Strategic Management of Transaction Cost Economics - Research Proposal Example

Executive Summary Transaction Cost Economics (TCE) is a theory that has been well elaborated on by Oliver E. Williamson. This paper looks at the TCE theory elaborating on its processes and its problems. It looks at the basic dimensions that govern it and their effect. It then looks at Situational analysis describing its role in setting up boundaries through contracts and their efficiency. It also looks at Human asset under the same analysis and the possibilities it offers. It finally looks at the issues that face TCE. Strategic Management Introduction In companies, there are several ways in which the management can influence the flow of income, which is profits, in their favour thus increasing their capital. The signing of new contracts and venturing into new partnerships is a way in which this can be achieved. However, there is the question of the transaction cost. That is to say, the cost incurred during the process of an exchange. Williamson’s transaction cost approach assumes that the transaction is the fundamental unit of analysis and through understanding its economization one is able to evaluate how their governing structures serve in their economization. In short, to understand a transaction, one must scrutinize the terms under which the transaction is taking place and ensure it is in the interest of the business. A transaction, as elaborated by Williamson, "occurs when a good or service is transferred across a technologically separable interface" (Klein 12) and this is governed through three dimensions: Asset Specificity Physical asset Site Human asset Temporal Dedicated assets Brand-name capital Uncertainty Frequency Asset specificity refers to the features of an asset that make it useful for single or multiple specific purposes and is the most important dimension (The economics of organization: The transaction cost approach – AcaWiki 4). Based on this, the more the specificity of an asset, the lower its chances for resale or redeployment. An example is workers trained to perform only a single task. Uncertainty basically is the state of an asset being unreliable to the goal. Uncertainty differs from risk in that risk can be measured through prior or situational probability while uncertainty is not measurable at all. Situational Analysis Being a multidimensional aspect, it holds an important role in the decision making process of the stakeholders, thus must be taken into consideration before contracts are signed. Lastly the frequency is the repeated times in which a transaction will occur between specific or multiple parties. Also, one has to consider the frequency of disturbance in the market. This is to say, the adaptation of the market to the change that is brought about with the transaction. This has to be accounted for, such that it must be known if the transaction is a one time deal or will it will be repeated. Having considered all the above in the for the transaction process, the situational analysis is carried out in the following levels (Williamson 2): The overall structure of the enterprise where the scope is given and determines how the operating parts are related Operating parts are determined in terms of activities that should be handled within and outside the firm with reasons. Organization of the human assets Situational analysis involves collecting and evaluating past and current data targeting the identification of internal and external forces that may influence the firm’s performance and choice of strategy and the assessment of present and upcoming potentials, flaws, and breaks. Generally it analyses the firm’s goals, provides a strategy and evaluates the resulting effect on it after execution. Through doing this one is able to see the best way forward and be able to determine which type of contract to choose and the details that lay within it. Through the use of situational analysis, the firm is able to replace the usual technology, skills, tools and raw materials used in the manufacture of products and services, and production expenditure as it studies the costs of planning, adapting and monitoring task achievement. Based on the human nature of being opportunistic, people need to set boundaries during the transaction period, thus leading to the development of contracts. Bounded rationality allows the firm to build efficient boundaries in places where there is firm-market dichotomy. This is done through deciding that should be done within the firm and what should be outsourced. This leads to vertical and horizontal integrations in firms (Klein 20-21). Vertical integration is the combination of various process and steps in the production process of two firms in order to consolidate time and expenses while horizontal integration is the assimilation of several firms in the same level of production into a single firm in order to share resources. The efficiency of the boundaries will therefore depend on the contract that is drawn up between the firm and the partner. Details of the process are important and the end result should get one “close” to the optimum. Fully dependent on asset specificity, different contract prevail in different conditions and assumptions. There are classical contracts, bilateral/obligatory contracts and hybrid contracts. Classical contracts are performed when the assets are non-specific. That is to say, when a buying goods/ hiring employees, get the best at the cheapest price/wage form whoever is offering them. Bilateral or obligatory contracts come up when the assets are semi specific. In short, one has two options to choose from. One is less costly while the other is more reliable thus leading the firm to choose the reliability over cost effectiveness or vice versa. Lastly, the hybrid contracts entail aspects of both obligatory and