The invisible hand is invisible but not free

We take for granted that companies exist.

But have you ever asked yourself why companies exist in the first place?

In 1937, the British economist Ronald Coase formulated an answer to this question. He received a Nobel price for it in 1991.

Coase argued that companies exist to reduce transaction costs. Transaction costs are the time and effort you have to invest to get stuff done on the market. If we were all free agents there would be a lot of interactions going on. Peter would have to call Mary and she would have to call Tom, and then Tom would have to call Mary, and you get where this is going. It gets cumbersome fast.

So, to get stuff done in an easier, more efficient way we found companies. Transaction costs are lower because individuals can interact more easily with each other.

And that’s the answer. Businesses are the answer to high transaction costs on the market.

So then for you in a leadership position, what does this imply?

One of your main responsibilities as a leader is to keep these transaction costs low. You can review everything through this lens: Does this action reduce or increase transaction costs? If we increase transaction costs, e.g. through meetings, is this offset by an increase in productivity? Or are you creating an internal market here?