limitation of transaction cost model

[KB]

Hi Mr Toh,

what are the few limitation of transaction cost model with examples?

[William Toh]

Why not you try to suggest some limitations for the discussion?  We all learn better that way.

[KB]

I'm really unsure since DM ignores social-cultural element and while
DMM ignores behaviour uncertainty, TCM takes these into account
seriously. So then, what other flaw does TCM has?

the subject guides states 2 major limitation of TCM. I don;t even
truly grasp the understanding, not mentioning the possibility of
citing examples to analyse.

1)the first limitation states that transaction cost economics is based
on a more sophisticated but still narrow view of the agent as
‘economic man’ who maximises utility despite the limits of his or her
rationality.
( does this mean there's still bounded rationality in processing
information?)

2)the second limitaion states the approach presents a static,
comparative view of why different economic institutions exist, develop
or decay. Transaction-cost economics indicates that for a given level
of uncertainty and amount of trust between the parties there is
usually a limited number of governance structures that are more
efficient and will survive in the long run. When circumstances change,
efficient governance structure must adapt swiftly, or it will be swept
away by competition. The approach is silent, however, on the forces
that make certain organisations stickier than others. In summary,
transaction-cost economics seems to assume an implicit notion of
frictionless change. It ignores the widespread role of transition
costs in socio-economic organisations undergoing continuous change.
( Totally unable to comprehend and provide substantial examples
relevant to this point.....what is even socio economic organisations
undergoing continuous change?)

I think this 2 limitations are important but I believe it wasn;t
discussed explicitly by Dr Antonio and I believe little student truly
understand these limitations.

Sorry for asking a direct answer on my initial post as I thought it is
just a little late and too much to be fully able to discuss those
issue at this moment.....

[Sabrina Tan]

hi mr toh, i have a few suggestions:

1) implementation of IS to reduce opportunistic behaviour that causes TC has actually incurred additional cost. one example i saw from Mr Toh's article on tripadvisor. tripadvisor is planning to sue hotels that posted fake positive reviews so as to boost their reputation. tripadvisor has to do this so that consumers from continue trusting the postings. if tripadvisor put in IS to monitor opportunistic behaviour, because this opportunistic behaviour increases contract cost, it would have incurred additional transaction cost.

2) another example is the use of SCM between the organisation and suppliers. SCM will reduce transaction cost but this increases switching cost for the organisation.

3) the investment of IS to reduce TC has already incurred cost for the organisation, in terms of having to invest in the IT infrastructure. examples are HW and SW. the way we can counter this is to reduce the cost of implementing IS. we can do this by outsourcing. an example is salesforce.com which allows users to make use of their crm. another way is to rent sw, aka saas. an example is dropbox.

are these examples right? but i can't think of real examples for 2) and 3) 

[KB]

Hey there Sabrina,

thanks for the information provided. However, I'm still really curious
on what the 2 major limitations truly meant and how we can discuss in
relation to them. Do you mind explaining to me? thanks!

[Sabrina Tan]

hi np :)

are you referring to 2) and 3) that i mentioned?

im not very sure but these are what i understood:

for 2) businesses use SCM to reduce contract and regulation cost. this means that the organisation is being "locked in" with the suppliers. hence, when the organisation wants to switch to a better supplier (other suppliers may provide better quality at a cheaper price), it is expensive for it to do so. 

im not very sure about this, what do you think?

for 3) IS is being implemented to reduce TC. but the irony is that when we have invested in IS, it means that costs has been incurred. costs in terms of having to build the IT infrastructure, which includes the HW and SW. 

the way to deal with this limitation is to try to reduce the cost of implementing IS. and one way is to outsource the service so that the organisation do not need to fully acquire the whole system which is very expensive. it can use HW and SW as utility instead.

[William Toh]

On Wednesday, May 2, 2012 12:40:28 AM UTC+8, KB wrote:

I'm really unsure since DM ignores social-cultural element and while
DMM ignores behaviour uncertainty, TCM takes these into account
seriously. So then, what other flaw does TCM has?

DM addresses technical, but ignores socio-cultural aspects (socio-psychological and socio-economical)

DMM addresses technical and socio-psychological aspects, but ignores socio-economical

TCM addresses technical and socio-psychological and socio-economical aspects.

 

the subject guides states 2 major limitation of TCM. I don;t even
truly grasp the understanding, not mentioning the possibility of
citing examples to analyse.

1)the first limitation states that transaction cost economics is based
on a more sophisticated but still narrow view of the agent as
‘economic man’ who maximises utility despite the limits of his or her
rationality.
 ( does this mean there's still bounded rationality in processing
information?)

What Antonio is saying here is that by viewing humans as "economic value-maximising individuals", we will always have to incur transaction costs to gain perfect knowledge before we are comfortable enough to transact with each other.  The fact is, this is not always true, and there are plenty of examples where humans collaborate not because of extrinsic rewards, but because they genuinely believe in the greater good.  In such cases, investing in systems to address opportunistic behavior would be wasted effort, and these systems do not come free.

2)the second limitaion states the approach presents a static,
comparative view of why different economic institutions exist, develop
or decay. Transaction-cost economics indicates that for a given level
of uncertainty and amount of trust between the parties there is
usually a limited number of governance structures that are more
efficient and will survive in the long run. When circumstances change,
efficient governance structure must adapt swiftly, or it will be swept
away by competition. The approach is silent, however, on the forces
that make certain organisations stickier than others. In summary,
transaction-cost economics seems to assume an implicit notion of
frictionless change. It ignores the widespread role of transition
costs in socio-economic organisations undergoing continuous change.
( Totally unable to comprehend and provide substantial examples
relevant to this point.....what is even socio economic organisations
undergoing continuous change?)

Antonio is trying to say that TCE is based on 2 key forms of governance structures: the hierarchy and the market, and that organisations must be prepared to switch from hierarchy form to the market form, or vice-versa, depend on the transaction-costs.  If TCs are low, firms do better to resort to the more efficient market-form.  If TCs are high, firms should keep more of their activities in-house as a hierarchy, to gain better control over costs.  According to TCE, if organisations fail to react properly to changes in TCs, they will not survive in the long run.

He goes on to say that the TCE ignores the cost of transiting from one form to the other form.  TCE assumes that there is no transition cost to switch from a market form to a hierarchy form or vice versa.  In reality, transition cost is always present in both technical and social aspects, and it could be prohibitively high.

 

I think this 2 limitations are important but I believe it wasn;t
discussed explicitly by Dr Antonio and I believe little student truly
understand these limitations.

Sorry for asking a direct answer on my initial post as I thought it is
just a little late and too much to be fully able to discuss those
issue at this moment.....

At the danger of over-simplifying the issues, you may think of the limitations of the TCM based on the above discussion as:

1) Investment in ICT to reduce transaction costs will actually increase transaction costs since ICT incurs IT coordination and processing costs

2) Transforming an organisation as a hierarchy to a more market-like form, eg. outsourcing, requires additional transition costs in the form of new investments in ICT and technical expertise, and massive structural changes within the organisation as it have to retrench its staff and hire new ones who are able to use the ICT to manage and coordinate its outsourced partners.