Why do firms do some activities “in house” and contract out others? British-American economist Ronald Coase gave a cogent explanation in a classic 1937 paper on the nature of the firm. Show host Gene Tunny explains to his colleague Tim Hughes how Coase’s insights (e.g. the concept of transaction costs) can be applied to understand the actions of an Australian construction firm Hutchinson’s deciding to employ people to do concrete formwork rather than relying on subcontractors.
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What’s covered in EP181
- Episode topic: What determines what activities a business does in house? [0:06]
- What is formwork and why does it matter? [3:29]
- Hutchinson’s moves to bring formwork in house [8:54]
- When is it important to have an in-house workforce in your firm [14:42]
- Why you don’t always contract out [20:00]
- What’s done in house and what’s outsourced? [25:03]
- Gig economy platforms (e.g. UpWork) [33:02]
- A closer look at The nature of the firm by Ronald Coase [40:56]
Links relevant to the conversation
Courier-Mail article on Hutchinson’s decision to do its own formwork:
Ronald Coase’s classic article on the nature of the firm:
https://onlinelibrary.wiley.com/doi/full/10.1111/j.1468-0335.1937.tb00002.x
American Express article on pros and cons of hiring versus outsourcing:
Transcript:
Using Coase’s 1937 theory to explain Hutchies doing its own concrete formwork – EP181
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Gene Tunny 00:06
Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning into the show. This is episode 181 on the boundaries of the firm, what determines how many activities a business does in house rather than relying on suppliers? In this episode, my colleague Tim Hughes and I begin with a real example in the Australian construction industry. And I’ll talk about how it illustrates the principles from a very important paper from 1937. That paper is the nature of the firm written by Ronald Coase, who won the Nobel Prize for Economics in 1991. Okay, let’s get into the episode. Tim, here is good to be chatting with you again, Gene Tunny, good to be here. Excellent. Tim. Tim, I thought today we could chat about the theory of the firm. And this conversation was prompted by some news about one of the major construction companies in Queensland, which is the state of Australia that we’re in. And indeed, I just walked past one of their building sites on Brunswick Street forward to valley a bit earlier before we call it up. And I think they’re 100. I think they’ve had their 100 and 10th anniversary or something like that recently. It’s a big company. Yeah. Huge company that’s passed down through the generations. So yes. But it’s experiencing challenging times as a number of building companies are in the current environment due to rising cost of materials. And also, I think, probably challenges getting the skilled labour that they need. So this is Hutchinson’s? Yeah. Yes. Yeah, that’s right. Didn’t know I’m done. I should have mentioned that upfront, but I didn’t think so. But there we go. Excellent. So it’s definitely Hutchinson’s and I saw this report in the Courier Mail. So that’s the paper here in Brisbane a few days ago. So we’re recording this on Friday, the 10th of March 2023. And there was a report Hutchinson builders reveals plan to hire trainees in house. So if you’re listening internationally, tradies is our word for tradespersons for carpenters, and bricklayers and plumbers, etc. Construction giant Hutchinson builders is taking drastic measures to survive in an increasingly cutthroat industry, forming his own in house team of tradies to keep its high rise projects on schedule. Hutchinson builders, Chairman Scott Hutchinson said a team of 106 concrete form workers had been established from former employees of subcontractors who had gone into liquidation.
Tim Hughes 03:29
Tim, you’ve worked in construction and you have at different times. Yeah, yeah. Are you able to explain what formwork is? Yeah, formwork is basically putting up wooden surrounds, I guess, to then be the boundary for a concrete pour. If you’re doing if, say, for instance, a floor is gonna have formwork around for the edges of where the concrete is. And then you’d have reinforcing etc, throughout. But yeah, basically, it’s, it’s whatever is there to contain the concrete. So that once it’s set, the formwork gets taken away, and you’re left with the structure.
Gene Tunny 04:04
Okay, and so you need this in place. Do you before you pour the concrete? Yeah. Yeah. So this is, so what’s going on here, it appears is that Hutchinson’s is bringing that in house. So rather than sub contracting that out there, making sure they’ve got the people on hand, that they’re employing them permanently, as you know, in their workforce to make sure that they’ve got the skilled labour that they need, when they need it. So that I guess, so they don’t delay a job. So because that’s on the critical path of the job, isn’t it getting there? Getting the formwork done, so then you can get the concrete poured?
