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Business operations and the need for contracts

September 4, 2013

Just this week, I was talking to a colleague about Professor Ronald Coase and my respect for his work. His death on Monday will probably not be noticed by most contract, commercial and procurement professionals – but it should be. Ronald Coase’s work as an economist and legal academic had a substantial effect upon the ideas that underlie our discipline and business role.

Back in 1937, Coase wrote a paper entitled ‘The Nature of the Firm’. In this he argued that in a pure world, there would be no firms or corporations. From an economic perspective, hiring full time labor made little sense – it would be far better to outsource work and maintain full flexibility over the amount and skills of resources. However, in reality, the operational costs associated with discovering and transacting with this outsourced labor would exceed the costs associated with longer term hiring.

These ideas were contentious and it was not until the 1950s that they gained wide acceptance in the academic community. Until then, no one had considered the impact of organization and operational costs on business decision-making, but steadily it became understood that this lies at the heart of ‘make or buy’ decisions. And it is of course those decisions that lie at the heart of the need for ‘trading relationships’ between businesses – and which keep contracts and procurement professionals in a job!

As soon as one grasps the significance of Ronald Coase’s work, we begin to see how our world is impacted by shifts in the underlying transactional costs that he identified. Back in 1930, technology was very limited. Conducting a search for sources of supply was expensive; hence either hiring people to do the job, or contracting with a nearby provider, was the obvious way to go. But as communications technology has developed, cost structures undergo dramatic change. The idea of large-sale outsourcing is no longer considered an expensive and unmanageable proposition. Nor is trading across borders.

The work that originated with Ronald Coase has inspired others, among them fellow Nobel prize-winning economist Oliver Williamson. Much of this work looks specifically at issues that affect how we view and use contracts – though only now are we truly refining our understanding of the economic impacts of contracting practices and policies.

At IACCM, we owe a debt of gratitude to Professor Coase for key theories that underlie our purpose and existence. Hence this acknowledgement and brief memorial to him.

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