A practical decision framework for sourcing product development services

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My M.Sc. (Tech.) thesis that develops a decision framework and a checklist for sourcing product development activities from external consultants.

It's long and somewhat academic, but if you're interested in hearing how you should manage external product development relationships it may be worth reading, or asking me about it :).

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A practical decision framework for sourcing product development services

  1. 1. HELSINKI UNIVERSITY OF TECHNOLOGY Faculty of Engineering and Architecture Department of Engineering Design and Production Janne M. Korhonen A practical decision framework for sourcing product development services Thesis submitted in partial fulfilment of requirements for the degree of Master of Science in Technology Espoo, 10 March 2009 Supervisor: Professor Kalevi Ekman Instructor: Roope Takala, M.Sc. (Tech.)
  2. 2. HELSINKI UNIVERSITY OF TECHNOLOGY ABSTRACT OF THE MASTER'S THESIS Author: Janne M. Korhonen Title of the thesis: A practical decision framework for sourcing product development services Number of pages: 222 + 37 Date: 10.3.2009 Faculty: Faculty of Engineering and Architecture Department: Department of Engineering Design and Production Professorship: Kon-41 Machine Design Supervisor: Professor Kalevi Ekman Instructor: Roope Takala, M.Sc. (Tech.) In recent years, firms have increasingly sourced some or all of their product development functions from outside specialists. Although the phenomenon is well documented, research in the theoretical aspects of new product development (NPD) sourcing has been limited. Existing sourcing frameworks and decision models are based on studies of functions such as manufacturing, logistics and back-office services. This approach has biased the sourcing decision frameworks towards arms- length contracts and cost focus, which are rarely the key drivers in NPD outsourcing. At the same time, it has ignored or downplayed the importance of interpersonal issues. As a result, there is a distinct lack of management toolkits for deciding how to properly outsource NPD-related functions. This study combines three research streams (outsourcing decision-making, new product development, and selection of service providers) and develops answers to two primary research questions, namely 1) what features make a product so essential to the firm that its development cannot be outsourced, and 2) how to determine what parts of the NPD process could be outsourced to a specific service provider? The research method is primarily conceptual, with emphasis on literary review from a wide range of sources. The results emphasize he importance of trust and relationships in NPD outsourcing. A systematic approach to sourcing is seen as a prerequisite to successful outsourcing. The study identifies three basic strategies followed by firms outsourcing their NPD services, and develops practical checklists to aid outsourcing decision-making. A framework that allows analysis of sourcing decisions is also produced, and practical implications discussed. The study also reports results from an industry survey featuring 60 respondents. The findings suggest that NPD outsourcing in Finland follows pan-European NPD outsourcing practices. Keywords: make or buy, outsourcing, product development, product strategy, design management, decision model, trust, best practices 2
  3. 3. TEKNILLINEN KORKEAKOULU DIPLOMITYÖN TIIVISTELMÄ Tekijä: Janne M. Korhonen Työn nimi: Käytännöllinen päätöksentekomalli tuotekehityspalvelujen ulkoistamiseen Sivumäärä: 222 + 37 Päivämäärä: 10.3.2009 Tiedekunta: Insinööritieteiden ja arkkitehtuurin tiedekunta Laitos: Koneenrakennustekniikan laitos Professuuri: Kon-41 Koneensuunnittelu Työn valvoja: Professori Kalevi Ekman Työn ohjaaja: Diplomi-insinööri Roope Takala Kuluneina vuosina yritykset ovat enenevässä määrin hankkineet tuotekehitysosaamista ulkopuo- lisilta spesialisteilta, ulkoistaen tuotekehityksensä kokonaan tai osittain. Vaikkakin ilmiö on hyvin dokumentoitu, on sen teoreettista taustaa tutkittu vain vähän. Olemassaolevat ulkoistamismallit ja päätöksenteon apuvälineet perustuvat suurelta osin valmistuksen ja logistiikan kaltaisten yrityksen funktioiden tutkimukseen. Näiden tulosten soveltamista tuotekehityksen ulkoistamiseen rajoittaa se, että ko. tapauksissa ulkoistamisella pyritään usein pääasiassa kustannussäästöihin. Lisäksi aikai- sempi tutkimus jättää usein henkilökohtaisten suhteiden merkityksen vähemmälle huomiolle. Näistä syistä olemassaolevat ulkoistamismallit sopivat heikosti tuotekehityksen ulkoistamiseen, mutta kirjallisuudessa ei ole myöskään selkeitä “työkalupakkeja” liikkeenjohdon päätöksenteon tueksi. Tämä diplomityö yhdistää kolmen tutkimussuunnan (ulkoistamisen päätöksenteko, tuotekehitys, ja palveluntarjoajien valinta) löydöksiä ja kehittää vastauksia kahteen pääasialliseen tutkimus- kysymykseen: 1) milloin tuoteominaisuus on niin tärkeä yrityksen kilpailukyvylle, ettei sen suunnittelua tule missään tapauksessa ulkoistaa, ja 2) kuinka päättää mitä tuotekehitysprosessin osia voidaan ulkoistaa tietylle palveluntarjoajalle? Tutkimusmetodi on pääasiassa konseptuaalisen teorian kehittämistä laajaan kirjallisuuskatsaukseen perustuen. Tutkimuksen tulokset korostavat luottamuksen ja henkilökohtaisten suhteiden merkitystä tuotekehityksen ulkoistamisessa. Systemaattinen lähestymistapa nähdään vaatimuksena onnistuneelle ulkoistamiselle. Yhtenä tuloksena tunnistetaan kolme perusstrategiaa, joita tuote- kehitystään ulkoistavat yritykset seuraavat. Tutkimuksen tuloksia pyritään jalkauttamaan yrityksiin kehittämällä käytännöllisiä tarkistuslistoja ja toimintamalleja, joiden avulla tuotekehityksen ulkois- tamista voidaan tarkastella järkiperäisesti. Lisäksi tutkimuksessa tarkastellaan löydösten käytännön merkityksiä eri toimijoiden kannalta. Työssä raportoidaan myös tulokset 60 teollisuusyritystä käsittävästä kyselytutkimuksesta. Tutkimuksen tulokset antavat syytä olettaa, että tuotekehityksen ulkoistaminen Suomessa noudat- telee yleisesti ottaen Euroopassa vallalla olevia käytäntöjä. Avainsanat: osta/tee-päätöksenteko, ulkoistaminen, tuotekehitys, tuotestrategia, design management, päätöksentekomallit, luottamus, parhaat käytännöt 3
  4. 4. 4
  5. 5. Foreword This thesis has been very much a learning process and very little just a task to be completed before graduation. Having to combine research and writing with the demands of starting up and working in a design agency – both something that the author hadn’t done before – is now, in retrospect, something that the author doesn’t recommend for the faint of heart, but it has definitely been an experience. However, all the hard work has been worth it. The subject, which surfaced when the author was working for TKK’s FutureLab of Product Design in late 2007, has been a fascinating yet understudied one; the process, where around 900 hours of research and writing were interspersed between long periods of subconscious thinking and – sometimes – even actually doing outsourced innovation has been very fruitful in depth of thought and insights into the subject. In the humble opinion of this author, the lengthy gestation period has greatly improved the thesis and how it is presented. At this point, thanks are in order. In addition to interviewees who generously donated their time for answering questions from the author, special mention is in order for the partners of Seos, our interdisciplinary design agency, for giving the author their support and allowing the author some time to work on the thesis. Both the advisor of the thesis, Roope Takala from Nokia Oyj, and the supervisor, professor Kalevi Ekman at TKK, deserve the author’s gratitude for enduring the process and giving helpful advice when it was most needed. Sincere apologies for not being able to complete the work sooner: hopefully the result is worth the wait. Finally, to Jaana, who kept me fed during the process. In Helsinki, 10.3.2009 5
  6. 6. Table of contents Foreword............................................................................................................................................. 5 Table of contents ............................................................................................................................... 6 List of figures...................................................................................................................................... 9 List of tables......................................................................................................................................10 List of diagrams................................................................................................................................11 List of abbreviations ........................................................................................................................12 1. Introduction..............................................................................................................................13 1.1. The need for a framework..............................................................................................16 1.2. Research questions...........................................................................................................18 1.3. The purpose and the outline of the thesis ...................................................................19 1.4. Research methodology ....................................................................................................21 1.5. Definitions ........................................................................................................................25 1.5.1. Outsourcing...................................................................................................................25 1.5.2. Offshoring .....................................................................................................................26 1.5.3. Product...........................................................................................................................26 1.5.4. Product development...................................................................................................27 1.5.5. Product development outsourcing.............................................................................27 1.5.6. Client ..............................................................................................................................28 1.5.7. Provider..........................................................................................................................28 1.5.8. Original Equipment Manufacturer (OEM) ..............................................................28 1.5.9. Original Design Manufacturer (ODM) .....................................................................29 1.5.10. Independent Design Team (IDT)............................................................................29 2. NPD outsourcing in theory....................................................................................................30 2.1. A brief history of outsourcing........................................................................................32 2.2. NPD outsourcing as a phenomenon ............................................................................35 2.3. Theory base: outsourcing and outsourced innovation...............................................39 2.4. Key research streams and positioning of the study ....................................................43 2.5. Strategic management......................................................................................................46 2.5.1. Make or buy decision-making.....................................................................................46 2.5.2. Outsourcing core competencies.................................................................................49 2.5.3. New product development .........................................................................................50 2.5.4. Modularity and design rules ........................................................................................51 2.6. Business to business services .........................................................................................57 6
