Monday, July 30, 2007

Transaction Cost Economics and IT Infrastructure

I was handed an interesting link by bloggerazzi about a part of economics that I had never heard about till date, called Transaction Cost Economics.
previously, the inefficiencies of a manufacturing system were found on the assembly line. So, if a production line slows down, or if extra material is machined, then you know where to pin the blame on! Catch the worker on the line, and improve the process!
But that only worked to an extent, and todays economies are now somewhat different. How, you might ask?
Firstly, todays production lines are not solely dependent upon the worker. They also depend on the supervisor, the inventory scheduler, the middle manager, the stores guy, the accounts man, and half a dozen lawyers to boot.
Basically, a transaction where the only trade is in intellect and services is subject to several unique features. First, is of course, how do you bill the transaction. Second, and linked to one, is measuring the effectiveness of the transaction.
For example, if you were performing a machining operation on a lathe, you could work out to the nearest penny how much it costs to produce a component. Right from the power consumed, and the cost of the interest on the loan for the lathe, to the wages the underpaid lathe man gets paid, everything is accountable.
But how do you rate the effectiveness of a manager? Or judge the utility of a lawyer? Most of the time, they seem useless...but trust me, when you are hit with a lawsuit, you will wish you had a good lawyer (And good accountants too).
Transaction Cost economics tries to quantify these things and come up with numbers that denote their worth. But at the same time, some interesting points come up! Firstly, we see that as an operation becomes more complex, there are more transactions needed to complete the job perfectly.
From this we come to the old one about the factors of production. We all know 3 factors of production. They are
1. Land
2. Labour
3. Capital
But there is a fourth factor which comes up, and transaction costs best defines the fourth factor of production, which is, Management.
In short, Management can be defined as the factor by which the transaction costs that determine the other three factors can be reduced. I do hope that last sentence made sense, because it is the crux of the next point.
Management is also about handling information efficiently. And today one of the points that has been made is that management requires information instantaneously. This has been the reason why IT investments have frequently been justified. They are supposed to reduce the transaction costs made due to lack of information. But IT investment adds another transaction layer to the entire system, and must justify itself. Also, it is seen that the amount of information gathered creates yet more transactions in information processing. This is one of the reasons why IT implementation frequently is seen as a failure. The initial gains that are promised are all used up in the implementation of the IT system itself.
So, one of the things that anyone interested in designing IT solutions should be doing is to map the transactions that take place in any process. Then, identify the transactions that can be reduced or eliminated. Third, quantify the costs that will be saved by reducing these steps. The last process is the one that is truly difficult. And that is to anticipate the additional transactions that will ensue from bringing your IT system into place.
One of the reasons why designing an IT system is not the same as simply automating the process. And why IT consultants earn their fat pay packets too!

No comments: