STRATEGIC RENTS AND TRANSACTION COSTS

IN THE THEORY OF THE FIRM

Josef WindspergerCenter for Business Studies

University of ViennaBrünner Str. 72A-1210 Vienna

AustriaTel.: 00431-4277-38180Fax: 00431-4277-38174

E-mail: josef.windsperger@univie.ac.at

Vienna, October 2003

Abstract:

The objective of this paper is first to explain the existence of the firm as knowledge-creating institution by developing a strategic efficiency criterion. Starting from Connor and Prahalad’s view, we critically comment on the resource-based theory of the firm and show that a strategic efficiency criterion is missing in the previous literature. Second, we show that the existence of the firm as a knowledge-creating and knowledge-exploiting governance structure can be only explained by combining transaction cost and resource-based reasoning because rent-yielding resources and capabilities are closely intertwined with asset specifity and transaction costs. Finally, we argue that ‘economizing is more fundamental than strategizing’ (Williamson) because the transaction cost theory of the firm can be established in a zero strategic rent world, but a strategic theory cannot be formulated in a zero transaction cost world.

Key-words: Transaction Cost, Rents, Strategic Theory, Resource-based Theory.

STRATEGIC RENTS AND TRANSACTION COSTS IN THE THEORY OF THE FIRM

1. Introduction

During the last decade the theory of the firm has made important progress. On the one

hand, contractual approaches of the firm have reached a new stage of development

through the new property rights theory (Grossmann and Hart 1986, Hart and Moore

1990, Hart 1995). In addition, the application of the transaction cost theory was very

successful in economics, law, organization and marketing (Rindfleisch and Heide 1997,

Anderson 1996, Macher and Boerner 2001). On the other hand, an alternative paradigm

has been evolving since the 1980-ies - the strategic theory of the firm (Wernerfelt 1984,

Rumelt 1984, Connor 1991, Barney 1991, Mahoney and Pandian 1992, Grant 1996,

Kogut and Zander 1996, Teece et al. 1997, Barney et al. 2001, Priem and Butler 2001,

Nickerson and Zenger 2001). Based on Penrose's resource-based theory (Penrose 1959)

and Porter's activity-based approach (Porter 1980, 1985), the strategic theory of the firm

investigates the influence of the market structure and internal resources and capabilities

on the firm strategy and organization. Hence it tries to explain the efficient strategy-

structure relationship. However, previous literature in the strategic theory of the firm

has not incorporated a strategic efficiency criterion to evaluate the competitive

advantage of organizational modes. Strategic efficiency refers to the realization of

sustainable competitive advantages as strategic rents of the firm. Depending on the

origin of competitive advantage, different strategic rents can be realized. If the

competitive advantage primarily results from monopolistic advantages, as argued by

Porter (1980, 1985), the strategic choice depends on the generation of monopolistic

rents. If the competitive advantage is primarily based on knowledge advantages due to

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specific resources, capabilities and competencies, Ricardian and Schumpeterian rents

can be realized (Peteraf 1993, Winter 1987).

Starting from Wernerfelt (1984), Winter (1987) and Barney (1991), Kogut and Zander

(1992, 1996) as well as Connor and Prahalad (1996) presented a resource-based view of

the firm. The firm is less a contractual network economising on transaction costs but

more a rent-yielding bundle of resources and capabilities. They differentiate their

approach from the transaction cost theory by emphazising that knowledge-based

advantages do not require the assumption of opportunism to explain the existence of the

firm. As Kogot and Zander formulated, firms exist because of their „higher order

organizing principles“ (1992, p. 384). Under the resource-based view this means that

knowledge-based competitive advantages can be more easily created when specific and

tacit resources are internally combined to build up organizational capabilities and core

competencies (Grant 1991, 1996). This view is also compatible with Nickerson and

Zenger’s knowledge-based theory of governance choice. Nickerson and Zenger (2001)

developed a theory of alignment that predicts under which problem-solving conditions

market supplants hierarchy as knowledge formation mechanism. Their theory can be

summarized by the following proposition: The governance mechanism as knowledge

formation mechanism depends on the complexity and decomposability of problems. The

more complex and non-decomposable the organizational problems, the higher is the

tendency toward hierarchy as consensus-based system. On the other hand, Nickerson

and Zenger’s theory does not include a knowledge-based efficiency criterion for the

governance choice. To summarize the previous literature we may conclude, that the

main difficulty of the existing resource-based theories lies in the missing efficiency

