Institutions and Success: a Tribute to Douglass North

Posted: 01/12/2018 - 01:09

In anticipation of the return of Kate Vitasek’s column “The Academics of Sourcing,” Outsource is pleased to showcase some of her best articles from the archives.

“The Academics of Sourcing” is a series that regularly shares some of the best academic insights and translates the learnings from academia into sound advice for practitioners.

Read on to get reacquainted with Kate Vitasek’s insight and experience into the world of sourcing and the academics behind it. 

This month’s Academic of Outsourcing tribute goes to Douglass C. North for his work on “new institutional economics.” North – a professor, economist, philosopher and economic historian – was the co-recipient (with Robert Fogel) of the 1993 Nobel Prize in Economic Sciences “for having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change.” 

A mouthful for sure, so let me translate. North, a former professor at Washington University’s Department of Economics in St. Louis, MO, led groundbreaking work on how institutions and societies interact and how those interactions can positively or negatively impact economics over time as they evolve. 

In a 1991 paper on institutions, North argued that institutions are “the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions and codes of conduct), and formal rules (constitutions, laws, property rights).” As an institution, these formal and informal behaviors have the power to “shape the direction towards growth, stagnation or decline.” 

Wow...powerful stuff. The formal policies and informal behaviors we have in business exchanges help form the basis of our future business success (or decline). 

A key premise of North’s work is that institutions are needed to “create order and reduce uncertainty in exchange.” Businesses eventually create a set of institutional norms and actions that drive the nature of the relationship, and in turn the economic value that follows from businesses doing business together. 

Viewing businesses as institutions mean that there are more than cold commercial calculations at work, because institutions, as North indicates, are also social arrangements. North examines this through a game theory lens: “Wealth-maximizing individuals will usually find it worthwhile to cooperate with other players when the play is repeated, when they possess complete information about the other player’s past performance, and when there are small numbers of players. But turn the game upside-down. Cooperation is difficult to sustain when the game is not repeated (or there is an end game), when information on the other players is lacking, and when there are large numbers of players.” 

The last sentence is worth repeating. “Cooperation is difficult to sustain when the game is not repeated (or there is an end game), when information on the other players is lacking, and when there are large numbers of players.” Bottom line: what North was getting at is that it’s hard to build a highly cooperative business relationship when you don’t trust the other party, or in other words, when there’s a win-lose “end game” underway. 

I wholeheartedly agree with North. For commercial relationships to work successfully over the long term, they must consciously adopt formal and informal ethical social norms of trust, integrity and honesty with the clear intention of raising the level of certainty in doing business with another party 

In my book – Vested: How P&G McDonald’s and Microsoft are Redefining Winning in Business Relationships – I describe how McDonald’s has created a “system” that includes long-term relationships with its most strategic suppliers based on a simple handshake. Ray Kroc’s handshake formed the basis for a social contract based on transparent, hyper-collaborative 

relationships under the “none of us is as good as all of us” mantra. McDonald’s social contracts have evolved, including formalization of fabulous governance mechanisms with the conscious goal of driving predictable, trusted relationships with their most strategic suppliers. 

Establishing social norms to drive predictable patterns of behaviors between business partners based on trust, integrity and honesty definitely has the power to motivate order and certainty in a business relationship. A case in point is that McDonald’s and its suppliers face the same dynamic and ever-changing world fraught with the same risk as their fiercest competitors. The difference is that McDonald’s and its suppliers de-risk the supply chain by working together to solve the most complex supply chain challenges – such as how to not run out of chicken during the Avian Flu crisis, or how to become the first restaurant to open after Hurricane Katrina. 

Think about it. Which side do you want to be on in the face of a dynamic and risk-filled business world? Someone you can trust? Or someone that is consistently opportunistic and will throw you under the bus in the face of adversity? If you ask me, I’d rather be on the same side of the table with my customer (or supplier) solving the tough problems rather than sitting across the table negotiating in a never-ending battle of tradeoffs, concessions and risk-shifting. 

North’s analysis of institutions and how they interact economically and socially is relevant – and encouraging.


About The Author

Kate Vitasek's picture

Kate Vitasek is an international authority for her award-winning research and Vested business model for highly collaborative relationships. She is the author of six books on the Vested model and a faculty member at the University of Tennessee. She has been lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce.