A Two Stage Investigation of the Determinants of Information Systems Outsourcing

Outsourcing has recently emerged as akey method of managing Information Systems especially since the report about Eastman Kodak and IBM\u27s outsourcing partnership in 1989 (Loh and Venkatraman, 1992a, 1992b). The importance of outsourcing is partially illustrated by the fact that there are myriad conflicting arguments both for and against outsourcing (Chaudhury et al, 1989, 1995; Gantz, 1990; Lacity and Hirschheim, 1993; Nam et al, 1995a, 1995b). Most outsourcing studies have focused on the investigation of the determinants of the decision to outsource by clients. Transaction cost economics (TCE) theory has recently been used in the study of the determinants of outsourcing (Lacity and Hirschheim, 1993; Nam et al, 1995a, 1995b). The theory of transaction cost economics (TCE) was originally formulated to address the make versus buy choice (Anderson and Coughlan, 1987; Erramilli and Rao, 1993) In TCE, Williamson (1989, 1987, 1981, 1979) proposed that firms should insource when they expect opportunistic behavior by the vendors. In particular when clients are locked-in with vendors, vendors\u27 opportunistic behavior will significantly impair the clients\u27 interests. This statement implies that attributes of existing relationships such as opportunism affect the firms\u27 subsequent make-or-buy decision with the incumbent vendors. However, most prior empirical research on TCE has treated each sourcing decision as an independent event (Masten, 1984; Walker and Walker, 1987, 1984) thereby disregarding the prior relationships that affect the subsequent sourcing decisions. Therefore, any outsourcing study must explicitly incorporate the role of prior ties in its analytical framework (Gulati, 1995). In the outsourcing context, it has been reported that very often clients continue their relationships with vendors. Also, many firms have to decide whether they should continue the outsourcing relationships with the vendors or not. Factors that affect continuation of the relationships are different from factors that affect the initial outsourcing behavior because client firms have locked-in relationships with vendors. According to Seabright et al (1992), and Levinthal et al (1988), prior relationships need to be investigated in order to study the subsequent relationships between clients and vendors. This study willfocus on i) the determinants of the outsourcing decisions and ii) the tendency to persist in the locked-in outsourcing relationship. We investigate the factors that determine outsourcing decisions in two stages. In the first stage, both insourcing and outsourcing firms are studied to investigate the determinants of make-or-buy decision. In the second stage, only outsourcing firms are considered in order to study the intention to continue with the relationship. Two dimensions are proposed in order to conceptualize the diverse types of outsourcing between clients and vendors (Nam et al, 1994a, 1994b). The first dimension is the extent of substitution by IS vendors and the second dimension is the strategic impact of IS applications. There are two types of strategic impact of IS applications: differentiation and cost reduction. The first dimension is proposed from the IS vendors\u27 point of view while the second dimension is proposed from the client firms\u27 point of view. Based on these two dimensions, four types of outsourcing relationships are proposed. These four types are support, reliance, alignment, and alliance. The support cell has a low extent of substitution and low strategic impact. This cell corresponds to the traditional IS vendors service. Vendorsare usually restricted to non-core IS activities and the size of contract is small. The reliance cell has a high extent of substitution and low strategic impact. The IBM and Kodak outsourcing example corresponds to this cell. In recent years, the trend ofoutsourcing has moved from the support cell to the reliance cell. The alignment cell has a low extent of substitution and high strategic impact. Examples in this cell are mostly IS consulting types of services. Even though vendors are not significantly involved with client firms\u27 IS operations, IS vendors significantly influence clients\u27 IS operations. The alliance cell has a high extent of substitution and high strategic impact. Outside vendors not only substitute in-house IS operations but also contribute to clients\u27 competitive advantages through provision of important IS functional activities. In the first stage, hypotheses are developed based on transaction and non-transaction cost factors with respect to the two proposed outsourcing dimensions. Threetransaction cost factors are studied as determinants of the two dimensions: asset specificity, uncertainty, potential number of vendors. Four non-transaction cost factors are also investigated. These four non-TCE factors are IT competency, IS influence, heterogeneity of information systems, and decision analysis effort. Multiple regressions are used to test hypotheses in the first stage. In the second stage, hypotheses are proposed based on prior relationships between clients and vendors in order to studythe determinants of the intention to continue with the outsourcing relationships. Prior relationships are represented by the four types of outsourcing relationships based on two dimensions of outsourcing, vendors performance in terms of client satisfaction, vendors\u27 opportunistic behavior and the length of prior relationships. Logistic regression is employed to test hypotheses in the second stage. Questionnaires were developed based on interviews with IS manager and pretested. Following a pretest, 800 questionnaires were sent to senior IS managers in the U.S. A follow-up letter was mailed to those who had not responded after about three weeks. In total 154 usable questionnaires were received representing a response rate of 19.25%. Out of 154, 93 respondedas outsourcing firms and 61 responded as insourcing firms