Out Sourcing

One thing I puzzle about is why some things are done inside of a firm while others are done outside. Data storage or product shipping are two examples but there are hundreds. I found this an amusing way to look at the problem: Brad DeLong quotes the abstract of a paper by Olivier Blanchard and Michael Kremer that attempts to puzzle out why output declined so far in Eastern Europe after the collapse of the Soviet Union.

Under central planning, many firms relied on a single supplier for critical inputs. Transition has led to decentralized bargaining between suppliers and buyers. Under incomplete contracts or asymmetric information, bargaining may inefficiently break down, and if chains of production link many specialized producers, output will decline sharply. Mechanisms that mitigate these problems in the West, such as reputation, can only play a limited role in transition. The empirical evidence suggests that output has fallen farthest for the goods with the most complex production process, and that disorganization has been more important in the former Soviet Union than in Central Europe.

To me the point is that when you have a single supplier it creates habits that are fundimentally at odds with the habits demanded when you have multiple
suppliers. To put it another way that managing in the face of diversity is a entirely different from managing in a strong heirarchy.

Thus while it seems like a fine idea in the abstract to outsource this or that function it is usually very difficult in practice because the entire day to day relationship between the function and the firm has to be transformed. It’s a demands a culture change and that in turn makes it a social reengineering problem.

Another place I see this: Microsoft, Oracle, IBM, Sibel, etc. Many firms have a single supplier relationship with for their platform, IT, CIO, etc. needs. In the abstract it may seem like a fine idea to shift to a more open market relationship for these functions pulling it off demands a very complex shift in culture.

All this is a huge part of what slows the adoption of open source solutions. In contexts where open source creates the platform of standards for an industry the vendors tend to be numerous. The buying firms then have to have an entirely different culture for managing the set of vendors from one time period to the next. More information has to be managed; information that sums up into the answer to the key question “Can I trust this vendor?”

When you settle into a single vendor, or in-house or out, there is a tendency to become lazy aobut these issues. “Incomplete contracts” and a “breakdown of bargining” indeed. The challenge of maintaining trust displaced and the habits of authority, strong loyality, and maybe an occational game of golf take their place.

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