Journal of Operations Management 25 (2007) 464–481

www.elsevier.com/locate/jom

Toward a model of strategic outsourcing

Tim R. Holcomb *, Michael A. Hitt 1
Texas A&M University, Mays Business School, Department of Management,
College Station, TX 77843-4221, United States

Available online 16 June 2006

Abstract
Acknowledging efficiency motives, firms have increasingly turned to outsourcing in an effort to capture cost savings.
Transaction cost theory (TCT) has been the dominant means of explaining outsourcing as an economizing approach whereby
cost efficiencies are achieved by assigning transactions to different governance mechanisms. Recent research has used the resource-
based view (RBV) to examine the role of specialized capabilities as a potential source of value creation in relationships between
firms. Although research in supply chain management has expanded substantially, only limited applications of TCT and the RBVare
available, especially in the field of operations management. We extend both perspectives to explain conditions leading to strategic
outsourcing.
# 2006 Elsevier B.V. All rights reserved.

Keywords: Strategic outsourcing; Operations strategy; Resource-based view; Transaction cost theory; Resource management; Value creation;
Operations management; Supply chain management; Capabilities; Vertical disintegration; Intermediate markets

1. Introduction (Leiblein et al., 2002). On the other hand, internaliza-

Understanding how firms establish firm scope has
interested management scholars for some time, and a
body of research has explored the boundary conditions
firms consider when choosing to source activity from
the marketplace (e.g. Fine and Whitney, 1999; Gilley
and Rasheed, 2000; Quinn, 1999). In particular, this
research highlights the complex choices firms make
when deciding whether to internalize or outsource
production. On the one hand, internalization requires
firms to commit resources to a course of action, which
may limit strategic flexibility and be difficult to reverse
* Corresponding author. Tel.: +1 979 845 4852;
fax: +1 979 845 9641.
E-mail addresses: tholcomb@mays.tamu.edu (T.R. Holcomb),
mhitt@mays.tamu.edu (M.A. Hitt).
1
Tel.: +1 979 458 3393; fax: +1 979 845 9641.
tion may be required by firms to more effectively carry
out production. The complexity of these boundary
decisions has intensified in recent years stimulated by
increased competitive pressures, the rapidity of tech-
nological change, and the dispersion of knowledge
across different organizations and geographic markets
(Hoetker, 2005; Teece, 1992). Accordingly, a variety of
outsourcing arrangements has emerged. We rely on both
transaction-based and resource-based logics to explain
the emergence of one such arrangement strategic
outsourcing in which firms rely on intermediate markets
to provide specialized capabilities that supplement
existing capabilities used in production.
What determines firm scope? A well-developed
approach for boundary decisions associated with firm
scope is transaction cost theory (TCT). According to
this perspective, firms integrate production to minimize
costs from opportunism and bounded rationality of

0272-6963/$ – see front matter # 2006 Elsevier B.V. All rights reserved.
doi:10.1016/j.jom.2006.05.003
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
firms and their suppliers, the uncertainty and frequency
of market exchange, and asset specificity that arises
from supplier-firm or firm-customer relationships
(Coase, 1937; Williamson, 1985). This theory holds
that certain types of governance mechanisms manage
exchanges with particular characteristics more effi-
ciently than others; cost economizing therefore reflects
a firm’s efforts to minimize costs arising from the
governance of market exchanges.2 Accordingly, the
decision to outsource often rests on economizing
motives related to the fit between firms’ governance
choices and specific attributes about an economic
exchange (Grover and Malhotra, 2003; Silverman et al.,
1997).
Recently, however, scholars have presented
resource-based perspectives of integration that augment
transaction-based views and sharpen the focus on firms’
relative advantages (Combs and Ketchen, 1999;
Leiblein and Miller, 2003; Poppo and Zenger, 1998).
This growing body of work, which is based on the
original work of Penrose (1959) and uses Barney’s
(1991) more recent translation of the resource-based
view (RBV) of the firm, emphasizes the importance of
resources in guiding firm activity and the management
of a firm’s portfolio of capabilities as central to
competitive advantage.3 More specifically, this research
contends that the reasons for internalization extend
beyond the cost of transacting through the market to the
conditions that enable firms to establish, maintain, and
use capabilities more efficiently than markets can do
(Conner, 1991; Ghoshal and Moran, 1996; Teece et al.,
1997).
2
There are multiple sources and aspects of transaction costs. Coase
(1937), for example, emphasized the ‘frictional’ costs, such as those
costs that arise from negotiating, drafting, and monitoring contracts.
Williamson (1975, 1985) expanded this perspective by focusing
attention on the costs of transactional hazards (e.g. difficulties) and
governance mechanisms to limit such hazards. Whereas Williamson
focuses on the tendency of transaction difficulties to emerge as a
function of the exchange, Coase’s frictional costs are a feature of
economic conditions that occur independent of deliberate calculation
or motives (see also Jacobides and Winter, 2005).
3
Resources, broadly defined, have often been used in the literature
in a generic sense to include capabilities (e.g. Barney, 1991). Other
scholars have claimed that capabilities represent how firms manage
resources (e.g. Dutta et al., 2005; Helfat and Peteraf, 2003) or that
capabilities represent a unique combination of resources that enable
firms to pursue specific actions that create value (Sirmon et al. in
press). For purposes of this paper, we use ‘resources’ to represent
tangible or intangible assets owned or controlled by firms (Barney,
1991; Grant, 1996) and ‘capabilities’ to represent organizational
routines that allow firms to effectively integrate and use resources
to implement their strategies (Lavie, 2006; Winter, 2003).
465
The resulting convergence between these two
theories has stimulated a number of empirical studies,
which has created a more effective understanding of
what drives strategic outsourcing. For example, in
recent years, transaction cost scholars have accepted
that transaction-based and resource-based perspectives
‘‘deal with partly overlapping phenomena, often in
complementary ways’’ and that capability endowments
matter to boundary decisions (Williamson, 1999, p.
1098). Combs and Ketchen (1999) found evidence that
firms often place resource-based concerns ahead of
exchange economies when deciding on potential
interfirm cooperation. Complementary to this view,
Madhok (2002) pursued the question of how firms
should organize production given certain resource-
based conditions (e.g. pre-existing strengths and
weaknesses). He suggested that boundary decisions
depend not only on the conditions surrounding the
transaction, but also on capability attributes, and the
governance context that it creates. Thus, substantial
empirical support exists for the proposition that
capability considerations trade-off with economizing
constraints in the decision to outsource (e.g. Hoetker,
2005; Jacobides and Winter, 2005; Poppo and Zenger,
1998).
Our work contributes to this stream by extending
earlier conceptualizations of outsourcing based on
economizing conditions, such as asset specificity, small
numbers bargaining, and technological uncertainty, to
include factors that influence the selection and
integration of capabilities from intermediate markets
(Argyres and Liebeskind, 1999; Jacobides and Winter,
2005). In particular, we consider the complementarity
of capabilities, strategic relatedness, relational cap-
ability-building mechanisms, and cooperative experi-
ence as four important conditions that establish a
resource-based context for strategic outsourcing.
According to this perspective, in the decision regarding
the strategic outsourcing of production, firms evaluate
internally accessed capabilities and those capabilities
available externally from intermediate markets, and
consider how they might best be integrated to produce
the greatest value.
