Transaction Cost Theory
• Transaction costs: the costs of negotiating,
monitoring, and governing exchanges
between people
• Transaction cost theory: the goal of an
organization is to minimize the costs of
exchanging resources in the environment
and the costs of managing exchanges
inside the organization
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Sources of Transaction Costs
• Environmental uncertainty and bounded rationality
– Bounded rationality: refers to the limited ability
people have to process information
• Opportunism and small numbers
– When organizations are dependent on a small
number of suppliers, the potential for exploitation is
great
• Risk and specific assets
– Specific assets: investments that create value in one
particular exchange relationship but have no value
in any other exchange relationship
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Transaction Costs and Linkage Mechanisms
• Transaction costs are high when:
– Organizations begin to exchange more specific
goods and services
– Uncertainty increases
– The number of possible exchange partners falls
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Transaction Costs and Linkage Mechanisms
• Bureaucratic costs: internal transaction
costs
– Bringing transactions inside the organization
minimizes but does not eliminate the costs of
managing transactions
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Using Transaction Cost Theory to
Choose an Interorganizational Strategy
• Managers deciding which strategy to pursue must
take the following steps:
– Locate the sources of transaction costs that may
affect an exchange relationship and decide how
high the transaction costs are likely to be
– Estimate the transaction cost savings from using
different linkage mechanisms
– Estimate the bureaucratic costs of operating the
linkage mechanism
– Choose the linkage mechanism that gives the most
transaction cost savings at the lowest bureaucratic
cost 5
Organizational Design
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Organizational Design
• The process by which managers select and
manage aspects of structure and culture so that
an organization can control the activities
necessary to achieve its goals
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Organizational Design
Role
Functions
Departments
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Organizational Design: Elements
• Differentiation
• “the differences in cognitive and emotional
orientations among managers in different
functional departments, and the differences in
formal structure among these departments”
(Lorsch, 1970, p. 5)
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Organizational Design: Elements
• Integration
• “the quality of the state of collaboration that
exists among departments that are required to
achieve unity of effort by the environment”
(Lorsch, 1970, p. 5)
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Balancing Differentiation & Integration
• Horizontal differentiation is supposed to
enable people to specialize and become
more productive
– Specialization often limits communication
between subunits
– People develop subunit orientation
• Subunit orientation: a tendency to view one’s role
in the organization strictly from the perspective of
the time frame, goals, and interpersonal
orientations of one’s subunit
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Balancing Differentiation & Integration (contd.)
• When subunit orientation occurs,
communication fails and coordination
becomes difficult
• Integration: the process of coordinating
various tasks, functions, and divisions so
that they work together and not at cross-
purposes
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Types of Integration Mechanisms
• Hierarchy of authority: dictates “who
reports to whom”
• Direct contact: managers meet face to
face to coordinate activities
– Problematic that a manager in one function
has no authority over a manager in another
• Liaison roles: a specific manager is given
responsibility for coordinating with
managers from other subunits on behalf
of their subunits
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Types of Integration Mechanisms
• Task force: managers meet in temporary
committees to coordinate cross-
functional activities
– Task force members responsible for taking
coordinating solutions back to their
respective functions for further input and
approval
• Teams: a permanent task force used to
deal with ongoing strategic or
administrative issues
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Types of Integration Mechanisms
• Integrating role: a new, full-time role
established to improve communications
between divisions
– Focused on company-wide integration
• Integrating department: a new
department intended to coordinate the
activities of functions or divisions
– Created when many employees enact
integrating roles
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Balancing Differentiation & Integration
• Managers facing the challenge of deciding
how and how much to differentiate and
integrate must:
– Carefully guide the process of differentiation
so that it develops the core competences
that give the organization a competitive
advantage
– Carefully integrate the organization by
choosing appropriate integrating
mechanisms that allow subunits to cooperate
and that build up the organization’s core
competencies
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Design Challenge 2: Balancing
Centralization and Decentralization
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Balancing Centralization & Decentralization
• Centralized organization: the authority to
make important decisions is retained by
top level managers
– Top managers able to coordinate activities to
keep the organization focused on its goals
• Decentralized organization: the authority
to make important decisions is delegated
to managers at all levels in the hierarchy
– Promotes flexibility and responsiveness
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Balancing Centralization & Decentralization
• Ideal balance entails:
– Enabling middle and lower managers who
are at the scene of the action to make
important decisions
– Allowing top managers to focus on long-term
strategy making
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Design Challenge 3: Balancing
Standardization and Mutual Adjustment
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Balancing Standardization and Mutual Adjustment
• Standardization: conformity to specific
models or examples that are considered
proper in a given situation
– Defined by rules and norms
• Mutual adjustment: the process through
which people use their judgment rather than
standardized rules to address problems,
guide decision making, and promote
coordination
• Formalization: the use of rules and
procedures to standardize operations
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Balancing Standardization and
Mutual Adjustment
• Socialization: Understood Norms
– Rules: formal, written statement that specify the
appropriate means for reaching desired goals
– Norms: standards or styles of behavior that are
considered typical for a group of people
• May arise informally
• External rules may become internalized norms
– Socialization: the process by which organizational
members learn the norms of an organization and
internalize these unwritten rules of conduct
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Balancing Centralization & Decentralization
• Challenge facing managers is:
– To find a way of using rules and norms to
standardize behavior, and
– To allow for mutual adjustment to give
managers opportunity to discover new and
better ways to achieve goals
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Recap: Organizational Design Challenges
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Acme & Omega: Case Study Discussion
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Organizational Design Choices:
Resulting Structures
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