Piero Mella

THE ROLE OF THE FIRM
IN THE CONTEMPORARY ECONOMY

Opening Lecture of the Academic Year 1988-89 at the University of Pavia

Index

• Preface. The Objectives
• Introduction: Systems of transformation and combinatory systems
• The endogenous and exogenous teleonomy of systems
• The universe in which economic behaviour occurs
• A fundamental event in the history of mankind: the separation between production and consumption. From self-production to production
• The role of production firms. The assumption of growing productivity
• Explaining productivity. The factors of productivity
• The risks of production. The firms
• The features of the modern firm: the firm as a financial and managerial transformer
• The role of the firm in the contemporary economy
• Conclusion: The future of the firm and of productivity
• Final greetings
  • References for further analyses
  • Notes

OPENING: THE OBJECTIVES

Rector Magnificus, Honourable Minister for Scientific Research, Officials, Honoured Guests, Esteemed colleagues and students, ladies and gentlemen,

in preparing these brief reflections on the role of the firm in the contemporary economy – that is, on our expectations regarding the role of the firm in today’s world – I have had to choose between two alternatives: to describe the role of the firm in the economic context and era in which we live, or to try and explain, not simply describe, what was, is, and presumably will be the role of the firm – that is of the profit oriented business organization - in the present phase of man’s evolution.

The first alternative would have made my task much simpler; in fact, I could have dealt with the topic with only two words: “Let’s look around!”.

The firm is certainly not the only wealth-producing institution known to man, but where and when it has existed – and looking back over time and space can only lead us to confirm this - well-being and “wealth” have been more abundant than elsewhere.

In particular, there are five “important phenomena” regarding the contemporary economy where the firm is viewed as a protagonist, and which can be observed by “looking around” (in this brief treatment I cannot deal with other, perhaps more relevant, phenomena):

1. there are evident disparities in well-being among countries equally well-equipped with resources and ingenuity; in some of these production takes place in the form of the firm, while in others in a non-firm centered manner;

2. in many countries where production occurs in a non-firm centered way, and in which there is a long-lasting lack of well-being, the firm arises spontaneously, with the government at times even officially introducing it into the economic system;

3. at the same time there are clear disparities in production efficiency among firms with the same endowment, in some of which production occurs in a business form while in others in a non-business form;

4. continuing with this parallelism, we can note that many production activities which institutionally are not carried out according to a business logic tend to be handed over to businesses and to for profit form. Examples are transport, telecommunications, education at all levels, and in some states even prison services … ;

5. finally, we can immediately observe that, in general, where firms already exist others arise more easily, and where a business network is lacking it is difficult to create such a network; instead there arise a “North” and a “South”, an “East” and a “West”.

The question that immediately comes to mind is: “How can we explain, if at all, such phenomena?”.

My answer depends on the following hypothesis: we must not view the firm only as a system capable of producing goods or services but as the center that supports to the maximum extent possible a more general phenomenon that guides the economic (and non-economic) fortunes of mankind: the phenomenon of productivity[1].

In my view productivity is the true phenomenon that has to be explained; the firm is only one of the means of production which is capable of supporting this phenomenon; but it has been the instrument which, compared to all the others, has accelerated to the maximum extent possible the growth in productivity.

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An introduction: systems of transformation and combinatory-type systems

To deal more easily with the topic it is useful to consider the “firm” from a systems perspective: each individual firm is seen as a system of transformation; firms, as a whole and in their mutual relationships, form a combinatory-type system.

Systems are ordered structures formed by elements that interact, in order to allow the system to produce a certain effect.

Based on the internal structure and the way they produce their effects, systems can be classified as:

1. operative systems of transformation,

2. combinatory systems.

Operative systems are systems made up of diverse parts (functionally differentiated elements) called “organs”, each of which is specialized in carrying out certain operations based on information; each biological individual represents the highest expression of an operative system; however, even a hair-dryer, a university, a large factory, a state apparatus can be observed as operative systems.

In particular, operative systems of transformation are those in which the organs are pre-arranged to carry out the transformation of given elements into others. The human mind that transforms information into operations, a mill that transforms grain into flour, or the giant corporation that transforms factors into production are all examples of transformation systems.We define as combinatory those non organized systems whose structure is composed of relatively similar agents, each of which produces a micro behaviour similar to that of the others. The macro behaviour of the system, as a unit, derives from the combination of the analogous behaviours of its similar agents, according to a feedback relation.

This internal feedback between micro and macro behaviours guarantees the maintenance over time of the system’s macro behaviour and directs the micro behaviour. When the system starts up “by chance”, it then maintains its behaviour “by necessity”, as if a Supreme Authority regulated its time path and produced the observable effects and patterns.

Firms, populations, ocean waves, a swarm of grasshoppers, the furious charge of a herd of elephants, the dynamics of a line of cars on the highway, spectators standing up at a stadium in response to those in the first row, can be viewed as clear examples of combinatory systems.

The behaviour of individuals gives rise to that of the system, but the behaviour of the system in turn absorbs, directs and conditions that of the individuals, almost as if a hidden director, an “invisible hand”, were guiding the micro behaviours in order to maintain the behaviour of the entire system.

I would like to continue on this particularly important point by giving a simple example: suppose we have a dance hall, and that the music begins, a beautiful waltz, and we take the floor to dance. At first all the couples are somewhat embarrassed since, dancing in a direction independently decided on by each couple, they begin to elbow, push and bump into each other; then, by chance, some couples begin to dance circularly, for example in a clockwise direction, thereby freeing up space. Other couples take advantage of the space to follow in the same direction, and soon all the couples on the floor adjust (they are “forced” to do so) to this tendency and end up by dancing in an ordered fashion, following a circular direction, almost as if a director had ordered them to do so. If “chance” had favoured an anti-clockwise direction, then “by necessity” the system would have shown the opposite macro behaviour.

How much simpler it would have been if an official master of ceremonies had from the start guided the direction of the dance![2]

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The endogenous and exogenous teleonomy of systems

We must, however, clear up another concept fundamental for our conclusions.

Systems are characterized by their “teleonomy”, and we can distinguish between endogenous and exogenous teleonomy.

This term is difficult to precisely define without making further considerations that would inevitably take us away from our topic. Very simply put, teleonomy can be considered as the feature of a system whereby it remains active in its environment; in the macro system it is a part of.

Endogenous teleonomy is the behaviour of the system whereby it maintains its structure; it is the effect of a behaviour undertaken by the system itself so as not to avoid disintegration.

Exogenous teleonomy, on the other hand, is the behaviour of the environment in keeping “alive” a certain type of system that the environment considers useful.

Human parasites have almost been eliminated, since they do not enjoy exogenous teleonomy. The environment has rejected them, even if … it is not difficult to imagine the effort of those small biological systems to remain alive despite the anti-parasite products … ; but they did not have enough endogenous teleonomy (despite the genetic mutations that have made some species resistent to anti-parasite products)[3].

With this minimum conceptual framework we can now deal with the role of the firm in the economy, and can already correctly pose the questions we will try to answer: if firms are operative systems of transformation that are part of a vaster combinatory system, then analyzing their role and function means searching for, on the one hand, those characteristics that move firms to remain in existence – by developing endogenous teleonomy – and, on the other, those that bring the economic system to accept them as instruments of production.

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The universe in which economic behaviour takes place

The “universe” that a scientist studies contains features that the scientist accepts without bringing them into question, features that are the essence itself of the reality that is to be analyzed, so that their absence would risk eliminating the object of study.

The physicist, for example, does not doubt the existence of the force of gravity or nuclear forces; without these there would be few phenomena to study! The biologist does not question the capacity of living organisms to reproduce, to try and perpetuate their species. Without such phenomena the object of biological studies would not exist.

Firms, as operative systems, act within a social-political-economic macro system in continuous evolution. Thus, let us ask ourselves above all what are the “forces” that guarantee the universe of economic behaviour its continuous movement, its continuous evolution.

