Transaction Costs is why B2B marketing is such a challenge: Ronald Coase (1910-2013)

Ronald Coase passed away yesterday at the age of 102. He wrote a paper in 1937  called The Nature of the Firm, that has inspired many posts on this blog. While Coase received the Nobel Prize in 1991, his student Oliver Williamson received the Nobel Prize in 2009 as discussed in an earlier post.  Here is how Ronald Coase’s ideas explain the challenges that B2B marketers face every day:

  • Why does the firm exist- why not outsource everything? Firms are reluctant to outsource everything to contractors because of “transaction costs” in the market. For example, for mission critical software US organizations employ highly paid programmers in house for a variety of reasons including intellectual property, too difficult to explain even when an outsourced virtual programmer might cost one-tenth of an employee. Transaction costs for recruiting a reliable B2B supplier for high value procurement of goods or services involve a lot of work and risk. You need to put together a detailed RFP (Request for Proposal), invite bids,evaluate bids, negotiate prices,sign a contract perhaps for a year. Several things can go wrong during the first year including that the supplier does not perform as expected, the supplied product /service has glitches as it is integrated into the value chain of the buyer firm. If things do go well, a buyer-seller relationship is established and both the supplier and buyer firms start getting to know each other at multiple individual levels, spend time at work and also form personal friendships, understand each other’s processes and are able to navigate them and get things done.
  • So how does a new supplier get in? Unless the existing supplier is seriously problematic – it is extremely difficult for a new supplier to get in. An existing entrenched supplier, when alert, is able to navigate changing management and even mergers and acquisitions at the buyer organization. Because the efficient and dedicated supplier works just like a reliable employee and as a trusted partner. By this time existing suppliers involve very little “transaction cost,” for the buying organization which tends to renew contracts. If the new supplier puts in a lower price bid, the existing supplier might even get a chance to match. Just in case the new supplier is really low in price, as in overseas suppliers, and the item is a standard item the new supplier gets a chance to supply. Even here entrepreneurial existing suppliers do set up their own low cost overseas supply system.
  • Innovation the solution: Yes new suppliers can succeed when they offer something that really changes opportunities for the buying firm. This could mean a solution that significantly increases production output, greatly enhances quality or final customer uptake.

 In a recent blog post (at the age of 101!) at HBR Blog, Coase urges economists to move beyond price and be “reoriented to the study of man as he is and the economic system as it actually exists.”  It is because of this gap in Economics that fields like Marketing and Supply Chain developed. Luckily Behavioral Economics responds in some part to Ronald Coase’s call.

RIP Ronald Coase.

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