Choosing to externalise or internalise an activity has long been a key strategic concern for companies. One that consulting firms made a business of supporting, providing tools and ready-made thoughts to help companies make their strategic choices. The dominant dogma has long been that they should focus on their core business and outsource everything else to other specialised companies.
But the digital revolution and the rise of freelancers are challenging our assumptions about what constitutes a wise corporate strategy. Some of the activities we used to outsource — in particular everything related to information systems — we can’t risk to outsource in the digital age. Not being able to design the main interface with our customers and generate a data-collecting machine could mean death. Freelancers offer new ways to insource key activities. If a company doesn’t yet have the crucial skills to do it internally, it can benefit from the skills of freelancers who will work hand in hand with employees and transfer some of their skills.
In our digital world, it’s not as clear anymore what’s inside and what’s outside a company. That’s why the line between employer brand and consumer brand is increasingly blurred. Freelancers used to be said to be “outside” companies. Not anymore. If they join a company, they are often no less loyal to it than an employee. They work with a team of insiders. And they will continue to work as ambassadors and influencers and help shape that company’s “holistic brand”. In other words, using freelancers does not count as outsourcing.
Here’s a short history of how we have made our corporate decisions to outsource an activity or not, and how we have developed corporate strategy to support these choices.
Transaction costs and the creation of the firm
Whether our economic transactions happen inside or outside the company is a key question of corporate strategy. Many 20th-century economists focused on the question. Some explained that it all boiled down to transaction costs: some transactions need to be internalised because they can be made cheaper and more effective. Fundamentally, that is how the firm came to be. The firm exists because it makes some transactions cheaper than on the market.
The leading figure on the subject is economist Ronald Coase (1910–2013), a British economist who lived to be 103 and received a Nobel Prize in Economics decades after publishing most of his work. He is best remembered for “The Nature of the Firm” (1937), which introduces the concept of transaction costs to explain the nature and limits of firms. In that essay, he tries to explain why the economy features a number of business firms instead of consisting only of a multitude of independent, self-employed people who contract with one another. Why does it make sense to hire people instead of just contracting out some particular task?
It used to be said that the market was always efficient, so it should always be cheaper to contract out than to hire. But Coase revealed the existence of numerous transaction costs involved in using the market: looking for information, procuring, bargaining, keeping trade secrets, enforcing contracts… Firms will arise which can internalise the production of goods and services required to deliver a product, thus avoiding these costs. Transaction costs exist because there is no such thing as pure and perfect competition.
Carl J. Dahlman, Head of the Thematic Division and Head of Global Development Research at the OECD’s Development Centre, divides all transaction costs into three categories:
- Costs related to information: studying the market, comparing the cost/quality ratio of all the offers, etc.
- Costs related to negotiation: drafting and signing contracts.
- Costs related to contract enforcement: controlling the quality of what’s delivered, checking on the deadlines, etc.
George Akerlof, (born 1940) is an American economist who also won a Nobel prize. He is best known for his article titled “The Market for Lemons: Quality Uncertainty and the Market Mechanism”, published in 1970. In that article he identified some of the problems that afflict markets characterised by asymmetric information. Often, only vendors have the information about they are selling. They can sell low-quality products for the price of high-quality products, thus generating adverse selection. That’s how the market’s famous “invisible hand” is actually blind.
Last but not least, we owe much to economist Oliver Williamson (yet another Nobel laureate: working on transaction costs has long been the best path to the Nobel prize!). Williamson laid the foundations of “transaction costs economics”. His work was extremely influential in the 20th century. According to Williamson, there are three ways to carry out transactions: through the market (price system), hybrid forms (contracts) or the company (organisation). Williamson was one of the first economists who showed an interest in corporate management.
For Williamson, there are transaction costs no matter how you transact (through the market, hybrid forms or an organisation). In a large organisation, the costs of bureaucracy are high, and transactions all the more expensive. So the question is not as easy as it seems: one must choose the optimal transaction vehicle, which depends on each situation.
