Offshore Outsourcing: Implications for

International Business and Strategic Management

Theory and Practice
Jonathan P. Doh
Villanova University
In this essay, I discuss the implications of the debate over offshoring for
our collective understanding of international business and management theories. I
review several core theories in international business expansion and management
strategy to assess which elements of these theories may need to be re-specied in
light of the offshoring phenomenon and which aspects remain relevant. I then
present normative implications and recommendations for public policy and corporate
strategy, drawing from emerging insights regarding the global responsibilities of
corporations. I suggest that international labour and environmental standards and
corporate codes of conduct could mitigate some of the most intense concerns raised
about offshoring but conclude that offshoring is likely to present challenges to
societies, corporations, and stakeholders for many decades.
INTRODUCTION
As the previous two essays illustrate, there is considerable divergence over the
causes and consequences of offshoring (Farrell, 2005; Levy, 2005). Inherent in this
debate are disagreements over basic assumptions in economic theory and man-
agement decision-making. Indeed, although offshoring is not new, its acceleration
real or perceived may challenge established theoretical orthodoxy regarding
the operation of the global economy generally, and management practice, in par-
ticular. In this essay, I explore the implications of the debate over offshoring for
our collective understanding of some leading international business and strategic
management theories.
Recent efforts to reconceptualize the IB eld, especially as it relates to global
strategic management, have stressed globalization, the changing strategy of MNEs
Journal of Management Studies 42:3 May 2005
0022-2380
Blackwell Publishing Ltd 2005. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ,
UK and 350 Main Street, Malden, MA 02148, USA.
Address for reprints: Jonathan P. Doh, Villanova University 800 Lancaster Avenue, Villanova, PA 19085,
USA (jonathan.doh@villanova.edu).
and their impact on the world economy (Buckley and Ghauri, 2004), the factors
that determine the success or failure of rms within this competitive environment
(Peng, 2004), and the growing importance of Civil Society and NGOs to the theory
and practice of IB (Teegen et al., 2004). These research directions capture the
context (culture, geography, institutions), rm-level goals (performance), and
societal impact (globalization and its challenges) that are critical to analysis of
offshoring and its impacts. Ramamurti (2004) recently identied offshore out-
sourcing of services as an emerging research theme in IB, however he notes that
to date, the IB research community has paid limited attention to this important
phenomenon.
In addition, the strategic management literature has grappled with the appli-
cation of resource-based perspectives on strategy in environments charac-
terized by turbulence and change. In particular, recent work in the area of
dynamic, co-evolutionary processes in organizations (Lewin and Volberda, 2003)
is directly relevant to the challenges for the rm of maintaining competitive advan-
tage in the face of pressures to reduce costs and shift production brought about
by shifting technology, markets, and competition, the principal forces at work in
offshoring.
IMPLICATIONS FOR MACRO THEORIES OF INTERNATIONAL
BUSINESS
Fundamentally, offshoring presents challenges to core theories which underpin
many assumptions within IB research. For example, the ease by which corpora-
tions shift operations and employment among countries has direct implications for
the relevance of a traditional comparative advantage view of global competition
(Maneschi, 1998). Although Porter (1990) and others have long criticized tradi-
tional Ricardian comparative advantage theory as too narrowly focused on the
role of factor endowments, offshoring provides further evidence that traditional
factors of land and labour are not sufcient (and may not even be necessary) con-
ditions for advancing economic development. At the same time, however, the com-
bination of one critical endowment (labour) with an additional, more variable
factor (education), does appear to provide a powerful inducement for rms to con-
sider decoupling their core production and service activities. The explosive growth
of offshoring in India attests to this reality. In addition, Porters (1990) require-
ment of home market demand as a necessary condition for internationally com-
petitive industries is anachronistic in an environment where new, efcient
industries have rapidly developed in regions with little home market demand for
their outputs.
