Outsourcing and the Personnel Paradox

William M, Fitzpatrick, Villanova University Samuel A. DiLullo, Villanova University

Introduction Outsourcing is designed to enhance organizational competitiveness by subcontracting key value-chain activities to other firms (Harrigan, 1984; Razzaque and Sheng, 1998; Fitzpatrick and Burke, 2000). It has been estimated that at current rates, 50% of U.S. manufacturing activities may be outsourced to firms in 28 emerging or developing countries by 2015. Additionally, outsourcing of services by U.S. firms is expected to lead to the migration of four million jobs to these nations by 2008 (Merrifield, 2006). The literature on virtual organizations has assigned a descriptive term, "hubs," to firms that extensively utilize outsourcers or independent contractors to accomplish strategic objectives (Dickerson, 1998). Named for their resemblance to the structure of a wagon wheel, organizational hubs are the irreducible core or center of an organization that unifies and links the efforts of subcontractors and outsourcers. Typically, organizational hubs comprise administrative infrastructures that facilitate management of activities deemed essential to both the firm's core competencies and the coordination of its outsourcer activities (Gaibraith, 1995; Dickerson, 1998; Goldman, 1998; Fitzpatrick and Burke, 2000). When outsourcing, hubs generally subcontract business activities that are not critical to their core competencies or can be performed more effectively by other firms (Webster, 1992; Christie,and Levary, 1998; Fitzpatrick and Burke, 2001; Rippin and Sayles, 1999). Thus, outsourcing permits hubs to enhance their performance by utilizing the core competencies of other firms (Buono, 1997). These can include 1) access to intellectual properties, 2) unique manufacturing or service efficiencies, 3) lower costs due to government subsidies, 4) specialized workforce talents or expertise, and 5) lower labor rates (Cinelli and Huffman, 2006; Elliot, 2006; Kakamanu and

Portanova, 2006; Menifieid, 2006). These last two core competencies often justify the offshoring variant of outsourcing activities (Kass, 2004; Kakamanu and Portanova, 2006). In the United States, governmental authorities are concerned that firms are outsourcing to avoid payroll taxes, workmen's compensation, overtime compensation, and legal liabilities associated with the violation of labor or immigration laws (Osterman, 2005; Pearce, 2006). In a variety of recent judicial rulings, the courts have sought to redefine compensatory and liability issues for firms or hubs when using subcontractors (In Re FedEx Ground Packaging System, Inc., 2005; Braun Consulting Group, 2006; Baker v. Flint Engineering & Construction CO.^ 1998; The Coastal Corporation v. Torres, et ai, 2004). The redefinition of these legal and financial responsibilities has evolved from a careful examination of the degree of control that firms have over the business activities of their independent contractors. The purpose of this article is to explore this emerging control doctrine and examine how the application of this doctrine may erode some of the traditional legal protections and labor cost advantages experienced by firms when using independent contractors.

The Control Doctrine and the Compensatory Status of Independent Subcontractors

Control and the legal determinauts of employee and independent contractor status In the United States, the utility of outsourcing methodologies for purposes of reducing labor costs and financial or legal liabilities frequently depends on whether legal or tax authorities afford outsourcer personnel the status of either (a) hub employees or (b) independent contractors {In re FedEx Ground Package System, Inc.,

SAM ADVANCED MANAGEMENT JOURNAL

2005). The Internal Revenue Service (IRS) has developed legal criteria for establishing personnel employment status (IRS, 2007). As evident from the IRS guidelines (see Table 1), personnel employment status is largely contingent on the degree of financial, behavioral, and relational control over them by hub organizations. From a financial perspective, independent contractors and outsourcers are generally responsible for (1) making their own asset investments to complete task assignments, and (2) are paid by the job and not reimbursed for job-related expenses. Conversely, employee status is conferred to employees when they are paid wages or salaries, reimbursed for job-related expenses, and rely on hub organizations to provide tools, equipment, or other assets needed to perform their tasks. Employees are supervised and directed by managers of the hub organization. Behaviorally, independent contractors exhibit higher levels of independence and autonomy with respect to the planning, timing, sequencing, and work methodologies associated with task activities. For independent contractors, job tenure expires at the completion of the project or task assignment. In general, employees have more continuous and longer-term employment relationships with bub organizations. These IRS guidelines for classifying personnel have significant ramifications for the overall cost effectiveness and success of outsourcing business models when used by hubs. As demon-

