30

Chapter 2 : Filling the Void

2.0 Introduction2.0.1 Purpose of the chapterIn the first chapter it was explained that the market-governmentdebate shows three major anomalies. In addition a counter-intuitivecase was described that does not fit into existing economic theory.

This chapter presents a framework in which the fourquestions implied can be answered:i) If differences of motivation are not the cause, why is the

efficiency of organisations in the market still significantlysuperior to organisations in the government sector?

ii) What causes the Sturm-de Haan paradox (economic growthis related to changes in “economic freedom” and not to itslevel)?

iii) If privately owned firms are far more efficient than publiclyowned firms, why are the consequences of privatisation sodisappointing?

iv) What explains the positive relationship between Spanish fluand economic growth?

2.0.2 Outline of the chapterIn this chapter a theoretical solution will be developed along thefollowing lines. All organisations will ultimately lose effectivity. AsSchumpeter has written extensively, changes in the environment(whether in technologies or scarcities) can render an organisationirreparably obsolete. But such irreparable deterioration can and willalso happen without any changes in the environment of theorganisation.

Having made a plausible conjecture that, irrespective ofexternal change, at some point of time all organisations irreparablylose their effectiveness, the next step is to establish that mostgovernment organisations that lose their effectiveness will survive,while commercial organisations and associations fall apart. Theinevitable economic damage of such a disintegration is mitigated bythe fact that there exists an alternative to radical dissolution(economic necrosis) being economic apoptosis. In apoptosis asignificant proportion of the economic value of the organisation isretained and even enhanced. Especially when economic apoptosis

31

is taken into account, the advantages in terms of averageeffectiveness of commercial organisations and associations ascompared to the average effectiveness of government organisationsbecome trivial. The final step is to explore whether theseconjectures contribute to a solution of the anomalies identifiedabove.

The structure of the second chapter (presented in figure 2.1)can be described as follows. A framework for describing theorganisation is selected in the first section. The concept of theorganisation is analysed within this framework in the secondsection. In the third section a major limitation of the size of anorganisation will be inserted, being control. While in third sectioncontrol is held constant, the fourth section introduces a model thatdescribes its dynamics. Specific attention will be given to thephenomenon of uncontrollability. It will be demonstrated that itsconsequences are irreparable. Uncontrollability plausibly ariseseven in the absence of external change (whether in technologies ormarkets). Absolute prevention seems impossible.

Other changes caused internally, for instance, bymismanagement or by inertia in the face of external change arediscussed in the fifth section. Changes in effectiveness can be alsocaused externally, either because the resources used by theorganisation become more (or less) scarce or because the demandfor the results of its endeavours becomes smaller (or greater).These external causes will be discussed in the sixth section. In the seventh section the approaches to ineffective organisationswill be discussed, being apoptosis, necrosis and subsidisation. Inthe eighth section a comparison will be made of sectors in whichapoptosis / necrosis are regular phenomena with sectors in whichthese phenomena are suppressed. The relevance of thiscomparison will then be ascertained.

2.1 The organisation: selecting an appropriate frameworkThe organisation is the theme of this chapter. In this section aframework will be selected for analysing this concept, suitable foranalysing the dynamics of its size, scope, efficiency andeffectiveness.

Like the proverbial blind Indians describing an elephant,organisational scientists have a range of models at their disposal to

32

Figure 2.1Structure of Chapter Two

For instance, Bruggeman (1996) and Péli, Bruggeman, Mausch and Ó Nuallain35

(1994) demonstrated that the open character of terms like “inertia” and “failure”,

and the use of natural language to formulate their theories led Hannan and

Freeman to a number of conclusions that did not follow from their premises. This

inspired Hannan to admit, rather weakly, that “the liability of newness does not

necessarily follow as an implication of the formalized Hannan and Freeman

theory of structural inertia” (Hannan, 1998: 128). In fact, Hannan’s work has

recently become much more formal in its approach (Hannan, Pólos and Carroll,

2002).

This chapter was written “standing on the shoulders” of these three economists36

(and of Kornai). W e had the choice of summarising their arguments and running

the risk of introducing “Bartlettian” distortion (Bartlett,1920, see page 49 of our

book) or of presenting extensive verbatim citations. For reasons of solidity and

soundness we chose the latter, fully realising that we sacrifice readability and

brevity.

33

describe an organisation, each focusing on dimensions pertinent totheir own line of enquiry. When “googling” to find an appropriatestarting point, “industrial organisation” is rather obvious. But ondigging further, one finds that the study of industrial organisation isconsidered to be synonymous with the study of the functioning ofmarkets (Tirole, 1989: 1), while the subject of this volume isorganisations, their “health” and the consequences of organisational“disease”.

To an - undogmatic - follower of Karl Popper the writings ofsociologists and management scientists such as Hannan andFreeman (1989), Mintzberg (1989) and Meyer and Zucker (1989) donot offer the strong anchor points to which the line of argument canbe connected. It must be added that these books are of great35

value in giving a first feel of parts of the field of enquiry andextending the enquiry in adjacent fields.

The anchor points were found among giants of economics, inparticular Coase, Simon and Williamson. As an introduction to his36

seminal article “The nature of the firm” the Nobel laureate Coase(1937: 5) wrote:

“The firm in modern economic theory is an organizationwhich transforms inputs into outputs. Why firms exist, whatdetermines the number of firms, what determines what firmsdo (the input a firm buys and the output it sells) are not

Aldrich sometimes uses the word “transformation” for what is to all practical37

purposes the same concept (see, for instance, Aldrich, 1999: 43).

34

questions of interest to most economists. The firm ineconomic theory, as Hahn said recently, is a “shadowyfigure.” This lack of interest is quite extraordinary, given thatmost people in the United States, the United Kingdom, andother Western countries are employed by firms, that mostproduction takes place within firms, and that the efficiency ofthe whole economic system depends to a very considerableextent on what happens within these economic molecules.”

It is an attractive proposition, impossible to prove, that Coase’s texteventually inspired quite a number of economists to focus theirattention on this very subject. Organisational economics hasbecome one of the most fertile fields of the profession.

When this author first scouted this field of enquiry, heexpected to find answers in the evolutionary approach of theentrepreneurship school, personalised in Aldrich (1979, 1999). Theline of thought can be summarised by the following quotation(Aldrich and Martinez, 2001: 4, emphasis added):

“An evolutionary approach studies the creation of neworganizational structures (variation), the way in whichentrepreneurs modify their organizations and use resourcesto survive in changing environments (adaptation) , the37

circumstances under which such organizationalarrangements lead to success and survival (selection), andthe way in which successful arrangements tend to beimitated and perpetuated by other entrepreneurs (retention).”

Aldrich brings some order in organisational change studies byidentifying six approaches to organisational change. Subsequentlyhe demonstrates how these six approaches are used by his ownevolutionary approach to explain organisational change. This resultsin table 2.1.

However, realisation came that evolutionary theoryconcentrates on whether or not organisations react to improve theirfit into their environment and on which organisations thrive and

For alternative structuring of theories of the firm/organisation see Francis, Turk38

and W illman (1983) and Foss (1998). Differences are far from trivial, but not

directly relevant to this book.

Friebel and Raith (2004), using an interesting game-theoretical approach,39

demonstrate that incentive considerations can have important communicative

consequences and can thus have implications for control designs.

35

survive, and which fail. To fill the theoretical void identified inchapter 1, we need an approach that explains why organisationscan fail irrespective of changes in the environment, how societytreats these failing organisations and what effects this treatment hason the performance of society as a whole. The evolutionaryapproach does not meet this requirement.

In an article by Gibbons (2005) four families of economic38

theories around the organisation are delineated, being the “rent-seeking”, “property rights”, ”incentive” and “adaptation” families.Gibbons demonstrates that these families are not inconsistent, andcan be combined into one integrative framework if such integrationis necessary when tackling a certain issue. When choosing amongthese four families, the first two essentially deal with externalchoices and cannot explain internal organisational dynamics. Assuch they only touch upon the argument of this book when theargument adds criteria to the strategic choices mentioned. Theincentive family focuses on the incentive problem between aprincipal and an agent, again only touching upon the fringes of our argument (Gibbons, 2005: 210). It will be demonstrated that an39

appropriate approach for our line of research can be found in thefourth family defined by Gibbons, the “adaptation” family of theories.

The proverbial foundation stone for the adaptation “school”was laid by Coase, in a neglected niche of his masterpiece “TheNature of the Firm” (1937). Corner stones were placed by Simon(1951) and Williamson (1967). Emphasis is laid on the merits anddemerits of transferring authority into the hands of a boss, whomakes decisions after uncertainties regarding the environment havebeen resolved. In other words, in the relational-adaptation theories

36

Perspective Variation, selection and retention Transformation

Ecological *Variation introduced via new organizations *Organizations are structurally

inert and slow to change

*Selection results from fit between

organization and environment

*Selection and transform ation

are fundam entally related

*Retention through external pressures and

internal inertia

Institutional *Variations introduced from external origins,

such as im itation

*Organizations change when

forced to do so

*Selection via conform ity *Institutionalization m akes

m any kinds of change

unim aginable

*Retention through transm ission of shared

understandings

Interpretive *Variation introduced as people negotiate

m eaning through interaction

*Organizations are not very

inert

*Selection via em ergent understandings and

com prom ise

*Discontinuities are frequent

*Retention is problem atic: depends on

learning and sharing

Organizational learning *Variation introduced via problem istic search

or inform ation discontinuities

*Organizations are open to

change

*Selection results from fit to target aspiration

level or existing organizational knowledge

*Most change is increm ental,

rather than radical

*Retention in program s, routines and culture

Resource dependence *Variation introduced as managers try to avoid

dependance

*Organizations are strongly

subject to external control

*Selection via asym m etric power relations *But managers are active

agents in trying to control their

environm ents

*Retention a tem porary result of coalition and

bargaining

Transaction costs

econom ics

*Variation introduced via intendedly rational

action

*Organizations are open to

change in response to market

conditions

*Selection involves actions to m inim ize

transaction costs

*But, transaction-specific

investments lim it adaptability

*Retention via transaction-specific investments

Table 2.1 Six perspectives on organisations: relation to evolutionary theory

(Aldrich, 1999: 44).

A tributary, concentrating on the organisation as a communication network,40

though overlapping, does not cover the same problems nor does it offer insights

into their solution (see Bolton and Dewatripont, 1994).

Foss (1998: 32) contains the words “Incomplete Contracts: The Coordination41

Perspective” to describe the angle of enquiry of the “adaptation school”.

In existing literature cursory mention is made here and there of the focus of this42

book. For example Bauer and Cohen (1983: 87) point to “Inertia, bureaucracy,

the exacerbation of internal conflicts and the rift between the top and the bottom -

the factors undermine monopoly from within. How then does it happen that these

monoliths take shape and endure?” The answer, of course, is that in the market

they often do not.

37

the key point is “that the integration decision is chosen to facilitatethe parties’ relationship” (Gibbons, 2005: 209). Or, in the words of40

Coase:

“At this stage it is important to note the character of thecontract into which a factor enters that is employed in a firm.The contract is one whereby the factor, for a certainremuneration (which may be fixed or fluctuating), agrees toobey the directions of an entrepreneur within certain limits.”(1937: 39; italics RC, underlining HvdM).

The enquiry of the adaptation school centres on the questionof whether “integration or non-integration better facilitates adaptive,sequential decision-making in environments where uncertainty isresolved over time?” (Gibbons, 2005 : 208). In other words, is41

integration or non-integration better when environments change? Instudying the dynamics of organisational effectiveness, which is thefocus of these pages, a “mirror issue” is tackled: the dynamics of42

authority, irrespective of changes in the environment. Or, - reversingGibbons’ phrase - the question to address is when the dynamics ofintegration stop facilitating parties’ relationship. When a line ofanalysis is found that is adequate for clarifying the mirror issue ofthe topic being tackled, this line of analysis will often be useful inclarifying that topic. It was therefore decided to embed our analysisin the adaptation theories.

