determinants of information technology outsourcing… · determinants of information technology...

Determinants of Information TechnologyOutsourcing: A Cross-Sectional Analysis

LAWRENCE LOH AND N. VENKATRAMAN

LAWRENCE LOH is a doctoral candidate in the Sloan School of Management atMassachusetts Institute of Technology. He is also a senior tutor in the Faculty ofBusiness Administration at National University of Singapore. His current researchinterests include information technology outsourcing, corporate governance, anddiffusion of innovation. His research has appeared in the Journal of BusinessResearch and he has presented papers at the Academy of Management NationalMeeting and the TIMS/ORSA Joint National Meeting.

N. VENKATRAMAN is Richard S. Leghorn Career Deveiopment Associate Professorof Management in the Sloan School of Management at Massachusetts Institute ofTechnology. His current research interests intersect strategic management and infor-mation technology. At Sloan, he teaches a course on strategic management andinformation technology and his research projects deal with the causes and effects ofelectronic integration and information technology strategy, especially the manage-ment of infonnation technology outsourcing. His doctoral thesis was awarded the 1986AT Kearney Award for Outstanding Research in General Management by the Acad-emy of Management and his research papers have appeared in the Academy ofManagement Journal, Academy of Management Review. Information Systems Re-search, Journal of Management Information Systems, Management Science, StrategicManagement Journaly and he has presented papers at several professional meetings.He serves on the editorial boards of Academy of Management Review. Journal ofManagement Information Systems, Organization Science, and Strategic ManagementJournal.

ABSTRACT. This paper develops and tests a mode! of the determinants of informationtechnology (IT) outsourcing by integrating both business and IT perspectives. Specif-ically, we attempt to explain the degree of IT outsourcing using business and ITcompetences as represented by their cost structures and economic performances. Inaddition, we posit that outsourcing is dependent on business govemance, particularlyfinancial leverage. Based on factor analyses and multiple regressions using data fromfifty-five major U.S. corporations, we observed that the degree of IT outsourcing ispositively related to both business and IT cost structures. We also established that thedegree of IT outsourcing is negatively related to IT performance. Finally, we concludewith implications and future research directions.

Acknowledgments: Authors are listed alphabetically.Thisproject was supported by the researchconsortium on Managing Information Technology in lhe Next Era (MITNE) of lhe Center forInformation Systems Research (CISR) at the Massachusetts Institute of Technology. We tliankJohn Rockart. Judith Quillard, three journal reviewers, and the Editor-in-Chief for commentson earlier versions of the paper.

Journal o/MaMogemginfii/bmaiioHSysttms/SwrmusT 1992. Vol. 9. No, 1, pp. 7-24

Copyri^l © 1992. M.E Sharpe. Inc.

8 LOH A>a3 VENKATRAMAN

KEY WORDS AND PHRASES: information technology outsourcing information technol-ogy strategy.

IT IS A TRUISM THAT INFORMATION TECHNOLOGY (IT) has transcended its establishedadministrative support function and has moved toward playing a more central role ofbusiness operations (see, for instance, [14,18,25,35]). Within this tradition, researchefforts have focused on the use of IT to influence ihe boundaries of a firm with itssuppliers, buyers, and other intermediaries [6,8,21]. There is, however, a glaring lackof research emphasis on the role of IT infrastructure as a component of the firmboundary itself. In other words, while IT has been considered a critical mechanism ofmultiorganizational business relationships, the research stream has treated the gover-nance of IT infrastructure as if it were within one single firm's hierarchy. Such anapproach fails to recognize the recent trend toward managing a firm's IT infrastructurethrough a variety of governance mechanisms with otber firms.

Under contractual arrangements popularly termed "outsourcing," firms are increas-ingly shifting specific components of their IT infrastructure away from a "hierarchi-cal" mode toward a "market" mode of governance. The well-publicized decision byEastman Kodak to hand over its entire data center to IBM, its microcomputeroperations to Businessland, and its telecommunications and data networks to DigitalEquipment Corporation and IBM is a classic illustration [43,45]. Beside this particularcase, it appears that IT outsourcing is becoming a serious strategic option for manyfirms. The Yankee Group estimated that all Fortune 500 firms would evaluateoutsourcing, that a fifth of them would sign outsourcing deals during the 1990s, andthat the outsourcing market would increase from $29 billion in 1990 to $49.5 billionin 1994 [7].

