Wald W2D1 6635

IS outsourcing – a strategic perspective

Ravi Foogooa School of Business Informatics and Software Engineering, University of Technology, Pointe aux Sables, Mauritius

Abstract

Purpose – The purpose of this paper is to study the different facets of the strategic perspective of information systems (IS) outsourcing, compare strategic IS outsourcing with traditional IS outsourcing and identify research opportunities.

Design/methodology/approach – This paper is based primarily on a review of the literature.

Findings – IS outsourcing is now an accepted practice and the market is growing regularly. The initial hype surrounding IS outsourcing has died out and there is now a more rational approach towards outsourcing with an increasing emphasis for a strategic approach towards IS outsourcing rather than just a cost-cutting motivation.

Originality/value – The paper clarifies the definitions of IS outsourcing and strategy, taking into consideration the evolution of the definitions before comparing strategic IS outsourcing with traditional IS outsourcing. The paper is concluded with identification of future research opportunities in the field of strategic IS outsourcing.

Keywords Information systems, Outsourcing, Strategic alliances, Management process

Paper type Literature review

1. Introduction Information systems (IS) outsourcing is now an accepted practice and the market is growing regularly with the 2005 market expected to reach US$159.6 in 2005 (Laplante et al., 2004) However, the initial euphoria of the 1990s has died down and the risks of IS outsourcing are fairly well documented. The question now is not whether to outsource or not but rather how to take advantage and balance the different sourcing options (market and internal) for IT services (Lacity et al., 1996).

There are several models for outsourcing and recently there has been further emphasis on strategic outsourcing as compared to traditional outsourcing for reaping the maximum benefits from outsourcing instead of just concentrating on the cost aspects (Willcocks et al., 1995; Quinn, 1999; Lacity et al., 2004).

The aim of this paper is to focus on the strategic perspective of IS outsourcing and try to investigate how it is different from supposed “traditional outsourcing”. It was found that many terms concerning strategy are often used inter-exchangeably and this conceptual confusion can lead to wrong decision making (Willcocks et al., 1995). This is why the first part of the paper is dedicated to clarifying terms and concepts in IS outsourcing and strategy.

Research opportunities are identified at the end of the paper.

2. Definition of IS outsourcing Outsourcing refers to the use of an external provider of goods or services instead of having recourse to internal resources to provide the same goods or services.

The current issue and full text archive of this journal is available at

www.emeraldinsight.com/1463-7154.htm

BPMJ 14,6

858

Business Process Management Journal Vol. 14 No. 6, 2008 pp. 858-864 q Emerald Group Publishing Limited 1463-7154 DOI 10.1108/14637150810916035

As such, outsourcing is a decision concerning the boundary of a firm and this has been a concern since the very existence of firms (Lonsdale and Cox, 2000).

Applied in the IS area, the term has the same meaning although different definitions have been given to it by different authors:

. “. . . the significant contribution by external vendors in the physical and/or human resources associated with the entire or specific components of the IT infrastructure in the user organization” (Loh and Venkatraman, 1992). This definition emphasizes that the role played by the external agent could be significant as compared to the internal provider. It is also mentioned that the external agent could be providing physical as well as human resources. Finally, it is specifically mentioned that the contribution is towards the IT infrastructure.

. “. . . the purchase of a good or service that was previously provided internally” (Lacity and Hirschheim, 1993a). This definition attracts attention to the fact that internal provision of goods or services may be replaced by outsourcing.

. “. . . the commissioning of a third party (or a number of third parties) to manage a client organization’s IT assets, people and or activities (or part thereof) to required results” (Fitzgerald and Willcocks, 1994). This definition is different from others in the sense that it moves from the concept of purchasing to that of managing. It also stresses the fact that a customer may have recourse to more than one provider at a time. It also specifies that IS outsourcing is not only restricted to goods or services but could also include people. Finally, it introduces the notion that outsourcing is performance oriented.

. “. . . turning over to a vendor some or all of the IS functions . . . ” (Apte et al., 1997). This definition points out that IS outsourcing could involve total dependence on a vendor. It also shifts the emphasis from goods or services to the broader view of IS function, probably showing the increasing importance of what result is required rather than how to achieve this result.

Several authors have used definitions which suit the purpose of their study. However, it would also seem that the differences in the definitions are related to the evolution of concerns in IS outsourcing practice. Initially, IS outsourcing involved mainly the use of service bureaus and systems houses to provide shared data processing services due to the prohibitive cost of computers. The emphasis moved from the hardware to the software (which though being a product, is often intangible and is better viewed as the service it provides), with the use of contract programmers to develop, customize or maintain application software. Later it became practice to group together hardware and software and to have recourse to total solutions (Lee et al., 2003) with more emphasis on results rather than on the process of obtaining the results. Recently, the line between IS outsourcing and business process outsourcing (BPO) is even becoming blurred, with some customers being more concerned with the provision of a full business function with a predefined performance rather than going into the details of the IS required to provide the business function (Dibbern et al., 2004).

