Global sourcing of services and market performance: An empirical investigation

Global Sourcing of Services and MarketPerformance: An Empirical Investigation

ABSTRACT

Masaaki Kotabe,Janet Y. Murray,and Rajshekhar

G. Javalgi

Submitted April 1996Revised April 1997

February 1998

^Journal of International MarketingVol. 6. No. 4. 1998. pp. 10-31

ISSN 1069-031X

Global procurement of services has received an increasing amountof managerial attention in recent years. Service firms seem to havebegun sourcing some of their activities from abroad in much thesame way that manufacturing firms have outsourced in the past 30years. However, little is known about the performance implicationsof a service sourcing strategy This study applies, with appropriatemodifications, a global components/finished goods sourcing strate-gy framework to the service sector. It also tests hypotheses relatingservice firms' global sourcing strategy to their market performance.

The world trade in services, which is growing faster than thetrade in goods, represents approximately 25% of the totalvalue of all global trade (Kotabe and Helsen 1998). The major-ity takes place within the Organization for EconomicCooperation and Development (Gdneng 1988); U.S. servicesimports in 1996 amounted to $150.4 billion (StatisticalAbstract of the United States 1997). The dramatic increase inU.S. services procurement abroad, either intra- or interfirm,is attributed chiefiy to government deregulation and techno-logical advances. The revolution in data processing andtelecommunications either makes the tradability of someservices possible or facilitates the transactions economically(Gerstein 1987; Sampson and Snape 1985).

Despite the increase in global procurement of services(Fortune 1994; Liu and McGoldrick 1995), few studies inves-tigate global sourcing issues and performance implications.The literature on service industries in the global arena stress-es their growing importance (Gowell 1983; Palmer 1985;Patterson and Gicic 1995); the motives, process, and prob-lems of internationalization (Bower 1968; Gaedeke 1973);determinants of foreign direct investment (Terpstra and Yu1988; Weinstein 1977); foreign market entry modes (Erramilli1990; Erramilli and Rao 1993); and the propensity for servicefirms to follow major clients abroad (Patterson and Gicic1995). Some of this research is dated, however, and a neg-lected topic is how to manage service procurement for com-petitive advantage (Anderson and Narus 1995).

This study examines the factors infiuencing global sourcingof services by U.S. service firms and the effect of such a strat-egy on market performance. A paradigm developed for com-ponents/finished goods sourcing is modified and applied to

10

the service sourcing context. The article is organized as fol-lows: The next section presents a brief background on globalsourcing of services. On the basis of the literature, hypothe-ses are developed for empirical testing. Subsequently,research methods and results are discussed. Finally, we con-clude w ith managerial implications and study limitations.

A global sourcing strategy generally refers to determiningwhich production units will serve which particular markets GLOBAL SOURCING OFand how components/goods/services will be procured SERVICES(Davidson 1982; Kotabe 1992). Whereas traditional importinginvolves a passive role in procuring merchandise, globalsourcing requires proactive decisions about where, when,what, how much, and from whom to buy (Liu and McGoldrick1995). The reasons for globalization of service industries andtheir sourcing activities are similar to those for manufacturing:labor cost differentials, market access, capital mobility, andincreasing dispersion of intellectual resources (Guile 1988).Foreign sourcing of some services may not be possible, due totheir inseparability, but technological advances in data pro-cessing and telecommunications have made more servicestradable (Patterson and Cicic 1995; Sapir 1982).

The focus of this study is global sourcing of services by serv-ice firms. Similar to procurement of components or finishedgoods, services sourcing has both locational and ownershipaspects. The locational aspect refers to domestic versus for-eign suppliers. Domestic sources are located in the samecountry as the buying firm. Foreign sources are located in adifferent country, such as a printing firm in Hong Kong thatsupplies a publishing company in the United States. At thecountry level, many studies report significant levels of serv-ice imports and exports, especially among industrializednations (Gbneng 1988; Kotabe and Helsen 1998). Using firm-level data. Carter and Narasimhan (1990) find that 16% ofrespondents used foreign suppliers in sourcing services.Although services trade is associated predominantly withinvestment, research on services in the United States suggeststhat the magnitude of service activity generated by trade issubstantially more significant than is publicized (King 1993;Shelp 1981).

The ownership aspect of global sourcing refers to internalversus external sourcing. A firm uses internal sourcing whenit procures services within the corporate system, either a par-ent from its subsidiaries or subsidiaries from their parent orother subsidiaries. External sourcing occurs when independ-ent suppliers are contracted. These activities often crossnational boundaries. For example, when the same publishingcompany in the United States sources printing services fromits subsidiary in Hong Kong, it is engaged in internal sourc-ing. Conversely, if the U.S. publishing company purchasesprinting services from an independent Hong Kong supplier, it

Global Sourcing of Services and Market Performance 11

is externally sourcing. Although studies have examined theownership aspect of global sourcing of services, data on thelevel of internal versus external procurement by multination-al firms are limited or anecdotal (Fortune 1994).

