ebiz - batch 3 handout

7/29/2019 EBIZ - BATCH 3 HANDOUT

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BATCH 3

MR JACK KOH

(IS3167) MANAGEMENT AND INNOVATION

OF E-BUSINESS(2012 Academic Year)


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Management & Innovation of E-Business(IS3167, 2790167 )

Slides (Set-3)

(Lectures 13 to 21)

Oct 2012 2Lect13/14: EBIZ - Mgt & Innovation eBusiness(by JackKoh)

e-BUSINESS is built on two main

infrastructures namely the economic

infrastructure and the technology

infrastructure.

Lectures 13/14 present the economic

infrastructure represented by the transaction

cost theory.

In transaction cost theory (TCM), we are

largely interested in the cost of transacting

rather than the transaction itself.



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A transaction (or exchange) is defined as the

transfer of property rights comprising ofUAIT properties from the seller to the buyer



Transaction costs (Ronald Coase, 1937) can

be viewed as the economic equivalent offriction in physical systems: the greater the

friction in the physical system, the more

impeded the movement (exchange of goods

& services); by the same token, the higher

the transaction costs.



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TRUST exists


Transacting parties will optimize .

Mistrust exists in the forms of


During the transaction life cycle (TLC): Search stage

Contract stage

Control stage

(Various frictions exist in these stages)



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Search stage: frictions ofuncertainty and

bounded rationality (no opportunistic

cost here) involved externalities.


Contract stage: frictions of uncertainty,

bounded rationality, opportunistic

behaviour, asset specificity, and small

numbers. Cost of bargaining, finding the right

price/qty/quality, due diligence of vendors , the

writing, finalising of contract terms are majors

activities here.


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Control (aka regulation) stage: frictions of

uncertainty, bounded rationality,opportunistic behaviour, small numbers,

asset specificity. Activities include the

execution and monitoring of the contract

terms.



Turn to Notes, page 100

Discuss the stages for the 2 screen-

dumps


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How is ICT a mediating technology and an intermediary?


In the transaction cost model, ICT is seen as a

factor that can decrease the costs of

transacting, thus improving the functioning

of the market. The logic behind this argument

is that the lower the transaction costs, the

more efficient the market will be.


reduce transaction costs by eliminating

the need for intermediaries changes the role of intermediaries in

matching supply and demand.

reduce search costs, contracting cost,control and regulation costs throughfacilitating the exchange of informationbetween economic agents


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Intermediation, disintermediation, and reintermediation(another form of new intermediary). I am so confusedregarding how it leads to reducing transaction costs.

I understand that e-business/e-commerce facilitatesdisintermediation....then you have thetransaction brokers which are intermediarybrokers (ithought ecommerce facilitates DISintermediation?) , andthey aid in reducing transaction costs....then there is thesearch engines which are intermediaries that support inlowering of TC, and then (mentioned by Dr Antonio), I-Tunes are facilitating disintermediation.....


also known as information brokers

Infomediary is an agent who works with the

customer to capture profiles about the

customers, helps them to manage those

profiles and maximize their value and helps

the customer to protect that information from

access by vendors.

two types of infomediaries



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increase information processing costs owing to

information overload? Hence, infomediaries

become relevant and useful. global connectivity and availability leads to a

high tendency to look beyond local sources

thus increasing complexity leading to higher

search, contracting, control cost


Is a compact set of concepts and a

uni fying languageto analyse and

interpret a variety of micro and macro

phenomena, such as vertical integration

between firms, employment contracts


based on a sophisticated but still narrow view

of the agent as economic man, whomaximises utility despite the limits of their

rationality.

a static, comparative view of why different

economic institutions exist, develop or decay.


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End of Lectures 13-14

Oct 2012 26Lect15: EBIZ - Mgt & Innovation eBusiness(by JackKoh)

1. Identify examples of infomediaries that you regularly useor have come acrossdo not just copy the ones listed byChaffey (2011). What roles do these infomediaries play?How important are those roles to e-business?

2. Consider the impact of online grocery shopping on thevalue chain. Does it disintermediate? Or has it broughtforth new intermediaries (or infomediaries)?

3. Identify examples of where ICT does not disintermediatethe value chain. Why is this so?

4. In the context of a B2B transaction, what are the mainclasses of information processing costs? Give specific

examples of each of these costs, using the example of ashop buying Christmas trees from a supplier. When, andhow, might they be incurred in this case?


5. How can transaction cost theory explain disintermediation andinfomediation?

6. Outline the myths that circulated during the dot.com boom.Which of these do you believe were completely unfounded, andcould never become a reality?

7. Consider this problem: if coordination costs encompass bothtransaction costs and information processing costs, couldinformation technology raise coordination costs despite reducingthe transaction costs? Discuss in detail how this might occur,justifying your answer with examples.

8. It has often been argued that information and communicationstechnology (ICT) is disintermediating electronic marketplacesInfomediaries are however increasing in electronic markets.Discus with examples.(SG Exam sample)


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9. Transaction costs can be described as frictions in the

market. How can ICT (information and

communications technology) reduce these frictions?Discuss the theoretical model of transaction costs and

explain how and why ICT can reduce or increase

transaction costs. (2011)

10. Describe the phases of the transaction lifecycle.

Critically analyse, using examples, how ICT can

reduce the transaction costs associated to ONE of

these phases.(2012 prelim)

Oct 2012 29Lecture 16: EBIZ - Mgt & Innovation eBusiness(by JackKoh)

e-BUSINESS is built on two main

infrastructures namely the economic

infrastructure and the technology

infrastructure.

Lecture 16 present the technology

infrastructure represented by Web 2.0 & ICT

technology


Web 2.0 is a concept that takes the network as a

platform for information sharing, interoperability,user-centered design, and collaboration on the World

Wide Web. A Web 2.0 site allows users to interact and

collaborate with each other in a social media dialogue

as creators and prosumers of user-generated content

in a virtual community, in contrast to websites where

users are limited to the passive viewing of content that

was created for them.


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Google AdSense

Flickr

BitTorrent

Napster

Wikipedia

blogging

search engine optimization

cost per click

wikis

tagging ("folksonomy") syndication


1. treat Network platform as residing externally to

users PC2. major shift from passive consumption to active

participation by users facilitate business harnessingof collective intelligence of users

3. active participation by users also means thecollected data is constantly be reviewed andupdated

4. improved software tools and cloud computingfacilitate same apps execution on many variousdevices.


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5. Provides an important form of social

marketing6. Embraces social communities

7. is the next step of information

revolution


Promote collaboration

Promote participation

How are these achieved?


Some Pros are free flow of information,

communication at minimal cost, content hasno expiry dates

Some Cons are information leakage , loss of

employee productivity, high level of

dependency of the Internet


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Lecture is to provide you with a brief

introduction to the information and

communications technology (ICT) underlyinge-business

careful not to become obsessed or blinded by

technological detail. Only key concepts

expected in this course !


Open up exciting opportunities for

communication, collaboration and markets.

Various types of networks: LANs, WANs,

intranets, extranets.

Why firewall?


WWW not = the Internet

WWW = web browser = URL = HTTP =

Web1.0 or Web2.0

Facilitates the devt of client-server network

and P2P network


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Designed as peer2peer network architecture seen as

an external network platform of the local machine.

