Outsourcing in entrepreneurial ventures
Abdul A. Rasheed and K. Matthew Gilley
Managers of entrepreneurial ventures are increasingly turning to outsourcing to enhance their firms’ effectiveness. While there are many intuitively appealing arguments for outsourcing as a means to increase organizational performance, there are few empirical studies of the topic. Moreover, these studies have primarily focused on large, established organizations. Thus, the outsourcing practices of entrepreneurial ventures, as well as the performance effects of those practices, are not widely understood. What is clear, however, is that outsourcing allows entrepreneurial firms to narrowly focus their scarce resources on what they do best, while leaving the remaining tasks to outside firms.
Defining Outsourcing
Outsourcing involves the procurement of physical and/or service inputs from outside organizations and can be divided into two categories: core outsourcing and peripheral outsourcing (Gilley and Rasheed, 2000). Core outsourcing refers to the outsourcing of strategically relevant, core activities, whereas peripheral outsourcing in volves non core activities having little potential to convey a long run competitive advantage.
Outsourcing represents the fundamental decision to reject the internalization of an activity and may arise in two ways. First, outsourcing may involve the substitution of market transactions for internal activities. This occurs when an organization ceases performing an activity in house and shifts it to an outside supplier. Second, outsourcing may arise through abstention. That is, a firm may decide never to engage in a given activity, thus abstaining from it al together. This latter form is especially relevant for new entrepreneurial ventures making internalization decisions for the first time. In deciding which resources and capabilities to assemble internally, new ventures must determine from which activities to abstain and upon which activities to focus their limited managerial and financial resources. As such, abstention related outsourcing decisions are key strategic decisions for new entrepreneurial ventures.
Theoretical Perspectives
Multiple theoretical perspectives are useful to the study of outsourcing by entrepreneurial ventures. Some of these perspectives are briefly presented below.
The resource based view. New entrepreneurial ventures must make numerous choices as to which activities to internalize and which to out source. Given limited resources and pressures to have a product or service ready for the market in the shortest possible time, most new ventures do not have the luxury of internalizing more than a very limited set of activities. Essentially, the decision to engage in outsourcing by entrepreneurial ventures hinges on which resources and capabilities to build internally and which to access through outsourcing agreements.
The resource based view (RBV) of the firm is valuable to managers of entrepreneurial ventures facing outsourcing decisions and trying to determine which resources and activities to develop internally. RBV focuses on re source heterogeneity among firms and seeks to explain competitive success on the basis of resource characteristics possessed by firms (Barney, 1991).
Brush, Greene, and Hart (2001) applied RBV to the study of new venture creation. They suggest that attracting resources to a new venture is the greatest challenge faced by entrepreneurs. To be successful, new ventures should be able to attract a set of human, social, financial, physical, technological, and organizational resources and combine them in ways that are valuable, unique, and difficult to imitate. Given that most new ventures tend to operate with limited resources, the key is to accurately specify which resources and activities are critical to the outsourcing in entrepreneurial ventures 199 venture’s success and to internalize those. The challenge, then, is to identify the resource and competence bundles that are most likely to yield a sustainable competitive advantage and focus on developing those in house, while outsourcing the rest. Indeed, the complex network of inter organizational outsourcing relationships established by managers of entrepreneurial ventures constitutes a resource critical to the venture’s viability. Of paramount importance to entrepreneurial ventures is the management of the activities that have been internalized. As the firm grows, it is imperative to conduct peri odic evaluations of the activities that were internalized at inception. Such evaluations may lead to further outsourcing by substitution, so that the firm can continue to focus on its core competencies.
Several organizations have outsourced with great success. For instance, much of Nike’s initial success was due to a clear decision to out source the manufacturing function and to combine the venture’s limited resources in a unique and inimitable fashion. The Topsy Tail Company, a Dallas based firm focusing on hair care items and fashion accessories, generated approximately $80 million in annual revenues with just three employees. Topsy Tail’s management did this through abstention based outsourcing by focusing from the company’s inception on a very narrow set of tasks, while outsourcing manufacturing and order fulfillment to outside specialists. Both Nike and Topsy Tail deter mined that resources and activities yielding the greatest potential for competitive advantage were to be internalized, while lower value adding activities were to be outsourced.
