Virtual Enterprise Transactions: A Cost Model

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1 VirtualEnterpriseTransactions:ACostModel AlessandroD Atri CeRSI,LuissGuidoCarliUniversity,Rome,Italy and AmihaiMotro ComputerScienceDepartment,GeorgeMasonUniversity,VA,USA Abstract Atransactionisabilateralexchangebetweentwopartiesinwhichgoodsaredeliveredinreturnfor payment.invirtualenterpriseenvironments,transactionsaretheprincipalmeansofcollaboration amongtheenterprisemembers,aswellasthemechanismwithwhichtheenterpriseprovidesits productstoitsexternalclients.inthispaperweexaminetheconceptoftransactionsinvirtual enterprises.wedefinetransactionsasrecursiveprocesses(similartosupplychains),andweformalize theconceptoftransactioncost.wethenexaminetransactionfailureandtransactionrisk,whichleadus totheconceptoftransactionexpectedloss.theoverallgoalistoallowenterprisememberstolaunch thosetransactionsthatminimizetheirexpectedlosses.wealsodiscusshowinitiatingredundant transactionscanfurtherreduceexpectedlosses. 1.IntroductionandBackground Atransactionisabilateralexchangebetweentwopartiesinwhichgoodsaredeliveredin returnforpayment.inavirtualenterpriseenvironment,transactionsarethemechanism withwhichtheenterpriseprovidesproductstoitsexternalclients.suchtransactionsare termedexternaltransactions.tofulfillanexternaltransaction,thecontractedenterprise membermayprocurenecessaryproductsfromothermembersoftheenterprise.these exchangesaretermedinternaltransactions.thesupplierofaninternaltransactionmay,in turn,initiateotherinternaltransactions(termedsub transactions).altogether,the executionofanexternaltransactionisadistributedeffortofagroupofenterprisemembers. Inthispaperweexaminetheconceptoftransactionsinvirtualenterprises.Webeginin Section2bydefiningtransactionsasrecursiveprocesses(similartosupplychains),andin Section3weformalizetheconceptoftransactioncost.InSections4and5weexamine transactionfailureandtransactionrisk,whichleadustotheconceptoftransaction expectedloss,describedinsection7.theoverallgoalistoallowenterprisemembersto launchthosetransactionsthatminimizetheirexpectedlosses.wealsodiscusshowinitiating redundanttransactionscanfurtherreduceexpectedlosses.thiseffortiswithinthe frameworkofthevirtuemodelforvirtualenterprisesthatwedefinedinearlierworks[3]. Theconceptoftransactionhasbeendiscussedextensivelyineconomicsandrelated disciplines(business,banking,etc.);and(withaconsiderablydifferentinterpretation)in computerapplicationssuchasdatabasesystems[5]orworkflowsystems[6].intheareaof virtualenterprises[2],thevirtuemodelintroducedaconceptoftransactionthatcombines elementsfrombothdistributeddatabasesystemsandeconomics.inotherwords,itused thestructuresofcomputertransactionstoimplementconceptsborrowedfromeconomics. Theworkherecontinuesinthisvein,withtheintroductionofacostmodel.Thiscost 1

2 model,whichborrowsconceptsfromtransactioncosttheory(forexample,searchand informationcost[7]),enablesustodiscussformallyconceptssuchastransactionfailure, transactionrisk,andtransactionexpectedloss invirtualenterpriseenvironments. 