Understanding the Supply Chain Outsourcing Cascade: When Does Procurement Follow Manufacturing Out the Door?

• Date: 01 July 2013
• Author: Barry L. Brewer,Bryan Ashenbaum,Joseph R. Carter
• Published date: 01 July 2013
• DOI: http://doi.org/10.1111/jscm.12021

UNDERSTANDING THE SUPPLY CHAIN OUTSOURCING

CASCADE: WHEN DOES PROCUREMENT FOLLOW

MANUFACTURING OUT THE DOOR?

BARRY L. BREWER

University of Wyoming

Bryan Ashenbaum

Miami University

Joseph R. Carter

Arizona State University

Does the outsourcing of manufacturing trigger a cascade of follow-on out-

sourcing, wherein related procurement activities are subsequently

entrusted to one’s outsourcing partner? We explored this question in a

survey of US-based electronics original equipment manufacturers (OEMs)

who have outsourced production to a contract manufacturer (CM). Trans-

action-cost economics and the resource-based view were used as theoreti-

cal lenses to assess six potential drivers of this decision, utilizing direct

and indirect-effects structural models across five phases of procurement

activity. Results suggest that some sets of conditions appear to lend them-

selves to a wholesale outsourcing approach, wherein the CM is entrusted

to both manufacture a product and engage in various procurement

activities. Other conditions foster a more retail approach to procurement

outsourcing, with limited or no follow-on outsourcing of procurement

activities. In general, firms seem more comfortable outsourcing tactical

procurement activities, entrusting strategic activities to CMs only when the

product is highly commoditized or when the CM controls access to

international resources the OEM is unable to leverage on its own. Overall,

the relationship between manufacturing and procurement outsourcing is

complex and contingent on a variety of factors.

Keywords: outsourcing (make or buy); procurement; purchasing; supply chain

management; contract manufacturing; transaction-cost economics; resource-based view

INTRODUCTION

The growth of contract manufacturing over the last

few decades is a well-documented phenomenon,

particularly within specific industries (Baatz, 1999;

Carbone, 2000; Plambeck & Taylor, 2005). Less well

understood is whether this triggers an “outsourcing

cascade” —does the outsourcing of manufacturing

make the follow-on outsourcing of related functions

(such as procurement) more likely, or less? What

contextual factors influence this? With regard to the

general outsourcing of procurement (absent a con-

tract manufacturing context), the literature is unclear.

Ellram and Maltz (1997) stated that “many organiza-

tions do not outsource these supply management

activities at all” (p. 23). On the other hand, more

recent literature suggests that firms are now willing to

shed activities once considered strategic to focus

on ever-more narrowed core competencies (Kroes &

Ghosh, 2010; Parry, James-Moore & Graves, 2006). A

2005 survey on strategic outsourcing indicated that

firms were outsourcing up to 20 percent of transaction

processing, 13 percent of supplier management

activities, and 15 percent of procurement strategy

activities for indirect/service purchases, with percent-

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ages for direct material procurement activities being

roughly half of these values, respectively (Monczka,

Markham, Carter, Blascovich & Slaight, 2005b).

When an original equipment manufacturer (OEM)

outsources manufacturing, it must make a series of

choices regarding the related procurement activities:

Should these be retained in-house, or likewise follow

the manufacturing activity to the contract manu-

facturer (CM)?

1

From a theoretical standpoint, the

decision to decouple or link manufacturing and

procurement activities holds great interest. OEMs that

outsource manufacturing but retain procurement may

consider expertise in the latter to be a distinctive capa-

bility that provides competitive advantage, or may sim-

ply be unwilling to risk allowing the CM to control a

portion of their supply base. Conversely, other OEMs

may have determined that the CM possesses a resource

or capability advantage in combined procurement and

manufacturing, or may see little hazard in allowing the

CM to negotiate on its behalf with suppliers.

