Innovar

Profiling the Firms

Small and Medium-sized Enterprises

"Small and medium-sized enterprises (SMEs) are non-subsidiary, independent firms which employ fewer than a given number of employees. This number varies across countries" (OECD, 2005, p. 17). Some scholars consider SMEs as specialists, suppliers of raw materials, components, parts, and subassemblies to MNEs, thereby becoming a key player in the global supply chain setup. SMEs are seen as narrower in vision, with shorter term goals than MNEs. Typically, SMEs deal with a highly centralized decision-making process, small capital base, limited information database, and low R&D emphasis, vis-à-vis MNEs (Morya & Dwivedi, 2009).

Besides the differences between SMEs and MNEs described by Morya and Dwivedi (2009), the literature on SMES highlights some of the characteristics of these firms that make their entry to foreign markets and the expansion of sales more difficult than that of MNEs. Internal lack of resources and skills seems to be a distinctive characteristic and the one most agreed upon by researchers (Chetty & Agndal, 2007; George et al., 2005; Kamyabi & Devi, 2011; Murphy et al., 2012; Oviatt & McDougall, 1994; Reuber & Fischer, 1997). Additionally, George et al. (2005) also include international inexperience as a particular feature of SMEs.

Emphasizing another distinctive feature of SMEs, Chetty and Holm (2000), Di Gregorio et al. (2009) and Korhonen, Luostarinen and Welch (1996), mention that some researchers, without focusing on the extent and scope of SMEs internationalization, have found some evidence indicating that the process of doing business outside the country of origin usually begins with the sourcing activity instead of the direct and indirect exports. Still, the small set-up makes it difficult for these firms to fully achieve economies of scale, which in turn causes an increase in overhead costs (Agrawal et al., 2010).

Additionally, Di Gregorio et al. (2009) point out that SMEs have a strong entrepreneurial perspective and an ability to adopt innovations that arise from their relations abroad. Others underline the ability of SMEs to adapt their structures and processes to the dynamic of overseas competition (Liesch & Knight, 1999). In this line, Etemad (2004) mentions that these firms are known for having a rapid pace, evidenced in the short life cycles of products and technology and the high cost of R&D.

Manufactures

Manufacturing has particular characteristics that distinguish it from other economic sectors. Lovelock and Wirtz (2016) mention that, typically, inputs and outputs needed for operational activities tend to be consistent, and that inventory is possible considering that goods can be stored. Additionally, according to these authors, manufacturing requires physical distribution channels, and clients are not involved in the production of the goods.

Somehow, all of the above characteristics make it possible to subcontract manufacturing activities in countries outside national borders. For example, when standardization of production is achieved, replication is feasible in other parts of the world. Similarly, one of the advantages of having inventory is that during the time span needed for goods to move from a location to the consumer, demand can be met with the product in storage. Moreover, production processes can be established in remote locations since clients are not directly involved in them. Finally, goods need to be moved from the manufacturing site to the buyer through physical channels, regardless of the location of the customer. For these reasons, the trend towards (offshore) outsourcing of manufacturing-related activities has been particularly pronounced (McIvor, 2010).

Services

Services firms usually carry out activities that can be classified into two types: the core service and the supplementary services (Kotabe & Murray, 2004; Lovelock & Wirtz, 2016). The core service includes those activities the company must provide and perform well to stay in business, while the supplementary services are those needed to carry out the core service or to improve its quality (Kotabe & Murray, 2004). The latter are probably more likely to be conducted offshore.

Tate and Ellram (2012) mention two aspects that differentiate services from goods: the nature of the relationships and how value is created. In this regard, academics have come up with a variety of characteristics to conceptualize this differentiation, particularly agreeing in four of them (Lovelock & Gummesson, 2004). The first characteristic is intangibility, meaning that services cannot be touched or grasped mentally, and this is considered a critical distinction. The second is heterogeneity, which refers to variability or difficulty in achieving uniform output. The third is inseparability, denoting a simultaneous production and consumption process. The fourth and last is perishability, which means that services cannot be saved, stored, resold or returned. Most of these characteristics represent a challenge for services firms in regards to performing particular activities overseas.

