Product Service Outsourcing: Impact of Environment Uncertainty and Partial Observability

Abstract

Problem definition: Product service plays a crucial role for brands to retain customers and spur revenue growth. It is, however, often outsourced to a third-party provider, driven by cost savings and the ability to focus on core businesses. Although there is a large body of literature studying service outsourcing, the impact of service environment uncertainty (i.e., changing customer needs and shifting resource requirements) has received sparse attention in the past but is becoming a major concern because of increased market turbulence. This research explores how environment uncertainty in service provision influences a brand’s intent to outsource, and, if the brand decides to outsource, how it can retain the potential cost advantages offered by a third-party provider. Methodology/results: This research develops a normative model to explore key drivers that impact service outsourcing outcomes under environment uncertainty and partial observability. We find that environment uncertainty can accelerate a brand’s propensity to outsource, and a brand typically benefits from outsourcing initially. Yet, we show that such benefits can dissipate over time because of partial observability. Monitoring efforts help to mitigate the adverse impact of environment uncertainty and partial observability, but cannot attain anticipated outsourcing benefits unless monitoring is costless. In contrast, nudging service providers to self-report the cost of resources is effective even if the monitoring cost is high. Managerial implications: Brands should carefully consider environment uncertainty, partial observability, and monitoring ability when deciding whether to outsource product services to third-party providers. A heuristic monitoring policy can be effective when the monitoring cost is very high or very low but can perform poorly when the monitoring cost is in the intermediate range. Thus, outsourcing is more attractive when environment uncertainty is significant, but the value of outsourcing can only be realized when (a) partial observability is insignificant, (b) monitoring is inexpensive, or (c) provider self-reporting can be nudged. If none of the conditions hold, then the brand can suffer significant losses from the anticipated benefits of product service outsourcing.Funding: This research is partially supported by the first author's 2022 Dean’s Excellence Summer Research Grant from W. P. Carey School of Business, Arizona State University.Supplemental Material: The online appendix is available at https://doi.org/10.1287/msom.2022.0222 .