Jump to main content

The Cost of Outsourcing

Isaac Wanasika

Isaac Wanasika, Ph.D., department chair and professor of Management in the Monfort College of Business. Photo by Woody Myers.

May 18, 2021

Professor of Management Isaac Wanasika, Ph.D., takes a close look at the cost of outsourcing — from basic manufacturing to high tech — then gives his students the chance to dive deeply into long-term implications.

As the global pandemic began to surge, Americans learned a hard lesson in transaction cost economics theory (TCE), which looks at the costs or efficiency of buying versus making something.    

“We cannot manufacture sufficient personal protective equipment (PPE),” Isaac Wanasika, Ph.D., department chair and professor of Management in the Monfort College of Business, says. “It used to be such a basic product that manufacturers decided to outsource the production. But when we get caught in a demand situation, such as the one we had, we then start begging for these products from other countries, even though PPE is very basic technology.”  

Outsourcing is a topic central to Wanasika’s TCE research.  

“Basically, I want to understand whether an organization should manufacture things in-house, whether they should go into long-term leasing or whether they should outsource their production entirely,” he says. “Organizations exist to minimize transaction costs, and the nature of transaction determines the emerging organizational form.”   

Wanasika first became interested in these questions in 2008 while he was a doctoral student at New Mexico State University. In response to previous antitrust action against Microsoft, Bill Gates had testified to Congress in defense of the accusation that Microsoft was a monopoly, and he asserted that part of his company’s success was their ability to innovate and develop technologies internally, efficiently. “It seemed to me the government’s reaction to monopoly was always antitrust action, without attempting to seek other explanations,” Wanasika says.   

“Bill Gates was basically saying, ‘We have chosen to minimize our transaction costs, and we have become very efficient to the extent that competitors cannot compete with the product. Everything is done internally, it’s done very well, and the costs are very low,’” Wanasika recounts. The sum of Internet Explorer and Windows was larger than the parts. Even though Microsoft lost the legal battle, consumers continued to purchase Microsoft’s bundled products.      

Where some saw a monopoly, Wanasika saw efficiency.  

“I started looking at the tech industry and the manufacturing industry, and there seemed to be a pattern: The U.S. seemed to be losing competitiveness in many areas where they had outsourced things,” he says.  

Wanasika points out that some companies are returning to manufacturing internally after facing situations where products they outsourced were poor quality, late to arrive or the manufacturing source created what he calls a “hostage situation,” as recently seen when automakers weren’t able to procure semiconductor chips for their vehicles. The shortage of chips began with pandemic-related shutdowns in assembly lines and, according to a recent CNBC article, is predicted to cost automakers billions in earnings.  

“It takes about 18 months to have in-house production of microchips,” Wanasika says. “China and other Asian countries supplying these inputs don’t want to supply (U.S. automakers) with the chips because they’re holding them for their own production, among other reasons. From a transaction cost perspective, that should have been a product manufactured internally to ensure safeguards against opportunism and avoid those hostage situations.”  

In addition, outsourcing can compromise intellectual property.  

“The U.S. has been very competitive in technology, but the moment technology companies started outsourcing technological production — the smartphone is a good example — to countries like Taiwan and China, suddenly these countries are manufacturing very similar products. At first, they seem to be cheap imitations, but they become better and better because these countries are learning,” Wanasika says. “It’s just not possible to hang on to our intellectual capital if we are hollowing out the production. Executing intellectual property protections in foreign lands is an uphill challenge.”  

Outsourcing high-tech innovations has impacted U.S. companies on a global scale. It’s a lesson Wanasika shares with his students as they study industries, like electric vehicles, and see how outsourcing production has cost American companies the technological edge.  

“China is way ahead. It has overtaken (the lead in electric vehicles). They have not done so because they are better, but because they have been able to adapt quickly and become better,” he says.   

His research helps students understand TCE theory, illustrating how factors like outsourcing or ethics carry costs that can impact an organization’s bottom line. Students begin to develop a long-term perspective of strategy rather than short-term gains. Students also learn to develop safeguards against human conditions of opportunism, self-interest and imperfect knowledge.     

“Ethics is very much related to transaction costs in practical ways, even though they are theoretically different,” he says. “We discuss this with the students and ask them, ‘Is it possible for a company that is efficient to survive if it’s unethical?’ We start looking at the costs of unethical behavior by sequencing long-term transaction costs associated with unethical behavior.”  

Wanasika says that at the beginning of these discussions, he asks student to perform a thought experiment by assuming an amoral position. Students may push back against seemingly mundane behavior, like cosmetic companies who aren’t forthright about their products’ efficacy and limitations.  

“(With certain cosmetics and nutritional supplements that are poorly regulated), you’re basically selling hope, and at the end of the day I tell them, if you don’t disclose the side effects or address the expectations, in the short term you may make a profit. But if that’s your core business, you’re not going to be around in five years, customers will find out, you’ll get bad reviews and you’ll be gone.”  

With real-world examples and classroom simulations that place them in thought-provoking situations, students begin to understand the actual transaction costs associated with unethical behavior. And UNC students have learned that lesson well, consistently winning and placing high in national and international ethics competitions, including those that are part of the Daniels Fund Ethics Initiative Collegiate Program, a consortium of 11 business schools and one law school across four western states.  

“They see in real time how ethics is affecting the long-term competitiveness of the organization,” Wanasika says. “The costs are quite prohibitive because they range from immediate government penalties to distant costs of reputational damage. You have customers defecting, and then you start attracting criminal-conduct costs. You have remedial costs. When you use a transaction cost approach to calculate the cost of unethical behavior, it’s simply not worth it.”

–Debbie Pitner Moors