The Use of Intermediate Sourcing Strategies

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The Use of Intermediate Sourcing Strategies

AUTHORS

Kirk C. Heriot

is associate professor of business administration at North Georgia

College & State University in Dahlonega, Georgia.

Subodh P. Kulkarni

is assistant professor of management in the School of Business at

Howard University in Washington, D.C.

Much of the existing literature discusses vertical inte- gration and competitive spot bidding as sourcing strategy choices, but often neglects intermediate sourcing strategies, such as taper integration and long-term supplier relationships. This exploratory

study examines the extent to SUMMARY which firms use intermediate

sourcing strategies, as opposed to the polar strategies, and attempts to improve our understanding of the sourcing choices available to manufacturing firms. Results from.a sample of 209 plant managers indicate that firms use taper integra- tion and long-term supplier relationships more fre- quently than vertical integration and competitive spot bidding. Further, the choice of a sourcing strategy was found to be dependent on the industry.

The Journal of Supply Chain Management A Global Review of Purchasing and Supply Copyright ( February 2001, by the National Association of Purchasing Management, Inc.

INTRODUCTION A firn’s sourcing decisions involve the choice of securing

inputs to its operations. The sourcing decision is variously termed the “market-hierarchy choice,” “vertical integra- tion,” or the “make-or-buy” decision. At the extreme, a -fin may choose to completely outsource or completely internalize its production.

Market (outsourcing) and hierarchy (vertical integra- tion) are, however, endpoints of a continuum of sourcing strategies. Some of the intermediate sourcing strategies incdude taper integration and long-term cooperative rela- tionships (Landeros and Monczka 1989). Much of the existing literature focuses on the “bipolar” choice of out- sourcing and vertical integration (Williamson 1985). Traditionally, the selection of a sourcing strategy involves a static comparison of the costs of outsourcing and ver- tical integration with not much consideration for the intermediate strategies.

Recently, Hennart (1993) asserted that firms are more likely to select intermediate sourcing strategies than out- sourcing or vertical integration. However, there is little empirical evidence that the distribution of sourcing strategies differs across firms. If firns overwhelmingly used either outsourcing or vertical integration, it would mean that the sourcing decision is essentially limited to these two choices. On the other hand, a significant occur- rence of intermediate sourcing strategies may indicate that managers need to broaden their strategic repertoire.

Hennart (1993) stated that the criteria for the selection of intermediate sourcing strategies are not ciear. Tradition- ally, researchers have used a “comparative-static” approach to evaluate the choice of sourcing strategies (e.g., Wllliamson 1985). This usually involves a simultaneous comparison of the costs of outsourcing and vertical integration, over- looking the intermediate strategies. Given the relative lack of theory in this area, there is a need for exploratory studies that examine whether the distribution of sourcing strategies is different across firms. Exploratory studies generally form the first important step in theory devel- opment (Schendel and Hofer 1979).

The primary purpose of this article is to identify the extent to which manufacturing firms use various

18 The Journal of Supply Chain Management I Winter 2001

Authors’ note: The authors’ names are listed in alphabetical order.

.- ‘ -1 4 ; 1 ~ ;, ‘: ;, ‘1 ! , H lt q- ‘ F ‘ . The Use of Internnediate Sourcing Strategies – \ i- Y”f-i eA,^ff

intennediate sourcing strategies. The selection of an as sourcing alternatives. Barter. denotes a purchase of appropriate sourcing-strategy can be important for a goods (dr services) by a finm in exchange for the goods fiEm’s competitive advantage when the sourcing strategy or services of another. This type of sourcing strategy is-“aligned” with the underlying costs (Hayes and Wheel- often offers.substantial tax advantages (Malitz 1998). wright-1984; also see Willliamson.1991a). This.article does- Countertrade arrangements often involve firms from dif- not discuss when intermediate strategies (as opposed to ferent countries. The importing firm can use a number the “bipolar” strategies) can generate a competitive’ *of different types of assets to repay exporters depending advantage. However;-it is conceivable that managers on the type of project, including goods and services, may overlook the intermediate strategies because of (Forker 1997). Sole sourcing involves a contractual rela- their limited knowledge’of sourcing choices, thereby. tionship with one supplier. Multiple sourcing; on the -jeopardizing a,firmn’s competitive advantage. Therefore, other hand, involves dealing with a number of suppliers. . – it is important to know whether, and to what extent, This offers a firm protection against opp6rtunistic.sup- managers have a strategic choice other than-vertical pliers (Richardson 1993). ; – integration and outsourcing. , – –

The remainder of this article is organized as foliows. THEORETICAL BACKGROUND – Tirst,-the types of sourcing decisions are briefly described. Transaction Cost Economics – Second, the theory underlying the choice of a sourcing Transaction cost economics (TCE) .has emerged as a . strategy is examined. Third, the frequency of sourcing theory that explains the choice of a asourcirg strategy

-decisions is investigated empirically. Finally, conclusions (Coase 1937; Williamson 1975, 1985). TCE corisiders – and implications of.the research are discussed-. the behavioral implications of the econormic actors –

TYPESO OURCING TRATEE . ‘. -involved in sourcing decisions. Transaction costs, or. -.: the costs of drafting, negotiating, monitoring, and. .

