Small Firms and Offshore Software Outsourcing: High Transaction Costs and Their Mitigation

Abstract

It seems surprising that small firms engage in offshore outsourcing given that they lack the resources that large firms possess to overcome the difficulties involved. We examine these factors using transaction cost theory’s three stages: contact costs, contract costs, and control costs. Then, using our field data from small client firms (in the United States and the United Kingdom), intermediaries, and offshore vendors, we analyze the mitigation approaches that reduce transaction costs for small firms. We identify nine such approaches: three for client firms and six for suppliers. For the small client firm, they are liaisons of knowledge flows, gaining experience, and overcoming opportunism; and, for the service providers, they are onshore presence, reducing contact costs, simplifying contracting, providing control channels, expert intermediaries, and standardization of services.