Transaction Cost Economics

Transaction cost economics is a theory of the firm, most closely associated with Ronald Coase's foundational 1937 article The Nature of the Firm and later substantially developed by Oliver Williamson, that explains why economic activity is organized within firms rather than coordinated entirely through market transactions. The theory holds that firms exist because conducting certain transactions through markets involves costs, such as the costs of searching for a trading partner, negotiating and enforcing a contract, and safeguarding against opportunistic behavior, that can be reduced by bringing the transaction inside a single organization instead. Transaction cost economics is widely used in management and strategy to analyze decisions such as whether a company should make a component itself or buy it from an outside supplier.