One of the things I really enjoy is applying (or observing) a concept from one field to another, unrelated field. Its a pattern thing.

This morning I had a good conversation with a patent attorney. He was telling me that legal fees were under price pressure from clients. In response, law firms are outsourcing some of their work to India. Indians speak english, are highly trained, and most of all, are willing to work for a fraction of our costs.

We have all heard about white-collar outsourcing. This morning I realized that this situation was an example of transport costs, a concept that I learned about in real estate.

the monocentric city model

Why do cities exist? Why is real estate more expensive downtown than it is in the suburbs? The answers are given by the monocentric city model and the idea of transport costs.

If you live downtown, the cost of transporting yourself or your goods to other people downtown is almost zero. The further you move away from downtown, the higher your transport costs. (Yes, its a simplistic model but good enough for this concept.)

When people price an apartment downtown, they add the transport costs they would save to the price of the apartment. Conversely, people that move out of town get a lower price for their home but they pay much more in transport costs, eg that hour you spend driving, parking, gasoline, taxes, vehicle costs. You feel like you are getting a deal on a house but if you add up the total costs (dont forget to include the hourly rate for your time commuting, which could be anything from $40 to $100 or more per hour), it may not be all that different. It feels different but that is emotional not fiscal.

total cost = cost of good/service + cost of transport/delivery

Everyone has seen transport cost tradeoffs in their own housing decisions but the same idea applies to all kinds of other situations.

Why is that law firm outsourcing to India? The cost of providing the service with India labor is much lower and the cost of communicating over the Internet is also very low which makes the total cost lower. The law firm can either lower their prices or take the difference as profit.

The key in that example is that transport costs, because of the internet, are very very low. Cheap bandwidth and communications is what is driving these changes to the white-collar world today.

transport costs in action

Surprisingly, the same thing has been happening for physical goods as well. Whether it is cars manufactured in Korea or produce from Malaysia, almost everything today is being produced in one country and shipped to another country. In some cases, the total costs are coming down, in other cases, we are providing goods that just didnt exist before - like strawberries in February.

Apparently the transportation costs of petroleum transport (planes, trains and trucks) are low enough to support our increasingly global supply chain. Without cheap transport, the global system we are rapidly creating just wouldn't work.

Transport costs also come into play when people, ie governments, want to change behavior. In these cases, we call them taxes or tariffs instead of transport costs. The US government wants to support American corn farmers so there is a 50-cent tariff on every gallon of ethanol imported into the country. In order to be viable, the total cost has to be competitive so if you raise the transport costs by 50-cents, you have to lower the cost of producing the product by at least that much.

Another example is urban sprawl. Are you unhappy with urban sprawl and wish people would live in denser cities? The mechanism to deal with this is a transport cost. Put a $5 tax on every gallon of gasoline and things will change. People will either develop cheaper transportation, like high MPG vehicles or alternative fuels, or they will change behavior, like moving back into the city.

Yes, I had never heard of transport costs or the monocentric city until I took that class on real estate but whether or not you know what it is called, its impact can be seen all around us. This is a big reason why the price of gasoline is so important to the global economy.