Technovation 26 (2006) 672–681

www.elsevier.com/locate/technovation

Innovation risks of strategic outsourcing

A. Hoecht*, P. Trott
University of Portsmouth, Business School, Portland Street, Portsmouth, Hampshire PO1 3DE, UK

Abstract

Outsourcing was originally confined to peripheral business functions and mainly motivated by a cost saving logic, but has now developed
into a routine strategic management move that affects not only peripheral functions but the heart of the competitive core of organisations. At
the same time there is a move from traditional outsourcing with one or a small number of key partners and long-term contracts to strategic
outsourcing with multiple partners and short-term contracts. This paper investigates the innovation-related risks that can arise from strategic
outsourcing and adopts a trust, collaboration and network perspective for this analysis. It uses the example of Information
technology/Information Systems (IT/IS) outsourcing to highlight the increased risks that arise from a move from traditional to strategic
outsourcing and discusses some measures that managers can take to attempt to control these risks. The nature of the risk is closely related to
the risk of information leakage that arises from collaborative research and technology development between organisations in technology-
intensive sectors that has been analysed by Hoecht and Trott [Hoecht, A., Trott, P., 1999. Trust, risk and control in the management of
collaborative technology development. International Journal of Innovation Management 3(1), 257–270].
q 2005 Elsevier Ltd. All rights reserved.

Keywords: Strategic outsourcing; Information leakage; Trust; Control; Innovation

1. Introduction when business organisations collaborate in order to gain

Just like ‘downsizing’ and ‘delayering’, outsourcing has
become one of the staple diets in the strategic management
field in the last decade and it has recently received much public
attention for its impact on national employment in the media as
outsourcing does not longer stop at national borders (Financial
Times, 2004). The academic and professional literature on
outsourcing has matured and overcome its original euphoria
stage. Some of the risks associated with large-scale out-
sourcing, in particular where non-peripheral business pro-
cesses are concerned, are now increasingly discussed in the
literature. These risks include the choice of the right supplier or
service provider, their ability to deliver the desired ‘best in
world’ expertise or service in the long run and the risk of losing
one’s core competencies to the service provider.
In this article, we wish to draw attention to another
strategic risk of outsourcing that so far has not been
discussed in the literature. This risk is closely related to
the more general issue of information leakage that arises
* Corresponding author. Tel.: C44 2392 844052; fax: C44 2392 844319.
E-mail address: andr.hoecht@port.ac.uk (A. Hoecht).
0166-4972/$ - see front matter q 2005 Elsevier Ltd. All rights reserved.
doi:10.1016/j.technovation.2005.02.004
access to knowledge and expertise that they cannot develop
on their own. Hoecht and Trott (1999) have demonstrated
that there is trade-off between access to cutting-edge
knowledge via collaborative research and technology
development in knowledge-intensive industries and the
risk of losing commercially sensitive knowledge to
competitors. This risk, they argue, cannot be controlled by
traditional management approaches and legal contracting
alone, but requires the operation of social control and in
particular the development of high levels of mutual trust.
We will discuss outsourcing-related risks in Section 2
and we will explain how outsourcing can create an
innovation dilemma that very much resembles the risk of
information leakage in collaborative research and technol-
ogy development. We will then discuss the importance of
trust for relationship management in outsourcing relation-
ships in general before we move on to explain the
innovation dilemma and how its relates to trust and ‘social
control’ in more detail. The next section will explain why
this innovation dilemma is much more prominent in the new
world of strategic outsourcing where companies have short-
term relationships with multiple partners than in traditional
large-scale long-term single provider relationships.
A number of potential management solutions for tackling
this problem are discussed at the end of this paper.
 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
2. Innovation-related risks of outsourcing
Outsourcing has become very widespread in the last
decade and has moved on from limited applications where
peripheral business functions are ‘outsourced’ to much more
vital business functions being outsourced today (Jennings,
1997; Quelin and Duhamel, 2003). Despite the rather mixed
record of large-scale long-term total outsourcing deals with
single suppliers in particular in the IT/IS industry (Lacity
and Willcocks, 1998), such contracts are still entered into
insignificant numbers. The academic literature has ident-
ified a number of expected gains that companies can derive
from outsourcing. They range from the reduction of
operational costs (Lacity and Hirschheim, 1993) and the
ability to transform fixed costs into variable costs (Alex-
ander and Young, 1996), to the ability to focus on core
competencies (Quinn and Hilmer, 1994) while having
access to the industry-leading external competencies and
expertise (Kakabadse and Kakabadse, 2002). There is,
however, also an emerging literature that highlights the
weaknesses and risks associated with large-scale outsour-
cing arrangements, in particular where non-peripheral
business functions are concerned. Alexander and Young
(1996) highlight the risk of becoming dependent on a
supplier, Barthelemy (2001) draws our attention to the
hidden costs of outsourcing and authors such as Doig et al.
