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APR 18 1991
ALFRED
P.
J
WORKING PAPER
SLOAN SCHOOL OF MANAGEMENT
'Outsourcing' as a Mechanism of Information Technology
Cross-Sectional Analysis of Its Determinants
Governance:
A
Lawrence Loh
and
N. Venkatraman
Working Paper No. BPS 3272-91
March 1991
MASSACHUSETTS
INSTITUTE OF TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASSACHUSETTS 02139
'Outsourcing' as a Mechanism of Information Technology
Cross-Sectional Analysis of Its Determinants
Governance:
A
Lawrence Loh
and
N. Venkatriiman
Working Paper No. BPS 3272-91
March 1991
U
•OUTSOURCING' AS A MECHANISM OF
INFORMATION TECHNOLOGY GOVERNANCE:
A CROSS-SECTIONAL ANALYSIS OF ITS DETERMINANTS
LAWRENCE LOH
Massachusetts Institute of Technology
and
National University of Singap>ore
N.
VENKATRAMAN
Massachusetts Institute of Technology
March
10, 1991
listed alphabetically. Address all correspondence to Professor N.
Venkatraman at E52-537 Sloan School of Management, Massachusetts Institute of
Technology, Cambridge, MA 02139; Phone: (617) 253-5044; Bitnet:
NVENKATR@SLOAN. This research was supported by the IBM Corporation Advanced Business Ii\stitute, and the MIT Center for Information Systems Research
(CISR) research consortium on Managing Information Technology in the Next Era
(MITNE).
Authors are
Determinants of IT Oursourcing.,
'OUTSOURCING' AS A MECHANISM OF
INFORMATION TECHNOLOGY GOVERNANCE:
A CROSS-SECTIONAL ANALYSIS OF ITS DETERMINANTS
Abstract
While 'outsourcing'
popular
among
as a
mechanism
the practitioners,
community. This paper attempts
it
to
of IT governance has
become very
has received scant attention from the research
develop and
test a set
of determinants of the
degree of IT outsourcing from the perspective of production/ coordination
Based on an
initial analytical
treatment of the IT outsourcing problem,
research framev^ork for the firm's decision to outsource
its
we
costs.
build a
IT infrastructure using
three explanatory constructs- product cost structure, financing cost structure, and
business performance— with firm size and industry serving as control variables.
Empirical tests using factor analysis and multiple regression on a sample of 57 major
U.S. corporations established that business performance
and financing
cost structure
are significant determinants of the degree of IT outsourcing. Subsequently,
develop directions for future inquiry.
we
Determinants of IT Ourscmrcing-
Introduction
It is
a truism that information technology (IT) has transcended beyond
traditional administrative support role
its
towards playing a more central part of
business operations (see for instance, Ives and Learmonth, 1984; Keen, 1988;
McFarlan, 1984; Scott Morton, 1991). Within
on
centered
the use of IT to influence the boundaries of a firm as
and other intermediaries (Cash and Konsynski,
suppliers, buyers
Yates,
this tradition, the research focus
and Benjamin,
1987; Gurbaxani
and Whang,
1991).
There
it
relates to
has
its
1985; Malone,
is,
how^ever, a
glaring lack of research emphasis on the role of IT infrastructure as a component of
the firm
boundary
itself.
In other words, while IT has been considered a critical
influence on multi-organizational business relationships, the research stream has
treated the governance of IT infrastructure to be vdthin a firm's hierarchy. Such an
approach
fails to
recognize the recent trend towcirds governing the IT infrastructure
through strategic alliances with key IT vendors, or what
'outsourcing' (see
Henderson and Venkatraman, 1991
recognizing IT strategy as involving
critical
is
for
popularly termed as
an exception
in terms of
governance options). The movement
from a liierarchicar mode to a 'market' mode of IT governance has been triggered
by several
factors,
including the need to enhance IT productivity as well as improve
IT effectiveness.
While several organizations were managing the governance of
their IT
operations either viithin their hierarchies (or with a set of technology vendors on a
by Eastman Kodak
contractual basis) the decision
to
IBM,
its
microcomputer operations
and data networks
to Digital
point of departure in the
to
hand over
to Businessland,
Equipment Corporation and
mode
of IT governance.
