Organisation and Management, Bargaining Theory - Essay Example

Institute Section: A What do you understand by “Bargaining Theory”? Is it helpful to managers? Introduction Bargaining theory is one of the mostimportant theories in economics. According to the theory, parties bargain in order to find out the best solution that benefits all parties without worsening any other. This theory is more applicable in economics and its related subjects like business and management. In this question an attempt is made to see how bargaining theory helps managers. No business venture can be initiated without proper management. More precisely it would be pertinent to say that management is an avenue leading towards business success. The more efficient the management is the greater will be the organizational success. The section of organization in which individuals are responsible for decision making pertaining to the business company is commonly called management. Management section is headed by manager or managers depending upon the structure of the organization. They conduct decision making practices according to the organizational objectives and goals. Richard L. Daft and Patricia Lane, (2009), state that the attainment of organizational goals by planning, managing and utilizing the available organizational resources is called management. Realizing the significance of management, manager selection should be done with great care. This is because it is ultimately managers who integrate organizational staff in a friendly manner, motivate them and push them to serve the company in the best way. Mangers need some tools in order to conduct management. Bargaining theory is one of the important instruments that help managers make successful decisions. Bargaining theory facilitates managers to settle down the differences between various business parties with the help of bargaining tool. In order to utilize bargaining theory in a best possible way, mangers need to be innovative. With the power of innovation, managers are in sound position to bargain efficiently. This question is composed of two parts; in the first part bargaining theory will be explained whilst the second part will seek to highlight the usefulness of the theory for managers. Bargaining Theory Bargaining theory is an offshoot of game theory, which is a very central mathematical and economic theory in itself. In this part of the question we will discuss the theory of bargaining in detail along with its historical background. The theory of bargaining is derived from the concept of bargaining. Bargaining is a type of negotiation for price settlement between varying business parties. It is a situation in which business parties agree on the matter of cooperation but face a conflict on how to corporate. Bargaining is a desirable business tool because it provides a solution accepted by all business players i.e. employers and employees. For some academics the process of bargaining is very tiresome, however it can be shown as otherwise. Undoubtedly, bargaining process is time consuming but this consumption of time does not go in vain. Instead, it gives all business parties a concrete agreement by which successful transactions can be made. Various economists have presented different bargaining models like Edgeworth’s bargaining model, hicks’s model, Nash bargaining model and the Rubinstein model of bargaining, etc in different time periods. In this question we will understand the theory of bargaining under the light of above mentioned models. Edgeworth’s bargaining model Edgeworth presented his model of pure exchange in 1881 which is constituted with the help of indifference curves and preliminary endowments. According to Edgeworth bargaining will settle the trade between two parties owning different goods. A better price and trade benefits will be won by the party who is able to bargain successfully. Moreover, Hicks suggests that the exact outcome of trade is indeterminate but it can be predicted to a certain extend. Hicks’s model Hicks presented his simple bargaining model of wage in which he presented wage determination in the presence of collective bargaining and the possibilities of strike. Although Hick’s work was pioneer in this context but it did not receive sufficient attention. In his model he assumed that acceptable wage is a function of probable future strike duration. He constructed his model very simply with the help of employer’s concession curve and the resistance curve of union. In Hicks model the equilibrium is established when both parties make out the same strike (work stoppage) duration. A work stoppage is not appreciated by both parties so both will make concessions within their capacities. The Nash bargaining model John Nash presented his model in 1950, which remained the principal model of bargaining till 80’s. The Nash bargaining model is a game–theoretic model in which two business players reach various Nash equilibriums by employing different bargaining strategies. Moreover, bargaining can also reach a disagreement point which is a threat to the bargaining game. Nash equilibrium is a solution of a bargaining game played by players. This equilibrium solution is obtained when one player reaches a decision by keeping in view the decision of his opponent. Although Nash equilibrium is not necessarily the best solution all the time; it does provide a unique solution by narrowing down various options. The Rubinstein model of bargaining Ariel Rubinstein presented his model in 1982 in which he proposed that business parties’ take turns negotiating until an agreement is reached between them with their mutual consent. The Rubinstein bargaining model is the most appreciated model because the negotiation process that Rubinstein suggests is more realistic as compared to others. He suggested that the players in the bargaining game keep on gaming with the tools of offers and counteroffers until the agreement is settled. Moreover, all players of game have complete information. Significance of the bargaining theory for managers After having a detailed look on various bargaining models, one can say that all bargaining models are useful in bridging the gap between managers and other parties involved in the business. Basically, bargaining is an act by which all business parties can easily reach some mutually accepted solution. Decision making process regarding pricing is the most delicate part of management which requires good managerial skills. As stated in Hick’s model, the work stoppage is not a desirable situation for business parties. Therefore, bargaining is the most appropriate technique to reach some reasonable and mutually acceptable business solution. Stefan Napel, (2002), states that bargaining theories are composed of strategic interactions, which are taken with the help of game theory. The game theory is a theory that is composed of gaming and