  7. 7. 2.6.1. Design management .....................................................................................................58 2.6.2. Selection and evaluation of service providers...........................................................63 2.7. Network theories..............................................................................................................67 2.7.1. Social capital...................................................................................................................68 2.7.2. Institutions .....................................................................................................................70 2.7.3. Trust and relationships.................................................................................................72 3. Outsourcing as a process ........................................................................................................75 3.1. Introduction ......................................................................................................................75 3.2. Motives for outsourcing (why?) .....................................................................................78 3.2.1. Motives for NPD outsourcing....................................................................................81 3.3. Risks in NPD outsourcing (why not?) ..........................................................................85 3.4. Assessment ........................................................................................................................89 3.4.1. Identifying the objectives: three basic strategies ......................................................92 3.4.2. Determining process modularity ................................................................................96 3.4.3. Identifying the key value-added competences....................................................... 100 3.4.4. Assessment of implications of decision.................................................................. 107 3.5. Selection and negotiation ............................................................................................. 111 3.5.1. Information search and preliminary evaluation .................................................... 113 3.5.2. Request for proposals................................................................................................ 117 3.5.3. Shortlisting .................................................................................................................. 121 3.5.4. Selection and negotiation of relationship............................................................... 127 3.6. Execution and relationship management .................................................................. 135 3.6.1. Project transfer ........................................................................................................... 135 3.6.2. Project management .................................................................................................. 137 3.7. Lessons learned.............................................................................................................. 143 3.7.1. Renewal or termination of contract ........................................................................ 144 3.8. Master checklists for NPD outsourcing .................................................................... 146 4. Empirical survey .................................................................................................................... 154 4.1. Hypotheses ..................................................................................................................... 155 4.2. Survey design.................................................................................................................. 158 4.3. Operationalization of variables ................................................................................... 159 4.4. Survey execution and response rate............................................................................ 163 4.5. Results of the study....................................................................................................... 164 4.5.1. Background data ........................................................................................................ 167 4.5.2. Reliability and validity................................................................................................ 171 4.5.3. Hypothesis 1 ............................................................................................................... 172 4.5.4. Hypothesis 2 ............................................................................................................... 173 7
  8. 8. 4.5.5. Hypothesis 3................................................................................................................175 4.5.6. Hypothesis 4................................................................................................................178 4.5.7. Conclusions about hypotheses .................................................................................180 4.6. Other findings ................................................................................................................181 4.6.1. Differences in product development process ........................................................181 4.6.2. Obstacles to outsourcing NPD ................................................................................184 4.6.3. Reasons for outsourcing NPD .................................................................................186 4.6.4. Previous outsourcing and NPD outsourcing.........................................................187 4.7. Limits of generalization.................................................................................................191 5. Discussion and practical implications.................................................................................192 5.1. Impact on products and brands...................................................................................194 5.2. Impact on organizations ...............................................................................................196 5.3. Impact on business strategies.......................................................................................197 5.3.1. Offensive flexibility: shaping the marketplace .......................................................198 5.3.2. Opportunistic flexibility: real options approach ....................................................199 5.3.3. Defensive flexibility: contractors and crises ...........................................................200 5.4. Links to Open Innovation and crowdsourcing.........................................................202 5.5. Implications for service providers...............................................................................205 6. Conclusions.............................................................................................................................206 6.1. Directions for further research ....................................................................................207 7. References ...............................................................................................................................209 8. Appendices..............................................................................................................................223 8.1. Appendix A: Semi-structured interview protocol.....................................................223 8.2. Appendix B: Overview of outsourcing decision models .........................................225 8.3. Appendix C: The economics perspective...................................................................230 8.4. Appendix D: Baldridge criteria for core competences.............................................233 8.5. Appendix E: Discovery-driven planning....................................................................235 8.6. Appendix F: Bidder due diligence checklist...............................................................239 8.7. Appendix G: Key questions for a lean organization ................................................241 8.8. Appendix H: Empirical survey questionnaire............................................................247 8.9. Appendix I: E-mail invitation for the survey.............................................................259 8
  9. 9. List of figures Figure 1. Sony Ericsson Xperia smartphone - designed and built by HTC...................... 36 Figure 2. The positioning of the study, key theoretical areas, and research gaps............. 45 Figure 3. Four different cases of integration and internalization........................................ 55 Figure 4. Social capital and firm innovation........................................................................... 69 Figure 5. Losing competitiveness through outsourcing ....................................................... 88 Figure 6. How core competences create value. ................................................................... 101 Figure 7. Outsourcing options: make, buy or ally ...............................................................128 Figure 8. Outsourcing trade-off: flexibility need vs. control need.................................... 131 9
