Resource Dependency and Transaction Cost Economics Theories

Resource dependency

Organizations are dependent on their environments They need resources to survive and grow

Environment becomes poor if: Important customers are lost or new competitors

enter Organizations manage their transactions with

the environment The goal: Ensure predictability of access to

resources, reduce uncertainty and dependency

Resource dependency (cont’d) Tools to minimize dependency:

1) Exert influence over other organizations to obtain resources

2) Respond to the needs and demands of other organizations in its environment

The strength of resource dependence is a function of:

1) Vitality of the resource for org’l survival

2) The extent to which the resource is controlled by other organizations (i.e., monopoly condition)

The general and specific environments

FIRM

SUPPLIER

CUSTOMER

COMPETITOR

DISTRIBUTOR

EMPLOYEE

REGULATORY INSTITUTIONS LEGISLATIVE INSTITUTIONS

OTHER INDUSTRIES GOVERNMENT

ECONOMIC INSTITUTIONS

Interorganizational strategies for managing resource dependence Specific environment:

Suppliers, labor unions, customers, customer interest groups

Two basic interdependencies in the specific environment:

1) Symbiotic interdependence Exist among an organization and its suppliers and

distributors

2) Competitive interdependence Exist among organizations that compete for scarce

inputs and outputs

Managing symbiotic interdependence Good reputation

Organization held in high regard because of fair and honest business practices Paying bills on time, providing high quality goods &

services, reliability, trustworthiness, goodwill Ex: De Beers diamond cartel

Acting honestly does not rule out negotiating over price and quality

The most informal way of managing sybiotic interdependence

Managing symbiotic interdependence (cont’d) Co-optation

Neutralizing problematic forces in the specific environment

Bring opponents on the organization’s side Give them a stake or claim to satisfy their interests

Ex: Phamaceutical companies and physicians, local schools and parents

Inter-locking directorates When a director from one company sits on the

board of another (Ex: Financial institution president elected for the board of the company)

Managing symbiotic interdependence (cont’d) Strategic alliances

An agreement that commits two or more companies to share their resources to develop joint businesses Ex: IBM (computer skills) and Sears (customer base)

establish a joint venture prodigy to provide on-line information service to customers

Types of strategic alliances: Long-term contracts Networks Minority ownership Joint venture

Managing symbiotic interdependence – Types of strategic alliances

Long-term contracts: Least formal type of alliance Can be oral or written,

Kellog has a written contract with the farmer suppliers of corn and rice Agrees to pay a certain price regardless of the

market rate when the produce is harvested They both eliminate uncertainty in their

environments

Managing symbiotic interdependence – Types of strategic alliances

Networks Defn.: “A cluster of different organizations whose

actions are coordinated by contracts and agreements rather than through a formal hierarchy of authority”

Network members work closely to support and complement one another’s activities

More ties that link members and greater formal coordination of activities Ex: Nike builds long-term relationships with suppliers,

distributors, and customers to keep core organization from becoming too large and bureaucratic.

Managing symbiotic interdependence – Types of strategic alliances Minority ownership

Organizations hold minority shares in each other Keiretsu shows how minority ownership networks

operate Members share proprietary information and

knowledge that benefit them collectively Capital keiretsu: To manage input-output linkages

Ex: Toyota and its suppliers Financial keiretsu: To manage linkages among

diverse companies. Has a large bank at the center Ex: Fuyo keiretsu

Managing symbiotic interdependence – Types of strategic alliances

Joint venture Defn.: “Strategic alliance among two or more

organizations that agree to share the ownership of a new business”

Companies that form the new business jointly design its organizational structure Provide resources for it to prosper,sends executives

to the new business The new company is free to develop its structure A JV allows the founding companies to stay small

Managing symbiotic interdependence

Merger & takeover The most formal strategy Resource exchanges occur within rather than

between organizations A powerful supplier can no longer hold an

organization as hostage Can be exercised only when an organization has

a great need to control a crucial resource or manage and important inter

Managing competitive interdependence Organizations don’t like competition since it:

Reduces the supply of scarce resources Increases uncertainty in the environment

Collusions Collusion is a secret agreement among

competitors to share information for collectively coordinating activities (illegal) Establishing industry standards for:

Price, product specifications, profit markup generally by the price leader(s) (Ex: Sony & Philips developing the standard for CD technology)

Managing competitive interdependence Cartels

An association of firms that agree to coordinate their activities

Organizations form cartels by: Signaling their intentions by public announcements

Ex: Announce price increases that they plan to see whether rivals will match those increases

Dominant industry players may discipline others that break the informal rules of the industry Some small firms may be forced out of the industry for

reducing prices below the price-cutting level of the industry

Managing competitive interdependence Third-party linkage mechanisms

A regulatory body that alows organizations to share information and regulate the way they compete Ex: Trade associations, chambers, cooperatives, etc.

