critical competencies in virtual service webs

European Management Journal Vol. 21, No. 1, pp. 48–61, 2003 2003 Elsevier Science Ltd. All rights reserved.Pergamon

Printed in Great Britain0263-2373/03 $30.00 + 0.00doi:10.1016/S0263-2373(02)00154-8

Critical Competencies inVirtual Service WebsJULIAN JONES, University of ManchesterB. BOWONDER, Administrative Staff College of India, HyderabadDOUGLAS WOOD, Manchester Business School

The paper reviews Williamson’s transaction costframework [Markets and Hierarchies (1975)] in lightof new, and often location-independent influencesto argue that conventional concepts including clus-tering, scale and scope economies and comparativeadvantage are becoming less clearly defined, andhence less useful in predicting industry structuresin service transactions. Using a sample of service-based innovations, we describe how Williamson’saccount omits the key role that underwriting playsin mobilising new web-based options. Theresulting ‘service web model’ provides a more com-plete account of the fragmentation of service chainsarising from virtualisation and adds another dimen-sion to discussion of comparative advantage con-ventionally focused primarily on goods exchanges. 2003 Elsevier Science Ltd. All rights reserved.

Keywords: Firm boundaries, Comparative advan-tage, Outsourcing, Global value chains, Virtualis-ation, Transaction costs, Services, Governance

Introduction

This paper investigates the growing phenomenon ofremote, increasingly transnational service provision.New technology provides an opportunity for remoteprovision of activities that hitherto have been geo-graphically constrained by the need to integrate themwithin service and commodity value chains. Increas-ingly services and service elements in manufacturingvalue chains are being freed from the logistic con-straints applying to remote suppliers. Indeed remote-ness, to the extent that it provides much lower costlocations and time zone differences may be positivelydesirable. Services, due to their predominant charac-teristic of customisation are generally more labourintensive, information sensitive and time sensitivethan either manufacturing or commodity production.To the extent that improved communications givefast, low cost access to exploit major international dif-

European Management Journal Vol. 21, No. 1, pp. 48–61, February 200348

ferences, remote service delivery has the potential formore fundamental changes in the internationaldivision of economic activity than globalisation ofmanufacturing activity.

Taking a transaction cost framework, the contri-bution of key technologies to redefining the bound-aries of firms competing in the production and deliv-ery of services differs considerably from the issuesthat affect commodities and manufactures. In com-modity and manufacturing activities, the logisticsinvolved in handling and transforming raw andvalue added materials and delivering them to finalconsumers commonly create structural and organis-ational constraints. Indeed these constraints tend tobe the main determinants of industries and in ident-ifying who competes in them. Services though tendto be almost weightless, so that logistic elements suchas the paper used in the consultants report, the polishused by the shoe cleaner or the sutures used by thesurgeon are minor elements in the value created bythe customised, real time delivery of the service.

Service industries do however though tend to beinformationally intensive, based on the cumulativehistory of a number of previous service encounters.The falling cost of information storage, retrieval andprocessing means that many of these service encoun-ters are now computer supported, with a service pro-vider’s inputs, transformations and outputs based ondigital rather than analogue formats. Such digital rec-ords can be transferred instantaneously and with noloss of information, so the same image can be madeavailable to a security guard in India and one sittingin the gatehouse of a US plant.

As ‘fly by wire’ technology replaces analogue trans-actions, a growing proportion of both service andcommodity value chains become internationally foot-loose, and delivered independently of the transactioncost limitations applying to physical processes. Thisleads to a dramatic increase in the range of marketbased alternatives to internal supply. With dramatic

VIRTUAL SERVICE WEBS

declines in communication costs and large factor costdifferences, cross border arrangements become notjust feasible but increasingly competitive, introduc-ing a new dimension to measurements of inter-national comparative advantage, based primarily ongoods exchanges.

This paper suggests that this new phenomenon ofremote service provision raises some challenges tothe robustness of widely used concepts such as clus-tering, competence analysis, industrial structure andcompetitiveness. As virtualisation brings nearcostless information exchange, the most competitiveproviders for given activities in the value chain mayno longer be within a particular industry. Rather,they may be enjoying scale and scope economiesbased across many industries. Capabilities relative towithin industry competitors are irrelevant if potentialexternal suppliers are, or could become, even morecompetitive. Nor do clusters, enjoying externalitiescreated by the physical proximity of many firms inthe same line of business provide robust solutionsonce virtualisation allows access to remote supplierswho may be large enough to have internalised theadvantages, have access to a broader range of exter-nalities in different value chains or access to lowerfactor costs.

Examining a number of case studies through the lensof transaction cost theory, this paper shows that anew set of remote service delivery options are emerg-ing because of the high co-ordination costs inresponding to rapidly evolving customer needs, theavailability of key competencies outside conven-tionally accessible boundaries, and the rapid dif-fusion of web-based innovations that lower the trans-action costs of locating, managing and monitoringremote service delivery. These indicate the unlockingof a new scenario that challenges conventionalnotions of competitiveness and governance of valuechain relationships.

Revolution in the Virtualisation ofServices

Historically, international transactions consisted pre-dominately of manufactured goods and commoditiessuch as oil, and issues of economic structure andcompetitiveness concentrated on a relatively narrowcategory of so-called ‘merchandise goods’. For a con-siderable period this focus seemed entirely appropri-ate as successive reductions in tariff and non-tariffbarriers that impacted raw materials and manufac-tured goods resulted in a rapid growth in cross bor-der trade transactions as a proportion of world GDP.

Taking the traditional definition of services as pro-ducts that could only be created by the combinationof their components at the point of delivery, most

European Management Journal Vol. 21, No. 1, pp. 48–61, February 2003 49

services were embodied in commodity or goodstransactions rather than sold in their own right. Socompetitiveness of services in their own right wasnot explicit, with underperformance in service qual-ity or competitiveness balanced against high com-petitiveness in raw materials or manufactured pro-cesses. Regulatory, financial, legal and accountinginfrastructures, to the extent that they contribute tothe overall competitiveness of nations also obscuredservice competitiveness.

