Transaction Cost Theory
Transaction Cost Theory
Transaction Cost Theory
A THEORY ACCOUNTING FOR THE ACTUAL COST OF OUTSOURCING PRODUCTION OF PRODUCTS OR SERVICES INCLUDING TRANSACTION COSTS, CONTRACTING COSTS, COORDINATION COSTS, AND SEARCH COSTS. THE INCLUSION OF ALL COSTS ARE CONSIDERED WHEN MAKING A DECISION AND NOT JUST THE MARKET PRICES. ESSENTIALLY THIS THEORY ILLUSTRATES THE MAKE VERSUS BUY DECISION FOR
OVERVIEW
> DEVELOPED BY RONALD COASE IN 1932 AS PART OF A LECTURE GIVEN TO STUDENTS AT THE SCHOOL OF ECONOMICS AND COMMERCE IN DUNDEE, SCOTLAND, THEN TURNED INTO A PAPER TITLED, "THE NATURE OF THE FIRM. AT ITS CORE IS THIS NOTION: WHEN A COMPANY TRIES TO DETERMINE WHETHER TO OUTSOURCE OR TO PRODUCE GOODS OR SERVICES ON ITS OWN, MARKET PRICES AREN'T THE SOLE FACTOR. THERE ARE ALSO SIGNIFICANT TRANSACTION COSTS, SEARCH COSTS, CONTRACTING COSTS AND COORDINATION COSTS. THOSE COSTS FREQUENTLY DETERMINE WHETHER A COMPANY USES INTERNAL OR EXTERNAL RESOURCES FOR PRODUCTS OR SERVICES. THIS IS THE ESSENCE OF THE MAKE-VS.-BUY DECISION. > TCT HAS BEEN DEVELOPED TO FACILITATE AN ANALYSIS OF THE COMPARATIVE COSTS OF PLANNING, ADAP- TING, AND MONITORING TASK COMPLETION UNDER ALTERNATIVE GOVERNANCE STRUCTURES. THE UNIT OF ANALYSIS IN TCT IS A TRANSACTION, WHICH OCCURS WHEN A GOOD OR SERVICE IS TRANSFERRED ACROSS A TECHNOLOGICALLY SEPARATE INTERFACE. TRANSACTIONS COSTS ARISE FOR EX ANTE REASONS (DRAFTING, NEGOTIATING, AND SAFEGUARDING AGREEMENTS BETWEEN THE PARTIES TO A TRANSACTION) AND EX POST REASONS (MALADAPTION, HAGGLING, ESTABLISHMENT, OPERATIONAL, AND BONDING COSTS). DECISION-MAKERS MUST WEIGH UP THE PRODUCTION AND TRANSACTION COSTS ASSOCI- ATED WITH EXECUTING A TRANSACTION WITHIN THEIR FIRMS (INSOURCING) VERSUS THE PRODUCTION AND TRANS- ACTION COSTS ASSOCIATED WITH EXECUTING THE TRANSACTION IN THE MARKET (OUTSOURCING). IF THEY CHOOSE TO
THE MODEL SHOWS INSTITUTIONS AND MARKET AS A POSSIBLE FORM OF ORGANIZATION TO COORDINATE ECONOMIC TRANSACTIONS. WHEN THE EXTERNAL TRANSACTION COSTS ARE HIGHER THAN THE INTERNAL TRANSACTION COSTS, THE COMPANY WILL GROW. IF THE INTERNAL TRANSACTION COSTS ARE HIGHER THAN THE EXTERNAL TRANSACTION COSTS THE COMPANY WILL BE DOWNSIZED BY OUTSOURCING.
IN ECONOMICS AND RELATED DISCIPLINES, A TRANSACTION COST IS A COST INCURRED IN MAKING AN ECONOMIC EXCHANGE (RESTATED: THE COST OF PARTICIPATING IN A MARKET). FOR EXAMPLE, MOST PEOPLE, WHEN BUYING OR SELLING A STOCK, MUST PAY A COMMISSION TO THEIR BROKER; THAT COMMISSION IS A TRANSACTION COST OF DOING THE STOCK DEAL. OR CONSIDER BUYING A SPATULA FROM A STORE; TO PURCHASE THE SPATULA, YOUR COSTS WILL BE NOT ONLY THE PRICE OF THE SPATULA ITSELF, BUT ALSO THE ENERGY AND EFFORT IT REQUIRES TO FIND OUT WHICH OF THE VARIOUS SPATULA PRODUCTS YOU PREFER, WHERE TO GET THEM AND AT WHAT PRICE, THE COST OF TRAVELING FROM YOUR HOUSE TO THE STORE AND BACK, THE TIME WAITING IN LINE, AND THE EFFORT OF THE PAYING ITSELF; THE COSTS ABOVE AND BEYOND THE COST OF THE SPATULA ARE THE TRANSACTION COSTS. WHEN RATIONALLY EVALUATING A POTENTIAL TRANSACTION, IT IS IMPORTANT TO CONSIDER TRANSACTION COSTS THAT MIGHT PROVE SIGNIFICANT.
