Asset Specificity

Conceptual Overview

TCE seeks to explain why some transactions are made in the marketplace while others are vertically integrated and conducted inside a hierarchy. Later versions of TCE seek to explain the existence of hybrid market-hierarchy arrangements such as strategic alliances, franchising, joint ventures, and relational contracting. TCE predicts that asset specificity will be a major determinant of vertical integration. TCE contends that, other things being equal, market governance is the most efficient means of governing transactions between technologically separable stages of production because of the bureaucratic costs of internalizing transactions. The condition of asset specificity creates transaction costs within a market context since it opens up the possibility of opportunistic behavior between independent market agents. Internalizing transactions minimizes transaction costs because internal organization agents do not have the incentives to behave opportunistically. Hence, to minimize their organizing costs managers must consider and trade-off both transaction and bureaucratic costs. In seeking to minimize these costs, TCE reasoning is said to explain the efficient boundaries of the organization, and is sometimes described as the discriminating alignment hypothesis.

Four types of asset specificity are commonly recognized: Site-specificity refers to the collocation of assets so as to minimize transportation and inventory costs, for example, the location of an electric power generation plant next to a coalfield. Physical-asset specificity refers to capital investments in specialized machinery to meet the needs of a particular customer, for example, a vehicle component maker's tools and dies dedicated to the needs of a particular vehicle assembler. Human asset specificity refers to knowledge and skills acquired in a learning-by-doing manner, for example, employees learning about an organization's unique culture and skill in operating in this context. Dedicated asset specificity refers to investments in capacity, such as a plant expansion, to meet the demands of a particular customer.

For many transactions, a firm has a choice among assets of differing specificities. Market versus hierarchy choices arise only when specialized assets are more efficient than general-purpose assets. For example, the oilfield/refinery owner may transport oil from field to refinery by means of generally available tanker trucks that are not specific to that transaction as an alternative to the oil pipeline. If the general purpose asset is more efficient than the more specialized asset, the general purpose asset may be purchased in the marketplace through a simple contract. However, when more transaction specific assets are more efficient then managers confront a more complex calculation.

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