Tim Hughes 04:42
Yeah. And one of the typical issues with any building project is that, you know, all the subbies have their different schedules that they’re trying to keep in they always have more than one job. And so, it becomes this issue of, then servicing different jobs at the same time, in general. And so it becomes this catalogue of finger pointing quite often, where somebody doesn’t do something because somebody else hasn’t done something. And so there’s a chain of events or a sequence of events, you know, for instance, you can’t pull the concrete, for example, unless the form where it’s been done, you know, yeah, if you know that has to follow, everything’s sequential, or largely sequential. Certainly, once you’ve got the roof on and everything like that, then there are different things that can happen at the same time. And you might end up with an electrician, Spark is chippies, carpenters, etc, they can work in the at the same time because the roofs on the site is watertight or secure. But there’s always that sequence of events. And it’s a strong like, it’s a confident move. And a smart move from Hutchinson’s from what I can see because they’re secure in the workforce. Because one of the problems at the moment is now trying to make sure that you can line somebody up and be certain that they’re going to be there when you need them. So it’s a confident move, but obviously, with having permanent workforce, then you’re taking that point that you can keep them working, you know, obviously, nobody wants to have somebody on the books and not enough work coming in.
Gene Tunny 06:15
I guess if you’re a big company like that, yeah, then well, I mean, they’re expecting they’re gonna have plenty of work for him and for them, and if they don’t, then they’re willing to bear the cost of that under utilisation, to an extent because there’s such a benefit from having them on hand, because the cost of the alternative is just so high for them, not having the people they’re not having the formwork done, and then the delays to the project, the costs associated with that, and not being able to get the work done and then be able to invoice for it.
Tim Hughes 06:49
Yeah. And it’s obviously been a well thought out move. But it’s good to see I mean, because there are, you know, they’ve done a lot of great work around Brisbane, for instance, certainly in the entertainment industry. And now Scott Hutchinson has been played a big part in keeping, for instance, the Tivoli, which was a den danger of being lost to development knocked down. And the same with the princess Theatre in Berlin, GABA, you know, to beautiful music venues, which historically, there have been some great venues lost in Brisbane, you know, in the 80s. Just being knocked down in the middle of the night, like Cloud lands, for instance. Yeah. You know, so it’s great to see a building company, Scott Hutchinson, I know, he’s led a lot of that with the music venues, it’s great to see them having this confidence. So yeah, yeah. Because well for them.
Gene Tunny 07:37
Yeah. I mean, they’re having to do it because of the conditions in the industry. And I think, I mean, they probably would rather not have to do it, then historically, they haven’t. So we might just go over their justifications for other reasons. And then I want to go on to the micro economics of it. So how would economists think about it? Yeah, sure. Because when I read that article, it made me think of a famous theory put forward by a British American economist, Ronald Coase, who was a Nobel Laureate. So Coase was at University of Chicago, toward the end of his career. 1910 to 2013. He had an incredible life. Yeah, that’s a good clip. 103 year. I think he got 202 102. Yeah, pretty good. Yeah. Yeah. Pretty impressive. He obviously managed stress well, and lived well or lived moderately. Differently, give into temptation.
Tim Hughes 08:39
I know, there’s another story that for sure, it’d be interesting to know. The secrets were
Gene Tunny 08:44
Yeah, I may learn that today. When I was preparing for the podcast. He lives so long. I’ll have to try and find out what it is. There’s got to be a story there. Yeah, absolutely. Okay. So we’ll get on to his theory in a moment. The moves so they’re talking about the Hutchinson’s moves to bring this formwork in house. Yeah. So rather than subcontracting, bring it into the business bringing it into the firm. And the article continues. The moves come as major national building company PBS building group collapsed, leaving at projects unfinished and owing $25 million. Due to the instability of the market, through insolvencies, we have had to sell sorry, we have had to self perform a number of the tradies we would otherwise subcontract out like formwork ceilings and partitions Mr. Hutchinson revealed in the company’s in house newsletter, hutches truth. We have to get subscribed to that, Tim Yeah, for sure. A looming threat to our business was a shortage of formwork contractors to build slabs and columns, which are vital to keep high rise projects on schedule. Okay, so that’s pretty much what we were talking about before.
Tim Hughes 09:57
Yeah, some that’s a good sign, you know? Like, because the last few years have been so interrupted with the whole pandemic and the supply chain being disrupted. The knock on effect is still going on and will do for some time. Now, there’s been a lot of a lot of companies and subbies subcontractors who have gone under, it’s been very, very challenging times.
Gene Tunny 10:21
Yeah, yeah. Now, as I mentioned, this story made me think about this important theory in economics, this very important paper from the 1930s, the nature of the firm in 1937 paper published in economics, which is one of the well, it was a major economic journal, I think, I think it comes out of LSE. I’ll have to check though. So this article, the nature of the firm, and what Coase was trying to do there was to think about, well, how do you define the firm the business? What are the boundaries of the business, because economics tells us that the market is efficient, the market competition brings benefits, there can be benefits from participating in the market and taking advantage of the competition amongst potential suppliers. But we know that their businesses exist. And in businesses, there’ll be some control there’ll be Well, I mean, they’re almost like a command economy inside a business. They’re not run. It’s not as if they’re bidding. In my business, I don’t have to bid all the time for the people working for me to do a particular job. I don’t have to put out a request for for quiet and get them to the bid for the work. Or I’m not having them compete against each other I’ll I will be determining who does what jobs. So there’s a there’s a socialist or a command element within a firm itself rather than a competitive market element. Right. And so the question is, how do you determine the boundaries of a firm? Why do firms exist? What determines what size they are? So? So for example, for a consultancy business? I mean, we talked about hutches before and we talked about the formwork and what they brought in, but they were bringing that in house well, for a consultancy business. consultancy businesses will typically they’ll have employees who do the jobs. But one option is just a subcontract every time so you could just hang out a shingle and you may not even need a physical office and there are some consultancy businesses that will do this. And they will subcontract, you know, a particular expert to help them out on a job as it comes in.
