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20041020 Wednesday October 20, 2004

[ Economics ] Accounting vs. Contracting Costs

In evaluating costs of deploying a piece of software or hardware in an enterprise, many speak of the total cost of ownership, fixed cost or variable cost. However, this view can rarely play an effective part in evaluation and selection. In fact, many who have only viewed costs from an accounting perspective have to come to regret their deployment decisions.

A more meaningful distinction for classifying costs and hazards involved in a buy vs. build question is whether the used assets are redployable or not. Here's what Oliver Williamson, the noted transaction cost economist says about the accounting vs. the contracting view of costs:

It is common to distinguish between fixed and variable costs, but this is merely an accounting distinction. More relevant to the study of contracting is whether assets are redeployable or not . . . Many assets that accountants regard as fixed are in fact redployable, for example, centrally located general purpose buildings and equipment. Durable but mobile assets such as general purpose trucks and airplanes are likewise redeployable. Other costs that accountants treat as variable often have a large nonsalvageable part, firm-specific human capital being an illustration.

Oliver E. Williamson, The Economic Institutions of Capitalism, p. 54.

When thinking about a buy vs. build decision, which is always a strategic decision, corporate strategists should (and often do) care more about the contracting costs than the accounting costs. However, this is often done intuitively after a great deal of practice. Some studies have shown that when IT strategists adopt a contracting rather than accounting view of transactions, they are generally happier with their buy vs. build decisions.

2004-10-20 09:47:43.0 -- ; Permalink ; Trackback.

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