The impact of business process outsourcing on firm valuation: An empirical study

In recent years outsourcing in general and business process outsourcing in particular has become an important phenomenon. Organizations in their efforts to focus on their core competencies have increasingly sought to outsource many non-core business processes and functions to external services providers. A new trend has been the ability and willingness of firms to source these services from service providers located in countries outside the U.S.; It is widely expected that business process outsourcing offers significant value to firms through lowered costs, increased ability to scale, enhanced flexibility and better access to knowledge and technological resources. While the potential exists, past experience of firms suggests that outsourcing has its pitfalls and that expected payoffs from outsourcing have been difficult to realize. Anecdotal evidence indicate that a large proportion of outsourcing contracts have fallen short of expectations both in terms of service delivery and cost reduction. So, the question remains: does business process outsourcing truly pay off?; This study is one attempt to address this question. We synthesize resource dependence theory, transaction costs theory and the knowledge based view of the firm to develop research models to address the following questions: (1) Does business process outsourcing affect firm valuation? (2) Does the impact of business process outsourcing on firm valuation vary by the nature of the process outsourced and location of the service provider? (3) Does the extent of outsourcing impact firm performance in terms of productivity and efficiency?; We develop a framework to classify business process outsourcing in terms of the location of the service provider and the knowledge intensity of the process outsourced. Drawing upon past research we examine our research questions pertaining firm valuation using the event study methodology. An event is defined as a public announcement in the media of a firm's BPO initiatives. Compilation of the study's data was done from a full text search of firm's announcements related to BPO in the period between January 1, 2000, and December 31, 2004, using web search engine, Wall Street Journal, and also on-line search features of Lexis-Nexis. The target population for the study is the Fortune 1000 companies.; We also posit and empirically test whether business process outsourcing intensity has an impact on firm performance in terms of profitability and productivity. Outsourcing intensity is measured as the number of unique processes that a firm has outsourced during the past five years.; Our results indicate that while business process outsourcing has a negative effect on firm valuation, the effects vary based on the nature of the process outsourced and the location it is outsourced to. We find that off-shoring has a significant positive effect and on-shoring has a significant negative effect on firm valuation. We also find that outsourcing knowledge intensive processes has a negative effect and outsourcing labor intensive processes has a positive effect on firm valuation. Our results also suggest that off-shoring labor intensive process is viewed favorably by the stock market. Finally, we find that outsourcing intensity has a positive impact on firm productivity and a negative impact on profitability. These results are interpreted and discussed in this thesis.