Recent improvement in technology together with theemergence of key standards for electronic inter-change have resulted in major changes in the costand capability of communication systems and con-tributed to the growing economic importance of ser-vices. Between 1980 and 1997, the share of GDPaccounted for by service value added increased from56 - 61 per cent overall, with the fastest growthexperienced by middle income countries (Table 1).This is reflected in the growth in value of world tradepost-digitisation. The value of services exports inparticular grew much higher ($392bn to $1371bn)than the growth in merchandise exports ($1733bn to$5241bn), emanating primarily from middle- andhigh-income countries.

New technologies such as video conferencing, digitis-ation of images and electronic data exchange proto-cols have provided mechanisms for instantaneousand near costless data exchange, whether betweentwo departments in the same organisations orbetween departments in two separate organisations.

These have in turn transformed many of the trans-action cost penalties associated with remote servicedelivery to the point where assembly and delivery ofan increasing array of activities have no spatialrequirement and their location is immaterial to ser-vice buyers. Exploiting any cost differentials betweeninternal and external supply is also easier with ser-vices than manufacture. A knowledge and protocolbase of the type used in financial and travel servicescan be straightforwardly transferred to an external,remote supplier, whereas manufacturing outsourcingoften involves the relocation of capital assets andspecialist skills. Initially global companies exploitedcost differences to transfer services to low costlocations via internal, subsidiary governancerelationships, but increasingly the range of insourc-ing and external outsourcing options have created anincreasingly globalised market for service provision.

In evidence, international transport services handlingphysical shipments have experienced a decliningshare of service activities while knowledge based ser-vices including travel, communications and financialservices have gained increasing shares (Table 2).


Table 1 Value of Services by Region

GDP ($bn) Services value added as % of Services exports ($bn)GDP

1980 1997 1980 1997 1980 1997

East Asia & Pacific 444 1528 29 37 8774 82,484Europe & Central Asia 1139 54 74,951Latin America 782 2088 50 60 16,777 47,034Middle East & North Africa 391 495 37 48 14,875 34,369South Asia 222 512 38 46 4177 13,805Sub Saharan Africa 269 326 43 48 9152 15,159Europe EMU 6283 58 152,970 409,507Low income 529 752 39 43 9757 25,593Middle income 2530 5408 41 52 54,746 242,215High income 7990 22,848 59 63 327,151 1104,142World 10,925 28,978 56 61 391,654 1,371,950

Source: OECD (1998). The influence of emerging market economies on OECD countries international effectiveness

Table 2 Shares of Physical Transport Shipments and Knowledge-based Service Activities in Total Services

Transport (share) Travel (share) Communication Insurance &computers (share) financial services

(share)

1980 1997 1980 1997 1980 1997 1980 1997

East Asia & Pacific 23.9 11.3 38.0 41.9 37.7 46.4 0.6 0.4Europe & Central Asia 46.0 26.5 24.7 38.9 25.5 31.3 3.9 3.5Latin America 27.4 25.7 40.9 43.2 25.2 26.3 6.7 5.0Middle East & North Africa 25.1 19.8 33.0 39.3 41.4 40.0 — 1.2South Asia 19.6 25.0 44.4 27.8 35.1 44.8 1.4 2.5Sub Saharan Africa 45.0 25.3 27.6 46.9 22.1 24.0 5.6 5.4Europe EMU 27.4 23.8 28.8 33.9 41.1 37.7 2.8 4.6Low income 35.4 24.6 29.9 28.1 32.1 45.3 2.9 2.3Middle income 29.6 20.3 36.4 41.4 30.3 36.0 4.9 2.6High income 34.1 23.9 24.7 29.6 29.0 41.7 2.6 5.6World 33.6 23.2 26.2 31.7 37.8 40.7 2.9 5.0

Source: OECD (1998). The influence of emerging market economies on OECD countries international competitiveness

Transaction Cost Analysis of Boundary Decisions

These developments can be broadly related to theinternalisation/externalisation concepts initiated byCoase (1937) and subsequently developed amongstothers by Williamson (1975, 1979, 1981). Coase (1937)proposed a powerful yet simplistic assumption thatthere may be decreasing returns from organisingadditional activities inside the firm; with the resultthat firms may fail to capitalise their scarce factors ofproduction. Accordingly, equilibrium firm sizeoccurs at a point where the operational synergies acompany can secure from bundling internally man-aged activities exceed the associated costs of organis-ing them externally. Firm size is thus determined byin-house servicing costs relative to the default pos-ition of market transactions (Williamson, 1975; Jonesand Hill, 1988).

Transaction cost theory originally rested on a com-parative account of organisational design (Klein and


Shelanski, 1994). In conditions of competitive equilib-rium and without constraints, organisations aredriven by competition to continually evaluate theirorganisation against structures adopted by competi-tors and other potential alternatives. The originalconsensus was that the appearance of unrealisedefficiency opportunities in this ‘strong form’ accountalways offered incentives to reorganise (Williamson,1975, 1979, 1981).

Imperfect markets inevitably alter firm choices andcritics suggested that in anything other than perfectcompetition, the kind of optimal solutions suggestedby Coase (1937) and Williamson (1975, 1979, 1981)need not always prevail. Decision makers often oper-ate under cognitive constraints (March and Simon,1958), and in these conditions, strict optimisingtheories become untenable (Demsetz, 1988). Ratherthan setting out to displace transaction cost econom-ics, March & Simon (1958), Robins (1987) andDemsetz (1988) repositioned it as providing the


viability conditions of internal versus external out-sourcing opportunities in imperfect markets, ratherthan being the motive force of change ‘When trans-action costs are dislodged from their position as themotive force of organisational change, the conditionsthat mandate more or less costly forms of governancebecome an integral part of the analysis.’ (Robins,1987, p. 82)

This leads to a conclusion that companies internaliseactivities, provided the direct servicing and transfercosts involved are lower than what would followfrom external, market transactions. These transfercosts are in turn influenced by four factors:

❖ The competitiveness of the external market,❖ Information asymmetries between a firm and its

external contractors,❖ The costs involved in locating contracting and

monitoring an external source, and❖ The specificity of the assets involved in trans-

actions.

