020-0628 A study of the factors influencing governance and location distance choice in services outsourcing Authors Martina Gerbl University of Ulster Ulster Business School Northland Road Derry BT48 7JL Northern Ireland Email: m.gerbl@ulster.ac.uk Phone: +44 (0)28 71375764 Prof. Ronan McIvor University of Ulster Ulster Business School Northland Road Derry BT48 7JL Northern Ireland Email: r.mcivor@ulster.ac.uk Phone: +44 (0)28 71675275 Prof. Paul Humphreys University of Ulster Ulster Business School Shore Road Newtownabbey BT37 0QB Northern Ireland Email: pk.humphreys@ulster.ac.uk Phone: +44 (0)28 90368410 POMS 22 nd Annual Conference Reno, Nevada U.S.A. April 29 May 2, 2011
ABSTRACT Services outsourcing has gained increasing importance in today s global economy. This paper focuses on the factors influencing governance and location distance choice in services outsourcing. Governance choice refers to the level of ownership in an outsourcing arrangement, and includes outsourcing to a captive or independent vendor. Location distance choice involves local, nearshore, and offshore outsourcing, and refers to the distance between the customer s home nation and location of the outsourced operation. As well as being influenced by economic factors, the combination of governance and location distance choice is driven by operations factors such as service quality, service design, and performance management. Based upon a study of German companies, this paper presents a framework that outlines key influences on governance and location distance choice, which were both found to be highly interrelated. This paper contributes to existing theory, and enhances our understanding of the factors influencing the international services outsourcing decision. 1 INTRODUCTION Outsourcing has been one of the most sustainable, though controversial trends over the last decade. Business developments such as globalisation (McIvor, 2005) and advances in information and communication technologies (ICTs) (e.g. Jahns et al., 2006) have facilitated international (services) outsourcing. The governance and location distance choice are part of the international services outsourcing decision. The governance choice refers to the level of ownership in an outsourcing arrangement. The options regarding the governance decision range from sourcing from a captive (McIvor, 2010), joint venture (eg. Pekar and Allio, 1994; Hergert and Morris, 1988), to an independent vendor (Rottman and Lacity, 2004). Captive outsourcing involves the customer building, owning, staffing, operating, and managing the facility. Joint ventures are an 1
outsourcing model in which the customer and the independent vendor share ownership of the facility. Outsourcing to an independent vendor means that processes are transferred to an (organisationally) independent firm, sometimes referred to as service provider. Location distance refers to the distance between the customer s home nation and location of the outsourced operation. Organisations have a range of location options to select from including local (Metters, 2008), nearshore (Rottman and Lacity, 2006), and offshore (Aron and Singh, 2005) when outsourcing services. Local outsourcing involves outsourcing to a vendor located in the customer s home nation, whilst nearshore outsourcing involves outsourcing work to a foreign, lower wage country that is relatively close in distance, time zone, culture, or language. Offshore outsourcing refers to outsourcing to a distant country, where there are significant cultural or language differences. 2 GLOBAL SERVICES OUTSOURCING Services outsourcing has gained increasing importance in today s global economy as organisations have been transferring responsibility for entire functions such as human resources, logistics, customer contact, and information technology (IT) services to both local and offshore vendors. Whilst the first wave of outsourcing involved outsourcing labourintensive manufacturing processes, the current wave of services outsourcing has expanded to include knowledge-intensive professional services such as accounting and legal support (Youngdahl and Ramaswamy, 2008). Much of the research conducted in the field of global services outsourcing has focused on cost considerations and macroeconomic impacts such as potential job losses and national competitiveness (Ellram et al., 2008). However, as well as being influenced by economic factors, the decision for a specific combination of governance and location distance choice is likely to be driven by operations factors such as service quality, service design, and per- 2
formance management. Due to the differences between services and manufacturing processes (e.g. intangibility of service output, lack of inventories, difficulty of portability, complexity in definition and measurement, simultaneous production and consumption) (Fitzsimmons and Fitzsimmons, 2006), organisations need sourcing models that more accurately account for the effects of service design and the roles of the customer and vendor in the service delivery process. A number of authors have developed classification schemes, positioning matrices, and frameworks for services outsourcing. However, much of this research is insufficient for understanding the complexities of the governance and location distance choice in services outsourcing. Research in this area has been dominated by information systems scholars, and more recently it has been attracting the attention of international business scholars. Research from operations management scholars is required to develop frameworks that consider the factors that influence governance and location distance choice in services outsourcing. This paper focuses on the factors influencing governance and location distance choice in services outsourcing and presents a framework that offers better understanding of the complexities in the international services outsourcing decision. 3 METHODOLOGY Eisenhardt (1989) suggests that the main purpose behind case study research lies in developing theory. Consequently, this paper uses the case study approach in order to make a contribution to theory building in the area of the services outsourcing decision. The findings of this paper were drawn from cases that were selected purposefully based on a set of pre-determined criteria (theoretical sampling): All cases have their company base in Germany. (German companies were chosen as much of the research in this area has been dominated by studies in the US and UK.) 3