Beyond
outsourcing has become a serious strategic option for
Group estimated that
all
and
its
its
IBM
entire data center
telecommunications
represents a major
this specific case, IT
many
firms.
The Yankee
Fortune 500 firms would evaluate outsourcing, and a
fifth
Determinants of IT Oursourcing—
of
them would
actually sign
outsourdng deals during the 1990s and that the
outsourdng market would increase from $29
billion in 1990 to $49.5 billion in 1994.1
The IT outsourcing phenomenon has been extensively documented
periodicals, but there
due
is
a lack of systematic theoretical
phenomenon.
to the recency of the
In this paper,
and empirical
we
in trade
research, partly
develop a preliminary
model on the determinants
of IT outsourcing using a set of firm-level determinants
that integrates perspectives
from business strategy and corporate finance. Testing the
model using data from a sample of 57 major
U.S. corporations,
we
empirically
demonstrate that poor business performance and high dependence on debt
financing lead to a higher degree of IT outsourcing.
We conclude with
a brief
articulation of important directions for future research.
A
Governance Model on IT Outsourcing
Within the stream of transaction cost economics (Williamson, 1975, 1985), IT
outsourcing reflects a
movement away from
governance possibly due to
its
the 'hierarchy to the 'market'
greater relative efficiency. Indeed,
of vertical integration wath suppliers of information resources
it is
To
of the
is
facilitate
and Teece,
as
1982;
1985).
systematic research,
phenomenon. Given
we need
a dear articulation of the definition
that the term 'outsourdng'
confusing and often misunderstood^,
we
is
viewed as a buzzword
that
begin by defining outsourcing in terms
of the degree of internalization of external technological
for the
of
a specific form
and can be framed
a 'make-versus-buy' choice for a firm (Anderson, 1985; Monteverde
Walker and Weber,
mode
governance of IT operations. By internalization,
and/or human resources
we mean
the possession of
ov^mership and authority rights associated to the deployment of the particular
resource. Internalization
lEckersona990).
^Wilder (1989-90).
is
an important element in the governance of
activities. It
Determinants of IT Chirsourcing..
is
analogous to concept of property rights in the
law and economics'
literature (e.g.,
Alchian and Demsetz, 1972). Technological resources refer to the entire set of
hardware and software
in the
computer and communications systems of the
firm,
while human resources refer to managers, administrators, programmers,
technicians,
and other related personnel involved
operation of the IT resources. Further,
we
in the design,
maintenance, and
argue that a simple dichotomy of 'inhouse
function' versus 'outsourcing' does not capture the complexity inherent in
managing IT
infrastructure. Consequently,
we propose
a superior conceptualization of IT outsourcing. Figure
measure
a continuous
1 is
that
is
a schematic
representation of the framework.
[Insert Figure
Based on
a critical
1
here]
review of the emerging literature on
this
phenomenon
well as discvissions with academics and practitioners in the field, four
outsourcing are highlighted within Figure
(1)
entire
is
the purest form of outsourcing,
computer and communications center
together with the related IT personnels from the user to the vendor. This
closest to the 'buy' strategy or the
specifies the strategic
responsibility in the
example, while other examples
(2) Facilities
the
market mode of governance. Here the user merely
of the IT resources. Eastman Kodak
are:
is
full
a popular
American Standard, Copperweld, and Dial.
Management Outsourcing. Here
have a significant role
is
and operational requirements, and the vendor takes
management
the IT personnel of the vendor
to operate the technological resources of the user. This
selected in those cases of shortage of specialized
operate the complex IT data centers. This
is
management agreement, where
still
technological resources.
of IT
1:
Complete Outsourcing. This mode
which involves the transfer of the
modes
as
the user
Some examples
and competent IT
is
staff necessary to
typically referred to as a facilities
bears the ownership of the
of this
mode
include: Ford
and
Unilever.
Determinants of IT Chirsourcing..
