Treating the waves as an asset

There was a great story in the Washington Post about what happens when you treat something as an intangible asset. All of a sudden, it has value. And then a case can be made that the value needs to be protected. Such was the case that surfers first made in 2002 about the waves off Rincon, Puerto Rico. The result was the birth of a new way of looking at the environment, according the Post story, “Surfonomics quantifies the worth of waves.”:

Surf­onomics is an offshoot of natural resource economics that seeks to quantify the worth of waves, both in terms of their value to surfers and businesses and their non-market value — or how much people would be willing to pay not to lose them.

In the case of the waves off Rincon, a real estate development was blocked because it would result in damage to the reef. Lose the reef, lose the waves, lose the surfers, and lose the tourist dollars. And it turns out that surfing is big business — worth over $2 billion to the US economy annually. Just the waves off Half Moon Bay, CA generate annual revenues of $23.9 million from visiting surfers and spectators. All of a sudden, those waves are worth protecting.

Pisano on Chandler and organizational innovation

I recently came across an essay by Gary P. Pisano of the Harvard Business School on “The evolution of science-based business: innovating how we innovate.” That subject matter is interesting in and of itself. But what I want to highlight is something different: the set up of his argument. The essay is part a special issue of the journal Industrial and Corporate Change: “Management Innovation-Essays in the Spirit of Alfred D. Chandler, Jr”. What I found compelling was Pisano’s summary of some of Chandler’s core thesis:

2. Chandler’s core propositions
Through his studies of the rise of the modern corporation and managerial capitalism in the United States, Alfred D. Chandler advanced three core propositions: (i) technological innovation and organizational innovation are interdependent; (ii) new forms of business organization and institutional arrangements are invented to solve specific economic problems; and (iii) organizational and institutional innovation is an evolutionary process–nothing guarantees “we get it right” every time. Together, these propositions constitute what might be called a “Chandlerian perspective” on the structure and organization of economic activity.
2.1 The interdependence of technological and organizational innovation
For decades, scholars have tried to understand the forces that influence the rate and direction of inventing activity. [Footnote: See e.g. National Bureau of Economic Research (1962) The Rate and Direction of Inventive Activity.] A subset of the innovation community, starting with the work of Nelson and Winter (1982), has long recognized that the “right” institutional arrangements play a critical role in facilitating technical advance and the diffusion of innovations. This perspective clearly has its roots in Chandler’s historical studies. Technical advances in steam power, steel making, mechanical engineering, and the like may have made railroads and mass production technically feasible, but it was a host of novel organizational and institutional arrangements–administrative hierarchies, professional managers (and business schools to train those manager), formalized capital budgeting systems, accounting and control systems, corporate governance structures that separated ownership and management–that made them economically feasible. Railroads were, in Chandler’s words, “the first modern business enterprise”:

No other business enterprise up to that time had had to govern a large number of men and office scattered over wide geographical areas. Management of such enterprises had to have many salaried managers and had to be organized into functional departments and had to have a continuing flow of internal information if it was to operate at all. (Chandler, 1977: 120).

A similar pattern repeated itself in other capital-intensive businesses. Advances in the application of mechanical and electrical power to production (and later chemicals) made mass production technical feasible, but again, without access to capital (made possible by the development of more sophisticated capital markets) and creation of administrative structures to coordinate the diverse activities of these large-scale enterprises, mass production would not have been economically possible. After reading Chandler, it is hard to think about technological innovation as anything but tightly intertwined with organizational and institutional innovation.
2.2 Organizational and institutional innovation as the product of human invention
Today, it is easy to take for granted such things as separation of ownership from management, hierarchical organizations, multibusiness corporations, capital markets, accounting and control systems, and other scaffolding of modern economies, as if they were somehow “natural.” Chandler teaches us that there is nothing natural about them. They were inventions. Indeed, virtually every aspect of the business world around us–every organizational form, every management technique, every formal and informal institutional arrangement, every principle of management, and every management function–is the product of human invention. Chandler also helps us understand that often–but not always–these inventions were made in response to very specific economic problems. As noted above, mass production required large infusions of capital. The traditional owner-manager company, institutionally, was not up to that economic task. To raise the requisite amounts of capital required capital markets, and a separation of owners (investors) from managers. The rise of professional management as an occupation was an invention to deal with the need to run these complex enterprises. Business schools were invented to supply such professionals. Other elements of the US system of higher education, particularly engineering focused schools like MIT, also played a critical role in supplying managerial talent for complex enterprises.
2.3 Organizational and institutional innovation as an evolutionary process
The first two points above provide a false impression that economic need and organizational/ institutional innovation mesh tightly. But Chandler teaches us that such a strict functionalist interpretation is flawed. Economic needs arise, but the response of organizations is slow, uneven, and not always perfect. The rise of the modern corporation itself was a constellation of innovations that spanned multiple decades, if not much of the 20th century. Norms about the roles and responsibilities of management, particularly their fiduciary duty to shareholders, probably evolved more in the last two decades of the 20th century than they did during the first eight. Not all organizations responded immediately. Even within the US national context, some responded with a lag and others not at all. The differences get even larger as one moves across international contexts. The notion that novel institutions and organizations always arise to enhance economic efficiency does not stand the test of historical analysis. Business trusts were also an organizational innovation of the late 19th century. It would be hard to argue that these were in any way motivated by a desire to increase economic efficiency, or that they had had any positive impact on efficiency. It took another institutional innovation–antitrust law–to rectify the problem.
Chandler’s analysis covered a period of great economic, technological, and social change in American industry. The propositions above help to explain the way institutions–particularly business organizations and markets–evolved to adapt to the challenges created by these changes. In short, a Chandlerian explanation for US economic success in the 20th century would place a great deal of weight on the country’s superior ability to invent, adopt and adapt innovative organizational structures and practices. Looking at the 21st century through a Chandlerian lens puts organizational and institutional innovation sharply into focus.
There are many potential transformative forces shaping business organization in the 21st century. The one I would like to focus on in the remainder of this essay concerns science, and in particular, the way in which business participates in and shapes science. Recent decades have witnessed intensive organizational experimentation in the way science is generated, diffused, and commercialized. Advances in the sciences of life, energy, and materials offer huge promise both to drive economic growth and improve welfare. Yet, to believe that promise will be realized without organizational and institutional innovation would be to ignore the lessons of Chandler.

Let me paraphrase that last statement: one of lessons of Chandler is that organizational and institutional innovation matter. Unfortunately, this is a lesson that innovation policy often misses. Policy tends for focus on the technological to the exclusion of all other forms of innovation. In our working paper Rethinking Innovation Policy (and numerous postings this and this), we noted that “Innovation policy needs to catch up to the innovation process.” Chandler, as Pisano points out, has described some of the important aspects of the innovation process. Now we have to match our policy to that process.
Tip of the hat to William Miller’s posting on the IC Knowledge Center for bringing this paper (in a different context) to my attention.