Information, Organization, and Management

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1 Information, Organization, and Management Unit 3: Transaction Costs: How ICT Changes the Rules of the Game Textbook: Wigand/Picot/Reichwald: Information, Organization and Management, John Wiley & Sons, 1997

de mhepp@computer.org http://www.heppnetz.

2 Overview Coase: The Nature of the Firm Williamson: The Economics of Organization Wallis and North: Measuring the Transaction Sector in the American Economy Read: I, Pencil. My Family Tree as told to Leonard E. Read Efficient Division of Labor Specificity of Goods Malone et al: Electronic Markets Sampson: The Myth of Diminishing Firms Cordella: Does information technology always lead to lower transaction costs? Wigand, Picot, and Reichwald: Factors Influencing the Level of Transaction Costs IMG - Unit 2 2

Read Efficient Division of Labor Specificity of Goods Malone et al: Electronic Markets Sampson: The Myth of Diminishing Firms

3 Coase: The Nature of the Firm Starting Point: Why do firms exist? At first sight, there is no reason to hire staff or engage in longterm committments with regard to other resources. Staff Staff Entrepreneur Staff Staff Staff Staff Staff IMG - Unit 2 3

4 Coase: The Nature of the Firm Explanation: Using the price mechanism (market) consumes resources Staff Staff Staff search select negotiate set-up contract exchange supervise enforce Staff Staff Entrepreneur Staff Staff IMG - Unit 2 4

5 Coordination of Economic Activity search select negotiate set-up contract exchange supervise - enforce Tasks in their own rights that consume resources, too! IMG - Unit 2 5

6 Williamson: The Economics of Organization Transaction costs: Friction... when a good or service is transferred across a technologically separable interface Can be used to explain the determination of efficient boundaries of the firm, the organisation of internal transactions IMG - Unit 2 6

separable interface Can be used to explain the determination of

7 Wallis/North: Empirical Findings Percentage of Transaction Costs on GNP Private Public Total simplied from Wallis/North (1986); cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 7

Total 0 1870 1920 1970 simplied from Wallis/North

8 Read: I, Pencil. My Family Tree as told to Leonard E. Read Example of how even trivial consumables require complex interaction between many individuals IMG - Unit 2 8

9 Division of Labor and Specialization Mutually dependent Division of Labor Breakdown of complex transformation processes into individual tasks and assigning dedicated workforce for single tasks or small sets of tasks Specialization One individual is involved in only a very small task of the overall transformation Motivation: Cognitive and temporal limitations of humans Productivity gains: Specific knowledge, processes, skills cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 9

individual is involved in only a very small task of the overall transformation Motivation: Cognitive and temporal

10 Coordination Division of labor increases the problem of coordination: who shall produce what in which quantity by when using which resources (...)? Coordination does not happen automatically, but is a task in its own right Exchanges must be initiated, negotiated, observed also consumes resources Management Ignored in neo-classical models Determining prices etc. free of cost cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 10

Coordination does not happen automatically, but is a task in its own right Exchanges must be initiated,

11 Trade-off: Specialization Gains vs. Cost of Coordination Further increase in specialization is limited by level of transaction costs (cost of coordination) Thus, technology and methodologies for reducing transaction costs are of utmost importance for future economic development. cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 11

transaction costs (cost of coordination) Thus, technology and methodologies for

12 Efficient Division of Labor Total Production Costs per Unit Coordination Production Division of Labor IMG - Unit 2 12 cf. Wigand/Picot/Reichwald (1997)

13 Williamson: The Economics of Organization (2) Complex contracts are costly to write and enforce. Humans have limited abilities in collecting and processing information Can be used to explain the determination of efficient boundaries of the firm, the organisation of internal transactions Contract IMG - Unit 2 13

Humans have limited abilities in collecting and processing information Can be

14 Williamson: Asset Specificity Specificity: A good s decrease in value if used for the second best purpose the most important dimension for describing transactions and the most neglected attribute in prior studies of organization Drivers: Nature of the resource Location Logistics [Will1981], [WiPR1997] IMG - Unit 2 14

transactions and the most neglected attribute in prior studies of organization

15 Specificity Value reduction of a good when used not for the originally intended purpose but the second best alternative. Sources Location Time Logistics IMG - Unit 2 15