IT outsourcing can bo dependent on several factors across multiple levels. At thelevel of the economy, ilie temporal effects of trends and cycles may motivate firmsto rationalize the management of the IT infrastnicture through arrangements likeoutsourcing. At an industry level, competitive pressures may induce firms toestablish "partnership-based" relationships with key IT vendors. At the firm level,the quest for competitive advantage may serve as a critical impetus to the IToutsourcing decision. Within the firm, the decision to outsource may be dependenton several managerial factors. For instance, managers may like to build empiresby accumulating control over corporate resources [27] such as the IT infrastruc-ture. Further, the association of information with power [17] may inhibit theoutsourcing decision.

The practice of IT ou^wurcing has been extensively documented in the businessperiodicals, but there is scant attention provided to articulate its determinants. In otberwords, we know the phenomenon in some detail but we do not fully grasp the set offactors leading to the outsourcing decision. Our objective in this paper is to developa research model on the determinants of IT outsourcing. We recognize Ihc complexarray of factors discussed above; but as a first attempt at establishing an empiricalmodel, we focus on factors at \ht,firm level with appropriate controls for industrysector effects.

DETERMINANTS OF IT OUTSOURCING 9

Frameworks of IT Outsourcing

OUTSOURCING CAN BE FRAMED as a "make-versus-buy" decision facing a firm. In itsgeneric form, it has been studied in several settings, such as the manufacturing of partsin the automobile industry [30, 40], the sales function in the electronic industry [1],the procurement of components or services in the naval shipbuilding industry [23],and the distribution of equipment, componcnis, and supplies across a broad set ofindustrial firms 116].

Within lhe IT profession, lhe term "outsourcing" is often viewed as a buzzword thatis confusing and often misunderstood [44]. We define IT outsourcing as the significantcontribution by external vendors in the physical and/or human resources associatedwith the entire or specific components of the IT infrastructure in the user organization.This definition is consistent with the conceptualization of the IT infrastructure in termsof "the intemal organization of people and resources devoted to computer-basedsystems . . . [involving] both the tangible equipment, staff and applications and theintangible organization, methods and policies by which the organization maintains itsability to provide system services" [22, p. 148].

In the context of IT sourcing, vendors may contribute computer assets for the user.Alternatively, the ownership of certain computer assets of the user may be transferredto the vendor. Similarly, vendors may utilize Iheir personnel to provide the requiredservices, or existing staff of the user may he employed by the vendor. In figure 1 wedepict the distinction between outsourcing and insourcing based on the two dimen-sions central to our definition: (1) the degree of intemalization of physical resourcesby the user, and (2) the degree of intemal ization of human resources by lhe user. Byintemalization, we mean the ownership of the computer assets or the employment ofthe system personnel. Several modes of the IT infrastructure have heen commonlyoutsourced by firms. These include applications development, data center, systemsintegration, systems design/planning, telecommunications/network, and timeshar-ing. The modes of IT outsourcing vary through the different levels of contributionof physical and human resources by the user and the vendor. We also illustrate inthis figure the typical location of each mode of outsourcing in the definitionalframework.

The various modes of IT outsourcing also differ in the domain of influence withinthe corporation. Domain of influence refers to the extent to which IT is inherent in thebusiness processes as well as the administrative and functional coordination of theorganization. For instance, an application development outsourcing arrangementordinarily affects a specific domain of the firm, while a telecommunications/nelworkoutsourcing arrangement may affect a more general domain of the firm. Further, anoutsourcing arrangement differs in terms of the contractual mode (i.e., the type ofrelationship between lhe user and the vendor as governed by the agreement). Forexample, a systems design/planning outsourcing contract may be project-based, whilea data center operations outsourcing contract may be period-based. In figure 2 weshow the characteristics framework and illustrate the various modes of IT outsourcingalong the two above dimensions.

