In this section, the transactional servitization of manufacturing phenomenon through
performance‐based contracts is approached through the end‐user’s (customer’s) perspective and
the focal area of the research is identified. Summarily, it is maintained that the reception of such
offerings for traditionally sourced industrial products constitutes, in principle, a form of activities
outsourcing on behalf of the customer. Furthermore, in adopting a transaction governance
perspective (Williamson, 1998), it is held that the reception of such long‐term contracts is
essentially an outsourcing endeavour within a hybrid/intermediate (Barney, 1999) governance
mode situated between the alternatives of spot market and hierarchical types of exchange
governance. To better conceptualise the aforementioned suppositions, the following theoretical
analysis is offered.
Supposing a firm operating in a given business environment, that firm may identify a particular
need akin to its business activities that needs to be satisfied. Further supposing that the need may
be satisfied by the functionality of a known‐to‐the‐world and mature (as opposed to a novel and
disruptive) technological artefact (Figure 4‐1), the firm must decide on the way with which this
functionality is to be accessed, utilized and maintained so as to satisfy the need in a sustainable
manner. Figure 4‐1. Addressing a business need through a technological artefact
Accessing the functionality pertains to the issue of somehow gaining control of, or access to, such
a technological artefact. Utilizing the functionality pertains to the issue of somehow exploiting the
artefact to the satisfaction of the identified need. Maintaining the functionality pertains to the
issue of ensuring that the functionality remains accessible and available to the satisfaction of the
identified need in accordance with the need’s specifications (Figure 4‐2).
Figure 4‐2. Basic issues pertinent to the satisfaction of a business need
In congruence with Williamson’s (1998) view of industrial organization it is argued that given
managerial choice all of these three issues may be chosen to be addressed through activities and
transactions performed either within or outside of the boundaries of the firm. When performed
within the boundaries of the firm, a hierarchical governance mode is said to be utilized. If elected
to be performed outside of the bounds of the firm they may be chosen to be performed in either
one of two ways: in a market governance mode meaning through arm’s length agreements
performed in a spot market, or in a hybrid/intermediate governance mode through more
structured and long‐term agreements performed with select suppliers (Figure 4‐3). It should be Technological artefact Functionality of the
technological artefact
Satisfaction of a particular
business need
Issue 1 Issue 2 Issue 3
Accessing the technological
artefact's functionality
Utilizing the technological
artefact's functionality to
address the business need
Ensuring that the
functionality remains
accesible & available in a
____________________________________________________________________________________ 39
Chapter 4 – The case of performance‐based contracts
noted that the aforementioned classification is in further accordance with the one put forth by
Toffel (2008) in his study on contracting practices in a servitized setting.
Figure 4‐3. Governance modes of activities needed for the three basic issues
In the case where the firm elects an entirely autonomous approach to these issues, all relevant
activities and transactions are performed internally. The artefact’s functionality is accessed
through the research, development and manufacturing of the artefact. Subsequently, the
functionality is utilized through the use of the artefact in appropriate ways, while the
functionality’s maintenance is addressed through the servicing and repair of the artefact (or by its
replacement by another artefact) that ensures the same functionality. To satisfy all of the
aforementioned functions, the firm must thus develop and coordinate several sets of activities
each pertaining to the effective and efficient fulfilment of each respective issue.
Due to various reasons though, as mentioned before, the firm may decide a less autonomous
approach where the aforementioned issues are not entirely addressed within the boundaries of
the firm. In accordance with Harrigan (1985) as well as Gilley and Rasheed (2000) it is recognized
that the decision to somehow address these issues externally to the firm’s boundary limits, by
assigning the activities and transactions related to them to external economic entities, falls within
the notion of outsourcing.
The most basic (or traditionally established) outsourcing decision primarily concerns the access of
functionality issue. In particular, when the focal firm operates in business segments that are
detached from the technological artefact’s manufacturing segment, it is most frequently the case
that the functionality access issue is approached through the procurement of the artefact from
other firms that have already researched, developed and manufactured them. This basic
outsourcing of the access issue is argued to reflect a traditional approach to the sourcing of
industrial products. Furthermore, the particular approach is held to reflect the basis on which a
manufacturer offers an industrial product to potential end‐users in a non‐servitized state.
Consequently, this paradigm of goods procurement is further utilized as the starting point for the
study’s exploration of the servitization of manufacturing, through the end‐user’s (i.e. customer’s)
perspective.
Issue 1 Issue 2 Issue 3
Performed internally through
proprietary organizational
routines
Performed externally through
long‐term agreements with
select suppliers
Performed externally through
arm's length transactions
in the market Accessing the technological
artefact's functionality
Utilizing the technological
artefact's functionality to
address the business need
Ensuring that the
functionality remains
accesible & available in a
sustainable manner
____________________________________________________________________________________ 40
Chapter 4 – The case of performance‐based contracts
Given that the access of functionality issue is addressed through the procurement of the
industrial product, the focal end‐user firm must then decide on a supplier for the artefact as well
as address the functionality utilization and maintenance issues. Thus, the firm must decide from
whom to acquire the artefact, how best to exploit the functionality offered and, finally, how the
functionality’s availability is to be ensured in a sustainable manner (given that the identified need
is a continuous requirement, while the artefact’s lifecycle is finite). In again supposing an
autonomous approach, as traditionally is the case, the focal firm still develops and coordinates
several sets of activities and transactions internally, each pertaining to the fulfilment of the
remaining two basic issues.
