According to the subject matter of New Institutional Economics, the determining factor of the performance of any organization is the nature of its institutional framework. In the scope of the said branch of economics, institutions are the formal rules, informal norms, and their enforcement mechanisms that govern an organization. Simply put, institutions are the rules of a game and organizations are the players who participate.
The institutional framework – an abstract set of rules – structures people’s behavior in an organization. This is to actualize some purpose or function, which the organization is defined to accomplish. In this brief article, we apply the concepts of New Institutional Economics to business organizations. The effort reveals the importance of the institutional makeup of a business – that is, the significance of its rules and norms.
Business and institutional framework
According to Investopedia, a business is “an organization or enterprising entity engaged in commercial, industrial, or professional activities.” Initially, a business is an idea in the mind of an entrepreneur. Later, the idea takes practical shape in the form of an organization.
A business takes a hierarchical structure under its institutional framework. The people in the organization interact with each other under a set of formal rules. Similarly, norms, which make up the business’s culture, influence the behavior of the people inside the firm.
The cultural norms of the business are direct offshoots of its core values. To induce performance and sustain growth, the formal rules of the business must be consistent with and ingrained in its informal norms and core values. The organization’s structure, practices, and values must be institutionalized, so to speak.
The institutional framework of a business can be traced back to its conceptual framework and practical model. The conceptual framework of a business comes to life in the entrepreneur’s mind. The practical business model is implemented on account of the collective synergy of teamwork. A business, then, is essentially a leadership-teamwork struggle, structured and directed by its abstract rules that constitute its institutional framework.
Why institutional framework matters?
The sustainability of a business organization depends on its institutional framework, that is, the set of rules and norms that govern it. This is because the efficacy of organizational behavior correlates to the performance of the business. Since organizational behavior depends on the business’s institutional structure, it is the efficacy of institutions that determines the performance of a business.
In management terms, business survival and growth are possible through some necessary traits, called Critical Success Factors (CSFs). Similarly, to assess an organization’s operations and behavior, management sciences use Key Performance Indicators (KPIs). As the name suggests, they reflect the company’s position in which it stands and the trend in which it slants.
Where the external market structure and competitiveness validate the usefulness of CSFs and KPIs, internally, their existence and performance depend on the dynamics of the business itself, i.e., its institutional framework.
It is noteworthy that it is the institutional framework of a business that determines its organizational structure and behavior, and not the other way around. Imitation of other businesses’ structure and appearance can never result in a strong foundation. The entrepreneur must realize that their business can stand strong only when founded on an original and efficient institutional framework, not on nifty mimicry of established businesses’ branding.
Types of institutional frameworks for business
Institutional Economics defines, primarily, two types of institutional frameworks: Efficient and Inefficient. An efficient institutional structure promotes open participation, principles of meritocracy, and just competition. On the flip side, an inefficient institutional structure revolves around limited access to participants, rent generation, and restrictive competition.
A business, similarly, can either have an efficient or inefficient institutional framework. Efficient institutions are the ultimate determinants of a quality management model and style. A quality management approach produces an effective business organization. In contrast, inefficient institutions are a precursor of a micro-management setup, which brings about an ineffective business.
Quality management promotes autonomy in thinking, working, and participating. This, as a result, produces self-regulated, teamwork-oriented, and creative workers and work practices. Whereas micro-management endorses the authority of the manager or leader, while the workers remain under the shadow of those in charge. This, on the one hand, disregards the synergistic benefits of cooperation and teamwork, while on the other, restricts creative thinking and autonomy.
Impersonal business frameworks
In institutional economics, impersonality is a vital characteristic of an effective organization. Impersonal organizations, or perpetually lived organizations, are those that treat everyone equally, on the same ground. Their institutional makeup is system-oriented and not person-specific. They are independent of the lives of their founders and members.
An effective business organization, similarly, embodies institutions that encourage impersonal (equal) relationships. Such a business is independent of the lives of its founder, management, and other stakeholders. It is impartial to the staff and loyal to customers. Impersonality is a vital characteristic of an efficient institutional framework, i.e., a quality management model and style.
Institutions are simply a set of rules – a product of our minds. When we define these rules on humanistic and just values, they stimulate behavior based on equality for all and sundry.
When the institutional framework of a business embodies its core values and principles, the management model in practice will automatically extend these values to all involved in the business organization. These values become part and parcel of the business personality and behavior.
Realizing institutional growth
Businesses face numerous challenges, time and time again, that sprout to test their capacity and ability to survive in the competitive realm. These challenges can attack from the outside or bud from within. Normally, the interior challenges are more decisive and critical for business survival and growth. Mishandling of these gives way for exterior threats to aggravate. On the contrary, businesses can divert or counter external challenges, if properly understood, through internal development.
The process of sustaining an efficient institutional structure in a business organization depends on its ability to evolve by adapting to changes and challenges over time. For this purpose, an institutional structure (and thus the business) must embody adaptive efficiency. Adaptive efficiency means learning, adapting, and self-organizing continuously. It describes the evolutionary tendency and dynamic nature of the whole business set-up.
Customer is king
A government should work to maximize the well-being of its people. Likewise, a business should work to offer maximum value to its customers. The ultimate success or downfall of a business depends on its customers. Institutions (abstract set of rules and norms) that underlie the potential of providing value and delight to customers are vital for an effective business organization. Without sincere commitment to customer care, the business is destined to fail, sooner or later.