Since businesses are the foundation of any economy, academics and professionals are interested in how businesses run, function, and adopt organisational structures. Recent years have seen much discussion among economists and sociologists on studying businesses and their behaviour (Kanter, 2019). Social embeddedness and transaction costs are alternate theories describing how organisations behave, function, and choose their organisational structure. These theories have substantial ramifications for comprehending healthy behaviour and were created to give a thorough grasp of company behaviour. (Ketokivi, 2020) In this article, I shall analyse the main distinctions between these two theories and their consequences for comprehending business behaviour.
Two alternate theories that may be used to describe how businesses run and the organisational structure they choose are social embeddedness and transaction costs. Both theories help understand how companies behave, but their views and ramifications differ. While transaction costs, as presented by Coase, concentrate on the expenses of getting a specific function on the market, social embeddedness, as proposed by Granovetter, highlights the impact of social interactions in influencing economic behaviour (Bair, 2008). In this article, I shall analyse the main distinctions between these two theories and their consequences for comprehending business behaviour.
According to Granovetter’s theory of social embeddedness, social interactions and norms are ingrained in economic behaviour. According to Granovetter, economic actors are social agents enmeshed in a network of social ties rather than independent people. This network of social connections develops a foundation of trust, which might encourage economic agents to act less selfishly and more cooperatively (Wang, 2022). This theory is especially helpful in explaining how businesses behave in industrial areas where there is competition, cooperation, innovation, and some degree of adaptation.
The cluster of small and medium-sized businesses in the automotive sector in the West Midlands area of the UK is an illustration of this idea in action. A vast number of businesses that specialise in various facets of automobile manufacture, including engine manufacturing, transmission production, and bodywork, are located in this industrial area known as the “Birmingham Automotive Cluster.” (Anoyrkati, 2022) These businesses are intensely competitive with one another, but they also work together in a number of ways. For instance, they frequently cooperate on research and development initiatives, exchange information and resources, and seek to entice new companies and investments to the area. Because of this societal integration, businesses in the West Midlands automotive cluster have a high level of trust and collaboration. This trust and cooperation have enabled the firms to innovate quickly and effectively. They can adapt to changes in the market and technology more efficiently than firms not embedded in such a network.
On the other hand, Coase’s theory of transaction costs concentrates on the expenses associated with designing and carrying out economic transactions. According to Coase, businesses exist to reduce transaction costs, such as those involved in searching for, screening for, and negotiating for a specific function on the market (Bylund, 2019). This idea is especially helpful in understanding how businesses behave in markets where it is dangerous to subcontract. In these industries, businesses frequently internalise tasks and provide incentives for employees to work together to meet changing demands without harming the district’s potential for productivity.
For instance, companies may produce certain parts and components internally rather than outsourcing them to external vendors in the UK’s automotive sector. The high transaction costs of organising and managing relationships with several suppliers, particularly in a sector where demand might change quickly, motivated this choice. Internalising production enables businesses to reduce transaction costs and better manage the quality and supply of these parts and components, both of which are essential for sustaining the business’s smooth operation and adjusting to demand variations.
In contrast to transaction costs, which stress the expenses associated with purchasing a specific function on the market, social embeddedness emphasises the influence of social interactions in determining economic behaviour. Transaction costs offer a more micro-level perspective on how companies make strategic decisions. In contrast, social embeddedness offers a more holistic perspective on how organisations run, function, and adopt organisational structures (Moeller, 2019). For instance, the idea of social embeddedness contends that societal norms and values, as opposed to only market factors, may impact enterprises. Due to this, businesses may behave cooperatively, even if it is not rational or in their best interests. On the other hand, the theory of transaction costs suggests that firms will only engage in efficient and profitable activities as determined by market forces.
The potential for collaboration and trust among businesses in industrial districts are highlighted by social embeddedness in terms of its ramifications and the significance of social interactions in influencing corporate conduct. This theory implies that promoting a positive social environment might result in improved outcomes for enterprises, which has significant consequences for practitioners and politicians. On the other hand, the theory of transaction costs has ramifications for managers and businesses since it contends that a firm’s ability to survive and thrive depends on its ability to minimise transaction costs. This theory emphasises how crucial it is to efficiently and effectively coordinate economic activities and how businesses should internalise tasks and foster collaboration to reduce transaction costs.
For instance, a company operating in an industrial area where businesses have strong social ties may find it simpler to collaborate and develop partnerships with other businesses there. Since businesses may exchange information and resources and cooperate more freely when there is trust between them, this can result in greater efficiency and creativity. On the other hand, a company operating in a sector with high transaction costs can find it more advantageous to internalise some operations, such as production or distribution, to reduce the expenses associated with obtaining those operations on the open market. As a result, the company may become more effective and have a more efficient organisational structure. In this case, the firm will minimise the cost of distribution and production and have substantial control over the quality of its product.
To sum up, two other theories may describe how businesses run and their chosen organisational structure: social embeddedness and transaction costs. Although their viewpoints and consequences differ, both theories offer insightful information about how firms behave. While transaction costs concentrate on the expenses of getting a specific function on the market, social embeddedness highlights the significance of social interactions in influencing economic behaviour. Practitioners and policymakers may make better judgments and boost business performance by being aware of the main distinctions between these two philosophies.
References
Anoyrkati, E. and Avarello, A., 2020, June. Creating Smart (er) Cities by Accelerating Innovation in Transport Small and Medium Sized Enterprises (SMEs): The Case of West Midlands Region. In Conference on Sustainable Urban Mobility (pp. 329-334). Springer, Cham. Available at: https://www.gov.uk/government/publications/automotive-sector-deal/auto
Bair, J., 2008. Analysing global economic organisation: embedded networks and global chains compared. Economy and Society, 37(3), pp.339-364.
Bylund, P.L., 2019. The firm vs the market: Dehomogenizing the transaction cost theories of Coase and Williamson. Strategic Management Review, Forthcoming.
Kanter, R.M., 2019. The future of bureaucracy and hierarchy in organisational theory: a report from the field. In Social theory for changing society (pp. 63-93). Routledge.
Ketokivi, M. and Mahoney, J.T., 2020. Transaction cost economics as a theory of supply chain efficiency. Production and Operations Management, 29(4), pp.1011-1031.
Moeller, K. and Sandberg, S., 2019. Putting a price on drugs: An economic, sociological study of price formation in illegal drug markets. Criminology, 57(2), pp.289-313.
Wang, F.F., Wu, J. and Gong, X., 2022. Relationship coordination between successor and top management team in family business under social embeddedness: a case study of trans-generational entrepreneurship. Nankai Business Review International, (ahead-of-print).
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