1 © Carliss Y. Baldwin and Kim B. Clark, 2002 Where Do Transactions Come From? Carliss Y. Baldwin Harvard Business School Presented at NBER Organizational

1 © Carliss Y. Baldwin and Kim B. Clark, 2002

Where Do Transactions Come From?

Carliss Y. BaldwinHarvard Business School

Presented at NBER Organizational Economics Conference, November 22, 2002


Transaction Cost/Incomplete ContractsWilliamson, 1985:A transaction occurs “when a good or service is

transferred across a technologically separable interface. … [R]arely is the choice among alternative organization forms determined by technology.”

Upstream Downstream

“Technologically separable interface”

In this literature, technologies and designs are fixed, asset ownership and decision rights move around.


But suppose designs and product definitions are not fixed a priori,

Then, where do Transactions Come From?


But suppose designs and product definitions are not fixed a priori,

Then, where do Transactions Come From?

From the engineering design of a system of production…


Our thesis:

The modular structure of a system of production reveals the places where:– The division of cognitive labor is high, and– Mundane transaction costs are low.

Transactions should go/can go only at those places.


Outline of the paper

T&T Network defined Mapping technique—TSM Encapsulation of T&T “blocks” Pinching the T&T Network Conclusion: Modular structure and

mundane transaction costs


Disclaimer We believe what we are saying is neither

radical nor new Many predecessors:

– Coase (1937)– Alchian and Demsetz (1972)– Barzel (1989) and North (1990)– Cremer (1980) and Aoki (2001)– Sako (1992) and Fixson and Sako (2001)

We aim for a clarification of language.


The T&T Network Defined


Task & Transfer (T&T) Network

All tasks and transfers needed to complete production of artifacts in the economy

Engineering Design is the work of designing the T&T Network

Transfers are ubiquitous– Because “agents” have bounded cognition

and physical capacity– True for both people and machines


What gets transferred? Material Energy Information

– Data– Designs – “Tags”

» Property rights and decision rights are a special form of tag

Money or credit = Purchasing Power


Transfers are

Dictated by technology Complex Logical Necessary (because of bounded capacity) Designed

But not planned centrally


Not all transfers are transactions A “transaction” requires

– Standardizing transfers– Counting transfers– Payment for the units transferred

These are extra and costly tasks – => “Mundane” Transaction Costs (MTC)

MTC vary depending on complexity of transfers– Contingent, interdependent, iterative transfers are very

complex– Hence such transfers are very costly to make into

transactions


Mapping the T&T Network


Mapping Technique = “Task Structure Matrix” (TSM)


Intel T&T Network—1993A Task Structure Matrix for the Design of a Semiconductor ChipCompiled by Sean Osborne (1993)

