SMEs, intellectual capital, and offshoring of service activities: An empirical investigation.

Author:Musteen, Martina
Position:RESEARCH ARTICLE - Report

Abstract Drawing on the extant research on offshoring in international business, entrepreneurship and strategy literature, we develop a model of offshoring of service activities by small and medium-sized firms (SMEs). Using the intellectual capital perspective as a theoretical framework, we hypothesize that the unique configuration of human, social and organizational capital of SMEs will be linked to offshoring of services to international providers. Using data from 119 SMEs in three industry sectors in the US and South Korea, we empirically test the hypothesized relationships and find at least some support for our predictions. Specifically, while we found no country-specific differences in offshoring, SMEs with more social capital and less human capital are more likely to engage in offshoring of service activities. However, the relationship between human and organizational capital and offshoring of such activities is contingent on the size of the SMEs. Implications for theory and practice are discussed.

Keywords Offshoring [??] Human capital [??] Social capital [??] Organizational capital [??] Intellectual capital [??] SMEs

1 Introduction

It is widely accepted that intellectual capital is essential for achieving competitive advantage and enhancing firm's performance (Nahapiet and Ghoshal 1998; Subramaniam and Youndt 2005; Youndt et al. 2004). Intellectual capital refers to an aggregate of three distinct types of capital--human, social, and organizational--which can help organizations attain and sustain competitive advantage. When managed effectively, intellectual capital is an asset that can lead to superior performance. For example, a firm that has high quality engineers (human capital), a trusted network of suppliers and/or distributors (social capital), and well documented operational procedures (organizational capital) will likely have better performance than firms without such resources. In this study, we focus on intellectual capital of smaller firms and the role it plays in offshoring.

Offshoring, defined as shifting a business process to a foreign firm (Di Gregorio et al. 2009; Lewin and Peeters 2006; Manning et al. 2011), has been subject to a lot of controversy in recent years (Smith 2006). Typically, it has been viewed as a phenomenon that allows firms to reduce cost and leads to loss of jobs (Levine 2012). In general, this research has focused on large companies and the number of jobs they moved to other countries (see Crino 2009; Schmeisser 2013; Wiener et al. 2010 for review of the literature). Most of this literature has suggested that firms consider offshoring when they possess advantages associated with disintegration of non-core value chain activities and find it advantageous to perform these activities outside of their home country (Kedia and Mukherjee 2009). Recently, the growing literature on offshore practices identified some interesting new trends (Contractor and Mudambi 2008; Jensen and Pedersen 2010; Roza et al. 2011) and highlighted the impact of offshoring on firm innovation (Mihalache et al. 2012; Nieto and Rodriguez 2011; Peeters et al. 2014). It also suggested that firms increasingly offshore activities such as R&D, software development and customer service.

Although most of the research on offshoring has focused on large multinational enterprises (MNEs), recent studies (e.g., Di Gregorio et al. 2009; Lewin et al. 2009) have shown that offshoring also applies to smaller firms (SMEs). Furthermore, research has demonstrated that cost does not always appear to be the primary reason for offshoring, particularly in case of SMEs and young ventures (Musteen 2016). It appears that SMEs are increasingly tapping the offshore talent in order to innovate and grow. Indeed, recent evidence suggests that SMEs that offshore their R&D activities benefit from increased innovation and sales growth (Rodriguez and Nieto 2016). Despite the growing interest in offshoring in the context of small firms, our understanding of this phenomenon is still fairly rudimentary given that only scant attention has been paid to the unique attributes of small firms that could enable or hamper their ability to offshore. For one, SMEs are typically more resource constrained but also more agile than large corporations, frequently searching for entrepreneurial solutions to either cope with their resource challenges or leverage their unique capabilities (Gupta and Cawthon 1996; Tagoe et al. 2005; van de Vrande et al. 2009). In this study, we argue that one such solution to such challenges is offshoring (Musteen and Ahsan 2013).

