Journal of Management Studies 47:8 December 2010
doi: 10.1111/j.1467-6486.2010.00945.x
Reconceptualizing the Firm in a World of Outsourcing
and Offshoring: The Organizational and Geographical
Relocation of High-Value Company Functions
joms_945
1417..1433
Farok J. Contractor, Vikas Kumar, Sumit K. Kundu and
Torben Pedersen
Rutgers Business School, Rutgers University; Discipline of International Business, University of Sydney;
Florida International University; Center for Strategic Management and Globalization, Copenhagen Business
School
abstract In the largest sense, global strategy amounts to (1) the optimal disaggregation or
slicing of the firm’s value chain into as many constituent pieces as organizationally and
economically feasible, followed by (2) decisions as how each slice should be allocated
geographically (‘offshoring’) and organizationally (‘outsourcing’). Offshoring and outsourcing
are treated as strategies that need to be simultaneously analysed, where just ‘core’ segments of
the value chain are retained in-house, while others are optimally dispersed geographically, as
well as dispersed over allies and contractors. This amounts to a reconsideration of the nature
of the firm that captures the dynamic changes in global configuration and a reconsideration of
what constitutes ‘core’ activities that need to be retained internally. The article proposes a new
research agenda that searches for each firm’s optimal degree of disaggregation and global
dispersion given that further scattering of value chain activities entail benefits as well as
increased complexity and costs.
INTRODUCTION
The relentless forces of competition and globalization are forcing firms to disaggregate
themselves and reach for foreign inputs, markets, and partners. By disaggregating their
value chain into discrete pieces – some to be performed in-house, others to be outsourced to external vendors – a company hopes to reduce overall costs and risks, while
possibly also reaping the benefits of ideas from their contractors or alliance partners
worldwide. Outsourcing can, of course, be both (1) in the home nation of the firm, as
well as (2) abroad, and entails an organizational restructuring of some activities. Outsourcing is a conscious abdication of selected value chain activities to external providers. Offshoring, on the other hand, is restructuring the firm along another dimension,
Address for reprints: Torben Pedersen, Center for Strategic Management and Globalization, Copenhagen
Business School, Porcelænshaven 24B, DK-2000, Copenhagen F. Denmark ([email protected]).
© 2010 The Authors
Journal of Management Studies © 2010 Blackwell Publishing Ltd and Society for the Advancement of Management
Studies. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street,
Malden, MA 02148, USA.
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namely geography. It entails the relocation of operations from the home nation to a
foreign location where the same company activities are performed under either (1) the
multinational company’s (MNC’s) own subsidiary or (2) allocated to a foreign contract
vendor. At stake are not only low-end manufacturing and service activities, but
increasingly, high-value company functions like R&D, design, and engineering that are
being increasingly relocated to foreign locations (Manning et al., 2008; Pyndt and
Pedersen, 2006).
The boundaries of many firms have therefore simultaneously shrunk organizationally
and expanded geographically, while also becoming more permeable. We treat outsourcing and offshoring as two outcomes of the same strategic drivers that force companies to
reconsider the configuration of their activities. A cursory examination of outsourcing and
offshoring would suggest cost reduction as a main driver. However, especially in recent
years, two other strategy motivators have gained significance. First, the knowledgeaccessing motive: with growing complexity of products and services, even the largest
companies no longer have all the diverse components of knowledge within their own
organization, or personnel, to be competitive in research, production, and marketing.
Hence the need for external knowledge inputs and expertise. Organizationally and
geographically distant knowledge can often be more valuable than internal or relatedparty knowledge (Bierly et al., 2009). Second, relocation of operations abroad helps the
MNC to better understand and exploit foreign markets. Local value-added builds legitimacy with local customers and governments. Thus outsourcing and offshoring simultaneously help the firm in three strategic needs: (1) ‘efficiency’ or cost reduction; (2)
‘exploration’ or access to knowledge and talented people; and (3) ‘exploitation’ or
development of foreign markets (Dunning, 1993).
Despite the increasing interest in offshoring and outsourcing only in the recent past,
neither of them is a very new phenomenon. Apparently, offshoring would appear to have
much in common with the geographical relocation under foreign direct investment
(FDI), and expansion of foreign subsidiaries. Outsourcing follows external purchasing
decisions, joint ventures, and strategic alliances that focus on organizational relocation.
But traditional theory lenses – such as transaction costs, or resource based theory, or
Dunning’s (1993) OLI (ownership, location, and internalization) paradigm for FDI – are
inadequate to fully explain, or capture the nuances of recent strategic thinking with
regards to offshoring and outsourcing decisions (as also emphasized by Doh, 2005 among
others). What is needed is a reconsideration of the nature of the firm that captures the
more dynamic configurational aspects of the firm. This article hopes to further advance
the reconceptualization of the firm based on these recent trends and in so doing stimulate
much needed theoretical development.