We can list the folloiwng “basic postulates” of business economics regarding the “forces” that give rise to the universe of economic behaviour, without which this same behaviour and the firms which produce it would not occur:

1. man seeks the survival of his species, of the group he identifies with in terms of territory (nation, tribe), of the family and himself. This is the equivalent of stating that man is a “teleonomic being”; but this also implies that when man senses a threat to his survival or prestige, or to that of the group he belongs to, he becomes a “bellicose being”; as a result, even the entire mankind-system becomes a teleonomic combinatory system;

2. within the human collectivity needs and aspirations are unlimited, both as regards their number and type; in other words, we assume that man is “insatiable”; needs and aspirations are the fundamental motives behind all economic activity[4];

3. we tend to maximize the degree of satisfaction of needs and the degree of satisfaction of aspirations, and we seek social gratification (from “Great, dad!” to the “personality cult”, from the desire to excel at the Olympics to the pleasure from being on the cover of Time magazine; from the supercar to the 30-karat diamond); in other words, we assume that man is “ambitious”;

4. there are goods that have value (or, technically speaking, there is “wealth”); that is, there are scarse resources – in other words, they can only be obtained through production – that are desired by everyone. In other words, we assume that man lives in an ecosystem with limited and appreciable resources;

5. an economic behaviour arises aimed at production, exchange and the final consumption of wealth; in particular, man is willing to supply his labor to satisfy economic motives. This is the same as assuming that man is industrious (the existence of needs and aspirations, and the tendency to maximize satisfaction – since they represent intentional states – can only be assumed by observing economic behaviour)[5];

6. man always saves part of his wealth, and there are individuals willing to risk their savings by investing; this is the same as assuming that man is provident, enterprising and a planner[6];

7. man tends to maximize the ratio between the benefit from the consumption of wealth and the sacrifice required to produce it; this is equivalent to assuming that man is rational; in particular, rationality can be observed in work, since man tends to maximize the ratio between the benefit from “working” and the sacrifice this entails;

8. economic activity takes place entirely within organizations , in which specialized and organized work activity for production and consumption develops; production or consumption oriented organizations, and firms in particular, represent the means for man to operate in the economic field; this implies that man is a “social being”, and accepts to work within organizations in line with the information received and the social rules[7];

9. the “connection” between production and/or consumption organizations mainly takes place through “monetary exchanges” and “investment”[8];

10. individuals and firms are capable of having a scale of preferences for goods by means of value measures (it is not necessary for the utility of goods also to be quantified)[9].

In an observable universe in which needs did not exist, and/or the available “resources” were in excess, and/or man was not industrious, and/or not provident, or he operated in an isolated fashion, without carrying out exchanges, there would be no economic behaviour and, as a result, no interest in economic science.

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A fundamental event in the history of mankind: the separation between production and consumption. From self-production to production

After having examined the assumptions that guarantee the existence of an economic system, we must now ask ourselves: “How did the firm arise?”. Only after clarifying this point can we understand its function, characteristics and role.

We can assume that at the start of man’s economic activity consumption was primary.

Production – that is, the application of labor to obtain the goods needed to satisfy needs and motivations – was, though necessary, joined to consumption activity; production for the sole aim of meeting the consumption of the producer can be defined as self-production.

There is an important consideration to make here: since production requires labor, and labor is unpleasant (tiring, burdensome), then through self-production man produced only those goods he personally felt the need for and in the quantity just necessary for consumption (rationality hypothesis).

Why produce more than necessary for personal, family or tribal needs? Why toil more than necessary? Self-production was aimed at consumption.

How many farmers still today in our country cultivate a small vegetable plot for their own needs, and breed rabbits for their own consumption? How many of these cultivate or breed animals beyond the amount they believe they can consume?

Thus, for thousands of years productive acitivity has taken the form of self-production; but with the increase in population density in a given territory, and the improvement in transport and communications, man has realized it was more convenient to specialize in the production of a particular good, obtaining a quantity that exceeded what was strictly necessary for his personal consumption, in order to exchange the excess amount for other goods.

Productive specialization (the first breeding activity, the first agricultural areas, the first fishermen) thus gives rise to four important phenomena: the first, which is fundamental for “our” firm, is the separation between “production” and “consumption”: man does not directly produce the goods he feels the need for and does not directly consume the goods obtained, but produces goods that others will consume and consumes goods that others have produced; the second is the spread of “exchange”; the third is the creation of money as the means of exchange, and above all as the instrument for transferring over time the purchasing power; the fourth is the substitution of money for goods as the immediate object of economic calculations: money itself becomes “the” good to acquire by means of work and production (from means to end)[10].

Production thus undergoes a radical change: from a process aimed at obtaining goods with utility – that is, capable of satisfying needs and aspirations - it becomes a process aimed at obtaining goods possessing value: that is, goods that must be requested, desired by some consumer. Thus, thanks to money the value of goods can be quantified by means of prices. With production we not only obtain goods which are useful, but wealth – in other words, goods possessing a value which is monetarily quantifiable.

Man begins to aspire toward well-being, for which the availability of money, even more than of goods, often becomes the index held to be most significant[11].

As a consequence, the production firm appears as a system of transformation, where two fundamental transformations are carried out:

1. a productive transformation, where the utility of goods is produced by means of labor;

2. an economic transformation of factor values (costs) into production values (revenues); production, in terms of monetary values (or exchange in the case of barter), brings into the firm the monetary resources that it distributes (still by means of prices) to the factors of production. The economic transformation thus concerns value and occurs by means of prices.

But according to a fundamental postulate – man is a planner – individuals do not consume all the available wealth.

The spread of production and the use of monetary payments facilitates saving and investment; this leads to the formation of capital. Originally the latter took the form of goods with value, derived from past labor, accumulated in manufactured items, subtracted from consumption, and reutilized in the production process. Then, thanks to the ability of money to transfer values over time, capital was transformed into monetary capital, to be accumulated and managed.

With the availability of such capital the manufacturing firms can thus more easily be created, quickly expand, and even multiply; very soon there is a sufficient number of such firms to give rise to the combinatory system of production units and to allow these to develop.

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The role of the production firm. The hypothesis of growing productivity

We have looked at the birth of production firms; but what is their role? To understand this we must consider the characteristic aspect of production: productivity.

This phenomenon, which perfectly reflects the rationality hypothesis, is the tendency to increase the ratio between the quantity of wealth obtained and the quantity of labor employed to produce it (in general terms, average productivity can be measured by the ratio of the quantity (or value, if quantified) of the goods produced to the quantity of the labor employed).

The cost of production depends on productivity: the higher productivity is, the lower is the cost of production.

Thus productivity is simply the measure of the degree of efficiency of the production firm, where the latter is understood as a productive system of transformation (or better yet, productivity is a function of the degree of efficiency of the productive transformation of labor into production).

From the above we can immediately observe that production – understood as an economic phenomenon – occurs only if the “producer” , through the production firm, can lower the cost of production below the limits of the cost of self-production for the other “consumers”; that is, if there is greater productivity in production than there is in self-production[12].

Nevertheless, in the combinatory system of production firms each firm can exist – and it is here where endogenous teleonomy manifests itself – if it produces at a level of productivity which is not below that of the other firms; and every production firm “tries” to continue along by attempting to improve its efficiency, and thus its level of productivity.

We can now understand what was, is, and, most likely, will be the role – that is, exogenous teleonomy – of the production firm and of production itself: to obtain ever higher levels of productivity.

The micro behaviour of every production firm – to try to achieve ever higher levels of productivity, and thus efficiency – determines the macro behaviour of the entire combinatory system of production: raising the average productivity of the system.

The increase in productivity becomes the dominant feature of the entire economic scenario; it is institutionalized. In fact, I would not hesitate in defining it as a true theoretical hypothesis of how man’s economic behaviour operates: the hypothesis of growing productivity, according to which economic behaviour in production tends to achieve ever greater productivity, while itself being governed by the continuous increase in productivity[13].

This increase in productivity manifests itself not only through an increase and spread of wealth, an improvement in the quality and variety of products, a shift from an economy that satisfies needs to one that satisfies aspirations, but also, and perhaps above all, in the gradual reduction in the average time dedicated to work and an improvement in the conditions of work. Only a century ago the reduction in the working day to 12 hours a day 6 days a week – and a further reduction to 10 hours for children – was considered a great social achievement. Today in advanced industrial countries the objective is a 5-day work week of 7 hours a day (and there is a continual increase in part-time work), while education is now obligatory until the age of 14. Perhaps tomorrow’s problem will be how to manage our free-time … , a problem to which I will return later.

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Explaining productivity. The factors of productivity

However, this naturally raises a question: what does productivity depend on?

