Williamson (1981)

The transaction cost approach

* Abstract

Unit of analysis: Transaction

Subject: Transaction cost economizing (economic organization economizes)

Application: Dimensionalized transaction (# What is the dimensionalizing?)

- What are the alternative governance structure

- Assigning transactions to governance structures in a discriminating way

- Efficient boundaries (Between firm and market, Organization of internal transactions, Employment relations)

* Introduction

Neoclassical theory of the firm

: The firm as a production function with a profit maximization objective (Black box)

<- In opposite, emphasis on internal organization

Transaction costs and efforts to economize

based on "human nature as we know if" (Knight 1965, p. 270) - Remarks about the human attributes of economic agents

If the organizational issue is about efficiency, TC aspect could usefully address the issue.

1) Treating the transaction - rather than commodities - the basic unit of analysis

2) Assessing governance structures (between firms and markets) 

in terms of their capacities to economize on transaction costs 

Level of analysis

1) The overall structure of the enterprise

Within a given scope, how the operating parts could be related one to another (Unitary, Holding company, Multidivisional form)

# Understanding

2) Which operating parts should be performed within the firm, which outside, and why: Efficient boundaries

# Assessing

3) The matching between the internal governance structure and the attributes of workgroups

# Human assets # Underdeveloped # Task characteristics?

Section 1: The antecedent literature

Section 2: The rudiments of the approach

Section 3: Applications to the study of efficient boundaries (# The study of efficient boundaries)

Section 4: Employment relation (# Interested)

Section 5: Comparisons between other OT and "power" approaches

* Antecedents

Three antecedents: Economics / Organization theory / Contract law (Since 1930)

1) Economics

Transaction as the basic unit of analysis (Commons, 1934)

The boundary of the frim is a decision variable (Coase, 1937)

Capacity to adapt efficiently to uncertainty (Hayek 1945) 

- Events are interesting when only they are changing and sequential adaptations are needed

"Failures" that ownership served to overcome (The postwar market failure literature)

Transaction costs matters  (Arrow 1969)

- impede and block the formation of markets

1) Organizations are purposive, but human actors are limited in bounded rationality 

2) The importance of informal organization (Barnard, 1938; Simon, 1947)

To cope with the complexity and uncertainty, hierarchical organizations and associated controls are traced ("Carnegie School", March and Simon 1958, Cyert and March 1963)

The organization is a "problem-facing and problem-solving" entity (Thompson 1967)

But organizational efforts are often myopic, and demands for control can and often do give rise to dysfunctional outcomes

Economic efficiency is dependent on the internal organizational structure (Chandler 1962)

Uncertainty and bounded rationality + Efforts to economize on transactions costs with structures (Thompson 1967)

- "under norms of rationality, organizations group positions to minimize coordination costs"

Various forms of the transaction (Llewellyn 1931)

- The distinction between "Hard contracting" and "Soft contracting" 

1) Discrete transactions are very rare in both law and economics 

2) The existence of "relational" forms of contracting which becomes more important (Macneil 1974)

The issue of alternative governance structures become important by the early 1970s

But the topic of transactions cost economizing cannot proceed regardless of the production cost ramifications

Economizing framework and its relevant trade-offs

# Sociologist: That is not rational!

* Some Rudiments

Transaction occurs when

Technologically separable interface

+ Transaction of a good or service

Transaction costs in economic organization = Frictions in the mechanical system

# Non-profit?

Focus on Technology and steady-state production to Comparative costs of planning, adapting, and monitoring task completion under alternative governance structures

** Behavioral Assumptions

Why some (complex) contracts are costly than others?

"Human nature as we know it"

BA 1: Human agents are subjected to bounded rationality

BA 2: At least some agents are given to opportunism

Bounded rationality with simplicity: All economic exchange could be efficiently organized

+ Complexity -> Incomplete contracting is the best that can be achieved (At least comprehensive contracting would be feasible)

Bounded rationality with simplicity + opportunism -> Feasible (X) Trustful (X)

Not work and difficult to distinguish opportunistic types ex-ante

Opportunism: Self-interest seeking with guile.

+ Effective ex-ante and ex-post competition 

Autonomous contracting become efficacious

Ex-ante competition: easier when there are large numbers of qualified bidders (small numbers cause problems)

Ex-post competition: depends on the characteristics of the transactions in question

** Dimensionalizing

Critical dimensions for (recurrent) transactions

1) Uncertainty

2) Frequency

3) Asset specificity (The degree to which durable, transaction-specific investments are required to realize least cost supply)

Investment specialized to a particular transaction (Idiosyncratic transaction-> Nonmarketability problem)

Asset specificity

1) Site specificity (cheek=by-jowl site for economization)

2) Physical asset specificity (specialized element)

3) Human asset specificity (which arises from learning by doing)

Asset specificity_general

"Locked into" the transaction

Once an investment has been made, buyer and seller are effectively operating in a bilateral (or at least quasi-bilateral ) exchange relation for a considerable period thereafter

Symmetricity => Both buyer and seller make special efforts to design an exchange that has good continuity properties

# really?

Asset specificity_Site specificity

"Core technology" (Thompson 1967)

"Natural" alternative governance structures are rarely considered (Invariant)

