Where Do Transactions Come from? Modularity, Transactions, and the Boundaries of Firms

This article constructs a theory of the location of transactions and the boundaries of firms in a productive system. It proposes that systems of production can be viewed as networks, in which tasks-cum-agents are the nodes and transfersmdash;of material, energy and informationmdash;between tasks and agents are the links. Transactions are defined as mutually agreed-upon transfers with compensation and are located within the task network. Placing a transaction in a particular location in turn requires work to define, count (or measure), and pay for the transacted objects. The costs of this work (labeled mundane transaction costs) are generally low at the thin crossing points of the task network, which correspond to module boundaries. Therefore, transactions are more likely to be located at module boundaries than in their interiors. Several implications arise from this theory. Among these: Modularizations create new module boundaries, hence new transaction locations. Areas in the task network where transfers are dense and complex should be located in transaction-free zones, so that the cost of transacting does not overburden the system. The thin crossing points between transaction-free zones constitute breakpoints, where firms and industries may split apart