(2001) and Quinn and Hilmer (1994) identify the possibility
of a loss of vital know-how in particular with respect to core
competencies as a major risk factor in outsourcing. There is
also the problem of selecting the most suited supplier/
service provider and their longer-term ability to offer the
capabilities that are needed in particular in business
environments with rapid technology change (Earl, 1996).
From an innovation and long-term competitiveness
perspective, the traditional cost concerns are far less important
than the question of how to identify and to retain a company’s
competitive core and not to lose its future ability to compete in
fast-moving and unpredictable markets. The strategic man-
agement literature is divided on this issue. There are tools like
Hamel and Prahalad’s (1994) three tests for critical business
processes, namely ‘customer value’, ‘competitor differen-
tiation’ and ‘extendibility’ that are claimed to be useful and
reliable for identifying core competencies and authors like
Quinn (1999) are optimistic that these competencies can be
identified but warn companies never to outsource their core
(defined as ‘best in world’) competencies. A number of
researchers also believe that not only the core competences but
also most special skills related to competitive advantage need
to be kept in-house (Reve, 1990; Quinn, 1999). Nevertheless,
there appears to be a general consensus in the strategic
management literature that at least the complementary skills or
organisational competences can be handled and developed
by alliances and opened up to collaboration and that goods and
services of little strategic value can be purchased on the open
market (Brandes et al., 1997). The key strategic management
controversy however, remains about the issue whether these
673
core competencies and specialised skills can be reliable
identified. McIvor (2000: 48), for example, is much less
confident than other writers that these competencies can be
accurately predicted:
A current competency may cease to be a source of competitive
advantage if there is a change in customer requirements or
competitors develop innovative technologies.
There is also the important question of the potential for
losing one’s core skills and competitive advantage to
competitors in the process of collaboration. Hamel (1991)
maintains that core skills can be learnt from the other party
and absorbed into one’s own company just as much as one’s
own skills can be absorbed by a partner and one’s unique
competitive advantage lost in the process. Bower and Keogh
(1997) observed the behaviour of technology leaders in the
close-knit North Sea upstream offshore oil and gas industry
and found that participating in networks sharing leading edge
technology was exposing firms to the risk of their
competitive edge being lost to competitors. Interestingly,
this risk was found to be much smaller for resourceful and
influential companies benefiting from a network centrality
position than for smaller and less well positioned companies.
3. The management of innovation within firms: why
outsourcing may hinder innovation
The management of innovation is a large and diverse
body of literature. It recognises that while there is much
complexity and uncertainty in managing innovation and
new product development much is known. There is already
considerable agreement on many of the factors that
contribute to success and the activities and processes that
need to be undertaken if innovation is to occur. Over the
past 50 years there have been numerous studies of
innovation attempting to understand not only the factors
necessary for it to occur, but how they influence the process
and when and where they are required and in what order.
Table 1 captures some of the key studies that have
influenced our understanding.
At the corporate level, a number of research paradigms
have attempted to explain the international difference in
technological development and innovation. Neo-classical
economic theorists believe market structure, competition
pressure, local supply of skills together with openness of
communication are the most important factors (Stoneman,
1983; Geroski, 1993; Ansoff, 1965; Porter, 1980, 1985,
1990). However, this approach has not been able to fully
explain the dynamics of innovation processes and the role
played by firms and other institutions (Patel and Pavitt,
1984; Lundvall, 1988). In terms of firm specific character-
istics that are required for firms to become more innovative
much has been written about this (Quinn, 1991; Kanter,
1998; Wolfe, 1994). There is also significant amount of
674 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
Table 1
Key studies of innovation management
Study
1 Carter and Williams
2 Project Hindsight-TRACES, (Isensen)
3 Wealth from knowledge (Langrish et al.)
4 Project Sappho (Rothwell et al., 1974)
5 Minnesota Studies (Van de Ven)
6 Rothwell
7 Sources of innovation (Wheelwright and Clark)
8 MIT studies (Utterback)
9 Project NEWPROD (Cooper)
10 Radical innovation (Leifer)
Source: Trott (2005).
literature on the strategic dimension of competition (Porter,
1980; Pavitt, 1984; de Woot, 1990). Many writers on
innovation consider it mainly as a process that needs careful
management (Souder, 1987; Trott, 2005; Twiss, 1992),
while others view innovation more as a cognitive and
behavioural phenomenon (Van de Ven, 1989; Madique,
1988). Despite their differences, most of these writers seem
to accept that innovation is a phenomenon that can be
subjected to human control and is considerably affected by
human interaction. We also know that individuals create
knowledge through collaborating with others in groups/
teams in an organisational context; helping individuals to
achieve their full potential and contribute new knowledge is
a critical management issue which has also received
considerable attention in the literature (Tidd, 2000; Nonaka,
1991; Nonaka and Takeuchi, 1995; Polyani, 1966).
