On Optimal Organization Size

It is generally accepted that communism is not economically competitive with a free market economy. Yet there is little difference between a communist government and a large corporation. Both are susceptible to motivations other than economics. Historically both have used violence to control workers (although that violates the principles of both systems, one for using violence and the other for hurting workers). The sole distinguishing characteristic is that a communist government has no competition at all (especially if they close the borders).

Competition inevitably results in wastes of known kinds. The most obvious is the duplication of functions between competitors. It is not uncommon for competitors to "fight it out" when the market is incapable of supporting all of them. Statistically, over 90% of all new businesses fail. Throw in economies of scale and one is led to the (erroneous) conclusion that a well planned economy would be far more efficient than a market economy.

Indeed, management theory admits to no known limits in the efficiency of organizations due to size. So why is it that communism is such a disaster?

In addition to the problems of bad communications and promoting attitude over ability (see Hierarchy), the key failing of hierarchical organizations is the inability to recognize, admit or correct mistakes. Indeed, if managers never made mistakes, a planned economy would function better than a market economy.

Mistakes are not only an inevitable result of human nature, managers seems particularly susceptible to certain kinds of mistakes.

During the Challenger investigation it was found that at both NASA and Thiocol, managers uniformly believed that the shuttle was fundamentally safe while engineers maintained that it was very dangerous. When told of this, the managers expressed surprise as if they had never been warned. The engineers were less surprised that their warnings had been ignored, having gotten used to it over the years.

The function of low or middle managers is to carry out the will of their superiors without bothering them with all the details. While this requires a certain amount of decision making, exercising individual judgement will inevitably result in questioning the wisdom of one's instructions. The end result is a kind of systematic blindness where one simply refuses to see anything which would cause a contradiction.

Regardless of how the mistakes are made, in the absence of competition it becomes very difficult to recognize that a certain decision was producing a less than optimal result. While trying something different in the hope than it might be better is characteristic of the market, where one needs a competitive edge, it is not characteristic of a hierarchical organization. If the new idea fails, then the attempt was a waste of resources. If the new idea works, then the people who were responsible for the old system (and who have since been promoted) will lose face. Plus there is the cost of conversion. Either way, simply trying a new idea will cause problems.

While there are ways to promote competition within a corporation, another approach would be to isolate the functions with the greatest economies of scale. One example was Sears, who would buy selectively from many suppliers then market all these products essentially under their own brand. Banks and other investment institutions provide smaller businesses with needed capital. Insurance companies provide risk sharing.

The key question is whether large corporations got that way because they better allocate resources between their divisions, or due to an orgy of empire building which will ultimately result in more economic disasters when their mistakes become known? Or is this simply another consequence of our over-regulated banking industry?