Outsourcing at the edge of chaos: why transaction cost economics fails under complexity

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School of Business | Master's thesis
MSc program in Information and Service Management
MSc program in Information and Service Management
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Transaction cost economics is one of the dominant paradigms in the study of outsourcing, namely in the study of what to outsource. However, many findings have questioned its power to explain or predict outsourcing. On the other hand, in recent years and decades the importance of complexity has been noted, and also that complexities tend to make it hard to use linear theories - such as transaction cost economics. In this thesis, transaction cost economics is studied carefully in order to show why its ability to predict either the decision to or the success of outsourcing is weakened by the complexities in economies, organizations, etc. Since complexity is the reason of the failure, also some foundations for a theory that takes it into account are expected to be laid. In order to approach the problem, each of the transaction cost economical constructs individually, as well as the theory in its entirety, are analyzed against economics, game theory, and complexity theory. The new theory is based on the findings from these analyses. The failure of transaction cost economics is successfully identified and related to complexities regarding the problems caused by statistics, nonlinear functions, iterated games, and so on. New theory that does not suffer from the weaknesses of linearity is also outlined. However, such an approach is not recommended because of its complexity: the theory requires a vast array of knowledge to be used (as opposed to the simple theories that fail under complexity). Also, it is extremely case-specific, and it will be difficult to operationalize. Furthermore, like other theories, it has a touch of tautology in it. Because of the problems related to transaction cost economics (as well as other views mentioned) are clear-cut, its use in outsourcing is not recommended. However, since the same applies to a more complex theory, the conclusions are rather surprising. In short, the author concludes that we should not focus too closely on what we intend to outsource, but rather on how do we handle the process of outsourcing. Its scientific study in academia is more likely to produce better generalizable results, and learning the principles is in all likelihood much more valuable to businesses (and as a result, to business students) than learning the "what theories".
transaction cost economics, outsourcing, complexity, economics
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