Reducing costs: A practical application of performance-based specification and transaction cost theories

Companies rarely examine the hidden costs of transactions. However, testing the appropriate transaction cost and performance-based specification (PBS) theories in a commercial environment can show real cost savings which could be delivered from appropriate process changes. The documentation from two completed projects was counted and grouped with a view to using them as a proxy for the volume of transactions in the projects, to examine the efficiency of the existing procurement route and to allocate a cost to the "administration" documentation. Analysis of the documentation using three different groupings showed that "administration" transactions were approximately 35% higher than the client anticipated - and that some ex ante and ex post costs (including enforcement) were not included. The client insisted that the outsourced Project Manager (PM) used the client's prescriptive-based suppliers. Consequently, the PM had less information on the sub-contractors than the client which gave rise to "asymmetrical information". This challenged the rationale of only partially-outsourcing the project management functions and also the client's muddled approach to the issue of using "market or hierarchy" for non-core commercial functions. Had PBS been used for these projects; there would have been a saving of approximately £114k of a total of £200k spend.