Introduction

This week’s post addresses the question “How do organizations interact with each other?” I am grateful to have collaborated on this post with Dr. Franz Wohlgezogen, who is Senior Lecturer at the University of Melbourne.

tl;dr: Organizational interactions – such as the exchange of goods, services, information, etc. – were classically considered as opportunistic (self-serving) and dyadic (between two parties). According to this view, an organization would try to squeeze (and claim) every last bit of value from its exchanges, and would assume every other organization would do the same (or worse). More recently, relational networks, reputation, and trust are more commonly considered the basis for inter-organizational collaborations such as joint ventures, partnerships, and alliances. In a world of organizations where relationships and reputation matter, gains from opportunistic behavior may be short-lived, because reputational fallout may preclude opportunists from participating in beneficial relations and networks.

Classic View: Transaction Cost Economics

We can take as a starting point an insight we gained from the previous post (“What is an organization?”). In that post, we suggested that individuals participate in organizations to the extent doing so furthers their interests. Similarly, an organization will interact with other organizations when doing so furthers its goals and interests.

Given that interactions with (potentially) ruthless partners are risky, a key question is: when will an organization interact with others in the first place? One classic view that addresses this question is called transaction cost economics (TCE). TCE’s guiding principle is sometimes called the “make-or-buy” question: is it cheaper for an organization to do or make something in-house, or to buy it?

The key idea of TCE is that the make-or-buy decision requires consideration not just of the total cost of making or buying a product or service, but also the effort and associated cost of contracting the provision of the product or service. It’s helpful to think about different steps of entering into a contract. Basically, there are three stages (and types of transaction costs): search, negotiation, and enforcement. Search has to do with finding parties and prices to contract with; negotiation with forming the actual contract; and enforcement with executing the terms of the contract.

If search, negotiation, and enforcement are difficult, transaction costs are high. These three steps also exist when an organization decides to make a product or service internally. Think about the effort involved in working through the internal bureaucracy to find the right decision maker to arrange for a senior process engineer to be seconded to a life-cycle analysis project – in some cases it may be easier (i.e., transaction costs may be lower) to hire an external consultant.  

There are two important assumptions in TCE. One is that people behave with “opportunism,” that is in such a way that maximizes their own benefits, with minimal to no regard for effects on the other party. Oliver Williamson, one of the “fathers” of TCE, described this type of behavior as ‘self-interest seeking with guile‘.

Another simplifying assumption is TCE’s emphasis on “dyadic exchange,” that is, on transactions between two parties. Taken together with opportunism, TCE considers transactions as one-off interactions between exactly two parties, each seeking to maximize their own gains.

Our experience in the real world, however, shows that organizational interactions are often much more complicated. As we also concluded in the previous post, social systems are complex. First, an organization doesn’t always look to take advantage of others. Second, an organization is embedded in networks and social structures that include much more than its direct transaction partners.

ACCOUNTING FOR COMPLEXITY: POWER AND INTERDEPENDENCE

OMS scholars often explain interactions between organizations by considering relationships of power and interdependence. Early MOS researchers said one organization has power over another when it can sway (or coerce) the other’s decisions. Such power may come from the interdependence between organizations.

Let’s say the multinational corporation Widget Inc. depends heavily on two of its suppliers, Alpha and Beta, to achieve its goals. Alpha, in turn, depends on Widget, because it presently has no other major customers for its products. Beta on the other hand, also supplies to Widget’s key competitor, Gadget Corp, and had other interested clients come knocking on its door – clients that Beta cannot even supply at the moment. As a result, Beta is the least dependent and most powerful of the four organizations. But if Beta opportunistically exploited Widget’s dependence, word may get around to Gadget Corp and to prospective clients and may severely affect Beta’s ability to nurture and grow these commercial relationships.   

One highlight from this example is that organizational interactions are rarely dyadic. Any of the four organizations’ decision-making involved consideration of its dependence on the remaining three actors and others in broader networks of existing and prospective relationships. This observation is an example of what OMS scholars would call “network embeddedness,” where actors vary in the degree to which they are tied to and dependent on (that is, embedded in) the web of medium or long-term relationships among other organizations.

