Thursday, October 15, 2009

Oliver Williamson

Although I have never met Professor Williamson, who won a Nobel Prize for Economics this week, I have long been under his influence. I was very broadly educated in the New Institutional Economics at Indiana University (no, I didn't study with this year's other winner, Professor Elinor Ostrom, of, oh yes, Indiana University), where I was tutored by the late Professor David Martin in Williamson's fine theory. Incidentally, in the year before Williamson switched from Yale to UC Berkeley, he spent at year at I.U., which attempted to recruit him, unsuccessfully. (Alas, I had already graduated the year before.)

Williamson's theory goes something like this:
  • Business firms exist to minimize the costs of doing business, called transaction costs, which are the costs of searching for good partners, negotiating contracts, and then enforcing them.
  • Although we would like to find business partners who are not difficult to find, easy to get along with when we do, and who routinely live up to their agreements without being bothered by litigation, human nature is such that this is not always, or even often, the case. Human beings have very specific, often severe limitations, among them: a) small slow brains that can only handle several (7) chunks of information at a time; and b) sneakiness, that is, a tendency to withhold valuable information when it will benefit us individually, and to heck with you.
  • Given this unfortunate situation (our lack of mental acuity, and/or that of our potential partners--and the fact that everyone is out to get us) the enforceability of contracts is a really big deal. Especially when assets are highly "specific," as they often are. "Specific" means specific to the contract. An example of a "specific" asset is, say, your construction of a large mine in a foreign country--a very expensive proposition. And, let's say, the government of this country decides to nationalize the mine. You lose your shirt. Because, your shirt was specific to the contract. In other words, the value of the asset depended upon the participation of the other party, in this case, the government.
  • Or, closer to home, consider the case of other people "taking credit for your work." Let's say that you are a functional manager in possession of specific information about a process. Or let's say that you have a brilliant idea that you need help to realize. The value of that information or idea may well depend upon the willingness of manager's from other business functions (in the first case) or a joint venture partner (in the second case) to cooperate in pursuing a common goal. Your information or idea is a "specific asset" in the contracts (largely informal, in many many cases) that you make with your fellow managers or joint venture partners.
Okay, what does this have to do with hoshin kanri and the A3 process?


Hoshin kanri exists to minimize the transaction cost of doing business, and Williamson's theory is a near perfect guide to explaining how, and why, hoshin works.
  1. The PDCA process at the heart of hoshin speeds up our small slow brains, courtesy of the scientific method--PDCA effectively offsets our unfortunate lack of gray matter;
  2. The catchball process of hoshin is slow and deliberate, which levels the playing field between mental tortoises and mental hares (this has other benefits, because sometimes the slow are deep)--on the one hand catchball is a very effective search process, and it makes it more difficult for the sneaky to take advantage of the honest;
  3. The use of A3 documentation (an A3 is essentially a contract--A3 team charter--"charter" is another word for "contract") in the catchball process makes it very difficult, if not impossible, for sneaky people to withhold vital information--the process of hoshin kanri is transparent and this rather effectively offsets the human being's natural tendency to be sneaky;
  4. Hoshin's reporting system of short, frequent, focused meetings again makes it difficult to withhold vital information. Also, individuals who are not compliant with the terms of their "contracts" are discovered almost immediately, and encouraged to comply;
  5. Finally, compliance is further encouraged by hoshin's drive-fear-out-of-the-organization approach, because noncompliant participants have relatively little to lose as well as little to gain from gaming the system.
There are other, more subtle ways, in which hoshin kanri and, indeed, the traditional tools of lean operations reduce the transaction costs of doing business. Some of the more subtle methods address the costs of searching for information. Take, for example,
  • Standard work
  • Successive and self-checks
  • 5S and visual control
  • Poka yoke or mistake proofing
All of these methods are designed to bring "defects" (which, because of standard work, may be understood as "breaches of contract") to the surface. Keep in mind, according to Williamson, transaction costs are the costs of:
  1. Searching for information;
  2. Negotiating contracts, formal or informal; and
  3. Enforcing contracts.
So efficient is hoshin kanri's system of achieving organizational alignment and encouraging members of the organization (including those pesky suppliers!), that I and others have spoken of Toyota's marvelous system as a system of self-organization. Another word for this is cybernetic. Toyota is a cybernetc or self-organization system.

You've had enough? Williamson's theory is about as clear as mud. And reading his wonderful books only makes it worse! But his theory is correct. It rests upon a profound understanding of human pyschology and markets that has been awarded the Nobel at least twice before (to Herbert Simon and Ronald Coase, with whom Williamson studied). And, if you really, really want to understand what makes Toyota tick, you need Williamson's theory.  Maybe one day, after I put my darling daughter through college, I'll write a book about it. It explains Toyota's miraculous supply chain, too.

In the meantime,

Congratulations, Professor Williamson!

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