|
Article Excerpt
Abstract
To date, most research on information technology (IT) outsourcing concludes that firms decide to outsource IT services because they believe that outside vendors possess production cost advantages. Yet it is not clear whether vendors can provide production cost advantages, particularly to large firms who may be able to replicate vendors' production cost advantages in-house. Mixed outsourcing success in the past decade calls for a closer examination of the IT outsourcing vendor's value proposition. While the client's sourcing decisions and the client-vendor relationship have been examined in IT outsourcing literature, the vendor's perspective has hardly been explored. In this paper, we conduct a close examination of vendor strategy and practices in one long-term successful applications management outsourcing engagement. Our analysis indicates that the vendor's efficiency was based on the economic benefits derived from the ability to develop a complementary set of core competencies. This ability, in turn, was based on the centralization of decision rights from a variety and multitude of IT projects controlled by the vendor. The vendor was enticed to share the value with the client through formal and informal relationship management structures. We use the economic concept of complementarity in organizational design, along with prior findings from studies of client-vendor relationships, to explain the IT vendors' value proposition. We further explain how vendors can offer benefits that cannot be readily replicated internally by client firms.
Keywords: Outsourcing of IS, case study, complementarity in organizational design, IS core competencies, management of computing and IS, systems maintenance, IS staffing issues, IS project management
Introduction
Outsourcing is a phenomenon in which a user organization (client) transfers property or decision rights over information technology (IT) infrastructure to an external (vendor) organization (Loh and Venkatraman 1992b). The brief history of IT outsourcing includes episodes of both high hopes and bitter disappointment. Since Eastman Kodak's landmark outsourcing of its IT services (Applegate and Montealegre 1991), the outsourcing industry has been growing at a staggering rate of about 20 percent a year (Caldwell and McGee 1997). Worldwide spending on IT outsourcing services reached almost $64 billion in 2001; in 2000, IT outsourcing represented about 30 percent of IT budgets (Mason 2000). Despite these numbers, both vendors and their clients are struggling to understand the outsourcing value proposition: can vendors deliver economic and management benefits to their clients that outweigh contracting costs and risks?
A number of studies indicate that the leading reason behind outsourcing is the need to reduce and control IT operating costs (Ang and Cummings 1997; Ang and Straub 1998; Casale 2001; Loh and Venkatraman 1992a, 1992b; Slaughter and Ang 1996), followed by the need to improve management focus and access technical talent not available in-house (Casale 2001; Lacity and Willcocks 1998). The intended benefits, however, often have not materialized (Hirschheim and Lacity 2000; Scheier 1997) and risks are significant (Aubert et al. 1998, 1999; Earl 1996). For example, one study found that only 54 percent of the agreements realized expected cost savings (Lacity and Willcocks 1998). More recently, a Gartner Dataquest Report claimed that about one of every three outsourcing contracts targeting cost reductions failed to match expectations (Caldwell 2002a, 2002b). Moreover, there is evidence that companies are willing to undergo the expense of canceling their contracts and rebuilding their in-house IS capabilities (Buxbaum 2002; McDougall 2002). The mixed success of existing agreements has not, however, led to disillusionment with the concept of outsourcing.
Growth in the outsourcing market signals that firms of all sizes believe that IT vendors will ultimately deliver value (Casale 2001). In fact, outsourcing results have been improving as the practice of outsourcing has matured (Willcocks and Lacity 2000). Variations in outsourcing outcomes call for an investigation of factors that shape the value delivered to clients through outsourcing. The objective of the research presented in this paper was to explore this question from the vendor's perspective. In particular, we examine how vendors create value in the case of application management (3) outsourcing.
The case study presented here contributes to the recent stream of research that uses qualitative data to examine the history of ongoing outsourcing relationships (Kern 1997; Koh et al. 1999; Lacity and Willcocks 1998; Lacity et al. 1995; Sabherwal 1999; Saunders et al. 1997). To explain how vendors provide value, this paper diverts from the more usual transaction cost economics (TCE) (Williamson 1979), institutional theory (DiMaggio and Powell 1983), and neoclassical economics (reviewed in Williamson 1985) accounts of IT outsourcing. Instead, it uses the concept of complementarity in organizational design (Milgrom and Roberts 1995), the core competency argument on outsourcing (Hamel and Prahalad 1996; Quinn 1999), and findings from the literature on the vendor-client relationship (Elitzur and Wensley 1997; Kern and Willcocks 2001; Willcocks and Lacity 2000). In this way, the analysis extends neoclassical economics accounts of outsourcing to suggest why many large firms may choose to outsource applications management.
