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1 © Carliss Y. Baldwin and Kim B. Clark, 2002
Where Do Transactions Come From?
Carliss Y. BaldwinHarvard Business School
Presented at NBER Organizational Economics Conference, November 22, 2002
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2 © Carliss Y. Baldwin and Kim B. Clark, 2002
Transaction Cost/Incomplete ContractsWilliamson, 1985:A transaction occurs “when a good or service is
transferred across a technologically separable interface. … [R]arely is the choice among alternative organization forms determined by technology.”
Upstream Downstream
“Technologically separable interface”
In this literature, technologies and designs are fixed, asset ownership and decision rights move around.
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3 © Carliss Y. Baldwin and Kim B. Clark, 2002
But suppose designs and product definitions are not fixed a priori,
Then, where do Transactions Come From?
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4 © Carliss Y. Baldwin and Kim B. Clark, 2002
But suppose designs and product definitions are not fixed a priori,
Then, where do Transactions Come From?
From the engineering design of a system of production…
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5 © Carliss Y. Baldwin and Kim B. Clark, 2002
Our thesis:
The modular structure of a system of production reveals the places where:– The division of cognitive labor is high, and– Mundane transaction costs are low.
Transactions should go/can go only at those places.
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6 © Carliss Y. Baldwin and Kim B. Clark, 2002
Outline of the paper
T&T Network defined Mapping technique—TSM Encapsulation of T&T “blocks” Pinching the T&T Network Conclusion: Modular structure and
mundane transaction costs
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7 © Carliss Y. Baldwin and Kim B. Clark, 2002
Disclaimer We believe what we are saying is neither
radical nor new Many predecessors:
– Coase (1937)– Alchian and Demsetz (1972)– Barzel (1989) and North (1990)– Cremer (1980) and Aoki (2001)– Sako (1992) and Fixson and Sako (2001)
We aim for a clarification of language.
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8 © Carliss Y. Baldwin and Kim B. Clark, 2002
The T&T Network Defined
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9 © Carliss Y. Baldwin and Kim B. Clark, 2002
Task & Transfer (T&T) Network
All tasks and transfers needed to complete production of artifacts in the economy
Engineering Design is the work of designing the T&T Network
Transfers are ubiquitous– Because “agents” have bounded cognition
and physical capacity– True for both people and machines
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10 © Carliss Y. Baldwin and Kim B. Clark, 2002
What gets transferred? Material Energy Information
– Data– Designs – “Tags”
» Property rights and decision rights are a special form of tag
Money or credit = Purchasing Power
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11 © Carliss Y. Baldwin and Kim B. Clark, 2002
Transfers are
Dictated by technology Complex Logical Necessary (because of bounded capacity) Designed
But not planned centrally
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12 © Carliss Y. Baldwin and Kim B. Clark, 2002
Not all transfers are transactions A “transaction” requires
– Standardizing transfers– Counting transfers– Payment for the units transferred
These are extra and costly tasks – => “Mundane” Transaction Costs (MTC)
MTC vary depending on complexity of transfers– Contingent, interdependent, iterative transfers are very
complex– Hence such transfers are very costly to make into
transactions
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13 © Carliss Y. Baldwin and Kim B. Clark, 2002
Mapping the T&T Network
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14 © Carliss Y. Baldwin and Kim B. Clark, 2002
Mapping Technique = “Task Structure Matrix” (TSM)
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15 © Carliss Y. Baldwin and Kim B. Clark, 2002
Intel T&T Network—1993A Task Structure Matrix for the Design of a Semiconductor ChipCompiled by Sean Osborne (1993)
Customer target 0 X X X
Sales volumes X 0 X X X
Pricing direction X 0 X X
Schedule 0 X Generative Learning
Development methodology X 0 X X X X
Macro targets/constraints X X 0 X X X X Concurrent Activity Blocks
Financial analysis (profitability) X X X X X 0
Program map X 0 X Iterative Loops
Initial QFD matrix X X X X 0
Technical requirements X X X X 0 X
Customer specification X X X X X 0 X X X X X X X X
High level modeling X X X X 0 X X X
Target specification X X X X X X X X X 0 X X
Test plan X X X X X 0 X
Product validation plan X X X X 0
Base prototype X X X X X X 0
Functional modeling X X X X X 0 X X X X X X X X X X X X X X X X X X
Product module developed X X X X X X X X X 0 X
Product integration development X X X X X X X X X 0
Integration modeling X X X X X X X 0 X X X
Random testing X X 0 X X X
Test parameters developed X X X X X X X 0 X X X
Schematics finalized X X X X X 0 X X X X X X X
Validation simulation X X X X X X X 0 X X
Reliability modeling X X X X X 0 X
Complete product layout X X X X X 0 X X
Continuity verification X X X X X X 0
Design rule check X X X 0
Design package X X X X X 0 X X X X X X X
Generate mocks X X X X 0 X X
Verify mocks in fab X X X 0
Run wafers 0 X X X X
Sort wafers X 0
Test programs X 0
Debug products X X X X X 0 X X X X
Package products X X X 0
Functionality testing X X X 0
Samples to customers X X X Sequential X 0
Feedback from customers Activites X 0
Sample functionality verified X 0
Packaged prodcuts verified X 0
Environmental validation X X X X X X 0
Product validation completed X X X X X 0
Develop technical publications X X X 0 X X
Service course developed X X 0 X
Marketing name determined X X X X X 0 X
Licensing strategy determined X X X 0
Demo created X X X X X X 0
Quality goals met X X X X X 0
Life testing X X X 0 X X
Infrared mortality testing X X X X 0 X
Manufacturing process stabilization X X X 0 X X
Field support plan developed X 0
Thermal testing X X X 0
Process meets standards X 0 X X
Package meets standards X X X X X 0 X
Meets certification envelope X X X X X X X X X X X 0
Volume production X X X 0 X
Distribution network prepared X X X X X X X X 0
Deliver products to customers X X X X X X X X X 0
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16 © Carliss Y. Baldwin and Kim B. Clark, 2002
Intel T&T Network—1993
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17 © Carliss Y. Baldwin and Kim B. Clark, 2002
TSMs show where transfers occur, but not what gets transferred
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18 © Carliss Y. Baldwin and Kim B. Clark, 2002
Where do transactions go?
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19 © Carliss Y. Baldwin and Kim B. Clark, 2002
The Smiths and the CooksSmithy Kitchen
S1 S2 S3 S4 S5 K1 K2 K3 K4 K5
S1 . x x x x
Smithy S2 x . x x x
S3 x x . x x
S4 x x x . x
S5 x x x x .
K1 Pot Hookx . x x x x
Kitchen K2 Transfer x . x x x
K3 x x . x x
K4 x x x . xK5 x x x x .
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20 © Carliss Y. Baldwin and Kim B. Clark, 2002
TSMs reveal T&T “Bottlenecks”Smithy Kitchen
S1 S2 S3 S4 S5 K1 K2 K3 K4 K5
S1 . x x x x
Smithy S2 x . x x x
S3 x x . x x
S4 x x x . x
S5 x x x x .
K1 Pot Hookx . x x x x
Kitchen K2 Transfer x . x x x
K3 x x . x x
K4 x x x . xK5 x x x x .
Transfer Bottleneck
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21 © Carliss Y. Baldwin and Kim B. Clark, 2002
Bottlenecks = Transactional “Gateways”
Smithy KitchenS1 S2 S3 S4 S5 K1 K2 K3 K4 K5
S1 . x x x x
Smithy S2 x . x x x
S3 x x . x x
S4 x x x . x
S5 x x x x .
K1 Pot Hookx . x x x x
Kitchen K2 Transfer x . x x x
K3 x x . x x
K4 x x x . xK5 x x x x .
“Place Transaction HERE” —
Few transfers; One-way transfers; Maximum “Division of cogitive labor”
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22 © Carliss Y. Baldwin and Kim B. Clark, 2002
Bottlenecks = Transactional “Gateways”
Smithy KitchenS1 S2 S3 S4 S5 K1 K2 K3 K4 K5
S1 . x x x x
Smithy S2 x . x x x
S3 x x . x x
S4 x x x . x
S5 x x x x .
K1 Pot Hookx . x x x x
Kitchen K2 Transfer x . x x x
K3 x x . x x
K4 x x x . xK5 x x x x .
“Place Transaction HERE” —BecauseMundaneTransactionCosts areProbablyLow
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23 © Carliss Y. Baldwin and Kim B. Clark, 2002
Encapsulation
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24 © Carliss Y. Baldwin and Kim B. Clark, 2002
Design Problem:
If every transfer had to be a transaction, little work would get done.
