Organizing the Modern Firm in the Worldwide Market for Market Transactions · 2017. 9. 9. · Organizing the Modern Firm in the Worldwide Market 5 For example, the total market for

ReseaRch aRticle

Abstract: 0 to represent the modern world economy, we introduce the worldwide market for market

transactions concept to enable us to model the organization of the firm.0 Outsourcing and offshoring are changing the nature of the firm, presenting internalization/ex-

ternalization decisions for international managers, and producing unprecedented international relocation of economic activity.

0 We engage with Williamson’s (1996) challenge to address ‘which transactions go where and why?’ to explain the outsourcing—offshoring phenomenon.

0 We offer a novel modelling approach to represent a firm of any scale and scope in this modern world economy. Propositions that frame our modelling approach are offered.

0 We conclude that foreign involvement alongside foreign investment shapes the scale and scope of the firm as the internationalization of productive capabilities, coordinated through the worldwide market for market transactions, redefines the modern world economy.

Keywords: Worldwide market for market transactions · Firm organization · Externalization · Offshoring · Outsourcing

Manag int Rev (2012) 52:3–21DOI 10.1007/s11575-011-0096-x

Organizing the Modern Firm in the Worldwide Market for Market Transactions

Peter W. Liesch · Peter J. Buckley · Bernard L. Simonin · Gary Knight

Received: 20.10.2009 / Revised: 22.10.2010 / Accepted: 29.03.2011 / Published online: 27.09.2011© Gabler-Verlag 2011

Prof. P. W. Liesch ()UQ Business School, The University of Queensland, St. Lucia,Brisbane, australiae-mail: [email protected]

Prof. P. J. Buckleyleeds University Business school, leeds, UKUniversity of international Business and economics (UiBe), Beijing, china

Assoc. Prof. B. L. SimoninFletcher school of law and Diplomacy, tufts University, Medford, Usa

Assoc. Prof. G. Knightcollege of Business, Florida state University, tallahassee, Usa

� P. W. Liesch et al.

Introduction

The internationalization of productive capabilities (Jacobides and Hitt 2005) is redefi-ning the modern world economy, presenting firms with new organizational configura-tion possibilities as the disintermediation of value chains is providing unprecedented opportunities for the outsourcing and offshoring of economic activity. Offshoring and outsourcing represent the global disaggregation of the firm’s value chain, combining the comparative advantages of geographic locations with the competitive advantages of the firm. The interplay of comparative and competitive advantages determines the optimal location of value chain activities at the boundary of the firm (Mudambi and Venzin 2010). Alongside outsourcing and offshoring opportunities significant challenges are posed such as language and service quality requirements, integration and coordination of dispersed operations worldwide, and threats such as loss of critical capabilities and the hollowing out of the firm.

the outsourcing and offshoring phenomenon is determining the scope and scale of economic activity that remains within the firm (Penrose 1959; Pfeffer and Salancik 1978), profoundly affecting the landscape of international business and the nature of the interna-tional firm. Identified as “entrepreneurial behaviour which consists in casting other firms (partners) for different parts of its overall system of activities”, impartition (outsourcing and offshoring) implies a global systems orientation and a strategic intent to configure the firm’s production system and organizational structure (Barreyre 1988, p. 507). Taking-up Williamson’s (1996, p. 51) observation that “each generic form of organization—mar-kets, hybrids, hierarchies, bureaus—is defined by a distinctive syndrome of attributes”, we address his proposition that scholars interested in organizational form should address “which transactions go where and why”. We do so in an international context.

Outsourcing occurs when firms procure selected value-adding activities, including the production of intermediate goods or finished products, from independent suppliers—they choose to buy-in rather than to make in-house. Offshoring occurs when firms relocate value-adding activities to another country (Doh et al. 2009; Jain et al. 2008; sako 2006). these trends can be represented along two dimensions, the location decision and the cor-porate boundary decision, with four distinct cases identified: in-house operations (domes-tic divisions), domestic outsourcing (domestic suppliers), captive offshoring (foreign affiliates) and offshore outsourcing (foreign suppliers) (e.g., Varadarajan 2009). Which option management chooses depends on a variety of factors, including the nature of the function or activity in question, its value contribution, rarity and imitability (Barney and hesterly 2006), its transactions costs (Murray and Kotabe 1999), potential for knowledge leakage (sampson 200�), and its contribution to overall global coordination costs borne by the firm (Contractor et al. 2010a).

the growth in outsourcing is fueled by falling trade and investment barriers, revo-lutionary improvements in global communications infrastructure, better enforcement of intellectual property rights, increasing competition in numerous sectors, talent shortages, and long-term foreign market development goals (e.g., Contractor et al. 2010b). Plunkett (2010) estimated that global revenues from outsourcing exceeded $ 500 billion in 2010. Most of this activity is domestic outsourcing. However, the international component is substantial and growing rapidly (Plunkett 2010; thuermer 2009; United Nations 2009).

