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PRICECollege of Business

University ofOklahomaUniversity ofOklahoma

Value Implications of IT Outsourcing Value Implications of IT Outsourcing Contextual CharacteristicsContextual Characteristics

Jee-Hae LimJee-Hae LimUniversity of WaterlooUniversity of Waterloo

Vernon J. RichardsonVernon J. RichardsonUniversity of ArkansasUniversity of Arkansas

Bob ZmudBob ZmudUniversity of OklahomaUniversity of Oklahoma

IT OutsourcingIT OutsourcingPRICECollege of Business


Current IT Outsourcing TrendsCurrent IT Outsourcing Trends

• The worldwide IT outsourcing market The worldwide IT outsourcing market is expected to increase from $180.5 is expected to increase from $180.5 billion in revenue in 2003 to $253.1 billion in revenue in 2003 to $253.1 billion in 2008 at a compound annual billion in 2008 at a compound annual growth rate of 7.2%. growth rate of 7.2%. ((Gartner Group, Gartner Group, 2004). 2004).

• $18.4 billion in global IT work and $18.4 billion in global IT work and $11.4 billion in business-process $11.4 billion in business-process services have been shifted abroad by services have been shifted abroad by U.S. firms (Business Week, January U.S. firms (Business Week, January 30, 2006). 30, 2006).



Scholarly InterestScholarly Interest

• 78 outsourcing articles in Wall Street Journal (2005).78 outsourcing articles in Wall Street Journal (2005).

• MIS QuarterlyMIS Quarterly Special Issue on Outsourcing (CFP, 2006). Special Issue on Outsourcing (CFP, 2006).

• Continuing interest expressed by major IS, accounting and applied Continuing interest expressed by major IS, accounting and applied management journals (1990-2005):management journals (1990-2005):

North American AIS JournalsNorth American AIS Journals MISQ, ISR, JMIS, CACM, TAR, JAE, JAR, MISQ, ISR, JMIS, CACM, TAR, JAE, JAR, CAR, RAS, JISCAR, RAS, JIS

1616

European AIS JournalsEuropean AIS Journals AMIT, EJIS, I&M, ISJ, JITAMIT, EJIS, I&M, ISJ, JIT 2929

Global AIS ConferencesGlobal AIS Conferences ICIS, AMCIS, HICSS, DSI, AAA, Mid-AAA, ICIS, AMCIS, HICSS, DSI, AAA, Mid-AAA, 3333

North American Non-AIS North American Non-AIS Management JournalsManagement Journals

AMJ, AMR, ASQ, DS, MS, OS, SMJAMJ, AMR, ASQ, DS, MS, OS, SMJ 1717

North American Applied North American Applied Management JournalsManagement Journals

CMR, HBR, SMRCMR, HBR, SMR 1818

TotalsTotals 113113



IT Outsourcing ResearchIT Outsourcing Research

Drivers of Value in IT Outsourcing

* Economic* Strategic* Technical* Political

Outsourcing Decision:

Determinants

Outsourcing Relationship:

Arrangement &Management

Firm Value

* ex ante:Market Assessment Management Expectations

• ex post:Financial Performance Management Satisfaction

Antecedents Process Value Creation



Prior Studies: IT Outsourcing OutcomesPrior Studies: IT Outsourcing Outcomes

Author(s)Author(s)

and Yearand Year

MethodsMethods Outcome Outcome TypeType

Testing VariablesTesting Variables

Grover et al. (1996)Grover et al. (1996) SurveySurvey SatisfactionSatisfaction Degree of outsourcing, Service quality, Degree of outsourcing, Service quality, Partnership qualityPartnership quality

Lee and Kim (1999) Lee and Kim (1999) Survey Survey SatisfactionSatisfaction Partnership quality, Outsourcing qualityPartnership quality, Outsourcing quality

Saunders et al. (1997) Saunders et al. (1997) Case research Case research Satisfaction Satisfaction Characteristics of IS functions, Partnership, Characteristics of IS functions, Partnership, ContractContract

Aubert et al. (1999) Aubert et al. (1999) SurveySurvey Expectations Expectations Market, Vendor competence, Client management Market, Vendor competence, Client management competence, Client contract management, competence, Client contract management, Characteristics of IS functionsCharacteristics of IS functions

Lee et al. (2004) Lee et al. (2004) Survey Survey SatisfactionSatisfaction IT Outsourcing Strategies, Contextual factors, Fit IT Outsourcing Strategies, Contextual factors, Fit as gestalts, Outsourcing success as gestalts, Outsourcing success

