Enterprise Resource Planning (ERP) software is among the most widely used software that many businesses used to streamline operations, integrate functions, and augment decision-making capability within their organizations.

Implementing an ERP system is expensive, and organizations have to determine if they want to build their own ERP systems or get them from specialized vendors. This choice is supported by Ronald Coase’s Transaction Cost Economics (TCE).

TCE argues firms exist to:

• Decrease market transaction costs.
• Manage the cost in conducting due diligence.
• Negotiate business contracts.
• Implement the laws for compliance.

Today, we’ll be doing the TCE impacts ERP development and its impact on reading events on real-life examples.

How Transaction Cost Economics Affects ERP Software Development?

Ronald Coase's TCE propose that companies exist because they cut transaction costs such as:

• Searching for information.
• Bargaining over contracts.
• Policing agreements.

Companies decide to produce a good or service in-house or buy it from outside depending on which path has lower transaction costs.

According to TCE: firms evaluate the costs associated with in-house development of ERP software with outsourcing.

Some key transaction costs in this decision are:

• Search and Information Costs – Identifying an appropriate ERP vendor or a team to develop a solution internally consumes time and resources.
• Bargaining and Contracting Costs – Negotiating software licensing, customization, and service-level agreements (SLAs) can be hard and costly
• Monitoring and Enforcement Costs – There is need for monitoring and enforcement, you have to have oversight of your outsourced ERP provider, follow up on their performance, and enforce the terms of your contract, and this can have a cost associated with it.

Why Do Companies Outsource ERP Software Development?

Firms prefer outsourcing over in-house development when ERP solutions that reduce transaction costs are available outside.

There are a number of reasons for this decision:

• High Cost of Development – Developing an ERP system needs experience in data integration, cybersecurity, and cloud computing. Hiring your own in-house team can be expensive.
• Economies of Scale – Established ERP vendors (SAP, Oracle, Microsoft Dynamics, etc.) are able to amortize their development costs over a large number of clients, providing a lower cost per user.
• Customization vs. Standardization – The caveat with custom-built ERP systems flexibility comes at the price of expensive upkeep. Example: Off-the-shelf solutions offer vendor support and periodic updates.

Real-World Examples of How Companies Adopt ERP

Tesla’s Shift to In-House ERP

Tesla was using third-party ERP providers at first but later created its own. In 2021, however, Elon Musk slammed SAP as inefficient and selected a proprietary ERP solution instead.

This was in lock step with TCE—Tesla concluded that engaging an outside vendor incurred elevated transaction costs, such as delays and lack of customization.

While expensive upfront, they decided building their own ERP would afford Tesla more control over its supply chain and more long-term efficiency over the decade.

SMEs and Cloud-Based ERP

Many ERP vendors sell their custom enterprise resources to small businesses, but for development, small businesses may not have much in their hand. Instead, net-new customers resort to cloud-based solutions such as NetSuite (Oracle) or SAP Business One.

For small and medium-sized enterprises (SMEs), the cost of hiring developers to maintain security and update the solution is significantly higher than the cost of subscribing to a cloud ERP.

For SaaS based ERP systems, costs of bargaining, monitoring, and enforcement are reduced due to contracts in place are more standardized and contracts can automatically get updated in actuating a breach.

The Future of ERP & Transaction Cost Economics

Technology will keep advancing and companies will continue to measure transaction costs when configuring an ERP solution.

Here are some of the notable emerging trends:

• AI-enabled ERP: AI-driven platforms that constantly track vendors, negotiate contracts and track performance to lower the cost of enforcement.
• Blockchain for smart contracts: Blockchain technology can lower compliance costs, cut disputes, and make vendor agreements more transparent.
• Hybrid ERP models: Some companies develop a blend of insider ERP solutions, alongside 3rd party alternatives, thus providing a best of both worlds approach to their functionality and cost.

Conclusion

Transaction Cost Economics (TCE) offers a practical model to explain why companies elect to build ERP internally, or to some specialist supplier. The specific move of Tesla to proprietary evidence is that the ERP and SMEs use a range of move makers to process or build the material.

This transitional technology can meet costs because ERP is unique, and organizations will experience how external factors would force trade-offs between costs and direct the firms to cope with them.

Finally, it comes down to reducing costs without sacrificing on the purpose of ERP solutions like having it aligned with business goals and process optimization