**Managing Tacit Knowledge in Strategic Outsourcing**

Karin Širec, Miroslav Rebernik and Barbara Bradač Hojnik *University of Maribor, Faculty of Economics and Business Slovenia* 

#### **1. Introduction**

110 New Research on Knowledge Management Models and Methods

Yukl, G. (2002). *Leadership in Organizations.* Fifth Edition. Upper Saddle River. NJ: Prentice

Zhang, W. and Kim, M. (2011), "Harnessing Explicit Knowledge," Journal of Economics and

Zheng, W., Yang, B. and McLean, G. N. (2010), "Linking Organizational Culture, Structure,

Strategy, Knowledge Management in Higher Education and Organizational Effectiveness: Mediating Role of Knowledge Management," Journal of Business

Behavioral Studies, Vol. 2, No. 3, Mar 2011, pp. 97-107.

Research, Vol. 63, No. 7, pp. 763-771.

Hall.

The globalization of modern economies and transition to integral knowledge society brings along complex issues of mastering outsourced activities, especially in managing tacit dimensions of knowledge transfer that takes place in outsourcing relationships. Relationships can be divided into several groups, among which the traditional and strategic ones are the most distinguished (Reuvid & Hinks, 2001; Espino-Rodriguez & Padron-Robaina, 2004; Linder, 2004). Traditional outsourcing is interpreted as a relationship in which the outsourcing provider can perform only well-controlled activities. This mindset has changed over the time due to fact that outsourcing providers usually have significant capabilities and a higher level of knowledge than outsourcers. Consequently, traditional outsourcing has evolved and transformed into problem solving (strategic) outsourcing (Linder et al., 2002), which seeks to achieve major changes in the company's performance (e.g., changes in business processes, access to new technology, innovation, productivity improvements) and is mostly based on long-term cooperation between companies that often develops into a business partnerships. Such outsourcing also enables companies to fully exploit investments of external providers, their innovations, and specialized skills and knowledge that would otherwise be very costly and almost impossible to replicate within company. In strategic outsourcing objectives and relationships between participants become very important; consequently, tacit knowledge dimensions (Polanyi, 1958, 1966; Howels, 1996; Rebernik & Širec, 2007) should be appropriately managed.

This chapter discusses some fundamental issues related to the importance of knowledge management in the outsourcing relationship. Managing the outsourcing relationship is incorporated primarily in the outsourcing process itself, and no special attention is paid to it, although it is crucial for the effectiveness of the outsourcing relationship. Such an approach neglects the importance of governing, supervising, and developing the relationship with the outsourcing provider, particularly because the outsourcing literature relates mainly to large companies (Rebernik & Bradač, 2009). A considerable number of organizations have had negative experiences with outsourcing because no relationship management had been established; this is an area in which a great deal of effort should be applied during the outsourcing process (Embelton & Wright, 1998). Rather, organizations have tended to establish teams of employees who govern the outsourcing process. In this process, participants involved in outsourcing activities share various information and exchange different types of knowledge and skills. Not only do they learn from each other,

Managing Tacit Knowledge in Strategic Outsourcing 113

Outsourcing is a widely accepted business tool for transferring part of the business activities to another company to achieve different business goals. Commons (1931), Coase (1937), and Williamson (1983) explained that companies outsource when costs of in-house activities are higher than buying products and services on the market. According to Sharpe (1997), outsourcing is a management tool that affects the competitiveness of a company in such a way that its business strategies are based on core activities while non-core or supportive activities are outsourced. The concept is to have the management and/or day-to-day execution of one or more activities performed by a third outsourcing provider who is internally providing those same activities. We suggest classifying the outsourcing concept into three main parts regardless of its type, each with its own specifics and characteristics (Rebernik & Bradač, 2009): (1) the decision to outsource or not, (2) the outsourcing process, and (3) management of the outsourcing relationship. We focus primarily on the third part,

Widely spread knowledge about outsourcing and its permanent growth has led to the extension of its use in all business areas. Based on the review of the literature, authors have classified outsourcing according to its effects; the commonly used classifications are traditional, which some authors call tactical (e.g., Espino-Rodriguez & Padron-Robaina, 2004), as well as strategic and transformational. The conventional concept of outsourcing indicates that the outsourcing provider can perform only well-controlled activities. Activities that could cause problems must be carried out in the outsourcer's company (Reuvid & Hinks, 2001). This mindset has changed over time as outsourcing providers may have significant capabilities and even higher levels of expertise. Consequently, the traditional outsourcing has evolved into more sophisticated problem-solving outsourcing. Other authors have similarly defined the traditional form (e.g., Greaver, 1999; Linder, 2004; Linder et al., 2002) and believe that this type of outsourcing focuses on cost reductions in order to achieve control in those areas in which the company does not achieve sufficient quality. Its foundation is to improve capacity at the operational level through the implementation of the same activities but better, faster, and cheaper. In such cases, the

