Problem Set 4 -- Sample Solutions
1. For many firms, allowing employees aceess to the World Wide Web (WWW) and internet-based electronic mail is potentially useful. The WWW permits employees rapid access to data and information they previously had to ask corporate librarians to obtain. Email is a lower cost and less intrusive means of communication than telephone conversations or fax exchanges. Lower information or communication costs can permit firms to realize new efficiencies.
However, as the attached article describes, the new capabilities can be value-decreasing when employees use them toward increasing their utility in ways that are not value enhancing to the firm.
Why is the misuse of firms' information and communication systems a potentially more severe problem with respect to the WWW and Email than in systems which rely on corporate librarians, letters, and faxes?
It can be more difficult to monitor usage of firms' information and communication resources. Corporate librarians serve not just as researchers, but as monitors. Letters and faxes are often accomplished with the aid of secretaries. Also, letters and faxes provide paper trails that allow firms to audit usage.
How might existing (pre-Web and pre-Email) information and communication systems be complementary with firms' organizational features? Explain why the features you cite or complements, using the definition of complementarities.
Organizational forms with these passive monitoring features (having secretaries or corporate librarians) are more valuable when the information system is letter- or fax-based. Letter- or fax-based systems make it difficult to circumvent passive monitoring. Conversely, letter- or fax- based systems are more valuable when there exist secretaries and corporate librarians to help reference, type, format, send, and file documents.
Why might a firm not respond to decreases in the price of electronic commerce (e.g., email) by moving away from a phone and fax-based system to an email-based system?
A firm may not switch over because moving to an internet-based system would be only valuable if they changed other organizational features as well. These organizational features would serve to monitor individuals' use (and misuse) of communication and informational resources. These organizational changes may be costly to conceive of or implement.
What organizational changes might be complementary to allowing employees web access and internet email accounts? Which of these might you be able to embed in the software itself? Which of these would involve changes in the relationships among employees, or between your firm and other firms?
One might, for example, allow individuals access to the Web only in certain offices where use could be easily monitored. Or only allow individuals who are paid primarily a function of their output access to the Web. Or a central computer might record each Web site each server visited. One might program the company email system so that each outgoing message be sent to an central computer. The monitoring accomplished by computer programs can clearly be embedded in software and would not require much organizational change.
None of these organizational changes required significant changes in relationships among employees or between firms. It seems that there are some conceptually simple ways of replacing the monitoring role of secretaries and corporate librarians, particularly when it is possible to embed monitoring elements into the Web browser or email systems companies use.
2. Trucking firms' profitability is higher when their trucks are used intensively and when they are driven so that their engines are not abused. Intensive use of capital in this case means that trucks are fully loaded and en route from a shipper to a receiver. Trucks are used less intensively when drivers take long breaks during or between hauls. Truck engines are abused with the driver accelerates too quickly, especially in severe conditions such as when making steep ascents.
Different trucking firms specialize in different hauls. Some specialize in short, repetitious hauls between the same two places. For example, this type of firm might haul fresh vegetables from farmers to a railroad; each truck might make five round trips per day. Others specialize in longer hauls which can take four to five days. For example, this type of firm might take canned fruit from firms in the central valley to distributors and supermarkets on the East Coast, then take manufactured goods from the East to Western distributors on their return trips.
Truck drivers' activities can be difficult to monitor. (One could do so by putting a supervisor in every truck, but this would be very costly and possibly ineffectual.) While one may obtain a signal of their effort (Did the trucker arrive late? Did the engine explode?), this is reflects both their effort and factors outside of their control (Was there traffic or road construction on the way? Did the truck's previous driver abuse the engine?).
Assume that truck drivers are risk averse, but that trucking firms are risk neutral. You are hired to serve as a consultant to the firm.
Truck drivers choose their effort in (at least) two dimensions according to the above account. What are they?
Drivers choose how intensively to use the truck (diminished intensity comes from longer breaks or from delays between hauls) and how carefully to operate the engine.
Is it desirable to provide incentives toward eliciting effort in each dimension? Why or why not?
Clearly it is desirable to provide incentives toward eliciting effort in both of these dimensions, because effort in both of these dimensions contributes to the firm's profitability.
Is it desirable simply to rent trucks to drivers and allow them to keep all the proceeds from any hauls they make?
It is probably not desirable to rent drivers trucks. This would provide them strong incentives to use the truck intensively, but no incentives to take care with the engine. This could mean that the driver goes too fast up and down mountain passes, overloads the truck, etc.
A new invention enables trucking firms to directly monitor how the truck driver is operating the engine. This invention records engine speed, ground speed, sudden accelerations, sudden decelerations, etc., and transmits these variables back to the trucking firm's computer.
Would this change how you compensate drivers? If so, how? If not, why not?
This change lowers the cost of paying truckers on the basis of how carefully they use the engine. Before, the only signal was "did the engine blow up." Now, one can evaluate how the driver operated the engine and look for signs of abuse. From Holmstrom and Milgrom, if the cost of using performance incentives in one dimension decreases, one will optimally choose to increase the intensity of incentives in all dimensions. Hence, one will pay them a higher commission rate, and provide stronger incentives based on engine operation statistics.
3. Describe the organizational and production technology innovations that took place during the late 1800s. Why were they complementary?
The innovations included:
These were complementary because the returns from each of the innovations was higher, given that the other innovations took place. For example, organizational innovations were complementary with the development of the railroads because a) railroads were more valuable given the organizational innovations because the organizational innovations meant that railroads could be used more intensively, and b) organizational innovations were more valuable given the emergence of the railroads because the sophisticated hierarchies were most useful in circumstances where one had to manage the production of high volumes of goods. Before railroads, product markets were much smaller so marketing high volumes of goods was impractial.
4. According to Nelson and Winter, why would management be more difficult for firms in industries where there are intermittent, unanticipated breakthroughs in technological capabilities (for example, in biotechnology) than in those where technological capabilites remain relatively constant over long periods (for example, in sugar production)?
Nelson and Winter propose that large changes in a firm's environment often create critical junctures for firms where they are forced to change or adapt their routines. This poses a difficult problem for management. Management is therefore more difficult in industries where changes occur often (biotech) than in those where they do not (sugar).