24 terms

Transaction Cost Theory

Transaction cost in an exchange
In the stock market, it is impossible that all buyers exchange directly with all sellers.
In an exchange: contract and exchange costs
A commission you pay to brokers when buying or selling a stock is a transaction cost
Pre-exchange and post-exchange transaction costs
Pre-exchange: search, information costs, negotiations

Post-exchange: policing and enforcement costs
US GDP share of transaction cost
Transaction costs since the 1870s have gone up in every sector from both the private and the public sector.
Neo-classical economics (NCE) vs. Transaction cost economics (TCE)
both share the efficiency principle
NCE assumes zero transaction costs
What does Efficiency Mean?
NCE: emphasizes the efficiency of production, and minimizes production cost

TCE: focuses on the efficiency of transaction, minimizes transaction cost
First assumption about behavior
bounded rationality
Second assumption about behavior
Opportunistic behavior
Market vs. Hierarchy (institution) Transaction and governance
Three dimensions of a transaction:
• Frequency
The higher frequency of transaction, the more likely to set up an integrated governance structure (for instance a firm)
• Uncertainty
The higher uncertainty, the less complete contracts, thus less attractive of using the market solution
• Specificity
The higher the specificity of the good, the less attractive of using the market solution
Middleman Entrepreneur Mou
One of China's ten richest men in the 1990s. At one time, the single richest person in China
Uncertainty and opportunity
• We are taking advantage of the collapse of the Soviet Union.
---Middleman Mou
• In transitional societies, institutions (rules) tend to be short-lived, leading to high transaction cost for normal businesses, but they create remarkable opportunities exist for smart businesspeople.
The complementary economic structures between Russia and China
Russia: In great need of daily appliances while airplanes are overstocked.

China: Daily appliances are overstocked in factories but aircrafts are in bad luck.

Sichuan Airlines Needed Four Russian Tupolev-154 passenger jets
The challenges of High Transaction Cost
• lack of trust on both sides, strong political uncertainties in both countries.
• lack of hard currency and financial support from the banks
• the buyer did not have money, and the seller did not want to sell for money
Mou's Solution
• Mou's company served a middleman through barter trade:
• it asked the Russians to send the aircrafts first, leased them to the Airlines, the banks lent money to the company while taking the aircrafts as collaterals, the company used the money to purchase various goods and sent them to the Soviet Aircraft company
Barter Trade for the Soviet Airplanes
• The greatest barter trade in the world
What did Mou use to get four aircrafts?
• 800 cargos of
• canned foods,
• Thermoses,
• Pigs,
• 600,000 pairs of
• Socks, and many
• Other light industry products
The challenge and Mou's solution
• The challenge: the Soviet aircraft company could not deal with more than three hundreds Chinese manufacturers
• The Solution: organizing commercial exhibitions of goods for the company

Mou was arrested in 1999 and ultimately received a life sentence for foreign exchange fraud in May 2002 in which he defraud the Bank of China of US$75 million in foreign exchange credit.
• an open call to an undefined group of people or community (crowd).
• It gathers those who are most fit to perform specific tasks with the most relevant and fresh ideas.
About iStockphoto
• 2000 It was founded by Bruce Livingstone as a free stock imagery website.
• 2001 It transitioned into its current micropayment model. It has been profitable since then.
• 2007 $71.9 million revenue, of which $20.9 million (29%) was paid to contributors.
The world's busiest image market
• An image downloaded every 2.5 seconds.
• It was one of the first social networking websites that pay contributors for the sales of their work.
• Artists are paid instantly every time one of their images is downloaded. Exclusive photographers can make 40 percent royalties on each image sold, and 50 percent on extended license agreements.
• It sold $ 4,000,000 per year at $ 1 each
Stock photography - traditional vs. online
Getty Images, Corbis
Studio staff photographers and independent photographers
Traditional, high-price professional cameras
$ 200
Professional reviews published in newspapers and magazines

Individual freelance amateur and hobbyist photographers
High-resolution digital cameras in the mass market
$ 1-5
Everyone can rate and comment on the online photographs.
How can the cost be reduced?
• IT tools reduce the coordination cost (transaction cost caused by bounded rationality).
• IT tools enables online searching and matching of images. Buyers can download and pay through a few mouse clicks.
• Traditionally, you need to ask the stock photography company or photographers you know whether they have photographs you need, or go to photo exhibits. Photographers need to go to photo exhibits to sell their works.
• In the "from community to commerce" crowdsourcing model, the trust that already exists in the online communities reduces opportunism and keeps participants motivated.
• "I love the community aspects of iStock so much and have learned a great deal from all my friends there since 2003."
--- Lise Gagné.
She may be the most prolific stock photographer on the planet
• "I got fired from my old design agency for spending too much time on iStock, and suddenly found myself with all the time in the world to give to photography."
--- Lise Gagné.
• She is the first member inducted at the iStock Wall of Fame for first hitting 500,000 downloads.
Why they participate at iStockphoto.
The opportunity to make money

It helps me improve my photography, video, and/or illustration skills

It is a creative outlet for me

It is fun

The opportunity to earn a reputation as a good photographer/artist

I can produce photos, videos, and illustrations that I like

It is a better way to make stock photography, video, and illustrations
How to turn community into commerce?
Key success factors of iStockphoto
1. Start free or affordable
2. Foster a loyal and active community
3. Technology availability: emergence of low-cost digital cameras
4. A three-step quality assurance system
a. Photographer's application: answer a pop-quiz to demonstrate they understand the basics of photography.
b. New photo approval process: a human eye check. The process takes about three days. iStockphoto relies on an in-house team plus 20 volunteer "image inspectors" around the world to review the photos.
c. Openly visible sales records, download count, and comments

5. How iStockphoto reduces transaction cost?
a. A small team and lots of volunteers
About 50 members of staff employed at the headquarters
A further 80 experts operate globally to inspect and approve images and other crowdsourced content, checking for intellectual property and creative and technical quality and integrity.
a. The initial marketing for iStockphoto depended mostly on "word of mouth" and viral marketing through other social networking websites.
b. It relies on contributors to drive traffic. Photographers selling via iStockphoto want to make money, so they are incentivized to drive others to this website.