Strategic outsourcing differs from the traditional outsourcing, which is based on the concept of performing the same activities at a lower cost while cooperation is static and unchangeable. Strategic outsourcing is based on changes in the management's perceptions and on continuous adaptations to needs and changes on the market (Reuvid & Hinks, 2001). The fundamental differences between traditional and strategic outsourcing lie in their objectives and in the relationship between the participants (Capgemini, 2004). The traditional form is typically used for outsourcing support and simple activities in order to lower costs due to economies of scale. Meanwhile, the strategic outsourcing focuses on core and supportive activities; it seeks to achieve further major changes in the company's performance (e.g., changes in business processes, access to new technology, innovation, productivity improvements). Its aim is predominantly to make a company more competitive by enabling it to stay focused on its core competencies. Strategic outsourcing—the core of our discussion—is focused on innovation and business improvements. Its main characteristic is a long-term relationship in which both parties stimulate and facilitate continuous and mutual business change in order to create value, develop capabilities, and manage uncertainty (Capgemini, 2004). As the strategic outsourcing relationship develops

in which problems of managing tacit knowledge are especially important.

impact on the fundamental changes in the company is small.

**2. Strategic outsourcing relationship** 

but they also need to unlearn some previously used procedures, routines, and ways of doing business that have become obsolete in newly established outsourcing relations.

In particular, in a knowledge society aimed at sustainable development, the exchange of knowledge among different agents is becoming increasingly important. To embrace the knowledge and use it productively, a critical mass of knowledge and skills has to be present already in the company. Without an appropriate knowledge base, new knowledge cannot be absorbed (Cohen & Levinthal, 1990; Zahra & George, 2002; Schmidt, 2005). In this knowledge exchange, learning and unlearning are continually taking place in all knowledge areas and with all types of knowledge. It makes the phenomena of strategic outsourcing very complex and hard to comprehend. The processes are not only mutually dependent on social, cultural, economic, and political contexts, which differ from country to country, but are also concealed by tacit knowledge (Tominc & Rebernik, 2007).

We will investigate problems of managing tacit knowledge together with the importance of unlearning it. We will also examine possible opportunistic behavior in strategic outsourcing relationships and indicate possibilities for avoiding it. Based on surveys in the literature, we will discuss several types of knowledge and issues related to sharing, learning, and—most importantly—unlearning obsolete tacit knowledge dimensions as well as several important aspects of managing successful outsourcing relationships. When we take into account the needed collaboration, the holistic perception of business processes demonstrates that participants must be interdependent, be aware of their interdependence, and have a longtermed strategic interest in cooperative relationships. As the main problem of managing tacit knowledge lies in the fact that it escapes observation and measurement, an adequate framework that would make some dimensions of tacit knowledge visible and manageable has to be developed. To overcome the perpetual elusiveness of tacit knowledge, we present a framework that could help highlight dimensions of tacit knowledge that can be mobilized and observed through the manifestation of different behaviors. It is to a certain degree possible to make explicit some dimensions of tacit knowledge that not only contribute to successful sharing and mutual learning, but also enable the identification of those parts of knowledge that hinder the ability to accept novelties and should be unlearned. The better we understand the process of creating and using new knowledge and discarding obsolete knowledge, the more likely it is that companies will foster innovative behavior in companies and that the outsourcing processes will be sustainable in the long run.

This chapter contributes to a better understanding of the importance of knowledge management related to managing tacit dimensions on the level of cooperation between companies. The aim is to develop a model for managing different types of knowledge in strategic outsourcing relationship in such a way that it will develop into a sustainable outsourcing partnership. First, we introduce the strategic outsourcing relationship and its major management areas among which knowledge management is in the focal point. Furthermore, we explore the complexity of different types of knowledge and the learning/unlearning process of tacit knowledge dimensions in the management of the outsourcing relationship. In the turbulent and ever-changing business environment, tacit knowledge dimensions grow obsolete very rapidly and hinder change processes, so ways of unlearning this obsolete knowledge have to be found. To develop a sustainable outsourcing partnership in the long term, it is necessary to recognize possible opportunistic behavior that might occur at both parties in the outsourcing relationship and find ways to avoid such behavior.

