper on the historical role of business in America to provide a solid foundation for discussions of the present and future, it must examine a number of questions: Who were the American businessmen? How did they come to go into business? How were they trained? How broad was their outlook? And, of even more importance, what did they do? How did they carry out the basic economic functions of production, distribution, transportation, and finance? How was the work of these businessmen coordinated so that the American economic system operated as an integrated whole? Finally, how did these men and the system within which they worked adapt to fundamental changes in population, to the opening of new lands, resources, and markets, and to technological developments that transformed markets, sources of supply, and means of production and distribution? The answers to these questions, as limited as they may be, should help to make more understandable the present activities and future capabilities of American business. p. 23

I want to highlight the role of what has to be the key determinant in the development of the economy, the Merchant. Specifically, the role of the merchants in financing business development and trade. This enabled much of the development of the corporation, the separation of ownership and management and the speed, scope and scale of the structured hierarchy. Without the critical skills and capital of the merchants, it is doubtful that the hierarchy would have been able to rise to such prominence.

The colonial merchant was an all-purpose, non-specialized man of business. He was a wholesaler and a retailer, an importer and an exporter. In association with other merchants he built and owned the ships that carried goods to and from his town. He financed and insured the transportation and distribution of these goods. At the same time, he provided the funds needed by the planter and the artisan to finance the production of crops and goods. The merchant, operating on local, inter-regional, and international levels, adapted the economy to the relatively small population and technological changes of the day and to shifts in supply and demand resulting from international tensions. p. 24

and

Only a few of the great landowners and leading lawyers knew the larger world. It was the colonial merchants who, allied with lawyers from the seaport towns and with the Virginia planters, encouraged the Revolution, brought about the ratification of the Constitution, and then set up the new government in the last decade of the eighteenth century. p. 24

The Merchants were the key to the development of the economy. In this paper Chandler documents how effectively the Merchants expanded economic activity to the point where the scale and scope was beyond theirs and their extended families reach. How this eventually created the "Manager" and developed the concept of the separation of management and ownership. It is noted the professionalism of the managers and their development during this time. Management replacing direct ownership as the means to effective management. Yet what is clear in the history, and is plainly clear today, is that management have no financial stake in the firm. Interestingly Chandler notes this is not the first time that this has been an issue.

In many ways, the managers were more of an elite than the earlier businessmen had been. Even though this elite was based on performance rather than birth and played a critically constructive role in building and operating the world's most productive economy, its existence seemed to violate basic American democratic values. At the same time, its control of the central sector of the American economy challenged powerful economic concepts about the efficacy of a free market. After 1930, the managers came to share some of their economic power with others, particularly the federal government. Nevertheless, they were forced to do so not because of ideological reasons, but because they failed by themselves to assure the coordination and growth of the economy, the basic activities they had undertaken after 1900. p. 35

In 2010 it is clear the division between ownership and management is as great as it ever has been. Management hold the reigns of power and have advanced their concerns over the shareholders. Leaving the ownership generally dissatisfied. Government, particularly the Obama administration, believes they are the natural progression to takeover from management. I think networks, and particularly People, Ideas & Objects and the Community of Independent Service Providers provide the best alternative to the innovative oil and gas producer.

The Depression clearly demonstrated that the corporation managers alone were unable to provide the coordination and adaptation necessary to sustain a complex, highly differentiated, mass production, mass-distribution economy. The coming of the Depression itself reflected population and technological developments. p. 35

I think the eight hundred pound Gorilla in the room is that management have no stake in this game. If failure occurs then shareholders and debtors will pay the price and management will fend for themselves. Whether it is at another firm, or their vested pension that provides them with their continuity, either is satisfactory. The point is that with no skin in the game, what is keeping management at the table.?

They have proven unwilling to fund People, Ideas & Objects software developments, why do the hard work when a new pension statement has just arrived? We are foolish to expect anything more of management, they are there for the good times and their history shows they are incapable of bridging critical economic changes such as what we are facing today.

