The Inner Beauty of Firms

By Jacob Kohlhepp

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Jacob Kohlhepp

Anyone who has shopped at a Costco and a corner convenience store knows that firms selling the same products assign tasks to workers differently and have dramatically different levels of profitability. Economists have long recognized via case studies and theoretical work that some of these differences are due to differences in organizational capability. For example, some companies use sophisticated workforce management software while others use a clipboard. But are these individual examples reflective of a larger reality? And if so, how does incorporating organizational capabilities change our understanding of economics?

In his paper “The Inner Beauty of Firms,” Professor Jacob Kohlhepp (UNC Chapel Hill and UCLA graduate) answers these questions using millions of task assignments across hundreds of hair salons. He finds that salons using the same management software assign work very differently. At some salons, workers essentially operate as miniature salons with little task specialization. At others, workers play a specific role as part of a task specialized team. Further, task specialization is positively associated with firm performance. Specialized salons earn more revenue per minute, are larger, and set higher prices. At least for hair salons, there is evidence that organizational capability plays a large role in economic outcomes.

He then builds a new model where competing firms with different organizational capabilities choose both who to hire and how to assign tasks. Firms strategically design the jobs of each employee based on individual skills, prevailing wages, consumer demand for quality, and importantly, a firm-specific organizational cost. He develops a procedure which uses machine learning to link the theory with the data, and estimate the firm’s organizational costs, worker skills and worker wages.

Using the estimated model, Professor Kohlhepp reexamines classic economic policies, using Manhattan’s hair salon industry as a laboratory. He starts with a minimum wage. When the minimum wage is increased from $15 to $20, firms which initially employ many minimum wage workers see a cost increase. All workers initially at these firms, minimum-wage or not, are disadvantaged. Internally, firms layoff minimum wage workers and the remaining workers pick up the slack by performing the leftover tasks. In this way, the minimum wage spills over onto non-minimum wage workers, generating wage increases for some and wage decreases for others that depend on the context.

He also considers a sales tax cut. When the sales tax decreases from 4.5% to 0%, workers flow towards more organizationally capable salons increasing productivity. In addition, cutting the sales tax makes producing a high quality product more profitable. This induces firms of all capabilities to increase specialization, which raises worker productivity across the market.

Both the minimum wage and sales tax cut tell a similar story: even firms which look similar on paper can be quite different in terms of their organization capabilities, and accounting for this changes what we predict even from classic economic policies.