Case1

We argue in this book that organizations arise as solutions to information problems. A similar line of reasoning was followed by The Economist when analysing the effects that the rise of the Internet and other new communication technologies may have on the shape of firms: A prime reason why economic activity is organized within firms rather than in open markets is the cost of communication. The costlier it is to process and transmit information, the more it makes sense to do things in firms; the cheaper communication becomes, the more efficient (relatively) markets will be. Because the Internet and other inventions have cut the cost of communication so much, firms ought to be able to do less in-house and to outsource more. In 1999, General Motors, a byword for vertical integration, spun off Delphi Automotive Systems, one of its supply divisions, for instance. In Chapter 11 we shall discuss vertical integration and show that more factors are involved in General Motors' decision than just the cost of communication. However, the basic reasoning in The Economist is sound and well in line with the approach taken in this book: markets and organizations represent alternative ways to coordinate transactions; information will determine their relative efficiency. Moreover, The Economist has been right to predict that the rise of the Internet, and the falling costs of processing information digitally, has led to companies that own less material assets and need fewer people to execute their transactions.

Question

It is argued that the rise of the Internet has cut the cost of communication so much that firms will be inclined to outsource more than before. Do you think this is true? Do you see an implicit assumption, made by the journalists ofThe Economist,that is highly relevant but which is not mentioned. Discuss