Just as the Merchants began the whole process. Applying their capital and skills to the economy. Future development of our economy is in the investor and shareholder hands once again. Society dictates, and I hear it in the Tea Party movement, that this process be renewed.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Chandler on Decision Making

In the March 1973 Journal of Economic History Professor Alfred D. Chandler presented a paper entitled "Decision Making and Modern Institutional Change". A few days ago I commented on the velocity of productivity in the volumes and speed of decision making and idea generation in oil and gas. The origins of these comments were the Google video of CEO Eric Schmidt, and the term velocity as used by teams of Agile-Scrum developers. Velocity is the key metric in determining the through put of the software development team. In this paper Chandler also discusses the concept of velocity and attributes it as the key success of the large firms over the past 100 years. I think many of the points that Chandler makes can also be applied today. A time when the challenges to the large firm are significant. Chandler notes;

The potential of the new means of transportation and communications could only be fully realized through new methods of organization. The operation of the railroad and telegraph systems required the operation of a complex managerial structure to assure steady and continuing flows of information and orders essential to guide the movement of trains, traffic and messages. Because of greater speed and fewer trans-shipments, a railroad car could make in two days the round trip that required a stage coach or canal boat a week. By careful coordination of flow within and between the large railroad enterprises, the time involved decreased still more. As the rate of traffic flow increased, so did output per worker and per unit of capital and equipment used in the movement of goods. p. 6

The Information & Communication Technology Revolution (ICTR) is assumed to be beginning its long process of impacting businesses now. Although these technologies have facilitated enhanced speed in all organizations, new methods of organization are necessary to enable greater speed and velocity. The movement to new methods of organization has been resisted by the current management, as it conflicts with their established power. People, Ideas & Objects has had no success in convincing management of the need to change to the JOC. Theirs is a static world where, as we will begin to see in the current annual report season, is commencing on a period where their speed and innovativeness are inadequate to meet even elementary financial performance. Specifically I think that higher operating and capital costs will be directly attributable to their lack of speed. And their large balances of indebtedness are long term constraints to their viability. Particularly during times of interest rate increases. All that management have done is fully valued their debt and obligations. I have asserted on this blog before, as the financial performance of the current bureaucracies deteriorate, the innovative producer supported by the People, Ideas & Objects software application and the Community of Independent Service Providers will enable the innovative producer to purchase many of these assets from these bureaucracies. But the software has to exist first.

The briefest of historical sketches of the rise of large scale managerial enterprise in American transportation's, communications, distribution and production, emphasize that the economies of scale within the firm resulted far more from speed then size. It was not the size of an enterprise but the velocity of throughput that permitted economies that lowered costs and increased output per worker and per machine and so provided the classic, competitive advantage. Speed brought size, but size in no sense brought speed. p. 9

Clearly the bureaucracies size and lack of increasing velocity are the issues. Such were the advantages of size and speed that Chandler notes;

Once such economies were attained, the large managerial, multi-unit enterprise rarely disappeared. p. 10

Therefore the problem can simply be rectified by increasing their size and speed. If only things were so simple.

Increased velocity in turn intensified the need for complex managerial organization. p. 11

In a dynamic, connected and virtual world it is easy to focus on the problem of today. Our focus however needs to be on larger issues as we have little that we can do to influence performance by focusing on the short term. This change in culture from optimizing today to innovative will not be an easy process. It however begins by the investor / shareholder seizing the industry from management through the process mentioned above. The process of seizing the control of the industry begins by building the necessary software and communities that will ultimately support the innovative producer.

The senior executives at the top attempted to focus their energies on the critical decisions concerning present and future allocation of resources. p. 11

As we reflect on the performance of the industry over the past year. We see the economy beginning to show signs of real life. One that may be as a result of the enhanced efficiencies and innovativeness brought about by the ICTR . Demand for energy will begin to grow again. Energy prices will respond, and the reallocation of the financial resources dedicated to innovation will increase. We should look back on the history of the hierarchy and realize two things. One is the significant contribution it has made to society in terms of our quality of life.

