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AN INVESTMENT PERSPECTIVE ON GLOBAL VALUE CHAINS
FIGURE 2.8 Advantages and disadvantages of outsourcing and offshoring Offshore Offshore in-sourcing Advantages • High level of control • Cost savings • Improved quality
Offshore outsourcing
Disadvantages • Increased costs of communication and coordination • Cultural barriers and regulatory and legal risks
Advantages Disadvantages • Potentially highest • Highest costs of cost savings communication and coordination • Focus on core • Cultural barriers and business regulatory and legal • Access to world-class risks capabilities • Knowledge or technology leakages • Highest risks of quality control • Reductions in strategic alignment Outsource
In-house Domestic outsourcing
Domestic in-house production Advantages • Highest level of control • No intellectual property leakages
Disadvantages • Highest costs due to expensive labor, internal administrative and bureaucratic expenses • Lack of expertise in certain stages
Advantages • Cost savings • Focus on core business • Access to domestic external capabilities
Disadvantages • Knowledge or technology leakages • Highest risks of quality control • Increased costs of communication and coordination • Reductions in strategic alignment
Domestic Source: Summary of Inman and Helms 2005 and Radlo 2016.
Economists have developed two main theories to explain firms’ boundary decisions (what to outsource and what to keep in house): transaction cost economics (TCE; pioneered by Klein, Crawford, and Alchian [1978] and Williamson [1973, 1975, 1985]) and property rights theory (PRT; pioneered by Grossman and Hart [1986] and Hart and Moore [1990]). TCE assumes that market transactions are plagued by incomplete contracts and locking-in among trading partners. Locking-in usually happens when relationship-specific investment in the trading partner is required. Locking-in leads the value of the partners’ relationship to exceed the value of the trading partners’ outside alternatives, creating “quasi-rents.” Firms decide what to own and what to outsource by comparing the efficiencies of the available transaction modes. TCE thus predicts that MNCs tend to integrate transactions for which there are high levels of quasi-rents and incompleteness in contracts. The PRT theory, in contrast, focuses on distortions in ex ante investments rather than in the ex post haggling costs central to TCE. When one external supplier is acquired by another, the supplier has less incentive to invest in the quality of its products because its profits are shared with the parent firm. The PRT theory predicts that MNCs outsource the production of key inputs
