Langlois Obsolescence

I am encouraged by the shareholder lawsuit against BP's directors. Each day there appears to be more and more people taking action to deal with these bureaucracies.

Chapter 2 of Professor Richard N. Langlois' book "The Dynamics of Industrial Capitalism"  is entitled "The Obsolescence of the Entrepreneur" and deals with the Schumpterian Dichotomy. That dichotomy is the declining importance of the entrepreneur in the latter part of Schumpeter writings. This appears to be in contrast to his earlier writings in which he focused on the entrepreneur. What this post seeks to better define is Professor Langlois' vanishing hand hypothesis and its application to oil and gas. That is, the era of the large bureaucracy had its time and place. That era is now passing, to be replaced once again by the entrepreneur.

In the "early" Schumpeter -- Schumpeter I -- the innovation process might best be characterized as a linear one. Christopher Freeman (1982) describes it this way. Basic inventions are more or less exogenous to the economic system; their supply is perhaps influenced by market demand in some way, but their genesis lies outside the existing market structure. p. 21

Freeman notes that innovation is under the direction of no one group or individual. Adam Smith's invisible hand is present and the market provides. In this next quotation we see Chandler's visible hand.

“The main differences between Schumpeter II and Schumpeter I,” says Freeman, “are in the incorporation of endogenous scientific and technical activities conducted by large firms... p. 21

These quotations are noting the changes in the source of innovation. From the entrepreneur to the rise of the successful corporate Research & Development (R&D) arms of large firms such as Xerox PARC, Bell Labs and others. These firms R&D activities replaced the role of the entrepreneur during the middle of the last century. Langlois vanishing hand suggest that the role of the entrepreneur will rise again in prominence to the bureaucracy. Therefore it is reasonable to ask, what is the critical role of the entrepreneur?

Indeed, the job of the entrepreneur is precisely to introduce new knowledge. The “Circular Flow of Economic Life” is a state in which knowledge is not changing. Economic growth occurs at the hands of entrepreneurs, who bring into the system knowledge that is qualitatively new – knowledge not contained in the existing economic configuration. p. 27

Its more then just knowledge. Ideas have a critical role in economic growth. People, Ideas & Objects is derivative of Professor Paul Romer's "New Growth Theory" of People, Ideas and Things. The idea of using the Joint Operating Committee as the key organizational construct of the innovative oil and gas industry was in front of everyone in the industry. Why didn't this idea percolate to the top earlier?

There has to be a mechanism by which new knowledge enters the system. And that mechanism cannot be rational calculation, for as David Hume (1978, p. 164) long ago observed, “no kind of reasoning can give rise to a new idea.” p. 27

What has been done already has the sharp-edged reality of all things which we have seen and experienced; the new is only the figment of our imagination. Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it. p. 27

How different a thing this is becomes clearer if one bears in mind the impossibility of surveying exhaustively all the effects and counter-effects of the projected enterprise. Even as many of them as could in theory be ascertained if one had unlimited time and means must practically remain in the dark. As military action must be taken in a given strategic position even if all the data potentially procurable are not available, so also in economic life action must be taken without working out all the details of what must be done. Here the success of everything depends on intuition, the capacity of seeing things in a way which afterwards proves to be true, even though it cannot be established at the moment, and of grasping the essential fact, discarding the unessential, even though one can give no account of the principles by which this is done. Thorough preparatory work, and special knowledge, breadth of intellectual understanding, talent for logical analysis, may under certain circumstances be sources of failure. (Schumpeter, 1934, p. 85.) pp. 27 - 28

I read this as not being the role of one entrepreneur. I have identified that the Joint Operating Committee is the key organizational construct of an innovative oil and gas producer. I have taken that idea and formulated a vision, the Draft Specification, of how the idea of using the JOC could be incorporated in the day to day of the industry. From this point forward, it is the work of many entrepreneurs to develop the application and make the industry as innovative as possible. That is where the Industrial District (ID), Business Groups (BG), Small Knowledge Intensive Enterprises (SKIE) and Community of Independent Service Providers play a key and different role then what is done today. Langlois notes.

Entrepreneurship – introducing the qualitatively new – is an activity inherently different, it would seem, from the kind of rational calculation portrayed in the imagery of neoclassical modeling.

It is interesting that Schumpeter regards the entrepreneurial act as requiring in fact greater conscious rationality than routine activity (Schumpeter 1934, p. 85). This reemphasizes the empirical nature of his conception of economic knowledge. Routine behavior requires less conscious rationality because it is essentially “preprogrammed” through trial-and-error learning. Notice, of course, that, at least in “early” capitalism, the conscious rationality of the entrepreneur is not adequate to the task of innovation. This is why entrepreneurship requires intuition, the leap of logic. But – and here we get to the heart of the matter – conscious rationality, for Schumpeter, is in fact becoming increasingly adequate to the job of dealing with the radically new.

The more accurately, however, we learn to know the natural and social world, the more perfect our control of facts becomes; and the greater the extent, with time and progressive rationalisation, within which things can be simply calculated, and indeed quickly and reliably calculated, the more the significance of this [entrepreneurial] function decreases. Therefore the importance of the entrepreneurial type must diminish just as the importance of the military commander has already diminished. (Schumpeter, 1934, p. 85, emphasis added.)