If we define “factors of productivity” as those elements that can increase productivity, then these can be grouped into three classes:

1. passive factors, which influence the quantity produced given the amount of labor; all this can be taken in by the concept of the fertility of the environment in which labor is supplied;

2. active factors, which reduce the quantity of labor given the quantity of production obtained; these are: the skill of the worker, the equipment, and the organization;

3. psychological factors, which affect the desire of the worker to take part in the production activity; these are: motivation, (that is, the expectation of favorable results, of advantages), and satisfaction (that is, the actual attainment of results and the concrete achievement of advantages).

Without question the first factor of productivity was the natural fertility of the land – from hunting grounds to fishing grounds, from places favoring tourism due to the snow and sun to those abundant in uranium or oil – so much so that as a result of this there arose the two most deeply-rooted institutions of all time and place: property and inheritance.

Empirical observation shows that where the economy is based on self-production, property is non-existent or limited to only a few pieces of production equipment. Native American Indians had no concept of the ownership of the natural environment they lived in before contact with the White Man, just as property does not exist among Pygmies today, if we exclude the territories (property claimed by the tribe and not individuals) and the equipment needed for self-production and consumption processes.

There is also no property in those communities that strictly pursue spiritual ends, as in cloistered monasteries of Buddhist communities.

But the idea of property is widespread today in all sectors (“Don’t enter my office and don’t use my computer”, says the clerk, even if the property claimed does not belong to him … ) and is often confused, or joined with, the idea of “belonging” (“my” institute, “my” factory, “my” university porter, “my” messenger-boy … ).

Fertility has given rise to, and continues to do so, great amounts of capital (from those that have made possible the building of the pyramids to petrol-dollars).

Even today the search for fertility is easily observable: studies on inexhaustible energy supplies, biological and bio-engineering to select– or even create – high-yielding edible vegetable and animal organisms.

Skill competes with fertility for first place among the sparks to productivity; the subdivision of the productive functions – hunting, fishing, fruit gathering, and so on – was the consequence of the various skills of individuals.

Skill thus leads to specialization and to the search for discretion in transmitting the acquirable skills: from art and trade workshops to post-university courses, from guilds to patent offices.

Equipment – the artificial expansion of the limited hardware represented by the human body – is an ancient discovery (from the first honed rock to the first wooden plough), but its extensive use in production firms dates to the Industrial Revolution, which occurred fewer than 10 generations ago.

The need for equipped labor has given a strong impulse, and was perhaps even the originating cause, to technological research and, in parallel fashion, to scientific research, with an exponential growth in discoveries and inventions.

The last effort, in chronological terms, to increase productivity was the organization of work (of work processes) and of the worker (the individuals who supply labor).

The organization is the most surprising of modern phenomena; it creates substantial productive synergies, since it leads to the formation of operative systems made up of individuals who carry out specialized functions: the organizational (or organic) structures.

The organization brings together various skills, specializing them into functions carried out by organs that live on, though with a continual turnover. Skills are passed on and survive even beyond the lifetimes of the individuals.

The organization creates rules which, when respected, suffice to advance productivity. Productive activity is depersonalized; it is no longer carried out by man as an individual but by the organizational structure of the firm the individual operates in based on the rules of organized labor.

The organization creates coordination, collaboration, learning (the transmission of information), incentives, and emulation; these elements, taken together, provide an identity to the individual within the organization he belongs to and makes the success of the organization a condition for his continuing participation.

Moreover, the logic of organized labor is such that productivity is also enhanced by the contribution of those who join the organization only for pecuniary reasons, because they desire to engage in pleasurable work, or because they simply want to find social gratification.

The consequence of organizations is the inevitable (and more or less intense) gradual separation of the act of working from the productive outcome.

For this reason we must solve the problem of providing incentives to the individual worker to participate in the productive organization.

Pertinent here are thus the last two elements of productivity: endogenous and psychological factors.

In fact, no individual offers his labor, despite a fertile environment, an innate or acquired skill, suitable equipment, and an efficient organization, if there is no prospect of advantages, gratification, and if, a posteriori, these prospects are not realized.

Motivation and satisfaction are the most difficult factors of productivity to achieve. Within the organization these can be adequately developed, but coercion has never been able to supplant these for very long[14].

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The risks of production. The firms.

In the above analysis I have spoken of production organizations as economic units that produce organized work in order to efficiently carry out productive transformations.

But what are firms? Are they the same as production enterprises?

We define firm as a production organization having the following features:

1. they carry out production activities clearly separated from the consumption activities of the individuals or the organizations that operate or that supply factors or production;

2. they carry out an economic transformation, based on prices, by selling their production in the market;

3. they bear two important production risks: the demand risk and that deriving from competition (that is, they operate in “markets”)[15];

4. they seek profits as the economic condition for their existence;

5. they seek maximum productivity as a condition to achieve profits[16];

6. they autonomously acquire the resources needed for their existence and have a lasting presence, since their endogenous teleonomy forces them to preserve the values invested in them;

7. they enjoy entrepreneurial autonomy in the choices concerning productive combinations, in the sense that the decisions to acquire factors, to transform them, and the sell their production does not have to be subordinate to the achievement of the goals of other firms or organizations, and management can carry out whatever actions are necessary (within the limits imposed by the social-political system) to structure a controlling organization[17].

When all of these features are not present the production organization or enterprise cannot be defined as a firm.

In particular, enterprises that operate without being able to autonomously carry out the management operations necessary to deal with the risks from demand and competition are not considered firms.

Let us now analyze the demand risk.

Since we have defined production as the activity through which goods and services are obtained which will then be sold to other consumer concerns, it is clear that production firms can continue to exist only if there is a sufficient demand for their products. Demand risk is an economic risk, since it is not enough to find people who require the produced goods, because they consider them useful; it is necessary that they attribute to goods a value which exceeds that of the factors that the firm has consumed in the production processes: in other words, the cost of production.

The demand risk is related to the degree of consumer freedom; that is, the possibility for the consumer to determine his own scale of preferences and to make use of the necessary information to freely choose among the products offered by the various production firms.

The competition risk, on the other hand, is connected to the fact that every production firm is subject to competition from other firms that can offer the same, or similar, products, on more favorable terms.

The risk of competition is related to the degree of freedom of economic initiative; that is, the possibility everyone has to create a production firm to satisfy the needs and aspirations according to the consumers’ scales of preferences (or to influence these).

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The features of the modern firm: the firm as a financial and managerial transformer

Today firms, though subject to the same logic as enterprises in the Middle Ages and during the Industrial Revolution, present two important characteristics which it is important to point out:

1. in addition to being productive and economic transformers, firms tend to become systems of financial transformation, financial transformers;

2. in addition to being instrumental systems, they become teleological systems; that is, systems of managerial (entrepreneurial) transformation.

The first firms operated with little capital, which represented a patrimonial investment undertaken and managed “for profit”, and directly controlled by a capitalist entity; this gave rise to the great industrial dynasties[18].

Thanks to the raising of large amounts of capital from modest shares of monetary savings by a large number of consumption concerns; thanks to the investment of this capital made possible by the creation of joint-stock companies, on the one hand, and financial intermediation, on the other; and thanks also to the effect of the “natural” expansion of capital for the continuous reinvestment of the operational cash flow from revenues and ammortization (the Lhoman-Ruchti effect), and that of self-financing (retained earnings), capital became relatively abundant – and flowed unendingly at the international level – so that the real problem today for economically “healthy” firms (those with autonomous economic efficiency and conditions to maintain this over time) is not so much to produce as it is to maintain the soundness of the capital invested in them. Capital is kept sound over time if it preserves its purchasing power and offers a financial return (interest or dividend) equal to the average return from other investments under conditions of similar risk.

Since the existence of profits means that capital has a yield, profits are not only a consequence of the firm’s efficient activity. Minimum levels of profit represent the condition for the existence of the firm itself, since they represent the condition for maintaining the soundness of the capital invested in the firm. For this reason they become the objective to achieve by means of the search for profitable production[19].

As we can see, the cycle is inverted: when capital was relatively scarse it was sought after to carry out and maintain production; with a relative availability of capital permanently invested in the firm (better yet, with capital that usually cannot be disinvested) it is instead economically-profitable production which becomes necessary to keep capital invested.

