Wednesday, June 1, 2016

Knowing When to Outsource Based on Transaction Cost

Firms can be thought of as a collection of transactions. The transactions within the firm are more efficient than what is outside the firm. Companies create theses efficiencies so they can compete against other firms and maximize profits. Knowing when  to outsource and when to bring in house operations can have a big influence on organizational success.

According to Transaction Cost Theory the cost of transactions will determine whether or not a service should be brought inside the company's borders. The efficiency by which a company can produce the product/service makes a big difference in their strategic approach. There needs to be a match between resources and need.

For example,a training department might consider the costs of conducting training internally or hiring an outside company to teach a course on a particular product. This would include the costs of hiring staff, facilities, and equipment. As the training becomes more complex and requires specialized equipment the more transactions costs rise.

Eventually, the cost of keeping the training in house versus outsourcing it reach parity. At this point, companies should seriously consider either investing in their training department or outsourcing the service altogether. The training program must add value beyond that which can be bought in the market.

Before making the decision to keep or outsource operations it becomes important to review the long-term strategies of the organization. Focusing on the core business allows for investment in lowering internal transaction costs while trying to be too much to too many, unless multiple focus creates parity and lowers long-term costs, can be a loosing game.

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