Core management concepts guide

Core management concepts
P. Willman
MN2177
2014
Undergraduate study in
Economics, Management,
Finance and the Social Sciences
This subject guide is for a 200 course offered as part of the University of London
International Programmes in Economics, Management, Finance and the Social Sciences.
This is equivalent to Level 5 within the Framework for Higher Education Qualifications in
England, Wales and Northern Ireland (FHEQ).
For more information about the University of London International Programmes
undergraduate study in Economics, Management, Finance and the Social Sciences, see:
www.londoninternational.ac.uk

This guide was prepared for the University of London International Programmes by:
Professor Paul Willman, Department of Management, London School of Economics and
Political Science.
This is one of a series of subject guides published by the University.We regret that due to
pressure of work the author is unable to enter into any correspondence relating to, or arising
from, the guide. If you have any comments on this subject guide, favourable or unfavourable,
please use the form at the back of this guide.
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Published by: University of London
© University of London 2014
The University of London asserts copyright over all material in this subject guide except where
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us know.

Contents
i
Contents
Chapter 1: Introduction........................................................................................... 1
1.1 Introduction to the subject........................................................................................1
1.2 Route map to the guide............................................................................................1
1.3 Syllabus....................................................................................................................2
1.4 Aims of the course....................................................................................................2
1.5 Learning outcomes for the course............................................................................. 2
1.6 Overview of learning resources.................................................................................2
1.7 Examination advice..................................................................................................5
Chapter 2: Management and the firm..................................................................... 7
2.1 Learning outcomes and reading................................................................................ 7
2.2 Introduction.............................................................................................................8
2.3 The British experience...............................................................................................8
2.4 Railways and the second Industrial Revolution.......................................................... 9
2.5 Market failure and management............................................................................. 10
2.6 Transaction cost economics.....................................................................................12
2.7 Overview of chapter ..............................................................................................14
2.8 Reminder of learning outcomes..............................................................................15
2.9 Test your knowledge and understanding................................................................. 15
Chapter 3: Taylorism, motivation and performance.............................................. 17
3.1 Learning outcomes and reading.............................................................................. 17
3.2 Introduction...........................................................................................................18
3.3 Scientific management: the apogee......................................................................... 21
3.4 Engineering and psychology....................................................................................23
3.5 Overview of chapter...............................................................................................25
Chapter 4: The rise and decline of labour............................................................. 27
4.2 Introduction...........................................................................................................28
4.3 Farmers and workers..............................................................................................29
4.4 Band of brothers....................................................................................................30
Chapter 5: The rise of human resource management........................................... 37
5.2 Introduction...........................................................................................................38
5.3 The emergence of HRM...........................................................................................39
5.4 Organisational behaviour........................................................................................44
5.5 The psychological contract......................................................................................46

MN2177 Core management concepts
ii
Chapter 6: The origins of management science.................................................... 49
6.2 Introduction...........................................................................................................49
6.3 Inventory management...........................................................................................50
6.4 Telephone networks................................................................................................52
6.5 Military planning....................................................................................................53
Chapter 7: Accounting, finance and the firm......................................................... 57
7.2 Background: definitions of accounting and finance.................................................. 58
7.3 Principal–agent theory............................................................................................58
7.4 The institutional environments of accounting .......................................................... 61
Chapter 8: Management accounting: costing....................................................... 65
8.2 Purposes of cost accounting...................................................................................65
8.3 Production and service departments........................................................................ 66
8.4 Activity-based costing ............................................................................................69
8.5 Overview of chapter ..............................................................................................71
Chapter 9: Management accounting: decentralisation and performance
measurement ........................................................................................................ 73
9.2 Introduction...........................................................................................................74
9.3 History...................................................................................................................74
9.4 Using return on investment (ROI)............................................................................ 76
9.5 The balanced scorecard...........................................................................................78
9.6 Financial (ROI) versus balanced scorecard performance measure ............................ 80
Chapter 10: Financial accounting.......................................................................... 83
10.1 Learning outcomes and reading............................................................................ 83
10.2 Management accounting and financial accounting................................................ 83
10.3 The elements of the financial report...................................................................... 84
10.4 Recognition and matching ...................................................................................89
10.5 Overview of chapter.............................................................................................90
10.6 Reminder of learning outcomes............................................................................ 90
10.7 Test your knowledge and understanding............................................................... 90
Chapter 11: Modern portfolio theory.................................................................... 91
11.2 Interest rates and the time value of money............................................................ 91
11.3 The return of a single security...............................................................................92
11.4 The return of a portfolio........................................................................................92
11.5 Probabilistic considerations...................................................................................92

Contents
iii
11.6 Asset classes........................................................................................................93
11.7 What is a hedge fund?..........................................................................................94
11.8 What is private equity?.........................................................................................94
11.9 Market efficiency..................................................................................................94
11.10 Optimal portfolio choice.....................................................................................95
11.11 The Sharpe ratio.................................................................................................97
11.12 Overview of chapter...........................................................................................97
11.13 Reminder of learning outcomes.......................................................................... 97
11.14 Test your knowledge and understanding............................................................. 97
Chapter 12: Security analysis and valuation......................................................... 99
12.2 Financial ratios.....................................................................................................99
12.3 Investment ratios..................................................................................................99
12.4 Profitability ratios...............................................................................................100
12.5 The profitability equation....................................................................................101
12.6 Margin ratios......................................................................................................101
12.7 Efficiency ratios..................................................................................................102
12.8 Leverage ratios...................................................................................................102
12.9 Solvency and liquidity ratios................................................................................103
12.10 Overview of chapter.........................................................................................103
12.11 Reminder of learning outcomes........................................................................ 104
12.12 Test your knowledge and understanding........................................................... 104
Chapter 13: The origins of modern strategy....................................................... 105
13.1 Learning outcomes and reading.......................................................................... 105
13.2 Two key definitions of ‘strategy’.......................................................................... 105
13.3 Porter and the five forces....................................................................................107
Chapter 14: Understanding organisational structures........................................ 113
14.2 Introduction.......................................................................................................113
14.3 Organisational design.........................................................................................114
14.4 Organisational boundaries: the issues................................................................. 115
14.5 Division of labour: the issues...............................................................................116
14.6 Authority and communication: the issues............................................................ 116
14.7 Bureaucracy: the issues.......................................................................................117
14.8 Know-how: the issues.........................................................................................117
14.9 The components of organisation......................................................................... 118
14.10 The ‘M’ form.....................................................................................................119
14.11 Overview of chapter.........................................................................................121
Chapter 15: The analysis of organisations.......................................................... 123
15.2 Strategy and organisational theory...................................................................... 123
15.3 Institutional theory.............................................................................................125
15.4 Organisational ecology.......................................................................................127
15.5 Critique..............................................................................................................128
15.6 Organisational sociology and economics............................................................. 129

iv
Chapter 16: Contemporary strategic management............................................. 131
16.2 Introduction.......................................................................................................132
16.3 Dynamic capabilities...........................................................................................135
16.4 Core competences..............................................................................................135
16.5 Critique..............................................................................................................136
16.6 Strategy today....................................................................................................137
16.7 Overview of the chapter......................................................................................137
Chapter 17: Strategy and decision-making ........................................................ 139
17.2 Introduction.......................................................................................................139
17.3 Efficient markets.................................................................................................142
17.4 The decision process...........................................................................................144
17.5 Overview of the chapter......................................................................................146
Chapter 18: The origins of marketing................................................................. 149
18.2 Introduction ......................................................................................................149
18.3 Definitions and a brief introduction to the history of marketing as a
distinct ‘discipline’ of study ........................................................................................150
18.4 Marketing and economic theory.......................................................................... 150
18.5 Where does economic theory leave us? .............................................................. 152
18.6 Marketing as ‘academic discipline’ ..................................................................... 152
18.7 The influence of other academic disciplines and marketing ................................. 153
18.8 Types of marketing problems ..............................................................................153
18.9 The triumph of marketing? .................................................................................154
18.10 Looking ahead: the marketing framework ........................................................ 155
18.11 Overview of the chapter....................................................................................156
Chapter 19: The origins of marketing − the development of the practice ........ 159
19.2 Introduction.......................................................................................................159
19.3 Product1...............................................................................................................................................................................................160
19.4 Markets..............................................................................................................161
19.5 Pricing................................................................................................................162
19.6 Channels and distribution...................................................................................164
19.7 Brands and advertising.......................................................................................165
19.8 Summary............................................................................................................167

