Last night I ran some simple performance tests on the transaction database. Using inexpensive stock hardware the DB server managed to process 312 payment transactions per second.
First I ran a Python script that created 10′000 employee records with their corresponding accounts [download script]. Then, a second script [download] simulated 10′000 transactions between randomly chosen employees.
The time was recorded with the Unix command time. The first script took 91 seconds to complete, the second 32 seconds (translating to ~ 312 transactions / sec). In both cases the network traffic between client and server was about 100 kbit/s.
The test setup:
The server: MySQL 5.0.34 running on an Intel P4 Linux machine
The client: the two Python scripts were run from a P4 Linux laptop connected to the server via 100mb/s Ethernet
No blue smoke came out of the server, so I guess the test was successful
Yesterday I sat down and had some fun designing a SQL database to implement the transactional storage and procedure layer of the software system that I outlined last week. It is a relatively simple implementation, yet it covers the core points of what the database should provide — store the employees’ money accounts and allow them to conduct transactions. My current plan is to implement all minimal components so that in a couple of months I have a working software for demonstration purposes, which then can be quickly adapted and put to practical use when a client comes and decides to test the concept at their company.
The RDBMS I chose is MySQL 5.0.32. It is open source and widely used in web applications, such as this blog (run by WordPress).
I designed a database with 3 tables:
TABLE employees to hold the login data for each employee. In a production environment one may instead have a dedicated server to manage identities and provide log-in.
TABLE accounts to store the transactional accounts of the employees.
TABLE transactions to log all transactions that are being made
The more important data fields of the three SQL tables. The foreign key relations are highlighted
The exact SQL spec of the three tables looks like this:
CREATE TABLE employees (
id MEDIUMINT UNSIGNED NOT NULL AUTO_INCREMENT PRIMARY KEY,
name VARCHAR(36) NOT NULL,
login VARCHAR(12) NOT NULL,
password CHAR(40) NOT NULL,
status ENUM ('active', 'departed') NOT NULL DEFAULT 'active'
)ENGINE=INNODB DEFAULT CHARSET=utf8;
CREATE TABLE accounts (
id MEDIUMINT UNSIGNED NOT NULL AUTO_INCREMENT PRIMARY KEY,
holder MEDIUMINT UNSIGNED NOT NULL,
balance DECIMAL(9,2) NOT NULL,
created DATETIME NOT NULL,
status ENUM('active', 'suspended', 'closed') NOT NULL DEFAULT 'active',
INDEX (holder),
FOREIGN KEY (holder) REFERENCES employees(id)
ON DELETE RESTRICT
ON UPDATE RESTRICT
)ENGINE=INNODB DEFAULT CHARSET=utf8;
CREATE TABLE transactions (
id INT UNSIGNED NOT NULL AUTO_INCREMENT PRIMARY KEY,
date TIMESTAMP,
sending_account MEDIUMINT UNSIGNED NOT NULL,
receiving_account MEDIUMINT UNSIGNED NOT NULL,
amount DECIMAL(9,2) NOT NULL,
reference VARCHAR(255),
INDEX (sending_account, receiving_account),
FOREIGN KEY (sending_account) REFERENCES accounts(id)
ON DELETE RESTRICT
ON UPDATE RESTRICT,
FOREIGN KEY (receiving_account) REFERENCES accounts(id)
ON DELETE RESTRICT
ON UPDATE RESTRICT
)ENGINE=INNODB DEFAULT CHARSET=utf8;
Two notes regarding the SQL description of the tables:
The foreign key relations have ON DELETE RESTRICT and ON UPDATE RESTRICT constraints in order to preserve the integrity of the records. For example, when an employee leaves the company his account data must not be deleted, otherwise the other employees may receive an incomplete account statement of their previous transactions. Instead, the status of the leaving employee record should be changed to ‘departed’ and his account flagged as ‘closed’.
The employee.id and accounts.id fields are defined as UNSIGNED MEDIUMINT to provide ID numbers for up to 16′777′215 records. The transactions.id field is an UNSIGNED INT which can provide up to 4′294′967′295 transaction IDs. I assume this number would suffice even to a large company for at least several years: 100′000 employees x 10 transactions daily x 365 = 365 mio. transactions p.a. If not, the integer size can be increased, but this won’t be the only IT issue then
I decided to implement the transactional business logic as stored procedures within the database. The idea is to keep the ‘transactional engine’ as compact as possible by having the data and the logic close to one another. Again, there is nothing fancy to the actual transaction rules, just simple common sense code that says, for example, that before making a payment the program should check whether the employee has enough money in his account.
