Ronald Coase
Buying is not free
A firm ends where doing it yourself costs the same as buying it
"The Nature of the Firm", Economica, 1937
Do I build this myself or hand it to someone outside? This page is about the line that is easiest to leave out of that sum.
What actually happened?
In 1937 Ronald Coase, then twenty-six, published a paper in Economica that asked what economists thought needed no asking. The textbooks said prices coordinate everything. Yet walk into a factory and nobody haggles: people do what the manager says. If prices work so well, why is there a firm at all? His answer was plain. Buying through the market costs something too: finding who sells, asking prices, settling terms, writing the contract, checking delivery.
The quote has more in it than the price
He put it plainly: it is profitable to set up a firm because "there is a cost of using the price mechanism." The price on the quote is only the part that shows. Finding the seller, agreeing terms and chasing delivery all take time, and none of it is in the price.
A photographer quotes five hundred pounds. Comparing three, briefing, two rounds of edits and chasing the files are not in it.
A firm turns many deals into one instruction
Rather than negotiate every time, you hire someone and buy, through one employment contract, the right to tell them what to do for a while. A firm exists because directing people inside is cheaper than bargaining outside, task by task.
A standing photographer needs only "Friday, you're on." The re-briefing and re-pricing disappear.
The edge sits where the two costs meet
Inside has costs too: the larger the operation, the harder it is for whoever runs it to know what each part needs, and the more gets misallocated. So the firm grows, he said, until the cost of organising one more transaction inside it equals the cost of doing it on the open market.
A support team goes from three people to thirty. Rotas, training and management get dearer every month, until buying the service looks cheaper.
The line moves
He pointed out that the telephone and the telegraph cut the cost of managing at a distance, and so change how big firms get. There is no standing answer to in-house or outside. There are two costs, and what each is today.
With remote tools you can hire a remote employee or buy a remote service, and both are cheaper than a decade ago.
How do I use it today?
Where you are: Deciding whether to build a function yourself, hire for it, or buy it in.
Ask first: Outside, how much effort will I spend finding, haggling and checking delivery? Inside, what does each extra head cost in meetings, coordination and waiting for sign-off? Write both columns.
Where it goes wrong: Comparing only the quote with the salary. The inside costs are on no payslip and the outside costs are on no quote, so you are comparing two numbers neither of which has been written down.
Lines to keep
Buying through the market is not free.
A firm grows until managing one more thing costs more than buying it.
The costliest line is the one the quote leaves out.
Same situation, other people are asking
I'm told this is just what it costs. Is it?Costs won't come down and I can't see where to cut first.Every stage in this takes a cut and each one says it is necessary.Every team keeps a buffer and I've stopped asking why.Everyone says it can't be done cheaper · all 8 questions →If this one named what you are going through,
send it to someone who needs it, or keep it somewhere you will find it again.