strated in recent litigation, affording "employee status" to a hub's independent contractors can significantly increase labor costs (i.e.. overtime compensation, social security contributions. Medicare contributions, unemployment taxes, etc.), administrative responsibilities, and downstream civil liabilities for these hub organizations (Osterman, 2005; In Re FedEx, 2005; Zavala v. Wal-Mart Stores, Inc., 2005; The Coastal Corporation v. Torres, et al., 2004; Lavallie v. Pride International, Inc., 2004).

Control and the Revised Compensatory Status of Independent Contractors

Overtime compensation, expense reimbursements, employee benefits and payroll taxes In 2004, FedEx employed approximately 17,000 independent contractors as package delivery drivers, who serviced either multiple routes or single work areas. In a case bought before the California Superior Court, single-route employees sought to be classified as employees and thereby become eligible for a variety of employee benefits and expense reimbursements. These plaintiffs argued that both the nature of their work and the control mechanisms deployed by FedEx to supervise them constituted an "employment" rather than an "independent contractor" relationship (Estrada et al v. FedEx Ground Package System, Inc., 2006). By virtue of their

Table 1. IRS Criteria for Employee and Independent Contractor Status Control Factor Financial Control Worker Investment Expenses Method of payment Risk Behavioral Control Supervision Tools and materials Details of work Other employment Evaluation system Relationship of Parties Duration Benefits Employee No investment Reimbursed Salary or wages No opportunity for profit or loss Independent Contractor Significant Investment Not reimbursed By the job Opportunity for profit and loss

Employer supervises Supplied by employer Controlled by employer Works only for employer Measures details

No supervision Supplied by worker Controlled by worker Works for multiple employers Measures end result

Extended continuous period Provided benefits

Specific project Receives no benefits

Adapted from IRS Guidelines (2007)

SUMMER 2007

operating agreements, single-route drivers were (a) governed by specific employment guidelines, (b) issued FedEx business cards, (c) wore clothing and drove vehicles with FedEx logos, and (d) engaged in exclusive, long-term task activities in support of FedEx business objectives. In adjudicating the case, the California court held that the "EedEx Ground purposely created controis of an employment nature, hoping that in spite of those strictures, the status would still be seen and considered to be that of an independent contractor" (Braun Consulting Group, 2004:7). These behavioral controls over single-route drivers were evident in a variety of ways. These drivers received direct supervision and operating guidelines from FedEx policy manuals or personnel. Equipment (e.g., uniforms, vehicles, and business cards) was provided to the drivers and incorporated FedEx logos. Additionally, the employment relationship was long term with no specific termination date or circumstances, and drivers were contractually compelled to work solely for FedEx. As can be seen from Table 1, each of these personnel requirements is more consistent with the behavioral characteristics governing employees than those associated with independent contractor/subcontractor relationships. This lawsuit (now on appeal) has generated a variety of other class action suits against EedEx by independent contractors seeking to gain "employee status" (In Re FedEx, 2005). Should these lawsuits be decided in favor of the plaintiffs, FedEx's cost efficiencies may erode legally mandated expense reimbursements, employee benefits, and payroll taxes associated with these newly classified "employees" (Osterman, 2005). The Fair Labor Standards Act (1938) uses a similar methodology for classifying independent contractors and employees. In a 1998 case involving this Act (Baker v. Flint Engineering & Construction Co, 1998), a group of oil rig welders sought to legally modify their employment status to qualify for overtime compensation and other benefits normally provided to employees. These welders had entered into a contract with Baker entitled an Agreement with Independent Contractor. This agreement indicated that the intent of Baker and the welders was to "establish and maintain an 'independent relationship' rather than an employer-employee relationship" (Baker v. Flint Engineering & Construction Co., 1998:1439). However, in reviewing the nature of the work activity, the court established that Baker exhibited behavioral and financial control