In delineating the growth strategies of service firms, variousresearchers (Anderson and Narus 1995; Carman andLangeard 1980; Lovelock 1992) have highlighted thenecessity of distinguishing core from supplementaryservices.! Core services are the necessary outputs of anorganization that consumers seek, whereas supplementaryservices are either indispensable for the execution of thecore service or are available only to improve the overallquality of the service bundle.^ Using the car rental industryas an example, the core service is providing customers withsafe and well-functioning vehicles for transportation.Supplementary services may include special benefits forfrequent renters, customer pick-up, ease of makingreservations, speedy check-in, availability of maps, and soon. This taxonomy is useful in the study of global sourcing ofservices, because it corresponds to the well-acceptedinternational product cycle thesis that primarily explainshow the sourcing strategy of a multinational firm evolvesover time and space (Utterback 1987; Vernon 1974).3

The competitive advantage of a service firm lies in the per-formance and sustainability of the core and supplementaryservices (Anderson and Narus 1995; Bharadwaj, Varadarajan,and Fahy 1993; Lovelock 1992). A service firm must providegood quality core services to its customers, but increasingly,it must augment these with supplementary services that dif-ferentiate it from competitors and add value for customers.Generally, core services are expected to be performed by thefirm because they are location-bound, but the sourcing ofsupplementary services tends to be location-free (Pattersonand Cicic 1995) and depends on the characteristics of thecore and supplementary services [Fortune 1994). Therefore,the main purposes of this study are to (1) investigate thedeterminants in sourcing of supplementary services and (2)evaluate the performance implications of sourcing strategiesfor supplementary services. A conceptual framework is pre-sented in Figure 1.

=^==^^^==^=^^^^= Despite the paucity of data on the level of internal versusDEVELOPMENT OF external sourcing of global services, many studies stress the

HYPOTHESES ^^^ °^ internal sourcing (e.g., Grubel 1977; Pecchioli 1983). Inthis study, both the locational (domestic versus foreign) andownership (internal versus external) aspects of global servic-es sourcing are examined. Because external sourcing is themirror image of internal sourcing and domestic sourcing isthe opposite of foreign sourcing, hypotheses were developedfor internal and foreign sourcing only to eliminate repetition.In investigating the determinants of global sourcing of servic-

12 Masaaki Kotabe, Janet Y. Murray, and Rajshekhar G. Javalgi

Core Services

Innovativenessof Core Services

External Availabilityof Core Services

Supplementarv Services

/ Innovativeness of \ H 6[ Suppiementary

Services

External Availabliityof Suppiementary

Services

Market Performance

FinancialPerformance

Service Quality

es and its influence on market performance, the most appro-priate level of analysis is the strategic business unit (SBU).Consequently, hypotheses are developed and empiricallytested at the SBU level.

Market performance measures the effectiveness of a businessstrategy. Studies on global sourcing strategy for compo-nents/finished goods use both the strategic (market share andsales growth rate) and financial (return on sales and return oninvestment) dimensions of market performance (e.g., Kotabe1992; Murray, Kotabe, and Wildt 1995). Due to the uniquecharacteristics of services (intangibility and variability), it isalso critical to evaluate the quality dimension of service per-formance. Although the relationship between quality and tra-ditional market performance measures is well established(Jacobson and Aaker 1987; Phillips, Chang, and Buzzell1983), superior service quality confers an especially effectivedifferentiation strategy (Berry and Parasuraman 1991;Bharadwaj, Varadarajan, and Fahy 1993; Quinn 1992).Therefore, in this study, three indicators of performance areexamined: strategic, financial, and quality.

Although service innovativeness can be expected to have apositive influence on the service firm's market performance,core and supplementary services seem to have a differenteffect on the three dimensions of market performance overtime. According to Lovelock (1992), innovativeness in coreservices may give a service provider initial competitiveadvantage (in terms of strategic and, thus, financial perform-ance), but as competition intensifies, supplementary servicesbecome more important (in terms of strategy and servicequality, and, thus, financial performance). In general, cus-tomers assume that the core service will be performed welland evaluate providers on their ability to provide supple-mentary services of value to the customers.

Figure 1.Conceptual Framework forGlobal Sourcing of Services

Market Performance

Direct Link Between ServiceInnovativeness and MarketPerformance

Global Sourcing of Services and Market Performance 13

Thus, supplementary, rather than core, services tend to givethe firm a differentiating strategic and service quality advan-tage over the competition (Lovelock 1992). This tendencybecomes all the more imminent as a product (i.e., a core serv-ice) matures (Quinn and Hilmer 1994). The firm can sustainadvantage through outstanding depth in selected humanskills, logistical capabilities, knowledge bases, and other sup-plementary service strengths that competitors cannot dupli-cate and that lead to greater demonstrable value for the cus-tomer (Prahalad and Hamel 1990; Quinn 1992). Thus, servicefirms tend to use a higher level of supplementary services tostay competitive (by way of strategic and service quality) asthe innovativeness of their core service declines. Therefore,

Hj! The more innovative a firm's core services, thehigher is its strategic and financial performancerelative to the competition.

H2: The more innovative a firm's supplementary serv-ices, the higher is its strategic, service quality, andfinancial performance relative to the competition.

