Capabilities and Governanace.

Continuing on with our review of Professor Richard N. Langlois, next up is his paper "Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization." Written by Langlois and Professor Nicolai J. Foss of the Copenhagen Business School. The title of this entry will take you to the Social Science Research Network to download the .pdf.

From the abstract of the document I would like to note how much of the work that Langlois et al are doing is applicable to the work being done here for oil and gas. I would suggest that oil and gas may become an excellent resource for this type of research. The abstract of this document states;

"However, a new approach to economic organization, here called "the capabilities approach," that places production centre stage in the explanation of economic organization, is now emerging. We discuss the sources of this approach and its relation to the mainstream economics of organization." pp. 1

Later in the document Langlois et al state

"One of our important goals here is to bring the capabilities view more centrally in the ken of economics. We offer it not as a finely honed theory but as a developing area of research whose potential remains relatively untapped. Moreover, we present the capabilities view not as an alternative to the transaction-cost approach but as complementary area of research" pp. 7.

And

"In sum, whether we see it from the perspective of the capabilities perspective or from the perspective of the modern economics of organization, there is an exciting theoretical frontier ahead." pp. 31

I can only concur.

A little review of Langlois' theories may help to assimilate the contents of this document. The market model requires "transactions" to occur between separate economic units. These transactions create "friction" in terms of the resources necessary to process the transaction itself. Typically these "transaction" costs were mitigated by industry forming companies that held the production and capabilities. This is referred to as the "transfer" model by Langlois et al. In the "transfer" model an employer only needed to tell his employees what needed to be done, there would be no transactions to process other then for the employee salary.

What happens as a result of this avoidance of "transaction" costs is that the industry needs to be defined and controlled through the traditional hierarchy's command and control structure. One of the key points that Langlois et al is providing evidence of is, transaction costs are used by the market to provide the oil and gas producer with what it needs in an entrepreneurial manner. The market is able to anticipate and make the determination of where the industry is heading and will work to anticipate and capture the future demands of the producer.

Langlois et al states that with the automation of transactions through the current Information Technologies. Transaction costs can be reduced to an immaterial level. This provides industry with evidence and a means to move from transfers within organizations, to transactions in markets.

It is at this point that I want to assert how damaging an economic model it can be when an industry is based on "transfers" instead of "transactions". In Calgary a few years ago many of the Drilling suppliers found their capacity utilization hit 100%. However, the market demand may have been at approximately 125% of capacity. Based on the history of the ups and downs in the market, the drillers were very hesitant to invest to increase their capacity. Recall that surplus capacity in any industry can become one of the largest fixed costs of a firm. Hence the producers who were needing the increased drilling capacity commissioned and paid for drilling rigs for their exclusive use. The drilling contractor would operate the new rigs for the producer on the basis of the producer's needs.

Why this type of "transaction" should be avoided is based directly on the Langlois et al theories that we have learned to date. The driller and his competitors, and most importantly the new drillers seeking to enter the business, seeing a new dynamic in the capacity increases and utilization, lost all incentive to take a risk in the market. Bringing a new rig or new technology to the marketplace would be too risky for any new player. What the producer signalled to the entire industry is that the hierarchies would now micro manage a drilling division due to the investment in drilling rigs. These types of "messages" are what Langlois et al is speaking about. The wrong message is being sent to both the competitive supplier side and the producer side. If producer A is willing to buy his own rigs, then producer B will have to do the same to have his wells drilled. The supplier marketplace, seeing that it is now possible to defer the risk and capital costs of new capacities to the industry will sit back and await the time for a producer to ask for the next great innovation. This is how the western capitalist marketplace begins to take on characteristics of the former Soviet Union.

In this scenario of market "transfers" it has become very difficult due to the lack of innovation and capabilities focus. The large producers don't understand why the marketplace can't accommodate its needs, and therefore feels compelled to get things done on its own. This is in essence what their large capital cost overruns are symptomatic of. Until an oil and gas producer does something to make the situation better by intervening in their suppliers marketplaces, nothing gets done.

The ability and capability of the management of the producers to deal and manage with the problems of the entire marketplace are as a result of what Langlois at al speaks of. The micromanagement of an entire industry, its suppliers and employees is not the domain of the producers hierarchical management. It is the responsibility of the market place left to resolve its own difficulties. That this has not been done for so long in the oil and gas industry only makes it look like there is strong demand for the producers management. This is false, it is an illusion. What is needed is the producers to signal to the marketplace in its entirety, that the innovative and risk oriented marketplace is what is necessary for all concerned to prosper in this new age.

