“Explaining the Swollen Middle: Why Most Transaction are a Mix of ‘Market’ and ‘Hierarchy’,” Organization Science 4(4): 529-547. Hennart, Jean-Francois. (1993).
Motivation • Extend Transaction Cost Theory to respond to critiques: • TCE is only a theory of market failure—it does not explain why firms succeed. • TCE does not distinguish between transaction cost and management costs • TCE neglects the complexity of actual institutions • Most transactions cannot be categorized as either pure market or pure hierarchy. • *No attempt is made to systematically incorporate the criticisms, though some are addressed.
6 Main Points • There is not a 1-to-1 correspondence between economic institutions (markets vs. firms) and methods of organizing (price system vs. hierarchy). • The price system meters/rewards output; the hierarchy, behavior (input). Each method is equally effective in a world with zero costs to exchange. • Price systems are vulnerable to cheating costs; hierarchies, shirking costs. • Price systems minimize shirking; hierarchies minimize cheating. • Institutions may find that using a mix of price incentives and behavioral constraints is optimal due to diminishing returns in measuring output and constraining behavior. • Most institutions are hybrids; hence, the bulging middle.
Cheating Costs How is the price system used in employment relations? Shirking Costs
Using Price Incentives in the Firm • Ceteris Paribus, should be used more when: • Large and diversified firm • Low managerial expertise (discern behavior & quality) • Limited knowledge and/or costly to supervise activities
Discussion • Can we use the framework developed by Mahoney 1992 (non-separability and low/high task programmability)? What else would (does) it need? • How does this paper relate to Chi 1994? • (Especially with regards to cheating) • The paper discussed the rise and fall of piecework and/or profit centers. What do you see happening in the future and why? • Outsourcing • Global Economy • New Incentive Schemes