Customer target 0 X X X

Sales volumes X 0 X X X

Pricing direction X 0 X X

Schedule 0 X Generative Learning

Development methodology X 0 X X X X

Macro targets/constraints X X 0 X X X X Concurrent Activity Blocks

Financial analysis (profitability) X X X X X 0

Program map X 0 X Iterative Loops

Initial QFD matrix X X X X 0

Technical requirements X X X X 0 X

Customer specification X X X X X 0 X X X X X X X X

High level modeling X X X X 0 X X X

Target specification X X X X X X X X X 0 X X

Test plan X X X X X 0 X

Product validation plan X X X X 0

Base prototype X X X X X X 0

Functional modeling X X X X X 0 X X X X X X X X X X X X X X X X X X

Product module developed X X X X X X X X X 0 X

Product integration development X X X X X X X X X 0

Integration modeling X X X X X X X 0 X X X

Random testing X X 0 X X X

Test parameters developed X X X X X X X 0 X X X

Schematics finalized X X X X X 0 X X X X X X X

Validation simulation X X X X X X X 0 X X

Reliability modeling X X X X X 0 X

Complete product layout X X X X X 0 X X

Continuity verification X X X X X X 0

Design rule check X X X 0

Design package X X X X X 0 X X X X X X X

Generate mocks X X X X 0 X X

Verify mocks in fab X X X 0

Run wafers 0 X X X X

Sort wafers X 0

Test programs X 0

Debug products X X X X X 0 X X X X

Package products X X X 0

Functionality testing X X X 0

Samples to customers X X X Sequential X 0

Feedback from customers Activites X 0

Sample functionality verified X 0

Packaged prodcuts verified X 0

Environmental validation X X X X X X 0

Product validation completed X X X X X 0

Develop technical publications X X X 0 X X

Service course developed X X 0 X

Marketing name determined X X X X X 0 X

Licensing strategy determined X X X 0

Demo created X X X X X X 0

Quality goals met X X X X X 0

Life testing X X X 0 X X

Infrared mortality testing X X X X 0 X

Manufacturing process stabilization X X X 0 X X

Field support plan developed X 0

Thermal testing X X X 0

Process meets standards X 0 X X

Package meets standards X X X X X 0 X

Meets certification envelope X X X X X X X X X X X 0

Volume production X X X 0 X

Distribution network prepared X X X X X X X X 0

Deliver products to customers X X X X X X X X X 0


Intel T&T Network—1993


TSMs show where transfers occur, but not what gets transferred


Where do transactions go?


The Smiths and the CooksSmithy Kitchen

S1 S2 S3 S4 S5 K1 K2 K3 K4 K5

S1 . x x x x

Smithy S2 x . x x x

S3 x x . x x

S4 x x x . x

S5 x x x x .

K1 Pot Hookx . x x x x

Kitchen K2 Transfer x . x x x

K3 x x . x x

K4 x x x . xK5 x x x x .


TSMs reveal T&T “Bottlenecks”Smithy Kitchen

S1 S2 S3 S4 S5 K1 K2 K3 K4 K5

S1 . x x x x

Smithy S2 x . x x x

S3 x x . x x

S4 x x x . x

S5 x x x x .



K3 x x . x x


Transfer Bottleneck


Bottlenecks = Transactional “Gateways”

Smithy KitchenS1 S2 S3 S4 S5 K1 K2 K3 K4 K5

S1 . x x x x

Smithy S2 x . x x x

S3 x x . x x

S4 x x x . x

S5 x x x x .



K3 x x . x x


“Place Transaction HERE” —

Few transfers; One-way transfers; Maximum “Division of cogitive labor”


Bottlenecks = Transactional “Gateways”

Smithy KitchenS1 S2 S3 S4 S5 K1 K2 K3 K4 K5

S1 . x x x x

Smithy S2 x . x x x

S3 x x . x x

S4 x x x . x

S5 x x x x .



K3 x x . x x


“Place Transaction HERE” —BecauseMundaneTransactionCosts areProbablyLow


Encapsulation


Design Problem:

If every transfer had to be a transaction, little work would get done.


Solution:

Transaction-free zones “Encapsulated Local Systems”

– Predecessors: Families, communes, tribes – Merchants and Proto-firms – Then: Full-functioned firms (1750s) and

Limited-liability Corporations (1830s) with Affirmative and Defensive Asset Partitioning


Creating an Encapsulated Local System 1

A B C D E F G H I J K L M N

A . x x x x x x x x x

B x . x x x x x x x x

C x x . x x x x x x x

D x x x . x x x x x x x

E x x x x . x x x x

F x x x x x . x x x x x x x

G x x x x x x . x x x x x x x

H x x x x x . x x x x x x

I x x x x x x . x x x x x

J x x x x x x x . x x x x

K x x x x x x x x . x x x

L x x x x x x x . x x

M x x x x x x x x x . xN x x x x x x x x .

Materials

Energy

People

Machines

Internal Flows are Designed by Engineers

Data

Agents andResourcesCome In;Products Come Out








E x x x x . x x x x









Materials

Energy

People

Machines

Data

TodayAll are ObtainedVia Transactions

$

$

$

$

$ $$$$




Materials

Energy

People

Machines

Data

Transaction-Free Zone:By design,many complex, contingent transfersoccur insidethe TFZ






E x x x x . x x x x











Boundaries of the Capsule

Materials

Energy

People

Machines

Data

Boundaries = Where Transfers take the form of Transactions, according to the Design of the Enterprise






E x x x x . x x x x









Boundaries are Designed by Engineers, too!


Financial Sufficiency

Materials

Energy

People

Machines

Data

When allClaimantsHave beenPaid…

$

$

$

$

$Revenue$$$$

$$$$$$$$$$$

Money is left over!

Costs:


Financial Sufficiency =Survival in a Money/Market Economy

Materials

Energy

People

Machines

Data

When allClaimantsHave beenPaid…

$

$

$

$

$Revenue$$$$

$$$$$$$$$$$

Money is left over!

Local System can survive.

Costs:


Encapsulated Local System =the “Kernel” of a Firm


Encapsulated Local System = the “Kernel” of a Firm

Why only “kernel”?