Technorati Tags: Langlois, Genesys, Research, Innovation

An excellent resource that is a must read.

The title of this entry will take you to Professor Langlois Economics 486 "The Economics of Organization" which to me is a highly recommended set of slides to view. They lay out in very fine detail the beginning and current theories of the firm and markets. I hope you enjoy this resource as much as I.

Technorati Tags: Innovation, Research, Langlois, Development

Langlois has more to say on transactions.

Professor Richard N. Langlois wrote a fairly current paper on "The secret life of mundane transaction costs". Clicking on the title of this entry will enable you to download the .pdf from the Social Science Research Network.

Professor Langlois refers to Oliver Williamson for a summary of what transaction costs are, "...costs of running the economic system". (2006 pp. 1) A large part of that system is the costs associated with establishing and supporting standards. Here in Alberta we have a number of groups that have created standard ways and means of conducting business in the oil and gas industry. These standards help to form and support the culture of the industry, and that is particularly, the joint operating committee, the organizational focus of these writings.

"The modularity theory of the firm."

Dr. Langlois uses the established industry standards and the methods of enforcing compliance into the economic system to "establish and maintain a system of property rights." Langlois organizes the costs into 3 categories, I will mention those categories and then provide examples of the types of costs that are incurred in each category.

1) "Contains the fixed costs of establishing and maintaining a system of property rights."

Including the basic laws of the land, and the Alberta Governments royalty and mineral rights development laws and regulations, Petroleum Accountants Society of Canada, Canadian Association of Petroleum Landman, Public Petroleum Data Model and other standards bodies. The point in this categorization is to determine what the real fixed costs of establishing and maintaining the standards of operations of oil and gas are in Alberta and Canada. Needless to say many of these organizations are representative of larger global groups that have influence through out the global oil and gas industry.

2) "Contains costs that are paid periodically. These depend on time, but not on number or volume of transactions."

Langlois interestingly takes this categorization and classifies items like salaries of police, costs that are a function of time, in application to oil and gas, this would include the SEC, FASB, Auditors, Engineering appraisals and other compliance costs to regulations as the variable or time dependent costs of establishing and maintaining property rights in the oil and gas industry.

3) "Contains all the costs that come with the number of transactions or volumes of transfers."

The last grouping of costs Langlois sets out is the definitive variable costs of production. Based on the level of activity is the criterion that establishes the volume of costs and what Lanlois describes as "Neo-Classical T-Costs." These would include the royalties actually paid, the investment dollars spent, the costs associated with the revenue from the production of oil and gas.

Langlois has categorized these further, and are combined into the following;

• Category 1 and 2 = Costs of establishing and maintaining property rights.
• Category 3 = the Neo-Classical T-Costs mentioned.
• Category 2 and 3 = Mundane transaction costs.

It is at this point Langlois sets out to establish that these costs categories "have a secret life" and indeed "have a secret life cycle". In summary he is establishing much of the information analysis, or the tool that I previously wrote about from Baldwin and Clark. Through this the architecture of the industry is combined with the standards to form not only the encapsulated (companies) and modules (individuals) but also a means of operation via the price system.

Dr. Langlois quotes Hayek in this regard; it is a salient point;

"The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. ...The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information passed on and passed on only to those concerned. It is more that a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more that is reflected in the price movement." (Hayek 1945, pp. 526 - 527)

The architecture of the industry is what I have asserted is broken. Represented by the hierarchy, the oil and gas industry has been able to establish the appropriate standards and therefore maintain the property rights that are so critical to the development of the oil and gas industry. What is now redundant is the level of capability that is built up within each of the producers. Hierarchies have focused on their own needs and capabilities within the firm itself. Building extensive capacities to accommodate all of the needs that are associated with the category 1) 2) and 3) cost. What is needed is to conduct the analysis on the standards such that the efficient point of each transaction becomes the point of transfer. The tools to use are contained within these two documents of Langlois, Baldwin and Clark. This in a nutshell is the purpose and desired outcome of the development of the Genesys application. A reorganization, and a re-architecture of the oil and gas industry on a global basis.

Ensuring the necessary level of hidden information in each transaction is critical according to Langlois.

"Indeed, as the field of object-oriented programming has taught us, these hidden design parameters generally must not be communicated to others. This is the principle of encapsulation and information hiding. To allow another module knowledge of an access to one's inner workings is to invite those other modules to tinker - and thus to invite butterfly effects."

