Transcript Fundamental ROIC Analysis

Where Do Transactions Come
From?
Carliss Y. Baldwin
Harvard Business School
Presented at Centre St. Gobain, Paris
November 8, 2002
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Where this work fits into economics
Samuelson, 1970:
Consider a profit-maximizing firm that sells output along a demand
curve…. [The] output is producible by … ninety-nine different inputs.
… [T]he production function relating outputs to inputs is smooth and
concave:
99
Max [R(v1, …, v99) – S pjvj ]
vi
.
1
∂R(v1*, …, v99*) / ∂vi = pi, (i = 1, …, 99).
But where does the production function (99
inputs –> 1 output) come from?
Who defined the products that are “the goods”?
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Transaction Cost/Incomplete Contracts
Williamson, 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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© 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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© 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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© 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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© 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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© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
The T&T Network Defined
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© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
What gets transferred?
 Material
 Energy
 Information
– Data
» Money or credit are a special form of data
– Designs
– “Tags”
» Property rights and decision rights are a special
form of tag
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© 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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© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
Mapping the T&T Network
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Mapping Technique =
“Task Structure Matrix” (TSM)
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© Carliss Y. Baldwin and Kim B. Clark, 2002
The Smiths and the Cooks
Smithy
Kitchen
S1 S2 S3 S4 S5 K1 K2 K3 K4 K5
Smithy
Kitchen
S1 .
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S4 x
S5 x
x x . x
x x x .
Pot Hook x
Transf er
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© Carliss Y. Baldwin and Kim B. Clark, 2002
TSMs show where transfers occur,
but not what gets transferred
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© 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
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Kitchen
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Pot Hook x
Transf er
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Transfer
Bottleneck
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Bottlenecks = Transactional “Gateways”
Smithy
Kitchen
S1 S2 S3 S4 S5 K1 K2 K3 K4 K5
Smithy
Kitchen
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“Place
Transaction
HERE” —
Few
transfers;
One-way
transfers;
Maximum
“Division of
cogitive
labor”
© Carliss Y. Baldwin and Kim B. Clark, 2002
Bottlenecks = Transactional “Gateways”
Smithy
Kitchen
S1 S2 S3 S4 S5 K1 K2 K3 K4 K5
Smithy
Kitchen
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S2 x
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S4 x
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Pot Hook x
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“Place
Transaction
HERE” —
Because
Mundane
Transaction
Costs are
Probably
Low
© Carliss Y. Baldwin and Kim B. Clark, 2002
Encapsulation
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© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
Solution:
 Transaction-free
zones
 “Encapsulated Local Systems”
– Predecessors: Families, communes, tribes
(Marc Bloch)
– Merchants and Proto-firms (Pirenne, Braudel,
etc.)
– Then: Full-functioned firms (1750s) and
Limited-liability Corporations (1830s)
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Creating an Encapsulated Local System 1
People
Machines
Data
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Agents and
Resources
Come In;
Products
Come Out
Internal Flows are Designed by Engineers
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Creating an Encapsulated Local System 2
People
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Machines $
Data $
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All are
Obtained
Via
Transactions
$$$$
Internal Flows are Designed by Engineers
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Creating an Encapsulated Local System 3
People
Machines
Data
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TransactionFree Zone:
By design,
many complex,
contingent
transfers
occur inside
the TFZ
Internal Flows are Designed by Engineers
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Boundaries of the Capsule
People
Machines
Data
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Energy
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C D E
Boundaries =
Where Transfers
M N
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take the form of
Transactions,
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according to
x
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the Design
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of the
x x
Enterprise
x x
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Boundaries are Designed by
Engineers, too!
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Financial Sufficiency
Costs:
People
Machines $
Data $
Materials $
Energy $
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When all
Claimants
Have been
Paid…
$
$$$$$$$$$$$
Money is left over!
Revenue
$$$$
© Carliss Y. Baldwin and Kim B. Clark, 2002
Financial Sufficiency =
Survival in a Money/Market Economy
Costs:
People
Machines $
Data $
Materials $
Energy $
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When all
Claimants
Have been
Paid…
$
$$$$$$$$$$$
Money is left over!
Local System can
survive.
Revenue
$$$$
© Carliss Y. Baldwin and Kim B. Clark, 2002
Encapsulated Local System =
the “Kernel” of a Firm
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Encapsulated Local System =
the “Kernel” of a Firm
Why only “kernel”?
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© 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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© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
“Pinching” the T&T Network
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© Carliss Y. Baldwin and Kim B. Clark, 2002
Mundane transactions costs are used to
create a “more modular” task structure
Negotiat ion:
(8 Specs
& Test s)
Engineering
Plast ic s
Produc t
and
Proc es s
Design
Negotiat ion between
Aut o and Engineering
Plast ic s Companies
. x x x x x x x
x . x x x x x x
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x x x . x x x x
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Eight
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Formal Tests
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Engineering Plast ic s Company
Aut o Company
“Mundane” transaction costs
Standards: To Define “Gateway”
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Rich
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Aut omot iv e
Company
Produc t
and
Proc es s
Design
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Eight
Formal Tests
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Eight
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© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
Conclusion
37
© 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
38
transaction costs are low.
© 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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© Carliss Y. Baldwin and Kim B. Clark, 2002
Merci de votre attention!
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© Carliss Y. Baldwin and Kim B. Clark, 2002