over these workers consistent with an employment and not an independent contractor relationship. In justifying the reclassification of these independent contractors as employees, the court examined six critical factors, including: 1) the degree of control exerted by the alleged employer over the worker, 2) the worker's opportunity for profit or loss, 3) the worker's investment in the business, 4) the permanence of the working relationship, 5) the degree to which skill is required to perform the work, and 6) the extent to which the work is an integral part of the alleged employer's business" (Baker v. Flint Engineering & Construction Co., 1998: 1440). In reviewing these criteria, the court noted that the welders received significant direction and supervision from Flint's foreman. Welders depended on Flint's foreman for originating work schedules, rest breaks, sequencing tasks with other construction crafts, and for providing work orders. The court also concluded that despite being highly skilled, welders did not actively participate in work-related decisionmaking. Therefore, both the supervisory arrangement and the lack of decision-making activities were deemed to be evidence of Flint's behavioral control over the welders and found to be inconsistent with the autonomy generally afforded independent contractors. From a financial perspective, independent contractors generally have opportunities for business profit or loss. However, Flint paid its welders an hourly salary or wage. This precluded these workers from actually generating business profits or losses. Additionally, while the welders were responsible for providing their own welding equipment, this investment was considered minor relative to the assets Elint had committed to this commercial relationship. Therefore, the court concluded that Flint maintained a level of financial control over the workers commensurate with an employer-employee relationship. Permanence of the welder's working relationship with Flint was also found to parallel the job tenure of other employees in the oil and gas industry and was not deemed to be a significant factor in determining the workers' employment classification. Einally, since welding operations were central to Flint's core business activities, the welders were deemed to support task activities characteristic of essential employee functions. Therefore, despite signing independent contractor agreements, welders were granted the status of employees under the Fair Labor Standards Act (1938). This made Flint liable for employee

SAM ADVANCED MANAGEMENT JOURNAL

benefits and overtime compensation commensurate with this new employment status, which resulted in an overall increase in their labor and operating costs, Workmen's compensation and financial control over independent contractors Court rulings in The Coastal Corporation v. Torres (2004) present an interesting variation on the issue of financial control, employment status, and liability for workmen's compensation. Coastal Corporation is involved in the refining of petroleum products. Like many firms in this industry. Coastal Corporation sought to organize many of its strategic business units as independent subsidiaries. Each subsidiary had its own management personnel who assumed responsibility for specific day-to-day operations of the business unit. However, Coastal Corporation did exhibit some generalized control and coordinating capabilities over these business units by virtue of formulating a centralized budget. One of these subsidiaries. Coastal Refining & Marketing, Inc., operated a refmery in Corpus Christi, Texas. In May of 1999, a pressure vessel at this refinery ruptured and subsequently exploded, severely injuring a number of workers. The investigation found that the cause of the rupture and explosion was likely due to internal corrosion in the pressure vessel. The injured workers filed suit against Coastal Corporation for gross negligence. They argued that by virtue of its budgetary authority over subsidiaries. Coastal had assumed responsibility for "control over maintenance, turnaround and inspection matters at the plant. . . [and] by limiting expenditures, controlled and influenced its subsidiary in a way that directly resulted in [the workers'] injuries." (Coastal Corporation v. Torres, 2004: 777, 779). Thus, under this legal theory of control, the plaintiffs' attorney argued that Coastal Corporation was obligated to pay workmen's compensation to the injured workers. When adjudicated before a district court, a jury held Coastal Corporation to be liable for these workers' injuries. However, the appellate court reversed this jury decision, largely based on an examination of the control doctrine. The court held that general budgetary control over a subsidiary's operation did not constitute direct control over operational responsibilities. Thus, liability for workman's compensation would only occur if Coastal had control over the means, methods, and details related to the implementation of work-related

