In an article for The New York Times, columnist Farhad Manjoo worries that the Uber model of app-based service companies has run its course. He points out that in a lot of cases the room for extra efficiency was small and that initial pricing models were distorted by venture capital funding, leading to customer-deterring higher prices. He concludes, “The lesson so far in the on-demand world is that Uber is the exception, not the norm. Uber, but for Uber—and not much else.”
This is, however, a very narrow view of the sharing economy, which is much more than the Uber model. It should in fact be called the Transaction Costs Economy, as what Uber did—and the other on-demand apps Manjoo talks about have so far failed to do—is to cut the transaction costs of finding a service in the market and the opportunity cost of using it. Here, of course, we’ll have to discuss what I mean by those two economic terms of art.
A transaction cost, a term first used by Nobel laureate economist Ronald Coase, is basically the cost of finding a supplier for a service I want to buy in the open market in order to make the transaction. So, if I want to find a carpenter to make a table leg, I will need to research the local market of carpenters, find one, research enough to make sure that she is reputable, negotiate a price with her, arrange a suitable timeframe for delivery, arrange for delivery, arrange for payment, and (potentially) incur legal costs if the job isn’t up to snuff or the job is never done at all. That’s a lot of considerations that go into one transaction. Coase’s great insight was that entrepreneurs employ people in firms to reduce these transaction costs to one employment contract when a job has to be done repeatedly.
Opportunity costs, on the other hand, are the value of things I could be doing with my time other than, in this case, engaging in the transaction. Rather than going through all of this business to get a new table leg, I could actually be earning money, or doing something else I value more, like binge-watching the new season of “Daredevil.” So if opportunity costs are high enough, I will choose not to do it and my table will continue to wobble.
What Uber did with ridesharing was to reduce the transaction cost of finding someone willing to offer a low-cost ride below the opportunity cost of standing on a street corner trying to hail a cab (which is what most ridesharers would be doing otherwise) or, increasingly, the opportunity costs of having a car parked nearby (people started using automobiles in the first place at least partly because there were significant opportunity costs involved in using public transport).
“On demand” apps like the ones Manjoo critiques concentrate on the opportunity cost aspect of the economic equation. People like them because they can get the service at one press of a smartphone screen. The transaction costs, however, remain high—all Luxe, for example, is doing, it seems, is getting someone else to bear those costs for you in finding a parking space and taking your car there. And if it doesn’t work out well, the opportunity cost to the customer goes up.
The sharing economy, therefore, is about finding ways to ensure these costs fall. The Uber model isn’t the only way to do that. Other ways include:
- Reducing payment costs. Many transactions don’t happen because payment costs are too high, either for the payer or the recipient or both. Systems like Bitcoin that reduce payment aspect of transaction costs can help these transactions happen.
- Creating two-sided markets. Many sharing economy firms don’t employ people (although unions would love that to be the case) – they put suppliers in touch with people who want their services who would otherwise have to take too long to find them.
- Generating trust. Transactions often don’t take place because people can’t be sure that they can trust the person supplying them, and the necessary research raises costs too much. Sharing economy firms that add feedback systems help provide this trust. It should be noted that a lot of regulation, including occupational licensing, has been imposed ostensibly to help solve this problem, but all it has done is replaced the trust transaction costs with regulatory costs.
- Providing proof of transaction. As noted above, legal costs involved with disputes over whether or not a transaction has occurred satisfactorily are part of transaction costs. New institutions like the blockchain and smart contracts can solve this problem and reduce these costs to zero.
As can be seen, there is a lot more to the new digital economy than the “on demand” nature of many platforms. The real threat to this economy is not that it doesn’t live up to its promise—there is trial and error in every innovative space—but that regulators might gum up the works by trying to solve problems these innovations can solve.