10 LOH AND VENKATRAMAN

H.gh

Intemalizationof HumanResources

Low

INSOURCING

OUTSOURCING

I Data II Center I I Application

I Development

LowIntemalization

ot' PhysicalResources

H.gh

Figure L Outsourdng versus Tnsourcing

The Research Model

IN THIS PAPER, WE DEVELOP A MODEL of ihc determinants of IT outsourcing, with aparticular emphasis on economic constructs from both the business and the ITcontexls. Our framework is based on an argument that management should constantlyreassess the scope of those activities that should be carried out with a firm's hierarchyand those that are best performed by extemal partners, including IT vendors. Theguiding considerations for such make-versus-buy decisions include: relative costadvantage, and economies of scale and scope. Thus, it is likely that in some cases, anIT vendor may be a more appropriate entity to manage Ihe firm's IT infrastructurethan the firm itself. This is because an outsourcing vendor—being a specialist—servesmultiple users simultaneously. To the extent that the knowledge, skills, and capacitycan be pooled across different customers, there ean be benefits of economies of scale,which are otherwise absent when single users perform the same tasks. In addition, thewide variety of IT projects undertaken by the vendors permits the reaping of econo-mies of scope. The lower costs attributable to the vendor also arise from the enhancedIT competence and experience, both of which are absolutely crucial in managing theIT infrastructure in the complex and rapidly changing information era.

DETERMINANTS OF rr OUTSOURCING U

General

CorporateDomain

Specific

Syslcms rteiPlan II ing

Telecoms/Network

Systems Integration

Center

Application Development

DataProcess jpg

Project-Based Period-Based

Contraclual Mode

Figure 2. CharacterisUcs of Different IT Oulsourcing Modes

We follow Henderson and Venkalraman's [12] model of aligning business and ITdomains to derive ihe specific constructs of the research model. Thus, business andIT strategies are viewed as involving the dimensions of competence and governance.Further, we posit that IT governance (specifically, outsourcing) is dependent on thestructural characteristics of the user organization, especially business competence,business governance, and IT competence. We elaborate our rationale below.

Business Competence

Business Cost Structure

A well-accepted axiom in the strategy and economics literature is that a firm *s businesscost structure (the entire spectrum of costs directly associated with tbe actual produc-tion and coordination of the firm's product line) is a significant source of businesscompetence given its role in explaining business profitability (see, for instance, [5,32]). Thus, firms try to produce their output below the average cost and are constantlyunder pressure in a competitive marketplace to reduce the relative cost of businessoperations. Given the ubiquitous nature of IT, which pervades the entire process of


transforming inputs into outputs [33], the costs associated with a particular ITgovemance include the direct technology cost and the indirect cost of supporting theadministration of the enterprise. Thus, a firm in a situation of high relative cost willseriously consider the available options to reduce its business cost structure, includingreassessing the positioning of its IT infrastructure within the scope of the firm'shierarchy.

Therefore we hypothesize that a firm's business cost structure is a crucial determi-nant of IT outsourcing;

Hypothesis 1: The firm's business cost structure will be positively related to thedegree of IT outsourcing.

Business Performance

Another component of business competence is reflected by the level of businessperformance. As noted in a trade periodical: "Reduced profits . . . are causing man-agement to look everywhere to increase margins" [9,p. 89]. Under conditions of poorbusiness performance, firms often seek to streamline their operations, including sellingoff or redeploying assets [10]. The traditional view of IT operations as an investmentcenter or a service center is rapidly giving way to an emergent notion of a profit center.Thus, the IT infrastructure is no longer off limits to the top management team seekingsuperior performance. In fact, "much of what is fanning the fire for . . . outsourcing isthat business is having to restructure to remain competitive" [9, p. 90]. When the firmdoes not perform well vis-5-vis its competition, the need to reevaluate the traditionalgovemance modes of all its major spheres of operations, including the IT arenabecomes even greater. We thus seek to test:

Hypothesis 2: The firm's business performance will be negatively related to thedegree of IT outsourcing.

Business Govemance

Financial Leverage

The need to reduce reliance on debt financing has been one of the key impetus tooutsource the IT infrastructure. Indeed, as widely cited among practitioners, increaseddebt "has been a major reason for cutting costs in the IS area, thus supporting the useof outsourcing" [9, p. 90]. Within the context of an imperfect corporate financingenvironment (see [28]), financial leverage can result in problems relating to financialdistress or bankruptcy [3] as well as agency [15]. Further, the cost of equity capitalincreases with financial leverage [13].