38

Having chosen the “river basin” (the family of adaptationtheories) we have to choose the “river bed” along which we willdevelop our theses. Initially our investigation led into the “Marketsand Hierarchies Programme” (Williamson, 1975). According toWilliamson (Williamson and Ouchi, 1981: 33) the coremethodological properties of this programme are:

“ 1 The transaction is the basic unit of analysis.2 Human agents are subject to bounded analysis and

self-interest.3 The critical dimensions for describing transactions are

frequency, uncertainty, and transaction-specificinvestments.

4 Economizing on transaction costs is the principalfactor that explains viable modes of contracting; it isthe main issue with which organisational design oughtto be concerned.

5 Assessing transaction cost differences is acomparative institutional exercise.”

However, we find that this methodology fails to satisfy thespecific demands of our line of enquiry, for reasons inadvertentlyformulated by the master himself (idem: 21):

”Consistent with the general thrust of the Markets andHierarchies approach, organization is addressed as atransaction cost issue, and economizing purposes areemphasised. The general argument is this: except wherethere are perversities associated with the funding process, orwhen strategically situated members of an organization areunable to participate in the prospective gains, unrealizedefficiency opportunities always offer an incentive toreorganize. Inasmuch as these perversities are morecommon in non-commercial than in commercial enterprises,the argument has stronger predictive force for the latter.“

We are concerned with both commercial and non-commercial organisations. Thus we seek a theory that is equallyvalid in both categories of organisations. We backtracked to three

39

articles that paved the way for the Markets and Hierarchiesprogramme - Coase (1937), Simon (1951) and Williamson (1967) -and decided to use Simon’s set-up. The model is extended from asingle bipolar model (employment) into a model of an organisation.The model is then broadened and deepened to incorporate newinsights and non-commercial organisations. When Simon arrives atthe point where participants do not know what future acts are mostadvantageous (the main rationale for the employment relationship),our treatise branches off to discuss the uncertainty of the authorityrelationship itself. Terra incognita is entered.

2.2 The nature of the organisationIn this section the first part of Simon’s paper (1951) will be citedextensively, alternated with additions necessary to broaden thescope from firms to all organisations, the analysis of the controlelement and to prepare for the eventual transformation from a staticmodel into a dynamic model.

“1 THE CONCEPT OF AUTHORITYThe authority relationship that exists between an employerand an employee, a relationship created by the employmentcontract, will play a central role in our theory. What is thenature of the relationship? We will call our employer B (for “boss”), and our employee W(for “worker”). The collection of specific actions W performson the job (typing and filing certain letters, laying bricks, orwhat not) we will call his behavior. We will consider the set ofall possible behavior patterns of W and we will let x designatean element of this set. A particular x might then represent agiven set of tasks, performed at a particular rate of working, aparticular level of accuracy, and so forth.We will say that B exercises authority over W if W permits Bto select x. That is, W accepts authority when his behavior isdetermined by B’s decision. In general, W will accept

0authority only if x , the x chosen by B, is restricted to somegiven subset (W’s “area of acceptance”) of all the possible

This refers to 1951, HvdM.43

In 2005 a Dutch national, Frans van Anraat, was convicted in a Dutch criminal44

court of complicity in war crimes because he sold chemicals to the Saddam

Hussein regime in Iraq, knowing these chemicals were ingredients for producing

mustard gas. This gas was used in the war against Iran and in the civil war

40

values. This is the definition of authority that is mostgenerally accepted in modern administrative theory.”43

(Simon, 1951: 293-294).

Later analysis, starting of course with Williamson’s (1967)article, showed the phrase “when his behaviour is determined by B’sdecision” to be too absolute. A modern writer would probably havereplaced the word “determined” with, for instance the word “defined”or “managed”, thus making room for both B intentionally trustingW’s discretion and giving free(er) rein, and for W thwarting B’sintentions, either wilfully or through misconstruction. This point willoccupy a central role in the development of our conjectures.

“2 THE EMPLOYMENT CONTRACTWe will say that W enters into an employment contract with Bwhen the former agrees to accept the authority of the latterand the latter agrees to pay the former a stated wage (w).This contract differs fundamentally from a sales contract -thekind of contract that is assumed in ordinary formulations ofprice theory. In the sales contract each party promises aspecific consideration in return for the considerationpromised by the other. The buyer (like B) promises to pay astated sum of money; but the seller (unlike W) promises inreturn a specified quantity of a completely specifiedcommodity. Moreover, the seller is not interested in the wayin which his commodity is used once it is sold, while theworker is interested in what the worker will want him to do(what x will be chosen by B.)”(Simon, 1951: 294).

Sometimes the seller does have a legal and/or moral interestin the way in which his commodity is used once it is sold. The Dutch“chemical Ali” case is an extreme and fortunately a very rare44

against the Kurd minority.

Including, for instance, military and medical expenditure and repair of fire45

damaged real estate, and excluding housekeeping and unpaid care of disabled

family members.

41

example. Product liability, which has been broadened spectacularlyin the United States, is a far less marginal example: the seller doesmaintain an intimate interest in the future use of his commodity(asbestos, tobacco). Product guarantees are a second example of acontinuing interest of the seller in the future use of his product.Therefore, instead of “is not interested” Simon would (fifty yearsafter this article was published) possibly have written “loses control”;this covers the needs of his argument, and is closer to 2006realities.

Another development would also have caused Simon toadapt his article. Since the 1950s the importance of services hasgreatly increased as compared to goods. For instance, at presentaround 65 per cent of the total value created in the Netherlands -measured conventionally - is in the form of services. This is45

especially important when a modern definition of a service is used.For instance, Ruys and Bruil (2005: 5) define a service as “a serviceis the carrier of a value generating relation between two or morepeople. The relation determines the type of a service; the carrierdetermines the content of a service (emphasis added).” Adapted tothis definition, the employment contract involves the transfer ofauthority - to enter into transactions regarding the content of aservice - from the performer (receiver) to the provider (procurer).

“We notice that certain services are obtained by buyers inour society sometimes by a sales contract, sometimes by anemployment contract. For example, if I want a new concretesidewalk, I may contract for the sidewalk or I may employ aworker to construct it for me. However, there are certainclasses of services that are typically secured by purchaseand others that are typically secured by employing someoneto perform them. Most labor today is performed by personswho are in an employment relation with their immediatecontractors.

Organisations consist of individual human beings, and organisational behaviour46

is the product of behaviour of interacting individuals. Therefore analysis will have

to start with some assumptions on individual behaviour. Simon implicitly assumes

that human beings maximise their private utility rationally, their ratio bounded by

limitations in the information available to them at the time they take the decision.

42

We may now attempt to answer two related questions aboutthe employment contract. Why is W willing to sign a blankcheck, so to speak, by giving B authority over his behavior? Ifboth parties are behaving rationally - in some sense - under46

what circumstances will they enter into a sales contract andunder what circumstance an employment contract?The following two conjectures, which, if correct, provide apossible answer to these questions, will be examined in theframework of a formal model:1 W will be willing to enter an employment contract

with b only if it does not matter to him “very much”which x (within the agreed-upon area ofacceptance) B will choose or if W is compensated insome way for the possibility that B will choose an xthat is not desired by W (i.e., that B will ask W toperform an unpleasant task).

2 It will be advantageous to B to offer W addedcompensation for entering into an employmentcontract if B is unable to predict with certainty, atthe time the contract is made, which x will be theoptimum one, from his standpoint. That is, B willpay for the privilege of postponing, until some timeafter the contract is made, the selection of x.”(Simon, 1951: 294-295)

A weak point in an extremely powerful line of argument:Simon does not explain why W does not simply wait until he doesknow what he wants, before entering the contract, thus saving theneed to pay added compensation to W. This weakness can berepaired by referring to Coase’s transaction costs. Suppose Bknows he has a multitude of different tasks, the precise nature ofwhich is not yet defined. B can wait until each task has beenidentified, and then enter into sales contracts. He will thereby

As mentioned earlier, when analysing associations w>0 is inoperative (HvdM).47

43

save himself the expense of compensating W for the possibilitythat he will choose some x’s less acceptable to W. But becauseof the great number of contracts to be concluded, the sum oftransaction costs will increase. The rationale of the employmentcontract is determined by the difference between anticipatedtransaction costs and the extra compensation needed to entice Winto transferring authority.

As discussed earlier, Simon describes the commercialorganisation. The association differs because, more often thannot, W will actually pay in order to participate in the activities ofthe organisation, simultaneously giving the organisation theauthority to determine x.

“3 THE SATISFACTION FUNCTIONSLet us suppose that W and B are each trying to maximizetheir respective satisfaction functions. Let the satisfactionof each depend on: (a) the particular x that is chosen. (For W this affects,

for example, the pleasantness of his work; for B thisdetermines the product that will be produced by W’slabor.)

(b) the particular wage (w) that is received or paid. Weassume further that these two components of thesatisfaction function enter additively into it asfollows:

1 1 1(3.1) S = F (x) - a w,

2 2 2(3.2) S = F (x) + a w,

1 2where S and S are the satisfactions of B and W,respectively, and w>0 is the wage paid by B to W. The47

opportunity cost to each participant of entering into thecontract may be used to define the zero point of hissatisfaction function. That is, if W does not contract with B,

1 2then S = 0, S = 0. Further, for the situations with which

W hen analysing associations this last sentence is inoperative (HvdM).48

W hen analysing associations this condition is inoperative (HvdM).49

44

1we wish to deal it seems reasonable to assume that F (x)

2 1 2$ 0, F (x) # 0, a >0, a >0 for the relevant range of x.48

1 2Since S = 0, S = 0 if B and W fail to reach an agreement,

1we may assume that, for any agreement they do reach, S

2$ 0, S $ 0. When an x and a w exist satisfying theseconditions, we say the system is viable. The condition maybe stated thus:

1 1(3.3) F (x) $ a w,

2 2(3.4) -F (x) # a w.

Equations (3.3) and (3.4) imply

2 1 2 1 1 2(3.5) a F $ a a w $ -a F .

2 1 1 2Conversely, if for some x, a F (x) > -a F (x), we canalways find a w $ 0 such that (3.5) holds. Hence (3.5) is49

a necessary and sufficient condition that the system beviable.” (Simon, 1951: 295-296).

The conclusion can be extended. As pointed out, in

2associations under normal conditions, w < 0 and F (x) > 0. Thiscondition is therefore also necessary and sufficient forassociations for the system to be viable.

45

“4. PREFERRED SOLUTIONSThus far we have imposed on the agreement between Band W the condition of viability - that the agreement isadvantageous to both. In general, if an agreement ispossible at all, it will not be unique. That is, if a viablesolution exists, there will be a whole region in the (x,w)-space satisfying the inequalities (3.5), and only inexceptional cases will this region degenerate to a singlepoint.” (Simon, 1951: 296)

We have arrived at the stage in which Simon analysesunder what conditions an employment contract is preferable to asales contract, in which the uncertainty surrounding theemployer’s preferences (caused by uncertainty of futureconditions) occupies a central position. The greater thisuncertainty, the greater the possibility that an employmentcontract is preferable. And, following Coase we would add, thehigher combined transaction costs are as compared to thecombined value of the tasks, the greater the advantages ofemployment as compared to trade.

