The Nature of the Firm #1

I have been reading The Nature of the Firm edited by Oliver E. Williamson and Sidney G. Winter.  The book derives from a 1987 conference to commemorate the 50th anniversary of Ronald Coase’s 1937 article “The Nature of the Firm.” The book includes that article, three more by Coase, and eight more by others. There is a summary of Coase’s article on Wikipedia. Both Coase and Williamson won a Nobel Prize.

Coase’s 1937 article was pioneering for two reasons. First, it asked the make or buy question. Does a firm itself make something that’s needed on the way to offering its final product for sale or does the firm buy it in the marketplace? For example, does an auto maker buy parts from a supplier or make the parts itself?  Prior to 1937 economic theory focused on marketplace transactions and price theory. The theory assumed the direction of resources was directly dependent on the price mechanism. Also, the theory focused on one- time (“spot”) market transactions and overlooked the reality of a wide variety of kinds of contractual relationships, including recurring transactions. Second, the article also considered the internal structure of a firm. Businesses are organized in many ways – sole proprietors (with or without employees), partnerships, corporations (from one to millions of stockholders, from one to a few to many employees), mutual companies, franchises, joint ventures, etc.  There are various kinds of contracts, such as compensation for employees (set wages, bonuses, commissions, etc.). What determines how a firm is organized? Make or buy decisions and the varying nature of transactions and contracts are factors.