Involves delivering hosted services over the Internet

Three types : Infrastructure-as-a-Service (IaaS),

Platform-as-a-Service (PaaS)and Software-as-a-

Service (SaaS).


todays mobile phones are effectively operate

like network computers

Mobile phonemobile commerce (M-

Commerce)

Type of applications

Limitations


extranets are used to coordinate and manage supply

chains with firewalls EDI

RFIDautomatic identification of stock items

Enterprise Information system (ERP)

Ebusiness security

Cloud?
http://searchcloudcomputing.techtarget.com/definition/Infrastructure-as-a-Service-IaaShttp://searchcloudcomputing.techtarget.com/definition/Platform-as-a-Service-PaaShttp://searchcloudcomputing.techtarget.com/definition/Software-as-a-Servicehttp://searchcloudcomputing.techtarget.com/definition/Software-as-a-Servicehttp://searchcloudcomputing.techtarget.com/definition/Platform-as-a-Service-PaaShttp://searchcloudcomputing.techtarget.com/definition/Platform-as-a-Service-PaaShttp://searchcloudcomputing.techtarget.com/definition/Infrastructure-as-a-Service-IaaS


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Purposes of securing data transmission

Cryptography

TLS and SSL protocols


End of Lecture 16a & 16b


New technologies facilitate the reorganisation of

work and offer new opportunities in terms ofwhere, when and how work is carried out.

How do these new forms of organisation impact

internal organisational structures as well as

relationships between firms?


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With many innovative, advanced electronic

technology over the last 2 decades, people workhave changed dramatically, but the way their

companies are organised lags far behind.


Outsourcing/Externalization

Partnership

Core competency

Efficient/smart technology like global networks, mobile

phone, video conferencing, computers, cloud

computing, social networks,

Reliable professional services

Open source

Crowd sourcing


..current traditional organisational forms

would not suffice (although relevant)


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Researchers and practitioners faced with the

problems of organisational structure saw the

potential of IT, and later e-business, to improvecoordination and provide opportunities for new

organisational forms.

NOFS are often ambiguous, in that some people

may not be fulltime members, and they are

typically fluid, in that people join and leave as

requirements change.


NOFS are typified by dynamic cross-functional

teams of experts set up to solve a particular

problem

NOFS also stretch outside the focal organisation

to encompass external relationships

move to the middle where organisations

construct structures that are between markets

and hierarchies


1. Virtual Organisation

2. Virtual teams and off-shoring3. Teleworking

4. Mobile working

5. Open source

6. Crowd sourcing

E-business offers a significant opportunity for changein both social and organisational structures, inparticular regarding how and where work is done andorganised.


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1. technological inflexibility and dependence

2. inter-organisational relationship problems

3. ambiguity4. Psychological aspects

5. Unclear lines of authority

6. Managerial implications

7. Data / confidential insecurity


End of Lecture 17


1. In what ways are web 2.0 technologies different to thoseof the first generation? Discuss, with examples

2. Social networking sites are purely for leisure purposesand companies should ban their use during workinghours. Discuss the validity of this statement.

3. What do you understand by the term web 2.0? Brieflydescribe the various collaborative components of web 2.0and show how each one exhibits the participative natureof web 2.0. (2011)

4. Why are many companies beginning to use web 2.0technologies? Give examples of web 2.0 technologiesthat companies are exploiting (2012)


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5. Discuss the similarities and differences between the

internet and cloud computing. What are the main business

opportunities offered by cloud computing? Mobile

technologies offer new business opportunities. Discuss,

with examples, whether mobile technologies can be a real

substitute for traditional wired technologies.

6. A B2B company has found that after an initial surge of

interest in its intranet and extranet, usage has declined

dramatically. The e-business manager wants to achieve

these aims: a) Increase usage, b) Produce more dynamic

content, c )Encouraging more clients to order (extranet).

What would you suggest?


7. Why are organisations increasingly considering new forms of

organisation (e.g. network organisations, tele-working)? What

are the problems in implementing them?

8. Discuss the benefits and drawbacks of mobile working (2012)

9. What are open source communities in the context of software

development? What do they offer in this context? What are the

problems in building and maintaining viable open source

communities? (2012)

10. Read the essential readings on traditional organisations and

open source, and then list all the potential issues that you can

think of when two such diverse forms of organisation are

encouraged to merge together. Think along the lines of control,communication, structure of both forms, and incentive and

sanctions methods.


E-business security deals with the matter of

planning and managing security within and

around computer systems.


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Five goals of information systems security

Integrity: data are not modified without authorisation

Confidentiality: ensuring that only authorised

individuals have access

Availability: information is available when it is needed

Non-repudiation: guaranteeing that someone cannot

deny his or her participation in a transaction

Authenticityensuring data & transactions are

geniune


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UOL/Ebiz concurs these goals can be

achievable through:1. technological implementations

2. organisational procedures


Adopt appropriate technical security

to the three layers:

1. Computer security layer

2. Network security layer

3. Internet security layer


1.Covers the socio-technical dimensions

of e-business security to design securitywith needs of users in mind

2.Cost-saving should not be the major

concern

3.Mgt involvement

4.Information security policieswell

crafted (see ISO) and enforce.


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1. User authentication technique such as

2FA2. Data integrity technique such as

Check-digit validation


End of lecture-19


A new business strategy involves evaluation of

all aspects of firms operations and environment,i.e. technologies, economics, and managementaspects. For our Ebiz studies, we are not veryconcern over how to use or implement the newtechnologies but more so the impact on theeconomics and management aspects (e.g.resources/budgeting - Marketing, scheduling -SCM, procurement, customers - CRM) for agiven e-business strategy.


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Chaffey: E-business strategy is a channel strategy

The e-business strategy document is often not a

long document as it does not contain detailed

plans or timelines.

Strategies are a result of careful analysis, it

defines a position in the marketplace, and aim atgaining a competitive advantage.



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Adding valuethrough improved products or

services or from using information toimprove customer relationships.

Reducing coststhrough efficiency savings

(e.g. reduced inventory within the supply

chain).

Managing risks

Creating a new reality


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Dynamic environment like e-business, wherethere may be radical changes in:

customer tastes and behaviour technology developments capabilities of trading partners availability of resources, especially skills and

investment capital legal frameworks (e.g. copyright laws) competitors actionsproduct and service developmentsespecially

from new entrants to the market


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End of Lecture-20


1. Discuss the role of technology in enforcing informationsystems security. Explain why more investment in IT doesnot always lead to more secure information systems.

2. Discuss how and why biometrics can solve many securityrelated IT problems. Explain, with examples, whetherthere are any shortfalls in biometric security basedsystems

3. Discuss the main technical and security related problemsin internet based e-business activities. Critically discusswith examples (2011).

4. Discuss the main organisational threats to e-business

security. Support your answer with examples (2012)


5. For each of the above six generic sell-side strategies, identify a

good example of a company that has successfully adopted that

strategy.

6. Imagine you are a consultant whose job is to design a new B2B

strategy in a firm which intends to open a buyer oriented

marketplace. Which factors would you consider in advising the

firm whether it is worthwhile pursuing such a strategy? Justify

your answer theoretically (2012).

7. You have been asked, as a consultant, to begin work on an e-

business strategy for a new pure-play, online, business-to-

consumer retailer. What areas would you examine regarding

this strategy? For each area, briefly discuss an issue that you

feel is likely to be important in this context (2012).