We will now enter a tributary of this flow of analysis of theeconomics of the organisation, different from the tributary thatSimon followed. But first two observations will have to be made.Firstly, while Simon concentrates on the transfer of authority overpaid work, the diversity of contents of the mandate given isactually very large. Procurement is a clear example, unionization(in which the authority to set standard terms of employment istransferred by union members to union leadership) another.Secondly, Simon’s article is considered to be one of thefoundations of organisational economics with good reason. Thisneeds explaining because the word “organisation” is absent in hisarticle. Simon wrote a treatise about employment. He did notdescribe the position of B, the boss. It is probable that B isemploying various W’s, who all have transferred authority to himto define their behaviour (during “working” hours and within thelimits agreed upon). Moreover, B will probably be employed bysomebody else, i.e. B plus, to whom B has transferred authority,not only over his own behaviour but also over what he demands

Ruys, van den Brink and Semenov (1999 : 3). Daft (1992: 7) uses the following50

definition: “organisations are social entities that are goal-directed, deliberately

structured activity systems with an identifiable boundary” (consistent with Aldrich,

1979: 6).

More elaborate mathematical models were developed by Keren and Levhari51

(1983 and 1989).

An interesting parallel regarding the size of a nation (India) is developed by52

Lewis (1991).

46

from the W’s. B plus also has other people reporting to him. Andso on and so forth. All these people together can be called anorganisation. An organisation can thus be defined as a number ofpeople connected by authority relationships, or - in a more formalvocabulary - a nexus of agency relations that can be representedby a directed graph. The article that we cited extensively is a50

seminal analysis of the raison d’être of these relationships(“edges”) and therefore of the principal features common to allorganisations. Considering it part of the corpus of organisationaleconomics is only natural.

In this section we have a followed Simon in assuming thatW will act in accordance with the wishes of B. In the next sectionwe will drop this assumption, and insert a measure of non-compliance into Simon’s model.

2.3 The nature of controlAs written earlier, Simon analyses under what conditions anemployment contract is preferable to a sales contract, in whichthe uncertainty surrounding the employer’s preferences (causedby uncertainty of future conditions) occupies a central position.We will follow a different tributary, pioneered by Williamson in hisequally seminal article “Hierarchical control and optimum firmsize” (1967). Williamson studied the character of the51

relationship between “boss” and “worker”, and its consequencesfor the size of the commercial organisation. The question to52

what degree a transfer of authority actually determines workers’behaviour now occupies central stage.

In section 2.2 we started the discussion of the nature of anorganisation by discussing the nature of employment. It is only

47

logical, when starting to discuss the nature of control, that weshould first discuss the nature of authority. For reasons both ofclarity and of sentimentality, we will start with an example. Mygrandmother employed a gardener, whom everybody calledJakob. He started off as a part-time chauffeur, but in World WarTwo the Germans stole my grandfather’s car and for somereason my grandfather never bought a replacement. So Jakobbecame full-time gardener. My grandmother cared very muchabout her garden in which nature was given a place much largerthan was custom at the time. Jakob loved the garden too. Thelawn was his great pride. And the more it resembled a billiardcloth, the happier he was. In his eyes daisies disturbed the lawn’sperfection; and whenever he saw a daisy, he would open hislarge pen-knife and carefully uproot it. This ran squarely againstthe wishes of my grandmother. She would have preferred a lessperfect and more natural lawn.

There is one gap in the story. We never found out whethermy grandmother knew of Jakob’s vendetta against daisies (andother pests and weeds) and simply turned a blind eye or that shedid not know, and sometimes wondered why, contrary to herneighbours’ lawns, her own lawn was always so perfect andgreen. To avoid confusing the argument, to which we are nowreturning, we will assume the latter. Even though Jakob hadtransferred authority on what he did or did not do during hisworking hours, he still spent several moments a day actingagainst his employer’s wishes. In this case he was probably fullyaware of this himself. But there must have been many instancesin which he did not know, and believed he acted in accordancewith her wishes simply because he did not understand mygrandmother’s plans, or because Jakob had forgotten to give hersome information which, had it been available to her, would havecaused her to give him other instructions. Summarizing, control isnegatively influenced by problems in cognition, information,communication and motivation.

Action is preceded by the processing (cognition) ofinformation. If Jakob did not succeed in processing theinformation my grandmother gave to him, or if he lacked all theinformation needed, his actions would deviate from her intentions.In the case of Jakob and my grandmother none of these three

1 2And S and S are the satisfactions of B and W , respectively, and w is the wage53

paid by B to W .

48

categories of problems played a significant role. To aconsiderable extent the intentions of the “boss” (my grandmother)were satisfied by the “worker” (Jakob). My Grandmother was verymuch “in control”, but this control was not absolute.

To enable insertion of this phenomenon into formalmodels, Williamson (1967: 127) defined control as the fraction áof the intentions of a superior effectively satisfied by asubordinate (0 < á < 1). Inserting á in Herbert Simon’s model hasthe following consequence:

1 1 1(3a.1) S = á F (x) - a w,

2 2 2(3a.2) S = F (x) + a w,

where á stands for control. The opportunity cost to each53

participant of entering into the contract may be used to define thezero point of his satisfaction function. That is, if W does not

1 2 1 2contract with B, then S = 0, S = 0. Since S = 0, S = 0 if B andW fail to reach an agreement, we may assume that, for any

1 2 agreement they do reach, S $ 0, S $ 0. When an x, an á and aw exist satisfying these conditions, we say the system is viable.The condition may be stated thus:

1 1(3a.3) áF (x) $ a w,

2 2 (3a.4) F (x) # a w

The equations imply that

2 1 2 1 1 2(3a.5) áa F (x) $ a a w $ -a F (x).

2 1 1 2Conversely, if for some x áa F (x) $ -a F (x), we canalways find a w such that (3a.5) holds. Hence (3a.5) is anecessary and sufficient condition for the system to be viable.

49

Let us now consider a more complicated situation. Theboss in his turn has another boss, the super-boss (BB). Of course

1S now indicates the satisfaction of BB. Equation (3a.5) still holds,with one significant difference: W is not controlled directly by BB,but indirectly through B. The only value that is not necessarilyunchanged is control. And the situation can become still morecomplicated, if another hierarchical level is added, and BB in his

1turn has a boss, BBB. In which case S indicates the satisfactionof BBB; W is now controlled through both BB and B.

The main question now becomes what consequence theaddition of hierarchical levels has on the level of control. In hisseminal article “Hierarchical Control and Optimum Firm Size”Williamson (1967: 126) described the mechanism by whichcontrol is influenced by the number of hierarchical levels asfollows:

“The aspect of bureaucratic theory that we regard asparticularly relevant for studying the question of a staticlimitation to firm size is what we will refer to as the “controlloss” phenomenon. It is illustrated daily in the rumor-transmission process and has been studied intensively byBartlett in his experimental studies of serial reproduction.His experiments involved the oral transmission ofdescriptive and argumentative passages through a chainof serially linked individuals. Bartlett concludes from anumber of such studies that: “It is now perfectly clear thatserial reproduction normally brings about startling andradical alterations in the material dealt with. Epithets arechanged into their opposites; incidents and events aretransposed; names and numbers rarely survive intact formore than a few reproductions; opinions and conclusionsare reversed - nearly every possible variation seems as if itcan take place, even in a relatively short series. At thesame time the subjects may be very well satisfied withtheir efforts, believing themselves to have passed on allimportant features with little or no change, and merely,perhaps, to have omitted unessential matters.” Bartlettillustrates this graphically with a line drawing of an owlwhich - when redrawn successively by eighteen

Interestingly, Marris and Mueller (1980: 39) reject this argument. In developing54

Lan extremely elegant model they define X as representing a message received

at level L purporting to be a message from L+1. If the message is not correctly

L L+1received or is misinterpreted, there is an error (X - X ). They assume the

possible correlation between the error and the message most generally to be

expressed by a regression equation,

L L+1 L+1 L(X - X ) = (â - 1)X + ì .

Marris and Mueller now state that ”with effective monitoring â could be less than

one.” This is plain nonsense, as it implies that a copy can more faithfully reflect

the original .. than the original itself. No amount of monitoring can ever achieve

that. In fact, the only university discipline in which this is regularly achieved is

theology. Unfortunately the remainder of their model, elegant as it is, is grounded

on this misconception; the result is that according to the model organisations can

grow infinitely without losing efficiency.

50

individuals, each sketch based on its immediatepredecessor - ended up as a recognizable cat; and thefurther from the initial drawing one moved, the greater thedistortion experienced. The reliance of hierarchicalorganizations on serial reproduction for their functioningthus exposes them to what may become seriousdistortions in transmission” (Williamson, 1967: 126) .54

Williamson continues:

“Downs has since elaborated the argument andsummarized it in his “Law of Diminishing Control: thelarger any organization becomes, the weaker is the controlover its actions exercised by those at the top “ (1966: 109).The cumulative loss of control as instructions andinformation are transmitted across successive hierarchicallevels is responsible for this result.

Thus, assuming that economies of specializationhave been exhausted and that superiors are normallymore competent than subordinates, a quality-quantitytrade-off necessarily exists in every decision to expand. Itarises for two reasons, both of which are related to thedistance of the top executive from the locus of productiveactivity. First, expansion of the organization (adding anadditional hierarchical level) removes the superior furtherfrom the basic data that affect operating conditions;

Again he is contradicted by Marris and Mueller who argue that cumulative errors55

increase linearly with the length of the chain of command (Marris and Mueller,

1980: 38). This is illogical. Assuming a certain constant percentage of correct

transmission at each stage, it is obvious that this percentage only affects data

correctly transmitted, and not data incorrectly transmitted.

51

information regarding these conditions must now betransmitted across an additional hierarchical level whichexposes the data to an additional serial reproductionoperation with its attendant losses. Furthermore, the topexecutive cannot have all the information that he hadbefore the expansion plus the information now generatedby the new parts (assuming that he was fully employedinitially). Thus, he can acquire additional information onlyby sacrificing some of the detail provided to himpreviously. Put differently, he trades off breadth for depthin undertaking the expansion; he has more resourcesunder his control, but the quality (serial reproduction loss)and the quantity (phenomenon capacity constraint) of hisinformation are both less with respect to the deployment ofeach resource unit. In a similar way, being further removedfrom the operating situation and having more subordinatesmeans his instructions to each are less detailed and arepassed across an additional hierarchical level. Forprecisely the same reasons, therefore, the behavior of theoperating units will scarcely correspond as closely to hisobjectives as it did prior to the expansion. Taken together,this loss in the quality of data provided to the peakcoordinator and in the quality of the instructions supplied tothe operating units made necessary by the expansion willbe referred to as “control loss”. It will exist even if theobjectives are perfectly consonant with those of theirsuperiors, and a fortiori, when subordinate objectives aredissonant” (Williamson, 1967: 126-127)

In elaborating his basic model, Williamson assumed thatcontrol loss is strictly cumulative across hierarchical levels andthat there is no systematic compensation. This assumption is55

reasonable. If, for instance, 90 per cent of the instructions from

52

the super- boss reach the boss reliably, and 10 per cent isgarbled, the assumption that these latter instructions will reachthe worker correctly would seem odd. Of the former, a certainpercentage (say 5 per cent) will become garbled duringtransmission from the boss top the worker, and 95 per cent willbe transferred correctly. This would mean that 0.95 * 0.90 = 85.5per cent of the original instructions would arrive at the workerundamaged; a cumulative control loss of 14.5 per cent. Thereader will realise that with each new hierarchical level, a newfactor is inserted in the multiplication.

