Outsourcing, Complementary Innovations and Growth



1 Introduction

The fragmentation of the production process through outsourcing has experienced a remarkable
growth in the last three decades (Feenstra, 1998). It is the most recent form of division of labor used
as a business strategy to exploit gains from specialization. At the same time, outsourcing is no longer
a concept limited to manufacturing and services. Given the complexities of today’s technologies and
supplier chains, farming out R&D is gaining remarkable importance for sustainable competitive
advantage and survival in the global market. The key to success tends to increasingly hinge on the
utilization of creativity and skills of specialized workers and engineers around the world linked in
‘global innovation networks’. An example on two giants of the computer industry, Apple and IBM,
helps clarify the concept. While IBM has adopted an ‘unbundling’ business strategy that goes as far
back as 1969, Apple has insisted on maintaining the production of its own hardware and software in
house.1 The IBM family today consists of some of the fastest growing names in the PC computer
industry such as Dell and Hewlett-Packard Co. as well as leading software and hardware producers
such as Microsoft and Intel. Outsourcing has created a market for complementary innovations giving
rise to a complex network of innovators that has helped IBM enjoy a much more significant role
in the computer industry than Apple.2 This has been possible through a simple division of labor,
which in turn has instigated a division of knowledge creation. Figure 1 shows the depth of IBM’s
innovation networks in the computer industry compared to that of Apple (Tomlinson, 1999).

Could the success of a network such as IBM’s be taken for granted in all sectors and under all
circumstances? We address this complex question from a specific angle by focusing on a special reason
why innovation networks arise, namely to serve the needs of fragmented production. From this angle
causation goes from the decision to outsource production to the emergence of innovation networks,
which allows us to study the conditions under which the static gains driving the outsourcing choice
may be associated with dynamic losses due to slower innovation and growth. In so doing, we develop
a dynamic model in which fragmented production (‘outsourcing’) and complementary innovations
1WALL STREET JOURNAL (1969).

2See Engardio and Einhorn (2005).



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