Innovate, commoditize, outsource

Ronald Coase has something to say about the role of innovation

Ronald Coase died last year. A Nobel Prize winning economist most famous for exploring the “theory of the firm,” he asked: why do companies even exist? Why do they enter into complex contracts with their employees and provide them with benefits and pay their health insurance and subsidize their lunch, when they could just get someone to do individual tasks at the lowest price?

Where does the company end, and, what does it mean to be inside the fence, as opposed to outside?

These questions have been at the heart of Silicon Valley labour disputes, from busdrivers to security guards. It is the core of a myriad current an future labour disputes for Uber, Taskrabbit and other platforms which match labour with demand, with weak connections iwth the labour side of the equation.

They are also at the heart of what managers should be thinking is their job — what is inside the organisation, what is outside it, and how should they distinguish between them?

For Ronald Coase, the “boundary of the firm” is set by friction.

If every time a manager wanted something done they had to enter into a contract with a freelancer, most of their time would be spent negotiating contracts — finding the talent, briefing out the job, negotiating the terms, comparing quotes, checking results, feeding back, remerating, disputing — with none left over to figure out what it is they are supposed to be asking them to do in the first place. High friction.

Much easier to be able to lift your head and bark an order, then kick arse if it isn’t done. Or thoughfully strategize, draw up an operational plan, set targets adn follow up, whichever is your management style. So much easier it is worth subsidizing some people’s lunch and contributing to their pension, in order to be on hand to receive said orders.

On the labour side, one reason, also friction. If a bus driver had to negotiate terms for every bus trip, he wouldn’t have time to drive the bus. Another important reason, security and risk aversion. The company takes on the risk of finding the bus routes, buying the buses, scheduling and charging customers.

For Coase, transactional friction defines who is inside the campus, and who is on the outside looking in. Defining who was in and who was out was a core part of a manager’s role. Now, there’s an app for that.

But digital technology has radically lowered transactional friction across huge swathes of the economy. Look at, for instance, TaskRabbit, or Mechanical Turk. These platforms — for home help and online piecework respectively — have pushed the cost of finding someone, briefing them, and negotiating a price to almost zero, and more or less limitlessly extended the availability of labour, commoditized at the lowest price. Famously, Uber has lowered friction for the service of urban driving to the point where neither the car nor the driver is inside the boundaries of the firm. Airbnb, has become the world’s largest accommodation operator, without a single property to have to look after.

Suffice it to say, the boundaries of the firm are fuzzier than ever.

Friction, in this sense, is a Nobel Prize winning insight, and one that is used by managers everyday. If you are considering taking on a new employee, at what point is the friction of not having someone greater than the cost of recruitment, commitment, and an extra company gym membership? Who, exactly, needs to be inside the walls of the firm, and who can you afford to leave outside and call when you need them? What should the people inside the firm be doing, and what should they call on others to do?

One answer is that transactional friction will always be high for the jobs which are of the highest value — the ones that are building the firm’s core. Inventing new things for the firm to do or make, exploring how to enter new markets, discovering better ways for the company to do what it does, these things are difficult if not impossible to do if you don’t have a direct interest in the mission of the company.

That’s why high level strategy consultants cost so much and have a questionable track record. Others cannot innovate on your behalf — there is too much to know.

So the job of those inside the firm is to do new stuff and to capture the value of that innovation. How do they do this? By commoditizing the innovation, and codifying it into a process or a task that can then be briefed out and sourced from the commoditized labour market, and shifting it outside the firm, so that the core inside the firm can get on with innovating some more.

It’s a cycle: innovate, commoditize, outsource, and if you are privileged enough to be on the inside the boundaries of the firm, it is your job to drive that cycle. Otherwise, it’ll be cheaper to outsource you.

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