Outsourcing fuel production

Last year, I can't remember where but it was a discussion about Just in Time in the oil industry, I suggested that it was probably more profitable to refine gasoline abroad and ship in just the finished gasoline, or at least gasoline less the final blending additives. Why? Because a shipful of oil is essentially gasoline plus some useful additives plus a lot of junk. Why should we pay to ship the junk? We also have to find someplace to dispose of it. Wouldn't it make more sense to just ship that part of the oil that we want (gasoline being primary)?

It turns out that some foreign oil tycoons have figured this out and are making it work for two reasons. Not only is the explanation above true, but expected demand is rising in places like India and China, reducing the risk of building new refineries abroad for export to the US. According to Steve Levine and Patrick Barta in today's WSJ (subscription required?), Mukesh Ambani is guiding Reliance Industries into a very lucrative market to take advantage of this 2-for-1. According to EIA figures cited in the post, gasoline imports into the US have risen from 7% to over 12% of the market between 200 and 2006. The gap between what refiners (including US refiners) pay for a barrel of oil and what they get for the refined products has risen from $3 to $13, drawing new competition into the market.

technorati tags: energy "Just In Time"

Work organization all in one post

Thanks for coming back, thanks to Kevin Carson for noticing (damn, two weeks too early), and welcome to all of the Mutualist Blog readers. I'm looking forward to Kevin's comments regarding Lean (or kaizen or whatever you want to call the amorphous set of principles that originated in the US, attained dominance in Japan, and are slowly being repatriated). I have seen far too little informed and intelligent criticism of Lean management.

This series (links below under Production Modes) has been an extended review of Oliver E. Williamson's (OEW) The Economic Institutions of Capitalism, starting with a roundup of New Workplace books listed in a pair of posts called The New Workplace and Flow . In one chapter of that book, OEW compares the efficiency and hierarchy of different modes of organization. The purpose is to examine whether hierarchy has merely enforced itself (the power explanation), as argued by Stephen Marglin and Katherine Stone, or whether the dominant modes of organization have an efficiency explanation. In Williamson's words,

The central issue, and my main interest here, is an assessment of alternative work modes in transaction cost terms. If, as alleged, hierarchy does not serve efficiency purposes, the power relationship hypothesis is more compelling. If, however, hierarchy serves to economize on transaction costs, then an alternative explanation for the historical events to which Marglin and Stone refer warrants serious consideration.

OEW examines 6 modes of organization under 3 broad categories, two modes of contracting used by each, two types of hierarchy, and 11 measures of efficiency.

Production modes:

• Entrepreneurial
  • Putting-out
  • Federated
• Collective
  
  • Communal-emh (every man for himself)
  • Peer groups
• Capitalist
• • Inside Contracting
  • Authority relation
    

Contracting:

• Continuous
• Periodic
  

Hierarchy:

• Contractual
• Decision-making
  

Efficiencies:

a. Product flow

1. Transportation expense

2. Buffer inventories
3. Interface leakage

b. Assignment attributes

4. Station assignments
5. Leadership
6. Contracting

c. Incentive attributes

7. Work intensity
8. Equipment utilization
9. Local shock responsiveness
10. Local innovation
11. System responsiveness

Mode	# Efficiencies	Contracting	Contract Hierarchy	Decision-making Hierarchy
Putting out	5	Continuous	Medium	Medium
Federated	5	Continuous	Low	Low
Communal-emh	4	Limited periodic	Low	Low
Peer groups	8	Limited periodic	Low	High
Inside contracting	6	Continuous	High	Medium
Authority relation	9	Complete periodic	High	Very high

First, a note about the aggregation of efficiencies: As OEW notes himself, this is not a very rigorous means of comparing. He says, "Aggregation to obtain an overall efficiency rating for each mode requires that the relative importance of the eleven efficiency indicators be addressed. This will obviously vary across industries." Later, he calls this system "rough".

Obviously, there is no way to directly compare the net total economy of two modes if, for example, they have the same total score but one scores higher in transportation and another in incentive. The efficiencies are rated as either existing or not (a "bivariate" measure), and no attempt is made to calculate or assert the magnitude.

