In our discussion, we focused on two main alternative forms of coordination: market and hierarchy. In real life, however, many more options are available. In real life spot markets and hierarchy can be considered as the extremes of a continuum of an almost infinite number of coordination arrangements. These intermediate forms are called ‘hybrids’ because they share traits of both spot market and hierarchy. A variety of hybrids exists. Different types of contracts, cooperatives, producer organizations, strategic alliances, joint ventures are just a few examples of organizing transactions that use more information than just prices (unlike spot markets) and retain separate ownership of the parties (unlike hierarchy). Ideally, we can place the hybrids along the coordination continuum based on three key variables: quantity of exchanged information, duration of the relationship, and the value of the resources the participants share. The more are the information we have, the longer the duration and the higher the value of the shared resources, and the closer the hybrid is to hierarchy. Now, let’s go back to the definition of coordination. We know that the spot market is a tool to coordinate transactions. Nevertheless, the jargon of organization economics has developed a peculiar distinction: coordination is often used only to point out “hybrids”, that is organizations that are neither spot markets nor hierarchy. In this jargon, ”hierarchy” is referred to as ‘Integration’ (spot markets remain spot market) Therefore, from now on, we define coordination as the action of organizing transactions among firms with separate ownership with the exchange of more information than just price and quantities. It is a small point, but it is a convenient distinction. Now let’s move on to the final topic of today’s lecture. Organization Design. The study question we are asking is: “When is coordination preferable to spot markets?” We discussed the role of transaction costs. Now we use a slightly different perspective, in order to obtain a simple rule. In general, we prefer coordination to the spot market if coordination allows us to achieve higher profits. That is, if there is a “coordination surplus”. Coordination surplus is the profit differential that firms achieve when they act under coordination, instead of acting independently. Economic literature found that there is a potential for coordination surplus when the transaction exhibits “design attributes”. That is, when the following two conditions are satisfied. First, there is at least one firm that has enough information about the optimal outcome. This a-priori knowledge must be sufficient to develop a plan and give instruction to the other participants to the transaction. Obviously, there is no point in acting together if no one knows the right direction. You might be familiar with those old stickers saying, “Don’t follow me, I am lost, too”. This is a concise way of saying that coordination is useless if there is no information about the optimal outcome allocation. The second condition concerns the cost of failure. You can consider market coordination as a trial-and-error procedure. I produce something. If I can sell it for a high price, it means that I am doing the right thing. If I have to sell it for a low price, it means that I am doing something wrong, indicating that I failed to coordinate with my buyer. I have to change my production and start over again. If this kind of failure is costly, it might be preferable to avoid the trial-and-error market mechanism. Often, quality food production relies on transactions among firms. Do these transactions exhibit Design Attributes? Consider the condition of a-priori Knowledge. It is a necessary, but a not sufficient, an insufficient condition for coordination. The firm in charge of the governance of the supply chain must have the necessary information to plan production. This means that the firm knows what consumers want. We discussed this problem in Modules 2 and 3, when you learned about Attributes and Market Research. Firms spend sizable resources to gain this a-priori knowledge. In this way coordination becomes feasible. Now consider the condition about cost of failure. In Module 9 you learned about the link between food quality and innovation. Failing in innovation is costly because of R&D expenses and logistics. Furthermore, innovation and quality are key competitive advantages in the agri-food value chains. Failure might imply losing market shares. Summarizing, we can say that, in general, quality food production exhibits design attributes, and coordination might be preferable to spot market. Obviously, this is just a general statement, and it is not necessarily true for each specific transaction. However, this perspective explains why coordination is so important in today’s Agri-Food Value Chains. Let’s summarize what we discussed so far into three “take-home” messages. Coordination is the act of organizing people (or firms) efficiently. The notion of efficiency embeds a common goal and an efficient use of resources. Coordination is important for the production of quality food because of the complexity of consumer demand and the presence of design attributes. There are many forms of coordination. The problem is choosing the most efficient organization among those available. Well, this is all for Lesson 1 of Module 11: Introduction to Coordination. Thank you for watching this video. Next, Lesson 2 of Module 11: Contracts. Goodbye!
