Transformational offshore outsourcing: Empirical evidence from alliances in China

Journal of Operations Management 26 (2008) 257–274 www.elsevier.com/locate/jom

Transformational offshore outsourcing: Empirical evidence from alliances in China§ Yuan Li a,*, Yi Liu a,1, Mingfang Li b,2, Haibin Wu a b

a School of Management, Xi’an Jiaotong University, China School of Business, Hohai University, Nanjing School of Management, Xi’an Jiaotong University, Xi’an Department of Management, California State University, Northridge, CA 91330-8376, USA

Available online 4 March 2007

Abstract Adopting a transformational offshore outsourcing perspective, we examine empirically the relationship among the motive to acquire tacit knowledge from outsourcing partners, formal and social control mechanisms, and innovation outcomes among Sinoforeign as well as local alliances. We constructed our theoretical model incorporating knowledge management, social exchange, and alliance risk perspectives, and hypothesized that motives to acquire partners’ tacit knowledge through offshore outsourcing will affect firm innovation via two forms of control, namely social control and formal control. Our empirical testing, utilizing two subsamples composed of Sino-foreign offshore outsourcing alliances and local outsourcing alliances, respectively, reveals that the motive to acquire outsourcing partner’s tacit knowledge and different control mechanisms are significant predictors of incremental and radical innovation outcomes, and that there are some intriguing differences between the Sino-foreign alliances and local alliances. # 2007 Elsevier B.V. All rights reserved. Keywords: Transformational offshore outsourcing; Tacit knowledge; Control mechanisms; Innovation

1. Introduction For firms in developed countries, offshore outsourcing began as an effective means to reduce manufacturing and processing costs and to focus on core business activities. As these firms continue to

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This paper was supported by NSFC (70472739, 79925004, and 70121001). The third author’s research was partially supported by the CSU Wang Faculty Fellow Grant (2004–2005). * Corresponding author. Tel.: +86 29 82665093; fax: +86 29 2668953. E-mail addresses: [email protected] (Y. Li), [email protected] (Y. Liu), [email protected] (M. Li), [email protected] (H. Wu). 1 Tel.: +86 29 82665029; fax: +86 29 2668953. 2 Tel.: 1 818 677 2421; fax: 1 818 677 6265. 0272-6963/$ – see front matter # 2007 Elsevier B.V. All rights reserved. doi:10.1016/j.jom.2007.02.011

search ways to gain competitiveness, offshore outsourcing is gradually gaining significance as an important source of business renewal and corporate transformation (Kakabadse and Kakabadse, 2005; Khan and Fitzgerald, 2004; Linder, 2004). In recent years, multinational enterprises in sectors from telecommunications to electronics to aerospace to pharmaceuticals have turned their attention to outsourcing partners in other countries for new designs, product development, and more importantly for corporation transformation (Engardio and Einhorn, March 21, 2005). Offshore outsourcing entails the transfer of parts of a Western firm’s value chain activities to partners in emerging economies such as China and India for a period of time, usually at least a few years. The main forms of offshore outsourcing include technological cooperation, manufacturing agreements, and distribution services.

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Clearly offshore outsourcing utilizes a variety of interfirm collaboration. Because of the greater need to collaborate closely with partner firms especially if such outsourcing relations become more central to a firm’s overall position, inter-firm collaboration and strategic alliances have become a vital form of offshore outsourcing arrangement. As technological management became absorbed within the broader field of knowledge management, alliances for offshore outsourcing have been viewed from a knowledge management perspective (Grant and Baden-Fuller, 2004). Acquiring the partner’s tacit knowledge through offshore outsourcing then becomes central to inter-firm collaboration. Transformational offshore outsourcing indeed relies on tacit knowledge acquisition to accomplish goals of strategic change, and corporate renewal (Linder, 2004). By acquiring and exploiting tacit knowledge developed by others, firms can speed capability development and minimize their exposure to technological uncertainties (Grant and Baden-Fuller, 1995). Following this perspective, innovation becomes a central outcome for firms pursuing transformational outsourcing. Comparing with this emerging trend, the research lags (Ramamurti, 2004). We have limited understanding how offshore outsourcing partners develop innovation, and furthermore, if the innovation generation dynamics in offshore outsourcing arrangements will exhibit the same pattern as those in domestic outsourcing arrangements. Conceptually a number of conflicting theoretical perspectives are available to inform scholars and managers effective management of offshore outsourcing. Empirically there is limited research in how offshore outsourcing facilitates innovation. We therefore developed a theoretical model linking the motive to acquire tacit knowledge in inter-firm outsourcing cooperation, control mechanisms, and innovation outcomes based on knowledge management, social exchange theory and alliance risk perspective. Furthermore, we empirically tested our model using two sub-samples, with data collected in China, of Sinoforeign offshore outsourcing alliance, and local firm outsourcing alliances. Thus, through this study we examined inter-firm outsourcing collaborations with a central focus on innovation outcome, and with a unique setting of China. Compared with their Western counterparts, most Chinese firms possess relatively limited resources and capabilities but are actively working to catch up (Mathews, 2002). Further, considering China’s increasing importance in global economies and significant growth of firm’s new product development in this country (Li and Atuahene-Gima, 2001), a focus on these firms can help Western competitors better

understand the innovation choices of these firms, and hence they can be better prepared to compete and collaborate with these firms. From a conceptual perspective, our theoretical model building integrates seemingly conflicting theories to explore factors contributing to innovation in inter-firm outsourcing alliances. We first review the relevant theory and the context specific situation of China’s transitional economy. We rely on the social exchange theory and alliance risk perspective to provide an overview of the research framework. Utilizing this framework we develop hypotheses concerning the effects of tacit knowledge acquisition motive in outsourcing alliances and control mechanisms on incremental and radical innovations. Following that, we describe the research methodology, and report the analysis and results. We conclude by discussing the study results and implications. 2. Theoretic background Traditionally, companies pursuing offshore outsourcing had two important motives. By migrating peripheral business processes and value chain activities to outsourcing partners in other (especially in emerging economy) countries, the outsourcing originator may be able to derive cost advantage, and also to focus on areas of core competences (Kakabadse and Kakabadse, 2005). Recent thinking in transformational outsourcing and business practices in outsourcing innovation however point out an even more important benefit of offshore outsourcing. The central theme of transformational offshore outsourcing relates to relocating core business processes and value chain activities to partners in other countries and coordinating those outsourced activities tightly with the originator’s strategic moves in order to realize strategic renewal and corporation transformation (Engardio and Einhorn, March 21, 2005; Farrell, 2005; Linder, 2004)! Researchers identify a number of important benefits associated with transformational offshore outsourcing. Those multinationals focusing on transformational offshore outsourcing will be able to tap into new suppliers as more cost effective technologies become available. With transformation in mind, offshore outsourcing would allow for quick responses to changes in the environment (Dess et al., 1995), without the attendant increase in bureaucratic costs associated with internal organizations (D’Aveni and Ravenscraft, 1994). In addition, utilizing, and integrating innovations from outsourcing partners will enable these firms to multiply and amplify their innovation outcomes. As