The dominance of our society by this and other large-scale organizations is one characteristic of the twentieth-century that distinguishes it from all others. The enormously increased speed and volume of economic activity is another. p. 15

And secondly realize that we stand on the shoulders of several generations of giants. If the bureaucracy degrades as a result of the forces aligned against it. How far will society degrade. We need to act to begin to develop the new organizational methods necessary to carry us for the foreseeable future.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Chandler on Organizational Capabilities

In a 1992 paper entitled "Organizational Capabilities and the Economic History of the Industrial Enterprise" Professor Alfred D. Chandler's summaries his work. Through this blog's review of Chandler, it is hoped that we gain insight into the role of the organization in the economic development of Western based businesses. Chandler's paper certainly provides that understanding and I highly recommend reviewing it for your own benefit. There are two other references to note here today. Both are in direct contrast to the firms that are noted in Chandler's paper, and lastly we will reference Professor William Lazonick's conclusion in "The Chandlerian Corporation and the theory of innovative enterprise".

The first reference is that Fitch has revised it's outlook for Royal Dutch Shell to negative from stable. Putting their AA+ credit rating in doubt due to Shell's medium term cash flow projections. These projections assume that Shell will be able to increase their production by 600,000 barrels by 2014 and prices will average $60.00. If Shell were able to increase their production by 600,000 barrels per day and earn only $60.00 in terms of an oil price, why would Fitch put them on notice? To me there seems to be more to the story then what Fitch is stating. Possibly they don't see the 600,000 barrels per day as "possible". This downgrade of Royal Dutch Shell strikes me as odd, after all the firm is only carrying a 15.5% net debt to capital ratio. Are the analysts seeing more in terms of difficulty in the oil and gas industry?

The second article that I want to draw attention to is from John Hagel on his blog "Edge Perspectives". His commentary reflects how the future economic conditions will have fundamental changes in the ways that industries are organized. What is clearly stated as the competitive advantages of firms in the past 100 years are no longer present in his future perspective. A future perspective that is consistent with the Draft Specification's view of the oil and gas industry.

Although these three introductions appear at first to not have any relevance to one another, they are all saying the same thing. Chandler notes the past was developed at different times and with different technologies, today the oil and gas producers are having difficulty in times of robust commodity prices and the future as Hagel notes, is always uncertain.

While understandable, these efforts to read near-term indices also present very significant risks.  We continue to be seduced by near-term news, while losing any perspective on longer-term trends. These longer terms trends tell a very different story and suggest that we may be lulled into complacency by the short-term news of recovery.

and

There is absolutely no reason to believe that the long-term performance erosion will not continue.

Those two references of Hagel's are certainly in line with the long term perspective taken at People, Ideas & Objects. We have consistently highlighted the work of Professor Carlota Perez and the accuracy of her prescient analysis of the long wave economic developments. Hagel is stating clearly that today we are experiencing these forces and now is the time to shift our focus to them.

The Power of Pull suggests that we are going through a fundamental shift in the source of economic value creation.  In the past, economic value creation depended on proprietary knowledge stocks.  The challenge for any company was to acquire some proprietary knowledge, rigorously protect it to make sure no one else had access to it, and then as efficiently as possible extract the economic value from this proprietary knowledge stock for as long as possible.  As change accelerates and uncertainty grows, though, knowledge stocks depreciate at a more rapid rate.  In this kind of environment, the key to economic value creation shifts to the ability to participate in a growing number of diverse knowledge flows to more rapidly refresh our knowledge stocks.

The Community of Independent Service Providers (CISP) is exactly what he is talking about. Participation as an independent entrepreneur that develops and implements the "knowledge stocks" of the innovative oil and gas producer is what the CISP is about. These people will also be the ones that work closely with the People, Ideas & Objects developers to instill their knowledge into the tools they will use to define and support the innovative oil and gas producer.

The good news is that there is a pragmatic migration path that can move us from where we are today to where we need to be in a world of pull.  Small moves, smartly made, can in fact set big things in motion. To pursue this path, though, we will need a sense of direction, harness different forms of leverage and deploy platforms that can accelerate the pace of change.

These small moves could be made by following this process to join the CISP. In the past week we provided a comprehensive review of Professor William Lazonicks work on Chandler. I want to close this post with a reference from Lazonick's conclusion that shows these changes are inevitable. Inevitable to everyone but the bureaucracies that are resisting these changes.

