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Article Excerpt
Abstract
Outsourcing has become popular in management literature and practice. The way in which it is implemented, however, differs from one organization to another. This makes our understanding of the concept very difficult because outsourcing means different things to different organizations in different situations. One reason for this confusion may be the lack of established theoretical frameworks for evaluating organizations' decisions and their application and impact on logistics. This article applies multiple social science theoretical perspectives to develop a framework within which logistics outsourcing decisions can be examined and evaluated.
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Outsourcing, the practice of charging external service providers with the task of performing in-house activities, has attracted growing interest in recent years as managers consider whether it is in their best interest to perform activities in-house or externally (Maltz and Ellram 2000; Lewis and Talalayevsky 2000; Mahnke, Overby, and Vang 2005). With respect to the logistics management activities of transportation, warehousing, order processing, and related information technology support, outsourcing has become a prominent strategy. Outsourcing has also drawn attention with regard to its role in achieving effective logistics integration by which inter- and intra-firm activities are integrated to enhance customer satisfaction and competitive advantage (Murphy and Poist 2000; Knemeyer, Corsi, and Murphy 2003).
In this article, we adopt the most recent definition of logistics (CLM 2003) provided by the Council of Supply Chain Management Professionals (CSCMP) as "that part of supply chain management that plans, implements, and controls the efficient, effective forward and reverse flow and storage of goods, services and related information between the point of origin and the point of consumption in order to meet customers' requirements" (www.cscmp.org). (1) Outsourcing may thus involve any of the aforementioned activity flows, storage, and related information.
Ten years ago, researchers indicated the need for theory development in the logistics discipline as much of the available research concerning it was largely conceptual, lacking rigorous orientation towards theory testing and application (Mentzer and Kahn 1995). Stock (1995) found that more than fifty theories were used by logistics researchers, concluding that logistics development can benefit from borrowing from other theories and its research is suited to approaches that "adopt multidisciplinary methodological pluralism." Being relatively new in theory-development terms, the evolution of logistics and its role in the supply chain can benefit from understanding how it exists in direct correlation, and/or in opposition, to established social science theory. Research of this nature responds to the CSCMP's call for more cross-disciplinary research, especially internationally and in the social sciences (CSCMP 2005 Annual Educators Conference).
Given the above discussion of the importance of theory building in the discipline, one might also ask if theory development can assist the practitioner. Supply Chain Management (SCM) stresses the importance of building relationships and business processes that deliver optimal value to customers (Lambert et al. 1998) by ensuring that value is created at each stage of the supply chain (Christopher 1998). Maintaining a supply chain that is capable of doing this becomes the organization's primary focus, with logistics identified as one of the activities that can be employed in the creation of such value. The ability to own or command (via outsourcing) logistics capability thus can be a driver to creating and sustaining competitive advantage. Given these conditions, the purpose of this article is threefold: (1) to use the social sciences literature to examine the theoretical foundations for outsourcing; (2) to apply that theoretical foundation to explain why organizations outsource logistics; and (3) to explain why the benefits are primarily cost-based, resource-based, and/or strategic in nature. (2) Rather than examine theory development specifically from a generic logistics management perspective, we focus specifically on outsourcing, which can be applied to many logistics (and other) activities. The article will use the following format: First, we discuss a number of theoretical perspectives that provide strong support for logistics outsourcing. Next, we compare and contrast these perspectives, and then we provide a theoretical framework for logistics outsourcing that integrates the varying perspectives. We conclude with observations concerning the theoretical and practitioner applications of logistics outsourcing.
THEORETICAL PERSPECTIVES FOR LOGISTICS OUTSOURCING
Figure 1 illustrates the logistics outsourcing decision. In quadrant #1, logistics activities critical to a firm's success and for which competence exists in-house increase the likelihood of generating profitability, while increasing the firm's ability and efficiency in carrying out these activities (Conner 1991). Prahalad and Hamel (1990) view these activities (i.e., "core competencies") as critical to a firm's success in creating a set of core products and/or services, and as such should not be contracted out. A competitive advantage results from the conversion activities that are based upon the firm's existing resources and/or asset base competencies (Lemelin 1982; Barney 1991), and provides opportunities for growth in profitability through internal integration. In quadrant #2, there are situations where the firm determines that logistics is not a critical success factor in the decision calculus, especially in situations where its perceived value to the focal business strategy is low; here the choice to spin off the logistics function is logical. As an example, many of today's top-performing 3PL firms are spin-offs from one or more long-established, asset-based transportation companies. C.H. Robinson Worldwide's parent company is best known as an intermodal marketing company, but it also offers trucking services. Ryder Integrated Logistics originally focused on managing private truck fleets. Landstar Logistics and USF Logistics Services both spring from multifaceted trucking concerns, and Transplace was created from the merger of the logistics divisions of Swift Transportation, Covenant Transport, J.B. Hunt, M.S. Carriers, U.S. Xpress, and Werner Enterprises. FedEx Supply Chain Services and UPS Supply Chain Solutions, of course, are subsidiaries of the parcel express giants, and Menlo Worldwide Logistics is a subsidiary of CNF Inc., which also owns trucking and other transportation service providers (Outstanding Outsourcing 2003).