16 Asset Specificity IMG - Unit 2 16

17 Asset Specificity (2) Complexity of Describing a Good IMG - Unit 2 17

18 Coase et al.: Efficient Size of the Firm The size of a firm is determined by the trade-off between costs of internal coordination and costs of using the market mechanism Coordination Effort Total Cost of Internal Coordination Cost of Internal Coordination Cost of Using the Market Size of the Firm IMG - Unit 2 18

between costs of internal coordination and costs of using the market mechanism

19 Market and Hierarchy: A Continuum in between Hierarchy Only Individuals Acting on Markets cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 19

20 Coordination Forms and Specificity Hierarchy Market Hybrid Form Transaction Costs Specificity cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 20

21 ICT promises to reduce Transaction Costs Froogle vs. printed yellow pages Communication by , IRC, Skype vs. TTY ERP Systems ebay vs. Flea Market etc. IMG - Unit 2 21

22 From Make to Buy Malone/Yates/Benjam in (1987): Electronic Markets and Electronic Hierarchies Computer-based trade processes reduce the transaction costs and trigger a shift towards the usage of markets. IMG - Unit 2 22

23 Malone et al: Electronic Markets ICT will reduce transaction costs by automating the processing of information in the various stages This will cause a shift towards markets over other forms of organization. Reduced Transaction Costs Increased Market Volume ebay: Active Users: 34.1 million Gross Merchandise Sales (GMS): $5.6 billion in Q2-03 Walmart Inc.: $ 62.1 billion in Q2-03 IMG - Unit 2 23

24 What is E-Business? Business Entity Business Entity 1 Any form of business operations between any two parties using digital communication over open networks, especially the Internet. cf. e.g. Thome/Schinzer/Hepp (2005) IMG - Unit 2 24

25 Computer-supported Coordination of Economic Activity Search Select Negotiate Contract Exchange Supervise Enforce Faster, cheaper IMG - Unit 2 25

26 Stages of E-Business ERP XML Transaction Shops Java Technology Interaction WWW HTML Information Editor Communication Scope of Functionality IMG - Unit 2 26 Cf. Thome/Schinzer/Hepp (2005)

27 Impact of ICT on Market Structures and Organizations Hierarchy Market Hybrid Form Transaction Costs Specificity Original version: Wigand/Picot/Reichwald (1997) IMG - Unit 2 27

28 Criticism on Malone et al. Sampson: The Myth of Diminishing Firms Cordella: Does information technology always lead to lower transaction costs? IMG - Unit 2 28

29 Factors Influencing Transaction Costs Behavioral Assumptions Environmental Factors Transaction atmosphere, availability of capital and know-how, transaction frequency Bounded Rationality Opportunism Distribution of Information Uncertainty/ Complexity Specificity cf. Wigand/Picot/Reichwald (1997) IMG - Unit 2 29

30 Limitation 1: Media Breaks in the Current Web xyz Corporate Data Sources abc ERP or PDM 3rd party IMG - Unit 2 30

31 Limitation 2: Building and Maintaining Machine-feasible Vocabularies ,0901 7,0401 6,1101 6,0801 6,0501 6,0315 5,1001 5,0915 5,0701 5,0415 5,0301 5,0201 5, Organic chemicals Automation, electrical-engineering, PLT Office supplies, furniture, equipment, and papeterie Machines, apparatus Inorganic chemicals Laboratory materials and technology Auxiliary supplies, additives, formulations Services Tools Machine elements and fixings Construction technology Medicine, medical technology, life science Polymers Packing materials Installations (complete) Marketing IT Industrial piping Equipment for mining, metallurgical plants, rolling mills, and foundries Home economics, home technolology Energy, basic chemicals, aux. agents Machines or devices (for special applications) Occupational safety, accident prevention Semifinished products, materials Automotive technology Number of Classes Q: M. Hepp, J. Leukel, V. Schmitz: A Quantitative Analysis of Product Categorization Standards: Content, Coverage, and Maintenance of ecl@ss, UNSPSC, eotd, and the RosettaNet Technical Dictionary IMG - Unit 2 31 in: Knowledge and Information Systems (KAIS), Springer, 2007.

32 Thank you! The slides of today s class will be available at shortly.

Structure of the Lecture

Structure of the Lecture Grundzüge der Wirtschaftsinformatik Introduction to Business Information Systems Unit 10 Prof. Dr. Martin Hepp http://www.heppnetz.de [email protected] http://www.heppnetz.de/teaching/gwi/ Structure of