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If markets are so efficient, why are there so many alternate forms of transaction?
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If markets are so efficient, why are there so many alternate forms of transaction?If markets were fully efficient, complete, and competitive, we would expect everything to be
transacted at a fair price in the open market. Hence, firms may face difficulty existing since they
are less efficient by virtue of being small command economies internally.
However, markets are in fact not so efficient due to transaction costs and other market
imperfections. This gives rise to a continuum of transaction governance structures:
internal intra-firm transactions on one end, arrangements like unilateral or bilateral
contracts, or equity-based joint ventures, and market buying on the other end.
This essay argues that many alternate forms of transaction exist beyond market buying
due to transaction costs.
Factors affecting transaction costs influence the form selected for a transaction, with
factors including technology appropriability, the nature of resources and synergy, and
external environmental factors.
Firstly, intra-firm transactions exist, and transactions are internalised in cases where costs of
accessing markets are high. Coase (1937) argues that firms internalise transactions when the
cost of arranging them internally are less than the costs of accessing the market. Market
transaction costs include searching, bargaining or negotiating, and contract enforcement costs.
Williamson (1981) explains that bounded rationality results in imperfect contracting, and
opportunists exploit this. In the case of dissimilar transactions, low contracting frequency, and
spatial distribution of transactions, costs may be high (Coase, 1937). Moreover, transaction
costs increase with higher site, human, or physical asset specificity (Williamson, 1981), when
supplier concentration creates bargaining disadvantages, and when high uncertainty enables
opportunism (Holcomb & Hitt, 2007). In such cases, choosing to 'make' rather than to 'buy'
could be more efficient. For example, General Motors merged with Fisher body in 1926, after
initially contracting them for automobile closed bodies under a 10-year contract. High asset
specificity of the supplier, and uncertainties in the form of demand and costs, made transaction
internalisation through merger attractive.
However, presenting transaction internalisation and market buying as the only options create a
false dilemma. Both have their drawbacks. Internalisation faces coordination costs, associated
diversification problems that could destroy value (Berger & Ofek, 1995), organic internalisation
though development of complementary resources may be slow, while the inorganic method of
acquisition is associated with problems like excessive premium payment (Hayward & Hambrick,
1997). Meanwhile, market buying may not always be possible due to market incompleteness
and high transaction costs. Between these two choices exist a continuum of hybrid forms of
transaction that could be better suited to a specific transaction's characteristics.
For instance, the extent of technological appropriability associated with a transaction lead to
the pursuit of different forms of transaction governance structures. Empirically, more
hierarchical alliance structures are used when contracting hazards are high (Oxley, 1997). In
, cases where contractual specification of rights is hard such as in alliances based upon product
or process design, and in cases where monitoring is difficult due to large technological, product,
or geographic scope, there is greater space for counterparty opportunism which raises
transaction costs and contractual hazards. In such cases, an equity-based joint venture could
align incentives and prevent opportunism, while preserving some flexibility and reducing the
risks associated with acquiring or merging with the partner. If these issues are less severe,
bilateral contracts such as cross-licensing and technology sharing agreements could act as a
form of hostage exchange to reduce the likelihood of opportunism by either party, while
unilateral contracts can be pursued if contractual hazard is low (Oxley, 1997).
The nature of the resources involved also leads to different optimal forms of transaction. In the
case of soft resources like human capital, equity alliances may enable better access while
nonequity alliances should be sufficient for hard resource access such as manufacturing facility
use (Dyer, Kale, Singh, 2004). For example, many western companies use nonequity contractual
agreements to outsource manufacturing to Asian firms: Apple's Foxconn iPhone manufacturing
deal, and Nike's not having any factories, outsourcing to Vietnam, China and Indonesia. In the
case of marketing-only resources, geography restrictions in licensing are logical since marketing
resources are often regionally and locally specific. In cases where additional specific
complementary investment is required, exclusive licenses could safeguard licensees and give
them the confidence to invest (Somaya, Kim, Vonortas, 2011).
The nature of synergies created also benefit from different forms of transaction. Nonequity
alliances are sufficient for modular synergies where results and not the resources themselves
are pooled, such as in the case of frequent flyer mile partnerships between airlines and hotel
chains. Examples include Marriott and Emirates or United Airlines, Hyatt and American Airlines,
or AirBnB with Delta Airlines. Sequential synergies where one company completes a task and
passes it on requires resource customisation, so equity alliances could act to align incentives,
make it worthwhile to customise resources, and reduce the need for significant monitoring. For
example, smaller biotech firms like Abgenix sometimes partner with large firms like
AstraZeneca to tap on their FDA approval process expertise. Lastly, reciprocal synergies
requiring extremely intimate combination and customisation of resources could benefit from
acquisition, such as in the case of the Exxon and Mobil merger (Dyer, Kale, Singh, 2004).
Lastly, external factors like industry maturity and market uncertainty are associated with
different forms of transaction. When there is high market uncertainty, potential acquirers may
prefer pursuing an equity alliance first to manage risk, only acquiring later when uncertainty
lowers (Dyer, Kale, Singh, 2004). Bleek & Ernst (1995) point out that many alliances often end
up in acquisition. Many corporate venture capital arms for instance, make strategic investments
into early-stage start-ups and partner with them, viewing them as potential acquisition targets
after they achieve certain levels of market success. In the world of licensing, early stage
technologies in new industries often have exclusive licensing due to licensee require significant
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