(3)
link
up
Systems Integration Outsourcing. With the recent upsurge in the need
the information systems both within
and across organizations
it
systems involving diverse hardware and software. In
many
is
contracted to
manage
the installation
to attain
necessary to deploy complex
comp)etitive advantage in the marketplace, firms find
vendor
to
instances, a single
and operations of the integrated
systems Vkith the overall responsibility for the quality and performance of the multi-
vendor environment. Users adopting
this
mode
include: Allegheny International,
American Airlines, and Boeing.
(4)
and other
to
Time-Sharing Outsourcing. This mode has long been practiced by banks
financial services companies,
run occasional batch data processing
physical IT resources
which cannot afford mainframe computers
Under
jobs.
by the user are kept
to a
this category,
minimum, while
ownership of
the IT personnel
simply buy computer time from the vendor to perform the relevant tasks.
An Analysis of the
We view
the choice of the best
activity as essentially
Outsourcing Problem
mode
of organization for any corporate
an optimization problem that minimizes the production and
governance costs associated with that
activity.
Production cost
microeconomic measure of the expenditure used
factors of production,
is
defined as the
sum
which are
we
reflected in the price
mode
we assume
mechanism. Governance
cost
and the transaction
of organization. 3 In our theoretical
adopt a production and coordination
governance choice problem. In other words,
while
the traditional
in the acquisition of the relevant
of the coordination (or bureaucratic) costs
costs associated with a particular
development,
is
we
costs perspective to the
treat these costs as
endogenous
transaction costs to be exogenous.
^The usage of the various categories of costs - coordination, governance, production, and transactiondiffers greatly between researchers in the field. Here, our definition is consistent those of Antonelli
(1988).
Determinants of IT Oursourcing._.
Our
central premise
paribus, the optimal decision of a firm
is that, ceteris
with a higher production and coordination cost function and a stronger marginal
incentive to outsource
is
to
engage
in a larger
degree of outsourcing.
We
use
s to
represent the degree of IT outsourcing, and denoting the optimal degrees of
outsourcing as
and Sl
Sj^
for the 'high-cost'
and
'low-cost' firm respectively. Let
PC(s) and TC(s) be the production and coordination cost function and transaction
We further
cost function respectively.
specify the production
and coordination
function for the Tiigh-cost' firm and 'low-cost' firm to be PCh(s)
respectively.
We
cost
and PCl(s)
have the following:
Proposition:
Proof:
When
A
PCh(s) > PCl(s) and
PC'lCs)
> PCh(s)
,
s^ > Sl
-
firm solves
Min
PC(s) + TC(s)
s
We
assume
optimal solution
order condition
that the cost functions are convex
exists.
Thus PC" >
and TC" >
0.
and
differentiable, so that
For the 'high-cost' firm, the
is
PCh(Sh) + TC'(sh) =
while that for the 'low-cost' firm
is
PCl(sl) + TC'(Sl) =
Thus we have
PCh(sh)
Supp>ose
Sp^
< Sl
•
-
PCl(s*l)
-
TC'(sh)
Then
TC"(Sl)
=>
-
TC(sh) ^
PCh(sh) - PCl(sl) >
=>
Now we
= TCis'O
PCh(Sh)
-
PCh(sL) ^
PC'lCs^}
have
PCh(Sh)
-
PCh(sl) ^
-
PCh(sl)
an
first-
.
Determinants of IT Oursourcirig..
=*
This
is
The
hierarchical
the market
to
move
in the
2,
we
illustrate the shift
vertical axis represents cost,
of outsourcing.
is
A
PCh(sl) ^
Q.ED.
mode
mode
'high-cost'
while the horizontal axis represents degree
of governance, while a point
away from
the origin corresponds to
of governance. Basically, the effect of having a 'high-cost' position
the entire production
minimum
toward more outsourcing by
point near the origin on the horizontal axis corresponds to the
and coordination
cost curve
upward. This
results
of the 'high-cost' firm's total cost curve being shifted to the right
of that for the 'low-cost' firm.
cost'
-
a contradiction. Therefore, s^ > s^
In Figure
finns.
PCl(Sl)
The end
effect is that, in the
optimal solution, a 'high-
firm will outsource a greater degree of the IT infrastructure than a 'low-cost'
firm.
