Relations Between Fisher Body and General Motors

The initial relationship between Fisher Body, a producer of auto bodies, and General Motors was a long-term contract of ten years. Such contract agreed that GM would only purchase its metal bodies from Fisher body with a price formula set to equal Fisher Body’s variable cost plus 17. 6 percent. (Klein 1998: 241) One would then ask why this was necessary since it restricted GM from being able to switch to other partners and use the market as its efficient government structure?

The answer lies on specific investments.

In order to produce metal bodies for GM, Fisher Body had to invest in very specific pieces of equipment that meant they could not have been able to use the same stamping machine to supply other automobile manufacturer. Once Fisher Body had made its specific investments, General Motors could have threatened Fisher Body in switching suppliers of its bodies unless they reduced its prices.

Fearing this hold-up problem was the attempt to draw up a contract before any such investments were to be made so to reduce both parties from behaving opportunistically.

However according to Masten (1996: 388), ‘as transactions become more complex and the environment more uncertain, the limitations of contracting as a safeguard against opportunism grow. ‘ An unforeseen substantial increase in demand for closed metal automobiles in 1920 allowed Fisher Body to hold up General Motors by taking advantage of the contractual incompleteness (Klein 1998: 241).

By adopting a highly labour-intensive production-process and locating their plant far away from General Motors’ production facilities, Fisher Body was able to inflate its variable costs and placed a ’17.

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6 percent surcharge on their transportation costs. ‘ (Klein 1998: 42) But by exploiting loopholes in the contract, the hold-up by Fisher Body had proved to be very costly for General Motors. This would not have been the case if the changes in market conditions were anticipated since GM would obviously have include such contingency in its contract.

In 1926, General Motors decided to integrate its transactions by acquiring Fisher Body. According to Williamson this was logical because where the ‘three critical dimensions of transactions’ (Masten 1996: 390) namely: frequency, degree of uncertainty, and asset specificity was present, the most efficient government structure emerged, this being vertical integration. Where GM integrated backwards in their supply chain in order to internalise transactions within one organisational structure, markets and hierarchies represent alternative government structures.

If General Motor’s assets were non-specific, then they could have purchased its assets through a normal market relationship based on relevant prices. But as we can see with such market structure, it poses the possibility for agents to act opportunistically. With GM and Fisher Body, we see the emergence of a vertically integrated firm as an efficient response to the transaction cost associated with market-type coordination.

Therefore, by adopting Transaction Cost Economics as a way of analysing organisations we can predict that vertical integration hierarchies will take place within an industry, like that of Fisher Body and General Motors, through the present of these three distinct dimensions1: i) the frequency of a transaction, ii) the uncertainty surrounding the transaction and iii) the level of asset specificity associated with the transaction.

However, the predictive validity of Transaction Cost Economics in an attempt to explain the Fisher-GM case study has been closely scrutinized when comparing the hold-up with Williamson’s behavioural assumption of opportunism. In Klein’s account of the hold-up problem between Fisher Body and GM, he proposes that ‘explanations of hold-up behaviour based upon transactors deception are often clearly inconsistent,’ in which ‘there was no real evidence of any precontract deception on either contractors’ part.’ (1998: 224) Both parties were aware of the possibilities of a hold-up due to the incomplete contracts they entered into yet they believed it would have been more costly to write a more complete contract covering every possible angle. (Klein 1998: 224) If both parties were to cover every contract criteria and contingency then not only would that be timely to write down, but also costly in having the need to inform, confer and verify with each other continuously.

And if we add the concept of bounded rationality, a complete contract is likely to be unrealistic because contractors simply cannot ‘determine all of the many events that might occur during the life of a contractual relationship and write a prespecified response to each. ‘ (Klein 1998: 242) As a result we can see that the contract between the two parties was, to some extent, infused by trust so that the costs of negotiating, writing and monitoring the contract could be economised.

Hence, ‘trust economises on transaction costs’. (Todd 1996: 88) Transaction Cost Economics’ behavioural assumptions offered by Williamson neglected this important aspect of trust. The statement made by Williamson that agents are “self-interest seeking with guile” (Williamson, p554) therefore does not necessarily justify why GM had accepted such an imperfect and incomplete contract with Fisher Body.

Where Fisher Body and GM had entered into a long-term contract, the role of trust rather than opportunism, can in fact alter the choice of government structure. (Todd 1996: 88) In his revisited paper in 2006, Coase makes a similar argument when he points out that ‘the contractual arrangements and working relationship prior to the 1926 merger exhibit trust rather than opportunism. ‘