Outsourcing and innovation: evidence for a local production system of Emilia-Romagna.

SUMMARY

The paper investigates how innovation relates to outsourcing for firms located in a specific local production system. A set of theoretical correlations between innovation related variables and outsourcing decisions is formulated by drawing on a heterogeneous body of literature. Correlations are tested with respect to a representative sample of firms of a local production system in Emilia-Romagna: Reggio Emilia. The main result of the paper is that, in the district-like context investigated, where networking intertwines with market mediated mechanisms, the firm's innovativeness correlates positively with the complexity of the outsourcing strategies. Once the firms' embeddedness is controlled for, the 'dualistic' argument that innovative firms do not outsource in order to avoid the impoverishment of their capabilities is not guaranteed. On the contrary, according to a 'developmental' argument, being innovative in Reggio Emilia requires the outsourcing of ancillary activities, in order to refocus on the business core and, though to a lesser extent, of supporting production activities in order to tap-into the external providers and benefit from their own competences. Confirming the results of other previous studies, the particular set of network interactions which make up the social capital of Reggio-Emilia thus seems to make the outsourcing-innovation relationship viable by attenuating the risks of firms getting locked in unbalanced and dependency relations from their suppliers.

KEYWORDS

outsourcing; firm organization; transaction costs; competences; innovation; local production systems; JEL codes L22, D23, J53

1. INTRODUCTION

The relationship between outsourcing, on the one side, and firm's innovativeness, on the other side, has emerged to be a truly 'complex' one, whose direction and sign is hard to establish a priori.

At the outset, firms can be claimed to innovate more or less depending on the vertical integration degree of their organization, and of the outsourcing strategies which contribute to determine it: (1) the now popular 'core competences' business argument, according to which the firm's innovation capabilities increase by focusing on the 'area of specialized expertise' and by externalizing non-core activities (Hamel and Prahalad, 1990: 164) is an example. On the other hand, it is also claimed that firms integrate and outsource to different extents depending on their innovative profile. The idea that the firm's distance from the technological frontier makes vertically integrated and disintegrated organizational structures more and less suitable in solving the trade-off between the managerial overload of the owners and their rent loss due to the suppliers' hold-up (Acemoglu, Aghion and Zilibotti, 2002), exemplifies the latter argument.

Out of these two interpretations, the paper focuses on the latter, that is on how the innovative strategies of the firm, and the relative innovative outcomes, might affect its outsourcing strategies: that is, on how the innovative profile of the firm might induce it to look for more or less vertically integrated organizational structures. Accordingly, outsourcing is the dependent variable in the empirical models below specified, while different variables related to the firm's innovation process are our main independent ones. However, it should be emphasised that this does not amount to assuming any causality from innovation to outsourcing, or vice-versa. The two phenomena are rather correlated and our empirical model just one point of view from which it is possible to detect such a correlation.

Also the sign of the relationship between outsourcing and innovation is far from unambiguous. The 'standard' view, which retains vertically integrated firms generally superior to disintegrated ones in dealing with innovation--either for the advantages in managing complementary assets (Teece, 1986) or in coordinating new and unrelated information bits (Silver, 1984)--has been recently questioned. Langlois and Robertson, for example, in a series of papers (e.g. Langlois and Robertson, 1996; Robertson and Langlois, 1995) have shown that the sign of the relationship between the firm's vertical scope and innovation crucially depends on both the kind of technological change the firm faces and the institutional and economic context it is based in (for example, an industrial district).

On the basis of this argument, how outsourcing actually relates to innovation should be established pragmatically, by looking at which mechanisms, out of those identified by both standard and non-standard theoretical perspectives, are at work when the firm is 'embedded' in the context it operates (Mazzanti, Montresor and Pini, 2006).

In the paper, this will be done by drawing 'outsourcing arguments' on both the theoretical and the empirical literature on innovation (Section 2), and translating them into 'expected' correlations. These correlations will be then tested with respect to the firms of the local production system of Reggio Emilia (in Emilia-Romagna), using a large dataset and an empirical model described in Section 3. Section 4 will present the main results of the application and Section 5 will conclude.

2. OUTSOURCING AND INNOVATION: AN AMBIGUOUS RELATIONSHIP?

Outsourcing is nowadays a strategic choice firms undertake pervasively and for different reasons. In broad terms, it can be defined as the 'turning over of all or part of an organizational activity to an outside vendor' (Barthelemy, 2003: 87) or, more rigorously, as 'the procurement of products or services from sources that are external to the organization' (Lankford and Parsa, 1999: 310). In a more economic vein, such as in the language of transaction cost economics, outsourcing is the choice of moving from 'make' to 'buy', that is the reverse of a vertical integration choice (e.g. Grossman and Helpman, 2005).

The relevance of outsourcing for the firm's innovativeness is manifold. This emerges clearly when a broad approach to the issue is adopted, which combines the two main theoretical perspectives emerged in the relevant literature: on the one hand, transaction cost economics (TCE) and the related research lines, which focus on such issues as contract incompleteness (e.g. Grossman and Helpman, 2002), ownership allocation and efficient investments (e.g. Grossman and Hart, 1986), formal versus real authority (e.g. Aghion and Tirole, 1997) and, in general, on the incentive conflicts entailed by contractual relationships (Foss, 2000); on the other hand, the 'resource-based-view' approaches and the evolutionary perspectives, which address the implications of outsourcing for the firms' capabilities and competences (e.g. Mahnke, 2001) and set the contractual analysis in 'real time' (e.g. Langlois, 1992; Argyres and Liebeskind, 1999) by pointing to path-dependency and inertia. (2)

The insights about the innovation/outsourcing relationship which emerge from this broad perspective are more than numerous. For the sake of clarity, we propose to organize them around four sub-issues, which relate outsourcing to, respectively: (i) technological uncertainty, (ii) technological innovations, (iii) innovation radicalness, (iv) organizational innovations and flexibility. In all these four respects the innovative firm finds in outsourcing an extremely sensitive variable, and for different reasons which we will try to summarize in expected correlations in the following sections (Table 1).

2.1 Technological uncertainty and technological regimes

Let us start by considering the turmoil technological change introduces in the firm's sector (Table 1: i, ii). At the outset, outsourcing can be retained a way firms deal with and transfer such a special kind of uncertainty on external suppliers. Apparently, this might sound inconsistent with the basic insights of TCE, according to which uncertainty, in general, makes vertically integrated hierarchies--in which residual decision rights only are agreed ex-ante--more flexible and preferable (Williamson, 1975). (3) However, an opposite and positive relationship between technological uncertainty and outsourcing can actually be established by introducing 'history' in TCE, and recognizing the role of 'governance inseparability '(Argyres and Liebeskind, 1999) for it: in brief, the linkage between new contractual arrangements (such as a prospective outsourcing) and the existing contractual nexus of the firm, as it has emerged along its history. 'Technological uncertainty', when it unfolds, might actually require to the firm an important governance switch and/or a governance differentiation, for example between its constitutional commitments and its non-constitutional contracts. And these prospective changes might be so costly to make the firm reluctant to augment present inseparability through vertical integration, and induce it to outsource more activities, at least until new technological standards are established. (4)