Here I’ll list only the make_payment() procedure, the rest are more or less of the INSERT/SELECT/UPDATE type of code. Expectedly, the procedure has to execute the transaction statements as an “atom” and makes use of the standard COMMIT and ROLLBACK commands.
# Make a payment
# returns SELECT as return_code:
# 0 on success,
# -1 on insufficient balance,
# -2 on missing/inactive sender account,
# -3 on inactive recipient account
CREATE PROCEDURE make_payment (
IN sending_account MEDIUMINT,
IN receiving_account MEDIUMINT,
IN amount DECIMAL(9,2),
IN reference VARCHAR(255)
)
proc: BEGIN
DECLARE status_result TINYINT SIGNED;
DECLARE sender_balance DECIMAL(9,2) SIGNED;
START TRANSACTION;
# Check if sending account is active/exists
SELECT COUNT(status) INTO status_result FROM accounts
WHERE accounts.id=sending_account AND
accounts.status='active';
IF (status_result != 1) THEN
ROLLBACK;
SELECT -2 AS return_code;
LEAVE proc;
END IF;
# Check if receiving account is active/exists
SELECT COUNT(status) INTO status_result FROM accounts
WHERE accounts.id=receiving_account
AND accounts.status='active';
IF (status_result != 1) THEN
ROLLBACK;
SELECT -3 AS return_code;
LEAVE proc;
END IF;
# Check if sending account has enough money for the payment
SELECT balance INTO sender_balance FROM accounts
WHERE accounts.id=sending_account LIMIT 1;
IF (sender_balance - amount < 0) THEN
ROLLBACK;
SELECT -1 AS return_code;
LEAVE proc;
END IF;
# Proceed with transaction
INSERT INTO transactions SET
sending_account=sending_account,
receiving_account=receiving_account,
amount=amount,
reference=reference;
UPDATE accounts SET balance=balance-amount
WHERE id=sending_account;
UPDATE accounts SET balance=balance+amount
WHERE id=receiving_account;
COMMIT;
SELECT 0 AS return_code;
END;
This SQL code of course isn’t final and would probably evolve further as the software development goes on.
Finally, if this programming code hasn’t scared you, you may want to have a look at these database software jokes
Last night I stopped by Ron Davison’s blog R World. There he had put together a graph of the growing income disparity in the US, the idea being that the current Bush administration is doing worse in this regard than Clinton did a decade ago.
Yes, the graph is backed by concrete statistical data. But these numbers, by themselves, speak nothing of their cause.
Were changes in fiscal policy the primary cause behind the divergence of incomes? Taxation does affect income: directly, through policies for its redistribution from the richer to the poorer, and indirectly, by stimulating the economy. The first mechanism, however, doesn’t address the economic problem that led to the income inequality in the first place, it is only meant as a relief after the fact, while the second has too broad an effect.
I would rather propose to look elsewhere for the cause. To me the government has very little to do with both the problem at hand and the solution. Those of you who have read my previous article “Held Together by Faith” would know where my argument is heading to.
Not only in the US, but also here in Europe politicians are talking about a growing income disparity and a falling behind of the middle class. Some attribute this to deficits in education, others to the increased competition that arrived with the globalisation.
I say the principal cause lies elsewhere: corporations have been stagnating with respect to the market and globalisation has come to expose this, revealing millions of employees caught in workplaces where they fail to develop their economic potential.
Who makes up the top 10% of the income bracket? Mostly investors in the stock market, entrepreneurs, independent professionals, people with own businesses. What is common to all of them? Their greater engagement and activity in the open market where they enjoy a higher degree of economic potentials – compared to the workplaces within companies where one generally has as an employee a much more constrained playing field.
This economic divide increased and became more apparent over the past 10 – 15 years. After the end of the Cold War the market capitalist system underwent a significant boom. It expanded to the countries of the former Eastern Bloc and to China where hundreds of millions of people live. In the Western world it also went through developments marked by the liberalisation of many sectors, the falling of various protectionist barriers to trade, the adoption of electronic communications and trading, the privatisation of major utility companies across Europe and the introduction of the Euro. Markets became global.
Therefore, it is no surprise that to the entrepreneurs in the market globalisation came like manna from heaven: access to more capital and larger markets, new possibilities for networking and investment, exchange of ideas and know-how on a broader scale.
Corporations, on the other hand, developed rather sparsely over the same period. Most internal structural shifts, however heroic, were limited to the accommodation of computer technology. Still, over the past 10 – 15 years an array of companies underwent huge expansion and posted record profits. You may wonder, “how come?” The answer is simple: the primary cause for this spectacular growth of corporations didn’t originate from within, but was due to the improved conditions in the market environment: more people to sell to, more sources of finance, access to cheaper labour.