Therefore, this work goes beyond the question of
governance mechanisms to enrich our understanding of
capability selection and use, providing a more mean-
ingful understanding of strategic outsourcing. Whereas
transaction-based perspectives typically confine out-
sourcing to more specialized, repetitive activities such
as manufacturing, logistics, and facilities management,
resource-based theory provides a context to explain
strategic outsourcing arrangements for more visible and
466 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
potentially sensitive functions such as research and
development (R&D), engineering design, and customer
support. This trend is evident in the personal computer
(PC) and communications equipment sectors, where
growing demand for new product offerings has driven
the market for third-party R&D and design. As a result,
the volume of outsourced R&D, design, and manu-
facturing services in these two sectors is expected to
grow almost two-fold between 2004 and 2009, from
$179 billion to $345.5 billion (Carbone, 2005).
Despite the dramatic increase in strategic out-
sourcing in recent years, few systematic studies of
strategic outsourcing have been completed (Gilley and
Rasheed, 2000). In fact, this topic has received only
limited exposure in the fields of healthcare management
(e.g. Billi et al., 2004; Roberts, 2001), economics (e.g.
Chen et al., 2004a; Shy and Stenbacka, 2003), and
strategic management (e.g. Fine and Whitney, 1999;
Quinn, 1999; Quinn and Hilmer, 1994). Accordingly,
this work represents an early attempt to frame and
provide a theoretical understanding to the strategic
outsourcing concept in operations and supply chain
management research using both transaction-based and
resource-based logics.
This work follows Grover and Malhotra’s (2003)
call for more research by operations management
scholars that integrate strategic management and
organizational theory into the study of interfirm
relationships. In particular, our work contributes to
the stream of research synthesizing TCT and the RBV
by integrating them to extend earlier conceptualiza-
tions of outsourcing. We also make three important
contributions to the outsourcing literature. First, we
offer a more concise definition of strategic outsourcing
that extends transaction-based logics and considers
value created when firms more effectively leverage the
specialized capabilities these relationships provide.
Second, we explain how developing a ‘capabilities
view’ better informs the discourse about the out-
sourcing choices that firms make. Prior work has
established a relationship between outsourcing and
cost economies from the selection of more efficient
governance mechanisms (e.g. Cachon and Harker,
2002; Walker and Weber, 1984). However, to date,
there has been little understanding provided of the role
that internal and external capabilities play in strategic
outsourcing decisions. Herein, we shift the focus on
value creation from different exchange conditions to
value chain structures and to the process by which firms
produce goods and services. Thus, we provide
managers with a richer framework to understand the
trade-offs between internalization, past relationships
and experience, and capabilities that guide their
decision to internalize or outsource. Third, we high-
light the expanded role that boundaries serve in the
formation of strategic outsourcing relationships.
Establishing firm boundaries requires understanding
more than how internally- and externally-sourced
production activities affect performance (Araujo et al.,
2003). It also requires a better understanding of the
bridging function that boundaries perform in linking
firms’ production activity with intermediate markets
(McEvily and Zaheer, 1999). Accordingly, we argue
that a more complete understanding of the organization
of economic activity requires a greater sensitivity to the
interdependence of capabilities, production activity,
and interfirm relations that emerge from boundary
decisions, as suggested by Coase (1988).
Fig. 1 summarizes our model for strategic out-
sourcing. This model depicts conditions for value
creation integrated with economizing arguments for
strategic outsourcing. These theoretical arguments are
examined in the following sections. We begin with a
concise review of the literature and derive a more
complete definition of strategic outsourcing. Next,
transaction-based and resource-based arguments for
outsourcing are reviewed. Building on these two
perspectives, we present a model of strategic out-
sourcing that uses transaction- and capability-based
factors to examine a firm’s decision to outsource.
Finally, we discuss opportunities for future research.
2. Theoretical foundation
Whereas transaction-based perspectives explain
different governance mechanisms, resource-based
theory considers the relative capabilities of focal
firms and exchange partners as important in vertical
integration decisions (e.g. Afuah, 2001; Argyres,
1996). According to this view, firms are largely
heterogeneous in terms of their resources and
capabilities (e.g. Barney, 1991; Wernerfelt, 1984),
and thus often carry out the same activity with
different production efficiencies and costs. As a result,
separate firms that display different ways of accom-
plishing the same task achieve different cost effi-
ciencies and performance outcomes.
2.1. Strategic outsourcing defined
We define strategic outsourcing as the organizing
arrangement that emerges when firms rely on inter-
mediate markets to provide specialized capabilities that
supplement existing capabilities deployed along a
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
Fig. 1. A theoretical model for strategic outsourcing.
firm’s value chain.4 Further, we suggest that strategic
outsourcing creates value within firms’ supply chains
beyond those achieved through cost economies. As
explained later, intermediate markets that provide
specialized capabilities emerge as different industry
conditions intensify the partitioning of production. As a
result of greater information standardization and
simplified coordination, clear administrative demarca-
tions emerge along a value chain (Jacobides, 2005).
Partitioning of intermediate markets occurs as the
coordination of production across a value chain is
simplified and as information becomes standardized,
making it easier to transfer activities across boundaries
(Richardson, 1972). Accordingly, an orientation toward
strategic outsourcing evolves, as specialized capabil-
ities emerge, resulting in a greater dependence on
intermediate markets for production (Fine and Whitney,
1999; Quinn, 1999).
The decision to outsource existing production
represents the simplest form of strategic outsourcing.
4
A value chain, as defined herein, consists of the set of value-adding
activities within a supply chain that may be undertaken for a product
to be made or a service to be rendered. The concept of the value chain
was originally used to conceptualize the set of productive activities
that occur within the boundaries of any given firm, such as research
and development, engineering design, inbound/outbound logistics,
marketing, etc. (see Porter, 1985). Our definition of the term is
consistent with the general use (e.g. Porter, 1985) to mean a structured
set of activities associated with a firm’s productive output, regardless
of whether they take place within the boundaries of a single integrated
firm or occur externally using intermediate markets. Focusing on
distinct activities that firms perform provides an efficient way of
examining how boundaries change and how specialized capabilities
from intermediate markets can be leveraged to accommodate some or
all of the activities within a value chain.
467
Gilley and Rasheed (2000) refer to this organizing form
as ‘substitution-based outsourcing.’ With substitution,
firms discontinue internal production (e.g. the produc-
tion of goods or services) and replace existing activities
and/or factors of production (e.g. resources) with
capabilities provided by intermediate markets. Accord-
ingly, applying a capabilities perspective, we suggest
that firm scope is partly determined by considering the
performance differential between existing internal
capabilities and those available in intermediate markets
for substitution. By contrast, firms can also decide to
outsource production a priori. Gilley and Rasheed refer
to this form as ‘abstention-based outsourcing,’ which
occurs when firms acquire capabilities from inter-
mediate markets, rather than incur the necessary
investments to internalize production. Thus, firm scope
is also determined by examining the differential
between the costs of internally developing new
capabilities against accessing these capabilities in
intermediate markets (Argyres, 1996; Langlois and
Robertson, 1995).
Research indicates that economizing firms often
consider the value of their capabilities in decisions
about internalizing an activity or conducting it
through intermediate markets (e.g. Argyres, 1996;
Combs and Ketchen, 1999; Hoetker, 2005). Specifi-
cally, in deciding whether or not to internalize, firms
often compare their capabilities with those of other
firms—as signaled by the price and quality terms that
exchange partners are prepared to provide (Jacobides
and Winter, 2005). However, due in part to ambiguity
that emerges based on imperfections in the market,
boundedly rational agents are often unable to foresee
potential synergies from the integration of distinctive
capability combinations.
