Fred Wilson recently wrote about the declining power of firms. Fred argues that the internet has reduced the costs of transacting with a market so significantly that the nature of firms (as outline by Ronald Coase) must change as well. I totally agree with this argument on an intuitive level. I see this trend coming.

However, as firms break into smaller pieces (or as small companies disrupt and displace large firms) what will happen to the the power of brands?

The power of brands was recently reinforced for me by a friend of mine from Stanford, Brendan O’Conner. Brendan ran an empirical test on search engine relevance. He compared the relevance of search results from Ask, Google, Yahoo, and Live by running real-world, common queries on all the engines and had subjects rate the relevance of the top five results. His methodology is spelled out in painstaking detail, so I won’t elaborate on it, but it definitely passed my sniff test. It’s important to note that branding was stripped from the results returned.

Brendan found that Google, Live, and Yahoo all performed equally well (within a margin of error) and only Ask had inferior search results relevance. Yet, this outcome is counter-intuitive, because so often you hear people say anecdotally that Google provides the best search results (thus justifying Google’s overwhelming lead in search share). So, why is Google so over-hyped? I would argue it’s because of the value of the Google brand.

Brand value is still very important online. Brand value is the reason why I only trust PayPal will my bank account data (instead of… Neteller, EasyCharge, AlertPay, etc…). I know that the PayPal’s (and eBay’s) brand, reputation, and market cap is on the line when I use PayPal. They have far more to lose if they screw up a transaction or expose my private data, and so I (perhaps naively) trust they will handle my account information with the utmost care.

Similarly, I think Google search results are the best because I associate their brand with great usability and user experience design. By contrast, I think of Live or Yahoo as a roach motels… sites designed with stickiness in mind that make me less efficient. That’s why I use Google every time.

So, returning to my original point, what happens to brands when firms fraction due to the lower transactional costs of marketplaces? Will high-value brands hold a firm together that might otherwise break apart? Or will brands become more niche (in other words, will I trust a greater number of brands to service a wider array of services)? I think brand value is a cost of engaging in a marketplace that will give large firms (with high brand equity) an edge over smaller companies.