This can be illustrated with a simple example: What effort would companies have to make to buy their balance sheet on the open market every year? An external accountant incurs high costs and must be constantly monitored. Once the project has been completed and the balance sheet drawn up, all his accumulated knowledge is lost again and has to be rebuilt the following year.
Transaction costs are the glue for traditional value chains: In the manufacturing economy of the 20th century, it was not worthwhile to incur the high transaction costs of creating goods and services externally. The monitoring and control costs were simply too high for assembly line activities, for example.
Companies simply save money if they do not have to buy every service on the market but can integrate it into the company's workflow.
Make or Buy:?
As a consequence, transaction cost theory provides the basic framework for difficult management decisions: The make-or-buy decisions. Should work processes such as customer consulting or parts of IT be "outsourced" or remain within the company?
When making such decisions, the transaction costs must be included in the calculation. The following applies: Outsourcing is worthwhile if the purchase price + the expected transaction costs are below the internal production costs. In a first wave in the 1970s and 1980s, this consideration led to the outsourcing of parts of production to Southeast Asia - and to the rise of the so-called Tiger States.
How digitization will change the value creation processes of the future
The economy is currently facing a new wave of outsourcing. Digitalization is having a massive impact on the upcoming make-or-buy decisions. New technical possibilities such as the cloud are leading to falling transaction costs - across all transaction cost types.
This, too, will be illustrated by a practical example. Just think briefly about how the public cloud provider AWS has changed the purchasing process for IT services in recent years:
- Start-up costs: IT services such as compute, network and storage are described and can be easily researched (example for compute).
- Agreement costs: Creating a new account is child's play (see here).
- Settlement costs: All processes for cost management, invoicing and account administration are automated or can be self-administered via a simple user interface (see here).
- Control costs: To simplify control tasks, Amazon provides services such as AWS Cost Explorer and cost/benefit reports (see here).
- Adaptation costs: One of the most relevant functions of the cloud is the so-called Autoscale (here). This allows resource consumption to be automatically adjusted to actual demand.
How did this compare to switching a data center provider 15 years ago?
Transaction costs without end: demand analyses, demand development scenarios, tenders, tender consultants, tender rounds, final offers, contract negotiations, transitions and change projects, escalations, misplanning, misunderstandings and much more.
The make-or-buy decision must be rethought
But our corporations, with their huge IT purchasing departments and sourcing experts for IT services, are tailor-made for these tasks: new tenders are issued every five years, escalated in the meantime, pressure is applied, and unsuccessful major projects are managed.
At the same time, two developers release an iOS app for sharing photos and videos in 2010. They find 30 million users within two years and sell their Instagram to Facebook for a billion dollars in 2012.
The comparison shows: The make-or-buy decision must be rethought. Processes that are not part of the core business can increasingly be outsourced. In the future, all processes that can be digitized and/or automated will be put to the test.