TRANSACTION COSTS HAVE COME TO BE KNOWN BY PARTICULAR NAMES: SEARCH AND INFORMATION COSTS ARE COSTS SUCH AS THOSE INCURRED IN DETERMINING THAT THE REQUIRED GOOD IS AVAILABLE ON THE MARKET, WHICH HAS THE LOWEST PRICE, ETC. BARGAINING COSTS ARE THE COSTS REQUIRED TO COME TO AN ACCEPTABLE AGREEMENT WITH THE OTHER PARTY TO THE TRANSACTION, DRAWING UP AN APPROPRIATE CONTRACT AND SO ON. IN GAME THEORY THIS IS ANALYZED FOR INSTANCE IN THE GAME OF CHICKEN. ON ASSET MARKETS AND IN MARKET MICROSTRUCTURE, THE TRANSACTION COST IS SOME FUNCTION OF THE DISTANCE BETWEEN THE BID AND ASK. POLICING AND ENFORCEMENT COSTS ARE THE COSTS OF MAKING SURE THE OTHER PARTY STICKS TO THE TERMS OF THE CONTRACT, AND TAKING APPROPRIATE ACTION (OFTEN THROUGH THE LEGAL SYSTEM) IF THIS TURNS OUT NOT TO BE THE CASE
RONALD COASE SET OUT HIS TRANSACTION COST THEORY OF THE FIRM IN 1937, MAKING IT ONE OF THE FIRST (NEO-CLASSICAL) ATTEMPTS TO DEFINE THE FIRM THEORETICALLY IN RELATION TO THE MARKET. ONE ASPECT OF ITS 'NEOCLASSICISM' LIES IN PRESENTING AN EXPLANATION OF THE FIRM CONSISTENT WITH CONSTANT RETURNS TO SCALE, RATHER THAN RELYING ON INCREASING RETURNS TO SCALE. ANOTHER IS IN DEFINING A FIRM IN A MANNER WHICH IS BOTH REALISTIC AND COMPATIBLE WITH THE IDEA OF SUBSTITUTION AT THE MARGIN, SO INSTRUMENTS OF CONVENTIONAL ECONOMIC ANALYSIS APPLY. HE NOTES THAT A FIRMS INTERACTIONS WITH THE MARKET MAY NOT BE UNDER ITS CONTROL (FOR INSTANCE BECAUSE OF SALES TAXES), BUT ITS INTERNAL ALLOCATION OF RESOURCES ARE: WITHIN A FIRM, MARKET TRANSACTIONS ARE ELIMINATED AND IN PLACE OF THE COMPLICATED MARKET STRUCTURE WITH EXCHANGE TRANSACTIONS IS SUBSTITUTED THE ENTREPRENEUR WHO DIRECTS PRODUCTION. HE ASKS WHY ALTERNATIVE METHODS OF PRODUCTION (SUCH AS THE PRICE MECHANISM AND ECONOMIC PLANNING), COULD NOT EITHER ACHIEVE ALL PRODUCTION, SO THAT EITHER FIRMS USE INTERNAL PRICES FOR ALL THEIR PRODUCTION, OR ONE BIG FIRM RUNS THE ENTIRE ECONOMY. COASE BEGINS FROM THE STANDPOINT THAT MARKETS COULD IN THEORY CARRY OUT ALL PRODUCTION, AND THAT WHAT NEEDS TO BE EXPLAINED IS THE EXISTENCE OF THE FIRM, WITH ITS "DISTINGUISHING MARK THE SUPERSESSION OF THE PRICE MECHANISM." COASE IDENTIFIES SOME REASONS WHY FIRMS MIGHT ARISE, AND DISMISSES EACH AS UNIMPORTANT: IF SOME PEOPLE PREFER TO WORK UNDER DIRECTION AND ARE PREPARED TO PAY FOR THE PRIVILEGE (BUT THIS IS UNLIKELY); IF SOME PEOPLE PREFER TO DIRECT OTHERS AND ARE PREPARED TO PAY FOR THIS (BUT GENERALLY PEOPLE ARE PAID MORE TO DIRECT OTHERS); IF PURCHASERS PREFER GOODS PRODUCED BY FIRMS. INSTEAD, FOR COASE THE MAIN REASON TO ESTABLISH A FIRM IS TO AVOID SOME OF THE TRANSACTION COSTS OF USING THE PRICE MECHANISM. THESE INCLUDE DISCOVERING RELEVANT PRICES (WHICH CAN BE REDUCED BUT NOT ELIMINATED BY PURCHASING THIS INFORMATION THROUGH SPECIALISTS), AS WELL AS THE COSTS OF NEGOTIATING AND WRITING ENFORCEABLE CONTRACTS FOR EACH TRANSACTION (WHICH CAN BE LARGE IF THERE IS UNCERTAINTY). MOREOVER, CONTRACTS IN AN UNCERTAIN WORLD WILL NECESSARILY BE INCOMPLETE AND HAVE TO BE FREQUENTLY RE-NEGOTIATED. THE COSTS OF HAGGLING ABOUT DIVISION OF SURPLUS, PARTICULARLY IF THERE IS ASYMMETRIC INFORMATION AND ASSET SPECIFICITY, MAY BE CONSIDERABLE.
