Information Technology Outsourcing: Asset Transfer and the Role of Contract
With Y. Chang and K. Ravindran, MIS Quarterly, forthcoming
Information Technology Outsourcing (ITO) is the predominant mode of acquiring information systems services, providing clear evidence that the economics of service delivery favor external service providers over in-house information systems departments. An interesting feature of many large ITO arrangements is that the production assets necessary for service delivery are transferred to the vendor. The argument in favor of such asset transfers, based in Property Rights Theory, is that they are necessary to incentivize vendors to continue to invest in the transaction-specific assets to improve service. On the other hand, Transaction Cost Economics predicts that transferring such assets increases bilateral dependence and will elevate the risk of post-contractual opportunistic behavior. The contracting challenge in this context is to specify the terms of exchange to achieve the client’s objectives for outsourcing while managing the risks of asset transfer. We develop a theoretical framework to derive propositions on contract design in the presence of asset transfer. We identify the importance of contractual clauses that mitigate the associated risks and the complementary role of compensation mechanisms, specifically the pricing scheme and IT-related performance incentives. We have compiled a unique dataset that allows us to test our propositions by comparing ITO contracts that include asset transfer to those that do not. We find that asset transfer does significantly affect contract design, manifested in the inclusion of clauses that protect both clients and vendors. Outsourcing objectives are more likely to be met when contracts include compensation mechanisms that complement asset transfer.
Social Capital and Contract Duration in Buyer-Supplier Networks for Information Technology Outsourcing
With K. Ravindran, A. Susarla, and D. Mani, June 2015
Abstract: This paper presents new evidence on the role of embeddedness in predicting contract duration in the context of Information Technology (IT) Outsourcing. Contract duration is a strategic decision that aligns interests of clients and vendors, providing the benefits of business continuity to clients and incentives to undertake relationship specific investments for vendors. Considering the salience of this phenomenon, there has been limited empirical scrutiny into how contract duration is awarded. We posit that clients and vendors obtain two benefits from being embedded in an inter-organizational network. First, the learning and experience accumulated from being embedded in client-vendor network could mitigate the challenges in managing longer-term contracts. Second, the network serves as a reputation system that can stratify vendors according to their trustworthiness and reliability, which is important in longer-term arrangements. In particular, we attempt to make a substantive contribution in theorizing about embeddedness at four distinct levels: structural embeddedness at the node level, relational embeddedness at the dyad level, contractual embeddedness at the level of a neighborhood of contracts and finally, positional embeddedness at the level of the entire network. We analyze a dataset of 22039 outsourcing contracts implemented between 1989 and 2008. We find that contract duration is indeed associated with structural and positional embeddedness of participant firms, with the relational embeddedness of the buyer-seller dyad and with the duration of other contracts to which it is connected through common firms. Given the nature of our data, identification using traditional OLS based approaches is difficult given the unobserved errors being clustered along two non-nested dimensions and the autocorrelation in a firm’s decision (here the contract) with those of contracts in its reference group. We employ a multi-way cluster robust estimation and a network auto-regressive estimation to address these issues. Implications for literature and practice are discussed.
IT Outsourcing and Firm Productivity: An Empirical Analysis
With Young Bong Chang, MIS Quarterly, December 2012
Abstract: Firms are increasingly sourcing internal information systems functions from external service providers. However, there is limited empirical evidence of the economic impact of this delivery option and, more specifically, of the productivity gains accruing to firms that have outsourced. Moreover, there is little evidence of the role and contributions of the individual mechanisms by which service providers create value for client firms. We are particularly interested in whether client firms benefit from the accumulated knowledge held by information technology (IT) service firms. In this paper, we examine the impact of IT outsourcing on the productivity of firms that choose this mode of services delivery focusing, on the role of IT-related knowledge. Since firms self-select into their optimal sourcing mode, we use a variety of econometric techniques including propensity score-based matching and switching regression to control for potential bias arising from endogenously determined sourcing modes. We demonstrate that IT outsourcing does lead to productivity gains for firms that select this mode of service delivery. Our results also suggest that IT-related knowledge held by IT services vendors enables these productivity gains, the magnitude of which is moderated by a firm’s IT intensity. Moreover, the value of outsourcing to a client firm increases with its propensity for outsourcing, which in turn depends on firm-specific attributes including efficiency level, financial leverage, and variability in business conditions. Our analyses also show that firms that outsource have been able to achieve additional productivity gains from contracting out compared with their counterfactuals.