5Organizing the Modern Firm in the Worldwide Market

For example, the total market for offshoring information technology (IT) and business processes exceeded $ 100 billion in 2009, and was growing between 7 and 10% annually (United Nations 2009). China and India are emerging as winners in securing the bulk of offshored activities from Western firms. India has about 50% of the global market for offshore IT and business process services. However, international outsourcing is a global phenomenon, with major suppliers located throughout asia, as well as europe, africa, and the Americas. The activities benefiting most from global outsourcing are financial services, manufacturing, and R&D (Contractor et al. 2010a; Plunkett 2010).

Kedia and Mukherjee (2009) argued that the presence of disintegration advantages, location-specific resourcing advantages, and externalization advantages provide the major rationale for firm-level offshoring. Disintegration refers to reconfiguring the firm’s value chain by divesting non-core activities and increasing focus on core areas that maximize organizational and customer value. It implies becoming more flexible, leaner and focused on the firm’s core competencies to stay competitive and responsive under demanding competition (afuah 2001; Jacobides 2005; Kedia and Mukherjee 2009). Location-spe-cific resourcing advantages refer to the comparative advantages firms obtain by locating particular value-chain activities in favorable locations (e.g., Buckley and Casson 1976; Dunning 1995; Kedia and Mukherjee 2009; Jacobides and Winter 2005). Especially important are specialized country-level advantages such as low-cost or skilled labor and superior industry-specific infrastructure (e.g., Doh et al. 2009; Demirbag and Glaister 2010). Kedia and Mukherjee (2009) distinguish markets (externalization) and hierarchies (internalization) as alternative approaches for completing specific transactions. Exter-nalization of particular transactions can generate economic value in the supply chain through reduction of costs by tapping into specialized supplier capabilities, but should be balanced against the transaction costs that arise from contracting with external suppliers. Firms tend to externalize non-core activities to independent suppliers when the perceived economic value of the relationship is seen to outweigh the costs and risks associated with it (Kedia and Mukherjee 2009; Kenney et al. 2009).

as a research stream, offshoring is closely associated with research on outsourcing and the make vs. buy decision (e.g., Walker and Weber 198�), the theory of the firm (e.g., coase 1937), and foreign direct investment (FDI) theories in international business (e.g., Buckley and casson 1976). As noted by Niederman et al. (2006, p. 55), “In response to the complexity of the phenomenon of offshoring, developing an understanding of the precursors, mechanics, and results of offshoring in a comprehensive manner will require its examination from multiple perspectives.” Hence, investigations into offshoring have drawn on various theoretical perspectives including institutional theory (Kshetri 2007), information systems theory (Mithas and Whitaker 2006) and human capital theory (Nie-derman et al. 2006). However, most research in this area has relied on transaction cost economics (e.g., Ellram et al. 2007; Mudambi and Venzin 2010; Murray and Kotabe 1999) and the resource-based view of the firm (e.g., Holcomb and Hitt 2007; Mudambi and tallman 2010).

a growing body of knowledge has emerged that parallels the evolution of offshoring in the field: from a manufacturing to service industries focus; from production and logis-tics to marketing related matters; and from IT to business process outsourcing. Likewise, a growing number of managerially-minded books, government and industry reports,

6 P. W. Liesch et al.

and large-scale surveys by consultants and academics have attempted to capture current trends and best practices (Brown and Wilson 2005; Contractor et al. 2010a; corbett 200�; Duening and click 2005; lewin and couto 2007; Vashistha and Vashistha 2006). Interest in scholarly work has also surged with several recent focused-issues in academic journals (e.g., Kenney et al. 2009; Parkhe 2007; Youngdahl et al. 2008). Decision frameworks have been introduced (Doh et al. 2009; Kumar and eickhoff 2006), and models developed and applied that have, for example, shown that outsourcing and offshoring can erode the firm’s competence base, ultimately leading to reversal of the externalization deci-sion (Kotabe et al. 2008). In a review of the literature, Dibbern et al. (200�) note that it outsourcing research has provided a definite foundation for research on business process outsourcing. In this research progression, the latest installment is the emerging interest in the offshoring of administrative and technical work in the context of what Lewin and couto (2007) have called the ‘new generation of offshoring.’

Despite the growing body of research on outsourcing and offshoring, much remains to be grasped at the theoretical level. As Doh (2005) has recognized, the companion fields of international management and international business, in particular (which seem the appro-priate scholarly fields) have not served well our understanding in this area. To address this shortfall, in this paper, we (1) introduce the worldwide market for market transactions as the fundamental concept that represents our modern world economy and that motivates impartition decisions; (2), introduce a representation of the firm as an implicit demand for market transactions; (3), through these concepts, we relate impartition—outsourcing and offshoring—to the organization of the firm, elaborating its scale and its scope; and (4) we call for a broader reflection on the theoretical merits of the worldwide market for market transactions and its operationalization. We conclude that foreign involvement coordinated through the worldwide market for market transactions, alongside foreign investment, shapes the scale and scope of the modern firm.