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criterion to evaluate the governance mode as knowledge creation mechanism. Starting

from this gap in the literature, the primary objective of our paper is to develop a

strategic efficiency criterion and to use this concept to explain the existence of the firm

as knowledge-creating institution. Furthermore, we develop an integrative view of the

firm and show that the existence of the firm as knowledge-creating and knowledge

exploiting mechanism is inseparably intertwined with strategic rents and transaction

costs. This simultaneity issue has not been featured in previous resource-based theories

of the firm, except Madhok’s discussion of the alignment hypothesis (Madhok 2002).

The paper is organized as follows: Section two criticizes Connor and Prahalad's

resource-based view of the firm and develops a resource-based theory of the firm by

incorporating strategic rents as efficiency criterion to evaluate the governance modes. In

section three we show that the transaction cost theory of the firm can be constructed

without assuming that the transactors have heterogeneous resources and capabilities.

Section four presents an integrative approach by combining the transaction cost and

resource-based view. Finally, we argue that a strategic theory of the firm cannot be

formulated without transaction costs, but a transaction cost theory of the firm can be

established in a zero strategic rent world.

2. Resource-based Theory of the Firm

2. 1. Connor and Prahalad's View

Connor and Prahalad’s theory (Connor and Prahalad 1996) is the most sophisticated

version of the resource-based theory developed in the last years. In the following, we

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summarize and criticize their view. Their resource-based approach of the firm is based

on the knowledge substitution and flexibility effect of the organizational mode:

(a) Knowledge substitution effect: If Y (as supplier) and Z (as final goods

producer) have certain resources and capabilities, both have two possibilities to

influence the other‘s actions: Firm organization and market contracting. The knowledge

substitution effect exists when one party (in Connor and Prahalad’s case Z) directs the

action of the other party (Y). Hence it refers to the hierarchical mode of coordination.

Under this mode, Z can require Y to act according to Z’s judgement. This effect results

in a competitive advantage if Z has a specific knowledge base that cannot be

internalized by market contracts. In this case, internal organization better enables

knowledge creation without full knowledge absorption. This is compatible with

Demsetz' view that „[d]irection substitutes for education“ (1991, p. 172). The greater

the initial difference in knowledge due to higher skills and capabilities, the larger the

knowledge substitution effect.

(b) Flexibility effect: „The flexibility effect accounts for the relative cost, under

the two organizational modes, of altering the parties’duties and responsibilities on an

ongoing basis, in order to incorporate learning or unexpected opportunities...“ (Connor

and Prahalad, p. 486). Hence it refers to the dynamic capabilities of the firm. The more

dynamic and competitive the environment, the more often changes in skills, duties and

responsibilities are required favouring the firm organization, because under market

contracting it will be difficult to provide for unanticipated acquisition of new

knowledge. However, the flexibility advantage of firm organization only exists if it is

assumed that Z has higher learning or knowledge-upgrading capabilities than Y. This

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flexibility effect is compatible with Langlois’s concept of dynamic transaction costs as

learning costs (Langlois 1992).

Which resource-based predictions can be derived from Connor and Prahalad's

approach? According to Connor and Prahalad, the firm existence is more likely, the

higher the knowledge substitution and flexibility advantages are. Consequently, the firm

will arise as knowledge-creating institution if the net value of the knowledge

substitution and flexibility is higher than under market contracting. Connor and

Prahalad’s approach can be criticized as follows:

First, the main critics refers to the missing knowledge-based (resource-based)

efficiency criterion: They compare the organizational modes according to the

knowledge substitution and flexibility effects without explicitly incorporating a

strategic efficiency criterion. Oliver Williamson (1999) also criticized this point, but he

does not propose a solution. Hodgson proposes a dynamic efficiency criterion for the

resource- or competence-based theories. Dynamic efficiency refers to „learning and

innovations“ (Hodgson 1998, p. 188). This is an important starting point to distinguish

transaction cost and resource-based approaches. However, Hodgson does not

operationalize this efficiency concept.

