Moving corporate boundaries: consequences for innovative redesign.
Many businesses today are cutting back on operations to focus on the core business, reorganizing their business practices by downsizing, restructuring or reengineering, and contracting out various functions and tasks (Ryans, 1996, p. 67).
This quote illustrates the significant movements of corporate boundaries through outsourcing during recent decades. Originating in the automotive industry, this approach received widespread attention in the 1980s (Kumpe & Bolwijn, 1988) and continued to exert a powerful influence on the organization of the business landscape (Bustinza, Molina, & Gutierrez-Gutierrez, 2010). Outsourcing narrowed the boundary around a firm through specialization and focus on core competence. This restructuring enabled outsourcing firms to enhance the performance of remaining internal functions and processes. Furthermore, overall cost efficiency was provided through the operations of specialized, large-scale suppliers. By relying on these suppliers, outsourcing companies could benefit from "specialized capabilities that would be prohibitively expensive to acquire or even impossible to duplicate internally" (Quinn & Hilmer, 1994, p. 43). A particular benefit of this reorganization was that a firm now could "tap into the much richer innovation skills that outside suppliers can offer" (Quinn, 1999, p. 16). By moving the ownership boundary, a firm was able to improve the conditions for innovation. This article deals with the interplay between corporate boundaries and a specific form of renewal, identified as "innovative redesign."
INNOVATIVE REDESIGN AND CORPORATE BOUNDARIES
Anything that is designed will sooner or later be subject to redesign, whether it is a product, an organization, a machine, or a service arrangement. This happens because new opportunities are made available through technical development and/or because of customer requirements. Redesign can take a multitude of forms (Rothwell & Gardiner, 1988). This article is concerned with redesign of an integrated physical system, for instance, a PC, a car, a telecommunication system, an airplane, etc. All the time, the designs of such systems are subject to successive minor modification and refinement. Innovative redesign is defined as the significant design revisions undertaken now and then owing to changes in the interplay between architectural knowledge and component knowledge, enabling redesign that "departs in a significant way from previous practice" (Henderson & Clark, 1990, p. 9). Because this article deals with movements of corporate boundaries, innovative redesign also affects the division of labor among firms.
The boundaries of the firm represent "an important strategic variable for innovating firms" (Teece, 1986, p. 304), implying that the location of the corporate boundary has a significant influence on the opportunities for innovative redesign. The above introduction demonstrated that in the late 1900s, firms had problems innovating within their current boundaries. They identified prospects for renewal through narrowing of the ownership boundary and relied on the skills and resources of specialized suppliers. This restructuring ended the era of the Modern Business Enterprises (MBEs). The strategy of MBEs was to integrate component manufacturing, system assembly, and sometimes raw materials extraction, within the ownership boundary of a single firm (Chandler, 1977). Owing to changing business conditions, the integrated hierarchies were no longer able to handle innovative redesign by the late 1900s. Interestingly enough, the MBEs were once established for exactly the same reason: to enhance innovative redesign. To redesign systems for car manufacturing, meat production, electricity generation, and other industries, innovative entrepreneurs integrated resources and operations previously located outside their ownership boundaries. In the early 1900s, firms thus had to widen their boundaries to succeed in innovative redesign, while one hundred years later, they narrowed the corporate boundary to achieve the same objective. These conditions call for further exploration of the consequences for innovative redesign when corporate boundaries are moved.
AIM AND OUTLINE OF THE ARTICLE
The aim of the article is to explore how movements of the boundaries of a firm impact its ability for innovative redesign. The analysis is literature based and deals with two major transformations of industry where boundaries were moved significantly: the establishment of the Modern Business Enterprise in the early 1900s and the subsequent disintegration of this type of organization at the end of the same century. As claimed above, these two boundary transformations impacted considerably on the potential for innovative redesign of physical systems.
In relation to the classification of research methods presented in Abbott (2004), this study represents a historical narrative, relying on direct interpretation in the analysis of data. Historical narratives are descriptive, "examining the question of what really was the state of affairs in a particular place and time" (Abbott, 2004, p. 17). When it comes to explanatory narratives, Abbot uses an example where the reasons for the French revolution are explained. According to Abbott, the texts in the narrative "here and there employ general laws," but the reason we think the author explains the revolution is that "he tells a followable, reasonable story in which a particular sequence of events under these general laws leads in some inevitable way to the revolution" (Abbott, 2004, p. 32). This article represents a modest attempt to apply these principles.
The article begins with arguments for a new view of the boundaries of firms and continues with a description of the establishment of the MBEs, including the reasons for this strategic shift and the consequences for innovative redesign when operations and resources were moved inside the boundary of the firm. This is followed by an analysis of the problems that became apparent over time with vertically integrated MBEs. The article continues with exploration of how recent outsourcing enhanced the opportunities for innovative redesign, as well as identification of the drawbacks of this approach. In these analyses, seven propositions are formulated, concerning the interplay between boundary changes and opportunities for innovative redesign. The findings of the study are discussed with regard to the multiple boundaries of firms, the impact over time of the dynamics of these boundaries and the implications for the individual firm. The article ends with some concluding remarks.
