GRADUATE SCHOOL OF INDUSTRIAL ADMINISTRATION
Reprint No. 3 I
Models in a Behavioral Theory of the Firm
by R. M. Cyert, E. A. Feigenbaum, and J. G. March 1959
CARN E G I E INSTITUTE OF TECHNOLOGY
Pittsburgh 13, Pennsylvania Keprinted Behavioral f:nck Vol. 4, No. April, 1!I5!I I'rinltd in
1 How do business organizations make decisions? What process do they follow in deciding how much to produce? And at what price? A behavioral theory of the firm is here explored.Using a specific type of duopoly, a model is written explicity as a computer program to deal with the complex theory implicit in the process by which businesses make decisions. This model highlights our need for more empirical observations of organizational de- cision-making. MODELS IN A BEHAVIORAL THEORY OF THE FIRM hi/ It. M . Cijert, K. A. Feigenbaum, and .1. G. March Carnegie Institute of Technology
attempts to develop a behavioral side of this point are not available. In our Rkck.nttheory of the firm have focused par- judgment, a major portion of the effort in ticularly on the internal characteristics of a the next decade of research on pricing should business firm as a decision-making organiza- he directed to answering this question (or tion. They have used the rough framework to making it irrelevant). But we do not pro- of both the theory of competitive pricing pose to discuss the point in detail here. and the modern efforts to extend that Second, a way must he found to deal with theory to situations of imperfect competition the complex theory implicit, in the decision- such as the case of oligopoly and duopoly making process approach. A major problem where onlya few, or possibly only two, firms perceived by those sympathetic to a be- supply a given market. They have, however, havioral theory has been the lack of a gone further in introducing as an important methodology suitable for handling the kinds part of the theory the process by which of complexities that seemed to be needed business organizations make decisions. Since (Koopmans, 1957). It is to this problem and business (inns are organizations, it has to the development of a specific model to seemed reasonable a priori to assume that a which we address ourselves in this paper. theory of business behavior ought not to We show that a relativelycomplex model treat them as individual decision-makers. of the firm as a decision-makingorganization (Alt, 1949; Bushaw & ('lower, 1957; can be developed and used to yield econom- Chamberlin, 194(1; Cooper, 1951; Cyerf & ically relevant and testable predictions of March, 1955; Cyert &. March, 195(i; business behavior. The methodology in- Cordon, 1948; Papandreou, 1952; Wein- volved is computer simulation. The model is traub, 1942). one of a specific type of duopoly. As a rough Two major obstacles to the acceptance of test of reasonableness, we compare the pre- such a theory of pricing are obvious. First, dictions of the model with actual data. Our it must be shown that the theory is at least, hope is that the model will illustrate the as good as other existing theories in its promise of simulation as a technique of ability to predict firm behavior (Friedman, model building in economic theory and the 195U). Convincing demonstrations on either behavioral sciences in general and at the same time demonstrate a general method * This paper is based on research supported by grunts made by the (Jraduate School of Industrial for examining many of the concepts previ- Administration, Carnegie Instituteof Technology, ously discussed in more abstract terms. from the School's research funds and from funds provided by the Ford Foundation for Ihe study of THE DECISION-MAKING PROCESS organizational behavior. The authors owe a con- Recent theories of organizational behavior siderable debt to a large group of colleagues and students for their comments on the general ap- have emphasized several important charac- proach and specific models presented here. teristics of the decision-making process that
from Sri 2, C.S.A.
SI Theory 82 FEKiEMiAUM AM) M.\lfCH Models in a Behavioral oe the Firm 83 are dealt with awkwardly in the theory of fact that firms assume something about the assume that a firm performs such computa- methods for influencing demand (e.g., an the firm. First, organizational decisions de- reactions of theirrivals is, of course, incorpo- tions more or less simultaneously and that additional advertisingeffort). In either ease, pend on information, estimates, and expec- rated in any theory of oligopoly. Our ap- all are substantially completed before any we expect organizations to revise demand tations that ordinarily differ appreciably proach is to build into the model some further action is taken. Since the subsequent estimates under some conditions and differ- from reality. These organizational percep- propositions about the ways in which organi- steps are all contingent, the order in which ent organizations to revise them in different tions are influenced by some characteristics zations gain, analyze, and communicate in- they are performed may have considerable ways. Evaluation (5) occurs again with the of the organization and its procedures. The formation on competitors. The concept of effect on the decisions reached. This is par- revised estimates. procedures provide; concrete estimates --if organizational learning, a process by which ticularly true with respect to the order of (8) Re-examine objectives. Where plans not necessarily accurate ones (Cyert & expectations of competitors' behavior are steps (0), (7), and (8). Thus, one of the are unfavorable, we expect a tendency to March, 1955). Second, organizations con- modified on the basis of experience, is u structural characteristics of a specific model revise objectives downward. The rate and sider only a limited number of decision major element in this formulation. is the order of the steps. extent of change we can attempt to predict. alternatives. The set of alternatives con- (2) Forecast demand. We have attempted (5) Evaluate plan. On the basis of the As before, evaluation (5) is made with the sidered depends on some feature's of organi- to build a model that can encompass de- estimates of (1), (2), and (M) alternatives revised objectives. zational structure and on the locus of search scriptions of the process by which the de- are examined to see whether there is at least (9) Select alternative. The