1. IE 463
Lec 3. Firm and External Cooperation-1

2. TRANSACTION COST ECONOMICS (TCE)
All exchange transactions encounter problems of
information
enforcement
Transaction: dealing or trading with others
Transaction costs: costs incurred during the process of
buying or selling, on top of the price of whatever is
changing hands;
costs of managing relationships
costs of performance evaluation
costs related to safeguarding the exchange relationship
adaptation costs
etc.

3. costs mainly caused by opportunism
economic costs
production costs
costs of transforming inputs into outputs,or direct production costs
transaction costs
costs of making exchange,or indirect production costs
motivation costs
costs of motivating specialized agents to align their interests, e.g.
cost of cheating or opportunistic
behavior
agency cost among owners,
managers, and debt holders
coordination costs
costs of coordinating the actions between specialized agents, e.g.
cost of obtaining information
cost of coordinating input in
production
cost of measurement
costs mainly caused by opportunism
costs mainly caused by bounded rationality

4. Agency cost:
can arise when somebody (the principal) hires somebody else (the
agent) to carry out a task and the interests of the agent conflict with
the interests of the principal. One way to reduce agency costs is for
the principal to monitor what the agent does to make sure it is what he
has been hired to do. But this can be costly, too. Another way to
lower agency costs, especially when monitoring is too expensive or
too difficult, is to make the interests of the agent more like those of the
principal.
Asset:
an economic resource belonging to a company or entity, an item
owned by the company or entity; an asset has future economic benefit and is the result of past financial transaction.

5. TCE is concerned with the examination of the comparative
costs of planning, adapting and monitoring task completion
under alternative governance structures like,
market
firm (hierarchy)
network
etc.
Question:
“ Why are some transactions directed by managers inside firms or networks rather than in an open market ? “

6. ASSUMPTIONS of TCE Bounded Rationality
can’t assimilate all the information at one’s disposal (limit to the amount of information one can hold)
can’t accurately work out the consequences of the information obtained (limit to the amount of calculations one can understand)
Opportunism
can possibly act in a self-interested way “with guile”,
not entirely honest and truthful about their intensions
attempting to take advantage of unforseen circumstances that gives them the chance to exploit others

7. Potential opportunism of economic actors is central in TCE, hence TCE focuses on the organization of a transaction through the most efficient governance structure; one which minimizes the transaction costs associated with safeguarding against opportunistic behavior.
If a firm chooses to conduct an activity through some form of collaboration, such a choice reflects the fact that the collaborative form is the transactionally efficient mode of organizing that activity.

8. VARIABLES OF TCE TCE uses three variables that are common to any
transaction;
Frequency
A firm would not want to internalize the activity concerning
a good or a service that is very rarely used (ie. will not
integrate within the firm) . It is then better to use the
services of another firm which has the competency for it.
Uncertainty
During the course of a transaction, it is difficult to forsee
all the consequences, especially for long transaction times.
When uncertainty is not low, the firm can choose to
integrate inside or establish long-term partnerships with
other firms in order to reduce uncertainty.

9. 3. Asset Specificity
Transactions involve assets that are only valuable in the
context of a specific transaction. In that case, transaction
costs will be reduced by integration,
within the firm or
amongst partners within a network structure
Such assets normally have low alternative use values so
that owners have a strong interest in continuing the
transaction. Strong asset specificity is a reason for
establishing long-term relationships, but because of
bounded rationality and opportunism factors, it involves
high risks. Other things being equal, when transactions
involve highly specific assets, transaction costs are
likely to be lower in hierarchies and networks than in
markets.

10. SOURCES OF ASSET SPECIFICITY
Site specificity
When successive stages of production are located in close proximity, common ownership generally results. This occurs when assets are immobile or, the set-up or relocation costs are large. Once an asset is in place, owners of the asset may use that asset for a single purpose.
2. Physical asset specificity
If the assests are mobile and their specificity is attributable to their physical features (specialized parts or components), market procurement of particular product might or might not be possible. If the seller has no other buyer for his particularized part/component then the seller’s assets have physical asset specificity.

11. Human asset specificity
Specialization in a particular field may give rise to human asset specificity. Where an emloyee had developed special skills that are useful only to a particular employer, the employee has developed a degree of human asset specificity.
degree of specificity
contractual response
non-specific
semi-specific
highly specific
spot market
long-term contracts
vertical integration

12. Transaction costs are low when;
organizations are exchanging nonspecific goods and
services
uncertainty is low
there are many possible exchange partners
Transaction costs are high when;
organizations are exchanging specific goods and
uncertainty is high
the number of possible exchange partners is small
According to TCE, organizations will adopt increasingly formal linkage mechanisms with their exchange partners as transaction costs increase (alliances etc.).
But these mechanisms also carry bureaucratic costs within the organization.