As a result, firms tend to become financial transformers; that is, “containers” of capital that from time to time invest and disinvest in businesses with a high revenue/cost ratio (ratio of economic efficiency) in order to have an adequate return.

Together with the increase in the size of firms (the effect of the hypothesis of growing productivity, which we do not have time to demonstrate here) there has also been a rise in the need for, and thus in the power of, managers.

Along with the appearance of managers who are distinct from “owners”, and who manage the capital of those who do not have the power to intervene in a management role, we have seen the well-known phenomenon of the formal separation between the ownership of capital and the control of the firm.

Firms have been transformed from instruments for producing remunerations and profit (financial transformers) into organizations where various groups satisfy their own institutional interests; organizations that see the creation of remunerations and profit as the condition for their existence in the combinatory system.

We come now to the second important feature: firms become teleological systems of entrepreneurial transformation; that is, systems (organizations) having autonomous profit objectives, able to act with reference to units capable of existing autonomously, with decision-making power, and with internal control aimed at the achievement of levels of efficiency needed for their preservation. Firms, as autonomous organizations, become systems differentiated with respect to the factors of production, and in particular to the suppliers of “risk capital”[20].

But even more importantly, firms become systems truly possessing endogenous teleonomy that tend to feed the system with their teleology, which is “necessarily” directed toward efficiency.

Let us see how.

We have seen above that firms can increasingly be considered financial transformers: instruments for the investment of capital; capital that management must keep economically integral through a continual flow of investments and disinvestments in support of productive activities with a certain amount of risk.

Technically speaking, firms are increasingly transformed into “business portfolios”; that is, into “containers” of productive activities involving given products for given markets, with the aim of obtaining profits from each business.

Management, on the basis of an accurate system of information and forecasts, and accepting a given degree of risk, continuously modifies the makeup of the businesses in its portfolio, eliminating low-profit ones for others with a higher profit. The type of production carried out in each business is not very relevant for the entrepreneurial and financial transformation: cars can be produced alongside of newspapers or hospitals; computers alongside of food firms; agricultural products alongside of chemical ones; and so on.

Nothing gives a better idea of the firm as a portfolio of businesses than the large diversified groups.

But this is not all: from a financial perspective each business is important not only because it yields an annual profit but because it can be sold, thus producing a capital gain.

There thus appears a new economic agent: the “business negotiator”, whose goal is to achieve a capital gain; this agent is known as an “entrepreneur-financier”.

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The role of the firm in the contemporary economy.

We can now finally see the role of the modern firm in the contemporary economy.

The firm represents the form that has historically responded to the desire for production: through profits the firm creates wealth, and those benefitting from profits can achieve a greater and/or better satisfaction of their needs.

A historical analysis shows that profits (in the same way as the yield from fertility which today is transformed into profits) represents one of the most powerful motivations for production, and thus one of the most important “endogenous” factors of productivity.

One the one hand, profits move individuals to risk their capital, investing it in productive activities; on the other, it is the strongest motivation for the creation of new businesses. Profit becomes a means for guaranteeing the remuneration and preservation of capital as well as an instrument for increasing the payments to labor (from job contracts to the recent Italian firms agreements) and producing a satisfactory amount of interest for the loan capital (from indexed securities to “futures”)[21].

As we have just seen, the freedom of the consumer and competition among producers guarantees that profits will occur only if the firms succeed in possessing the factors of productivity, which thus also become factors essential to profits. This makes it vital for firms to create new businesses, explore new markets for their old products, or invent new products for old needs (solar cells to heat water and ? ) and new needs (antipollution purifiers); and above all, goods to create new aspirations … (from automatically-adjusting car seats to wall-length televisions).

The need for profits obliges the firm to rationalize its technical processes of production and management control (from the Decision Support System to Just-In-Time production), thereby favoring applied scientific research and technological innovation, and improving product quality while reducing price, which permits efficiency to expand throughout the entire combinatory system.

The endogenous teleonomy of the firm viewed as a business portfolio obliges the firm to maintain integral the invested capital and to increase it, along with the necessary increase in the size of the firm.

Its teleology resides in the ability of management to independently decide on the makeup of the business portfolio, on the basis of hypothesized environmental scenarios and the acceptable risk threshold.

In order to produce adequate levels of profit, in order to remain in the combinatory system – which tends to become international, if not “global” - firms, as systems of entrepreneurial transformation, can, rather have to, follow one of the following two paths:

1. increase productivity: in other words, search for productive or transformation efficiency;

2. increase their “contractual strength”, with the possibility of controlling prices; that is, seek external or negotiational efficiency[22].

The second path, the increase in selling prices or the reduction in purchasing prices, is difficult to pursue: the freedom of the consumer, anti-trust laws aimed at guaranteeing the liberty to take initiatives, economic incentives for restructuring, associations of workers and consumers, and so on, are roadblocks along the way over the long run.

There remains only the first path, the steadier one, the one the hypothesis of growing productivity foresees as long-lasting: the search for the economic efficiency of the businesses through an increase in internal efficiency, in productivity.

“Never before throughout history has the problem of productivity raised so much interest. Until recently it was only an economic problem; now it has become a serious political problem, since it is one of the most critical aspects of trade relations among nations. At this point we would be truly happy if the Toyota production system, which we have created, could be useful for solving the problem of productivity”. This is a quote from Taiichi Ohno, the creator of the just-in-time production system[23].

And who does not somewhat fear Japanese productivity?

Once again we have to take into account the combinatory system: the search for internal efficiency, the increase in productivity, implies a pursuit, an infinite feedback among firms in order to survive[24].

But is this search for efficiency a cause or effect of the law of increasing productivity?

There is one crucial question: why does man desire wealth, and ever greater wealth, for which profit today is only one of the most powerful impulses and motivations for obtaining it through the firm?

However, to try and explain the reasons why people long for “wealth” and desire profits lies outside the observable universe of business economics; it is like asking why we like a car that goes 180 miles per hour, a $100,000 watch, or a $50 million painting: certainly not only because they better satisfy our needs for transport, to be on time, or better occupy our free-time!

These are psychological more than physiological reasons, and fall into the field of study of sociology and anthropology. But they represent very powerful motivations, considering that already 20 centuries ago … it was easier for a camel to pass through the eye of a needle than a rich man to enter into the Kingdom of God … unless … the rich man had gained his wealth by investing the talents the “Lord” had given him; and only a strong spiritual enlightenment can produce another St. Francis.

[Index]

Conclusion. The future of the firm and productivity

I will begin the conclusion by going back to the initial questions we posed:

1. Why are there evident disparities in wealth among countries with differing forms of production?

2. Why have many countries tended to introduce the firm into the economic system?

3. Why also are many forms of production that institutionally are not carried out according to the logic of the firm characterized by low levels of efficiency?

4. Why do firms arise where others already exist, and where a network of firms is lacking this network fails to appear?

I shall leave it to you to answer these questions.

An increase in productivity follows the logic of production, but the impetus provided by the search for well-being, for wealth, and for profits accelerates this phenomenon. It is easy to understand that inequalities in productivity derive from the differing weights by which the factors of productivity operate, and in particular the factors of organization and motivation.

Certainly production in the form of the firm is still considered to be useful today, since this leads to the efficient production of remunerations (wage, interest, rent, profit). And it is precisely here where the endogenous teleonomic strength lies, which moves firms – and more generally production firms – to maintain themselves in the economic system by means of their teleology. Moreover, firm-based production allows the system to increase its productivity, leading to a general increase in well-being. Here is where the exogenous teleonomic force resides that moves the system to try to maintain itself, to expand, and, in some cases, to introduce firm-based production.

However large the wealth that is produced, however vast the quantity and quality of needs that “productive man” manages to satisfy, the logic of production says that productivity will increase further, and the logic of wealth in particular makes this progress vital for the economic system and for all of mankind.

The axiom of insatiability guarantees the system the energy necessary for further progress.

The firm seems to be the instrument for this progress, at least until other forms of production organizations succeed in carrying out productive and economic transformations which provide sufficient motivation for obtaining efficiency from labor and the use of capital, in the context of a controlling organization (with a consensus that generates collaboration), not one that is controlled.

But for this to occur the firm must have exhausted its reason for existing as a propulsive element of productivity.

When, and if, this moment will arrive is impossible to predict.

On the other hand, the exogenous teleonomy of the firm is stronger than ever.