Dependency theory emerged in the late 1960s and early 1970s to counter the
presumption that the growth patterns of developing and developed countries
would converge, and that barriers to capital and technology ows prevented this
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convergence. Dependency theorists countered that the development of industrial-
ized nations occurred at the cost of the developing nations who were the victims
of uncontrollable global forces such as multinational corporations and interna-
tional development institutions (Cardoso and Faletto, 1979; Frank, 1967). In much
of the world, the dependency and related Import Substitution Industrialization
(ISI) model have been repudiated as research increasingly suggests that foreign
direct investment (FDI) may be as or more important to a countrys growth than
domestic investment, since investment by MNCs brings improved technology and
does contribute, eventually, to convergence (Taylor, 1999).
Although most of the concerns about offshoring have been directed to the devel-
oped countries in which jobs and wages appear threatened, offshoring raises con-
cerns about a new kind of dependency. Offshoring, when unrelated to domestic
demand, may exacerbate reliance by developing countries on the capital and
resources of industrialized nations. If so, developing countries become vulnerable
to the vagaries of MNCs who may choose to shift production from developed to
developing countries, or from one developing country to another.
On the other hand, there is some evidence of convergence between the wages
of developed and developing countries in high-end service industries. The wages
in Ireland, once a fraction of those in the EU, have now caused many rms to
move call centres and other back ofce operations elsewhere. In India, wages in
business services have been increasing steadily, suggesting the emergence of a
global market (rather than a national one) for many of these positions (Scheiber,
2004).
IMPLICATIONS FOR THEORIES OF INTERNATIONAL
EXPANSION
In 1966, Vernon described a theory of international competition known as the
international product life cycle model (PLC). The PLC proposes that capital inten-
sive and technologically sophisticated innovations are typically developed in the
USA for the domestic market, and progress through various stages in which pro-
duction shifts to other developed countries and nally to developing countries that
become platforms for MNC exports to their home country and other developed
markets. As a complement to Vernons macro orientation on cycles in international
trade, Johanson and Vahlne (1990) developed a model of sequential internation-
alization on a rm level that emphasizes incremental internationalization through
acquisition, integration, and use of knowledge of foreign markets.
Recently, scholars have questioned the validity of the PLC model (Cantwell,
1995) and of the internationalization perspective (Anderson, 1993; Itaki, 1991) to
contemporary IB phenomenon. Vernon himself suggested the PLC may lose utility
in an increasingly complex and integrated international trade environment
(Vernon, 1979), and other researchers argue that many international ventures do
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not follow the slow, sequential process anticipated by the PLC and international-
ization perspectives, but rather may experience a more uneven or accelerated
process of internationalization (McDougall et al., 1994).
Vernon (1966) emphasized the importance of local demand conditions as a cat-
alyst for export abroad, and the subsequent commoditization of products as an
impetus for FDI. Contrary to this slow, sequential internationalization, the inputs
to nal production of many services may be de-coupled from intermediate inputs
early in the internationalization process under offshoring schemes. Hence, the link-
ages between production location and core knowledge-based activities may be
weak. Examples include lm production, programming, back ofce, and call centre
functions in audio-visual, software, legal, and accounting services. For production
of these services, local demand is less (or un-) important, while specic country
factors land, labour, and infrastructure are proportionately more important.
Moreover, as Levy (2005) notes, the development of communications technologies
and the requisite mobility of labour have allowed for an accelerated internation-
alization of production that accords neither with the product life-cycle nor the
sequential internationalization perspective. Indeed, some have argued that many
rms are now born global (Knight and Cavusgil, 2004) and that the notion of
sequential internationalization whether on a country, industry, or rm scale is
outmoded and anachronistic.
A third perspective on international expansion, internalization theory (Buckley
and Casson, 1976), suggests that rms seek to develop and deploy their resources
across international boundaries to take advantage of asymmetries in knowledge
and capabilities. Internalization theory, when combined with constructs related to
location and ownership, has provided a sophisticated and multi-dimensional ratio-
nale for international production collectively known as the OLI perspective on
international investment. The OLI framework (Dunning, 1980, 1981) proposes
that rms will choose investment locations, develop international strategic priori-
ties, and select entry modes by considering three sets of variables: ownership
advantages (control and the costs and benets of inter-rm relationships and trans-
actions), location advantages (resource commitments and requirements, and the
availability and cost of resources), and internalization advantages (the ability to
reduce transaction and coordination costs and prevent opportunistic exploitation
of tacit knowledge).
