How Does Outsourcing Affect Performance Dynamics? Evidence from the Automobile Industry

Abstract

This paper examines the impact of vertical integration on the dynamics of performance over the automobile product development life cycle. Building on recent work in organizational economics and strategy, we evaluate the relationship between vertical integration and different dimensions of product performance. Outsourcing facilitates access to cutting-edge technology and the use of high-powered performance contracts. Vertical integration allows firms to adapt to unforeseen contingencies and customer feedback, maintain balanced incentives over the life cycle, and develop firm-specific capabilities over time. Together, these effects highlight a crucial trade-off: while outsourcing is associated with higher levels of initial performance, vertical integration will be associated with performance improvement over the product life cycle. We test these ideas using detailed data from the luxury automobile segment, establishing three key results. First, initial performance is declining in the level of vertical integration. Second, the level of performance improvement is significantly increasing in the level of vertical integration. Finally, the impact of vertical integration is mediated by the level of preexisting capabilities, by the salience of opportunities to access external technology leaders, and by the scope for learning over the product life cycle. Together, the findings highlight a strategic governance trade-off between short-term performance and the evolution of firm capabilities.