Bjarne Berg

1. Factors considered when Outsourcing a IS System - an Empirical examination of the impacts of Organizational Size, Strategy and the Object of a Decision Bjarne Berg

2. Agenda • Background and Motivation • Literature Review • Propositions • Methods and Measurements • Findings • Wrap-up

3. Background As companies have become more focused on IT expenditures over the last few years, some organizations have decided to outsource parts IS Operations. Unfortunately there is a lack of research in the impact that the object of an outsourcing decision may have on the factors considered when making such a decision, nor is the impact of organizational size and the firm's strategy conclusively established in the literature either. This paper examines the different supplier, costs, technology and internal factors considered when outsourcing an On-Line Transaction Processing or a Decision Support System (the object of a decision). It also examines the divergent decision factors for large, medium and small organization; and the core competitive strategy’s impact the some of the cost factor that are considered. This research found impacts to the relative importance assigned to factors considered based on the object being outsourced and the firm's competitive strategies, and also differences based on organizational sizes. The paper is based on a longitudinal study with four samples of a total of 1,889 individuals working in organizations that uses ERP software.

4. Motivation Despite early mistakes and misgivings, many organizations are now reporting successes in their outsourcing relationships. In a recent global survey in 19 countries, 87 percent of customers stated that outsourcing delivers the benefits projected in their original business plan and 91 percent said that they would do it again [40]. During this growth in business outsourcing activities, a substantial amount of research has been conducted in the area of outsourcing of IT. These papers have either been focusing on the decision process or the implementation of the outsourcing decision [1]. While, others have looked at related transaction oriented success factors such as industry process standardization [2b]. However, a gap exists in the literature in the area of comparative studies involving the object of the outsourcing [1 – p89] and the factors related to the different objects being considered for outsourcing

5. Agenda • Background and Motivation • Literature Review • Propositions • Methods and Measurements • Findings • Wrap-up

6. Firm Strategy and Outsourcing A fundamental principle of business is that a firm’s strategy should drive its actions. Porter, outlines three fundamental competitive strategies that a firm can undertake; being a low cost provider of products and services, being a niche player, or as a differentiator [2]. These strategies can either drive the organizations core competencies or are sometimes created based on the core competencies already in place [41]. Traditionalists have argued that for outsourcing to be effective, the outsourcing of IS should only be considered when it is not a core activity of the organization and do not provide a strategic differentiation [16]. While, others have argued that the first step in outsourcing is to create a strategic objective of the transaction [4a]. There are also several proposed guidelines for when to outsource of IS functions based on a firms strategic positioning [12][13][15] or a strategy's possible need for dynamic capabilities [42] that may be provided through outsourcing.

7. Firm Strategy and Outsourcing Unfortunately, the impact of a firm’s competitive strategy on the decision of IS outsourcing is weakly supported in the literature. Despite proposed models, a link between core competencies and outsourcing has been hard to establish [3]. For example, a link between the strategy types, such as prospector, defender or analyzer, and the outsourcing decision has not been conclusively established [4], and some researchers found only partial support that an organization’s strategy may have some moderating effects on outsourcing (to solve lack of internal resources) [5]. While, conflicting support for a link were found when examining the negative impacts of outsourcing core competencies [10][14]. On the other hand, when viewed in context of the object for outsourcing, empirically supported links were found by examining computer firms' core competencies and a tendency to keep these in-house [6] and by examining positive factors between strategic importance and outsourcing contract extensions [11]. As a result of these conflicting findings, conclusive evidence for links between a firm’s strategy and the decision to outsource has yet to emerge. It has been suggested that this may be due to the effects of examining multiple outsourcing decisions without also examining the object of those decisions. It is likely that a closer examination of the objects of the decisions (what to outsource) may prove more closely linked to a firm’s strategy in certain cases, while unimportant in others [4].

8. Firm Size Research has been more successful in establishing a link between a firms size and outsourcing decisions. Repeated studies has found that the size of a firms assets have an effect on the outsourcing decision process [7][8], and produced empirical evidence that smaller firms tends to outsource less than larger organizations [9]. Since there are several pros and cons to measuring a firm's size by its revenues [20], in this paper we classified companies as Fortune-500, 1000 and smaller organizations by both revenues and the number of employees [21].

9. Object of a Decision A recent survey of 357 firms, suggested that total outsourcing, without consideration of each object, can be a very dangerous strategy due to the inflexibility it creates, and that managers should be very selective in what IT functions are outsourced [22]. We suggest that Decision Support Systems (DSS) are at the heart of the firm’s ability to become aware of new opportunities and subscribe to the idea that by adding a longer time horizon between the discovery and need for actions has a high intrinsic value to an organization [17]. To be able to meet shifting analysis demands over time DSS must also have a very high degree of flexibility [23] and are of relatively higher value to organizations that are engaged in a business strategy that is designed to set them apart from their competitors. Since, the focus of outsourcing has often been on the transaction cost advantages [4b], the competitive advantage achieved through differentiation have often been ignored. As a result, we propose that the object of the outsourcing (i.e. a DSS) should result in using significantly different factors to make a decision than those used to make a decision of outsourcing transaction processing systems.