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8. Why do companies formulate e-business strategies?

Briefly outline how companies usually go about

formulating these strategies. What are the main

problems involved in e-business strategyformulation?

9. What is an e-business strategy? Which aspects of a

companys business should it cover? Who should

be involved in its preparation? Justify your answer.

10. How does e-business strategy differ from traditional

business strategy?

Oct 2012 86EBIZ - Mgt & Innovation eBusiness(by JackKoh)

Good luck !


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Management & Innovation of E-BusinessIS3167, 2790167 (2011) (assembled by Jack Koh)

Set 3 of 3 sets of Ebiz study notes Page 87/ 154

EBIZ Course Material for 2012 (Set-3)

Acknowledgment:

1) All text in italics are replicated from the UOL Study Guide, for easy references by students

2) All diagrams are taken from Chaffeys instructor guide

Lecture/

Lesson

Topics (chapter-no refers to the chapter of the UOL study guide)

1

(16/9/12)

Chapter-1: Introduction: growth of e-business and strategies

Group Mini-research Assignment: TripAdvisor.com (or Netflix.com or Facebook). Form a group of 2

members (or 3 maximum). Write a research report and post it on the Internet. The report should, at least,

explain briefly the nature of its business, and how the 8 key elements of the business model are addressed

by them. Seewww.uol-ebiz.blogspot.comfor sample layout-format of report. The leader shall submit their

url-link by the start of lecture-4 to Jack Koh ([email protected] cc [email protected] ).

Start-date: Lecture-1

Due/Deadline: Lecture-4

2-3 Chapter-4: Business-to-consumer (B2C) retail systems and strategies

4 Tutorial-1

5 Chapter-6: Business-to-Business (B2B) wholesaler models and strategies

Individual Assignment-1: Start-date: lecture-5, Due/Deadline: lecture-76 Tutorial-2

7-8 Chapter-5: Marketing for e-business (e-business strategy)

Individual Assignment-2: Start-date: lecture-8, Due/ Deadline: lecture-10

9 Tutorial-3

10-11 Chapter-7: Supply Chain Management

Individual Open-book Test-1: 2nd

half of Lecture-11

12 Tutorial-4

13-14 Chapter-3: Economic theories of e-business (economic infrastructure)

15 Tutorial-5

16 Chapter-8: Web 2.0 in business and society (technical infrastructure)

Chapter-2: e-Business, technology & infrastructure (technical infrastructure)

17 Chapter-9: New forms of organisation (Managing Change)18 Tutorial-6

Individual Open-book Test-2: 2nd

half of Lecture-18

19 Chapter-10: Security issues in the digital environment

20 - 21 Chapter -11: Conclusion & implications of e-business strategies

Tutorial-7

Appendix-1: Past year Exam & Discussions

Appendix-2: How to publish your group report on the Internet

Assignment and Test Schedule

You are advised to participate in assignments and tests. One of the benefits is these assignments and tests will add credits to

your personal testimonial and will greatly facilitate the writing of reference letter for you later on.

1. Group Mini-research Assignment: TripAdvisor.com (or Netflix or Facebook). Form a group of 2 members (or 3maximum). Write a research report and post it on the Internet.

Start-date: Lecture-1

Deadline: Lecture-4 (Participants will receive the Ebiz bible auto-email to them in Mar 2013)

2. Individual Assignment-1:Start-date: lecture-5

Deadline: lecture-7 (Participants will receive the Ebiz bible auto- email to them in Mar 2013)

3. Individual Assignment-2:Start-date: lecture-8

Deadline: lecture-10 (Participants will receive the Ebiz bible auto-email to them in Mar 2013)

4. Individual open-book Test-1: 2nd half of Lecture-11 (sample solution shall be auto emailed to participants later) 5. Individual open-book Test-2: 2nd half of Lecture-18 (sample solution shall be auto emailed to participants later)
http://www.uol-ebiz.blogspot.com/http://www.uol-ebiz.blogspot.com/http://www.uol-ebiz.blogspot.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]://www.uol-ebiz.blogspot.com/


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Lecture-13 & 14: Supporting notes SG chapter-3/ Economic theories of e-business

(All text in italics are extracts from the UOL Study Guide, for your easy references)

(All diagrams are taken from Chaffeys instructor guide)

Suggested reading:

a) Chaffey, D. E-business and e-commerce management. (Harlow: Financial Times/Prentice Hall, 2009) fourth edition[ISBN 9780273719601] Chapter 2.

b) Cordella, A. Transaction costs and information systems: does it add up? Journal of Information Technology 21(3)2006, pp.195202.http://personal.lse.ac.uk/cordella/Transaction%20costs%20and%20information%20systems.pdf

Abstract: Transaction cost theory has often been used to support to support the idea that information and

communication technology (ICT) can reduce imperfection in the economic system. Electronic markets and hierarchies

have repeatedly been described as solutions to inefficiencies in the organisation of transactions in complex and

uncertain settings. Far from criticising this assumption, this paper highlights the limits associated with this application

of transaction cost theory that has been prevalent in IS research. Building on the concepts first proposed by Ciborra, the

paper argues that information-related problems represent only some of the elements contributing to transaction

costs. These costs also emerge due to the interdependencies among the various factors contributing to their growth. The

study of the consequences associated with ICT design and implementation, grounded in transaction cost theory, should

therefore consider the overall implication ICT has on these interdependences and not only the direct effect it has on

information flow, distribution, and management.

c) Cordella A. Does information technology always lead to lower transaction costs?http://csrc.lse.ac.uk/asp/aspecis/20010024.pdf

Abstract: This paper reconsiders the effect of information technology on transaction costs in view of IT externalities

and coordination costs. The aim of the paper is to show that IT has ambivalent (i.e negative) effects on the overall

transaction costs. This analysis is based on the idea that IT externalities have both positive and negative effects on

coordination and thus transaction costs. Two different strategies to use IT in an organizational setting are identified: one

to increase the amount of information available to decision makers thus to reduce the uncertainty and hence transaction

costs. The other to reduce the amount of available information to decrease the complexity faced and thus coordinationand transaction costs. Finally, the effects of IT externalities impose the awareness that one strategy is not a substitute to

the other rather that they can both coexist.

d) Malone, T.W., J. Yates and R.I. Benjamin Electronic markets and electronic hierarchies, Communications of the ACM30(6) 1987, pp.48497 or a copy of the article at website:

http://is.esade.edu/faculty/wareham/Teaching/StratNetComp/Readings/Electronic%20Markets%20and%20electronic%2

0Hierarchies.pdf

Abstract: By reducing the costs of coordination, information technology will lead to an overall shift toward

proportionately more use of markets - rather than hierarchies - to coordinate economic activity. New information

technologies are allowing closer integration of adjacent steps on the value-added chain through the development of

electronic markets and electronic hierarchies. Although these mechanisms are making both markets and hierarchies

more efficient, we argue that they will lead to an overall shift toward proportionately more market coordination. Some

firms will be able to benefit directly from this shift by becoming market makers for the new electronic markets.

Others will be able to benefit from providing the interconnections to create electronic hierarchies. All firms will be able

to benefit from the wider range of options provided by these markets and from the possibilities for closer coordination

provided by electronic hierarchies.

