The Boundaries of the Firm as a Design Problem
Abstract
This paper starts from the observation that firms are increasingly engaging in collaborations with their input suppliers, even as they are reducing the extent to which they are vertically integrated with those suppliers. This fact seems incompatible with traditional theories of the firm, which argue that integration is necessary to avoid the potential for hold-up created when non-contractible investments are made. Our view is that pragmatist mechanisms such as benchmarking, simultaneous engineering, and "root cause" error detection and correction make possible "learning by monitoring"--a relationship in which firms and their collaborators continuously improve their joint products and processes without the need for a clear division of property rights. We provide several examples of such relationships in the automotive industry, both current and historical. Data from recent surveys of automotive suppliers reveal a proliferation of communications and knowledge transfer activities characteristic of the new collaborative arrangements. We also provide new evidence showing that the famous Fisher Body-GM merger of 1926 (the canonical example in discussions of theories of the firm) was motivated more by considerations of promoting learning than of avoiding hold-up. We then elaborate our comparison of the "standard" and "non-standard" firm, first at the level of ongoing operational activities and then at the level of strategic direction and corporate governance. We argue that the pragmatist mechanisms crucial to the operations of the non-standard firm have "learning by monitoring" analogues that are applied to strategy-making and governance decisions.