Author Abstract
The duration of a vertical relationship depends on two types of costs: (i) the transaction costs of reselecting a supplier and (ii) the cost of being matched to an inefficient supplier when the relationship lasts too long. For commodified goods and services, this tradeoff can be the primary determinant of the duration of supply contracts. I develop a model of optimal contract duration that captures this tradeoff, and I provide conditions that identify underlying costs. Latent transaction costs are identified even when the exact supplier selection mechanism is unknown. I estimate the model using federal supply contracts and find that transaction costs are a significant portion of total buyer costs. I use the structural model to estimate the value of the right to determine duration to the buyer, compared to a standard duration. Finally, a counterfactual analysis illustrates why quantifying transaction costs is important for the accurate analysis of welfare.
Paper Information
- Full Working Paper Text
- Working Paper Publication Date: December 2017
- HBS Working Paper Number: HBS Working Paper #18-058
- Faculty Unit(s): Strategy