Wealth, it is true, is not possessed by everyone; today it is distributed in quite unequal ways and amounts. The opulent North and poverty-ridden South represent painful realities that heighten social tensions.

But wealth is inevitably destined to spread, even if the expansion of productivity is unequal in nature and, what is more, has existed as a consistent phenomenon only for a few generations[25].

Perhaps within a few generations the globe could be transformed into a huge productive enterprise capable of providing benefits to all, and whose operational logic could be different from that of the firm.

But trying to forecast today the future spread of wealth and destiny of the firm 100 years, or even one generation, from now would be like trying to predict the weather in a year’s time by simply observing for one minute the movement of the clouds from the window of our house.

Scientific research and technological progress, made possible and necessary by the need for the growth in productivity, have reached levels that allow us to foresee the possibility of an extreme increase in productivity, which will result in the absence of a need for the majority of human labor; much production will tend toward the ideal of “zero cost” (today you get a free radio for buying a few cookies; how much marmalade will we have to eat tomorrow to get a free computer?).

At the theoretical level Turing and Von Neuman have demonstrated the possibility of realizing self-replicating robots. At the applied level, progress in the science and engineering of systems has led to the creation of robots capable of carrying out complex activities, guided by systems (and not too sophisticated ones at that) of electronic programming.

It is not difficult for artificial intelligence to convince us that it is not pure fantasy to believe in the feasibility of the production of robots by other robots, as part of a closed technological chain, and the use of such robots in automated production systems with cybernetic controls.

Even now in large-scale North American farming ploughing, seeding, and threshing is done almost entirely without human intervention, by means of agricultural machines guided by underground magnetic tracks; even now large ships plough the oceans guided by satellites; and even today there are international expositions of automatic plants. And robots have only just begun to appear on the stage of productive transformation! Perhaps the real problem for tomorrow will be to manage our free-time, the maximum expression of man’s freedom ...

But will man be able to overcome boredom? To reach cultural levels that allow him to abandon the obscure systems he has always thought up and which today’s increasing productivity has made abundant?

But, above all, will man reach such levels in time?

Like productivity, pollution (and, in general, the impoverishment of our ecosystem) is growing, transforming into scarce resources those which until yesterday were held to be abundant or self-reproducing. Unfortunately, the law of increasing productivity has not spared the production of arms; on the contrary: growth is greater here than in any other sector… as is guaranteed by the axiom of the teleonomic man.

And even if pollution allows us to make it to tomorrow, the first postulate of human behaviour, in spite of ourselves, states that man is bellicose …

[Index]

Final Greetings

Rector Magnificus, Esteemed Guests, Colleagues, Students and patient audience. I have concluded my simple considerations on the proposed topic.

I urge you not to consider these statements as value judgements.

I leave any moral, ethical and political judgements to other disciplines; I leave it to other forms of knowledge to make judgements on wealth and poverty, on earthly needs or transcendental aspirations, on cereals and citrus fruits that are thrown away, on children that die of hunger, on public or private enterprises, on socialization and privatization, on collectivist or capitalist regimes, on morally useful or reprehensible production, on unemployment or inflation, on space lasers and shields, on protectionism and car and wine wars … , on the good or the bad, the selfish or the altruistic, the private or social use of skills, fertility and technology.

As a researcher I observe and theorize, not judge.

As a man I have many hopes, since “the” science I believe in tells us that all social combinatory systems can be directed toward political and moral objectives which are consonant with the human spirit. The dynamic of the system, though feeding the micro behaviours of its elements, is also fed in turn by these behaviours; and thus it is possible “to govern the system” by setting rules for the micro behaviour.

Even the production combinatory system can be directed toward desired objectives by setting clear and stable rules – above all, just ones – for the behaviour of the production units, in particular the firms, as well as that of consumers.

As a man I hope that the direction of the system is enlightened, or at least humanely rational.

But of one thing I am convinced: in the context of the postulates of human behaviour, no matter what rule is set for the system, it will always act or react according to the hypothesis of increasing productivity, unless the rules are such as to inhibit the factors of productivity.

[Index]

Further References

The main topics in this inaugural speech have been subsequently dealt with in:

P. Mella, Economia Aziendale, Utet, Turin, 1992

P. Mella, Dai sistemi al pensiero sistemico, FrancoAngeli, Milan, 1997

P. Mella, Razionalità e libertà nel comportamento collettivo, FrancoAngeli, Milan, 1999

See also the following sites, edited by the Author:

EconomiAziendale2000web

Combinatory System Theory

[Index]

Notes

[1] The hypothesis follows the observational logic of Business Economics; this discipline, which seeks models and sets out rules for the rational economic behaviour “in” firms, and as a result develops models and norms for the effective and efficient behaviour “of ” firms understood as operative systems designed for optimizing the production and/or consumption of wealth.

[2] Combinatory systems can often be described as models that represent the relationship between micro and macro behaviours. Who has ever been in a crowded place will have witnessed the phenomenon of the “rising buzz”: as soon as the place is sufficiently crowded a buzz arises that slowly increases and is inevitably transformed into a deafening noise. How can we represent and explain this?
It is very simple: the place represents the environment in which the combinatory system composed of individuals operates; the latter, wishing to communicate for personal reasons, begin to talk to each other, thereby creating a buzz.
The murmuring represents each person’s micro behaviour; the buzzing is the effect of the system, the macro behaviour that refers to the entire unit. The buzz – the effect of the system – stops those who are murmuring from hearing and being heard, and they are thus “forced” by the system to raise their voice, thereby producing individual micro behaviours. If the voices are raised, the buzz increases and the voices must be further raised … until they are transformed into a deafening sound.
The effect of the system – that is, the buzzing – conditions the micro behaviours; that is, the volume of the voices of those present, even if it seems that it is the micro behaviours that create the buzz.
We can describe this system by the following simple model (we have omitted time references in order to make the model clearer):

D VOLUME OF INDIVIDUAL VOICE = INTENSITY OF NOISE + DECIBELS TO BE HEARD

D INTENSITY OF NOISE = VOLUME OF INDIVIDUAL VOICE x NOISE COEFFICIENT

The first function describes the micro behaviour – the individual, to be heard, must speak at a higher voice volume than the background volume – as a function of the system’s macro behaviour, the background noise intensity.
The second function describes the macro behaviour of the system: the system produces a background noise, as a function of the micro behaviours; in fact, the background noise derives from the micro behaviours of those who, in order to be heard, have to speak in a loud voice.
The “macro” behaviour depends on the noise coefficient of the environment in which the system “exists”. In a locale with bad acoustics the noise coefficient would be greater than 1, and soon a noise so deafening would arise that people would stop talking; silence arrives!
If “by chance” someone begins speaking again, even only to say “Come on!”, then “by necessity” the background noise would start up again and the combinatory system would probably start to operate again.
In the cinema, which has sound-absorbing panels, the noise coefficient would be less than 1; if a buzzing arises it remains stable at an acceptable level.
This is the difference between the observational plan for business economics and that for the micro economy.
The latter mainly studies the behaviour “of” firms as “black-box systems”, dering behavioural laws without considering the knowledge about the “operational mechanisms” of such units; business economics, on the other hand, mainly considers the units under study as “white-box systems”, as “systems that can be opened”, searching for behavioural laws “in” firms in order to produce general behavioural models “of ” firms.

[3] I would like to note the similarity to the problem of the elimination of “useless institutions”: we can compare the effort of the latter (which apparently has succeeded) to remain in existence with that of the biological systems. The endogenous teleonomy of such institutions (retribution, power, usefulness for other institutions) is stronger than the exogenous teleonomy.

