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The Digital Firm: Markets, Hierarchies, and Networks in the New Economy

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

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  1. The Digital Firm: Markets, Hierarchies, and Networks in the New Economy

  2. 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

  3. The Theory of the Firm Why care? • Macro-sociological level • Micro-economic level • Empirical level

  4. Firms and Markets • Adam Smith’s pin factory  Team production yields more than the sum of individual productions

  5. 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

  6. 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

  7. 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

  8. Ronald Coase #2: “The Problem of Social Cost” (1960) What determines the boundaries of the firm?  enforcing property rights is costly

  9. Ronald Coase Nobel Prize in Economics, 1991 What determines the boundaries of the firm?

  10. 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)

  11. Oliver E. Williamson A Transaction Cost Theory of Economic Organization The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting (1985)

  12. 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)

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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

  19. 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

  20. 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

  21. 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

  22. 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?

  23. Falling TC & Economic Organization We should expect… • more market, less hierarchy • fewer intermediaries • more networks • from trilateral to bilateral governance

  24. 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)

  25. 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

  26. 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

  27. 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

  28. E-commerce Myths and Realities (3) Perfect, Disintermediated Markets Disintermediation? Yes – Southwest Airlines Reintermediation? Yes – Priceline.com Old Intermediaries? Yes – STA Travel

  29. E-commerce Myths and Realities (4) Direct Contracting and Private Governance • P3P and PGP for privacy protection? • Instead, demand for government intervention

  30. 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

  31. Political Explanations for “Stubborness”of Real World • The deliberate creation of market “stickiness” • The socio-political embeddedness of transactions

  32. 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!

  33. 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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