[Insert Figure 2 here]
We
can also relate the performances of firms to the choice of the optimal IT
governance mode. Letting Sp and Sq denote the optimal degree of outsourcing
'poor-performing' and a 'good-performing' firm respectively,
we have
for a
the
following as the result of our previous proposition:
Corollary:
When
PCh(s) > PCl(s) and PCl(s) > PCh(s)
,
sJ,
> s^
Proof: Essentially, the profit maximization problem of the firm
isomorphic to cost minimization of the firm.
for a particular firm is
there
is
no
We
assume
that the
is
revenue function
independent of the degree of outsourcing. In other words,
difference in the quality of the products offered to the user's customers
whether the IT infrastructure
arguments similar
to
is
managed by the user
our above proposition,
profit functions that the corollary holds.
it
or the vendor. Using
follows from the concavity of the
Q.ED.
Dctenninants of IT OursourcLng..
The Research Framework
Our framework
is
based on
a
premise that the gains from outsourcing IT
operations will be critically dependent on the 'value-added' of outsourcing
stemming from
a comparative
advantage of the vendor
An
operations relative to the user.
outsourcing vendor
is
service provider serving multiple users simultaneously.
knowledge,
and systems could be pooled across
skills,
benefits of economies of scale,
perform the same
very often a specialized IT
To
the extent that the
projects, there could
undertaken by
tasks. In addition, the v/ide variety of IT projects
vendor also
arise
which are absolutely
be
which are otherwise absent when single users
the vendors permits the reaping of economies of scope.
to the
performing the IT
in
The lower
costs attributable
from the enhanced IT competence and experience, both
crucial in
managing IT
in the rapidly
of
changing information
era.
From
the perspective of the user, the lower cost of the IT infrastructure also
emanates from the competitive bidding process and possible negotiation with
multiple vendors. Gains can then extracted by the user from the vendor through
this
market
mode
of governance. In addition, the user can enhance
its
own
advantage by lowering the potential lock-in' or switching costs by introducing
"escape clauses that allows the user to migrate operations to an alternative provider
should the vendor
Hence,
we
fail
to
meet performance or other contract
stipulations."^
develop our research model parsimoniously using three constructs
reflecting the general business context, while recognizing that additional constructs
reflecting the specific IT context
model
are: (1)
may
product cost structure,
^Eckerson (199a 58)
exist.
(2)
The constructs used
in this preliminary
financing cost structure, and
(3)
business
10
Determinants of IT Oursourcing.-.
performance. In the following paragraphs,
we
argue
why
these are explanatory
constructs for IT outsourcing.
Product Cost Stnictxire
A well-accepted
axiom
in the strategy
and economics
literature is that a firm's
product cost structure (the entire spectrum of costs directly associated with the actual
production and coordination of the firm's product
of
its
line) is a significant
determinant
business performance (see for instance Buzzell and Gale, 1987; Porter, 1980).
Thus, firms, under
ceteris paribus conditioris, try to
produce
the average cost. Further, given the ubiquitous nature of IT
their
products below
— pervading
process of transforming input into output (Porter and Millar, 1985)
—
the entire
the cost
associated with a particular IT governance includes the direct technology cost and
the indirect cost of supporting the administration of the enterprise. Thus, a firm in a
situation of high relative cost will seriously consider the available options to reduce
its
cost structure including vertical integration
and disintegration of
its
manufacturing operations and IT infrastructure. Indeed, in the three often-dted
early cases of IT outsourcing, American Standard reportedly saved $2 million per
year for
its
financial
and payroll operations, Copperweld cut
$8 million to $4 million, and Foodmaker slashed
its
its
systems budget from
data processing costs by 17%.5
Other recent cases are Wabco and American Ultramar, which trimmed their annual
processing costs from $3 million to $1.8 million, and from $3 million to $1.5 million
respectively.^
Thus, in line with our earlier theoretical analysis,
product cost structure
is
we
hypothesize that the
a crucial determinant of IT outsourcing. Formally:
Hypothesis 1: The product cost structure will be positively related
degree of IT outsourcing, ceteris paribus.