So, in a way globalisation both exposes and masks the growing gap between the market and the corporation. On one hand it presented companies with “free” room to expand, on the other, it exposed the fact that many employees behind corporate walls are falling behind. I suspect businesses would have faced greater pressures to reinvent themselves had the spread of the market capitalist system not provided new pastures to compensate for that.
Sooner than later, however, the world will run out of countries with non-market economies as the last stubborn supporters of “communism” succumb to capitalism; the population growth will slowly begin to level off. At last then the corporations will notice that they’ll have to look inward if they are to avoid stagnation, that we cannot have sustainable growth – of corporate profits, of personal income, if the economic potential of employees is being depressed.
There aren’t many options to close the gap, in fact I see just one – companies becoming more like their environment by adapting mechanisms from it: allowing monetary relations between employees, decentralising decision making, trimming frustrating bureaucracy. Yes, there will be initial suspicion and resistance to these changes, but in the end most people will like their new transformed workplaces – the possibilities for unrestricted interaction with colleagues, the more personal touch of relations in the office, the simple money rules, the ability to earn more.
This blog’s aim is to walk you through this new and transformed company. Stay tuned!
Last week I received an email from Michel who was wondering how The Transaction Company could function in the real world:
I thought about your idea during my bus ride to work this morning. I asked myself: How can the bus driver participate in the transaction company? Should he be able to reward the technician that maintains the bus for him? Should he give him 10 Euros every time he feels like giving it him? How does he determine this value anyway. How do you determine the [credits amount] he can hand out during a period of time? [...] How do you know that employees know how to value the services of the other?
Transactions are not this complicated. Actually, they can be quite intuitive and easy to grasp.
Let’s take Michel’s example of the bus driver and create a hypothetic bus company built around internal transactions. I chose it to have five people, which should suffice to illustrate the concept:
The boss of the bus company
Three bus drivers
A technician
A company normally requires material assets and people in various functions in order to operate. In our bus company these are arranged as follows:
The boss provides the material assets. He obtained a bank loan to buy three buses and a bus garage to park them overnight. He is also responsible for the marketing and for obtaining the required bus line licenses from the city council.
Three drivers for each bus. They also sell the tickets to their passengers.
A technician who takes care of the buses’ maintenance. His repair shop is located in the bus garage.
How do you turn the bus company into a Transaction Company?
The recipe: Give our five little heroes the possibility to establish monetary relations with one another in order to obtain the required inputs for their jobs and then to gain from what they produce/provide. The concept does not prescribe anything more specific because the exact terms for a given transaction are best left to the interested parties to define.
The recipe for The Transaction Company is simple
A word of caution: Driven by a desire to achieve greater control, the boss (or anyone else in the company) has to be careful not to distort the recipe by insisting on transactions with employees with whom one actually has no direct work relations. This is most likely to be counter-productive, resulting in moral hazard and perverse incentives — precisely the problem, common to many conventional organisations, that The Transaction Company aims to solve. This is an important issue which I would like to write about in another article.
Let’s now apply the recipe to the bus company, together with some economic common sense in order to anticipate how the five heroes might set up the transactional relations among themselves. Here is one possible scenario:
For the three buses that the drivers need for their job, the boss agrees with them on a lease fee to be paid to him monthly. In addition, a percentage of the ticket sales is agreed to go to the boss for his administrative and marketing work. Finally, the drivers agree with the technician on a pay for his maintenance services. He, however, needs some space in the bus garage to set up his repair shop, and for that he negotiates a monthly rent with the boss.
To sum up, for any one of our heroes to identify their possible transactional relations, they simply have to ask themselves two questions:
“Who do I need for my job?”
“Who needs me?”
The following interactive diagram maps the internal transactions (among our five little heroes) along with the external ones (with the customers and the bank). The internal transactions of a company cannot be regarded in isolation from the market environment. This is a great feature of The Transaction Company that adds to the understanding of the business in its financial relations with customers, suppliers and creditors.
Now that we know how the transacting partners in the firm identify one another, the next logical step is to look into the valuation of the actual transactions. But before we discuss this, let’s remember how personal income is derived. The Transaction Company says that this is simply the difference between the inbound (money received) and outbound transactions (money paid) for a person over a period of time (here I ignore the special case when shareholder dividend is paid):
For each bus driver, this is the money collected from the ticket sales after the bus lease, the sales percentage and the maintenance service have been paid for.