strategic decision making pertinent to a particular business. In the theory, management and employers make strategies in order to reap benefits. Napel, (2002), further states that parties involved in a business transaction solve their differences with the help of bargaining games. Bargaining games is a name given to techniques adopted by rational people to solve their problems in varying social set ups. Let’s hire an example to see how bargaining theory can be helpful for managers in devising their managerial decisions. Wage determination is one of the most fragile tasks of managers. Bargaining is such a tool with the help of which both parties i.e. managers and employees can reach a mutually suitable wage rate. Smith proposed that the bargaining strength of employers is greater than that of employees. This is so because the former can endure the loss of their income for a longer time period. In contrast to Smith, John Davidson suggested that wage determination depends on the bargaining strength of the parties. The bargaining strength is further influenced by various other factors and that is why wage determination is a very delicate task. Similarly Hicks is of the view that strike is not acceptable either by a firm or employers so both parties will bargain to settle on a mutually accepted wage rate. Similarly, bargaining theories also help managers to examine the point of view of labors as suggested in the Nash bargaining model. Both players reach a solution pertaining to the wage rate by making various strategies. Such strategies are made by assessing the actions that might be taken by the other party. In a word, the theories of bargaining are of great help to managers. They help managers’ in the decision making process. They need some instruments with the help of which they can perform their duties efficiently. This is the reason why bargaining theory is not only attractive to managers but to workers also. Managers try to fix a lower wage rate whilst laborers want a higher wage. By employing the bargaining theory, both parties can settle down on a mutually accepted wage rate. It would be pertinent to say that bargaining theory is an avenue to the appropriate business solution. Section: B Why do some organizations integrate vertically whereas others do not? Introduction In section B an attempt is made to understand why some organizations vertically integrate whilst others do not. And this cannot be done without knowing the meaning of organization and organizational structure in detail. A social unit pursuing a collective goals and objectives in any kind of environment is commonly known as an organization. Organizations vary in structure from one another on the basis of their objectives and available resources and environment. Organizational structure is a composition of those policies and rules upon which organization establish its authority and assign duties and rights to different individuals. An organization assigns rights and duties to individuals according to their qualifications, faculties and capabilities. The success of an organization greatly depends on the structure of the organization because it determines the extent of an organization. Organizational structure is usually based on hierarchy in which the Chairman or President are the top most people. Besides President or Chairman, other important seats are of the Vice President or Managers. The hierarchical structure of an organization can be illustrated as : The next step after having understood the definition of organization and its structure is to delve into the meaning of vertical integration. Vertical integration is a diversification strategy of management which is adopted by organizations to increase the financial growth and business efficiency. It is a diversification strategy because it is aimed at increasing organizational comprehensiveness and continuity. According to Inter-American Development Bank, (1998), vertical integration means a reduction in transactional cost by creating efficient organizational alternatives. Barry D. Leiyu Shi, Douglas A. Singh, (2008), states that vertical integration is achieved through the following ways ; joint ventures, alliances , ownership collaborations and service expansion, etc . This question will give managers a deep insight on when it is best to adopt the strategy of vertical integration and when it is better to avoid it. Why do organizations integrate vertically? Vertical integration is more successful in big organizations. This is because small organizations are not physically and financially in a sound position to handle business expansion which results from vertical integration. Organizations usually integrate vertically to reap economies of scale. The cost advantages obtained as the result of business expansion is commonly known as economies of scale. Andrew Carnegie was a steel mill owner from Pennsylvania, who later established his steel company named as Carnegie Steel Company. This company is one of the most common examples of vertical integration. Initially, Carnegie just owned a steel mill but when he grew his business he started reaping economies of scale in the form of greater steel production, extraction and sale. John Stuckey and David White, (1993), state that when bilateral trading loses its usefulness then the organization makes the decision of vertical integration. They do so in order to attain the coordination between the stages of industrial chain. Other benefits for which organizations integrate vertically are cost reduction and attainment of competitiveness. Although transactional cost reduces as a result of vertical integration, at the same time a handsome set-up cost is required for this integration which can only be borne by a financially strong company. Transaction cost is one of the most common reasons behind the vertical integration of organizations. A cost that is incurred in the process of economic exchange is known as transaction cost. Some economists opine that besides monopolies and economies of scale, the transactional cost is one of the most dominant reasons of vertical integration .Williamson, (1975), states that firms react to forces like rationality and opportunism, etc. by reducing transaction cost. And, vertical integration is the result of this reduction. The life of organizations greatly depends on the transaction and its cost. As the result of this dependence, the distinctive features of transaction also affect the form of organizations. Being well aware about the prevailing prices and market trends is known as rationality. It is assumed in transaction cost economics, that human behavior possesses some stingy courses which are revealed by intended rationality. However, this intended rationality is bridled up by cognitive limits. Opportunism is a name given to efforts that confuse or mislead, and further cause serious threats to contractual relationships