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Oliver Williamson: not examining all costs can really cost you

Oliver Williamson: not examining all costs can really cost you
Kate Vitasek
  • On July 4, 2011

Many of the economists I’ve highlighted in this space, from Coase (do the math!) to Nash (win-win behavioral economics) to Solow (importance of innovation and technology) laid the economic foundation for outsourcing.
Another Nobel laureate, Oliver Williamson, has taken those threads, added a few of his own and weaved them directly into modern outsourcing, which makes him, in my mind, the most influential.

Williamson, professor emeritus of business, economics and law at the University of California at Berkeley, took transaction cost analysis to a new and seminal level with the concept of ‘transaction cost economics’ (TCE). TCE looks at the entirety of the costs of doing business, including the contracting process, and at how organizations behave with regard to the contract and how people behave during contract negotiations.

Over a long career Williamson applied TCE directly to the vagaries of outsourcing and to the cost of contracting. His article in the April 2008 Journal of Supply Chain Management (“Outsourcing: Transaction Cost Economics and Supply Chain Management”) examined outsourcing from the TCE perspective. Williamson states “all complex contracts will be incomplete– there will be gaps, errors, omissions and the like,” and he advises that organisations shift to contracts with a more flexible framework.

Williamson advises that having a contract that is too rigorous ultimately leads to higher transaction costs and that companies should create mechanisms that preserve continuity and that can cope with unanticipated disturbances as they arise.

I like to think of it as “business happens”.  In short we need to create outsourcing deals that embrace change, rather than fight about it. One of my favorite lessons from Williamson is that your style of working with suppliers matters. Williamson states that “muscular buyers not only use their suppliers, but they often ‘use up’ their suppliers and discard them.” Organisations that flex their “muscle” to gain an advantage over suppliers may have a short-term win, but they will lose over the long term.

Williamson stresses the need for companies to use a “credible” style of contracting that builds long-term trust.

One tactic that Williamson says is effective for building trust is to leave money on the table when it comes to negotiating. Leaving money on the table may sound counter-intuitive, but when striking a strong business relationship it can signal a constructive intent to work cooperatively that will build an environment that is credible from start to finish.

Williamson also takes Nash’s concept of win-win behavioral economics out of the theoretical realm of strategy and into the reality of contracting by showing that the contract itself can have negative impacts on business if an organisation does not think clearly about how to structure and negotiate the contract properly.

It goes without saying that Williamson is an advocate of win-win thinking with his clear advocacy for creating contracts with “mutual advantage.”

For those interested in learning more about Oliver Williamson’s Nobel Prize winning work, the University of Tennessee teamed with Georgia Southern University, Cranfield School of Business, and the International Association for Contract and Commercial Management to produce a white paper titled “Unpacking Oliver: 10 Lessons to Improve Collaborative Outsourcing”, which is available for a free download at the Vested Outsourcing site.

I like Williamson’s thoughts on outsourcing because he digs beyond the numbers to substantiate the value of a collaborative, win-win approach to outsourcing.

It is the best academic work I’ve seen that shows how to address contract and governance structures in developing advanced, collaborative outsourced relationships. The bottom line on Williamson’s work is that the bottom line is not always apparent; the contracting process is full of the hidden costs of doing business.

I think Williamson brilliantly captured mathematically what my mamma always told me: you get what you pay for.

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