Transaction costs and information systems: does IT add up?

Antonio Cordella

Abstract
Transaction cost theory has often been used to support to support the idea that information and
communication technology (ICT) can reduce imperfection in the economic system.
Electronic markets and hierarchies have repeatedly been described as solutions to inefficiencies
in the organisation of transactions in complex and uncertain settings. Far from criticising this
assumption, this paper highlights the limits associated with this application of transaction cost
theory that has been prevalent in IS research. Building on the concepts first proposed by Ciborra,
the paper argues that information-related problems represent only some of the elements
contributing to transaction costs. These costs also emerge due to the interdependencies among
the various factors contributing to their growth. The study of the consequences associated with
ICT design and implementation, grounded in transaction cost theory, should therefore consider
the overall implication ICT has on these interdependences and not only the direct effect it has on
on information flow, distribution, and management.

Introduction:
The diffusion of information and communication technology (ICT) in society is always
associated with an increased amount of information becoming available. Moreover, information
society is not only defined by the greater amount of information required in an ever increasing
range of human activities, but also by the expanded number of sources from which information
emanates. A significant volume of unwanted unsolicited information is received via traditional
physical channels of communication such as post, but increasingly, more is being sent via ICT
such as e-mail and the Internet. In an era of ever shortening product life cycles and lead times, it
has become essential for companies to improve their internal and external information flows.
More information is necessary to deal with emergent complexity, dictating a requirement for
faster information processing. A key resource for survival in this new environment is the ability
to obtain access to more information and to be able to manage this information flow. As Lewis
(1996) states: professional and personal survival in modern society clearly depends on our
ability to take on board vast amounts of new information. Yet that information is growing at an
exponential rate.
ICT has become the major enabler of the efficient exchange and retrieval of information in
organisations. However, conflicting approaches indicate that ICT is either a powerful tool to
support the economic system managing information or, conversely, one that creates a more
complex environment that is difficult to manage. A clear indication of the first perspective is
found in ICT studies based on the transaction cost approach (Malone et al., 1987; Ciborra, 1993;
Wigand et al., 1997). Such studies argue that ICT supports the economic system, providing a
more efficient information flow that facilitates the interaction among economic agents under
complex and uncertain circumstances, and reducing transaction costs. On the other hand, the
literature addressing the problem of information overload underlines the negative effects of
ICT due to a greater level of complexity being faced as a consequence of the increased quantity

of information made available by the technology (Palme, 1984; Schultze and Vandenbosch,
1998).
While being cognisant of these different approaches to the effects of ICT on organisational
settings, this paper will focus only on the transaction costs approach, depicting that it is possible
to identify situations where rather than reducing transaction costs, ICT will increase them.
Building on Ciborras (1993) work on transaction costs theory (TCT) and ICT, the paper will
present the main elements of the theory to discuss the effects of ICT on the different dimensions
of the transaction cost model. The paper highlights the importance of considering the
interdependency among the factors contributing to transaction costs when ICT is designed and
implemented to reduce the effects of these factors on transaction costs.
The paper is organised in a number of sections: Section two reviews transaction costs theory;
section three presents a summary of Ciborras contribution to information system research and
TCT; section four summarises the debate on TCT and ICT; section five reviews how this
literature has often underestimated the importance the interdependencies between the various
factors contributing to transaction costs to explain the overall effect of ICT on transaction costs;
section six reflects on any possible strategic implications from the ideas proposed in the paper.

