Make , Buy , or Cooperate ?

In 1937, Ronald Coase argued that firms will exist only in environments in which firms perform better than markets could. To create space for firms, Coase suggested that some environments might be plagued by “transaction costs” that cause markets to perform poorly. Coase’s paper was to become the cornerstone of the economic theory of the firm (i.e., the “make or buy” decision: which activities should be conducted within firms and which between?), but for several decades the paper lay fallow. Finally, in 1975, Oliver Williamson significantly deepened Coase’s argument by suggesting both why markets might perform poorly and why firms might perform better than markets. Roughly, Williamson argued that markets rely on formal contracts (i.e., those enforceable by a court), whereas firms might use “relational contracts” (i.e., informal agreements not adjudicated by courts) to overcome some of the difficulties with formal contracts.