Limits to Outsourcing and the Evolutionary Perspective on Firm Boundaries

Although there is reason to expect that outsourcing plays an increasingly important role in world of commerce, theories of firm boundaries poorly address associated processes of governance change. This paper seeks to address this gap in the spirit of the evolutionary theory of the firm. This approach highlights the significance of outsourcing as a "process of shifting from internal to external procurement of activities." Adopting an evolutionary process perspective suggests limits to outsourcing due to governance inseparability and partly tacit complementarity of capabilities as well as related dis-aggregation costs, including the costs of knowledge codification in the specification of interfaces in supplier/buyer relations, loss of absorptive capacity and integrating capabilities in the supplier’s system. A key departure from earlier approaches to firm boundaries is an explanation of such limits to outsourcing and their impact on two interrelated sources of efficiency: incentives and capabilities. For instance, when limits to outsourcing obtain, governance change for particular activities involves compromises of capability- and/or incentive efficiency in the experimental determination of organizational boundaries. Also discussed are environmental dynamics that variously emphasise efficiency properties of dispersed or concentrated ownership and capability development.