MPIDR Working Paper

Application of the transaction cost approach to households – the demographics of households’ ‘make or buy’ decisions

Abstract

This study suggests that outsourcing to service providers is becoming the third edge in the economics of households in the 21st century. By referring to the household as an organizational unit, we use the transaction cost approach of the organizational economists to discuss and conceptualize the questions of what, why, and how 21st-century households decide to outsource. Our analysis demonstrates that the efficient boundaries of households are flexible, so that the core functions of households are being outsourced with different levels of intensity and scope. Moreover, we find that better cost control, access to technical expertise, and the potential for time savings might foster outsourcing by households; while normative and social beliefs, trust problems, power relations, and asymmetric information might inhibit outsourcing. With regard to the question of how, we find that households ‘make and buy’ rather than ‘make or buy’. Both the demand and the supply aspects of the outsourcing phenomenon are further discussed with regard to institutional mechanisms. Our analysis also offers theoretical contributions to the transaction cost approach, both by proposing the governance structure of ‘make and buy’, and by emphasizing the role of power in the organizational decision-making process regarding outsourcing.