The vast majority of what I have written on pricing and pricing strategy is drawn from my business owner and consulting experience. But when I wrote my book Pricing Strategies for Small Business in 2008, I had to re-visit my academic roots as an economics student at the London School of Economics.
In September of 2014, Ronald Harry Coase died. I had read a number of books and articles quoting and referring to him while at the school - all about the application of economics in companies, but I never realized his major contribution to understanding how companies work.
Coase is best known for one article in particular: "The Nature of the Firm" (1937), which introduces the concept of transaction costs to explain the nature and limits of firms. It was, to paraphrase Coase, a contribution on the theory of economic systems so obvious that it tended to be overlooked.
What Coase realized in observing US auto manufacturers, was that the existence of the firm compensated for a critical flaw in the price-setting mechanism. Transaction costs, like the need to draw up or negotiate contracts, prevent the price mechanism from working smoothly. Firms existed where it was easier and cheaper to co-ordinate activity within a centrally planned organization as opposed to spelling out the details for every step in the production process.
So, companies exist to spread the costs of price setting and writing contracts for hundreds of variables by bringing them under the umbrella of a single company. Think of the costs of having to buy each piece of lumber to build your house, or each screw and panel for your car?
Why is this important today? In the Okanagan, for example a VERY high proportion of people are self-employed, working from coffee shops and basement offices. I know a number of them. When I chatted to them about why they got into business, many told me that the company they worked for or got work done for them charged many dollars per hour and they could do it for less. That is true.
But 4 factors are consistently missing from their calculations.
- Negotiating a price each time is, well, time consuming and that time is unpaid.
- All the time hunting for business is unpaid time.
- Preparing a contract is unpaid time, and a contract may just lead to a flat NO!
- There are no medical and dental benefits.
So the reality Coase found in his research in 1937 still applies. Without companies, the entire costs are on the shoulders of the entrepreneur and woe betide the business owner who does not get his sums right.
This column focuses on business problems and how to solve them. Andrew Gregson, BA, MA , M.Sc.Econ is an economist, author and a Senior Partner in iNTENT Financial Inc, a Kelowna based finance and consulting company. The 4 partners specialise in finance, pre-determined profitability, sales and marketing. If you need further information, please contact us through the website at www.intentfinancial.com.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.