Organizational Innovation

10 April 2007 at 11:57 pm Nicolai Foss 10 comments

| Nicolai Foss |

Organizational economists, new institutional economics, contract theorists, etc. are taken up with assessing alternative feasible allocations of decision and income rights, contracts, governance structures and institutions in terms of their impact on value creation for a relevant social system, whether a dyad, a multi-person firm, an industry, or a whole economy.

However, they usually assume that the set of alternatives is given to the choosing agent or set of agents. For example, in the Grossman/Hart/Moore property rights view, agents may not entirely understand the sources of payoffs, but they know exactly how alternative allocations of property rights impact payoffs. Of course, this is entirely in line with what we — given Peter’s post on Lionel Robbins below — may call “Robbinsian maximizing” in which the discovery and/or creation of new alternatives is deliberately disregarded.

Of course, economists often engage in rationalizing history, and prominent organizational economists have done this as well. Thus, Oliver Williamson argues that Alfred Chandler’s account of the emergence of the M-form is consistent with transaction cost economics (e.g., this paper).

Now, there seems to be a curious asymmetry here. Economists usually quite readily admit that innovation is a highly uncertain process that may be characterized by Knightian uncertainty, and involves judgment, creativity, search processes, experimentation, etc. However, this recognition does not appear to carry over to discussions of organizational innovation. In Alfred Chandler’s account in Strategy and Structure DuPont certainly did not make an informed choice among well-defined alternatives in some organizational choice set. Rather, the M-form was tried out as a sort of wild guess. And succeeded.

In Williamson’s TCE explanation of the functioning and spread of the M-form, however, such experimental processes are not discussed. More generally, organizational economists seem to stray away from discussing the process of organizational innovation. However, they certainly would seem to have something to add to the understanding of such innovation. Thus, organizational innovation impacts payoffs across the relevant agents; some agents may be harmed; it may be costly to transfer utility to them; etc. In other words, conflicting incentives and transaction costs would seem to be an integral part of organizational innovation.

More generally, organizational innovation seems to be considerably less studied than technological innovation, although we have reasons to believe that organizational innovation may matter a great deal for welfare. This means that we are pretty much in the dark with respect to such issues as what are the main antecedents to organizational innovation, and whether organizational innovations processes have the same overall characteristics as technological innovation processes.

Entry filed under: - Foss -, Business/Economic History, Institutions, New Institutional Economics.

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10 Comments Add your own

1. Joe Mahoney | 11 April 2007 at 10:10 am

In this regard, Williamson (1975: 192) in Markets and Hierarchies quoting A.H. Cole writes: “If changes in business procedures and practices were patentable, the contribution of business change to the economic growth of the nation would be as widely recognized as the influence of mechanical inventions or the inflow of capital abroad.”
2. twofish | 11 April 2007 at 11:27 am

I think part of the problem is the “composition fallacy” which is that people assume that rationality in social systems involves rationality among individuals. People have a hard time imagining that a social system can make rational choices, even if the individuals that make up that system aren’t consciously aware of the consequences of the choices that they make.

For every organizational innovation that works, there may be hundreds that don’t. The ones that do, get copied. The ones that don’t, get forgotten. The thing that people I don’t think realize is that there may be no way *a priori* to know what works and what doesn’t. If this is the case, then it becomes impossible for the individual to rationally plan strategy, since the information that he needs to know in order to plan strategy *does not exist*. However, the system is rational, because you have lots of people doing different things for irrational reasons. Some work. Some don’t. What works survives. What doesn’t work, doesn’t. It’s only *after* you do the experiment that you can try to piece together why something worked, and *even then* you might not really know.

The other thing that makes biological analogies more useful than mechanical ones is that organizations exist within a social context, however changes within organizations change their social context which forces other changes within organizations. What works in one socio-cultural context may be completely broken in another.
3. JiE | 12 April 2007 at 1:43 am

Technological innovation as a concept is quite clear but organizational innovation is quite vague, in my view.