^^^=^^^=^^=^^==^^^= Based on an examination of the literature, two major determi-Determinants of Services nants of services sourcing strategy are the proprietary nature

Sourcine Strategy (product and process innovations in the components/finishedgoods context) and external availability (offshore sourcing inthe components/finished goods context) of core and supple-mentary services. We investigate the applicability of a sourcingparadigm that has been found to work in a components/fin-ished goods marketing context (Kotabe 1992). Although itsdirect application to the services marketing area is arguable,concepts derived from components/finished goods marketingresearch historically have been applied to services marketing(e.g., Bharadwaj, Varadarajan, and Fahy 1993).

Service Innovativeness. The role of innovation has beeninvestigated extensively in international business and eco-nomics using Williamson's (1979) transaction cost and inter-nalization of imperfect markets approach, which underliesthe international product cycle thesis. Previous studies onglobal sourcing strategy of components/finished goods useWilliamson's framework (Buckley and Casson 1976; Dunning1980) to examine the innovation-sourcing linkage (Kotabe1992; Murray, Kotabe, and Wildt 1995) under the generalrubric of the international product cycle. Boddewyn,Halbrich, and Perry (1986) show its applicability in explain-ing the growth of multinational service firms. Transaction-cost analysis helps a firm decide which transactions shouldbe contracted out and which should be performed internally.

According to transaction-cost theory, multinational servicefirms should preserve proprietary knowledge—technologicalknow-how as well as marketing and management skills—

14 Masaaki Kotabe, fanet Y. Murray, and Rajshekhar G. favalgi

within the corporate system to maintain competitive advan-tage. This proprietary knowledge base enables independentservice firms (e.g., Automatic Data Processing, ServiceMas-ter) to specialize in particular activities, automate them, andcreate higher value added at lower cost than their competi-tors (Quinn 1992). By internalizing knowledge and expertise,the firm can keep its technologies to itself without undulydisseminating them to competitors as if they were "public"goods. Internalizing proprietary capabilities in supplemen-tary services is particularly crucial when they are highly idio-syncratic or novel in the marketplace, because theireconomic value to the firm generally exceeds the marketvalue (Buckley and Casson 1976; Dunning 1980). Further-more, due to the intangibility and variability of services,maintaining the quality of distinctive services is necessary toretain the goodwill and confidence of consumers (Casson1982). Therefore,

Hgi The less innovative a firm's core services, the morethe firm relies on internal sourcing of supplemen-tary services for competitive advantage.

H4: The more innovative a firm's supplementaryservices, the more the firm relies on internal sourc-ing of supplementary services for competitiveadvantage.

With respect to the locational aspect of sourcing, as in thesourcing of components and finished goods (Kotabe 1992),service innovativeness plays an important role in influencinga service firm's decision about domestic or foreign suppliers.As in manufacturing, the proximity of the source facilitatesthe interaction and feedback critical to the service provider'sperformance and customer satisfaction (Bharadwaj,Varadarajan, and Fahy 1993). In addition, because of the per-ishability and inseparability of some services, which requirecustomer involvement in production, proximity of the serv-ice provider to the receiver is imperative until these servicesbecome a "commodity" service (Lovelock 1992). Also, Minand Galle (1991) report that firms are concerned about quali-ty assurance and language barriers when sourcing both goodsand services overseas. These issues may be especially pro-nounced for services, particularly highly innovative core orsupplementary services. Therefore, we would expect that thegreater the innovativeness of supplementary services, thelower is the level of foreign sourcing.

In the case of highly innovative core services, a service firmalso may be constrained to in-house sourcing, as predicted inthe early stage of the international product life cycle. To com-pensate for this locational constraint, the firm might capital-ize on the cost and strategic advantages of tapping into for-eign supply of supplementary services (those that are not

Global Sourcing of Services and Market Performance 15

highly innovative). Rapid technological change and shortproduct life cycle are the most salient factors in proactivebehavior by multinational firms, whether U.S. or foreign(Miles and Snow 1986; Porter 1986; Schuller 1988).Furthermore, the purchasing literature confirms that execu-tives generally prefer components and finished goodssourced from abroad for cost and quality reasons (e.g., Birouand Fawcett 1993; Carter and Narasimhan 1990).

Foreign sourcing for supplementary services might be desir-able when there are additional benefits used for differentia-tion, cost reduction is possible, and they are not consumedwith the core services simultaneously. In other words, whenproximity is not crucial, supplementary services are moretradable [Fortune 1994). Core services require proximity tothe market, but technological advances in data processingand telecommunications have made it increasingly feasiblefor a service firm to source supplementary services byassembling and electronically storing, transmitting, process-ing, and retrieving words, numbers, images, and sounds(Cerstein 1987). Porter and Millar (1985) further argue thatinformation technology provides service firms new ways tooutperform rivals through cost reduction and differentiation,construction of entry barriers, and sometimes completechanges in the basis of competition. Since information tech-nology has made the tradability of some supplementary serv-ices across national boundaries possible [Fortune 1994;Cerstein 1987; Sapir 1982), service firms can compensate forthe general lack of flexibility in sourcing innovative coreservices by procuring supplementary services in the globalmarket. Therefore,

Hg: The more innovative a firm's core services, themore the firm relies on foreign sourcing of supple-mentary services.