organization responsibility in the organization. This mand curve (the relationship between the one alternative that satisfies the objectives requires a mechanism (a) for generating dependence seems to be particularly con- price of the product and the quantity which defined by (4). If there is, we transfer im- alternatives to consider and (b) for choosing spicuous in such planning processes as can be sold at that price) is estimated in the mediately to (9) and a decision. If there is among those generated. The method by budgeting and price-output determination firm. In this manner, we are able to intro- not, however, we go on to step (6). This which alternatives are generated is of con- (Alt, 1949). Finally, organizationsvary with duce organizationalbiases in estimation and evaluation represents a key step in the siderable importance since it affects the respect to the amount of resources they allow for differences among firms in the way planning process that is ignored in a model order in which they areevaluated. Typically, devote to organizational goals on the one in which they adjust their current estimates that uses objectives solely as the decision the procedures involved place a high pre- hand and suborganizational and individual on the basis of experience. rule. Certain organizational phenomena mium on alternatives that are "similar" to goalson the other. In particular, conflict and (M) Estimate costs. We do not assume, as (e.g., organizational slack) increase in im- alternatives chosen in the recent past by the partial conflict of interests is a feature of in the theory of the firm of economics, that portance because of the contingent conse- firm or by other firms of which it. is aware. most organizations and under some condi- the firm has achieved the optimum combina- quences of this step. If alternatives are generated strictly se- tions organizations develop substantial in- tion of resources and the lowest cost per ((>) Re-examine costs. We specify that quentially, the choice phase is quite simple: ternal slack susceptible to reduction under unit of output for any given size plant. We the failure to find a viable plan initially choose the first alternative that falls in the external pressure (Cyert & March, 19.%). believe it is necessaryto introduce thefactors results in the re-examination of estimates. estimate space, that is the set of positions The concept of organizational or internal that actually affect the firm's costs, esti- Although we list the re-examination of costs determined by the estimated demand and slack is used to describe a situation within an mated as well as achieved. first here, the order is dependent on some estimated cost curves. If more than one al- organization in which individual energies (4) Specify objectives. As has been noted features of the organization and will vary ternative; is generated at a time, a more potentially utilizable for the achievement of above, organizational "objectives" may from firm to firm. 1 An important feature of complicated choice process is required. For organizational goals are permitted to be di- (Miter at two distinct points and perform organizations is the extent to which a firm example, at this point maximization rules verted. The form of the slack may vary two quite distinct, functions. First, in this is able to "discover" under the pressure of may be applied to select from among the from a labor force not working at its full step they consist, in goals the organization unsatisfactory preliminary plans "cost sav- evoked alternatives. In addition, this step capability to overly large departmental wishes to achieve and which it uses to deter- ings" that could not be found otherwise. In defines a decision rule for the situation in budgets. The extent and regularity with mine whether it has at least one viable plan fact, we believe it is only under such pressure which there are no acceptable alternatives which the organization meets its goals, es- [see step (s)]. There is no requirement that that firms begin to approach an optimum (even after all re-examination of estimates). pecially the profit, goal, will affect the the objectives be co-measureable since they combination of resources. With the revised There are two important observations to amount of internal slack. enter as separate constraints all of which estimate of costs, step (5) occurs again. If be made about a theory having these; general Our objective is to show how the; general "must" be satisfied. Thus, we expect to be an acceptable plan is possible with the new characteristics. First, as we; increa.se the attributes of decision-making, some 1 of able to include profit geials, share of the estimates, the decision rule is applied. emphasis on describing in some detail the which have been described above, can be market gemls, production goals, ete\ (Simon, Otherwise, step (7). actual pre>cess by which thefirm makes price introduced into a behavioral theory of the 1955). Second, the; objectives may be used (7) Re-examine demand. As in the case and output eleeisions, we eleerease the rele- firm. Although ourelaboration is an obvious as decisiem e'riteria in step (9). As will be- of e'ost, demand is reviewed to see whether vance' of one of the major debates in the abstraction of the; details of procedures used come e'lear below, the fact that objectives a somewhat more favorable demand picture theory of the firm. Whether the firm maxi- 2 in a complex organization, each of the se;rve this twin function rather than the cannot be obtained. This might reflect mizes, "satisfices," or just tries to survive is serve; headingsfor single (decision-rule) function commonly simple optimism or a consideration of new processes spee-ifie'el can as 2 "The to the simplification of the choice assigned to them is of major importance to key a further set of subprocesses. We have speci- 1 Although we have identified these re-evalua- process in both cases is the replacement of the fied a decision process that involves nine the theory. tions in terms of strict sequence, an alternative goal of maximizing with the goal of Katisjicing, of distinct steps: The order of steps (1), (2), (3), and (4) is interpretation can be made in terms of intensity finding a course of action that is 'good enough'." T (Simon, 1957, pp. (1) Forecast competitors' behavior. The; irrelevant in the present formulation. W e of search. 204-205).