Transaction costs
The need for a better understanding of the impact of ICT on organisational structures, such as
markets and hierarchies, has increased the attention received by transaction costs theory in the
study of information systems. Transaction costs theory represents one of the first attempts to
develop a comprehensive theory that considers the structure of the firm as a source of
explanation for outcomes, in contrast to viewing the firm as a black box that has little influence
in explaining such outcomes.
Presenting a minimalist version of the theory, Williamson (1975, 1985) and Coase (1937)
considered the cost of organising and managing the firm as analogous to the cost of constructing
and working in an ideal organisational structure. In contrast, transaction costs were depicted as
analogous to the costs associated with the management of the imperfections of this structure. In
economic terms, the ideal structure (i.e. the one without imperfections), would be a perfectly
informed and efficient market where prices were sufficient to communicate to dispersed buyers
all the knowledge required to make a purchase decision (Hayek, 1945). Through the price
mechanism, the market efficiently collects and transfers a large amount of information between
economic agents; information that would be prohibitively costly to capture and distribute by
other means.
Defining the elementary unit of analysis as the economic exchange between at least two
individuals, the transaction costs model depicts the exchange process with reference to the
resources that required to execute this exchange. While in the optimal case these costs approach
zero, when imperfections occur, these costs increase. Inefficiencies and imperfections in the
organisation of the transactions, called market failures, are the result of information and
behavioural-related problems, with these imperfections defining the complexity of the
transaction (Ciborra, 1993). Economic agents invest in resources to mitigate the effects of these
imperfections in the execution of the exchange. These investments are the costs associated with
the transactions, and defined as transactions costs. Transactions costs are the consequence of the
asymmetrical and incomplete distribution of information among the economic agents involved in

the transaction. More specifically, every transaction life cycle is characterised by different cost
phases, with each incurring specific information-related costs:
- Search costs: the costs of locating information on the opportunities for exchange
- Negotiation costs: the costs of negotiating the terms of the exchange
- Enforcement costs: the costs of enforcing the contract
Transactions will conclude successfully only when all the participating agents possess the
necessary information to rationally assess the equity of the exchange.
When costs reach a particular level, it can be more convenient to re-organise the exchange
processes within a structure that more adequately addresses uncertainty and information
asymmetry. This shift in the organisation of transactions occurs in order for the effects of
transaction costs not to jeopardise the opportunity to conclude an exchange that is advantageous
to all the involved parties. The model proposes a theoretical apparatus that assists in explaining
why alternative forms in the organisation of transactions exist.
Markets and hierarchies are proposed as alternative forms in the governance of transactions.
Adhering to the underlying assumptions of the theoretical model, transactions that take place
once, such as those on the spot markets, will incur relatively little transaction costs because
they are associated with a low level of uncertainty (both environmental and strategic). In these
cases it is straightforward to collect all the required information and to manage this information
using the price mechanism. On the other hand, transactions that involve a commitment over time
have a certain level of endogenous uncertainty related to the future behaviour of agents and of
resource dependencies established within the transactional process (Barney and Ouchi, 1986).
To manage these contingences, investment in resources and strategies designed to address
emerging challenges is required. These solutions are maintained by the development and
enforcement of rules and regulations that produce a new coordination mechanism to replace the
price mechanism. TCT argues that the alternative to the market found in organisational forms
and hierarchies, are responses to the need to minimise the transaction costs associated with the
management of transactions (Coase, 1937; Alchian and Demsetz, 1972; Williamson, 1975). This
both explains and justifies the decision to reorganise the transaction process. The hierarchy
organises exchanges on the basis of rules and procedures within a regulatory framework that is a
substitute for prices. Long-term commitment and contractual arrangements are developed to
reduce the uncertainty facing agents, while enforcing alternative ways to organise the exchange
process (Varian, 1992). The cost associated with the transaction will be lower than the one that,
ceteris paribus, would be supported if the exchange was managed through a market mechanism.
The same uncertainty is managed by a more efficient mechanism, the hierarchy, based on
adherence to predefined norms and rules.
Transaction costs theory explains the existence of alternative forms of organisation on the basis
of their relative efficiencies in response to the combined effects of environmental factors
(uncertainty and small numbers) and human factors (opportunism and bounded rationality)
(Williamson, 1975; Moe, 1984). Transaction costs for a specific exchange can be captured by the
function:
Tc = f(U;C;Br;Ia;As;Ob;Cc)

