Discriminating Alignment

Our theory suggests an alignment between the search needs of problems and the search costs and performance of governance alternatives. We summarize the proposed alignment in Table 3 and Figure 1. Table 3 summa­rizes the set of relationships from problem type to gov­ernance choice. Figure 1 compares the stylized costs we described above for each governance alternative over a range of problems that vary in the degree to which knowledge sets interact to define the solution landscape. For simplicity of presentation, we represent the hori­zontal axis as a continuous measure of this degree of knowledge set interaction, holding the actual number of knowledge sets constant (this assumption equates to holding constant the N in an NK model and varying K). The vertical axis represents the expected cost of find­ing a valuable solution. Also, while the cost curves are all upward sloping, which might suggest that the abso­lute lowest cost (e.g., the cost of the market for low- interaction problems) is most desirable, it is important to remember that the highest peak of the landscape, and hence the value of the optimal solution, increases with knowledge set interaction. Thus, the relevant issue is finding the lowest governance cost for a given problem.

Our hypothesis is that markets efficiently govern low-interaction problems, authority-based hierarchy effi­ciently governs moderate-interaction problems, and consensus-based hierarchy efficiently governs high­interaction problems. With low-interaction problems, markets promote specialization and directional search. However, knowledge-exchange hazards ensure that the cost of the market (indicated by M(K)) accelerates rapidly as the degree of knowledge set interaction increases. For low-interaction problems, the cost of authority-based hierarchy (indicated by ABH(K)) is greater than markets, reflecting the inability of authority to efficiently motivate the intense specialization required to facilitate directional search or for those in author­ity to constrain their predilection to meddle.¹⁶ As prob­lems become increasingly complex, the costs of markets accelerate rapidly, reflecting their inability to cope with knowledge-exchange hazards. By contrast, the cost of authority-based hierarchy accelerates less quickly, leav­ing authority as the efficient governance choice for prob­lems with moderate levels of interactions, which are between the points K_x and K₂. Nonetheless, authority- based hierarchy’s costs continue to accelerate, eventually leading to organizational failure as problems display high levels of interaction and the central authority lacks the relevant knowledge to guide search. The cost of consensus-based hierarchy (indicated by CBH(K)) is higher than the cost of authority-based hierarchy for problems with low and moderate levels of interaction. Thus, the organization provided by consensus-based hierarchy fails with these types of problems. Nonethe­less, the costs of consensus do not accelerate until it is used to organize problems with high levels of interac­tion, which makes it the economic choice for problems with levels of interaction greater than K₂.

Source: Nickerson Jack A., Zenger Todd R. (2004), “A Knowledge-Based Theory of the Firm: The Problem-Solving Perspective”, Organization Science, Vol. 15, No. 6 (Nov. – Dec., 2004), pp. 617-632, http://www.jstor.org/stable/30034765.