The phenomenon of offshoring would appear to both reafrm and to challenge
the OLI framework. Location, an important variable for market-seeking, resource-
seeking, and cost-minimization strategies, is prominent in the apparent motiva-
tions for offshoring. The relevance of ownership and internalization advantages,
on the other hand, is somewhat less evident. By disintegrating production stages
along the supply chain and transferring them to other geographic locations, rms
may create conditions for the erosion of ownership and internalization advantages.
Indeed, recent concerns over the intellectual property protection in software pro-
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duction in India are an early indication of what could be a growing phenomenon.
This could cause rms to reexamine which aspects of their production must
remain close both geographically and conceptually to their core activities. For
example, Dell was forced to repatriate some of its call centre staff from India to
Texas due to quality control problems (Houston Chronicle, 2003). For a company that
has little on-site service, the call centre capability is core to Dells competitive posi-
tion. Contracting out as opposed to simply changing production locations
could further undermine some of the advantages associated with both ownership
and internalization.
For some rms, however, the service of offshoring is intrinsic to their business
model. For these companies, capabilities in developing focused offshore outsourc-
ing service requires specialized expertise in managing and coordinating disparate
activities across geographic, sectoral, and functional boundaries. These strategies
may reinforce the importance of the OLI framework, albeit with distinct compe-
tencies not related to production and markets but rather efciency in organizing
and assembling work process, often as a service to other rms. Business process
outsourcing specialists such as EDS and IBM, and contract manufacturers Flex-
tronics and Solectron, are developing new ways of exploiting OLI-type advantages
by combining low labour costs, specialized technical capabilities, and organiza-
tional coordination expertise.
IMPLICATIONS FOR STRATEGY: THE RESOURCE-BASED VIEW
AND DYNAMIC CAPABILITIES
Offshoring also has implications for strategic management. In particular, it poses
challenges to collective understandings related to the development and deployment
of rm-level capabilities. Offshoring potentially constitutes a rm-level capability
and a resource to be developed and deployed as under internalization theory. It
may also serve to undermine or reduce the value of rm-level advantages, espe-
cially those that are immobile or tied to core activities.
Building on earlier work by Penrose (1959) and Nelson and Winter (1982), pro-
ponents of the resource-based view (RBV) examined the economic returns to
resources that a rm owns, acquires, or develops (Barney, 1991). In order for
resources to be valuable in facilitating exploitation of an opportunity in the busi-
ness environment or in neutralizing a threat, they must be scarce or must come
together in a unique way as a result of how the rm packages or bundles them,
immobile such as those that are idiosyncratic to the rm, those for which prop-
erty rights are not well dened, or those that are co-specialized with other assets
(Teece, 1986). In addition, they must be difcult to imitate so that the rm can
maintain rent-earning status for a period of time. For a rm to be in a position to
exploit a valuable and rare resource, it must have a resource position barrier pre-
venting imitation by other rms.
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Offshoring, both as internal process and business strategy, could be an outcome
of successful management of resources, and may itself represent a direct applica-
tion of rm-level capabilities as envisioned by the RBV. At the same time, however,
offshoring may reect the commoditization of a production function and erode
benets derived from management of resources and capabilities if it becomes an
activity that is widely imitable and not unique to a rm or confederation rms.
The Dell example, and others unreported, may argue that there are real limits to
the competitive benets of offshoring, at least for some industries and companies.
The RBV has been criticized for lacking sufcient focus on how and why certain
rms have competitive advantage in situations of rapid and unpredictable change
(Eisenhardt and Martin, 2000), and for overlooking the managerial coordinative
processes by which rms assemble and leverage knowledge assets. In response,
strategy researchers have offered an extension of the RBV and other strategy per-
spectives in the form of a dynamic capabilities view of competitive strategy
(Kogut and Zander, 1992; Teece et al., 1997). Dynamic capabilities refer to capa-
bilities by which managers integrate, build, and recongure internal and external
competencies to address rapidly changing environments (Teece et al., 1997).
