Last Updated 06 Jul 2020

Critical assessment of Transaction Cost Economics

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Two Nobel Prize winners have extensively contributed to one of the theories that will be discussed in this essay. It is very exciting to access Transaction Cost Economics and Resource Based View theories in terms of their usefulness in explaining firms’ internationalisation strategies. This assessment will be based on two American companies: Harley Davidson-motorcycle manufacturer operating internationally and Wal-Mart - multinational Retail Corporation.

First of all, The beginnings of TCE- Transaction Costs Economics Theory is associated with British economist Ronald Coase, who used the term Transaction cost excessively to explain why firms to accomplish a number of tasks use in House capabilities and for the other part use external providers-market. A good illustration is when internal Transaction costs go up the firm is more likely to outsource and vice versa if external Transaction costs exceed Internal then firm should perform these tasks in House.

Ronald Coase received a Nobel Prize "for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy" (Nobelprize. org 2013). The other key contributor to TCE Theory is a great American economist also a Nobel Prize winner for contributing to economic sciences - Oliver E. Williamson.

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The Theory has been developed to great lengths since 1930s and today Transaction Cost Theory is not only used to explain Mechanisms of Governance in the home market, but to analyze the structure of the firm that should be used in foreign markets to manage risks and reap better results from international operations. Such structures are: a) Markets; b) Hybrids c) Hierarchies. Those structures are regarded as a) structure having the least control over firms’ international operations and the least risk exposure while c) having the most control and having biggest exposure to risks in unstable markets.

The next point that will be focused on is TCE theory usefulness in Harley Davidson Internationalization process. Harley Davidson-HD is a motorcycle manufacturer based in a U. S. founded in 1903. It provided motorcycles for military during World War I and World War II, as there was a high demand for reliable heavy-weight motorbikes. Currently Harley Davidson is operating in more than 60 countries around the globe and is a well known Brand associated with an American feeling of freedom, and being part of ‘bad boys‘ known as HOG (Harley Owners Group).

In 1990s Harley Davidson Management has recognized the need for international expansion as they were facing slowing sales growth in U. S. and increased competition by Suzuki, Honda, Ducati etc. In 2005 Harley Davidson has expanded to Japan by opening its subsidiary and developed distribution network. In 2008 HD has acquired MV Augusta Group based in Italy but mainly because of Global recession had to divest in Augusta in 2010.

Harley Davidson has been selling its motorcycles in Brazil since 1993 and in 1999 decided to start manufacturing there, because of increased imports taxes by the Brazilian government. In addition, Harley Davidson was able to access cheap Brazilian labour and avoid import taxes at the same time. We can make a fair assumption that the main reason why HD has come up with this strategy was- producing in U. S. costs were exceeding costs of transferring part of manufacturing to Brazil.

In Case of expanding to Italy, making the assumption that Harley Davidson being a U. S. based company were aware of the global recession, HD could have used Transaction Based Cost theory to reduce its exposure to risk by choosing different entrance strategy i. e. instead of acquiring MV August – Hierarchical structure, Harley Davidson could expand in Italy trough channels requiring much less commitment-markets governance structure. Moreover, HD has divested from Italy as operating-transaction costs were exceeding the benefits.

The two examples above were explained using part of broader Transaction Cost Theory, therefore TCE theory is a useful in explaining Harley’s Davidson internationalizing strategy. The second firm, Wal-Mart were opened first time in Rogers (Arkansas), USA in 1962 by Sam Walton and his brother. Since then Wal-Mart has become a renowned multinational retail corporation - which at the moment is the single largest retailer in the world (Berfield 2013). In the 1990’s, the liberalization of international trade provided new opportunities to expand globally.

When entering Europe, Wal-Mart chose Germany as an entrance point due as it was the 3rd largest economy in the world and was in a good geographical position to further expand throughout the continent (Pervez and Cateora 2010:574). Nevertheless, Wal-Mart received much critique of its decision from various business analysts, for the reason that players in Germany markets were likely to engage in price wars In addition to this, the retailing industry was slow-growing and cultural differences, such as shopping habits, work culture and underlying business practices, were significantly different.

Wal-Mart ultimately failed to enter the German market in 1998 successfully, and after having losses year on year until 2006, an American giant sold its operations to Metro - Wal-Mart’s largest competitor in Germany (Wiesmann and Birchall 2006) and still to this day doesn't operate in Germany (Berfield 2013). Jay B. Barney and William S. Hesterly (2006:106) have argued that when firms achieve sustained competitive advantage through utilizing their resources and capabilities in their home country, the next rational choice is to make use of these same capabilities in foreign markets, and start the firm’s internationalization process

Following successful expansion to North and South America and seeing other multinational companies such as McDonalds expand throughout Europe; it is not surprising that Wal-Mart had gained a significant amount of confidence in their business model and hence thought this could be applied around the globe without issue. However, Barney himself and Hesterly (2006:106) stated if ‘a firm’s resources are valuable, rare, costly to imitate in one country does not necessarily mean they will be in a different country.’

In case of Wal-Mart’s entrance to Germany if Resource Based View and VRIO framework would be used alone it’s unlikely it had been able to prevent Wal-Mart Failure, as Resource Based View model is part of Internal firms analysis (please see Figure 1) rather than external, whereas the main reasons behind Wal-Mart’s fiasco were external. I. E. Cross-Cultural Differences-Wal-Mart has hired greeters at German outlets, which is well accepted by Americans whereas Germans understood that they are paying extra for products in the store because of the greeter standing at the door and didn’t appreciate it at all.

Moreover a great example of Resource that gave competitive advantage in Home country but didn’t translate to competitive advantage in Germany is Wal-Mart’s utilization of its financial resources on global scale to push competitors in the Germany out of the market by selling products such as milk and butter below purchasing costs. The strategy has violated German Laws and was investigated by Federal Cartel Office further damaging the brand and increasing losses. On the other hand, if Wal-Mart would have done due diligence research in an external environment in Germany.

And if understood The Valuable, Rare, Hard to imitate, organization - resources and capabilities in Home country, those could have been adjusted to the German market to some degree or at least not used to gain a disadvantage instead of competitive advantage. For example in US Wal-Mart has developed Strong work culture and a common goal that unites employees – to implement EDLP which stands for Every Day Low Prices.

However in Germany Wal-Mart failed to unite workers by discouraging from forming unions, paying low wages, stating English as official language etc. , which resulted in employee unrest lack of employees working within the firm and further problems in the distribution chain. Moreover, Wal-Mart advertised their EDLP message lowering their prices on products to gain ascendency in the German market, but were challenged with a fierce competition from German retailers like Aldi, Lidl, Rewe and Edeka, and in particular Edeka broadcast their slogan saying ‘The prices Wal-Mart offers are not lower than ours’.

Furthermore, as it was mentioned above, Wal-mart where pressured on the other side by the government not to lower their prices below product costs as it was forbidden by local law.

In Conclusion, Resource Based View and VRIO framework could be used only to a minor extent in Wal-Mart’s entering into the German market case as it is focused to firms internal analysis, whereas the main reasons for Wal-Mart’s fiasco were external factors and using analysis such as PESTLE or Four Risks in International Business would have been more appropriate and could have saved Wal-Mart from ruining it’s brand in Germany in addition to incurring losses.

When Harley Davidson faced increased Import taxes by Brazil’s government, Transaction Costs were driving force behind HD motivation to manufacture within Brazil. Transaction Cost Theory application could also have prevented unintentional divestment in Italian motorcycle firm MV Agusta. For that reason Transaction Costs economics are fairly useful theory in explaining Harley Davidson internationalizing strategy.

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