32 of 35 people found the following review helpful:
4.0 out of 5 stars
Markets and Hierarchies by Oliver Williamson, March 29, 2000
This review is from: Markets and Hierarchies : Analysis and Antitrust Implications (Paperback)
Markets and Hierarchies is considered a most influential contribution to the institutional economics approach in the strategy literature. Introducing a transaction-cost dimension, it bridges economics and organization theory. Hence, both economists and researchers from the fields of social sciences can find this book appealing. Williamson begins by claiming that conventional economic analysis makes unnecessary assumptions and is too abstract to capture the characteristics of economic exchange and its effect on the transaction consummation mechanism, namely the preference of intrafirm versus interfirm trade. Then he introduces concepts of bounded rationality and opportunism to expand the discussion of organizational forms. He suggests the transaction as the appropriate unit of analysis to evaluate hierarchies and markets. The main argument in the book is presented in the Organizational Failures Framework (OFF), which is designed to specify which mode will be relatively efficient in formulating and executing contracts based on a combination of environmental and human factors. The OFF offers two combinations, a derived condition and a general system effect to explain organizational failures: (1) Bounded Rationality and Uncertainty/Complexity - Faced with conditions of uncertainty and complexity, where the decision tree is not clear, bounded rationality poses information processing and communication problems. A hierarchy would be preferred to a market in this case because internal organization can economize on bounded rationality. (2) Opportunism and Small Numbers - Williamson extends the self-interest assumption in microeconomics to suggest opportunistic behavior. Under such conditions, participants in transactions are expected to reveal partial or distorted information and provide self-disbelieved promises. A small numbers situation at the outset or renewal of a contract induces the risks of opportunistic behavior, which cannot be detected ex ante. Here again, hierarchies would be preferred to markets because in internal organization it is harder to appropriate gains from opportunistic behavior, and because monitoring and conflict resolution mechanisms are more effective. (3) Information Impactedness (asymmetric information) - Under conditions of opportunism and uncertainty, one party can find it costly to achieve information equality. Hierarchies will be preferred to markets because they reduce opportunistic tendencie encourage information sharing and effective communication. (4) Atmosphere - OFF assigns value not only to the outcomes of the transaction but also to the economic exchange process. Internal organization provides more encouraging atmosphere in terms of the development of reciprocal social relationships. Williamson offers several applications to illustrate his arguments and discuss antitrust implications. The replacement of markets by nonmarket alternatives first considers cooperative peer groups. Relative to hierarchies, peer groups are vulnerable to free rider problems and have inefficient communication and decision-making mechanisms. In hierarchies, centralized decision making, auditing procedures and experience rating enable more efficient organization relative to both markets or peer groups. Another application of the transactional perspectives considers the rationale for preferring internal employment relation to markets for idiosyncratic tasks. Transactional difficulties arise in both contingent claims and sequential spot market contracting, thus suggesting an authority relation of internal labor market as a possible solution. The most interesting application of the markets and hierarchies approach refers to vertical integration. The author tries to specify when production components will take place within the firm and when across intermediate product markets. Vertical integration, which leads to the creation of complex hierarchy is justified because: (1) successive processes are more efficient under common ownership; (2) it reduces required monitoring costs; (3) assures efficient factor combinations when one component is under monopolistic supply; (4) reduces bargaining costs to determine ownership of spillovers; and (5) economizes on the acquisition of information relevant to multiple stages. Williamson suggests three ways in which internal transactions can be organized: (1) sales contracts for component supply include contingent claims, incomplete long-term and sequential spot contracts, (2) Unified ownership of plant and equipment extends the simple hierarchy, (3) A complex hierarchy extends the employment relation to including department managers and achieves higher cooperation. An employment relation provides advantages over the other two. Williamson attempts to offer some qualifications to vertical integration. For instance, he claims that when recurrent transactions in the market are characterized by norms of trustworthy, valuable reputation and advanced evaluation mechanisms - incomplete contracts with informal enforcement may become a possible alternative to vertical integration. Furthermore, because vertical integration in highly concentrated industries can create price discrimination and barriers to entry, antitrust concerns may rise where there is a certain degree of monopoly. In addition to the antisocial consequences, vertical integration, can also result in preserved nonviable activities, cross-subsidization, distortion of procurement decisions and uneconomic reciprocity, inefficiencies due to policing costs, managerial commitment to unproductive or obsolete projects, communication distortion and other consequences of opportunism paired with small numbers and information impactedness. Hence, the size of the hierarchical organization is limited by bounded rationality, bureaucratic insularity, discouragement of innovativeness and atmospheric consequences. The reminder of the book is devoted to discussion of the multidivisional structure, conglomerates, dominant firms and oligopolies. These issues raise antitrust questions, and it seems that Williamson offers an unconventional perspective that better scrutinizes the situations that require government interference. In the discussion of market structure and organizational innovation, the author divides innovation to three stages: invention, development and final supply. Williamson suggests that the optimal path is that independent investors and small firms will engage in innovation and initial development, while successful developments will be acquired and be marketed by large M-form firms. In the last few chapters the OFF provides some insights to the evolution of monopolies. Williamson opposes governmental intervention in the case that a monopoly position results from incompetent competitors or from historic accident. Williamson also refutes the convention that oligopoly is no better than monopoly because of maximization of joint profit and collusion. In the OFF view, oligopolists will find it difficult to reach, implement and enforce agreements even when contracts are lawful. Only in highly concentrated mature industries with homogeneous products and exceptional barriers to entry, oligopolistic behavior may turn successful, but exactly in these cases it will be subject to antitrust reaction.
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2 of 23 people found the following review helpful:
4.0 out of 5 stars
great, June 20, 1999
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This review is from: Markets and Hierarchies : Analysis and Antitrust Implications (Paperback)
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