Complexity, Genuine Uncertainty, and the Economics of Organization

Abstract

We argue that the distinction between complexity of the economic environment on the one hand and genuine uncertainty about the future on the other hand is crucial to understanding the relative survival value of organizational forms. We develop this distinction between complexity and uncertainty, and apply it to the theory of the boundaries of the firm. Our argument is that, although the management of complexity may have been an important factor in the historical emergence of the large corporation, vertical integration per se does not necessarily convey an advantage over a decentralized network in the ability to manage static complexity. Rather, the rationale for vertical integration lies in the existence of dynamic transaction costs arising from economic change. Nonetheless, the vertically integrated organization has limits to its ability to deal with change, and a decentralized network of independent agents may have the advantage when uncertainty is greatest.