Information Systems and Outsourcing

As noted in the introduction, Transaction Cost Economics (TCE) is one of the most widely adopted theories used to study IT outsourcing (ITO) decisions. Early ITO articles argued that TCE is a useful framework for studying ITO decisions for various reasons (Clark et al. 1995; Cronk and Sharp, 1995; De Looff, 1995; Jurison, 1995; Klepper, 1993, 1995; Lacity and Hirschheim, 1993a; Beath, 1987). First, TCE specifically addresses sourcing decisions, that is, the decision to produce a good or service internally or purchase it externally. Second, TCE captures the widely-held perception that organizational members make sourcing decisions based upon an economic rationale and that outsourcing should reduce costs (Anthes, 1990, 1991; Hamilton, 1989; Hammersmith, 1989; Kass, 1990; Kelleher, 1990; Krass, 1990; Morse, 1990; O’Leary, 1990; Oltman, 1990; Rochester and Douglas, 1990). Third, many practitioners use “TCE-speak” to explain why outsourcing is predicted to reduce IT costs: IT is most efficiently provided by external vendors because it is a commodity service (translated into “TCE-speak” as a “nonspecific asset”) (Ward, 1991; Ambrosio, 1991). Fourth, TCE has enjoyed an abundance of empirical and theoretical academic attention in other organizational contexts (Anderson, 1994; Bowen and Jones, 1986; Griesinger, 1990; Hill, 1990; Hennart, 1991a, 1991b; Hesterly et al., 1990; Joskow, 1985; Lieberman, 1991; Malone, 1987; Malone et al., 1987; Pisano, 1990; Robins, 1987; Walker and Poppo, 1991).

In the previous chapter, Lacity and Willcocks found that 61 actual IT outsourcing (ITO) decisions did not map well to Transaction Cost Economics (TCE). Our findings were initially written in 1995 when large scale ITO decisions were still novel. As time progressed, other researchers found better results with ITO tests of TCE propositions. For example, Poppo and Zenger (1998) found that asset specificity and measurement accuracy did have the effects on ITO as predicted by TCE (although uncertainty did not). In 2002, Lacity and Poppo began discussing their TCE results in the context of ITO. This chapter is the result of that collaboration.

Information technology (IT) outsourcing ventures have been termed successful or less successful in achieving their expected outsourcing objectives according to the operational effectiveness of the ensuing client-supplier relationship. Yet, even now, researchers and practitioners know little about the actual operational characteristics of these outsourcing relationships. This lack of insight on outsourcing relationships forms the rationale for the research on which this chapter is based. An attempt at bridging the gap is made by adopting the IMP group’s dyadic “Interaction Approach” to shed some light on the crucial dimensions of IT outsourcing relationships. Exploratory research into twelve organizations identified the potential of the “interaction approach”, but also highlighted its various limitations. Despite these, we find that the “Interaction approach” represents a very useful foundation for delimiting such relationships. The “Interaction” approach also helps to identify a number of management issues that warrant careful consideration if IT outsourcing relationship management is to be improved. Our more recent work (Kern and Willcocks, 2001; Willcocks and Cullen, 2005) confirms that relationships remain a problematic area in outsourcing, and that the Interaction approach retains considerable potency for analyzing outsourcing arrangements.

This chapter is based on one of the first articles we published for practitioners (Lacity and Hirschheim, 1993). At that time, very little research had been conducted on what actually happens in client organizations when they outsourced IT. Based on 14 case studies in US organizations, the article examined three myths about outsourcing and proposed that clients need to sign much better contracts. Since its initial publication, clients and suppliers have indeed become much better at contracting. Defining services, setting prices, and creating a flexible framework to adapt to business and technical changes are now norms in ITO contracts. Although our research focus soon evolved from contractual issues to decision strategy and relationship management, it is certainly interesting to reflect back on this early contribution. It is also interesting to see how IT sourcing practices changed as the overall perception as to the role of IT changed.

In this chapter, we present our ITO decision framework which guides practitioners to consider business, economic, and technical factors. Originally published as Lacity, Willcocks, and Feeny (1996), this framework is still remarkably relevant. When discussing business factors, we dismiss the traditional “core versus non-core” criterion because we found it was difficult for practitioners to differentiate IT activities on this basis. Instead, we guide practitioners to consider an IT activity’s contribution to competitive advantage as well as to its critical support of daily business operations. In the discussion of economic factors, we challenge practitioners to examine the practices that lead to economic efficiency rather than just economies of scale. Surely, suppliers operate on a larger scale than internal IT departments, but economic efficiency depends more on practices such as standardization, centralization, and tight controls than size. In the discussion of technical issues, we discuss a technology’s maturity (stability, measurability, and requirements certainty) and technology’s integration with other business functions as the most important technical criteria to consider. This framework continues to be used by practitioners and is still widely cited by academics.

Today, nearly every manager calls their outsourcing deals “strategic.” In reality, much of outsourcing is still about cost reduction in back-office services. For us, the term “strategic outsourcing” is restricted to circumstances for which suppliers play a key role in helping clients deliver innovative products to the market faster and cheaper than competitors.

