In 1930, R. H. Coase wrote an article titled "The Nature of the Firm." This is a classic work among economists, but perhaps not as well known among technology and consulting professionals. However, the concepts presented by Coase over 70 years ago are very applicable to the current world of professional services. In this article, I'll review Coase's model of transaction costs and apply it to the decisions that product companies are presently faced with regarding their strategies for professional services.
Theory of Transaction Costs
Back in 1930, R. H. Coase asked a simple question: "Why don't companies grow indefinitely?" In his transactional cost model, Coase concluded that firms grow and manage activities internally until it's cheaper to outsource that activity. Let's take a simple example like payroll. If it's cheaper for a company to manage payroll internally, they'll do so. But if the company can outsource that activity more cost-effectively, they'll do that instead. Figure 1 shows how that make/buy decision plays out for companies. Of course, there are many variables to consider when reviewing the make/buy decision; Coase highlighted the following costs that firms should consider:
- Search and information costs
- Bargaining and decision costs
- Policing and enforcement costs
Figure 1 Theory of transaction costs.
The premise is simple: If a company can purchase a service more cost-effectively than they can provide it internally, that service is clearly a candidate for outsourcing. This has been the mantra of business executives for years now.