468 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
An important distinction introduced herein is how
resource-based logics influence the decision to strate-
gically outsource more effective specialized capabilities
along a value chain, beyond that which we know by
examining different governance mechanisms. More
effective capabilities can enable firms to increase
inventory turns, shorten product development cycles,
and reduce the time-to-market for new products (Clark
and Fujimoto, 1992; Petersen et al., 2005). Stated
differently, we contend that strategic outsourcing not
only creates cost economies by shifting production
activity from a focal firm to intermediate markets, but
also creates economic value, especially when produc-
tion involves the use of potentially more valuable
specialized capabilities (Fine and Whitney, 1999;
Mowery et al., 1996). Argyres (1996) was one of the
first to provide qualitative evidence on the role of
capabilities in internalization decisions, observing that
capabilities are a significant driver of firm scope in the
cable connector industry. When comparing transaction-
and firm-level influences on firm scope, Leiblein and
Miller (2003, p. 854) found that firm-level capabilities
‘‘independently and significantly’’ influence firms’
boundary decisions. Jacobides and Hitt (2005, p.
1222) examined how capability differences shape the
make-versus-buy decision concluding that, ‘‘productive
capabilities can and do play a major role in the
determination of vertical scope, and account for ‘mixed
governance modes’.’’
2.2. Specialized capabilities and the emergence of
intermediate markets
A stream of research originally characterized as
‘vertical disintegration’ (Stigler, 1951) helps explain
strategic outsourcing by developing a ‘capabilities
view’ (e.g. Langlois and Robertson, 1995; Leiblein and
Miller, 2003). According to this perspective, the
emergence of new intermediate markets is driven
largely by the desire of firms to pursue gains from the
trade of specialized production. Richardson (1972) was
one of the first to suggest that boundaries were
contingent on the different activities in which firms
engage, the capabilities such activities require, and the
selection and use of those capabilities along a value
chain. Jacobides (2005) examined conditions leading to
increased specialization. He explained the emergence of
new intermediate markets on the basis of gains from
intrafirm specialization that condition a market, divid-
ing previously integrated value chains among different
sets of specialized firms and shifting the focus on value
creation from the final market for goods or services ‘‘to
the value chain structure and the process by which the
good or service is produced’’ (2005, p. 490).
In the automobile sector, for example, advances in
engineering and production technologies have led
manufacturers to decouple supply chain capabilities
giving up parts of the value chain to newly formed
specialists in intermediate markets (Fine and Whitney,
1999). Similar trends are evident in the PC and
communications sectors, with the emergence of electro-
nics manufacturing services (EMS) and original design
manufacturing (ODM) firms, such as Flextronics, Hon
Hai, Sanmina, and Compal Communications, and the
corresponding growth of original equipment manufac-
turers in these sectorsthat only market, but do notdesign or
manufacture their own equipment. In the banking sector,
standardization and advances in information technology
led to significant specialization of production activities
such as application development and data processing,
which enabled non-financial firms such as IBM, EDS, and
Accenture to become key participants in the intermediate
market for information services. Accordingly, given
advances in technology and standardization, new inter-
mediate markets emerge, decomposing the value chain,
allowing firms to ‘acquire’ valuable yet specialized
capabilities cost-effectively via the market. As a result,
firm boundaries shift as activities that were carried out
internally are ‘transferred’ to newly formed intermediate
markets. We therefore argue that strategic outsourcing not
only allows firms to reduce costs, but also to enhance their
portfolio of capabilities, and value creation potential,
especially whenfirmsproduce unique combinationsusing
capabilities provided by these markets.
We suggest that three assumptions underlie resource-
based views about strategic outsourcing. First, selection
determines gains available to firms from capabilities
accessed in the intermediate markets and then
intensifies the effect of these capabilities on firm
performance. Complementarity and relatedness creates
uniquely valuable synergy, especially when specialized
capabilities are effectively combined and when no other
combination can replicate the resulting value chain
activities (Harrison et al., 1991, 2001; Prahalad and
Bettis, 1986; Richardson, 1972; Tsai, 2000). To the
extent that intermediate markets have superior cap-
abilities that complement a firm’s existing capabilities,
selection processes will combine the specialized
internal and external capabilities. By contrast, if a firm
possesses superior capabilities that are already inte-
grated, selection will accommodate internalization.
Second, strategic outsourcing relationships form
within a social context. Ties, both direct and indirect,
with firms in intermediate markets create a network
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
(Uzzi, 1997), and become an important source of
information about the reliability and performance of
current and future exchange partners (Granovetter,
1985). Such information helps a focal firm to learn
about capabilities available in intermediate markets.
Repeated ties improve trust in current and potential
exchange partners and increase the likelihood of future
cooperation (Gulati, 1995). Accordingly, cooperative
experience forges close bonds over time and increases
confidence that exchange partners will pursue mutually
compatible interests thereby reducing the probability of
opportunism (Das and Teng, 1998), and facilitating the
exchange of capabilities crucial for performance (Combs
and Ketchen, 1999; Uzzi, 1996). Because strategic
outsourcing involves coordinating the actions of two or
more firms, cooperative experience is vital to its success.
Third, firms enhance their ability to leverage
specialized capabilities by developing and refining
mechanisms that strengthen the synergies such cap-
abilities provide. We refer to these mechanisms as
relational capability-building mechanisms (Dyer and
Singh, 1998; Makadok, 2001), which allow firms to
enhance the potential value of specialized capabilities
deployed along a value chain. When purposefully
developed, relational capability-building mechanisms
allow firms to accumulate, integrate, and leverage
experience over time; they are derived from previous
capability-building actions, the results of those actions,
and the future actions firms pursue (Fiol and Lyles,
1985). From a transaction-based perspective, these
mechanisms reduce coordination and integration costs
and enable firms to exploit new opportunities in the
market, especially when they develop the mechanisms
to more effectively manage the portfolio of capabilities
they acquire from intermediate markets. These mechan-
isms also create causal ambiguity, obscuring the use of
capabilities deployed across a value chain and making it
difficult for competitors to determine a priori the
sources of value within firms’ supply chains.
In sum, we contend that specialized capabilities
accessed by strategic outsourcing may allow firms to
achieve greater performance gains. In the following two
subsections, we briefly describe several economic
incentives behind strategic outsourcing and contrast
this organizing arrangement with two related concepts:
strategic purchasing and strategic alliances.
2.3. Economic motives and incentives behind
strategic outsourcing
Although previous empirical studies of outsourcing
have produced equivocal results, there is increasing
469
evidence that certain economic motives may prompt a
firm’s decision to pursue this organizing form. We
provide three possible economic motives behind strategic
outsourcing. First, strategic outsourcing potentially
reduces bureaucratic complexity. As firms grow, infor-
mation asymmetries emerge (Hitt et al., 1996). Asym-
metries produce information deficits. Information
deficits add to the administrative demands of organizing
transactions. Excessive bureaucratic costs associated
with governance oversight reduce firm performance
(D’Aveni and Ravenscraft, 1994; Rothaermel, Hitt and
Jobe, in press). In turn, these demands distract managerial
attention from important sources of innovation and
growth and add to the costs of internalization (D’Aveni
and Ravenscraft, 1994). As transaction volumes increase,
mobility and exit barriers form reducing strategic
flexibility and often trapping firms in obsolescent tech-
nologies (Harrigan, 1985). Thus, strategic outsourcing
helps firms align competing priorities, focus manage-
ment attention on growth and innovation opportunities,
and target resources to those tasks firms do best.
Second, strategic outsourcing improves production
economies, especially when firms fail to achieve
sufficient production scale to overcome cost disadvan-
tages (Teece, 1980). Because decisions about price and
production are made before actual demand is observed,
as transaction volumes vary, firms may find it difficult to
make optimal use of available capacity or may ration
production when existing production scale limits
activity (Green, 1986). Strategic outsourcing allows
firms to avoid or reduce rationing and meet production
requirements by relying on intermediate markets as
demand varies over time; it also provides a mechanism
for firms to reduce uncertainty, transfer risk, and share
scale economies with specialized firms from these
markets. As a result, overhead is reduced, production
costs decline, and investments in certain facilities and
equipment are eliminated, which in turn reduces firms’
break-even points.
