Why Transaction Cost Economics Belongs in a Sourcing Readiness Checklist
A sourcing process usually starts with the assumption that we will buy something. The discussion quickly moves to suppliers, specifications, and tender routes.
But the earlier decision—whether delivery via a third party makes sense (basically, whether we insource or outsource, or make vs. buy)—may never have been properly examined.
This is why I included transaction cost economics (TCE). It provides a structured way to examine the costs and dependencies created by organizing work internally or through a supplier.
The supplier’s quotation covers only part of the external delivery cost.
The buyer must also define the requirement, select a supplier, negotiate obligations, monitor performance, manage changes, and resolve disagreements. Switching or exiting may introduce further costs. Internal delivery has its own coordination and management costs, so neither option is inherently superior.
TCE Checklist
The checklist examines five transaction characteristics:
Factor | Why it matters to the delivery decision |
Asset specificity | Dedicated equipment, skills, or interfaces may have limited value elsewhere. Once committed, the parties may find switching difficult, creating dependency. |
Frequency | Repeated work may justify investing in internal capability. For occasional work, maintaining that capability may be difficult to justify. |
Volume uncertainty | Changing demand affects capacity commitments, pricing and the allocation of risk between buyer and supplier. |
Technological uncertainty | Changes in technology or delivery methods may require adaptations that cannot be fully specified at contract award. |
Behavioral uncertainty | How difficult would it be to observe and verify the supplier’s performance and deal with opportunistic conduct? |
The Price Alone is Not an Answer
These factors interact. A repeated activity requiring dedicated knowledge, frequent adaptation, and difficult performance verification deserves a different delivery discussion from a standard service available from several interchangeable suppliers.
That does not mean the first activity must be brought in-house. It means that the supplier price alone is an inadequate basis for deciding. External delivery may still be appropriate, provided the arrangement addresses the dependencies and coordination demands it creates.
TCE also helps explain why a hybrid model can be useful. An organization might retain architecture, critical knowledge, and integration ownership internally while buying a defined development or support service. The split needs clear boundaries; otherwise, the organization adds coordination costs without securing the intended control.
TCE Analysis in the Sourcing Readiness Stage
Including TCE analysis at the sourcing readiness stage matters because specifications and sourcing scenarios follow from the key category management decision - Make vs Buy.
If we decide too early to outsource the entire activity, we may spend considerable effort preparing a tender for a scope that should have been divided differently—or retained internally.
The proposed checklist uses TCE as a teaching heuristic to support that discussion. It then checks supplier availability, internal capability, and urgency to assess whether the suggested route is feasible. These practical constraints matter: a theoretically attractive internal model is of little use if the organization cannot develop the capability in time.
My purpose was to put a neglected question before supplier selection: what arrangement gives us an optimal balance of cost, capability, adaptability, and control?
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