Financial Clarity for Entrepreneurs

Why Does Your Company Exist?

Why Does Your Company Exist? If you answered “to make money for me and my family,” or “to create opportunities for my employees,” or even “to make the world a better place,”  you need to adjust your thinking.  The fact is your customers don’t care about you, your family, your employees or even that you want to improve the world.  What they care about is you making their little part of the world better: more comfortable, more entertaining, more meaningful, more profitable.

We recently marked the 100th birthday of Ronald Coase, who besides having one of the best first names in the English language, is also a Nobel prize winner in economics and an overall really smart guy.Early in his career, Coase pondered the question of why, in a free market, companies exist.  In other words, why would a company take on the permanent expense of having employees on the payroll instead of contracting with free-agents to work on specific tasks as they were needed?  On the surface, it seemed to him that in an ideal world companies would consist only of the owners and a rotating roster of subcontractors, and the company itself would not necessarily be permanent.  He envisioned the virtual company several decades before the idea became popular.  

Businesses Exist to Reduce transaction costs

Coase’s key insight into the reason for the existence of permanent organizations with employees was transaction costs.  These are all the extra costs, over and above the actual price of a good or service, that are incurred when a buyer and a seller engage in a commercial activity.  They include the time and money expended on acquiring information, the time required to bargain over the terms of the transaction,  the risk of exposing trade secrets, the risk of not being able to obtain supply when needed, and the inability to react quickly to market conditions.  The higher the transaction costs the more likely a business will take a function in-house.  The lower the transaction costs, the more likely a business will outsource (hopefully to your company.) 

Reduce transaction costs for your customers

It’s important to note that Coase’s insight into transaction costs applies to companies as purchasers.  So no matter if your customers are other businesses or individuals this can give us some insight into creating a business model.  How can you reduce the transaction costs for your customers to make their world just a little bit better?  What are the transaction costs that bedevil your customers?: Are their costs too high in terms of time, money, or hassle?

For example, could you:

Make it easier for your customers to buy (iTunes, Netflix, Dominos Pizza)

Offload an undesirable or expensive function to yourself and do it faster and cheaper than the customer can do it (Jiffy Lube, UPS Logistics)

Reduce the time and expense of finding information, suppliers or customers (Google, Ebay)

Reduce or eliminate the risk of making a bad decision (Zappos – free return shipping)

There are as many ways to reduce transaction costs as there are types businesses.  The important thing is to spend some time thinking about your customers’ pain, how that pain is not being addressed adequately in the marketplace, and how you can remove that pain profitably.

This assumes that you can already deliver a quality product or service at a reasonable price.  But since quality and price are no longer competitive advantages (they’re just the price of admission) you need to think deeper about the value you can create for your customers.  A full understanding of their transaction costs will help you get there. 

What transaction costs are you eliminating for your customers?