Debt and equity have been argued to be more than altemative financial instmments:they are different business govemance stmctures [47]. Accordingly, it is posited thatthe choice between debt and equity depends on the characteristics of the assets in


which the funds are used. Debt govemance is more appropriate for financing redeploy-able assets, while equity govemance is more suitable for nonredeployable assets. Dueto the complex and customized nature of systems, applicalions, and staff, the degreeof redeployability of an installed IT infrastracture may be limited. Thus, debt gover-nance is not the optimal foim of business govemance. A high level of debt henceresults in a need to reduce the non-redeployable assets which then gives rise to a greaterlevel of IT outsourcing. Thus we test

Hypothesis 3: The firm'sfinancial leverage will be positively related to the degreeof IT outsourcing.

I T Competence

r r Cost Structure

Investment in IT has recently escalated, and its importance is nowhere less evidentthan in its dramatic increase from $55 billion to $190 billion in the economy; in fact,IT accounts for about balf of most large firms' capital expenditures [18]. Due to theenormous outlay associated with the IT infrastructure, firms have found it necessaryto adopt a better cost control approach to IT. In line with this notion, IT must be treatedas a capital investment and not just an overhead of lhe firm. Firms have been plaguedby the astronomic rise of IT expenditure in many specific IT areas that are necessaryto run the business. For instance, in the area of application development, a criticalproblem has been the control of the cost of internally conceived software [11].Consequently, corporations arc rationalizing iheir capital outlay on IT. Where possible,drastic restructuring of the traditional inhouse mode of IT govemance is undertaken totrim the high costs of IT infrastniciurc. As Weizerand Associates [42] put it: "Outsourcingcan free capital tied up in data center hardware and save operating costs."

An extremely attractive option available to firms is to outsource their IT infrastruc-ture to value-added vendors who are more efficient in terms of managing and operatingthe IT. In three often-cited early cases of IT outsourcing, American Standard report-edly saved $2 million per year for its financial and payroll operations, Copperweldcut its systems budget from $8 million to $4 million, and Foodmaker slashed its dataprocessing costs by 17 percent [36]. Other recent cases are Wabco and AmericanUliramar, which trimmed iheir annual processing costs from $3 million to S1.8 million,and from $3 million to $1.5 million respectively [46]. We thus seek to verify:

Hypothesis 4: The firm's IT cost structure will be positively related to the degreeof IT outsourcing.

IT Performance

With the elevation ofthe role of ITIrom the "backroom" to lhe "frontline" of businessoperations, firms are making IT directly accountable for its direct contribution to lhe


overall corporate profitability. The profit-oriented posture imposed on the IT infra-stmcture puts intense pressure on the technology to result in tangible economic returns.With the escalating level of IT investments needed to support business in the contem-porary marketplace, there is a need to reconfigure the IT infrastructure in ways thatmake it possible to ascertain the benefits in a clear manner [38]. As IT expenditurehas risen rapidly over the last decade [41], it is not surprising that managers arc morestringent than ever before in assessing the productivity of their IT infrasmicture. Thus,when economic profits fall in relation to IT investments, management faces animmense need to reevaluate the roleof IT. As efficiency of organizing is tied intimatelyto the mode of govemance, it is natural that there is a greater shift from the usualinhouse management to extemal involvement. Indeed, it has been the view within thepracticing and consulting IT communities that "outsourcing is a key strategy thatenable [companies t o ] . . . improve retum on equity" [31]. Therefore, we test:

Hypothesis 5: The firm's IT performance will be negatively related to the degreeof IT outsourcing.

Figure 3 is a schematic representation of the research model with the five hypotheses.