The degree of intangibility provides a way to classify services firms as "pure" or "non-pure", depending on the amount of tangible or intangible elements embedded in their activities (Shostack, 1977). Service-related activities with a higher degree of intangibility usually require the involvement of people (Kotabe & Murray, 2004; Lovelock & Yip, 1996) and tend to be more customized in order to fit the needs of particular customers (Bitner, Brown & Meuter, 2000; Kotabe & Murray, 2004). In contrast, services firms that engage in activities with a lower degree of intangibility typically make use of physical goods, which implies there is a gap between the order and the actual delivery of the good (Kotabe & Murray, 2004).

According to Lovelock (1983), a useful way to identify suitable strategies for services is to group them by their shared characteristics. In this context, the author presents a classification scheme that considers the nature of the service act, the relationship between the service firm and the customer, the customization and judgment in the service delivery, the nature of demand and supply, and the method of service delivery. This classification makes it possible to define which activities can be more easily outsourced abroad.

Offshore Outsourcing: The Motivations Underneath

Academics have combined different theoretical approaches to address the motivations of firms that seek subcontracting their activities, either domestically or overseas. Cost, resource and organizational perspectives have been the most reiterated explanations for outsourcing, particularly among MNEs. Some scholars (Di Gregorio et al, 2009; Sinha et al, 2011) argue that such explanations are equally valid for SMEs.

Researchers explain that firms' motives to engage in offshore outsourcing typically change over time (Nieto & Rodríguez, 2011; Lewin & Couto, 2007). Initially, firms pursue cost reductions and efficiency in other countries, but as the need for resources and flexibility arises (Nieto & Rodríguez, 2011), structural adaptations take place (Tate et al, 2009). The paragraphs that follow discuss in some detail the three theoretical perspectives in the context of offshore outsourcing, including both MNEs and SMEs, but additionally making a distinction between manufacturing and services firms.

Transaction and Production Costs Perspective

The roots of the transaction cost perspective can be found in Coase's (1937) argument about the firm. He states that all economic exchanges have a cost and businesses will continue to grow until the costs of undertaking an additional activity inside the firm are equal to doing the transaction in the market or to subcontract it to another firm. Later on, Williamson separates transaction costs from production costs; the former embodies all the costs related to the movement of the product from one partner to the other within the supply chain, while the latter refers to all the costs associated with the production of a good or service (as cited in Kotabe, Mol & Murray, 2009). Harland, Knight, Lamming and Walker (2005) argue that the make or buy decision is based on the most effective option in terms of costs.

The reduction of transaction costs is one of the reasons for the establishment of foreign subsidiaries (Yang, Wacker & Sheu, 2012), since it is more efficient for MNEs to maintain control of intangible assets when there are market failures (Buckley & Casson, 1976; Dunning, 1988; Kotabe & Swan, 1994; Rugman, 1985). In addition, Kotabe et al. (2009) state that the establishment of a subsidiary may reduce the transaction costs related to institutional, cultural and language barriers; although firms subcontracting activities abroad can benefit from lower production costs, considering that foreign suppliers typically produce more efficiently (Kotabe et al., 2009). Overall, (offshore) outsourcing is probably an attractive option when savings in production costs outweigh transaction costs (Farrell, 2005; Kang, Wu & Hong, 2009; Sinha et al, 2011).

Manufacturing firms, regardless their size, typically require a significant amount of labor. This cost can be reduced when the related activities are subcontracted overseas (Choi & Beladi, 2014; Paul & Wooster, 2010). The production of many services, however, cannot be separated from their consumption. This makes the offshore outsourcing of labor-related tasks less viable and more oriented toward the reduction of administrative costs (Paul & Wooster, 2010).

The increasing internationalization of R&D has made MNEs, both from the manufacturing and services sectors, benefit from a cost reduction in this activity. Meanwhile, manufacturing SMEs can reduce costs by achieving economies of scale through offshore outsourcing, while services SMEs can avoid initial set-up costs and its related fixed costs (e.g., office space and infrastructure). Technology has played an important role in the reduction of transaction costs by reducing information asymmetries, particularly benefiting services firms given that they are mainly dependent on information technology and telecommunications to be offered (Tate et al., 2009). The development and evolution of business services models, producing costs reductions, have also driven the rise of service offshoring (Lovelock & Wirtz, 2016). Altogether, reducing costs frees financial resources that can be invested in other profit-generating activities, such as new lines of production or R&D, employee training, or adding a new business venture (Bahrami, 2009).

When it comes to the motivations of doing offshore outsourcing from the transaction and production costs perspective we propose the following:

P1a: MNES will subcontract activities overseas when the savings in production costs outweigh transaction costs.