Of course, the number of hierarchical levels is not onlydetermined by the number of workers, but also by the scope ofeach manager, being the number of subordinates he manages. Ifeach “boss” manages ten workers, and each “super-boss”manages ten bosses, a hundred workers will be led by onesuper-boss, through those ten bosses (three hierarchical levels).If, however, a manager did not handle more than fivesubordinates, four hierarchical levels would be needed. Becausein the latter case each manager can spend more time with eachsubordinate, control between each hierarchical level wouldincrease, but depending on the values the cumulative effect couldbe either negative or positive. In other words, a trade-off betweenscope and control plausibly exists.

yLet us assume control between levels y and y+1 equals á ,and the number of employees is N, the scope of each manager iss. The number of hierarchical levels will then equal log N + 1.s

Cumulative control is symbolised by Á. Then

In order to simplify the model, Williamson assumed that controlloss was equal for each additional hierarchical level. In that case,when log N equals n-1, naturally, Á = á .The result is thats n-1

control loss becomes a power function of the number of levels,being equal to 1 - á .n-1

An interesting addition is that in industries where potential control is high, the56

maximum size will be larger than in industries where potential control is low.

53

Adopting a number of quantitative assumptions, some of thembrave, Williamson (1967: 123) demonstrates the plausibility of hisprincipal thesis that the control phenomenon is “the mostfundamental reason for supposing that there are ultimatelydiminishing returns to scale” (Williamson, 1967: 123).56

We return to Simon’s model describing the viability of anemployment contract, in order to include Williamson’s argument.To start, we assume that the satisfaction the worker derives frombeing employed is independent of the size of the organisation.Furthermore, the result of the employment of an additional workerdepends not only on what he is expected to do (x), but also onthe size of the organisation. The number of employees is denotedby N, and scope by s. Additional productivity, that could beachieved by the worker if control is perfect, is assumed to be

1F (x,N). Control is determined by the size of the organisation.Therefore:

2 1 2 1 1 2(3b.5) áv logN ( a F (x,N) $a a w$-a F (x).s

Unfortunately, this model is very subtle and complex, and hard toanalyse formally with the instruments available today in economicscience. One could, of course, adapt this model to mathematicalneeds, in order to explore its implications for the size oforganisation. In our opinion this is both inappropriate andunnecessary for our line of thinking.

1The derivative of áv logN is sharply negative. F (x,N) can bes

1 2assumed to be concave (“law” of diminishing returns). a F (x) is a

2 1constant. Therefore, at a certain stage, áv logN(a F (x,N) wills

decrease with an increasing N. When N reaches a certain level,

2 1 1 2áv logN ( a F (x,N) < -a F (x). s

When the organisation reaches that size, we cannot find a w suchthat (3b.5) holds. A viable agreement advantageous to bothprincipal and worker/member is no longer possible. In the case ofa commercial or governmental organisation the wage needed to

In a sense the USSR constituted one giant organisation that was already falling57

apart through control loss before the Gorbachev revolution. For an analysis

implicitly based on the control loss concept the reader is referred to an excellent

article by McFaul (1996).

54

entice the worker to accept employment exceeds the increase ofproduction enabled by employing him. In the case of anassociation, the cost of supplying an additional member with thebenefits to which he is entitled exceeds the membership fees.Growth no longer makes economic sense. Or, to look at this pointfrom the opposite angle, the membership fee needed to supplyan additional member with the benefits to which he is entitledexceed the value accorded to these services by the prospectivemember.

This conclusion runs parallel with the conclusion reachedby Williamson, that “control is the most fundamental reason forsupposing there are ultimately diminishing returns to scale.”There is one significant difference. This model extends theconclusion outside the realm of the firm (the commercialorganisation) and can also be applied to associations and publicorganisations, because it accommodates non-monetary costsand returns.

For the sake of clarity, the flow to and from theorganisation of taxes and grants has not been included. We havearrived at the point where this becomes necessary (T is tax, G isgrant). Inclusion results in:

2 1 2 1 1 2(3c.5) a (áv logN(F (x,N) +d(G-T)/dN) $a a w$-a F (x).s

It follows (ceteris paribus) that when marginal grants(including subsidy-equivalents) are higher, and marginal taxationis lower, maximum size increases.57

In this third section of the second chapter we haveenriched Simon’s model by inserting Williamson’s control factor.Possibly motivated by mathematical elegance, Williamson’smodel implicitly assumes that this factor is static and not affectedby time. We will now discard this assumption and investigate thedynamics of control.

For an excellent introduction see J. Galbraith (1977).58

The original programme was developed together with César García-Díaz. This59

version contains one parameter (the exponent of IB2W ) that was inserted by the

author for the purpose of this enquiry. For the rationale see page 57.

55

2.4 The dynamics of control under conditions of randomlybounded availability of managerial information

2.4.1 Introducing the modelControl loss (decrease of Williamson’s control factor á) can becaused by many circumstances and types of behaviour. Most ofthese can either be avoided or repaired, or both. In this section amodel will be developed that describes a particular cause ofcontrol loss and eventual uncontrollability. Being theoretical, anda gross simplification, the model does not prove anything. Itsinclusion in this book is owed to the fact that it increases theplausibility of a central conjecture of this book: that in the long runthe uncontrollability of any organisation is both inevitable andirreparable.

In order to take appropriate decisions a manager needsinformation, and the more detailed his instructions, the moreinformation he needs. At a cost the manager can diminish theinformational flow called for by creating organisational slack. Hecan also limit the managerial information needed by extendingthe scope of operational decisions; in other words, by delegatingauthority. This can involve creating lateral information channels(J. Galbraith, 1977: 111). It is one of the tasks of the manager tomonitor lateral flows and to take the actions necessary tomaintain and repair them, or to design the organisation in such away that these flows are optimal. 58

But, in the end a number of decisions will have to be takenat a higher level of the hierarchy. And there is one type ofauthority that cannot be delegated; the higher level will alwayshave to preserve the right to receive the information he requestsand that is available at a lower level.

The following model was developed incorporating the59

conjectures presented in the preceding sections of this book. Itshould be realised that the model describes an “adult” boss-

In democratic societies the most important additional sources for public60

organisations are, of course, the media and elected representatives. In clubs,

(associations in which authority is not top-down but bottom-up; see Ruys, van

den Brink and Semenov, 1999) there are the membership councils and other

governing bodies that, in addition to exercising authority, also provide an

additional source of information to management. In the “continental” business

model (contrary to the Anglo-Saxon model), work councils can, if given half a

chance, provide an invaluable flanking informational structure, invaluable both for

56

worker relationship, “adult” being defined as the situation in whichthe routines of an organisation have already been developed. Attime 0, the boss therefore knows what information he needs atthe time. This is not a valid assumption for a “juvenile”organisation. In a “juvenile”organisation many routines still haveto be designed, tested, evaluated and trained, and during theseprocesses the flow of information within an organisation ofnecessity has to be much larger (in an “adult” organisationappropriate routines are established, and the flow of informationcan be smaller).

It is also based on the “broken windshield” paradigm. EvenMichael Schumacher (many years the world champion Formula Iracing driver) cannot keep his car on track if his windshield isshattered. Especially if management unknowingly lacksinformation, or if it is fed erroneous information through fraud orotherwise, wrong decisions will be taken. It is with reason that thecontrol function occupies centre stage in a well-run organisation.

It is therefore not a model that shows how our conclusions(and no other) follow logically from our assumptions - still less aproof of their validity. It does show that our conjectures areconsistent, and that specifications and parameters of the modelexist that result in an output that fits the windshield paradigm.This output also visualises, in fact spectacularly, our conjecturesof the dynamics of the flow of managerial information in adultorganisations, and of the resulting control levels.

2.4.2 Model presentationFor the sake of clarity, it is assumed that the principal is

wholly dependent on hierarchical information flows. This is asimplification, as there are often additional sources ofinformation. As in Simon’s model we have two people, the boss60

management and for workers. This was an important reason Unilever Nederland

positively cultivated its works councils, both at plant and at national level

(personal communication Henri de Bijll Nachenius, former national industrial

relations officer, Unilever Nederland). Their relevance is emphasized in Brezet

(1998: 132). The potential of such a flanking informational structure is further

enhanced by democratisation of the organisation (de Jong and van

W itteloostuijn, 2004).

57

(B) and the worker (W). The boss is extremely intelligent, thequality of his instructions is bounded only by the information

tavailable to him (another simplification). At time t the boss has I

t tavailable (I < 1). If I = 1 he can give such instructions to W thatif the worker follows them to the letter, the intentions of the boss

twill be completely fulfilled. If I < 1, the instructions that B can give

tare obviously less perfect. At time t B will give orders OA to W.The appropriateness of these orders is assumed to be

t t tproportionate to I (OA % I ). However, there is always some “noise” in communication;

twe therefore include a random garbling factor g . We assume that

t t(1 - g ) * OA is understood by W. Without any orders W will do hischores, R. Because W is a most obedient employee, his

t+1additional actions, A , closely follow his understanding of the

t+1 t t t torders A ! R = (1 - g ) * OA % (1 - g ) * I . If no garbling takes

tplace (g = 0), and if the availability of information is perfect (I ),

t+ 1the actions will also be perfect (A = 1) and therefore control, asdefined earlier, is 100 per cent.

B knows that he will have to give orders again in t+2 andwill need information to give adequate orders. He therefore

trequests information IB2W . A perfect request would be 100 percent. However, the information available to him is not perfect, andthe adequacy of his request is proportionate to that knowledge.

t tTherefore RI % I . Our obedient W is more than willing to providethe request, according to what he understands the boss wants to

tknow, because again we encounter the random garbling factor g .He provides the answers

t t t t (1 - g ) *RI ^1.2 % (1 - g ) * IB2W ^1.2.

Of course, raising RI to a higher power must be justified. Whenorders are nearly perfectly appropriate, possible slight gaps are

In an earlier version of this model, this power was assumed to be 1 (see61

Appendix 1), and therefore omitted. The “broken windshield” phenomenon did not

appear. One of the conclusions that can be drawn from Bartlett’s (1920 and

1932) experimental work is that the less realism is experienced by the receiver,

the higher the distortion.

58

easy to fill in. The relationship between the appropriateness oforders and their fulfilment is therefore not linear. Choosing a61

relationship with a higher exponent than 1 is one way ofincorporating this insight into our model.

However, because B realises that things can happen atthe level of W of which B is ignorant, he has arranged that W willprovide him with some extra information that W considersrelevant. In addition, B will demand the information he needs forproviding the yearly reports (cash in- and outflows, store dataetc.).These data are also available for management purposes,especially if they arrive in time to take appropriate action.Together these data are included as rr. He sends a message to

t+1 t tW being IW2B = (1 - g ) * RI ̂1.2 + rr.Again the random garbling factor is encountered. But

information can never be more than perfect, so the quality of the

t+2 t+1 t+1information arriving is I = min [IW2B *(1 - g ),1].

tAssuming I to be irrelevant for the decisions to be taken at t+2(this is a simplification for the sake of clarity), we can now repeatthe cycle.

Presented more formally the model is based on thefollowing:

a) Coefficient 1 - g(t) is the “noise effect” in the communication ofinformation IB2W(t) from boss B to worker W and vice versa(IW2B(t)). The coefficient mg(t) represents an upper bound forprecision in information transmission. We assume gt(t), mg(t)[0,1] and g(t) = 1 - min([(1.5 - mg) e+mg,1]), where e is a randomnumber drawn from a uniform distribution between 0 and 1.

b) IB2W(t) and IW2B(t) are the information amounts available tothe boss B and worker W at time t, respectively. IB2W(t), IW2B(t)[0,1]. Value of 1 means “perfect information” and IB2W(1) = IW2B(1) = 1 are the initial conditions.

