Question

Major car manufacturers tend to have long-term strategic relationships with core sub-assembly suppliers (e.g. drive train - engine, interior furniture, electrical system, etc.). Using Williamson’s Transaction Cost Economics theory, identify two reasons why each party (the manufacturer and the supplier) would wish to have a privileged relationship rather than rely on the marketplace (pure price-based tendering) for their buying and selling.

Answer 1

According to Williamson's Transaction Cost Economics theory, transaction costs can be divided into three broad categories:

• Search and information costs are costs such as in determining that the required good is available on the market, which has the lowest price, etc.
• Bargaining costs are the costs required to come to an acceptable agreement with the other party to the transaction, drawing up an appropriate contract and so on.
• Policing and enforcement costs are the costs of making sure the other party sticks to the terms of the contract, and taking appropriate action (often through the legal system) if this turns out not to be the case.

Two reasons why each party (the manufacturer and the supplier) would wish to have a privileged relationship rather than rely on the marketplace (pure price-based tendering) for their buying and selling are:

1. Each party would incur significant search and information cost if they go through a pure price-based tendering method for their buying and selling. Any economies achieved through the process would be negated by the additional cost involved in finding the right supplier at the right price.

2. In cases where manufacturer & supplier have a long standing relationship, bargaining costs are minimized as the parties have dealt with each other in the past. Enforcement and policing costs are also less due to goodwill and trust between parties.