Examining Managerial Preferences and Choices: The Role of Value Creation and Value Appropriation Drivers in Strategic Outsourcing
Introduction
Firms pursuing strategic outsourcing rely on intermediate markets to provide specialized capabilities that have the potential to create value beyond cost economies alone (Contractor et al, 2010, Holcomb, Hitt, 2007, Quinn, Hilmer, 1994). Most studies view outsourcing choices as rational decisions based on economic factors (e.g., Bettis et al, 1992, McIvor, 2009, Walker, Weber, 1984, Williamson, 2008) or resource-based factors (e.g., Holcomb, Hitt, 2007, McIvor, 2009, Quinn, 1999, Quinn, 2000), and hence argue that these decision-making processes are influenced by expectations about value creation (e.g., cost reduction and revenue enhancement synergies) in an outsourcing relationship, and the focal firm’s ability to capture this value (Mayer, Salomon, 2006, Verwaal et al, 2009). These studies suggest that managers hold certain expectations about value creation and value appropriation. In turn, these expectations influence the choices they make about strategic outsourcing. However, work in this area has not addressed questions about the extent to which the value component influences managerial decisions, nor has it examined whether heterogeneity exists in these decisions.
In this study, we examine the extent to which different relational factors affect managerial choice when considering discrete outsourcing engagement options between a focal firm and its outsourcing provider(s) (i.e., contracts). We view the choice of strategic outsourcing engagement as a function of the value (i.e., utility) managers of focal firms associate with value creation (the total value a given outsourcing relationship creates) and value appropriation (the total value the focal firm captures from the outsourcing relationship). Specifically, we examine the extent to which managers weigh specific value creation and value appropriation factors when choosing among discrete outsourcing options. Further, we conduct a post-hoc analysis to examine heterogeneity in the preference models of strategic outsourcing. In particular, we consider idiosyncrasy in the preferences managers hold about their choice of different outsourcing governance forms, thereby moving away from firm-based logics to micro-foundational behavioral logics to understand forces that drive managerial choice. While the decision to engage in an outsourcing relationship is made collectively within an organization, individual managers’ perceptions and expectations constitute the micro-motor that guides their judgments about the benefits of outsourcing (Mantel et al., 2006), and coalesce to constitute a collective-level decision about which outsourcing engagement the firm will pursue. Because decision makers often base valuation judgments and choices on idiosyncratic knowledge and preferences, these judgmental decision outcomes can vary across managers (Felin, Foss, 2005, Felin et al, 2012, Foss, Lindenberg, 2013).
We use a utility-based experimental method — discrete choice experimentation (Louviere et al, 2000, Train, 2003) — to untangle the degree to which the different value components influence managerial choices of outsourcing. The experimental methodology permits us to take a fine-grained approach by focusing on the decision models of the individual managers. This approach requires managers to make trade-offs among choice options and, therefore, establishes a more realistic context to examine managerial decision-making than traditional Likert survey-based approaches provide. Further, the orthogonal design we use also allows us to look at the effect of each value components separately, thereby avoiding confounding effects related to correlations that naturally exist amongst the components of a decision. Finally, our use of a Bayesian approach to estimate covariance enables us to consider the extent to which managers consistently value certain well-known outsourcing drivers, and, if heterogeneity exists, this approach allows us to examine factors that contribute to this variance.
Our work makes four primary contributions. First, this work extends our understanding of value creation and value appropriation in strategic outsourcing decision-making (see Leiblein, 2003, Verwaal et al, 2009). Specifically, we demonstrate how managers’ expectations about value appropriation and value creation interact to affect their choice from among discrete outsourcing options. Second, while a significant body of research has examined outsourcing selection, we know less about individual variance in outsourcing choices. In this paper, we use a Bayesian model to examine idiosyncrasy in individual decision models. Bayesian models recognize that decision makers often have imperfect information concerning some important aspect of their decision-making settings, about which they form (possibly incorrect) subjective beliefs. This approach allows us to extract unexplained variance that we cannot capture by simply examining an error term. In response to calls for studies on micro-foundational issues (Devinney, 2013, Foss, Lindenberg, 2013), we also attempt to explain how the variance in individual- and firm-level characteristics can produce variance in preference models for managers making simulated discrete outsourcing choices. As a result, we provide a deeper understanding of when and why the choices of outsourcing relationships are likely to be heterogeneous. Third, by utilizing structured experimental methods and Bayesian estimation, we move beyond a focal emphasis on the development of generalized singular model of outsourcing choice to individual decision models used by managers. These individual decision models allow us to capture and explain individual level variance in strategic outsourcing engagement choices. Finally, a combination of experimental discrete choice modeling and Bayesian econometrics potentially opens up a new avenue for the examination of the micro foundations of strategy. To date, most work in applying micro-foundational thinking applies behavioral logics but has yet to coalesce around an appropriate and accepted set of methodologies that link theory to proof in a structured and direct manner (see, for example, Devinney, 2013).
