Theory of the Firm in Decline

The theory of the firm posits that internal transaction costs of coordinating production are lesser than external transaction costs. Basically, it costs less to get things done within the company than to accomplish those things through coordination between smaller companies.

What is included within a firm is a constant battle between market forces, and in the last two decades management consultants have been paid a lot of money to identify what “core competencies” firms hold, with an eye to outsourcing anything which doesn’t absolutely have to be done internally to the firm.

The compounded effects of outsourcing and automation have lead to the latest round of thought leadership, whereby we are informed that employees are coming to an end, and that there “will be no employees outside of the C-suite” in the near-future.

There is a strong narrative building in the popular media linking the end of employees (and therefore jobs) to the need for a universal basic income. People will need the basic income, of course, in order to pay for the goods made possible by a handful of companies to which all known wealth will gravitate.

The wildly popular prediction is not only disingenuous, but also manages to ignore most known aspects of human behaviour, and seems to be preparing the populace to welcome a profoundly authoritarian regime from whatever extreme end of the political spectrum.

Furthermore, this inevitability is inevitably blamed solely on technology. Technology is to blame. Yes, technology was intended as a freeing force which might have allowed sovereign humans to spend more of their time on pursuits of their choosing, but alas, all was lost, and it turns out that technology only frees a lucky few within a 60 mile radius of Stanford University (or however far Sand Hill Road venture capitalists are willing to drive for board meetings these days).

No. Indeed, should the press’ favourite version of the future actually come to pass, it won’t be technology that’s to blame, but simply a total lack of ingenuity.

Technology doesn’t just make outsourcing more efficient: technology decreases the advantages of centralized ownership and increases the efficiencies of distributed ownership and control. And to let you in on a little secret, engineers have been going gangbusters inventing new systems and protocols that widen this advantage.

American Airlines, which owns 936 aircraft, might today enjoy all sorts of efficiencies over a rag-tag group of 936 pilots who are owner-operators of individual aircraft. Uber, who claims to manage over 50,000 drivers, clearly reaps billions of dollars more than those same drivers operating individually.

The idea that a few hundred pilots - operating individually and with their own equipment - might be able to operate more efficiently than a major airline might seem like a funny idea. There’s no management! Who’s in charge? How would anything get coordinated!

Fortunately, we have a nifty technology known as the open market which lends itself to these predicaments better than you might imagine. Gate management and flight scheduling would be deftly handled by an appropriate combinatorial auction, baggage handling outsourced to one of several providers per airport, and flight crew organized on a much more personal basis.

There are, however, several non-efficiency related disadvantages which today continue to prevent the above scenario from playing out. Large companies enjoy monstrous advantages in raising debt financing. Two pilots planning to offer continuous service of a Boeing 747 would find it impossible to raise the funds, while a mammoth corporation would have no difficulty acquiring the funds and hiring the same pilots to perform the same task.

Similar structural disadvantages abound in other business-to-business relationships. No airport in the world would today agree to do business with twenty thousand airlines. They likely have dedicated employees for each account, which wouldn’t scale to any other model. This interface of sole-operator, or ‘microcorp’, to larger company would require complete reinvention of the latter firm.

A final issue affecting both consumers and B2B interfaces is torts: there absolutely must be someone to sue. America in particular has become accustomed to being able to sue an entity for 9-digit values should anything go wrong, and all parties to a transaction derive some obtuse sense of security from this ability. A more distributed economy would dramatically reduce the ability of a wrongee to recoup millions from a party to an agreement. Larger businesses will simply have to come to terms with this new reality.

Interfacing with consumers has not yet been entirely solved in the distributed scenario, but there’s hope. Open market technologies would allow individual drivers to, say, bid openly on who could supply a ride, and a distributed system could resolve the auction in real-time. The most significant outstanding issues facing consumer access then are less about coordination and control, but are largely marketing-related. How does quality control occur? How can a consumer come to expect comfort and consistency? (Distributed reviews may end up solve these to a sufficient degree)

So, while major technological progress is making distributed ownership and micro-corporations possible from a coordination and control perspective, major advantages remain in most other aspects of business, with particular problems interfacing with large companies. Why bother at all?

Because, in the end, a distributed economy has the potential to be significantly more efficient than one where mega-corps throw their weight around the world. Astronomic executive salaries are only possible due to profound lack of competition and the extreme profits this translates into, especially when applied to a global market scale.

There are also indications that a distributed economy would heavily contribute to self-determination and human thriving and eliminate any need for some forced redistribution scheme. And because distributed systems are, by their nature, anti-fragile.


Now read this


One of the truths I’ve constantly re-arrived at over the past several years is that optimization is boring. It’s a bit of a shame, since I tailored most of my senior engineering courses toward optimization. But although I understand many... Continue →