For the technician this is the money received from the bus drivers for his maintenance services minus the amount he paid to the boss to have his repair shop in the garage.
For the boss this is the money received from the three bus drivers and the technician minus the loan instalment owed to the bank.
Getting back to the valuation of transactions, there is a question that I often get bombarded with: “But how would the person X know how much a particular transaction is worth?” I have answered this in a previous post, but now I’ll explain it again, using the bus company example at hand.
As I mentioned above, the mantra of The Transaction Company is “give people a framework for monetary transactions, the rest they shall sort out themselves”. This also includes the pricing of transactions. Valuation is subjective, therefore I see no point in attempting to impose some “objective” rules to it.
I can’t tell for sure what strategy a particular person would choose to determine and negotiate transaction value, but here is one possible to start with. For example, it is not hard to imagine that many people would aim to earn at least the typical average for their profession (this kind of strategy is called satisficing). So, let’s assume that one of our bus drivers wants to earn at least as much as his peers, e.g. 2000 Euros per month. In order to net this amount, when negotiating the terms of his transactional relations he would have to achieve such a balance between received and spent money, so that at the end of the month he is left with minimum 2000 Euros. As a simple equation:
Sum of received money - Sum of spent money ≥ € 2000
or more specifically
Ticket sales - Bus lease - Sales percentage - Bus maintenance ≥ € 2000
The bus driver may then notice that of the four factors affecting his pay, some are more variable than others, or that some he can influence more easily. For example, the boss may agree on better terms of the bus lease, while the technician may not accept to work for less because his skills are in high demand; or he may see a chance to increase his passengers by adjusting the timetable. In any case, our bus driver has a clear picture of the factors that make up his personal income and a direct mechanism to act upon them. Employees in conventional companies do not enjoy this kind of transparency and flexibility.
Regardless with which strategies our five small heroes set out initially, in the end they will balance out. And because the bus company is part of a larger economic system, the transaction values will have to balance not only internally, but also with respect to the market. This balance, of course, will be dynamic; it will shift as internal and external business conditions change.
Mathematically, you can represent the problem of transaction value balance as a system of equations. For our bus company of five people we will have five such equations, that is, one per person.
If we assume the following
The three bus drivers aim to earn at least € 2000, the technician at least € 4000, and the boss at least € 7000
The bus lease (BL) and ticket sales percentage (SP) is the same for all drivers
TS1,2,3 signify the ticket sales for the corresponding driver
BM1,2,3 signify the bus maintenance outlays for the corresponding driver
RS is the rent paid by the technician for his repair shop
LR is the loan repayment owed by the boss to the bank
the resulting system of equations will look like this:
TS1 - BL - (TS1 x SP) - BM1 ≥ € 2000
TS2 - BL - (TS2 x SP) - BM2 ≥ € 2000
TS3 - BL - (TS3 x SP) - BM3 ≥ € 2000pre>
BM1 + BM2 + BM3 - RS ≥ € 4000
3 x BL + (TS1 + TS2 + TS3) x SP + RS - LR ≥ € 7000
Now, I didn’t mean to scare anyone with this equation. I just wanted to demonstrate that transactions cannot have arbitrary values, but values that are balanced by the interplay of the people’s economic relations within the company and the greater market environment.
I hope this argument is going to calm Michel’s concerns that people in The Transaction Company may turn irrational (in the economic sense) and, for instance, start awarding each other exorbitant sums of money. Michel, money always has to come from somewhere in the end! The fact that The Transaction Company doesn’t have a centralised remuneration system doesn’t mean that people would have an incentive to do crazy things. Actually, it is quite the opposite — we have a robust system with transparent economic mechanisms that emphasise self-responsibility.
Whereas the universe is held together by the laws of physics, the social systems on our planet, whether religious or economic, are held together by faith alone. It is people’s faith in the concepts of the state, the religious institutions, the fiat money system, that makes their existence possible. Once people lose trust in a given social construct, it crumbles.
In a recent interview, Alan Greenspan, former chairman of the Fed, shared his opinion that the expansion of the market capitalist system (referring mostly to the former Eastern Bloc and China) is due to the spread of the general belief among people that it leads to material prosperity. He, however, noted that if the currently increasing gaps in income, health-care and education continue to widen, people may lose faith in the system and its existence may become threatened:
“You cannot have a market capitalist system if there is a significant view within the population that its rewards are unjustly distributed.”
– Alan Greenspan on Charlie Rose’s TV Show, 21 September 2007
As I have previously said, the market capitalist system highlights the solution; it is not a cause of the problem. Increasing taxation or attempting to appropriate some of the core market functions only distorts the situation; it doesn’t bring us further.
