Question

In: Operations Management

Explain how asset specificity can lead to transaction costs please give 2 examples Please explain well...

Explain how asset specificity can lead to transaction costs

please give 2 examples


Please explain well and upto 500 words

Please solve asap

Solutions

Expert Solution

Asset Specificity can be defined as the degree or extent to which a thing (for instance resource or asset) or person (for instance employee) of value can be adapted for any other purpose. Therefore, assets with high specificity can be used for certain specific purposes or tasks in certain specific circumstances. The more flexible resources are assets with low specificity and hence they can be more valuable because of their versatility. In general, assets that have been customized and personalized will have low specificity as they are made to attain the special objectives for the clients. Assets having low specificity will carry high resale value as they can be used for many different purposes and therefore will have a larger market and demand.

Asset specificity can also be related to financial, business, and economic situations, and the inter-party relationships in any transaction. Here it is the extent to which the value of investment made in one sphere compares to the value of the same investment made in some other sphere or when deployed for some other purpose. Therefore, asset specificity relates closely to the concept of opportunism or opportunity cost.

An example of how to accept asset specificity leads to transaction cost that can be seen in the IFAs or the Improved Farming Activities (certain farming practices) in Australia. The IFAs are well known to reduce the adverse nutrient and sediment impacts of sugar farming on the Great Barrier Reef in Australia, a World Heritage site. IFAs are also known to provide for a better profitability of sugar cane cultivations. Still, the IFAs have not been adopted by the farmers in the country to a great extent. This is due to the asset specificity of the investments made towards adopting these practices. The cost that the farmers incur towards adopting IFA practices (along with the resources their adoption requires) is greater than the benefits that they can provide. The adoption of IFA practices require investments in assets that cannot be transferred to any other part or kind of farming operations. Therefore, asset specificity is high and hence the transaction costs are high. Therefore, farmers will have to make separate investments for IFA practices and for their other farming practices, which will increase the transaction costs overall.

An investment in computer software that is customized and created for controlling the operations and planning the resources (ERP software) is again an investment in an area with high asset specificity. This software could not be used in any other department of the same organization, or by other organizations as well, due to customization.

On the other hand, the Microsoft Office suite is an asset with low specificity. It can be used for recording/processing/storing data and information, for generating reports, for visualization and presentations, and for other purposes by the many different organizations and their many different departments. The MS Office suite can be used by the operations, finance, marketing, human resources, and other departments of an organization. Therefore, the asset has a low specificity. Because a single asset can be used for performing functions in many different departments and organizations, a firm is not required to procure and buy separate data processing and presentation suits for its different departments. It hence reduces the overall transaction cost.

Learning the English language is a highly specific investment, as English is one of the most widely spoken and understood languages in the world. The learner will be able to communicate using the language in many different countries, contexts, and settings. Hence a low asset specificity reduces the overall cost of a transaction made towards learning English as well.



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