Markets, hierarchies and hybrids

Transaction cost analysis (TCA) is viewed as the main theory to explain coordination of exchange, i.e. governance of transactions (Rindfleisch and Heide 1997, Heide 1994).

Exchange needs to be governed in order to control the behavior of the actors involved. In TCA it is assumed that actors are prone to behaving opportunistically (Williamson 1985) and are limited by bounded rationality (Simon 1961). The exchange parties, according to the

Theory theory, cannot be certain that the partner has behaved as agreed, and therefore the relationship needs to be governed. Alternatively, there is a risk of high transaction costs in the exchange.

TCA has pinpointed the fact that there are systematic characteristics of transactions that corresponded with dermed governance structures (Williamson 1975, 1979).

The characteristics are specific assets, uncertainty and frequency (Williamson 1979). The main prediction from TCA is that the characteristics affect the costs of transacting. If the costs are high, it is efficient to implement the hierarchy as a governance structure (i.e. vertically integrate). As such, TCA explicitly views the firm as a governance structure, which is the theory's dependent variable (Rindfleisch and Heide 1997). In the hierarchy, coordination is achieved through the mechanism of authority. If the costs of transacting on the other hand are low, there is no need for further control and coordination is achieved through utilization of the market as a governance structure. The price mechanism coordinates transactions that are conducted in the markets. The prices are assumed to carryfullinformation to the actors in the trading arena.

TCA' s original framework posed the governance question as a discrete choice between market exchange and internal organization (Williamson 1975, 1985). The discriminating alignment hypothesis to which transaction-cost economics owes much of its predictive content holds that transactions, which differ in their attributes, are aligned with governance structures, which differ in their cost and competencies, in a discriminating (mainly transaction-cost-economizing) way (Williamson 1991). Rindfleisch and Heide (1997) pose that the basic premise of TCA is that if adaptation, performance evaluation and safeguarding costs are absent or low, economic actors favor market governance. If these costs are high enough to exceed the production cost advantages of the market, firms favor internal organization.

Vertical integration, or the make-or-buy decision, has been described as the paradigm problem of TCA and much of the earlier empirical work addresses this topic (Shelanski and Klein 1995). Later work, however, explicitly acknowledges that features of internal organization can be achieved without ownership or complete vertical integration (Rindfleisch and Heide 1997). A variety of hybrid organizations have been identified in the literature, such as contractual provisions, equity arrangements and joint ventures (Houston and Johnson 2000, Hu and Chen 1993, Osborn and Baughn 1990, Borys and Jemison 1989, Joskow 1987).

Studies have examined the antecedents of hybrids, and have also found support for the 50

theoretical propositions of TCA within this type of governance (Rindfleisch and Heide 1997).

The various. governance structures can be illustrated along a continuum from market to hierarchy with hybrid structures in between. As one moves from the market to the hierarchy, the governance structures are combined with an increasing level of authority. The figure below illustrates this:

Increasing level of authority

Authority mechanism Market Hybrid governance structures

• •

Price mechanism

Figure 3.2:The scope of governance structures as argued in TCA

TCA has contributed to the understanding of how to characterize transactions and implement the necessary institutional arrangements to coordinate exchange. However, it is necessary to differentiate the hybrid governance structures in order to identify the proper manner in which to regulate e.g. vertical relationships. Indistribution systems and vertical relationships, it is not an issue of having control per se but achieving coordinated action. Governance is implemented to discipline actors in order to make sure that they perform in accordance with the common interests of a distribution system and, at the same time, are able to achieve self-interests. Invertical interorganizational relations, the companies stay as separate organizations but still seek to behave as one unit, Le. secure coordination. Distribution systems are characterized by consisting of independent but coordinated agencies (Alderson 1954), and are referred to as superorganizations (Reve and Stem 1979), social action systems (Van de Ven 1976), interorganizational collectivity (Reve and Stem 1979, Van de Ven, Emmet and Koenig 1974) or domesticated markets (Arndt 1979). The fact that vertical relationships consist of independent actors that are tied together in a system makes it difficult to govern them within the form of 'market' or 'hierarchy', as the actors are neither autonomous (in markets) nor internal (inhierarchies). Hybrid governance structures are relevant for the governance of transactions invertical relationships (Rindfleisch and Heide 1997).

Research has demonstrated that authority is achieved inhybrid governance mechanisms. Of specific relevance for this is the work of Ouchi (1979), where it is demonstrated that control

in organization is achieved through the market, bureaucratic and clan mechanisms. The choice of market and bureaucratic mechanisms depend on the organization's ability to measure output and/or behavior. If neither is possible, however, it is argued that clan control is the proper form of governance. Thus, three distinct types of control can be implemented in the organizations to achieve governance. Market mechanisms are used when output is easily identified and easily compensated (e.g. internal pricing). Bureaucratic mechanisms are used when behavior needs toand can be observed and are compensated accordingly (e.g. wages).

Clan mechanisms are used when the performance is subtle and ambiguous, and dependent on socialization processes.

Ouchi (1979) demonstrates that variations in organizations need different types of control and he specifies the available governance mechanisms. However, the same conditions are demonstrated to exist betweenorganizations, and studies have found that the mechanisms also apply to interorganizational relationships (Macneil 1980, Stinchcomb 1985, Bergen, Dutta and Walker 1992, Eisenhardt 1989). In the next section, we address the mechanisms that are implemented to achieve coordination between organizations.