The studies in Table 1 have widely contributed to the
accepted view that a firm’s ability to successfully develop
innovative new products is not only the result of public and
private investments in tangibles and intangibles by individ-
ual elements in the economy, but that it is also strongly
influenced by the character and intensity of the interactions
between the elements of the system. This position is
strongly advocated in the literature on ‘National Innovation
Systems’ (Freeman, 1982; Lundvall, 1992; Nelson, 1993).
In this view, innovation and technological development in
particular depend increasingly on the ability to utilise new
knowledge produced elsewhere and to combine this with
knowledge already available in the economy and its actors.
The capacity to absorb new knowledge, to transfer and
diffuse knowledge and the ability to learn through
interaction are crucial success factors in innovation
(e.g. Cohen and Levinthal, 1989; Chesborough, 2003).
New and commercially useful knowledge is not only the
result of the conscious action of creative individuals.
It is also the outcome of the interaction and learning
processes among various actors in innovation systems, i.e.
producers, users, suppliers, public authorities, and scientific
institutions, which David and Foray (1995) have coined the
‘knowledge distribution power’ of the innovation system.
Date Focus
1959 Industry & technical progress
1968 Historical reviews of US government funded defence
industry
1972 Queens Awards for technical innovation
1974 Success & failure factors in chemical industry
1989 14 case studies of innovations
1992 25 yr review of studies
1992 Different levels of user involvement
1994 5 major industry-level cases
1999 Longitudinal survey of success & failure in new
products
2000 Review of mature businesses
Indeed, Rothwell (1992) put forward the idea of a fifth-
generation model of innovation management, based on
inter-company networking facilitated by IT systems. More
recently, the term network has become widely used.
The need for connectivity and the complexity of the
interactions it entails therefore emerges as a major factor
influencing the management of innovation.
Given the significance of the beneficial effect of inter-firm
collaboration and the role of networks for innovation and
organisational learning (Hamel, 1991), it is necessary to
explore this concept in more detail. March (1991) dis-
tinguishes between exploration and exploitation in organis-
ational learning. He argues that there are major differences
between experimentation with new alternatives (exploration)
and the refinement of existing technologies and organis-
ational competencies (exploitation). The latter can be
conceived as a close relative of the keep in house-or
outsource decision, where collaboration arises from an
unwillingness to go-alone and a strong preference for risk-
limitation will always be prevalent. On the other hand,
explorative knowledge creation relies on much more ‘open-
ness’ and a dedicated participation in research communities,
firms, universities, research laboratories, suppliers and
customers (Powell, 1990). What is required here is a much
more intimate form of collaboration where both parties are
contributing, rather than the handing over of responsibility of
an activity, which is often associated with the outsourcing
decision. Furthermore, Powell et al. (1996) argue that the
locus of explorative innovations is to be found in networks of
inter-organisational relationships and that a firm’s success
crucially depends on its ‘centrality-position’ in such net-
works and the experience gained in managing its networks.
Powell et al. (1996:119) argue that internal capability and
external collaboration rather than being substitutes are
complementary:
“Internal capability is indispensable in evaluating research
done outside, while external collaboration provides access
to news and resources that cannot be generated internally.
A network serves as a locus of innovation because it
 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
provides timely access to knowledge and resources that are
otherwise unavailable, while also testing internal expertise
and learning capabilities.”
In their empirical study of the network behaviour of
biotechnology firms operating in the human therapeutics
and diagnostics field (1960–94) they found strong support
for their hypothesis that a firm’s centrality in network
relationships and its incrementally acquired experience in
managing network ties is a strong predictor for its growth
and economic success. Network experience, it appears,
should be considered as an incremental learning process
both in terms of the management of collaborative ties and in
terms of the actual technical learning of biotechnology
innovations (Powell et al., 1996). The decision to outsource
an activity includes the inherent risk of forgoing a firm’s
centrality of participation in valuable networks.
The development of network models of innovation have
helped to illustrate further the prominence now given to
internal and external interactions (networks) within the
innovation process. All these knowledge flows contribute to
the wealth of knowledge held by the organisation (Woolgar
et al., 1998; Rothwell, 1992; Major and Cordey-Hayes,
2003). Recognising this, capturing and utilising it to develop
successful new products are the difficult management
process of innovation. Here then lies the potential problem
for firms if key activities are outsourced: whether at the very
least the firm risks disrupting the knowledge flows to the
organisation and more worryingly for senior managers is
whether it will isolate a firm from valuable networks.