Second, as already criticized by Foss (1996), Connor and Prahalad assume that

the knowledge substitution and flexibility effects are primarily realized under firm

organization. This need not be the case. For instance, as shown by Argyres (1996),

market contracting may result in strategic advantages if the supplier has higher

organizational capabilities.

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Third, Connor and Prahalad present a comparison of the resource-based theory

with the transaction cost approach as the opportunism-dependent approach (Connor and

Prahalad, p. 489). The problem of this comparison is that they do not specify the

conditions under which the predictions are possible. The restriction of the transaction

cost theory to the opportunism-based view as a reference theory cannot be justified,

because transaction cost theory is more than the opportunism-based view. This

comparison neglects the information processing view of the firm as an important

component of transaction cost theory because – as already argued by Coase 1937,

McManus 1972, and Casson 1994 – bounded rationality is sufficient to move from

market to hierarchy due to information cost savings. In a world of bounded

rationality/zero opportunism the firm exists as an information processing mechanism

due to high market coordination costs. The extent of information processing advantage

of the firm depends on the degree of environmental uncertainty. If high environmental

uncertainty exists, frequently new information arises resulting in high search, bargaining

and adjustment costs under market contracting. In this case, the firm organization may

lower the coordination costs by installing a higher information processing capacity.

2.2. A Resource-based Approach of the Firm

Starting from the Connor and Prahalad’s approach we develop a resource-based theory

of the firm by incorporating strategic rents as efficiency criterion to evaluate the

organization modes. As discussed in section 3.1., Connor and Prahalad developed a

knowledge-based approach for the existence of the firm. They argue that the firm’s

existence can be explained on the basis of the transactor’s knowledge advantages

resulting from firm-specific resources and dynamic capabilities. The first refers to the

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knowledge substitution effect and the latter to the flexibility effect under changing

environmental conditions. In the following, we argue that knowledge substitution and

flexibility effects are only relevant for a resource based theory of the firm, when they

are closely related to the rent-generating potential of organizational mode.

As argued by Barney (1991), Amit and Schoemaker (1993) and Alvarez and Busenitz

(2001), the firm's resources, capabilities and competencies (as strategic assets) may

generate a sustainable competitive advantage if rarity, imperfect imitability and

nonsubstitutability exist. Under this resource-based view of the firm, strategic rents

(including Ricardian and Schumpeterian rents) are the efficiency criteria to evaluate the

firm’s competitive advantage. Ricardian rents result from knowledge advantage due to

differences in existing firm-specific resources and "static capabilities" (Fujimoto 1998,

p. 17), and Schumpeterian rents result from knowledge creation due to differences in

dynamic or innovation capabilities (Teece et al. 1997, Penrose 1959, p. 85). This

organizational learning refers to the knowledge-leveraging capabilities to strengthen the

firm’s competitive advantage in the future. This concept of strategic rents is also

compatible with Putterman’s “information rents” (1995, p. 379), but Putterman does not

differentiate between rents due to static and dynamic capabilities.

In the following, we show that the resource-based theory explains the firm as

knowledge-creating institution due to its higher strategic efficiency, compared to market

contracting. We differentiate between two strategic criteria: Ricardian rents (RR) due to

static resource advantages and Schumpeterian rents (SR) due to dynamic capabilities

(innovation capabilities) advantages. The results of the comparison of the rent-

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generating effect of the firm organization and market contracting are summarized in

figure 1. Based on Connor and Prahalad’s analysis, we use Y as supplier and Z as buyer

(final goods producer) and investigate the strategic efficiency of the organizational

modes from Z’s point of view. We differentiate four cases:

Insert Figure 1

(1) The firm organization results from Z’s static resource advantages and Z's

more efficient organizational learning due to its higher innovation capabilities.

Thus Z can realize both higher Ricardian and Schumpeterian rents by internal

bundling of resources and capabilities.

(2) In this situation, the firm organization arises if Z's Schumpeterian rents due

to its higher innovation capabilities are not compensated by Z's static resource

disadvantage.

