We continue with our review of Professor Richard N. Langlois July 2009 "
Economic Institutions and the Boundaries of the Firm: The Case of Business Groups". Today's post will deal with
similarity and
complementarity as they relate to gap filling. In the example provided by Langlois, LG Groups former chairman cited how the need to have "gaps" filled launched new lines of business to fill a need "At the time, no company could supply us with plastic caps of adequate quality for cream jars, so we had to start a plastics business". And the new lines of business were then used to expand into areas that were related "This plastics business also led us to manufacture electric fan blades and telephone cases".
It has been suggested in my recent blog posts that the capacity to "gap fill" is non-existent in the oil and gas industry. The collaborations between suppliers and oil and gas companies is best represented by BP blaming TransOcean and Halliburton for the problems in the Gulf of Mexico. To move forward based on innovation and further development of the sciences will require the oil and gas producers to begin to work together with the service sector. Blaming them and calling them greedy because the cost structures are escalating are symptomatic of the bigger issues. These all stem from the fact the oil and gas companies are only reaping what they've sowed. And I would also suggest that these costs are increasing due to the limited, if any, real innovation being conducted at each and every Joint Operating Committee. People are unwilling to offer any suggestion for fear of the repercussions. Why bother doing anything above and beyond when the status-quo will be accepted.
Management of the bureaucracies have reigned over the service sector with the grace of a Roman Emperor. Putting thumbs up or down on an innovation on the basis that they have immediate need for it or not, and expecting solutions to spontaneously exist when problems do arise. This entire process of development has devolved to the point where little is being done and ranks on par with the oil and gas companies suggesting to the service industry to "
let them eat cake."
The point I am trying to make here is that the ability to change from this type of mindset is difficult if not impossible. After all where are the Romans today? The transition in cultures that will build on the gap filling
similarities and
complementarities is under way, in my opinion. What this process needs is to develop the market supporting infrastructure that will support these types of innovation. That means the
Draft Specification is the crucial first piece of infrastructure.
Langlois notes two important points. 1) "Economic historians, especially those of what we might call the Stanford School (David 1975, 1990; Rosenberg 1976), have long stressed the importance of such complementarities for the pace and direction of technological change and economic growth". 2) "But that doesn’t explain why and when other institutional structures like markets or multidivisional firms arise to solve the same kinds of problems".
So how do we analyze this and change it...
A satisfying explanation, I argue, will have to be a contingent one, an explanation that takes into account the facts on the ground of markets and institutions. With only a little oversimplification, we can think of the these contingent facts as falling on three levels.
• The level of markets. How extensive are markets for complementary resources? How easy is to marshal the necessary complementary capabilities (or their outputs)?
The creativity and innovativeness of the oil and gas industry is clearly missing in the Gulf of Mexico. Gone is the can-do attitude that built the business. Today one is more likely to overhear the management openly discuss their pension benefits. The oil and gas industry is a bureaucratic nightmare.
• The level of market-supporting institutions. How well developed are the institutional structures that help markets function well – that reduce the costs of coordinating complementary activities through relatively anonymous exchange among legally separate entities rather than through internal coordination within an organization? Such institutions would run the gamut from technological standards (Langlois and Robertson 1992) to legal and organizational innovations like double-entry bookkeeping (Rosenberg and Birdzell 1986) or the anonymous limited-liability corporation (Hansmann and Kraakman 2000).
Here we have seen the capacity of the industry to employ up to 11,000 people working on the well and the flow of oil in the Gulf of Mexico. Yet no one seems to have an idea as to what to do! The thinking for the solutions to cap the leaks is at its most basic level. This is representative as to why the companies cost structures have gotten out of control. Throwing more money is the first and only instinct of management.
• The level of political institutions. What is the character of the state, the organization with a territorial monopoly on the use of force? How well protected are property rights? In what ways does the government intervene in the economy? What is the nature and degree of corruption? pp. 11 - 12
Politics in oil and gas are at a truly global scale. These forces will undoubtedly increase as the pressures from consumers and environmentalists escalate.
I think these three institutions (markets, market-supporting and political) accurately captures the tone of business in the industry. It is a do-nothing, cover yourself and make sure you get lots of cash type of operation. Other then building the
Draft Specification, what other market-supporting institutions are necessary and how do we build them? What type of organizations and institutions do we need to build? How far will the sciences advance in the next 10 years, and how will the industry keep up?
