Category: business

Chatting and messengers

So the wife has just moved abroad and I haven’t even bothered getting international calling enabled on my mobile phone. It’s not that I’m not concerned about keeping in touch with her – it’s more to do with the plethora of options to keep in touch with her than a normal phone call.

Firstly there’s whatsapp, which I’ve used for the last two years (the trigger to join whatsapp was the limit in the number of text messages one could send per day which was introduced in 2012 as a “rumour prevention mechanism”). A large number of people on my contacts list use WhatsApp, which means that it is extremely rare that i use normal text messaging to connect to them.

And earlier today, while she was waiting for a connection at Frankfurt airport, the wife asked me to install Viber, saying it allows us to talk without any international dialing cost. I just had a brief conversation with her and the quality was extraordinary (especially given i’m on a weak BSNL broadband here and she was in a car there). Then I looked at my contacts who are on viber, and the number of my contacts who are using Viber is insanely high! Almost makes me seem foolish for not joining in so far.

And then earlier today I spoke to someone in Singapore using Skype. Call quality wasn’t that great – we dropped a couple of times – but it was still pretty good. And then there is google hangouts. And then there is apple’s facetime (perhaps the main reason the iPad fell my side when we were dividing our assets prior to the wife’s move is that I could have an Apple device with me so that we can FaceTime!).

The number of options for messaging is so large that I wonder how long the whole calling and messaging model will continue. I had shown in a recent blog post (on my public policy blog) that the number of SMSs sent per user in India peaked three years ago and has then been on a secular decline. And now there is news that the telecoms regulator in India is thinking of instituting a fee on providers such as WhatsApp and Viber because of the revenue losses they are causing to the mobile phone service providers in India (like Airtel, Vodafone, etc.).

The question therefore is what the future of telecom will look like given the large number of internet based reliable communication providers who are springing up. My prediction is that the phone call is not going to die – what sets apart a phone call from a Voice over IP connection (such as Skype or Viber) is that it is “online” (i forget the technical term for it – ok got it it’s “network switching” as opposed to “packet switching” which is how the internet works).

To explain that in English, when I talk to you over the phone (normal phone call) there is a dedicated line that goes out from me to you. Basically your telecom provider and mine and the network interchange come together so that a virtual line is drawn from me to you, and this is exclusive for us as we talk (call dropping on mobile phones happens when we try to move from one “cell” to another and get lost in between).

The internet doesn’t work that way. When I send you a “voice message” over the internet, it goes one hop at a time. There is no dedicated line from me to you. The reason we are now able to voice chat online reliably is that the bandwidth available is so much that packets usually get connected quickly enough (think of a bus network so dense that you can change buses instantly to get to your destination – it virtually simulates a “direct bus”). When the network is busy or the bandwidth clogged, however, there might be some delays (while a phone call once connected remains connected).

Given this distinction the phone call offers a level of reliability that packet switching based voice messengers can never reach. And there will always be a market for extremely high reliability. Hence the phone call is not going anywhere.

The SMS, on the other hand, is again packet switched, and a mechanism in which carriers could extract large amounts of money. The SMS will soon die a natural death – kept alive only by means of government mandated services such as two factor authentication of credit card transactions.

While the fees on carriers such as Viber might become a reality in a place like India they are unlikely to sustain as international norms become uniform. What we are likely to see instead is mobile carriers coming to terms with existence of such providers, and some interesting internet pricing plans.

Currently, to use Viber for a fair bit you need a fairly high FUP (fair usage policy) limit on your phone (carrying voice digitally takes a lot of bandwidth). Carriers might introduce some kind of a graded payment structure such that they can partly recover (through higher internet charges) the lost revenues thanks to lost call charges.

If any mobile phone operator is reading this and needs help on devising such pricing mechanisms, feel free to use my consulting services. Among other things in the past I’ve done revenue management for airline ticketing and cargo (the holy grail of revenue management) while working for Sabre – the pioneer in revenue management.

Impact of online retail on offline retail

The other day we had to buy a couple of electronics items, and we went to this long line of electronic stores close to home. Since what we were looking for was closer to the long tail, we eschewed the small “standalone” stores and went to the chain stores. And the service at each store was simply underwhelming.

Sales staff seemed extremely demotivated, and seemed to have no incentive to make a sale. There seemed to be no senior sales staff around who would guide these staff to serve us well. They just stood by standing around, and the only thing they did was to pull out the item that we requested, and then look at the price tag and tell us the price.

