Capabilities and Governance Part III
[I]t seems to me that we cannot hope to construct an adequate theory of industrial organization and in particular to answer our question about the division of labour between firm and market, unless the elements of organization, knowledge, experience and skills are brought back to the foreground of our vision (Richardson 1972, p. 888).This comment captures very succinctly the reason that I am so closely reviewing this. I have suggested that the Joint Operating Committee is the ideal organizational construct and I now have strong concurrence of that concept in industry. I have recently suggested the Military Command analogy provides a management framework for the command and control mechanisms, and is a possible replacement of the hierarchy. And that is also receiving strong support in the industry. I now have stumbled into the collective works of Professor Langlois et al and can see things in a different perspective that provides the clear definitions of how this software will need to be built.
II Production and Governance: the Post-Coase literature.
A. Historical Sources of the Neglect of Production in the Post-Coase Literature.
The clear definition of production costs being incurred by the Joint Operating Committee and the transaction costs being incurred by the Military Command structure is a fairly clear and well established classification for the purposes of this review. Why is it that Langlois et al want to establish such a tie-in of these classifications with the governance and capabilities views of the firm? I will attempt to clarify for myself and my readers the validity of these theories in relation to the Joint Operating Committee and the Military Command Structure.
"Production costs determine technical (substitution) choices, but transaction costs determine which stages of the productive process are assigned to the institution of the price system and which to the institution of the firm. The kinds of costs are logically distinct; they are orthogonal to one another. As a result, issues of economic organization - such as the boundaries of the firm - cannot turn on considerations of production costs. Present-day theory has not only bought into this view but has arguably reinforced the separation." pp. 10In a nutshell, the boundaries of the firm can not be defined by production costs. The methods the industry will use to organize its production is through the ability of transaction costs to determine the origin of the production cost from the market or the firm.
B. Production, Coordination, and Incentives in Present-Day Theory.
One of the key points that I noted in the October 2006 Final Research Report was the manner in which the command and control of the firm was not being tossed to the four winds in favour of the joint operating committee. It is specifically suggested that the command and control of the firm is supported through what I have called the Military Command style of management. A Military Command analogy that would enable a pooling of the industries resources and capabilities. Reducing the redundant duplication of capabilities that is built into each and every producer. The redundant duplication of capability necessary to conduct the operation of the producers assets. This has the effect of diluting the overall industry capability, decreasing the speed of operations and increasing the production and transaction costs of operations.
With Langlois' clear definition of "production costs" and "transaction costs." Langlois et al permits the experienced oil and gas worker to clearly discern the two separate components of the "firm" and its redefined boundaries. Boundaries that clearly fall into the two types of costs (production & transaction) and management functions (Joint Operating Committee & Military Command like matrix structure).
"As we will argue in more detail below, there are in fact two principal theoretical avenues closed off by a conception of organization as the solution to a problem of incentive alignment. And both have to do with the question of production knowledge. One is the possibility that knowledge about how to produce is imperfect - or, as we would prefer to say, dispersed, bounded, sticky and idiosyncratic. The second is the possibility that knowledge about how to link together one person's (or organization's) productive knowledge with that of another is also imperfect. The first possibility leads us to the issue of capabilities or competencies; the second leads to the issue of qualitative coordination". pp. 11and
"A close reading of this passage suggests that Coase's explanation for the emergence of the firm is ultimately a coordination one: the firm is an institution that lowers the costs of qualitative coordination in a world of uncertainty." pp. 11Here we have justification and need for the Military Command style of management control. Without the ability to organize the people in the manner that best suits the opportunity, co-ordination of the work would not occur. Production knowledge is a fundamental component of the tacit knowledge of the people in the organization. Each representative on the Joint Operating Committee operating in their respective disciplines know intuitively how to get the work that needs to get done, done. However, is that enough? It would appear to me that there is a role for the authorization, authority, policies and procedures to provide a framework of how oil and gas operations are conducted for company X. And this can be asserted through the Military Command type recognition of Generals to Privates. I would certainly stand guilty of Langlois et al's following quotation in asserting the Joint Operating Committee as the key, and only, organizational construct. However, clearly to do so, I would be incorrect as their are essentially two different organizations operating in two separate domains. Those that deal with production costs (JOC) and those that deal with transaction costs (Military Command). And each of these organizational domains need to be defined and supported in the software. A software application that identifies and supports the legal, financial, operational decision making, cultural, and most importantly the accountability frameworks of the oil and gas producer.
"Largely in a quest to make Coase's ideas more "operational," this literature has arguably both narrowed his explanation for the firm and moved its focus away from issues of coordination, especially qualities coordination. More precisely, both the issue of capabilities and the issue of the coordination of production - in the sense of aligning the knowledge and expectations of the parties who need to cooperate in production - have been overshadowed by a dominant interest in issues of incentive compatibility." pp. 12and
"If, by contrast, the transacting parties were to pool their capital into a single enterprise in whose profits they jointly shared, the incentives for unproductive rent-seeking would be attenuated. And, because such unified organizations would choose the more productive specialized technology, they would win out in the competitive struggle against the contractual alternative." pp. 13and
"If, however, assets are specifics, or if opportunism becomes possible for other reasons, it may be efficient to place the residual rights of control in the hands of only one of the parties by giving that party ownership of both sets of assets. In general, the owner ought to be the party whose possession of the residual right minimizes rent-seeking costs, which typically means the party whose contribution to the quasi-rents of cooperation is greater." pp. 14and
"All recognize that knowledge is imperfect and that most economically interesting contracts are, as a consequence, incomplete. But most of the literature considers seriously as coordinating devices only contracts and the incentives they embody. It thus neglects the role- the potentially far more important role - of routines and capabilities as coordinating devices. Moreover, the assumption that production costs are distinct from transaction costs and that production costs can and should always be held constant obscures the way productive knowledge is generated and transmitted in the economy." pp. 14These last few quotes providing valuable information on how this software will be developed. I will be following this entry up with Capabilities and Governance Part V in the next few days. This will speak to the role of contracts as coordinating devices.
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