Methods

Sample

WE BEGAN WITH A SAMPLE FROM THE UST of companies in a study of 200 major U.S.corporations carried out by G2 Research, Inc., which provided data on their level ofIT outsourcing [24]. We also required that the level of total IT expenditure be availablefor operationalizing some of our independent constructs. Data availability across thesetwo variables limited our study sample to fifty-seven firms (see the appendix for thelist of companies). We collected corresponding data on the independent constructspertaining to each firm in our sample for the fiscal year 1989 from Standard and Poor'sCompustat II and Lotus' CD/Corporate on CD-ROM.' Thus, our data represents theuse of both primary and secondary sources. During discussions with the managers ofG2 Research, we ascertained that the data on outsourcing expenditure are an integralpart of their professional service to their clients. Our overall assessment is that theirmethod of data collection and verification meets the standards of our researchpurposes. Further, the integrity of the secondary data sources for the independentconstmcts is widely accepted within accounting, economics, and finance research.

Operationali zation

We need to operationalize four key constructs. For the degree of outsourcing (Y), wedeveloped a ratio of IT outsourcing expenditure to total assets for each firm so that

DETERMINANTS OF FT OUTSOURCING 15

Business Governance

Compelence

/ ^ \/ Business \1 Cost Structure K

V yf Business \( Perfurmance Y

KzzyH2(-)

f Financial \1 Leverage 1

^^—

ITCompetence

H3(+)

^ — ^

I IT \ ^I Outsourcing 1

IT GovernanceII5(-)

4 CosI Slructuro I

V y1 IT \

T Performance 1

Figure 3. The Research Framework

the level of IT outsourcing is normalized by firm size. The business cost structure (X{)was computed as lhe sum of the cost of goods sold and the selling, general, andadministrative expenses, divided by net sales and total assets.^ Business performance(X^) was capttu^ed by retum of assets and earnings per share (fully diluted andexcluding extraordinary items), representing the economic efficiency of lhe entirebusiness as measured by its assets or equity. For financing leverage (X^), we look theratios of long-term debt as well as of total liabilities with shareholder equity.

Operationalization of constructs in the IT context is more difficult given the paucityof prior research. The metric used lo evaluate lhe effectiveness of IT has evolved fromcode analytic (1970-78), through design analytic (1978-84) and function analytic(1984-90), to thecurrent business directed (1990-present) measures [37]. In short, thecriteria used are shifting from metrics thai focus on IT output to those that focus onthe economic outcomes of IT activities. Further, it has been argued that the economicbenefit of information systems can be best evaluated by measurements pertaining tothe company's entire IT expenditure level, as opposed to the economic benefitsderived from individual systems [4]. Thus, for IT cost structure (X4), we used (he ratioof IT expenditure with both gross plant, property, and equipment (i.e., before depre-ciation) and net plant, property, and equipment (i.e., after depreciation), which is analogousto the extent to which the physical infraslructure of lhe firm is represented by the ITinfrastructure. IT performance (X5) was measured by ncl income and sales divided by ITexpenditure, which corresponds to lhe economic efficiency of the IT assets.


In addition, we specified two control variables, one for business size (X^) and anotherfor industry (X^). The size variables included net sales and total assets, while binarydummy variables werc formed for service and industrial sectors.

Analysis

Due to the possibility of multicollinearity among our independent measures, weperfonned a factor analysis using the principal components method and a varimaxrotation to discem the factor pattem inherent in the data structure. This procedureensures thai the independent constructs used for our subsequent regression are orthog-onal. We obtained the corresponding scores associated with a prespecificd set of thefour factors for the business context and two factors for the IT context. In our mul tipleregression, we used the ratio of IT outsourcing expenditure to total assets as thedependent variable and the set of factor scores for the business and the IT contextsand the industry sector dummy variable as the independent variables. The econometricspecification for our analysis is as follows:

(1) r = po + piXi -

where e represents the random error.

Results

Descriptive Statistics and Factor Structure

TABLE I SUMMARIZES THE MEANS AND STANDARD DEVUTIONS for all the individualindicators, while Table 2 provides the matrix of zero-order correlations. In Table 3,we depict the results of factor analysis for the business and IT contexts. With a varimaxrotation, four factors in the business context can be interpreted: (1) business perfor-mance; (2) business cost stmcture; (3) business size; and (4) financing leverage. Twofactors extracted for the IT context can be interpreted as: (1) IT cost stmcture, and (2)IT performance.

