Transaction Cost Economics aims to explain why certain transactions are done within an organizations rather than on an open market and this fundamental question had been already raised in “The nature of the firm” by Coase (1937). Ronald Coase argued that organizations attempt to minimize transaction costs as these costs can be costly because of the cost of information search, bargaining, etc.
So Williamson subsequently stated the purpose of transaction economics in a more general form, referring to its objective as to “analyze the efficiency of different forms of governance using transaction as the basic unit of analysis” (Williamson 1985). Transaction Cost Economics came against such influential theories regarding the rise of large organizations as the Market Power Theory, that claimed that as an organization grows it is able to exert greater control over a market, so the Market Power provided an explanation for the organizational growth.
Nevertheless, Williamson provided an alternative explanation: the market failure. In a perfect market the transaction costs are null, so the organizations exist and grow because of the transaction costs.
Main variables in transaction cost economics
- Frequency: If a particular transaction occurs very infrequently in an organization, the cost of maintain the necessary resources in-house are too high.
- Uncertainty: If there is a high level of uncertainty, some events may occur that can hurt one of the two counter-party.
- Asset specificity: If the assets involved in a particular transaction are specific to the transaction, the two parties are linked.
Nevertheless, some of the limitations of the Transaction Cost Economics are:
- Behavioral Assumption on profit maximizing
- Differentiating between Transaction Cost and Production Cost is often difficult
- Reputation and Trust are not considered.
- Transactions are assumed to be independent.
With this brief overview it is possible to have a better understanding of the roots of the Transaction Cost Economics.