Offshoring when undertaken in foreign subsidiaries (as opposed to foreign arm’s
length vendors) is a subset of FDI. But the study of offshoring goes beyond traditional
FDI theory, or exploiting country-specific advantages. Offshoring, in a fuller sense, is
the building of a global network whose strategic objectives go well beyond serving a
local market, to a focus on global network efficiency and coherence. The same distinction can be made between outsourcing and traditional views of organizational
reconfiguration such as external purchasing. Outsourcing strategy goes beyond the
‘make versus buy’ decision, to encompass technology accessing, risk sharing, joint
© 2010 The Authors
Journal of Management Studies © 2010 Blackwell Publishing Ltd and
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development, comparative economies of scale in the focal firm and in vendor organizations, and the help that a local vendor may sometimes provide in marketing related
activities.
Outsourcing and offshoring have grown, not only in terms of the number of companies involved, not just in the number of foreign nations involved, and not just in terms of
macro-economic statistics. An OECD study (Miroudot et al., 2009) finds that ‘Trade in
intermediate inputs among developed countries represents, respectively, 56% and 73%
of overall trade flows in goods and services’. While their methodology overstates the role
of intermediate services and goods in world trade, the statistics leave little doubt that
disaggregation of company value chains, and their dispersal internationally, is progressing rapidly.
At the firm level, there are two salient changes in strategy – first, the division of the
firm’s value chain into ever smaller pieces, and second, the willingness to outsource and
offshore even activities close to the ‘core’ competencies of the firm. Companies are
engaged in a micro-analysis and dissection of their value chains into finer slices than ever
before. The value chain is no longer divided into large groupings such as R&D, Production, or Marketing. The functions and operations within each category can be sliced
into dozens or hundreds of sub-activities. For each sub-activity or operation the question
then asked is where to perform it and whether to perform it within the firm, or outsource
it. Even within R&D (still considered by many companies as a ‘core’ activity not to be
outsourced) one can disaggregate various functions, keeping sensitive aspects in-house,
while outsourcing others.
For instance, software companies can offshore or outsource the actual programming
of new software programs that might be essential for their competitive advantage,
while keeping the architectural and design knowledge close to their headquarters.
Similarly in pharmaceuticals, the preparation of test batches can be outsourced, while
the science or genetics behind the experiments are closely guarded. In some testing,
hundreds or thousands of different ingredient combinations may need to be tested.
The same compound can be prepared with different mixes, or proportions of ingredients, with different granular sizes and properties, which can radically change the rate
of absorption of the drug into the body. The molecular properties and how the ingredients interact, is kept as a proprietary secret. But the actual preparation and mixing
of the ingredients into different test batches is a function that can be outsourced, to
reduce R&D costs. The recent willingness to dissect or fine-slice all pieces of the value
chain increases – for the firm as a whole – the proportion of value added externally
and the percentage of operations abroad, while decreasing the (global) total costs. It
also gives new meanings to the demarcation between a ‘core’ and a ‘non-core’ activity
of a firm.
ALLOCATIONAL CHOICES WITHIN THE FIRM
From an integrated strategic perspective, outsourcing and offshoring are separate dimensions or aspects of the same goals of firm reconfiguration. The firm analyses the division
and reconfiguration of its activities over:
© 2010 The Authors
Journal of Management Studies © 2010 Blackwell Publishing Ltd and
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Domestic country
In-house (conducting activity
Foreign country
1
2
3
4
5
6
inside the firm)
Cooperative (conducting
activity cooperatively with
partner)
Market transaction
(conducted by arms-length
provider)
Figure 1. Six allocation choices for each value chain activity
Note: The figure lists a subset of the strategy changes involved in reconfiguring the global firm.
Source: Some concepts in this figure are adopted from Miroudot et al. (2009).
• Function: Deciding how far to slice its value chain activities into dozens or hundreds of discrete pieces. For each slice of the value chain, the subsequent decision is
about its
– organization mode (outsourcing): in-house, vs. contract provider, vs.
alliance;
– geography (offshoring): foreign location decisions driven by comparative
advantage, local market size, cultural distance and institutional environment.
• Time: The coordination and integration of the firm’s activities into a chronologically coherent global system (and assessing the cost thereof).
For each sub-activity, or slice of the firm’s value chain, Figure 1 presents six allocation
choices and some of the strategies that follow from changes in the configuration of the
value chain activities. The dimension on organizational restructuring (the vertical axis in
Figure 1) is the focus of the article by Mudambi and Tallman (2010). They provide a
similar scale of market, alliances, and hierarchy for this dimension and discuss thoroughly how characteristics of the activity, and the level of integration with other activities, might affect the allocation choice. Yuan et al. (2010) also investigate the dimension
of organizational restructuring. However, they do so from the perspective of the vendor
(in China). The other dimension (the horizontal axis in Figure 1), geographical relocation, is the key focus in the article by Demirbag and Glaister (2010) as they investigate the
factors determining offshore location of R&D projects.
