Performance variables: Transaction costs and value

In this section we discuss the performance variables that reflect whether the coordination mechanisms of commercial interests are able to align behaviour in distribution systems. The performance variables are represented in terms of transaction costs (Milgrom and Roberts 1992) and transaction value (Zajac and Olsen 1993). The goal of governance mechanisms is to minimize the cost of exchange, i.e. transaction costs (Williamson 1991). Recently, it has also been argued that governance needs to be designed in order to stimulate value creation (Ghosh and John 1999, Dyer and Singh 1998, Zajac and Olsen 1993). We start with the transaction costs and then discuss the argument for value creation.

There are costs in carrying out transactions (Milgrom and Roberts 1992, Coase 1937).

Transaction costs are independent of the price of goods or services but are determined by the nature of the exchange (Robins 1987). The execution of a transaction has, in principle, four dimensions. Firstly, there is apre period before the transaction is executed, where parties prepare for exchange. Secondly, there is theactual execution of the transaction and how the exchange is conducted. Thirdly, there is a post sequence after the transaction has been executed, where the exchange parties experience the transaction. Fourthly, there is the idea of an alternative to the transaction, which refers to other possible transaction the exchange parties could have conducted instead. These four dimensions are cost drivers and incur what is known as ex ante, ex post, direct and opportunity costs respectively. Dahlstrom and Nygaard (1999) refer to this as the multiple facets of transaction costs. In studying the coordination of commercial interests, the transaction costs influence the performance of the distribution systems. In the table below, we have included some key defmitions oftransaction costs:

Table3.7:Definitions of transaction costs

ti!O$ts> ri ^{i .}

Williamson (1985) Comparative costs ofplanning, Ex ante transaction costs: costs of drafting, negotiating adapting and monitoring task and safeguarding an agreement.

completion under altemative Ex post transaction costs: the maladaptation costs, the governance structures. haggling costs, the set-up and running costs, and

bonding costs.

Milgrom and Roberts Transaction costs are the costs Coordination costs: The need to detennine process and (1992) of running the system; the costs other details of the transaction, to make the existence

of coordinating and of and location of potential buyers and sellers known to motivation. one another, and to bring the buyers and sellers

together to transact.

Motivation costs: Costs generated from information incompleteness and asymmetries, and from imperfect commitment.

Rindfleisch and Heide Transaction costs are the costs Direct transaction costs: Costs of crafting safeguards, (1997) of running the system, and communication, negotiation and coordination costs,

include such ex ante costs as screening and selection costs (ex ante) and drafting and negotiating measurement costs (ex post).

contracts, and such ex post Opportunity costs: Failure to invest in productive costs as monitoring and assets, maladaptation costs: failure to adapt, failure to enforcing agreements. identify appropriate partners (ex ante) and productivity

losses thro~gh effort adjustments (ex post):

Transaction costs has been an area of some confusion but currently the nature of these costs is much better understood (Rindfleisch and Heide 1997). Still, transaction costs are often difficult to quantify, However, this is mitigated when transaction costs are assessed in a comparative institutional way, in which one mode of contracting is compared with another.

Accordingly, it is the difference between rather than the absolute magnitude of transaction costs that matters (Williamson 1985). Thus, it is argued that simpler arguments suffice to demonstrate an inequality between two quantities than are required to show the conditions under which these quantities are equated at the margin (Simon 1961). Empirical research in transaction costs hardly ever attempts to measure such costs directly (Williamson 1985).

Houston and Johnson (2000) give such an indirect comparison when comparing the efficiency of joint ventures, with contracts based on shareholder value post the relationship announcement There is, however, a lack of empirical research concerning how governance mechanisms influence transaction costs (Dahlstrom and Nygaard 1999, Rindfleisch and Heide

1997).

Govemance is also viewed as a vehicle to create value (Ghosh and John 1999, Zajac and Olsen 1993). The studies question a static transaction cost perspective, where a given (governance) situation is optimized. Rather, the authors argue that it is possible to influence a relationship once it is 'running'. Zajac and Olsen (1993) particularly point out that 68

relationships have two parties and argue that traditional transaction cost analysis views a relationship from one side.Itis assumed that adjustments in relationships are made, as parties seek to maximize the value oftheit business opportunities. In their view, there is a transaction process and they " ... view the exchange partners in interorganizational strategies as primarily concerned with how to estimate expected value over the expected duration of the interorganizational strategy, how to create that value with the partner firm, and finally, how to claim that value" (Zajac and Olsen 1993:137). The partners in cooperation createjoint value.

