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Flexible vs. Deep: What are the Ties that Bind a Firm Together?

Summary:
One of the classic questions in economics is about what determines what is inside or outside a company: that is, why do companies buy some inputs or higher some workers from outside their firm through market transactions, but hire other workers to produce certain inputs inside the firm? Economists will recognize this as the central question posed by Roland Coase (Nobel '91) in his famous 1937 essay, "The Nature of the Firm" (Economica, November 1937, pp. 386-405). Coase points out that economic activity within firms is coordinated by conscious administrative action, while economic activity between firms is coordinated by supply and demand. In one passatge that always makes me smile, Coase writes (footnotes omitted): As D. H. Robertson points out, we find "islands of conscious power in

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One of the classic questions in economics is about what determines what is inside or outside a company: that is, why do companies buy some inputs or higher some workers from outside their firm through market transactions, but hire other workers to produce certain inputs inside the firm? Economists will recognize this as the central question posed by Roland Coase (Nobel '91) in his famous 1937 essay, "The Nature of the Firm" (Economica, November 1937, pp. 386-405). Coase points out that economic activity within firms is coordinated by conscious administrative action, while economic activity between firms is coordinated by supply and demand. In one passatge that always makes me smile, Coase writes (footnotes omitted):
As D. H. Robertson points out, we find "islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk.” But in view of the fact that it is usually argued that co-ordination will be done by the price mechanism, why is such organisation necessary? Why are there these “islands of conscious power”? Outside the firm, price movements direct production, which is co-ordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-co-ordinator, who directs production. It is clear that these are alternative methods of co-ordinating production.
The line between what activities are coordinate more effectively by administrative action inside a firm and what is coordinated more effectively by market actions between firms shifts over time, and across different types of firms. One current example is the number of firms that sell manufactured goods but are "factoryless"--that is, they don't own or manage the factory in which their goods are produced. Diane Coyle and David Nguyen offer some recent examples in ""No plant, no problem? Factoryless manufacturing and economic measurement" (ESCoE Discussion Paper 2019-15 September 2019). In a short overview of that paper, they write:
Did you know that Mercedes does not actually produce its heavy-duty G-Class? To be fair, it does keep design, development and marketing of the SUV in-house, but the vehicle is entirely built in the factory of Magna Steyr, a contract manufacturer based in Graz, Austria. In the same plant one will also find entire production lines for the Jaguar I-Pace and E-Pace, as well as BMW’s Series 5.
Coyle and Nguyen are focused on the question of how to measure "output" of an economy if design, development, and marketing are in one place, but the physical production intimately inked to design development and marketing is in another. For a previous discussion of factoryless manufacturing, in the US economy, see "Factoryless Goods Producing Firms" (May 16, 2015).

In thinking about these shifting lines between  what is produced inside and outside a company, I was i intrigued by the Edward Tenner's discussion of "a long-developing tension between two iconic corporate models: the flexible organization and the deep organization" in "The 737 MAX And the Perils of the Flexible Corporation" (Milken Institute Review, Fourth Quarter 2019, pp. 36-49). Tenner describes the difference in this way:
Depth is not just a matter of corporate size or scale. It is an attitude of public responsibility. Executives of a deep organization may strive for the highest possible profits — but only in the context of a perceived essential role in the social order. The gospel of flexibility, rooted in business-school doctrines of the primacy of shareholder value ... seeks to preserve freedom of short-term optimization and cost reduction. By contrast, the gospel of depth has been mainly a tacit one, based on the idea that a dominant organization has a distinct role in the social order. It seeks to serve multiple stakeholders, to provide safety and security to consumers even if it raises costs and to plan for its long-term future. Deep organizations have often subscribed to what has been called welfare capitalism, providing impressive health, educational and recreation services for employees, expecting exceptional loyalty and higher productivity in return. Many, though not all, deep organizations have government ties and semi-official roles. John D. Rockefeller’s Standard Oil was not a deep organization in this sense; AT&T before the breakup of Ma Bell was.
A deep organization has extraordinary in-house capabilities, managed administratively inside the firm. A flexible organization is more likely to add a mixture of shifts in locations or outside contractors where this seems to increase efficiency and to raise profits. 