Furthermore, the inability to retain a company’s
competitive core will not only endanger its future competi-
tiveness, but can also create a serious risk of dependency on
outside providers. A crucial question is whether the desired
access to ‘best in industry’ capabilities are sufficient to
sustain its competitive advantage in particular where the
provider serves ‘many masters’ and the particular expertise
ceases to be unique and becomes best-practice industry
standard. While there is no shortage of advice in the
literature on how to manage the risk of dependency from
outside providers and suppliers in general (see for instance
Currie and Willcocks, 1998 who suggest multi vendor
approaches and shorter term contracts for handling large-
scale long-term total outsourcing contracts with IT/IS
providers), the specific problem that access to world-leading
expertise via outsourcing may well be compromised by the
‘levelling-out’ of unique advantages when leading service
providers spread their world-leading expertise to several
clients has not received much attention.
As a consequence of the problem of ‘levelling out’ of
leading edge expertise, the innovation impact of outsourcing is
not limited to the issue of core competencies and the need of
companies to retain at least the absorptive capacity to exploit
innovations that have been developed by outside service
providers. There is also the problematic assumption that
service providers are always able to infuse best practice into
675
the company. In a traditional outsourcing relationship, a long-
term commitment is entered into that ‘locks’ a company to a
service provider for the length of the service contract. The
ability to infuse best industry practice may not only depend on
the relative competence of the provider, but the service
providers may also be restricted in their ability to pass on best
practices by confidentiality agreement with previous and other
current clients. A significant dilemma emerges: Individual
firms have a reasoned case against competitors gaining the
fruits of their investment and innovation efforts, while at the
same time the majority of companies choose outsourcing not
least in the hope of gaining such advantages from other firms.
This dilemma is mainly left to the service providers and the
individual consultants they employ to resolve. It is, however, a
very important issue from an organisational innovation
perspective. We will see below that this issue becomes even
more pressing when companies and industries move away
from traditional long-term outsourcing relationships with
single service providers to strategic outsourcing, i.e. to much
more open, short-term relationships with multiple suppliers
involving all business processes.
4. The important role of trust in the management
of outsourcing relationships: the example of Information
Systems outsourcing
Outsourcing has a long tradition in relation to the IT
industry. Because of the high costs of IT infrastructure and
the rapid change in technology, many organisations have
been looking at external providers for the IT function since
the early 1980s.
The reasons for this move are rational. If information
services play a supporting role for the key business
functions and this service can be bought in at higher quality
of service delivery without having to commit substantial
assets and resources, it makes good sense to look at the
external market for providers.
In most cases, the outsourcing relationship goes further
than just substituting for an internal IT service and a
contractual relationship is sought where the service provider
assumes responsibility for one or more of the organisation’s IT
or even business functions (Willcocks and Lacity, 1999).
In this case, the relationship includes the transfer of resources
of the outsourcing organisation to the external service provider
and involves a long-term commitment with a detailed legally
binding contract. Significant organisational changes are
needed as the role of the internal IT department changes
from being a supplier of its own services to assuming
the function of a controller and broker of IT and/or business
services. Because of the level of mutual commitment, lengthy
contract negotiations (9–12 months) and detailed rules are
the norm which later can become problematic as technology
base and business requirement tend to change, at times even
before the contract is finally signed (Woolfe, et al., 2001).
As the original focus is traditionally on cost saving on the basis
676 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
of existing solutions, both parties can be locked in inflexible
arrangements that lead to a lack of satisfaction with the
services received by the outsourcer and frustration with the
constraints imposed by the service provider (Da Rold, 2001).
Due to the long-term timeframe, the level of resources
committed and the emphasis on cost efficiency, a bureaucracy-
based approach to relationship management and management
control is often pursued which as it is not well suited for coping
with changing requirements and therefore leads to disappoint-
ment on both sides and further enforces the desire to impose a
high level of management control. Ironically, despite a high
level of dissatisfaction with current service providers, a high
number of organisations stick with their existing provider
when it comes to contract renewal because of the high level of
sunk costs (Barthelemy and Geyer, 2000).