of organizations. For some academics behavioral vagueness in transaction is the cause of opportunism. And this uncertainty affects organization along with asset specificity. Organizations are prone to opportunism in high asset specificity. As a result, they require protection. At this point, organizations plan to integrate vertically. This is so because after vertical integration, the market governance is replaced by unified governance, which is aimed at joint profit maximization. Durable investments with the help of transactions having low opportunity cost is known as asset specificity. It is a composition of all sorts of assets like physical, human and dedicated assets, etc. Moreover, it is higher with fixed cost as compared to variable cost. Additionally, some organizations integrate vertically to gain monopolistic position which is only possible if the decision of vertical integration is taken at appropriate point of time. Managers take the decision of vertical integration if the markets are extremely risky and unreliable. Moreover, companies also integrate vertically to create barrier for new entrants in an industry so that they can establish their power in the market. When any industry is going in decline, the weaker firms/companies leave the industry as a result of which existing companies can easily be exploited either by customers or suppliers. Normally, to avoid this exploration organizations integrate vertically. Price discrimination is a strategy employed by companies to reap abnormal profits. This strategy can only be applied by monopolistic firms. Therefore companies integrate vertically in order to increase their market extension. As a result, they would be able to make the best use of the tool of price discrimination. The above stated reasons are some of the very common reasons for adopting a vertical integration strategy. Why organizations do not integrate vertically? It is not necessary that every firm or organization decides to integrate vertically. Vertical integration, as mentioned before, is only possible for financially big organizations. Also, low budgeted organizations or firms prefer vertical integration because they cannot bear organizational inefficiencies. Due to the vertical integration the implementation and formulation of business and corporate policies becomes more complicated. Such complications cannot be handled by organization with small set ups and that is another reason why vertical integration is not a best option for them. Williamson, (1975), calls this inefficiency a loss of control phenomenon. Whilst Ferguson & Maurice, (1979), say that the lack of implementation of organizational policies after vertical integration is called managerial diseconomies of scale (DES). The indetermination of the degree of vertical integration between organizations is another main reason behind the non vertical- integration of organizations. The capacity and work load increase after vertical integration and small organizations cannot make balance between new and old activities. As a result, organizations have to bear big losses. Some financially strong organizations also do not integrate because they are already operating in an efficient market. There is no need to buy supply outlets if the market in which the organization exists is efficient. The organizations that integrate vertically in efficient market structure are in great self- deception. The technological developments in the information and telecommunication systems all over the world facilitate vertical integration between organizations. At the same time such advancements also decrease the transactional cost which is one of the prominent features of the vertical integration. When organizations reckon that they can obtain transactional cost reduction via advance telecommunication and information facility, they prefer not to go with vertical integrations. The organizations operating under condition of perfect competition choose not to vertically integrate as well. Those managers who make the decision of vertical integration in such kind of market have to face failure. This is because in such market structures, transactions are not the only things which are risky but the contracts required to overcome the risks are also very costly. As the strategy of vertical integration is difficult, risky and time consuming to adopt, managers of organizations are not readily open to it. A market is a complex place; therefore decision making pertaining to it also involves many technicalities. And that is why managers need to take great care while choosing to vertically integrate. Conclusion In short, the decision whether organizations should vertically integrate or not is one of the most delicate decisions that the manager has to make. In unnecessary cases of vertical integration potential benefits (competitiveness cost reduction, economies of scale and control over suppliers) can turn into monetary losses. Before vertical integration, managers should keep in mind the following things; set-up cost, effectiveness of coordination, transactional cost and risk. The set up cost includes costs on capital and expenditure of organization for the training of employers, etc. Similarly, a transactional cost is the cost which is spent on sale/purchase and on information collection. Transactional risks involve sudden price changes and supply shock, etc. And last but not the least is coordination effectiveness which includes assessing inventory rates, performances and quality. Although, above stated points seem easily measurable, in actuality, it is very difficult to assess all factors when making a decision regarding vertical integration. Managers should choose to vertically integrate only in case of extreme necessity; such as to safeguard their organization. Reference Daft, R. L. Lane, P (2009) Management 9th ed. Canada: Cengage Learning. Maurice, S.C. et al., (1982).Economic Analysis: theory and application . 4th ed .Homewood, IL: Richard D. Irwin. Inter-American Development Bank (1998) Organization matters: agency problems in health and education in Latin America; Inter-American Development Bank. Washington, D.C: Inter-American Development Bank. Napel, S (2002) Bilateral bargaining: theory and applications.Berlin: Springer. Stuckey, J. White, D (1993). When and when not to vertically integrate. McKinsey Quarterly, ( 3), 3-27. Shi, L.Singh, D. A (2008) Delivering health care in America: a systems approach. 4th ed. USA: Jones & Bartlett Learning. Williamson, O.E, (1979) Transaction Gost Economics: The Governance of Contractual Relations, Journal of Law and Economics, 22, 233-261. Williamson, O.E, (1975). Markets and hierarchies: analysis and antitrust implications. New York. Free Press. Williamson, O.E, (1987). Transaction costs economies: the comparative contracting perspective. Journal of economic behavior and organization, 8,617-25. Read More