Contents
v
Chapter 20: Marketing in the digital age............................................................ 169
20.2 Introduction.......................................................................................................170
20.3 Impact on conventional businesses..................................................................... 172
20.4 Internet and branding.........................................................................................174
20.5 Summary............................................................................................................174
Appendix 1: Syllabus........................................................................................... 177

Notes
vi

Chapter 1: Introduction
1
1.1 Introduction to the subject
This subject guide is for the MN2177 Core management concepts
course. It covers the main areas of general management and the
intellectual foundations of management concepts as well as the functional
areas of accounting, business strategy, finance, marketing, organisational
behaviour and operations management. This is an alphabetical list, but
each subject will be dealt with in an integrated fashion. The aim is to
present the core concepts in each area, then to show the relationships
between these concepts. This course forms the basis for the study of more
specialised courses.
The course begins by showing how these functional areas emerged as
subjects for academic study. It will pay particular attention to the social
scientific origins of the management field in the core disciplines of
economics, psychology and sociology. It then proceeds chronologically,
illustrating the rise and development of the functional area disciplines in
response to specific business problems.
1.2 Route map to the guide
We begin by looking at the pre-industrial roots of some management
tools such as accounting and operations. It then deals specifically with the
growth of the large industrial firm and the intellectual issues raised by this
development. It describes the separation of ownership and control and
the problems of agency. Several chapters deal with the issues of creating
and managing an industrial labour force, looking at scientific management
and the growth of theories rooted in psychology and sociology for the
management of labour. The rise of collective labour organisation and the
response of human resource management is then covered.
The second broad section of the course is more quantitative, showing how
mathematical techniques were applied to the management of the firm. We
then move on to consider, first, the rise of internal accounting measures in
the firm and, second, financial accounting, particularly the firm’s reporting
requirements. There is then a specific focus on the increasingly important
area of finance; we look at risk, return and asset pricing, before turning to
the financial analysis of the firm. These materials are presented in a non-
technical way wherever possible.
The third broad theme is organisation and strategy; looking at the origins
of business strategy and the various ‘schools’ within the strategy discipline.
We pay particular attention to contemporary developments in business
strategy and to strategic decision-making.
Finally, we look at the marketing field. The location of this at the end
of the course has a two-part rationale. First, marketing was a later
development than some other disciplines and it is possible to show
how ideas were borrowed and used. Second, it synthesises economics,
psychology and sociology and thus is a good ‘case study’ of the use of
social science in management.

2
1.3 Syllabus
The full syllabus for this course can be found in Appendix 1 on p.177 at
the end of the guide.
1.4 Aims of the course
The aims of the course are to:
• give you a thorough grounding in the key management sub-disciplines
• provide an overview of the development of these disciplines
• illustrate the disciplinary anchors of these disciplines in sociology,
psychology and economics.
1.5 Learning outcomes for the course
At the end of the course, and having completed the Essential reading and
activities, you should be able to:
• demonstrate an understanding of core management concepts
• apply these concepts to specific business situations
• analyse and evaluate managerial tools such as balance sheets and
marketing plans
• explain the relevance of social science to business practice.
1.6 Overview of learning resources
1.6.1 The subject guide
This subject guide presents a basic introduction to the concepts of
management covered in the course. It seeks to describe and explain
the central concepts, and to provide reading lists and advice on the
examination. However:
1. It is not a textbook and often refers you to other texts or readings.
2. If you do not follow up the Essential readings, you will find it very
difficult to do well in the examination.
For each chapter, we recommend that you begin by reading the text of the
guide itself and thinking about the ‘Test your knowledge and understanding’
question at the end of each chapter, then work through the Essential
readings outlined at the start of the chapter. Further reading is identified
should you wish to study a topic in more detail, and a comprehensive list
can be found on the virtual learning environment (VLE).
The advice normally given to International Programmes students is that,
if they are studying one course over a year, they should allow at least six
hours of study every week.
1.6.2 Essential reading
To study this course, you need to study Essential readings from a range of
textbooks and academic journals.
Textbooks to borrow or purchase
Make sure you have a copy of the core textbook for the course:
Willman, P. Understanding management: social science foundations. (Oxford:
Oxford University Press, 2014) [ISBN 9780198716921].

3
This will be referred to as ‘Willman’ in the reading lists at the beginning of
each chapter, followed by the relevant chapter or theme numbers.
You will also need to refer to several chapters of the following book so
either make sure that you have access to a library copy or purchase it:
Kaplan, R. and A. Atkinson Advanced management accounting. (Harlow: Pearson
Education, 1998) third edition [ISBN 9780130802200].
Detailed reading references in this subject guide refer to the editions of the
set textbooks listed above. New editions of one or more of these textbooks
may have been published by the time you study this course. You can use
a more recent edition of any of the books; use the detailed chapter and
section headings and the index to identify relevant readings. Also check
the VLE regularly for updated guidance on readings.
Other Essential readings
The guide also refers to various other Essential readings. We aim to ensure
that all these are freely available to you. As a general rule, if an Essential
reading is a journal article, you will be able to find it in the Online Library;
if it is an extract from a book, registered students on the course will be
able to download it from the VLE. We have also made a few of the further
readings available to download from the VLE.
If you have any problems accessing any of the Essential readings, let us
know by raising a query via the Student Portal.
1.6.3 Further reading
Please note that as long as you read the Essential reading you are then free
to read around the subject area in any text, paper or online resource. You
will need to support your learning by reading as widely as possible and by
thinking about how these principles apply in the real world. To help you
read extensively, you have free access to the VLE and University of London
Online Library (see below).
A list of Further readings relevant to the subject matter covered in each
chapter is given at the beginning of the chapters. You can find a complete
list of all the Further reading and references cited on the VLE.
You may also find the following additional textbooks useful in relation to
the different parts of the course:
Additional introductory reading
Witzel, M. Builders and dreamers: the making and meaning of management.
(Harlow: Pearson, 2002) [ISBN 9780273654377].
Accounting
Atkinson, A.A., R.S. Kaplan, E. Matsumura and S.M. Young Management
accounting. (Harlow: Pearson, 2011) [ISBN 9780273760160].
Business strategy
Grant, R.M. Contemporary strategy analysis. (Chichester: John Wiley & Sons,
2012) [ISBN 9781119941880].
Finance
Brealey, R.A., S.C. Myers and F. Allen Principles of corporate finance – global
edition. (Maidenhead: McGraw Hill, 2013) [ISBN 9780077151560].
Marketing
Weitz, B.A. and R. Wensley Handbook of marketing. (London: Sage, 2006)
[ISBN 9781412921206].

4
Operations management
Hopp, W.J. and M.L. Spearman Factory physics. (Long Grove, Illinois: Waveland
Press, 2011 reissue of 2008 edition) [ISBN 9781577667391].
Organisational behaviour
Buchanan, D. and A. Huczynski Organisational behaviour. (Harlow: Pearson,
2013) [ISBN 9780273774815].
1.6.4 Online study resources
In addition to the subject guide, it is crucial that you take advantage of the
study resources that are available online for this course, including the VLE
and the Online Library.
You can access the VLE, the Online Library and your University of London
email account via the Student Portal at:
http://my.londoninternational.ac.uk
You should have received your login details for the Student Portal with
your official offer, which was emailed to the address that you gave on
your application form. You have probably already logged in to the Student
Portal in order to register. As soon as you registered, you will automatically
have been granted access to the VLE, Online Library and your fully
functional University of London email account.
If you have forgotten these login details, please click on the ‘Forgotten
your password’ link on the login page.
The VLE
The VLE, which complements this subject guide, has been designed to
enhance your learning experience, providing additional support and a
sense of community. It forms an important part of your study experience
with the University of London and you should access it regularly.
The VLE provides a range of resources for EMFSS courses:
• Self-testing activities: Doing these allows you to test your own
understanding of subject material.
• Electronic study materials: The printed materials that you receive from
the University of London are available to download, including updated
reading lists and references.
• Past examination papers and Examiners’ commentaries: These provide
advice on how each examination question might best be answered.
• A student discussion forum: This is an open space for you to discuss
interests and experiences, seek support from your peers, work
collaboratively to solve problems and discuss subject material.
• Videos: There are recorded academic introductions to the subject,
interviews and debates and, for some courses, audio-visual tutorials
and conclusions.
• Recorded lectures: For some courses, where appropriate, the sessions
from previous years’ Study Weekends have been recorded and made
available.
• Study skills: Expert advice on preparing for examinations and
developing your digital literacy skills.
• Feedback forms.
Some of these resources are available for certain courses only, but we
are expanding our provision all the time and you should check the VLE
regularly for updates.