(3) The firm organization will arise if Z's Ricardian rents due to its static

resource advantages exceed the lower Schumpeterian rents (higher learning

costs) due to Z's lower innovation or dynamic capabilities compared to Y.

(4) Market contracting is more efficient from Z’s strategic point of view,

because Z can leverage its resources and capabilities by acquiring and

exploiting Y’s static resource and innovation capabilities advantage.

Consequently, the firm will arise as a knowledge-creating institution (Nonaka et al.

2000), if the sum of Ricardian and Schumpeterian rents from internal bundling of

resources and capabilities are higher than under market contracting. Therefore, a

resource-based explanation of the existence of the firm is only possible if the rent-

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yielding potential of resources under internal organization is higher than under market

contracting. The resource-based theory can be summarized by the following

proposition:

The firm organization (F) as a knowledge creating institution is more efficient

than market contracting (M), if the knowledge-based rents (Ricardian and

Schumpeterian rents) under internal organization exceed the rents under market

contracting (RF – RM > 0).

3. A Transaction Cost View of the Firm

Compared with the resource-based theory, the transaction costs approach does not

require heterogeneous resources and capabilities of the transactors to explain the firm’s

existence and organization (Barney and Hesterley 1996). Under given transaction-

specifity and frequency, environmental uncertainty and opportunism influence the

organizational mode (Williamson 1975, 1985). Transaction costs, due to environmental

uncertainty, are coordination costs consisting of search, information processing and

adjustment costs, and transaction costs, due to opportunism (behavioral uncertainty), are

motivation costs resulting from adverse selection, moral hazard and hold-up. Based on

transaction costs as coordination efficiency criterion, we show that transaction costs

differences can explain the firm as knowledge-exploiting institution, due to its

information processing and incentive effects, without recourse to heterogeneous

resources and capabilities.

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We differentiate between two transaction cost criteria: Coordination and motivation

costs According to the transaction cost theory (Williamson 1975), coordination cost

savings of the firm organization are higher, the higher the uncertainty is. The results of

the comparision are summarized in figure 2.

Insert Figure 2

(1) Under low environmental uncertainty, market contracting results in low transaction

costs because Z already has the relevant knowledge to conclude a relatively

complete contract.

(2) Under high environmental uncertainty, high market coordination costs as search,

information processing and adjustment costs arise because market contracts must be

frequently adjusted to new information. On the other hand, Y does not behave

opportunistically and is willing to adjust its plans to new relevant knowledge.

Consequently, under internal organization Z can realize coordination cost

advantages, if the savings of market transaction cost exceed the higher setup-costs

of internal organization structure.

(3) Under low environmental uncertainty and opportunism, market contracting results

in relatively low coordination and motivation costs. Although Z behaves

opportunistically, moral hazard, adverse selection and hold-up behavior can be

easily detected in this situation. Thus Z may realize coordination and motivation

cost advantages under market contracting.

(4) Under high environmental uncertainty and opportunism, the firm organization will

arise as a knowledge-exploiting institution. High uncertainty results in information

asymmetry between Y and Z, hence in high market transaction costs. In addition,

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high environmental uncertainty increases Y‘s tendency toward opportunistic

behavior and hence Z‘s motivation costs, because information selection and

manipulation cannot be easily detected.

Consequently, in a world of bounded rationality and opportunism the firm existence can

be explained by transaction cost differences without recourse to heterogenous resources

and capabilities of the transactors. The transaction cost view of the existence of the firm

can be summarized by the following proposition:

The firm organization as a coordination mechanism (knowledge-exploiting

institution) is more efficient than market contracting, if the transaction costs

under market contracting exceeds the transaction costs under internal

organization.

4. An Integrative View

Finally, we show that the existence of the firm as institutional entity requires an

integrative view of the firm by combining the resource-based and the transaction cost

theory, because transaction costs incurred in the exchange of resources are not

independent of the rent-generating effects of resources and capabilities (Madhok and

Talmann 1998, p. 327). Hence the question to ask is, which relationship exists between

transaction costs and strategic rents?

