Alexia Azzopardi M167 Transaction costs can be described as frictions in the market.

How can ICT (information and communications technology) reduce these frictions? Discuss the theoretical model of transaction costs and explain how and why ICT can reduce or increase transaction costs. Transaction costs refer to costs incurred when buying or selling. These include brokers' commissions and spreads, meaning the difference between the price the dealer paid for a security and the price at which it can be sold. Transactions costs may be referred to as frictions in the market which shall be opened up on what such frictions are. The transaction cost model will be discussed in order to better understand whether such costs may be reduced or increased. Transaction costs are direct costs associated with transacting trades. Indirect costs, such as staff salaries, computer systems or overhead are not included. Some transaction costs are visible and explicit, such as; Commissions paid as compensation to brokers acting as agents, Exchange fees.

Transaction costs are mostly related to information processing costs, where not all information is available and it is costly to process the available information. Types of information costs that individuals face are; search costs these are costs necessary to set up the minimal social unit for the exchange and identify the party within which one wishes to conduct the transaction. Contracting costs- these are costs related to the negotiation of the terms of the trade and drawing up the contract which regulates the exchange. Also one can face control costs & negotiation costs- which relate to the implementation of the contract under conditions of uncertainty, the policing of deviations from the contract terms and the enforcement of sanctions to restore conditions suitable to the terms agreed. Transaction cost theory has often been used to support the idea that information and communication technology (ICT) can reduce imperfection in the economic system. ICT might contribute to lower transaction costs by making the exchange of goods and services more efficient and also by improving the overall efficiency of 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. 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. ICT provides better opportunities to process the information related to the exchange, it reduces the need for support for buyers and sellers in managing the essential information needed for the exchange. ICT also reduces the need for the third party services and hence the costs faced by buyers and sellers.
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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. 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. Transaction cost model Ciborra 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. 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. 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. It follows that the evaluation of the effects of ICT on the economic system must be considered in the context within which transactions occur. Alternative frameworks need to be considered when studying the design of ICT in order to reduce transaction costs. Ciborra suggests that ICT solutions designed to lower transaction costs should follow the efficiency criterion when designed: costbenefit analysis is proposed as the optimal approach to aid such design. Ciborra discusses alternative architectures by adapting the analytical model proposed by Williamson to appreciate how technology and organisational forms jointly can make more efficient certain ways of coordinating the task of producing goods. In the transaction cost model, markets are viewed as organisational structures which coordinate buyers and seller by making the reciprocal expectation related to the price of the quantity or quality relationship. Transaction is coordinated on the basis of a contractual arrangement which specifies buyers and sellers, the object of the exchange and the price at which the transaction will take place. Ciborra suggests
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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.

It is said 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. Organisations are opting to use the electronic market in different ways such as using an infomediary which works as a personal agent on behalf of consumers to help them take control over information gathered about them for use by marketers and advertisers. Also disintermediation which is the removal of intermediaries such as distributors or brokers that formerly linked a company to its customers, for instance a virtual travel agent. Disintermediation occurs because ICT does for free what an intermediary does for a fee. Vauxhall UK provides a good example of the response to the opportunities provided by new electronic channels. Their main aim was raising profile and branding awareness and lead generation for dealerships. However to achieve such aims online approaches where used, which include differential pricing, an online sales support tool and an e-mail newsletter. Another factor is countermediation, the advent of e-commerce which means that markets cannot rely on the online presence of existing intermediaries, instead they create their own online intermediaries. Opodo has used such an approach that has been set up by line European airlines including, Air France, BA, KML and Lufthansa. Even though the transaction cost model has proved to be beneficial in reducing transaction costs, one major limitation is that transaction cost economics is based on a sophisticated but still narrow view of the agent as economic man who maximises utility despite the limits of their rationality. Also information overload underlines the negative effect of ICT due to the greater level of complexity being fixed as a consequence of the increased quantity of information made available by the technology.

As seen above ICT reduces the need for third party services and the costs faces by buyers and sellers, that was also seen in Ciborras transaction cost model. Many organisations are opting to use the electronic market such as Amazon, E-bay, Ryanair and more, this is due to such cost savings (reducing transaction costs). As seen ICT does for free what an intermediary does at a fee. As can be seen in todays world market and more companies are going online!

References:

http://www.investopedia.com/terms/t/transactioncosts.asp#axzz1cjgqEYiC http://www.riskglossary.com/link/transaction_costs.htm http://en.wikipedia.org/wiki/Infomediary Lecture Notes 3a Transaction costs and information systems: does IT add up?- Antonio Cordella (Journal)