HIDDEN TRANSACTION COSTS

In an uncomplicated and trustworthy world, cost for any item would be expressed
with one clear, comprehensive attribute — the price tag. You would simply ask
yourself what is the best price for the item you require. Often, this is the first question
considered, and if the cost is too high from external sources, the decision runs to
making the product internally (i.e., the common decision to make rather than buy
food in the third world).

But our world, especially the industrialized “first world,” is anything but simple,
and transactions of any kind can have a number of hidden costs, some of which can
be devastating if not fully considered.

These contributors to transaction costs are
referred to as “hidden” because they are not as easily quantified as the price tag,
even though they may be more fundamental to the ultimate value of the purchase.
A sample of hidden transaction costs includes:
•
Availability:
Before one can buy a product, one must locate a satisfactory
supplier and then set about the process of negotiating and contracting with
that supplier. Does the product exist in the form desired? Will the provider
sell to your enterprise? Each of these steps requires information, communication,
and trust to determine if the transaction is worthy and the supplier
reliable.
•
Quality:
Fitness for intended purpose has many facets, such as specification,
inspection, terms, and rates of rejection, and the cost of customer
returns both in actual terms and in lost future opportunities.
•
Transport:
It is one thing to buy a product, it is quite another to pay to
have it moved. Some products are easily transported (software over communications
systems), while others are bulky or perishable, requiring
proximity in their production (for example crushed rock, medical isotopes,
fresh produce). Goods in transport represent an inventory cost that impacts
the total transaction cost.
•
Punctuality:
A product may be of perfect quality and inexpensive price,
but delay in its delivery could close down production at a multimilliondollar
facility. Such costs must be considered as risk in the make-or-buy
decision.
•
Inventory:
One must decide how making or buying a product will affect
inventory. Inventory requirements are a part of the capital needed to
produce and deliver products, as well as tax consequences.

Switching:
Switching costs (the costs associated with “switching” to
another supplier) can mitigate or amplify the impact of other transaction
costs. If switching costs are low (other quality sources, easily accessed,
instantaneously available, etc.) then the consequences of other hidden
transaction costs can be reduced because a secondary supplier can be
readily obtained if the primary source fails to deliver. If the switching
costs are high (sole source, proprietary formulation, unknown quality,
distance), then the consequences of other hidden transaction costs are
amplified.
•
Risk:
What are the organizational risks involved with outsourcing a particular
endeavor? Risk could be financial (production outages due to
supply interruption), strategic (lost trade secrets), or relational (conflict
of interests with other partners). If the risk is too high, the financial gain
from outsourcing might be overshadowed by the potential risks associated
with a certain path.
•
Others:
A number of other factors — trade laws, regulations, tariffs, etc.
— may determine complete transaction costs for any endeavor. Your own
situational analysis will uncover these.

Figuring out many of the hidden transaction costs boils down to quality and
availability of information and the trust you can place in the reliability of that
information. Long-standing relationships are often worth a premium price due to
the trust garnered through the years. As global competition has increased, competition
in the marketplace has forced lower-priced alternatives to be considered. Likewise,
the combination of the Internet and electronic commerce has allowed new
sources for supplies to be located, considered, quoted, validated, surveyed, and used.
The falling cost of telecommunications has made it economical to connect distant
manufacturing systems in order to monitor production rates, shipments, key quality
measurements, and payments.

Today, it is as easy and potentially more cost
effective to perform these tasks across the world as it is to do them across town. All
these technological changes have reduced the transaction costs for outsourcing
production. Monolithic manufacturing facilities are rapidly yielding to manufacturing
networks that are centrally monitored, but geographically decentralized. The
ideal of “perfect information” plays a key role in reducing hidden transaction costs.