where Tc is transaction costs, U is uncertainty, C is complexity, Br is bounded rationality, Ia is

information asymmetry, As is asset specificity, Ob is opportunistic behaviour, and Cc is
coordination costs. Information technologies have also been discussed within the transaction
costs model, with their impact on the factors in this equation often questioned.
A number of authors have criticised the assumptions underpinning TCT. Opponents to the
Theory have previously criticised its failure to consider the power of stakeholders within
organisations (Francis, 1983; Perrow, 1986; Braddach and Eccles, 1989; Collin and Larsson,
1993). Others have criticised what they deem to be unrealistic assumptions, including that
market based resources are always available (Bauer and Cohen, 1983; Dugger, 1983; Etzioni,
1988; Dietrich, 1994). Finally, several researchers claim that TCT is an inadequate unit of
analysis because it ignores broader contextual issues that influence sourcing decisions, such as
organisational learning (Collin, 1993; Elg and Johansson, 1993; Dietrich, 1994).
Some criticism of TCT (Lacity and Willcocks, 1995) focuses on the ambiguity of the definition
of the factors contributing to transaction costs. These include asset specificity and uncertainty,
which are posited as making the operationalisation of the theory extremely difficult. Similarly,
some authors question the possibility of clearly defining the micro level unit of analysis of
transactions, particularly where ICT outsourcing occurs (ibid).

Ciborra, ICT and TCT

Ciborra (1981) was the first author to propose TCT as an approach to explain the design of
computer based information systems. He argues that TCT brings together many of the concepts
that had been traditionally used to analyse the effects of ICT on organisations, and that TCT
illuminates the transactional dimension of economic exchanges. This includes the problem of the
rational action of the organisational agents; the economic view of organisational forms such as
teams and hierarchies; the notion of mediating technologies, and the use of ICT to support
markets, hierarchies and teams. In depicting the transactional dimension of economic exchanges,
TCT discusses varying organisational forms as alternative responses that are enacted to
overcome problems in the efficient allocation of economic resources. As a result, ICT is
proposed as a solution that can reduce transaction costs. Following these ideas, Ciborra views the
problem of designing information systems as something connected to the problem of designing
an efficient economic system. He states that the key feature of . (ICT) is in the framework
proposed here, the possibility of lowering the costs of transacting. Accordingly, data processing
can be identified with other devices that lower such costs as mediators and money, (Ciborra,
1993).
ICT designed to lower transaction costs must take into consideration that the introduction of this
technology reduces the costs of exchange and increases gains for both parties, if the resources it
consumes are less that the transaction costs incurred,1 (Ciborra, 1993). It follows that the
evaluation of the effects of ICT on the economic system must be considered in the context within
which transactions occur. Markets, hierarchies, and teams are alternative solutions enforced to
mitigate the effects of the complex set of factors that contribute to the emergence of transaction
costs. Alternative frameworks need to be considered when studying the design of ICT in order to
1

This is a significant point that will be iterated later in this paper when a discussion occurs of the development of the ideas first
produced by Ciborra, in relation to the introduction of ICT as possible instruments in lowering transaction costs.

