The economics of organization: The transaction cost approach

Citation: Oliver E. Williamson (1981) The economics of organization: The transaction cost approach. The American Journal of Sociology (RSS)
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Tagged: Sociology (RSS) organization theory (RSS), transaction cost economics (RSS)

Summary

Williamson's article is not the first article introducing his concept of transaction costs but it is the first published in an a sociology journal and targeted clearly at sociologists. It makes an attempt to lay out the basic structure and thinking of transaction cost economics to this audience.

Transaction cost economics builds on Coase's work (specifically: (1937) The nature of the firm) by offering a more realizable theory and set of tools for studying organizations. Williamson's theory treats transactions as the basic unit of analysis and claims that economizing on these costs drives organizations' design of governance structures. The theory assumes opportunism among actors and bounded rationality (a la Simon, 1957).

A transaction, as defined by Williamson, "occurs when a good or service is transferred across a technologically separable interface." (p552) Williamson argues that the critical dimensions for describing transactions are (1) uncertainty, (2) frequency, and (3) the degree to which transaction-specific investments are required to realize least cost supply (i.e., "asset specificity").

Williamson argues that asset specificity is the most important dimension. This is in part because actors are assumed to be opportunistic, and a transaction regarding a specific asset puts people in both sides in a vulnerable position. In the case of one supplier, for example, a buyer can be forced to pay a higher price and if there is only one seller, the opposite situation is in play. In Williamson's terms, under high asset specificity, "buyer and seller are effectively operating in a bilateral (or at least quasi-bilateral) exchange relation for a considerable period thereafter." (p555) In general, Williamson claims that high specificity will drive transaction costs up.

Speaking specifically to the question of organizational boundaries (a key issue in organization theory, see Santos and Eisenhardt (2005)), Williamson's key argument is that we can view a firm based on a series of what to include inside a firm and what to keep outside. Essentially, firms are attempting to design "efficient" boundaries in a world where there is a firm-market dichotomy. Firms allow hierarchy to invoke fiat to resolve differences to provide better access to information. Similarly, increased uncertainty may drive the firm to internalize resources and/or work upon which it is dependent.

Williamson argues that his model also applies to human assets. For example, if a company is investing in firm-specific skills, it won't want to lose employees with those skills. It might therefore choose to focus on internal labor markets.