BALANCING MODULARITY AND KNOWLEDGE IN DESIGNING

AGILE ORGANIZATIONS

The Case of Outsourcing

Kris Ven, Benazeer Shahzada and Jan Verelst

Department of Management Information Systems, University of Antwerp

Prinsstraat 13, B-2000 Antwerp, Belgium

Keywords:

Modularity, Knowledge, Absorptive capacity, Outsourcing, Agility.

Abstract:

The ability to innovate is of increasing importance for organizations to increase their competitiveness. Since

organizations are becoming increasingly dependent on information technology (IT) to support their operations,

IT nowadays plays a crucial role in stimulating innovation in organizations. It has also been shown that

IT offers opportunities to organizations to increase their agility. In this paper, we argue that in order for

organizations to innovate with IT, design parameters are needed which can be governed by organizations. Our

focus in this paper is on how modularity and knowledge can be used as design parameters. Although the

importance of knowledge has been widely acknowledged in literature, organizational modularity has received

far less attention. We will demonstrate that attention to both design parameters is essential to innovate with

IT. We focus hereby on an application within the context of IT outsourcing. We provide a framework that

has a strong theoretical foundation which illustrates how the concepts of modularity, knowledge, outsourcing,

agility, and innovation are related to each other.

1 INTRODUCTION

The ability to innovate is of increasing importance for

organizations to increase their competitiveness. Sev-

eral authors have indeed argued that the ability to in-

novate successfully will to a large degree determine

the competitiveness of organizations (Hamel, 1998).

In today’s increasingly volatile environments, organi-

zations must be able to respond quickly to their en-

vironment in order to innovate successfully (Teece

et al., 1997; Eisenhardt and Martin, 2000). By being

able to detect changes in its environment and to re-

spond to these changes in an effective and swift man-

ner, an organization can become more agile. Agility

can be considered a measure of an organization’s abil-

ity to change and adapt to its new environment (Neu-

mann and Fink, 2007).

Organizations are becoming increasingly depen-

dent on information technology (IT) to support their

operations. As a result, IT nowadays plays a crucial

role in stimulating innovation in organizations (Bryn-

jolfsson and Saunders, 2010). It has indeed been

shown that IT offers opportunities to organizations

to increase their agility and ﬂexibility (Neumann and

Fink, 2007; Sambamurthy et al., 2003).

Lately, it has been argued that organizations

should be designed. An organization designed using

design rules can be more agile and is therefore bet-

ter able to react to changes in the environment. This

issue is explored in the Enterprise Architecture (EA)

domain. Unfortunately, current EA models and arti-

facts have a descriptive, rather than prescriptive na-

ture. In addition, it is not fully clear yet which design

rules exist. We therefore argue that a strong theoreti-

cal basis is required to identify design parameters that

can be governed by organizations. In this paper, we

discuss how modularity and knowledge can be used

as design parameters. Both knowledge and modular-

ity represent hands-on design parameters that can be

governed by organizations. We illustrate this within

the context of IT outsourcing. IT outsourcing is an

interesting topic, since it offers many opportunities,

but at the same time it may also pose some threats to

organizations. We will demonstrate that attention to

both design parameters is essential to innovate with

IT. In addition, it will be shown that both modular-

ity and knowledge are strongly interrelated and that

organizations need to ﬁnd a balance between both de-

sign parameters. To this end, we provide a frame-

work that has a strong theoretical foundation which il-

189

Ven K., Shahzada B. and Verelst J. (2010).

BALANCING MODULARITY AND KNOWLEDGE IN DESIGNING AGILE ORGANIZATIONS - The Case of Outsourcing.

In Proceedings of the Multi-Conference on Innovative Developments in ICT, pages 189-194

DOI: 10.5220/0002967101890194

 SciTePress

lustrates how the concepts of modularity, knowledge,

outsourcing, agility, and innovationare related to each

other.

2 BACKGROUND

In this section, we brieﬂy introduce the concepts of

modularity and knowledge.

