On the role of sunk costs and asset speci®city in outsourcing
decisions: a research note
Filip Roodhooft *, Luk Warlop
Katholieke Universiteit Leuven, Department of Applied Economics, Naamsestraat 69, 3000 Leuven Belgium
Abstract
The accounting literature has argued that ®rms overengage in outsourcing because they tend to ignore the transac-
tion costs involved in buying services from external suppliers. A ®eld experiment with managers of health care orga-
nizations shows that decision makers are actually quite sensitive to the asset speci®city associated with the ``buy''
option in an outsourcing decision. However, they also appear inappropriately sensitive to the sunk costs inherent in
most real-life outsourcing decisions, and may actually underengage in outsourcing. Prior commitment to internal pro-
curement systematically reduced the willingness to outsource, relative to a pure ``make or buy'' scenario. # 1999
Elsevier Science Ltd. All rights reserved.
1. Introduction
Ecient ®rms allocate their own resources to
those activities within the value chain for which
they enjoy a comparative advantage over compe-
titors (Shank & Govindajaran, 1992). Other activ-
ities are increasingly being outsourced to external
suppliers. Outsourcing often involves important
production cost savings relative to internal pro-
duction because outside suppliers can aggregate
demand, which enables them to bene®t from
economies of scale, smoother production schedules
and centralization of expertise. Management
accountants play an important role in the decision
whether to ``make'' or ``buy'' an activity because it
requires an accurate analysis of the relevant costs
associated with both options.
Optimal choices between continued internal
production and a switch to market procurement of
an activity require more than mere consideration
of production cost dierences. According to
transaction cost economics, the degree of asset
speci®city is an important consideration in the
outsourcing decision. Outsourcing is only desirable
when expected governance and coordination costs
resulting from asset speci®c investments in the
relationship with the future supplier are lower
than the production cost advantage that the supplier
may bring (Chalos, 1995). Because transaction costs
are often dicult to specify and estimate, many
authors in accounting warn against head-over-
heels commitment to outsourcing. Case studies
(Drtina, 1994; Lacity, Willcocks & Feeny 1996)
have suggested that decision makers within ®rms
Accounting, Organizations and Society 24 (1999) 363±369
0361-3682/99/$ - see front matter # 1999 Elsevier Science Ltd. All rights reserved.
PII: S0361-3682(98)00069-5
* Corresponding author. E-mail: ®lip.roodhooft@econ.ku-
leuven.ac.be