2
Cooperation and Transaction Costs Theory
2.1. Introduction
The “new” theories of the firm, which cover transaction costs, the theory of the agency (Chapter 3) and property rights theory (Chapter 4), all challenge the neo-classical paradigm of the firm according to which an “abstract” producer combines the factors of production in the most favorable way. In the 1970s and the 1980s, when this restrictive outlook no longer adapted to the complex reality of the firms, new theoretical approaches emerged, which placed firms at the heart of the analysis and incorporated other parameters such as uncertainty, information asymmetry, limited rationality and opportunism.
These thoughts around the notions of transaction, contract and coordination costs, with the ultimate aim of increasing performances, have been largely analyzed by many authors in the field of strategic management in order to better assess the phenomenon of cooperation. In this sense, alliances have emerged as an intermediate form between the market and the hierarchy, in that they reduce transaction costs while preventing an increase in organizational (or bureaucratic) costs.
2.2. The logics of transaction costs
According to the theory developed by [COA 37], resources can be allocated in two ways: either via the market or via the firm. The originality of this analysis lies in that the author acknowledges the existence of operating costs in the market. The system that relies on market-specific prices engenders transaction costs, which justify the existence of firms, which are then responsible for minimizing the same costs. Building on previous works, [WIL 75] intended to ascertain the origin and the nature of transaction costs, he observed that an optimal structure (either market or hierarchy) can be determined by combining asset specificity costs, the degree of uncertainty of the transaction and the total number of transactions performed.
2.2.1. Coase and the market costs
Robertson was the first author to try to explain the reasons for the birth of a firm. His question was formulated in the following terms: why these islands of conscious power emerge in the ocean of unconscious cooperation “like lumps of butter coagulating in a pail of buttermilk”? As organized entities, firms represent a true paradox for market theory [JOF 87]. Coase later tried to provide answers to this interrogation, going against the neoclassical tradition (even if he used the concept of substitution at the margin), which denied the specificity of the firm, reducing it to an abstract entity, to a “simple function of production”. [COA 37] explained: “Since there is apparently a trend in economic theory towards starting analysis with the individual firm and not with the industry, it is all the more necessary not only that a clear definition of the word ‘firm’ should be given but that its difference from a firm in the ‘real world’, if it exists, should be made clear.” The firm can then be interpreted as an alternative mechanism to market, presenting advantages and disadvantages in resource allocation. In this way, Coase intended to reveal the specificity of the firm in economic action by establishing a difference between price and hierarchy coordination.
The firm can be defined as the place where resource allocation through pricing mechanisms is no longer valid. “The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism” [COA 37]. Until the writings of Coase, numerous authors had focused their attention on the role of prices as system coordinators. However, economic analysts had completely ignored other possible means of coordination, in particular those taking place within the firms themselves (hierarchical coordination). Let us make a difference between two types of costs:
- – Market-related costs. Firms buy goods and services on the market. The pricing system is the main variable for orienting production, and coordination is done by exchange. However, there is a cost for using this system. The workings of the market are not free. Why? First because there is a cost associated with information research. It is “the most evident cost of organizing production” via the pricing system, which requires the determination of an adequate price. This type of cost can be reduced but not eliminated, thanks to the assistance of specialists who sell this type of information [COA 37]. Information costs may be related to market research studies for detecting needs and their evolution, as well as shopping and consuming habits of future buyers. Then, there is the second cost, associated with negotiating and concluding separate contracts for each transaction taking place in the market;
- – Internal organizational costs. A way in which a firm may reduce market costs is by internalizing transactions. The firm exists because it enables certain economic transactions between its different members at a lower cost that exclusive market mechanisms do not permit [OUC 80]. Under these conditions, a priori, we should witness a continuous and unlimited expansion of the productive system until manufacturing is only assured by a single firm. However, this is not what usually happens and the reason is that the organization itself has costs. The existence of organizational costs sets a limit to the capacity of firms to completely replace the market. The bigger a firm becomes, the more its “coordinating” function is confronted to decreasing returns (information poorly identified by the entrepreneur). In this sense, the more a firm internalizes, the lower its internalization benefits.
“A firm becomes larger as additional transactions (which could be exchange transactions coordinated through the price mechanism) are organized by the entrepreneur and becomes smaller as he abandons the organization of such transactions” [COA 37].