2.1 Modularity

Modularity is a concept from systems theory that has

been used in several domains. A common theme un-

derlying the concept of modularity in each of these

domains is agility and ﬂexibility (Sanchez and Ma-

honey, 1996; Baldwin and Clark, 2000). The idea be-

hind modularity is that a system should be composed

in such a manner that all components are loosely cou-

pled. To this end, system elements that must in-

tensively interact with each other should be isolated

in a separate module to ensure that changes to this

module do not have an inﬂuence on the rest of the

system. Communication between modules is man-

aged by well-deﬁned interfaces (Baldwin and Clark,

2000). The concept of modularity has, amongst oth-

ers, been used in software engineering and product

design. More recently, modularity has also been used

with respect to the design of organizations (Tiwana,

2008; Campagnolo and Camuffo, 2010; Sanchez and

Mahoney, 1996; te Winkel et al., 2008). This re-

search area investigates how organizations can be

constructed using loosely coupled autonomous orga-

nizational units that allow organizationsto adapt more

quickly to changing environments (Sanchez and Ma-

honey, 1996; te Winkel et al., 2008).

2.2 Knowledge

The importance of organizationalknowledgehas been

acknowledged in several ﬁelds, including manage-

ment and information systems (Teece et al., 1997;

Eisenhardt and Martin, 2000; Kogut and Zander,

1992; Attewell, 1992). It has been noted that activities

such as skill acquisition, the management of knowl-

edge, and know-how and learning are key strategic

issues (Teece et al., 1997). Knowledge is also con-

sidered a particularly important dynamic capability

that allows organizations to compete in volatile mar-

kets (Eisenhardt and Martin, 2000; Kogut and Zan-

der, 1992; Grant, 1996). Some scholars even con-

sider knowledge to be the most important resource

of an organization (Grant, 1996). Hence, it is im-

portant that organizations invest in further expand-

ing their knowledge base. This is emphasized by the

absorptive capacity theory which starts from the as-

sumption that external sources of knowledge are crit-

ical to guide the innovation process within organiza-

tions. Organizations will differ in their ability to ex-

ploit this external knowledge and will therefore ex-

hibit different patterns of innovation. The higher the

organization’s absorptive capacity, the greater the or-

ganization’s ability to create new knowledge (Cohen

and Levinthal, 1990). Exposure to outside sources of

knowledge is crucial to the innovation process within

organizations, since the organization can then com-

bine this external knowledge with the internally avail-

able knowledge and put it to new use (Cohen and

Levinthal, 1990). This requires that some knowledge

transfer takes place from the environment to the orga-

nization (Cohen and Levinthal, 1990; Kogut and Zan-

der, 1992).

3 OUTSOURCING

In this section, we will show how organizational mod-

ularity and knowledge can be used as design parame-

ters and how they can impact an organization’s agility

and ability to innovate. We illustrate this within the

context of IT outsourcing decisions.

Figure 1: Theoretical framework.

The theoretical framework developed in this study

is shown in Figure 1. This framework can be used

to balance the modularity and knowledge design pa-

rameters with respect to the outsourcing decision. In

this framework, it can be seen that there is a positive

link between the use of outsourcing and the agility of

the organization. Previous studies have indeed sug-

gested that the use of outsourcing can increase the

agility of organizations (White et al., 2005; Mason

et al., 2002). Through the use of outsourcing, organi-

zations can become more ﬂexible since they can gain

access to speciﬁc knowledge possessed by the service

provider, without having to invest in a learning pro-

cess. Conversely, when speciﬁc expertise is no longer

needed by the organization, outsourcing contracts can

be relatively easily terminated without having an im-

pact on the internal human resources. By being more

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agile, organizations increase their ability to innovate,

as it allows them to react more quickly to changes in

the environment (Sambamurthy et al., 2003; Eisen-

hardt and Martin, 2000). We will now discuss how

modularity and knowledge inﬂuence the outsourcing

conﬁguration and innovation.

3.1 Modularity and Outsourcing

Previous literature on product modularity indicates

that there is a positive link between modularity and

the use of outsourcing (Frigant and Talbot, 2005;

Sako, 2003; Campagnolo and Camuffo, 2010). In or-

der to be able to outsource certain tasks to external

organizations, some degree of modularity is required

(Campagnolo and Camuffo, 2010; Sako, 2003). This

ensures the deﬁnition of clear interfaces that allow ef-

ﬁcient communication between the customer and ser-

vice provider which form a basis for the outsourcing

contract (Baldwin and Clark, 2000). Relatively few

studies have investigated this link with respect to or-

ganizational modularity. The few studies so far sug-

gest that modularity also has a positive effect on the

use of outsourcing in such contexts (Tiwana, 2008;

Campagnolo and Camuffo, 2009). This can be ex-

plained by the fact that some level of organizational

modularity is required to be able to outsource cer-

tain tasks to a service provider. Moreover, the more

loosely coupled the organizational structure, the eas-

ier it is to outsource certain components. Neverthe-

less, additional research on this topic is required.

