Is Valve's Business Model the Future, or a Fad?

The digital era is revolutionizing the way entrepreneurs interact with consumers, but it's also transforming business organization behind the scenes. Many profit-seeking businesses are adapting to new technologies by giving up traditional management hierarchy in favor of more flexible, "democratic" organizations where employees work without supervision.

Valve is a good example of these trends. Valve employs around 400 people, and is valued at more than $3 billion. It also has no hierarchy, managers, or job titles. Instead, its employees organize themselves into independent groups in order to carry out the projects they think will create the most value. There is no direct oversight: in order to work on a project, employees need only convince other potential contributors of its worth, and then deliver by creating a successful product.

Pundits argue that this kind of innovative company could completely replace traditional business. Some even suggest that such businesses challenge economic logic about how firms operate by showing that management is completely unnecessary. Yet although Valve might seem radical, its success doesn't undermine economics; in fact, it reinforces several key insights about entrepreneurship. Anyone interested in learning more about this topic can also read through the recent symposium on Valve's business model in the Journal of Organization Design.

The Uncertainty of Markets

First, markets are inherently uncertain. Entrepreneurs don't know what consumers will want in the future, so they rely on their own good judgment to decide how to create value. Because markets are constantly changing, entrepreneurs must be able to experiment with their organizations. That means designing the kind of businesses that they believe will be most effective.

In other words, there isn't one "correct" form of business. What matters is that entrepreneurs are free to choose the forms that work best for them and for their consumers. Valve's "flat" model reflects the particular needs of the company, which may not be relevant for every business or industry. Just how applicable the model is to other contexts is uncertain, and can only be revealed by experimentation in the market.

The process of economic calculation places limits on the size and structure of firms, while profits can tell entrepreneurs if they're wasting resources, or if their companies are too bureaucratic or controlling. Because the customer is king in the market economy, business organizations must change constantly to keep up with consumers and maintain profitability. After all, consumers are unlikely to support wasteful, bureaucratic enterprises for their own sake.

The Role of Management

Second, although Valve's model has passed the market test so far, it may not be as revolutionary as it seems. Nicolai Foss and Peter Klein have shown that the success of highly decentralized or "wikified" companies is often exaggerated, while the use of informal or hidden management methods is underestimated. Valve has not completely done away with management: rather, it has changed its form.

It's true that traditional top-down management is often inefficient. But managers can do more than boss people around and give direct orders: they can also provide rules or goals, frameworks within which workers make their own decisions. And despite its lack of hierarchy, Valve does indeed haverules and informal management structures. For instance, there is a rule that at least three employees must agree to work on a project for it to be taken forward. Similarly, while Valve employees work without active supervision, they also undergo an extremely rigorous screening process in order to become employees in the first place. Workers who are likely to need monitoring are unlikely to be hired.

A Unique Market Position

Third, Valve enjoys a unique place in the market that allows it to be flexible where other companies can't be. For example, management hierarchies matter more in situations where decisions are time-sensitive, which is not the case for Valve (insert Half-Life 3 joke here). In addition, Valve's costs are lower than many of its competitors, because it has access to an especially favorable labor market. Many workers in the game industry would love to work for Valve, even on relatively poor financial terms. At the same time, Valve is also able to open-source some of its work, effectively acquiring labor for free from devoted programmers who love the thrill of being involved in the creative process.

Entrepreneurs vs. Managers

Fourth, the problem of management highlights a deeper economic insight: entrepreneurship is a vital part of all business organizations. Some type of decision-making authority is always necessary for a company to function. In Valve's case, Gabe Newell, who is founder, CEO, and majority shareholder, acts as the ultimate decision-maker for the business. "He can fire an employee but an employee cannot fire him." This distinction is exactly the one used by economist Ludwig von Mises to explain the difference between entrepreneurs and managers. In fact, one of the errors of socialism is to try to remove entrepreneurs from their businesses by shifting their authority to a central planning board, thus turning entrepreneurs into mere managers. Management takes many forms, but entrepreneurs remain the driving force of every business, and of the economy itself.

Ultimately, these examples help to show that while Valve is a fascinating case study of innovative organization, it's also an outlier. It produces a specific kind of product that lends itself to a flat, modular structure that isn't feasible for many other companies and industries, at least, not for now. Novelty and good public relations do not a revolution make.

Nevertheless, Valve is an important example of the freedom to experiment that underlies a healthy, competitive economy. Its corporate structure invokes many intriguing principles: lack of hierarchy, decentralization, innovation, and cooperation. However, we should be careful not to assume that these models necessarily reflect the future of commerce. After all, prophecies of revolution are common, especially in the tech industry. It's more prudent to be humble in our predictions, and recognize the inherent uncertainty of the market economy, which makes fools of us all.

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Cross-posted at the Foundation for Economic Education.