Since the development of large digital networks and marketplaces, the subject of transaction costs has made a comeback. In 2006, Don Tapscott and Anthony Williams tackled the subject at length in their book Wikinomics. The firm is said to be doomed to disappear, because transaction costs have fallen with the Internet. Companies used to have to control the life cycle of a product in its entirety. Now, write Tapscott and Williams, companies must reorganise their production and make sure the internal cost of an activity is no higher than the cost of outsourcing it. The software open source revolution leads everyone to radically rethink what the firm is all about.
The rise of freelancing platforms such as Malt contributes to that revolution: transaction costs are lower than ever. It is often a better choice to hire freelancers than to recruit new employees.
The old dogma: externalise everything that is not your ‘core business’
Companies have been outsourcing some of their activities since long before the internet became a thing and freelancers platforms came to be. Since the 1960s, strategy consulting firms have advised their clients to focus on their ‘core business’ and outsource everything else. That’s how most companies started subcontracting ‘non-strategic’ activities to outside companies — support activities, cleaning, cooking, etc. And of course a lot of strategic activities unrelated to a company’s core business had also been performed by specialised agencies for some time, like advertising. (As you can see in the series Mad Men, the golden age of US advertising agencies started in the 1960s!)
One of history’s most influential consultants was Bruce Henderson, the founder of the Boston Consulting Group, who advocated relentlessly in favour of “focusing on one’s core business”. In the 1960s, the BCG became one of the most prestigious strategy consulting firms.
We owe the BCG a certain number of tools and grids that are still in use today, like the famous growth-share matrix (a chart created in 1970 by Bruce Henderson to help corporations analyse their business units and product lines. It divides all activities into four categories depending on their growth and market share: cash cows, dogs, question marks, and stars). The matrix helps companies decide how to allocate their resources, which portfolio activities they should abandon to other companies and which activities they should focus on.
Henderson also launched a famous publication titled Perspectives, which helped the BCG spread the ideas central to 1960s strategy thinking, among which the Learning Curve. He made everyone understand that production costs are not stable. The larger your market share, the more you can operate at scale, capitalise on your experience, and produce cheaply. In competitive markets, production methods change fast and companies are incentivised to pursue their own competitive advantage.
Up until the invention of the Learning Curve, companies only pursued growth for growth’s sake and they sought to diversify their activities to continue to grow. Henderson was the first to prove this strategy was often wrong and ineffective. He sought to make managerial decisions more rational. The framework developed by the BCG helped spread the idea that small-market-share slow-growth activities ought to be abandoned to other companies with better cost structures. So outsourcing some activities can lead to huge savings because the company to which these activities are outsourced is more effective. It can produce more cheaply if the outsourced activity is its core business. And it will accept to share some of these savings with its clients, thus making them more competitive too.
That’s how a large number of service companies were created in the 1960s and 1970s: cleaning services, catering services, and IT services. Meanwhile with globalisation, supply chains became ever more complex and international (the container was a revolution). More and more the firm became a complex ecosystem, a network that aggregates and coordinates different activities performed by a multitude of actors.
Thus a key question has arisen: what is a company’s strategic core? Is it one line of business in particular or is it the company’s ability to coordinate teams of different actors around a given project? It seems there is no easy answer to that question anymore…
Why everything IT-related has become ‘core business’
Corporate strategy made a triumph after the 1970s and all of the large corporations of the 20th century started outsourcing their activities that didn’t generate enough revenues. It was seen as a strategic imperative. A lot of corporate restructuring followed. Many companies decided to focus on their core business. But what is a core business? What activities are deemed important enough to be a part of it? Conversely, what are the activities that can safely be outsourced to an outside firm?
In 1997 two German economists, Wilfried Krüger and Christian Homp tried to answer the question with a new matrix, one that takes strategic relevance and strength of competence into account. The activities whose strategic relevance is highest must, they explained, be internalised, if the company doesn’t yet do it internally. If an internal activity is strategically irrelevant, then it must be transferred (often sold) to other companies.
