Digital revolution in business relations (part 2)

Transaction and resource

Ronald Coase defines the nature of firm through two elements - resource and transaction. Resource is a source of the function of this resource (i.e. food satisfies hunger- it is its function). Connection of the resource with other resources is ensured by transactions.

As for the resource, its basic characteristic is the temporality of functionality. The functionality of the resource may decrease (food may end), but also may increase (such as skills and competence of specialists). Functionality of the resource may depend on transactions, i.e. it can depend on a combination of neighbouring resources in the system, development and change. Shortly speaking, when we talk about resources it is important to keep in mind the temporality of functionality, as well as the dependence of the resource’s functionality on the transaction system in which they are included (the same functions in different labor division systems work with varying degree of efficiency).

Transaction involves at least two parties, who negotiate about terms of the transferring value from one side to another. In addition, there is a party certifying the fact of the transitioning this value. Namely existing legal institutions play the role of a third party. In the world of blockchain and smart contracts the third parties are the ones stated in smart contracts or a community that at any time can look at the terms of the transaction.

Actually, through transactions firm includes various resources in such combinations. And as a result, being a part of these combinations, they work much faster and more efficient than others.

If it is so, then it becomes obvious that it is possible to create such counting of transactions that would take into account only these elements - the functionality of the resource, the temporality of this functionality and the transactions that manage interaction of this resource with other functions.

Why do we need this?

Let us consider the typical problem of a modern firm on the example of production. You have a machine line, production sites (in our terminology - resources with their functionality) are included in certain technological connections. As it often happens lately, market requires not the mass production of minimal assortment, but small consignments of goods of a wide range. And what often happens is that you constantly have to rebuild technological links between production sites. To save business profitability, you need to constantly reconstruct connections between machines and production sites. This can be done if you understand in general which orders should be fulfilled, their priorities and time of performance. Then using the simplest methods of linear programming you can figure out how to make production sites work the best way and allocate workload of each machine and production site.

Linear programming through transaction system is the solution to a problem of overload work of production resources.

And now just imagine to yourself that production sites are firms that perform a specific function. At this very moment, coordination of their activities is in no particular order: one of these firms is looking for and doesn’t find its neighbours along the production chain, others can’t prepare production capacities on time. The main thing is that it takes an enormous amount of time and efforts of marketing specialists, sales managers, lawyers, financiers, etc. in order to plug activity of production functions of firms in a single chain. And all this is called transactional costs.

The use of transaction and resources counts in constructing value's chain of several firms and radically reduces these transaction costs.


Transaction costs

In economies where overproduction becomes an everyday phenomenon, transaction costs become the main problem. There are different researches showing that the scale of transaction costs in the modern economy reaches 30% or more.

What are the transaction costs and how can they be reduced?

Ronald Coase defined transaction costs as following: transaction costs are the costs that emerge with contracting (including the use of market mechanisms); costs that are a part of economic agent’s relations.

Transaction costs can usually be divided into following categories:

• costs of collecting and processing information,

• costs of negotiating and decision-making,

• control costs,

• costs of legal protection of the contract fulfilment.

I would also add to them various costs of deception - the costs of internal theft, kickbacks, corruption, mislead of the counter-party about prices and so on. Costs of money-movement can also be considered as a transactional cost, namely bank commissions, loss of time for financial transactions between banks, etc.

Reduction of them is the aim of numerous blockchain projects and our project in particular.

A system without transaction costs

Let’s imagine an ideal system of business transactions where transactional costs tend to zero, where you are an owner of assets as well as of your professional competencies and you are interested in your assets to be constantly utilized and always bring you money.

Your firm can consist of several assets (sales department, production department, department of supply, etc.), united in a certain configuration of a business model. They can be considered as assets, because we can withdraw them from a firm and turn into an independent firm. If you look at your business from this angle, it turns out that your firm is focusing on features of relations between various relatively autonomous assets. In that case the specificity of the links between assets determines the production of products and services more efficiently than in the subsistence farming. But this is only on one hand. On the other hand, as the owner of assets you are focused on the constant maximum exploit of assets and earning profits from it. But configuration of your assets within business model depends on the role of your assets in the value chain, distributed along the chain of firms. The business model is not just a result of your creativity, it is built on accurate economic calculations in accordance with the requirements of the production network into which your firm is incorporated to. Once there is a demand for a certain kind of products and services on the market, all participants of network receive a proposal for an optimal configuration of network of existing assets. Also you receive smart contracts that only need to be signed, they include precise production targets for each firm or its asset. In contracts are the mechanisms for profit sharing of the entire network interaction between owners of production assets that are included in the networks. Smart contracts note your current workload, as well as your plans. Some of the long-term contracts are generally performed automatically (separate smart contracts are automatically concluded between machines and production units).

What else can you do, besides the control of quality of your assets?

  1.  You can develop assets; invent ways to reduce the cost on producing a useful function of your asset.
  2.  You can generate brand new products by your company, already being aware of what functionality of your assets will be in demand. But how will you know which functionality of assets will be in demand? The answer is simple: from the agreed (also under smart contracts) plans to develop technology production of goods and services within network of firms.
  3.  You can search goods for orders produced by the whole network. As a reward for this, you get a trade commission and the priority in using your assets in case of a large choice. But in general, it all depends on your arrangements with other participants in the network.
  4.  Within the whole network, you can implement innovations throughout the entire asset network.
  5.  You can make new assets as a combination of already existing and new ones. The purpose of creating new assets is to produce new useful functions or to produce old ones, but at a lower cost.
  6.  You can also invest in new projects (i.e. new networks of function’s production and new transactions between them).

There is no commission for mutual settlements between the owners of assets. Platform takes the commission only as a percentage of what the whole network earns from the outside.

The platform constantly monitors the effectiveness of both individual assets and the relations between them, finds better solutions and better experience, and invites you to cooperate with the new projects that are based on best practices. Ways of communication which have already proved its reliability are used together with smart contracts that involve you to get commission for the found optimal solution (in any case commission is less than reduced costs and savings).

System is decentralized and it means that at the entry point of the network there are many sellers who launch process of combining various production assets.

We should also remember about participants’ projects of the platform.


What prevented us from building such a system before?

There have already been attempts to build systems like this. One of them is “Project Cybersyn” based on a network of telex machines (Cybernet) by Stafford Beer from Chile and “OGAS” - a Soviet project by Victor Glushkov to create a nationwide information network. But first of all these projects were not implemented and secondly they assumed austerity, centralization and planned economy. Which means they neither took into consideration nor based requirements for reliability that the market economy would do. However these projects viewed as an attempt to build new type of structure are of a great interest.

The following reasons can be named to explain why similar systems haven’t been built previously:

• Lack of a public mechanism for making domestic, alternative payments - banks were mediators as well as barriers to information flow.

• Paper-based workflow, legal nature of documentation rather than informational (to use document information for production purposes was impossible- firstly, due to the fact of the very legal nature of these documents, and secondly, all information was on paper).

• Heavy administrative structures verifying agreements (courts, lawyers, etc.).

• Lack of link research regarding functions of firm and economy – namely, no connections between macro and microeconomics and highly peculiar view on firm and economy. As a result, economy was seen as a set of random operating firms.

• To collect information about real productivity and effectiveness of firms is a difficult matter. It is so due to the relatively weak computer processing ability and inability to collect necessary data. And also due to the fact that firms considered this information as a part of their competitive advantages and therefore did not wish to disclose it.

What has happened in the world now? Why do we think it is possible to build such system in today’s realities?


To be followed…

Article by Andrey Miroshnichenko, Translated by Elena Krasovskaya.


Digital revolution in business relations  (part 1)