CYERT, 84 FKi(iK.\n.-u;.\i Cyert, and Models in a Behavioral Thkoky the Imrvi 85 ne>t the- (if main issue indeed it is an issue' think we have) tenels to be emalitative in I alternative give-n the' torecasts. If this at all). The emphasis on the process of nature in situations where it would be I'ItOCESS MODKI, OCTI'I'T DICCISIOX OF FIRM "be>st" alternative' is inconsistent with making the decisions in an organizatiem obviates ele'sirable te> be; euiantitative. profit goal, a re-examination phase ensues, the' nee-el for the simple ele>cisie)ii rules and Because of 1. Forecast: i C'cmipuU' conjecturalvariation term these' consielerations, the period t as a in which an e'lfort is maele> to revise- ce>st and simple' models implicit in much erf actual that medels of firms with whie'h we will de;al here; < 'ompetit*)r's reactions reactions observed in the past demand estimate's. If re-examination fails to controversy. should be viewe'el as tentative approxima- yield a ne-w best alternative e-emsistent with The se'ce)iid point is a related one. Conven- tions. 2. Forecast: Keep slope perceived demand They contain substantial elements of curve constant pa.ss it through the profit goal, the immediate profit goal is tional mathematics a but is somewhat awkward arbitrariness and unrealistic eharacteriza- the last realized point in the abaneloned in favor of "ele>ing the best pe>s- tool for eleve'loping Demand market the implicatienis of a tiems. For example, we> believe that eae-h of sible uneler the edrcumstance-s." The spe- the'ory such as the' one elese-ribed here. It is the moelels as it stanels almost certainly ■I. Kstimntc: curve this period is the cific eletails of the models follow this frame- no acciele'iit, that in el<;- s as therefore', intere>st exaggerates the computational precision of ime last period. If profit weirk. tailed process models has gmwn with the organizatiemal god has been achieved two suc- de;cisie)ii-making. In gene;ral, cessive i average unit, ek'velopnie-nt of the' digital e'omputer. s' costs Forecasting competitor's Coni- we> have not attempted te> introdue:e all erf Avcraße uni, costs i uZIincrease' '"" "''""" """ """'" a behavior puter siniulatit)!) is well suited te> the com- the; revisiems we e'onside>r likely at this time i « ■( ,- a, ■, .- , , medel being analyzed".y"<<. in the; naner1 1 plexitie>s I. Specify objectives: Specify profit goal as n I" !" that are intreduce'd when internal primarily te) . " because wish examine the actual profits achieved over assumes twe) linns in the market (a dimpoly). firm variables are the'ory. |,r utilized in the The- whe'the>r some maje>r re;visions proeluce 11 past periods As a re;sult one e)f the significant variable's in significance e>f simulation for business be- re;sults " "" which rease)iiably approximate ob- h d(,('i*i<>" the <|Uailtity of Output tf) havior has be'en cxplortnl vigorously in the Evaluate: Evaluate alternatives within the served phenomena. estimate space, if an aitemat ive *proeluce° h)r e>ach firm become's an estimate so-ealkd "business game's" eleveloped as which meets The> model is develope'd for a duopoly situ- Rout is ko of the riviil firm's output. For example, busine>ss training de>vices; the'ir potential Kxamine Alternatives to (Hi. If not, ko lo (li! for ation. The product is houmgene'ous and, assume the monopolist, in period (t) is con- economic theory is at levist as great. therefore', emly one price exists in the market. fi. Hc examine: ' yields a cost reduction, (io sidering a change in output from period The major decision that each of the> to (s>. If evaluation there, (/ 1). At A SPECIFIC DUOPOLY MODEL two decision be (9.1. — the same time the monopolist- an can Ko to firms makes is output elecision. In making estimate If not, ko to (7l makes an estimate of the change the splinter The' theoretical we' have' emt- this decision the firm must estimate the will make. At the end of period I the- mo- lined in the> preceding se'etiein can be viewe>d marke-t price for varying 7. He examine: Kstimate demand increased emtputs. When the search. ("Jo to (5). If evalua nopolist can look hack and determine the as an executive program for e)rganizational output the; is sold, heme'ver, actual selling decision can be made, ko to amount of change the splinter made in rela- ele'eisions. That wo (A to (Si is, conceive e>f any large price will be eletermined by the \o I>emand estimate Ifriot, ko tion to his own change. ratio of changes scale oligopolistic market. The business organizatiem as eliscrepancy ( between emtput and sales is He examine: [ profit goal t:, a 'IUI ,M CXpre'SSed as follows: pursuing the steps inelicated. Reduce level consist- ' A change in assumed, and thus no inventory problem ent with best alternative in the the; elecision must (within theory) be ex- exists in medel. estimate space as .. V*,( — V^'.f 1 the Profit, goal I (6) and (7) '".' = .-) plained in terms of some change in one We assume1 __J __ _ of the a dimpoly e'omposed of an ex- -- .