Ghosh and John (1999) challenge the reduced form oftransaction cost theory by questioning the exogenous choice of an ex post situation. Itis expected that ex post transaction costs rise if changes and/or opportunistic action take place in an agreement. Thus, in fear of such a situation, the parties to the agreement may forego the opportunity. However, in the argument of Ghosh and John (1999), the exchange characteristics are not exogenous during the execution of an agreement. The parties may contribute with strategic choices that rearrange the situation during a later stage in the execution period. Thus, it is argued that there is an interaction between the creation and claiming of value, and thepositioning and resources influence the choice of governance mechanisms (Ghosh and John 1999).

The transaction costs perspective argues that exchange incurs costs, however, an initiated exchange may also offer additional value opportunities. Diverging behaviors from the common interests in distribution systems may, therefore, increase costs but also contribute to added value. In evaluating the performance of distribution systems, it is necessary to classify whether or not behavior is aligned in accordance with the agreement. If not, the behavior has to be evaluated as to whether it is contributing to added value for the distribution system or whether it is incurring added cost. The evaluation discloses whether the coordination mechanisms for the commercial interests are contributing to coordinated action in the distribution system.

3.5 Summary

Our thesis is that each flow in the distribution system needs to be coordinated specifically but that there are also interaction effects between the flows that contribute positively to coordinated action. We expect there to be a pattern between the coordination mechanisms. In this thesis, we have concentrated on the physical flows and commercial interests. In the literature on distribution, we have found that coordination mechanisms address each of the

flows but not specific insights into how these coordination mechanisms interact. Our aim is to contribute to this knowledge.

Inorder to ensure the physical movement of goods in a distribution system, it is necessary to coordinate activities in an activity structure. We have learned that interdependencies in the activity structure determine the choice of coordination mechanisms. We have argued that the activity structures are subject to the same type of variations as Thompson's (1967) technologies. Therefore, the coordination mechanisms of standardization, planning and mutual adjustment are argued to apply as coordination mechanisms of activity structures in order to ensure high performing physical flows. The coordination mechanisms are implemented to secure integrated activities, asitis assumed that a higher level of integration results in increased performance in physical flows. Performance for physical flows is measured in terms ofoperations costsandcustomer service level.

Contracts coordinate commercial interests in distribution systems. We have learned that the contracts need to be able to both control and motivate the actors that take part in the distribution system. The contracts need, therefore, to incorporate both formal and informal governance mechanisms, which include hierarchical mechanisms, incentives andnorms. The three types of governance mechanisms balance control and motivation. The goal of the contract and the governance mechanisms is to ensure that the actors taking part in distribution system actually align their behaviorwith the common interest of the system. If the contracts are not effective in achieving this goal, actors are expected to seek self-interests at the expense of the other actors taking part in the distribution system. If the commercial interests are well coordinated, the self-interests and the common interests are aligned. The evaluation of how well contracts are able to achieve aligned behavior is reflected in the performance variables transaction costsand transaction value.These variables reflect to what extent there are actors with diverging behavior in the system.

Insummary, our argument is that well-adapted coordination mechanisms of both physical flows and commercial interests contribute to a higher probability to achieve coordinated action in a distribution system. The arguments that we have made are isolated for each of the flows. Inthe next chapter, we continue with the development of a framework to analyze how the sets of coordination mechanisms interact.

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The logic of the theory is developed based on distribution systems in general. Our interest is to understand coordination inreverse distribution systems. Inthe introductory section of this chapter, we have shown that there are specific features to reverse distribution systems. Such features include activities like collection and reprocessing but also characteristics, such as that end-consumers have a passive behavior as suppliers in reverse distribution systems. We have shown that there are certain waste management options (e.g. reuse vs. recycling) and that reverse distribution systems may be coordinated in either a closed or open manner. However, despite the specific reverse characteristics, we argue that the analysis of reverse distribution systems departs readily from theories that are applied to the understanding of forward distribution settings.

As 'the reverse' is a relatively new and empirically interesting area, it is our primary interest to understand how coordinated action is achieved in reverse distribution systems. Taking the components of theory in this chapter further we continue by developing a framework for analyzing coordinated action.