Based on the considerations noted above, financial
advantages evolve in three ways. First, firms pursuing
strategic outsourcing through substitution (Gilley and
Rasheed, 2000) benefit from financial capital (cash)
exchanged for internal factors of production (e.g.
facilities, equipment, management and production
personnel, etc.) when assets are transferred or sold to
firms in intermediate markets. The nature and size of
this financial capital-factor exchange often has sub-
stantial effects on the total value of strategic out-
sourcing ‘deals’. Second, with strategic outsourcing,
firms can reduce or eliminate longer-term capital
outlays to fund future investments related to the
470 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
‘outsourced’ production. This allows firms to partly
shift specific internal costs, including fixed charges,
such as amortization and depreciation costs, to
intermediate markets. Finally, strategic outsourcing
can buffer firms by providing access to resources (Miner
et al., 1990). Thus, firms reduce their exposure as
capacity and costs are more directly linked to actual
production output (e.g. the number of ‘units’ produced).
This allows firms to transfer the risk of changes in
production as well as responsibility for future capital
outlays to intermediate markets.
Third, increases in bureaucratic complexity increase
the coordination costs associated with different factors
of production, especially when specialization reduces
the degrees of freedom (Rothaermel et al., in press).
Diminishing returns result when the loss of strategic
flexibility and the increase in administrative costs
outweigh the benefits of integration (Jones and Hill,
1988). Accordingly, when increased specialization
simplifies coordination across a value chain (Jacobides,
2005), or when internal production is more efficient
through intermediate markets, firms are more likely to
integrate and use specialized capabilities.
2.4. Strategic outsourcing and related concepts
We draw a distinction between strategic outsourcing
and strategic purchasing. Strategic purchasing refers to
the ongoing process of soliciting, negotiating, and
contracting for the delivery of goods and services from
suppliers (Chen et al., 2004b; Murray and Kotabe,
1999). Key activities include procurement, supplier and
contract management, and other related supply chain
management actions (Salvador et al., 2002) that involve
arms-length transactions with suppliers (Chen and
Paulraj, 2004). Firms regularly purchase products or
services from suppliers on a frequent or recurring
basis—from the procurement of production inputs to
the purchase of supplies for office and administrative
use (Walker and Weber, 1987). Accordingly, these
decisions tend to be more routine and rarely involve the
transfer of resources (Chen et al., 2004a). By contrast,
strategic outsourcing is less common, and may involve
the transfer or sale of resources to firms in intermediate
markets. Moreover, strategic outsourcing reflects a
primary ‘‘relational view’’ involving linkages with
exchange partners that provide access to specialized
capabilities. This relational view explains performance
gains that arise when these capabilities are configured
along the value chain to create value that cannot be
realized through internalization (Das and Teng, 1998;
Sirmon et al., in press). Equating strategic outsourcing
with the purchase of goods and services fails to capture
full nature of this organizing form.
We also differentiate strategic outsourcing from
strategic alliances. Strategic alliances represent colla-
borative arrangements that firms establish to achieve
common goals in which benefits are ultimately shared
by alliance partners (Inkpen, 2001). As such, in
alliances, individual firm performance is a function
of both the total value generated by the alliance and the
share of this value each firm appropriates (Alvarez and
Barney, 2001; Hamel, 1991). Alliances also allow
partners to share risks and resources (Ireland et al.,
2002), to gain access to new knowledge (Dyer and
Singh, 1998), and to obtain access to new product
markets (Hitt et al., 2000). By contrast, strategic
outsourcing arrangements generally involve a focal
firm’s decision to deploy specialized capabilities along
its value chain thereby linking firm performance
directly to the productive activities it controls. While
alliances infer joint decision-making and shared
residuals, strategic outsourcing primarily benefits firms
that originate the action (Insinga and Werle, 2000) by
allowing them to appropriate directly the residual value
such actions create. Accordingly, outsourcing decisions
are not based on appropriation logic per se, rather on
economic terms defined by a focal firm after consider-
ing the different cost/performance trade-offs.
3. Transaction-based arguments for strategic
outsourcing
Efficiency assumptions in TCT drive the classical
reasoning for strategic outsourcing. With this view,
difficulties that emerge from market-based exchanges
generate transaction costs. Such costs include negotia-
tion, contracting, monitoring, and enforcement costs, as
well as costs incurred when resolving disputes. Based
on this perspective, the performance implications of
outsourcing and thus the decision criteria firms apply
are based on the alignment of different governance
structures with attributes of the exchange and the
underlying contracting environment. For example, a
firm that selects a simple governance structure lacking
adequate safeguards and controls is exposed to moral
hazard and hold-up risks when the contracting
environment is complex or when it involves transac-
tion-specific investments (Leiblein et al., 2002). By
contrast, selecting an excessively complex governance
structure for a simple contracting environment unne-
cessarily intensifies bureaucratic complexity, which
reduces decision-making speed, decreases strategic
flexibility, and increases overall costs (Williamson,
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481 471

1985). Accordingly, cost economies as a consequence ate markets negatively affect the likelihood a firm will
of effective governance structures represent important pursue strategic outsourcing.
criteria in the decision to strategically outsource. We
Under certain conditions, however, asset specificity
briefly describe three transaction-based considerations
may serve as a catalyst for interfirm cooperation. When
for strategic outsourcing: asset specificity, small
firms involved in outsourcing relationships are required
numbers bargaining, and technological uncertainty.
to invest collectively in the development of specific
3.1. Asset specificity assets or new capabilities, such collaboration can form a
reciprocal interdependency that increases the level of
Among the exchange conditions originally identi- cooperation and reduces the incentive to engage in
fied by Williamson (1975), asset specificity has been opportunism. These conditions reduce the costs of using
perhaps the most robust empirically. Specific assets, in capabilities from intermediate markets (Combs and
contrast to general purpose assets, are considered an Ketchen, 1999; Teece, 1992). Accordingly, in contexts
obstacle to market efficiency, because they are costly that involve mutual investments in capabilities, colla-
to redeploy to alternative uses (Williamson, 1991). boration may encourage mutual gain, even when such
Thus, asset specificity is the principal factor giving investments result in exchange-specific assets, and thus
rise to transaction costs. Williamson (1985) defined increase the likelihood a firm will pursue strategic
asset specificity as durable investments that are made outsourcing. Thus, we propose that:
in support of particular exchange transactions.