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noted by Quinn, ‘‘virtually all staff and value chain activities are activities that an outside entity, by concentrating specialists and technologies in the area, can perform better than all but a few companies for whom that activity is only one of many’’ (Quinn, 1992, p. 37). Beyond the specialist advantage Quinn emphasized, however, we can also envision the potency of combining innovations from various outsourcing partners with benefits to all involved. For example, Pocket PC is taking a firm hold in the mobile information appliance market place today. This success cannot be attributed to any single company but a dynamic network of companies working together. They include Microsoft developing the Windows Mobile OS, hardware designers such as HTC in Taiwan, software companies, wireless venders as well as value-added distributors throughout the world. Naturally all parties involved gain from the advancement of a common platform. Thus, firms aiming at transformational offshore outsourcing may achieve greater long-run competitive advantages compared to those merely focusing on cost saving and concentrating core competences. The combinative contributions of offshore outsourcing may be more important than the pure cost motivations and individual benefits identified above. Clearly from a more macro level we can envision further benefits of transformational offshore outsourcing. The dynamic process by which offshore outsourcing partners develop together and individually their respective capabilities may contribute not only to a vibrant global economic landscape (Doh, 2005) but also may enhance the positive outcome of transformational outsourcing as more and more companies in emerging economies gain greater ability to innovate. It is clear that offshore outsourcing frequently has positive impacts on the firms in emerging economies such as China and India. We can indeed observe a trend towards wage convergence in these economies over the long run and at the same time we can envision corporate capability enhancement for firms in emerging economies (Levy, 2005). Furthermore, while firms in emerging economies may initially offer cost advantage to, and benefit in capability building from their multinational partners, the exchange is not a one-way street! These firms in emerging economies may be able to generate powerful indigenous innovations from which multinationals can derive more benefits as well (Li et al., 2006a). In addition the mere cost advantage may be short-lived as these economies become more affluent. In a private conversation an executive remarked to one of the authors that some companies

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were ‘‘forever chasing the cheap labor.’’ Another executive deadpanned about the transformational changes in offshore outsourcing: ‘‘we came for the cheap labor, and we stayed for the innovation.’’ From a higher level of analysis, enhanced globalization of economic activities and global offshore outsourcing may contribute to increased salaries in emerging economies, and also diffuse corporate capabilities through the network effects (Storper, 1997). Responding to local market competitive environment, and emerging opportunities these firms may be able to develop indigenous innovation (e.g., Lu, 2000). In addition, there are opportunities for these firms to upgrade their capabilities, through collaboration with multinationals (Bair and Gereffi, 2003) as well as other domestic firms. Thus, the local firms may have two important sources of capability development, namely, indigenous innovation (Li et al., 2005), and close collaboration with multinational as well as local partners. Outsourcing partners in emerging economies may certainly lose their cost advantage (Dutta and Roy, 2005). On the other hand, these firms may become more attractive as potential partners in transformational outsourcing. In summary, instead of focusing on the traditional vision of global division of labor that has firms in developed countries focusing on innovative and more value added activities, and firms in emerging economy countries on simple processes and manufacturing activities, researchers now envision the possibility and strategic significance that innovation can happen everywhere and firms in developed countries ought to develop effective ways to utilize offshore outsourcing for innovation, strategic change and corporate renewal (Linder, 2004). For transformational outsourcing to happen, outsourcing vendors must go beyond the simple transactions to consider knowledge integration and effective management processes. From a transformational outsourcing perspective, innovation is a central outcome. Innovation can be divided into radical innovation and incremental innovation (Dosi, 1982; Munson and Pelz, 1979). Radical innovations are fundamental changes that represent revolution in technology. In contrast, incremental innovations are minor improvements or simple adjustments in existing technologies (Munson and Pelz, 1979). The major difference captured by radical and incremental innovations is the degree of new and tacit knowledge embedded in the innovation. Different types of knowledge have different transferability. Explicit knowledge is codified and can be transferred through formal language or communication systems. Tacit

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knowledge (skills, know-how, and contextual knowledge) on the other hand is manifest only in its application—transferring it from one individual to another is costly and time consuming (Kogut and Zander, 1992; Nonaka, 1994). In addition, the complexity, cost and risk of radical innovation and incremental innovation are different. Herbig (1994) found that the conditions that favored high-order or radical innovation differed from those that favored incremental innovation. Van de Ven et al. (1999) argued that some organizations may be better suited to one type of innovation than the other. Thus, the motive to acquire tacit knowledge may have different impacts on different types of innovation. Two incompatible explanations shed lights on the linkage between the motive to acquire tacit knowledge in an alliance relationship, and innovation outcome. The transaction cost economics (TCE) literature has highlighted partner opportunism in interorganizational relationships. Building upon it, the subsequent literature on knowledge-based alliances dubbed these relations as a learning race (Khanna et al., 1998) in which partners often engaged in opportunistic attempts to outlearn each other. At the same time, there are indications that strategic alliances may suffer from particular learning problems, such as the risk of uncontrolled tacit knowledge information disclosure and asymmetric diffusion of core competencies to partner firms (Bresser, 1988; Hamel, 1991; Inkpen and Beamish, 1997). This opportunistic behavior may result in failure of cooperative innovation. On the other hand, the networks-for-learning approach considered the inter-organizational network as a resource generation entity that has the ability to enhance learning among partners. Powell et al. (1996) contend that the locus of innovation will be found in interorganizational networks of learning rather than within individual firms. Teece and Pisano (1994) argued that strategic alliances are an important approach for enhancing organizational learning and a crucial element in firms’ competitive strategies, since they are used by firms to acquire technology-based capabilities from partners (Cohen and Levinthal, 1990; Kogut, 1988, 1991; Mowery et al., 1996). Inkpen (2000) argued that in alliances, through the shared execution of the alliance task, mutual interdependence and problem solving, firms can acquire tacit knowledge from their partners effectively. Based on this perspective, we suggest that interorganizational tacit knowledge acquisition would accelerate the process of innovation. These two contradictory assertions lead us to explore further the relationship between tacit knowledge acquisition and firm innovation. A fruitful approach that

