Explaining Outsourcing Failure

Abstract

This paper attempts to explain the phenomenon of outsourcing failure by integrating the Relational View and network-/graph theory. Whereas traditional transaction cost theory focuses on problems of ensuring cooperation (motivation) in vertical client-provider relations, we advocate extending the notion of transaction costs to include cooperation and coordination issues in vertical and horizontal relations. Our model depicts organizational structure as a set of nodes and relations (graph). Upon outsourcing, a subset of nodes is removed from the graph. Transaction costs are incurred as a function of both the number of relations across organizational boundaries and the extent of cooperation and coordination problems pertaining to any single relation. We compare production efficiency and transaction cost effects of three types of outsourcing (domestic, offshore, and FDI) vis-à-vis integration to derive a set of testable propositions on the determinants of outsourcing failure and success. Emphasizing the complexity of coordinating a multitude of horizontal, collaborative inter-firm relations, our research sheds a new light on outsourcing failure.