With the coming of online retail, one reason for people to shop offline is service. When we had to buy a refrigerator recently, we wanted some human help in determining the pros and cons of various brands, and which are the faster selling ones. And off we went to the nearby (standalone, non-chain) “white goods store”. And we had booked a refrigerator on our way out!

What online sales is doing is to set a higher bar for salesmanship in offline stores, and stores need to recognize this. Just standing around when a customer shops and showing him price tags will not cut it any more – what offline stores need to figure out is what service they can offer that online stores don’t. And provide that aggressively, in order to not lose business to the e-retailers.

Another advantage for offline stores is in terms of letting the customer touch and feel the goods – a refrigerator or a washing machine or a television, for example. The downside is that inventory costs can be prohibitive and there are only so many models that the retailer can put on display – but then based on sales patterns they can choose which models to actually put on display (the top selling ones).

One reason mobile phone sales have so easily moved online (Moto and Xiaomi, for example) is that even at an offline retailer you don’t have much opportunity to touch and feel a mobile phone – in a large number of cases it’s dummy models that are stuck there rather than working ones, and that doesn’t particularly add value to the customer in terms of purchase decision.

Finally, based on my limited sampling of “white goods” stores on 10th Main, Jayanagar 1st Block, Bangalore, I think the coming of online retail is not going to affect the standalone family businesses (that the BJP seeks to protect) as much as it is going to affect the chain stores. The former are agile and able to adapt to customer needs. It is the latter that are sluggish and seek protection.

Damodaran on Uber’s Valuation

It is fascinating to watch this back–and–forth between NYU Prof Aswath Damodaran and Uber board member Bill Gurley on the taxi company’s valuation.

To set the context, when the latest funding round for Uber was announced, valuing it at USD 17 billion, Damodaran – a guru in valuation – wrote his own analysis which valued the company at about a third of that value. While it was a typical Damodaran post – long, detailed and making and stating lots of assumptions – it was probably intended as an academic exercise (the way I see it).

Instead it seems to have really caught the fancy of the silicon valley investment community, and led to a response by Gurley (I admit I haven’t read his full response – it seemed to attack straw men in places). And Damodaran has responded to the response. Now that the Three Way Handshake is complete I don’t expect any more backs and forths, but I won’t rule it out either (it’s possible but not plausible, to use Damodaran’s terminology).

What fascinates me is why an academic’s academic post on valuation of a company has created so much of a flutter – so much to merit a long-winded response from the board member. I’m reminded of two things that my valuation professor had told me some 10 years back when I was in business school.

1. Valuation is always wrong
2. Value of a company is what the market thinks it’s valued at

The first of these is a bit of a motherhood statement and adds no value to this particular discussion so let’s not take that into account. It’s the second reason that has got the investors’ knickers in a twist.

In the past, I’ve seen Damodaran publish valuations of companies that are about to go public, or are already public – Tesla and Twitter for example. It is usually an academic exercise, and Damodaran’s valuations value these companies at lower than what the market values. However, given that these posts have appeared after there has been a broad consensus of a company’s valuation, it has not really impacted a company’s valuation, and thus have been treated as an academic exercise.

The problem with Uber is that it is a private company, and unlikely to go public for a very long time. The problem with a private company is that it is difficult for investors to agree on its valuation – there are very few trades and the stock is illiquid (by definition). And illiquidity means extremely high bid-ask spreads (to put a technical spin on it) and widely varying valuations.

Sometimes, when nobody knows what something is valued at (like Uber – which is creating a new category which no one has any experience in valuing), what people look for is some kind of a peg, or an “anchor”. When they see what they think is a reasonable and broadly reliable valuation, they tend to use that valuation as an “anchor” and if a large number of investors agree on one such anchor, the anchor ends up being the company’s valuation itself.

To reiterate, value of a company is what the market thinks it’s valued at. Nobody knows what Uber is valued at. Investors and existing shareholders agreed at a particular valuation, and did a deal at that valuation. However, this valuation is not “deep” – not too many people agree to this valuation.

It is in this context that an (very well renowned) academic’s valuation, which values the company at far less than the last transacted price, can act as an anchor. Damodaran is extremely widely respected in investing circles, and hence his valuation is likely to have received much attention. It might even be possible that his valuation becomes an “anchor” in investors’ minds of Uber’s valuation. And this is where the problem lies.

