Unlocking the business outsourcing process model

Journal of Operations Management 27 (2009) 344–361

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Journal of Operations Management journal homepage: www.elsevier.com/locate/jom

Unlocking the business outsourcing process model Sean M. Handley a, W.C. Benton Jr.b,* a

Department of Supply Chain Management and Marketing Sciences, Rutgers Business School, Rutgers, The State University of New Jersey, 111 Washington Street, Newark, NJ 07102, USA b Department of Management Sciences, Fisher College of Business, The Ohio State University, 2100 Neil Avenue, Columbus, OH 43210, United States

A R T I C L E I N F O

A B S T R A C T

Article history: Received 29 November 2007 Received in revised form 18 November 2008 Accepted 19 November 2008 Available online 27 November 2008

Outsourcing has emerged as a prevalent business practice that is having a transformational impact on how many organizations manage their global supply chains. Despite this prominence, anecdotal reports from multiple reputable organizations suggest that many businesses fail to realize the benefits anticipated from their outsourcing initiatives. Motivated by these observations, this study investigates those management practices during the outsourcing process that are key drivers of outsourcing performance. Specifically, detailed data from 198 sourcing executives and managers responsible for outsourcing initiatives are used to investigate the influence that strategic evaluation, contractual completeness, and relationship management practices have on achieving projected outsourcing results. The results offer strong empirical evidence that outsourcing performance is significantly influenced by extensive strategic evaluation and proactive relationship management practices. Moreover, the impact strategic evaluation has on outsourcing performance is not direct, but rather is partially mediated by the relationship between the parties. Finally, the results show that contractual completeness does not distinguish between successful and unsuccessful outsourcing efforts, and can be considered qualifying activity. ß 2008 Elsevier B.V. All rights reserved.

Keywords: Outsourcing Supply management Empirical research method

1. Introduction There is hardly a more salient question faced by industrial leaders than ‘‘which aspects of our value chain should we perform internal to our organization and which aspects should we source externally?’’ Some have addressed this question as the classic make-or-buy decision or the decision as to the extent of vertical integration. More recently, this demarcation of firm boundaries has been studied from the perspective of outsourcing. When considering outsourcing, firms are evaluating whether or not to reverse a prior decision to ‘‘make’’. In other words, outsourcing involves the re-shaping of existing firm boundaries. Outsourcing can further be conceptualized as a process which begins with the development of a sound

* Corresponding author. Tel.: +1 614 292 8868. E-mail address: [email protected] (W.C. Benton Jr.). 0272-6963/$ – see front matter ß 2008 Elsevier B.V. All rights reserved. doi:10.1016/j.jom.2008.11.002

business case for outsourcing followed by the implementation of the external sourcing model, and ultimately the management of the relationship with the provider. Outsourcing has clearly emerged as a prevalent and transformational business practice. Given this popularity, the experiences being reported by many organizations are somewhat surprising. According to a Deloitte Consulting study (Landis et al., 2005), 64% of respondents indicated that they had brought outsourced services back in-house and 44% did not realize cost savings. Moreover, Dunn and Bradstreet found that 20–25% of all outsourcing relationships fail within 2 years and half fail within 5 years (Doig et al., 2001). A more recent and expansive Deloitte survey of 300 business executives also found the need for improved outsourcing practices. Only 34% were satisfied with the provider’s innovation and 61% indicated that they had to ‘‘escalate’’ problems to senior management within the first year (Robinson et al., 2008). Further, 75% of service providers interviewed felt that their clients were ill prepared for the

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outsourcing initiative often lacking a well-developed strategy and clear understanding of how it would work. These anecdotal findings which suggest that there is a troubling gap between expectations and reality serve as the motivation for this research. This study contributes to the operations and supply chain literature in several fundamental ways. First, the construct of strategic evaluation in defined and developed. Traditionally, empirical studies concerning firm boundary decisions focus on the ability of the various ‘‘theories of the firm’’ (e.g. transaction cost and resource based) to predict or explain existing firm boundaries found in practice (Harrigan, 1986; Masten, 1984; Masten et al., 1989; Monteverde and Teece, 1982; Novak and Eppinger, 2001). However, with few exceptions (Gopal et al., 2003; Lee et al., 2004; Leiblein et al., 2002; Poppo and Zenger, 1998), this literature stops short of testing the performance implications of these decisions. Moreover, the sourcing decision itself is the focus of this literature, and not the actual management of the outsourcing effort. Performing an extensive strategic evaluation of an outsourcing opportunity not only facilitates the sourcing decision, but also develops a clear understanding of the risk and coordination implications of outsourcing. This knowledge can be utilized to inform the development of an effective contract and strengthen the development of a mutually beneficial relationship with the provider. To our knowledge, these effects have not been empirically explored in the literature. This study also contributes a contractual completeness construct. The closest concept found in the extant literature is contractual complexity. The complexity of a contract has been operationalized by the level of customization (Poppo and Zenger, 2002) and the length of the contract (Joskow, 1988; Poppo and Zenger, 2002). The length and customization of a contract is not the same as the current conceptualization of contractual completeness. Other stu-

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dies have looked at the effect of contract enforcement as a means of mitigating principal-agent conflict (Tosi et al., 1997). A study by Aron et al. (2008) considers at how recent technological advances allow firms to more effectively monitor the activity of off-shore business process outsourcing providers resulting in more effective enforcement of contractual process quality objectives. Contract enforcement is certainly an important aspect of activity management. However, enforcement only comes into play after the development of a contract with well-specified service objectives. Thus, the focus in the current study is on the extent to which the outsourcing organization developed an effective contract and not on contract enforcement. Concurrently evaluating the effects of contractual completeness and relationship management on outsourcing performance is the third contribution of this study. There is an impressive body of supply chain literature which evaluates how inter-organizational relationship practices influence the performance of pre-established exchanges. Many have studied the positive effect of cooperative buyer–supplier relationships on exchange performance from the buying firm’s perspective (Carr and Pearson, 1999; Chen et al., 2004; Shin et al., 2000). Others have considered these effects from the perspective of the supplier (Benton and Maloni, 2005; Prahinski and Benton, 2004). The current study extends this literature to realm of outsourcing which entails the establishment of new exchanges for business activities traditionally performed within the firm, often with no physical product involved. Moreover, the influence of relationship management on outsourcing performance is considered along with the influence of contractual completeness. To date, the influence of these two constructs on outsourcing performance has not been concurrently evaluated. Fig. 1 summarizes the conceptual model to be evaluated in this study as described above. In the next section, an

Fig. 1. Conceptual model.