  10. 10. List of tables Table 1. Different types of outsourcing in terms of motives...............................................31 Table 2. Primary theoretical foundations for outsourcing. ..................................................42 Table 3. Primary research streams in outsourcing research. ................................................44 Table 4. Approaches used for selecting service providers....................................................66 Table 5. Motives for outsourcing .............................................................................................80 Table 6.. Primary motives for outsourcing NPD and their rationales................................84 Table 7. Activities modular enough to be considered for outsourcing at Widgets Ltd...99 Table 8. Preliminary division of core and non-core activities at Widgets Ltd................ 106 Table 9. Spotting strategic skills............................................................................................. 108 Table 10. Providers identified by Widget Ltd...................................................................... 116 Table 11. 'Hard' qualifications................................................................................................ 123 Table 12. 'Soft' qualifications. ................................................................................................ 124 Table 13. 'Pros' and 'Cons' of short-term versus long-term relationships in NPD....... 133 Table 14. Examples of measures of NPD quality, time, and cost.................................... 141 Table 15. Checklist for preliminary activities....................................................................... 147 Table 16. Checklist for identifying the objectives............................................................... 147 Table 17. Checklist for determining process modularity. .................................................. 147 Table 18. Checklist for identifying key competences. ........................................................ 148 Table 19. Checklist for assessing the strategic implications. ............................................. 148 Table 20. Checklist for information search and preliminary evaluation.......................... 149 Table 21. Checklist for request for proposals...................................................................... 150 Table 22. Checklist for shortlisting ....................................................................................... 150 Table 23. Checklist for selection and negotiation of relationship. ................................... 151 Table 24. Checklist for project transfer................................................................................ 152 Table 25. Checklist for project management....................................................................... 152 Table 26. Checklist for lessons learned. ............................................................................... 153 Table 27. Key figures of survey respondent firms/SBUs.................................................. 167 Table 28. Top three obstacles to outsourcing NPD. ......................................................... 184 Table 29. Five criteria for successful user innovation........................................................ 204 Table 30. Benefits and assumptions...................................................................................... 238 Table 31. Assumptions grouped with milestones form a task list.................................... 238 Table 32. Core competences checklist.................................................................................. 241 Table 33. Existing partnerships checklist............................................................................. 242 Table 34. Searching for new partners checklist................................................................... 242 Table 35. Negotiating a partnership deal checklist ............................................................. 243 Table 36. Implementing a partnership checklist ................................................................. 244 Table 37. Outsourcing partnerships checklist ..................................................................... 245 Table 38. Management disciplines for partnerships and outsourcing checklist............. 246 Table 39. Partnership culture checklist................................................................................. 246 Table 40. Technology enablers checklist.............................................................................. 246 10
  11. 11. List of diagrams Diagram 1. Classification of respondents by category........................................................165 Diagram 2. Extent of NPD outsourcing. .............................................................................166 Diagram 3. Firm/SBU personnel. .........................................................................................168 Diagram 4. Firm/SBU turnover, in millions €. ................................................................... 169 Diagram 5. Firms by field of business. .................................................................................170 Diagram 6. The effect of client-provider relationship on NPD outsourcing. ................173 Diagram 7. The effect of key technology maturity on NPD outsourcing.......................175 Diagram 8. The effect of firm size to NPD outsourcing...................................................177 Diagram 9. The effect of product life cycle to NPD outsourcing.................................... 179 Diagram 10. Different product development approaches.................................................183 Diagram 11. What of the following are obstacles to NPD outsourcing?........................185 Diagram 12. Reasons for outsourcing NPD........................................................................ 187 Diagram 13. The extent of previous outsourcing initiatives..............................................188 Diagram 14. Previous NPD outsourcing experience..........................................................189 Diagram 15. Why firms aren’t outsourcing NPD any longer............................................190 11
  12. 12. List of abbreviations AEI: Abductive Explanatory Inferentialism CEO: Chief Executive Officer GT: Grounded Theory IDT: Independent Design Team NDA: Non-disclosure agreement NPD: New product development ODM: Original Design Manufacturer OEM: Original Equipment Manufacturer RFP: Request for Proposals SBU: Strategic Business Unit 12
  13. 13. 1. Introduction New product development – the ability to identify the needs of customers and quickly create products that meet these needs at low cost - is widely recognized to be the mainstay of economic success of manufacturing firms (e.g. Hart, 1993; Wang and Ahmed, 2004; Ulrich & Eppinger, 2008). Without effective new product development, practically every firm will struggle and eventually fail in today’s heavily competed markets. To make matters worse, in most cases product development is a continuous race against time, budget, technology constraints, changing trends, shortening product lifetimes and, ultimately, competitors. Nevertheless, product innovation is the lifeblood of great companies. When conducted effectively, it blunts competitive pressures, raises internal growth potential and adds an aura of excellence (Teresko, 2008a) that helps to bring about a virtuous circle of continuous improvement. In recent years, increasing complexity has made product development far more expensive. At the same time, decreasing product lifetime has made rapid product development even more important than it used to be. Competitive advantages are fleeting and short-lived, and creating new competitive advantages necessitate more and more effective new product development. However, simply pouring more money into same product development processes as before faces the law of diminishing returns. Furthermore, many large companies have outgrown their internal ability to innovate fast enough to sustain investor- pleasing growth rates: a 70-billion euro firm seeking a 10% yearly growth needs to invent ways to make seven billion Euros more in what is already a competitive market (Huston and Nabil, 2006). New approaches are needed. In many cases, this means that firms sharing mutual interests - and sometimes even competitors - must learn to cooperate and network with each other, with other firms in the market, and with the customers that are ultimately buying their products. 13
  14. 14. More than perhaps any other function, new product development has traditionally been shrouded in secrecy. New product development is intimately tied with the key technologies and the strategy of the firm, and few firms want to share their secrets. Nevertheless, the challenges outlined above, as well as opportunities awaiting innovative companies, have spurred several firms to try out new and more open approaches to both new and traditional problems. What we have, as a result, is a dizzying variety of options available for product managers and CEOs in an uncertain, rapidly developing environment. From ‘traditional’ product development outsourcing - using consultants for tasks such as mechanical engineering or industrial design - to novel, Internet-enabled approaches such as Open Innovation (Chesbrough, 2003) and crowdsourcing (Howe, 2006), the range in both choice of partners and variety of options has exploded. The practice is collectively known as the ‘extended enterprise’ (Jagdev and Browne, 1998; Dyer, 2000). Firms across the globe and across the industries have entered short and long- term arrangements with other firms to acquire some aspects of product development they have deemed important for the firm’s long-term success. What is missing, on the other hand, are guidelines for choosing the right option. Outsourcing manufacturing and infrastructure functions, and related decision- making, have been discussed at length (for example, see Walker, 1988; Venkatesan, 1992; Quinn, 1994; Cánez et al. 2000; Jennings, 2002; Kakabadse and Kakabadse, 2002; Kumar and Eickhoff, 2005; Brannemo, 2006). Outsourcing has also been criticized for being dangerous to long-term innovativeness of the firm (for example, Tisdale, 1994; Chesbrough and Teece, 1996) and for being a product of management fads, internal politics and political ideologies (Hendry, 1995). Different approaches to ‘internal’ new product development processes have been comprehensively covered by a variety of authors (for just some examples, see Brown and Eisenhardt, 1995; Cooper, 2001; Ulrich and Eppinger, 2008). Researchers have also been active in trying to find the economic and managerial rationale for outsourcing innovation-related activities (some prominent examples 14
  15. 15. include Quinn, 2000; Chesbrough, 2003 and 2006; Hoetker, 2005; Love and Roper, 2005). Some of the drivers for outsourced product development have been identified (Calantone and Stanko, 2007) and even the make-or-buy decision in product development has been discussed, at least to some extent (Morin, 1999; Barragan et al. 2003). However, despite the fact that companies consider sourcing decisions as complex and tend to lack models supporting the decision process (Brannemo, 2006), so far there have been no studies that provide firms interested in outsourcing their product development tasks a prescriptive framework for dealing with issues such as what to outsource and to whom. Although providing a comprehensive framework for such a wide-ranging issue is beyond the scope of this thesis, this study attempts to partially rectify the situation by developing a prescriptive framework for choosing what to outsource, and to whom. 15
  16. 16. 1.1. The need for a framework This lack of knowledge has implications beyond product managers and product development teams. Any outsourcing decision should be viewed as a strategic decision that has potential long-term implications, but outsourcing product development, an activity central to the economic success and continuity of the firm, should be treated with extreme caution. Therefore, even a sketch of an unified framework on which to base the product development outsourcing decision-making should be useful to general managers, product and line managers, and product development teams. As Kakabadse and Kakabadse (2003, 61) conclude, ‘…unless top management has a clear view for both the strategic pathways to pursue and the contribution of outsourcing in determining the shape and nature of their organization, outsourcing may well be transactionally competently handled, but still not achieve the desired outcomes.’ Although firms that routinely outsource product development often have their own frameworks and procedures, to date no general model has been published. As especially smaller firms may lack the resources to develop such models, this study should be especially helpful to managers in smaller companies and business units that are considering their options, but do not know how to proceed. Furthermore, without a careful consideration of the future needs of the firm, outsourcing critical functions piece by piece - ‘outsourcing creep’ - can spell disaster in the long term. This is a real danger, given the fact that today many manufacturers have expanded their businesses by providing design services for their clients (Schweber, 2003). This can make it all too easy for stressed managers to make decisions with potentially disastrous consequences for the long-term competitiveness of the firm. 16
