Transaction cost economics and risks when law departments retain law firms

“The theory of transaction cost economics (TCE) provides insight into when firms should perform a task internally versus when it is more economical to outsource a task. TCE advises against outsourcing when the firm is at risk of becoming dependent on a supplier because the supplier either has or develops specific assets (such as information and ordering systems) that the firm needs and does not itself possess.”

That quote from Cal. Mgt. Rev., Vol. 49, Summer 2007 at 51 (emphasis in original), made me wonder how often TCE would argue against use of law firms, because a law firm can develop “specific assets” (people, procedures and software) that the law department retaining it lacks. That, in fact, is the reason why in-house counsel retain law firms – to draw on expertise and assets not available inside.

“TCE also advises against outsourcing in situations of uncertainty, such as when the firm cannot adequately judge whether the supplier is performing as promised or when it cannot clearly specify what it wants in terms of outcomes.”

Both of these arguments of TCE bear the heavy hand of procurement thinking. They might trouble in-house counsel for the reason that it is difficult to determine objectively whether a law firm is performing as promised (all evaluations are subjective and what do law firms ever promise?) and it is sometimes difficult to specify what the in-house lawyers want a matter’s resolution to be.

Maybe I am misapplying transaction cost economics (See my posts of March 26, 2006 for other economic concepts applicable to law department management.).

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