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extensive review of related research streams is presented to develop the conceptual domains represented in the conceptual model. The theoretical justification for the hypotheses is detailed in Section 3. Section 4 offers an overview of the research methods. The development of the measurement model and statistical analysis of the hypotheses are discussed in Sections 5 and 6. Section 7 discusses the managerial implications of the research findings, and the paper concludes with the research limitations and future opportunities. 2. Outsourcing process: critical elements 2.1. Strategic evaluation Strategic evaluation reflects the extent to which the outsourcing team performed a comprehensive evaluation of the strategic implications of outsourcing the business activity. The degree to which firms effectively perform a strategic evaluation is concurrently reflected by their evaluation from a capability perspective and from a risk perspective. The capability or resource evaluation is grounded in the resource based view of the firm, while the strategic risk assessment is guided by transaction cost theory. The resource based perspective stipulates that when demarcating firm boundaries an organization must consider the degree to which the firm’s resources and capabilities contribute to the development of a sustainable competitive advantage (Barney, 1999). Firms must develop a thorough understanding of their core competencies and how a particular business activity is related to the successful achievement of broader strategic objectives when deciding whether or not to outsource a particular business activity (Insinga and Werle, 2000; Quinn and Hilmer, 1994). Thus, a thorough evaluation of the current and potential strategic value of a firm’s capabilities is a critical aspect of the overall strategic evaluation. The transaction cost perspective suggests that organizations must consider the costs and resources required to effectively coordinate with an external party and mitigate the risks inherent in external sourcing. Common risks often associated with the use of an independent external organization include provider shirking due to imperfect observability (Alchian and Demsetz, 1972), the provider acting opportunistically in the presence of transaction specific investments (Williamson, 1979), and improper use of shared intellectual property (Aron et al., 2005). Transaction cost theory would suggest that the level and implication of these risks must be considered when developing the strategic business case for outsourcing. Conceptually, the firm’s desire to develop a comprehensive understanding of outsourcing’s strategic implications initiates an evaluation along these two dimensions. Thus, strategic evaluation is modeled as a multidimensional reflective construct. This conceptualization is supported by prior studies which identify the complementary nature of the resource based view of the firm and transaction cost theory (Ahmadjian and Lincoln, 2001; Leiblein and Miller, 2003) for describing firm boundary decisions made in practice. In their study of sourcing

decisions made in the automotive industry, Ahmadjian and Lincoln (2001, p. 696) assert that there are ‘‘important complementarities between these theories of alliance. Used in conjunction, they enable a richer assessment of evolving supply relations than either provides alone.’’ 2.1.1. Capability evaluation Capability evaluation is the extent to which the outsourcing team evaluated the strategic value of the capabilities and resources associated with the business activity, considering the organization’s current and anticipated sources of competitive advantage. It is broadly suggested that an organization’s capabilities at performing a function or activity must be evaluated when making outsourcing decisions (Barney, 1999; Insinga and Werle, 2000). This capability evaluation must consider not only how well an organization performs but also the strategic importance of the activity or function (Barney, 1991; Dierickx and Cool, 1989; Wernerfelt, 1984). The strategic value derived from being a high performer in a certain area must be considered. This notion is the essence of the resource based view of the firm (RBV), and also reflects what Prahalad and Hamel (1990) have coined the organization’s core competencies. Quinn and Hilmer (1994) further suggest that organizations must focus on developing a few core competencies internally and consider outsourcing the rest. This strategic focus can potentially free up resources to be concentrated in areas that are expected to yield competitive advantage. The capability evaluation must also consider what skills or capabilities may be critical to competitive differentiation in the future (Eisenhardt and Martin, 2000; Holweg and Pil, 2008). As markets evolve, capabilities that are non-core today may become core in the future (Helper et al., 2000). 2.1.2. Strategic risk assessment Strategic risk assessment represents the degree to which the outsourcing team evaluated the multitude of strategic risks associated with outsourcing the business activity. With outsourcing there is a variety of strategic risks which must be assessed. First, organizations are making once proprietary information available to an external organization (Kogut and Zander, 1992). Thus, firms must consider the ramifications to intellectual property when choosing to switch to an external sourcing structure (Gottfredson et al., 2005). Walker (1988) terms this concern as ‘‘diffusion risk’’ while Aron et al. (2005) refer to it as ‘‘poaching’’. A second strategic risk is supplier shirking or moral hazard (Eisenhardt, 1989), which arises to due goal misalignment and an imperfect ability to observe all of the providers actions (Alchian and Demsetz, 1972; Aron et al., 2005). Finally, transaction cost theory asserts that in the presence of uncertainty, transaction specific assets, and contractual incompleteness firms must heavily evaluate the risk of providers acting opportunistically (Klein et al., 1978; Williamson, 1979). This has become known as the classic ‘‘hold-up’’ problem (Holmstro¨m and Roberts, 1998). This portfolio of concerns must be explicitly assessed as part of a comprehensive strategic evaluation.

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2.2. Contractual completeness Contractual completeness is the extent to which the outsourcing firm and chosen provider develop a contract which effectively coordinates resources and addresses identified inter-organizational risks. Poppo and Zenger (2002) assert that a more complex contract specifies ‘‘promises, obligations, and process for dispute resolution.’’ Effective contracting practices such as clear service level agreements and performance contracting with well established penalty and reward structures are suggested to offer benefits in terms of improved goal alignment and reduced strategic risks (Alexander and Young, 1996; Barthe´lemy, 2001, 2003; Lacity and Hirschheim, 1993). More specifically, it has been suggested that a more complete contract serves two fundamental functions: coordination and control (Mellewigt et al., 2007). The establishment of coordinating provisions outlines how each party’s resources will interface across firm boundaries (Mellewigt et al., 2007). Coordination provisions clarify mutual expectations as well as delineate roles, rules, programs, and procedures that enable the joint endeavor to accomplish collective goals (Mayer and Argyres, 2004; ˜ o, 2007). On the other Mellewigt et al., 2007; Reuer and Arin hand, control provisions are designed to determine and influence what the parties will do (Das and Teng, 1998). The intent of contractual control provisions is to make outcomes more predictable (Das and Teng, 1998; Poppo and Zenger, 2002) and mitigate the relational risk associated with an inter-organizational arrangement (Das and Teng, 1998; Mellewigt et al., 2007). Finally, Argyres and Mayer (2007) study contract design from a firm capability perspective. Their study highlights the need to have a cross-functional team involved in the development of the contract due to various groups within the firm having uniquely qualified capabilities to develop certain contractual provisions. 2.3. Relationship management Relationship management represents the degree to which the outsourcing firm has strived to establish and maintain a mutually beneficial relationship with the supplier or vendor. The supply chain literature has provided empirical support for relationship management being modeled as a multidimensional reflective construct (Benton and Maloni, 2005; Prahinski and Benton, 2004). Effective cooperation often entails investment in relationship specific processes, procedures, and technologies (Dyer and Singh, 1998). Firms are often reticent about investing in relationship specific resources unless the exchange is characterized by high levels of trust and mutual commitment (Madhok and Tallman, 1998; Zhao et al., 2008). On the other hand, making relationship specific investments expresses trust and goodwill which gains commitment from the other party (Anderson and Weitz, 1992; Das and Teng, 1998). Morgan and Hunt (1994) find strong evidence that commitment is critical for effective cooperation in exchange relationships. Thus, it is clear that commitment and cooperation are intertwined in establishing mutually beneficial exchange relationships. That is to say that