Notice the syllogism. Because the unknown can be increasingly calculated rationally, the “extra-logical” function of the entrepreneur becomes increasingly unnecessary, and so the importance of the entrepreneurial type must diminish. p. 28

Placing the caveat "experienced entrepreneur" on the ID, BG, SKIE or CISP is a necessary. People who are able to see the forest for the trees in terms of what has to be done. As much as no one was in control of the innovation in the entrepreneurial era of Schumpeter's first writings, no one can influence the scope and scale of the project defined here. What we can do is share the understanding of how the industry operates, capture that in the software and apply it through the innovative tools that we develop.

We are at the beginning of this process. The bureaucracy remains in complete control. However we find encouragement in the ongoing activities in the industry. In these next three quotations Langlois provides us with an understanding of where we are in the process and how the transition will come about.

"Defenseless fortresses invite aggression, especially if there is rich booty in them. Aggressors will work themselves up into a state of rationalizing hostility -- aggressors always do. No doubt it is possible, for a time, to buy them off. But this last resource [sic] fails as soon as they discover that they can have it all" (Schumpeter 1950 [1976, p. 143]). p. 30

and

“Thus the modern corporation, although the product of the capitalist process, socializes the bourgeois mind; it relentlessly narrows the scope of capitalist motivations; not only that, it will eventually kill its roots” (Schumpeter 1950 [1976, p. 156]). Like Marx, then, he sees capitalism as leading to its own destruction. But unlike Marx, Schumpeter sees capitalism as the victim of its own economic success not its economic failure. This tale stands Marx on his head, its plot laced with a heavy and self satisfied irony. The tone is disinterested and the attitude fatalistic; but the message is largely cautionary. At base, Schumpeter is nothing so much as a neoconservative, perhaps the first neoconservative. p. 30

Lastly a word of caution to put these points in context.

In the end, however, taking all this too seriously puts us in danger of reading Schumpeter literal-mindedly. The force of the argument is in the texture of the landscape -- not in its details. Indeed, there is a sense in which the “Schumpeterian tension” -- the tension between the Schumpeter who comes to praise entrepreneurship and the Schumpeter who comes to bury it -- actually enriches the majestic irony of Capitalism, Socialism, and Democracy. p. 31

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 II

In Part II of our review of Professor Richard Langlois book "The Dynamics of Industrial Capitalism", Chapter I "Progressive Rationalization" we discuss the role of capabilities. In People, Ideas & Objects Draft Specification capabilities reside in both the firm and the market, however, the division of labor between the two is different then what exists today. We will also see in this chapter that the multi-unit vertically integrated firm is of diminishing value. How the hierarchical organizational construct was designed to provide control to the means of production and how today, that means of production is best met through dynamic markets.

As Chandler tells us on the first page of The Visible Hand, two characteristics set the managerial corporation apart from earlier modes: (1) it is overseen by salaried professionals rather than by owners, and (2) it comprises multiple units or stages of production each of which could in principle have stood on its own as a separate organization. The last characteristic is really the essential one. In the large corporation, management supersedes the price system as a method of coordinating stages of production. p. 8

Scratch the surface of any start-up oil and gas firm today and you will find the primary owners are the engineers and earth scientists that are running the firm. Using debt for leverage and to expand their scope, these small teams are actively developing a number of oil and gas fields over a five to ten year time frame. When the fields are fully developed, they will monetize their investments by selling the firm to one of the major independents or International Oil Companies (IOC's). This focus on building value is the future of the industry. Although the scope of the projects may not be as large as the multi-billion dollar programs of the IOC's. They are prototypical of how I see People, Ideas & Objects Draft Specification providing all members of the oil and gas industry with the means of value generation through exploration and development.

The future configuration of a producer firm will have a handful of engineers and earth scientists augmented by similar resources from the partner firms of the Joint Operating Committee. These individuals will be joined by the various resources of the dynamic field and service sectors on as required basis. The JOC will implement a comprehensive governance structure through the applications Military Command & Control Metaphor. The scientists and engineers will be leading these groups through the five to ten year development of the oil and gas reserves. Langlois notes;

The question, then, is clear: why did managerial coordination supersede the price system? Why did “managerial capitalism” supersede “market capitalism” in many important sectors of the American economy beginning in the late nineteenth century? p. 9

In breaking down the way that oil and gas firms operate, People, Ideas & Objects is only providing the ERP software that identifies and supports what is desired by those in the industry. The difficulty today is that each producer firm is conflicted and constrained by their own needs. One of the conflicts is that they are focused on their own compliance needs. Focused on the compliance requirements of their tax, royalty and SEC requirements as opposed to the business of the oil and gas business. Companies are also attempting to secure the global scope of capabilities that their firm may require. As a result they may have a greater in-house capability then required at any point. Replicate this over each producer firm and we see independent and mutually exclusive capabilities silo's being built. The industry as a whole can not afford to maintain capabilities in this fashion.  