Even if you were to account for the consistent downward bias in Damodaran’s valuations and adjust Uber’s valuation accordingly, it is likely to lead  to a much lower anchor compared to the last transacted price. And this is not likely to be good for existing investors. Hence, they need to take steps to quickly debunk Damodaran’s valuation, to make sure it doesn’t end up as an anchor! And hence the long response by Gurley, and the silicon valley investor community in general!

To summarize, all that this entire brouhaha on Uber’s valuation shows is that its price discovery so far has been rather shallow.

Available only on flipkart

This mornings mint has a full page advertisement on the front page announcing the launch of the moto x phone in India. The ad mentions that the phone is available in India exclusively on flipkart the online retailer. The question is if this is a good idea.

While it is true that online retail offers the best costs and prices – thanks largely in part to the massive savings on real estate and inventory costs, I’m not sure if we are still thee at a stage where retail can be online only. In fact people like to touch and feel the stuff that they’re buying. Especially when it comes to big ticket purchases such as a phone. Without giving people the opportunity to do so – shops won’t carry the dummy model unless they’re also selling it, at a good margin – I’m not sure how many will want to make the jump and buy.

On a related note I saw a report last week, again in mint, talking about pushback from offline retailers and malls to the online retail phenomenon. This brings into focus how retail will evolve going forward since people now have a low cost (low inventory, zero real estate) option for making their purchases. We’re already seeing some “progress” in that direction where people go to malls and high streets to browse and get a touch and feel and then buy online where the prices are lower.

This points to one direction in which retail might evolve – soon stores in malls and high streets might be set up with the primary purpose of building the brand and letting customers get a touch and feel. Any sales from these stores for the brands will only be a bonus – the primary purpose being to let people know what is out there and to let them touch and feel and experience it.

If this were tO happen we can expect malls and high streets to move to more brand stores and less multi brand stores – unless the latter can somehow either match the cost and price structure of online or get paid for purely providing the experience to the customers.

Either ways we can expect the overall demand for retail real estate space to come down in the next few years. If there are any malls or retail real estate firms which are listed its time to short them. Or by hedging against them by going long on online retail.

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Countercyclical business

I realize being a freelance management consultant is countercyclical business. For two years in succession, I’ve had a light March – both years I’ve ended up finishing projects in Jan/Feb. With March being the end of the Indian financial year, most companies are loathe to commit additional spending in March, and it is a bad time to start new projects!

This is counter-cyclical because most other businesses end up having a bumper March, since they have end-of-year targets, and with a short sales cycle, they push their salespersons hard to achieve this target in March!

Is TripAdvisor killing Expedia?

The coming of the internet has led to one round of disintermediation in the travel market, and I hypothesize that review websites such as TripAdvisor are going to lead to another. Let me explain.

In the “good old days” if you wanted to travel there was no option but to reach out to the neighbourhood travel agent who would give you options of a few airlines and hotels. The best you could do to figure out if you were being taken for a ride was to check across multiple agents, but even then the only thing you could compare was price. It was impossible to compare hotels in terms of quality and you would take the word of the travel agent.

And then the internet happened.

Now, with sites such as Expedia or Travelocity, you got more transparency in pricing – especially when it came to airline ticketing. The travel agent could no longer take you for a ride when it came to the air fares – you could cross check online and bypass the agent if he wasn’t offering you a good deal (of course some things such as flexible schedules were best booked via agents, and they continue to hold sway in the corporate segment for that reason). Simultaneously airlines started selling tickets direct, via their own websites (this was led in part by “low cost carriers” who saw this as a good way of saving cost by cutting out agent fees).

This was the  first round of disintermediation in the travel industry. Airlines selling tickets direct and customers being able to book directly online meant the overall business of travel agents reduced. Some of them were cut out completely while others were replaced by large-scale technology enabled agents such as Expedia or Travelocity. Those that survived either have corporate clients (who need flexible schedules and have little time to book online) or have resorted to packages – where they arrange for flights, accommodation and cars, and quote you a consolidated fee – in which there are margins to be made.

The move to large-scale technology-enabled agents meant that some of these agents were now large-scale aggregators. This gave them significant bargaining power vis-a-vis hotels and this allowed them to bargain for deep discounts. While earlier conventional wisdom was that “travel agents” could get you “good deals”, now these large online aggregators were the ones providing the “best deals”. Thus it made eminent sense to book via these aggregators.

Simultaneously most hotels also started direct booking on their own websites. However, the problem was that the hotels themselves did not have the technological capability to implement good revenue management practices on their own websites. They also did not have the technological capability to offer a seamless and smooth booking experience. Thus, large online agents such as booking.com and Agoda prospered.