2.TransactionModel Atransactionisabilateralexchangebetweentwopartiesinwhichgoodsaredeliveredin returnofpayment.thepartyinitiatingthetransaction,requestingthegoodsandproviding thepaymentistheclient;thepartyrespondingtotherequest,providingthegoodsand receivingthepaymentisthesupplier.transactionsconsistofdistinctphases,andinthis paperweshallassumetransactionshavethreephases:(1)orderistherequestbytheclient tothesupplierthatdescribesthegoodsneeded;(2)manufacturingisthephaseinwhichthe supplierpreparesthegoods;and(3)fulfillmentisthedeliveryofthegoodsbythesupplier totheclient.thus,ordersinitiatetransactions,andfulfillmentsconcludethem. Inavirtualenterpriseenvironment,transactionsarethemechanisminwhichthe enterpriseprovidesproductsorservicestoitsclients.inthevirtualenterprise environmentdescribedinvirtue[1],suchtransactionsaretermedexternaltransactions. Tofulfillanexternaltransaction,theenterprisemembermayprocurenecessaryproducts orservicesfromothermembersoftheenterprise.theseexchangesaretermedinternal transactions.inaninternaltransactionboththeclientandthesupplieraremembersofthe enterprise.thesupplierofaninternaltransactionmay,inturn,initiateotherinternal transactions.altogether,theexecutionofanexternaltransactionisadistributedeffortofa groupofenterprisemembers. AsdescribedinVirtuE, 1 whenreceivingorders(ineitherinternalorexternaltransactions), enterprisemembersconsulttworesourcestodeterminehowtorespondtothetransaction. Theseresourceshelpthememberdeterminewhatisneededtofulfilltheorder,andhowto obtainit. 1. Whatisneeded:productionplan.Aproductionplanisalocalresourcethat enumeratestheproductsthatthemembermustprocurefromotherenterprise memberstomanufactureagivenproduct. 2 Notethatagivenproductmayhave multiple(alternative)productionplans. 2. Howtoobtainit:theproductcatalog.Theproductcatalogisanenterprise wide resourceinwhichmembersadvertisetheproductsthattheysupply.eachrecordin thiscatalogdescribesaproduct,asupplieroftheproduct,andadditional information,notablytheprice. Oncethememberdecidesontheproductionplanandselectsthesuppliersofthenecessary componentproducts,itlaunchesasetoftransactionstoprocurethesecomponents.when thesetransactionshavebeenfulfilled,themembercanassembletheproductanddeliverit totheclient.atransactionisthereforearecursiveprocess.weassumethattheprocess 1VirtuEconsidersgoodsthatareeitherproductsorservices.Forsimplicity,andwithoutlossof generality,weshallassumeheregoodsthatareproducts. 2 VirtuE sproductionplansconsideralsocomponentpartsthatareavailabletothismemberlocally. Withoutlossofgenerality,weshallassumeherethatallcomponentpartsareprocuredexternally. 2

3 terminateswithtransactionsthatprocureprimitiveproducts:productswhose manufacturingdoesnotrequireimportation. Transactionscanbeillustratedwithtreediagrams,inwhichnodesrepresentmanufacturing ofproductsbysuppliers,andedgesindicateinitiationofsub transactions.inatransaction treetherootnodemodelsthemanufacturingoftheultimateproduct(theproductordered bytheexternalclient),internalnodesmodelthemanufacturingofcomponentproducts,and leafnodesmodelthemanufacturingofprimitive(import free)products.eachtransaction isassumedtohaveauniqueidentifier,whichisassignedtothemanufacturingnode.a simpletransactiontreeisshownfigure1.inthisexample,anexternalclientsubmitsa transactiont 0toorderproductp 0frommemberm 0.Tofulfillthisorder,m 0submitstwo sub transactions:t 1ordersproductp 1frommemberm 1,andt 2ordersp 2fromm 2.m 1fulfills t 1locally;butm 2submitstwoadditionalsub transactions:t 3ordersp 3fromm 3,andt 4 ordersp 4fromm 4.Bothm 3andm 4fulfilltheirorderslocally. t 0 t 1 t 2 3.TransactionCost t 3 t 4 Figure1:Atransactiontree Therearedifferentcostsassociatedwiththeexecutionofatransaction,andweadopta simplecostmodel,inwhicheachtransactionhasanassociatedprice.thisistheamount paidbytheclienttothesupplierinreturnfortheproduct(thispriceisadvertisedinthe catalog).weassumethatprice(t)isthesumofthreecostcomponents.lett 1,,t nbethe sub transactionsof. 