" The TCE ApproachThe Transaction Cost Economics (TCE) approach notes that in addition to production costs,governance costs exist that need to be weighed when considering whether to make or buy aparticular asset/activity.Transaction costs = production costs + governance costsGovernance costs include those associated with the effort required to select partners (adverseselection), to negotiate and monitor contractual compliance (moral hazard) and to protectagainst the potential that a partner may opportunistically recontract (holdup). Governancecosts include:? Adverse selection (select partners)? Moral hazard (negotiate and monitor compliance)? Holdup (protect against opportunism)In contrast to approaches that emphasise bargaining power or trust, the TCE approach notesthat market transaction costs increase more than internal administrative costs under certainconditions. Two factors dominate. First, environmental uncertainty increases the cost ofselecting and contracting with partners. Second, as an asset becomes more specific to thepartners (i.e. it is costly to redeploy in a second-best use), the potential for holdup increases.The goal of the transaction cost approach is to estimate the transaction cost of a relationshipand to select between governance mechanisms (e.g. in-house or outsource) based on a fullaccounting of production and transaction costs.The main drivers of transaction costs are the specificity of the assets required for therelationship and the uncertainty regarding a sourcing partner’s future behavior. This behavioral uncertainty may be affected by exogenous uncertainty due to the inability topredict demand or shifting technologies. More volatile demand or technology suggests morefrequent opportunities for opportunistic partners to renegotiate the contract. That is, the TCEapproach suggests that uncertainty both directly influences transaction costs and interactswith asset specificity (see Figure). Digging deeperMoreover, in their book, Pursuing the Competitive Edge, Hayes et al. (2005) added thedimensions of coordination, strategic control and intellectual property to the assessment ofmake or buy decisions. Quinn and Hilmer (1994) discussed the impact of core competencyand the strategic vulnerability on the sourcing decision. They defined core competency as thepotential that the activity will be a source of competitive edge. They also defined the degreeof strategic vulnerability as the risk that the outsourcing of this activity will have on theoverall strategy of the firm. Chopra and Meindl (2007), in their book Supply ChainManagement, discussed how the presence or absence of ?supply chain surplus? will impactsourcing decisions. The main question raised by them was, Does outsourcing produce supplychain surplus? In other words, will the vendors offer any economies of scale or riskaggregation that a buyer cannot achieve by itself? Or, can they do it cheaper and better?6 Total Cost of Ownership[This page should take about 30 minutes to complete] flickr photo sharedby Hacklock under a Creative Commons ( BY-NC-SA ) licenseIn general, purchasing managers utilise four basic procedures to determine potential vendors’prices:? commodity markets,? price lists,? price quotations, and? negotiations.As noted in the Sourcing Decisionschapter of this workbook,, the process begins with thebuyer sending potential vendors requests for quotes (RFQ). In turn, the vendors examine thecost they will incur in filling the order including profitability. The purchaser compares thevendor’s quoted price and offer specifications with those of other vendors.Negotiation is useful when the other methods (i.e. commodity markets, price lists, pricequotations) do not apply or have failed and is particularly effective when the buyer isinterested in a strategic alliance or long-term relationship. "