www.elsevier.com/locate/jom

Journal of Operations Management 26 (2008) 257–274

Transformational offshore outsourcing: Empirical

evidence from alliances in China§

Yuan Li a,*, Yi Liu a,1, Mingfang Li b,2, Haibin Wu a

a School of Management, Xi’an Jiaotong University, Chinab School of Business, Hohai University, Nanjing School of Management, Xi’an Jiaotong University,

Xi’an Department of Management, California State University, Northridge, CA 91330-8376, USA

Available online 4 March 2007

Abstract

Adopting a transformational offshore outsourcing perspective, we examine empirically the relationship among the motive to

acquire tacit knowledge from outsourcing partners, formal and social control mechanisms, and innovation outcomes among Sino-

foreign as well as local alliances. We constructed our theoretical model incorporating knowledge management, social exchange, and

alliance risk perspectives, and hypothesized that motives to acquire partners’ tacit knowledge through offshore outsourcing will

affect firm innovation via two forms of control, namely social control and formal control. Our empirical testing, utilizing two sub-

samples composed of Sino-foreign offshore outsourcing alliances and local outsourcing alliances, respectively, reveals that the

motive to acquire outsourcing partner’s tacit knowledge and different control mechanisms are significant predictors of incremental

and radical innovation outcomes, and that there are some intriguing differences between the Sino-foreign alliances and local

alliances.

# 2007 Elsevier B.V. All rights reserved.

Keywords: Transformational offshore outsourcing; Tacit knowledge; Control mechanisms; Innovation

1. Introduction

For firms in developed countries, offshore out-

sourcing began as an effective means to reduce

manufacturing and processing costs and to focus on

core business activities. As these firms continue to

§ This paper was supported by NSFC (70472739, 79925004, and

70121001). The third author’s research was partially supported by the

CSU Wang Faculty Fellow Grant (2004–2005).

* Corresponding author. Tel.: +86 29 82665093;

fax: +86 29 2668953.

E-mail addresses: liyuan@mail.xjtu.edu.cn (Y. Li),

liuyi@mail.xjtu.edu.cn (Y. Liu), mli@csun.edu (M. Li),

xjtu_whb@sina.com (H. Wu).1 Tel.: +86 29 82665029; fax: +86 29 2668953.2 Tel.: 1 818 677 2421; fax: 1 818 677 6265.

0272-6963/$ – see front matter # 2007 Elsevier B.V. All rights reserved.

doi:10.1016/j.jom.2007.02.011

search ways to gain competitiveness, offshore out-

sourcing is gradually gaining significance as an

important source of business renewal and corporate

transformation (Kakabadse and Kakabadse, 2005; Khan

and Fitzgerald, 2004; Linder, 2004). In recent years,

multinational enterprises in sectors from telecommu-

nications to electronics to aerospace to pharmaceuticals

have turned their attention to outsourcing partners in

other countries for new designs, product development,

and more importantly for corporation transformation

(Engardio and Einhorn, March 21, 2005).

Offshore outsourcing entails the transfer of parts of a

Western firm’s value chain activities to partners in

emerging economies such as China and India for a period

of time, usually at least a few years. The main forms of

offshore outsourcing include technological cooperation,

manufacturing agreements, and distribution services.

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274258

Clearly offshore outsourcing utilizes a variety of inter-

firm collaboration. Because of the greater need to

collaborate closely with partner firms especially if such

outsourcing relations become more central to a firm’s

overall position, inter-firm collaboration and strategic

alliances have become a vital form of offshore out-

sourcing arrangement. As technological management

became absorbed within the broader field of knowledge

management, alliances for offshore outsourcing have

been viewed from a knowledge management perspective

(Grant and Baden-Fuller, 2004). Acquiring the partner’s

tacit knowledge through offshore outsourcing then

becomes central to inter-firm collaboration. Transforma-

tional offshore outsourcing indeed relies on tacit

knowledge acquisition to accomplish goals of strategic

change, and corporate renewal (Linder, 2004). By

acquiring and exploiting tacit knowledge developed by

others, firms can speed capability development and

minimize their exposure to technological uncertainties

(Grant and Baden-Fuller, 1995). Following this perspec-

tive, innovation becomes a central outcome for firms

pursuing transformational outsourcing. Comparing with

this emerging trend, the research lags (Ramamurti,

2004). We have limited understanding how offshore

outsourcing partners develop innovation, and further-

more, if the innovation generation dynamics in offshore

outsourcing arrangements will exhibit the same pattern as

those in domestic outsourcing arrangements. Concep-

tually a number of conflicting theoretical perspectives are

available to inform scholars and managers effective

management of offshore outsourcing. Empirically there

is limited research in how offshore outsourcing facilitates

innovation.

We therefore developed a theoretical model linking

the motive to acquire tacit knowledge in inter-firm

outsourcing cooperation, control mechanisms, and

innovation outcomes based on knowledge management,

social exchange theory and alliance risk perspective.

Furthermore, we empirically tested our model using two

sub-samples, with data collected in China, of Sino-

foreign offshore outsourcing alliance, and local firm

outsourcing alliances. Thus, through this study we

examined inter-firm outsourcing collaborations with a

central focus on innovation outcome, and with a unique

setting of China. Compared with their Western counter-

parts, most Chinese firms possess relatively limited

resources and capabilities but are actively working to

catch up (Mathews, 2002). Further, considering China’s

increasing importance in global economies and

significant growth of firm’s new product development

in this country (Li and Atuahene-Gima, 2001), a focus

on these firms can help Western competitors better

understand the innovation choices of these firms, and

hence they can be better prepared to compete and

collaborate with these firms. From a conceptual

perspective, our theoretical model building integrates

seemingly conflicting theories to explore factors

contributing to innovation in inter-firm outsourcing

alliances.

We first review the relevant theory and the context

specific situation of China’s transitional economy. We

rely on the social exchange theory and alliance risk

perspective to provide an overview of the research

framework. Utilizing this framework we develop

hypotheses concerning the effects of tacit knowledge

acquisition motive in outsourcing alliances and control

mechanisms on incremental and radical innovations.

Following that, we describe the research methodology,

and report the analysis and results. We conclude by

discussing the study results and implications.

2. Theoretic background

Traditionally, companies pursuing offshore outsour-

cing had two important motives. By migrating

peripheral business processes and value chain activities

to outsourcing partners in other (especially in emerging

economy) countries, the outsourcing originator may be

able to derive cost advantage, and also to focus on areas

of core competences (Kakabadse and Kakabadse,

2005). Recent thinking in transformational outsourcing

and business practices in outsourcing innovation

however point out an even more important benefit of

offshore outsourcing. The central theme of transforma-

tional offshore outsourcing relates to relocating core

business processes and value chain activities to partners

in other countries and coordinating those outsourced

activities tightly with the originator’s strategic moves in

order to realize strategic renewal and corporation

transformation (Engardio and Einhorn, March 21, 2005;

Farrell, 2005; Linder, 2004)! Researchers identify a

number of important benefits associated with transfor-

mational offshore outsourcing.