1. Procurementcost:price(t 1),,price(t n).thisistheamountpaidbythe manufacturer(theclient)toeachofitssuppliers. 2. Transactionoverheadcost:overhead(t 1),,overhead(t n).thisisthecost associatedwiththeexecutionofeachsub transactionandbornebytheclient. 3. Manufacturingcost:manufacture(t).Thisisthecostofmanufacturingtheproduct fromitsncomponents(itincorporatesthecostofcomponentlocallyavailableand themanufacturer'sprofit). Altogether: price(t)=manufacture(t)+ i=1,n(price(t i)+overhead(t i)) Thecostofexecutingtransactionsisgenerallysplitbetweentheclientandthesupplier. Here,theclientistheenterprisememberexecutingt,andthesuppliersarethemembers executingt 1,,t n.weassumethatthetransactioncostsbornebythesuppliershavebeen incorporatedintoprice(t 1),,price(t n).similarly,wecouldhaveassumedthatthe 3

4 transactioncostsbornbytheclientthavebeenincorporatedintomanufacture(t).yet,for reasonsthatwillbecomeapparentlater,weprefertokeepthiscostseparate,as overhead(t i). Lett 0denotetherootofatransactioninitiatedbyanexternalclient,thenprice(t 0)isthe amounttheexternalclientpaysfortheultimateproduct.aspriceisalwaysarecursive summationofmanufacturingcostsandtransactionoverheadcosts,itissufficienttorecord thelattertwo.hence,welabeleachnodeofatransactiontreewiththeassociated manufacturingcost,andwelabeleachedgewiththeassociatedoverheadcost. WeillustratecostsinFigure[2],whichshowstheexampleofFigure[1]withexamplecosts. Inthisfigure,nodelabelsdenotethetransactionidentifiersandthemanufacturingcosts, andedgelabelsdenotethetransactionoverheadcosts.thederivedtransactionpricesare then:price(t 1)=10,price(t 3)=20,price(t 4)=15,price(t 2)=70,andprice(t 0)=110. t t 1 10 t t 3 20 t TransactionFailure Figure2:Atransactiontreewithitsassociatedcosts. Untilnowweassumedthatallordersarefulfilled,andtransactionscompletesuccessfully. Weconsidernowthepossibilityoftransactionfailure.Atransactionfailswhenanorder thathasbeenplacedisnotfulfilled.failurecouldbeduetoavarietyofdifferentreasons:a communicationfailure,suddenwithdrawalfromtheenterprise,refusaltohonorprior commitments,andsoon.failurecanbemodeledasadisconnectionofanedgeinthe transactiontree. Toanalyzethecostoftransactionfailure,wemakeseveralassumptions.First,paymentis partoffulfillment.second,allthesub transactionsofagiventransactionareplaced simultaneously,anditisnotpossibletocancelordersthathavealreadybeenplaced. Finally,transactionscannotbereversed;i.e.,itisnotpossibletoreturnthegoodsandobtain arefund. 3 Undertheseassumptions,theclientofafailedtransactiondoesnotpayforthecostofthe product(asfulfillmentnevertookplace),anditbearsonlythecostofthetransaction overhead(asthiscostwasalreadyinvested).theclient,howeverstillpaysforalltheother componentproductsthathavebeendelivered,andforthecostofmanufacturing(although manufacturingwasnotcompleted).assumingthesupplierofthefailedtransaction 3 InVirtuE,theseassumptionscanbeexpressedbymeansofconstitutionalrules. 4

