Context : OnEconomics
One of the simplest arguments I've used to get people out of a traditional mindset is to point out a statistic – the cost of transactions in the U.S. More than 50% of the non-government GDP in the U.S. is based on transaction costs. Now, what's interesting is that the way most people think about economics is that execution costs are on the periphery. If you start from the premise that transaction costs are central to the productivity of any system, and if you then recognize that most of our time is spent negotiating, securing, monitoring, making sure people did what we expected them to do, dealing with the fact that motivations aren't entirely aligned, and so on, you realize that we have to find a way of working together amid this asymmetry of information. About half of our time is spent doing those things.
This changes the way you think about productivity in organizations where innovation, adaptability and dealing with complexity are the key challenges. So much of reengineering, which is what major corporations have been about for the last 10 or 15 years, has been about linear efficiency – lining everything up in as tight a way as possible along a path. That's wonderful if you know exactly what it is you want to do, and the aim of that task will never change. Increasingly, that's not the relevant challenge. The challenge is adaptability, complexity, uncertainty and your capacity to mine the elements of your business, people and knowledge into different and new combinations. If that's what you are trying to do, then your transaction costs become the biggest inhibitor to your capacity to do that. The key thing about the principles that Ross and Janice were describing is that they enable an environment where transaction costs are lower.
There's a spectacular example which illustrates that technology isn't really the key. When you compare Toyota with the Big Three automakers in the U.S. there's a fundamental difference in the way they deal with their suppliers. The Big Three basically negotiate to the last penny. In particular, if a supplier succeeds in a process improvement that lowers costs, he knows darn well in one negotiation round that General Motors will come back and demand a price concession taking away that benefit. That gives that supplier a very powerful incentive not to share with anybody, least of all General Motors, what that process improvement was.
Toyota has a different philosophy. The company allows its suppliers to keep the benefits of their innovation, but it insists that that process improvement in technology is shared not just with Toyota but also with all the other component suppliers. As a result, you see among that population of 60 or 70 companies a rate of sharing ideas beyond what you see in the U.S. It has a cumulative effect over time of driving up productivity in the whole Toyota supply chain. Over a 30-year period, its productivity has gone up six times as much as in the U.S. system. I think that's entirely because of the difference in philosophies. At a time when 50% of the cost of a car comes from outside components, and your suppliers are 600% more productive, that buys you one hell of an advantage – even if you give some of it back to them in price concessions.
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