Why Theories of Firm Boundaries Need an Evolutionary Process Dimension?

This paper addresses a process gap in economic theories of firm-boundaries by explaining switching costs during governance change in the case of outsourcing. Three perspectives on firm boundaries are considered: modern property right theory, modern transaction cost theory, and evolutionary theory. The first explains firm boundaries by the optimal allocation of residual decision rights to physical assets, while the second is premised on the idea that transaction attributes determine comparative advantages of intra-firm vs. inter-firm resource allocation. Neither of these theories suits the needs of one of the most recent and increasingly important users of economic theories of the firm, namely, those in charge of making decisions whether to outsource and how to manage the process of governance change. The paper reviews why understanding processes of governance-change and associated switching costs are fundamental in a managerial relevant theory of firm boundaries. It is argued that an evolutionary perspective on firm boundaries with its strong focus on knowledge, processes of learning and capability development is instrumental in providing a remedy for the process gap in conventional theories of the firm. DRUID-Conference 2001