Along the vertical (organizational) dimension, the progression from cell 1 to cell 5 entails
a progressive externalization of that activity within the home nation of the firm (with cell
© 2010 The Authors
Journal of Management Studies © 2010 Blackwell Publishing Ltd and
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3 as an intermediate step often called ‘relational contracting’ (Kale et al., 2000) or an
‘alliance’ (Contractor and Lorange, 2002)). A similar set of organizational choices exist
abroad, in going from cell 2, for a fully-owned subsidiary to cell 6 with foreign arm’s length
vendors. Along the horizontal or geographical dimension, the choice is between performing the particular function (or value chain activity) in the home nation, or abroad.
A priori, one cannot say which of the six cells is necessarily better, or cheaper, or more
fruitful. That depends on the function or activity in question, its transactions costs
(Murray and Kotabe, 1999), its value contribution, rarity and imitability (Barney and
Hesterly, 2006), risk associated with knowledge leakage (Sampson, 2004), and its contribution to overall global coordination overheads borne by the company. For example,
in some cases domestic outsourcing, despite being in high-wage nations, can be better
than outsourcing the activity to an emerging country (and sometimes no more expensive)
when flexibility and speed to market are more important than saving every penny. Wage
rates alone have little explanatory significance in comparing countries as attractive locations, as demonstrated in studies such as Contractor and Mudambi (2008) and Demirbag
and Glaister (2010). One cannot generalize as to which of the six cells in Figure 1 are best
for each operation. For example, in clinical trials in the pharmaceutical industry, Thakur
(2010) shows that trials conducted in foreign subsidiaries are more expensive than those
performed by foreign contract organizations. The choice between the six alternatives in
Figure 1 and the determinants of the different choices is further discussed in the articles
in this issue. Organizational restructuring is the main focus in the three articles by
Grimpe and Kaiser (2010), Mudambi and Tallman (2010), and Yuan et al. (2010), while
the two articles by Demirbag and Glaister (2010) and Mudambi and Venzin (2010) have
a stronger focus on the dimension of geographical relocation.
The choice between the six cells of Figure 1 is also determined by the institutional and
environmental characteristics, human resources, and infrastructure of the nation being
considered. In the broadest sense, for each function the company needs to perform, it can
choose between its foreign subsidiaries which compete with each other to earn a ‘global
mandate’ (Frost et al., 2002) for that particular operation or task as well as external
outsource vendors in various nations who also compete to earn the same ‘mandate’ (Luo,
2005; Sturgeon et al., 2008). Indeed, in many cases, the optimal choice is to perform a
certain piece of the value chain in the home nation and within the company itself. That
decision is more likely when the activity in question involves the ‘core competence’ of the
firm – although as we see in a later section, the finer disaggregation, or slicing of the value
chain, has forced firms to reevaluate their core activity.
The disaggregation of the value chain enables companies to make finer allocation
choices, for each slice of their value chain. But disaggregation and dispersion of the firm
– beyond an optimal degree – also entails more complexity and more costs in terms of
added management and communication efforts. Alternatively, in economic terms the
incremental search, coordination and transactions cost may at some point exceed the
benefits of incremental disaggregation and dispersion. The task of global strategy then is
to determine the optimal level of disaggregation of the firm’s operations over its entire
value chain, to then determine the optimal global allocation of each piece over the six
cells in Figure 1, in light of the overall benefits, costs, and risk of such allocations for the
firm as a whole.
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The rest of this article surveys trends that have accelerated the outsourcing and
offshoring phenomena in the past decade, discusses what the fine-slicing of the value chain
entails, core versus non-core classifications, and concludes with implications for the theory
of the firm. A brief overview of this special themed section is presented in the final section.
THE STRATEGY DRIVERS OF OFFSHORING AND OUTSOURCING
The recent wave of offshoring and outsourcing has been fuelled by changes in the business
and regulatory environment worldwide, as well as by shifts in corporate thinking. With
phenomenal improvements in communication infrastructure and significant cost reduction in global telecommunication, offshoring and outsourcing have reached new heights
(Blinder, 2006; Levy, 2005). Government policy changes, such as the liberalization of FDI
regimes have reduced the barriers to foreign entry (UNCTAD, 2009). The tighter
enforcement of intellectual property rights in many nations has reduced the fears of
technology misappropriation and, at the margin, increased the propensity to outsource or
share knowledge with alliance partners (Contractor and Lorange, 2002).