„ ' Wm,l pre>cesse>s specified. As we> have noted "■ original .above, moimpeilist anel a firm devek)ped by former "''''"ic: alternative in ,1,,,„„ I' .1 l .i i- , whcl = th« <'hunge in t.he Splinter's. such a conception of the theory seems to members of the established firm. We shall estimate space to meet original '" " '. suggest a computer-simulation goal,in estimate space to emtput°'during pcried tas a percentage of the model rather call the latter, "the original or in splinter," and the for- meet original goal, in me)lH)pollst's Output change during / than treatment in form e.stimate space to meet , PCried mathematical mer, "the ex-monopolist" en-, for brevity, lowered 4. i i , i set output goal Va — v»,(-i = the actuitl change in" the; (Cyert, Simon, it Trow, 105(i). The ratmn- "memopolist." Such a specific case is taken a.le, of course, re>mains the; splinter's output eluring peried t. same. We- wish to se> that some' rough assumptions can be' e'xplore> implie-itions of the .. , Qm.i — Qm ,i-\ = the actual change in the the medel. maele abemt appropriate functions for ot the paper we attempt to provide The the will nmnopolist's output during perioel t. intention has be'en te) e-emstruet a various processes in the medel. The somewhat greater detail (and rationale) plausible assump- for ,„ th(, Wlinp Wliy wp hilvo for thp ,splinlor set erf estimation anel elee-ision rules tions are gross; but it is emly the specific decision through some and estimating rules \\ H, followinir for different 3 type's of organizations, anel te> such rough medel that a start can be made. used. simulate on a compute'!' the be'havien' of these Tei elemonstrate that the medel as a wheile The elecisiem-making process postulated ]' = _*'".".' *_■!_:}. — 1 firms over time. When we attempt to de- has some reasonable empirical base, we will by the theory begins with a phase — Q».t-\ V,„,i medels exhibiting "forecast" velop the proce'ss charac- e;e)mpare certain e>utce>mes with (in ce.mpetite.r's e>f the model which reaction, demand, The ex.monopolist. When the monopolist te'ristics we have' eliscusseel above', it bee'omes data from the can estimated) industry, where approxi- and costs are anel a goal specif.- in , ljmni hjs ()ut hp ck'ar that our knowledgeof how actual firms mately iod is the same initial conditions hole!. ea,on phase (in which a profit gou ,s estab- ps(imilt(v elf), in fact, estimate make ;m ()f hjs riva ,,s ()u aR demanel, cost, etc., is We can elescribe the specifie; model at l.sheei). An evfiluation phase follows, m discouragingly We know noted :ll)()Ve . In ord.'r to make this estimate small. with reasema- several levels erf de-tail. In Table I which an is the skele- effort made to find the "best" W( , assum(l th;lt the (irst m;lkos ble confidence some of the things that many ton of the medel is indicated the "flow monop()list — il ( stil» !,te of the pere'e-ntage' change firms do but at a number erf points in the eliagrams" of the eleeasion-making process. The computer program, developed in the IT . ' in the language" the IBM 650 computer, splinter's" output ill relation to his model we can make emly educated gue'sses. This will permit a e|iiEk cennparison for can he oh- erf the tained from the authors. change, that is, an estimate of V„,,,. Moivover, what kimwledge we> have (or twei firms. In the remiaineler erf this sectiein We
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OU'II 86 Cyekt, Fekienbaum and Mawh Models in a Behavioral Theory of the Firm 87 have assumed that the monopolistwill make curve anel the actual demand curve the ae;tual per-unit cost (Cyert & March, monoperfist, its size, its substantial this estimate on the basis of the splinter's (Weintraub, 1942), and it is this concept 11)56). The concept of organizational slack e-omputational ability, and its established behavior over the past three time periejds. thatis incorporated in the model. The values as it affects costs is introdue;ed at this point. procedures for dealing with a stable rather More speedfically we have assumed that the of the parameters of the "imagined" demand Average unit e;ost for the present period is than a highly unstable environment, will monopolist'sestimate is based on a weighted emrve are based on rough inferences from estimated to be the same as last period, but tend to maintain a relatively stable profit average, as follows: the nature of the firms involved. if the profit goal of the firm has been objective. We assume that the e>bjective will The ex-monopolist. We assume that, be- achieved for two e-onsecutive time periods, be the moving average of the realized profit v'm,t = ie,,,,-, ymvnu-i v m _s) + - + e;ause of its past history of dominance and then costs are estimated to be 5% higher over the last ten time periods. Initially, of ,,_ monopoly, the ex-monopolist will be over- to 2(7M - Vm ,,-?) + than "last time." e'ourse, the monopolist will seek maintain pessimistic with respect to the quantity The specific values for costs are arbitrary. the profit level ae'hieved during its monopoly. ( V 1 m,l-4)J m ,t-3 which it can sell at lower prices, i.e., we as- The general shape of the e'ost e-urves has The splinter. The splinter firm will pre- Where VL.t = the monopolist's estimate of sume the initial perception of the demand been ediscussed in detail in the literature and sumably be (for reasons indicated earlier) e;urve slope the e;hange in the splinter's output during will have a somewhat greater studied empirically (Dean, 1951). The e-on- inclined to consider a somewhat shorter period t as a percentage of the monopolist's than the actual market demand curve. On cept of organization slack has some im- period of past experience. We assume that assumption output e;hange during period t, that is, an the that information about portant implications for the theory of the the profit objective erf the splinter will be the actual demand is used to improve its esti- over past e.stimate erf Vm, t firm and has been defined earlier. average of experiene'ed profit the . mate, we that the ex-monopolist Note that (VL, t )-(Qm, t - #,„,*_■) is the assume The ex-monopolist. The monopolist's ini- five time periods and that the initial profit monopolist's estimate of the; splinter's