Lee Ann Moore, EquaTerra Chief Marketing Officer

While the word ‘outsourcing’ is never used in Oliver E. Williamson’s paper, The Theory of the Firm as Governance Structure:  From Choice to Contract, it might as well be. The recent Nobel Prize winner crafted an economic theory that EquaTerra observes regularly as organizations utilize third parties, or outsourcing, for the goods and services they need to run their business and serve their clients. These third parties create the need for a new operating paradigm that should shift the leadership structure of organizations to a governance approach moving away from direct management of people and production. For services performed outside an organization, the procuring company is no longer able control the labor or the output of the service provider and as such it requires that organizations build an effective governance structure for these ‘nodal relationships’ and not one as managing a ‘production function’ as cited by Williamson.

Organizations have choices in how they buy goods and services needed to run their business and serve their clients. The paper describes The Sciences of Choice and Contract where organizations have the profit objective and as a result use choice to maximize profits. Choice allows an organization to look outside its walls for the provider of best fit when the internal organization is not a commercially viable option. The paper compiles the theories of many current and former economists, but the basic premise of choice drives the science of the contract and governance structures. Challenges and conflicts in outsourcing result from inadequate contracts and poorly defined and executed governance. The migration to a governance structure as opposed to an internal management structure requires different skills and roles and many organizations struggle to clearly define operating principles, decision rights and communication protocols with the third parties that now provide them services.

Many of our private and public sector clients continue to struggle with this operating model shift. The use of multiple service providers exacerbates the problem as these relationships often operate under different contract structures and governance principles. Williamson uses a term ‘logic of efficient alignment’ that suggests that although relationships differ in their cost and competencies, one could argue that aligning governance structures and approaches across an organization further creates an economizing operating model. EquaTerra has long advocated a common a governance approach, or the use of Governance Centers of Excellence, to manage complex third-party relationships across an organization.

As we observe the outsourcing market maturing and creating more capable providers across the globe, the choices available to organizations increase. Williamson makes a point long advocated by EquaTerra, more choices (i.e. more outside parties providing goods and services) require that companies shift to a governance view of leading their business as opposed to more historical managerial or production view.

For more from EquaTerra on the topic of Governance, visit our Library at http://www.equaterra.com/fw/main/Ongoing-Operational-Governance-336.html (membership required).

Filed under: Market Trends and News, Outsourcing by EquaTerra