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