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The purpose of this study is to theoretically clarify under which circumstances MNCs should outsource the innovation function. In the globalization era, multinational companies (MNCs) face the challenge of making a strategic decision. They ought to adjudicate upon outsourcing the research and development, i.e. innovation function and bearing the risks of it, or keeping innovation function in house and paying the price of this decision. This decision becomes more crucial when the host country has dissimilar characteristic and high uncertainty compared to the home country.

This study is among the very first studies that evaluate the issue of outsourcing innovation for MNCs from a transaction cost economics (TCE) theoretical perspective. By setting forward propositions that serve as a guideline for conditions in which MNCs should outsource innovation, this paper contributes to innovation, new product development, global business and, last but not least, to the TCE literature. This study also provides managerial implications and avenues of future research for academicians.

This study shows that heterogeneity between the home and host country affects the autonomy of the innovation at the host country; this autonomy in turn leads to higher transaction cost, and finally, transaction cost is the main determinant of the decision on whether to outsource the innovation.

This study fills this gap by looking at the problem of outsourcing innovation from a TCE theoretical perspective and, based on an extensive literature review, puts forward a set of propositions that clarify under which circumstances MNCs should outsource the innovation function.