Hayes et al. (2000) Hayes et al. (2000) Event Study Event Study Market Market valuationvaluation

Overall effects, Firm size, Industry typeOverall effects, Firm size, Industry type

Peak et al. (2002) Peak et al. (2002) Event Study Event Study Risks/EffectsRisks/Effects Pre- vs. post- event, stock option, NYSE/AMEX, Pre- vs. post- event, stock option, NYSE/AMEX, Stock option ISD Stock option ISD



Purpose of this StudyPurpose of this Study

• To examine firms that outsource IT functions, identify salient contextual To examine firms that outsource IT functions, identify salient contextual characteristics of the outsourcing arrangements, and assess objective characteristics of the outsourcing arrangements, and assess objective performance impactsperformance impacts

– Contextual characteristics:Contextual characteristics:• selective vs. total outsourcingselective vs. total outsourcing

• low vs. high asset specificity of the IT activity being outsourcedlow vs. high asset specificity of the IT activity being outsourced

• onsite vs. offsite IT activity handling (client control)onsite vs. offsite IT activity handling (client control)

• domestic vs. offshore IT activity handlingdomestic vs. offshore IT activity handling

– Performance OutcomesPerformance Outcomes• ex ante ex ante effectseffects: : stock market reactionsstock market reactions

• ex postex post effects: firm financial performance effects: firm financial performance



Theoretical FrameTheoretical Frame

• Transaction Cost EconomicsTransaction Cost Economics– total cost = production costs + transaction costtotal cost = production costs + transaction cost

– Major component of transaction costs are those Major component of transaction costs are those associated with fabrication of appropriate associated with fabrication of appropriate governance structures to reduce potential hazardsgovernance structures to reduce potential hazards

• Nature of the IT activity being outsourcedNature of the IT activity being outsourced– ScopeScope– Asset specificityAsset specificity

• Potential for client to exert controlPotential for client to exert control– Onsite vs. offsiteOnsite vs. offsite– Domestic vs. offshoreDomestic vs. offshore



ScopeScope

• Can be operationalized two waysCan be operationalized two ways– Number of IT activities involvedNumber of IT activities involved

– Number of organizational units involved (used here)Number of organizational units involved (used here)

H1: Selective IT outsourcing contracts yield better financial performance compared to total IT outsourcing contracts.



Asset SpecificityAsset Specificity

• The extent to which the IT activity being outsourced must be The extent to which the IT activity being outsourced must be customized to the client’s organizational context (Grover et customized to the client’s organizational context (Grover et al., 1996):al., 1996):– Low asset specificity: system operations/management, Low asset specificity: system operations/management,

telecommunication/network operations/management, telecommunication/network operations/management, end-user end-user supportsupport

– High asset specificity: application development, IS planning and High asset specificity: application development, IS planning and managementmanagement

H2: Outsourcing contracts involving low asset-specific IT activities yield better financial performance compared to contracts involving high asset-specific IT activities.



Onsite vs. OffsiteOnsite vs. Offsite

• The extent to which the client can exert direct control of the The extent to which the client can exert direct control of the IT activities being handledIT activities being handled– Onsite: buy-in contractOnsite: buy-in contract

– Offsite: fee-for-service contractOffsite: fee-for-service contract

H3: Onsite IT outsourcing yields better financial performance compared to off-site IT outsourcing.



Domestic vs. OffshoreDomestic vs. Offshore

• The extent to which the vendor & client must confront The extent to which the vendor & client must confront geographical, cultural, language, etc. barriers in negotiating, geographical, cultural, language, etc. barriers in negotiating, specifying, implementing and monitoring contractual and specifying, implementing and monitoring contractual and relational governance mechanisms regarding the IT activities relational governance mechanisms regarding the IT activities being outsourcedbeing outsourced– Domestic: IT activities carried out at an offsite but US-based locationDomestic: IT activities carried out at an offsite but US-based location

– Offshore: IT activities carried out at an offsite and non US-based Offshore: IT activities carried out at an offsite and non US-based locationlocation

H4: Domestic IT outsourcing arrangements yield better financial performance compared to offshore IT outsourcing arrangements.



ex anteex ante vs. vs. ex postex post Outcomes Outcomes

• It would be expected that investors’ incorporation of a firm’s It would be expected that investors’ incorporation of a firm’s capability to effectively carry out its announced actions into capability to effectively carry out its announced actions into valuation assessments (i.e., stock market reactions to events) valuation assessments (i.e., stock market reactions to events) would be validated by actual improvements in realized value would be validated by actual improvements in realized value from these actions (i.e., future financial performance). To from these actions (i.e., future financial performance). To our knowledge, this has not been assessed previously.our knowledge, this has not been assessed previously.

