Part II: What Is Changing?

Chapter List

Chapter 2: The Boundaries of the Firm Revisited

Chapter 3: Is Empowerment Just a Fad? Control, Decision Making, and IT

Chapter 4: Beyond Computation: Information Technology, Organizational Transformation and Business Performance

Chapter 5: The Dawn of the E-Lance Economy

Chapter 6: Two Scenarios for 21st Century Organizations: Shifting Networks of Small Firms or All-Encompassing "Virtual Countries"?

Chapter 7: The Interesting Organizations Project: Digitalization of the 21st Century Firm

Many factors have been changing business organizations in recent years: globalization, deregulation, the growing pace of innovation, the increasing education and affluence of people, and new technologies. This section focuses on how these factors are affecting and will affect organizations and how they will shape the choices we have in creating the organizations of the future.

Of all these factors, one stands out as especially important: new technologies, especially new information technologies. These new technologies have been advancing at a remarkable rate over the past few decades. Moore's Law, which predicts that the power of microchips will double every 18 months, has held true since the mid-1960s and appears likely to continue for the foreseeable future. Bandwidth, the capacity to move data over communications networks, has doubled every two years since the late 1970s.

Technological advances alone don't directly change business, but these technological developments have also been key enablers for many other factors that are spurring business change (like globalization, faster innovation, and increasing education). Thus these new technologies have been—directly and indirectly—both enablers and drivers for many of the organizational changes that are sweeping through the business world today.

Why Are Things Changing?

The relationship between organizations and the forces that are reshaping them— especially information technology—is by no means simple. We begin with a subsection—Why Are Things Changing?—that includes three perspectives on this relationship.

The first chapter in this subsection is a theoretical essay by Bengt Holmstr m and John Roberts on what determines the boundaries of a firm. This article reviews some of the classic works on the economics of organization, a field that examines why economic activity is sometimes managed inside large firms and sometimes through external market-based transactions. Holmstr m and Roberts note that the most influential past work on this question has focused primarily on what economists call the "hold-up problem"—a situation where one party makes an investment and the other party can then "hold them up" when bargaining about how to share the returns from that investment. Holmstr m and Roberts go on to show that many recent organizational developments—supply chain links within Japanese keiretsu, long-term exclusive contracting relationships, the alliances and interconnections that prevail in networked industries, certain kinds of sales force and franchising arrangements, the use of spin-offs, knowledge transfer, and the leveraging of brands inside large firms—cannot be understood by consideration of the hold-up problem alone. Past work on the economics of organization was oriented toward issues that arose in traditional multidivisional corporations. Such an approach is no longer adequate to address the range of emerging organizational forms, many of which involve activities formerly undertaken inside the firm now being governed by interactions between firms. Holmstr m and Roberts point out that the longstanding approach of organizational economists, which was to consider the implications of a one-time transaction between two players, needs to be augmented by new thinking, which takes into account a long-term series of interactions among many players.

Next is an article by Thomas Malone on how information technology affects decision-making in organizations. The key message is that information technology, by dramatically decreasing the costs of communication, is enabling much more decentralized ways of organizing work. This means smaller, more decentralized firms and "empowerment" and delegation of decisions within hierarchical organizations. But as Malone notes, this relationship is not always straightforward. History has shown that advances in information technology have sometimes led to more centralization, sometimes to more decentralization. Malone resolves this seeming paradox though a simple model that plots the costs of transmitting information— communication costs—against the value of remote information. The model reveals that if other factors are equal, organizations will tend to move through a three-stage process as communications costs go down. At the first stage, when communications costs are high, independent, decentralized decision-making is favored. As costs drop, there comes a point where centralized decision-making works better. And as costs drop still more, decentralized, connected structures prevail. This progression has parallels in the historical development of business organizations over the past two centuries—from the small, disconnected partnerships of the early nineteenth century; to the large corporations that arose in the mid-nineteenth century and dominated through most of the twentieth; to the decentralized organizations that began to emerge at the end of the twentieth century.

Malone shows that the connected, decentralized organizations enabled by today's new technologies have many advantages. When given more freedom and, at the same time, provided with the right communications tools, front-line workers can be empowered to make decisions based on local information to which only they have access; at the same time, the autonomy they've been granted tends to make them more enthusiastic, committed, and creative. In a growing number of situations in our knowledge-based economy, these factors are likely to be critical to success.

The first section ends with an article by Erik Brynjolfsson and Lorin Hitt that shows IT associated with a wide range of complementary organizational changes, in particular decentralization inside firms and greater reliance on external relationships. The authors go on to show that these changes have been associated with significant gains in efficiency.

Brynjolfsson and Hitt cite empirical studies that link high levels of IT investment with a range of innovative organizational practices inside companies—granting greater autonomy to more highly skilled workers, smaller firm size and less vertical integration. These attributes tend to occur together as "clusters" of reinforcing organizational characteristics. Lay parlance instinctively recognized this phenomenon in the late 1990s when it termed firms that operated in this way as part of the "new economy", as contrasted with the "old economy" approach reliant on practices of the mass production era—lots of physical capital and hierarchical command-and-control structures. The article also shows how IT has enabled greater reliance on relations between firms, for example, in tighter supply chain linkages or the more intimate ties with customers associated with mass-customization, build-to-order business models.

