Strategic Control and IT Outsourcing

1. Strategic Control and IT Outsourcing Detmar Straub, Georgia State University Peter Weill, MIT Kathy Schwaig, Kennesaw State University Workshop 28 April 2006 Carlson School of Management University of Minnesota

2. Agenda • Motivation and Problem • IT Outsourcing and Performance • Theoretical Framework • The Strategic Control Model • Research Design • Results • Implications • Questions

3. Motivation and Problem • Firms have been increasingly outsourcing, and this decision has been dominated by economic considerations • Strategic issues have not always been uppermost in managerial choices to outsource • Core competencies can be lost (Kotabe and Murray 2004; Lee et al. 2004; Linder 2004; Stavros 2004)

4. Motivation and Problem • Limited amount of scholarly work dealing with the question of strategic evaluations of IT outsourcing (Review of the extensive literature can be found in Dibbern et al. 2004) • Much of it – positivist, qualitative, or interpretivist – categorizes IS as a core business activity or not • Overly simplistic, of course • What tests there are are mixed

5. IT Outsourcing and Performance • Mixed Results for Strategic IT Outsourcing  Firm Performance • Strongly Positive: e.g., Slaughter and Ang 1996 • Weakly Positive: e.g., Grover et al. 1994 • Insignificant: e.g., Smith et al. 1997 • Negative: e.g., Lacity (et al.)’s work; Teng et al. 1995

6. Performance IT Outsourcing and Performance • Ang & Straub (1997) studied U.S. banks Surprising!! Benefits to firm were in the wrong direction!!! -.173* + Degree of IS Outsourcing

7. IT Outsourcing and Performance • This strong but opposite relationship between degree of IT outsourcing and firm performance runs counter to advocates in the literature (Quinn & Hilmer, 1994; Huber, 1993) • It is consistent, though, with findings of Teng et al. (1995), Loh and Venkatraman (1992) and Smith et al. (1997) • In a study of over 20 major US-based outsourcing decisions, Smith et al. (1997) found few significant relationships between extent of IT outsourcing and firm-level performance measures.

8. Performance Benefits to firm were generally not significant!!! IT Outsourcing and Performance • Smith, Mitra and Narasimhan (1997) analyzed the following COMPUSTAT metrics over 5 year windows: SG&A / Sales; Operating expense/ Sales; Sales / Employee; Asset Turnover; Return on Assets; Return on Equity; Operating Margin; Growth Rate; Dividend yield; Dividend / Sales; Market to book ratio; Cash and Equivalent / Sales; Total Liabilities / Sales; Long term debt / Sales; and Current Liabilities / Sales + Major IS Outsourcing

9. IT Outsourcing IT Outsourcing and Performance • Ang (1993) studied 200+ banks through the American Banking Association # of Vendors Slack Resources Firm Size -4.65* -2.30* 1.03/.11 Cost Advantages 5.81* 2.19* -2.03* Imitative Proclivities View IT as Strategic Asset

10. Theoretical Framework • Resource dependency theory (RDT) • The key to organizational survival is the ability to acquire and maintain resources (Pfeffer and Salancik, 1978). • Firms adapt to changes in their environment that impact the flow of resources to the firm. • Adaptation is not passive, but a strategic choice to cope with pressure in the environment (De Wit and Verhoeven, 2000).

11. Theoretical Framework • Outsourcing is one way to acquire resources • Horizontal & vertical integration • Human resources • Machines & technology • Physical assets, land, facilities • But it also leads to undesirable dependencies • Successful organizations attempt to minimize their dependence on organizations in their environment (Birkinshaw, Toulan, and Arnold, 2001).

12. Theoretical Framework • The balance that must be achieved is dependency versus control • Organizations interact dynamically as they act strategically to manage their resource dependency on other firms (Pfeffer and Salancik, 1978).

13. Types of Outsourcing Less Control More Control Informal Alliance Alliance Contracting Joint Ventures Wholly- Owned Subsidiaries Trading External Outsourcing Alliance Outsourcing Internal Sourcing (Insourcing) Arms-Length Transaction Strategic Alliance Equity Position -Based partly on: Heeks, 1996

14. Types of Outsourcing Figure 1: Continuum of Control of the IT Resource Higher Levels of Lower Levels of Total Total Outsourcing Outsourcing Insourcing Outsourcing Locus of Control

15. Resource Acquisition, Dependency, and Outsourcing • Bates, Meckler, Bulger & Tilson and Arthur Andersen Worldwide's Consulting Arm -Source: The Outsourcing Institute, 1995

16. Need for Human Capital • Bates, Meckler, Bulger & Tilson, a litigation law firm, began in February 1994. • In just over 18 months, the practice grew from 16 lawyers and a total staff of 25 people to 45 lawyers and a staff of over 80 people.

