Research note: an analysis of specificity in transaction cost economics

Introduction

In Transaction Cost Economics (TCE), as developed by Williamson (1975, 1985), so-called transaction specificity of assets is crucial, in combination with opportunism and bounded rationality. If there are assets which are specific to the transaction, i.e. have no, or substantially less, worth outside the transaction, this will cause dependence between transaction partners which yields transaction costs if there is risk of opportunism and if rationality is bounded. Mostly, symmetric dependence is assumed: if a producer uses assets specific to the transaction, this yields a unique or at least differentiated product, and discontinuity of the transaction will then be a problem, not only for the producer but also for the user (who will not immediately find an alternative supplier of an equivalent product, and thereby suffers discontinuity, lower quality or higher costs of production).

'Specificity' means something like this: 'to achieve a given purpose there is no alternative for a given means'. For example, there is no alternative use for a given asset -- the asset can be used to make this product, but not another; or, there is no alternative technology (asset) to produce this product -- the asset is required to make this product; or, there is no alternative demand for a given product -- a product is required by this customer but not another. Together, these conditions yield transaction specificity of the asset, which means 'no alternative transaction': the asset is required for this transaction, but is useless elsewhere. Another example is where there is no alternative for a given product and no substitute; the buyer requires this product but not another. The claim of the present article is that in standard TCE there is too much looseness in the application of the concept of specificity, leading to a misrepresentation of relations of dependence between buyer and supplier. A rigorous, more formal, analysis of specificity shows up more complicated patterns of dependence. With different forms of specificity there can be more or less symmetric dependence or unilateral dependence on the part of the supplier or the buyer.

Complications of Specificity

Upon close scrutiny, TCE, as formulated by Williamson (1975, 1985), raises a number of questions. While the garment of TCE is well-designed, has a reasonable fit, and is certainly doing well in the fashion houses of economics, the seams are badly stitched. The questions concern the ways in which dependence and asset specificity hang together, and the symmetry of dependence between buyer and supplier. There is a range of possibilities. Consider the following cases.

A. There can be investments which are specific with respect to the transaction, without their being specific to the product that is exchanged. These investments are directly related to the transaction and there is no alternative use for them. Here one can think of search costs or costs of marketing: investment in knowledge about the transaction partner (her/his needs, decision-making, logistics, operating procedures, administrative procedures, ...). They may be symmetric or completely unilateral, on the part of only the supplier or the buyer, thus causing one-sided dependence.

B. Suppose we have transaction specificity in the paradigmatic form that the supplier has investments specific to the product (no alternative use for the asset) which is, in turn, specific to the buyer (no alternative demand for the product). Then there is no alternative use for the asset, outside the transaction. While the supplier stands to lose his investment (in case the investment is fully sunk) -- when the transaction is discontinued, the buyer only stands to incur some compromise in cost, quality or time. The latter dependence appears less binding than the former and the switching costs would appear to be lower, in general. The dependence of the buyer rests on how unique the supplier's product is (alternative supply); on the price elasticity of demand; on the extent to which the product is differentiated between suppliers or is protected by patents or other entry barriers. This is not a direct consequence of asset specificity, so that the issue of buyer dependence requires further analysis.

C. When there is supplier dependence, as under B, one question could be whether it can be circumvented. Could the product be made in a different way, with less specific assets; or is there no alternative, more flexible, technology? In other words, is the product specific with respect to that type of asset (technology); is the supplier incapable of using such alternative technology; or does the buyer demand that specific technology of production, and no other?

D. If one assumes that supplier dependence is inevitable, as under C, then the degree of this dependence will be linked to whether the supplier has other products and markets to fall back on; on whether, for the supplier, there are alternative products, or, in other words, we might say on whether the supplier is specific with respect to the product. If this condition also obtains, then the supplier is fully and inevitably bound to the buyer. This often applies to smaller firms, with a limited product range. Effectively, then, all assets are specific to the product, even if some of them could technically be used for other products, if only the firm carried them.