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120 Part One Organizations, Management, and the Networked Enterprise

As transaction costs decrease, firm size (the number of employees) should
shrink because it becomes easier and cheaper for the firm to contract for the
purchase of goods and services in the marketplace rather than to make the
product or offer the service itself. Firm size can stay constant or contract even
as the company increases its revenues. For example, when Eastman Chemical
Company split off from Kodak in 1994, it had $3.3 billion in revenue and 24,000
full-time employees. In 2011, it generated over $7.2 billion in revenue with only
10,000 employees.
Information technology also can reduce internal management costs.
According to agency theory, the firm is viewed as a “nexus of contracts”
among self-interested individuals rather than as a unified, profit-maximizing
entity (Jensen and Meckling, 1976). A principal (owner) employs “agents”
(employees) to perform work on his or her behalf. However, agents need con-
stant supervision and management; otherwise, they will tend to pursue their
own interests rather than those of the owners. As firms grow in size and scope,
agency costs or coordination costs rise because owners must expend more and
more effort supervising and managing employees.
Information technology, by reducing the costs of acquiring and analyzing
information, permits organizations to reduce agency costs because it becomes
easier for managers to oversee a greater number of employees. By reducing
overall management costs, information technology enables firms to increase
revenues while shrinking the number of middle managers and clerical workers.
We have seen examples in earlier chapters where information technology
expanded the power and scope of small organizations by enabling them to
perform coordinating activities such as processing orders or keeping track of
inventory with very few clerks and managers.
Because IT reduces both agency and transaction costs for firms, we should
expect firm size to shrink over time as more capital is invested in IT. Firms
should have fewer managers, and we expect to see revenue per employee
increase over time.

ORGANIZATIONAL AND BEHAVIORAL IMPACTS

Theories based in the sociology of complex organizations also provide some
understanding about how and why firms change with the implementation of
new IT applications.

IT Flattens Organizations
Large, bureaucratic organizations, which primarily developed before the computer
age, are often inefficient, slow to change, and less competitive than newly created
organizations. Some of these large organizations have downsized, reducing the
number of employees and the number of levels in their organizational hierarchies.
Behavioral researchers have theorized that information technology facili-
tates flattening of hierarchies by broadening the distribution of information
to empower lower-level employees and increase management efficiency (see
Figure 3.6). IT pushes decision-making rights lower in the organization because
lower-level employees receive the information they need to make decisions
without supervision. (This empowerment is also possible because of higher
educational levels among the workforce, which give employees the capabilities
to make intelligent decisions.) Because managers now receive so much more
accurate information on time, they become much faster at making decisions,
so fewer managers are required. Management costs decline as a percentage of
revenues, and the hierarchy becomes much more efficient.

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