Transaction Cost theory

Definition

Transaction Cost Economics (TCE) theory investigates transaction risks between organizations

operationalized through make-buy or ally decisions, contractual solutions, buyer-supplier relationships, and sourcing strategy. Transaction cost arises in settings where actors limited by bounded rationality engage in transactional exchange relationships. Thus, actors must behave in an economically efficient manner by minimizing transactions. A critical liability in organizations is opportunistic behavior induced by bounded rationality putting constraints on human behavior. Thus, resulting in intentional or unintentional adverse behavior, reducing communication and processing in a business transaction (Schniederjans, Hales, 2016).

Nonetheless, erratic customer demand and elevated in-house cost of production attract organizations to outsourcing non-essential business activities (Prajapati, Kant, Tripathi, 2020).

Incomplete contracts

TCE emphasizes the importance of minimizing transaction costs by looking for solutions that maximize value for all parties involved in a transaction (Schniederjans, Hales, 2016). It permits the study of information asymmetry between vendors and customers. Customers seek oversight of a transaction by adopting the method for its governance, such as contractual governance. Nonetheless, literature asserts that contracts are incomplete due to information asymmetry or that one cannot make every detail explicit for any given context during a transaction. That would be an almost impossible and very inefficient task (Maklouf, 2020). The dimensions of asset specificity, performance measurement difficulty, and uncertainty level are the three pillars of TCE (Schniederjans, Hales, 2016).

Asset specificity

Asset specificity relates to the degree of specific value an investment detains in a respective transaction. The higher the specificity, the harder it is to apply that value to other business areas. The more intertangled involved parties become, the more the resource's value is constrained to that specific relationship

(Schniederjans, Hales, 2016). According to Williamson (1985), asset specificity is considered a long-term investment to support a particular decision. The alternative cost relates to how specific that investment is to the project and the discarding of the investment. The more tailored the investment is to the transaction, the higher the asset specificity. In a cloud context, this means moving across cloud vendors in a lean manner, customize cloud service, and all other costs related to supporting the cloud solution, including switching provider, change management, services, and business process reengineering (Maklouf, 2020).

Performance measurement difficulty

The level of performance measurement difficulty determines the extent to which a given transaction offers exact cost and benefits to the parties involved. Information asymmetry is a frequent source of performance measurement difficulty. The superior computing power of cloud computing mitigates this discrepancy through rapid deployment enabling better analyzing and storage capabilities, effective information sharing, coordinating, and planning. Thus, decision synchronization is improved, increasing consumer market responsiveness. In addition, collaborative knowledge creation diminishes service-level challenges (Schniederjans, Hales, 2016).

Uncertainty

Uncertainty refers to unforeseen changes concerning the transaction in question. Cloud computing lessens uncertainty due to superior information sharing capability on many platforms regardless of location or type of platform. Thus, alleviating the risk of transaction cost and its impact on collaborative communication.

Furthermore, the virtualization capability of the cloud relieves organizations of the necessity to invest in costly IT equipment to store and transmit information. CC maintains data centers with minimized effort (Schniederjans, Hales, 2016). In a cloud context, legal compliance, monitoring, and contract management determine the level of uncertainty. In combination with the cloud transaction frequency and asset specificity, organizations can discern a holistic perspective of transaction costs related to transitioning to the cloud (Maklouf, 2020).

Furthermore, environmental turbulence relates to unpredictable interruptions in the environment, such as market or technological disruption, which may negatively impact organizations by enabling conflicts and performance liabilities. Hence, technology absorption capability is critical (Shao, Yang, 2021).

Trust and relational governance

Trust encompasses an individual's beliefs and expectations that all parties in a transaction or relationship will exhibit socially appropriate behavior and not engage in opportunism. Trust is a social mechanism that regulates social complexity by mitigating adverse behavior. This notion applies to the cloud paradigm as end-users must trust their provider to act ethically, thus mitigating information asymmetry related to

complex decisions in the face of uncertainty. Which in turn may increase purchasing decisions and recurrent purchasing behavior. Evidence suggests trust to moderate the relationship between perception of risk and behavioral intention (Garrison, Rebman, Kim, 2018).

One way to enforce trust between vendor and customer is through Service Level Agreements. The latter is correlated to customer satisfaction as it is a negotiation between price and quality of service between cloud service providers and customers. (Schniederjans, Hales, 2016).

Competitive advantage

Outsourcing is common, especially among small and medium enterprises (SME). Most organizations face a make-buy or ally decision (Asiatini, Penttinen, Kumar, 2019). However, in business transactions between vendors and customers, price is not juxtaposed with the cost of the solution. The transaction itself may engender additional unforeseen costs (Maklouf, 2020).

TCE is a well-suited theoretical perspective to exploit the advantages of outsourcing for business benefits purposes by investigating various outsourcing alternatives and assess costs related to managing, monitoring, and controlling a transaction (Maklouf, 2020; Prajapati, Kant, Tripathi, 2020). Through the lens of TCE, it is possible to get a sense of how cloud computing might mitigate transaction risk and facilitate collaboration (Schniederjans, Hales, 2016). The critical success factors of outsourcing apply to cloud sourcing as the motivation to go cloud may involve economies of scale and demand pooling (Maklouf, 2020).

Organizations who adopt this way of thinking are better suited to improve economic efficiency by assessing unexpected costs when engaging in business transactions in competitive environments. However,

organizations can benefit from nurturing their strengths from within. Employees are the cornerstone of any organizational success. Thus this chapter's last theoretical aspect involves Self-Determination Theory.