By the end of this chapter, and having completed the essential reading and activities, you should be able to:

explain transaction cost theory and identify the main types of transaction costs

analyse the impact of e-business technology on transaction costs

explain how and why disintermediation occurs in electronic markets

discuss the impact of e-business technology on the organisation of markets with examples from the real world explain the myths that were current during the dot.com boom.
http://personal.lse.ac.uk/cordella/Transaction%20costs%20and%20information%20systems.pdfhttp://personal.lse.ac.uk/cordella/Transaction%20costs%20and%20information%20systems.pdfhttp://personal.lse.ac.uk/cordella/Transaction%20costs%20and%20information%20systems.pdfhttp://csrc.lse.ac.uk/asp/aspecis/20010024.pdfhttp://is.esade.edu/faculty/wareham/Teaching/StratNetComp/Readings/Electronic%20Markets%20and%20electronic%20Hierarchies.pdfhttp://is.esade.edu/faculty/wareham/Teaching/StratNetComp/Readings/Electronic%20Markets%20and%20electronic%20Hierarchies.pdfhttp://is.esade.edu/faculty/wareham/Teaching/StratNetComp/Readings/Electronic%20Markets%20and%20electronic%20Hierarchies.pdfhttp://is.esade.edu/faculty/wareham/Teaching/StratNetComp/Readings/Electronic%20Markets%20and%20electronic%20Hierarchies.pdfhttp://is.esade.edu/faculty/wareham/Teaching/StratNetComp/Readings/Electronic%20Markets%20and%20electronic%20Hierarchies.pdfhttp://csrc.lse.ac.uk/asp/aspecis/20010024.pdfhttp://personal.lse.ac.uk/cordella/Transaction%20costs%20and%20information%20systems.pdf


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Introduction

e-BUSINESS is built on two main infrastructures namely the economic infrastructure and the technology infrastructure .

In lectures 13 and 14 we dealt with the economic infrastructure and in lectures 16 we cover the technology infrastructure.

Without these 2 main infrastructures, there would be no e-business commerce.

This chapter presents the economic infrastructure represented by the transaction cost theory.

What is a transaction? What is cost of transacting? In transaction cost theory, we are largely interested in the cost of

transacting rather than the transaction itself. However, we must be aware that the different type of transactions affects the

degree of cost of transacting. Can e-Business (through innovative use of IT) removes most or all of these transacting cost so

at to make market more attractive?

The transaction costs theoretical framework to explain the deployment of and challenges faced by e-business strategies. This

framework provides a robust explanation of the basic economics of e-business. On this basis, the chapter discusses how

information and communications technology (ICT) can be designed and deployed to reduce the costs of transactions and

hence to change the structure and dynamics of markets for products and services exchanged through e-business. The chapter

also discusses the theoretical implications of disintermediation and re-intermediation (the changing roles of intermediaries

or middle men), according to the economics of transaction costs.

The purpose of this chapter is to introduce the most common theories that have informed the management and economics of

e-business. The chapter will mainly focus on transaction cost theory and conceptual approaches to intermediation and

disintermediation. In order to match the literature on the theories, in this chapter we refer to e-business technology as ICT

(information and communication technology) and hence you should treat these terms as being synonymous.

The main economic theory you need to understand is the transaction cost model. Examining how markets are organised and

how and why ICT can be designed and implemented to facilitate the functioning of market mechanisms, we discuss thefundamental factors that produce electronic markets. We therefore present and discuss a limited version of transaction cost

theory, focusing on those factors that affect the exchange of goods and services in a market context.

We discuss the circumstances under which ICT can make market mechanisms more efficient. For a more detailed

presentation of transaction cost theory, you can refer to Ciborra (1993) and Williamson (1985). Cordella (2006) presents a

useful discussion of the application of transaction cost theory to information systems and we recommend that you read this

article.

The basic assumption of transaction cost theory is that economic agents (buyers and sellers) face costs to make the exchange

of goods and services possible (see Picot et al., 1997). These costs are not necessarily reflected in the price at which goods

and services are exchanged. These costs, called transaction costs, are mostly related to information processing costs: not all

the information needed by buyers and sellers about the object of the exchange is available; it is costly to process the

available information, etc.

We identify the different types of information processing costs that individuals face, namely search costs, contracting costs

and control costs.

We also elaborate on how ICT might contribute to lower transaction costs, which, in turn, makes the exchange of goods and

services more efficient, and therefore improves the overall efficiency of the economic system within which these exchanges

take place.


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After introducing the basic elements of transaction costs, we discuss how ICT can affect the roles of the different economic

agents involved in the exchange of goods and services. Disintermediation is a typical example: this is the process by which

the number of economic agents involved in an exchange (i.e. resellers, wholesalers and mediators)

is reduced. Disintermediation typically occurs because ICT does for free what intermediaries do for a fee.

Following the transaction costs argument, ICT provides better opportunities to process information related to the exchange,

reducing the need for support for buyers and sellers in managing the essential information needed for the exchange.

ICT therefore reduces the need for third party services and hence the costs faced by buyers and sellers. The first reason why

disintermediation occurs is therefore rooted in transaction cost theory. Moreover, building on Picot et al. (1997), we discuss

how and when ICT-led disintermediation occurs

What is a transaction?

A transaction (or exchange) is defined as the transfer of property rights [Picot/Dietl,Reichwald/ Wigand], whereas

property rights are the rights of individuals to the use, make alteration, income (make profit) and transfer (UAIT)of

resources [DeAlessi,/Franck].

A transactionis contract carried out between separate entities often involving the exchange of items of value, such as

information, goods, services and money. Today, transactions not only refer to the obvious cases of buying and selling, but

also day-to-day emotional interactions, not necessarily commercial like informal gift exchanges, etc.

Take an elementary unit of analysis the transaction or exchange between at least two individuals, we can appraise

management information systems in terms of the reasons why transactions use and produce information. If we consider the

organization as a network of exchanges and contracts between and among members, both co-operation and conflict can be

taken into account because individuals might withhold information while they are in the process of exchange.

The transaction-cost theory introduces the hypothesis of opportunistic behaviour according to which organization membersmight distort the use of information to achieve their individual goals. Human beings are not capable of listing down all

aspects of complexity and uncertainty accurately nor ascertain an exact true price.

Take the transactions of the sales of a table and a musical CD. We need to examine the exploit of the property rights. In

both cases, the new owner could use it, make alteration, make an income out of it, or transfer the ownership. The sale of the

table is likely done through a traditional marketplace. The table is physically limited in form and the new owner, in

exercising his ownership rights of the property, would likely be constricted when trying to vary its form or structure.

However, the transaction of the musical CD is different. The transaction has a greater opportunity of being exposed to

opportunistic behavior e.g. it can be burn to produce more copies, musically mixed to produce a new musical

version, duped as video background music, etc. In other words, it could be altered take on many other different market

forms. This results in increased complexity and uncertainty giving rise to further opportunism, and bounded

rationality.

Contracting Parties

In the ideal typical world of perfectly competitive markets where all contracting parties are deemed to possess all the

information required to make fully informed rational choices (about past, present and future contingencies), they are

indifferent between market and organizational co-ordination. It is when information is incomplete (and in practice it nearly

always is) that the choice is pertinent for contracting parties.