IF A FIRM OPERATED INTERNALLY UNDER THE MARKET SYSTEM, MANY CONTRACTS WOULD BE REQUIRED (FOR INSTANCE, EVEN FOR PROCURING A PEN OR DELIVERING A PRESENTATION). IN CONTRAST, A REAL FIRM HAS VERY FEW (THOUGH MUCH MORE COMPLEX) CONTRACTS, SUCH AS DEFINING A MANAGER'S POWER OF DIRECTION OVER EMPLOYEES, IN EXCHANGE FOR WHICH THE EMPLOYEE IS PAID. THESE KINDS OF CONTRACTS ARE DRAWN UP IN SITUATIONS OF UNCERTAINTY, IN PARTICULAR FOR RELATIONSHIPS WHICH LAST LONG PERIODS OF TIME. SUCH A SITUATION RUNS COUNTER TO NEO-CLASSICAL ECONOMIC THEORY. THE NEO-CLASSICAL MARKET IS INSTANTANEOUS, FORBIDDING THE DEVELOPMENT OF EXTENDED AGENT-PRINCIPAL (EMPLOYEE-MANAGER) RELATIONSHIPS, OF PLANNING, AND OF TRUST. COASE CONCLUDES THAT A FIRM IS LIKELY THEREFORE TO EMERGE IN THOSE CASES WHERE A VERY SHORT-TERM CONTRACT WOULD BE UNSATISFACTORY, AND THAT IT SEEMS IMPROBABLE THAT A FIRM WOULD EMERGE WITHOUT THE EXISTENCE OF UNCERTAINTY. HE NOTES THAT GOVERNMENT MEASURES RELATING TO THE MARKET (SALES TAXES, RATIONING, PRICE CONTROLS) TEND TO INCREASE THE SIZE OF FIRMS, SINCE FIRMS INTERNALLY WOULD NOT BE SUBJECT TO SUCH TRANSACTION COSTS. THUS, COASE DEFINES THE FIRM AS "THE SYSTEM OF RELATIONSHIPS WHICH COMES INTO EXISTENCE WHEN THE DIRECTION OF RESOURCES IS DEPENDENT ON THE ENTREPRENEUR." WE CAN THEREFORE THINK OF A FIRM AS GETTING LARGER OR SMALLER BASED ON WHETHER THE ENTREPRENEUR ORGANISES MORE OR FEWER TRANSACTIONS. THE QUESTION THEN ARISES OF WHAT DETERMINES THE SIZE OF THE FIRM; WHY DOES THE ENTREPRENEUR ORGANISE THE TRANSACTIONS HE DOES, WHY NO MORE OR LESS? SINCE THE REASON FOR THE FIRM'S BEING IS TO HAVE LOWER COSTS THAN THE MARKET, THE UPPER LIMIT ON THE FIRM'S SIZE IS SET BY COSTS RISING TO THE POINT WHERE INTERNALISING AN ADDITIONAL TRANSACTION EQUALS THE COST OF MAKING THAT TRANSACTION IN THE MARKET. (AT THE LOWER LIMIT, THE FIRMS COSTS EXCEED THE MARKETS COSTS, AND IT DOES NOT COME INTO EXISTENCE.) IN PRACTICE, DIMINISHING RETURNS TO MANAGEMENT CONTRIBUTE MOST TO RAISING THE COSTS OF ORGANISING A LARGE FIRM, PARTICULARLY IN LARGE FIRMS WITH MANY DIFFERENT PLANTS AND DIFFERING INTERNAL TRANSACTIONS (SUCH AS A CONGLOMERATE), OR IF THE RELEVANT PRICES CHANGE FREQUENTLY. COASE CONCLUDES BY SAYING THAT THE SIZE OF THE FIRM IS DEPENDENT ON THE COSTS OF USING THE PRICE MECHANISM, AND ON THE COSTS OF ORGANISATION OF OTHER ENTREPRENEURS. THESE TWO FACTORS TOGETHER DETERMINE HOW MANY PRODUCTS A FIRM PRODUCES AND HOW MUCH OF EACH.