SRothfeder (1989)
^Wilder (1990)
to the
.
Determinants of IT Oursourcmg—
11
Financing Cost Structure
Financing requirements of a business
overall cost of production
come
in various forms,
capital.
is
another important component in the
and coordination within the
firm. Financing resources
each associated with a different component of the cost of
Within the context of an imperfect corporate financing environment
Modigllani and Miller, 1963), risky debt
is
a
more
costly source of capital,
(cf.
compared
with internal sources such as retained earnings (Myers, 1977). This may, in part be
due
to the cost of financial distress (e.g., bankruptcy) (Baxter, 1967;
Litzenberger, 1973)
The
and agency problems (Jensen and Meckling,
Kraus and
1976).
cost of financing resources, thus, enters the cost position for production
and coordination within the firm
as highlighted in
our earlier analysis. Indeed, as
widely dted amongst practitioners increased debt "has been a major reason for
cutting costs in the IS area, thus supporting the use of outsourcing...."''
We
thus
specify the following:
Hypothesis 2: The financing cost structure will be positively related
degree of IT outsourcing, ceteris paribus.
to the
Business Performance
As noted
in a trade j^eriodical:
"Reduced
profits.. .are
causing management to
look everywhere to increase margins."^ Under conditions of poor business
performance, firms often seek to streamline their operations, including selling-off
or redeploying assets (Harrigan, 1980). With the steady increase in the level of IT
expenditure observed over the
it is
last
decade (Weill and Olson, 1989; Strassman,
1990),
not surprising that managers are more stringent in assessing the productivity of
their IT infrastructure.
Thus, the IT infrastructure
is
no longer
management team seeking superior performance. The
^Hammersmith
^Hammersmith
(1989: 90)
(1989:89)
off-limits to the top
traditional
view of IT
12
Determinants of IT Chirsourcing^
operations as a cost center or as a service center
a profit center.
With the escalating
is
level of IT investments
business in the contemporary marketplace, there
ways
infrastructure in
manner (Strassman,
In fact,
modes
of
"much
it
a
need
needed
to the notion of
to support
to reconfigvu-e the IT
possible to ascertain the benefits in a dear
of
to
what
is
fanning the
fire for... outsourcing is that
remain competitive."'
When
business
is
the firm does not perform
competition, the need to re-evaluate the traditional governance
its
all its
make
is
way
1990).
having to restructure
well vis-a-vis
that
rapidly giving
becomes even
functions, including the IT arena
with our earlier corollary,
we
thus seek to
greater. Consistent
test:
Hypothesis 3: The firm's business performance will be negatively related
the degree of IT outsourcing, ceteris paribus.
to
Methods
Sample
We began
with a sample from the
U.S. corporations carried out
of IT outsourcing.
We
by G2
list
of companies in a study of 200 major
'•°
Research, Inc.
that
provided data on
their level
also required that the level of total IT expenditures be
available to normalize the outsourcing data so as to arrive at a meaningful
measure
of the degree of IT outsourcing. Data availability (Information Week, September 10,
1990) across these
Appendix
for the
two
list
variables limited our study
of companies). Further,
we
sample to 57 firms (see the
collected data
on the independent
constructs for the fiscal year 1989 from Standard and Poor's Compustat
One Source on CD-ROM. Thus, our data represents the use
hammersmith
^^
II
and Lotus'
of multiple primary and
(1989:90)
A ranking of the IT outsourcing expenditures within
four numerical ranges
is
provided for 153 firms
September 10, 1990). Discussions with G2 Research, Inc revealed that the
outsourcing expenditures were for the period July 1988 to June 1989, and were generally consistent with
our definition of IT outsourcing. Due to the confidentiality of individual companies' data, we did an
(Information Week,
interpolation within each category to estimate the actual outsourcing expenditures for the
firms.
list
of 153
Detennmants of IT Oursourcing—
13
secondary sources corresponding to the study objectives. Based on discussions with
the managers of
G2
Research,
we
ascertained that this data base
their professional service to their clients
method
is
an integral part of
and our overall assessnnent
is
that their
of data collection and verification appeared adequate for our research
purposes. The reliability of the secondary data sources for the independent
constructs has been widely accepted.