The market system has been so successful because it enables participants to interact with one another efficiently, stimulating productive economic activity that generates material well-being. Entrepreneurs, that is, people with extensive direct symmetrical presence in the market, note — both as consumers and producers of value, have prospered tremendously. Starting your own business is widely regarded as the way to go if you want to become rich.
Contrast this with the general perception about companies: how many people truly believe that they can earn riches by becoming employees? Not many!
The real ‘disparity’ here is that employees have a one-sided presence in the market - only as consumers of goods/services, never as producers. In this they miss a lot. Within companies millions of employees are isolated from many of the beneficial mechanisms of the market, like the ability to form direct monetary relations with colleagues, to reward one another financially, to enjoy a higher degree of economic agency — in order to learn, develop and earn more.
It is in this asymmetry where the real ‘gap’ is hidden: companies that are internally devoid of the beneficial mechanisms of their market environment; employees that don’t have a chance to fully experience their economic potential as producers of value but only as final consumers.
You don’t have to be an independent entrepreneur in order to prosper, you can also become rich as an employee of a company. It is a mission of The Transaction Company to restore this faith in our workplaces.
Some time ago I received comments from a reader who was concerned that The Transaction Company would require ‘intelligent’ people to run. Yes, the concept does demand a certain set of skills, but they can be acquired. Moreover, the environment is actually very much conductive to learning.
Fig. 1. Traditional enterprises tend to compartmentalise their economic intelligence
Businesses have traditionally been organised in a way that compartmentalises economic decision making within the enterprise, constricting it to a group of people called the ‘managers’. This group has the task to be the ‘economic brain’ of the organisation, taking care of the economic survival and growth, while the rest are to be devoid of all economic thinking.
This division, however, requires a good communications channel between the ‘brain’ and the ‘body’. As corporations grow and responsiveness begins to matter more in our fast paced age, this channel becomes overloaded and noisy. The solution? Add more brain cells? Make the channel fatter? No, I would rather say “decentralise the economic reasoning of the enterprise!” But is this possible?
This long-standing status quo has created the unfortunate perception that employees generally have low economic intelligence and cannot be entrusted to deal with money matters. But at the same time, these same people, in their private lives, go shopping every day, seek out the best holiday packages, and sign contracts for car leases or house mortgages. Nobody was born with these particular skills, people have learned them.
It doesn’t take much to obtain the skills to work in The Transaction Company. We just have to bring sensible and simple economic feedback mechanisms into the workplace. This, in fact, is precisely what the concept is about, thus creating a self-learning environment where people can quickly orient themselves and progress much on their own. The higher degree of both independence and interaction, the simplicity of monetary transactions, the overall transparency of the organisation, all these factors contribute to a great place, not just to learn, but to have fun too.
This would gradually lead to the collective economic intelligence of the enterprise becoming both more evenly spread across it, as well as having a higher overall level compared to traditional businesses. Transaction companies will still have their ‘economic brain’, but it will be relieved to pursue more pleasurable and higher-level tasks.
Fig. 2. Distribution of economic intelligence across the enterprise
The greater independence, responsibility and social skills that The Transaction Company teaches would also benefit people beyond their jobs, in their personal and social life. Do not be surprised if we eventually witness some profound shifts in our society too!
The idea for this article was born at Easter, during a cycling tour in Greece, when my friend Drago and I exchanged a few thoughts on the topic of accounting. Back then he was working for an accounting software company with established clientèle in the US aerospace industry. Airliners and rockets belong to the most complex products of our economy and accounting for their development and production can be quite daunting. Indeed, it’s not hard to imagine that a godzillean manufacturing process that involves the punching of several million rivets and the laying of hundreds of kilometres of cable can be difficult to grasp in its various financial facets. Unsurprisingly, spectacular cost overruns happen too.
Accounting relies on the ability to portray the business in terms of money, and do this accurately. Here I want to write about the role of the market in the monetary measurement of assets, internal processes and their input/output. It’s a fundamental role, for without it we wouldn’t be able to express value in terms of money, the standard unit of account.
I found the initial version of this article superficial in its conclusions so I left my thoughts to simmer for a while. Now you should have a much more definitive text in your hands. Management accountants who seek to gain a better system understanding in their work should find this reading useful.
Where do things obtain their monetary dimension?
The purpose of accounting is to measure aspects of a business in terms of money. In business, money is the universal and the ultimate measure, for important things like capital, sales and profit. Therefore, money is the standard unit of account.