Second, there is little discussion of why this particular set of measures and no other is used. During the course of this review, I have introduced two that I thought could be relevant, especially as we note the growing dominance of the Toyota model and demise of the GM model of management. The two I have introduced were Quality Control and Worker Satisfaction. The GM model neglects both, while Toyota obtains much better economies in both areas. By this, I am not arguing that GM's quality is lower, but rather that the method by which they achieve quality is more expensive (less economical) than the method by which Toyota obtains it and that GM worker satisfaction is obtained by less economical methods than those used by Toyota. There may well be more measures of efficiency than those used by OEW than the two I have added, and some may well be more important.

Finally, I note that OEW does little analysis of the conditions in which these alternative modes are employed. The conditions of 18th century England, in which the Putting Out system was created, are different from those of 21st century United States. Yet Putting out saw its zenith in manufacturing then and there, while Putting out as a method of developing software may be still on the rise. As Kevin Carson is sure to point out, the rise of state capitalism has almost certainly corresponded with a rise in companies preferring Authority relation to more agorist modes, possibly to the detriment of all.

OEW's purpose was to demonstrate the technique, not to prove that one or another mode was superior and that his efficiency claims were definitive. The nature of the market system is that companies are always trying ideas in new combinations, so while the analysis of Authority relation may hold, in general, it is possible that someone will find a way to combine the effective parts of that mode with the effectiveness of others while suppressing the negative parts of both. For example, the Toyota style of subcontracting has much in common with both Putting out and Inside Contracting.

technorati tags: organization theory "Oliver E. Williamson" "Transaction Cost Economics" book review economics

Authority Relation

The last production mode listed by Williamson (OEW) in The Economic Institutions of Capitalism is "Authority Relation". It is what most of us have come to know as the "normal" work environment, with a boss directing workers (and perhaps that boss has a boss, and that boss has a boss, and so on up to the capo di tutti capo).

• It is classified by OEW as a "capitalist mode" (as opposed to entrepreneurial or collective)
• Not compatible with agoric modes almost by definition
  
• This form seems to have existed from the Renaissance forward, but apparently does not seem to have taken hold in large scale (manufacturing) organizations until the 18th or 19th century, after "putting out" and "inside contracting". Certainly, the M-corporation (multi divisional) did not come along until the 20th century, with GM as the archetype.
  
• OEW considers it to be a "periodic contracting" mode. However, he qualifies this: "Contracting under Authority Relation is apt to be somewhat more complete, in that explicit and implicit understandings regarding the zone of acceptance of the employment relation [...] need to be reached. Once agreement has been reached, however, this is an essentially noncontractual mode. Adaptations of an operating kind are made within the framework of that rather general contract, whereby boss and worker essentially agree to "tell and be told."
  
• In terms of contractual hierarchy, OEW classifies it at the top (very hierarchical), tied with Inside Contracting.
  
• In terms of decision-making hierarchy, this is the most hierarchical.
  

OEW finds this to be the most efficient method of organization with the analysis below.

Efficiencies:
a. Product flow
1. Transportation expense - Economic, everyone under the same roof.
2. Buffer inventories - Can be controlled economically. Fiat takes the place of pecuniary penalties to eliminate these.
3. Interface leakage - Workers making a salary have no incentive to "shade quality" as they would under Inside Contracting

b. Assignment attributes
4. Station assignments - Effective. In comparison to Inside Contracting especially, workers in this mode "are less given to aggressive subgoal pursuit and do not resist adaptations because they do not possess the requisite property rights."
5. Leadership - Effective.
6. Contracting - Effective.

c. Incentive attributes
7. Work intensity - Not efficient. The worker's compensation is not tied directly to his productivity. I'm not sure I agree: recent studies have shown that the people working the longest hours are professionals and white collar workers whose compensation is highest, and I don't know if he is considering workers making piece rate. I intend to say more about this some time in the future, but for now, please consider the work of Edward Lazear (via MarginalRevolution and Kathleen's informed comments at Fashion-Incubator).
8. Equipment utilization - Effective.
9. Local shock responsiveness - Effective.
10. Local innovation - OEW finds this mode to lack economy with respect to this attribute, but doesn't explain himself (or maybe I just can't find it). It seems to resonate with the finding for work intensity, but again I think that the rediscovery of Deming may work counter to this. The entire goal of (insert favorite descriptor here - kaizen, TQM, Quality Circles, TWI, Lean) is to encourage local innovation. To the extent that these management techniques are actually (not rhetorically) adopted, workers are also happier with their work.
11. System responsiveness - Effective. Workers may slack off under supervision, but the flip side is the ability to direct change effectively.