In such a context, the preservation or development of these relationships may be the overriding consideration for organizations, rather than the transaction costs of a particular exchange. The housing bubble preceding the subprime mortgage crisis of the late 2000s saw such relationship preservation at play, with ratings agencies inappropriately providing favorable credit ratings to extremely risky securities created by investment banks. In this case, ratings agencies sought to preserve their favorable position with investment houses – thereby responding to reinforcing existing network embeddedness – while giving relatively less consideration to costs associated with proper enforcement of the securities contracts.

TRANSACTION VALUE AND COLLABORATION

If interdependence and embeddedness loosen the dyad assumption, what about opportunism? Should we assume ‘self-interest seeking with guile’ is the norm or at least a primary concern that leads organizations to build relationship aimed to minimize transaction costs?

One school of thought in OMS proposes that transaction value, not transaction cost, may be a more pertinent issue for organizations. Organizations that seek to maximize transaction value with exchange partners behave differently than those that seek to minimize transaction costs. They might share more information, because they hope that cross-pollination of ideas breeds innovation, and more available information allows partners to jointly use data analytics to improve efficiencies in their exchange processes.

A transaction value view focuses on the benefits – to all parties – that may arise from collaboration. We see this particularly in strategic alliances (e.g. Ford x Google to develop tech for the connected vehicle) or joint ventures (e.g. LG x GM for manufacturing electric vehicle batteries). For these long-term partnerships trust and reputation are crucial. But beyond alliances and joint venture the idea of shared value creation has become increasingly popular. 

CONCLUSION

This post traced how conceptions of organizational interactions evolved in OMS over time. We started with transaction cost economics and its assumptions of dyads and opportunism. A resource-dependent view on power loosened the dyad assumption, while the more recent transaction value perspective attributes benefits to organizational collaboration.

As organizations around the world are striving to rebound from the COVID downturn, and face societal challenges like climate change, geopolitical tensions, and income inequality, what perspective do you think will best predict their behavior and interactions?

Introduction

This post has two parts: a series overview, and a discussion of what is an organization.

tl;dr: Three definitions highlight complementary elements of organizations. The definitions all conceptualize organizations as social systems, that is, as collectivities of two or more interdependent people; in which participants are better off with the organization existing and functioning than not in pursuit of their interests.

Series Overview

This is the first in a series of posts on topics in organization and management studies, or OMS for short.

The guiding idea is that organizations are a key feature of human life, and that literally everyone has ideas to contribute to the discussion and study of organizations. Non-OMS folks (and OMS folks, for that matter) experience organizations every single day of their lives. Their experiences, that is, your experiences, matter and have meaning — in and of themselves, of course, but more pertinent to this series is how OMS folks might think of them, through our theories, perspectives, and other insights.

Why should you care about what OMS folks think? I ask myself the same thing every day… kidding! I assume that you, as a human being, seek meaning in your own experiences and, perhaps, may wonder how your environment shapes you and your experiences and, conversely, how you and your experiences can shape your environment. If that’s too fluffy, then knowing some OMS concepts can equip you to operate more effectively in your environment, however that may be defined. So if we have these two poles — interpretive to instrumental — I assume most people fall somewhere in between. In fact, I’m willing to bet you oscillate between these two poles at different times in your organizations!

The point is, I think (or at least hope) there’s something for everyone to learn through reading these posts.

My goal for the series is to foster discussion between non-OMS and OMS communities, primarily by translating OMS concepts for non-OMS folks. Comments are welcome to clarify, challenge, and elaborate ideas in the post. I make no claim of having perfect knowledge or even of representing perfectly what all OMS folks think. One thing that will quickly emerge from these posts is that not all OMS scholars agree completely on all OMS topics. I nevertheless hope to cover enough ground to represent the diversity of thought.

Voting for future posts will take place on LinkedIn. The winner of each poll will be the topic of the following post and will be removed from the poll. A new topic will replace the winning topic in future polls (selection mechanism TBD, but I hope to involve reader input). The runner-up topic will move to the “Like” position of the next poll — substantively meaningless, since it doesn’t prevent anyone from selecting another option, but recognizing (and drawing on OMS research!) that ordering of options matters, all else equal.

Enough overview; let’s get to organizations!

What is an Organization?

The subtitle of the book Organizations and Organizing: Rational, Natural, and Open Systems Perspectives by W. Richard (Dick) Scott and Gerald F. (Jerry) Davis lists right there the three main perspectives on organizations in OMS. For each perspective, I’ll share their definition and add a few (non-peer-reviewed) observations. The book, by the way, is an excellent resource, written at the late undergraduate to early graduate level of complexity.