59

1 1c) W receives OA(t) = K * I(t), K = 1. OA(t) might be interpretedas the “appropriateness” of the orders (information) given to W.

d) Worker W takes total actions A(t+1) = (1 - g(t)) * OA(t).

2 2e) B requests RI(t) information to W. RI(t) = K I(t), K = 1. Theinformation that B receives at time t+1 is IW2B(t+1) = min[(1 -g(t))RI(t) + rr, 1]. Coefficient rr is the extra information B asksfrom W.

f) Information available to B at time t+2 is IB2W(t+2) =min[IW2B(t+1)(1 - g(t)), 1] .

The relevant part of the model/programme (written in Matlab) ispresented in box 2.2.

60

K1 = 1

K2 = 1

rr = 0.03

mg = 0.98

z = 1.1

g(t) = 1-min([rand(1,1)*(z-mg)+mg,1]);

if t~= 1

if mod(t,2)==0 %odd number

IW 2B(t) = min((1-g(t-1))*RI(t-1)^1.2 + rr,1);

IB2W (t) = IB2W (t-1);

else

%even number

IW 2B(t) = IW 2B(t-1);

IB2W (t)= min(IW 2B(t-1)*(1-g(t-1)),1);

end

else

IB2W (1)=1;

IW 2B(1)=1;

end

OA(t)= K1*IB2W (t);

if t>=2

A(t)= min((1-g(t-1))*OA(t-1),1);

else

A(t)=1;

end

if t>=2

RI(t)= K2*IW 2B(t-1);

else

RI(t)=1;

end

end

Box 2.2Stochastic logistic equation

61

2.4.3 Results of the modelThe model is a stochastic logistic equation. A representativegraphical presentation of the result after ten runs is given in figure2.2, in which each line represents a run. In eight runs controldeteriorates permanently, while the timing is completely random.In two runs control continues to hover at a high level. In the longrun both will inevitably also deteriorate. This is fully consistentwith our conjecture that uncontrollability is haphazard, inevitableand irreparable. It can be concluded that it is possible to constructa formal modeli) that is consistent with the Williamson view on “control”, ii) that describes the dynamics of control under conditions of

randomly bounded availability of managerial information,and

iii) the results of which are consistent with the “brokenwindshield” paradigm.

We can add the conclusions reached in joint work withGarcía-Díaz (presented in Appendix 1), specifically that “small

62

changes in information reliability might lead to significant negativeconsequences in terms of organisational control.” This conjectureis, of course, an addition to economic theory developed in thisbook.

We find that the model significantly increases theplausibility of the conjectures on which it is grounded. The mainconjecture is that: an organisation can run into grave difficultieswhen management lacks essential information and theorganisation has become uncontrollable. Such deterioration isunpredictable, irreversible and probably inevitable in the long run.In fact, because of the nature of uncontrollability, it can only beeliminated as a contributory or even causal factor in situations ofextreme and rare unambiguity. Excellent illustrations are providedin the fourth chapter of this book, in which the sad stories ofCrédit Lyonnais and Barings are told.

2.4.4 Consequences of uncontrollability

In the above we have defined uncontrollability as the situation inwhich control falls below a certain level, and the principal cannottake any remedial action because diagnosis is not possible, forlack of relevant information. We have demonstrated that it isplausible that uncontrollability is a situation which is inevitable,unpredictable and irreversible.

Time has now come for a slight differentiation. Control canhave various dimensions. For instance, financial control of ahospital can be perfectly in order; management knows preciselyhow much money is being spent on what and precisely how muchmoney is collected from whom and for what reason. At the sametime, it can lack the most elemental knowledge on the quality ofthe care being provided by the hospital. Or, as anotherillustration, the US high command during the Vietnam war knewwith high precision how many US servicemen were wounded.Care for these unfortunate soldiers was optimal, and the highcommand was completely in control of this dimension of warfare.On the other hand, the high command only had a rough idea ofthe number of enemy casualties and their replacement. Becauseof this huge hiatus in information (and possibly because ofdeliberate misinformation) the war effort was strategically out of

This is an entirely realistic figure: see Conijn (2005: 68) and Verlaan (1999).62

63

control, and leadership up to the Tet-offensive had a totallyerroneous idea whether the USA/South Vietnam were winning orlosing the war.

We return to equation (3c.5) developed earlier.

2 1 2 1 1 2(3c.5) a (áv logN*F (x,N) +d(G-T)/dN) $a a w$ -a F (x).s

In a commercial organisation or an association, G = 0.Instead of varying N and s we now vary á. The

organisation is undergoing control loss. This can be significant,cumulative control decreasing to say 30 per cent. 62

Most commercial organisations and associations areselling goods or services, and therefore clients are veryinterested in what they are buying and for what price. Situationsin which uncontrollability does not affect cash flows areexceptional.

Remembering that revenue from clients and members isthe only source of cash, it can become impossible to find a viablew under conditions of uncontrollability. The organisation will nolonger take up additional workers/members. In fact, when we look

1at equation (3b.1), dS /dN can become negative, which meansthat firing workers/shedding members becomes advantageous:

1 1 1(3b.1) dS /dN = áv logN*(dF (x,N)/dN) - a w.s

The effectiveness of an organisation can be defined as thedegree to which an organisation satisfies the objectives of itsprincipal(s), within the limits imposed by its environment. “Itbecomes advantageous for an organisation /association to fireworkers/shed members” is therefore identical to “anorganisation/association is becoming less effective”.

Contrary to commercial organisations and associationspublic organisations can cover part or all of their expenditurethrough levies imposed directly or indirectly on other

64

organisations. Their expenditure does not have to be covered byselling goods and services.

Returning to equation (3c.5) developed earlier,

2 1 2 1 1 2(3c.5) a (áv logN*F (x,N) +d(G - T)/dN) $a a w $-a F (x), s

with G>0.

We repeat the exercise. Instead of varying N and s we now varyÁ. The organisation is undergoing control loss. This can besignificant, cumulative control decreasing to say 30 per cent. Butcontrary to commercial organisations and associations it is notnecessarily impossible to find a viable w, because of G.Therefore the organisation is not automatically forced to takeremedial action. The organisation can still take up additionalworkers.

1When we look at equation (3b.1), dS /dN can becomenegative:

1 1 1(3b.1) dS /dN = áv logN * F (x,N) - a w < 0s

This implies that the organisation can only maintain output, if atall, by increasing G. We repeat that the effectiveness of anorganisation defined as the degree to which an organisationsatisfies the objectives of its principal(s), within the limits imposedby its environment. If it is one of the objectives of a publicorganisation to minimise costs, control loss will therefore alwaysresult in loss of effectiveness. Obviously, output cannot bemaintained; the organisation is losing effectiveness.

From the above it can be concluded that control lossimplies loss of effectiveness. If uncontrollability is indeedunpredictable, irreversible and probably inevitable in the long run,then organisations would unpredictably, irreversibly and probablyinevitably lose their effectiveness.

In the next sections we will present other internal andexternal causes of loss of effectiveness.

See, for instance, Beverland (2000: 11).63

The author observed how his employer, IW ACO, was nearly bankrupted64

because, unknown to the CEO, a project manager placed orders that vastly

exceeded his budget. At that time no prior certification was made that an order

was included in a budget and orders only appeared in the management

information system when the bill arrived. In earlier years, when IW ACO was

much smaller, the CEO would have been informed “by the grapevine” or would

have found out by “walking around”, before any damage was done.

65

2.5 Other internal causes of changes in effectiveness

The effectiveness of an organisation is most volatile during thefirst few years of its existence. The organisation is learning themanagement practices, the technologies and the marketsinvolved; is still building an adequate management informationsystem; and still lacks fluent internal communication and trust. Inmany cases the principal simply misread the potential of hisinitiative. This is most evident in commercial organisations, wherethe great majority fails during these years. As Low and MacMillan(1988: 142) wrote, "the list of potential pitfalls associated withstarting a new venture appears limitless.” A small minority ofsurvivors crosses the hurdles, both internal and external,achieving spectacular gains in effectiveness.

In subsequent years effectiveness becomes more stable.However, two extremely hazardous phases are encountered inthe infancy of a growing organisation:1) when the number of participants exceeds the scope of the

principal and the latter must delegate some decision-making authority to an intermediary. Many principals arenot proficient in the art of delegation.63

2) when the size and/or complexity of the organisationbecomes so large that “management by walking around”must be replaced by formal lines of communication and bya fully-developed management information system.64

An interesting parallel exists in bank operations. In lendingto small firms a small bank can rely to a greater extent onsubjective but highly relevant criteria such as information on thecharacter of the borrower, while a large bank will be forced to

The reader obviously realises that the complete list of internal causes of65

organisational crisis is given only cursory treatment. Except for control loss, the

subject plays only a very minor role in arriving at the conclusions of this book.

The reader who wishes to gratify his interest in the subject is referred to

textbooks such as Daft (1992, 1997) and Mintzberg (1989).

W ikipedia (entry: Pétain, Dutch version, 22 August 2005); Holmes (1999: 148).66

66

employ mainly standard criteria obtained from financialstatements in the loan decision process (Cole, Goldberg andWhite, 2004).

Daft (1997: 113) describes further stages in theorganisational life cycle (collectivity, formalization andelaboration), each followed by a crisis. Mintzberg (1989: 283)develops a different life cycle model (in which organisationalgrowth is not an essential feature). Both authors define difficulttransition periods in an organisational life during which thepossibility of failure is enhanced. In neither is external changedescribed as a causal factor.

Even when the number of participants in an organisation,whether they are workers or members, does not grow anorganisation can still experience changes in effectiveness whenthe principal retires. Well-known are the risks when the nextgeneration takes over in a family firm.65

Changes made by management to improve effectivenesscan pay off. An illustration of this point is the replacement of theFrench general Nivelle in 1917. After a calamitous operation bythe French army in the “Chemin des Dames” area, mutiny spreadwidely. Large units refused orders. Nivelle was fired and Pétainwas appointed as commander in chief. He visited units andlistened to their complaints. He was considered a soldiers’general. He turned the tide by launching much more defensivetactics, with a very different balance between artillery andinfantry. He also considerably improved living conditions, leavearrangements and pay of the ordinary “poilu”. The tide wasturned.66

But management changes can also misfire. JürgenSchrempp and consorts’ attempts to globalize Mercedes Benzarguably not only drained the finances of this giant firm, but were

The Economist, July 28, 2005.67

67

also the cause of the deterioration of the brand’s absolute quality,a core value in the organisation.67

As discussed by van Witteloostuijn and Boone (2006)change as such has a price; whether this is compensated by itsintended benefits depends on various contingencies, such aswhether the organisation has a tradition of change or not. Theirempirical corroboration indicates that in the newspaper industry inthe Dutch province of Limburg the relationship between thenumber of changes and performance is convex.

A major element that determines organisationaleffectiveness is the agency phenomenon. As formulated byDowns (1967: 2): “the fundamental premise of the theory (Downs’theory of bureaucracy, HvdM) is that bureaucratic officials, like allother agents in society, are significantly - though not solely -motivated by their own self-interests (and not per se by theinterests of the organisation).” Jensen (2000: 86) describes theagency problem as follows:

“We define an agency relationship as a contract underwhich one or more persons - the principal - engageanother person - the agent - to perform some service ontheir behalf that involves delegating some decision-makingauthority to the agent”, subsequently adding:” We defineagency costs as the sum of 1 the costs of creating and structuring contracts

between the principal and the agent,2 the monitoring expenditures by the principal,3 the bonding expenditures by the agent, and4 the residual loss.”

