The Inner Beauty of Firms

Abstract

This paper studies how the internal organization of firms interacts with labor and product markets using millions of task assignments within hundreds of hair salons. I develop a measure of organization complexity and provide evidence of firm-specific organization costs, which grant complex salons a comparative advantage in producing high-quality products. Based on these facts, I develop a model where oligopolistic firms with different organization costs choose their internal structure. Complexity is costly, but it allows firms to improve product quality by better matching workers with multidimensional skills to tasks. I characterize the profit-maximizing organization, and identify and estimate the model for Manhattan hair salons. Counterfactuals reveal that allowing internal organization to be heterogeneous and endogenous changes the equilibrium effects of policy. A sales tax cut increases specialization and therefore the productivity of all workers, while a minimum wage increase generates new types of wage spillovers.