Kogut and Zander (1992) refer to combinative capabilities as the ability to
acquire and synthesize knowledge resources and build new applications from those
resources, especially in a changing environment.
The focus of the dynamic capabilities perspectives on rapid change captures the
environment in which rms consider often under intense pressure from com-
petitors and the external environment how and where to deploy and redeploy
assets across geographic space. As both Farrell and Levy acknowledge, this process
is at the core of the motivations for outsourcing (Farrell, 2005; Levy, 2005). As is
the case under the RBV framework, some rms combinative capabilities lie in
their ability to arrange, organize, and coordinate offshore outsourcing for others.
The combinative contributions of offshore outsourcing may, in fact, be more
important than the pure cost motivations. Microsoft recently revealed the company
has been paying two Indian outsourcing companies, Infosys and Satyam, as much
as $90 an hour for software architects to do work at its US facilities, or a yearly
rate of more than $180,000 (Lohr, 2004). Although it paid only $2336 an hour
for software programmers in India, these rates were a multiple of the wages
received by the workers themselves. This suggests that the added value was less in
the skilled labour and more in the strategic deployment of that labour. This gap,
however, also reinforces Levys concerns about the shifting balance of power in
global strategy (Levy, 2005). And many Indian companies are beginning to develop
these very capabilities globally, as evidenced by their investments in European and
North American call centres and business processing outsourcers. The Indians are
looking to build a global model quickly, according to a partner with WestBridge
Capital Partners, a Silicon Valley venture-capital rm that invests in outsourcing
companies (Kripalani, 2004). Hence, the dynamic process by which rms develop
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and preserve unique capabilities in offshoring may constitute a positive and vibrant
contributor to global economic development. Others, however, are concerned that
rms will become hollow, virtual organizations with little allegiance or responsi-
bility to any of the disparate geographic regions in which they operate and unac-
countable to regulators or the social impact of their activities.
A NORMATIVE PERSPECTIVE: GLOBAL CORPORATE
RESPONSIBILITY
Despite these limitations, offshoring will remain an important tool for managing
and deploying international human resources. If anything, the trend is accelerat-
ing. Forrester Research recently estimated that 830,000 US service jobs will be
moved abroad by 2005, a 40 per cent increase from a projection of 588,000 jobs
it made in November 2002. Forrester also estimated that US companies will send
3.4 million service jobs offshore by 2015 (Geewax, 2004). A survey by UNCTAD
showed that the offshoring trend is quickly catching on in Europe, with four out
of 10 European rms already relocating service operations offshore (UNCTAD,
2004). Although subcontracting provides important exibility in the human
resource practices of MNCs operating globally, it also requires skilled international
managers to coordinate and oversee the complex relationships that arise from it.
Hence, offshoring is a reality that is unlikely to recede, and quite likely to accel-
erate. What can management scholars contribute to this debate, and more impor-
tantly to government policy-makers and company managers who are grappling
with how best to respond? Diana Farrell proposes an insurance scheme developed
by Kletzer and Litan that would provide adjustment assistance to workers dis-
placed by offshoring (Farrell, 2005; Kletzer and Litan, 2001). But the concerns
about global sourcing and the transfer of jobs abroad go beyond the economic
challenges facing those displaced by specic lay-offs. Instead, offshoring suggests
a broader examination of the global responsibilities of corporations.
Corporate social responsibility refers, in part, to the activities of the rm to
provide social contributions that include, but are not necessarily limited to, the
economic returns to investors (Wood, 1991). In the global environment, many
MNCs have come under pressure from civil society and nongovernmental orga-
nizations (NGOs) to be more responsive to the range of social needs in develop-
ing countries, including addressing concerns about the working conditions in
factories or service centres, and attending to the environmental impacts of their
activities. Dunning (2003) has recently argued for a more responsible global
capitalism that incorporates the interests of individuals, corporations, NGOs,
governments, and supranational agencies.
