Jiri’s Notepad

More from Irving Wladawsky-Berger:

For over one hundred years, the vertically integrated firm has been the dominant model for organizing work, especially complex work, as opposed to having multiple, independent, self-employed people who contract with one another to get the same work done. The reason for this was first explained by British economist Roland Coase in a 1937 paper called “The Nature of the Firm,” for which he won the 1991 Nobel Prize in economics.

As Coase explained it, there are additional transaction costs incurred in obtaining goods and services outside the firm, in the marketplace — tasks such as searching for the right people, negotiating a contract, coordinating the work, managing intellectual property and so on. Firms will arise when they can get the work done internally with significantly lower transaction costs than going outside the firm for the same services.

In other words, businesses have followed an inside-out, “self-centered” model because of the high costs of orchestrating and integrating their various processes, many of which are still labor-based and one-of-a-kind and therefore require quite a bit of management and coordination, which is most efficiently handled with a “classic,” hierarchical organization. Coase also pointed out that, for a variety of reasons, there is a natural limit to what can be produced efficiently within the firm, which is why all businesses also have a more or less extensive supply chain, and strive for an optimal balance between what work gets done inside and outside the firm.

This balance is now in flux. Since we can now use technology, the Internet and open standards to begin to automate, standardize and integrate business processes, those transaction costs described by Roland Coase are dropping precipitously. Consequently, the whole nature of the firm, and what it means to run an efficient business, is going through very extensive changes.