ACCORDING TO OLIVER E. WILLIAMSON, THE EXISTENCE OF FIRMS DERIVES FROM ASSET SPECIFICITY IN PRODUCTION, WHERE ASSETS ARE SPECIFIC TO EACH OTHER SUCH THAT THEIR VALUE IS MUCH LESS IN A SECOND-BEST USE. THIS CAUSES PROBLEMS IF THE ASSETS ARE OWNED BY DIFFERENT FIRMS (SUCH AS PURCHASER AND SUPPLIER), BECAUSE IT WILL LEAD TO PROTRACTED BARGAINING CONCERNING THE GAINS FROM TRADE, BECAUSE BOTH AGENTS ARE LIKELY TO BECOME LOCKED INTO A POSITION WHERE THEY ARE NO LONGER COMPETING WITH A (POSSIBLY LARGE) NUMBER OF AGENTS IN THE ENTIRE MARKET, AND THE INCENTIVES ARE NO LONGER THERE TO REPRESENT THEIR POSITIONS HONESTLY: LARGE-NUMBERS BARGAINING IS TRANSFORMED INTO SMALL-NUMBER BARGAINING. IF THE TRANSACTION IS A RECURRING OR LENGTHY ONE, RE-NEGOTIATION MAY BE NECESSARY AS A CONTINUAL POWER STRUGGLE TAKES PLACE CONCERNING THE GAINS FROM TRADE, FURTHER INCREASING THE TRANSACTION COSTS. MOREOVER THERE ARE LIKELY TO BE SITUATIONS WHERE A PURCHASER MAY REQUIRE A PARTICULAR, FIRM-SPECIFIC INVESTMENT OF A SUPPLIER WHICH WOULD BE PROFITABLE FOR BOTH; BUT AFTER THE INVESTMENT HAS BEEN MADE IT BECOMES A SUNK COST AND THE PURCHASER CAN ATTEMPT TO RE-NEGOTIATE THE CONTRACT SUCH THAT THE SUPPLIER MAY MAKE A LOSS ON THE INVESTMENT (THIS IS THE HOLD-UP PROBLEM, WHICH OCCURS WHEN EITHER PARTY ASYMMETRICALLY INCURS SUBSTANTIAL COSTS OR BENEFITS BEFORE BEING PAID FOR OR PAYING FOR THEM). IN THIS KIND OF A SITUATION, THE MOST EFFICIENT WAY TO OVERCOME THE CONTINUAL CONFLICT OF INTEREST BETWEEN THE TWO AGENTS (OR COALITIONS OF AGENTS) MAY BE THE REMOVAL OF ONE OF THEM FROM THE EQUATION BY TAKEOVER OR MERGER. ASSET SPECIFICITY CAN ALSO APPLY TO SOME EXTENT TO BOTH PHYSICAL AND HUMAN CAPITAL, SO THAT THE HOLD-UP PROBLEM CAN ALSO OCCUR WITH LABOUR (EG LABOUR CAN THREATEN A STRIKE, BECAUSE OF THE LACK OF GOOD ALTERNATIVE HUMAN CAPITAL; BUT EQUALLY THE FIRM CAN THREATEN TO FIRE). PROBABLY THE BEST CONSTRAINT ON SUCH OPPORTUNISM IS REPUTATION (RATHER THAN THE LAW, BECAUSE OF THE DIFFICULTY OF NEGOTIATING, WRITING AND ENFORCEMENT OF CONTRACTS). IF A REPUTATION FOR OPPORTUNISM SIGNIFICANTLY DAMAGES AN AGENTS DEALINGS IN THE FUTURE, THIS ALTERS THE INCENTIVES TO BE OPPORTUNISTIC. WILLIAMSON SEES THE LIMIT ON THE SIZE OF THE FIRM AS BEING GIVEN PARTLY BY COSTS OF DELEGATION (AS A FIRMS SIZE INCREASE ITS HIERARCHICAL BUREAUCRACY DOES TOO), AND THE LARGE FIRMS INCREASING INABILITY TO REPLICATE THE HIGH-POWERED INCENTIVES OF THE RESIDUAL INCOME OF AN OWNER-ENTREPRENEUR. THIS IS PARTLY BECAUSE IT IS IN THE NATURE OF A LARGE FIRM THAT ITS EXISTENCE IS MORE SECURE AND LESS DEPENDENT ON THE ACTIONS OF ANY ONE INDIVIDUAL (INCREASING THE INCENTIVES TO SHIRK), AND BECAUSE INTERVENTION RIGHTS FROM THE CENTRE CHARACTERISTIC OF A FIRM TEND TO BE ACCOMPANIED BY SOME FORM OF INCOME INSURANCE TO COMPENSATE FOR THE LESSER RESPONSIBILITY, THEREBY DILUTING INCENTIVES. MILGROM AND ROBERTS (1990) EXPLAIN THE INCREASED COST OF MANAGEMENT AS DUE TO THE INCENTIVES OF EMPLOYEES TO PROVIDE FALSE INFORMATION BENEFICIAL TO THEMSELVES, RESULTING IN COSTS TO MANAGERS OF FILTERING INFORMATION, AND OFTEN THE MAKING OF DECISIONS WITHOUT FULL INFORMATION. THIS GROWS WORSE WITH FIRM SIZE AND MORE LAYERS IN THE HIERARCHY. EMPIRICAL ANALYSES OF TRANSACTION COSTS HAVE RARELY ATTEMPTED TO MEASURE AND OPERATIONALIZE TRANSACTION COSTS. RESEARCH THAT ATTEMPTS TO MEASURE TRANSACTION COSTS IS THE MOST CRITICAL LIMIT TO EFFORTS TO POTENTIAL FALSIFICATION AND VALIDATION OF TRANSACTION COST ECONOMICS.