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25 © Carliss Y. Baldwin and Kim B. Clark, 2002
Solution:
Transaction-free zones “Encapsulated Local Systems”
– Predecessors: Families, communes, tribes – Merchants and Proto-firms – Then: Full-functioned firms (1750s) and
Limited-liability Corporations (1830s) with Affirmative and Defensive Asset Partitioning
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26 © Carliss Y. Baldwin and Kim B. Clark, 2002
Creating an Encapsulated Local System 1
A B C D E F G H I J K L M N
A . x x x x x x x x x
B x . x x x x x x x x
C x x . x x x x x x x
D x x x . x x x x x x x
E x x x x . x x x x
F x x x x x . x x x x x x x
G x x x x x x . x x x x x x x
H x x x x x . x x x x x x
I x x x x x x . x x x x x
J x x x x x x x . x x x x
K x x x x x x x x . x x x
L x x x x x x x . x x
M x x x x x x x x x . xN x x x x x x x x .
Materials
Energy
People
Machines
Internal Flows are Designed by Engineers
Data
Agents andResourcesCome In;Products Come Out
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27 © Carliss Y. Baldwin and Kim B. Clark, 2002
Creating an Encapsulated Local System 2
A B C D E F G H I J K L M N
A . x x x x x x x x x
B x . x x x x x x x x
C x x . x x x x x x x
D x x x . x x x x x x x
E x x x x . x x x x
F x x x x x . x x x x x x x
G x x x x x x . x x x x x x x
H x x x x x . x x x x x x
I x x x x x x . x x x x x
J x x x x x x x . x x x x
K x x x x x x x x . x x x
L x x x x x x x . x x
M x x x x x x x x x . xN x x x x x x x x .
Materials
Energy
People
Machines
Data
TodayAll are ObtainedVia Transactions
$
$
$
$
$ $$$$
Internal Flows are Designed by Engineers
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28 © Carliss Y. Baldwin and Kim B. Clark, 2002
Creating an Encapsulated Local System 3
Materials
Energy
People
Machines
Data
Transaction-Free Zone:By design,many complex, contingent transfersoccur insidethe TFZ
A B C D E F G H I J K L M N
A . x x x x x x x x x
B x . x x x x x x x x
C x x . x x x x x x x
D x x x . x x x x x x x
E x x x x . x x x x
F x x x x x . x x x x x x x
G x x x x x x . x x x x x x x
H x x x x x . x x x x x x
I x x x x x x . x x x x x
J x x x x x x x . x x x x
K x x x x x x x x . x x x
L x x x x x x x . x x
M x x x x x x x x x . xN x x x x x x x x .
Internal Flows are Designed by Engineers
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29 © Carliss Y. Baldwin and Kim B. Clark, 2002
Boundaries of the Capsule
Materials
Energy
People
Machines
Data
Boundaries = Where Transfers take the form of Transactions, according to the Design of the Enterprise
A B C D E F G H I J K L M N
A . x x x x x x x x x
B x . x x x x x x x x
C x x . x x x x x x x
D x x x . x x x x x x x
E x x x x . x x x x
F x x x x x . x x x x x x x
G x x x x x x . x x x x x x x
H x x x x x . x x x x x x
I x x x x x x . x x x x x
J x x x x x x x . x x x x
K x x x x x x x x . x x x
L x x x x x x x . x x
M x x x x x x x x x . xN x x x x x x x x .
Boundaries are Designed by Engineers, too!
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30 © Carliss Y. Baldwin and Kim B. Clark, 2002
Financial Sufficiency
Materials
Energy
People
Machines
Data
When allClaimantsHave beenPaid…
$
$
$
$
$Revenue$$$$
$$$$$$$$$$$
Money is left over!
Costs:
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31 © Carliss Y. Baldwin and Kim B. Clark, 2002
Financial Sufficiency =Survival in a Money/Market Economy
Materials
Energy
People
Machines
Data
When allClaimantsHave beenPaid…
$
$
$
$
$Revenue$$$$
$$$$$$$$$$$
Money is left over!
Local System can survive.
Costs:
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32 © Carliss Y. Baldwin and Kim B. Clark, 2002
Encapsulated Local System =the “Kernel” of a Firm
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33 © Carliss Y. Baldwin and Kim B. Clark, 2002
Encapsulated Local System = the “Kernel” of a Firm
Why only “kernel”?