Tim Hughes 12:48
hang out a shingle.
Gene Tunny 12:50
Isn’t that what you say? Don’t know. Actually, if you don’t have an office, you probably don’t hang out a shingle?
Tim Hughes 12:55
I haven’t heard that term before. Okay. I’m not sure if it’s legal. But um, yeah, I get the gist of it. Yeah.
Gene Tunny 13:08
I think you do put out a hang out a shingle. I think that’s what the term is. Do I get the gist of it, though? Yeah. Okay. Very good. It was not the right term. I’ll cut this out. So there’s this issue about what determines the size of the firm, what activities should be done in house where there’s not a reliance on the market mechanism within the within the business, there’s somebody directing things, what should be done in house in a particular business versus what should be done through the market? So it could just be I mean, there could just be one entrepreneur, and then for every job that their business needs to do they just contract out every time they just get someone to supply the services. And then there are things that I’m contracting out in my business. I mean, I’m contracting out the website, design, the website management, or the podcasts. Yeah, the editing. Yeah, podcast editing. Because, I mean, that takes time. And I can’t do it as quickly as someone else. And not as skillfully. So that’s something that I’m happy to contract out. And now because of things like Upwork, and free, what’s the other one? Fiverr it’s so much easier to find people to do stuff to contract out. So the lower cost of contracting now that’s going to mean there should be more of it. So it should mean that yeah, there’s maybe you do have fewer people in your business than otherwise, because you can contract out so much.
Tim Hughes 14:42
Yeah. And I guess because that I mean, it’s part of the gig economy, like Yeah, and it makes a lot of sense. So that’s something we’ve talked about before is, you know, being agile being able to scale up or down quickly, which is something for instance, like there’s a an office at WhatsApp ended just moved to a larger office. So it’s like a, like we share, or we work rather, it’s a workspace. And so it allows you to be agile and sort of move around and go up and down and expand and contract. And I guess that’s we’re not contracting, but not contracting, there’s no going back. But is that thing of like? Obviously, it’s like paying casual rates, etc. So you pay a little bit more when you when you saw something, you know, occasionally, etc. Whereas, like, using hutches, for instance, as an example, that will be paying the guys doing the formwork, a little bit less than they would do for subcontractors, because they’re on the books, you know, and they would have then holidays and all that kind of stuff. I would imagine. I mean, I could be wrong there. But it was suggested in a normal traditional situation, that’s what would be happening.
Gene Tunny 15:50
Yeah. And I think that’s because when you’ve got people on in your firm, to some degree, they will be. I’m just trying to think through this. If they’re a subcontractor, yep, they’ve got all of their overhead costs as well. Yeah, if they’re in your firm, you’re paying the overhead costs yourself. But when you subcontract out, you have to pay for the overhead costs of the subcontractors. And as well as their you know, what they need to do the job. And then there’s also the fact that they’re possibly more specialised, and they’re going to get the job done. Now, they’re really motivated to get the job done if they’re a subcontractor.
Tim Hughes 16:36
Yeah, I mean, I guess that would be a question for Hutchinson’s really like it would be, it’d be great one day too. If I, Scott, I shouldn’t listen to the podcast, and pick his brains. Because, yeah, I wouldn’t know about that. But you can imagine that that would be the case, for sure.
Gene Tunny 16:52
Well, I think that might be one of the motivations for contracting things out. Because you can specify the job, you can have the the scope of work, and you can say, I need this by this demand, and you’re paying more, and there’s an expectation it gets done by that day. And
Tim Hughes 17:11
the responsibility lies with the subcontractor to say that on one of the things, though, as well to consider is having your in house workforce, if you like, would give a lot of confidence, I would imagine to people who are giving up projects, you know, if you’ve if you’ve got a project someone is bidding for, and they’ve got a large in house workforce, that gives a lot of confidence that, you know, that aren’t maybe the issues that may be around with other developers and builders that have to rely on the subcontractors to be available for when they need them. So there’s a level of confidence so that that would, you know, maybe attract or give them a better chance of winning different, different contracts?
Gene Tunny 17:50
Yeah, so certainly in the current market environment where it’s been hard to get those skills, because there’s been a lot of work on and there’s a lot of competition for skilled labour. Yeah, that could make sense. Yeah. Okay, so I should get back to COEs did my explanation of the problem the intellectual issue, the what Coase was trying to address the the question he was trying to answer. Did that make sense about the nature of the firm? Why should you have a business at all? Why should you have a business that employs people rather than just say, a single entrepreneur? No, it didn’t make sense.
