Key Characteristics of Transaction Cost Economics - Essay Example

Task Identify The Key Characteristics Of Transaction Cost Economics. Analyze The Vertical Boundaries Of A Company By DescribingThe Critical Role Played By Coordination In A Vertical Chain. 1. Theory The concept of transactions cost economics (TCE) emphasizes that the most basic unit that is used in economic activities is the transaction. It suggests that a transaction occurs when goods and/or services are traded between two separate interfaces on a company’s technology. The costs involved are incurred as a result of the economic exchanges made. They are also described as costs that are beyond the prices of the products procured (Basenko, Dravone, Shanley & Schaefer, 2009). The transaction costs can be further grouped into coordination along with motivation costs. The motivation costs are said to be comprising of opportunism along with the agency costs. The costs involved in coordination include the costs of searching, coordination of inputs along with the costs of measurement. In the real world, the transaction costs extension across multiple monetary exchanges can be achieved. To achieve these exchanges, some forms of governance frameworks are needed since they will be vital in determining the integrity’s of various transactions (McNutt, 2005). This can be accomplished adequately by using the formal along with informal frameworks to ensure that transactions are carried out in monetary manners. The notion of transaction cost economics stipulates that the other alternative forms of structures that can be utilized for organizing the economic activities are markets along with hierarchies. The concept of TCE additionally suggests that companies require aligning the governance frameworks with their transactional traits. The concept of TCE disagrees with the issue of people making decisions concerning the usage of government frameworks that will maximize the costs associated with transactions. The criterion that is most basically used in organizing the transaction costs involves economizing the total costs involved in their expenses and transactions. Markets whose total costs are high can appropriately use governance frameworks such as hierarchies (Basenko, Dravone, Shanley & Schaefer, 2009). The distinct traits of transactions have been argued to be the specifying of assets, uncertainty and the frequency of the transactions occurring. The trait known as asset specificity means the degree to which investments made on transactions are special to a particular transaction. In case a transaction flops, then the investments will be deemed as below value when utilized in another way. A circumstance of this nature can easily lead to the establishment of dependencies between the sellers along with buyers of a particular product (McNutt, 2005). This is because the buyers are tied up to the seller and cannot purchase from other sellers in the market. A partner in a transaction who only invests through specialized possessions will be more vulnerable to encounter opportunism. They will be required to carry out specialized efforts aimed at protecting their investments through the implementation, monitoring and enforcement of contractual controls (Basenko, Dravone, Shanley & Schaefer, 2009). An appropriate method of safeguarding against such problems is to apply the policies of vertical amalgamation/integration. This means that a company will have to indulge in the production of goods and services rather than purchase the already manufactured goods in the market. High levels of asset specificity imply that a company has to indulge in internally organizing their production rather than indulge in governing their markets (Basenko, Dravone, Shanley & Schaefer, 2009). The other trait of a transaction that is known as uncertainty mainly implies that the company will or may face situations which are currently unknown. These conditions could result from different sources such as their environment and behaviors. Uncertainty that comes from the environment refers to the difficulties encountered in foreseeing and anticipating several changes that might occur in their environments. The issue of environmental uncertainty causes the signing of contracts to become difficult since there are changes that could arise in the future. This may in turn require a company to renegotiate or adapt on several issues that had already been agreed upon. This activities will result in a rise in the transaction costs involved (McNutt, 2005). On the other hand, behavioral uncertainties refer to the difficulties encountered in the evaluation and monitoring of our transaction partners. It actually refers to the difficulties we encounter when verifying the performances of our transactional partners. The use of appropriate governance frameworks helps companies in addressing the different varying standards of uncertainties facing them. Companies have to produce their products along with services internally when the uncertainty facing them is high (Basenko, Dravone, Shanley & Schaefer, 2009). Lastly, the characteristic of TCE on the frequency with which transactions occur does influence the production and transactional costs involved in a company. It is of great importance to researchers on information systems because there are many new transactional partnerships that deal with high transaction volumes. As the frequencies of transactions increases, companies tend to internalize their production activities. In contrast, there are researchers who have constantly argued that the emergence of the internet would give companies some competitive advantage. This will be achieved after they have externalized most of their transactions that deal with high volumes. This will mainly be applicable when dealing with products and services which can be electronically executed (Basenko, Dravone, Shanley & Schaefer, 2009). A company’s vertical boundary defines what it can do on their own other than purchase from other the independent companies. On the other