IT systems have become omnipresent since the start of the digital revolution in the 1970s. Yet everything IT-related was not always regarded as strategically relevant. Indeed, information systems were long regarded as part of the “infrastructure” necessary for a company to function properly, like roads, bridges, pumbing and offices. The same way companies didn’t regard building roads and doing the plumbing as part of their core competencies, they didn’t see running IT systems as something they should do themselves: it was something that could naturally be outsourced to an external specialist. Information systems were an operational necessity, but not a core competency.
That is why we outsource as much as 30% of all information systems, sales administration and customer relationship management, according to EY (see “Outsourcing in Europe” by EY), who believe there is potential for more outsourcing in the future. But marketing and sales are not outsourced much (only 2% in France, according to EY) because marketing and sales are seen as highly strategically relevant.
And so IT services companies have operated on a fast-growing market: developing software packages, CRM (customer relationship management) systems, sales and inventory management systems, etc.
However since the digital revolution, the mobile revolution and the emergence of cloud-based IT services (everything-as-a-service), information systems are increasingly strategically relevant. As our economy is more and more digital, these systems are to become every company’s core competency. They can no longer be regarded as the “pipes” that support more strategic activities. They are not like plumbing anymore. In many sectors, digital companies have transformed traditional value chains and blurred the old definition of what information systems were all about. In a digital economy, controlling one’s information systems is key to providing customers with an “exceptional customer experience” and maximising value creation. IT competencies are as critical as they have ever been and they must be mastered internally.
Unfortunately for them, many companies still choose to outsource their information systems to IT services companies, thus giving up on the idea of developing their core competencies. Sometimes it’s because their leaders have not fully grasped the criticality of information systems. In other cases, it is because they find it too hard to do it internally: they fail at hiring, training and retaining the necessary resources. Or they find their culture is too alien to the digital world. For whatever reason, many companies turn to turnkey solutions developed by outside companies. Sometimes they have completely given up on the idea of managing IT projects which are deemed too complex.
But the more digital our economy becomes the more dangerous it is to outsource information systems to external companies. Your ability to be agile and to respond to consumers’ evolving expectations depends on your ability to leverage your information systems. That’s how you collect consumer data and “iterate” on the product to meet the needs of your users. If you don’t master the consumer-facing interface, you risk being marginalised in the value chain: your products or services will become commodities and a larger chunk of the value will be seized by whoever controls the consumer-facing interface and the vast amounts of data generated by these consumers. Whatever your business is, that interface is your business.
Why freelancers offer companies a new alternative
A survey carried out by the platform Malt together with Ouishare, “Freelancing in France 2017: Proud to be a Freelancer”, sheds light on France’s new class of freelancers, most of whom see themselves as empowered by digital. The survey reveals these workers have embraced freelancing as a lifestyle and are on average much happier than they were as employees with 9-to-5 work schedules.
France is changing fast. A recent McKinsey survey suggests as many as 13 million French people are to some extent involved with independent work, either because they have a part-time gig on a digital platform, or because they rent their apartment on Airbnb, or because they sell their services full-time to companies. French people have embraced the digital transition more fully perhaps than other Europeans. French workers are hungry for more autonomy, flexibility and purpose and passionately adopting new work models.
A whole new class of young (and not so young) freelancers is rising and transforming work and organisations in an unprecedented way.
In more ways than one, freelancers make it possible to overcome the internalisation / externalisation dilemma. The freelancing model is still relatively new and sometimes complicated for large companies that are used to working with IT services companies. Sometimes the purchasing department prefers to stick to its list of referenced (more traditional) providers. In other cases the purchasing department is reluctant to handle contracts with a large number of different independent individuals. Sometimes a referenced provider will act as intermediary between the freelancer and the client, without creating any added value whatsoever.
Freelancers often join a team composed of salaried employees. A company project can have an internal core completed by external talent, depending on the needs of the moment. Freelancers are used to enriching that core by collaborating with employees, transferring knowledge and skills, sometimes even teaching others what they know. When you outsource a project in its entirety, it will often remain a “black box” over which you have no control. Freelancers are the best way for you to regain control over whatever activity is strategically most relevant.