As such, this study considers the following research

question: When manufacturing is outsourced, what

are the factors that influence the decision to engage in

follow-on outsourcing of the related procurement

activities or to retain them in-house? The answer to

this question would, in our opinion, provide useful

and interesting insights for academics and practitio-

ners within the supply chain management field. While

“outsourcing” in a broad or single-function sense has

been widely studied, there has been little work done

to understand the linking of multiple outsourcing

decisions, a situation which (in our view) is likely

something with which all companies who have made

an outsourcing decision must contend. Practitioners

would likewise benefit from a deeper understanding

of the drivers and contextual influences on whether or

not to escalate the outsourcing decisions already

made. Two widely used theoretical lenses, transaction-

cost economics (TCE) and the resource-based view

(RBV), are utilized in this study to focus our examina-

tion and sharpen hypothesis development.

The next section of this paper details the conceptual

development and presents the study’s hypotheses.

Subsequent sections detail the methodology, results

and implications thereof. We close with a recap of

study contributions and limitations, and a call for

future research.

CONCEPTUAL DEVELOPMENT

The Contract Manufacturer’s Expanding Role

Contract manufacturing has been defined in several

ways (Kim, 2003; McClintock (2002); for this study,

it is defined as the act of contracting with a firm to

produce a product that will carry the OEM brand.

Growth has been rapid for several decades: In 1999,

Baatz reported that 54 percent of computer, commu-

nications, automotive, medical, and industrial control

equipment OEMs outsourced some manufacturing,

and in pharmaceuticals, estimates of CM use have

climbed from 20 percent in 1988 to 60–70 percent in

2005 (Plambeck & Taylor, 2005). While initially con-

sidered a buffer to meet capacity surges, contract man-

ufacturing has grown into a competitive weapon for

many firms (Carbone, 2000; Gregory, 1995; Harring-

ton, 2000; Kador, 2001). Increasing rates of techno-

logical change, a reluctance to invest in manufacturing

equipment, a booming economy, and increased global

competition all contributed to the CM’s transforma-

tion from temporary relief valve to strategic supply

chain partner (Carbone, 2000; Frohlich & Dixon,

2001; Mason, Cole, Ulrey & Yan, 2002).

The service offerings of CMs have also broadened in

scope during this time frame, including new product

development, MRO parts procurement, assembly,

inventory management, distribution, and order fulfill-

ment (Carbone, 1996a,b; Cheng, 2010; Greenstein,

2005; Hameri & Paatela, 2005; Harrington, 2000;

Kador, 2001; Sherman, Leone & Klomp, 2009). While

OEMs have taken advantage of these expanded offer-

ings, the outsourcing of direct materials procurement

had traditionally been far less prevalent (Ellram &

Maltz, 1997; Ulku et al., 2007). Possibly, this is due

to the strategic role procurement has played in sup-

plier selection, contract management, and evaluation

(Kotabe & Mol, 2009; Rajagopal & Bernard, 1993).

Alternately, fears of weakening vital supplier relation-

ships or realizing fewer gains in cost reduction may

also have impacted these decisions (Edwards, 1997;

Koskie, 2002; O’Brien, 2002).

As noted above, however, the outsourcing of pro-

curement activities seems much more mainstream. As

such, it is incumbent upon academics and practitio-

ners to understand the drivers of this trend. The sec-

tion below details the theoretical lens through which

this study attempts to better understand these drivers

and develop testable hypotheses.

The Theoretical Lens: A Transaction-Cost and

Resource-Based Synthesis

While a number of theoretical lenses have been uti-

lized to study outsourcing as a phenomenon, perhaps

the two most directly connected with this decision

are TCE and the RBV. Sometimes referred to as an

1

For example, Apple has outsourced procurement to Solectron

for Product Commoditization (PC) manufacture, but retained

direct materials procurement responsibility for photocopiers

made by Flextronics (Ulku, Toktay & Yucesan, 2007). In a differ-

ent situation, Motorola outsourced materials procurement to a

CM, then pulled it back in-house (Sullivan, 2003).

July 2013

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