reduce transaction costs. Ciborras (1993) book Teams, Market and Systems is a significant
contribution to this debate. Following TCT, this work discusses how it is possible to formulate
alternative ICT solutions to enforce the different transactional mechanisms of teams, markets,
and hierarchies. What characterises the originality of this contribution is its depth and extensive
analysis of alternative transactional mechanisms, in addition to depicting the proposed solutions
in terms of ICT development driven by TCT. Additionally, a framework is proposed that guides
the decisions steps to be followed when assessing the cost-benefits associated with these
alternative choices. Building upon the ideas proposed by socio-technical studies, Ciborra (1993)
suggests that ICT solutions designed to lower transaction costs should follow the efficiency
criterion when designed: cost-benefit analysis is proposed as the optimal approach to aid such
design.
Following this paradigm, Ciborra (1993) discusses alternative architectures by adapting the
analytical model proposed by Williamson (1985) to appreciate how technology and
organisational forms jointly can make more efficient certain ways of coordinating the task of
producing goods. A model is proposed that compares alternative organisational forms and the
subsequent impact of ICT on these forms. This comparison considers the possible combination
of factors contributing to transaction costs and the effect of ICT on these factors. Utilising
empirical data, Ciborra (1993) suggests that the impact of ICT on transaction costs should be
appraised not only in quantitative terms but also by taking into account qualitative changes that
can be induced by ICT when it fosters a shift in the paradigm of the organisation that hosts it:
from hierarchies to the market, or from clans to hierarchies. If this occurs, Ciborra (1993)
suggests that the costs or benefits associated with such a shift must be taken into consideration
when assessing the effects of ICT on the economic system. Drawing upon the ideas underpinning
socio-technical analysis, Ciborra (1993) concludes that, appraising the costs and benefits of
information technology is more than accounting or auditing tangible and intangible
consequences of computer applications. Apart from the easiest cases, each time we carry out an
economic analysis of the actual or expected impacts of information technology, we need a point
of view and a conceptual framework on which to ground our evaluation. The point of view has
been spelled out by adopting a dichotomy: work tool vs organisational technology. The first
perspective allows us to look for the automating effects of information technology; the second
for the more subtle, but not less relevant, information effect.
Ciborra suggests that care should be exercised in evaluating the costs and benefits ICT can have
on transaction costs, because this assessment is not always as clear as it first appears. The
problem of assessing the information effects associated with the adoption of ICT, has not been
neglected by the author in his latest research. The information effect of ICT, produced by what
Zuboff (1988) defines as informating technologies, coupled with Ciborras depiction of
mediating technologies, were starting points for the development of his more recent research on
phenomenology and IS. Ciborra (forthcoming in 2008) posits that as informating technology,
ICT embodies the notion that all types of data models and representations embedded in
information systems provide a powerful set of representation of the processes of the firm that is
an important means of conveying, sharing and harnessing knowledge well beyond the
information stored in systems. ICTs not only represent tools that support information flows, but
they possess an enframing force that converts everything they encounter into a reserve stock of
resources to be harnessed and deployed for further development, (Ciborra and Hanseth, 1998).
ICTs are not tools but are a Gestell (ibid). The phenomenological argument underpinning the
vision of ICTs as enframing forces (Gestell) does not allow for claims in favour of the

managerial approaches to the study of ICT. These tend to examine the implementation of ICT as
a process that can be completely designed and controlled ex ante (Ciborra, 2000), and hence
easily measured ex post. This conclusion had already been reached when Ciborra made his claim
that the effect of ICT on transaction costs cannot be assessed ex ante by only examining the
results of technologies as automation tools. This paper explores these ideas, including a
discussion on the effects of ICT on transaction costs.

