Remembering Ronald Coase (Dec 29, 1910- Sept 2, 2013)

Ronald Coase passed away this past week, at the ripe old age of 102 1/2.  He represents one of the truly brilliant economists who helped shaped our understanding of management enterprise.  Coase took on the challenges of management and the evolution of the modern firm, and was awarded a Nobel prize for his work.  He was also an important contributor to our understanding of the modern field of procurement and supply chain relationship management.

The early roots of interorganizational behavior was first referenced by Coase who wrote “The Nature of the Firm” in 1937, while attending the London School of Economics working on his doctorate.    Few people paid attention. Economists were more interested in supply, demand, and the impact of prices in the market.

The essence of Coases’ argument is that firms make economic sense because they reduce or eliminate the “transaction” cost of going to market by doing things in-house.  The implicit assumption is that the external costs of doing business involves negotiation, contracting, and transfer of information on what exactly firms want from their suppliers.  This argument made sense in 1937 – because procurement was viewed primarily as a transactional activity.  The only focus they had was to drive prices down – otherwise they would keep the job inhouse.

With the risk of outsourcing in the 80s and 90’s however, firms were trying to drive out as many business processes as possible!  The number of different acitvities that went out to global suppliers in India, China, Vietnam, Brazil, Mexico, and other “Low Cost Countries” was a function of the lower costs – something that Coase couldn’t have possibly imagined in 1937!

It is true that with the rise of global sourcing, the internet, and globalization of supply chain networks, transaction costs have indeed fallen.  And as organizations seek to build collaborative relationships, contractual-related complexities related to higher transaction costs fall by the wayside and are replaced by exchange processes that are more efficient, giving rise to a new body of thinking around “social exchange theory” by sociologists like Peter Blau (1964).  And then Oliver Wiliamson came along later and presented Transaction Cost Analysis – which states that the risk of partner opportunism limits the effectiveness of relational governance in exchange relationships.  So firms are then bouncing around between higher opportunism that might arise, if companies get too close to one another through social exchanges.

After bouncing around England at several schools preaching to students, he finally ended up in a presentation in 1959 at the University of Chicago – presenting to a bunch of economic heavyweights, including George Stigler and Milton Friedman.  In two hours, he blew these gurus away with his insights!  His presentation talked about  “The problem of social costs”, and he converted this into a paper in 1961 that led to further acclaim.  This paper really became one of the foundational theories arguing about the need to consider the social costs of pollution, and today, is also concerned with the issue of human rights.

Looking at his work, I believe that Coase was the first one to really drive the entire insourcing-outsourcing argument to begin with.  It is also interesting to note that the last book he wrote (at the age of 101), “How China Became Capitalist”, Coase notes how the Chinese economic model and its trajectory differs remarkably from the Western experience.  Certainly an important difference here is the radically different role of social exchange in outsourced relationships in China, owing to the importance of both business and personal relationships that lie at the heart of China’s Confucian culture.  This concept, often referred to as “guanxi” – is another subject altogether – for another blog.  Even to the very end – Coase was still wondering why firms behave the way they do.  What an amazing career and contribution to the field of supply chain.

I’ll finish with one of my favorite quotes from Coase, quoted from this week’s Economist, that he made almost 70 years after the first Dundee lecture on the Theory of the Firm.  During his speech upon receiving the Nobel prize for economics, Coase noted: “A scholar must be content with the knowledge that what is false in what he says will soon be exposed.  As for what is true, he can count on ultimately seeing it accepted, if only he lives long enough.”