Academic journal article SAM Advanced Management Journal

The Impact of Outsourcing on Firm Value: New Insights

Academic journal article SAM Advanced Management Journal

The Impact of Outsourcing on Firm Value: New Insights

Article excerpt

With 82% of large and mid-size firms outsourcing all or parts of activities, calculating the effects of outsourcing on firm value would seem an obvious need. Previous research generally has determined that outsourcing decisions are driven by opportunities to reduce costs or gain strategic advantages. The effects of each motivation on firm value have been examined, but not the effects of both combined. To help fill this gap using the CARs measure (cumulative abnormal returns of stock prices), outsourcing announcements were analyzed for a 14-year period ending in 2004 to assess stock price movements vis a vis the announced outsourcing rationale. Results showed that announcements citing both cost reduction and strategic motives positively affected firm value, and that citing a desire to focus on core competence further increased firm value.

Delivering long- and short-term results at the same time is what it's all about. (Welch and Welch, 2007)


Outsourcing as a way to improve firm performance has grown steadily over the past several decades. Recent survey evidence indicates that 82% of large and medium-sized firms in Asia, Europe, and North America use outsourcing to accomplish all or part of at least one activity (Gottfredson, Puryear, and Phillips, 2005). Moreover, the business press regularly reports that firms send more types and greater proportions of work formerly performed internally to outside providers. Reflecting upon this trend, Burkholder opines that, "In today's globalized economy, it is impossible not to outsource" (2006).

As outsourcing grows, so too have studies that examine the decision whether to outsource an activity or perform it within the organization. Researchers often use transaction cost economics (TCE) and the resource-based view (RBV) theories to explain outsourcing decisions. TCE asserts that the characteristics of a transaction determine whether market, hierarchy, or alliance is the most efficient governance structure (Williamson, 1975). In outsourcing decisions, TCE predicts that a firm will perform an activity in-house (hierarchical governance) when it anticipates high transaction costs, and will outsource an activity (market governance) when it expects low transaction costs. Transaction costs include negotiating, monitoring, enforcing, and resolving disputes associated with an outsourcing contract.

The RBV maintains that a firm attempts to build idiosyncratic resources and capabilities that competitors find difficult to understand and copy (Barney, 1991). By doing this successfully the firm may gain a competitive advantage. In the RBV perspective, outsourcing can help a firm access resources and capabilities more valuable than those it currently has (McIver, 2009). A firm might build idiosyncratic resources and capabilities by combining its resources and capabilities with those of its vendor (Holcomb and Hitt, 2007).

Studies from the TCE and RBV perspectives suggest that firms base their decisions on whether outsourcing reduces costs or builds strategic advantages. This has generated much research on how using outsourcing to cut costs or gain strategic advantages affects firm performance. A review of the literature reveals that most empirical research and discussion examine cost cutting and strategic advantages as mutually exclusive motives for outsourcing. We find this curious, because when companies outsource to reduce costs they often realize long-run secondary strategic benefits (Quinn, Doorley, and Pacquette, 1990). Moreover, news releases and the business press often cite both motives as influencing a firm's decision to outsource. In fact, 27.5% of the outsourcing announcements in our study's sample explicitly cite both motives for outsourcing. For example, Unilever announced outsourcing its data network operations to cut overhead and increase efficiency in the short run, while enhancing product development and marketing in the long run (Keller, 1992). …

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