EXPERT's REPORT

on

Intrapreneurial Groups

A Transaction Cost Analysis Approach

To be able to assess new kinds of corporate organization, like Intrapreneurial Groups, in a more theoretical context, the framework of the wide spread method of Transaction Cost Analysis, combined with a comparative institutional analysis, will be presented. We refer to the classical book by Oliver E. Williamson, who, at the end of the last century, has applied the transaction analysis approach to all types of enterprises engaged in material production. He not only investigated contemporary firms, but enterprises of the 18th and 19th centuries as well. Pinmaking was used as a case study, as other famous scholars have done before. Adam Smith and Charles Babbage were only two of them. Different from the approach adopted by the group of Radical Economists which had a somewhat distorted view by looking at the production process in terms of power between capitalists and the workers only, and different from the mainstream economists tied to Neoclassical Theory who neglected power completely, Williamson gave evidence that not only power is not only a category which is responsible for changes in organization of work but of efficiency as well. He virtuously developed criteria for the analysis and evaluation of efficiency in a manner rather loosely connected with the traditional categories of class struggle and property relations preferred by Marxian economists. These criteria are listed and explained below. The objects of his analysis, six alternative work modes, represent an analytical framework of six "Idealtypen" (Max Weber's "ideal types"), where any newly created and invented one can be placed, located, and evaluated.

The six types are grouped into pairs by different types of station ownership relations, called entrepreneurial, collective ownership, and capitalist.

1. Entrepreneurial Modes

Each station is owned and operated by a specialist.

1.a Putting-Out system

A merchant-coordinator supplies raw materials, and makes contracts with the individual entrepreneurs. They, separated by location, use their own equipment at their homes, and perform specialized operations. They are not independent entrepreneurs, but hirelings, tied to a particular employer, for whom they work at a price fixed in advance.

Example: Spinning and weaving in Silesia, cutlery manufacture of Solingen and Thiers in 18th century, performed by dispersed cottage labor.

1.b Federated

The stations are closely located in a common building or area. Material flow between the stations is set by contract. If buffer inventories fall below prescribed levels, penalties are due.

Example: Leasing space and power in a mill to individual artisans, common in 19th century England.

2. Collective Ownership

Work stations or land are owned by the entire group of workers.

2.a Communal Mode - every person for him/herself

Every person has a claim to the output associated with his/her own labor. Workers move from station to station at prescribed intervals, each bringing his/her own work-in-process inventory with him and selling his/her final product on the market. Resources are pooled. There is no specialization among workers.

Example: "Artels" in Russia, 19th century.

2.b Peer Groups

Workers are not compensated on the basis of their own product but are paid in accordance with the average turnover realized by the group. Workers may or may not rotate between stations. They may elect temporary leaders (in rotation) to improve logistics and administration. Strategic decisions remain with the Peer Group.

Example: Co-operatives, "socialist firms" (Ernest Mandel).

3. Capitalist Modes

Plant, equipment, and inventories are owned by a single party.

3.a Inside Contracting

The management of a firm provides floor space and machinery, raw material and working capital, and arranges for the sale of the final product. The production job is delegated to inside contractors, who hire their own employees and receive a negotiated piece rate from the company.

Example: Construction industry, 20th century.

3.b Authority Relation

Capitalist ownership of equipment and inventories, employment relationship between capitalist and worker.

Example: Average capitalist firm, 20th century.

The above six modes may be rearranged by analyzing them from a different point of view. Williamson looked at them as well by using the concepts of contracting and hierarchy. The following figure shows his result for a refined view of contracting. While I have filled the matrix by the modes of organization in the way Williamson has linked them to rows and columns, one can see that even more refinement in principle is possible by separately showing the degree of reliance on contractual detail (column) from the time structure of the bargaining (row). A closer look will show that one off-diagonal element will nevertheless remain empty, however. The reasons for that are the inertia of organizations and the limited capacity to process information. The framing contract between the members of an organization cannot be changed in a continuous manner, because the necessary psychological adaptations to a changed consensus would stretch them too far (lower left corner of the matrix). In a similar manner, the periodic and fundamental change of contracts for all the details of the production and remuneration process would burden the members by an information overflow to which they cannot react appropriately (upper right corner of the matrix).
time-structure of bargaining contracts

degree of

contractual detail

continuous contracting periodic contracting
comprehensive contracting Putting-Out (1.a),

Federated (1.b)

Inside Contracting (3.a)

contracts as a framework Communal Mode (2.a)

Peer Group (2.b)

Authority Relation (3.b)

For hierarchy Williamson found it useful to distinguish between a hierarchy of contracts and a hierarchy of decision-making. Contractual hierarchy is strong if only one or a few agents are responsible for negotiating all contracts; it is weak if each agent negotiates each interface separately. The decision-making hierarchy is great, where the responsibility for effecting adaptations is concentrated by one or a few agents; it is slight where agents are themselves responsible for adaptations, or they are subject to collective approval. The table following shows the rank ordering of modes from least to most hierarchical in contractual and decision-making terms.


