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Sourcing strategies of US service companies: A modified transaction-cost

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 Strategic Management Journal
Strat. Mgmt. J., 20: 791–809 (1999)

SOURCING STRATEGIES OF U.S. SERVICE

COMPANIES: A MODIFIED TRANSACTION–COST
ANALYSIS
JANET Y. MURRAY*1 and MASAAKI KOTABE2
1
James J. Nance College of Business Administration, Cleveland State University,
Cleveland, Ohio, U.S.A.
2
The Fox School of Business and Management, Temple University, Philadelphia,
Pennsylvania, U.S.A.

Global procurement of services has been receiving an increasing amount of managerial attention
in recent years. Service firms seem to have begun sourcing part of their service activities from
abroad in much the same way as manufacturing firms have sourced components and finished
goods in the past 30 years. However, little is known about the nature of service sourcing
strategy. In this study, we employ a modified transaction–cost analysis to examine empirically
the locational (domestic vs. global sourcing) and the ownership (internal vs. external sourcing)
aspects of service sourcing strategy. In addition, performance implications on both the locational
and ownership aspects of service sourcing are investigated. The results show that, similar to
components and finished goods procurement, supplementary services are sourced globally, either
internally or externally. Furthermore, the relationship between asset specificity and internal
sourcing of supplementary services is moderated by the level of inseparability and transaction
frequency. Finally, internal sourcing and foreign sourcing of supplementary services are
negatively related to a service’s market performance. Copyright  1999 John Wiley & Sons, Ltd.

INTRODUCTION vice companies have expanded their service pro-

In 1996, among the top global service exporters
and importers, the United States was ranked the
largest exporter, providing $223.9 billion of ser-
vices to the rest of the world. However, the
United States was also the top importer of ser-
vices, receiving $150.4 billion worth of services
(Statistical Abstract of the United States, 1997).
Furthermore, according to a recent government
estimate (Sondheimer and Bargas, 1992),
approximately 16 percent of the total value of
U.S. exports and imports of services were con-
ducted across national boundaries on an intrafirm
basis (i.e., between parent companies and their
subsidiaries). Increasingly, U.S. multinational ser-
Key words: global sourcing; services; transaction–cost
analysis; market performance
*
Correspondence to: Janet Y. Murray, James J. Nance College
of Business Administration, Cleveland State University, BU
463, 1860 East 18th Street, Cleveland, OH 44114, U.S.A.
curement activities on a global basis, either on
an intrafirm or interfirm basis from foreign as
well as domestic sources.
Despite the increasing use of global strategies
by multinational firms, research in global strategy
for service firms is still at an evolutionary stage
(Lovelock and Yip, 1996a). Along the same line,
although there is much evidence illustrating the
importance of global sourcing as a means to
garner competitive advantage, previous studies
focused mainly on global sourcing of components
and finished goods by manufacturing firms, and
seldom on service sourcing by service firms (e.g.,
Kotabe, 1992; Murray, Kotabe, and Wildt, 1995).
Despite an increasing amount of managerial inter-
est in sourcing of services (Fortune, 1994), no
empirical study has been conducted as to the
nature of service sourcing strategies. Previous
studies on services in an international context
examined the determinants of foreign direct
investment in service industries (e.g., Terpstra

