Transaction Cost Analysis as Framework
According to TCA, a transaction is the transfer of goods or a service and the analysis of transactions emphasizes on achieving efficiency in their administration (Rindfleisch & Heide 1997). Firm is a particular form of organization for administering transactions between one party and another and is characterized as a managerial hierarchy. In contrast, market governance is characterized as transaction taking place without managerial oversight. Firms exist because they can sometimes reduce the costs of negotiating and enforcing terms and conditions of exchange relative to market transacting. Transaction costs may consist of ex ante and ex post costs. In the sales service setting, the ex ante costs include the expense of searching for an independent representative and negotiating the price and contract. The ex post costs, such as incompetent sales service (e.g. not meeting sales quota), are incurred after the contract has been signed but before the entire transaction has been completed. If the cost of organizing an exchange in a market exceeds the cost of coordinating the exchange in a firm, the company may go for in house sales, and vice versa.
Williamson’s TCA framework rests on two assumptions about human behavior: bounded rationality and opportunism. First, individuals in a company are bounded rational. It is impossible for a man to foreknow all probabilities and matters that will occur in the future. This limitation makes it impossible to structure perfect contracts. It is also the case that any contract will be incomplete even if all information is available. In fact, environmental uncertainty and behavioral uncertainty worsen the situation. First, environmental uncertainty leads to difficulties in revising the agreement to fit the changing situation. Second, behavioral uncertainty becomes problematic in evaluating whether the performance adhering to the established agreement (Rindfleisch & Heide 1997). In short, TCA holds that when uncertainty is high, internalization will be more efficient than market contracting because market contracts will be excessively costly to write, govern, and enforce.
Second, individuals behave opportunistically. They will act in “self-interest with guile” (Howard & Lam 2001). Theoretically, opportunism is inherent in most of the transactions. Anderson (1988) defines opportunism in sales setting as “1. misrepresenting information, activities or efforts (e.g. falsifying call reports); 2. distorting results (e.g. deliberately selling to questionable credit risks to raise reported sales); 3. misrepresenting intentions (e.g. promising to increase hours worked without intending to do so); 4. misrepresenting selling costs”. A firm is especially vulnerable to opportunistic behavior when it has imperfect control over sales rep, sales rep has personal interest, and contract with sales rep is incomplete. According to Williamson, hierarchical structure is likely to be preferred under such opportunistic situation. The exertion of legitimate authority over employees, monitoring of behavior and offering of more varied incentives can dampen opportunism. It is therefore clear that the TCA has been used to explain not only the existence of firms but also the scope of firm, in terms of vertical integration.
In-House Selling Agents Decision
In house selling agents are the hierarchical governance mode. They are working for the company as employees who are paid by salary or salary plus commission. With the bounded rationality and opportunism assumptions, Wiliamson suggests that three factors play a fundamental role in determining if market or bureaucratic transaction is optimal. The factors are asset specificity, uncertainty, and frequency of transaction (Davies and Lam, 2001)....
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