Those multinationals focusing on transformational

offshore outsourcing will be able to tap into new

suppliers as more cost effective technologies become

available. With transformation in mind, offshore out-

sourcing would allow for quick responses to changes in

the environment (Dess et al., 1995), without the

attendant increase in bureaucratic costs associated with

internal organizations (D’Aveni and Ravenscraft,

1994). In addition, utilizing, and integrating innovations

from outsourcing partners will enable these firms to

multiply and amplify their innovation outcomes. As

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 259

noted by Quinn, ‘‘virtually all staff and value chain

activities are activities that an outside entity, by

concentrating specialists and technologies in the area,

can perform better than all but a few companies for

whom that activity is only one of many’’ (Quinn, 1992,

p. 37). Beyond the specialist advantage Quinn

emphasized, however, we can also envision the potency

of combining innovations from various outsourcing

partners with benefits to all involved. For example,

Pocket PC is taking a firm hold in the mobile

information appliance market place today. This success

cannot be attributed to any single company but a

dynamic network of companies working together. They

include Microsoft developing the Windows Mobile OS,

hardware designers such as HTC in Taiwan, software

companies, wireless venders as well as value-added

distributors throughout the world. Naturally all parties

involved gain from the advancement of a common

platform.

Thus, firms aiming at transformational offshore

outsourcing may achieve greater long-run competitive

advantages compared to those merely focusing on cost

saving and concentrating core competences. The

combinative contributions of offshore outsourcing

may be more important than the pure cost motivations

and individual benefits identified above. Clearly from a

more macro level we can envision further benefits of

transformational offshore outsourcing. The dynamic

process by which offshore outsourcing partners develop

together and individually their respective capabilities

may contribute not only to a vibrant global economic

landscape (Doh, 2005) but also may enhance the

positive outcome of transformational outsourcing as

more and more companies in emerging economies gain

greater ability to innovate.

It is clear that offshore outsourcing frequently has

positive impacts on the firms in emerging economies

such as China and India. We can indeed observe a trend

towards wage convergence in these economies over the

long run and at the same time we can envision corporate

capability enhancement for firms in emerging econo-

mies (Levy, 2005). Furthermore, while firms in

emerging economies may initially offer cost advantage

to, and benefit in capability building from their

multinational partners, the exchange is not a one-way

street! These firms in emerging economies may be able

to generate powerful indigenous innovations from

which multinationals can derive more benefits as well

(Li et al., 2006a). In addition the mere cost advantage

may be short-lived as these economies become more

affluent. In a private conversation an executive

remarked to one of the authors that some companies

were ‘‘forever chasing the cheap labor.’’ Another

executive deadpanned about the transformational

changes in offshore outsourcing: ‘‘we came for the

cheap labor, and we stayed for the innovation.’’

From a higher level of analysis, enhanced globaliza-

tion of economic activities and global offshore out-

sourcing may contribute to increased salaries in

emerging economies, and also diffuse corporate

capabilities through the network effects (Storper,

1997). Responding to local market competitive envir-

onment, and emerging opportunities these firms may be

able to develop indigenous innovation (e.g., Lu, 2000).

In addition, there are opportunities for these firms to

upgrade their capabilities, through collaboration with

multinationals (Bair and Gereffi, 2003) as well as other

domestic firms. Thus, the local firms may have two

important sources of capability development, namely,

indigenous innovation (Li et al., 2005), and close

collaboration with multinational as well as local

partners. Outsourcing partners in emerging economies

may certainly lose their cost advantage (Dutta and Roy,

2005). On the other hand, these firms may become more

attractive as potential partners in transformational

outsourcing.

In summary, instead of focusing on the traditional

vision of global division of labor that has firms in

developed countries focusing on innovative and more

value added activities, and firms in emerging economy

countries on simple processes and manufacturing

activities, researchers now envision the possibility

and strategic significance that innovation can happen

everywhere and firms in developed countries ought to

develop effective ways to utilize offshore outsourcing

for innovation, strategic change and corporate renewal

(Linder, 2004). For transformational outsourcing to

happen, outsourcing vendors must go beyond the simple

transactions to consider knowledge integration and

effective management processes.

From a transformational outsourcing perspective,

innovation is a central outcome. Innovation can be

divided into radical innovation and incremental

innovation (Dosi, 1982; Munson and Pelz, 1979).

Radical innovations are fundamental changes that

represent revolution in technology. In contrast, incre-

mental innovations are minor improvements or simple

adjustments in existing technologies (Munson and Pelz,

1979). The major difference captured by radical and

incremental innovations is the degree of new and tacit

knowledge embedded in the innovation. Different types

of knowledge have different transferability. Explicit

knowledge is codified and can be transferred through

formal language or communication systems. Tacit

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274260

knowledge (skills, know-how, and contextual knowl-

edge) on the other hand is manifest only in its

application—transferring it from one individual to

another is costly and time consuming (Kogut and

Zander, 1992; Nonaka, 1994). In addition, the complex-

ity, cost and risk of radical innovation and incremental

innovation are different. Herbig (1994) found that the

conditions that favored high-order or radical innovation

differed from those that favored incremental innovation.

Van de Ven et al. (1999) argued that some organizations

may be better suited to one type of innovation than the

other. Thus, the motive to acquire tacit knowledge may

have different impacts on different types of innovation.

Two incompatible explanations shed lights on the

linkage between the motive to acquire tacit knowledge

in an alliance relationship, and innovation outcome. The

transaction cost economics (TCE) literature has high-

lighted partner opportunism in interorganizational

relationships. Building upon it, the subsequent literature

on knowledge-based alliances dubbed these relations as

a learning race (Khanna et al., 1998) in which partners

often engaged in opportunistic attempts to outlearn each

other. At the same time, there are indications that

strategic alliances may suffer from particular learning

problems, such as the risk of uncontrolled tacit

knowledge information disclosure and asymmetric

diffusion of core competencies to partner firms (Bresser,

1988; Hamel, 1991; Inkpen and Beamish, 1997). This

opportunistic behavior may result in failure of

cooperative innovation.

On the other hand, the networks-for-learning

approach considered the inter-organizational network

as a resource generation entity that has the ability to

enhance learning among partners. Powell et al. (1996)

contend that the locus of innovation will be found in

interorganizational networks of learning rather than

within individual firms. Teece and Pisano (1994) argued

that strategic alliances are an important approach for

enhancing organizational learning and a crucial element

in firms’ competitive strategies, since they are used by

firms to acquire technology-based capabilities from

partners (Cohen and Levinthal, 1990; Kogut, 1988,

1991; Mowery et al., 1996). Inkpen (2000) argued that

in alliances, through the shared execution of the alliance

task, mutual interdependence and problem solving,

firms can acquire tacit knowledge from their partners

effectively. Based on this perspective, we suggest that

interorganizational tacit knowledge acquisition would

accelerate the process of innovation.

These two contradictory assertions lead us to explore

further the relationship between tacit knowledge

acquisition and firm innovation. A fruitful approach that

might incorporate these two assertions appears to be the

differentiation between two types of innovation, namely

incremental and radical innovations (Damanpour, 1992;

Drazin and Shoonhoven, 1996; Klein and Sorra, 1996).