Business processes or IT-intensive processes have been outsourced locally, nearshore, or offshore. The outsourcing arrangements can be regarded as collaborative relationships (contact duration ranging from 3-12 years). The data collection involved a multiple case design with six main cases (case companies) and 14 subcases in total. In these companies, 32 interviews (20 initial face-to-face interviews and 12 follow-up face-to-face/telephone interviews) were carried out. The interviewees were leading management personnel that were directly involved in the services outsourcing decision process. Each face-to-face interview lasted between two and six hours and all interviews included site visits. Besides interviews, data derived from the site visits, observations, internal company documentation as well as public available company information (e.g. company annual reports) was analysed. An overview of the cases used in this study can be seen in Table 1. An overview of the subcases of each case company can be seen in the appendices (Table 3). The findings and framework presented in this paper are based on existing literature and empirical case study evidence. 4
Table 1 Overview of case companies 5
4 FINDINGS An overview of the studied case companies combinations regarding governance and location distance choice can be seen in Figure 1. As evident, Case company 4, Case company 2, and Case company 3 feature a combination of location options for the outsourced process(es). Independent vendor SECTOR I SECTOR II SECTOR III C1 Hosting L C1 Support L C4 Infrastructure L C4 Helpdesk L C5 Sales L C1 SWdevelopment N C4 Infrastructure N C6 SWdevelopment N C4 Infrastructure O SECTOR IV SECTOR V SECTOR VI Captive C2 BPO L C2 BPO N C2 Infrastructure O C3 SWdevelopment L C3 SWdevelopment N Local outsourcing Nearshore outsourcing Offshore outsourcing Figure 1 Overview of combination of governance and location distance choices of subcases The management decision framework for the combination of governance and location distance options for the analysis at a process level can be seen in Table 2. This framework informs about the most appropriate options with regard to company factors and service process characteristics. There are six sectors that result from combining governance choice (i.e. independent vendor; captive) and location distance choice (i.e. local; nearshore; offshore). 6
Table 2 Management decision framework for the combination of governance and location distance choice 7
The following sections discuss management implications for each sector with reference to the case companies factor combinations that led to a specific governance and location distance choice. Brief descriptions in alphabetic order of each of the discussed factors that influence a specific combination of governance and location distance choice can be seen in the appendices (Table 4). 4.1 SECTOR I: Local outsourcing to an independent vendor Local outsourcing to an independent vendor was the chosen combination of governance and location distance choice of Case company 1 (C1 Hosting L, C1 Support L), Case company 4 (C4 Infrastructure L, C4 Helpdesk L), and Case company 5 (C5 Sales L). A high volatility of demand implies that organisations face difficulties in efficiently satisfying fluctuating demand coming from the customer company s end customers. For example, Case company 1 locally outsourced application hosting to an independent provider and explained: Now we have the big advantage that if we need more resources we can have them and if we need less, we can take less. We would not have this flexibility internally. ( ) Outsourcing to an independent vendor in a situation where there is a relatively high volatility of demand offers the advantage of balancing demand and thus increasing flexibility (evident in Case company 1 and Case company 4, and Case company 5). Moreover, a high volatility of demand can be easier managed in case of local outsourcing with close physical proximity. Another factor impacting Sector I is the lack of in-house human resources required for service provision. Outsourcing to an independent vendor can be used as a way of gaining access to needed resources and capabilities that are not already in-house (evident in Case company 1, Case company 4, and Case company 5). For example, Case company 4-8 -
was sold to private investors without the IT department and had to establish the whole IT organisation as IT processes could no longer be used together with the former corporation: (...) We were forced to become independent in a very short time, meaning we had to establish the whole IT organisation ourselves. (...) Resources provided by an independent vendor can be accessed relatively quickly and uncomplicated as the customer company only has to negotiate with the independent vendor. The ability to precisely define interfaces and measurable service levels also impacts Sector I. The precise definition of interfaces ensures smooth process intersections between processes provided by the independent vendor and processes that remain within the customer company. For example, Case company 1 reported that regular performance monitoring was seen as a useful tool in the management of the independent vendor: We started to make supplier evaluations. ( ) We focussed on 4 stages: competence, quality, portfolio and conditions. ( ) We defined these fields and defined sub areas such as the competence of the employees, the vendor organisation, processes and tools. There are criteria for each of these areas and there is a degree of performance for each. This is how we calculate percentages. (...) This year we expect significant improvement because we connected the evaluation with concrete suggestions, which we also discussed with our vendor. Then we saw that many points can be improved with small actions. ( ) Measurable service levels are important in order to assess the service quality provided by an independent vendor. When interfaces can be precisely defined, outsourcing to an independent vendor is a viable option as the responsibilities of customer company vendor can be clearly defined, thus ensuring a smooth operation (evident in Case company 1, Case company 4, and Case company 5). The development of measurable service levels reduces the risk of opportunism from vendors, resulting from customer companies inability to measure service quality. A low level of prior international outsourcing experience or bad experiences with international outsourcing is likely to lead to local outsourcing to an independent vendor. Experience of best practices in outsourcing can be collected by evaluating the independent vendor s course of actions and this knowledge can be used later on when - 9 -
