Standard operating procedures of the firm

Any organization as complex as a firm adapts to its environment at many different (but interrelated) levels. It changes its behavior in response to short-run feedback from the environment according to some fairly well-defined rules. It changes rules in response to longer-run feedback according to some more general rules, and so on. At some point in this hierarchy of rule change, we describe the rules involved as “learning” rules. By this we mean (in effect) that we will not examine the hierarchy further, although it is clear wherever we stop that we can still imagine higher-level learning rules by which the lower-level learning rules are modified.In this section we consider the standard operating rules used by business firms. We consider these rules at two different levels of generality. First, we examine the general decision procedure that is followed. In part, this procedure is implicit in earlier chapters; in part it comes from a look at actual operating procedures in firms. Second, we examine several of the key procedures used by large organizations to implement the general procedure. Although we would assume the procedures at both levels to be susceptible to learning, the general procedures would adapt less readily and less rapidly than the more specific rules.

1. General choice procedure

We have already considered several major features of choice procedures. In particular, we should note that organizations make decisions typically by solving a series of problems. Whether we consider what we have said about organization goals or what we have said about organizational search, it is clear that the organizations described here devote rather little time to long-run planning (that has operational significance for decision making), especially when that planning is dependent on long-run estimates. They move from one crisis to another. At the same time, they rely heavily on traditional methods, general industry practice, and  standard operating procedures for making decisions.These general choice procedures can be summarized in terms of three basic principles:

  1. Avoid uncertainty. Rather than looking for ways of dealing with uncertainty through certainty equivalents, the firm looks for procedures that minimize the need for predicting uncertain future One method uses short-run feedback as a trigger to action, another accepts (and enforces) standardized decision rules.
  1. Maintain the rules. Once it has determined a feasible set of decision procedures, the organization abandons them only under duress. The problems associated with continuously redesigning a system as complex as a modern firm are large enough to make organizations cautious about
  2. Use simple rules. The firms rely on individual “judgment” to provide flexibility around simple One of the most common forms of a decision rule consists in a basic, simple procedure and the specification of a list of “considerations” describing the conditions under which the procedure may be modified.

We assume that these general procedures have been learned. In fact, we can specify rather easily a set of environmental conditions and internal constraints that make these general rules sensible from the point of view of long-run rationality. It is not hard to see how an adaptive system existing in an environment such as that of the modern firm might reasonably develop a set of general rules along these lines. Moreover, we would assume that these general procedures condition changes in learning at the level of more specific decision rules. Thus, if an organization has been avoiding uncertainty about competitors’ behavior by overt collusion and has had some adverse experience with the Justice Department and public opinion, we would expect it to seek some new modes of uncertainty avoidance rather than immediately abandon the general strategy.Because of this distinction between learning at the level of general procedures and learning at the level of specific procedures, we would expect that only a long-run model would need to consider adaptation with respect to general choice procedures. A short-run model need consider no  significant adaptation. Assuming that most models would probably fall somewhere between these extremes, we would expect a typical model to introduce learning with respect to some specific procedures but to treat many specific procedures (as well as all general procedures) as given.

2. Specific   standard   operating procedure

In general the specific procedures most likely to be treated as fixed are those incorporated in the explicit standard operating procedures of the firm. These procedures change slowly. They give stability to the organization and direction to activities that are constantly recurring. In addition to providing needed stability, the standard operating procedures influence (and in many cases dictate) the decisions made in the organization. We consider here four major types of procedures.

  1. Task performance rules. How does the part get fabricated? How are the books kept? How are the products priced? In terms of quantity of words, probably most of any given recorded standard operating procedure consists in specifications of methods for accomplishing whatever task is assigned to an individual member or subgroup of the organization.
  2. Continuing records and reports. Every business organization maintains a set of more or less permanent records about certain aspects of its Naturally, these records tend to be related to those elements of business operations that have seemed most important to the effective operation of the firm.
  1. Information-handling rules. In any large-scale business organization, transmitting information in the form of directions, estimates, and results represents a major In order to provide reasonable certainty that relevant information will be available at the proper place at the proper time, a communication system is specified in the regular operating code of the organization.
  2. Plans. Plans for organizational behavior represent one of the major outputs of high levels in the organization as well as a significant output at other Such plans take the general form of an intended allocation of resources among the alternative activities available to the firm or its subunits. They range from short-run budgets of operating expenses to long-run plans for capital expenditures.