Transaction costs and ICT

Following Ciborras (1981) initial proposal that transaction cost theory is a potential framework
for undertaking research in the design and impact of ICT, this model has been used extensively
in the field. Typically, studies in information systems based on the transaction costs approach
depict ICT as a tool that sustains information needs, providing additional information and
information management power. ICT is perceived as a powerful tool to foster the efficiency of
the transactional process within which economic exchanges take place. There is little
disagreement that the effects of ICT on the economic organisation of exchanges continue to be
positive.
Malone et al. (1987) discussed the impact of ICT on the market and hierarchies, arguing that ICT
facilitates the transactional process, supporting information flow and management during the
various phases of transactions. It was theorised that the use of ICT supports market structures
where without the presence of ICT, a hierarchical solution would be required. Similarly, Ciborra
(1993) argued that the use of ICT reduces information asymmetry and resultantly increases the
conditions under which the market mechanism is an efficient allocative structure. Analogous
conclusions are also supported by Brynjolfsson et al. (1994) and Wigand et al. (1997). Other
authors discuss ICT as a factor behind the increased interest on network and virtual
organisations. Ciborra (1993), Malone et al. (1987), and Bakos and Brynjolfsson (1997)
highlight that ICT can reduce the effect of opportunistic conduct increasing the possibility of
monitoring agents behaviour in partnerships. None of these works, however, discussed the
impact of ICT on transaction costs in light of the interdependency existing among the various
factors, both human and environmental, that ultimately generate transaction costs.
In their research, Malone et al. (1987) argue that ICT lowers transaction costs because
technology allows information to be communicated in real-time and at much lower costs, thereby
reducing the costs that are required in order to find a particular good that is focus of the
transaction. These authors also suggest that ICT enables an easier matching between buyers and
sellers once goods have been located, and lowers the cost of brokerage. Wigand (1997) posits
technology and ICT as enabling the design and deliberate strategic deployment of linkages and
networks among cooperating firms intending to achieve joint strategic goals to gain competitive
advantage.
Benjamin and Wigand (1995a) discuss how ICT can reduce transaction costs by decreasing
coordination costs within the value chain, resulting in benefits for consumers through lower
prices. Additionally, producers/retailers can reduce their intermediation and coordination costs.
Bakos (1991, 1998) depicts the effect of ICT on electronic markets through its impact on search
costs in particular, with a resulting reduction in transaction costs occurring when subsequent
exchanges take place in electronic markets.

These various approaches addressing the impact of ICT on transaction costs underestimate the
effects of the interdependence among contributory factors. By considering these
interdependencies and their combined effects on transaction costs, an assessment can occur of
the real effects of ICT on the reduction of these costs.
TCT is grounded in the assumption that the relationship between human and environmental
factors is the reason transaction costs increase in the economic system. This is, however, not the
only reason why these costs exist. The interdependence of factors contributing to transaction
costs can contribute to their increase. Attempts to reduce transaction costs should not aim to
reduce the effect of a single factor, but the effects of the interdependencies between factors.
Transactions costs are not only the sum of the costs generated by the different factors, but are
influenced by the imbricate, interdependent relationship between them. The effect of ICT on
transaction costs must be studied by assessing this imbrication. Research in information systems
has mainly focused on the first approach. Illustrations of the second can be found in principal
agent theory (Grossman and Hart, 1983; Laffont and Martimort, 2002).
The following section extends Ciborras (1993) notions on TCT and ICT, discussing the effects
of ICT on transaction costs by not only considering the factors contributing to transaction costs,
but also their interdependencies. This will provide a richer theory in order to understand if ICT
is, ceteris paribus, always lowering transaction costs.

Re-thinking ICTs effects on transaction costs

When scholars state that ICT reduces transaction costs by affecting constitutive elements of a
transaction such as search, negotiation, and enforcement, they usually assess the effect of ICT on
one specific transactional problem. For example, ICT can reduce search costs by increasing the
amount of information available and the speed at which it is collected and processed (Bakos,
1991, 1998; Ciborra, 1993). However, IS studies that consider the interdependencies among the
factors contributing to transaction costs and the effect of ICT on these interdependencies are rare.
Ciborra (1993) highlights this problem when pointing out that positive and negative externalities
are associated with the use and adoption of ICT in organisations. He does not discuss this issue
in detail, however. This paper discusses the implication this concept can have for the further
development of research on TCT and ICT. To accomplish this, externalities are explored that are
generated by the interdependence of the factors contributing to transaction costs and the effects
ICT can have on these externalities are discussed.
This approach embodies the notion that transaction costs are not the sum of the costs generated
by the single factors, but rather, are the result of the interlinked relationships between them: they
do not sum each other and are functionally interdependent. A simple example is presented that
reflects how ICT can reduce uncertainty and increase the amount of information available while
augmenting complexity. Transactions take place in settings where human and environmental
uncertainties are not isolated but intertwined. Ciborra (1993) posited that ICT reduces transaction
costs if the resources it consumes are less that the transaction costs it generates. The reduction of
transaction costs occurs only if certain conditions are met, with these unlikely to occur through
chance.
When assessing the impact of ICT, an understanding of the interdependencies and imbrication of
the factors contributing to transaction costs produces a clearer picture of the problems inherent in
the evaluation of the economic consequences of ICT adoption. When the aim is, for example, to