the customer company considers outsourcing the process to a captive afterwards. Outsourcing is often regarded as a learning process and customer companies are in most cases better off making experience with outsourcing to a local independent vendor as they are familiar with the country including its regulations (evident in Case company 5). In addition, prior international outsourcing experiences, which are perceived as unsuccessful, may lead the customer company to return to local outsourcing. Case company 1 had considerable nearshore (services) outsourcing experience but was reluctant to offshore outsource due to negative experiences that were made indirectly with a former vendor that established a location in India: We also considered going to India. (...) But we were reluctant mainly because of the many bad experiences other companies have made. We ourselves also made experiences that were not positive. It was with our previous vendor who established a captive in India. The resources working for us were based there and it did not work. We think it was because of the location India and this is why the topic (offshoring) was dismissed in an early stage and we restricted ourselves to Eastern Europe. ( ) High process specifiability was found to positively influence outsourcing to an independent vendor, and in conjunction with other factors described in this section, to local outsourcing to an independent vendor. Highly specifiable processes reduce the need for frequent coordination and communication as the processes can be described in detailed written instructions and the outsourcing contract (evident in Case company 1 and Case company 4). Specifiable processes also imply that the service outcome can be compared, thus making quality control of the vendor possible. Another factor influencing Sector I is knowledge embeddedness and the need for frequent coordination and communication. A relatively high degree of knowledge embeddedness leads to a situation where the independent vendor has to be located in close physical proximity so that communication can take place frequently face-to-face along with the transfer of embedded knowledge (evident - 10 -
in Case company 1 and Case company 5). For example, Case company 1 continued that knowledge embeddedness was another motive for locally outsourcing application hosting: We have a much intertwined relationship with our vendor, meaning a lot of things only work when there is physical proximity to our vendor. ( ) Otherwise it would not work if there was no proximity. They also have to know a lot about our processes; to understand what it means when a server does not work any more. It is rather difficult because of the process depth and complexity of the applications. ( ) If you go into the processes of the customer and there is deep application knowledge needed, then it is important to have physical proximity. ( ) The application of process improvement techniques prior to outsourcing to an independent vendor can decrease the amount of embedded knowledge in a process, therefore making international outsourcing a more viable option. The amount of customer contact was found to constitute a major factor impacting Sector I. Processes containing a relatively high proportion of direct customer contact (face-to-face or mediated by communication technology such as telephone or email) are best outsourced locally as native speakers can be accessed easily (evident in Case company 1 and Case company 5). Case company 1 located its hotline and customer support, which have a relatively high degree of customer contact, in Germany: With hotline & support we have the majority of enquiries in German, thus it is important to have native speakers. ( ) I think the geographical proximity is very important. The project managers that develop solutions drive to the supplier and spend there one day to see what problems and enquiries are reported. There is a lot of exchange of information and I would not want to outsource this further away. The borderline is for me between three and four hours driving distance. Generally we have a regional mix for things that require close coordination. For other topics it is important to be in a similar time zone. ( ) Also, potential service quality is typically higher as there is a lower chance of misunderstandings between customer company including its end customers and the independent vendor. The final factor impacting Sector I is the degree of criticality with regard to protection of data and information. Independent vendors located in Europe have higher standards with regard to data and information protection than vendors located in (Far) Eastern coun- - 11 -
