This link comes from Sidebar 3 of our white paper on payors & friction. Prior to this Sidebar 3, the discussion built on a CAP white paper and an AMA white paper.
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Below is a paper-by-paper summary, with emphasis on what each one contributes to our “payer friction as transaction cost” project.
1. Williamson 1971 — The Vertical Integration of Production: Market Failure Considerations
Williamson’s 1971 paper is an early, compact statement of the transaction-cost view of vertical integration. His starting point is the classic puzzle: if competitive markets operate at zero cost, vertical integration should be unnecessary. The reason firms integrate, he argues, is not only technological complementarity, but “transactional failures” in markets for intermediate goods. In other words, firms may internalize transactions because the market interface itself becomes too costly, unreliable, or hard to adapt.
The most useful point for our purposes is Williamson’s emphasis on adaptation under non-stationary conditions. He says transaction-cost analysis is relatively uninteresting under fully stationary conditions; the problem becomes engaging when parties must make “unprogrammed adaptations.” That is exactly the world of health care claims, prior authorization, medical necessity, new technologies, coding changes, and exception cases. The payer-provider relationship is not a simple purchase order. It is a continuing adaptive relationship under uncertainty.
Williamson also gives the firm three advantages over arm’s-length market exchange: better incentives, better controls, and structural advantages. Internal organization can reduce the aggressive advocacy of arm’s-length bargaining and can use more sensitive control instruments than market exchange. But he is careful that internal organization also has administrative frictions; the question is comparative, not romantic.
Use for Sidebar Three: Williamson supplies the core argument that health care friction is not just “waste.” It is the cost of governing complex transactions where contracts are incomplete and adaptation is continuous. Prior authorization and denials are payer-side tools for governing the gray zone.
2. Alchian and Demsetz 1972 — Production, Information Costs, and Economic Organization
Alchian and Demsetz approach the firm differently. They reject the idea that firms are mainly defined by superior “fiat” or command. The employer, they argue, does not possess magical authority different from ordinary contracting; the employer can essentially fire or sue, just as a buyer can stop buying from a grocer or sue for defective performance. What distinguishes the firm is not authority alone, but the team use of inputs and a centralized contractual position.
Their key concept is the metering problem. Economic organization must measure productivity and allocate rewards in relation to contribution. Markets often do this fairly well when output is separable: if a farmer produces 10% more wheat, receipts rise roughly 10%. But in team production, individual contributions cannot be cleanly separated from total output. Their simple example is two people jointly loading heavy cargo: total output is observable, but each person’s marginal contribution may not be.
This creates the classic problem of shirking and monitoring. If rewards are not tied to actual contribution, incentives weaken. The firm, in their model, exists partly because it can create a monitor, and that monitor has incentives to measure performance and allocate rewards. This is why the paper is so useful for health care: clinical care is team production par excellence. The diagnostic outcome is not produced by one billable unit; it is produced by pathologists, treating physicians, nurses, lab staff, imaging, hospital systems, and others.
Use for Sidebar Three: The payer is trying to “meter” clinical production from outside the clinical team, using claims, codes, documentation, prior authorization, and utilization patterns as proxies. That makes payer friction a crude form of external metering — sometimes justified, often distorted, and sometimes strategically burdensome.
3. Demsetz 1988 — The Theory of the Firm Revisited
Demsetz is the healthy skeptic in the packet. He agrees that Coase was seminal in asking why firms exist if markets are efficient, and he agrees that markets are not costless. But he argues that the theory of the firm remained incomplete because it gave too little weight to information cost, especially information used in production and management.
His first useful move is to attack the “perfect competition” model as really a model of “perfect decentralization.” It is elegant for studying the price system, but almost useless for studying firms as problem-solving institutions. In that model, production possibilities, prices, products, techniques, and markets are assumed to be known at zero cost, so management is emptied of real content.
His second major move is a critique of simple transaction-cost reasoning. He says the make-or-buy question is often framed too crudely as “market transaction cost versus internal management cost.” But both options contain both kinds of costs. In-house production still requires market purchases of inputs. Buying from another firm still buys that firm’s management services. The correct comparison is the sum of management and transaction costs under each arrangement.
[NewCo says management costs of making X are high, so I'll purchase X from ABC. But ABC will also have faced, and paid for, those high management costs of making X, so they will be part of NewCo's price paid for ABC when NewCo gets its invoice from X for ABC.]
His third move is especially important: firms differ in productive knowledge, commitments, personnel, methods, and firm-specific information. Transaction-cost theory can mistakenly assume that what one firm can produce, another can produce equally well, thereby neglecting differences in production capability.
Use for Sidebar Three: Demsetz disciplines the argument. We should not say “payer friction is bad because transaction costs are bad.” We should ask whether payer friction actually reduces total system cost, including the costs shifted to providers and patients. Demsetz also helps defend pathology against commoditization: not every lab or pathology service is interchangeable merely because the code descriptor looks similar.
4. Cuypers, Hennart, Silverman, and Ertug 2021 — Transaction Cost Theory: Past Progress, Current Challenges, and Suggestions for the Future
This is the broad modern review. It says transaction cost theory began with Coase and Williamson, especially the make-versus-buy and vertical integration questions, but has since expanded into strategy, international business, alliances, supply chains, public-private partnerships, platforms, AI, trust, behavioral economics, and nonpecuniary goals.
The authors restate Williamson’s basic framework: actors assign transactions to governance structures based on transaction attributes, especially asset specificity, uncertainty, and frequency. The classic governance alternatives are markets, hierarchies, and hybrids. Their figure on page 4 lays out the classic model: bounded rationality and opportunism shape the alignment between transaction characteristics and governance choice, which then affects performance.
The paper is especially useful because it shows how the field has moved beyond the old model. It notes that later work emphasized behavioral uncertainty, appropriability, knowledge leakage, hybrid governance, formal and informal contracts, trust, and credible commitments. It also notes that “frequency,” although part of the original Williamson triad, has been underdeveloped empirically and theoretically.
One particularly useful discussion concerns opportunism. The authors explain that Williamson’s view does not require believing everyone lies or cheats all the time. The problem is that some actors may behave opportunistically some of the time, and it is difficult to know in advance who will do so or when. That small probability can be enough to justify governance safeguards.
The paper’s most novel element for our purposes is its future-facing agenda. It calls for a more dynamic TCT, more integration with behavioral psychology, more attention to trust and formal-informal governance, and more work on platforms, AI, and two-sided markets. Its updated framework includes “bounded reliability,” market thickness, network effects, behavioral uncertainty, appropriability, output measurement costs, behavior measurement costs, and macro context such as polity and culture.
Use for Sidebar Three: This paper lets us modernize the payer-friction argument. Modern payers are not just insurers; they are platform-like governance entities, with claims systems, PBMs, analytics, provider assets, MA plans, network design, AI tools, and utilization-management vendors. It also helps us avoid saying “payers are opportunists.” The more nuanced point is that the system is built around low trust, behavioral uncertainty, and administrative safeguards that can themselves become burdensome or strategic.
5. Wiki Transaction Cost article — useful mainly as a map of definitions and extensions
The Wiki article is not the authority here, but it is a useful orientation map. The obvious part is the basic definition: transaction costs are costs incurred in making economic exchanges, alongside production costs. It summarizes Williamson’s determinants as frequency, specificity, uncertainty, limited rationality, and opportunistic behavior. It also gives Dahlman’s familiar triplet: search and information costs; bargaining and decision costs; and policing and enforcement costs.
The more useful material is the broader genealogy. The article notes John R. Commons’s institutional view: the basic unit of analysis is not merely commodities or individual behavior, but transactions governed by working rules of collective action. That helps with our payer argument because health care is not just “services exchanged for payment”; it is a system of rights, permissions, rules, documentation, obligations, and institutional control.
It also mentions Douglass North’s framing: transaction costs include measurement, enforcement, ideological attitudes/perceptions, and market size. This is more interesting than the generic definition. In health care terms, “measurement” maps to clinical necessity, coding, quality, and appropriateness; “enforcement” maps to audits, denials, recoupments, and appeals; “ideological attitudes” maps to payer-provider distrust and differing beliefs about overuse; and “market size” maps to whether transactions are impersonal, competitive, or dominated by a few large intermediaries.
The Wiki article also includes Steven Cheung’s broader definition: transaction costs are costs that would not exist in a Robinson Crusoe economy — essentially institutional costs. Many economists define the term more narrowly, but Cheung’s broad version is actually useful for health care because so many payer burdens are institutional artifacts rather than clinical production costs.
Finally, the more contemporary note is that Fourth Industrial Revolution technologies, including distributed ledgers and blockchains, may reduce transaction costs compared with traditional contracting. That is only a brief Wiki-level point, but it opens an interesting health-care question: could automation, APIs, smart contracts, transparent medical policies, or real-time adjudication reduce payer friction — or would they merely automate the payer’s rule layer and make denials faster?
Cross-paper synthesis for our payer-friction project
The papers line up into a useful architecture:
Williamson gives us transactional failure and adaptation. Health care contracts cannot pre-specify every future clinical circumstance, so payers and providers fight over interpretation.