Although not covered in these areas of efficiency, Quality Control is again not explicitly addressed. Workers encouraged to work faster may cut corners, requiring oversite and inspection. That is a diseconomy. A culture where active participation exists will be more economical WRT quality control.

Also not covered explicitly is Worker Satisfaction, which I find surprising given the attention given to the subject of labor organization and unions later in the book. While this measure may be implicit in Work intensity and other incentive attributes, it isn't addressed directly. Admittedly, OEW and others might protest that Worker Satisfaction is no measure of efficiency, but I would beg the case that it is. Workers who find little job satisfaction may have to be placated with other concessions, including pay, perquisites, vacation, health care, and so on. Workers finding none of the above may leave, which could be detrimental if they take any significant investment in training with them, or seek alternative means of protest including strikes, slacking off, spreading hatred and discontent, and a host of aggressive and passive-aggressive behaviors that serve as disincentives to others.

Bottom line: Williamson finds Authority Relation to be not only very hierarchical, but also very efficient. It succeeds in 9 of the 11 areas of efficiency. This exceeds the Peer Group mode's 8 of 11 efficiency score by 1, so it is neither much more efficient nor much more hierarchical that that collective mode.

Next: a wrap-up.

The Pigou Club

Greg Mankiw started a list of economists and others who favored a Pigouvian (or Pigovian if you must, the man's name was Pigou for crying out loud) tax on carbon via a tax on gasoline, and called it the Pigou Club. Others chimed in. Lynne Kiesling and Patri Friedman declined to join. Patri is half right when he says the problem with it is that the proceeds from the tax might be wasted: they might also miscalculate the tax rate.

I have some questions for members of the club:

• When you fill up, do you seek out the most expensive gas you can buy? Why not?
• What is your personal price elasticity for gas? What is the shape of your demand curve? Is it kinked?
• When the Pigovian [sic] tax is passed, what steps do you plan to take to reduce your consumption? Or do you simply expect everyone else to change their lifestyles.
  

Cuz, y'know, enquiring minds want to know.

For what it's worth, I'm slightly* in favor of gasoline price increases. If I'm not mistaken, gasoline prices have gone up all by themselves over the past 2 years. If we must have intervention, let's:

• Remove all federal and state subsidies to the oil industry. I'm not sure what all that entails, but let's charge back any costs of terminal operation and security, tanker security, pipeline security, and cleanup costs as user fees for a start.
  
• Make sure 100% of fuel taxes to go to highways in proportion to the traffic thereon. That means no more windfalls to state and federal governments in the form of excise taxes on oil pumped, by the way.
  

Yeah, that sounds a lot like a free market. Just to be a consistent contrarian, I propose that the cost of the Iraq conflict be 100% paid out of a gasoline tax (though I think it is only partially "about oil"). Divide expected costs for the coming year plus the difference between actual and expected costs from last year by the number of gallons expected to be sold this year and add that to the price of a gallon.

* I'm still concerned about the effect on poor consumers, as are the compassionate libertarians at Econlog. Sorry, couldn't find the specific post, though I did see this wry observation from Arnold Kling:

the biggest reason that Detroit has such a stranglehold on auto innovation is the regulatory structure that Washington set up, particularly in response to Ralph Nader. Today, I'll bet that it takes more lawyers than engineers to bring out a new car. Deregulate autombiles, and small, innovative companies will have a chance.

technorati tags: "free market environmentalism" regulation Pigouvian tax

Inside Contracting

I'm glad I'm finally getting to this mode of organization. This is the first production mode that Williamson (OEW) lists under "Capitalist modes" in The Economic Institutions of Capitalism. It also happens to have a rich history that may still be active. Inside contracting was the standard organization used by the New England armories throughout in the 18th and most of the 19th century. It carried on into sewing machine manufacture, reaper manufacture (McCormick), and possibly even bicycle manufacture, all of whom evolved from the armory manufacture. It was an integral part of The American System, as explained by Hounshell (
From the American System to Mass Production, 1800-1932: The Development of Manufacturing Technology in the United States).

