Category Archives: business economics

Why Large Corporations?

Posted on by

In a comment on an earlier post, Ajay asks,

what is the point of a large corporation in the first place?

Some possibilities:

1. Governments want them. Surely, from a “seeing like a state” perspective it is better to have large corporations that are dependent on favors than small firms that are not.

2. There are genuine economies of scale and scope, including network effects.

3. Workers believe that they are more secure working for large corporations, and they are willing to take less compensation as a result. Note that this sort of belief could be self-fulfilling. Note also that it is not terribly consistent with the data: compensation appears to be higher at large firms, although that comparison assumes that the investigator’s idea of objective value of workers is more meaningful than their actual choices.

Think about Google. It needs to retrieve, store, and process huge amounts of data. There are scale economies. Once you have that data, you can benefit from other data, so you want to expand into email, location services, social networking, phones, and anything else that generates data. So there are economies of scope as well.

Maybe that is an exceptional case.

My tendency is to think that economies of scale are fairly common, but economies of scope are relatively rare. I understand big companies that specialize in a relatively narrow capability–something like Fedex, for example. I am less convinced about organizations that branch into many functions, like universities or large financial firms.

When I re-read what I wrote on this topic fifteen years ago, I see that my views have not moved very much.

Charter Cities and Corporate Soap Opera

Posted on by

I cannot recommend strongly enough listening to this edition of This American Life. Thanks to Tyler Cowen for the pointer.

The episode looks into what happened with the Charter City concept in Honduras. The reporters, Chana Joffe-Walt and Jacob Goldstein, hone in on exactly the aspect that most fascinated me about the story: what I call corporate soap opera. It’s all there–the egos, hurt feelings, control issues. I feel as though I have been, at one time or another, in the shoes of all the major participants in this story.

Human beings seem hard-wired to create conflict. That is why speaking of “the state” or “the corporation” as a unitary decision-maker strikes me as often misleading.

Organizational Mediocrity is No Accident

Posted on by

Tim Kane’s book, Bleeding Talent, earns a review from the New York Times.

That act binds the military into a system that honors seniority over individual merit. It judges officers, hundreds at a time, in an up-or-out promotion process that relies on evaluations that have been almost laughably eroded by grade inflation. A zero-defect mentality punishes errors severely. The system discourages specialization — you can’t expect to stay a fighter jock or a cybersecurity expert — and pushes the career-minded up a tried-and-true ladder that, not surprisingly, produces lookalikes.

Pointer from Tyler Cowen. Reihan Salam has more praise for the book.

This reminds me of the Federal Reserve Board, or of the public school system. To some extent it reminds me of the way large corporations treat middle managers. As I explained almost fifteen years ago,

For corporations, encouraging middle managers to take good risks is not as easy as it sounds. Middle managers understandably do not want the same degree of personal downside risk as entrepeneurs. However, in the absence of personal downside risk, the middle manager’s incentives would be skewed toward taking unjustifiable risks. Bureaucratic controls and limits on upside incentives may be an appropriate adaptation for correcting this potential bias.

I think that mediocrity is the natural state of organizations. Only the discipline of competition serves to bring about improvement.

Activities vs. Results

Posted on by

Edward Glaeser writes,

The U.S. has six large programs — Temporary Assistance for Needy Families, Medicaid, food stamps, housing vouchers, unemployment insurance and the earned-income tax credit — spread across four Cabinet departments and the Internal Revenue Service.

Pointer from Reihan Salam. Salam also recommends an essay by Steven Teles on kludgeocracy.

Unfortunately, this is not an accident. There is a tendency in all organizations to focus on activities rather than results. Every program represents an activity. Managers of an activity seek to perpetuate and expand their domains.

Activities are easy to measure. The impact on results is difficult to quantify. Think tanks report on how many op-eds their scholars publish. How many think tanks report on their impact on results?

Corporations are often the victims of activity-centered thinking. Activities acquire a momentum of their own. One thing that management consultants do is challenge the mindset and power of departmental managers who focus on activities rather than results.

Fortunately, corporations face market constraints and competition. These forces serve to weed out mindless activities and re-focus attention on results. In government, those checks are missing. Thus, it is almost inevitable that government programs will be perpetuated without regard to results. That is the natural behavior in organizations, and only if there are countervailing forces will that natural behavior be overcome.