  17. 17. The absence of a structured framework affects suppliers of product development services, too. Without knowledge of the factors that should be considered when a client outsources a product development task, providers and their clients, run the risk of committing mistakes that can have serious consequences to the success of the project. Ultimately, this means reduced client satisfaction and damage to the provider’s reputation and prospects of repeat business. Of course, having - and using - a framework does not eliminate the risk. Frameworks can only help the involved parties avoid some most common mistakes. A framework can also help stimulate the thinking about the entire process, and raise awareness about importance of involving different functional areas of the firm in the outsourcing decision. As Ulrich and Eppinger (2008, 7) note, structured methods 1) make the decision process explicit and allow everyone on the team understand the decision rationale, reducing the possibility of moving forward with unsupported decisions (again, helping to avoid the ‘outsourcing creep’), 2) act as a ‘checklist’ of the key steps, and 3) are largely self-documenting for future reference, evaluation and education. In fact, previous research has found structure and documentation being virtual prerequisites for successful decision-making in production outsourcing projects (Cánez et al., 2000). Of these, of particular importance is the role a structured process has in the continuous development of the firm. Without a documented process, development efforts grind to a halt. Even some hypothesis and a process is usually better than none, and the process described in this thesis should serve as a basis for more detailed framework which can then be customized to fit the specific needs of a firm. 17
  18. 18. 1.2. Research questions The research questions of this thesis can be stated as follows: To produce a decision-making aid and guidelines for outsourcing product development activities to external product development consultancies, especially 1) How to determine what functions or products could be outsourced to a specific service provider? 2) What features make a product or a function so essential to the firm that know- how to develop it must be kept within the company and cannot be outsourced? 18
  19. 19. 1.3. The purpose and the outline of the thesis Focusing on core competencies while outsourcing the peripheral functions is becoming more and more important, not to mention attractive, to firms in hypercompetitive markets. However, as stated in the Introduction, increased outsourcing may easily backfire. In particular, valuable competencies can be lost. On the other hand, equally valuable opportunities may be lost if the firm hesitates to make a decision. In new product development (NPD) settings, the choice is often between starting a project with external help, or drastically reducing its scope to fit it into busy schedules of internal NPD staff. Unprepared, both decisions can be harmful to the firm. But how to make sense of the subject? How to build a ‘mental model’ of NPD outsourcing, when existing research on NPD outsourcing is fragmentary and limited? What’s more, due to interdisciplinary nature of the phenomenon (see e.g. Hoetker, 2005; Hätönen, 2008), simply re-using old outsourcing frameworks may easily result to misleading conclusions. A framework based on one discipline – say, cost-minimizing, transactional outsourcing of easily standardized component parts of the final product1 – is not just inadequate for NPD outsourcing; at worst, it can be outright harmful to the firm. This thesis tries to address the issue of NPD outsourcing based on most relevant disciplines and help managers build a mental model of what NPD outsourcing is about. Developing this mental model requires some background in phenomena related to the subject, such as social capital. As a result, this thesis should be treated more as a literature review and a sketch on the subject rather than a definitive study. It is hoped by the author that this review helps firms struggling with the question of outsourcing their core competencies to make some sense of the subject – at least as far as new product development is concerned. 1 That is, the ‘traditional’ view of outsourcing as utilized in manufacturing industries. 19
  20. 20. The outline of the thesis is as follows: after a discussion of research methodology and defining the terms used, the historical context of the thesis is briefly sketched out by short histories of outsourcing in general and outsourced innovation in particular. These, in turn, build foundations for short treatise on theories underpinning outsourcing research. Research streams used in the thesis are identified and briefly outlined. The arguments from theory are then introduced. The thesis also includes an empirical research on NPD outsourcing in Finnish export business. The study aims to map the extent of phenomenon, as well as highlighting challenges inherent in the field. A number of hypotheses are developed from foreign literature, and are tested against empirical data. Finally, the thesis includes a brief discussion on phenomena. Practical implications are identified and presented. Discussion is based on literature review, empirical research, and semi-structured interviews with various managers and other personnel with experience in NPD outsourcing. 20
  21. 21. 1.4. Research methodology A challenge that both inspired and shaped this thesis was lack of available data on the new product development outsourcing. Although prominent authors (e.g. Hagel and Singer, 1999; Quinn, 2000; Rifkin, 2000; Friedman, 2005) have been declaring the 2000s as the age when even core competences can and should be considered for outsourcing, the phenomenon of outsourcing new product development is still far from widespread. In addition, several journalists and researchers (e.g. Engardio et al., 2005; Carson, 2007; Calantone and Stanko, 2007) have noted that even firms that practice NPD outsourcing are often reluctant to talk openly about the subject. Both of these difficulties were encountered during the research. Nevertheless, the growing strategic importance of the subject became very clear from nearly every interview of NPD professionals conducted by the author. Since the subject was considered important but hard data – especially from Finnish firms – was difficult to come by, the research relied heavily on literature, secondary data, and semi- structured interviews and other discussions with professionals from various fields. As outsourcing and new product development are in themselves broad subject areas, understanding a phenomena as complex as NPD outsourcing by using a single theoretical framework or only through qualitative or quantitative studies and surveys would almost certainly lead to an oversimplified analysis. As stated above, several authors (e.g. Hoetker, 2005; Hätönen, 2008) argue for an interdisciplinary approach to the phenomenon. As a result, the research approach used in this thesis is a generation of theory from various forms of data and various theoretical backgrounds. The author recognizes that this approach results to a relatively lengthy thesis; however, it is felt that the breadth is necessary for explaining the outsourcing phenomenon. The data has been primarily qualitative, but quantitative data (e.g. Holopainen and Järvinen, 2006) has also been used where appropriate. Of special importance have been in-depth interviews of NPD professionals from companies A 21
  22. 22. and B2, whose comments helped to shape especially the final revision of this text. The insights from the interviews are attributed in the text as Firm A interviews (2008) or Firm B interviews (2008), respectively. These interviews were conducted according to semi-structured interview protocol outlined by Bryman and Bell (2007, 474) and detailed in Appendix A. In addition, a survey of 60 Finnish export-oriented firms was conducted as a preliminary to the study to determine the extent of the phenomena in Finland. This study, its methodology, and results are detailed in Chapter 4. Although this thesis has been structured according to a standard theory-hypothesis- test model, in reality the research has gone iteratively back and forth as new data, literature, and ideas have emerged. Of course, this is what most researchers do anyway: it is simple common sense to retrospectively formulate new hypotheses to fit the data during the research process. Where this thesis differs is that hypotheses were deliberately formed late in the research process, instead of picking a hypothesis based on limited research and trying to prove or disprove it in some manner. The latter is an example of ‘hypothetico-deductive orthodoxy’ (Haig, 1995) that may cause researchers to be perhaps too concerned about empirical adequacy and testability of their theories (Haig, 1995). In Master’s theses read by the author in preparation to this research, this has sometimes led to low-content, underdeveloped theories being prematurely tested with empirical methods. It is the opinion of philosophers of science Thagard (1992) and Haig (1995), and also of this author, that in social sciences - business research included – the focus should be on establishing theory’s explanatory coherence. Explanatory coherence means, in short, that theories developed should have more explanatory breath than previous theories, be as simple as possible in terms of special assumptions made, and be supported by analogies to theories that scientists already find credible (Thagard, 1992; Haig, 1995). 2 The names and details of participating companies and the interviewees have been obscured for reasons of confidentiality. 22
  23. 23. The research approach of this thesis resembles, but does not entirely follow, so- called ‘grounded theory’ methodology (Glaser and Strauss, 1967; Glaser, 1978; Strauss, 1987; Strauss and Corbin, 1990; Glaser, 1992). Grounded theory (GT) contradicts the traditional model of research, where the researcher chooses a theoretical framework, and only then applies the model to the studied phenomenon. The research principle behind GT is neither inductive nor deductive, but combines both in a way of abductive reasoning (Glaser, 1998; see also Kantorovich, 1993). This leads to an iterative research practice where data sampling, data analysis and theory development are not seen as distinct and separate, but as steps to be repeated until one can describe and explain the phenomenon that is to be researched, and new data does not change the emerging theory anymore. As the goal in grounded theory is to generate concepts that explain people’s actions regardless of time and place, instead of accurately describing the events or ‘proving’ a hypothesis, it is particularly suitable for generating aforementioned ‘mental models’ and frameworks to help decision-makers do better decisions. Where this thesis differs from ‘pure’ grounded theory approaches is in details and some practices of research. Grounded theory expects the researcher to start with as few preconceptions as possible (Glaser, 1992) and, for example, start with research, not with literature review. Grounded theory also demands more systematic coding of research data than was actually practiced during this research, although given this text’s highly iterative creation process3 the end results might not have been very different. Nevertheless, simply because the author came into contact with grounded theory methodology only late in his research, this study cannot be said to follow the ‘textbook’ grounded theory approach, and fits better with a more general account of scientific method called ‘abductive explanatory inferentialism’ or AEI (Haig, 1995). This means that the theory is generated heuristically, or abductively (Kantorovich, 3 11 substantial revisions with a total of nearly 850 pages, some 250 pages of notes, and nearly 500 references. 23