• It is classified by OEW as an "capitalist mode" (as opposed to entrepreneurial or capitalist)
• It was extensively used in the early gunmaking industry, which in turn lies at the heart of mass production and modern manufacturing and quality control methods. David Hounshell writes, "the inside contract system had been used for many years throughout American manufacturing, particularly in New England. In some respects, inside contracting resembled the putting out system, but its particular characteristics were derived from the factory system. Although the Springfield Armory never adopted inside contracting [...], almost all the New England armsmakers employed it. When coupled with armory gauging systems and machine tool design, inside contracting became a distinguishing characteristic of the Yankee armory practice extensively employed in all types of metal fabrication in the second half of the nineteenth century." Pratt & Whitney were inside contractors at the Colt armory, and went on to become first machine tool makers and then engine makers.
  
• Because of the influence of the armory practice on the manufacture of sewing machines and reapers (among other things), inside contracting was used in other industries. Hounshell writes, "[Lebbeus B.] Miller [a man Singer hired to "'design and supervise the construction of special tools for the production of interchangeable parts' for Singer machines" but who eventually rose to become superintendent] helped introduce inside contracting, a system that characterized the New England armory approach to manufacture and would be used at Singer until the early 1880s."
  
• Volkswagen under Piech attempted to set up Inside Contracting with its Brazilian plant in Resende. At the time it was purported as revolutionary, but that would be true only in the sense of revolving, not revolting. When searching for more information on this, I frequently found it in conjunction with "Supplier Parks" and "modularization". I am not sure it is still in use, and have not completely vetted the literature enough that I am confident in placing a link here.
  
• There is a fine line between Vendor-managed supply used in JIT and Inside Contracting, as the use at Resende indicates. More on this below.
  
• OEW considered it to be a "continuous contracting" mode, and an intensive user of contracts at that.
  
• In terms of contractual hierarchy, OEW classifies it as very hierarchical
  
• In terms of decision-making hierarchy, as moderately hierarchical. There is a central contractor, but his authority is dissipated by the contracts.
  

Efficiencies:
a. Product flow
1. Transportation expense - Because everyone is under one roof, transportation is economized in this mode.
2. Buffer inventories - Because no contractor has any hold on any other, buffer inventories may arise.
3. Interface leakage - Because different contractors run different areas, leakage may occur and become a subject of dispute. Frequent disputes and their settlement is not economical.

b. Assignment attributes
4. Station assignments - This mode economizes on station assignments.
5. Leadership - This mode also economizes on leadership. Bad contractors are let go, and the Yankee mechanic did not gain a reputation for efficiency for nothing.
6. Contracting - Because the central contractor can serve as a consolidating agent for things such as maintenance contracts, this mode can achieve efficiencies in contracting.

c. Incentive attributes
7. Work intensity - Inside contracting was frequently preferred precisely because of the work intensity attributes.
8. Equipment utilization - The contractors used the central agent's equipment and was frequently abusive of it. OEW says that contractors were prone to stop spending time and money maintaining equipment toward the end of their contracting interval, postponing them until the new interval.
9. Local shock responsiveness - Inside contractors did not adapt to local shocks well. Although OEW does not explain this thoroughly, we might assume that they would take the opportunity of a shock to negotiate opportunistically.
10. Local innovation - Inside contractors were very adept at local innovations because they - having negotiated fixed price contracts - would reap all of the benefits.
11. System responsiveness - The inside contracting system would not adapt to system changes well.

Bottom line: Williamson finds Inside Contracting to be moderate-to-highly hierarchical, and moderately efficient. It succeeds in 6 of the 11 areas of efficiency, less than the Peer Group []'s 8.

Inside contracting seems very similar to the Just-In-Time model of vendor-managed inventory. That is apparently the idea behind the Resende plant. Interestingly, such ideas had been tried in the past by American automotive companies, ultimately leading to vertical integration.

Say you have a manufacturer of brakes. You do business with them but don't buy them partly because they achieve some economy of scale by selling to your competitors that you yourself could not achieve (because your competitors won't buy from you). Now you ask them to locate their plant under your roof or at least very near your plant. If your competitor is located much further away, the economy of scale may longer apply. If you are further having them tailor every aspect of their operation - design, timing, part numbering - with your own, you have further thwarted the economy of scale that led you to do business with them in the first place. Okay, but in the process you are achieving an economy derived from their special investments into your production schedule and component design. Any company could see that this would be the case before it happened, so surely they would seek a commitment from you. Now we're back into the start of OEW's analysis of those factors that lead to vertical integration. Why VW and its partners are going through with this is not quite clear to me.

