Transaction Cost Economics of Agricultural Product Exchanges for Biopower: Theory and Evidence

1. Transaction Cost Economics of Agricultural Product Exchanges for Biopower: Theory and Evidence Ira Altman Graduate Research Assistant Community Policy Analysis Center Department of Agricultural Economics University of Missouri-Columbia

2. Overview • Background • Theory • Empirical Literature • Application • Conclusion

3. Background • 2 power plants considering the use of agricultural products in Missouri • CPAC current project • Complementary project • Working research question: How can a biomass exchange be most efficiently organized?

4. Theory • Leading organizational economics theory – Williamson’s transaction cost economics • Designed to compare the costs and benefits of competing organizational forms • The theory is still developing • Application to biomass exchange may test the theory on an emerging industry and lead to efficient organization of the biopower industry

5. Theory • Working hypothesis: transactions are aligned with organizational form in a transaction cost minimizing way • Transaction attributes imply varying levels of transaction costs depending on the organizational form chosen • Decisions makers will choose the least cost method of exchange • Key attributes of the transaction are: asset specificity, uncertainty and frequency

6. Theory • Asset specificity creates bilateral dependency and opens players up to opportunism • Asset specificity– durable assets that have a significantly lower value in alternative uses by alternative users • Types of asset specificity include physical, spatial, dedicated assets, human asset specificity, and temporal asset specificity

7. Theory • Organizational forms include spot markets, hybrids such as the use of contracts, and internal organization (vertical integration) • Two key predictions: 1. If asset specificity is low: a market organizational form is least cost 2. If asset specificity is high: an internal organizational form is least cost

8. M(k) $ X(k) H(k) k2 k k1 Asset Specificity Organizational Costs as a Function of Asset Specificity Source: Adapted from Williamson, 1991

9. Empirical Literature • Types: – qualitative case studies – quantitative case studies – cross sectional and panel regressions • Focus: – contract level – governance level – institutional level • The choice of organizational form is modeled as some function of asset specificity and other explanatory variables

10. Empirical Literature • Dependent variables: – internal versus market exchange (the governance level) – price and length of contract or other contract provisions (the contract level) – policy choice as an institutional variable (the institutional environment level)

11. Empirical Literature • Common independent variables include some measure of asset specificity and uncertainty • Measures for asset specificity: – characteristics of the technology – number of buyers and sellers – closeness of buyers and sellers

12. Empirical Literature • Supportive of the theory– asset specificity variables statistically significant • Addressing data problems did not change the support of the data for the theory • Several studies on natural resource industries such as coal, natural gas and oil

13. Application • Mail survey of 200 biopower plants – contact information from the Energy Information Administration • Important information from the survey: • Biomass exchange type (external, internal or both) • Asset specificity including: physical asset specificity, spatial asset specificity • Other potential explanatory variables

14. Application • Physical asset specificity measured by the flexibility of the technology – high biomass flexibility and fossil fuel flexibility would imply low levels of asset specificity • Spatial specificity measured by average hauling distances to the power plant – low hauling distances or adjacency may indicate high spatial specificity

15. Application • Data are moderately supportive of the theory

16. Application

17. Application • Other variables less supportive • What explains why the data may not support the theory? – Survey design – Small sample size

18. Application – Missing important variables– other organizational theories may be required to advise the industry – Inefficient firms – empirical assumption that observed organizational forms are efficient – may be an inappropriate assumption because industry immaturity – a dynamic approach may be necessary

19. Conclusion • Use spot markets or short term contracts if: – Flexible technology – Many possible fuel types – High hauling distances – Many suppliers (low asset specificity) • Use long term contracting or internal organization under the opposite conditions

20. Conclusion • Future research – update the survey results and use more empirical methods to understand the data – apply the theory to logistical questions: who should complete storage and processing of biomass? – apply the theory to contracting questions: what type of contracts should be used? What type of vertical integration should occur?