CCC 0143–2095/99/090791–19 $17.50 Received 30 June 1997

Copyright  1999 John Wiley & Sons, Ltd. Final revision received 22 January 1999
792 J. Y. Murray and M. Kotabe
and Yu, 1988; Weinstein, 1977) and foreign mar-
ket entry modes for service companies (e.g., Erra-
milli, 1990; Erramilli and Rao, 1990, 1993),
among others, but did not address global sourcing
of services. In this paper, we fill part of the void
in the literature by examining the determinants
of sourcing of services by U.S. service companies
on a global basis.
CONCEPTUAL FRAMEWORK
Global sourcing strategy generally refers to those
decisions determining which production units will
serve which particular markets and how
components/finished goods/services will be pro-
cured (Davidson, 1982; Kotabe, 1992). By
operating in multiple countries, multinational
firms have the ability to coordinate activities on
a global scale to exploit not only their competitive
(firm-specific) advantages but also the compara-
tive (location-specific) advantages (Dunning,
1988). Firm-specific advantages are utilized
through the ownership aspect of sourcing (internal
vs. external sourcing), and location-specific
advantages are exploited through the locational
aspect of sourcing (domestic vs. foreign
sourcing).
A service firm uses ‘internal sourcing’ when it
procures services within the corporate system,
either a parent from its subsidiaries, or subsidi-
aries from their parent or from other subsidiaries.
‘External sourcing’ occurs when sourcing orig-
inates from independent suppliers either on an
arm’s length or on a long-term relationship basis.
These activities often cross national boundaries.
For example, when an insurance company in the
United States sources data-entry services from its
subsidiary in Ireland, it is said to be engaged in
internal sourcing. On the other hand, if the same
company sources services from an independent
Irish supplier, then it is using external sourcing.
‘Domestic sourcing’ occurs when a customer and
its suppliers are located in the same nation (e.g.,
both in the United States), while ‘foreign sourc-
ing’ means procuring from overseas suppliers
(e.g., a U.S.-based service firm procures services
from a supplier in Ireland). In general, ‘foreign
sourcing’ is possible for separable services in that
suppliers and customers do not have to be at the
same place at the same time, thus simultaneous
production and consumption is not critical to the
Copyright  1999 John Wiley & Sons, Ltd.
service transaction; ‘domestic sourcing’ is the
only viable option for inseparable services, in
which case production and consumption cannot
be decoupled.
In developing competitive strategies for service
firms, various researchers (Anderson and Narus,
1995; Carman and Langeard, 1980; Lovelock,
1992) have highlighted the necessity of dis-
tinguishing core and supplementary services. Core
services are the necessary outputs of an organi-
zation that consumers are looking for, while sup-
plementary services are either indispensable for
the execution of the core service or are available
only to improve the overall quality of the core
service bundle. Using an example of the
healthcare industry, the core service is providing
patients with good-quality medical care. The sup-
plementary services may include filing insurance
claims, arranging accommodation for family
members (especially for overseas patients), hand-
ling off-hour emergency calls, and so on. The
same phenomenon arises in the computer software
industry. When the industry giant, Microsoft,
needed help in supporting new users of Windows
95, it utilized external sourcing with Boston-based
Keane, Inc. to set up a help desk with 350
support personnel (Grupe, 1997).
An important paradigm used to explain ‘make
or buy’ decisions is based on efficiency consider-
ations of transaction–cost analysis (TCA) (e.g.,
Anderson and Coughlan, 1987; Anderson and
Gatignon, 1986; Klein, Frazier, and Roth, 1990;
Williamson, 1985). As suggested by Erramilli
and Rao (1993) in their recent study of service
firms, a modified version of TCA is employed to
investigate the determinants of sourcing of core
and supplementary services by service firms. In
addition, performance implications of the
locational and ownership aspects of sourcing of
services are also provided. Figure 1 presents the
composite model that includes the Modified TCA
Model (examining the determinants of sourcing
of services) and the Sourcing Model
(investigating the relationship between sourcing
strategy of services and market performance).
DEVELOPMENT OF HYPOTHESES
Most of the studies on global sourcing of
components/finished goods have utilized the vari-
ables in transaction–cost analysis to examine the
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
Figure 1. A conceptual framework for the global sourcing of supplementary services: A Modified TCA Model
appropriate sourcing strategy (e.g., Murray et al.,
1995). Indeed, ‘the theory appears to be
especially effective in explaining vertical inte-
gration decisions’ (Erramilli and Rao, 1993: 20).
Three variables were considered in Williamson’s
(1985) TCA: asset specificity, uncertainty, and
transaction frequency. When applied to services,
Erramilli and Rao (1993) found that the relation-
ship between asset specificity and entry modes is
contingent upon the influence of a number of
moderating factors. Following their recommen-
dation, we propose in the Modified TCA Model
that capital intensity, inseparability, uncertainty,
and transaction frequency moderate the relation-
ship between asset specificity and the sourcing of
services (refer to Figure 1).
Determinants of sourcing of core vs.
supplementary services
As mentioned earlier, the distinction between core
and supplementary services is necessary in strat-
egy development. Core services may gradually
partake of a ‘commodity’ and lose their differen-
tial advantage vis-à-vis competitors as competition
intensifies over time. Subsequently, a service pro-
vider may increase its reliance on supplementary
services to maintain and/or enhance competitive
advantage. ‘After all, if a firm can’t do a decent
job on the core elements, it’s eventually going
to go out of business’ (Lovelock, 1992: 27). In
other words, the reason why a service firm exists
is to provide good-quality core services to its
Copyright  1999 John Wiley & Sons, Ltd.
793
customers; however, in some instances, it simply
cannot rely solely on core services to stay com-
petitive. Based on this premise, we can expect
that core services are usually performed by the
service firm itself, regardless of the characteristics
of the core service. On the contrary, although
supplementary services are provided to augment
the core service for competitive advantage, the
unique characteristics of supplementary services
may influence ‘how’ and ‘where’ they are sourced.
This argument concurs with Lei and Slocum’s
(1992) recommendation that, once a firm’s core
business is defined, the best partner with which
to align may be the one that is not even in the
industry. In this way, the firm is able to leverage
its skills across multiple centers of competence.
In other words, a firm should support its core
business by performing these core services inter-
nally by capitalizing on its core competency;
however, supplementary services which often
belong to a different industry would be best
provided through external sourcing by manipulat-
ing the supplier’s core competency. Indeed, it is
well documented by business journals as well
as academic literature that any activity can be
performed through external sourcing as long as
it is not a core activity, which is supported by
the core competency argument (Bettis, Bradley,
and Hamel, 1992; Kelley, 1995; Lacity,
Willcocks, and Feeny, 1995; Mullin, 1996;
Piesch, 1995; Prahalad and Hamel, 1990; Rothery
and Robertson, 1995). ‘Now the question is not
whether to outsource but what to outsource, as
Strat. Mgmt. J., 20: 791–809 (1999)
794 J. Y. Murray and M. Kotabe
companies redirect valuable internal skills and
capabilities to high value-added areas’
(Venkatraman, 1997: 60).
Due to rationalization, firms have the ability
and opportunity to procure components/finished
goods that have proprietary technology on a
global basis (Birou and Fawcett, 1993; Kotabe,
1992). This may also apply equally to services,
especially for supplementary services. The tech-
nological revolution in data-processing and tele-
communications (trans-border data flow, telemat-
ics, etc.) either makes the global tradability of
some services possible or facilitates the trans-
actions economically (Gerstein, 1987; Sampson
and Snape, 1985; Sapir, 1982). Furthermore,
because the production and consumption of some
services do not need to take place at the same
location or at the same time, as in the case of
supplementary services, global sourcing may be
a viable strategy for service firms. For example,
a technologically advanced consulting firm can
utilize video conferencing, satellite linkage and
other voice/image/data-processing modes to get
access to its own global network of expertise in
order to serve its customers (Mathe and Perras,
1994). Consequently, ‘the value chain is broken
up across different countries; with management
adopting a strategy of creating supplementary
services in one country (or a limited number of
countries) for worldwide delivery, rather than
duplicating each activity in many different coun-
tries‘ (Lovelock and Yip, 1996b: 547).
In summary, supplementary services may be
performed internally or externally, with most sup-
plementary services being procured externally to
reap the benefits of the supplier’s expertise in the
area. Since no one company can or should source
all activities internally, sourcing strategies are
utilized to balance the required skills and com-
petencies from internal and external sources
(Venkatraman, 1997) so as to augment the com-
pany’s capability to achieve and sustain customer
satisfaction (Perry and Devinney, 1997). Simi-
larly, supplementary services may be sourced
either from domestic or foreign suppliers. Con-
trarily, as discussed earlier, since core services
are usually performed internally, the ownership
aspect of sourcing of core services is not influ-
enced by the characteristics of the core services.
In addition, because consumption and production
of many core services have to take place at the
same location and at the same time, global sourc-
Copyright  1999 John Wiley & Sons, Ltd.
ing may be less feasible for core services than
that of supplementary services.
Since there are two types of services, and
either service may be procured through internal
members domestically only or from internal mem-
