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The Eponymous Principles of Management

The Eponymous Principles of Management – Coase’s Ceiling and Floor

Every interaction between two persons faces inherent “internal friction”, caused by everyone’s own biases, beliefs, experiences, knowledge, outlook, natural resistance to change etc. This creates a situation where that person does not fully hear or understand or accept what is being told or is not able to fully explain what he thinks. A similar set of “internal friction” factors operate within the counterpart of that interaction. And then there are factors like their past and present relationships, their perception of why the transaction is (or should be) taking place, what it is ultimately going to lead to, etc. that cause ‘externa; friction’ And as more and more persons directly or indirectly participate in a chain of interaction(s), the organization needs to generate enough power, by way of processes, systems, structures, strategies, even rewards and punishments etc. so that the sum total of all the frictions is overcome and the wheels of organization’s purpose starts, and remains, running.

You may have started thinking that we are leading you towards the eponymous laws of friction, viz. Amontons’ First and Second Law of Friction or Coulomb’s Law of Friction. No, we do not want to revisit the school and college lessons on friction[1]. For the ease of convenience let us accept that we do remember ‘that friction is > linear in the number of independent components. This, for example, is why you can’t build a clock that will run for ten years on a winding, although it would be trivially easy to *design* one.

‘In the context of organizations, each additional person adds more friction until a point — the “Coase’s ceiling” — at which all the energy that the organization can generate goes to overcoming internal friction, and there is none left over to apply to the organization’s nominal purposes.

‘Actual experience implies that Coase’s Ceiling is ~~100 persons, and that it is an extremely hard ceiling indeed. This limitation of Coase’s ceiling would still operate even if the Peter Principle [or for that matter Dilbert Principle or Putt’s Law or Gervais Principle] could be overcome. [2]

Yes, that is a right guess! People may interact with anyone from any hierarchical level to any other person at any other hierarchical level, irrespective of his level of competence (or incompetence in his job, or in the interaction skill, the interaction will have some degree of internal and some degree of external frictions, nonetheless.

Author Clay Shirky, in the chapter two of his book. Here Comes Everybody – The Power of Organizing Without Organizations[3] [4]has presented the term Coase’s Celling and its adjunct term Coase’s Floor.

The Coase’s Ceiling is defined as –

The point above which the transaction costs of managing a standard institutional form prevent it from working well.

It indicates the maximum size an organisation can grow to before the costs of managing its internal complexity rise beyond the gains the increased size can offer. At that point, it becomes more efficient to acquire a resource externally (e.g. to buy it) than to produce it internally. This has to do with the relative transaction costs generated by each way of securing that resource. If these costs decline in general (e.g. due to new communication technologies and management techniques) two things can take place. On the one hand, the ceiling rises, meaning large firms can grow even larger without becoming inefficient. On the other hand, small firms are becoming more competitive because they can handle the complexities of larger markets. This decline in transaction costs is a key element in the organisational transformations of the last three decades, creating today’s environment where very large global players and relatively small companies can compete in global markets. Yet, a moderate decline does not affect the basic structure of production as being organised through firms and markets.

In 2002, Yochai Benkler was the first to argue that production was no longer bound to the old dichotomy between firms and markets. Rather, a third mode of production had emerged which he called ‘commons-based peer production’. Here, the central mode of coordination was neither command (as it is inside the firm) nor price (as it is in the market) but self-assigned volunteer contributions to a common pool of resources. This new mode of production, Benkler points out, relies on the dramatic decline in transaction costs made possible by the internet.  Clay Shirky develops this idea into a different direction, by introducing the concept of the ‘Coasian floor’. [5]

The Coase’s Floor is defined as –

The point below which the transaction costs of a particular type of activity, no matter how valuable to someone, are too high for a standard institutional form to pursue.

These definitions represent the constraints under which institutions, or people, really operate w.r.t. theories from the 1937 paper The Nature of the Firm by Nobel Prize winning economist Ronald Coase to access the various challenges that Transaction Costs pose to institutions. Clay Shirky’s observation in his book, which states as “[Every] institution lives in a kind of contradiction: it exists to take advantage of group effort, but some of its resources are drained away by directing that effort. Call this the institutional dilemma–because an institution expends resources to manage resources, there is a gap between what those institutions are capable of in theory and in practice, and the larger the institution, the greater those costs.”, correlates the concept of friction presented at the beginning of this article.

Note:

The Ronald Coase’s Nobel prize-winning paper, The Nature of the Firm, in essence, provided a breakthrough on the significance of transaction costs and property rights for the institutional structure and functioning of the economy.. However subsequent discussions emanating from this paper carried the logic to Coase’s Theorem etc, which in turn is considered to be the basis for origin of the terms Coase’s Ceiling and Floor,. That paper, or for that matter even so-called Coase’s Theorem. are essentially subject matters of Economics and as such would be basically beyond the scope of our discussions at this stage.

Here are some representative references that can be used to gain more knowledge of the subject matter –


[1] Friction

[2] Opposite of the Peter Principle by John D. Cook

[3] Here Comes Everybody. (2008) @ Wikipedia

[4] Here Comes Everybody Summary and Review – Clay Shirky

[5] Analysis Without Analysis. Review of Clay Shirky’s “Here Comes Everybody”Felix Stalder