Disentangling the Role of Modularity and Bandwidth in Entry Mode Choice: The Case of Business Services Offshoring

This paper investigates the role of modularity on entry mode choice of companies’ offshoring of business services. We distinguish between functional modularity, which reflects the possibility to subdivide a function into smaller modules, and architectural modularity, which reflects the interdependence between these modules. Lower architectural modularity requires greater interaction (greater ‘bandwidth’) between the organizational units to reintegrate the individual modules. Using modularity appropriately can decrease transaction costs and reduce the risks of knowledge leakages associated with offshoring, and improve the effectiveness of the sourcing process, thus increasing the probability that firms opt for less hierarchical entry modes. Firms that are less experienced with offshoring tend to underestimate the associated resources and costs of architectural modularity and select entry modes that do not provide sufficient bandwidth to efficiently reintegrate offshored modules, increasing the risk of failure of the offshoring initiatives. Our empirical analysis, which involves 490 offshoring initiatives, supports our arguments, especially in high-tech and knowledge-intensive industries.