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commitment and cooperation act in a complementary manner. It is the nexus of commitment and cooperation that is of interest in this study. 2.3.1. Relationship commitment Relationship commitment is the degree to which the outsourcing firm feels pledged or obligated to the development and maintenance of a stable relationship with the supplier or vendor (Prahinski and Benton, 2004). Anderson and Weitz (1992) describe relationship commitment as ‘‘a willingness to make short-term sacrifices to maintain the relationship.’’ For outsourcing relationships to work, it requires a strong commitment from both parties (Anderson and Weitz, 1992; Boyle and Dwyer, 1992; Dwyer et al., 1987). Although longer-term relationships can bear significant benefits, the road will not always be smooth. Even cooperative relationships are often characterized by significant levels of uncertainty (Ring and Van de Ven, 1994). Thus, it is important that the parties sufficiently value the relationship and are willing to expend resources and work to maintain it (Morgan and Hunt, 1994). Without commitment from both leadership teams, it would be easy to regress into traditional adversarial thinking. For this reason, the outsourcing literature has cited the need to have involvement from top management as well as mid-level management in the relationship management process (Kakabadse and Kakabadse, 2003; Quinn, 1999). Ultimately, the organization must view the engagement as a partnership (Dwyer et al., 1987; Mohr and Spekman, 1994; Prahinski and Benton, 2004) where the driving question is ‘‘how do we maximize the total system value’’ rather than ‘‘how can we maximize our portion of the pie at the expense of our provider’’. If this mentality is not maintained, goal alignment will erode and opportunism will likely follow. 2.3.2. Cooperation Cooperation represents the extent to which the outsourcing firm works with the provider to maintain flexibility, plan collaboratively, and jointly work through problems as they arise (Prahinski and Benton, 2004). One hallmark of cooperation is extensive information sharing. Frequent sharing of important, sometimes proprietary, information allows the exchange partners to complete tasks more effectively (Mohr and Spekman, 1994). As the relationship becomes more strategic, the type of information shared with the supplier becomes more critical often including long-term forecasts, planning information, and future product designs (Noordewier et al., 1990). Closely related to rich information exchange is the idea that true buyer–provider partnerships work collaboratively in many areas. Collaboration entails joint efforts by the two organizations. Common collaborative initiatives include joint problem resolution or continuous improvement (Cannon and Perreault, 1999; Heide and Miner, 1992), mutual strategic planning (Dwyer et al., 1987; Helper et al., 2000), and joint product or service development efforts (Ragatz et al., 1997; Shin et al., 2000; Yeung, 2008). Finally, as noted in Dwyer et al. (1987), ‘‘divergence of goals and role preferences’’ is inevitable as conditions change and the relationship evolves. Therefore it is critically important to

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approach such conflicts and disputes constructively, with a mindset of improvement (Frazier and Rody, 1991). As stated by Anderson and Narus (1990), ‘‘When partner firms use disagreements as a means of ‘clearing the air’ of potentially harmful tensions and ill-will, conflict can have functional and productive consequences.’’ Hence, strong inter-organizational relationships are characterized by a significant cooperative orientation in which both firms can benefit from the collective efforts. 3. Theoretical model and hypotheses

trajectory of competence development. Organizations must also fully consider the strategic risks that arise due to outsourcing. These include capability erosion (Dierickx and Cool, 1989; Quinn and Hilmer, 1994), intellectual property breaches (Aron et al., 2005; Gottfredson et al., 2005; Walker, 1988), shirking (Alchian and Demsetz, 1972; Aron et al., 2005; Eisenhardt, 1989), and opportunistic renegotiation (Holmstro¨m and Roberts, 1998; Klein et al., 1978; Williamson, 1979). It is postulated that a more comprehensive evaluation of these strategic implications of outsourcing will be associated with more successful outsourcing efforts. Without conducting such an evaluation, firms run the risk of outsourcing the wrong activities or functions and opening themselves up to substantive competitive damage. Formally stated:

The theoretical underpinnings for each of the hypothesized relationships, is provided in the following sections. Fig. 2 illustrates the hypothesized direct and indirect influence of strategic evaluation on outsourcing performance, along with the direct effects of contractual completeness and relationship management on the performance of outsourcing initiatives.

Hypothesis 1. Strategic evaluation has a significant positive effect on outsourcing performance.

3.1. Strategic evaluation and outsourcing performance

3.2. Strategic evaluation and contractual completeness

Prior to leaping into an external sourcing model, firms must consider the drawbacks and long-term implications of an exchange with an independent party. It is critically important that organizations develop a thorough understanding of what activities and associated resources provide for a sustained competitive advantage (Barney, 1991; Dierickx and Cool, 1989; Wernerfelt, 1984) and represent their core competencies (Insinga and Werle, 2000; Prahalad and Hamel, 1990). Moreover, due to path dependencies, decision making teams must fully consider what may or may not represent valuable capabilities in the future and how outsourcing may influence their portfolio of strategic alternatives (Hayes et al., 2005; Lei et al., 1996). Teece et al. (1997) assert that ‘‘firms must follow a certain trajectory or path of competence development. This path not only defines what choices are open to the firm today, but is also puts bounds around what its internal repertoire is likely to be in the future.’’ It can certainly be said that outsourcing, which often involves the disposal or transfer of human and physical resources, can impact this path or

Formal contracts serve two primary functions with respect to inter-firm exchanges: control and coordination (Das and Teng, 1998; Mayer and Argyres, 2004; Mellewigt et al., 2007). Yet, contracts developed in a vacuum, without regard for the operating environment, are of limited value. A more refined understanding of the strategic implications of outsourcing puts the outsourcing organization in a better position to craft and agree to a more effective contract. A deep appreciation for the risks associated with outsourcing and the strategic importance of the outsourced business activity leads to the development of specific contractual provisions (Mellewigt et al., 2007). Das and Teng (1996) discuss the relational and performance risks associated with inter-organizational relationships. Whereas relational risks concern expectations about the partner’s cooperation, performance risks concern the probability of not achieving performance goals, given that cooperation is obtained. Das and Teng’s conceptualization of relational and performance risks are consistent with the requirements for control and coordination respectively.

Fig. 2. Hypothesized relationships.

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Moreover, assets or resources (e.g. human and physical) which are strategically important require extensive communication and coordination among the outsourcing partners (Borys and Jemison, 1989; Mellewigt et al., 2007). These communication and coordination requirements are specified and structured through appropriate contractual provisions. A more extensive strategic evaluation results in better knowledge about the control and coordination requirements to effectively achieve the outsourcing objectives. This knowledge subsequently leads to the development of contractual provisions to clarify responsibilities, formalize procedures, and ultimately better align incentives. Hypothesis 2. Strategic evaluation has a significant positive effect on contractual completeness. 3.3. Strategic evaluation and relationship management Just as a more robust strategic evaluation is hypothesized to assist firms with developing a more complete contract, it is also expected to better prepare outsourcing organizations for managing their relationship with the provider. Through an extensive strategic evaluation the outsourcing organization will develop a more detailed understanding of the coordination and control requirements for the exchange. Due to bounded rationality exacerbated by environmental uncertainty, a contract alone cannot be relied upon to completely achieve the control and coordination objectives (Crocker and Reynolds, 1993; Klein et al., 1978; Poppo and Zenger, 2002). Thus, the coordination requirements identified by the strategic evaluation must also be effectively achieved through relational mechanisms which foster trust and mutual commitment (Das and Teng, 1998; Mellewigt et al., 2007). It has been recognized that not all supplier relationships should be created equal, but rather the depth and type of relationship should depend upon the strategic importance of the activity and the risks associated with a market form of governance (Dyer et al., 1998; Kraljic, 1984). A thorough strategic assessment can facilitate this relationship segmentation. An extensive strategic evaluation forces the outsourcing organization to fully consider the strategic implications of outsourcing, including how the particular business activity fits within the organization’s overall strategic plan. This in turn informs the firm on which capabilities need to be collaboratively developed with the provider. This knowledge also allows the outsourcing organization to more clearly communicate expectations and strategic objectives to the provider. When the firm cannot offer this clarity of expectations to the provider, the supplier often finds it difficult to deliver value to its customer (Willcocks et al., 2004). It is critical that the resource coordination and risk control requirements, which are outputs of the strategic evaluation, be used to structure the committed and cooperative relationship with the supplier. It is this clarity of risks and capability requirements that allows the strategic evaluation to strengthen the effectiveness of relationship management efforts.