ACCORDING TO ECONOMIST AND ECONOMIC HISTORIAN DOUGLASS NORTH, BELIEVES THAT WHEN MARKET EXCHANGES ARE CONCEIVED THIS WAY THEY CAN BE SHOWN TO INVOLVE A HOST OF "HIDDEN" COSTS RANGING FROM THE ENERGY AND SKILL NEEDED TO ASCERTAIN THE QUALITY OF A PRODUCT, TO THE DRAWING OF SALES AND EMPLOYMENT CONTRACTS, TO THE ENFORCEMENT OF THOSE CONTRACTS. IN MEDIEVAL MARKETS, HE ARGUES, THESE TRANSACTION COSTS WERE MINIMAL, AND SO WERE THEIR ENFORCEMENT CHARACTERISTICS: THREATS OF MUTUAL RETALIATION, OSTRACISM, CODES OF CONDUCT AND OTHER INFORMAL CONSTRAINTS SUFFICED TO ALLOW FOR A MORE OR LESS SMOOTH FUNCTIONING OF A MARKET. BUT AS THE VOLUME AND SCALE OF TRADE INTENSIFIED (OR AS ITS CHARACTER CHANGED, AS IN THE CASE OF FOREIGN, LONG-DISTANCE TRADE) NEW INSTITUTIONAL NORMS AND ORGANIZATIONS WERE NEEDED TO REGULATE THE FLOW OF RESOURCES, RANGING FROM STANDARDIZED WEIGHTS AND MEASURES, TO THE USE OF NOTARIAL RECORDS AS EVIDENCE IN MERCHANT LAW COURTS. NORTH'S MAIN POINT IS THAT AS MEDIEVAL MARKETS GREW AND COMPLEXIFIED THEIR TRANSACTION COSTS INCREASED ACCORDINGLY, AND HENCE THAT WITHOUT A SET OF INSTITUTIONAL NORMS AND ORGANIZATIONS TO KEEP THESE COSTS DOWN THE INTENSIFICATION OF TRADE IN THE WEST WOULD HAVE COME TO A HALT. ECONOMIES OF SCALE IN TRADE AND LOW-COST
ACCORDING TO INSTITUTIONAL ECONOMIST JOHN R. COMMONS , INDIVIDUAL ACTIONS ARE REALLY TRANS-ACTIONS INSTEAD OF EITHER INDIVIDUAL BEHAVIOR OR THE "EXCHANGE" OF COMMODITIES. IT IS THIS SHIFT FROM COMMODITIES AND INDIVIDUALS TO TRANSACTIONS AND WORKING RULES OF COLLECTIVE ACTION THAT MARKS THE TRANSITION FROM THE CLASSICAL AND HEDONIC SCHOOLS TO THE INSTITUTIONAL SCHOOLS OF ECONOMIC THINKING. THE SHIFT IS A CHANGE IN THE ULTIMATE UNIT OF ECONOMIC INVESTIGATION. THE CLASSIC AND HEDONIC ECONOMISTS, WITH THEIR COMMUNISTIC AND ANARCHISTIC OFFSHOOTS, FOUNDED THEIR THEORIES ON THE RELATION OF MAN TO NATURE, BUT INSTITUTIONALISM IS A RELATION OF MAN TO MAN. THE SMALLEST UNIT OF THE CLASSIC ECONOMISTS WAS A COMMODITY PRODUCED BY LABOR. THE SMALLEST UNIT OF THE HEDONIC ECONOMISTS WAS THE SAME OR SIMILAR COMMODITY ENJOYED BY ULTIMATE CONSUMERS. ONE WAS THE OBJECTIVE SIDE, THE OTHER THE SUBJECTIVE SIDE, OF THE SAME RELATION BETWEEN THE INDIVIDUAL AND THE FORCES OF NATURE. THE OUTCOME, IN EITHER CASE, WAS THE MATERIALISTIC METAPHOR OF AN AUTOMATIC EQUILIBRIUM, ANALOGOUS TO THE WAVES OF THE OCEAN, BUT PERSONIFIED AS "SEEKING THEIR LEVEL." BUT THE SMALLEST UNIT OF THE INSTITUTIONAL ECONOMISTS IS A UNIT OF ACTIVITY -- A