17. Importance of Customer Billing • This growth was made possible by outsourcing essential accounting systems such as billing to Arthur Andersen's IT Consulting Group

18. Boost to Available Resources • Five people from Arthur Andersen were there for 10 to 14 hours a day getting the attorneys’ billings out for the firm’s first month of operations.

19. Statement by Client Organization "When you start up, you just can’t afford the kind of talent you really need. Over the past 18 months we’ve tripled our personnel, revenue, and profitability partially through having access to people with great familiarity with their areas of expertise. This has made our growth much easier to manage." -Walter Roth, executive director at Bates Meckler

20. Or, Outsourcing Drains an Organization’s Resources • Texas (U.S.) Department of Human Services and Transactive, Inc. (Outsourcer) -Source: Back, 1993

21. Texas Department of Human Services • The Texas Department of Human Services outsourced the replacement of welfare checks with plastic debit cards • It was the U.S.'s largest electronic benefits system serving nearly 3 million people • Welfare recipients were to use plastic debit cards to buy food or clothing from 16,000 retailers hooked up to point-of-sale (POS) terminals

22. IT Failure by Outsourcer • The system front end could not handle the dial-up volume of 10 to 12 POS devices calling the host simultaneously • A call coming from a retailer would get lost, held or dropped

23. Catastrophic Results • In the weeks that followed system installation, the central Human Services office went into crisis mode • Employees quit • Overtime skyrocketed • Key players were fired or quit • The U.S. federal government demanded improvement

24. "I had a full head of hair when I started this." -Robert J. Ambrosino, Director of the Human Services Department's Lone Star Technology Program Statement by the Client Organization

25. Dependence on IT as Strategic Resource Org. Performance Locus of Control: Extent of IT Outsourcing The Strategic Control Model - + Objective Measures Subjective Measures Pricing against Competitors Profits ROI

26. Research Design: Participating Global Firms ANZ Banking Group; BP (Singapore and Australia); Brash Holdings; Caltex; Carlton and United Breweries (Fosters Brewing Group); Citibank, Asia Pacific; Coles Myer (Target, K-Mart, Department Stores); Commonwealth Bank of Australia; Development Bank of Singapore; Development and Commercial Bank Malaysia; Hoffmann-LaRoche Switzerland; ICI Australia; Johnson and Johnson (USA and Australia); Maybank Malaysia; Metway Bank; Monier/PGH; National Australia Bank; Royal Auto Club of Victoria; Ralston Purina; Southcorp Holdings; Sunlife of Canada; Times Publishing, Asia; Unum; S.G. Warburg, Europe; Woolworths (including Safeway)

27. The Strategic Control Model-Measures Construct Code Description of Measure Dependence on IT as a Strategic Resource: RESOURCE1 % of strategic IT investment in prior year Objective Measures RESOURCE2 % of strategic IT investment - average % change over previous 5 years Dependence on IT as a Strategic Resource: RESOURCE3 The extent that BU managers consider IT in their strategic decision-making Subjective Measures 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 Locus of Control of IT Resource: CONTROL1 Average of rankings of the extent to which IT is outsourced by the BUs in each of 15 functional areas Extent of Outsourcing 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: PERF1-2 Profits per employee ($) Business Units PERF3 Pricing against competitors (index) PERF4 Return on assets

28. Mediating Variable as Outsourcing Core Assets

29. Results Table 6. Overall Results of Hypothesis Testing

30. Qualitative Evidence against Indiscriminate Outsourcing Bendigo Bank, a regional Australian bank, decided to bring information technology back in house. Vicky Kelly, Bendigo Bank’s CIO, explains (Zampatakis, 1997): “In banking now, the lines between the business of banking and IT are becoming blurred. We need the IT knowledge within our organization so we can use it to help the business and we want immediate access so we can change direction at a moments notice. Outsourcing doesn’t provide that.”

31. Scholarly Implications • The present study represents a successful departure from the usual outsourcing theory bases of institutional theory, transaction cost, psychological contracting, and incomplete contracting (Ang and Cummings, 1998; Ang and Straub, 1998; Lacity and Hirscheim, 1993; Koh et al., 2004; Richmond, et al., 1992a; Richmond, et al., 1992b).

32. Scholarly Implications • RBT has proven itself to be a useful lens for formulating theoretical propositions related to the outsourcing decision. • The theory suggests that firms should selectively outsource.

33. Practical Implications • Practitioners should recognize that outsourcing strategic IT assets can be disastrous.

34. Practical Implications • Retaining IT assets that are strategic will enable the firm to remain competitive and better capable of responding to future technological uncertainty. • Non-core assets can be taken over by outsourcers with no loss of strategic control.

35. Limitations • Measure dependencies on strategic versus nonstrategic assets and then the outsourcing of each of these separately • Test other critical outcome variables besides performance: e.g., loss of flexibility or ability to innovate or loss of entre- or intrapreneurial spirit • Consider RBV or dynamic capabilities as other viable theory bases

36. Questions