H5: There is a positive relationship between the abnormal stock returns around a firm’s announcement of an IT outsourcing arrangement and the firm’s subsequent financial performance.



MethodsMethods

• Sample Selection: 1990-2003Sample Selection: 1990-2003– Firm’s first announcements onlyFirm’s first announcements only

– Final Sample: 335 announcementsFinal Sample: 335 announcements

• Research Window: 1989-2004Research Window: 1989-2004– Four years for each firm include one year before (Year -1), Four years for each firm include one year before (Year -1),

through one year and two years after the year of the IT through one year and two years after the year of the IT outsourcing event.outsourcing event.

• Client Disclosure BiasClient Disclosure Bias



Announcements by YearAnnouncements by Year

Year Frequency Year Frequency

1990 2 1997 10

1991 4 1998 28

1992 4 1999 32

1993 3 2000 41

1994 2 2001 47

1995 14 2002 61

1996 18 2003 69

Total 335



Contextual Nature of the Outsourcing ArrangementsContextual Nature of the Outsourcing Arrangements

Contextual Attribute N Mean

Selective 335 0.458

Low Asset Specificity 335 0.426

Onsite 335 0.429

Off-shore 335 0.312



Analyzed VariablesAnalyzed Variables

• Pre-post analysis:Pre-post analysis:

– (ROS (ROS FIRM.POSTFIRM.POST – ROS – ROS FIRM.PREFIRM.PRE))

• Potential Outlier Control: windsorized at Potential Outlier Control: windsorized at ++3 Standard Deviations.3 Standard Deviations.• No Multi-Collinearity Problem.No Multi-Collinearity Problem.



Simplified Porter’s Value ChainSimplified Porter’s Value Chain

Selling, General, and Administrative Expense (SGAS)

ROS

Market Value

Abnormal ReturnGrowth Rate (GR)



Logit for Self-Selection Bias (DIS)Logit for Self-Selection Bias (DIS)

Model 2.1 Model 2.2

Beta t-stat.(p-value) Beta t-stat.(p-value)

ROS-1 1.432 3.012 (0.016) *

ROA-1 1.321 2.542 (0.023) *

SGA-1 2.012 6.943 (0.000) ** 1.874 5.996 (0.003) **

GR-1 1.243 1.856 (0.021) * 1.012 1.538 (0.024) *

LNSIZE-1 -0.873 1.398 (0.039) * -0.701 0.901 (0.048) *

Model Chi-Square 96.562 (0.000) ** 88.694 (0.006) **

Pseudo R2 0.573 0.524



Cumulative Abnormal ReturnCumulative Abnormal Return

Parametric Tests Non-Parametric Tests

Days CumulativeAbnormal

Return (%)

Z Number of [positive: negative]

CARs

Generalized sign Z

(-1, -1) -0.15% -1.125 169:166 -0.018

(0, 0) 0.43% 4.014 ** 183:152 3.514 **

(+1, +1) 0.09% -0.103 174:161 0.091

(-1, +1) 0.37% 1.688 $ 170:165 1.473 $

(-1, 0) 0.31% 2.019 * 172:163 1.863 $

(0, +1) 0.52% 2.529 ** 194:141 2.287 **



CAR by ContextCAR by Context

Contextual Attribute N CAR Z

Selective 148 0.49% 2.698 **

Low Asset Specificity 141 0.38% 1.894 *

Onsite 152 0.45% 3.125 **

Offshore 104 0.48% 2.127 **



Multiple Regression: CAR by ContextMultiple Regression: CAR by Context

Model 6.1 Model 6.2

Predicted Sign

Beta t-stat Beta t-stat

Constant 0.003 1.976 (0.036)* 0.002 1.452 (0.081) $

Selective + 0.007 2.012 (0.012) *

Low Asset Specificity + 0.010 1.842 (0.046) * 0.097 1.673 (0.058) $

Onsite + 0.008 2.148 (0.023) * 0.101 1.521 (0.062) $

Offshore - -0.004 -1.398 (0.112) -0.076 -1.383 (0.112)