THE CHANGING 'VIEW OF BOUNDARIES
By far, the most influential theoretical approach related to corporate boundaries is transaction cost economics, originating in the seminal paper by Coase (1937). The corporate boundary is significant also for the resource-based view of the firm (Wernerfelt, 1984) and in property rights theory (Grossman & Hart, 1986). Transaction cost theory, further developed by Williamson (1975, 1979), provides distinct recommendations for efficient boundary setting on the basis of the interplay between uncertainty, opportunism, bounded rationality, frequency of transactions, and asset specificity. Despite its popularity, transaction cost theory has been criticized for a limited perspective on corporate boundaries. For example, Demsetz (1991, p. 175) concluded that "some problems are amenable to solution by application of the logic ..... but other problems, equally important, are not." Similarly, Holmstrom and Roberts (1998, p. 75) call for "a much broader view of the firm and the determination of its boundaries," than offered by mainstream theory. A step in this direction was taken by Weyer, Wagnum, Trienekens, and Omta (2012) by extending the analysis from bilateral exchange to transactions within a supply chain context. One conclusion from their study is that most research applies a static view of these processes, while a dynamic approach is recommended for a better understanding. A broadened and dynamic perspective is required, because boundary issues have become increasingly complex (Qudin Duhamel, 2003). Another argument for reorientation is the shift away from considering a firm a production function toward seeing it as a knowledge-based unit. This change led Nonaka and Toyama (2002, p. 1006) to conclude that "the legal boundary of a firm is not as important" as other connections between firms. Furthermore, Holmstrom and Roberts (1998, p. 91) analyzed theories of property rights and transaction cost economics and found that the views of these approaches have become "too narrowly focused on the hold-up problem and asset specificity." The focus on the ownership boundary is criticized also by Araujo, Dubois, and Gadde (2003) in their claim for consideration of alternative boundaries.
Most advocates of the need for complementary framings follow Nonaka and Toyama (2002) and focus on the impact of knowledge. For instance, Brusoni, Prencipe, and Pavitt (2001, P. 598) concluded that decisions concerning knowledge exchange across ownership boundaries are quite different from decisions regarding the location of production activities. Moreover, they claimed that in their study "the knowledge boundaries of firms stretched beyond their production boundaries." In a similar vein, Fine and Whitney (1996) distinguished between a firm's dependence on production capacity and dependence on knowledge and found that the latter is both more important and more complex to handle.
The above discussion indicates that the most important boundary aspect to consider is in what way knowledge is distributed among firms. In this respect, the significant border is not between the actual knowledge bases of the two firms. Increasingly, companies are dependent on the resources of other firms and involved in knowledge sharing, spanning ownership boundaries. Therefore, knowledge of the skills and competencies of business partners is vital in the current business landscape. Following Dubois (1998), this border is defined as the awareness boundary of a firm. The awareness boundary determines what a firm knows about the operations and resources of others in the network of which the firm is a part. Awareness "constitutes a basis for interaction," at the same time as it is "through interaction that the individual firm's awareness boundary can be extended" (Dubois, 1998, p. 109). The relevance of mended awareness is illustrated in many studies. For example, a survey conducted by Bustinza et al. (2010, p. 31) concluded that a company "must maintain a certain quality of knowledge about the outsourced activity even though it is no longer performed internally." This finding echoes the conclusion of Granstrand, Patel, and Pavitt (1997) that firms have to know more than they strictly need for their own productive purposes to use and combine external capabilities with their own resources. The significance of the location of the awareness boundary was pointed out by Wilcocks, Hindle, Fee-fly, and Lacity (2004, p. 7) in their claim that "there has been too little focus on what happens to knowledge when an organization outsources."
When the ownership boundary is emphasized, firms are assumed to have full control over in-house resources and operations, but limited opportunities to control what is outside this border. Fellows and Liu (2012) claim that boundary setting involves not only the location of the boundary, but also considerations related to its permeability. Current attention to partnerships and close relationships has made ownership boundaries increasingly permeable. Particularly in relation to innovation, it has been shown that renewal is the outcome of interaction among firms (Hoecht & Trott, 2006). The crucial role of interactive relationships in innovation is pointed out also by Holmstrom and Roberts (1998, P. 81) in the claim that "the long-term and repeated nature of interaction [is] key to these operations."
Once ownership boundaries in this way become increasingly permeable, the perception of control needs to be modified. Owing to interdependences in relation to business partners, a firm can no longer fully control its own operations and resources. On the other hand, the same conditions imply that a firm can affect the resources and operations of the business partners to some extent. In the labeling of the boundary of these opportunities, we avoid the word control. Instead, we rely again on Dubois (1998), who launched the concept of an influence boundary. This boundary is important, because existing interdependences lead to mutual influences among businesses. Influencing occurs through interaction, but also through the exercise of power (Dubois, 1998). The impact of these conditions is significant, because in-house competence is required in the utilization of the resources of others. For example, Powell, Koput, and Smith-Doerr (1996, p. 119) claimed that "internal capability is indispensable in evaluating research done outside."
Finally, this article is concerned with movements of boundaries. It is a common notion that the boundaries of firms are dynamic (Afuah, 2001; Broedner, Kinkel, & Lay, 2009). This dynamism is strongly related to the expansion of knowledge as illustrated by modifications of the R&D boundaries of firms (Pisano, 1990). Of particular interest in this respect is "what happens with the boundary of firms in the face of a technology change" (Afuah, 2001, P. 1211). In this article, the attention is focused on the consequences for innovative redesign, when ownership boundaries are moved to exploit the expansion of knowledge. These movements concern widening and narrowing of ownership boundaries through insourcing and outsourcing of operations and resources. The above discussion shows that boundaries are multifaceted. Therefore, exploration of the consequences for innovative redesign owing to movements of ownership boundaries needs to be supplemented with investigation of the interplay with the awareness and influence boundaries.
In this section, the critical concepts of the study are presented: the interplay between innovative redesign and narrowing/widening of boundaries with respect to ownership, awareness, and influence. According to Wacker (2008), such definition of concepts is a crucial aspect of any theory generating attempt, because it explains what the study is about. Two other aspects discussed in the same paper are also dealt with in this section: the domain of the study (when and where the theory applies) and its relationships (explains how and why the concepts link). In the following sections, we describe the narratives and the related propositions, beginning with the efforts to promote innovative redesign through widening of boundaries.
INNOVATIVE REDESIGN THROUGH INSOURCING
The Modern Business Enterprise emerged in the middle of the 19th century in railroad organizations that were the first transportation companies "to build and to own rights-of-way and at the same time operate as common carriers" (Chandler, 1977, P. 81). At the same time, telegraph companies "both built the links and ran the messages through them." This new infrastructure for transportation and communication established by these industries paved the way for the integration of mass production with mass distribution that represents the typical form of the MBEs. These firms grew and spread fast, and at the millennium shift, "these integrated enterprises came to dominate many of the nation's most vital industries" (Chandler, 1977, p. 285).
