Measuring and Managing Ex Ante Transaction Costs in Public Sector Contracting

Date01 September 2019
AuthorMatthew Potoski,Erik Baekkeskov,Ole Helby Petersen,Trevor L. Brown
Published date01 September 2019
Measuring and Managing Ex Ante Transaction Costs in Public Sector Contracting 641
Trevor L. Brown is dean of the John
Glenn College of Public Affairs, The Ohio
State University. He conducts research
and teaches on public management and
leadership, governance, government
contracting, public-private partnerships,
and democracy and democratic transitions.
Matthew Potoski is professor in the
Bren School of Environmental Science and
Management, University of California, Santa
Barbara. He is coauthor of
The Voluntary
(Cambridge University
Press, 2006) and
Complex Contracting
(Cambridge University Press, 2014) and
has written on a variety of topics, including
businesses environmental strategies,
environmental policy, and public and
nonprofit management.
Erik Baekkeskov is senior lecturer
in public policy and political science at
the University of Melbourne, Australia.
His research interests include public
administrative reforms and public policy
Abstract: Transaction cost attributes, such as the complexity of the product being purchased, shape the risk that
government contracts will fail. When transaction cost risks are particularly strong, a common prescription is to avoid
contracting altogether or, if it is unavoidable, to spend additional resources on contract management activities. This
article presents evidence on the size and variability of governments’ ex ante transaction cost spending, using original
data from 72 contracts issued by 47 Danish local governments. Ex ante transaction costs average 2.7 percent per
contract and are relatively higher when services are more complex and lower when governments have prior contracting
experience and contracts were larger. The analyses suggest the importance of distinguishing between transaction cost
attributes and governments’ choices to spend resources in response to them. Effective management spending in the face
of transaction costs can help governments organize and capture value from contracting with private businesses.
Evidence for Practice
• Danish local governments spend 2.7 percent of contract value on ex ante transaction cost expenditures.
• Ex ante transaction cost spending varies in response to the complexity of the product, the size of the contract,
the government’s fiscal capacity, and the government’s contracting experience.
• Governments’ transaction cost spending reflects transaction cost attributes that influence the risk of negative
contract outcomes.
Governments often look to reduce costs by
purchasing products and services instead of
making them, under the idea that market
competition among suppliers drives down prices
(Sclar 2000; Van Slyke 2003). When governments
purchase a product or service, part of the overall
cost is the resources it expends on finding and
selecting vendors, negotiating contract terms,
monitoring vendor performance, and ensuring
that the delivered product meets specifications—
items that are collectively referred to as transaction
costs (Williamson 1996). At first glance, spending
motivated by transaction costs can seem wasteful—it
raises the total cost without directly increasing the
amount or quality of the purchased product. On
closer scrutiny, however, transaction cost spending
can be essential for mitigating risk and ensuring
that contracts produce value. For instance, without
proper care in writing and monitoring a refuse
collection contract, the vendor may fail to pick up
garbage on a regular schedule or return bins to their
proper locations. Getting the right contract terms
may be even more important for products that
are more complex, such as eldercare programs or
information technology systems (Brown, Potoski,
and Van Slyke 2010).
An important objective in contract management is to
allocate resources and establish procedures to manage
contract risk and improve contract value. The nature
of this challenge depends on characteristics of the
product and circumstances of the contract—what
are sometimes called transaction cost attributes
(Williamson 1979, 1991, 1996). The practice of
contract management can be challenging for several
reasons. First, unlike purchasing costs, where prices
tend to be negotiated and posted, transaction cost
spending can be more difficult to observe and
measure. Such spending tends to be dispersed across
budget categories and involves less tangible resources
such as time, effort, and expertise. Second, the
need for transaction cost spending is highly variable
across products and circumstances; the need is lower
for simple products that are commonly bought
and sold in robust markets, and the need is higher
for complex products that must be designed and
produced for the purchaser’s unique requirements
(Levin and Tadelis 2010). Finally, while spending
on some transaction cost items is inevitable, such
as specifying a refuse collection schedule, other
transaction cost spending can be managed, and
perhaps even reduced in some circumstances,
without sacrificing value.
Ole Helby Petersen
Roskilde University
Erik Baekkeskov
University of Melbourne
Matthew Potoski
University of California, Santa Barbara
Trevor L. Brown
Ohio State University
Ole Helby Petersen is professor of
public administration and director of the
Center for Research on Public-Private
Collaboration at Roskilde University,
Denmark. His research interests include
public sector contracting, transaction
costs, privatization, and public-private
Public Administration Review,
Vol. 79, Iss. 5, pp. 641–650. © 2019 by
The American Society for Public Administration.
DOI: 10.1111/puar.13048.
Measuring and Managing Ex Ante Transaction Costs in
Public Sector Contracting
Research Article

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