safety policies. Therefore, the negligence-based control theory advocated by the injured workers failed to demonstrate the level of detailed behavioral or financial control needed to establish Coastal's liability. Workman's compensation and piercing the corporate veil Workman's compensation liability was also the subject of the Lavallie v. Pride International, Inc. (2004) case. Mr. Lavallie was employed by Pride International Personnel, Ltd (Pride Personnel), an independent subsidiary of Pride International, Inc. Pride Personnel recruited workers to provide a variety of services for its corporate parent (Pride International). While performing services on a ship owned by Pride International and its subsidiaries, Mr. Lavallie suffered serious injuries to his lower back. Despite numerous requests by Lavallie, neither Pride International nor its subsidiaries agreed to pay his medical fees or compensate him for his injuries. After six months of unpaid medical leave, his employment with Pride Personnel was terminated. In his subsequent lawsuit, Mr. Lavallie contended that the parent corporation of Pride Personnel (Pride International) was responsible for compensating him for injuries sustained while working for one its subsidiaries. As a matter of law, injured workers usually have recourse only against the corporate entity responsible for the liability and not its corporate parent (Baker v. Raymond, 1981). Therefore, in order to seek recompense from the parent corporation, Lavallie's attorneys needed to establish the civil liability of Pride International by piercing the corporate veil of ownership. When organizations seek to establish each of their operating subsidiaries as independent corporations, they are attempting to insulate themselves from the civil liabilities generated by their principal business units. To establish civil liabilities of the parent for the activities of its offspring, plaintiffs must pierce the corporate veil of ownership by demonstrating that corporate parents exhibit significant control over the activities of their subsidiaries. In Baker v. Raymond (\9S\), the court established the ability of litigants to establish civil liabilities for parent corporations when their subsidiaries served as business conduits or "alter egos." This level of direction or control over subsidiaries erodes the independence of these business units and makes the parent corporation responsible for their actions. In determining whether the corporate veil

SUMMER 2007

of liability has been breached, courts have examined nine factors, including: "1) common stock ownership [i.e., does the parent own all of the stock in the subsidiary], 2) common directors or officers, 3) whether the parent finances the subsidiary, 4) whether the parent caused the incorporation of the subsidiary, 5) whether the subsidiary operates with grossly inadequate capital, 6) whether the parent pays the salaries and other expenses or losses of the subsidiary, 7) whether the subsidiary receives any business except that given to it by the parent, 8) whether the parent uses the subsidiary's property as its own, and 9) whether the directors and officers of the subsidiary act independently in the interest of that company or take orders from the parent and act in the parent's interest" (Lavallie v. Pride International, 2004: 3). In the Lavallie case, the high level of overlap in corporate officers between Pride International and Pride Personnel and the undercapitalization of Pride Personnel were considered by the court to indicate the subsidiary's true lack of independence. Since Pride Personnel was acting as a business conduit for Pride International, it was held that the parent could be sued for civil liabihties generated by its offspring.

Apparent Control and the Civil Liabilities Associated with Outsourcer Activities
As a principle of law, employers are generally not held to be legally accountable for civil liabilities arising from the activities of their independent contractors. This liability shield stems from the fact that employers have no direct control over the activities of independent contractors and their personnel (Clarkson, Miller, Jentz and Cross, 2004). However, in a variety of recent court cases involving medical practitioners, application of the "apparent agency doctrine" has circumvented this liability shield (Alstott, 2004). The apparent agency doctrine is based in part on the notion that appearances can be deceiving. Under this doctrine, firms or hubs can be held liable for the actions of their independent contractors if these contractors are perceived by clients to be employees under the "apparent control" of the hub. In Baptist Memorial Hospital System v. Sampson (1998), the Texas Supreme Court set forth criteria by which hospitals would be liable for the actions of their independent contractors. This liability would be established to the degree that patients " ( 1 ) . . . had a reasonable belief that the physician was the agent or employee of the hospital; (2) such be-