might incorporate these two assertions appears to be the differentiation between two types of innovation, namely incremental and radical innovations (Damanpour, 1992; Drazin and Shoonhoven, 1996; Klein and Sorra, 1996). Since incremental and radical innovations are two different innovation outcomes, conditions that favor one type may actually inhibit the other, and the innovation process should be managed differently (Koberg et al., 2003). This consideration leads us to focus on the management practices involved in inter-firm collaboration. Transformational outsourcing puts knowledge acquisition and integration on the center stage of firm strategic change and corporate renewal. Effective management of outsourcing holds the key for this strategic goal. If different types of innovation comprise different types of information content, we would believe the types of control mechanism adopted to manage those will vary as well (Fiol and Lyles, 1985). It therefore is important to explore how control mechanisms enable firms to pursue different types of innovation through inter-firm cooperation (Damanpour, 1992; Drazin and Shoonhoven, 1996; Klein and Sorra, 1996). Because outsourcing may cause both competitive advantage and disadvantage for partners, the firms involved may prefer to carry out peripheral outsourcing and avoid core outsourcing (Gilley and Rasheed, 2000) unless there are effective control mechanisms involved to enhance outsourcing success for both partners. If these firms could not learn useful tacit knowledge from their partners, the relationship between both partners may be destroyed. To ensure their cooperation success, both partners need to choose effective control mechanisms to reduce opportunisms and to improve their competitive advantage. Especially under high environment uncertainty, the relationship between core outsourcing from outsourcing firms and their performance will be weakened (Gilley and Rasheed, 2000), which imply that, under high environment uncertainty such as China’s transitional economy, both sides of an alliance will depend on effective control mechanisms to enhance outsourcing success (Li et al., 2005). Control is intended to reduce goal incongruence and preference divergences among alliance participants, and is widely acknowledged as essential for alliances (Geringer and Hebert, 1989). Control mechanisms are safeguards that firms put in place to govern interorganizational exchange (Jap and Ganesan, 2000). As control mechanisms influence transaction costs, coordination costs, and the willingness of alliance partners to engage in value creating initiatives, they play a key role in the success of inter-firm cooperation (Artz and Brush, 2000; Dyer and Singh, 1998).

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In alliances, social control mechanism and formal control mechanism are two basic and important control mechanisms (Das and Teng, 2001). The social control mechanism relies on shared organizational norms, values, and culture, and the internalization of goals to ensure desirable behavior and outcome. Social exchange theory suggests that exchanges, including inter-firm cooperation, often carry a social dimension (intrinsic utility) and an economic dimension (extrinsic utility). Thus, economic behavior occurs under the influence of social relations (Nooteboom et al., 1997). The formal control mechanism emphasizes the establishment and utilization of formal rules, procedures, and policies to monitor and reward desirable performance. The social control on the other hand focuses on utilizing norms, values and shared preferences to regulate individual behavior. Clearly various control mechanisms, including communications, structural approaches and social means, are useful for sustaining inter-organizational cooperation (Grandori and Soda, 1995). Within the Chinese context, social means, such as building guanxi or personal relations and trust, are very important in regulating the behaviors of partners (Lovett et al., 1999; Luo, 2001; Park and Luo, 2001). However, because of the yet to be fully developed market environment during China transitional period as well as limited accumulation of experience in managing knowledge-based alliances (Li et al., 2006b), most Chinese alliances face a great deal of uncertainty. Under the circumstance,

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firms with high uncertainty tend to feel a strong urge to control events and situations. The need for uncertainty reduction leads these firms to create detailed instructions, more rules and regulations, and standardized work procedures (Youngdahl et al., 2003). The formal contract or formal control is thus becoming increasingly important for Chinese firms engaged in alliances, especially for Sino-foreign cooperation. Do Chinese alliances both with multinationals and locals involve motives to acquire tacit knowledge? Does the motive to acquire tacit knowledge leads to increased use of both social and formal controls? How does the motive to acquire tacit knowledge affect innovation outcome directly? How do social control and formal control affect different types of innovation? We examine these questions with a theoretical model as depicted in Fig. 1, and a series of hypotheses linking motives to acquire tacit knowledge through outsourcing alliances, control mechanisms and innovation. 3. Hypotheses 3.1. Choice of control mechanisms: social exchange theory and alliance risk perspective Learning alliances are motivated primarily by the desire to acquire partners’ knowledge, especially tacit knowledge (Grant and Baden-Fuller, 2004). Tacit knowledge acquisition however involves a great deal of uncertainty and ambiguity. It is rather difficult to

Fig. 1. The theoretical model with hypotheses.

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define the learning targets clearly in the beginning stage of acquiring tacit knowledge in the process of collaboration or offshore outsourcing. Kogut and Zander (1992) noted that the targets of learning alliances changed frequently. In inter-organizational learning from outsourcing firms, a key consideration is the codifiability of knowledge. The more codifiable the knowledge is, the greater the ability to structure that knowledge into a set of easily communicated rules and relationships (Kogut and Zander, 1992). Tacit knowledge by definition is noncodifiable. It is rather difficult to identify, acquire, synthesize and disseminate tacit knowledge (Linderman et al., 2004). Social control may provide the appropriate ambiguity at the beginning and let members develop a consensus in the process of collaboration or offshore outsourcing. Organizations can, thus, avoid the problem of not being able to measure either behavior or the outcome of such behavior, but still be able to influence the behavior of the members for their own benefit (Das and Teng, 2001). Zucker (1986) contended that social control may make an important contribution to interorganizational learning. Dyer (1997) suggests that when personal attachment within cooperation is established through socialization, it becomes social capital that can enhance the capability of innovation. Powell (1990) noted that social control is the most efficient organizational arrangement for sourcing information because information is difficult to price and to communicate through a hierarchical structure. Therefore, we suggest: H1a. The motive to acquire tacit knowledge in outsourcing alliances is positively related to the social control. Two perspectives offer important insights into the relationship between the motive to acquire tacit knowledge in outsourcing alliances and formal control. First, the formal control can limit tacit knowledge acquisition, because this control mechanism only focuses on those exchanges specified in the contract. Tacit knowledge is transferred only through exchange and contact with partners frequently, thus every partner is very difficult to contact its partners and cannot obtain the partners’ tacit knowledge under formal control (Grant and Baden-Fuller, 2004). Contrary to the first perspective, the second one offers a strikingly different conclusion based on the relational risk analysis and the social context of knowledge transformation. The probability and consequences of not having satisfactory cooperation in alliance is viewed as relational risk by Das and Teng (1996). This risk arises because of the potential for opportunistic behavior on the part of both

