Testing Coase's Law

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    According to Sun Microsystems software guy Dave Brillhart, "Coase's Law states that: firms should only do what they can do more efficiently than others, and should outsource what others can do more efficiently, after considering the transaction costs involved in working with the outside suppliers."

    Mr. Brillhart suggests that transactions are coming down in price, which means outsourcing will become more prevalent in business operations.

    Now cut to Baseline magazine where author Paul A. Strassmann, in "Does Outsourcing Deliver the Goods," decided to find out whether the financial benefits really accrued to big-time outsourcers. He did this by calculating the "outsourcing ratio" for 1,100 companies, then ranking them by return on shareholder equity (ROE). The goal: to find out if the top producers of ROE were also the companies with more dominant sourcing strategies.

    Mr. Strassmann's conclusion:

    The statistics suggest that outsourcing does not appear to follow Coase's Law. Increasing purchases indefinitely in search of the cheapest source of supply does not seem to deliver profitability, as measured by the return generated on shareholders' investments in their companies.

    It's possible, says Mr. Strassmann, that those with lower rankings of ROE don't manage their "purchases" well.

    The article itself provides more detail. But the bottom line is this: If you screw up the management of outsourcing efforts, you lose out on the value of outsourcing in the first place.

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