e;hanges its demand estimate on the basis of tial average unit cost is assumed to be objective will be linked to the experience of experience in the market. The firm assumes relative of change in emtput, Q,, t — Q.,t-i. per unit in the range of outputs from 10% the monopolist and the capacities The splinter. We would expect the splinter that its estimate of the slope of the demand to 90% of capacity. Below 10% and above the two. Thus, we spee'ify that the initial curve is firm to be more responsive to recent shifts e'orrect and it "repositions" its 90 % the initial average unit cost is assumed profit objectives of the two firms will be in its e'ompe;titor's behavior and less atten- previous estimate to pass through the ob- to be proportional to their initial capacities. tive to ancient history than the monopolist, served demand point. The splinter. It is assumed that the com- posit costs berth because it is more inclined to consider The splinter. We that the splinter petitor will have somewhat lower initial Re-examination of the mememolist a key part of its environ- firm will initially be optimistic with respect costs. This is because its plant and eeiuip- We assume that when the original fore- ment and bee'ause it will generally have less to the quantity which it can sell at low ment will tend to be newer and its produc- casts define a satisfactory plan there will be prietes. e'omputational capacity as an organization That is, the initial slope (absolute tion methods more modern. Specifie'ally, nofurther examination of them. If, however, value) of its to proe;ess and update the information demand curve will be somewhat initial average costs are in the range of such a plan is not obtained, we assume an necessary to deal with more complicated less than that of the actual market demand outputs from 10% to 90% of capaeuty. effort to achieve a satisfactory plan in the rules. assumption is that the splinter curve. Secondly, we assume that initially Below 10% and above 90 % costs are as- first instaneie by reviewing estimates and Our splinter will simply use the information from the last the firm perceives demand as in- sumed to average per unit produced. finally by revising objectives. We assume creasing over time. Thus, -_ until demand are reviewed before de- two perieds. Thus V',, t = V,, t + that cost estimates shows a down turn, the splinter firm esti- Specifying objectives that are only (IE, i_i — V,. t-z).* In the same manner as mand estimates and the latter mates its demand to be 5% greater than abe>ve (V,,.)"((}„,t Q,,t-i) is the splinter's The multiplicity erf organizational objeev re-examined if a satisfactory plan cannot be — perceived estimate erf the monopolist's change in out- that found by repositioning its tives is a fact with which we hope to deal in developed by the revision of the former. The point put, m( demand through the last observed in costs a Q — Qm ,t-i. later revisions of the present models. For re-evaluation of is search for methods the marketplace. the present, however, we have limited our- of accomplishing objectives at lower cost Forecastingdemand terms appeared possible pressure. Estimating costs selves to a single objective defined in than under less We assume that theactual market demand of profit. In this model the fune'tion of the We believe this ability to revise estimates curve is linear. That is, we assume the mar- In the proe;essfor forecasting andrealizing profit objective is to restrict or encourage when forced to do so is characteristic of ket price to be a linear function of the total costs, we do not make the assumption that search as well as to determine the decision. organizational decisiein-making. It is, of output offered by the two firms together. the firm has ae'hieved optimum costs. We If given the estimates of competitors, de- course, closely relateel to the organizational We also assume that the firms forecast a assume, rather, that the firm has a simplified mand, and cost, there exists a productiem slae'k e-one-ept previously introduced. In linear market demand curve (ejuite different, estimate erf its average cost curve, that is, level that will provide a profit that is satis- general, we have argueei that an organiza- perhaps, from the actual demand curve). the e'urve expressing cost as a function of factory, we assume the firm will adopt sue;h tion e;an ordinarily find possible cost reduc- There has been considerable discussion in emtput. It is horizontal over most of the a If there is more than one tions if forced to do so and that the amount the eesonomics literature of the frequent dis- range erf possible outputs; at high and low tory alternative, the firm will adopt that of the reductions will be a function of the crepaneiy between the "imagined" demand outputs (relative to capae'ity) costs are per- ejuantity level that maximizes profit. amount of slack in the organization. ceived to be somewhat higher. even such a restricted maximiza- is assumed that the re-examination of 4 Obviously Whether It we do not maintain that the form Further, we make the assumption that tinder pressure of trying to meet and parameters of these "learning" functions are tion proe'edure is appropriate is a subject for costs the empirically validated. The functions are some- these cost estimates are "self-confirming," further research. objectives enables eae:h of the organizations what arbitrary hut we hope not unreasonable. i.e., the estimated costs will, in fact, become The ex-monopolist. We assume that the to move in the diree:tiem erf the "real" mini-
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$800
$900.
