# 7 Networks

Question 1

What is transaction cost economics.

Answer 1

• A part of economics viewing the firm as a governance structure, rather than as a production function.
• It examines how transaction costs shape economic activity. A basic question is: Why are some transactions performed within firms rather than in the market.
  Firms exist because of the cost to using the market –> No transaction cost = no firms

Question 2

What are transaction costs?

Answer 2

The costs of information and communication needed to find, negotiate, agree upon and monitor contracts.

Question 3

Structural holes

Answer 3

Lack of connections in network. Benefiting from structural holes relies on the idea, that some network positions are better than others.
“By occupying the structural location between otherwise unconnected nodes (a structural hole), the firm realizes greater returns”

Question 4

Strategic networks

Answer 4

“Strategic” because it potentially allows firms to gain competitive advantage.
These network relations have characteristics of “investments” due to “asset specificity”, yet the contracting parties remain independent organizations. Not strictly based on either market or hierarchy, but on adaptions.

Formally, the theoretical frameworks adds to the idea of market vs hierarchy, by applying an additional dimension: approach to relationship. Strategic networks are market-based, but unlike in a traditional market model, strategic networks are based on a cooperative, rather than competitive, approach to relationships.

Question 5

What are the benefits of strategic networks for individual firms and for the entire network

Answer 5

If External price + transaction cost > Internal cost –> integrate (hierarchy)
If External price + transaction cost < Internal cost –> buy

The benefit of strategic networks lies in lowering the transaction costs through changing structural characteristics. When lowered enough, this means that firms will buy, rather produce, allowing for specialization on the essential activities in the value chain. The overall network is also more efficient, which is shown by the ‘market test’ (how is production most efficient).

Question 6

Linkages

Answer 6

A broad definition of linkages includes transactions between foreign subsidiaries and local businesses as well as non- business entities.
3 types of linkages: 1) supply chain, 2) collaborative, 3) institutional

The primary purpose of linkage formation from the MNE’s point of view (beyond that of simple transactional exchange) is to overcome the deficiencies of pure-market relationships

Question 7

Spillover

Answer 7

Spillovers are externalities arising from the presence of MNEs (FDI)

• Indirect spillover effects: labor effects, competition
• Direct: occur through linkages with local firms

Question 8

What are the different linkage attributes?

Answer 8

“Scope” =  Extent of linkage in terms of types (SC, collaborative, institutional) and breadth (of industries and sectors)
“Quantity” = number of linkages or value in pecuniary terms (number and value)
“Quality” = interactions for non-pecuniary benefits (extent of transfer, duration of relationship and depth of linkage)

Question 9

What are the types of embeddedness?

Answer 9

4 types of embeddedness: Cognitive embeddedness, political embeddedness, structural embeddedness, cultural embeddedness. The focus is on social relations and trust.

Question 10

Explain the relationship between embeddedness and economic succes?

Answer 10

• Degree of embeddedness follows an inverted U-shape.
• Positive: Trust –> reciprocity –> lower transaction costs (no information exchange, amoral individualism)
• Negative: Reciprocity –> obligation (lock-in: norms constrain behavior; no ties to the outside of the group)

Question 11

What is the difference in cost between production in markets and in hierarchies?

Answer 11

Market:
- Lower production costs
- Higher coordination costs
- Pricing schedule by market forces
Hierarchy:
- Higher production costs
- Lower coordination costs
- Pricing schedule by managerial decisions

Question 12

What are the key characteristics of transaction costs?

Answer 12

• Bounded rationality
• Asset specificity
• Opportunism

Question 13

What is bounded rationality?

Answer 13

Bounded rationality is the idea that decision makers have constraints on their cognitive capabilities and limits on their rationality.

Question 14

What is asset specificity?

Answer 14

Asset specificity refers the transferability of the assets that support a given transaction.
Assets with high specificity are sunk cost.

Question 15

What is opportunism?

Answer 15

Behavior based on “self-interest”, which may include extreme behavior such as lying and cheating, and more subtle forms of deceit, as violating agreements.

Question 16

What are the types of asset specificity?

Answer 16

• Site
• Physical asset
• Human asset
• Time

Question 17

Impact of IT on transaction costs?

Answer 17

IT decrease costs of coordination, i.e. Transacion costs.

All else equals, this leads to less hierarchy and greater importance of markets.

Question 18

What is the “weak tie arguments”?

Answer 18

According to weak ties argument, the stronger the tie between two people is, the more likely their contacts will overlap so that they will have common ties with the same third parties.[6]This implies that bridging ties are a potential source of novel ideas.