The intensification of competition in many sectors has forced companies to reach
beyond the more familiar strategies to reduce costs (Dossani and Kenney, 2007). Scientific infrastructure and equipment needed for research and sophisticated skills and
operations have been added in emerging nations (see, e.g. the article by Yuan et al.,
2010, that explores the knowledge upgrading of vendor firms). The new wave of offshoring and outsourcing includes not only standardized activities driven by cost savings and
involving lower-skilled labour, but as highlighted in many studies (e.g. Baden-Fuller
et al., 2000; Lewin and Cuoto, 2006) it also includes more sophisticated and advanced
activities like research, design, engineering, and product development. The number of
scientists and engineers abroad, as well as their sophistication and technology absorptive
capacity, has dramatically escalated (Florida, 2005). The article by Demirbag and
Glaister (2010) discusses how the pattern of location of R&D units abroad has significantly changed with the recent wave of offshoring. By locating a critical function in an
important foreign market (and especially by designating it as a ‘global competence
centre’ or giving it a ‘global mandate’) the firm earns legitimacy and reputation with local
customers, opinion makers, and government. For example, several location decisions
and ‘mandates’ in the biochemical sector have been driven by the realization that
regulators and consumers in China, India, or Brazil will respond more favourably when
the global firm is seen to perform a critical operation within their country (Farrell, 2006;
Flores and Aguilera, 2007).
Finally, as a socioeconomic trend, advanced nations have seen emerging shortages in
engineering and scientific talent in their own country which is forcing some companies
to relocate technical operations and R&D abroad (McKinsey Global Institute, 2009). It
has been described as ‘the emerging global race for talent’ and as such shown to be an
important explanatory factor for offshoring of high-value company activities (Lewin
et al., 2009).
At the firm level, the dauntingly higher costs and risk of R&D, and the competitive
need to shorten commercialization times have made companies more willing to disaggregate at least some safer and discrete portions of their R&D and allocate those pieces
© 2010 The Authors
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to contract providers at home and abroad. For instance, in pharmaceutical R&D, key
company secrets are kept in-house while the clinical trial portion of research (comprising
around 40 per cent of overall R&D budgets) is increasingly being offshored and outsourced (Azoulay, 2004; Cockburn, 2004). This strategy rethinking first requires companies to closely examine their research procedures to see how the whole process can be
divided and modularized into separable bits. Second, the firm identifies those portions of
R&D that can be standardized, routinized, and codified. Third comes the decision, for
a particular R&D operation, as to which R&D activity may be safely externalized or
offshored and allocated over the six cells in Figure 1.
This disaggregation and routinization, in R&D, production, and marketing, has been
aided by the increased codification of corporate knowledge. Procedures that used to be
just in the minds of engineers or managers are now put down in written routines,
software, or expert systems (Balconi et al., 2007). Once codified, the manuals or software
can be read, absorbed, and implemented even outside the firm by contracted outsource
providers. Ceteris paribus, codification of knowledge increases the likelihood of outsourcing
and offshoring. However, it might also increase the likelihood of technology leakage, but
if only a discrete bit of the entire process or routine is shared with a contract provider or
alliance partner, then the latter is unable to put the whole system together to become a
competitor. Thus judicious outsourcing of safer, selected bits of a larger R&D or production process may not greatly increase the threat of opportunism. Dossani and Kenney
(2007, p. 779) recognize this notable attitudinal change and conclude that ‘offshoring of
services have evolved from an exotic and risky strategy to a routine business decision’.
Companies are also recognizing that the growing complexity of products and services
today require ever-broadening knowledge inputs, many outside the range of the firm’s
internal capability. Hence such inputs can only be accessed by contract, or by alliance
(Alcacer and Chung, 2002), or from foreign knowledge clusters (Cantwell and Mudambi,
2005). In short, the new strategic thinking accepts the notion that even a large firm can
no longer always rely on its own internal resources, even for critical or core functions.
Large firms are now content to be part of global networks of expertise.
Offshoring and outsourcing activities have shifted from being seen as an operational
tool with a focus on cost savings to becoming activities with strategic importance, closer
to the heart of the firm. Therefore, the current wave has significant implications for how
companies organize their global network of activities. Many firms must rethink their
organizational structures and processes as a consequence, not just abroad but also at
home, in order to reap the full benefits of an optimized global value-added network
(Ernst and Kim, 2002).
FINE-SLICING THE FIRM: SEEKING THE OPTIMAL LEVEL OF
DISAGGREGATION AND DISPERSION
With increasing offshoring and outsourcing comes the necessity of splitting up the value
chain in finer and finer modules (set of activities) that are internally coherent, and with
standardized interfaces to other modules that limit the need for extensive communication
and coordination – i.e. the incremental costs associated with the disaggregation and
dispersion of the value chain. To give an example, many pharmaceutical companies
© 2010 The Authors
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continue to perform R&D in-house in the headquarters country, for fear of technology
and data leakage. But many have analysed and sliced their R&D operations into discrete
pieces and relocated several of them. Fundamental research may continue to be done at
headquarters. But the grinding, mixing, and preparation of test batch compounds may
be outsourced to contract providers in the home nation. Different batches are then
delivered back to the pharmaceutical company’s central laboratories for Phase I and II
screening. For field tests, the firm may use its home office as well as affiliates, but selected
portions of field test administration are outsourced. The pharmaceutical company may
appoint an outside (home country) IT vendor for worldwide data management of clinical
trial data, working with it to prepare data reporting templates for patients, doctors, and
hospitals worldwide. Sometimes, these data templates are customized – for each nation
depending on local regulations and language – with suggestions from foreign affiliate
staff. Once the clinical trials begin, the (home country) IT outsource vendor, in turn,
outsources the data reporting and data entry work to yet other contract call centres in
each foreign nation, who gather and transmit individual patient or foreign hospital data
back to the (home nation) IT vendor. Thus even the R&D portion of the value chain can
be divided in many slices over home office, foreign affiliates, home country contract
providers, and foreign contractors.
