Market within organizations
Maître de conférences (Assistant Professor), Ecole Centrale de Lille
BP 48 59651 VILLENEUVE D'ASCQ FRANCE
Do organizations working in a complex and turbulent environment adopt market-like organizational arrangements?
We discuss this through an analysis of Weber's work and observation of "trading rooms". Two questions are raised: "Is the concept of 'market' instrumental in understanding trading rooms"; "What are the achievements and limits of market-like arrangements?".
Keywords: Market, Organization, Dealing room, Trading room, Coordination, Ideal type.
In this paper, we aim at studying market-like arrangements as they are implemented inside an organization. This shall be done though the exploration of organizations operating on international financial markets: trading rooms. Compared to 'classical' industrial settings, trading rooms are both different and similar. Different because the main issue is decision-making rather than the production of material goods. Similar because they both incorporate more and more market-like practices, like subcontracting, profit centers, bonuses and internal contracting.
The first trading rooms (also known as 'dealing rooms') appeared in the US banks of the early seventies. The purpose of a trading room is to regroup a series of formerly-separated departments into a single unit placed under a single supervisor. Trading rooms gradually spread to other countries as they adopted reforms deregulating their foreign exchange and financial markets. In 1997, 4500 dealing rooms were in operation worldwide, with approximately one hundred thousand operators. Trading room organization is very standardized worldwide: all operators ('traders'), gathered in a large room ('floor'), are arranged in semi-autonomous workgroups ('desks').
In considering the environment of trading rooms - i.e. financial markets - three foremost points need to be made:
Thus, despite their potential disastrous effect, dozens of deals are made every minute. The trading room of a big financial company often hosts more than a hundred operators, each of them buying and selling over a hundred million Euros daily.
Starting questions and methodology
The functioning of a trading room is at once very fast and very complex. Our purpose is to better understand it. More precisely, we are interested in finding whether and how the concept of 'market' is instrumental in understanding trading rooms (Q1). Going further, we want to highlight the achievements and limits of market-like arrangements (Q2). We also aim to bring a contribution to the understanding of other forms of organizations, mainly in services and the design of industrial products.
However, our problem is not only to gain access to trading rooms and to understand who does what, but also to characterize what we mean by 'market'. This concept is so rich that its meaning needs to be accurately defined. Classical economy defines mathematically what a market is, but mathematics are of little help in understanding human relations. Thus getting to define the market as a concrete organizational structure is a prerequisite. We shall deal with this from the next section on.
As for gaining access to dealing rooms, it has been accomplished through field research. Three years of participant observation (starting 1994) as a computer engineer were followed by a series of forty-five interviews in trading rooms of Paris, London and Hong Kong. Choosing field research was motivated by the difficulty of 'getting in' as well as the need to acculturate to the very specific culture of trading rooms and establish a network of relations with traders worldwide (mainly through the "Association Cambiste Internationale").
Max Weber's Market community
We shall initiate the definition of the market through an exploration of Weber's work, starting from the theories he developed on "the market community" and the concept of ideal type.
Of all early twentieth century sociologists, Weber is the one that had the most prominent interest for the market. After he passed his University degree in law, he took part in a study on the mechanisms of speculation and an international comparative approach of stocks markets. Weber claimed sociology must include a branch dedicated to the "sociology of the market", because this phenomenon could not be reduced to the generation of prices.
In "Wirtschaft und Gesellschaft", he asserts that social interactions on a market develop in two phases: competition and exchange.
Competition: "A market exists when there is competition (…) to secure exchange opportunities". Competition is merciless: "(the market) has consideration for things only, not for human beings nor for doing one's duty by fraternity or piety". Because of this continual competition, the boundaries of the market are blurred. They can be extended at all times in order to include more potential partners: "partners are guided in their offers by the potential action of a group of competitors of an unknown size rather than by their own action". However, if Weber agrees that if there his an antagonistic relation, the conflict remains pacific because it is motivated by the desire to precede another in the realization of an exchange. Thus conflict remains indirect and is not aimed against a single opponent. Instead of destroying an opponent, one tries to be better than he is. Weber also notes that exchange on a market is very special as it is the most rational interaction possible between human beings "the archetype of rational action" and in consequence "an abomination for any system of brotherly ethics".
Exchange: the next phase is different: the deal is made and the transaction executed. The deal is a compromise by which counterparts barter things or trade goods against money in reciprocal compensation. Although they are the central purpose of the market, exchanges are reduced to a minimum, as well as their social side. Once completed, they are forgotten "market shows a simultaneity and succession of rational sociations each of these being so ephemeral that it dies with the exchange it was initiated for". After a deal is made, all sides are free of mutual engagement.