lief was generated by the hospital affirmatively holding out the physician as its agent or employee or knowingly permitting the physician to hold herself out [as such], and (3) [patients] . . . justifiably relied on . . . [this] .. . representation of authority" (Baptist Memorial Hospital System v. Sampson, 1998:949). Belief that a physician is an employee and not an independent contractor can occur when hospitals fail to overtly disclose this outsourcing relationship. In Sword V NKC Hospitals, Inc. (1999), the court . ruled that this failure of disclosure could occur even when admission forms clearly stipulated that physicians working in the hospital were independent contractors. In this case, a matemity patient was admitted to NKC hospital for delivery of her child and subsequently suffered from anesthesia difficulties due to alleged physician malpractice. Advertisements for the women's pavilion indicated that the hospital's medical staff was composed only of physicians specializing in obstetrics and anesthesiology. In the court's opinion, this advertising program gave potential clients the impression that (a) the hospital was the complete medical provider, and (b) the medical staff were NKC employees and under the direct control of the hospital. Additionally, other than the disclaimer on the admission forms, the hospital used no other overt techniques to disclose their use of independent contracting physicians. Since the hospital had created the appearance that these physicians were employees, NKC was therefore required to assume legal liability for their actions.

Control, Empioyment Law, and Criminal Litigation Risks

Independent contractors and the hiring of illegal workers In 2001 and 2003, the Immigration and Customs Enforcement Division (ICE) of the Department of Homeland Security conducted a variety of employment "raids" on Wal-Mart stores in 21 states. During these raids, 345 illegal aliens were arrested. These "illegals" were employed by independent contractors providing janitorial and custodial services to Wal-Mart. During the ensuing investigation and criminal complaint, ICE alleged thai Wal-Mart and its independent contractors were both complicit in violating the Immigration and Reform Act of 1986 (Pearce, 2006). As noted, firms or hubs had traditionally not been held liable for the actions of their independent contractors (Clarkson, Miller, Jentz and

SAM ADVANCED MANAGEMENT JOURNAL

Cross, 2004). However, ICE contended that WalMart's complicity was evidenced by its permitting independent contractors to knowingly assign "illegal workers" to perform tasks in WalMart stores. On May 18, 2005, the Department of Justice and ICE announced an out-of-court settlement of this issue. In exchange for dropping the criminal complaint, Wal-Mart signed a consent decree and paid an $11 million fine (Pearce, 2006). The terms of this consent decree established new oversight responsibilities for Wal-Mart when dealing with independent contractors. Wal-Mart was required to develop a program that would (a) monitor and verify the compliance of independent contractors with immigration laws, and (b) provide store management with training regarding their responsibilities in preventing unauthorized aliens from working in Wal-Mart facilities (Pearce, 2006). While the consent decree did not require WalMart to admit guilt, it did establish a series of new legal responsibilities and fmancial liabilities for Wal-Mart when dealing with the employment practices of independent contractors. Control and the redefinition of criminal and civil liabilities when dealing with outsourcers The Wal-Mart consent decree has potentially broad implications for others electing to use independent contractors. Should the consent decree evolve into an industry-wide precedent, hubs may be forced to develop employment oversight programs and assume added financial responsibilities for the inadvertent or intentional violation of employment law by such contractors. These oversight programs might also serve to reinforce the hub's behavioral control over independent contractor activities. As noted in the prior discussion of IRS guidelines and selected court cases, behavioral control has (1) often been used as a legal justification for affording independent contractors the status of employees, and (2) created hub liabilities for a variety of unanticipated labor costs, taxes, civil and criminal liabilities. Therefore, if applied to the activities of other hubs and independent contractors, the Wal-Mart decree has significant implications for redefining the competitive value and cost savings traditionally associated with the outsourcing business model.

Control and Offshoring Variants of Outsourcing Strategies

As noted, hubs have often outsourced business activities to subcontractors in other countries to