The prerequisite to gaining the benefits of disaggregation, of course, is that companies
must first analyse and learn about their own operations and processes in-depth – to assess
which of them can be standardized, bundled in new ways, as well as to identify activities
where the frequency of occurrence, or scale, of the operation is too small to justify
keeping in-house. Next, the firm must specify interfaces and coordination mechanisms
among the activities (Ernst and Kim, 2002; Sturgeon et al., 2008). Very often such
analysis is carried out under the heading of Lean Production or Six Sigma, where the
goal is to reorganize, standardize, and specify interfaces among different activities. A
major advantage of the more modularized and fine-sliced structure is that it facilitates
dissemination of information to decision-makers that are best placed to use it. It identifies
activities which for reasons of trade secrecy or sufficient scale may well be retained
in-house, while other activities or functions – that are not so sensitive, or which are done
infrequently, or where internal demand does not add up to a large enough scale within
the firm – can be outsourced. In fact, one of the drivers of outsourcing lies in the simple
fact that outsource vendors, by aggregating similar work over their many contract
customers can achieve economies, of large scale and experience, for a particular task,
that their individual clients cannot.
The precondition to reconfiguring the firm is a thorough internal analysis that divides
all its activities into small, discrete pieces. But how far should a company go in its
disaggregation? If one divides the value chain too finely, that may be suboptimal. First,
the interfaces between the modularized activities or slices have to be managed. The
interface or coordination costs increase with geographical and organizational distance if
two sequential (or concurrent) activities are separated in different departments, or in an
outsource company, or located abroad. Second, each relocation entails additional search
costs – searching for external vendors, and searching in unfamiliar foreign locations
(Grossman and Helpman, 2001). The contracting environment, culture, work habits,
and institutional environment in each foreign nation need to be learned. The costs of
© 2010 The Authors
Journal of Management Studies © 2010 Blackwell Publishing Ltd and
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Figure 2. The optimal degree of disaggregation and dispersion
data transmission may have reduced substantially, but cultural and institutional distance
between nations remains an obstacle and a significant cost (Zaheer and Manrakhan,
2001).
Finally, the greater the number of discrete slices into which the firm’s value chain is
divided, the greater the complexity and overall coordination overheads. After all,
someone or a large staff has to then manage the entire globally-distributed enterprise,
achieve efficient coordination across various sub-units, internal and external actors, both
chronologically and in terms of quality and production efficiency. In the broadest sense,
such a reconfiguration will also dilute firm-specific resources and competencies, deteriorate integrative capacities, place high demands on managerial attention, and blur the
identity of the company in negative ways (Santos and Eisenhardt, 2005).
While disaggregation, reconfiguration, and dispersion of the firm yields benefits, as a
function of the level of restructuring this may be at a diminishing rate. Overall costs of
managing greater complexity, disaggregation, dispersion, relocation, and coordination
may however escalate more quickly after a certain point. In fact, the strategy question is
highly complex as it entails the optimization of the degree of disaggregation as well as the
degree of geographical and organizational dispersion. (We us the term ‘dispersion’ in
both organizational as well as geographical meanings – that is to say, the spreading out
of the company over internal and external vendors, as well as the spread of activities over
various nations.) However, the two variables – degree of disaggregation and degree of
dispersion – are not independent but interrelated. Figure 2 shows the performance effects as
a function of degree of disaggregation and dispersion. The hypothesis is that the benefits
of fine-slicing and organizational and geographical dispersion come at a cost in terms of
increased complexity and coordination. At some point in time the increased management and coordination costs might exceed the benefits. Stringfellow et al. (2007) have
argued along the same line and proposed that offshoring and outsourcing entails invisible
or hidden costs that only becomes visible when firms start to manage and operate their
more complex global value chain configuration. However, firms might very well be able
to find ways to organize their activities in such a way as to reduce the costs of complexity
and coordination below the benefits of reconfiguration – for example, by specifying
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up-front a clear division of labour, modularization of activities, and applying modern
information technology (e.g. virtual communication). As firms gain experience in managing and operating their global network of value chain activities they might be able to
apply more sophisticated techniques and management tools, allowing them to keep
benefits of expanding their global network higher than the costs. In a dynamic sense, the
building of a global network of disaggregated and dispersed value chain activities is also
a learning process, which is the focus of the article by Mudambi and Venzin (2010) as
they unfold the dynamics of offshoring and outsourcing in the mobile handset and
financial services industries. The article by Grimpe and Kaiser (2010) provides further
support for the trade-off between incremental benefits and incremental costs, as they
emphasize that R&D outsourcing involves ‘pains’ as well as ‘gains’. The ‘pains’ stem
from dilution of resources, deterioration of integrative capabilities, and high demands on
management attention. Accordingly, they find evidence for an inverted U-shaped relationship between R&D outsourcing and innovation performance.