classic contract combined into one thus giving maximum exploitation capability of the firm (Williamson 12). Williamson claims that his model can also be applied to human assets. For example, in the training of an office secretary, once trained, the secretary may leave for a better job because you have increased her skills thus her value. This is unless you retain her by paying her/him a higher salary than before. Thus, one can draw up a contract between the two of you in which you agree to pay her the same amount for a certain period of time upon which you will raise her pay to match here skills. In the process, the secretary may acquire skills that are associated with your office only and as a result, you would retain her/him because those skills are non transferable. In this way, you save on costs that would be required in the training of a new staff member in the same position (Williamson 15). According to transaction cost approach, human assets can be measured in terms of degree of firm specific and difficulty of individual productivity measurability. When both of the two are low, it indicates an internal spot labour market. In cases where individual productivity is high and firm specificity, low, that is primitive team and in an opposite situation, there is the presence of an obligatory market with set rules for performance. When both are at high levels, it shows the relation in which assets are specific to the firm and the individual output of an individual is hard to measure (Williamson 4). The problems that arise from these issues of contracts are that the wording used may be in favour of one party while it is against the other. This issue if not dealt with, will cost the discriminated party a great deal. Thus, when signing contracts one has to look at the wording with great scrutiny ensuring that it is correct and in the interest of both parties. Unfortunately, there are those contracts that are too wordy and lengthy, thus containing the conflict of interest. Contracts should be as short possible and straight to the point in delivering the basics of details in the signed agreement. With these contracts come three types of transaction costs namely Search and information costs Bargaining costs Policing and enforcement costs Search and information costs involve the search of relevant information and meeting with the relevant agents with whom the transaction shall happen with. Without the proper research done, the firm would end up with a transaction that would cost them more than they would have wanted in terms of poor choice of partners or poor products inquired. Bargaining costs are those involved in coming up with reasonable understandings and the writing of an appropriate contract that suite the purpose of the joint venture. Bargaining cost is of course negligible because it involves coming to an agreement, but some are costly like the transfer of a player from one team to another. Lastly is the policing and enforcement costs are those linked to the supervision of the fulfilment of the contract. Because at times people sometimes deviate from the contract, it is important to put in place structures that help regulate this deviance and to ensure the both parties uphold their ends of the deal with litigation expenses serving as the best example. Main Problem Issues The above characteristics of transaction cost economics are similar to the modern day macroeconomic theories. As a result, they share the same issues, but the major difference of TCE is in its definition of the firm. The main issue facing the firm is the drawing up of contracts. Contracts are drawn up having numerous pages and lots of legal wording that some people sign them without consideration of what is in the text but rather what was discussed. This is a problem based on the opportunistic nature of man where they want to make profits at the expense of the other party. Another problem is the ambiguity of the situation of getting into a contract. Unlike risks, Uncertainty is immeasurable thus assurances on delivery of the other end of the contract are left to ones imagination. Risks can be analysed through probability thus determining the efficiency of a given action. Lastly hierarchal organization of the firm may tend to undermine the process of transaction cost. Those at the top would do what they want in their favour without considering the ripple effect it would cause down the chain of command. For example, a manager will make a transaction in his interest rather than that of the firm’s stakeholders, thus increasing his job security but compromising firm profits. Conclusion In the end, it all lies in the efficiency of the execution of the transaction cost process. The three criteria of asset specificity, uncertainty and frequency must be looked at and met and the process of strategic analysis must be followed. Here through the study of the costs of planning, adapting and monitoring will help in the choice of contract to be obtained by the firm in order to improve efficiency. Truly Williamson did well in the development of this theory as it tackles every day process in the world of economics. Works Cited Klein, Peter G. "Transaction Cost Economics." Slideshare.net, 2006. Web. 16 Apr 2014. http://www.slideshare.net/encoreunefois/transaction-cost-economics  Unknown. "The economics of organization: The transaction cost approach - AcaWiki." Acawiki.org, 2011. Web. 16 Apr 2014. http://acawiki.org/The_economics_of_organization:_The_transaction_cost_approach Williamson, Oliver E. "Williamson - Transaction Cost Approach." Faculty.babson.edu, 2014. Web. 16 Apr 2014. http://faculty.babson.edu/krollag/org_site/org_theory/granovet_articles/william_trans.html Williamson, Oliver E. "Untitled Document." Ssr1.uchicago.edu, 2014. Web. 16 Apr 2014. http://ssr1.uchicago.edu/NEWPRE/Orgs2/Williamson.html Read More