Executive Briefings

Economic Theory: 5 Schools of Thought to Help Supply Chains Prosper

Analyst Insight: In a time of rapid political and economic change, uncertainty and tight budgets, R&D and education can often get short shrift. Perversely those are the times when the latest ideas are needed the most - especially for professionals wanting to learn and implement new techniques. – Kate Vitasek, faculty member, University of Tennessee's Haslam College of Business Administration

Economic Theory: 5 Schools of Thought to Help Supply Chains Prosper

There is a huge chasm between theory and practice. There are many reasons for this, but two common reasons are that companies are often too busy or too budget-constrained to invest in education to close the gaps. Simply put, they are hunkering down to deliver the goods.

Many academic theories are not just theories. Rather they are often mathematically and economically proven approaches that can help companies drive true transformation. For example, contract theory was last year's winning topic for the Nobel Prize in Economic Sciences.

Two professors and economists — Oliver Hart and Bengt Holmström — received the 2016 Nobel Prize for their insights into modern contract theory, specifically how businesses and organizations can better understand and design contracts in the “real world,” with all of its complexities and uncertainties.

The Nobel Prize Committee described contract theory as “a comprehensive framework for analyzing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and copays in insurance, and the privatization of public-sector activities.”

Hart said, “Contracts are just an incredibly powerful way of thinking about parts of economics. They’re just fundamental to the whole idea that trade is a quid pro quo and that there are two sides to a transaction.”

In fact, Hart, an economics professor at Harvard and Holmström, an MIT economics professor, believe that contracting is an art. The Nobel Prize committee noted, “Relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions…Oliver Hart’s and Bengt Holmström’s research sheds light on how contracts help us deal with conflicting interests.”

Hart and Holmström are not the only academics with great advice. Here is a list of five Nobel Prizing-winning economists and how you can begin to apply some of their theories into practice:

1. Oliver Hart (2016 winner): Contract Theory. Application: All complex contracts are incomplete. Develop contracts that are flexible frameworks and allow for changes.

2. Oliver Williamson (2009 winner): Transaction Cost Economics:  Use a credible (not a muscular) approach for working with business partners. 

3. Ronald Coase (1991 winner): Transaction Costs. It is not enough to include only production and transportation costs — companies need to understand all transaction costs, such the cost of entering and executing contracts. 

4. Robert Solow (1987 winner): Solow’s Law. There is a crucial connection between innovation and economic growth, with economic growth being tied to “technological improvements” defined by improvements in business processes or products.

5. John Nash (1994 winner): Game Theory. The best results come from everyone in a group cooperating to do what’s best both for themselves and the group.

The Outlook

The supply-chain function has come a long way. Yet there is work — brain work — that procurement and supply chain professionals can apply to help them further improve their supply chains. That brain work involves turning academic theories into practice. It’s never too late to go back to school, but the real magic happens when organizations seek ways to bridge the gap between academic theories to practice.

There is a huge chasm between theory and practice. There are many reasons for this, but two common reasons are that companies are often too busy or too budget-constrained to invest in education to close the gaps. Simply put, they are hunkering down to deliver the goods.

Many academic theories are not just theories. Rather they are often mathematically and economically proven approaches that can help companies drive true transformation. For example, contract theory was last year's winning topic for the Nobel Prize in Economic Sciences.

Two professors and economists — Oliver Hart and Bengt Holmström — received the 2016 Nobel Prize for their insights into modern contract theory, specifically how businesses and organizations can better understand and design contracts in the “real world,” with all of its complexities and uncertainties.

The Nobel Prize Committee described contract theory as “a comprehensive framework for analyzing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and copays in insurance, and the privatization of public-sector activities.”

Hart said, “Contracts are just an incredibly powerful way of thinking about parts of economics. They’re just fundamental to the whole idea that trade is a quid pro quo and that there are two sides to a transaction.”

In fact, Hart, an economics professor at Harvard and Holmström, an MIT economics professor, believe that contracting is an art. The Nobel Prize committee noted, “Relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions…Oliver Hart’s and Bengt Holmström’s research sheds light on how contracts help us deal with conflicting interests.”

Hart and Holmström are not the only academics with great advice. Here is a list of five Nobel Prizing-winning economists and how you can begin to apply some of their theories into practice:

1. Oliver Hart (2016 winner): Contract Theory. Application: All complex contracts are incomplete. Develop contracts that are flexible frameworks and allow for changes.

2. Oliver Williamson (2009 winner): Transaction Cost Economics:  Use a credible (not a muscular) approach for working with business partners. 

3. Ronald Coase (1991 winner): Transaction Costs. It is not enough to include only production and transportation costs — companies need to understand all transaction costs, such the cost of entering and executing contracts. 

4. Robert Solow (1987 winner): Solow’s Law. There is a crucial connection between innovation and economic growth, with economic growth being tied to “technological improvements” defined by improvements in business processes or products.

5. John Nash (1994 winner): Game Theory. The best results come from everyone in a group cooperating to do what’s best both for themselves and the group.

The Outlook

The supply-chain function has come a long way. Yet there is work — brain work — that procurement and supply chain professionals can apply to help them further improve their supply chains. That brain work involves turning academic theories into practice. It’s never too late to go back to school, but the real magic happens when organizations seek ways to bridge the gap between academic theories to practice.

Economic Theory: 5 Schools of Thought to Help Supply Chains Prosper