"The secret life"

Professor Langlois notes the friction that is created in transactions. The costs of standardization, counting and compensation when the tasks are assigned to a third party, or as Coase stated "the costs of using the price mechanism." These "friction" costs are incurred in the transaction as opposed to asking that the work be completed within the firm itself which Langlois suggests it simply doesn't pay to simplify and standardize the transactions, that the coordination costs can be limited by the market size, or if the transactions are more dynamic in nature and are subject to frequent change.

"The secret life cycle."

"With a larger extent of the market, and in the absence of any other kind of transaction costs, it starts to pay not only to subdivide tasks further but also to turn more transfers into transactions." pp. 26

And provides a necessary caution;

"But this is not the same thing as saying that we should observe vertical disintegration in a growing industry. Growth takes place in disequilibrium. And disequilibrium can lead to dynamic transaction costs, especially when the increase in the extent of the market calls for a systemic reorganization of the task-and-transfer system." pp. 27

As time passes, the volume of transactions increase, and the volume of dynamic transaction cost decrease. This makes inherent sense in that the ability to build an industry would require more transfers to mitigate the costs of un-standardized transaction costs. However, after time the reverse becomes the norm in that "thick markets will increasingly come to supplant management as a mechanism for buffering uncertainty". pp. 30 This phenomenon is what Langlois has called "The Vanishing Hand".

Technorati Tags: Development, Langlois, Research, Strategy

I want to reiterate my concern.

First, yes I want an iPhone as soon as possible. The networking and Mac OS / X underpinnings will make the "tool" usable by everyone and anyone.

Secondly, yes I will develop unique applications that employ the iPhone in the many ways the oil and gas users will want. Using Cascading Style Sheets, Ajax and JavaScript limit the scope of the applications that can run on the iPhone to ones imagination.


And thirdly, yes, I want to reiterate a concern that I mentioned last summer. As with any new technology the security and access privelages are becoming much more difficult to have under even reasonable control. My concern about wifi enabled pod slurping can and will be one of the greater risks to corporate security.

Technorati Tags: Security, Software, Innovation
Photo Courtesy of Apple.

Determining transactions, transfers and the division of labor.

Clicking on the title of this entry will enable you to download an article from the Social Science Research Network. This article was noted on Professor Langlois' guest blogging posts on Organizations and Markets and is a continuation of my research into his thinking. The article is written by Carliss Y. Baldwin and Kim B. Clark and is entitled:

"Where do organizations come from? A network design perspective of the theory of the firm."

The article discusses transactions and transfers of value in the business setting. A rather boring topic however, I think this article is of value in defining a tool for a company such as Genesys, with the means to analyze and develop new divisions of labor in oil and gas.

The approach that I am making here is based on the need to expand the growth opportunities of the oil and gas industry. Agreement amongst most economists would reflect that the expansion of Adam Smith's division of labor is the means to enhance the productivity of the oil and gas worker and the industry as a whole. Enabled by the new technologies, and reflected in the different make-up of markets as I proposed in the Human Resource Marketplace and Petroleum Lease Marketplace. The division of labor will need to be "adjusted" for every process, transaction, transfer and job. The tool that is defined in this paper provides us with the means to do this analysis.

Tearing into the document we find the articles definition of a transaction is:

"...objects that are transacted must be standardized and counted to the mutual satisfaction of the parties involved. Also in a transaction, there must be valuation on both sides and a backward, compensatory transfer - consideration paid by the buyer to the seller. Each of these activities - standardizing, counting, valuing, compensating - adds a new set of task and transfers to the overall task and transfer network. Thus it is costly to convert even the simplest transfer into a transaction."

The authors provide us with an appropriate definition. I would also assert the makeup and origin of these transactions might change due to the available information technologies. Oil and gas will have new more efficient means and methods to conduct transactions, and that is where the focus and value of this blog’s concepts are concerned. Does it make sense that a "Production Accountant" focus only on their employer’s production, or would it be more valuable to have the "Production Accountant" work for a variety of Joint Operating Committee's in a specific geographical area? "What would the revised job consist of..." is how we could analyze the changes with this tool.