5
Making use of the Online Library
The Online Library contains a huge array of journal articles and other
resources to help you read widely and extensively.
To access the majority of resources via the Online Library you will either
need to use your University of London Student Portal login details, or you
will be required to register and use an Athens login:
http://tinyurl.com/ollathens
The easiest way to locate relevant content and journal articles in the
Online Library is to use the Summon search engine.
If you are having trouble finding an article listed in a reading list, try
removing any punctuation from the title, such as single quotation marks,
question marks and colons.
For further advice, please see the online help pages:
www.external.shl.lon.ac.uk/summon/about.php
1.7 Examination advice
Important: the information and advice given here are based on the
examination structure used at the time this guide was written. Please
note that subject guides may be used for several years. Because of this
we strongly advise you to always check both the current Regulations
for relevant information about the examination, and the VLE where you
should be advised of any forthcoming changes. You should also carefully
check the rubric/instructions on the paper you actually sit and follow
those instructions.
The examination will be a three-hour unseen written examination covering
all aspects of the syllabus. In the examination, you will be asked to:
• Reproduce some knowledge. This will get you close to a pass, but you
will also need to be able to apply this knowledge to the question.
• Apply knowledge to new situations. This will lift you to high lower-second
or low upper-second marks, provided you get the questions right.
• Make new connections between topics and concepts. This will enable
you to gain a first-class mark.
In the examination you must read the questions carefully to make sure you
have understood them, choose the questions you wish to answer from the
list available and manage your time carefully. You should always check the
instructions on the examination paper before you begin and follow them
carefully.
Remember, it is important to check the VLE for:
• up-to-date information on examination and assessment arrangements
for this course
• where available, past examination papers and Examiners’ commentaries
for the course, which give advice on how each question might best be
answered.

Notes
6

Chapter 2: Management and the firm
7
2.1 Learning outcomes and reading
2.1.1 Learning outcomes
By the end of this chapter, and having completed the Essential reading and
• explain key elements in the history of the firm
• discuss the main theories of firm formation
• outline several key managerial problems in the firm.
Willman, Chapters 1 and 2.
Chandler, A. The visible hand: the managerial revolution in American business.
(Harvard: Harvard University Press, 1977) [ISBN 9780674940529].
Di Maggio, P. ‘Introduction: making sense of the contemporary firm and
prefiguring its future’ in Di Maggio, P. (ed.) The twenty-first century firm:
changing organisation in international perspective. (Princeton: Princeton
University Press, 2001) [ISBN 9781400828302].
Jensen, M.C. and W.H. Meckling ‘The theory of the firm: managerial behaviour,
agency costs and ownership structure’, Journal of Financial Economies 3
1976, pp.305–60.
Williamson, O.E. ‘The modern corporation; origin, evolution, attributes’,
Journal of Economic Literature 19 1981, pp.1537–68.
2.1.4 Works cited
Arrow, K. J. The limits of organization. (New York: Norton, 1974)
[ISBN 9780393093230].
Bromiley, P. The behavioral foundations of strategic management. (Oxford,
Blackwell, 2005) [ISBN 9781405124706].
Cassis, Y. ‘Big business’ in Jones, G. and Zeitlin, J. (eds) The Oxford
handbook of business history. (Oxford: Oxford University Press, 2007)
[ISBN 9780199263684; 9780199573950], p171–94.
Coase, R.H. ‘The nature of the firm’, Economica, 4(16), 1937, pp.386–405.
Coase, R.H. The firm, the market and the law. (Chicago, Ill: University of
Chicago Press, 1988) [ISBN 9780226111001].
Davis, G. Managed by the markets. (Oxford: Oxford University Press, 2009)
[ISBN 9780199216611].
Doeringer, P. and M. Piore Internal labour markets and manpower analysis.
(Armonk, NY: M.E. Sharpe, [1971] 1985) [ISBN 9780873323321].
Ghoshal, S. and P. Moran ‘Bad for practice: a critique of the transaction cost
theory’, Academy of Management Review 21(1) 1996, pp.13–47.
Gospel, H. ‘The management of labor and human resources’ in Jones, G. and
Zeitlin, J. (eds) The Oxford handbook of business history. (Oxford: Oxford
University Press, 2007) [ISBN 9780199573950], pp.420–46.
Landes, D.S. The Unbound Prometheus: Technological Change and Industrial
Development in Western Europe from 1750 to the Present. (Cambridge:
Cambridge University Press, 2003) [ISBN 9780521534024].
Michie, R.C. The global securities market. (Oxford: Oxford University Press,
2006) [ISBN 9780199280612].
Penrose, E. The theory of the growth of the firm. (Oxford: Oxford University
Press, [1959] 2009) [ISBN 9780191570360].

8
Pfeffer, J. New directions for organisational theory. (Oxford: Oxford University
Press, 1997) [ISBN 9780195114348].
Prais, S.J. The evolution of giant firms in Britain. (Cambridge: Cambridge
University Press, 1981) [ISBN 9780521282734].
Salaman, G. Class and the corporation. (London: Fontana, 1981)
[ISBN 9780006355182].
Thompson, E.P. The making of the English working class. (London: Penguin,
1966) [ISBN 9780394703220].
Williamson, O.E. The economic institutions of capitalism. (New York: Free Press,
1985) [ISBN 9780684863740].
2.2 Introduction
The corporate firm is a rather late arrival on the scene. Before the 19th
century, only a handful of corporate-type entities existed and these
were largely extensions of state power. Companies such as the Hudson
Bay Company or the Dutch East India Company were important agents
of empire. Governments granted them exclusive rights to trade and
to conduct business in certain markets or products. So, for example,
in 1670 the Hudson Bay Company was granted exclusive rights to fur
trapping in large areas of Canada by the British government. It was a truly
international venture, being the idea of two Frenchmen who gained a
Royal Charter in Britain with the encouragement of Boston merchants. The
company built forts, extended the speaking of English, founded cities and
established distribution channels. The Hudson Bay Company still exists in
Canada as a chain of department stores. At its inception, the company had
32 investors who shared risks and returns.
The Dutch East India Company, founded earlier, in 1602, funded risky
long-distance trading in any items between Europe and the Far East.
Investors, primarily in Amsterdam, would pool funds to support risky
trips which, if successful, provided huge returns. This in turn prompted
the development of the Amsterdam securities market in which spot and
future contracts, call and put options, hedging and short selling were all
possible (Michie, 2006, p.27). The number of investors was very large
indeed. These entities have some important characteristics for the future
analysis of the firm. Investors control supply side risk (with monopoly)
before sharing investor risk, they get government to provide the support,
and they diversify away some operational risk by embracing a range of
uncorrelated activities.
2.3 The British experience
The Industrial Revolution took off in Britain in the early 19th century and,
as Michie notes, in the period before 1850, ‘The British economy remained
mostly untouched by joint stock enterprise’ (2006, p.69). Enterprises
were either entrepreneurially owned, as in manufacturing, or owned by
local inhabitants, as in utilities and canals, and were funded by retained
profit or bank loans. Railways changed everything, requiring large-scale
finance but set against the prospect of steady low-risk returns from
natural monopoly. This provided investors with an attractive alternative to
government debt.
A crucial early development in Britain occurred in the textile industry:
the growth of the factory. As well as the massive impact on output, it is
significant for the development of management as an activity. Historically,
cloth had been produced domestically (for example, in the home),
usually by workers who had other concerns such as farming, using simple