5 _ completedallitssub transactionspromptly, 4 itbearsthecompletecostoftheproductit wascommittedtoproduce. ConsiderthetransactiontreeinFigure[3].Forsimplicity,assumethatallmanufacturing costsare5,andalltransactionoverheadcostsare1.theoverallpriceisthen107.assume nowtwofailures:int 7andint 11.Theformerfailurepropagatestot 2,andthelatter propagatestot 5andt 1,andconsequentlyt 0fails.Theexternalclientdoesnotpaythevirtual enterprisethepriceof107,andthislossisdistributedasfollows:t 11:5,t 5:12,t 1:12,t 7:17, t 2:24,andt 0:37.Thus,onlymembersonafailurepathbearthepriceoffailure(t 0,t 1,t 5and t 11areonthepathofthefirstfailure,andt 0,t 2andt 7areonthepathofthesecondfailure). Essentially,thepricetheypayistheiroverheadforthesub transactionstheylaunched,and thepriceofproductsthatweredeliveredbutprovedunnecessarybecausetheproductfor whichtheywereintendedwasnotmanufactured. 37 t 0 12 _ t 1 t 2 t 3 24 _ = 12 t 4 t 5 17 t 6 t 7 t 8 t 9 = 5 t 10 t 11 t 12 t 13 t 14 t 15 t 16 t 17 Figure3:Thedistributionoffailurecosts. Becausethepriceoftheultimateproductisthesumofallthenodecostsandalltheedge costs,andourdistributionofthecostsassignedeachofthesecoststoexactlyonemember, thelossesbornebytheparticipatingmembersadduptothepriceoftheultimateproduct.an obviousconclusionisthatbecausethepriceofproductsincreasesalongthesupplychain, highlevel supplierstendtopayahighershareoftheloss.althoughthishigherriskwould normallybemitigatedbyhigherprofitmargins,itisimportanttominimizetheriskof failure.thisissueisdiscussednext. 5.TransactionRisk Wedefinetransactionriskastheprobabilitythatatransactionfails;thatis,theprobability thatasupplierwillnotfulfillanorderforaparticularproduct.risk(t)denotestheriskin transactiont.weassumethatrisk(t)combinestwodifferentcomponents:(1)supplierrisk measurestheriskassociatedwithaparticularsupplierm;itisthepronenessofthesupplier tofail.(2)productriskmeasurestheriskassociatedwiththemanufacturingofthe particularproductp.weinterpretthisriskastheprobabilitythatatleastoneofthe transactionstoprocurecomponentsforpfails.withthisdefinition,productriskincreases withthecomplexityoftheproduct(itsnumberofcomponents):ifaproductischangedto requireanadditionalcomponent,productriskwillincrease.altogether,theriskofa 4 Ifnot,thentherehadbeenanearlierfailure. 5

6 transactiont,inwhichsuppliermisrequestedtomanufactureaproductp,isthe probabilitythatmfails,oratleastoneofthesub transactionstoprocurecomponentsforp fails. Foratransactiontthatordersaprimitive(import free)productfromsupplierm,theriskis simplythatofsupplierfailure.itisconvenienttoviewsupplierfailureastheprobabilityof nodefailure,andtransactionfailureastheprobabilityofedgefailure. Ingeneral,itcannotbeassumedthatthen+1eventsthatdefinerisk(t)(thefailureofmorof oneofthensub transactionitissues)aremutuallyexclusive;i.e.,itmaynotbeassumedthat thereisatmostonefailure.insuchcases,risk(t)mustbecalculatedaccordingtode Moivre sinclusion exclusionprinciple[4].inpractice,however,unlessnissmall,itis normallyimpossibletocalculaterisk(t)inthisway,andonewouldhavetobesettlefor lowerandupperbounds,suchasthosesuggestedbythebonferroniinequalities[1].ifwe assumethatthen+1eventsareindependent(i.e.,thefailureofanodeandthefailureofeach incomingedgeareunrelated),thenrisk(t)maybecalculatedfromsupplierriskvaluesonly. Thatis,riskvaluesmaybepropagatedfromtheleafnodestotherootofthetransaction tree. Asanexample,considertheprevioustransactiontreeandassumethattherisksof memberfailureare0.01forprimitivemanufacturers,and0.03fortheothers. 