exploit situational advantages in costs and specialized workforce expertise (Kass, 2004; Kakamanu and Portanova, 2006). However, achieving these economic benefits is strongly contingent on domestic labor and corporate laws in the outsourcer's country of origin, and bilateral treaties or economic agreements that jointly influence the strategic autonomy and responsibilities of U.S. hubs and their foreign outsourcers (Offshore Outsourcing.org, 2007). An example of a bilateral treaty with implications for behavioral and financial control and cost effectiveness of offshoring strategies is the U.S.-India Tax Treaty (Shah. 2006; Tax Convention with the Republic of India, 1991). Article 9 seeks to evaluate the independence of the outsourcing relationship between hub organizations and Indian outsourcers based upon a doctrine of control. Therefore, if hubs exhibit significant levels of managerial control over outsourcer activities, the global profits they earn as a result of outsourcer work become taxable in India (Tax Convention with the Republic of India, 1991). Article 5 of this treaty also indirectly addresses elements of the control doctrine in defining hub-outsourcer relationships and subsequent tax liabilities. It states that the loss of autonomy by Indian outsourcers or business subsidiaries when dealing with hubs may result in the reclassification of the Indian firms as permanent establishments (RE.) of the hub. Under the treaty, this is likely to occur if business activities between the hub and Indian outsourcer or subsidiary are not characterized by "armslength" transactions (Shah, 2006). Erosion of these arms-length activities can occur when (1) hubs fail to establish more contract-oriented compensation methodologies for outsourcers, (2) hubs use their own employees for prolonged direct supervision of outsourcer business activities, or (3) the Indian outsourcer or subsidiary is permitted to negotiate contracts for the hub or conduct hub-related business outside of India. The first two of these criteria resemble elements of the IRS fmancial and behavioral control doctrines used to evaluate or determine independent contractor status (IRS, 2007). The second and third criteria also suggest that the outsourcer or subsidiary is merely a business conduit for hub competitive activities. Should any of these three conditions arise, (a) PE. status can be afforded to the Indian outsourcer or subsidiary, and (b) global profits that the hub earns on the Indian P.E.'s work are subject to Indian taxation. These tax liabilities may subsequently erode many of

SUMMER 2007

the cost savings traditionally associated with offshoring strategies. These outcomes under the U.S.-India Tax Treaty are directly analogous to the control issues and erosion of labor cost benefits experienced by hubs when outsourcing to U.S. firms.

Managerial Implications and Suggestions

To preserve the viability of the outsourcing or independent contractor business model, firms

and hubs may have to revise the typical contracting methodologies used for coordinating the activities of their subcontractor personnel. As noted in Figure 1, firms and hubs using independent contractors or outsourcers must be sure to implement behavioral and financial control methodologies consistent with IRS guidelines, court rulings, and international treaties to escape additional taxes, labor costs, civil and criminal liabilities. These control methodologies are

Figure 1. Control and the Management of Outsourcers and Independent Contractors

FINANCIAL^ CONTROL"

BEHAVIORAL CONTROL

1. Parent organizations should insure adequate capitalization of their independent subsidiaries in order for them to achieve fmancial autonomy. 2. Parent organizations should create general financial budgets only and avoid micromanagement of expenditures by independent subsidiaries. 3. Payments to independent contractors (ICs) should not resemble wages/salaries. ICs should have the opportunity to experience profits or losses and pay for their own expenses from contract fees.

1. Hubs should not maintain a direct supervisory relationship with IC personnel. 2. Hubs should assign goals and provide general project scheduling information to IC management. 3. IC management should assume responsibility for communicating work goals, schedules, and quality control objectives to their own personnel.

APPARENT^
CONTROL"

1. ICs should wear identification or uniforms that specifically identify them as outsourcer and not hub personnel. 2. At hub service locations, signs and other materials should notify clients that ICs/subcontractors are being used. 3. IC persormel should verbally inform clients of their subcontractor affiliation.

10

SAM ADVANCED MANAGEMENT JOURNAL

designed to establish a level of true independence between the activities of independent contractors, subsidiaries, and hubs. From a financial control perspective, hubs must ensure that the financial linkages binding them to their outsourcers or contractors and subsidiaries permit these latter parties to exhibit sustainable levels of independence. For hubs, the financial independence of subsidiaries can be achieved by establishing adequate capitalization and budgetary autonomy among these latter firms. Therefore, parent firms and hubs must provide both an adequate resource base for their corporate offspring and permit them to allocate and supervise their own expenditures without undue influence or micromanagement (Coastal Corporation v. Torres, 2004). Relationships with independent contractors should also exemplify elements of financial independence. Consistent with IRS (2007) guidelines. Figure 1 proposes that this financial independence be established by structuring payments to independent contractors so that (a) compensation does not resemble traditional wages or salaries, and (b) outsourcers have the opportunity to experience profits or losses and assume responsibility for their own expenses (Baker v. Flint Engineering & Construction Co., 1998). With respect to behavioral control, hubs should give independent contractors significant autonomy with respect to the completion of assignments and responsibilities. Creating this autonomous relationship can be facilitated by ensuring that hubs do not exercise significant oversight of the employees and activities of their independent contractors (IRS, 2007). Therefore, independent contractors should remain responsible for project management activities, work scheduling, and quality assurance. When using the personnel of independent contractors to provide services, hubs should act affirmatively to avoid the appearance of control and should clarify this employment status for clients and patrons. To deal with this apparent control issue, outsourcer personnel should wear identification or uniforms signifying their independent contractor status and should inform clients of their status. Hubs should also inform clients and customers of their use of independent contractors through signs or other materials.

