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The Digital Firm: Markets, Hierarchies, and Networks in the New Economy. Lecture Outline. The Theory of the Firm A Transaction Cost Theory of Economic Organization E-commerce Myths and Realities A Political Theory of Economic Organization. The Theory of the Firm. Why care?

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The digital firm markets hierarchies and networks in the new economy l.jpg

The Digital Firm:

Markets, Hierarchies, and Networks in the New Economy


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Lecture Outline

  • The Theory of the Firm

  • A Transaction Cost Theory of Economic Organization

  • E-commerce Myths and Realities

  • A Political Theory of Economic Organization


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The Theory of the Firm

Why care?

  • Macro-sociological level

  • Micro-economic level

  • Empirical level


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Firms and Markets

  • Adam Smith’s pin factory

 Team production yields more than the sum of individual productions


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Firms and Markets

  • Adam Smith’s pin factory

  • factory  firm

Factory:

- a physical thing where people meet for team production

Firm:

- a legal structure that provides the organizational basis for team production


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Ronald Coase #1: “The Nature of the Firm” (1937)

What determines the boundaries of the firm?

 employing the price mechanism to allocate resources is costly

Market:

- resource allocation through price mechanism

Firm:

- resource allocation by authoritative direction


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Ronald Coase #1: “The Nature of the Firm” (1937)

What determines the boundaries of the firm?

 cost of employing the price mechanism determines firm/market boundary

Market:

- resource allocation through price mechanism

Firm:

- resource allocation by authoritative direction


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Ronald Coase #2: “The Problem of Social Cost” (1960)

What determines the boundaries of the firm?

 enforcing property rights is costly


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Ronald Coase

Nobel Prize in Economics, 1991

What determines the boundaries of the firm?


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Oliver E. Williamson

  • Cost of exchanging good in a market

  • Cost of enforcing property rights

Transaction Costs

A Transaction Cost Theory of Economic Organization

Markets and Hierarchies (1975)


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Oliver E. Williamson

A Transaction Cost Theory of Economic Organization

The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting (1985)


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Oliver E. Williamson

Not firm, not market – networks?

A Transaction Cost Theory of Economic Organization

The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting(1985)


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A Transaction Cost Theory of Economic Organization

Variables in Williamson’s model:

Dependent variable: efficient economic governance

Independent variables: frequency and asset specificity of transaction


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

Market

Governance

Unified

Governance

Frequency

Bilateral

Governance

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

David at Café Strada

Unified

Governance

Frequency

Bilateral

Governance

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

Market

Governance

Unified

Governance

Frequency

Bilateral

Governance

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Mel Gibson in Overboard

Occasional

Market

Governance

Unified

Governance

Frequency

Bilateral

Governance

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

Market

Governance

Unified

Governance

Frequency

Bilateral

Governance

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

Market

Governance

Unified

Governance

Frequency

Ford and its suppliers

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

Market

Governance

Unified

Governance

Frequency

Bilateral

Governance

Recurrent

Efficient Governance


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A Transaction Cost Theory of Economic Organization

Investment Characteristics (Asset Specificity)

Nonspecific

Mixed

Idiosyncratic

Trilateral

Governance

Occasional

Market

Governance

Frequency

AT&T and @Home

Bilateral

Governance

Recurrent

Efficient Governance


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What TCE Is and Is Not

  • Explains what most efficient form of governance should be, given certain transactional attributes

     a functionalistargument

  • What is missing?

    Politics: Who are the actors? What are their interests? What is their power?


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Falling TC & Economic Organization

We should expect…

  • more market, less hierarchy

  • fewer intermediaries

  • more networks

  • from trilateral to bilateral governance


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Falling TC & Economic Organization

“The dominant business organization of the future may not be a permanent corporation, but rather an elastic network”

“There is a fundamental shift in power, and it’s shifting to the consumer”

“A new world of low-friction, low-overhead capitalism”

The Friction Free Economy (1997)


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E-commerce Myths and Realities

(1) The Dawn of the E-Lance Economy

  • Probably more freelance today than 30 years ago

  • Probably less than 100 years ago

  • Open office space so people can easily collaborate


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E-commerce Myths and Realities

(2) The End of Geography

  • Rent in Palo Alto and traffic on 101 South

  • VCs and local networking

  • But…

  • Bangalore


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E-commerce Myths and Realities

(3) Perfect, Disintermediated Markets

Barriers to entry?

Easy to enter, hard to stay

Many sellers?

On the way to oligopolies

Friction-free?

No

Transparency?

Mixed at best


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E-commerce Myths and Realities

(3) Perfect, Disintermediated Markets

Disintermediation?

Yes – Southwest Airlines

Reintermediation?

Yes – Priceline.com

Old Intermediaries?

Yes – STA Travel


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E-commerce Myths and Realities

(4) Direct Contracting and Private Governance

  • P3P and PGP for privacy protection?

  • Instead, demand for government intervention


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Economic Explanations for “Stubborness”of Real World

  • Transaction costs haven’t come down all that much

    (2) It’s about information costs, not transaction costs

    (3) Information asymmetries and market failures

    (4) Increasing returns and path dependence


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Political Explanations for “Stubborness”of Real World

  • The deliberate creation of market “stickiness”

  • The socio-political embeddedness of transactions


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A Political Theory of Economic Organization

Historical Institutionalism

  • Actors, with power and interests, interact in pre-institutionalized setting

  • Building coalitions, striking bargains  path-dependence

  • Gotta work from path in the next round

    No efficiency assumed!


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Conclusion

  • Transaction Cost Economics is a very useful starting point

  • But when outcomes deviate from functionalist expectation, from economic efficiency, that is when it gets interesting


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