In the 2000s, it can fairly be said that the Chandlerian corporation has ceased to exist. In historical retrospect, Alfred Chandler uncovered the dynamics of a historically-specific business model that drove the development of the world’s richest economy. The essence of capitalism is, however, as Schumpeter recognized, change. The work of Chandler has provided us with a deep understanding of the foundations of US economic power in the middle decades of the last century. His work does not provide us with a roadmap for understanding the business models that have become dominant in the first decades of the 21st century. There is a need for us, who seek to build on the Chandlerian legacy, to remain committed to the integration of theory and history. My claim is that, with its focus on strategic control, organizational integration, and financial commitment, “the theory of innovative enterprise” is a potent framework for analyzing the process of change. It is a framework that, through the integration of theory and history, can enable us to “catch up with history” so that we can analyze the present as an evolving reality before the present as history passes us by. p 29

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Lazonick on Chandler Part IV

Part IV of what has turned out to be a phenomenal paper, reviews Lazonick's "Part 3. Social Conditions of Innovative Enterprise" of "The Chandlerian Corporation and the theory of innovative enterprise". I indicated in an earlier post that the Joint Operating Committee and the application of the Draft Specification were consistent with Lazonick's Strategy, Organization and Finance; which make up his framework for "Social Conditions of the Innovative Enterprise". In this post I want to go into more detail as to how I see these three social conditions provide value for the investor / shareholder. Value in using the JOC through application of the People, Ideas & Objects Draft Specification and Community of Independent Service Providers (CISP).

Before we begin I want to make a quick note to highlight one attribute of the Draft Specification. In order to make the Draft Specification functional we needed to develop an alternative governance structure to replace the hierarchy. That is the Military Command & Control Metaphor (MCCM) used at the Joint Operating Committee to give the necessary structure for it to operate. Without this structure it would be difficult to implement any plans or to enable any actions. This MCCM replacement structure adopts a pooling of the resources available from the various producers represented at the JOC. This pooling of resources is further augmented by the objective (ie not affiliated with any one producer) and JOC focused pool of CISP that the JOC hires directly. All of these resources adopt a military styled command structure based on their education, experience, skills and the chain of command determined by the JOC representatives.

3. Social conditions of innovative enterprise

Lazonick provides in his social conditions a clarity in how the system is workable when strategy, organization and finance are aligned.

The theory of innovative enterprise provides a framework for analyzing the roles of strategy, organization, and finance in generating the competitive advantage of one firm over another within the same industry (see e.g., Carpenter et al., 2003; Lazonick and Prencipe, 2005; Lazonick, 2009a: ch. 2).... As I have shown in this work [for syntheses, see Lazonick (2003, 2004b, 2007)], the theory of innovative enterprise permits us to identify three social conditions that may support the transformation of strategy, organization, and finance into innovation across the industries and constituent enterprises that characterize the national economy. Even in the highly globalized world of the 21st century, the social conditions of innovative enterprise differ across nations characterized by distinctive economic institutions for governing the allocation of resources, employing labor, and financing investment. pp. 14 - 15

In the Preliminary Research Report it was noted financial interest at the JOC drove consensus and collaborative decision making. People, Ideas & Objects appeal is to the investor / shareholder in oil and gas. It is these individuals that we are attempting to provide an alternate organizational structure, the JOC supported by this software development capability and community, to manage their assets. I therefore see the participants who are sitting at the JOC the individuals that directly own the working interest or their designated proxy. With that in mind lets begin the review of Lazonick's social conditions of the innovative enterprise.

If the shareholder / investor is the one sitting at the JOC, representing their interests, based on the culture of the industry, they are endowed with the operational decision making authority for that property. These decision rights are critical to Lazonick's first social condition.

In the framework that I have developed, the social condition that can transform strategy into innovation is strategic control: a set of relations that gives decision-makers the power to allocate the firm’s resources to confront the technological, market, and competitive uncertainties that are inherent in the innovation process. For innovation to occur, those who occupy strategic decision-making positions must have both the abilities and incentives to allocate resources to innovative investment strategies. Their abilities to do so will depend on their knowledge of how the current innovative capabilities of the organization over which they exercise allocative control can be enhanced by strategic investments in new, typically complementary, capabilities. Their incentives to do so will depend on the alignment of their personal interests with the interests of the business organization in attaining and sustaining its competitive advantage. p. 15

In reading this I am struck by what Professor Carlota Perez said about "new" organizational constructs being "Common-Sense". Those with a reasonable understanding of oil and gas operations can see the nature of this ownership / control mechanism at work in the strategic control social condition. When a JOC is formed it is by agreement. Included within the agreement is an operating procedure with the means spelled out as to the decision making authority under the agreement for that JOC. Therefore the use of the JOC meets the first social condition necessary in Lazonick's framework.