#### **2. Strategic outsourcing relationship**

112 New Research on Knowledge Management Models and Methods

but they also need to unlearn some previously used procedures, routines, and ways of doing

In particular, in a knowledge society aimed at sustainable development, the exchange of knowledge among different agents is becoming increasingly important. To embrace the knowledge and use it productively, a critical mass of knowledge and skills has to be present already in the company. Without an appropriate knowledge base, new knowledge cannot be absorbed (Cohen & Levinthal, 1990; Zahra & George, 2002; Schmidt, 2005). In this knowledge exchange, learning and unlearning are continually taking place in all knowledge areas and with all types of knowledge. It makes the phenomena of strategic outsourcing very complex and hard to comprehend. The processes are not only mutually dependent on social, cultural, economic, and political contexts, which differ from country to country, but

We will investigate problems of managing tacit knowledge together with the importance of unlearning it. We will also examine possible opportunistic behavior in strategic outsourcing relationships and indicate possibilities for avoiding it. Based on surveys in the literature, we will discuss several types of knowledge and issues related to sharing, learning, and—most importantly—unlearning obsolete tacit knowledge dimensions as well as several important aspects of managing successful outsourcing relationships. When we take into account the needed collaboration, the holistic perception of business processes demonstrates that participants must be interdependent, be aware of their interdependence, and have a longtermed strategic interest in cooperative relationships. As the main problem of managing tacit knowledge lies in the fact that it escapes observation and measurement, an adequate framework that would make some dimensions of tacit knowledge visible and manageable has to be developed. To overcome the perpetual elusiveness of tacit knowledge, we present a framework that could help highlight dimensions of tacit knowledge that can be mobilized and observed through the manifestation of different behaviors. It is to a certain degree possible to make explicit some dimensions of tacit knowledge that not only contribute to successful sharing and mutual learning, but also enable the identification of those parts of knowledge that hinder the ability to accept novelties and should be unlearned. The better we understand the process of creating and using new knowledge and discarding obsolete knowledge, the more likely it is that companies will foster innovative behavior in companies

This chapter contributes to a better understanding of the importance of knowledge management related to managing tacit dimensions on the level of cooperation between companies. The aim is to develop a model for managing different types of knowledge in strategic outsourcing relationship in such a way that it will develop into a sustainable outsourcing partnership. First, we introduce the strategic outsourcing relationship and its major management areas among which knowledge management is in the focal point. Furthermore, we explore the complexity of different types of knowledge and the learning/unlearning process of tacit knowledge dimensions in the management of the outsourcing relationship. In the turbulent and ever-changing business environment, tacit knowledge dimensions grow obsolete very rapidly and hinder change processes, so ways of unlearning this obsolete knowledge have to be found. To develop a sustainable outsourcing partnership in the long term, it is necessary to recognize possible opportunistic behavior that might occur at both parties in the outsourcing relationship and find ways to avoid such

business that have become obsolete in newly established outsourcing relations.

are also concealed by tacit knowledge (Tominc & Rebernik, 2007).

and that the outsourcing processes will be sustainable in the long run.

behavior.

Outsourcing is a widely accepted business tool for transferring part of the business activities to another company to achieve different business goals. Commons (1931), Coase (1937), and Williamson (1983) explained that companies outsource when costs of in-house activities are higher than buying products and services on the market. According to Sharpe (1997), outsourcing is a management tool that affects the competitiveness of a company in such a way that its business strategies are based on core activities while non-core or supportive activities are outsourced. The concept is to have the management and/or day-to-day execution of one or more activities performed by a third outsourcing provider who is internally providing those same activities. We suggest classifying the outsourcing concept into three main parts regardless of its type, each with its own specifics and characteristics (Rebernik & Bradač, 2009): (1) the decision to outsource or not, (2) the outsourcing process, and (3) management of the outsourcing relationship. We focus primarily on the third part, in which problems of managing tacit knowledge are especially important.

Widely spread knowledge about outsourcing and its permanent growth has led to the extension of its use in all business areas. Based on the review of the literature, authors have classified outsourcing according to its effects; the commonly used classifications are traditional, which some authors call tactical (e.g., Espino-Rodriguez & Padron-Robaina, 2004), as well as strategic and transformational. The conventional concept of outsourcing indicates that the outsourcing provider can perform only well-controlled activities. Activities that could cause problems must be carried out in the outsourcer's company (Reuvid & Hinks, 2001). This mindset has changed over time as outsourcing providers may have significant capabilities and even higher levels of expertise. Consequently, the traditional outsourcing has evolved into more sophisticated problem-solving outsourcing. Other authors have similarly defined the traditional form (e.g., Greaver, 1999; Linder, 2004; Linder et al., 2002) and believe that this type of outsourcing focuses on cost reductions in order to achieve control in those areas in which the company does not achieve sufficient quality. Its foundation is to improve capacity at the operational level through the implementation of the same activities but better, faster, and cheaper. In such cases, the impact on the fundamental changes in the company is small.