  24. 24. 1993), and is appraised in terms of what philosophers have come to call inference to the best explanation (Haig, 1995), i.e. whether the theory provides a better explanation of the evidence than its rivals. Thus, it is a hope of the author that this study be evaluated on its explanatory coherence, rather than methodological purity. 24
  25. 25. 1.5. Definitions Evolution of practice and theory over the last decades has caused researchers, managers and trade press to use often inconsistent and sometimes contradictory terms for many activities that fall under the outsourcing paradigm. For this reason, this section seeks to define the important terms used in the study. Most of the terminology follows current practice in electronics industry (see Schweber, 2003), with some additions from general outsourcing research (e.g. Gilley and Rasheed, 2000). 1.5.1. Outsourcing Generally, past studies about outsourcing have defined outsourcing so broadly that it can include virtually any good or service that an organization procures from outside firms (Gilley and Rasheed, 2000, 764). A narrow definition of outsourcing covers only situations where the ownership of an activity is transferred by divesting previously internal functions or processes4. However, for reasons of clarity and simplicity this thesis uses a broader definition that also includes other long-term contracts that seek to buy capabilities that the firm needs, even if the firm didn’t originally produce that capability5. Therefore, activities that are considered as outsourcing in this thesis include capability sourcing (e.g. Godfredsson et al., 2005) and strategic procurement (Venkatesan, 1992). A prudent choice is to use definitions that fit the phenomena under study. As this thesis deals mostly with outsourced R&D services, with the exception of cases where the NPD service provider also manufactures the final products (so-called Original 4 ‘Outsourcing through substitution’ (Gilley and Rasheed, 2000, 764). 5 ‘Outsourcing through abstention’ (Gilley and Rasheed, 2000, 765). 25
  26. 26. Design Manufacturing), definition of the word ‘outsourcing’ used in this thesis is purchasing any capabilities, activities, processes or functions from outside the company as a part of the new product development process. 1.5.2. Offshoring An important differentiation is between outsourcing and offshoring, i.e. transferring jobs to low-cost countries in order to take advantage of cheaper labour (so-called labour arbitrage). Outsourcing may involve offshoring, but offshoring can also take place within the company, without involving any outside suppliers. As location decision is beyond the scope of this thesis, the text does not explicitly make a distinction between in- and offshored activities. 1.5.3. Product A product is something sold by an enterprise to its customers (Ulrich & Eppinger, 2008, 2). Today, this increasingly refers to a mix of physical products, software, and services - collectively known as the offering - but for reasons of clarity, the word product is used throughout this text. Although the focus of this text is on engineered, discrete, and physical products, most of the methods and findings are broadly applicable to development of services or software (however, for software NPD outsourcing, see Hätönen, 2008). 26
  27. 27. 1.5.4. Product development Product development is the set of activities beginning with the perception of market opportunity and ending in the production, sale, delivery (Sheldon, 2004; Ulrich & Eppinger, 2008, 2) and ultimate re-use or disposal (see McDonough & Baumgard, 2005) of the product. For the purposes of this thesis, product development is defined to include the following phases (Ulrich & Eppinger, 2008, 9): 1) Planning 2) Concept development 3) System-level design 4) Detail design 5) Testing and refinement 6) Production ramp-up Reader may note that these phases correspond roughly to the famous and often- used ‘Stage-Gate™’ model of product development and management (Cooper, 1992). However, since this thesis is more concerned with sourcing the individual tasks and sub-processes included in a product development process, rather than the management of the entire process, Ulrich and Eppinger’s generic model is used as a framework. 1.5.5. Product development outsourcing Product development outsourcing, or NPD outsourcing, refers to product development activities performed by an external provider. In practice, product development outsourcing can be anything from buying ‘turnkey’ designs and 27
  28. 28. manufacturing from external sources, to engaging a consultant to design a particular component or perform e.g. industrial design for the product. 1.5.6. Client The word ‘client’ in this thesis refers to a person or organization that is purchasing product development services, i.e. the customer for those services. 1.5.7. Provider In this thesis, the term ‘provider’ refers to a person or organization supplying product development services to a client. ‘Provider’ can also refer to a network of providers working collaboratively or competitively, as is the case in open innovation (Chesbrough, 2003) and crowdsourcing (Howe, 2006), respectively. These networks include, but are not limited to: 1) suppliers, 2) supplier’s suppliers, 3) distributors, 4) franchisees, 5) other middlemen, 6) customers, 7) customer’s customers, and other specialized resources such as university professors and consultants (Peters, 1992, 310). 1.5.8. Original Equipment Manufacturer (OEM) Original Equipment Manufacturer is a term that has, in practice, been used to refer to very different and even contradictory business practices6. The definition used in this thesis is that an OEM is a company that gains most of their profit from either manufacturing its own products or purchasing products or components from another company and reselling the products or components with the purchasing 6 The term ‘OEM’ is sometimes used to refer to firms that make products for others to brand and sell; in this thesis, this practice is called Original Design Manufacturing (ODM). 28
  29. 29. company’s name or logo on them. Thus, OEMs are clients for ODMs. Today, many OEMs are primarily product definers and marketers, leaving manufacturing and sometimes detailed design to ODMs and contract manufacturers. (Schweber, 2003, 68) 1.5.9. Original Design Manufacturer (ODM) Original Design Manufacturers are companies that design and build products for marketing under another company’s brand and usually own the intellectual property rights of the product, in contrast to simple contract manufacturers who manufacture products designed by their clients. The clients of ODMs include Original Equipment Manufacturers (OEMs) and other brand-name organizations such as large retail chains or mobile telephone operators. It is important to note that the distinction between ODM and OEM is rather flexible, especially as many ODMs are in a track for becoming branded OEMs in their own right (see e.g. Engardio et al., 2005). For the purposes of this thesis, a company is considered an ODM if most of their profit comes from ODM activities. (Schweber, 2003, 68) 1.5.10. Independent Design Team (IDT) IDT’s are vendors that provide for-hire design services and are capable of doing most if not all of the new product development process by themselves. In some cases, IDTs can have manufacturing capabilities (at least in limited amounts, such as for trial runs and prototyping) but they expect to make most of their profit from design rather than manufacturing phase. (Schweber, 2003, 68) 29
  30. 30. 2. NPD outsourcing in theory The world can doubtless never be well known by theory: practice is absolutely necessary: but surely it is of great use to a young man, before he sets out for that country, full of mazes, windings, and turnings, to have at least a general map of it, made by some experienced traveller. Lord Chesterfield (1694-1773), a British statesman. This first part of the thesis aims to explain the theoretical and historical background for outsourcing phenomenon. To a large extent, the theoretical position of this thesis falls between several different but – to some extent – overlapping research traditions. This is largely because the complex and extensive nature of outsourcing phenomenon encourages the adoption of a highly interdisciplinary perspective (see also Hätönen, 2008, 35-37; and Hoetker, 2005). In fact, it could be argued that outsourcing, and particularly innovation outsourcing, cannot be fully understood from just one theoretical position alone. Understanding outsourcing requires also an understanding of historical developments that have made outsourcing first an attractive option for cutting costs, and later a viable way of acquiring competencies and transforming the organization in the ‘age of access’ (Rifkin, 2000): a world where ownership of activities matters less than access to world-class competencies. Both in practice and in theory, outsourcing has proceeded through several distinct phases. Hätönen (2008, 19 and 69) identified three distinct phases of outsourcing, which he dubs ‘big bang’ of outsourcing (1980s to early 1990s, with focus on cost cutting), ‘bandwagon’ (early 1990s to early 2000s; focus on cost cutting and capability enhancement) and ‘barrierless organization’ (from the early 2000s onwards; focus on organizational transformation). These phases are summarized in Table 1. 30
  31. 31. Table 1. Different types of outsourcing in terms of motives. Adapted from Hätönen (2008, 19 and 69) Type Definition Examples of motives Emerged Transactional Outsourcing aimed directly Reduce costs Big bang: outsourcing at cutting and reducing Cost discipline/control 1980s-early operational costs Lower operational costs 1990s Resource-seeking Outsourcing primarily aimed Aim to achieve and acquire best Bandwagon: outsourcing at acquiring resources practices early 1990s to and/or capabilities that are Improve service quality early 2000s unavailable, inadequate or Access to new technology and insufficient internally skills Lack of expertise in-house Access to a flexible workforce Transformational Outsourcing aimed at Focus on core Barrierless outsourcing transforming the competencies/activities organization: organization into a more Improve business from the early dynamic, efficient, and more focus/internal reorganization 2000s focused economic unit Flexibility onwards Free up internal resources Accelerate projects In the following sections, these historical and theoretical developments are briefly outlined. First, a brief history of outsourcing in general is presented, followed by a discussion of history of innovation outsourcing. After this introduction, theory base underpinning outsourcing and innovation outsourcing research is reviewed and examined. Theories and research streams used in this thesis are also selected and outlined. 31