9
equipment and raw materials provided by an entrepreneur – who was also
the purchaser of the finished product. This was a flexible and relatively
low-capital-cost operation, but it left the entrepreneur with little control
over production volumes. As the key historian of the Industrial Revolution
has noted:
…the domestic weaver or craftsman was a master of his time,
starting and stopping when he desired. And while the employer
could raise the piece rates with a view to encouraging output,
he usually found that this actually reduced output.
(Landes, 1969, p.59)
This backward-sloping labour supply curve arose because the workers
tended to have a subsistence income target, not a utility maximising one.
Cutting the rates did no good either − it led either to the worker quitting
or stealing some of the raw material in compensation (Salaman, 1981,
p.27). In short, incentives alone did not work. What the entrepreneur
needed was control of labour time and, to achieve that, work discipline
and the absence of alternative income sources. The answer: the factory,
in which workers were monitored (or managed). This was problematic
because it was not, generally, a process they welcomed (Thompson, 1968).
Now this process is highly significant. The modern economic theory of the
firm relies heavily on the ideas of monitoring, incentives and hierarchy.
Historians have debated the relative importance of these contractual
arguments for the growth of the firm versus technological ones; once the
factory existed, it became possible to apply steam power and technological
innovations in equipment to the raising of output, but the factory came
first.
Economic structure aside, there is no doubt that the scale of firms
increased. Prais (1976) quotes figures for both USA and the UK indicating
that in both by the late 1920s the 100 largest firms accounted for
approximately a quarter of all output. It was to rise to over a third by
1960. A vast amount of economic activity was moving from markets into
firms. With this, a vast amount of employment came to be located in large,
bureaucratic enterprises under formalised employment contracts. Let us
look at the story in slightly more detail, and chronologically.
2.4 Railways and the second Industrial Revolution
As Cassis (2007, p.175) puts it, ‘big business in the third quarter of the
nineteenth century primarily meant the railroad companies’. They became
exemplars in two ways. The first we have noted: they are almost the
prototypical joint stock enterprise in that they needed lots of investors. The
second concerns models of employment and management. They were the
first modern organisations to develop ‘extensive hierarchies of managerial
and white collar staff’ (Gospel, 2007, p.427). They engaged in systematic
recruitment, set up promotional hierarchies and pay scales. Assuming
lifetime or at least long-term employment, they introduced welfare
arrangements such as housing, sick care and pensions. In the UK at least,
they liked to recruit employees with a military or police background or
relatives of those already employed; this led to a readier acceptance of
the employment relationship as an authority relationship, necessary for a
dispersed workforce. There were no unions until after the First World War.
By the turn of the century, as Cassis notes, in a variety of sectors:
The large enterprise of the turn of the twentieth century…
appears as a centralised and vertically integrated firm, with its

10
own distribution and purchasing facilities, whose various
functions, including marketing, were entrusted to a hierarchy of
salaried managers, and which tended to cluster around sectors
where economies of scale and scope could be achieved through
mass production.
(2007, p.178)
This was more true of the USA than many parts of Europe.
The impact of the First World War was crucial. First, these mass-
production industries – food, chemicals, oil, engineering – became central
to the war effort, and expanded considerably. There was little product
market competition. After the war, there were further merger waves in
these sectors, particularly in Germany (Cassis, 2007, p.181). Big business
became bigger. Second, there was a massive change to the labour market:
labour markets were tight (because labour was scarce) and labour was
crucial to the fighting of industrialised war. In Europe, a significant
proportion of the male labour force was in the army, then dead. Unions
became strong and employers had to bargain. Global securities markets
collapsed. There was a mass of government debt to compete with equity
investment. Governments wanted to control the securities markets in
which this debt was traded and capital markets contracted. UK investors
sold massive amounts of overseas securities and the London stock market
became more localised. US investors had a very good war, and US markets
– particularly New York – grew massively. As Michie puts it:
…the global securities market was reduced to a series of
compartmentalized marketplaces only loosely linked to each
other rather than the fully integrated system that was in full
flow before 1914.
(2006, p.204)
After the War, in the 1920s and 1930s, government involvement in
business, particularly in European labour and capital markets, continued.
2.5 Market failure and management
Coase argues that firms exist because of market – or, more specifically,
price mechanism – failure in the presence of transaction costs.
[T]he fact that it costs something to enter into…transactions
means that firms will emerge to organize what would otherwise
be market transactions whenever their costs were less than
the costs of carrying out the transactions through the market.
(1988, p.7)
Certain types of transactions in markets entail considerable costs of price
discovery, negotiation and enforcement. For such transactions, Coase
argues, it may be more efficient for what he terms an ‘entrepreneur’ to use
‘authority’ to direct resources to their most efficient ends. The boundary of
the firm is set where the costs of organising a transaction within the firm
equal the costs of carrying it out through the market. Within this boundary,
the firm makes products or services; beyond it, it buys or sells them.
The revolutionary idea that Coase introduced in 1937 was the notion of
transaction costs. Much later, he argued that without transaction costs
firms would not exist, but nor would markets (1988, pp.6–8). Although
economists were primarily interested in markets, they focused primarily
on prices, and when they discussed market structure, they referred to
the number of firms and products, rather than the ‘social institutions that
facilitate exchange’ (1988, p.8) and thus defined transaction costs.

11
Coase has pointed the way to an explanation of why so much economic
activity took place outside markets, but it was many years before this
insight was pursued − we see how below. But what the market failure
approach did not do, was to offer a route to the study of the firm’s
internal operations. The stylised ‘entrepreneur’ allocated resources using
‘authority’ to maximise ‘efficiency’ and set the boundary of the firm where
market and hierarchy transaction costs equate. None of these concepts is
defined, and they really do not tell you much about what went on within
the firm. Coase is not really concerned with why some ‘entrepreneurs’
might be better than others. As a result, Coase made little impact – at the
time – on the study of management either. However, in the longer term,
the impact was substantial.
Several features of the Coase argument are replicated in much economic
theorising about organisations down to the present day. First, in the
pursuit of a theory of the firm, organisations are considered simple
alternatives to markets such as the pursuit of efficiency by other means.
There are two problems with this: first, firms may pursue multiple
objectives (of which efficiency is one), and since these objectives may be
in conflict, efficiency might not be the prime objective in the short term.
Moreover, there is no obvious reason why markets could not emerge from
organisational failure, rather than vice versa. In fact, much later, with the
growth of outsourcing, they did, and one needed to explain why a ‘make’
decision turned into a ‘buy’ decision, with the corollary that firm size
tended to shrink (Pfeffer, 1997).
Transaction cost arguments can provide a perfectly reasonable explanation
of this shrinkage, but Coase did not pursue it. Second, as Penrose (1959)
was to note many years later, markets do not make anything; they
exchange but do not produce – firms do both and are thus much more
than mere alternatives to markets. She makes the perceptive observation
that there is a difference between a theory of the firm and the economics
of the firm. Much later, Bromiley (2005, p.13) makes a parallel point
about the difference between explaining why firms exist versus explaining
what they do. For business strategy: ‘The existence of firms stands more
as a constraint on theorizing than an interesting problem; a theory that
predicts firms should not exist is clearly deficient.’
To use a metaphor: on the one hand, economists tended to see the world
as a sea of markets with the occasional island (the firm). Those who study
management tend to see the world as a desert of firms with the occasional
oasis.
The second feature which has endured in economics is the representation
of the firm in terms of one or more stylised actors; for Coase it is the
‘entrepreneur’, for later economists it is the ‘principal’ or ‘agent’. This
simplification enables formal modelling but it is not receptive to ideas
about organisational diversity or complexity; firms are timeless and
geographically unembedded. The third feature is that intra-organisation
relationships are treated in a very unproblematic way. Coase’s
‘entrepreneur’ exercised authority unproblematically, obeyed by those
she hired. For Jensen and Meckling, monitoring ensures compliance
and incentives provide motivation. Fourth, and related, rationality is
an assumption, not a variable. Actors within firms are built in the same
way as actors within markets, so that if one replicates the competitive
conditions of markets within firms, the same behaviours will emerge. By
extension, if an organisational feature is empirically common, logically it
must be efficient, since inefficient organisations will disappear over time.
Organisational diversity should disappear too.

