Contract Duration and the Costs of Market Transactions

83 Pages Posted: 8 Jan 2018 Last revised: 12 May 2020

See all articles by Alexander MacKay

Alexander MacKay

Harvard University - Business School (HBS)

Date Written: May 11, 2020

Abstract

The optimal duration of a supply contract balances the costs of re-selecting a supplier against the costs of being matched to an inefficient supplier when the contract lasts too long. I develop a structural model of contract duration that captures this tradeoff and provide an empirical strategy for quantifying (unobserved) transaction costs. I estimate the model using federal supply contracts for a standardized product, where suppliers are selected by procurement auctions. The estimated transaction costs are substantially greater than consumer switching costs and a significant portion of total buyer costs. Counterfactuals illustrate the importance of accounting for the duration margin.

Keywords: Supply Contracts, Intermediate Goods, Switching Costs, Auctions

JEL Classification: D22, D44, H57, L13, L14

Suggested Citation

MacKay, Alexander, Contract Duration and the Costs of Market Transactions (May 11, 2020). Harvard Business School Strategy Unit Working Paper, Available at SSRN: https://ssrn.com/abstract=3096534 or http://dx.doi.org/10.2139/ssrn.3096534

Alexander MacKay (Contact Author)

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Boston, MA 02163
United States

HOME PAGE: http://alexandermackay.org/

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