The Dissolution

The same floor needs cleaning after the name on the cleaner's payslip changes. The building's owner can employ a cleaning staff or purchase the service from a contractor; the contractor may itself employ the staff, organize the shifts, and own the equipment. The boundary of one firm has contracted while work continues within another. This is the moving frontier that the earlier plates prepared us to see. Tasks, assets, decisions, and obligations can cross it separately. To understand the dissolution of the firm, we must follow what has moved: who promises the service, who directs its performance, who supplies the capital, and who receives the return when the arrangement succeeds.

The comparison begins with the costs of doing the same work in different ways. Suppose a producer can make a component internally for 80, with 12 more spent on coordination, giving a total of 92. A specialist can produce an equivalent component for 75, but finding a supplier, settling specifications, and managing the relationship cost another 22: buying costs 97. If a new system lowers that external coordination cost to 10, buying costs 85 and outsourcing saves 7. Now allow the same advance to reduce internal coordination from 12 to 2. Making costs 82 and is cheaper again. The figures hold quality, quantity, and all other consequences constant. Coase expressly recognized the two directions: an invention can reduce the cost of using markets and the cost of organizing within firms. Its relative effect determines which boundary moves.¹

The franchise makes the boundary more intricate than a choice between a department and an occasional purchase. A local proprietor can own an outlet, receive its residual income, and buy access to a name and a business format under a continuing agreement. The brand supplies standards that customers recognize; the proprietor supplies local effort and knowledge. Those contributions can conflict. Saving on quality at one outlet may damage a name used by others, while directing every local decision from headquarters can waste information that the proprietor possesses. Royalties, inspection, quality requirements, and agreed standards divide these incentives and powers. A contract can preserve extensive coordination between separate owners. The franchise is therefore a way of arranging the boundary: its existence leaves open how much discretion each side retains and how well the arrangement makes their contributions fit.²

A platform makes another allocation possible. It may enable professionals to deal directly with clients while the professionals retain decisions about their services. In Hagiu and Wright's model, that arrangement can reward effort that the intermediary cannot observe and let decisions respond to information that only the professional knows. Integration has a different strength: the firm can coordinate decisions whose effects spill across the services supplied by different people. An advertising choice can draw customers toward neighboring providers or divert them away. The comparison depends on the importance of these spillovers, the information, and the incentives available through payments. Their model allows bonuses inside the firm and variable charges on the platform; these instruments change the comparison without making the two forms equivalent. Choosing a platform is a choice about control over specified decisions, with a corresponding account of what remains difficult to coordinate.³

Cheap communication can support any of these arrangements. A common specification may let a buyer compare distant suppliers. A better account of inventories may let headquarters coordinate more plants. A reputation record may help strangers trade, while the organization that maintains the record can still set admission rules and charge for access. Each improvement removes a particular obstacle; the remaining obstacles determine how the activity is governed. Even an intermediary that contracts out the underlying service needs an organization to maintain its own systems and decide their rules. Its users' independence in one decision can coexist with dependence in another. The word platform gives the inquiry a starting point. The allocation of actual decisions tells us how far the enterprise has moved from directing production to enabling exchange.⁴

For the people who cross the boundary, the allocation of gains and exposure matters as much as the sum. A lower invoice can represent fewer resources used, a lower payment to someone doing the same work, or a shift of risk onto someone less able to bear it. Only the first is an immediate resource saving; the others require their own account of incentives, opportunities, and welfare. Suppose the work and its cost are unchanged, but a service provider receives 5 less and the purchaser retains 5 more. Their combined resources have not increased. A real saving of 5 in administration would change that total, although its division would remain open. The inquiry therefore follows the promises as well as the money: who commits to pay during interruptions, who must replace failed equipment, and who has enough information and resources to enforce performance when the relationship breaks down.⁵

The boundary of the firm was always a choice, and its movement leaves a trail of choices behind it. An enterprise can shed a task and retain its brand, delegate a decision and retain a veto, or buy an output while leaving the supplier to organize the work. Some changes economize on coordination; others alter bargaining positions; many do both. The relevant comparison follows the whole arrangement, including the organization on the other side of the line. As markets become cheaper to use, the firm revises the reasons for bringing activities within its authority. Every revision must still specify enough of a relationship to make cooperation possible. The final frontier of this volume is therefore made of promises: the instructions that may be given, the performance that may be demanded, and the contingencies the parties leave unresolved. The next volume takes up the instrument that carries those promises across the boundary: The Contract.