Transaction Cost

Transactions costs have been defined by Coase (1937) as the costs to using the market that can be eliminated by using the firm. They include the time and expense of negotiating, writing, and enforcing contracts as well as the costs arise when one or more firms exploit incomplete contracts to act opportunistically. Transactions Cost Economics (TCE) means the actions of the firms in the economy are controlled by the transactions costs faced by the firms in the market. If a firm thinks the cost of using markets is lower than its internal co-ordination, it will make a Buy decision; otherwise a Make instead. To simplify, we should say “using the market” means “buying the goods from the market” and “using the firm” means “making the goods itself”. Or we can just say outsourcing or production.
Before every firm makes this decision, the first step it takes must be checking and evaluating the suppliers in the market. If there are suppliers can produce the goods in cheaper cost and better quality than the firm to do itself, it will further consider if the suppliers are suitable to be an alliance of the firm. A supplier is considered to be suitable only if it has good relationship assets, normal coordination and able to keep confidential information for the firm. When the supplier has passed the above conditions, the firm can decide to use the market, i.e. outsourcing. However, if the suppliers in the market cannot fulfill all the conditions, other forms of “using the market” can be considered. The firm can make a joint venture or other close-knit non-ownership arrangement with the suppliers to ensure the cost of its production can be minimised. Apart from the economics of scale, the contracting issue is also an important point. The firm should choose production if any one of them has problem. The process above is known as defining vertical boundaries, i.e. determining what to make and what to buy.
Vertical chain is the process that begins with the acquisition of raw...