There are two functions that a travel agent performs – helping customers discover hotels and then actually executing the booking. In the traditional model, agents don’t charge for the discovery process. That service is instead cross-subsidized by the fees they make on the actual booking process. The first level of disintermediation in the travel agency (which we’ve seen above) has chipped away at this model, however. What do I, a travel agent, have to gain if I put in painstaking research and find you a hotel, only for you to find that you can book it for a lower price online? Agents, however, have not figured out a way to charge for the discovery process.

However, it is unlikely that they need to. For you now have websites such as TripAdvisor which have user-generated reviews and ratings for a large number of hotels, and which rank hotels in each city by type and user ratings. TripAdvisor has become so ubiquitous for user-generated ratings for hotels that nowadays travel agents add links to TripAdvisor profiles of hotels that they are recommending. Thus, we can see that the hotel discovery process can exist independently of travel agents.

What of the bookings itself? Don’t we need travel agents for that? Note that irrespective of whether a travel agent is online or offline, the hotel has to pay them a commission for selling their inventory. In the past given their size, hotels (unlike airlines) were unable to effectively sell rooms on their own websites and thus resorted to paying travel agents. However, advances in technology now mean that it is easy for a hotel to adopt a third-party software to effectively manage their inventory and sell tickets on their own website, and at a fraction of the cost they need to pay travel agents.

So, if TripAdvisor helps you discover hotels and then you can book hotels directly through their own websites, who needs travel agents? For now, most large online aggregators have a price matching policy and thus match the prices that hotels quote on their own websites. However, in order to save booking fees (rumoured to be of the order of 17% of the total booking value) hotels are trying to innovate and add freebies to their offering.

For example, a hotel in Cambodia I stayed in last week offered a free massage to guests who had booked through their own website (unfortunately I booked via Agoda and couldn’t avail of this offer). The Bangkok hotel I stayed in last week offered a 10% discount on payments made via American Express on their own website (again we discovered this after we had booked on Agoda, using an AmEx. To their credit, Agoda gave us a refund to the extent of the discount we would have got on the hotel website).

Essentially hotels have figured that with the growing popularity of platforms such as TripAdvisor, they don’t really need travel agents, small or large. As TripAdvisor gets more popular and third party hotel booking softwares gain traction, we are likely to see the decline of large travel aggregators such as Expedia, Travelocity and Agoda.

In essence, the growth of TripAdvisor is going to lead to the partial downfall of its erstwhile parent Expedia.

Differential levels of service

On Wednesday I had to send a package to Mumbai by courier. I walked over to the nearby DTDC office and was told that I had two options – i could pay Rs. 85 for “standard courier” or Rs. 180 for “next day guaranteed delivery”.  I asked the guy at the counter when the courier would be “cleared” (i.e. leave the booking office) and he said “this evening”. Assuming that courier gets sent by flight, it would reach Mumbai the next day, so it made me wonder what would take a courier longer to  reach.

I’m reminded of this famous story of HP (or was it Xerox? Or Epson?) adding an additional component to their printer to slow it down so that they could sell it as an “economy model”. The problem with offering differential levels of service in what is essentially the same product is that you know that the service provider has an incentive to willfully offer mediocre service when you go for the cheaper option.

Let us get back to courier, and assume that it is theoretically possible for DTDC to deliver my courier to Mumbai in a day. Suppose they start delivering most “standard” (Rs. 85) packages the following day, then people will have no incentive to go for the “premium” (Rs. 180) service! Because a “premium” service exists, they actually have an incentive to provide poor service for the “standard” package.

It is a similar case with Indigo’s “fast check in” counter at airports. For Rs. 200 you can skip the lines in the airport and go to a special “fast check in” counter. There is the same conflict of interest there – if the regular check in counters were efficient and there were no long lines, there would be no incentive for anyone to go to the “fast check in” counter. So if Indigo has revenue targets for the fast check in counter, it makes sense for them to make the regular check in more inefficient and create longer lines.

Coming back to DTDC, how is the market likely to react to their premium service? Let’s say that I’m someone who regularly sends couriers (but not regularly enough for me to have a deal with DTDC). I’ve been using the “standard” package so far. Most of my letters arrive in Mumbai the next day but a small number (let’s say 10%) take two days to arrive. Now, DTDC introduces the premium package, but I continue using the standard package. What do I see now? Rather than 90% of the letters arriving the next day, only 10% do, and 90% take longer (in line with DTDC’s revised incentives). It is likely that I’ll either start using the premium service or I’ll move to another operator.

