Transactions Costs

1
Transactions Costs

• Inside the black box
• Certain products require teamwork either to be
  produced at all or to be produced efficiently
• Markets are not free the market is a powerful
  co-ordinating device but there are a range of
  transactions costs associated with it

2
Transactions Costs

• Coase (1937) transactions incur contracting
  costs
• Trading on spot markets
• Long-term contracts
• Internalizing the transaction within the firm
• Choice should be made dependent on which of these
  minimises transactions costs

3
Characteristics of Transactions Costs

• Frequency
• Infrequent transactions spot markets
• Frequent transactions long-term contract with
  single supplier or internalization?
• Timeliness/reliability
• JIT or inventory?
• Timeliness long-term contract
• Timeliness Reliability - internalization

4
Characteristics of Transactions Costs

• Complexity
• Occurs when the transaction involves a
  significant degree of private information e.g.
  difficulty in measuring quantity and/or quality
• Supplying party has incentive to engage in
  post-contract opportunism
• If transactions are complex, frequent but with a
  relatively short period of time before quality is
  revealed long-term contracting
• If period of time is long integration may be
  preferred

5
Characteristics of Transactions Costs

• Asset Specificity
• Buyer-specific investments and sunk costs
• Positive sunk costs mean that the supplier may
  only be prepared to make the investment if a
  long-term contract is offered
• Ex-post opportunism may occur
• External supply may therefore be a problem and
  the input will not be outsourced but produced
  internally

6
Categories of Asset Specificity

• Site or locational specificity process has to
  be located close to other assets coal mine and
  electricity generating station (Joskow)
• Type specificity plant machinery that can
  only be used in a particular firm
• Human asset specificity individuals may have
  knowledge/skills which are not easily transferable

7
Asset Specificity An Example

• Fisher Body supplied car bodies to General Motors
  (market transaction)
• GM wanted Fisher to invest in a new dedicated
  plant adjacent to one of GMs assembly plants
• Planned reductions in
• Transport costs
• Cost
• Inventory

8
Asset Specificity An Example

• Fisher refused they were afraid of ex-post
  opportunism in the form of pressure to reduce
  prices
• GM eventually acquired Fisher
• This strategy to reduce transactions costs was
• Internalization
• Vertical Integration
• In-sourcing

9
Coasian Transactions Costs

• Search and information acquisition costs
• In markets buyers need to search for best prices,
  quality, availability. Sellers have to decide
  which prices to set market research, monitoring
  competitors and may need to invest in
  advertising.
• In organizations information is gathered at lower
  levels and passed up the hierarchy, then
  decisions are made and passed back down.

10
Coasian Transactions Costs

• Bargaining and negotiating costs can be long
  and costly e.g. wage negotiations
• Contracting costs both for new contracts and
  the termination of existing ones
• Policing and enforcement costs the need for
  costly monitoring

11
Agency-based Transactions Costs

• Hidden information pre-contract opportunism can
  cause mutually beneficial transactions to fail
• Hidden action post-contract opportunism can
  cause inefficient outcomes when the actions of
  one (or more) of the parties is not observable

12
Transactions Cost Minimisation

• Taking the technology of production as given the
  organization should be structured to minimise
  transactions costs
• Market transactions may be attractive but firms
  exist to reduce transactions costs by
• Reducing the number of transactions
• Reducing the overall cost per transaction

13
Cost Minimisation by Reducing the Number of
Contracts

• All Coasian transactions costs increase with the
  number of parties involved
• The firm as a nexus of contracts
• Bilateral and Multiparty contracts
• 6 workers 3 products
• Firm negotiates 639 contracts
• Market would require 6x316 contracts

14
Cost Minimisation via Implicit or Incomplete
Contracting

• Internalization reduces the costs in drawing up,
  monitoring and enforcing explicit contracts which
  are required for market transactions
• Spot contracts
• Sequential Spot Contacts
• State-Contingent Contracts Bounded Rationality

15
Cost Minimisation via Implicit or Incomplete
Contracting

• Most contracts within firms are incomplete this
  makes them easier to write but more difficult to
  enforce the employment contract
• Implicit contracts are unwritten extremely
  difficult to enforce - promotion

16
Caveats on Transactions Costs Theory

• Economies of scale the volume of input required
  by a firm may be too small for the firm to
  produce it internally utilities
• Competitiveness of External Market
• CompetitiveOut-sourcing
• Non-CompetitiveIn-sourcing
• Interdependencies between Transactions
  Technologies JIT technology efficiency of
  contracting