Does the web really decrease transaction costs ?

Ronald Coase
Ronald Coase
Ronald Coase

Transaction costs are a common argument to justify the need to transform organizations. As a matter of fact, if enterprises as we know them exist today it’s because it’s to decrease transaction costs. The day there won’t be transaction costs to optimize anymore, we won’t need enterprises anymore.

Transaction costs are the raison d’etre of enterprises

This approach to the nature of the firm is everything but new and is the result of the work of Ronald Coase. The principle is simple : should it be about production, supply chain management etc. the costs of negotiation and of managing contracts – the costs of accessing the suppliers market – are too expensive. Coordination and organization costs between “non integrated” players also add to these costs. So it’s better for any business to integrate its partners to create a managed production environment that’s economically more efficient than the market. That’s why enterprises exist : if transaction costs were non-existent we would have ecosystems of businesses linked with contracts instead of enterprises and work contracts.

Today the web lowered transactions cost nearly to zero – or that’s what we’re being told – and that’s the reasons why enterprises as we used to know them, designed for integration and coordination, as no raison d’etre anymore. It’s never been cheaper to identify products, services, suppliers, to find the cheapest and establish a relationship.

The web lowered transaction costs outside of the enterprise, not inside

It’s true that if we look outside of the enterprise boundaries, this is true. If this world looks obvious to us, don’t forget that Coase built his theory in 1937, a time that had nothing to do with what we know, even with the “pre-web” era. To some extent we can say that most of the reasons Coase see as the reason for enterprises have disappeared. If the enterprise is a social object we consider as invariable because it’s always been around, we can dream and think that if internet existed in the early 1900s it would not appear as the norm today. Even more : a large part of the “new economy” is made of small structures, startups, working in network within an ecosystem. Globally speaking, businesses that integrated digital in their DNA need less resources than their predecessor from the pre-digital era.

Digital made transaction costs obsolete so the raison d’etre for enterprises has disappeared. In fact not totally.

Let’s have a look at internal transaction costs. Those related to identifying, mobilizing, coordinating and organization resources. Have they decreased or disappeared ? Not at all and what we see outside can even make us think that they increased (what they did compared to external ones). They increased despite of the digitization of the workplace and the advent (and  piling) of communication, collaboration and social networking tools.


Web technologies + pre-web practices = unproductive mix

Once again, consider this quote from Goldratt ;

We should not expect an application to work in environments for which its assumptions are not valid

What’s peculiar to the consumer web and the web as digital minded companies use it and, to a smaller extent, to the web as traditional companies use it for external interactions, is the freedom of players, the informal and flexible nature of relationships. Inside, it’s the contrary.

The advent of new tools did not come with a redesign of systems, operating models, procedure. Even worse, it often lead to formalize new ones that piled up on existing ones, building a heavy, complex and irrelevant work environment. Some examples….

• It’s easier to locate internal expertise but the hierarchical process to get in touch with them and mobilize them did not change.

• It’s easier to coordinate but lots of useless meetings and workflows counterbalance the benefits.

• It’s easier to share, inform, make one’s work visible but reporting has being reinforced and many meetings have no other purpose than to share what’s already available online.

• it’s easier to solve problems but the implementation of the solution found still requires a long validation process or depends on someone who don’t pay attention to what happens outside of old practices.

The rules establish to deal with the lack of collaboration tools are the new constraint

The web and social technologies have an impressive potential to reduce internal transaction costs. But only a potential because it never happens in reality.

The reason is easy to get. To accommodate to the lack of communication tools, related activities were formalized and structured. Procedures, meetings, workflows that are the cornerstones of methodologies and work practices. Without this necessary structuring coordination would not have been possible. All these rules were set to deal with one constraint : the absence of communication and collaboration tools.

What did change with the advent of technology ? Nothing. But when one establishes a system that aims at getting rid of a constraint and the constraint disappears, the system becomes the new constraint. Worse, rules related to technology were added to the existing ones instead of replacing them.

Does it mean  that keeping the old rules protect the enterprise as a structure ? Of course not. It’s even worse. Not only the traditional enterprise does not make the most of its potential – what has no impact on competitiveness if no one does – but they can’t compete with new competitors that acknowledge this new normal and adapt a size and a structure that allow them to keep internal transaction costs as low as possible and work in ecosystems to make the most of low external transaction costs.

The web alone can’t reduce transaction costs that management models keep at a high level

So yes, to some extent the web is making transaction costs obsolete. But for many businesses the matter is not to learn to operate in a zero transaction costs environment but to reduce transactions costs to zero. Technology alone won’t be enough to reach the goal. Assuming that transaction costs have become non-existent is mistake that would make businesses overlook what matters.

The availability of technology may make people think that transaction costs have decreased but that’s only an illusion until work models that keep them at a high level are still alive.