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SECTION 1: INTRODUCTION
This report offers insights for those involved in procurement and acquisition
management from a relatively new field in Economics called Transaction Cost Economics
(TCE). We begin with a summary and synthesis of TCE—its roots, useful principles for
formulating acquisition strategy, and implications for acquisition management in the
Department of Defense (DoD). We then offer a synthesis of management practices in DoD,
presenting examples of defense acquisitions and their associated governance strategies.
We conclude with recommendations about how the application of fundamental principles of
TCE might improve current defense acquisition management practices.
A) Antecedents of the Project
This paper is part of an ongoing effort to apply the insights of Transaction Cost
Economics to DoD acquisition management practices (see Franck & Melese 2005).1
Transaction Cost Economics (TCE) is the study of the “vertical” boundaries of business
enterprises—defined primarily by what goods and services are produced within the firm
(“make”) and which are acquired from the market (“buy” or “outsource”). TCE has a wellestablished
niche in economics as an academic discipline. Among the pioneers of this
literature are Nobel Prize winner Ronald Coase and Oliver Williamson. TCE is also a major
feature in a movement called the “New Institutional Economics.”2 Unfortunately, these
literatures focus almost exclusively on the private sector. More recent work by Pint and
Baldwin (1997), Franck and Melese (2005), and others have begun to study TCE in a
government setting—yielding some interesting insights.
B) Early Insights from TCE
The initial focus of the work by Franck and Melese (2005) was to examine the key
document that guides all federal policy for the competition of commercial activities—Office of
Management and Budget (OMB) Circular A-76. For competitive sourcing competitions
between a government activity and private sector suppliers, OMB A-76 calls for a one-time
10% production cost advantage to justify outsourcing.
Applying TCE suggests one size does not fit all. Outsourcing relationships vary
widely in their characteristics and potential difficulties. A key insight is that increases in
transaction costs (required to govern an outsourcing relationship) can more than offset any
production cost advantages from outsourcing. Herein, the authors extend their observations
1 Serious research into TCE at the Naval Postgraduate School (NPS) began in the late 1990s
with Prof. Francois Melese’s inquiries into the relevant literature and applications to government. The
intent of this research is to highlight TCE insights useful for public sector acquisition and, accordingly,
to improve defense acquisition management practices. Raymond Franck, also at NPS, joined this
effort a few years later. Products of this effort so far include several conference presentations, one
student thesis (jointly advised by Melese and Franck), and one paper published in the proceedings of
the Second Annual NPS Acquisition Research Symposium Proceedings in 2005.
2 A good summary of New Institutional Economics is available (for example) in Wikipedia,
http://en.wikipedia.org/wiki/New_institutional_economics.
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