One of the forerunners in the evolution of the MBEs was the emerging automobile industry. Langlois and Robertson (1995, P. 47) describe the conditions in the first phase of this industry as a typical craft system. Automobile companies were best characterized as assemblers rather than manufacturers, because "early cars could be easily put together from components developed for other purposes, such as bicycle wheels, or from variations on known themes, such as wooden bodies." The components and parts developed for other purposes were all available and ready to install, which made the basic design concept for early cars known as the "horseless carriage" (Langlois & Robertson, 1989). These features provided automobile firms with excellent preconditions concerning efficient operations, because they offered economies of scale in component production.
At the same time, however, these conditions were unfavorable for new and innovative solutions when car assemblers wanted to innovate by changing the basic principles for design and manufacturing (Piore & Sabel, 1984). Such renewal required the involvement of many suppliers in the crafting network, because each firm normally "handled only a single economic function, dealt in a single product line, and operated in one geographical area" (Chandler, 1977, p. 3). Any effort to redesign the car would thus affect many suppliers and require their changes to be coordinated. Moreover, the outcome in financial terms was uncertain and could be expected to be very diverse for suppliers, depending on their roles in a new industrial set-up. Another problem was that suppliers were heavily involved with other customers that represented their core business, while the pioneers in the new car industry still accounted for small-scale business only. These conditions made it difficult for the potential entrepreneurs to engage in innovative redesign, because most resources and operations that needed modification were located outside their influence boundaries.
Another illustration concerns the meat industry where the innovator (Gustavus Swift) realized that "if the systems of meat packing, shipping and distribution were completely redesigned, it would be possible to reduce transportation costs and to take advantage of a number of scale economies, including those of a 'disassembly line' in a high-throughput slaughterhouse" (Langlois, 2003, p. 361). However, achieving these economies required substantial modifications of assets and capabilities throughout the whole industry, including the development and production of refrigerated railcars and the establishment of a nationwide network of properly equipped branch houses for warehousing and merchandizing. Swift found it more economical to integrate into many of these complementary stages "than to persuade the various asset owners to cooperate with him through the market" (Langlois, 2003, p. 363).
The greater and the more complex the technical interdependencies, the more difficult they are to change without vertical integration. Piore and Sabel (1984, p. 38) explained the rationale behind General Electric's strategic decision in the late 19th century to integrate power-generating companies with its electrical equipment division to control the whole system. This strategic move made it possible to ensure that "power-generating capacity was planned to coincide with the distribution of lamps produced by the manufacturing process." The above examples provide the arguments for the first proposition regarding the interplay between corporate boundaries and innovative redesign:
Proposition 1: Innovative redesign is problematic for a firm in situations where central resources and operations are located outside its influence boundary.
Langlois and Robertson (1995) argue that systemic innovations, such as the redesign of cars, sometimes force firms to integrate vertically and become involved in tasks they would have preferred to delegate to specialists. The reason may be that suppliers literally cannot understand what the innovating firm needs or that they do not find the innovation commercially viable for themselves. Therefore, in situations where many different pieces of a system must be changed simultaneously, Langlois (2003, p. 361) prescribes integration and centralized ownership as a means "to overcome the narrow visions of local participants" and a way "to more easily trump the vested interests of those participants." Similar opinions were expressed by Chesbrough and Teece (2002, p. 129) in the argument that "unaffiliated companies linked through arm's length contracts often cannot achieve sufficient coordination." Moreover, economic history suggests that there is generally a link between the level of vertical integration and the rate of innovation. For example, Frankel (1955) claimed that the lack of vertical integration constrained innovation in the British textile and iron and steel industries. Kindleberger (1964) came to the same conclusion regarding innovation in the British railroad industry.
INNOVATIVE REDESIGN WITHIN WIDENED BOUNDARIES
The ambitions to enhance innovative redesign by exploiting technological development thus called for organizational changes. Actually, the MBE has been interpreted as an outcome of the combined effects of organizational adjustments and technological inn ovation (Piore, 1992). This complex interplay was discussed by North (1981, P. 169) who claimed that organizational changes (such as relocation of boundaries) "induced the technical change which in turn required further organizational innovation to realize the potential of the new technology." Vertical integration provided opportunities for innovative redesign, because resources and operations were brought within the influence boundary of the MBEs.
When operations previously undertaken by suppliers were moved in-house and "performed in proximity to one another, people were led to perceive the productive processes in new ways and this changed perception was itself a source of innovation" (Piore, 1992, p. 440). In the car industry, the outcome of this boundary shifting was that people at Ford "found that their inspiration and needs outstripped the talents of their suppliers" when they developed tools and machines in-house (Langlois & Robertson, 1995, p. 46). The reason was not that the technical advances were beyond the understanding of independent suppliers: ".... it was because only the men at Ford understood the uses to which the new machines would have been put" (Langlois & Robertson, 1995, p. 53). This means that vertical integration not only solved the problem with influence boundaries, but also provided benefits through extension of the awareness boundary, thus leading to the second proposition:
Proposition 2: Firms extending their awareness boundaries to include vital resources and operations are provided with opportunities for innovative redesign that are unavailable to individual suppliers.
The benefits of the integrated hierarchy were obvious, and over time, the business philosophy of the MBE diffused broadly. The integrated hierarchy became the role model and showed to be significant also in "modern" industries in the middle of the 1900s. Chesbrough and Rosenbloom (2002) describe the launch of the Xerox model 914 that revolutionized photocopying. At the time, Xerox was a small player and tried to cooperate with firms like Kodak, General Electric, and IBM. When these efforts failed, Xerox had to conduct its own research and perform all the required development activities to launch and support the innovative solution. Xerox manufactured most of its products internally and distributed through its own channels. Moreover, Xerox provided its own financing to customers and its own service and support. Xerox even made its own paper to ensure proper handling characteristics. Similar conditions were at hand in other industries. For example, in the beginning, "the disc drive industry was led by a group of large-scale firms" (Christensen, 1993, p. 531) and in its early days "the computer industry was dominated by integrated players such as IBM" (Christensen, Verlinden, & Westerman, 2002, p. 970).
