AI Is Transforming the Nature of the Firm

To truly understand business strategy, you have to accept that it is, by nature, bullshit. Of course, the practice of guiding a business, making choices with trade-offs, and responding to unexpected crises is real. But the academic study of business strategy is something closer to divination.

You may have heard of such famous frameworks as disruptive innovation, blue ocean, or Porter’s five forces. They look smart, sound smart, and are frequently cited by writers like myself. They try to add structure to something innately chaotic and mysterious.

So, why are they bullshit? Simple. The value of a forecasting method is in its ability to be right, not sound right. Despite decades of study and the relentless efforts of the good people over at the Harvard Business School, we have yet to discover any strategy that is universally predictive. 

This does not mean that the study of business strategy has no value. Counterintuitively, because no single theory is wholly predictive, you can bundle multiple theories together to generate differentiated insights. Strategy is not business physics—it's analytic art. 

When the world gets confusing—say, for example, AI is remaking the entire technology landscape—these frameworks can inform the choices you need to make. The better you know these theories, the more instinctual their lessons become, the more prepared your intellect is, the faster you’ll be able to react to new opportunities in front of you. And when change is happening fast (like it is right now), speed is one of the biggest advantages.

Can you answer the big questions about what AI means for computers and the internet in general? With the proper study of business strategy, you should be able to make a pretty good guess.

Today I’d like to explain what I consider one of the very first pieces of business strategy writing, from 1936. Despite being 88 years old, it can help us answer some of those questions about the nature of companies, what they chose to outsource, and how they interact with each other.

The foundation of business strategy 

Our current AI conundrum would not have been a surprise to British economist Ronald Coase. At age 26, he published his legendary essay, "The Nature of the Firm." Coase grapples with a fundamental problem: If the market is efficient, shouldn’t it be cheaper for a firm to outsource the majority of its internal activities to specialized contractors? Markets typically reward specialized labor that can focus on performing one task better than anyone else. At its most elemental, Coase is trying to understand the relative merits of integration (i.e., a company makes all the stuff that goes into its products, like Tesla making many of the components of its cars) versus modularization (a company that uses off-the-shelf components like IBM).

Coase's major insight on this topic was to focus on transaction costs, which are the costs associated with using the market for production and exchange.