As each barrel of oil produced requires progressively more earth science and engineering resources, where will the future technical resources come from? With each producer firm attempting to secure all the capabilities they can, they quickly realize the industry wide demand for these capabilities far exceeds the resource base. The capacity to increase the capability is very limited, and therefore the alternative means of deploying a limited capability over a greater scope of projects is through re-organization. Reorganizing to the JOC as the key organizational construct; permits a pooling of the capabilities from all the producers represented in the JOC and the greater service sectors. Langlois helps to define capabilities with the following definitions.

Coase noticed that there can be costs of transacting because of limitations of knowledge and information; capabilities theory insists that limitations of knowledge and information are the key to understanding everything an organization does (Langlois and Foss 1999). Indeed, transacting is just one of the many activities an organization undertakes – one of many activities requiring capabilities (Winter 1988). p. 11

Richardson (1972, p. 888) describes capabilities as “the knowledge, experience, and skills” of the firm. p. 12

Why is there an assumption that the capacities resident in the earth science and engineering resources fixed? To train and deploy them takes the better part of ten years, and the community that exists today have a predetermined retirement date. In other words its not an assumption but a fact that the population of these technical resources will probably remain constant over the foreseeable future. Based on that fact, would it be reasonable to assume, that the industry will produce no more oil and gas over the foreseeable future? That isn't the case, this therefore becomes an economic problem and not a resource constraint.

Economic growth is fundamentally about the emergence of new economic opportunities. The problem of organization is that of bringing existing capabilities to bear on new opportunities or of creating the necessary new capabilities. Thus, one of the principal determinants of the observed form of organization is the character of the opportunity – the innovation – involved. The second critical factor is the existing structure of relevant capabilities, including both the substantive content of those capabilities and the organizational structure under which they are deployed in the economy. p. 13

Innovation in oil and gas will arise as a result of People, Ideas & Objects use of the Joint Operating Committee in the manner as described in the Draft Specification. No other alternatives, that I am aware of, have been suggested. The bureaucracy can not function in today's environment, and are certainly incapable of transforming itself to the future demands of the marketplace.

In highly developed economies, moreover, a wide variety of capabilities is already available for purchase on ordinary markets, in the form of either contract inputs or finished products. When markets are thick and market-supporting institutions plentiful, even systemic change may proceed in large measure through market coordination. At the same time, it may also come to pass that the existing network of capabilities that must be creatively destroyed (at least in part) by entrepreneurial change is not in the hands of decentralized input suppliers but is in fact concentrated in existing large firms. The unavoidable flip-side of seeing firms as possessed of capabilities, and therefore as accretions of habits and routines, is that such firms are quite as susceptible to institutional inertia as is a system of decentralized economic capabilities. Economic change has in many circumstances come from small innovative firms relying on their own capabilities and those available in the market rather than from existing firms with ill-adapted internal capabilities. Chapter 5 will reconstruct the New Economy of the late 20th and early 21st centuries along exactly these lines, once again adding nuance and historical texture. If the antebellum period reflected the Invisible Hand of market coordination, and if the late 19th and early 20th centuries saw the rise of the Visible Hand of managerial coordination, then the New Economy is the era of the Vanishing Hand. p . 14

Management are being unreasonable in expecting that theirs is the only way in which to proceed. Managerial coordination in today's marketplace is redundant. People, Ideas & Objects have received no support from the bureaucracy. As a result there is no competitive form of organization to challenge managements ways. Control of the financial resources of the industry ensures that we are reduced to blind sleep-walking experts in the hands of whoever wants to feed us. (Habermas)

Schumpeter’s account of progressive rationalization takes the form of a contrast between two modes of economic organization, modes roughly cognate to the difference between the small owner-managed firm and the large multi-unit enterprise. Characteristically, however, the issue in Schumpeter is a dynamic one: he is concerned with the respective merits of these two modes of organization not in the static allocation of existing resources but in generation of economic change and growth. The paradox of Schumpeter is that he famously defended, and has come to be associated with, both of these modes as drivers of economic growth. Schumpeter has returned to prominence today as champion of the role of bold entrepreneurs in creating new combinations and redirecting the means of production into new channels, to such an extent that he is revered as an inspiration to the present-day field of entrepreneurship studies (Shane and Venkataraman, 2000). In this (Schumpeterian) literature, the force behind economic growth comes from individuals or small groups of individuals who work mostly outside the established structure of organization rather than from within it. pp. 17 - 18

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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Baldwin's "Option Value"

In a presentation entitled "Unmanageable Designs: What Some Designs Need from the Economy and How They Get It". Professor Carliss Baldwin provides more support for those people who are contemplating becoming a member of the Community of Independent Service Providers.

Harvard Professor Carliss Baldwin is someone that we watch closely here at People, Ideas & Objects. Review of her papers have provided clear direction in the areas of "modularity and thin crossing points", "mirroring hypothesis" and "actionable transparency". We have benefited substantially from these concepts. In this presentation Professor Baldwin brings another substantial concept to this project, "Option Value".

There is a definitive reason that the Draft Specification is eleven modules. Particularly from a software development point of view. Having everything operate as one integrated system with the size and scope of the Draft Specification is probably impossible. The ability to break down the size of the system into modules helps the developers deal with the complexity that larger systems provide. Modularity also allows users to be familiar with a smaller set of application functionality, familiarity that is consistent with their training and skills. For example a person that works in the "land" function will probably rarely leave the Petroleum Lease Marketplace Module.