The concept of market failure and Williamson’s(1975, 1979, 1981) discussion of the way that numbersof service providers and information asymmetrybetween parties challenges the perfect marketassumption seem directly applicable to contempor-ary issues in the virtualisation of services. If there arefew suppliers in any market influencing the price ofthe service, clients become exceptionally dependenton the provider. With little public information on fairor market prices as a guide, information asymmetriesgive rise to potentially opportunistic behaviour anduncertainty. Further, structuring costs in re-routingwork to external service providers create ‘switchingcosts’, making it difficult for clients to step over fromone supplier to another. These are exacerbated wherea history of in-house provision creates legacy prob-lems relative to industry standards, and where therewill be an absence of service benchmarks or contractdevelopment skills.

Supply market competition, contract developmentcosts, switching and monitoring costs are thereforefeatures of both traditional supply contracts and ofsupply within a virtual network. Services and inparticular information based services, to the extentthat they are not constrained by the need forexchange of physical material and product areinherently more sensitive to changes in transactioncosts than goods based transactions. Provided theoutsource market offers workable levels of compe-tition, Williamson’s (1975, 1979, 1981) concerns withmarket failure in supply markets are, therefore rel-evant to outsource supply. However when trans-action costs decline, the number of competitors in theoutsource market increases. Since insourcing andoutsourcing opportunities will no longer be con-strained by organisation’s customary industrial andgeographical domiciles, the impact on firm bound-aries is unclear.


In the remainder of this section, we review the majorcommunication enablers that have simultaneouslyreduced transaction costs together with the driversof a variety of remotely created services.

Transaction Cost Enablers

DigitisationDigitisation captures information in electronic formand, unlike copying, preserves the structure of infor-mation allowing recipients to manipulate and addvalue. Digitisation provides a basis for low cost, errorfree intra- and inter-organisation informationexchange, thus reducing any spatial disadvantagessuffered by external or even offshore provision.

This expands the number of potential partners, hencereducing the small numbers problem in suppliersearch and contracting, and subsequent dependency.Global service provision is increasingly a reality andas a result, both hierarchical and market governancesystems are giving way to virtual systems, operatingthrough digitally delivered and globally co-ordinatedshared information infrastructures.

The power of information technology to simul-taneously allow decentralised delivery of digitisedinformation through personal communication net-works and at the same time allow centralised controlthrough intelligent client servers supports a plethoraof new business models which can be located withoutreference to the value chain they support. Remotemedical transcription, telediagnostics, expert consul-tations, data mining, online entertainment, productservice centres and transaction processing centres aresuch examples of spatially unrestricted businesses.

Communication Networks

In 1975, Gordon Moore, Intel co-founder predictedthat the number of transactions on a semiconductordoubles roughly every 18 months, with a 50 per centreduction in area, based on a log-linear relationshipbetween device performance (higher circuit densityat reduced cost) and time. The evolution of Intelchips through the 8086/88 in 1979, the 286 in 1982,the 386 in 1985, the 486 in 1989, the PentiumTM in1993, and the Pentium ProTM in 1996 has exemplifiedthe technical progress anticipated by Moore’s Law(Figure 1). The effects have been dramatic with theJoint Economic Committee of Congress concluding inJuly 2001 that ‘At least a half of the recent increasein labour productivity… is attributable to IT.’ US pro-ductivity had almost doubled between 1995 and 2000(Fixmer, 2002).

The latest processors provide ample power to sup-port the virtualisation and intense communicationneeded for remote service delivery. 1.5 GHz and 42Mtransistors already support applications such as


Figure 1 Power to Support Remote Service Delivery

streaming video on the web, real-time video enco-ding, 3D virtualisation, speech recognition and voiceover image processing. Communication power hasincreased commensurately with Internet broadbandcapacity, for example starting at 1.5 Mbps (i.e. lasersswitch 1.5m times/s) to fibre-optic systems carrying80 channels providing Internet access at 10 Gbps.Already 40 Gbps capacity networks are being testedwhile 1/2 trillion bits of data per second are beingproposed. Such systems could carry one month’straffic at current bandwidth in less than a second(Savage, 2001). Effectively Moores Law, alongsideintense competition as bandwidth becomes commod-itised and traded (Buckley, 2000), are driving pro-cessing and communications towards zero cost, inthe process ensuring that almost all analogue busi-ness processes not involving physical manipulationbecome uneconomic.

Global Infrastructures

Developing countries share the World Bank’s viewthat telecoms infrastructure is a prerequisite fordevelopment. While the developed world has a teled-ensity of just over five per 100 population comparedto an average of 50-plus in the developed world, thevirtualisation process is dependent on focusedinvestment on high capacity business-to-businesslinks, rather than mass investment on diffuse, lowcapacity business-to-consumer networks.

In Mexico, a $600m investment in a ‘crystal triangle’project of fibre optic cables linking Mexico’s threelargest business centres — Monterey, Mexico Cityand Guadalajara with 30 other cities is nearing com-pletion.1 The result is an open access resource wherescale and service advantages enjoyed in private net-works disappear. Low entry costs provided by ‘open’Internet systems and standard payment and deliverymanagement have facilitated the emergence of small-


scale international business units experimenting withnew business architectures and servicedelivery/processing innovations. This goes a longway to making global service provision a reality;again mitigating problems associated with suppliersearch and negotiations.

Global Standards

Global communication and computing standards likeTCP/IP protocols, packet switching standards, filetransfer protocols, and ‘impeg’ standards provideanother set of enablers since they eliminate the heavyset up and maintenance costs and restricted choice ofpartner inherent in proprietary value chains.

Effectively service providers and service owners caninterconnect without formality anywhere around theglobe. Standards in satellite broadcasting, imagecompression, and image file transmission haveopened many new services to international compe-tition and have been a positive and pervasive factorin growth.

Regulation/Competition

Harmonisation of legal and accounting frameworksand protocols such as ‘Globally Accepted AccountingProtocols’ (GAAP), progressive dismantling of mon-opolies in telecoms and increasing protection andenforceability of intellectual property rights such aspatents, designs, copyrights and trademarks havelowered the barriers to remote service contracting.Countries are learning that harmonisation to inter-national standards brings down investors’ trans-action costs, so facilitating global networking in ser-vices such as design, software development anddrug research.