3. Strategic management concepts Strategy is derived from the Greek word “the art of the general” and its practice has its origins well anchored in the military. Businesses started making use of strategy in the 1960s and thus came the term “strategic management”. Strategic management has

IS outsourcing

859

been defined as “consisting of the analysis, decisions, and actions an organization undertakes in order to create and sustain competitive advantage.” (Dess et al., 2004).

This definition raises the question about competitive advantage and sustained competitive advantage. Barney’s (1991) definitions for these terms are quite explicit. A firm is said to have a competitive advantage when it is implementing a “value creating strategy” which is unique, i.e. not being implemented at the same time by other competitors. A competitive advantage is said to be sustained only if it still prevails after competitors have stopped trying to copy it.

Strategic management involves a series of non-linear and inter-dependent processes of strategy analysis, strategy formulation and strategy implementation (Dess et al., 2004).

All the different functional strategies (including IS strategy) rest upon the business strategy, thereby raising the issue of strategic alignment, i.e. the need for IS goals and business goals to be in harmony. Moreover, IS is a bit different in the sense that it can be supporting or even driving the business strategy in the sense that it could be the element causing business transformation (Luftman et al., 2004).

IS governance is an important component of the IS strategy as it involves the selection and use of organizational processes to make decisions about how to obtain and deploy IS in the organization (Luftman et al., 2004). It is at this point that IS outsourcing comes into picture as one of the governance mechanisms put into place to procure and deploy all the components of an IS.

4. Strategic role of IS The 1980s could be considered the golden days of IS – these were the days when the strategic role of IS was being emphasised and IS was being actively recommended as the way to secure competitive advantage, which was believed to be sustainable. Using the five forces model or the value-chain model, it was advocated (Porter and Millar, 1985) that the information revolution was affecting competition in three ways:

(1) It changed industry structure – it could affect the strength of the individual five forces in an industry.

(2) It created competitive advantage by giving companies new ways to outperform their rivals either by lowering cost or enhancing differentiation (due to an improvement in the activities in the value chain or in the linkages between the activities).

(3) It spawned whole new businesses often from within a company’s existing operations – it could make new businesses feasible, create demand for new products or create new businesses within old ones.

However, the 1990s put more emphasis on downsizing and focus on core competencies (Prahlad and Hamel, 1990). Many organisations thus felt that IS did not necessarily form part of their core activities. Moreover, Barney (1991), in his classic paper on the resource-based view of the firm claims that information technology alone can be purchased across markets and is thus easily imitable. He however points out that it is in fact the embedding of IS in the formal and informal decision making processes of an organization that are difficult to imitate and thus may have the potential of sustainable competitive advantage.

BPMJ 14,6

860

The above combined with other factors such the need for cash, perception of inefficiency or ineffectiveness of IS department and lack of competency of IS (Lacity and Hirschheim, 1993b) and the effect of the outsourcing decision by Kodak in 1989 popularised the concept of IS outsourcing. It was more and more believed that IS was more of a commodity and could thus be outsourced as other commodities.

Current research and practice recognise that IS may be treated as a commodity in some companies whereas in others it may be contributing to a competitive advantage depending on the nature of the activity of the organisation.

5. Strategy for IS outsourcing Early experiences of customers outsourcing immediately showed that even outsourcing was not an easy task and that it entailed several risks such as (Lacity and Hirschheim, 1993b; Earl, 1996; Quinn, 1999):

. Cost savings do not materialize due to hidden costs in the contract.

. Service levels do not meet expectations.

. Locking in with near-obsolescent technology with outsourcing vendor.

. Loss of core competencies of organization.

. Negative impact of morale on staff.

Moreover, it was soon realised that the decision to outsource was very difficult (both technically due to lost skills and financially due to sunk costs) to reverse (Lacity and Hirschheim, 1993b). Thus, after the initial hype concerning outsourcing in the beginning 1990s, there followed a period where the merits of insourcing were again highlighted with the recommendation to consider outsourcing only if insourcing is not viable (Earl, 1996).

Nevertheless, it was also realized that the question was not whether to outsource or not to outsource but rather to approach outsourcing in a strategic manner rather than an incremental or “hard learning” manner (Willcocks et al., 1995) and to analyse the different IT activities in an organization separately (Lacity et al., 1996). Several frameworks were also proposed to decide on which IT services to outsource (Willcocks et al., 1995; McFarlan and Nolan, 1995; Cronk and Sharp, 1995; Lacity et al., 1996).