REDESIGN PROBLEMS IN THE INTEGRATED HIERARCHY
Langlois and Robertson (1995) argued that once vertical integration was initiated, it was "self-reinforcing." This momentum of the MBE also had its disadvantages and affected the potential for innovative redesign. According to Langlois and Robertson (1995), the integration was sometimes driven too far. The mass production logic of the MBE called for economies of scale, which required standardization. Lampel and Mintzberg (1996, P. 21) identified this period in American industry as the era when the "logic of aggregation" ruled the game and built on "standardization of design that allowed for mechanized mass production and a resulting standardization of products." The logic of aggregation provided limited breeding ground for variation and renewal and also led to "deskilling" of workers (Langlois, 2003, P. 364). According to Piore and Sabel (1984), the machinery of mass production was so precise that no hand finishing was necessary, and the final assembly of the product required very little craft skill. Whereas the worker had once defined the product, the worker was now defined by the product and the machine "whose purpose, far from translating human skill into action, was to make human involvement in the production of the good superfluous" (Piore & Sabel, 1984, p. 23).
Nor did the MBE receive much stimulus for renewal from the environment. Relationships with suppliers outside the ownership hierarchy were governed in most cases by arm's length conditions (Scherrer, 1991). Suppliers received detailed blueprints of the components they supplied. Exchange of information was restricted to "fine-tuning the engineering effort" and only in "very rare cases did suppliers and assemblers cooperate in the initial design of the project" (Scherrer, 1991, p. 219). Consequently, innovative activities in the MBE gained little contribution from external suppliers. According to Helper (1991), the interaction between the assembly operations and those of intrafirm suppliers was not much more developed. Therefore, the scope of research and development in the internally oriented MBE was limited to the capabilities of its own employees. It is not surprising therefore that over time "the radical change in product characteristics had given way to incremental product change" (Langlois & Robertson, 1995, P. 51).
The integrated hierarchy was not an appropriate organization for promoting the dynamic capabilities of a firm, because the conditions of the MBE did not stimulate "the capacity to renew competences so as to achieve congruence with the changing business environment" (Teece, Pisano, & Shuen, 1997, p. 515). The strategy of the MBE to control all critical resources and operations through ownership thus became a drawback to innovative redesign. This approach provided little room for interaction because boundaries to suppliers featured low permeability. This leads to the third proposition:
Proposition 3: Long-term focus on internal resources and operations reduces the interaction with other organizations, which restricts the firm's scope for innovative redesign to what is achievable within its ownership boundary.
The main reason for the problems of MBEs was the substantial expansion of the technological frontier, implying a "continuously increasing number of technological fields that firms must monitor and master" (Pavitt, 2002, p. 121). This evolution concerned both the depth of knowledge within established disciplines of technology and the continuous emergence of new and useful disciplines (Brusoni et al., 2001). Furthermore, the late 1900s imposed greater inter-relatedness between formerly distinct fields of technology (Fai & Cantwell, 1999). The outcome of these changes was a considerable increase in the technological capabilities a firm needed to handle its design and development operations. Consequently, the MBE had to begin to look outside its ownership boundaries to identify specialized suppliers of equipment and knowledge to supplement in-house research and development efforts (Brusoni et al., 2001).
Another reason for the cracks in the facade of the MBE was that the standardization residing in the "logic of aggregation" had successively been replaced by enhanced customization and its corresponding "logic of individualization" (Lampel & Mintzberg, 1996). Over time, there was a general move toward greater individualization, and "tailor-made" became a keyword in a wide variety of industries. Involvement of the user in the design of offerings (e.g., Comet et al., 2000) also contributed to opening the doors of the MBE.
Furthermore, technical facilities in manufacturing and distribution evolved in directions that made the MBE outdated and paved the way for satisfaction of individual needs without sacrificing economic efficiency (Hayes & Pisano, 1994). The basic conditions that once led to the establishment of MBEs had thus changed drastically. Despite these conditions, the integrated firms continued to expand because of the pronounced tendency of large organizations to grow beyond their optimal size and become ends in themselves (Powell, 1987). In the claim for "unbundling" of the integrated hierarchies, Hagel and Singer (1999) concluded that the MBE contained three types of businesses with quite different characteristics: a customer relationship business, a product innovation business, and an infrastructure business. When these businesses are bundled together within a single corporation, conflicts will inevitably appear: "Scope, speed and scale cannot be optimized simultaneously" (Nagel & Singer, 1999, p. 136). Therefore, it was no longer a fruitful approach for the individual company to try to keep all crucial resources and operations under its ownership. The technological expansion and the benefits of specialization discussed above required organizational changes that narrowed the ownership boundary and enhanced its permeability. The fourth proposition is therefore:
Proposition 4: In periods of rapid expansion of technologies, an integrated firm is unable to bring in all knowledge required for innovative redesign within its awareness boundary.
There are several examples of large MBEs that failed to adapt to the new conditions and requirements. For instance, in the locomotive industry, the dominant firms were "unable to re-align technological aspirations with technological realities" when new opportunities were made available (Marx, 1976, p. 23).
INNOVATIVE REDESIGN WITHIN NARROWED BOUNDARIES
Through recent developments of technology, most products and systems today are affected by a multitude of complex and interdependent technologies. For this reason, Masi (2006, P. 14) points out the benefits of a cross-company approach in a time when the "mix of skills needed to produce even a simple household appliance exceeds what any company can assemble or, more importantly, manage." This technological race made it impossible for any individual firm to be at the cutting edge in all the various areas of capabilities on which it is dependent. Instead, companies realized the benefits of utilizing the resources that can be accessed through suppliers specializing in a limited range of technologies (Flakansson, Ford, Gadde, Snehota, & Waluszewski, 2009). Similar thoughts were expressed by Chesbrough and Teece (2002, P. 128) in the claim that "a virtual company can quickly access the technical resources it needs" while "large companies that attempt to do everything inside will flounder."