Hg! The more innovative a firm's supplementaryservices, the less the firm relies on foreign sourcingof supplementary services.

External Availability. The availability of alternative suppliersinfluences the intensity of competition in an industry, as wellas the bargaining power of suppliers and buyers, which in turnaffects the internal or external sourcing choices of firms. Thenumber of suppliers available, domestic and foreign, affectsthe sourceability of the service from multiple suppliers (Porter1980). If many suppliers are capable of providing the core serv-ices or if different aspects of these services can be obtainedfrom different service providers, the service firm can no longerdifferentiate itself from competitors on the basis of its coreservice dimension. Thus, the service firm is expected to relyheavily on its supplementary services for competitive advan-tage when the external availability of core services is high.

16 Masaaki Kotabe, fanet Y. Murray, and Rajshekhar C. favalgi

In contrast, if supplementary services are readily available fromindependent suppliers, the service firm may rely all the moreheavily on internal procurement of these services for two rea-sons. First, as discussed previously, core services are the neces-sary outputs of a service firm that consumers seek, whereassupplementary services are either indispensable for the execu-tion of the core service or available only to improve the overallquality of the service bundle. It is supplementary services thathelp improve competitive advantage over time (Lovelock 1992).Second, the intangibility and variability of services require thatthe service firm internally manage the quality of distinctivesupplementary services to retain the goodwill and confidenceof consumers (Casson 1982). Therefore,

H7: The more readily available a firm's core servicesfrom external sources, the more the firm relies oninternal sourcing of supplementary services forcompetitive advantage.

Hg: The more readily available a firm's supplementaryservices from external sources, the more the firmrelies on internal sourcing of supplementary services for competitive advantage.

The availability of alternative suppliers also has implicationsfor sourcing location. As a service matures, the industrystructure may resemble that of perfect competition, withmany suppliers and buyers. Therefore, one would expect thatthe more readily available a firm's core services, the more thefirm must rely on supplementary services for gaining com-petitive advantage. According to the international productlife cycle theory (Utterback 1987; Vernon 1974), mature serv-ices are prime candidates for foreign sourcing, based on cost.Also, the effect of proximity on the quality and tradability ofservices may be reduced: As production processes becomestandardized, the quality of delivery can be controlled moreeasily. In addition, technological advances help decouple theconsumption and production of services, especially thosethat are mature. Therefore,

Hg! The more readily available a firm's core servicesfrom external sources, the more the firm relies onforeign sourcing of supplementary services.

H^Q-. The more readily available a firm's supplementaryservices from external sources, the more the firmrelies on foreign sourcing of supplementary services.

Previous empirical research examining the relationship of glob-al components/finished goods sourcing and market performancemostly uses aggregate data (Kim 1986; Moxon 1974). One study(Kotabe 1992) concludes that internal sourcing of crucial (non-standardized) components is related positively to a finished

Global Sourcing of Services and Market Performance

Market Performance Effects ofGlobal Services Sourcing

17

good's market performance. However, whether a firm assemblesthe finished good internally or externally or domestically orabroad does not significantly influence its market performance.The finding on crucial components is consistent with the pre-diction of transaction-cost theory (Buckley and Casson 1976;Williamson 1979). When markets for intermediate goods andproprietary technology are imperfect, multinational firms aremore likely to internalize and control inefficient market transac-tions; often, these internal transactions transcend nationalhoundaries. The internal transfer of crucial components signifiesfirms' motivation "to maximize the henefit of R&D effort andcommitment to maintain and/or improve their competitivenesson a global basis" (Kotabe and Swan 1994, p. 121).

Although the evidence is anecdotal. Fortune (1994) reportsthat more and more firms are sourcing supplementary servic-es externally. Although these services are used to maintainand/or enhance the value of core services, providing theminternally may not he advisable or feasible. In many cases,they are not within the domain of the firm's core competen-cy, so the service firm may not he ahle to provide them atcompetitive cost. In other words, internal sourcing of crucialcomponents in the manufacturing industry is known to berelated positively to a firm's market performance, but theopposite seems to apply in the case of supplementary servic-es in the service industry. Therefore,

H^i Internal sourcing of supplementary services isrelated negatively to the firm's market perform-ance in terms of (a) strategic performance, (h)financial performance, and (c) service quality.