Outsourcing relationships need to be managed during the
lifespan of the projects concerned. The costs involved and the
complex nature of the projects that frequently involve the
transfer of assets from the outsourcer to the provider call for
detailed contractual arrangements. Theses are also in the
interest of the service provider who does not wish to face
spiralling costs due to ambiguities. In principle, detailed
contractual arrangements are often considered good pro-
fessional practice—the one who has good intentions can sign a
detailed contract—and need not be considered as a substitute
for or undermining trust in relationships. Detailed contracts
and legal means are of course more of a background safeguard,
providing contract parties with the confidence that although
the law is slow and costly and seeking legal redress is not the
best avenue to solve conflicts, they do have a safeguard against
gross malfeasance (Sitkin and Roth, 1993; Deakin et al.,
1994). Beyond contract, however, a fair amount of trust1 is
required to make outsourcing relationships work. The out-
sourcing organisation must at least have trust in the service
provider’s competence and willingness to keep to
contractual obligations. This will normally be based on
the service provider’s record of achievement and repu-
tation. Most of the larger outsourcing contracts are
awarded to the reputed and established players in
1
There are literally hundreds of definitions of trust. A useful pragmatic
definition of trust is that ‘an agent exhibits trust when he/she exposes
herself/himself to the risk of opportunistic behaviour by others and when
he/she has no reason to believe that the trusted other will exploit this
opportunity’ (Humphrey and Schmitz, 1996:4). A key point is that trust
makes the trustor vulnerable to the behaviour of the trustee, but the trustor
ignores this possibility. This chosen ignorance makes social interaction
possible. According to Zucker (1986), trust can be based on ascription (such
as membership of same group), can be process-based (tied to past or
expected exchange such as previous interaction experience and reputation)
and can be institutional-based (where trust is tied to formal structures,
depending on individual or organisation-specific attributes, for example
membership in professional associations). Trust is more difficult to produce
in modern complex societies as there is normally no direct personal
knowledge or interaction experience as a basis for developing trust and
institutional trust becomes paramount. Lane and Bachmann (1998)
provides a very useful concise introduction into theories and issues related
to trust within and between organisations.
the industry who can point towards a record of previous
achievements or who have been directly recommended
although the contract tendering process will be principally
open to all contender who can meet the project
requirements. As outsourcing involves close cooperation
between internal and external staff, interpersonal trust
relationships become very important for the success of the
project. The long-term time frame of the contracts allow
for interpersonal trust relationships to be built, but this
trust-building can be undermined if the contractual terms
do not sufficiently allow for a dynamic adjustment of the
services to be delivered to changing circumstances of the
outsourcing organisations (such as growth through acqui-
sitions or moving into new markets) or to changes to the
technology and products/services available at the cutting
edge of the market. In such cases, rather than having
governance procedures in place that allow for quick
response and dynamic adjustment of terms, outsourcing
contracts often are inflexible, require substantial renegotia-
tion and lead to dissatisfaction on both sides. Once
however, disagreements and tensions have set in, it
becomes more difficult to renegotiate and find mutually
beneficial solutions on the basis of trust (Sitkin and
Stickel, 1996). Even worse, signals that relationships with
service providers have become difficult seem to reinforce
preferences for a bureaucracy-based approach
to management control (van der Meer Kooistra and
Vosselman, 2000) with closer supervision and monitoring
and more direct intervention of the outsourcing company.
Given that at least one of the causes of this adverse
dynamic, the rate of technology change is bound to
increase, the nature of IT outsourcing contracts is in need
of flexibilisation. Rather than chasing ‘moving targets’
with closer nets, a more developmental, trust-enabling
approach to contact and relationship management is
needed. A move towards a trust-enabling governance
structure and management control approach would need to
incorporate changes such as shared flexible decision-
making and goal setting by a joint alliance board with
backing from senior management level, open book
accounting, outcome-based rewards with a clear recog-
nition of a priority to meet dynamic goals rather than
static contractual obligations (Dekker, 2001). Such an
approach to management control, however, must be
implemented before trust has been lost. It also requires
a move away from a mainly tactical orientation towards
cost efficiency to a more strategic consideration of overall
business objectives and the role IT and IS can play to that
end.
5. Information leakage, trust, reputation
and the innovation dilemma
We have argued above that from an innovation
perspective, the reliance on outside providers can be
 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
problematic, not only because key areas of expertise may
be gradually lost to the outsourcing organisation but also
because outside providers may not have the desired
leading edge expertise over the long-term (Earl, 1996) or
may spread their expertise among many clients so that it
degrades from ‘best in world’ to mere industry standard.
The problem of information leakage lies at the heart of
this dilemma. Companies want exclusivity in their
relationship with their service providers, but consultants
who work with many clients are unlikely to be able not
be influenced and not to spread the best practice that
they acquire when working with many client firms.
Detailed legal contracts may offer short-term solutions as
they can protect tangible outcomes from specific projects
undertaken, but not every innovation related project
outcome is tangible and can be clearly defined in legal
contracts. And consultants are clearly expected to work
at the cutting edge of their professional expertise for all
of their clients.
