Outsourcing Contracting Strategies from Supplier's Side: A Real Options Approach Based on Transaction Costs

AbstractOutsourcing is the process of contracting a business function to an outside supplier. Two parties exist in an outsourcing contract; the supplier and the client. Transaction costs, consisted of ex-ante transaction costs that occur before assigning the contract such as costs of searching, collecting information and negotiating, and ex-post transaction costs that arise after assigning the contract as costs of monitoring and enforcement, occur for both parties after the outsourcing contract is assigned. However, the studies in the outsourcing literature are mostly from the client's perspective. The paper explores the ex-ante and ex-post transaction costs from the supplier's side with respect to selection of an investment strategy on specific or flexible production assets. Sanchez's framework that integrates real options and transaction cost economics is modified for outsourcing contracts from the supplier's perspective. An illustrative case study demonstrates the applicability of the proposed model