2.2.2. Developing the theory of transaction costs: Williamson
These first explorations were further developed by Williamson [WIL 85], who defined a transaction as “a transfer across a ‘technologically separate interface’”.
“A transaction entails a cost: first, it is necessary to find a contact for the transaction, and then an agreement has to be reached, and its terms, respected” [THI 87].
Williamson’s contribution was to account for all the factors that affect transaction costs, bearing in mind that these can be defined in various ways. Briefly, transaction costs can be considered as a set of costs specifically related to the management of the “face-to-face between two economic agents, either individual or collective” [JOF 87]. In more general terms, transaction costs can be defined as the “operating costs of the economic system” as Arrow (ARR 69) phrased it, and specifically, it is “what it costs to resort to the market to allocate resources and to transfer ownership rights” [MEN 90]. They are, in fact, “market utilization costs” [MOR 91] and [WIL 85] stresses that these are not to be confused with production costs.
Williamson continued to build upon Coase’s problematic, which in fact connected two dimensions: transaction costs and the decision concerning a “pertinent” or “adequate” price, together with the unforeseeable character of the contract’s negotiation and conclusion. Nevertheless, he deepened his analysis by identifying the different actors at the origin of transaction costs in a market setting. He particularly made a distinction between human factors (bounded rationality, opportunism and information-processing capacities) and the factors related to the firm’s environment (namely uncertainty and small numbers.)
2.2.2.1. Composition of transaction costs and behavioral assumptions of agents
2.2.2.1.1. Limited rationality
In neo-classical theory, the economic agent is considered as a rational being seeking to maximize his/her well-being. Among these agents, firms intend to maximize their profit. Indeed, this rationality (maximization of benefits under certain conditions) – at the level of either the individual or the firm – is a complete abstraction. In fact, even if agents are supposed to make rational decisions, their aptitude to do so is seriously limited. The concept of bounded rationality was updated by Simon (1957), who referred to “the capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required for objectively rational behavior in the real world — or even for a reasonable approximation to such objective rationality” [SIM 57].
The complexity of current operations and uncertainty are so acute that individuals cannot perform truly rigorous calculations. They simply do not have all the information that would be necessary for making decisions. Moreover, even if they had all the information, they would not be able to store or process it.
2.2.2.1.2. Opportunism
The second category of factors at the core of transaction costs is linked to opportunistic behavior. This type of behavior involves the agents acting in their own interest, to the detriment of that of partners, and seek to achieve supplementary gains or take ownership of a part of the surplus that would have otherwise been destined to other partners (hold-up behavior). The opportunist seeks individual interest through cunning [WIL 81]. This result can be explained by a gap in information, which may have led to different appraisals of the situation or the non-respect of engagements. The feeble number of protagonists equally enhances the opportunist’s behavior. [WIL 75] further distinguished between the “small numbers ex ante” and the “small numbers ex post”.
“Transaction costs appear when -starting at a largely competitive situation- the execution of the contract itself transforms the commercial relation into a dependency bond between the parts, because these progressively acquire specific experiences or are invited to make specific investments linked to the contract’s execution. When the moment comes to renew the contract, the parties will have more difficulties in changing partners and will find themselves, in a certain measure, locked in the bilateral exchanges” [GAR 91].
This eventually leads partners to a situation similar to that of “bilateral monopoly” [WIL 75]. Opportunism entails a degree of “moral hazard” or “moral peril” [WIL 81] over the different partners of a transaction (or cooperation) in the measure that personal aims can be pursued to the detriment of collective interest. Here, we may also refer to information opacity, which amply results from uncertainty, opportunism and limited rationality [WIL 75]. Information flows are not necessarily known to all of the agents; those who are not involved in the transaction will not be able to acquire this piece of information, which has a supplementary cost. Williamson made a difference between ex ante opacity (which exists at the beginning of negotiations) and ex post opacity (which develops during the execution period of the contract). He later made a distinction between ex ante and ex post transaction costs.
2.2.2.2. The features of transactions
Apart from analyzing its costs, Williamson also described the appearance of a transaction. Inspired by Coase, Williamson reminded us that transactions reunite three features:
- – specificity, a fundamental aspect;
- – uncertainty degree;
- – frequency with which the transaction takes place.
