Theories of Supply Ch ain M an agement

2.2 Theoretic al Review

This study w as guided by two theories n amely the Tr ans action Cost Theory  and the Resource b ased

theory.

2.2.1 Tr ans action Cost Theory

This theory posits th at costs guide, to  a gre at extent, the decision on whether to produce products or

services in-house or to  acquire them in the open m arket. This me ans th at if the cost of procuring  a

product from the m arket is lower th an the cost which would be incurred to produce the product

intern ally, then it should be  acquired from the open m arket (H atonen & Eriksson, 2009). Tr ans actions

tend to be ch ar acterized by c an be ch ar acterized with the degree of  asset specificity, the complexity

of the tr ans action al rel ationship  and the frequency of the tr ans action (Greenberg, Greenberg &

 Antonucci, 2008). This implies th at tr ans action costs h ave three key drivers: The tr ans action itself,

the prev ailing business environment  and the p arties to the tr ans action. Tr ans action costs include the

costs of selecting suppliers, negoti ating prices, writing contr acts, monitoring the perform ance,  as well

 as the potenti al for opportunism from suppliers (Grover & M alhotr a, 2003). 11
The potenti al for opportunism incre ases if investments h ave to be m ade which  are specific to  a

p articul ar rel ationship. The tr ans action cost theory implies th at if firms’ tr ans actions h ave simil ar

ch ar acteristics  and the m arket h as set the s ame conditions for them, they will tend to m ake simil ar

decisions on whether to buy or produce non-core goods  and services Holcomb  and Hitt (2007).

In asmuch  as short term s avings guide outsourcing decisions, there  are other motiv ations for

outsourcing.  A firm might for inst ance w ant to  acquire noncore superior goods  and services from

suppliers who tre at production of these products  as core Digby (2006). This theory is benefici al to the

study  as the rese archer seeks to determine how the decision to outsource besides minimizing the cost

of doing business will  affect the d airy v alue ch ain.

2.2.2 Resource-b ased Theory

This theory posits th at the firm  as is  a set of bundled  assets  and resources.  As such, these it c an be

possible to cre ate competitive  adv ant age if m an agement deploys these resources in  a distinctive

m anner. The gist of this theory is th at firms should m ake perpetu al efforts to  acquire or otherwise

g ain control of desir able resources which would give it  an edge in the m arket (Lonsd ale 2009;

H arl and et  al. 2005; H andley & Benton 2012). Holcomb & Hitt (2007) view the resource b ased theory

of the firm  as more superior to the tr ans action cost theory since it views cre ation of the competitive

edge through  addition al dimensions, r ather th an cost only.

With respect to outsourcing, this theory views m  arket link ages with outsourcing p artners, especi ally

those who h ave  a comp ar ative  adv ant age in production of the pertinent product,  as str ategic

resources which c an give  a firm  an edge over competition. This is bec ause the firm will be  able to

 access the best non core products  and services  at  a lower cost th an it would incur if it were to

undert ake the production itself (Log an 2000; Hätönen & Erikkson 2009). 12
Dyer  and Singh (2008) on the other h and criticize the resource-b ased view of the firm theory  as too

simplistic to expl ain the more complex re alities on the ground. They  argue th at there might be  an

in ability to lever age str ategic resources due to industry/firm specific f actors  and the st age of the firm

life cycle th at the firm is currently in.

2.3 Empiric al Review

This section presents  an empiric al review on the rel ationship between outsourcing of milk collection,

processing  and distribution  and the v alue ch ain.

2.3.1 Outsourcing of Collection of Milk  and the V alue Ch ain

 A we alth of liter ature h as  addressed the dilemm a on whether firms should outsource collection or

they should h ave their own collection fleet (Co ase 2007, Willi amson 2005, Grossm an  and H art 2006,

Grossm an 2002). Vertic al coordin ation in  agribusiness firms h as  also received signific ant  attention

(B arry 2002, Hobbs 2007). Gillespie (2007) posits th at th at less work, however, h as been devoted to

underst anding vertic al coordin ation in d airy production th an in other  agribusiness sectors. Sumner

 and Wolf (2002) found signific ant rel ationships between d airy f arm size, vertic al integr ation,

speci aliz ation, diversific ation,  and region using 1993-2001 USD A F arm Costs  and Returns Survey

d at a.

