Academic journal article Innovation: Organization & Management

Sustaining Innovation When Outsourcing Components in Multi-Technology, Multi-Component Systems

Academic journal article Innovation: Organization & Management

Sustaining Innovation When Outsourcing Components in Multi-Technology, Multi-Component Systems

Article excerpt

The past two decades have been characterised by a marked increase in outsourcing stimulated by the imperative of reducing costs or by the mana- gerial maxim of specialising on distinctive capabili- ties (Gilley & Rasheed, 2000; Holcomb & Hitt, 2007; Mol, van Tulder, & Beije, 2005; Prahalad & Hamel, 1990). While much outsourcing still con- cerns the provision of well-specified inputs be they physical products (e.g., components) or services (e.g., IT operations), it is increasingly being applied in contexts where there is continued technologi- cal change and where linking with external firms is believed to enhance innovation (Chesbrough, 2003; Weeks & Feeny, 2008).

An important context for outsourcing where continued innovation is likely to be crucial is multi-technology, multi-component systems as their constituent 'components' are prime can- didates for external supply (Wolter & Veloso, 2008). These systems range from mass-produced goods such as automobiles (Dyer, 1996; Langlois & Robertson, 1989) up to so-called 'complex systems' which are either one-offs or highly cus- tomised (Davies, 1997; Miller, Hobday, Leroux- Demers, & Olleros, 1995). There is evidence that the use of outsourcing is increasing over time (Brusoni, Prencipe, & Pavitt, 2001; Helper, MacDuffie, & Sabel, 2000). Managers of the firms who produce the overall systems - sometimes called assemblers or systems integrators but here termed 'system firms' - face two decisions: (1) which components of the system should we outsource (and by implication which should we internalise) and (2) for those component where outsourcing appears advantageous, what kind of contractual and organisational arrangements with the supplier(s) should we utilise? These decisions are inter-related as more effective inter-organisa- tional linkages will stimulate greater outsourcing.

Factors influencing the outsourcing decision

The 'boundaries of the firm' literature has sought to inform the fundamental 'outsource versus integrate' decision. Focussing on a 'market ver- sus hierarchy' dichotomy and on broadly static situations, research has identified a series of dis- tinct perspectives which managers should con- sider to determine the best option in any given situation. Outsourcing would be favoured where an external supplier has superior volume in the presence of economies of scale (hence leading to lower unit costs), for example because they can more easily sell to multiple buyers than an in- house unit (Stigler, 1951). Outsourcing would also be favoured where the external supplier has superior capabilities, the underlying assump- tions being that firms specialise, single firms can't be good at everything and acquisition isn't always possible (Barney, 1991; Penrose, 1959). By contrast, internalisation would be favoured if there are likely to be significant costs of trans- acting in the market (Coase, 1937; Williamson, 1971). While the frequency of transactions is one factor that would elevate direct external trans- action costs, transaction cost theory is mainly concerned with the costs that arise from incom- plete contracts where uncertainty and bounded rationality can lead to opportunistic behaviour by one party or the other. This opportunistic behaviour could involve misrepresentation or hold-up (Williamson, 1985). Hold-up would be more likely where one side has invested in transaction-specific assets such as equipment, training or location and where there is small numbers bargaining. Transaction cost economics has been operationalised for managers by strate- gists who talk in terms of the relative power of suppliers; one role of strategy being to reduce supplier power. We note that this perspective is all about 'value capture' by the system firm as it assumes that there is a zero-sum game between buyer and supplier. Finally, a 'strategy' perspec- tive warns against outsourcing any part of the system which underpins its competitive advan- tage (Chesbrough & Teece, 1996), the classic example is the outsourcing of the microproces- sor and operating system for the IBM PC where IBM's remaining 'systems integration/assembler' role provided little opportunity for competitive advantage once proprietary architectural knowl- edge had been imitated. …

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