Page 18 - The Handbook for Quality Management a Complete Guide to Operational Excellence

rganizations exist because they serve a useful purpose. The trans-
action-cost theory of a firm (Coase, 1937) postulates that there are
Ocosts associated with market transactions, and organizations pros-
per only when they provide a cost advantage. Examples of these costs
include the cost of discovering market prices, negotiation and contracting
costs, sales taxes and other taxes on exchanges between firms, cost of reg-
ulation of transactions between firms, and so on.
Transaction-cost theory offers a framework for understanding limits on
the size of a firm. As firms grow, it becomes more costly to organize addi-
tional transactions within the firm, called “decreasing returns to manage-
ment.” When the cost of organizing an additional transaction equals the
cost of carrying out the transaction in the open market, growth of the firm
will cease. Of course, these costs are also affected by technology: facsimile
machines (in their day), satellites, computers, and more recently the Inter-
net each altered the cost of organization, impacting the optimal size of the
firm accordingly. Such inventions simultaneously impact the cost of using
external markets, so the relative impact of the technology on market costs
and organization costs determines the overall impact on the organization.
Clearly, the ability to efficiently carry out market transactions, with minimal
bureaucratic overhead, impacts an organization’s usefulness to the market,
and its prosperity and eventual life span.

General Theory of Organization Structure

Organizations consist of systems of relationships that direct and allocate
resources; therefore the purpose of organization structure is to develop
relationships that perform these functions well. There are several possible
ways in which these relationships can be viewed. The most common is the
reporting relationship view. Here the organization is viewed as an entity
consisting of people who have the authority to direct other people, their
“reports.” In this view the organization appears as a stratified triangle, with
the positions higher in a given strata of the triangle having the authority to
direct the lower positions. In modern organizations, the authority to set
policy and plan strategic direction is vested in the highest level of the

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