Thursday, March 22, 2012

Criticism to the Transaction Cost Theory

In the last blog we looked at TCT being applied to hybrid organizations. In today's blog we discuss about the criticism to the Theory.

All is not perfect with any theory, and TCT is no exception. There are 3 major criticisms to the theory
  1. It focuses on Cost Minimization 
  2. It understates the cost of organizing
  3. It neglects the role of social relationship in economic transactions

There are a set of theories classified under - Resource based theories, which emphasize that organizations would have to make and exploit transaction specific investment under conditions of uncertainty to gain long term competitive advantage. Minimization of transaction cost would have little advantage if transaction specific assets aren’t valued in the market. Hence, it is important to move beyond the perspective that "economy is the best strategy" for an organization.

When we attempt to do a certain transaction in house, there is no guarantee that this would reduce the negotiations and haggling associated with the transaction. In reality, there is a higher possibility of costly bargaining and influential behavior. Even the authority to resolve such issued could behave opportunistically. Given this situation, TCT underestimates the costs associated with the organizing the transaction within the firm.

In real life, many transactions are influenced by the expectations that are formed by the history of the relationship between the parties. This indicated that transactions are embedded in the networks of social relationship. It is these relationships that explain the situations like trade between close friends without the presence of any contracts, commitments etc. The TCT neglects the role of social relationships in transactions. 

TCT is still an evolving field and it is important to note that the criticisms are definitely been evaluated for improvements.

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