3.2 Modularity and Innovation

Several studies have explored the impact of modu-

larity on innovation. However, the exact nature of

the relationship is not very clear. Some studies have

suggested that modularity has a positive impact on

innovation. Those studies have argued that modu-

lar product architectures provides increased ﬂexibil-

ity, thereby allowing organizations to innovate with

respect to product features that are important to cus-

tomers such as speed, convenience, and customiza-

tion (Baldwin and Clark, 2000). In addition, mod-

ular structures are preferred over integrated struc-

tures when ﬂexibility and rapid innovation are impor-

tant (Baldwin and Clark, 2000). Other authors have

warned that modularity can also have a negative im-

pact on innovation. It has been noted that increased

modularity generally reduces the need for knowl-

edge sharing between customer and service provider,

given the increased codiﬁcation of knowledge and the

speciﬁcation of standard interfaces (Tiwana, 2008).

This reduction in the degree of knowledge sharing

may become an obstacle to innovation, since the cus-

tomer may have insufﬁcient knowledge of—and con-

trol over—the activities of the service provider. Fi-

nally, although higher modularity may facilitate the

identiﬁcation of emerging technologies, organizations

may lack the absorptive capacity to assimilate it and

to innovate(Cohen and Levinthal, 1990). The link be-

tween organizational modularity and innovation has

received very little attention in literature. One of the

very few studies on this topic suggests the presence of

a positive link (te Winkel et al., 2008). It has also been

noted that modular organizational forms are more

likely in industries with a higher number of product,

process and organizational innovations (Campagnolo

and Camuffo, 2009). Hence, the exact relationship

between modularity and innovation is not fully clear.

3.3 Knowledge and Innovation

Literature provides strong evidence for the positive

inﬂuence of knowledge on innovation (Cohen and

Levinthal, 1990; Wheeler, 2002; Fabrizio, 2009;

Kogut and Zander, 1992). The importance of inter-

nal knowledge, and the need for organizations to ex-

pand their knowledge base forms the basis of the ab-

sorptivecapacity theory (Cohen and Levinthal, 1990).

Organizations with a higher absorptive capacity will

be able to recognize the potential of emerging tech-

nologies more quickly, and adopt them before their

competitors to innovate (Cohen and Levinthal, 1990;

Wheeler, 2002). Having a broad knowledge base also

facilitates the identiﬁcation of new opportunities by

making connections between different pieces of in-

formation that have not been made before. The ab-

sorptive capacity theory therefore considers external

sources of knowledge to be critical in guiding the in-

novation process within organizations. Although ex-

ternal knowledge can be obtained through outsourc-

ing, the organization still requires a minimum level

of internal knowledge to recognize opportunities for

the organization to innovate (Cohen and Levinthal,

1990). Otherwise, it is fully dependent on external

parties to support its innovation process. In today’s

information economy the production of information

goods becomes increasingly important (Brynjolfsson

and Saunders, 2010). Since the production of infor-

mation goods relies on IT, innovation becomes in-

creasingly a knowledge-intensive activity.

3.4 Knowledge and Outsourcing

Knowledge and outsourcing can inﬂuence each other

in two ways. First, the availability of internal knowl-

edge can have an effect on the outsourcing conﬁgu-

BALANCING MODULARITY AND KNOWLEDGE IN DESIGNING AGILE ORGANIZATIONS - The Case of

Outsourcing

191

ration. If sufﬁcient internal knowledge is available,

the need for outsourcing may be small. Conversely,

if speciﬁc knowledge that is required by the organi-

zation is not available internally, this knowledge can

be obtained from service providers (Tiwana, 2008).

Second, the outsourcing conﬁguration can also have

an effect on the knowledge base of the organization.

