*** Long post. ***

*** Nature and role of transaction costs in product design. ***


Hi, Amanda,

Thanks for your reply. Your comment has two parts. I’ll respond to
one now and the rest later.

With respect to the explanation of transaction costs, you write,
“I’m not sure [the explanations] help me understand the
insights Terry got from thinking about transaction costs of design.”

Understanding this isn’t so difficult.

Terry Love wrote, “An issue that has not yet been mentioned is
transaction cost issues of design – of particular importance in some
areas of product design such as mass-customization. Transaction costs
associated with design give some useful insights into relative
effectiveness of the different value creation processes associated with
design activities in different product development contexts.”

You asked Terry, “Not sure what you mean about transaction costs. Are
you talking about how the brokerage of design activity can result in
path dependencies?”

Responding to this, I explained that transaction costs means something
else. My note was an attempt to clarify terms and what they mean. It was
my sense that you were using economic terms such as “externalities”
or “transaction costs” without recognizing them as technical terms
with specific meanings. Now there seems to be another possibility: using
economic terms in a theatrical or cultural sense without any concern for
what the terms mean. This resembles the approach of an anthropologist
who observes the forms of a ceremony without addressing the intellectual
and technical content of the ceremony, divorcing it from the meaning it
holds for those who create it. In this case, you’re not interested in
what the terms means to economists. Rather, you seem to be treating
economists as a strange tribe whose ceremonies you partially describe by
repeating the words. As I see it, this is exactly what you criticize
when you criticize those who “decontextualize, dissociate, detach and
disentangle” ideas and processes.

In one sense, that’s fair enough. Some economists may indeed be
members of a strange tribe. In my former life as a professor of
leadership and strategic design at the Norwegian School of Management, I
sometimes found surrounded by economists. Some seem to work with strange
symbols and a highly technical vocabulary that they refined by
manipulating representations of ideas with mathematical skill. Some
imagine that the rest of us belong to the species “homo economicus,”
imagining that we make all decisions in an effort to maximize profit
based on rational calculation. These economic models represent human in
a mechanical way, out of context and detached. But these are not the
only kind of economists.

Economics is a behavioral science. This behavioral science studies
aspects of human behavior among individuals, groups, and societies with
respect to the allocation of resources through choices. Some forms
economics don’t need numbers to describe behavior. This is true of
economists such as Ronald Coase or, for that matter, David Ricardo.
Gunnar described some aspects of their work in his note. (Thanks,
Gunnar, for pointing to interesting issues.) Another example is Herbert
Simon. These economists could all use numbers, but they described human
behavior. This is where the use of terms comes in.

If we want to describe what economists mean, we must understand some of
the basic concepts and terms. If your only interest than observing a
dance of representation to analyze the choreography, you’ll miss what
it is they represent. When we understand the words that sing as they do
their dance of representation, their ceremonies take on new and deeper
meaning. What economists mean and how their dance represents meaning is
different to what you think if you do not bother to understand the
meaning of their words.

We must sometimes work to understand words. Even economists who speak
English come from different traditions and disciplines to our own, as
you’ve noted. It’s not like learning French or Maori, but to
understand how economists represent the issues important to their
disciplinary cultures, you must know what the words mean. You’ve got
to do some of the same work you’d have to do if you want to understand
what French people or Maori people mean when they speak of some
concepts.

No one from disciplines outside economics who reads what economics
write thinks that all economists are the same in their approaches,
ideas, or methods. This should have been evident from my earlier
comments. What I do think is that the terms economists use have fairly
accepted meanings. These meanings allow economists to understand each
other despite “the variety of theoretical approaches that together
make up the discipline of economics” (Ruccio 2008: 3-4).

Since you’ve been deploying economic terms and concepts, I thought
you were attempting to represent economic concepts. What you write now
suggests that this was a mistake on my part. You aren’t interested in
the terms or concepts, or even interested in what economists think. Your
interest involves “researching the economic representations that
design is using in order to strengthen and reproduce itself as an
economic and social institution.”

Before going on, I want to be precise, so I’m going to translate this
sentence. Design is a process or – in some usages – a series of
outcomes of the design process. When you use the word “design” in
this sentence, you must mean “designers.” If not, you are reifying
design, mistaking an abstract category for a concrete being. I’d have
written that you are “researching the economic representations that
designers use to strengthen and reproduce their field as an economic and
social institution.”