The Worldwide Market for Market Transactions

as a representation of the nature of the modern world economy appropriate to the present context, we introduce the worldwide market for market transactions concept, following alston and Gillespie (1989) and their consideration of the analysis of the firm/market boundary, accepting explicitly that “the ultimate unit of activity … is a transaction” (commons 1932, p. 4). Alston and Gillespie (1989, p. 210) establish a resource coordi-nation model to determine that while the firm and the market are two explicit types of economic organization, “between them it is difficult to draw any ‘hard and fast line,’ ” as the distinction between the firm and the market rests with the distribution of the factors of production brought to bear in organizing for economic activity. Some factors of produc-tion will be assembled for organization internal to the firm and some will be drawn from the external market. Hence, the organization of the ‘firm in the market’ is our research frame (Pitelis 199�; shipman 2002), and the distribution of factors of production for the organization of the firm is central to our explication. This orientation captures both the changing nature of the modern firm (Harvey 1989, 1999; langlois 2003) and of markets


worldwide in the present context of increasing outsourcing and offshoring of economic activity.

in their study of the interdependence of the transaction costs of using both the market and the firm for organizing resource coordination, Alston and Gillespie (1989) explore questions of resource ownership and the joint determination of transaction costs through their demand for, and supply of, market transactions framework. We develop our concep-tualization from their market for transactions notion, extending it beyond the domestic economy to capture the essence of the multinationality of business and the re-organiza-tion of the contemporary firm, in the modern world economy, as the firm responds to increasing opportunities to draw upon factors of production outside of the firm, in other firms—impartition (Barreyre 1988; Jacobides 2005; Jacobides and Hitt 2005; Jacobides and Winter 2005). We adopt our unit of analysis from transaction cost analysis which has received significant exposure in management and organization studies. While theoretical rather than empirical analysis has remained the cornerstone of transaction cost econom-ics, transactions cost analysis nonetheless has found widespread application in the study of modern organization.

theorizing on the governance structures of organizations and the nature of contract-ing between organizations, using transaction costs, has been well-represented in the core management and organization literature (e.g., Argyres et al. 1999; hill 1990; Jones et al. 1997; lepak and snell 1999; Rangan et al. 2006; Ring and Van De Ven 199�; Roberts and Greenwood 1997; Wolter and Veloso 2008). In addition, empirical studies using transac-tion cost frameworks are similarly well-reported (e.g., Afuah 2001; Brouthers et al. 2008; D’aveni and Ravenscraft 199�; Geyskens et al. 2006; Jacobides 2005; Masters and Miles 2002; Mesquita and Lazzarini 2008; steensma and corley 2001; White 2000). For exam-ple, afuah (2001) addresses the question of what happens to the boundary of a firm in a dynamic technological change context giving explicit consideration to these changes on suppliers and customers, while Wolter and Veloso (2008) integrate transaction costs and competence arguments to establish vertical organization boundaries in dynamic environ-ments as firms respond to the effects of innovation.

Jacobides and Winter (2005) and Jacobides and Hitt (2005) importantly integrate trans-action costs and capability-based views to explore vertical scope and the organizational structure of production in industries. That is, Jacobides and Winter (2005) orient towards the systemic implications of the co-evolution of transaction costs, capability development and distribution, and vertical scope on the institutional structure of production. In par-ticular, these authors “By explicitly recognizing that using the ‘market’ is really using the capabilities of another firm willing to transact, (their) analysis brings productive capabili-ties to the forefront” (Jacobides and Hitt 2005, p. 1210). It is the productive capabilities of other agents, at home and abroad that attract interest in outsourcing and offshoring deci-sions, and pose the question whether these activities should be kept within the boundary of the firm. To orchestrate an outsourcing or offshoring deal, a market for transactions is entered.

Consistent with the received orthodoxy (e.g., Koutsoyiannis 2003), the market of interest to us is an assembly of many agents, buyers and sellers, engaged in exchanges of transactions, commons’ (1932) fundamental unit of economic activity. These agents are firms engaging in transactions to buy-in and to supply productive capabilities. The seller


is a firm offering its services to deliver certain business functions under contract, and sellers can be located in the home-country or overseas. The buyer is a firm contracting to have these functions undertaken outside of its parent organization either in its own home-country subsidiary or in an independent home-country firm or abroad in its own subsidi-ary or in an independent firm (the four location × corporate boundary options).