Tim Hughes 18:30
Not to me, but I mean, it’s funny, because I did quickly read it beforehand. And for that, for me, it didn’t jump out at me as being one of the things that, for instance, myself, can take on straightaway, I think I’d have to absorb that over a period of time and really take a bit more time. Because I understand the premise of a business, but I don’t fully understand what the nature of the firm is addressing or talking to. But that might have just been me. And my,
Gene Tunny 19:01
I guess it’s a it’s a rather subtle thing, isn’t it? So he’s asking the question, Why did firms exist at all? Okay, let me see if I can find,
Tim Hughes 19:15
I mean, by firms, it’s business, yeah, business, any business or company. And I guess they exist to make money. I mean, that they’re set out to be profitable, and to serve a purpose and solve problems, you know, builders, build places, you know, everybody has a job to do kind of thing. And if you’re going to build a business, the idea would be to be a profitable one, I would imagine.
Gene Tunny 19:39
Yeah, I mean, this is an article that has been very influential, and it was identified as having solved that problem of how do we justify the existence of a business that employs people and has this long term relationship with employees rather than just sub contracting? All the time to get the services that it needs. So to me it, it’s an important article because it it highlights the relevant considerations and it’s all about minimising the transaction costs. So the reason why you don’t just always contract out so why Hutchinson’s for example, why did it actually employ some people? And it’s not just contracting now for everything so Hutchinson’s would have its own project managers, I suppose, or, you know, people in the head office. And so it’s not going to contract out every time to get someone to come in to, I’ll have to be careful here, because I can’t say I’m totally familiar with their business. But say their accounting, I mean, they, they will have a dedicated, Chief Financial Officer. Yep. I’m pretty sure that have that. So each time they they need some financial analysis, or they need the someone to sign off on their books, they won’t just they won’t contract out that every time they won’t go to the market to try and get that done, they’ll probably have someone who does that, that they’ve employed. And they’ve worked out that that’s the least cost way of getting that thing done. Over the longer term, is if they contracted it out, then they’d have to pay a bit more, presumably. And there’s always a cost in trying to engage with the market. So trying to find out who the people are, who could supply the services, what the cost of the services are selecting the best person?
Tim Hughes 21:38
I mean, I guess like for me, I don’t truly understand the question behind it, because I just thought it would be clear that a business grows or bills, deer to be profitable. And so the decisions that you make along that way would be, well, if it’s more profitable to have in house people for this department, it was something rather than something that out, then that would be an economic or financial decision to be more efficient and save money. And so it’s all about, you know, making money at the end of the day. And then obviously, there are there are quantum leaps taken at different times, which might be a bit of a pun, and they either work or they don’t, but they’re the best guess at the time. But it’s all about growing safely to increase profits. I mean, that isn’t at the foundation of any any business in terms of supply and demand. And, you know, the market in that regard. Yeah, exactly. Competition, etc.
Gene Tunny 22:33
Yeah. So I guess what Carlos was trying to do was to provide a solid intellectual foundation for what you were saying there, which is rough, you know, roughly what he’s driving at. It’s about finding the way for the business to be profitable to be most profitable as as it grows. And so yeah, I think, yeah, maybe it’s a case of over analysis. But it has been an important paper in economics. And I mean, yeah, I guess I might have explained it very well. Why it’s an important paper.
Tim Hughes 23:07
That’s the thing. I’m sure there’s more to it, but like, it seems like a clear question, as to I mean, there’s there’s obviously more.
Gene Tunny 23:14
Yeah. So we’re, I guess where it comes from, is that economists talk a lot about supply and demand and the market and the virtues of the, what they call the price mechanism, which is the fact that, well, we don’t need someone who’s responsible for the control of the supply of bread to the City of London, for example, because the market sort of set out, okay, don’t need someone to allocate that. You’ve got people wanting to supply businesses wanting to supply because there’s, there’s a demand there. And so I might read from coasters papers, because I think this, hopefully, this is illuminating, and it resolves this, an economist thinks that the economic system has been coordinated by the price mechanism and society becomes not an organisation, but an organism, the economic system works itself. This does not mean that there is not planning by individuals. These exercise, foresight and choice between alternatives. This is necessarily stuff there has to be order in the system. But this theory assumes that the direction of resources is dependent directly on the price mechanism. Indeed, it is often considered to be an objection to economic planning that it merely tries to do what has already been done by the price mechanism. Yeah, so what the issue is, is, what’s the limit to a firm? I mean, I clearly there’s reason for many firms to have more than just the the entrepreneur or the the owner manager, they will hire people in rather than just contract out each time to get the services that they need. Where’s the limit to that? I mean, why don’t we just have one big Corporation. Yeah, that does everything or one. So I guess that’s what?