RankContractual RankDecision-making
(1)Federated (1.b) (1)Federated (1.b)
Communal Mode (2.a) Communal Mode (2.a)
Peer Group (2.b)
(2)Putting-Out (1.a) (2)Putting-Out (1.a)
Inside Contracting (3.a)
(3)Inside Contracting (3.a) (3)Peer Group (2.b)
Authority Relation (3.b)
(4) Authority Relation (3.b)

One can see that the contractual order is not completely the same as the decision-making order. Peer Group makes the main difference.

Williamson developed eleven simple criteria on the efficiency of an institutional arrangement within an enterprise. They refer to three types; product flow; assignment attributes; and incentive attributes. Following is the listing and a short explanation of each.

Product Flow

1. Transportation expense: The cost of the physical transport of the raw, intermediate, and final product. Modes that save on these costs are favored. The rule is true only under the condition of ceteris paribus.

2. Buffer inventories: To separate activities at stations distant from each other, buffer inventories are installed. The lower the buffer minimum level, the better.

3. Interface leakage: The amount of actual or effective losses of product during manufacturing. The lower the leakage (e.g. by embezzlement, by hiding true quality attributes), the better.

Assignment Attributes

4. Station assignments: When workers are not equally skilled at every task, modes are favored that make discriminating job assignments on the basis of comparative advantage.

5. Leadership: Modes that economize on coordination needs and make discriminating leadership assignments are favored.

6. Contracting: The capacity to aggregate demands and contract experts to serve the needs of many stations (e.g. maintenance workers) is the focus of this point. The more easily contracting is accomplished, the better.

Incentive Attributes

7. Work intensity: Modes that encourage workers to give their best are favored.

8. Equipment utilization: Modes that disfavor equipment abuse and neglect are favored.

9. Local shock responsiveness: Modes that facilitate quick recovery from machine breakdown or workers illness are favored.

10. Local innovation: The more process improvements that can be carried out at low cost, the better.

11. System responsiveness: Modes that adapt easily to changing market conditions and permit cheap improvements are favored.

One can see that Williamson's criteria refer to a technology which is focused on material production. As modern multimedia computer technologies and electronic networks have become of paramount importance and ubiquity, his criteria have to be modified to take into account the tremendous progress which was made in the exchange of information of all kinds. The new technologies influence not only management methods, but logistics and cooperation between workers as well. Let us discuss Williamson's eleven criteria on efficiency under the influence of new electronic technologies, when the production process has mainly changed from physical production to processes of information generation, retrieval, consumption, transport and exchange. Today such processes account for the majority of work activities performed in the modern offices of the developed world. In essence, the above "station" can be a work station in the office, a personal computer at the telecenter, or a personal digital assistant at home, as telework has started to boom after some initial reluctance.

Thus one has to adopt the content of Williamson's key terms to the electronic age. In contemporary information society the raw, intermediate, and final products consist of packages of bits and bytes coded into electric potentials, currents, electromagnetic waves or modulated light beams. The former term "station" now refers to a computer screen and keyboard, an intelligent TV set, AI-assisted tele- or visiphones and virtual-reality booths. In the same way as Williamson, and before him, Adam Smith, has used a characteristic example to illustrate his analysis, pinmaking, we have in mind the immaterial phases of hypertext production as the prime example. The assumed steps necessary are: reading of other related texts, papers and books on screen; data acquisition; creative writing; translation; correction; and layout.

By the transformation from material production to an electronically mediated service economy, some of the above criteria become redundant, and one can skip them; some of them experience a change in importance and weight, and some of them have to be modified in content. The adapted list of criteria and their content is shown below.

Information Flow

1. Transportation expense: The cost of information exchange between distant stations becomes a neglectable item in total cost. The modes do not differ with respect to information exchange costs. Thus this criterion becomes irrelevant if the appropriate communication infrastructure is provided.

2. Buffer inventories: Buffer inventories now become electronically stored information (text, data, visual or acoustic information), residing on electronic readable data carriers. To separate and at the same time to couple activities at distant stations, central or local servers are installed. Although the cost of transport of information is negligible, it still remains an important task to provide adequate and sufficient information as an input for the next station. The modes differ in their ability to give incentives to the person at a single station to finish a task in a coordinated manner, taking into account the time structure of the next station. That mode will be favored which can perform the task efficiently, as well as eliminates standstill. The advantage of the electronic system is that it can be used for the transport and storage of intermediary information at the same time as for data related to coordination of the different stations.

