Procurement is An Integral Part of Resource-­ Based View of An Organization

Phuong Duong

University College Dublin (12251697) 4112 words

ABSTRACT Procurement has become an increasingly widespread practice among organizations and is today of strategic importance that attract great interest from scholars in the literature. The primary purpose of the paper is to contribute with a review of leading studies that analyze procurement from the resource-­‐based view of the organization. The paper begins by setting out the business environment of procurement and then presents the development and propensity of procurement. This is followed by a review of principal works and differences of perspectives of resource-­‐based view. The next section contains an analysis of the relationship between procurement and resource-­‐based theory and discusses empirical works on outsourcing that address outsourcing from the resource-­‐based view. The studies are classified into two categories: those studying the propensity to procure and those studying the relationship between procurement decision and firm’s performance. Finally, some insights are put together to assess the outsourcing decision influenced by resource-­‐based view with the aim of contributing to a better understanding of outsourcing and its role from the perspective of resource-­‐based view of an organization.

1. Procurement and the propensity to procure in modern business context

Procurement, or in other words, “sourcing”, for years has become “a financial material, but strategically peripheral, corporate function” of an organization (Gottfredson et al., 2005). In the literature, procurement becomes a key component and is of major strategic importance to many organizations (Humphreys et al., 1998, Paulraj et al., 2006). Recent decades have witnessed significant changes in macro-­‐economic trends that direct business environment. These changes have been driven by increased globalization, technology innovation, changing consumer behaviours, and consequently, a shift toward procurement and outsourcing (Giunipero et al., 2005, Giunipero et al., 2006, Zheng et al., 2007). Gottfredson et al. (2005) argued that globalization, accompanied by technological advances, is causing the core of competition to change. These days, the ownership of capabilities of an organization is not as important as its ability to govern and take advantage of critical capabilities, whether or not they are the organization’s assets. Procurement is developing so sophisticatedly that even core functions such as engineering, R&D,

manufacturing and marketing can be outsourced. That, according to Gottfredson et al. (2005), in turn, is changing the way the firms think about their organizations, their core values and their competitive abilities. The author also revealed that an emphasis on capability sourcing could result in an organization’s better strategic position by reducing costs, streamlining the company, and enhancing quality. Critical functions provided by more qualified partners usually allow organizations to improve their core capabilities that help them take the lead in their industries.

With the business world changing everyday, the propensity to procure becomes prominent than ever. Nowadays procurement is not only practiced by companies in the technology industries but also spread to multiple businesses such as supply chain, manufacturing, services and so forth. It is recognized that not passive cost-­‐focused, but proactive value-­‐focused procurement strategies are a means of achieving competitive advantage and integral to long-­‐term organizational strategy (Leseure et al., 2005, Mehra and Inman, 2004, Noonan and Wallace, 2004). In a study of the impact of procurement or purchasing on supply integration and performance, Paulraj et al. (2006) also concluded that: (1) a more strategic purchasing function leads to better supply integration; (2) managers must comprehend the importance of purchasing in incorporating buyer-­‐supplier by focusing on “process, relational, information, and cross-­‐ organisational teams”; (3) strategic procurement can create a win-­‐win situation for both buyer and supplier. Taking these into account, it is undeniable that there is a tendency to procure or outsource among organizations.

To assist with procurement decision making, Gottfredson et al. (2005) developed a sourcing opportunities map like Figure 1 to help companies judge the relative merits of their outsourcing possibilities. The vertical dimension of the exhibit “measures how proprietary a process or function is” while the horizontal axis indicates the degree of commonality, both within and outside the company’s industry. The author found that capabilities locating in the upper right portion of the map are potential candidates for procurement.

Once capabilities promising strong candidates for alternative sourcing are discovered, the company needs to figure out how to source them. In this stage, cost and quality requirements should be taken into account to detect key capability gaps to be filled and top-­‐performing competitors or suppliers to partner with. To address these issues, another assessment map has been introduced, again by Gottfredson et al. (2005) as described in the Figure 2 below.

Figure 1

What should you outsource? Source: Adapted from (Gottfredson et al., 2005).

Figure 2

How strong are your capabilities? Source: Adapted from (Gottfredson et al., 2005)

The author explained that the position of capabilities on this grid determinates suitable goals for an outsourcing relationship. Specifically, functions that fall in the upper left should be outsourced to low-­‐cost providers regardless of reduction in quality, while those falling in the lower left require outsourcing partners that can both reduce costs and improve quality.