understand the effects of ICT on transaction costs, the impact of environmental complexity on
transactions needs to occur, due to bounded rationality. If economic agents have infinite
computational capabilities, then complexity and coordination costs should not affect the
transaction costs. At the same time, environmental uncertainty, information asymmetry and asset
specificity affect the transaction because of the risk derived through opportunistic behaviour. The
factors are deeply interdependent and when one increases or decreases, this variation requires
analysis in relation to the effects reflected in the interdependencies among all of the various
factors.
Adopting an analytical perspective congruent with the one proposed by Ciborra (1993), namely
that TCT is applicable in depicting the process of designing information technologies, an
exploration can occur on what conditions are required to successfully design ICT that reduce
transaction costs. The effect of ICT in reducing the impact of any of the factors contributing to
transaction cost has to occur in light of the overall consequences that a solution has on the set of
interdependencies that generate transaction costs. The impact of the adoption of ICT can be
negative as a result of unplanned consequences produced by these interdependencies. The nature
and direction of these effects cannot always be considered positive and unidirectional. As already
outlined (Cordella, 2001), ICT does not always positively impact transaction costs. The
interdependencies between human and environmental factors have to be made explicit in order to
assess if the impact of ICT will produce an overall positive or negative effect.
Following the depiction of the three major phases of transactions and the associated costs
proposed by Ciborra (1993), a more relevant description of the possible cross-effects of ICT can
occur. This facilitates better positioning while designing ICT that aims to reduce these costs. The
following presents an overview of the three phases of search costs, negotiation costs and
enforcement costs:
Search costs
ICT can lower search costs only if the increased amount of information and/or speed in its
exchange is balanced by an equal increase in its ability to manage, process, and evaluate that
information2 (Malone et al, 1987). Greater information results in lower uncertainty but greater
complexity. The effect of ICT on this phase of the transaction is positive only if the increased
information flow is equally balanced by an improvement in the ability to manage it. When this
does not occur the costs required to manage the increased information flow provided by ICT will
be greater than the advantage supplied by this new information. This will result in a negative
effect of ICT, leading to higher transaction costs. The positive effects of ICT on search costs
have often discussed in terms of disintermediation of the exchange processes. Traditionally,
intermediaries are considered a necessary transaction costs that has to be incurred in order to
reduce the search costs for sourcing and retrieving information. To complete an exchange, the
collection of information regarding available options is required, in addition to the location of the
goods and their characteristics. Malone et al. (1987) highlight that ICT can lower these costs by
making the retrieval process easier and cheaper while providing additional information on the
characteristics of the goods. Once acquired, ICT does for free what intermediaries do for a fee.
One of the most visible consequences of the diffusion of ICT in electronic markets is the
disintermediation of these markets (Malone et al., 1987; Benjamin and Wigand, 1995b; Chircu
and Kauffman, 1999).
2

