I just read the first installment of the Institute for The Future's report entitled The Intuit Future of Small Business Report . The main theme of the report was that we are in the midst of an economic revolution that started in the 1980's when 80% of American workers were at companies with greater than 1000 employees to today where 40% of American workers are at companies with greater than 1000 employees to some percentage far less than that 10 years from now. I happen to wholeheartedly agree with the Institute's thesis. Prior to the 1980's, most people worked for a company for life and received retirement checks from their employer in retirement. From the 1980's to today, most people work for a company for a "few years" and roll their 401k plans over. I suspect by 2017, most people will become more like free agent contractors who more often than not have a "client" than an "employer" and need to worry about their own retirement.

The report lists some reasons why this shift is happening and will continue, but I think it missed some of the fundamentals behind the economic decentralization, much of which can be explained with Coase's theorums.

Ronald Coase was a Nobel Prize winning economist who wrote an essay entitled "The Nature of The Firm" back in the 1930's that tried to predict the number/size of "business firms" by analyzing the conditions under which we expect a firm to decide whether to hire help versus contract out for a particular task. Coase uses a term called "transaction costs" to describe the friction between a company and a task contracted out (presumably to another company). These transaction costs include things like contract creation, contract negotiation, time zones, distance, language barriers, process/definition differences, etc.  Coase's theory says that the lower the transaction costs, the higher the likelihood for outsourcing a function to another company.

Among lots of other reasons, Coase would likely explain the decentralization of business (more firms) since the 1980's as being induced by a reduction in "transaction costs" between firms. Much of this reduction can be attributed to networking technology. New networking infrastructures tend to lower transactions costs and enable firm specialization, including railroads, highways, telephones, fax machines, and email. There's no doubt that the widespread use of broadband networks has reduced transaction costs which often make the choice of outsourcing a task versus hiring a new worker more "efficient" which overall increases the number of firms.  The most famous example of this being the outsourcing of entire business processes to India as was so well articulated in "The World Is Flat."

Another major contributor to the decentralization of business is that small/new businesses no longer need to rely on huge sales organizations to "find" customers. Search engines make every niche market more "efficient" enabling smaller businesses to be "found" by the right customers who are shopping in a newly efficient niche. I believe search engine optimization further lowers the transaction costs between companies making the decision to outsource versus hire more attractive and making the barrier to starting a business lower which should lead to a further decentralization of business.

This article talks about decentralization in a macro-economic sense and how the new network infrastructure has led to a widespread decentralization of the economy. Well, it turns out that not every industry is decentralizing. For example, the enterprise software industry has been centralizing (consolidating) over the past several years. My next article will talk about how/why the boundaries between companies within industries change and how you might go about predicting whether your industry will be consolidating or decentralizing. If you can predict that, you should be able to figure out a way to make money from it.

-- Brian Halligan

 

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Originally published Feb 9, 2007 11:55:00 AM, updated March 21 2013