$760
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e^ourse. satisfae;- 88 CYERT, FeiCKN'BAUM AND M.\KCH Models in a Behavioral Theory of the Firm 89
mum cost point. For purposes of this model The ex-monopolist. As a result of the re- TABLE 111 it is assumed that both firms reduce costs examination of demand estimates, it is Values Selected Variables at 2-Period Intervals 10% of the difference between their esti- assumed that this firm revises its estimates "i~ mated average unit costs and the "real" of demand upward by 10%. I ill v VII IX XI XIII XV minimum. The splinter. The assumption here is that the upward revision of demand Market Re-examination of demand is 5 % - Price 1,420 1,710 2,196 2,763 3,283 3,927 4,430 4,942 Re-examination of objectives ' Output 290 311 262 205 209 195 303 466 The re-evaluation of demand serves the Ex-Monopolist same function as the re-evaluation of costs Because our decision rule is one that maxi- Aspiration Level 163,100 165,671 169,631 176,800 173,221 1178,385 '203,693ii 246,7462 above. In the present models it occurs only mizes among the available alternatives Conjectual Variations 0 0 .74 -22.4 1.09 .74 .26 .35 and 826 813 881 944! 1,041 1,106 1,219 1,344 if the re-evaluation of costs is not adequate our rule for specifying objectives depends Costs (A.U.C.) to define an Output 240 251 206 153 161 150 233 363 acceptable plan. It consists in only on outcomes, the re-evaluation of ob- Number of He-examination revising upward the expectations of market jectives does not, in fact, enter into our Steps 2 0 0 3 0 0 0 0 demand. The reasoning is that some new present models in a way that influences be- Competitor i Aspiration Level 20,387 27,107 31,448 39,763 46,218 39,684 54,245 79,090 alternative is selected which the firm believes havior. The procedure can be interpreted as 8.72 3.39 3.96 aspirations Conjectural Variations 0 0 9.2 -1.78 -6.58 will increase its demand. The new approach iidjusting to the "best possible Costs (A.U.C.) 760 798 865 954 1 ,023 1 ,057 1,166 1,285 may be changed advertising procedure, a ull
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for
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Profit,
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'
last, 90 Cyert, Feigenbaum and March
TABLE 111, Continued XXXIII I XXXV I XXXVII j XXXIX I XLI I XLIII i XLV Ex-Monopolist Aspiration Level 159,060 179,859 203,892 239,045 280,940 260,501 340,745 Conjectural Variations. .85 .95 .96 .65 3.77 1.91 1.35 Costs (A.U.C.) 1,363 1,502 1,656 1,826 2,013 2,071 2,283 Output 125 195 303 432 342 320 500 Number of Re-examination Steps | 0 0 : 0 0 0 ; 0 j 0 Competitor J Aspiration Level 38,6278 , 627 ! 53,005 | 77,001 109,136 164,566 266,512 396,911 Conjectural Variations . 1.32 !] 1.31 : 1.32 2.3 -.8 3.16 .79 Costs (A.U.C.) 1,840 I| 2,029 ! 2,2372,237 2,466 2,719 2,771 3,055 Output 93 Ij 145 :: 226 303 435 407407 626 Number of Re-examination I i Steps 000! 0 0 0 0 Profit Ratio I Competitor's Profit -f- Mo- nopolist's Profit "49 .49 .49 ; .47 .90 .97 .95 Share of Market Competitor's Output -f- To- I i I ! tal Output ! -43 ! .43 ! .43 .41 J .56 .56 .56 maximization with respect too its perception of the behavior that is generated by the of costs, demand, and competitor'sompetitor's be- interacting models, we have reproduced in havior. The spee'ific alternativesives selected, of Table 111 the values of the critical variables course, depend on the pointit at which this on each of the major decision and output step is invoked (i.e., how manyny re-evaluationre-evaluatiem factors. 5 By following this chart over time, steps are used before an ae-ceptableceptable plan is one (.an determine the time path of such identified). The output decisionecision is con- variables as cost, conjectural variation, and ways: (1) strained in two A firm cannot pro- output for both of the firms More than any due;e, in any time period, beyondyond its present Qne thi ;l (>areful stud of thig table wiU capacity. Both nrndels allowiv fortor change in r . , , ... lve il ee ln or the major characteristics plant e'apacity over time. rp,The process Kby S °f the behavioral' ' theory we have described. which e^apacity changes is the same cfor"ubothi ' we have compared the firms. If profit goals have been met for two In addition, share successive periods and production is above of market and profit ratio results with actual 90% erf capacity, then capacity increases data generated from the competition be- 20%. (2) A firm cannot change its output tween American Can Company and its from one time period to the next more than splinter competitor, Continental Can Com- ±25%. The rationale behind the latter pany, over the period from 1913 to 1956. assumption is that neither large cutbacksnor These comparisons areindicated in Figures I large advances in production are possible in and II.8 In general,wefeel that the fit of the the very short run, there being large organi- behavioral model to the data is rather sur- zation problems connected with either. The various initial conditions specified 6 Market demand was varied in the following are way: (1) The slopeof the elemand curve was held above summarized in Table 11, along constant. (2) At each time period the intercept, with the other initial conditions reejuired to It, was set equal to a!t-\. The value of "a" was program the models. 1.08 for perioels .90 for periods 1 .(X) KEY _ PROFITS 1-16, 17-20, ,„,„,„- SPLINTER for periods 21-26, and 1.08 for periods 27-43. DATA FROM COMPUTER MODEL SHOWING RESULTS OF THE DUOPOLY MODEL 6 One of the parameters in the model is the — ——-—^-^^ length of time involved in a single cycle. In com- „„.„,.,_ _ CONTINENTAL CAN PROFITS We have now described a decision-making the of the with the American- „ paring output model DATA FROM MOODY'S INDUSTRIALS SHOWING AM£R|CAN pRQF|TS model of a large ex-monopolist and a splinter Continental data, this parameter was set at 12 — competitor. In order to present some detail months. Fig. I. Comparison of Share of Market Data. 91