P1b: MNES will establish a subsidiary when the transaction costs of doing business abroad outweigh the savings in production costs.

P2a: Manufacturing MNES and SMES mainly seek a reduction in labor costs.

P2b: Services MNES and SMES mainly seek a reduction in administrative costs.

P3a: Manufacturing SMES mainly seek economies of scale.

P3b: Services SMES mainly seek to avoid set-up costs and its related fixed costs.

Resource-based View Perspective

The perspective based on resources has surfaced with the objective of analyzing the sources of sustainable competitive advantage of firms. The resources of the firms (including capabilities) are strengths that allow enterprises to develop and implement strategies (Barney, 1991). These, in turn, facilitate companies to gain efficiency and effectiveness. Grant (1991) highlights that resources allow firms to obtain certain capabilities (core competences) that create competitive advantages.

Authors using the resource-based view (RBV) perspective have argued that firms decide to outsource as an opportunity to focus on their core competences (Gilley & Rasheed, 2000; Harland et al., 2005; Hätönen & Eriksson, 2009; Jain & Ramachandran, 2011). Therefore, focusing on these abilities allows the firm to center its attention in allocating resources on the activities it does best, and outsource those tasks for which it has a relative disadvantage (Gilley & Rasheed, 2000). This allows the exploitation of more advanced technology owned by other firms (Harland et al., 2005).

In the context of services, Kedia and Lahiri (2007) use the RBV perspective to explain strategic partnership as a way to gain from accumulative experience and learning scope resources. "RBV thus provides a compelling argument to empower the management of client companies to focus on their most promising activities by releasing them from non-core responsibilities" (Wirtz, Tuzovic & Ehret, 2015, p. 577). For Doh (2005), the motivation for focusing on the core competencies may have more weight than the motivation for merely reducing costs that has been taken from the transaction and production costs perspective. Value enhancement seems to be a more powerful motivation (Agrawal et al., 2010; Quinn, 1999).

Taking advantage of the resources available overseas is an important strategy for firms' international competitiveness (Bahrami, 2009; Kamyabi & Devi, 2011; McIvor, 2010; Orberg & Pedersen, 2012). MNEs have the option of establishing international subsidiaries, while SMEs depend on doing business with enterprises outside their home country. Smaller firms need this strategy to compensate their lack of certain capabilities and resources (Gooderham, Tobiassen, Doving & Nordhaug, 2004; Kamyabi & Devi, 2011). Nevertheless, as in the cost perspective, under the RBV there are also motivations for MNES to do offshore outsourcing.

Considering that core activities are those that offer competitive advantage, firms most likely will keep these under their control and subcontract abroad non-core activities. In the case of manufacturing multinationals, given their branding and marketing skills (Fujita, 1995), the activities that provide competitive advantage do not necessarily have to be manufacture-related. For example, firms like Nike specialize in the design and marketing phases while outsourcing abroad the manufacturing of their products. In contrast, the intangibility, inseparability and perishability of services makes it more common for these companies to gain competitive advantages from a service-related activity, even when other manufacturing or service activities are performed in-house or outsourced overseas (Kotabe & Murray, 2004). Business services such as call centers, financial processing, data management and accounting are some of the non-core activities being internationally outsourced by many firms because they lack the ability to provide competitive advantage (Tate & Ellram, 2012).

The heterogeneity of services increases their asset specificity, resulting in a smaller amount of the core business being subcontracted abroad. In the case of manufacturing firms, activities with high asset specificity remain difficult to imitate, and therefore more challenging to outsource; however, technology is making outsourcing possible over time (Kamyabi & Devi, 2011; Massini & Miozzo, 2012). As a result, the manufacturing industry is becoming saturated, making offshore outsourcing an attractive tool for multinationals to access new markets (Gilley & Rasheed, 2000). For manufacturing SMEs, decreasing transportation and communication costs are allowing access to sources of innovation and dynamic capabilities (Sinha et al., 2011).

Offshore outsourcing allows firms to take advantage of the existing experience around the world (Bean, 2003), where suppliers are specialized companies that offer higher quality and expertise in a particular area and, therefore, can contribute to the creation of knowledge (Agrawal et al., 2010; Quinn & Hilmer, 1994). Through this interaction between firm and supplier occurs a co-creation of value (Songailiene, Winklhofer & McKechnie, 2011).

