Abstract:

In this paper we consider issues of organization of economic activity, especially coordination of productive activity. The general topic of organization has been raised in the form of the question ''Which activities are (should be) coordinated by market mechanisms and which by administrative organizations, sometimes referred to as 'hierarchies'?'' Questions like this have usually been addressed in the context of 'theory of the firm.' But that seems to us not a useful setting in which to study choice among coordinating mechanisms. A mechanism of coordination that is used within a firm may also be used across firms. One can observe a variety of coordinating mechanisms each commonly and persistently used in the economy, especially in the production sector, between, across and within firms. This phenomenon is not likely to be understood by way of theories in which the only coordinating mechanisms are firms and markets. The concept of 'firm' prevalent currently is essentially legal, namely, a firm is seen an entity in which someone (or several ones) has a defining property right--the claim to residual earnings. While important questions have been investigated in this framework, it seems not to be suitable for the study of coordinating mechanisms. The following examples suggest why this might be so.

A manufacturer of tractors, Company A, requires a gear-train for each tractor it produces. Company A buys the gear-trains from another firm that makes them. The design of the gear-train is unique to Company A; there is no market for it as such, and the desirability of coordinating the delivery of them with the production schedule of tractors makes the desired time of delivery essentially unique. It is common practice in this situation that the transaction between the gear supplier and the tractor maker is coordinated by direct exchange of information and negotiation between the two parties.

At the same time another producer of tractors, Company B, has a unit that produces gear-trains. The same coordination problem exists inside Company B as exists between Company A and its supplier. It may happen that the same coordinating mechanism is used in both cases, for the same reasons. It is not infrequent that a firm will use another firm as a supplier of components, then instead set up an internal unit for the same purpose, and at a still later time shut down or sell the internal unit, returning again to using an outside supplier, all with essentially the same coordination mechanism.

A second example involves an integrated petrochemical firm with a number of divisions. The activities of these divisions are coordinated by having each division operate as if it were an independent producer; they exchange intermediate products at transfer prices set equal to external market prices. This well-known mode of organization uses a market mechanism to coordinate production across divisions within a firm. Because our focus is on understanding choice among coordination mechanisms, it seems best to approach that problem directly, without asking whether it is within or across firms.

The environment of production provides a setting in which specific coordination problems arise naturally, because specialization entails dispersion of information among agents. Therefore we begin by defining a production environment. The model used for this purpose is a modification of a standard model of technology used, for instance, in general equilibrium models. After introducing a formal model in which choice among alternative coordinating mechanisms can be analyzed, we present an example in which there are two stages of production, and in which there are two slightly different conditions of demand for final products. In one demand regime users of final products regard units of product delivered at any time within a given week as equivalent (perfect substitutes). In the other regime, users regard units delivered early in the week as different from those delivered late in the week (not perfect substitutes). The technology of production is the same in each case. Two modes of coordinating the intermediate stages of production are considered: a mechanism using a market channel, and a mechanism using a direct channel. (These are defined in the model.) In the example under the first demand regime the market mechanism cannot achieve efficient coordination of production, while the mechanism using a direct channel can achieve efficient coordination. Under the second demand regime both mechanisms achieve efficient coordination.