The monetary dimension of things, however, cannot be taken with a ruler or derived from a formula. Neither it is given arbitrarily. Instead, it is a result of a dynamic exchange process - the market.
Fig. 1. In the market traded goods and services obtain a monetary dimension
The market value of traded goods and services derives from the interaction between supply and demand, and can change with time, hence is dynamic. You’ll never know how much money something is worth until it’s transacted in the market and because of this market dynamics you can never predict future monetary value with absolute certainty.
The magic of market proximity
This economic connection between monetary value and the market is crucial for the functioning of accounting. Interestingly, financial accountants do not really need to be aware of this to do their job. I call this phenomenon “the magic of market proximity”. According to it, the ease and the accuracy of monetary measurement depends on how close the accounting events are to the market:
In situations when we have to account for transactions that cross the company/market boundary (e.g. purchases or sales, where market distance = 0), there really is no concern with the monetary measurement of the transactions - we simply record the amount that was paid. The market plays its role so well here that we don’t even notice it. It’s almost like magic.
However, as soon as we step away from the company/market boundary (market distance > 0) and enter the domain of management accountants, that is, the internals of the business, things change. When we try to measure the internal business processes and their intermediate inputs/outputs, we notice that they no longer have an immediate monetary dimension. Accounting in this context suddenly becomes much harder.
Fig. 2: Accounting at the company/market boundary is comparatively easier and more accurate. Inside the business, as the distance between accounting objects/events and the market grows, monetary measurement becomes more difficult.
Recreating the lost connection
You can now see how critical the transactional connection to the market becomes as the distance between accounting object/event and the market increases. This is of particulate concern to larger enterprises, with deep and complex processes, which in effect produce a lot of intermediate goods and services for internal consumption. How do you measure the monetary value of things that never reach the market (in a direct form)?
The market connection that financial accountants take for granted, management accountants have to establish themselves.
When we look at the various existing strategies to measure the internal aspects of a business in monetary terms we’ll notice that they all aim to establish an economic link between the object/event to be accounted for and the market. Some approaches provide more accurate linking, others less, but the underlying principle is the same:
The methods to measure cost (direct/indirect costing, Activity-Based Costing, etc.) are based on a simple premise: everything that a business produces (output) is some composition of materials, labour and knowledge (collectively called inputs) obtained from the market. This premise applies whether the output is the final product shipped to the customers or some intermediate stage in the production line. To calculate its cost you add up the costs of the respective composing inputs, which should be traceable back to the market and their price well known. Complications arise when inputs have to be traced over several production steps, or when they spread out over many areas of the business (overheads).
Fig. 3: a) Measuring cost using input decomposition. Complications arise with b) deep production lines and c) extensive cost fan-out as with overheads
The ability to measure how much (customer) value each part of the enterprise creates can be of much use to managers, yet is still underdeveloped. Here you cannot apply simple decomposition as with costs, because the market value of the product is normally different (and hopefully more!) than the sum of its parts. We will discuss this issue, along with a possible solution, at the end of this article.
The measurement of asset depreciation (for management purposes and not necessarily for tax reporting) also relies on establishing an economic link to the market, so that the current market value of the asset is well reflected.
Shortening the distance
The following graph gives an idea of how the accuracy of monetary measurement (cost) develops as business processes become more complex and the accounting objects/events more distant from the market. This curve, of course, is a rough guess. More definite curves can be obtained from empirical data or from simulations based on network theory.
Fig. 4. Accuracy of monetary measurement vs. distance from the market
Now that we know the importance of market distance, how can we improve measurement accuracy?
There are two possible approaches:
Improve the technical ability of the accounting system to trace costs
Restructure the economic connection between the accounting objects/events and the market in order to shorten distance
The first approach has a shallower reach than the second and its potential for improvement is more limited. It is usually pursued by adopting sophisticated accounting technology (e.g. through ERP software) and implementing some organisational changes in order to accommodate the technology. But ultimately, the ability to account for a business is constrained by its structure and functioning. If our business is in a state of mess, expensive accounting systems won’t bring much.
The second approach comes from a different side. In it we realise that improved accountability results from restructuring the underlying business so that it is better connected to the market. If the various parts of your business have a strong, streamlined and economically sound connection to the market, we shorten the distance between accounting objects/events and the market, thus improving measurement accuracy. This, by the way, is the approach of The Transaction Company.
Some of you may be surprised to discover this effect of market-connectedness and orientation on the accuracy of monetary measurement. I love such system insights because they show us how deeply interconnected things can be and reveal new “hidden” options that we have for bringing about improvement.
Seamlessly interconnected
Let’s now examine how The Transaction Company affects monetary measurement within the enterprise.
