Networked Horizontal LSP Cooperation I. Abstract of Part
III. Transaction Cost Economics and Market Mechanisms
4. The Role of Information Technology in Economic Organization
The role of IT in economic organization has been investigated by several scholars (see e.g. Clemons & Row 1993; Bakos 1991; Bakos 1997; Bakos 1998). In this section, how- ever, we focus on the article by Malone et al. (1987), which can be considered the first comprehensive contribution to this area, and their findings have direct relevance for this thesis.
4.1. Impact on Governance Structures: Electronic Markets and Electronic Hierarchies
Malone et al. (1987) distinguish between two types of “electronic” governance structures (1) electronic markets and (2) electronic hierarchies.Electronic markets(or marketplaces) are markets where interactions between buyers and sellers are enabled and supported by IT. As Bakos (1991:296, italics original) defines it
“[a]nelectronic marketplace(or electronic market system) is an interorganiza- tional information system that allows the participating buyers and sellers to exchange information about prices and product offerings.”
Electronic markets exploit theelectronic brokerage effect, which suggests that a central database that connects many buyers and suppliers is equivalent to a broker who is in contact with a large number of buyers and suppliers (Malone et al. 1987:488).
With the recent proliferation of the internet, electronic markets have become a ubiquitous phenomenon that has attracted the attention of scholars (see e.g. Hagiu 2009; Hagiu &
Spulber 2013; Hagiu 2014; Gawer 2014). Examples include Google’s Play Store, eBay, and Amazon’s Marketplace. However, rather than using the term “electronic markets,”
scholars more commonly refer to them as “platforms” or as “two-sided” or “multi-sided markets:”
“Platforms fundamentally create value by acting asconduits between two (or more) categories of consumers who would not have been able to connect or transact without the platform. Platforms create value by coordinating these groups of consumers and in the economic view this coordination is effected through pricing” (Gawer 2014:1241, italics original).
Research particularly focuses on the creation ofnetwork effects, which means that users benefit from an increasing number of other users present on the same platform (see e.g.
Gawer 2014:1241).
Malone et al. (1987:490ff.) identify different types of actors’ motives for establishing electronic markets. Sellers may do so to tie buyers more tightly to them by trying to reduce the number of alternative providers buyers consider in their procurement process.
Conversely, buyers may establish electronic markets to gain access to a larger number of alternative sellers and compare them with ease. Intermediaries such as financial firms may aim to increase revenue by processing a larger volume of transactions. Finally, IT vendors may establish electronic markets to increase their revenue from IT infrastructure and the software they provide. By introducing electronic markets, these actors may become market makers(Malone et al. 1987:484).
Electronic hierarchiesestablish a situation in which either buyers or sellers
“use information technology to create joint, interpenetrating processes at the interface between value-added stages” (Malone et al. 1987:488).
Electronic hierarchies take advantage of the electronic integration effect which means that IT is not only used to increase communication speed, but also to change the under- lying processes that create and use this information, leading to tighter coupling between buyers and sellers (Malone et al. 1987:488). Databases are at the core of electronic hierar- chies (similar to electronic markets) because they integrate processes across organizational boundaries by enabling continuous and convenient information sharing via the internet (Malone et al. 1987:495).
Malone et al. (1987:493f.) suggest that electronic hierarchies have the potential to partic- ularly improve product development and product distribution, where the former includes a design database to shorten product life cycles, and the latter includes procurement and inventory databases as used in JIT systems to reduce inventory costs. In fact, shortening product life cycles, introducing lean logistics concepts, such as JIT, and integrating and synchronizing value adding processes across organizational boundaries are all actions that have already been observed in the meso-logistics system environment as a means of raising revenue and decreasing costs (see above Section B.V.2).
4.2. Impact on Structural Choice
While the analysis of Williamson (1991) above primarily focuses on transaction costs associated with making adaptations to align with disturbances, Malone et al. (1987) focus on how the use of IT impacts “coordination costs” and thus governance choice.
Coordination costs comprise “the transaction (or governance) costs of all the information processing necessary to coordinate the work of people and machines that perform the primary processes” (Malone et al. 1987:485). In markets, they include costs for searching and selecting transacting parties, negotiating contracts, and making financial settlements.
In hierarchies, they include costs for managerial decision-making, accounting, planning, and controlling processes. Coordination costs are comparatively high in markets and low in hierarchies: Markets have a costs disadvantage over hierarchies because buyers need to identify and screen multiple alternative suppliers, while a “single” supplier is already predefined in hierarchies, so no search and information costs are incurred (Malone et al.
1987:485). Because of information processing and transmitting costs, products with more complex descriptions are more likely to be obtained through hierarchies than markets (Malone et al. 1987:486f.).
The introduction of IT reduces coordination costs by reducing the time and cost of pro-
cessing and transmitting information (Malone et al. 1987:484; also see Groth 1999:144;
Argyres 1999). Malone et al. (1987:488) refer to the reduction of time and costs as the communication effectof IT. While this effect makes both markets and hierarchies more efficient, reducing coordinating costs
“lead[s] to an overall shift toward proportionately more market coordination”
(Malone et al. 1987:484).
They argue that this is because markets benefit comparatively more from lowered (unit) coordination costs than hierarchies do because coordination costs in markets represent a larger share of total costs (sum of coordination and production costs). Specifically, IT reduces the search and information costs in markets by creating transparency into potential buyers and sellers (Malone et al. 1987:489; also see Bakos 1991; Bakos 1997;
Bakos 1998).
The role of IT also impacts the types of products and services exchanged through markets.
Figure 7 depicts governance choice as a function of the complexity of product descriptions and asset specificity. Regarding the complexity of product descriptions, Malone et al.
(1987:489) argue that increasing information processing and communication capability, reduces the costs for handling complex product descriptions, thus shifting the horizontal line up:
“Databases and high-bandwidth electronic communication can handle and communicate complex, multidimensional product descriptions much more readily than can traditional modes of communication.”
As a result, products and services with complex descriptions, previously exchanged via hierarchies, may now be exchanged via markets. Regarding asset specificity, Malone et al.
(1987:489f.) argue that IT can support the introduction of new “flexible manufacturing technology,” which incurs fewer costs when switching production lines to alternative prod- ucts, thus making some transaction specific assets, less specific, which moves the vertical
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Figure 7.:Product Attributes Affect Forms of Organization (adopted from Malone et al. 1987:487)
line to the right. In sum, reducing coordination costs moves transactions previously orga- nized in hierarchies to markets, especially those that involve products and services with complex descriptions.