Tim Hughes 25:05
So is it like, for instance, whatever widgets you might be selling, at some point, you have your own delivery drivers or Exactly, yeah, you outsource it to the the post service, etc. So at some point there’s a parameter to what’s in house and what’s outsourced or
Gene Tunny 25:23
exactly. That’s what is driving it. Right. Okay. Yeah,
Tim Hughes 25:26
I get that. Because yeah, there’s so there’s a, there’s a limit, or there’s a wall, if you like to, you know, what you do in house? Exactly. Yeah. And that would be, then back to those things we talked about, like, you know, well, is it efficient? Is it profitable, you know, what risk is involved, etc. And I guess that’s when those decisions, come to the fore and drive where that wall is?
Gene Tunny 25:48
Exactly, yeah,
Tim Hughes 25:49
I get it. Yeah.
Gene Tunny 25:52
Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 26:27
Now back to the show. The fundamental concept that Coast introduced, which is then had been widely applied in economics is this idea of transaction cost of the fact that there’s a cost of transacting in the market, right? There’s a cost of trying to find, you know, issuing a request for quiet and you know, sorting through those and and then contracting them in particularly like if you need a lawyer to, to write a contract for you. I mean, that’s an additional cost.
Tim Hughes 26:59
Well, that’s a good point, actually. Because I guess you get to a critical point or a critical mass where you have your own in house legal department. So I guess there are certain sizes of you know, the need for those different services, professional services, whereby at some point, you then have your own department in the company. You know, that your own legal department, for instance? Yeah. Marketing, yeah, marketing department, etc.
Gene Tunny 27:23
Exactly. If you’ve got enough work for them. Yeah.
Tim Hughes 27:27
So I mean, so going back to Hutchinson, for instance. So that’s, and you would have to say, in every instance, it’s a sign of confidence, of expansion or of growth, to have that in house, because that’s obviously a commitment and a cost. That wouldn’t be easily withdrawn, because it’s expensive to, to let people go, you know, there’s a cost with everything. I guess
Gene Tunny 27:50
there’s positive in in that sense that they expect that we’ll be able to keep these people employed doing formwork? Yeah, they’ve got to, they’re confident they’ve got enough work to do that. But I mean, it looks like it’s a defensive measure to me, they wouldn’t be doing this if it weren’t for the the challenging conditions in the industry, the difficulties of finding people the the challenges of, you know, what you don’t know whether the subcontractor, you engage with whether they’ll survive, and no, because they could let you down mid job?
Tim Hughes 28:23
Yeah. So I see what you mean. And I think you’re absolutely right. Like, it wouldn’t necessarily have been done if the certain situations weren’t around, and maybe other people will follow suit.
Gene Tunny 28:34
I mean, how cheese can do it? Because it’s a reasonably big company. So it’s got the, the real, I mean, you need some, some cash on hand to be able to finance this. Yep. And they’re able to do it. Yeah, some other businesses may not be able to, but it could give them a as I think you were suggesting this before it could give them a competitive advantage in the market, because the purchases are the people wanting the work done. They’ll see how Jesus got this capability. And that reduces the risk.
Tim Hughes 29:08
Yeah, I can only imagine via that it gives them an advantage. Going for contract. Yeah. You know, and also, depending on Well, if they’re taking skilled workers from the labour force, and who are fewer to go around for the other potential competitors.
Gene Tunny 29:26
Yes. Mm hmm. Yeah, it could be a cunning plan or something suggesting to
Tim Hughes 29:32
plan would be proud, very good.
Gene Tunny 29:35
Guy. So might, I might read Ronald Coase as explanation. I’ll put a link in the show notes to the nature of the firm, which I think is one of those. Just one of those outstanding
Tim Hughes 29:46
sisters 1937 Yeah, so he was 27 years old. Yeah.
Gene Tunny 29:51
Pretty impressive. Yeah. Yeah. Yeah. And it well, and then he followed it up with another famous paper and economics. So he won the Nobel Got a prize in 1991? For the essentially for this paper and another paper in the early 60s called the Theory of social cost. Both of them were hugely influential. Yeah.
Tim Hughes 30:12
That’d be interesting to do another episode on that paper.
Gene Tunny 30:17
Yeah, we could. Yeah. It’s, it’s about how you manage pollution and things like that. And yeah, so maybe we could talk about that.
Tim Hughes 30:27
Well, that’s topical all the time, but never more so than right now.
