Ronald Coase won a Nobel Prize in Economics for asking and answering why individuals choose to form companies over contracting out their work.
In a frictionless, efficient market it is always cheaper to contract out work. But the world isn't frictionless. There are transaction costs. Search, information, bargaining, maintaining confidentiality and enforcing agreements all cost time and money. Meanwhile, overhead costs and the management error grow as in-house functions increase. Balancing labour transaction costs and management scaling inefficiencies results in an optimal firm size. This firm will outcompete less agile and well-integrated small firms and distended behemoths.
In a frictionless, efficient market it is always cheaper to contract out work. But the world isn't frictionless. There are transaction costs. Search, information, bargaining, maintaining confidentiality and enforcing agreements all cost time and money. Meanwhile, overhead costs and the management error grow as in-house functions increase. Balancing labour transaction costs and management scaling inefficiencies results in an optimal firm size. This firm will outcompete less agile and well-integrated small firms and distended behemoths.
http://www3.nccu.edu.tw/~jsfeng/CPEC11.pdf