The discovery of the potential opportunities residing outside ownership boundaries resulted in massive outsourcing, particularly in industries based on assembly of components and systems, such as vehicles, telecommunications, PCs, and household appliances. In 1980, Ford still manufactured 70 percent of the components and systems they assembled, while two decades later, this figure was down to 30 percent (Quinn, 1999). Similar dissolutions of hierarchical structures are reported, for example, from the bicycle and electronic industries (Gereffi, Humphrey, & Sturgeon, 2005). The disk drive industry followed the same pattern, and by the 1990s, nearly all of the integrated firms that once established the industry "had decoupled their vertically integrated operations" and now relied on interfirm coordination of development and manufacturing (Christensen, 1993, p. 572). IBM was above characterized as one of the integrated hierarchies in the computer industry. However, in the launch of their PC in 1981 (considered a success by Teece, 1986), IBM "embarked on an uncharacteristic strategy," because they "produced the PC almost entirely by assembling parts bought on the market" (Langlois & Robertson, 1992, p. 307). This arrangement included outsourcing of the microprocessor to Intel and the operative system to Microsoft, both quite small players at the time. The reasons for the new approach were that IBM wanted to reduce time-to-market and also to focus on "what it did best--designing, assembling and selling computers" (Christensen & Raynor, 2003, p. 5).
Increasing specialization, following these boundary movements, provides advantages for innovative redesign in several respects. By relying on the technological capabilities of suppliers, the buying firm can focus its own competence base on a limited aspect of the total resource constellation. The buying firm can thus profit from economies of scale in its knowledge development. Moreover, because other activities are outsourced to suppliers that normally work on a larger scale, the economies of these operations also will be improved.
Securing such economies was once a main driving force for insourcing in the MBE. Over time, however, most firms in an industry evolve toward a common product architecture--a "dominant design" (Utter-back, 1994). Dominant design leads to two consequences in relation to innovation and boundaries. First, dominant design has a powerful impact on future technological innovation, because "acceptance of the dominant design of the original innovation created certain boundaries within which subsequent waves of innovation wisely developed" (Utterback, 1994, p. 50).
Second, once firms relied on the same basic design, the greatest benefits were to be gained from increasing scale in the design and manufacturing of parts and components. For example, in the car industry, independent component manufacturers were now able to supply several assemblers and thereby obtain economies of scale beyond what was possible even for the largest carmaker. Moreover, a dedicated supplier is in a better position to follow the technological forefront in the area of its particular specialization.
Capturing the technological capabilities on the outside of the firm required substantial organizational renewal. The arm's length relationships promoted by the MBE would not have made it possible to exploit the skills and competencies of suppliers. Therefore, the previous recipe of avoiding dependence on individual suppliers was successively replaced by an approach to handle the interdependences that were required for making the best use of the vendors (Gadde, Hakansson, & Persson, 2010). The activities within the factories of the large hierarchies were synchronized and closely integrated. When some of these activities were outsourced to suppliers, operational efficiency required that they continued to be tightly integrated with the internal activities in the outsourcing company. Securing this business process coordination across ownership boundaries called for enhanced cooperation and increased involvement. Once the nature of the relationships and the attitudes toward suppliers changed, buying firms realized that suppliers could play a much more important role than as subcontractors of buyer-dictated manufacturing operations. Over time therefore, suppliers became increasingly engaged as technology providers and partners in product development (see for example, Bonacorsi & Lipparini, 1994; Chesbrough & Schwartz, 2007).
Owing to these potential benefits, it is not surprising that massive outsourcing took place. The initial contracting out of component production was extended to involve other shifts in the make-or-buy strategy. Over time, buying firms engaged in "system sourcing," where "first-tier suppliers" are given the responsibility for a system of pre-assembled components (Carbone, 1999). Moreover, the efforts of firms to deliver extended offerings increased the complexity of outsourcing (Collins, Bechler, & Pires, 1997), because these "total solutions" rely on an extended enterprise where design and redesign "is very much a question of combining value activities of multiple actors" (Windahl & Lakemond, 2006, p. 808). As long as the responsibility for design stayed within the influence boundary of the buying firm, this form of outsourcing was quite unproblematic. The fifth proposition is therefore:
Proposition 5: Interaction and close collaboration with specialized partners enable a firm to improve conditions for innovative redesign by widening its influence and awareness boundaries to extend the ownership boundary.
REDESIGN PROBLEMS IN THE SPECIALIZED FIRM
In the beginning of the outsourcing boom in the 1980s, the strategy of most firms was to insist that "all the important research and development would remain in-house" (Engardio & Einhom, 2005). Over time, however, design-engineering tasks were outsourced on a contract basis (Pisano & Shih, 2009). At the shift to the new millennium, the initial conditions had changed quite dramatically, and companies like Dell, Motorola, and Philips were now buying complete designs from suppliers (Engardio & Einhom, 2005). This change is part of an overall reorganization of business in which leading Western companies are turning toward a new model of innovation: "one that employs global networks of partners that can include U.S. chipmakers, Taiwanese engineers, Indian software developers, and Chinese factories," loosely tied in network organizations (Engardio & Einhom, 2005, p. 2). This brings us far from the ideal of the MBE. In fact, we seem to be closer to the situation before the MBE was established, when firms "handled only a single economic function" (Chandler, 1977, p. 3). We also know that these conditions were unfavorable to renewal. What problems for innovative redesign can then be identified in the industrial structures of the new millennium?