10. Agenda • Background and Motivation • Literature Review • Propositions • Methods and Measurements • Findings • Wrap-up

11. Proposition 1. Organizations that employ a niche or a differentiating strategy are less likely to consider cost factors, than organizations that are primarily competing using a low cost strategy. 2. The factors considered when outsourcing is different for organizations of various sizes. 3. The object of an IS outsourcing decision results in significantly different factors being considered by organizations.

12. Agenda • Background and Motivation • Literature Review • Propositions • Methods and Measurements • Findings • Wrap-up

13. Cost Factors - Labor and Overall Costs A driving factor out outsourcing has been to reduce costs while being able to provide the same level of service at lower costs. Justifications are that the outsourcer have “better economies of scale, tighter control over fringe benefits, better access to lower cost labor pools and a more focused expertise in managing IS” [19, p64]. This economic perspective has been confirmed in many studies [24][25][26][27] with the two measures used being either as a function of labor costs or a function of overall costs reduction, measured as the total reduction in spending on those activities being outsourced. The importance of labor costs as a factors was confirmed in a recent survey of 114 senior IS managers who ranked labor cost as the most important factor considered when outsourcing IS [28], well ahead of other factors such as flexibility and agility, or a set of supplier factors. In this paper we therefore make an distinction between labor costs and overall costs which include all cost items.

14. Technology Factors Some organizations choose to outsource IS due to uncertainty around technology choice,or task complexity [28]. The technology factors in our research include the perceived uncertainty of long-term DSS and OLTP technology choice, and the perceived complexity of these systems. Since large-scale transaction systems have a high degree of complexity and often have relatively high costs, some organizations have selected not to acquire these systems, and instead rely on outsourcing as a mean to get access to technology without making formal committements to certain software or hardware. Technology factors also include perceptions on technology environment changes [7][11] and uncertainty on long-term strategic information technology direction of the organization due to mergers, acquisitions and divestitures.

15. Supplier Factors Most empirical research on outsourcing has either been on firm or supplier factors. This include studies of predictive models for outsourcing success where measures include; supplier’s expertise of the client with the IT operations; supplier’s expertise with IS operations; supplier expertise with the outsourcing; supplier's investment in the outsourcing process; supplier’s human resources specificity; and the external relatedness of the organizations [31]. An area of contention is the impact of the number of available suppliers on a outsourcing decision. Nam et al. [11] did not find support for this measure, while Bahli and Rivard [31] found that a small number of supplier affected the success of an outsourcing effort. Others have found that the number of suppliers may not be as important as the mere presence of one in the relevant technology or process area [7]. Other supplier factors have established by studies on outsourcing advice and include supplier’s demonstrated understanding of organizational needs, apparent trustworthiness of the supplier’s employees, and the supplier’s prior experience with the object being outsourced [32]. In addition, companies have reported that obtaining access to a supplier’s county skilled workforce and taking advantage of a supplier’s host country’s universities ranks among the top-five reasons for outsourcing [27]. Our research include all these measures individually and also groups them as an overall average score of all supplier factors.

16. Measures - Summary

17. Measures - Size As measures of company size, published revenues and number of employees for the world’s largest 1000 organizations were used .

18. Measures – Competitive Strategies Competitive strategies To determine the respondent's relative competitive strategies, we asked three questions related to their organizations and used clustering of responses to determine their predominant strategy types. The clustering was performed using group average and Minikowski as a distance measure (p=3). This yielded 3 useful clusters, each representing a niche, a low cost, and a differentiating strategy, using a 5 point Likert scale. As the cluster centroids were established, each response was classified based on their Minikowski distance. Of the 1,899 respondents, 44 did not identify company size, and 36 did not identify a strategy (response = ‘n/a’). This yielded a sample size of 1,809 for further study,

19. Measures – Competitive Strategies Competitive strategies To determine the respondent's relative competitive strategies, we asked three questions related to their organizations and used clustering of responses to determine their predominant strategy types. The clustering was performed using group average and Minikowski as a distance measure (p=3). This yielded 3 useful clusters, each representing a niche, a low cost, and a differentiating strategy, using a 5 point Likert scale. As the cluster centroids were established, each response was classified based on their Minikowski distance. Of the 1,899 respondents, 44 did not identify company size, and 36 did not identify a strategy (response = ‘n/a’). This yielded a sample size of 1,809 for further study,

20. Internal Factors Some organization are looking at internal factors when considering outsourcing. This include the need to sustain 24/7 operations and perceived improvements in IS flexibility and agility [28] and the internal relatedness processes being outsourced [29][30]. It is more likely that a process that is outside the normal operations of a company, or an operation that is not deemed a good fit with the core operations of a business model to be outsourced. Other internal factors may include an organization’s expertise with outsourcing in general, or in a specific related area.

