top of page
Search
  • Writer's pictureJose Arrieta

Munificent Labor Markets Create Flater Firms

Updated: May 17

Once upon a time, society deemed it appropriate for at most one person per household to be educated or trained in a technical discipline. Furthermore, only the trained and educated could go out and earn the money to make bread. Society ran like this for a century (1850 to 1950 according to Goldin). It ran well, so the uneducated wanted more, and they got it.


This post deals with the aftermath. Namely, what could happen if broadly uneducated workers entered the marketplace? Furthermore, it looks at what could happen as economists drive society's economy to pursue. (myopic) prosperity.


Society of Screeners

This is a minimalistic, naïve experiment in over-generalization. Any parallel with the society our parents grew up in is just happenstance -- a curious one though.


Assumption 1. The simplest definition of a worker is one who performs an activity and produces an output. For this example, I overgeneralize and assume everyone in society has the same role. All workers screen products and choose whether to buy them or not. Furthermore, each worker just cares whether the product has value or not. In other words, the outcome of said decisions can be a success or a failure depending on whether the choice (i.e., to buy or not) is linked to a valuable or a worthless product.


This over-generalization leads to four possible outcomes.

  • They could acquire products that are valuable (i.e. true positives)

  • They could acquire products that are worthless (i.e. commission errors)

  • They could pass on the chance to acquire a valuable product (i.e. omission errors)

  • They could pass on the chance to acquire a worthless product (i.e. true negatives)

Nothing else is possible.


Decision Structures

Under these conditions, perfection is easy to define. A perfect system acquires every valuable product and passes on every worthless product. Sadly, as it often is in life, perfection is impossible when we work alone. Single workers often acquire worthless products and pass on valuable ones.


Organization design comes to the rescue. If a designer is provided with enough employees and the inflow of products is architected accurately, the decision-making output can approach perfection. What's more, superhuman performance is accessible under simple architectures, such as majority voting rules.


Csaszar (2013) -- i.e., Table C.1 in that paper -- shows that a majority voting triad -- a group of three people who all vote towards what they will jointly acquire if at least two of them want it -- can decrease omission and omission errors by 33% when compared with individuals. That said, exchanging one person for three is quite expensive. What if we compromise?


Myopia

A2. Let's assume that whoever runs the show cares about making mistakes rather than missing out on good products. If that is the case, we could exchange an individual for two people who acquire a product only if both of them want it. According to Felipe's work, the commission error rates would decrease by over two-thirds (Its omission error rate is 70% higher than the individual, though). To rephrase, this consensus dyad makes less than a third of a single individual's mistakes.


A3. Now, imagine that a boss's job is to handle mistakes. Day in and day out, they are called in when a problem arises. They check it and decide what to do after that. Every other second of the day, they are inactive, [insert joke about bosses not doing anything]


If this were the case, the decrease in error rates would prove it. A single boss can now manage six times as many employees as before. So, if we assume that back in the good old patriarchal days, the CEOs listened to Graicuna and made each boss rule over six employees. Then, now, as women come aboard, each boss can rule over three dozen people, and the number of decisions they need to make remains the same. Let that sink in.


Corollary 1: Inertia

A fun corollary of narrowly focusing on minimizing commission errors is that organizations will need to invest in randomness-enhancing tools to explore and innovate. In a society filled with myopic commission error-averse managers and consensus-guided employees, a munificent market for change management consultants ought to exist. --> John Oliver on McKinsey, Boing, etc.


Spacey

Just as the #metoo movement did to House of Cards, this consensus dyad has a remarkable effect. The lower level of the organization just became twice as wide, but the number of first-level managers decreased by a boatload. See the table below.

The left column presents a standard Graicuna's firm -- think a corporation from the 50's. Every rung has one-sixth the managers that the rung below had of employees. The 7th heaven/level is the C-suite, where the CEO, CFO, and COO meet with the board to determine what the firm should do.


The right column presents the future. The bottom rung has twice as many employees. The second rung has a manager for every 36 employees in the bottom rung. Every other rung follows Graicuna.


The first thing we can see is that we need one layer fewer than before. The C-suite now has six members, a common reality of our times, with firms having CTOs, CMOs, CHROs, and the like. The second insight comes at the bottom of the table. The proportion of employees in the second and higher rungs has decreased dramatically. Before, one-sixth of employees were managers. Now, only one in 31 employees is a manager.


To put it bluntly, in the new firm, there are less than half as many managers than there were front-line managers in the past. This dearth of the managerial class accompanies the (almost) doubling of the total employee count in the firm. Imagine all the people..


C2. Careers

Before we continue, let's think about the lives of the people in this organization. Back then, you needed to be better than six other people to become a manager and leave the bottom of the pyramid. Now, you must be better than 30 people to do the same. If we think of it in terms of a normal distribution, before, you needed to be at least one SD away from the performance means to become a manager.


Now, you need to be significantly different from the norm to lead; your performance ought to be at least two SD above the mean. To put it in context, Mensa, the genius club, accepts the top 2%. In this new era, ceteris paribus, two-thirds of managers would need to be geniuses to be promoted. The good thing, though, is that after you are promoted, life at the top is easy.


C3. Cute papers

Now, imagine what a cute paper with a stamp that says you could be a good boss and the stamp of a fancy higher education institution would be sold for in both societies. Just as in Monopoly, paying for a "get out of [the bottom rung]" card can be a great gift/investment.


C4. Ladders

Back in the day, you worked all your life in the same firm. Or at least that was the dream. We do not do that anymore. A simple reason can be drawn from this model. Given that jumping out of the bottom rung is just a dream that the exceptional or the rich can afford, for most employees the only chance to improve their welfare is by jumping boat to a firm that pays them more. In this new reality, loyalty is not something employees and firms have to one another. Dog eat dog.