firms. Opportunistic behavior includes shirking, cheating, and distorting information. In contrast with resource complementary alliance, tacit knowledge acquisition also has relatively higher relational risk. One possible reason for this high relational risk is that particular tasks in tacit knowledge acquisition remain low in measurability, including low output measurability and low investment measurability. Das and Teng (2001) argued that in the beginning of interorganizational learning, it is hard to measure the amount of knowledge invested in the alliance. At the end of the cooperation, the achievement in cooperation is also hard to measure accurately. The other possible reason for high relational risk is that the tacit knowledge acquisition increases the likelihood of unilaterally or disproportionately losing one’s own core capability or skill to the partner. Thus, firms are faced with the challenging task of managing the balance between ‘trying to learn and trying to protect’ (Kale et al., 2000, p. 217). These two reasons result in the high relational risk in interorganizational tacit knowledge acquisition. Following this perspective, formal control should be emphasized in order to avoid or reduce this risk. Powell et al. (1996) deal with learning as a social construction process wherein knowledge is created in a social community context. When taking into consideration the Chinese context, we believe the second perspective is more relevant. Since 1990s, under the rule of ‘‘exchanging markets for technology,’’ Chinese firms adopted the various forms to cooperate with multinationals. The main goal of these kinds of cooperation is to accelerate the process of technological innovation. Foreign parents normally bring in technology and management know-how, and are a vital source of useful knowledge. But in the practice of Chinese firms, there still are critical problems. For example, it has been observed that patent and copyright violations, ineffective contract enforcements, and unfair competitive practices have become widespread in China (Luo, 2001). This observation about contract enforcement challenges is important but must be supplemented with the observation that China’s is a transitional economy. As China continued its economic reform, the authorities engaged in a systematic effort to upgrade its legal and regulatory infrastructure. Important laws and regulations have been adopted and put into practice. At the same time, both multinationals and domestic firms have been exploring effective ways to utilize formal control to enhance their alliance effectiveness while at the same time also relying on social control. The intellectual property rights of new technology ventures resulting from product innovation may go

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unprotected, making interorganizational innovation a highly risky and less profitable strategy. If these alliances are only based on guanxi, the formal rules and contracts may be ignored. In this case, the relational risk is higher in the emerging and transitional setting than developed countries. Therefore, we may indeed observe a greater deal of uncertainty, and limited level of inter-firm collaboration unless we utilize formal control. In order to control the partners’ opportunistic behavior, detailed contracts containing explicit deterrents to opportunistic behavior will need to be written (Das and Teng, 2001). Therefore, we hypothesize: H1b. The motive to acquire tacit knowledge in outsourcing alliances is positively related to formal control in a transitional China. 3.2. Control mechanisms and innovation: social exchange perspectives There is more tacit knowledge involved in radical innovation than in incremental innovation. To accomplish radical innovation, the partners involved need participate actively in the relevant organizational processes in which the tacit knowledge is embedded. The process will rely heavily on joint decision-making and frequent communication. In addition, social control mechanisms permit the flexibility and adaptability that are critical to the high order learning (Dyer, 1997). Therefore, we hypothesize: H2a. There is a positive relationship between the social control mechanism and radical innovation. In contrast with social control, formal control mechanism emphasizes the use of formal rules, procedures, and policies to monitor and reward desirable performance. But in the process of radical innovation which large amount tacit knowledge is embedded, it is hard to describe the target of cooperation and the way in which tacit knowledge transferred. In addition, contractual renegotiations frequently would increase the transaction cost in interorganizational tacit knowledge acquisition, which may cause the dissolution of alliance (Reuer and Arino, 2002). Therefore, we suggest: H2b. There is a negative relationship between the formal control mechanism and radical innovation. As compared to radical innovation, the knowledge embedded in incremental innovation is more codifiable. Thus, in this knowledge transferring process, formal rules can be used to regulate the behavior of partners.

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Formal control mechanism may guarantee the resource needed invested rapidly which is important for incremental innovation. Therefore, we suggest: H2c. There is a positive relationship between the formal control mechanism and incremental innovation. As Dyer and Singh (1998) argue although informal safeguards have the greatest potential to generate relational rents and lower the transaction cost, they need substantial time to develop. It appears that many effective alliances begin with the use of formal mechanisms and then, over time, take on more social ones (Gulati, 1995). But for the incremental innovation which needs little time and small resource input to develop, there is no time to establish the social control mechanism, and social control mechanism will increase the innovation cost because of its high transaction cost. Therefore, we hypothesize: H2d. There is a negative relationship between the social control mechanism and incremental innovation.

3.3. The motive to acquire tacit knowledge in outsourcing alliances and innovation Outsourcing alliances and especially those involving offshoring often bring together partners from different cultural backgrounds, and with greater differences in collaborating firms’ knowledge bases. This diversity may be important as it brings together reciprocal strengths and complementary resources furnished by the alliance partners. Such alliances will enable one partner to acquire the skills and technologies it lacked at the time of alliance formation, tacit knowledge acquisition will actually facilitate the formulation, development of new knowledge (Parkhe, 1991), thus, it is helpful for the radical innovation. But for the incremental innovation which is related to minor improvements or simple adjustments in current technology, deep insights into the existing technology is crucial for the adjustments. Furthermore, tacit knowledge acquisition requires considerable amounts of time. For firms to absorb effectively their partners’ tacit knowledge, they need to devote more resources to their joint activities as well. So, tacit knowledge acquisition would appear to aid radical innovation while at the same time would reduce a firm’s ability to pursue incremental innovation. Therefore, we hypothesize: H3a. There is a positive relationship between the motive to acquire tacit knowledge in outsourcing alliances and radical innovation.

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H3b. There is a negative relationship between the motive to acquire tacit knowledge in outsourcing alliances and incremental innovation. 4. Research methodology 4.1. Survey design and sample To test the hypotheses advanced in this study, we utilized a questionnaire survey method to seek responses from top executives of the firms in our study sample. We initially assembled a questionnaire utilizing measurement items from several previous studies on innovation and management control system. Through our review of the extant literature mainly reported in the Western academic journals, we identified key measurement items from several sources. We believe utilizing these previously validated measurement items would aid our study effectively and also would allow us to compare study outcomes across settings. The questionnaire was therefore first compiled in English. It was then translated into Chinese. We consulted with top executives in local firms and business experts – two management professors at Xi’an Jiaotong University – to ensure the measurement items in Chinese reflect accurately the business environment firms in China face. Modifications to the questionnaire items based on the input of these business executives and management experts reflected mainly clarifications and amplifications to the original items. The Chinese questionnaire with such modifications was subsequently back-translated into English by a third party to ensure that the items included accurately reflect the original meanings in the Chinese context (Brislin, 1970; Brislin et al., 1973; Chen et al., 1998; Chong and Chong, 1997). We reviewed carefully these two English versions, and were satisfied that there were no substantial differences between the two versions in the meanings of the scales used in the study. Our study population is composed of Sino-foreign alliances and domestic alliances in Shaanxi, Henan, Shanghai, Guangdong, Liaoning, Sichuan, Shandong and Shanxi Provinces of China. The special administrative body in charge of overseeing the firms of these eight Provinces, the Economic Commerce Committee provided the sample frame—a random sample of the enterprises in these areas. We undertook the main survey during summer 2002. The time frame selected for the study was from 1997 to 2001 since significant restructuring activities occurred during this period.

