"Many firms have outsourced their payroll systems, while hardly any are "buying" R&D services. Explain why this is generally true, and why Monsanto followed a different strategy."
INTRODUCTION TO STRATEGY
Question (b)
“Many firms have outsourced their payroll systems, while hardly any are ”buying” R&D services. Explain why this is generally true, and why Monsanto followed a different strategy.”
Many firms outsource different functions of their business, such as payroll systems, IT services etc, where these are auxilliary functions to the firm i.e. they are functions which help the firm in day-to-day operations. I will here contend that it is possible to reduce a “make-or-buy” dilemma to a simple dichotomy between functions or competencies which are strictly auxilliary to a firm and others which constitute its very “core”.
The discipline of Transaction Cost Economics frames the dilemma as a range of trade-offs where the firm should make the “make-or-buy” decision based on the most cost effective alternative. By outsourcing a firm exposes itself to transaction costs such as the costs of negotiating and enforcing contracts with licencees. These costs must be evaluated with regards to “ownership costs” - the extra costs the firm incurs by performing the functions themselves. Such costs involve the extra bureaucracy needed and the draining of resources which could have been used more profitably elsewhere. Finally the firm must evaluate where the function can be produced most cheaply, in direct costs. Summing up this simplefied problem will give a firm two sets of costs, the cheapest of which it should choose.
This presentation is problematic for functions such as R&D. The firm’s very existence is based- and dependent on its R&D. The firm is built around an idea where R&D is the function to develop the idea further or find related ideas which can be exploited. One can safely say that a firm will never outsource all R&D because that would to a great extent remove the whole justification for the firm. However a firm might want to outsource parts of R&D for different reasons. A whole set of problems arise if the firm wants to outsource this function. Chesbrough and Teece (1996) mention three questions which the firm must pose itself before making the decision. “Is the information necessary to be passed on codified or tacit”, “is the kind innovation sought autonomous or systemic to the firm” and “what is most important, incentives on the part of licencees or coordination and control over the R&D process”. They regard R&D in this sense as any other function of the firm where questions of costs and convenience will decide the “make-or-buy” decision. The problem is that R&D is a function which is highly interrelated with all other functions of the firm and may have strong complementarities with them. By outsourcing it the firm may risk that essential inputs to the R&D are lost, simply because it is removed from the firm itself (i.e. its natural environment). Another problem is of the very creative nature of R&D. Even though it may have all the characteristics that Chesbrough and Teece state, there is no guarantee that a decision to outsource is what is necessary for the creative process.
