Wei, Zhe
Why do firms exist? Economist did not have conscious about the secret of the black box – firm until Ronald Coase was recognized by his famous work “The Nature of the firm” approximately half century after its publication (The Economist, 2010). As Coase first grew interested in the studying of firms in the begin of 1930s with followers, Oliver Williamson, fleshed out his thought decades afterwards, the central insight of this theory reveals that firms exist because market might impose heavy transaction costs all the time. And the costs can be identified as holdups, specific assets, opportunism, bounded rationality, vertical chain coordination, make-or-buy decision and so forth. The rest of this article will mapping these types of transaction costs to a small business in packaging and printing industry by my own experience.
Several years I have had opportunity to establish a small business in packaging and printing industry. As a shareholder of a tiny printing factory, other shareholder and I experienced transaction cost negotiation, which can obviously be identified right now as a retrospect. The business did not have much direct customer at that time, and the industry was also full of intermediaries, who could hold orders from the end customer and outsource the printing services or packaging products to factories. As a result, the printing factory, lying on the downstream of the entire vertical chain, could not provide a relative as higher price to intermediaries as that offer to end customer in terms of asymmetric information, because all of the intermediaries, who once are the insiders of the printing factories, know quite well about the market price and operating process. One of their role is to monitoring the printing service and the produced packages in order to satisfy end customers’ requirement. And the intermediaries in the chain do not hold any asset and all of their income come either from the asymmetric information between end customers and printing factories and the opportunism pricing variance among service providers, as they are always seeking for lower price. During that period of time, another story in the business is that we found printing factory alone were not capable to bid contracts, because many orders asked from customers requires not only printing service but also its downstream packaging as well as the final product. As a result, shareholders negotiated a long-term strategic contract to setup an alliance with a packaging factory that did not have printing machine and would act as post processing service provider. As complementary to each with mutual benefit, not only could it enhance the capability to provide integrated service to customers for both factories in the vertical chain, but it also reduces time-consuming outsourcing partner searching, contract negotiating, let alone the possibly unstable quality. It looks like a relatively rational decision to strategic alliance, however, shareholders made another make-or-buy decision that led the small business to nightmare. The printing factory owned two monochrome machines at that time and would often outsource colored cover page printing services. Since some of shareholders found the colored printing services were quite profitable and the negotiating and monitoring cost for outsourcing process is relatively high, it was decided to buy another four color offset machine and integrate color printing business. Unfortunately, since the demand for colored printing service was not so strong to support the maintenance fee and wages for more specialized technicians, the factory suffered a great loss after the investment on the new machine. Though the business is small and it is not as complex as Apple or Airbus that could provide fruitful of cases such as holdups or specific assets, transaction costs can still be observed every where in this personal involvement story. Parties, no matter upstream or downstream, no matter agent or intermediaries, try every means to minimize transaction cost and pursue maximized economic profit in such game. However, the failure shows that the original intention in pursuit of an efficient outcome does not always result in an efficient outcome for a single point. Let alone the overall one for parties sharing common interests.
In summary, it is proved that firms exist with certain reason that costs to using market can be eliminated by using the firm (Coase, 1937). And these costs known as transaction costs, which in forms such as holdups, specific assets, opportunism, bounded rationality, vertical chain coordination, make-or-buy dilemma, could possibly be negotiate away by firms to ensure an efficient outcome (Besanko, Dranove, Shanley, Schaefer, 2009). Unfortunately, there is not only one or two players on board, each firm will make endeavors to achieve their economic profit and it is much harder than people think.
Besanko, D., Dranove, D., Shanley, M., Schaefer, S., (2009) Economics of strategy: John Wiley & Sons.
Coase, R.H. (1937) The nature of the firm. economica, 4(16), 386-405. The Economist. (2010) Why do firms exist? Available at: http://www.economist.com/node/17730360 (Accessed: 20 August 2016)