Thus Figure 2 hypothesizes that for each firm there is an optimal level of disaggregation
and dispersion. The value of the global firm is maximized at some intermediate points on
both the disaggregation and the dispersal axes, resulting in a three-dimensional map which
is bell shaped. As a hypothesis for further research scholars may fruitfully investigate what
constitutes an optimal level of disaggregation and dispersion of the firm and what can be
done in terms of reducing the increased costs of complexity and coordination.
IMPLICATIONS FOR ‘CORE’ VS. ‘NON-CORE’ CLASSIFICATIONS
If even R&D can be sliced into many constituent pieces, and distributed both organizationally and geographically, what are the implications for ‘core’ versus ‘non-core’ classifications? Conventional theoretical wisdom based on transaction cost theory and the
resource based view is that companies should keep their core activities very close to the
heart, i.e. at headquarters in the home nation, to protect the core competences. Offshoring or outsourcing core activities might imply a risk, and loss of control.
Current literature typically divides the spectrum of activities across a ‘non-core’ and
‘core’ distinction (Gilley and Rasheed, 2000; Levy, 2005). But is the scale really dichotomous? And does it imply that when companies are offshoring high-end activities (e.g.
product development and R&D) they are really offshoring core activities? In the auto
industry (one of the earliest in offshoring) it is not uncommon to offshore activities that
were previously conducted close to the headquarters – for example, when an entire
sub-system of a car, such as the power-train, is offshored to a subsidiary which is given
the global mandate to develop this part of the car. However, the architectural core
activities will typically still be conducted close to the heart of the company where the
headquarters can exercise full control (Harland et al., 2005). In the pharmaceutical
industry, ‘contract research organizations’ (CROs) today offer services like product
development, clinical trial management, and preclinical, toxicology, and clinical laboratory services for processing trial samples. Some pharmaceutical firms have sliced and
narrowed the scope of their core activities to high-technology functions at the very
beginning of the innovation process (the architecture of new discoveries), while the
operational part of the research process is outsourced to CROs. Pharmaceutical com© 2010 The Authors
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Figure 3. A finer distinction between core and non-core activities
Source: Adapted from Quinn (1999).
panies were outsourcing approximately $15 billion to CROs in 2007 (Frost & Sullivan,
2007). These examples show how companies have begun to redefine their core activities,
and focus on a more narrow set of high value added activities that constitute the
architecture of the system, and manage the interfaces among the elements in the system,
while the more operational parts of the value chain are outsourced or offshored.
This is a call for a more fine grained distinction, where the ‘core’ is grouped into the
true core activities, i.e. those that are distinctive and crucial for the competitive advantage
and often of more architectural nature, and essential activities, i.e. advanced activities that
are complementary and important for the competitive advantage. Quinn (1999) makes
a similar distinction and defines three types of activities: (1) core activities, those that the
firm performs better than any other company (best-in-world capability); (2) essential
activities, those that are needed for sustaining its profitable operations; and (3) non-core
activities, those that can easily be outsourced.
A finer distinction between core activities and essential activities is in line with the finer
slicing of value chain activities (as shown in Figure 3). The implication of fine-slicing and
development of more sophisticated techniques and management tools for handling
disaggregation and dispersion is that essential activities can be offshored and outsourced
to a larger extent. Thus essential activities that used to be classified as high-value
activities will to a greater extent be treated in the same way as the true non-core activities.
Gottfredson et al. (2005) describe this as keeping the ‘core of the core’ inside the firm,
while ‘outsourcing is becoming so sophisticated that even core functions like engineering,
R&D, manufacturing, and marketing can – and often should – be moved outside’ (p.
132).
Another strong argument for narrowing the scope of ‘core’ functions performed within
the firm is that after shedding essential and non-core activities, the company is better able
to allocate more resources, both human and capital, and time and effort towards creating
and maintaining their true core activities (Gilley and Rasheed, 2000; Quinn and Hilmer,
1994). In addition, a narrower focus builds on the advantages of specialization, and a
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leaner organization increases the flexibility of the firm to better respond to changes in the
external environment.