Section snippets
Decomposing strategic outsourcing decisions
We conceive the strategic outsourcing decision to be a function of managers’ expectations about the total potential (latent) value an outsourcing engagement creates, and the level of value they expect their focal firm to capture from the outsourcing engagement. In this way, managers maximize expectations about the size of the pie (i.e., value creation) and the fraction of the pie they can capture (i.e., value appropriation). Following Leiblein (2003), we integrate transaction cost economics
Economic value from cost savings
Research from the RBV perspective suggests that two key criteria drive outsourcing decisions: the level of specificity or scarcity required to obtain resources and capabilities in the external market (Argyres, 1996), and the cost of developing those resources and capabilities or of acquiring them from other firms that possess them (Barney, 1991). According to this view, when the costs of using hierarchy are high a firm will adopt a non-hierarchical structure to obtain such resources and
Research participants
We identified managers involved in outsourcing decision-making using the 2009 membership database of the International Association of Outsourcing Professionals (IAOP), a global consortium of leading companies involved in outsourcing as customers, providers, or advisors. Managers who are members of IAOP play an active role in outsourcing decisions that affect the firms they represent. From this database, we randomly selected a subsample of managers with experience in outsourcing decision making
Dependent variable
The dependent variable is the manager’s choice of a preferred outsourcing option (value of 1 when the respondent selected a preferred outsourcing option and value of 0 otherwise) among potential outsourcing options (i.e., two options in DCE, see Figure 2). Figure 2 shows an example of DCE choice tasks and will be explained in the next section. We asked managers to make outsourcing choices while we manipulated the level of variables to observe how each factor poses different effects on
Discrete choice model aggregate sample results
To estimate the probability of a manager choosing each outsourcing engagement, we employed the multinomial logit (MNL) model (Train, 2003) (see Appendix C for more detail). Table 3 presents the results from series of MNL analyses on responses from the DCE. The dependent variable is the choice of the outsourcing engagement possessing the focal factor levels, as represented by Question 1 (see Figure 2); in other words, a selected option, which is a manager’s most preferred strategic outsourcing
Post-hoc analysis: heterogeneity in strategic outsourcing decisions
While the aggregate results offer insights about the relative significance of each value component and their interplay in an outsourcing selection model, they do not allow us to identify whether there are different preference profiles in the sample. One of the fundamental precepts of modern strategic thinking is that firms survive and persist because of the underlying heterogeneity in their assets and capabilities (see, e.g., Penrose, 1959, Richardson, 1972). Indeed, a significant focus of
Discussion and conclusion
In this study, we examine the degree to which managers consider value creation compared to value appropriation in their choice from among discrete outsourcing options, and, through the post-hoc analysis, whether heterogeneity exists in managers’ outsourcing engagement preference. By integrating both the value creation and the value appropriation dimension of outsourcing decision making, our study sheds light on the relatively limited extant studies of how managers weight various value
Limitations and future research directions
We recognize that there are limitations in our study. First, while our findings tease out some of the factors explaining the variance in strategic outsourcing choices using individual- and firm-level covariates, our recruitment of the sample does not allow us to analyze the firm and industry fixed effects in general as we did not sample to do this. Hence, our attempt to examine heterogeneity in strategic outsourcing choices is exploratory in nature. While it hints at the importance of
Contributions to theory and practice
This research has direct implications for managerial practice and research in outsourcing decisions and, more broadly, strategic decision-making processes, especially those examining heterogeneity and inconsistency in strategic decision-making. Our findings contribute to extant outsourcing decision-making research in that they highlight how managers strategically distribute value (i.e., utility) among value creation and value appropriation components in their outsourcing choices, which reflects