Modularity is something that Professor Baldwin has spent much of her time on during the past decade. What really brings out the value of modularity is what she calls the "option value". This is particularly important as we have recently been discussing the Industrial Districts (ID), Small Knowledge Intensive Enterprises (SKIE), Business Groups (BG) and Community of Independent Service Providers (CISP). Option value is critical to the performance of this community.

In slide number two Professor Baldwin summarizes her three main points. I want to subsequently address each point in detail.

• Designs need to become real.
• They become real by creating the perception of value.
• Designs act as a financial force.
• Perception of value = incentive to invest
• In making the design = "use value"
• In making the design better = "option value"
• Modular designs with option value.
• Create hurricane type forces
• Will change their economic "space"
• Unmanageable and dangerous (unless you understand them)
  

To her first point, the Draft Specification is real because people can see the value that the specification can provide. The purpose of the specification is to provide a vision of how the industry could operate using the Joint Operating Committee (JOC) as the key organizational construct of the innovative producer. Perception is reality.

Baldwin's second point should note that members of the Community of Independent Service Providers (CISP) have a substantial business opportunity. By joining, these people have the opportunity to develop a service based offering that delivers the People, Ideas & Objects software applications to the innovative producer. They have as their overall objective; "to provide the most profitable means of oil and gas operations". To address the "use value", as we have noted before, we are moving towards the systemic culture of the oil and gas industry, the JOC. By recognizing the JOC we are indeed adopting the culture of how the industry works. Contrast this "use value" to the SAP culture of a manufacturing firm.

And lastly to address the "option value". The power of a modular specification, particularly in software that supports an industries culture, that is backed up by a dedicated software development capability, and most importantly, the producers, CISP and People, Ideas & Objects gaining the option value. This type of design becomes a "hurricane" financial force that will change the oil and gas "space". I can assure you that this hurricane is beginning. If you have an interest in becoming a member of the CISP, I would highly recommend that you begin your research phase today.

The critical element of this hurricane force is the Community of Independent Service Providers. Having the Draft Specification without this community does not generate the value. As Baldwin notes on Slide 23 "Modularity in the absence of option potential is at best a breakeven, at worst an expensive waste of time". This is intuitively the case, Professor Baldwin then asks the important questions.

• What is this elusive property that gives rise to option value?
• Where does it arise?
• Can we measure it?

Answering that first question, what is the "elusive property" Baldwin notes on Slide 29:

• Option value lies in seamless, asynchronous upgrading
• Modeled in design rules.

I have been a strong proponent of asynchronous communications. People, Ideas & Objects adopted a technical vision early on in the design of the Draft Specification. Within that technical vision, a cornerstone of it is what we call Asynchronous Process Management (APM). Today I am stating that the methods that the CISP and user communities interact with the developers of People, Ideas & Objects is in this asynchronous manner. Therefore we have captured that "elusive property that gives rise to option value". The creative and iterative development of the applications and communities.

In terms of measuring option potential. I have selected the following five points from slides 29, 30 and 32 as key to the CISP.

• Successive, improving versions are evidence of option potential being realized over time - after the fact.
• Designers see option potential before the fact.
• What do they see?
• Users - new perceptions => new preferences

• Perceptions of desires emerge through use.
• Value of discovery, direct experience play.
• Unexplored potential = option potential.
• Pfister's Observation (In Baldwin's words)
  
• Recombining modules in new ways has more option value than the modules themselves.

Lastly, Professor Baldwin suggests ways in which we can gain from "option value". These past few months we have been reviewing many of the principles that were used in forming People, Ideas & Objects, Community of Independent Service Providers and the Draft Specification. Whether that is through ID's, SKIE's, BG's, or the CISP I think the value is there and this project is moving forward.

• What do option rich modular designs do to the economy?
• Answer: Attract entry with a promise of lots of $$$
  
• How do you manage something inherently unmanageable?
• At first you don't.
• Then, small footprints yield high ROIC.
• Then, lead firm M & A
  
• Will you always get a modular cluster of firms?
• Yes, almost certainly.
  

And what actions does Professor Baldwin's recommend you should do: (Recall this is a 2005 presentation.)

• Plunge in.
• Get lucky
• Watch out for Microsoft
• Get bought by HP.

Professor Baldwin's research strategy - look for;

• Stable patterns of behavior involving several actors operating within a consistent framework of ex ante incentives and ex post rewards.

My personal opinion of what is valuable today, and this ties in with this project, is ownership or access to Intellectual Property (IP). It's the only asset that provides any long term sustainable value generation. Members of the Community of Independent Service Providers have access to all of the IP that is part of People, Ideas & Objects, the ideal framework of "ex ante incentives and ex post rewards". Management of this IP at People, Ideas & Objects is noted here.

