Distributed Business

The basis of large firms, as proposed by Ronald Coase at the University of Chicago, nearly a century ago, has been the minimization of transaction costs. It has held remarkably well for many decades, helping to explain the forward and backward integration of firms in many industries. Since the advent of Internet, however, transaction costs have been declining. Both the cost of computing and transactions are approaching zero and this has implications for contemporary companies based on the same ideas of scale and scope.

A larger firm has many disadvantages including bureaucratic friction, incompetent managers with excessive power and the inability to nourish break through innovation. Biased selection has been at work for nearly a decade now in larger firms and this has led to a level of stagnation that cannot be easily reversed. The returns to entrepreneurship has been increasing in spite of (not because of) inefficient capital providers who have managed to stem capital flow to the right opportunities. Zero transaction costs and comparatively lower returns from conventional scale should drive the optimal size of firms smaller and smaller. It is conceivable that the most efficient scale of firm is one and each individual may be better off as a firm rather than attempting to create traditional companies. We are likely approaching this scenario faster than anticipated.

Policy prescriptions have to take this eventuality into account. In healthcare for example, the advantages held by larger companies in negotiating prices will not be enough to hold them together. Thus for both the providers and payers of healthcare, it is time to think of more innovative products that cater to individuals rather than groups of individuals. Similarly, in crafting energy policies, the implications of distributed firms (individuals spread across larger geographical scope) have to be taken into account, In this context, it is not just generation of power that is important but the efficient distribution of power. It is clear from recent advancements that we are closing in on generation of a high percentage of power from alternative sources such as solar energy. However, such innovations appear to focus on concentrated generation. If a larger level of distribution is needed in the future, the losses can be significant. So, funding of innovation for more mundane materials sciences arena for efficient transmission materials is needed.

It is clear that the world is heading toward a distributed model of production and communication. Policies that aid the implementation of this in a more efficient fashion are needed.