tries. In addition, trust with vendors located in the same country as the customer company s base is typically higher than with nearshore or offshore vendors (evident in Case company 1, Case company 4, and Case company 5). Therefore, local outsourcing is an appropriate option for processes with a relatively high degree of criticality with regard to the protection of data and information. 4.2 SECTOR II: Nearshore outsourcing to an independent vendor Nearshore outsourcing to an independent vendor was the chosen combination of governance and location distance choice of Case company 1 (C1 SWdevelopment N), Case company 4 (C4 Infrastructure N), and Case company 6 (C6 SWdevelopment N). In addition to Sector I, the lack of in-house human resources also influences Sector II. Nearshore outsourcing is an attractive option in case the quantity of required resources cannot be provided by the customer company s home country, or because specialist know-how is not available or very rare, and consequently extremely expensive (evident in Case company 1 and Case company 6). Company size and process scale are also likely to influence Sector II. Nearshore outsourcing is only a viable option if the process reaches a critical scale. The higher the process scale, the lower are the transaction costs resulting from nearshore outsourcing as part of the overall costs. Hence, nearshore outsourcing demands a critical scale in order to be economically profitable (evident in Case company 1, Case company 4, and Case company 6). Furthermore, the company size has to be large enough to possess the organisational structure to manage international operations. Case company 3 discussed the importance of critical mass for international services outsourcing: A critical mass is needed and the topics have to have a specific duration. Topics that only last 3 months should not be shifted abroad because the expenses are too high. (...) The critical team size would at least be five (FTEs) for one year. (...) But there are also a lot of other important factors. The nature of the - 12 -
topic etc. (...) Also, if the people have worked already on similar projects, which shortens the project time, and how much know how is in Germany. (...) Economic benefit through labour arbitrage is one of the main motivators for nearshore outsourcing to an independent vendor. Considerable labour cost differences around the globe open up the possibility to profit from cheaper labour abroad (evident in Case company 1, Case company 4, and Case company 6). For example, Case company 1 nearshore outsourced software development and stated: Nearshoring was a clear decision with regard to cost. We also got offers from German companies but with our vendor we have about half of the cost. ( ) Of course we could also go somewhere else where it is even cheaper. ( ) However, the effect of lower costs through cheaper labour was somewhat mitigated through the lower labour productivity abroad. Nearshore outsourcing to an independent vendor causes also additional transaction costs such as the cost for increased coordination and communication. The ability to precisely define interfaces and measurable service levels was, apart from Sector I, also an influence on Sector II. The ability to precisely define interfaces and measurable service levels has an even higher importance for nearshore outsourcing to an independent vendor than with local outsourcing (evident in Case company 1, Case company 4, and Case company 6). The management of nearshore operations is more challenging due to the physical and cultural distance and the decreased frequency of face-to-face communication as a management tool. In addition, a low level of prior international experience with international outsourcing or bad experiences with offshore outsourcing influences also Sector II, in addition to Sector I. Nearshore outsourcing is often being the first step towards international outsourcing with management being not as challenging as with offshore operations due to cultural closeness (evident in Case company 6). Sector II is also influenced by the adoption of process improvement techniques. Process improvement techniques cause the processes to be highly specifiable and modularisable, which in turn makes nearshore outsourcing to an independent vendor easier (evident in Case com- - 13 -
pany 1, Case company 4, and Case company 6). High process specifiability and modularisability ensure smooth process intersections between processes outsourced to the independent vendor and processes that remain in-house. When the physical distance between the customer and independent vendor increases, process specifiability and modularisability become even more important. Due to physical distance, face-to-face communication and coordination become more difficult, time-consuming, and costly. For example, Case company 3 described that precise separation in international outsourcing arrangements was crucial in order to reduce friction: ( ) Distance can be an obstacle. Because everything has to be specified very thoroughly and all changes have to be communicated. International outsourcing is problematic ( ) if not the whole competence is outsourced. ( ) If I do international outsourcing then I have to separate the processes very precisely so that complete developments, so to say competence centres, are bundled. Then there is no friction. ( ) High process specifiability and modularisability make a more structured approach with regard to service provision, and therefore coordination, possible. 4.3 SECTOR III: Offshore outsourcing to an independent vendor Offshore outsourcing to an independent vendor was the chosen combination of governance and location distance choice of Case company 4 (C4 Infrastructure O). In-house human resources with foreign language and culture skills influence Sector III. Offshore outsourcing requires in-house human resources that have experience in dealing with people from a different cultural background. Moreover, foreign language skills are necessary to reduce the language barrier when dealing with independent vendor employees abroad. For example, Case company 4 (C4 Infrastructure O) held employees that had sufficient cultural and language skills and thus chose to offshore outsource IT infrastructure and helpdesk proc- - 14 -