Alchian and Demsetz give us team production and metering. Health care output is produced by teams, but payers meter it externally through administrative proxies.
Demsetz gives us caution and completeness. The question is not whether payer friction creates costs, but whether it reduces total costs after counting provider burden, patient delay, and lost clinical productivity.
Cuypers et al. give us modernization. The theory now includes hybrids, platforms, trust, bounded reliability, AI, behavioral uncertainty, and formal-informal governance — all highly relevant to modern payers.
The Wiki article gives us taxonomy and vocabulary: search, bargaining, enforcement; measurement and enforcement; institutions; and the possible role of digital technologies.
The short version: these papers make our sidebar stronger because they show that payer friction is not merely annoyance, waste, or bad manners. It is a governance system for incomplete, uncertain, team-based, clinically complex transactions — and under payer concentration, the party designing the governance system can also shift much of its cost to others.
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What did Coase do, since Williamson is credited decades later with many of the classic aspects of the field?
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Yes. That is exactly right: Coase supplied the foundational question and the conceptual door; Williamson later built much of the machinery inside the room.
Coase’s 1937 paper, The Nature of the Firm, was Nobel-worthy because it changed the unit of analysis. Before Coase, economics had a powerful theory of prices and markets, but a weak theory of why firms exist at all. In the clean textbook model, if prices coordinate everything efficiently, why do we need firms, managers, employees, internal departments, and command structures? Demsetz later summarized this as Coase’s seminal contribution: he called attention to the missing theory of the firm and to the crucial fact that markets do not operate costlessly.
Coase’s core move was simple but radical:
Using the market is not free.
Finding suppliers, discovering prices, negotiating terms, writing contracts, enforcing agreements, and adapting to changes all require effort. Coase called these the “costs of using the price mechanism.” The later phrase “transaction costs” became the standard label, though the Wiki article notes that Coase did not coin that exact term in 1937.
That insight explains why firms exist. A firm arises when it is cheaper to coordinate some activities internally than to repeatedly bargain across markets. Instead of negotiating a new contract for every tiny task, the firm creates a continuing relationship in which some directions can be handled administratively. In effect, the firm substitutes internal coordination for a series of external market transactions.
But Coase also avoided a crude “firms are always better” view. His framework was comparative. Firms grow until the cost of organizing one more transaction internally equals the cost of carrying it out through the market. That is the essential make-or-buy logic. Williamson later turned this into a much richer theory of governance, but Coase created the basic comparison: market coordination versus internal organization, each with costs.
What Coase put in place, before Williamson, was therefore four big ideas:
First, the market itself is an institution, not a frictionless natural state. Classical economics often treated markets as if they just worked. Coase asked what it costs to use them.
Second, the firm is a problem-solving institution. A firm is not merely a production function or a black box transforming inputs into outputs. It is a way of organizing transactions when pure market exchange is too costly.
Third, the boundary of the firm is an economic question. Why is this activity done inside the firm while that activity is bought outside? Coase made that question central.
Fourth, the right comparison is institutional. The question is not “markets good, hierarchy bad” or vice versa. The question is which arrangement handles the transaction at lower total cost.
Williamson then made the theory more strategic by asking: Which kinds of transactions are especially hazardous? His answer: transactions involving asset specificity, uncertainty, frequency, bounded rationality, and opportunism. Williamson also developed the vocabulary of governance structures: markets, hierarchies, and hybrids. The Cuypers review’s figure on page 4 captures this Williamson framework: transaction characteristics are aligned with governance mechanisms under bounded rationality and opportunism.
So, for our payer-friction sidebar, the distinction is useful:
Coase gives us the first question:
Why is payer-provider exchange costly at all, instead of being a clean market transaction?
Williamson gives us the second question:
Which features of payer-provider exchange make those costs especially severe, manipulable, and strategically important?
In our setting, Coase helps us say: payer friction is not an accidental annoyance outside economics. It is exactly the kind of cost Coase told economists to pay attention to — the cost of using the payment-and-contracting system. Williamson helps us go further and say: those costs become especially dangerous where there is incomplete contracting, clinical uncertainty, asset-specific care relationships, and asymmetric power.
A concise sidebar sentence could be:
Coase’s foundational contribution was to show that markets are not free to use: finding terms, negotiating agreements, enforcing promises, and adapting to contingencies all impose costs. Williamson later supplied the more detailed strategic anatomy — asset specificity, uncertainty, bounded rationality, opportunism, and governance choice — that helps explain why payer-provider friction can become not merely expensive, but controlling.