Since incremental and radical innovations are two

different innovation outcomes, conditions that favor

one type may actually inhibit the other, and the

innovation process should be managed differently

(Koberg et al., 2003). This consideration leads us to

focus on the management practices involved in inter-firm

collaboration. Transformational outsourcing puts knowl-

edge acquisition and integration on the center stage of

firm strategic change and corporate renewal. Effective

management of outsourcing holds the key for this

strategic goal. If different types of innovation comprise

different types of information content, we would believe

the types of control mechanism adopted to manage those

will vary as well (Fiol and Lyles, 1985). It therefore is

important to explore how control mechanisms enable

firms to pursue different types of innovation through

inter-firm cooperation (Damanpour, 1992; Drazin and

Shoonhoven, 1996; Klein and Sorra, 1996).

Because outsourcing may cause both competitive

advantage and disadvantage for partners, the firms

involved may prefer to carry out peripheral outsourcing

and avoid core outsourcing (Gilley and Rasheed, 2000)

unless there are effective control mechanisms involved

to enhance outsourcing success for both partners. If

these firms could not learn useful tacit knowledge from

their partners, the relationship between both partners

may be destroyed. To ensure their cooperation success,

both partners need to choose effective control mechan-

isms to reduce opportunisms and to improve their

competitive advantage. Especially under high environ-

ment uncertainty, the relationship between core out-

sourcing from outsourcing firms and their performance

will be weakened (Gilley and Rasheed, 2000), which

imply that, under high environment uncertainty such as

China’s transitional economy, both sides of an alliance

will depend on effective control mechanisms to enhance

outsourcing success (Li et al., 2005).

Control is intended to reduce goal incongruence and

preference divergences among alliance participants, and

is widely acknowledged as essential for alliances

(Geringer and Hebert, 1989). Control mechanisms are

safeguards that firms put in place to govern inter-

organizational exchange (Jap and Ganesan, 2000). As

control mechanisms influence transaction costs, coor-

dination costs, and the willingness of alliance partners

to engage in value creating initiatives, they play a key

role in the success of inter-firm cooperation (Artz and

Brush, 2000; Dyer and Singh, 1998).

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 261

In alliances, social control mechanism and formal

control mechanism are two basic and important control

mechanisms (Das and Teng, 2001). The social control

mechanism relies on shared organizational norms,

values, and culture, and the internalization of goals to

ensure desirable behavior and outcome. Social

exchange theory suggests that exchanges, including

inter-firm cooperation, often carry a social dimension

(intrinsic utility) and an economic dimension (extrinsic

utility). Thus, economic behavior occurs under the

influence of social relations (Nooteboom et al., 1997).

The formal control mechanism emphasizes the estab-

lishment and utilization of formal rules, procedures, and

policies to monitor and reward desirable performance.

The social control on the other hand focuses on utilizing

norms, values and shared preferences to regulate

individual behavior.

Clearly various control mechanisms, including

communications, structural approaches and social

means, are useful for sustaining inter-organizational

cooperation (Grandori and Soda, 1995). Within the

Chinese context, social means, such as building guanxi

or personal relations and trust, are very important in

regulating the behaviors of partners (Lovett et al., 1999;

Luo, 2001; Park and Luo, 2001). However, because of

the yet to be fully developed market environment during

China transitional period as well as limited accumula-

tion of experience in managing knowledge-based

alliances (Li et al., 2006b), most Chinese alliances

face a great deal of uncertainty. Under the circumstance,

Fig. 1. The theoretical mo

firms with high uncertainty tend to feel a strong urge to

control events and situations. The need for uncertainty

reduction leads these firms to create detailed instruc-

tions, more rules and regulations, and standardized

work procedures (Youngdahl et al., 2003). The formal

contract or formal control is thus becoming increasingly

important for Chinese firms engaged in alliances,

especially for Sino-foreign cooperation. Do Chinese

alliances both with multinationals and locals involve

motives to acquire tacit knowledge? Does the motive to

acquire tacit knowledge leads to increased use of both

social and formal controls? How does the motive to

acquire tacit knowledge affect innovation outcome

directly? How do social control and formal control

affect different types of innovation? We examine these

questions with a theoretical model as depicted in Fig. 1,

and a series of hypotheses linking motives to acquire

tacit knowledge through outsourcing alliances, control

mechanisms and innovation.

3. Hypotheses

3.1. Choice of control mechanisms: social

exchange theory and alliance risk perspective

Learning alliances are motivated primarily by the

desire to acquire partners’ knowledge, especially tacit

knowledge (Grant and Baden-Fuller, 2004). Tacit

knowledge acquisition however involves a great deal

of uncertainty and ambiguity. It is rather difficult to

del with hypotheses.

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274262

define the learning targets clearly in the beginning stage

of acquiring tacit knowledge in the process of

collaboration or offshore outsourcing. Kogut and

Zander (1992) noted that the targets of learning

alliances changed frequently. In inter-organizational

learning from outsourcing firms, a key consideration is

the codifiability of knowledge. The more codifiable the

knowledge is, the greater the ability to structure that

knowledge into a set of easily communicated rules and

relationships (Kogut and Zander, 1992). Tacit knowl-

edge by definition is noncodifiable. It is rather difficult

to identify, acquire, synthesize and disseminate tacit

knowledge (Linderman et al., 2004). Social control may

provide the appropriate ambiguity at the beginning and

let members develop a consensus in the process of

collaboration or offshore outsourcing. Organizations

can, thus, avoid the problem of not being able to

measure either behavior or the outcome of such

behavior, but still be able to influence the behavior of

the members for their own benefit (Das and Teng,

2001). Zucker (1986) contended that social control may

make an important contribution to interorganizational

learning. Dyer (1997) suggests that when personal

attachment within cooperation is established through

socialization, it becomes social capital that can enhance

the capability of innovation. Powell (1990) noted that

social control is the most efficient organizational

arrangement for sourcing information because informa-

tion is difficult to price and to communicate through a

hierarchical structure. Therefore, we suggest:

H1a. The motive to acquire tacit knowledge in out-

sourcing alliances is positively related to the social

control.

Two perspectives offer important insights into the

relationship between the motive to acquire tacit

knowledge in outsourcing alliances and formal control.

First, the formal control can limit tacit knowledge

acquisition, because this control mechanism only

focuses on those exchanges specified in the contract.

Tacit knowledge is transferred only through exchange

and contact with partners frequently, thus every partner

is very difficult to contact its partners and cannot obtain

the partners’ tacit knowledge under formal control

(Grant and Baden-Fuller, 2004). Contrary to the first

perspective, the second one offers a strikingly different

conclusion based on the relational risk analysis and the

social context of knowledge transformation. The

probability and consequences of not having satisfactory

cooperation in alliance is viewed as relational risk by

Das and Teng (1996). This risk arises because of the

potential for opportunistic behavior on the part of both

firms. Opportunistic behavior includes shirking, cheat-

ing, and distorting information. In contrast with

resource complementary alliance, tacit knowledge

acquisition also has relatively higher relational risk.

