In the last century, sea freight costs have fallen by 70%, air transport costs by 90% and international calling costs by 99%. (See picture). This is one of the reasons why global trade today is more than 40-times larger than in 1913. The expansion & integration of trade over the last century has been largely possible because of reductions in transaction costs stemming from technological advances.
A transaction cost is a cost in making any economic trade when participating in a market. Transaction costs are so fundamental to business strategy because they determine what an organization must build internally vs. what it must buy from suppliers or service providers. As transaction costs change, organizations must adapt their build vs. buy strategy too.
In the last couple of decades, Internet and related technologies have further reduced transaction costs: by creating electronic marketplaces, helping to realize cost reductions, increasing productivity, enabling e-procurement, integrating business processes and allowing for the creation of customized services.
The next step in this path will be enabled by Blockchains & Distributed Ledger Technologies. A Blockchain has value because it offers a secure and distributed mechanism for value exchange.
To understand why, we must first consider the source of transaction costs in B2B networks like Supply Chains & Distribution Networks.
The source of Transaction Costs in B2B Networks
In today’s highly inter-connected world, economic value gets created by firms collaborating with each other. Inter-firm collaboration can take many forms: from supply chains & distribution networks to industry consortia and geographically co-located economic clusters. These collaboration networks effectively create a network or a market clique, enabling trades among these firms.
B2B relationships in these networks are maintained using a variety of mechanisms (e.g. contracts) and tools (e.g. ERPs). In B2B networks & markets, transfer of value (products, services, payments) is carefully recorded by each organization (e.g. in an ERP).
As the long-lived transactions proceed, information is exchanged by emails, phone calls etc. Despite efforts like EDI, processes relying on emails, spreadsheets & pdfs are still common - the primary challenge is that each party has a “copy” of the transaction e.g. purchase orders, invoices, payments etc. Given the complex workflows, these copies can get out-of-sync. Transactions that are not in agreement require time consuming research, repair, revision, reconciliation, negotiation and hopefully settlement.
An important aspect of this challenge is technology adoption. Achieving friction-less trade in B2B settings requires that technology must be adopted not just inside one organization but across organizations involved in the whole supply chain. Over 60 % of procurement organizations judge the suppliers’ lack of awareness and infrastructure to optimize B2B processes as a hindrance on the way to integrated B2B solution. They also acknowledged that current B2B integration scenarios are not balanced and neglect the position of the suppliers. Unless a solution benefits every organization in the network, it is unlikely to see adoption.
The problem is outdated technology. Given the speed of innovation, a lot of today’s enterprise technology is obsolete. Few people realize, for example, that ERP was launched in 1974, almost half a century ago.
How Blockchains will reduce transaction costs?
Consider the paradigm of Smart Contracts in Blockchains. A Smart Contract is a piece of software which is guaranteed to execute once deployed without any need for human intervention and the result of whose execution are stored on a Blockchain. Thus, all stakeholders in the ecosystem can access provenance, authenticate records, prove compliance & automate contract enforcement.
A cornerstone of enterprise technologies today are ERPs: a critical tool for managing operations in modern enterprise. In spite of deploying the best ERP and EDI systems, large swathes of critical information are still exchanged through emails, PDFs, excel sheets. What were the prices at the time of the shipment, the mode, the service level and what extra charges were allowed? Is the billing correct, were the service levels met, are there issues with the shipment which need remediation before billing goes out? On average, procurement professionals spend the majority of their time on the 80%–90% of the suppliers that represent less than 5%–10% of spend and business value.
At the heart of the issue is enforcing terms of the contract negotiated with business partners. Contract Management is challenging for two reasons:
- Contracts are in text format — enforcement thus requires manual interpretation. This can lead to disputes & in the worst case may require legal recourse;
- The information required to verify contract terms is replicated across ERPs; this must be reconciled before payments can be settled.
By embedding incentives & penalty terms in Smart Contracts, marketsN enables automatic enforcement of contract terms using transaction data recorded on the Blockchain. This reduces enforcement costs and enhances process transparency. Invoices are automatically generated & reconciled protecting against fraudulent billing and ensuring that buyers pay only for goods & services which were delivered as contracted.
Since Smart Contracts are coded in software, there is no ambiguity in what bonuses or penalties will be applied under any given condition. Since they are deployed on Blockchain, they execute as coded — without human intervention.
Terms coded in a Smart Contract are applied in a transparent, trusted way across organizations, it reduces disputes & arbitration. By automating enforcement, Smart Contracts reduce the cost of administering contracts — this opens the door to designing more effective contracts leading to further supply chain efficiencies.
marketsN is a complete end-to-end solution for enterprises to use the power of Blockchains to reduce transaction costs with their business partners, suppliers etc. The aim of marketsN is to create networks, markets & economies with trusted information & incentives.
marketsN contains a library of pre-built procurement contracts codified as Smart Contracts. These contracts embed customizable bonuses & penalties incentives to align the incentives of organizations in the group to be aligned. These contracts are flexible enough to be optimized on a case-by-case basis based on empirical data. With marketsN, auditors can focus on confirming the validity of the codified contracts rather than auditing transactions. This enables greater oversight & accountability.
If you are interested in using the power of Blockchains in your organization, reach out to us at email@example.com.