Is Your Company Ready to Operate as a Market?

Traditional hierarchies are giving way to market forms of organizing that will recast the role of management.
by MASSACHUSETTS INSTITUTE OF TECHNOLOGY | JUNE 29, 2016
Traditional hierarchies are giving way to market forms of organizing that will recast the role of management.

MIT SMR Frontiers
This article is part of an MIT SMR initiative exploring how technology is reshaping the practice of management.

Market Company Financial System Rita McGrath
Editor’s Note: This is the third in a special series of commissioned essays MIT Sloan Management Review will be publishing in Frontiers over the Spring and Summer of 2016. Each essay gives the author’s response to this question:

“Within the next five years, how will technology change the practice of management in a way we have not yet witnessed?”

New technologies make possible the rapid erosion of transaction costs, creating a world that is increasingly connected. The resulting level of interdependence in turn creates a radically new set of challenges for management by replacing complicated situations with complex ones.

In a complicated system, even though there may be many inputs and outputs, one can predict the outcome by knowing how the system works. For instance, the unprecedented safety of the global air travel system is made possible by driving down the margin of error and correcting known defects. In a complex system, on the other hand, different parts can interact in ways that make predicting, and therefore controlling, the outcome nearly impossible. For instance, the interconnectedness of the global financial system means that events occurring in one part of the system have unexpected interactions with others, leading to unpredictable outcomes. As Janet Yellen has said, “Complex links among financial market participants and institutions are a hallmark of the modern global financial system. Across geographic and market boundaries, agents within the financial system engage in a diverse array of transactions and relationships that connect them to other participants.” Such interconnectedness was blamed for both the severity of the 2008 financial crisis and the difficulty in resolving it.

Connecting parts of a system that used to be sealed off from one another can create enormous benefits. For instance, companies installing Enterprise Resource Management Systems benefit from having different operations across silos able to share information. Companies using various electronic payment systems benefit from decreased costs of doing business. In a complex system, however, benefits for one set of players can create losses for others.

Consider, for instance, what shipping was like before the 1950s-era invention of the shipping container. It required tens of thousands of dockworkers to load and unload ships. Not only was this a time-consuming process, but it also left cargo vulnerable to theft, as it was very difficult to track the contents of an individual load. The introduction of a container that could be sealed at the factory, shipped, and then transported in-land by train or truck transformed global trade. The Economist recently reported that containerization “is associated with a 320% increase in bilateral trade over the first five years and 790% over 20 years. A bilateral free-trade agreement, by contrast, boosts trade by 45% over 20 years, and membership of GATT raises it by 285%. In other words, containers have boosted globalization more than all trade agreements in the past 50 years put together.”

The dramatic fall in the cost of shipping fundamentally altered the assumptions management had taken for granted at the time. Where once it became possible to ship even low-value goods and make a profit, the rules of competition changed. Rather than labor being a relatively fixed commodity located in one physical place — the docks — now labor could be sourced from anywhere containers could be packed. And rather than employers and their workers being tied to each other in relatively enduring relationship, an army of outsourced and freelance workers came into play and redefined the dynamics between management and labor. The advent of shipping containers created global competition for jobs and transformed entire supply chains. As Andy Grove lamented in 2010, the unintended consequences of all this were to undermine job-creation efforts in the United States, even as employment growth among trade partners skyrocketed.

The markets vs. hierarchies concept, originally pioneered by Oliver Williamson, suggested the conditions under which one could operate purely by contracting on an open market as opposed to requiring some kind of organization (a hierarchy) to accomplish one’s goals. Hierarchies are favored, in his formulation, when uncertainty is high, various parties face a risk of opportunism in market exchanges, and information about what is being exchanged is asymmetrically distributed.

Containerization 60 years ago, new ways of sharing information today, and most likely robotics and data analytics in the near future have the effect of continuing to push transactions that were once executed within an organization’s boundaries out into open markets. Consider how clearly the Ubers and AirBnB’s of the world illustrate the fallacy that one needs to own assets in order to use them. And it goes well beyond these popular examples, as the rise of Amazon Web Services and the proliferation of software-as-a-service offers demonstrates.

How does management attention then need to shift as the world moves more toward market forms of organizing? Clearly, we are moving from a world of hierarchies in which assets are controlled by a firm, to a world of markets, in which assets can be accessed when needed. The conventional relationship between buyers and suppliers then shifts to more complex configurations in multi-sided markets and ecosystems. Networks become a primary vehicle for exchanging information of all kinds. Increasingly porous organizational boundaries mean that information is less likely to be hoarded. And increasingly, customers are looking to organizations for complete experiences rather than product and service features.

Managing in such a complex environment requires not only traditional management skills such as planning and controlling, but new ones, such as negotiating complex agreements, early detection of the unexpected, accelerating organizational learning, and the creation of trusting relationships among groups and teams who may be only temporarily associated with one another. And, this all takes place at an accelerated pace of change for which many will be unprepared. The lines between a defined managerial role in a traditional firm and an entrepreneurial role in these newly emerging market contexts are definitely blurring.

Practically, what does this mean for managers looking for a new way of operating? First, the assumption that change is the unusual thing and stability is the normal thing is worth challenging. Today, leaders need to be sensing, as early as possible, the patterns that deserve their attention and make constant course-correcting adjustments. Instead of being precise, but slow, and reinforcing existing perspectives, leaders need to be comfortable with roughly right and fast decisions and with challenging the status quo. Instead of using traditional management tools such as the net present value rule, managers need to be more discovery-driven and options-oriented. And remember that one of the most valuable gifts colleagues can give one another in a complex environment is candor about what is really going on out there.