As-a-service upstarts will KILL OFF THE CORPORATES?


Worstall on Wednesday Amazingly, economists have figured out a few things...even things that can help in this brave new digital world. One of these is the "marketplaces vs firm" debate.

So I was surprised to find a fascinating little piece in TechCrunch singing the praises of all those "online freelance work marketplace" sites. You know the sort of things: ODesk, ELance, Mechanical Turk.

The point being made was that this was a great new revolution that was going to (is, in fact) eat all the companies and firms out there. And Hurrah! Brave New Dawn and all that.

I was waiting for the other shoe to drop, or at least an accurate explanation as to how the basic thesis was conceived. And I didn't find it. So, here it is.

Or, if you prefer, you can take this as evidence that some economists have, some of the time, actually made not only interesting but also useful points about the structure of the world around us.

The centrepiece of our booster for this freelance economy's piece was this:

Many startups are trying to disrupt the traditional “firm” structure. The biggest driver of adoption is the massive cost savings that these marketplaces provide.

For example, a marketplace with low fees is a very efficient delivery mechanism. Typical markups in law firms or consulting firms might be 4x - a worker making $50 per hour would get billed out at $200.

The same person on a marketplace might raise their rate to $75 to compensate for utilization, but the end price to the customer might end up at $85 – $95 per hour.

And yes, OK, one can see the point. But as I say, I was waiting for that other shoe and it didn't come. That other shoe, of course, would be Ronald Coase's paper “The Nature of the Firm”, one of two publications that won him a Nobel. Now Coase was of his time, he was at the LSE in 1937 when he published this, so he didn't quite express it in these words. But his question was: “Why in buggery do firms exist?”

The almost tautologous answer is that firms exist when they're more efficient than those marketplaces, and marketplaces exist when they're more efficient than firms. As with so many interesting things, it's obvious once it's pointed out, but not obvious until someone does.

Market transactions costs

In more detail, Coase pointed out that a firm has overheads. It also has continuity: and continuous bills that come with having that permanent existence. So, on the face of it we've got to explain why they ever arise. They're going to be, at first sight at least, more expensive than simply swapping contracts in a free and liquid market of suppliers. Yet they do exist and that is the thing that must be explained.

The answer is that at times it's still cheaper to have the firm than the contracting out the work: whether and when is going to depend upon the transactions costs in that market. It's a bit of a catch all: it can include the reputational benefit that the permanence of a firm can provide, for example. But at heart it is again obvious. If the costs of having to assemble a new team for each and every project are higher than the costs of maintaining a firm, then firms there will be, and contracting markets there won't be.

We can all think of examples: if you're running a steel mill then you're probably better off with engineers you know and trust running your billion-dollar plant than hiring whoever looks good on the street on a Monday morning. If you're hiring unskilled dock labour, heavily dependent upon when the wind and the tides will bring the boat in, you might well go for that contractual policy of hiring a few hunks onto the pier as and when you need them.

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Next page: Continuity counts

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