Test of Hypotheses

The results of estimating equalion (1) are shown in Table 4. The overall model hasan F-value of 2.10 (p < 0.06), and explains about 24 percent of the variance, which isacceptable for an exploratory research and a limited number of independent variables.In the business context, we accept HI since the coefficient for business cost structureis significant at the 0.05 level with the expected sign. In the IT context, we accept H4and H5 since the coefficients for IT cost stmcture and IT performance are significantat the 0.1 and 0.05 levels, respectively. In contrast, the other two hypotheses (H2 and


Table 1 Means and Slandard Deviations

Description

Outsourcing Expenditure/ Total Assets

Cost of Goods Sold-nSelling, General, &Administrative Expenses/ Sales

Cost of Goods Sold+Selling, General, &Administrative Expenses/ Total Assets

Lons-Term Debt/ Shareholders' Equitv

Total Liabilities/ Shareholders' Equitv

Return on Assets

Earnings per Share ($)

IT Expenditure/ Gross Plant, Property, &Equipment

IT Expenditure/ Net Plant, Property, &Equipment

Net Income/ IT Expenditure

Sales/ IT Expenditure

Total Assets ($ million)

Sales ($ million)

Service Sector

Industrial Sector

Variable

OSTA

CSSA

CSTA

LDSE

TLSE

REOA

EAPS

ITGP

ITNP

NUT

SAIT

ASSE

SALE

SERV

INDU

Mean

0.002578

0.8336

0.6754

0.4783

5.138

0.02667

3.089

0.1355

0.1522

2.385

56.91

21000

9405

0.5965

0.4035

Std Dev

0.004085

0.1555

0.6706

1.989

7.005

0.06765

5.257

0.1748

0.1738

7.298

44.81

26500

9877

0.4950

0.4950

H3) relating to business performance and financial leverage in the business contextare not supported. Further, the two control variables did not emerge as significant.

Discussion

THE EMPIRICAL RESULTS PROVIDE GENERAL SUPPORT for our research model. First,HI was accepted, which suggests that the business cost structure is a critical determi-nant of IT outsourcing. A high level of business cost structure may motivate a firm toreview its overall cost structure reflected in its costs of physical infrastructure (suchas plant and equipment), including its IT infrastructure. Such restructuring may signalto the capital markets the strong commitment of corporate management to improve itsbusiness efficiency. Further, as IT pervades the entire value chain of the business, theadoption of IT outsourcing may result in a superior control of the business through the

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Table 3 Factor Analysis Results

3(a) Factor Structure for Business Context

EigenvalueCum. Prop, ofVar. ExplainedVariablesCSSACSTALOSETLSEREOAEAPSASSESALE

Factor 11 BusinessPertormancel:.3?hlI) 2945

Factor 2(Business CostSlructure)1.48bO0.5428

Factor 3<Busines5 Size)

1.30700.7062

Factor 4(FinancUiLeverage)

0.S308

Rotated Factor Pattern-0.0287-0.0191•0.0270-0.23230.92570.9257-0.05860.1780

0,79090.S6U0.0981•0.4195-0.08610.0474-0.42250.1413

-0.01940.05130.11280.00090.13190.S2I70.9. 21

0.0187-0.12330.91720.7561-0.1503-0.03240.2159-0.0132

3(b) Factor Structure for IT Context

EinenvalueCum. Prop, ofVar. ExplainedVariablesITGPITNPNIITSAIT

Factor 1(IT CostStruclurel

2.07820.51%

Factor 2IIT Performancel

1.08220.7902

Rotated Factor Pattern0.97SS0.98140.2032-0.3246

-0.0241-0.03800.S2460.6409

Note; See Table 1 tor a description of the variables.

"variable costing" of IT outsourcing, as opposed to the traditional "fixed costing" ofinhouse govemance.

Second, H4, which posited a positive relationship between IT cost structure andoutsourcing, was empirically supported. As noted in a trade periodical, "Outsourcingis being seriously considered in more and more organizations as a poteniial solutionto rising IS [information systems] costs" [9, p. 89]. To compete effectively in lhemodem informalion era, complex and costly systems are required to support andpropel a corporation in its quest for competitive advantage. In particular, the keycompelling force driving companies to outsource is cost savings: "In some cases,outsourcing vendors have promised to reduce annual IS outlays by 50%, although 15%to 30% savings are more common" [7, p. 47]. Thus, our empirical finding is consistentwith the prevailing view regarding the need lo rationalize the IT cost structure in orderto slay competitive in the market.

