The Effects of Supply Chain Integration on the Cost Efficiency of Contract Manufacturing

• Author: Yoon Hee Kim,Tobias Schoenherr
• Published date: 01 July 2018
• Date: 01 July 2018
• DOI: http://doi.org/10.1111/jscm.12168

THE EFFECTS OF SUPPLY CHAIN INTEGRATION ON THE

COST EFFICIENCY OF CONTRACT MANUFACTURING

YOON HEE KIM

Georgia Southern University

TOBIAS SCHOENHERR

Michigan State University

While the literature on supply chain integration (SCI) is proliferating, the

link between SCI and a firm’s contract manufacturing performance has

not been investigated yet. To fill this gap in the literature, we investigate

the effects of supply chain integration on contract manufacturing effi-

ciency using the objective measure of return on contract manufacturing.

Unlike prior studies, this research uses finer-grained dimensions of SCI by

not only differentiating between customer and supplier integration but

also by separating integration activities depending on their purpose for

either product development or process improvement, thus enhancing our

understanding of the underlying theoretical dynamics by disentangling

each dimension’s respective contribution to a firm’s contract manufactur-

ing efficiency. Using archival survey data from 322 manufacturing firms

collected by the Korea Productivity Center, we demonstrate that integra-

tion activities with customers and suppliers, depending on whether they

focus on products or processes, generate contradicting outcomes in terms of

return on contract manufacturing, thereby challenging the implicit

assumption about the equivocal benefits of SCI across manufacturing sys-

tems. Furthermore, our findings substantiate the positive moderating

effects of cross-functional integration on the external integration–perfor-

mance links by demonstrating the amplified effects, either positive or neg-

ative, of integration on return on contract manufacturing.

Keywords: supply chain integration; contract manufacturing efficiency; product

integration; process integration; archival survey data

INTRODUCTION

Contract manufacturing (CM), which refers to a sup-

ply chain arrangement that allows a manufacturing

firm to outsource some of its internal manufacturing

processes, such as assembly operations (Kim, 2003),

has become the de facto standard for many competi-

tive industries, including automotive, telecommunica-

tions, and garment production (Berggren &

Bengtsson, 2004; Dyer, 1996; Plambeck & Taylor,

2005; Uzzi, 1997). By shifting production capacity to

contract manufacturers, manufacturing firms aim to

focus their own efforts on new product and technol-

ogy development while reducing production costs

(Berggren & Bengtsson, 2004; Kakabadse & Kak-

abadse, 2002; Plambeck & Taylor, 2005). Coupled

with the growing reliance on CM, firms have

increased investments in supply chain integration

(SCI) to create a seamless flow of information, materi-

als, products, and services across organizational

boundaries. Such integration is needed to maintain

and improve the quality and delivery of products and

services while capitalizing on the cost benefits associ-

ated with CM (Flynn, Koufteros & Lu, 2016; Leusch-

ner, Rogers & Charvet, 2013; Ralston, Blackhurst,

Cantor & Crum, 2014).

However, the link between SCI and contract manu-

facturing performance has not been investigated in the

literature. Extant studies on SCI provide evidence for

the effects of SCI on product development outcomes

(Koufteros, Cheng & Lai, 2007; Perols, Zimmermann &

Kortmann, 2013) and production costs (Schoenherr &

Swink, 2012; Wong, Boon-itt & Wong, 2011), but fail

Volume 54, Number 342

Journal of Supply Chain Management

2018, 54(3), 42–64

©2018 Wiley Periodicals, Inc.

to detect relationships to profitability measures, such as

return on sales and return on assets (Flynn, Huo &

Zhao, 2010; Swink, Narasimhan & Wang, 2007). Based

on case studies involving Ericsson’s and Nokia’s con-

tract manufacturing, Berggren and Bengtsson (2004)

argue that initial savings in production costs from

cheaper labor and economies of scale are likely offset

by “hidden costs,” which refer to the time, effort, and

resources associated with achieving adequate levels of

coordination and control among outsourcing partners

(Gulati & Singh, 1998; Handley & Benton, 2013). This

can be one reason for the unsupported links of SCI to

profitability measures in prior works. Compared to

those with in-house assembly responsibilities, firms

relying on CM have to coordinate and control informa-

tion and activities across a wider span of organizational

boundaries, involving not only part suppliers but also

contract manufacturers. This inherent and elevated

complexity associated with CM raises several research

questions: How does SCI influence the cost efficiency

of contract manufacturing? Are there trade-offs between

cost savings from contract manufacturing and invest-

ments in SCI? What impact do different types of inte-

gration activities have on the cost efficiencies derived

from contract manufacturing?