2.2.2.2.1. Specificity of assets
This refers to the existence of a “specific” investment inherent to the transaction, which entails a cost (this is related to the notion of sunk costs). The concept of asset specificity can be interpreted in terms of complementarity and re-deployment. The assets are specific when they are complementary. In this way, their cooperation engenders a quasi-rent regarding their use without cooperation [BRO 89]. These assets cannot be easily re-deployed because they are specialized.
“Specificity is the attribute of resources which determines that their productive value is much higher within a particular process –for which they are being the object of the transaction-than in any other type of activity” [GAF 90a].
2.2.2.2.2. Uncertainty
The second most important attribute of a transaction is uncertainty in relation to the environment where it shall take place. In fact, “the different states of nature” cannot be known with certainty or precision, nor even be imagined, because the ability of agents to conceive plans is dramatically reduced and their rationality is limited. There is a distinction between risk and uncertainty [KNI 21]. Risk can be assessed in terms of probability and can be measured. In contrast to this, uncertainty cannot be measured through a probability distribution because of its random character.
2.2.2.2.3. The frequency of transactions
The more a transaction takes place, the more the agents have an interest to organize it in the long term. In fact, in a situation where the three factors are combined, it is important to save the resources involved in the transaction. As we have previously mentioned, these factors are asset specificity, uncertainty and frequency of transactions.
Williamson summarized his ideas in a diagram representing the direct relations between limited rationality, uncertainty and complexity, as well as opportunism and the small numbers. Opacity can generate situations leading to small numbers. The advantages of internalization according to [WIL 75] can be summed up in five major points:
- – when market relations become too complex and contracts become unenforceable, the organization facilitates sequential and adaptive decision-making;
- – in the face of small numbers, internalization makes it possible to decrease the bias toward opportunistic behavior;
- – it favors the reduction of uncertainty;
- – internal organization combats information opacity and reduces the propensity toward strategic behavior;
- – a generally more satisfying environment is obtained.
2.3. Alliance, market and hierarchy
Coase was not interested in the intermediate forms of organization, equally known as “quasi-internalization”, “quasi-integration” or cooperation. It was other authors, namely Williamson, who provided an explanation for the existence of these intermediate forms. On the basis of transaction costs, two tendencies can be drawn concerning the triptych “alliance, market and hierarchy”. The first trend considers alliances as an intermediate form between market and hierarchy [HEN 88, HEN 89, HEN 90b, IMA 84]. The second approach privileges alliances as an alternative form to market transactions and hierarchy [RIC 72, CIB 91]. This distinction basically unveils the difficulty of defining the notions of market and hierarchy with accuracy.
2.3.1. The alliance, an intermediate form between market and hierarchy
Williamson built on the works of Coase and Chandler. [CHA 88] was particularly interested in the dynamics of competition and cooperation in the US railway industry between the 1870s and the 1890s. He studied and identified the beginnings of active cooperation between private firms in the sector, a totally unprecedented phenomenon at that time.
Williamson conceived the possibility of a “hybrid mode of organization”, a distinct set of intermediate situations combining market mechanisms with administrative procedures. In this perspective, Williamson was followed by other authors.
Still, [WIL 81] grew beyond the classic dichotomy market/hierarchy. He mainly focused on the most effective governance structure: the market, the company and the “mixed” forms, including franchising. It is interesting to observe that Williamson long denied the fact that these forms could even exist, before having to admit that they were, in fact, widespread.
“Whereas I was earlier of the view that transactions of the middle kind were very difficult to organize and hence were unstable, on which account the bimodal distribution was more accurately descriptive (Williamson, 1975), I am now persuaded that transactions in the middle range are much more common” [WIL 85].
Alliances reduce transaction costs without having to bear an increase in organizational costs. They limit market utilization costs because they are generally focused on the long term. They equally make it possible to reduce information imperfection, to soften opportunistic behavior and reduce aversion to risk and uncertainty.