[4] The distinction between needs and aspirations is fundamental for explaining man’s economic behaviour.
We can easily see through self-analysis that man feels needs – that is, psychic-physical states of disequilibrium, unpleasant, present (or supposed to be) at a given moment, which are necessary to eliminate or avoid , as well as aspirations – that is, pleasant states to be maintained or heightened.
The desire for a fashionable dress does not derive so much from the need to protect ourselves from the cold as it does from the aspiration to be admired; we feel the need for a car (it would be more accurate to say the need for transport), but we aspire to have a Ferrari, even if many other cars would be able to satisfy the same need.
The distinction between needs and aspirations is difficult to make in a clear way, but one criterion seems appropriate: the intensity of the need decreases with its satisfaction, only to subsequently arise again; the intensity of the aspiration, on the other hand, increases with satisfaction (in order to cease, abruptly at times, when boredom arises).
The quality of our life depends on the number and types of needs and aspirations we can satisfy, and above all if we succeed in achieving this satisfaction.
One thing seems clear: while most needs are common to man, aspirations seem to vary more.
Until some decades ago, man, in those economic systems we consider advanced, managed to satisfy only his primary needs for food, clothing, protection from disease; and only a limited number of people could achieve their aspirations for culture, art, and free-time which today are now available to everyone.
Our quality of life continues to increase; the fundamental needs for our existence are satisfied, and there is ever more room for the achievement of our aspirations.
Almost everywhere today in advanced countries, hot and cold water come out of taps, and it is no longer necessary to get it from the well and heat it on the stove; light is available everywhere by simply turning on a switch; we can communicate in nearly all countries by simply dialing a telephone number. Basic needs are only a distant memory. But despite this man wants to further progress, and when his needs are satisfied aspirations suddenly appear: we want a mixing tap for hot and cold water, we desire sensors that allow us to turn on the lights simply by the sound of our voice, and we covet a video-telephone.
If the snow does not fall, we have artificial snow-making machines; if the summer is lacking in sun, we have indoor, salt-water pools even at the seaside. Aspirations grow not only in their intensity but also in number and quality.
Only natural disasters (earthquakes, floods, etc.), or human ones (chemical or nuclear pollution, etc.) appear able to remind us of the existence of oft forgotten needs: houses, roads, uncontaminated food.

[5] Very simply, we can state that we have an economic behaviour when man undertakes activities aimed at satisfying needs or aspirations.
In order to satisfy needs and aspirations we need to create work, normally in order to obtain and employ goods (material or non-material, or services), where by work we mean all unpleasant human undertakings – that is, which man would, if he could, avoid – by means of which the goods can be obtained and used for the satisfaction of human needs.
In technical terms, economics defines the activity of “obtaining” goods and services through work as production; that aimed at their “application” to needs as consumption:
Production and consumption are thus fundamental economic activities of man; they represent those activities by which he can satisfy his needs.
While production and consumption are “observable”, economic motives – needs and aspirations – are “intentional” elements and cannot be directly observed but only assumed based on the observation of man’s behaviour. It is necessary, however, to assume their existence in addition to simply verifying them from self-observation.

[6] Saving and investment are clearly distinct activities, even if investment assumes saving and saving (monetary) is indirectly transformed into investment thanks to financial intermediation.
Savings is the activity by which man does not fully consume the goods available to him in order to satisfy present needs, but destines a part for future needs. Saving is foregoing present consumption for future consumption.
Investment is the economic activity that consists in giving up the consumption of certain goods today in order to obtain a greater quanitity of goods in future. Investment requires a sacrifice today in order to obtain a future benefit, with a more or less elevated amount of risk.
A bit of grain is saved for future needs, and part of this is invested in new cultivations.
A part of income is saved to buy a house, or is invested to initiate a business activity in a firm.

[7] Production and consumption are not usually carried out by single individuals, but by organized and specialized individuals that make up organizations and firms.
Firms represent the basic economic units, where the fundamental economic activities of the production and consumption of wealth are developed independently and permanently.Labor is supplied to firms to produce goods (from the first forms of collective hunting to organized farming) or to consume these in order to satisfy needs and attain aspirations (from the household to the tribe).
We can now immediately distinguish between the for production organizations and the for consumption organizations.
Experience allows us to observe alongside of the production and consumption concerns the public composite concerns as well; public in that their activity is directly carried out by Territorial Public Entities (state, region, province, commune) or by entities managed by them; they are composite concerns because they carry out at the same time production activities (for example, they produce transport, road, and judicial services) as well as consumption ones (they satisfy the collective need for education, transport, roads, protection, and so forth).

[8] We thus see the chain of man’s economic activities appear, which are made up of five links:

® PRODUCTION ® EXCHANGE ® CONSUMPTION ® SAVING ® INVESTMENT

Production and consumption represent the basic economic activities; exchange, saving and invesment the complementary economic activities.

[9] Utility is an associated qualitative-quantitative dimension of goods and services that are identified by their ability to satisfy given needs and certain aspirations; drinkable water, for example, is useful in satisfying aspirations for prestige, but one might need a diamond to cut a sheet of glass or build a high-performance electric conductor.
Utility is a quantitative dimension, to the extent we accept some measuring procedure held to be efficient; otherwise it remains an ordinal qualitative dimension.
Value is an associated quantitative dimension for goods and services identified by their ability to be “demanded”; that is, “requested” or “obtained” by some person; the “value” is not identified with the “utility”, but depends on:

• the utility of the good (objective technical feature);
• the way it is obtained (originating characteristic);
• the destination: that is, the type and intensity of the need it can satisfy (subjective feature of destination);
• relative abundancy or scarcity (environmental characteristic).

Gold, for example, though having the same utility if used as a means of exchange, takes on a different value for the miser, who desires to accumulate it in ever greater quantities, or for the monk who has taken a vow of poverty.

[10] Even the relation between labor and needs is weaker, since money inserts itself between these two phenomena, which lengthens the chain of economic production; from:

® LABOR ® PRODUCTION ® GOODS ® CONSUMPTION ® UTILITY

the process becomes:

® LABOR ® PRODUCTION ® [GOODS ® EXCHANGE] ® MONEY ® [EXCHANGE ® GOODS ® CONSUMPTION] ® UTILITY

Thus the immediate relationships between labor and production in terms of goods are no longer highlighted, and only those between work and monetary remunerations are perceived, forgetting the fact that normally the labor supplied is nevertheless always inferior to the cost of the self-production of the goods the worker could obtain with this.

[11] The “miser” – who, in order to accumulate “wealth” does not satisfy his most basic needs – is the symbolic model of how powerful is the desire for monetary “wealth”; on the other hand, the collectionist – who, in order to purchase a “unique piece” is willing to give his entire capital and even go into debt for the rest of his life, living in the most absolute poverty just to be able to admire his “treasure” – represents the symbolic model of how powerful the aspiration toward non-monetary “wealth” is.

[12] From these considerations we immediately see that production – understood as an economic phenomenon – only occurs if:

1. the “producer” is able to lower the cost of production below the cost of self-production of the other “consumer” units;
   
2. an exchange relationship can exist between producer X and consumer Y by which X gives his production to Y.

Condition a) asserts that, in general, production takes place if:

C(B) < CA(B), [1]

Having indicated by C(B) the cost of production of a given good B, and by CA(B) the cost of self-production of that good, assuming that the cost of self-production is equal for all persons (if it were less for some people then it would be convenient for those people to produce the good themselves).
If we assume an economy characterized by barter as a form of exchange, then the difference between the cost of self-production and that of production derives from the greater productivity of the labor employed by the producer in production compared to that employed in self-production by the consumer unit.
We define “productivity differential” – or, more simply, total productivity advantage from the production of B - as the following difference:

CA(B) – C(B) = P(B) [2]

When there is a productivity differential for a given production process it could be convenient to institutionalize that process with regard to given economic units, in which labor, instead of being directed toward self-production for final consumption, is directed toward production to obtain goods to exchange with other units; thus there arises the production concern as a means of producing.
Let us now consider whether it is worthwhile for two traders, X and Y, to exchange goods B' and B"; B' is produced by X and B" by Y.
When it is ascertained that there is a productivity differential, then the exchange is advantageous for X if there is an “exchange rate” (price, if the exchange is monetary), p, such that:

C(B') < p < U(B") [3]

where C(B') is the cost of production of the production process necessary to obtain the good B' traded in the exchange, and U(B") is the consumption combination brought about by good B" received in the exchange.
Moreover, it must also be true that:

p < CA(B") < U(B") [4]

Naturally, this must also hold – in symmetrical fashion – for the other trader, Y, as well, for whom the exchange of good B" (necessary for final consumption) produced by means of good B' is convenient only if:

C(B") < p < U(B') [5]

and

p < CA(B') < U(B') [6]

Considering [3] and [6] together, and eliminating U(B') and U(B"), which are not quantifiable, it follows that:

C(B') < p < CA(B') [7]

Considering [4] and [5], after disregarding utility, we have:

C(B") < p < CA(B") [8]

This leads us to conclude that, after also considering the interconnected phenomena of “production”” and “exchange”, it must generally be the case that:

C(B) < p < CA(B) [9]

where as before B is a good obtained by a given production process.
If p < C(B) the producer does not produce; if p > CA(B) the consumer does not purchase, but produces on his own. [9] thus reveals how the exchange rate divides the productivity deriving from production into two shares:
1) the difference:

p – C(B) = producer’s advantage [10]

which represents, as we can easily see, the amount called income or profit, if positive;
2) the difference:

CA(B) – p = consumer’s advantage [11]

which represents the advantage to the consumer from consuming the production of others purchased at a price below the cost of self-production.

