Before I get started, let me just give a shout out to this amazing website that provides a really nice illustration of variations on the famous Prisoner’s Dilemma.
Ok, so the Prisoner’s Dilemma is one of my favorite thought experiments. Another of my favorite things is an article called The Nature of the Firm by Ronald Coase (1937). The article is about why people organize into firms instead of just interacting as independent contractors. It identifies a few factors that might determine why this happens and thus, efficiency limits on the size of firms:
- High transaction costs for each interaction with an independent contractor make it smart to hire employees
- High costs for getting employee contracts right, and difficulty hiring/firing make it better to hire contractors
- Limits on the abilities of managers can make it better not to hire employees (or grow firm size)
The Prisoner’s Dilemma postulates that there are certain benefits to cooperation. But these benefits may not be attainable in the absence of trust. One way to view an employee contract is as a (relatively) long term agreement to trust each other. And the more people can trust each other, the more they can achieve synergistic Prisoner’s Dilemma type benefits.
But the trust between employee and employer is limited. This is becoming more and more obvious, and it is a widely known fact (story?) that millenials are prone to hopping from one job to the next.
At the same time, technology is developing to reduce the transaction costs associated with independent contractors. The result is the growth in the gig economy.
But wait! One of my big concerns lately is that by nature, human beings are happiest when they are surrounded by a circle of trust. And I have lamented the fact that the modern economy tends to result in people growing ever more distant from each other, and in particular a growing separation between the people we work with and the people we care about. So do trends like the gig economy spell doom for human happiness?
Yes, kind of. But I believe there is something we can do about it. The solution has to do with both the Prisoner’s Dilemma and the Nature of the Firm. Specifically, we need to expand Coase’s set of economic forms from two to three:
- Contractor (contract covers single transaction)
- Employee (contract covers ~ one year)
- Partner (contract is permanent)
That is, the level of trust between employee and employer may be higher than that between client and vendor, but it is also less than that between true partners.
One of the main points of Coase’s paper was to explain why firms grow to the size they do (and not bigger). As mentioned above, the answer lies in a combination of transaction costs and managerial limits. But what limits the size of partnerships?
Well, as I have written about previously, I think the answer is that building true trust requires a lot of grooming. That is, it takes a lot of time and commitment to build a trusting relationship. So our partnerships are going to be very limited in size.
This circle of trust, which I have previously called the “inner circle” is essentially a small group within which you can truly take advantage of Prisoner’s Dilemma type cooperative synergy because you have a long term commitment. So in addition to trust, a prerequisite to forming an effective inner circle is something like synergistic potential, or complimentary skills.
In any case, I think the economy is best understood in three layers instead of two. A partnership, or inner circle, corresponds to a very limited group of people that trust each other implicitly. A Firm corresponds to people connected by relatively long term employee/employer relationships. And the external economy is comprised of arms-length contractual relationships. Perhaps there is a fourth level that consists of people you can’t even trust enough to engage in a contractual relationship (i.e., enemies).
In any case, a modern economy is typically made up of a bunch of interconnected firms and contracts between firms (and independent contractors). But what about partnerships? And I don’t mean anything like law firm partnerships. Believe me, I have seen those from the inside and they aren’t characterized by long term commitments of mutual trust.
Obviously, close partnerships exist in the modern economy. I know of a few people who have built businesses around them. They just don’t seem like a fundamental part of the economy. But what if they were?
In particular, what would it look like if an economic organization was built from the ground up to accommodate all three levels of economic exchange? One version (which is still pretty much hypothetical) is something I call a team of teams (ToT). I am not the first person to think of it, but my version goes something like this:
The basic constituent parts (i.e., the “cells”) of a ToT firm are teams. Each team consist of a few partners, a few associates, and perhaps a few interns or contractors (i.e., borderline team members). The partners are the core of the team, and their relationship is essentially permanent. The associates are employees, and they are engaged with the team on a semi-permanent basis (e.g., one or two years). In some cases, teams may engage in exchanges (for associates) or rotations (for interns) to increase firm connectedness.
The organization of the firm centers around a formalization of the relationship between various teams, rather than between individuals. The relationships between the teams can vary from firm to firm depending on the nature of the work.
For example, for professional services, the relationship between different teams may be rather loose, like the firm may provide a few basic services, and take a small portion of team revenue. In other cases, like when the function of the firm is to operate a huge manufacturing system (or produce and maintain a massive technology platform), there might be a more hierarchical relationship among teams.
In other words, a ToT can be organized pretty much like any other firm except that the unit of organization is a team instead of an individual, and the firm does not necessarily have the authority to break up and reorganize people within teams.
So there it is, a new kind of firm organization. Creating even one such team is a major undertaking, so creating a team of teams is a herculean task. But I think it would be easier if there were existing template for people to follow. That is, if it became normal for people to create permanent teams, it would be easier for any particular person to do it.
I have heard of a new platform that focuses on team-based hiring, so it is clear I am not the only one thinking about this kind of thing. That particular platform doesn’t require that the teams are anything like the permanent partnerships I have described here, but it is a step in the right direction.
Ultimately, I believe that team based firms can not only provide an opportunity to be more productive (because of all the lost Prisoner’s Dilemma type potential that can only come from engaging with people you trust), but it can also provide an opportunity to fight back against the tendency for the economy to become an ever more impersonal world that is not suited to our tribal psychology.
