Transaction cost theory
Transaction costs occur when dealing with another party.
If items are made within the company itself, therefore, there are no transaction costs
Analysing these costs can be difficult because of:
Bounded rationality - our limited capacity to understand business situations
Opportunism - actions taken in an individual’s best interests
Company will try to keep as many transaction as possible in-house in order to:
reduce uncertainties about dealing with suppliers
avoid high purchase prices
Are the transaction costs (of dealing with others and not doing the thing yourself) worth it?
The 3 factors to take into account as to whether the transaction costs are worthwhile are:
Do we trust the other party enough?
The more certain we are, the lower the transaction / agency cost
how often will this be needed
The less often, the lower the transaction/agency cost
How unique is the item
The more unique the item, the more worthwhile the transaction / agency cost is
Applied to Agency theory
This can be applied to directors who may take decisions in their own interests also:
Uncertainty - Will they get away with it?
Frequency - how often will they try it?
Asset specificity - How much is to gain?