esses. Case company 4 emphasised the importance of cultural and language factors and stated: Cultural and language factors are extremely important. On our side, there is a mixture because of the multiplicity of countries. On the vendor side, there is another mixture. To reduce these different cultures to a common denominator is extremely difficult and a challenge. This influences the success of a project very much. (...) Large company size and critical process scale are, apart from Sector II, also an influence on Sector III. Sufficient company size is needed to provide the organisational structure needed for managing foreign operations (evident in Case company 4). Moreover, critical process scale is needed for offshore outsourcing in order to scale down transaction costs. The expected high economic benefit through labour arbitrage was, apart from Sector II also an influence on Sector III. Offshore outsourcing is usually motivated by the expected high economic benefit and is often achieved by making a compromise with regard to service quality (evident in Case company 4). For example, Case company 4 (C4 Infrastructure O) offshore outsourced IT infrastructure and explained that compromises regarding service provision countries had to be made in order to achieve a specific cost level: We always have a local (i.e. more expensive) component. ( ) Otherwise, service is provided through the service desk countries Spain, Germany, and Malaysia. We always have a mixture. ( ) I think if you want to achieve a specific cost level, you have to make compromises regarding the countries where services are provided. You cannot insist that everything is done in high wage countries when you have bought something with low price service. ( ) Local outsourcing is typically superior to offshore outsourcing from a service quality perspective. The ability to precisely define interfaces and measurable service levels is an influence on both Sector II and Sector III. As communication cannot easily take place faceto-face, management is more challenging than with local outsourcing to an independent vendor. The precise definition of interfaces is a precondition for offshore outsourcing to an independent vendor (evident in Case company 4). Also, measurable service levels have to - 15 -
be implemented in order to track and manage vendor performance. Another factor that influenced Sectors II and III is the adoption of process improvement techniques. Process improvement techniques are often used to make processes more specifiable and modularisable, and therefore more appropriate for offshore outsourcing (evident in Case company 4). In addition, process improvement techniques can increase process standardisability and process scale. A high level of company internationalisation was found to positively influence Sector III. Through extensive experience with foreign cultures, customer companies lose the inhibition threshold connected to international outsourcing, and can better manage foreign operations (evident in Case company 4). High process specifiability and modularisability were found to influence both Sector II and Sector III. In addition, process standardisability was found to influence Sector III (evident in Case company 4). Process standardisability is especially important for offshore outsourcing as it decreases the need for frequent coordination and communication due to the highly standardised responses. For example, Case company 4 discussed that through a high degree of centralisation and standardisation of IT infrastructure and helpdesk, coordination from offshore locations was possible: I think we have also chosen a construct where many things can be coordinated through the network. The helpdesk can access every computer worldwide. Software can be distributed through the net. ( ) But there is always a local component. When there is for example a hardware fault, a technician has to replace the device. You could never do these things centrally. When it comes to the central components, we are able to say to our vendor that we want this from a specific country. ( ) The end user won t notice that. But this is only possible though high standardisation and centralisation. 4.4 SECTOR IV: Local outsourcing to a captive Local outsourcing to a captive was the chosen combination of governance and location distance choice of Case company 2 (C2 BPO L) and Case company 3 (C3 SWdevelopment - 16 -
L). Large company size and critical process scale was found to be an influence on Sector IV, in addition to Sector II and Sector III. Large company size has a stronger influence on Sector IV than on Sector II or Sector III, as it is one of the main preconditions for captive outsourcing. Captive outsourcing requires a critical company size in order to build up an organisational structure, as well as necessary critical process scale in order to efficiently outsource to a captive (evident in Case company 2 and Case company 3). The importance of quality was found to influence Sector IV. The high importance of service quality points towards captive outsourcing as for captive organisations service quality is crucial in order to ensure the future existence of the captive (evident in Case company 2 and Case company 3). For example, Case company 2, a Shared Services Centre (SSC) emphasised its service quality: It is very interesting that customers, who used to be affiliated to the corporation, but are not longer part of it, stay with us. These companies have no obligation to buy from us. But if vendors on the market would be much cheaper, they would surely change the vendor in the long term. It is a good indicator of our quality that these companies stay with us because they are satisfied customers. ( ) Captive organisations are organisationally separated from the corporation and thus can theoretically be relatively easily shifted to an independent vendor in case the delivered service quality of the captive is insufficient. In addition to service quality, innovations were also found to influence Sector IV. If innovations are important for the customer company, captives are more likely to deliver innovations with regard to increased cost efficiency or better service quality than independent vendors (evident in Case company 2 and Case company 3). For example, Case company 2 opted for the captive model and emphasised the importance of innovations in order to deliver added value for the corporation: We have a budget for research and development, not in the sense of basic research, but we ( ) observe the market and try and test for our customers if it (technical innovations) makes sense. It is very important for us to be close to - 17 -