Weber's idea of the market we just described is not an image of the market that can be observed in the 'real world', it is an ideal type.
Weber claims no concept can represent the whole of reality, and suggest to resort to the ideal type as a conceptual tool to understand complex social phenomena. Weber himself invented many ideal types. In this way, he designed the "Bureaucracy" as a mean to study the impact of rationality on organizations. Another ideal type, the "spirit of capitalism" was correlated with the rise of Protestantism.
How to construct an ideal type? Weber compares the building of an ideal type to the work of a caricaturist. The caricaturist, guided by his instinct, produces a drawing which highlights a series of features of the person he represents. The scientist designing an ideal type does just the same. However, features of an ideal type must be mutually articulated and form what Weber calls "an homogenous chart of thought". From the point of view of science, what is at stake is to put together a logical construct, even if the building of the construct itself demands some intuition. Thus, the ideal type cannot be created outside a subjective point of view, but at the same time, it goes beyond subjectivity because it is rational.
When he tries to further define the status of the ideal type, Weber chooses to tell what it is not.
Where then lies the interest of ideals types? In their heuristic value. The ideal type is not an hypothesis, but something to help formulating hypotheses. It does not describe reality, but only to guide its exploration and put in light emerging phenomena.
An ideal type of the market
Using the concept of ideal type as it has been created by Max Weber leads us to propose an ideal type of the market, defined by three groups of features:
1) Explicit and quantitative exchanges
Exchange of goods or services is the reason why a market exists. The division of work and specialization it allows is essential to the development of society. This is described by Adam Smith as a domination of 'exchange value' over 'use value' and leads to a weakening of traditional social relations. We have shown the primary importance of this to Weber, but most sociologists of this period support this idea. Marx describe how bourgeoisie "eradicated the complex ties binding feudal man to his natural superiors, (…) to leave no other bond between man and man than cold interest (…) (Bourgeoisie) drowned the sacred thrills of religious ecstasy, knightly enthusiasm and cheap sentimentality into the freezing waters of selfish calculation". Thus market stimulates coordination and exchange, but at the expense of social integration. Parties aspire to a reduction of their mutual dependence, not to a lasting association. All sociologists of modernity refer to this "great transformation" of social relations.
This explicitness of the "give and take" is supported by the expression of quantities. Market relations are bound to the expression of amounts expressing the reciprocal flows exchanged: prices. However, quantification is not restricted to the expression of prices. Other amounts, like profits, also play a major role.
Use of prices is heralded by Hayek who sees them as means to share and broadcast information. Although human communication is imperfect, prices can convey information accurately. Although human knowledge is incomplete, prices can summarize, coordinate and optimize decision.
2) Competition and extended boundaries
The presence of exchanges and prices is not enough to characterize a market. These exchanges must take place in a situation of concurrence. As we remarked before, social interactions on a market develop in two phases: competition and exchange. Then the cycle starts again with a phase of competition.
This is why understanding the market cannot be reduced to analyzing a series of bilateral relations, but must encompass the existence of other bidders and buyers. All parties need not be gathered on a single location. As Weber notes, the "physical gathering in a given place, whether the market square, the fair or the stock exchange" is not necessary. The boundaries of the system that need to be taken into account are greatly widened, and one of the sources of uncertainty comes from the fact that new competitors can 'step in' at all times.
3) Autonomy, accountability and global rules
Parties striking a deal are supposed to be doing so 'of their own free will', although they do not always have the same bargaining power. However, they have to take on responsibility for the consequences of their decisions. This accountability is enforced and objectives defined, not in terms of actions taken, but in the expression of results achieved. Objectives like 'return on capital' or profits are a good example of this.
This accountability cannot be implemented and is senseless if not accompanied with autonomy of decision and action. This allows the market to be very flexible because all individual components are at once obliged and capable to adapt.
But market must resolve a paradox. How to give parties full responsibility for their actions while maintaining a fair competition? How to promote a maximal amount of freedom while being able to eliminate misfits?
Rules applicable to all parties must be elaborated and enforced. These rules must at once be minimal to give parties a maximum of autonomy and be sufficient to avoid cheating. These rules themselves must be global (apply to every actor of the market), minimal (thus less costly to enforce) and non-negotiable (they cannot change all the time). As Coase remarks, setting up an arrangement for the elaboration and enforcement of this rules amounts to a cost.
Q1: How is our ideal type of the market useful in understanding trading rooms?
