The Treatment of Frequency in Transaction Cost Economics

6 September 2006 at 10:19 am 7 comments

| Peter Klein |

Every schoolboy knows that transactions are characterized by asset specificity, uncertainty, and frequency. (Every schoolboy schooled in transaction cost economics that is.) Yet, while asset specificity and uncertainty have been treated exhaustively in the literature, frequency has become the red-headed stepchild of the transaction cost triple.

As I read the TCE literature, frequency shows up in at least three distinct forms, not all of them compatible.

The first is the frequency of trade between specific trading partners. This is the repeated-game notion of frequency, the one appearing in the literature on relational contracting (e.g., Baker, Gibbons, and Murphy, 2002). In this sense, frequency and hierarchical governance are substitutes; with repeated interaction, the incentive to maintain a reputation for fair dealing may be sufficient to mitigate opportunism, even in the absence of contracts or vertical integration.

Second, there is the frequency of trade among many trading partners — i.e., the frequency with which a particular transaction occurs in the market, regardless of who is transacting. This is how frequency appears in Williamson’s Economic Institutions of Capitalism (e.g., pp. 60-61). Williamson’s point is to distinguish “standard” (i.e., frequently occurring) and “nonstandard” (i.e., idiosyncratic) transactions. Writes Williamson (p. 60):

The cost of specialized [i.e., hierarchical] governance structures will be easier to recover for large transactions of a recurring kind. Hence the frequency of transactions is a relevant dimension. Where frequency is low but the needs for nuanced governance are great, the possibility of aggregating the demands of similar but independent transactions is suggested.

In other words, for given levels of asset specificity, the greater the volume of trade, the more likely the benefits of hierarcial governance exceed the costs. Frequency, in this sense, thus increases the probability of hiearchy, rather than decreasing it as in the first case above.

Third, in his 1991 ASQ paper “Comparative Economic Organization: The Analysis of Discrete Structural Alternatives,” Williamson refers to the frequency of disturbances in the environment. Here he is comparing markets, hierarchies, and hybrids according to how well they adapt to change. As depicted in the figure below (p. 117 of The Mechanisms of Governance), in a relatively stable environment the choice among market, hybrid, and hierarchy depends primarily on asset specificity. (Market below k1, hybrid between k1 and k2, and hierarchy above k2.) With more frequent environmental disturbances, however, hybrid forms of organization become relatively unattractive, even at “intermediate” levels of asset specificity, because of the high cost of coordinating the necessary adaptations among multiple, independent partners. 

Moral of the story: Be careful when invoking frequency in crafting a TCE explanation. Be sure to describe precisely what kind of frequency you mean, how it is measured, and what you think it implies for efficient governance. 

Entry filed under: - Klein -, Management Theory, Strategic Management, Theory of the Firm.

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7 Comments Add your own

  • 1. Joe Mahoney  |  6 September 2006 at 12:09 pm

    Peter, you and Nicolai seem to place ideas for publishable papers on your blog. I am not too concerned, however, because you each have so many ideas you do not have time to do them all yourselves and so thanks for sharing.

    Typically, the confusion in the literature is between the first and second uses of frequency that you described. I had not absorbed the third use of the term in my reading of the literature and so I thank you for being part of my education.

    Empirical testing is, as you stated, rare along the frequency dimension (for each of the three uses) in TCE.

  • 2. Peter Klein  |  6 September 2006 at 12:22 pm

    Hmmm, I guess we’re crowdsourcing. And because our objective is knowledge creation, rather than personal gain, we don’t care about the credit. (Though we’ll take coauthorship if anyone insists….)

    Actually, I read somewhere that legal citation indexes are starting to track citations to academic blogs written by law professors. So perhaps bloggers can appropriate some of the gains after all.

  • 3. Jung-Chin Shen  |  6 September 2006 at 3:36 pm

    A great post!

    One further question that I have about the concept of frequency is that this term is usually associated with learning in management literature. The three uses of frequency involve different types of learning and mutual learning. Would some of them be rejected under certain circumstances such as when the focal firm can easily learn from its past experience, others, or specific transacting partners?

  • 4. Peter Klein  |  7 September 2006 at 8:52 am

    Jung-Chin, that is a great question. On learning in a TCE framework I highly recommend Mayer and Argyres, “Learning to Contract: Evidence from the Personal Computer Industry,” Organization Science 15(4), pp. 394–410.

    As I recall they don’t deal explicitly with the “frequency” variable as described above, but the point of the paper is to show how parties that contract with each other repeatedly adjust their behavior over time.

  • 5. Torsten Kleiss  |  14 May 2007 at 4:11 pm

    Peter, thanks for the post. There is really not much written about the definition of frequency and I find Williamsons explanations not sufficient.
    One remark to the third form: I would argue that the frequency of disturbances are part of the transactional dimension of uncertainty. Am I wrong?

  • 6. Peter Klein  |  14 May 2007 at 4:39 pm

    Torsten, yes, I think the third form of frequency can be interpreted as a kind of uncertainty (the subject heading for this discussion in the ASQ article is indeed “Uncertainty”). It doesn’t map in a straightforward way to the longer discussions of uncertainty elsewhere in Williamson’s writings (e.g., pp. 56-60 of Economic Institutions), however.

  • 7. MARCO SEGATO  |  29 July 2008 at 1:26 pm

    Hi Mr Klein,

    The final work of my MSc is focused on TCE and in particular I’m working on a case study in order to evaluate the relevance of frequency on TCE.

    As you wrote above, frequency has not been treated exhaustively in the literature. I looked a lot for a paper about the empirical evidence of frequency (as intended in the first use) on transaction costs but I didn’t found nothing interesting.

    may be you colud help me

    thanks in advance

    ps: I’m sorry for my english

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