Tenner uses Boeing as an example of a shift from a "deep" to a "flexible" organization. As an illustration from the days of a "deep" Boeing, he tells the story of the launch of the 747 back in 1969:
In 1968, construction of the first 747 from scratch, a plane that was radically different than any existing aircraft, was completed in only 29 months. Boeing had to build an entirely new factory (the world’s largest) to produce it. But the company already had the asset on hand that mattered most, a staff of some 50,000 experienced engineers, technicians and managers known within the company as “the Incredibles.” In contrast to the trial and error of many engineering projects, the 747 was completed with such remarkable precision that the head of the project, Joe Sutter, could predict exactly where on the runway the plane would take off — and test pilots lauded its handling from Day 1. 
A deep organization, like Boeing in the 1960s and 1970s, has not only a reservoir of professional skills, but also an esprit de corps that can resist policies that threaten the mission. At one point in the project, Boeing senior management wanted to cut 1,000 of the 4,500 engineers assigned to the 747. But at the risk of his own job, Sutter walked out of the meeting at which the proposal was made; Sutter prevailed.
But over time, Boeing shifted toward flexibility. It moved its headquarters from Seattle to Chicago. It opened a major production facility in South Carolina. There were strong arguments for these and other changes, but there were also tradeoffs in terms of in-house expertise and cohesiveness. And when it came time to design and build the 737 MAX, two of which crashed earlier this year. There are typically multiple reasons for plane crashes, and this is no exception, But some of the reasons that have been proposed in media reports include problems with manufacturing in the South Carolina facility "including manufacturing debris left in finished aircraft," "some key software of the Boeing 737 MAX had been developed by $9-an-hour programmers outsourced abroad," and "yhe FAA’s delegation of some essential monitoring tasks to Boeing employees."

As Teller argues, we are in an age of flexibility gospel, and the advantages of flexibility in many contexts are very real. However, Teller is pushing back, gently, pointing out that deep organizations have their benefits, too.

For example, deep organizations often had in-house corporate research laboratories, which often proved remarkably fertile places for the interaction of cutting-edge science and real-world production issues.  And sometimes those corporate research labs produced extraordinarily important spinoff innovations like the transistor or the laser, or even the idea of the relational database.


Deep organizations sometimes provided quality that was so high it was sometimes redundant. In the case of AT&T during its days as a deep organization before it was broken up in 1984, Teller notes:
And, in the 1950s, handsets designed by the renowned Henry Dreyfuss and manufactured by its own Western Electric subsidiary, were rated to stand decades of punishing use. One result was the Bell System’s astonishing reliability rate of 99.999 percent call completion. In 2011, a senior Google executive acknowledged that the web had yet to achieve reliability even remotely as high.
Products that seem overengineered can look like a place for cost-cutting, but the lessons learned from producing in this way can be valuable--and when it comes to airplane manufacturing, overengineering and redundancy in the name of safety seems important. 

There is also a certain kind of deep expertise that can be developed by in-house professonals. Teller writes:
In 1989, the information scientist Michael J. Prietula and the Nobel economist Herbert A. Simon published an article in the Harvard Business Review, “The Experts in Your Midst,” on the wealth of knowledge and capabilities that underappreciated specialists in an organization possess. Theoretically, a lean, agile company might try to substitute outside consultants and temporary workers for in-house talent. Yet because in-house professionals bring years of tacit knowledge to problems, they paradoxically may be better equipped to find solutions than experts unfamiliar with the organization’s workings. The sociologist Chandra Mukerji has even argued that the government sponsors academic oceanography generously not because its findings are directly applicable to, say, Navy operations, but because its support creates a reserve army of scientific experts for urgent needs.
There's no single "right" answer to whether a company should be flexible or deep. Factoryless may work just fine for some firms. Deep in-house expertise may be important to others. Teller cites Google as a leading example of a modern "deep" firm. He writes:
From the perspective of 2020, the state of deep organization in American industry is not as discouraging as it appeared a generation earlier. Google, still an obscure academic startup in the late 1990s, is the old AT&T’s successor as a deep organization, hegemonic in the new field of online search as the Bell System had been in telecommunications. In 2017, fully 16 percent of Google employees held PhD degrees, over three times the proportion at Microsoft, Apple and Amazon. If a measure of a deep organization is its efforts to plan the future privately, it is hard to think of any 20th-century corporation’s plans as ambitious (and controversial) as those of a Google subsidiary for creating a network-controlled smart city in Toronto.
Although it's not one of Teller's themes, I would also add that the flexible corporation has strong incentives for how it invests in the human capital of its workers. When a deep firm expects many of its workers to stay for a substantial period of time, it has an incentive to invest in their skills and training, to view them as candidates for future promotions, to encourage them to build up specific knowledge about the company, and in general to envision the company as made up of people who are building longer-term careers at that company. When a flexible firm buys from outside, it doesn't need to care much about those who work for its suppliers. The notion of firm and employee making investments in a long-term career is diminished. Workers instead need to think semi-continually about where their next job will be, and firms need to think semi-continually about hiring from outside to replace departing workers. The notion that many workers will eventually settle into a career progression of rising skills and pay with a single employer comes to seem outdated and obsolete. That, too, is a tradeoff of the flexible firm.


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