We spent one week to train twenty research assistants about the background information, main objectives of this study, the interviewing techniques, and most importantly, the exact meaning of each question in the questionnaire. Researchers telephoned potential respondents and solicited personal interviews from the list of firms included in this sample. They thoroughly explained to respondents the questionnaire and assured that their responses would be confidential. If our request was accepted, one or two research assistants would be sent to conduct the interview. Our research assistants were available to answer any questions the respondents might have as they filled out the questionnaire. This procedure helped ensure correct interpretation of questions in the survey instrument. In our survey, the top executive who was our main contact was asked clearly that different sections of the questionnaire must be filled by the relevant personnel in a management position. The items of a construct were sometimes filled by several departments. For example, the construct of innovation involved not only vice president in R&D, but also the managers of production and R&D departments. This procedure was taken to ensure that we would obtain an overall perspective from the top executive and also expert perspective from different areas of the firm. A total of 850 enterprises were contacted between February and July 2002. Of these firms, 603 agreed to participate and provided the information. Eighteen firms were excluded for reasons such as company policies of non-participation in survey, company liquidation, and inadequate completion of the survey questionnaire. We obtained useable returns from 585 firms. The overall response rate for the survey was 69%. This response rate is quite high, given that surveys were completed by CEOs or their designees whose time is often scarce. Thus, our response rate can be considered very high. Among these valid questionnaire returns, 198 firms established Sino-foreign alliances. The other 351 firms established domestic alliances. Of particular interest to this study are the 140 Sino-foreign alliances which involve offshore outsourcing. According to the long term outsourcing agreements we reviewed, sixty seven Sino-foreign alliances were involved in manufacturing and distribution outsourcing, sixty two were involved in R&D and knowledge service technological cooperation, the remaining eleven were involved in other forms of offshore outsourcing. Among the 351 domestic alliances, 204 were involved in manufacturing and distribution outsourcing, 98 alliances were involved in R&D and knowledge service technological coopera-

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tion, the remaining were involved in other forms of outsourcing. Thus, we conducted our empirical analyses using two study samples—the Sino-foreign offshore outsourcing alliances, and the domestic outsourcing alliances. A profile of the firms in the overall study sample is provided in Table 1. As can be seen, the main respondents were primarily from medium and large size firms with nearly 33.2% working for firms employing more than 1000 employees. Nearly 77.5% of the firms had annual sales turnover of 15 million Renminbi (about US$ 1,206,000) or above in 2002. Such companies are considered to be medium-to-large companies in China. With respect to the annual sales volume, the respondents were evenly distributed among various groups. Types of firm ownership institution are also presented in Table 1. As Table 1 shows, most main respondents are from top management positions, and had 18.82 years with the same company. This exceeds the 5 year timeframe for measuring our dependent and independent variable, adding to confidence that respondents were knowledgeable and did possess accurate information concerning their firm’s management and innovation. Due to the rapid development in Table 1 Firms and respondents in the study sample Firm and main respondent characteristics

%

1. Job positions of respondents President/CEO Vice President R&D/General manager Others

39.4 19.0 37.8 3.8

2. Tenure of respondents with the firm (average) (years)

18.82

3. Company size (number of employees) 50 51–200 201–500 501–1000 >1000

11.2 22.5 16.2 16.7 33.2

4. Company sales revenue (in million) 10 10–50 50–200 >200 Unreported

15.0 32.0 26.0 19.5 7.5

5. Firm ownership State-owned enterprises Joint ventures Limited companies Private companies Collective enterprises Village enterprises

28.6 12.9 37.6 13.8 4.6 2.5

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China’s market economy, they may also represent the perception and orientation of those who are employed in firms located in different areas in China. 4.2. Reliability and validity We took several steps to ensure data validity and reliability. Validity refers to the extent to which the instrument measures what it is supposed to measure. Each scale employed in the study was pre-tested using personal interviews with senior level managers. Interviewees were asked to comment on any difficulty or lack of clarity in the scale items or instructions. In the instrument itself, we used previously validated measurement items wherever possible to help ensure the validity of our measures. Multiple-item measures were used for all constructs to enhance content coverage. As noted in Table 2, most constructs in our study have Cronbach’s alpha of 0.70 or above, and the incremental innovation construct shows Cronbach’s alpha of greater than 0.67. Two issues commonly raised in the literature concern with survey methodology are non-response bias and common method variance bias. To check for nonresponse bias (the difference between the answers of respondents and non-respondents (Lambert and Harrington, 1990), the final sample was spilt into two, depending on the dates they were received. The early wave group consisted of 318 responses, the late wave of 267 responses. The respondents of the second wave were compared with those of the first wave along all the response items to check for non-response bias (Armstrong and Overton, 1977; Lambert and Harrington, 1990). The t-tests performed on the responses of these two groups yielded no statistically significant differences on demographic characteristics (at a 99% confidence interval), thus showing that non-response bias is not a problem in this study. Furthermore, we also examined the non-response issue with the procedure suggested by Armstrong and Overton (1977). Two years earlier, using the same questionnaire, we undertook a survey with the same firms and included as part of the survey instrument the same questions as those included in the current survey. In our second survey, the respondents were asked to respond to these questions according to the situation as it was at the time of initial survey. All the validation items correlated significantly with the original measures (correlations ranging from 0.230 to 0.687). This suggests that non-response would not likely bias the findings. Clearly, we relied upon respondents’ assessments and evaluation of their company situation to derive

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Table 2 Convergent reliability of the measurement models Sino-foreign alliances (the 140 firm sample)

Domestic alliances (the 351 firm sample)

Factor loading

Cronbach’s a

Factor loading

Cronbach’s a

Acquiring market development knowledge

0.860

0.905

0.893

0.937

Learning management skill Acquiring new product development knowledge Obtaining important information

0.894 0.875 0.898

Formal control (FC)

Detailed contract Regulating the behavior of partner Valuing the development of cooperation Detailed cooperative rules Cooperative procedures

0.734 0.732 0.611 0.832 0.752

0.780

0.674 0.735 0.754 0.765 0.746

0.786

Social control (SC)

Trusting our partner Shared vision and values Confident of the capability of the partner Fulfilling the obligations without monitoring Communications

0.764 0.852 0.893 0.683 0.736

0.930

0.887 0.895 0.506 0.880 0.848

0.703

Incremental innovation (II)

Innovation in product appearance Improving existing process Exploiting existing technologies

0.681 0.818 0.820

0.667

0.651 0.845 0.830

0.674

Radical innovation (RI)

Creating new radical product Introducing radical new concept Developing new technology Creating new techniques