Task performance rules. Consider a new employee in an organization  who is given the simple instruction, “Set price so as to maximize profit.” If such an employee lasted long enough in the organization — and the organization lasted long enough — some ways for handling the pricing problem that were reasonably satisfactory would eventually be developed. But presumably prior employees have dealt with the same problem and developed some procedures. The organization’s rules permit  the transfer of past learning.

There is another reason for rules, however. The organization requires solutions that are consistent with a large number of other solutions to other tasks being performed in the organization. So long as there exists a number of different “solutions” to the pricing problem and each requires a different set of coordinative mechanisms with other parts of the organization and other adjustments in the behavior throughout the organization, the problem of pricing is not adequately solved. The organization needs not only an acceptable solution (i.e., “acceptable” within the confines of the smaller unit) but also a solution that has some “uniqueness” properties. This uniqueness is needed to permit other parts of the organization to coordinate their activities with those of the pricing unit. Where (as is usually true) the task itself does not provide a unique solution, it is the function of the task performance rules and training to achieve the uniqueness. In this way an internally consistent, feasible schedule of activities is developed for the organization. Thus, rules not only transmit past learning; they also control (make predictable) behavior within the firm.

Task performance rules exist in considerable detail at many different levels in the organization. Highly trained engineers dealing with complex design problems may have their work as precisely described by performance rules as the  individual member of the production line. More important for our purposes is the fact that in most organizations pricing, output, inventory, and sales strategy decisions are made within heavily circumscribed limits. In most of the firms we have studied, price and output decisions were almost as routinized as production line decisions. Although the procedures changed over time and the rules were frequently contingent on external feedback, price and output were fixed by recourse to a number of simple operating rules. What was apparently a complex decision problem involving considerable uncertainty was reduced to a rather simple problem with a minimum of uncertainty.

Performance rules may have several sources. For example, work procedures that stem from time study methods are generally devised for the specific job to be performed and introduced into the system by instructing and training workers. Similarly, price and output rules are learned within the organization in large part and communicated to subsequent members of the organization. Not all rules are purely internal, however. On the one hand, some rules are introduced not by training but by recruitment and selection. On the other hand, some rules are more general than the individual firm and are identified as a more pervasive code called “standard industry practice,” “standard business practice,” “ethical business practice,” or “good business practice.”

Through recruitment and selection, many employees come to a firm with established task performance rules. Their “craft” specifies how a job is to be performed (whether it is wiring a switch or scheduling production). Although some obvious examples of such pretraining can be found in the case of employees working in the standard craft areas, such a phenomenon is not limited to what are commonly called “blue collar” activities. When a business firm hires an accountant, a dietician, a doctor, or a sanitary engineer, it hires not only an individual but also a large number of standard operating procedures that have been trained into the new member of  the organization by outside agencies. One of the important consequences of professionalization in general is that extraorganizational groups have the responsibility of providing task performance rules for the organization.

The rules of good business practice mentioned above have a similar effect. Enforced by management literature, management consultants, accounting firms, trade associations, and many other managerial reference groups, “good practice” — especially at management levels — tends to be shared among firms. We will not attempt to discuss in any detail the psychological reasons for the ready acceptance of such general rules. It is clear, however, that they serve the important function of providing an operational procedure for the manager to use in a situation of comparative ambiguity. Insofar as the external situation consists in other firms, it becomes predictable. Competitors’ behavior can be predicted in the areas covered by standard practice. Insofar as potential failure is of concern to the decision maker, “standardization” provides a defense.

Records and reports. The continuing records and reports kept by the organization are a second major component of standard operating procedures. Just as we could describe an organization in terms of the task specifications it made, we can also describe it by the kinds of records and reports it maintains over time. In fact, an analysis of the records kept should enable us to deduce some important characteristics of the firm’s decision-making system. For example, the kinds of records kept tell a good deal about the firm’s perceptions of its own  internal structure and the kind of world within which it exists. In most organizations record- and reportkeeping serve two main purposes: control and prediction. These are, of course, the general purposes of a number of organizational subsystems.Records, such as the financial statement or the standard cost report, have a control effect in the short run merely because they are being kept and the organization members presume that they are being kept for some purpose (or at least that their existence will induce some purpose for them). Obviously, in the long run, records that do not trigger some action within the system become simply irrelevant parts of  the corporate memory. Generally, the action involved is action by a supervisor or executive administratively responsible for the department. It may also involve other individuals, however. For example, the simple publication of industry resource allocation statistics creates a reference group for the manager and generally results in modifications of behavior in the direction of homogeneity within the reference group.A second major apparent function of records in an organization is to help the organization predict its environment. As we pointed out in Chapter 4, organizations, in fact, do not use predictions to nearly the extent suggested by classical theory. Moreover, such predictions as are used tend to be based on simple hypotheses about the relation between the past and the future. In order to make such restricted predictions, however, the firm needs both some idea of the relation between past and future events and also some records of the relevant past events.Two important consequences stem from the organization’s dependence on a particular set of records for predictive purposes:

  1. The significance of records for the individual members of the organization increases substantially. To a limited extent, organizational decisions about the allocation of resources among the various subunits and individual employees depend on rough estimates of future events and information about consequences of past Thus, advertising managers feel that  they should (within reason) ensure records favorable to the proposition that increases in sales revenue more than compensate for increases in advertising expenditure.
  2. The records that are kept determine in large part what aspects of the environment will be observed and what alternatives of action will be considered by the firm. We have placed considerable emphasis on the process by which organizations find alternatives to consider. Records ofpast behavior are one of the major sources for such a process. As aresult, there is more stability of organizational decisions from one period to another than one would predict if the organization entered each situation without records of prior  experience. Similarly, when the environment changes suddenly and in such a way as to make a new statistic important to decision making, the firm is likely to be relatively slow in adjusting. It will attempt to use its existing model of the world and its existing records to deal with the changed conditions. Here, as in the case of task performance rules, the standard operating procedures serve as the organization’s primary memory. They permit the organization to deal more effectively with previously experienced situations than could an individual considering the situation without prior experience, but they normally retard adjustment to strikingly different situations.

Information-handling rules. As a communication system, the firm can be defined in terms of four things:

  1. The characteristics of the information taken into the firm. Information comes to the organization from outside in a wide variety of ways and forms. Salesmen receive orders from customers and information about competitors. Executives read trade journals and formulate conclusions about general conditions in the All of these bits of data comprise inputs for the firm.
  2. The rules for distributing and condensing input information. What does the salesman do with information about competition? What does the executive do with the trade journal information?
  3. The rules for distributing and condensing internally generated Different parts of the organization make decisions, issue orders, and request clarification. How are such pieces of information moved through the organization?
  4. The characteristics of the information leaving the The organization communicates with its environment through orders to suppliers, deliveries to consumers, advertising, petitions for patents, and in many other ways.

Not everyone in an organization seeks or receives all of the information needed by the firm to pursue its business. There is considerable specialization in securing information just as there is in task performance and record keeping. In large part, this specialization is defined by some operating rules linked closely to the rules for information flows that we will discuss below. Generally speaking, a firm will allocate responsibility for securing particular information to subunits having (1) regular contact with the information source or (2) special competence in securing the information. Thus, in the course of their regular contacts with customers,salesmen are ordinarily expected to provide information on market demand. Alabor relations department is expected to keep management informed of impending labor demands. A purchasing department would ordinarily be responsible for providing information on the availability of supplies.All of these cases represent instances where regular contact with the relevant outside environment makes the department members obvious”experts” on the subject.

In many cases, however, the organization does not rely simply on contact as a criterion for selecting information sources. In almost all of the areas of  major concern to the firm — market demand, labor supply, money market, and so forth — large firms maintain staff experts whose sole function is to secure and evaluate information. Almost any large business firm has professional market analysts, financial analysts, and economists, all providing services supplementary to the information gathered by regular operating units.

Does it make any difference who gathers the information? We show below that it is potentially important because the person who gathers the information is also the first to communicate, condense, and evaluate it. It is also important in another way. The environment of the firm generates an extremely large amount of information that might be relevant to decision making within the firm. As a result, some initial screening decisions are made at the periphery of the organization. Most of these screening decisions are trivial. The salesman learns that one of his customers is driving a new automobile, but he probably does not consider that a relevant fact for the organization. However, some screening decisions have important effects If the market analyst decides to rely on a certain informant in an outside organization, he has linked his own firm’s policies to the accuracy and relevance of the informant’s reports. Standardization of screening rules (e.g., by professional organizations) leads to extensive standardization in information. Similarly, all parts of the organization — from clerks dealing with visitors to vice-presidents dealing with bankers — make decisions about what questions they will direct to whom on the outside.These decisions depend on their past training and their perceptiveness of the situation. Organizational decisions, in turn, depend in part on the questions asked and the information received.