So when would we expect the problems of coordinating complementary activities to be solved by the emergence of market-supporting institutions (and thus by markets, broadly understood) and when by vertical integration? This is a crucial — and, in my view, under-researched — question. Clearly, issues of cost matter, as in the grain example. Such issues include neoclassical economies of scale; Williamson-style transaction costs; the costs of diversifying into activities requiring capabilities dissimilar from those one already possesses; and the costs of setting up and maintaining market supporting institutions (Langlois 2006). Once again, these costs are contingent: they depend on the nature and level of capabilities and of market-supporting institutions already in place. And this suggests two related hypotheses (holding other things constant, of course). pp. 16 - 17
The first is that the processes involved are likely to be path dependent and linked to the passage of time. p. 17
The second hypothesis, which has resonances at least as far back as Gerschenkron’s famous “backwardness” thesis (Gerschenkron 1962), is that the way an economy responds to the problems of coordinating economic development depends not only on its own institutions and capabilities but also on institutions and capabilities elsewhere. It depends not only on an economy’s own history but on the history of other economies as well. The force of this observation is that an economy at the frontier of economic development (however we care to define that) is likely to respond to the coordination problem differently than an economy lagging behind that frontier. Specifically, an economy at the frontier is arguably more likely to rely on decentralized modes of coordination. This is so because uncertainty is greater at the frontier — uncertainty about technology, organizational form, market direction. p. 18
For the purposes of this post I want to exclude discussion of the first hypothesis. Since we are assuming that these bureaucratic nightmares are failing, we need not rely on them. The second hypothesis suggests that depending on the degree of "frontier of economic development" will determine the level of decentralization. The world produces 120 million barrels of oil equivalent per day. Dealing with an industry of this size on a centralized basis, as the bureaucracies are attempting to today, is foolhardy. What I am suggesting is that we not only pool the producers resources represented in the Joint Operating Committee (JOC), but include the service sectors in the definition of the market-supporting infrastructure. The solution that is being suggested is represented in the Draft Specifications
Military Command & Control Metaphor,
Resource Marketplace and
Research & Capabilities modules.
If we go back to the
Preliminary Research Report we will find the work of Professor's Wanda Orlikowski and Anthony Giddens on Structuration. We will find that structuration states the organizations, society and people move together or there will be failure. In Professor Orlikowski's Technological Model of Structuration, technology identifies and supports societies. Technology is both an enabler and an inhibitor. If society and people demand more from our organizations, which clearly they are demanding of the oil and gas industry. Then technically a failure has occurred. And particularly we can see the current situation in oil and gas being inhibited by the technologies that are employed. Therefore to change organizations and culture, structuration requires that we change the technology that identifies and supports the industry, to resemble the institutions that we desire.
To Langlois' point about the frontier. The industry is transitioning from a banking mentality of earning guaranteed returns on investments. This is born of the cheap energy era where survival was the key to financial success. Now as a scientifically based industry, the two cultures are clashing and the industry is not structured to operate on this frontier. Expectations that this transition will happen naturally is incorrect.
Langlois also notes Gerschenkron's backwardness as a precursor to the second hypothesis. In The Capitalist & the Entrepreneur (
Free download available here.) by Professor Peter Klein, I find this quote that better exemplifies the current status of the energy industries efforts.
Indeed, traditional command-style economies, such as that of the former USSR, appear to be able only to mimic those tasks that market economies have performed before; they are unable to set up and execute original tasks. The [Soviet] system has been particularly effective when the central priorities involve catching up, for then the problems of knowing what to do, when and how to do it, and whether it was properly done, are solved by reference to a working model, by exploiting what Gerschenkron . . . called the “advantage of backwardness.” ... Accompanying these advantages are shortcomings, inherent in the nature of the system. When the system pursues a few priority objectives, regardless of sacrifices or losses in lower priority areas, those ultimately responsible cannot know whether the success was worth achieving. The central authorities lack the information and physical capability to monitor all important costs—in particular opportunity costs—yet they are the only ones, given the logic of the system, with a true interest in knowing such costs. (Ericson, 1991, p. 21).
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