Virtuous cycle

Bartlomiej Owczarek weblog

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Raison d’etre of firms

There are firms, and there is the market. In firms, people are directed by managerial signals (you do what you are told to do). On the market, people are directed by prices (you do what pays out most).

Now, there is a certain amount of business done inside the firms, and the rest is done outside on the free market – but what determines the border line?

While writing my master thesis I got to know Coase’s theory regarding boundaries of firms. These are determined by the transactional costs, which make market transactions more expensive, and provide incentives to embed them within the firms – till the moment when the organizational cost is higher than transactional one (management has its cost, too).

Ok, I wrote all this to introduce one paragraph of Hagel’s article, which is adding some new perspective to the theory:

At the most fundamental level, the rationale for the firm is shifting. As JSB and I have written, the rationale for the firm articulated by Ronald Coase back in the 1930s ? that firms exist to economize on transaction costs – is diminishing in importance as continued innovation in IT systematically drives down transaction costs. In its place, we are seeing a new rationale for the firm emerge ? firms exist to accelerate talent development. This is increasingly the reason why people choose to affiliate with firms. They believe they can get better faster by working with others within the firm, as well as with others across firms, through the privileged relationships built by the firm. If firms can?t find ways to deliver on this promise, talent will exit and Tom Malone?s e-lance economy will flourish.

Firms allow talent to develop faster, thus gain another advantage over the market.

On a first glance I can’t tell if this couldn’t be retained in the transactional costs framework. Take consultants. It’s true that in the company one can learn more than as a free lance consultant (at least in the beginning). That’s because of the experienced people that you have a chance to work with.

But the team could be assembled on the market basis, by contracting and sub-contracting (we sometimes do that to some extent, when we involve external experts). Usually it’s not… because of transactional costs.