bers located both domestically and from abroad,
four models are constructed. As our focus is on
internal sourcing, the term ‘internal’ is dropped
to reduce repetition for the sake of clarity; there-
fore, the four models are: the domestic sourcing
model for core services, global sourcing model
for core services, domestic sourcing model for
supplementary services, and global sourcing
model for supplementary services. First, the do-
mestic sourcing model was considered in which
only domestic sourcing of services through inter-
nal members is examined with the assumption
that sourcing of services from abroad is still an
anomaly in service firms’ strategy development.
Second, the global sourcing model posited that
service firms consider global sourcing (using both
domestic and foreign sourcing) explicitly as part
of their service procurement strategy.
Therefore, the following propositions postulate
that internal sourcing of core services may be
independent of the nature of the core services. In
other words, it is suggested that a service firm
usually performs core services by itself, so the
factors contained in the Modified TCA Model do
not influence either the level of internal domestic
sourcing or that of internal global sourcing of
core services. On the contrary, since supplemen-
tary services are sourced either internally or exter-
nally, and either from domestic or foreign sup-
pliers, the level of internal global sourcing for
supplementary services is influenced by the fac-
tors in the Modified TCA Model. A summary of
the preceding discussion is presented in Figure 2.
The results obtained from testing these proposi-
tions would allow us to further examine the
boundaries of generalizability of these four mod-
els (Whetten 1989). Therefore:
Proposition 1a: The factors in the Modified
TCA Model do not account for the degree of
domestic sourcing of core services.
Proposition 1b: The factors in the Modified
TCA Model do not account for the degree of
global sourcing of core services.
Proposition 1c: The factors in the Modified
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
Figure 2. Applicability of the Modified TCA Model
TCA Model do not account for the degree of
domestic sourcing of supplementary services.
Proposition 1d: The factors in the Modified
TCA Model account for the degree of global
sourcing of supplementary services.
Based on the previous discussion, the following
hypotheses are developed using the global sourcing
model (Proposition 1d) for supplementary services.
Asset specificity
Asset specificity refers to investments made in
specific (nonmarketable) resources. When these
investments are made, a supplier and a buyer are
‘locked into’ the transaction because the assets
are specialized to that transaction and have lim-
ited or no value outside that transaction
(Williamson, 1985). ‘Because nonredeployable
specific assets make it costly to switch to a
new relationship, the market safeguard against
opportunism is no longer effective’ (John and
Weitz, 1988: 124). Under these situations, firms
would utilize internal sourcing to avoid opportun-
ism. Indeed, Murray et al. (1995) found that
manufacturing firms tend to source major compo-
nents requiring highly specific assets internally.
Major components (e.g., engines for automobiles)
are those components that render a firm competi-
Copyright  1999 John Wiley & Sons, Ltd.
795
tive advantage over its rivals, and they can rep-
resent the core competency of a manufacturer
(Prahalad and Hamel, 1990). While the core
proposition of the transaction–cost theory’s
assertion that specialized assets have lower trans-
action costs within the firm was supported,
Walker and Poppo (1991) claimed that the recent
proliferations of relational contracting challenge
both the theory’s basic assumptions and its pre-
dictive power.
Erramilli and Rao (1993) raised the problem
of a lack of literature discussing the origin of
transaction-specific investments in the service sec-
tor. They indicated that providing idiosyncratic
services requires highly specific assets. Consistent
with their suggestion, this study defined idiosyn-
cratic services as those that require a high level
of professional skills, major investments and
training, and specialized know-how. For those
supplementary services that have high asset speci-
ficity, they should be sourced internally. Indeed,
transactions of this kind pose a greater risk to the
sourcing firm if the supplier does not deliver the
service according to the specification or render the
service on time, because alternative sources of
supply are either limited or unavailable. Therefore,
Hypothesis 1: The higher the asset specificity
of the supplementary services, the more they
are sourced internally.
Strat. Mgmt. J., 20: 791–809 (1999)
796 J. Y. Murray and M. Kotabe
Moderator variables
The conventional TCA predicts the need for inter-
nal sourcing under a high level of asset speci-
ficity. However, recent studies (Nishiguchi and
Brookfield, 1997; Walker and Poppo, 1991) chal-
lenged the economic rationale for coordinating an
exchange within a hierarchy when specific assets
are involved. Similarly, Hill (1990) asserted that
hierarchical governance has proved to be an
imperfect solution to the problem of structuring
exchanges involving specific assets alone; how-
ever, hierarchical governance has efficiency
properties when moderators (e.g., uncertainty,
competitive market equilibrium) exert influence
on the relationship between asset specificity and
governance structure. Similarly, Erramilli and
Rao (1993) suggested that the positive relation-
ship between asset specificity and internal
sourcing of supplementary services may be
moderated by other variables. In other words,
this modified version of TCA on sourcing of
supplementary services considers these moder-
ators to have accentuating or diminishing effects
on the relationship between internal sourcing of
supplementary services and asset specificity.
The following are the discussions on each of
the moderator variables and the resulting
hypotheses.
Capital intensity
Capital intensity is the level of investments on
fixed assets to generate sales revenue (Erramilli
and Rao, 1993; Kim and Lyn, 1987). The level
of capital intensity can range from extremely low
to extremely high in different service industries.
‘Since the level of capital intensity represents the
relative magnitude of fixed investment, increasing
capital intensity signifies rising resource commit-
ments and escalating costs of integration’
(Erramilli and Rao, 1993: 24). Other things being
equal, the higher the capital intensity, the more
difficult it is for service firms to utilize internal
sourcing through vertical integration. Further-
more, committing a high level of capital resources
on supplementary services would drift the firm
away from its strategic focus of concentrating on
providing its core services.
Based on Hypothesis 1, it is hypothesized that
at high levels of asset specificity supplementary
services are sourced internally. However, the
Copyright  1999 John Wiley & Sons, Ltd.
positive relationship between asset specificity and
internal sourcing of supplementary service may
be moderated by the level of capital intensity
involved in providing the service. In other words,
at high levels of asset specificity, supplementary
services are sourced internally when the capital
investment is low. On the contrary, when capital
intensity is high, the rising costs make it more
difficult for firms to utilize internal sourcing,
thereby inducing these firms to source the services
from external suppliers (Erramilli and Rao, 1993).
Since supplementary services are those services
that either achieve operational efficiency or sup-
port current stratgies, firms should source these
services from external suppliers (Venkatraman,
1997). Therefore, the higher the capital intensity,
the lower the degree of internal sourcing by high-
specificity firms. Hence:
Hypothesis 2: The positive relationship
between asset specificity and internal sourcing
of supplementary services will become weaker
with increasing capital intensity.
Inseparability
Based on the classical discussion on the charac-
teristics of services, services are said to be insep-
arable. However, due to technological advance-
ment, supplementary services can be made
separable because their production and consump-
tion can be decoupled. For example, a technologi-
cally advanced consulting company can utilize
video conferencing, satellite linkage and other
voice/image/data-processing modes to get access
to its own global network of expertise in order
to serve its customers (Mathe and Perras, 1994).
However, some supplementary services may
remain inseparable. Inseparability ‘forces the
buyer into intimate contact with the production
process’ (Carman and Langeard, 1980: 8) and
requires close buyer–seller interactions (Erramilli
and Rao, 1993; Gronroos 1983). The close
buyer–seller interaction due to service insepa-
rability has two significant implications. First, it
demands the tight coordination of the demand
and supply of the service activity (Bowen and
Jones, 1986). Second, it necessitates close inter-
action between (employees of) the supplier and
(employees of) the buyer. Both of these are
attained more effectively by performing the
activity internally. The use of internal sourcing
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
for inseparable services is more pronounced for
services that have high asset specificity. For
inseparable services, high-specificity firms would
likely source services internally because of the
unique training required for providing the ser-
vice, and the necessity to control quality for
potential service variability during service
encounters. In addition, the employee can pro-
vide feedback of crucial areas that need to be
addressed. Also, when service variability arises,
the employee can make ‘on-the-spot’ remedies
for dissatisfied customers without having to
resort to negotiate with external suppliers for
corrective action. Worse still, if corrective
action is not provided, the firm would likely be
stuck with the current supplier since locating
alternate suppliers who would invest in specific
assets for the services immediately is very dif-
ficult. As the service requires major investments
in providing training to employees for skills
and specialized know-how, the source of supply
is limited and the terms for securing the supply
of such services are unfavorable (Williamson,
1985). Consequently, the higher the insepar-
ability of the supplementary services, the higher
the degree of internal sourcing for high-
specificity firms.
Hypothesis 3: The positive relationship