12
This has had consequences for the relationship between economic theories
of the firm and empirical studies of what managers do, such as those
discussed below. Specifically, as Pfeffer (1997, p.46) notes, the economic
approach sees hierarchy design in terms of the prime need to control
managers with self-interested goals and employees who are effort-averse.
These assumptions about individuals within firms lead to the argument
that hierarchies have control and coordination costs, rather than focusing
on the positive impact managers might have on a firm’s performance.
In fact, as we shall see, were one to design an organisation according to
economic principles, it would probably be inoperable, primarily because
of the reaction of employees to such organisational controls. However,
before we turn to this, we need to look at the development of economic
ideas about hierarchy. Coase looked at market failure, but what about the
dynamics of hierarchy?
2.6 Transaction cost economics
Williamson’s early work concerned managerial decision-making; he found
that managerial discretion often undermined efficiency. Much later, he
would articulate the problems of the ‘propensity to manage’ in two forms.
It exists:
• instrumentally – managers pretend they can manage complexity,
when they cannot
• strategically – managers pursue their own sub-goals (Williamson,
1985).
However, rather than turning to markets as the answer, he focused on
the internal operations of the firm. The two aspects of ‘propensity’ rest on
two assumptions about individual behaviour which are core to the entire
project. Individuals are boundedly rational; they have limited capabilities
to deal with information complexity and information uncertainty.
Specifically, and crucially, they cannot write complete contracts. Second,
individuals are opportunistic, in that they pursue ‘self-interest seeking
with guile’ (1985, p.47); this is an extension of the conventional economic
assumption about the pursuit of self-interest which may roughly be
summarised as the idea that, since one cannot discover in advance who is
trustworthy, organisations need to be designed to cope with a pandemic of
dishonesty.
The third leg of this structure is the idea of asset specificity. The central
issue is the existence of human or physical assets which are locked into
a particular exchange relationship, for example, they have lower values
elsewhere. This might be ex ante; for example, you have to build a pipeline
to an oilfield and you are creating (in effect) bilateral monopoly. Or it
might be ex post; for example, you have worked in the same firm for many
years developing firm-specific skills. The three legs come together, as
Bromiley notes:
… efficient operation may require investments that have
little value outside that operation, but the parties cannot
trust one another, nor can they write the perfect contract…
bringing both parties to the transaction into the same company
(internalisation) may be more efficient than doing the
transaction in the market.
(2005, p.97)
As with Coase, transaction costs in markets and hierarchies are important
and Williamson borrows Arrow’s (1969) definition as follows:

13
• Ex ante costs: the costs of drafting, negotiating and safeguarding an
agreement
• Ex post costs: misalignment, haggling costs, the costs of running and
referring to governance structures, ‘bonding’ costs.
But contractual governance costs can be optimised in either markets or
hierarchies – ‘… transactions, which differ in their attributes, are aligned
with governance structures, which differ in their costs and competences’
(1985, p.27) so that transaction costs are minimised.
The influence of transaction costs economics has been substantial, perhaps
because of its scope, but also because of the nature of its assumptions.
Asset specificity alone does not give you the firm; opportunism is key.
Since opportunism is a very strong form of the self-interest assumption,
it has attracted substantial criticism. It is a very negative view of human
propensities (Ghoshal and Moran, 1996), it may well be ethnocentric and
it is not empirically grounded. However, it not only gives you a theory of
firm formation but also an approach to the optimisation of firm structure;
for example, Williamson explains the growth of the multi-divisional firm
in terms of efficiency – it economises on the transaction costs of capital
markets and minimises managerial activity detracting from shareholder
value (1985, p.288).
Activity 2.1
What assumptions about human behaviour does Williamson (1985) make? Try to make
a list.
Williamson also develops an approach to the employment contract which
is of generic interest to the relationships between owners, managers and
labour, which we discussed at the outset of this chapter. Employment
contracts are often characterised in economics as incomplete. They also
have asymmetric authority (the employer issues instruction), asymmetric
information (sometimes in favour of the employee), asset specificity (the
skills and equipment used are often not transferable) and they are often of
long duration. They are, empirically, the building blocks of hierarchy since
monitoring and incentives are central to them. Williamson’s approach can
be illustrated by reference to Figure 2.1.
Williamson (1985) discusses three contractual possibilities. Under spot
contracting the parties contract at T1 that, when event 1 occurs, the
exchange of money for effort (X1) will occur. If this occurs once, the
spot contract form is efficient. However, if the game is repeated, two
problems emerge. First, the transaction costs are high, both ex ante and ex
post. Second, opportunism – by both parties – is likely. Under contingent
claims contracting, the parties at T1 try to write a comprehensive contract
covering all events and their related effort bargains. This fails the bounded
rationality test in many circumstances, particularly where the number
of discrete events is high. The third option is adapted from Simon (who
was Williamson’s PhD supervisor). According to this approach the parties
agree to an authority relationship. The employee, in exchange for a single
comprehensive effort bargain, agrees to allow the employer the authority
to make state-of-the-world definitions across a range of events. The
problem here is how to define the acceptable range of events. However,
an authority relationship economises on transaction costs and does allow
some form of monitoring.

14
Spot contracts
T1..........E1..........X1
T2..........E2..........X2
T3..........E3..........X3
Contingent claims
E1..........X1
E2..........X2
E3..........X3
Authority relation
T1..........
T2.......... ..........X2
T3..........
Figure 2.1: Alternative contractual forms
What Williamson comes up with as the optimal form relies very heavily on
Doeringer and Piore’s (1971) idea of an ‘enterprise market’. He emphasises
several elements: internal promotion ladders to encourage on-the-job
training and cooperation, pay rates attached to jobs within these ladders
(rather than individual performance), ascending with position on the
hierarchy, moderate rather than intensive metering, and job security
bolstered by a grievance or arbitration procedure to resolve disputes. He
is, in effect, describing the institutional structure of managerial capitalism
– what Davis (2009, pp.195–200) has referred to as ‘corporate feudalism’
– in which long-term attachments between firms and employees, bolstered
by firm-specific benefits and privileges such as pensions, profit sharing and
long-term employment, characterised not only the fabric of managerial
work but, increasingly with the advent of labour unions and particularly in
the USA, that of all permanent employees. And a key part of the efficiency
gains that come from this considerable investment in hierarchy comes
from its impact on the behaviours of those in the hierarchy. His distinction
between ‘consummate’ and ‘perfunctory’ cooperation outlines but does not
perform a theory of value creation by managers.
Consummate cooperation is an affirmative job attitude –
to include the use of judgement, filling gaps, and taking
initiative… Perfunctory cooperation, by contrast, involves
job performance of a minimally acceptable sort … where…
incumbents… need merely to maintain a slight margin over the
best available inexperienced candidate.
Based on findings from different disciplines, understanding this difference
provided the motivation for the development of theories about both
management and labour performance.
Activity 2.2
What are the advantages to employers of long-term relationships with employees?
2.7 Overview of chapter
In this chapter, we have tried, first, to describe in brief the emergence of
the large firm and, second, to outline the first main attempt to develop a
theory of it. This theory has a number of features that are significant for
the chapters to follow.
1. It emerges essentially as a negative explanation about market failure:
firms are implicitly second-best structures that arise when markets
fail. Logically, one optimises the performance of a firm hierarchy by
making sure it runs as close to being a market as possible. Within

15
firms, managers potentially engage in problematic behaviours because
the structures bring out the worst in them – opportunism. Coase is the
precursor of a range of anti-managerial theories of organisation.
2. The theory is not empirically based. Not only is it surprising that
economics developed a theory of the firm long after firms came
to dominate industries (and then ignored it), it is surprising that
the theory was not informed by any extensive observation of
industry structure or firm behaviour. Empirical examination of the
internal operation of the firm has remained unfashionable within
economics and, as we shall see, it does not infect the modern field of
organisational economics very much either.
3. Because the transaction cost approach remained marginal to
economics for 30 years, and economics remained relatively
uninterested in the firm, a space was created into which business
disciplines such as marketing, organisational behaviour and strategy
moved. Academic economics becomes much more involved with the
study of managerial behaviour than with the growth of the economics
of strategy and organisation and, less directly, of financial economics
from the 1960s.
2.8 Reminder of learning outcomes
Having completed this chapter as well as the Essential reading and
• explain key elements in the history of the firm
• discuss the main theories of firm formation
• outline several key managerial problems in the firm.
2.9 Test your knowledge and understanding
What is transaction cost economics and why is it important for the theory
of the firm?

