Elephants and Fleas and Employment Contracts

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Employees and ContractorsHave you ever thought why it is that a firm comes about?  Why is it that a firm exists at all?  And indeed if Charles Handy’s projections become truths, how it is that the firm will exist in the future? It’s a lot about employment contracts. Expanding Handy’s discussion, it’s all about Elephants, flees and employment contracts.

Handy describes in The Elephant and the Flea, how it is that many of us have now become fleas – micro-firms with no employees – just the principal.  That principal sells his or her portfolio of services to elephants – larger firms engaged in a more traditional market.
Handy’s world is a return to the cottage industries of the pre-industrial revolution.  It’s a world substantially enabled today by technology and the possibility of home working.

And if UK national statistics are anywhere near correct, something like 20% of us work as fleas.

So how did the SME or larger firm arise?

Market Transaction

Firms transact business using the market.  In a world of cottage industries, people could likewise transact business with firms and with those businessmen and women (entrepreneurs) who coordinate activities to provide saleable goods and services to the public and to the elephants.  But for an entrepreneur to make or supply something of substance there’s a huge overhead in completing all these negotiations with maybe thousands of fleas.  Ronald Coase suggested in 1937[1] that this situation carried with it transaction costs (not least in time) and that the firm is a reaction to reduce these costs.  And the result is that at some point it’s worthwhile for those entrepreneurs to reach a different form of contract with the fleas – a longer term contract and a lower cost contract in which the exact nature of the services provided are only loosely defined.

As Coase notes, “the essence of the (employment) contract is that it should only state the limits to the powers of the (employing) entrepreneur”.

Employment Contracts

And so the employment contract was born: a longer term contract that defines what the employee will do in broad terms rather than defining the nature of the products or services that a cottage worker should deliver.

Coase went on to illustrate that it is of course always possible to return to the free market for supply of what is otherwise provided by ‘employees’.  If the factors of production (like skills and knowledge) can be obtained at a lower price on the open market, the situation can revert.  He called this the firm’s “make or buy decision”.  Firms are now encountering this situation and so we see a small but significant return to the cottage industry and the new order of the fleas.

Elephants, Flees and Employment Contracts

For a host of reasons, the firm needs those long term contracts.    The future firm will therefore comprise permanent employees under employment contracts with whom the firm will build a trust-based relationship and more loosely connected workers under business-to-business contracts.  The core employees will have the key skills, knowledge and values needed for the future development of the firm.  The more loosely connected workers in sub-contract small firms or micro-businesses will add specialist skills or relatively low cost effort.

And so the future will be a harmony between elephants and fleas.

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[1] Coase, R. H. (1937). The Nature of the Firm. Economica, 4(16), 386-404.

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