Another implication of research on global sourcing in manu-facturing is that production location has little bearing on thefirm's market performance, because most components or fin-ished goods are transported easily (e.g., Kotabe 1992). Whetherthis applies in the service context is doubtful for two reasons.First, the perishability and inseparability of services make itdifficult, if not impossible, for services to be performed awayfrom the customer. Therefore, the extent of domestic sourcingdetermines the agility of a service firm and should have a pos-itive effect on its market performance. Second, as the interna-tional product cycle thesis (Utterhack 1987; Vernon 1974) sug-gests, foreign sourcing hegins in order to maintain cost com-petitiveness as manufactured goods mature and competitionintensifies over time. In other words, foreign sourcing wouldbe a service firm's strategic reaction to its declining competi-tiveness (Quinn and Hilmer 1994). Therefore,

Hi2: Foreign sourcing of supplementary services isrelated negatively to the firm's market perform-ance in terms of (a) strategic performance, (b)financial performance, and (c) service quality,

18 Masaaki Kotabe, Janet Y. Murray, and Rajshekhar G. Javalgi

The data for this study were collected hy a mail survey ofFortune 500 U.S. service firms and their major affiliates. Theunit of analysis is sourcing decisions at the SBU or divisionallevel. Because the target sample group consists of large serv-ice firms whose top management at headquarters might not beinvolved in individual sourcing decisions, it was important toidentify informants knowledgeable about sourcing operations.As noted in the literature, reliance on a single informant mightnot enable an assessment of either the reliability of informantreports or potential sources of error in such reports. Becauseof this concern, extreme care was taken to ensure that appro-priate personnel responded to the questionnaire.

The data were collected in two stages. In the first stage, an intro-ductory letter requesting participation was sent to the presi-dent/CFO of the Fortune Service 500 firms and their major affil-iates to determine if they engaged in glohal sourcing of servic-es. If they did and agreed to participate, they were asked toidentify up to three major divisions (SBUs) and name the exec-utives in direct charge of service sourcing operations. Thisprocess resulted in the identification of 202 potential SBUs andtheir respective executives to he contacted in the second phase.

A questionnaire was developed and extensively pretestedwith managers involved in service sourcing activities forfirms located in two metropolitan areas of the United States(one in the Midwest and one in the Southwest), In the secondstage, the refined questionnaire was mailed to the 202 execu-tives along with a personalized cover letter; two follow-upswere sent as needed. Twenty-two executives declined to par-ticipate hecause they believed the questionnaire was too sen-sitive in their line of husiness (14 cases), did not appropri-ately capture their sourcing decisions (4 cases), or did notapply in any significant way to their activities (4 cases). The100 usahle questionnaires returned from the remaining 180executives constituted a response rate of 49.5%. There wereno significant differences on the key constructs between earlyand late respondents.

Eighty percent of the respondents are in the cadre of top man-agement at the divisional level (presidents, vice presidents,and directors); the rest are functional managers (marketing,finance, international procurement, and so on) or strategicplanning executives. Their positions ensure the credibility ofinformation provided. To determine whether job positionaffected responses, the surveys were classified into three cat-egories (top management, functional manager, or director ofcorporate planning), and the variahles were compared. Nosignificant differences were ohserved.

Thirty-four percent of the sample represented financial husi-nesses (hanks, securities, and insurance). Utility and trans-portation firms constituted 17% and 13% of the sample.

METHODOLOGY

Data

Profile of the Sample

Global Sourcing of Services and Market Performance 19

respectively. Construction and puhlishing/communicationcompanies represented 8% each. Retailing/wholesaling husi-nesses represented 5%, and health care 4%, Others were notspecified. The distrihution oi Fortune Service 500 companieswas generally well represented in the sample.

On average, services obtained from abroad constituted 9,8%of the total cost of services provided to customers. Thiscompares well to the figures of 10,3% reported for U,S,multinational firms in the manufacturing sector (Kotabe andScott 1994), Such similarity in the extent of glohal sourcingbetween service and manufacturing firms strongly suggeststhat service firms are not necessarily laggards in this regard,

^=^=^^=^^^==^=^=^^^= Prior to testing the hypotheses, principal components analy-Analysis and Results sis was conducted with varimax rotation to develop the

measures to represent the constructs in the model. Thisanalysis showed that three factors represent three differentdimensions of market performance (strategic performance,financial performance, and service quality), as expected.Therefore, the performance implications of service sourcingstrategy were examined separately for each of the three per-formance measures. The measures used for this study, alongwith their Cronhach's alpha values, are presented in theAppendix,

The relationships hypothesized in the conceptual fiameworkin Figure 1 were tested using a series of regression analyses.The sample constraint prevented us from employing a simul-taneous structural equations model. The analysis followed athree-stage procedure. The first stage investigated a directeffect of service innovativeness on market performance.Regression analysis was run on the direct effect of core andsupplementary service innovativeness on each of the threedimensions of market performance. The models were signifi-cant for strategic (R = ,20, p = ,002) and service quality (R =.10, p = ,10) dimensions of market performance, hut not forfinancial performance (R = ,09, p = ,13), Only the significantresults are presented in Tahle 1,

As expected, the innovativeness of both core and supple-mentary services were related positively to the strategicdimension of market performance (p = ,02 and p = ,04,respectively, fi^om Table 1, Part A), and the innovativeness ofsupplementary services was related positively to the servicequality dimension of market performance {p = ,02 from Tahle1, Part B), Innovativeness had little hearing on the financialdimension of market performance, which was not expected.Therefore, H and H2 received support for strategic and serv-ice quality dimensions of market performance, respectively,hut not for financial performance. Incidentally, though no for-mal hypotheses were stated, availability of core services fiomindependent providers was not at all significant in explaining