It is generally agreed that those activities which do not contribute significantly to business positioning should be outsourced directly. However, it is recommended to insource those activities which are close to the core activities of the organization. For other types of activities, the situation is less clear cut but in general they may be outsourced with a relationship contract or in-sourced in the context of an alliance partner.

The complexity of the process of entering and managing a vendor relationship (i.e. proper vendor selection, comprehensive contract and the skills to properly manage the outsourcing relationship) and its contribution to outsourcing failure have also been highlighted (Ngwenyama and Bryson, 1999).

Some decision making frameworks for accompanying the customer to take the proper sourcing decision have also been proposed (Cronk and Sharp, 1995; Dibbern et al., 2004).

6. Strategic IS outsourcing Strictly speaking strategic IS outsourcing could be defined as outsourcing of IS using a strategic approach (Willcocks et al., 1995). However, there is more to strategic IS

IS outsourcing

861

outsourcing than just the approach – in fact the characteristics of the relationships itself change completely as described by several authors (Lee et al., 2003; Hoecht and Trott, 2006):

. Short term contracts (typically less than five years) as compared to 10 year contracts in traditional outsourcing.

. Multi-vendor contracts as compared to single vendor contracts in traditional outsourcing.

. Scope of services changing from commodity type (such as maintenance of PCs, network support, etc.) in traditional outsourcing to higher value added services (such as integrated IS development) in strategic outsourcing.

. Focus on win-win relationship with contribution of both partners in strategic outsourcing rather than just cost reduction as in traditional outsourcing.

It is more and more accepted that strategic IS outsourcing will yield more long-term benefits as compared to the short-term benefits of traditional outsourcing. The definition of core activities has been refined in the context of outsourcing with the recommendation that all services are candidates for outsourcing except those where the organization has got “best-in-world capability” (Quinn, 1999). Nevertheless, real core activities are still better kept inhouse (Quinn, 1999).

Other organizations have pushed strategic IS outsourcing even further – they have outsourced what were initially viewed as non-core business functions to partners who have provided the necessary IS and taken control of the redesigned business function altogether and intend to generate revenue by replicating the same success with other customers in the same business (Lacity et al., 2004).

7. Discussions and conclusion The literature is almost unanimous on the issue of insourcing core activities although as pointed above, over the years, the definition of core activities has been refined; thereby further reducing this group of activities. Yet, there is no agreement on how to identify these core competencies (Hoecht and Trott, 2006) although some authors have provided means to identify these “best in world” competencies (Quinn, 1999). The fact that an activity identified as core may cease to be core if customers’ requirements change or if competitors develop innovative technologies (McIvor, 2000) further complicates matters.

Moreover, as early as 1996, some outsourcing frameworks had identified reasons for outsourcing of strategic IT activities even though the general recommendation was to insource them (McFarlan and Nolan, 1995):

. Taking over an ailing IT department.

. Benefiting from a fresh input of cash.

. Introduce flexibility by transforming fixed costs into variable costs.

. Facilitate transition when involved in mergers/acquisitions/divestures.

Nevertheless, outsourcing strategic IS activities is risky especially from the innovation point of view (Hoecht and Trott, 2006).

BPMJ 14,6

862

It is thus felt that there is an opportunity to research on outsourcing of strategic IS activities. Possible research questions could be:

. Is it possible to identify weaknesses in core activities and possible contributions of a potential external partner?

. How could relationships in a strategic outsourcing alliance be managed, especially in a global multi-vendor context and a relatively short contract period?

. How to assess and control risks, especially those related to innovation and long-term competitiveness in a strategic outsourcing alliance

Despite an almost five-year old comment that IS outsourcing research is very much customer-oriented and that there is an opportunity for research on the vendor-related perspective (Hui and Beath, 2001), the situation is still very much the same in 2006. There is thus ample opportunity in the maturing area of outsourcing research for further research in outsourcing of strategic IS activities from the vendor-perspective, i.e. how can a vendor position itself as a strategic partner whilst reassuring the customer on the risks of such a relationship.

With the market for BPO becoming as significant, if not more than, that of IS outsourcing (Lacity et al., 2004; Laplante et al., 2004), it is also worthwhile noting that any decisions concerning IS outsourcing, may need to consider the broader picture of the business process rather than just the IS part although currently, it would seem that BPO is affecting mainly those business activities considered as non-core such as human resource, accounting, etc. (Quinn, 1999).

References

Apte, U., Sobol, M.G., Hanaoka, S., Shimada, T., Saarinen, T., Salmela, T. and Vepsalainen, A.P. (1997), “IS outsourcing practices in the USA, Japan and Finland: a comparative study”, Journal of Information Technology, Vol. 12, pp. 289-304.