Cohen and Young (2006) claim that outsourcing has become a victim of its own success. Because of the perceived advantages of outsourcing, companies have been driven to externalize more and more of their operations on the basis of increasingly unrealistic assumptions concerning positive outcomes. This conclusion is shared by Broedner et al. (2009, p. 144) arguing that "outsourcing has been pushed much too far in general" and that many outsourcing projects are "detrimental to business performance." Windrum, Reinstaller, and Bull (2009, p. 198) bring up the "outsourcing productivity paradox," according to which outsourcing firms are able to reduce costs in the short term, while in the long run, they tend to "suffer lower productivity growth."
The overemphasis on outsourcing and focus on core competence through the narrowing of corporate boundaries is criticized for several reasons. Gadde et al. (2010, p. 183) conclude that in a short-term perspective, every company knows what is their core capability--while in the long run, "no firm can predict what will become the particular competence required." Christensen et al. (2002, P. 986) argue that the logic of core competence "make compelling sense on the surface." But this logic may lead firms to outsource these pieces that contain the bulk of future added value. This claim is exemplified by IBM's outsourcing to Microsoft and Intel that once was perceived a success, but later severely criticized. Furthermore, too strong a reliance on core capabilities "may both impel and constrain future learning and action" (Nonaka & Toyama, 2002, P. 1003), and in the end, core capabilities can even turn into core rigidities (Leonard-Barton, 1992). Finally, Lonsdale (2001, p. 22) argues that too much focus on the core, accompanied by outsourcing, makes firms increasingly dependent on suppliers, which may make them "locked-in to supplier dominance."
The "principle of modularity" was launched as a means for firms to enhance the customization of their offerings (e.g., Feitzinger & Lee, 1997). Modular product architecture implies that a total system is designed to consist of independent modules that can be assembled into a huge range of product variants. There is a clear link to the above-mentioned shift from component purchasing to system sourcing. By relying on a limited number of first-tier suppliers for subassembly of modules, the final assembler can focus on designing the overall modular structure. Modularization provides the advantage that improvements can be made to "just one sub-component of the system, avoiding the need to simultaneously change all the other" (Windrum et al., 2009, p. 204). This independence featuring individual subcomponents requires well-designed interfaces between the parts and the whole to "ensure that the whole structure functions in an integrated way" (Windrum et al., 2009, p. 209). These conditions are at hand as long as all design activities are located within the influence boundary of the buying company and suppliers receive instructions regarding the features of the interfaces among modules.
However, Baldwin and Clark (1997, p. 879) found that "module makers take on most of the design responsibilities." The capabilities of these module suppliers tend to expand in the direction of the development of the specific modules for which they are responsible. The standardized interfaces between modules keep the whole system together and make it work in an integrated way. This approach allows suppliers to innovate in various directions, independently of each other. The total system, however, has to remain within its established architecture to maintain the standardized interfaces between modules. These conditions imply that the total capability required for redesigning the whole system becomes increasingly scattered (Gadde & Jellbo, 2002). This explains why it is difficult to reorganize and restructure operations, when changing conditions provide opportunities for innovative redesign. The above conditions lead to the sixth proposition:
Proposition 6: The greater the specialization of activities and resources, the more difficult it is for a single firm to redesign the total system. Particular problems occur when design responsibilities are located outside the influence boundary.
In this respect, we recall the claim from Wilcocks et al. (2004) concerning the lack of focus on what happens to knowledge when organizations outsource. Furthermore, Lei and Hitt (1995, p. 836) argued that a serious threat resulting from extended outsourcing is that this approach "can erode the firm's potential for organizational learning and development of new technologies." The literature review indicated that the internal organization of the outsourcing company is critical to its ability to exploit knowledge generated outside its boundary, because "innovative capability cannot be simply bought and sold" (Hoecht & Trott, 2006, p. 678). For example, Helper (1991) concluded that in the remodularizing of carmaking through exploitation of the resources of suppliers, the buyer must first make changes in its own organization. Similar results were found by Chesbrough and Teece (2002) in the workstation process business, where both MIPS Technologies and Sun Microsystems were striving for control. MIPS functioned as a virtual player, and this "hollowness left the company at the mercy of its partners" in a network "that fell apart and pulled MIPS down with it." Sun also relied on alliance partners, but was able to take the lead in the industry because "it had strong internal capabilities in system design, manufacturing etc." (Chesbrough & Teece, 2002, p. 133).
It is a common claim that buying firms need to retain the technical knowledge required for remaining a competent buyer. These internal capabilities are critical because they help firms "to make the best use of other people's knowledge" (Loasby, 1999, p. 88). Companies neglecting this issue will experience problems because "firms that excessively rely on external sources for new skills, technological developments or new products are likely to lose their initiative" (Lei & Hitt, 1995, p. 857). The underlying explanation is that the required knowledge then is located outside the awareness boundary of the company, which means that "the outsourced activities are no longer available for splitting and recombining with other activities into new and more effective organizational modules" (Windrum et al., 2009, p. 225). Thus, our final proposition is formulated in the following way:
Proposition 7: Over-reliance on external sources of technical knowledge and development narrows the awareness boundary of the firm and constrains its ability to take initiatives in innovative redesign.
This proposition is illustrated by IBM's attempts to redesign their PC, which required the coordination of many inter-related pieces of the architecture. The efforts failed because the "hardware and software suppliers that had helped establish the original architecture did not follow IBM's lead" (Chesbrough & Teece, 2002, p. 132). These conditions illustrate a general problem for firms relying on narrow boundaries. In such situations, "members of a virtual organization are dependent on the other members, over whom they have no control" (Chesbrough & Teece, 2002, p. 128).
The findings of this study center on three main issues related to the interplay between innovative redesign and corporate boundaries. The first concerns the multifaceted nature of the boundaries of firms. The second deals with the dynamics over time of the principles applied in the formation of boundaries. The third concerns the consequences for individual firms in terms of boundary setting and innovative redesign.