Transferring professionals

to the US involves matching

US salaries, while remote

contracts facilitated by

virtualisation involve local

costs


In any event remote service contracts, since theyinvolve little in the way of tangible foreign invest-ment are subject to relatively low regulatory risk.Once an adequate contracting market exists, bothsupplier and buyer can switch partners at low costand inconvenience when an unwillingness orinability to honour a serviceagreement is manifest.

Effective regulation, as with theother enablers, is self-reinforc-ing. Falling costs lower trans-action barriers and so widenthe pool of potential contrac-tors. In turn this increases com-petition, and by creating trans-parency and lowering risks,further lowers transaction costsand increases the potential vol-ume of business. This in turncreates pressures to standardise communicationsinfrastructures, business practices and regulatoryenvironments, driving transaction costs downfurther. In the next section we move from consider-ing enablers that remove barriers to remote servicedelivery, to consider drivers that create advantagesfor virtualisation.

Virtualisation Drivers

Time to MarketThe opportunity to shorten time to market has beena major driver in the virtualisation of many servicevalue chains. Virtualisation supports parallel work-ing and hence reduces cycle-time relative to valuechains that are sequential with major benefits for pro-ducts such as pharmaceuticals or aircraft that typi-cally involve long development times and majorexpenditures. Boeing’s 777 was developed through avirtual ‘wired network’ covering many componentsdeveloped by independent suppliers in a number ofcountries. Virtual development allowed continualmonitoring to ensure interconnectibility and com-patibility of ‘virtual prototypes’ allowing Boeing todefine contracts in terms of component performancerather than their physical characteristics. Digital rep-resentation of components allowed Boeing todevelop a completely new generation of aircraft infour rather than seven years, with development ofthe Boeing 737-800 further reduced to 27 months.

Cost Differential

Another major driver has been cost differentials thatcan be realised offshore. Contracting research or pro-cessing activities to suppliers in low cost locationscreates a new source of advantage. In medical tran-scription, Indian skilled labour costs are almost onetenth of the US equivalent. Virtualisation meansIndian transcription services can provide a direct


input into the production of medical services in USconsulting rooms, effectively substituting for the timethe physician would otherwise commit to updatingand organising records. In film animation, virtualis-ation has ended reliance on skilled artists that couldonly be found in adequate numbers in Hollywood.

Instead, virtualisation allowscomputer animators and ani-mation software engineers toimplement an entertainmentconcept from anywhere in theworld. In business services andscientific research the costgradient for qualified pro-fessionals may be even moreadvantageous since the trainingcost for a scientist, lawyer oraccountant is much cheaper inIndia than in the US. Transfer-ring professionals to the US

involves matching US salaries, while remote con-tracts facilitated by virtualisation involve local costs.

Time Difference

Time zone differences provide a further driver.Development work on software or engineeringprototypes can continue 24 hours a day through arelay of contractors working in different time zones.Microsoft maintains a Development Centre in Indiafor precisely this reason. Remote service deliveryplays a key role in shortening service delivery cyclesin three ways:

❖ Service support outside normal business hours(medical transcription, credit card and insurancepolicy processing),

❖ New product design, and❖ Software development.

Confidentiality

The low asset specificity of services means that mostproprietary advantage comes from implicit knowl-edge. Competitors who headhunt key personnel caneasily acquire such knowledge. Indeed the ease withwhich headhunting can be accomplished may be oneof the key synergies leading to industry clustering.Virtualisation and remote service delivery providessome protection against such appropriation of com-petitive advantage since personnel with access toimplicit knowledge will have no contact with cus-tomers or competitors. Furthermore, competitors areunlikely to have a facility that can provide localemployment possibilities. Unlike outsourcing in pro-duct value chains where logistic advantages necessar-ily require co-located partners, service outsourcingallows remote location where proprietary infor-mation is less at risk. Remoteness is also an advan-tage for activities such as credit card processing and


airline ticketing since the difficulties in exploitingconfidential information locally make fraud lesslikely.

Set-up Costs and Speed

The low marginal cost of set up is a driving force forthe virtualisation of service value chains. Forexample, training is often a major element in servicedelivery set-up and without virtualisation, is almostof necessity provided through experience at onshoresites. However where training uses virtual materials,low labour cost locations become both feasible andcheap. Pilot training for example already relies heav-ily on the use of simulators and the same approachallows remote service personnel to be trained in theparticular skills needed to serve remote markets.Indian call centre agents receive cultural trainingthrough video clips and television programmes thatimbue them in the culture of the region they willbe serving.

Virtualisation of training programmes also permitssimultaneous training in multiple locations, speedingthe rollout of a new operation or updated proceduresfor query handling. In the UK, piloting and thennational coverage by NHS Direct, a computer aidedtelephone/Internet gateway into the health andemergency services was achieved in less than threeyears.

Capabilities

Leibenstein (1966) has long believed that there wasmore to output determination than clearly observableinput resources. He argued that the exclusive focuson allocative efficiency (i.e. price and/or quantitydistortions) was to the exclusion of other types of(initially undefined) efficiency, referred to as ‘X-efficiency’. The implication from this simplistic, yetpowerful notion was that firms and nations often failto maximise the transformation of inputs into out-puts. As such, they work at performance levelscomfortably within feasible boundaries. The reasonsadvanced for this are that:

1. Labour contracts are incomplete,2. The production function is not completely speci-

fied or known,3. Not all factors of production are fully marketed,

known or accessible, and4. Interdependence and uncertainty leads competing

firms to cooperate tactically with each other insome respects in imitating rather than maximising.

To the extent that service contracts are incompleteand knowledge accumulated through experience, thevalue and quality of service output is often difficultto determine with few commonly accepted standardsto define productivity, cost, quality or timeliness.


This coupled with significant transfer costs, hindersthe efficient transfer of excess resources that shouldin principle, be generated as activities are routinised(Penrose, 1959).

The advent of cheaper and more effective communi-cations allows firms to access a greater range ofresource-based advantages in service based valuechains. Effectively the universe in which the bound-aries of the firm are defined has expanded and asSpender (1994, p. 829) notes ‘The organisation is nolonger a production function seeking internalefficiency. It is more of a node in a complex networkof economic relationships, dependencies and mut-ual obligations’.