Brynjolfsson and Hitt then marshal evidence that these IT-enabled approaches are more productive than the mass-production-era practices they supplanted. They cite a number of firm-and industry-level studies, including their own, that demonstrate a correlation between IT investment and increases in productivity, especially when the IT investment is combined with the kinds of organizational changes recounted above.

Finding evidence that IT has contributed to productivity increases in the economy as a whole has proven more difficult, leading economists to speak of a so-called "productivity paradox." Brynjolfsson and and Hitt argue that two unique characteristics of IT create problems for productivity accounting. First, purchases of IT equipment are associated with a need to build complex organizational capabilities to use that equipment properly. The costs of building these organizational skills can exceed the initial costs of IT hardware and software by a ratio of ten to one or more. Second, the benefits associated with IT are frequently intangible—things like higher quality, greater variety or convenience, and higher levels of customer service. Today's productivity accounting does not handle either of these factors well, leading to a significant understatement of the productivity benefits of IT, which Brynjolfsson and Hitt estimate may be on the order of 1 percent per annum or more. Even with these accounting problems, official measurements of labor productivity in the U.S. economy still moved strongly upward in the late 1990s, to levels unseen since the 1960s.

These three articles don't constitute the final word on why organizations are changing, but they suggest the range of issues that need to be considered and the complexity of the relationships involved. They also provide some tantalizing glimpses of where we are headed.

How Are Things Changing?

The next subsection—How Are Things Changing?—looks in more detail at where we are headed. An important goal of this subsection is to stretch your thinking about what is possible.

The subsection opens with an article by Thomas Malone and Robert Laubacher that explores in detail a provocative scenario of radical decentralization. They call this scenario the "e-lance economy" where "e-lance" is a term they coined to mean "electronically connected freelancers."The basic idea explored in this chapter is that much of the work done in the past inside large, hierarchical corporations may in the future be done by temporary combinations of very small companies or independent contractors. An important implication of such a development could be radical changes in management practices. The example of the Internet—a vast, global system with no central leadership that is enabled by a handful of simple technical standards—is illustrative. There will still be a need for managers, but the role will differ considerably from that which existed inside the traditional hierarchical firm. Managing in an e-lance world will involve influencing and coordinating networks that no one can really control. Also, a likely prerequisite of a radically decentralized e-lance economy is broad acceptance of standards of various kinds—ranging from technical specifications such as those that allow communication between computers on the World Wide Web to sets of widely agreed-upon cultural assumptions— the "rules of the games"—to allow effective interaction among people.

The next chapter, also by Malone and Laubacher, broadens our view of what is possible by exploring two possible extreme scenarios on the dimension of firm size. It grew out of the 21st Century Initiative's scenarios project, which attempted to envision what the dominant form of business organization would be in the year 2015. The first of the scenarios ("Small companies, large networks") is described only briefly in this excerpt because we have already seen it described in detail as the "e-lance economy." The other scenario is the opposite extreme: companies so large that they assume the character of "virtual countries." This scenario explores what the world might look like if companies became far larger and more pervasive in their employees' lives but at the same time grew more decentralized in their internal decision-making—so decentralized that employees were able to elect their own managers at every level of the hierarchy, much as voters elect the leaders of their governments today.

The real world of the future will likely include elements of both scenarios. In fact, the distinctions between large and small firms may even blur and become less important. The point of scenarios such as these is to help expand our thinking about the range of possibilities.

Another way of expanding our thinking about what is possible is to look at intriguing examples of things that are already happening today. That is the focus of the last chapter in this section, in which Michael S. Scott Morton describes the "Interesting Organizations Database." This project compiled a collection of examples of organizations that are "unusual today, but likely to become more common in the future." This approach, which involved looking at novel practices, then thinking about whether they could become more widespread in the future, became a way of seeing and thinking that had influence in other 21st Century Initiative projects as well. After initially gathering data on more than 250 companies, Scott Morton focused his efforts on a group of eight large firms that had been radically transformed through innovative use of information technologies. These examples show both the possible pitfalls and the potential breakthrough benefits of IT-enabled transformation—what Scott Morton calls "digitalization."

Taken together, these articles offer a snapshot view of the twenty-first century organization. Inside the firm, increasingly skilled workers will operate more and more autonomously, relying on extensive links with colleagues inside the organization and close ties with suppliers, partners, and customers. In some cases, the key unit will be a decentralized, global corporation; in others, a network of suppliers and partners will comprise a virtual "extended enterprise." In still other instances, small teams and independent e-lancers, collaborating on a project basis, will actually constitute a temporary "firm" that will dissolve when the work is complete. High-speed networks will stitch together the whole, providing rich, real-time communication between computers and people and enabling a system that's both flexible and efficient.