One possible reason for this high relational risk is that

particular tasks in tacit knowledge acquisition remain

low in measurability, including low output measur-

ability and low investment measurability. Das and Teng

(2001) argued that in the beginning of interorganiza-

tional learning, it is hard to measure the amount of

knowledge invested in the alliance. At the end of the

cooperation, the achievement in cooperation is also hard

to measure accurately. The other possible reason for

high relational risk is that the tacit knowledge

acquisition increases the likelihood of unilaterally or

disproportionately losing one’s own core capability or

skill to the partner. Thus, firms are faced with the

challenging task of managing the balance between

‘trying to learn and trying to protect’ (Kale et al., 2000,

p. 217). These two reasons result in the high relational

risk in interorganizational tacit knowledge acquisition.

Following this perspective, formal control should be

emphasized in order to avoid or reduce this risk.

Powell et al. (1996) deal with learning as a social

construction process wherein knowledge is created in a

social community context. When taking into considera-

tion the Chinese context, we believe the second

perspective is more relevant. Since 1990s, under the

rule of ‘‘exchanging markets for technology,’’ Chinese

firms adopted the various forms to cooperate with

multinationals. The main goal of these kinds of

cooperation is to accelerate the process of technological

innovation. Foreign parents normally bring in technol-

ogy and management know-how, and are a vital source

of useful knowledge. But in the practice of Chinese

firms, there still are critical problems. For example, it

has been observed that patent and copyright violations,

ineffective contract enforcements, and unfair compe-

titive practices have become widespread in China (Luo,

2001). This observation about contract enforcement

challenges is important but must be supplemented with

the observation that China’s is a transitional economy.

As China continued its economic reform, the authorities

engaged in a systematic effort to upgrade its legal and

regulatory infrastructure. Important laws and regula-

tions have been adopted and put into practice. At the

same time, both multinationals and domestic firms have

been exploring effective ways to utilize formal control

to enhance their alliance effectiveness while at the same

time also relying on social control.

The intellectual property rights of new technology

ventures resulting from product innovation may go

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 263

unprotected, making interorganizational innovation a

highly risky and less profitable strategy. If these

alliances are only based on guanxi, the formal rules

and contracts may be ignored. In this case, the relational

risk is higher in the emerging and transitional setting

than developed countries. Therefore, we may indeed

observe a greater deal of uncertainty, and limited level

of inter-firm collaboration unless we utilize formal

control. In order to control the partners’ opportunistic

behavior, detailed contracts containing explicit deter-

rents to opportunistic behavior will need to be written

(Das and Teng, 2001). Therefore, we hypothesize:

H1b. The motive to acquire tacit knowledge in out-

sourcing alliances is positively related to formal control

in a transitional China.

3.2. Control mechanisms and innovation: social

exchange perspectives

There is more tacit knowledge involved in radical

innovation than in incremental innovation. To accom-

plish radical innovation, the partners involved need

participate actively in the relevant organizational

processes in which the tacit knowledge is embedded.

The process will rely heavily on joint decision-making

and frequent communication. In addition, social control

mechanisms permit the flexibility and adaptability that

are critical to the high order learning (Dyer, 1997).

Therefore, we hypothesize:

H2a. There is a positive relationship between the social

control mechanism and radical innovation.

In contrast with social control, formal control

mechanism emphasizes the use of formal rules,

procedures, and policies to monitor and reward

desirable performance. But in the process of radical

innovation which large amount tacit knowledge is

embedded, it is hard to describe the target of

cooperation and the way in which tacit knowledge

transferred. In addition, contractual renegotiations

frequently would increase the transaction cost in

interorganizational tacit knowledge acquisition, which

may cause the dissolution of alliance (Reuer and Arino,

2002). Therefore, we suggest:

H2b. There is a negative relationship between the

formal control mechanism and radical innovation.

As compared to radical innovation, the knowledge

embedded in incremental innovation is more codifiable.

Thus, in this knowledge transferring process, formal

rules can be used to regulate the behavior of partners.

Formal control mechanism may guarantee the resource

needed invested rapidly which is important for

incremental innovation. Therefore, we suggest:

H2c. There is a positive relationship between the for-

mal control mechanism and incremental innovation.

As Dyer and Singh (1998) argue although informal

safeguards have the greatest potential to generate

relational rents and lower the transaction cost, they need

substantial time to develop. It appears that many

effective alliances begin with the use of formal

mechanisms and then, over time, take on more social

ones (Gulati, 1995). But for the incremental innovation

which needs little time and small resource input to

develop, there is no time to establish the social control

mechanism, and social control mechanism will increase

the innovation cost because of its high transaction cost.

Therefore, we hypothesize:

H2d. There is a negative relationship between the

social control mechanism and incremental innovation.

3.3. The motive to acquire tacit knowledge in

outsourcing alliances and innovation

Outsourcing alliances and especially those involving

offshoring often bring together partners from different

cultural backgrounds, and with greater differences in

collaborating firms’ knowledge bases. This diversity

may be important as it brings together reciprocal

strengths and complementary resources furnished by

the alliance partners. Such alliances will enable one

partner to acquire the skills and technologies it lacked at

the time of alliance formation, tacit knowledge

acquisition will actually facilitate the formulation,

development of new knowledge (Parkhe, 1991), thus, it

is helpful for the radical innovation. But for the

incremental innovation which is related to minor

improvements or simple adjustments in current tech-

nology, deep insights into the existing technology is

crucial for the adjustments. Furthermore, tacit knowl-

edge acquisition requires considerable amounts of time.

For firms to absorb effectively their partners’ tacit

knowledge, they need to devote more resources to their

joint activities as well. So, tacit knowledge acquisition

would appear to aid radical innovation while at the same

time would reduce a firm’s ability to pursue incremental

innovation. Therefore, we hypothesize:

H3a. There is a positive relationship between the

motive to acquire tacit knowledge in outsourcing alli-

ances and radical innovation.

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274264

H3b. There is a negative relationship between the

motive to acquire tacit knowledge in outsourcing alli-

ances and incremental innovation.

4. Research methodology

4.1. Survey design and sample

To test the hypotheses advanced in this study, we

utilized a questionnaire survey method to seek

responses from top executives of the firms in our study

sample. We initially assembled a questionnaire utilizing

measurement items from several previous studies on

innovation and management control system. Through

our review of the extant literature mainly reported in the

Western academic journals, we identified key measure-

ment items from several sources. We believe utilizing

these previously validated measurement items would

aid our study effectively and also would allow us to

compare study outcomes across settings.

The questionnaire was therefore first compiled in

English. It was then translated into Chinese. We

consulted with top executives in local firms and

business experts – two management professors at Xi’an

Jiaotong University – to ensure the measurement items

in Chinese reflect accurately the business environment

firms in China face. Modifications to the questionnaire

items based on the input of these business executives

and management experts reflected mainly clarifications

and amplifications to the original items. The Chinese

questionnaire with such modifications was subsequently

back-translated into English by a third party to ensure

that the items included accurately reflect the original

meanings in the Chinese context (Brislin, 1970; Brislin

et al., 1973; Chen et al., 1998; Chong and Chong, 1997).

We reviewed carefully these two English versions, and

were satisfied that there were no substantial differences

between the two versions in the meanings of the scales

used in the study.

