Volume 19, Number 2 Article by Sourav Mukherji and J Ramachandran June, 2007
Outsourcing: Practice in Search of a Theory :
Specialisation and outsourcing are recognised as complementary business imperatives in the present age of innovation-driven competitiveness. In seeking to understand which of the organisation’s activities should be conducted in-house and which should be sourced from the market, managers need to understand the costs and benefits of both options. Sourav Mukherji and J Ramachandran use transaction cost economics to generate a decision rule for outsourcing and develop a decision model for evaluating potential costs and benefits of outsourcing decisions such that practising managers can rise above intuitive arguments and base their outsourcing decisions on robust analysis.
Based on examples from Indian and international business, the paper identifies, analyses and classifies four ways in which organisations gain from outsourcing decisions, namely cost minimisation, resource access, superior resource leverage and risk diversification. However, these advantages are not without their risks and the contours of a framework for decision making have been well laid out by the proponents of transaction cost theory. Managers will have to consider that the total cost of accessing the market can be more than the total cost of in-house production even when the market price is less than the cost incurred to do the activity in-house because transaction costs (such as those of searching, drawing, negotiating and enforcing contracts) often exceed organisational (agency) costs to a greater extent than the difference between the market price and in-house production cost. Further, the risks of knowledge spillover, poor performance by suppliers, and the considerations of long-term competitiveness may lead organisations to conduct activities in-house. The authors discuss the conditions under which the model is valid as well as its assumptions, and incorporate the considerations of knowledge spillover and reputation capital to explain why market based transactions among specialised organisations take place even when market conditions are far from ideal.
Reprint No 07202
