What term refers to the costs incurred by buyers when they change to a different supplier?

Looking at the paragraphs above, you may notice that Poulton et al frame their thinking about the advantages and disadvantages of small farms in terms of transaction costs.

3.3.1 A definition of transaction costs

In a food marketing setting, transaction costs are the whole array of costs associated with buying, selling, and transferring ownership of goods and services. They are:

• the information costs incurred in identifying and screening different trading opportunities, outlets and partners
• the costs of negotiating trading agreements
• the costs of actually transferring goods, services and ownership rights
• the costs of monitoring trade conditions to determine whether the agreed terms are complied with
• the costs of enforcing stipulated terms through legal, social or other means

Source: based on Jaffee (1995) p. 28.

Jaffee (1995) describes three main dimensions that determine the level of transaction costs in the trading environment:

• Asset specificity: the extent to which physical and other assets required for production and exchange are durable and specialised for a particular product or trading relationship. Investing in specific assets exposes the investor to the risk of severe bargaining and contractual enforcement problems, as they may be locked into a particular trade relationship. Tree-crops, with extended gestation periods, are an example of asset specificity: for instance coffee takes at least three years after planting to produce its first crop. Once the farmer has planted coffee, it is difficult to switch their investment to an alternative.
• Uncertainty: the overall degree of uncertainty surrounding the exchange leads to increased transaction costs because more effort needs to be expended collecting information in order to minimise risk, and monitor contract implementation. A farmer might choose to sell their produce through a broker, for example, but they need to know whether the broker is trustworthy and giving them a good deal. Finding this out may incur additional costs.
• Competitive market structure: in particular the number of alternative buyers and sellers affects the ability of trading partners to negotiate and enforce agreements. Where remote farmers have only one or a few intermediaries offering to buy their produce at the farmgate, they are in a poor negotiating position to get a good price, raising their transaction costs.

While these three elements may determine the level of transaction costs faced by market participants, a weak institutional environment can exacerbate transaction costs for all participants, and conversely changes to the institutional environment can help reduce overall transaction costs, reducing the cost of doing business - and of marketing products.

3.3.2 Weak institutions and transaction costs

'The 'weak institutions' argument adds a further explanation for slow market development in terms of weak institutional support to market and private sector development (World Bank, 2002) with cultural, political and legal factors undermining clear property rights and hence private investment incentives. Here the liberalisation agenda that tried to escape the problem of state failure in market interventions has run up against different problems of serious state failure, now in delivering public goods - the institutions and infrastructure needed for privatised competitive markets to operate in the challenging conditions where poverty is most intractable.'

Source: Dorward et al (2005) p. 81.

Can you think of an example of ways in which the institutional environment might help limit transaction costs?

Which 'dimension' of transaction costs would this affect?

Jaffee distinguishes six different types of transaction costs, identifies their origins and provides examples of different forms of transaction costs, shown in 3.3.3 below.

3.3.3 Transaction costs in a commodity trading setting

Source: Jaffee (1995) p. 30

What is the term switching cost?

What are the three types of switching costs?

What is it called when individuals or organizations incur an expense to move from one product or service to another?

What is an example of customer switching cost?