Is it something the organization just creates, or as Wikipedia it defines:

“Organizational innovation involves the creation or alteration of business structures, practices, and models, and may therefore include process, marketing and business model innovation.”
4. Nicolai Foss | 12 April 2007 at 2:18 am

JiE, I think the Wiki definition is fine. Why exactly is this “vague” and the definition of technological innovation “quite clear”??
5. Nicolai Foss | 12 April 2007 at 2:27 am

Two fish, you argue that with respect to organization innovation we are essentially completely ignorant and all we can do is to leave it to the competitive system to perform its sorting function. Well, firm strategists, consultants, and managers just cannot afford this attitude for obvious reasons. I also provided some indications that organization economists may, with a little effort, have interesting things to say about organizational innovation. Thus, we are not entirely ignorant. (Imagine if geneticists, molecular biologists etc had adopted your attitude — in that case, we would still be completely ignorant about the sources of biological variation and only study selection).
6. JiE | 12 April 2007 at 3:23 am

Prof. Foss, my word choice was poor. I met that I understand much better the concept of technological innovation than the concept of organizational innovation. The reason might be, as you posted, that the organizational innovation is considerably less studied (and less used concept). So at least for me organizational innovation was not clearly understandable before this discussion.
7. twofish | 12 April 2007 at 4:48 pm

Foss: Well, firm strategists, consultants, and managers just cannot afford this attitude for obvious reasons.

The problem is that firm strategists, consultants, and managers then start claiming knowledge that doesn’t exist. I applaud people that look at the results of the competitive sorting function and then try to explain why what happened, happened.

However, I have seen an institutional bias in favor of assuming knowledge that doesn’t exist, and this has led to some of the worst economic and social disasters in human history.

Applying the rhetoric of science in this situation is especially dangerous since one ends up with something with the authority of science, without a lot of the internal checks and balances. One of the big institutional checks and balance that I’ve seen in physics that doesn’t seem to be as strong in the social sciences, is the ability to get up in front of a group of people, and say “I have no freaking clue what is going on here” and get respect for this.

It’s not what you don’t know that gets you, it’s what you think you know that isn’t.
8. Awie Foong | 12 April 2007 at 8:08 pm

the chinese has a saying: “for every battle to be won, the combination of environment, time, place, and people must be right.” and this ain’t easy, although some people claim that they are able to predict what’s the right environment and time and place and people.

organizational inovation deals with too many intangibles and many uncertainties; total replication is just not possible. Replicate and adapt, and you are back to the environment-time-place-people choices again. Technological innovation, on the other hand, has the luxury to deal with mainly the tangibles, although tacit knowledge is a vital input.

and here is where the different theoretical perspectives come into play: Economists deliberately avoid the issues of individual differences because of its macro perspectives; organizational scientists take a more micro approach, dealing more realistically with incentive problems; and psychologists go even further to the micro level. At different level of analysis, these theories would be especially useful for different people dealing with issues at the corresponding levels.

all those works are great stuffs. williamson’s and chandler’s and etc. they are celebrated for their contribution, but i guess it is also our job to fill-in the limitations. maybe a meta-theory-of-contingency on organizational innovation, anyone?
9. srp | 14 April 2007 at 7:45 pm

I hope no one is proposing a scientific theory that could predict organizational innovations. That would be like a scientific theory that could predict entrepreneurial success, or future technology, or future history, for that matter. Take a dose of McCloskey’s If You’re So Smart and call me in the morning.
10. twofish | 16 April 2007 at 10:41 am

Something that annoys me as someone with a physics background is that social scientists often do something that strikes me as “cargo cult science.” Theories in the social sciences are often structured as if they were done by someone who heard what a physics theory looks like retold several times. In particular, there is a tendency to think that if you add lots of equations to a theory, that gives it respectability, whereas the point of physics is to use equations so that you get to the point that you don’t need them to explain what is going on.