To address these questions, this study examines the

relationships between a manufacturing firm’s invest-

ment in SCI and its return on contract manufacturing,

which is defined as the ratio of net income to contract

manufacturing expenses. With this investigation, we

can identify trade-offs between cost savings from CM

and investments in SCI. In addition, unlike prior stud-

ies which primarily differentiated SCI based on cus-

tomers or suppliers (Flynn et al., 2010; Schoenherr &

Swink, 2012; Srinivasan & Swink, 2015), the present

research further separates integration activities by their

focus either on product development or on process

improvement. Thus, we consider customer product and

process integration, and supplier product and process

integration. Several researchers have argued that task-

specific characteristics, such as interdependency and

complexity, affect coordination costs in outsourcing

relationships (Crook & Combs, 2007; Gulati & Singh,

1998; Handley & Benton, 2013). Our finer-grained

dimensions of SCI can capture the differing interde-

pendency and complexity of a firm’s integration activi-

ties, which may lead to differential performance

outcomes. Using the four dimensions of SCI, this

study disentangles each dimension’s respective contri-

bution to return on contract manufacturing which

captures the cost efficiency derived from contract man-

ufacturing. Overall, this is the first study that investi-

gates the relationship between various dimensions of

SCI and contract manufacturing performance.

Our research uses publicly available archival survey

data collected in 2013 from Korean manufacturing

firms as part of a large-scale research program by the

Korea Productivity Center (KPC) at the Korea Ministry

of Trade, Industry and Energy. We chose this dataset

for our study because contract manufacturing has a

lion’s share in the Korean manufacturing industry.

About half of Korea’s manufacturing industry (49.7%)

is comprised of contract manufacturers, including

mostly small- and medium-sized enterprises (Kim &

Park, 2016). From the KPC dataset, we selected 322

responses that provided the necessary information on

CM and SCI, as conceptualized in this research. A

unique feature of the KPC data employed in the cur-

rent research is that they were collected in a mixed-

response format from diverse respondents within each

firm, therefore enhancing the rigor of our research by

alleviating common method bias. As respondents

were not aware of this study or our research frame-

work at the time of data collection, response bias is

also reduced.

Our analyses of the data demonstrate that integra-

tion activities, depending on whether they focus on

products or processes, have differential impacts on CM’s

cost efficiency. While product integration (especially

with customers) detracts from a firm’s return on con-

tract manufacturing, efficiency gains from process inte-

gration with suppliers contribute to greater return on

contract manufacturing. These contradicting effects

between product and process integration on return on

contract manufacturing highlight the critical role of

manufacturing decisions in determining performance

outcomes of SCI, thereby challenging the implicit

assumption in the literature on the uniform effects of

such efforts across manufacturing systems. Further-

more, our results for customer and supplier integration

suggest differential magnitudes of costs associated

with managing the behavior of customers and suppli-

ers. This finding challenges theoretical notions under-

lying transaction cost economics that assume the

equivocality associated with risks of opportunism and

risk-control costs irrespective of the party’s role in a

relationship. Taken together, our findings advance our

theoretical insight into the relationship between SCI

and performance outcomes by offering greater levels

of precision and detail to the trade-offs between con-

trol and coordination costs, which are inherent to the

transaction costs associated with integration efforts.

LITERATURE REVIEW

Interorganizational Coordination and Control

Coordination and control are two primary sources

of “hidden costs” in interorganizational relationships.

Whereas coordination intends to facilitate information

sharing, communication, and decision-making across

organizational boundaries, control aims to mitigate

such behavioral uncertainty as opportunism between

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