Purposeful Disownership: Paying Contract Manufacturers to Reduce Ownership and Termination Cost

Abstract

Firms often persist with failing products due to excessive organizational ownership and relational commitments to suppliers. We propose that firms make strategic use of contract manufacturing to purposefully reduce ownership and termination costs. Using detailed data on 249,705 products (or designs) in the fashion industry, we show that firms are more likely to contract manufacture new products that have a high risk of commercial failure even when they can be readily produced in-house. In exchange, firms pay production costs that are 10 to 16 percent higher. Organizational hierarchy, which reduces ownership, significantly moderates the increase in contract manufacturing. Our findings suggest that firms actively manage escalating commitment and path-dependence through make vs. buy decisions and revise the prevailing view that contract manufacturing is a myopic strategy that trades learning opportunities with short-term cost savings. We show that our theory generalizes and successfully explains decisions between direct capital investment and rentals by US public firms.