the customer, to push innovations, further develop them, and introduce them, maybe with external partners. ( ) Independent vendors are less likely to deliver innovations, as in a lot of cases this would mean giving up parts of their revenue. Innovations are also only likely to develop from long standing cooperation between the customer company and the captive, which is easier developed on a local basis. For this reason, local outsourcing to a captive is most likely to lead to the generation of innovations. Another factor that was found to influence Sector IV is the requirement for frequent process changes. The need for frequent process changes leads to increased demands with regard to communication, coordination, and monitoring. Communication and coordination with the captive model is easier as opposed to an independent vendor, as the organisations of corporation and captive are usually strongly intertwined (evident in Case company 2 and Case company 3). In addition, local outsourcing involves less physical, cultural and language distance, and is therefore more suitable for processes that require frequent process changes. For example, Case company 3 discussed that a high speed of process changes could best be dealt with by the centralisation of locations nearshore or locally: When there are quick cycles and the reaction has to be flexible, the distance can be an obstacle. ( ) When you have to react quickly to market changes and have offshored processes, then, even though you do it well, there are several locations and this causes a loss of time. The decision is whether I have to be quick or whether the cost is more important. When I don t have the time, then I also don t have it to specify thoroughly. ( ) If I ( ) have to act quickly than I need teams that are in one location where I have close communication. ( ) Embedded knowledge and the need for coordination and communication were also found to influence Sector IV. Captive outsourcing makes the transfer of embedded knowledge easier as typically many of the captive s employees were employed by the corporation and are thus familiar with corporation specific knowledge that is needed for executing the outsourced process (evident in Case company 2 and Case company 3). For example, Case - 18 -
company 3 regarded corporation specific know-how as a major factor why the corporation locally outsourced software development captive: We are strongly involved in the customer s decision making. We know how the customer thinks and why he outsources. ( ) I think the domain know how is crucial. ( ) Furthermore, we have the advantage to be closer to the customer. ( ) It is our main task to communicate with the customer and know how he thinks. A lot of our employees used to be employed by the parent company and thus know how it works there. ( ) In addition, local outsourcing accounts for the need for frequent coordination and communication that is related to the outsourcing of processes with relatively high knowledge embeddedness. An additional factor influencing Sector IV is the level of direct customer contact needed for executing the process. Local outsourcing of processes with relatively high customer contact is more likely to lead to a trustful relationship as people with similar cultural backgrounds and the same language are communicating (evident in Case company 2 and Case company 3). Local outsourcing of processes with relatively high customer contact is therefore often regarded as a precondition for sufficient service quality. High process criticality with regard to competitive advantage was also found to influence Sector IV. Process criticality with regard to competitive advantage is often the main motive for local outsourcing to a captive (evident in Case company 2 and Case company 3). Captive outsourcing ensures that knowledge creating or leading to competitive advantage is not leaving the corporation s boundaries and potentially falling into competitors hands. In some cases, corporations also have agreements that the captive is only allowed to work for the corporation. For example, Case company 3 stated that the corporation requested to be the only customer in order to protect know-how: It has been like this since 4 years ago (that the corporation requested to be the only customer). ( ) We only provide services for our parent company. We would be allowed to work for strategic partners of our corporation. ( ) But in the end the corporation has to agree when we want to provide services for others. ( ) We work on a lot of topics that are crucial for the corporation s competitive advantage. This was one of the reasons why the corporation decided to - 19 -
buy the majority share of our company, to make sure that we don t start working for one of the corporation s competitors someday. ( ) Moreover, local captive outsourcing ensures sufficient service quality, which is crucial for future sustainable competitive advantage. The final factor that was found to influence Sector IV is process criticality with regard to the protection of data and information. This factor is somewhat related to process criticality with regard to competitive advantage. Captive outsourcing is most appropriate when the protection of data and information is a concern as information is not transferred to an organisationally independent company (evident in Case company 2 and Case company 3). Moreover, local captive outsourcing ensures that the information and data protection standards are on an appropriate level. 4.5 SECTOR V: Nearshore outsourcing to a captive Nearshore outsourcing to a captive was the chosen combination of governance and location distance choice of Case company 2 (C2 BPO N) and Case company 3 (C3 SWdevelopment N). Large company size and critical process scale was found to influence, apart from Sector II, Sector III, and Sector IV, also Sector V. As previously noted, captive outsourcing demands for a large company size and critical process scale in order to be beneficial (evident in Case company 2 and Case company 3). In comparison with Sector IV, critical process scale has a higher importance for Sector V. International outsourcing causes transaction costs that can be considered as fixed costs. The higher the number of outsourced processes, the lower will be the transaction costs per process. In addition to Sector IV, the importance of quality was also found to influence Sector V. Highest possible service quality is likely to result from local outsourcing to a captive. However, through outsourcing to nearshore destinations with a highly qualified workforce, a relatively high level of service quality can be achieved (evident in Case company 2 and Case company 3). - 20 -