When the relationship between the interests of the organisation(as defined by the principal) and the perceived interests of theindividual agent shift, the agent will behave differently, andagency costs, and therefore the effectiveness of the organisationwill change. To name but a few examples:

Marks (1998), in his epical description of the cipher section of a British secret68

service unit in the Second W orld W ar, illustrates this point dramatically. Marks

found out that Dutch wireless operators had been caught. His boss ordered him

not to let anybody know, as this would seriously diminish the standing of his unit.

See Pardoe, 1977. The Stalinist regime was exceptional in this sense, both for69

its scale and its extreme character (Montefiore, 2003; Davis, 1996: 960), but less

spectacular examples are not difficult to find. One could point at the troubles of

Philips in the late 1980s, when the power struggle between the corporate board

and the various subsidiaries and divisions nearly destroyed the firm (Metze,

1991). Another example is the “civil war” that broke out in Marks & Spencer in

1998 and 1999 around the succession of the CEO, Sir Richard Greenbury

(Bevan, 2001). Most people will also mention politics, where party interests can

prevail over quality of government. The fall of the Dutch Biesheuvel government

is a well-documented example from the early seventies of the last century

(Drees, 2000: 193).

The governance of the Netherlands suffered from the awkward and70

uncommunicative relationship between Joop den Uyl and Dries van Agt, leaders

of the two largest political parties, that formed or tried to form a coalition

government together (for instance, Terlouw (1983: 208) and van Thijn (1977)).

68

a) Just a few employees “adjusting the rules of the game”and becoming corrupt can cause enormous damage.

b) Even the most loyal employee can come into a situationwhere he has to ask the question: “loyal to whom?”68

c) Evolutionary logic will cause employees who are primarilyinterested in their own career to be, on average, morespeedily promoted than employees who are primarilymotivated by the goals of the organisation. It is up tomanagers to control this phenomenon, which has a verynegative influence on organisational effectiveness. Oftenthese efforts fail. 69

d) The problem of incompatibility of temperaments, or simply,people who cannot get on with one another, provides otherexamples. 70

In the above we have explained how that the effectivenessof an organisation can change for reasons that are purely internal.No change in the environment needs to happen, andorganisational effectiveness can still deteriorate significantly.

Chandler (1962), Ansoff (1965) and Porter (1980).71

See also Colombo and Delmastro (2002).72

69

2.6 External causes of changes in effectiveness

An example of an organisation losing its effectiveness purelybecause of changes in its environment is the system of“trekschuiten” (horse-drawn barges) that provided inland transportin the Netherlands from the mid-seventeenth century up to the1880s. Because of the introduction of railways, the objectives ofthe principals (earning a living by providing intercity transportation)could no longer be attained. The difference between anorganisation suitable for the trekschuit and an organisation suitablefor operating a railway system was much too large to use theexisting organisation for providing railway transport. Leaving theold organisation to fall apart and setting up an entirely neworganisation based on the new technology was the only realisticapproach. This very point played a pivotal role in developmentthinking for a very long time. In his seminal treatise “Theorie deswirtschaftlichen Entwicklung” Schumpeter (1911: 66) describes“new combinations” as the centrepiece of economic development.“New combinations are, as a rule, embodied, as it were, in newfirms which generally do not arise out of the old ones but startproducing beside them; to keep to the example already chosen, ingeneral it is not the owner of stage-coaches who builds railways”(emphasis added).

In the wave of academic publications on business strategyfrom the 1960s onwards a prime question was how to ensure that71

a firm could survive, or even flourish, under dynamic conditions.Flexibility and adaptation to changing markets (both of productsand resources) and technologies are keywords in this respect. 72

Adaptation has its price. Berends and van Witteloostuijn(2003: 2) write:

“An interesting counter-theory is developed in theorganizational ecology tradition (Carroll and Hannan, 2000).There, the argument is that competitive selection dominatesthe evolution of industries to the extent that organizational

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change is a key determinant of organizational failure,particularly if the change involves core features of theorganisation or, the other way around, that organizationalinertia is a prerequisite for organizational survival (Hannanand Freeman, 1984). This claim is backed with reference tothe dominant force of legitimation, which operates next tocompetition. That is, an organisation cannot survive withoutlegitimacy in the face of important stakeholders, inside andoutside the boundaries of the organisation: clients, creditors,employees and regulators – i.e., society at large – expectthat an organisation is accountable and reliable.Accountability and reliability require reproducebility, andhence organizational inertia. If an organization does changecore features, then the batteries of the liability of newnessare recharged, implying an increased hazard of mortality(Amburgey, Kelly and Barnett, 1993). Note that theargument is not so much that organizations never change,but rather that organizational change tends (i) to lag behindthe rhythm of environmental turbulence and (ii) to beassociated with organizational failure.”

The empirical evidence of this last statement is irrefutable,but the explanation of this phenomenon is not definitive. Theadoption of new farming systems can be regarded as acomparable reaction of a firm to external change. Many studies inagriculture show that innovations (i.e. crop changes) are notintroduced on all farms simultaneously. There are habitualinnovators, early adopters, late adopters and laggards (Rogers,1962). Research shows that failure is highest among bothinnovators and laggards. Individual entrepreneurs show the samedynamics as commercial organisations. Contrary to the situationprevailing in commercial organisations, in farming there is usuallymuch less question of legitimacy, accountability, reliability orreproducebility, as the owner, the manager, the main provider ofcapital and the main worker are often one and the same person.Dependence on interpersonal relationships is negligible incomparison with most industries.

Having observed that significant change in the environmentis accompanied by changes in the effectiveness of organisations,

See also Tushman and Anderson (1986) and Romanelli and Tushman (1994) in73

which the bridge to the punctuated equilibrium literature is made.

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what can be expected when change comes in the form of aninflection point (Grove, 1995)? Martin van der Mandele (2004:73

10) defines such a point as a change in which a firm is confrontedby “a major, abrupt and environmentally caused discontinuity.”“These are characterized by the major impact they have on thefirm (amplitude), by the speed and suddenness with which theyoccur (abruptness) and by the fact that they are at least perceivedto come from outside the firm (externality).” Van der Mandele(2004: 106) concludes that each of the three different phases inan inflection point has an appropriate leadership approach. Duringthe first phase leadership will tend to be “ecological”. Localmanagement is put in full control of strategy, while leadershiplimits its tools to target setting and accountability. During thesecond phase the appropriate leadership approach is directive(taking full charge, defining the business portfolio), while in thethird phase the leadership will tend to revert to a conditionalapproach (delegation, setting only overall direction and targets,and defining the framework of organisation and processes withinwhich delegation can take place). Three entirely differentapproaches succeeding each other in a relatively short period oftime; the resulting turmoil in the organisation will be large, oftenresulting in a serious deterioration of control and a subsequentdecrease in effectiveness. The alternative would of course be notto adapt to changed circumstances, which could be a still riskierapproach in terms of operational effectiveness. However, if thetransition succeeds, a significant increase of organisationaleffectiveness can be the result.

Reverting to our extension of Simon’s model, we canconclude that changes in the environment will change the utilities

1of the employer and/ or the employee, formally in F (x) and/or

2F (x). This could have the consequences for the circumstances inwhich (3b.5) on page 53 holds, which could mean that theorganisation should shrink. Attempts can be made to correct thisdevelopment by changing (x), in other words by adapting theorganisation to the changed circumstances. However, a price will

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often have to be paid in terms of (temporarily?) lowering control(á).

In summary, changes in the environment often have annegative impact on the effectiveness of an organisation. Thisinfluence can be direct through changes in the value of the outputand of the resources used. It can also be indirect, through costs interms of control, legitimacy etc.

Having described how the effectiveness of an organisationcan be lost through causes internal and external, predictable andunpredictable, avoidable and inevitable, and reversible andirreversible we will direct our attention to the consequences of aloss of effectiveness in the next section.

2.7 Consequences of loss of effectiveness

When a firm loses effectiveness the situation can become soprecarious that the sum of wages to be paid exceeds the cashavailable; the organisation has to fire workers, to diminish cashneeds. In the case of an association, membership fees willbecome so high or benefits so low that members will leave.

However, it does matter whom you fire, and who leaves. Ifproblems started because of a drop of control, top managementdoes not know what is happening in the organisation, andtherefore does not know which workers/members are contributingwhat to organisational effectiveness. Whether downsizing offers asolution is a matter of chance, even when not accompanied by anincrease of agency-related costs.

If the drop in productivity cannot be solved by downsizing,the problem of not being able to find a viable wage level will causethe organisation to fall apart. Because of its connotation, the termeconomic necrosis is introduced to describe this phenomenon.

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These parallels are:

cell organisationenvironment organism societyprocess destruction destructionborder membrane employment contracteffect on border dissolution dissolutionmovement contents-leakage dismissal/resignationfinal result death disintegration

This is not the end of the story. Organisms and economieshave another card up their respective sleeves. Not only in biology,but also in the economy there exists another, often vastly superiorsolution for an uncontrollable organisation. Up to now we have

assumed that the level of control between each hierarchical level is a constant. This assumption, introduced by Williamson, is asimplification that improves the feasibility of elegant mathematical

Pathological cell death or necrosis“There are many ways to die, but from cell biological point of view

only two forms exist: physiological and pathological death (Kerr,

W illie and Currie, 1972). Pathological or accidental cell death

occurs as a catastrophic accident ... when these are exposed to a

severe physical, chemical or osmotic injury, including hypoxia

and complement attack. During this accidental or pathological cell

death, which is called necrosis, the cell membrane loses its

selective permeability and ion-pumping capacity as result of

direct membrane damage. This leads almost instantaneously to

swelling of the cell and its organelles, including the mitochondia,

and the leaking of the cellular contents into the extracellular

space. Activation of enzymes such as hydrolases,

phospholipases, proteases, RNases and DNases results in

further degradation of membranes, proteins, RNA and DNA,

which accelerates the cellular and nuclear desintegration.”

(Vermes, 1999: 1)

Box 2.3

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modelling. But this assumption is not realistic and the time hasvery much arrived to discard this assumption, which we do infigure 2.3.

The figure represents an organisation with about 2800employees. The actual work is done at the shopfloor by theworkers (W). Each manager coordinates seven subordinates(scope is seven). The principal (BBBB) coordinates seven plantmanagers (BBB), each plant managers oversees seven managers(BB), each manager oversees seven foremen (B) and eachforeman leads seven workers.

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In the figure one specific employee is identified by a box,that contains two numbers. The first indicates control (the fractioná of the intentions of a superior effectively satisfied by asubordinate (0 < á < 1)). In this example it is assumed that Wsatisfies an extremely high percentage of B’s intentions (98 percent), significantly higher than his colleague, described at theside, who satisfies 95 per cent of his boss’s intentions. In thesame way B satisfies 40 per cent of BB’s intentions, BB satisfies90 per cent of BBB’s intentions, and BBB satisfies 90 per cent ofthe principal’s intentions.

Can the principal be satisfied with what our virtuous W isdoing? Not at all, because control is cumulative. As indicated bythe second number only 31 per cent of the principal’s intentionsare being satisfied (from top to bottom 0.90*0.90*0.40*0.98). Theproblem lies with the control loss of 60 per cent occurring betweenB and BB. If somebody, for instance BB, finds out what is

Figure 2.3Economic Apoptosis

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happening, the problem can be solved and productivity restored.However, as described earlier, control loss usually involvescommunication loss.

In our example there seems to be nothing wrong with therelationship between B and his seven Ws. Simply firing theseseven people could be a waste. Sometimes there is a solution tothis problem, to cut the hierarchical relationship between B andBB (indicated by the thick double line). If the output of theseworkers is an input to the remainder of the organisation (or viceversa), one could replace the hierarchical relationship by a marketrelationship. This group of eight people has high control, and quitepossibly also high productivity, so they would stand a chance inthe market. Control and management costs between BB and B(extremely high in this case) would be replaced by transactioncosts. Productivity would be restored.

