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The End of an Age

Survival in the new market requires embracing new technologies and practices.

Fortnightly Magazine - April 2014
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Then Elrond and Galadriel rode on;

for the Third Age was over and

the Days of the Rings were passed

and an end was come of the story and song of those times.

- J.R.R.Tolkien, The Return of the King

 

The age of the "natural monopoly" is over.

Changes in technology and the economic environment dictate that our industry, once considered as a natural monopoly, is transitioning to a disaggregated group of entities operating across all segments of the supply market for electricity. Those who don't embrace this transition and seek to understand the forces and reasons underlying it will fail.

Ronald Coase was a Nobel Prize winning University of Chicago economist. In 1937, in his book, The Nature of the Firm, Coase first asked the question "Why are there firms?" and then asked, "Why are they so large?" Coase pointed out that various tasks such as design, payroll and accounting (performed to complete any process) had costs associated with them. He noted that in most cases these transaction costs were cheaper to do internally than externally. For instance in 1940 it would've made little sense for a firm to outsource its payroll as manual entries would need to be carried over to the payroll firm and the payroll checks carried back. Coase postulated that, with respect to any individual task, "a firm will tend to expand until the costs of organizing an extra transaction within the

firm become equal to the costs of carrying out the same transaction by means of an exchange on the open market..." Coase's early insight is fundamental to the rise of firms the size of GM and U.S. Steel in only a few decades. Coase also pointed out that bureaucracy costs grow in concert with the size of the firm. As a result, the firm would be unable to react to change efficiently and bureaucracy costs could override lower internal transaction costs.

For years the Coase theorem foretold the creation of larger and larger utilities, as large utilities were able to do tasks cheaper internally as they obtained economies of scale. Further regulatory policy closely followed Coase in designating utilities as "natural monopolies," entities where it's most efficient (lowest long-run average cost) for production to be concentrated in a single firm. Alfred Kahn for instance described a natural monopoly as one where "One company can serve any given number of subscribers ... at lower cost than two."

In many cases it's no longer cheaper to do a task internally, primarily due to advances in technology. Coase would then predict that firms would outsource the task and shrink in size. Alternatively, outside competitors, being able to perform tasks cheaper

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