The host firms overseas can be independent entities or they can be subsidiaries of the parent client firm. In this system, buyers and sellers need not necessarily have direct contact with one another, and do not in many cases. In addition, we assume that par-ticipants enter into and exit from this market and can generally access the information that they are seeking to undertake their exchanges with relative ease. A transaction is an exchange between parties that willingly conduct business (Menard 1997; shipman 2002). Transactions in the present context are those that are exploited to arrange for tasks to be performed outside the firm that might otherwise be undertaken within the firm, or alternatively, they may be to arrange for these tasks to be performed within the firm, in its own subsidiaries in the home-county or abroad (hooper and Richardson 1991; Menard 1997). These transactions can be undertaken within the domestic economy and they can be undertaken across country borders into host countries. International markets are char-acterized by greater competition and larger numbers of potential buyers and sellers than are to be found within a domestic economy. There are many more market participants able to arbitrate supply and demand worldwide than there are in any one domestic economy, irrespective of its size; internationally, markets are thicker than they are domestically. accordingly, our interest is with a worldwide market for market transactions, a market of transactions drawn upon to organize for the acquisition of productive capabilities (Jaco-bides and hitt 2005; Jacobides and Winter 2005), and we consider necessarily both the demand and supply sides of this market.

Operationalizing the Worldwide Market for Market transactions

Our diagrammatic representation of externalization is a supply/demand interaction in which, following convention, the vertical axis is labeled price and cost (Alston and Gille-spie 1989) and the horizontal axis refers to the quantity of market transactions potentially available to the international firm. Each firm has a unique utility function that describes the full extent of its internalization of transactions and its use of market transactions. That is, each firm has a particular organizational structure that can be represented by its assem-bly of market-based transaction arrangements vis-à-vis its internalized organization.

In our representation, the organization of each firm is typified by an implicit demand function for market transactions. In the general case, the firm’s demand function for mar-ket transactions will be downward sloping and curvilinear; that is, ceteris paribus, as the cost of market transacting declines, the rational firm will undertake more transactions through these external mechanisms. When market transacting is costly, the firm’s demand function is likely to be relatively inelastic. Here, the firm has adopted an internalized structure to economize on costly external market transactions. A significant reduction in the price of these transactions will be necessary to elicit a demand response in favor of market transacting. An inertial aversion to change, an administrative heritage (Miller and Friesen 1980; Bartlett and Ghoshal 1989), is likely to have developed within this firm from the fixed costs of such a structure. Administrative heritage is characteristic of estab-


lished firms that tend to constrain strategic and tactical choice (e.g., Collis 1991; Miller 198�). The cultural and physical heritage of the firm cumulatively gives rise to a unique corporate culture and directly frames the context of strategic decision-making. This iner-tia limits flexibility as well as the speed and direction of desired strategic changes, con-straining strategic choice.

The demand function for a firm already undertaking a large number of market transac-tions is likely to be relatively elastic. With low costs of market transacting, a cost-con-scious competitive firm will maintain a governance structure that exploits the cost-efficient external market. This firm will become more experienced in the use of market-based trans-acting, and with further reductions in the price of those transactions, will likely undertake proportionally more market transactions than will the firm constrained by a hierarchical structure. Clearly, in the perfectly competitive and idealized case, market-based transact-ing will be the norm and will be undertaken without friction and, hence, without trans-action costs. However, all markets incorporate some imperfections and, hence, market exchange will always incur at least some transaction costs. Moreover, in the context of the firm in the market, all firms have an implicit demand for market transactions that reflects their uptake of transactions in order to effect exchanges within markets and across market interfaces. That is, all firms have some implicit internal organizational form that they utilize in their business operations; some internalized organizational structure that defines its boundary with the market.

these implicit demand functions that characterize particular organizational forms will vary across different product-industry-market configurations. For example, virtual corporations subcontract most of their value chains to external markets while the value chains of firms in the petroleum refining industries, for example, are largely internalized. In general, firms’ demand-for-market-transaction functions will locate differently within our cost/price-quantity framework reflecting their respective organizational forms. In the Coasian sense, all firms might be considered as bundles of transactions that are internal-ized variously (coase 1937; Williamson 1985). In our diagrammatic representation, the closer the demand function to the origin, the more internalized will be this firm’s organiza-tional form. This representation is akin to Buckley and Casson’s (1976, p. 37) “… optimal scale of the firm set at the margin where the costs and benefits of further internalisation are equalised”, and Coase’s (1937, p. 404) heuristic for the size of the firm: “The costs of organising within the firm will be equal either to the costs of organising in another firm or to the costs involved in leaving the transaction to be ‘organised’ by the price mechanism”. Accordingly, within the context of a worldwide market for market transactions, a firm of any scale can be represented by an implicit demand for market transactions.