Willi amson (2005)  and Grossm an  and H art (2006) emph asize the roles of outsourcing costs in

determining whether  a firm should own the inbound logistics function or it or outsource it to outside

service providers. They  argue th at l ack of high qu ality providers of outsourcing services or high

 agency costs, driven by m arket concentr ation tends to encour age milk firms to build well-defined

inbound logistics functions thereby m aking them more vertic ally integr ated. 13

Grossm an  and Helpm an (2002) exp and the economic theory of the firm’s “own-the-function or

outsource” decision, citing the roles of tr ans action costs, competition,  and the holdup problem. They

conclude th at in highly competitive m arkets, outsourcing must le ad to  a signific ant cost  adv ant age

to offset the tr ans action costs  associ ated with se arching for  a reli able input source  and the costs

 associ ated with holdup. With milk production, the l arge number of firms producing the commodity is

indic ative of  a competitive m arket, suggesting th at the m agnitude of tr ans action  and holdup costs is

p articul arly import ant in the decision.

Grossm an  and Helpm an (2002) further suggest th at in c ases where outsourcing costs  are highly

sensitive to specific ch ar acteristics of milk (such  as specific density), the vi ability of outsourcing will

be reduced. B arry (2002)  argue th at in countries with well-developed outsourcing m arkets for inbound

logistics, the long-run cost  associ ated with outsourcing the milk collection function might be expected

to be competitive with the cost of owning it, including  a ch arge for the  addition al employees’ l abor.

The cost of the outsourcing  arr angement would be determined by the m arket price for milk, milk

production costs, f arm g ate qu ality of milk,  and  adjustments for qu ality. Whether to own the

collection function or outsource it would depend prim arily upon m an ageri al f actors such  as the

benefits  associ ated with speci al requirements, such  as collection of milk by its v arious gr ades of

qu ality, i.e. without mixing the v arious gr ades first  and debt concerns.

Summer  and Wolf (2002) note th at Outsourcing the milk collection function  allows the milk firm to

develop expertise by concentr ating effort on core fe atures of the enterprise. Furthermore, reduced

pressure on the limited firm resources would  allow the comp any to  allow the firm to devote resources

to producing thereby c ausing the g ains of economies of sc ale  and, hence, lower cost per unit produced.

14
 Another incentive for milk producers to outsource milk collection is the lower initi al investment

 associ ated with the outsourcing rel ative to  acquisition of  a collection fleet. Vehicle  and equipment

purch ases  associ ated with collection, cooling,  and pre-processing require subst anti al st art-up costs,

perh aps requiring credit. B arry, Sonk a,  and L ajili (2002) cite fin anci al constr aints  as  a re ason for

milk firms to enter outsourcing contr acts with outsourcing firms  as opposed to vertic ally integr ating.

This m ay be p articul arly import ant for new firms th at  are credit-constr ained  and/or desire to limit

debt. Before m arket liber aliz ation in the e arly 1990s, there w as  an org anized milk collection  and

bulking system in the form al m arket, with two types of milk delivery to KCC f acilities: by individu al

d airy f armers; or by d airy cooper ative societies. With liber aliz ation  and the coll apse of KCC, the

collection  and bulking system  also coll apsed.  At present, collection  and bulking is  a complex of

different systems depending on processors, intermedi aries, the ro ad network, milk sheds  and m any

other f actors (Muriuki, 2011).

The tr ansport ation of milk depends on the  amount  and the buyer. M ajor processors h ave their own

collection, bulking  and tr ansport ation systems. St ainless steel (se amless) c ans,  and occ asion ally

pl astic c ans,  are used for bulking milk from individu al suppliers  and delivering it to processors’

collection, bulking  and cooling centers, from where it is tr ansported in c ans or by refriger ated t anks

to the m ain processing pl ants. In some  are as, powerful milk intermedi aries (tr aders) h ave positioned

themselves between the m arket  and the milk producers. Their presence complic ates the tr ace ability

of milk  and brings  a risk of cross-cont amin ation  and microbi al overlo ad (Muriuki, 2011). In view of

the reviewed liter ature, the study hypothesized  as follows:

H01: Outsourcing of milk collection h as no signific ant effect on the efficiency of milk firms’ v  alue

ch ains 15
2.3.2 Outsourcing of Milk Processing  and the V alue Ch ain

Gillespie (2007) notes th at the Indi an milk m arket is ch ar acterized by  a high dem and for processed

milk,  a poor milk processing c ap acity,  and  a strong competition for r aw milk supplies.  Addition ally,

he notes th at milk firms would dr am atic ally improve their output of milk supply id they eng aged

independent milk processors to tr ansform their r aw milk into processed milk  and by products of milk

production. Hobbs (2007) investig ated the d airy industry of Southwest Chin a. He noticed th at

dem and for end products of milk processing, in p articul ar Ultr a He at Tre ated (UHT) milk  and

Cheese, w as growing in the v ast metropolis regions of Sh angh ai, Beijing,  and Gu angzhou. He

 attributed the  ability of d airy firms to fulfill the surge in dem and to their  ability to outsource

processing of r aw milk. This en abled firms to grow their s ales outre ach without necess arily h aving

to incre ase the size of their b al ance sheets