2. Resource-­based view In the opinion of Mol (2003), resource-­‐based view has today become the domineering perspective of analyzing corporation strategy. However, this concept has been perceived and developed by different scholars in the literature. Porter (1985) suggested a firm’s competitive position can be analyzed by looking at industry structure and the role of internal decision making was overlooked. This theory contradicts itself with earlier strategic management arguments which highlighted both internal and external factors (Skinner, 1969, Ansoff, 1965) and therefore several scholars such as Barney (1991), Amit and Schoemaker (2006), and Peteraf (2006) felt a different perspective and went on developing the resource-­‐based view based on the researches of Coase (1937) and Wernerfelt (1984). In an effort to stress the significance of managerial choice and internal factors, Barney (1991) concluded that the resource-­‐based view “examines the link between a firm’s characteristics and performance” by investigating varied resources within the firm. By the nature of its activities, procurement management is subject to obtaining inputs from outside partners in the organization’s environment (Mol, 2003). According to Wernerfelt (1984), resource-­‐based approach “views the firm as a historically determined collection of assets or resources which are tied semi-­‐ permanently to the firm’s management”. Lockett and Thompson (2001) criticized that resource-­‐based view is sometimes used to distinguish “appropriate resources, such as physical capital or brand names, from less tangible assets, such as organizational routines and capabilities”. Appropriate resources can be seen as assets utilized as appropriate over a specific period, while dynamic resources may lie in capabilities that form additional opportunities over time. The crucial requirements of resource-­‐based view are that relevant resources, regardless of their nature, are specific to the firm and not easy to be imitated by rivals (Barney, 1991). It was noted by Lockett and Thompson (2001) that resource-­‐based view is implied in the sense that each firm’s opportunity set is exclusive and a product of the resources is obtained from its past experience. “Therefore, it follows that decisions about the appropriate boundaries of a firm’s activities should reflect its existing resource bundle. If firms face a similar external environment, in the sense of similar product and factor markets, the resource-­‐based view suggests that those firms with a similar initial resource endowment should display similar ceteris paribus patterns of behavior and performance”.

3. Procurement is an integral part of resource–based view of an organization Procurement and resource-­based view Procurement, or in many context, usually referred to as “outsourcing”, is defined as “ astrategic decision that entails the external contracting of determined non-­‐ strategic activities or business processes necessary for the manufacture of goods or the provision of services by means of agreements or contracts with higher

capability firms to undertake those activities or business processes, with the aim of improving competitive advantage” (Espino Rodriguez and Padron Robaina, 2006). According to resource-­‐based view, resources can be exploited by means of contracts (Barney, 1999, Gainey and Klaas, 2003, Grant, 1991) and this perspective can be used as a framework to help organizations decide which activities should be outsourced and which to perform in-­‐house. In this regard, one of the dominant frameworks that explain the propensity of procurement is core competences approach (Gilley and Rasheed, 2000, Teng et al., 2007). Based on this approach, a firm should invest in activities generating core capabilities and outsource the rest (Prahalad, 1990, Hilmer and Quinn, 1994), regarding that the former activities are those providing the firm’s growth and development (Peteraf, 2006). It is pointed out by Prahalad (1990) that a firm can perform better by focusing on those resources generating the core competences. According to the author, short-­‐term success results from the price and the attributes of the products, while long-­‐term competitive advantages lie on the core capabilities, which derives from the firm’s collective learning. Strategic outsourcing, based on resources and capabilities, signifies a deep understanding of the core competences, which assist organizations to build their long-­‐term competitiveness (Bettis et al., 1992). Espino Rodriguez and Padron Robaina (2006) concluded that the resource based view helps to distinguish the core competences and provides knowledge (Hilmer and Quinn, 1994) about which activities to perform with internal resources and which to procure, “determining that the possession of some resources and capabilities is what defines what the firm itself will do and what it will obtain from third parties”.

In order to explain the integral part that procurement plays from resource-­‐based view, it is important to look into the framework developed by Grant (1991), in which a firm’s resources and capabilities are the main considerations in formulating strategies. In this framework for strategy formulation, five stages were established to associate strategy, competitive advantage and resources and capabilities. Among these five stages, the last one refers to “identifying the resource gaps which need to be filled and invest in replenishing, augmenting and upgrading the firm’s resource base” where there is a place for procurement. This is demonstrated in Figure 3 as below. Grant (1991) believes that regarding the lack of firm’s resources and capabilities, the firm needs to decide between developing resources in-­‐house and outsourcing resources from the third parties. Hence, in order to control the firm’s resources and capabilities and to develop a strategy that improves competitive position, it is essential to acquire complementary resources externally, and therefore an organization should not be limited to exploiting its own stock of resources and capabilities (Teng et al., 2007). In fact, any lack of resources can be supplemented by procurement or strategic alliances, and outsourcing is one way of enriching the firm’s resources and capabilities by helping to improve the organization’s strategy to take better advantage of its capabilities when dealing with external opportunities. Following Grant’s (1991) framework, prior to the decision making process about procurement, the firm must assess the resources that sustain the organization’s activities. It is stated by Cheon et al. (1995) that a firm’s resources may vary, depending on their attributes (valuable, rare, inimitable and non-­‐substitutable) as well as the