a variety of costs and legal liabilities (Kakamanu and Ponanova, 2006; Merrifield, 2006; Cinelli and Huffman, 2006). However, in the United States, the competitive benefits of this strategy are being targeted through legal doctrines of control (In Re FedEx Ground Package System. Inc., 2005; Baker v. Flint Engineering & Construction Company, 1998). Consisting of behavioral, fmancial, and apparent dimensions, this doctrine of control has eroded the traditional independence of outsourcers by reclassifying their personnel as employees of hub organizations. When upheld by the courts, this reclassification has resulted in the imposition of new compensatory obligations on those using outsourcers, independent contractors, or independent business subsidiaries. Many of these firms have now been required to assume fmancial and legal responsibilities for overtime compensation, workman's compensation, payroll taxes, and civil litigation costs or judgments generated by their outsourcer cadre (Osterman, 2005). This, in turn, has raised the level of costs not generally anticipated with business models based on outsourcing (Osterman, 2005; Lavallie V. Pride International, Inc., 2004). To better manage these new fmancial and legal liabilities, this paper recommends that firms and hubs should take affirmative steps to (1) understand the legal complexities of the control doctrine as represented in emerging case law, and (2) introduce a variety of contractor management strategies designed to preserve true independence between themselves and their outsourcer cadre. As noted by the courts, freedom from costs and liabilities may only accrue to firms that maximize the autonomy of their outsourcers. Dr. Fitzpatrick's teaching and publishing activities are in the areas of strategic planning and decision-making, competitive intelligence systems, corporate security management, intellectual property management, and organizational design and general management. Samuel DiLullo, an attorney, teaches business law and conducts research on bankruptcy, contracts, and constitutional and intellectual property law.
REFERENCES
Alstott, A. (2004). Hospital liability for negligence of independent contractor physicians under principles of apparent agency. Journal of Legal Medicine. 25.485-504. Baker v. Flint Engineering & Construction Company. (1998). LU F. 3d 1436. Baker v. Raymond. International, Inc. (I98t). 656 F. 2d 173.

Conclusion
Outsourcing has been heralded as a strategy permitting firms and hubs to simultaneously increase their competitive flexibility and reduce

