Our analyses show that IT outsourcing confers significant productivity gains on client firms. Importantly, our results suggest that IT knowledge transmitted from IT service providers is a major driver of these productivity gains. We find that firms with higher IT intensity accrue larger benefits from vendors’ IT knowledge. Interestingly, the magnitude of returns to in-house IT capital is higher for firms that outsource relative to those that do not. Accordingly, we infer that the reorganization of production from internal to external delivery is an important component of the value created by IT and that the knowledge-based capabilities of a vendor underpin its ability to generate value.