0.698 0.647 0.679 0.808

0.669

0.783 0.762 0.787 0.759

0.775

Construct

Acquiring tacit knowledge through offshore outsourcing (ATK)

Indicators

measures of key variables utilized in this study, so there might exist potential dangers of common method variance bias. We examined the possibility of common method variance via Harman’s one-factor test for all variables in the study (Podsakoff and Organ, 1986). Significant common method variances would result in one general factor accounting for the majority of covariance in the variables. We performed factor analysis on items related to the dependent and independent variables. No general factor was apparent in the unrotated factor structure, with the first factor accounting for only 25% of total variance and the independent and dependent variables loading on different factors. Thus, common method variance is unlikely to be a serious threat to the findings of this study. 4.3. Construct measurements We consulted the extant literature to compile measurement items for our instrument. As noted some items were modified to reflect the specific context of the study. Where this was not possible, new questions were

0.925 0.918 0.932

developed based on a review of the inter-firm cooperation literature. All constructs were measured by the average of the responses, on a 7-point Likert scale. These items were summarized in the Appendix A. 4.3.1. The motive to acquire tacit knowledge in outsourcing To develop the measure of tacit knowledge acquisition motive, we relied primarily on a measurement instrument created and validated by Gupta and Govindarajan (2000) and Shenkar and Li (1999). We adjusted their measures to fit our research better. Four indicators used here are: Through (offshore) outsourcing, we hope to (1) often acquire knowledge of market development from the partner; (2) often learn operations management skills from the partner; (3) learn the knowledge of new product and new service development from the partner; and (4) obtain the new and important information from our partner. 4.3.2. Social control mechanism Following the work of Jap and Ganesan (2000), Uzzi (1997) and Dyer and Singh (1998), we measure the

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social control mechanism with five items. The items include: (1) we can trust our partners in the process of cooperation; (2) the shared vision and values have been built in the cooperation; (3) we are confident of the capability of our partner; (4) without monitoring, the partner would fulfill his obligations; and (5) we often communicate the ideas about selling, production and services with our partner. 4.3.3. Formal control mechanism According to Das and Teng (2001) and Poppo and Zenger (2002), the items which measure the reliance on formal control mechanisms focused on the monitor mechanism in cooperation, and the importance of formal contract and openness of partners. We utilized five indicators: (1) a detailed contract is the most important way to guarantee cooperation success; (2) the contract is useful to regulate the behavior of partner; (3) in the process of cooperation, we use financial and market index to value the development of cooperation; (4) detailed cooperative rules have been written in the contract; and (5) both partners know the cooperative procedure. 4.3.4. Radical innovation Consistent with the definition and measurement provided by Ettlie (1983) and Dewar and Dutton (1986), we measured radical innovation utilizing four items: (1) creating radically new products, (2) introducing radically new concepts in innovations, (3) develop and introduce new technologies into industry, and (4) the firm is a creator of new techniques and technologies. 4.3.5. Incremental innovation Based on Herbig (1994) and Dosi (1982), incremental innovation was measured by three items comparing the focal firm against its competitors along: (1) developing new fashions of product, (2) improving existing process and product and (3) exploiting existing technologies. The Appendix A summarized these constructs, their respective indicators, and literature sources. 4.4. Analytical methods The path relationships depicted in Fig. 1 were further analyzed by a structural equation modeling (SEM) approach using AMOS (Arbuckle, 2003). The primary aim of SEM is to explain the pattern of a series of interrelated dependence relationships simultaneously between a set of latent (unobserved) constructs, each measured by one or more manifest (observed) variables.

267

The measured (manifest) variables in SEM have a finite number of values, and these variables are gathered from respondents through data collection methods. They are represented by numeric responses to a rating scale item on a questionnaire. On the other hand, latent (unobserved) variables are not directly observed, have an infinite number of values, and are usually continuous. Latent variables are theoretical constructs which can only be determined to exist as a combination of other measurable variables. We include in our model the following latent constructs. They are the motive to acquire tacit knowledge (ATC) through (offshore) outsourcing alliances, social control mechanism (SC), formal control mechanism (FC), incremental innovation (II), and radical innovation (RI). 5. Results 5.1. Reliability analysis The composite reliability refers to inter-item consistency, operationalized and estimated using Cronbach’s alpha. Typically, reliability coefficients of 0.70 or higher are considered adequate (Cronbach, 1951; Nunnally, 1978). Nunnally (1978) further states that permissible alpha values can be slightly lower (0.60) for newer scales. The constructs developed in this study were based primarily on previously validated measurement items and strongly grounded in the extant literature. They were adopted to the Chinese context. Therefore, an alpha value of 0.60 was considered as the cut-off value. As can be seen from Table 2, the Crohbach’s alpha values for all except radical innovation in domestic alliance and both radical innovation and incremental innovation in Sino-foreign alliance are greater than 7.0, and the Crohbach’s alpha values of these three factors are substantially higher than 0.6. These results suggest that the theoretical constructs exhibit good internal consistency. 5.1.1. Content validity The content validity of a construct is the extent to which the set of measures provides adequate coverage for the construct domain or essence of the domain being measured (Churchill, 1979). The determination of content validity is not numerical, but subjective and judgmental (Emory, 1985). Instructions on the cover of our questionnaire told those respondents clearly that the purpose of this study was to explore firms’ management practices and innovation outcomes. Confidentiality is also assured. In addition, we sought feedback from a

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demonstrated if the average variance extracted for each construct is greater than the squared correlations between constructs (Hatcher, 1994). Bagozzi’s (1980) criterion can also be used through x2 difference tests. In this study, discriminant validity is established using confirmatory factor analysis (CFA). Models were constructed for all possible pairs of latent constructs. These models were run on each selected pair, first allowing for correlation between the two various constructs, and then fixing the correlation between the various constructs at 1.0. A significant difference in chi-square values for the fixed and free models indicates the distinctiveness of the two constructs (Bagozzi and Phillips, 1982; Bagozzi et al., 1991). The chi-square difference was tested for statistical significance at p < 0.01 confidence level. For the 6 constructs, a total of 15 different discriminant validity checks were conducted. As can be seen in Table 3, all the differences between the fixed and free solutions in chi-square are significant. This result provides a strong evidence of discriminant validity among the theoretical constructs.

panel of four academics in the area of innovation management, and two practitioners regarding our selected measures to ensure they were in fact capturing constructs of interests. We asked these members to comment on the clarity of our measurement items. We subsequently modified various items based on their concrete feedback. 5.1.2. Convergent and discriminant validity Convergent validity is ‘‘the degree to which multiple attempts to measure the same concept by different methods are in agreement’’ (Campbell and Fiske, 1959; Phillips, 1981). Two tests were used to assess convergent validity, they are respectively Cronbach’s alpha and average variance extracted by constructs (Fornell and Larcker, 1981). The average variance extracted by constructs was computed based on the extent to which all questions measuring a construct actually tapped into the same underlying construct. Fornell and Larcker (1981) suggested 0.5 as the indication of adequate variance extracted. As the factor loadings for final model show, the expected measurement model performed very well. Discriminant validity is the degree to which measures of different latent constructs are unique enough to be distinguished from one another, which is