To describe this type of re-organisation the term economicapoptosis is introduced, defined as: “carefully carving up anorganisation, ideally along those hierarchical lines where control islowest, and replacing these lines by market relationships.” Theword apoptosis is inspired by its biological parallel, again, asdescribed in box 2.4.

Apoptosis is entirely different (in the view of this author)from downsizing. In downsizing, the carving takes place accordingto those lines that (according to the information available tomanagement) best restore productivity. The parts of theorganisation that (according to the information available tomanagement) contribute least to organisational goals are sold oreliminated. During downsizing, employees are fired and unitsclosed.

In apoptosis the emphasis is on control, and hierarchicallines are cut. Management does not try to analyse units, butanalyses hierarchical lines. If units thus isolated from theremainder of the organisation are viable, they are sold, or giventhe chance to operate on their own. If they are not viable, they willbe dissolved.

It has been suggested that delayering, the elimination ofcertain layers of management and the “flattening” of theorganisation is based on the same principals. By eliminating onelayer control would increase. Instead of control being á it wouldn

77

become á . It should be realised that in this reasoning á does notn-1

change. In reality, it will decrease, because the scope of themanager increases. Whether the result is an increase ordeterioration of total control will depend on the actual level of control and of a comparison of scopes, before and afterdelayering.

In these pages we started by giving the diagnosis(uncontrollability). Reality is even more complicated. The readerwill realise that in actual life, managers will only know thatsomething is going terribly wrong, and that this could be causedby uncontrollability, but also by inflection points that were passed,by stupidity, incompetence, foul play or plain bad luck. This isbecause uncontrollability often causes loss of communication andlack of reliable and relevant information. The actual cause of theproblem will be misdiagnosed; management will takeinappropriate action (for instance, firing our competent and

78

virtuous W). In other words, more often than not nobody really knows if uncontrollability is at the root of the trouble. If it isassumed that the problem is not uncontrollability, and it actuallyis, ineffective action will be taken. If it is assumed that the problem is uncontrollability, and it actually is not, then apoptosis willperhaps not be optimal but it will often have a positive effect. Or,to simplify the prescription still more: when in doubt apoptose; ifthat is impossible, necrose.

But where to carve the organisation? How can the optimalplace to cut the organisation be found? Leaving all otherconsiderations of practicality and triviality aside, good places tocut are the places where most control is lost. From the theory ofcontrol described earlier these are the places where managementscope (either qualitative or quantitative) is largest. This is the logicbehind the organisational strategy of concentrating on “core

Programmed cell death or apoptosis.Physiological cell death is a genetically encoded cell elimination

program which ensures an equilibrium between cell proliferation and

cell death. This programmed cell death (PCD) is an active bioenergy

saving cell elimination mechanism by which aged, unwanted or

sublethal damaged cells are abolished and their contents with

precious caloric value are reutilised by macrophages or by

phagocystosing adjacent cells. The term apoptosis is derived from the

Greek záðï “apart” and ðôïóéò “fallen”, meaning the shedding of

leaves from trees during the autumn ... without continuous signalling

by growth factors, hormones or cytokines cells undergo apoptosis. ...

During apoptosis a specific pattern of cell abolition takes place. ...The

cell adopts a convoluted outline and subsequently the cell breaks up

into small vesicles enclosing fractional parts of the cellular contents

and several apparently intact organelles. The apoptotic bodies end up

in extracellular space, where they are phagocytosed by nearby cells

and macrophages. The whole process takes only a few hours and the

cell remnants do not elicit any inflammatory reaction. This is one of

the reasons that apoptotic cell death has been long overlooked and

has been discovered only in 1972 (Kerr, W illie and Currie, 1972).”

(Vermes, 1999: 1, 2)

Box 2.4

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business”. Looking at the number of hierarchical levels can alsoprovide important clues.

Economic apoptosis is always effective in increasingcontrol. If normal control loss is estimated at 10 per cent for eachlevel (an estimate given, for instance, by Williamson, 1967: 130) -and in all likelihood circumstances will be abnormal, with muchhigher control loss - chances of an inappropriate economicapoptosis are not that great, considerations of economies of scaleaside.

Before being accused of horsemanship on foot, the authorhas to emphasize that this stratagem can be observed in actualcommercial life. The splitting of the old Dutch PTT into atelecommunication and a logistics company was a consequenceof this type of reasoning. It saved the company(ies) two stages ofcontrol loss. The way Lindenbergh of ING tackled the Baringsorganisation was a another clear example of economic apoptosis(see chapter 4).

It should be mentioned that principals wishing to implementeconomic apoptosis will encounter serious agency problems.Remuneration, both in terms of money and in status, is intimatelyrelated to the hierarchical level occupied and the number ofpeople supervised. Diminishing these will be fought will greatvigour by the managers involved, especially those at the upperend of the hierarchical lines being cut. The power these managerscan exert is large, but is countervailed by another power: thethreat of bankruptcy. A bankrupt organisation by definition doesnot have money to provide the wages needed to counterbalancethe negative utility of working for the organisation. Employees willhave to leave, and the organisation will dissolve.

Up till now, our analysis concentrated on commercialorganisations. But the reader will have no trouble at all in seeingthat in associations identical processes, remedies and obstaclescan be found, with the sole difference that instead of employeesleaving, because their wage no longer balances the negativeutility of their efforts, members will be leaving, because thepositive satisfaction of their participation (much lower because ofthe loss of effectiveness of the organisation) no longer balancesthe negative satisfaction of paying their membership fees.

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In the case of public organisations we encounter a numberof circumstances not found when studying commercialorganisations and associations. As a first example, they oftenhave a monopoly in performing certain essential services. Thismeans that it is impossible to shut down such a publicorganisation simply because its performance relative to the costsis unacceptable. The public will pay as long as the organisation

1produces anything; in mathematical terms, as long as F (x,N)>0,the organisation will survive.

In practice, control rarely disappears entirely in publicorganisations:1) as demonstrated in the model the principal will always

treceive (1 - g ) * rr information (see page 58). This isnegligible only in cases of rebellion and fraudulentbehaviour. Otherwise, control will not disappearcompletely.

2) depending on the sector in which the organisation is active,the media and public reactions will supply additionalmanagement information.

Uncontrollability does not mean that control is zero, and itdoes not automatically mean that the effectiveness of theorganisation will disappear completely. In the case of controlbeing 100 per cent, all the intentions of the principal are effectivelysatisfied by the worker. In other words, the actions of the workerare bounded by the intentions of the principal. In case ofuncontrollability, the actions of the worker are bounded by theinappropriate instructions given and by the monitoring, reward andpenalty options still feasible and in place. Within these much widerbounds personnel will follow their own private inclinations. Manyworkers have selected their job because they liked it. A bus driverlikes to drive his bus, albeit in his own time and according to hisown schedule. An uncontrollable public bus company willtherefore still see its buses driving around. But the principals donot know why buses are late, why so many buses remain idle inthe workshop, why passengers are treated atrociously by somedrivers (nasty characters) or courteously by other drivers (nicechaps who like to interact with people), why some bus-stops are

For a more systematic analysis of a certain type of uncontrollable organisations,74

“organized anarchies”, the reader is referred to Cohen, March and Olsen (1972).

The meaning given to the word “organisation” in his book can be deduced from75

the following statement (Kaufman, 1976: 28): ”As long as a boundary around a

group of people included in the study was uninterruptedly maintained we treated

them as an ongoing organization, even if the composition, activities, outputs, and

inputs of the group did not remain constant.”

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ignored, and why productivity is so unacceptably low and costs soexcessively high.74

Uncontrollable public organisations are seldom completelyout of control. Their cash management can still be in order, and itcan still comply with a rigorously hard budget constraint. In orderto comply, output will adapt itself either in terms of quantity, orquality or both. If output is not considered to be essential, thebudget constraint will be kept in place and output will be allowedto sink. Anybody can provide many examples; just to illustrate thepoint, one such case is presented. In the 1980s this authorencountered a soil survey project of the United Nations in SierraLeone. The project had been planned on the basis of the UNDPproviding (expensive) expatriate personnel, while the localgovernment was to provide transport. The local government, forreasons lost in the fog of this author’s memory, did not meet itscommitments and no transport was available. After a few monthsof desk work all work was forced to stop, but after two or threeyears the experts were still there. No work of any value could bedone (except helping this author to a number of maps he neededfor his own work). It is a mystery what hierarchical level in the UNwas informed of this fantastic waste of money, but someonedecided not to inform his superior. In any case, the informationwas lost and no action was taken to stop this nonsense. Howeverplanning and budget were probably completely in order. Theauthor (a former employee of UNDP himself) often observed howstrict and controlled expenditure was managed. Because at thetop nobody knew that output was absent, no action was taken.

Kaufman (1976) is to our knowledge one of the very fewsocial scientists who systematically analysed the death of publicorganisations. His definition of an organisation differs from the75

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definition used in this book. He considers the Diplomatic Bureauand the Consular Bureau to be separate organisations, while wewould have considered them to be parts of one organisation, theUS State Department. His analysis of the forces involved indetermining death or survival is still highly relevant.

Kaufman (1976: 3-11) identifies seven complexes offactors that favour long agency life in the United States:i) Most agencies are established by statute or accorded

statutory recognition; they can therefore only be abolishedby statute, a lengthy and tortuous process.

ii) Agencies often develop close ties with individual membersof Congress, who provide shelter and security from criticsand adversaries.

iii) Budgets are determined incrementally and not zero-based.Elimination or wholesale slashing of agency budgets is, forall practical purposes, unknown.

iv) Some agencies are isolated from executive control and aretherefore protected from meddling by other sectors of theexecutive branch of US government.

v) Employees can form a highly motivated political actiongroup. For many the continuation of an agency makes thedifference between having a job and being unemployed fora time. In this the US is different from many othercountries, where many if not all civil servants havepermanent tenure.

vi) Most agencies have friends outside the government wholook after them.

vii) Professional and trade associations can be effective alliesof “their” agencies.

However, Kaufman (1976: 11-21) also mentions a number ofhazards to agency survival of which he himself states “you maybegin to wonder that any of them survive for any time at all”:

i) Many government agencies are rendered nearly immobileby their protective armour, limiting their ability to respond tochanges in their environment.

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ii) Most agencies must meet the challenge of rivals inside themachinery of government standing ready to take over theirfunctions.

iii) Agencies have to compete for funds, as the federaltreasury is not bottomless.

iv) Some agencies are created for the purpose of creatingpositions with which to compensate distinguished publicservants or to reward friends, or as a symbolic response toa real problem or under other conditions that virtuallyguarantee their life to be limited. In addition, an agency canmake mistakes, alienating friends or strengtheningadversaries.

v) Every agency has natural enemies as well as naturalfriends.

vi) A favourite agency of one administration may, ipso facto,be viewed as a monument to be demolished by the next.(This is probably a phenomenon more typical of a politicalsystem based on “first past the post” than of proportionallyrepresentative governments).

Economic necrosis is difficult if not impossible in the caseof monopolistic public organisations performing essentialcollective services (MPOPECS), but what about economic apop-tosis? When we were analysing commercial organisations andassociations, we mentioned that principals wishing to implementeconomic apoptosis will encounter serious agency problems.Remuneration, both in terms of money and in status, is intimatelyrelated to the hierarchical level occupied and the number ofpeople supervised. Diminishing these will be fought with greatvigour by the managers involved, especially those at the upperend of the hierarchical lines being cut. The power these managerscan exert is large. In the case of commercial organisations andassociations this power is countervailed by another power: thethreat of bankruptcy. In the case of MPOPECS this is not thecase. Apoptosis is politically not feasible because the principalsimply does not have the power to enforce it.