4.1. Asset Specifity, Transaction Costs and Rents

The mediating factor between transaction costs and rents is asset specifity. Asset

specifity is an important theoretical concept both in the resource-based and in the

transaction cost theory. But many authors do not differentiate between firm specifity, on

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the one hand, and transaction specifity, on the other hand. In order to be able to explain

the relationship between transaction costs and strategic rents, we have to distinguish the

two forms of asset specifity:

(I) Transaction-specifity: The concept of transaction-specifity is based on the

transaction cost theory developed by Klein et al. (1978) and Williamson (1979). An

asset is transaction-specific when it realizes a quasi rent (QR), which refers to the higher

value of the transaction compared to the best alternative. Two cases can be

distinguished (Anderson and Weitz 1992, Buvik and John 2000, Wathne and Heide

2000): (a) Asymmetric specific investments: If the transaction-specific investments of

the supplier are high and of the buyer are low, the opportunism risk is high because the

buyer may appropriate the supplier's quasi-rents under unilateral dependency. (b)

Symmetric specific investments: When both partners invest into relationship-specific

assets, bilateral dependency mitigates the opportunism risk because both can realize

high quasi-rents. Consequently, the following propositions between transaction-

specifity and transaction costs can be derived: If asymmetric specific investments exist,

the quasi-rents of the more dependent party are exposed to the hold-up risk by the less

dependent party, hence transaction costs rise with transaction-specifity (e.g., Anderson

1988). If symmetric specific investments exist, both parties can realize high quasi rents

under the current relationship, hence transaction costs decline with transaction-specifity

due to the incentive effect of bilateral dependency (e.g., Dyer 1997).

(II) Firm-specifity: The concept of firm-specifity is based on the resource-based

view of the firm (Wernerfelt 1984, Barney 1991, Connor 1991, Amit and Schoemaker

1993). Strategic assets as resources, capabilities and competencies are firm-specific

because they are difficult to transfer and imitate due to high transaction costs.

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Consequently, sustainability of competitive advantage is closely intertwined with high

transaction costs.

Now we can answer the question regarding the relationship between asset specifity,

transaction costs and strategic rents. Two cases can be distinguished:

If the assets of one party (buyer) are firm-specific and generate strategic rents (R) but do

not require transaction-specific investments of the other party (supplier), high

transaction costs may arise due to the hold-up behavior of the less dependent party. On

the other hand, if the buyer‘s assets are firm-specific and require transaction-specific

investments of the supplier, high relationship-specific rents arise under "idiosyncratic

investments" (Jap 1999, p. 471, Bensaou, Anderson 1999). In this case, the buyer

realizes high strategic rents (R) due to its firm-specific resources and capabilities, and

the supplier realizes high quasi-rents (QR) due to the transaction-specifity of its

investments. For instance, as argued by Asanuma 1989, Dyer and Singh 1998, Kalwani

and Narayandas 1995, Nishiguchi and Brookfield 1995 and Helper and Sako 1995, the

close relationship between Japanese automobile suppliers and producers is characterized

by high relationship-specific assets that result from the dynamics of firm-specific and

transaction-specific investments. The change of assets specifity during the relationship

life-cycle can be explained as follows (Asanuma 1989, Jap and Ganesan 2000, Dyer et

al. 1998) (see figure 3): We assume that the producer (buyer) realizes a competitive

advantage (strategic rents) due to its capabilities in the design and production of

automobiles. These firm-specific assets require transaction-specific investments by the

supplier (1). Over time these transaction-specific investments trigger a capability-

upgrading and knowledge leverage effect for the supplier (2). Conversely, the high firm-

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specifity of the supplier's resources and capabilities results in transaction-specific

investments by the producer (3) which may lead to a knowledge leverage effect for the

producer (4) and hence to an increase in strategic rents (as Schumpeterian rents).

Insert Figure 3

Consequently, strategic rents and transaction costs are closely intertwined with asset

specifity. In order to explain the existence of the firm as knowledge creating and

knowledge exploiting institution the transaction cost and resource-based theory have to

be combined. The results of the theory development are depicted in figure 4; thereby we

assume a medium degree of environmental uncertainty. We differentiate four cases:

Insert Figure 4

(1) The buyer’s (Z’s) high rent-yielding resources and innovation capabilities show a

high degree of firm-specifity. In addition, the probability of opportunistic behavior

is high if the supplier (Y) has not to undertake transaction-specific investments

resulting in high hold-up risks for Z. Therefore, both resource-based and transaction

cost predictions lead to internal organization by Z.