21. Sampling Based on the set of established measures, a survey was created to answer the three proposals. The preliminary instrument was reviewed by five information technology professors from two institutions as well as a set of graduate students. Based on this input, a test sample was made (n=23) of a preliminary instrument to address clarity, terminology usage, and instrument organization.

22. Survey Response rates

23. Agenda • Background and Motivation • Literature Review • Propositions • Methods and Measurements • Findings • Wrap-up

24. Overall Findings

25. Overall Findings Significant differences found within strategy groups (single factor ANOVA), and within system (two-factor ANOVA without replication) using alpha = 0.05 (p ranging from 5.93E-05 and 2.63E-55). Note: 270 respondents did not engage in any form of outsourcing and was not planning to do so either (within 3 years) or had no responses to factors considered. Overall sample size is therefore 1,575.

26. Overall Findings

27. Overall Findings

28. 1. Proposal Findings Our first hypothesis was that the object of an IS outsourcing decision results in significantly different importance being assigned to the supplier, costs, internal and technology factors considered by organizations. In our study, we found that there were statistical differences between the factors considered for 12 out of our 18 questions.

29. 1. Proposal Findings

30. 1. Proposal Findings When aggregating the questions to the factors, we find that there relative importance for all factors are different. This indicates that the organizations are placing different emphasis on each of the factors depending on what object is being considered. This supports our hypothesis, and lends credence to the need to observe not only the strategy, supplier, costs, technology and firm characteristics, but also include the object of the outsourcing decision to get more granular information of the relationships that exists at that level. We therefore suggest that further research in this area should include object characteristics as well.

31. 2. Proposal Findings Our second research proposal was that the factors considered when outsourcing is different for organizations of various sizes. This hypothesis is mostly supported and concurs with previous research [7][8].

32. 2. Proposal Findings The level of importance attached to supplier factors there were statistical significant different in Fortune-500 companies and the rest, while there were no significant differences between Fortune-1000 and smaller organizations. Overall supplier factors were less important to Fortune-500 companies than to the other organization sizes. It is also important to note that the level of importance attached to internal factors there were statistical significant different in all organizational sizes, and that Internal factors were most important to Fortune-1000 companies.

33. 2. Proposal Findings Technology factors were least important to Fortune-500 companies. This may be due to the organizational resources and the ability to acquire needed technologies. While there were no statistical differences between Fortune-1000 and smaller organizations, overall technology factors scored consistently lower than all other factors regardless of the size of the organizations.

34. 2. Proposal Findings The level of importance attached to cost factors there were also statistically significant different between Fortune-1000 and Fortune-500 companies. The latter attached more importance to cost factors than any other factor. There were no differences between Fortune-1000 and smaller organizations.

35. 2. Proposal Findings Overall, Fortune-1000 and smaller organizations had attached no significant differences on any factors considered when making an outsourcing decision except for internal factors. In general we found the largest differences between the Fortune-500 and the other organizations. This may indicate that future research should look at these groupings as two, and that further classifications may yield little information (except in very small companies).

36. 3. Proposal Findings Our third research proposal was that organizations that employ a niche or a differentiating strategy are less likely to consider cost factors, than organizations that are primarily competing using a low cost strategy. Using a test of sample means assuming equal variance in the population we found this hypothesis supported by our data (95% conf., p = 0.016, n=1,699) . This indicates that a firm’s strategy appears to impact the factors that are used when a firms is making a decision to outsource an information system. When we analyzed the data without respect to the object of the outsourcing decision, we found that the relative importance of costs factors for firms with a low costs strategy was 3.18, while firms with a different core strategy attached only a 3.03 score to the cost measures. There was a statistical significant difference between these scores. This means that firms with a low costs strategy do in fact attach more importance to cost factors than those who have other core strategies.

37. Agenda • Background and Motivation • Literature Review • Propositions • Methods and Measurements • Findings • Wrap-up

38. Your Turn!! Questions?

39. Validity We found strong positive correlations using between the questions measuring the various factors

40. Validity We found some issues around discrinant validity. It appeared that the question related to the outsourcer’s desire to take advantage of the skilled workforce at the service partner’s location was closer correlated to internal factors than the supplier factors as we initially supposed. We found strong convergent validity by examining the strong positive correlations between the questions measuring the various factors.