Why isn’t every individual their own company, or an independent contractor? There are some very good reasons, but new technology is beginning to change the equation…
One of my favorite economists, Ronald Coase, famously postulated that companies, or “firms,” exist because the transaction costs of engaging in tons of exchanges with tons of individual contractors often exceeds the benefit. If you have to take bids from several accountants every time you need accounting services, the time searching, comparing, and finalizing agreements could be costly. That’s why you hire a full-time, dedicated accountant. Once you begin hiring employees, you’ve got a firm.
This makes a lot of sense, and there are huge savings and a lot of stability with the formation of firms. But they, too, have costs. Anyone who’s ever worked for a large company knows that a lot of people cut corners, skimp, communicate poorly, schedule too many meetings, pilfer staples from the supply closet, delay progress, play politics, etc. All of these things are costs that make firms less efficient. Theory tells us that once these kind of costs (in economics they’re called “agency costs”) exceed the saved transaction costs, the firm is too big and no longer efficient. This is why the structure, size, and number of organizations is always in flux. It’s a constant process of trial and error to find the best mix.
That balance – between agency costs and transaction costs – which determines the size and number of firms has seen a fundamental shift. Instant communication via the internet and mobile phones plus new software platforms that enable things like the sharing economy have dramatically reduced the transaction cost when individuals engage in exchange. This tips the balance and makes firms less efficient than they were before. They still have the same agency cost problems, but the cost of dealing with individuals or smaller groups of trading partners has fallen. We can expect to see a growing number of people acting as their own firm, rather than joining a larger corporation.
And that’s exactly what’s happening. Anecdotally, the number of people I know who piece together their income through freelance projects and short term contracts has exploded. They can outsource their accounting functions to cloud-based companies, rather than needing a full-time finance department or CFO. They can communicate their services, or learn about other service providers, on a project-by-project basis instantly with services like O-Desk, and Work Market. What Uber and Lyft and AirBnB have done to coordinate providers and consumers of personal transportation and lodging, other companies are doing for the providers and consumers of all manner of other services typically only exchanged within the firm.
So what does this shift mean for you? As a consumer, it means lower prices and more options. But far more importantly, as a producer, it means you can be your own business.
This opens a world of opportunity for flexibility, independence, innovation, and entrepreneurship. The challenge is to discover what you can create that is of value to others. These tools can help you market and operate it.
This means that, even if you never start a firm in the traditional sense, you are a business. This means now, more than ever, entrepreneurial skills and thinking are valuable and necessary. Are you ready?