Criticisms have been especially sharp in relation to the activities of multina-
tional companies such as Nike, Levis, United Fruit, and others whose sourc-
ing practices in developing countries have been alleged to exploit low-wage
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workers, take advantage of lax environmental and workplace standards, and
otherwise contribute to social and economic degradation. More recently, business
process offshoring rms have been implicated as well. Many governments, inter-
national organizations, and both local and multinational NGOs have criticized the
low-cost labour seeking behaviour of MNEs in developing countries, suggesting
such rms scan the globe for the cheapest, least regulated, and most exploitive sit-
uations in which to source raw materials and semi-nished products (Singer, 2002).
Global corporate responsibility the actions, practices, policies, and procedures
governing the conduct of rms when doing business internationally provides a
useful heuristic for examination of possible proscriptions associated with the exter-
nalities described in David Levys essay. MNCs, with prodding from governments,
NGOs, and other representatives of civil society, are increasingly agreeing to
agreements and codes of conduct under which they commit to maintain certain
standards in their domestic and global operations (Doh and Guay, 2004). These
agreements, which include, inter alia, the UN Global Compact, the Global Report-
ing Initiative, the social accountability SA8000 standards, and the ISO 14000
environmental quality standards, provide limited assurances that when corpora-
tions increase production in developing countries, they will maintain a minimum
level of social and environmental standards in the workplace and community in
which they are doing business. These codes help offset the real or perceived
concern that companies move jobs to get around higher labour or environmental
standards in their home market. They may also contribute to rising standards in
the developing world by exporting standards of developing countries and MNCs
to host countries and local rms in those countries.
The application of these standards, however, becomes further complicated
when offshoring also incorporates outsourcing via contracting out services that
have previously been part of a rms activities. It is difcult but not impossible
for rms to trace the standards of their contractors, subcontractors, etc. There
are, however, several precedents that would suggest such efforts are not outside of
the reach of MNCs. For example, the rules of origin under the North American
Free Trade Agreement and other trade agreements require importers to verify the
origin of the products they source using a very technical process that in many cases
can only be met with the cooperation of producers, contractors, subcontractors,
etc. In the area of anti-corruption, the Transparent Agents Against Contracting Entities
(TRACE) standard, which was developed after a review of the practices of 34
companies, applies to business intermediaries, including sales agents, consultants,
suppliers, distributors, resellers, subcontractors, franchisees and joint venture part-
ners, so that nal producers, distributors, and customers can be condent that no
party within a supply chain participated in corruption.
Individual companies have also taken steps to extend core standards to suppli-
ers. Motorola is engaged in efforts to certify literally thousands of suppliers for
meeting its global corporate responsibility standards. In some instances, it has
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accepted comparable standards of those suppliers as meeting or exceeding those
of Motorola itself. Mattels Board independently contracts with the International
Center for Corporate Accountability, an NGO, to provide unscheduled on-site
audits of its factories and rst and second-tier suppliers to determine compliance
with the companys Global Manufacturing Principles.
CONCLUSIONS
In the end, offshoring represents a natural continuation of a process that has been
underway for centuries. Paradoxically, the apparent acceleration of offshoring
reects both the successes and failures of economic globalization. Labour not
just capital has now become a mobile factor that can be deployed and rede-
ployed at a moments notice.
Yet other institutional rules and norms that are designed to buffet the potential
negative spillovers of capitalism are not so portable. While all human capital has,
to some extent, become itinerant, the social fabric that envelops our collective pro-
ductive capacities has not become uniform, creating an asymmetrical distribution
that has had disruptive and dislocating impacts on some regions, rms, and workers,
while providing added economic stimulus to others. The development of global cor-
porate responsibility standards and adoption of agreements and codes of conduct
governing labour and environmental practices regularize these norms. In so doing,
these initiatives may help to mitigate or at least reassure those most concerned
about some of the most extreme disruptions associated with offshoring.
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