Operational ization
We
need
we developed
firm.
to operationalize four
a ratio of IT outsourcing expenditure to total IT expenditure for each
The business
and the
cost structure
selling, general,
total assets. ^°
key constructs. For the degree of outsourcing,
was computed
liabilities
sum
goods sold
of the cost of
and administrative expenses, normalized by net
For financing cost structure,
well as of total
as the
we
sales
and
took the ratios of long-term debt as
with shareholder equity. Business performance
is
represented by return of assets and earnings per share (fully diluted and excluding
extraordinary items).
In addition,
for industry.
dummy
The
we
specified
two
control variables, one for firm size
size variables include net sales
and
total assets,
and another
while binary
variables are formed for each of the following industries: computers and
electronics, conglomerate, financial, manufacturing, natural resources, service
industries, telecommunications, transportation,
and
utilities.
Analysis
Most
studies involving financial ratios in multiple regressions
assume
the
absence of coUinearity between the various variables. In our case here, due to the
possible high correlations
among
different accounting-based measures,
ensure that the independent constructs are orthogonal. To achieve
^"^It is
necessary to
firms and
sum
these two
'costs' as
the accounting treatment
'service-type' firms in the sample.
is
this,
we had
we
to
first
not consistent for 'producf-t>-pe'
14
Determinants of IT Chirsourcing—
carried out a factor analysis using the principal
components method.
We
then
applied a varimax rotation to discern the factor pattern inherent in the data
structure.
We obtained
the corresponding scores associated with a pre-specified set of
the four factors. In our multiple regression,
we used
the proportion of IT
outsourcing expenditures as the dependent variable. The set of four factor scores and
the industry
dummies were used
as the
independent variables.
Results
Descriptive Statistics
Table
1
shows the means, standard
deviations,
and correlation matrix
key variables. The mean proportion of degree of IT outsourcing
is
for the
0.1537 with a
standard deviation of 0.1822.
[Insert
Table
1
here]
Factor Analysis
In Table
total
2,
we summarize
the results of factor analysis.
variance explained by the four factors
can directly discern four factors as follows:
structure; (3) firm size;
and
(4)
is
(1)
0.8307.
The proportion
With a varimax
business performance;
financing cost structure.
rotation,
(2)
of
we
product cost
The standardized scoring
coefficients for the factors are also reported.
[Insert
Table 2 here]
Multiple Regression
The
results of the miiltiple regression are
model has a F-value of
shown
2.11, significant at p<0.05,
in Table 3.
The
and the value of R2
overall
is 0.37.
For the
key independent constructs, financing cost structure and business performance are
significant at the 0.1
and
0.01 levels respectively
thus accept Hypotheses 2 and
3.
On
with consistent (expected) signs.
the other hand, the results for Hypothesis
reflected in the coefficient for product cost structure, does not
seem
1,
conclusive.
We
as
As
2
Determinants of IT Otirsourcing
15
for the control constructs, firm size
is
variable pertaining to utility industry
dummy
not significant and only the industry
significant (at 0.1 level).
is
[Insert
Table 3 here]
Discussion
Explaining the Results
The empirical
this paper. Specifically,
critical
it
app>ears that the business performance factor
determinant for the change in the
reflects a colloquial
profitability,
model proposed
results generally support the theorerical
American maxim:
"If
mode
it
is
in
the most
of IT governance. In a way, this
ain't
broken,
why
fix it?"
Low
however, strongly motivates drastic restructurings, moves
that
may
signal to the capital markets the strong comn\itment of corporate
management
improve the firm's future performance. Furthermore, the iDottom
line'
controlled
by the
'variable costing' advantage of IT outsourcing, as
traditional 'fixed costing' of inhouse function. Indeed,
survival in the 1990s'
where the reason
is:
recommended by
one of the
a trade periodical
to
can be better
opposed
to the
'top ten tips for IS
consider outsourcing,
is:
"Tougher competition and profit pressures
will force
more
IS
executives to take a hard look at outsourcing functions and services that
traditionally
have been done in-house."^^
The need
to mitigate debt financing
resources are the driving force in funding
is
also supported
critical fixed asset
company. These resources are scarce and need
aptly noted by a top IS executive
"-.another important reason
was
14)
^'^Computerworld (1989: 72)
to
why we
results. Financial
investments of the
put to their most efficient use. As
whose company outsourced
its
IT function,
turned our data processing over to outsiders
the proper allocation of resources."^
"LudJum (1989-90:
by our
16
Detenninants of IT Oursourcing—
The
results relating to the
selling, general,
conclusive.