(2) Z has no competitive advantage in resources and capabilities implying a low degree

of firm-specifity. On the other hand, transaction costs are high under a high

probability of opportunistic behavior. This can be only the case, if one agent (Z or

Y) has to undertake high transaction-specific investments resulting in high hold-up

risks under unilateral dependency. Firm organization is more efficient than market

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contracting, because it can more easily process the relevant information and it may

mitigate the opportunism risk by creating incentive and control devices.

(3) Z‘s rent yielding knowledge-based advantages are high due to the firm-specific

resources and capabilities. On the other hand, market transaction costs are low under

a low probability of opportunistic behavior. This can be the case if a high degree of

bilateral dependency exists, due to high transaction-specific investments by Y.

Hence Z’s firm-specific assets are complemented by Y‘s transaction-specific

investments. Under this bilateral dependency, market contracting results in low

transaction costs. Consequently, the resource-based and transaction cost theories

lead to different predictions. The firm organization will arise if the higher rent-

yielding potential of internal knowledge creation exceeds the transaction cost

savings of market contracting.

(4) The firm organization cannot realize rent-yielding resource and innovation

capabilities advantages. Hence no knowledge leverage effect exists. In addition,

transaction costs under market contracting are low because Z and Y undertake low

transaction-specific investments. Consequently, market contracting is more efficient

than firm organization under the transaction cost view.

As a result, the existence of the firm as a knowledge-creating and knowledge–exploiting

institution can be explained by combining the transaction cost and resource-based

reasoning, because the rent-yielding resources and capabilities are inseparately

intertwined with high transaction costs. Under these conditions, the knowledge- or rent-

generating organizational mode cannot be separated from the transaction cost

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minimizing organizational mode. The existence of the firm as a knowledge-creating and

knowledge-exploiting institution can be summarized by the following proposition:

The firm organization (F) is more efficient than market contracting (M), if the

rent-yielding potential of internal bundling of resources and capabilities exceeds

the transaction costs disadvantages, or the transaction cost savings of the firm

organization exceed the rent-yielding advantage of market organization (RF – RM

> TCF – TCM or TCM – TCF > RM – RF).

4.2. Existence of the Firm and Primacy of the Transaction Cost Explanation

Finally, we argue that “economizing is more fundamental than strategizing”

(Williamson 1994, p. 362) to explain the existence of the firm as governance

mechanism. Although the resource-based theory does not depend on the existence of

opportunism, the existence of the firm as a knowledge-creating (or rent-generating)

institution requires positive transaction costs. This is compatible with the view of

Mahoney (2001) and Foss (2001, 2002) that market frictions (transaction costs) explain

sustainable firm-level rents, because transaction costs make the transfer and imitation of

resources and capabilities more difficult. A similar view was already presented by

Lippman and Rumelt (1982) and Reed and DeFillippi (1990). They suggest that

uncertainty and ambiguity regarding which factors are responsible for performance

differences between competitors explain the existence of rents. Conversely, if

transaction costs are zero, the firm resources are mobile and easily imitable and do not

generate sustainable strategic rents. On the other hand, a zero strategic rent world is

compatible with a positive transaction cost world. If no strategic rents are generated,

due to homogeneous resources and capabilities, the existence of the firm can be only

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explained by transaction cost differences. As argued in section 4, transaction cost

differences result from transaction specifity, transaction frequency, as well as

environmental and behavioral uncertainty consequences under firm and market

organization. Therefore we may conclude: Contrary to Mahoney’s view (2001, p. 655),

market frictions (transaction costs) that explain the existence of the firm as knowledge-

exploiting institution (in transaction cost theory) are not always sufficient isolating

mechanisms that explain sustainable strategic rents (in resource-based theory). Only

when market frictions exist due to firm-specific resources and capabilities, the market

frictions are sufficient to explain sustainable strategic rents. From this reasoning we can

derive the primacy of transaction cost explanation: If strategic rents are zero, the firm

only exists as coordination or knowledge-exploiting governance structure. But if

transaction costs are zero, the firm exists neither as knowledge-exploiting nor as

knowledge creating-governance structure.