between asset specificity and internal sourcing
of supplementary services will become
stronger, the higher the inseparability of these
supplementary services.
Uncertainty
Uncertainty was a construct proposed by William-
son (1979) in TCA. Harrigan (1986) asserted
that, in extreme market volatility, excessive inte-
gration often overexposes firms to demand uncer-
tainty. Similarly, several organization theorists
argued that less vertically integrated structures
are more effective under high external uncertainty
conditions (Lawrence and Lorsch, 1967; Pfeffer
and Salancik, 1976). However, these studies did
not distinguish between transactions that involve
low or high asset specificity.
Williamson (1979) contended that low-
specificity firms that encounter uncertainty, albeit
high or low, are able to arrange for supply of
services from new suppliers. As high-specificity
firms provide services with idiosyncratic invest-
Copyright  1999 John Wiley & Sons, Ltd.
797
ments, a high level of uncertainty will pose spe-
cial risks to these firms. The firm is faced with
two choices. First, the firm can rely on market
governance and sacrifice valued design features
in favor of a more standardized service. Second,
in retaining the specialized services as the firm’s
competitive advantage, the firm would internally
source through vertical integration. Since service
firms increasingly adopt differentiation of sup-
plementary services as a source of competitive
advantage, one would argue that the firm would
be more prone to the second option. As suggested
by many scholars (Anderson and Narus, 1995;
Bharadwaj, Varadarajan, and Fahy, 1993; Love-
lock, 1992), the existence of a service firm is to
provide good-quality core services to its cus-
tomers; however, a service firm increasingly has
to augment the core service by providing sup-
plementary services for differentiation and added
value to its customers. For example, because of
the hectic schedule of working families, some
grocery chains have started providing a delivery
service (a supplementary service) to customers;
however, the delivery service is often provided
by external suppliers.
Klein, Frazier, and Roth (1990) argued that
internal sourcing allows the absorption of uncer-
tainty through specialization of decision-making
and savings in communication expenses, facilitat-
ing an adaptive, sequential decision process. In
addition, the firm may be able to, at least par-
tially, control uncertainty generated by environ-
mental chaos and its own destiny through certain
internal arrangements (Akerlof, 1970; Toffler,
1984), thus inducing path dependencies that cre-
ate causal ambiguity (making imitation from other
firms difficult) (Lei, Hitt, and Bettis, 1996). This
argument is consistent with Hill’s (1990: 508)
assertion that ‘vertical integration has proved to
be an imperfect solution to the problem of struc-
turing exchanges involving specific asset invest-
ments.’ However, ‘hierarchical governance has
efficiency properties when outcomes are highly
uncertain or ambiguous’ (Hill, 1990: 511). Simi-
larly, Anderson and Schmittlein (1984) found
that uncertainty was a much greater predictor of
hierarchy than asset specificity. Hence:
Hypothesis 4: The positive relationship
between asset specificity and internal sourcing
of supplementary services will become stronger
with increasing uncertainty.
Strat. Mgmt. J., 20: 791–809 (1999)
798 J. Y. Murray and M. Kotabe
Transaction frequency
Transaction frequency relates to the frequency
with which transactions involved in sourcing the
same service recur. Under different levels of
transaction frequency, whether a firm should rely
on market governance or vertically integrate is
contingent upon the level of asset specificity
(Williamson, 1985). For low-specificity firms,
external sourcing is appropriate under both
occasional and recurrent transactions as the mar-
ket for the services transaction is competitive and
the supplier is not required to make specialized
investments. However, whether high-specificity
firms should use internal or external sourcing is
contingent upon the level of transaction fre-
quency. Williamson (1979) recommended that for
recurrent transactions with highly specific assets
the firm should vertically integrate. For occasional
transactions with high asset specificity, external
sourcing is beneficial for the firm because it can
avoid investing in specific assets. However, a
trilateral governance structure (i.e., third-party
assistance in resolving disputes and evaluating
performance) is necessary. If the firm cannot
secure this kind of modified external sourcing
arrangement, internal sourcing may provide the
firm with more advantages.
Indeed, because of the unique characteristics
of services (e.g., inseparability and
heterogeneity), one may argue that it is more
appropriate for high-specificity firms to provide
services in-house when transaction frequency is
low for the following reasons. First, because the
independent evaluation of the quality of a service
by a third party is far more difficult than that of
a product, a trilateral governance structure may
not be feasible. Second, there is a lack of incen-
tives for a supplier to invest in idiosyncratic
assets if it expects to provide the service
infrequently, and the deployment of specialized
assets is not used elsewhere. Therefore, if the
supplier invested in idiosyncratic assets, it could
become vulnerable to opportunistic action by the
customer. Third, by internalizing infrequent trans-
actions that involve a high level of asset specificity,
the firm can potentially prolong its sustainable
competitive advantage by providing the same ser-
vice without resorting to modify the service con-
tinuously for differential advantage. Hence:
Hypothesis 5: The positive relationship
Copyright  1999 John Wiley & Sons, Ltd.
between asset specificity and internal sourc-
ing of supplementary services will become
stronger with decreasing transaction fre-
quency.
Market performance and sourcing of
supplementary services
Various studies (e.g., Kotabe, 1992; Murray et
al., 1995) concluded that internal sourcing of
major components is positively related to firm
performance. As major components are those
elements that differentiate a firm’s product away
from its competitors but within the domain of a
firm’s core competency, internal sourcing of these
major components allows the firm to keep its
unique technology within the corporate system,
thus prolonging the competitive advantage.
Although supplementary services are used to
maintain and/or enhance the value of core ser-
vices, providing supplementary services (e.g.,
tracking services) internally, in some instances,
may not be the core competency of a service
firm (e.g., a delivery service firm). Therefore,
external sourcing of supplementary services can
reduce fixed investment and increase operational
flexibility; in this sense, internal sourcing of sup-
plementary services may be negatively related to
a service’s market performance.
Another major finding in the area of global
sourcing of components and finished goods is
that sourcing locations of major components do
not have an impact on the product’s market per-
formance (Kotabe, 1992; Murray et al., 1995).
Rather, the level of the product’s market perform-
ance is influenced by the degree of internal sourc-
ing used, as discussed earlier. However, the appli-
cability of global components/finished goods
sourcing research in the service context is sus-
pected for two reasons. First, it is because the
‘perishability’ and ‘inseparabilty’ characteristics
of services make it essentially difficult, if not
impossible, for services to be performed away
from the customers. Therefore, the extent of do-
mestic sourcing of services determines the agility
of a service firm and should have a positive effect
on its market performance; conversely, foreign
sourcing would have a negative effect on a ser-
vice’s market performance. Second, as the inter-
national product cycle thesis (Utterback, 1987;
Vernon, 1974) suggests, foreign sourcing begins
in order to maintain cost competitiveness as the
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
components/finished goods mature and compe-
tition intensifies over time. In other words, foreign
sourcing is rather suggestive of a service firm’s
strategic reaction to its declining competitiveness
(Quinn and Hilmer, 1994). Because of the unique
characteristics of services, we suspect that the
locational aspect of service sourcing may be
important for the service’s market performance.
Indeed, the geographical distance between a ser-
vice supplier and a customer may magnify the
problems of intangibility and heterogeneity of
services, which may make the outcome of the
service even less predictable and less control-
lable. Therefore:
Hypothesis 6a: Based on the core com-
petency argument, the extent of internal sourc-
ing of supplementary services is negatively
related to a service’s market performance.
Hypothesis 6b: Due to the unique character-
istics of services, the extent of foreign sourcing
of supplementary services is negatively related
to a service’s market performance.
RESEARCH METHOD
The sample
The data were collected in two stages by a mail
survey of Fortune 500 U.S. service firms and
their major affiliates operating in the United
States. In the first stage, a request letter for
participation in the survey was sent to the
president/CEO of these firms. For those firms
that were involved in international sourcing of
services and agreed to participate, the
presidents/CEOs were asked to identify up to
three major divisions (SBUs) and provide the
names of executives who were in charge of ser-
vice sourcing operations. Consequently, 202
SBUs and their respective executives were iden-
tified. Those 202 SBUs originated from 96 service
firms, with an average of 2.1 SBUs being pro-
vided per service firm.
In the second stage, after a preliminary ques-
tionnaire was pretested with managers of firms
involved in service sourcing activities, the final
questionnaire was mailed to 202 executives with a
personalized cover letter. Twenty-two executives
declined to participate, with reasons that ranged
from sensitivity of the questionnaire to the insig-
Copyright  1999 John Wiley & Sons, Ltd.
799
nificant levels of international service sourcing
used. For the remaining 180 executives, 100
responded and returned the questionnaire,
resulting in an effective response rate of 55.6
percent which compares favorably with response
rates reported in other international marketing
surveys (e.g., Erramilli and Rao, 1993; Kotabe,
1990). Thirty-four percent of the sample rep-