Barney, J. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-120.

Cronk, J. and Sharp, J. (1995), “A framework for deciding what to outsource in information technology”, Journal of Information Technology, Vol. 10, pp. 259-67.

Dess, G.G., Lumpkin, G.T. and Taylor, M.L. (2004), Strategic Management – Text and Cases, McGraw-Hill/Irwin, New York, NY.

Dibbern, J., Goles, T., Hirschheim, R. and Jayatilaka, B. (2004), “Information systems outsourcing: a survey and analysis of the literature”, The DATA BASE for Advances in Information Systems, Vol. 35 No. 4, pp. 6-102.

Earl, M.J. (1996), “The risks of outsourcing IT”, Sloan Management Review, Vol. 1996, Spring, pp. 26-32.

Fitzgerald, G. and Willcocks, L. (1994), “Contracts and partnerships in the outsourcing of IT”, Proceedings of the 15th International Conference of Information Systems, Vancouver, Canada, pp. 91-8.

Hoecht, A. and Trott, P. (2006), “Innovation risks of strategic outsourcing”, Technovation, Vol. 26, pp. 672-81.

Hui, P.P. and Beath, C.M. (2001), “The IT sourcing process: a framework for research”, working paper, University of Texas, Austin, available at: http://disc-nt.cba.uh.edu/chin/ speakerseries/The%20IT%20Sourcing%20Process.pdf

IS outsourcing

863

Lacity, M. and Hirschheim, R. (1993a), “The information systems outsourcing Bandwagon”, Sloan Management Review, Vol. 1993, Fall, pp. 73-86.

Lacity, M. and Hirschheim, R. (1993b), “Implementing information systems outsourcing: key issues and experiences of an early adapter”, Journal of General Management, Vol. 19 No. 1, pp. 17-31.

Lacity, M., Willcocks, L. and Feeny, D. (1996), “The value of selective IT sourcing”, Sloan Management Review, Vol. 1996, Spring, pp. 13-25.

Lacity, M., Willcocks, L. and Feeny, D. (2004), “Commercializing the back office at Lloyds of London: outsourcing and strategic partnerships revisited”, European Management Journal, Vol. 22 No. 2, pp. 127-40.

Laplante, P.A., Costello, T., Singh, P., Bindiganavile, S. and Landon, M. (2004), “The who, what, why, where, and when of IT outsourcing”, IT Professional, Vol. 2004, January-February, pp. 19-23.

Lee, J-N., Huynh, M.Q., Kwok, R.C-W. and Pi, S-M. (2003), “IT outsourcing evolution: past, present, and future”, Communications of the ACM, Vol. 46 No. 5, pp. 84-9.

Loh, L. and Venkatraman, N. (1992), “Determinants of information technology outsourcing: a cross-sectional analysis”, Journal of Management Information Systems, Vol. 9 No. 1, pp. 7-24.

Lonsdale, C. and Cox, A. (2000), “The historical development of outsourcing: the latest fad?”, Industrial Management & Data Systems, Vol. 100 No. 9, pp. 444-50.

Luftman, J., Bullen, C.V., Liao, D., Nash, E. and Neumann, C. (2004), Managing the Information Technology Resource – Leadership in the Information Age, Pearson Education, Harlow.

McFarlan, F.W. and Nolan, R.L. (1995), “How to manage and IT outsourcing alliance”, Sloan Management Review, Vol. 1995, Winter, pp. 9-23.

McIvor, R. (2000), “Strategic outsourcing: lessons from a systems integrator”, Business Strategy Review, Vol. 11 No. 3, pp. 41-50.

Ngwenyama, O.K. and Bryson, N. (1999), “Making the information systems outsourcing decision: a transaction cost approach to analyzing decision problems”, European Journal of Operational Research, Vol. 115, pp. 351-67.

Porter, M.E. and Millar, V.E. (1985), “How information gives you competitive advantage”, Harvard Business Review, Vol. 63 No. 4, p. 149, 12 p..

Prahlad, C.K. and Hamel, G. (1990), “The core competence of the corporation”, Harvard Business Review, Vol. 68 No. 3, pp. 79-91.

Quinn, J.B. (1999), “Strategic outsourcing: leveraging knowledge capabilities”, Sloan Management Review, Summer, pp. 9-21.

Willcocks, L., Fitzgerald, G. and Feeny, D. (1995), “Outsourcing IT: the strategic implications”, Long Range Planning, Vol. 28 No. 5, pp. 59-70.

Corresponding author Ravi Foogooa can be contacted at: [email protected]

BPMJ 14,6

864

To purchase reprints of this article please e-mail: [email protected] Or visit our web site for further details: www.emeraldinsight.com/reprints

Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.