Procurement: the Transaction Costs Perspective in a Globalising World

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TI 2007-091/3

Tinbergen Institute Discussion Paper

Procurement

Frank A.G. den Butter

VU University Amsterdam, and Tinbergen Institute.

Tinbergen Institute

The Tinbergen Institute is the institute for

economic research of the Erasmus Universiteit Universiteit Amsterdam. Tinbergen Institute Amsterdam Roetersstraat 31 The Netherlands Tel.: Fax: 1018 WB Amsterdam +31(0)20 551 3500 +31(0)20 551 3555

Rotterdam, Universiteit van Amsterdam, and Vrije

Tinbergen Institute Rotterdam Burg. Oudlaan 50 The Netherlands Tel.: Fax: 3062 PA Rotterdam +31(0)10 408 8900 +31(0)10 408 9031

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This version: 19 November 2007

Procurement: the transaction costs perspective in a globalising world Frank A.G. den Butter ∗
Abstract Fragmentation of production into more and more complex supply chains is a prominent feature of globalisation. It implies that transaction costs as part of total costs of ownership carry a large weight in procurement decisions. An analysis of the various types of transaction costs is also essential in the “make or buy” and location decisions in global sourcing. A distinction can be made between “hard” and “soft” transaction costs. Soft transaction costs are difficult to quantify but become more important in strategic business decisions now that formal trade barriers gradually disappear and transport costs are reduced. Business strategies to keep transaction costs low in the long run can also, to a considerable extent, explain socially responsible business conduct from the perspective of rational economic behaviour Keywords: procurement, outsourcing, transaction costs, managing transactions, orchestrating the supply chain. JEL-codes: F23, M14, M21

A previous version of this paper was presented at the “Supply management summit: Globalisation, how far can we go?”, November 8th and 9th, 2007, De Holtweijde, Lattrop.



Vrije Universiteit, Department of Economics, De Boelelaan 1105, NL-1081 HV Amsterdam, The Netherlands, tel. +31-20-5986044, fbutter@feweb.vu.nl..

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Procurement: the transaction costs perspective in a globalising world 1. Introduction The split up of the supply chain in more and more parts is a prominent feature of the ongoing globalisation in the world. In fact this fragmentation of production is a consequence of the process of specialisation, which is a major source of productivity growth and economic welfare. In his famous example of the pin factory, Adam Smith already noted the importance of specialisation and division of tasks for productivity. However, on the one hand the economics of scale associated with specialisation reduces production costs, on the other hand, production processes and activities should be coordinated so that the need for coordination increases. The result is an increase in all kinds of transaction costs, associated with the various forms of coordination. The better the coordination processes are organised, the lower these transaction costs are. Therefore, a decrease in transaction costs enables more specification and will result in a further split-up of the supply chain, and in more fragmentation of production. That is exactly what happens in a globalising world. In a globalising world we also observe specialisation in the management of production. On the one hand there is specialisation within the parts of the supply chain where using economics of scale and factor endowments (e.g. cheap labour, available capital, natural resources) production within that part of the supply chain is made more efficient. These are the comparative advantages described by the traditional theory of international trade. On the other hand there is specialisation with respect to organising the coordination processes. More efficient methods in linking the various parts of the value chain are developed and implemented . Here the comparative advantages relate to keeping the transaction costs low...
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