Gene Tunny 30:32
It’s a controversial paper, because some critics of it argue that what Carlos was talking about was a very special case. And it’s been interpreted as saying, Well, you don’t have to worry about pollution, because people affected by it will. They’ll do some deal with the people doing the pollution, and it’ll be resolved somehow. So that’s a simplistic way of describing it. But it’s a controversial paper, there’s Coase was, it looks like he was talking about a special case. And it can be interpreted as saying, well, we could just leave things to the market, we don’t necessarily have to have regulation, which wasn’t really what he was saying. So it’s controversial. I think we’ll have to cover that in another episode be interesting to have a look at that. Yeah, it’s another famous paper. Yeah, so 1937 27 years of age. I mean, he might even been 26, when he wrote it. So he did well, he writes, the main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of organising production through the price mechanism is that of discovering what the relevant prices are, these costs may be reduced, but it will not be eliminated by the emergence of specialists who will sell this information, the cost of negotiating and concluding a separate contract for each exchange transaction, which takes place on a market must also be taken into account. And I think that’s, that’s going to be one of the major ones, isn’t it? And, and also the delays in finding people. So I think about why I would want to have a, well, if you think about the choice between, say, a permanent person, a full time person and a casual person, for example, then it’s good to have a permanent person, because they’re on hand, they can deal with a variety of different issues, which, whereas with the casual person, you’re not always sure if they’re available. And if you want to contract out, if you want to get on up work, then the people that you might have used previously might be busy doing something else. And you don’t always know what the other person on the other end is what they’re telling you is that right? I guess without work, there’s an advantage in that platforms like that as a rating, and there’ll be some feedback. But still, if you haven’t worked with them before, it’s hard to know how they’ll, they’ll go.
Tim Hughes 33:02
I mean, the costs of doing business on those sort of platforms is has gone up from what it started out as, but it’s still relatively inexpensive compared to outsourcing locally, certainly, I mean, because one of the benefits of this is you can get work done from anywhere in the world. And that’s one of the technological advances that we have at our disposal for sure. It’s cheaper than it used to be 1520 years ago.
Gene Tunny 33:28
It is. So there’s that arbitrage, again, that geographical arbitrage you can take advantage of you could employ someone to, to do a job that you’d have to pay more for here in Australia in the US, and you might be able to find someone who can who’s really good who can do it. And they might be living in India, or Pakistan or somewhere like that. But generally, I think what you find is that the more skilled, well, the higher the rate they charge, generally, the more productive they are, and you get what you pay for, ultimately, so that geographical arbitrage isn’t as or that opportunity to get lower cost. Labour in other countries is not as great, I don’t think it’s as great an opportunity is, as some might think, oh, at least that’s my that’s my experience,
Tim Hughes 34:20
I guess, with increasing any workforce within the company. The nightmare for any employer is to have people twiddling their thumbs and not earning money for the company. So you have to keep that source of work coming in, you have to and also to make sure that people are working efficiently, you know, because the bigger everywhere becomes then I mean, you know, I haven’t had huge experience in this, but I’ve worked with so many people at different levels of management and you know, it’s clearly not straightforward in the bigger companies as to how the hierarchy works. And there’s always people unhappy with how things are the in those really big companies, but yeah, It seems to be there. They take on a life of their own these big companies with all the departments and the hierarchy. And it’s an interesting human experiment. I think, having these insights into these big companies that, obviously, some do really well, some do do not so well, but they become their own living, breathing thing that is clearly difficult to manage, you know, but at every level, the bigger it gets, it comes with a whole different problems for Yeah, just managing the sheer size of something.
Gene Tunny 35:32
And that’s why they’re often Outsourcing Things or something, sometimes they asked us and they bring back in because they had sorted didn’t work out too well. But in terms of outsourcing, look, cuantas. And, and that’s, that’s possibly a good example of the one of the trade offs there. So quite as, as you remember, when they outsource their baggage handling. And they did that to save money. And I mean, they just had a record profit didn’t know. So obviously,
Tim Hughes 35:59
it was very controversial. And I do have a friend who has a lot to say about this particular thing, because he used to work at quantas. And, and so he has insights that far, closer than anything I know. Yeah. But it did appear certainly, from what I understand that like, that didn’t seem to be a great thing. And I’m just going from what I’ve read in the news with this. And, you know, clearly it’s a skilled job, you know, that could that kind of thing where there’ll be problems all the time with baggage handling, as an example that always be these issues with that will come up and experience in any job. And using that as an example, experience wasn’t there with a new workforce, to be able to sort out the issues as they came up. And you can imagine that with pretty much anything, you know, if you change the workforce, and you don’t have that experience of what can go wrong, and what you do to fix it, there’s going to be issues, and that clearly seems to be the case with the baggage handlers. And as to how fair it was or unfair. You know, there’s plenty of commentary on that. But just losing that experience base yourself was, you know, that’s, that’s a difficult thing to replace, it takes time to build. And it’s, it’s clearly clearly was an issue anyway, at the time.