Proposition 1b. Requirements for collaborative invest-
Specific assets are investments made in specific,
ments in exchange-specific assets between a firm and
non-marketable resources and reflect ‘‘the degree to
specialized firms from intermediate markets positively
which an asset can be redeployed to alternative uses
affect the likelihood a firm will pursue strategic out-
and by alternative users without sacrificing productive
sourcing.
value’’ (Williamson, 1991, p. 281). Highly specific
supply chain assets, for example, might include
3.2. Small numbers bargaining
investments in facilities, equipment, personnel, and
firm- or process-specific training associated with the
TCT scholars also argue that small numbers
production of goods or services that have little or no
bargaining situations create market inefficiencies that
use outside the exchange relationship (Grover and
create higher switching costs and increase the like-
Malhotra, 2003).
lihood of opportunistic behavior (e.g. Klein et al., 1978;
With strategic outsourcing, one of the principal
Williamson, 1975). The possibility of opportunistic
challenges in deciding whether to make a specific
behavior arises when the number of specialized firms in
investment concerns the possibility that exchange
intermediate markets is small, resulting in small
partners might act opportunistically. Asset specificity
numbers bargaining (Williamson, 1975). Moreover,
creates a bilateral interdependency between the firms
the likelihood of opportunistic behavior is most severe
(Carney, 1998; Jones, 1983). As such, conditions of
when focal firms are required to make significant
outsourcing often lead to one or more firms being
exchange-based investments because such investments
‘‘locked in’’ and increasingly vulnerable. Trading
may be subject to hold-up by external partners (Klein
hazards created by the structure of the market exchange,
et al., 1978). Small numbers bargaining affects the
in turn, produce transactions costs. Diseconomies
distribution of bargaining power in outsourcing
related to weak incentives and monitoring costs emerge.
relationships. Bargaining power is defined as the ability
Under these conditions, asset specificity exposes
to influence the outcomes of negotiated relations
outsourcing firms to potential opportunism, when
(Bacharach and Lawler, 1981; Schelling, 1956). Firms
exchange partners advance their own self-interest.
with more bargaining power can obtain more favorable
Contracting in such situations is difficult, expensive,
outcomes. In this case, bargaining power is important
and often counter-productive. Consequently, where
because it can lead specialized firms to act opportu-
resource investments by focal firms are idiosyncratic to
nistically in order to gain an advantage in outsourcing
an exchange relationship, interfirm cooperation is likely
relationships. Thus, small numbers bargaining reduces
to involve internalization. Thus, we propose that:
the likelihood firms will pursue outsourcing.
Proposition 1a. Requirements for firm-specific invest- Moreover, when the degree of competitiveness
ments by a focal firm in exchange-specific assets within intermediate markets is low (e.g. small number
between the firm and specialized firms from intermedi- of specialized firms), specialized firms acting oppor-
472 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
tunistically may be less willing to share costs caused by
changes in production volume or design specifications,
thereby increasing transaction costs for a focal firm
(Walker and Weber, 1987). By contrast, the higher the
degree of competitiveness in an intermediate market,
the more likely that partners will collaborate to share
scale economies by leveraging adjustment costs across
customers (Walker and Weber, 1984). Such economies
dampen opportunistic bargaining, reduce potential
transaction costs, and therefore provide a stronger
incentive for firms to outsource. Accordingly, the
greater the density of specialized firms, the lower a focal
firm’s exposure to small numbers bargaining, and the
more likely that strategic outsourcing will emerge.
Thus, we propose that:
Proposition 2. The number of specialized firms from
intermediate markets is positively related to the like-
lihood a firm will pursue strategic outsourcing.
3.3. Technological uncertainty
Technological uncertainty refers to unanticipated
changes in circumstances surrounding technology, i.e.,
new generations of technology that render existing
technology obsolete (Folta, 1998; Robertson and
Gatignon, 1998). Broadly defined, technology repre-
sents theoretical and practical knowledge, skills,
production and supply chain systems, and related
artifacts that can be deployed along a firm’s value chain
to develop goods and services (Burgelman et al., 1996).
Changes in technology create new complexities for
structuring value chain activities, especially when new
knowledge is applied at a faster rate reducing the time
between innovations (Song and Montoya-Weiss, 2001).
In the presence of technological uncertainty, greater
resource commitments produce more exposure to
negative ‘shocks’. Thus, relative to arrangements that
provide ‘on-demand’ access to capabilities through
intermediate markets, technological uncertainty may
serve as a disincentive to internalize because it often
requires greater resource commitments.
These conditions may prompt firms to pursue
strategic outsourcing to reduce their exposure to
unforeseen contingencies and to improve financial
and operational stability and predictability. Schoon-
hoven (1981, pp. 355–356) found that ‘‘destandardiza-
tion’’ and ‘‘decentralization’’ of task execution had
positive effects on firm performance under conditions of
technological uncertainty. Harrigan (1985, 1986)
argued that increases in technological uncertainty
may lead firms to use less firm-specific resources. As
a consequence, internalization is likely to decrease in
the long-run, because strategic outsourcing allows firms
to partly transfer the risk of task variability to the
intermediate markets. Specialized firms in these
markets may be better able to achieve cost efficiencies
that are difficult for focal firms to achieve by balancing
task requirements across multiple customers. As
technological uncertainty increases, internal economies
of specialization deteriorate in relation to the external
economies of specialized firms (Teece, 1980). As such,
strategic outsourcing not only can provide scale
economies during periods of technological uncertainty,
but may also act as a coping strategy helping to deal
with risk. From this perspective, strategic outsourcing
provides more predictable and orderly patterns of
exchange within and between firms.
However, at higher levels of technological uncer-
tainty, larger information deficits increase the likelihood
for opportunism, making it costly to handle exchanges
through intermediate markets. These asymmetries
reduce the ability to foresee potential contingencies
that may occur in the future making it costly to write,
monitor, and enforce complete contracts (Grossman and
Hart, 1986). As a result, parties to such exchanges are
more likely to regularly renegotiate the terms of their
relationship, which increases the likelihood of oppor-
tunism. At increasingly higher levels of uncertainty,
greater information deficits emerge, reducing cost
economies and increasing the difficulty of interfirm
collaboration. Reductions in cost economies lead to
diminishing returns. At higher levels of technological
uncertainty, firms find it difficult to accurately predict a
priori the combination of possible events and outcomes
that are likely to emerge from production (March and
Simon, 1958). Thus, beyond a certain level of
technological uncertainty, we expect this relationship
to be negative. Specifically, we propose that:
Proposition 3. Technological uncertainty will have a
non-linear (inverse U-shaped) effect on the likelihood a
firm will pursue strategic outsourcing, with the slope
positive at low and moderate levels of technological
uncertainty but negative at high levels of technological
uncertainty.
3.4. Critique of transaction-based arguments for
strategic outsourcing
While providing a number of important insights
regarding the most efficient means to govern a
particular economic exchange (Grover and Malhotra,
2003), TCT generally involves a set of restrictive
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
assumptions that ignore the potential influence of a
firm’s extant governance forms, its portfolio of
exchange transactions, and other firm-specific capabil-
ities on value created through value chain activities.
Thus, in equilibrium, TCT implies that all firms facing a
similar set of exchange conditions and transactional
attributes will reach similar conclusions regarding
which activities to internalize and which activities to
outsource (Leiblein and Miller, 2003). However, this
proposition is untenable. Comparisons of internaliza-
tion decisions across firms in the same industry suggest
that the internalization decisions often differ dramati-
cally. For instance, while companies such as IBM and
Nokia have remained historically integrated, other
companies such as Dell, HP, Ericsson, and Motorola
outsource a variety of production functions ranging
from R&D and engineering design to manufacturing
and logistics. Moreover, variance in performance within
and between these two groups of firms suggests a more
complex set of factors affect the decision to outsource.
Thus, using economizing motives alone limits the
quality of discourse about the decision to outsource. In
the following section, we extend the conceptual
orientation of strategic outsourcing to consider
resource-based factors.
4. Resource-based arguments for strategic
outsourcing
Drawing on the RBV, we extend transaction-based
perspectives of strategic outsourcing by focusing
attention on the role of specialized capabilities obtained
through intermediate markets. This approach, however,
requires a refinement in the traditional role of
boundaries. In particular, while conventional
approaches to boundary conditions emphasize bound-
aries as an economizing buffer to environmental
contingencies (Araujo et al., 2003), boundaries also
act as a bridge to intermediate markets through
relationship ‘ties’ formed by a focal firm. In other
words, boundaries integrate as well as separate a firm
from its environment. In this work, we define bridging
as the process by which firms establish linkages with
intermediate markets, suggesting that new capabilities
may be obtained through relationships established
within and across a firm’s relationship network (e.g.