[FIGURE 1 OMITTED]
On the other hand, there are circumstances as in quadrant #3 where the capabilities and resources for developing logistics core competence are not available within the firm. If logistics is not a critical success factor in the decision calculus, and the firm's in-house operational performance of logistics services is low, then the choice to fully outsource the function to a capable third party is logical. An example of this is when the activity is a basic transportation delivery activity in a heavily utilized traffic lane with multiple service providers. This is a "commodity" transaction with little to no value-added--and primarily cost-based. If the logistics process is considered critical to a firm's success, a "hybrid" form of outsourcing may be most logical (Earl 1996; Spear 1997). In this situation, illustrated in quadrant #4, in-house activities (i.e., the "process") combine with external resources and capabilities (i.e., the "functions"). For example, there is a trend towards smart sourcing of those services that provide substantial business value but for which internal operational performance and competence is weak (Earl 1996). This is a typically popular practice but may lead to complexity for 3PLs, the outsourcing firm, and its supply chain because of the split between "processes" and "functions" as well as the challenge of re-deploying two sets of firm-level routines, incentives, and cultures. (3)
The decision of whether to outsource or spin off logistics services can be made only through a rigorous evaluation of the service's value and earnings potential. Typically, companies explore the outsourcing option to liberate capital and reduce overhead. If in-house resources are extensive, however, with a potential (or current ability) to serve outside customers, these resources may constitute an effective, viable, stand-alone third-party logistics business that can be sold to a strategic or financial buyer, or spun off as a separate operation, especially if the parent company or shareholders have no need for the liquidity that a sale would generate.
Given that the decision to outsource has been made (or not) as described in the preceding paragraphs, what theoretical bases for that decision(s) can be used to rationally explain that logic? Table 1 lists a number of social science theories that provide a rationale for logistics outsourcing as a strategy. The list is by no means exhaustive but includes those theories with a strong connection to logistics principles and practice and their integration with supply chain management. Of the theories highlighted, several are particularly relevant to logistics outsourcing practices and decision strategies: (1) Transaction-Costs Analysis (TCA) and Agency Theory; (2) Resource-Based Theory (RBT); and (3) Network Theory (NT) and General Systems Theory. We discuss each in the following sections.
TRANSACTION COSTS ANALYSIS, AGENCY THEORY, AND OUTSOURCING
Transaction costs refer to the costs of physical and human resources incurred in order to complete an exchange of goods and services between parties. Factors that contribute to these costs include opportunistic behavior, the search for the "true" price at which purchases ought to take place, and the need to discover the "true" quality of a good/service. In transaction cost economics, a firm's ownership decisions focus on minimizing the sum of its transaction and production costs (Coase 1937; Williamson 1975). Excessive costs may cause transactions to be transferred to other institutions. These institutions in turn internalize market transactions by governing them through long-term contracts that create mutual dependence, improve reciprocal control, curb opportunism, and allow for better cooperation between the parties involved (Williamson 1985). Transaction cost analysis (TCA) proposes that firms exist in order to maximize profits by reducing transaction costs through three different forms of governance structures: market (arms-length, one-off transactions for standard investments); hierarchical (vertical integration through direct ownership); and hybrid structures (combining elements of the market and hierarchical mechanisms). Examples of hybrid governance mechanisms include bilateral governance (Heide and John 1990), relational contracting (Palay 1984), incentives (Anderson and Weitz 1992), buyers' asset safeguarding (Stump and Heide 1996), and contractual safeguards (Parkhe 1993). These examples have been considerably endorsed by social science scholars. Generally speaking, TCA is comprised of two types of variables: dependent and independent. With regard to dependent variables, in reality most transactions are complex and do not possess pure market or hierarchical characteristics due to prevalent economic situations of high transaction frequency and medium asset specificity. In these situations, the most efficient governance structure is the "hybrid mechanism" (Demsetz 1988; Hennart 1993). With regard to independent variables, the issues of asset specificity and (environmental and behavioral) uncertainty become problematic.
Coase (1952) and Williamson (1975) both agreed that for a firm's existence to be justified, the firm--with its internal network of relationships--must outperform the alternative external, arm's-length transactions. Understanding performance discrepancies between firm-based and market-based transactions, therefore, motivates and drives the decision-making process with respect to organizations' positions within the supply chain by establishing boundaries and structural mechanisms for outright ownership of the distribution channel or arm' s-length transactions on the open market. As the firm and its service provider...
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