quantity of resources allocated to the business process. In particular, organizations outsource what they lack competences and develop internally what they do better than the suppliers, with the result of efficient production (Argyres, 1996). This leads to conclusion of Teng et al. (1995) that the discrepancies in the perceptions of the outcomes (cost, quality of activity and financial performance) are positively related to the propensity to outsource.

Figure 3

A resource-­based approach to outsourcing strategy. Source: Adapted from Grant (1991, 115).

The resource-­‐based view of the firm is based on an assumption of the inside-­‐out perspective, which is described by Prahalad (1990) as “a perspective that builds on an assumption that organisations should clarify the availability of internal resources before they seek outside the organization after resources”. This is in accordance with the conventional approach on the resource-­‐based view of the firm, which views organizations as a collection of productive resources. A major distinction in the theory is that a resource provides organizations with sustained competitive advantage, and to accomplish that, the firm need to fulfill different attributes for the resources. Hedman (2002) found that there are many resource attributes described in the resource-­‐based theory literature that gives a firm its competitive advantage. Four attributes were identified by Barney (1991), Cheon et al. (1995) and Hedman & Kalling (2002) are: valuable, rare, costly to imitate and efficiently organized. Barney (1991) also distinguishes between three various groups of resources: physical capital resources, human capital resources and organizational capital resources. Hedman & Kalling (2002) suggest that the core issue in resource-­‐based theory is how to identify and utilize existing resources more effectively in the organization. The authors came to a conclusion

that if a resource is seen as a necessary for the organization’s competitive advantage, it should be handled internally.

Considering the fact that procurement or outsourcing is a strategic decision (Venkatesan, 1992, Quinn et al., 1990, Hilmer and Quinn, 1994), it is necessary for organizations to assess the strategic potential of its activities. Thus, according to the resource and capability approach, the willingness to outsource an activity depends on the extent to which outsourcing leads to competitive advantage. Espino-­‐Rodriguez and Padron-­‐Robaina (2005) used Cox's (1996) classification of resource specificity to divide activities into three strategic-­‐value groups by type of contractual relationship as in Figure 4.

Figure 4

Strategic value and contractual relationships. Source: Adapted from Cox (1996).

According to the resource-­‐based view of the firm, the organization’s ultimate goal is to achieve competitive advantage by obtaining resources and defending competitive positions (Wernerfelt, 1984, Barney, 1991, Conner, 1991). It is found out by Day and Wensley (1988) that superior resources and capabilities are influenced by specific strategic choices, “including objectives, the quality of tactical decisions and the implementation of those strategies”. Therefore, procurement as a strategic choice can lead to superior resources and capabilities becoming positional advantages, which in turn leads to better company’s performance. A firm’s resources and capabilities should focus on its core competences as well as on the efficient allocation of its resources, and outsource only those activities, which do not depend on strategic resources. This way the firm’s competitive advantage can be maintained.

The resource-­‐based view suggests that the primary focus of any strategy is to improve the value-­‐creation potential of firm resources (Wernerfelt, 1984). This is based on certain conditions, such as resource attributes and their availability

(Barney, 1991). The firm’s resources are classified by Barney (1991) into three categories. First, “there are physical capital resources that include technology, plant and equipment, location, access to raw materials, and related physical resources (Williamson, 1975). Second, the firm requires “human capital resources that include training, expertise, judgment, intelligence, relationships, and insights and knowledge of the members of the workforce” (Javalgi et al., 2009). Third, there are organizational/social resources “that include reporting structures, formal and informal planning processes, administrative and management systems, and informal relationships among groups within the firm and between a firm and its environment” (Tomer, 1987). In addition, the firm also has financial capital resources (Hayes and Abernathy, 1980, Rumelt, 1991), particularly the firm’s debt and equity structures and cost of capital providing advantages. The resource-­‐based view for procurement, as Javalgi et al. (2009) stated, provides a framework for examining the pool of resources and capabilities that may or may not be able to carry out a given strategy during the formulation stage.