A criticism that has been made against this point, was thatthe privatization of, for instance, the Dutch railways was anexample of economic apoptosis. Dutch railways became state

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enterprises that wrote contracts with the Ministry of Transport.The results would falsify the theory. When looking back at thedefinition “replacing a hierarchical relationship by a marketrelationship” one immediately realises that this type ofprivatisation is not an example of apoptosis, because the newrelationship between the Railway company and the state is not amarket relationship. Theoretically provision of railway servicescould be opened to competitive bidding; in reality this would bepolitically and practically a non-starter in most countries.This type of privatisation is not a case of economic apoptosis, butone of extreme delegation of authority along hierarchical lines.The Dutch government was the principal of Dutch Railways and itstill is.

Even transferring ownership of a MPOPECS to privateshareholders is not a case of economic apoptosis. Implicitly, orexplicitly, the state will always act as final arbiter of itsperformance and should, economicly if not legally, be regarded asthe hierarchical principal of the organisation. It is only when asituation is created in which the state can realistically replace theorganisation that one can speak of apoptosis.

What does happen when a MPOPECS becomesuncontrollable, implying that productivity and effectiveness sink,the resulting drop of output causing political damage? Action willbe taken, but the organisation will not be allowed to collapse to bereplaced by another organisation. All types of remedial action willbe taken. Because of the ultimate cause of the problem(uncontrollability), it is only by (remote) chance that the actionswill restore organisational effectiveness. Finally, a situation willappear in which everybody realises that things are amiss, the toplevels of the organisation function in a virtual reality, franticallytrying to solve virtual problems with virtual and symbolic methods,while most workers on the shop floor try to sort out the problemsas they come as they see fit, according to their ownunderstanding of what the country and/or their organisationexpects.

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2.8 Comparing market and governments

2.8.1 Public and market organisationsIn this section a simple, quasi-formal model will be developed thatenables us to compare the consequences of the conjecturesdeveloped in the preceding sections for the effectiveness of publicand market organisations, respectively. Let us imagine twosectors each containing a great number of organisations. There isno systematic difference between these two sectors and, initially,average organisations perform equally well in either sector.However, each year a number of organisations fall intouncontrollability. Uncontrollable organisations perform much lessthan organisations that are in control. There are alsoorganisations that see performance drop because ofmismanagement, fraud, inflection points, non-adaptation totechnological or market change, or any other cause.

These two sectors differ in one aspect. In the first, “S”, thegovernment believes that survival is good and dissolution is bad.In this sector any organisation that sees its performance drop willreceive sufficient help to survive. In case of mismanagement orfraud replacing the culprits will often solve the problem andperformance can be restored. Adaptation to changed markets ortechnologies can sometimes be achieved through restructuringand the like. If the cause of the problem can be found, diagnosisand cure are available. However, if the problem is uncontrol-lability, this is not the case. An essential characteristic of un-controllability is that the disease is frequently invisible, and oftendisguised as some other disease. Diagnosis is impossible, and anappropriate cure will only be found by accident. Performancecontinues, at a basic level. Uncontrollability is inevitable. So intime one organisation after another will become uncontrollable. Inthe long run all organisations in the sector will perform at this verybasic level.

As described earlier, control is defined as a percentage oftime. Uncontrollability means that workers spend a certain - low -percentage of time in accordance with the priorities of theorganisation. It is as reasonable to assume that the performanceduring that time rises in parallel with potential performance, as it isto assume that to assume that it rises faster (for instance, due to

For a more complete view on theories regarding the dynamics of firm growth76

see Hart (2000).

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“catch-up” phenomena) or slower (for instance, due to theabsence of incentives

In the other sector, “E”, the government believes in neglect.The market rules and the market is harsh. Any organisation thatperforms below a certain level is subjected to economic necrosisor apoptosis. This leaves room for new organisations, which arestarted in great numbers. Initially their performance is low, butsome learn the tricks of the trade, and have the financial backingto survive this period. They catch up, replacing dissolvedorganisations.76

In order to compare performance of these two sectors, wepresent an extremely simplistic model, contained in figure 2.4.Let us assume that at its birth the performance of an organisationis 0 per cent of potential; in y years performance reaches“maturity”. Performance will then stabilise, fluctuating between100 per cent and c per cent. On average it takes d years until per-formance drops to b per cent, because of reasons reparable(mismanagement, fraud) or irreparable (Schumpeter,uncontrollability). In the “E” category, the organisation thenbecomes insolvent, and is subjected to economic necrosis orapoptosis. The organisation is replaced by a new organisationand the cycle starts anew. Therefore the average performance of“E”-sector organisations will be the average level of theperformance line between birth and age d.

In the “S” category, the organisation survives, even thoughit is uncontrollable. The performance of an organisation drops to bper cent on average and stays there. Therefore, in the long runperformance in the “S”-sector will be fluctuating around b per centof potential performance.

If assumptions are realistic, this implies that theperformance ratio AE between the “E”-sector and the “S”-sectorwill also stabilise. Precise data are not available. Using data fromSouth Korea (Lim, 2003) one could consider four years to be arealistic guesstimate of the average number of years y it takes asurviving start-up to reach performance levels of the industry as awhole. As in 1997 in the Netherlands of the 31,352 firms with

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more than twenty employees, 1,958 (6 per cent) folded (OECDfirm-level study), this would result in an average lifetime of 16 years as a realistic guesstimate for d. The difference ofperformance between “adult” organisations in the “E”-sector (olderthan y) as compared to “adult” organisations in the “S”-sector(older than d) would therefore have to be around 10 per cent forthe “E-sector, taken as a whole - including “immature”organisations - to perform better than the “S”-sector. In reality,where direct comparison is possible, the difference is much higher(Wolf, 1997: appendix B).

It was already mentioned that this model is simplistic. Tomention but one complication: the growth of performance ofstarting organisations is assumed to be linear, while availabledata indicate growth to be concave (Lim, 2003).

Figure 2.4

Typical performance of an organisation

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Many readers will have realised that the letter “S” wasinspired by the word “sheltered”, while the letter “E” was inspiredby “exposed”. This distinction does not fully coincide with thatbetween market and government, but there is a considerableoverlap. In this model, the only distinction between thesecategories of organisations is that in the “E” category,organisations where performance drops below a certain level aredissolved and replaced by new organisations, while “S”organisations are allowed to survive, even if they have becomeuncontrollable. No other element is included in the model than i) a minimum performance in the “E”- category, ii) necrosis of all “E”-organisations, the performance of which

falls below that level,iii) eventual uncontrollability of all organisations (if allowed to

survive),iv) low performance of an uncontrollable organisation,v) non-existence of necrosis or apoptosis in “S”-category

organisations, andvi) a significant correspondence between “S”-category

organisations and public organisations.

Without resorting to any of the traditional argumentsexplaining non-market failure, the model predicts a superiorperformance of market sectors (commercial organisations andassociations) as compared to public organisations. This differenceis enhanced by the introduction of economic apoptosis, throughwhich performing parts of failing organisations survive. It isassumed that this does not take place in the “S”-sector.

It should be emphasised that the model does not provide,nor is intended to provide, a rebuttal of the thinking sketched in thefirst chapter of this book. But if it survives - for a period of time - thecritical empirical research that this author hopes to have inspired,this model does solve some anomalies currently plaguing themarket-government debate.

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2.8.2 Intersectoral dynamics, a quasi-formal demonstrationAt this point we will demonstrate quasi-formally a consequence ofour conjectures for economies as a whole. Let us assume that theperformance and productivity levels of an organisation run parallel.Let us also assume that in a certain economy in year t we have twosectors, the “E”-sector and the “S”-sector. As defined earlier, in the“S”-sector, the government believes that survival is good anddissolution is bad. In the other sector, “E”, the government believes

tin neglect. The market rules and the market is harsh. Workers (L )

e sare divided in the “E”-sector (L ) and the “S”-sector (L ). Therefore:

.

When we use the symbol ESR for the E/S ratio (in this case thenumber of people employed in “exposed” organisations, divided bythe total number of people employed in “sheltered”organisations),we get:

.

Assuming that average productivity in the “E”-sector is AE timesthe productivity in the “S”-sector:

This relationship is assumed to be static. Production in the

t eteconomy as a whole (Y ), the “E”-sector (Y ) and the “S”-sector

st(Y ) respectively would behave as follows:

Defining productivity as:

we get:

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stBecause we assume that i) AE is static, that ii) P is independent

t tof ESR and that iii) a positive ESR’ implies that the ratio of thenumber of people working in the “E-sector relative to those workingin the “S”-sector increases, the model predicts an increase ofproductivity when people move from the “S”-sector into the “E”-sector. If the distinction between government and market fallstogether with the distinction between the “S”-sector and the “E”-sector, moving people from the government into the market (adimension of liberalisation) will accelerate productivity growth.

Three aspects of this model put its conclusions inperspective. In the first place the usual assumption of ceterisparibus. This assumption will not be valid if changes in the E/Sratio are more than marginal. In the second place the modelassumes that in the “E”-sector employees are evenly spread overorganisational lifetime, in other words, as many employees work intheir first year of operation, as work in the second year and so on.Especially if the E/S ratio increases more than marginally, this willnot be the case, and relatively more employees will be employed inorganisations in their initial years of existence with a correspond-ingly lower performance. AE would drop temporarily. In the thirdplace, if the E/S ratio drops, it will take some time beforeorganisations formerly in the “E”- and now in the “S”-sector wouldexperience loss of effectiveness (and surviving, contrary to whatwould have happened if they had remained in the “E”-sector).Again, AE would drop temporarily.

2.9 Summary and conclusionIn section 2.1 an appropriate framework was selected fordescribing and analysing the effectiveness of an organisation. Theconclusion was that incorporating Willamson’s concept of controlinto the “employment model” of Simon would serve the purposes ofthis treatise best. This elaboration of Simon’s model was presentedin sections 2.2 and 2.3.

The second step was to put aside Williamson’s implicitassumption that control is a constant. In section 2.4 a model waspresented in which the process of control loss, and its inevitableeventual progression towards uncontrollability and thereforetowards a definitive loss of effectivity is visualised.

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In section 2.5 an overview of other internal causes of loss oforganisational effectiveness was given while section 2.6 describedexternal causes (as those pointed out by Schumpeter). Mostcauses can be identified, and some of them can be repaired.

In section 2.7 the consequences of loss of effectivenesswere described. Ineffective commercial organisations andassociations will not be able to continue their activities, becausethey will eventually not be able to pay their workers or provide theirmembers with expected enjoyment of their membership. Workersand members will leave the organisation. Public organisationsoperate under a soft budget constraint (as pointed out by Kornai),and survive.

The two processes the market applies to eliminateineffective associations and commercial organisations weredescribed. While during the first, economic necrosis, theorganisation simply disappears, during economic apoptosis partsof the organisation survive. Obviously during the latter losses interms of capital, knowhow and human suffering are much lower.

Finally, in section 2.8, the relevance of these conjectures (ifthey survive scrutiny, quite a big if) for the market-governmentdebate is shown. Without resorting to any of the “traditional”assumptions these conjectures predict a better averageperformance in organisations exposed to dissolution(corresponding with commercial organisations and associations),than organisations that are sheltered (corresponding with publicorganisations).

In the next chapter these conjectures will be confronted withreality. In particular, confrontation will be sought with the threeanomalies that, in the absence of these conjectures, lack atheoretical explanation.