The observed relative number of market transactions that the firm undertakes (vis-à-vis those transactions that it internalizes, that is, the scale of the firm) will emerge as a consequence of three possibilities: (1) a fixed demand accompanied by a shift in the supply; (2) a fixed supply accompanied by shifts in demand; and (3) shifts in both supply and demand. Our interest here is with shifts in the supply-of-market-transactions function facilitated by the supply shift factors of globalization and advancing technologies, fac-tors that characterize our modern world economy. Buckley and Casson (1976, pp. 37–40) consider other factors that govern internalization. Technological change traditionally has been considered to shift supply functions, and globalization is at least partially technol-ogy contingent. The supply function for market transactions will be infinitely elastic, at


least in the simplifying case. That is, the pool of participants potentially able to supply transactions at a given price in the worldwide market for market transactions is very large and increasing over time. Digitization and communications technologies integrate into the global workforce capable persons located anywhere, provided they possess the technol-ogy to go online (Kenney et al. 2009). Countless capable individuals and new-economy firms dramatically increase the number of available international market transactions for arbitrating demand and supply.

In the accompanying Figures, the supply function is depicted initially at SS. Pivotal to our approach will be supply-function shifts such as a shift to s′s′. This shift derives, in our particular case, from increasing globalization and/or technological developments in information and communications sectors that lubricate international transacting. A typical demand function is represented by DD (Fig. 1). In the initial case, the quantity of market transactions taken up by our firm will be q; that is, our firm will locate at point A, the intersection between DD and SS. Motivated by a shift in the supply function to S′s′, a rational, utility-maximizing firm will respond to this favorable shift by undertaking more market transactions, reflected by a movement to q′ and will now locate at point a′. This firm has been favorably responsive to the changed conditions in the worldwide market for market transactions and has pursued its new venturing through a market-based mode; it has taken up more market transactions.

The inflexible firm (Fig. 2) will not respond and this will simply result in decreased prices and cost of market transactions as the firm fails to adapt by outsourcing. It main-

Fig. 1: The flexible firm. Note: a shift in the supply function ss to s′ s′ increases market transactions (outsourcing) from q to q′

Fig. 2: A hierarchical firm with inelastic administrative herita-ge. Note: A shift in the supply function ss to s′s′ does not increase market transactions


tains its existing business practices and organizational form. This firm pursues the new international venture through an approach more consistent with its past behaviors. For example, the large hierarchical MNE with an established culture of market internaliza-tion, might well overlook the favorable supply shift in the worldwide market for market transactions and adopt an internalized mode for the next venture. Rather than moving to a′ (as does the flexible firm in Fig. 1) this firm locates at point B on the S′s′ function with no change in its uptake of market transactions. That is, this firm undertakes no additional market transacting than that undertaken prior to the favorable shift in the supply function for market transactions.

A third case illustrates interstices that are created by an inflexible firm (Fig. 3). This firm’s failure to take up the q′-q increase in market transactions, which would be achieved at a reduced cost of transacting, incurs a substantial opportunity cost. This opportunity cost penalizes this firm in that it has failed to capitalize upon a favorable shift in the avail-ability of market transactions, preferring to internalize and thereby providing an opportu-nity exploitable by another, more agile and enterprising firm. This is the case described by Penrose (1959) where interstices are inevitably created in the wake of an inertial aversion to change that sometimes is observed in large firms. This scenario is illustrative in the extreme of the stereotypical large MNE characterized by a rigid administrative heritage of hierarchical exchange in which internalization has become the accepted orthodoxy (Miller and Friesen 1980; Bartlett and Ghoshal 1989). Consequently, administrative herit-age can lead this type of long-established MNe to undertake international activities that may not optimize organizational effectiveness.

As Fig. 3 shows, the inflexible, hierarchical firm does not react to the change in the supply function and simply responds by downsizing with lower cost and price. However, if we assume that the increased supply of market opportunities is met by other firms, fill- ing the interstices created by the new opportunities, these firms will supply (q′—qf) at c′ or p′. The alternative equilibrium is provided by the flexible firm (demand schedule D/Df) which supplies qf at cf pf. The flexible firm operates at higher cost/price than the alternative of inflexible firm plus interstices firms as it does not absorb all the supply shift in quantity terms (as does the inflexible alternative). The above discussion leads us to propose:

Fig. 3: Upward sloping supply function for market transactions: The inelastic firm and “inter-stices” versus the flexible firm. Notes: q, c′/p′—inflexible firm equilibrium. qf, cf/pf—flexible firm equilibrium. q′, c′/p′—in-flexible firm with interstices—filing firms equilibrium


Proposition 1a: A firm unconstrained by an administrative heritage of market internali-zation is more likely to respond to favorable shifts in the worldwide mar-ket for market transactions by undertaking the next international venture through a market-based mode (Fig. 1).

Proposition 1b: A firm constrained by an administrative heritage of internalized exchange is more likely to respond to favorable shifts in the worldwide market for market transactions by continuing to rely on internalized modes of trans-acting (Fig. 2).

