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Category: Organizational Behavior

  • Applying TCT to Multinational Enterprises

    In the last blog we looked at an extension of TCT model by Ouchi, in today’s blog we look at the application of TCT to Multinational Enterprises (MNEs).
    The essential search by theorists studying this topic could be reframed – “why do MNE’s exist?” Just like we began discussion on why does an organization exist; TCT was applied on MNEs to figure out which of the transactions would be internalized and which transaction would be driven by market exchange. It is in market imperfections that we find the answers. Markets for different assets and more so for knowledge are subject to imperfections. Research by Organization Theorists – Buckley and Casson as early as 1976 has concluded that markets are more efficient when there are large number of buyers and sellers. When the transaction has high uncertainty, is complex and is heterogeneous, and is catering to a small number of buyers and traders – internationalization is seen to be more effective.
    Continuing on this initial work, Teece (in 1986) attempted to determine the boundaries of an organization. When trading of knowledge becomes difficult – generally due to the following reasons 
    • It would mean giving away the knowledge
    • lack of necessary infrastructure capabilities, communication codes or even culture.

    In such situations, firms tend to internalize the activities.
    In many ways, when we look the application of TCT to MNEs it seems to be a special case of application of TCT to vertical integration.

  • How TCT applies to Multidimensional form organization

    In the last blog, we looked at the application of TCT to understand vertical integration. In today’s blog we look at the application of TCT in understanding the Multidimensional (M) -Form of organizations.
    When functionally organized organizations expand their operations, size and diversity increases. The top management at such a juncture would find it extremely hard to deal with such operations; the interdependence of the various functional units makes it difficult to assign responsibilities for the outcomes of the business. 
    The M form of organization resolves these difficulties by organizing the firms into product or geographical divisions where operational decisions and performance accountability are assigned to the divisional manager. The top management retains only the strategic decision making. This way the source of such a problem – bounded rationality of the top managers at the corporate office is resolved.
    Another side-effect of this structuring is – the firm could function like a miniature stock market. The highest revenue generating unit would get a larger budget in the next cycle. The top management is also free to look out at diversification, acquisition and other activities of that nature. 

  • When to choose Markets/Hierarchy as a governance mechanism

    In the last blog, we looked at the 2 underlying assumptions of the TCT. In today’s blog we shall discuss about how a choice of governance could be made between the market based approach and the hierarchy based approach.
    Organizations will invariably choose that form of governance that reduces any potential exchange problems created by bounded rationality compared to the threat of opportunism. There is not second thought that governance of economic transactions is a costly venture. Given this premise, we could state the following regarding the choice
    If organizations had to worry about minimizing the costs of governing their economic exchanges, then they would always choose market forms of governance. Alternatively, if the worry was about minimizing the effects of bounded rationality and opportunism on their exchanges, organizations would always choose hierarchical forms of governance.
    The organizations necessarily would have to take a call on which approach to take considering the priority and looking at the potential outcomes of the choice of governance they make.

  • Assumptions of the transaction cost theory


    In the last blog, we looked at Williamson’s TCT formulation. In the current blog we look at the 2 essential assumptions about economic actors engaged in a transaction.
    1. Bounded Rationality
    2. Opportunism

    Bounded Rationality is a term that we have used multiple terms thus far and essentially means – those who are engaged in a transaction are rational but have a limit to this rationality. What does this mean? I helps us realize that we would in the absence of such an assumption be writing contracts that would have unlimited complexity. Economic actors involved in the transaction simply cannot envision all the possible outcomes in an exchange relationship and there for formulate contracts for all eventualities.

    Opportunism refers to incomplete or distorted information disclosure towards misleading or confusing partners in the exchange. It would be highly complex to assume that all actors are always opportunistic, however it would be easier if we begin with the assumption that actors may behave opportunistically and it is extremely costly to make the distinction who is opportunistic and who is not – this is what TCT assumes. It is this threat that in the world we deal with much more than merely the promises.

    These two are important considerations – firms and people should always safeguard to avoid being victimized by the others.

  • Formulation of the Transaction Cost Theory – Williamson

    In the last blog, we looked at how hierarchies could enable effective and efficeint handling of the transactions within the organization. In today’s blog, we look at how Williamson formulates the Transaction Cost Theory – and discuss this further over the next few blogs.
    Williamson approahes TCT stating that markets and hierarchies are alternative instruments for completing a set of transactions. These are called “Governance Mechanisms”.
    While market form of governance relies on prices, competition and contracts to keep all parties to exchange informed rights and responsibiltiies; the hierarchical form of governance get these exchanges doen under an autoritative third part (the boss) who attempts to keep all parties in the exchange informed of their rights and responsibiltiites.
    The following picture summarizes these alternatives as suggested by Williamson’s TCT

  • Why do we require organization?

    In the last blog we
    began our journey towards understanding the various organizational economic
    theories. In today’s blog we initiate a discussion on “why organizations
    exist?”
    For many this
    question would raise some odd feeling – Why even as such a question? We know
    organizations exist, so why did into this at all? It is important to understand
    this question – since in many ways this forms the starting point of
    organizational analysis and there by organizational economics.
    We shall begin
    attempting to answer this question with Adam Smith’s insight that – economy
    could be coordinated by a decentralized system of prices – “the invisible
    hand”. Economics post this aimed at identifying the necessary conditions
    for the effective use of the invisible hand, and designing changes in these
    settings where the conditions are lacking. Continuing on the same lines, it
    would be interesting to ask – since the market is so effective in coordinating
    economic exchanges why would we ever need firms to manage this?
    The answer to this
    question of the existence of firm was provided for the first time by Coase (1937)
    who suggested that sometimes the cost of managing economic exchanges across
    markets is greater than the cost of managing economic exchanges within the organizational
    boundaries. – This argument essentially placed “transaction costs” at
    the center of the analysis of the reason for firm’s existence. In a way the
    theory put markets and organizations as alternatives to managing the same
    transaction.
    Over the next few
    blogs we look at understanding the various theories that fall into this stream
    of organizational economics