Information Systems Outsourcing

Costs, Transaction-Specific Investments and Vendor Dominance of the Marketplace: The Economics of IS Outsourcing (p. 26-27)

Soon Ang
School of Accountancy and Business, Nanyang Technological University, Nanyang Avenue 2263, Republic of Singapore, asang@ntuvax.ntu.ac.sg, FAX: (65) 792-2313

Detmar Straub
Robinson College of Business, Computer Information Systems Department, Georgia State University, University Plaza, Atlanta, GA 30303-4012, dstraub@gsu.edu, 404-651-3880, FAX: 404-651-3842

1 Introduction

The strategic importance of information systems (IS) in banking is widely substantiated (Steiner and Teixeira 1990, OECD 1992, Office of Technology Assessment 1984, Office of Technology Assessment 1987, Apte et al 1990, McFarlan and McKenney 1983). Yet, in spite of this, some banks have outsourced their entire information services function (American Bankers Association 1981, 1986, 1990). On the surface, it seems counterintuitive that banks should potentially erode their competence in the design and delivery of strategic financial services relying heavily on information technology (IT). Part of the explanation lies in past behaviors and long standing theories about how organizations respond to their environment. According to classical theories of the firm, organizations strive toward autonomy (Gouldner 1959, Burt 1982). They maintain independence by integrating as many business activities as possible within their hierarchical control. By means of backward and forward integration, organizations secure access to markets, safeguard suppliers to raw materials, and prevent competitors from obtaining such access.

While corporations overall have demonstrated many of these tendencies in the post World War II era, a reversal of this trend had begun to emerge by the mid- 1980s (Harrison and St. John 1996). Described as "hollowing out of the corporation," organizations began to relinquish internal control and depend more heavily on external service-providers. Outsourcing prompted firms to abandon internal production bases and rely on others for manufacturing, distribution, and other business functions.

The growing practice of outsourcing in modern corporations has led both academics and practitioners to theorize and speculate about the underlying momentum towards outsourcing. The intriguing question is: If organizations are "dependence-avoiders" (Gouldner 1959), why expose oneself to inter-organizational dependencies in outsourcing arrangements? In addition to external dependencies, outsourcing brings on costly and radical changes. It creates upheavals in existing organizational structure and redefines organizational roles. Organizations must hire and terminate employees, sell off fixed assets, and plan for geographical relocation of firm operations.

The evolving literature on information technology (IT) outsourcing offers a variety of explanations for why outsourcing occurs. Many of these arguments have a basis in economic theories and models. One of the most commonly cited reasons, for example, is that managers feel that they can gain cost advantages by hiring outsiders to perform certain services and produce certain products (Alpar and Sharia 1995, Loh and Venkatraman 1992a). Transaction cost theory offers another economic perspective (Nam, Rajagopalan, Rao, and Chaudhury 1996) that typically frames outsourcing as a decision about drawing firm boundaries (Pisano 1990, Mosakowski 1991) or as vertical integration (Anderson and Schmittlein 1984, Monteverde and Teece 1982, Harrigan 1985). Financial slack and firm size are other factors which can be conceptualized, at least in part, as economic constructs.

This study argues that we can improve our ability to explain outsourcing within the larger context of organizational responses to their strategic environment by focusing on such economic considerations. Our findings suggest which factors play into the outsourcing decision and their relative importance in sourcing choices.