[13] The hypothesis of increasing productivity, being a theoretical hypothesis, can never be proved, only corroborated by positive examples, though it is capable of being falsified (in the sense of Popper).
The hypothesis of the gradual increase in productivity can be considered a particular case of a broader hypothesis (ontological) of continuing improvement (or progress).
Above all, we can state that an observation of “reality” appears to show the existence of three important hypotheses or laws regarding the origin of matter (but what is matter exactly?):

1. the law of disorder, or chaos;
2. the law of order, or of systems;
3. the law of improvement, or progress.

[14] In organizations (for simplicity’s sake we use this term to refer to organized structures) human work is undertaken according to the hypothesis of rationality (increase in the benefits of work and reduction in the sacrifice from working). Based on the form the rationality hypothesis takes, it is necessary to distinguish between two types of organization: controlling and controlled.
I define a controlling organization as one where the organization, through its control organs, succeeds in “directing” the rational behaviour of its workers for the benefit of the organization itself.
The organizational structure acts so that the worker, in supplying his services, continuously increases his efficiency and gains an advantage, so that he is motivated to further increase his levels of efficiency in order to achieve further advantages.
In these conditions the increase in the efficiency of the worker translates into a greater efficiency for the entire structure, and thus in an increase in business productivity.
Controlled organizations, on the other hand, are those where it is the worker himself who “subjects” the organization to his own rational behaviour.
In this case the worker gains the benefits of “working”, thereby impoverishing the structure; or, for the same level of benefits, he gradually reduces the quality and/or quantity of his labor.
In these organizations each increase in the efficiency of the worker normally translates into a reduction in the efficiency of the structure.
Modern systems of time, zero-based budgeting, quality circles, internal corporate ventures, and other modern forms of management, can increase efficiency only in controlling organizations; controlled organizations will oppose such forms of control.
“I’m in a meeting with the President”, says the sign at the desk in the government office where someone was working (so to speak) who, just a few moments before, was seated at the bar reading the sports newspaper. If after a half hour of waiting you give up and leave, know that that worker had a perfectly rational behaviour… in the context, however, of a controlled organization. Know also that that worker will, as soon as it is possible, ask for incentives based … on productivity.
The first and more lasting forms of controlling organizations were those where control was based on coercion. Today, while there are still areas where coercion is the only form of organizational control, such control occurs through collaboration.

[15] Production firms are subject to various risks that can be divided into three related categories

1. the technical risk of not being able to obtain the desired production due to factors connected to the carrying out of production processes; falling under this category are risks owing to chance events: the impossibility of getting supplies of raw materials, a breakdown of equipment, floods, unfavorable weather conditions, etc.;
   
2. the economic risk of not being able to sell the production; that is to say, the risk of a lack of demand and the related one of competition from other producers (“market” risks);
   
3. the financial risk of not being able to obtain a sufficient return on the capital invested in production (that does not maintain the economic-financial integrity of such capital) and not being able to disinvest this capital.

[16] Profit represents the result of the economic transformation carried out by the firm, a result, however, that is quantified from the point of view of the firm itself; it measures the increase in wealth from production.
If we view the firm as an operative system able to develop productivity, then we can easily see that the increase in productivity leads to a reduction in the cost of production.
In formal terms, the economic result of production is quantified by the difference between the exchange rate p(B) that the producer can obtain and the cost of production C(B). This quantity represents (unit) “profit”.
If for now we leave out the problem of the quantitative uniformity of the two terms, we can write in simple terms:

Profit(B) = p(B) - C(B) [1]

The exchange rate allows us to determine the “revenues” of the firm; indicating these by R(B) and by CM, CL, and CK the cost of materials, labor and capital employed in production (this distinction is typical…economics distinguishes between the factors Land, Labor and Capital), we can rewrite [1] as:

Profit = R(B) - (CL + CT + CK) [2]

However, as we have demonstrated in another footnote, the exchange rate has the function of separating the total productivity of the production firm into two shares: one of which is retained by the firm and the other for the benefit of the consumer.
We can thus interpret profit as the measure of the productivity obtained by the firm and retained within it, in that it is not passed on to either the “consumer”, by means of a reduction in the selling price, or the “factors of production” by means of increases in the payments to them.
For this reason profit is not a complete measure of the productivity and efficiency of the system, but only of the firm.
Let us assume that a firm produces at a cost of 80 and sells at a price of 100, thereby gaining a profit of 20.
Let us also assume that the firm sees an increase in productivity that reduces costs to 60.
If the price does not vary, then all the increase in productivity is transformed into profits, which increase to 40.
Nevertheless, part of this profit can benefit the consumer through a reduction in the sales price, let’s say to 90, and another can benefit the worker, let’s say by 15, so that the cost of production does not fall to 60 but to 75. The difference between the reduced price of 90 and the cost of production, which has fallen to 75 instead of 60, becomes 15, which represents the firm’s profit. This can be retained by the firm (self-financing) or given as payment to some factor of production (historically profits have been earmarked for an additional payment to capital).

[17] Firms are not always controlling organizations; however, the condition says that a firm does not exist if management does not have the possibility of “attempting” to structure a controlling organization.
This occurs, for example, in many public service production organizations, where socio-political constraints force manager not to control the work performance of subordinates. Inevitably the rational behaviour of the worker leads to a controlled structure. Observation confirms this.
Thus in order to have an “entrepreneurial” management of public service organizations it is not enough to give greater responsibility to managers and to allow “administrative autonomy”; it is necessary to create for management the conditions to form a controlling organization where the measure of efficiency resides in an economically measurable result (whatever name is given to this). Otherwise, in order to avoid risks, even the managers will respond in accordance with the rationality hypothesis.

[18] From this perspective firms are seen as a means of transforming a capital investment of K(t) into a quantity CN(t+T) at the end of the production cycle T.
Monetary resources are invested and are subject to production risks; profit is also monetary and is defined as the result of the investment: that is, as the increase in K(t) in period T;

Profit = K(t+T) - K(t)

The resources invested, K(t), are used to acquire productive factors for the processes; the acquisition costs C(T) arise, understood as the amount of monetary resources to recuperate at the end of the production process; the goods produced are sold and the firm can recuperate the monetary resources that were spent; earnings, R(T), arise, which represent the amount of monetary resources recuperated at the end of the production process; thus, profit represents the “measure” of the excess of the resources that are recuperated with respect to those spent to carry out the production processes, and can be expressed as:

Profit = R(T) – C(T)

We thus have:

CN(t+T) – CN(t) = RV(T) – CA(T)

This equation is now accepted as the foundation for the applied rules of all modern accounting theories. Based on this equation, profit can be viewed as the increase in capital due to management; however, it also shows that capital increases if, due to management, the firm earns a profit.