The ostensible reason for DTDC introducing an “overnight guaranteed” courier service is easy to see – earlier, 90% of the packages were arriving in a day, and now they guarantee that it is 100%. The problem, however, is that the company will soon want to target increased sales of this “premium” service, and so will start taking steps to prevent the “standard” service from “cannibalizing” the premium sales.

Tata Sky’s Revenue Management (or the lack of it)

Last week Direct To Home (DTH)  television provider Tata Sky launched a new channel called “Star World Premiere HD”. As the name suggests it is a high definition channel, and it broadcasts TV shows from the United States simultaneously in India (as opposed to the usual lag of about a year before a show goes on air in India). The business case for this channel itself is particularly strong – for people are nowadays unwilling to wait for a TV series’ release in India and instead download it from illegal torrents. The availability of the TV Series now through a legal channel will discourage torrents, and also allow the producers to make some money via selling advertisements.

The problem, though, is with the pricing. With great fanfare, Tata Sky had launched this “Mega Pack” a few years ago, where for a fixed annual fee (of the order of Rs. 6000) you would get all channels for an entire year. Built in to this plan was the promise that any channels launched during the year would be available for free for all Mega Pack subscribers. It was like the subscribers were paying a premium for the option of not having to pay for any newly introduced channels.

For the last few years, this plan has been going well. Numbers are not available publicly but based on a small sample of people I know, I know that the Mega Pack has a large number of subscribers (Disclosure: I too subscribe to this). Given the “bundled pricing” (which is what the Mega Pack essentially is), Tata Sky is making more money than it would have with subscribers picking only the channels they wanted.

Unfortunately their handling of Star World Premiere HD is likely to change this. With this channel, they have reneged on their promise to provide any new channels for free to Mega Pack subscribers and have asked subscribers to pay Rs. 60 per month for the channel. Over the course of the last week, there has been considerable outrage on Twitter about this. There are reports of people (Mega Pack subscribers) calling up the call centre and talking of failed promises and getting the channel for free. There are other reports of subscribers who last updated their Mega Pack after February 1st 2013 getting this channel free for the remainder of their current Mega Pack subscription period. Tata Sky CEO Harit Nagpal has been on Twitter, and has explained that he wasn’t able to offer the channel for free due to some fee arrangements with the broadcaster (Star TV India). In all, the entire handling of the launch of this new channel has been a mess.

So far, there has been a cozy relationship between Tata Sky and Mega Pack subscribers. Subscribers pay up once a year, no questions asked. In return, they get all channels for free. So far, the renewal process has been fairly mindless – given the seamless experience customers are renewing without much thought.

What this mis-handling of the Star World Premiere HD launch by Tata Sky will do is to get the customers thinking. With this one breakage of promise on the part of the distributor, customers whose Mega Packs come up for renewal will soon start asking themselves if Tata Sky will not renege on their promise with respect to other channels also. While porting across DTH operators is still not easy, what is likely to happen is that customers will critically evaluate whether they need all the channels they are paying for, and opt for a package which only includes channels they need (after a regulatory change last year, all channels have to be offered a la carte).

In short, Tata Sky’s mishandling of this episode is likely to reduce the number of their Mega Pack subscribers, and thus a decrease in their overall revenue. The additional amount they are charging for Star World Premiere HD is Rs. 720 per subscriber per year. The price gap between the price of a Mega Pack and any other pack is much more than that. In short, it has been a process of extremely bad revenue management by Tata Sky.

PS: We would be interested in offering revenue management consulting to Tata Sky or any of its competitors. If you are from any of these companies, get in touch with us through the contact form in the Contact page.

Cartels, good and bad

This post is about two professional cartels in India, and why one is better than the other. The “better” cartel is the Institute of Chartered Accountants of India (ICAI). The “worse” is the Medical Council of India (MCI). As the names suggest, they regulate the profession of chartered accountants and doctors respectively. And the way the former works is better than the latter.

First of all, let me convince you that these two are cartels. The basic concept is that in order to practice as a Chartered Accountant in India, you need certification from the ICAI. And who does the ICAI consist of? Other CAs. So it is nothing but a trade guild, which tries to control who gets to join the guild. It is a similar case with the MCI and doctors. Doctors trying to control who else can be doctors. As the more perceptive of you might have figured out, it is in the interest of both these guilds to not admit too many new members, since that would lead to supply of their profession to a level that significantly affects profit margins for the incumbents.