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A diagram below will help appreciate the possible distribution scenario of relevant information between contracting parties

call them A and B.

What is the cost of transaction?

The cost of transacting refers to the cost of incurred to conduct a transaction such as administration cost, IT processing cost,

information cost, transportation, manpower, coordination cost, storage, lost, replacement, insurance, damages, currency

exchanges, legal expenses, correspondences and visitations to intermediaries cost. Such cost are incurred from the time the

buyer takes an interest in a product or service until the time the product or service is satisfactory acquired by the buyer.

The cost of transacting is not the cost of product or service itself. The transacting cost adds to the final selling price of the

product or service. The cost of transacting rises with the level of opportunistic behaviours and mistrust associated between

the transacting parties. Transaction costs (Ronald Coase, 1937) can be viewed as the economic equivalent of friction in

physical systems:the greater the friction in the physical system, the more impeded the movement (exchange of goods

& services); by the same token, the higher the transaction costs. Costless transaction is impossible and can only take

place in an ideal world, where there are no frictions, impediments or barriers.

Where exchanges involved external parties, market uncertainty, processing, contractual obligations and other market-level

frictions normally get more complex. There are many reasons and factors of cost. Whereas, in an exchange or transaction

involving only actors within the organization, says the planning department placed a work order to the production floor, the

processes are regulated by rules and internal systems. Opportunism and mistrust are not real concerns here. The internal

processes are not as complex as issuing the purchase order to an external provider where the cost of transacting can be costly,

and hence the reason that some firm takes to internalization (or vertical integration) to save cost and minimize complexity.

The transaction cost model

Transaction Cost Theory was first introduced by Ronald Coase [1937]. Coase used it to develop a theoretical framework

for predicting when certain economic tasks would be performed by firms (internal), and when they would be performedon the market (external). Coase spoke of the cost of using the market mechanism for exchanging goods and services.

A complete contract is defined as one where all the relevant information (i.e. all possible contingencies,

past, present and future) are covered by both the contracting parties.

BA Rectangle =complete information

Bs private information

(asymmetric information)

Common information

Information not access by both

A & B

Imperfect market

Both A and B will have their own

private information. This leads to

information asymmetry between

the 2 actors. Their common

knowledge of the product lies in

the overlapped circles. But both

actors are unaware of the

information, represented by the

space between the rectangle and

the circles to attain completeinformation.

perfect market

Both actors will have access to

same information in market

Q. So how will A or B improve

their information space?


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In the transaction cost model, markets are viewed as organi sational structur eswhich coordinate buyers and sellers by

matching the reciprocal expectation related to the price-quantity/quality relationship. The transaction (exchange) is

therefore coordinated on the basis of a contractual arrangement which specifies buyers and sellers, the object of the

exchange and the price at which the transaction will take place. If you take as the elementary unit of analysis the

transaction or exchange between at least two individuals, you can envisage the information-related problems that create

uncertainty regarding the object of the exchange and the relationship between price and quantity/quality, which is

fundamental to the decision of the two parties to engage in the transaction.

Looking at the transaction as the unit of analysis, we can identify how and where ICTs can be used to facilitate access to

this information and why ICT can be used to reduce the transaction costs. If you consider the market as a network of

exchanges and contracts between buyers and sellers,both cooperation and conflict should be taken into account because

individuals might withhold information during the process of exchange. This in fact can generate extra profits and

higher revenues for either buyers or sellers. Every business activity is characterised by a certain amount of uncertainty

and this may stem from the task, the technology or the environment.

However, the transaction cost framework considers another, rather distinct, form of uncertainty, namely behavioural or

strategic uncertainty, which has its origins in the conflict of interests that exists between buyers and sellers. The information

that buyers or sellers receive or gather may well be unreliable, with the result that they have to undertake excessive

information processing in order to evaluate its reliability.

The fact that information is obtained from human sources means that it cannot be trusted a priori (i.e as facts). In fact,

humans can exploit the use of information to obtain extra profit.

This strategic consideration is due to the fact that interdependent strategic intents are affecting the exchange and use of

available information. Buyers and sellers cannot be seen as solo chess players whose only opponents are the technology, a

random environment or random nature. Put differently, in order to pursue individual interests, buyersand sellers are willing to manipulate, omit or even distort information to gain extra value from the exchange. In so doing,

they pollute the information setting within which the exchange takes place.

Needless to say, this generates the need to invest in sophisticated solutions to double check information. Buyers and sellers

cannottrustthe information that is exchanged, so they have to invest in solutions that reduce the risk of becoming exposed to

polluted information. This leads to an increase in transaction costs, which explains the design of

information systems that aim to make more reliable and transparent the information exchanged between buyers and sellers.

As we discuss below, specific intermediariesinfomediaries become highly relevant to facilitating transactions in

situations where complex information settings make it difficult for buyers and sellers to finalise the exchange.

Types of transaction costs

The transaction cost model assumes that the market is a bundle of transactions or exchanges between individuals who

behave so as to optimise their revenues from the exchange.

The transaction cost model defines this behaviour as opportunistic. As noted above, transactions entail costs in terms of

resources that need to be deployed to complete an exchange of goods or services between the parties (i.e. buyers and sellers).

Hence, transaction costs reflect the imperfections of the market mechanism in allocating resources on the basis of the price-

quantity relationship.

There is always some information-related problem that makes it difficult, and therefore expensive, to finalise the transaction.


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You may view transaction costs as the economic equivalent of friction in physical systems: the higher the friction in a

physical system, the more the systems movement is impeded. By the same token, the higher the transaction costs, the lower

the degree of economic activity occurring in the market.

Costless transactions only take place in an ideal world where there are no friction, impediments or barriers to the immediate

perception of the equity of the exchange (i.e. perfect knowledge of the price-quantity/quality relationship).

Factors that may contribute to the cost of a transaction in the real world can be identified as follows:

Searching for the product or service in question, as well as for the trueprice at which the sale/purchase ought to take

place. There are two types of search costs: (1) the costs associated with searching for the actual product or service, and (2)

the costs involved in determining the best price at which the product or service could be bought.

Carefully crafting the contract that regulates the exchange, so as to avoid later claims.

Monitoring its execution so as to pinpoint responsibilities and penalties if modifications have to be made to the original

contract.

Finally, checking the reputation of the partners in order to minimise subsequent surprises related to the undiscovered

properties of the transaction.

These costs are generally defined as the costs of gathering information, evaluating alternative options, negotiating

and contracting. They are the consequences of the complexityanduncertaintyof the economic system. Uncertainty and

complexity can be related to either human behaviour or environmental or unpredictable events.

More specifically, we may group the information-processing costs related to transacting through negotiation of an exchange

into four main classes:

search costs: the costs necessary to set up the minimal social unit for the exchange (i.e. identify the party with which one

wishes to conduct the transaction)

contracting costs: the costs related to the negotiation of the termsof the trade and drawing up the contract which regulates

the exchange

control costs and regulation costs: these costs relate to the implementation of the contractunder conditions of uncertainty,the policing of deviations from the contract terms and the enforcement of sanctions to restore conditions suitable to the terms

agreed.

Each of these affects a segment of the transaction lifecycle, which can be divided into three stages:

search

contracting

control/regulation.


