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SME Outsource

Complexity of the Outsourcing Decision

Outsourcing provides one possible answer to the question of how to manage the technology, although it does not absolve management from the need to ask why the business needs technology and what aspects of technology are appropriate. Some managers who signed long-term outsourcing contracts have regretted that they also delegated the issue of which technology to use to their outsourcing suppliers. The latter are sometimes reluctant to keep the technology up to date while the contract still has some years to run.
Companies often consider outsourcing the functions where they have relatively little expertise or interest. In this case, independent consultants will be needed to supply the expertise to choose a supplier and write the outsourcing contract. The alternative of accepting a standard contract from the outsourcing supplier can lead to extra costs or restrictions on the business that are not always apparent at the time the contract is signed.

Ten years ago, outsourcing was an all-or-nothing affair and contracts were for five years or longer. Now it is much more selective and contracts are typically shorter, perhaps as short as two years. This is happening partly because of increasing competition among the outsourcing suppliers and partly because companies are finding it harder to look ahead and decide what may or may not be strategic in five years’ time. This added complexity in the outsourcing decision offers further opportunities for consultants to add value by advising on what to outsource, how to do it, and for how long.

Theory of Outsourcing

With two theories of transaction cost economics and resource-based view the rationale and evolutionary dynamics of business network embeddedness is explained. Embeddedness refers to how business networks are formed (Gulati, 1998).

  • Transaction Cost Economics (TCE)

Jarillo (1988) further claimed that business networks can effectively reduce transaction costs. And business networks are an appropriate governance mechanism when transaction costs are not high enough to need hierarchical control, and not low enough to need market governance. 


  • Resource-Based View (RBV)

A resource-based view of business networks has recently begun to emerge, emphasizing that the complementary core resources of business networks can create competitive advantage (Madhok, 1997; Das and Teng, 2000). In contrast to transaction cost logic, which focuses on cost minimization, the resource-based view

emphasizes value maximization (Madhok, 1997).

Rationale of Business Outsourcing

Even if the degree of complementarity among members of business networks is not as greater as that with potential partners outside the existing business network, the high cost of adjusting business networks makes firms tend to search for partners within existing business networks, unless the benefits of changing the members of a business network clearly exceed the incurred costs (Ahuja, 2000).

EC (External Cost) + TC (Transaction Cost) < IC (Internal Cost)
However, the above deduction implies perfect rationality. In fact, a (1) human being has bounded rationality, and makes decisions based upon Subjective cognition. Furthermore, (2) the greater embeddedness of business networks corresponds to lower transaction costs. So firms tend to repeat collaboration when faced with new opportunities, and reluctant to reconstruct business networks.

A combination of transaction cost economics and the resource-based view may be powerfully explanatory of the dynamic evolution of business network embeddedness. Initially, since firms lack complementary resources, they must create opportunities for collaboration to access needed resources. Then, collaborative relationships provide the foundations of trust, information exchange, communication and coordination, effectively reducing transaction costs. The resource-based view emphasizes resource synergy, and transaction cost economics concentrates on the minimization of cost. Both facilitate the emergence of the embeddedness of the business network, because when opportunities arise for collaboration, the resources of business networks can be used and transaction costs reduced through co specialization, social capital and routines. Collaboration can be repeated and a cyclic process shaped.