If the organization decides to outsource certain ac-

tivities that were previously performed in-house, the

organization risks loosing the knowledge related to

those activities (Earl, 1996). Conversely, if the orga-

nization decides to cancel an outsourcing contract and

to perform these activities in-house, the organization

will have to (re)acquire the necessary knowledge to

perform these activities. Some scholars have indeed

warned about the potential negative impact of out-

sourcing on organizational learning, the competence

of the internal IT staff and the loss of innovative ca-

pability (Earl, 1996). Outsourcing a set of activities

may reduce the organization’s ability to bring those

activities back in-house at a later time. If the organi-

zation decides to reverse its decision to outsource a set

of activities, this means that the organizationwill have

to invest in a process of organizational learning since

the knowledge required to perform these activities has

to be reacquired. The ease with which this process of

organizational learning can take place depends on the

absorptive capacity of the organization (Cohen and

Levinthal, 1990). Once an organization ceases to in-

vest in absorptive capacity, it will become difﬁcult to

acquire external knowledge in the future, even if this

knowledge was once present in the organization (Earl,

1996). In the extreme case, this may even create a sit-

uation in which the organizationis locked out from fu-

ture opportunities (Cohen and Levinthal, 1990). The

longer it takes the organization to complete this learn-

ing process, the lower the ability of the organization

to react to changes in its environment. As a result, the

agility of the organization decreases and so does the

ability of the organization to innovate.

4 DISCUSSION

In this paper, we developed a comprehensive frame-

work that integrates the results from previous stud-

ies and that provides a better understanding of the

various relationships between modularity, outsourc-

ing, knowledge, agility and innovation (see Figure 1).

This framework provides one possible explanation for

the conﬂicting evidence with respect to the impact of

modularity on innovation. Although a positive rela-

tionship exists between modularity and outsourcing,

the use of outsourcing may have a negative effect on

the knowledge base of the organization. This will

have a negative impact on the agility of the organi-

zation and its ability to innovate. Whether this neg-

ative impact on innovation will take place, depends

on how both modularity and knowledge simultane-

ously impact innovation. Hence, organizationsshould

consider both effects when making outsourcing deci-

sions.

Both modularity and knowledge are therefore im-

portant design parameters. Organizations can make

strategic decisions to make changes with respect to

both parameters in order to increase their agility and

ability to innovate. Evidently, some trade-off will

have to be made with respect to both parameters. We

have provided an example of how such evaluation

can take place within the context of outsourcing. It

is important to note that our framework does not in-

tend to assign a priority to modularity and knowledge,

or even agility and innovation. Rather, organizations

should decide on the importance of these parameters

within the organization-speciﬁc context and depend-

ing on their strategy. Based on the goals of the organi-

zation, they should ﬁnd a balance between the design

parameters of modularity and knowledge.

Outsourcing is an important topic to study in

this regard. In the past, outsourcing has primar-

ily been used to externalize non-core and non-

knowledge-intensive activities (e.g., programming).

Currently, outsourcing is increasingly used for highly

knowledge-intensive activities that affect the core of

the organization. For example, service providers are

gaining knowledgeabout the business processes of or-

ganizations. The outsourcing of business processes

requires highly modular structures, but this may im-

ply that little knowledge transfer takes place between

customer and service provider, and as a result valu-

able knowledge leaves the organization (Earl, 1996;

Tiwana, 2008). In discussions with informants in Bel-

gian organizations, we have noted that several orga-

nizations are loosing valuable knowledge about their

IT infrastructure and their business processes. This is

an issue that has been understudied in literature with

respect to innovation, and current management tools

and frameworks pay too little attention to this issue.

Our ﬁndings have important practical implica-

tions. It is commonly known that European orga-

nizations are—on average—smaller than US organi-

zations. Eurostat statistics show that 98.7% of Eu-

ropean organizations have less than 50 employees.

Even when omitting so-called micro-organizations

with less than 10 employees, organizations between

10 and 49 employees still represent 84.2% of the Eu-

ropean organizations with 10 or more employees (Eu-

rostat, 2010). We have learned from meetings with

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192

informants in Belgian organizations that in many of

these organizations, no internal technical IT staff is

present, with the exception of one person who is re-

sponsible for making decisions with respect to IT.

