Companies versus markets: how will the future workforce evolve?

In November 1937, at the age of 26, British economist Ronald Coase published The Nature of the Firm. The paper,…

In November 1937, at the age of 26, British economist Ronald Coase published The Nature of the Firm. The paper, which went largely unread for decades, posed a seemingly simple question: Why do companies exist?

If markets are such an effective way of delivering the goods and services that people want, Coase asked, why does so much work take place within stable, hierarchical and bureaucratic structures called companies, rather than being done through individual exchanges by market participants?

Those with an interest in the future of work should study the ideas of Ronald Coase. The changing nature of employment, the growth of freelancing and the rise of the so-called ‘gig economy’ – which recently prompted a major UK government review of working practices – can all be better understood by applying Coase’s insights.

Easier to mobilise resources

According to Coase, firms exist because mobilising resources is easier in a company, as going to the market imposes heavy transaction costs, such as hiring workers, negotiating prices and enforcing contracts.

Markets might work more effectively for exchanges of simple or standardised goods, where a contractor can be paid a fixed sum for their work. However companies work better where goods aren’t standardised or require those involved to follow varied or changing instructions, which rely on upfront investment and complicated, longer-term contracts and agreements. Essentially companies provide a vehicle for creating long-term contracts because short-term ones create too many transaction costs.

Coase developed his theory of the firm while visiting factories and businesses in America. Does it still apply today? Perhaps not: the development of open source software, crypto-currencies and crowdsourcing all seem to suggest that loose networks of individuals are quite capable of mobilising vast resources, albeit in a more haphazard way.

Likewise, increasing number of people are members of the gig economy, undertaking all sorts of work sourced via online marketplaces as free agents – it is estimated that around five million workers in the UK alone are employed in this way.

Transaction costs eliminated

Many of the transaction costs identified by Coase, such as those associated with searching for and hiring workers, have been eliminated by technology. Online talent marketplaces like UpWork, TopCoder, and InCloudCounsel all link companies with expertise in the same way that Uber links riders with drivers.

Lexoo, a marketplace for freelance lawyers who undertake legal work for a flat fee, has developed its own algorithms to match those in need of legal expertise with the exact talent they’re looking for.

Even highly complicated, skilled work can be sourced via these talent markets – Topcoders’ networks of one million developers, designers and data analysts have built enterprise grade software for the likes of eBay, IBM and UBS. Because the platform breaks down projects into discrete stages – such as conceptualisation, architecture design and testing – its workers are highly specialised and able to work on different stages simultaneously.

Are markets the future of work?

If technology eliminates more of the transaction costs that make firms competitive, will markets replace companies? Today’s biggest firms routinely move billions of dollars-worth of goods and services and employ thousands of people. Will these companies be superseded by leaner structures that harness markets to get work done? Will we all be working in the gig economy, taking on one discrete project after another to earn a living?

Many in Silicon Valley, where Ronald Coase’s ideas have enjoyed a resurgence in popularity, certainly think so. Apps like Uber and Deliveroo are commonly held up as harbingers of a new employment paradigm, even if their workers aren’t entirely happy about this. Elsewhere, others have argued that we’ll see a return to guilds or professional associations as freelancing becomes more widespread.

Difficult to breakdown jobs

It seems unlikely, however, that transaction costs can be eliminated entirely. While it may be possible to break down a great amount of jobs into discrete activities which can be sourced via a market, much of the work that people do is broadly defined, highly varied and difficult to measure in terms of performance.

Breaking down these types of jobs would require highly complicated contracts, particularly for jobs involving use of residual rights over any required inputs. Most economists are highly sceptical that such contracts can ever be achieved. Moreover, companies will want – and will be willing to pay a premium – to keep the skills of top performers on whom they rely in-house, not least to prevent them from working for the competition.

Markets will undoubtedly play a greater role in the way work is undertaken in the future, but the organisations of the future are likely to be a hybrid of both companies and markets.

A core of employees will be supported by a network of freelance and specialist expertise, brought in when needed. Where transaction costs can be eliminated, companies will increasingly rely on markets to get work done. In certain roles – where transaction costs are stickier – it will continue to make sense to retain these people as employees.

Owen King is Associate Director of UnWork