Enables competitors to meet and make informal agreements to monitor each other’s activities

Lobby for government policies to protect industry members Increase the flow of information to industry members Stabilize industry competition Promote cooperation between domestic rivals

Managing competitive interdependence Strategic alliances

Competitors can cooperate to develop common technology Ex: IBM - Apple JV to develop a common microchip

that will make their machines compatible Ex: Ford and Mazda cooperated to produce vehicles

in the Ford U.S. plant Alliances and JVs in the telecommunications industry

Managing competitive interdependence

Merger and takeover Ultimate weapon to manage competitive

interdependencies Enlarges the domain and product range of a

company Sabancı takes over Gima, Koç takes over Tansaş to

increase their control over the expanding retail market in Turkey

Downside: Tall, centralized, mechanistic structures unable to

meet challenges of a rapidly changing environment

Transaction cost theory (TCE)

Tries to answer the question: “Why organizations exist?”

Why and under what conditions to select and change the aforementioned strategies

Transaction costs: Negotiating, Monitoring, Governing,

Exchanges between people and firms

Transaction cost theory (cont’d)

The goal of the organization is: To minimize costs of exchanging resources in the

environment To minimize costs of managing exchanges inside

the organization “Every dollar or hour of a manager’s time spent in

negotiating or monitoring exchanges with other organizations or inside the organization is a dollar or hour not used for creating value” Transaction costs siphon off productive value

Sources of transaction costs

Environmental uncertainty and bounded rationality The environment is uncertain and complex People have a limited ability to process

infromation and to understand the environment surrounding them The higher the level of uncertainty in the environment

the greater is the difficulty of managing transactions between organizations

Sources of transaction costs (cont’d)

Opportunism and small numbers Though not all, some people behave

opportunistically — they cheat or exploit other stakeholders in the environment When an organization is dependent on one

supplier or a small number of traders, the potential for opportunism is higher The organization has to spend resources to negotiate,

monitor, and enforce agreements with trading partners to protect itself (i.e., transaction costs increase)

Sources of transaction costs (cont’d) Risk and specific assets

Investments in skills, machinery, knowledge, and information that create value in one exchange relationship but have no value in any other exchange relationship Specific asset investments increase risk in a

business relationship To counter such a risk, the investing firm may try to

negotiate extensively and enforce terms of a contract which increases transaction costs

TCE and Linkage mechanisms Transaction costs are low when:

Organizations are exchanging nonspecific goods and services

Uncertainty is low There are many possible exchange partners

Transaction costs increase when: Organizations exchange more specific goods and

services Uncertainty increases The number of trading partners fall

TCE and Linkage mechanisms

According to TCE: As transactions costs in an exchange increase,

the firm should choose a more formal linkage mechanism such as: A joint venture A merger or a take over

The downside of formal mechanisms Internal transaction costs —communication,

negotiation, monitoring, governance of exchanges within the organization — increase

Strategies for integration and unique

design of Motorola & Chrysler

Standard versus custom parts

With suppliers of standard parts and commodities: Focused competition

Some shifting among firms Cost improvement

Highest-preferred supplier asked for a bid Competitive bids from several other preferred

suppliers Achievement of lowest possible cost

Standard versus custom parts (cont’d)

With suppliers of custom parts: Design and make a unique item Protect investments in design and any unique

tooling it may need Life-of-part agreement

Supplier is assured the business as long as the part is needed and performance keeps pace (Ex: semiconductors, liquid crystals)

At the end of custom part’s life a new design competition between preferred suppliers is initiated

Substantial design cooperation on future generations; changing suppliers is disruptive

When integration is needed Motorola’s Paging Products Group

Technological change for most parts rapid Will not change suppliers unless something

drastic occurs Process of adjustment builds deep shared

understanding Motorola looks for long-term commitment to continued

change and its objectives Shifting suppliers entail high cost and threat to

cycle time Existing suppliers are given a hand to improve

performance

With unique designs Life-of-part agreements used with custom

goods Protects the supplier’s interest Predicting future costs can be difficult

Price or productivity curve may deviate from reality over time

May damage customer or supplier Motorola enters an agreement for only the first

year to learn and set targets Quality audits to characterize generic supplier

processes, develop a generic cost model Highlighting problems, deciding on best performance

With unique designs (cont’d) Chrysler

90% of all purchases are custom designed Substantial design cooperation Supply base integrated into design work Shifts among suppliers expensive and disruptive Suppliers get life-of-part agreements, but without

price curves Each supplier suggests changes to save costs Accepted changes are shared by Chrysler on a 50-50

basis What if supplier underreports savings?

With unique designs (cont’d) Chrysler’s approach has achieved better

costs over other auto firms Relationships with suppliers that encourage more

sharing Sharing costs build trust with suppliers A need for high design integration brings about a

need for continuity Suppliers of unique parts continue from one

generation to the next Preferred supplier for the custom designed part

does not automatically get the job for Motorola and Ford