How digital disrupts economics: individuals vs organizations

Probably like some of you, when I started to study economics, one of the first things I learnt is that where there is a market, there are organizations. Economic science is based on the idea that a transaction on a market almost always requires two organizations rather than two or more individual agents. That’s what we call the Ronald Coase theory of the firm (« The Nature of the firm », Economica, 1937), which has become the corner stone of economics when analyzing market structures. To put it briefly, Ronald Coase explains that companies emerge because transaction costs exist on any market — search and information cost, bargaining cost, legal cost, etc. Producing internally, via a business entity, becomes less expansive than contracting out with individual agents. The market equilibrium becomes more optimal (combination of quantity and price):

For decades this theory has perfectly reflected the way we looked at markets and companies. Just think about a car manufacturer like Ford. From an outsider point of view, Ford was the most advanced company in building mass production cars with a very standardized approach. As Henry Ford used to say, « A customer can have a car painted any color he wants as long as it’s black. » The production was scale-centric because: i) there were very heavy fixed costs to enter the market; ii) demand kept booming — between the 1950s and the 1970s, wages used to grow by 4 to 7% per year in the US and in Europe. In other words, anybody thinking about sub-contracting for production was just a fool.

Then, from an insider point of view, Ford was a pyramidal organization with a radical top-down approach. Every rule, every tool, every piece had to be validated by the management (the famous « white collars »). That was the time of organizations. For further details and scientific analysis, I strongly recommend you read Henry Ford’s autobiography, My Life and Work. (Btw, it is astonishing to see the differences between Henry Ford and Elon Musk — in terms of beliefs, management skills, etc. — while the two are considered as entrepreneurial heroes of their time.) Companies were just big black boxes, where the organization and its members were assimilated into one single economic agent. Economic theories about diverging interests within a company — think about the agency theory by Jensen & Meckling — really appeared during the 1970s and 1980s.

That old world started to shake in the 1980s with globalization. Companies soon realized that — first by externalization and then internalization — they could reduce their production cost if they placed their production units where it made more sense — both in terms of domestic demand and cost. Governments encouraged the evolution, at a WTO-level or national level. Just remember what Carla Hills once said while US Trade Representative during Georges Bush’s administration (1989–1993): « We will open foreign markets with a crowbar where necessary, but with a handshake whenever possible. » Be it voluntary or not, a large number of developing countries opened their markets despite temporary and regional crises — 1994 in South America, 1997 in South-East Asia, 1998 in Russia, 2000 in Turkey, etc. As a consequence, globalization contributed to put Ronald Coase’s theory in question: international transaction costs kept shrinking while international business rules made it easy for companies to externalize at a larger scale. International business mainly became a matter of contracts than companies.

But things really started to look different when our beloved Internet kicked off in the late 1990s:

With the Internet, transaction costs experienced a decrease never seen before in human history. Thanks to Google, finding business and legal information about your customer, supplier or partner is done (almost) for free in a couple of minutes. The same goes for other transaction-related costs — how much does it cost you to negotiate a contract with a partner now, 1 cent max? Thanks Skype, Hangout and all!. But that’s also true for any other cost: every human being can create, share, distribute and sell for almost nothing. We have all (potentially) access to the new production factors of the digital economy. Welcome to the era of individuals against organizations!

From that you can deduce many trends, opportunities and problems. But there are two trends that I would like to emphasize on, « from work to tasks » and user-centrism:

  • thanks to the Internet and the new mindset of the digital native, 9–5 work is no longer the holy rule of organizations. Companies can contract with individuals to complete specific tasks, instead of employing them full time or contracting with a classical supplier. Players like Upwork, Task Rabbit or Side (previously WeSlash) are surfing on a strong trend reshaping human organizations. According to the US Labour data, already 1/3 of American workers earn complementary income from non-classical jobs. For economics, that’s a real revolution: labour markets as well as companies can no longer be analyzed through the prism of Coase’s theory. But so far, no real alternative theory has emerged;
  • a growing number of B2B companies have switched from focusing on the decision-making agent in a company to focusing on internal prescribers. GitHub yesterday, Slack today, others tomorrow. They all have understood that a good B2B solution is not the one that is purchased by top managers, but used and evangelized by final users. In terms of economic science, this means that theories about diverging interests within an organization have lots of room for improvement! While they first focused on shareholders vs stakeholders during the 1990s, they should probably now focus on organizations vs individuals.

Every industrial revolution has initiated a new paradigm in economics. But the Internet revolution stands apart: economists are still looking for new models to describe and analyze market structures, companies, competition, pricing, labour markets, etc. We keep referring to Schumpeter’s theory of innovation and business cycles by lack of more actual references. Maybe it’s time economists stopped considering digital as non-serious/non-viable and started rethinking their theories based on that « new normal ».