20 Masaaki Kotabe, Janet Y. Murray, and Rajshekhar G. Javalgi

VariableStandardized t-

Coefficient value value

A, Strategic Performance (R2 = ,20, F = 4,58, significant at tbe ,002 level)Innovativeness of core services ,311 1,99 .02Innovativeness of supplementaryservices ,231 1,73 .04External availability of coreservicesExternal availability ofsupplementary services

B. Service Quality Performance (RInnovativeness of core servicesInnovativeness of supplementaryservicesExternal availability of coreservicesExternal availability ofsupplementary services

= ,10, F

-.11

-.24

= 2.05,.10

.281

-,19

.05

-.69

-1.73

significant at tbe.60

1.88

-1,06

,29

,25

.04

.10 level).28

,03

,15

,39

service firms' market performance. In contrast, external avail-ability of supplementary services was found to be relatednegatively to firms' strategic performance. This finding isplausihle, hecause ahundant independent suppliers wouldrender supplementary services nondistinguishahle as a com-petitive weapon.

In the second stage, the determinants of internal and for-eign sourcing of supplementary services were examined.The regression model for the internal sourcing of supple-mentary services was not significant [p = ,24, not shown).Therefore, H3, H4, H7, and Hg were not supported. Theregression model for foreign sourcing of supplementaryservices was significant (R = ,16, p = ,01), The results arepresented in Tahle 2,

According to H5, the greater the innovativeness of the coreservices, the greater is the reliance on foreign sourcing of sup-plementary services. Although a positive relationship wasobserved, it was not significant (p = ,24), so H5 is not sup-

Variable

Innovativeness of core servicesInnovativeness of supplementaryservicesExternal availability of coreservicesExternal availability ofsupplementary services

Note: R2 = ,16, F = 3,46, significant

StandardizedCoefficient

.21

-.14

,68

.33

at tbe ,01 level.

t-value

.72

-.56

2.37

1.26

P-value

.24

.29

.01

.11

Table 1.Regression Results for theEffect of ServiceInnovativeness on MarketPerformance

Table 2.Regression Results forForeign Sourcing ofSupplementary Services

Global Sourcing of Services and Market Performance 21

Table 3.Regression Results for

Strategic and FinancialPerformance

ported. Hg states that the more innovative the supplementaryservices, the less is the reliance on foreign sourcing of theseservices. The results showed a negative but insignificant [p =.29) relationship; therefore, Hg is not supported. Hg and H oexamine the effects of the availability of core and supplemen-tary services on the firm's foreign sourcing of supplementaryservices. The results support Hg; the greater the external avail-ability of core services, the greater the level of the firm's for-eign sourcing of supplementary services [p = .01). Although asimilar tendency emerged for the availability of supplemen-tary services, the relationship fell somewhat short of signifi-cance (p = .11); therefore, H^Q does not receive strong support.

In the third stage, the relationship between sourcing strategy(internal and foreign sourcing of supplementary services) andeach of the performance measures (strategic, financial, andquality) was evaluated. The models were significant forstrategic (R = .07, p = .07) and financial (R = .10, p - .01)performances, but not for quality performance [p = .76).Therefore, only the significant models for strategic and finan-cial performance are presented in Table 3.

H^ addresses the effect of internal sourcing of supplementaryservices on the firm's strategic performance (H^ a), financialperformance (H^J, and service quality (H,iJ. Both H^^ {p =.02) and H^b ip = -02) are supported; H^ , is not (p = .33).Thus, it appears that the higher the level of internal sourcingof supplementary services, the lower is the firm's market per-formance in terms of (a) strategic and (b) financial perform-ance, but not (c) service quality.

The final hypothesis addresses the infiuence of foreign sourc-ing of supplementary services on the firm's strategic perform-ance (Hi2a). financial performance (Hi2b). and service quality(Hi2c)- The negative, statistically significant estimates for Hi2a(p = .05) and Hi2b (p = -003) suggest support for the hypothe-ses. Although the direction of infiuence on service quality wasnegative (as hypothesized), the relationship was insignificant(p = .34). Therefore, the greater the extent of foreign sourcing

VariableStandardized

Coefficientt-

valueP-

value

A. Strategic Performance (R2 = .07, F = 2.81. significant at the .07 level]

Internal sourcing of supplementary services -.23 -2.21 .02Foreign sourcing of supplementary services —.11 -1.66 .05

B. Financial Performance (R2 = .10, F = 4.46, significant at the .01 level)

Internal sourcing of supplementary services -.22Foreign sourcing of supplementary services -.20

-2.04 .02-2.80 .003

22 Masaaki Kotabe, fanet Y. Murray, and Rajshekhar G. favalgi

of supplementary services, the lower is the level of the firm'smarket performance in terms of (a) strategic and (b) financialperformance, but not (c) service quality.

Our study applied and modified a global sourcing strategyframework originally developed for manufacturing firms.This is the first empirical research on the performance impli-cations of global sourcing'for services using multi-industrydata. Some hypotheses were supported, which suggests thatthe paradigm may not be completely applicable to services.The findings indicate that proper development of a sourcingstrategy for services would increase a firm's market perform-ance. Furthermore, the nature and structure of the servicesindustry have a significant influence on the feasibility andappropriateness of the type of sourcing strategy used.