Our study population is composed of Sino-foreign

alliances and domestic alliances in Shaanxi, Henan,

Shanghai, Guangdong, Liaoning, Sichuan, Shandong

and Shanxi Provinces of China. The special admin-

istrative body in charge of overseeing the firms of

these eight Provinces, the Economic Commerce

Committee provided the sample frame—a random

sample of the enterprises in these areas. We undertook

the main survey during summer 2002. The time frame

selected for the study was from 1997 to 2001 since

significant restructuring activities occurred during

this period.

We spent one week to train twenty research assistants

about the background information, main objectives of

this study, the interviewing techniques, and most

importantly, the exact meaning of each question in

the questionnaire. Researchers telephoned potential

respondents and solicited personal interviews from the

list of firms included in this sample. They thoroughly

explained to respondents the questionnaire and assured

that their responses would be confidential. If our request

was accepted, one or two research assistants would be

sent to conduct the interview. Our research assistants

were available to answer any questions the respondents

might have as they filled out the questionnaire. This

procedure helped ensure correct interpretation of

questions in the survey instrument.

In our survey, the top executive who was our main

contact was asked clearly that different sections of the

questionnaire must be filled by the relevant personnel in

a management position. The items of a construct were

sometimes filled by several departments. For example,

the construct of innovation involved not only vice

president in R&D, but also the managers of production

and R&D departments. This procedure was taken to

ensure that we would obtain an overall perspective from

the top executive and also expert perspective from

different areas of the firm.

A total of 850 enterprises were contacted between

February and July 2002. Of these firms, 603 agreed to

participate and provided the information. Eighteen

firms were excluded for reasons such as company

policies of non-participation in survey, company

liquidation, and inadequate completion of the survey

questionnaire. We obtained useable returns from 585

firms. The overall response rate for the survey was 69%.

This response rate is quite high, given that surveys were

completed by CEOs or their designees whose time is

often scarce. Thus, our response rate can be considered

very high.

Among these valid questionnaire returns, 198 firms

established Sino-foreign alliances. The other 351 firms

established domestic alliances. Of particular interest to

this study are the 140 Sino-foreign alliances which

involve offshore outsourcing. According to the long

term outsourcing agreements we reviewed, sixty seven

Sino-foreign alliances were involved in manufacturing

and distribution outsourcing, sixty two were involved in

R&D and knowledge service technological cooperation,

the remaining eleven were involved in other forms of

offshore outsourcing. Among the 351 domestic alli-

ances, 204 were involved in manufacturing and

distribution outsourcing, 98 alliances were involved

in R&D and knowledge service technological coopera-

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 265

tion, the remaining were involved in other forms of

outsourcing. Thus, we conducted our empirical analyses

using two study samples—the Sino-foreign offshore

outsourcing alliances, and the domestic outsourcing

alliances.

A profile of the firms in the overall study sample is

provided in Table 1. As can be seen, the main

respondents were primarily from medium and large

size firms with nearly 33.2% working for firms

employing more than 1000 employees. Nearly 77.5%

of the firms had annual sales turnover of 15 million

Renminbi (about US$ 1,206,000) or above in 2002.

Such companies are considered to be medium-to-large

companies in China. With respect to the annual sales

volume, the respondents were evenly distributed among

various groups. Types of firm ownership institution are

also presented in Table 1. As Table 1 shows, most main

respondents are from top management positions, and

had 18.82 years with the same company. This exceeds

the 5 year timeframe for measuring our dependent and

independent variable, adding to confidence that

respondents were knowledgeable and did possess

accurate information concerning their firm’s manage-

ment and innovation. Due to the rapid development in

Table 1

Firms and respondents in the study sample

Firm and main respondent characteristics %

1. Job positions of respondents

President/CEO 39.4

Vice President 19.0

R&D/General manager 37.8

Others 3.8

2. Tenure of respondents with the firm (average) (years) 18.82

3. Company size (number of employees)

�50 11.2

51–200 22.5

201–500 16.2

501–1000 16.7

>1000 33.2

4. Company sales revenue (in million)

�10 15.0

10–50 32.0

50–200 26.0

>200 19.5

Unreported 7.5

5. Firm ownership

State-owned enterprises 28.6

Joint ventures 12.9

Limited companies 37.6

Private companies 13.8

Collective enterprises 4.6

Village enterprises 2.5

China’s market economy, they may also represent the

perception and orientation of those who are employed in

firms located in different areas in China.

4.2. Reliability and validity

We took several steps to ensure data validity and

reliability. Validity refers to the extent to which the

instrument measures what it is supposed to measure.

Each scale employed in the study was pre-tested using

personal interviews with senior level managers. Inter-

viewees were asked to comment on any difficulty or

lack of clarity in the scale items or instructions. In the

instrument itself, we used previously validated mea-

surement items wherever possible to help ensure the

validity of our measures. Multiple-item measures were

used for all constructs to enhance content coverage. As

noted in Table 2, most constructs in our study have

Cronbach’s alpha of 0.70 or above, and the incremental

innovation construct shows Cronbach’s alpha of greater

than 0.67.

Two issues commonly raised in the literature concern

with survey methodology are non-response bias and

common method variance bias. To check for non-

response bias (the difference between the answers of

respondents and non-respondents (Lambert and Har-

rington, 1990), the final sample was spilt into two,

depending on the dates they were received. The early

wave group consisted of 318 responses, the late wave of

267 responses. The respondents of the second wave

were compared with those of the first wave along all the

response items to check for non-response bias

(Armstrong and Overton, 1977; Lambert and Harring-

ton, 1990). The t-tests performed on the responses of

these two groups yielded no statistically significant

differences on demographic characteristics (at a 99%

confidence interval), thus showing that non-response

bias is not a problem in this study. Furthermore, we also

examined the non-response issue with the procedure

suggested by Armstrong and Overton (1977). Two years

earlier, using the same questionnaire, we undertook a

survey with the same firms and included as part of the

survey instrument the same questions as those included

in the current survey. In our second survey, the

respondents were asked to respond to these questions

according to the situation as it was at the time of initial

survey. All the validation items correlated significantly

with the original measures (correlations ranging from

0.230 to 0.687). This suggests that non-response would

not likely bias the findings.

Clearly, we relied upon respondents’ assessments

and evaluation of their company situation to derive

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274266

Table 2

Convergent reliability of the measurement models

Construct Indicators Sino-foreign alliances

(the 140 firm sample)

Domestic alliances

(the 351 firm sample)

Factor

loading

Cronbach’s a Factor

loading

Cronbach’s a

Acquiring tacit knowledge

through offshore

outsourcing (ATK)

Acquiring market development knowledge 0.860 0.905 0.893 0.937

Learning management skill 0.894 0.925

Acquiring new product development knowledge 0.875 0.918

Obtaining important information 0.898 0.932

Formal control (FC) Detailed contract 0.734 0.780 0.674 0.786

Regulating the behavior of partner 0.732 0.735

Valuing the development of cooperation 0.611 0.754

Detailed cooperative rules 0.832 0.765

Cooperative procedures 0.752 0.746

Social control (SC) Trusting our partner 0.764 0.930 0.887 0.703

Shared vision and values 0.852 0.895

Confident of the capability of the partner 0.893 0.506

Fulfilling the obligations without monitoring 0.683 0.880

Communications 0.736 0.848

Incremental innovation (II) Innovation in product appearance 0.681 0.667 0.651 0.674

Improving existing process 0.818 0.845

Exploiting existing technologies 0.820 0.830

Radical innovation (RI) Creating new radical product 0.698 0.669 0.783 0.775

Introducing radical new concept 0.647 0.762

Developing new technology 0.679 0.787

Creating new techniques 0.808 0.759

measures of key variables utilized in this study, so there

might exist potential dangers of common method

variance bias. We examined the possibility of common

method variance via Harman’s one-factor test for all

variables in the study (Podsakoff and Organ, 1986).

