Why Do Firms Exist

Why Do Firms Exists?

ME/9595034/Jul15/1

Introduction

The Economist marked the Nobel Prize winner Ronal Coase’s 100th birthday with an article

namely “Why Do Firms Exists?” In Professor Coase’s paper “The Nature of the Firm” which

was published in 1937, he concluded that there must be costs to using market than can be

eliminated by using the firm (The Economist, 2010). The costs are known as transaction

costs. In economic theory, the conditions for perfect competition are very strict. For

examples, some key features of perfect competition include zero transaction costs, nonincreasing returns to economics of scale and perfect information. It is hard to find their

existence in the market. Thus we find it rare to see perfectly competitive market. That

explains why not everything can be done by the market. According to Ronald Coase, people

begin to organize their production in firms when the transaction cost of coordinating

production through the market exchange, given imperfect information, is greater than within

the firm (Besanko et al, 2010). Firms exist to make it less costly to get work done.

Successful companies build up powerful capabilities in processes of vertical chain. These

capabilities enable companies to make decisions in complex situations that could be more

costly done by an open market. In following sections, I will elaborate transaction cost theory

using a string of business cases relating to Alibaba Group Holding Limited (“Alibaba”) in the

context of e-commerce.

Understand the transaction cost economics in e-commerce world

Alibaba is a Chinese e-commerce company that also provides electronic payment services.

Alibaba’s customer-to-customer portal Taobao supports online sales particularly for small

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business and individuals. In the supply chain of e-commerce, online retailers are the

principals who engage Taobao to support their online business from procurement, logistic

management to sales and promotions in established...