This second social condition is not present in the oil and gas industry today. There is substantial conflict between the JOC and the bureaucracy. The bureaucracy, which represents the operator, conducts all or most of the operations as if it were their own. The JOC is relegated to a few ceremonious meetings to make decisions based on the agreement in hand. It is then the bureaucracy that essentially implements the will of the JOC within its annual operations. There is no pooling of human resources and the non-operator is relegated to spectator status for the better part of the year. This situation can not be sustained when the operators are required to develop their internal capabilities to deal with all of the individual possibilities and contingencies within the areas they operate in. There are not enough engineers and geologists available to meet the needs of each producer building redundant silo's of capabilities that may or may not be required. The Resource Marketplace Module deals with breaking down these silo's and the development of the means to dynamically pool the resources of the producers represented in the JOC. These resources are further augmented by the CISP and the service industries to develop this dynamic capability.

The social condition that can transform organization into innovation is organizational integration: a set of relations that creates incentives for people to apply their skills and efforts to organizational objectives. The need for organizational integration derives from the developmental complexity of the innovation process—that is, the need for organizational learning—combined with the imperative to secure high levels of utilization of innovative investments if the high fixed costs of these developmental investments are to be transformed into low unit costs. Modes of compensation (in the forms of promotion, remuneration, and benefits) are important instruments for integrating individuals into the organization. To generate innovation, a mode of compensation cannot simply manage the labor market by attracting and retaining employees. It must be part of a reward system that manages the learning processes that are the essence of innovation; the compensation system must motivate employees as individuals to engage in collective learning. This collective learning, moreover,cumulates over time, thus necessitating the sustained commitment of financial resources to keep the learning organization intact. p. 15

The Financial Marketplace Module looks to move the financial structure of the industry away from supporting the corporate entity and moves it to directly support the JOC. This implies that, within reason, the property represented would source their bank debt from one bank for all producers. This could be extended to include each working interest owner securitizing the asset on an exchange. (Please see the Compliance & Governance Module for further information on this point.) The point being that strategy and finance need to be aligned. Producers at the JOC are currently conflicted by varying degrees of financial flexibility based on the size of the producer and its financial situation. The size of the producer has no bearing on the innovativeness at the JOC or its upside. A small producer may be more inclined to drag its feet if left to fund their commitments through general bank assignments on the corporation, whereas, the bank representing the JOC could be better positioned to mitigate its risks through a general assignment of the specific JOC.

The social condition that can transform finance into innovation is financial commitment: a set of relations that ensures the allocation of funds to sustain the cumulative innovation process until it generates financial returns. What is often called “patient” capital enables the capabilities that derive from collective learning to cumulate over time, notwithstanding the inherent uncertainty that the innovation process entails. Strategic control over internal revenues is a critical form of financial commitment, but such “inside capital” must often be supplemented by external sources of finance such as stock issues, bond issues, or bank debt that, in different times and places, may be more or less committed to sustaining the innovation process. pp. 15 - 16

Lazonick is talking about more then what the Financial Marketplace Module of the Draft Specification considers. The financing mechanisms are one of the key areas where additional value, flexibility and innovativeness can be generated from. But what Lazonick notes here as the social condition is the role of the CISP . These people are not affiliated with one individual supplier or one individual producer. They are independent as their name reflects. They have not been constrained by the Exxon or Schlumberger way. And I am not stating that those firms ways are wrong, the CISP is independent of that. Their focus is on the needs of the JOC and the ability to be innovative and support this software development capability as well as the JOC.

In yesterday's post I offered the "Velocity of Productivity" as a new concept to consider for the future. This is the domain of the CISP in terms of ensuring that the value of the industry, the JOC and the software development are all consistent with social conditions that Lazonick correctly asserts are necessary for Strategy, Organization and Finance to be in alignment.

