Transaction Costs and Competency Development

In 1937, Ronald Coase, wrote an essay “The Nature of the Firm”, through which he introduced the concept of “transaction costs”. Ronald Coase was to later on receive the Nobel Prize for Economics. In economics a transaction cost is a cost incurred in making an economic exchange. Transactions costs are the costs which directly hamper the competitiveness of companies and where all things being equal, would determine the rise or fall of these companies.

So how does one relate the concept of transaction costs to long term viability of organizations? One answer as given by Jeffrey K Liker, in “The Toyota Way” is:

“Base your management decisions on a long-term philosophy, even at the expense of short-term financial goals”

This is an important aspect to be considered by the service industry. The service industry has been growing globally and in many countries represents in excess of 50% of those countries GDP. The Indian IT industry is primarily composed of the services sector. So what is a service and how do we reduce transaction costs here?

A Service has been defined in many ways. One definition has been given in the ITIL Service Design Book; “A means of delivering value to customers by facilitating outcomes customers want to achieve without the ownership of specific costs and risks.”

This is like a caterer providing cooked food to an organization for lunch where the company does not want to set up its own kitchen and hire its own workers to produce lunch, or an Insurance company engaging the services of a BPO to process its claims, or a Telco using the services of a provider to process the paperwork of the millions of clients signed up each year. There are so many other services, like remotely managing infrastructure, or software maintenance work, or even development work.

Efficiencies in all are achieved by better “quality”. Better the quality, lower are the transaction costs. For service providers the quality comes from better equipped people. If the service provider has systems in place to ensure less wastage, or reduced effort in providing services, it is more competitive. To have better quality one needs to understand Peter Drucker’s statement “Quality in a product or service is not what the supplier puts in. It is what the customer gets out and is willing to pay for”. So reading Drucker’s statement, we can take it that quality is developed by creating internal competencies or capabilities which help in reducing the transaction costs and hence improve competitiveness over time.

Further in organizations, one of the supplier’s is the L&D or competency development department. Developing internal competencies is not a one shot affair, but a process of continual effort of time and money in building people. Developing capability happens when you enable people to get a sense of real life exposure through scenario based training. As Confucius said:
“I hear and I forget, I see and I remember, I do and I understand.”

For any company to grow, its people are its strength’s. This is a Maxim, we have heard for a very long time. However the true strength is not in the people alone, but in the “talented and productive people”. To develop people, one needs to see the long term perspective and build in the systems and their associated costs and not take the short cut by having a transactional approach to competency development.