Frequently, this person also has other responsibili-

ties. This especially applies to organizations that do

not make intensive use of IT. As a result, all activ-

ities related to IT are outsourced to a local service

provider. Given the lack of internal resources, this ser-

vice provider will provide the organization with an IT

infrastructure and will continue to maintain it, while

no knowledge is being transferred between both or-

ganizations. Hence, the organization does not learn

about the opportunities IT could offer to the organiza-

tion, and its ability to innovate with IT remains lim-

ited. Traditionally, literature has suggested a positive

link between organization size and innovation, due to

the fact that large organizations have more resources

that can be used to innovate(Rogers, 2003). However,

it has recently been argued that smaller organizations

may be more agile and better able to react to changes

in the environment (te Winkel et al., 2008). When

organizations grow, they may adopt a bureaucratic or-

ganizational structure. This structure may slow down

their ability to change, or even kill innovative ideas

that arise within the organization and that are not in

line with the strategy of the organization. We there-

fore argue that many small organizations in Europe

have much unrealized potential to innovate with IT

by not having sufﬁcient internal knowledge.

In large organizations, there is an increasing trend

towards the outsourcing of IT. Various—legitimate—

reasons exist for this: increasingly modular structures

that facilitate outsourcing, the lower cost of offshore

developers,and a lack of skilled domestic labor. How-

ever, if all IT-related activities are outsourced, this

also means that valuable knowledge leaves the orga-

nization, and the absorptive capacity of the organiza-

tion decreases. We are aware of large organizations in

Belgium in which only a few (1–3) persons are still

knowledgeable about the IT infrastructure. Evidently,

this seriously restricts the ability of the organization

to innovate with IT, and poses a considerable risk if

that person leaves the organization.

Both scenarios imply that organizations develop

little IT knowledge, or even loose their existing IT

knowledge. As previously noted, IT is becoming in-

creasingly important to support the innovation pro-

cess in organizations (Brynjolfsson and Saunders,

2010). This implies that organizations should try to

adopt new IT that may offer opportunities to the orga-

nization to innovate. However, it has been shown that

the adoption of IT is frequently knowledge-intensive

(Attewell, 1992). It is reasonable to expect that this

will certainly apply to IT that allows organizations to

truly innovate. In order to adopt knowledge-intensive

IT, organizations must engage in a process of orga-

nizational learning (Attewell, 1992). Organizations

with a higher absorptive capacity will be able to move

more quickly through the learning process, and will

therefore be able to react more quickly to the envi-

ronment by innovating with IT. However, both sce-

narios described above imply that organizations have

a low absorptive capacity. This considerably limits

their ability to identify, assimilate and exploit emerg-

ing technology that becomes available on the market

(Wheeler, 2002; Cohen and Levinthal, 1990). Hence,

organizations with little internal IT knowledge are

in this respect rather limited in their ability to inno-

vate. As a result, they tend to take a more reactive

stance with respect to new technology by relying on

the judgment of service providers, rather than proac-

tively exploring the opportunities of new technology.

This suggests that—rather than begin provided

with black-box IT solutions—organizations should

seek to learn form their service provider. Such al-

ternative outsourcing models include co-sourcing al-

liances and transaction exchanges. Research has

shown that although the success rate for both are

higher than for traditional outsourcing arrangements,

the organization must exhibit a higher maturity in

terms of its modular enterprise architecture (Ross and

Beath, 2006). This further illustrates that the design

parameters of modularity and knowledge should be

considered simultaneously.

5 CONCLUSIONS

In this paper, we have argued that in order for orga-

nizations to innovate with IT, design parameters are

needed which can be governed by organizations. We

have focused on the role of knowledge and modular-

ity as hands-on parameters that have a strong theoret-

ical foundation and that can be controlled by organi-

zations. Our results imply that managers should ﬁnd

a balance between both design parameters to assess

their impact on the agility of the organization and its

ability to innovate with IT.

This study has two important contributions. First,

we have developed a comprehensive framework that

integrates literature on modularity, knowledge, and

innovation within the context of outsourcing. Sec-

ond, we have shown that both modularity and knowl-

edge are essential design parameters for construct-

ing organizations. We have further shown that both

knowledge and modularity are strongly intercon-

nected within the context of outsourcing and how they

BALANCING MODULARITY AND KNOWLEDGE IN DESIGNING AGILE ORGANIZATIONS - The Case of

Outsourcing

193

both simultaneously inﬂuence innovation.

Our study providesseveralopportunitiesfor future

research. The framework developed in this paper can

provide a basis for future empirical studies to study

how organizations consider the inﬂuence of modular-

ity and knowledgein their strategy for innovatingwith

IT. In future research, we also intend to further vali-

date this framework to investigate how managers take

into account knowledge and modularity in making de-

cisions on IT outsourcing.

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