The paper is organized as follows. First, we review existing relevant research on IT outsourcing. We then explain our choice of methodology for collecting and analyzing the data. In the following section, we present an overview of the case. Then we analyze and interpret data from the case using the theory of complementarity in organizational design, and from the standpoint of client-vendor relationship factors, to build a framework for understanding the value proposition for IT outsourcers. Finally, we discuss the contributions this paper makes to research and practice.
Background: Perspectives on Outsourcing
Historically, research on IT outsourcing has focused on the sourcing decision itself, trying to understand why organizations outsource. Drawing on economic literature, such as TCE (Williamson 1979) and the theory of incomplete contracts (Hart 1989), the sourcing decision is often seen as a rational decision made by firms that have considered transaction-related factors such as asset specificity, environmental uncertainty, and other types of transaction costs (Ang and Beath 1993; Ang and Cummings 1997; Ang and Straub 1998; Nam et al. 1996; Nelson et al. 1996; Richmond and Seidmann 1993; Richmond et al. 1992; Walker and Weber 1984). An alternative theory, neoclassical economics (reviewed in Williamson 1985), posits that firms outsource IT to attain cost advantages from assumed economies of scale and scope possessed by vendors (Ang and Straub 1998; Loh and Venkatraman 1992a; Slaughter and Ang 1996). This theory has attained more empirical support in studies of outsourcing decisions than TCE (Ang and Cummings 1997; Ang and Straub 1998; Casale 2000, 2001; Loh and Venkatraman 1992a, 1992b; Slaughter and Ang 1996; Walker and Weber 1984). However, the economies of scale and scope argument would predict that outsourcing has little to offer larger firms, because they can generate economies of scale and scope internally by reproducing the production methods used by vendors. The data on outsourcing, however, indicates that many large firms continue to pursue outsourcing arrangements (Chabrow 2002; McDougall 2002).
Because of the focus on the sourcing decision of firms on average, this set of economic theories is generally not used for explaining outcomes of the outsourcing decision. Alternative theories used to study IT sourcing decisions suggest that sourcing decisions are motivated by political (Lacity and Hirschheim 1993) or institutional (Ang and Cummings 1997; Hu et al. 1997; Loh and Venkatraman 1992b) factors, but again these theories do not help in explaining variability among outsourcing outcomes.
IS research on the value generation potential of an outsourcing relationship has considered three factors: client characteristics, vendor characteristics, and the vendor-client relationship (Goles 2001). A key client characteristic is an understanding of how to manage resources that a firm does not own (Elitzur and Wensley 1997; Henderson and Venkatraman 1990; Kern 1997; Lacity and Willcocks 1998; Lacity et al. 1995; Sabherwal 1999; Saunders et al. 1997; Useem and Harder 2000). This involves, for example, retaining in-house capabilities to ensure that IT resources are adequate and appropriately distributed to meet organizational requirements. It also encompasses vendor selection, relationship management, managerial competence, architecture planning, and monitoring emerging technologies (Currie 1998; Goles 2001; Lacity et al. 1995; McFarlan and Nolan 1995; Quinn 1999). Although there are few in-depth investigations of how firms develop these characteristics, their importance is widely accepted.
The major thrust of the literature on IT outsourcing outcomes investigates various aspects of the vendor-client relationship. From this literature, we learn that informal (interpersonal trust) and formal (contractual) aspects of the relationship are equally important (Poppo 2002; Sabherwal 1999) and need to be developed (Kern and Willcocks 2001; Willcocks and Kern 1998; Willcocks and Lacity 2000). Integrative work on this topic by Willcocks and Kern (2001) suggests that strategic intent as well as technical capability shape both contract structure and interpersonal relationship development. For example, a relationship that aims to tap into the technical leadership capabilities of a vendor to achieve IT efficiency may generate higher value if it is run as a partnership, whereas one that aims to achieve IT efficiency by tapping into a vendor's widely available resource pool may be better managed as a technical supply pay-per-service relationship. A recent surveybased study of outsourcing proposed that higher vendor-client alignment, teamwork, balance of control, and process agility in the relationship will lead to more successful outcomes (Goles 2001). From the standpoint of building effective relationships, we know that certain contractual methods are more conducive to value sharing. For example, empirical studies show strong support for carrot and stick incentives, shorter term contracts, and engagement of multiple vendors (Currie 1998; Lacity and Willcocks 1998). Game theoretic economics models advocate pilot projects (Snir and Hitt 2002), penalties and multi-phased contracts (Whang 1992), proper choice between time and material versus fixed-price contracts (McDonnell and Lichtenstein 2002), and risk sharing and reputation building contracting mechanisms (Elitzur and Wensley 1997).