Review and classification of the principal studies of procurement/ outsourcing from resource-­based view After an exhaustive view of the literature on procurement/outsourcing from the resource-­‐based view, Espino Rodriguez and Padron Robaina (2006) have classified the reviewed works into two categories according to their objectives: works that study the tendency to procure and works that study the relationship between the decision to procure and organizational performance. The authors of the works in the first group analyze the level of outsourcing according to moderating variables such as the type of resource, environment, strategic orientation, suppliers’ capabilities (Argyres, 1996; Klaas et al., 2001; Leiblein and Miller, 2003; Hilmer and Quinn, 1994). Argyre (1996) states that firms have a propensity to procure when the suppliers have superior capability and the firm does not accept the short-­‐term cost of internal development with the aim of developing the necessary capabilities in-­‐house. In another conceptual work, Quin and Hilmer (1004) suggests core activities be developed internally and procurement be practiced with other strategic objectives to aim at reducing the vulnerability of the firm. Klaas et al. (2001) conducted a most complete study of the procurement of human resources with specific variables of human resources management such as strategic involvement, significance of human resources, salary scale and promotion opportunities. Meanwhile, the later study group use specific assets and other resource-­‐based view related variables to assess the relationship between procurement/outsourcing and the performance of the organization (Gilley and Rasheed, 2000, Klaas et al., 2001, Murray et al., 1995, Teng et al., 2007). Gilley and Rasheed (2000) uses competitive strategy as moderating variable to analyze the effect of outsourcing and they come to a conclusion that the good effect is made in the case of a cost leadership strategy and a differentiation strategy causes negative impact. On the other hand, Murray et al (1995) study a negative relationship between outsourcing and organizational performance as the asset specificity and innovations in products and processes increase. Teng et al (1995) states that the discrepancies in the

perceptions of the outcomes such as cost, the quality of the activity and financial performance makes a positive impact on the tendency to outsource. Moreover, these authors differentiate core outsourcing from peripheral outsourcing, based on how important executives considers the principal activities are for increased sales and profitability. The study of Klaas et al. (2001) is one of studies in this group, as it assesses the relationship between human resources performance and outsourcing and identifies a negative relationship only for some of the human resources functions.

Barney (1991), Grant (1991) and Peteraf (1993) are one of the first resource-­‐ based theorists that offer a general model of resources and performance from an integrating perspective. According to the analysis of Collis and Montgomery, (1995), owning valuable resources can generate competitive advantages for the firm so that it performs activities better or at lower cost than their competitors. Barney (1991) thought that in order to have that potential, a resource must meet four conditions: “it must be (1) valuable, (2) rare, (3) imperfectly imitable and (4) non-­‐substitutable. Sharing the same idea, Grant (1991) states that core competences of a firm are those valuable resources and capabilities “that are difficult to identify and understand, imperfectly transferable, not easily replicated and over which the firm possesses clear ownership and control”. It is agreed among Barney (1991), Grant (1991) and Peteraf (1993) that heterogeneity plays the key role in the achievement of competitive advantages and to ensure the sustainability of that competitive position, such heterogeneity must be continuous and prevent competitors from being able to imitating or substitute the resources that form competitive differential. Espino Rodriguez and Padron Robaina (2006) also developed a framework that relates outsourcing with the characteristics of the resources and their impact on performance as in Figure 5. This framework shoes that the outsourcing of services or business processes is based on the strategic value of the resources forming them. The strategic value is constituted by “the heterogeneity of the resources (valuable, specific), and the persistence of that heterogeneity (non-­‐substitutable, inimitable and the appropriability of the rents)”. Additionally, the framework analyze the relationship between outsourcing and organizational performance based on the type of activity to be outsources and concludes that to improve organizational performance and to develop capabilities across organizational boundaries, it is required for the relationship between the organization and the supplier “to convert into invisible assets (Itami, 1987) and capabilities with their own significance that generate inimitable inter-­‐organizational routines.

Figure 5

Outsourcing framework based on the RBV. Source: Adopted from Espino-­Rodriguez & Padron Robaina (2006).