Market exchanges, competition and accountability
The main activity of dealing rooms operators is to strike deals. All these deals are formalized by oral contracts. Most of the time they consist in agreeing on the amount exchanged and a price. Traders often calculate continuously what profit or loss they make. Operators from the same dealing rooms make deals with one another but they can often choose to strike the deal with a counterpart not belonging to the same firm. These transactions have all the characteristics of market exchanges. Sophisticated information and communication technologies put all parties in a situation of continual concurrence with the rest of the world.
Traders or desks managers are accountable for the profit or loss made: when there is a profit they receive their share of it. Bonuses that can make for a very important part of the total salary. But when losses are made, they are at a risk to lose their job.
Thus, competition can be very hard, even between traders from the same company. These rivalries are not shunned by the trading room manager who does not always consider them unhealthy.
Traders are given a lot of freedom and delegation. The decisions they take often involve millions of Euros. They are also enabled to buy and sell different types of financial products in order to fund or hedge their position. They can even try to anticipate price variations and speculate. With this growing autonomy, each operator and each desk becomes a profit center in itself: "we have a budget for everything like a small firm: material, telecommunications, capital" a quota for overheads like the administrative processing of transactions and computer maintenance is added. Therefore traders often hold the decision over computer engineers when buying computer software, material or feeds.
Before trading rooms appeared, banks featured a series of departments, each one specialized in the trading of one category of financial products. Considering the ideal type of the market, the grouping of all these departments under a single supervisor does not only bring economies of scale. It also allows for:
This rule are also minimal in that they set objectives and limits to individuals or to teams but do not specify anything in terms of choices to make. Theses decisions are left for traders to take … and retain responsibility for their consequences.
Relevance of the ideal type of the market
Comparing the ideal type of the market with the situation inside dealing rooms can bring up a better understanding of their functioning, although some features or situations do not match with our ideal type. They mainly fall in two categories:
We shall revert to these categories later.
Q2: What are the achievements of market-like arrangements and their limits?
Two categories of achievements and two categories of limits can be singled out:
Market brings fast coordination and adaptation to a complex environment
Thus, coordination through the action of the famous 'invisible hand' of the market is implemented. In this way, all traders of the dealing room are coordinated, not to embrace a given strategy, but to make profits. The dealing room itself is very versatile and can adapt quickly to crises and changes in its environment.
Market can face situations of strong uncertainty and complexity
Trading on a financial market is very risky and some theories claim it is impossible to forecast future prices. The setting up of a market seems to solve this problem: although trading rooms sometime account for big losses, they are on average a source of profit. Of course, a trading room do not earn money through speculation only, but also by acting as an intermediary for the bank's customers or through other means.
Market is stressful for individuals
For young and talented individuals, working in a trading room is an attractive job. They can have more responsibilities and get better paid than in most other positions. However, working in a market-like organization is very demanding. The workload is sometimes enormous, stress stands high and the dismissal can come very fast.
Employee turnover is very high and can have harmful side effects:
High bonuses can also lead to certain problems, as profits can sometimes be obtained at the expense of their colleagues.
Finally, as market permanently keep people 'on their toes', it tends to 'burn them out': "a trader is like a high-level sportsman, he can get excellent results for a time, but he wears off quickly". Most traders cannot stay in this job past forty
Market does not manage important risks
In principle, a market as a whole is not exposed to risk. Exchanges allow each individual to take some risks, and he has to manage it by himself. If he fails and goes bankrupt others individuals are not affected since the parties are independent. They simply go on trading with other counterparts.
Unfortunately, there are limits to this approach of risk-management:
Most disasters that occurred lately can be charged on this inability of the market to manage risks. The bankruptcy of the Barings Banks is a prominent example of this. It is spectacular to see how a single man can lead to the bankruptcy of a whole firm.
Nowadays, market-like structures are more and more adopted by firms. The first organizations to be concerned are those whose main task is to manage information. In this way, trading rooms can be paralleled with control towers in air traffic control, integrated engineering floors in the automotive industry or telephone help line desks in insurance companies. More: market arrangements are implemented in situations were they were thought to be impracticable. In manufacturing, internal contracting is becoming widespread and new factories are implemented in which independent firms manage different sections of a single assembly line.
In this paper, we try to characterize what a market can be by building an ideal type and testing his relevance in understanding the functioning of dealing rooms. We have shown how market helps setting up a form of organization which both versatile and able to face a very complex and turbulent environment. We have highlighted some weaknesses: mainly the inability to manage important risks and the stress it puts people under.
A study of the empirical organization also shows that, although the ideal type of the market is relevant, the organization of trading rooms cannot be understood without resorting to other concepts. As a suggestion for further study, we suggest adding two other ideal types, which would be called "hierarchy" and "network". Testing their relevance and mutual interaction could be done on the same field: trading rooms.
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