This is the first in a series of posts, wherein we’ll be discussing the origins and evolution of insurance industry outsourcing. In this post, we discuss the early economic principles that laid the foundation for modern outsourcing.
We can trace the origins of outsourcing back hundreds of years in one form or another. As Kate Vitasek, Faculty Member, Center for Executive Education, University of Tennessee notes in her article A History Lesson in the Economics of Outsourcing, “…we’ve traced a clear line from the giants of academic and economic theory to the emergence and evolution of modern outsourcing.” One of those giants is Adam Smith, an 18th century Scottish academic who is considered the father of Modern Economics.
Outsourcing for Centuries
Vitasek also notes that an important premise of Adam Smith’s doctrine was, “society benefits as a whole from a variety of trading transactions because humans will naturally seek what is best for them, resulting in fairness and honesty among equals. That was the theory. As demand for repeat transactions emerged, trading preferences evolved and modern transaction-based business models developed. These transactional business models became a cornerstone of conventional business relationships.”1
In Smith’s time, this might mean the village baker acquired eggs, milk and flour from a local farmer to produce his baked goods. Or that dressmakers would purchase silks and finery from merchants bringing goods from the far east. To this point, Adam Smith said, “if a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.”2
A More Modern Interpretation
As Kate Vitasek notes, “If you substitute “company” for “foreign country” in that quote you have the idea behind outsourcing. Put another way, what Smith said sounds very similar to what Tom Peters and Peter Drucker famously said more than 200 years later, “Do what you do best and outsource the rest!”3
In more recent years, Ronald Coase, awarded the Nobel Prize in Economics in 1991, built on Adam Smith’s premise in his highly influential essay, The Nature of the Firm, 1937. In it he “attempts to explain why the economy features a number of business firms instead of consisting exclusively of a multitude of independent self-employed people who contract with one another.”4
Coase talks about there being a natural limit to what firms can produce internally. He goes on to talk about “decreasing returns to the entrepreneur function”5, such as overhead costs and the tendency for overwhelmed managers to make mistakes in resource allocation. These factors become cost-prohibitive for the firm, limiting the firm’s ability to grow, reinforcing the economic premise of outsourcing.
Outsourcing: A Cornerstone of Our Economy
Our economy is built on ‘outsourcing’. We ‘outsource’ our legal counsel, tax preparation, office cleaning, IT resources and so much more; and we do it because it makes economic and business sense. As mentioned above, it’s been a cornerstone of our economy for centuries. Modern outsourcing has evolved and become both viable and more efficient as a result of technology. In our next post, we’ll be talking about how technology and improved communications fueled this evolution.
1, 3: Kate Vitasek, Faculty Member, Center for Executive Education, University of Tennessee, A History Lesson in the Economics of Outsourcing, Oct. 18 2012.
2: Adam Smith, An Enquiry into the Nature and Causes of the Wealth of Nations, 1776.
4, 5: Ronald Coase, “The Nature of the Firm” 1937, Wikipedia.