INFS 780 Rick Christoph Why Do Firms Exist
- Slides: 8
INFS 780 Rick Christoph Why Do Firms Exist: Transaction Cost Concepts
Value Innovation n Why do firms exist? n Economists state that markets are the most efficient way to distribute goods n n Think of commodities markets for oil, wheat, corn, etc. If this is true, why create a firm to distribute goods in place of a market? n Firms must add expense over a plain market!
Why do firms exist? n Ronald Coase suggested in 1937 that transaction costs were the reason firms are created. n Transaction costs are all costs buyer and seller incur as they gather information and negotiate a sale. n n These quickly add up Consider trying to buy a car – what do you have to do?
Example of transaction costs n Imagine you are selling digital TV’s You could engage in market transactions with all makers of TV’s n To do this, you would find the makers, visit them, evaluate their product, negotiate the sale, delivery, support, etc. n This obviously costs you significant expenses n
Example n Perhaps another person noticed you were going through this expense. n They decide to create a firm that would build, sell and ship TV’s to you. n n Certainly this new firm will make a profit, but it might be worth it to you since they would save you time and money This savings represent transaction costs.
Transaction costs n Costs are higher when the product is complex and varied; conversely, costs are lower when the product is a commodity n n Corn futures markets work well since there are low transaction costs Home sales have high transaction costs, so firms (Realtors) have developed n When firms are created, functions are “aggregated”
What about technology? n How has technology changed transaction cost over time? More information is quickly available n This lowers transaction costs n Reduces need for the middle firm n n What were the E-value chains have large impact n Technology allows dis-aggregation
Disaggregation Trends n What does this mean? n This is considered outsourcing! n Why do it? n To save money n Is this not the exact opposite of vertical/horizontal integration? Which is right? n How do transaction costs enter in this? n Transaction costs are the key!