The third factor shaping the outsourcing value proposition is the vendor's own capabilities (Goles 2001; Saunders et al. 1997; Willcocks and Lacity 2000). Despite growing interest in this factor, there has not been an in-depth examination of these capabilities and how they generate value in outsourced relationships. Through theoretical hypothesizing, Goles proposed that the vendor must possess such capabilities as technical competence, understanding of the customer's business, and relationship management. However, we are not aware of empirical investigations of vendors' competencies, which actually create value, and the ability or inability of client firms to instead generate that value internally. This gap in the literature limits understanding of outsourcing outcomes and how value is generated and transferred from vendor to client. By analyzing what a vendor does on a successful outsourcing contract, we can start to explain when and why firms find value in outsourcing.
Methodology
We chose a case study methodology for our investigation of the research question. The case study method is preferred "when 'how' or 'why' questions are being posed, when the investigator has little control over events, and when the focus is on a contemporary phenomenon within some real-life context" (Yin 1984, p. 16). The investigation of how vendors deliver value in outsourcing satisfied all of these criteria. Specifically, we conducted an explanatory case study (Yin 1984, p. 16) with the goal of posing competing explanations and developing new ones. The case study method is well established in IS research, especially when it is used for "sticky, practice-based problems" such as the value delivered by IS services vendors (Benbasat et al. 1987).
Following Eisenhardt (1989), we used the case study to build theory in a grounded and inductive fashion. We drew on a grounded theory approach (Glaser and Strauss 1967) similar to the way it was used by Orlikowski (1993) to develop theory from qualitative data. Grounded theory is a way of iteratively collecting and analyzing data in order to build first a substantive theory of a particular phenomenon and than a formal theory on its basis (Dey 1999; Glaser and Strauss 1967; Myers 1997). A key difference between our use of the grounded theory and that of Orlikowski was that we found a formal, positivistic theory (i.e., concepts of core competence and complementarity in organizational design) that explained some of our findings, whereas Orlikowski's account was interpretive.
Eisenhardt (1989) outlines the steps necessary for using a case study to build theory grounded in data. After identifying our research question, we reviewed the literature on IS outsourcing and determined that no current theory answered the research question. Thus, we started our work with no theory under consideration and no hypothesis to test--an ideal for this kind of research (Eisenhardt 1989, p. 536). We then proceeded to select our case based on the concept of theoretical sampling so that we could best answer the question posed (Glaser and Strauss 1967).
Site Selection
Since our goal was to understand how vendors deliver value to clients, we needed a case where (1) the vendor provided extensive access to individuals at multiple levels who could describe management practices and how they deliver value, (2) the client acknowledged receiving value from outsourcing, (3) the client was willing to share perceptions as to how the vendor delivers value, and (4) the contract had been active long enough to demonstrate long-term outcomes. The case we studied satisfied all of these criteria. Our site presented a rare opportunity for broad access to a successful outsourcing engagement. This case was revelatory (Yin 1984, p. 48) or exemplar in the sense that we had an opportunity to study something previously not researched, but not unique. The research method did not require multiple sites. However, replicating our study to contrast or compare it with studies of less successful outsourcing cases would provide further insights.
Data Collection and Analysis
The study employed qualitative methods to understand the socially rich nature of the vendor's management practices and of the vendor's value, as they were perceived by the client. Data collection took place in the spring of 1998. It involved a variety of techniques including unstructured and semi-structured interviews, documentation, archival records, direct observations, published sources, physical artifacts such as manuals, forms, and project archives, and follow-up e-mail and telephone interviews (Yin 1984). Semistructured interviews lasted from 40 minutes to 2 hours. Table 1 shows the types of interviewees and number of interviews. (4) One author also observed several project meetings and training sessions on-site.
In addition to ongoing field notes, where the investigator tried to record what was going on without specific focus (Eisenhardt 1989), more targeted interviews and document collection focused on six dimensions of inquiry described in Table 2. (5) Each dimension was aimed at furthering our understanding of the main unit of analysis: a practice by which the vendor provided inimitable value to the client. Our data collection was iterative: as data was collected, major themes were identified to guide further data collection, which then modified or built on prior themes and concepts (Glaser and Strauss 1967)
As suggested by Pettigrew (1990) and Eisenhardt (1989), we broke down data analysis into overlapping phases resulting in three different types of case write-ups. (Table 3 describes the analytical processes associated with each level of output.) We started with...
|