As with Sector II and Sector III, a high expected economic benefit through labour arbitrage is likely to influence Sector V. When companies aim to reduce costs, nearshore outsourcing is able to offer lower costs through labour cost advantages abroad (evident in Case company 2 and Case company 3). The adoption of process improvement techniques is, apart from Sector II and Sector III, also likely to influence Sector V. Process improvement efforts include techniques such as consolidation and standardisation that lead to highly specifiable and modularisable processes that can relatively easily be shifted abroad (evident in Case company 2 and Case company 3). High process specifiability and modularisability are consequently found to influence Sector V, in addition to Sectors I, II, and III. Knowledge embeddedness and the need for coordination and communication also influence Sector V, apart from Sectors I and IV. As previously described, embedded knowledge can best be outsourced with the captive model as the employees of the captive are typically familiar with the corporation specific embedded knowledge (evident in Case company 2 and Case company 3). For example, Case company 2 named the captive s ability to perform processes that contained embedded knowledge as a main motivator for nearshore outsourcing to a captive: ( ) We have to know what the corporation wants, what happens at the market, and then provide optimal services that comply with the corporation s requirements. I think this is one of our most important assets because we know our customer very well and are also present at strategy conferences of the corporation. ( ) Similarly to Sectors I and IV, the level of customer contact influences Sector V. Nearshore locations are often able to offer employees with language skills of the customer company s nationality due to the physical closeness. Nevertheless, a high level of customer contact is likely to lead to local outsourcing. Processes, however, with a relatively high degree of customer contact, but only limited contact to the customer companies end customers, are well suited for nearshore outsourcing to a captive (evident in Case company 2 and Case - 21 -
company 3). In addition to Sector IV, high process criticality with regard to competitive advantage was found to influence also Sector V. If the protection of knowledge leading to competitive advantage is important, captive outsourcing is an appropriate organisational model (evident in Case company 2 and Case company 3). Furthermore, high process criticality with regard to the protection of data and information influences Sector V, like Sectors I and IV. If process criticality with regard to the protection of data and information is a concern, special security precautions, such as the anonymisation of data, or the physical separation of employees working for different customers, make captive nearshore outsourcing an appropriate choice (evident in Case company 2 and Case company 3). For example, Case company 3 described its security precautions that had to be taken to be in accordance with the corporation s requirements: The regulations regarding data and information protection are very severe and apply for us as well as our partners. There are internal audits. The customer also has been at the locations. ( ) In some cases, the partner even has completely separated networks. ( ) These topics are provided at specific locations in specific secure rooms to take security into account. These topics are physically separated so that the projects are separated and also the employees. ( ) The networks with the corporation s processes are also administered from Germany and partly our partner does not have access to them. ( ) 4.6 SECTOR VI: Offshore outsourcing to a captive Offshore outsourcing to a captive was the chosen combination of governance and location distance choice of Case company 2 (C2 Infrastructure O). The availability of in-house human resources with foreign language and culture skills was found to influence Sector VI. In-house human resources with foreign language and culture skills are experienced in managing employees with different cultural backgrounds. The management of offshore outsourcing is much more challenging than local or nearshore outsourcing, as physical and cultural distance are considerable. The outsourcing management through experienced in- - 22 -
house human resources with foreign language and culture skills is likely to have beneficial effects on offshore operations (evident in Case company 2). As with Sectors II, III, IV, and V, large company size and critical process scale influences Sector VI. The importance of sufficient process scale increases with the physical distance to the customer and consequently incurring transaction costs (evident in Case company 2). Case company 2 with 106,000 (corporation) employees was the largest company out of the six case companies and reached sufficient scale in order to make offshore outsourcing to a captive a viable option. Another factor is high expected economic benefit through labour arbitrage that influences Sector VI, just like Sectors II, III, and V. Offshore outsourcing involves the biggest differences in labour costs. Due to this, the potential for economic benefit through labour arbitrage is the highest with offshore outsourcing. The expected economic benefit through labour arbitrage is often the main motivator for captive offshore outsourcing (evident in Case company 2). Similarly to Sectors II, III, and V, the adoption of process improvement techniques influences Sector VI. Process improvement techniques lead to highly specifiable and modularisable processes, which are necessary if processes want to be relocated to offshore destinations (evident in Case company 2). High process specifiability influences Sector VI, in addition to Sector I, Sector II, Sector III, and Sector V. High process modularisability influences Sector VI, in addition to Sector II, Sector III, and Sector V. High process standardisability influences Sector VI, in addition to Sector III. High process standardisability is especially important as it decreases the need for frequent coordination and communication that could potentially lead to problems due to significant cultural and language differences involved in offshore outsourcing (evident in Case company 2). A high level of company internationalisation is a major precondition for offshore out - 23 -
