Strategic Horizontal Outsourcing

Project: Research

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Firms competing in the same market often subcontract production of some components of their final products to their rivals. This so-called horizontal outsourcing phenomenon is common, especially in some major industries such as automobiles, computers, electronics, and pharmaceuticals. It often involves firms that have the technology knowhow to produce key intermediate components in-house outsource from a rival who competes against them in the downstream market.Since horizontal outsourcing occurs between rivals, executives should look beyond cost reduction as a tool to improve their firms’ competitiveness. Otherwise, they may outsource for a wrong reason and misalign the outsourcing strategy with firms’ business strategy. Yet, in practice, according to a survey of over 300 business and IT executives conducted in 2008 by Deloitte consulting, cost reduction is considered the primary factor motivating most outsourcing decisions. Only 27% of the firms selected gaining competitive advantage as motivation for outsourcing, and a merely 15% of the firms include increasing shareholder value as one of the motivations. Our research attempts to uncover the role of strategic consideration on horizontal outsourcing.Specifically, in this project, we attempt to address several under-studied issues that could be critical for firms to make a sound decision on horizontal outsourcing. Is cost reduction still a right motivation? What are the implications of horizontal outsourcing on the final product market competition? Under what conditions are firms better off with horizontal outsourcing than producing in-house or sourcing from a non-competitor? How does the degree of substitutability of rivals' end products affect outsourcing decision? And, how does market uncertainty affect horizontal outsourcing?Our initial results show that focusing only on cost reduction but ignoring the strategic implication of outsourcing in the end product market competition, firms may lose opportunities to make greater profits. Under some conditions, a firm could make greater profit by sourcing from a rival at a price higher than in-house production cost!We expect this research will generate managerial insights to guide mid-and-high level managers whether to source components from a competitor or to produce in-house. Our initial results can be a wake-up call for many companies that primarily use outsourcing as cost reduction strategy. After completion of this project, we expect to obtain more insights on how other important factors such as demand uncertainty and contracting terms affect horizontal outsourcing.


Project number9042134
Grant typeGRF
Effective start/end date1/01/1511/09/17