[FOLLOW-UP] Aw, geez, I totally forgot to discuss a section of Economic Institutions in which OEW relates an article about Inside Contracting in the steel industry. The article, (Stone, K., "The origins of job structures in the steel industry," Review of Radical Political Economics, 6 (Summer): 61-97) explains how the steel industry used inside contracting through the late 19th century. The system was dominated by the Amalgamated Association of Iron, Steel, and Tin workers, who enforced a system that "suppressed innovation" by (among others)

• restricting output per worker
• fixing the proportion of scrap used in a furnace
• forbidding use of brick and fire clay by puddlers
• prohibiting skilled workers from teaching other workers
• requiring approval by the union's executive committee to fill vacancies and to make changes in the physical plant

After Frick and Carnegie challenged the union in the Homestead mill in 1892 (a violent incident, to be sure), the union declined and the steel industry took off. The lesson is that this particular union arrangement was not efficient (as opposed to others, see my review of OEW's chapter on unions). In part, this inefficiency looks like a tragedy of the anti-commons.

Technorati tags: organization theory
"Oliver E. Williamson"
"Transaction Cost Economics"
book review

Prudhoe Bay waste

I was driving home the other night and heard the tail end of a snippet of Chuck Schumer's bloveating about the Prudhoe Bay shutdown.

From what I understand, BP had a leak. When they investigated the leak, they discovered that the corrosion in the pipes exceeded the corrosion they would expect in those pipes based on their computer models. Therefore, they decided to shut down more pipelines in order to carefully assess the corrosion and their models. If true, this is very prudent, exactly what I would expect a company - whose green credentials are sound, BTW - to do. At a loss of short term profit, you figure out why your assumptions or your execution or whatever is wrong because doing so in in your long-term interests.

Let's understand a few things about the situation.

1. The law does not require periodic maintenance or corrosion controls on this type of pipeline. See this article in USAToday.
   
2. They perform periodic maintenance and corrosion analysis anyhow. I saw a show last year (Discovery Channel) that showed the use of maintenance pigs in the pipeline, but can't find a link to it. This is a high tech industry that takes every gallon spilled very seriously (and the more so as the prices rise).
   
3. There was a recent leak of 210 gallons that prompted an internal investigation. This was in the wake of a leak on another pipeline that leaked 201,000 gallons.
   
4. As the result of the investigation, they decided to do the prudent thing and shut it down. The shutdown will cost BP $30 million per day. Perhaps not so incidentally, it will cost the state of Alaska $6.4 million per day. This is not a decision made lightly. And also not one that is forced upon them by a regulator. And also, incidentally, one that is likely to cost them money in lost market share even if it does drive prices up in the short term.
   

So, there is no market failure here; maintaining these lines is in the interest of operators. They understand that so well that they actually monitor the lines and run sophisticated computer models and maintenance pigs with high tech telemetry. It is costing them money, but they are taking the long term rather than the short term view (another market failure claim defanged). But Chuck Schumer (a trained lawyer) and John Dingell (a lawyer who once studied chemistry) insist that this means that we need more regulation. Sez newly-minted petro-engineering expert Schumer,

"The bottom line is we cannot afford for this incident to be a canary in the mineshaft. Now is the time to aggressively search for and fix any other problems before another disruption causes a national energy emergency."

Schumer said officials should review the inspection schedules companies file to determine whether pipeline operators are adhering to their required plans.

What will regulators do? Insist that someone do maintenance on these lines.

Y'know, like they already do.

Other than that, this is a chance for guys like Schumer and Dingell to insist that we "get our energy house in order". One suspects that they mean something that requires lots more intervention than simply allowing drilling in ANWR, but it would be hard to square their calls for action and their belief that we don't need more or cheaper oil through such drastic measures.