The Multifaceted Nature of Boundaries
The study shows that the boundaries of firms are multifaceted. Previous claims regarding the need to extend the analysis of boundary setting to include technology and knowledge issues are highly relevant. This article illustrates how the understanding of the consequences for innovative redesign is improved when the awareness and influence boundaries are taken into account. A firm may be able to impact on activities and resources critical to redesign, even when they are located in other companies, as long as its influence and awareness boundaries stretch outside its ownership domain. On the other hand, firms with narrow awareness boundaries may have major problems in making efficient use of the resources that are potentially accessible through business partners. Moreover, they will find that their influence on redesign is constrained, because of limitations in their awareness and knowledge capacities. The historical expose clarified the considerable divergences between influence boundaries, awareness boundaries, and ownership boundaries. This multiplicity makes it impossible to identify anything that can be classified as the boundary between organizations.
The above conclusion is in line with previous research findings dealing with the conditions both before and after the establishment of the MBE. Concerning the pre-MBE era, Helper (1991) concluded that boundaries. among firms were fluid, while in the post-MBE era, Hakansson and Snehota (1989) claimed that firms appear without clear and distinct boundaries. In line with this, Abbott (1995) suggested that rather than starting with organizational entities and then looking for the boundaries between them, one should start with exploration of boundaries and then identify the features of the entities that are linked through the boundaries.
This approach directs the emphasis to the characteristics of the relationships between firms as suggested by Araujo et al. (2003) and the role of interaction as described by Holmstrom and Roberts (1998). The absence of interaction with outside suppliers was one of the main problems for innovative redesign in the integrated hierarchy. According to Helper (1991), Ford and GM applied supplier relationship practices that improved their bargaining power, but created a fiercely competitive supplier industry because these practices were based on short-term contracts and involved several suppliers. The major drawback of this supply system was that it created disincentives to innovation (Helper, 1991) and led to stagnation because it isolated the buying firm from innovation (Abernathy, 1978). These unfavorable conditions for innovative redesign called for changes when hierarchies began to dissolve. The necessary modifications of relationships concerned the time perspective considered, the nature of interaction, and the level of involvement (Gadde & Snehota, 2000).
The multiplicity of boundaries calls for alternative conceptualizations. This study shows that the influence and awareness boundaries modified the view of the extent of control that vertical integration can provide. In a similar vein, Gereffi and Lee (2012) suggested three intermediate forms of coordination between market governance and vertical integration. They show how firms through modular governance, relational governance, and captive governance are able to exercise various degrees of influence in relation to business partners, without direct ownership.
The Dynamics of Boundaries
The second issue for discussion concerns the impact on innovative redesign stemming from the dynamic nature of boundaries. The analysis of the establishment and disintegration of the MBE hierarchies provides interesting insights concerning this issue. What is particularly intriguing is that after the two major transformations of the business landscape in the 1900s, current conditions resemble those prevailing before the MBE was established. Most firms are now dependent on the capabilities of their suppliers in the design and redesign efforts. For example, it is claimed that the changes in the late 1900s tended to "move the U.S. auto industry back to a supplier relation system seen earlier when vertical integration was rare" (Helper, 1991, p. 781).
The dynamics of corporate boundaries over time illustrate the dual roles of boundaries identified by Thompson (1967)--boundaries as buffers and boundaries as bridges--through which corporate borders can be seen as either separating or connecting two organizations. The perspective applied will have significant consequences for innovative redesign. The MBE obviously considered boundaries as buffers and received limited stimulus for innovation from the outside. In current network constellations, boundaries are perceived as connecting mechanisms and critical tools for innovative resource sharing.
A particular consequence of dynamics is the self-reinforcing nature of boundary changes. There are two underlying reasons for these conditions. First, companies move their ownership boundaries as a means of performance improvements. As shown in this article, these modifications impact on the influence and awareness boundaries. Some of these effects are planned "but boundaries also evolve more unconsciously," resulting in consequences that over time may contradict the intentions with the boundary movement (Hernes, 2003, p. 51). Second, this article shows that both hierarchical integration and the dissolution of the same organizational form are considered to have been carried too far. A specific modification of corporate boundaries that appears successful develops its own momentum. In this way, it will evolve into a "business recipe" that is sometimes applied in situations when other approaches would be more advantageous (Gadde & Araujo, 2007). For example, the strong adherence to the MBE recipe made the Ford Motor Company integrate into fields that were only loosely connected to car manufacturing, such as rubber, glass, and railroads. Some of these acquisitions had no particular efficiency rationale and were undertaken only because Ford wanted to control these resources within its ownership boundary (Langlois & Robertson, 1995).
Similar tendencies are observed in the dissolution of the hierarchies when outsourcing evolved into a business recipe that "was applied uncritically since it was perceived as the way to improve firm performance" (Araujo & Gadde, 2009, p. 16). The initial use of outsourcing as a means of "efficiency-seeking" changed to outsourcing as "recipe following," leading to the effects that "the virtues of being virtual have been oversold" (Chesbrough & Teece, 2002, p. 127). This conclusion is in line with Berggren and Bengtsson (2004, p. 211), who claim that the fundamental query "to outsource or not to outsource" has been beyond the scope of any analyses, implying that performance improvements "tend to be taken for granted, but detailed analyses of actual outcomes and potential side-effects are hard to find" (Berggren & Bengtsson, 2004, p. 211). This is a severe problem in relation to innovative redesign because "overoutsourcing poses a serious threat to a firm's innovation performance" (Grimpe & Kaiser, 2010, p. 1484).
The narrowing of corporate boundaries in recent decades is accompanied by geographical fragmentation of supply chains through increasing globalization (Gereffi & Lee, 2012, p. 27). These authors point out the important role of buyers and retailers in these processes, concluding that buyer-driven supply chains "highlights the powerful role of large retailers such as Walmart and Tesco and highly successful brand name merchandizers." The geographical fragmentation and the modification of production boundaries enhanced the criticality of supply chain management. The underlying reason is that disintegration of manufacturing increases trade, because intermediate inputs may cross national borders several times during the manufacturing processes. This development puts even greater emphasis on boundary issues because "the rising integration of world markets has brought with it a disintegration of the production process" (Feenstra, 1998, p. 31).