resented financial businesses (banks, securities,
and insurance). Utility and transportation busi-
nesses constituted 17 percent and 13 percent of
the sample, respectively. Construction and
publishing/communication businesses represented
the next 8 percent each. Retailing/wholesaling
businesses represented 5 percent, and health care
4 percent. Others were not specified. The distri-
bution of Fortune service 500 was generally well
represented in the sample.
Following the nonresponse bias detection
method suggested by Armstrong and Overton
(1977), key constructs of responding firms were
compared between earlier and later respondents
to provide an indication of nonresponse bias.
The analysis showed no significant differences
between earlier and later respondents. This
finding offers some assurance about the rep-
resentativeness of the responding firms. Eighty
percent of the respondents are in the cadre of
top management at the divisional level
(presidents, vice-presidents, and directors),
while the rest are functional managers
(marketing, finance, international procurement,
etc.) or strategic planning executives, thereby
assuring the credibility of information provided.
To see if the job position of the respondents
had any impact on the way they responded to
the questionnaire, they were classified by job
position (top management, functional manager,
or director of corporate planning). Similarly,
the variables in this study were compared by
job position. As no significant differences were
observed, the respondents’ job position would
not bias the findings of this study.
Measures
Asset specificity and capital intensity of core and
supplementary services, and market performance
were represented by multiple-item measures.
Inseparability, uncertainty, and transaction fre-
quency of core and supplementary services were
measured by single items.
Strat. Mgmt. J., 20: 791–809 (1999)
800 J. Y. Murray and M. Kotabe
Extent of global sourcing of core services
The extent of global sourcing of core services
was measured as a percentage of total value of
core services that were procured inside the corpo-
rate system on a global basis (both from domestic
and foreign sources). Core services were defined
as those services that fulfill customers’ needs
for a basic benefit, which were similar to the
competitors’ offerings.
Extent of global sourcing of supplementary
services
The extent of global sourcing of supplementary
services was measured as a percentage of total
value of supplementary services that were pro-
cured inside the corporate system on a global
basis (both from domestic and foreign sources).
Consistent with Lovelock (1992), supplementary
services were those services that facilitated and
enhanced the use of core services and provided
competitive advantages over the firm’s competi-
tors.
Extent of domestic sourcing of core and
supplementary services
The extent of internal domestic sourcing of core
(supplementary) services was measured as a per-
centage of total value of core (supplementary)
services that were procured from domestic sup-
pliers inside the corporate system.
Asset specificity of core and supplementary
services
Specific assets were investments in producing
core (supplementary) services that might have
little or no outside uses (Williamson, 1985). The
degree of asset specificity for core
(supplementary) services was measured using
three items: the level of major investments and
training, the level of professional skills, and the
level of specialized know-how required in provid-
ing the core (supplementary) services. These three
indicators were adapted from Erramilli and Rao’s
(1993) study. The levels of these three indicators
were measured by 5-point scales (5 = very high,
%, 1 = very low) (Cronbach’s ␣ = 0.75 for core
services; Cronbach’s ␣ = 0.85 for supplemen-
tary services).
Copyright  1999 John Wiley & Sons, Ltd.
Capital intensity of core and supplementary
services
Capital intensity measures the major investments
made in providing the core and supplementary
services. It is measured by two items, respec-
tively: the degree of capital intensity of the core
(supplementary) services, and the level of one-
time cost involved in switching from one service
provider to another if the firm were to change
service providers of the core (supplementary)
services. The levels of these two indicators were
measured by 5-point scales (5 = very high, %,
1 = very low) (Cronbach’s ␣ = 0.49 for core
services and ␣ = 0.78 for supplementary
services).
Inseparability of core and supplementary
services
Inseparability of core (supplementary) services
was defined as the degree of which production
and consumption of core (supplementary) services
would occur simultaneously; it was measured
using a 5-point scale (5 = very high, %, 1 =
very low).
Uncertainty of core and supplementary services
The demand uncertainty of core (supplementary)
services was assessed using a 5-point scale (5 =
very high, %, 1 = very low).
Transaction frequency of core and
supplementary services
Transaction frequency of core (supplementary)
services was defined as the frequency with which
transactions involved in sourcing the same core
(supplementary) services recurred (Williamson,
1985); it was measured using a 5-point scale (5
= very high, %, 1 = very low).
Market performance
Roth and Morrison (1990) suggested that a firm
may pursue both the strategic and financial
dimensions of market performance as the objec-
tives of its business operation. Based on their
recommendation, in this study, market perform-
ance consisted of two composite measures: stra-
tegic market performance and financial market
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
performance. Strategic market performance
included market share and sales growth rate. Mar-
ket share and sales growth rate were measured
relative to the three largest competitors over the
last 3 years in the U.S. market using 5-point
scales (5 = much higher, %, 1 = much lower)
(Cronbach’s ␣ = 0.83). Financial market perform-
ance included return on sales, return on invest-
ment, and return on equity. These three variables
were measured relative to the three largest com-
petitors over the last 3 years in the U.S. market
using 5-point scales (5 = much higher, %, 1 =
much lower) (Cronbach’s ␣ = 0.84).
ANALYSIS AND RESULTS
Contingency relationships were estimated by
using moderated regression analysis (Sharma,
Durand, and Gur-Arie, 1981). Four models
(global sourcing model for core services, global
sourcing model for supplementary services, do-
mestic sourcing model for core services, and
domestic sourcing model for supplementary
services) and their respective hypotheses were
examined. The dependent variables were the
degree of internal global sourcing and the degree
of internal domestic sourcing for each of the
services (core and supplementary), respectively
(for testing Propositions 1a–1d). The models con-
sisted of asset specificity (predictor variable) (for
testing Hypothesis 1 for the main effect of asset
specificity on the level of internal sourcing of
supplementary services, as predicted by the con-
ventional TCA); capital intensity, inseparability,
uncertainty, and transaction frequency (moderator
variables); and the interaction terms between asset
specificity with each of the moderator variables
(for testing Hypotheses 2– 5 for the moderating
effects of the above-mentioned variables). In
other words, the models hypothesized that some
variables (i.e., capital intensity, inseparability,
uncertainty, and transaction frequency) moderated
the impact of asset specificity on the level of
internal sourcing of supplementary services. For
example, Hypothesis 2 hypothesized that, other
things being equal, when asset specificity was
high, the level of internal sourcing of supplemen-
tary services was dependent on the level of capital
intensity. In testing Hypotheses 2–5 for potential
moderating effects, only the coefficients for the
interaction terms were analyzed and interpreted.
Copyright  1999 John Wiley & Sons, Ltd.
801
If some of these coefficients turned out to be
significant, it meant that some of these variables
were significant moderator variables. If some of
these coefficients were insignificant, it meant that
they were not moderator variables, but they might
exert direct influence (main effects) on the level
of internal sourcing of supplementary services.
Hypothesis 6a was tested by examining the
relationship between a service’s market perform-
ance and the extent of internal sourcing of sup-
plementary services, while Hypothesis 6b investi-
gated the relationship between a service’s market
performance and the extent of foreign sourcing
of supplementary services. Therefore, both
Hypotheses 6a and 6b tested the main effects of
the extent of internal sourcing and foreign sourc-
ing of supplementary services. In the models
(one for strategic performance and the other for
financial performance), an interaction term (the
extent of internal sourcing × the extent of foreign
sourcing) was included to explore potential inter-
action effects, although the study of the effects
of the interactive term was not part of this study.
The results show that both the domestic sourc-
ing model (R2 = 0.18, p-value = 0.11) and the
global sourcing model (R2 = 0.08, p-value = 0.76)
for core services were insignificant; therefore,
Propositions 1a and 1b were supported. On the
other hand, the domestic sourcing model for sup-
plementary services was insignificant (R2 = 0.09,
p-value = 0.66), while the internal global sourcing
model for supplementary services was significant
(R2 = 0.24, p-value = 0.02). Hence, Propositions
1c and 1d were supported, and we can conclude
that supplementary services are sourced from both
domestic and foreign sources for strategic reasons.
Consequently, only the results related to the inter-
nal global sourcing model for supplementary ser-
vices are presented in Table 1. The following
results for Hypotheses 1–5 were based on the
internal global sourcing model for supplementary
services in Table 1.
Hypothesis 1 explored the relationship between
asset specificity and the extent of internal sourc-
ing of supplementary services. Contrary to what
was hypothesized, asset specificity, although a
significant predictor variable, was negatively
related to the extent of internal sourcing of sup-
plementary services (p-value = 0.02); therefore,
Hypothesis 1 was not supported. The result sug-
gests that, unlike product sourcing strategy, idio-
syncratic supplementary services tend to be
Strat. Mgmt. J., 20: 791–809 (1999)
802 J. Y. Murray and M. Kotabe
Table 1. Multiple regression results for internal global sourcing of supplementary services