Nidthida Lin is a Lecturer at Newcastle Business School, University of Newcastle. She has a PhD in Strategic Management from the Australian Graduate School of Management (AGSM), University of New South Wales and University of Sydney. Upon completion of her PhD, Nidthida worked on the Offshoring Research Network (ORN) project as a Senior Research Associate at Center of International Business Research and Education (CIBER), Fuqua School of Business, Duke University, USA. Her scholarly interests
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Nidthida Lin is a Lecturer at Newcastle Business School, University of Newcastle. She has a PhD in Strategic Management from the Australian Graduate School of Management (AGSM), University of New South Wales and University of Sydney. Upon completion of her PhD, Nidthida worked on the Offshoring Research Network (ORN) project as a Senior Research Associate at Center of International Business Research and Education (CIBER), Fuqua School of Business, Duke University, USA. Her scholarly interests are mostly in the areas of innovation management, strategic outsourcing, global sourcing of business services, managerial decision-making and choice modeling. Her PhD dissertation was awarded a Highly Commended in the ANZAM Best Doctoral Dissertation Award at the 2011 ANZAM Annual Conference, and her work has been published in international academic journals such as MIT Sloan Management Review, European Management Journal, European Management Review and Industry and Innovation. E-mail: [email protected]
Timothy M. Devinney is the Professor and University Leadership Chair in International Business at University of Leeds, UK. Prior to that he was a University Professor of Strategy at the University of Technology-Sydney, Professorial Research Fellow at the Australian Graduate School of Management (AGSM), Director of the AGSM Centre for Corporate Change, and the AGSM Executive MBA. Before joining the AGSM, he held positions on the faculties of The University of Chicago, Vanderbilt University and UCLA, and has been a visiting faculty member at numerous universities in Europe (Copenhagen Business School, Humboldt University-Berlin, Wirschaftsuniversität Wien, and the Universities of Hamburg, Trier, Konstanz, Ulm & Frankfurt) and Asia (Hong Kong University of Science and Technology & City University, Hong Kong) and taught at many others (e.g., CEIBS, Helsinki University of Technology and Helsinki School of Economics). He has published eleven books (e.g., Managing the Global Corporation, with J. de la Torré and Y. Doz, and, The Myth of the Ethical Consumer, with P. Auger and G. Eckhardt) and more than ninety articles in leading journals including Management Science, Journal of Business, Academy of Management Review, Journal of International Business Studies, Organization Science, California Management Review, Management International Review, Journal of Marketing, Journal of Management, Long Range Planning, Journal of Business Ethics and Strategic Management Journal. E-mail: [email protected]
Tim R. Holcomb is an Associate Professor and holds the Endowed Chair in Entrepreneurship in the Farmer School of Business at Miami University. Tim has accumulated more than 25 years of consulting, international executive management, and venture startup experience, including work in the U.S. and more than thirty countries abroad. He joined Andersen Consulting (now Accenture, www.accenture.com, NYSE: ACN) following graduate school. Tim conducts research in strategic management and entrepreneurship. His work examines resource — based theory and managerial human capital, entrepreneurial opportunity identification and evaluation, initial public offerings (IPOs) and IPO firms, and behavioral decision theory and appears in top-tier academic journals. His research appears in Strategic Management Journal, Journal of Management, Long Range Planning, Journal of Operations Management, Organizational Research Methods, Entrepreneurship Theory and Practice, and Journal of Business Research, among others and has earned awards from Academy of Management, Strategic Management Society, Kauffman Foundation, and Babson College Entrepreneurship Research Conference. Tim earned his Ph.D. in strategic management and entrepreneurship from the Mays Business School at Texas A&M University in 2007. Previously, he earned his Bachelor’s degree in accounting and business data processing and his Master’s degree in business administration from the University of Louisiana at Monroe where, in 2005, he received the Golden Arrow Award, conferred annually by the university to its outstanding alumnus. E-mail: [email protected]