[19] We indicate by ROE (Return on Equity) the annual yield of the capital invested in the firm (ROE = income/capital).
The decision to invest capital, or to keep it invested in a given firm, should not depend only on the ROE it can earn in that firm, but also on the yield of the alternative investments that could be undertaken with that capital.
It is immediately evident that if a person, by investment A, can obtain a financial yield on his capital of 12% (ROE(A) = 12%), if he is free to invest as he likes and is rational, he will refuse any investment that has a lower yield.
Opportunity cost is defined as the capital earmarked for a given investment – also the implicit cost of the capital to invest – the yield offered by the best alternative investment.
Let us assume that investments X, Y and Z are possible, and that their yields are, respectively, ROE(X) = 12%, ROE(Y) = 14%, and ROE(Z) = 18%. Then the cost of capital for the person concerned is 18% (the highest financial yield).
This person will decide to invest in A only if ROI(A) > 18%.
We can show that capital remains financially integrity if it achieves an ROE at least equal to the opportunity cost.
Financial mathematics tells us that if a person invests an amount of capital K at rate i for an entire period of time (T=1), then the yield on the capital for that period of time will be:

R = K i

Given K and i we can determine the income R.
However, we can invert the equation and write:

K = R/i

In this case K represents the economic value of the income R, and K itself can be defined as the “economic capital” and represents the economic value of the firm.
A capital K is defined as financially integrity if it yields an average future income, R, such that if we calculate its present value using a rate equal to the opportunity cost of the investor we get the economic capital.
Thus, if we assume we have invested 1,000 $ to obtain an annual income equal to 110 $, the capital yields an annual ROE equal to 11%.
If the investor has an opportunity cost of 10%, then the present value of the investment income at this rate allows us to obtain an economic capital equal to:

K = (110/10) 100 = 1,100

In this case not only does the investment maintain financially integral the 1,000 of capital invested, but it increases its economic value 1,100, earning a capital gain of 100 with respect to the best of the alternative investments.
If the opportunity cost of the investor were 15%, the economic capital of the investment would be equal to:

K = (110/15) 100 = 733

In this case the investment would not be able to maintain the 1,000 of capital invested financially integral in order to obtain an annual income of 110.
Referring to the firm, the investor of the risk capital – that is, the person or entity that has provided his own capital, CN – expects that management will be able to maintain the value of this capital financially integral over time; this condition occurs when the firm is able to provide the investor with an income which is at least equal to that which can be earned from the best alternative investment.
From these equations we can thus deduce as the maximum managerial objective in firms considered to be financial transformers is the maintenance of the financial integrity of the capital invested in them.
Thus, in general, management does not set itself the general objective of “maximum profit”, but specifies desired levels of profit which are able to maintain the integrity of the capital invested in the firm.

[20] The modern firm can thus be considered an operative system of transformation, in which four transformations are carried out: 1) productive, 2) economic, 3) financial, 4) entrepreneurial, all aiming at achieving maximum efficiency.
This view of the firm can be represented by the following model:

[21] We must not confuse the problem of determining the propulsive role of profit in the growth of productivity with the ethical one of its distribution.
The first problem implied the question: “What are the consequences of the search for profit?”; I have tried to provide an answer in this paper; the second answers the question: “Who has a right to the profit; that is, the surplus in productivity created by the organized work which has not yet been distributed by the firm?”
Let us consider the second aspect: from a theoretical point of view this amount belongs to the firm, since, as we have observed, only it produces the synergies from organized work.
Profits can be retained by the firm and reinvested, thus giving rise to a process of capital expansion and a further increase in productivity; or they can be distributed by various means to the factors of production in the form of supplemental payments.
However, an analysis of the forms of profit distribution are outside the field of study of business economics.
The distribution of profit, as it is a distribution of part of the productivity jointly achieved by the employment of various factors, is in fact the consequence of the power relationships between the suppliers of the factors of production, and thus must be subordinated to the search for those who hold the most power in the firm.
Economic logic and the observation of reality reveal that, in principle, the distribution of profit is influenced by the scarcest factor, thus the most useful one, thus the most powerful one.
Historical observation demonstrates that distributed profit has benefitted those persons or entities who were the first to undertake production by employing some “productivity factor”; these, thanks to the undistributed productivity differentials obtained by employing such “factors”, were able to accumulate the necessary wealth to anticipate the capital expenditures necessary for production, personally assuming the economic risk of production, thereby becoming “suppliers” of capital. These individuals, having the capital necessary to “set up” an enterprise, assumed the role of “owners”, thereby creating, also through legal obligations, strictly controlled organizations able to produce with ever higher productivity.
Profit has thus been the object of a power struggle for its appropriation, a struggle which has pitted the capitalist-owners against the workers and has often concluded tragically.
With the increase in the size of enterprises – and above all with the spread of “joint-stock companies” – the power of capital to decide the share of distributed profits has been considerably reduced; more and more the scarcest factor has become managerial ability; on the one hand, there is an increase in the tendency to retain profits to favor expansion and security; on the other hand, there has been a continual increase in the share of profit destined for the other factors.
The famous “iron law of wages” states that wages would not have been able to exceed the minimum subsistence levels of the workers, and certainly this law is based on the observation that the first enterprises, being managed by the capitalist-owner, since they were organizations often controlled by coercion, were prone to retain the productivity surplus to use for further expansion, and the distribution of profits was almost entirely to the benefit of the capitalist-owner. The workers were offered a wage that tended toward the productivity of labor without capital; a payment that, without skill and organization, would tend to fall to the levels of productivity in the case of self-production.
Today, however, even workers receive increasingly greater shares of profits, since their power as a group has increased with the help of labor unions. Wage demands not only permit an increase in pay well above the levels of self-production, but also the destination of shares of the productivity surplus to workers as well, as the recent agreements involving leading Italian companies show (the OLIVETTI and FIAT agreements are clear examples of this, but in general pay incentives based on peformance are widespread throughout the small- and medium-sized firms).

[22] To clarify this essential point regarding this subject, let us go back to the model in footnote [20] and quantify the efficiency of the economic transformation (third box from the top); that is, the efficiency of the firm as a system for the economic transformation of costs (INPUT) into revenue (OUTPUT).
This type of efficiency can be defined as the ability of the system to maximize the gap between the positive economic flows (revenues) and the negative ones (costs); that is, to maximize the following ratio, which is defined as the ratio of economic efficiency:

Revenues (output)
E = -------------------------
Costs (input)

Recalling that revenues and costs are quantified by multiplying the quantities by their respective prices, the above ratio can also be written as follows:

Revenues                Quantity sold                Selling price
E = ------------- = ------------------------ x ----------------------
      Costs                Factors employed           Average unit cost

The first of the final ratios is the productivity ratio (physical) of the factors of production; this expresses the efficiency of the economic transformation (second box from the top in figure [20]) and is defined as the internal or combination efficiency.
The second ratio – that between prices and unit costs, indicates instead the capacity of the firm to negotiate to the “best extent possible” the production – on the outlet markets – and the factors – in the supply markets; for this reason it can be defined as the external efficiency, the business efficiency, or the negotiation efficiency ratio.
Just as the economic transformation depends on that of productivity, economic efficiency is a function of both the internal (productive) and external (business) efficiency.

[23] Cfr. Yasuhiro Monden, Just-in-Time Production, ISEDI, Turin, 1986, p. XXX (Preface)

[24] This conclusion can be represented by the following simplified model of the firm as a transformation system of efficiency into profits.
The inputs are represented by the selling prices, which are a function of external efficiency, and by the unit costs of production, which can be considered an important indicator of internal efficiency, since they depend on the productivity of the factors (we assume that the effect on costs of the external negotiating efficiency of the factors is negligible).

We read the model in the following way: when there is a variation in the level of expected profits, set as the objective (in the business programme), and the actual level of profits (output), then the firm must try to modify the inputs; that is:

1. try to increase prices;
2. and/or reduce unit costs.

The first type of measure is carried out by means of a search for “power” positions in the market (reduction of competition) and, as we have noted, this type appears strongly hampered by the combinatory system.
The reduction in production costs implies an increase in internal efficiency, which can be achieved through either a form of productive rationalization or “economies of scale”.
In both cases the business action can be favored by an increase in the size of the firm, as an attempt to gain a monopoly-type position as well as to carry out productive integration.
The search for efficiency thus favors an expansion in the size of the firm.

[25] The industrial revolution began less than two centuries ago. A century was needed before we could attain a modest but dignified life style.
During the First and Second World Wars the quality of life in the West, where firms were inspired by profits, underwent a considerable increase.
The destruction to the productive system caused by the Second World War was enormous, in some cases almost total, in the West as well as the East. Nevertheless, less than 10 years after the end of the war both Western societies – where the search for profit led to greater productivity – as well as Eastern ones – where the search for productivity is part of an order of priorities which are not always economic (“…Business is war!”, “Loyalty to the firm and obedience to one’s superior are duties!”) – have carried out the task of economic reconstruction, even though they emerged from the conflict practically devoid of capital, but with skilled labor, and today an “opulent society” exists in these countries.
The firm has managed to transform equipped and organized labor into wealth, through savings and profit, and has been able to initiate a process of expansion which is so rapid as to even be defined as an “economic boom”.

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