Variable Standardized t-value p-value

coefficient

Asset specificity −0.38 −2.47 0.02

Capital intensity 0.29 2.05 0.04
Inseparability −0.17 −1.50 0.14
Uncertainty 0.20 1.65 0.10
Transaction frequency −0.10 −0.83 0.41
Asset specificity × capital intensity 0.00 0.04 0.97
Asset specificity × inseparability 0.27 2.19 0.03
Asset specificity × uncertainty 0.11 1.04 0.30
Asset specificity × transaction frequency −0.31 −2.41 0.02

R2 = 0.24, significant at the 0.02 level

sourced externally so that the service firm can
excel on its core competency of delivering the
core service (Fortune, 1994).
Hypothesis 2 explored the moderating effect of
capital intensity on the relationship between asset
specificity and internal sourcing of supplementary
services. However, the result showed that capital
intensity was an insignificant moderator (p-value
= 0.97). Hence, Hypothesis 2 was not supported.
However, the results showed that capital intensity
had a direct effect on the degree of internal
sourcing of supplementary services (p-value =
0.04).
Hypothesis 3 examined the moderating effect
of inseparability on the relationship between asset
specificity and internal sourcing of supplementary
services. It was hypothesized that for supplemen-
tary services that have high asset specificity, the
firm would be more prone to source inseparable
services internally. As expected, this moderating
effect was positive and significant (p-value =
0.03), and therefore supporting Hypothesis 3.
Hypothesis 4 posited that for supplementary
services that have high demand uncertainty, the
firm would be more likely to source these services
internally. However, while the coefficient was
positive as expected, this moderator was not sig-
nificant (p-value = 0.30). Hence, support was not
found for Hypothesis 4. However, uncertainty had
a marginal direct effect on the degree of internal
sourcing of supplementary services (p-value =
0.10).
Hypothesis 5 investigated the moderating effect
on the relationship between transaction frequency
and internal sourcing of supplementary services.
It was confirmed that the moderator effect of
Copyright  1999 John Wiley & Sons, Ltd.
transaction frequency was negative and significant
(p-value = 0.02); therefore, Hypothesis 5 was
supported.
In examining the relationship between a ser-
vice’s market performance and the sourcing
(internal sourcing and foreign sourcing) of sup-
plementary services, an interaction term (internal
sourcing × foreign sourcing) was also included
in the model to explore any potential effect on
market performance. The results showed that the
interaction was insignificant; however, both main
effects were significant. Hypothesis 6a examined
the relationship between a service’s market per-
formance and internal sourcing of supplementary
services; the results showed that the relationship
was negative and significant for both strategic
market performance (p-value = 0.03) and finan-
cial market performance (p-value = 0.08); there-
fore, Hypothesis 6a was supported. Hypothesis
6b evaluated the relationship between a service’s
market performance and foreign sourcing of sup-
plementary services; the relationship was negative
and significant for both strategic market perform-
ance (p-value = 0.01) and financial market per-
formance (p-value = 0.00), thus providing support
for Hypothesis 6b. The results for Hypotheses 6a
and 6b are contained in Tables 2 and 3.
CONCLUSIONS AND IMPLICATIONS
Managerial implications
One of the most critical decisions for managers
in manufacturing and service firms is to evaluate
how goods and services are procured. Recently,
several empirical studies provided directions in
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies 803
Table 2. Multiple regression results for sourcing of supplementary services on strategic market performance

Variable Standardized t-value p-value

coefficient

Internal sourcing of supplementary services −0.20 −1.99 0.03

Foreign sourcing of supplementary services −0.23 −2.31 0.01
Internal sourcing × foreign sourcing of supplementary
services −7.57 −0.75 0.46

R2 = 0.10, significant at the 0.05 level

Table 3. Multiple regression results for sourcing of supplementary services on financial market performance

Variable Standardized t-value p-value

coefficient

Internal sourcing of supplementary services −0.15 −1.43 0.08

Foreign sourcing of supplementary services −0.31 −2.88 0.00
Internal sourcing × foreign sourcing of supplementary
services −10.39 −0.97 0.33