5. Conclusion

The paper focuses on the role strategic rents and transaction costs in the theory of the

firm. Resources, capabilities and competencies are the building blocks of a strategic

theory of the firm. According to Barney, they generate competitive advantage when

rarity, imperfect imitability, and nonsubstitutability exist. Based on this view, Connor

and Prahalad developed a resource-based theory of the firm by trying to show that the

firm can realize a competitive advantage by internal bundling of resources and

capabilities. Starting from Connor and Prahalad‘ s view, we developed a resource-based

theory by explicitly incorporating a strategic efficiency criterion. Strategic efficiency is

operationalized by the concept of strategic rents, consisting of Ricardian and

Schumpeterian rents. Ricardian rents result from static resource advantages and

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Schumpeterian rents from innovation or dynamic capability advantages. Only if the

organization of resources and capabilities influence strategic rents, rents can serve as

efficiency criterion in a resource-based theory of the firm. We have shown that the firm

as a knowledge-creating institution may arise, if strategic rents under internal

organization exceed the rents under market contracting. However, to explain the firm as

a knowledge-creating and knowledge-exploiting institution the transaction cost and

resource-based views must be integrated because strategic rents as resource-based

advantages are closely related to transaction costs. Finally we argued that a primacy of

transaction cost explanation exists. A transaction cost theory of the firm can be

formulated in a zero strategic rent world, but a strategic theory of the firm organization

cannot be established in a zero transaction cost world.

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Ricardian Rents (RR) Resource Advantage Resource Disadvantage Schum

pterian Rents (SR

)

Innovation Capabilities

Advantage (1) FIRM:

(SR + RR > 0)

(2a) FIRM: (SR + RR > 0) (2b) MARKET: (SR + RR < 0)

Innovation Capabilities

Disadvantage

(3a) FIRM: (RR + SR > 0) (3b) MARKET: (RR + SR < 0)

(4) MARKET: (RR + SR < 0)

RR > 0/SR > 0: Compared to market contracting, the firm organization can realize higher Ricardian/Schumpeterian rents due to its resource advantages or higher innovation or learning capabilities.SR < 0/RR < 0: Compared to market contracting, the firm organization realizes lower Ricardian/Schumpeterian rents because the firm has resource or innovation capability disadvantages.

Figure 1: Resource-based Theory

23

Coordination Costs (CC)Low Environmental

UncertaintyHigh Environmental

Uncertainty

Motivation C

osts (MC

)

No O

pportunism

(1) MARKET: (CC > 0)

(2a) FIRM (CC < 0) (2b) MARKET: (CC > 0)

Opportunism

(3) MARKET: (CC + MC > 0)

(4) FIRM: (CC + MC < 0)

CC > 0/MC >0: Market Contracting results incoordination/motivation cost savings.CC < 0/MC < 0: Firm organization results incoordination/motivation costs savings.

Figure 2: Transaction Cost-View of the Firm

24

Producer’s Capabilities(Firm-specific Assets)

(1)

(4) Supplier’s Transaction-specific Investments

(2)

Supplier’s Capability-upgrading (Knowledge-leveraging)(Firm-specific Investments)

(3)

Producer’s Transaction-specific Investments

Figure 3: The Dynamics of Asset Specifity

25

Strategic Rents (R) YES NO T

ransaction Costs (T

C)

High Probability of O

pportunistic B

ehavior

(1) RB+: FIRM (R > 0) OB: FIRM (TC < 0)

(2) RB: FIRM or MARKET (R = 0) OB: FIRM (TC < 0)

Low Probability of

Opportunistic B

ehavior

(3) RB: FIRM: (R > 0) OB: MARKET: (TC > 0)

(4) RB: FIRM or MARKET: (R = 0) OB: MARKET: (TC > 0)

+: RB refers to the resource-based view and OB to the transaction cost view.

R > 0: The firm can capture higher strategic rents (Ricardian and/or Schumpeterian Rents) under internal organization, compared to market contracting.TC < (>) 0: The firm organization (market contracting) results in transaction cost savings.

Figure 4: An Integrative View

26