Multinationals have the financial resources to take advantage of the worldwide capabilities available through the establishment of subsidiaries, whereas smaller firms do not have the same option. Consequently, we propose:

P4a: Offshore outsourcing is a matter of choice for MNEs.

P4b: Offshore outsourcing is necessary for the survival and acquisition of competences by SMEs.

Subcontracting overseas the non-core activities can provide certain benefits to all type of firms, although it is still important to perform core activities in-house, which provides competitive advantage. Therefore, we propose:

P5a: Manufacturing MNEs perform the core activities in-house, which can be manufacture-or-service-related.

P5b: Manufacturing SMEs perform the core activities in-house, which are manufacture-related.

P5c: Services firms perform the core activities in-house, which are service-related.

When it comes to manufacturing firms, the main motivation to search for international suppliers basically differs depending on the size. Smaller firms lack more resources than larger firms, but have an advantage in capturing niche markets. Thus, we propose:

P6a: Manufacturing MNEs seek new markets through offshore outsourcing.

P6b: Manufacturing SMEs seek access to sources of innovation and capabilities.

Nevertheless, all firms, regardless their size and industry, equally benefit from the expertise and knowledge of international suppliers. As a result, we propose:

P7: MNEs and SMEs from the manufacturing and services sectors seek co-creation of value by partnering with international suppliers.

Organizational Perspective

Within the broad range of theories about the organization and the firm, Hätönen and Eriksson (2009) point out that systems theory (Alexander, 1964; Simon, 1962) and network theory (Hakansson & Johanson, 1992; Johanson & Mattson, 1988) have been used in the literature to explain the motivations of MNEs to do outsourcing. The systems perspective sees the organization as interconnected subsystems that are mutually dependent (Alexander, 1964; Simon, 1962). In a complementary way, a network is composed of enterprises that act more like partners with common objectives rather than adversaries (Hunt, Arnett & Madhavaram, 2006).

Previous research has found that another motivation for MNEs (Hätönen & Eriksson, 2009) and manufacturing firms (Scherrer-Rathje, Deflorin & Anand, 2014) to outsource is the need to transform the organization into an adaptive system in an era where sustainable competitive advantage not necessarily lies in cost-efficiency or in the resources, but in the flexibility of the organization. Thus, systems theory offers a useful approach by focusing on the interrelated processes that can make the firm more adaptable, while the network approach offers a valuable way of understanding the complex relationships among the actors involved in each of the processes (Hätönen & Eriksson, 2009).

For all types of firms, finding a supplier they can trust and establish a long-term relationship facilitates the decision of doing offshore outsourcing (Agrawal et al, 2010). Establishing and managing a partnership is particularly easier for SMEs given their entrepreneurial skills and ease for doing business (Etemad, 2004). For MNEs, these relationships with foreign companies are important because they allow a degree of flexibility that vertically integrated organizations usually do not have (Agrawal et al., 2010). In addition, they enable business transformations that facilitate 24/7 operations (Bahrami, 2009; Bean, 2003). Finally, through these partners MNEs acquire knowledge about culture and consumption patterns in other countries (Bahrami, 2009) that facilitate product adaptation.

SMEs can equally benefit from gathering information about culture and consumption patterns, but their focus is directed towards finding niche markets. Additionally, these small companies can achieve increased operational capacity and reduction of risk (Mazzanti, Montresor & Pini, 2011; Rasheed & Gilley, 2005; Sinha et al, 2011); although MNEs can also gain from the latter, but to a lesser extent.

Following Agrawal et al. (2010), establishing long-term relationships with a trustful supplier is an important part in any firm's decision for offshore outsourcing. However, the benefits multinationals and smaller firms gain from these partnerships may differ. With this in mind, we propose the following:

P8: MNEs seek through partnerships with suppliers to increase flexibility and business transformations to operate 24/7.

P9: SMEs seek through partnerships with suppliers to increase capacity and share the risks.

P10: Both MNEs and SMEs seek through partnerships with suppliers to gain knowledge about foreign cultures and consumption patterns, although MNEs pursue information that is valuable for product adaptations, while SMES focus on finding niche markets.