The
product cost structure (cost of goods sold and
and adnunistrative expenses) are
direction of change
insignificant
and hence not
also contrary to expectation.
is
One
explanation
could be that the proportion of IT infrastructure costs on the overall product costs
is
minimal, and that the imperative to outsource IT operations does not necessarily
stem from a high
we
product costs (with lower IT proportion). Given our data,
level of
could not develop a better measure to capture this proportion.
Firm
size as a control variable
view
that the traditional
infrastructure
involved
is
many
that small
not supported. In
Icirge firms.
is
not significant. The specific implication
companies tend
fact,
to outsource the expensive IT
the recent spate of IT outsourcing has
As underscored by
a trade periodical:
"No matter what
the reasons for outsourcing, companies of varying size can benefit from
As
for industry variables, except for utility industry
significant,
none seems
status of a natural
pricing
and
to
be
monopoly,
profits.
The
critical.
is
is
The
which
is
it.''^^
negatively
utility industry, often associated
with the
on
a highly regulated one, with strong limitations
prop)ensity to
improve efficiency via IT outsourcing may
hence be smaller. Although higher profits can be attained in the short run via IT
outsourcing, the gains
may
eventually be eroded by
more
stringent control
on
allowed rates of return in the future.
Toward
a
Comprehensive Model of IT Governance
Transaction Cost Perspective. Our approach has been to delineate a set of
constructs related to the internal costs
and performance of a firm from the
perspective of production and coordination.
constructs
from external governance
costs
A
(i.e.,
constructs such as asset specificity, complexity
^^Hammersmith
(1989: 92)
natural extension will be to include
transaction costs), reflected in specific
and small numbers. In addition,
it
Determinants of IT Oursotudng.,.
may
be appropriate to
reflect
influence costs (Milgrom
activity.
17
refinements such as the articulation of bargaining and
and Roberts, 1990)
in the organization of
economic
Within the dataset assembled here, archival data for such constructs were
not available.
- would be
to
A
future line of inquiry
-
presently under design stage by the authors
understand and predict not only the degree of IT outsourcing but also
the type of outsourcing (see Figure
1)
along such an extended transaction cost
perspective using primary data.
Explanatory Variables Reflecting the IT Context. The preliminary model
developed here primarily captured the business context that directs the shape of IT
activities.
While
this represents
an important
facet,
an equally relevant facet
IT context. This could capture emerging constructs such
as: criticality of
is
the
IT in
operations, the role of IT in products/ processes/administration, IT scope and
systemic competence as a
way
of aligning the business context with the IT context of
& Venkatraman,
the firm (Henderson
1991).
To
reflect
such constructs,
we
attempted to adopt the approach of structured content analysis of annual reports
employed by Jarvenpaa and
Chairman/Presidenf s
Ives (1990).
letters to the
However, using our sample, only 26
shareholders were available; and within these,
only five occurrences of relevant key phrases
study
—
pxjssibly
due
to the
(far less
than the Jarvenpaa and Ives
heterogeneous nature of the industries represented in
our sample) were found. However, a meaningful line of future inquiry would be
op>erationalize a set of constructs relating to the IT context via
of testing the relative importance of business
and IT contexts
to
primary data as a way
in explaining the
degree and type of IT outsourcing.
A
Process Model of IT Outsourcing.
model (Mohr, 1982)
to focus
mode
on
We
have developed
for explaining IT outsourcing in firms.
the organizational processes underlying the
of governance
by developing
A
a limited 'variance'
powerful extension
management
a 'process' model. This
would go
is
of this IT
a
long
way
in
.
