Transaction Cost

Topics: Contract, Transaction cost, Ronald Coase Pages: 8 (2302 words) Published: April 7, 2013

In order to explain and discuss with practical example the concepts of TCE, firm v market, vertical boundaries of the firm, and vertical chain make-or-buy dilemma, I have chosen FAO (Food and Agriculture Organization) of UN, a non-profit specialized United Nation agency, the one I am currently working for. It would be very challenging to describe how TCE theory apply to big international non-profit organizations in terms of complex transaction’s exchanges occurring among UN agencies, members countries and donors aimed to the achievement of difficult multiple Millennium goals (UN,2012) and FAO(2012)[1], not explainable through the model of profit maximization or organization as black-box. Therefore my TCE analysis is restricted to the current internal project GRMS FAO(2012) [3] as one of technical team leader. However I will focus about internal GRMS project managed by AF (Corporate services and procurement, human Resources and finance divisions) and CIO IT divisions. GRMS project is about the implementation of IPSAS (international accounting standard) and the extension of ERP processes and services to all worlds’ offices. The creation of a more consistent administration structure of tools, processes and support is needed by managers to delegate responsibilities more effectively and support the decentralization of emergency operations. Another important benefit is a more efficient management of all 8,000 non-staff human resource employees (NSHR). For the success of the project PRINCE2 (PRINCE2[1]) Process Model has been adopted as shown below Figure2 and than translated in the project vertical chain shown in Figure3.


TCE literature

Transaction cost economics (TCE) theory become popular during the 80s and 90s, however its first definition can be found in the famous Coase’s paper on “The Nature of the Firm”. Coase, in contraposition with economist’s idea since Adam Smith (1776) that market mechanism was the solely efficient coordinator of goods and service exchanges among different traders, affirmed the existence of the firm as an alternative exchange coordinator. At that time the concept of market as efficient coordinator meant that market cost/price of goods and services exchanges were determined as result of equilibrium between consumer demand and quantity supplied (price mechanism) and that the right quantity of goods/service to be produced was driven by consumer demand. As consequences whether a firm would result in allocating efficiently its own resources was depending on its ability to produce the exact quantity in order to meet consumer demand with neither surpluses nor shortages.

Coase(1937) questioned this paradigm by wondering: “Why does most economic exchange happen within organisations if markets are so efficient?” Coase arrived to its conclusion by observing that the production of finished goods or service was a succession of stages of processing and assembling activities. While outside the organization the exchange among different stages was coordinated by the market and therefore the movement of price was driving the production, within the firm instead this costly transaction is eliminated and the complicated market structure is replaced by the entrepreneur co-coordinator. He assumed that agent-principal relationships occurring within organization was a zero-cost transaction. With this argument supported the idea that organizations are an alternative production’s coordinator compared to the market as within the vertical chain of production some factors are coordinated without the intervention of price mechanism (market). The nature of “vertical integration”, in terms of production factors not coordinated by price mechanism, can vary with both industry and firm. Therefore “boundary of the firm” were based on the assessment at any stage whether vertical integrate (make) or make use of the market (buy). However Coase stated that using the “market mechanism...
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