At this point, it is argued that the offering of a performance‐based contract for the technological
artefact, seeks by definition to change the paradigm of internally developing the activities needed
to address the remaining two basic issues. This is attempted by soliciting the performance of said
activities and promising the sustained access, exploitation and availability of the artefact’s
functionality to the satisfaction of the identified business need. Thus, it is argued that the
reception of the performance‐based contract entails the outsourcing of activities previously
developed (or at least handled) by the customer internally. However, apart from entailing the
outsourcing of the activities in a general sense, it is further held that such a contract (also by
definition) seeks to ensure that the activities are: (1) outsourced in a particular form of
governance, namely a hybrid governance mode (Figure 4‐4) as well as (2) outsourced to a
particular supplier firm, i.e. the firm offering the contract.
Hence, it is proposed that the study of factors that affect an end user’s willingness or propensity
to employ an outsourcing governance mode to address the activities and transactions related to
the three primary issues that that were previously performed internally, constitutes a focal
research area that reflects the study of factors affecting the successful implementation of a
transactional servitization strategy in the form of performance‐based contracts. Figure 4‐4. Governance mode advocated by performance‐based contracts
Issue 1 Issue 2 Issue 3
Accessing the technological
artefact's functionality
Utilizing the technological
artefact's functionality to
address the business need
Ensuring that the
functionality remains
accesible & available in a
sustainable manner
Hierarchical Governance Hybrid Governance
Performance‐based contract Market Governance
Performed internally through
proprietary organizational
routines
Performed externally through
long‐term agreements with
select suppliers
Performed externally through
arm's length transactions
____________________________________________________________________________________ 41
Chapter 4 – The case of performance‐based contracts
4.4 The customer’s dilemma: A make‐or‐buy or firm boundary decision
As evidenced in the previous section, the acceptance of performance‐based contracts, on behalf
of the customer, entails the outsourcing of a number of activities previously performed within the
bounds of the customer firm. As such, it is put forth that when a customer firm is presented with
such an offering, it is essentially faced with a classic make‐or‐buy or otherwise a firm boundary
decision. That is to say that when a manufacturer proposes a performance‐based contract to a
potential customer, that customer has to decide on whether the associated activities are better
left to be performed within the bounds of the firm (as they have traditionally been) or whether
they should be outsourced to the manufacturer and thus performed outside of the bounds of the
firm. Hence, it can be argued that the customer is faced with a firm boundary changing dilemma.
The firm boundary problem, otherwise known as the make‐or‐buy decision in a manufacturing
context and perhaps appropriately paraphrased as the perform‐or‐buy decision in service related
contexts, is the issue of determining whether a firm should make a component or perform an
activity within its hierarchical boundaries or somehow procure it from an outside source.
In a manufacturing context, the make‐or‐buy decision relates to a manufacturer’s choice of
whether to internally produce a given component of one of its products or to procure it from an
external (OEM) manufacturer. In a services related context, the perform‐or‐buy decision relates
to a firm’s choice on whether to internally perform an activity that renders a useful service, or to
procure the service from an external provider. In reality, in both manufacturing as well as service
contexts, the focal firm determines whether it wants to perform certain activities internally or
not. In the first case, it relates to activities that lead to the production of a good, while in the
second case, it relates to activities that lead to the rendering of a service. As such, in both cases
the related decision can parsimoniously be regarded as a firm boundary decision or a firm
boundary related problem.
More neutrally, the firm boundary issue is also regarded as the insourcing/outsourcing problem,
where in exactly the same way a focal firm is called to determine whether it should insource or
outsource an activity leading to the production of a physical good or the rendering of a service.
Similarly, yet in a more confined way the firm boundary issue has also been referred upon as the
vertical integration or disintegration issue, where focus is put on the insourcing or outsourcing of
vertically (or value chain) linked activities. In any case, in the interest of parsimony, these
instances are again regarded as firm boundary decisions.
On a final note, of interest to the characterization of firm boundary decisions as sourcing
decisions is the distinction between the a priori and a posteriori insourcing/outsourcing of an
activity. When the sourcing decision is made prior to a firm’s establishment (e.g. in the business
plan phase), then it may be referred as an abstention‐based insourcing/outsourcing decision,
while when the decision is made in any other instance of a firm’s lifecycle, it may be referred as a
substitution‐based sourcing decision (Gilley and Rasheed, 2000; Holcomb and Hitt, 2007).
No matter what the nomenclature is, the point remains that when an end‐user of an industrial
good is faced with the offering of a performance‐based contract for it, the acceptance or rejection
of the offering will depend on the customer’s decision on whether or not to outsource the