Transaction Cost Economics in Construction Industry

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TCE asserts that transactions have distinct characteristics that explain how firm’s boundaries are drawn and when determine whether “market or hierarchy” will have the lower transaction costs in various circumstances. Asset specificity, uncertainty and frequency are the three variables of TCE that are used to characterise transactions.

Williamson (1979) suggested four main forms of asset specificity, namely site specificity, physical asset specificity, dedicated assets and human asset specificity. Asset specificity refers to the degree to which the investments for a transaction are specific to that particular transaction. In other words it refers to the extent to which the resources required are available from a large number of sources which can be bought from competitive market; or only a few sources and the market is oligopolistic. In the later case, the investment would be less valuable in some second best use if the transaction fail.

Such situations are rare in construction, and are probably limited to the more demanding civil engineering projects (Reve and Levitt, 1984) and high performance specifications in areas such as building services. For instance, most large infrastructure contractor would invest in batching plant/ on-site concrete mixer, which allow specialty concrete mixtures to be developed and implemented on respective construction sites, instead of buy from ready mix concrete manufacturing company. The reasons being (1) concrete has limited timespan of approximately 90 minutes between mixing and going-off; (2) most batching plants are mobile and relocating them is relatively inexpensive; (3) the contractor can easily locate a potential buyer in the market should he decided to dispose it.

There is uncertainty in life. Harold S. Geneen quotes “Uncertainty will always be part of the taking charge process”; John Allen Paulos quotes “Uncertainty is the only certainty there is….”. The issue in transaction uncertainty is that how hard is it to foresee the eventualities that might occur during the course or even at the beginning of the transaction.

Over the last two decades, construction industry has been profoundly affected by economic and industrial change as a result of recession, changing market and increasing competition arising from greater regional and global integration. These changes exposed construction industry players to a great uncertainty in terms of construction projects available and awarded as the pie to be shared are limited. In addition, erratic weather and geological conditions (natural uncertainty) and temporary project-based construction team (organisational uncertainty) levelled up the potential unforeseen circumstances. Not to mention that each project has its own architecture design, structure, mechanical and electrical specification and building material requirement (task uncertainty) that will generate learning curve problems.

While asset specificity and uncertainty has been discussed exhaustively, frequency has received far less treatment in literature (Macher and Richman, 2008). Nevertheless frequency of transaction involved, ranging from occasional to recurrent. Williamson (1985) notes that higher level of transaction frequency provides an incentive for internal organisation as “the cost of specialised governance structure will be easier to recover for large transaction of recurring kind” and vice versa.

For instance, a construction firm might not want to employ architect even though all buildings require architecture design. If the construction firm did employ architect, it would then need to compete with ‘more competent’ architecture consulting firm in the market to seek opportunities to sell the service when the architect is not designing for the firm’s project.

Above-mentioned key characteristics of transactions are made in a behavioural context of bounded rationality and opportunism. Bounded rationality refers the fact that people have limited cognitive...
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