Specifically, we suggest that that offshoring of service activities (as opposed to routine, manufacturing tasks) by SMEs is associated with the desire to access resources and competencies while leveraging their external relationships (Doh 2005; Musteen and Ahsan 2013; Rilla and Squicciarini 2011; Stephan and Silvia 2008). We draw on the intellectual capital literature (Subramaniam and Youndt 2005) to develop and test a model of offshoring of service activities by small firms. Consistent with previous literature (Bunyaratavej et al. 2011; Jensen 2009; Peeters et al. 2015; Stringfellow et al. 2008; Youngdahl et al. 2010), we define service as activities which require more "soft" skills than routine manufacturing and include R&D, software development, administrative work and customer service. We argue that SMEs' decision to offshore these activities to offshore providers is driven, at least in part, by the configuration of their intellectual capital. Specifically, we link three categories of intellectual capital--human, social and organizational--to the likelihood of service-based offshoring. We also argue that the link is contingent on the size of the firms. We test our framework empirically using a sample of US and South Korean SMEs in three industry sectors.

While there is a variation in the complexity regarding service activities, research (Peelers et al. 2015) suggests that offshoring of such activities can increasingly occur both via captive models or outsourcing (subcontracting). In our study, we use the term service offshoring in a stricter sense to only refer to subcontracting of service activities to offshore providers. As Nieto and Rodriguez (2011) point out, relative to offshore captive models, subcontracting mode of offshoring is typically more accessible to smaller firms giving them the option to overcome resource scarcity and seek innovation inputs from abroad.

By addressing our research questions--that is, examining (1) whether there is a link between the intellectual capital of SMEs and offshoring of their service activities and (2) whether this link is contingent on SME size--our study is designed to add to the growing literature on offshoring by SMEs. The extant literature has predominantly explained offshoring as a function of cost and/or location advantages for larger enterprises while largely ignoring the characteristics of smaller firms. Besides having a narrower resource and capability base, for example, research has suggested that SMEs are more likely to utilize alliances or external network as a means to enhance their technological competences (Edwards et al. 2005; Rothwell 1991; van de Vrande et al. 2009). However, their ability to partake in such activities can be limited due to their lack of internal technological competence (Narula 2004). Our study thus seeks to contribute to the literature by considering how the unique challenges (and advantages) of SMEs motivate (and enable) them to engage in offshoring of service activities. Since our study draws on the literature in international business (IB), entrepreneurship, and strategy, we hope to add to these literatures by linking the internal resources and external relationships of firms to the decision to perform business activities abroad via offshore providers. We view offshoring as an important mechanism that gives small firms the opportunity to supplement as well as leverage their capabilities by tapping those developed by providers in foreign countries. Thus, our findings should also be of interest to a wide range of scholars.

2 Literature Review and Theoretical Background

Research on offshoring has been conducted in a number of disciplines (e.g., economics, public policy, international business) as well as on different levels of analysis. On the global and national level, studies of offshoring have typically addressed the impact of the offshoring phenomenon on employment and economy (e.g., Farrell et al. 2006; Harisson and McMillan 2006; Patibandla and Petersen 2002). On the industry level, research has been primarily concerned with the drivers of offshoring (e.g., Krishnaswamy and Pashley 2007; Vecina et al. 2012) and impact of offshoring on productivity (Yoon 2014). Firm-level stream of research--to which this study belongs--remains quite fragmented. It has investigated drivers of international outsourcing (Jain et al. 2008), various management aspects of offshoring relationships (Beugre and Acar 2008; Kedia and Lahiri 2007; Levina and Su 2008; Park and Krishnan 2001; Tiwana and Keil 2007), influence of offshoring on organizational and geographical boundaries of the firm (Contractor et al. 2010), impact of internal resources and capabilities on performance of offshoring providers (Lahiri et al. 2012) and performance outcomes associated with offshoring (Bhalla et al. 2008; Caniato et al. 2015; Farinas et al. 2014; Nieto and Rodriguez 2011; Rodriguez and Nieto 2016). Martinez-Noya and Garcia-Canal (2011) in their study examined environmental and firm factors influencing technology intensive firms' decision to offshore R&D services. They found that as the firm's technological resources and capabilities increase, the likelihood of offshoring R&D activity also increases.

Relatively little research has dealt with offshoring in the context of small firms. Di Gregorio et al. (2009) study of US-based SMEs...

To continue reading