'
.> Models in a Behavioral Theory the Firm 93
prisingly goe)d, although we do not regard e;an be better understood when variables re- this fit as validating the approach.7 lating to the internal operation of a business It should be noted that the results in firm are added to the theory. Accordingly, periexl XLV do not necessarily represent an we would hope that such a theory would not equilibrium position. By allowing the firms only lead to impraveel prediction on the to continue to make decisions, changes in usual ejuestions but would also facilitate the output as well as changes in share of market investigation of other important problems, would result. One of the reasons for the ex- e.g., allocation erf resources within the firm. pected c;hange is the demand curveis shifting The theory we have used differs from con- upward. Another, and more interesting ventional theewy in six important respects: reason, is that no changes have been made (1) The models are built on a description of within the organizations. In particular, the the dee-ision-making process. That is, they splinter firm by period XLV is a mature specify organizationsthat evaluate competi- firm, but the model has it behaving as a tors, costs, and demand in the light of their new, young firm. One of our future aims is own objectives and (if necessary) re-examine to build in the effect em organization, and eae'h of these to arrive at a decision. (2) The hence on decision-making, of growth and models depend on a theory of search as well maturity erf the organization. as a theory of choice. They specify under An examination of Table 111 indicates what conditions search will be intensified that the re-examination phase of the deci- (e.g., when a satisfactory alternative is not sion-making process was not used frequently available). They also specify the direction by either firm. This characteristic is the in which search is undertaken. In general, result of a demandfune'tion that is increas- we predict that a firm will look first for new ing over meist of the periods. alternatives or new information in the area Whether this stems also from an inade- it views as most under its control. Thus, in quae:y in the model's dese'ription of organi- the present moelels we have made the spe- zational goal-settingor is a characteristic of eufic prediction that e'ost estimates will be the real world of business decision-making re-examined first, demand estimates second, is a emestion that can be answered only by and organizationalobjee;tives third. ('.,) The empiricalresearch . models describe organizations in which ob- jeerfives change over time as a result of ex- DISCUSSION perieneie. Goals are not taken as given ini- One erf the primary points that has been tially and fixed thereafter. They e'hange as stressed here is the importance of the the organization observes its sue'e'ess (e)r decision-making process for the theory of the lack of it) in the market. In these models the firm. The implication of this position is that profit objective at a given time is an average the decisions studied by conventional theory erf achieved profit over a number of past periods. The number of past perioels cein- 7 It should be clear that the validity erf the ap- proach presented in this paper is not conclusively sidered by the firm varies from firm to firm. demonstrated by the goodness of fit to the can (4) Similarly, the models describe organiza- industry data. We have indicated that under the tions that adjust forecasts on the basis erf appropriate assumptions, models of firm decision experience. Organizational oce-urs processes learning can be specified that yield predictions as a of competi- approximating some observed results. However, result observations erf actual the situation is one in which there are ample tors' behavior, actual market demand, and elegrees of freedom in the specification of parame- aerfual costs. Eae;h of the organizations we ters to enable a number of time series to be ap- have used readjusts its perceptions on the proximated. Although in this case we havereduced the number of free parameters substantially by basis of such learning. The learning rules specifying most of them a priori, the problems of used are quite simple. This is both because DATA FROM COMPUTER MODEL SHOWING EX ~ MONOPOLIST OU" MARKET OUTPUT identification faced by any complex model are simple rules are easier to handle than com- faced by this one and will have to be solved. The plex general rules and because we expect the true DATA FROM MOODY'S CONTINENTAL SALES methodology for testing models that take INDUSTRIALS SHOWING the form of computer programs remains to be rules to be susceptible to cle>se approxima- CONTINENTAL* AMERICAN SALES developed. tion by simple ones. (5) The mexlels Fig. intra- 11. Comparison of Profit-Ratio Data. 92
of 94 Feigenbaum Cyert, and March Models in a Behavioral Theory of the Firm 95
duce organizational biases in making esti- need for more empirie'al observations of or- Press, 1946, sth ed., pp. 30-55, 117-129, R. A. Short-period price extermination. mate's. For a variety erf reasons we expect ganizational decision-making. Each of the 165-171. Amer. Econ. Rev., 1948, 38, 265-288. some organizations to be more conservative major steps program Cooper, W. W. A proposalfor extendingthe theory Koopmans, T. C. Three essays on the stale of outlined in the defines economic science. New York: McGraw- with respect to cost estimates than other or- an area on of the firm. Quart. J. Econ., 1951,65, 87-109. for research business behavior. Cyert, M. & March, J. ti. Organizational struc- Hill, Inc., 1957, pp. 208-217. ganizations, some organizations R. to be more How do organizations predict the behavior ture and pricing behaviorin an oligopolistic Papandreou, A. G. Some basic problems in the optimistic- with respect to demand than of competitors? How do they estimate de- market. Amer. Econ. Rev., 1955, 45, 129-139. theory of the firm. In B. F. Haley, Ed., A others, some