  32. 32. 2.1. A brief history of outsourcing There are very few new things under the sun. In practice, outsourcing traces its roots to Roman tax collectors who were sold rights for collecting taxes (Kakabadse and Kakabadse, 2000), and outsourcing as a theoretical phenomena has been around at least since the publication of Adam Smith’s famous thesis Wealth of the Nations (1776), where Smith argued that the specialization of labour would bring benefits to all. In the early 1900’s, both industrial practice and management theory argued for vertically integrated and self-sufficient firms in a belief that size and vertical integration were an advantage to a firm (Greaver, 1998, 77). This was challenged during the 1950’s when outsourcing was first suggested as a corporate strategy (Quinn and Hilmer, 1994). Since the late 1960’s, as the average size of industrial firms has decreased, outsourcing has been rising in importance. The importance of outsourcing has risen dramatically after the communications revolution of early 1990’s provided companies with ways to communicate even with far-flung suppliers and made outsourcing a viable strategy not just for cutting costs, but also for seeking value- adding skills, competences, and knowledge outside the organization (e.g. Quinn and Hilmer, 1994; Kakabadse & Kakabadse, 2000; Kakabadse & Kakabadse, 2005). This ‘strategic outsourcing’ (e.g. Quinn and Hilmer, 1994; Alexander, 1996a) involved more strategic functions and encouraged firms to build closer relationships with their vendors as arms-length, cost-minimizing approaches to relationship management became insufficient. Increased knowledge and practice in outsourcing led organizations to outsource many activities traditionally carried out in-house. By the end of the 1990s, outsourcing had become a standard operating procedure in nearly all industries (Hätönen, 2008, 18). Because standard operating procedures cannot provide competitive differentiation, during the 1990s outsourcing moved on from focusing primarily from divesting the peripheral, non-core activities of the business - such as 32
  33. 33. cleaning, catering and site security - in order to focus on ‘core’ businesses (Prahalad & Hamel, 1990; Kakabadse & Kakabadse, 2005) towards more critical areas such as design, manufacture, marketing, distribution and information systems (e.g. Jennings, 1997; Quélin and Duhamel, 2003, Gottfredson et al., 2005; Carson, 2007). Outsourcing previously internal activities is possible, because in an increasingly integrated world economy, there is no longer such a need to ensure reliable suppliers of raw materials such as iron and oil. In addition, uncertainties due to limited communications capabilities have diminished and communication in general has become ubiquitous; and, perhaps most importantly, brainpower, not raw material, is the source of most value added (Peters, 1992, 305). As the pace of change in every business is accelerating, business leaders have noted that leveraging the skills, contacts, and expertise of a network enables firms to grow much faster than they would by just internal growth and competency development (von Ghygzy et al., 2002). This, in turn, has attracted investors who have come to reward focus and innovation over size and diversity (Greaver, 1998, 77). The end result has been an explosion of outsourcing across industries as diverse as aerospace, automobiles, chemicals, computers, electronics, energy systems, financial services, healthcare, software, and telecommunications (e.g. Quinn, 2000; Dahan and Hauser, 2002; Carson, 2007). As a result, our current hypercompetitive economic system could be referred to as an outsourcing economy, given the increased focus on core organizational activities and the simultaneous leveraging of assets not controlled by the firm (Hätönen, 2008, 15). Formally, the discussion about outsourcing is a discussion about vertical integration of the firm. As scholars such as Hayes et al. (2005) have noted, the advice on what actually is the optimum vertical integration strategy has been changing with the times. For example, Hayes et al. (2005, 116) note that ‘In the mid-1980s, BusinessWeek, for example, warned from dire consequences that would result from extensive outsourcing and even coined the pejorative term ‘hollow corporations’ to 33
  34. 34. describe companies that possessed no manufacturing capabilities of their own. But in a more recent article the same magazine trumpeted the virtues of outsourcing and argued, ‘The effect on innovation could be huge…’’ In fact, it was BusinessWeek’s Pete Engardio who first coined the term ‘transformational outsourcing,’ (Engardio, 2006) referring to strategies that aim to create radically new business models that can change the game in a firm’s industry. In this view, the future competitive edge is seen to lie in flexibility achieved through a tight operational focus and the leveraging of external core competences outside of this focus area (e.g. Quinn, 1999). As rapid change across industries makes core competences only temporal, coping in the new economy requires firms to constantly refine and modify their existing pools of knowledge, skills, and resources. Fine et al. (2002) even suggest that a firm’s real value-creating competency, and perhaps the only sustainable one, might be its ability to continuously restructure its value chain. This leads to outsourcing more and more critical and knowledge- intensive business components, often in close cooperation with the provider (Hätönen, 2008, 19). The key management challenges lie in recognizing the key competence areas, creating a flexible organization that focuses on value-creating competences, finding providers to provide the value to the rest of the operations, and managing the resulting global network of providers (Hätönen, 2008, 16-19). In parallel with the new challenges, this industrial fragmentation also offers firms various opportunities. 34
  35. 35. 2.2. NPD outsourcing as a phenomenon Today, the focus of outsourcing activities has moved from ‘simple’ activities upwards in the value chain, towards more knowledge-intensive activities (e.g. Jennings, 1997; Quinn, 2000; Chesbrough, 2003; Quelin and Duhamel, 2003; Brannemo, 2006; Salminen, 2008; Hätönen, 2008). Even though manufacturing firms have long outsourced much of actual manufacturing of their products or components, most have insisted that all the important research and development work would remain in-house. As common wisdom and anecdotal evidence point out that ability to develop new products can be accidentally lost by ‘hollowing out’ the firm through outsourcing all production (Tisdale, 1994; Chesbrough and Teece, 1996; Hayes et al., 2005), outsourcing product development deliberately has been viewed with some suspicion. Nevertheless, considerable empirical evidence exists of the value of utilizing external resources for promoting new product development (e.g. Freeman, 1991; Karlsson, 1997; Koschatzky, 1998; Oerlemans et al., 1998; Love and Roper, 1999, Hätönen, 2008), and the use of outside consultants for product development has, for years, been routine in many if not most firms. Beginning with industrial design outsourcing in the 1980s and 1990s, the increasing complexity of products and their shorter life-cycles demanded expertise from a range of different sources, while the use of technology (i.e. CAD/CAM, embedded systems, etc.) in the design process facilitated a change in practice that increased the opportunities for changing organizational forms (Bruce and Morris, 1998). In short time, outsourcing has dramatically altered new product development in various industries where product development has come to be viewed fundamentally as a function dispersed across collaborating firms (Quinn, 2000; Dahan and Hauser, 2002). This decomposition of production activities from each other and from design (Ulrich and Ellison, 2005; Carson, 2007) has created market opportunities for several large and small firms, causing a shift towards buyers’ markets where firms of all sizes in nearly all 35
  36. 36. industries can capitalize on their external sources of knowledge and capabilities (Hätönen, 2008, 16). With services ranging from specialist expertise provided by design and engineering consultancies to so-called original design manufacturers (ODMs) who market complete, manufacturing-ready and rebrandable designs, these providers are playing an increasingly important part in the global economy. For example, in 2005, estimated 70% of PDAs, 65% of notebook PCs and MP3 players, 30% of digital cameras and 20% of mobile phones were designed either completely or at least significantly by ODMs and sold under other, better-known brand names (Engardio and Einhorn, 2005). Examples from less high-technology industries such as Procter and Gamble7 suggest that a trend towards greater outsourcing is not confined to high-tech consumer electronics. Figure 1. Sony Ericsson Xperia smartphone - designed and built by HTC. (Photo credit: Sony Ericsson) 7 Procter and Gamble’s ‘Connect and Develop’ Open Innovation initiative aims to source 50% of its new products from outside the company; see e.g. Nambisan (2007). 36
  37. 37. As technologies mature, the borderline between mission-critical and commodity R&D is sliding year by year. As a result, NPD outsourcing has been steadily on rise for the last two decades (Roberts, 1995; Duga and Studt, 2005; National Science Foundation, 2005). Firms are increasingly turning to their providers for complete turn-key solutions, as even co-design with help from outside specialists is becoming too difficult, expensive, or slow. For their part, providers are hungry to expand the scale and scope of their services, so that parts suppliers build up capabilities in design, and (more rarely) design firms claim stakes in manufacturing. In other cases, firms turn to outsiders for big ideas, and then turn those concepts into actual products8. The fine line between NPD services and other business services is further blurred by developments where brand-building agencies have employed product designers and even engineers to help them build entire customer experiences for their clients, from establishing the brand identity to delivering products that follow and enhance that identity (e.g. Alviani, 2008; Merholz et al., 2008). When all goes well, these developments have resulted to impressive increases of productivity. Through adroit use of outsourcing and new information technologies, firms have been able to reduce their time to market for new innovations by as much as 60 to 90 %, decrease their investments by similar amounts, and radically increase the value added from innovation (Quinn, 1994, 2000; Narula, 2001; Harland et al., 2005). It is no wonder that, according to a preliminary investigation by Calantone and Stanko (2007), there appears to be consensus among researchers and managers that outsourcing of innovation-related activities is here to stay, and that it could conceivably become extremely important in the future. However, firms still need to guard some sustainable competitive advantage, whether it’s control over the latest technologies, the look and feel of new products, or the customer relationship (Engardio and Einhorn, 2005) or risk being surpassed in the marketplace. 8 For one example, see Helm (2007). 37