In a simple organization it would be possible to allow all information to be shared among all members of the organization and to permit this sharing in the informal manner characteristic of small groups. In a large organization with specialization of function, however, it is necessary to establish regular procedures for transmitting information, whether it be information from outside the organization or such things as decisions and instructions from within the organization. We turn now to a consideration of therules regulating the movement of information through a firm.

There are two aspects to standard operating procedure for information flows: routing rules and filtering rules. Routing rules specify who will communicate to whom about what. The most obvious, best known, and one of the most important of such rules is the “through-channels” rule, where the organization requires that certain kinds of information be handled through channels. In such a system, the president talks only to the board of directors, his staff assistants, and vice-presidents. Vice-presidents talk only to their staff assistants, the president, and division managers. For many purposes the standard organization chart is viewed as a rule for communication. Obviously no organization can adhere strictly to such a rule without severe strains, but most business organizations observe it for a wide variety of information handling.

The reason for the extensive use of through-channels rules is clear when one considers the reasons for organizational departmentalization. Departmentalization as a basis for a business organization depends on the proposition that the activities necessary to accomplish the firm’s goals can be grouped so that any given group can act more or less independently of other groups. The production division can ignore the finance division except for a rather small number of special occasions. Such atomization of the firm is complemented by a similar atomization of relevant information (e.g., it is not particularly important to the production division to know the current state of the money market in detail). The departmental organization defines reasonably well the groups within which sharing of information is needed. Since information needs and task specialization are highly correlated, it  is appropriate to process information through the hierarchy defined in terms of task specialization. The rules themselves als observe to accentuate the specialization; for example, they make it relatively awkward to maintain a continuing close connection between production decisions and sales strategy decisions.

By the same token, we can predict when communication that is not through channels will become part of the operating procedures of the firm. Where it is necessary to coordinate the activities of subunits in the organization, communication through channels is frequently quite inefficient. As a result, procedures for transmitting information across channel sare developed. These procedures are more likely to be the result of innovation than of conscious organizational planning at the top, but if the same problem persists over time, they develop and become as fully legitimized as the other kind.

What difference do routing rules make? Provided the information is unchanged from receipt to final destination and all information is ultimately sent everywhere, about all that can be affected by routing is the length of time required to transmit the message. What makes the routing rules important is their linkage with filtering at the various communication relay points and the fact that there are dead ends in the routes. Information is condensed and summarized as it goes through the organization and some information never reaches some points.

We have already discussed (Chapter 4) the relevance of filtering rules in the formation of organizational expectations. From the point of view of the theory, they pose a rather interesting question. On the one hand, it is clear that biases introduced in the filtering rules are real. Sales departments have consistent biases with respect to sales estimates; accounting departments filter cost data differently from other departments; the computation center provides different data on computer efficiency than otherdepartments. On the other hand, as we have already observed, in the long run the organization learns to provide counter biases for each bias. In addition, the existence of information filtering and bias has another long-run learning effect. One of the ways in which the organization adapts to the unreliability of information is by devising procedures for making decisions without attending to apparently relevant information. Thus, the internal biases in the organization increase the pressure (from external uncertainty) to develop decision methods that do not require reliable information (other than the simplest, most easily checked information).

The dead ends in information routes similarly have short- and  long-run consequences. In the short run, they result in the familiar organization problem that relevant information is frequently not available where it can be used. It is difficult for an organization to assemble all of the information that would be recognized as relevant (if known) at one point if itis buried at another point. In the long run, dead ends lead to a decision strategy that involves extensive use of essentially contingent decisions. Decisions are used as devices for learning about their  hidden consequences (through outcries or other quick feedback — simulation in the raw).

Plans and planning rules. We have suggested several times that we think that long- term planning in the sense in which it is usually discussed in the theory of the firm plays a relatively minor role in decision making within the firm. However, any business firm engages in activities that come under the general rubric of planning and, in fact, are described as “planning” by the organization. These activities are usually as closely specified as other aspects of the standard operating procedures, and the fact that plans are made and features of periodicity surround them enforces a variety of interesting behaviors within the firm.