Notes
16

Chapter 3:Taylorism, motivation and performance
17
Chapter 3: Taylorism, motivation and
performance
• describe the main elements of Taylor’s approach
• discuss the strengths and limitations of scientific management
• explain the main elements of the human relations approach.
Willman, Theme 1.
Braverman, H. Labor and monopoly capital. (New York: Monthly Review Press,
1974) [ISBN 0853453403]; 1988 edition [ISBN 9780853459408].
Guillen, M.F. Models of management: work, authority and organisation in
a comparative perspective. (Chicago: Chicago University Press, 1994)
[ISBN 9780226310367].
McGregor, D. The human side of enterprise. (New York: McGraw-Hill, [1960]
2006) [ISBN 9780140091243] Chapter 1: Management and scientific
knowledge.
Taylor, F.W. The principles of scientific management. (New York, Harper, 1923)
[ISBN 9781599866796] Chapter 1.
3.1.4 Works cited
Abernathy, W.J. The productivity dilemma. (Baltimore: Johns Hopkins, 1978)
[ISBN 9780801820816].
Batt, R. and Moynihan, L. ‘The viability of alternative call centre production
models’, Human Resource Management Journal, 12(4), 2002, pp.14–34.
Burawoy, M. Manufacturing consent: changes in the labor process under
monopoly capitalism. (Chicago: University of Chicago Press, 1979)
[ISBN 9780226080383].
Granovetter, M. ‘Economic action and social structure: a theory of
embeddedness’, American Journal of Sociology 91 1985, pp.481–510.
Lewchuk, W. ‘Fordism and British motor car employees, 1896–1932’
in H.F. Gospel and C.R. Littler Managerial strategies and industrial
relations: an historical and comparative study. (Farnham: Ashgate, 1983)
[ISBN 9780435323653].
Marglin, S. ‘What do bosses do?’, Review of Radical Political Economics 6 1974,
pp.60–112.
Mayo, E. The human problems of an industrial civilization. (New York:
Macmillan, 1933).
Nelson, D. Frederick W. Taylor and the rise of scientific management. (Madison:
University of Wisconsin Press, 1980) [ISBN 9780299081607].
Nelson, D. A mental revolution: scientific management since Taylor. (Columbus,
OH: Ohio State University Press, 1992) [ISBN 9780814205679].
Norwich, J.J. A History of Venice. (London: Allen Lane, 1982)
[ISBN 0713915625].
Quattrone, P. ‘Accounting for God: accounting practices in the Society of Jesus’,
Accounting, Organisations and Society 29 2004, pp.647–83.

18
Rose, M. Industrial behaviour. (London: Penguin, 1988) [ISBN 0140091335].
Sabel, C.F. Work and politics: the division of labor in industry. (Cambridge:
Cambridge University Press, 1982) [ISBN 9780521230025].
Thompson, E.P. The making of the English working class. (London: Penguin,
1966) [ISBN 9780394703220].
Willman, P. Technological change, collective bargaining and industrial efficiency.
(Oxford: Oxford University Press, 1986) [ISBN 9780198272625].
Witzel, M. Builders and dreamers: the making and meaning of modern
management. (Harlow: Prentice Hall (2002) [ISBN 9780272654377].
Wren, D.A. The History of Management Thought. (New York, Wiley, 2005).
[ISBN 9780471669227].
3.2 Introduction
The 19th and early 20th centuries in Europe and USA were, arguably,
characterised by two features relevant to the design and conduct of
business. The first was a belief in technological progress (and its benefits).
The second was an inclination towards optimisation; put differently, if one
thought systematically and rationally about a business problem, one could
improve the chosen dependent variable – efficiency, productivity, profits,
etc. In the absence of a theory of the firm, many analysts and practitioners
felt the appliance of science to the factory could yield substantial benefits.
Many had an engineering background (Witzel, 2002) and, again arguably,
saw the optimisation problem as an engineering problem.
The problem to be optimised was how to run the most efficient business.
Intellectual furniture existed; there were not many examples of large-
scale manufacturing businesses but there was a history of large-scale
organisation in two fields: government (particularly military) and religion
(particularly international religious orders). In these organisations, many
‘managerial’ techniques had been developed. I offer two examples.
Jesuits knew about accounting. They had resources, international reach
and an objective: saving souls. But,
A strictly economic analysis of the nature and role of accounting
as an instrument for allocating, monitoring, and administering
resources within the hierarchical structure of the Society of
Jesus would leave undiscovered important aspects of the
practices deployed by the Order to manage, organise, and
account for its multifaceted activities.
(Quattrone, 2004, p.675)
How to optimise the allocation of resources to maximise the saving of
souls? The first thing one needs is a management accounting system to
tell you where the resources come from and go to. The second thing, more
controversial perhaps, is you have to put an economic value on a soul. At
the margin, one might have to choose which soul to save or whether the
expenditure was worth the return.
Venice knew about fighting wars at sea to generate and protect trade (they
are not the only historical example). In the Arsenale, they built assembly
lines.
[Venice] could standardise designs and build up stores of spare
parts, making it possible to complete even major refits in a
fraction of the time… the designs themselves, as well as the
techniques, could be revolutionized….One of the secrets of
Venice’s rise to power lay in the fact that she never saw the twin
necessities of defence and commerce as altogether separate…
the nobles were merchants and the merchants noble…
(Norwich, 1982, p.109)

19
How to maximise throughput and reduce production times;
standardisation of inputs, process and product is an important component.
Alignment of defence and commercial interests is another. You could use
the ships to fight and then carry the spoils home.
How are these examples relevant to the operation of the industrial firm
centuries later? First, they indicate that techniques for resource allocation
and mass production had a long history in ostensibly non-commercial
operations which could be adapted; there was something to work on
for engineers to optimise. Second, they hint at the source of the agency
problem in business. Military operations (which are a matter of life
and death) and religious organisations (which are a matter of afterlife
and eternal death) can generally exert more forces for cooperation or
compliance on organisational participants than organisations that rely
primarily on shared financial interests. Borrowing the techniques from
such organisations did not borrow the underlying cooperation.
In much of the West, for the majority of the early period of
industrialisation, it was not entirely clear why a pre-industrial workforce
would wish to become an industrial one (Marglin, 1974; Thompson,
1968). If one invested in a factory in, for example, the cotton industry
in England (which was important for the first Industrial Revolution),
the capital investment required in steam production and productive
equipment required high rates of utilisation which in turn required long
hours of work. Control of absenteeism, turnover and simple inactivity was
required to generate a rate of return. What incentives could be used to
exact this? Money is one obvious answer, but we saw also the problems
with simple incentives in the last chapter. Moreover, what would one buy
with it? Penalties are another; throughout the 19th century in England,
employment in factories was governed by the ‘master and servant’ Acts;
the presumption of obedience was central. A third was the removal of
opportunities. Prior to factories, farmers and their families used to spin
cotton as an activity supplemental to their central activities. With the
advent of expensive machinery, such an approach became hazardous
to profit, and the need for a workforce with no other means of support
became paramount.
Many management ‘theorists’ emerged in the late 19th and early 20th
centuries, convinced that applying scientific principles to the management
of firms would result in improvements in efficiency and productivity and,
for the more messianic, a better world. The term ‘scientific management’
has often been applied to the ideas they promoted. We will look at just
the most influential, F.W. Taylor, however, several characteristics of the
set are relevant. First, they were obsessed with efficiency as an outcome
variable; many of their works display a strong tendency to sample on this
dependent variable, often with erroneous results. Second, they believed
in general rather than specific solutions; their recipes were in principle
universally applicable and promoted one best way of doing things. Third,
they inclined, like Emerson and Fayol, to sets of points or principles which
summarised their approach; 12 principles of efficiency for Emerson, 14
points of administration for Fayol. Fourth, since they were often engineers,
they saw agency problems in engineering terms. Employees were
important appendages to machines ‘and in the interests of plant efficiency
should be treated at least as well as we treat machines’ (Emerson, cited
in Witzel, 2002, p.227). Some were even military engineers who saw the
exercise of authority as unproblematic.
An enormous amount has been written about Taylor (Braverman, 1974).
He tends to be better thought of by those in operations management and

