Strategy and IT Outsourcing: A Test of the Strategic

Control Model

Kathy Stewart SchwaigCo-authors:

Detmar StraubPeter Weil

February 13, 2004

Information Technology Outsourcing Defined

The handing over to a third party of the development, management and/or operation of an organization's IT assets and activities.

History of IT Outsourcing

Stats

Outlived the five-year period of a typical management fad

Between 1992-2000, growth rate was 15-20% per year

In 2003, large organizations spent 30-35% of their IT budgets on outsourcing

In 2003, IT Outsourcing was a $70 billion dollar market. IDC estimates that it will grow at a rate of 7.7% per year and by 2007, will be a $100 Billion market.

Why Outsource IT?

Cost vs. value Access to technical expertise Change fixed cost to variable cost Improve financial position Focus on core competency

Lacity, Willcocks, Feeny, 1996

Successful organizations carefully select which IT activities to outsource, rigorously evaluate vendors, tailor the terms of the contract and carefully manage the vendor.

Lots of anecdotal evidence to support the idea of selective outsourcing.

IT Outsourcing Decision and Outcomes 1991-2000(Lacity and Willcocks, 2000)

Decision Success Failure Mixed

Unable to determine

TOTAL

Total Outsourcing

11 33%

10 30%

8 24%

412%

33

Total Insourcing

1368%

4 21%

0 0%

211%

19

Selective Outsourcing(by 2000, 82% US, 75% UK)

43 67%

1117%

2 3%

813%

64

Total 6758%

2522%

109%

1412%

116

Strategic IT Sourcing Analysis (Lacity Willcocks and Feeny, 1996).

Qualifiers(Best-source:

In-House/Partner)

Order Winners(in-house/buy-

in)

Necessary Evils

(Outsource)

Distractions(Migrate or eliminate)

Commodity Differentiator

Contribution to Competitive Positioning

Critical

Useful

Contribution to Business Operations

Theoretical Background Resource Based View of the Firm (RBV)

Asserts that managers create above-average returns and superior value by developing and deploying unique and costly-to-imitate resource bundles to exploit environmental opportunities or to neutralize threats (Barney, 1991).

Characteristics:• Valuable, rare, inimitable, nonsubstitutable

Core Competency (Quinn and Hilmer 1994; Tsang, 2000).

Fundamental Argument

Firms need to own, nurture, have exclusive access to and thus control those resources that will lead to competitive superiority. Conversely, it is not necessary for firms to control those assets that are not integral to their distinctive competence.

Control=Selective Sourcing

Strategic Control Model

Control of IT Resource:(Selective Sourcing)

Performance

H1a

H2

IT as Strategic Resource:

Objective

IT as Strategic Resource:

Subjective

H1b

Hypothesis Hypothesis 1a (H1a):

The more the firm invests strategically in IT, the greater the control of the IT resource (and, hence, the less the outsourcing of these resources).

Hypothesis 1b (H1b): The more the firm views itself as employing IT

strategically, the greater the control of the IT resource (and, hence, the less the outsourcing of these resources).

Downstream Effects: IT Outsourcing and Business Unit Performance

Hypothesis 2 (H2): The greater the control of the IT resource (more selective sourcing), the better the performance.

Strategic Control Model

Control of IT Resource:(Selective Sourcing)

Performance

H1a

H2

IT as Strategic Resource:

Objective

IT as Strategic Resource:

Subjective

H1b

Research Methods

Study Design & Sampling• 54 Business Units in 27 Firms• Finance, Retail and Manufacturing• 7 countries (USA, Canada, Malaysia, Singapore,

Australia, UK, Switzerland)• Firm level & Business Unit

Minimum of 4 participants per organization• CIO• IS executives from BU• Corporate Executive (CE)

Survey, interviews, examination of documents

Constructs and Measures

Construct Code Description of Measure

IT as a Strategic Resource: Objective

Measures (CIO)

RESOURCE1 % of strategic IT investment in prior year

RESOURCE2 % of strategic IT investment - average % change over previous 5 years

IT as a Strategic Resource: Subjective Measures (CIO)

RESOURCE3 The extent that BU managers consider IT in their strategic decision-making

RESOURCE4 The extent that IT infrastructure has a role in BU decision-making

  RESOURCE5 Senior managers see IT as providing competitive advantage

  RESOURCE6 IT enables new business strategies

Control of IT Resource:

(Selective Sourcing) (BU)

CONTROL1 Average of rankings of the extent to which IT is outsourced by the BUs in each of 15 functional areas

 (CE) CONTROL2 % of IT investment spent on services outside the firm-- average % change over past 5 years

  CONTROL3 % of IT investment spent on services outside the firm over last two years

Performance: (CE) PERF1-2 Profits per employee ($)

Business Units PERF3 Pricing against competitors (index)

  PERF4 Return on assets

Instrument Validation

Cronbach’s Alpha PLS Loadings Convergent and discriminate validity

confirmed All measures were acceptable

Descriptive Statistics Firms varied in the level of their strategic IT investment from 0%

to 70% of their portfolios, with the average strategic IT investment being 27% of IT portfolio

Over the five year period, the change in investment in strategic IT ranged from a 100% decrease to a 75% increase with an average increase of 2%.