Because… Can assemble several Encapsulated Local Systems

within “a bigger firm” Can have transactions within “a bigger firm” Transaction costs/incomplete contracts/ property

rights economics basically looks at different configurations of kernels within/across firms

In practice, Mergers, Acquisitions & Alliances serve to adjust kernel boundaries across firms


In summary—

Encapsulation is a technology in the engineering design of the T&T Network

Encapsulation creates the kernels of firms Kernel boundaries are artifacts, which can be

designed and re-designed (within constraints of physics and logic of technology)

Mergers, Acquisitions & Alliances are visible adjustments of kernel boundaries


“Pinching” the T&T Network


An Example from Practice:

Engineering plastics company (=designer and supplier)

Auto manufacturing company (=customer and user)

Product to be designed:– High heat resistant plastic compound


“Natural” TSMEngineering Plastics Company Auto Company

. x x x x x x xx . x x x x x x x x xx x . x x x x x x x xx x x . x x x x x x x

Engineering x x x . x x x x xPlastics x x x . x x x x xProduct x x x . x x x x xand x x x x . x x x xProcess x x x . x x x xDesign x x x x . x x x x

x x x x x x x . xx x x x . xx x x x x x . x x x xx x x x x x x

x . x x x x xx x . x x x x x x x

Automotive x x x x x . x x x x x x xCompany x x x x . x x x x x xProduct x x x . x x x x xand x x x x x x . x x x x xProcess x x x x x x . x x x xDesign x x x x x x x x . x x x

x x x x x x x x x . x xx x x x . x


Transaction-supporting TSMNegotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies

. x x x x x x xNegotiation: x . x x x x x x(8 Specs x x . x x x x x& Tests) x x x . x x x x

x x x x . x x xx x x x x . x xx x x x x x . xx x x x x x x .

x . x x x x x x xx x . x x x x x x x

Eight x x x . x x x x x xFormal Tests x x x x . x x x x x x

Engineering Ex ante x x x x . x x x xPlastics x x x x . x x x xProduct x x x x . x x x xand x x x x x . x x x xProcess x x x . x xDesign x x x x . x x x

x x x x x x x . x Rich x x x x . x Lustrousx x x x x x . Appearance

x x x x x x x

x x x x x

Eight x x x . x x x x x x xAutomotive Formal Tests x x x x . x x x x x x xCompany Ex ante x Eight x x x . x x x x x xProduct x Formal Tests x x x x . x x x x xand x Ex post x x x x . x x x x xProcess x x x x x x x . x x x xDesign x x x x x x x x . x x x

x x x x x x x x . x xx x x x . x

Is “more Modular”

(by defn of Design Rules, Vol. 1)









x x x x x x x

x x x x x



“Mundane” transaction costs









x x x x x x x

x x x x x



Standards: To Define “Gateway”


But Standards were incomplete…

[A]s development proceeded, it became clear ... that there were other characteristics of the material that were very important to important players in the auto company, which were not in the specs. (Example: the interior designers wanted a material with a “rich, lustrous appearance.”) They were not in the specs, because the auto company had no way to make the requirement specific, no testing protocol and no standard to use in the specifications.









x x x x x x x

x x x x x



“Relational” or “Obligational” contract needed


Mundane transactions costs are used to create a “more modular” task structure

Negotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies







x x x x x x x

x x x x x



“Relational” or “obligational” contract needed

“Mundane” transaction costs

Standards: To Define “Gateway”


“Pinching” is an Investment

In a Task Structure and Relationships that support a strict(er) partition of cognitive labor

Value of “Pinching” =

+ Avoided cost of real-time interdependency/iteration (clt)

– MTC (mundane transaction costs)

+ Free-riding (smaller unit, better individual incentives)

– Upstream-Downstream opportunism (in supply chain)


Conclusion


Where do Transactions Come From?

The modular structure of a system of production reveals where:

The division of cognitive labor is high…

and

Mundane transaction costs are low.


The modular structure of a T&T Network Can be mapped using TSM graphs Transactions go at the “bottlenecks” of network

– Transfers few and simple– Division of cognitive labor high

Blocks need to be “transaction-free zones”– Encapsulated via transactions at the boundaries of the

zone– Encapsulated Local Systems = Kernels of Firm

“Pinching” can create a more modular structure– Costs = Mundane Transaction Costs– Standardizing, Counting, Valuing, Payment


Thank you!

Documents

1 © Carliss Y. Baldwin and Kim B. Clark, 2002 Where Do Transactions Come From? Carliss Y. Baldwin Harvard Business School Presented at NBER Organizational