Gene Tunny 37:13
And I think the people who worked for cuantas, as baggage handlers were better motivated, they had better morale, they cared about the image of cuantas. And so they weren’t just throwing pegs around. Well, we’re human
Tim Hughes 37:24
at the end of the day, yeah, there’s that thing of like, whatever job you have, if, if there’s pride in it, and if, you know, I think when people talk about culture in a in a company, you know, this is, this is the reality of it, you know, you can’t just do broad sweeps here and there, and expect everything to maintain some level of pride in the work, for instance, you know, and all of you know, there are very human things that we all sort of respond to, and taking pride in your work, for instance, will be one of them, no matter what your job is, you know, and so I think, yeah, I guess I don’t know enough about that particular thing. But I know, there’s a lot of commentary that has gone on, and it didn’t appear to be a very popular outcome.
Gene Tunny 38:04
No, no, exactly. And I think that’s why, you know, occasionally I have to try and find an example of a company which is outsourced and then brought something back into the company is don’t know any off the top of my head, but I’m sure it’s occurred, brought something back into the company. Well, because there’s what I’m driving at is that, I mean, you’re talking about companies and they can serve, you know, they can grow and you know, you can end up with all of these different departments. But then when they get into financial trouble, that they might realise, oh, we have to rationalise or we have to do things better, and they’ll outsource various different parts of their business. Yeah. And, you know, the baggage handling was one example. I’m thinking, where’s an example where there’s something that’s been previously in house has been outsourced, and then it’s been brought back in house? If you’re in the audience, and you if you know, of an example, please let us know. I’ll try and dig one up and put it in the show notes. But you know what I’m driving it.
Tim Hughes 39:05
I think every scenario that you can imagine must happen, some of has happened. But yeah, for sure, that would have happened.
Gene Tunny 39:12
Yeah, yeah, definitely. Okay, so we might get toward the end of coasters, or his summary of his argument. And then I’ll just go over a couple other things. Chris writes, we may sum up this section of the argument by saying that the operation of a market costs something and by forming an organisation and allowing some authority and entrepreneur to direct the resources, certain marketing costs are saved. The entrepreneur has to carry out the function at less cost taking into account the fact that he may get factors of production at a lower price than the market transactions which he supersedes because it is always possible to revert to the open market if he fails to do this. That’s just saying that yeah, I mean, you’re only going to hire someone if it ends up being cheaper than going out to the market each time. Yeah, to subcontracted out the question of uncertainty as one, which is often considered to be very relevant to the study of the equilibrium of the firm, it seems improbable that a firm would emerge without the existence of uncertainty. And I think that’s an important point, what is driving out there is uncertainty is one of the major reasons why you have a business, you know, that the Will you hope that people are going to turn up to work. And you know, they’re going to turn up, it provides some certainty, whereas in this is the situation Hatch’s was facing, or has been facing, it’s concerned about the uncertainty of whether it will get the formwork the people with the form working skills to make sure the form work gets done the so that the concrete can get poured, and the building projects can go ahead on shedule.
Tim Hughes 40:56
It’s interesting, actually, because some it’s just formwork is that they’ve taken on just thinking about it a little bit more. And it’s the big guts of the building, you know, concrete pour. From that point, everything else can sort of happen. I mean, there are still things that happened before a concrete pour. But it’s, you know, it allows everything else to sort of go. So it’s one of the first you know, it’s an ongoing thing, depending on the structure of the place, there’s going to be more than one pour. But yeah, it means all those other things can then happen, you know, so for instance, yeah, it’s different than having a whole team of electricians or a whole team of carpenters, chippies, whatever it may be, and I’m sure they’re building companies that do maybe hajis to have some of those guys on board too. But because it’s the formwork, it’s like, yeah, they need that at that very, you know, the putting the skeleton, the bones of the place together so that all the the rest of it can happen. I think
Gene Tunny 41:53
in project management, you would say it’s on the critical path. Yeah, yeah. Yeah, exactly. Okay. So many questions or any thoughts on on that the theory of the firm the the nature of the firm by Ronald Coase,
Tim Hughes 42:08
it’s interesting, I can’t say I fully get it. But that’s what I enjoy about these conversations. I come in as a layman and get exposed to these different things. And it’s always interesting. And I have to add, there was another venue, of course, the first value musical that The Hutchins centre Scott Hutchinson was involved
Gene Tunny 42:27
in service when I saw the Johnny Cash tribute concert. Yeah, it was that textbook and no, that was another one though. It was someone else. It wasn’t textbook, it’s unfortunate textbook.
Tim Hughes 42:37
And yeah, if you get a chance, hello.
