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Value Implications of IT Outsourcing Contextual Characteristics. Jee-Hae Lim University of Waterloo Vernon J. Richardson University of Arkansas Bob Zmud University of Oklahoma. Current IT Outsourcing Trends.
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Value Implications of IT Outsourcing Contextual Characteristics Jee-Hae Lim University of Waterloo Vernon J. Richardson University of Arkansas Bob Zmud University of Oklahoma
Current IT Outsourcing Trends • The worldwide IT outsourcing market is expected to increase from $180.5 billion in revenue in 2003 to $253.1 billion in 2008 at a compound annual growth rate of 7.2%. (Gartner Group, 2004). • $18.4 billion in global IT work and $11.4 billion in business-process services have been shifted abroad by U.S. firms (Business Week, January 30, 2006).
Scholarly Interest • 78 outsourcing articles in Wall Street Journal (2005). • MIS Quarterly Special Issue on Outsourcing (CFP, 2006). • Continuing interest expressed by major IS, accounting and applied management journals (1990-2005):
IT Outsourcing Research Drivers of Value in IT Outsourcing * Economic* Strategic* Technical* Political Outsourcing Decision: Determinants Outsourcing Relationship: Arrangement &Management • Firm Value • * ex ante:Market Assessment Management Expectations • ex post:Financial Performance Management Satisfaction Antecedents Process Value Creation
Purpose of this Study • To examine firms that outsource IT functions, identify salient contextual characteristics of the outsourcing arrangements, and assess objective performance impacts • Contextual characteristics: • selective vs. total outsourcing • low vs. high asset specificity of the IT activity being outsourced • onsite vs. offsite IT activity handling (client control) • domestic vs. offshore IT activity handling • Performance Outcomes • ex ante effects: stock market reactions • ex post effects: firm financial performance
Theoretical Frame • Transaction Cost Economics • total cost = production costs + transaction cost • Major component of transaction costs are those associated with fabrication of appropriate governance structures to reduce potential hazards • Nature of the IT activity being outsourced • Scope • Asset specificity • Potential for client to exert control • Onsite vs. offsite • Domestic vs. offshore
Scope • Can be operationalized two ways • Number of IT activities involved • Number of organizational units involved (used here) H1: Selective IT outsourcing contracts yield better financial performance compared to total IT outsourcing contracts.
Asset Specificity • The extent to which the IT activity being outsourced must be customized to the client’s organizational context (Grover et al., 1996): • Low asset specificity: system operations/management, telecommunication/network operations/management, end-user support • High asset specificity: application development, IS planning and management H2: Outsourcing contracts involving low asset-specific IT activities yield better financial performance compared to contracts involving high asset-specific IT activities.
Onsite vs. Offsite • The extent to which the client can exert direct control of the IT activities being handled • Onsite: buy-in contract • Offsite: fee-for-service contract H3: Onsite IT outsourcing yields better financial performance compared to off-site IT outsourcing.
Domestic vs. Offshore • The extent to which the vendor & client must confront geographical, cultural, language, etc. barriers in negotiating, specifying, implementing and monitoring contractual and relational governance mechanisms regarding the IT activities being outsourced • Domestic: IT activities carried out at an offsite but US-based location • Offshore: IT activities carried out at an offsite and non US-based location H4: Domestic IT outsourcing arrangements yield better financial performance compared to offshore IT outsourcing arrangements.
ex ante vs. ex post Outcomes • It would be expected that investors’ incorporation of a firm’s capability to effectively carry out its announced actions into valuation assessments (i.e., stock market reactions to events) would be validated by actual improvements in realized value from these actions (i.e., future financial performance). To our knowledge, this has not been assessed previously. H5: There is a positive relationship between the abnormal stock returns around a firm’s announcement of an IT outsourcing arrangement and the firm’s subsequent financial performance.
Methods • Sample Selection: 1990-2003 • Firm’s first announcements only • Final Sample: 335 announcements • Research Window: 1989-2004 • Four years for each firm include one year before (Year -1), through one year and two years after the year of the IT outsourcing event. • Client Disclosure Bias
Analyzed Variables • Pre-post analysis: • (ROS FIRM.POST – ROS FIRM.PRE) • Potential Outlier Control: windsorized at +3 Standard Deviations. • No Multi-Collinearity Problem.
Simplified Porter’s Value Chain Selling, General, and Administrative Expense (SGAS) ROS Market Value Abnormal Return Growth Rate (GR)
Limitations • Bias toward positive returns in sample • Disclosure by client and/or vendor • Survivorship bias • Only examined first announcement • Learning effects absent
Contributions • Demonstrated ex ante and ex post performance effects from IT outsourcing • Demonstrated relationship between ex ante and ex post performance effects • Demonstrated that positive returns from outsourcing are most likely with selective, onsite and domestic sourcing • Surfaced concerns about viability of offshore sourcing
Conclusion • Numerous factors not addressed • Client objectives • Client and vendor capabilities • Importance of the IT activity being outsourced • Learning effects • Many aspects of applied contractual and relational governance mechanisms applied • Interactions amongst predictors • … • We hope that these findings are found interesting and that they stimulate further and deeper examinations of this and related IT outsourcing phenomena.
