Page 54 - Electronic Commerce

Introduction to Electronic Commerce

Markets and Hierarchies
29
Coase reasoned that when transaction costs were high, businesspeople would form
organizations to replace market-negotiated transactions. These organizations would be
hierarchical and would include strong supervision and worker-monitoring elements.
Instead of negotiating with individuals to purchase sweaters they had knit, a hierarchical
organization would hire knitters, and then supervise and monitor their work activities.
This supervision and monitoring system would include flows of monitoring information
from the lower levels to the higher levels of the organization. It would also have control of
information flowing from the upper levels of the organization to the lower levels. Although
the costs of creating and maintaining a supervision and monitoring system are high, they
can be lower than transaction costs in many instances.
In the sweater example, the sweater dealer would hire knitters, supply them with
yarn and knitting tools, and supervise their knitting activities. This supervision could be
done mainly by first-line supervisors, who might be drawn from the ranks of the more
skilled knitters. The practice of an existing firm replacing one or more of its supplier
markets with its own hierarchical structure for creating the supplied product is called
vertical integration. Figure 1-7 shows how the sweater example would look after the
knitters and the individual sweater dealers were vertically integrated into the hierarchical
structure of a single sweater dealer.

Top Buy
managers
Monitoring information managers Control information Sell Buy

Middle

First-line
supervisors
Learning
Knitters
Buy
Cengage

2015
Sweater dealer Retail clothing shops ©
FIGURE 1-7 Hierarchical form of economic organization

Oliver Williamson, an economist who extended Coase’s analysis, noted that firms in
industries with complex manufacturing and assembly operations tended to be
hierarchically organized and vertically integrated. Many of the manufacturing and
administrative innovations that occurred in businesses during the twentieth century

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