Transaction-Cost Economics

Transaction is defined as the exchange of resources such as information, raw material, and
services etcetera between two or more individuals. The article focused on the three
dimensions of a transaction, which are: Uncertainty that is defined as the degree to which
we can ensure the outcome of an event, frequency of the transaction, and the degree of
Investment Idiosyncrasy. The article then talked about the different Contractual Law such
as Classical, Neo-classical and Relational. The author explicated the concept of each of the
laws vis--vis their adoption contingent upon the degree of investment idiosyncrasy.
Classical contract law facilitates exchange by enhancing discreteness and intensifying
presentation. Under this law, the identity of any party is irrelevant and is attuned with the
ideal market condition. There is more formal structure in the written format, which is the
only binding force in the event of dispute. It does not allow for and encourage third-party
arbitration. Neo-classical contract law fits in where the classical contract law fails to deliver
such as in the case of more specific transactions. This law is based on the premise that no
contract is complete due to bounded rationality of an individual drafting the contractual
terms, not all contingencies and their relevant adaptations can be identified. Hence, an
additional governance structure is devised which advocates third party arbitration and
dispute resolution system to maintain continuity of relations. Relational Contract laws are
beneficial in the case of more complex and idiosyncratic transactions such as specialized
machinery requirement from a supplier. In this law the relationship between the two firms,
which has evolved over time, is paramount. The author touched base upon the economics of
Idiosyncrasy where he averred that the idiosyncratic goods and services are the ones where
the human and physical capital investments are transaction-specific such as purchase of a
specialized component from a supplier that requires specialized machinery to manufacture
such component. The incentive to cheating is minimal in such cases because none of the
party gains by dishonouring the covenant due to highly specified requirements.
The cornerstone of commercial contracting is cost economizing which comprises the total of
production and transaction costs. The author categorized transactions in a 3X2 matrix and
advised setting up of governance structure based on the 6 types of transactions. The basic
aim is to make us understand the application of each of the contract laws and governance
structure based on the position of the transaction in the matrix.
Table: Explanation of different contract laws in different transaction-based instances
Investment Characteristics
Frequency



Occasional

Recurrent
Non Specific Mixed Idiosyncratic
Market
governance
(Classical
Contracting)
Trilateral Governance (Neo Classical)
Bilateral
Governance
(Relational)
Unified
Governance
(Relational)

This article helps us in explaining the emergence of unified contract approach with the
context of family relations, public utility regulations and labour laws. It also buttresses the
importance of transaction-based economics and its framework by simultaneously utilizing
the concepts of economics, features of organizational theory and contract laws.
Firm Resources and Sustained Competitive Advantage
The article pays emphasis on the sustained competitive advantage, which is an
important field of research in strategic management. The core concept of the article
is that firms use the resource based view to get the maximum out of the resources.
This in the long run generates the sustained competitive advantage.
The internal analysis model talks about exploiting the internal strengths & avoiding
weaknesses while the external analysis model talks about finding opportunities and
minimizing threats. The resources of a firm can be physical capital, human capital
and organizational capital. The study believes that homogenous and mobile
resources will not generate the competitive advantage. In the resource based view,
the resources are heterogeneous and not perfectly mobile, and these resources
sustain for a long period.
There are primarily four empirical resources to generate the competitive advantage:
Value: The resources must be able to exploit opportunities and/or neutralize
threats.
Rareness: Competitors should not be able to get the resources freely.
Imitability: The resources should be able to imitable.
- Historical condition: Ability to acquire resources depends on space
and time.
- Causal Ambiguity: Competitors imperfectly understand the resources.
- Social Complexity: The resources may be socially complex.
Substitutability: The resources should not be substitutable with an
equivalent resource.
To further examine the importance of resources in sustained competitive advantage,
Barney uses an example to explain how three resources can have an impact on the
sustained competitive advantage. He explains the relationship between strategic
planning, information processing system, positive reputations of a firm and
sustained competitive advantage.
To summarize, for a firm to be successful it is important for it to understand what its
key resources are and how it utilizes these resources ensures its sustained
competitive advantage.
The resource-based view, Barney explains, aligns with traditional social welfare
concerns and behavior and organization theory. Barney, finally, highlights the
importance of managers in generating the sustained competitive advantage. They
have to understand the performance potential of firms capabilities.
In a nutshell, the empirical resources and the internal resources of the firm play a
vital role in developing the sustained competitive-advantage which ensure higher
profits for the firm as compared to its competitors.