Transaction cost

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In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange. 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 banana from a store; to purchase the banana, your costs will be not only the price of the banana itself, but also the energy and effort it requires to find out which of the various banana products you prefer, where to get them and at what price, the cost of travelling 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 banana are the transaction costs. When rationally evaluating a potential transaction, it is important to consider transaction costs that might prove significant.

A number of kinds of transaction cost 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, who 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.
  • 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.

The term "transaction cost" is frequently thought to have been coined by Ronald Coase, who used it to develop a theoretical framework for predicting when certain economic tasks would be performed by firms, and when they would be performed on the market. However, the term is actually absent from his early work up to the 1970s. While he did not coin the specific term, Coase indeed discussed "costs of using the price mechanism" in his 1937 paper The Nature of the Firm, where he first discusses the concept of transaction costs. The term "Transaction Costs" itself can instead be traced back to the monetary economics literature of the 1950s, and does not appear to have been consciously 'coined' by any particular individual [1].

Arguably, transaction cost reasoning became most widely known through Oliver E. Williamson's Transaction Cost Economics. Today, transaction cost economics is used to explain a number of different behaviors. Often this involves considering as "transactions" not only the obvious cases of buying and selling, but also day-to-day emotional interactions, informal gift exchanges, etc.

The determinants of transaction costs are according to Williamson frequency, specificity, uncertainty, limited rationality, and opportunistic behaviour.

At least two definitions of the phrase "transaction cost" are commonly used in literature. Transaction costs have been broadly defined by Steven N. S. Cheung as any costs that are not conceivable in a "Robinson Crusoe economy" -- in other words, any costs that arise due to the existence of institutions. To Cheung, "transaction costs", if the term is not so popular in economics literatures, should be called "institutional costs" [2] [3]. But many economists seem to restrict the definition to exclude costs internal to an organization [4]. The latter definition parallels Coase's early analysis of "costs of the price mechanism" and the origins of the term as a market trading fee.

Starting with the broad definition, many economists then ask what kind of institutions (firms, markets, franchises, etc.) minimize the transaction costs of producing and distributing a particular good or service. Often these relationships are categorized by the kind of contract involved. This approach sometimes goes under the rubric of New Institutional Economics.

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[edit] IT's relationship to transaction costs

Implementing a new information technology is generally seen as a means for reducing the transaction costs of an organization. However, in practice, implementing new IT often results in higher transaction costs. This is because the amount of information that needs to be processed by the organisation increases. This can result in information overload. Antonio Cordella and Kai A. Simon [5] [6] call the cost of processing this information coordination cost. If these costs exceed the benefits of IT, then the implementation becomes something negative and expensive. (For an alternative view of coordination costs, see Malone, Yates, and Benjamin, 1987 [7].)

To reduce coordination costs, organizations can do one of two things:

  1. Improve information processing capabilities. This can be done either through implementing new information systems or creating lateral relations [8].
  2. Use IT to reduce the need for coordination through increased slack resources (which reduces the need for extreme precision) or increased reliance on self-contained tasks which provides more of the information to a single point of contact rather than requiring communications and coordination among multiple units [8]. The decreased amount of information to process means lower coordination costs and lower transaction costs.

Technologies like enterprise resource planning (ERP) can provide technical support for these strategies.

[edit] Information Infrastructure's relationship to transaction costs

Firms, or more generally, organizations, develop and become larger over time, using more and more computers to work. This growth in the number of computers leads to a growth of software use (operating systems and their applications, for example) and, as a result, to the growth in the number of software use/access licenses to be purchased and managed. For the owners of software intellectual property rights, this process leads to a greater supervision of users to regulate/enforce lawful access to software.

The situation occurs when all of the software used by an organization is proprietary. This results in some costs — transaction costs — that are not usually taken into account by administrators and managers. The use of FLOSS - Free/Libre/Open Source Software leads to a reduction in transaction costs in terms of computation costs and in terms of the number of managed contracts, which can be numerically reduced by half [9].

[edit] References

  1. ^ Robert Kissell and Morton Glantz, Optimal Trading Strategies, AMACOM, 2003, pp. 1-23.
  2. ^ Steven N. S. Cheung "On the New Institutional Economics", Contract Economics
  3. ^ L. Werin and H. Wijkander (eds.), Basil Blackwell, 1992, pp. 48-65
  4. ^ H. Demsetz(2003) “Ownership and the Externality Problem.” In T. L. Anderson and F. S. McChesney (eds.) Property Rights: Cooperation, Conflict, and Law. Princeton, N.J.: Princeton University Press
  5. ^ Cordella, A. & Simon, K.A. (1997), 'The Impact of Information Technology on Transaction and Coordination Cost', Conference on Information Systems Research in Scandinavia (IRIS 20), Oslo, Norway, August 9-12
  6. ^ Cordella, A. (2001), 'Does Information Technology Always Lead to Lower Transaction Costs?', The 9th European Conference on Information Systems, Bled, Slovenia, June 27-29
  7. ^ Malone, T. W., J. Yates and R. I. Benjamin (1987), "Electronic Markets and Electronic Hierarchies," Communications of the ACM, 30, 484-497.
  8. ^ a b Galbraith, J. A. (1973), Designing Complex Organizations, Addison-Wesley Longman Publishing Co., Inc., Boston, MA.
  9. ^ Soares, MVB (2004), 'Reducing Transaction Costs in Information Infrastructures using FLOSS - Free/Open/Libre Open Source Software', 4S/EASST Conference, Paris, France, August 26-28

[edit] See also

[edit] External links

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