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Hypothesis 3. Strategic evaluation has a significant positive effect on relationship management. 3.4. Contractual completeness and outsourcing performance Extensive theoretical and anecdotal support exists for the important role that a more complete contract has in determining outsourcing performance. Lacity and Hirschheim (1993) warn outsourcing firms about the negative consequences of agreeing to incomplete contracts and the importance of establishing agreed to service level objectives. A more complete contract reduces the likelihood of opportunistic behavior and costly renegotiation (Barthe´lemy, 2003). Conversely, failing to contractually specify important elements of the exchange increases the potential for undesired behavior, which is costly to the exchange (Poppo and Zenger, 2002). Similarly, Mellewigt et al. (2007) find that a contract can serve to limit opportunistic behavior and/or ‘‘facilitate value creation’’ through its control and coordination provisions respectively. Through the establishment of contractual provisions which clearly articulate each party’s obligations, clarity is enhanced and uncertainty is reduced. Along with controlling or mitigating inherent risks, complete contracts serve to effectively coordinate resources and align incentives between the firms. In order to create inter-firm value, resources must be effectively pooled and integrated, division of labor established, and channels of communication specified. The coordination provisions within a contract can facilitate ˜ o, these activities (Mellewigt et al., 2007; Reuer and Arin 2007). It is posited that a more complete contract has a positive influence on outsourcing performance. This positive effect results not only from a reduction in risk and uncertainty due to more detailed specification of obligations and procedures, but also due to enhanced inter-firm resource efficiency facilitated by contractual coordination provisions. Hypothesis 4. Contractual completeness has a significant positive effect on overall outsourcing performance. 3.5. Relationship management and outsourcing performance Increasingly, the establishment of close buyer–supplier relationships is being heralded as a means to achieve superior performance. The theoretical foundation for the posited influence that relationship management has on outsourcing performance lies in the relational view of the firm (Dyer and Singh, 1998). According to this theoretical perspective, the development and maintenance of a network of close, cooperative, and committed relationships with suppliers can be a source of competitive advantage for an organization. Dyer and Singh (1998) describe the generation of these relational rents as ‘‘a super normal profit jointly generated in an exchange relationship that cannot be generated by either firm in isolation and can only be created through the joint idiosyncratic contributions of the specific alliance partners.’’ The notion of collaboration-specific quasi-rents (Madhok and Tallman, 1998) is based upon the same

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concept of the unique synergistic benefits derived from combining each firm’s specific resources with those of the trading partner. Madhok and Tallman (1998) further suggest that the realization of the potential value in a collaborative inter-firm arrangement requires ‘‘greater appreciation of the relationship management process.’’ Dyer (1996) empirically demonstrated that the development of close supplier relationships, as exemplified by Japanese automakers, leads to more significant relationship specific investments, lower transaction costs, and superior operational performance. Nahapiet and Ghoshal (1998) posit that greater social capital leads to improved dissemination of information and reduced motivation for opportunistic behavior. Similarly, Helper et al. (2000) suggest that collaborative relationships can improve learning and control opportunism. There is also strong empirical evidence in the supply chain literature that supports the hypothesis that committed and cooperative relationship management practices lead to superior exchange performance (Chen et al., 2004; Prahinski and Benton, 2004; Shin et al., 2000). Formally stated: Hypothesis 5. Relationship management has a significant positive effect on overall outsourcing performance. 4. Research methods This study employs the two-stage structural equation modeling (SEM) approach advocated by Anderson and Gerbing (1988). In the first stage, the reliability and validity of the measurement model is evaluated and established. In the second stage, the nomological validity of the structural

model is assessed and the hypothesized relationships are statistically evaluated. 4.1. Measures and questionnaire The research instrument contained 26 items representing outsourcing management practices that are well grounded in the literature streams reviewed. Where possible, items were adapted from prior validated scales. The specific outsourcing initiative is the unit of analysis used for this study, and the survey instrument is designed to ascertain practices used during a specific outsourcing effort (see Fig. 3). An extensive literature review did not reveal any wellvalidated scales for the capability evaluation, strategic risk assessment, and contractual completeness constructs. The literature outlined in Sections 2.1 and 2.2 provides a significant theoretical foundation for the items developed for the capability evaluation, strategic risk assessment, and contractual completeness scales. For developing the two relationship management constructs, prior empirical studies were relied upon. Measurement of the relationship commitment construct was largely based on the prior work of Anderson and Weitz (1992) as well as Prahinski and Benton (2004). An item was included to capture top management’s commitment, which has been identified as being an important aspect of a committed outsourcing relationship (Quinn and Hilmer, 1994; Useem and Harder, 2000). An item was included to represent risk and reward sharing, which has also been identified as being an important aspect of committed relationships (Anderson and Weitz, 1989; Dwyer et al., 1987). Measurement of cooperation was predominantly guided by the work of

Fig. 3. Questionnaire with item means and standard deviations.

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(Mohr and Spekman, 1994). It is important to also capture the provider’s involvement in new product or service development which has been identified as being a central cooperative activity (Helper et al., 2000; Ragatz et al., 1997; Shin et al., 2000). This study follows in the tradition of Poppo and Zenger (1998) in utilizing a multi-dimensional or balanced scorecard approach to performance assessment. Specifically, informants are asked to evaluate performance in terms of total annual cost, quality, responsiveness, and reliability relative to expectations. All questions were five-point Likert scales (1 = Strongly disagree; 5 = Strongly agree). Informants were asked to refer to any documentation and materials used to manage the outsourcing process (e.g. business case documents, project plans, contracts, performance evaluations, etc.). Being that the utilized scales were either new or modified, a rigorous multi-stage methodology was used to ensure statistical validity and reliability of the measurement model. This thorough measurement assessment is detailed in Section 5. Prior to implementing the survey, the original questionnaire was reviewed by five sourcing experts for clarity and conceptual appropriateness. Feedback from these industry experts resulted in minor refinements to the survey questionnaire. The final questionnaire along with the mean and standard deviation for each item is provided in Fig. 3.

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of 10.4%. While a higher response rate is desirable, a rate of response around 10% is common for survey-based research in the operations literature (e.g. Koufteros et al., 1998; Rosenzweig et al., 2003; Roth and van der Velde, 1991). In 16 cases, responses were incomplete, leaving a usable sample of 198. Table 1 illustrates the response profile. Assessments of data normality did not yield any evidence to cause concern. A final set of tests prior to further data analysis is for the potential of non-response bias. The first test for evidence of non-response bias is a comparison (independent sample t-tests) of answers between early and late submitted questionnaires (Armstrong and Overton, 1977). Further analysis was performed by comparing the response sample to the total pool of invited professionals along the dimensions of firm size (annual revenue) and primary industrial classification. These analyses revealed no observable differences that would be cause for concern of significant non-response bias. 5. Measurement quality The extensive literature survey and review of the questionnaire by industry experts established content validity for the measurement model. Next, a pilot data set is used to perform an exploratory analysis on the original measurement model and refine the model as required. Finally, a larger hold-out data set is used for the confirmatory analysis on the refined model.