What Malone et al. (1987) call electronic communication effect

The above conclusion is predicated on the assumption that ICT reduces the transaction costs of
electronic markets by making more information available at a lower cost while making the task
of processing the information easier and cheaper. The literature does not in general consider
cross-effects in cost benefit analyses, with different conclusions reached that discuss the case of
re-intermediation as it occurs in electronic markets (Bakos, 1991; Sarkar et al., 1995). Bailey and
Bakos (1997), studying thirteen different firms participating in electronic markets, find evidence
for the emerging roles of new intermediaries. This implies that disintermediation does not occur
and new transaction costs emerge as consequence of the digitalisation of the marketplace. The
most direct effect of this digitalisation on search costs is the problem of matching buyers and
sellers. Electronic marketplaces are bigger and more disperse, making it more difficult to retrieve
information about the available goods and their characteristics.
As a result of ICT, customers have access to a greater number of goods and considerable
information about these goods. Empirical work by Bailey and Bakos (1997) reveals that this can
lead to ambiguous results: on one hand lower search costs will reduce the importance of
intermediaries by allowing buyers to search directly for appropriate suppliers, while on the other
hand the overwhelming abundance of information offered by internet-based market infrastructure
my increase the need for intermediaries that can help to match customers and suppliers by
filtering information, (Bailey and Bakos, 1997). This scenario leads to greater transaction costs.
What Bailey and Bakos (1997) discover through empirical evidence is presented theoretically in
this paper. Namely, once ICT is implemented in order to lower transaction costs, the externalities
of the cross-effects of the interdependencies among the factors contributing to transaction costs
may be negative, resulting in the overall effect of the adoption of ICT being negative: under this
scenario, transaction costs increase rather than decrease.
Negotiation costs
These are the costs of executing the transaction and may include commission costs, the costs of
physically negotiating the terms of an exchange, the costs of formally drawing up contracts, and
others. Within this stage, better control over the transaction can occur through the use of ad hoc
ICT applications, in term of quality evaluation and service provisioning3 (Malone et al, 1987). A
more sophisticated inventory system can reduce the costs associated with the management of
transactions when goods require delivery according to specific contractual requirements. Ad hoc
systems can be designed to facilitate the evaluation of the services purchased. However, the
evaluation of this effect of ICT on the transaction cannot be fully assessed without considering
the costs associated with new coordination requirements that emerge as a consequence of the
adoption of the ICT application. Moreover, in changing the distribution of information among
economic actors, ICT can alter the information symmetry between them, increasing or
decreasing it, and offering new opportunities for opportunistic behaviour; what Williamson
(1975) defines as conditions of information impactedness. The effects of ICT on this phase of the
transaction have to be considered within the associated effects on the interdependent factors. A
positive balance is reached if all of the factors are counterbalanced and aligned. It cannot be
taken for granted that this always occur.
Bakos (1998) argues that electronic marketplaces, as physical markets, need to fix prices in order
to process transactions, manage inventories, guarantee quality, and to monitor the process of
transacting. These needs provide a fertile platform for the proliferation of new intermediaries that
3

What Malone et al. describe as brokerage effect (op cit).

facilitate these activities in global, bounded-less electronic marketplaces. Sarkar et al. (1995)
presents extensive analysis of the process that redesigns the organisation of intermediaries in
electronic marketplaces. Criticising the conclusion reached by Benjamin and Wigand (1995a) on
the effect of disintermediation in digital markets, they show that the number of intermediaries
and their role can increase, potentially leading to higher negotiation costs for the agents that
exchange in those markets. The assessment of the effects of the introduction of ICT on
transaction costs is once again complex and not unidirectional. Any analysis of this impact must
consider the cross-effects and externalities associated with attempts to overcome the limits of the
analyses that assume that a change in the exchange channel structure does not have effects on the
redistribution of the welfare among the agents that use this structure (Sen and King, 2003).
Enforcement costs
The costs in this phase encompasses those incurred by the buyers and sellers in order to ensure
that the virtual goods and services they transact, and the terms under which the transaction is
made, are translated into physical goods and services. This encompasses any negotiations that
address inadequate delivery, payment disputes, and any investment undertaken to ensure
unsatisfied buyers and sellers have their issues remedied through the enforcement of their initial
contract. As was evident in the previous two phases, ICT can provide a more efficient
environment for the enforcement of the exchange process by facilitating a match between
contractual agreements. ICTs can also assist in the process and subsequent monitoring of quality
certification. In this scenario, radio tags facilitate the monitoring of production and distribution,
making it easier to control the quality of goods. Moreover, ICT can make the information
exchange between the parties more expedient, efficient and extensive, increasing the links
between them and the resulting quality of the information flaw underpinning the exchange
process4 (Malone et al., 1987). In this scenario, a positive result occurs only if solutions exist to
manage the enriched information setting provided by ICT. The enhanced communication flow
with additional information increases the requirement for coordination. This scenario can alter
the information symmetry and the prospects and risks associated with opportunistic behaviour.
The effect of ICT can be positive if specific conditions are matched.
The globalisation of the digital economy increases the complexity and the uncertainty in the
enforcement of contractual agreements (Milosevic et al., 2003). From the transaction costs
perspective this more complex and uncertain environment also makes the definition of
contractual agreements more difficult and expensive. Angelov and Grefen (2003) depict that the
increased complexity and uncertainty faced by companies in digital markets are the reasons for
the increased number of contracts established by companies trading in these markets. In extreme
cases, these authors argue that a situation of contract overload has occurred. Daskalopulu and
Sergot (1997) provide evidence highlighting the increased complexity of the content of these
contracts, which supports the argument presented in this paper: higher costs will be incurred in
order to stipulate the use of contracts under these conditions. A greater number of contracts
coupled with increased complexity leads to higher transaction costs. An increased number of
contracts create the need for a company to invest in contract management systems. The increased
complexity of contractual agreements has therefore necessitated investment in technological
solutions that facilitate the establishment and execution of electronic contracts (Allen and
Widdison, 1996; Merz et al., 1998). Once again, the cross-effects of the adoption of ICT are
difficult to assess.
4