organizationsto be more atten- mand and costs? What determines organi- Cyert, R. M. & March, J. C. Organizational fac- survey of contemporary economics, Home- theory D. vol. 2. tive to and perceptive of changes in competi- objectives? tors in the of oligopoly. Quart. J. wood', 111.: It. Irwin, Inc., 1952, zational planning In the models H. A. A behavioral model of rational tors' plans than others. As we develop more we specified we em- Econ., 1956, 70, 44E64. have have introduced Cyert, It. M., H. A., & Trow, D. B. Ob- choice. Quart. J. Econ., 1955, 69, 99-118. detailed submodels of theestimation process, pirical assumptions for such things as or- servation of a business decision. J. of H. A. Models of man. New York: John these factors will be increasingly obvious. ganizationallearning and changes in organi- Business, 1956, 29, 237-248. Wiley 1957, pp. 204-205. In the present models we have not attempted zational aspiration levels. Dean, Joel. Managerial economics. New York: Weintraub, S. Monopoly eeiuilibrium and antici- We have ignored pated demand. J. Political Economy, 1942, to develop such submodels but have simply several factors we consider quite important Prentice-Hall, 1951, pp. 292-296. predicted Friedman, Milton. Essays in positive economics. 50, 427-434. the outcome of the estimation (e.g., informational biases stemming from Chicago: Univ. of Chicago Press, 1953, pp. process in different (fi) The models all variations in the communication structure). 14-15. (Manuscript received November 17, 1958). introduce features of "organizationalslack." In the final development of the model these That is, we expect that over a periodof time relationships must be defined from observa- during which an organization is achieving ble characteristics of business organizations. its goals a certain amount of the resources We see three major directions for further of the organization are funneled into the research. First, we would hope that further satisfaction of individual and subgroup ob- attempts will be made to comparethe results jectives.This slack then becomes a reservoir of the models with observable data. In these of potential economies when satisfactory studies it will be possible to change such plans are more difficult to develop. variables as have been indicated above and In order to de;al with these revisions, the others that appear to be important in the models have been written explicitly as com- model. Second, we need a great deal of work puter programs. Such treatment has two in actual organizations identifying the de- major values. First, simulation permits the cision procedures used in such things as introduction of process variables. The lan- output decisions. Field research on organi- guage of the computer is such that many of zations has frequently been extremely the phenomena of business behavior that do time-consuming and costly relative to the not fit intoclassical models can be considered results it has produced, but we believe that without excessive artificiality. Entering research focused on the questions raised by naturally into the model are cost and de- the model is both necessary and feasible. mand perceptions within the firm in relation Third, there is room for substantial basic re- to such factors as age of firm, organizational search in the laboratory on human decision- structure, background of executives, and making under the conditions found in busi- phase of the business cycle; information ness organizations. Many of the major handling within the firm and its relation to propositions in organization theory depend the communication structure, training, and on evidence generated by studies in the reward system in the organization; and the laboratory and many of the mechanisms effects of organizationalsuccess and failure with which we have dealt can be profitably on organizational goals and organizational introduced into controlled experiments. slack. Secondly, simulation easily generatesdata REFERENCES on path prices, the time of outputs, etc. For Alt, R. M. The internal organization of the firm that large class of economic problems in and price formation: An illustrative case. which eeiuilibrium theory is either irrelevant Quart. J. Econ., 1949, 58, 92-110. or relatively uninteresting, computer meth- Bushaw, D. W. & It. W. Introduction to odology provides a major alternative to the mathematical economics. Homewood, 111.: It. D. 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Chamberlin, Graduate School of Industrial Administration William Larimer Founder
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(Continued) 23. Management in the 1980's, by Harold J. Leavitt and Thomas L. Whisler. Harvard Business Review, November-December 1058. 24. Extremal Principles for Simulating Traffic Flow in a Network, by Abraham Charnes and William W. (kwper. Proceedingsof the National Academy of February 1058. 25. Determining the "Best Possible" InventoryLevels, by Kahnan Joseph Cohen. Industrial Quality Control, October 1058. 26. The Theory of Search: Optimum Distribution of Search Effort, by A. Charnes and W. W. 1 Cooper. Management October 1058. 27. The Role of Expectations in Business Decision Making, by R. M. Cyert, W. R. Dill, and J. G. March, Administrative Science Quarterly, December 1958. I 28. Application of Linear Programming to Financial Budgeting and the Costing of Funds, by A. W. W. Cooper, and M. H. Miller. Journalof Business, January 1950. 29. Nonlinear NetworkFlows andConvexProgrammingOver Incidence Matrices,by A. Charnes and W. W. Cooper. NavalResearch Logistics Quarterly,September 1058. 30. The Role of the Field Staff Representative,by Myron L. Joseph. Industrial and Labor Rela- tions Review,April 1959. 31. Models in a Behavioral Theoryof the Firm, by R. M. Cyert, E. A. Feigenbaum, and J. G. March. Behavorial April 1959. 32. An OrganizationalModel of Soviet Industrial Planning, by David Granick. The Journal of Political Economy, April 1950.
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