Consider, for example, the budget. Manuals on the budgeting process are commonplace in firms and many of the more interesting phenomena within the firm (especially those concerning internal resource allocation) occur within a framework defined by budget rules. The budget in a modern, large-scale corporation plays two basic roles. On the one hand, it is used as a management control device  to implement policies on which executives have decided and to check achievement against established criteria. On the other hand, a budget is a device to determine feasible programs. In either case, it tends to define — in advance — a set of fixed commitments and (perhaps more important) fixed expectations. Although budgets can be flexible, they cannot help but result in the specification of a framework within which the firm will operate, evaluate its success, and alter its program. Typically, for example, one of the characteristics of a budget period in an oligopolistic firm is that it covers the period for which the firm considers prices fixed. Similarly, any budget tends to identify as given some factors that are in an absolute sense variables within the control of the organization.More generally, we can make four observations on plans within an organization:

  1. A plan is a In classical economics the importance of planning predictions is obscured by the assumption that the predictions are always correct (and correct without benefit of an interaction between the prediction itself and firm behavior). Outside of such a utopia of perspicacity, a planning prediction functions both as a prediction of sales, costs,profit level, and so forth, and also as a goal for such factors. Under some circumstances (and within limits) an organization can induce behavior designed to confirm its prediction (goal).
  1. A plan is a schedule. It specifies intermediate steps to a predicted outcome. Such guides take the form of both time goals and subunitgoals and need not be fixed completely in Frequently, however, they are fixed either absolutely or in terms of a ratio to a factor (e.g., sales) that is considered exogenously variable. In any event, the firm is forced by its plan (if for no other reason) into the specification of acceptable achievement levels for its subunits as well as for the organization as a whole, for segments of the planning period as well as for the period as awhole.
  2. A plan is a theory. For example, the budget specifies a relationship between such factors as sales and costs on the one hand and profits on the other, and thereby permits the use of sales and cost data as guide posts to the achievement of a satisfactory level of profits. Thus, although monthly profit and loss and departmental profit and loss statements are now frequently used in firms, their use is neither so widespread nor so significant as one might Because of the accounting difficulties involved in  partial profit and loss statements (especially with respect to burden application), many operating executives appear to prefer other, plan-oriented, criteria of performance.
  3. A plan is a It defines the decisions of one year and thereby establishes a prima facie case for continuing existing decisions. Only in quite exceptional cases do firms in fact re-examine the rationale of existing functions, for example, or alter radically the expenditures for them. This tends to be particularly true of overhead functions (e.g., advertising, research and development, clerical help).

Because of these characteristics of plans and planning, the decisions within the firm have both temporal periodicity and consistency overtime that they would not necessarily have otherwise. When we say that a plan is a goal, schedule, theory, and precedent (as well as a prediction), we are suggesting that plans, like other standard operating procedures, reduce a complex world to a somewhat simpler one. Within rather large limits, the organization substitutes the plan for the world — partly by making the world conform to the plan, partly by pretending that it does. So long as achievement levels continue to be satisfactory, budgetary decisions are exceptionally dependent on decisions of previous years, with shifts tending to reflect the expansionist inclinations of subunits rather than systematic reviews by top management. 9

3. General implications of standard operating procedures

Choice and control within an organization depend on the elaboration of standard operating procedures of the types described here. It is hard to see how a theory of the firm can ignore the effects of such procedures on decision-making behavior within the organization. The effects we have noted seem to fall into four major categories:

  1. Effects on individual goals within the organization. The specification of a plan or other rule has a distinct effect on the desires and expectations of organizational members.
  2. Effects on individual perceptions of the state of the Different parts of the organization see different environments, and the environments they see depend on the rules for recording and processing information.
  3. Effects on the range of alternatives considered by organization members in arriving at operating decisions. The way in which the organization searches for alternatives is substantially a function of the operating rule it has.
  4. Effects on the managerial decision rules used in the organization. In fact, these rules frequently are specified explicitly

The relevance of these effects for a behavioral theory of the firm is twofold. First, prediction of the price and output behavior of a specific firm will depend on a rather detailed knowledge of the standard operating procedures of that firm. Conversely, detailed knowledge of the procedures will go far toward predicting the behavior. Second, a more general model of price and output decisions by modern large-scale corporations will have to include both the dependence on standard operating procedures and the general characterization of such procedures that we have outlined here.

Source: Skyttner Lars (2006), General Systems Theory: Problems, Perspectives, Practice, Wspc, 2nd Edition.

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