Orthodox economists ordinarily profess a complete lack of interest in the processes by which firms actually make decisions. From their perspective, the fact that our discussion to this point has been con cerned with how organizations function means that it offers no clue as to “whether firms really maximize profits,” since that question re lates to “what they do” – that is, to the transactions they engage in, not to how they decide to do it. Insofar as their point relates to the possible optimality of particular actions in particular circumstances, we agree with it. Indeed, the evolutionary model of the following chapter illustrates the possibility that firms modeled according to the spirit of our own view of decision process may wind up taking profit-maximizing actions in selection equilibrium. However, if their claim is that firms consistently optimize, even under completely unanticipated circumstances, then we obviously disagree. And we would argue that evidence relating to decision processes is highly relevant to that issue.
We will not go into the subtle questions of methodological principle involved in this area. However, one rather simple point illumi nates the nature of the clash between the orthodox view that firms optimize and the evolutionary view that they function according to routine. Imagine a firm that functions with a completely inflexible routine, totally unresponsive to its changing environment. It pur chases inputs at constant flow rates and converts them into outputs which it sells at constant rates. The profitability of this operation varies as the environment changes, but imagine that it is always pos itive. Orthodoxy can accept this firm’s behavior as profit maxi mizing, since the behavior is interpretable as reflecting optimization over a production set that contains only the single input-output list corresponding to the firm’s routine-or perhaps that list and some others that are strictly inferior to it.
The key point here concerns the empirical basis of the claim that only that one pattern of behavior is available to the firm. If one ac cepts the methodological principle that “what the firm actually does” in market transactions is the only relevant evidence on the alterna tives available, then the orthodox claim that this inflexible firm is an optimizer is safe from refutation. But if other sorts of evidence are admissible- for example, evidence that the firm’s inflexibility re flects the existence of a delicate truce in an extremely severe case of latent intraorganizational conflict, or evidence on what other firms do- then the claim that this very rigid firm is an optimizer may well be refuted. More generally, the hypothesis that routinized behavior patterns really reflect optimization after all is likely to be more vul nerable to evidence that provides some sort of independent check on the alternatives that might be considered available than it is to evi dence on the market transactions arising from the routine itself.
Although a highly defensive and skeptical stance toward decision process evidence is typical, occasionally evidence of this sort is put forward in support of orthodox theory. Thus, for example, the fact that a particular firm has sophisticated accounting techniques, em ploys formal optimization procedures in some part of its decision making, or has a permanent in-house operations research unit may be adduced as evidence corroborative of the general proposition that firms optimize. Of course, the first question to be raised about this evidence is how representative it is, and whether orthodox analysis is to be understood as relevant only to the historical periods, econ omies, industries, and firm-size ranges in which these features of firm decision processes are typical. Beyond that, we emphasize that this sort of evidence fits into the evolutionary framework as useful information on the details of the routines that some firms follow.
We would conjecture, for example, that firms that have operations research (OR) groups not only go about making decisions in different ways from firms that do not, but that the decisions themselves are likely to differ. Whether a firm has an OR group and systematically does OR as part of its higher-order decision making is a question that we view very much in the same light as the question of whether a firm does or does not use the oxygen process for making steel. Both questions are about the routines employed by firms . The exercise of an OR capability indicates that a firm has that capability in very much the same way that exercise of the oxygen process for making steel means that the firm has that particular capability.
However, the fact that a firm has an OR group that builds models and that this group is influential in decision making does not imply that the firm’s actual decisions are “truly” optimal. Indeed, we would view particular attention of the OR group on a certain area of decision as an indication that the firm presently is not satisfied with its current routines in that area. Presuming the OR group comes up with a proposal for reform, we would regard it meaningless to say that the new policy is truly optimal; only God knows what policy truly would be optimal. There is no guarantee that the policy that would be optimal within the operations research model is even supe rior in the actual economic environment to the policy that is being re placed.
Also, and relatedly, knowledge of the fact that the firm goes through explicit maximization calculations to guide its decision making does not mean that the orthodox economist can on the basis of his own model make good predictions of what the firm will do. His model and that used by the operations research group may differ in important respects. It does mean, however, that if the economist knew the model used by the firm’s operations research group, that information might help him predict and explain the firm’s actions. The economist would then have direct information on the ro utine employed in decision making by the firm. And that, of course, is the heart of our theoretical proposal: the behavior of firms can be ex plained by the routines that they employ. Knowledge of the routines is the heart of understanding behavior. Modeling the firm means modeling the routines and how they change over time.
Source: Nelson Richard R., Winter Sidney G. (1985), An Evolutionary Theory of Economic Change, Belknap Press: An Imprint of Harvard University Press.