SUMMER 2007

11

Baptist Memorial Hospital System v. Sampson. (1998). 969 S.W. 2d 945-950. Birch V. Illinois Bone & Joint Institute. Ltd. (2006). U.S. Dist. Lexis 7022. Buono, A. F. (1997). Enhancing strategic partnerships. Journal of Organizational Change Management^ /0,251 -266. Braun Consulting Group. (2004, Winter). FedEx Ground vs. Ups; Two worldviews. Braun Consulting News, 1 (6) 16. Retrieved November 17, 2006, from http:// www.braunconsulting.com/bcg/newslaners/winter2004/ winter2004Lhtmi Christie, P. M. J., and Levary, R. R. (1998, July/August). Virtual corporations: Recipe for success. Industrial Management. 40{4).l-[ I. Cinelli, G. M., and Huffman, J. K. (2006). Outsourcing: Is it really worlh the cost? Intellectual Property and Technology Law Journal, 18(4), 21-23. Clarkson, K., Miller, R., Jentz, G., Cross, F. (2004). West's business law (9'' ed.l. Mason, OH: Thompson/South-Westem. Dickerson; C. M. (1998, January). Virtual organizations: From dominance to opportunism. New Zealand Journal of Industrial Relations. 35-46. Elliot, G. (2006). International outsourcing; Values vs. economics. Quality Progress. i9(8), 20-25. Ernst and Young. (2006, June). Ruling on foreign companies with captive business process outsourcing units. International Tax Review, 1. Estrada et al. v. FEDEX Ground Packaging System. Inc. (2006). Court of Appeal of California Lexis 10580. Fair Labor Standards Act. (1938). 29 U.S.C.A. 203. Fitzpatrick, W.M., and Burke, D.R. (2000). Form, functions and financial performance realities for the virtual organization. SAM Advanced Management Journal. 65(3), 1320. Fitzpatrick, W.M., and D.R. Burke (2001, Auttjmn). Virtual venturing and entry barriers: Redefining the strategic landscape. SAM Advanced Management Journal, 66(4), 2230. Gaibraith, J.R. (1995). Designing organizations. San Francisco, CA: Jossey-Bass. Goldman, S.L. (1998. May/June). From bricks to bytes: Creating the virtual healthcare organization. The Healthcare Forum Journal. 4 5 ^ 7 . In re FedEx Ground Package System. Inc. (2005). 381F. Supp 2dl380.

Internal Revenue Service. (2007). Employee or independent contractor? Retrieved January 20, 2007, from http:// www.irsgov/govt/fslg/artic!e/0..id=l 10344,00.html Kakanamu, P.. and Portanova, A. (2(X)6). Outsourcing: Its benefits, drawbacks and other related issues. Journal of the American Academy of Business, 9(2), 1-7. Kass, E. (2004, February 2). On again, ofF again. Network World, 34-36. Lao, N., and WU, T. C. (2006). Outsourcing operations: A case of one machine tool manufacturer and its subcontractor in Taiwan. The Business Review, 5(2), 155-162. Lavallie v. Pride International. Inc. (2004). 2004 WL 1950321. Merrifield, D. B. (2006). Make outsourcing a core competency. Research Technology Management. 49(3), 10-13. Pearce, J. (2006). The dangerous intersection of independent contractor law and the immigration reform and control act: The impact of the Wai-Mart settlement. Lewis and Clark Law Review, 10, 597-623. Offshore Outsourcing.org. (2007). Legal issues: Offshore outsourcing. Retrieved May 28. 2007. from http:// www.offshoreoutsourcing.org/legal-issues-offshoreoutsourcing.asp Osterman, R. (2005). A new division of labor: Independent Contractor or employee. Sacramento Bee. Sunday Metro Final Edition. Dl. Razzaque, M. A., and Sheng, C. C. (1998). Outsourcing of logistics fiinctions: A literature survey. InternationaUournat of Physical Distribution and Logistics Management, 25(2), 89-107. Shah. P. P. (2(X)6). Direct taxes: Advance rulings. Retrieved November 14, 2006, from http://aiftpoinline.org/joumal/ mayO6/Direct_Taxes_Advance_Ruling.htm Sword V NKC Hospitals. Inc. (1999). 714 N.E. 2d. 142. . Rippin, K.M.,and Sayles, L.R. (1999). Insider strategies for outsourcing information systems. New York: Oxford University Press. Tax Convention with the Republic of India. (1991). Retrieved May 28,2007, from http://undefed.com/ForTaxProfs/Treaties/lndia.pdf The Coastal Corporation v. Torres, Bourland and Natividad (2004). 133S. W. 3d776. Webster. Jr., F.E. (1992, October). The changing role of marketing in the corporation. Journal of Marketing, 56,1-17. Zavala v. Wal-Mart Stores. Inc. (2005). 393 F. Supp 2d295.

"GLOBAL CHALLENGES AND GOVERNANCE"

SAM 2007 BUSINESS CONFERENCE PROCEEDINGS AVAILABLE SOON IN CD FORMAT To order please call: 361-825-6045 or e-mail: moustafa.abdeisamadfgitamiicc.edu Special price $25.00 (postage for overseas $5.00)

12

SAM ADVANCED MANAGEMENT JOURNAL