Global businesses including Microsoft, Texas Instru-ments, Warner Brothers, Walt Disney and Sony haverecognised for some time that performance and/orcost advantages from specialist offshore service pro-viders compensate for set-up transaction costs andadditional risk. By establishing proprietary com-munication channels and specialist underwritingprocedures (local contract management, performanceguarantees) they initially used outsourcing tosqueeze-out any residual economic benefit from com-moditised activities (Leibenstein, 1966, p. 413), latermoving into more innovative service outsourcingwhere their offshore service delivery platform servedas a mechanism for superiority rather than parity(Leibfried & McNair, 1992, p. 36).

Case Studies

In this section, a number of case studies arepresented, illustrating how technology has changedthe delivery mechanism of a variety of services awayfrom a location-dependent model to one seeking newsources of comparative advantage, irrespective ofphysical location or origination.

Beginning with the case of IT-enabled service centresand working up the services value chain to considerremote delivery of a more complex range of highervalue services including telemedicine, finance andaccounting services and research and development,the cases illustrate emerging skills in using virtualvalue webs to access remote sources of comparativeadvantage.

Case 1. IT-enabled Service Centres

Call Centres, or IT-enabled service centres have cre-ated a new service and distribution channel in allcountries with an adequate infrastructure(teledensity, third party delivery and Internetpenetration). However the call centres themselveshave no infrastructure requirement other than broad-band access, which is almost universally available.


Beyond this, the technology employed is non-spe-cific, allowing switching between activities and cli-ents almost instantaneously. Call centres are effectivefor many activities traditionally provided through in-house departments or line staff. While HR support,customer interaction services, accounting, banking,financial processing and data management servicesare commonly serviced through this means. Reser-vations, information and advice lines,inventory/purchasing control and emergency servicecall handling illustrate the much broader scope ofcall centres.

Currently international transactions account for asmall part of call centre activity. However call centrelocation generally reflects the cost and availability ofappropriate labour pools without reference to clientor customer location. Services that are remotelylocated nationally can therefore be remotely locatedinternationally and with wages accounting for 70–80per cent of total costs, international labour cost differ-entials are particularly compelling. Additional trans-action costs such as intercontinental operations mayincrease communication costs by 10–20 per cent butinternational wage differentials of up to 90 per centresult in net savings in the range of 50–60 per cent.

India and Ireland in particular have emerged asattractive call centre locations due to the availabilityof skilled labour and appropriate communicationsprovision. Oracle has an $80m call centre in Dublinhandling 100,000 calls per month in 20 languagessupporting sales of its $40,000 database packages(Zwick, 1998). Citibank offers direct access bankingfacilities in 20 countries with the whole of continentalEurope served by a single call centre in Germany(Survey, 1999).

In the last three years many international companiesincluding GE, Bechtel, BA, SGS, and Thompson haveestablished global service centres in India. BritishAirways dedicated call centre ‘World Network Ser-vices’ employs 700. GE in pursuit of its CustomerRelations Management initiative employs 1400people at its Delhi call centre, with another centrescheduled to open in Hyderabad. Although the vir-tualisation process is mainly centred on transactionprocessing activities, iDLX Technology partners havealso established an Indian shared service centre toprovide third party shared technology services to thefinancial sector.

Both Ireland and India have significant time differ-ences from the US, which means that European andUS companies can obtain 24-hour cover and forexample overnight updating without paying pre-mium rates.

The opportunity to decouple the value chain into dis-crete activities that can utilise remote service chainsis created by the parallel working and shared infor-mation features of digitisation. Without digitisation,


one person who would have to combine line oper-ations with query handling necessarily controlledinformation. Now a remote operative has access toon-line data, so line operations and query handlingcan be separated providing productivity gains inboth activities. With cost, time differences and secur-ity benefits favouring remote locations the trans-action cost barriers are generally subjective, revolv-ing round issues of control, confidence and trust.

Case 2. Film Animation

Pentafour Multimedia is an Indian company active inproviding computer-aided animation and productionservices for the global entertainment industry. Filmanimation is a labour-intensive activity requiringexperienced illustrators in sufficient numbers to ani-mate a full-length film. Traditionally, these were onlyavailable in Hollywood. Pentafour though developedsoftware allowing ‘real time motion capture’ so thatactors’ movements could be captured and used toanimate virtual characters through a three-dimen-sional computer model. The movie ‘Sinbad’ was theworld’s first animated film featuring human charac-ters using motion capture technology.

As well as motion in 3D form, Pentafour’s softwareprovides 2500 special effects, together with the sup-port needed to offer animated story content, R&D,and pre-production and production services on a glo-bal basis to holders of entertainment contracts andtheir production teams.

The success of Pentafour effectively challenges thelocation imperative of the filmmaking cluster in Cali-fornia, which brought together film finance, distri-bution expertise and critical masses of specialistssuch as animation illustrators, film directors, stunt-men, special effects companies and skilled pro-duction specialists. Pentafour’s software, combinedwith the ability to transfer work in progress instan-taneously between India and cutting rooms in the USeffectively turns a large part of a localised labour-intensive service activity into an internationallytraded product. Pentafour’s software and expertise inanimation and in virtual client provision also pro-vides significant time and cost advantages. A tra-ditional animated film takes two years with ani-mators in Hollywood costing US$250 p/hour.Pentafour charges around US$75 p/hour andguarantees delivery in six months. Effectively remoteservice provision lowers animation costs by 70 percent.

Based on its software strength, Pentafour’s digitalimaging studio in Madras can produce:

❖ Four animation films per year,❖ Four 52 episode television serials, and❖ 100 minutes of special effects.


While the comparative advantage of Walt Disney,Warner Brothers and Sony are still in origination,financing and distribution of films, virtualisationmakes remote service provision instead of local ser-vice provision a contender for a large portion of thevalue chain.