sourcing, and therefore influences, apart from Sector III, also Sector VI. A high level of company internationalisation implies extensive experience with international operations and a reduced inhibition threshold to outsource to countries that are far away from the customer company s location (evident in Case company 2). 5 CONCLUDING DISCUSSION Existing literature on international services outsourcing is dominated by international business (IB), information systems (IS), and information technology (IT) literature. This paper approached the topic from an operations perspective, and is therefore in contrast to much of the existing literature. An operations perspective was chosen as OM and its principles are highly relevant for the services outsourcing decision. The adoption of an operations perspective responded to research agendas that regularly name the topic in conjunction with services (e.g. Machuca et al., 2007). The research findings demonstrated that even if some factors relevant for the services outsourcing decision are adapted from a manufacturing context, the services sector is more complex and demands for a multitude of other factors such as the foreign language and culture skills of in-house human resources, the ability to precisely define interfaces and measurable service levels, process improvement techniques, innovations, process specifiability, process modularisability, process standardisability, knowledge embeddedness, the level of customer contact, and the protection of data and information. Current research in the field of services outsourcing treats governance and location distance choice as separate decisions. This research, however, found that the governance and location distance choice are highly interrelated, with no choice preceding one another, and therefore should be studied collectively. - 24 -
Existing literature on the location distance choice regards the location options local, nearshore, and offshore as clearly separated. The findings of this research, however, indicated that the options local, nearshore, or offshore outsourcing are a continuum with a blurring between the different options. Local outsourcing and offshore outsourcing were clearly influenced by several company factors and service process characteristics. Nearshore outsourcing is positioned in the middle and is often regarded as an alternative to offshore outsourcing when the customer company cannot fulfil important factors such as high level of company internationalisation or in-house resources with appropriate foreign language and culture skills. This paper contributes to existing theory on the services outsourcing decision, and enhances our understanding of the important factors influencing the combination of governance and location distance choice. - 25 -
APPENDICES Table 3 Overview of subcases of case companies Case company 1 Case company 2 Case company 3 Case company 4 Outsourced process(es) Application Hosting Hotline & support Softwaredevelopment IT infrastructure & applications Procurement & logistics Consulting Human Resources Finance & Accounting IT infrastructure & applications Procurement & logistics Finance & Accounting IT infrastructure & applications Softwaredevelopment IT infrastructure Helpdesk IT Infrastructure Subcase labels C1 Hosting L C1 Support L C1 SWdevelopment N C2 BPO L C2 BPO N C2 Infrastructure O C3 SWdevelopment L C3 SWdevelopment N C4 Infrastructure L C4 Helpdesk L C4 Infrastructure N C4 Infrastructure O Case company 5 Tele sales C5 Sales L Case company 6 Softwaredevelopment C6 SWdevelopment N BPO Business process outsourcing C Case company L Local outsourcing N Nearshore outsourcing O Offshore outsourcing SW Software
Table 4 Factor Brief descriptions of company factors and service process characteristics Company internationalisation Company size and process scale Description A customer company s general international experience or level of company internationalisation (e.g. proportion of sales abroad). The size of a customer company and the scale of the process to be sourced. Criticality with regard to competitive advantage or service quality The criticality of a process to be sourced with regard to being core or delivering competitive advantage, and the criticality of service quality. Criticality with regard to the protection of data and information Customer contact Economic benefit through labour arbitrage Frequent process changes Importance of quality In-house human resources required for service provision at the required service quality level In-house human resources with foreign language and culture skills Innovations Knowledge embeddedness and the need for coordination and communication The criticality of a process to be sourced with regard to the protection of data and information or the criticality of process proprietary data falling into competitor s hands. The amount of physical customer contact, telephone contact, or Internet-mediated contact in the service delivery process. The ability to lower costs through labour cost differences in foreign countries. The pace and frequency at which changes of the processes to be sourced take place. The importance of service quality of the process to be sourced or the risk level of declined service quality for the customer company. The existing quantity of in-house human resources (on customer side) required for service provision with required qualification. Foreign language and culture skills of inhouse human resources (on customer side). Improved business outcomes for the customer through changes for which the independent vendor or captive is responsible. Knowledge embeddedness is closely related to the skills needed to execute a process. Processes that contain embedded knowledge often contain tacit (i.e. hard to capture in repeatable routines, codified, and transferred) as opposed to explicit (i.e. easily transferred) knowledge.