Workleaf

Interaction costs have been popularly used in the development of a general network theory for social sciences.  It has been used to illuminate the shaping of networks and the interaction within them. The same set of concepts can be applied to the world of outsourcing to illustrate the overheads associated with adding incremental supplier/vendor relationships to the existing set of dynamics for an organization. This is a crude attempt at answering the fundamental question of – Why are organizations still interested in vertical integration? Why are we not seeing organization frantically shedding all their non-core processes to external service providers while exclusively focusing on their core competencies?

Interaction can be crudely defined as — the searching, coordinating, and monitoring that people and firms do when they exchange goods, services, or ideas. In the realm of outsourcing, interaction costs are generally categorized under the relationship/account management category. The activities that come under this category include -

1. Searching, evaluating and identifying vendor(s),

2. Establishing a communication protocol

3.  Maintaining technology and people resources for the general functioning of the communication channels

4. The overhead of provisioning for these costs within the general operations of the organization/business unit

If interaction costs were negligible, an organization could in theory be atomized into a collection of individuals, geographically dispersed but connected by a communications network. In reality, however, substantial interaction costs and the human aspects of effective interaction limit the range of realistic configurations.

Firms trade off the value of specialization against the interaction costs associated with external suppliers when they set their boundaries and choose their focus. This is a choice that firms make based on business models and the general direction of where they want their venture to head. Technology has been one of the activities that has received increased focus in the recent decade, where firms have consciously chosen to consider the interaction costs of having to engage with external specialists. Firms realize and understand that, to include technology focus within an organization’s focus umbrella is a resource-intensive undertaking, thereby, justifying the interaction costs associated with engaging external specialists in this area. Companies trade off the effectiveness of alternative organizational forms against the interaction costs involved in managing them.

In theory, interaction standardization reduces interaction costs. Technology advancements and proliferation of standard communication tools & mechanisms (e-mail) have significantly influenced the standardization of some of the elements of interaction in a firm’s ecosystem. The growing use of networks/internet has created an explosion in the ability to interact. Vast improvements in connectivity and bandwidth technologies over the next five to 10 years promises to multiply the inter-active power of networks. But does it mean that we are moving closer towards the existence of atomic/network driven organizations? In other words, will outsourcing take-over as the inevitable skill that every firm in every industry have to build competency in? 

Increases in the rate of transmission don’t automatically translate into improvements in interactive capability, however. Most interactions have a human component that remains largely unaffected by technological innovation. Technology may enable us to write and distribute a memo very quickly, but it doesn’t tell us what to say or how to say it. These cultural and human factors have a significant role to play, in influencing the interaction costs in an organization’s ecosystem. These lead me believe that – although technology helps in reducing interaction costs, which in turn, facilitates a reduction in the overheads of engaging multiple external service providers, it does not exclusively promote an organization’s ability to evolve to an atomic state.