3. Interface leakage: As output and intermediary product now consist of information, a completely different picture has to be drawn related to fraud and embezzlement. It becomes a question of survival as to whether confidential data can be kept under cover and personal data are not available for abuse (which does not necessarily mean data must stay inside a small geographical area, but must be kept inside the network of stations of the enterprise used by the workers or by an authorized subset of them). In the information age keeping personal data and research results secret is one major goal of the firm. If only one single case of violation of privacy is reported to the public the prestige of an enterprise fades immediately - as does the price of its stock. The lower the leakage (e.g. by embezzlement, by hiding true quality attributes), the better. While much can be done by cryptographic means (a standard of public key systems is now established world-wide), there is still the risk of information abuse by employees of the firm who have official access privileges to qualified data. Thus it is of vital importance to establish high standards of trust in the enterprise, as well as satisfying working conditions and a high degree of co-determination to bring up a convergence of individual goals of the workers and those of the enterprise. An example of the importance of security and safety is that many firms still do not transport their data by electronic networks but use human couriers for this purpose.

Assignment Attributes

4. Station assignments: When workers are not equally skilled at every task, modes are favored that make discriminating job assignments on the basis of comparative advantage. This criterion remains valid, although the means to perform the task have changed considerably, by the high degree of electronic connectivity reached all over Europe for the private and public enterprise sector, private households and public institutions. Services for personal evaluation and staff recruitment are provided by a flourishing industry founded around the year 2000. It is still of great importance to create qualifications which exactly fit the tasks to be performed. The more the mode can succeed on this level, the better.

5. Leadership: While electronic networking assists management in its coordinative functions, the problem of leadership assignment is only dealt with by a better database on available staff. The final decision still remains a highly volatile art.

6. Contracting: The European Electronic Network allows for tele-consulting and tele-repair, in particular for software and hardware problems. The more easily contracting is accomplished, the better.

Incentive Attributes

7. Work intensity: Modes that encourage workers to give their best are favored.

8. Equipment utilization: A particular threat has developed as the result of the new information technology: Computer viruses and hacking. Modes that disfavor equipment abuse and neglect are favored.

9. Local shock responsiveness: Modes that facilitate quick recovery from machine breakdown or workers' illness are favored.

10. Local innovation: The greater the ability to use the potential of information technologies for process improvement at low cost ,the better.

11. System responsiveness: Modes that adapt easily to changing market conditions and permit cheap improvements are favored.

Because of the need to perform the overall task in a continuous manner, without interrupts and breaks (the latter refers to the overall process of production only, not to the single individual), a 12th criterion must be stated.

12. Susceptibility to inference: As electronic technology is not determined entirely by its technical parameters, there is a high degree of freedom for the organizatorial mode to set the degree of reliability of the production system. The flexibility of the mode to handle the likelihood of standstill time is of crucial importance, not for one single operation, but on a statistical basis, in the average period of, say, one year.

It has to be mentioned that the modified eleven criteria should help to determine optimal or at least appropriate organizational arrangements. There are two procedures possible. First, they could be selected from the list of the six modes at the beginning of the report, or second, a new organizational mode could be invented which is designed and appropriately tailored according to the highest scores in fulfilling the criteria.

Let us look now at the first method. We shall evaluate the six modes of organizations under the condition of contemporary electronic technologies and apply the modified criteria to them.

As the result of the advent of communication and network technologies, we can observe a basic difference to the former material production technologies. The potential is now evolving for a less hierarchical interaction between the members of a production unit, in particular on the operational level. Networking technologies will not be favored by management if they have to defend some monopoly on information. Strongly hierarchical organizations will thus experience great difficulties in appropriating the potential fruits of networking in view of the higher speed of formal and informal information flows, the shrinking "distance" between the members of the firm ("Japan is just a mouse-click away"), the existence of a unique network within which all tasks of employees can be performed, the creative power of self-organization, and the possibility for synchronous as well as asynchronous modes of collaboration.

Now let us apply the method of elimination to find the optimal solution. If we look at the echelon of hierarchy, the topmost (Authority Relation - 3.b) will assume a lower ranking. It cannot offer the degree of flexibility information oriented enterprises need with respect to fast adaptation to the changing markets. It shows a major disadvantage: Authority Relation is not a voluntary relation for the worker, it is an incomplete form of contracting. The employee is subject to detailed supervision. He/she has to accept orders and instructions as premises of his/her behavior. Authority rule is less and less accepted by the majority of people. The degree of education, training and qualification, both formally gained, or by training on the job, has increased to such an extent that people do not like to be in a completely subordinated position any longer.