Offshore outsourcing of IT work has generated quite a controversy, with some saying it is stealing US jobs, others stating that it is improving the US economy, and still others claiming that all the studies are biased, one way or the other. Based on our past research of domestic outsourcing, and the best practices we uncovered, we have now studied offshoring as well (see also Chapter 9). We have found five practices that apply equally to both domestic and offshore, ten practices that are more important to offshore, and five practices unique to offshore sourcing. Together, these 20 practices can help CIOs swiftly move through the learning curve, mitigate risks, work with offshore suppliers, and achieve satisfactory costs and service levels.

Outsourcing—and as part of this, choosing and leveraging suppliers — is most successful when managed as a life-cycle, and not as a one-off transaction. In our version (see Cullen et al., 2006), this outsourcing life-cycle consists of nine building blocks in four phases. The first four blocks comprise the Architect Phase, which lays the foundation for the deal. The fifth and sixth blocks make up the Engage Phase, when the client selects the supplier and negotiates the deal. The seventh and eighth blocks make up the Operate Phase, when the deal is operationalized and managed. Regenerate, the final phase, is where the client assesses options and then resumes the cycle. The client’s bargaining power fluctuates throughout this life-cycle, as shown in Figure 11.1.

As noted in the Introductory chapter, IT outsourcing research has evolved from a focus upon what firms outsource to successfully managing outsourcing relationships. In this chapter, we aim to contribute to practice by better understanding the underlying nature of the client-supplier relationship. In analyzing our rich research base comprising in-depth interviews with senior executives, CIOs, suppliers, IT staff, IT users, and IT outsourcing consultants, we found that the client-supplier dichotomy fails to capture the complexity of all stakeholder relationships involved in IT outsourcing. The “client” actually includes senior business managers who pay for IT, senior IT managers who manage IT, IT staff who deliver IT, and finally the users who actually receive the IT service. The “supplier” includes senior management who negotiate deals, account managers responsible for earning a profit on the deal, and supplier IT staff charged with delivery. If IT unions, external consultants, lawyers, subcontractors, or multi-sourcing are involved, additional sets of stakeholders are added to the party. By attending to these multiple stakeholders, we have a better understanding of the complex relationships among stakeholders, and operate from a more informed base for improving these relationships.

For more than 15 years, the authors have studied the best, worst, and emerging sourcing practices in 543 large and small organizations world-wide. In this chapter we present the major lessons customers have learned, in order to successfully exploit the global IT outsourcing market. Major supplier lessons are also identified, which call for superior supplier integrity in selling, negotiating, and delivering IT services. Customers now expect many business advantages from IT outsourcing, including lower costs, better service, infusion of new technology, transformation of fixed IT budgets to variable IT budgets, improved business processes, and even increased revenues (Lacity and Willcocks, 2001; Willcocks and Lacity, 2006). In short, customers expect IT outsourcing to transform IT functions into lean, dynamic groups that respond quickly to business needs and opportunities. But how do customers actually achieve such business advantage? Our research shows that customers must become adept at managing four continual processes to successfully exploit IT outsourcing: Although many people view these activities as sequential, we found that these are continual and concurrent processes. Even within the same customer-supplier relationship, customers frequently revisit the scope of the deal and re-craft contracts several times. This iterative learning process is reflected in Figure 13.1.

On our figures, revenues from offshore outsourcing of information technologies exceeded US$25 billion by 2008, and will experience compound annual growth averaging 20% over the next five years (Willcocks and Lacity, 2006; Willcocks and Cullen, 2005). For IT executives this means off-shoring, either directly, through a captive, or indirectly through a domestic supplier, has become a serious option; indeed many have already embarked down this path. For outsourcing vendors this means a growing number of clients will offshore outsource their IT systems expecting the vendors to maintain and in some cases to continue developing their IT applications from remote locations. But client executives already ponder a major question: where do you draw the line on outsourcing knowledge and expertise? How can a selected vendor develop knowledge and expertise of the client’s domain, systems and practices, not only to maintain continuity of service, but also to achieve the much vaunted targets of innovation and transformation? At the same time, we find executives of IT outsourcing vendors themselves asking: how can expertise be quickly developed around new areas, particularly where teams are remote and dispersed? How can we retain knowledge when people, in which it resides, move on? This chapter describes ongoing research into how one IT outsourcing vendor built expertise management systems in order to ensure the diffusion of client knowledge and the sharing of learning across the entire organization.¹ Our research experiences point to major lessons for client and supplier organizations. At a big picture level, we show how, in order to compete and deliver on client expectations, over the next five years a supplier will need to make operational a transactive memory system for managing knowledge and expertise — in several ways something clients themselves could learn from.

When making Information Technology (IT) outsourcing decisions, organizations are faced with not only the decision of what to outsource, but also what to keep in-house. A robust stream of research has developed to provide guidelines on what Information Systems (IS) human resource capabilities are core to the business’s future capacity to exploit IT successfully. Here we make the crucial step of detailing how these IS capabilities can be evolved over time. We examine three organizations that used the same framework to develop their internal IS capabilities. Two already had large infrastructure and applications outsourcing deals in place; the third was preparing itself to be in a position leverage outsourcing in the future. Several learnings emerge: 1) Organizations are invariably playing “catchup” on IS capabilities. Business contexts move too fast for it to be otherwise. But creative and flexible management using ideas from experience can speed the evolution of capabilities and produce superior business results 2) Process, culture and structure mechanisms can be used to develop, nurture, and maintain these capabilities; 3) Internal IS capabilities can be developed through plotting the “where is” on three stages of evolution and moving the organization forward; and 4) The state of IS and organizational context determine how and when to use the external IT services market.