To understand the impact of services outsourcing on a firm's market performance, it is useful to distinguish between 'core' and 'supplementary' services. Core services are the outputs that consumers seek, while supplementary services are either indispensable for the execution of the core service or are available only to improve the overall quality of the service bundle. The core services represent the 'front office' offerings; supplementary services are mostly performed in the 'back office'. In the car rental industry, for example, the core service is providing customers with vehicles for transportation. Supplementary services range from reservations to check-in and route-finding.

Outsourcing. The competitive advantage of a service firm lies in the performance and sustainability of the core and supplementary services. Innovative core services may determine a service provider's initial competitive advantage (in terms of strategic and thus financial performance), but core services will gradually resemble commodity characteristics as competition intensifies over time. Subsequently, a service provider needs to increase its reliance on supplementary services to add value to its customers by offering differentiated service bundles. In general, customers expect service providers to do a good job in performing the core service as a given, and evaluate different service providers on the ability of providing supplementary services that are of value to them. Generally, core service activities are performed by a service firm itself (internal sourcing or 'in-house sourcing') as they are location-bound; supplementary services can be separated from core services and sourced from external suppliers (external sourcing or outsourcing).

Recent studies have found that due to various resource constraints, service firms that build in-house supplementary service capabilities tend to dilute their core service competencies, thus losing competitive advantage. This suggests that service firms focus on their core competencies and outsource supplementary services from the best-in-class providers. Indeed, an increasing number of service firms are shifting some of their back office service activities (eg applications support) to foreign sites in countries such as Ireland, India and Argentina to capitalise on cost advantage.

Pitfalls. Although service-buying firms enjoy greater leverage, there are potential problems related to outsourcing of service activities:

Recent studies have shown that foreign sourcing of supplementary services is negatively related to service firms' strategic and financial performance. This is mainly because of the inherent differences between manufactured goods and services. Manufactured goods can be sourced anywhere in the world because they can be stored for future use, so the decisions on whether to source manufactured goods are contingent on the cost or strategic benefits involved. However, the unique properties of services may introduce constraints in terms of location and tradability. Such constraints arise from difficulty of storing service activities for later use, and from the fact that in many cases, production and consumption of services take place simultaneously.

Partnering. Service firms differentiate themselves by their supplementary service activities, which generally require highly specialised investments. Although the number of suppliers available to provide the supplementary service might be limited, it does not automatically follow that these services should be performed in-house. One alternative is to find strategic partners to become suppliers who have the competency to deliver innovative supplementary services and the ability to make necessary investments. Through the use of competent partner firms, the service-buying firm has tighter control over quality, which in turn fulfils the two most important requirements of supplier selection: supplier's competency and service quality control. Foreign sourcing of supplementary services simply for cost reasons might not offer the benefits that would accrue to manufactured goods.

Implications. At the macro level, international trade in highly separable 'back-office' service activities (including software development, product design, applications support) will increase. However, to the extent human contacts are important in providing service bundles, those service activities will remain location-bound. This location 'boundedness' will be even more salient in 'high-context' cultures, where trust, group consensus, and long-term relationships are considered important (eg in Asia, Latin Europe and Latin America) than in 'low-context' cultures, where legal contract and individual responsibility are considered important (eg United States, Germany and Nordic countries).

Firms in low-context countries tend to believe the divisibility (ie outsourceability) of service activities more than those in high-context countries. Consequently, firms in low-context countries will lead the globalisation of services, making it appear that firms in high-context countries are lagging behind in services globalisation. However, the world consists of more high-context countries than low-context countries. The more global the market becomes, the more important high-context markets become to firms from low-context countries. It may prove to be a fundamental strategic mistake if firms from low-context countries rely on a high level of outsourcing of back-office service activities in providing their service bundles in high-context countries where customers would prefer more personal service experiences. This suggests a higher degree of constraints in services globalisation than that which faced globalisation in manufactured goods.

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