Notes

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In this segment, we'll look at the predictive part of transaction cost and
we'll also try and
understand some other fundamental assumptions which are built in.
And then we'll look at a broader question. If we evolve as a society in this
particular world into good human beings, what will happen to transaction cost?
Well, let's do this one by one.
The predictive power of transaction cost, that's right.
Can transaction costs allow us to predict what's going to happen in an industry?
Consider the following scenario. An industry has high prices.
Will the Internet make a difference in this particular industry?
How will this industry be impacted due to the Internet?
Let's use the concept of transaction cost.
If an industry is characterized by high prices, well, let's do the following.
Can an Internet solution come in,
it allows searching across organizational boundaries.
If in a country the prices are very high, can we allow people access to
providers beyond the geography of that particular country or
that particular nation, and can we widen the pool of providers?
Can somebody go to an online portal and
find, let's say, sellers in China if they are sitting somewhere in India?
So all they're doing is increasing the search pool and
widening the pool of providers,
and in that particular case, that Internet solution becomes valuable.
So how do you bring down prices in this particular case?
Well, you bring down prices by widening that particular pool, or
reducing transaction cost.
Look at a slightly different example in the predictive power of transaction cost.
Let's say in an industry, an industry's becoming like a commodity.
There are many, many different players, what they sell look essentially alike
how might this industry be transformed, you might ask.
What can the Internet do?
What kind of an Internet solution is going to be valuable in this
particular industry?
Okay. So industry,
let's say there are hundreds of players.
So, what will happen?
So, look at it from a consumer perspective.
If a consumer wants to buy a product in that particular industry,
they don't know who to, do not know who to choose.
There are so many different providers that all sell the same things, right?
So what can the Internet do?
How can this particular industry be impacted by the Internet?
Well, too many players means that we have to spend too much time searching.
Consumers, we do not know what the best price is,
although the products are all the same.
For example, here in the Singapore context,
we all know that Singapore has very high quality medical system.
But for many of the consumers, we do not know what the cost of
the different procedures or what the cost of medical treatment is going to be.
How do we improve that particular situation, when our
search costs are so high?
What can the Internet do?
Well, what the Internet can do is, you can do a comparison.
You can provide data, make it visible across providers, so
that everybody's data is present online
or it's visible.
Consumers can go and
therefore quickly decide which particular provider do they want to view.
It helps reduce our search cost.
So you compare and present data across providers.
All providers are the same.
I put them on the same platform, people can see, and that kind of
a value proposition is going to be very useful, because compare and contrast.
Do we have such models online, do such Internet companies exist,
or such players?
Of course, they do.
There are comparative search engines.
You go to one place.
For example, you want to buy an airline ticket.
You go to one site and they will tell you what's the price of that particular ticket
on multiple sites, on over, on online travel agents,
on websites, so where can you find a price that you're willing to pay for?
And what are those kind of place called?
Aggregators.
So, step back.
So we say, what are aggregators useful?
Why have aggregators risen in certain industries?
Aggregators essentially arise in industries where
the products are generally similar.
There are many, many different players.
If you don't have many,
many different players, aggregators add no value because they reduce,
they do not reduce enough of our costs, and the cost is low in the first place.
And aggregators have nothing to compare or
aggregate if the products are very, very different, then it's very hard to know.
So, industries which are essentially commodities but
have many, many different players, aggregators can play a very large role.
So, think about an industry in which aggregators are very controversial, and
they're often criticized.
And let me take the example of Google News.
Well, what's Google News?
Google News is an aggregator.
It takes news items from different newspapers and puts them all in one place
so you don't have to go to different sources.
Why does Google News make sense?
Why is it so popular?
Why do people read their news from Google News?
Let's apply our own particular model, what I said earlier.
How many newspapers are there around the globe?
Many, many, many.
So many newspapers, many providers.
Are the news essentially same across the different newspapers?
And most of us would probably say yes.
So it's a commodity.
Many, many providers essentially supplying the same product.
Aggregators come in, they take all that information, put it in one place, so
that we don't have to go anywhere else.
So that's why aggregators make sense in the news business.
But the news business is changing.
If I want to predict what's going to be happening in the newspaper industry,
just look at some trends.
What's happening tomorrow as far as news is concerned?
The newspaper industry is consolidating, okay.
Many newspapers have gone out of business.
The number of players is dramatically shrinking.
Newspapers are not making money.
Will aggregators still make sense?
You decide.
Will aggregators still make sense based upon the things that we are discussing?
That's the predictive power, using the lens of transaction cost.
Just the newspaper industry, why has it been hit by aggregators, and
Google News is often criticized.
But if Google News no longer is going to be valuable,
what do you think should be the ingredients in that particular industry?
If you are Google,
should you be worried about the trends in the newspaper business?
Perhaps so, because of all these particular things which are happening.
Right, so
transaction costs offer an exploratory framework to
understand how different industries will get impacted and
to make some predictions of industries that are going to be evolving.
All you have to do is to look at rise and fall in transaction cost, and
you can look at whether that industry is right for transformation, or the Internet
won't make that much of a difference in that particular industry, yeah?
Before we conclude this particular segment and the discussion on
transaction cost, I'd like us to understand some fundamental assumptions.
We haven't talked about those.
