Asset Quality Rating: Definition and Key Concepts

What Is Asset Specificity?

In economics, asset specificity is the degree to which a thing of value, or even a person of value, can be readily adapted for other purposes. A thing with high specificity is useful only for certain tasks or in certain circumstances. An asset with low specificity is a more flexible resource, and therefore a more valuable one.

Key Takeaways

  • A resource that can be readily adapted for many purposes is said to have low specificity.
  • A resource that is customized for specialized uses has high specificity.
  • The resource that has low specificity generally has a higher resale value.

Generally, the more specific an asset is, the lower its potential resale value is. There is a smaller pool of buyers for a highly specialized resource.

Understanding Asset Specificity

Asset specificity is the degree to which an asset is useful across multiple situations and for multiple purposes. It may be equipment designed to have a single function or labor trained to perform a single task. Think of a generalist who can perform many tasks and wear many hats within a startup versus an employee with deep experience in a single function.

Customized computer software is an example of a highly specific asset. The oil and gas industry, the airline industry, and the manufacturing sector all have high asset specificity. Oil drills, jetliners, and assembly lines are not easily or cheaply adapted to other purposes.

Generally, industries in the service sector and the people that staff them have low asset specificity. Education, government, and finance all require highly skilled labor forces made up of individuals who can adapt to other professions. Most of the facilities and equipment they rely on also can be adapted.

Asset Specificity in Contracts

Asset specificity can be an issue in contractual agreements between companies. An agreement may require one company to build and use highly specific assets that are of value only to the other company in the contract. It may also require that other company to rely solely on the company that is creating those highly specific assets.

Asset specificity can be a red flag to either party in a contract negotiation. It generally calls for a long-term business commitment.

For example, say a manufacturer is offered a contract to build a new gadget that has an unusual form and is made of unusual materials. A new and expensive machine must be custom-built just to manufacture this gadget.

Those companies are effectively stuck with each other. The manufacturer must rely on a single customer to order sufficient quantities to make that machine profitable. The buyer is reliant on a single supplier for its new gadget and is unable to compare prices and quality among various sources.

Negotiations for such a contract would probably rely on long-term commitments that protect both parties.

Variations on Asset Specificity

One variation of asset specificity is site specificity. An asset might be considered highly specific because it is impossible or prohibitively expensive to move to a different location.

There also is physical specificity, which indicates equipment, machinery, or software that has been customized for a specific customer or a unique use.

Human asset specificity is a ponderous term for company employees who are highly trained in a specialized task that is not easily transferable.

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