R2 = 0.11, significant at the 0.03 level

the sourcing of goods (Kotabe, 1992; Murray et
al., 1995); these studies stressed the importance
of internal sourcing of major components. Major
components are those components that render
crucial differential advantage to a product. As for
services, various studies (Anderson and Narus,
1995; Carman and Langeard, 1980; Lovelock,
1992) suggested that a service provider increases
its reliance on supplementary services to maintain
and/or create differential advantage when core
services partake of a ‘commodity.’ However, the
discussion on ‘how’ and ‘where’ these services
should be procured is mainly anecdotal and has
not been subjected to the rigor of empirical inves-
tigation.
Although the objective of this study is to exam-
ine the moderating effects of several variables on
the relationship of asset specificity and internal
sourcing of supplementary services, the main
effect of asset specificity and internal sourcing
was also investigated (as hypothesized by the
conventional TCA). Contrary to the prediction of
the conventional TCA, the relationship between
asset specificity and internal sourcing of sup-
plementary services was a negative (instead of a
positive) one. Based on the hypothesized inter-
active effects of asset specificity with each of the
moderator variables, one may argue that it may
be appropriate to interpret only the interaction,
Copyright  1999 John Wiley & Sons, Ltd.
rather than the main, effects on internal sourcing
of supplementary services.
But the opposite result obtained on the relation-
ship between asset specificity and internal sourc-
ing of supplementary services suggests that TCA
may be less relevant for intangible goods. Indeed,
the result of this study is not consistent with
earlier findings in manufactured good that asset
specificity is positively related to internal sourcing
of major components (Kotabe and Murray, 1996).
The inconsistent results may be due to the follow-
ing reasons. First, TCA may be relevant in pre-
dicting the sourcing of tangible goods, but not
that of intangible ones, as suggested by the result
obtained by Kotabe and Murray (1996) and that
in this study.
Second, one may contend that major compo-
nents are analogous to core services, and stan-
dardized components are similar to supplementary
services. Because major components are crucial
components contained in a tangible good that
may not be substituted, internalizing these crucial
components (especially those with high asset
specificity) would shield the firm from potential
opportunistic behavior by external suppliers. Con-
versely, supplementary services are those services
that resemble standardized components and are
selected by the firm to augment the core service
for competitive advantage; in other words, sup-
Strat. Mgmt. J., 20: 791–809 (1999)
804 J. Y. Murray and M. Kotabe
plementary services do not represent the basic
benefits of a core service that are sought by
customers. Although the risk of opportunistic
behavior displayed by external suppliers who pro-
vide supplementary services with high asset speci-
ficity may still be present, one may conjecture
that the probability of such opportunistic behavior
occurring may be lower for supplementary ser-
vices than that for core services. Because sup-
plementary services are used to augment a core
service and many types of supplementary services
may be potentially available for such purposes,
external suppliers are aware that the sourcing
firm has the liberty to include other types of
supplementary services in the service package if
these opportunistic behaviors arise, without hurt-
ing the delivery of the core service.
Therefore, even though supplementary services
would help augment the core service, it may not
necessarily mean that they should be sourced
internally, especially those with high asset speci-
ficity. Indeed, Hill (1990) questioned whether
Williamson’s (1979) assumption that if asset
specificity is high, the risk of opportunism is
often great enough to warrant replacing the mar-
ket with a hierarchy. In reality, based on the
practice reported by service firms, the higher the
asset specificity of supplementary services, the
more externally sourced these services are
(Fortune, 1994). By doing so, the service firm
can focus on its core service competencies (e.g.,
banking services for banks) without diverting
resources on noncore, supplementary services
(e.g., information technology services for banks)
(Lovelock, 1996). For example, Chase Manhattan
Bank selected AT&T to manage its voice and
data networks, which allows Chase to focus on
its core competencies and devote added attention
to developing new financial services. Federal
Express provides tracking services for deliveries
to make its services more attractive; however, the
company relies on outside suppliers to provide
this supplementary service. Consequently, Federal
Express can avoid investing a substantial amount
of resources in a noncore area and performing a
service of which it has no knowledge since its
core competencies are not in this area.
The failure of the conventional TCA in pre-
dicting the significant negative relationship
between asset specificity and internal sourcing of
supplementary service may also be due to the
assumption that service firms make sourcing
Copyright  1999 John Wiley & Sons, Ltd.
decisions based on transaction cost minimization
which determines the fit between transaction
characteristics and form of governance. However,
whether a firm indeed can internalize the services
is constrained by its organizational capability
(Madhok, 1997). More importantly, vertical inte-
gration (internal sourcing) has proved to be an
imperfect solution to the problem of structuring
exchanges involving specific assets, as found in
the case of General Motors and Ford. ‘Both
General Motors and Ford found that vertical inte-
gration, by giving in-house incentives for in-
house suppliers a captive market, has attenuated
incentives for in-house suppliers to maximize
efficiency’ (Hill, 1990: 508). Moreover, recent
studies (Coase, 1988; Walker and Poppo, 1991)
argued that asset specificity is not a sufficient
condition for vertical integration and that
relational contracting (from external suppliers)
diminishes the role of asset specificity as a neces-
sary condition for low transaction costs using
internal sourcing and as a sufficient condition for
high transaction costs using external sourcing.
The role of asset specificity on a firm’s gover-
nance structure was further questioned by Nishig-
uchi and Brookfield’s (1997) examination of Bri-
tish and Japanese electronics subcontractors in
that asset specificity is not the cause, but rather
the consequence of strategy. In Williamson’s
(1979) view, the level of asset specificity causally
precedes the type of governance structure; how-
ever, in Nishiguchi and Brookfield’s (1997) his-
torical examination, the firm’s strategy is respon-
sible for the genesis of the relevant governance
structure.
This study contributes by providing empirical
guidance for managers that supplementary ser-
vices are not comparable to major components.
The results showed that the modified TCA frame-
work confirms that managers should not simply
evaluate the level of asset specificity in deciding
how services should be procured. Instead, the
decision on the sourcing of supplementary ser-
vices with high asset specificity should be made
while considering the levels of other factors.
The results provide specific managerial direc-
tions. First, because of technological advances
and the lowering of trade barriers in services,
service firms now source services in much the
same way as manufacturing firms source compo-
nents and finished goods. Moreover, because sup-
plementary services are used to enhance and/or
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
augment the core service, production and con-
sumption may not need to take place at the same
time, thus making supplementary services a good
candidate for global sourcing to tap into the best
available supply.
Second, high-specificity firms might rely more
on internal sourcing for inseparable supplemen-
tary services. This result provides important
managerial implications. Because the perception
of service quality is on the decline (Koepp,
1987), providing services, especially inseparable
ones, has become more and more challenging.
This negative perception of service quality is
mostly based on the moment when the customer
and the service provider interact—‘service
encounter’ (Lovelock, 1988). Previous research
suggested that the human interaction component
was crucial to consumer satisfaction/dissatis-
faction (Brown and Swartz, 1989; Crosby and
Stephens, 1987; Surprenant and Solomon, 1987).
In fact, Bitner (1990) found that in some
instances, even if the core services provided are