20
research who are interested in the optimisation of processes than by those
in organisational behaviour who are interested in the human response
to this. Frederick Taylor argued that ‘scientific management’ consisted
in devising the one best way to complete a task and then ensuring the
workmen closely followed the rules, using supervision and monetary
incentives. Five principles were central.
• The separation of conception from execution: managers analysed and
designed work tasks, employees performed them.
• Simplification of tasks: each task was broken down into simple
components which were then aggregated to exclude unnecessary
efforts.
• Close supervision: employees were closely monitored to ensure
adherence to best practice.
• Strict obedience to ‘one best way’: employee innovations in work
design were excluded.
• Monetary performance incentives were applied to output generated in
this way.
After initial successes, Taylorism was adopted by large firms such as
DuPont and Ford. It was seen at the time as industrial science not capitalist
ideology – Lenin was a fan. As we shall see, elements of it were adapted
much later. It provided one basis for the modernisation of Japanese
industry in the post-Second World War period. Its utilisation in service
businesses grew as scale economies were pursued. ‘The factory of the past
becomes the office of the future’ (Batt and Moynihan, 2002). However, it
generated some of the characteristic problems of later versions of agency
theory. The model ‘first-class’ workman in Taylor is a passive and obedient
agent, indeed selected on those characteristics.
Let’s put the above list together, again in a negative way.
• Separation of conception from execution – the operator has no
incentive to learn or share learning. If the operator does learn a better
way, he is likely to appropriate the benefits.
• Simplification of tasks – skills are not worth developing, either
for the firm or the employee. Indeed ‘de-skilling’ and thus loss of
market power by employees is seen as one major consequence of the
application of Taylorism (Braverman, 1974).
• Close supervision – many supervisors are needed and overhead rises.
Taylorist firms develop high supervisory ratios, and efficiency losses.
• Strict obedience to ‘one best way’ – attracts the intrinsically obedient
who are unlikely to innovate.
• Monetary performance incentives – given that people respond to
symbolic rewards – this is expensive and likely to generate a simply
calculative approach by the employee.
In fact, Taylorism depends on what in a different context Granovetter
(1985) has referred to as both an oversocialised and undersocialised idea
about the employee: oversocialised into obedience and undersocialised
in being entirely motivated by money, not intrinsic rewards. Moreover,
Taylor’s optimal employee is individually selected not collectively
organised; in early 19th-century USA, this emerged as a problem.
Activity 3.1
Consider an organisation you know − school, shop, office.What would be the advantages
and disadvantages of applying scientific management to that organisation?

21
Let’s look at the model of organisation and of management. Organisations
are seen as machines. Some of the machines are people but they can be
managed the same way: managers think, workers do. Standardisation
of (labour) input, work process and product output are the sources of
efficiency; this is a mass-production model. The market does not send in
shocks that disturb the organisation of work on a regular basis. Employee
recalcitrance is endemic and monitoring is permanent. Task- or peer-based
intrinsic rewards do not operate and the employee is homo oeconomicus.
How well has Taylor understood the employee as economic man?
We would argue that in at least two respects the Taylor approach
anticipates later developments by academic economists, albeit not
formally.
• In the emphasis on the importance of selection and fit, there is
understanding of both moral hazard and adverse selection.
• In the rigid adherence to the separation of conception from execution,
there is a grasp of the problems of information asymmetry.
3.3 Scientific management: the apogee
Scientific management in general and Taylor’s version in particular left a
substantial legacy. The engineering efficiency approach to the design of
operations generated huge returns to scale, and many large businesses
in chemicals, engineering and car manufacture adopted it (Nelson,
1992). Much of the thinking was to become incorporated in the academic
disciplines of operations research and management, which in turn found
a central place in the MBA curriculum. For many, the ultimate expression
of the engineering approach to production management came in the car
industry, and in particular the operations of Ford, the most successful of
the early car manufacturers.1
Ford dominated the early history of the car industry, both in success and
failure. The Model T introduced in the 1920s was based on a strategy of
low price and simple design; this generated huge growth in car ownership
and thus market size. The production approach underpinning this was
standardised design, assembly line technology and mass production. This
had a number of implications. For Ford, the most serious was inflexibility;
his early factories could only produce Model T cars, and retooling for
product innovation required long-term plant closure that led to permanent
loss of market leadership to General Motors (Lewchuk, 1983).
In assembly line car production, capacity utilisation is vital. Mass
production degenerates into batch production whenever the line is stopped
or product rectification is required; fixed capital costs are high, and the
gap between capacity and output needs to be small. This is exacerbated by
vertical integration; car assembly – the final operation before distribution
and sale – has lower minimum efficient scale than upstream operations
such as engine manufacture and body production, so interruptions to
assembly within an integrated car manufacturing operation generate costs
throughout the firm. Assembly is also the most labour-intensive phase of
production.
1
This section relies on
Abernathy (1978) and
Willman (1986).

22
PRESS SHOP BODY SHOP PAINT SHOP
Stamping of
body panels
Steel: sheet
strip and coil
Panels
Sub-
assemblies
Body
assemby
Body in
white
Clean, prime,
paint body
Painted body
ASSEMBLY PLANT
Trim lines
Final
assemby
Test and
rectification
Finished car
shipped to
distributors/
dealers
Thousands of parts
and trim items
Component
plants Engine dress
and rear end
assembly
RAW-
MATERIAL
SUPPLIERS
Steel: rod and
bar stock
Forging of high-
strength parts
FORGE
Casting of engine
blocks, crankshafts
etc.
FOUNDRY
Machining
Machining
ENGINE PLANT
Engine
assembly
and test
TRANSMISSION PLANT
Transmission
assembly
and test
Engine
Transmission
Figure 3.1: Cost components of car assembly
Figure 3.1 identifies the cost components of car assembly. There are three
sets. First, capital equipment in the form of plant layout; this defines
capacity and is fixed. The next two concern labour. The first is the hourly
cost of labour. If the system is optimised at 100 per cent operation, these
are the only costs. The third component represents lost capacity; the source
of most lost capacity is labour behaviour, and control of this is at the centre
of the derivative of Taylorism that some commentators call ‘Fordism’. The
key dependent variable is ‘man hours per car’, for example, the labour
input to each unit produced. Absenteeism, errors in work, stoppages due to
disputes and the need for direct supervision inflate this denominator.
The key elements of the labour strategy that supports optimisation were as
follows.
• The simplification of tasks and high assembly line speeds; automation
of simple tasks where possible.
• Use of high levels of hourly pay and the avoidance of bonuses. Ford
introduced the ‘$5 day’2
to attract and retain the labour required, and
to reduce absenteeism.
• Close supervision of employees and strict discipline.
• Avoidance of labour unions.
In order to do this, Ford favoured company towns and company housing.
Most significantly the firm invested in a ‘personnel department’ that
not only provided welfare but also acted as a labour police force,
monitoring absence, sickness, agitation and dissent. Optimising workforce
performance was the key to optimising capacity utilisation. The main
Taylorist absentees from this labour-management formula were incentives
and heavy supervision; assembly line speeds substituted for both
(Guillen,1994, p.56).
Many of these considerations still apply to the modern car industry.
By extension, they apply to many capital-intensive mass-production
operations. Labour costs may be a small proportion of total costs, but
labour control becomes vital. As Braverman has put it:
2
This was a lot of money
at the time.

23
Taylorism dominates the world of production; the practitioners
of ‘human relations’ and ‘industrial psychology’ are the
maintenance crew for the human machinery.
(1974, p.86)
How did psychology intervene, and what is ‘human relations’ in this
context?
3.4 Engineering and psychology
There were parallel but discrete origins in the USA and UK. In the USA,
Munsterberg at Harvard – an admirer of Taylor – became concerned with
fatigue, monotony and learning in work; he advocated selection testing
and motivational tools. In the UK, the influence of wartime research on
soldiers was deployed in the 1920s by Myers, among others, to study stress
and fatigue and to develop recommendations on the optimal working
day and rest periods and the avoidance of accidents and absenteeism
(Rose,1988). The unit of analysis tended to be the individual worker (and
by extension individual differences), but the concern was less directly with
individual well-being and more with those variables also of concern to
scientific management. As Wren puts it:
While the engineer studied mechanical efficiency, the industrial
psychologist studied human efficiency with the same goal in
mind of improved overall greater productivity. Acceptance
by industry of the heretofore ivory tower psychologist was
facilitated by the psychologist’s interest in efficiency.
(2005, p.193)
A paradox of early theorising about employee behaviour was that
both scientific management and the early psychologists focused on the
individual as the unit of analysis but the employee response to both
frequently involved collective action, which in turn generated the high
levels of labour conflict that were of so much concern. An alternate
approach relied on late 19th-century sociology and focused on the group.
Durkheim focused on the bonds that held societies together to generate
solidarity. Traditional societies were bound together by kinship, religion
and similarity; this generated ‘mechanical solidarity’. The division of
labour, the growth in differentiation of status and the scale of modern
societies broke down these bonds and generated anomie; this was an
individual state of confusion, normlessness and anxiety, but it was
generated by the absence of any groups or institutions that could provide
a set of norms and values appropriate to a highly differentiated society –
‘organic solidarity’. Durkheim’s work contains far more analysis of societies
with mechanical solidarity than those with organic and he is a little short
on detail about how it might be achieved. The enduring legacy for the
management field was his concept of the individual as plastic, shaped and
shapeable by membership of norm-generating groups.
To get from this to a set of management techniques one needed something
approaching an optimisation model – and it came from economics. Pareto,
a 19th-century polymath who was an engineer, economist and sociologist,
referred to the idea of a ‘social system’ – characterised by interdependent
and varied components with self-equilibrating tendencies. This went into
Harvard University as a broad idea and came out as a major influence on
academic sociologists such as Parsons and Homans on the one hand and,
on the other, as a central plank of what became the ‘human relations’
school – the idea of the factory as a social system that could achieve

