Measuring and Managing Ex Ante Transaction Costs in Public Sector Contracting

Transaction cost attributes, such as the complexity of the product being purchased, shape the risk that government contracts will fail. When transaction cost risks are particularly strong, a common prescription is to avoid contracting altogether or, if it is unavoidable, to spend additional resources on contract management activities. This article presents evidence on the size and variability of governments' ex ante transaction cost spending, using original data from 72 contracts issued by 47 Danish local governments. Ex ante transaction costs average 2.7 percent per contract and are relatively higher when services are more complex and lower when governments have prior contracting experience and contracts were larger. The analyses suggest the importance of distinguishing between transaction cost attributes and governments' choices to spend resources in response to them. Effective management spending in the face of transaction costs can help governments organize and capture value from contracting with private businesses.