What Malone et al. define as electronic integration effect (op cit).

As argued by Ciborra (1993) the evaluation of the effects of ICT on the economic system must
take into consideration the socio-technical context within which the transactions occur.
Similarly, Lacity and Willcocks (1995) argue that transactions occur in dynamic environments
that change over time, rendering it difficult to take decisions that minimise transaction costs
without considering the context within which these transactions occurs.

Conclusion and implications for ICT strategies

The transaction costs approach is a powerful theory that describes the potential of information
technology to improve information flow and to reduce transaction costs, thereby improving the
efficiency of the economic system. This paper has, however, shown that in order to achieve this
goal, a more informed approach to the study of the effects of ICT is required. Transaction costs
in fact often increase as a consequence of the adoption of ICT. Lower transaction costs can be
achieved when the costs associated with ICT adoption do not exceed the cost of the externalities
that are affected by this adoption. When this occurs, the usefulness of the strategy producing
such a result has expired.
This paper has shown that the externalities linked to ICT can alter from being positive, to
becoming negative. The adoption of ICT in this setting will result in significantly increased
transaction costs because of the associated extra costs required to accommodate the more
complex environment that emerges as a consequence of the effects of externalities. The use of
information technology will subsequently be unable to establish the conditions for a more
efficient economic system, but will contribute to the creation of electronic disorder and suboptimal economic results. Accordingly, the use of ICT may present diseconomies of scale when
the externalities associated with its diffusion reach a particular level (Cordella, 2001).
The traditional strategy of ICT adoption, based on transaction cost theory utilising ICT to
increase information availability, is undoubtedly efficient when accelerating and increasing the
amount of information available and its exchange. ICT makes economic exchanges easier and
more efficient, reducing search, negotiation and enforcement costs.
In order to account for the consequences of ICT, externalities, and the associated effects on the
coordination of exchanges, an approach other than the traditional one has to be identified. This is
required in order to avoid the failure of the economic system as a consequence of high search,
negotiation and enforcement costs. By reducing the amount of information, filtering it
appropriately, and reducing coordination needs, it is possible to decrease costs while maintaining
an efficient economic system when these conditions are met.
The ideas proposed in this paper offer a theoretical explanation for the proliferation of
alternative, sometimes opposite strategies, in the design and adoption of ICT to reduce
transaction costs. These strategies either conceive ICT as a powerful instrument that increases
the amount of information managed in support of transacting on economic exchanges, or see ICT
as a powerful tool to reduce the complexity and the amount of information to be considered
while transacting.

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