SER Control 0.012 2.224 (0.021) * 0.121 1.876 (0.019) *

LNSIZE Control -0.002 -1.852 (0.043) * -0.109 -1.978 (0.036) *

DIS Control 0.008 1.865 (0.043) * 0.099 1.785 (0.054) $

F-stat (sig.) 1.884 (0.021) * 1.645 (0.049) *

Adjusted R2 0.054 0.036



Contextual Effects on Firm PerformanceContextual Effects on Firm Performance

PredictedSign

ΔROSY2 ΔSGAS21 ΔGR2

Beta (t-stat) Beta (t-stat) Beta (t-stat)

Constant 0.086 (1.580) 0.188(2.357)* 1.645(0.101)

Selective + 0.350(3.462)** -0.309(-2.522)** 0.207(2.069)*

Low Asset Specific

ity

+ 0.172(1.87)* -0.109(-1.68)* 0.105(1.743)*

Onsite + 0.274(2.694)** -0.316(-2.564)** 0.203(2.018)*

Offshore - -0.091(-1.248) 0.182(1.47)$ -0.057(-0.92)

ABR + 0.117(1.852)* -0.054(-0.098) 0.136(1.962)*

DIS Control 0.087(1.346) -0.117(1.308) 0.096(1.572)

F-stat: 2.415(0.006)** 1.806(0.049)* 2.872(0.001)**

Adj. R2: 0.064 0.061 0.076



Contextual Effects on Market ValueContextual Effects on Market Value

Predicted Sign Model 8.1 Model 8.2

Beta t-stat (p-value) Beta t-stat (p-value)

CONSTANT 1.743 (0.082)* 0.481 (0.633)

BV + .126 2.390 (0.009)** .139 1.806 (0.078)*

IBEI + .800 15.218 (0.000)** .847 10.220 (0.000)**

SELECTIVE + .110 2.102 (0.012)*

LOWAS + .009 0.450 (0.355)

ONSITE + .052 1.432 (0.072)$

OFFSHORE - -.041 -1.597 (0.046)*

SER Control .066 2.242 (0.018)*

DIS Control .046 0.964 (0.442)

F-stat (sig.): 665.526 (.000)** 202.362 (0.000)**

R2 .832 .843

Adj. R2: .831 .839



DiscussionDiscussion

H1: Selective vs. TotalH1: Selective vs. Total SupportedSupported

H2: Low vs. High Asset SpecificityH2: Low vs. High Asset Specificity SupportedSupported

H3: Onsite vs. OffsiteH3: Onsite vs. Offsite SupportedSupported

H4: H4: Domestic vs. OffshoreDomestic vs. Offshore Marginally Marginally SupportedSupported

H5a: H5a: ex ante ~ ex postex ante ~ ex post SupportedSupported



LimitationsLimitations

• Bias toward positive returns in sampleBias toward positive returns in sample– Disclosure by client and/or vendorDisclosure by client and/or vendor

– Survivorship biasSurvivorship bias

• Only examined first announcementOnly examined first announcement– Learning effects absentLearning effects absent



ContributionsContributions

• Demonstrated Demonstrated ex anteex ante and and ex postex post performance effects performance effects from IT outsourcingfrom IT outsourcing

• Demonstrated relationship between ex ante and ex post Demonstrated relationship between ex ante and ex post performance effectsperformance effects

• Demonstrated that positive returns from outsourcing are Demonstrated that positive returns from outsourcing are most likely with selective, onsite and domestic sourcingmost likely with selective, onsite and domestic sourcing

• Surfaced concerns about viability of offshore sourcingSurfaced concerns about viability of offshore sourcing



ConclusionConclusion

• Numerous factors not addressedNumerous factors not addressed– Client objectivesClient objectives– Client and vendor capabilitiesClient and vendor capabilities– Importance of the IT activity being outsourcedImportance of the IT activity being outsourced– Learning effectsLearning effects– Many aspects of applied contractual and relational governance Many aspects of applied contractual and relational governance

mechanisms appliedmechanisms applied– Interactions amongst predictorsInteractions amongst predictors– ……

• We hope that these findings are found interesting and We hope that these findings are found interesting and that they stimulate further and deeper examinations of that they stimulate further and deeper examinations of this and related IT outsourcing phenomena.this and related IT outsourcing phenomena.



Questions or Comments?Questions or Comments?



Thank You Very Much! Thank You Very Much!

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