C5. Free food

What do you do when you can no longer prevent your employees from leaving the firm? Well, you make the firm sticky. You add perks, like fancy-free food at the office. You add free daycare and dry cleaning. You do all you can so that the grass looks brown, not green when they look outside.


CEO to Worker Pay Ratio

A4. Why would managers choose for this? Thanks for asking. See the table below. It is similar to the one above. However, it shows the total salaries paid at each rung of the hierarchy. Given that I have no idea of how much salaries change across rungs, I say they grow by 50% every rung. This leads to the people in the C-suite having a salary around ten times higher than the bottom layer. This is close to the historic 10-20x CEO-to-worker ratio at the time (link).

A5. On the right, I show what the managers gain from this new Battle-Royale themed bottom rung. Namely, the proportion of remunerations paid to managers is much lower than in the 50's. In the right column, I show a tripling of salary when a manager goes up one rung. This leads to the six C-suit members boasting a salary close to 250 times the salaries of those below. However absurd this sounds, it is a very conservative remuneration as the CEO-worker ratio is currently close to 400x.


The insight we gain from this is that although managers now earn much more than they did before, their total aggregate compensation is much lower than in the 1950s. Back then, a quarter of all the firm's salary went to managers. Now, it is around one in seven. As a board member, I might see this as progress, even more so if the CFO is very charismatic and helps me forget how to think.


Can we afford this?

An important question is not being addressed. How are we paying for all this? The total cost of running the firm was 186k [FTE$] in the '50s, and now it is 325k [FTE$]; where is the increase coming from?


One reason I dare to raise is Godhardt's law. See the figure below. It presents the percentage of people aged between 25 and 64 who are employed in the US. This graph shows an increase of around one-third between the 1950s and the 2000s (62% vs 82%).

In contrast, the story is quite different when we look at minimum wages. It decreased from 12 real$ at the height of the civil rights movement to 8 real$ today. This decrease of around 1/3 can serve as a way to maintain total compensations constant. If you are looking for solid quantitative analysis, you are reading the wrong post.

A6. If government officials were focused on keeping unemployment at bay, they might have forgotten to increase the minimum wage after discrimination based on gender became illegal. This Goodhardt-law like explanation is plausible given that unemployment is central to economic policy. Governments faced with a munificent labor market might see the other way when they realize that although household incomes remain stagnant compared to productivity (see below), more and more people were employed per household.

If you remember, the title of this section is: Can we afford this? My answer is IDK, maybe?


C6. Care Work

In this new era, managers are happy. But employees have a tough life. They need to be exceptional to leave the lowest rung. Minimum wages let them bring home fewer and fewer read dollars every week, and the total number of hours their household work continues to increase. And one wonders, what's up with the children?


Back in the 1950s, Mom would clean, cook, and care (CCC) for everyone's emotional well-being. Now, Mom is at work. She still has a second shift, but she is (more) tired. So, nannies and extended daycares have become common. This new billion-dollar industry siphons out the strained resources of our CCC-starved households. Median household incomes might remain stable even after mom left for the office, but expenses have risen.


C7. Elephantine Society

That said, this economic tightness would not be felt by everyone in the same way. Think of the 3.2% of managers. In every rung of the firm, they now earn much more than before. Their riches will allow them to pay for nannies, invest in stock, buy second houses to rent to workers, and buy cute papers to gift wealth to their children ad infinitum.


In short, a two-class society will emerge, one populated by the rich and the other by those who pay just to stay afloat. This elephant-like society, as shown below, makes the very tippy top of the income scale richer than they have ever been while extracting wealth from the middle.


Think of the tens of thousands of managers who were thrown down to the working class. The new objective battle for leaving the bottom rungs. Imagine the smile on the face of whoever thought of hiring more people at the bottom and the riches it brought its new class.

Coda

Starting in the 1980s, organizations faced strong corporate restructuring. GE, IBM, Ford, and many other organizations dramatically flattened their organizational diagrams. The span of control at the top grew while, at the same time, the width of the organization remained constant.


Myriads of theories about why this happened exist (e.g., the increase in computing power, the internet, the rise of knowledge work). However, I have yet to stumble upon one that links the plethora of cheap, structurally uneducated employees who rushed out of the civil rights era as one of the said drivers. But it might be worth the time to engage in such thinking.


Get Better at Flatter

I wrote this while thinking about Markus Reitzig's talk next week at INSEAD Between the Lines series hosted by Henning Piezunka. Feel free to register!


Post Script

Although the whole model is built on exchanging one person for a consensus-based dyad, we could go further. We could exchange one person for a triad, who decide by consensus. If we do this, the commission error rates would decrease by ~90%. That means that each manager would be able to supervise 180 employees. The firm would look as in the figure below. It would have almost a million workers in its bottom rung, supervised by just over 6k managers.


These managers would be the true 1%. They would earn at least three times as much as their workers but face tremendous inequalities, with the richest earning almost 250 times as the people in the bottom 99%!

Disclaimer

I am a feminist. I believe in the pursuit of equality and equity among genders. However, as Popper explained in the Paradox of Tolerance, one cannot single-mindedly pursue one goal. I share Keynes's dreams for his grandchildren: leisure and boredom should be their tragedies, not exhaustion and oppression. As you read the text above I hope you view it as a critique of our need to be overworked and not at any point as a critique of the feminist movement and its constrained wins.



7 views0 comments

Recent Posts

See All

Comments


Post: Blog2_Post
bottom of page