Significant common method variances would result in

one general factor accounting for the majority of

covariance in the variables. We performed factor

analysis on items related to the dependent and

independent variables. No general factor was apparent

in the unrotated factor structure, with the first factor

accounting for only 25% of total variance and the

independent and dependent variables loading on

different factors. Thus, common method variance is

unlikely to be a serious threat to the findings of this

study.

4.3. Construct measurements

We consulted the extant literature to compile

measurement items for our instrument. As noted some

items were modified to reflect the specific context of the

study. Where this was not possible, new questions were

developed based on a review of the inter-firm

cooperation literature. All constructs were measured

by the average of the responses, on a 7-point Likert

scale. These items were summarized in the Appendix A.

4.3.1. The motive to acquire tacit knowledge in

outsourcing

To develop the measure of tacit knowledge acquisi-

tion motive, we relied primarily on a measurement

instrument created and validated by Gupta and

Govindarajan (2000) and Shenkar and Li (1999). We

adjusted their measures to fit our research better. Four

indicators used here are: Through (offshore) out-

sourcing, we hope to (1) often acquire knowledge of

market development from the partner; (2) often learn

operations management skills from the partner; (3)

learn the knowledge of new product and new service

development from the partner; and (4) obtain the new

and important information from our partner.

4.3.2. Social control mechanism

Following the work of Jap and Ganesan (2000), Uzzi

(1997) and Dyer and Singh (1998), we measure the

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 267

social control mechanism with five items. The items

include: (1) we can trust our partners in the process of

cooperation; (2) the shared vision and values have been

built in the cooperation; (3) we are confident of the

capability of our partner; (4) without monitoring, the

partner would fulfill his obligations; and (5) we often

communicate the ideas about selling, production and

services with our partner.

4.3.3. Formal control mechanism

According to Das and Teng (2001) and Poppo and

Zenger (2002), the items which measure the reliance on

formal control mechanisms focused on the monitor

mechanism in cooperation, and the importance of

formal contract and openness of partners. We utilized

five indicators: (1) a detailed contract is the most

important way to guarantee cooperation success; (2) the

contract is useful to regulate the behavior of partner; (3)

in the process of cooperation, we use financial and

market index to value the development of cooperation;

(4) detailed cooperative rules have been written in the

contract; and (5) both partners know the cooperative

procedure.

4.3.4. Radical innovation

Consistent with the definition and measurement

provided by Ettlie (1983) and Dewar and Dutton (1986),

we measured radical innovation utilizing four items: (1)

creating radically new products, (2) introducing

radically new concepts in innovations, (3) develop

and introduce new technologies into industry, and (4)

the firm is a creator of new techniques and technologies.

4.3.5. Incremental innovation

Based on Herbig (1994) and Dosi (1982), incre-

mental innovation was measured by three items

comparing the focal firm against its competitors along:

(1) developing new fashions of product, (2) improving

existing process and product and (3) exploiting existing

technologies. The Appendix A summarized these

constructs, their respective indicators, and literature

sources.

4.4. Analytical methods

The path relationships depicted in Fig. 1 were further

analyzed by a structural equation modeling (SEM)

approach using AMOS (Arbuckle, 2003). The primary

aim of SEM is to explain the pattern of a series of inter-

related dependence relationships simultaneously

between a set of latent (unobserved) constructs, each

measured by one or more manifest (observed) variables.

The measured (manifest) variables in SEM have a finite

number of values, and these variables are gathered from

respondents through data collection methods. They are

represented by numeric responses to a rating scale item

on a questionnaire. On the other hand, latent

(unobserved) variables are not directly observed, have

an infinite number of values, and are usually

continuous. Latent variables are theoretical constructs

which can only be determined to exist as a combination

of other measurable variables.

We include in our model the following latent

constructs. They are the motive to acquire tacit

knowledge (ATC) through (offshore) outsourcing

alliances, social control mechanism (SC), formal

control mechanism (FC), incremental innovation (II),

and radical innovation (RI).

5. Results

5.1. Reliability analysis

The composite reliability refers to inter-item con-

sistency, operationalized and estimated using Cron-

bach’s alpha. Typically, reliability coefficients of 0.70

or higher are considered adequate (Cronbach, 1951;

Nunnally, 1978). Nunnally (1978) further states that

permissible alpha values can be slightly lower (0.60) for

newer scales. The constructs developed in this study

were based primarily on previously validated measure-

ment items and strongly grounded in the extant

literature. They were adopted to the Chinese context.

Therefore, an alpha value of 0.60 was considered as the

cut-off value. As can be seen from Table 2, the

Crohbach’s alpha values for all except radical innova-

tion in domestic alliance and both radical innovation

and incremental innovation in Sino-foreign alliance are

greater than 7.0, and the Crohbach’s alpha values of

these three factors are substantially higher than 0.6.

These results suggest that the theoretical constructs

exhibit good internal consistency.

5.1.1. Content validity

The content validity of a construct is the extent to

which the set of measures provides adequate coverage

for the construct domain or essence of the domain being

measured (Churchill, 1979). The determination of

content validity is not numerical, but subjective and

judgmental (Emory, 1985). Instructions on the cover of

our questionnaire told those respondents clearly that the

purpose of this study was to explore firms’ management

practices and innovation outcomes. Confidentiality is

also assured. In addition, we sought feedback from a

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274268

panel of four academics in the area of innovation

management, and two practitioners regarding our

selected measures to ensure they were in fact capturing

constructs of interests. We asked these members to

comment on the clarity of our measurement items. We

subsequently modified various items based on their

concrete feedback.

5.1.2. Convergent and discriminant validity

Convergent validity is ‘‘the degree to which multiple

attempts to measure the same concept by different

methods are in agreement’’ (Campbell and Fiske, 1959;

Phillips, 1981). Two tests were used to assess

convergent validity, they are respectively Cronbach’s

alpha and average variance extracted by constructs

(Fornell and Larcker, 1981). The average variance

extracted by constructs was computed based on the

extent to which all questions measuring a construct

actually tapped into the same underlying construct.

Fornell and Larcker (1981) suggested 0.5 as the

indication of adequate variance extracted. As the factor

loadings for final model show, the expected measure-

ment model performed very well.

Discriminant validity is the degree to which

measures of different latent constructs are unique

enough to be distinguished from one another, which is

Table 3

An assessment of the discriminant validity: chi-square differences between

Constructs ATK

Acquiring tacit knowledge through offshore outsourcing (ATK)

Formal control (FC) 4.6

Social control (SC) 4.3

Incremental innovation (II) 55.5

Radical innovation (RI) 31.5

All chi-square differences were significant at the 0.05 level (for 1 degree of f

Sino-foreign alliances, and the upright the domestic alliances.