The problem of information leakage in collaborative
research and technology development has been investi-
gated by Hoecht and Trott (1999). They contend that
companies need to be outward-looking to gain access to
new knowledge and that this openness comes at the risk
of commercially sensitive information being leaked to
competitors. The more outward-looking the R&D strategy
of these companies, the less suitable are traditional
approaches such as legal instruments for controlling this
risk and the more these companies have to rely on
mechanisms of social control, in particular trust and
reputation concerns. When companies pursue an extrovert,
the most outward-looking technology development strat-
egy, they rely on the expertise of distinguished individual
researchers, either as temporarily hired subject field
experts or as prominent members of research community
networks working within an organisation and acting as
boundary spanners between the organisation and the
scientific community. Because of their superior subject
knowledge and their privileged position in the research
community, which is after all the prime reasons for
employing them, they have, at least in theory, ample
opportunities to leak information to competitors and to
betray the organisations hiring their services if they wish
to do so. Direct, bureaucratic control is largely ineffective
and non-implementable in situations where the controllers
lack detailed understanding of the nature of the controlled
person’s work,2 legal contracts such as detailed secrecy
clauses and intellectual property agreements are accepted
as a matter of professional good practice, but detection of
contravention would be very difficult and the contra-
vention difficult to prove and any legal redress would not
compensate for the commercial damage incurred. In such
2
Quinn (1999) acknowledges this as a major problem in controlling the
risks involved in ‘intellectual outsourcing’.
677
cases when legal instruments and direct, bureaucratic
control are of limited effectiveness, companies need to
rely on trust and social control in order to be able to work
with the individuals in question. And although trust is
always ‘ultimately a leap into the dark’ (Luhmann, 1979),
research organisations have good reasons to trust these
individuals as their personal and professional integrity is
based on their need to protect their professional reputation
as the ‘social capital’ (Coleman, 1990) which makes them
so desirable to their employers. As a consequence of their
self-awareness of the need to protect their reputation as
their social capital, external hired experts and organis-
ational boundary spanners more than any other group of
scientists ‘internalise’ proper professional conduct in
themselves.
The problem of information leakage and how to control it
also applies in the case of outsourcing of knowledge-
sensitive business processes with high innovation potential.
We have encountered this issue as a pressing ethical and
professional problem for a number of IS consultants that we
interviewed for another innovation-related research project
(Trott and Hoecht, 2004). With the move from traditional
long-term single provider to strategic outsourcing, it will
become much more of an issue as will be discussed in the
next section.
6. Strategic outsourcing and the innovation dilemma
Strategic outsourcing goes beyond traditional outsour-
cing in the sense that competitive advantages are being
sought through opening up all business functions, including
the core competencies which should provide competitive
advantage to whoever can provide the perceived best
solution, internal or external (Quelin and Duhamel, 2003).
In contrast to traditional outsourcing, there are no protective
boundaries around core activities in the hope that the
organisations can maximise their innovative capacity by
being an active part of a networked economy. This means
that rather than having exclusive arrangements with one or
very few service providers of long periods of time which
will be expected to offer tailor-made solutions, strategic
sourcing arrangements will be with multiple partners over
short periods of time and with very little protection of
internal core competency functions against outsiders (Berg
and Young, 2001).
There is a certain paradox inherent in this approach: a
very high level of trust is required for such relationships as
the risks involved are substantial while at the same time the
conditions for building trust are undermined by a shorter-
term orientation with less commitment compared to
traditional outsourcing relationships. The risks are signifi-
cantly higher than with traditional outsourcing: Not only is
the risk of leakage of commercially sensitive information
significantly increased when firm cooperate with multiple
partners (Hoecht and Trott, 1999), but also the very core of
678 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
the competitive advantage in terms of knowledge, expertise
and capabilities will be made dependant on outsiders. There
is a danger that the organisations pursuing strategic sourcing
may even loose the absorptive capacity required to
recognise and exploit new opportunities by themselves.
There appears to be a general consensus that complementary
skills or organisational competences can be handled and
developed by alliances and opened up to collaboration and
that goods and services of little strategic value can be
purchased on the open market (Brandes et al., 1997).
A number of researchers, however, believe that the core
competences and most special skills related to competitive
advantage need to be kept in-house (Reve, 1990). Hamel
(1991) maintains that core skills can be learnt form the other
party and absorbed into one’s own company just as much as
one’s own skills can be absorbed by a partner and one’s
unique competitive advantage lost in the process. Bower
and Keogh (1997) observed the behaviour of technology
leaders in the close-knit North Sea upstream offshore oil and
gas industry and found that participating in networks
sharing leading edge technology was exposing firms to the
risk of their competitive edge being lost to competitors.