Determinants of IT Chirsgurcing—
18
enhancing our understanding of the emerging phenomenon in the marketplace.
Such a process model
may
incorporate
responsibility; property rights;
and
new
structures
risk-bearing),
(e.g.,
shared authority;
management processes
allocation
and coordination of resources; performance assessment; and
planning),
and managerial
roles (e.g., liaison; decision-making;
(e.g.,
joint
and leadership)
that
are required to effectively derive the benefits of this governance mechanism.
Conclusion
In this paper,
we have
analyzed the
effects of
and business performance on the IT governance
research framework
were used
and financing
determinants of the degree of IT outsourcing.
research were also highlighted.
With the increased
cost
choice.
as a foundation for
indicated that business performance
The
production/ coordination costs
An
and
analytical treatment
our empirical
testing. Results
cost structure are significant
Some
possible directions of future
interest in IT outsourcing
is
definitely not a fad.
and complexity of IT investments and operations, the
shortage of skilled IT personnel, and the need to focus on core business and not
problems associated with IT management, outsourcing remains a very viable
alternative. Indeed, as argued, "[o]utsourcing is here to stay;
pan
or a temporary solution."^^The challenge for corporate
era of IT rationalization
is
aptly
question fadng IS departments
outsource."i5
I'kDltman (1990: 77)
^^Wilder (1989-90: 8)
summed
is
it is
not a flash in the
management
in the
up: "in the 1990 and beyond, the key
not only whether to outsource, but what to
new
Determinants of IT O\irsourcing._.
iq
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22
Determiiiants of IT Oursourcmg„
APPENDIX
List of
Aetna Life and Casualty Co
Air Products and Chemicals
Amax
Annco
Inc
Inc
Ashland Oil Inc
Atlantic Richfield
Companies
in the
Sample
Harrier Inc
Homefed Corp
Illinois Power Co
Ingersoll Rand Co
Keycorp
Co
Lincoln National Corp
Mack Trucks Inc
Bank of Boston Corp
Bankamerica Corp
Baxter International Inc
International
Chrysler Corp
Champion
Manufacturers Hanover Corp
NCR Corp
Corp
Norfolk Southern Corp
PNC
Corp
Financial
Consolidated Rail Corp
Continental Bank Corp
Control Data Corp
Quantum Chemical Corp
Reynolds Metals Co
Coming Inc
CSX Corp
Rohm and Haas Co
Dow
Security Pacific
E
I
Chemical Co
Pont De Nemours and Co
Du
Duke Power Co
Eastman Kodak Co
Rockwell International Corp
SCECorp
Texaco Inc
Textron Inc
Corp
Entergy Corp
Travelers
Bank System Inc
Reming Cos Inc
Geico Corp
General C^amics Corp
UAL Corp
General Electric Co
General Re Corp
Great Western Financial Corp
U S Air Group
First
GTE Corp
Corp
Sun Co Inc
Union Carbide Corp
Unisys Corp
United Technologies Corp
Inc
Valley National Corp
Westinghouse
Electric
Corp
Determinants of IT Oursoujcing.
23
TABLE
1
Descriptive Statistics
1(a)
Variable^
Means and Standard Deviations
24
Determinants of IT Oursourcing.-.
TABLE 2
Factor Analysis Results
2(a) Factor Pattern
Determinants of IT Oursourcing-
25
TABLE 3
Multiple Regression Results
26
Determinants of IT Ourso\iTcing„
FIGURE 1
A Definitional Framework of Outsourcing
Figure
1:
Alternative
Modes
of IT
Governance
High
Rental
Complete
Inhouse
Contracts
Operations
Time-sharing
Outsourcing
(A
(IV)
Installation/
Procurement
Contracts
•^ VM ii
Systems
Integration
o
ri
s
Outsourcing
Maintenance/
(HI)
Programming
Contracts
Facilities
Low
Complete
Management"
Outsourcing
Outsoiu-cing
(n)
(I)
Low
Internalization
of
Technological Resources
High
Determinants of IT OursourcLng.,.
27
FIGURE
Effects of Cost Structure
2
on IT Outsourcing
Cart
H
Degree of IT
Outsouning
b27b
1.82
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