Sales: A Transaction Cost Theory Perspective
Hello everyone!
Let’s say we want a table. There are few ways you can go about getting a table. First, you may go to the market, climb into a few shops, compare alternatives, and then make a purchase and plan to ship it home. But this is by no means the only way to get a table. That brings us to the second option – make it. Let’s say you’re a DIY kind of person. You can go to the market, get some wood, nails, power drills, saw, sandpaper, paint, and other items and then work on the material and make a table. Third, you could theoretically get some mahogany seeds, plant them, wait for the tree to grow up. Use this time to mine for some iron ore and learn smelting and make your tools yourself. I can go and on and make it more ridiculous with every attempt, but I’m sure you get the idea. Whenever we want to get something, we must choose between making something and buying it readymade (remember are can be options in the middle too- shades of grey are always present). Now. How does one decide which route to follow? The answer, according to Ronald Coase and Oliver Williamson (both Nobel Laureates btw) is transaction costs.
A quick Wikipedia search will tell you that transaction costs are the “total costs of making a transaction”, and that they include “planning, deciding, changing plans, resolving disputes, and after-sales” costs. Simply put, these are the hidden costs that one incurs when doing just about anything in the economy. And by extension, ‘hierarchies’ (companies, firms, and other forms of organisations) begin to emerge when transaction costs are very high and it makes economic sense to ‘make’ instead of ‘buy’.
Let me take the example of Indus towers to illustrate this point. Indus Towers Limited is an “independently managed company offering passive infrastructure services to telecom operators and other wireless services providers such as broadband service providers” according to their website. Its job is to own and operate the towers that provide the 4g cellular connectivity. Let’s say we want to start a telecom firm today to compete with Mukesh Ambani, we can go to Indus towers and ask them to provide us with connectivity across the country. Subject to us having the necessary licenses from the telecom ministry, we will be allowed as well. This is a marketplace solution. Basically, it’s a solution that emerges when I go to the market and get something readymade. However, I can also choose to set up my own towers and invest in land and labor and other resources to manage the towers. This is a hierarchical solution. Whenever the marketplace solution is more expensive than the hierarchical solution, I go ahead and build a hierarchy (meaning firm or institution). However, if the marketplace solution is cheaper, I would use that instead. Ronald Coase and Oliver Williamson basically argue that it is precisely for this reason that firms exist.
A little bit of digging into your textbooks will tell you that there are three types of transaction costs. They are, (1) information and search costs, (2) bargaining costs, and (3) enforcement costs. i.e., the costs of acquiring and searching for suitable alternatives, the costs of bargaining for the best possible price, and the costs of ensuring that the product or service that has been purchased performs as intended. What’s interesting about this and why are we talking about this in the sale and distribution class you ask? Well, a good salesperson knows that he owes his job to transaction costs. Think about it this way. If you were to take useful and actionable insights to your clients, give them a transparent pricing structure with no reason to bargain, and ensure that your product really meets their requirements – you basically help reduce transaction costs for your clients and help build profitable long-term relationships with them. In fact, salespeople have the unique option of being very close to clients. So close that they know the needs of the clients ‘as if’ they worked for the client.
Until some time back, Apple and Intel were strategic partners. This was announced by Steve Jobs with a lot of fanfare way back in 2006 (I’m attaching a video of this event for you, do check it out).
Imagine the kind of intimacy that must have existed between the firms. Apple was notoriously making their devices thinner and lighter. That meant that Intel needed to make processors that enabled this. If Intel was not able to push its limits, then Apple would not be able to offer ridiculously long battery life. This kind of changed and we witnessed this happen just a few years back. Apple and Intel broke up, and Apple decided to make it’s own processors. According to this CNBC article., “The first M1 Apple chip was launched in 2020 in a MacBook Air laptop. It was more powerful than Intel’s chip while offering longer battery life and enabling a fanless design, which helped keep Apple’s new MacBook Air even quieter. It proved to be an early success.”. If one were to read between the lines, one could make out that the breakup happened because of some sort of incompatibility. Perhaps Intel was not able to supply chips to the specification that Apple was demanding.
Who made it possible for such organisations to work so closely together? Salespeople!! That’s basically ‘future you’!! Maybe you sell copier paper to small offices. But then, could you think about it using transaction costs?
Can you, in some way, ensure that hundreds of small offices do not have to go around routinely searching for copier paper in the market? Yes. That’s why you do visits!
Can you ensure that there is lowering of bargaining costs? Yes. That’s why you have negotiated prices and automatic replenishments set up.
Can you ensure that their printers don’t jam due to low quality paper and reduce their down time? Yes!! That’s basically ensuring that the product that you send them reaches them in the best possible condition.
That’s basically it. Salespersonship summarised from a theoretical perspective!
To push it a little further. If your competitor can lower transaction costs down even further for a client, he gets the client. Plain and simple!
Remember, sales is not only about getting approvals for lower selling prices and pushing the product into the market. It is about retaining your existing customers and making sure that they are happy. It’s pretty easy to propose to someone and sweep them off their feet with your charm, but then, staying in that relationship and making it work- that’s a whole other ball game. A game that you will have to learn to play!
Good night!
See you with another newsletter article! I’m thinking of calling it “Salespeople: Netas in suits?”
