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This study w as guided by two theories n amely the Tr ans action Cost Theory and the Resource b ased
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
This theory posits th at the firm as is a set of bundled assets and resources. As such, these it c an be
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
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
This section presents an empiric al review on the rel ationship between outsourcing of milk collection,
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
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
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
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
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