Professor Richard N. Langlois wrote a fairly current paper on "The secret life of mundane transaction costs". Clicking on the title of this entry will enable you to download the .pdf from the Social Science Research Network.
Professor Langlois refers to Oliver Williamson for a summary of what transaction costs are, "...costs of running the economic system". (2006 pp. 1) A large part of that system is the costs associated with establishing and supporting standards. Here in Alberta we have a number of groups that have created standard ways and means of conducting business in the oil and gas industry. These standards help to form and support the culture of the industry, and that is particularly, the joint operating committee, the organizational focus of these writings.
"The modularity theory of the firm."
Dr. Langlois uses the established industry standards and the methods of enforcing compliance into the economic system to "establish and maintain a system of property rights." Langlois organizes the costs into 3 categories, I will mention those categories and then provide examples of the types of costs that are incurred in each category.
1) "Contains the fixed costs of establishing and maintaining a system of property rights."
Including the basic laws of the land, and the Alberta Governments royalty and mineral rights development laws and regulations, Petroleum Accountants Society of Canada, Canadian Association of Petroleum Landman, Public Petroleum Data Model and other standards bodies. The point in this categorization is to determine what the real fixed costs of establishing and maintaining the standards of operations of oil and gas are in Alberta and Canada. Needless to say many of these organizations are representative of larger global groups that have influence through out the global oil and gas industry.
2) "Contains costs that are paid periodically. These depend on time, but not on number or volume of transactions."
Langlois interestingly takes this categorization and classifies items like salaries of police, costs that are a function of time, in application to oil and gas, this would include the SEC, FASB, Auditors, Engineering appraisals and other compliance costs to regulations as the variable or time dependent costs of establishing and maintaining property rights in the oil and gas industry.
3) "Contains all the costs that come with the number of transactions or volumes of transfers."
The last grouping of costs Langlois sets out is the definitive variable costs of production. Based on the level of activity is the criterion that establishes the volume of costs and what Lanlois describes as "Neo-Classical T-Costs." These would include the royalties actually paid, the investment dollars spent, the costs associated with the revenue from the production of oil and gas.
Langlois has categorized these further, and are combined into the following;
- Category 1 and 2 = Costs of establishing and maintaining property rights.
- Category 3 = the Neo-Classical T-Costs mentioned.
- Category 2 and 3 = Mundane transaction costs.
It is at this point Langlois sets out to establish that these costs categories "have a secret life" and indeed "have a secret life cycle". In summary he is establishing much of the information analysis, or the tool that I previously wrote about from
Baldwin and Clark. Through this the architecture of the industry is combined with the standards to form not only the encapsulated (companies) and modules (individuals) but also a means of operation via the price system.
Dr. Langlois quotes Hayek in this regard; it is a salient point;
"The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. ...The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information passed on and passed on only to those concerned. It is more that a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more that is reflected in the price movement." (Hayek 1945, pp. 526 - 527)
The architecture of the industry is what I have asserted is broken. Represented by the hierarchy, the oil and gas industry has been able to establish the appropriate standards and therefore maintain the property rights that are so critical to the development of the oil and gas industry. What is now redundant is the level of capability that is built up within each of the producers. Hierarchies have focused on their own needs and capabilities within the firm itself. Building extensive capacities to accommodate all of the needs that are associated with the category 1) 2) and 3) cost. What is needed is to conduct the analysis on the standards such that the efficient point of each transaction becomes the point of transfer. The tools to use are contained within these two documents of Langlois, Baldwin and Clark. This in a nutshell is the purpose and desired outcome of the development of the Genesys application. A reorganization, and a re-architecture of the oil and gas industry on a global basis.
Ensuring the necessary level of hidden information in each transaction is critical according to Langlois.
"Indeed, as the field of object-oriented programming has taught us, these hidden design parameters generally must not be communicated to others. This is the principle of encapsulation and information hiding. To allow another module knowledge of an access to one's inner workings is to invite those other modules to tinker - and thus to invite butterfly effects."
"The secret life"
Professor Langlois notes the friction that is created in transactions. The costs of standardization, counting and compensation when the tasks are assigned to a third party, or as Coase stated "the costs of using the price mechanism." These "friction" costs are incurred in the transaction as opposed to asking that the work be completed within the firm itself which Langlois suggests it simply doesn't pay to simplify and standardize the transactions, that the coordination costs can be limited by the market size, or if the transactions are more dynamic in nature and are subject to frequent change.
"The secret life cycle."
"With a larger extent of the market, and in the absence of any other kind of transaction costs, it starts to pay not only to subdivide tasks further but also to turn more transfers into transactions." pp. 26
And provides a necessary caution;
"But this is not the same thing as saying that we should observe vertical disintegration in a growing industry. Growth takes place in disequilibrium. And disequilibrium can lead to dynamic transaction costs, especially when the increase in the extent of the market calls for a systemic reorganization of the task-and-transfer system." pp. 27
As time passes, the volume of transactions increase, and the volume of dynamic transaction cost decrease. This makes inherent sense in that the ability to build an industry would require more transfers to mitigate the costs of un-standardized transaction costs. However, after time the reverse becomes the norm in that "thick markets will increasingly come to supplant management as a mechanism for buffering uncertainty". pp. 30 This phenomenon is what Langlois has called "The Vanishing Hand".
Technorati Tags: Development, Langlois, Research, Strategy