Naturally, the equations used in this study can be regarded asa system of equations. They each were estimated separatelybecause of sample size considerations. When viewing the sys-tem of equations, separate equation estimation may lead to abiased estimate of the whole system. Subsequent researchshould focus on estimating the whole system simultaneously,now that the feasibility of the single equations has been shown.

Our primary research interest was the influence of servicesourcing strategy on market performance, above and beyondthe direct effect of innovativeness. It was found that innovationin core and supplementary services is crucial for strategic per-formance, and for supplementary services, it adds to servicequality. This finding is consistent with Lovelock's (1992) asser-tion that the service firm's core services must be augmented bythe innovativeness of supplementary services over time.

One focus was the determinants of internal and foreignsourcing of supplementary services. Several factors weidentified (innovativeness and external availability of coreand supplementary services) did not have a significanteffect on the level of internal sourcing of supplementaryservices. The results indicate that the ownership aspect ofsourcing these services may be different from that of crucialcomponents in manufacturing. Because crucial componentsprovide competitive advantage to a manufacturer, theirsourcing should be internalized (Kotabe 1992; Murray,Kotabe, and Wildt 1995).

Yet, even though supplementary services often are used to aug-ment the core service for value-added purposes, these two maynot be related. For example, a barbecue chain offers the coreservice of preparing good-tasting barbecue and the supplemen-tary service of home delivery. Generally, it would rely on inter-nal sourcing ofthe core service (i.e., the chain would prepareits own barbecue) but could use external sourcing for the sup-plementary service (i.e., the chain would rely on Federal

CONCLUSIONS

Determinants of GlobalSourcing for Services

Clobal Sourcing of Services and Market Performance 23

Express for the delivery). In other words, it is inappropriate orchallenging for the firm to operate in two industries.

Similar to manufactured goods, more and more supplemen-tary services are sourced from foreign suppliers. The resultsof this study show that the more availahle the core services(and supplementary services, to some extent) from independ-ent suppliers, the greater is the extent of foreign sourcing ofsupplementary services. That is, if there is an ahundant sup-ply of core and supplementary services from independentsources, the service firm's competitive advantage will hediminished in the home market. To stay competitive, the firmtends to resort to foreign suppliers for supplementary servic-es. As discussed previously, these services are more likely tohe separahle than are core services.

In general, core services represent the "front office" offerings,whereas supplementary services are mostly performed in the"hack office" (Lovelock and Yip 1996). Increasingly, U.S. com-panies are shifting some hack office activities (e.g., applica-tions support) to countries such as Ireland, India, andArgentina to capitalize on cost advantages (Ramarapu,Parzinger, and Lado 1997). Therefore, the more availahle thesesupplementary services are in the glohal market, the greater thelikelihood of foreign sourcing. In addition, "historically, husi-nesses that rely on trust and the reputation of their personnel—such as law firms and other professional service providers—have found it difficult to demonstrate quality to potential for-eign customers and to adopt a professional style that fits thelocal culture" (Lovelock and Yip 1996, p, 81), This prohlemwould he exacerhated for highly innovative core services andwould not he eliminated even if they were widely availahle.

For supplementary services, the ownership aspect of glohalGlobal Sourcing of Services sourcing (the extent of internal sourcing) is related negatively to

and Market Performance two dimensions of a service firm's market performance: strategicand financial performance. In other words, a service firm thatdevelops supplementary services in-house may end up dilutingits core service competencies. Our findings reinforce the notionthat the core competency of a service firm lies in providing coreservices, which is its main function. By augmenting the servicepackage to add more value and differentiation, the firm likelywould maximize its market performance, hut these supplemen-tary services (which might not he related to the core functions ofthe firm) should he procured from independent suppliers.

Kotahe (1992) indicates that the locational aspect of glohalsourcing (the extent of foreign sourcing) of components is unre-lated to a product's market performance. Our findings differ inthe case of services. The results show that foreign sourcing ofsupplementary services is related negatively to two dimensionsof a service firm's market performance (strategic and financial).This is mainly hecause of the inherent differences hetween

24 Masaaki Kotabe, Janet Y. Murray, and Rajshekhar G. Javalgi

manufactured goods and services. Components and finishedgoods can be stored for future use, so decisions about where tosource them are contingent on the cost or strategic benefitsinvolved. However, the perishability and inseparability of aservice may introduce location and tradability constraints.Furthermore, Li and Guisinger (1991) find that cultural distancehas a significant inftuence on the failure rate of service industrysubsidiaries abroad. In summary, foreign sourcing for servicescan have transmission/processing costs, and geographic andcultural distance can create problems with quality control andfeedback that may hurt a service firm's market performance.

This research is the first attempt to investigate global sourc-ing of services by service firms, and as an exploratory study,it has certain limitations. First, the hypotheses were based ontheories related to manufacturing, so the results should beinterpreted with caution. Second, the sourcing of supple-mentary services may be contingent on their type; they can beclassified as information-, people-, or possession-processing,and each may place different constraints on a service firm'ssourcing activities (Bharadwaj, Varadarajan, and Fahy 1993;Lovelock and Yip 1996).