LACITY AND WILLCOCKS (1996; P. 218) USE ONLY ASSET SPECIFICITY AND FREQUENCY TO DETERMINE WHICH GOVERNANCE MODE SHOULD HAVE BEEN CHOSEN ACCORDING TO TCT FOR THE IT TRANSACTIONS UNDERTAKEN BY THEIR SAMPLE OF FIRMS. FOR SOME REASON, THEY DID NOT CONSIDER THE EFFECTS OF UNCERTAINTY (PRE- SUMABLY THEY WERE UNABLE TO MEASURE UNCERTAINTY). PARTICULARLY AT THE MARGIN, HOWEVER, TCT PREDICTS THAT THE LEVEL OF UNCERTAINTY IS LIKELY TO AFFECT WHETHER A DECISION-MAKER CHOOSES TO OUT- SOURCE OR INSOURCE. LACITY AND WILLCOCKS RECOGNIZE, THEREFORE, THAT THE EFFECTS OF UNCERTAINTY MAY ACCOUNT FOR SOME OF THE ANOMALIES THEY FOUND. TO MEASURE FREQUENCY, LACITY AND WILLCOCKS ALLOWED PARTICIPANTS TO SPECIFY A TRANSACTION AS EITHER OCCASIONAL OR RECURRENT. IN MOST CASES THE CHOICE MADE SEEMS APPROPRIATE (E.G., DATA CENTER OPERATIONS WERE RECURRENT). IN SOME CASES, HOWEVER, THE CHOICE IS QUESTIONABLE. FOR EXAMPLE, SYSTEMS DEVELOPMENT IS DESIGNATED AS AN OCCASIONAL TRANSACTION. IF AN ORGANIZATION REGULARLY ENGAGES IN SYSTEMS DEVELOPMENT WORK, HOWEVER, THE TRANSACTION IS MORE LIKELY TO BE RECURRENT. AGAIN, LACITY AND WILLCOCKS RECOGNIZE THAT A PROBLEMATICAL MEASURE OF FREQUENCY MAY ACCOUNT FOR SOME OF THE ANOMALIES THEY FOUND. A MAJOR CONCERN WITH LACITY AND WILLCOCKS MEASURE OF ASSET SPECIFICITY. WILLIAMSON (1985) IS UNEQUIVOCAL ABOUT THE PRIMACY OF ASSET SPECIFICITY IN TCT: THE PRINCIPAL DIMENSIONS WITH RESPECT TO WHICH TRANSACTIONS DIFFER ARE ASSET SPECIFICITY, UNCERTAINTY, AND FREQUENCY. THE FIRST IS MOST IMPORTANT AND MOST DISTINGUISHES TRANSACTION COST ECONOMICS FROM OTHER TREATMENTS OF ECONOMIC ORGANIZATION, BUT THE OTHER TWO PLAY SIGNIFICANT ROLES (OUR EMPHASIS). HAVING A VALID AND RELIABLE MEASURE OF ASSET SPECIFICITY, THEREFORE, IS CENTRAL TO UNDERTAKING ROBUST TESTS OF TCT. IN SHORT, IF THE ASSETS SUPPORTING A TRANSACTION WERE SPECIALIZED, LACITY AND WILLCOCKS DESIGNATED THEM AS SPECIFIC (MIXED OR IDIOSYNCRATIC). MOREOVER, WHERE ORGANIZATIONS TOOK A DECISION OF TOTAL OUTSOURCING OR TOTAL INSOURCING,
LACITY AND WILLCOCKS (1996 RIGHTFULLY POINT OUT, TCT IS FRAUGHT WITH IMPRECISE CONSTRUCTS THAT ARE DIFFI- CULT TO OPERATIONALIZE. SIMILAR CRITICISMS APPLY TO THE RBV. IT IS IMPORTANT TO FURTHER REFINE MEASURES OF STRATEGIC VALUE, ASSET SPECIFICITY, AND SPECIALIZATION. ALL ARE LINKED TO RARENESS, BUT THEY CAN LEAD TO CONTRARY PREDICTIONS ABOUT THE DESIRABILITY OF ASSET OWNERSHIP. RE-ANALYZING LACITY, WILLCOCKS, AND HIRSCHHEIMS CASES LEADS TO AN IMPORTANT CONCLUSION. TCT AND THE RBV COMPETE TO EXPLAIN THE SOURCING DECISION. IF BOTH LEAD TO THE SAME PREDICTIONS, THEY CANNOT BE DIFFERENTIATED EMPIRICALLY. IF THIS WERE THE OUTCOME, THEY ARE PROBABLY PRESENTING THE SAME CONCEPTS USING DIFFERENT WORDS. WE OBTAINED DIFFERENT RESULTS, HOWEVER, WHEN WE ANALYZED THE CASES FROM TCT AND RBV PERSPECTIVES. THUS, WE HAVE A PRIMA FACIE CASE THAT THE TWO THEORIES CAN BE DIFFERENTIATED EMPIRICALLY. MOREOVER, OUR RESULTS INDICATE THAT SPECIALIZATION BETTER PROXIES FOR STRATEGIC VALUE AND NOT ASSET SPECIFICITY.