Lastly as I indicated in the first part of this post the Military Command & Control Metaphor is a critical concept in making these "Social Conditions for the Innovative Enterprise" work. Without structure there will be failure. What is needed is a means to extend the structure of the JOC to include the producers represented, the CISP and the suppliers who make the industry function. The broadening of the scope outside of the current "operator-only" methodology is a necessity due to the resource constraints, particularly the engineering and earth science resources of an innovative oil and gas industry. What we need to do is introduce a different means of organization in order to expand the potential output of the oil and gas industry. The MCCM and Lazonicks "Framework for Social Conditions of the Innovative Enterprise" are the means to do that.

People, Ideas & Objects and the Community of Independent Service Providers need to see this financial commitment from the oil and gas investor and shareholder. We are offering a more effective manner in which to manage the oil and gas resources of the producer firm, and this effectiveness will not come about without the commitment's from these producers. Management have proven time and again that they will not fund these developments. There's is a situation that compromises the separation of management and ownership to the benefit of management. Why would they support an effective means of managing oil and gas assets.

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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Lazonick on Chandler Part IIIb

This is our third post from Lazonick's paper "The Chandlerian Corporation and the theory of innovative enterprise." In our past two blog posts we have learned some interesting things that are directly relevant to People, Ideas & Objects. In the first post we noted the three generic activities that require alignment; strategy, organization and finance. How the Draft Specification provides for these three activities. And the differences between two corporate strategies defined as "optimizers" and "innovators". Noting that Lazonick defines optimizers as non-innovators. In the second post we determined that the business of the oil and gas business required substantial investment to attain the necessary innovative strategic footing. How today the current bureaucracies are unwilling and incapable of making these investments. And that the investors / shareholders in oil and gas have the opportunity to form their own new and revised organizational ways and means around using the Joint Operating Committee as the key organizational construct, and the People, Ideas & Objects software development capability.

In the Preliminary Research Report it is noted that the higher commodity prices are a reallocation of the financial resources to support innovation. It is the product revenues from oil and gas sales that fuel the innovations. Financing of innovation through debt, equity or profits would be too costly and would generally be inadequate in terms of affecting the performance of the industry. A much larger source of funding is required to fuel the type of innovation that the oil and gas needs. Innovation is a profit generating activity. This fact becomes clearer in today's review of Lazonicks paper.

2. The theory of innovative enterprise cont

In the first quarter of 2010 People, Ideas & Objects attempted to fund its budget needs for the calendar year. As we are aware, the total sum of these activities generated $0.00. This in direct contrast to the 30 compelling reasons supporting why we should be funded. I have pointed to this funding failure as a fact that proves the bureaucracy will never fund these developments. The point is that this environment needs to be created and supported. As Schumpeter noted "innovation drives economic development."

The optimizing firm may calculate, on the basis of prior experience, the risk of a deterioration of current market conditions, but it has no way of contemplating, let alone calculating, the uncertainty of returns for conditions of supply and demand that, because innovation is involved, have yet to be created. The fact, moreover, that the optimizing firm will only finance investments for which an adequate return already exists creates an opportunity for the innovating firm to make innovative investments that, if successful, can enable it to out compete optimizing firms. Indeed, in the future optimizing firms may find that the cause of the “poor market conditions” that they face is not the result of an exogenous shift in the industry demand curve but rather the result of competition from innovating firms that have gained competitive advantage while their own managers happily optimized (as indeed the economics textbooks instructed them to do) subject given technological and market constraints. p. 9

Therefore I see the existence of two fundamentally different oil and gas industries for the next 10 years. Those that are optimizing and atrophying, and those that are innovating and growing. A key difference is the use of the People, Ideas & Objects software that supports and defines the innovative oil and gas producer. The critical role of the Community of Independent Service Providers (CISP) in enabling oil and gas innovation. And the direct investments in innovation that are needed.