You are not researching economics or the way that economists represent
issues. You are researching the way that designers employ economic
representations for their own purposes, including the way that designers
appropriate and deploy economic terms or economic issues to achieve
higher status for their professional field. This would include designers
using economic terms or concepts to gain resources they could not
otherwise obtain.

This is common in many fields. This is a claim that the work of a
certain group creates social value or economic value for the larger
economy, benefitting a wider range of people than the group making this
claim. This claim, therefore, justifies using the resources of the
larger society to further the work of the group making the claim.

Nearly all of us agree that this is true of some groups. We value the
work of the firefighters who keep our homes and cities safe. We
therefore value the work of scientists who work on firefighting methods
and technology. We value the work of physicians and surgeons who help us
to remain healthy and restore us to health when we get sick. We
therefore value the expensive medical research that has made so many
advances for humanity over the past century.

There is less agreement about the work of financiers and hedge fund
managers. Fortunately for them, they don’t have to persuade all of us.
They make their claims to the politicians and legislators whose campaign
funds they support: in the United States, this means that hedge fund
salaries and bonuses are treated as investment income on the argument
that hedge fund managers are investors who should pay tax rates as
though their own money were at risk rather than other people’s money.


Either way, I understand the nature of these claims. They are
reasonable for firefighters and dubious for hedge fund managers.
Designers are learning to play this game now, and you are “researching
the economic representations that design is using [designers use] in
order to strengthen and reproduce itself as an economic and social
institution.”

This is where Jurgen’s question is important. Jurgen is trying to
find out whether these claims are true, and if so, how. As I said, many
people wish to know this. I am guarded when I speak about the economic
contribution of design process to the increased value of goods and
services because I do not wish to mislead people. I believe there is
some evidence to support this position. I believe the evidence is
reasoned and responsible. Nevertheless, the evidence is inferential
rather than direct. It may be that we cannot do better.

It is now clear that this issue doesn’t actually interest you. If,
however, you are “researching the economic representations that design
is using [designers use] in order to strengthen and reproduce itself as
an economic and social institution,” then you are studying design
culture and the culture that designers use. You are not studying
economists. Economists have no responsibility for the ways in which
designers appropriate and use their vocabulary.

The problem is that relatively few designers have much interest in
economics, and most designers use economic terms and concepts badly.
This is even the case of relatively simple terms and concepts.
Understanding some of these terms and concepts is not difficult, but
you’ve got to be willing to read carefully and think the issues
through. Since you’ve been using these terms and pointing to
references by economists throughout this thread, I had been assuming
that you were attempting to do this.

Since others on the list do seem to be following the thread with an
interest in these issues, I’ll offer a few notes that may help in
“understand[ing] the insights Terry got from thinking about
transaction costs of design.”

Terry wrote, “An issue that has not yet been mentioned is transaction
cost issues of design – of particular importance in some areas of
product design such as mass-customization. Transaction costs associated
with design give some useful insights into relative effectiveness of the
different value creation processes associated with design activities in
different product development contexts.”

Terry is more skilled in economic analysis than I am, but what I think
he means is fairly straightforward. When we design something, there are
transaction costs. I have already defined these. These are the costs we
incur whenever we engage in transactions of some kind. This is the cost
of doing business. While all transactions incur costs of some kind, not
all transaction costs are monetary. Transaction costs may include, time,
attention, or other forms of value. In any business that pays a salary
to each employee, however, time and attention take on monetary value.

When we design something that can be designed only once, something that
never needs to be designed again, transaction costs of design are low.
When we design something that must be redesigned, renewed, or revised on
a regular basis, the transaction costs of design are high.

Many high tech products, for example, must be redesigned, renewed, or
revised on a regular basis. 90% of the products that some information
technology companies manufacture in January will be redesigned by
December, possibly even renewed. Design transaction costs are high. In
these fields, however, sales volume and product price is so great that
the companies do very well despite high transaction costs.

In mass-customization, the transaction costs of design may be
associated with nearly every unit sold. This means that transaction
costs are high compared with mass production. Nevertheless, the idea of
mass customization is that we find ways to tailor the product to the
needs of each customer, using design services and flexible manufacturing
to ensure high customer satisfaction while preserving some economies of
scale associated with mass manufacturing. A combination of carefully
designed parameters, a good service system, and an appropriate range of
choices with a well-tuned interface between customer and producer can
sometimes achieve this.

Danish street-side sausage vendors offer rudimentary example of mass
customization. The vendor offers several choices: the kind of sausage,
the kind of bread (or no bread), differents kind of toppings and spices,
service modes, and drink or no drink. By themselves, none of these is a
big choice – but if you factor them out, an average vendor offers
thousands of different choices. Each customer chooses what he or she
wants. Customers step up to the window, place their order. The vendor
fills the order. Customers get what they want as they wish it, and move
off. This is mass customization.