.A firm’s sourcing strategies may include-vertical inte- enforcing asourcing contract, increase because-of the gration, taper integiation, long-term cooperative rela- .~bounded rationlality and opportunism on the.part of tionships, and competitive spot biddink (Landeros anda p~~ 1989) . . a ~~~~~~~~~firin’~ mianagers and suppliers. Bounided rationality-‘

Mmeans that managers are intendedly rational, but only Vertical integration is the combination of technologi- ‘Iimitedly so (Simon 1961). Opportunism means self-

cally distinct production, distribution, selling, and/or – interest s wt mson 1985). . — – other economic processes within the confines of a single . Transaction costs are largely influenced’bythree tans- firm. ItJis also a dedsion to use internal or administrative action-parameters: asset specificty, uncertainty and the mechanisrms -the hierarchy as Williamson (1975) noted, – frequency of transaction. Asset specfaty refers to the (lack rather than market transactions, to secure nee&d inputs. of ease with which the human ca Vertical integration requires that a fudndamental commit- ical assets, and es petal (employe phys- ment be made to produce items in-house. fclt pcfclyte otemnfcment be.made to produceitemsin-ture of an item.can.be:used by alternative users or put

Taper integration is a combination of vertical;integra- to alternative uses. Transaction-specific assets’lock trans- ‘ ‘ .tion and spot-bid contracts. It.means that a firm buys, acting parties into a bilaterally dependent -relationship, a particular input from outside suppliers in addition to thereby increasing transactionicosts. Similarly, recumring making it in-house (Harrigan.1984). Taper integration transactions are subject to-frequent haggling’with’sup- requires a firn to manage its own production of the input, pliers’. Asset specificity is perhaps the most important. and maintain a relationship with an outside supplier. – parameter that inifluences transaction costs (Williamson “.

Long-term cooperative;relationships sometimes involve 1985). Unpredictability or uncertainty in.the behavior of a form of “credible comritment” on the part of a firm -transacting parties; also raises transaction costs because and a supplier.’For example, a supplier may.make a :transacting:parties.need to safeguard the contract in uncer- financial commitment to supply parts over an extended tain situations. – .i . . . . time period., . — ” . :.’– – Williamson (i985) stated that it may not be necessary,

A firmil may secure inputs by turning to market — to estimate the transaction costs of vertical integiation mechanisms, usually.in the form of a.spot-bid contract and outsourcing. It is usuallyzsufficient to merely compare’ (Williamson 1975). A spbt-bid contract represents -a legal ‘these costs at a given time (i.e., in a-“compaiative-static”. .- agreement between a buyer and a seller to engage in an fashion). Managers choose between vertical integration economic exchange within the parameters established and outsourcing-deperidihg on which economizes on ‘ – in- a written document over a specified time period. the transaction costs. For example, firns with specialized Typically,:a spot-bid contract is completed after one or resourcesimay findit more efficient to integrate vertically,_ .more firms successfully bid for the right to engage in anv whereas those,with unspecializedresources may opt f6r;- economic exchange. – – . outsourcing. – . -‘ C. r -. *

Besides the strategies described above, -firmsmay use – , – . barter, countertrade, sole sourcing, and; multiple souicing’ .

; . ‘ .-. i ‘ -i. :.;:: ::; .. -0-: ,,, The Journal ofSupply Chain ManagementI Winter.2001 19

7he Use of Intermediate Souirng Strategies

Research Questions Traditionally, TCE offers an explanation for the choice of

vertical integration, as opposed to outsourcing. However, the criteria for the selection of intermediate sourcing strate- gies are not clear. Hill, Hwang, and Kim (1990) argued that TCE views a transaction in isolation (e.g., to integrate vertically or not). Therefore, it usually does not allow all transactions to be compared simultaneously. Although some researchers (e.g., Williamson 1991b) have attempted to address these shortcomings, the existing research does not offer concrete guidelines for the choice of intermediate sourcing strategies. Following the spirit of exploratory studies, several “research questions” are outlined in this article instead of developing “hypotheses” (e.g., Schendel and Hofer 1979; Garvin 1986). Next, the rationale under- lying the research questions is outlined.

