The Transaction Costs Theory of the Firm

The Transaction Costs Theory of the Firm
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The Transaction Costs Theory of the Firm
Transaction cost theory description
The theory regarding transaction cost as put forward by Oliver Williamson and Ronald Coase, highlight that organizations are faced with huge economic costs together with matching economic advantages within the entire transactions or captivities (Carroll, 1999, p.11).
Transaction cost theory attempts to give explanations concerning why companies survive, and why they experience expansion or supply activities towards external environment. This theory presumes that companies attempt to minimize resource exchange costs with environment, as well as attempting to minimize exchange cost bureaucracies in the company (Sautet, 2000, p.7). It is therefore clear that companies weigh resources exchange costs with the involved environment, in opposition to bureaucratic costs regarding accomplishment of activities internally.
The theory perceives markets and institutions as diverse in coordinating and organizing economic transactions (Williamson, 1981, p.549). In cases whereby higher external costs are experienced compared to internal routine costs of the company, growth of the company is experienced, due to the fact that the company has the capacity to accomplish its activities in ways which are cheaper than situations whereby the activities would be accomplished within the market (Dow, 2003, p.21). Nevertheless, in cases whereby the higher technical costs of activities’ coordination are experienced compared to external costs of transaction, it is clear that downsizing of the company will be realized.
In accordance with Coase, companies have the capacity to expand provided that their activities may be carried out cheaply in the company, compared to cases whereby the activities are outsources to external providers within the market (Casson, 2001, p.33). Transaction costs come up when transfer of commodities occurs across separable interfaces in technological terms. For that reason, a rise in transaction costs is experienced whenever transfer of commodities occur across stages, wherein new technological capabilities’ sets are required towards making of the commodities.
Transaction cost theory has been found to consider the assertion that existence of the firm is attributed to its ability to economize upon market-oriented production costs (Williamson, 1988, p.70). Firms turn out to be the most fundamental economic device towards market costs’ reduction. As a result, the effectiveness advantages regarding any firm or organization are looked upon by Coase as supreme in cases whereby contracts in long-term are negotiated. It has been pointed out that long-term contract together with contracts as well as further arrangements which address employment and staffing issues are usually preferred unless negotiation costs and enforcement regarding short-term or separate market contracts turn out to be low (Sawyer, 2000, p.51). Within the present report context, understanding of transaction costs will be within the employee turnover context, by means of special reference towards the involved industries.
Related transaction costs to resources’ exchange with external environment may be reflected by a variety of factors including core assets of the company, bounded rationality, risks, opportunism and environmental uncertainty. These factors have the capacity to potentially augment external costs of transactions, in which case it may turn out to be highly costly for the factors to be controlled by a company (Penrose, 2000, p.66). As a result, it may be more economical for internal activities to be maintained, so as to ensure that resources will not be used by the company towards activities such as supervision, meetings and agreements with suppliers. This supports the idea that in cases whereby the company perceives high environmental uncertainty, they have the likelihood of choosing not to exchange or outsource resources with their environment.
In accordance with the theory, managers have to weigh transaction costs which are internal against transaction costs which are external, prior to making of decisions about whether to carry out activities internally or externally (Foss, 2005, p.17).
Differences between transaction cost theory and traditional firm theories
A variety of differences have been experienced amid transaction theory and other transaction form theories. These may best be brought out by examining the aspects upon which each of the theories focuses upon. This may be brought to light as follows.
For instance, theories which are more tradition hold that firms make production decisions which allow them to attain maximum possible profits. It points out that companies are generally profit maximizers. Owing to the fact that firms have the capacity to maximize profits in cases whereby Marginal costs are equivalent to marginal revenue, traditional firm the...