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, Economic Institutions Part IV

This will be our last post on Professor Richard Langlois July 2009 paper "Economic Institutions and the Boundaries of the Firm: The Case of Business Groups." Langlois analysis of Business Groups (BG) follows on our review of his work on Industrial Districts (ID's), Professor Carlota Perez' Small Knowledge Intensive Enterprises (SKIE) and People, Ideas & Objects Community of Independent Service Providers (CISP). What ever we may call these "institutions", they all seek to build the "market-supporting" infrastructure of an industry. Although there is a strong service sector supporting the oil and gas industry, it does not have the market-supporting institutions necessary for it to qualify as a BG, SKIE, ID or CISP. What is needed, critically, is an ERP styled software development capability that supports these communities. A capability that supports the innovation that is occurring in these communities. Langlois helps to further define the decentralized nature of the concept that I am referring to: (For the remainder of this post I will use communities to describe ID, SKIE, BG or CISP.)

So far I have talked generally about vertical integration and disintegration, not specifically about business groups. And I have yet to engage the third level of contingent facts, political institutions. I now propose to argue that business groups and political institutions are closely related; indeed, in some of their forms, they are the same thing.

Scholars generally distinguish business groups from more loosely arranged structures like business networks. “When ownership and control are more centralized and organizational subunits enjoy limited autonomy, the commonly used term is business groups. When subunits enjoy more autonomy with respect to ownership, control, and operations, interfirm network is the correct term. In other words, business groups are more centralized and closely held, while interfirm networks are more decentralized and loosely held” (Fruin 2008). Indeed, in some eyes, the “groupness” of a business group is orthogonal to its structure of corporate governance. Mark Granovetter (1995, p. 95) considers business groups to be “collections of firms bound together in some formal and/or informal ways, characterized by an ‘intermediate’ level of binding.” Purely anonymous market relations don't qualify in Granovetters definition; but neither do American-style conglomerates, whose wholly owned divisions have little connection with one another and are but modular pieces on the financial chessboard. But a variety of governance structures, from hierarchical and structured chaebols on the one hand to Marshallian industrial districts (Marshall 1920, IV.x.3) on the other, would qualify as business groups in Granovetter’s sense. p. 21

Therefore, providing a governance model is a necessity for these communities. The Draft Specification implements the Military Command & Control Metaphor (MCCM) to provide a governance structure. Originally conceived to provide a pooling of the resources of each producer within a Joint Operating Committee, the definition was expanded to include the necessary technical resources that can be sourced from the communities as reflected in the Resource Marketplace Module. This enables a JOC to cobble together the necessary people to implement their plans. Each of these people are able to quickly determine theirs and others qualifications in terms of their experience, training and skills. Once assigned their role in completing the tasks, they can also see how others are able to interact within the process. Gaps will begin to show. And the innovative solutions necessary to fill those gaps will begin. Without a global industry wide governance model as contemplated in the Draft Specification, innovation will remain the domain of the bureaucracy.

Explaining the existence of business groups in Granovetter’s sense is arguably easier than explaining the mantle of ownership and governance those groups take on. “Intermediate” linkages are essential to the process of gap-filling. Links among entrepreneurs, whether formal or informal, permit the sharing of information about gaps and encourage the coordination of necessary complements (Kock and Guillén 2001). p. 22

As a result of implementing this governance structure, there is an increased potential of innovation within the community! I am making the connection that the market-supporting institutions the oil and gas industry needs are the MCCM and the Draft Specification.

There may yet be another explanation. Even in developed open-access societies, pyramidal business groups may exist because they play a gap-filling role. In this case, the issue is not vertical integration but governance. In developed economies – which increasingly means one integrated global economy – markets are relatively thick and market-supporting institutions relatively abundant, making it possible to coordinate complementary activities in a decentralized way. But there are still gaps: new products, new processes, new ways of organizing, new profit opportunities to seize. p. 27

The gap's that need to be filled become more obvious as a result of implementing the MCCM governance structure over the community. As gaps are filled, more gaps become noticeable. The capacity to change is highly dependent on the software that these communities will use. If that software is static, then their will be only one iteration of gap filing. What the industry needs to do is to iterate on the earth sciences and engineering disciplines, and innovations based on those sciences.

But even in “developed” economies, novelty and change creates the sorts of gaps that call for business groups, including less-formal sets of “intermediate” relationships, as, for example, in geographic (or, increasingly, “virtual”) industrial districts. In this sense, the economics of organization generally can learn from the literature on business groups outside the developed world. The problem of gap-filling in highly developed economies differs from that in less-developed economies because the path ahead is cloudier, which suggests that more-decentralized organizational structures may be more successful at the cutting-edge of technology. p. 29

In today's energy marketplace we see many examples of how the industry is failing. I believe the expectation that today's oil and gas company can transform themselves into these communities is unreasonable. An expectation that will lead to disappointment. With the debt crisis about to play out across the global economy, I expect those producers that are carrying even reasonable amounts of debt to be severely constrained in the short to mid-term. This during a time when the industry needs to be as innovative as it can just to keep its costs under control. Whether the industry as it stands today will look the same in ten years isn't the point. The point is that we need to enable these types of capabilities within the industry irrespective of the oil and gas companies actions. The industry will need to be built brick-by-brick and stick-by-stick to enable these types of attributes to become the norm. The bureaucracies have chosen not to participate. It's now up to these communities to begin this process by starting with People, Ideas & Objects.