hand, the vertical chain describes the process that commences with the acquiring of raw materials and terminates with the selling of finished products and services. Companies that are vertically integrated perform most of the activities within the vertical chains by themselves (McNutt, 2005). The vertical boundaries of a company include issues such as where the company participates in the chain of value and how they intend to interface with their external along with their internal sellers and buyers. It also involves defining their horizontal and vertical relations in reference to the transfers of prices, allocation of resources and the management of their divisional reasons. The definition of these boundaries has facilitated many companies in augmenting their effectiveness along with efficiencies. This has also enabled them to enhance their learning along with their monitoring activities in addition to facilitating better resource and funds allocation (McNutt, 2005). It could most likely result in changing how their employees cooperate, take responsibilities along with initiatives when working. The flow of goods and services on the vertical depends on where the company is located on the chain. All companies are faced with the decisions of buying and selling at every stage in the chain (Basenko, Dravone, Shanley & Schaefer, 2009). When the company makes a decision to purchase a commodity from their market it is said to be utilizing the markets. When it decides to make an activity by itself, it is said to be vertically integrated. A company’s coordination is greatly required when making this decisions and the management must consider the benefits along with the costs involved. This is when using either of the two options of utilizing their markets or performing the activities in question on their own (Basenko, Dravone, Shanley & Schaefer, 2009). The benefit of increasing the operational efficiency and effectiveness of a company results from the defining of their vertical boundaries. This in turn results from a company’s efforts of augmenting their efficiencies through the introduction of monitoring and benchmarking inducements. It could also result from an improvement in their resource differentiation capabilities (Basenko, Dravone, Shanley & Schaefer, 2009). The benefit of having the propensity to induce is brought by the development of capabilities through biased integrations performed for reasons of adaptations. The biased utilization of the markets in fostering open inducements also facilitates the achievement of these benefits. The final benefit that companies acquire as a result of defining their vertical boundaries which concerns itself with resources allocation. It comes from the improvements made in divisional relations and inducement structures along with effective capacity usage (McNutt, 2005). Coordination in using the market could help a company in achieving the economies of amount which when companies produce only for their own wants cannot achieve. This coordination in the market place will subject a company to the discipline present in a market. It implies that it must become more efficient and creative for it to survive in this market. The success achieved by companies producing commodities for their own usage may be a hindrance to exposing the inefficiency and lack of creativity that exists within it (McNutt, 2005). Utilizing the market might compromise the coordination of a company’s production flow when activities are bought from other firms than be performed within the company. The performance of activities by external companies could also result in the leakage of a company’s private information. Other forms of transaction costs incurred when dealing with outside companies can also be avoided through the performance of these activities on their own. The act of coordination is generally carried out by companies that want to exploit the benefits that come from the economies of scale (Basenko, Dravone, Shanley & Schaefer, 2009). Coordination only succeeds when it is made based on the decisions others have made. It is vital for suppliers in their production of adequate supplies along with their distribution. For coordination of transactions to be adequately achieved, contracts should be signed between the transacting parties. This helps in ensuring that all the transacting parties know what is required of them (McNutt, 2005). 2. Business Examples(s) The company known as Pepsico along with its bottlers was initially a primary manufacturer of syrups. It bought raw materials from their market and utilized independent companies for their bottling and distribution activities. As time passed, the company’s management did consolidate the distribution along with marketing activities to themselves. They brought in technological changes in the bottling activities that in turn enabled the company to enjoy the economies of amount in their activities. Their management also introduced centralized systems for information coordination when trading with nationwide retailers such as Wal-Mart. Their coordination activities enabled the company to greatly reap the benefits of their transactions. The management of the company also saw an urge to coordinate their advertising and promotional activities in order to reach a wider population and increase their profitability. For the purpose of achieving greater coordination, the company’s management purchased most of the bottling companies. They were successful in controlling 60% of the world’s bottling operations by the year 1990. The company also coordinated with the other companies who purchased shares in their bottling companies. They however remained the majority shareholders with over 40% of these shares and still command control of the industry (Basenko, Dravone, Shanley & Schaefer, 2009). References Basenko, D., Dravone, D., Shanley M. & Schaefer S. 2009. Economics Of Strategy (5th edition), John Willey & Sons, New York. McNutt, P. 2005. Game Embedded Strategy, Edward Elgar Publishing, New York. Read More