only adequate, but if the service provider pro-
vided extra supplementary services, the customer
would perceive the encounter as a highly satisfac-
tory incident. For high-specificity firms, the sig-
nificant nature of inseparable supplementary ser-
vices accentuates the need for internal sourcing
to ensure tighter quality control.
Third, high-specificity firms may favor internal
sourcing of supplementary services with decreas-
ing transaction frequency. Indeed, Bitner (1990)
and Booms and Bitner (1981) suggested that
service firms should also emphasize additional
variables (physical evidence, participants, and
process), beyond the marketing mix, in capturing
customer satisfaction. Of these, ‘process’ is
related to the ‘how’ of service delivery instead
of the ‘outcome’ or the ‘what’ of service delivery,
which means that customer satisfaction is not
only based on the final performance of a service,
but also the procedures under which it is car-
ried out.
Therefore, for high-specificity firms, sup-
plementary services should also be sourced inter-
nally if these services are performed infrequently
for the following reasons. First, the lower the
transaction frequency, the lower the justifications
for external suppliers to invest in idiosyncratic
services that require a high level of professional
skills, major investments and training, and
specialized know-how. Consequently, the firm
Copyright  1999 John Wiley & Sons, Ltd.
805
may incur higher costs in finding and screening
potential suppliers. However, in internalizing
these services, the firm is able to control both
the ‘outcome’ and ‘process’ of the service deliv-
ery which may not be attainable through a trilat-
eral governance structure. Second, customer satis-
faction toward a service is different from
perceived service quality (Parasuraman, Zeithaml,
and Berry, 1988) in that satisfaction assessments
relate to individual transactions and that perceived
quality is similar to an individual’s general atti-
tude toward the firm (Zeithaml, 1988). Hence,
customer satisfaction is based on the process
(among other factors) of a particular transaction,
and customer attitude is related to the overall
reputation of a service provider, such as pro-
fessional skills, etc. Although there may be sup-
pliers available to invest idiosyncratic assets for
services that have low transaction frequency, the
firm still runs the risk of not knowing what the
problem is when customer dissatisfaction occurs
even though the overall perception of the service
provider is good.
Third, the lower the transaction frequency of
services that involve high asset specificity, the
higher the level of internal sourcing being used.
The trilateral governance structure, as rec-
ommended by Williamson (1979), may not be
feasible for services since it is more difficult for
a third party (other than the supplier and the
customer) to evaluate the quality of the service
independently. In addition, for the fear of oppor-
tunistic action by the customer, it would be quite
difficult to locate suppliers for infrequent trans-
actions who would be willing to invest specific
assets that would facilitate the production of the
service needed.
The result on the relationship between internal
sourcing of supplementary services and market
performance has important implications. The
assumption on internally sourced major compo-
nents that would give a firm differential advantage
over its competitors may not hold true for sup-
plementary services. The negative relationship
between market performance and internal sourc-
ing of supplementary services is contradictory to
that of a positive one for manufactured goods. In
other words, service firms should refocus on what
they exist for and strive to augment the service
offering to stay competitive. The challenge for
the firm is to design a package (include other
supplementary services in addition to the core
Strat. Mgmt. J., 20: 791–809 (1999)
806 J. Y. Murray and M. Kotabe
service) that is desired by its target market, but
the actual delivery of some of these supplemen-
tary services may be executed by outside sup-
pliers. Furthermore, because of the problems of
cultural differences and geographic distance
between a foreign supplier and the sourcing firm,
the use of foreign sourcing is related to the
service’s market performance negatively. Indeed,
Li and Guisinger (1991) concluded that cultural
distance significantly influenced the failure rate
of foreign services subsidiaries. Therefore, the
use of domestic sourcing of services can help
eliminate problems that arise from cultural differ-
ences.
While this study provides important managerial
implications, one should note that it has several
limitations. First, the dichotomous classification
of the ownership aspect of sourcing does not
capture the increasing popularity of strategic
alliance formation between a supplier and a cus-
tomer. Second, instead of using a global definition
of supplementary services, classifying them into
either people-based, possession-based, or infor-
mation-based services (Lovelock and Yip, 1996a)
may render more insights on sourcing of services.
Third, some of the constructs were represented
by single-item measures. Since well-informed
executives responded to the survey, the quality
of their response could be assured. However, the
scale reliability of those meaures was not quan-
tified. Fourth, in making sourcing decisions, man-
agers would evaluate the comparative production
costs of supplementary services performed inter-
nally vs. those externally; however, this study did
not examine these comparative production costs.
Therefore, the explanation for the results obtained
may be that the production costs externally are
cheaper, and that is why incidence and perform-
ance tie to external sourcing of supplementary
services. Despite these limitations, this study rep-
resents the first attempt to investigate service
sourcing empirically, and hopefully will open
avenues for further research.
Theoretical contributions
Most investigations into global sourcing of ser-
vices employ aggregate data tracking the inflows
and outflows of services to and from a nation.
As global sourcing activities relate to the strategic
readiness of a firm, it is more appropriate to
examine this issue on a firm basis, or, better still,
Copyright  1999 John Wiley & Sons, Ltd.
on a strategic business unit level. This paper is
the first to study global sourcing of services using
strategic business units of diverse service firms
as the unit of analysis.
Furthermore, this study used constructs from
Williamson’s (1979) TCA in examining global
sourcing of services. Teece (1986: 24–25) con-
tended that TCA ‘provides a framework for dis-
criminating between those transactions which
need to be internalized and those which do not.
Without such a framework, internalization
theories of the multinational enterprise must be
considered incomplete, and perhaps even tauto-
logical.’
Although TCA is a principal theoretical
framework in explaining and predicting global
sourcing of products, the unique characteristics
of services (e.g., inseparability) and their varied
levels of capital intensity may limit the explana-
tory power of the conventional TCA on services.
Poole and Van de Ven (1989: 562) critically
asserted that ‘because organizational theories
attempt to capture a multifaceted reality with a
finite, internally consistent statement, they are
essentially incomplete’. In addition, Quinn and
Cameron (1988) contended that significant
advances in management and organization
theory will require ways to address paradoxes
inherent in human beings and their social
organizations. In line with this, recent studies
(Nishiguchi and Brookfield, 1997; Walker and
Poppo, 1991) questioned the traditional relation-
ship between asset specificity and the relevant
type of governance structure. Indeed, the con-
ventional TCA might have to be modified to
capture the sourcing of services, which might
be very different from that of goods. The result
of this study challenged the internal consistency
of transaction–cost theory. However, this study
addresses the following concern expressed by
Poole and Van de Ven (1989: 562): ‘Social
science loses an important resource for theory
development if the incompatible or inconsistent
theses which inevitably arise in the study of
organizations are ignored or are eliminated’.
Furthermore, ‘the tensions, inconsistencies, and
contradictions between theories provide
important opportunities to develop better and
more encompassing theories’ (Van de Ven,
1989: 488). This modified TCA serves as a first
attempt in developing a general theory of global
sourcing of services.
Strat. Mgmt. J., 20: 791–809 (1999)
 Sourcing Strategies of U.S. Service Companies
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