5.2. Assessment of model fit Table 4 presents summary statistics of models estimated in the modeling procedure as well as chi-

Table 3 An assessment of the discriminant validity: chi-square differences between the fixed and free models Constructs

ATK

Acquiring tacit knowledge through offshore outsourcing (ATK) Formal control (FC) Social control (SC) Incremental innovation (II) Radical innovation (RI)

4.668* 4.372* 55.526** 31.571**

FC

SC

II

RI

39.979**

18.866** 15.808**

37.208** 188.172*** 76.562**

16.198** 59.533** 50.025** 5.020*

10.501** 54.762** 39.270** *

48.103** 36.719**

3.634*

**

All chi-square differences were significant at the 0.05 level (for 1 degree of freedom). p < 0.05; p < 0.01. The bottom left matrix represents the Sino-foreign alliances, and the upright the domestic alliances. Table 4 Structural fitness measurements Indicator

Discrepancy Discrepancy/d.f. p GFI AGFI NFI TLI CFI IFI RMSEA

Sino-foreign alliances (the 140 firm sample)

Domestic alliances (the 351 firm sample)

Desired value

Model estimates

Desired value

Model estimates

>0.05 >0.90 >0.80 >0.90 >0.90 >0.90 >0.90 <0.06

124.385 1.091 0.238 0.968 0.935 0.971 0.995 0.997 0.998 0.016

>0.05 >0.90 >0.80 >0.90 >0.90 >0.90 >0.90 <0.06

130.112 1.075 0.270 0.927 0.847 0.927 0.989 0.994 0.995 0.023

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Table 5 Hypotheses tests for the final models Paths and hypotheses

H1a (+): ATK ! SC H1b (+): ATK ! FC H2a (+): SC ! RI H2b (): FC ! RI H2c (+): FC ! II H2d (): SC ! II H3a (+): ATK ! RI H3b (): ATK ! II

Sino-foreign alliances (the 140 firm sample)

Domestic alliances (the 351 firm sample)

Standardized path coefficient

p-Value

Support

Standardized path coefficient

p-Value

Support

0.220 0.229 0.724 0.753 0.726 0.603 0.044 0.213

0.023 0.034 0.047 0.049 0.038 0.049 0.722 0.098

Y Y Y Y Y Y N Y

0.175 0.175 0.549 0.387 0.662 0.549 0.197 0.089

0.004 0.008 0.005 0.047 0.044 0.050 0.029 0.172

Y Y Y Y Y Y Y N

square statistics and goodness-of-fit information for the final models for the two sub-samples. The chi-square statistic and goodness-of-fit measures for final models on Table 4 reflect a very strong model. 5.3. Results of hypothesis tests Since we undertook the study to compare between two distinctly different samples—Sino-foreign offshore outsourcing alliances, and local firm alliances, we tested the structure equation models using those two subsamples, respectively. Interestingly enough, we observed significant consistency between the two sub-samples. As indicated in Table 5 and Fig. 1, the motive to acquire tacit knowledge is positively related to formal control and social control for both samples. Thus, Hypotheses 1a, 1b received support. Social control is positively related to the radical innovation but negatively related to the incremental innovation in both samples. Thus, H2a and H2d were supported. Formal control was found to be positively related to the incremental innovation but negatively related to the radical innovation in both samples, providing supports for H2c and H2b. While these consistencies are interesting, the inconsistency we observed between the two samples provided additional insights. Specifically we should examine carefully the direct impacts of the motive to acquire tacit knowledge (ATK) on radical and incremental innovation in the two study samples. For the Sino-foreign alliance sample, the ATK to radical innovation link is not statistically significant (H3a was not supported), but the ATK to incremental innovation is negative and statistically significant (H3b was supported). On the other hand, for the domestic alliance sample, we observe precisely the opposite. The motive to acquire tacit knowledge affects radical innovation positively, but does not have any impact on incremental innovation.

6. Discussion This paper compares the differences between Sinoforeign alliances based on the offshore outsourcing and the domestic alliances, and examined the effects of the motive to acquire tacit knowledge in the alliances, and control mechanisms on incremental and radical innovations in China. Based on the social exchange theory and alliance risk perspective, we develop a theoretical framework to link these important concepts together. The analytical results provided strong support for the model and hypotheses presented in Fig. 1. Researchers (Van de Ven et al., 1999) speculated that factors that contributed to radical innovation may at the same time have an opposite impact on incremental innovation. Our study focused on the motive to acquire tacit knowledge as such a factor. We discovered that firms with greater motive to acquire tacit knowledge from outsourcing alliance partners tended to emphasize both social control and formal control. This finding differs from prior research. Liebeskind et al. (1996) argued that contracts were rarely used to control the tacit knowledge transfer and the use of social control would increases both their learning and their flexibility. Powell (1990) also argued that social networks were the most efficient organizational arrangement for sourcing information because information is difficult to price and to communicate through a contract. We believe the differences could be because of the particular setting. In the Chinese context, the legal system and reputation mechanisms still remain rather weak (but we note they are being developed rapidly). Opportunistic behaviors, which would gain private benefits at the expense of damaged reputation, might be the main reason for the failure of alliances or other inter-firm cooperation in China. So it is dangerous to establish the cooperation only on the basis of social control in China where the crisis of trust is ubiquitous. This finding is critical given the increased use of transformational

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offshore outsourcing and gained importance of emerging economy firms on the global economic landscape. Gulati (1995) also argued that social control mechanism would not function very well without trust. In addition, more and more researcher suggested that formal control and social control governance function as complements (Poppo and Zenger, 2002). Well-specified contracts may actually promote more cooperative, long-term, trusting exchange relationships, and relational exchanges may gradually develop more complex formal contracts, as mutually agreed upon processes become formalized. According to this logic, both formal and social control should be strengthened simultaneously. These results have important implications to both outsourcing firms (knowledge donor) and outsourcing vendors. On the one hand, for outsourcing firms, in order protect their core business and core knowledge, they should emphasize contract formulation and enforcement. Furthermore, through improving the trust relationship with the venders, outsourcing firms can increase the reliance of the vendors on them so that they can keep flexible choices for outsourcing venders under an uncertain environment and continuously keep their cost advantage (Doh, 2005; Levy, 2005). On the other hand, using both social control and formal control would enable outsourcing venders to learn useful tacit knowledge from knowledge donors and push forward their innovation. Our findings also suggest that the two different control mechanisms have their respective impacts on different types of innovation. The social control mechanism is beneficial to radical innovation, but may limit incremental innovation. On the other hand, formal control has a positive effect on incremental innovation, but may limit radical innovation. These findings are consistent with the literature in general. For example Ettlie et al. (1984, p. 692) state that the ‘‘strategy–structure causal sequence for radical innovation is markedly different from the strategy– structure sequence for incremental innovation.’’ While there’s no clear conclusion in the extant literature regarding the efficacy of social and formal control in outsourcing alliances when they relate to innovation, in a recent research study, Das and Teng (2001) suggested that social control may effectively reduce perceived relational risk in an alliance. This paper confirms and extends this proposition. First, this paper provides empirical evidence that formal control has its advantage in dealing with opportunism; second, our findings also suggest that formal control mechanism may guarantee the efficiency of transferring of codifiable knowledge. These results indicated that