All we've said is there are costs to using the market.
These costs are called transaction costs.
But if we stepped back and say why do these costs occur in the first place?
All I said earlier is that that's an architecture of the market.
That is, because of the structure of the market.
Because there's a market, there's a cost.
But why do these costs exist in the first place?
What's the underlying fundamental reason?
Let's understand those particular assumptions.
So, why are search costs so high?
Well, as consumers, why do we get tired?
Why do I keep on saying, look, I cannot keep on searching all the time?
Well, why do we say that this cost is too high?
Right.
Why can't I as a consumer say, look, I have infinite amount of time,
I have a computer system, I can put hours, I can do all I want.
So search costs are trivial for
me because I have all the tools at my particular disposal.
But you know one thing, you can have all the tools,
you can have all the technology,
you could be sitting in front of the computer all day.
But is it humanly possible to spend all that particular time?
And so, do we have the mental ability to search and compare?
And the answer is obvious,
obviously not.
Our cognitive abilities are,
we have only that much of cognitive abilities, or cognitive bandwidth, right.
You cannot just keep on searching, even if you have all the tools in the world.
Because of our human brain,
because of the limitations of our own particular cognitive thinking.
So it's this particular cognitive thinking as human beings which imposes these
particular search costs.
And this particular underlying reason is called bounded rationality.
So the first assumption underlying transaction cost,
the reason transaction costs arise, is bounded rationality.
Our rationality is bounded,
we have limited memories and limited cognitive processing powers.
If I was to give you a slightly perhaps off-the-cuff example.
We are living in the age of machines.
Does a machine have the same limited memory and cognitive powers ability?
Would machines suffer from bounded rationality?
And obviously, the answer is no, they don't get tired.
Okay. Robots are not going to get tired.
If a robot is going to be doing something there is no question of
a search-related transaction cost because they don't have bounded rationality.
But humans beings do.
So that's why there are those bounded rationality costs, so
that's the first fundamental assumption.
What else?
Why else, let's look at another underlying assumption.
Why do transaction costs arise?
Take bargaining.
Why do we find, why is bargaining so cumbersome?
Why is bargaining so high?
We know that there is bargaining, but
why is there bargaining in the first place?
And in some industries, why is bargaining cost so high?
Well, very simple.
Bargaining is a function of how much information buyers or sellers have.
And typically, sellers have more information, right.
Only then you have bargaining.
You walk in to, let's say you want to buy a used car.
You walk in to a salesman, he has a whole lot more information,
you know you're going to be in for a ride, metaphorically speaking.
It's not going to be fun.
So, sellers have a lot more information, and because of this particular fact,
there is bargaining which takes place.
Because of this information inequality, or what's called information asymmetry.
If there is no information asymmetry, there is no bargaining.
So the second assumption behind transaction cost is information asymmetry.
And the reason for understanding this assumption is,
as we move forward, in the future, is information going to be more asymmetrical?
Are people going to be having unequal amounts of information? Or
generally information will become more equal,
everybody will have the same amount of information? Which means what's going to
happen to transaction cost, in general, across all industries as we move forward.
We can look at it and we can make our own particular assumptions about
information asymmetry and bargaining.
The third reason why a transaction cost arise. See,
information asymmetry by itself is not bad.
You have more information, somebody has more information, somebody has less.
But we can share all that particular information with each other.
Information asymmetry only becomes bad if you use information asymmetry, or
information that we have, in our own self-interest or
to take advantage of somebody else.
So by itself, information differential is okay.
But I've used that information differential to my own selfish advantage,
to take advantage of others,
that's what makes it bad.
It's the human behaviour which results, the tendencies that we have,
our own particular proclivities.
Okay. And this particular inclination of trying to act on
our own particular self-interest is called opportunism.
So that, I have this tendency, people have this tendency not to be entirely honest,
and people have a tendency to take advantage of others.
Okay.
So three fundamental assumptions,
three fundamental reasons why transaction costs exist.
If I can summarize, bounded rationality -
we have only that much of brains and cognitive abilities.
Information asymmetry, there's always going to be, I know something more,
you know something more.
There's always going to be information asymmetry between two people.
And lastly, the tendency to act in our own particular interest.
That's where we are.
Those are some of the reasons behind transaction costs.
But think about society going forward.
Where are we headed as a society?
Do you think, as we move forward in society,
if I was to pose you just one single last question.
As we go forward, for example, are we becoming smarter?
If we are becoming smarter, will there still be transaction costs?
Or what's going to happen to transaction costs?
If, as we go forward, are we becoming more selfless?
Less selfish?
If the answer is yes, what will happen to transaction costs in the future?
Are we becoming more social, more giving, more understanding of each other.
If that's the case, what is going to happen as transaction cost is concerned?
As you ponder out these particular things, and through the lens of transaction cost,
ask this broader question, also about the Internet.
We say the Internet has been a powerful transformation force.
The Internet, one of the reasons why the Internet has been so
transformational is because it has reduced transaction cost.
But have we as a society evolved,
become smarter, become more understanding, less selfish?
What will the Internet then hold the same power as it does today?
Ask the question in the, with the lens of transaction cost, and
that's the power of transaction cost -
to allow us some predictive abilities as well as interpretation ability.