13. When deciding the firm strategy;
locate and estimate the transaction costs of an
exchange relationship
estimate the transaction cost savings from using
different linkage mechanisms
estimate the bureaucratic costs of operating the linkage
mechanism
choose the strategy that gives the most transaction cost
savings at the lowest bureaucratic costs.
However, TCE is criticised for
assuming that individuals usually behave
opportunistically not paying sufficient attention to trust
and market instruments that strengthen it
6 -

14. RESOURCE BASED VIEW (RBV)
Basic Assumptions:
Firms are unique bundles of resources and capabilities
Competitive advantage derives from unique (not tradable and difficult to substitute) and inimitable resources and competencies, which allow to achieve a superior customer benefit
Firm derives competitive advantage from unique (not
tradable and difficult to substitute) resources and
competencies.

15. Resources
(Stocks)
Activities
(Flows)
Resource
Commitments
Capability
Development

16. TYPES OF RESOURCES Tangible Resources
Relatively easy to identify, and include physical and financial assets used to create value for customers
1. Financial resources
firm’s cash accounts
firm’s capacity to raise equity
firm’s borrowing capacity
2. Physical resources
modern plant and facilities
favorable manufacturing locations
state-of-the-art machinery and equipment

17. 3. Technological resources
trade secrets
innovative production processes
patents, copyrights, trademarks
4. Organizational resources
effective strategic planning processes
excellent evaluation and control systems
Intangible Resources
Difficult for competitors (and the firm itself) to account for or imitate, typically embedded in unique routines and practices that have evolved over time
1. Human
experience and capabilities of employees
trust
managerial skills
firm-specific practices and procedures

18. 2. Innovation and creativity
technical and scientific skills
innovation capacities
3. Reputation
effective strategic planning processes
excellent evaluation and control systems

19. Organizational Capabilities:
outstanding customer service
excellent product development capabilities
innovativeness of products and services
ability to hire, motivate, and retain human capital
Routines:
“... an executable capability for repeated performance in some context that has been learned by an organization in response to selective pressures”
“… the decision rules which firms employ, both in terms of highly defined production techniques and extremely tacit strategic directions. These routines encompass most of what is regular and predictable about business behavior, and represent the genetic material of the firm in the evolutionary model. They are persistent within the firm, and heritable toward the future of the firm. They define not only how the firm operates now, but also how it will tend to operate in the future”

20. It is the input to a firm’s production process. Capability
Resource
It is the input to a firm’s production process.
Capability
It is the ability to exploit resources. They consist of a set
of organization processes and routines that manage the
interaction among the resources.
A capability resides in a particular function i.e. it is
functionally based. (“teams” of resources).
Competence
It is the cross-functional integration and coordination of
capabilities and resources.
capabilities
competitive
advantage
competence
resources

21. competencies resources capabilities tangible intangible structures
processess
systems

22. Core Competence
It is a well-performed internal capability that is central, not peripheral, to a company’s strategy, competitiveness, and profitability. Core competence reflects a collective learning in the organization, especially how to coordinate
diverse production skills and integrate multiple streams of technologies.
Distinctive Competence
It is a competitively valuable core competence that a company performs better than its rivals, something a company does especially well in comparison to its competitors.

23. DEVELOPING COMPETENCIES
increasing
Distictive competencies
core competencies
competencies
difficulty
value
capabilities
resources

24. EXAMPLES: DISTINCTIVE COMPETENCIES
Toyota, Honda, Nissan
Low-cost, high-quality manufacturing capability and short design-to-market cycles
Intel
Ability to design and manufacture ever more powerful microprocessors for PCs
Motorola
Defect-free manufacture (six-sigma quality) of cell phones

25. Cooperation is a strategic response to conditions of
uncertainty and dependence:
the primary goal of organizations is to maximize power
organizations need to obtain resources and competencies from their environment for survival
environment is uncertain
few organizations are self-sufficient w.r.t. critical resources and competencies
Therefore
reliance on others for resources and competencies is unavoidable
when resource flows are not under control, it causes uncertainty in firm’s decision making

