This unit talked about the reasons why firms choose to set boundaries the way they do. It discusses the advantages of expanding its boundaries and also outsourcing. The boundaries of a firm define the activities that a firm performs itself rather than purchasing from the market. The unit only really concentrated on the vertical chain of production and not talk about boundaries dealing with scope of a business. Expanding a firms boundaries can have the following advantages;
- Reduce transaction costs of contracts from purchasing from the market.
- Possibly help coordination of production, as it may be less costly, less uncertain and more efficient to coordinate certain activities in-house rather than outsourcing.
- Reduce the risk of sensitive information about the firm’s product/service being leak, if the firm produces it in-house than market firms, because employees within the firm will feel a big effect if information is leaked than employees of another firm and therefore, the firms employees are less likely to leak information as will affect them more.
- Avoid hold-ups affects that come with relationship-specific outsourcing.
- Also tax issues might mean a firm is better off if it performs its operations in house rather than outsourcing.
I can think of a situation where a kind of hold-up happened in New Zealand. In a very large development of the South Island, the biggest crane and construction specialist company was employed to help with the construction of the project. The crane and construction specialist company, was known to be the best for this development. As the project was unique in nature the crane and construction brought a specially designed crane from approximately $1 million dollars that could only be used specifically on this development. This created a positive quasi rent number for the crane and construction company. The developer would of known this and when the GFC hit and he struggled to pay bills he knew he would get away with not paying the crane and construction company bills, as they relied on his project to pay off the specialized crane they brought. The project fell over and a settlement was eventually made between the developer and the crane and construction company, however the crane and construction company did talk a large financial cost of the failed development. The issue now is the crane and construction company are not willing to invest in relationship-specific infrastructure in other projects it is working on as it does not want to make a loss. Therefore, the developers projects are not being done using the best equipment as due to the hold-up effect.
Firms may outsource activities (i.e. narrow boundaries) for the following reasons:
- · Reduce transaction costs such as monitoring and policing activities.
- · Market firms may have economies of scale that in-house operations might not be able to achieve.
- · Market firms are subject to market discipline, whereas in house operations may not be able to achieve the same discipline as market firms in the same costly manner.
- · A function may no longer fall within the core competencies of a company and therefore may make sense to outsource the activities.
An common example of where firms struggle to gain the same discipline as market firms is government organizations. Often in New Zealand anyways, I have heard employees of government organizations talk about the in efficiency of the workforce. And this generally because of the environment that has aroused of a slack workforce, because responsibility and budgetary constraints are not as effectively used as Market firms. Therefore, management of these government firms often outsource some activities as it is more cost efficient due to the issues of policing and monitoring slack staff.