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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McKinsey on Valuing Value

Today we have a short article from McKinsey on valuing value. Entitled "Why value value? -- defending against crisis: Companies, investors and governments must relearn the guiding principles of value creation if they are to defend against future economic crisis." The crisis in the economy is now called a debt crisis and no longer the financial crisis. The financial crisis was a liquidity driven issue and our current debt crisis is a solvency issue. Liquidity can be resolved relatively easily by governments providing cash to the markets, debt crisis' can only be solved with difficult choices and significant hardship one way or another.

An interesting perspective on the current economic situation is provided in this weeks EconTalk podcast by Professor Russ Roberts. Here Professor Roberts breaks down how things became unhinged from an investment point of view. I find the discussion around housing as an investment, Collateral Debt Obligations (CDO's), Synthetics and most of what Wall Street has been involved in as gambling. Nothing is generated out of all these machinations. No new products or services, nothing tangible or worthwhile. It seems to me that Wall Street management have provided leadership to the energy industries management. Leadership in terms of losing sight of what is real.

Discussion of the current economic situation is of importance to the development of People, Ideas & Objects. We can only institute the levels of cultural change within the oil and gas industry through an economic transition that causes the existing bureaucracies to atrophy, and the alternative, as represented in the Draft Specification, is built and grows to replace it. The debt crisis is this mechanism, and we are focused on building value throughout the oil and gas industry.

What I expect will continue to happen is the existing bureaucratic firms will have difficulty in earning "real" income from their operations. Commodity prices are high, and the expectation that they will stay high is supported through the increase in global energy demand and the difficulties in increasing reserves and production. Costs of operations will continue to escalate due to the inability of the bureaucratic culture to build the necessary scientific and engineering capabilities in the time they are required. Throwing more money at the problem will continue to be the only solution that management can provide. The point of making the changes as suggested in People, Ideas & Objects Draft Specification, is to enable the oil and gas producer to focus on generating value. It is the point of generating value that is discussed in this McKinsey paper.

In response to the economic crisis that began in 2007, several serious thinkers have argued that our ideas about market economies must change fundamentally if we are to avoid similar crises in the future. Questioning previously accepted financial theory, they promote a new model, with more explicit regulation governing what companies and investors do, as well as new economic theories. p. 1

One continuous theme that we are finding in our review of Professor Richard Langlois' papers is that markets need "market-supporting" institutions. Leaving the future to unfold as it "should" is consistent with the Lassiez Fairre form of capitalism that brought us here. Now, as represented in the Gulf of Mexico, it could be argued that the inability of BP to shut in the well is a market failure. I would argue that it is a failure of establishing the appropriate market-supporting institutions. I have also argued that software plays a key role in establishing these market-supporting institutions. Software is an enabler or inhibitor to innovation. The current bureaucracies use of SAP has cemented the hierarchies ways and means permanently.

In this next quotation the author intimates that crisis' are created as a result of a miss allocation of capital. This is accurate in the sense that the low costs of money over the past few years has created a lack of discipline in making the right investments. Do we save for the future or buy a bigger house? These types of decisions have been made by consumers and businesses and have led to the situation where everyone is now carrying large debts supported by poorly performing assets. What is the investment capital discipline in the oil and gas industry?

My view, however, is that neither regulation nor new theories will prevent future bubbles or crises. This is because past ones have occurred largely when companies, investors, and governments have forgotten how investments create value, how to measure value properly, or both. The result has been a misunderstanding about which investments are creating real value—a misunderstanding that persists until value-destroying investments have triggered a crisis. p. 1

and

The guiding principle of value creation is that companies create value by using capital they raise from investors to generate future cash flows at rates of return exceeding the cost of capital (the rate investors require as payment). The faster companies can increase their revenues and deploy more capital at attractive rates of return, the more value they create. p. 1

Oil and gas firms have been profitable, many have had record profits. And that would denote they have generated value. However, what about the long term. These record profits have been generated as a result of increased multiples of the commodity prices. These profits have not been effectively invested in expanding reserves or productive capacity. Now that costs are escalating systemically and culturally, as I argue in the review of Professor Langlois, how much longer will value as defined by McKinsey continue to build?

In the Draft Specification, strategy is set by the producer at the Joint Operating Committee level. The producers competitive advantages are structured around their unique asset base and the scientific and engineering capabilities that are made available to them. With these tools the producer firm is able to focus on increasing their reserves and deliverability. Determining the best manufacturing methods to build drill bits do not provide value, and I have suggested that their involvement in owning and operating field level innovations be limited to defining and funding these types of industry capabilities.

Companies can sustain strong growth and high returns on invested capital only if they have a well-defined competitive advantage. This is how competitive advantage, the core concept of business strategy, links to the guiding principle of value creation. p. 2

The oil and gas industry stands at a unique time and place. We recently learned through our review of Professor Alfred D. Chandler that bureaucracies essentially failed during the great depression. We see hierarchies in the global banking system have also failed. Do we need to wait until it is evident to everyone that the energy industries management are failing? High commodity prices have made these companies look like they are functioning properly. However, the excess cash flow has not increased their reserves or production? Knowing what we know about the duration of the commodity price spike, and the logarithmic decline curve, what is the future deliverability of these companies. Understanding the role that energy plays in our lives we need to act before the failures become too obvious.