In a situation where there is a conjunction of the three factors (asset specificity, uncertainty and transaction frequency), it is important to save the resources involved in the transactions. The higher the level of uncertainty surrounding a transaction, the more expensive it will be to resort to contracts to coordinate the successive stages of production, and the stronger the incentive to internalize. Williamson considered that each type of transaction can be associated with a type of management structure (see Table 2.1), thus resulting in four different situations:
- – The first case is that of the market. This type of coordination is more effective in the case where an investment is unspecific or where transactions are not recurring. It propitiates “classical contracts”, aimed at standardizing products. It is more a question of sales rather than contracts. Opportunism risks are limited thanks to the existence of substitutability between partners and the virtual absence of “small numbers”;
- – The second case is that of three-sided structure. Transactions are subjected to a relatively high degree of specificity, what leads to a “small number” context, risking opportunism. The choice of an integrated structure is not justified (non-recurring transaction). A third party (arbiter) is in charge of solving possible conflicts and evaluating performances;
- – The third case is that of an internalized structure which becomes imperative when the asset is very specific and utilization frequency is very high. Indeed, such a situation leads to a major risk of opportunism;
- – The fourth case particularly strikes our attention in the measure that it resonates with inter-firm cooperation. It refers to bilateral contracts in which the autonomy of each party is respected and every partner has a trustworthy commitment toward another. Resorting to such formulas is appealing when relatively specific assets are the object of frequent transactions. This negotiation formula costs less than internalization [GLA 92].
Table 2.1. Management structures and typology [WIL 86]
| Type of investment Frequency | Unspecific | Moderately specific | Idiosyncrasy |
|---|---|---|---|
| Weak | Market structure (classical contract) | Three-sided structure (with arbitration) (neo-classical contract) | |
| Strong | Two-sided structure (personalized contract) | Internalized structure |
Several agreements have been analyzed thanks to the theoretical framework suggested by Williamson (see Table 2.2). This is particularly true of the joint venture (JV), a privileged agreement in international economic relations (see Chapter 8).
Kogut studied the reasons behind the creation of a JV [KOG 88a, KOG 88b]. He considered that this can be explained with the help of three theoretical approaches: “transaction analysis”, the study of strategic behavior (see Chapter 5) and finally, organizational learning. Kogut explained the extent to which the JV differs from other organizational forms, and more precisely, under what conditions a JV will be preferred to a contract. Two elements are involved in this choice: on the one hand, there is the question of sharing the assets’ ownership and control and, on the other hand, there is the question of how to manage joint resources. It is the combination of two factors, namely a high degree of asset specificity and the uncertainty over the definition and control of performances that lead to the creation of a JV rather than signing a contract. To illustrate this point, Kogut identified two categories of JV.
Table 2.2. Transaction costs theory: a conceptual framework of different organizational forms
| Themes | Authors |
|---|---|
| Cooperation and resource allocation system | Imai and Itami [IMA 84] |
| Joint venture (JV) agreement | Kogut [KOG 88a, KOG 88b] |
| JV and company multi-nationalization | Hennart [HEN 88, HEN 09] Beamish and Banks [BEA 87] Svejnar and Smith [SVE 82, SVE 84] |
| Mutual organization | Thietart and Kœnig [THI 87] |
| Alliance, clan, network, market and hierarchy | Richardson [RIC 72] Ouchi [OUC 80] Jarillo [JAR 88] Ciborra [CIB 91] |
| Vertical integration (empirical works: aerospace, automotive industries) | Masten [MAS 84] Walker, Weber [WAL 84] Walker, Poppo [WAL 91] Monteverde, Teece [MON 82] |
| Licenses | Teece [TEE 81] |
| Costs associated to different organizational forms | Williamson [WIL 91] |
The first category represents a vertical investment for a firm and a horizontal investment for the partner. In this case, the JV replaces a simple supply contract. The alliance is the result of an advantage in terms of production costs for the supplier, associated with the risks run by one of the firms (or both) involved in the agreement. There are different types of risks: market-related information possessed by the firm placed downstream, the use of new technologies and the quality of the supplier’s services. The JV makes it possible to solve these problems by stabilizing the agreement on how to share the costs and benefits. As Williamson cleverly observed, the agreement is stabilized through “mutual hostage exchange” via a shared commitment of financial or real assets, as well as incentive mechanisms.
In the case of contracts where there is no financial participation, cooperative behavior may be adopted, but this requires more stringent conditions than a JV. In order to prevent opportunism, the contract must clearly stipulate all the rules of conduct and obligations. In a JV, initial commitments and profit-sharing rules are specified, parallel to the introduction of administrative procedures for monitoring and evaluation.
