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Ana Anjdelic responded to my latest post with some very interesting points.  She commented that some of my suggestions would significantly increase transaction costs, specifically information search costs incurred by firm.  Ana notes that increasing transaction costs in this way contradicts (or runs logically counter to) Coase’s view of the firm.  She writes:

It’s true – knowledge “reshuffling” is key to innovation (or, as you said “when it comes to thinking, we need more disruption, not less.”) This reshuffling, however, creates a lot of “noise” (how do you know what you are looking for before you find it?), and ultimately accounts for less-than-efficient organization, because it creates crazy transaction costs.

And reduction of transaction costs is what made firms show up in the first place (in opposition to markets), as Ronald Coase would have said.

So, the very condition that’s critical for generation of new knowledge and/or recombining old and new knowledge is actually detrimental for efficiency. The question then is, how to combine organizational efficiency with innovation?

I think Ana is right to invoke Coase’s theory and to be concerned about drastically increasing transaction costs and it got me thinking.

My view: while historically firms were able to lessen the search costs associated with valuable information, this no longer applies.  Firms are no longer the most efficient and effective means for collecting and sourcing innovative ideas and insights.  Therefore, as Coase’s theory would predict, firms may need to go beyond their four walls an turn to the market, effectively outsourcing (or co-sourcing) a large portion of idea generation.  Additionally, firms can further reduce information and search costs by leveraging technologies that tag, catalog, and organize knowledge–both within and outside firms.

The basic logic behind traditional, integrated firms is that it was cheaper to bring the various elements of production under one roof.  The idea was that it made sense for firms to enter into long-term contracts with employees because it would eliminate the potentially massive transaction costs associated with, for example, search and information costs one finds in the market.  In theory, when transaction costs are less within a firm than within the broader market, firms will take those items (e.g. labor, technology, distribution, etc.) in-house.  When costs are less in the market, firms will choose to outsource those items.

What many firms are realizing now is that, in many cases, they don’t have the knowledge internally to problem solve and innovate effectively.  The rapid and profuse rise of Open Innovation initiatives by tradional R&D stalwarts provides evidence for this shift.  And even if they do have that knowledge internally, firms are quite inefficient when it comes to quickly locating and leveraging that knowledge.  Firms are typically not structured to efficiently leverage the vast knowledge base they have accumulated internally in the form of their employees, especially as they grow in size and stove-pipe various functions and departments.  It can take weeks, if not months, for firms to locate individuals that have specific knowledge sets that can contribute to a particular problem or project (I’ve seen it firsthand, working with various clients on this very issue).

Given that firms are no longer as efficient at collecting, organizing, and tapping into knowledge under their own roof there are three likely (and logical) outcomes:

  1. Firms will continue to outsource this function to minds outside of their four walls.  This could take the form of Open Innovation, crowdsourcing, or partnerships with more specialized firms that have developed platforms for locating and taxonomizing expertise and knowledge holders;
  2. Firms will invest more heavily in software and technology that will allow them to catalog the knowledge under their roof, making search and location of that knowledge less costly.  Internal social networks are one way, talent software is another.
  3. Firms that fail to adapt to this new reality will fail to innovate as effectively as other firms that due adapt, becoming obsolete.

Ana also brought up a simpler question–how do you know what you are looking for before you find it?  To me, social media makes it quite easy to bump into new perspectives in a quasi-directional or directionaless way.  You can use it to casually challenge your own views and find new and interesting ideas, or you can use it to conduct a focused search for specific experts or knowledge communities.