Anecdotal evidence suggests that a firn’s choice of sourcing strategy is not limited to vertical integration and outsourcing, but also includes intermediate sourcing strategies. As an example, taper integration is considered to reduce the threat of opportunistic suppliers (e.g., Harrigan 1983). Alternatively, long-term cooperative relationships can also help an organization to foster a trusting relationship with suppliers and counter oppor- tunism to some extent. Therefore, in principle, a fimn that aims to reduce the threat of supplier opportunism can choose among vertical integration, taper integration, and long-term cooperative relationships.

A firm with unspecialized assets may find it more effi- cient to outsource than to integrate vertically. However, taper integration and long-term cooperative relation- ships can also serve as substitutes for outsourcing. It is not clear a priori why firms choose the intermediate sourcing strategies, as opposed to the polar strategies, based on the TCE rationale alone.

Question 1: Are firms equally likely to select intermediate sourcing strategies and polar sourcing strategies?

Among the intermediate sourcing strategies, the criteria for the selection of taper integration and long-term coop- erative relationships are not clear. Ring and Van de Ven (1992) stated that a number of firms are adopting coopera- tive supplier relationships m favor of adversarial strategies. In particular, cooperative supply arrangements, such as Just-In-Time, are reportedly becoming more widespread among industrial firms. The trust (or the relative lack of opportunism) between a firm and its supplier, fostered in a cooperative supply arrangement, reduces the transaction costs and results in a competitive advantage-in the long run.

Presumably, a firm can select taper integration instead of a long-term cooperative relationship. Taper integra- tion also requires a greater degree of trust between a firm and its supplier than an adversarial strategy such as competitive spot bidding. Therefore, both taper integra- tion and long-term cooperative relationships provide an altemative to competitive spot bidding.

Question 2: Are firms equally likely to use taper integration and long-term supplier relationships, when choosing an intermediate sourcing strategy?

The industry in which a firm operates may be one of the factors that influence a firm’s choice of sourcing strategy. For example, an industry that is characterized by general-purpose, nonspecialized assets is likely to be asso- ciated with low levels of transaction costs (Williamson 1985). This is because a firm can easily obtain inputs through alternative means, should a supplier act oppor- tunistically. Sometimes, firms develop industry-specific assets through production networks. Production networks among firms often build trust among the players and lower the transaction costs of outsourcing (Carney 1998).

Question 3: Does the type of industry signifi- cantly influence a firm’s sourcing strategy?

METHOD

Survey Design and Sample A questionnaire was developed as part of a larger study

of sourcing strategies. It was mailed to plant managers in 1,000 Southeastern manufacturing facilities. Nine hun- dred eighty-three plant manager names and addresses were used from a list provided by American Business Lists (ABL). An additional 17 had to be drawn at random from the 1995 Industrial Directory because some plants on the ABL list had a policy of not responding to sur- veys. Only two surveys from the original mailing were not deliverable. These two companies were eliminated and replaced with two other companies from the 1995 Industrial Directory to ensure 1,000 companies on the mailing list.

A modified version of Dillman’s Total Design Method (Dillman 1978) was used to develop the instrument, pretest the instrument with plant managers and strategic management scholars, mail the instrument, and follow up on non-respondents. Ten business school faculty members and doctoral students were asked to assess the face and content validity of the survey items (Stone 1978). The resulting instrument was then pretested by 10 plant managers in a cross-section of industries. These interviews yielded useful suggestions to strengthen the face and content validity of the instrument. In each interview, the plant manager was given a cover letter and survey. The managers were asked to read the cover letter and complete the survey in the presence of the researchers. The managers’ actions were observed to detect any delays or indications of concern or confusion on their part. In the event they seemed concemed or confused, clarifications were offered. Feedback was obtained from nine plant managers in nine different industries. A tenth manager declined to participate due to competitive pressures.

20 The Journal of Supply Chain Management I Winter 2001

The Use of Intermediate Souraing Strategies

Tollowing Dillman (1978), several techniques were used on a nominal scale.’Table I also shows the cumulative to increase the response rate. .Three follow-ups were mailed relative frequency distribution for the employee and after the initial mailing of the instrument: I . ‘sales categones.The employee size of the plants ranged

* A postcard was sent one week after mailing the from 20 to .4,999. Sixty-one percent of the’ plants ‘had survey to thank those who had returned the employees’fewer than 250. Sales ranged from.$2.5 mil- survey and to remind those who had not.- lion to $1 billion. Sixty-seven percent of the plants had

* A letter, and questionnaire was’sent three weeks sales less than $50 million. The plants were located in after the initial mailing to non-respondents. seven’Southeastem states.

 

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