Transaction Costs and Modes of Service Provision: The Moderating Effect of Sourcing Availability

Abstract

This study adds to the Transaction Cost Economics (TCE) literature by focusing on the decision to produce organizational services through three modes: (1) internalization, (2) privatization, and (3) co-provision. We examine the relative effects of two dimensions of transaction costs – asset specificity (AS) and contract management difficulty (CMD) – on the likelihood of choosing amongst the modes of service provision. We also investigate the moderating effects of sourcing availability on the relationship between transaction costs and governance modes. The hypotheses are tested with longitudinal data on local government organization provision of public services over the 1992-2007 time period. The results suggest that: (1) services characterized by higher AS and CMD are more likely to be internalized and are less likely to be privatized; (2) services with intermediate levels of AS and CMD are more likely to be co-provided; (3) greater sourcing availability positively moderates the relationship between transaction costs and the likelihood of using privatization or co-provision over internalization; and (4) while sourcing availability negatively moderates the relationship between AS and the likelihood of co- provision in comparison with privatization, it has no impact on the effect of CMD on the likelihood of co-provision over privatization. The findings suggest that the problems associated with hold-up from AS may be mitigated by a well-functioning external market for services, whereas the problems associated with monitoring services are not as easily resolved by external markets. We discuss the implications of these findings for theory and research.