In the reorientation of boundaries, firms need to modify their business models. A business model represents "the view of a firm's logic for creating and commercializing value" (Osterwalder, Pigneur, & Tucci, 2005, p. 7). For Chesbrough and Rosenbloom (2002, p. 529), the main function of a business model is that it "connects technical potential with the realization of economic value." Obviously, these relationships are vital to the performance of innovative redesign. The two transformations of the business landscape resulted from modifications of the basic business models of firms. The business model construct also explains the over-reliance on particular business recipes because it assumes that "a firm's knowledge is cognitively limited and biased by the earlier success" (Chesbrough & Rosenbloom 2002, p. 535).
Implications for Boundary Setting
The multiple roles of boundaries and their inherent dynamics have significant implications for individual firms, leading to the third theme for discussion: the impact on innovative redesign owing to the boundary-setting principles applied by firms. The analysis of these conditions involves two types of interplay: one is concerned with specialization and integration, while the other considers the combining of internal and external capabilities. Specialization is favorable for the efficient undertaking of individual activities, because this approach provides advantages in terms of economies of scale and learning. However, any type of specialization requires its own particular form of integration, because the output from a bundle of individual activities must be integrated "into a cognitive form in which they have economic meaning" (Piore, 1992, P. 442). This means that the operations of specialized suppliers need to be coordinated to form a total system for the buyer--a PC, a car, a logistics solution, etc. The relationship between the two issues is quite straightforward: the greater the level of specialization--the greater the need for integration of both production and development activities. With regard to innovative redesign, it is important to realize that each task requires its specific ability because "it is one thing to coordinate the development and production of artefacts and quite another to coordinate the evolution of the underlying knowledge bases" (Brusoni, 2005, p. 1888). Concerning redesign of systems, Pavitt (2002, p. 21) concluded that firms must have the coordinative means to integrate "architectural change periodically into new improved systems."
This article shows that the interplay between internal and external capabilities is crucial to innovative redesign. As described in the literature review, organizational adjustments (internally and externally) are required for the successful exploitation of technological development. Windrum et al. (2009, p. 198) claim that such adjustments build on "experimentation with different combinations of value-adding activities, and the insourcing/outsourcing of activities." As this article shows, experimentation with regard to insourcing/outsourcing is not frequent because one of the two approaches tends to dominate over long time periods. This means that experimentation with new combinations of value-adding activities, critical to renewal, is severely constrained. These effects for innovative redesign were clearly observable in the MBE. They are also visible in the post-MBE business landscape where Lei and Hitt (1995, p. 840) claim that "sustained outsourcing denigrates the firm's existing skill set," which is problematic because any firm needs "its own set of scientists and technical staff to understand changes in technologies and processes." Applying the vocabulary suggested in this article, such effects appear in situations where companies rely on awareness boundaries that are too narrow.
The first contribution of this article is the simultaneous analysis of the two transformations of the business landscape during the 1900s. Previous studies have generally focused on either the establishment of the integrated hierarchies or the evolution of current network constellations. The dual analysis applied shows how the capacity for renewal is affected by changes of the location of the boundaries of firms--with regard to both narrowing and widening. The study also shows that the content and permeability of the boundary in terms of the level of involvement in the relationships between business partners and the associated features of their interaction are even more important for innovative redesign. To exploit the resources of business partners, it is crucial to recall that ambitions in knowledge sharing "do not work without extensive internal efforts" (Takeishi 2001, p. 419). It is crucial therefore that firms retain knowledge also within the competence areas where they rely on external resources.
The second contribution concerns the analysis of the multiple boundaries of firms. Supplementing the ownership boundary with awareness and influence boundaries provides new insights, because insourcing and outsourcing not only move ownership boundaries. Over time, the influence and awareness boundaries become affected with particular consequences for innovative redesign. The distinction between boundaries with diverse characteristics is important to the understanding of the potential for innovative redesign. Both the establishment of the MBE and its disintegration are significant illustrations of Einstein's rejoinder that a system cannot be improved with the level of thinking which created it (Silverstein, DeCarlo, & Slocum, 2005). Because the context in which the system is used changes over time, the skills and capabilities required for innovative redesign must be adjusted accordingly. In some situations, these adjustments call for narrowing of the ownership boundary, while sometimes boundary widening may be appropriate. In both cases, it is important to consider what effects can be expected with regard to the influence and awareness boundaries.
Finally, the third contribution is concerned with implications for individual firms. As suggested by Pavitt (2002), companies need innovative routines to handle the complexities of technological change and its consequences for the boundaries of firms. This study shows that many firms tend to rely on popular recipes rather than on thorough analysis of their boundary-setting issues. Therefore, some companies tend to overexploit the benefits available from modifications of boundaries by extending either specialization or integration to levels at which the disadvantages outweigh the benefits. Instead, Chesbrough and Teece (2002, p. 133) recommended a balanced approach, based on the findings from a study where "some technologies were purchased from other companies, others were acquired through licenses, partnerships, and alliances and still other critical technologies were developed internally." A continuous interplay among these mixed approaches modifies the business model and makes it possible for a firm to adjust its boundaries in accordance with changing conditions, because "efficient boundaries of a firm are dynamic" (Broedner et al., 2009, p. 132).
This invited paper underwent a double-blind peer review.
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Chalmers University of Technology
Lars-Erik Gadde (Ph.D., Gothenburg University) is a professor of industrial marketing at the Chalmers University of Technology in Gothenburg, Sweden. His research interests are focused on business relationships, distribution networks, and supply networks. Dr. Gadde has published extensively in journals that include the Journal of Business Research, the Journal of Management Studies, Industrial Marketing Management, Marketing Theory, the Journal of Purchasing & Supply Management, and the International Journal of Research in Marketing. He is a member of the IMP (Industrial Marketing and Purchasing) Group and a co-author of Business in Networks and Supply Network Strategies, among other books.
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|Publication:||Journal of Supply Chain Management|
|Date:||Oct 1, 2013|
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