Understanding the Fundamental Economic Problems “Solved” by Management

It is an understatement to say that economic theory underplays the role of the manager; in fact, the strategic manager simply does not exist in any recognizable form. True, shareholders appoint agents (managers) to stewardship roles in the enterprise, but eco- nomic theory says little about what executives actually do and the economic function, if any, that they perform.1 Sometimes execu- tives manage workers through the employment relationship; but otherwise the executive in economic theory is rather a lacklus- ter being who is almost completely invisible, and doesn’t really perform an economic function, other than standing in for the owner/investor.

At least one well-known economist has commented on this lacuna. William Baumol notes that in economic theory:

There is no room for enterprise or initiative. The management group becomes a passive calculator that reacts mechanically to changes imposed on it by fortuitous external developments over which it does not exert, and does not even attempt to exert, any influence. One hears of no clever ruses, ingenious schemes, brilliant innovations, of no charisma or of any of the other stuff of which outstanding entrepreneurship is made; one does not hear of them because there is no way in which they can fit into the model. (Baumol, 1968: 67)

The  cavalier  treatment  of  entrepreneurship  and  management in economics stems in part from a failure to understand the importance of managing organizations and the absence of well- developed and well-functioning markets for intangibles and other idiosyncratic assets, particularly those of the cospecialized variety. Because markets are often viewed, at least in the neoclassical paradigm, as working rather frictionlessly, the special role the managers play in transactions and in asset deployment, business model design, strategy formulation and implementation, and lead- ership seems quite unnecessary. In a perfectly competitive world with homogeneous inputs and outputs and technology that are ubiquitously available for all, the functions identified above aren’t needed. The manager is left simply as a calculator, setting marginal revenue equal to marginal cost. Of course, if this is all managers do, a reasonably simple software program and a set of rules for the organization would void the need for managers and management. On closer examination, however, executive management per- forms several distinctive and important roles, which help the eco- nomic system overcome special problems, problems that might otherwise result in “market failures”. That is, but for the actions of astute managers, competitive markets wouldn’t function very well. Moreover, business organizations couldn’t function either. Seven particular classes of economic functions can be assigned in economic theory to management. They are: (1) orchestrat- ing cospecialized assets; (2) selecting organizational/governance modes and associated incentive systems; (3) designing business models; (4) nurturing change (and innovation) processes/routines; (5) making investment choices; (6) providing leadership, vision, and motivation to employees; and (7) designing and implementing controls and basic None of these functions can be per- formed well, if at all, by computers or by naked market processes. Managers are needed to make markets work well, and to make organizations function properly.

The first six classes of decisions are “strategic” and/or entrepre- neurial and must be performed astutely for firms to compete effect- ively. They relate to issues of strategic “fit” between the company and its competitive environment, as well as between and amongst the assets that comprise the resource base of the firm. We do not discuss the seventh set of decisions at length in this chapter, as it focuses on more operational issues. The management skills required for successful execution of operational decisions are con- ceptually different from those required for strategic management. The fact that they are not at the essential core of this book does not make them unimportant. Operational capabilities can provide a strong point of differentiation and advantage for a particular company. Nevertheless, we largely ignore these considerations in this chapter, which focuses on strategic management in general and decisions around resource allocation and asset alignment in particular.

If managers did not perform strategic functions within and among business enterprises, the entire adjustment and resources allocation function in the economy would fall on the price system. However, it is also generally accepted that a complete set of con- tingent claims markets does not exist, and even when markets do exist, trading volumes are often thin. If certain assets are rarely if ever bought and sold, then how can the economic system be restructured and assets brought into alignment?

The economics literature contains some general recognition that “internal organization” solves the problem. Exactly how internal organization solves the problem is never explained very well, if at all. Williamson and others have suggested that, with intern- al organization, adaptive behavior is facilitated and “managerial fiat” can be used to make decisions and coordinate and allocate resources. Unfortunately, the extant literature doesn’t go much further. In this chapter,  we  seek  to  identify  the  functions  of the executive that matter in a fundamental economic sense, and with regard to dynamic capabilities in particular. In this man- ner, we may better understand the distinctive role of managerial activity.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.

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