All firms engaged in making decisions about which IT functions to outsource.

No firm or business unit completely outsourced all IT activities. Firms outsourced an average of 8.44% of their IT investment over

the last two years with a range from 0% to 50% The average change over the five years was a positive 3.7%,

suggesting that firms were gradually outsourcing more IT activities over time.

Descriptive Statistics Construct

Scale Items/Code

(Rank) Mean

 S.D.

 Rang

e

 Max

 Min

             IT as a Strategic RESOURCE1 26.88 23.11 NM* 70 0

Resource: Objective Measures RESOURCE2 1.78 27.37 NM 75 -100

             

IT as a Strategic RESOURCE3 2.85 1.53 1-5 5 1

Resource: RESOURCE4 4.00 1.21 1-5 5 2

Subjective Measures RESOURCE5 3.89 1.42 1-5 5 1

  RESOURCE6 3.72 1.32 1-5 5 1

             

Control of IT Resource CONTROL1 1.47 NM 1-3 2.13 1.0

(Selective Sourcing) CONTROL2 3.70 22.07 NM 63.36 -33.15

  CONTROL3 8.44 12.18 NM 50.00 0

             

Performance PERF1 94109 12216 NM 553000

0

  PERF2 54048 8531 NM 446760

0

  PERF3 79.07 45.17 NM 126.2 0

  PERF4 12.22 20.94 NM 110.43

-23.24

Data Analysis PLS was used to analyze the variables and

relationship posited for explaining the IT outsourcing environment

Path coefficients and their T-statistics and the explained variances for the model components are shown. The model explains 25% and 23% of the variance in the dependent variables

Data Analysis H1a (coefficient =.483; p-value<.05) supported

The finding suggests that firms that invest in IT as a strategic asset are less likely to outsource, and supports the proposition that strategic or core competencies should be retained within the organization and not be outsourced (Prahalad, 1993).

H1b (coefficient =-.048; p-value>.05) not supported. The CIO’s view of whether or not the BU managers perceived

IT as strategic did not lead to more strategic control.

H2, (coefficient = .477, p-value < .05) supported. The extent of selective IT outsourcing has a significant relationship

with the performance variables in the predicted direction

Main PLS Results

Control of IT Resource: Selective

Sourcing Performance

R = .2512

* significant at the .05 level

IT as Strategic Resource: Objective

Measures

+

1

2

3

R = .2282

Coefficient T-Statistic

1

2

3

.483 2.75*

-.048 0.55

.477 4.29*

IT as Strategic Resource:

Subjective Measures

+

+

Results of Hypothesis Testing

# Hypothesis Supported

1a The more the firm invests strategically in IT, the greater the control of the IT resource.

Yes

1b

The more the firm views itself as investing strategically in IT, the greater the control of the IT resource.

No

2 The greater the control of the IT resource (more selective sourcing), the better the performance.

Yes

Qualitative Analysis A senior manager of a financial services firm, which is a low-end user of outsourcing,

explains the strategic role of IT in cross-selling: IT is critical to the successful operations of our business. The basis of the organization

is the databases of customers and from that flows opportunities to sell a wide range of (other) products and services.

Similarly, another light user of outsourcing, a senior manager in a manufacturing firm, states their approach:

We want to position our IT capabilities and resources in a manner that will ensure competitive readiness.

 By way of contrast, the senior manager of a different manufacturing firm, which is a heavier user of outsourcing, explains the transactional role of IT:

On the whole our systems are not considered strategic and the use of IT is largely transactional and functional.

A senior executive of a manufacturing firm that is a heavier user of outsourcing illustrates their focus no costs:

IT investments have been aimed at reducing costs and taking advantage of economies of scale. There is no input from IT into the strategic direction of the firm and the central IS function plays a reactive role within the organization.

Conclusions The strategic control thesis was supported in

H1a and H2. Firms that invest at significant levels in strategic systems are sensitive to when they should retain control of core assets and this sensitivity leads to better performance.

Sustained IT competitive advantage requires continuous innovation, environmental scanning. Hard to cultivate if we hand IT over to an integrator.

Limitations and Future Research Further studies in different settings and

locales Further development of measures Asking whether an IT activity is strategic or

core and then asking in the same instrument whether it was outsourced has a built-in methods bias.

While two of the three hypothesis were supported, the view of CIOs were not related to resource control. Empirical work is need to probe more deeply this result.

Contribution

This study raises interesting questions about the worldwide trend of increasing IT outsourcing

The results of this study strongly support a selective approach to outsourcing based on strategic control of key IT assets and the core competencies of the organization.

Strategic control should be the purpose of outsourcing, rather than any arbitrary attribution of value to IT outsourcing in its own right.

Managers in the position to influence key outsourcing decisions should think about the need to strategically control each IT activity and make their decisions accordingly.