Outsourcing: Transaction Cost Economics and Supply Chain Management

Article Critique

Outsourcing: Transaction Cost Economics and Supply Chain Management




Article reviewed

Williamson, O. (2008). Outsourcing: Transaction Cost Economics and Supply Chain Management. Journal of Supply Chain Management, Vol.44, No.2, pp. 5-16.

The article, “Outsourcing: Transaction Cost Economics and Supply Chain Management”, by Williamson Oliver seeks to address outsourcing practice from the perspective of transaction cost economics.  The research problem being addressed is whether firms should outsource or not based on a view of transaction cost. The paper takes the treatment of transaction cost economics. The framework holds that exchange between independent parties is characterized by transaction costs of varying degree. According to Williamson (2008), the transaction cost can be reduced by promoting continuity in contract development.

The author uses contract lens, describes human actors, explanation of positive transaction costs, and pragmatic methodology as the background of the article. On the lens of contract, the author recognizes the need for a contract that results in a win-win situation. He uses relevant examples to emphasize the need for efficiency gains (Williamson, 2008). He argues that additional gains can be obtained from a contract if cooperation is preserved during contract execution. This argument in in line with the theory of transaction cost economics which focuses on the collaboration of business partners with a purpose of shielding one another from any subsidiary harm with varying relationships (Schwabe, 2013).

The author then discusses human actors as study background. He argues that humans influence transaction costs (Williamson, 2008). He clearly explains that humans are subject to limited objectivity which may influence them to favour their own interests.  This calls for a mechanism that can address such disturbances in case they arise. As the theory of supply chain management states, business partners need to engage in integrated planning, co-ordinate, and take control of all activities in the supply chain. This will ensure that customers receive superior value in a cost-effective manner. Additionally, addressing all the activities and processes, all the stakeholders will be satisfied (Chopra and Meindl, 2001). This statement supports Williamson’s argument of establishing mechanisms that will address disturbances related to humans’ limited objectivity for a successful contract. 

On pragmatic methodology, the author identifies three precepts. These three are clearly explained where keeping it simple involves eliminating things that are not fundamental and focusing on the main case. Getting it right involves focusing on the logic by using accurate mathematics to verify logical operations (Williamson, 2008). Making it plausible involves making sense for reasonable values.  While the author starts the discussion with three precepts, he ends the section by adding a fourth precept which is deriving refutable implications. While the precept is clearly explained, this precept comes as a surprise to a reader and may be the author should have mentioned it at the beginning to prepare the reader for a better understanding of the concept (Chopra and Meindl, 2001). It is however clear that making a conclusion based on pure analysis is better compared to empirical evidence.

According to Williamson (2008), the decision of managers in whether to outsource an economic activity or not depends on transaction costs. This argument is supported by economists’ argument that all economic transactions are costly. However, the most efficient activity would be the one that reduces the transaction cost. While sometimes it is better to engage in internal transactions, other times outsourcing is less costly. For managers who choose to transact in an open market, Williamson argues that the cost increases with complexity and with asset specificity. This brings in the issue of contracts (Williamson, 2008). The author clearly explains that all contracts that are complex. This means that involved parties have to adapt to the anticipated disturbances that may arise different from the original contract.

Confines on human rationality which explains why contracts inevitably omit vital consequences and strategic behaviour for gaining an advantage over other parties make complex contracts incomplete. This means that disputes are unavoidable (Williamson, 2008). It is thus the work of managers to interpret contracts in a farsighted manner. This involves perceiving potential hazards with the purpose and effect of mitigating the hazards. This complexity calls for a transaction in a single legal entity instead. Such a setting simplifies a complex transaction. This means that for a successful outsourcing arrangement, vendors must ensure the contracts are transparent and not ambiguous. Williamson (2008) recognizes the need for vendors and clients to expect omissions and ambiguities in contracts. This will enable them to be flexible whenever agreements arise on contract terms. The author has clearly explained this issue of contract complexity. However, giving more examples would have helped to get a clearer picture of the issue.

The author has identified three styles of hybrid contracting for complex transactions. According to the author, the paper has focused on middle kind transactions because of the focus on continuity. The author has explained what muscular contracting is which involves large buyers dealing in a peremptory manner with smaller suppliers. The author considers the approach inefficient in outsourcing for certain assets. It is not clearly explained what a benign approach means. Use of more examples and evidence would have helped understand the approaches (Michael, 2011). On credible contracting approach, the author takes an approach of comparing it to the other two approaches. This makes it seem more appropriate than others.

While it is clear that the best contracting approach should be aware that complex contracts are incomplete, a detailed explanation with the support of examples would have helped understand the contracting approaches for complex transactions (Williamson, 2008). Managers should however, promote credible commitment to discover potential hazards and factor them back in the contractual design. According to the author, managers can use safeguards with the contracts to prevent opportunity behaviour by one partner harmful to a business practice. Through credible commitment, it is possible to mitigate hazards. The author however notes that sometimes people can select unconventional forms of safeguards to mitigate hazards. He clearly calls for credible commitment just as other researchers in a cost effective degree (Michael, 2011). Giving examples of the conventional forms of safeguards is warranted in this article.

In conclusion, Williamson emphasizes the need to consider transaction costs when people are making decisions on whether to outsource or not.  He discusses outsourcing from a perspective of transaction cost. The author uses information on contract lens, positive transaction cost, human actors’ behaviours, and pragmatic methodology as the background of the study. From the article, managers have to consider transaction costs in deciding about contracts. Outsourcing should only be considered if it is less costly and still delivers value to the clients. It is important to acknowledge that complex contracts are incomplete and thus the use of credible commitments to mitigate potential hazards. The article provides clear information on outsourcing and TCEs. However, to have more people engage and understand thee it, more relevant examples should be provided. Use of evidence will also help in getting the message clearer. Generally, this is a good article that is well written and has vital information for organizations. The theory is relevant and convincing.


Chopra, S. and Meindl, P. (2001). Supply Chain Management. Prentice Hall.

Michael, B. (2011). A Transaction Cost Economics View of Outsourcing. International     Journal of Business, Humanities and Technology, Vol. 1 No. 2, pp. 34-43.

Schwabe, T. (2013). Transaction Cost Economics in Supply Chain Management. University        of Twente. Thesis, pp.1-14.

Williamson, O. (2008). Outsourcing: Transaction Cost Economics and Supply Chain Management. Journal of Supply Chain Management, Vol.44, No.2, pp. 5-16.