4.2. Data collection and non-response evaluation 5.1. Exploratory factor analysis The research objectives were best achieved by obtaining responses from professionals holding senior level positions and representing a diverse set of outsourcing experiences in terms of the type of outsourcing activity (e.g. manufacturing vs. business process, domestic vs. international, contract size), industry, and firm size. Contact information for well-qualified sample informants was identified with the assistance of an officer of the International Association of Contract and Commercial Management, and utilizing a professional online database. The industry experts who reviewed the preliminary survey also provided insights as to the type of job titles that would reflect probable knowledge of outsourcing initiatives. Utilizing this guidance, the sample was selected based upon job titles and job descriptions available. Employing the multiple contact strategy as advocated in Dillman (2007), a total of 2171 procurement and sourcing professionals were invited to participate in the online survey from May to August of 2007. Four email contacts were made with the potential informants including a prenotice, the primary invitation letter along with a survey link, and two brief reminder letters. As part of the correspondence with potential informants, they were asked to notify the research team if they were inappropriately identified for participation. A response was received from 119 individuals indicating that they were not well qualified to effectively complete the questionnaire. Common reasons provided include retirement, change of jobs, or only peripheral involvement with outsourcing. Of the remaining 2052, a questionnaire was returned by 214 informants indicating a response rate

The exploratory, pilot analysis seeks to use a separate data set to refine the initial measurement model by purifying the scales and evaluating reliability. The pilot data set was created by randomly selecting 50 cases from the overall set of 198 cases. While this pilot sample size is modest, it compares well with the sample size of other pilot studies in operations and supply chain management (Koufteros et al., 1998; Nahm et al., 2003). The exploratory analysis is conducted in two stages. First, the original measurement model is analyzed and modifications identified. In the second stage, the modified or re-specified model is evaluated with the same pilot data set. Corrected Item to Total Correlation (CITC) is used to assess the reliability of each item and is a measure of internal consistency which evaluates the correlation of each item to the overall summated scale. It is recommended that items within a scale should have a CITC value of 0.50 or higher (Hair et al., 1998; Kerlinger, 1986; Robinson et al., 1991). Convergent validity was assessed by performing maximum likelihood (MWL) factor analysis at the individual factor level. While loadings above 0.30 are considered to meet minimum standards, loadings in the 0.40–0.50 range are more valid (Guadagnoli and Velicer, 1988; Hair et al., 1998). Using these criteria, three manifest variables were removed from the original measurement model. The first removed item (SR1), which represents the consideration of the impact that outsourcing would have on customers, had both a CITC less than 0.50 and factor loading at 0.45. While outsourcing may impact customers some of the time, some outsourcing efforts may have little

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352 Table 1 Response data profile. Title of respondent

Percent

Organization annual revenue

Percent

Respondent summary CXO Vice president Director Senior manager Manager Other

3.8 15.3 29.0 8.2 35.0 8.7

Less than $500 million Between $500 million and $1 billion Between $1 billion and $4.9 billion Between $5 billion and $9.9 billion Between $10 billion and $25 billion More than $25 billion

9.0 9.7 20.6 17.4 23.2 20.0

Source: Hoover’s Online (a Dunn & Bradstreet Company) SIC

Industry description

Percent

Respondent summary 20 Food and kindred products 26 Paper and allied products 28 Chemicals and allied products 30 Rubber and miscellaneous plastics products 33 Primary metal industries 34 Fabricated metal products, except machinery and transportation equipment 35 Industrial and commercial machinery and computer equipment 36 Electronic and other electrical equipment and components, except computer equipment 37 Transportation equipment 38 Measuring, analyzing, and controlling instruments; photographic, medical and optical goods; watches and clocks 45 Transportation by air 48 Communications 49 Electric, gas, and sanitary services 51 Wholesale trade-non-durable goods 52 Building materials, hardware, garden supply, and mobile home dealers 57 Home furniture, furnishings, and equipment stores 60 Depository institutions 61 Non-depository credit institutions 62 Security and commodity brokers, dealers, exchanges, and services 63 Insurance carriers 67 Holding and other investment offices 73 Business services

1.9 1.3 11.3 1.3 1.3 1.3 11.9 7.5 9.4 3.8 1.3 5.0 3.1 2.5 1.3 1.3 4.4 4.4 1.3 5.0 2.5 8.1

Source: Hoover’s Online (a Dunn & Bradstreet Company) Category of outsourced activity

Percent

Annual contract size in US$

Percent

Outsourcing initiative summary Business process—information technology or systems Other—business process Manufacturing of end items Manufacturing of component parts Other—manufacturing Business process—human resources Logistics services Call center or customer service center Business process—accounting or finance

25.8 19.2 16.7 12.1 6.6 5.6 5.6 4.5 4.0

Less than $5.0 million Between $5.0 million and $49.9 million Between $50.0 million and $99.9 million Between $100 million and $499.9 million Between $500.0 million and $999.9 million $1.0 billion or more

21.5 43.6 15.9 11.3 1.5 6.2

Location of chosen providers

Percent

Planned contract duration

Percent

Outsourcing initiative summary Both domestic and international providers Domestic provider(s) only International provider(s) only

43.9 26.5 29.6

1 year 2 years 3 years 4 years 5 years More than 5 years

7.1 9.6 36.0 3.6 24.4 19.3

or no impact on customers. This item would potentially not be relevant in a number of outsourcing engagements and was therefore removed from the model. The second item removed (CC6) indicated the clarity of service requirements in the contract. Again, this item had a lower than desired CITC and factor loading. Further examination also revealed that this item was redundant with other items in the construct. Similarly poor statistical results led to the deletion of the item representing unique relationship

investments (RC5). A similar question was found to be problematic in a prior study as well (Prahinski, 2001). These three items exhibited insufficient reliability and convergent validity, and could be removed from the measurement instrument without sacrificing the conceptual domain of the respective constructs. The original measurement model was re-specified to incorporate the modifications suggested by the exploratory analysis. The overall CITC values and factor loadings

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were improved as a result. The Cronbach’s alpha values, which measure the reliability of each construct, are well above the minimum threshold for new (0.60) or existing scales (0.70) (Carmines and Zeller, 1979; Nunnally, 1978). Each of the factors has an Eigen value above 2.0 and the percentage of variance explained ranges from 54.1% to 73.5%. Collectively, this analysis offers initial evidence of a reliable and valid measurement model. 5.2. Confirmatory factor analysis The specification of the relationships between latent constructs and their respective manifest variables is based on theory and modifications made as a result of the exploratory pilot analysis. The maximum likelihood method within LISREL 8.7 (Scientific Software International, 2005) is used to conduct the confirmatory factor analysis (CFA) and the structure equation modeling analysis discussed later. Table 2 illustrates that the multiple measures of absolute and incremental model fit reflect a reasonable to good fitting measurement model (Bollen, 1989; Gerbing and Anderson, 1992; Hu and Bentler, 1998, 1999). 5.2.1. Empirical assessment of second-order factors Second-order factors are latent constructs used to explain the covariance between two or more first-order factors. In this study, second-order factors are utilized because of the expected correlation among the management practices representing the first-order factors. A benefit of using second-order factors as more encompassing meta-constructs influencing first-order factors is that the individual first-order factors can capture more ‘‘homogeneous, narrowly defined content domains’’ (Gerbing et al., 1994). Moreover, second-order factors can capture external influences that are common to first-order factors (Bollen, 1989). Stated differently, the second-order factor is the ‘‘component common to’’ the first-order factors (Gerbing and Anderson, 1984). The statistical validation of the reflective second-order factors provided in this section complements the theoretical justification offered in Section 2. Statistical evaluation of the second-order factor model can be evaluated by comparing the fit of the first-order model with that of the more restrictive second-order model. The target coefficient (T), which is the ratio of the x2 for the first-order model to the x2 of the second-order model, provides an indication of the degree to which the Table 2 Confirmatory factor analysis overall model fit. Model fit criterion

Value

Suggested range

x2

378.31 225 1.68 0.068 (0.056; 0.080)

N/A N/A 2.0 0.08 (reasonable fit) (0.00; 0.08)

0.063 0.95 0.96 0.96

0.10 0.90 0.90 0.90

Degrees of freedom (d.f.) x2/d.f. RMSEA point estimate RMSEA 90% confidence interval RMR NNFI CFI IFI