Gene Tunny 42:41
Okay, so in the shownotes, so as well as linking to that story about Hutchinson’s and the the nature of the firm by Ronald Coase. I’ll link to a really good article on the American Express website, the pros and cons of hiring in house versus outsourcing. And yeah, I thought it went over a lot of the relevant considerations. Things like one of the best things about having people in house is you get the face to face conversations, you build the relationship, you learn how to work together. So there’s benefits from that. Possibly, you can get a sense of whether people are ethical and honest. I mean, I guess one of the challenges and one of the problems with issues with contracting out is that sometimes you could get ripped off, right? It’s
Tim Hughes 43:29
definitely I mean, it’s an interesting point, like, certainly, I’ve heard from friends in the creative industries like architecture, where a lot of the benefits were lost during the lockdowns and working from home was in the collaboration of different ideas. And that yeah, that sort of thing, where you just sort of organically go and check in with someone and someone else might. I mean, of course, there’s, you know, people can waste time, but with creative industries or creative work, that collaboration is really important to be able to share ideas organically as they come up, and it is different face to face as it would be on the screen, you know, like so. It was it was good seeing the respect and the sort of benefit for those kinds of face to face interactions, you know, which I think people have valued since the pandemic and it’s like yeah, that’s something worth holding on to.
Gene Tunny 44:26
Yeah, for sure. The other pros have in house are in that they talk about intellectual property may be more likely to remain confidential. You don’t have to worry about some supplier coming in and learning about your business and ripping off some of your IP so perhaps that’s an issue. However, there are cons of in house hiring could be well it can be difficult finding the right people. There, there might be others. is no benefits you have to pay them. So medical and dental benefits. So that’s more of an issue in the states where the employers have to cover that. And finding, interviewing and negotiating can take time. And then if someone leaves, you have to find them again. So there can be there’s a cost of onboarding people. Yeah. There’s a cost associated with trying to get people to get suppliers in through the market. There’s also and there’s also a cost of trying to get people to work for you.
Tim Hughes 45:28
I guess it’s building trust as well. I mean, what yeah, of course, isn’t exclusive to it working out if it’s in house, you know, look in the house or outsource to the seller level of trust, that takes time to build up which has value.
Gene Tunny 45:45
Yeah. Pros of outsourcing. Most freelancers are pros at a very targeted discipline. So you can get really good people. Outsourcing can be ideal for short term projects in which talent is only needed for the completion of a one off project. Yeah, so the so I’m going to outsource the design of my website every few years or so there’s no point me having a dedicated web designer. Yeah. In the firm, obviously, not yet. Not yet. Yeah, so cons of outsourcing. Near the IP issue. Fake freelance profiles can exaggerate talent. Yeah, there could be different different styles, you may not be used to how the Freelancer works, or the can the person you outsource to, there may be some cultural differences. For example, there can be communication gaps. And yeah, freelancers can get quite expensive. Yeah. So I think that’s quite a good list of pros and cons of in house hiring and pros and cons of outsourcing. So I’ll put a link in the show notes. Okay, I’ll have to have a another read of the nature of the firm when I get a chance, and maybe I’ll have to come back to it and and try and illuminate it a lot better than that. But I was hoping that, at some, at least some of the core principles are clearer.
Tim Hughes 47:17
Yeah, I certainly have a better understanding of it from my first overview of that, again, but it’s, you know, it’s that thing of like, it’s interesting seeing it put down in a single paper, you know, like, I guess, in many ways, I’ve got to the point where I’ve taken it for granted, that kind of outlining, and, and formed my own opinions as to why it has happened. And so it seems like, you know, I’m sure there’s more to it than what I originally saw, you know, which we wish we got to in the in the conversation, but I’d be very interested in having a chat about the other paper whose it was the theory of social cost. Yeah. And with the pollution and everything, that would be good. Yeah. And also to find out what his health regime is, I mean, he got 102 That’s probably fine. It was a chain smoker and drank lots of whiskey, you know, but if it works, it works.
Gene Tunny 48:10
That’s right. I mean, that’s that’s funny, isn’t it? When they asked the 109 year old woman, what was that? What was the secret fear of longevity? I had a brand new every day.
Tim Hughes 48:20
There’s always some French farmer who lives 114 And he’s a chain smoker with colour wise and he drinks red wine for breakfast. These are outliers in the genetic field. So yeah, all power to them.
Gene Tunny 48:34
Good. Save any any other thoughts or any anything else that’s on your mind?
Tim Hughes 48:38
That probably is gene but I think we should probably leave it at that and I look forward to the next one. Okay, thanks to Jeremy.
Gene Tunny 48:50
Okay, have you found that informative and enjoyable? Ronald Coase, his article on the nature of the firm is one of my favourites in the economics literature. It’s highly readable and incredibly insightful. The paper was probably so good because it was based on extensive fieldwork by coasts is a great 9097 reason interview with coasts in which the story is told about how he wandered around the US Heartland in the 30s talking to business owners about how they organise their firms. Based on that field workers concluded that business people were well aware of the relevant trade offs, trade offs that Tim and I talked about in our conversation. Unfortunately, I’ve been unable to get any insights into how COAs lives so long 102 is an impressive run. If you know anything about rollercoasters health regime, then yes, get in touch and let me know and they’ll share it with other listeners. Also, let me know what you thought about my conversation with Tim. As always, feel free to email me at contact at economics explore.com Thanks for listening. rato thanks for listening to this episode of economics explored you Have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.
50:42
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Credits
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