Link Between Information Technology on Transaction Costs
Information Technology refers to electronic processing, storage and communication of information. By transaction costs, are meant the sum of production cost, the effort, and cost incurred to find and negotiate for the goods. Transaction costs include both internal and external coordination costs as well.
Information technology has vague effects on overall transaction costs. Information technology externalities have both helpful and unhelpful effects on synchronization and transaction costs. Galbraith (1977) argues that larger the vagueness of task, higher is the amount of information that must be processed between decision makers during execution of task to achieve a level of performance.
Thus, in general, information technology is seen as a prevailing tool that can trim down the costs of transacting by giving more information to decision makers. This results in reducing uncertainty and improving the functioning of the market. (Ciborra, 1993).
Lewis argues, “professional and personal survival in modern society clearly depends on our ability to take onboard vast amounts of new information. Yet that information is growing at an exponential rate." With the adoption of IT, a number of communication channels drastically increase. IT networks are organized so that the number of possible interactions is almost unlimited and cost of interaction is negligible. (Fowler 1997).
However, the contradicting view to this theory states that the usage of IT leads to more information that may lead to information overload, leading to higher processing costs, and eventually leading to higher TC. If information available would be reduced, complexity would decline leading to lower coordination and transaction costs. (Palme 1984).
Although, this market efficiency of too much information could be fixed by efficiently supporting the IT by improving information processing capabilities and reducing the number of coordinating activities which don’t contribute to the value of the organization. Further, firms could reduce this uncertainty by better planning and coordination, often by forming rules, hierarchy, or goals. The above-mentioned views/strategies cannot be substituted but could co – exist.
The theory of institutional economics states that increasing the complexity of transactions will result in the failure of the coordination mechanisms within a market because transaction costs will be too high. Therefore, as exchange related complexity increases, it becomes more efficient to use IT.
Thus, to conclude, on one hand IT gives more and better information, making communication easier and on the other hand, increased amount of information has to be processed in order to coordinate the organizational activity, therefore, it can result in lower or higher coordination costs to the organization.