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Therefore, transaction cost frictions occur in transactions (exchanges). Being able to realise their impacts, firm can exploit

and use them to compete effectively in e-business operations. These frictions occur during various stages of the transaction

cost, such as

- Search stage: frictions of uncertainty and bounded rationality (no opportunistic cost here) involved externalities.

- Contract stage: frictions of uncertainty, bounded rationality, opportunistic behaviour, asset specificity, and small numbers.

Cost of bargaining, finding the right price/qty/quality, due diligence of vendors , the writing, finalising of contract terms

are majors activities here.

- Control (regulation) stage: frictions of uncertainty, bounded rationality, opportunistic behaviour, small numbers. Asset

specificity. Activities include the execution and monitoring of the contract terms.

We can expand the activities in Coases transaction life cycle, thus

Stage-1: Cost of searching for buyers and sellers (vendors)

Searching, collecting, collating product information during procurement Comparing prices of product and services during the procurement process Marketing of services and products

Stage-2: Cost of selection of partner and writing the contract

Due diligence investigations: Research the background, reliability, dependability and tenure of partners Evaluation of reputation of partner Selection of partner Drafting the terms of contract Negotiate terms of contract Securing and writing the contract

Stage-3: Cost of monitoring and enforcing the contract

Sales order processing: capturing, monitor, supervising and allocating Delivery and transportation of goods Customer servicesFeedbacks Back-end processes with back-end partners. IT processing and coordination cost. Monitoring and enforcing contract. Control and regulation costs - costs relate to the implementation of the contract

(supply, storage, replacement, payment, etc) under conditions of uncertainty, the policing of deviations from the

contract terms and the enforcement of penalty to restore conditions suitable to the terms agreed upon

The diagram below summarise where frictions may occur during the transaction and between transacting partners:

Bounded Rationality: "The capacity of the human mind for formulating and solving complex problems is very small

compared with the size of the problems whose solution is required for objectively rational behavior in the real world --

or even for a reasonable approximation to such objective rationality." Hence, individual turns to their past experiences,

exposures, tried & tested methods and this has a limiting effect on getting the best value from the transaction.

-boundedrationality

- opportunism-bounded

rationality

- opportunism- Asset specificity- Uncertainty- Small numbers

Transaction

Partner A

Transaction

Partner B


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All human as decision makers has limited cognitive capabilities, and bounded rationality increases with incomplete

information in imperfect market [Simon, 1957; Selten, 1998]. In short, bounded rationality refers to an individuals

limited memory capacity, limited experience and inability to achieve maximal value on the information available. This

constitutes increased cost, particularly in the area of search (as in the examples of manual checking on airline arrivals or

checking the best value of a netbook at a IT-fair or Sim Lim Square), contract, and monitoring and control costs.

Individual, limited by bounded rationality and being unfamiliar with the market or not knowing what to look for, may be

actually conducting excessive searches and be overwhelmed with both

relevant and irrelevant information.

The graph shows that the more imperfect the market, bounded

rationality will increase. The same bounded rationality limits the

individual ability to negotiate and draft an elaborate contract which

can end up with higher cost eventually. Thus, humans are inclined to

make erroneous decisions. Error constitutes increase search, contract

and control costs.

Opportunism: Opportunism describes the human self-interest in taking actions, including cheating, lying and infringing

contracts [Williamson]. Satisfying one ego rather than monetary gain, like Nick Lesson rampaging trading and

subsequent destruction of Barings Bank, is another example of opportunism. Refers to the suggestion (widely associated

with transaction cost analysis) that a decision-maker may unconditionally seek his/her self-interests, and that such

behavior cannot necessarily be predicted.

This proposition extends the simple self-interest seeking assumption to include "self-interest seeking with guile" thereby

making allowance for strategic behavior (Williamson, 1975). Some examples are strategic manipulation of information

or misrepresentation of intentions; false or empty, i.e. self-disbelieved, threats or promises (Goffman, 1969), has

profound implications for choosing between alternative contractual relationships.

Opportunistic behavior contrasts with stewardship behavior that involves a trust relation in which the word of the party

can be taken as his bond. In a way, trust is informal rules. Formal rules, controls (i.e. hierarchy form) can help in

reducing cost.Opportunism increases contract, and control costs. Trust will lower contract, and control costs. The opposite is

altruistic behavior which TC does not take into consideration.

Uncertainty: Uncertainty is embodied in any kind of future action. Uncertainty feeds opportunism.

Uncertainty is reference to the lack of knowledge (ignorance) about the state of the environment or other decision

variables. Uncertainty about the future, uncertainty about other places, events, structures and other phenomena.

Risk is reference to the consequences of uncertainty, such as regret often expressed in terms of probabilities of such

consequences. Uncertainty then reduced to uncertainty about actual occurrence and, possibly, about the reliability of

probabilities.

It shall be suggested that "complexity" (at a point in time) and "instability" (over

time) are two different root causes of uncertainty and (following Lawrence &

Lorsch) that these two attributes of decision environments lead to

o poor quality of information, increases information asymmetry. The graphshows the reverse is true in reducing information asymmetry and

uncertainty.

o leads & lags in the economy resulting in delays in in formation feedback,and

o a lack of causal understandingo and thereby contribute to the individual's uncertainty and can be identified as more immediate "causes" for

uncertainty

The higher the uncertainty the impact of increasing cost, particularly in search, contract and control costs.

Bounded Rationality

Imperfect Mkt

TC

Uncertainty

Info Quality
http://faculty.washington.edu/krumme/450/uncertain.htmlhttp://faculty.washington.edu/krumme/450/uncertain.htmlhttp://faculty.washington.edu/krumme/450/uncertain.html


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Asset Specificity: Asset specificity terms the significance of certain assets that support a specific transaction. These are

assets which cannot be transferred to or used within other transactions [Williamson]. The BBQ pit is highuse asset

specificity since it cannot be use in other forms (as a chair, a table?). Refers to the relative lack of transferability of

assets intended for use in a given transaction to other uses i.e. assets which cannot be transferred to or used within other

transactions (U.A.I.T). All specialized equipment has high asset specificity. Highly specific assets represent sunk costs

that have relatively little value beyond their use in the context of the specific transaction.

Asset specificity is a major theme of transaction cost based economic analysis for a very basic reason. The more

committed one becomes to a transaction, the more one stands to lose from unforeseen events and the possibility that

contracting partners may find it in their interests to renegotiate more favorable terms from you given that you have

committed (or sunk) assets the various forms of asset specificity make transacting parties fearful of making a

commitment that might later prove to be 'one way'. The other dimensions of transaction costs are more closely tied to the

importance of informational availability.

Williamson has suggested six main types of asset specificity.

o Site specificitytransactions that are specifically bound to a certain location. But the Internet facilitates transfersacross countries easily leading to the question of copyrights between countries with different legalities. E.g. Sales

of audio CDs mean for uses only in USA.

o Physical asset specificity e.g. digital content, a tableo Human asset specificity e.g. special skills for contract worker in middle of Timbaktuo Dedicated assets e.g. special tool for mega casinoo Brand names e.g. Sony, BMWo Temporal specificity: time dependent asset. Value expires after limited time. E.g. perishable goods and auction

items

High asset specificity requires strong contracts or internalization to combat the threat of opportunism. Here is an

example of the small subcontractors locating and investing next to the handful of 2 or 3 customers who could potentially

turn to alternative suppliers because of non-value maximizing reasons (supplier = site and physical asset specificity).

The most popular example for the consequences of assets specificity has been the relationship between General Motors

and Fisher Body between 1919 and 1926. After a 10 year contractual agreement was signed in 1919, GM's demand for

closed-body cars increased to extent that it became unhappy with the contractual price provisions and "urged Fisher to

locate its body plants adjacent to GM assembly plants, thereby to realize transportation and inventory economies (for

GM)." [Williamson].

Finally, Fisher Body was merged (internalized) into GM in 1926 after Fisher had resisted GM's locational demands. As

R.Coase recalls, "I was told [by GM officials] that the main reason for the acquisition was to make sure that the body

plants were located next to General Motors assembly plants." [R.H.Coase, "The Nature of the Firm: Origin", Williamson

& Winter. High asset specificity increases contract cost, and possibly control cost.

Small numbers: Small numbers is about monopolistic conditions where there are few suppliers. So, they are more

susceptible to opportunism. The firm can control and raise prices, in small numbers (small increases), and the customers

are unlikely to go somewhere else. Cases of Singapores NETS, StarHubs cablevision and SMRT.

NETS Fee Hike. Case of unfair monopoly? (TODAY, 5/6/07)

IT MAY seemed, at first, not to affect your pocket directly. But when the Network for Electronic Transfers

(Nets) raises its levy on businesses offering it as a mode of payment, the increased burden on retailers

could lead to higher prices for consumers, warned the Consumers Association of Singapore (Case). At a

press conference yesterday, Case president Yeo Guat Kwang minced no words in calling the three- to four-fold increase by Nets unacceptable and monopolistic.


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The watchdog is even considering the possibility of bringing the matter up to the Competition

Commission Singapore, the statutory board monitoring fair competition here. About 80 per cent of

HDB retail outlets accept Nets and no other debit cards or credit cards, said Mr Yeo. Even government

agencies accept Nets as a mode of payment.

He added: They have been given this monopolistic mode of operation becau se we see this as a basic

infrastructure, to provide a basic mode of payment for all Singaporeans. So, they cant just come out and

tell Singaporeans now I see this as ... a commercial decision.

Nets chief executive officer Poh Mui Hoon said Nets needed to respond effectively to competition, by

paying the interchange fee card-issuers expect from facilities like Nets.

Elsewhere in the world, domestic debit networks similar to Nets have been overtaken by international debit

networks offering higher returns to card-issuers, Ms Poh added.

But Mr Yeo disagreed with the justifications. They should consider other cost -saving methods (rather than

increase the levy), he pointed out. And what happens when other debit and credit cards adjust their fees

upward? Will Nets do the same?And it is not as if retailers can simply stop offering Nets as a mode of

payment, even if they want to.

With small numbers (few suppliers), the contract cost will be likely be high as contracting parties resort to establishing a

strong negotiation in the contractual terms, with customers trying to hold down price & quality. Low search cost applies

asit is futile to search for alternative suppliers in a monopolistic market, as there is only one or very few suppliers. In t he

above NETs situation, the retailers may bear the additional charges (owing to competition) and will incur more cost both

in the transaction and negotiating the contract terms.

With small numbers, sourcing and searching for new sources will unlikely score any success. In such monopolistic

condition, it would be futile to search, so the search cost is likely to be low or of no consequences from the customer,

retailer or middlemans perspective.

Within a country where there is a very limited number of available suppliers, investing in IT to expand search facilities

will not help. BUT in today context, the world is the very connected. Already in place are effective infrastructure (ITexternalities) such as the Internet, connected industries, public distributed databases where the world is becoming a "w/o

boundaries" - a dot community. Search extending to other new suppliers in other countries is very viable.

Outsourcing is another viable solution. This extended search, with some IT investment, will increase search cost but has

the effect of diminishing the conditions associated with "small numbers". Again, it also depends on asset specificity

factor. Small numbers in some assets may remain entrenched.

Small numbers also refer to situation where customers allowed themselves to be victims of the service

provider because they have complete trust in the provider. In such cases, the providers manipulate the

situation by raising small increases in prices. The customers are likely to accept the small number

increases and continue to use the services of the same provider.


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Quick check

Actually, Ronald coases transaction life cycle has 4 stages. The last stage on Maintenance is not of concern for the purpose

of the study in our course. Which stages of transaction are these screen referring to?

Externalities

In economics, an externality is a cost or benefit from an economic transaction that parties "external" to

the transaction receive. Externalities can be either positive, when an external benefit is generated, or

negative, when an external cost is imposed upon others. It is a form of indirect or side effects though not

necessarily an unintended consequence.

Example of positive externalities:

a) A beekeeper keeps the bees for their honey. A positive side effect or externality associated withhis activity is the pollination of surrounding crops by the bees. The value generated by the

pollination may be more important than the value of the harvested honey. The negative effect

for neighbours is the bees come and watch TV with them, and sometimes stink their children, so

they have to put up with some kind of screens (costs) on their doors and windows to keep the

bees out.

b) A neighbour planting an extensively attractive garden may provide positive benefits to hisimmediate neighbours and others living in the immediate vicinity, and even financial benefits in

the form of increased property values to property owners.

c) The government will build an MRT station near/in an estate. Houses around it will benefit botheconomically and practicallypositive externalities.

Examples of negative externalities:

a) Pollution by a firm in the course of its production which causes nuisance or harm to othersb) A public transportation resource (such as roads, rail tracks) laid across the estate, imposing

congestion, noise, and dust.

c) Centralise all crematoriam & wake activities in Upper Thomson area.IT related externalities:

a) Networks of Information can unintentionally lead to information overload (a negativeexternality) where executives are overwhelmed with too much information and do not know

how to use them effectively. Thus increasing cost! To correct the situation, more IT processing

will be required to analyse, collate, summarise into relevant concise effective information.

More cost!b) We can also said that the IT investment may have a negative impact on transaction cost

(although, the original objective of the investment was to reduce transaction cost!) as seen in

(a) above with more coordination effort.

c) Starhub cable network is a costly investment for starhub. But it provides an IT externalityfactor for competition -"competitor push" and "technology pull. If a Video Company decide to

exploit this externalities (technology pull) to provide a new service of VOD, its

implementation cost to hook on to Starhub cable is minimal, but it can cause a negative

externality on its competitors who do nothing or show indifferent to this competitor push

d) Investment in wired network is affected with new implementation of WIFI and WIMAXtechnology


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Information technology as a mediating technology

In the transaction cost model, we may conceive of information technology as a mediating technology because it mediates the

transactions or exchanges between the parties. Information technology can reduce the costs of transacting (i.e. the

information costs) because it enables more information to be communicated in the same amount of time.

1. Source: Ctrip.com. Hotel-room availability check

2. Source: Ctrip financial Report

3. TripAdvisor. Reviews posted bypasthotel guests


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Ciborra, Malone and Picot (1997) argue that information technology can be used to reduce transaction costs in different

economic organizations. This argument is based on the idea of using information technology to make more information

available to decision makers, thus contributing to the reduction of uncertainty.