353

second-order model accounts for the relations among the first-order factors (Marsh and Hocevar, 1985; Tanriverdi and Venkatraman, 2005). Conducting confirmatory factor analysis and evaluating both a firstorder and second-order factor model yields a (T) coefficient of 0.984. This indicates that the second-order factors explain the vast majority of the relations among capability evaluation and strategic risk assessment, and the relations among relationship commitment and cooperation. The paths from both strategic evaluation and relationship management to their respective firstorder constructs were all statistically significant at p < 0.01 providing further support for the use of second-order factors (Venkatraman, 1989). Therefore, it is theoretically and statistically appropriate to model strategic evaluation and relationship management as a reflective second-order constructs. 5.2.2. Convergent validity, discriminant validity, and reliability Along with assessing the fit of the overall model, it is necessary to confirm the validity and reliability of each construct. Fig. 4 provides an overview of these results. Anderson and Gerbing (1988) recommend that the tvalues for the factor loadings of manifest variables on their intended latent factor represent a p-value < 0.01. Others have simply suggested that loadings exceed a minimum value of 0.30 or 0.40 (Carmines and Zeller, 1979; Hair et al., 1998). The factor loadings exhibit a high degree of convergent validity with the minimum t-value for a factor loading being 4.35. Cronbach’s alpha (a) is again used to examine the internal consistency reliability of each scale. The Cronbach’s alpha values for each factor all comfortably exceed the desired level even for well-established scales (0.70). Additional indications of acceptable levels of reliability are the average variance extracted (AVE) and composite reliability statistics. These results also provide evidence of sufficient construct reliability (Fornell and Larcker, 1981). The AVE for cooperation is below the ideal threshold of 0.50 but still at an acceptable level of 0.40 (Hatcher, 2003; Menor et al., 2007). The composite reliabilities are all strong. Finally, the inter-factor correlation matrix is examined to evaluate discriminant validity. The inter-factor correlation point estimates and standard errors in Fig. 5 clearly indicate that discriminant validity is sufficiently supported in that the 95% confidence intervals do not contain the value of 1.0 (Anderson and Gerbing, 1988). As an additional test, the method for evaluating discriminant validity offered by Bagozzi et al. (1991) was utilized. A series of matched constrained and unconstrained models were tested for statistical difference using a x2 test for differences. In each constrained model, a pair of firstorder constructs was specified to have a correlation of 1.0. The fit of each constrained model was then compared to the unconstrained model, which allows the inter-factor correlations to be free parameters. The p-values associated with each x2 test for differences again indicate that all constructs represent unique scales (O’Leary-Kelly and Vokurka, 1998). This collective statistical evidence firmly establishes discriminant validity.

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Fig. 4. CFA factor loadings and reliabilities.

Fig. 5. Inter-factor correlations (point estimates are below the diagonal and standard errors are above the diagonal).

5.2.3. Common methods variance Data for this study was collected from a single informant. Therefore, it is prudent to statistically test for unacceptable levels of common methods variance prior to evaluating the research hypotheses. To do so, the approach recommended by Podsakoff et al. (2003) was followed. Using this method, an additional unmeasured ‘‘methods’’ factor is introduced into the measurement model to control for a latent methods effect. In doing so, all items continued to load significantly on their intended factors. This evidence suggests that common methods variance is not a significant concern. 6. Analysis and results The outsourcing performance variable included in the structural models is a composite of the informant’s rating of performance for annual cost, quality, responsiveness or

flexibility, and reliability relative to expectations. Factor analysis was used to develop this information into a composite performance variable, and resulted in all factor loadings being above 0.50. As with the measurement model, multiple measures were used to assess the overall fit of the structural model. The results for root mean squared error of approximation (RMSEA) (0.064), RMSEA 90% confidence interval (0.053; 0.074), and root mean square residual (RMR) (0.071) provide sufficient evidence for reasonable to good absolute model fit. Good incremental model fit is supported by the figures for the non-normed fit index (NNFI) (0.95), comparative fit index (CFI) (0.95), and incremental fit index (IFI) (0.95). The results for the structural model are presented in Fig. 6 and Table 3. Fig. 6 graphically illustrates the standardized path coefficients for each hypothesized relationship. Dashed lines indicate that the path coefficient

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355

Fig. 6. Structural model results.

is not significantly different from zero (p < 0.05). Table 3 provides similar information in tabular format along with the t-value for each path coefficient. Table 3 also offers evidence the structural model has a level of statistical power well above the commonly desired threshold of 0.80. The algorithm presented in MacCallum et al. (1996), based upon the non-central x2 distribution and degrees of freedom in the model, was used to determine the power level. 6.1. Hypothesis 1: strategic evaluation and outsourcing performance It was hypothesized that an extensive strategic evaluation will have direct benefits in terms of outsourcing performance. Such an evaluation may prevent organizations from outsourcing a core competency or outsourcing activities for which the strategic risk is too high. It also allows them to achieve a clear understanding of the outsourced activity, how it must be managed, and how resources must be coordinated with the partner firm. This hypothesis is directly tested by assessing the statistical significance of path g5. The standardized path coefficient from strategic evaluation to outsourcing performance

SE ! capability evaluation SE ! strategic risk assessment SE ! CC SE ! RM SE ! outsourcing performance CC ! outsourcing performance RM ! relationship commitment RM ! cooperation RM ! outsourcing performance R2 in outsourcing performance Statistical power

6.2. Hypothesis 2: strategic evaluation and contractual completeness Strategic evaluation was hypothesized to positively influence contractual completeness. It was reasoned that a more extensive strategic evaluation provides the outsourcing firm with more detailed insights on the strategic implications associated with outsourcing. These insights can then be utilized to develop a more effective contract to address the identified coordination and control requirements that were identified as a result of the strategic evaluation. This hypothesis is evaluated by assessing the statistical significance of path g3. The standardized path coefficient from strategic evaluation to contractual completeness (g3 = 0.76; t-value = 6.86) is highly significant at p < 0.01 in the structural model. Therefore, Hypothesis 2 receives strong statistical support. Strategic evaluation has significant positive effect on contractual completeness. 6.3. Hypothesis 3: strategic evaluation and relationship management

Table 3 Structural path coefficients and associated t-values. Path

(g5 = 0.23; t-value = 1.12) was not statistically significant. Based upon this result, Hypothesis 1 would not be supported (see Fig. 6).

Full model Standardized coefficient

t-Value

0.86 0.86 0.76 0.65 0.23 0.07 0.89 0.89 0.37

7.56 7.56 6.86 5.27 1.12 0.45 5.62 5.62 2.60 0.25 0.9991

SE = strategic evaluation; CC = contractual completeness; RM = relationship management.

Strategic evaluation was also hypothesized to be an antecedent to effective relationship management. Relationship managers can structure their cooperative behaviors in a manner that will mitigate a priori identified concerns. Further, by developing the relationship as a partnership with tightly integrated goals and incentives, inherent strategic risks to external sourcing such as shirking and opportunism can be diminished. This hypothesis is evaluated by assessing the statistical significance of path g4. The standardized path coefficient from strategic evaluation to relationship management (g4 = 0.65; t-value = 5.27) is highly significant at p < 0.01. Therefore, Hypothesis 3 receives strong statistical support. Strategic evaluation has significant positive effect on relationship management.

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6.4. Hypothesis 4: contractual completeness and outsourcing performance

managerial implications of each finding will be discussed in the following sections.

The academic literature has provided theoretical support for the hypothesis that contractual completeness positively influences outsourcing performance. A more complete contract is posited to more effectively coordinate inter-organizational resources, align incentives, and mitigate opportunistic behavior. The fourth hypothesis is tested by evaluating the statistical significance of path b3 in the model. The standardized path coefficient from contractual completeness to outsourcing performance (b3 = 0.07; t-value = 0.45) is found to be statistically insignificant. Based upon this result, Hypothesis 4 is not supported. This study does not offer statistical evidence that contractual completeness has a significant impact on outsourcing performance.