Transaction cost theory. The classic approach to transactions costs (Williamson, 1975) suggests that if the transactions costs associated with pro curing a product or service from outside the firm are lower than the coordination costs associated with internalizing the activity, it is preferable to source it from outside. However, for entrepreneurial ventures considering abstention related outsourcing, the costs of internalization are difficult to determine accurately. Many of these are intangible, such as the reduction of managerial focus caused by internalizing more activities. This should tilt the scales in favor of outsourcing for many entrepreneurial ventures, especially upon start up.
Institutional theory. Institutional theory seeks to explain organizational isomorphism, which is the tendency towards increasing homogeneity of organizational forms and practices within an industry, through mimetic, coercive, and normative processes. Ang and Cummings (1997) studied information system (IS) outsourcing in banking and found that federal regulator influence (coercive and normative) and peer influence (mimetic) affected IS outsourcing. They found that smaller firms (banks in this case) engage in more IS outsourcing. The conclusion is that institutional pressures may be stronger for smaller firms. Extrapolating these results to the new venture context, it seems reasonable that new ventures, due to their limited resources as well as pressures from their peers, venture capitalists, and banks, are more likely to resort to outsourcing than older, larger, more well established firms.
Antecedents and Outcomes of Outsourcing
Recently, researchers have examined a number of contextual factors that affect the relationship between outsourcing and performance, as well as factors considered to be important motivators of the decision to outsource. Some of this research is discussed below.
Business level strategy. Gilley and Rasheed (2000) found that the effects of outsourcing are not the same for firms pursuing different business level strategies. Studying small and medium sized manufacturing firms, they found that peripheral outsourcing has a positive effect on performance for cost leaders. Similarly, a positive relationship was found between core outsourcing and performance for firms pursuing an innovative differentiation strategy. Thus, it seems that financial success is predicated on matching outsourcing strategy and business level strategy for small and medium sized enterprises.
Environmental dynamism. Environmental dynamism refers to the rate of unpredictable environ mental change. Gilley, McGee, and Rasheed (2004) found that higher levels of perceived 200 outsourcing in entrepreneurial ventures environmental dynamism were associated with increased manufacturing outsourcing. Further, they found that newer firms engage in more manufacturing outsourcing than their mature counterparts when the environment is perceived to be more dynamic. Thus, it appears that entrepreneurial ventures adapt to rapidly changing environmental conditions through the use of outsourcing.
Managerial risk aversion. Outsourcing allows an entrepreneurial venture to shift risks associated with business cycles, technological and skill obsolescence, and financial investment to the sup plying firm. The level of outsourcing, therefore, may be a function of managerial risk aversion. Gilley, McGee, and Rasheed (2004) found that mature firms outsource more than newer firms when their top management teams are relatively more risk averse. Surprisingly, they found that risk aversion does not have much of an influence on the manufacturing decisions of younger firms. Thus, in the case of new ventures, out sourcing seems to be driven more by resource limitations than by risk aversion. A likely ex planation is that entrepreneurs who start new ventures are risk takers and thus risk aversion alone cannot explain their propensity to out source.
Conclusion
Given the relative infancy of outsourcing re search, it appears premature to propose a normative theory of outsourcing. However, considerable advances have been made recently in classifying the types of outsourcing (core versus peripheral), identifying organizational and environmental antecedents of outsourcing, and exploring potential moderators of the out sourcing–performance relationship. Although research focusing on outsourcing by entrepreneurial ventures is rather limited, it is clear that outsourcing stands to have an important effect on the success of those ventures. Future research should seek to further determine both the reasons for outsourcing by entrepreneurial ventures and how outsourcing affects new venture success.
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