Burt, 1992; Granovetter, 1973). Herein, our focus is on
the specialized capabilities provided through these
relationships.
The ability to access new and potentially more
valuable capabilities is a critical driver of strategic
outsourcing because these actions can fundamentally
473
alter a firm’s capability endowments (Morrow et al.,
2005), making it easier to pursue new opportunities in
the market. We maintain that different conditions affect
the value of capabilities sourced from intermediate
markets. In particular, we briefly describe four resource-
based considerations for strategic outsourcing: com-
plementarity of capabilities, strategic relatedness,
relational capability-building mechanisms, and coop-
erative experience.
4.1. Complementarity of capabilities
Beginning with Penrose (1959), strategy scholars
have proposed that firms enhance value chain perfor-
mance when they align with exchange partners in order
to access complementary capabilities (e.g. Harrison
et al., 1991; Rothaermel, 2001; Teece, 1986). Applied to
strategic outsourcing, this argument suggests that firms
seek ties with specialized firms that possess capabilities
beneficial to and needed by a focal firm. Such
capabilities may be required to replace existing
capabilities deployed along a value chain (e.g.
substitution-based outsourcing) or to fulfill a specific
need not currently available in a firm (e.g. abstention-
based outsourcing).
Capability complementarity reflects a situation in
which specialized capabilities enhance the value
creation potential of a focal firm’s own capability
endowments. Complementary capabilities are differ-
ent, yet mutually supportive (Luo, 2002a; Hitt et al.,
2001). Richardson (1972) suggests that capabilities
are complementary when they ‘‘represent different
phases of production and require in some way or
another to be coordinated’’ in order to create
maximum value (Richardson, 1972, p. 889). Where
complementarities exist, the integration of internal
and external capabilities enhances the potential
performance gains firms realize, especially when
economies of scope in production increase their
market power (Mahoney and Pandian, 1992). When
complementary capabilities are idiosyncratic and
indivisible, and thus not otherwise available in the
factor markets (Barney, 1986), strategic outsourcing
can provide access to them.
When complementary capabilities are linked
together, they are especially difficult for competitors
to duplicate because imitation not only requires
obtaining the capabilities from intermediate markets,
but also duplicating their deployment along a value
chain (Holcomb et al., 2006). Barney (1988) suggested
that acquiring firms gain above normal returns from
acquisitions only when private or uniquely valuable
474 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
synergies can be realized. Private and uniquely valuable
synergy is created when information about the
combination is obscured from rivals and when no other
combination of firms could produce the same value.
Research suggests that firms participating in exchange
relationships that involve complementary capabilities
perform better than firms with relationships that are
formed to achieve cost economies (Harrison et al.,
2001; Holcomb et al., 2006). Chung et al. (2000) also
found the likelihood of alliance formation was
positively related to the complementarity of investment
banks’ capabilities. Similarly, other research suggests
that firms consider the potential for complementarity an
important partner selection criterion (Hitt et al., 2000,
2004).
Different but complementary resources can help a
firm improve scale economies, enhance responsiveness
and innovative potential, and increase quality. Further-
more, because complementary capabilities are gener-
ally relationship-specific (Dyer and Singh, 1998), the
value created may be unavailable to rivals through
alternative sources (e.g. private; Barney, 1988), which
may create a sustainable competitive advantage. Thus,
strategic outsourcing relationships are more important
to value-creating activities when these relationships
provide specialized capabilities that are complementary
to those currently held by a firm, especially when the
integration of those capabilities across a value chain
create private and uniquely valuable synergy. From the
resource-based perspective, firm scope then is deter-
mined by the limits in specialization and the need to
maximize gains from the combination of complemen-
tary capabilities along a value chain.
By applying this logic, we argue that strategic
outsourcing is a likely alternative when benefits from
specialized capabilities accessed from intermediate
markets are based on complementarity. A complemen-
tarity perspective for strategic outsourcing suggests that
a firm will ally with partners in whom the greatest
complementarity exists between the firm’s capability
endowments and those held by partners in intermediate
markets. Thus, we conclude that the complementarity of
capability endowments between a firm and its exchange
partners has a positive effect on the likelihood the firm
will pursue strategic outsourcing. Specifically, we
propose that:
Proposition 4. The extent of complementarity that
exists between a firm’s existing capability endowment
and capabilities available from intermediate markets
positively affects the likelihood a firm will pursue
strategic outsourcing.
4.2. Strategic relatedness
Strategic relatedness characterizes the degree to
which firms are strategically similar; it reflects the
extent to which firms produce similar goods and
services, serve similar markets, utilize similar produc-
tion and supply chain systems, or rely on similar
technologies. Relatedness provides a rationale for
capability-sharing between firms (Prahalad and Bettis,
1986; Rumelt, 1974; Tsai, 2000). We expand this view
of ‘relatedness’ to include goal congruence and the
commonality of knowledge-sharing routines. A high
degree of relatedness between a firm and its exchange
partners implies that they share common goals and are
able to transfer knowledge between them more
effectively. Accordingly, strategic relatedness is an
important factor in a firm’s decision to pursue strategic
outsourcing.
Goal congruence is the degree to which firms’
operational, strategic, and performance objectives
overlap and/or reinforce one another. When firms’
goals are not congruent, performance considered
satisfactory to a focal firm may not be satisfactory to
exchange partners and vice versa. Likewise, behavior
promoting the interests of a focal firm may not promote
the interests of those partners (Luo, 2002b). The
presence of congruent goals helps to resolve these
potential concerns. Despite the importance of goal
congruity for success in exchange relationships (Luo,
2002a), evidence suggests a lack of goal congruity in
many such relationships. As profit-maximizing goals
are aligned, strategic outsourcing not only reduces
monitoring and enforcement costs associated with the
arrangement but also increases synergies as well. When
goals are aligned, specialized firms are more likely to
share common interests with a focal firm and thus be
more supportive of exploiting new opportunities, even if
such opportunities require these firms make additional
investments. These synergies enable firms with ‘com-
mon goals’ to more quickly exploit competitive
imperfections observed in the market (Mahoney and
Pandian, 1992), and thus hold the potential to create
value beyond cost savings alone.
Goal congruency also reduces conflict and
encourages cooperative behavior (Parkhe, 1993). Thus,
firms with exchange partners that share congruent goals
find it easier to collaborate thereby enhancing the value
of these relationships. Moreover, congruent goals
improve the quality of relationships with exchange
partners, which reduce the probability of opportunism
(Granovetter, 1985; Uzzi, 1996). With the threat of
opportunism reduced, exchange partners may be more
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
willing to make additional resources available. Finally,
congruent goals can reduce the need for formal
contractual arrangements (Dyer and Singh, 1998).
These informal agreements in turn promote adaptability
and reduce the need for formal governance mechanisms
(Uzzi, 1997). Thus, costs are reduced to the extent that
less monitoring and enforcement is required.
By contrast, incongruent goals often lead to the
development of sub-goals, which exchange partners
may pursue at the expense of a focal firm (Williamson,
1975). Incongruent goals also impede cooperation, limit
the exchange of resources between exchange partners
(Luo, 2002a), and can lead to early termination of these
relationships. Furthermore, in the presence of incon-
gruent goals, the time and energy spent resolving
disputes detract from developing and implementing
innovative strategies and can prevent valuable strategies
from emerging. Incongruent goals therefore make it
difficult to leverage specialized capabilities accessed by
firms through strategic outsourcing. Thus, we argue that
goal congruency affects the likelihood a firm will
pursue capabilities from intermediate markets through
strategic outsourcing. Specifically, we propose that:
Proposition 5a. Goal congruency between a firm and
specialized firms from intermediate markets positively
affect the likelihood a firm will pursue strategic out-
sourcing.
