The firm as an adaptive institution

In Chapter 2 (and subsequently) we suggested that the classic theory of an omniscient firm is inappropriate for a theory of the firm directed toward answering questions about microbehavior. Without denying the substantial abilities of organizations as problem-solving and decision-making institutions, we have suggested that a business firm is constrained by the uncertainty of its environment, the problems of maintaining a viable coalition, and the limitations on its capacity as a system for assembling, storing, and utilizing information. As a result, the theory outlined in this volume characterizes the firm as an adaptively rational system rather than an omnisciently rational system. In general, we assume that an adaptive system has the following properties:

  1. There exist a number of states of the system. At any point in time, the system in some sense “prefers” some of these states to others.
  2. There exists an external source of disturbance or shock to the system. These shocks cannot be controlled.
  3. There exist a number of decision variables internal to the system. These variables are manipulated according to some decision rules.
  4. Each combination of external shocks and decision variables in the system changes the state of the system. Thus, given an existing state, an external shock, and a decision, the next state is determined.
  5. Any decision rule that leads to a preferred state at one point is more likely to be used in the future than it was in the past; any decision rule that leads to a nonpreferred state at one point is less likely to be used in the future than it was in the past.

We argue on the basis of the above criteria that a business organization is an adaptive institution. In short, the firm learns from its experience.

With such a view of the firm, we can deal effectively with a number of classic problems in the analysis of firm decision making. However, it is important to recognize one feature of the adaptation before proceeding to a more detailed discussion of the mechanisms and procedures used by firms to make decisions. In the language and formulation of Chapter 3, an organization is a coalition of diverse subgroups; it is also a complex system in which different decisions are made at different places in the organization. Such a system adapts in a rather special way. In particular, note that we have described an adaptive system as in some sense preferring some states of the system to other states. In what sense does an organization have “preferences”? We have already indicated our perception of the sense in which organizations have goals (and therefore preferences). If we are correct in our formulation, organizational adaptation will depend, in part, on such considerations as what goals are currently evoked and what part of the system is involved in making the decision. Such phenomena can be subsumed under the rubric of adaptation without doing violence to the concept, but they suggest a somewhat more complicated form of adaptation than is commonly associated with the term in dealing with individual human systems. This will become clear when we turn to the development of actual price and output models.

If we view the business firm as an adaptive institution, we may (depending on the environment of the firm) be interested either in some long-run consequences of the adaptive process or in the short-run results of that process. Proceeding from the former point of view, some attempts have been made to indicate the long-run relation between adaptive rationality in the firm and omniscient rationality.  6 Although it is possible to show that most adaptive processes tend toward “long-run rationality,” we think such demonstrations are of modest relevance for a theory of firm behavior. The conditions required for the nonfortuitous achievement of strictly rational behavior are extremely implausible as descriptions of the world.  In particular, so long as the environment of the firm is unstable (and unpredictably unstable), the heart of the theory must be the process of short-run adaptive reactions. The long-run properties of the processes under stable conditions are relevant primarily as indicators of logical properties (and therefore consistency with general concepts).

Thus, our primary concern here is in the relatively short-run adaptive process and its consequences. In order to examine the major attributes of short-run adaptation by firms existing in a changing world, we need to take a new look at the standard operating procedures of a business organization and the ways in which those procedures change. Standard operating pro-cedures are the memory of an organization. Like any other memory or learned behavior, standard operating procedures change over time at varying rates. Some rules seem to change frequently; others appear to have been  substantially unchanged for as long as the organization has existed. Because many of the rules change slowly, it is possible to construct models of organizational behavior that postulate only modest changes in decision rules. One such model has been presented in this chapter; others will be presented in Chapters 7 and 8.

When we ignore adaptation with respect to decision rules, we are simply saying that relative to the time span being considered these rules are given. For example, one might want to use a basic full-cost pricing rule in a model of a particular industry for the next ten years, without necessarily assuming that full-cost pricing (much less the mark-ups used) would persist indefinitely. In general, if we investigate a firm and determine that it uses a set of decision rules, we can ordinarily assume that within the next few years these rules will be pursued and that adaptation in the short run will be restricted largely to adaptation in goals and rule-directed reaction  to feedback. From this point of view, standard operating procedures should be one of the major objects for study by students of organizational decision making. The result of adaptation rather than the adaptation itself can be studied.

At the same time we may want to extend our time span and examine the adaptation itself. Some of the main features of interest in an adaptive system are the problems of learning, and some organizational learning occurs within a time span that permits analysis. Thus, we will want to consider such questions as how the decision rules, treated as fixed in shorterrun models, change in response to long-run experience. We have introduced some assumptions about such long-run shifts in the general model presented in Chapter 8; but since little or no research has been carried out on organizational learning, the assumptions are borrowed from the study of other adaptive systems and have only limited prima facie validity.

In the remainder of this chapter, we consider standard operating procedures as they exist in contemporary firms in the United States. We do not think a reasonable theory of the firm can ignore such procedures. We think it is possible to characterize their main features in such a way as to contribute to the development of such a theory — that is, to abstract from the specificity of any one firm’s procedures. We think they confirm — both in their form and in their changes — the description of a firm as an adaptively rational system.

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

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