How resource-­based view informs outsourcing evaluation of the firm The resource-­‐based view is critical to the study of procurement/outsourcing, as superior performance achieved in organizational activities compared to competitors would explain why such activities are performed in-­‐house. McIvor (2009) figures out that a major concern of the resource-­‐based view is how an organization’s capabilities develop and influence its competitive differential and performance. The argument of Langlois and Robertson (1995) is that firm boundaries can be identified by comparing internal competences with the competences of competitors. The outsourcing decision, hence, is affected by the ability of a firm to invest in developing a capability and maintaining a superior performance position in activities relative to competitors. Activities in which the firm lacks internal resources or capabilities can be outsourced and through that, firms can achieve complementary capabilities from external parties where they can gain no advantage from performing such activities in-­‐house. Focusing on and developing certain capabilities is critical to the resource-­‐based view, which in return has important implications for which activities to perform internally and which to outsource. The resource based view, according to McIvor (2009), therefore can assist with identifying organizational capabilities, which can link outsourcing or procurement with performance and the competitive priorities of the organization. The following classification of capabilities and outsourcing decision is also based on perspective of this author.

Critical to competitive advantage and a distinctive capability position A firm would wish to have superior performance in as many core activities as possible, however, due to the resources required, it is only feasible to achieve advantaging positions in a limited number of activities. Under certain circumstances, any superior performance position that a firm currently possesses is not long-­‐lasting and can be quickly replicated. In addition, it is probably safer to focus on other activities in which the organization owns a stronger performance advantages, and which are more important to competitive

position in long term. Thus, when outsourcing is seen as a potential sourcing strategy, the firm should consider the opportunism associated with outsourcing measure (McIvor, 2009).

Critical to competitive advantage and a non-­distinctive capability position According to McInvor (2009), this is a potential strategy where replicating a superior performance position held by a competitor of supplier is both challenging and costly. Barney (1995) thought that changes in the business environment such as technology advances or changes in customers’ preferences may render the activity less valuable in the future. This is in line with the concept of dysfunctional resources. “Resources that have created value in the past can become dysfunctional, i.e. they prevent change and lead to a lack of innovation capability”. These resources are referred to by Leonard-­‐Barton (1992) as “core rigidities”. McInvor (2009) agreed that where outsourcing is considered as a potential option, the firm should consider the opportunism associated with outsourcing measure.

Not critical to competitive advantage and a distinctive capability position In this instance, the sourcing organization has more advantages over competitors or suppliers in an activity that is not central to competitive advantage. Hence, employing the logic of the resource-­‐based view, McInvor (2009) concluded that the organization should consider outsourcing such an activity, and focus resources on developing capabilities in activities that are more significant to organizational success. The organization may exploit capability in this area by creating “a spin-­‐off business”, which specializes in this area of activities. The success of a spin-­‐off business will rely on the ability “to attract a significant percentage of sales from third-­‐party customers, rather than sales primarily from the founding customer. Nevertheless, where there is a lack of potential to develop this area as a separate business, the firm should consider the opportunism of outsourcing.

Not critical to competitive advantage and a non-­ distinctive capability position In this context, when there are competitors or suppliers that are more competent than sourcing organization for an activity not central to competitive advantage, adhering to the logic of resource-­‐based theory, such as activities should be outsourced. In short, where outsourcing is regarded as the most suitable strategy, the firm should consider the opportunism associated with outsourcing measure.

Opportunism associated with outsourcing As analyzed above, where outsourcing is a potential strategy, McInvor (2009) suggests that the firm should undertake an assessment of the opportunism associated with outsourcing measure. The author found that there are three

scenarios that an organization will be faced with. The first scenario is that opportunism associated with outsourcing is manageable by selecting a suitable relationship strategy. In this instance, the decision depends on each type of strategies: non-­‐specific contracting, recurrent contracting and relational contracting. While it is not possible to manage outsourcing via selecting an appropriate relationship strategy, the firm is recommended to reduce the potential for opportunism. In cases that this practice cannot be performed, it is advisable that the sourcing organization will perform the activity in-­‐house.

CONCLUSIONS This work involved a review of principal contributions in the field of procurement or outsourcing from the resource-­‐based view of an organization. The paper begins by presenting the definition of procurement and the propensity to procure in modern business environment and then discusses the development of resource-­‐based view in the literature. Then, it analyzes the relationship between procurement and resource-­‐based view, looks into major studies of procurement or outsourcing from the perspective of resource-­‐based theory and finally assesses how the theory informs outsourcing evaluation of an organization. It may be concluded from this paper that the empirical application of the resource-­‐based view to outsourcing derives from early days and the complexity of considering aspects still remain. The findings have highlighted the importance of procurement in the context of resource-­‐based view of an organization. The theory views the firm as a bundle of assets and resources that if employed in distinctive ways can create competitive advantage (Peteraf, 1993; Barney, 1991). The core competence evolved from resource-­‐based view has been extremely influential in outsourcing practice, with the distinction core and non-­‐ core business firmly influencing many practitioners.

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