The second type of JV refers to a horizontal investment made by both firms. Companies combine their efforts in one (or several) fields of activity along the value chain. This case appears to correspond to the alliance of type Y, defined by Porter (see Chapter 1). The characteristic of this more complex JV is that it employs assets that are likely to devalue: technological advantage, reputation and image related to a trademark. In fact, it is the initial complementarity between the partners’ assets that motivates joint cooperation (see Richardson) and which can encourage innovation in the first place. It may also give rise to a transaction risk problem for the externalities related to imitation and technology (see Chapter 4). This type of behavior would then push the other contracting party to reduce the amounts of goods produced or to increase their prices. A JV solves these problems through the creation of a homogeneous asset management structure controlled by both firms through ownership and rights control.
Ultimately, resorting to a JV is recommended when uncertainty about the outcome is high and when the assets of one firm (or both) are specific, because this strategy avoids having to face the high cost of fully acquiring a firm.
2.3.2. The alliance, an alternative form to market and to hierarchy
Some authors have tried to expose the need to reduce divide between those transactions made within the firm and those made on the market, thus permitting a better apprehension of the phenomenon of cooperation. In contrast to previous works, they considered that the alliance is an alternative form, different from the market and hierarchy.
2.3.2.1. Alliance, clan, market and hierarchy
[CIB 91] developed a typology in which alliances, far from being hybrid arrangements, constitute a completely new form, independent of that of markets, hierarchies and clans. [CIB 91] took up the concept of clan, developed by [OUC 80], based on reciprocity, the legitimacy of authority and the belief in common values.
| Control mechanism | Normative conditions | Informative conditions |
|---|---|---|
| Market | Reciprocity | Price |
| Bureaucracy | Reciprocity Legitimacy of authority | Regulations |
| Clan | Reciprocity – Legitimacy of authority Common values and beliefs |
Traditions |
In this typology, agents have a limited capacity to influence the market and mainly depend on local information. Hierarchy possesses a greater capacity to process information, but has limited learning capacities, a certain inertial bureaucracy. On the contrary, the cohesion within a clan or a group is strong because its members share values, implicit traditions and common aims, all of which practically erase the possibility of opportunistic behavior. Also, clans rely on a dense but flexible communication network. This is their greatest asset.
The alliance simultaneously shares the features of the market and the clan. While it has a weaker capacity to manage information than a clan, it favors flexibility, trust and learning more than markets do. As an organizational form, the alliance can establish itself more rapidly than a clan or a hierarchy, thus revealing a higher dynamic efficacy. In some ways, it represents a decentralized form of organization, combining high levels of autonomy, certain market elements and limited opportunism.
[JAR 88] equally completed the analysis of [OUC 80] by adding a fourth category to the three forms, which have recently been mentioned (market, clan and bureaucracy). This is the strategic network that enables a large company to maintain dense and regular relationships with other companies. Contractual relations that are often knit within networks may, in certain cases, be assimilated to full-fledged alliances. The question of interorganizational networks will be studied in Chapters 5 and 6.
2.3.2.2. Richardson’s approach
Richardson first defined cooperation as a coordination mechanism. From his viewpoint, as indicated by [DUL 94]: “co-operation represents the output of the agreement: the agreement aims to produce the cooperation process itself, the partners work together and coordinate their activities with distant objectives in view.”
Contrary to this, when cooperation is considered as an input, it “dissolves in its own materialization, because each of the partners separately exploits the pool of assets constituted by the agreement” [DEL 91a].
[RIC 72] considered the broad variety of inter-firm cooperation forms:
“What confronts us is a continuum passing from transactions, such as those on organized commodity markets, where the cooperative element is minimal, through intermediate areas in which there are linkages of traditional connection and goodwill, and finally to those complex and inter-locking clusters, groups and alliances which represent co-operation fully and formally developed. And just as the presence of co-operation is a matter of degree, so also is the sovereignty that any nominally independent firm is able to exercise on a de facto basis, for the substance of autonomy may often have been given up to a customer or a licensor.” [RIC 72]
On the basis of this observation, he developed the idea that cooperation is not a form of intermediary organization between the firm and the market, but an alternative form to market transactions, which constitutes a different viewpoint from the perspective of transaction costs. As stated in [RAV 90]: “Richardson aims to formally set up the role of inter-firm cooperation as a relevant phenomenon in the study of industrial activities coordination.”
