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N) Results from a Bargaining-game Model of Transactions
A fundamental insight of TCE is the importance of uncovering both production and
transaction costs associated with the “make-or-buy?” decision. Here, comparative static
results from a stylized bargaining game model developed in Appendix A are applied to the
special case of public-private competitions regulated by OMB Circular A-76. This approach
reveals characteristics of transactions that can be used to distinguish between two
categories of internal government transactions: “good” as opposed to “more challenging”
candidates for outsourcing.
According to the documents, five steps are required to conduct a public-private
competition for an activity currently done by the government:
1. Develop a Performance Work Statement (PWS) to define performance and a Quality
Assurance Surveillance Plan (QASP) to measure performance.
2. Construct a Most Efficient Organization (MEO) for the insourcing (in-house) cost
estimate.
3. Prepare an Invitation for Bid (IFB) for well-defined, routine commercial activities, or a
Request for Proposal (RFP) for ill-defined, complex, uncertain projects that involve
specific assets.
4. Compare bids or proposals with the in-house estimate, and select a winner. In the
case of an IFB, the concern is to minimize costs. In the case of an RFP, the concern
is cost-effectiveness. In the case of an IFB, continue to in-source unless the
government can obtain equivalent performance and threshold savings are above
10% of direct personnel costs or a cumulative $10 million over the performance
period. The same holds for the case of RFP, with the further possibility of
outsourcing if it is judged significantly better performance can be achieved at the
same cost as the MEO.
5. Address appeals.
O) Characteristics of Good Candidates for Outsourcing
Where a transaction requires little in the way of specific assets (no holdup problem),
and involves a product or service that is a) well-defined and homogeneous (IFB), b) easy to
measure (limited complexity and mild information asymmetry), c) routinely used
(recurring/frequent purchases), d) not subject to change (limited demand uncertainty), and
e) is offered by competing suppliers, then there is little room for negotiation (price and
performance are market-driven), and the marginal benefit of unproductive bargaining is
essentially zero. With little room for bargaining over such routine and uncomplicated
transactions, substantial production and transaction cost savings can be expected from
outsourcing, or from purchasing directly in spot markets (say over the Internet). (This can be
seen directly from [3a,b] in Appendix A: since if σ =0, then b=0).
Moreover, since administrative, incentive, and enforcement costs tend to be low for
goods and services produced in competitive markets, the marginal cost of engaging in the
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