Accordingly, the information problem that jeopardizes market efficiency can be fixed by supporting the system with

information technology. Information technology can be used to reduce the cost associated with transactions. Accordingly to

Malone, three different effects of IT on the exchange process can be identified:

o Communication effect: increase information per unit of timeo Electronic integration effect: easier linkage between buyer and sellero Electronic brokerage effect: the contracting process between seller and buyer becomes more efficient and effective

These effects increase the smoothness of the information flow so that, supported by IT, people involved in the economic

system, both market and hierarchy, can better use the existing information and deal better with the uncertainty they have to

face.

In the transaction-cost model, information technology is seen as a factor that can decrease the costs of transacting, thusimproving the functioning of the market or leading to market-like forms of organization. Market-like form of organizing

involves exploitation of intermediaries. The hierarchy form of organizing entails internalizing external processes and

reduction of intermediaries. The effect is thus providing the enterprise more bureaucratic control over the transactions and

processes.

Recall that the logic behind this argument is that the lower the transaction costs, the more suitable the market as a form of

organizing. In other words, markets as opposed to bureaucracies entail transaction costs, while bureaucracies replace

transactions with hierarchical decision-making, thus entailing a higher amount of managerial costs (agency cost) rather than

transaction costs. The more one uses information technology, the lower the transaction costs and, therefore, the more

efficient the market as an allocation mechanism.

However, we should consider that the increased amount of information being communicated in the same time uni tmight

increase the information processing costs that the transacting parties need to endure, information technology does not

necessarily lead to lower transaction costs.

In the transaction cost model, information technology is seen as a factor that can decrease the costs of transacting, thus

improving the functioning of the market or sustain ing market-like forms of organisation. The logic behind this argument

is that the lower the transaction costs, the more efficient the market will be. The more you use information technology, the

lower the transaction costs and, therefore, the more efficient the market will be as an allocation mechanism.

uncertainty

Transaction

CostMarket or Hierarchy

e-Market or e-hierarchy

For the same cost, more

uncertainty may be dealt

with in the e-market


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Strength & Weaknesses of TC economics

The strength of the transaction cost perspective is that it offers a compact set of concepts and a uni fyi ng languageto

analyse and interpret a variety of micro and macro phenomena, such as vertical integration between firms, employment

contracts and internal labour relations, anti-trust laws and interventions, and even the emergence and failure of economic

institutions.

Nevertheless, it has two majorlimitations.

First, transaction cost economics is based on a sophisticated but still narrow view of the agentas economic man, who

maximises utility despite the limits of their rationality. Therefore altruistic behaviour, for example, is beyond its

scope. See video of economistMiltonFriedmans arguments of capitalism over altruistic economics.

Second, the approach presents a static, comparative view of why different economic institutions exist, develop or decay.

Transaction cost economics suggests that, for a given level of uncertainty and trust between the parties, there are usually a

limited number of governance structures that are efficient and will survive in the long run. When circumstances change, an

efficient governance structure must adapt swiftly or it will be swept away by competition. The approach is silent, however, on

the forces that make certain economic organisations stickier than others. In sum, transaction cost economics seems to

assume an impli cit notion of f ri ctionless change. It ignores the widespread role of transition costs in socio-economic

organisations undergoing continuous change.

ICT and disin termediation

Traditionally, disintermediation in this context has been seen to occur when ICT implementations enable economic agents to

bypass third parties and directly engage in economic activities with their counterparties. In the context of the web, it has

come to signify the disappearance of a wide variety of middlemen, or intermediaries, and the creation of an enhancedsales

network in which customers deal directly with service providers. The result is supposed to be a frictionless economic

environment that reduces both inefficiencies and transaction costs.

Understanding the impact of e-commerce on intermediaries requires an appreciation that:

ICT supports many business activities and, as a result, it can lead to changes in market configurations; in particular, it

changes the role of intermediaries in matching supply and demand.

ICT can reduce transaction costs by eliminating the need for intermediaries that used to make the transaction possible:

disintermediation occurs because ICT does for free what an intermediary does for a fee.

Chaffeys Chapter-2 demonstrates the costs saved in a conventional producer-wholesaler-retailer-consumer value chain by,

first, disintermediating (eliminating) the wholesaler and then, secondly, disintermediating both the wholesaler and the

retailer. In the latter case, the price to the consumer becomes the same as that charged originally by the producer to the

wholesaler and is less than half the old price that the retailer charged the consumer.

This happens because ICT can reduce search costs, contracting cost, control and regulation costs through facilitating the

exchange of information between economic agents (described by Malone etal., 1987 as electronic communication effects)

and because it makes iteasier to match buyers and sellers (Malones electronic brokerage effects).

There are therefore valid economic incentives for both producers and consumers to bypass intermediaries and push them out

of the value chain. Intermediaries add significant costs to the value chain and, by suppressing them, the profit margins of

producers can increase while at the same time offering lower prices to consumers. Advanced uses of ICT and the evolution of

electronic marketplaces have reduced the transaction costs for producers, thus enabling them to internalise activities thathad to be served by intermediaries in a traditional market. This has created the opportunity to distribute profits within the


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value system by driving the intermediaries to extinction. Under such a scenario, producers can benefit from increasing their

profit margins and passing part of their savings to consumers who thus enjoy lower prices and greater choice.

An email from a student:

Intermediation, disintermediation, and reintermediation (another form of new intermediary). I am so confused regarding how

it leads to reducing transaction costs pertaining to E-Business.

I understand that e-business/e-commerce facilitates disintermediation....then you have the transaction brokers which

are intermediarybrokers (i thought ecommerce facilitates DISintermediation?) , and they aid in reducing transaction

costs....then there is the search engines which are intermediaries that support in lowering of TC, and then (mentioned by Dr

Antonio), I-Tunes are facilitating disintermediation.....

Jacks answer:

Disintermediate = removes intermediaries (in manual physical market place, often has long line of intermediate parties)

Intermediary = act as middleman between 2 parties. If you do everything yourself, then there is no need for any intermediary

to help you. BUT is this really possible? if you take a taxi to go to the a tour agent, who calls a wholesaler agent to book

hotel room from a Taiwan hotel... in this physical manual approach, you use three intermediaries to get to the Taiwan hotel

room. But, if you now use online B2C Asiaroom.com to book the Taiwan hotel, you use only one intermediary i.e. B2C

AsiaRoom.com, (an IT e-business) acting as the intermediary. In this case there is also disintermediation. Search engines act

as an intermediary replacing physical intermediaries like taking a taxi (an intermediary) all over town to many shops

(intermediaries) searching for the right item. iTunes dis-intermediates because you can now buy directly from the

manufacturer of the song titles instead of going through the supply chain involving retails and wholesalers. iTunes shop

happens to be the only intermediary now.

I nfomediari es and In termediaries

Intermediaries are profoundly affected by the adoption and diffusion of ICT(same as IT) in markets. ICT changes the way in

which information is accessed and therefore allows agents to bypass traditional intermediaries to execute transactions.

It must, however, be noted that a new form of intermediation is emerging alongside the wide adoption of ICT. Electronic

markets are characterised by a very rich information setting which, in certain circumstances, makes it difficult to find the

right information needed by the agents.

If you are looking for information on a specific product, you will find it difficult to identify the right website to support your

search without the use of a search engine such as Google. Search engines are intermediaries which reduce the cost of gaining

access to and using information.

These intermediaries, given the nature

ebiz - batch 3 handout

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