The authors then introduce two concepts that are of critical competitive value, "Information Hiding" and "Thin Crossing Points". These two concepts define the need for the transaction and transfer to occur at the point where the simplest interface between the two parties exists. This "Thin Crossing Point" provides both vendor and purchaser with the ability to hide information from each other and still achieve the greatest level of efficiency in conducting the transaction, asserting that:

"The user and Producer need to deploy knowledgeable in their own domains, but each needs only a little knowledge about the other's. If labor is divided between two domains and most task-relevant information hidden with each one, then only a few, relatively simple transfers of material, energy and information need to pass between the domains." pp. 17

Using the example of the "Production Accountant" we can now analyze whether the transactions of his / her efforts should be conducted at the simplest point. This is because the transactions that are involved are standardized, counted, valued and compensated on the basis of (here in Canada) the EUB, the Accounting and Operating Procedures as defined and agreed to by the Joint Operating Committee.

The reason that I have selected the Production Accountant is due to the fact that there are never enough of them. A position that requires specific skills that always seems to be in short supply. The industry as I have suggested throughout these writings needs to undertake a revolutionary new approach to the business of oil and gas. Based on the science and engineering, it's obvious that wells will be drilled at a faster rate and the decline in reserves will continue to accererate. Therefore to sustain and grow the base of oil and gas production will require more Production Accountants, or, as I have proposed a different way of accounting for the production.

The authors then note:

"Placing a transaction - a shared definition, a means of counting, and a means of payment - at the completed transfer point allows the decentralized magic of the price system to go to work." pp.22

Intuitively Langlois was correct in his assertion that the decentralized production methods were more efficient then the high throughput production methods the industry is configured around. Therefore this last quotation provides a very detailed tool to determine the division of labor of the "revised" oil and gas industries. From this process the authors note:

"The most significant fact about this system, is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information is passed on..." Frederick Hayek (1945)

The authors provide another definition and concept:

"Encapsulated Network in a larger system of production is to facilitate complex transfers without making all of them transactions". pp 28

Which to my mind shows where the real value in this entire process is not only would the encapsulated network achieve the greatest efficiencies in the transfer and transaction. It would enable the participants to focus on their unique competitive advantages. I have suggested in previous postings and the research documents that the oil and gas industries competitive advantages lie in the oil and gas leases in which they own. The ability to find, develop and produce those reserves are the critical activity that the company is evaluated on. The producer should consider these assets and skills as the key point of where their competitive advantages are. The direct employment of production accountants within each company does not provide any value to the producer.

Therefore, the make or buy solution provides the justification for the new approach to defining the Production Accountants job, organization and processes. The ability to buy the services would offload the need to have each company with adequate production accountants to complete the required reporting. This assumes of course that the production accountants would be able to organize themselves in some manner that provided a greater overall capacity then what is currently available, and that is what the division of labor sets out to provide, an increased throughput from the same resource.

Technorati Tags: Innovation, Langlois, Research

Photo Courtesy Guileite

A quick note...

Clicking on the title of this entry will enable you to download the paper that Professor Langlois won for Shumpeter Prize, entitled. The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy.

Technorati Tags: Langlois, Research

Langlois provides more food for thought.

Dr. Richard N. Langlois has, to my mind, hit a few more balls out of the park. They come from "Chapter 4 The rise of the corporation." In it he suggests the organizations that developed over the past centuries sought "buffers" in order to mitigate the variances in markets. These buffers include inventories and in oil and gas commercial storage has been an area of significant investment over the past decade. These "buffers" help to offset the difficulties of the business and make the potential variances dissipate in terms of their magnitude and frequency. Langlois notes that buffers come with the cost of a lack of operational flexibility.

In the last three days the price of oil has fallen almost $8.00 or 12.5%. It is fair to assume that the costs of production have not declined by that amount, but what will we see the producers do from this price decline? They will probably revisit their capital budgets for the next year and slash them based on this new pricing information. The ability to reduce production, particularly from the fields that are high cost, and may now be losing money, does not exist.

Langlois states the concentration of high throughput production, the current industry makeup, is contrasted to the decentralized production model.

"In a world of decentralized production, most costs are variable costs; so, when variations or interruptions in product flow interfere with output, costs decline more or less in line with revenues. But when high-throughput production is accomplished by means of high-fixed-cost machinery and organization, variations and interruptions leave significant overheads uncovered." pp.58

What would be required to transform the industry from a concentration of high throughput production to an industry using the decentralized production model?

With the radical shifts in the commodity prices the industry adopts one of two positions, full production with no capital expenditures or full production with full capital expenditures. Leading only to further and further problems down the road. What is needed is what Langlois suggests, a move to a decentralized production model, which to me sounds like the joint operating committee. Without the ability to limit the production of a facility that has begun costing due to the commodity price declines. The industry will forever be subject to wild swings in the prices of their commodities.