Now that we have established why these two are cartels, and that they both have an interest in restricting membership, let us see how they go about the process.

The ICAI follows what can be described as “exit level testing”. There are no restrictions on anyone wanting to be a CA – all you need is a high school (12th standard) degree with mathematics as one of your subjects. They have three levels of examination – “basic”, “intermediate” and “final”, and one needs to clear all of these in order to become a member of the guild. And how does the guild control membership? By making these examinations super-tough, so that only a select few pass these exams every year. There are several “CA institutes” who train students for these examinations. And there is no restriction (AFAIK) on anyone opening one such institute.

The MCI does it differently. Anyone with a recognized degree in medicine is automatically a member of the MCI. They regulate the numbers instead by controlling the number of medical colleges, so that only a select few can even aspire to get into the MCI. More importantly, the entry to medical colleges is not strictly on “merit” – colleges are free to allocate a certain portion of the seats on discretion, and they do so based on recommendations, donations, etc. I’m not really saying any of this is wrong. Just describing the situation as it is. However, when you combine this with the fact that an entry into a medical college guarantees membership of the MCI (provided you pass your college exams, which shouldn’t be too hard), it effectively means that you can buy your way into the MCI.

Actually, thinking about it, this option of creating additional membership of the MCI “upon payment” is a masterstroke by that guild. The concept is that when people pay large sums of money to gain entry, they are not going to be in a hurry to look to slash profit margins (key here is the fact that the amount of work a doctor can do is constrained by his/her time, so doctors cannot play  the “volume game”). So the pricing of these seats ensure additional revenue for the MCI and their constituent colleges, while not compromising on the members’ margins.

Note, however, that it is not possible to buy your way into the ICAI. Yes, aspiring members who seeks to buy their way in might buy “training” and “apprenticeship” under the best CAs who are members of the cartel, but still, to get a membership they need to pass the examination, which is not easy at all. Contrast this with the MCI where either money or the right connections get you straight in.

I’m not saying that the ICAI is a wonderful guild. Cases such as the Price Waterhouse – Satyam case or the Deloitte-FTIL case have shown that the profession is deeply flawed, and doesn’t regulate itself adequately. All I’m saying that the entry criteria it uses, as opposed to the one used by the MCI, ensures a higher quality in terms of the ability of its members.

As for me, I’m happy that I’m involved in a profession (or professions) that don’t need any certification or guild membership.

Coase

In the wake of the passing of Ronald Coase, two incidents, both professional. The first was with an established company to whom I suggested a partnership – they are in a space where I don’t have much skill, but have access to companies who I would love to sell to, and they don’t have my skill and our skills are complementary. So I reached out to them (through common contacts) suggesting that we could work together. They came back to me saying they would love to work with me, but would want me to join them as an employee.

The second was an incoming lead. This was a rather small company doing something similar to what I’m doing but with bigger ideas. They want me to join this “innovation hub” they are trying to create. This is a loose federation they are creating including professionals from various fields. Nobody is obliged to work full time for the hub, but this gives people an opportunity to get together and work together on projects where their respective expertise can combine well.

As the more perceptive of you who would have read every Coase obituary in the last two weeks would have figured out, the piece of work that Coase is most well known for is about the theory of the firm. The question is rather simple – why should you and I get together and form a firm if we have to work together, if we can remain independent and just come together for projects. The answer lies in transaction costs.

The advantage of coming together as a firm is that you negotiate only once. Let us suppose you are a graphic designer and I’m a data scientist. If we decide to work together on a visualization project, how do we decide how much you get and how much I get? We will need to negotiate. Let’s say we negotiate and agree on a price. And complete a project and split the spoils. What would happen the next time we were to bid for a project? We will need to negotiate again on how we will share the spoils.

If on the other hand we were to form a partnership firm, then for every project that we do, our respective share is fixed! Thus we don’t have to negotiate before every single projects. Thus, firms exist so that you don’t have to repeatedly negotiate.

However, there is a downside to this. What if I form a firm with a graphic designer, and then we see a significant opportunity in projects that involve a lot of analysis but little visualization? In that case, I have no use of my partner, and would loathe to pay him his share of the profits. Or consider if I were to somehow become much better at my job, while my partner stagnates. There is little I can do, for we’ve been locked in into the financial arrangement.

These are only some of the complications that arise when you need to decide whether you want to become a firm. I just thought it is pertinent that I’m having some of these dilemmas (employee versus consultant versus partner versus member of federation) in the few weeks after Coase’s passing.