IS outsourcing – a strategic perspective

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