External Technology Supply and Client-Side Innovation

Dynamic market environments and consumer preferences demand firms to assure a high degree of flexibility. At the same time, competitive pressure from globalized markets leads to constantly raising efficiency requirements. Organizations change their design from static to dynamic concepts in order to react adequately to these developments and challenges. A common strategy is to reach beyond the boundaries of the firm to access critical resources. Accordingly, we observe that technology transfer from providers of knowledge intensive business services attracts more and more attention. A specific case is the external supply of information technology. A major reason why firms outsource IT, is the potential to cut cost. We argue that there is also a potential of knowledge transfer in IT outsourcing relationships, leading to client-side innovation. The aim of this paper is to contribute to resolving an empirical puzzle arising from the prior literature. Some authors find beneficial effects of IT outsourcing, others underline that firms often fail to achieve their expected strategic goals. Our stylized theoretical model combines a knowledge production function framework and transaction cost economics. We hypothesize that the right balance between internal and external knowledge is critical for innovation. The empirical application is German firm-level data covering a wide range of industries from 2003 to 2006. Our results largely support the theoretical arguments and suggest a positive linear relationship between the level of outsourcing and process innovation. For product innovation we find a hump-shape, indicating a positive relationship only up to a tipping point. Partial outsourcing seems to be more beneficial than complete outsourcing.

Peukert, Christian (2011), External Technology Supply and Client-Side Innovation, ZEW Discussion Paper No. 11-082, Mannheim.