Market Forces vs. Firms: Understanding the Balance

Why Are Some Activities Directed by Market Forces and Others by Firms?

His answer was that firms are a response to the high cost of using markets. It is often cheaper to direct tasks than to negotiate and enforce separate contracts for every transaction. Such "exchange costs" are low in markets for standardized goods.

It argued that private bargaining could resolve social problems, such as pollution, as long as property rights are well defined and transaction costs are low (they rarely are).

Spot markets cover most transactions. Once money is exchanged for goods, the deal is completed. The transaction is simple: one party wants, another supplies. Spot markets are thus largely self-policing. They are well suited to simple, low-value transactions, such as buying a newspaper or taking a taxi.

For many business arrangements, it is difficult to set down all that is required of each party in all circumstances. In such cases, formal contracts are by necessity "incomplete" and sustained largely by trust. For example, employment contracts.

Successful economies need both the benign dictatorship of the firm and the invisible hand of the market.

Customer Relationships:

• Butterflies: high potential profitability and short-term projected loyalty
• Strangers: low potential profitability and short-term projected loyalty
• True Friends: high potential profitability and long-term projected loyalty
• Barnacles: low potential profitability and long-term projected loyalty

Growth-Share Matrix:

Evaluates a company's SBUs in terms of market growth rate and relative market share. Problems: Difficult, time-consuming, and costly to implement. Difficult to define SBUs and measure market share and growth.

Focuses on classifying current businesses but provides little advice for future planning.

• Star: fast-growing
• Cash Cow: mature business that throws off cash
• Bright Prospects: risky but big-upside business in fast-growing markets
• Dog: business with a weak position and few prospects for growth

Internal vs. External Recruiting

External: PRO: acquire fresh perspective & discipline effect on existing staff. CON: costly in terms of time to find and to learn (learning curve) & depressing effect of existing staff.

Internal: PRO: signals opportunity to workforce (it motivates the other workers if they see that someone else is promoted) & less costly. CON: barriers to new ideas & might spur resentment among those not promoted.