7.1. Strategic evaluation and outsourcing performance It was hypothesized that an extensive strategic evaluation will have direct benefits in terms of outsourcing performance. The results from the statistical analysis in the prior section indicate a lack of a direct effect of strategic evaluation on outsourcing performance. These findings merit deeper evaluation. The statistical evidence illustrates that the effect of strategic evaluation on outsourcing performance is perhaps better characterized as indirect. Put differently, this effect appears to be at least partially mediated. To shed insight into this notion, two additional structural models were evaluated and an analysis of the direct and indirect effects conducted. A second model that only contains the strategic evaluation and contractual completeness constructs was evaluated. A third model examines the strategic evaluation and relationship management constructs along with their effect on outsourcing performance. By evaluating the disaggregated models (contractual and relationship models) along with the full model, it becomes very clear on how these constructs uniquely mediate the effect of strategic evaluation on outsourcing performance. Since these relationships were not formally hypothesized, the analysis is not detailed here (results from this analysis are readily available from the authors). The supplemental analysis reveals significant evidence that strategic evaluation’s effect on outsourcing performance is partially mediated by relationship management but not contractual completeness. When relationship management is not present in the model, strategic evaluation has a significantly positive direct effect on outsourcing performance. Yet, the results from the relationship model indicate that it is the indirect effect of strategic evaluation on outsourcing performance that is significant. This influence is partially mediated by relationship management. Thus, there is sufficient statistical evidence to conclude that strategic evaluation plays a significant, positive role in determining the success of outsourcing initiatives; however its positive influence is indirect in that it strengthens relationship management, which in turn has a significant direct effect on outsourcing performance. From a managerial perspective, conducting an exhaustive strategic evaluation of outsourcing opportunities allows firms to enter the arrangement with more realistic expectations and allows them to focus on critical manage-

6.5. Hypothesis 5: relationship management and outsourcing performance The marketing channel literature and operations supply chain literature have both offered wide support for the impact that relationship commitment and cooperation have on the performance of established exchange relationships. This study uses the validated relationship management construct to capture the outsourcing organization’s commitment to the external sourcing relationship and its cooperative behaviors. The fifth hypothesis is tested by evaluating the statistical significance of path b4. The standardized path coefficient from relationship management to outsourcing performance (b4 = 0.37; tvalue = 2.60) is found to be statistically significant. Based upon this result, Hypothesis 5 is strongly supported. Therefore, there is strong evidence to suggest that there is a direct positive influence of relationship management on outsourcing performance. 7. Discussion and managerial implications This study presented an outsourcing process model represented by three sets of management practices hypothesized to influence outsourcing performance. Strategic evaluation, contractual completeness, and relationship management theoretically represent critical aspects of the outsourcing process. In total, the structural model explained 25% of the variance in outsourcing performance (R2 = 0.25). Table 4 summarizes the findings from the statistical analysis as they relate to each hypothesis. The

Table 4 Hypotheses testing summary. Hypothesis

Structural model path

Result

Conclusion

1: 2: 3: 4: 5:

g5 g3 g4 b3 b4

Insignificant Significant Significant Insignificant Significant

Not supporteda Supported Supported Not supported Supported

Strategic evaluation ! outsourcing performance Strategic evaluation ! contractual completeness Strategic evaluation ! relationship management Contractual completeness ! outsourcing performance Relationship management ! outsourcing performance

a Formally, Hypothesis 1 was not supported. Further analysis revealed the presence of a significant total and indirect effect, but not a significant direct effect.

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ment factors to mitigate potential strategic risks. Another potential benefit of a comprehensive strategic review that is not explicitly captured by the model in this study is the avoidance of outsourcing strategically important functions or those with excessive strategic risks. These findings highlight the importance for management teams to perform a thorough strategic due diligence prior to moving forward with outsourcing opportunities. Outsourcing opportunities may offer considerable short-term financial gains, however these benefits must be weighed against the risks that are being assumed. Moreover, a strategic evaluation harnesses organizational knowledge, which when used to select the retained team, structure the contract, and collaborate with suppliers can yield significant benefits in terms of improved outsourcing performance. From this study, it is recommended that management teams thoroughly consider not only the economic implications, but also the strategic implications of each outsourcing opportunity. The analysis indicates that a more extensive strategic evaluation does not directly lead improved performance of the outsourcing initiative. Instead it is the indirect benefit of this knowledge which is of value. The knowledge gained from the strategic evaluation yields benefits in terms of effectively implementing the external sourcing arrangement, and enhancing the relationship management involved with the outsourced business activity. 7.2. Strategic evaluation and contractual completeness It was hypothesized that a more extensive strategic evaluation influences contractual completeness. The results from the structural equation modeling analysis offer strong support for this hypothesis. This finding demonstrates that a thorough strategic evaluation is positively related to the development of a more complete contract with clearly defined service objectives and risk/ reward provisions in order to align incentives. The managerial implication of this result is that prior to contract development, the organization must have a clear understanding of how the outsourcing initiative is supportive of its broader strategic objectives and the risks involved with external sourcing. Through an extensive strategic evaluation, the outsourcing firm develops a keen understanding of the resources and capabilities anticipated to derive competitive advantage now and in the future. While resources and capabilities at an organization’s core will likely remain within the firm, it is certainly possible that valuable and complementary resources will also reside within the partner firm. This evaluation will lead to a better understanding of inter-firm resource coordination requirements, which can be facilitated through coordinative contractual provisions (Mellewigt ˜ o, 2007) A more extensive et al., 2007; Reuer and Arin strategic evaluation reveals the value and location of key capabilities as well as the potential risks involved with outsourcing a particular business activity. This knowledge can and should be utilized by management teams to craft effective coordinating and control provisions within their outsourcing contract.

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7.3. Strategic evaluation and relationship management Strategic evaluation was also hypothesized to be an antecedent to effective relationship management. This hypothesis receives strong statistical support from the results of this study with the path from strategic evaluation to relationship management being positive and highly significant. The managerial relevance of this finding is impressive. The comprehensive strategic assessment highlights the potential strategic risks and underscores the need to partner with the external provider rather than taking an arms-length approach to the relationship. Along with being in a better position to mitigate outsourcing risks, an extensive strategic evaluation identifies those capabilities which must be codeveloped with the provider. While it was stated previously that contractual provisions can be established to facilitate resource coordination and control for identified risks, contracts are widely known to be incomplete to some extent (Crocker and Reynolds, 1993; Poppo and Zenger, 2002). Due to bounded rationality it is impossible if not prohibitively expensive to craft a perfectly complete contract (Klein et al., 1978; Williamson, 1979). For this reason, it is also critical that the resource coordination and risk control requirements, which are outputs of the strategic evaluation, be used to structure the committed and cooperative relationship with the supplier. It is this clarity of risks and capability requirements that allows the strategic evaluation to strengthen the effectiveness of relationship management efforts. In order to clearly articulate expectations to the supplier, the outsourcing organization must first internally comprehend its strategic goals and concerns. While the knowledge acquired by the strategic evaluation is itself useful to the organization, its value to the performance of the exchange is enhanced when shared with the provider. Sharing the knowledge that results from the strategic evaluation establishes a mutual understanding of the objectives and concerns of the outsourcing firm, which in turn places the provider in a more informed position to allocate resources in a manner that is consistent with the goals of the customer. Thus, an extensive strategic evaluation creates a knowledge set encompassing capability value, resource coordination and development requirements, and the strategic risks associated with external sourcing. Capitalizing on this information allows the outsourcing firm to appropriately structure the relationship, and sharing it with the provider allows them to more effectively service the outsourcing organization. 7.4. Contractual completeness and outsourcing performance The expected positive influence that a more complete contract has on outsourcing performance was expressed as the fourth hypothesis. The standardized path coefficient from contractual completeness to outsourcing performance was found to be statistically insignificant. Based upon these results, hypothesis four was not supported. The managerial implication of this finding is intriguing. Developing a more complete contract alone is simply not sufficient to distinguish between well performing and

