Oliver E. Williamson

Nobel 2009 | Transaction cost theory: How should firms organize their transactions?

Oliver Williamson revolutionized the way economists look at organizations by opening the “black boxes,” a name he gave to the inner working of firms. While other economists concentrated on the existence of firms, Williamson focused on its mechanisms. Known to his loved ones as “Olly,” he paved a new way for business enterprises to be analyzed. According to his research, organizations are sometimes more efficient than markets because the conflicts are easier and less expensive to solve. The study of Transaction Cost Economics is just one highlight. His unique style of interdisciplinary, methodical, detailed and complex scientific research made it possible for many other economists to build on his groundwork. Williamson is one of the founding father of organizational sociology as his work approached both the formal organization of the fir, and also the cultural and social norms found within it.

Oliver E. Williamson

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (shared), 2009

At a glance

Born: 1932, Superior, Wisconsin, USA

Field: Economic governance

Prize-winning work: For his analysis of economic governance, especially the boundaries of the firm

Sentence of his life: “Daaaaad! I think this is the call.”

Favorite place: Summer home on Lake Nebagamon in Wisconsin

Spleens: Starts every sentence with “Well…” and pauses to think

A rich life

Ask anyone who knows Williamson well to describe him and four words crop up repeatedly: firms, organization, transaction and humor. On his terrace in Berkeley Hills, California, Williamson shows us why.

“Mr. Williamson, how do you define a rich life?” The question floats in the air. He has to concentrate. He admits his age is beginning to catch up with him and looking out over the Berkley campus, the hills and San Francisco Bay he begins as he begins most sentences.

“Well,” he says. “I guess I have a rich house.” He laughs. “You ask good questions, I give bad answers.” His wife Dolores, who passed away a few years ago, was what made his life rich he says with sincerity.

Exploring Mr. “Tough Stuff”

Inside the Haas School of Business, Williamson is an institution himself. He’s no longer teaching these days but he still has an office on campus. Of course, there are lectures referencing and addressing his work. While reading a Williamson course, a lay person would become lost almost immediately. Even his students admit that Williamson’s course is the “tough stuff” and that his style is abstract. Fellow Laureate Oliver Hart agrees. Not even Hart, who has built on Williamson’s work, is able to fully understand all of Williamson’s ideas in the field of institutional economics.

Hart shares an example that illustrates the core of Williamson’s theory of the firm. “If you’re a coal mine, you’re fixed in place,” Hart says. “It would be good to have someone next to you using your coal. There are a lot of power companies around the country and any one of them could locate a plant there. So, at that point we’re at a competitive point in the market.” Then Hart brings in something Williamson called ‘fundamental transformation.’ “If one of them decided to locate next to you, it’s you versus them and all those other power plants are out of the picture. It’s costly for the power plant to find coal from elsewhere, it would have to ship it in. It has become dependent on you by locating its plant there,” he said. “Williamson talked about the fact that it’s in these situations that the bargaining costs are going to be large.”

Williamson thought of how to develop better ways of protection. He saw one solution in a long-term contract, which in Hart’s example, specifies the amount of coal, the kind of coal and the price, so that the coal mine could not take advantage of the power plant. The only problem is that a contract may be incomplete. This instability led Williamson to something new.

What are relationship-specific investments?

In 1937, economist Ronald Coase laid the groundwork for Williamson’s field of transaction cost economics. Coase explored why so much activity takes place inside firms. Williamson would elaborate and find that the idea that haggling costs is important when one or both of two independent contractors need to make a relationship-specific investment, investments that bind them together.

How can we lower the costs of market trading?

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Produce or buy? Is vertical integration the best strategy?

When we meet a friend and colleague of Williamson, Professor Christian von Hirschhausen, we discuss the second opportunity, called ‘vertical integration.’ Should the power plant buy the coal mine? “Let’s take Amazon”, he says. “It’s becoming not only a sales platform but also a logistics provider, so it integrates logistics within its sales-platform, to deliver Amazon Prime products within one hour.”

Other companies are unlikely to follow this strategy and are at a disadvantage due to the cost associated to logistics. “But then they might be more diverse for other services,” von Hirschhausen says. “It’s not one organizational structure that prevails. But the structure depends on the business strategy, the technologies available, and also the cost of contracting these services.”

Produce or buy?

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Can we organize economic activity when there is greed?

After receiving the Nobel Prize, Williamson quickly realized he was now expected to know all the answers. During his first press conference post prize at Berkeley a young man wanted to know whether greed is the biggest threat to economies.

Williamson is not a behavioral economist but he does take social norms and cultural aspects into account.

“If you start thinking about organizing economic activity through the length of contract, the main benefits to accrue the contract are those of mutual gain. There are sellers and buyers and mutual gains to be realized,” said Williamson. More intelligent organization could help avoid excess intervention and regulation he explained.

Do not assume that a system is fundamentally corrupt, but try to make improvements to prevent corruption from happening.

“We’ve come a long way and we’ve made some mistakes,” he said. “Some of them we should have had the intelligence to [foresee] and avoid, and that’s the challenge for the future.”

Is greed the core problem of our economy?

Back at his home in Berkeley Hills, Williamson sits in his living room chair, surrounded by framed photos of his wife and their five children. With a big family, and a playful dog, it’s no surprise that Williamson is an expert in organization. He admits jokingly, that intelligence sometimes can be an obstacle to being called an expert. In some situations, he says with smile, the only advice he could think of was “Take the water and run!”

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