Integrating IT-Enabled Social Networks with Transaction Cost Economics and the Resource Based View of the Firm

Abstract

Prior research has mostly focused on transaction cost economics (TCE) to interpret the effect of information systems (IS) on organizational governance structures. A TCE based approach predicts that information technology (IT) will lead to increased use of electronic markets to coordinate economic transactions from electronic hierarchies. However, there is contradictory evidence in the literature regarding the rise and importance of cooperative relationships, joint ventures, and value-added partnerships integrated through information systems. To reconcile these contradictions, this paper analyzes the effect of IT on governance structures based on the TCE, social network theory, and the resource based view (RBV) of the firm. The most important aspect of this paper is that instead of overemphasizing the economic perspective, as has been done in prior IS research, it pays equal attention to economic, social, and knowledge perspectives of the firm. By considering variables such as product demand uncertainty, human specificity, task complexity, and frequency of interaction, the effect of IT on governance structure has been analyzed. In this paper, we suggest that, in knowledge intensive companies, a greater degree of outsourcing will take place, not through markets as hypothesized by earlier researchers, but through an increasing number of social networks. This differentiation can not be understood in simple economic terms because social networks are not based on contracts. Therefore, we suggest that the integration of IT-enabled social networks with the TCE and RBV of the firm leads to a better understanding and improvement of decision-making and corporate governance structures in knowledge intensive firms. INTRODUCTION Information systems (IS) research has mostly focused on transaction cost economics (TCE) to predict the effect of information technology (IT) on governance structures. The term 'governance' in general refers to the systems by which an organization or society operates; however, business scholars have mostly paid attention to markets and hierarchies. Due to its theoretical foundation and empirical support, TCE based approach has been of enormous importance in explaining the basis for the existence of firms and markets (Foss 1996). The basic questions in TCE are: Why do firms exist? How are their boundaries determined? Since Ciborra (1993) postulated that information technology (IT) reduces transaction cost, resulting in more efficient markets and hierarchies, there has been an enthusiastic response from researchers in applying TCE logic for interpreting the effect of IT on governance structures. Malone et al. (1987) argued that IT reduces the unit cost of transaction, resulting in the emergence of electronic markets. Clemons and Row (1991) and Clemons et al. (1993) extended the above themes by incorporating transaction risk into transaction cost and showed that IT can lower the transaction cost without increasing the transaction risks, which leads to a greater degree of outsourcing and more cooperation between a fewer number of partners. Gurbaxani and Whang (1991) integrated TCE and agency cost G. D. Bhatt, J. N. D. Gupta & S. K. Sharma 2007 Volume 16, Number 2 thesis. Their arguments were inconclusive for the emergence of markets or hierarchies. Bakos and Brynjolfsson (1993) argued that relationships between suppliers and firms require that suppliers invest in transaction specific assets, but because these investments are non-contractible and specific to a relationship, suppliers may not be in a bargaining position. By reducing the number of suppliers, a firm can maintain a tighter relationship and convince them that the returns on their investments will not be expropriated in ex post bargaining. TCE based analysis predicts that information technology (IT) will lead to more use of electronic markets to coordinate economic transactions from electronic hierarchies. However, there is evidence in the literature that indicates an increase in the importance of strategic social networks, cooperative relationships, joint ventures for R & D, value-added partnerships, virtual organizations, and logistics, integrated through common information systems (Piore and Sabal 1984, Powell 1990, Amit and Zott, 2001). Factors impacting the role of IT on governance structures include trust, reputation, and innovation in TCE. Social networks and social capital in an IT perspectives are gradually emerging (Kumar et al. 1998, Huysman and Wulf 2004). This paper, therefore, undertakes the goal of integrating the social perspective, the resource-based view (RBV) of the firm, and TCE to analyze the effect of IT on governance structures. The most important aspect of this theory is that instead of overemphasizing the economic perspective, it pays equal attention to social embeddedness in economic exchange (Granovetter 1992) and the knowledge-based perspective of the firm (Mahoney and Pandian 1992). Recent examples include open-source software development process that is initiated by volunteer programmers dispersed worldwide. These programmers are heavily dependent on electronic media, yet work as members of several social networks (Scacchi 2004). Thus, in this paper, we analyze the effect of IT on governance structures and argue that a greater degree of outsourcing will take place, but not through markets as hypothesized by earlier researchers. Instead, exchanges increasingly will be conducted through social networks and will not be based on contracts. This paper makes three contributions to the IS field. First, it shifts the focus of IS research from transaction cost economics toward a realistic approach in which firms’ exchanges are considered socially embedded. It also attempts to integrate IT enabled social networks with the economic perspective of organizations and the RBV of organizations. Since TCE theory has been widely criticized because of its over-reliance on the economic perspective at the expense of social norms and relations (Ghosal and Moran 1996), this is an important line of inquiry. Second, this paper examines the dynamic aspects of IT to find its effect on governance conditions with particular emphasis on knowledge based firms. The prior research has taken a static view of IT and does not account for the changes in organizational tasks, human expertise, and organizational structures as a result of IT. We argue that with the introduction of IT, a firm often reorganizes its tasks and structures, which, in turn, cause shifts in organizational knowledge and managerial capabilities. Third, this paper suggests that knowledge-intensive firms are more likely to enter into collaborative structures because of their inherent need to learn and strengthen their complementary capabilities (Kogut and Zander 1992). For these firms, the motivation is not only to reduce transaction costs, but also to satisfy their inherent drive to process and share complementary knowledge across social networks. The rest of the paper is organized as follows. First, we briefly describe transaction cost economics, social networks, resource-based perspective of the firm, and the information intensity of the firm. Second, we discuss the characteristics of information technology (IT) and its effects on different governance conditions. Next, we describe the governance conditions under which participant firms are likely to enter into social networks for coordinating their exchanges, instead of markets and hierarchies. Finally, we briefly outline the implications and conclusions of our study. TRANSACTION COST ECONOMICS (TCE) TCE is a comparative efficiency framework for selecting alternative governance structures (Williamson 1994). Earlier work within the TCE framework has shown that relational contracting is the basis of an alternative governance structure between markets or hierarchies (Rockart and Short 1997). Traditionally, TCE has mostly distinguished between two kinds of sourcing: markets and hierarchies (Coase 1937, Williamson 1975). Markets govern external exchanges through price mechanisms and legal contracting, and hierarchies govern the firm’s internal exchanges through direct employment and asset ownership (Powell 1990, Williamson 1975). Exchanges conducted through markets are considered to provide advantages in production cost, as a market usually takes the benefit of the economies of scale in production. However, exchanges conducted through markets incur considerable transaction costs in searching for the right supplier, writing and negotiating the contract, monitoring and enforcing the contract, and coordinating with the supplier for the duration of the project. On the other hand, in