The relationship between construction project management theory and transaction cost economics

Engineering, Construction and Architectural Management 1999 6 � 2, 166–176

The relationship between construction projectmanagement theory and transaction cost economics

ANTHONY WALKER & CHAU KWONG WINGDepartment of Real Estate and Construction, The University of Hong Kong, Pokfulam Road, Hong Kong

explanation. This approach holds that an understandingAbstract The process of managing the design and con-of transaction cost economizing is central to the study ofstruction of a project on behalf of a client may be

analysed using project management theory based on a organizations as it determines whether functions areprovided by the market or by hierarchy. This paper seekscontingency approach. The analysis provided by this ap-

proach, whilst useful for understanding the interaction of to explore the relationship between these two powerfulapproaches in explaining the structuring and manage-the parts of the system, the functions of project manage-

ment and the effectiveness of the organization structure, ment of project organizations on behalf of clients and tomay be limited by not incorporating an economic expla- explain the benefits of combining these approaches in

furthering construction project management theory.nation of how a project organization structure is chosen.The transaction cost approach to the study of economic Keywords clients, consultants, contractors, project

management theory, system approach, transaction costsorganization may provide a theoretical basis for such an

INTRODUCTI ON

This paper aims to increase understanding of whyproject organizations are structured with certainconfigurations by arguing that transaction cost eco-nomics may provide an alternative theoretical basiswhich can be integrated with project managementtheory and associated models of organization toprovide insights to decision-makers’ behaviour. Its fo-cus is the management of projects on behalf of clients.The conceptualization of this process is from the firstbeginnings in the eye of the client to the completionand occupation of the project. Other work on transac-tion costs and the construction industry have eithernot seen project management to be relevant to thesituation examined (Casson 1987) or have defined itnarrowly (Reve & Levitt 1984). It is important to makethis standpoint clear as nearly all other work has takenthe object of analysis as the firm, particularly an expla-nation of the relationship of main contractors withsubcontractors (Eccles 1981; Stinchcombe & Heimer1985; Casson 1987; Chau & Walker 1994; Hillebrandt& Cannon 1994). Winch (1989)) criticized Levitt andhis associates (Gunnarson & Levitt 1982; Reve &Levitt 1984) for analysing the project rather than thefirm. However, even Levitt and his colleagues did notfocus specifically on the project management processbut did include consultants in their analysis. Winch iscorrect in pointing out that analysis of the firm usingtransaction cost economics is most fruitful but this

focus is not particularly helpful in understanding theproject management process on behalf of clients.

Research in project management has been con-cerned mainly with process (cf. Bennett 1991; Morris1994; Walker 1996) and technique. The latter aims atincreasing efficiency, the former is concerned withincreasing understanding why construction projects areorganized with particular configurations and how bestto design them. The major works adopt a systemsapproach with the focus on how the parts are interre-lated and interact in seeking clients’ objectives. Thedesign of project organizations is still essentially ex-plained by the positivist contingency theory (Lawrence& Lorsch 1967) although there are arguments for aless deterministic mode which have been rebuffed(Donaldson 1996). Hence, a diversity of organizationaland procurement methods now exist for constructionprojects.

The forces which determine the most appropriateproject organization structure for a specific project andthe management functions which should be carried outon behalf of the client are understood (Morris 1994;Walker 1996) but these ideas do not incorporate theeconomics of structures and how the functions shouldbe provided. Transaction cost economics can con-tribute to this and allow an examination of the rela-tionship between the systems approach to organizationand the transaction cost approach to markets andhierarchy to establish whether each enriches the otherto further consolidate project management theory.

© 1999 Blackwell Science Ltd166

167Construction project management theory and transaction cost economics

Buckley & Enderwick (1989) point out that what ismissing in a transaction cost analysis of constructionfirms is the specification of the organizational struc-ture, this is even more pronounced in an analysis ofproject management on behalf of clients.

This perspective cannot ignore behavioural theoriesand approaches based on such theories, e.g. political,cultural, sociological models. All have a contributionto make to the multifaceted explanation of the effec-tiveness of project organizations. However, it is in thisarea that controversy has arisen (Barney 1990; Don-aldson 1990a,b). The behavioural assumptions under-pinning transaction cost economics, particularlyopportunism, moral hazard and shirking are difficultfor management theorists to accept. But transactioncost economics clearly recognizes behavioural phe-nomena as having a strong influence on organizationaleffectiveness but does so for the purpose of generatingrefutable implications rather than an intrinsic theoreti-cal explanation. Transaction cost economists believethat this allows the examination and integration ofbehavioural elements in explaining the configuration ofproject organizations and how they perform.

TR ANSACTI ON COST ECONOMICS AND

MANAGEM ENT

Neoclassical economic analysis assumes that economicactivities can be co-ordinated costlessly by a system ofprices. Transaction cost economics recognizes thatthere are costs of using the pricing system and thatsuch costs give rise to various forms of economicorganizations Coase (1988). The transaction cost ap-proach emerged from the seminal work of theeconomist Coase (1937) in which he advanced histheory of the existence of firms. Coase said that, in theabsence of transaction costs, there is no economicbasis for the existence of the firm. Coase (1991) ar-gued that ‘a firm could only continue to exist if itperformed its co-ordination function at a lower costthan would be incurred if it were achieved by means ofmarket transactions and also at a lower cost than thissame function could be performed by another firm’.

Hart (1990) believes that ‘outsiders to the fieldwould take it for granted that economists have a highlydeveloped theory of the firm’ but that this is far fromthe truth. Neoclassical theory tells us nothing aboutthe structure of firms. Demsetz (1991) states that ‘thefirm’ in neoclassical theory is ‘simply a rhetoricaldevice adopted to facilitate discussion of the pricesystem. Tasks normally to be expected of managementare given only the most superficial, formal discussion;

they are performed without error and costlessly, as ifby a free and perfect computer. The real tasks ofmanagement, to devise or discover markets, products,and production techniques, and actively to manage theactions of employees, have no place in the perfectdecentralization model because it assumes that allproducts, markets, production techniques, and pricesare fully known at zero cost.’

Williamson (1981) considers that the transactioncost approach has been applied at three levels ofanalysis. Firstly, at the level of the overall structure ofthe enterprise which asks how the operating parts arerelated to one another; a direct reflection of the sys-tems approach to organization design. The secondlevel focuses on the operating parts and asks whichactivities should be performed within the firm andwhich outside it and why. The third level is concernedwith the manner in which human assets are organizedto match internal governance structures.

This description complies with Coase’s (1991) ideaof co-ordination costs which reflects the basic systemscomponent of integration. The transaction costs in-volved in providing governance through the marketwill include the cost of drafting contracts, setting upthe mechanisms for obtaining tenders, preparing othercontract documentation and for ensuring the subse-quent execution of the contracts by consultants andcontractors. These are practical manifestations of themore abstract project management activities of integra-tion, maintenance and monitoring.

The basic idea is that organizational variety arisesprimarily in the service of economizing in transactioncosts and that transaction costs are assigned to gover-nance structures which differ in their organizationalcosts and competencies (Williamson 1985). This ideacontributes significantly to an understanding of why avariety of organizational forms are used to manageconstruction projects by the same and by differentclients. Whilst the transaction cost literature has beenconcerned with firms, the project organization as atemporary multi organization (Cherns & Bryant 1984)lends itself to similar analysis as the economy of itsco-ordination function should determine its form.

A BASIC FRAMEWORK

The integration of project organization theory and thetransaction cost approach arises through project orga-nization theory defining the type and nature of transac-tion costs by modelling the process and transactioncost economics providing an analytical framework forderiving testable implications concerning the be-

© 1999 Blackwell Science Ltd, Engineering, Construction and Architectural Management 6 � 2, 166–176

168 Walker, A. & Chau, K.W.

haviour of the different parties of a constructionproject.

A client could define, design and construct a build-ing entirely in-house (hierarchy) when both productionand transaction costs would be internal to the client.Transaction costs would include the cost of identifyingthe project, setting up a design office and a contractingorganization, and hiring all necessary personnel andmonitoring their performance. Such costs correspondto the information gathering and integration costs etc.defined by project management theory. This is a taskon which a client will embark rarely, that is only whentransaction plus production costs are lower thanproviding these activities through the market.

Normally, clients will purchase from the market thedesign and construction activities required. The clientwill decide the type of building required and a strategyfor providing it. These are transaction costs. Advicemay be obtained on contract strategy from a projectmanager (which may not be the best advice in terms ofeconomizing in transaction costs) which is again atransaction cost. The contract strategy selected willgenerate a governance structure. Williamson (1981)recognizes that choice of an appropriate governancestructure is pre-eminently an organization theory issue.If governance is the equivalent of the managementsystem defined by project management theory then theprocess both within the client organization and exter-nal to it comprises the governance structure and itstransaction costs consist of the costs for activitieswithin the client organization, such as approving pro-posals, defining objectives, and providing policy direc-tives, and of hiring project management functions inthe market.

The attraction of transaction cost analysis to projectmanagement is that it ‘integrates economics, organiza-tion theory, contract law and behavioural assumptionsin an interdisciplinary study of organizational phenom-ena’ (Williamson 1981). It adopts a comparative insti-tutional approach in which the transaction is made thebasic unit of analysis (Williamson 1985). Using theterm governance structures to include the organiza-tional approaches required to regulate and controlactivities, Williamson (1981) generalizes that in thelong run governance structures which have bettertransaction cost economizing properties displace thosethat have worse. This view lines up with systemstheory in that organizations will survive only if theyadapt to their environment. Members of the organiza-tion make the decisions which adapt organizations toenvironments and which define governance structures,hence the behavioural characteristics they exhibit will

influence the optimality of the structures chosen.Williamson believes the object is to identify the mosteconomical governance structure and that it seemsgenerally sensible that simple governance structuresshould be used in conjunction with simple contractualrelations and complex structures for complex relations,reflecting contingency theory in relation to task andenvironmental complexity.

WHAT ARE THE TRANSACTION COSTS?

What then are the transaction cost which the client hasto bear when developing a project? Essentially they arethe costs of setting objectives, integrating contribu-tions, making the various managerial decisions andcontrolling the contributors, costs which arise from theorganization structure selected, all of which are aimedsolely at achieving the client’s objective. The structureselected should aim to minimize transaction costs.Before this can be achieved an understanding of howtransaction costs arise is needed and is provided byproject management theory.

The analysis here relies on the positivist version ofcontingency theory as defended by Donaldson (1996).Whilst a number of reformulations have taken place,for example, strategic choice (Child 1972), typologies(Mintzberg 1979), the deterministic mode still remainsrelevant to project organization design as there is littleor no scope for choice as the project organizationstructure that fits the contingencies will need to beadopted to avoid underperformance of the project inuse. It may well be that the task-specific duration-lim-ited nature of the temporary management structuresrequired to manage construction projects for clients isnot susceptible to neocontingency analysis. The orga-nization of the firms which contribute to project man-agement may well respond to such analysis butpromoters of such advances nevertheless state that ‘thefact still remains that a basic contingency argument isinevitable’ (Sorge 1991).

Analysis in these terms focuses upon the need tointegrate the differentiated yet interdependent contrib-utors (Dalton et al. 1970). The construction processrequires a high level of integrative activity which hasnot traditionally been recognized and provided. Also,the control function should be designed to reflect thetechnical demands of the project and its environmentand be based on the anticipated decision points whichform ‘pinch points’ through which the process mustpass if it is to make progress (Walker 1996). Decisionpoints characterize the process and determine the in-terdependency of the contributors to each decision.



The organization structure for each project should bedeveloped from first principles. Although a range of‘standard solutions’ may emerge, it should not bepresupposed that any predetermined solution iscorrect.

Decision points can be classified into one of threetypes; primary, key and operational. Primary decisionpoints are fundamental and consist of the decisionwhether real property is required for the client toachieve objectives and, if real property is required,what form it should take, e.g. build a new building,lease an existing building. These decisions are invari-ably taken within the client organization and may notincorporate advice from construction consultants. Thenext level is key decision points. Key decisions, e.g.approval of design and budget proposals, are alsomade by clients and determined by environmentalinfluences and are usually based on the advice ofconstruction consultants. Bennett (1991) confirmsthat experienced clients often ask for formal reports atkey decision points. A project team makes operationaldecisions upon which key decisions are based. Thecosts of arriving at operational decisions are produc-tion costs whereas the costs of the other decisions aretransaction costs borne by the client. Contributors tooperational decisions include the appropriate consul-tants and contractors. Project management has re-sponsibility for integrating the project team to ensurethat all advice has been given before an operationaldecision is taken. The tasks separated by operationaldecisions define the operating system which comprisesall the professional and technical tasks required todesign and construct the project. The form taken bythe units carrying out the tasks, e.g. private practices,in-house to the client, can be explained by transactioncost economics.

The managing system carries out decision-making,maintains, controls and regulates the operating system,controls the boundaries between the subsystems cre-ated by decision points and integrates their output toensure that primary and key decisions are compatiblewith the clients’ requirements. It also controls theboundaries between the process and its environmentand between the process and the client and its environ-ment. It monitors the performance of the subsystemsto ensure that appropriate approaches and techniquesare used, ensures that the resources that produce theoutput of the subsystems (in particular, people) areprocured and replenished. Also included are the activi-ties of recommendation and approval of the proposi-tions which arise from the system. Whilst many ofthese activities appear to be technical, they can only be

achieved effectively if the behavioural characteristics ofthe contributors are channelled to the objectives of theproject and to the benefit of the project outcome.

None of these activities is costless. They generatetransaction costs, hence project management on behalfof a client is entirely a transaction cost. The managingsystem can be organized in various ways. It may besolely within a client’s organization; in other cases itmay consist of a client’s representative and a ‘consul-tant’ project manager, or the architect acting in a dualrole of manager and designer. Transaction cost eco-nomics argues that economizing in such costs takesplace to determine how such activities are organized.Whilst some costs may be easy to conceive others arenot; the costs of approval and recommendation can behidden, but large, as they frequently involve majorgroups of high level people in client organizations.

The above articulates the transaction costs of projectmanagement using project management terminology.In contrast, as a transaction cost economist,Williamson (1985) describes transaction costs as draft-ing and negotiating agreements, setup and runningcosts of the governance structure which monitors andwhich settles disputes, haggling costs, and bondingcosts of effecting secure commitments. Dahlman(1979) classifies transaction costs as search and infor-mation costs, bargaining and decision costs, policingand enforcing costs. He then argues that the threeclasses reduce to one: resource losses due to lack ofinformation. Reve & Levitt (1984) present one of thefew attempts to relate these ideas in practical terms toconstruction but their focus was on the client/contrac-tor relationship and not project management. Never-theless the compatibility of the ideas is clear.

A client’s and a consultant project manager’s inter-est may not coincide. For example, when the projectmanager has a number of clients whose projects allrequire urgent attention, the project manager mayprioritize to the disadvantage of some clients. Suchsituations gives rise to another type of transaction cost,namely agency cost. We will return to this in moredetail later. An example of the application of agencytheory to the analysis of organization is the recentstudy by Aghion & Tirole (1997). They have devel-oped a theory of allocation of formal authority and realauthority within organizations. The degree of delega-tion of formal authority from a principal to an agent isthe result of the trade-off between loss of control andthe agent’s initiative. One of the findings is that formalauthority is more likely to be delegated for decisionsthat are relatively unimportant for the principal. Thisis also in line with organization design literature (Jen-



nergren 1981). Aghion and Tirole’s formal model alsoimplies that real authority (not formally delegated butactually excerised) of an agent increases with span ofcontrol, urgency, reputation for moderate interven-tionism, performance measurement, and multiple prin-cipals and that centralization may jeopardizecommunication by making the agent concerned aboutbeing overruled unless the agent trusts his principal.

The recognition that management had been largelyignored by economists was the catalyst for integratingeconomics and organization theory. Coase (1991) saidthat ‘what happens in between the purchase of thefactors of production and the sale of the goods that areproduced by these factors is largely ignored byeconomists’ and that ‘what economists have conven-tionally studied is a system which lives in the minds ofeconomists but not on earth’. Demsetz (1991) ac-knowledged that understanding of firms can be im-proved by recognizing that management is a scarceresource in a world in which knowledge is incompleteand costly to obtain. This will not startle students ofmanagement but the fact that economists seem to haveonly recently discovered this helps to explain the lackof relevance felt by managers of much economictheory.

Many transaction costs arise from preparing andenforcing contracts and procedures designed to pro-duce behaviour on the part of members of projectorganizations which is compatible with project objec-tives. However, such processes are not foolproof,hence, there is a risk that such behaviour is not com-patible and not controlled, the cost of which can alsobe conceived as a transaction cost.

AN I LLUSTRATION

A comparison of a traditional organization structure,with the architect as designer and project manager andthe contractor appointed in competition, and a design-and-build structure, can be used to illustrate the rela-tionship between project management theory andtransaction cost economics by analysing why the de-sign and construction processes are separated in thetraditional system. Text book explanations include tra-dition, professionalism, division of labour and flexibil-ity. The problems created are also well documented,lack of buildability, communication problems, co-ordi-nation problems and unclear responsibility betweendesigner and contractors, to name a few. However,whatever arrangement is chosen is done so voluntarilyby all parties. The obvious question is: if there exists abetter (more efficient) alternative arrangement that

consumes less resources, why didn’t the parties adoptit and share the benefits?

By analysis using transaction cost economics, webelieve the choice of a structure is a result of therelative costs of specifying the nature of the projectarising from different structures and depending on thetype of project. The cost of managing the process ofproject specification and the actual detailed specifica-tion are transaction costs. The management activitiesrequired to achieve this are defined by project manage-ment theory.

The distribution of project management activitiesvaries considerably between traditional and design-and-build structures. In the former the client organiza-tion will be involved in integrating with the projectteam in order to transmit their ideas, the architect willundertake a large number of the project managementfunctions but other consultants will also be involved insome project management work as will the contractor.Thus, transaction costs will be distributed widely. If aproject management consultancy firm was used ratherthan the traditional structure, their costs would also betransaction costs and the total of such costs wouldprobably increase as the architect would still undertakesome residual project management functions. In thecase of design-and-build, the client will still be in-volved in project management but a large part will beaccounted for by the design-and-build company. If theclient also uses separate consultants to monitor thedesign-and-build company then their costs would alsobe transaction costs.

To explain this further, imagine a situation wherethe design-and-build structure is the only procurementsystem that is allowed, how could the willing buyer(client) and the willing seller (the design-and-buildcompany) meet and agree at a price for the project?How could the client ensure that the product deliveredby the contractor was the project that he/she wanted topurchase in the first place? These problems cannot beresolved without a clear description of the projectbeing traded.

The project is only specified in detail when its designis complete. When the design is not complete, theproject can only be described by defining the client’srequirements. Such requirements are essential for thedesign-and-build contractor to quote and agree a pricewith the client. For most buildings, the costs of defin-ing requirements in detail would be very high as theclient’s requirements are often in very vague terms andperception orientated (for example aesthetic require-ments). The nature of such descriptions, even whendefined in a detailed manner, are often not sufficient to



determine the physical characteristics of the project.Such difficulties can be overcome if a designer isemployed by the client to design the project before theconstructor is chosen (the traditional system). Oncethe project is designed, it would be much easier tospecify and price the project. Although such an ar-rangement is costly, in most cases it is still cheaperthan the design-and-build arrangement. However, ifthe client’s requirement can be defined clearly and(relatively) cheaply, for example, when the require-ments are simple and more functional than perceptionorientated (such as low rise industrial buildings, publichousing and many civil engineering works), design-and-build contracts would be adopted.

In practice this theoretical scenario may not beimplemented due to a client’s risk profile. In cases inwhich the above analysis would result in the choice ofdesign-and-build, a client who is risk averse may per-ceive a greater risk in such an approach if it fears thatthe definition of its requirements may not be under-taken effectively, and as a result may choose a tradi-tional approach. The client may perceive that it canbetter protect itself contractually using the traditionalapproach but this would incur transaction costs. Theperceived risk under a design-and-build structurecould theoretically be removed by a greater and greaterlevel of detail definition of requirements but this wouldof course, generate further transaction costs. So, ulti-mately risk can be seen and analysed in transactioncost terms. However, this theoretical scenario does notprevent clients making suboptimal choices if transac-tion cost minimization is not adopted by the parties.

PR ODUCTI ON COSTS

This paper argues that project management theory,dealing with integration, decision-making and controlmakes clear the activities which give rise to transactioncosts and this is the point at which construction pro-ject management theory and transaction cost econom-ics meet. However, many accounts of transaction costsfail to make clear that the object is to economize in thesum of transaction and production costs. As Demsetz(1991) puts it: ‘the emphasis that has been given totransaction costs (or that has been claimed to be given)dims our view of the full picture by implicitly assumingthat all firms can produce goods or services equallywell’. Economists’ generalizations of transaction costsequate to project management activities. Specialistconsultants, e.g. architects, engineers, are producersand their costs are mainly production costs but certainof their functions may be categorized as transaction

costs, e.g. architects who also manage the project.Quantity surveying is a transaction cost. An increase intransaction costs may be accompanied by a reductionin production costs but this does not have to be so.Each case has to be judged on its merits.

These ideas throw up some interesting questionsfrom the client’s point in view. The client, whetherprivate or public sector, wishes to acquire a project inorder to satisfy a need which is to do with the client’smain purpose which may be, for example, to deliverhealth care or to manufacture motor cars. The clienthas a wide range of organizational structures availablefor designing and constructing the project. Thesestructures can provide the various skills and commer-cial activities either through the market, in-house or insome combination of these. Two basic questions arise.How are costs (of either kind) defined in construction?Which are transaction costs and which productioncosts?

The view which emerges from the transaction costliterature is the acquisition in the market or hierarchyof a product which can be clearly specified and deliv-ered in the form specified. And that either the marketor the firm can delivery it in exactly the same form(albeit perhaps at different production costs). This isnot the case in construction where the product isusually bespoke and would be designed differently byall designers and as a result would perform its functionto different degrees of effectiveness. The extent towhich the project meets the client’s expectation will bea product of the definition of the client’s requirements,the effectiveness of their articulation by the designersand the effectiveness of the realization of the design.The methods by which these processes can be moni-tored and controlled are numerous and generate differ-ent costs. Also, production costs can vary relative tothe quality of the product. For instance, a worldfamous architectural practice may well charge morethan a local one. The quality of the output will vary(but not predictably). The idea of cost in relation toconstruction projects then becomes most complex.

The second question asks which are transactioncosts and which are production costs. This questionrevolves around the costs of project management func-tions. Even when project management and all otherskills and activities are obtained from the market, somemanagement costs will arise in the client organizationas a result of the firm embarking on a constructionproject. The converse will also apply in that even whenthe client purports to undertake the project entirelyin-house some elements are likely to have to be ac-quired from the market which reflects Reve and Lev-



itt’s (1984) argument that market and hierarchy over-lap and their identification of trilateral governance andStinchcombe & Heimer’s (1985) conclusion that con-tracts for construction incorporate aspects of hierarchyin order to protect against opportunism. In this re-spect, of appeal is Cheung’s (1983) generalization ofCoase’s theory of the firm. Coase’s main concern isthe choice between (complete) direction by the marketand (complete) direction by the firm. Instead of view-ing the market and the firm as competing rivals, Che-ung suggests that what matters is the choice ofcontractual arrangements.

BEHAVI OURAL ASSUMPTIONS

Williamson (1981) believes that two behavioural as-sumptions underpin the transaction cost approach;bounded rationality and opportunism and that theseassumptions represent ‘human nature as we know itand supplants the fiction of economic man’. It is worthexamining these ideas relative to the project manage-ment process.

Bounded rationality implies a limit on rationality,not in terms of being ‘partly irrational’, but in contrastto the traditional assumptions of economics of theperfectly rational being in that people act rationally butare limited by their analytical and data-processing ca-pabilities; a concept which is easier for managers toaccept. This is reflected in client’s project managementby the likelihood of their not selecting the most appro-priate organizational structure and procurementmethod usually as a result of not considering the fullrange of options available to them due to inappropriateearly advice. This is less likely to be the case for clientswhich build regularly.

The second behavioural assumption of opportunismis more controversial. Opportunism takes a dismalview of human nature as it maintains that ‘humanagents will not self-enforce promises but will defectfrom the letter and the spirit of an agreement when itsuits their purpose’ (Williamson 1985). Accompanyingterms are moral hazard and shirking. The conjunctionof economics and organization theory has led to muchdebate due to the different human motivation andbehavioural perspectives taken, no better recountedthan in a discussion in 1990 (Barney 1990; Donaldson1990a,b). Put simply, Donaldson objected to the as-sumption that managers behave opportunisticallywhilst Barney argues that the cost of distinguishingbetween opportunistic and nonopportunistic behaviouris in fact a transaction cost. Williamson’s (1985) betterargument is that ‘this unattractive view of human

nature nevertheless generates numerous refutable im-plications’ and ‘does not preclude the possibility thatthey [individuals] will forge durable alliances’. He alsoargues (Williamson 1990) that ‘organization theoristswere familiar with opportunism long beforeeconomists got around to it’. Thus, in undertaking atransaction cost analysis behavioural theory is incorpo-rated into the analytical framework, albeit from aneconomic perspective, and other models of organiza-tion can be used to explain departures from theassumptions.

Both Winch (1989) and Reve & Levitt (1984) recog-nize the potential for opportunism in construction.Winch uses the illustration of change in project specifi-cation leading to opportunist opportunistic pricing of‘extras’ by contractors. Reve and Levitt argue thatclear relationships between contractors and consul-tants reduce incentives for opportunism. Detailed doc-umentation of the contracts between clients and maincontractors and between main contractors and subcon-tractors, e.g. specifications, are intended to preventopportunism. The cost of their preparation by consul-tants is a transaction cost. Whilst these costs may behigh, the potential for high hidden costs (or losses) dueto underperformance of the completed project due toopportunistic behaviour by consultants is even greater.Contracts between clients and professional advisors,including project managers, are not usually as carefullyprescribed as between clients and contractors, provid-ing scope for opportunistic behaviour by consultants.This is further complicated by the fact that profes-sional advisors’ efforts are difficult to measure andinformation is distributed asymmetrically between theclient and the professional advisors. Agency theory is aspecial branch of transaction economics that has beendeveloped to deal with such situations. Pioneer contri-butions to agency theory include, for example, thework by Spence & Zeckhause (1971), Ross (1973) andJesen & Meckling (1976).

Moe (1984) describes the agency relationship as thecontract (explicit or implicit) between a principal andan agency where the principal delegates some rights toan agent who is bounded by a contract to represent theprincipal’s interest in return for payment. The relation-ship between the client (principal) and his/her profes-sional advisors (agents) in the project managementprocess falls into this category. As a result of oppor-tunism, and since the interest of the principal andagent may not coincide, decisions made by the agentmay not be in the best interest of the principal. There-fore, ways have to devised to constrain the opportunis-tic behaviour of the agent. Such costs are often very



high. Agency cost includes both the cost of constrain-ing the agent’s behaviour (or the cost of the agent’sopportunistic behaviour if the cost of constraining suchbehaviour is higher) and the cost of loss in productivityand flexibility as a result of constraining the agent’sbehaviour. The problem of designing efficient con-tracts mirrors that of the problem of deciding thedegree of control in management. Since agency costsarise as a result of divergence between the interest ofthe agent and principal, one method of reducingagency costs is to design contracts that tie together theinterest of the agent and principal. The evolution ofprofessionalism can be explained in terms of efforts toreduce agency costs. In the past in the UK, fee scalesfor services were mandatory, professionals could onlycompete on the quality of the services provided, thisled to well developed professionalism and codes ofconduct of the professional institutions which reflected‘the system’ defined by Bowley (1966) as typical of theUK class structure. Subsequent removal of the manda-tory fee scale allowed professionals to compete onprice as well as quality, which provides the clients witha wider variety of choices but also increases the cost ofmonitoring and measuring the output of professionalconsultants. The consequence is increase in premiumsfor professional indemnity insurance and complexity ofthe conditions of contract between clients and profes-sional consultants. All of which may add up to greatertransaction costs for project management by clients.

Williamson (1979) recognized that transaction costsare particularly significant when economic agents makerelationship-specific investments (asset specificity) aris-ing in three ways: site specific, plant specific, andhuman asset specific. In situations such as these, buyerand seller are locked in, competition is before invest-ments are made but not afterwards. Asset specificityraises opportunities for opportunism.

The focus of asset specificity in construction due tosite and plant has been on the relationship between theclient and contractor but not on the project manage-ment process. This has lead to the ideas of bilateral(Williamson 1979) and trilateral governance (Reve &Levitt 1984) as a function of frequency of investmentand specificity. Winch (1989) believes asset specificitydue to site and plant will probably only relate toparticular types of civil engineering projects. Humanasset specificity is more widely relevant to projectmanagement where, as the design develops, detailedknowledge is held in a firm, usually by a relativelysmall number of people. Both client and consultant arelocked into the arrangement (Reve & Levitt 1984).

In such circumstances the impact of transactioncosts relative to project managers, designers and otherconsultants is interesting as detailed contractual ar-rangements may not be made, rather the relationshiprelies on trust and the professional standards of theconsultants. In such circumstances the prospect foropportunism is high as many clients do not monitorthe performance of their consultants. Whilst the levelof actual transaction costs may not be great, if thecompleted project performs at less than the expectedeffectiveness the cost of not monitoring effectively canbe extremely high. Alternatively, and increasingly, de-tailed negotiations are carried out with consultantsbefore appointment, contract conditions are spelledout in detail and monitoring is undertaken, leading tohigh transaction costs which in the long-term may beadvantageous. Increasingly, therefore, reliance on for-mal contractual relations emerges, not only betweenclients and contractors but also between clients andproject managers and consultants which lends the pro-cess amenable to analysis as a nexus of contractualarrangements (Cheung 1983, 1992).

With increasing commitment to project manage-ment by clients, the recognition of human asset specifi-city related to design knowledge may move therelationship to a bilateral monopoly. A similar relation-ship may also exist between the client and contractorwhen relational contracting is found to be valuable inreducing transaction costs. Thus, an array of bilateraland trilateral governance structures are possible de-pending on the configuration of the contributors whichgenerate the transaction costs of project management.

CONCLUSIONS

This paper argues that project management is notcostless, that the project management costs carried bya client are entirely transaction costs and that the roleof project management is to minimize the total oftransaction and production costs; a situation which hasthe potential for conflicts of interest. For clients tomake the best decision regarding the project process tobe adopted, they need to consider their internal costsin setting up the project, the cost of any externalproject management and of the consultants and otheradvisors and the production costs of constructing theproject. Frequently in practice, only constructioncosts, which often only equate with the predictedtender sum, are considered. Reducing transactioncosts at the expense of a greater increase in productioncosts is obviously unsound but is not a factor which isexplicitly considered for most projects. Against the



total of transaction and production costs clients haveto consider the extent to which the completed projectfulfils their need; aesthetically, functionally, financiallyand in terms of delivery. Minimization of total costsusing a system which does not deliver a project of anappropriate quality does not maximize the client’sbenefit. This process will always carry some element ofrisk as when selecting the process for producing theproject, the output cannot be entirely guaranteed. Ona microlevel this can be illustrated by the unlikelihoodof it being possible to develop specifications and con-tract documents to such an extent that additionalunanticipated costs are not incurred. Incurring highertransaction costs to reduce the likelihood will noteliminate the possibility, so the issue becomes one ofthe amount of risk to be accepted by the client againstincreasing transaction costs.

Put in practical terms, the significance to construc-tion professionals of an understanding of the relation-ship between transaction costs economics and projectmanagement theory is that:

� when recommending project organization structuresto clients the total cost of project management(transaction costs) and design and construction(production costs) should be evaluated;

� different organization structures generate differentproject management approaches and costs which inturn generate different costs for design andconstruction;

� higher project management costs may not lead tolower design and construction costs and vice versa;

� the choice of organizational structure should mini-mize the sum of project management and designand construction costs whilst delivering a projectwhich meets the client’s requirements;

� organization structures which increase project man-agement costs can only be justified if design andconstruction costs are reduced and the effectivenessof the project is maintained or, if design and con-struction costs are held constant, by improving theeffectiveness of the project.

The project management costs to be minimized insuch an evaluation include:

� in-house client costs such as the opportunity costsof the time that senior executives spend on theproject; a major part of which comprises definingobjectives, their detailed development and the costof making decisions;

� the cost of establishing the project organizationstructure, which may also require substantial inputfrom the client’s executives;

� the cost of co-ordination within the client organiza-tion and within the project team (including thecontractors) and between the client and the projectteam;

� the cost of producing contract documentation foragreements with consultant and contractors includ-ing terms of engagement, contract agreements, billsof qualities and specifications;

� the costs of negotiation between all parties; client,consultants and contractors;

� the cost of monitoring agreements and contractswith consultants and contractors to ensure that allparties are complying, including supervision of con-struction work;

� the cost of enforcing the contract, including alldispute and settlement costs.

Project management theory explains the choice of anorganizational structures as an interaction of the envi-ronment and the project tasks and identifies the activi-ties which constitute project management on behalf ofa client. While such generalization is useful in terms ofproviding a general framework for analysing how deci-sions are made and projects managed, it is sometimestoo general for analysing real world problems. Whilesome detailed description of the key features of theprocess is necessary to operationalize the analysis, theproblem is that of identifying key issues. Moreover,there is also the danger of giving too detailed a descrip-tion which results in ad hoc theorizing leading toresults with no general applicability. The transactioncost economics approach can be used to supplementmanagement theory by focusing on the market forcesthat determine the behaviour of the parties involved inthe system. Thus, the transaction cost economics ap-proach not only provides an explanation for the choiceof project management system, it also provides insightsof the key elements that shape decision-makers’ deci-sions in the development process. Most importantly itcan also give more rigour to organization theory byproviding the analytical framework for identifying hy-potheses for empirical work. On the other hand, theapplication of the seemingly reductionist transactioncosts economics approach to real life situations can beimproved by richer specification of the managementprocess which determines the actual transaction costsincurred and their distribution amongst client, consul-tants and contractors.

For practitioners the theoretical ideas developed inthis paper provide a framework for deciding whichproject management system to recommend to clientsand for clients it offers a framework for critically



reviewing the advice offered to achieve a more objec-tive evaluation than is usual. Thus, it lays down a basisfor learning so that mistakes are not repeated. Furtherunderstanding of the effective management of projectsbased on an integration of the two paradigms dependson more empirical work to which the obstacle is thelack of data on contracts and the activities of firms(Coase 1991). Construction projects may provide afruitful source of such data but the efforts needed toprovide them should not be underestimated. AsWilliamson (1985) says ‘the microanalytic features oforganization that are of special interest to transactioncost economics involve asset specificity, informationasymmetry, uncertainty (especially surprise), formaland informal governance apparatus, and incentives.Few studies of organization address those matters withthe needs of transaction cost economics in mind.’

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The relationship between construction project management theory and transaction cost economics