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Transaction Costs in Web 2.0

Coasean economics is something most of the Internet is intimately familiar with.  Ronald Coase won a Nobel prize for describing transaction costs.  When he described how firms work, he determined that a firm could continue to expand as long as the additional cost of the expansion was less than the cost of acquiring the same service from outside plus the transaction costs associated with integrating the outside service.

Technology has changed the nature of the firm in many ways.  When Coase first formulated his theories many of the ideas centered on pulling services into organizations, eliminating transaction costs and lowering costs by having in-house HR, IT, manufacturing and marketing.  Firms could get larger and larger by taking services internal, eliminating costs associated with vendors, lowering prices to reflect this cost, and expanding market share.  Theories like this were the basis for companies like GE.

Today, all of these approaches have been radically altered.  Transaction costs have declined so sharply due to the Internet that the nature of the firm no longer tends towards expansion, but instead tends toward reduction.  How small can I make my company?  Everything can be outsourced easily and is built for integration.

Let me offer up this idea then:  Internet Company 2.0.  Marc Andreesen recently poked the blogosphere with a sharp stick by saying there is no Web 2.0.  There is definitely some spin here, but I would say that one of the most interesting things about Web 2.0 is the capital structure that drives it.  Lots of people have talked about how capital requirements have changed to build Web 2.0 companies.  We live in an era where Internet Companies have virtually no capital requirements and this is because all of the outsource-able things that a company might need have been outsourced, their cost has gone to almost zero, and the transaction cost to take advantage of the service has gone to zero.

Technology is the most common example: Hosting is a couple of bucks a month, development environments are free, everything is open-source, and support is in free forums of like-minded samaritans.  Marketing is another area where costs are rock-bottom.

This doesn’t apply to other businesses.  I love software because there are no manufacturing costs, but it certainly offers a new model for business building that is exciting, inexpensive, and offers more people the opportunity to be entrepreneurs, which I love.

This post was supposed to be about APIs, but I guess that will be the next post.

One Response to “Transaction Costs in Web 2.0”

  1. Cogblog » Blog Archive » Early Stage Venture Capital Becomes a Smarter Investment Every Day Says:

    […] have talked before about how it is far cheaper to build stuff today than it was previously: languages like Ruby, dev environments like AWS, and tools such as Github and Basecamp allow small […]