GHOSHAL (2005), IN A POSTHUMOUSLY PUBLISHED ARTICLE, LAMENTED THE FACT THAT THE ECONOMIC THEORIES CURRENTLY DOMINATING THE DEBATE OVER CORPORATE GOVERNANCE HAD WRECKED PREVIOUSLY GOOD MANAGEMENT PRACTICES. THESE SCANDALS ARE INTERPRETED AS THE CONSEQUENCE OF THE DOMINANT PRINCIPALAGENT AND TRANSACTION COST VIEW IN CORPORATE GOVERNANCE (SEE ALSO ADLER 2002; OSTERLOH AND FREY 2005). THE STANDARD ECONOMIC VIEW IS BASED ON THE ASSUMPTION OF OPPORTUNISM AS A WORST-CASE SCENARIO. OPPORTUNISM IS CONSIDERED TO BE A PRUDENT CONSIDERATION FOR INSTITUTIONAL STRUCTURES (MILGROM AND ROBERTS 1992; WILLIAMSON 1996). HOWEVER, IN THE VIEW OF ITS CRITICS, PREVALENCE OF STANDARD ECONOMIC APPROACHES IN THE TRAINING OF NEW MANAGERS AT REPUTABLE MBA CENTRES LEADS TO A SITUATION IN WHICH THESE THEORIES CONCEPTION OF HUMAN BEINGS AS OPPORTUNISTS TENDS INCREASINGLY TO BECOME REALITY. IT SEEMS TO BECOME TRUE WHAT GHOSHAL AND MORAN (1996) IN THEIR OFT-QUOTED ARTICLE BAD FOR PRACTICE: A CRITIQUE OF THE TRANSACTION COST THEORY, HAD CRITICISED: WILLIAMSONS (1990) TRANSACTION COST APPROACH IS NOT ONLY WRONG BUT DANGEROUS FOR GUIDING MANAGEMENT AND POLICY DECISIONS.
ACCORDING TO AN ARTICLE BY PROF. RAM SINGH CAPTURES A WELL ILLUSTRATIVE THEME OF TRANSACTION COSTS ANALYSIS FALLING WITHIN THE DOMAIN OF WHAT IS KNOWN AS INSTITUTIONAL ECONOMICS. IN FACT MOST OF THE TIMES IT HAPPENS THAT CONTRACTS ARE CARRY OUT INFORMALLY (EVEN IF IT IS BACKED BY FORMAL TREATY). THIS IS TRUE MORE IN CASE OF MANAGEMENT OF NATURAL RESOURCES ESPECIALLY IN THE COUNTRY SIDE. HOWEVER, THIS THEORY IS NOT ONLY TRUE FOR MANAGING NATURAL RESOURCES EFFICIENTLY BUT ALSO HOLDS EQUALLY GOOD IN CASE OF CORPORATE STRUCTURE. FOR EXAMPLE: IT IS OFTEN SEEN THAT FIRMS OPERATING IN SILICON VALLEY - THEY USE TO EXCHANGE THE INTERNAL INFORMATION FOR OPTIMIZATION OF THE RESOURCES THOUGH THEY ARE ARCH RIVAL CATERING TO THE SAME HOMOGENOUS PRODUCT BY AND LARGE. THE BASIC TENET BEHIND THE WORKING OF INFORMAL CONTRACTS IS SOMETHING CALLED THE CONCEPT OF "SOCIAL CAPITAL" IN THE REALM OF POLITICAL ECONOMY. THERE ARE LOTS OF EMPIRICAL EVIDENCES ARE AVAILABLE WHICH TRACES ABOUT HOW A WELL KNITTED AND INTEGRATED SOCIETY IS ABLE TO USE THE RESOURCES EFFICIENTLY. E.G. IN CASE OF SOUTH ITALY THE SOCIETY DOES NOT HAVE MUCH OF BRIDGING-BONDING ADHESIVENESS WITHIN THEM, WHEREAS IN CASE OF NORTHERN ITALY THE SOCIAL CAPITAL IS HIGH AND AS A RESULT WE CAN SEE ITS MANIFESTATION IN TERMS OF THE ECONOMIC DEVELOPMENT OF NORTHERN ITALY OVER SOUTHERN ITALY. EFFICIENT MANAGEMENT OF SCARCE NATURAL RESOURCES ARE VERY SUCCESSFULLY CARRIED OUT BY THE LONG STANDING INFORMAL LAWS OF THE LOCAL PEOPLE. BUT ONLY THING WHICH REMAINS UNANSWERED IS THAT WILL THIS TREND CAN BE CARRY OUT SUCCESSFULLY WHEN THE DEPENDENCY (POPULATION) OF THE PEOPLE WILL RISE IN THE DAYS TO COME.