Technologically < Transaction-cost economizing judgments

Scope

Efficient governance structure on earlier stage, later stage, and lateral transactions

Based on Physical asset specificity (Section 3) & Human asset specificity (Section 4)

* Efficient boundaries

+ Only two organizational alternatives: Firm / Market

(Franchising, Joint ventures are disregarded)

+ Core technology as given

+ Single line of commerce (Particular manufacturing division within a larger industrial enterprise)

** A simple model (C-O, D-O, R-X, S-X)

Transaction cost reasoning:

Trade-offs between production cost economies (Market) and governance economies (Internal organization)

1) The value of the physical asset is determined only by demands # Valuation

2) Valued demand consequences are often realized only at greater production expense # Value < Production cost

3) The demand and production cost consequences are taken into account simultaneously # Demand + Production cost (Firm choice)

4) Governance costs vary with asset specificity # Asset specificity -> Governance cost

The choice between firm and market in 4)

- Nonspecific assets

Market: Advantage in both Production cost and Governance cost

Costless (Scale economies) & Risk-pooling (Aggregate uncorrelated demands) & Avoid hazards of internal procurement

- Specific assets

Reduced, Reduced, Internal procurement -> Government cost! in Market

The exchange takes on a stronger bilateral character 

# 19 (Footnote) If the focal asset is physical and mobile, it could be purchased. 

# But the contractual difficulties would arise if he is not locked into a bilateral exchange

# And the buyer starts the "refinement" of transaction cost

# On the other hand, if the asset is humane or immobile

The governance of recurrent transactions for which uncertainty is held constant (in intermediate degree)

Nonspecific assets: Classical market contracting

Semispecific assets: bilateral or obligational market contracting

Highly specific assets: Internal organization

The advantages of firms over markets in harmonizing bilateral exchange

1) Common ownership reduces the incentives to sub-optimize

2) Internal organization is able to invoke fiat to resolve differences, whereas costly adjudication is needed when an impasse develops between autonomous traders

3) Internal organization has easier access to the relevant information when dispute settling is needed

Uncertainty

The incentive to shift bilateral transactions from markets to firms increases as uncertainty is greater

△C: Production cost difference between the internal organization and the market

△G: Government cost difference between the internal organization and the market

A: asset specificity

△C = f(A), △G = f(A)

△C + △G > 0 leads to Market 

△C + △G = 0 Indifference

△C + △G < 0 leads to Internal procurement

** Two examples

1) When the asset specificity increased, GM made a merger agreement with Fisher Body

2) Forward integration from manufacturing into distribution. Only for commodities that required considerable asset specificity.

(Contingent on differential degrees of asset specificity and the differential hazards of opportunism)

* Managing human assets: the employment relation

Internal organization warranted only for the site-specific transaction 

Human asset specificity -> Internal governance = Efficiency?

Human asset characteristics of the internal transactions & Employment relation # Relational inequality

** Governance, General

The continuing supply of services # Scope condition, What if the consistency harms the survival rate

Focus on Intrastage activity # Passing over the communication cost

1) Asset specificity

Skill acquisition is a necessary but not a sufficient condition for a human asset governance problem to arise

The nature of the skills also matters = Transaction specific / Nonspecific human assets

Only when the skills are deepened and specialized to a particular employer, continuing employment relation becomes a special interest to both employer and employee # Flexibility # VOC # Environment

Mere deepening of skills (X) + Firm-specific value

Neoclassical: Valued skills leads to greater compensation

Transaction cost: 

+ Skills acquired in a learning-by-doing fashion # Therefore firm-specific?

+ Skills imperfectly transferable across employers # Learning-by-doing

would be embedded in a protective governance structure

2) Uncertainty

Evaluation of the productivity of human assets

The metering problem (Alchian & Demsetz 1972): Firms arise when tasks are technologically nonseparable. The output of team is not a sum of separable outputs of each of its members # Meritocracy, Grusky

Individual productivity cannot be assessed by measuring output when tasks are nonseparable

Then an assessment of inputs? Or effort accounting? Metering is difficult to either.

Human assets

1) The degree to which they are firm-specific

2) The ease with which productivity can be metered

1) Internal governance is not unified. It could be multiple depending on the stage

2) High asset specificity under unified governance is not sufficient to assure the efficiency

(Site, Physical, and human asset categories would be specified and considered)

3) Differential meterability matters 

** Some Remarks on Union Organization

What about the production-level employees (not the staff)

Human asset specificity increases

1) The incentive to organize production workers within a collective governance structure 

2) The degree to which an internal governance structure is elaborated

+ 3) The elaboration of other governance structures too

* Relation to the organizational literature

TC: Contrasted with the "power" approach to the study of organizations

* Concluding remarks 

Commercial > Noncommercial # (?: Functional approach makes it reliable)

based on natural selection forces # (other values?) # Organization changes?

1) Functional analysis

2) Straddle between maximizers and satisficers

3) Relies on the natural selection forces # Operationalization? DV IV

Semi-microanalytic analysis

# Enlargening Scope condition

1) When the slack is deficient?

Start-up with scarce resources have difficulties to the integration.

2) The variety of skills

3) When there is an exogenous shock

3-1) The breakdown of the equilibrium

When the continuing supply of services,