Explaining the swollen middle: Why most transactions are a mix of “Market” and “Hierarchy”? By: Hennart, Jean-Francois. Organization Science A Paper Summary By Amit Darekar

Questions this paper addresses…  Why are firms sometimes more efficient than markets at organizing transactions?  Why are most transactions arrayed in the “swollen middle” incorporating features of both “market” and “ hierarchy”?  Why don't firms make greater use of price incentives?

Key Building Blocks  The distinction between organizing methods (hierarchy & the price system) and institutions (firms & markets)  Hierarchy and Price System –  These are distinct methods for organizing transactions  Firms and Markets –  These are institutions which use one or both of these methods of transactions

Enforcement properties of Hierarchy & Price Key AspectHierarchyPrice Control Individuals are controlled directly by constraining their behavior Individuals are controlled indirectly by measuring their outputs Rewards One receives salary to do as told One receives remuneration basis one’s output Pros Few incentives to cheatMaximizes efforts Cons People tend to minimize their efforts unless supervised Encourages individuals to inflate prices and / or reduce quality of output Shirking Costs Cheating Costs

Organizing Costs  Sum total of Shirking Cost and Cheating Cost is Organizing Cost  The paper shows that Shirking Cost and Cheating Cost increase more than proportional as one tries to concentrate in pure price or pure behavior constraints  Using a mix of both the methods generally minimizes organizing costs

Hybrid Arrangements  Determinants of the choice of institution with non-linear organizing costs  Explains the presence of transactions exhibiting features of both markets and hierarchy.

Conclusion  The paper shows how Transaction Cost Economy (TCE) theory can be extended to respond to questions raised by its critiques  The paper outlines the differences in the two polar organizing methods of price and hierarchy  It goes on explaining that the hybrid arrangements that make up the "swollen middle" can be analyzed as a tradeoff between these two types of costs resulting in lower organizing costs  It also discusses the limits to the use of price incentives in firms  Further the paper clarifies the relationship between hierarchy and firms  Lastly, it addresses the problem of distinguishing “firms” from “market”; this can be done by making clear distinctions between organizing methods and institutions