While large players could afford to stay more aloof and to
withhold their most novel technology solutions, small firms
found that their technology solutions were prone to being
appropriated by network rivals.
If we are experiencing a move towards a global
networked economy (Castells, 1996) with rapid technology
change and an increasing need for sharing information and
cooperative R&D, then long-term exclusive relationships
between buyers and service providers may have too
unsustainably high opportunity costs because of the
inherent lock-in that can seriously hinder innovation.
From a risk-control perspective exclusive relationships
with clearly defined organisational boundaries may be
preferable, but the cost of restricting information exchange
among service providers in networks and limiting oneself
to the expertise of just one firm can be significant.
Furthermore, as discussed above, such exclusive relation-
ships, when managed with a bureaucracy rather than trust-
based approach to management control can be unproduc-
tive. The challenge then is to find ways in which more core
business functions (but not all!) can be opened to the
shared knowledge of the external service providers as a
networked industry without losing core competitive
capabilities, be it as a consequence of extensive reliance
on outsiders, or through imitation by competitors as a
consequence of information leakage.
In a networked economy, there is hardly any choice for
a firm but to have close relationships with more than one
service provider. If an industry develops closer networked
links among constituent firms and if every single service
provider firm entertains more and shorter-term relation-
ships with competing buyer firms, then ‘information
boundaries’ (Zucker et al., 1996) are opened up and
long-term relationship commitments are reduced. By
entertaining more than one relationship with external
service providers itself, the individual buyer firm would
still have less certainty than before in its exclusive
relationships, but at least it would also have the chance
to benefit from the more widely shared industry best
practice, spread among its competitors by the service
providers. The effect might be a levelling out of core skill
advantages within the industry, benefiting the industry
overall, but eroding the competitive advantage of some of
its members. From the point of view of the individual firm,
the question is how it can maintain a commitment to
secrecy and confidentiality from multiple service provider
firms while sharing in the benefits of best practice in the
industry. As the example of inter-firm collaboration in the
North sea oil and gas industry suggests, this may well be a
question of the relative bargaining power of client firms as
well as the service provider firms’ interest in repeat
transaction with their key clients.
The problem of information leakage is inherent in all
outsourcing relationships, but the magnitude of this problem
is greatly increased when dyadic relationships are replaced
by multiple partner and network arrangements. There is
some tentative evidence that ‘powerful’ firms may be more
able to protect their sensitive information than weaker ones,
but this is far from certain and may well be influenced by
managerial competence of the participating firms. It is also
not always easy to determine the exact boundaries between
the required up-to-date professional knowledge of individ-
ual consultants derived from current industry experience
and cutting edge innovative practices exclusively developed
for a particular client that have to be kept confidential. This
boundary will become even more blurred the faster
technology development progresses.
7. Discussion and managerial implications: innovation,
networks and trust
Innovative capability of the firm is largely dependent
on cumulative knowledge built up over many years of
experience. Contrary to the model used by economists,
innovative ability cannot be simply bought and sold.
Hence, the need to remind senior managers of the
unwitting harm that may be inflicted on the ability of
the organisation to survive in the long term if its core
competencies are slowly eroded through outsourcing. This
paper has put forward a different conceptual approach for
how companies can view the role of outsourcing and its
impact on innovative capability. We need to look again at
what delivers long-term success as opposed to short-term
gains. A different conceptual approach is required.
Managers should not be obsessed with cutting costs in a
vain effort to compete with developing countries. They
should be concentrating on utilising their organisational
knowledge bases to develop new products for the future
(sometimes referred to as ‘high added-value products’).
 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
Senior managers need to reconsider their strategies to
ensure they have activities in place that will facilitate
creativity and ultimately realise new products in the
future. This of course has to be achieved against a
backcloth of fierce pressures to reduce costs and ensure
the business remains competitive in the immediate term.
This paper has highlighted two particular strategic risks
associated with outsourcing. Firstly, that not only does
outsourcing involve the inherent risk of forgoing the
development of the knowledge base of the firm but also
that the firm’s existing skills and core competencies may be
unwittingly being leaked via the third party provider. The
concept of trust is introduced as a possible mechanism for
managers not only to understand the dynamics of knowl-
edge leakage, but also as a means of managing the dilemma.
From the point of view of the individual firm, the question is
how it can maintain a commitment to secrecy and
confidentiality from multiple partners. One solution would
be their interest in repeat dealings. If the buyer firm is a
significant player in its industry, the service providers may
fear to loose it as a future customer and may therefore
control their own behaviour. This would require a certain
likelihood that potential betrayals would be noticed, which
in terms depends on the nature of the relations between
service providers. If there is sufficient competitive rivalry
(despite the network cooperation) between service provi-
ders, some of their members may be prepared to ‘shop’ the
betraying service provider to the buyer in the hope of
securing a future contract.
