In this post, I advance a simple argument: A combined Strategy, Law, and Organization lens provides superior solutions to difficult business and legal problems. Good business lawyers understand that legal problems are necessarily business problems. Yet, understanding the law, by itself, is insufficient to understand and solve complex business problems. Examples include mergers and acquisitions and intellectual property. Strategy is the lynchpin because strategy is about business activity. Organization puts the focus on the legal structure of business deals.
The Transaction Cost Problem: Revisiting The Roche/Genentech Merger
I recently discussed how the high transaction costs of writing intellectual property agreements inhibited research and development collaboration between Roche and Genentech. Transaction costs, and their attendant risks, became an intractable problem when the companies were separate entities. Transaction costs greatly decreased after the acquisition because one entity owned all of the intellectual property. The problem of allocating intellectual property rights by contract was solved, and the risks of intellectual property allocation could be managed and optimized.
- How big of a factor were the transaction costs of allocating intellectual property rights in the merger decision?
- If, as Ronald Gilson contends, lawyers add value as transaction cost engineers, why did the lawyers fail to write agreements that satisfied the business people? Was it even possible to write a contract to cover the intellectual property issues that spanned organizational boundaries?
- Did factors other than transaction costs drive the merger decision?
Why A Combined Strategy, Law, And Organization Lens Is Needed To Solve Business And Legal Problems
Why is knowing the law, by itself, insufficient to understand problems that both are business and legal in nature? Because such problems cut across easy, clean categories.
Oliver Williamson, the 2009 Nobel Co-Laureate in Economics, explains how a combined lens of law, economics and organization informs strategy:
This review shows that a combined law, economics, and organization theory approach leads to different and deeper understandings of the purposes served by complex contract and economic organization. The business firm for these purposes is described not in technological terms (as a production function) but in organizational terms (as an alternative mode of governance). Firm and market are thus examined comparatively with respect to their capacities to organize transactions, which differ in their complexity, so as to economize on transaction costs.
(emphasis added)
Applications
Consider two quick examples of how a combined lens enhances understanding of business and legal problems.
1. Mergers and Acquisitions: Mergers and acquisitions economize on the transaction costs of contracting in the market. The Roche/Genentech example powerfully illustrates how a merger or acquisition can dramatically reduce the transaction costs (i.e., risks) of contracting. However, mergers and acquisitions involve much more than transaction cost reduction. From the legal side, mergers and acquisitions are about getting the legal structure of the deal right. In addition, though, risk can be optimized, or turned into a positive, through a merger or acquisition. Within the context of a company’s strategy, when and how do risk optimization considerations affect how merger and acquisitions should be done?
2. Intellectual Property: Transaction costs of allocating intellectual property rights are related to strategy and organization. First, organization theory implicates legal decisions and activities. Whether transaction costs are high or low affects the effectiveness of undertaking intellectual property activities within the firm or to writing intellectual property agreements with other parties. Second, decisions about organization are decisions about strategy. How the firm does its intellectual property activities is one element of strategy. Since transaction costs are but one small influence on strategy, how do legal and business interact? Business priorities should drive legal moves. Legal considerations should not dominate business strategy.
Discussion
Again, the question is: Why strategy, law, and organization?
Certainly economic analysis, and transaction cost analysis in particular, provides insights into law and organization. Economics also informs strategy, or choices about how the firm will compete.
The important point is that strategy is the practical application of economics. Strategy is what leaders and managers formulate and execute. Leaders do not develop and implement economics.
As the two examples demonstrate, strategy is about making decisions concerning risk management and risk optimization. Economics educates the analysis of risk management and risk optimization. Strategy provides the framework for choosing among alternatives in light of competitive priorities, and provides the direction for achieving those priorities. By contrast, economics does not provide the competitive priorities, or tell leaders how to pursue those priorities. In this way, Legally Informed Strategy and a combined Strategy, Law, and Organization lens go hand in hand.
For these reasons, a combined Strategy, Law, and Organization lens provides superior solutions to complex business and legal problems.
Douglas Y. Park
Twitter: @DougYPark
NOTE: The full citations for the two articles mentioned are:
Ronald J. Gilson, Lawyers as Transaction Cost Engineers, in The New Palgrave Dictionary of Economics and the Law. Peter Newman, ed. New York: Stockton Press, 1998. p.508-514.
Oliver E. Williamson. 2005. “Why Law, Economics, and Organization?” Annual Review of Law and Social Science 1: 369-396.