Demand Uncertainty and Production Outsourcing
60 Pages Posted: 20 Aug 2015 Last revised: 19 Apr 2019
Date Written: July 1, 2014
We examine the relation between demand uncertainty and firms’ production outsourcing decisions. Contrary to the traditional view on make-or-buy decisions in management accounting textbooks, we predict that demand uncertainty deters outsourcing by a manufacturer from a supplier. Building on transaction cost economics and operations management research, we argue that outsourcing can increase the production lead time and cause excessive production variability due to incentive misalignment between the manufacturer and the supplier. These adverse effects increase the transaction costs of outsourcing. When demand uncertainty is high, these transaction costs can outweigh the supplier’s cost advantage, leading to less outsourcing. Using a large representative sample of manufacturing firms in Turkey, we find a significant negative relation between demand uncertainty and outsourcing, as predicted. This relation varies predictably with moderating factors that influence the tradeoff between the transaction costs of outsourcing and the supplier’s cost advantage, consistent with the theory.
JEL Classification: M11
Suggested Citation: Suggested Citation