Organizational Innovation and Market Structure

1. Economic Importance of Organizational Innovations

As the study of innovation goes, organizational innovation, by compari- son with technical innovation, is a relatively neglected subject. Conceivably this is because, judged at least in economic terms, it is much less important. This is contradicted, however, by views such as Arrow’s, who contends : “Truly among man’s innovations, the use of organization to accomplish his ends is among both his greatest and his earliest” (1971, p. 224). In a similar vein, Cole has observed that “if changes in business procedures and practices were patentable, the contributions of business change to the economic growth of the nation would be as widely recognized as the influence of mechanical inventions or the inflow of capital from abroad (1968, pp. 61-62). The organizational innovations to which Cole refers to include, in addition to the organization form changes treated in earlier chapters, refinements in cost accounting, work scheduling, personnel, collective bargaining procedures, and so forth. The patenting of such innovations would, at a minimum, have announcement effects. If, in addition, such patents could be enforced, their profitability potential could be better established.

That property rights, in the form of patents, on organizational innova- tions are not awarded is less attributable to problems of describing the patented organizational form or procedure, although this, too, can pose i îculties, than it is to problems of imitation and enforcement. Since it is impossible to tell, by monitoring output streams, what types of adminis- trative procedures have been followed, detection would probably require on-site inspection. Also, inventing around such patents would be easy. Once the new structure or procedure has been disclosed and its merits proved variants would be easy to devise. Lacking enforceability, the rights would be quite illusory.

In addition to these “defects” common to organizational innovations in general, the economic significance of organization form changes — which are of special interest to the study of firm and market structures – are especially difficult to assess. The initial response of rival firms and financial analysts to an organization form innovation is typically to disregard it. Tartly this is because reorganization is a common reaction by firms that are experiencing adversity. Discerning whether the response is intended to eliminate accumulated bureaucratic deadwood, to buy time from the stock- holders by giving the impression that corrective action has been taken, or, instead, represents a really fundamental change in structure that warrants more widespread attention is initially unclear. (It is noteworthy that the General Motors executives went to considerable effort in the 1920’s to apprise the business community at large of the character and importance of the multidivisional structure which they had devised – but to little avail ) Expressed in transaction cost terms, the problem is that opportunistic structural changes cannot easily be distinguished from fundamental ones because of information impactedness and bounded rationality. Given the incapacity (or high cost) of communicating about and abstractly assessing the importance of organizational changes, due partly to the fact that the language for characterizing organization form changes is rather primitive, the tendency is to wait and see how organizational changes manifest them- selves m performance consequences. Inasmuch as performance is a function of many factors other than organizational structure alone, sorting this out is difficult. Accordingly, a long recognition lag between fundamental in- novation and widespread imitation is common. Being conceptually less tractable, organization form innovations have received much less in the way of formal analysis than have technical innovations.

2. Market and Economy-wide Concentration Effects of Form Organization Form Changes 

But while changes in the internal structure and control procedures in the firm have not received much quantitative analysis, it is not as though the implications of such developments have been altogether neglected by academics and other policy analysts. Changes in organization form are frequently associated with increases in the breadth and depth of economic activity performed within the firm and, where such effects obtain, often give rise to expressions of dismay.

Dismay is registered because such innovations are regarded as devices for realizing monopoly power. Schumpeter’s early work on economic development suggested that organization form and monopoly were associated (1961, p. 66)— although the effect was not unidirectional; organizational innovations could either create or destroy monopoly. The connection between organization form and monopoly is somewhat less evident in his later work (1942, pp. 84-85), but the impression that organization form changes have competitive effects has persisted while recognition of their bidirectional nature has been supplanted by a tendency to regard such changes as mainly anticompetitive.

As the discussion in earlier chapters makes evident, vertical integration and multidivisionalization plainly can and sometimes do have anticompetitive purpose and effect. The principal motivation for and consequence of these innovations, however, has been to enhance efficiency. Although future organizational innovations may represent an effort to achieve monopoly power in a novel and subtle fashion, really fundamental organization form changes are apt to signal beneficial efficiency effects as well or instead.128

As had been indicated repeatedly, internal organization and market exchange can be usefully regarded as substitutes. Integration and diversifica- tion, viewed in this way, are usually matters of degree; pure cases of firms that are fully integrated or completely specialized, although possibly interesting, generally fall in the null set.


Partly the incentive for vertical integration is traceable to such institutional rules of the game as the practice of collecting sales taxes on market- mediated but not internal transactions. But vertical integration is mainly explained by the costs of writing and enforcing interfirm contracts that are avoidable, in large measure, by resorting to internal organization. That firms do not fully displace intermediate product markets is because internal organization, mainly for bureaucratic reasons, is also costly.129 The arguments on both sides of this issue are already familiar from preceding chapters.

Vertical integration, by itself, has no immediate effect on market con- centration at any stage. It may, however, be a means of mobilizing latent monopoly power (for example, by facilitating price discrimination) and can have eventual concentrating effects as well. The latter might obtain if, by foreclosing markets, entry were inhibited to any but a fully integrated sup- plier, thereby raising capital requirements.

Concentration can also result if vertical integration is used against rivals in a predatory manner. The circumstances in which vertical integration can be successfully used in these ways, however, are rather special. Except where vertical integration involves the combination of stages with nontrivial market shares in already concentrated industries, monopoly purpose is apt to be lacking or ineffectual. The integration of successive stages by already very large firms can, of course, lead to an increase in economy-wide concentra- tion—but this raises large-size rather than market power issues.


Given the evident inability of the unitary form organization to deal with large size and complexity, it seems safe to predict that, but for the develop- ment of the multidivisional structure (or some comparable corporate form innovation), firms that had attained large size would have had their growth arrested. Smaller rivals that did not experience as severe coordination and control problems would, presumably, have grown relatively.130 Diseconomies of large scale attributable to control loss experience would in this way have placed a limit on firm size; concentration of production would have been checked.

The multidivision form of organization, by overcoming many of these control loss conditions, permitted already large firms that adopted this structure to continue their growth — at least absolutely and, for many of them, relatively as well. In classical natural selection fashion (Friedman, 1953, p.22), those that adopted the new form and realized the economies which it permitted prospered and acquired resources with which to expand. The initial impact of the multidivision structure can thus be judged to have in- creased industry concentration above what it otherwise would have been.

That its eventual effect has been to increase concentration (expressed in an industry rather than economy-wide basis) is less clear. A related and frequently more important consequence of divisionalization than mere magnification has been that it has facilitated diversification. Thus, although some of the firms that have adopted the multidivision structure have indeed maintained high product specialization ratios, many others have not. Hence, while the overall effect of the multidivision form innovation has been to increase feasible firm size, and in this way has permitted economy-wide concentration to increase, its diversification consequences leave the effect on industry concentration uncertain.

There are, of course, important concentration influencing factors other than organization form to consider (Bain, 1968, Chap. 6). It is, nevertheless, interesting to note in this connection that adoption of the multidivision form of organization has been particularly common among large firms since World War II (Chandler, 1966), and that from 1945 to the present the major concen- tration increases have occurred on an economy-wide but not on an industry basis (Subcommittee on Antitrust and Monopoly, 1966, pp. 2-3; Bain, 1968, Chap. 5). This may be strictly coincidental, but the progressive adoption of the multidivision structure would appear to have been a contributing factor. Of greater relevance to the purposes of this chapter, however, is the systems impact (which, generally, has hitherto been neglected) of organization form changes as these relate to technical innovation.

Source: Williamson Oliver E. (1975), Markets and hierarchies: Analysis and antitrust implications, A Study in the Economics of Internal Organization, The Free Press.

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