The nature of filmmaking whereby almost all thecosts are spent before any revenues arise, meansthere is little chance of recovering from productionerrors so the risks of using remote service provisionmay be a deterrent. In the case of Pentafour this wasovercome by setting up a front office studio in Holly-wood to handle the interface with clients. This lim-ited onshore presence proved sufficient to translatecreative instructions into production requirements,which could then be implemented remotely. At thesame time, offshore work-in-progress in India can bemonitored in the US via high-speed web links, ensur-ing seamless liaison between onshore clients andremote providers.

Case 3. Remote Military Operations

The effectiveness of military equipment is increas-ingly limited by the physical frailty and functionalspecificity of the service personnel in local control. Acarefully selected and trained military pilot can sur-vive a maximum of 8g while aircraft technology canhandle forces up to 18g. In addition to protecting andassisting the limited information processing andretention abilities of a single pilot, enormous invest-ment has to be made in advanced avionics equip-ment, highly specific pilot training, on board life-sup-port systems and communications. All these systemsneed to be maintained by skilled engineers who willbe located close to the combat zone to maximise oper-ational availability. In turn, the space and weightrequired for pilot support imposes design constraintson the aeroplane and limits the range of armamentoptions available.

Unsurprisingly, the alternatives enabled by digitaltechnology have become increasingly important.UAVs, (unmanned air vehicles), remotely controlledand supplying information to remote commandcentres (the Afghan campaign was run from CentralCommand in Florida) are increasingly displacingconventional manned weapon systems.

The Predator, developed by General Atomics andcosting $4m, is a low-level reconnaissance vehicle,equipped with streaming colour video cameras andradar that penetrates smoke or haze. It can also carrymissiles for combat use. The plane can remain onstation at an altitude of between 15,000 and 20,000 ft,for 16 hours and is navigated from a ground controlstation up to distances of 600 km from the target. TheGlobal Hawk, developed by Teledyne, is a high alti-tude long-range reconnaissance UAV capable ofremaining at 65,000 ft for 24 hours. It transmits infor-


mation from radar and electro-optical and infraredsensors through a satellite connection and because itis under the command of an expert system pre-pro-grammed with flight and navigation details, it canoperate autonomously thousands of kilometres frombase. In development is Boeing’s X45A, anunmanned combat vehicle designed to knockoutenemy air defence and control systems.

The same digitisation and communications develop-ments that are reshaping non-military value chainsare having a similar effect on warfare. They enable aspecific, previously non-substitutable and expensiveservice (combat zone piloting) to be replaced by aremote service that can divide the task into compo-nents handled by units specialised in particular areassuch as engineering, navigation, intelligence and tar-get acquisition. Unmanned vehicles are estimated tocost a third as much as manned vehicles to build,offer several times as much operational time andinvolve much lower operating costs.2

Unlike civilian outsourcing where remote servicemay be regarded as risky, in military applications,distance from combat is risk reducing; hence militaryapplications will be at the forefront of digitisationand communications technology. Advanced com-pression technology, high frequency transmissionand laser communication via satellites are all areasunder current development.

Case 4. Telemedicine & Remote Diagnosis

The role of technology in redefining the boundariesof service firms is also evident in medical services.

A large (and due to legal concerns an increasing) pro-portion of doctors’ time is spent recording, updatingand reviewing patient records. This area of activity issuitable for remote delivery. Doctor interactions withpatients and other health professionals can be cap-tured by audio recorders and subsequently tran-scribed into digital records by a medical transcriptionservice. The types of information handled includeexamination reports, consultation reports, operativereports, discharge summaries, medical imagingreports, pathological reports, radiology reports, elec-trocardiograms, autopsy reports, death summaries,and emergency room notes.

Currently, approximately 250,000 medical transcrip-tions per annum are conducted in this form in theUS alone, with an industry turnover in the order of$17bn per annum, growing at approximately 25 percent per annum. According to American Associationfor Medical Transcription, two factors are responsiblefor this growth:

1. Demand for greater transparency in patient rec-ords has grown along with the volume of such rec-ords, and


2. As litigation costs rise, medics have been forced toreengineer and tele-source medical services tofocus doctors’ time on knowledge-orientatedactivities and systematic, defensible treatment.

While medicine has always been a highly customisedclient-specific service, necessitating face-to-face con-tact with patients, the fact that elements of a valuechain with high risk of failure are being virtualisedis further support of the disaggregation phenomenaaffecting service delivery. In this case, diagnosis andtreatment remain as core features of service pro-vision, with insurance companies and health man-agement organisations setting up telemedicine ser-vices in remote locations such as India that offer lowtraining and employment costs and time differencesto provide next day service.

Reliable infrastructures and an increasing flow ofdigitised information alter medical services in otherways too. Remote medicine, where mobile medicalexaminations conducted by paramedics can be trans-mitted back to doctors for diagnosis brings high qual-ity treatment to remote locations and is spearheadedby military applications where doctors, particularlyin the US, are generally unwilling to be in the frontline. In 1995, US troops, deployed to Bosnia-Herzego-vina, as part of the UN’s stabilisation force (IFOR)could be x-rayed from an army base in Hungary.3British defence medical services opted for a simpler,less expensive system of recording and transmittingdiagnostic-quality digital radiographic images fromordinary radiographs in a tented and isolated Britishfield hospital in Sipov, Bosnia, linked to the Navy’sRoyal Haslar Hospital, Portsmouth. Images of radio-graphs, electrocardiograms, wounds and skin rasheswere digitally transferred from Bosnia via a high-res-olution digital camera, a laptop computer and a satel-lite phone to consultant specialists (Ritchie, 1998).

Japan too has long since provided mass screeningand full medical services in remote locations frommobile units, housing a CT scanner and telecom-munications equipment for examinations and tele-conferencing facilities to provide on-line, two-waytransfer of image data to medical centres for special-ist consultation. Pilot studies report that mass screen-ing of 19,117 residents resulted in the identificationof 75 early lung cancer cases (Takizawa et al., 2001).4

Further developments involve remote medical inter-vention. Micro- and nano-technologies use digitalinterfaces between surgeon and patient, making itpossible for a remote surgeon to perform a specialistprocedure while local staff undertake life supportprocedures. The prevalence of head injuries in battle-field casualties has stimulated the search foroperating helmets that contain all the sensing andsurgical equipment to enable a remote surgeon tointervene.