A high degree of strategic relatedness also results
when focal firms and specialized firms share common or
similar knowledge-sharing routines (Dyer and Singh,
1998). We define knowledge-sharing routines as regular
patterns of interactions that permit the transfer,
assimilation, and integration of new knowledge (Grant,
1996). The advantage of such routines lies in the ability
to economize effort, which reduces coordination costs
and affords greater capacity for knowledge-sharing
between firms.
Common knowledge-sharing routines may emerge
as new intermediate markets are formed by increasing
specialization within an industry (Jacobides, 2005). For
example, with the emergence of intermediate markets
specializing in information services, firms have
increasingly transferred in-house computing systems
resources—i.e., programming and data center opera-
tions personnel, computer hardware, and enterprise
application software as well as software design and
programming processes and methodologies—to firms
in these markets (e.g. EDS, IBM, and Accenture) who
integrate and use these resources. As a result of these
transfers, focal firms commonly share routines with
their partners, which facilitates knowledge-sharing.
475
Further, because firms within an industry often share
common knowledge structures, the emergence of
vertically specialized markets in an industry increases
the likelihood they will share common knowledge-
sharing routines. Accordingly, the emergence of
intermediate markets increases the diffusion of knowl-
edge and thus increases the probability of strategic
outsourcing in an industry.
Various scholars have argued that interorganizational
learning is also critical to competitive success, noting
that firms’ partners are, in many cases, the most
important sources of new knowledge (Powell et al.,
1996; Von Hippel, 1988). Common knowledge-sharing
routines between a firm and its exchange partners
enable more efficient absorption and use of acquired
knowledge (Cohen and Levinthal, 1990). Absorptive
capacity includes relationship-specific capabilities,
such as knowledge-sharing routines, that arise when
firms develop mutually specialized ways of exploiting
each other’s capabilities. Dyer and Singh (1998) define
partner-specific absorptive knowledge as a function of
(1) the extent to which firms develop overlapping
knowledge bases, and (2) the extent to which partners
develop routines that maximize the benefit of their
interactions. In sum, we conclude that effective
knowledge-sharing routines are crucial to the exploita-
tion of intermediate markets and thus affect the
likelihood firms will pursue strategic outsourcing.
Thus, we propose that:
Proposition 5b. Commonality of knowledge-sharing
routines between a firm and specialized firms from
intermediate markets positively affects the likelihood
a firm will pursue strategic outsourcing.
4.3. Relational capability-building mechanisms
Evidence suggests that firm performance is affected
by its abilities to integrate, build, and reconfigure
resources. This process is referred to as dynamic
capabilities (Teece et al., 1997). According to Loasby
(1998, p. 139), ‘‘‘managing capabilities’ is itself a
capability’’; that is, firms develop capabilities over time
that help them develop and link productive capabilities
across a value chain. In particular, dynamic capabilities
have been used to explain why firms in the same industry
perform differently. For example, Helfat and Peteraf
(2003) suggest that dynamic capabilities are embedded
within firms and consist as a set of specific and
identifiable strategic and organizational routines. We
use the work on the dynamic capabilities (e.g. Teece et al.,
1997; Helfat and Peteraf, 2003) to define relational
476 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
capability-building mechanisms as routines that allow
firms to synthesize and leverage specialized capabilities
(Dyer and Singh, 1998; Makadok, 2001). Our view of
these mechanisms also complements ‘recombinatory’
(e.g. Galunic and Rodan, 1998; Grant, 1996; Kogut and
Zander, 1992) views of capabilities, which emphasize the
manipulation of competences residing within the firm.
Accordingly, these mechanisms improve a firm’s ability
to accumulate, integrate, and leverage specialized
capabilities across a value chain, and affect its ability
to pursue new opportunities in the future.
Relational capability-building mechanisms also act as
a focal point for learning and leveraging experiences from
past capability-building actions, the results of those
actions, and the firm’s future actions (Fiol and Lyles,
1985). They represent a more systematic and routine
implementation of dedicated processes that support
production activity involving the use of specialized
capabilities. For example, Kale et al. (2002) found that
firms with a dedicated capability to manage interfirm
relationships generated substantially higher market value
than firms without such capability. Stated differently,
firms that systematically invest in developing the ability to
manage interfirm relationships consistently perform
better than others that choose not to make such
investments. Zollo and Singh (2004) found that dedicated
processes in which firms accumulate and explicitly codify
acquisition experience significantly improved overall
acquisition performance by counteracting the coordina-
tion problems that future contingencies create. Accord-
ingly, we expect investments in development of relational
capability-building mechanisms will reduce coordination
and integration costs, and improve the synergistic benefits
available through strategic outsourcing.
In sum, relational capability-building mechanisms
not only enable firms to generate greater value
(Mahoney and Pandian, 1992; Makadok, 2001), but
also create additional ambiguity that allow firms to
sustain certain advantages over time (Rumelt, 1984).
Under these conditions, we expect relational capability-
building mechanisms to directly affect the likelihood
firms pursue strategic outsourcing. Accordingly, we
propose that:
Proposition 6. Relational capability-building mechan-
isms positively affect the likelihood a firm will pursue
strategic outsourcing.
4.4. Cooperative experience
Strategic outsourcing relationships are formed
within a social context that influences selection
decisions and the pattern of interfirm linkages that
emerge. We represent cooperative experience as
repeated ties, direct and indirect, formed with specia-
lized firms from intermediate markets. Repeated ties
with these firms create a pattern of relationships in
which focal firms can access information about the
reliability and performance of current and future
partners (Granovetter, 1985; Uzzi, 1997). These ties
reduce information asymmetries, heighten awareness
about specialized capabilities and firms from inter-
mediate markets, and establish a basis for trust. In turn,
trust enhances the potential benefits of strategic
outsourcing by reducing the risk of adverse selection
and improving the level of collaboration once such
relationships are established. Herein, we define trust as
a firm’s confidence in the reliability of a specialized firm
to fulfill its obligations and act fairly when the
possibility for opportunism is present. Zaheer et al.
(1998) found that organizational trust formed by
repeated market exchanges is an important driver of
interfirm relationships because it enhances overall
performance, decreases the complexity and costs of
negotiation processes, and reduces conflict. Examining
international joint ventures (IJVs), Luo (2002b) found
that cooperation had a linear effect on IJV performance,
especially at higher levels of contract term specificity
and contingency adaptability, which represents the
extent to which unanticipated contingencies are
accounted for and the guidelines for handling such
contingencies are specified in a contract. We suggest
that a focal firm’s cooperative experience with
specialized firms reduces information asymmetry and
opportunistic behavior, and thus enhances the potential
benefits of strategic outsourcing. Accordingly, coop-
erative experience increases the likelihood that addi-
tional outsourcing arrangements will be pursued with
these firms in the future.
Whereas, according to the transaction-based view,
interfirm cooperation occurs only when the costs of
governing production can be minimized, the resource-
based perspective suggests that firms share capabilities in
order to stimulate growth (Combs and Ketchen, 1999).
As such, cooperation represents ‘‘the willingness of a
partner firm to pursue mutually compatible interests . . .
rather than act opportunistically’’ (Das and Teng, 1998, p.
492). Because market exchanges are embedded in a
social context, the governance of interfirm exchanges
involve more than contracts; they depend on the level of
cooperation between the firm and its partners (Luo,
2002b). For such relationally-governed exchanges, the
enforcement of obligations, promises, and expectations
involves social processes that promote norms of
 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
adaptation and information exchange. The significance
of cooperative experience is reflected in the paradox that
results: firms are expected to pursue strategies and
programs that best serve their interests; however,
interfirm relationships require simultaneous investment
and restraint in order for each party to gain maximum
value from the relationship (cf. Das and Teng, 1998).
