It’s time to return to the quiz that I posted last week.

As a whole, it was about transparency (Q1, Q3), economic reward (Q2) and employee involvement (Q4) in the company. These three factors are important for the following reasons:

• Transparency removes uncertainties and helps decision making. People who work and invest in the company can see their business context more clearly. Transparency reduces stress and the potential for conflicts within the organisation.
• Economic reward makes for satisfied and happy people. If poorly structured it drains motivation, energy is spent on counterproductive activities and frustrations.
• Employee involvement depends a lot on the above two factors. People can’t act effectively unless they feel motivated and work in a clear environment.

Most businesses, if not all, won’t get past question 1a, thus effectively failing the quiz. Some of you may have found the questions absolute and uncompromising. You might be asking yourself, how can you possibly have a company that passes the quiz with 100%?

I tell you, this can be done. What seems exceptional today will be the norm in a couple of years. The key is called “transactions”. Let’s now go through the quiz questions and see how this key applies to them:

Question 1: Quantifying individual performance

The first question asks every employee in the company for three basic figures:

• his reward: whether he knows his salary, e.g. “My salary is $10′000″ (1a)
• the value of his work output: whether he knows the value of his work, e.g. “This month my work contribution was worth $25′000″ (1b)
• his productivity: whether he knows how productive he is, e.g. “My productivity is normally 40%” (1c)

Figures stating the value of input/output and productivity are also used to describe the business performance of companies. And while employees may have difficulty quantifying their performance, the companies where they work are normally able to report aggregate figures stating corporate expenditures, sales and profits.

Comparing employees and companies side-by-side in this manner, it may occur paradoxical that a larger, compound economic entity can be more transparent in terms of figures describing its overall economic activity. But in fact, there is no paradox here.

Companies operate on the market, where their activities (buying and selling goods and services) take the form of transactions. Because transactions are discrete and have an associated price, company performance on the market can be easily measured. For example, to find out the annual output of a company, you simply have to sum up the values of its sale transactions over the year.

Contrast this with the situation within companies, where work relations between employees lack the discrete form and the pricing mechanism of transactions. In such a fuzzy context individual contribution and productivity can only be roughly estimated. For example, one could take a key figure that describes the company performance on the market (e.g. revenue) and divide it by the number of employed people. But this is an overly simple approximation.

This fuzzy business environment has a considerable overhead:

• Significant efforts are spent on trying to measure and understand performance within the firm
• Lack of transparency makes managing and investing riskier
• Frustrations among employees and managers who are concerned with fair pay

Fortunately, now we know how to get out of this blurred situation. The formula for more clarity within the firm is simple: allow people to transact among themselves.

Question 2: Remuneration proportional to productivity

The second question is concerned with remuneration for work, more specifically how closely it reflects the productivity of an individual and whether artificial limitations exist.

You can’t have objective and fair remuneration, unless you know the exact figures for output and productivity of everyone in the company. Discussion and conclusion are similar to the above section. The key to this question therefore is the same: for objective remuneration you need transactions. They also have the additional advantage of making remuneration a simple and quasi automated process.

Question 3: Process transparency

This question is about how transparent and measurable your business processes are. Any business process is essentially a series or network of stages, which would ideally deliver an increment of value.

In manufacturing businesses it is relatively straightforward to observe and measure the production process. But in a service or knowledge oriented business you don’t have assembly lines and components.

The universal solution is to allow for transactions between the stages of the process. That way you get to see how value is added at every stage, how money, resources and knowledge flow from one stage to another.

This “flow” information is integral to markets. If we follow the paths of transactions between market participants, we can identify distribution chains, observe the process of value accretion, spot areas with growth potential. This market information isn’t collected centrally on a large scale due to various issues such as privacy. Within companies however, fewer technical and social issues exist, so the only prerequisite to make work flow and value chains transparent is to introduce internal transactions.

Question 4: Business awareness and involvement of employees

It’s increasingly recognised that decentralising responsibility and decision making is a way to make the enterprise more competitive. But you need more than just good will to have successful decentralisation:

• A major limiting factor is the quality of the fabric that couples the individual departments, teams and employees. Ideally, it would allow for both a high degree of independence and a high degree of interconnection. Suppose you have highly independent teams which excel at what they do. But all this competence is wasted unless they have a chance to pass on their results to those in the company who need them.
• Clear separation of responsibilities based on the rule “you can only be responsible for yourself”. Failure to understand this results in stagnant dependencies and control situations across the company.
• Clear and simple internal relations
• A transparent environment, where teams and departments can easily measure their own performance. To have poor feedback means to stray away. Good feedback mechanisms promote learning and raise the business awareness of everyone in the company. This in turn allows for decentralisation to happen.

Transactions offer a simple mechanism for decentralisation of companies. If you look at transactions in the market economy, you’ll see that they provide optimal independence and interconnection of businesses, without blurring of responsibilities. The market is also an excellent learning environment and doesn’t require central control to function(*).

To return to the actual quiz question, you now shouldn’t be surprised that you can have a company where every employee would be able to initiate and oversee investments related to his particular job function. Of course, the all-embracing investment plans will still be led by the corporate HQ. But investments which pertain to a particular department, team or employee will be initiated and managed on the same level where they are being consumed. Once you have functioning internal transactions in your company, you can establish an internal capital market with a credit rating system to further streamline the process of internal investing.

(*) Recently I’ve been playing with the idea that the urge for governmental regulation of the market is proportional to the level of centralisation of businesses. More about this in a future post.