The scaling back of production based on its contribution is a scenario that I can easily see the ownership consensus of the joint operating committee attaining. Methods and procedures to map the costs to the prices and ensure that the facility is not run at a deficit in terms of its earnings. This would have the immediate effect of removing the high cost production from the market, so that the market could adjust based on that information. Is this not what OPEC has been doing in the last year?

Currently the greatest influence on the price of oil and gas is the 5 day weather forecast. This strikes me as insane. I am asserting the oil and gas industry is failing as a high throughput production type of industry. Langlois states that there is a process to enable these changes.

"Economic growth occurs at the hands of entrepreneurs, who bring into the system knowledge that is quantitatively new - knowledge not contained in the existing economic configuration." pp.27.

I can only hope that industry will accept these facts and proceed with this project. As next week marks the start of the marketing of these concepts we will know fairly soon.

Technorati Tags: Call-to-action, development, Langlois, Research, strategy

"Economic growth is about the evolution of a complex structure"

In his book "The Dynamics of Industrial Capitalism" Richard N. Langlois, Professor of Economics at the University of Connecticut stated, "Economic growth is about the evolution of a complex structure". This expands on Adam Smith's theory of the division of labor.

If the energy industry is going to increase its output, the first order of business is to settle on a new form of organizational structure. In oil and gas the joint operating committee is the legal, financial, operational decision making and cultural frameworks of the industry. This is on a global basis. Once the software is built to explicitly support the joint operating committee, recall that software defines and constrains the organization; the industry can then proceed to expand its output. I am at a loss to determine what other means could be used to increase the capacity output?

Here we have further academic support for using the Joint Operating Committee. With over 230 years since Adam Smith wrote his theory on the division of labor, it is a testament to the strength of his thinking that we quote him so frequently. Dr. Langlois' quotation provides further evidence that the ability to expand will first and foremost require new organizational forms to institute growth. To me the choice is very simple.

Technorati Tags: Call-to-action, Military-Command, Research

Enterprise Search and Security.

New Idea Engineering publish a monthly newsletter that discusses the difficult topic of enterprise search and security. They have recently published a series of articles under the heading "Enterprise Search: Mapping Security Requirements to Enterprise Search." The three articles are available here, here and here.

In terms of the technology used in this application, I have stated the architecture that will be used here. Two major additions being added to the Genesys architecture are;

• Use of the Google Search Appliance.
• Virtualization of a producers environment on the Grid.

These New Idea Engineering articles point out a number of very important issues that I will address when we are getting closer to the start of development.

Photo Courtesy of fox2mike
Technorati Tags: Development, Strategy, Software, Security, Search

A new addition for 2007.

During December of 2006 I added the books that I have found of interest and feel provide some value to the readers who may share my passion for this topic. Another area that I think I will add some value for the reader is a listing and my justification for readers to go out and secure documents that are published in a variety of journals.

There are three authors that provide the stimulation for many of the ideas here. They are Dr. Paul Romer at Stanford, Dr. Giovanni Dosi at the Sant'Anna School of Advanced Studies and Dr. Carlota Perez who is a guest researcher at Cambridge University. These three have formed a topic that is of much interest to me and I would like to point out the individual documents that are currently being research by myself.

In the past I would post many of their thoughts and ideas, however, I believe that to be a violation of their Copyright. I therefore will only point them out and suggest that many of the documents are hard to source and in most cases, require access to the major academic database services.

So for this first installment I want to highlight three documents that combine to form a series of discussions about the changes that are happening in the business and technical worlds. They reflect the changes will be some of the most radical that we have faced in many years and will be difficult for people and organizations to adapt. Much of the writing notes a transition to a different time where the fundamental basis of the economy has changed. We are in this period now and it seems timely to review these three documents.

1. Perez, Carlota (2004) Finance and Technical Change: A Long Term View (Provided here from her website.)
2. Romer, Paul (2007) Economic Growth (Provided here from the Concise Encyclopedia of Economics.
3. Perez, Carlota (2003) Rethinking Globalization After the Collapse of the Financial Bubble: An essay on the challenges of the Third Millennium (Provided here from her website.)

I hope that you enjoy them as much as I. As I begin to conduct more research, I trust there will be many more of these types of posts.

Technorati Tags: Research, Innovation, Cluster, Dosi