  38. 38. In practical terms, NPD outsourcing happens on two levels. Firms either purchase specialist expertise needed for a certain task from outside providers acting as consultants to the NPD process9, or they define the required product features and completely or nearly completely outsource the actual design work. Whether and how much firms work with these independent design teams or original design manufacturers during the process depends on the nature of the project and the firm’s strategy. Some product definers are actively involved in the externalized design process, while others prefer a hands-off approach. A borderline case that can also be counted as NPD outsourcing is when firms create designs themselves but work collaboratively with outsourced manufacturer to refine the design’s manufacturability. As contract manufacturers are eager to capture a greater share of the value in NPD process, this has increased to a point where most manufacturers offer some kind of manufacturing ramp-up or design services. 9 Examples include market research, industrial design, mechanical engineering etc. 38
  39. 39. 2.3. Theory base: outsourcing and outsourced innovation Research on using markets to conduct transactions previously conducted in-house dates back to 1970’s (e.g. Williamson, 1975), with the first mention of the concept ‘outsourcing’ occurring in the mid-1980s10. Initially, research focus was on transaction cost economics (Williamson, 1975; Coase, 1937), which suggest that transactions should be organized within a firm when the cost of doing this was lower than the cost of using the market. Since then, research has expanded to other fields and become interdisciplinary in nature (Hoetker, 2005). Hui and Beath (2001) analyzed 143 studies on outsourcing and identified four main theoretical bases underpinning outsourcing research: 1) Transaction cost economics, 2) Other economic theories such as agency theory and production cost economics, 3) The resource-based view of the firm, and 4) Social-exchange/trust/relationship theories. Research on outsourced innovation, in contrast, remained for long a province of historians of technology. Before the 1980s and the rise of computer start-ups and specialized design agencies, typical examples of outsourced innovation were 19th century independent inventors who sold their inventions to burgeoning industries of the time (Howells, 1999). As a research concept, outsourcing NPD activities became under discussion after the initial wave of transactional outsourcing (see Nyström, 1985). However, research in outsourced innovation really took off only in the late 1990s. Of particular importance to the topic was the publication of articles and books on open innovation (Chesbrough, 2003, 2006). The idea behind open innovation is that in 10 According to Hätönen (2008, 39), the concept was first used by Pastin and Harrison (1987). 39
  40. 40. a world of widely distributed knowledge, firms cannot rely entirely on their own research, but should instead buy or license innovations from other firms while simultaneously using outsiders to help commercialize innovations that are developed in-house but don’t fit the firm’s business model. The similarities to historical examples discussed above (Howells, 1999) are readily apparent, although Chesbrough (2003) goes beyond simple licensing of external inventions by stating that firms should also out-license technologies they don’t see as attractive to commercialize by themselves. More recently, crowdsourcing, or outsourcing design problems to the public rather than to another organization (Howe, 2006; Tapscott and Williams, 2006) has attracted both attention and criticism in the business press. Again, this practice has deep historical roots in various prizes awarded for solving some particularly important problem, for example the 1714 ‘longitude prize’ offered by the British government to anyone who could solve the problem of time-keeping at sea. Such practices have continued to the present day; some prominent examples are DARPA Grand Challenges and Ansari X-Prizes, both intended to stimulate innovation by giving inventors an incentive to develop radical new solutions. Compared to other types of outsourcing, the relative lack of research on NPD outsourcing is partly due to the problem lamented in several of the studies about NPD outsourcing: the difficulty of getting hard data on the phenomena due to NPD’s sensitive role and the importance of confidential personal relationships (e.g. Engardio et al., 2005; Carson, 2007; Calantone and Stanko, 2007). Some data exists in form of industry surveys and benchmarking studies (e.g. Roberts, 1995; Love and Roper, 1999, 2004; Sobrero and Roberts, 2001; Howley, 2002; Duga and Studt, 2005; National Science Foundation, 2005; Holopainen and Järvinen, 2006, among others), and an abundance of less academic accounts such as trade press articles, case studies and books on NPD outsourcing can be found (e.g. Engardio et al., 2005; Huston and Sakkab, 2006; Tapscott and Williams, 2006; Helms, 2007; Alviani, 2008; Brown, 2008; Neumeier, 2008). The latter often include ‘how-to’ guides about best practices when outsourcing NPD activities. 40
  41. 41. Nevertheless, research literature has approached R&D sourcing and innovation outsourcing from a variety of theoretical bases, including knowledge flows (e.g. Tarun et al, 1998), location and industry clusters (e.g. Koschatzky, 1998), transaction cost economics (e.g. Love and Roper, 1999; Ulrich and Ellison, 2005; Calantone and Stanko, 2007) industry networks (e.g. Powell, 1998; Hagel and Singer, 1999; Zirpoli and Caputo, 2002; Baloh et al., 2008), Calantone and Stanko, 2007), resource-based view of the firm (e.g. Quinn, 2000), and intellectual property rights (e.g. Love and Roper, 2004; Hoecht and Trott, 2006). Outsourcing industrial design – often a precursor for more comprehensive NPD outsourcing – has also been discussed at length (e.g. Bruce and Morris, 1998; Best, 2006). One of the latest additions to literature discusses outsourced innovation in terms of real options (Vanhaverbeke et al., 2008), or small, initial investments that help firms deal with uncertainties by buying ‘options’ to new ideas or technologies, thus increasing their flexibility11. Hoetker (2005), discussing the problems of identifying a manufacturer for technically innovative components, identified three relevant research bases for analyzing component development and manufacturing relationships. These are 1) Transaction cost economics (e.g. Williamson, 1975), 2) Firm capabilities (e.g. Barney, 1991; Winter, 1987). 3) Inter-firm relationships (e.g. Gulati, 1995; Uzzi, 1996) In summary, Table 2 presents main theoretical foundations for outsourcing research. As can be seen from the Table, this thesis is based primarily on the resource-based view of the firm and on social exchange/trust/inter-firm relationship theories. As NPD outsourcing is only rarely about cutting the costs, transaction costs and other economic theories are not as relevant to the thesis as they would be in more transactional outsourcing. 11 For an overview of real options approach and how it helps firms increase their flexibility and cope with uncertainty, see e.g. Kogut and Kulatilaka (2003). 41
  42. 42. Table 2. Primary theoretical foundations for outsourcing and innovation outsourcing. Research bases for Research bases for R&D Research bases outsourcing (Hui and relationships (Hoetker, 2005; primarily used in this Beath, 2001) Hoecht and Trott, 2006) thesis 1. Transaction cost economics 2. Other economic theories 1. Transaction cost economics 1. The resource-based (agency theory, production cost 2. The resource-based view of the view of the firm (firm economics) firm (firm capabilities) capabilities) 3. The resource-based view of 3. Social exchange/trust/relationship 2. Social exchange/trust/ the firm theories relationship theories 4. Social 4. Intellectual property rights exchange/trust/relationship theories 42
  43. 43. 2.4. Key research streams and positioning of the study Both Hätönen (2008) and Hoetker (2005) argue that to understand the trade-offs involved in outsourcing decisions, multiple viewpoints and multiple theories should be integrated. Hätönen (2008, 43) went on to identify four discipline-based research streams on outsourcing in general (Table 3). However, in contrast with Hätönen’s work on software NPD outsourcing in small firms, this thesis deals primarily with discrete, engineered goods and their design and development. Additionally, this thesis does not cover the location decision (in-shore or off-shore) and therefore lacks the explicit international business aspect. On the other hand, this thesis argues that the role of relationships and relationship management, specific features of service businesses, and the role social capital plays in the process have been undervalued by previous research. Therefore, relevant research streams for this thesis include strategic management, service businesses, and social capital, including institutions12. In addition, the author argues that research on external design services can provide insights into the practice and future of NPD outsourcing. (Table 3) 12As defined by Akerlof (1970) and Holmström (1985); i.e. mechanisms and organizations that provide clients with more complete information in regard to services purchased. 43
  44. 44. Table 3. Primary research streams in outsourcing research, and those used in this thesis. Research streams on Primary research Key theoretical areas used in this outsourcing streams used in thesis and an example of sources (Hätönen, 2008, 43) this thesis 1. Make-or-buy decision making (e.g. de Boer, 2006) 1. Strategic management 2. Outsourcing core competencies (e.g. 2. Supply chains 1. Strategic Gottfredson et al., 2005) 3. International business management 3. New product development (e.g. Ulrich and 4. Information systems Eppinger, 2008) /technology 4. Modularity (e.g. Baldwin and Clark, 1997) and design rules (Ulrich and Ellison, 2005) 1. Selection and evaluation of service providers (e.g. Gallouj, 1997) 2. Service business 2. Design management (e.g. Bruce and Morris, 1998) 1. Trust/relationship and innovation (e.g. Mu 3. Social capital et al., 2008) 2. Institutions (e.g. Holmström, 1985) The positioning of the study and its key theoretical areas are introduced graphically in Figure 2. The primary research streams and theoretical areas used in this thesis are introduced briefly in the following sections. 44
  45. 45. Figure 2. The positioning of the study, key theoretical areas, and research gaps to be addressed. 45
