In search of insource v. outsource equilibria

via Tim Harford:

So, one day the boss has this crazy thought. He asks himself a question that has never occurred to him before: Why have any employees at all? Why have a building? Why not just sit home, wearing his jammies and bunny slippers, sipping a nice cup of tea, and outsource everything? He can write contracts to buy parts, he can pay workers to assemble the parts, and he can use shipping companies to box and transport the product.

You can tell that this parable is not going to end happily ever after. As Munger argues, there's a balancing act: too little outsourcing and a firm becomes a socialist state, denied incentives or price signals; too much and the problem of coordinating all the contracts becomes impossible.

It's worth thinking about how changing technology may alter this balancing act. The answer is not obvious. Some outsourcing decisions are made much easier to coordinate thanks to the internet and all the rest. At the same time, inter-firm communications also improve. And if the world is full of firms making more complex, intangible products, that may favour more implicit contracts and therefore larger firms. I simply don't know the answer and I'm not sure anyone else does either.