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Small Businesses Are Causing Economic Collapse

I have talked about Coasean economics before: Firms grow or shrink around the concept of transaction costs. As long as the marginal value of absorbing a function into the company is positive, a company will continue to vertically and/or horizontally integrate. Similarly, as services become cheaper, it makes sense for companies to shrink – sometimes in unfriendly ways.

One of the most common manifestations of this law are the axioms we hear around building start-ups today: You can get pretty far on a few hundred thousand dollars, when you needed millions in the past. Companies that had to have 20 people and tons of hardware and software (Sun boxes and Oracle licenses) to launch can have two guys and AWS and be ready to roll. It is widely agreed that there are more rapidly growing companies (thanks to the market testing going on by the sheer volume of new start-ups) and more start-ups than ever before.

Still, the economy is sucky. I read an article in the Atlantic that really got my gears turning last week. You should read it.

Unemployment is high. Super high!

And I don’t think there is much to be done, frankly. Manufacturing jobs are moving off-shore. The global value of manufacturing work will be set by countries with far lower standards of living than the US, unfortunately. Knowledge work is moving off-shore as well, although I think we are seeing, as organization focus on agility, that the nature of software and business requires a nimbleness and group-think best served by co-location. In fact, the value of that nimbleness and co-location dejustify distribution, even as tools for distributing work become more widespread. Isn’t that amazing?

Still, when you pay more for co-location, that limits the amount of people you can employ. But that is okay because we have nimble technology. Unless you need a job. Then it is tough because companies only have a few employees.

I want to go one level deeper in the analysis of how Web 2.0 technologies have changed the game: I think most small service businesses will disappear also. When I look around my local market, I see dozens, probably hundreds, of four to twelve person service companies. Why? I am increasingly seeing a trend where the employees of these companies realize that they are not adding a lot of value. Small businesses like that frequently struggle to keep staff utilized, resulting in low utilization and poor profitability. The result is that nobody is making mad cash at a business like this. Plus, the possibility of losing a big client and two or three people getting laid off happens with alarming regularity.

Why not go free agent? More and more people are choosing exactly that. And with the growth of things like co-working facilities, the terror and loneliness of being a free agent, as well as the stigma, are being erased. Further, I am seeing at places like the Baltimore Beehive that the aggregation of free agents helps free agents find work: If a programmer wins a job, he pulls in a designer. And vice versa. Rarely does he look to a big firm to help him. And he is co-located with the designer so the relationship is easy to manage.

Ronald Coase would say that even a small firm adds a lot of overhead. Does it lower the price of services? As the economy has changed, frequently not. Markups usually shrink as people become free agents.

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