Blockchain Revolution

Transaction Costs and the Structure of the Firm

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Let’s start with a little economics. In 1995, Don used Nobel Prize–winning economist
Ronald Coase’s theory of the firm to explain how the Internet would affect the
architecture of the corporation. In his 1937 paper “The Nature of the Firm,” Coase
identified three types of costs in the economy: the costs of search (finding all the right
information, people, resources to create something); coordination (getting all these
people to work together efficiently); and contracting (negotiating the costs for labor
and materials for every activity in production, keeping trade secrets, and policing and
enforcing these agreements). He posited that a firm would expand until the cost of
performing a transaction inside the firm exceeded the cost of performing the
transaction outside the firm.
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Don argued that the Internet would reduce a firm’s internal transaction costs
somewhat; but we thought, because of its global accessibility, it would reduce costs in
the overall economy even more, in turn lowering barriers to entry for more people.
Yes, it did drop search costs, through browsers and the World Wide Web. It also
dropped coordination costs through e-mail, data processing applications like ERP,
social networks, and cloud computing. Many companies benefited from outsourcing
such units as customer service and accounting. Marketers engaged customers directly,
even turning consumers into producers (prosumers). Product planners crowdsourced
innovations. Manufacturers leveraged vast supply networks.
However, the surprising reality is that the Internet has had peripheral impact on
corporate architecture. The industrial-age hierarchy is pretty much intact as the
recognizable foundation of capitalism. Sure, the networks have enabled companies to
outsource to low-cost geographies. But the Internet dropped transaction costs inside
the firm as well.