Table 4

Structural fitness measurements

Indicator Sino-foreign alliances (the 140 firm samp

Desired value Model estim

Discrepancy 130.112

Discrepancy/d.f. 1.075

p 0.270 >0.05

GFI 0.927 >0.90

AGFI 0.847 >0.80

NFI 0.927 >0.90

TLI 0.989 >0.90

CFI 0.994 >0.90

IFI 0.995 >0.90

RMSEA 0.023 <0.06

demonstrated if the average variance extracted for each

construct is greater than the squared correlations

between constructs (Hatcher, 1994). Bagozzi’s (1980)

criterion can also be used through x2 difference tests. In

this study, discriminant validity is established using

confirmatory factor analysis (CFA). Models were

constructed for all possible pairs of latent constructs.

These models were run on each selected pair, first

allowing for correlation between the two various

constructs, and then fixing the correlation between

the various constructs at 1.0. A significant difference in

chi-square values for the fixed and free models indicates

the distinctiveness of the two constructs (Bagozzi and

Phillips, 1982; Bagozzi et al., 1991). The chi-square

difference was tested for statistical significance at

p < 0.01 confidence level. For the 6 constructs, a total

of 15 different discriminant validity checks were

conducted. As can be seen in Table 3, all the differences

between the fixed and free solutions in chi-square are

significant. This result provides a strong evidence of

discriminant validity among the theoretical constructs.

5.2. Assessment of model fit

Table 4 presents summary statistics of models

estimated in the modeling procedure as well as chi-

the fixed and free models

FC SC II RI

39.979** 18.866** 37.208** 16.198**

68* 15.808** 188.172*** 59.533**

72* 10.501** 76.562** 50.025**

26** 54.762** 48.103** 5.020*

71** 39.270** 36.719** 3.634*

reedom). *p < 0.05; **p < 0.01. The bottom left matrix represents the

le) Domestic alliances (the 351 firm sample)

ates Desired value Model estimates

124.385

1.091

0.238 >0.05

0.968 >0.90

0.935 >0.80

0.971 >0.90

0.995 >0.90

0.997 >0.90

0.998 >0.90

0.016 <0.06

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 269

Table 5

Hypotheses tests for the final models

Paths and hypotheses Sino-foreign alliances (the 140 firm sample) Domestic alliances (the 351 firm sample)

Standardized path coefficient p-Value Support Standardized path coefficient p-Value Support

H1a (+): ATK! SC 0.220 0.023 Y 0.175 0.004 Y

H1b (+): ATK! FC 0.229 0.034 Y 0.175 0.008 Y

H2a (+): SC! RI 0.724 0.047 Y 0.549 0.005 Y

H2b (�): FC! RI �0.753 0.049 Y �0.387 0.047 Y

H2c (+): FC! II 0.726 0.038 Y 0.662 0.044 Y

H2d (�): SC! II �0.603 0.049 Y �0.549 0.050 Y

H3a (+): ATK! RI 0.044 0.722 N 0.197 0.029 Y

H3b (�): ATK! II �0.213 0.098 Y �0.089 0.172 N

square statistics and goodness-of-fit information for the

final models for the two sub-samples. The chi-square

statistic and goodness-of-fit measures for final models

on Table 4 reflect a very strong model.

5.3. Results of hypothesis tests

Since we undertook the study to compare between

two distinctly different samples—Sino-foreign offshore

outsourcing alliances, and local firm alliances, we tested

the structure equation models using those two sub-

samples, respectively. Interestingly enough, we

observed significant consistency between the two

sub-samples. As indicated in Table 5 and Fig. 1, the

motive to acquire tacit knowledge is positively related

to formal control and social control for both samples.

Thus, Hypotheses 1a, 1b received support. Social

control is positively related to the radical innovation but

negatively related to the incremental innovation in both

samples. Thus, H2a and H2d were supported. Formal

control was found to be positively related to the

incremental innovation but negatively related to the

radical innovation in both samples, providing supports

for H2c and H2b.

While these consistencies are interesting, the

inconsistency we observed between the two samples

provided additional insights. Specifically we should

examine carefully the direct impacts of the motive to

acquire tacit knowledge (ATK) on radical and incre-

mental innovation in the two study samples. For the

Sino-foreign alliance sample, the ATK to radical

innovation link is not statistically significant (H3a

was not supported), but the ATK to incremental

innovation is negative and statistically significant

(H3b was supported). On the other hand, for the

domestic alliance sample, we observe precisely the

opposite. The motive to acquire tacit knowledge affects

radical innovation positively, but does not have any

impact on incremental innovation.

6. Discussion

This paper compares the differences between Sino-

foreign alliances based on the offshore outsourcing and

the domestic alliances, and examined the effects of the

motive to acquire tacit knowledge in the alliances, and

control mechanisms on incremental and radical

innovations in China. Based on the social exchange

theory and alliance risk perspective, we develop a

theoretical framework to link these important concepts

together. The analytical results provided strong support

for the model and hypotheses presented in Fig. 1.

Researchers (Van de Ven et al., 1999) speculated that

factors that contributed to radical innovation may at the

same time have an opposite impact on incremental

innovation. Our study focused on the motive to acquire

tacit knowledge as such a factor. We discovered that

firms with greater motive to acquire tacit knowledge

from outsourcing alliance partners tended to emphasize

both social control and formal control. This finding

differs from prior research. Liebeskind et al. (1996)

argued that contracts were rarely used to control the

tacit knowledge transfer and the use of social control

would increases both their learning and their flexibility.

Powell (1990) also argued that social networks were the

most efficient organizational arrangement for sourcing

information because information is difficult to price and

to communicate through a contract. We believe the

differences could be because of the particular setting.

In the Chinese context, the legal system and

reputation mechanisms still remain rather weak (but

we note they are being developed rapidly). Opportu-

nistic behaviors, which would gain private benefits at

the expense of damaged reputation, might be the main

reason for the failure of alliances or other inter-firm

cooperation in China. So it is dangerous to establish the

cooperation only on the basis of social control in China

where the crisis of trust is ubiquitous. This finding is

critical given the increased use of transformational

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274270

offshore outsourcing and gained importance of emer-

ging economy firms on the global economic landscape.

Gulati (1995) also argued that social control mechanism

would not function very well without trust. In addition,

more and more researcher suggested that formal control

and social control governance function as complements

(Poppo and Zenger, 2002). Well-specified contracts

may actually promote more cooperative, long-term,

trusting exchange relationships, and relational

exchanges may gradually develop more complex formal

contracts, as mutually agreed upon processes become

formalized. According to this logic, both formal and

social control should be strengthened simultaneously.

These results have important implications to both

outsourcing firms (knowledge donor) and outsourcing

vendors. On the one hand, for outsourcing firms, in

order protect their core business and core knowledge,

they should emphasize contract formulation and

enforcement. Furthermore, through improving the trust

relationship with the venders, outsourcing firms can

increase the reliance of the vendors on them so that they

can keep flexible choices for outsourcing venders under

an uncertain environment and continuously keep their

cost advantage (Doh, 2005; Levy, 2005). On the other

hand, using both social control and formal control

would enable outsourcing venders to learn useful tacit

knowledge from knowledge donors and push forward

their innovation.