As perspectives, the three are not mutually exclusive. I think a better metaphor is that if we examined an organization under a microscope, we can zoom closer to or further from certain parts of the organization. Alternatively, we could imagine each perspective as shining a different colored light onto the same object. Under each light, different aspects are more or less (or in)visible, but the underlying object is the same.

There’s no right or wrong, or better or worse, way to conceive of an organization. To get the widest lens, then, it can make sense to think through your organizations from each perspective, and notice what aspects stand out more or less.

Rational systems

“Organizations are collectivities oriented to the pursuit of relatively specific goals and exhibiting relatively highly formalized social structures” (p. 38; emphases added).

The key points are

• One person cannot be an organization, that is, there is some coordination of activity going on;
• Organizations vary in how specific their goals are;
• Organizations vary in how their rules, roles, and behavior are prescribed independently of the individual people that form part of the organization.

This is fairly jargony, so what’s going on? The rational systems perspective on organizations is sort of like seeing organizations as machines. Machines have specific functions, that is, they are designed to do certain tasks; and machines have blueprints that specify how pieces fit together. Ideally, the pieces work together more smoothly to accomplish the goal, than they would separately.

The rational systems perspective is a useful starting point for understanding organizations because it distills them down to their fundamentals, keeping aside some of the “messiness” associated with any social system, that is, any entity involving two or more interdependent people. But if the messiness is what interests you (and, let’s be real, who doesn’t like to get their hands dirty?), then we can draw on other perspectives on organizations.

Natural systems

“Organizations are collectivities whose participants are pursuing multiple interests, both disparate and common, but who recognize the value of perpetuating the organization as an important resource” (p. 39; emphases added).

Compared with the rational systems view, the natural systems view is more “bottom-up,” and recognizes the multiple, potentially competing interests that members bring to an organization. This perspective focuses more on what organizational members actually do, instead of what they are “supposed” to do.

One way to think of this perspective is by imagining the multiple organizational identities people have, or multiple “hats” they wear within an organization. For example you may work for your company, but within the company you may work for one vertical or one function, to which you may have more loyalty than to the broader company. One step further, you may work for a particular manager or on a team you are most loyal to. You can apply details from your own experience onto this skeleton framework, but what you might realize is that at each area or sub-system of an organization, goals and interests are different. What might be best for your team may not be best for the vertical, or vice versa, and so on.

Finally, like the rational systems perspective, the natural systems perspective recognizes that participants in the organization believe that their participation brings about their interests more smoothly than not.

Open systems

“Organizations are congeries of interdependent flows and activities linking shifting coalitions of participants embedded in wider material-resource and institutional environments” (p. 40; emphases added).

Like with the other two perspectives, we can tease this apart by thinking through effects at the level of an organization broadly, as well as among individual people that make up the organization. For organizations, we can imagine that an organization lies at the intersection of many “streams” of activities: the legal environment, societal culture, technological developments, and more local things like labor markets, supply chains, and funding. All these streams “flow into” the organization, and the organization may try to optimize its position relative to all these streams.

For individuals, we can go back to the idea of identities and interests. The natural systems perspective highlights the within-organization identities that matter. Remember how we said the rational systems perspective isolates the organization away from all the other “messiness” out there? In that sense, the natural systems coincides, while the open systems perspective differs by explicitly accounting for environment.

Besides looking at identities and interests within the organization like in natural systems, is looking at identities and interests outside the organization. You may go to the office every day (ha) as an employee, but you don’t leave your other identities (family member, partner, neighbor, friend, etc.) at the door. Similar to the natural systems case, what may be good for one identity (working more for a bigger paycheck) may not be good for other identities (missing out on quality time with friends).

Where the first two definitions tend to isolate the organization as a discrete, independent (“closed”) entity, this perspective recognizes that the organization is enmeshed in a complex web of interdependent social forces. Rather than taking a “top-down” or “bottom-up” view of the organization, this perspective can be thought of as taking an “outside-in” and “inside-out” view.

Wrap-up

In short, organizations are social systems: collectivities of two or more people wo are interdependent in the pursuit of interests that vary in the degree to which they are shared. We can examine organizations from the perspectives of what they’re supposed to do, what they actually do, and how they fit in their environment. These are not mutually exclusive perspectives, and in fact the most interesting insights emerge when we combine two or more perspectives.