26. However RBV,
neglects cooperative relations when actors have no direct dependence (does not adequately adress the issues of networking)
motivation and rationale for cooperation is restricted to gaining resources and power (but, org.s make strategic choices to join networks when the advantage of increased survival capacity outweighs the costs of maintaining relations)

27. RESOURCE BASED APPROACH TO STRATEGY
4. Select a strategy which best exploits the firm's resources and capabilities relative to external opportunities.
3. Appraise the rent-generating potential of resources and capabilities in terms of,
their potential of sustainable competitive advantage, and
the appropriability of their returns 
2. Identify the firm's capabilities: What can the firm do more effectively than its rivals? Identify the resources inputs to each capability, and the complexity of each capability.
1. Identify and classify the firm's resources. Appraise Strengths and weaknesses
relative to competitors. Identify opportunities for better utilization of resources .
Identify resource gaps, replenish, augment and upgrade.
Modify strategy to develop new capabilities.
Strategy
Competitive
Advantage
Capabilities
Resources

28. STRATEGIC MANAGEMENT THEORY (SMT)
Firms enter into cooperative relationships with other firms;
to acquire competencies that the firm lacks
to learn how to operate in new markets
to acquire resources
to diversify into new business
to capitalize on economies of scale
to circumvate trade or foreign restrictions
...
Strategic management involves both long-range thinking
and adaptation to changing conditions.
It concentrates on the development, manintanence and
explotitation of strategic potentials.
Firm derives competitive advantage from strategic fit with
its external environment.

29. Porter’s Five Forces of Competition
SUPPLIERS
bargaining power of suppliers
INDUSTRY
COMPETITORS
threat of
substitutes
threat of
new entrants
POTENTIAL
ENTRANTS
SUBSTITUTES
Rivalry among
existing firms
bargaining power of buyers
BUYERS
Industry analysis to identify attractive industries for corporate
strategy 7

30. Strategic Positioning:
Superior performance comes from close linkages and correspondence
from;
distinctive value propositions
(unique added value an organization offers customers through their operations; it describes how an organization will differentiate itself to customers)
a carefully designed product-market focus
(comprises the products a firm chooses to trade in and the customer
segments it targets)
a set of unique value activities
(the things a firm does to deliver the value proposition to the target product-market segments; value system/chain)

31. Porter: A cooperative strategy might offer a mutually
advantageous opportunity for firms to modify their
market positions and increase market power.
Strategic approach to inter-org. linkages:
competitive advantage often is derived from linkages among activities
alliances provide competitive benefits in improving firms’ strategic posture within the industry
firms enter cooperative relationships in order to achieve expansion and growth as well as to secure efficiencies of the kind identified in transaction cost economies
in SMT, networking is a competitive strategy which is used by managers to position their firms in a favorable environment

32. firm’s competitive advantage lies in its capacity to gain
access to, and exploit, valued external resources and
expertise through the network
Network is regarded as an investment for future access to other firm’s internal assets.
However STM is criticised for
not considering socially organized relations as important

33. EFFICIENCY
In the framework of the strategic business management the issue of organization’s efficiency is of primary importance.
i. Previously, efficiency was perceived through the internal resources (technological, technical, informational, economic) and was based on comparing costs and results. In that case the process of strategic planning is about the functions of
defining the organization’s targets
interpreting the environment
forming a strategy
adjusting the organization to the needs of implementing the adopted strategy.

34. The "network" model gave rise to an altogether different
approach to the problem of an effective management of an organization. Relationships move to the center of the strategic management.
The cooperative dimension of strategy ensures its
efficiency through a coordinated behavior of individuals within the system of interactions,
relationship becomes the main focus in defining efficiency
and setting the strategy
thus, efficiency of organization’s strategy is based on its
interactive behavior.

35. DEPENDENCE
Linking of activities and exchange of resources among the network members are sources of dependence and power. These aspects are missing in the literature on marketing. For example, in the models of marketing buyers and sellers are free to choose and change business partners. It is assumed that suppliers and buyers can be always changed.
However, dependence on external resources is important. As a result, in industrial marketing neither sellers nor buyers are free to pick and change partners and such steps are highly risky. The degree of dependence of a firm on the partner depends on,
the partner’s resource collection and
the partner’s monopoly (control) for such supplies.

36. Therefore,
dependence is rather a characteristic of the structure of complementary activities and the distribution of the resources of ‘interacting firms’ than a characteristic of the buyer and the seller
dependence is the basis for power relationships.
As soon as interacting firms begin to appreciate interfirm relationships and not isolated transactions,
coordination of the activities and
cooperation of the firms
across the network is achieved.