Information technology outsourcing has become a pervasive and important phenomenon in business organizations and there is substantial evidence about its benefits and pitfalls. Initially, firms used outsourcing as a way to lower costs, gain access to expertise and focus on core activities. Recently, there is a shift in focus and more firms are outsourcing to attain innovative products and services. However, current research is still unclear about how innovation can be achieved through outsourcing. Drawing predominantly from the dynamic capability theory, the objective of this paper is to explore how absorptive capacity unfolds as a process within and between firms when client firms outsource their information technology services with expectations of innovation generation. In this paper, we propose a research model that links absorptive capacity to innovation generation. We draw on three case studies to focus on how absorptive capacity, as a process, impacts innovation generation. Results show that assimilation and transformation stages are critical in generating radical innovation while acquisition and exploitation play a key role in incremental innovation. The implications of these findings for both researchers and practitioners are discussed.