5 Then,inthe threephasesofpropagation(showninfigure[4]),wederivethattheriskoftheexternal transactionisrisk(t 0)= Astheexampledemonstrates,theriskincreaseswiththe numberofprimitiveproducts(inthisexample,10),andthenumberofintermediate suppliers(inthisexample,8) t 0 t 1 t 2 t t 4 t 5 t 6 t 7 t 8 t t 10 t 11 t 12 t 13 t 14 t 15 t 16 t 17 Figure4:Thepropagationofrisk. Thus,tocalculatetransactionrisk,ourmodelrequiresthecompletetransactiontreeandthe supplierriskvaluesforeachparticipatingmember.wemayassumethattheseriskvalues arecalculatedbytheenterprise(andupdatedaftereachcompletedorabortedtransaction), andareavailabletoitsmembers. 6 IntermscommonintheInternettoday,supplierrisk correspondstothesupplier's reliabilityrating. 5 Ingeneral,itshouldnotbeassumedthatmanufacturersaredividedintothesetwotypes. 6 VirtuEhandlesthesevaluesasmember specificperformanceindicators. 6

7 AfeatureofthetransactionmodelintroducedinSection2isthepossibilityclientshaveto procureproductsfromdifferentsuppliers.thissuggestsinitiatingthesub transactionwith thelowestrisk.weshowedhowtransactionriskcanbepropagatedupwardsthe transactiontree,butitcannotbeassumedthataclientknowsinadvancethesubtreethat willbeassociatedwitheachofitsorders(informationnecessarytocalculaterisk).this couldbeaddressedbyassumingthateachsupplierassociateswitheachitsproductsan estimateofthetransactionrisk. Asecondflexibilitybuiltintoourtransactionmodelisthepossibilityofalternative productionplansforagivenproduct(differentproductionplansrequiredifferentsetsof components).theavailabilityofriskvaluesforeachsub transactionwillalsoallowclients toestimatetherisksofalternativeproductionplans. Altogether,wesketchedhowenterprisememberscanapplyknowledgeoftransactionrisk toeither(1)chooseamongalternativesuppliers(foragivenproducttheyneed),or,more ambitiously,(2)chooseamongalternativeproductionplans(tofulfillanorderthey received).yet,choosingtheoptionwiththelowestriskmaynotalwaysbethebestchoice, astheleast riskytransactionmayhaveamuchhigherprice.consideringbothpriceand riskisdiscussednext. 7.ExpectedLossandRedundantOrdering Assumememberminitiatesatransactionforproductpforpricecwithriskr.Inthe previoussectionwediscussedhowmcouldoptimizeitsoperationtominimizetheriskr. Similarly,mcouldoptimizeitsoperationtominimizethecostc.Yet,boththeseapproaches maybeunattractive:minimizingriskcouldcomeathighcost,andminimizingcostcould comeathighrisk.amorebalancedapproachistobalancetheirproductc r,whichwe termthetransactionexpectedloss. Forexample,assumetwoalternativeoptionsforprocuringp,onewithcost10andrisk0.7, andtheotherwithcost20andrisk0.4.optimizingcostsuggestschoosingtheformer, whereasoptimizingrisksuggeststhelatter.consideringtheexpectedlosses,whichare7 and8,respectively,suggestsapreferencefortheformertransaction. Tominimizeexpectedlosses,memberscouldfindadvantageinplacingredundantorders. Thatis,mcouldprocuretheproductpfromtwomembers:fromm 1withcostc 1atriskr 1, andfromm 2withcostc 2atriskr 2.Thecostincreasestoc 1+c 2but(assuming independence)theriskisreducedtor 1 r 2.Theexpectedlossisthen(c 1+c 2) r 1 r 2. Asanexample,assumethecostsare10and20andtherisksare0.3and0.2,respectively. Theexpectedlossesare,respectively,3and4.Byplacingbothorders,thecostincreasesto 30,buttheriskisreducedto0.06,withexpectedlossofonly1.8.If,ontheotherhand,the costofthelessriskyorderwas70insteadof20,thecombinedcostwouldhavebeen80and theexpectedloss4.8,makingredundantorderingunattractive. Asimilarapproachcouldbefollowedforcompleteproductionplans,wheretheexpected lossofaproductionplanwithcostcandriskrtoisdefinedtobec r.memberscould choosetheproductionplanthatminimizestheirexpectedlosses,andtheycouldconsider redundantorderingthatwillreducetheirexpectedlossesevenfurther. 7

