Flexibility as firm value driver: Evidence from offshore outsourcing

• Author: Xiaotian T. Zhang,Jongmoo J. Choi,Lenos Trigeorgis,Ming Ju,Masaaki Kotabe
• DOI: http://doi.org/10.1002/gsj.1181
• Date: 01 May 2018
• Published date: 01 May 2018

RESEARCH ARTICLE

Flexibility as firm value driver: Evidence from

offshore outsourcing

Jongmoo J. Choi

1

| Ming Ju

2

| Masaaki Kotabe

1

| Lenos Trigeorgis

3,4

|

Xiaotian T. Zhang

5

1

Fox School of Business, Temple University,

Philadelphia, Pennsylvania

2

Department of Economics and Finance, College

of Business, Louisiana Tech University, Ruston,

Louisiana

3

University of Cyprus, Nicosia, Cyprus

4

King’s College London, London, U.K.

5

Saint Mary’s College of California, Moraga,

California

Correspondence

Masaaki Kotabe, The Washburn Chair Professor

of International Business and Marketing, Temple

University, The Fox School of Business, 1801

Liacouras Walk, 559 Alter Hall (006-14),

Philadelphia, PA 19122-6083.

Email: mkotabe@temple.edu

Research Summary: This article tests real options theory

predictions that uncertainty and flexibility are key value

drivers for offshore outsourcing moderated by switching

costs. Examining firm-specific and market data for out-

sourcing cases by U.S. firms, we find that the impact of

market and environmental uncertainty and flexibility on

outsourcing value is net positive and that it is greater for

offshore than for domestic outsourcing. Outsourcing bene-

fits are related to flexibility arising from growth options

and moderated by switching costs underlying outsourcing

activities, including loss of innovative capability and eco-

nomic, institutional, and cross-country cultural differences.

Managerial Summary: In the popular business litera-

ture, the “footloose”nature of outsourcing strategy char-

acterized by an outsourcing firm’s flexibility, as well as

the ability in finding appropriate suppliers on a global

basis, has often been touted as an important means of

dealing with market uncertainty. However, the academic

literature has not offered direct empirical support for the

inherent value of such outsourcing strategies. Our study

shows that firms tend to perform better financially when

they have such outsourcing flexibility under uncertain

market and environmental conditions, although this rela-

tionship may be somewhat weakened by potential loss of

innovative capability and cultural and other differences in

dealing with foreign suppliers.

KEYWORDS

offshore outsourcing, real options, strategic flexibility,

switching costs, uncertainty

Received: 8 September 2015 Revised: 25 August 2017 Accepted: 26 August 2017

DOI: 10.1002/gsj.1181

Copyright © 2017 Strategic Management Society

Global Strategy Journal. 2018;8:351–376. wileyonlinelibrary.com/journal/gsj 351

1|INTRODUCTION

Offshore outsourcing has become a prominent part of the restructuring of global firms’supply

chains. Both academics and consulting firms have supported the view that outsourcing is a key

driver of firm performance (e.g., Hätönen & Eriksson, 2009; Jensen, Larsen, & Pedersen, 2013;

Kotabe & Mol, 2009). Offshore outsourcing in particular has received considerable attention in the

media due to its role as a vehicle of international trade and its implications for employment and eco-

nomic growth (e.g., Wall Street Journal, 2006b). Yet, empirical work on the value of offshore out-

sourcing at the firm level has been limited and inconclusive (Mukherjee, Gaur, & Datta, 2013).

Surveys of U.S. executives by Gilley and Rasheed (2000) and Bryce and Useem (1998) find little or

no performance enhancement from outsourcing.

In prior literature, there are opposing arguments for and against outsourcing. Those in favor

of outsourcing emphasize performance improvement as a result of increased strategic focus, lower

production costs from outsourcing to lower-cost suppliers, reduction of bureaucratic costs, or rela-

tional rents. Those against outsourcing highlight the weaknesses potentially arising from poor

functional interface or diseconomies of scope, opportunistic partner behavior, increased transaction

and coordination costs, or hampered learning benefits and innovative capability (Kotabe &

Mol, 2009).

Flexibility as a driver of outsourcing has received limited attention, with the exception of a few

early authors, including Quinn and Hilmer (1994) and Linder (2004). The notion of flexibility stem-

ming from real options theory (ROT) has been examined in diverse organizational contexts that

affect the boundaries of the firm: multinational networks (Kogut & Kulatilaka, 1994), international

joint ventures (Reuer & Tong, 2005, 2007), foreign market entry (Chi & McGuire, 1996), and

others.

1

In this article, we examine the underexplored questions of flexibility for outsourcing cases:

Does flexibility emanating from offshore outsourcing enhance firm value? What is the value of flex-

ibility as a driver in offshore outsourcing decisions by U.S. firms?

The outsourcing decision provides an important forum for testing alternative theories on the

boundaries of the firm and its performance. While outsourcing may be part of broader organiza-

tional strategies affecting the boundaries of the firm (Coase, 1937; Williamson, 1979), we focus

in this article on strategic make-or-buy decisions under uncertainty from the perspective of ROT,

and we assess the value impact of outsourcing decisions in an international context. We build on

and extend the work of Kogut and Kulatilaka (1994), Trigeorgis (1996), Leiblein (2003), and

others, and we consider flexibility in the case of outsourcing viewed as a real option and examine

its empirical implications. Our real options view of outsourcing focuses on the notion that out-

sourcing by contracting out a supply of noncore functions or inputs for a fixed but renewable

time period provides flexibility, which is valuable to the firm under market uncertainty. The firm

can renew or terminate the contract (and switch to domestic or other production alternatives)

depending on market conditions at contract expiration. This view of flexibility providing a means

of framing a strategic response to uncertainty is not a core part of extant TCE/internalization or

RBV theories of outsourcing. The predicted role and impact of environmental uncertainty in gen-

eral on the make-or-buy decision and firm boundaries as examined here via the outsourcing deci-

sion under ROT is different from that under prevailing management theory. Under ROT, the

1

For work on real options in economics and finance, see Myers (1977), McDonald and Siegel (1986), Pindyck (1988), Dixit (1989),

Triantis and Hodder (1990), Trigeorgis (1993, 1996), and Bernardo and Chowdhry (2002).

352 CHOI ET AL.