formal control is helpful for accomplishing incremental innovation. The results of this study have important implications for business practitioners. First, the framework provided useful guidance for selecting control mechanisms appropriate for the respective types of innovation. Formal control minimizes opportunistic behavior among alliance partners. Detailed contracts specify contingencies, and adaptive processes to mitigate opportunistic behavior. However, formal control does not guarantee the intent of mutuality, bilateralism and continual exchange and contact of partners. Relational governance complements such adaptive limits of formal control by fostering continuance of the exchange and entrusting both parties with mutually agreeable outcomes. Therefore, it is important to strengthen both formal control and social control for tacit knowledge acquisition during the transitional period in China’s economic reform. Our findings also suggest that different control mechanisms should be adopted for different types of innovation. In order to strengthen formal control, formal policies and procedures should be established, and this result consists with the research of Littler and Leverick (1995). The reporting structure also should be used to provide role specifications for everyone in the system (Heide, 1994). In addition, staffing and training are important measures to regulate and standardize behavior in alliance. If incremental innovation is the main target, formal control is better than social control. On the other hand, in order to accomplish radical innovation, social control should be more helpful. In the process of cooperation, partner firms can create shared visions and values through a participatory decision-making process (Grandori, 1997). Such a process ensures that the preference of each party is understood and integrated into mutually acceptable goals and plans. In addition, partner firms can also stress cultural activities such as rituals, ceremonies, and networking, to help establish shared norms and beliefs. They are informal but effective ways to translate organizational ideals into behavior models that can provide guidance. Finally the differences in the study findings from the two samples are of important value as well. For the Sino-foreign sample, the motive to acquire tacit knowledge does not have a direct positive impact on radical innovation (but does have a direct negative impact on incremental innovation). It appears Sinoforeign alliances require control mechanisms in order to achieve radical innovation outcomes. On the other hand, for the local alliances, the motive to acquire tacit knowledge does appear to have a direct positive impact

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on radical innovation. We believe that local alliances may be able to pool local knowledge together more effectively to achieve radical innovation. Clearly the effective social control may also help. 7. Conclusion This study makes three important contributions. First, integrating existing theoretical perspectives on offshore outsourcing and transformational offshore outsourcing as well as social exchange, and alliance risk perspective, we built a model linking the motive to acquire tacit knowledge in outsourcing alliances, social and formal control with two types of innovation. Second, this paper reported an empirical study set in China’s transitional economy comparing between Sinoforeign offshore outsourcing alliances and local outsourcing alliances to highlight both commonalities and differences, revealing the challenges of realizing radical innovations in the Sino-foreign alliance samples, and at the same time the importance of cultural and business practice familiarities involving local alliance partners. We argued and empirically demonstrated that in the Chinese context it is important to utilize both formal and social controls. Differing with prior research, we took into consideration the background of Chinese economy transition, and indicated that basic formal control mechanism is necessary for tacit knowledge acquisition from the partners because the yet to be fully developed market environment and law environment.

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According to this logic, both formal and social control should be strengthened simultaneously. Finally, our findings highlighted the different effects of two control mechanisms on different types of innovation. The social control mechanism is beneficial to radical innovation, while the formal control has a positive effect on incremental innovation. Departing from cost reduction and core focus logic central to the traditional view of offshore outsourcing, transformational offshore outsourcing focuses on business renewal and corporate transformation. Innovation through offshore outsourcing becomes a promising new direction. This study examined Sino-foreign alliances and local alliances from this perspective. Our study identified the importance of tacit knowledge acquisition, and control mechanisms when it comes to radical and incremental innovation. We also uncovered the cultural and business practice familiarities as an important contributing factor. Extending this study in other settings will be useful such that we will be able to compare important conclusions across different contexts. Furthermore, conducting this study with a longitudinal design will be profitable as we may learn further if the findings in this study are transitional situational specific or not. Extending the concept of innovation to include other dimensions of innovation (such as organizational and strategic innovations) will be promising as well since the transformational outsourcing focuses on business renewal and corporate transformation.

Appendix A. List of items measuring each theoretical construct

Factors and variables (survey questions) Acquiring tacit knowledge through offshore outsourcing (ATK) 1. We often acquire market development knowledge from the partner through offshore outsourcing

Reference sources Gupta and Govindarajan (2000), Linderman et al. (2004), Nonaka (1994), Nonaka and Konno (1998), Nonaka and Takeuchi (1995), Shenkar and Li (1999)

2. We often learn operations management skills from the partner through offshore outsourcing 3. We learn new product development knowledge of from the partner through offshore outsourcing 4. We obtain new and important information from our partner through offshore outsourcing Social control mechanisms (SC) 1. We can trust our partners in the process of cooperation 2. The shared vision and values have been built in the cooperation 3. We are confident of the capability of our partner 4. Without monitoring, the partner would fulfill his obligations 5. We often communicate ideas about selling, production and servicing with our partner

Jap and Ganesan (2000), Uzzi (1997)

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Appendix A (Continued ) Factors and variables (survey questions)

Reference sources

Formal control (FC) 1. Detailed contract is the most important way to guarantee cooperation success 2. The contract is useful to regulate the behavior of partner 3. In the process of cooperation, we use financial and market indices to evaluate cooperation success 4. Detailed cooperative rules have been written in the contract 5. Both partners know the cooperative procedures Incremental innovation (II) 1. We often create new patterns of product 2. We often improve existing process and product 3. We often exploit existing technologies Radical innovation (RI) 1. We often create radically new products 2. We often introduce radically new concept in innovations 3. We often develop and introduce new technologies into the industry 4. We are often the creator of new techniques and technologies

Dosi (1982), Herbig (1994)

Dewar and Dutton (1986), Ettlie (1983)

Note: Respondents used a 7-point Likert scale to provide responses on each item (1: strongly disagree and 7: strongly agree).

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