Business process outsourcing (BPO) is rapidly emerging as an imperative for competitive success in modern organizations. This study characterizes contractual coordination, or the mutual exchange of rights, and procedural coordination, or the relational norms and processes that facilitate mutual exchange of information, as two fundamental elements of governance of BPO relationships, and posits that the choice of these elements is contingent on the type of uncertainty encountered in the BPO task environment. In particular, we focus on relational uncertainty (or uncertainty perceived by the user firm about its relationship with the service provider) and process uncertainty (or uncertainty in execution and management of the outsourced process across organizational boundaries). We draw on transaction cost economics and theories of inter-firm coordination to posit that the extent of contractual coordination in the BPO relationship is determined by relational uncertainty while the extent of procedural coordination is determined by process uncertainty. Further, while performance of the BPO relationship is explained by the complementary relationship between contractual and procedural coordination function, it is also significantly influenced by the alignment between contractual coordination and relational uncertainty and procedural coordination and process uncertainty. Our analysis of survey data on 137 active BPO relationships provides strong support for our hypotheses. The contingency approach to governance of BPO relationships helps reconcile the economic conceptualization of governance of outsourcing relationships as a nexus of contracts and the organizational perspective of governance as a complex work system by applying each perspective in a discriminating fashion based on the effects of relational and process uncertainty.
[...] This introduces the potential for sample selection bias business processes characterized by high levels of process and relational uncertainty will be internalized and therefore, not observed in our sample of BPO transactions. The calculation of the inverse Mills ratio in the governance choice model and its inclusion in the performance model is an accepted method for correcting such sample selection bias in OLS. However, its use is particularly problematic in other approaches such as the two stage least squares procedure used in our model (Poppo and Zenger 2002). [...]
[...] However, the design of procedural coordination mechanisms requires insights into uncertainty in execution and management of the outsourced business process across organizational boundaries, which is different from relational uncertainty. Such process uncertainty refers to the rate of information change in the outsourced process, and relates to whether the outsourced process is well understood, how process tasks will be allocated between participant firms, and the extent to which mutual adjustment in behavior is required during process management and execution (Gulati and Singh 1998). [...]
[...] However, our results emphasize the unique antecedents of contractual and procedural coordination and their complementary role in explaining BPO performance The Contingent Effects of Uncertainty on Dimensions of BPO Governance The significant interaction between contractual coordination and relational uncertainty in Model 5 provides support for Hypothesis 3a, i.e., when relational uncertainty is high, managers will use complex customized contracts as a potential safeguard against the threat of opportunistic behavior. Similarly, the strongly significant interaction between procedural coordination and process uncertainty in Model 5 provides support for Hypothesis 3b, i.e., when process uncertainty is high, managers will invest in exchange processes that facilitate adaptation to changing task requirements in the outsourced business process. [...]
[...] Hence, Hypothesis Contractual coordination and procedural coordination will function as complements in explaining the performance of the BPO relationship Contingent Effects of Relational and Process Uncertainty We contend that although contractual and procedural coordination function as complements in explaining BPO performance, there are distinct limitations to the use of each in governance of the BPO relationship. Problems of relational uncertainty are problems of conflict of interest, and are rooted in the intent to cooperate and therefore, are effectively addressed by incentive alignment through formal contracts (Gulati 2005). [...]
[...] Process uncertainty circumscribes the ability of the user firm to ex ante anticipate and contractually specify needs and contingencies in execution and management of the outsourced process, resulting in frequent negotiation of specified contractual responsibilities. The ensuing repetitive cycles of impact assessment, bargaining, and reconciliation between the user firm and the service provider result in “excess haggling costs that are not recouped later in the form of dispute prevention or resolution” (Mayer and Argyres 2004). Frequent renegotiation also introduces the potential need for variety in coordination efforts required to transfer value from the outsourced task environment back to the user firm, thereby increasing process execution costs. [...]
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