Third, H5, which specified a negative relationship between IT performance andoutsourcing, was also empirically supported. Low economic retums on IT investmentappear to affect the propensity of firms to outsource more of their IT infrastructure tovendors. The present dilemma facing many IT executives appears to be a justification


Table 4 Multiple Regression Results

Constant

Busine.ss CosI Structure<Xi)

Business Performance (X2)

Financial Leverage (X3)

IT Cost Structure (X4)

IT Performance (X5)

Business Size (X6)

Service Sector (X7)

Model Fit

OLS Estimate

0.{X)32I7

0.001498

0.000548

-0.000313

0.000806

-0.001520

0.000255

-0001017

F = 2.I0

StandardDeviation0.000902

0.000637

0.000623

0.000579

0,000621

0.000655

0.000543

0.001251

R2 = 0.24

Significance

(••)

(•)

Nole: (*"), ("), and (") denote one-tailed significiince at 0.01, 0.05, and 0.10 levels respeclively.

of investing in an IT infrastructure based on its productivity. Although there are severalpossible metrics to gauge the perfomiance of IT such as reliability, quality, timeliness,and the like, our results suggest that economic measures are valid indices to evaluatethe productivity of IT in terms of the adoption of an efficient mode of IT govemance.

Fourth, we did not find empirical support for H2—which specified a negativerelationship between business pcrfoimance and outsourcing and H3—which specifieda positive relationship between financial leverage and outsourcing. The generalimplication from these two results is that business performance and financial leveragemay be too far removed in terms of influencing the level of IT outsourcing direcUy.Although we specified direct effects, which were not empirically supported, we urgethat future research consider indirect effects (for example, through business and/or ITcost structures) or moderator effects.

Finally, both business size and industry sector as control variables did not emergeas significant determ inants. The implication is lhat our results are generally robust andvalid across firms differing in sizes (within the spectrum covered by the sample) aswell as industry versus service categorization.

Toward a Comprehensive Model of IT Govemance

While we have provided some empirical support for a set of conventional wisdomregarding IT outsourcing in this paper, we recognize the limited scope of our model.We suggest a set of directions for refining this line of inquiry in lhe future. As wemove away from the consideration of a firm-level focus using a neoclassical economicperspective, we identify three avenues of future research: (a) an organizationiU


economic model of IT oulsourcing; (b) a diffusion process model of IT outsourcing;and (c) an organizational process model of IT outsourcing.

An Organizational Economic Model of IT Outsourcing

Research in the general arena of make-versus-buy (including outsourcing) has beenanchored within an organizational econ(Mnic perspective [2], especially transactioncosttheory(forareview,see [48]). In addition.agency theory with particular emphasison constructs such as goal alignment, incentive payment, and monitcning [15] has thepotential to provide insights on the govemance of IT outsourcing. Moreover, it maybe appropriate to reflect refinements such as the articulation of bargaining andinfluence costs [26] in the govemance of IT infrastmcture. For instance, constmctsrelevant to bargaining costs may involve cowdination failure and information acqui-sition/asymmetry, and those related to influence costs may include exchange facilita-tion and competition foreclosure. While the present dataset did not allow us tooperationalize ccmstmcts from an wganizational economic perspective, a research designinvolving primary data from organizational informants would allow us to better understandand predict not only the degree of IT outsourcing (as done in the present smdy), but alsothe mode of outsourcing (see figures 1 and 2). We are inthe midst of such a study.