As the name of the concept implies, it gives employees the ability to conduct monetary transactions among themselves, replacing many of the traditional organisational constructs. Management, allocation of resources, control, remuneration as well as accounting are done through transactions. This essentially leads to an integrated system of transactions to encompass the enterprise from end to end on two related planes:
All employees across the company in all their work-related interactions
All processes across the business that make up the value chain
The resulting network of transactions within the enterprise connects seamlessly to the market as the company’s interactions with the market are traditionally also transactional. At the same time, every transaction within the enterprise has a defined monetary value and therefore, whatever becomes subject of a transaction (any activity across the value chain or any intermediate process inputs/output) can be directly measured and accounted for in monetary terms. This in effect restores the lost “magic of market proximity” which I described in the beginning of this article. Wonderful, isn’t it!
Fig. 5. A system of transactions that encompasses the whole enterprise and connects seamlessly to the market. Every subject of a transaction has a clear monetary connection to the market
The magic of transactions works so well, that it brings monetary measurement to a whole new level. It practically does away with the traditional problems of overheads accounting - of how to allocate or apportion costs on an equitable basis. In fact, there is no explicit distinction between variable and overhead costs, because the supporting enterprise activities (according to M. Porter’s value chain representation, i.e. firm infrastructure, HR, development and procurement) are so tightly integrated into the primary ones. If we want to classify a transaction as variable-cost-related or overhead-related, we may have to do that separately by determining the case for it.
Here is a small example showing the engineer Jack and the three production lines of the company he works for. Occasionally the production lines experience technical problems and their respective managers call for his support. When such a case occurs, the manager and Jack agree on a price for his service. Regardless of the range of problems that Jack services and how his work divides among the three production lines, to calculate the cost of his support for a given line you just add up the money that was paid to him by the corresponding manager.
Fig. 6. Example of transactional accounting for overhead support services
Notice that the price for every rendered service is agreed between Jack and the line manager. It is not imposed by some third party within the company. Greater economic independence and self-responsibility of people is central to the philosophy of The Transaction Company. Every employee has the freedom to evaluate of the contributions related to his own job, either received or given, and then negotiate the price to be paid for them.
Measuring how value is generated
This higher degree of economic agency of people in The Transaction Company, which also brings us functionally closer to the market, has many benefits over traditional organisations where employees have more restrictions put upon them. In terms of accounting and monetary measurement, besides the improved cost accounting discussed above, it also makes it possible to measure how much value is added at each stage of the enterprise.
Value is always subjective and is determined on a personal basis. As I mentioned above, it is not the same as the sum of its parts, and cannot be allocated or apportioned the same way costs can. The Transaction Company enables the monetary measurement of value within the enterprise by allowing employees to evaluate directly each other’s work contributions.
The following example shows a simplified value chain of a firm consisting of three employees. Notice how the chain of internal transactions connects to the market on the supplier and customer side. The value added by each person can be calculated by subtracting the values of the inbound from the outbound transactions. It’s then distributed as personal wage (90%) and dividend to the shareholders (10%). The actual percentages can be chosen differently.
Fig. 7. Example of a simplified transactional value chain showing how the added value is measured
Also notice that despite the subjective nature of added value, it is not arbitrary given but regulated economically. On one hand, employees would presumably try to add more value in order to maximise their gain, while on the other hand, they would have to make sure that they fit into the value chain.
Traditionally organised businesses can never truly measure the creation of value to the same extent because their employees have a lower degree of economic interaction and independence. While we can relatively easily determine the margin of the whole enterprise or of a well distinguished value chain, we cannot come to more structured information by simple measurement.
I hope you enjoyed this tour of accounting and the role of the market in monetary measurement. I certainly did!
Why can’t we fully experience this wonderful feeling at work?
Do we really live in an exchange economy?
When I was working at PEMTec I used to keep a box of chocolate pralines in the drawer of my desk, Ritter Sport’s yummy Schoggiwürfel. I used to hand them out to colleagues as an expression of special gratitude, for example when a colleague engineer would provide me with a much needed input or when our technician Martin managed to tune an ECM machine to a record level of accuracy. The chocolate was of course of little material value, but it was a wonderful mean to show recognition and foster relations with colleagues.
I also used chocolate as a sweet “bribe” to speed up passage of my paperwork through the bureaucratic mechanisms of the company. The packing of Ritter’s pralines was particularly suitable for this purpose, because they could be easily stapled to documents. Imagine, you sit at your desk and find a piece of paper in your inbox that has a bit of chocolate clipped to it. Of course you’re going to give it higher priority!
