Transactions Costs Exaplanation for the Creation of Organizations
A newer, economic-based interpretation expanded by Oliver E. Williamson
concerns transaction costs (Williamson 1975, 1985). Transactions are "the
exchange of goods or services between persons or across boundaries"
(Scott p. 156). Instead of production the exchange of resources is deemed
the critical factor in the creation and development of organizational structures.
William contrasts two main governance structures -- the market and the organization.
In the market, exchanges are negotiated contracts where all parties are
assumed to operate in self-interest. In its pure form little knowledge about
the other exchangers is needed, and pricing is purely based on individual
interests and the "invisible hand" of a free economy (large number
of buyers and sellers, instantaneous exchanges, etc.). Little coordination
costs are needed in this pure market.
While these assumptions work well for quick, spot contracts, they are less
relevant for contracts that require estimates of future value (contingent
claims contract). In these situations, organizations may be viewed as a
more attractive alternative to pure market-mediated transaction. The uncertainty
of exchange is reduced if it can be brought into an organized group of people
with a framework of rationality and organizational mechanisms to dissuade
The organization supports the division of problems, simplifies choices,
channels information, and restricts alternatives (Scot p. 157). Organizations
help individuals deal with cognitive limits to assess and reduce uncertainty
and make decisions.
Williamson introduced the market failures framework to explain why in some
situations bringing exchanges into organizations is better than leaving
them in the marketplace. In situations where exchangers have good opportunities
to cheat , and there are few exchangers to choose from, it's better to bring
the exchanges "inside" organizations where there can be better
surveillance and monitoring and more defined incentive systems that reduce
The organization also supplants the need for long-term open contracts among
exchange partners (which are replaced by the employment contract). People
sell their promise to obey commands (Commons, 1924) which allows the flexibility
to alter exchange contracts with internal workers more easily than with
"The transactions costs framework provides a general explanation for
the origins of organizations as mechanisms for supporting decisions under
conditions of uncertainty and supressing opportunism under conditions of
restricted exchange" (Scott p. 158). This approach focuses primarily
on efficiency (like most economic approaches).
Granovetter notes that Williamson's model fails to note that individual
actions are embedded in a matrix of personal relationships that strongly
affect this exchange behavior (Granovetter, 1985).