A Diffusion Process Model of IT Outsourcing

In this paper, we have developed a "variance" model [29] for explaining IT outsourc-ing. We can adopt the view that an IT outsourcing arrangement constitutes anadministrative innovation [19, 39]. Such an argument is based on the emergentdeparture of many firms firom an established hierarchical mode of goveming the ITinfrastmcture toward a market mode. Outsourcing fundamentally transfomis thetraditional requirements of managing IT from those rooted on an adversarial, "arms-length" approach to those structured on a cooperative 'partnership-based' relationship.Using a macro-organizational level of analysis, the diffusion model will specificallyexamine the underlying force that motivates firms to adopt IT outsourcing. With thisapproach we can analyze whether the diffusion of IT outsourcing can be explained byimitative behavior. The findings are interesting in view of the prominence of theKodak-IBM outsourcing contract which purportedly encouraged many other firms toconsider such a govemance option seriously [34], We arc currently pursuing thisdiffusion-of-innovation study of IT outsourcing.

An Organizational Process Model of IT Outsourcing

Another complementary extension would be to focus on the organizational routinesunderlying the management of this IT mode of govemance by developing an organi-

22 LOH AND VENKATTIAMAN

zational process model. Such a research initiative would go a long way in enhancingour understanding of the new phenomenon in the marketplace. The process modelmay incorporate new structures (e.g., shared authority, responsibility, property rights,and risk-bearing), management processes (e.g., allocation and coordination of re-sources, perfonnance assessment, and joint planning), and managerial roles (e.g.,liaison, decision making, and leadership) that are required to derive the benefits fromthis mechanism effectively.

Conclusion

BASED ON DATA FROM LARGE U.S. CORPORATIONS, we empirically identified a set ofimportant determinants—reflecting both IT and business contexts—of IT outsourcing.Thus, we offer the fu^t empirical assessment of a set of widely held assertions andbel iefs as to why firms outsource their IT infrastructure. We have also identified someimportant directions for extending ihis line of inquiry—reflecting an organizationaleconomic view, a diffusion-of-innovation view, and an organizational process view.We hope that our attempt at empirically testing this emergent phenomenon willstimulate others to look at this important strategic challenge facing firms from arigorous theoretical perspective. Such research initiatives will allow us not only tobetter understand this complex phenomenon, but also to derive useful managementprescriptions grounded on systematic theory-based research.

NOTES

1. The final sample size is 55 due to missing data in Compustat and CDAI^oiporale. Oursample comprises a rough split between industrial and service firms (about 4O--60). The selectionis limited by the availability of data across multiple sources. It is possible that the primary dataregarding IT expenditures may have been skewed, since our sources surveyed only largecorporate users of FT (e.g., firms wilhin the Fortune 500 and Fortune Service 500 categories).In our sample, the level of IT expenditures as a percentage of revenue is 1.8 percent. This iscompared with another survey [20] that obtained figures for ten different industries, rangingfrom 0.9 percent to 4.2 percent. Although the set of companies used is not a random sample ofthe entire population of firms in the economy, we believe that our choice of data sources allowsus to include a sample that is representative of the set of major users of IT (i.e., large firms).

2. It is necessary to sum these two "costs" as the accounting treatment is not consistent forindustrial and service fiims in the sample.

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APPENDIX: List of Companies in

Aetna Life and Casualtv CoAir Products and ChemicalsAmax IncArmco'IncAshland Oil IncAtlantic Richfield CoBank ot Boston CorpBankamenca CorpBaxter International IncChampion International CorpChrysler CorpConsolidated Rail CorpContinental Bank CorpControl Data CorpCorning IncCSX CorpDow Chemical CoE I Du Pont De Nemours and CoDuke Power CoEastman Kodak CoEntergy CorpFirst Bank System Inc iFleming Cos IncGeico CorpGeneral Dynamics CorpGeneral Electric CoGeneral Re CorpGreat Western Financial CorpGTE Corp

the Sample

Harrier IncHometed CorpIllinois Power CoIngersoU Rand CoKeycorpLincoln National CorpMack Trucks IncManufacturers Hanover CorpNCR CorpNorfolk Southern CorpPNC Financial CorpQuantum Chemical CorpReynolds Metals CoRockwell International CorpRohm and Haas CoSCECorpSecurity Pacific CorpSun Co IncTexaco IncTextron IncTravelers CorpUAL CorpUnion Carbide CorpUnisys CorpUnited Technologies CorpU S Air Group IncValley National CorpWestinghouse Electric Corp

determinants of information technology outsourcing… · determinants of information technology...

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