Proposition 1c: the inability or unwillingness of the large, internalized MNe to respond to transaction cost-reducing shifts in the worldwide market for market transactions gives rise to unexploited interstices and incurs opportunity costs. These interstices manifest in international market opportunities, that tend to be exploited by ‘new economy’ firms and other entrants more attuned to market-based transacting (Fig. 3).

the interesting scenario of the possibility (likelihood) of a range of organizational form variants for viable firms existing alongside one another in a particular industry is left for future modeling. For example, a firm entering a market characterized by a weak intel-lectual property protection regime might choose a more internalized mode. Alternati-vely, this firm entering a well-practiced market-based regime with a strong intellectual property protection regime might demonstrate a preference for a contractual or more extreme market-based mode, such as export. It is also possible that supply-function shifts could be accompanied by shifts in the firm’s demand function for market transactions. For example, this demand shift might be prompted by an increased capacity within the firm to undertake market-based transacting through better market knowledge, and/or by a management culture more receptive to and competent at market relationship building. Demand shifts of this type are likely to accentuate the outcomes presented here.

the Offshoring case

The supply curve shifts highlighted in this analysis are not exclusive to domestic interme-diaries arbitrating supply and demand for market transactions. In our offshore case, over-seas entrants also expand into the worldwide market for market transactions, and can do so in large numbers (e.g. Jacobides 2005; Parkhe 2007; Youngdahl et al. 2008), so large in fact that over time, the supply curve for market transactions for particular tasks, such as business process tasks, becomes increasingly elastic. With the ever-increasing supply of technically and administratively competent personnel throughout the world, this is a likely prospect. We represent this shift by the movement of SS to the more elastic S′s′ in Fig. 3. Where are these intermediaries located? Relative factor endowments and invest-ment throughout the developed and developing world in advanced factors of production (e.g. Afuah 2001; sako 2006; Wolter and Veloso 2008), such as educational systems that produce talented persons, will determine the locations of this new enlarged supply of intermediaries (Dunning 1995). Some economies abroad will demonstrate a propensity to move populations in large numbers into these new industries (such as the business process services sectors) enlarging the worldwide pool of intermediaries able to arbitrate


supply and demand in these skilled sectors. We observe the case of India, for example, in the provision of business process services (e.g. Sako 2006; Youngdahl and Ramaswamy 2008), and we observe that this increased supply is both factor endowments and invest-ment in advanced factors explained. We propose

Proposition 2: the increasing supply of market-based transactions globally, through the worldwide market for market transactions, will increase the proclivity of firms of any scale and organizational form to adopt external, market solu-tions for non-core business processes in preference to internalization of these processes within the firm’s organizational structure.

Interestingly, with the internationalization of production and the global reconfiguration of value chain activities (e.g. Afuah 2001; Daft and lewin 1993; Griffith and Harvey 2001; Jacobides 2005; lewin and couto 2007; Wolter and Veloso 2008) in our modern era of alliance capitalism (Dunning 1995), alongside improved codifiability of business process tasks and public and private sector investment in advanced factors, our representative firm might elect to relocate some of its business functions to optimal overseas locations. this will see it undertake some of its business process tasks in-house in offshore loca-tions; the case of captive offshoring (Farrell 2006; levina and Vaast 2008; sako 2006). For example, Microsoft has invested billions in India to develop company-owned R&D and technical-support operations. London-based HSBC bank has its own software-deve-lopment centre near Mumbai. Firms can thus take advantage of the increasing supply of advanced factors in particular locations throughout the world able to deliver on business functions through their ‘comparative advantage’ (Jacobides and Winter 2005; Mudambi and Venzin 2010) “which focuses on the role of particular firms’ productive capabilities” (Jacobides and Hitt 2005, p. 1209). Our firm elects to internalize at least some of these productive capabilities into its own offshore facilities.

This is the interesting example of firms competing in the same industries, for example, but able to do so with different organizational forms, more or lesser internalized, and tak-ing advantage of the worldwide market for market transactions in different ways. They adopt different heuristics (Dean et al. 1998) in their determination of ‘which transactions go where’ and hence, in determining ‘the scale of the firm’. Management must ascertain the optimal level of control for the firm’s value chain activities. Management should retain control over the activities and processes that enable it to create and appropriate the most value. Conversely, activities that contribute relatively less value are candidates for outsourcing (Mudambi and Venzin 2010). The flexible firm leaves these exchanges to the external market and contracts with independent suppliers offshore for their productive capabilities (outsourced offshoring). It is also possible to recognize the efficacy of this worldwide market in the form of its more abundant capabilities resourcing, but to capture these capability advantages by internalizing these advantages in-house, but nonetheless offshore. This is the tendency towards captive offshoring. We are led to propose

Proposition 3a: Firms of different scale and organizational form can competitively co-exist by using the worldwide market for market transactions differ-ently, either externalizing the transaction into this worldwide market or,

1� P. W. Liesch et al.

alternatively, internalizing the capability advantages ensuing from this worldwide market into the firm’s own organization through a market internalization mode.