An innovative strategy, with its fixed costs, results from the assessment by the firm’s strategic decision-makers of the quality and quantity of productive resources in which the firm must invest to develop higher quality processes and products than those previously available or that may be developed by competitors. It is this development of productive resources internal to the enterprise that creates the potential for an enterprise that pursues an innovative strategy to gain a sustained advantage over its competitors and emerge as dominant in its industry. p. 10

Lets be clear, the costs of these software developments are minuscule to the costs of developing the innovative oil and gas industry. The global oil and gas industry is currently a $3.8 trillion / year industry. I see a significant portion of those annual revenues being dedicated to the processes of innovation. A critical enabling resource within the industry will be the Community of Independent Service Providers, they are the ones that will have the skills and resources necessary to support the innovative oil and gas producer. They are how the energy industry evolves and matches or supports the innovations made at the producer level. Achieving the CISP's overall objective of providing their producer clients with the most profitable means of oil and gas operations. What is needed for both the software and communities to develop is to have access to these financial resources.

Such development of productive resources, when successful, becomes embodied in products, processes, and people with superior productive capabilities than those that had previously existed. But the high fixed costs that such investments entail mean that in and of themselves these investments place the firm at a competitive disadvantage until such time that, by developing and utilizing these investments, it can transform the technologies and access the markets that can generate returns. An innovative strategy that can eventually enable the firm to develop superior productive capabilities may place that firm at a cost disadvantage because such strategies tend to entail higher fixed costs than the fixed costs incurred by rivals that choose to optimize subject to given constraints. p. 10

I can not for the life of me see the energy industry as it exists today changing to the one described in the previous quote. It isn't in their organizational DNA. The process of creative destruction, or as I have detailed the two oil and gas industries, one optimizing the other innovating, is the only means that change of this scale can take place. As the optimizing firms atrophy and their earnings decline, assets will be sold to the innovators, creating a substantial opportunity for the innovative producer through this process of renewal.

If the size of investments in physical capital tends to increase the fixed costs of an innovative strategy, so too does the duration of the investment required for an organization of people to engage in the collective and cumulative—or organizational—learning that is the central characteristic of the innovation process. p. 10

and

The revenues (and not just the profits) that the innovating firm generates can be critical to maintaining its organization intact. When the innovating firm generates revenues, it has financial resources that can be allocated in a number of ways. If the gains from innovation are sufficient, the firm’s revenues create the possibility for self-financing....For the innovating firm, financial resources not only fund new investment but also enable the firm to keep its “learning” organization intact. The innovating firm can use the gains of innovative enterprise to reward its employees for their application of skill and effort to transforming technology (unbending the cost curve) and accessing markets (shifting out the demand curve). p. 13

We have commented on this blog many times before about the mechanical leverage that man has achieved over the past century. 18,000 man hours of labor is contained within each barrel of oil. To convert this factor into the number of man years of physical effort that is offset each year for each American, that number is 385. That is; each American receives the equivalent benefit of 385 man years of physical effort per year. Truly surprising and something that has to be maintained by ensuring that the oil and gas is available to continue to provide the offset. The point in raising this is to ask the question, at what point in time do we achieve an equivalent level of leverage in terms of intellectual thought? And as importantly, how do we get there? I know the first two steps are to gain a software development capability and secondly begin the development of the Community of Independent Service Providers.

The innovation process, that is, can potentially overcome the “constrained-optimization” trade-offs between consumption and production in the allocation of resources as well as between capital and labor, and even between enterprise and society, in the allocation of returns. It is for this reason that innovation can form the foundation for equitable and stable economic growth, or what I have called “sustainable prosperity” (Lazonick and O’Sullivan, 2002; Lazonick, 2009a). p. 14

Our appeal should be based on these eight "Focused on" priorities and values of how better the oil and gas industry and its operations could be handled. They may not initially be the right way to go, but we are committed to working with the various communities to discover and ensure the right ones are. If your an enlightened producer, an oil and gas director, investor or shareholder, who would be interested in funding these software developments and communities, please follow our Funding Policies & Procedures, and our Hardware Policies & Procedures. If your a government that collects royalties from oil and gas producers, and are concerned about the accuracy of your royalty income, please review our Royalty Policies & Procedures and email me. And if your a potential user of this software, and possibly as a member of the Community of Independent Service Providers, please join us here.

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