These principles have stood the test of time. Economist Alfred Marshall spoke about the return on capital relative to the cost of capital in 1890. When managers, boards of directors, and investors have forgotten these simple truths, the consequences have been disastrous. The rise and fall of business conglomerates in the 1970s, hostile takeovers in the United States during the 1980s, the collapse of Japan’s bubble economy in the 1990s, the Southeast Asian crisis in 1998, the dot-com bubble in the early 2000s, and the economic crisis starting in 2007 can all, to some extent, be traced to a misunderstanding or misapplication of these principles. Using them to create value requires an understanding of both the economics of value creation (for instance, how competitive advantage enables some companies to earn higher ROIC than others) and the process of measuring value (for example, how to calculate ROIC from a company’s accounting statements). p. 2

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, Economic Institutions Part III

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).

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, Economic Institutions Part II

Comparing the existing bureaucracies that operate the oil and gas companies to the industry standard Joint Operating Committee provides value to those that work in the oil and gas industry. This is not an exercise that compares two theoretical situations in a vacuum. Both organizational constructs (markets and firms) exist and the examples provided in this blog reflect today's issues. As frustrating as it is for me to deal in the context of what "could" happen in the future, I would prefer to be working on building that future, I can console myself on the fact that these arguments are not theoretical in nature and have a strong academic foundation. Langlois notes:

The set-up here is an instance of what Coase in his later writings (Coase 1964) would call comparative-institutional analysis. Rather than comparing the world we observe against an abstract theoretical model (a practice Coase derided as “blackboard economics”), we should set two real-world institutions side-by-side and compare their respective costs and benefits. From the point of view of prescription or policy analysis, Coase’s plea amounted to a salutary attack on the doctrine of “market failure.” It is meaningless to compare real-world institutions against a blackboard standard of perfection, and dangerous to imply (often tacitly) that government intervention is in order without specifying the precise institutional form of that intervention and scanning it thoroughly for “government failure” (Coase 1964; Demsetz 1969). But the doctrine of comparative-institutional analysis also operates at the level of explanation. Implicitly in Coase, and explicitly in Williamson, one explains an observed organizational form by comparing that form with hypothetical discrete alternatives in order to show that the observed form minimizes transaction costs. The thought experiment is to compare “the market” as an organizational structure with “the firm” as an organizational structure. pp. 2 - 3

Suggesting that the Joint Operating Committee be the key organizational construct of the innovative oil and gas producer has a rich substance in that it is the legal, financial, cultural, operational decision making and communication framework of the industry. To move forward as an industry requires retirement of the bureaucratic ways of the hierarchy and recognition that the industry is based on partnerships. It is these partnerships that are summarily ignored in all of the ERP systems that are operating today.

The Draft Specification defines the boundaries of the firm with clear "market" and "firm" organizational structures. In September 2007 I prepared this chart of the Primary (P) and Secondary (s) roles and activities to take place in each of these organizations.

Construct	Market	Firm
Joint Operating Committee	P	s
Military Styled Command and Control (Governance)	s	P
Transaction Costs	s	P
Production Costs	P	s
Innovation	P	s
Routine, compliance and accountability	s	P
Research	s	P
Development (the D in R&D)	P	s
Financial Framework	P	s
Legal Framework	P	s
Cultural Framework	P	s
Operational Decision Making Framework	P	s

To the majority of people who have worked for a period of time in oil and gas. Will notice that these boundaries between the firm and market is a conceptual model of how the current industry operates! The difference is that the ERP systems that define and support the market and firm institutions only adopt a firm definition based on some theoretical example of a manufacturing firm (SAP). What is needed to fully explore and support the necessary innovation within the industry is that the ERP systems adopt these frameworks within the systems. A task that People, Ideas & Objects is providing with the Draft Specification. As Langlois stated above "we should set two real-world institutions side-by-side and compare their respective costs and benefits". Imagine how much better the industry might operate if our systems adopt the table above in comparison to SAP's determination of what a manufacturing firm might look like.

If we look at the table of how the Draft Specification defines the firm and market, we can ask how and where will the "gap filing" occur. Drawing on our example of a few days ago, in Transaction Design, we saw that the enhancement of some drilling technologies was the desire of some producers. Noting the needed capabilities were unavailable in the marketplace, the producers were able to approach a group of engineers who had done some extensive research into the problem. It was then incumbent on the producers to engage the engineers and fund and support the development of the capability. To who's benefit are these actions taken?

Let’s take a closer look at the nature of the “gaps” involved. Adam Smith tells us in the first sentence of The Wealth of Nations that 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 (Richardson 1975; Young 1928). p. 7

Based on the understanding put forward in yesterday's post. That Intellectual Property (IP) resides with those individuals, groups or firms that conduct the difficult work of solving problems and creating science & innovation. In yesterday's example the engineers will earn the IP and be able to market their skills and the developed capability to other producers that may have similar needs. The producers have benefited by either enhancing their reserves, increasing their technical capability, reducing their costs or increasing their production. Gap filling is a means of enhancing the division of labor.