Another way of securing commitment would be for the
buyer to acquire a stake in one or more of the service
providers. Partial ownership may make the service provider
as a consultant/provider less attractive to other buyers, but it
would offer a degree of control in the sense that the buyer
firm could exercise direct influence in managerial decisions
and the employees of the service provider would be less
likely to harm ‘part of their own’ organisation. This is,
however, a very costly way to buy loyalty and the associated
costs could well be far higher than the benefits derived from
strategic sourcing itself.
Tightening legal contracts would also be an option, at
least in theory. In practice, the knowledge base of core
competencies is often of a tacit nature and difficult to codify,
and it is next to impossible to prove that betrayal has
occurred. Furthermore, the essence of strategic sourcing is
to move to shorter relationships including more flexible, less
closely defined contracts.
To some extent, developments in IT may provide a
solution. Those services which are mainly focused on IT
(cost) efficiency (such as product support, network main-
tenance and help desk services) may well cease to require
buyer-owned assets and to be firm specific altogether.
Instead of longer-term service contracts, buyers may opt for
a just in time/pay as you go ‘access’ model where they tap
into standardised solutions (Da Rold, 2001). As this will
679
normally not affect their core skills and competitive edge,
the risks will be acceptable.
If networking and shared technology development is the
future for the IT industry, another option would be for large
buyers to retain the capacity to participate themselves
directly in these networks. This could be achieved by either
retaining or recruiting individuals into the buyer firms who
have the ability to judge industry developments and to
actively participate in industry networks. The task of these
individuals, who have to be highly regarded experts in their
field, would be to act as boundary spanners between
scientific research, the service providing consultancy firms
and their respective buyer firm. Their job would entail the
definition and demarcation of high-risk areas within their
home organisations and the selection and supervision of
those ‘externals’ who would be granted access to the
business functions and processes identified as high risk. As
external service providers can easily be made to specify the
individuals assigned to specific tasks as part of the tendering
process specification and as part of the final contract, the
boundary spanner’s judgement on the competence as well as
trustworthiness of the specified individuals could be used as
a device to control the risk of secrecy betrayal. As a
consequence, it would be very much in the career interest of
the staff of external service providers to keep and earn the
trust of the boundary spanners of their main client firms as
this would become a key selection criterion for the award of
future contracts to their firms. As a consequence, the
problem of trust would be transferred onto a higher level,
from trust in service providers to trust in the controllers/
boundary spanners. Although this resounds of Shapiro’s
(1987) observation that ‘ one of the ironies of trust is that we
frequently protect it and respond to its failure by bestowing
even more trust’—onto regulators and guardians in this
case, the experience of other industries such as biotechnol-
ogy with boundary spanners as guardians of company
secrets is positive (Liebeskind and Oliver, 1998; Hoecht and
Trott, 1999). Boundary spanners have an overwhelming
interest in guarding their reputation as being both trust-
worthy and competent as this reputation amounts to their
‘social capital’ (Coleman, 1990). Naturally, the monitoring
and supervision which can be exercised by boundary
spanners themselves is limited to ‘working hours’ and the
‘trusted externals’ could still pass on information after hours
and during future assignments with competing firms, in
particular as there are no sufficiently effective legal
sanctions to prevent this from happening. Therefore, in
order to control this risk, some minimum level of exchange
of information among boundary spanners of large buyers
would be required. It is, after all, in the collective interest of
buyers to limit the risk of betrayal and therefore to expel
unreliable individuals from the circle of consultants with
access to high risk areas in their clients’ organisations.
Whether this collective interest would prevail or the short-
term benefits derivable from acts of betrayal would prove to
be too tempting is very much a question of the character of
680 A. Hoecht, P. Trott / Technovation 26 (2006) 672–681
the network of boundary spanners in question. Given that
the collective sanctioning interest of networks cannot
necessarily be relied upon particularly if detection is
unlikely, other safeguards would be needed. Such as
safeguard could be the external consultants own interest in
protecting their reputation as their social capital. It may not
be likely that a boundary spanner can be proven to have
failed to inform his network colleagues of a betrayal, but the
self-interest of the external consultants themselves is likely
to stop them from committing acts of betrayal in the first
place.
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Dr. Andreas Hoecht is a Senior Lecturer at the Business School,
University of Portsmouth. He is an economist and political scientist
with a particular research interest in the role of trust in business
relations. He holds a doctorate in Economics (Budapest) and an MA in
Political Science (Hamburg).
Dr Paul Trott is a Principal Lecturer at the Business School,
University of Portsmouth. He holds a PhD from Cranfield University.
His research focuses on aspects of innovation management.