A Transaction-Efficiency Analysis of an Internet Retailing Supply Chain in the Music CD Industry*

Decision Sciences, Winter 2003 by Rabinovich, Elliot, Bailey, Joseph P, Carter, Craig R

Transaction costs may affect the supply side of the market, the demand side of the market, or both. Some supply-side transaction costs include menu costs, customer-demand data collection outlays, marketing expenses, and inventory control costs stemming from uncertainty in the level of material supplies and product distribution operations (Blois, 1972; Levy, Bergen, Dutta, & Venable, 1997; Stigler, 1961). Some demand-side transaction costs include the existence of imperfect and costly information available to buyers (Stiglitz, 1989), search activities needed to identify sellers and discover their prices (Stigler, 1961), and resource expenditures needed to overcome location boundaries to transact with sellers (Hotelling, 1929; Smithies, 1941).

Equilibrium prices are a result of the balance of these different transaction costs. Therefore, price levels necessary to clear markets stem from supply-side (Coase, 1937; Spulber, 1996; Williamson, 1975) as well as demand-side transaction costs involving search (Diamond, 1971; Salop & Stiglitz, 1977, 1982) and location costs (Hotelling, 1929; Smithies, 1941). In individual supply chain dyads supporting traditional retailing operations, these supply- and demand-side components are dependent on four intrinsic exchange characteristics: (1) asset specificity, (2) uncertainty, (3) opportunism, and (4) frequency (Williamson, 1975).

Asset specificity relates to the degree to which inventory can be redeployed to alternative uses and by alternative users without sacrifice of productive value (Williamson, 1989). Thus, commoditized inventory exhibits low specificity since it is easily exchangeable and the transaction costs needed to transfer its ownership are low. Specificity also depends on the geographic location of inventory. It may translate into transaction costs resulting from the expenditure of either demand- or supply-side resources to search for or change the asset's location and complete the transaction (Malone, Yates, & Benjamin, 1987). Inventory may also be considered time-specific if its value is dependent on its reaching retailing patrons within a specified time period (Malone et al., 1987). Failure to perform the transaction within a time window may translate into transaction costs and higher prices.

Uncertainty arises from unpredictable changes in consumer preferences and lack of communication among transacting entities (Koopmans, 1957). In a retailing environment, these conditions bound rationality among transacting parties (Feldman & Kanter, 1965), generate negotiation costs, make cheating opportunities available to the parties (Simon, 1991), or lead to excessive inventory carrying or backorder costs prior to transaction completion.

Opportunism involves a transacting entity's strategic manipulation of information to extract transaction costs from its counterparts and impose higher prices through the consolidation of individual advantages (Goffman, 1969; Williamson, 1975).

Frequency results from the volume of exchanges between transacting parties. It is inversely related to fixed and short-term transaction costs associated with the monitoring, writing, and enforcing of contracts that could minimize, ex post, uncertainty and opportunistic behavior among supply chain transacting parties (Levy, 1985; Williamson, 1975).