As Ritter’s marketing slogan goes: “quadratisch, praktisch, gut”
Some people say the Transaction Company is about internal markets . I say it’s basically about the freedom to give and receive. The market comes as a secondary effect.
We, humans, are social beings and companies are essentially collaborative efforts. People running businesses gradually begin to understand the importance of collaboration. Today we have wonderful technology that enables us to exchange ideas, to make contacts and work together. But we miss a crucial bit: no matter how good our technology is, no matter how well we understand the various benefits of being interconnected, you can’t have real collaboration in the firm unless you give employees the freedom to reward each other for their contributions.
This is what the Transaction Company is about.
To receive your remuneration from your peers with whom you work with feels much more satisfying and fulfilling than simply getting a formal paycheck from the company at the end of the month. Reward, as is collaboration, should feel personal and engaging, have a human face. It doesn’t have to feel anonymous and distant, wearing the artificial face of a “corporate” entity.
One way to imagine the Transaction Company is to think of the World Wide Web with its hyperlinks. The parallels are strong:
The Transaction Company
WWW
Transactions represent work relations that generate value
Hyperlinks relate information
Transactions between employees define the structure of the business
Hyperlinks between documents define the structure of the web
Employees are free to transact with each other
Documents can be freely linked to
Active employees are involved in many transactions
Useful websites have many links pointing to them
Transactions are a measure of economic value and activity
Links are a measure of popularity and usefulness
A simple enabling concept: the transaction
A simple enabling concept: the hyperlink
In a similar manner, the relation between the Transaction Company and the market is very much like the relation between intranets and the Internet.
The underlying philosophy of corporate intranets was to create a secure internal environment for communication and collaboration that resembles the Internet. Likewise, the Transaction Company aims to turn enterprises into places for trusted and productive collaboration that use the highly efficient mechanisms of the free market.
This is my reply to Ron’s comment on Transactional Remuneration Based on Work Relations. In that post I focused on remuneration in The Transaction Company. Now I’m going to write about the pricing of output/contribution and why we shouldn’t be worrying about it.
Here is the central bit of Ron’s comment:
But I’m going to push back a bit. For me, systems thinking is one key to the transformation of the corporation. One reason is that ultimately we have these complex systems that produce value in ways that aren’t always particularly clear to the managers of them, much less the participants in them. Your system seems to casually assume that people actually know the value of their output, or the value of someone’s contribution to them. So often, projects are 18 months away from launch and the revenue is uncertain, much less what any one person would do to help generate those revenues. Lots to talk about on this score, but what kind of system would you suggest for creating market signals akin to stock market indices or commodity prices?
The Transaction Company says only two things about the pricing of output/contribution:
People are free to value output/contribution as they see fit
Transaction value is mutually agreed upon
These two points are enough. To attempt to specify more would lead to a sub-optimal organisation. If you look at the market, you’ll see that it’s defined by the same kind of conditions. They may seem too minimal, but they work: the market is the most efficient and proliferating economic system today.
The rationale behind these two points is simple:
When we look at value, we see that it’s man-made concept. It’s a subjective measure of worth given by man to things. There is no such thing as intrinsic value. Therefore, value cannot really be “known”.
The Transaction Company recognises this subjective and fluid nature of value and eschews distorting it in any way, e.g. by pretending that there is a “right formula” to value output.
The second point simply says that people are free to set the terms of their work relations between themselves, implying that no central authority will be dictating how output is to be valued.
This unrestricted way for valuing output, of course, doesn’t automatically install a system with market-like mechanisms and efficiency. It only creates an environment that allows this to happen, gradually, depending on how fast people in company learn and grow.
We shouldn’t therefore worry how people are going to go about valuing output and contribution. They’ll sort it out, with excellent outcomes, so we should just step back and allow this to happen naturally. This is how the market functions.
An engineer, for example, might get the latest IEEE salary survey and check the average salary level that matches his skills, then aim at a monthly transaction balance that matches this pay level. If the company where he works is able to make economic use of his skills, he’ll get his reward. Else, he might look for a different place to work.
A salesman might try to negotiate a certain percentage that he finds acceptable and rewarding. If his sales contribution is valued, he’ll get his reward, maybe even a bonus.
But once again, we shouldn’t worry about these things.
The question of project management under uncertainty is a topic worthy of a separate post. For now I’ll just say that one has to distinguish between internal uncertainties (coming from within the organisation) and external ones (coming from the external environment), but understand their interplay as well. The Transaction Company has no formula for estimating revenues. But it does reduce business risk by making the company more nimble and responsive.