Variable Measure

Innovativenessof Core Services

Innovativenessof SupplementaryServices

A 4-item measure. .84

To our firm, the level of serviceinnovation in the core services (i.e..the innovativeness of the coreservices) is ... (1 = very low, 5 =very high).

To our firm, the level of processinnovation in the core services (i.e.,the set of innovative ideas involved inproviding the core services) is ... (1 =very low, 5 = very high).

The numher of potentialapplications (or uses) ofthe service innovations in the coreservices (i.e., the set of innovativeideas involved in providing the coreservices) is ... (1 = very low, 5 = very high).

The numher of potential applications(or uses) of the process innovationsin the core services (i.e., the set ofinnovative ideas involved inproviding the core services) is ... (1 =very low, 5 = very high).

A 4-item measure. .81

The same as ahove, except for thesuhstitution of "supplementaryservices."

Cronbach's Alpha APPENDIX

Measurement Items

Global Sourcing of Services and Market Performance 25

Variable

External Availabilityof Core Services

External Availabilityof SupplementaryServices

Foreign Sourcingof SupplementaryServices

Internal Sourcingof SupplementaryServices

Measure

A 3-item measure.

The number of external serviceproviders capable of providing tbecore services is ... (1 = very few,5 = very many).

It is possible to serve our U.S.customers by producing the coreservices abroad and importing them tothe U.S. (1 = strongly disagree, 5 =strongly agree).

It is possible to serve our customersby producing different aspects of tbecore services by more than one serviceprovider (our firm and/or other serviceproviders) (1 = strongly disagree,5 = strongly agree).

A 3-item measure.

The same as above, except for thesubstitution of "supplementary services.

A single-item measure.

For service industries, servicesprovided to a firm's customers areoften performed by tbe firmitself and/or by otber serviceproviders. Regardless who theservice providers to our customersare (i.e., our firm and/or otherservice providers), thepercent of the total costs ofsupplementary services currentlyobtained from sources outside theUnited States is %.

A single-item measure.

In our firm, the percent of the totalcosts of supplementary servicescurrently provided by our firm,our parent, and fully- and majority-owned affiliates witbin our corporatesystem (i.e., internal members) is %.

Alpba

.71

.70

n.a.

n.a.

Strategic Performance A 2-item measure. .83

Relative to our three largest competitorsover the last three years in the U.S.market, our market share is ... (1 = muchlower, 5 = much higher); oursales growth rate is ... (1 = much lower,5 = much higher).

Financial Performance A 3-item measure. .84

26 Masaaki Kotabe, fanet Y Murray, and Rajshekhar G. Javalgi

Variable Measure Alpha

Service Quality

Relative to our three largestcompetitors over the last three yearsin the U.S. market, our return onsales is ... (1 = much lower, 5 = muchhigher); our return on investment is ...(1 = much lower, 5 = much higher);our return on equity is ... (1 = muchlower, 5 = much higher).

A 2-item measure.

Relative to our three largestcompetitors over the last three yearsin the U.S. market, service qualityis ... (1 = much lower, 5 = muchhigher); service value is ... (1 = muchlower, 5 = much higher).

.87

Carman and Langeard (1980) refer to "peripheral" serv-ices, whereas Anderson and Narns (1995) and Lovelock(1992) use the term "supplementary." In this study,core services are those that fulfill customers' needs for abasic benefit and are similar to competitors' offerings.Supplementary services are those that facilitate and en-hance the use of core services and provide advantagesovercompetition.Although the terminology used in the literature can beconfusing, it should be noted that Prahalad and Hamel's(1990) core competency argument applies more to supple-mentary than to core services. They argue that acquiring afar superior position over competitors in some activitiesalong the value chain is crucial for a firm to differentiateand maintain its competitive advantage. As Anderson andNarus (1995) and Lovelock (1992) argue,however, servicefirms that emphasize just core services as their core com-petency may be at a competitive disadvantage due totheir inherently un- or under-differentiated nature.The international product cycle model provides a com-pelling description of dynamic patterns of internationaltrade in manufactured products and direct investment as aproduct advances through its life cycle. The model incor-porates the phenomenon of overseas direct investment inrelation to international trade, stressing successive stagesof product standardization (i.e., technology diffusion),manufacturing process innovations, and product sourcingthrough time and space. The model provides a dynamicframework for the timing of innovation, the effects of scaleeconomies, and the influence of ignorance and uncertaintyon trade patterns. Changes in inputs and product charac-teristics that tend toward standardization over time woulddetermine the most economic production location at anyparticular phase of the product's life.

NOTES

THE AUTHORS

Masaaki Kotabe is the WashburnChair of International Businessand Marketing and director ofresearch at the Institute of GlobalManagement Studies at TempleUniversity.

Janet Y. Murray is associateprofessor of marketing andinternational business atCleveland State University.

Rajshekhar G. favalgi isprofessor of marketing atCleveland State University.

Clobal Sourcing of Services and Market Performance 27

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