This approach sets the author apart from the majority of inter-firm cooperation analysts, who have generally assimilated the concept of cooperation to a hybrid form of organization, which combines the advantages of hierarchy to those of the market [IMA 84, AOK 88].
“The dichotomy between firm and market, between directed and spontaneous coordination, is misleading; it ignores the institutional fact of inter-firm cooperation and assumes away the distinct method of co-ordination that this can provide” [RIC 72].
From the viewpoint of [RIC 72], the theories of the firm do not explain the principle of labor division between firms and markets, or the multiplicity of alliances models. This is due to a partial perception of the firm, which limits it to a productive function, neglecting other essential elements such as organization, knowledge, experience and skills.
Basic assumptions made by [RIC 72] are closely related to the concepts of similarity and complementarity. The notion of industry is introduced as accompanying a very large number of activities, which may represent different phases of a production process (R&D, production, sales, etc.). These activities should be carried out within organizations on the basis of appropriate competencies. The author considers that the activities of a firm have a strong tendency to be similar and that complementary activities must be coordinated from quantitative and qualitative viewpoints. While activities described as similar are those that require an exercise of identical abilities (same knowledge, same experience, same qualifications), complementary activities are those that correspond to the different phases of the same production process.
The coordination of economic activities finally comes down to an analysis of the complementarity of the different forms of organization at hand:
- – direction: the activities are subject to a unique control and integrated in a coherent plan;
- – cooperation: two or more independent organizations agree on how to harmonize their plans beforehand;
- – market transactions, in the context of “spontaneous coordination”.
There is a labor division between management and other forms of cooperation in economic activities. The nature of the division depends on the complementarity and similarity of tasks. When the activities are similar and complementary, they are coordinated by the organization (hierarchy). When activities are closely complementary but dissimilar, they need to be coordinated ex ante through the implementation of cooperation agreements between firms. Finally, when activities do not require any kind of qualitative coordination, they are the responsibility of the market.
In sum, the contribution of [RIC 72] can be applied to operations in which a vertical type of cooperation takes place, but it suffers from certain limitations for strategic alliances.
In more recent works, [RIC 03] revisited the arguments of his 1972 article and once again stressed the importance of the thorny question of cooperation, which still remains to be addressed.
2.4. Limitations of the contribution of transaction costs theory to the analysis of strategic alliances
Two series of critical observations can be made in relation to the theory of transaction costs. The first one is linked to the very concepts of this analysis and, more particularly, to the notion of transaction costs. The second one has to do with the fact that this theory cannot account to explain the “Why” and the “How” of cooperation practices. By itself, the theory of transaction costs can barely explain the choice of one organizational mode over another [GUG 91]. It may well justify the contractual or internalized efficacy of organizations, but does not account for their prime motives [DEL 91a].
2.4.1. Issues associated with transaction costs
It is advisable to undermine the commonly held view that contractual agreements make it possible to avoid both transaction costs and organizational costs [DEL 89].
2.4.1.1. Persistence of transaction costs in the context of alliances
Alliances do not systematically eliminate transaction costs, particularly those associated with opportunism, even if this behavior is largely mitigated in the context of more formal cooperation modes than joint ventures. However, even in this case, [HEN 88, BEA 87] highlighted that the incentives for opportunism do not completely disappear. In fact, each partner could eventually find it more rewarding to maximize his/her own gain to the expense of the agreement. The efficacy of a JV finally depends on the type of aims pursued by the agreement partners.
This is also the case for mutual organization, which is formed in such a way that the partners behave in the interests of all.
On the contrary, while licensing agreements help avoid certain costs related to the creation or acquisition of a production unit, they nevertheless generate transaction costs. Several difficulties related to transactions were identified by [TEE 81] and summarized in three terms: identification (recognition), disclosure (communication) and organization in collective work.