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34 © Carliss Y. Baldwin and Kim B. Clark, 2002
Because… Can assemble several Encapsulated Local Systems
within “a bigger firm” Can have transactions within “a bigger firm” Transaction costs/incomplete contracts/ property
rights economics basically looks at different configurations of kernels within/across firms
In practice, Mergers, Acquisitions & Alliances serve to adjust kernel boundaries across firms
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35 © Carliss Y. Baldwin and Kim B. Clark, 2002
In summary—
Encapsulation is a technology in the engineering design of the T&T Network
Encapsulation creates the kernels of firms Kernel boundaries are artifacts, which can be
designed and re-designed (within constraints of physics and logic of technology)
Mergers, Acquisitions & Alliances are visible adjustments of kernel boundaries
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36 © Carliss Y. Baldwin and Kim B. Clark, 2002
“Pinching” the T&T Network
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37 © Carliss Y. Baldwin and Kim B. Clark, 2002
An Example from Practice:
Engineering plastics company (=designer and supplier)
Auto manufacturing company (=customer and user)
Product to be designed:– High heat resistant plastic compound
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38 © Carliss Y. Baldwin and Kim B. Clark, 2002
“Natural” TSMEngineering Plastics Company Auto Company
. x x x x x x xx . x x x x x x x x xx x . x x x x x x x xx x x . x x x x x x x
Engineering x x x . x x x x xPlastics x x x . x x x x xProduct x x x . x x x x xand x x x x . x x x xProcess x x x . x x x xDesign x x x x . x x x x
x x x x x x x . xx x x x . xx x x x x x . x x x xx x x x x x x
x . x x x x xx x . x x x x x x x
Automotive x x x x x . x x x x x x xCompany x x x x . x x x x x xProduct x x x . x x x x xand x x x x x x . x x x x xProcess x x x x x x . x x x xDesign x x x x x x x x . x x x
x x x x x x x x x . x xx x x x . x
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39 © Carliss Y. Baldwin and Kim B. Clark, 2002
Transaction-supporting TSMNegotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies
. x x x x x x xNegotiation: x . x x x x x x(8 Specs x x . x x x x x& Tests) x x x . x x x x
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Eight x x x . x x x x x xFormal Tests x x x x . x x x x x x
Engineering Ex ante x x x x . x x x xPlastics x x x x . x x x xProduct x x x x . x x x xand x x x x x . x x x xProcess x x x . x xDesign x x x x . x x x
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x x x x x x x
x x x x x
Eight x x x . x x x x x x xAutomotive Formal Tests x x x x . x x x x x x xCompany Ex ante x Eight x x x . x x x x x xProduct x Formal Tests x x x x . x x x x xand x Ex post x x x x . x x x x xProcess x x x x x x x . x x x xDesign x x x x x x x x . x x x
x x x x x x x x . x xx x x x . x
Is “more Modular”
(by defn of Design Rules, Vol. 1)
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40 © Carliss Y. Baldwin and Kim B. Clark, 2002
Transaction-supporting TSMNegotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies
. x x x x x x xNegotiation: x . x x x x x x(8 Specs x x . x x x x x& Tests) x x x . x x x x
x x x x . x x xx x x x x . x xx x x x x x . xx x x x x x x .
x . x x x x x x xx x . x x x x x x x
Eight x x x . x x x x x xFormal Tests x x x x . x x x x x x
Engineering Ex ante x x x x . x x x xPlastics x x x x . x x x xProduct x x x x . x x x xand x x x x x . x x x xProcess x x x . x xDesign x x x x . x x x
x x x x x x x . x Rich x x x x . x Lustrousx x x x x x . Appearance
x x x x x x x
x x x x x
Eight x x x . x x x x x x xAutomotive Formal Tests x x x x . x x x x x x xCompany Ex ante x Eight x x x . x x x x x xProduct x Formal Tests x x x x . x x x x xand x Ex post x x x x . x x x x xProcess x x x x x x x . x x x xDesign x x x x x x x x . x x x
x x x x x x x x . x xx x x x . x
“Mundane” transaction costs
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41 © Carliss Y. Baldwin and Kim B. Clark, 2002
Transaction-supporting TSMNegotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies
. x x x x x x xNegotiation: x . x x x x x x(8 Specs x x . x x x x x& Tests) x x x . x x x x
x x x x . x x xx x x x x . x xx x x x x x . xx x x x x x x .
x . x x x x x x xx x . x x x x x x x
Eight x x x . x x x x x xFormal Tests x x x x . x x x x x x
Engineering Ex ante x x x x . x x x xPlastics x x x x . x x x xProduct x x x x . x x x xand x x x x x . x x x xProcess x x x . x xDesign x x x x . x x x
x x x x x x x . x Rich x x x x . x Lustrousx x x x x x . Appearance
x x x x x x x
x x x x x
Eight x x x . x x x x x x xAutomotive Formal Tests x x x x . x x x x x x xCompany Ex ante x Eight x x x . x x x x x xProduct x Formal Tests x x x x . x x x x xand x Ex post x x x x . x x x x xProcess x x x x x x x . x x x xDesign x x x x x x x x . x x x
x x x x x x x x . x xx x x x . x
Standards: To Define “Gateway”
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42 © Carliss Y. Baldwin and Kim B. Clark, 2002
But Standards were incomplete…
[A]s development proceeded, it became clear ... that there were other characteristics of the material that were very important to important players in the auto company, which were not in the specs. (Example: the interior designers wanted a material with a “rich, lustrous appearance.”) They were not in the specs, because the auto company had no way to make the requirement specific, no testing protocol and no standard to use in the specifications.