Strategic outsourcing differs from the traditional outsourcing, which is based on the concept of performing the same activities at a lower cost while cooperation is static and unchangeable. Strategic outsourcing is based on changes in the management's perceptions and on continuous adaptations to needs and changes on the market (Reuvid & Hinks, 2001). The fundamental differences between traditional and strategic outsourcing lie in their objectives and in the relationship between the participants (Capgemini, 2004). The traditional form is typically used for outsourcing support and simple activities in order to lower costs due to economies of scale. Meanwhile, the strategic outsourcing focuses on core and supportive activities; it seeks to achieve further major changes in the company's performance (e.g., changes in business processes, access to new technology, innovation, productivity improvements). Its aim is predominantly to make a company more competitive by enabling it to stay focused on its core competencies. Strategic outsourcing—the core of our discussion—is focused on innovation and business improvements. Its main characteristic is a long-term relationship in which both parties stimulate and facilitate continuous and mutual business change in order to create value, develop capabilities, and manage uncertainty (Capgemini, 2004). As the strategic outsourcing relationship develops

Managing Tacit Knowledge in Strategic Outsourcing 115

old routines have to be unlearned, and efforts have to be made to manage different dimensions of tacit knowledge that could hamper the introduction of new routines. As knowledge management is one of the most important areas in strategic outsourcing

Knowledge is a living asset; dynamic and volatile, it is often difficult to observe and understand. Unlike information, it is not final and stored, but emerging and being constantly recreated and socially reconstructed in particular work contexts. Knowledge may be tangible or intangible by its nature. Know-how, when articulated into the organization's database and operating technologies, is tangible. Similarly, explicit knowledge is tangible because it has been encoded into documents, databases, or some other permanent medium

All kinds of knowledge together, as an emerging synergy, make knowledge a system that, in combination with values, needs, and possibilities, is the starting point of any human action (Mulej et al., 2000). Thus, knowledge is an important part of a more complex system. On the other hand, organizations' knowledge resources have pertinently been described as an iceberg (Svelby, 1997; Haldin-Herrgard, 2000). Structured, explicit knowledge is the visible top of the iceberg; this part of the knowledge resource is easy to find and recognize, and therefore also rather easy to share. Beneath the surface of conscious thought lies a vast sea of tacit knowledge, derived from a lifetime of experience, practice, perception, and learning. This concept is captured in Polanyi's (1958, 1966) often-quoted statement, "We know a lot more than we can express"; therefore, this part of the intangible knowledge resource can be

Tacit knowledge often enables us to perform at a higher level than our explicit knowledge does. For example, novices cannot become experts simply by being exposed to explicit information; they need to experience the activity itself and the cooperation relating to it. For these reasons, the success of a manager is heavily dependent on tacit knowledge. Therefore, supporting the sharing of tacit knowledge throughout the company will be possible with methods like apprenticeship, direct interaction, networking, and action learning that includes face-to-face social interaction and practical experiences. Four categories of tacit

1. Hard-to-pin-down skills. "Know-how"; the word *skill* implies tacit knowledge. People

2. Mental models. We draw on mental models or schemas when trying to make sense of a situation; they determine how we understand and analyze situations—that is, how we understand cause-and-effect connections and what meaning we attribute to events. The schemas we use are often subconscious abstractions rather than explicit models we consciously employ; therefore, they belong to tacit knowledge. They affect whether or not we see people as trustworthy, whether we see opportunity in a situation, and how

3. Ways of approaching problems. Tacit knowledge underlies the decision trees people use. 4. Organizational routines. Much of a company's tacit knowledge is stored in its routines. This tacit knowledge embedded in routines includes an intuitive grasp of what data to focus on and of the relative priority of competing demands. In time, managers leave,

but the routines remain as a legacy of their knowledge.

need to repeatedly practice skills, receive feedback, and get a feel for them.

relationship, we will focus on this dimension of managing relationships.

**3. Types of knowledge important in strategic outsourcing** 

more difficult to share (Haldin-Herrgard, 2000, p. 358).

knowledge exist (Lubit, 2001, p. 166):

we judge risk.