A totally different medical service enabled by digitis-


ation is data mining. Digital records of symptompresentation, diagnostic investigations, treatmentand outcome together with lifestyle information sup-port the development of expert systems whichprompt doctors on best procedures at each stage oftreatment and also help pinpoint risk factors thatmight otherwise be ignored. Effectively, skills inhigh-speed numerical analysis, supported by digitalinformation are providing an alternative source forpart of the traditional medical service chain.

Case 5. Finance & Accounting

Shell formed a joint venture ‘Tasco’ with accountancyfirm Ernst & Young in an ambitious plan to provideoutsource accounting services to multinational com-panies. Initially the company took over the account-ancy function from many of the Shell group compa-nies with the intention of extending the service tocompanies operating in Shell’s supply chain and tothird parties. Describing the outsourcing activities ofErnst and Young in Europe, Nick Land, a senior part-ner reported, ‘The new business will start in Europewhere the market for that sort of activity is wortharound £600m a year’5. He expected turnover of thejoint business to be worth £60 million within 5 yearsand said, ‘other outsourcing companies take on thefunction completely, but by forming a joint venture,the client continues to have a stake in the work…Similarly each major client will have its ownapproach.’

Both companies complemented each other’s expertisein creating the new venture. By virtualising account-ing and finance operations, Shell is able to focus onits core energy and distribution businesses andsecure scale benefits and profits as EY attractadditional customers. EY in return secure credibilityfor ‘Tasco’ through Shell’s endorsement, a criticalmass of Shell business and the potential (by acquiringfurther contracts) to provide accounting servicesprofitably, at below current internal cost to third par-ties of whatever size.

Effectively, through endorsement and provision ofactivity volume, Shell was underwriting the initiat-ive. In turn, by accepting a service agreement, EYaccepted responsibility for technical delivery. As ajoint enterprise ‘Tasco’ avoided the significant moni-toring and enforcement costs that would otherwisebe involved in a stand-alone service agreementbecause Shell have access to, and benefit from‘Tasco’s’ operational success. In turn, ‘Tasco’s’ man-date to pursue external work makes otherwise spe-cific site, physical, human and dedicated assets non-specific, reducing the potential for, and rewards of a‘hit and run’ strategy (Klein, 1980).

%core competencies will

no longer be core if they can

be acquired more cheaply from

the external market


Case 6. Research & Development

The impact of digitisation on widening strategicsourcing options and reducing international co-ordi-nation costs is illustrated by the global design centreestablished by Texas Instruments in Bangalore, India.Established in 1985 at a cost of $15m, the centre usesa dedicated satellite link between the Indian centre,TI Headquarters in the US and their R&D Centre atHouston, Texas, allowing Texas Instruments (IndiaLimited) to utilise the time zone differences to workin parallel with the Houston facility.

The Bangalore centre designs against user require-ments set by US-based Business Managers. Require-ments are then converted into specific design con-cepts with prototype and final designs encrypted anddirectly transmitted to the Texas manufacturingfacility. Changes to specifications in response to mar-ket developments are then transmitted back to India.

Three decisive factors led to Texas Instruments vir-tualising this part of its operations. First, it allowedTexas Instruments to restructure its global operationsto focus on a leading edge market segment growingten times faster than for basic general-purposemicroprocessors. Secondly, virtualisation alloweddevelopment times for very large-scale integratedsoftware circuits to be cut. Thirdly, a new pool ofhighly-skilled software devel-opers could be accessed, cre-ating new competencies inanticipation of technologicaldevelopments.

The Bangalore centres’ trackrecord speaks for itself. In 1988,it developed the first commer-cial digital signal processor,leading to a family of digitalsignal processing ICs. In the same year, the FederalCommunication Commission released the US stan-dards for digital HDTV, and the THS 8133 chip, fullydesigned in Bangalore was released in June 1989,ahead of Philips, Sony and Fairchild. The Bangalorecentre also recently designed a new family of ICs thatsupport a digital visual interface standard fordesktop LCD monitors and a chip for Minolta thatdoubles the speed of colour printers. Texas Instru-ments further gained valuable lead-time against theswitch to digital TV, using high-speed communi-cations to allow designs to be tested in Texas as theywere developed in Bangalore.

Research is a key source of competitive advantagein the software industry, and disaggregating researchservices in a way that allowed them to be outsourcedto an Indian service centre was a bold, though riskystep. The high level of strategic control possiblethrough ownership and the high level of operationalcontrol possible through advanced communicationsmitigated the transaction costs. In turn, the repu-


tational endorsement and front office support pro-vided by TI meant that the Indian origins of the tech-nology were not a factor in customer purchasingdecisions. The potential gain in terms of cost, accessto software and hardware competencies and leadtime reduction through parallel (time zone enabled)working was sufficiently compelling for TI to moveto remote provision.

Since the Indian research centre would be dealingwith proprietary information and designs, a locationremote from customers and competitors was desir-able. However, for US-based business managers tocontrol and integrate the facility, a failsafe businessprocess model was required. This consisted ofmandatory notice and approval of modificationsthrough the engineering change notice system thatstrictly controls quality and performance parameters.Other elements enabling a remote service option forthe design stage of the value chain included:

❖ Comprehensive system protocols based on gate(approval) and stage (of design),

❖ Continuous interaction through teleconferencing,❖ Intensive human resource development to inter-

national standards, and❖ Strict adherence to cycle times.

Through these elements Texas Instruments (IndiaLimited) has achieved inter-national competitiveness. With120 US patents granted in itsfirst 13 years, it has been recog-nised as the most productiveresearch centre in India. Theeffectiveness of parallel work-ing in Bangalore and Houstonis reflected in the fact that by2000, Texas Instruments hadcaptured 60 per cent of the

US$45bn, global market for digital signal processors.

Conclusion

Unlike commodity markets where logistics createstructural, location and organisational constraints,the service economy comprises a wide range ofactivities that can be delivered from anywhere in theworld. Many of these activities may also form partof manufacturing value chains. Effectively virtualis-ation makes it impossible in many cases to dis-tinguish between internal and external supply, orlocal or remote delivery. The ability to specify, moni-tor and control an activity is little different. Givenlarge international cost differences in hitherto non-traded service resources, the low-level remote deliv-ery reflects inertia as much as equilibrium under tra-ditional transaction cost theory.