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43 © Carliss Y. Baldwin and Kim B. Clark, 2002
Transaction-supporting TSMNegotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies
. x x x x x x xNegotiation: x . x x x x x x(8 Specs x x . x x x x x& Tests) x x x . x x x x
x x x x . x x xx x x x x . x xx x x x x x . xx x x x x x x .
x . x x x x x x xx x . x x x x x x x
Eight x x x . x x x x x xFormal Tests x x x x . x x x x x x
Engineering Ex ante x x x x . x x x xPlastics x x x x . x x x xProduct x x x x . x x x xand x x x x x . x x x xProcess x x x . x xDesign x x x x . x x x
x x x x x x x . x Rich x x x x . x Lustrousx x x x x x . Appearance
x x x x x x x
x x x x x
Eight x x x . x x x x x x xAutomotive Formal Tests x x x x . x x x x x x xCompany Ex ante x Eight x x x . x x x x x xProduct x Formal Tests x x x x . x x x x xand x Ex post x x x x . x x x x xProcess x x x x x x x . x x x xDesign x x x x x x x x . x x x
x x x x x x x x . x xx x x x . x
“Relational” or “Obligational” contract needed
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44 © Carliss Y. Baldwin and Kim B. Clark, 2002
Mundane transactions costs are used to create a “more modular” task structure
Negotiation betweenAuto and Engineering Engineering Plastics Company Auto CompanyPlastics Companies
. x x x x x x xNegotiation: x . x x x x x x(8 Specs x x . x x x x x& Tests) x x x . x x x x
x x x x . x x xx x x x x . x xx x x x x x . xx x x x x x x .
x . x x x x x x xx x . x x x x x x x
Eight x x x . x x x x x xFormal Tests x x x x . x x x x x x
Engineering Ex ante x x x x . x x x xPlastics x x x x . x x x xProduct x x x x . x x x xand x x x x x . x x x xProcess x x x . x xDesign x x x x . x x x
x x x x x x x . x Rich x x x x . x Lustrousx x x x x x . Appearance
x x x x x x x
x x x x x
Eight x x x . x x x x x x xAutomotive Formal Tests x x x x . x x x x x x xCompany Ex ante x Eight x x x . x x x x x xProduct x Formal Tests x x x x . x x x x xand x Ex post x x x x . x x x x xProcess x x x x x x x . x x x xDesign x x x x x x x x . x x x
x x x x x x x x . x xx x x x . x
“Relational” or “obligational” contract needed
“Mundane” transaction costs
Standards: To Define “Gateway”
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45 © Carliss Y. Baldwin and Kim B. Clark, 2002
“Pinching” is an Investment
In a Task Structure and Relationships that support a strict(er) partition of cognitive labor
Value of “Pinching” =
+ Avoided cost of real-time interdependency/iteration (clt)
– MTC (mundane transaction costs)
+ Free-riding (smaller unit, better individual incentives)
– Upstream-Downstream opportunism (in supply chain)
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46 © Carliss Y. Baldwin and Kim B. Clark, 2002
Conclusion
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47 © Carliss Y. Baldwin and Kim B. Clark, 2002
Where do Transactions Come From?
The modular structure of a system of production reveals where:
The division of cognitive labor is high…
and
Mundane transaction costs are low.
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48 © Carliss Y. Baldwin and Kim B. Clark, 2002
The modular structure of a T&T Network Can be mapped using TSM graphs Transactions go at the “bottlenecks” of network
– Transfers few and simple– Division of cognitive labor high
Blocks need to be “transaction-free zones”– Encapsulated via transactions at the boundaries of the
zone– Encapsulated Local Systems = Kernels of Firm
“Pinching” can create a more modular structure– Costs = Mundane Transaction Costs– Standardizing, Counting, Valuing, Payment
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49 © Carliss Y. Baldwin and Kim B. Clark, 2002
Thank you!