The Real Reason Microsoft Bought Nokia. Transaction Costs

As we all digest the news that Microsoft MSFT -0.27% is buying Nokia NOK -2.19%‘s handset division there’s increasing evidence of what actually drove the decision. And remarkably it’s all best described in the terms invented by the recently deceased Nobel Laureate in economics, Ronald Coase. It’s all about transaction costs, you see?

Here’s something from one of the Microsoft managers:

Nokia and Microsoft worked closely together on the company’s Lumia 1020, and Microsoft made core changes to its Windows Phone operating system as a result. Sources familiar with Microsoft’s Windows Phone work have revealed to The Verge that Nokia was left frustrated by some Windows Phone restrictions on its Lumia 1020 camera software. Specifically, the restrictions made it difficult to store the large image files and make them easily accessible to phone owners.

These secrets secrets and frustrations will no longer occur, and the collaboration appears to have helped Microsoft realize its priorities elsewhere. A Bluetooth file sharing feature is particular popular in developing countries, but Microsoft wasn’t aware as US consumers don’t typically use it. “We didn’t even have that feature, and we didn’t even understand or appreciate the degree to which it was critical,” says Belfiore.

And here’s a piece discussing Coase and thosetransaction costs:

“I found the answer,” Coase recalled in his 1991 Nobel lecture, “by the summer of 1932. It was to realise that there were costs of using the pricing mechanism… There are negotiations to be undertaken, contracts have to be drawn up, inspections have to be made, arrangements have to be made to settle disputes and so on. These costs have come to be known as transaction costs. Their existence implies that methods of co-ordination alternative to the market, which are themselves costly and in various ways imperfect, may nonetheless be preferable to relying on the pricing mechanism, the only method of co-ordination normally analysed by economists.”

It sounds simple, but it was a groundbreaking insight because it explained why, for example, companies often became vertically integrated as they grew. Transaction costs are why a manufacturer of car tyres would come to own and operate rubber plantations in some fetid tropical country; not because its executives want to farm rubber, but because the transaction costs of not owning the supplier are higher than the costs of operating it themselves.

While Microsoft and Nokia were working closely together on the hardware and software for their phones they weren’t working together closely enough. Those pesky transaction costs getting in the way there. Thus the bet that by being owned by the same company those costs will be reduced and thus better phones will be made.

Well, it could work but I do wonder myself. For as another Nobel Laureate, Hayek, pointed out, all knowledge is local. So if the combined firm is managed from Redmond then there’s going to be a certain loss of that knowledge as it does or does not get transmitted up the managerial pecking order. Those Coasean reasons for the merger could indeed work out but only if the management and design work stays sufficiently local to the knowledge base.


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