Information Technology and Efficiency: The Role of IT Intensity and Competition
With Young Bong Chang, Information Systems Research, September 2013.
Abstract: We analyze the impact of information technology (IT) on the technical efficiency of firms in the context of their observed competitive settings. Because competition can be a driver of efficiency and industries display varying degrees of competitiveness, firm-level efficiency is likely to display considerable heterogeneity. To shed light on these questions, we analyze the economic impact of IT on technical efficiency, a key component of efficiency, in heterogeneous competitive settings. Our study employs a number of econometric techniques, including a stochastic frontier and a generalized method of moments approach, on data from firms in a wide cross-section of industries. We find, after controlling for firm-level heterogeneity and potential endogeneity, that IT is positively associated with gains in technical efficiency but its impact is moderated by the degree of competition. Firms display large variation in their levels of technical efficiency partly because of the heterogeneous market competitiveness conditions they face. In more competitive industries, firms tend to deploy IT more intensively and use it more efficiently. Our study makes a distinct contribution relative to prior studies that have focused on the productivity impacts of IT while assuming perfect competition and not allowing for potential heterogeneity in firm-level efficiency. Overall, our results demonstrate that IT and competition are significant determinants of gains in technical efficiency and provide insight into how competition affects the returns to IT investment.
The Impact of IT-Related Spillovers on Long-Run Productivity: An Empirical Analysis
With Young Bong Chang, Information Systems Research, September 2012.
Abstract: This paper examines the effects of IT-related spillovers on firm-level productivity improvements over a long-term horizon. In contrast, prior research has largely focused on the direct and contemporaneous impacts of IT investments. As a result, we do not fully understand how IT investments are associated with ongoing productivity improvements in future periods and how spillovers influence these gains. In this paper, we examine whether firms receive incremental benefits from IT-related spillovers and whether these spillovers lead to more persistent returns. We focus on the spillovers that accrue to firms from their interindustry transactions, especially the IT services industry. We model and estimate the impact of spillovers on long-run productivity using firm-level data from the manufacturing, transportation, trade, and services sectors. We find that spillover impacts are highly significant, but that the magnitude and persistence of the impacts vary. Firms with high IT intensity receive greater spillover benefits from the IT services industry. Moreover, these benefits are sustained over a long-term horizon. However, the impact of IT-related spillovers does not persist in low IT intensity firms regardless of the source. Overall, our results shed light on the existence and sources of IT-related spillovers and on their important role in shaping the long-run returns to IT investment. Our results also help explain the findings of excess returns to IT investment in the IT productivity literature.
IT Outsourcing Contracts and Performance Measurement
With David Fitoussi, Information Systems Research, March 2012.
Abstract: Companies that outsource information technology (IT) services usually focus on achieving multiple objectives. Correspondingly, outsourcing contracts typically specify a variety of metrics to measure and reward (or penalize) vendor performance. The specific types of performance metrics included in a contract strongly affect its incentive content and ultimately its outcome. One specific challenge is the measurement of performance when an outsourcing arrangement has a mix of objectives, some that are highly measurable and others that are not. Recent advances in contract theory suggest that the design of incentives for a given objective is affected by the characteristics of other objectives. However, there is little empirical work that demonstrates how relevant these “multitask” concerns are in real-world contracts. We apply contract theory to examine how objectives and incentives are related in IT outsourcing contracts that include multiple objectives with varying measurement costs. In our context, contracts generally share the objective of reducing IT costs but vary in the importance of increasing IT quality. We establish empirical results about performance measurement in IT outsourcing contracts that are consistent with recent theoretical propositions. We find that the use of strong direct incentives for a given measurable objective is negatively correlated with the presence of less measurable objectives in the contract. We show that outsourcing contracts that emphasize goals with high measurement costs employ more performance metrics than initiatives whose objectives have a lower measurement cost profile. Surprisingly, as the number of performance metrics increases, satisfactory outcomes decrease, which we explain within a multitask theory framework. Overall, our results provide empirical support for multitask principal-agent theory and important guidance in designing outsourcing contracts for complex IT services.