Knowledge management has in important role in effective outsourcing. The decision to outsource knowledge should be attained through careful review of the firm’s knowledge management (KM) structure, goals, and the benefits of obtaining innovation externally. “Knowledge is the single most important resource for organizations today andmanaging knowledge like any other resource is therefore critical to business performance (Davenport and Prusak, 1998)” (Aydin & Bakker, 2008, p.294). In order for the outsourcing relationship to function successfully, the outsourcing parties must design the KM framework to encourage, incent and leverage knowledge transfer.Stewart (2001) states three forms of organizational capital form intellectual capital: structural, human and customer. Structural capital is the organizational tools that promote knowledge by connecting people to the explicit data or tacit experience they need. Human capital is individual specific, and it is representative of the value the employee to the firm. Customer capital is the value of an organization’s relationships with its clients (Stewart, 2001). Willcocks then argues that a fourth capital, social capital, is the trust that it is built between the firm and the external community (Willcocks, 2004).Outsourcing knowledge is desirable because it is the intersection of these four forms of capital. The firm’s challenge is not only to identify where the knowledge advantage occurs, they must then increase the knowledge exchange with these outsourced groups.The organization has the incentive to keep all processes within its company and therefore keep the knowledge generation to itself. There is no confusion of knowledge ownership, and they control all rights to this intellectual capital. However, this closed approach can ultimately be detrimental to innovation in knowledge creation. The firm may be too entrenched in already used practices and the cultural climate to take Michaelsen 1advantage of all knowledge generation possibilities and utilization of external intelligent resources.Outsourcing through consultants can result in a benefit of rented knowledge that is not readily absorbed within the company, as mentioned by Davenport and Prusak (1998). Although some knowledge might be transferred, the contract and arrangement should be such that the organization will continually gain from the interaction. This external and temporary relationship is an example of how the design of the outsourcing process must be focused on creating KM systems in order to fully benefit from the outsourcing itself.Outsourcing groups need to be vigilant in addressing KM before the interaction occurs. Due to managerial fears about losing valuable knowledge to the outsourced party, the framework for dealings needs to be established well before the relationship takes place. The agreement should be arranged so that knowledge can be transferred and leveraged. While the outsourcing occurs, the groups need to constantly analyze the critical knowledge and how it can be captured and transferred. A governance board or a hierarchal knowledge management system is a productive knowledge management tool that can ensure that knowledge will be retained by an organization after the outsourcing iscomplete. Also, Service Level Agreements (SLA) provide a clear documentation for the outsourcing parties and can provide better control over the knowledge acquisition process(Aydin, 2008). Choosing the right individuals to manage the outsourcing relationship is imperative to the ultimate success of the venture as well as future relationships. Ideally, the benefit of the knowledge outsourcing will be reciprocal for all parties involved and allMichaelsen 2will be working towards a common, profitable goal. However, the competitive nature of firms vying for resources will deteriorate this relationship and make it difficult for outsourcing parties to benefit from the process. Maintaining the outsourcing relationshipis a complicated, yet important process for ensuring that all parties can mutually benefit. The outsourcing relationship should be a cross fertilization of ideas. “When managers at Deere made the decision to source a hydrostatic transmission from a supplier, they simultaneously created a group of engineers to work closely with its supplier engineers” (Venkatesan, 1992, p. 103). This paring of resources between the outsourced party and the firm may seem redundant or evidence of a poorly designed and inefficient system. However, this system ensures that any knowledge creation can be retained within the firm. Those who manage the outsourcing should be vigilant in creating this joint focus. “Provide ongoing training and job shadowing so that critical institutional knowledge isn't lost if an IT worker were to leave the outsourcer (Hoffman, 2004, pg. 50).Addressing the knowledge gap when people leave the company is an important process in managing knowledge during outsourcing. The firm must identify the key employees and knowledge centers. Aydin and Bakker (2008) mention that an intervieweediscussed the Sarbanes-Oxley law’s effect in their firm’s identification of key areas and personnel. Care must be taken to recognize critical points in which one person or only a select group of people control knowledge. Walden and Wetherbe (2005) argue that exclusivity concerns should be addressed before the decision to outsource innovation. “Companies hoping to strike similarly advantageous deals must recognize that information assets (intellectual property) differ Michaelsen 3from physical assets in that they can be at once given away and retained” (Walden & Wetherbe, 2005, p 32.). The authors describe Merrill Lynch’s outsourcing deal with Bloomberg in 1983 to build a software program for delivering the most current financial data to the firm. They created an agreement in which Merrill Lynch would have exclusive rights to the software in the initial period and retain a share in its interests. Merrill Lynch not only had the advantage of being the first to market with this innovation, they made a large profit from selling off its share of the company in 1996. This structure exemplifies strategic knowledge outsourcing through foresight to ensure that the company will benefit from the knowledge creation and transfer, as well as maintain incentives for the innovation.The following is a case study discussion concerning designing