Our findings also suggest that the two different

control mechanisms have their respective impacts on

different types of innovation. The social control

mechanism is beneficial to radical innovation, but

may limit incremental innovation. On the other hand,

formal control has a positive effect on incremental

innovation, but may limit radical innovation. These

findings are consistent with the literature in general.

For example Ettlie et al. (1984, p. 692) state that the

‘‘strategy–structure causal sequence for radical inno-

vation is markedly different from the strategy–

structure sequence for incremental innovation.’’ While

there’s no clear conclusion in the extant literature

regarding the efficacy of social and formal control in

outsourcing alliances when they relate to innovation, in

a recent research study, Das and Teng (2001) suggested

that social control may effectively reduce perceived

relational risk in an alliance. This paper confirms and

extends this proposition. First, this paper provides

empirical evidence that formal control has its

advantage in dealing with opportunism; second, our

findings also suggest that formal control mechanism

may guarantee the efficiency of transferring of

codifiable knowledge. These results indicated that

formal control is helpful for accomplishing incre-

mental innovation.

The results of this study have important implications

for business practitioners. First, the framework provided

useful guidance for selecting control mechanisms

appropriate for the respective types of innovation.

Formal control minimizes opportunistic behavior

among alliance partners. Detailed contracts specify

contingencies, and adaptive processes to mitigate

opportunistic behavior. However, formal control does

not guarantee the intent of mutuality, bilateralism and

continual exchange and contact of partners. Relational

governance complements such adaptive limits of formal

control by fostering continuance of the exchange and

entrusting both parties with mutually agreeable out-

comes. Therefore, it is important to strengthen both

formal control and social control for tacit knowledge

acquisition during the transitional period in China’s

economic reform.

Our findings also suggest that different control

mechanisms should be adopted for different types of

innovation. In order to strengthen formal control, formal

policies and procedures should be established, and this

result consists with the research of Littler and Leverick

(1995). The reporting structure also should be used to

provide role specifications for everyone in the system

(Heide, 1994). In addition, staffing and training are

important measures to regulate and standardize behavior

in alliance. If incremental innovation is the main target,

formal control is better than social control. On the other

hand, in order to accomplish radical innovation, social

control should be more helpful. In the process of

cooperation, partner firms can create shared visions and

values through a participatory decision-making process

(Grandori, 1997). Such a process ensures that the

preference of each party is understood and integrated

into mutually acceptable goals and plans. In addition,

partner firms can also stress cultural activities such as

rituals, ceremonies, and networking, to help establish

shared norms and beliefs. They are informal but effective

ways to translate organizational ideals into behavior

models that can provide guidance.

Finally the differences in the study findings from the

two samples are of important value as well. For the

Sino-foreign sample, the motive to acquire tacit

knowledge does not have a direct positive impact on

radical innovation (but does have a direct negative

impact on incremental innovation). It appears Sino-

foreign alliances require control mechanisms in order to

achieve radical innovation outcomes. On the other hand,

for the local alliances, the motive to acquire tacit

knowledge does appear to have a direct positive impact

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274 271

on radical innovation. We believe that local alliances

may be able to pool local knowledge together more

effectively to achieve radical innovation. Clearly the

effective social control may also help.

7. Conclusion

This study makes three important contributions.

First, integrating existing theoretical perspectives on

offshore outsourcing and transformational offshore

outsourcing as well as social exchange, and alliance

risk perspective, we built a model linking the motive to

acquire tacit knowledge in outsourcing alliances, social

and formal control with two types of innovation.

Second, this paper reported an empirical study set in

China’s transitional economy comparing between Sino-

foreign offshore outsourcing alliances and local out-

sourcing alliances to highlight both commonalities and

differences, revealing the challenges of realizing radical

innovations in the Sino-foreign alliance samples, and at

the same time the importance of cultural and business

practice familiarities involving local alliance partners.

We argued and empirically demonstrated that in the

Chinese context it is important to utilize both formal

and social controls. Differing with prior research, we

took into consideration the background of Chinese

economy transition, and indicated that basic formal

control mechanism is necessary for tacit knowledge

acquisition from the partners because the yet to be fully

developed market environment and law environment.

Appendix A. List of items measuring each theoretical co

Factors and variables (survey questions)

Acquiring tacit knowledge through offshore outsourcing (ATK)

1. We often acquire market development knowledge from the

partner through offshore outsourcing

2. We often learn operations management skills from the

partner through offshore outsourcing

3. We learn new product development knowledge of from the

partner through offshore outsourcing

4. We obtain new and important information from our partner

through offshore outsourcing

Social control mechanisms (SC)

1. We can trust our partners in the process of cooperation

2. The shared vision and values have been built in the cooperation

3. We are confident of the capability of our partner

4. Without monitoring, the partner would fulfill his obligations

5. We often communicate ideas about selling, production

and servicing with our partner

According to this logic, both formal and social control

should be strengthened simultaneously. Finally, our

findings highlighted the different effects of two control

mechanisms on different types of innovation. The social

control mechanism is beneficial to radical innovation,

while the formal control has a positive effect on

incremental innovation.

Departing from cost reduction and core focus logic

central to the traditional view of offshore outsourcing,

transformational offshore outsourcing focuses on

business renewal and corporate transformation. Innova-

tion through offshore outsourcing becomes a promising

new direction. This study examined Sino-foreign

alliances and local alliances from this perspective.

Our study identified the importance of tacit knowledge

acquisition, and control mechanisms when it comes to

radical and incremental innovation. We also uncovered

the cultural and business practice familiarities as an

important contributing factor. Extending this study in

other settings will be useful such that we will be able to

compare important conclusions across different con-

texts. Furthermore, conducting this study with a

longitudinal design will be profitable as we may learn

further if the findings in this study are transitional

situational specific or not. Extending the concept of

innovation to include other dimensions of innovation

(such as organizational and strategic innovations) will

be promising as well since the transformational

outsourcing focuses on business renewal and corporate

transformation.

nstruct

Reference sources

Gupta and Govindarajan (2000), Linderman et al. (2004),

Nonaka (1994), Nonaka and Konno (1998), Nonaka and

Takeuchi (1995), Shenkar and Li (1999)

Jap and Ganesan (2000), Uzzi (1997)

Y. Li et al. / Journal of Operations Management 26 (2008) 257–274272

Appendix A (Continued )

Factors and variables (survey questions) Reference sources

Formal control (FC)

1. Detailed contract is the most important way to guarantee

cooperation success

2. The contract is useful to regulate the behavior of partner

3. In the process of cooperation, we use financial and market

indices to evaluate cooperation success

4. Detailed cooperative rules have been written in the contract

5. Both partners know the cooperative procedures

Incremental innovation (II)

1. We often create new patterns of product Dosi (1982), Herbig (1994)

2. We often improve existing process and product

3. We often exploit existing technologies

Radical innovation (RI)

1. We often create radically new products Dewar and Dutton (1986), Ettlie (1983)

2. We often introduce radically new concept in innovations

3. We often develop and introduce new technologies into the industry

4. We are often the creator of new techniques and technologies

Note: Respondents used a 7-point Likert scale to provide responses on each item (1: strongly disagree and 7: strongly agree).

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