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poor performing outsourcing initiatives. As shown in Fig. 3, the mean values for these items are similar to the mean values for the other constructs. The mean rating for all items reflected within the contractual completeness factor is 3.84, compared with 3.91 for strategic evaluation and 3.71 for relationship management. This indicates that outsourcing teams are striving to develop more complete contracts. However, the path from contractual completeness to outsourcing performance does not indicate that these practices drive outsourcing performance. A contract can be considered a legal legitimate form of power, which does not guarantee successful execution of an interorganizational exchange. This finding is also consistent with the notion of contractual incompleteness discussed in the literature (Grossman and Hart, 1986; Klein et al., 1978). Although contracts can be structured in an effort to align incentives and mitigate risks, these measures alone cannot be complete due to the complexity and uncertainty surrounding many outsourcing engagements. In summary, it is not recommended that the findings associated with this hypothesis be interpreted to mean that organizations should not be concerned about developing a more complete contract. An effective contract can serve to structure coordinating routines, clarify responsibilities, and provide a legal means for addressing irresolvable disputes. However, firms need to be aware of the limits to which these efforts can ensure achieving performance objectives. These results make it clear that a more complete contract alone cannot be relied upon by firms to completely realize the performance objectives of their outsourcing efforts. 7.5. Relationship management and outsourcing performance The final hypothesis indicated that relationship management has a significant positive effect on outsourcing performance. The results of this study leave little doubt as to the importance of effective relationship management practices on outsourcing performance. The managerial implication of this finding is clear. There is a tremendous difference between an outsourcing opportunity which offers potential value and the realization of this value (Madhok and Tallman, 1998). The results related to this hypothesis offer strong evidence that a key to realizing this potential value lies in relationship management. Due to the inherent complexity and uncertainty associated with many outsourcing engagements, a contract alone is not sufficient to align objectives and mitigate external sourcing risks. It is critical that organizations are committed to their outsourcing relationships and behave in a cooperative and collaborative manner if they wish to extract the full value from outsourcing. Only in an environment characterized by commitment and cooperation, will providers make investments uniquely intended to benefit a particular exchange. These relationship specific investments coupled with a long-term orientation ultimately drive down transaction costs associated with contracting, monitoring, enforcement, and opportunism while simultaneously improving learning and operational performance (Dyer, 1996; Helper et al., 2000). In the absence of a committed and cooperative relationship, the

potentially inherent risks associated with external sourcing may manifest in goal misalignment, undesired myopic behavior, and performance degradation. As well documented, the automotive industry offers a clear example of how firms with the same suppliers, but employing a different relationship orientation, can realize vastly different results (Liker and Choi, 2004). These results indicate that organizations that wish to incorporate outsourcing as part of their broader strategic plan must invest resources into the development of a strong relationship management competence. As organizations are continuing to outsource ever more important aspects of their value chain, they must be able to effectively coordinate and control outsourced business activities which no longer lie within their hierarchical control. Due to contractual incompleteness and the cost of managing contracts to the letter of the law, legal forms of redress are not completely effective. Thus, organizations must invest in capabilities that allow them to coordinate and control outsourced activities using relational rather than formal mechanisms. 8. Conclusions This study identifies salient elements of the business outsourcing process and made significant contributions to the academic literature. There are three main contributions of this study. First, an outsourcing model that is strongly grounded in theory was presented and tested. Secondly, a rigorous multi-stage methodology was used to refine and validate new scales for constructs pertaining to the strategic evaluation and contractual completeness of outsourcing initiatives. Finally, a thorough empirical methodology was utilized to establish unambiguous prescriptions for the management of outsourcing initiatives. These managerial recommendations include:  Outsourcing management teams must focus on the development of a cooperative and mutually committed relationship with the provider if they are to fully realize their performance expectations.  The positive influence of strategic evaluation on outsourcing performance is indirect rather than direct. The true value of a more extensive strategic evaluation lies in its direct influence on relationship management which in turn directly influences outsourcing performance.  While extensively sought, a more complete contract cannot be relied upon to guarantee improved outsourcing performance. Future studies concerning the drivers of outsourcing performance are warranted. The model evaluated in this study explained a substantive 25% of the variance in performance, yet also points to the need for understanding other elements of the outsourcing process that meaningfully impact performance. This evolving field offers many complexities that must be more fully understood. For instance, recent work by Aron et al. (2008) offers initial insights into how advances in information technology are allowing buying firms to gain more control over their offshore BPO providers which results in improved levels of

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process quality. Also, the current study did not find support for the hypothesis that contractual completeness influenced outsourcing performance. Future research could look at specific outsourcing environments where the contract plays a more or less significant role in determining performance outcomes. Alternatively, future empirical efforts could investigate whether a more complete contract when used in conjunction with other ‘‘enforcement’’ practices (e.g. monitoring, inspections, audits) would significantly influence performance outcomes. Additionally, there are often significant employee related issues that arise with outsourcing and complicate the implementation of the new sourcing arrangement. Future empirical studies could take a more focused look into these areas. For example, one could study a sample of outsourcing initiatives which result in layoffs or employee transfers. Finally, it is often said that outsourcing alters the risk profile of supply chains. This notion offers rich opportunities for exploration. Future studies could seek to develop detailed insights as to how organizations can balance the potential financial benefits of outsourcing with the inherent risks (financial and/or strategic) involved. These are just a few examples of potential studies in what is anticipated to be a blossoming research stream. Acknowledgements This study was partially supported by a Doctoral Dissertation Grant from the Institute for Supply Management. We would also like to acknowledge the feedback and guidance offered by the International Association for Contract and Commercial Management during the study. References Ahmadjian, C.L., Lincoln, J.R., 2001. Keiretsu, governance, and learning: case studies in change from the Japanese automotive industry. Organization Science 12 (6), 683–701. Alchian, A.A., Demsetz, H., 1972. Production, information costs, and economic organization. American Economic Review 62 (5), 777–795. Alexander, M., Young, D., 1996. Outsourcing: where’s the value? Long Range Planning 29 (5), 728–730. Anderson, E., Weitz, B., 1992. The use of pledges to build and sustain commitment in distribution channels. Journal of Marketing Research (JMR) 29 (1), 18. Anderson, E., Weitz, B., 1989. Determinants of continuity in conventional industrial channel dyads. Marketing Science 8 (4), 310–323. Anderson, J.C., Gerbing, D.W., 1988. Structural equation modeling in practice: a review and recommended two step approach. Psychological Bulletin 103 (3), 411–423. Anderson, J.C., Narus, J.A., 1990. A model of distributor firm and manufacturer firm working partnerships. Journal of Marketing 54 (1), 42– 58. Argyres, N., Mayer, K.J., 2007. Contract design as a firm capability: an integration of learning and transaction cost perspectives. Academy of Management Review 32 (4), 1060–1077. Armstrong, J.S., Overton, T.S., 1977. Estimating nonresponse bias in mail surveys. Journal of Marketing Research 14 (3), 396–402. Aron, R., Bandyopadhyay, S., Jayanty, S., Pathak, P., 2008. Monitoring process quality in off-shore outsourcing: a model and findings from multi-country survey. Journal of Operations Management 26, 303–321. Aron, R., Clemons, E.K., Reddi, S., 2005. Just right outsourcing: understanding and managing risk. Journal of Management Information Systems 22 (2), 37–55. Bagozzi, R.P., Yi, Y., Phillips, L.W., 1991. Assessing construct validity in organizational research. Administrative Science Quarterly 36 (3), 421–458.

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