Technorati tags: energy"market failure"regulation

Peer Groups

The fourth of the organizational modes in Oliver Williamson's Economic The Economic Institutions of Capitalism are Peer Groups. A Peer Group factory is communally owned, but rather than being paid for their own products which they make from start to finish under Communal-emh, each worker is compensated equally based on the factory output. Workers may rotate stations as desired. Rather than devolving into negotiation over every detail, the workers elect leaders to make tactical, operational decisions, while strategic decisions are still made collectively (consensus or majority rule). The leader elections should rotate to avoid any hierarchy.

They have the following features:

• The second of the two Collective Ownership modes (as opposed to Entrepreneurial and Capitalist modes)
• I'm not familiar with lots of examples of actual attempts to organize along these lines, though there may be some. Owens Societies followed something like this, but were relatively unsuccessful. Workers attempting to establish communes in early revolutionary Russia quickly found their movement co-opted by the authoritarian Leninists who imposed authority from above while retaining the appearance and rhetoric of collective ownership. Lenin himself was a Taylor enthusiast, an ironic twist of history.
  
• OEW considered it to be a "Periodic contracting" mode, but one in which contracting was relatively unimportant because democratic decision-making would direct adjustments between work stations and workers.
  
• In terms of contractual hierarchy, OEW classifies it at the lower end of the spectrum. Other than a need to decide how new members could join the group and how unwanted members would be ejected, there is little need for contractual relations.
  
• In terms of decision-making hierarchy, the Peer Group rates near the top. An elected leader makes the decisions which everyone must abide by for the system to work. It is not the most hierarchical, however, because the workers do have the option of electing someone new. They can't continually do that, however, or it will devolve into a system where only popular decisions are made.
  

In Williamson's efficiency analysis, this mode does rather well.

Efficiencies:
a. Product flow
1. Transportation expense - Everything is under one roof, relatively economical
2. Buffer inventories - The system is flexible enough that it is unnecessary to keep buffer inventories in theory
3. Interface leakage - Since workers are sharing the outcome, there is incentive to monitor, report, and control leakage in theory

b. Assignment attributes
4. Station assignments- Since decisions and leadership selections are made democratically, it is possible for manipulators, demagogues, and self-promoters to get what they want even if this is not the most efficient outcome. There is opportunity for log-rolling: you vote me to be the QA inspector and I will vote you to be the buyer. Neither of us is very good at our job, but we can get at least 2 votes that way.
5. Leadership - The comments above about voting, log-rolling, rotation, and popularity all hold for leadership selection efficiency.
6. Contracting - As mentioned above, there is little need for contracting, so this is an efficient organization for that characteristic

c. Incentive attributes
7. Work intensity- Since pay is by average productivity and not marginal productivity, there is little incentive to work harder. Another Tragedy of the Commons: my hard work will benefit my neighbor as much as me, but I will enjoy all of my own laxity. Slacking will be overproduced.
8. Equipment utilization- Workers will note the abuse of equipment and seek to minimize it because everyone suffers equally. Does this seem to contradict the previous point? I think not, since it is easier to prove that your neighbor is letting his equipment deteriorate than to prove he is not working as hard as he possibly can.
9. Local shock responsiveness- All workers share in the outcome equally, so when one station or worker is broken down, it is in their interest to solve the problem.
10. Local innovation- Again, everyone stands to benefit from innovations made, so workers will enthusiastically accept new ideas. Or will they? Some people will resist change for the sake of resisting it, and if they are good at arguing their point, they will prevail in a democratic organization. However, this works in the opposite direction, also.
11. System responsiveness- The group makes tactical decisions through an elected agent, so it should respond well to immediate problems, and it makes strategic decisions through consensus, so it should respond well to longer term problems, but it will not respond quickly. Japanese corporations are largely run this way, and they seem to adapt quite well.

Again, Quality Control is not explicitly addressed. It seems that this mode would be economical with respect to such practices as continuous improvement and team production which rely on consensus.

Bottom line: Williamson finds the Peer Group to be of mixed hierarchy (low in contractual, high in decision-making), and very efficient (scoring positive on 8 of 9 tests). In some ways, Deming management principles emphasize consensus-based decision-making, so many of the operations would be similar to what is already seen in Japanese and Lean manufacturing environments. However, there is still a concern that "the management" would become highly politicized and unwilling to face or confront hard problems.

organization theory "Oliver E. Williamson" "Transaction Cost Economics" book review "lean manufacturing" "lean production"