ACCORDING TO KENNETH ARROW (1983) , THE DISTINCTION BETWEEN TRANSACTION COSTS AND PRODUCTION COSTS IS THAT THE FORMER CAN BE VARIED BY A CHANGE IN THE MODE OF RESOURCE ALLOCATION, WHILE THE LATTER ONLY DEPEND ON THE TECHNOLOGY AND TASTES, AND WOULD BE THE SAME IN ALL ECONOMIC SYSTEMS. IT HAS BEEN ESTIMATED THAT AT LEAST 45 PER CENT OF THE GROSS NATIONAL PRODUCT IN A DEVELOPED SOCIETY IS
AOKI (1990) HAS IDENTIFIED SOME OF THE BASIC DIFFERENCES BETWEEN JAPANESE AND AMERICAN STYLE MANAGEMENT, AND THEN USED ELEMENTS OF TRANSACTION COST THEORY TO EXPLAIN THESE DIFFERENCES. ONE OF HIS OBSERVATIONS IS THAT SPONTANEOUS AND VOLUNTARY COORDINATION IS MUCH MORE PREVALENT THAN IN WESTERN FIRMS. THUS THE NEED FOR EXPLICIT PERFORMANCE CONTRACTS IS REDUCED. THIS IS ACHIEVED BY HAVING A LONG PERIOD OF SOCIALISING AMONG EMPLOYEESTHE SYSTEM OF LIFETIME EMPLOYMENT COMBINED WITH A PROMOTION SYSTEM BUILT ON SENIORITY. A CONSEQUENCE IS THAT IT IS CRITICALLY IMPORTANT TO HAVE STABLE HIERARCHIES WITH CLEARLY DEFINED ROLES, AND IT IS DIFFICULT TO INJECT OUTSIDE EXPERTISE OF A TEMPORARY NATURE. THUS, WHILE JAPANESE FIRMS ARE ADEPT AT USING SUPPLIERS FOR STANDARD PRODUCTS AND SERVICES, THEY FIND IT MUCH MORE DIFFICULT TO USE HIGH VALUE-ADDED SERVICES FROM THE OUTSIDE.
ENGLANDER (1984) APPLIED THE THEORY TO THE SHORT-LIVED PRACTICE OF INSIDE CONTRACTING THAT WAS PREVALENT IN THE EARLY DAYS OF THE MANUFACTURING ERA, ESPECIALLY IN NEW ENGLAND. UNDER THIS SYSTEM, OWNERS CONTRACTED WITH SUPPLIERS TO PERFORM ALL OPERATIONS WITHIN A FACTORY, WHILE PROVIDING THE PRODUCTIVE ASSETS SUCH AS MACHINERY. IN ESSENCE, THE INSIDE CONTRACTOR AGREED ON A TRANSFER PRICE WITH THE OWNER, AND THEN HAD THE FREEDOM TO HIRE WORKERS, DEVELOP WORK METHODS, AND TAKE WHATEVER ACTION NECESSARY TO GENERATE A PROFIT. THE PRACTICE BROKE DOWN FOR FUNDAMENTAL TRANSACTION-COSTTHEORETICAL REASONS. THE HIGH ASSET SPECIFICITY BETWEEN OWNER AND CONTRACTOR (INCLUDING PHYSICAL, HUMAN, AND SITE SPECIFICITY) MADE IT IMPOSSIBLE TO DESIGN CONTRACTS BETWEEN OWNERS AND CONTRACTORS THAT GAVE A FAIR SHARE OF PROFITS TO BOTH PARTIES. THE CONTRACTOR, HAVING SUPERIOR KNOWLEDGE OF OPERATIONS, FOUND WAYS TO IMPROVE PRODUCTIVITY BEYOND THE EXPECTATION OF THE OWNER. THUS, SUPERNORMAL RENTS ACCRUED TO THE CONTRACTOR. AT THE SAME TIME, THE INTERNAL CONTRACTOR DID NOT HAVE MANY PROPRIETARY SKILLS AND IT WAS THEREFORE RELATIVELY EASY FOR THE OWNER TO REPLACE THE INSIDE CONTRACTOR WITH HIS OWN SUPERVISOR AND WORK FORCE. BY THE END OF THE NINETEENTH CENTURY THE INSIDE CONTRACTING SYSTEM HAD GIVEN WAY TO THE VERTICALLY INTEGRATED INDUSTRIAL FIRM WHERE ALL RESOURCESHUMAN AND PHYSICAL WERE UNDER THE CONTROL OF MANAGEMENT. ONE MAY WONDER IF MANAGEMENT CONSULTING, WHICH HAS MUCH IN COMMON WITH THE INSIDE CONTRACTOR, WILL DISAPPEAR IN A SIMILAR WAY.