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, Economic Institutions Part I

Next up in our review of Professor Richard N. Langlois work is a paper he wrote in July 2009. "Economic Institutions and the Boundaries of the Firm: The Case of Business Groups". This paper provides another interesting perspective on how businesses within an industry can be organized. In our review of "Innovation Process and Industrial Districts" we learned of the close approximation of Langlois "Industrial Districts" (ID) and Professor Carlota Perez' Small Knowledge Intensive Enterprises (SKIE) to People, Ideas & Objects Community of Independent Service Providers (CISP). How ID's, SKIEs and the CISP were a direction that the industry should move toward building and supporting. In this paper we learn of Business Groups and their application. Business Groups are more common in the developing economies, however, I think that they have some important attributes that we can learn from. These Business Groups are best described in this paper by Koo Cha-Kyung a former chairman of the well known LG Group:

My father and I started a cosmetic cream factory in the late 1940s. 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. Plastic caps alone were not sufficient to run the plastic molding plant, so we added combs, toothbrushes, and soap boxes. This plastics business also led us to manufacture electric fan blades and telephone cases, which in turn led us to manufacture electrical and electronic products and telecommunication equipment. The plastics business also took us into oil refining, which needed a tanker shipping company. The oil refining company alone was paying an insurance premium amounting to more than half the total revenue of the then largest insurance company in Korea. Thus, an insurance company was started. This natural step-by-step evolution through related businesses resulted in the Lucky-Goldstar group as we see it today. (Aguilar and Cho 1985, p. 3.)

Notice that the “natural step-by-step evolution through related businesses” involved both spreading excess resources over similar activities and calling forth dissimilar complementary activities. p. 10

The process being described in the LG example is one of "Gap Filling" as is described below.

As Harvey Leibenstein long ago pointed out, economic growth is always a process of “gap-filling,” that is, of supplying the missing links in the evolving chain of complementary inputs to production. Especially in a developed and well functioning economy, one with what I like to call market-supporting institutions (Langlois 2003), such gap-filling can often proceed in important part through the “spontaneous” action of more-or-less anonymous markets. In other times and places, notably in less-developed economies or in sectors of developed economies undergoing systemic change, gap-filling requires other forms of organization — more internalized and centrally coordinated forms. p. 6

In the example that I posted on Friday entitled "Transaction Design" it was noted the need to have the producers work with a group of engineers to bring about an innovation to enhance the industries capabilities. How the oil and gas producers, with 100% of the revenues of all industries associated within oil and gas, need to develop and maintain the industries capabilities within the ID's, SKIEs or CISP. This is "Gap Filling" as described in the paper.

Oil and gas is certainly a sector that is undergoing systemic change. And we are witnessing the oil and gas companies expectation that field level innovations will spontaneously exist, yet expend none of the money necessary to bring those innovations to market. In their opinion that is the responsibility of the investment capital groups. Well let me be the first to explain to the oil and gas companies management, the investment capital groups became tired of the thumbs down they received for any and all efforts that they undertook. They have left the industry, and I would suggest will not be back. Expecting others to fulfill your needs when you need them, without financial support, just isn't going to work.

This same issue is the paramount issue that People, Ideas & Objects is facing. With no support from the industry, how and why would anyone get behind this project on a speculative basis? Management have made their opinion known and are clearly uninterested in sponsoring a competitive means to manage the industry. What is clearly necessary in 2010 is not only the ID's, SKIE's and CISP. But also the market supporting software necessary to identify and support the market. Without People, Ideas & Objects any attempt at organizing the development of further capabilities will be futile. And that is why management have refused to fund these developments.

The underlying assumption, normally unspoken, is that relevant background institutions — things like respect for private property, contract law, courts — are all in place. Whatever transaction costs then arise are thus the result of properties inherent in “the market” itself, not of inadequacies in background institutions. There is generally a tacit factual or historical assumption as well: that the relevant markets exist thickly or would come into existence instantaneously if called upon. p. 3

In thinking through the points of discussion that have been raised in the past few weeks. I notice that something is missing that is critical to making the ID's et al work. What is the motivation in spending the time and effort necessary to make producers reserves and production more prolific? There has to be something in it for the one that is developing the science or innovation that will sustain them above and beyond the producers desire to have the capabilities. That is the Intellectual Property belongs to the individual or group that developed it. In the example that I provided on Transaction Design, the IP would be the property of the engineers. This is the manner that the Draft Specification in the Knowledge & Learning, Resource Marketplace and Research & Capabilities modules provides.

I have implied this handling of IP in many of the previous posts. I am now stating it explicitly. The only way that the oil and gas industry is going to solve the scientific and engineering problems that it faces is through those with the ideas earning the rights to those ideas. I have consistently argued that the producer firms are focused on their competitive advantages of their oil and gas assets and the necessary earth science and engineering capabilities applied to their assets. This applies to where ever those capabilities are located. How a firm may manufacture drill bits is of absolutely no concern to the producer firm that purchases or rents drill bits. The same can be applied to all aspects of the industry.

This management of Intellectual Property is counter to the attitudes present in the oil and gas industry. Until, and only when, those that do the hard work of solving the problems in oil and gas, earn the rights to their efforts, will we move forward from here. Intellectual Property rights must reside within the firms and individuals who make up the Business Groups, ID's, SKIE's and CISP.

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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