Widespread unlinking of service and manufacturing


chains raises considerable uncertainty not just overthe boundaries of the firm, but also over the value oftraditional measures of organisational performancesuch as competitiveness, core competencies, corebusiness and industry structure. The problem is thatcompetitiveness and competencies are generallydefined by within industry and within market com-parisons. However, once weaker competitors out-source under-performing activities to world-classsuppliers, their disadvantage turns to an advantage.Similarly core competencies will no longer be core ifthey can be acquired more cheaply from the exter-nal market.

Organisations that own world-class activities poseinverse questions, since their best use of resourceswill be to expand those activities with outside con-tracts and reduce under-performing activities else-where in the organisation. In activity terms, theorganisational boundaries shrink, but at the sametime they expand as geographical and applicationscope increases. The billing expertise of United Util-ities for example was exploited by forming Vertexwhich now sells customer relationship managementwithout reference to the geographical and industryboundaries of its parents’ operations.

The break-up of service value chains and their reas-sembly in the form of value webs across industry andgeographical boundaries seems a likely next stage inorganising service-based resources and the next stagein the development of market-based governancemodels. As early as 1937, transaction cost theoristsmoved from addressing the basic question of whyfirms exist to concerns about the viability conditionsfor market exchanges. Subsequently, business pro-cess models such as Porter’s (1985) concentrated onprofitability drivers and the role of proprietaryknowledge and time competition in creating hard toimitate advantages. But proprietary business modelsoften involve non-standard interfaces that exclude orcomplicate access to world-class suppliers. Increas-ingly, networks are offered as the engine providingaccess to proprietary resources for growth and elimi-nating competitive weaknesses in resources (Thorelli,1986, p. 46). Such networks will be loosely governedby transactional relationships and social controlmechanisms, rather than by logistics or ownership.

The case studies have shown that once the possibilityof external suppliers, drawn from outside traditionalindustry and geographical boundaries exist, businessprocess models and comparative advantages becomeless precise. Comparative advantage is no longerdefined relative to competitors’ internal provision,but by competencies available within the global valueweb. World-class outsource providers are, by defi-nition, institutional benchmarkers, vacuuming upbest practice and revising their service offering inorder to protect and nurture their own competenceand few, if any, companies could match this throughinternal provision. In the value web model, firms no


longer rely on competitive intelligence in the conven-tional sense but on their ability to separate and moveservice elements that have long operated as ‘defectivemonopolies’ (Drucker, 1954) with little incentive toimprove outside conventional boundaries.

Comparative advantage in the value web model isfurther defined as the ability to manage continuouslychanging knowledge requirements rather than by ref-erence to functional competence. Transnational play-ers such as GE, Texas Instruments, Walt Disney,Warner Brothers and Sony have accessed remote ser-vice providers outperforming any pre-existing pro-vision. What they have retained is knowledge of cus-tomer requirements, cognitive knowledge and anultimate hold on the customer by controlling distri-bution channels.

The cases also demonstrate the importance of under-writing skills in mitigating ‘psychic’ transaction costs,such as distance, unfamiliarity; low trust levels anda difficulty in assessing competencies available in dif-ferent markets. Underwriting, by reputationalendorsement, participation and local physical liaisonplay an important role in reducing these problems.While this is at odds with both competence andtransaction cost principles, it does validate Scar-brough’s (1995) account that transaction cost econom-ics is a rather under-socialised account of governancerelationships, and that not all exchanges reflect theruthless pursuit of transaction efficiency.

While Williamson (1975, 1979, 1981) and indeedCoase (1937) would not have had in mind the kindof technological advances that have influenced thefragmentation of service value chains, this paper hasshown that modern governance choices for servicesare also influenced by:

1. Underwriting skills that allow for outsourcedtransactions in markets subject to a degree of fail-ure,

2. Effectiveness in organising boundaries to exploiteconomic benefits available out of industry and inintermediate positions within value chains.

Only if these are considered in conjunction with mar-ket failure principles does transaction cost economicsprovide an encompassing explanation of governancechoices in the modern value web. Distinct sources ofcompetencies in this value web model as opposed tothose originally outlined by competence theorists(Prahalad and Hamel, 1990) include locating or cre-ating a supply market, structuring a mutually ben-eficial i.e. non-opportunistic governance structure,and maintaining information advantages that sustainrelationships with present and future customers.

Notes

1. BT/MCI Global Communications Report (1996/97)2. Source: The Economist (2002), Transformed? A Survey of the

Defence Industry.


3. Source: Georgetown University Medical Centre (1998)4. Since X-ray film requires storage of new unexposed films,

storage and use of chemicals and water for processing, allof which previously had to be collected and shipped outof the area, this drastically improved the operationalefficiency of military medicine.

5. Source: Petroleum Economist (1997).

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JULIAN JONES, School of B. BOWONDER, Admin-Accounting and Finance, istrative Staff College ofUniversity of Manchester, India, Bella Vista, Hydera-Crawford House, Booth bad, 500 082, India. E-mail:Street East, Manchester [email protected] 9PL, UK. E-mail: juli- [email protected]@man.ac.uk

B. Bowonder is ITC ChairedDr Julian Jones is Lecturer Professor of Strategic Man-in Management Accounting agement of Technology,at the University of Manch- Dean of Research and Chair-ester. His research interests man, Centre for Energy

centre on global outsourcing strategies, re-engineering Environment and Technology at the Administrativeand competitiveness of business services. Staff College of India. In addition to his teaching and

research, he is Editor of the International Journal ofInformation Technology Management and theInternational Journal of Biotechnology.

DOUGLAS WOOD,Manchester BusinessSchool, University ofManchester, ManchesterM15 9PL, UK. E-mail: [email protected]

Douglas Wood is Director,International BusinessCentre, and Professor ofBanking and Corporate Fin-ance, Manchester Business

School. His main interests are in international finance,editing Blackwell’s New Encyclopedic Dictionaryof Finance.


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