8 8.Conclusion Wedescribedasimpleyetpowerfulcostmodelfortransactionsinvirtualenterprises. Simplicityismaintainedwithseveralassumptions,including:(1)Transactionsinvolveonly threephases:ordering,manufacturingandfulfillment;(2)allsub transactionsareplaced simultaneously(e.g.,itisnotpossibletochoosethesecondsub transactionafterthefirst hasbeencompleted);(3)ordersmaynotbecancelledorreversed(norefunds);(4) transactioncostisthesumofexternalprocurement,transactionoverhead,andinternal manufacturing;(5)transactionriskisthecombinationofmanufacturerriskandproduct risk,wherethelatteristheriskinprocuringtheproductcomponents;and(6)thefailureof anode(amanufacturer)andanyofitsincomingedges(thesub transactionsitissued)are independentevents,allowingforsimplecalculationofriskbasedonprobabilitiesof individualeventsonly. Thepowerofthemodelisinitsabilitytorepresentappropriatelymanyreal world situationsandperformseveraloptimizations,including:(1)thefreedomtoorderparts fromdifferentsources,andtoassemblepartsaccordingtodifferentschemes;(2)thejust distributionofthecostofafailedtransactionamongthesuppliersonthefailurepath,with highercostsbeingbornebysuppliershigheronthesupplychain;(3)thepositive correlationbetweenproductcomplexityandproductrisk;(4)thepropagationofproduct risksupwardthesupplychain;(5)theoptimizationofindividualmemberoperationsto reducecosts,risks,orexpectedlosses;and(6)theabilitytoplaceredundantordersto furtherimproveanyofthesevariables. Muchworkremainstobedone,withfutureworktobefocusedon:(1)Relaxingsomethe abovementionedmodelrestrictions;(2)allowingmemberstomaintainstock,thusallowing economicsofscale (forexample,transactionoverheadwouldbepaidlessfrequently);and (3)devisingefficientalgorithmsforoptimizingmembersoperation(inparticular,howto deployredundantorderingefficiently). References [1]C.E.Bonferroni.Teoriastatisticadelleclassiecalcolodelleprobabilità.IstitutoSuperioredi ScienzeEconomicheeCommercialidiFirenze,Vol.8,1936,pages1 62. [2]L.M.Camarinha MatosandH.Afsarmanesh.TheVirtualEnterpriseConcept.InProceedingsofthe IFIPTC5WG5.3/PRODNETWorkingConferenceonInfrastructuresforVirtualEnterprises:Networking IndustrialEnterprises,IFIPConferenceProceedings,Vol.153,1999,pages3 14. [3]A.D AtriandA.Motro.VirtuE:aFormalModelofVirtualEnterprisesforInformation Markets.InternationalJournalofIntelligentSystems,Vol.30,No.1,February2008,pages [4]A.DeMoivre.Doctrineofchances amethodforcalculatingtheprobabilitiesofeventsinplays. Pearson,London,1718. [5]A.K.Elmagramid.DatabaseTransactionModelsforAdvancedApplications.M.Kaufmann Publishers,SanMateo,California,1992. [6]P.Grefen.TransactionalWorkflowsorWorkflowTransactions?InProceedingsofDEXA02, 13thInternationalConferenceonDatabaseandExpertSystemsApplications,LectureNotesin ComputerScience,Vol.2453,Springer,2002,Pages [7]G.E.Smith,M.P.Venkatraman,R.R.Dholakia.Diagnosingthesearchcosteffect:Waitingtimeand themoderatingimpactofpriorcategoryknowledge.journalofeconomicpsychology,vol.20,1999, pages