To be specific, different types of costs can be identified. Firstly, there are costs linked to searching negotiation partners and problems related to contract execution and control. It is necessary to carry out the negotiations, establish (draft) the contract and verify that the terms of the contract have been respected. Nevertheless, the transfer of knowledge and technological or managerial expertise are private pieces of information, demanding a degree of reserve concerning the divulgation of the contents. Hence, there is a “fundamental paradox” of information, as was pointed out by [ARR 71]. The talent of the salesperson comes down to “partially” disclose his know-how before a contract is signed in order to reduce the buyer’s uncertainty, who would courageously accept the risk of such a transaction.
There are also costs associated with the risk of dissipation of transferred technological advantage: this risk grows bigger when the appropriation regime is weak (insufficient legal protection), and opportunistic behavior on behalf of one of the partners cannot be taken for granted (see Chapter 4).
Finally, there are the costs attributable to the risk of loss in the final quality of the product. [HOR 87] particularly insisted on this point: “the existing reputation of a product engenders a consequence: every license agreement encourages the license holder to keep up with the reputation of the product and thus gives him a motive for internalizing transactions.”
2.4.1.2. Underestimation of other costs
This theory largely underestimates the various types of costs associated with different organizational modes. We may wonder up to what extent transaction costs are more significant than other types of costs, such as transportation, production or distribution costs.
Business surveys such as the one carried out by [MAR 83] concluded that the reduction in transaction costs is not a driving force in business agreement strategies. In their research, these two authors were expecting to find that the aim of cooperation was to reduce not only the transaction costs of specific contracts but also other legal or otherwise identifiable costs. For this, they interviewed various business executives across all sectors to determine whether transaction costs were significant in their decision for entering into alliances. In all cases, the executives argued that the avoidance of transaction costs was not a fundamental gauge in their decision-making scheme.
Another interesting study carried out by [WAL 84] showed that when confronted with the choice “to make or to buy”, the executives of an American automotive firm made their decision focusing exclusively on production costs and ignoring transaction costs. Both authors confirmed the influence of transaction costs on the decision of whether to manufacture components or to purchase them through the effects of competition on the supplier market, as well as the uncertainty factor surrounding desired volumes and technology. The author’s hypothesis was that in addition to transaction costs, decisions were predictable under the light of a buyer’s previous productive experience, as well as by comparing production costs between the buyer and the supplier. The results revealed the pre-eminence of production costs involved in the decision, which could also be explained by the complexity of the components.
2.4.1.3. Partial analysis of strategic alliances
Williamson did not establish an alliance typology. However, he associated a particular management structure to each type of transaction (Table 2.1). Among the different types of contracts he identified, he particularly focused on the “framework contract”, which implies a long-standing relationship between the partners. This contract symbolizes outsourcing relations. From this perspective, an alliance is reduced to a simple form of vertical integration. It would then seem that the theory of transaction costs:
“is most fertile when analyzing and modeling the relations between actors at the different stages of the economic sector (filière économique) that is to say, essentially, during vertical integration […]. The approaches derived from the theory of transaction costs, including the scale/link problematic, do not clearly distinguish between the alliances of competing firms from the whole range of inter-firm cooperation” [DUS 91].
Since the beginning of the 1990s, alliances have mostly taken place between rival firms. The reduction of transaction costs does not systematically constitute the major reason for forging strategic alliances.
Besides, the theory of transaction costs neglects the sectoral dimension and leads to difficulties in interpreting strategic alliances, particularly in high-tech sectors. As noted in [RAI 88], because of the uncertainty associated with R&D and the specific investments that this industry requires, such an activity cannot be separated from production. On the contrary, this situation calls for integration into the company. Yet,
“Cutting down on transaction costs is simply not enough for explaining why an alliance should take place in a very innovative sector. Reasoning in terms of transaction costs should always entail the use of internalization under these conditions. However, practice has shown the opposite: it is mainly in the high-tech sectors where the alliances take place. Firms invest enormous financial resources and undertake strategic investments” [CIB 91, p. 55].
2.5. Conclusion
The theory of transaction costs has given rise to numerous works in the field of not only economics but also strategic management. In particular, a closer understanding of hybrid forms of organization (cooperation agreements, joint ventures, franchising, etc.) has been made possible thanks to this conceptual framework. Two broad categories of agreements must be distinguished. Transaction costs have a certain degree of explanatory power over well-defined cooperative structures [CIB 91] such as the formation of joint ventures. However, these explanatory factors are insufficient to account for more flexible forms of cooperation and of the lesser defined factors such as strategic alliances.