RETHINKING THE NATURE OF THE FIRM IN A WORLD OF
ORGANIZATIONAL AND GEOGRAPHICAL RECONFIGURATION
Since Coase’s (1937) classic article on the nature of the firm, management scholars have
grappled with defining this entity and sought theories to explain its workings. It was
easier to define the boundary of a firm in days when the entire organization physically
resided under one roof, as in Adam Smith’s baker or butcher shop (Smith, 1776). Even
before Smith’s day, internal division of labour, specialization of skills embedded in each
worker, and the sequencing of production processes, was commonplace. This was followed by specialization in different divisions of large companies, with each division
(located within the same precinct or nation) concentrating on one portion of the value
chain. Today, the fragmentation of production has progressed to an unprecedented
level, with the value chain sliced finely into dozens or hundreds of discrete steps in each
firm, with each slice being subject to an evaluation as to its best or optimal geographical
location (for possible offshoring), and optimal organizational mode (for possible outsourcing) either in the firm’s own nation or abroad. Figure 1 presents six allocation
choices where a particular piece of a firm’s value chain may be placed. Large companies
have their own internal operations and employees spread over 40 or more nations, and
may boast of thousands of supply chain and strategic ‘partners’ worldwide from whom
they receive inputs, co-develop services and products, and with whom the firm also
competes in certain arenas (Palmisano, 2006). So fragmented, or dislocated are some
firms that it is hard for an outside observer and sometimes hard even for the company’s
own management, to tell who is ‘inside’ or ‘outside’ and who is local or foreign. With the
acceleration of outsourcing and offshoring, the percentage of value added internally (as
a fraction of output value) in most companies has shrunk. At the same time, the firm’s
boundaries have become more permeable while its geographical scope has increased.
The traditional theoretical lenses of the OLI paradigm (Dunning, 1993) or the
resource based view (Barney and Hesterly, 2006) mainly treat situations where firms have
already created ownership advantages. The firm’s main challenge is to exploit these
advantages on a global scale. This is a rather static focus on protection and exploitation
of ownership or resource advantages, whereas the new offshoring and outsourcing
agenda highlights the need to learn and operate in a dynamic world, where advantages
are created in the global network and where boundaries of the firm become more
permeable. The focus shifts from static protection to dynamic creation of new advantages
in collaboration with external counterparts where competitive advantage is created and
developed by sourcing the necessary pieces and knowledge in many parts of the world
and not just in the local pond at home. Similarly, transaction cost theory, while useful for
analysing each ‘internalization versus externalization’ decision, or analysing each market
entry mode choice, does not approach the puzzle of the firm as a global whole. It does
not provide much help in answering the larger question posed in Figures 1 and 2, namely
determining the optimal configuration of a firm’s activities worldwide. Similarly, the
resource based view explains why some firms obtain sustainable competitive advantages
© 2010 The Authors
Journal of Management Studies © 2010 Blackwell Publishing Ltd and
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based on the pool of resources and activities existing within the boundaries of the firm.
However, it provides few answers to the question of the optimal disaggregation and
dispersion of the resources and activities of the firm.
In this introduction, we present the firm in a larger and different light, as an organization that performs some core activities in-house, while simultaneously offshoring and
outsourcing selected segments of its value chain, after an internal (ongoing) analysis of
how far the company’s operations may be optimally disaggregated or ‘fine-sliced’. We
represent offshoring (geographical dispersal) and outsourcing (organizational dispersal)
as two distinct dimensions (or variables) that are neither correlated nor independent.
What then is the 21st century firm’s core competence? Besides its internalized technological strength, we argue that a firm’s core competence or competitive advantage is
its ability to analyse, coordinate and optimize along four related dimensions:
•
•
•
•
degree of value chain disaggregation
organization form (the mix of internal, alliance-based, and contractual modes)
space or geography (spread of activities over nations)
time (chronological coordination of distributed tasks).
The firm is simultaneously an exploiter, a knowledge seeker, and cost reducer
(Nicholls-Nixon and Woo, 2003). It is a codifier of its internal knowledge that previously
was tacit (Balconi et al., 2007). It is an arbitrageur (based on market imperfections which
create price differences across geographically separated factor markets) and a seeker of
comparative advantage (Ghemawat, 2007). It is skilled at contracting (while understanding the limitations of contracts and the theory of ‘incomplete contracts’; Hart, 1988). It
develops alliance negotiation and management skills, so as to increase the value of its
quasi-externalized relationships with partners worldwide (Contractor and Lorange,
2002). The firm is also a global supply chain and innovation network manager (Ernst and
Kim, 2002).