(Meso & Smith, 2000, p. 232).

over time, it relates to a deepening partnership and an increasing range of skills and has a more fundamental and significant business impact. Companies increasingly outsource activities that are crucial to the competitive advantage of the firm. In itself, this type of outsourcing can be beneficial if rents can be obtained from the relation (Mol, 2007).

Two main criteria for defining outsourcing as strategic are (1) strategic policy at the company level concerning outsourcing and (2) preparation to consider the outsourcing of core activities (Alexander & Young, 1996). Strategic outsourcing offers the possibility to manage step-by-step changes in the organization. It focuses on three main areas: technology, business, and finance. The essence of strategic outsourcing is the strength of an outsourcing provider that can take on existing services, implement new technology and business processes, and bundle these initiatives in an appropriate management of the relationship with the outsourcer to develop common knowledge and innovation.

In the management of outsourcing relationships, several issues need special attention. Power et al. (2006) classify these into six major areas: work administration, communication management, knowledge management, personnel management, training and education, and financial management (see Figure 1).

Fig. 1. Strategic outsourcing relationship management framework

Work administration ensures that the work undertaken is done and involves tracking work assignments, deliverables, and resource consumption as well as ensuring that the timeline is reached (Power et al., 2006). Communication management is especially crucial in the early stages of the relationship, when partners do not know each other. However, managers and entrepreneurs often believe that, when the contract is signed, their work is done. Over time, communication is simplified as the partners get to know each other. Training and education (Power et al., 2006) of the leader and involved employees is an inevitable part of process of building successful outsourcing relationships because cooperation with the other company brings about different ways of doing things, as cultures, forms of communication, and other issues are very often different. During outsourcing, the entrepreneur is constrained to gain new knowledge and experiences. Personnel management involves managing the employees involved in the outsourcing process and, when appropriate, establishing different teams (e.g., a governance team, a financial team). Financial management is the area in which monitoring and controlling are crucial, particularly in the early stages of cooperation and particularly if performance standards have not been implemented as agreed. Knowledge management involves sharing best practices, ideas, and innovations and improving processes with the outsourcing provider, which involves establishing new routines (Power et al., 2006); as such,

over time, it relates to a deepening partnership and an increasing range of skills and has a more fundamental and significant business impact. Companies increasingly outsource activities that are crucial to the competitive advantage of the firm. In itself, this type of

Two main criteria for defining outsourcing as strategic are (1) strategic policy at the company level concerning outsourcing and (2) preparation to consider the outsourcing of core activities (Alexander & Young, 1996). Strategic outsourcing offers the possibility to manage step-by-step changes in the organization. It focuses on three main areas: technology, business, and finance. The essence of strategic outsourcing is the strength of an outsourcing provider that can take on existing services, implement new technology and business processes, and bundle these initiatives in an appropriate management of the relationship

In the management of outsourcing relationships, several issues need special attention. Power et al. (2006) classify these into six major areas: work administration, communication management, knowledge management, personnel management, training and education, and

Work administration ensures that the work undertaken is done and involves tracking work assignments, deliverables, and resource consumption as well as ensuring that the timeline is reached (Power et al., 2006). Communication management is especially crucial in the early stages of the relationship, when partners do not know each other. However, managers and entrepreneurs often believe that, when the contract is signed, their work is done. Over time, communication is simplified as the partners get to know each other. Training and education (Power et al., 2006) of the leader and involved employees is an inevitable part of process of building successful outsourcing relationships because cooperation with the other company brings about different ways of doing things, as cultures, forms of communication, and other issues are very often different. During outsourcing, the entrepreneur is constrained to gain new knowledge and experiences. Personnel management involves managing the employees involved in the outsourcing process and, when appropriate, establishing different teams (e.g., a governance team, a financial team). Financial management is the area in which monitoring and controlling are crucial, particularly in the early stages of cooperation and particularly if performance standards have not been implemented as agreed. Knowledge management involves sharing best practices, ideas, and innovations and improving processes with the outsourcing provider, which involves establishing new routines (Power et al., 2006); as such,

outsourcing can be beneficial if rents can be obtained from the relation (Mol, 2007).

with the outsourcer to develop common knowledge and innovation.

Fig. 1. Strategic outsourcing relationship management framework

financial management (see Figure 1).

old routines have to be unlearned, and efforts have to be made to manage different dimensions of tacit knowledge that could hamper the introduction of new routines. As knowledge management is one of the most important areas in strategic outsourcing relationship, we will focus on this dimension of managing relationships.
