Value Chain Glossary: Transaction Costs
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Transaction Costs
Transactions costs are the costs of organizing and conducting business activities. They determine the way economic activity is organized and have a powerful influence on business planning and investment horizons. High transaction costs also cause market failure – when the costs of transacting are high, markets do not function efficiently or even exist at all and it takes substantial resources to define and protect property rights and enforce agreements. In the extreme case, high transactions costs can result in total market failure so that some activities that are the norm in low transactions costs environments do not take place at all.
Another way of looking at transactions costs is that they are the costs of arranging, monitoring, and fulfilling contracts.
Examples of transactions cost include:
• costs of gathering information
• costs of negotiating a contract
• costs of enforcing the terms of a contract
• cost of buying and selling goods and services
• cost of raising finance and capital
• cost of securing and enforcing property rights
• cost of obtaining information regarding business associates and opportunities
• cost of forming and organizing companies
• cost of bankruptcy for creditors
• cost of entering into and enforcing contracts
• cost of hiring and dismissing workers
• cost of transporting, importing, and exporting goods
• cost of complying with government regulations and government representatives
Transactions costs have significant fixed costs components. Consequently, the relative impact of high transactions costs is felt more by smaller businesses than by larger ones. This result has a powerful effect on the size structure of firms and their relationship to other firms along the value chain. The impact of transaction costs absorbed by small farmers, for instance, is far greater than transaction costs taken on by larger, stronger firms up the value chain. Example: A World Bank study reveals that at one boarder crossing in India, transporters incur a series of informal expenses to get their product from production site to market. They pay off custom officials a "speed money" fee estimated at 2.5 percent the total value of their shipment. Transporters estimate that they spend time equal to 7.44 percent of the value of their shipment waiting for transport and customs clearance. [1]
Related Articles
- Value Chain Finance resource page
- World Bank Study: Trade Financing, Logistics and Transaction Costs
- World Bank Study: Transaction Cost Analysis Case Study: Chad Cotton Sector PSIA. 2007