The bottom of the echelon is formed by Federated (1.b) and Communal Mode (2.a) on both sides of the hierarchy, the contractual and the decision-making one. These two fall short as appropriate organization modes for a different reason than Authority Relation. Because markets are more volatile than in the 19th century, the product of the enterprise has to be redefined at irregular intervals. While agricultural or milling activities remained constant for generations, information as a product or service is changing its content fairly rapidly. As there is no way to redesign the tasks of the enterprise in an organized manner, the two modes will have difficulties to survive in this environment of fast changing demands.

The concept of the Peer Group (2.b) does not encourage work intensity enough through compensating workers by the average product. The problem of free riding comes up sooner or later. As Peer Groups are weak in assignment to stations and in leadership, the ability for flexible and fast adjustment is missing (similar to the case of the two other modes mentioned above).

Only two more candidates remain, remnants of completely different historical periods: Putting-Out (1.a), a mode rooted at the outset of early capitalism, and Inside Contracting (3.a), a type of organization used by large capitalist firms during the late era of Fordism to overcome the problems of rigidity and petrifaction. Both seem to be interesting candidates to become the winner of our competition of modes. Let us look closer and use the method of analogy. Putting-Out forms a rather centralized, but only slightly hierarchical system. Networking technology can be shaped in a very similar structure. The "star" (in addition to the "ring") is one of the frequently used types of electronic networks as well as the structure of the widely used electronic client-server-architecture. The analogy may be continued with respect to material flow, now called data. Data may be owned by a merchant-coordinator (located at the center of the star) who submits them to the workers' stations on a contractual basis, and, after the workers have finished working on them, they are sent back to the center. The weakness of this mode is the isolation of the workers. If they are not integrated in additional social relationships they become more and more dependent on the center. They have no other choice and alternative than to sell their work - although formally independent - to the merchant-coordinator. They can thus easily become subject to exploitation, face low wages, weak social benefits, experience feelings of loneliness, etc.

The last mode remaining to be characterized is Inside Contracting (3.a). As is the case with Putting-Out, a high degree of centralization may be combined with a slight degree of hierarchy, but in decision-making terms only, not in contracting terms. In Williamson's definition, Inside Contracting does not control material assets of any kind, but it depends vitally on workers hired. Through electronic networking technologies, an Inside Contracting firm faces a greater range of alternative possibilities. The "Inside" is no longer limited to geographic space. Information workers may be tied up at locations everywhere in the world. At the same time, there is no need to be related to only one "parent" firm. It is possible to build up a portfolio of parent firms. The monopoly power of a single firm can be mitigated. The spreading of risks could be helpful in economic depression.

The discussion of attributes different from the original definition of ideal types shows that there could be viable alternatives, more appropriate to modern technology than the six versions discussed by Williamson. Let us recapitulate which mode we are looking for:

a. Because of the low price of computers and the abundant network links all over the country the means of production could be owned by the workers on an individual basis;

b. The cultural tendency toward a high rated value of the individual restricts us to vote for any authoritarian organization with a leadership which is not legitimized by the workers;

c. Negative effects can result through the isolation of the workers. Group approaches may satisfy the need for collective action, assistance, guidance, resistance etc. better than a model based on single individuals. This is not only a vote in favor to the workers. It is rational for the parent firm or the entrepreneur as well. In case of illness, the tasks can be more easyly shifted by the members of the group to one or more other members. There is no need for the management of the parent firm to deal with such contingencies;

d. Group organizations create possibilities for self-organized collective action. They may educate people in rational decision-making, in learning to assume responsibility for their actions, in enabling them to become socially competent, etc. In case of stress, occupational risks or illnesses, the group can become a center of preventive activities far more easily than a single individual; and

e. A group of workers organized as a legally competent institution has the right and the abilities to hire additional people. This could not only serve to increase the firms capacity but it could be used as well for social integration of invalids, the impaired, the hitherto unemployed, displaced persons, etc. Of course one can not expect this will happen by itself. Incentives have to be offered by legislation to encourage the group to show this socially oriented behavior.

If we take into account the above mentioned five demands, it should be possible to construct a new mode of organization which fits into the contemporary needs much better than any other mode previously discussed. Let us call this new creation an "Intrapreneurial Group". It is a small-group-based, legally empowered institution. It is allowed by law to own assets, to sell and buy commodities and services, to hire workers, and, of course, it is subject to taxation. Usually it enjoys elected leadership, with rather short election periods. The remuneration is based on average earnings, but wages are bargained for individually inside the group. Intrapreneurial Groups form only one element of a new scheme (the others are Peer Group Care, Green Taxes, Negative Income Tax, and Workers' Health Assurance Group). Their balanced interplay is vital for a more sustainable society.

(See our report on the visit to Opteam, a very successful Intrapreneurial Group in car design, in this volume!)



Reference

Williamson, O. E., The Economic Institutions of Capitalism - Firms, Markets, Rational Contracting, Macmillan, New York and London 1987.