All of the above multi-faceted managerial tasks point towards the firm’s main goal,
which is to improve its allocation and coordination efficiencies. This might be done by a
high level of modularization, development of standardized interfaces, greater clarity in
the division of labour within the firm as well as between the firm and its external network
partners and contractors worldwide, development of centres of excellence (which are
then given a global mandate for specifically defined activities), and a reduction of
coordination and communication costs with continued investments in information and
communication technology that allow for richer communication at a distance. The
competitiveness of the global firm in the 21st century will be determined not just by its
technological competencies, but equally by its strategic management competencies,
along multiple dimensions, in a world of outsourcing and offshoring.
OVERVIEW OF THE SPECIAL THEMED SECTION
This special themed section was developed with the objective of shedding light on the
growing phenomenon of outsourcing and offshoring of high-value added company
functions. The articles in this special themed section, individually and collectively, further
© 2010 The Authors
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F. J. Contractor et al.
our understanding of this relatively recent phenomenon, by adopting a variety of theoretical and methodological approaches. We would like to thank all the authors who have
responded to the ‘call for submissions’ for this special themed section. The response was
quite overwhelming, illustrating that many scholars and researchers are already studying
this phenomenon. A total of 65 manuscripts were submitted to this special themed section
and many of these manuscripts were of very high quality, so 26 manuscripts were invited
for further revision. We would also like to thank all the (more than 75) reviewers and the
JMS editors for their careful and thorough evaluation of all the submissions that guided
us in the selection of papers and for providing invaluable feedback.
The first article, by Mudambi and Tallman (2010), proposes a new theoretical conceptualization of the ‘make-or-buy’ decision in the context of knowledge process outsourcing. They argue, rightfully, that outsourcing of high value added company
functions can more appropriately be examined through a ‘make-or-ally’ decision, where
‘ally’ covers a range of cooperative alliances. Key to their argument, based in the
resource-based and transaction cost theories, is the fact that knowledge is often the basis
of sustainable competitive advantage for firms and that its transfer is complex. Given
such inherent characteristics of knowledge-intensive activities, the new integrative framework of outsourcing proposed in this article substantially helps in enhancing our understanding of this phenomenon.
The second article, by Yuan et al. (2010), examines the effects of entrepreneurial
orientation and market orientation on emerging country based local vendors’ knowledge
acquisition from foreign outsourcers. Their finding, based on an analysis of primary data
collected from 140 Chinese firms spread across the country, is indicative of some
interesting relationships between entrepreneurial orientation, market orientation, and
knowledge acquisition with unique insights about emerging country firm strategic
endeavours. Most interestingly, they suggest that the two orientations work best in
tandem with regard to acquiring knowledge from partners in cross-border outsourcing
activities. Their theoretical framework and empirical evidence advances our understanding of the benefits of offshore outsourcing from the perspective of the vendor, a perspective hitherto underrepresented in the outsourcing and offshoring literature.
The third article, by Grimpe and Kaiser (2010), analyses primary data containing
3966 different German firms over the 2001–09 time period pertaining to their innovation activities (internal and external R&D) and market success of their products. Their
panel dataset provides evidence of the existence of an inverse U-shaped relationship
between R&D outsourcing (innovation activity through external agents) and performance – a partial validation of the hypothesis in Figure 2. More interestingly,
the effectiveness of such outsourcing is dependent on the amount of internal R&D and
R&D collaborations the firm engages in. This article highlights the importance of
understanding the limits to gains from outsourcing by focusing on the negative effects
of ‘over-outsourcing’.
The fourth article, by Mudambi and Venzin (2010), through case illustrations from the
mobile handset and financial services industries, explores linkages between offshoring
and outsourcing strategies. Relying on transaction cost theory, they contend that firms
disaggregate their value chain across geographies maintaining control over their most
valuable processes in an attempt to maximize overall competitive advantage. Specifi© 2010 The Authors
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cally, they address the magnitude, sequence, and the dynamics of offshoring and outsourcing, and their inter-linkages for achieving optimal decisions.
The final article in this special themed section, by Demirbag and Glaister (2010),
examines the determinants of offshore location choice between country clusters. Their
analysis of 1722 offshore R&D projects undertaken from 2002 to 2005 by multinational
enterprises, based in developed and emerging countries, demonstrates the impact of host
and home country related factors on the choice of offshore location. As per their findings
the EU15 region is the least attractive for offshore R&D projects, while India and China
emerge as the most attractive. Their findings have significant implications for location
choices of multinational enterprise, the non-regional nature of R&D expansion, as well
as the capability building internationalization strategy of emerging country firms.
Together, the articles in this special themed section highlight the unique challenges
and opportunities for future research on the outsourcing and offshoring of high value
company functions. Existing theories and concepts have explained outsourcing and
offshoring of typically low value company functions; but these may be insufficient for
explaining the unique motives, processes, and consequences associated with high value
activities. Similarly, new theoretical perspectives are needed to better explain the organizational and spatial dispersion of the global firm A more thorough understanding of
the phenomenon, touched upon in this special issue, will help to refine and develop new
theories, as well as provide better guidance to practising international executives engaged
in outsourcing and offshoring.
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