Proposition 3b: the worldwide market for market transactions presents new organizational form possibilities, altering the scope of the firm, where different decision heuristics on ‘which transactions go where’ trade off control through internalization against flexibility through accessing the produc-tive capabilities of other market participants.

Discussion

The modelling presented here provides justification for management in the cost-consci-ous, competitive large or small firm, and the firm that is not well-resourced in all business functions to ‘go to the market’ when the thickness of markets provides a competitive alternative to internalizing the transaction within the firm. Increasingly, markets for many business functions, including high-value activities, are becoming thicker (corbett 200�; Gartner 2008; OecD 200�; sako 2006) with more-and-more agents able to arbitrate sup-ply and demand, enabling management to reconfigure the firm and relocate some business activities overseas.

Investments in advanced factors of production by private firms and by national govern-ments are creating hubs of expertise in countries that motivate the international relocation of business activity (Dunning 1995). Not only is traditional manufacturing activity now the target of outsourcing and offshoring, but so too are the high-valued business process services (Brown and Wilson 2005; Duening and click 2005; Murray and Kotabe 1999; Vashistha and Vashistha 2006). These activities are contracted to firms through our world-wide market for market transactions, ‘a market’ that is emerging across a wide spectrum of business functions, high- and low-valued. While the disaggregation of the firm is not new (Blois 1972; Barreyre 1988), its internationalized reconfiguration (Afuah 2001; Daft and lewin 1993; Griffith and Harvey 2001; Jacobides 2005; lewin and couto 2007; Ring and Van De Ven 199�; Wolter and Veloso 2008) is proceeding at an unprecedented pace into business processes that were once deemed near-core to the firm’s competitive advantage.

The existence of a worldwide market for market transactions typifies the modern world economy, this being a stylized representation for the multifarious global markets in productive capabilities that are emerging. These global markets are characterized by many agents able to arbitrate supply and demand and are indicative of a growing inter-nationalization of the division of labor (langlois 2003). The present era of cross-border transacting differs from the post-WW II, particularly post-1970s, exclusive dominance of the very large vertically integrated multinational enterprise (hennart 1982; harvey 1989, 1999; Buckley 1988; Buckley and casson 1976). The approach adopted here captures the nature of this changing international business context (Buckley and Casson 1976) in that the market imperfections explanation, and internalization theory, derived from an era (Buckley and lessard 2005) when the pervasiveness of imperfections in interna-tional markets led management to determine that the transactions costs of dealing in these


imperfect markets was often too high. In such environments, the decision heuristic in establishing the nature of the firm and its scope was one of minimizing these transactions costs through internalizing the exchange. That is, markets were made (Hennart 1982; Buckley and casson 1976; casson 2005) within the firm’s organizational boundaries.

internalization works well in environments that are characterized by market imperfec-tions and when the explanation is that of the vertically integrated firm and its predominant mode of internationalization, FDI. However, in environments that are more characterized by the efficacy of the market and when the organizational form of the business enterprise is more a disaggregated collection of value creation activities, and the activity overseas is involvement rather than investment, a complementary explanation to internalization theory is needed. In this new-economy world with firm multinationality also evidenced as Barreyre’s (1988) impartition and as Jacobides and Hitt’s (2005) internationalization of productive capabilities, the scale and scope of the modern firm becomes a question of involvement and not only of investment. International involvement is facilitated, and largely determined, by the existence of the worldwide market for market transactions.

In the 1960s, the genesis of scholarly interest in the new field of international busi-ness, as distinct from an international economics and trade treatment, arose in response to the observation that the leading form of international economic involvement that had emerged, alongside trade, was FDI (e.g., Buckley and Lessard 2005). The vehicle for FDI was then, and remains, the multinational enterprise with its distinct organizational form. Following internalization theory, the organizational form of the traditional, large multi-national enterprise is a collective of internalized markets (hennart 1982; Buckley 1988; Buckley and casson 1976) amassed to economize on costly transacting in external mar-kets when imperfections in these markets proscribe market exchange. The transactions costs incurred through externalized market exchange equate with the additional coordina-tion costs incurred through internal bureaucracy when the transaction is brought within the firm. This defines the ‘scale of the firm’ (Buckley and Casson 1976).

Since the1970s, an increasing flexibility in the multinational enterprise (Buckley and casson 1976), and the firm more generally (Afuah 2001; Argyres et al. 1999; Geyskens et al. 2006; Jacobides 2005; Jones et al. 1997; lepak and snell 1999; steensma and corley 2001) has become possible with markets now thicker and more diverse in our changing world economy. There is a worldwide-market-for-market transactions. The Chandlerian (1962) bureaucratic, vertically integrated organizational form presents a rigidity from its fixed capital investments, a rigidity that Harvey (1989, 1999) sees being ‘cast’ off into our modern world economy (Barreyre 1988), both temporally and spatially. Such a spatial displacement is evidenced by the internationalization of economic activity from within the firm that can now be dispersed to those agents in the market anywhere with the nec-essary productive capabilities (Barreyre 1988; Jacobides and Hitt 2005) to carry out this economic activity. The emerging internationalization of the division of labor, as observed by langlois (2003), is an evolutionary force that is altering the nature of the firm as new organizational forms evolve to internalize and externalize business activities variously.