Concluding Remarks

The practice of offshore outsourcing has shown accelerated growth, particularly by MNEs. However, a reduced number of academics have shown interest in the theoretical issues or topics of offshore outsourcing involving SMEs. Most probably, researchers perceive SMEs as being too involved with domestic markets, even when scholars themselves acknowledge that SMEs play important roles in the international arena (i.e. export and employment growth). Furthermore, economic liberalization and improvements in telecommunications have made possible to transfer business activities to firms located around the world, contributing to offshore outsourcing growth.

The purpose of this paper was to question if SMEs could also benefit from offshore outsourcing given their particular characteristics, and to inquire about the possible similarities and differences in the motivations these firms might have to subcontract internationally in comparison to MNEs. Knowing what drives SMEs to subcontract internationally is especially important for the countries and the foreign suppliers in order to adapt and expand their offerings to the particular needs of these firms. The propositions established in this paper are an attempt to model the possible motivations based on the existing literature (see appendix 1).

Our review of the available literature leads us to conclude that even when the motives to engage in offshore outsourcing may change over time, both MNEs and SMEs might participate in international outsourcing as a way of reducing labor costs. These costs are typically lower in underdeveloped and emerging economies, whereas in the developed world labor costs are increasing due to demands from unions and/or due to the cost of living in those countries. One could argue that as manufacturing evolves and new ways are introduced to automate production activities, MNEs will be motivated to base their offshore activities on market expansion and/or competitive advantages rather than on labor costs.

The literature also reveals that in the case of services organizations involvement in offshore outsourcing is probably due to the need to reduce administrative costs related to activities such as information processing, customer services and research and development, rather than to the service provision itself. This is not true on those occasions in which services providers cannot separate production from consumption, as would be the case of haircuts and surgeries, for example. However, as services providers look to satisfy customers' needs without simultaneously being present at the location of production (i.e. courses taught at a distance), offshore outsourcing to reduce production costs could become an attractive option.

Following the RBV, engaging in offshore outsourcing is advantageous when an organization needs to focus on core competencies and recognizes that it cannot improve as needed in a number of operational (productivity) and strategic (goal achievement) areas. That is the moment to search for answers wherever available. Although most firms equally face competition from domestic and international suppliers, SMEs probably lack more competencies than larger organizations; thus, are in more need to subcontract third parties outside their borders in order to succeed in places where they do business. MNEs will also need to subcontract offshore in order to advance market expansion and to get to new developments within their area of business (i.e. innovations). As the globalization of operations and markets continue to move forward, new competition will be available, and markets will be able to communicate with suppliers anywhere in the world. Stagnation is no longer acceptable, so partnerships and strategic alliances are becoming imperative for doing business.

In the case of SMEs, alliances and partnerships might be easier to implement. We assert this because these type of firms are known for being more flexible and easier to adapt than their counterparts (MNEs). Probably, it is because SMEs are characterized by fewer bureaucratic layers than MNES, because in many cases they are managed by its founder who defines the route to follow without delays. Increasing production and marketing capabilities might be more of a motivation for SMEs to engage in partnerships, either because market saturation makes sales growth difficult or because there are no local suppliers to look at as investors.

Nonetheless, MNEs could also benefit from finding trusted partners outside their domestic frontiers who can help them achieve more flexibility, which nowadays seems be a more important business endeavor for these firms.

The conceptual framework and the typology suggest an opportunity for theory building, empirical testing, development of better measures and methods, and the application/replication of findings from other fields. Following, Mihalache and Mihalache (2015), future research should consider a more integrated approach. The propositions in this study provide various starting points for research. Each one could be explored and expanded through empirical research. In addition to the basic research suggested by the framework and propositions, there is a need for research that will illuminate the differential importance and differential effects across types of MNEs and SMEs. Research opportunities also are available in exploring the ability to achieve particular objectives of the firm, and at what cost.

Our research has limitations as well. We centered our attention on the motivations for offshore outsourcing, yet there are risks involved that were not fully considered. Although the propositions are based on the literature available at the time of writing this paper, they have not been empirically tested. In addition, we did not consider the place of origin of the firms. Perhaps, the motivations for subcontracting internationally would be different if a distinction was to be made between firms from advanced and emerging economies. Furthermore, studies such as that by Musteen and Ahsan (2013) introduce an analysis from the intellectual capital perspective that goes beyond the theories usually cited in the literature on offshore outsourcing. Future research should take into account new theories and keep in mind that prominent MNEs in the manufacturing sector, such as Apple, Ford and General Electric, are reshoring their manufacturing activities back to their homeland (Abbasi, 2016).