Economic Organization in the Construction Industry: A Case Study of Collaborative Production Under High Uncertainty

Abstract

A central question of law and economics is how complex productive activity is initiated, organized, and carried out successfully without central planning. What are some of the most important organizational devices and what is their function? The effort to respond to this type of inquiry has led, among other things, to the dichotomy between transactions within firms and transactions across markets - also referred to as the make-or-buy decision or the outsourcing decision. This dichotomy, leading to explanations of the functions of firms and markets, has proved to be a powerful tool in analysis of economic organization. As with most simple descriptions of complex reality, however, it emphasizes some aspects of reality at the expense of others and is not a good fit in certain settings. One such setting is construction, where the organization of the economic activity (the construction project) is mostly contractual (technically, across markets), but where vital organizational ingredients are networks of relationships as well as collaboration and teamwork, generated in large part by pride, commitment, and reputation. The present paper is a case study that examines those ingredients and others that play, at most, a minor role in traditional thinking about firms and markets. This study also illustrates the notion that bilateral contracts are part of a mosaic of such contracts, with the performance of each dependent on the performance of the others, and contractual relationships exist within an industry in which individual projects are of limited duration but the participants are in for the long haul. Perhaps an even more interesting and important observation is that in construction, and no doubt in other economic activities as well, it is not the firm that is the locus for production. Nor does the idea of market exchanges between firms properly describe the productive process. Instead, production is in the hands of teams of people who are associated with various firms but who operate autonomously with respect to their firms. The teams may perform the functions of firms but they lack the critical firm attribute of hierarchical control. Related to this and also important in at least some settings is the manner of selection of team members: the client/owner may contract with, say, an architectural firm but expects to be working with particular, identified individuals within that firm. This raises the question: when a person contracts for services, what is the role of the individual (e.g., an architect or a lawyer) and what is expected of the firm of which that individual is a member? And what does this tell us about the nature and the boundaries of firms? We also offer some observations about fixed fees versus hourly rates and other contingent compensation.

Keywords: construction contracts, economic organizations