24
equilibrium. In order to explore this approach and its effect on modern
management theory, let us look at its most famous piece of research – the
Hawthorne studies.
The Hawthorne studies took place in the USA in the eponymous plant
of Western Electric from 1924–1933.3
It was a massive factory; by 1929,
40,000 men and women worked there. Western Electric was one of the
forerunners in applying scientific management to its production units
and it was regarded as a well-run plant. Numerous researchers using a
variety of methods performed a series of behavioural experiments and
deployed interviewing and observation techniques in ways that would get
modern researchers fired and, given that the experiments involved some
behavioural manipulations and physical deprivations, maybe sued (Wren,
pp.370–73). In fact, the most widely quoted finding is simply a method
flaw. Over time, researchers realised that every time they paid attention
to a group of workers (subjected them to a ‘treatment’) output rose
temporarily, then fell back – the ‘Hawthorne effect’.
The studies began with a concern for physical environment. The
illumination tests, 1924–1927, subjected groups to lighting variations
and, broadly, found no correlations between lighting and productivity.
Subsequently, the ‘relay’ tests, 1927–29, involved experimental alteration
of bonus arrangements, rest periods and hours of work, with mixed
results. A third set of studies, in the ‘Bank Wiring Room’, probably had the
greatest impact. Researchers discovered output restriction under incentive
schemes that was enforced by informal groups. Workers felt that if they
produced too much output, management would cut the rates, and if too
little, they would be disciplined. Informal work groups emerged enforcing
output norms lower than those management wanted, using emotional and
physical sanctions. Further studies analysed informal group structure in
depth, finding that supervisory behaviour with respect to informal groups
was important. Managers who listened and communicated well were likely
to be more integrated into work groups.
The results had potentially radical implications. Workers would act against
self-interest by obeying group output norms. Managers who integrated
with informal groups, using what would later be called a management
‘style’, gained much better understanding of group structure and how
to manipulate it. Such groups could be used to improve output. In these
studies we see the seeds of the organisational behaviour discipline –
in its concern with intrinsic (non-economic) motivators, teams and
team building and leadership. We can also see a logic which leads to
the development of the modern human resource function; individual
and collective affect (emotional states) may have an impact on firm
performance, and it is thus worth investing to control these variables.
More immediately, it allowed one of the key researchers, Elton Mayo, to
identify worker discontent as anomie remediable by intervention designed
to restore Pareto equilibrium to the social system of the factory. The
intervention points were selection of workers, allocation and organisation
of tasks, leadership style and the construction of teams (Guillen,1994). To
quote Mayo:
The hallmark of human-relation theories is the primacy given
to organizations as human cooperative systems rather than
mechanical contraptions…
Any company controlling many thousands of workers…tends…
to lack any satisfactory criterion of the actual value of its
methods of dealing with people.
(Mayo, 1933)
3
This section relies on
Rose (1988).

25
Since cooperation was the objective, unions were peripheral to the
analysis.
Hawthorne in particular and the human relations school in general
have been subject to a number of criticisms. However, the impact of
human relations thought on subsequent academic research agendas is
considerable, and the notion that the ‘mechanical’ and the ‘social’ systems
of industrial enterprises must be jointly maximised was exported from the
USA, most particularly in the work of the Tavistock Institute.
In an influential study, Guillen has analysed the theoretical development
of both scientific management and human relations thought, and their
impact on business practice in four Western countries. He argues that:
The development of engineering as a profession was the direct
cause of scientific management, much as the development of
social-psychological science accounted for the appearance of the
human relations paradigm.
(Guillen, 1994, p.26)
Scientific management adoption always precedes human relations
adoption, and indeed in Germany he finds, for various reasons, human
relations thinking has little effect on practice. The more consistent
impact of scientific management on production is associated with the
simultaneous development of cost accounting, production and inventory
controls and incentive schemes (also developed by engineers) (1994,
p.41).
If, as in the USA, human relations thinking emerges as a solution to
problems of labour unrest generated by the application of scientific
management, its ideological component becomes important. Several
eminent sociologists in the 1950s, such as Daniel Bell, C. Wright-Mills and
W.H. Whyte, saw human relations as a manipulative technique promoting
solely managerial ends; later Marxist sociologists such as Braverman
(quoted above) saw it as ‘manufacturing consent’ (see also Burowoy, 1979,
and Sabel,1982). In Britain, however, it gave rise to a set of concerns
about humanising the workplace through the reorganisation of work.
Activity 3.2
One key question emerging here is the relative primacy of engineering and social
considerations. Does one, as Braverman implies above, (a) optimise on process efficiency
and productivity and mould social concerns around that (as the human relations approach
implies), or (b) is it worthwhile to choose a sub-optimal production technique because
it has compensatory effects on the workplace as social system which, in turn, positively
affects some performance measure?
3.5 Overview of chapter
1. Early theorists were concerned to optimise production in large firms
using both existing organisational tools and a systematic ‘engineering’
approach.
2. This became systematised in the influential work of Taylor whose
techniques were widely adopted and developed.
3. However, widespread concern about the approach to employees
led to the application of social psychology to understanding worker
behaviour, also in the interests of increasing performance.
4. This in turn led to the emergence of the ‘human relations’ approach.

26
3.6 Reminder of learning outcomes
Having completed this chapter as well as the Essential reading and
• describe the main elements of Taylor’s approach
• discuss the strengths and limitations of scientific management
• explain the main elements of the human relations approach.
3.7 Test your knowledge and understanding
What was scientific management? Is it still influential in business today?

Chapter 4:The rise and decline of labour
27
Chapter 4: The rise and decline of labour
• outline the key features of the history of labour unions
• describe the potential benefits of unions to firms and employees
• discuss the reasons for union decline in modern industrial societies.
Freeman, R. and Medoff, J. What do unions do? (New York: Basic Books, 1984)
[ISBN 9780465091324] Chapter 11.
Willman, Chapter 3, Theme 2.
Gospel, H. ‘The management of labor and human resources’ in Jones, G. and
J. Zeitlin, J. (eds) The Oxford handbook of business history. (Oxford: Oxford
University Press, 2007) [ISBN 9780199573950], pp.420–47.
Pencavel, J. ‘The demand for union services: an exercise’, Industrial and Labor
Relations Review 24(2) 1971, pp.180–90.
4.1.4 Works cited
Berg, M. The machinery question and the making of political economy.
(Cambridge: Cambridge University Press, 1980) [ISBN 9780521227827].
Blanchflower, D. and A. Bryson ‘Changes over time in union relative wage
effects in the UK and the US revisited’, Chapter 7 in J.T. Addison and
C. Schnabel (eds) International handbook of trade unions. (Cheltenham
England and Northampton Mass., USA: Edward Elgar, 2003)
[ISBN 9781840649796].
Blanchflower, D. and A. Bryson ‘What effect do unions have on wages now?’,
Journal of Labor Research 25(3) 2004, pp.383–414.
Braverman, H. Labor and monopoly capital (New York: Monthly Review Press,
1974) [ISBN 9780853453406].
Crouch, C. Trade unions: the logic of collective action. (London: Fontana, 1982)
[ISBN 978006358732].
Davis, G. Managed by the markets. (Oxford: Oxford University Press, 2009)
[ISBN 9780199216611].
Freeman, R. and J. Rogers What workers want. (Ithaca: ILR Press, 1999)
[ISBN 9780801485633].
Gomez, R., A. Bryson and P. Willman ‘Voice transformation: the shift from
union to non-union voice in Britain’ in A. Wilkinson et al. (eds) The Oxford
handbook of participation in organisations. (Oxford: Oxford University Press,
2010) [ISBN 9780199207268].
Hobsbawm, E. The age of extremes: the short twentieth century, 1914–1991.
(London: Michael Joseph, 1994) [ISBN 0718133072]. Vintage (1996)
[9780679730057].
Marglin, S. ‘What do bosses do?’, Review of Radical Political Economics 6 1974,
pp.60–112.
Tuchman, B. The proud tower. (London: Macmillan, 1966)
[ISBN 9781299237247].

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