The supply chains for mail order or on-line clothiers such as Land’s
End or Brooks Brothers offer further example of mass customization: some
products are completely pre-defined. Ties for men and scarves for women
are all manufactured in advance. Customers order what they wish among
pre-defined choices. Other products require tailoring, hemming, cuffing,
etc. These items are mass customized. The order as a whole is also mass
customized with respect to the mix of products and shipping mode.

In the rudimentary example of the sausage stand, the design process is
embedded in the customer interface. Transaction costs are low. This is a
case of co-design at the point of sale.

In the more complex example of a pair of trousers or a skirt, the
design process takes place at several points: the customer provides
specifications, but design is embedded in the supply chain and filling
any order involves multiple kinds of transaction costs at different
points. Transaction costs are higher. Clothing goods are more valuable
than sausages, so higher prices justify higher transaction costs and the
customer still receives a product at far lower costs than true custom
tailoring.

This is also the case for Hong Kong’s huge semi-custom tailoring
industry. Lower labor costs than Saville Row tailors are only part of
the story. Mass customization and a well tuned service and supply system
are another. These reduce the transaction costs that Saville Row tailors
must incur to produce a suit. Customers can get a good suit from Hong
Kong at better quality than an off-the-rack suit, while the price is far
lower than bespoke tailoring. In bespoke tailoring, every suit is
designed, cut, and tailored to the individual customer in every detail,
with work done by hand, and transaction costs at every stage of the
value chain.

Some mass customization involves customized mass production. Levi’s
had a line of jeans called Original Spin that allowed customers to
choose among 30 styles with a total of 50,000 different size details for
a total of nearly 1,500,000 options at a cost of just under $60.
Customers ordered them in the store. Production and shipping took two or
three weeks, when customers received custom jeans. This was a textbook
example of mass customization. Levi’s closed the line a few years
back. It was apparently profitable, but the company was having larger
financial problems, and this required plant closures, including the
plant that handled the Original Spin line. Land’s End jeans are mass
customized to a far lower degree, but they cost one third to half the
price that Levi’s charged for true mass customization. Customers
choose style (including fabric), waist, and leg length. Fewer choices
for the customer mean fewer transaction costs associated with the design
of each product.

As an engineer interested in manufacturing, Terry can give you better
examples. The examples I present here are fairly rudimentary, and some
people might argue that these might not be the best examples. I offer
them for the virtue of simplicity. The economist Hal Varian suggests
that economic models should be as simple as possible to identify and
capture the features one is trying to understand.

Even though there may be better examples, these examples have a second
virtue. They demonstrate ways in which mass customization entails
different ranges of transaction costs. These are also related to the
value of the product and its location in a value chain of systems and
services. The degree of customization that one expects of a restaurant
meal is greater than that of a street-side sausage. We specify, we
choose from a wider range, we may ask for substitutions, and we expect
the kitchen to customize to our needs.

If we were hedge fund managers, we might have a private chef who
prepares everything for us in individual customized products made to our
tastes every time. At McDonald’s, we order what’s on the menu.
McDonald’s uses mass production food service. In between, mass
customization ranges from street-side sausages in Copenhagen up to
higher degrees of customization in restaurant chains, and on to
restaurants with service chains that move into a zone that some will
argue are outside mass customization.

Sushi spans several of these ranges. A master sushi chef is an artist
who works with select ingredients for a restaurant experience. Most
sushi in Australia and New Zealand is mass-produced with no
customization whatever. Master chef, sit-down sushi is expensive.
Lunch-box, take-away sushi is cheap. In between, there are sushi
restaurants that capture some of the economic attributes of both.
Depending on how such a restaurant is set up, some might qualify as
examples of mass customization.

I hope this provides some understanding of how transaction costs change
the nature of production cost and possible profits. With respect to
manufactured goods, transaction costs include design at several points
in the value chain. These in turn offer “useful insights into relative
effectiveness of the different value creation processes associated with
design activities in different product development contexts.”

Yours,

Ken

Professor Ken Friedman, PhD, DSc (hc), FDRS | University Distinguished
Professor | Dean, Faculty of Design | Swinburne University of Technology
| Melbourne, Australia

Reference

Ruccio, David F., ed. 2008. Economic Representations: Academic and
Everyday. Abingdon. Routledge.