Ronald Coase, the Nobel Prize winner of economics in 1992, brought the transaction cost theory to the world (or at least this transaction cost theory has been assigned to him). This theory postulates (amongst other things) that organizations exist because of market inefficiencies.

Coase dedicated much of his studies to the differences between the economic systems and firms. Transaction costs link both of these:

Transaction costs, in my view, become the factor upon which the productivity of the economic system depends. (http://coase.org/coaseremarks2002.htm)

Because of inefficiencies in economic markets, it is more efficient to organize activities in organizations. The normal coordination role of the price mechanism is missing when the market is inefficient or non-existing.

So, if there is no (external) market you can organize that specific market activity within the organization and save transaction costs. The transaction is the object of study. This is interesting of you think about outsourcing and the transactions that are involved when dealing with outsourcing.
The cost elements of the transaction involve information costs, the costs of the setting up the agreement as well as the costs as maintaining the contract.

Now, picture the following situation.

Your company is located on the third floor of a building with two wings. There was no wall between the wings and people could walk and communicate over and through. Easily. If there was a problem you ran across to the other side and with the output where the problem as printed, you discussed the issue and tried to solve it at the moment. “This is urgent.”

After the outsourcing deal, there is this wall and if you want to go from one wing (building) to another you need a security key in order to access. Each communication involves time.
One of the advantages of outsourcing is just that, different locations. Indeed for large corporations the spreading the activities over more locations spreads the business risk. But the additional problem is the management of the various activities over the different locations.

Yet there is this wall and you cannot longer step over it at the moment you wish to.

So what to do… (to be continued)

Hans Bool is the founder of Astor White a traditional management consulting company that offers online management advice. Astor Online solves issues in hours what normally would take days.
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