Articulated long ago by Pfeffer and Salancik (1978) in their resource dependency theory, organizations cannot survive alone, and this worldwide market for market trans-actions in our modern world economy now encourages ‘going to the market’ to capture access to the resources and capabilities held in other firms (Barreyre 1988; Jacobides


2005; Jacobides and Hitt 2005; Jacobides and Winter 2005). While FDI, alongside inter-national trade, is of no lesser importance today, these established forms of international economic involvement are being supplemented, and sometimes displaced, with the newer forms of foreign direct involvement—outsourcing and offshoring. Which transactions go where? Some transactions remain within the firm, while others are put to the market, and some put to the market remain at home in the domestic economy, while others go overseas. Firms that are not internationalized by exporting, importing, or through other modes of final and intermediate product exchange across borders become involved over-seas through offshoring outsourced business activities.

Enabling this newer form of international economic involvement is the improved effi-cacy of international markets as more and more participants worldwide come together into a worldwide market for market transactions which motivates a new decision milieu for firms: are they to externalize the transaction into the increasingly thicker markets that are emerging, addressing Williamson’s (1996) ‘which transactions go where’, or are they to keep the transaction within the firm? Williamson’s (1996) ‘… and why’ is at least partially addressed by the costs of undertaking economic activity (either within the firm or outside) and the capabilities imperative as firms from anywhere can develop Jaco-bides’ and hitt’s (2005, p. 1209) “… comparative advantage which focuses on the role of particular firms’ productive capabilities (the authors’ emphasis) (the operational effi-ciency of a portion of a production process)”. These productive capabilities are emerging in firms from anywhere throughout the world providing firms with strategic options on organizational form. Resource coordination and ultimately organizational form hinges on “this distribution of the factors of production” (Alston and Gillespie 1989, p. 211), and organizational form becomes a strategic variable (Daft and lewin 1993).

Conclusions

the multiplicity of recent conferences and special issues of scholarly journals reveal a sense of excitement and urgency in explaining outsourcing and offshoring and the nature of the new organizational forms that are generated. To both scholars and practitioners, this is reminiscent of the rise and take-off of the study and practice of strategic alliances in the mid-late 1980s. As then, if the phenomenon under scrutiny is to be fully accounted for and explained, the field must consider the challenge of theory-building. It is timely that scholars in the international management and international business fields apply their understanding of cross-border exchanges and the changing international context to take-up this challenge in the context of outsourcing and offshoring.

While the international management and international business literatures have reported studies that isolate factors important to the offshoring decision, including impor-tantly, the broader externalization advantages of offshoring (e.g., Kedia and Mukherjee 2009; Contractor et al. 2010b), discussed implications for existing international business and strategic management theory and practice (e.g., Doh 2005), and empirical studies are widely reported in the scholarly literature and the business press, we introduce and spe-cifically incorporate the key theoretical tenet that identifies the modern, new economy of internationalized production that facilitates increased externalization. This is the world-


wide market for market transactions, and we apply it in a novel modelling approach to the externalization decision. Second, we represent the modern firm in this worldwide market, operationalizing our theoretical framing of a firm of any scale and scope as a source of demand for market-based transactions from this worldwide market. Third, we apply this theoretical framing to the impartition decision on outsourcing and offshoring to offer propositions on the organization of the modern firm in our worldwide market for market transactions. The externalization of certain activities into thick international markets for productive capabilities (Jacobides and Hitt 2005) on the one hand, and accessing these capabilities through an internalization mode on the other hand ensures different organi-zational forms as managers adopt different decision heuristics on ‘which transactions go where’ (Williamson 1996). Fourth, we conclude that alongside foreign investment, the scale and scope of the modern firm is determined by foreign involvement as the firm seeks out the productive capabilities of other firms at home and abroad. We recognize, as did Daft and lewin (1993), organizational form becomes a strategic variable as the scale and scope of the modern firm becomes a decision for managers with access to the worldwide “distribution of the factors of production” (Alston and Gillespie 1989, p. 211), captured in our operationalization of the worldwide market for market transactions.

The modern firm thus advances with the internationalization of productive capabilities (Jacobides and Hitt 2005), coordinated through the worldwide market for market transac-tions, a defining feature of the modern world economy. Managers have capitalized on the efficacy of this worldwide market for market transactions, in our modern world economy, through increases in outsourcing and offshoring as they internationalize their firm, alter-ing the organization of the modern firm. Internalization and externalization decisions are complementary in this modern context as decision heuristics trade off managerial control against organizational flexibility.

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