Resource Dependency and Transaction Cost Economics Theories

Resource dependency Organizations are dependent on their environments They need resources to survive and grow Environment becomes poor if: Important customers are lost or new competitors enter Organizations manage their transactions with the environment The goal: Ensure predictability of access to resources, reduce uncertainty and dependency

Resource dependency (cont’d) Tools to minimize dependency: 1) Exert influence over other organizations to obtain resources 2) Respond to the needs and demands of other organizations in its environment The strength of resource dependence is a function of: 1) Vitality of the resource for org’l survival 2) The extent to which the resource is controlled by other organizations (i.e., monopoly condition)

The general and specific environments REGULATORY INSTITUTIONS LEGISLATIVE INSTITUTIONS COMPETITOR SUPPLIER FIRM EMPLOYEE DISTRIBUTOR CUSTOMER ECONOMIC INSTITUTIONS OTHER INDUSTRIES GOVERNMENT

Interorganizational strategies for managing resource dependence Specific environment: Suppliers, labor unions, customers, customer interest groups Two basic interdependencies in the specific environment: 1) Symbiotic interdependence Exist among an organization and its suppliers and distributors 2) Competitive interdependence Exist among organizations that compete for scarce inputs and outputs

Managing symbiotic interdependence Good reputation Organization held in high regard because of fair and honest business practices Paying bills on time, providing high quality goods & services, reliability, trustworthiness, goodwill Ex: De Beers diamond cartel Acting honestly does not rule out negotiating over price and quality The most informal way of managing sybiotic interdependence

Managing symbiotic interdependence (cont’d) Co-optation Neutralizing problematic forces in the specific environment Bring opponents on the organization’s side Give them a stake or claim to satisfy their interests Ex: Phamaceutical companies and physicians, local schools and parents Inter-locking directorates When a director from one company sits on the board of another (Ex: Financial institution president elected for the board of the company)

Managing symbiotic interdependence (cont’d) Strategic alliances An agreement that commits two or more companies to share their resources to develop joint businesses Ex: IBM (computer skills) and Sears (customer base) establish a joint venture prodigy to provide on-line information service to customers Types of strategic alliances: Long-term contracts Networks Minority ownership Joint venture

Managing symbiotic interdependence – Types of strategic alliances Long-term contracts: Least formal type of alliance Can be oral or written, Kellog has a written contract with the farmer suppliers of corn and rice Agrees to pay a certain price regardless of the market rate when the produce is harvested They both eliminate uncertainty in their environments

Managing symbiotic interdependence – Types of strategic alliances Networks Defn.: “A cluster of different organizations whose actions are coordinated by contracts and agreements rather than through a formal hierarchy of authority” Network members work closely to support and complement one another’s activities More ties that link members and greater formal coordination of activities Ex: Nike builds long-term relationships with suppliers, distributors, and customers to keep core organization from becoming too large and bureaucratic.

Managing symbiotic interdependence – Types of strategic alliances Minority ownership Organizations hold minority shares in each other Keiretsu shows how minority ownership networks operate Members share proprietary information and knowledge that benefit them collectively Capital keiretsu: To manage input-output linkages Ex: Toyota and its suppliers Financial keiretsu: To manage linkages among diverse companies. Has a large bank at the center Ex: Fuyo keiretsu

Managing symbiotic interdependence – Types of strategic alliances Joint venture Defn.: “Strategic alliance among two or more organizations that agree to share the ownership of a new business” Companies that form the new business jointly design its organizational structure Provide resources for it to prosper,sends executives to the new business The new company is free to develop its structure A JV allows the founding companies to stay small

Managing symbiotic interdependence Merger & takeover The most formal strategy Resource exchanges occur within rather than between organizations A powerful supplier can no longer hold an organization as hostage Can be exercised only when an organization has a great need to control a crucial resource or manage and important inter

Managing competitive interdependence Organizations don’t like competition since it: Reduces the supply of scarce resources Increases uncertainty in the environment Collusions Collusion is a secret agreement among competitors to share information for collectively coordinating activities (illegal) Establishing industry standards for: Price, product specifications, profit markup generally by the price leader(s) (Ex: Sony & Philips developing the standard for CD technology)

Managing competitive interdependence Cartels An association of firms that agree to coordinate their activities Organizations form cartels by: Signaling their intentions by public announcements Ex: Announce price increases that they plan to see whether rivals will match those increases Dominant industry players may discipline others that break the informal rules of the industry Some small firms may be forced out of the industry for reducing prices below the price-cutting level of the industry

Managing competitive interdependence Third-party linkage mechanisms A regulatory body that alows organizations to share information and regulate the way they compete Ex: Trade associations, chambers, cooperatives, etc. Enables competitors to meet and make informal agreements to monitor each other’s activities Lobby for government policies to protect industry members Increase the flow of information to industry members Stabilize industry competition Promote cooperation between domestic rivals

Managing competitive interdependence Strategic alliances Competitors can cooperate to develop common technology Ex: IBM - Apple JV to develop a common microchip that will make their machines compatible Ex: Ford and Mazda cooperated to produce vehicles in the Ford U.S. plant Alliances and JVs in the telecommunications industry

Managing competitive interdependence Merger and takeover Ultimate weapon to manage competitive interdependencies Enlarges the domain and product range of a company Sabancı takes over Gima, Koç takes over Tansaş to increase their control over the expanding retail market in Turkey Downside: Tall, centralized, mechanistic structures unable to meet challenges of a rapidly changing environment

Transaction cost theory (TCE) Tries to answer the question: “Why organizations exist?” Why and under what conditions to select and change the aforementioned strategies Transaction costs: Negotiating, Monitoring, Governing, Exchanges between people and firms

Transaction cost theory (cont’d) The goal of the organization is: To minimize costs of exchanging resources in the environment To minimize costs of managing exchanges inside the organization “Every dollar or hour of a manager’s time spent in negotiating or monitoring exchanges with other organizations or inside the organization is a dollar or hour not used for creating value” Transaction costs siphon off productive value

Sources of transaction costs Environmental uncertainty and bounded rationality The environment is uncertain and complex People have a limited ability to process infromation and to understand the environment surrounding them The higher the level of uncertainty in the environment the greater is the difficulty of managing transactions between organizations

Sources of transaction costs (cont’d) Opportunism and small numbers Though not all, some people behave opportunistically — they cheat or exploit other stakeholders in the environment When an organization is dependent on one supplier or a small number of traders, the potential for opportunism is higher The organization has to spend resources to negotiate, monitor, and enforce agreements with trading partners to protect itself (i.e., transaction costs increase)

Sources of transaction costs (cont’d) Risk and specific assets Investments in skills, machinery, knowledge, and information that create value in one exchange relationship but have no value in any other exchange relationship Specific asset investments increase risk in a business relationship To counter such a risk, the investing firm may try to negotiate extensively and enforce terms of a contract which increases transaction costs

TCE and Linkage mechanisms Transaction costs are low when: Organizations are exchanging nonspecific goods and services Uncertainty is low There are many possible exchange partners Transaction costs increase when: Organizations exchange more specific goods and services Uncertainty increases The number of trading partners fall

TCE and Linkage mechanisms According to TCE: As transactions costs in an exchange increase, the firm should choose a more formal linkage mechanism such as: A joint venture A merger or a take over The downside of formal mechanisms Internal transaction costs —communication, negotiation, monitoring, governance of exchanges within the organization — increase

Strategies for integration and unique design of Motorola & Chrysler

Standard versus custom parts With suppliers of standard parts and commodities: Focused competition Some shifting among firms Cost improvement Highest-preferred supplier asked for a bid Competitive bids from several other preferred suppliers Achievement of lowest possible cost

Standard versus custom parts (cont’d) With suppliers of custom parts: Design and make a unique item Protect investments in design and any unique tooling it may need Life-of-part agreement Supplier is assured the business as long as the part is needed and performance keeps pace (Ex: semiconductors, liquid crystals) At the end of custom part’s life a new design competition between preferred suppliers is initiated Substantial design cooperation on future generations; changing suppliers is disruptive

When integration is needed Motorola’s Paging Products Group Technological change for most parts rapid Will not change suppliers unless something drastic occurs Process of adjustment builds deep shared understanding Motorola looks for long-term commitment to continued change and its objectives Shifting suppliers entail high cost and threat to cycle time Existing suppliers are given a hand to improve performance

With unique designs Life-of-part agreements used with custom goods Protects the supplier’s interest Predicting future costs can be difficult Price or productivity curve may deviate from reality over time May damage customer or supplier Motorola enters an agreement for only the first year to learn and set targets Quality audits to characterize generic supplier processes, develop a generic cost model Highlighting problems, deciding on best performance

With unique designs (cont’d) Chrysler 90% of all purchases are custom designed Substantial design cooperation Supply base integrated into design work Shifts among suppliers expensive and disruptive Suppliers get life-of-part agreements, but without price curves Each supplier suggests changes to save costs Accepted changes are shared by Chrysler on a 50-50 basis What if supplier underreports savings?

With unique designs (cont’d) Chrysler’s approach has achieved better costs over other auto firms Relationships with suppliers that encourage more sharing Sharing costs build trust with suppliers A need for high design integration brings about a need for continuity Suppliers of unique parts continue from one generation to the next Preferred supplier for the custom designed part does not automatically get the job for Motorola and Ford