  46. 46. 2.5. Strategic management According to Hätönen (2008, 44), the literature on strategic management is largely focused on the resource base, the core competencies and the boundaries of the firm. Where outsourcing is concerned, the main focus in the literature is the rationale and incentives behind the actions leading to outsourcing. Strategic management literature used to see outsourcing as a tool for either trimming the cost base (transactional outsourcing) or acquiring resources that were insufficient or not internally available (resource-seeking outsourcing), but as increased competition and falling interaction costs have caused companies to outsource more critical functions and processes, the focus in strategic management literature has shifted to the creation of superior customer value (see, for example, Merholz et al., 2008). As a strategy, outsourcing is typically used either to outsource only a part of an integrated function while retaining responsibility for coordinating the function, or as a ‘turnkey’ or total outsourcing, where the client outsources an entire function to an external provider (van Weele, 2000, 54-55).13 2.5.1. Make or buy decision-making In strategic management literature, outsourcing or make-or-buy decision has been approached from different perspectives such as economics, purchasing, operations research, accounting and strategic management (Cánez et al., 2000). Despite their outward differences, most outsourcing decision-making frameworks basically 13 According to Willcocks and Choi (1995), total outsourcing generally refers to a situation in which more than 80 percent of the function or process is outsourced. In NPD practice, the client commonly undertakes product concepting and gives the resulting specifications to the total service provider, who then performs detailed design and engineering for the product. 46
  47. 47. consist of a limited number of steps and share common aspects.14 The outsourcing process itself will be discussed in more detail in Section 3. The discussion about what actually causes firms to start the outsourcing process, beyond vague references to trends and market forces, is not present in all of the studies. Although some studies seem to make the implicit assumption that firms are always on a lookout for a ‘better deal,’ Cánez et al. (2000; see also de Boer et al., 2006) note that usually only ‘trigger’ events, such as changes in economic conditions, cause firms to re-evaluate their policies. Unless such events occur, firms only rarely start costly search and evaluation processes. Triggers also serve as bases for performance measures for the success of outsourcing initiative. For instance, if the trigger is cost reduction, cost saving is logically the key performance measure. An important addition from de Boer et al. (2006) is that the resulting search includes both cognitive (i.e. cost analysis and other analytical tools) and experiential (‘trying before buying’) evaluation, and continues only until the quality and/or quantity of information exceeds a threshold level, when a tentative solution is determined and evaluated. The primary contribution of de Boer et al. (2006) was to take explicitly into account concepts of bounded rationality and satisficing. Current strategic management theory recognizes (see e.g. Mintzberg et al., 1998) that most decision processes stop after first ‘good enough’ solutions are identified (satisficing) and the decision-maker is expected to work under conditions of bounded rationality, where all the information is not available, and the decision-maker cannot know whether s/he knows everything. Bounded rationality also allows for the fact that decision-makers are usually 14 The frameworks reviewed for this study were from Walker (1988), Venkatesan (1992), Welch and Nayak (1992), Quinn and Hilmer (1994), Apte and Mason (1995), Bruce and Morris (1998), Lonsdale et al. (1998), Greaver (1998), Vining and Globerman (1999), Sislian and Satir (2000), Fill and Visser (2000), Cánez et al. (2000), Chiesa et al. (2000), McIvor (2000), Probert et al. (2000), Milgate (2001), Jennings (2002), Kakabadse and Kakabadse (2002), Momme and Hvolby (2002), Offodile and Abdel-Malek (2002), Eklund (2004), Kumar and Eickhoff (2005), de Boer et al. (2006), and Hätönen (2008). For a reader interested in a more detailed description, Appendix B contains brief summaries of several more prominent frameworks. 47
  48. 48. operating under time pressure: even if they had resources to conduct an exhaustive search, most often they simply do not have time to do so. However, the most obvious problem with simply re-using existing outsourcing frameworks in this thesis is that most frameworks have been developed by researchers using data from manufacturing, logistics, and IT outsourcing.15 The need to support these functions in the most efficient way, and the resulting arms- length models, tend to bias the existing outsourcing frameworks towards cost optimization and leave the purchasing process to hands of lower-level procurement professionals (Laios and Moschuris, 1999; Barragan et al., 2003). In a summary, these arms-length, adversarial approaches are still perfectly adequate for outsourcing less critical or non-core activities, but it is easy to see how they can lead the organization to eventually use them, unwittingly perhaps, to more strategic areas such as product development and thus inadvertently ‘hollow out’ the corporation. Therefore, the typology of three different outsourcing strategies (transactional, resource-seeking and transformational; see also Section 2) proposed by Hätönen (2008) is particularly valuable, since it allows practitioners to mentally separate cost-minimizing outsourcing from more strategic options. 15Notable exceptions to this include Pisano (1990), who examined R&D sourcing decisions in the biotechnology industry, and Novak and Eppinger (2001) who studied automotive component sourcing, as well as contributions from e.g. Chiesa et al. (2000), Barragan et al. (2003), and Ulrich and Ellison (2005), of which only Barragan et al develop a prescriptive framework. In addition, Hätönen (2008) studied NPD outsourcing in context of Finnish small and medium software businesses. Design management research should also be mentioned here, as lessons learned from design consultancies can be extremely valuable in understanding NPD outsourcing (e.g. Bruce and Morris, 1998). These contributions will be explored in more detail later in this thesis. 48
  49. 49. 2.5.2. Outsourcing core competencies As outsourcing becomes more strategic and inches towards the organization’s core competencies, outsourcing decisions become more complicated and require input from a wider base of stakeholders and experts. In NPD settings, outsourcing decisions require input from technology, design and marketing functions to distinguish truly strategic and non-strategic activities (Barragan et al., 2003). Nevertheless, strategic management literature now recognizes that even outsourcing core competencies may be possible in certain circumstances (e.g. Gilley and Rasheed, 2000; Gottfredson et al., 2005). In this transformational outsourcing, new dynamic core competences are needed. Hätönen (2008, 44) refers to these competences as strategic restructuring competencies (see also Hagel and Singer, 1999; Fine et al, 2002). These mean competences that give the firm the ability to continuously restructure its value chain. This issue is often considered in terms of value-chain management, but it is also closely connected to core competency analysis: the firm undertaking transformational outsourcing must know which activities actually increase customer value or capture value from the network and concentrate on those activities that provide best return for investment. Outsourcing also requires many firms to develop another ‘new’ core competency in managing the geographically dispersed network of providers that results from outsourcing economic activities (Hätönen, 2008, 45; Kakabadse and Kakabadse, 2002). In the context of new product development, these networks of providers can either supply individual product development tasks, or they can supply the entire product development process as total outsourcing (van Weele, 2005, 54-55). In order to define what these tasks are, a brief overview of product development management is required. 49
  50. 50. 2.5.3. New product development Literature review finds that the coordination of product development activities has been a subject of much study. Numerous authors have attempted to develop generalized models of product development process, but most of the resulting models differ only in details. Predominant product development models focus on staged task sequencing (Cooper, 2001), the use of project management and cross- functional teams, and the development of widely shared product concepts early in the process (Brown and Eisenhardt, 1995). All of the models reviewed divide the product development process into distinct phases or stages, with common elements including a problem-definition stage, a concept-generation stage, preliminary and detailed design, and concept embodiment (Seidel, 2007). The actual number of stages differs between four and six (Ulrich and Eppinger, 2008) but include essentially the same activities. For example, Ulrich and Eppinger’s generic product development process (Ulrich & Eppinger, 2008, 14) consists of six phases: 1) planning, 2) concept development, 3) system-level design, 4) detail design, 5) testing and refinement, and 6) production ramp-up. Each of these phases includes different responsibilities for organization’s key functions – marketing, design, manufacturing and other functions, which have a different technological profile, involve different risks and costs and therefore have unique risk/reward balances if outsourced (Love and Roper, 2005). A recurring question in product development literature is whether the product development should be integrated (so-called concurrent or integrated product development, e.g. Cagan and Vogel, 2001; Ulrich and Eppinger, 2008) or disaggregated to separate tasks. Concurrent product development became a buzzword during the 1990s, when it was seen as a way to faster time-to-market cycles and better product quality. Today, cross-functional, integrated product development is widely seen as a virtual requirement for innovative new products 50
  51. 51. (see e.g. Brown, 2008). But this raises a question: if product development needs to be integrated, either as a process, or with e.g. manufacturing, can it be outsourced at all? 2.5.4. Modularity and design rules Much of the existing literature tend to address the decision to outsource a single activity in isolation, instead of considering interactions between two or more sourcing decisions. In case of NPD outsourcing, this gives a relatively limited view since, for example, decisions to outsource research or concept design may very well have implications to detailed design and manufacturing decisions. How these interactions and interdependences affect the organization is a subject of much research in modularity (e.g. Ulrich, 1995; Baldwin and Clark, 1997, 2000; Schilling, 2000; Brusoni and Prencipe, 2001; Fine et al., 2002; Langlois, 2002). Modularity reflects the degree to which the products and their production processes are decomposed into smaller subsystems and activities, which may be designed and managed independently yet function as a whole (Baldwin and Clark, 2000; Brusoni and Prencipe, 2001; Mikkola, 2006; Hätönen, 2008). Originally, modularity research arose from product design strategy research as product modularity (Ulrich, 1995; Baldwin and Clark, 1997). Product modularity refers to products where interdependencies between different parts and subsystems or modules are kept to a minimum and where these modules communicate and interact with each other through standardized interfaces and specifications. The idea is to decrease the complexity of the system by decomposing its complex tasks into simpler independent tasks or units that communicate with each other through standards without compromising the overall performance (Mikkola, 2006). However, in practice modularity can be at odds with performance, because 51

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