The pattern of cooperation that emerges when
intermediate markets form around specialized capabil-
ities (Jacobides, 2005; Richardson, 1972) encourages
firms to engage in repeated exchanges, especially as these
markets mature improving accessibility to specialized
capabilities. Repeated ties with specialized firms
improve trust and increase the likelihood of future
cooperation (Gulati, 1995). This pattern of connections
broadens the firm’s scope and also affects the nature of
ongoing capability development processes (Araujo et al.,
2003; Jacobides and Winter, 2005), i.e., the way in which
a firm shapes or improves its value chain over time.
Changes in capabilities then reshape intermediate
markets, allowing additional firms to participate. These
changes facilitate growth in the number of potential
suppliers but also increase the complexity of the selection
and coordination process. Cooperative experience
provides knowledge that helps in selecting and coordi-
nating specialized capabilities in which relationship ties
serve as a valuable conduit for rich information.
Previous cooperation, defined in terms of both the
length and quality of the exchange relationship, fosters
a climate of trust, openness and confidence. Repeated
interactions or ‘‘cycles of exchange’’ between parties
strengthen their willingness to trust each other and to
expand the boundaries the relationship (Rousseau et al.,
1998). Over time, such relationships become integrated
into the social context that develops between firms,
which fosters knowledge-sharing, supports adaptability,
and deters opportunism. In so doing, the synergy from
exchange relationships is magnified. Specifically,
exchange relationships based on trust are more likely
to exploit market opportunities requiring access to
resources from exchange partners. Such relationships
are more likely to result in collaborative efforts to
exploit emerging opportunities in the market. We
conclude that cooperative experience affects the like-
lihood firms will pursue strategic outsourcing. Thus, we
propose that:
Proposition 7. Cooperative experience between a firm
and specialized firms from intermediate markets,
defined by the length and the quality of previous rela-
tionships, positively affects the likelihood a focal firm
will pursue strategic outsourcing.
477
5. Discussion and conclusion
The dominant goal most often cited for strategic
outsourcing is cost efficiency. According to this
perspective, firms internalize value chain activity to
minimize costs from opportunism and bounded
rationality, the uncertainty of frequent market
exchanges, and specific assets that may arise from this
organizing arrangement. This rationale, in part, holds
that specific governance mechanisms used to manage
certain exchanges are more efficient and reflects the
view of firm boundaries as the point at which resource
owners relinquish control over access and use.
Accordingly, transaction-based perspectives develop
logic for strategic outsourcing on the basis of
economizing motives linking governance choices to
attributes of an exchange.
The restrictive assumptions offered by TCT suggest
that, in equilibrium, firms with similar exchange
conditions will make the same decisions about strategic
outsourcing. However, the arguments presented herein
show this proposition to be incomplete. Strategic
outsourcing enables firms to bridge boundaries and
access capabilities from intermediate markets that are
subsequently deployed along the value chain. Accord-
ing to the RBV, resource heterogeneity leads to
otherwise similar firms displaying significantly differ-
ent ways of accomplishing the same set of value chain
activities, emboldened by the use of different capabil-
ities. We argued that by linking value chain activities
with intermediate markets for the purpose of gaining
access to valuable specialized capabilities, firms can
accrue value beyond the cost economies available
through more efficient governance mechanisms. Thus,
we augmented transaction-based arguments with
resource-based perspectives to sharpen the focus on
conditions that might favor the use of specialized
capabilities.
The purpose of this work has been to extend our
understanding of strategic outsourcing by integrating
transaction-based and resource-based logics. First, we
offered a more concise definition of strategic out-
sourcing and extended the focus on cost economies
resulting from more efficient governance mechanisms
to consider value that is created when firms more
effectively leverage the specialized capabilities that
outsourcing relationships provide. An important dis-
tinction introduced herein is how firms’ understanding
of their capabilities and those of specialized firms affect
their decision to strategically outsource. We also
showed how the emergence of new intermediate
markets (e.g. vertical disintegration; Jacobides, 2005;
478 T.R. Holcomb, M.A. Hitt / Journal of Operations Management 25 (2007) 464–481
Richardson, 1972) provides a theoretical framework
explaining the logic for a ‘capabilities view’ of strategic
outsourcing. In particular, we shift the focus on value
creation from different exchange conditions to value
chain structures and to the process by which firms
produce goods and services. Accordingly, intermediate
markets that maintain specialized capabilities emerge as
conditions within an industry intensify the partitioning
of production activity. As a result, boundaries shift to
accommodate access to specialized capabilities that are
then deployed along a firm’s value chain.
Second, we extended the view of boundaries as
providing a bridge between firms and intermediate
markets (Araujo et al., 2003) to explain how value chain
linkages are enabled through strategic outsourcing. On
the one hand, boundaries provide a space for the
development of valuable and difficult-to-imitate cap-
abilities within the firm—the buffering function. On the
other hand, boundaries provide a bridge to access
specialized capabilities outside the control of the firm.
While TCT generally establishes firm boundaries on the
basis of anticipated efficiencies, our extended model of
strategic outsourcing accommodates a view of bound-
aries in which firms join with exchange partners to
create synergies they cannot realize alone.
This extended model of strategic outsourcing
suggests several research questions worthy of further
investigation. First, we still know very little about the
process by which specialized capabilities are deployed
and integrated along a value chain. For example, how do
firms integrate specialized capabilities along the value
chain? What performance measures best reflect
synergies created by the use of specialized capabilities
across the value chain? Although exchange transactions
through the market can often be economized, value
derived from strategic outsourcing lies more in the
combinative value of specialized capabilities available
through intermediate markets. Thus, scholars should
closely examine the underlying processes involved with
integration and measurement of specialized capabilities
along a value chain.
Second, our understanding of the sources of value
creation is limited. Do focal firms pursuing outsourcing
benefit more by selecting valuable capabilities from
intermediate markets or by more effectively integrating
these capabilities in difficult-to-imitate ways? Using our
model of strategic outsourcing, for example, scholars
can evaluate Makadok’s (2001) assertions regarding
synergies from the two main sources of rent genera-
tion—resource-picking and capability-building—
within a strategic outsourcing context. According to
this perspective, specialized capabilities affect firm
performance by enhancing the productivity of other
capabilities that firms possess.
Finally, as strategic outsourcing arrangements con-
tinue to expand in scope and complexity, scholars
should more closely examine specific attributes of
outsourcing ‘deals,’ especially when such deals involve
the divestment of assets by a focal firm as part of the
exchange. In some cases, these arrangements involve
the exchange of substantial financial considerations for
assets controlled by a focal firm. Where is value created
(and lost) by focal firms and intermediate markets? How
do financial considerations affect focal firms’ decision
to outsource? What are the implementation challenges?
How do investors view these arrangements? Thus,
research that provides a more comprehensive view of
strategic outsourcing deals and anticipates aggregate
economic considerations is needed.
The value-creating potential of the firm is at the heart
of the theory of the firm. Adopting a model of strategic
outsourcing can help scholars and practitioners to
understand the strategic, operational, and financial
motivations and incentives behind this organizing
arrangement. If outsourcing is pursued strategically,
firms can achieve above normal returns. Examining the
different conditions in which value creation occurs can
extend management’s view of strategic outsourcing and
provide a new paradigm for supply chain practitioners
to demonstrate the practical benefits of strategic
outsourcing.
Acknowledgements
We thank David Ketchen, Tomas Hult, and the two
anonymous reviewers for their helpful suggestions. We
also benefited from valuable comments and suggestions
by Sharon Alvarez, Lorraine Eden, and Michael Holmes
on earlier drafts of this article.
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